10-Q 1 form10q033108.htm FORM 10-Q 3/31/08 form10q033108.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
_____________________________________________

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008

or

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

Commission File No. 0-20862

VINEYARD NATIONAL BANCORP
(Exact Name of Registrant as Specified in its Charter)
 
 
California
(State or other jurisdiction of incorporation or organization)
 
 
33-0309110
(IRS employer identification number)
 
1260 Corona Pointe Court, Corona, CA
(Address of principal executive offices)
 
92879
(Zip Code)
 
 

Registrant's telephone number, including area code: (951) 271-4232

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
                                                                                                                  Yes [x] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ]                                                                                                Accelerated filer [x]

Non-accelerated filer [ ]                                                                                                  Smaller reporting company [ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                                                                                                Yes [ ] No [x]
 
10,220,465 shares of Common Stock of the registrant were outstanding at April 21, 2008.
 
 

 
VINEYARD NATIONAL BANCORP AND SUBSIDIARIES
FORM 10-Q INDEX
FOR THE PERIODS ENDED MARCH 31, 2008 AND 2007,
AND DECEMBER 31, 2007


   
     
ITEM 1.
 
     
 
4
     
 
5
     
 
6
     
 
8
     
 
10
     
ITEM 2.
20
     
ITEM 3.
44
     
ITEM 4.
45
     
 
PART II – OTHER INFORMATION
 
     
ITEM 1.
45
     
ITEM 1A.
46
     
ITEM 2.
46
     
ITEM 3.
46
     
ITEM 4.
46
     
ITEM 5.
47
     
ITEM 6.
47
     
 
48
     
Exhibits
   
     


 
Forward-looking statements

Certain matters discussed in this Quarterly Report on Form 10-Q may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and as such, may involve risks and uncertainties.  These forward-looking statements relate to, among other things, expectations of the environment in which we operate and projections of future performance including future earnings and financial condition. Our actual results, performance, or achievements may differ significantly from the results, performance, or achievements expected or implied in such forward-looking statements.  For a discussion of some of the factors that might cause such differences, see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on May 19, 2008. We do not undertake, and specifically disclaim any obligation, to update any forward looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.

 
PART I

VINEYARD NATIONAL BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2008 AND DECEMBER 31, 2007
(unaudited)

(Dollars in thousands)
 
March 31, 2008
   
December 31, 2007
 
             
ASSETS
           
Cash and cash equivalents
  $ 35,452     $ 83,537  
Investment securities
    138,572       177,321  
Loans held-for-sale
    103,061       119,427  
Loans, net of unearned income
    1,978,524       2,008,071  
Less:  Allowance for loan losses
    (48,222 )     (48,849 )
Net Loans
    1,930,302       1,959,222  
Bank premises and equipment, net
    17,950       18,326  
Accrued interest
    11,077       11,834  
Other real estate owned
    12,642       17,375  
Federal Home Loan Bank ("FHLB") and other stock, at cost
    19,846       25,066  
Deferred income tax asset
    27,346       28,357  
Goodwill and other intangibles
    4,501       4,637  
Other assets
    57,197       38,177  
TOTAL ASSETS
  $ 2,357,946     $ 2,483,279  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Liabilities
               
Deposits
               
Non-interest bearing
  $ 302,886     $ 316,905  
Interest-bearing
    1,495,972       1,618,747  
Total Deposits
    1,798,858       1,935,652  
                 
Exchange balances
    18,135       47,515  
FHLB advances
    227,000       175,000  
Other borrowings
    54,300       45,250  
Subordinated debentures
    5,000       5,000  
Junior subordinated debentures
    115,470       115,470  
Accrued interest and other liabilities
    42,942       46,367  
TOTAL LIABILITIES
    2,261,705       2,370,254  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
Stockholders' Equity
               
Contributed capital
               
Perpetual preferred stock - authorized 10,000,000 shares
               
Series C - no par value, issued and outstanding 10,000
               
shares in 2008 and 2007
    9,665       9,665  
Series D - no par value, issued and outstanding 2,300,000
               
shares in 2008 and 2007
    21,950       21,950  
Common stock - no par value, authorized 50,000,000 shares;
               
issued and outstanding 9,884,441 and 10,285,775 shares
               
in 2008 and 2007, respectively
    89,474       92,772  
Additional paid-in capital
    1,399       1,727  
Accumulated deficit
    (20,085 )     (5,372 )
Unallocated Employee Stock Ownership Plan ("ESOP") shares
    (5,009 )     (5,168 )
Accumulated other comprehensive loss, net of income taxes
    (1,153 )     (2,549 )
TOTAL STOCKHOLDERS' EQUITY
    96,241       113,025  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 2,357,946     $ 2,483,279  
                 
See accompanying notes to consolidated financial statements.
               
 
 
 
VINEYARD NATIONAL BANCORP AND SUBSIDIARIES
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(unaudited)

(Dollars in thousands, except per share amounts)
 
Three Months Ended March 31,
 
   
2008
   
2007
 
Interest Income
           
Interest and fees on loans
  $ 40,473     $ 42,211  
Interest on investment securities
    1,679       2,938  
TOTAL INTEREST INCOME
    42,152       45,149  
                 
Interest Expense
               
Interest on savings deposits (1)
    5,594       6,539  
Interest on time deposits in denominations of $100,000 or more
    7,170       6,393  
Interest on other time deposits
    4,343       4,141  
Interest on FHLB advances and other borrowings
    5,163       5,583  
TOTAL INTEREST EXPENSE
    22,270       22,656  
NET INTEREST INCOME
    19,882       22,493  
                 
Provision for Loan Losses
    (26,900 )     (1,200 )
                 
NET INTEREST (LOSS)/INCOME AFTER
               
PROVISION FOR LOAN LOSSES
    (7,018 )     21,293  
                 
Other Income
               
Fees and service charges
    348       483  
Gain on sale of SBA loans and SBA broker fee income
    170       600  
Loss on sale of securities and other loans
    (131 )     -  
Other income
    74       119  
TOTAL OTHER INCOME
    461       1,202  
                 
Other Expense
               
Salaries and employee benefits
    8,389       7,594  
Occupancy expense of premises
    1,501       1,379  
Furniture and equipment
    1,203       1,079  
Professional services
    3,040       647  
Office supplies, postage and telephone
    541       627  
Business development
    583       566  
Loan related
    582       213  
Write down of assets
    3,868       -  
Other
    1,468       1,022  
TOTAL OTHER EXPENSES
    21,175       13,127  
(LOSS)/INCOME BEFORE INCOME TAXES
    (27,732 )     9,368  
INCOME TAX (BENEFIT)/PROVISION
    (14,480 )     3,859  
NET (LOSS)/INCOME
  $ (13,252 )   $ 5,509  
                 
(LOSS)/EARNINGS PER SHARE (2)
               
BASIC
  $ (1.43 )   $ 0.49  
DILUTED (3)
  $ (1.43 )   $ 0.48  
                 
CASH DIVIDENDS DECLARED PER SHARE (2)
  $ 0.08     $ 0.08  
CASH DIVIDENDS PAID PER SHARE (2)
  $ 0.08     $ 0.08  
                 
See accompanying notes to consolidated financial statements.
               
_________________________________
(1)  
Includes savings, NOW, and money market deposit accounts.
(2)  
Per share amounts have been retroactively adjusted to reflect the 5% stock dividend issued in June 2007.
 (3)   In a loss scenario, diluted EPS equals basic EPS.
 
 
VINEYARD NATIONAL BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(unaudited)


(Dollars in thousands)
                                           
Accumulated
       
   
Perpetual
   
Common Stock
   
Additional
                     
Other
       
   
Preferred
   
Number of
         
Paid-in
   
Comprehensive
   
Retained
   
Unallocated
   
Comprehensive
       
   
Stock
   
Shares
   
Amount
   
Capital
   
Income
   
Earnings
   
ESOP
   
Loss
   
Total
 
Balance at December 31, 2006
  $ 9,665       10,939,310     $ 88,819     $ 2,149           $ 52,105     $ (5,765 )   $ (3,913 )   $ 143,060  
                                                                       
Restricted shares surrendered to Vineyard
                                                                     
    National Bancorp (“Company”)
            (3,446 )     (83 )                                           (83 )
Transfer of unissued common stock to
                                                                     
restricted stock
                    1,326       (1,326 )                                   -  
Purchase of restricted stock
            (36,750 )             (858 )                                   (858 )
Vesting of restricted stock
            17,944                                                     -  
Amortization of restricted stock
                            171                                     171  
Share-based compensation expense
                            24                                     24  
Release of ESOP shares
                            (5 )                   136               131  
Cash dividends declared on
                                                                     
preferred stock
                                          (229 )                     (229 )
Cash dividends declared on
                                                                     
common stock
                                          (851 )                     (851 )
Comprehensive income
                                                                     
Net Income
                                  $ 5,509       5,509                       5,509  
Unrealized security holding
                                                                       
gain (net of $314
                                                                       
tax provision)
                                    433                       433       433  
Total comprehensive income
                                  $ 5,942                                  
Balance at March 31, 2007
  $ 9,665       10,917,058     $ 90,062     $ 155             $ 56,534     $ (5,629 )   $ (3,480 )   $ 147,307  

             (continued)
 
 
VINEYARD NATIONAL BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME / (LOSS)
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
 (unaudited)
 (continued)

(Dollars in thousands)
                                           
Accumulated
       
   
Perpetual
   
Common Stock
   
Additional
                     
Other
       
   
Preferred
   
Number of
         
Paid-in
   
Comprehensive
   
Accumulated
   
Unallocated
   
Comprehensive
       
   
Stock
   
Shares
   
Amount
   
Capital
   
Loss
   
Deficit
   
ESOP
   
Loss
   
Total
 
Balance at December 31, 2007
  $ 31,615       10,285,775     $ 92,772     $ 1,727           $ (5,372 )   $ (5,168 )   $ (2,549 )   $ 113,025  
                                                                       
Exercise of stock options
            26,763       104                                             104  
Restricted shares surrendered to the Company
            (7,039 )     (63 )                                           (63 )
Purchase of common stock
            (383,500 )     (3,339 )                                           (3,339 )
Purchase of restricted stock
            (59,292 )             (458 )                                   (458 )
Vesting of restricted stock
            21,734                                                     -  
Amortization of restricted stock
                            387                                     387  
Reversal of share-based compensation expense
                            (176 )                                   (176 )
Release of ESOP shares
                            (81 )                   159               78  
Cash dividends declared on preferred
                                                                     
stock
                                          (644 )                     (644 )
Cash dividends declared on common
                                                                     
stock
                                          (817 )                     (817 )
Comprehensive loss
                                                                     
Net Loss
                                  $ (13,252 )     (13,252 )                     (13,252 )
Unrealized security holding
                                                                       
losses (net of $1,012
                                                                       
tax provision)
                                    1,396                       1,396       1,396  
Total comprehensive loss
                                  $ (11,856 )                                
Balance at March 31, 2008
  $ 31,615       9,884,441     $ 89,474     $ 1,399             $ (20,085 )   $ (5,009 )   $ (1,153 )   $ 96,241  
                                                                         
See accompanying notes to consolidated financial statements.
                                                         


 
VINEYARD NATIONAL BANCORP AND SUBSIDIARIES
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(unaudited)

(Dollars in thousands)
 
Three Months Ended March 31,
 
   
2008
   
2007
 
Cash Flows From Operating Activities
           
Net (Loss) / Income
  $ (13,252 )   $ 5,509  
Adjustments to Reconcile Net (Loss) / Income
               
to Net Cash (Used in) / Provided by Operating Activities
               
                 
Depreciation and amortization
    1,432       1,479  
FHLB stock dividends
    (227 )     (116 )
(Reversal) / recognition of share-based compensation
    (239 )     24  
Provision for credit losses
    26,676       800  
Release of ESOP shares
    78       131  
(Increase) / decrease in deferred tax assets
    (1 )     102  
Gain on sale of loans
    (27 )     (139 )
Gain on sale of investments
    (12 )     -  
Write-down of assets
    3,868       -  
Changes in assets and liabilities
               
Increase in other assets
    (4,047 )     (647 )
(Increase) / decrease in net taxes payable
    (14,311 )     3,859  
Increase in unearned loan fees
    (550 )     (482 )
Decrease / (increase) in interest receivable
    757       (185 )
(Decrease) / increase in interest payable
    (346 )     145  
(Decrease) / increase in accrued expense and other liabilities
    (2,840 )     1,367  
Origination and purchase of held-for-sale loans,
               
net of principal payments
    -       (7,183 )
Total Adjustment
    10,211       (845 )
Net Cash (Used In) / Provided By Operating Activities
    (3,041 )     4,664  
                 
Cash Flows From Investing Activities
               
Proceeds from sales of mortgage-backed
               
securities available-for-sale
    36,528       -  
Proceeds from principal reductions and maturities of
               
mortgage-backed securities available-for-sale
    3,993       6,464  
Purchase of FHLB and other stock
    (1,366 )     (4,257 )
Redemption of FHLB stock
    6,813       -  
Origination and purchase of loans, net of principal payments
    (3,061 )     (95,229 )
Proceeds from sale of loans
    22,889       8,455  
Proceeds from sale of property, plant, and equipment
    16       -  
Capital expenditures
    (563 )     (195 )
Net Cash Provided By / (Used In) Investing Activities
  $ 65,249     $ (84,762 )

                                                                                                                               (continued)

 
VINEYARD NATIONAL BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(unaudited)
(continued)

(Dollars in thousands)
           
   
2008
   
2007
 
Cash Flows From Financing Activities
           
Net decrease in non-interest bearing deposits
  $ (14,019 )   $ (5,051 )
Net decrease in interest-bearing deposits
    (122,775 )     (33,630 )
Decrease in exchange balances
    (29,380 )     -  
Net increase in FHLB advances
    52,000       118,000  
Increase in other borrowings
    9,050       5,400  
Purchase of common stock
    (3,339 )     (83 )
Purchase of restricted stock
    (458 )     (858 )
Dividends paid on preferred stock
    (664 )     (234 )
Dividends paid on common stock
    (812 )     (851 )
Proceeds from exercise of stock options
    104       -  
Net Cash (Used In) / Provided By Financing Activities
    (110,293 )     82,693  
                 
Net (Decrease) / Increase in Cash and Cash Equivalents
    (48,085 )     2,595  
                 
Cash and Cash Equivalents, Beginning of year
    83,537       35,129  
                 
Cash and Cash Equivalents, End of period
  $ 35,452     $ 37,724  
                 
Supplementary Information
               
Cash paid during period for:
               
Interest
  $ 22,616     $ 22,511  
Other non-cash items:
               
Charge-offs in loan portfolio
  $ 27,838     $ 77  
Net change in unrealized loss on investment securities
  $ (2,408 )   $ (747 )
                 
See accompanying notes to consolidated financial statements.
               

 
VINEYARD NATIONAL BANCORP AND SUBSIDIARIES

Note #1 – Nature of Business and Summary of Significant Accounting Policies

Nature of Operations

Vineyard National Bancorp (referred to herein on an unconsolidated basis as “VNB” and on a consolidated basis 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 in Corona, California which is located in the Inland Empire region of Southern California.  The Bank operates sixteen full-service banking centers within Los Angeles, Marin, Orange, Riverside, San Bernardino and San Diego counties of California, as well as four regional financial centers (“RFCs”) in Los Altos, Westlake Village, Orange and Sherman Oaks, California, which are located in Santa Clara, Ventura, Orange and Los Angeles counties of California, respectively. RFCs are offices that operate principally with loan and/or deposit gathering functions.  The Bank is our principal asset.  In addition to the Bank, VNB has two consolidated operating subsidiaries, 1031 Exchange Advantage, Inc. and 1031 Funding & Reverse Corp. (collectively, the “Exchange Companies”), which act as qualified intermediaries under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Code”). VNB also has ten unconsolidated statutory business trust subsidiaries, 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”), which were created to raise capital through the issuance of trust preferred securities.

We are dedicated to relationship banking and the success of our customers.  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, individuals, and other private and public organizations.

Basis of Presentation

Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the banking industry.  In our opinion, our unaudited Consolidated Financial Statements contain all normal recurring and non-recurring adjustments necessary to present fairly our Consolidated Financial Position at March 31, 2008 and December 31, 2007, the results of operations for each of the three months ended March 31, 2008 and 2007, and changes in stockholders’ equity and comprehensive income/(loss) and results of cash flows for each of the three months ended March 31, 2008 and 2007.

Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. The unaudited Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q and Article 10-01 of Regulation S-X as promulgated by the Securities Exchange Commission (“SEC”). The unaudited interim Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes included in our Annual Report on Form 10-K for the year ended December 31, 2007 (“2007 Form 10-K”).  Our results of operations for the three months ended March 31, 2008 and 2007 may not necessarily be indicative of the operating results for the full year.

Significant Accounting and Reporting Policies

The following significant accounting and reporting policies are consistent with our accounting and reporting policies included in our 2007 Form 10-K. Our significant accounting and reporting policies are described in more detail in Item 8. Financial Statements and Supplementary Data; Note #1 – Summary of Significant Accounting Policies in our 2007 Form 10-K.

Principles of Consolidation

The Consolidated Financial Statements include accounts of VNB, the Bank and the Exchange Companies.  Inter-company balances and transactions have been eliminated in consolidation.

Use of Estimates

 
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results could differ from those estimates.

Estimates that are particularly susceptible to significant changes relate to the determination of the allowance for losses on loans, the determination of non-performing and criticized loans, and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans.

We use available information to recognize probable losses on loans and other real estate owned (“OREO”), however future additions to these allowances may be necessary based on changes in local economic conditions.  In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowances for losses on loans and valuation of OREO.  Such agencies may require us to recognize additions to the allowances based on their judgments about information available to them at the time of their examination.  Because of these factors, it is reasonably possible that the allowances for losses on loans and valuation of OREO may change.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash, due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.

Investment Securities

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS No. 115”), which addresses the accounting for investments in equity securities that have readily determinable fair values and for investments in all debt securities, securities are classified in three categories and accounted for as follows: debt securities that we have the intent and ability to hold to maturity are classified as held-to-maturity and are measured at amortized cost; debt and equity securities bought and held principally for the purpose of selling in the near term are classified as trading securities and are measured at fair value, with unrealized gains and losses included in earnings; and debt and equity securities deemed as available-for-sale are measured at fair value, with unrealized gains and losses reported in a separate component of stockholders’ equity.  Gains or losses on sales of investment securities are determined on the specific identification method.  Premiums and discounts on investment securities are amortized or accreted using the interest method over the expected lives of the related securities.

Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are other-than-temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses.  In estimating other-than-temporary impairment losses, management considers i) the length of time and the extent to which the market value has been less than cost; ii) the financial condition and near-term prospects of the issuer; iii) our intent and ability to retain our investment in a security for a period of time sufficient to allow for any anticipated recovery in market value; and iv) general market conditions which reflect prospects for the economy as a whole, including interest rates and sector credit spreads.

Other Real Estate Owned
 
OREO, which represents real estate acquired through foreclosure, is originally recorded at fair value less associated selling costs of the related real estate. Thereafter, OREO is carried at the lower of this new cost basis or the estimated fair value less estimated selling costs of the related real estate. Loan balances in excess of the fair value of the real estate acquired at the date of acquisition are charged against the allowance for loan losses. Expenses of operating or holding the property are expensed as incurred and included in other non-interest expense. Subsequent declines in the fair value of OREO below the new cost basis will be recorded through the use of a valuation allowance by charges to other expense. In connection with the determination of the foreclosed real estate value, management obtains independent appraisals for significant properties.  We had $12.6 million and $17.4 million in OREO on our Consolidated Balance Sheets at March 31, 2008 and December 31, 2007, respectively.  We recorded $3.7 million of other expense related to declines in the fair value of OREO held during the three months ended March 31, 2008.

Loans Held for Sale

Loans held for sale in the secondary market are carried at the lower of cost or estimated market value. At the time of transfer from loans held-for-investment to loans held-for-sale, any write-down in the loan’s cost basis attributable to its credit quality is reflected with a corresponding decrease in the allowance for loan losses (“ALL”).  Net unrealized losses due to changes in market rates are recognized through a valuation allowance by charges to income.  Gains or losses on the sales are recognized at the time of sale and are determined by the difference between the net proceeds and the carrying value of the loans sold. Net gains and losses on sales of loans are included in non-interest income.

 
Allowance for Credit Losses

The ALL and the reserve for unfunded commitments, when combined, are referred to as the allowance for credit losses.

The ALL is maintained at a level which, in our judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the ALL is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans and economic conditions.  The ALL is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries.

The reserve for unfunded commitments is increased by the provision for unfunded commitments, and is calculated based on the level of the undisbursed loan portfolio and letters of credit.  The reserve for unfunded commitments is included in other liabilities on our Consolidated Balance Sheets, and the provision for unfunded commitments is included in other non-interest expense on our Consolidated Statements of Operations.

Loans are charged off in whole or in part when the obligation is considered uncollectible or when its carrying value has decreased significantly in value.

Reclassifications

Certain reclassifications have been made to the 2007 financial statements to conform to the 2008 presentation.


Note #2 – Recently Issued Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurement,” (“SFAS No. 157”) a statement that provides enhanced guidance for using fair value to measure assets and liabilities. The statement also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The statement applies whenever other statements require (or permit) assets or liabilities to be measured at fair value. Under the statement, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. The statement clarifies that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, for example, the reporting entity’s own data.  Under the statement, fair value measurements would be separately disclosed by level within the fair value hierarchy.  We adopted SFAS No. 157 on January 1, 2008 which did not have a material impact on our financial condition or operating results. See Note #8 Fair Value Disclosure for fair value disclosures and further discussion.

In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value.  This statement requires companies to display on the face of the balance sheet the fair value of those assets and liabilities for which they have chosen to use fair value.  This statement also requires companies to provide additional information that will help investors and other users of financial statements to easily understand the effect on earnings of a company’s choice to use fair value.  SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities.  We adopted this statement as of our fiscal year beginning January 1, 2008 and we chose not to take the fair value option on any of our existing qualified financial assets or liabilities on the date of adoption nor any new qualified assets originated or liabilities generated subsequent to the adoption date.  Therefore, the adoption of SFAS No. 159 did not have a material impact on our financial condition or operating results.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” which is a revision to SFAS No. 141. The provisions of this statement establish principles in which the acquirer in a business combination is required to recognize and measure in its financial statements all identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. As such, contingent consideration will need to be recognized based on estimated fair value at the date of acquisition.  In addition, the costs related to the acquisition are to be recognized separately from the acquisition rather than allocated to the individual assets and liabilities. Also, if applicable, where the fair value of the assets acquired exceeded the acquisition cost, the excess asset value will be recognized as income. This statement makes significant amendments to other statements and other authoritative guidance. The provisions of this statement apply prospectively to business combinations with acquisition dates on or after January 1, 2009.

 
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”. This statement amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements”. This statement clarifies that a noncontrolling interest (minority interest) in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Sufficient disclosure should be provided to identify and distinguish between the interests of the parent and the interest on the noncontrolling owners. This statement also establishes that purchases or sales of equity securities that do not result in a change in control will be accounted for as equity transactions. Upon loss of control, the interest sold, as well any interest retained will be measured at fair value with any gain or loss recognized in earnings. This statement will be effective as of our fiscal year beginning January 1, 2009.


Note #3 - Share-Based Compensation

Stock Option Awards

Under the modified prospective transition method adopted under SFAS No. 123(R) “Share Based Payment” (“SFAS No. 123(R)”) and the SEC Staff Accounting Bulletin No. 107 (“SAB No. 107”), we are required to record share-based compensation expense for all awards granted after the adoption date and for the unvested portion of previously granted awards outstanding on the adoption date. Compensation cost related to the unvested portion of previously granted awards is based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123. Compensation cost for awards granted after the adoption date is based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R).

Under the provisions of SFAS No. 123(R), we recognize share-based compensation costs relating to stock option awards over the requisite service period of the award, which is generally the option vesting term.  We measure the fair value of the award as of the award’s grant date using the Black Scholes option pricing model. Expected volatility is based on the historical volatility of our common stock. We also use historical data to estimate stock option exercise and forfeiture rates within our valuation model. The expected life of the options granted is derived from the award’s vesting period and the award recipient’s exercise history, if applicable, and represents the period of time that we expect the options to be outstanding.  The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury strip rate at the time of the grant.

We did not grant any stock options during the three months ended March 31, 2008. During the three months ended March 31, 2007, we granted 52,500 stock option awards, as adjusted for the 5% stock dividend issued in June 2007, to our former President and Chief Executive Officer, in accordance with the terms of his employment contract.  The assumptions relating to the stock option grant occurring in the three months ended March 31, 2007 were as follows:

   
Three months ended
 
   
March 31, 2007
 
Dividend yield
    1.42 %
Expected life (in years)
    3.25  
Expected volatility
    27.14 %
Risk-free rate
    4.48 %
Weighted average fair value of options granted
  $ 4.79  

On January 23, 2008, Norman A. Morales agreed to resign as a director and his employment as President and Chief Executive Officer of VNB and the Bank was terminated.  Upon his termination of employment, the 105,000 outstanding, unvested stock options he held were forfeited. Therefore, during the first quarter of 2008, we reversed all compensation expense associated with these forfeited awards.

A summary of stock option activity during the three months ended March 31, 2008 and 2007 is presented below:
 

 
(Dollars in thousands, except per share)
             
Weighted-
       
         
Weighted-
   
Average
       
         
Average
   
Remaining
   
Aggregate
 
         
Exercise
   
Contractual
   
Intrinsic
 
   
Shares
   
Price
   
Term
   
Value
 
Outstanding at December 31, 2007
    390,850     $ 8.60    
3.89 years
    $ -  
Granted
    -       -       -       -  
Exercised
    (26,763 )     3.89       -       -  
Forfeited or expired
    (105,000 )     21.25       -       -  
Outstanding at March 31, 2008
    259,087     $ 3.97    
3.92 years
    $ 1,075  
Exercisable at March 31, 2008
    259,087     $ 3.97    
3.92 years
    $ 1,075  


(Dollars in thousands, except per share)
             
Weighted-
       
         
Weighted-
   
Average
       
         
Average
   
Remaining
   
Aggregate
 
         
Exercise
   
Contractual
   
Intrinsic
 
   
Shares
   
Price
   
Term
   
Value
 
Outstanding at December 31, 2006
    388,579     $ 6.19    
5.03 years
    $ -  
Granted
    52,500       21.44       -       -  
Exercised
    -       -       -       -  
Forfeited or expired
    -       -       -       -  
Outstanding at March 31, 2007
    441,079     $ 8.01    
4.68 years
    $ 6,146  
Exercisable at March 31, 2007
    336,079     $ 3.87    
4.96 years
    $ 6,075  

As of March 31, 2008, there were no unvested stock options outstanding.  A summary of the status of our non-vested stock options as of December 31, 2007 and changes during the three months ended March 31, 2008 is presented below:

         
Weighted-
 
         
Average
 
   
Non-vested
   
Grant-Date
 
   
Shares
   
Fair Value
 
Nonvested at December 31, 2007
    105,000     $ 4.78  
Granted
    -       -  
Vested
    -       -  
Forfeited or expired
    (105,000 )     4.78  
Nonvested at March 31, 2008
    -     $ -  

A summary of the status of our non-vested stock options as of December 31, 2006 and changes during the three months ended March 31, 2007 is presented below:

         
Weighted-
 
         
Average
 
   
Non-vested
   
Grant-Date
 
   
Shares
   
Fair Value
 
Nonvested at December 31, 2006
    52,500     $ 4.76  
Granted
    52,500       4.79  
Vested
    -       -  
Forfeited or expired
    -       -  
Nonvested at March 31, 2007
    105,000     $ 4.78  

Restricted Share Awards

We grant restricted share awards periodically to employees and directors.  Restricted shares generally cliff vest after four years of service.  Recipients of restricted shares have the right to vote all shares subject to such grant, and receive all dividends with respect to such shares, whether or not the shares have vested.  Recipients do not pay any cash consideration for the shares.  We recorded compensation expense relating to restricted share awards, which amounted to $0.4 million and $0.2 million for the three months ended March 31, 2008 and 2007, respectively.  As of March 31, 2008, we had $4.6 million of non-vested restricted share awards, with a weighted average life to vest of 2.7 years, which are included in “additional paid-in capital” in stockholders’ equity.

 
A summary of the status of our restricted stock outstanding and the changes during the three months ended March 31, 2008 is presented in the table below:

         
Weighted- Average
 
   
Restricted Shares
   
Fair Value
 
Outstanding at December 31, 2007
    298,466     $ 23.72  
Granted
    66,925       7.27  
Forfeited
    (7,633 )     9.19  
Vested
    (21,734 )     21.40  
Outstanding at March 31, 2008
    336,024     $ 20.93  


Note #4 – Dividends

On February 5, 2008, our Board of Directors declared a quarterly cash dividend of $0.08 per common share, which was paid on March 14, 2008 to shareholders of record on February 29, 2008. The Board of Directors similarly declared and paid a $0.08 per common share cash dividend during the three months ended March 31, 2007.

On February 20, 2008, our Board of Directors declared a $0.2 million cash dividend on our Floating Rate Series C Noncumulative Redeemable Perpetual Preferred Stock (“Series C Preferred Stock”) to be paid on April 1, 2008 to shareholders of record on March 15, 2008. A $0.2 million preferred stock cash dividend was similarly declared during the three months ended March 31, 2007.

On February 20, 2008, our Board of Directors declared a $0.4 million cash dividend on our 7.5% Series D Noncumulative Preferred Stock (“Series D Preferred Stock”) which was paid on March 17, 2008 to shareholders of record on March 3, 2008.

Our ability to pay cash dividends is limited by California law.  With certain exceptions, a California corporation may not pay a dividend to its shareholders unless (i) its retained earnings equal at least the amount of the proposed dividend, or (ii) after giving effect to the dividend, the corporation’s assets would equal at least 1.25 times its liabilities and, for corporations with classified balance sheets, the current assets of the corporation would be at least equal to its current liabilities or, if the average of the earnings of the corporation before taxes on income and before interest expense for the two preceding fiscal years was less than the average of the interest expense of the corporation for those fiscal years, at least equal to 1.25 times its current liabilities.

At March 31, 2008, we had an accumulated deficit of $20.1 million and did not otherwise satisfy the minimum asset to liability ratios for paying dividends under California law.  As a result, we are legally prohibited from paying dividends on both our common stock and preferred stock.

The banking agencies have the authority to prohibit VNB from paying dividends, depending upon the Bank’s financial condition, if such payment is deemed to constitute an unsafe or unsound practice or based on the Federal Reserve Bank ("FRB") requirement that VNB must act as a source of financial and managerial strength to the Bank.  In this regard, the FRB has advised VNB that in light of VNB’s obligation to serve as a source of financial and managerial strength to the Bank, VNB may not make payments to third parties, including dividend payments to the holders of its common stock and preferred stock, without prior FRB approval.  Furthermore, under the federal Prompt Corrective Action regulations, the banking agencies may prohibit VNB from paying any dividends if the Bank is classified as “undercapitalized.”


Note #5 – Commitments and Contingencies

Financial Instruments with Off-Balance Sheet Risk

In the normal course of business, we are a party to financial instruments with off-balance sheet risk.  These financial instruments include commitments to extend credit and letters of credit.  To varying degrees, these instruments involve elements of credit and interest rate risk in excess of the amount recognized in our Consolidated Financial Statements.  Our exposure to credit loss in the event of non-performance by the other party to the financial instruments for undisbursed loan funds and letters of credit is represented by the contractual amount of those instruments.

 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  We evaluate each customer's creditworthiness on a case-by-case basis.  The amount of collateral which we obtain, if deemed necessary upon extension of credit, is based on our credit evaluation.  Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing commercial properties, residential properties and properties under construction.

Standby letters of credit are written conditional commitments which we issue to guarantee the performance of a customer to a third party.  Commercial letters of credit are conditional commitments which we issue to facilitate trade or commerce.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

The following table presents a summary of our commitments and contingent liabilities as of March 31, 2008 and December 31, 2007:

(Dollars in thousands)
 
As of
 
   
March 31, 2008
   
December 31, 2007
 
Commitments to extend credit
  $ 519,477     $ 618,336  
Commitments to extend credit
               
to directors and officers
  $ 391     $ 365  
Standby letters of credit
  $ 8,909     $ 7,425  
Commercial letters of credit
  $ -     $ -  

Legal Proceedings

In the ordinary course of business, we are, from time to time, a party to litigation which we believe is incidental to the operations of our business. We are not aware of any material legal action or complaint asserted against us that would have an adverse affect on our financial position, results of operation, or liquidity of the Company at March 31, 2008.


Note #6 – Employee Stock Ownership Plan

During April 2004, our Board of Directors approved the formation of a Company-sponsored Employee Stock Ownership Plan (the “ESOP”) under the Vineyard National Bancorp Employee Stock Ownership Plan Trust (the “ESOP Trust”) for the benefit of our eligible full-time employees.  This leveraged ESOP is funded by a loan, which is secured by the ESOP shares.  The number of shares released is based on the principal pay down of the loan balance.  The amount of shares allocated to each participant under the ESOP is based on the employee’s annual compensation.  ESOP shares become fully vested to our employees upon the completion of five years of service.  ESOP participants are entitled to receive distributions from the ESOP account generally upon termination of service, which includes retirement and death.

To fund the purchase of shares of our common stock in the open market, the ESOP Trust initially secured a loan in the amount of $7.0 million with a third party bank which we guaranteed.  The ESOP loan, which bore a floating interest rate of 0.5% over the national prime rate, was scheduled to mature ten years after the date of initial advance.  During the fourth quarter of 2004, the ESOP Trust refinanced the ESOP loan with a new note with the same terms through the Company and paid off the note with the third party bank, therefore eliminating the loan payable balance on our financial statements. We guarantee the outstanding balance of the ESOP loan, which is collateralized by the assets of the ESOP.  We may elect to pay debt service or trustee fees with the dividends paid on the unallocated shares owned by the ESOP.  Shares held by the ESOP are held by an independent trustee for allocation among participants as the loan is repaid.

The ESOP used the full amount of the loan to purchase 149,000 shares of our common stock in the open market.  As a result of a subsequent stock split and stock dividend, the ESOP held 312,900 shares of our common stock.  The cost of shares held by the ESOP and not yet released or allocated to employees is reported as a reduction of stockholders’ equity.  Upon release of the shares, released shares of the ESOP are charged to compensation expense based on the fair value of the shares transferred, with a corresponding credit to our equity.  We recognized $0.1 million of compensation expense for the release of ESOP shares for the three months ended March 31, 2008 and 2007.

For purposes of earnings per share (“EPS”) computations and in accordance with SOP 93-6, we treat ESOP shares as outstanding if they have been allocated to participants, released, or committed to be released.  As of December 31, 2007, the ESOP had allocated 81,119 shares to participants. During the three months ended March 31, 2008, 2,101 of the allocated shares were forfeited due to participants’ termination of employment.  Forfeited shares are considered to be released but unallocated shares.  The forfeitures resulted in a balance of 79,018 allocated shares.  For the three months ended March 31, 2008, the ESOP released 6,772 shares in conjunction with a paydown of the ESOP loan.  All shares released during 2008 will be allocated to participants in December 2008.

 
As of March 31, 2008, 79,018 of the ESOP shares were allocated to participants, and an additional 8,873 shares were released but unallocated to participants.  The 233,882 unallocated shares represented 2.4% of the total number of common shares outstanding at March 31, 2008.  The fair value of unallocated ESOP shares as of March 31, 2008 was $1.9 million.


Note #7 – Income / (Loss) per Common and Common Equivalent Share

Basic EPS excludes dilution and is computed by dividing income/(loss) available to common shareholders by the weighted-average number of common shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.

The following is a reconciliation of net income/(loss) and shares outstanding to the income/(loss) and number of shares used to compute EPS. All share and per share data have been adjusted to reflect the 5% stock dividend issued in June 2007.

(Dollars in thousands)
 
Three Months Ended March 31,
 
   
2008
   
2007
 
   
Income
   
Shares
   
Income
   
Shares
 
Net (loss) / income as reported
  $ (13,252 )         $ 5,509        
Less: Preferred stock dividends declared
    (644 )           (229 )      
Shares outstanding at end of period
            9,884,441               10,917,058  
Unreleased and unallocated ESOP shares
            (225,009 )             (251,731 )
Impact of weighting shares
                               
issued during the period
            70,600               18,139  
Used in basic EPS
  $ (13,896 )     9,730,032     $ 5,280       10,683,466  
Dilutive effect of outstanding
                               
stock options and warrants
            -               243,648  
Used in diluted EPS (1)
  $ (13,896 )     9,730,032     $ 5,280       10,927,114  
______________

(1)  
In accordance with SFAS No. 128 “Earnings per Share”, due to the net loss for the three months ended March 31, 2008, the impact of securities convertible to
common stock is not included as its effect would be anti-dilutive.

Note #8- Fair Value Disclosure

Effective January 1, 2008, we adopted SFAS No. 157, which establishes a hierarchy for measuring fair value under GAAP.  This standard applies to all financial assets and liabilities that are being measured and reported at fair value on a recurring and non-recurring basis.  Fair value is measured in levels, which are described in more detail below, and are determined based on the observability and reliability of the assumptions used to determine fair value.

Level 1: Valuation for assets and liabilities traded in active exchange markets.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2: Valuations for assets and liabilities traded in less active dealer or broker markets.  Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.

Level 3: Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models, and similar techniques, and not based on market exchange, dealer, or broker traded transactions.  These valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

We measure and report trading securities and available-for-sale securities at fair value on a recurring basis.  The following table shows the balances of these assets based on their SFAS No. 157 designated levels.
 

(Dollars in Thousands)
 
At March 31, 2008
 
   
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
                         
Trading securities
  $ 5,007     $ 5,007     $ -     $ -  
Available-for-sale securities
    133,565       -       133,565       -  
Total
  $ 138,572     $ 5,007     $ 133,565     $ -  

We may also be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis in accordance with GAAP.  During the three months ended March 31, 2008, we measured loans held-for-sale, collateral dependent impaired loans and OREO at fair value.  For these assets measured at fair value on a nonrecurring basis during the three months ended March 31, 2008, the following table provides the assets’ SFAS No. 157 designated levels, as well as the fair value losses recognized during the three months ended March 31, 2008.

                           
Quarter ended
 
(Dollars in Thousands)
 
At March 31, 2008
   
March 31, 2008
 
   
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
   
Fair Value Losses
 
Loans held-for-sale
  $ 103,061     $ -     $ -     $ 103,061     $ (195 )
Impaired loans (1)
    162,439       -       -       162,439       (3,406 )
OREO (2)
    12,642       -       -       12,642       (3,673 )
Total
  $ 278,142     $ -     $ -     $ 278,142     $ (7,274 )
____________

(1)  
Represents carrying value of impaired loans net of corresponding specific reserve in the ALL.
(2)  
Represents the carrying value and related losses of foreclosed real estate owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

Because we did not elect the fair value option for any financial assets or liabilities under SFAS No. 159, there were no other assets or liabilities that we measured at fair value during the three months ended March 31, 2008.


Note #9 – Line of Credit Modifications

We had a $53.3 million secured line of credit with a correspondent bank at March 31, 2008. This line is collateralized by 100% of the Bank’s common stock. At December 31, 2007, VNB was in default on the line of credit due to non-compliance with certain covenants including: 1) a return on assets percentage not less than 0.9%, 2) a percentage of non-performing loans to the Bank’s gross loan balance not to exceed 2.25%, and 3) a consolidated Tier 1 leverage capital ratio not less than 7.0%.  VNB was granted a waiver of such financial covenant defaults as of December 31, 2007.

Effective March 16, 2008 VNB entered into a modification agreement and covenant waiver (the "Agreement") which extended the maturity date from March 15, 2008 to June 30, 2008 and extended the waiver of VNB’s financial covenant defaults through June 30, 2008. In connection with the agreement, VNB repaid $5.0 million of the outstanding balance in the second quarter of 2008 plus a lender fee in an amount equal to 0.25% of the outstanding balance. In addition, VNB agreed that the correspondent bank had no further obligation to advance any new proceeds under the line of credit.

There was $53.3 million and $45.3 million outstanding under this secured line of credit as of March 31, 2008 and December 31, 2007, respectively.  The outstanding balance and all accrued but unpaid interest will be payable by VNB on June 30, 2008.  Prior FRB approval will now be required in order for VNB to make this payment on the line of credit.  In the event that we are unable to make this payment on or before June 30, 2008, we will be in default under the line of credit and the correspondent bank will thereupon be entitled to exercise its rights as a secured party against the collateral to collect, enforce or satisfy the obligations under the line of credit.

Note #10 – Subsequent Events

Borrowing Line Changes

On April 21, 2008, the FHLB decreased the Bank’s borrowing capacity on its secured borrowing line with the FHLB from 40% of the Bank’s assets to 30% of the Bank’s assets.  The amount that we borrow from the FHLB is limited by the amount of collateral that we pledge.  We did not rely on the maximum borrowing capacity under the old limits, as the amount of all eligible assets pledged to secure the FHLB line was less than that capacity limit and continues to be below the new capacity limit of 30% of the Bank’s assets.  As such, our operations were not adversely affected by the decrease in borrowing capacity.

 
During May 2008, we were notified in writing by three lenders that our unsecured borrowing lines have been suspended.  The suspensions comprise $40.0 million in unsecured borrowing lines.  We have five remaining unsecured borrowing lines which comprise $91.7 million in aggregate borrowing capacity.

Regulatory Actions

On May 5, 2008, the Bank was informed in writing by the OCC that, as a result of an examination, the Bank has been designated to be in a “troubled condition” for purposes of Section 914 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989.  As a result of this designation, the Bank may not appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without providing the OCC with 90 days prior written notice. Such appointment or change in responsibilities may be disapproved by the OCC in its sole discretion.  In addition, the Bank may not make indemnification or severance payments to, or enter into agreements providing for such indemnification or severance payments with, institution-affiliated parties, which include key employees and directors of the Bank, without complying with certain statutory restrictions including prior approval of the OCC and FDIC.  This designation does not affect the Bank’s status as a well-capitalized institution.
 
On May 20, 2008, VNB was informed in writing by the FRB that VNB has been designated to be in a “troubled condition” for purposes of Section 914 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989.  As a result of this designation, VNB will not be able to appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without providing the FRB with 30 days prior written notice. Such appointment or change in responsibilities may be disapproved by the FRB.  In addition, VNB is not able to make indemnification or severance payments to, or enter into agreements providing for such indemnification or severance payments with, institution-affiliated parties, which include key employees and directors of VNB, without complying with certain statutory restrictions including prior approval of the FRB and FDIC.
 
The FRB has also advised VNB that in light of VNB’s obligation to serve as a source of financial and managerial strength to the Bank, VNB may not make payments to third parties, including, without limitation, dividend payments to the holders of its common stock and preferred stock, payments of interest and principal to its creditors, and payments for salaries and other operating expenses, without prior FRB approval.

 
Dividend Restrictions

We have an accumulated deficit and do not otherwise satisfy the minimum asset to liability ratios for paying dividends under California law.  As a result, we are legally prohibited from paying dividends on both our common stock and preferred stock.  The banking agencies also have the authority to prohibit us from paying dividends, depending upon the Bank’s financial condition, if such payment is deemed to constitute an unsafe or unsound practice or based on the FRB requirement that a bank holding company must act as a source of financial and managerial strength to its subsidiary banks.  In this regard, FRB approval will now be required before we can pay dividends on our common stock or preferred stock.  Furthermore, under the federal Prompt Corrective Action regulations, the banking agencies may prohibit us from paying any dividends if the Bank is classified as “undercapitalized.”

Strategic Alternatives

On May 1, 2008, we announced that we have engaged financial advisors to explore strategic alternatives, including potential significant capital raises, in order to address the financial impact of the abrupt and severe decline in real estate values and the consequent increase in our provision for loan losses.  We also announced that we were in discussions with one party regarding a potential capital infusion transaction and those discussions are ongoing.

Notification of Delisting

On April 2, 2008, we received a NASDAQ Staff Determination letter notifying us that our failure to timely file our 2007 Form 10-K constitutes a failure to satisfy the filing requirement for continued listing under NASDAQ Marketplace Rule 4310(c)(14) and, therefore, trading in our common stock is subject to suspension and delisting unless we request an appeal of the determination.  We filed an appeal and a hearing before the NASDAQ Listing Qualifications Panel (the “NASDAQ Panel”) is scheduled on May 22, 2008 to review the determination.  Pending a decision by the NASDAQ Panel, our common stock will remain listed on NASDAQ.  While we believe the filing of our 2007 Form 10-K on May 19, 2008 satisfies the filing requirement for continued listing under NASDAQ Marketplace Rule 4310(c)(14), there can be no assurance that the NASDAQ Panel will grant our request for continued listing.

 
On April 2, 2008, we received a letter from the American Stock Exchange (“AMEX”) notifying us that our failure to timely file our 2007 Form 10-K constitutes a failure to satisfy the requirements of Sections 134 and 1101 of the AMEX Company Guide and is a material violation of our listing agreement and, therefore, trading in our 7.5% Series D Noncumulative Preferred Stock is subject to suspension and delisting unless we submit a plan (“Plan”) to AMEX advising AMEX of action we have taken, or will take, that would bring us into compliance with Sections 134 and 1101 of the AMEX Company Guide.  Although we have submitted a Plan to AMEX, such Plan has not been accepted by the AMEX Listings Qualifications Panel as of the filing of our Annual Report on Form 10-K for the year ended December 31, 2007.  While we believe the filing of our 2007 Form 10-K on May 19, 2008 satisfies the filing requirements of Sections 134 and 1101 of the AMEX Company Guide, there can be no assurance that the AMEX Listings Qualifications Panel will grant our request for continued listing.


ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 business, financial condition, results of operations, liquidity and interest rate sensitivity.  The following discussion and analysis should be read in conjunction with our quarterly unaudited Consolidated Financial Statements, and notes thereto, contained in this report, which have been prepared in accordance with GAAP, and with our Annual Report on Form 10-K for the year ended December 31, 2007 (the “2007 Form 10-K”), which is incorporated herein by reference.

General Business and Organization

Vineyard National Bancorp (referred to herein on an unconsolidated basis as “VNB” and on a consolidated basis 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 in Corona, California which is located in the Inland Empire region of Southern California.  The Bank operates sixteen full-service banking centers within Los Angeles, Marin, Orange, Riverside, San Bernardino and San Diego counties of California, as well as four regional financial centers (“RFCs”) in Santa Clara, Ventura, Orange and Los Angeles counties of California, respectively. RFCs are offices that operate principally with loan and/or deposit gathering functions.  The Bank’s deposit accounts are insured by the FDIC up to the maximum amount permitted by law.  The Bank is our principal asset.  In addition to the Bank, VNB has two consolidated operating subsidiaries, 1031 Exchange Advantage, Inc. and 1031 Funding & Reverse Corp. (collectively, the “Exchange Companies”), which act as qualified intermediaries under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Code”). VNB also has ten unconsolidated statutory business trust subsidiaries, 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”), which were created to raise capital through the issuance of trust preferred securities. At March 31, 2008, we had consolidated total assets of $2.4 billion, total deposits of $1.8 billion and consolidated stockholders’ equity of $96.2 million.

Executive Overview

We reported a net loss for the quarter ended March 31, 2008 of $13.3 million, or $1.43 per common share, compared with net earnings of $5.5 million, or $0.48 per common share, for the same period in 2007. The net loss for the first quarter 2008 was due primarily to $26.9 million of provision for loan losses principally associated with our construction loan portfolio.

In the midst of a challenging quarter and a distressed economic environment, we implemented a strategy to reduce our loan production levels and achieved a net contraction of our balance sheet.  Overall, we have contracted our balance sheet by $125.3 million, or 5%, during the first quarter of 2008, from $2.5 billion at December 31, 2007 to $2.4 billion at March 31, 2008.

At March 31, 2008, we had $2.0 billion in loans, net of unearned income and $103.1 million of loans held-for-sale. We have decreased our loans, net of unearned income and loans held-for-sale by $29.5 million and $16.4 million, respectively, from $2.0 billion and $119.4 million, respectively, at December 31, 2007. At March 31, 2008, our loan portfolio, excluding loans held-for-sale was comprised of 51.5% construction and land loans, 26.6% commercial real estate loans, 8.0% residential real estate loans, 8.4% commercial loans, and 5.5% consumer loans.  The majority of our loans are originated in our primary market areas throughout Southern and Northern California.

 
Commensurate with our asset contraction, at March 31, 2008, total deposits were $1.8 billion representing a decrease of $136.8 million from $1.9 billion at December 31, 2007 mainly due to a decline in money market deposits of $123.7 million.  Our deposit portfolio at March 31, 2008 was comprised of 50.4% in time certificate of deposits, 32.8% in savings deposits (which include money market, NOW, and savings deposits) and 16.8% in demand deposits.  There was also a $29.4 million decrease in exchange balances, which are 1031 exchange balances associated with the Exchange Companies.  We continue to focus on obtaining lower cost non-interest bearing deposits in order to reduce our cost of funds.

Significant Events

The following information provides an overview of significant events that occurred in the first quarter of 2008.

Resignation of Norman Morales

On January 23, 2008, Norman A. Morales agreed to resign as a director and his employment as President and Chief Executive Officer of VNB and the Bank was terminated.  In connection with such resignation and termination, we entered into an Agreement and Release with Mr. Morales dated January 23, 2008 (the “Agreement”), under which Mr. Morales received (a) a lump sum payment in the amount of One Million One Hundred Fifty Thousand Dollars ($1,150,000), (b) reimbursement of premiums incurred in continuing group health insurance coverage pursuant to COBRA through January 23, 2009, (c) any and all interest of VNB and the Bank in Mr. Morales’ country club membership, and (d) title to the vehicle currently leased by VNB on Mr. Morales’ behalf.  We also agreed to use commercially reasonable best efforts to facilitate the transfer to Mr. Morales of our entire interest in the “key-man” term life insurance policies under which Mr. Morales is the insured party and we are the beneficiary.  Pursuant to the Agreement, Mr. Morales agreed to, among other things, provide us with consulting services for a period of one year, release any and all claims against us arising from or in any way related to his employment with us, and refrain from soliciting our customers and employees for a period of one year.  As a result of the Agreement, that certain Amended and Restated Employment Agreement dated April 9, 2007, by and among VNB, the Bank and Mr. Morales has been terminated.

New Regional Financial Center Office

The Bank entered into a five-year operating lease for office space in Sherman Oaks, California effective February 1, 2008. On March 31, 2008, the Bank opened this office as an RFC. This new RFC will focus primarily on the generation of lower-cost core deposit relationships.

Consent Solicitation and Proxy Contest

On February 25, 2008, our former President and Chief Executive Officer, Norman A. Morales, and a stockbroker, Jon Salmanson, publicly announced their intention to solicit written shareholder consents to amend our Bylaws to permit them to nominate a slate of directors for possible election at our 2008 Annual Meeting of Shareholders (the “Consent Solicitation”).  On April 21, 2008, IVS Associates, Inc., the independent inspector of elections retained by VNB in connection with this Consent Solicitation, certified that the Bylaw amendments proposed by Messrs. Morales and Salmanson were approved by our shareholders.  We have now received notice that Messrs. Morales and Salmanson will be submitting a slate of seven alternative nominees to stand for election at our 2008 Annual Meeting of Shareholders.  As a result of the FRB’s designation of VNB as an institution in “troubled condition,” none of the alternative nominees will be eligible to serve on our Board of Directors without the consent of the FRB.

We incurred substantial costs and management expended substantial time and energy in opposing the Consent Solicitation initiated by Messrs. Morales and Salmanson, and we will likely be engaged in a proxy contest with respect to the election of directors that will require significant additional time and expense and further divert the attention of our management and disrupt our business.

Investigation of Internal Controls

We were unable to file our 2007 Form 10-K within the prescribed time period because of an ongoing review and assessment by our Audit Committee regarding the nature, scope and circumstances of certain internal violations of security policies, procedures and controls concerning our Information Technology function, and the impact, if any, of such violations on our internal control over financial reporting.

 
The investigation found no evidence that the violations of security policies resulted in the disclosure of customer information, sensitive Company documents or confidential information to unintended recipients.  The investigation also found no evidence that the violations of security policies resulted in a material misstatement of our financial statements.  However, as a result of the investigation, management concluded that a material weakness existed at December 31, 2007 in the Company’s operating procedures and oversight in the Information Technology function.  This material weakness in internal controls is more fully described under "Item 9A. Controls and Procedures” in our 2007 Form 10-K.

Recent Developments

Regulatory Actions

On May 5, 2008, the Bank was informed in writing by the OCC that, as a result of an examination, the Bank has been designated to be in a “troubled condition” for purposes of Section 914 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989.  As a result of this designation, the Bank may not appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without providing the OCC with 90 days prior written notice. Such appointment or change in responsibilities may be disapproved by the OCC in its sole discretion.  In addition, the Bank may not make indemnification or severance payments to, or enter into agreements providing for such indemnification or severance payments with, institution-affiliated parties, which include key employees and directors of the Bank, without complying with certain statutory restrictions including prior approval of the OCC and FDIC.  This designation does not affect the Bank’s status as a well-capitalized institution.
 
On May 20, 2008, VNB was informed in writing by the FRB that VNB has been designated to be in a “troubled condition” for purposes of Section 914 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989.  As a result of this designation, VNB will not be able to appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without providing the FRB with 30 days prior written notice.  Such appointment or change in responsibilities may be disapproved by the FRB.  In addition, VNB will not be able to make indemnification or severance payments to, or enter into agreements providing for such indemnification or severance payments with, institution-affiliated parties, which include key employees and directors of VNB, without complying with certain statutory restrictions including prior approval of the FRB and FDIC.
 
The FRB has also advised VNB that in light of VNB’s obligation to serve as a source of financial and managerial strength to the Bank, VNB may not make payments to third parties, including, without limitation, dividend payments to the holders of its common stock and preferred stock, payments of interest and principal to its creditors, and payments for salaries and other operating expenses, without prior FRB approval.

Strategic Alternatives

On May 1, 2008, we announced that we have engaged financial advisors to explore strategic alternatives, including potential significant capital raises, in order to address the financial impact of the abrupt and severe decline in real estate values and the consequent increase in our provision for loan losses.  We also announced that we were in discussions with one party regarding a potential capital infusion transaction and such discussions are ongoing.

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.  In light of current real estate market and general economic conditions, we have intensified our focus on risk reduction through a restructuring of our balance sheet, protection and preservation of capital, and the enhancement of shareholder value.

Risk Reduction

We recognize that the current challenging real estate and operating environments require a disciplined focus to achieve quality core earnings with a reduced risk profile. Beginning in 2007, and now continuing into 2008, we have established four primary objectives as a basis to achieve the long-term success of our franchise. These areas are as follows:

1)  
Reduce our Overall Risk Profile: This objective includes the significant reduction of single family residential tract construction lending and related land development projects, enhanced borrower sponsorship requirements, increased and expanded core deposit growth, expanded business and commercial real estate lending in supportive sub-markets, and enhanced balance sheet management;
 
 
2)  
Loan Portfolio Management: In order to produce a base of stabilized long-term earnings, we will seek to proactively rebalance the existing loan portfolio and pursue new and diversified business generation to reduce our risk profile, meet our targeted concentration ranges within sub-markets and sub-portfolios, and maintain an overall portfolio yield consistent with quality and sustainable returns;

    3)  
Liquidity Enhancement and Funding Cost Reduction: We will seek to reduce our funding costs by an intensified focus on lower cost core deposits, cash management driven business relationships, the effective repricing of our time deposit portfolio in a decreasing interest rate environment, and reduction of our reliance on higher costing liabilities; and

4)  
Corporate Reallocation and Reorganization: To improve our operating efficiencies, we will continually review our resource allocation to ensure the optimum allocation of talent among functions. We seek to continue to deploy and redeploy resources, both personnel and other operating costs, toward achievement of our objectives.

Capital Protection

As we move forward with our strategic plan, we are focusing on protecting and preserving capital.  Income from the Bank is expected to be a contributor to increasing capital and accretive to our risk based capital ratios.  In light of current economic conditions and to address the deterioration in the Bank’s loan portfolio, management is also moderating loan growth, which combined with loan sales and repayments may make additional capital available.  In addition, in order to address the financial impact of the abrupt and severe decline in real estate values and the potential continuing deterioration in the loan portfolio, we are also pursuing strategic alternatives, which may include a significant capital raise, to strengthen our capital.  See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments – Strategic Alternatives.”

Strategic Initiatives

As a result of the current economic environment, our focus has moved from the expansion of our loan portfolio to the stabilization, repositioning and contraction of our balance sheet to mitigate the risks identified by management and generate quality earnings.  We continue to examine our loan portfolio’s credit quality and are aggressively addressing problem assets.  We continue to focus on maintaining our customer relationship management approach while also implementing the delivery of products and services to our customers.

In order to provide exceptional service to 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.  Once management believes economic conditions have stabilized to support further growth, we will seek to expand and mature our franchise.

Market Area and Competition

We are currently focused on providing relationship banking services to the following California markets:

(i)  
the coastal communities of Los Angeles, Orange and San Diego counties;
(ii)  
the San Gabriel Valley and San Fernando Valley regions of Los Angeles county;
(iii)  
the Inland Empire region, which primarily includes San Bernardino and Riverside counties; and
(iv)  
the northern communities of Marin, Monterey, and Santa Clara counties.

The banking and financial services business throughout California and within our specific market area is highly competitive.  Our market area is dominated by a small number of large multi-regional banks, as well as various independent community banks.  These institutions typically compete with one another based on, among other things, customer service, convenience, technological innovation and pricing.  Competition for loans and deposits comes primarily from other commercial banks, savings institutions, credit unions, financial institutions and other investment alternatives.  The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services, credit policies, underwriting standards and personalized services.

 
Specialty Lending Product Offerings

The Bank augments its traditional commercial and residential loans with several specialty lending products.  These specialty product divisions, as described below, are 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 product divisions provides existing customers with an array of specialty products and allows the Bank to serve new customers throughout its primary market areas.  The Bank continues to strive to reduce the risk profile in the current loan portfolio by reducing its exposure in the tract home construction and land financing product lines.

·  
Luxury Home Construction Lending: The Bank originates single family residential (“SFR”) luxury home construction loans (consisting of attached and detached homes generally priced at $2.0 million and above) primarily within Los Angeles’ “south bay” coastal communities (including Manhattan Beach, Hermosa Beach, El Segundo, Redondo Beach, and the Palos Verdes Peninsula area), Los Angeles’ “west side” (including Beverly Hills, Brentwood, Bel Air and Malibu) and Orange County regions where we believe the Bank has a competitive advantage based on established builder and customer relationships and expertise in the construction market.  The Bank established its Santa Clara RFC in February 2007 primarily to generate SFR luxury home construction loans.  Although the general California real estate market has slowed considerably, and the selling time for luxury homes has increased as of year end 2007, we believe the median price of these homes has not deteriorated significantly.  Therefore, we continue to believe there is relative strength in the demand for this loan product within the luxury housing market along the California coast and in other established affluent regions of California.  However, we have moderated production in this business line given the current softness and uncertainties in the general real estate market. We believe the high employment level, strong incomes, wealth accumulation and good schools in these luxury regions contribute to a continued confidence and stability in these markets.  These types of construction loans typically range from $1.0 million to $5.0 million.
 
During the three months ended March 31, 2008 and December 31, 2007, gross commitments generated for this loan product amounted to $56.0 million and $59.2 million, respectively. The Bank’s SFR luxury home construction loans outstanding amounted to $573.1 million and $583.0 million at March 31, 2008 and December 31, 2007, respectively, net of participations sold of $53.2 million and $65.9 million, respectively. As of March 31, 2008 and December 31, 2007, the Bank had $208.8 million and $243.7 million, respectively, in undisbursed SFR luxury home construction loan commitments.
 
·  
Commercial Construction Lending: The Bank originates commercial construction loans, which primarily include loans for the construction of office buildings, retail space, churches, and multifamily/apartment projects.  The majority of commercial construction loans are used for the construction of low-rise office buildings and medical offices.  This product is mainly originated throughout Southern California, with 28% of projects in the Inland Empire, followed by 24% and 22% of projects in Los Angeles and Orange counties of Southern California, respectively.  Commercial construction loans generated from this division typically range from $2.0 million to $25.0 million.  The Bank had a balance of $218.5 million and $198.2 million of commercial construction loans at March 31, 2008 and December 31, 2007, respectively, net of undisbursed commitments of $94.2 million and $115.9 million for the same periods, respectively.  Due to the current softness and uncertainties in the general real estate market, we have moderated production in this business line.

·  
Tract Construction Lending:  The Bank has SFR tract construction loans, primarily secured by newly-constructed, entry to mid-level detached and attached homes.  The majority of these loans were originated within the Inland Empire of Southern California, and the remainder were originated throughout California. This division has experienced a significant slowdown in the last several quarters, as home sales decline, inventory levels increase, and housing prices in the Inland Empire region continue to soften. The majority of the Bank’s builder clients continue to offer various buyer incentives to complete projects and move inventory in the face of declining absorption rates.  Although we cannot control many economic and market driven factors impacting this business segment, we have completed an analysis of our tract construction portfolio and we believe we are taking proactive steps to address identified risk factors within our control.
 
These types of construction loans typically range from $5.0 million to $20.0 million.  During the three months ended March 31, 2008 and December 31, 2007, gross commitments generated for this loan product amounted to $2.3 million and $31.5 million, respectively representing a decrease of 92.6%.  At March 31, 2008 and December 31, 2007, the Bank’s SFR tract construction loans outstanding amounted to $130.0 million and $146.6 million, respectively. This represents a reduction of tract construction loans of $16.6 million or 11.3%. While $21.3 million of the loan balance decrease resulted from the charge-off of tract construction loans, there were $7.1 million of principal paydowns and payoffs associated with this portfolio during the first quarter of 2008. As of March 31, 2008 and December 31, 2007, the Bank had $32.4 million and $57.2 million, respectively in undisbursed SFR tract construction loan commitments.
 
 
 

·  
Income Property Lending:  The Bank has an income property lending division to service the lending needs in growing markets for commercial real estate and multifamily/apartments in California and neighboring states.

o  
Commercial Real Estate: The Bank’s commercial real estate loan portfolio includes loans secured by office buildings, retail outlets and industrial properties, the majority of which are located in Los Angeles county, Orange county, and the Inland Empire region in Southern California.  Keeping in line with our risk reduction efforts, we continue to focus on loans with strong sponsorship and properties in established markets.
 
Commercial real estate loans generated from this division typically range from $2.0 million to $10.0 million.  The Bank had a balance of $526.2 million and $524.9 million of income property commercial real estate loans generated from this division at March 31, 2008 and December 31, 2007, respectively.  The Bank also had $45.0 million in commercial real estate loans held-for-sale at March 31, 2008 and $45.8 million at December 31, 2007.
 

o  
Residential Real Estate:  The Bank’s residential income property loan portfolio consists primarily of multi-family/apartment loans.  These loans are originated primarily in Los Angeles and Orange counties, with some lending in the Inland Empire region.  This portfolio is currently benefiting from low home affordability as potential home buyers are choosing to remain in rental housing.
 
Multi-family/apartment loans typically range from $0.5 million to $5.0 million.  The Bank had a balance of $157.0 million and $149.9 million of residential income property loans at March 31, 2008 and December 31, 2007, respectively. Because multi-family/apartment loans generally command a lower yield relative to the Bank’s other lending products, it has moderated the growth of this type of loan to optimize our overall portfolio yield. The Bank had $58.1 million in multi-family/apartment loans held-for-sale at March 31, 2008 and $73.6 million at December 31, 2007.
 
 
Specialty Deposit Product Offerings

As a complement to the Bank’s lending product offerings, the Bank also seeks to improve its customers’ banking experiences by offering a vast array of technologically advanced deposit services.  These products and services include the following:

·  
Branching System:  Several of the Bank’s full-service banking centers have recently been redesigned to offer a high-tech, high-service environment.  Along with the Bank’s traditional teller lines, it has also incorporated client service desks that integrate both traditional teller and new account operations with state-of-the-art cash machines.  To further the reach of each of the Bank’s banking centers, its RFCs operate exclusively to generate deposits and/or loans.  The Bank also offers courier services, internet-based banking, and ATMs and kiosks to make banking more convenient to our customers.

·  
Cash Management:  To offer expedient banking with new and emerging technologies, the Bank offers various cash management services to its customers.  These services facilitate business customers’ cash flow and aid in maximizing their investment potential by aligning products and services to a customer’s needs. The Bank’s cash management services include the following:

o  
Remote Item Capture:  This technology, also known as “electronic deposit”, allows clients to scan items for deposit and electronically send images of the items securely to the Bank’s processor.  This service also provides customers with the convenience to perform banking activities from within their place of business and after traditional banking hours.

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

o  
Lockbox Processing: The Bank’s lockbox services aid customers in expediting the processing of their deposits and increasing their float value for investment purposes.  This product also provides same-day reporting of deposits.
 
 
o  
Positive Pay:  This service provides business customers with increased efficiency and security by allowing them to review checks presented against their accounts prior to disbursing funds while helping clients to identify potentially fraudulent activity in their account.

Each of the foregoing specialty lending groups and depository services brings diversity to the Bank’s traditional product lines, offering its customers greater flexibility while providing additional opportunities for the Bank to serve new customers within its market areas.

1031 Exchange Services

The Exchange Companies, headquartered in Encinitas, California, act as qualified intermediaries for tax-free exchanges of real property permitted under Section 1031 of the Code.  They are nationwide providers of qualified intermediary services and are equipped to structure and administer all types of 1031 exchange transactions.  The Exchange Companies were an early provider of reverse exchanges and build to suit or improvement exchanges. Due to the slowdown in the real estate market, the number of exchange transactions and related exchange deposits has decreased in 2008 versus 2007. Our exchange balances decreased from $47.5 million at December 31, 2007 to $18.1 million at March 31, 2008 representing a decrease of $29.4 million or 61.8%.

Critical Accounting Policies and estimates

In preparing these financial statements, we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, we evaluate our estimates including those related to allowance for loan losses and the fair value of carried securities.  We base our estimates on historical experience and on various other assumptions that we consider reasonable under the circumstances.  These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates.

Our significant accounting policies are described in Part II, Item 7 “Management Discussion and Analysis of Financial Condition and Results of Operations” in our 2007 Form 10-K.  We believe that the policies described below are critical to our business operations and the understanding of our financial condition and operating results.

Allowance for Credit Losses and Impaired Loans

The allowance for credit losses is maintained at a level which, in our judgment, is adequate to absorb credit losses inherent in the loan portfolio and in undisbursed loan commitments.  The allowance for credit losses is comprised of the allowance for loan losses and the allowance for unfunded commitments.  It accounts for probable credit losses in both the on-balance and off-balance sheet loan portfolios.  The amount of the allowance is based on our evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans and economic conditions.  The allowance for loan losses is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries.

The allowance for unfunded commitments is increased by the provision for unfunded commitments, and is calculated based on the level of the undisbursed loan portfolio and letters of credit.  The allowance for unfunded commitments is included in other liabilities on our Consolidated Balance Sheet, and the provision for unfunded commitments is included in other non-interest expense on our Consolidated Statement of Operations.

We consider a loan to be impaired when, based on current information and events, we do not expect to be able to collect all amounts due according to the loan contract, including scheduled interest payments.  When we identify a loan as impaired, we measure impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral.  In this case, we value the loan using the current fair value of the collateral, net of selling costs.  If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize the impairment reserve as a specific component to be provided for in the ALL.  The Bank also maintains an unallocated allowance to provide for other credit losses inherent in the loan portfolio which may not have been contemplated in the credit loss factors.  The unallocated amount is reviewed periodically based on trends in credit losses, the results of credit reviews, and overall economic trends.

Goodwill and Intangible Assets

We recorded $2.8 million in goodwill from our acquisition of the Exchange Companies in the fourth quarter of 2007. We also took a $40.8 million write-off of our goodwill in the fourth quarter of 2007 primarily associated with our acquisition of Rancho Bank on July 31, 2006. For additional information regarding the write-down of goodwill, refer to Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the section captioned “Critical Accounting Policies and Estimates” in our 2007 Form 10-K.

 
Goodwill, which is considered to be a long-lived asset with an indefinite life, may not be amortized, in accordance with GAAP.  We evaluate goodwill at least annually for any impairment. The process of evaluating goodwill for impairment requires us to make several assumptions and estimates including market trends and multiples of companies engaged in similar lines of business and forecasts of future earnings.  If any of our assumptions in our valuation of goodwill change over time, the estimated value assigned to our goodwill could change significantly.  If our impairment analysis indicates that the fair value of the banking operations acquired is less than its carrying amount, we will write down the carrying value of goodwill through a charge to our Consolidated Statements of Operations.

We amortize core deposit intangibles over their estimated useful lives. Core deposit intangibles (“CDI”) are recognized apart from goodwill at the time of acquisition based on market valuations prepared by independent third parties.  In preparing these valuations, the third parties consider variables including deposit servicing costs, attrition rates, and market discount rates.  CDI are amortized to expense using the sum-of-the-years digits method over their useful lives, which we have estimated to be 8 years, and are reviewed for impairment no less than annually.  If the recoverable amount of CDI is determined to be less than its carrying value, we would then measure the amount of impairment based on an estimate of its fair value at that time.  If the fair value is below the carrying value, the intangible asset would be reduced to such fair value and additional amortization would be recognized.

Income Taxes

We account for income taxes by deferring income taxes based on estimated future tax effects of temporary differences between the tax and book basis of assets and liabilities considering the provisions of enacted tax laws.  These differences result in deferred tax assets and liabilities, which are included in our Consolidated Statements of Financial Condition.  Our judgment is required in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income. We consider the relative merits and risks of appropriate tax treatment in accordance with statutory, judicial and regulatory guidance.  However, fluctuations in our estimates in determining our tax provision may materially impact our results in a given reporting period.

Results of Operations

Overview

We incurred a net loss for the three months ended March 31, 2008 of $13.3 million, as compared to net income of $5.5 million for the same period in 2007, representing a decrease of 340.6%.  On a per share basis, we had a net loss of $1.43 per common share for the three months ended March 31, 2008 and net earnings of $0.48 per diluted share for the same period in 2007, representing a 397.9% decrease.  Per share data has 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 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 owned.

The prime rate, which generally follows the federal funds rate and is the main driver for interest rate changes, was 7.25% at December 31, 2007. In the first quarter of 2008, the Board of Governors of the FRB decreased the targeted federal fund rate by 200 basis points to 2.25%; the prime rate, in turn, decreased to 5.25%.

For the three months ended March 31, 2008, operating results were significantly affected by a provision for loan losses of $26.9 million primarily associated with the Bank’s construction loan portfolio, write-down of assets of $3.9 million related to foreclosed real estate owned and loans held-for-sale, and loss of interest on non-accrual loans of $3.2 million.

In response to the challenging conditions in the real estate market and the broad financial services industry as well as mounting recessionary pressures in the economic environment overall, management is continually reviewing our loan portfolio and its associated credit risks. Consistent with this review, we had $27.5 million in net charge-offs, or 1.29% of average loans for the three months ended March 31, 2008 and approximately $62,000 in net charge-offs for the same period in 2007.  The risks associated with our loan portfolio necessitated an increase in our provision for loan losses in the amount of $26.9 million for the three months ended March 31, 2008 as compared to $1.2 million for the same period in 2007.  Of the provision, $3.4 million and $0.3 million was a specific valuation allowance which corresponds to specific, identified loans as of March 31, 2008 and 2007, respectively. The ALL was 2.44% and 1.04% of gross loans, excluding loans held-for-sale at March 31, 2008 and 2007, respectively and the allowance for credit losses was 2.48% and 1.09% of gross loans for the same periods, respectively.  At March 31, 2008 and December 31, 2007, we had $121.9 million and $75.4 million in non-performing loans, respectively. We had $12.6 million and $17.4 million of OREO through foreclosures at March 31, 2008 and December 31, 2007, respectively.

 
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, was 55.4% and 104.1% for the three months ended March 31, 2007 and 2008, respectively.  The significant increases in our efficiency ratio during the three months ended March 31, 2008 related primarily to professional service expenses associated with the internal control investigation and the Board of Director’s opposition to the Consent Solicitation, as well as the write down of OREO and loans held-for-sale.

Net Interest Income

Total interest income for the three months ended March 31, 2008 and 2007 was $42.2 million and $45.1 million, respectively, while total interest expense was $22.3 million and $22.7 million for the same periods, respectively.  Therefore, net interest income was $19.9 million and $22.5 million, respectively, for the same periods.

For the three months ended March 31, 2008, interest income from loans decreased 4.1% to $40.5 million compared to $42.2 million for the same period in 2007.  This decrease was mainly a result of the loss of $3.2 million of interest income associated with our non-accrual loans.  Beginning in 2007, the Bank implemented a strategy to moderate its loan production levels, which led to a compression of the loan portfolio. Our total loan portfolio, including loans held-for-sale, decreased $45.9 million, or 2.2%, during the first quarter of 2008.  During the three months ended March 31, 2008, the decrease in loans included $21.3 million of tract construction loan charge-offs, $32.0 million of commercial real estate loan payoffs, and $82.7 million in luxury construction loan payoffs and payments.  These decreases were offset by $74.2 million in disbursements on new and existing luxury construction loan commitments, and the sale of $14.5 million of multi-family loans held-for-sale.

We generated gross loan commitments of $101.4 million during the three months ended March 31, 2008 compared to $240.8 million in gross loan commitments during the three months ended December 31, 2007 representing a decrease of $139.4 million or 57.9%. We continue to focus on the previously stated objectives of our strategic plan, which call for the reduction of our overall risk profile, including a significant reduction of the construction and land loan portfolio, and a focus on loan portfolio management, including a rebalancing of the existing loan portfolio to produce a base of stabilized long-term earnings. We monitor our loan portfolio composition on a monthly basis to minimize risk while maximizing our loan yield.  We also 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 March 31, 2008, loan fee income represented $1.6 million or 3.9% of the $40.5 million in interest and fees on loans.  For the three months ended March 31, 2007, loan fee income was $2.4 million or 5.6% of the $42.2 million in interest and fees on loans.

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 generate the majority of loan origination fee income. Our loan fee income has decreased for the three months ended March 31, 2008 as compared to the same period in 2007 due to the origination of longer duration assets, such as commercial real estate loans, causing fees to be amortized over a longer period.  The decrease in fees is a result of the strategy to diversify and reduce the risk profile of the loan portfolio and less construction loan fees.

Interest income from investment securities decreased from $2.9 million to $1.7 million for the three months ended March 31, 2007 and 2008, respectively.  Our investment portfolio decreased $38.7 million or 21.9% during the three months ended March 31, 2008, primarily as a result of principal pay downs of $4.0 million and sale of investments of $36.5 million.  These decreases in the investment portfolio caused a decrease in the related interest income. Declines in the value of our trading securities underlying our deferred compensation plan further decreased our interest income during the three months ended March 31, 2008 as compared to the same period in 2007.

Interest expense on deposits totaled $17.1 million for each of the three months period ended March 31, 2008 and 2007. Average interest bearing deposits increased slightly from $1.5 billion for the three months ended March 31, 2007 to $1.6 billion for the same period in 2008, respectively, however interest expense on deposits did not change due to recent declines in interest rates. We anticipate declines in our interest expense on interest-bearing deposits, but the speed of such declines is dependent on the lag between time deposit maturity and the repricing of other deposit products.  We continue to offer promotional deposit products, generally consisting of time and money market products, to attract and retain deposits in each of our banking center geographic locations.  

 
Interest expense on borrowings decreased from $5.6 million for the three months ended March 31, 2007, to $5.2 million for the same period in 2008.  Average total borrowings have decreased slightly from $360.5 million for the three months ended March 31, 2007 to $358.3 million for the same period in 2008. Rates on these borrowings have decreased during the first quarter of 2008, resulting in lower interest expense than the same period in 2007.

Net Interest Margin

Commensurate with our asset contraction, for the three months ended March 31, 2008, deposits decreased by $136.8 million compared to December 31, 2007, related primarily to a decline in money market deposit accounts.  There was also a $29.4 million decrease in exchange balances, which are 1031 exchange balances associated with the exchange companies. As a result of the decline in funding deposits, we have increased our use of higher-cost borrowings, such as FHLB advances.  We will continue to focus on obtaining low cost deposits to reduce our cost of funds, and will continue to adjust and refine our asset/liability management strategy to minimize interest rate risk and maximize our net interest income.

We experienced a decrease in the yield on our total interest-earning assets from 8.4% to 7.3% for the three months ended March 31, 2007 and 2008, respectively.  The yield on our loans decreased from 8.8% to 7.7% for the three months ended March 31, 2007 and 2008, respectively. Our average loan balance was 92.1% of total average interest-earning assets for the three months ended March 31, 2008, respectively, as compared to 89.0% of total average interest-earning assets for the same period in 2007.  The yield on our loans has declined as a result of several factors, including 1) interest income lost on non-accrual loans, 2) the increase in our production of commercial real estate and commercial loans, which have a lower effective yield than our construction loan portfolio, and 3) the decrease in interest rates due to the decrease in the prime rate.

For the three months ended March 31, 2008, investment yields decreased as a result of the declines in the value of our trading securities underlying our deferred compensation plan. The average balance of investment securities decreased by $59.5 million or 24.7% as compared to the same period in 2007 due to sales and principal paydowns of mortgage-backed securities. The majority of investment securities are fixed-rate, and thus the yield from these investments does not change as the market rates change.

The cost of interest-bearing liabilities decreased from 5.0% to 4.6% for the three months ended March 31, 2007 and 2008, respectively, as a result of our declining deposit rates in a highly competitive market for deposits. We anticipate further declines in our cost of interest-bearing liabilities as high cost time deposits mature and are renewed at lower rates.

The average interest cost on FHLB advances decreased from 5.0% to 4.7% for the three months ended March 31, 2007 and 2008, respectively, as we borrowed $52.0 million less at March 31, 2008 than in the same period in 2007.  Similarly, the cost of other borrowings, comprised of federal funds purchased and draw downs on our secured and unsecured lines of credit, decreased 47 basis points from the three months ended March 31, 2007 to the same period in 2008. The decrease in average interest costs is a result of lower interest rates for the three months ended March 31, 2008 as compared to the same period in 2007.

The cost of subordinated debt decreased from 8.7% to 8.0% for the three months ended March 31, 2007 and 2008, respectively.  The cost of junior subordinated debentures decreased 100 basis points from the three months ended March 31, 2007 to the same period in 2008. The decreases in the cost of subordinated debt and junior subordinated debentures are a result of the lower interest rates in 2008, 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 lower interest rates during the period, resulted in a net interest margin of 3.47% for the three months ended March 31, 2008. The margin decreased from the 4.18% level for the three months ended March 31, 2007.

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 months ended March 31, 2008 and 2007.  Loans include non-accrual loans where non-accrual interest is excluded.
 

(Dollars in thousands)
 
For the three months ended March 31,
 
   
2008
   
2007
 
   
Average
         
Average
   
Average
         
Average
 
   
Balance
   
Interest