The following is an analysis of the results of operations and financial condition of the Company as of and for the three and six month periods ending June 30, 2009 and 2008. The analysis should be read in connection with the consolidated financial statements and notes thereto appearing elsewhere in this report.

The Company

Heritage Oaks Bancorp (the "Company") is a California corporation organized in 1994 to act as a holding company of Heritage Oaks Bank ("Bank"), a 15 branch bank serving San Luis Obispo and Santa Barbara Counties. In 1994, the Company acquired all of the outstanding common stock of the Bank in a holding company formation transaction.

In October 2006, the Company formed Heritage Oaks Capital Trust II ("Trust II"). Trust II is a statutory business trust formed under the laws of the State of Delaware and is a wholly-owned, non-financial, non-consolidated subsidiary of the Company.

In September 2007, the Company formed Heritage Oaks Capital Trust III ("Trust III"). Trust III is a statutory business trust formed under the laws of the State of Delaware and is a wholly-owned, non-financial, non-consolidated subsidiary of the Company.

On October 12, 2007, the Company acquired Business First National Bank ("Business First"). Business First was merged with and into Heritage Oaks Bank, a wholly owned subsidiary of the Company. In connection with the acquisition, two additional branches were added to the Bank's network. For additional information regarding this acquisition, please see Note 23 to the consolidated financial statements of the Company's 2008 annual report, which was filed on Form 10-K.

Other than holding the shares of the Bank, the Company conducts no significant activities, although it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), the Company's principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking. The Company has also caused to be incorporated a subsidiary, CCMS Systems, Inc. which is currently inactive and has not been capitalized. The Company has no present plans to activate the proposed subsidiary.

Where You Can Find More Information

Under the Securities Exchange Act of 1934 Sections 13 and 15(d), periodic and current reports must be filed with the SEC. The Company electronically files the following reports with the SEC: Form 10-K (Annual Report), Form 10-Q (Quarterly Report), Form 8-K (Current Report), and Form DEF 14A (Proxy Statement). The Company may file additional forms. The SEC maintains an internet site, www.sec.gov, in which all forms filed electronically may be accessed. Additionally, all forms filed with the SEC and additional shareholder information is available free of charge on the Company's website:
www.heritageoaksbancorp.com.

The Company posts these reports to its website as soon as reasonably practicable after filing them with the SEC. None of the information on or hyperlinked from the Company's website is incorporated into this Quarterly Report on Form 10-Q.

Management's Discussion and Analysis

Executive Summary

For the three and six month periods ended June 30, 2009, earnings available to common shareholders were approximately $0.3 million and $1.3 million, respectively. This when compared to the same periods ended a year earlier represents a decline of approximately $0.4 million and $1.0 million, respectively. Earnings per diluted common share for the three and six month periods ended June 30, 2009 were $0.03 and $0.17, respectively, representing respective declines of $0.06 and $0.13 when compared to the same periods ended a year earlier. Year over year declines in earnings can be attributed to elevated provisions for loan losses, a one time assessment imposed by the FDIC and several one time charges incurred as a result of OREO properties the Bank acquired. The FDIC assessment was imposed on all insured institutions with the intent to replenish the Deposit Insurance Fund. Additionally, during the second quarter of 2008 the Bank recognized income related to the Visa, Inc. IPO in the approximate amount of $0.3 million. The absence of this income in the second quarter of 2009 is another factor behind the year over year decline in earnings.

One time charges during the first six months of 2009 include the special FDIC assessment in the amount of $0.4 million, booked during the second quarter, and expenses incurred related to OREO properties the Bank acquired in the amount of $0.2 million and $0.3 million for the three and six months ended June 30, 2009, respectively. Absent these charges, non-interest expenses would have been approximately $0.1 million and $0.4 million lower that that reported for the same three and six month periods ended a year earlier. Management has and will continue to focus on cost controls and efficiency gains while navigating through this difficult economic environment.

Net interest income for the three and six month periods ended June 30, 2009 showed slight increases of $0.3 million and $0.7 million, respectively, when compared to year ago levels. Although interest income fell approximately $0.3 million and $1.2 million for the three and six month periods ended June 30, 2009 when compared to year ago levels, interest expenses fell at a faster pace, allowing for the increases seen in net interest income. Throughout 2008 and early 2009, the Bank stayed relatively short with respect to maturities on various interest bearing liabilities, allowing the Bank the opportunity to take advantage of lower rates in a rates down environment. Additionally, floors within the loan portfolio were instrumental in abating any substantial year over year decline in interest income.

Non-performing assets at June 30, 2009 were approximately $18.9 million or $4.3 million lower than that reported at March 31, 2009 and $1.1 million lower that that reported at December 31, 2008. Although approximately $6.7 million in loan balances moved to OREO status during the second quarter, the Bank saw pay-downs of approximately $1.2 million on non-accruing credits, the result of proceeds obtained from the liquidation of collateral and principal guarantees. During the second quarter the Bank sold three spec construction properties acquired through foreclosure for approximately $2.9 million. In connection with the sale of these properties, the Bank recognized a loss of approximately $104 thousand. For the first six months of 2009, losses on the sale of OREO totaled approximately $131 thousand. As discussed in Note 10. Subsequent Events, to the consolidated financial statements, the Bank closed escrow for the sale of three additional OREO properties in late July 2009. In connection with the sale of these properties, the Bank received aggregate proceeds of approximately $2.5 million and recognized an aggregate pre-tax loss of approximately $0.3 million in July 2009.

Deposit growth was strong during the first six months of the year, with total deposits of $704.0 million at June 30, 2009, representing a $100.5 million or 16.6% increase from that reported at December 31, 2008. Net of brokered, retail deposits grew approximately $110.6 million or 19.9% from that reported at December 31, 2008. Growth in deposit balances was driven in large part by increases in non-interest bearing demand, retail money market deposits and time certificates. As a result of increased deposits, the Bank was able to pay down approximately $46.0 million in brokered funds during the second quarter and approximately $10.1 million on a year to date basis. Borrowings with the Federal Home Loan Bank ("FHLB") declined $44.0 million during the first six months of 2009, directly attributable to growth in retail deposit balances.

The following provides a summary of operating results for the three and six month periods ended June 30, 2009 and 2008:

· Interest income for the three and six month periods ended June 30, 2009 was approximately $12.3 million and $24.2 million, respectively. This, when compared to the $12.6 million and $25.4 million reported for the same periods ended a year earlier, represents declines of approximately $0.3 million and $1.2 million or 2.4% and 4.8%, respectively. The year over year decline is primarily attributable to the actions taken by the Federal Reserve within the fourth quarter of 2008 to lower the overnight Fed Funds rate from 2.00%, as of June 30, 2008, to within a range of 0.00% and 0.25%. However, as previously mentioned, floors in the loan portfolio were instrumental in mitigating any substantial year over year decline in interest income.

· Interest expenses for the three and six month periods ended June 30, 2009 were approximately $2.4 million and $4.8 million, respectively. This, when compared to the $3.0 million and $6.7 million reported for the same periods ended a year earlier, represents declines of approximately $0.6 million and $1.9 million or 18.7% and 28.8%, respectively. The year over year decline is mainly attributable to the dramatic declines in the overnight Fed Funds rate previously referred to above and the ability of the Bank to re-price a significant portion of its interest bearing liabilities over the last year.

Management's Discussion and Analysis

· Net interest income for the three and six months ended June 30, 2009 was approximately $9.8 million and $19.4 million, respectively. When compared to the same periods ended a year earlier, this represents increases of approximately $0.3 million and $0.7 million or 2.6% and 3.7%, respectively. As previously mentioned, the ability of the Bank to re-price a significant portion of its interest bearing liabilities in a rates down environment contributed greatly to the year over year increases seen in net interest income.

· The net interest margin for the second quarter and the first six months of 2009 was 4.91% and 4.97%, respectively. When compared to the same periods a year earlier, this represents declines of approximately 37 and 34 basis points, respectively. Declines in the yields on earning assets when compared to year ago levels, contributed to the decline in the net interest margin.

· Non-interest income for the three and six months ended June 30, 2009 was approximately $1.5 million and $3.2 million, respectively. This, when compared to the same periods ended a year earlier, represents declines of $0.3 million and $35 thousand, respectively. The year over year decline in the second quarter of 2009 can be attributed to income the Bank recognized in the second quarter of 2008 related to the Visa, Inc. IPO, totaling approximately $0.3 million.

· Non-interest expenses for the three and six months ended June 30, 2009 were approximately $8.0 million and $15.4 million, respectively. This, when compared to the $7.5 million and $15.1 million reported for the same periods ended a year earlier, represents increases of approximately $0.5 million and $0.3 million or 6.9% and 2.1%, respectively. As previously mentioned the Bank incurred several one time charges related to the special FDIC assessment and expenses related to OREO properties the Bank acquired. Exclusive of these one time items, non-interest expenses would have been approximately $0.1 million and $0.4 million lower that that reported for the three and six month periods ended a year earlier, respectively.

The following provides a summary for significant year to date changes in balances as of June 30, 2009:

· At June 30, 2009, net loan balances were approximately $685.2 million or approximately $17.2 million and 2.6% higher than the $668.0 million reported at December 31, 2008. See also "Loans" under "Financial Condition" of this discussion and analysis for additional information regarding the Bank's loan portfolio.

· At June 30, 2009, total deposits were approximately $704.0 million or approximately $100.5 million and 16.7% higher than the $603.5 million reported at December 31, 2008. Deposits, exclusive of brokered were approximately $665.5 million or $110.6 million higher than the $554.9 million reported at December 31, 2008. See also "Deposits and Borrowed Funds" under "Financial Condition" of this discussion and analysis for information regarding the Bank's deposit liabilities.

· At June 30, 2009, borrowings with the FHLB were $65.0 million or approximately $44.0 million lower than the $109.0 million reported at December 31, 2008. Higher retail deposit balances during the first six months of 2009 resulted in fewer borrowings with the FHLB.

The following provides an overview of asset quality as of June 30, 2009:

· At June 30, 2009, the balance of non-performing loans was approximately $12.2 million or $6.5 million lower than the $18.7 million reported at December 31, 2008. As of June 30, 2009 the balance of non-performing loans as a percentage of total gross loans was 1.75% compared to 2.75% as of December 31, 2008.

· As of June 30, 2009, the allowance for loan losses represented 1.59% of total gross loans and 1.53% of total gross loans as of December 31, 2008.

· During the three and six months ended June 30, 2009, the Bank made provisions to the allowance for loan losses in the approximate amount of $2.7 million and $4.8 million, respectively. Charge-offs during the same periods were approximately $2.0 million and $4.1 million, respectively.

· For the three and six months ended June 30, 2009, net charge-offs to average gross loans were 0.29% and 0.59%, respectively. When compared to the 0.14% and 0.16% reported for the same periods ended a year earlier, represents increases 15 and 43 basis points, respectively.

Management's Discussion and Analysis

· During the first six months of 2009, the Bank moved approximately $8.4 million in loan balances to OREO status of which approximately $6.7 million occurred during the second quarter of 2009. As of June 30, 2009, the balance of OREO was $6.7 million compared to the $1.3 million reported at December 31, 2008. In spite of the year to date increase in OREO balances, the Bank sold three spec construction properties during the second quarter in the aggregate amount of $2.9 million. See also "Non Performing Assets" under "Financial Condition" of this discussion analysis for additional information related asset quality.

Recent Developments

As previously mentioned and as discussed in Note 10. Subsequent Events, to the consolidated financial statements, the Bank closed escrow for the sale of three additional OREO properties in late July 2009. In connection with the sale of these properties, the Bank received aggregate proceeds of approximately $2.5 million and recognized an aggregate pre-tax loss of approximately $0.3 million in July 2009.

During the third and fourth quarters of 2008, the credit and equity markets came under significant duress as confidence by many in the U.S. financial system began to wane. During the later part of 2007 and throughout 2008, many U.S. financial institutions were forced to significantly write-down the values of certain classes of assets in response to the weakened real estate market. These losses lead to strained capital levels, impairing the confidence of many depositors and others providing funding to the nation's banks, which in turn lead to a crisis of liquidity. With liquidity levels of many financial institutions significantly weakened, borrowing costs began to rise considerably and the flow of credit to consumers and between banks all but came to a halt. In response to this, the weakened economy and other factors, the U.S. Congress passes the Emergency Economic Stabilization Act of 2008 (the "EESA") in October of 2008. Under the EESA, the Department of the U.S. Treasury formed the Troubled Asset Relief Program (the "TARP"). The TARP gives the U.S. Treasury the power to make purchases of certain troubled assets as well as the direct purchase of equity from U.S. financial institutions under the CPP. Although the Company's liquidity levels remained adequate and the Bank and Company were well capitalized throughout 2008, the Company applied to participate in the CPP to keep all capital raising options available. On February 27, 2009, the Company received shareholder approval to add an authorized class of preferred stock to the Company's Articles of Incorporation that allowed the Company to participate in the CPP and will also allow for more flexibility in capital raising efforts in general. On March 20, 2009, the Company issued 21,000 shares of Senior Preferred Stock to the U.S. Treasury under the terms of the CPP for $21.0 million. Additionally, the Company issued a warrant to the U.S. Treasury to purchase 611,650 shares of its common stock at a price of $5.15 per share, representing 15% of the preferred issuance or approximately $3.2 million. For a more detailed discussion regarding the Company's participation in the CPP, see Note 9. Preferred Stock, to the consolidated financial statements filed on this Form 10-Q.

Dividends and Stock Repurchases

During the second quarter of 2009, the Company paid approximately $160 thousand in dividends on its Senior Preferred Stock issued to the U.S. Treasury under the CPP. See also Note 9. Preferred Stock, to the consolidated financial statements filed on this form 10-Q for additional information about dividends on the Company's Senior Preferred Stock.

On April 24, 2008, the Board of Directors declared a 5% stock divided to be paid on May 16, 2008 to shareholders of record on May 2, 2008. This stock dividend represented a change in the form of dividend payment to the Company's shareholders away from cash dividends in order to retain the Company's capital for future growth.

On January 24, 2008, the Board of Directors declared a quarterly cash dividend of $0.08 per share to be paid on February 15, 2008 to shareholders of record on February 1, 2008.

The Company paid no dividends on or made repurchases of its common stock during the three and six months ended June 30, 2009.

Management's Discussion and Analysis
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Selected Financial Data

The table below provides selected financial data that highlights the Company's
quarterly performance results:

                                                                                           For the quarters ended,
(dollars in thousands except per share
data)                                     06/30/09        03/31/09        12/31/08        09/30/08        06/30/08        03/31/08        12/31/07        09/30/07

Return on average assets                        0.23 %          0.54 %         -0.63 %          0.27 %          0.35 %          0.91 %          1.11 %          1.12 %

Return on average equity                        2.20 %          6.04 %         -6.93 %          2.94 %          3.84 %          9.55 %         11.65 %         12.09 %

Return on average common equity                 1.41 %          6.19 %         -6.93 %          2.94 %          3.84 %          9.55 %         11.65 %         12.09 %

Average equity to average assets               10.68 %          8.95 %          9.06 %          9.16 %          9.14 %          9.48 %          9.49 %          9.27 %

Average common equity to average
assets                                          8.47 %          8.64 %          9.06 %          9.16 %          9.14 %          9.48 %          9.49 %          9.27 %

Net interest margin                             4.91 %          5.03 %          5.04 %          5.18 %          5.28 %          5.33 %          5.33 %          5.44 %

Efficiency ratio*                              70.02 %         66.71 %         66.43 %         64.40 %         66.31 %         72.17 %         67.26 %         66.89 %

Average loans to average deposits             103.58 %        112.39 %        109.95 %        111.54 %        109.26 %        103.64 %         96.40 %         95.79 %

Net Income                               $       507     $     1,102     $    (1,254 )   $       534     $       691     $     1,675     $     1,978     $     1,628

Net income available to common
shareholders                             $       257     $     1,091     $    (1,254 )   $       534     $       691     $     1,675     $     1,978     $     1,628

Earnings Per Common Share:
Basic                                    $      0.03     $      0.14     $     (0.16 )   $      0.07     $      0.09     $      0.22     $      0.26     $      0.24
Diluted                                  $      0.03     $      0.14     $     (0.16 )   $      0.07     $      0.09     $      0.21     $      0.25     $      0.23
Outstanding Shares:
Basic                                      7,696,027       7,689,317       7,660,342       7,709,600       7,705,174       7,694,546       7,682,730       6,796,286
Diluted                                    7,866,962       7,824,377       7,721,460       7,798,321       7,830,390       7,851,831       7,887,206       7,013,070

* The efficiency ratio is defined as total non interest expense as a percent of the combined net interest income plus non interest income, exclusive of gains and losses on the sale of investment securities and sale of other real estate owned.

Local Economy

The economy in the Company's service area is based primarily on agriculture, tourism, light industry, oil and retail trade. Services supporting these industries have also developed in the areas of medical, financial and educational services. The population of San Luis Obispo County, the City of Santa Maria (in Northern Santa Barbara County), and the City of Santa Barbara totaled approximately 262,000, 86,000, and 86,000 respectively, according to the most recent economic data provided by the U.S. Census Bureau. The moderate climate allows a year round growing season for numerous vegetables and fruits. Vineyards and cattle ranches also contribute largely to the local economy. The Central Coast's leading agricultural industry is the production of wine grapes and production of premium quality wines. Vineyards in production have grown significantly over the past several years throughout the Company's service area. Access to numerous recreational activities including lakes, mountains and beaches, provide a relatively stable tourist industry from many areas including the Los Angeles/Orange County basin, the San Francisco Bay area and the San Joaquin Valley. While the economy in the Company's primary markets of San Luis Obispo and Santa Barbara counties have not been immune to the negative impacts of both the national and state economies, the abundant tourism that has developed over the past decade in our market area, especially in the wine industry and coastal communities, has helped sustain our local economy in previous economic downturns. According to a recent publication by Smith Travel Research in regard to hotel occupancy rates comparing May 2009 to May 2008, there was a decline in occupancy of 2.6%, 4.9% and 12.3% for Paso Robles/San Luis Obispo, Santa Barbara/Santa Maria and the State of California, respectively.

Management's Discussion and Analysis

2008 proved to be a challenging year not only on the national level, but within the state of California and more specifically our primary market area. As the U.S. housing market continued to wane throughout 2008 and economic growth began to significantly slow, the ability of borrowers to satisfy their obligations to the financial sector began to languish. These among other factors placed severe stress on the U.S. financial system, leading to a crisis of confidence, further downturn in economic growth and unprecedented volatility in the U.S. equity and credit markets. As mentioned, our primary market area has historically enjoyed a more stable level of economic activity; however we believe these more macro level concerns have started to become more evident within our market area. Recent indications show the unemployment rate within California to be approximately 11.5%. Within the Company's primary market area, recent indications show the unemployment rate within San Luis Obispo and Santa Barbara major metropolitan areas to be approximately 8.4% and 7.6%, respectively. Additionally, housing prices have fallen significantly year over year within California, showing an approximate 42% year over year decline as of December 2008. Within the Company's primary market, housing prices have fallen in San Luis Obispo and Santa Barbara counties from year ago levels by approximately 17% and 27%, respectively. However, sales have been relatively strong within the State of California and the Company's primary market area, climbing over 30% compared to 2008, the majority of which can be attributed to sales of distressed properties. That said, the lack of oversupply in the Company's market, desirable climate, close proximity to beaches, lakes and the wine industry, for both San Luis Obispo and Santa Barbara Counties have resulted in lower percentage declines in prices for the local real-estate market, relative to other areas of California.

Critical Accounting Policies

The Company's significant accounting policies are set forth in the 2008 Annual Report, Note 1 of the consolidated financial statements, which was filed on Form 10-K.

The following is a brief description of the Company's current accounting policies involving significant Management valuation judgments.

Loans and Interest on Loans

Loans receivable that Management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances reduced by any charge-offs of specific valuation accounts and net of any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans.

Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment in yield of the related loan.

Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. The accrual of interest on loans is discontinued when principal or interest is past due 90 days based on contractual terms of the loan or when, in the opinion of Management, there is reasonable doubt as to collectibility. When loans are placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction to the loan principal balance. Interest accruals are resumed on such loans only when they are brought current with respect to interest and principal and when, in the judgment of Management, the loans are estimated to be fully collectible as to all principal and interest.

The Company considers a loan to be impaired when it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Measurement of impairment is based . . .