The following is an analysis of the results of operations and financial condition of the Company as of and for the three and nine month periods ending September 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 nine month periods ended September 30, 2009, net losses available to common shareholders were approximately $5.6 million and $4.2 million, respectively. In the same periods ended a year earlier, the Company reported net income available to common shareholders of approximately $0.5 million and $2.9 million, respectively. Losses per diluted common share were ($0.73) and ($0.56) for the three and nine months ended September 30, 2009. The Company reported earnings per diluted common share of $0.07 and $0.37 for the same three and nine month periods ended a year earlier. Several significant factors that contributed substantially to the year over year decline in earnings were: elevated provisions for loan losses, losses incurred from the write-down and sale of certain OREO properties, increases in regulatory assessments costs, the one-time assessment imposed by the FDIC on all insured institutions, interest reversals related to loans placed on non-accrual status, as well as the absence of income in the amount of $0.3 million the Bank recognized related to the Visa, Inc. IPO during the second quarter of 2008.

Provisions for loan losses during the three and nine months ended September 30, 2009 were approximately $9.8 million and $14.6 million, respectively. When compared to the $3.2 million and $6.2 million reported for the same periods ended a year earlier, this represents respective increases of approximately $6.6 million and $8.4 million. Elevated provisions for loan losses during 2009 are the primary factor behind the year over year decline in earnings. See also "Provision for Loan Losses" of this Discussion and Analysis for more information regarding factors impacting the level of provision for loan losses during 2009.

During the third quarter of 2009 the Bank wrote down the value of one foreclosed property in the amount of $1.3 million. This property represents land for commercial development and is located within the Bank's primary market area. Additionally, the Bank sold five properties during the third quarter and recognized aggregate losses in connection with those sales of approximately $0.2 million.

Contributing further to the year over year decline in earnings were increased regulatory assessment costs, resulting from a one-time special assessment imposed by the FDIC on all insured institutions that totaled approximately $0.4 million for the Bank and was booked during the second quarter. Year over year increases within this category can also be attributed to a one-time charge in the approximate amount of $0.5 million to correct for the cumulative effect of an error related to the accrual of FDIC assessments from 2007 through June 30, 2009. Management determined that the amounts were not material to the Company's financial condition and results of operations in each reporting period from 2007 through June 30, 2009, and as a result processed the correcting entry in the third quarter of 2009.

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

· For the three and nine months ended September 30, 2009 interest income totaled approximately $11.9 million and $36.0 million, respectively. This when compared to the same three and nine month periods ended a year earlier, represents declines of approximately $0.7 million and $1.9 million, respectively. Although, floors within the loan portfolio were instrumental in abating any substantial year over year decline in interest income, interest reversals related to loans placed on non-accrual during the first nine months of the year negatively impacted this line item. Contributing significantly to the amount of interest reversed during the third quarter, was the reversal of approximately $0.8 million in interest income related to one loan placed on non-accrual, the result of an issue related to the treatment of an interest reserve. As disclosed in Note 10. Subsequent Events of the consolidated financial statements, upon working with the borrower the Bank was able to recover the uncollected interest in October 2009 and subsequently moved the loan back to performing status. For the three and nine months ended September 30, 2009, interest reversals totaled approximately $1.1 million and $1.2 million, respectively.

· For the three and nine months ended September 30, 2009, interest expense totaled approximately $2.6 million and $7.4 million, respectively. When compared to the same periods ended a year earlier, interest expense declined approximately $0.4 million and $2.3 million, respectively. Although core deposit balances increased significantly when compared to that reported a year earlier, declines in the overnight Fed Funds rate during the later part of 2008 helped to bring down the cost of deposits and borrowings for the Bank, contributing substantially to the year over year decline in interest expense. Additionally, 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 more rapidly re-price those funds in a declining interest rate environment, further contributing to the decline in interest expense.

· Net interest income for the three and nine months ended September 30, 2009 totaled approximately $9.3 million and $28.7 million, respectively. Net interest income declined approximately $0.3 million from that reported during the same three month period ended a year earlier and increased approximately $0.4 million when compared to same nine month period ended a year ago. Year over year changes in net interest income can be attributed in large part to the items mentioned in the preceding paragraphs.

Management's Discussion and Analysis

· Non-interest income totaled approximately $1.6 million and $4.8 million for the three and nine month periods ended September 30, 2009, representing respective increases of approximately $80 thousand and $45 thousand when compared to the same periods ended a year earlier. The modest year over year increases within this category can be attributed to increases in mortgage origination fee income of approximately $0.1 million and $0.5 million for the three and nine month periods ended September 30, 2009, respectively. Additionally, gains on the sale of securities and SBA loans in the aggregate amounts of $0.3 million and $0.4 million for the three and nine months ended September 30, 2009, respectively contributed further to the increase within this category. Offsetting these increases were year over year declines in service charge fee income of approximately $0.1 million and $0.3 million for the quarter and year to date periods ended September 30, 2009. For more information related to non-interest income, please see "Non-Interest Income" of this Discussion and Analysis.

· Non-interest expense for the third quarter and the first nine months of 2009 totaled approximately $10.3 million and $25.7 million, respectively. Non-interest expense increased approximately $3.1 million during the third quarter and $3.5 million for the first nine months of 2009, respectively when compared to the same periods ended a year earlier. The primary factor behind the year over year increases within this category can be attributed to the write-down of one OREO property in the third quarter of 2009, totaling approximately $1.3 million. For the third quarter and the first nine months of 2009, OREO write-downs totaled approximately $1.4 million and $1.5 million, respectively. OREO write-downs accounted for approximately 44.0% and 42.3% of the increase in non-interest expenses for the three and nine month periods ended September 30, 2009. Further contributing to the increase in non-interest expenses was an increase in regulatory assessment costs, the Special Assessment imposed by the FDIC on all insured institutions during the second quarter of 2009 and a one-time charge related to the cumulative effect of an error related to the accrual of FDIC assessments from 2007 through June 30, 2009, previously mentioned. For more information related to non-interest expenses, please see "Non-Interest Expenses" of this Discussion and Analysis.

· For the three and nine months ended September 30, 2009, the Company's efficiency ratio was 95.12% and 77.02%, respectively. This compares to 64.40% and 67.55% reported for the same periods ended a year earlier. The efficiency ratio was negatively impacted during the third quarter and the first nine months of 2009 by several one-time charges previously mentioned and that include: increased regulatory assessment costs, expenses and write-downs related to OREO properties, and a one-time charge related to the cumulative effect of an accounting error related to the accrual of FDIC assessment premiums. Additionally, the reversal of approximately $1.1 million and $1.2 million in accrued interest related to loans the Bank placed on non-accrual during the three and nine months ended September 30, 2009 contributed to the rise in the efficiency ratio. As previously mentioned, interest reversals include approximately $0.8 million related to one loan placed on non-accrual during the third quarter of 2009. In October 2009, the Bank recovered all previously accrued interest on this loan and returned the loan to performing status. Exclusive of one-time charges and the reversal of $0.8 million in interest income related to the loan previously mentioned, the efficiency ratio for the three and nine month periods ended September 30, 2009 was 68.44% and 66.28%, respectively. Management remains focused on cost controls in an effort to mitigate the rise in non-interest expenses brought on by the one-time charges previously discussed.

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

· At September 30, 2009, net loan balances were approximately $692.4 million or approximately $24.4 million and 3.6% 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 September 30, 2009, total deposits were approximately $753.5 million or approximately $150.0 million and 24.9% higher than the $603.5 million reported at December 31, 2008. Deposits, exclusive of brokered were approximately $736.5 million or $181.6 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 September 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 nine months of 2009 resulted in fewer borrowings with the FHLB.

Management's Discussion and Analysis

· Investment securities totaled approximately $102.9 million or approximately $52.1 million higher than the $50.8 million reported at December 31, 2008. The year to date increase in the portfolio can be attributed to purchases the Bank made to take advantage of increased credit spreads available on investment securities and to invest excess liquidity in cash flow generating instruments in the absence of loan originations. The lower volume of loan originations relative to historical periods can be attributed in part to lower demand for certain types of credit as well as the Bank becoming more selective with respect to the types of loans it chooses to originate. For additional information on the Bank's investment securities portfolio, please see "Investment Securities and Other Earning Assets" of this Discussion and Analysis.

· Federal Funds sold totaled approximately $45.7 million at September 30, 2009, representing an increase of approximately $39.1 million over that reported at December 31, 2008. Increased balances within this category can be attributed to increased core deposit balances throughout 2009. See also "Investment Securities and Other Earning Assets" of this Discussion and Analysis for additional information regarding Federal Funds sold.

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

· At September 30, 2009, the balance of non-performing loans was approximately $39.8 million or $21.1 million higher than the $18.7 million reported at December 31, 2008. As of September 30, 2009 the balance of non-performing loans as a percentage of total gross loans was 5.61% compared to 2.75% as of December 31, 2008. During the third quarter of 2009, the Bank added approximately $34.2 million in loan balances to non-accruing status. Contributing to the increase in non-accruing balances was the addition of one loan in the approximate amount of $10.7 million. As mentioned, upon working with the borrower, Management was able to recover the interest reversed during the third quarter and move the loan back to performing status during the month of October 2009. Please see "Non-Performing Assets" of this Discussion and Analysis for a more complete discussion of the loans the Bank has placed on non-accrual.

· As of September 30, 2009, the allowance for loan losses totaled approximately $15.9 million, representing 2.24% of total gross loans. This compares to the $10.4 million or 1.53% of total gross loans reported at December 31, 2008. Provisions for loan losses during the three and nine month periods ended September 30, 2009 totaled approximately $9.8 million and $14.6 million, respectively. See also "Provision for Loan Losses" of this Discussion and Analysis for a more complete discussion regarding loan loss provisions.

· Charge-offs during the three and nine month periods ended September 30, 2009 were approximately $5.0 million and $9.1 million, respectively. For the three and nine months ended September 30, 2009 net charge-offs to average gross loans were 0.70% and 1.29%, respectively. When compared to the 0.15% and 0.31% reported for the same periods ended a year earlier, represents increases 55 and 98 basis points, respectively.

· During the first nine months of 2009, the Bank moved approximately $9.7 million in loan balances to foreclosed status of which approximately $9.6 million was classified as OREO. During the third quarter of 2009 balances that moved to OREO totaled approximately $1.2 million. As of September 30, 2009, the balance of OREO was $2.6 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 five properties during the third quarter, previously booked at $3.9 million. Aggregate net losses the Bank incurred related to these sales totaled approximately $0.2 million. For the first nine months of 2009, the Bank incurred aggregate net losses of approximately $0.3 million related to the sale of OREO properties. See also "Non Performing Assets" under "Financial Condition" of this Discussion Analysis for additional information related asset quality.

Recent Developments

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.

Management's Discussion and Analysis

Dividends and Stock Repurchases

During the first nine month of 2009, the Company paid approximately $424 thousand in dividends on its Senior Preferred Stock issued to the U.S. Treasury under the CPP. The Company paid dividends of approximately $263 thousand on its Senior Preferred Stock during the third quarter of 2009. 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 nine months ended September 30, 2009.

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)    09/30/09        06/30/09        03/31/09        12/31/08        09/30/08        06/30/08        03/31/08        12/31/07

Return on average assets                             -2.30 %          0.23 %          0.54 %         -0.63 %          0.27 %          0.35 %          0.91 %          1.11 %

Return on average equity                            -22.54 %          2.20 %          6.04 %         -6.93 %          2.94 %          3.84 %          9.55 %         11.65 %

Return on average common equity                     -30.41 %          1.41 %          6.19 %         -6.93 %          2.94 %          3.84 %          9.55 %         11.65 %

Average equity to average assets                     10.18 %         10.68 %          8.95 %          9.06 %          9.16 %          9.14 %          9.48 %          9.49 %

Average common equity to average assets               8.06 %          8.47 %          8.64 %          9.06 %          9.16 %          9.14 %          9.48 %          9.49 %

Net interest margin                                   4.34 %          4.91 %          5.03 %          5.04 %          5.18 %          5.28 %          5.33 %          5.33 %

Efficiency ratio*                                    95.12 %         70.02 %         66.71 %         66.43 %         64.40 %         66.31 %         72.17 %         67.26 %

Average loans to average deposits                    98.20 %        103.58 %        112.39 %        109.95 %        111.54 %        109.26 %        103.64 %         96.40 %

Net (loss) / income                            $    (5,242 )   $       507     $     1,102     $    (1,254 )   $       534     $       691     $     1,675     $     1,978

Net (loss) / income available to common
shareholders                                   $    (5,594 )   $       257     $     1,091     $    (1,254 )   $       534     $       691     $     1,675     $     1,978

(Loss) / Earnings Per Common Share:
Basic                                          $     (0.73 )   $      0.03     $      0.14     $     (0.16 )   $      0.07     $      0.09     $      0.22     $      0.26
Diluted                                        $     (0.73 )   $      0.03     $      0.14     $     (0.16 )   $      0.07     $      0.09     $      0.21     $      0.25
Outstanding Shares:
Basic                                            7,699,377       7,696,027       7,689,317       7,660,342       7,709,600       7,705,174       7,694,546       7,682,730
Diluted                                          7,699,377       7,866,962       7,824,377       7,660,342       7,798,321       7,830,390       7,851,831       7,887,206

* 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, sale of other real estate owned and sale of SBA loans.

Management's Discussion and Analysis

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 . . .