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Article by DailyStocks_admin    (05-14-08 07:34 AM)

Filed with the SEC from May 1 to May 7:

Vineyard National Bancorp (VNBC)
Shareholder Douglas Kratz is concerned with the company's delay in filing its annual report, as well as the board's opposition to the recently completed consent solicitation by Jon Salmanson and Norman Morales, who successfully sought to have the company's bylaws modified.
Kratz says that he is "outraged" at Vineyard's continued delay in filing its form 10-K with the Securities and Exchange Commission.
In addition, the investor maintains that it's "utterly ridiculous" that it has taken this long to resolve any technology/accounting issues, and a timing issue related to loan-loss provisioning in back-to-back fiscal quarters.
Kratz added that he might seek the removal of one or more members of senior management, or might initiate a tender offer for more or all of the company's shares.
Kratz currently holds 530,000 shares (5.2% of the total outstanding).
BUSINESS OVERVIEW

Vineyard National Bancorp

Vineyard National Bancorp (referred to on a consolidated basis in this report as “we”, “our”, “us”, or “the Company”) is a financial holding company which provides a variety of lending and depository services to businesses and individuals through our wholly-owned subsidiary, Vineyard Bank, National Association (the “Bank”). The Bank is a national banking association headquartered Corona, California, which is located in the Inland Empire region of Southern California. We are also the sole common stockholder of Vineyard Statutory Trust I, Vineyard Statutory Trust II, Vineyard Statutory Trust III, Vineyard Statutory Trust IV, Vineyard Statutory Trust V, Vineyard Statutory Trust VI, Vineyard Statutory Trust VII, Vineyard Statutory Trust VIII, Vineyard Statutory Trust IX, and Vineyard Statutory Trust XI (collectively, “the Trusts”). The Trusts are our wholly-owned unconsolidated subsidiaries created to raise capital through the issuance of trust preferred securities.

We incorporated under the laws of the State of California on May 18, 1988 and commenced business on December 16, 1988 when, pursuant to reorganization, we acquired all of the voting stock of the Bank. We are registered under and subject to the Bank Holding Company Act of 1956 , as amended (“BHCA”). On November 12, 2002, our common stock was listed on the NASDAQ Global Select Market (formerly NASDAQ National Market System) and is publicly traded under the symbol “VNBC”. We had approximately 3,700 shareholders that owned 10,432,244 shares of our common stock as of February 28, 2007.

In September 2006, we changed our designation from a bank holding company to a financial holding company. Our principal business is to serve as a holding company for the Bank, which conducts banking operations through sixteen banking centers and five loan production offices located throughout California, and for other banking or financial-related subsidiaries which we may establish or acquire. We may, in the future, consider acquiring other businesses or engaging in other activities as permitted for financial holding companies under the Federal Reserve Board (the “FRB”) regulations, including insurance and financial advisory services.

Our principal source of income is dividends from the Bank. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to us (See Item 1. Business; Supervision and Regulation; Dividends and Other Transfer of Funds).

On July 31, 2006, we completed a merger with Rancho Bank, pursuant to which Rancho Bank merged into the Bank, with the Bank as the surviving entity. The merger was an all-cash transaction with an aggregate transaction value of $56.1 million. As part of the merger, the Bank acquired $116.7 million in net loans and assumed $198.2 million in deposits. We recorded $40.5 million in goodwill in conjunction with this transaction. See Notes #2 and #3 to our Consolidated Financial Statements in Item 8 hereof for further discussion of the terms and accounting for this transaction. We continue to operate the former Rancho Bank’s four banking centers as part of the Bank’s sixteen banking centers.

As of December 31, 2006, we had total consolidated assets of $2.3 billion, total consolidated net loans of $1.9 billion, total consolidated deposits of $1.8 billion and total consolidated stockholders’ equity of $143.1 million.

We make available free of charge on our website at www.vnbcstock.com our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments thereto, as soon as reasonably practicable after we file such reports with, or furnish them to, the Securities and Exchange Commission (“SEC”). Investors are encouraged to access these reports and the other information about our business on our website.

Vineyard Bank, National Association

The Bank was organized as a national banking association under federal law and commenced operations under the name Vineyard National Bank on September 10, 1981. In August 2001, the Bank changed its name to Vineyard Bank and converted its charter to a California-chartered commercial bank. At that time, the Bank determined that it could better serve its customers by converting to a state bank, which provided the Bank with increased lending limits.

In December 2005, we determined that a national bank charter would be better aligned with our strategic plan, and therefore submitted an application to the Office of the Comptroller of the Currency (“OCC”) to convert the Bank’s existing charter to a national banking association charter. In addition to providing greater flexibility for expansion into new markets, a national bank charter provides more consistency in the applicability of laws and regulations, as the Bank is supervised by only one bank regulatory agency.

On May 1, 2006, the OCC approved the Bank’s application to convert to a national banking association. The conversion became effective on May 11, 2006, and the Bank’s name was changed from Vineyard Bank to Vineyard Bank, National Association. Under the previous California charter, the Bank operated under the supervision of the California Department of Financial Institutions (“DFI”) and the Federal Deposit Insurance Corporation (“FDIC”). Upon conversion to the national banking association, the Bank began operating under the supervision of the OCC. The Bank’s deposit accounts are insured by the FDIC up to the maximum amount permitted by law.

Banking Services

The Bank is a community bank, dedicated to exceptional customer service in developing long-term customer relationships. We are primarily involved in attracting deposits from individuals and businesses and using those deposits, together with borrowed funds and capital, to originate loans. We focus on serving the needs of commercial businesses, single-family residential developers and builders, individuals, commercial real estate developers and investors, non-profit organizations, and other local private and public organizations. We have experienced substantial organic, or internal, growth in recent years through the expansion of our deposit franchise in order to fund our growth in loan originations. We have also experienced inorganic growth as a result of our merger with Rancho Bank in July 2006.

We operate sixteen full-service banking centers located in each of the communities of Chino, Corona, Covina, Crestline, Diamond Bar, Irvine, Irwindale, Lake Arrowhead, La Verne, Manhattan Beach, Rancho Cucamonga, San Diego, San Dimas, San Rafael, Upland, and Walnut, all of which are located in Los Angeles, Marin, Orange, Riverside, San Bernardino and San Diego counties in California. We are headquartered in Corona, California, which is in the Inland Empire region of California. The Inland Empire area consists of Riverside and San Bernardino counties and is located approximately 50 miles east of Los Angeles, California.

In addition to our full-service banking centers, we operate five loan production offices (“LPOs”) in Anaheim, Carlsbad, Palo Alto, Monterey, and Westlake Village, California, which are located in Orange, San Diego, Santa Clara, Monterey, and Ventura counties of California, respectively. The LPO in Westlake Village focuses primarily on the origination of single-family luxury home construction loans. The LPOs in Anaheim, Carlsbad and Monterey focus principally on the origination of SBA loans, and are considered satellite offices of the Bank’s SBA department located in the San Diego banking center. The Palo Alto LPO, which was opened in February 2007, will principally focus on the origination of single-family luxury home construction loans to further expand this existing product line into northern California.

Specialty Lending Product Offerings

We emphasize the organic growth of our loan portfolio by augmenting our traditional commercial and residential loans with several specialty lending products. These specialty product divisions, as described below, are each staffed with experienced lending professionals who focus on maintaining long-term relationships with customers within their respective product division’s business sector. Each of these specialty lending groups brings diversity to our traditional product lines, which in turn provides our existing customers with an array of specialty products and allows us to serve new customers throughout our primary market areas.


Luxury Home Construction Lending: We originate high-end single-family residential luxury construction loans primarily within Los Angeles’ “south bay” coastal communities (including Manhattan Beach, Hermosa Beach, El Segundo and Redondo Beach, as well as the Palos Verdes Peninsula area), Los Angeles’ “west side” (including Beverly Hills, Brentwood, Bel Air and Malibu) and Orange County regions where we believe we have a competitive advantage based on established builder and customer relationships and expertise in the construction market. Although the general California real estate market has shown signs of slowing, we continue to believe there is relative strength in the demand for this loan product within the luxury housing market (consisting of homes $2.0 million and above) along the California coast and in other established affluent regions of California. We believe the high employment level, strong incomes and wealth accumulation, stable interest rates and good schools in these luxury regions allow continued confidence in the stability of these markets. These types of construction loans typically range from $1.0 million to $5.0 million. In addition to the establishment of the Palo Alto LPO in February 2007, we plan to expand this group in new geographic areas similar in demographics to our existing market area. During the years ended December 31, 2006 and 2005, gross commitments generated for this loan product amounted to $434.1 million and $497.3 million, respectively. Our single-family residential luxury construction loans outstanding amounted to $514.4 million and $392.2 million at December 31, 2006 and 2005, respectively, net of participations sold of $86.7 million and $114.7 million, respectively. As of December 31, 2006, we had $265.0 million in undisbursed single-family luxury home construction loan commitments. As of December 31, 2006, 90% of such loans that we originated will contractually mature within one year and 10% will mature within one to two years.


Tract Construction Lending: We originate single-family residential tract construction loans, primarily secured by newly-constructed, entry to mid-level detached and attached homes. Although these loans are predominantly originated within the Inland Empire of Southern California, we have financed projects throughout California. During 2006, we originated less tract construction loans than 2005, primarily due to the softening housing market conditions in southern California. Despite changing real estate market factors, we believe the Inland Empire continues to provide reasonably priced housing alternatives, particularly when compared to the higher priced coastal regions of Los Angeles, Orange, and San Diego counties. These types of construction loans typically range from $5.0 million to $20.0 million. We plan to expand this group in new geographic areas similar in demographics to our existing areas. During the years ended December 31, 2006 and 2005, gross commitments generated for this loan product amounted to $211.3 million and $260.7 million, respectively. Our single-family residential tract construction loans outstanding amounted to $152.1 million and $129.7 million at December 31, 2006 and 2005, respectively, net of participations sold of $3.2 million and $11.6 million, respectively. As of December 31, 2006, we had $150.7 million in undisbursed single-family residential tract construction loan commitments. Single family tract construction loans typically have shorter terms than our other loan products. As of December 31, 2006, 100% of such loans which we originated will mature within one year.


SBA Lending: We offer SBA 7(a) and 504 loans to small businesses throughout our market area, and our SBA lending division has received national preferred lending status. SBA loans are a complement to our focus on strengthening and supporting local communities. SBA loans are generally made pursuant to a federal government program designed to assist small businesses in obtaining financing. The federal government guarantees 75% to 85% of the SBA loan balances as an incentive for financial institutions to make loans to small businesses. In 2006, we funded $36.7 million of SBA loans. We generally sell the guaranteed portion of the SBA loan which is approximately 75% to 85% of the originated balance at a premium sale price between 105% and 110%. We had $12.4 million and $12.8 million of outstanding SBA loans at December 31, 2006 and 2005, respectively, net of participations sold of $50.4 million and $42.0 million, respectively. In 2006, we sold $22.9 million of the guaranteed and unguaranteed portions of SBA loans, resulting in gain on sale and broker fee income of $2.8 million.


Non-Profit Services Group : We provide loan and deposit services to non-profit organizations, including churches and private schools throughout our market area. These activities are also a complement to our focus on strengthening and supporting local communities. Loans to non-profit organizations amounted to $45.6 million and $30.3 million at December 31, 2006 and 2005, respectively.


Income Property Lending: We have an income property lending division to service the growing markets for commercial real estate and residential real estate in Southern California.

Commercial Real Estate
The commercial real estate portfolio includes office buildings, retail outlets and industrial properties, the majority of which are located in the Inland Empire region, and Los Angeles and Orange counties. Economic data contained in various studies and reports, including the UCLA and Chapman University economic forecasts, indicates that this real estate sector in southern California has gained momentum over the past few years, fueled by new job growth and tenant demand. Further, that data indicates certain commercial real estate markets are expected to experience a continued tightening of vacancy rates and rising rents, suggesting that large investors may continue to view commercial real estate as a viable investment. Commercial real estate loans generated from this division typically range from $2.0 million to $10.0 million. At December 31, 2006 and 2005, the balance of income property loans generated from this division amounted to $355.1 million and $210.1 million, respectively, for commercial real estate loans. Of our total commercial real estate loan portfolio as of December 31, 2006, 5% will mature within one year, 17% will mature within one to five years, and 78% will mature after five years.

Residential Real Estate
Our income property residential real estate portfolio consists primarily of multifamily/apartment loans. These loans are originated primarily in Los Angeles and Orange counties, with some lending in the Inland Empire region. Economic data seems to indicate that this market is currently benefiting from the weaker California real estate market as potential home buyers are choosing to remain in rental housing. Vacancy rates have remained low in the southern California rental market. Apartment loans typically range from $0.5 million to $5.0 million. At December 31, 2006 and 2005, the balance of income property residential real estate loans generated from this division amounted to $206.9 million and $230.0 million, respectively. As of December 31, 2006, 16% of our total residential real estate loan portfolio will mature within one year, 4% will mature in one to five years, and 80% will mature after five years.

Specialty Deposit Product Offerings
As a complement to our lending product offerings, we also seek to enhance our customers’ banking experiences by offering a vast array of technologically advanced deposit services. These products and services are described below:


Branching System: The majority of our full-service banking centers have recently been redesigned to offer a high-tech, high-service environment. Each of our client service desks, which have replaced the traditional teller lines, incorporate both new account and traditional teller operations with state-of-the-art circulating cash machines present at each desk. In order to further the reach of each of our banking centers, we may open deposit production offices (“DPOs”) or LPOs, which are satellite offices of the existing banking centers that will exist exclusively to generate deposits and loans, respectively. We also offer courier services, internet based banking, and ATMs and kiosks to make banking more convenient to each of our customers.


Cash Management: In order to offer expedient banking with new and emerging technologies, we offer various cash management services to our customers. These services facilitate business customers’ cash flow and aid in maximizing their investment potential by bundling products and services including the following:

o
Remote Item Capture: This technology, also termed ‘electronic deposit’, allows clients to scan items for deposit and electronically send images of the items securely to our processor. This service allows customers the convenience to perform banking activities from within their place of business.

o
Online Banking: Our online banking includes services such as automated wire processing, electronic tax payments, electronic transfers, loan payments, bill payments, and account reconciliation.

o
Lockbox Processing: Our lockbox services aid customers in expediting their deposits and increasing their float value for investment purposes. This product also provides same-day reporting of deposits.

o
Positive Pay: This service allows business customers increased efficiency and security by allowing them to review checks presented against their accounts prior to disbursing funds. This product also helps clients to identify potentially fraudulent activity in their account.


Our Strategic Plan

As we move forward in the development of our business plans and initiatives, we continue to focus on the foundational principles for a customer relationship management business approach which includes the core values of creativity, integrity and flexibility.

Organic Growth Initiatives
We have been successful to date in expanding our loan portfolio through the specialty offerings mentioned above. Through the implementation of our asset-generating business initiatives, we have grown from $110.8 million in assets at December 31, 2000 to $2.3 billion in assets at December 31, 2006, while maintaining sound business practices. Until recently, deposit generation, to support the loan growth, was largely the domain of our branching system, and we employed various strategies to supplement our deposit gathering and funding operations.

As we continue to grow our business, we will strive to maintain our customer relationship management approach while also implementing the delivery of products and services to the following customers:


Commercial customers with annual revenues typically from $10 million to $75 million;

Entrepreneurs and individuals with a focus on their unique objectives, operations and activities; and

Non-profit organizations, such as religious institutions, schools, and government and quasi-government agencies.

In order to provide exceptional service to these customers, we will highlight non-real estate based lending and cash management services, in which we bundle products, including remote item capture (electronic deposit), positive payment services, lockbox transactions and other electronic banking services.

We will continue to develop new products and services to act as additional tools and resources for our customers, while seeking low to moderate cost deposits and diversifying our loan portfolio. As we achieve increased dimension and diversification in our business, markets and talent, we will continue to expand and mature our franchise. This may include the establishment of new full-service banking centers, LPOs and DPOs. We will also continue to seek talented individuals and teams that can bring skill sets and delivery systems to our business that are either consistent with our current products, services, and markets or that provide unique, synergistic and accretive business opportunities to our existing business.

Inorganic Growth Initiatives
While we strive to grow primarily through organic means, to the extent they are accretive to us and provide a means to efficiently implement our strategic growth initiatives, we may also utilize the following approaches to grow:


Mergers or acquisitions of businesses which are synergistic to our current business or our strategic goals;

Acquisitions of banking centers in locations complementary to our existing network or which expands our presence into new markets; and

Asset and liability acquisitions, such as deposit relationships, loan portfolios or facilities.

CEO BACKGROUND

Frank S. Alvarez , 72, has served as a Director of the Company since its inception in 1988 and a director of the Bank since its inception in 1981. Mr. Alvarez served as the Chairman of the Board from January 2000 thru December 2006. Mr. Alvarez is a retired certified public accountant, formerly with the accounting firm of Bowen McBeth, Inc. Mr. Alvarez also serves on the Board of Directors of Casa Colina Rehabilitation Hospital in Pomona, California.

David A. Buxbaum , 62, has served as a Director of the Company since 2004. Mr. Buxbaum is one of the three founders of the Bank in the early 1980’s. Mr. Buxbaum is an attorney at the law firm of Buxbaum and Chakmak, which he co-founded in 1970. Mr. Buxbaum has served on the City of Claremont Commission for 13 years, including chairman of the Planning Commission and as a member of the Architecture Commission. Mr. Buxbaum has also served as a member of the Board of Trustees of the Gould Foundation at Claremont McKenna College for almost 20 years. Mr. Buxbaum is a licensed California Real Estate Broker.

Charles L. Keagle , 67, has served as a Director of the Company since 1998. Mr. Keagle is the founding owner, Chairman and Chief Executive Officer of The C & C Organization, which operates restaurants in Southern California known as The Cask ‘n Cleaver and The Sycamore Inn. Mr. Keagle is a founding organizer and director of the Bank. In addition to his community service involvement, Mr. Keagle is a member of the Board of Directors of The California Restaurant Association and The Board of Advisors of the Collins School of Hospitality Management at Cal Poly Pomona.

James G. LeSieur , 65, has served as a Director of the Company since 2004 and as Chairman of the Board since January 2007. Mr. LeSieur serves as a member of the board for the Lennar Charitable Housing Foundation and Banker Benefits, a subsidiary of the California Bankers Association. Previously, Mr. LeSieur served as the Director for the Ralph W. Leatherby Center for Entrepreneurship and Business Ethics at Chapman University, and was on the board for the Orange County affiliate of Habitat for Humanity, where he also served two terms as Chairman. Prior to his appointment as a Director of the Company in December 2004, Mr. LeSieur served as the President, Chief Executive Officer and a Director of Sunwest Bank. Prior to Sunwest Bank, Mr. LeSieur served as a management consultant for Arthur Young & Company.

Norman A. Morales , 46, has served as Director, President and Chief Executive Officer of the Company and the Bank since 2000. Mr. Morales previously served as Executive Vice President/Chief Operating Officer and Chief Credit Officer of Cedars Bank in Los Angeles, California, from February 1999 through September 2000. Mr. Morales’ prior executive experience includes serving as Executive Vice President and Chief Financial Officer for Hawthorne Savings, F.S.B. in El Segundo, California, from January 1995 through January 1999. Mr. Morales served as Executive Vice President/Chief Financial Officer and Chief Administrative Officer of Southern California Bank in La Mirada, California, from July 1987 through January 1995.

Dr. Robb D. Quincey , 45, has served as a Director of the Company since October 2006. Dr. Quincey has more than 20 years of management experience in the business and public sector. Currently, Dr. Quincey serves as City Manager for the city of Upland, California. Prior to his service to the city of Upland, Dr. Quincey served the city of Hesperia, California, as city manager for 5 years. Dr. Quincey also served as Chief Executive Officer for the Inland Empire Utilities Agency, becoming a local advocate for development opportunities in California. Dr. Quincey has served as the president of the board for the Monte Vista Water District for more than 13 years. Dr. Quincey received his Doctorate in public administration with an emphasis in economics and organization development from the University of La Verne in 1987. Dr. Quincey completed post-doctorate education at Harvard University, Stanford University and University of California, Berkeley.

Joel H. Ravitz , 61, has served as a Director of the Company since 1988. Mr. Ravitz is Chairman of the Board and Chief Executive Officer of Quincy Cass Associates, Inc., a Los Angeles-based securities broker dealer and a member of the NASD, as well as QCA Capital Management, Inc., a registered investment advisor. Mr. Ravitz has held these positions for more than ten years. Mr. Ravitz is a past member of the NASD District #2 Committee (2001 thru 2004) and is currently a member of the NASD Consultative Committee and the District #2 Nominating Committee. Mr. Ravitz is a past President and serves as a Director of Therapeutic Living Centers for the Blind, a non-profit corporation, and is a member of Town Hall of California. Mr. Ravitz has been a Bank Director since 1983.

COMPENSATION

Setting Executive Compensation

Based on the foregoing objectives, the Company has structured its executive compensation to motivate executives to achieve the business goals set by the Company, and to reward the executives for achieving such goals.

Elements of 2006 Executive Compensation

For the fiscal year ended December 31, 2006, the principal elements of compensation for the NEO’s were:







base salary;




performance-based incentive compensation including cash (short term) and equity (long term);




other equity compensation;




retirement and other benefits; and




perquisites and other personal benefits.

Base Salary

The Company provides NEO’s and other employees with base salary to compensate them for services rendered during the fiscal year. Base salary ranges for NEO’s are determined by using market assessments and internal evaluations for each executive based on his or her position, experience, anticipated contributions and responsibilities.

As part of its review of base salaries for executives, the Committee primarily considers:







market data provided by public proxy information which may be confirmed or reviewed by independent sources;




internal review of the executive’s compensation, both individually and relative to other officers;




scope of the roles, duties and responsibilities of the executive and the impact these duties have on the Company; and




individual performance of the executive.

Salary levels are typically reviewed bi-annually as part of the Company’s performance review process as well as upon a promotion or other change in job responsibility.

Performance-Based Incentive Compensation

The Company’s performance-based incentive compensation program is designed to provide cash (short-term) and equity-based (long-term) incentive compensation to:


promote high performance and achievement of corporate goals by executive management and key employees;


encourage the growth of shareholder value; and


allow key employees to participate as an equity shareholder in the long-term growth and profitability of the Company.

The cash portion of the incentive compensation is intended to reward the implementation of shorter-term operating initiatives, which generally produce the current year operating earnings, and the equity portion is intended to reward the creation of long-term shareholder value over a three to four year horizon.

The allocation between cash and equity incentive compensation paid to each NEO depends on the NEO’s role and performance within the Company. For fiscal year 2006, the cash allocation portion of the Company’s performance based incentive compensation was based upon a percentage of Return on Average Common Equity (“ROACE”) and the individual’s base salary. As discussed below, the equity allocation of this compensation is based upon a percentage of the cash portion.

NEO’s are awarded a cash incentive based on the Company’s ROACE for the annual measurement period. Each participant receives a cash award based on a range of 0.25 to 2.0 times the ROACE, multiplied by their respective base salary. The determination of the percentage by which the ROACE is multiplied by is determined by comparing the Company’s final operating results with its operating plan targets, and determining whether the final operating results “generally mostly meet,” “generally meet” or “generally mostly exceed” the Company’s operating plan targets. If the Company “generally mostly meets” its operating plan targets, the ROACE is multiplied by between 0.25 and 0.75, if the Company “generally meets” its operating plan targets, the ROACE is multiplied by between 0.75 and 1.0, and if the Company “generally mostly exceeds” its operating plan targets, the ROACE is multiplied by between 1.0 and 2.0. In addition, the Committee retains the discretion to adjust an executive officer’s incentive compensation amount (cash and equity) to reflect elements of the executive’s performance that may not have been reflected in the ROACE.

For 2006, the Company “generally mostly met” its operating objectives, therefore, it multiplied the ROACE by 0.50.

For the 2006 fiscal year, the cash awards for the NEO’s, collectively, were approximately 0.50 times the ROACE of 17.6%, or 8.8%, of the respective base salaries.

The equity-based component to the annual performance-based incentive compensation was established to align the NEO’s with longer-term franchise and shareholder value creation, and to recognize the achievement of individual qualitative performance objectives. Equity awards are granted to participating individuals, including NEO’s, based on the cash awards earned through the ROACE calculation identified above. Although the equity payout is based on the cash awards earned by each individual, the plan is discretionary and the Committee retains the discretion to adjust an executive officer’s equity compensation amount to reflect elements of the executive’s performance that may not have been reflected in the ROACE cash payment. For the 2006 fiscal year, the equity awards for the NEO’s, collectively, were approximately three times the cash awards, or approximately 30.0% of the respective base salaries.

Other Equity Compensation

The Company also utilizes equity compensation to:







enhance the link between the creation of shareholder value and long-term executive compensation;







provide an opportunity for increased equity ownership by executives;







maintain competitive levels of total compensation (relating to base compensation as well as incentive compensation); and



retain employees.

Under the equity-based programs, the Committee may grant participants shares of the Company’s Common Stock, restricted stock, share units, stock options, stock appreciation rights, and incentive Awards. In granting these awards, the Committee may establish any conditions or restrictions it deems appropriate. Further, the Committee has the discretion to increase or decrease the amount of any performance based awards. To date, no such adjustments have been deemed necessary. Some of the factors the Committee considers in making such adjustments include: (i) failure to achieve individual designated performance goals; (ii) exceeding individual designated performance goals; (iii) the Company’s financial performance and other performance based factors. In addition, the CEO has discretionary authority to grant restricted shares or share units to certain high-performing executives. Awards of restricted shares or share units generally cliff vest after four years from the date of the grant. Awards of restricted shares or share units to individuals subject to Section 16 of the Exchange Act require the approval of the Committee.

All awards of shares of the Company’s Common Stock under the aforementioned programs are made at the market closing price on the date of grant.

Subject to certain exceptions set forth below, the Company typically issues restricted stock grants to its executive officers once a year following the disclosure of year-end operating results on Form 8-K. These grants are based on each executive officer’s contribution and performance during the previous year as recommended for approval to the Committee by the CEO. Restricted stock grants may also be issued to select new employees as part of their initial compensation package, and such grants are traditionally issued on the date of hire. All restricted stock grants are valued using the fair value of the shares issued at the date of the grant. Typically these restricted stock grants have a four year cliff vesting from date of grant. As of March 26, 2007, the Section 16 reporting officers and non-employee directors owned 106,888 shares of restricted stock granted under the restricted stock programs.

Retirement and Other Benefits

The Company has a Non-Qualified Deferred Compensation Plan for certain key members of management that permits such individuals to defer base salary and cash incentive compensation which is later paid out at the benefit distribution date. This plan provides for payments commencing upon retirement, death, participant termination or plan termination. Participants in this plan always have a fully vested right to benefits attributable to deferrals and Company contributions made under the plan. The Company may make matching contributions of officers’ deferrals up to a maximum of 25% to 100% of the participants’ deferrals, up to a maximum of 10% of the participant’s pre-tax annual base salary. The level of Company match is determined by a participant’s officer title. For all NEO’s the Company’s match is dollar for dollar up to 10% of annual base salary. The Company’s contribution, in the aggregate, for all participants cannot exceed 4% of the total compensation of all Company employees. As this is a non-qualified plan, the participants are not limited to the amount in which they can defer on an individual basis. Additional information with respect to each NEO’s contribution to this Non-Qualified Deferred Compensation Plan and the Company’s matching contribution appears in the “All Other Compensation” column and related footnotes of the “Summary Compensation Table” on page 18, and also in the Non-Qualified Deferred Compensation Table on page 27.

In addition, the Company has a 401(k) Plan for all eligible employees. For the fiscal year 2006, employees could contribute between 1% and 100% of their compensation, up to a maximum of $15,000, to this plan. The Company’s contributions to the plan are based upon an amount equal to 50% of each participant’s eligible contribution for the plan year not to exceed 6% of the employee’s compensation. The Company’s matching contributions vest immediately. Additional information with respect to each NEO’s contribution to the 401(k) Plan, and the Company’s matching contribution thereto appears in the “All Other Compensation” column and related footnotes of the “Summary Compensation Table” on page 18.

The Company covers the costs of all health benefits provided to NEO’s while such persons are employed by the Company or the Bank. The health benefits generally include medical, dental and vision benefits. Additional information with respect to the cost of benefits provided to the NEO’s appears in the “All Other Compensation” column and related footnotes of the “Summary Compensation Table” on page 18.

The Company also has an ESOP in which all employees are eligible to participate. Additional information with respect to the Company’s contribution provided to the NEO’s appears in the “All Other Compensation” column and related footnotes of the “Summary Compensation Table” on page 18.

Perquisites and Other Personal Benefits

The Company provides perquisites and other personal benefits that the Company and the Committee believe are reasonable and consistent with its overall compensation objectives of attracting and retaining superior employees for key positions. The Committee periodically reviews the levels of perquisites and other personal benefits provided to NEO’s.

Perquisites provided for NEO’s may include, but are not limited to, the use of Company automobiles, automobile allowances, travel and transportation accommodations, entertainment expenses, participation in the plans and programs described above and the use of administrative assistant services for personal matters.

MANAGEMENT DISCUSSION FROM LATEST 10K

Executive Overview and Highlights

We are a financial holding company whose principal asset is the capital stock of the Bank, a nationally chartered bank headquartered in the Inland Empire region of Southern California. We are dedicated to relationship banking and the success of our customers, and we focus on the core values of creativity, integrity and flexibility.

We cater to the needs of small-to-mid-size commercial businesses, entrepreneurs, retail community businesses, single family residence developers and builders, individuals, non-profit organizations, and other local public and private organizations by offering specialty lending and depository solutions. At December 31, 2006, we had $1.9 billion in gross loans, of which 42.0% are construction loans, 27.9% are commercial real estate loans, 20.2% are residential real estate loans, 6.4% are commercial loans, and 3.5% are consumer loans. The majority of our loans are originated in our primary market areas throughout southern and northern California. Therefore, our loan portfolio’s credit quality and value may be affected significantly by the California real estate market.

We attract deposits from the communities where we have established banking centers by offering competitive interest rate products and providing value-added banking services. We endeavor to obtain non-interest bearing deposits in order to fund our lending activities. Our deposit portfolio at December 31, 2006 was comprised of 48.7% in time certificate of deposits, 35.0% in savings deposits (which include money market, NOW, and savings deposits) and 16.3% in demand deposits.

We also strive to add value for our shareholders by optimizing our net interest margin and expanding the volume of our earning assets. To optimize our net interest margin, we focus on loan yields and deposit costs, as net interest income comprises 93.7% of our net revenues (defined as net interest income before provision for loan losses plus other income).

In the past six years, we have grown significantly; however, our business is subject to various risks which are discussed in “Business; Risk Factors” in Item 1 hereof. Management has implemented several strategies to manage risks such as interest rate risk and liquidity. (See “Business” in Item 1 hereof). Based on historical results and current economic forecasts, we anticipate that we will continue to grow in the future. However, due to risk factors that are beyond our control, actual results could differ from our estimates.

Management’s discussion and analysis of financial condition and results of operations is intended to provide a better understanding of the significant changes in trends relating to our financial condition, results of operations, liquidity and interest rate sensitivity. The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements.

The following information provides the operating highlights for 2006.

Merger Completion

On July 31, 2006, we completed a merger with Rancho Bank, pursuant to which Rancho Bank merged into the Bank, with the Bank as the surviving entity (the “Merger”). The Merger was completed pursuant to the Agreement and Plan of Reorganization, which was signed on April 19, 2006. Rancho Bank operated four banking centers located in Covina, San Dimas, Upland and Walnut, which are located in San Bernardino and Los Angeles counties of California. We continue to operate all four banking centers. The Merger expands our footprint and allows us to deliver our products and services to the clients of the former Rancho Bank. We believe the addition of the four banking centers also provides additional opportunities to expand our relationship banking efforts and strengthen our marketplace presence between the San Gabriel Valley and greater Inland Empire regions.

Upon closing of the Merger, we paid cash consideration of $38.50 for each outstanding share of common stock of Rancho Bank. The Merger consideration resulted in an aggregate transaction value of approximately $56.1 million. See Note #2 to the Consolidated Financial Statements for further transaction details.

During August 2006, we successfully completed the integration of Rancho Bank’s employees and customers into the Bank, along with the conversion of systems, products and services. The addition of accounts resulting from the Merger with Rancho Bank reduced our overall funding costs.

We are able to offer the former Rancho Bank’s client relationships our increased lending resources, while also affording these clients additional cash management services not previously available. In addition, we have been able to develop new relationships through our product and service packages that Rancho Bank did not previously offer.

We incurred $1.3 million in transitional expenses during the year ended December 31, 2006 relating to the completion of the Merger and the integration of systems and personnel. The costs were comprised primarily of transitional period bonuses, stay-on bonuses, and employee salaries.

Bank Charter Conversion

In December 2005, we determined that a national banking association charter would be better aligned with the Bank’s strategic plans, and therefore submitted an application to the OCC to convert the Bank’s existing charter to a national banking association charter. In addition to providing greater flexibility for expansion into new markets and product lines, we believe that a national banking association charter will provide more consistency in the applicability of laws and regulations, as the Bank would be supervised by one bank regulatory agency.

On May 1, 2006, the OCC approved the Bank’s application to convert to a national banking association. The conversion became effective on May 11, 2006, and the Bank’s name was changed from Vineyard Bank to Vineyard Bank, National Association. Under the previous California charter, the Bank operated under the supervision of the DFI and the FDIC. Upon conversion to the national banking association charter, the Bank began operating under the supervision of the OCC.

Financial Holding Company Designation

In September 2006, the FRB approved our request to change our designation from a bank holding company to a financial holding company. In addition to our current banking activities, this new designation will allow us to engage in activities such as insurance, financial advisory services, and other activities deemed by the FRB to be financial in nature.

We believe that this new designation will provide more flexibility for expansion into new markets and product lines as we examine future opportunities for growth while building on our current strategic initiatives and plans.

Registered Direct Offering

On May 5, 2006, we completed the sale of $31.8 million of our common stock in a registered direct offering, through which 1.2 million shares were sold through a prospectus supplement to our shelf registration statement. Our shelf registration statement, which was filed with the SEC in August 2005, allows us to offer and sell $125.0 million in debt and/or equity securities, the terms of which will be established at the time of the offering by means of a written prospectus or prospectus supplement. As of December 31, 2006, there was $93.2 million in debt and equity securities available for issuance through the shelf registration statement.

The shares were sold to three accredited institutional investors with RBC Capital Markets Corporation acting as sole placement agent for the transaction. We used the proceeds of this transaction to support the Bank’s growth, payoff outstanding debt, fund the merger with Rancho Bank and for general corporate purposes.

Junior Subordinated Debentures

On May 16, 2006, we established a wholly-owned subsidiary, Vineyard Statutory Trust XI (“Trust XI”), which issued $18.0 million in trust preferred securities to preferred investors. We simultaneously issued $18.6 million of junior subordinated debentures to Trust XI.

Results of Operations

Overview

Net income for the periods ending December 31, 2006, 2005 and 2004 was $19.7 million, $18.9 million and $14.0 million, respectively, representing an increase of 4.4% for the year ended 2006 compared to the year ended 2005 and an increase of 35.2% for the year ended 2005 as compared to the year ended 2004. On a per diluted share basis, net income was $1.89 for the years ended December 31, 2006 and 2005, and $1.55 for the year ended December 31, 2004, representing a 21.9% increase from 2004 to 2005.

Our earnings are derived predominately from net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. The net interest margin is the net interest income divided by the average interest earning assets. Net interest income and net interest margin are affected by several factors including (1) the level of, and the relationship between, the dollar amount of interest earning assets and interest bearing liabilities; (2) the relationship between repricing or maturity of our variable rate and fixed rate loans and securities, and our deposits and borrowings; and (3) the magnitude of our non-interest earning assets, including non-accrual loans and other real estate loans.

The prime rate, which generally follows the federal funds rate and is the main driver for interest rate increases, was 7.25% at December 31, 2005. The FRB raised the targeted federal funds rate by 25 basis points in the first four meetings of 2006, and did not change the rate for the remainder of the year. This activity in the federal funds rate prompted the prime rate to increase 100 basis points in the first half 2006 and remain stable at 8.25% throughout the last half of 2006.

We have implemented an interest rate risk management strategy to maximize our net interest income while maintaining a relatively interest rate neutral position. This strategy is built around the elements of interest rate, asset duration and funding risks. We conduct ongoing analysis of our interest rate risk to ensure that we are not subject to undue risk from volatility in the movement of interest rates.

For the year ended December 31, 2006, operating results demonstrated growth over the same periods in 2005 and 2004 as the volume of loans increased. In addition to the organic growth of our loan portfolio, we acquired $118.8 million in gross loans through the Merger with Rancho Bank. Total deposits at December 31, 2006 totaled $1.8 billion, representing an increase of $530.1 million or 41.5% as compared to December 31, 2005. Of this increase in deposits, $198.2 million was attributable to deposits assumed through the merger with Rancho Bank. Because of the large increase in deposits, we were able to decrease our total borrowings by $39.4 million. This decrease in borrowings is mainly related to the $88.0 million decrease in FHLB borrowings, offset by a $30.0 million increase in other borrowings and an $18.6 million increase in junior subordinated debentures.

Total net revenue (defined as net interest income and non-interest income) for the year ended December 31, 2006 increased by $15.9 million or 21.8% to $88.7 million as compared with the same period in 2005. Total net revenue for the year ended December 31, 2005 increased by $14.4 million or 24.6% to $72.8 million as compared with the same period in 2004.

The quality of our loan portfolio remained strong, sustaining $0.3 million in net charge-offs or 0.02% of average loans in 2006 and $0.1 million in net charge-offs or 0.01% of average loans in 2005. The continued growth of our loan portfolio and the general risks associated with our loan portfolio necessitated an increase in our provision made to the allowance for loan losses in the amount of $4.1 million, $1.9 million and $4.9 million for the years ended December 31, 2006, 2005 and 2004, respectively. We also assumed $2.1 million in ALL relating to the Rancho Bank merger. The ALL was 1.0% of gross loans at December 31, 2006 and 2005 and the allowance for credit losses was 1.1% for the same periods. At December 31, 2006, 2005 and 2004, we had $16.7 million, $1.0 million, and $0 in non-performing loans, respectively. For each of the same period ends, we did not have any other real estate owned through foreclosure. At December 31, 2006, $14.4 million of our non-performing loan balance relates to land development loans on non-accrual status, the largest of which is $11.7 million. All of these loans represent two inter-related client relationships. Although subsequent events may further affect these loans, we currently believe these loans are well secured and we expect to collect all principal and non-default interest on the loans.

Net Interest Income

Our net interest income before our provision for loan losses, which is the main driver of our earnings, increased by $15.6 million or 23.1% to $83.1 million for the year ended December 31, 2006 as compared with the same period in 2005 and increased by $14.5 million or 27.4% to $67.5 million for the year ended December 31, 2005 as compared with the same period in 2004.

Total interest income for the years ended December 31, 2006, 2005 and 2004 was $158.3 million, $110.9 million and $75.1 million, respectively, while total interest expense was $75.2 million, $43.3 million and $22.1 million, respectively. Therefore, the net interest income was $83.1 million, $67.5 million and $53.0 million for each of the years ended December 31, 2006, 2005 and 2004, respectively, for a net interest margin of 4.38%, 4.47% and 4.72%, respectively.

During the year ended December 31, 2006, we experienced significant loan growth, as our average gross loan balance increased $422.3 million, which was attributable to loans acquired in the Rancho Bank merger and to organic loan growth. We also experienced a measured increase in the yield on our total interest-earning assets primarily due to the repricing of existing loans at higher interest rates as well as generation of new loans at higher interest rates than the same periods in 2005. Yields on our loan portfolio were 9.0%, 8.1% and 7.3% for the years ended December 31, 2006, 2005 and 2004, respectively. Although interest rates on loans have increased, our loan yield compressed during 2006 and 2005 primarily due to our strategy to diversify our loan portfolio. In 2006, we increased our production of commercial real estate and multifamily loans, which have a lower effective yield than our construction loan portfolio. During 2006, we had $0.8 million in unrecognized interest income as a result of our non-accrual loan balance, the majority of which is related to a single land development loan of $11.7 million.

Loan origination fees, net of loan origination costs, are deferred and amortized over the expected life of the loan. The amortized amount, combined with the interest income earned from the note rate, creates the effective loan yield for that period. Construction loans and commercial real estate loans generate the majority of loan origination fee income. The amortized loan fee income earned has increased while the percentage of such loan fees earned has decreased as a percentage of total interest and fees, due to the origination of longer duration assets, such as commercial real estate loans, whereby fees are amortized over a longer period. These increases in fees are a result of the strategy to diversify the loan portfolio.

For the year ended December 31, 2006, loan fee income represented $11.9 million of the $146.2 million in loan income, or 8.2% of total loan-related income. For the year ended December 31, 2005, loan fee income represented $11.2 million of the $98.3 million in loan income, or 11.4% of total loan-related income. For the year ended December 31, 2004, loan fee income was $9.6 million of the $66.4 million in total loan income, or 14.4% of total loan-related income.

Although a portion of our loan origination focus is shifting toward commercial real estate loans, we continue our emphasis in single-family luxury home construction loans, concentrating on California’s coastal communities in Los Angeles, Orange and San Diego counties and affluent communities in northern California including Marin and Santa Clara counties. The loan fees we generate from these construction loan products continue to generate greater loan yields relative to other loan types we offer. Construction loans generally have a duration of 12 to 18 months. As a result, construction loans generate higher yields than longer term loans because the loan fees are recognized over the shorter life of the construction loan compared to longer term loans.

Although the yield on investment securities increased slightly in 2006 and 2005, the majority of investment securities in our investment portfolio are fixed-rate, and thus the yield from these investments does not increase as the market rates increase. During 2006, we did not purchase any investment securities, and therefore, our average investment securities balance decreased by $42.3 million as a result of principal paydowns on the mortgage-backed securities in our investment portfolio.

As part of our strategy to maintain a strong net interest margin, we strive to obtain low-cost deposit accounts. During 2006, our demand deposit balance increased by $138.9 million. We assumed $85.7 million of demand deposit accounts in conjunction with the Rancho Bank merger, which accounts for a substantial portion of this increase. Time certificate of deposit accounts increased by $217.2 million, representing a significant portion of the $391.1 million increase in interest-bearing deposits we experienced during 2006.

As a result of our deposit growth in 2006, interest expense on deposits increased $29.9 million for the year ended December 31, 2006 as compared with the same period in 2005. Aggregate interest expense on deposits was $57.9 million, $28.0 million and $15.7 million for the years ended December 31, 2006, 2005 and 2004, respectively. As of December 31, 2006, our deposits were comprised of 16.3% of non-interest bearing deposits, 35.0% of money market, NOW and savings deposits, and 48.7% of time certificates of deposit, while the composition of deposits as of December 31, 2005 was 12.1%, 36.0% and 51.9%, respectively. For the year ended December 31, 2006, the total cost of deposits was 3.7% as compared with 2.6% for the same period in 2005. The increase in our cost of deposits corresponded mainly to the increase in interest rates, and the growth of our time certificate of deposit accounts, which had an effective cost of 4.7% in 2006 compared to 3.2% in 2005 and 2.5% in 2004.

Interest expense on borrowings was $17.4 million, $15.3 million and $6.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. Due to the considerable growth of interest-bearing deposits during 2006, we were able to notably decrease our high-cost borrowings. At December 31, 2006, FHLB advances totaled $126.0 million, representing a decrease of $88.0 million as compared to December 31, 2005. However, as market rates continued to increase, the effective cost of FHLB borrowings increased from 3.3% at December 31, 2005 to 4.7% at December 31, 2006.

During 2006, we utilized our secured and unsecured borrowing lines, increasing the average balance of other borrowings from $0.4 million for the year ended December 31, 2005 to $14.8 million for the same period in 2006. These balances correspond to effective costs of 6.3% and 7.5% for the same years, respectively. The cost of subordinated debt and junior subordinated debentures also increased from 6.7% and 6.4% respectively, for the year ended December 31, 2005 to 8.3% and 7.7%, respectively, for the year ended December 31, 2006.

Our consolidated cost of funds for the year ended December 31, 2006 was 4.1%, up from 3.0% for the year ended December 31, 2005.

The aforementioned changes in our interest-earning assets and interest-bearing liabilities, along with changes in the interest rates, resulted in a net interest margin of 4.4% for the year ended December 31, 2006. This margin represents a decrease from the 4.5% and 4.7% levels of the years ended December 31, 2005 and 2004, respectively. The shift is due to strategic changes in assets, from higher yielding loans to lower yielding loans for diversification purposes, and higher cost of funds, including borrowings utilized to fund the merger with Rancho Bank.

The following table presents the distribution of our average assets, liabilities, and stockholders’ equity in combination with the total dollar amounts of interest income from average interest earning assets and the resultant yields without giving effect for any tax exemption, and the dollar amounts of interest expense and average interest bearing liabilities, expressed both in dollars and rates. Loans include non-accrual loans where non-accrual interest is excluded.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Overview

Net income for the three and nine months ended September 30, 2007 was $5.5 million and $17.0 million, respectively, as compared to $4.7 million and $14.3 million for the same periods in 2006, respectively, representing increases of 17.6% and 19.1%, respectively. Our earnings during the three and nine months ended September 30, 2007 produced diluted earnings per share of $0.45 and $1.46, respectively, as compared to $0.40 and $1.31 for the same periods in 2006, respectively, representing increases of 12.5% and 11.5%, respectively. Prior period earnings per share amounts have been retroactively adjusted for the 5% stock dividend issued in June 2007.

Our earnings are derived predominately from net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. The net interest margin is calculated by dividing net interest income by the average interest-earning assets for the period. Net interest income and net interest margin are affected by several factors including (1) the level of, and the relationship between, the dollar amount of interest-earning assets and interest-bearing liabilities; (2) the relationship between repricing or maturity of our variable rate and fixed rate loans and securities, and our deposits and borrowings; and (3) the magnitude of our non-interest earning assets, including non-accrual loans and OREO.

The prime rate, which generally follows the federal funds rate and is the main driver for interest rate increases, was 8.25% at December 31, 2006. In the third quarter of 2007, the FRB decreased the targeted federal funds rate by 50 basis points to 4.75%, which led the prime rate to decrease to 7.75%.

For the three and nine months ended September 30, 2007, operating results demonstrated growth over the same period in 2006 as the volume of loans increased primarily due to organic growth. At September 30, 2007, total deposits were $1.9 billion representing an increase of $44.5 million from December 31, 2006. Total deposits at September 30, 2007 included $39.1 million in brokered money market and saving deposit accounts.

Our efficiency ratio, which is a measure of non-interest expense divided by net interest income before provision for loan losses plus non-interest income (collectively, “total net revenue”), improved from 59.9% to 58.8% for the three months ended September 30, 2006 and 2007, respectively, and improved slightly from 57.5% to 57.1% for the nine months ended September 30, 2006 and 2007, respectively. The improvement in our efficiency ratio resulted from non-recurring operating expenses in 2006 due to transitional expenses related to the Rancho Bank Merger. For the three months ended September 30, 2007, total net revenue increased by 10.9% and operating expenses increased by 8.9% as compared to the same period in 2006 which resulted in an improved efficiency ratio. For the nine months ended September 30, 2007, total net revenue increased by 14.2% and operating expenses increased by 13.5% as compared to the same period in 2006.

Net Interest Income

Total interest income for the three and nine months ended September 30, 2007 was $48.7 million and $141.3 million, respectively, and was $40.9 million and $113.5 million for the same periods in 2006, respectively. Total interest expense was $24.4 million and $71.1 million for the three and nine months ended September 30, 2007, respectively, and $19.7 million and $53.2 million for the same periods in 2006, respectively. Therefore, the net interest income was $24.3 million and $70.2 million for the three and nine months ended September 30, 2007, respectively, and $21.2 million and $60.3 million for the same periods in 2006, respectively.

For the three and nine months ended September 30, 2007, interest income from loans increased 20.3% and 26.8%, respectively, to $45.6 million and $132.4 million, respectively, compared to $37.9 million and $104.4 million, for the same periods in 2006, respectively. This increase was a result of the growth in our loan portfolio. During the nine months ended September 30, 2007, we increased luxury home construction loans by 12.2%, commercial construction loans by 21.7%, commercial and industrial loans by 20.9% and tract construction loans by 7.5%, offset by a 12.2% decrease in land loans. In addition, multifamily loans decreased by 56.0%, mainly as a result of transferring $93.3 million of multifamily loans to held-for-sale status during the quarter ended September 30, 2007. For the third quarter of 2007 and 2006, we had $0.6 million and $0.4 million, respectively, in unrecognized interest income related to non-performing loans.

We generated gross loan commitments of $0.9 billion during the nine months ended September 30, 2007, including $339.4 million of originations in luxury home construction loans, $143.2 million of originations in commercial real estate loans, $79.1 million of originations in commercial construction loans, $63.7 million of originations in SFR tract construction loans and $85.4 million of originations in commercial loans. In addition, we had $143.7 million in loans held-for-sale at September 30, 2007, which includes $48.0 million of commercial real estate loans and $93.3 million of multifamily loans. We transferred these commercial real estate and multifamily loans to held-for-sale status in September 2007, which we anticipate selling in the fourth quarter of 2007, for liquidity purposes and to increase profitability.

We monitor our loan portfolio composition on a monthly basis to manage risk while maximizing our loan yield. To that end, we are moving our focus from higher-risk SFR tract construction and land loans toward commercial real estate and commercial and industrial loans. In conjunction with our strategy to optimize our loan yield, management anticipates selling the loan pool described above, with a weighted average yield of 6.5% and reinvesting the proceeds into higher yielding loan products. We evaluate the current portfolio mix on a monthly basis as compared to the targeted portfolio mix as approved by the Board of Directors.

For the three months ended September 30, 2007 and 2006, loan fee income was $2.1 million and $2.7 million, respectively, representing 4.5% and 7.0%, respectively, of total interest and fees on loans. For the nine months ended September 30, 2007 and 2006, loan fee income was $6.8 million and $9.0 million, respectively, representing 5.2% and 8.6%, respectively of total interest and fees on loans. Our loan fees have decreased due to the origination of longer duration assets as part of the strategy to diversify the loan portfolio into such loans as commercial real estate loans, whereby fees are amortized over a longer period.

Loan origination fees for portfolio loans, net of loan origination costs, are deferred and amortized over the expected life of the loan. The amortized amount, combined with the interest income earned from the note rate, creates the effective loan yield for that period. Construction loans and commercial real estate loans generate the majority of loan origination fee income.

Interest income from investment securities totaled $3.1 million and $9.0 million for the three and nine months ended September 30, 2007, respectively, as compared to $3.0 million and $9.1 million for the same periods in 2006, respectively.

Interest expense on deposits totaled $19.0 million and $53.2 million for the three and nine months ended September 30, 2007, respectively as compared to $16.1 million and $40.1 million for the same periods in 2006, respectively, resulting in increases of 18.1% and 32.6% for the same periods, respectively. The increase in interest expense resulted from an increase in our average interest-bearing deposits and increased interest rates associated with our promotional time and money market deposit products. Average interest-bearing deposits increased from $1.4 billion and $1.3 billion for the three and nine months ended September 30, 2006, respectively to $1.6 billion and $1.5 billion for the same periods in 2007, respectively. We continue to offer promotional deposit products, generally consisting of time and money market products, to capture additional market share in each of our banking center geographic locations.

Interest expense on borrowings increased from $3.7 million and $13.0 million for the three and nine months ended September 30, 2006, respectively, to $5.4 million and $17.9 million for the same periods in 2007, respectively. This resulted from the increase in our average total borrowings during the three and nine months ended September 30, 2007 by $140.7 million and $96.5 million, respectively, as compared to the same periods in 2006.

Net Interest Margin

For the nine months ended September 30, 2007, loan growth exceeded deposit growth, causing us to increase our use of higher-cost borrowings, such as FHLB advances. In addition, we made use of $39.1 million in brokered deposits as we believed this to be an efficient and cost-effective source of funds to augment organic low-cost deposit origination to fund our loan growth. We will continue to focus on obtaining low cost core deposits to support the growth of the loan portfolio and to reduce our borrowings, and will continue to adjust and refine our asset/liability management strategy to minimize interest rate risk and maximize our net interest income.

The yield on our total interest-earning assets was 8.35% and 8.36% for the three months ended September 30, 2006 and 2007, respectively and was 8.27% and 8.36% for the nine months ended September 30, 2006 and 2007, respectively.

Our average loan balance continues to increase as a percentage of average interest-earning assets and was 89.6% and 89.3% of total average interest-earning assets for the three and nine months ended September 30, 2007, respectively, as compared to 86.4% and 85.3% of total average interest-earning assets for the same periods in 2006, respectively. The yield on our loans was 9.0% and 8.7% for the three months ended September 30, 2006 and 2007, respectively, and was 8.9% and 8.8% for the nine months ended September 30, 2006 and 2007, respectively. The yield on loans began declining in mid-2006 due to compression in construction yields resulting from higher competition in this product, as well as changes in the loan portfolio mix and lost interest income on non-accrual loans.

The majority of investment securities are fixed-rate, and thus the yield from investments only changes slightly from slower premium amortization as the market rates increase and as the estimated life of the investments are adjusted.

The cost of interest-bearing liabilities increased from 4.8% and 4.5% for the three and nine months ended September 30, 2006, respectively, to 5.0% for the three and nine months ended September 30, 2007, as we have increased our deposit rates in the midst of a highly competitive market for deposits. As a result of our promotional rate offerings, average interest-bearing deposits have increased from $1.4 billion and $1.3 billion for the three and nine months ended September 30, 2006 to $1.6 billion and $1.5 billion for the three and nine months ended September 30, 2007. In addition, the cost of interest-bearing liabilities increased due to higher borrowing costs and higher reliance on borrowings. We are increasing our focus and efforts on providing deposit growth through our existing community banking network, developing our commercial and business banking initiatives, as well as increasing strategic recruitment of personnel in both of these areas.

The average interest cost on FHLB advances increased from 4.8% and 4.7% for the three and nine months ended September 30, 2006, respectively, to 4.9% and 5.0% for the three and nine months ended September 30, 2007, respectively, as interest rates were higher during 2007 as compared to the same periods in 2006. In addition, in 2007 we have relied more heavily on high-cost overnight FHLB borrowings to supplement deposit generation, thereby increasing our cost of borrowings.

The cost of subordinated debt changed from 8.7% and 8.3% for the three and nine months ended September 30, 2006, respectively, to 8.6% and 8.7%, for the three and nine months ended September 30, 2007, respectively. The cost of junior subordinated debentures remained stable for the three months ended September 30, 2007 as compared to the same period in 2006, while increasing by approximately 30 basis points from the nine months ended September 30, 2006 to the same period in 2007. The increases in the cost of subordinated debt and junior subordinated debentures for the year-to-date 2007 are a result of the higher interest rates in 2007, as these debt securities bear variable interest rates indexed to LIBOR that adjust on a quarterly basis.

The aforementioned changes in our interest-earning assets and interest-bearing liabilities, along with rising interest rates, resulted in a net interest margin of 4.19% and 4.17% for the three and nine months ended September 30, 2007, respectively. The margin decreased from the 4.32% and 4.40% levels for the three and nine months ended September 30, 2006, respectively.

The following tables present the distribution of our average assets, liabilities and stockholders’ equity in combination with the total dollar amounts of interest income from average interest-earning assets and the resultant yields without giving effect for any tax exemption, and the dollar amounts of interest expense and average interest-bearing liabilities, expressed both in dollars and rates for the three and nine months ended September 30, 2007 and 2006. Loans include non-accrual loans where non-accrual interest is excluded.

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