**UNITED STATES**SECURITIES AND EXCHANGE COMMISSION

**Washington,D.C. 20529**

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FORM 10-K

**(Mark One)**

**x**                               ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended December 31, 2004**

**or**

**o**                                  TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(b) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period N/A to N/A**

**Commissionfile number 000-23925**

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**MID-STATE BANCSHARES**

(Exact name of registrantas specified in its charter)
| **California**                                                   | **77-0442667**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction  of incorporation or organization) | (I.R.S.  Employer Identification No.) |
| **1026 Grand Ave.  Arroyo Grande, CA**                           | **93420**                             |
| (Address of  principal executive offices)                        | (Zip Code)                            |

**(805)473-6829**

Registrant’s telephonenumber, including area code :

**None**

Securities registeredpursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) ofthe Act:

**Common Stock**

**(nopar value)**

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2). Yes x   No o

The aggregate market valueof the common stock held by non-affiliates of the registrant as of June 30,2004 was $523,007,621.

The number of shares ofcommon stock of the registrant outstanding as of March 2, 2005 was22,993,521.

The following documentsare incorporated by reference herein:  Part III,Items 10 through 14 are incorporated from Registrant’s definitive proxystatement for the 2005 Annual Meeting of Shareholders.

Thisannual report on Form 10K is 91 pages long.

 

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**TABLEOF CONTENTS**
|            | ** **                                                                                                                   | **Page** |
|------------|------------------------------------------------------------------------------------------------------------------------------|----------|
|       |                                                                                                                         |     |   |
| ** ** | **PART I**                                                                                                              |     |
|       |                                                                                                                         |     |   |
| ITEM 1.    | BUSINESS                                                                                                                     | 1        |   |
| ITEM 2.    | PROPERTIES                                                                                                                   | 20       |   |
| ITEM 3.    | LEGAL PROCEEDINGS                                                                                                            | 22       |   |
| ITEM 4.    | SUBMISSION OF MATTERS TO A VOTE OF  SECURITY HOLDERS                                                                         | 22       |   |
|       |                                                                                                                         |     |   |
| ** ** | **PART II**                                                                                                             |     |   |
|       |                                                                                                                         |     |   |
| ITEM 5.    | MARKET  FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER  PURCHASES OF EQUITY SECURITIES  | 23       |   |
| ITEM 6.    | SELECTED FINANCIAL DATA                                                                                                      | 26       |   |
| ITEM 7.    | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                  | 27       |   |
| ITEM  7A.  | QUANTITATIVE AND QUALITATIVE  DISCLOSURE ABOUT MARKET RISK                                                                   | 48       |   |
| ITEM 8  .  | FINANCIAL STATEMENTS AND  SUPPLEMENTARY DATA                                                                                 | 49       |   |
| ITEM 9.    | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                                        | 86       |   |
| ITEM  9A.  | CONTROLS AND PROCEDURES                                                                                                      | 86       |   |
| ITEM  9B.  | OTHER INFORMATION                                                                                                            | 86       |   |
|       |                                                                                                                         |     |   |
| ** ** | **PART III**                                                                                                            |     |   |
|       |                                                                                                                         |     |   |
| ITEM 10.   | DIRECTORS AND EXECUTIVE OFFICERS  OF THE REGISTRANT                                                                          | 87       |   |
| ITEM  11.  | EXECUTIVE COMPENSATION                                                                                                       | 87       |   |
| ITEM  12.  | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                                                              | 87       |   |
| ITEM  13.  | CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS                                                                              | 87       |   |
| ITEM  14.  | PRINCIPAL ACCOUNTING FEES AND  SERVICES                                                                                      | 87       |   |
|       |                                                                                                                         |     |   |
| ** ** | **PART IV**                                                                                                             |     |   |
|       |                                                                                                                         |     |   |
| ITEM 15.   | EXHIBITS AND FINANCIAL STATEMENT  SCHEDULES                                                                                  | 88       |   |
|       | SIGNATURES                                                                                                                   | 89       |   |

 

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**PART I**

**Certain statementscontained in this Annual Report on Form 10-K (“Annual Report”),including, without limitation, statements containing the words “estimates”, “believes”,“anticipates”, “intends”, “may”, “expects”, “could” and words of similar import,constitute “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities andExchange Act of 1934. These forward- looking statements relate to, among otherthings, our current expectations regarding future operating results, netinterest margin, strength of the local economy, allowance for credit losses andthe integration of our acquisition of Ojai Valley Bank. They involve known andunknown risks, uncertainties and other factors that may cause the actualresults, performance or achievements of the Company to be materially differentfrom any future results, performance or achievements expressed or implied bysuch forward-looking statements. Such factors include, among others, thefollowing: general economic and business conditions in those areas in which theCompany operates, demographic changes, competition, natural disasters, growthin loans and deposits, fluctuations in interest rates, changes in businessstrategy or development plans, changes in governmental regulation, creditquality, the availability of capital to fund the expansion of the Company’sbusiness, economic, political and global changes arising from the war onterrorism and the conflict in Iraq, and other factors referenced in thisreport, including in “Item 1. Business—Factors that May Affect FutureResults of Operations.” When relying on forward-looking statements to makedecisions with respect to our Company, investors and others are cautioned toconsider these and other risks and uncertainties. The Company disclaims anyobligation to update any such factors or to publicly announce the results ofany revisions to any of the forward-looking statements contained herein toreflect future events or developments.**

**This discussion should be read in conjunction with ourfinancial statements, including the notes thereto, appearing elsewhere in thisreport.**

**ITEM 1**.BUSINESS

***Mid-State Bancshares and Mid-State Bank &Trust***

Mid-State Bancshares (the Company) is the parentcompany to Mid-State Bank & Trust (the Bank), its 100% owned principalsubsidiary. The Company is registered as a bank holding company under the BankHolding Company Act of 1956, as amended (BHC Act) and is subject to thesupervision and regulation of the Board of Governors of the Federal ReserveSystem (Federal Reserve Board).

The Company, through the Bank, derives its incomeprimarily from interest received on loans, and to a lesser extent, frominterest on investment securities, fees received in connection with loans andother services offered, including loan servicing and deposit services. TheCompany’s major operating expenses are the interest it pays on deposits andborrowings and general operating expenses. The Company’s operations, like thoseof other financial institutions operating in California, are significantlyinfluenced by economic conditions in California, including the strength of thereal estate market, the fiscal and regulatory policies of the federalgovernment and of the regulatory authorities that govern financial institutions.See “Supervision and Regulation.”

Mid-State Bank & Trust was incorporated underthe laws of the State of California and commenced operations on June 12,1961 as a California state chartered bank. The Bank’s accounts are insured bythe Federal Deposit Insurance Corporation (FDIC), but it is not a member of theFederal Reserve System. At December 31, 2004 the Company had total assetsof approximately $2.3 billion, total deposits of $2.0 billion and totalshareholders’ equity of $275 million.

The Bank operates 41 full service retail-bankingoffices along the central coast of California in Santa Barbara, San Luis Obispoand Ventura counties. The Bank’s headquarters is located in Arroyo Grande andit also serves the communities of Paso Robles, Cambria, Templeton, Atascadero,Cayucos, Morro Bay, Los Osos, San Luis Obispo, Pismo Beach, Grover Beach,Guadalupe, Nipomo, Santa Maria, Orcutt, 

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Lompoc, VandenbergVillage, Buellton, Santa Ynez, Solvang, Goleta, Oxnard, Camarillo, Ojai, OakView, Ventura and Santa Barbara. The headquarters’ street address is 1026 GrandAve., Arroyo Grande, CA 93420. Its mailing address is P.O. Box 6002,Arroyo Grande, CA 93421-6002. The telephone number is: (805) 473-6829.The Bank can also be reached through its internet address at *www.midstatebank.com*.

The Bank is a full-servicecommunity bank offering a broad range of banking products and services,including accepting time and demand deposits, originating loans and leases,providing trust services, and making other investments. The Bank originatesseveral types of loans, including secured and unsecured commercial and consumerloans, residential real estate mortgage loans, and residential constructionloans. The Bank’s loans are both short-term and intermediate term in length andconsist of both fixed and adjustable rate contracts. Special services andrequests beyond the lending limits of the Bank are arranged throughcorrespondent banks.

***Bank Subsidiaries***

The Bank operates two wholly owned subsidiaries—MidCoast Land Company and MSB Properties. Mid Coast Land Company was founded in1984 pursuant to section 751.3 of the Financial Code of the State of California.Section 751.3 provided that state-chartered banks were authorized toinvest in a corporation that engaged in real estate activities. Under theFederal Deposit Insurance Corporation Improvement Act (FDICIA) which became lawin December 1991, the Bank, through Mid Coast Land Company, was requiredto divest itself of its real estate development activities. That process wascompleted in January 2003. The holdings and results of operations of MidCoast Land Company are included within the consolidated financial statements ofthe****Company. On a stand-alone basis, MidCoast Land Company had after-tax earnings of $379 thousand in 2004, $322thousand in 2003, and a loss of $72 thousand in 2002. For further informationconcerning Mid Coast Land Company, see the Subsidiary Activity section of theManagement’s Discussion and Analysis section included in Item 7 of this Report.

MSB Properties was incorporated under the laws of theState of California in May of 1968, allowing for the ownership of propertywhich may be reasonably necessary for the expansion of the Bank’s business, orwhich is otherwise reasonably related to the conduct of the Bank’s business,pursuant to Section 752 of the Financial Code of the State of California.

The holdings and resultsof operations of MSB Properties are included within the consolidated financialstatements of the Company. On a stand-alone basis, MSB Properties had earningsof $1.2 million, $1.4 million, and $1.3 million in 2004, 2003, and 2002,respectively. For further information concerning MSB Properties, see theSubsidiary Activity portions of the Management’s Discussion and Analysis sectionincluded in Item 7. of this Report.

***Acquisition of Ojai Valley Bank***

On October 31, 2003, Mid-State Bancshares and itswholly owned subsidiary Mid-State Bank & Trust acquired 100 percent ofthe outstanding common stock of Ojai Valley Bank. The results of Ojai ValleyBank’s operations have been included in the consolidated financial statementssince that date. Ojai Valley Bank was a community bank serving the communitiesof Ojai and Oak View in Ventura County. The merger gives Mid-State Bank &Trust two new offices in Ventura County.

The aggregate purchaseprice was $25.0 million, including $11.8 million in cash paid to Ojai ValleyBank shareholders, $11.8 million in Mid-State Bancshares’ common stock issuedand $1.3 million for other merger related expenses. The value of the 498,153shares issued was determined based on the average closing market price ofMid-State Bancshares’ common stock over the twenty consecutive trading daysthat Mid-State Bancshares’ stock traded ending October 24, 2003. Theaverage price of Mid-State Bancshares’ stock over that period was $23.78. Themerger was accounted for utilizing the purchase method of accounting.

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***Services***

The Bank offers a fullrange of commercial banking services including checking accounts, NOW accounts,savings accounts, money market accounts, and various types of time certificatesof deposit (including various maturities and individual retirement accounts). TheBank makes a variety of construction and land development loans, real estaterelated loans, home equity credit lines, installment loans, agricultural andcommercial loans, business equipment leases and SBA loans. Other servicesoffered by the Bank include, but are not limited to, trust services, safedeposit boxes, travelers cheques, notary public, merchant depository servicesfor VISA and Mastercard, cash management, home banking, telephone voiceresponse system and ATM’s. The Bank’s organization and structure is designed toserve the banking needs of individuals and small to medium sized businesses in SantaBarbara, Ventura and San Luis Obispo counties.

***Deposit and Liability Management***

Deposits represent the Bank’s primary source of funds.As of December 31, 2004 the Bank had approximately 36,713 non interestbearing demand deposit accounts representing $517.1 million, or an average of$14,085 per account. The Bank also had approximately 121,526 NOW, Money Marketand Savings accounts amounting to $1,083 million, or about $8,912 average peraccount. There were 16,054 time certificates of deposit outstanding at December 31,2004, representing $394.3 million with an average deposit balance ofapproximately $24,559. Of the total time certificates of deposit, $166.3million represented holders who carried an amount on deposit of $100,000 ormore, approximately 42% of the total.

The Bank is not dependent on a single or a fewcustomers for its deposits. Most deposits are obtained from individuals andsmall-to-medium sized businesses. This results in the relatively small averagebalances noted above and allows the Bank to be less subject to the adverseeffects of the loss of a large depositor. As of December 31, 2004, noindividual, corporate, or public depositor accounted for more than 2% of theBank’s total deposits.

Liquidity is the Bank’s ability to meet fluctuationsin deposit levels and to provide for the credit needs of its customers. Theobjective in liquidity management is to maintain a balance between the sourcesand uses of funds. Principal sources of liquidity include interest andprincipal payments on loans and investments, proceeds from the maturity ofinvestments and growth in deposits. The Bank holds overnight Fed Funds Sold asa cushion for temporary liquidity needs. For 2004, Fed Funds Sold averaged$37.4 million representing 1.6% of average assets. In addition, the Bankmaintains Federal Funds lines of credit totaling $70 million with majorcorrespondents, subject to customary terms for such arrangements.

The Bank’s internally calculated liquidity ratio,which measures the percentage of total liabilities (excluding equity) which areused to fund cash, cash equivalents and non-pledged marketable securities, was34.2%—in excess of the Bank’s policy minimum of 15%.

Liquidity demands at theHolding Company have been limited historically to dividend payments it makes toits stockholders, the repurchase of its common stock, and certain payments tovendors. Management does not anticipate any further demands requiring liquidityin the near term. Currently, the liquidity needs of the Holding Company arefunded by dividends it receives from the Bank.

***Loans***

The Bank’s loan-to-deposit ratio stood atapproximately 71.3% at year-end 2004. It is the Bank’s goal to maintain itsloan-to-deposit ratio in the 65% to 75% range while maintaining credit quality.

The Bank maintains an allowance for loan losses whichis netted against loans on the balance sheet. Additions to the allowance aremade by charges to expense. All loans deemed to be uncollectible are 

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charged to the allowance;subsequent recoveries are credited to the allowance. The amount in the loanloss allowance is an estimate of the losses inherent in the loan portfolio asdetermined by a variety of factors considered by Management. Factors include,but are not limited to, the current economic climate, type and quality of loansin the portfolio, trends in delinquencies, historical loss rates, non-accrualtotals, diversification of the portfolio, value of available collateral and thecost of collateral liquidation.

As of December 31,2004, the Bank’s allowance for loan losses stood at $13.8 million. Additionally,the Bank has an allowance for losses on unfunded commitments totaling $1.8million. Collectively, these allowances for losses represent 145.6% ofnon-performing loans (non-accrual loans plus loans 90 days or more past due). Outsidefactors, not within the Bank’s control, such as adverse changes in the economy,can affect the adequacy of the allowances and there can be no assurance that inany given period, the Bank might not suffer losses which are substantial inrelation to the size of the allowances. During 2004, the Bank experienced netrecoveries after charge-offs, of $0.4 million, or 0.03% of average loans.

***Underwriting and Credit Administration***

The lending activities of Mid-State Bank &Trust are guided by the lending policies approved by the Bank’s Board ofDirectors. The credit policy is managed through periodic reviews and approvedannually by the Board.

Each loan is evaluated using underwriting criteriaestablished in the Bank’s lending policy. Lending authority is granted toofficers of the Bank on a limited basis, dependent upon individual knowledgeand experience. Loan requests exceeding individual limits are submitted to theBoard Loan Committee, which consists of the President, Chief Credit Officer andthree non-management directors. The Board Loan Committee meets on a regularbasis in order to provide timely responses to the Bank’s clients.

Mid-State Bank &Trust’s credit administration function includes an internal review and theregular use of an outside loan review firm.

***Loan Portfolio***

At December 31,2004 and 2003, Mid-State Bank & Trust’s gross loan portfolio totaled$1.4 billion and $1.1 billion, respectively. The portfolio was distributed asfollows:
| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Construction and  Land Development          |       | 16.1                  | %          | 20.8 | % |
| Real Estate—Farmland                   |       | 2.3                   | %          | 2.1 | % |
| Real Estate—Residential                |       | 13.7                  | %          | 7.4 | % |
| Real Estate—Non  Farm, Non Residential |       | 37.5                  | %          | 39.6 | % |
| Home Equity  Credit Lines                   |       | 11.2                  | %          | 7.8 | % |
| Cash Reserve                                |       | 0.3                   | %          | 0.6 | % |
| Installment                                 |       | 1.3                   | %          | 2.2 | % |
| Agricultural  Production                    |       | 2.8                   | %          | 2.9 | % |
| Commercial, Other                           |       | 14.8                  | %          | 16.6 | % |
|                                        |       | 100.0                 | %          | 100.0 | % |

 

The interest rates charged for the loans made by theBank vary with the degree of risk, size and maturity of the loans. Rates aregenerally affected by competition, the client’s deposit relationship with theBank, and the Bank’s cost of funds.

*Commercial Loans.*   The Bankprovides financial services to diverse commercial and professional businessesin the marketplace. Commercial loans consist primarily of short term loans(normally with a 

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maturity of one year orless) for working capital and business expansion. Commercial loans typicallyinclude revolving lines of credit, either uncollateralized, or collateralizedby inventory, loans secured by accounts receivable and equipment loans. Emphasisis placed on the borrower’s earnings history, capitalization, secondary sourcesof repayment, and in some instances, third-party guarantees or highly liquidcollateral (such as time deposits and investment securities). Commercial loanpricing is generally at a rate tied to the prime rate (as quoted in the *Wall Street Journal*) or the Bank’s reference rates. Certainequipment loans may be made at fixed rates for short to medium terms.

The Bank participates in a Small BusinessAdministration (SBA) loan guarantee program. Those programs used include boththe 504 program, which is focused toward longer-term financing of buildings andother long-term assets, and the 7A program, which is primarily used forfinancing of equipment, inventory and working capital needs of eligiblebusinesses, generally over a three to twenty-five year term. The Bank’scollateral position in the SBA loans is enhanced by the SBA guarantee in thecase of 7A loans, and by lower loan-to-value ratios under the 504 program. TheBank is designated as a preferred lender by the SBA, allowing it to processthese loans more quickly. Under the SBA’s Preferred Lending Program, the SBAdelegates a substantial degree of lending authority to participating lenders,such as the Bank. The Bank also participates in other government sponsored loanprograms offered by various government agencies, such as through the CaliforniaCoastal Rural Development Corporation, Central Coast Development Companies andothers.

*Agricultural Loans*.   TheBank provides production loans to help finance the seasonal needs of farmingoperations, including crop and livestock financing, inventory purchases, andreceivable financing. The Bank has very limited vineyard lending exposure (lessthan $10 million at December 31, 2004). Equipment loans are also financedon everything from field equipment to office automation systems. Emphasis isplaced on the borrower’s earnings history, capitalization, secondary sources ofrepayment, and in some instances, third-party guarantees or highly liquidcollateral (such as time deposits and investment securities). Agricultural loanpricing, like Commercial loan pricing, is generally at a rate tied to the primerate (as quoted in the *Wall Street Journal*)or the Bank’s reference rates. Certain equipment loans may be made at fixedrates for short to medium terms.

*Real Estate Construction and Development Loans.*   TheBank’s real estate construction loan activity has focused on providingshort-term (maturity of two years or less) loans to individuals and developerswith whom the Bank has established relationships, for the constructionprimarily of single family residences in the Bank’s market area.

Residential real estate construction loans aretypically secured by first deeds of trust. The economic viability of theproject and the borrower’s credit-worthiness are primary considerations in theloan underwriting decision. The Bank utilizes approved independent localappraisers as well as in-house staff, and loan-to-value ratios that generallydo not exceed 80% of the appraised value of the property. The Bank monitorsprojects during the construction phase through regular construction inspectionsand a disbursement program tied to the percentage of completion of eachproject.

The Bank also occasionally makes land loans toindividuals and developers who intend to construct a single-family residence(s) onthe lot, generally within 24 months. In addition, the Bank makes commercialreal estate construction loans for construction of office and warehouseproperties, generally to high-net-worth clients with adequate liquidity. Theeconomic viability of the project and the borrower’s credit-worthiness areprimary considerations in the loan underwriting decision. Such loans aretypically secured by first deeds of trust.

*Commercial Real Estate Term Loans and Loans Securedby Farmland.*   The Bank provides medium-term commercialreal estate loans secured by commercial or industrial buildings or farmlandwhere the properties are either used by the owner for business purposes(owner-user properties) or have income derived from tenants (investmentproperties). As a general rule, the Bank’s loan policies require the 

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principal balance of theloan to be no more than 70% of the stabilized appraised value of the underlyingreal estate collateral. The loans, which are typically secured by first deedsof trust only, generally have terms of no more than ten years and are amortizedover 25 to 30 years. Some of these loans have rates tied to Wall Street Journalprime rate that adjust whenever the prime rate changes. The remaining loansadjust every three, five or seven years depending upon the index to which theloan is tied.

*Residential Real Estate Loans*.   TheBank provides a variety of real estate loans secured by residential real estate.These loans are generally secured by first or second trust deeds on individualresidential properties. Most of these loans are sold, servicing retained, inthe secondary market. Certain shorter term mortgages, especially jumboadjustable rate mortgages, may be kept in portfolio and not sold in thesecondary market depending on the Bank’s appetite for these earning assets.  These consist of adjustable rate loans with ashort fixed rate period of 3, 5 or 7 years, then adjusted annually using anindex of the 1 year treasury constant maturity or 1 year LIBOR. These loans areoriginated using FNMA/FHMLC underwriting guidelines. Although the loans areheld for investment, they are eligible for sale in the secondary market.

*Home Equity Credit Lines*.   TheBank provides lines of credit secured by a first or second deed of trust on theborrower’s residential real property. The loans have a 15 year draw periodfollowed by a 15 year amortization of the outstanding principal balance. Theloans have an interest rate that adjusts monthly with the Wall Street Journalpublished prime rate. The total combined percentage of the of the Home EquityCredit Line and first mortgage is dependent on several factors such as creditscore, income ratios, stability of employment etc, and can go as high as 100%.

*Consumer and Other Loans.*   TheBank’s consumer and other loan portfolio is divided between installment loanssecured by automobiles, other consumer purposes and revolving, unsecuredconsumer debt such as reserve lines of credit. Installment loans tend to befixed rate and longer-term (one-to-five-year maturity). The Bank’s portfolio ofrevolving credit plans, issued as an additional service to its clients, isminimal at just 0.3% of total loans.

***Investment Securities***

The Bank maintains a portfolio of investmentsecurities to provide income and to serve as a secondary source of liquidityfor its operations in conjunction with Federal Funds Sold (see Deposit andLiability Management above). The Bank’s investment policy provides for thepurchase of United States Treasury Securities, United States Government AgencySecurities, Mortgage Backed Securities, Obligations of State and PoliticalSubdivisions, and Other Securities as permitted by Federal and State regulation.As of December 31, 2004, the aggregate carrying value of the InvestmentPortfolio was $644.8 million. Of this total, $25.5 million was invested in U.S.Treasury Securities, $216.7 million in U.S. Government Agencies, $9.4 millionin Mortgage Backed Securities, $377.0 million in Obligations of State andPolitical Subdivisions and $16.2 million in Other Securities. The types ofsecurities held are influenced by several factors, which include: rate ofreturn, maturity, and risk. Generally, the Bank endeavors to stagger thematurities of its securities so that it has regular maturities for liquiditypurposes. The Bank does not participate in any swap or hedge activity on theinvestment portfolio (or any other part of the balance sheet) and has no plansto begin such activity.

Acceptable securities maybe pledged to secure public deposits from State and Public Agencies. As of December 31,2004, the Bank had public funds totaling approximately $55.6 million. The Bankhas made available $106.4 million of securities to securitize these funds. Excesscollateral can be released as needed.

***Economic Climate***

The economy in the Bank’strade area is based upon agriculture, oil, tourism, light industry, governmentservices, aerospace industries and retail trade. Services supporting thoseinvolved in these 

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industrieshave also developed in the areas of medical, financial and educational services.Population in the Tri-county area, according to the California Department ofFinance, is estimated at January 2004 to be 1,475,400. Ventura Countyrepresents about 54% of this total with Santa Barbara and San Luis ObispoCounties accounting for 28% and 18% respectively. Certain economic activitiesare unique to the area such as the space launching facilities at Vandenberg AirForce Base and the production of seeds for various flowers grown worldwide. Whilemajor oil companies have elected to do business elsewhere (due to verystringent county business regulations), smaller production companies have movedin to continue the oil industry in the area. The moderate climate allows a yearround growing season for numerous vegetables and fruits. Vineyards and cattleranches make large contributions to the local economy. There are large numbersof retail businesses and light manufacturers with only limited numbers of hightech firms throughout the service area. Access to numerous recreationalactivities, including both mountains and beaches, provide a fairly stabletourist industry from larger metropolitan areas such as the Los Angeles/OrangeCounty basin and the San Francisco Bay area. Real estate values throughout theTri-counties have steadily increased in recent years. With the diversity of thevarious types of industries in the Bank’s service area, the Central Coast,while not immune from economic fluctuations, has historically tended to enjoy amore stable level of economic activity than many other areas of California.

***Competition***

The banking business in California generally, and inthe Bank’s primary service areas specifically, is highly competitive withrespect to both loans and deposits and is dominated by a relatively smallnumber of major banks with many offices and operations over a wide geographicarea. Among the advantages such major banks have over the Bank are theirability to finance wide-ranging advertising campaigns and to allocatetheir investment assets to regions of higher yield and demand. Such banks offercertain services such as international banking which is not offered directly bythe Bank, but which can be offered indirectly by the Bank through correspondentinstitutions. In addition, by virtue of their greater total capitalization,such banks have substantially higher lending limits than the Bank. (Legallending limits to an individual customer are based upon a percentage of a bank’stotal capital accounts.) The Bank’s secured and unsecured lending limits at December 31,2004, were approximately $56.5 million and $33.9 million, respectively. Theselevels compare to $54.3 million and $32.6 million, respectively, at December 31,2003.

Other entities, both governmental and in privateindustry, seeking to raise capital through the issuance and sale of debt orequity securities, also provide competition for the Bank in the acquisition ofdeposits. Banks also compete with money market funds and other providers ofmoney market instruments.

Commercial banks compete with savings and loanassociations, credit unions, other financial institutions, securities brokeragefirms and other entities for funds. For instance, yields on corporate andgovernment debt securities and other commercial paper affect the ability ofcommercial banks to attract and hold deposits. Commercial banks also competefor loans with savings and loan associations, credit unions, consumer financecompanies, mortgage companies and other lending institutions.

The financial services industry is undergoing rapidtechnological changes involving frequent introductions of new technology-drivenproducts and services that have further increased competition. There can alsobe no assurance that these technological improvements, if made, will increasethe Bank’s operational efficiency or that the Bank will be able to effectivelyimplement new technology-driven products and services or be successful inmarketing these products and services to our customers.

The trend towardconsolidation of banking assets exhibited over the past few years in Californiacontinued in 2004. Statewide, through November 2004, 21 banks are mergingout of existence based on announced merger transactions. According to theCalifornia State Department of Financial Institutions however, 14 new bankshave filed in 2004 to start a new bank in California, as of November 2004.

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***Employees***

At December 31, 2004,the Bank had a total of 860 employees. A number of these employees arepart-time however. On a full-time equivalent basis, employees represent 794positions. The Bank believes that its employee relations are positive.

***Effect of Governmental Policies and Legislation***

Banking is a business that depends on ratedifferentials. In general, the difference between the interest rate paid by theBank on its deposits and its other borrowings and the interest rate received bythe Bank on loans extended to its customers and securities held in the Bank’sportfolio comprise the major portion of the Bank’s earnings. These rates arehighly sensitive to many factors that are beyond the control of the Bank. Accordingly,the earnings and growth of the Bank are subject to the influence of local,domestic and foreign economic conditions, including recession, unemployment andinflation.

The commercial banking business is not only affectedby general economic conditions but is also influenced by the monetary andfiscal policies of the federal government and the policies of regulatoryagencies, particularly the Federal Reserve Board. The Federal Reserve Boardimplements national monetary policies (with objectives such as curbinginflation and combating recession) by its open-market operations inUnited States Government securities which effect short term rates such as theFed Funds rate, by adjusting the required level of reserves for financialinstitutions subject to its reserve requirements and by varying the discountrates applicable to borrowings by depository institutions. The actions of theFederal Reserve Board in these areas influence the growth of bank loans,investments and deposits and also affect interest rates charged on loans andpaid on deposits. The nature and impact on the Bank of any future changes inmonetary policies cannot be predicted.

From time to time,legislation is enacted which has the effect of increasing the cost of doingbusiness, limiting or expanding permissible activities or affecting thecompetitive balance between banks and other financial intermediaries. Proposalsto change the laws and regulations governing the operations and taxation ofbanks, bank holding companies and other financial intermediaries are frequentlymade in Congress, the California legislature and before various bank regulatoryand other professional agencies. See “Financial Services ModernizationLegislation,” and “Sarbanes-Oxley Act of 2002.”

***Supervision and Regulation***

The Bank is extensivelyregulated under both federal and state law. Set forth below, is a summarydescription of certain laws which relate to the regulation of the Company andthe Bank. The description does not purport to be complete and is qualified in itsentirety by reference to the applicable laws and regulations.

***Mid-State Bancshares***

The Company is a bank holding company within themeaning of the Bank Holding Company Act of 1956, as amended (the “Bank HoldingCompany Act”), and is registered as such with, and subject to the supervisionof, the Federal Reserve Board. It is required to file with the Federal ReserveBoard quarterly and annual reports and such additional information as theFederal Reserve Board may require pursuant to the Bank Holding Company Act. TheFederal Reserve Board may conduct examinations of bank holding companies andtheir subsidiaries.

The Company is required to obtain the approval of theFederal Reserve Board before it may acquire all or substantially all of theassets of any bank, or ownership or control of the voting shares of any bankif, after giving effect to such acquisition of shares, the Company would own orcontrol more than 5% of the 

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voting shares of such bank.Prior approval of the Federal Reserve Board is also required for the merger orconsolidation of the Company and another bank holding company.

The Company is prohibited by the Bank Holding CompanyAct, except in certain statutorily prescribed instances, from acquiring director indirect ownership or control of more than 5% of the outstanding votingshares of any company that is not a bank or bank holding company and fromengaging, directly or indirectly, in activities other than those of banking,managing or controlling banks or furnishing services to its subsidiaries.However, the Company may, subject to the prior approval of the Federal ReserveBoard, engage in any, or acquire shares of companies engaged in, activitiesthat are deemed by the Federal Reserve Board to be so closely related tobanking or managing or controlling banks as to be a proper incident thereto.

The Federal Reserve Board may require that the Companyterminate an activity or terminate control of or liquidate or divestsubsidiaries or affiliates when the Federal Reserve Board determines that the activityor the control or the subsidiary or affiliates constitutes a significant riskto the financial safety, soundness or stability of any of its bankingsubsidiaries. The Federal Reserve Board also has the authority to regulateprovisions of certain bank holding company debt, including authority to imposeinterest ceilings and reserve requirements on such debt. Under certaincircumstances, the Company must file written notice and obtain approval fromthe Federal Reserve Board prior to purchasing or redeeming its equitysecurities.

Under the Federal Reserve Board’s regulations, a bankholding company is required to serve as a source of financial and managerialstrength to its subsidiary banks and may not conduct its operations in anunsafe and unsound manner. In addition, it is the Federal Reserve Board’spolicy that in serving as a source of strength to its subsidiary banks, a bankholding company should stand ready to use available resources to provideadequate capital funds to its subsidiary banks during periods of financialstress or adversity and should maintain the financial flexibility andcapital-raising capacity to obtain additional resources for assisting itssubsidiary banks. A bank holding company’s failure to meet its obligations toserve as a source of strength to its subsidiary banks will generally be consideredby the Federal Reserve Board to be an unsafe and unsound banking practice or aviolation of the Federal Reserve Board’s regulations or both.

The Company and the Bank are prohibited from engagingin certain tie-in arrangements in connection with any extension of credit, saleor lease of property or furnishing of services. For example, with certainexceptions, neither the Company nor the Bank may condition an extension ofcredit to a customer on either (1) a requirement that the customer obtainadditional services provided by the Company and the Bank or (2) anagreement by the customer to refrain from obtaining other services from acompetitor.

The Company’s common stockis registered with the Securities and Exchange Commission (the “SEC”) under theSecurities Exchange Act of 1934, as amended. As such, we are subject to theinformation, proxy solicitation, insider trading, corporate governance, andother requirements and restrictions of such Act.

***The Bank***

The Bank is chartered under the laws of the State ofCalifornia and its deposits are insured by the FDIC to the extent provided bylaw. The Bank is subject to the supervision of, and is regularly examined by,the California Department of Financial Institutions (DFI)****andthe FDIC. Such supervision and regulation include comprehensive reviews of allmajor aspects of the Bank’s business and condition.

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Various requirements and restrictions under the lawsof the United States and the State of California affect the operations of theBank. Federal and California statutes relate to many aspects of the Bank’soperations, including reserves against deposits, interest rates payable ondeposits, loans, investments, mergers and acquisitions, borrowings, dividendsand locations of branch offices. Further, the Bank is required to maintaincertain levels of capital.

If, as a result of anexamination of a bank, the FDIC or the DFI should determine that the financialcondition, capital resources, asset quality, earnings prospects, management,liquidity, or other aspects of the Bank’s operations are unsatisfactory or thatthe Bank or its management is violating or has violated any law or regulation,various remedies are available to these regulatory agencies. Such remediesinclude the power to enjoin “unsafe or unsound” practices, to requireaffirmative action to correct any conditions resulting from any violation orpractice, to issue an administrative order that can be judicially enforced, todirect an increase in capital, to restrict the growth of the Bank, to assesscivil monetary penalties, to remove officers and directors, and ultimately toterminate the Bank’s deposit insurance, which for a California chartered bankwould result in a revocation of the bank’s charter.

***Capital Standards***

The Federal Reserve Board and the FDIC have adoptedrisk-based minimum capital guidelines intended to provide a measure ofcapital that reflects the degree of risk associated with a banking organization’soperations for both transactions reported on the balance sheet as assets andtransactions, such as letters of credit and recourse arrangements, which arerecorded as off balance sheet items. Under these guidelines, nominal dollaramounts of assets and credit equivalent amounts of off balance sheet items aremultiplied by one of several risk adjustment percentages, which range from 0%for assets with low credit risk, such as certain U.S. Treasury securities, to100% for assets with relatively high credit risk, such as certain businessloans.

A banking organization’s risk-based capitalratios are obtained by dividing its qualifying capital by its total risk-adjustedassets. The regulators measure risk-adjusted assets, which includes offbalance sheet items, against both total qualifying capital (the sum of Tier 1capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1capital consists primarily of common stock, retained earnings, non-cumulativeperpetual preferred stock (cumulative perpetual preferred stock for bankholding companies) and minority interests in certain subsidiaries, less mostintangible assets. Tier 2 capital may consist of a limited amount of theallowance for loan and lease losses, cumulative preferred stock, long termpreferred stock, eligible term subordinated debt and certain other instrumentswith some characteristics of equity. The inclusion of elements of Tier 2capital is subject to certain other requirements and limitations of the federalbanking agencies. The federal banking agencies require a minimum ratio ofqualifying total capital to risk-adjusted assets of 8% and a minimumratio of Tier 1 capital to risk-adjusted assets of 4%.

In addition to the risk-based guidelines,federal banking regulators require banking organizations to maintain a minimumamount of Tier 1 capital to total assets, referred to as the leverage ratio. Fora banking organization rated in the highest of the five categories used byregulators to rate banking organizations, the minimum leverage ratio of Tier 1capital to total assets is 3%. For all banking organizations not rated in thehighest category, the minimum leverage ratio must be at least 100 to 200 basispoints above the 3% minimum, or 4% to 5%. In addition to these uniform risk-basedcapital guidelines and leverage ratios that apply across the industry, theregulators have the discretion to set individual minimum capital requirementsfor specific institutions at rates significantly above the minimum guidelinesand ratios.

Future changes in regulations or practices couldfurther reduce the amount of capital recognized for purposes of capitaladequacy. Such a change could affect the ability of the Bank to grow and couldrestrict the amount of profits, if any, available for the payment of dividendsto the Company.

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On January 1, 1998 legislation became effectivewhich, among other things, gave the DFI power to take possession of thebusiness and properties of a bank in the event that the tangible shareholders’equity of the bank is less than the greater of (i) 3% of the bank’s totalassets or (ii) $1.0 million.

For information concerning the capital ratios of theCompany and the Bank, see, “Item 7—Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”

Under applicableregulatory guidelines, the Bank was considered “Well Capitalized” as of December 31,2004.

***Prompt Corrective Action and Other EnforcementMechanisms***

Federal banking agencies possess broad powers to takecorrective and other supervisory action to resolve the problems of insureddepository institutions, including but not limited to those institutions thatfall below one or more prescribed minimum capital ratios described above. Aninstitution that, based upon its capital levels, is classified as wellcapitalized, adequately capitalized, or undercapitalized may be treated asthough it were in the next lower capital category if the appropriate federalbanking agency, after notice and opportunity for hearing, determines that anunsafe or unsound condition or an unsafe or unsound practice warrants suchtreatment. At each successive lower capital category, an insured depositoryinstitution is subject to more restrictions. The federal banking agencies,however, may not treat a significantly undercapitalized institution ascritically undercapitalized unless its capital ratio actually warrants suchtreatment.

In addition tomeasures taken under the prompt corrective action provisions, commercial bankingorganizations may be subject to potential enforcement actions by the federalregulators for unsafe or unsound practices in conducting their businesses orfor violations of any law, rule, regulation, or any condition imposed inwriting by the agency or any written agreement with the agency. Enforcementactions may include:

·       theimposition of a conservator or the issuance of a cease-and-desist order thatcan be judicially enforced;

·       thetermination of insurance of deposits (in the case of a depository institution);

·       theimposition of civil money penalties;

·       theissuance of directives to increase capital;

·       theissuance of formal and informal agreements;

·       theissuance of removal and prohibition orders against institution-affiliatedparties; and

·       theenforcement of such actions through injunctions or restraining orders basedupon a judicial determination that the agency would be harmed if such equitablerelief was not granted.

Additionally, a holding company’s inability to serveas a source of strength to its subsidiary banking organizations could serve asan additional basis for a regulatory action against the holding company.

Banks are also subject tocertain Federal Reserve Board restrictions on extensions of credit to executiveofficers, directors, principal shareholders or any related interests of suchpersons (i.e., insiders). Extensions of credit (1) must be made onsubstantially the same terms and pursuant to the same credit underwritingprocedures as those for comparable transactions with persons who are neitherinsiders nor employees, and (2) must not involve more than the normal riskof repayment or present other unfavorable features. Banks are also subject tocertain lending limits and restrictions on overdrafts to insiders. A violationof these restrictions may result in regulatory sanctions on the bank or itsinsiders*.*

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***Premiums for Deposit Insurance***

The Bank’s deposits are currently insured to a maximumof $100,000 per depositor through the Bank Insurance Fund administered by theFDIC. The Bank is required to pay deposit insurance premiums, which areassessed semiannually and paid quarterly. The premium amount is based upon arisk classification system established by the FDIC. Banks with higher levels ofcapital and a low degree of supervisory concern are assessed lower premiumsthan banks with lower levels of capital or a higher degree of supervisoryconcern.

The FDIC is also empowered to make special assessmentson insured depository institutions in amounts determined by the FDIC to be necessaryto give it adequate assessment income to repay amounts borrowed from the U.S.Treasury and other sources or for any other purpose the FDIC deems necessary.

The FDIC is authorized toterminate a depository institution’s deposit insurance upon a finding by theFDIC that the institution’s financial condition is unsafe or unsound or thatthe institution has engaged in unsafe or unsound practices or has violated anyapplicable rule, regulation, order or condition enacted or imposed by theinstitution’s regulatory agency.

***Sarbanes-Oxley Act of 2002***

On July 30, 2002, the Sarbanes-Oxley Act of 2002(“SOX”), was signed into law to address corporate and accounting fraud. SOXestablishes a new accounting oversight board that will enforce auditingstandards and restricts the scope of services that accounting firms may provideto their public company audit clients. Among other things, SOX also (i) requireschief executive officers and chief financial officers to certify to theaccuracy of periodic reports filed with the SEC; (ii) imposes newdisclosure requirements regarding internal controls, off-balance-sheettransactions, and pro forma (non-GAAP) disclosures; (iii) accelerates thetime frame for reporting of insider transactions and periodic disclosures bypublic companies; and (iv) requires companies to disclose whether or notthey have adopted a code of ethics for senior financial officers and whetherthe audit committee includes at least one “audit committee financial expert.”

Under SOX, the SEC is required to regularly andsystematically review corporate filings, based on certain enumerated factors.To deter wrongdoing, SOX: (i) subjects bonuses issued to top executives todisgorgement if a restatement of a company’s financial statements was due tocorporate misconduct; (ii) prohibits an officer or director frommisleading or coercing an auditor; (iii) prohibits insider trades duringpension fund “blackout periods”; (iv) imposes new criminal penalties forfraud and other wrongful acts; and (v) extends the period during whichcertain securities fraud lawsuits can be brought against a company or itsofficers.

As a public reportingcompany, the Company is subject to the requirements of SOX and related rules andregulations issued by the SEC and Nasdaq. The Company has incurred additionalexpense as a result of the requirements of the Act, but does not expect thatsuch compliance will have a material impact on its business overall.

***Financial Services Modernization Legislation***

On November 12, 1999, the Gramm-Leach-Bliley Actof 1999 (the “Financial Services Modernization Act”) was signed into law. TheFinancial Services Modernization Act is intended to modernize the bankingindustry by removing barriers to affiliation among banks, insurance companies,the securities industry and other financial service providers. It providesfinancial organizations with the flexibility of structuring such affiliationsthrough a holding company structure or through a financial subsidiary of abank, subject to certain limitations. The Financial Services Modernization Actestablishes a new type of bank holding company, known as a financial holdingcompany, which may engage in an expanded list of activities that 

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are “financial in nature,”which include securities and insurance brokerage, securities underwriting,insurance underwriting and merchant banking. The Company has not chosen to seek“financial holding company” status.

The Financial Services Modernization Act also setsforth a system of functional regulation that makes the Federal Reserve Boardthe “umbrella supervisor” for holding companies, while providing for thesupervision of the holding company’s subsidiaries by other federal and stateagencies. In addition, the Bank is subject to other provisions of the FinancialServices Modernization Act, including those relating to CRA, privacy andsafe-guarding confidential customer information, regardless of whether theCompany elects to become a financial holding company or to conduct activitiesthrough a financial subsidiary of the Bank. The Company does not, however,currently intend to file notice with the Federal Reserve Board to become afinancial holding company or to engage in expanded financial activities througha financial subsidiary of the Bank.

The Company and the Bankdo not believe that the Financial Services Modernization Act will have amaterial adverse effect on their operations in the near-term. However, to theextent that it permits banks, securities firms, and insurance companies toaffiliate, the financial services industry may experience further consolidation.The Financial Services Modernization Act is intended to grant to communitybanks certain powers as a matter of right that larger institutions have accumulatedon an ad hoc basis. Nevertheless, this act may have the result of increasingthe amount of competition that the Company and the Bank face from larger institutionsand other types of companies offering financial products, many of which mayhave substantially more financial resources than the Company and the Bank.

***USA Patriot Act of 2001***

On October 26, 2001,President Bush signed the Uniting and Strengthening America by ProvidingAppropriate Tools Required to Intercept and Obstruct Terrorism, or the PatriotAct, of 2001. Among other things, the Patriot Act (i) prohibits banks fromproviding correspondent accounts directly to foreign shell banks; (ii) imposesdue diligence requirements on banks opening or holding accounts for foreignfinancial institutions or wealthy foreign individuals (iii) requiresfinancial institutions to establish an anti-money-laundering complianceprogram, and (iv) eliminates civil liability for persons who filesuspicious activity reports. The Patriot Act also increases governmental powersto investigate terrorism, including expanded government access to accountrecords. The Department of the Treasury is empowered to administer and make rules toimplement the Patriot Act. While the Company and the Bank believes the PatriotAct may, to some degree, affect their recordkeeping and reporting expenses,they do not believe that it will have a material adverse effect on theirbusiness and operations.

***Transactions between Affiliates***

Transactions between abank and its “affiliates” are quantitatively and qualitatively restricted underthe Federal Reserve Act. The Federal Reserve Board issued Regulation W on October 31,2002, which comprehensively implements Sections 23A and 23B of the FederalReserve Act. Sections 23A and 23B and Regulation W restrict loans by adepository institution to its affiliates, asset purchases by a depositoryinstitution from its affiliates, and other transactions between a depositoryinstitution and its affiliates. Regulation W unifies in one public document theFederal Reserve Board’s interpretations of Section 23A and 23B. RegulationW had an effective date of April 1, 2003.

***Community Reinvestment Act***

The Bank is subject to certain fair lendingrequirements and reporting obligations involving home mortgage lendingoperations and CRA activities. The CRA generally requires the federal bankingagencies to evaluate the record of a financial institution in meeting thecredit needs of their local communities, 

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including low and moderateincome neighborhoods. In addition to substantial penalties and correctivemeasures that may be required for a violation of certain fair lending laws, thefederal banking agencies may take compliance with such laws and CRA intoaccount when regulating and supervising other activities.

When a bank holding companyapplies for approval to acquire a bank or other bank holding company, theFederal Reserve will review the assessment of each subsidiary bank of the applicantbank holding company, and such records may be the basis for denying the application.A bank’s compliance with its CRA obligations is based on a performance-basedevaluation system which bases CRA ratings on an institution’s lending serviceand investment performance, resulting in a rating by the appropriate bankregulatory agency of “outstanding”, “satisfactory”, “needs to improve” or “substantialnoncompliance.” At its last examination by the FDIC, the Bank received a CRArating of “Satisfactory.”

***Safety and Soundness Standards***

The Federal DepositInsurance Corporation Improvement Act (“FDICIA”) imposes certain specificrestrictions on transactions and requires federal banking regulators to adoptoverall safety and soundness standards for depository institutions related tointernal control, loan underwriting and documentation and asset growth. Amongother things, FDICIA limits the interest rates paid on deposits byundercapitalized institutions, restricts the use of brokered deposits, limitsthe aggregate extensions of credit by a depository institution to an executiveofficer, director, principal shareholder or related interest, and reducesdeposit insurance coverage for deposits offered by undercapitalized institutionsfor deposits by certain employee benefits accounts. The federal bankingagencies may require an institution to submit to an acceptable compliance planas well as have the flexibility to pursue other more appropriate or effectivecourses of action given the specific circumstances and severity of aninstitution’s noncompliance with one or more standards.

***Privacy***

Federal banking rules limitthe ability of banks and other financial institutions to disclose non-publicinformation about consumers to non-affiliated third parties. Pursuant to theserules, financial institutions must provide:

·       initialnotices to customers about their privacy policies, describing the conditionsunder which they may disclose non-public information to non-affiliated thirdparties and affiliates;

·       annualnotices of their privacy policies to current customers; and

·       areasonable method for customers to “opt out” of disclosures to non-affiliatedthird parties.

These privacy provisions affect how consumerinformation is transmitted through diversified financial companies and conveyedto outside vendors. We have implemented our privacy policies in accordance withthe law.

In recent years, a numberof states have implemented their own versions of privacy laws. For example, in2003, California adopted standards that are more restrictive than federal law,allowing bank customers the opportunity to bar financial companies from sharinginformation with their affiliates.

***Federal Home Loan Bank System***

The Bank is a member of the Federal Home Loan Bank (“FHLB”)of San Francisco. Among other benefits, each FHLB serves as a reserve orcentral bank for its members within its assigned region. Each FHLB is financedprimarily from the sale of consolidated obligations of the FHLB system. EachFHLB makes available loans or advances to its members in compliance with thepolicies and procedures established by the Board of Directors of the individualFHLB.

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A new capital planof the FHLB of San Francisco was approved by the Federal Housing Finance Boardand was implemented on April 1, 2004. The new capital plan incorporates asingle class of stock with a par value of $100 share, and may be issued,exchanged, redeemed, and repurchased only at par value. Each member must ownstock in an amount equal to the greater of:

·       amembership stock requirement with an initial cap of $25 million (1.00% of “membershipasset value” as defined), or

·       anactivity based stock requirement (based on percentage of outstanding advances).

The new capital stock isredeemable with five years’ written notice, subject to certain conditions. Theeffect of this plan was that the Bank had to purchase $5.9 million ofadditional FHLB stock.

***Predatory Lending***

The term “predatorylending,” much like the terms “safety and soundness” and “unfair and deceptivepractices,” is far-reaching and covers a potentially broad range of behavior.As such, it does not lend itself to a concise or a comprehensive definition.But typically predatory lending involves at least one, and perhaps all three,of the following elements:

·       makingunaffordable loans based on the assets of the borrower rather than on theborrower’s ability to repay an obligation, or asset-based lending;

·       inducinga borrower to refinance a loan repeatedly in order to charge high points andfees each time the loan is refinanced, or loan flipping; and

·       engagingin fraud or deception to conceal the true nature of the loan obligation from anunsuspecting or unsophisticated borrower.

Federal ReserveBoard regulations aimed at curbing such lending significantly widened the poolof high-cost home-secured loans covered by the Home Ownership and EquityProtection Act of 1994, a federal law that requires extra disclosures andconsumer protections to borrowers. The following triggers coverage under theHome Ownership and Equity Protection Act of 1994:

·       interestrates for first lien mortgage loans in excess of 8 percentage points abovecomparable Treasury securities,

·       subordinate-lienloans of 10 percentage points above Treasury securities, and

·       feessuch as optional insurance and similar debt protection costs paid in connectionwith the credit transaction, when combined with points and fees if deemedexcessive.

In addition, the regulationbars loan flipping by the same lender or loan servicer within a year. Lendersalso will be presumed to have violated the law—which says loans shouldn’t bemade to people unable to repay them—unless they document that the borrower hasthe ability to repay. Lenders that violate the rules face cancellation ofloans and penalties equal to the finance charges paid. The Company does notexpect these rules and potential state action in this area to have amaterial impact on our financial condition or results of operation.

***Accounting Changes***

From time to time theFinancial Accounting Standards Board (“FASB”) issues pronouncements whichgovern the accounting treatment for the Company’s financial statements. For adescription of the recent pronouncements applicable to the Company see theNotes to the Financial Statements included in Item 8 of this Report.

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***Off Balance Sheetand Other Related Party Transactions***

As noted in Footnote 12 tothe financial statements, the Company is contingently liable for letter ofcredit accommodations made to its customers in the ordinary course of businesstotaling $30.2 million at December 31, 2004 compared to $31.0 million oneyear earlier. Additionally, the Company has undisbursed loan commitments, alsomade in the ordinary course of business, totaling $656.1 million, whichcompares to $523.4 million outstanding one year earlier.

There are no SpecialPurpose Entity (“SPE”) trusts, corporations, or other legal entitiesestablished by the Company which reside off-balance sheet. There are no otheroff-balance sheet items other than the aforementioned items related to letterof credit accommodations and undisbursed loan commitments.

As noted in Footnote 5 tothe financial statements, the Company does make loans to related parties(directors and officers) in the ordinary course of business at prevailing ratesand terms. These loans totaled $8.7 million at the end of 2004, compared to the$1.2 million outstanding one year earlier. While loans to insiders and relatedparties are generally prohibited under SOA, as a bank, Mid-State is exempt fromthis rule.

***Factors That May AffectFuture Results of Operations***

*Dependence on Real Estate*.   Asignificant portion of the loan portfolio of the Company is dependent on realestate. At December 31, 2004, real estate served as the principal sourceof collateral with respect to approximately 80.8% percent of the Company’s loanportfolio. A decline in current economic conditions or rising interest ratescould have an adverse effect on the demand for new loans, the ability ofborrowers to repay outstanding loans, the value of real estate and other collateralsecuring loans and the value of real estate owned by the Bank, as well as theCompany’s financial condition and results of operations in general and themarket value of the Company’s common stock. Acts of nature, including earthquakesand floods, which may cause uninsured damage and other loss of value to realestate that secures these loans, may also negatively impact the Company’sfinancial condition. The impact of the San Simeon earthquake in 2003 did nothave a significant adverse impact on the Bank’s premises or on the value of thecollateral supporting the Company’s real estate loan portfolio.

Management continuouslymonitors residential real estate reports and markets, and is aware of pressarticles that have discussed a possible slow down in and/or drop in value ofresidential real estate in the Bank’s service area. While long term interestrates remain historically low and the Bank’s service area is marked by limitedsupply and strong demand, residential projects financed by the Bank areunderwritten with a requirement of a percentage of cash equity to the totalcost of the project in addition to prudent exposures to current appraisedvalues. To further mitigate this risk, individual projects financed areanalyzed using direct, current and historical project trends with limitationsto production unit starts ahead of sales using the projected absorptionanalysis contained in the appraisal of each project. The Bank believes, basedupon past experience, that this process helps mitigate against the productionof a supply of units that would exceed the current market demand.

Additionally, due to thepopularity of our market area to urban retirees and others wanting to enjoy theenvironment and life style it provides, we have seen and continue to see amigration of wealthier individuals and families absorb the residential housingproduction with greater cash equities than is typical of other areas throughoutthe country. This assumption is supported by the fact that the Bank’s portfolioof residential mortgages have an average loan to value ratio of less than 60%along with average credit scores substantially exceeding industry standardswith low delinquency ratios.

*OperatingStrategies.*   From time to time, the Company developslong-term financial performance goals to guide and measure the success of ouroperating strategies. The Company can make no assurance that we will besuccessful in achieving these long-term goals or that our operating strategieswill be successful. Achieving success in these areas is dependent on a numberof factors, many of which are 

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beyond the Company’s direct control. Factors that mayadversely affect the Company’s ability to attain its long-term financialperformance goals include:

·       Deteriorationof asset quality;

·       Inabilityto control non-interest expense, including, but not limited to, rising employeeand healthcare costs;

·       Inabilityto increase non-interest income;

·       Abilityto increase loan growth;

·       Abilityto find acquisition targets at valuation levels we find attractive;

·       Abilityto effectively integrate acquired institutions into the Company;

·       Regulatoryand other impediments associated with making acquisitions;

·       Deteriorationin general economic conditions, especially in the Company’s core markets;

·       Decreasesin the Company’s net interest margin;

·       Increasesin competition;

·       Adverseregulatory or legislative developments;

·       Unexpectedincrease in costs related to regulatory compliance; and

·       Unexpectedincrease in costs related to acquisitions.

*Expensing of Stock Options.*   TheCompany expects to adopt a new accounting pronouncement in the third quarter of2005. The new accounting will require the Company to recognize additionalexpense for employee services received in exchange for an award of equityinstruments, such as stock options, based on the grant date fair value of theaward and the estimated number of awards that are expected to vest. Pro formadisclosures of net income and earnings per share for the years 2004, 2003 and2002 are disclosed in Note 15 of the Notes to the Consolidated FinancialStatements in Part II, item 8 of this Annual Report on Form 10K. Managementexpects that the adoption of the new accounting pronouncement will have a materialeffect on its Consolidated Statements of Income, Comprehensive Income andChanges in Capital Accounts.

*Interest Rate Changes*.**  **The earnings of the Company and the Bank are substantiallyaffected by changes in prevailing interest rates. Changes in interest rates affectthe demand for new loans, the credit profile of existing loans, the rates receivedon loans and securities and the rates the Bank must pay on deposits andborrowings. The difference between the rates the Bank receives on loans and securitiesand the rates it must pay on deposits and borrowings is known as the interestrate spread. Given the Bank’s current volume and mix of interest-bearing liabilitiesand interest-earning assets, the Bank’s interest rate spread can be expected toincrease when market interest rates are rising, and to decline when market interestrates are declining. The Federal Reserve Board’s decrease in rates during 2001,2002 and 2003 substantially impacted the Bank’s interest rate spread, as itsspread for 2004 declined to 5.36% (taxable equivalent) from 5.54% (taxableequivalent) in 2003 and from 5.74% (taxable equivalent) in 2002. Increases inshort term rates by the Federal Reserve Board in the latter half of 2004 arehaving the effect of beginning to reverse this trend with the Bank’s interestspread rising to 5.42% (taxable equivalent) in the fourth quarter of 2004. Althoughthe Bank believes its current level of interest rate sensitivity is reasonable,significant fluctuations in interest rates may have an adverse impact on itsbusiness, financial condition and results of operations.

*Competition*.   Competitionmay adversely affect the Bank’s performance. The financial services business inthe Bank’s market area is highly competitive, and becoming more so due tochanges in regulation, technological advances and the accelerating pace ofconsolidation among financial service 

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providers. Mid-Statefaces competition both in attracting deposits and making loans. Mid-Statecompetes for loans principally through competitive interest rates and theefficiency and quality of the services provided. Increasing levels ofcompetition in the banking and financial services businesses may reduce marketshare or cause the prices charged for services to fall. Results may differ infuture periods depending on the nature or level of competition.

*Regulation*.   Boththe Company and the Bank are subject to government regulation that could limitor restrict their activities, adversely affecting operations. The financialservices industry is heavily regulated. Federal and state regulation isdesigned to protect the deposits of consumers, not to benefit shareholders. Theregulations impose significant limitations on operations, and may be changed atany time, possibly causing results to vary significantly from past results.Government policy and regulation, particularly as implemented through theFederal Reserve System, significantly affects credit conditions.

In response to severalwell-publicized corporate and auditing scandals, the President signed theSarbanes-Oxley Act into law. This act calls for increased federal regulation ofthe accounting profession and imposes new requirements upon boards ofdirectors, audit committees and executive officers of public companies. Theserequirements increased the accounting and legal costs to the Company. As apublic company whose securities are listed on the Nasdaq national market, theCompany was subject to all of these provisions of the Act and implementingregulations as well as additional corporate governance standards which Nasdaqadopted. The company expended significant amounts of internal staff time and$913 thousand in outside hard dollar costs to comply with the variousprovisions of these requirements in 2004. Management does not expect the amountof staff time and hard dollar costs to be as significant in future years,however, the effect of the legislation has created a permanent annual increasein the cost structure to the Bank of at least $400 to $500 thousand.

*Borrowers’ Failure to Perform*.   Asignificant number of the Bank’s borrowers and guarantors may fail to performtheir obligations as required by the terms of their loans, which could resultin larger than expected losses. This risk increases when the economy is weak,as it has been recently. The Bank has adopted underwriting and credit policies,and loan monitoring procedures, including the establishment and monitoring ofallowances for credit losses. Management believes these provisions arereasonable and adequate, and should keep credit losses within expected limitsby assessing the likelihood of nonperformance, tracking loan performance anddiversifying the credit portfolio. However, these policies and procedures maynot be adequate to prevent unexpected losses that could materially andadversely affect the results of operations.

*Operations Risks.*   TheBank is subject to certain operations risks, including, but not limited to,data processing system failures and errors, customer or employee fraud andcatastrophic failures resulting from terrorist acts or natural disasters. TheBank maintains a system of internal controls to mitigate against such occurrencesand maintains insurance coverage for such risks, but should such an event occurthat is not prevented or detected by the Bank’s internal controls, uninsured orin excess of applicable insurance limits, it could have a significant adverseimpact on the Company’s business, financial condition or results of operations.

*LoanDemand.  *The Company is significantly affected by thelevel of loan demand available to it in its markets. The inability to makesufficient loans directly affects the interest income it earns. Lower loandemand will generally result in lower interest income realized by the Companyas it places funds in lower yielding investments.

*Goodwill.*   Pursuantto GAAP, the Company is required to periodically asses its goodwill,intangibles and other long-lived assets to determine if they are impaired. Disruptionsto our business, end market conditions and protracted economic weakness,unexpected significant declines in operating results of reporting units,divestitures and market capitalization declines may result in additionalcharges to goodwill and other asset impairments. Future impairment chargescould substantially affect our reported earnings 

18

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in the period ofsuch charge. In addition, such charges would reduce our consolidated net worthand our shareholders’ equity.

*Geographic Concentration.*   TheCompany’s operations are located almost entirely in the Central Coast region ofCalifornia. As a result of this geographic concentration, our results dependlargely upon economic and business conditions in this region. A deteriorationin economic and business conditions in our market area could have a materialadverse impact on the quality of our loan portfolio and the demand for ourproducts and services, which in turn may have a material adverse effect on ourresults of operations.

*War on Terrorism.*   Theterrorist attacks of September 11, 2001, the ensuing worldwide war onterrorism and the actions in Afghanistan and Iraq, may lead to unexpectedshifts in cash flows, deposit levels, and general economic activity. U.S.banking agencies have warned of the possible impact of such events on thecapital ratios of banks.

*Company Cash Flow.*   Asa holding company, all of the Company’s cash flow typically comes fromdividends from the Bank. Various statutory provisions restrict the amount ofdividends the Bank can pay to the Company without regulatory approval.

*Small Business Administration (SBA)Lending.*   SBA lending is a federal government createdand administered program. As such, legislative and regulatory developments canaffect the availability and funding of the program. This dependence onlegislative funding and regulatory restrictions from time to time causeslimitations and uncertainties with regard to the continued funding of suchloans, with a resulting potential adverse financial impact on the Company’sbusiness.

*Environmental Liabilities.*   Inthe course of our business the Bank may foreclose and take title to realestate, and could be subject to environmental liabilities with respect to theseproperties. It may be held liable to a governmental entity or to third personsfor property damage, personal injury, investigation and clean-up costs incurredby these parties in connection with environmental contamination, or may berequired to investigate or clean up hazardous or toxic substances, or chemicalreleases at a property. The costs associated with investigation or remediationactivities could be substantial. In addition, as the owner or former owner of acontaminated site, the Bank may be subject to common law claims by thirdparties based on damages and costs resulting from environmental contaminationemanating from the property. If the Bank ever becomes subject to significantenvironmental liabilities, its business, financial condition, liquidity andresults of operations could be materially and adversely affected.

***Where You Can FindMore Information.***

Under the SecuritiesExchange Act of 1934 Sections 13 and 15(d), periodic and current reports mustbe filed with the SEC. The Company electronically files the following reportswith the SEC: Form 10-K (Annual Report), Form 10-Q(Quarterly Report), Form 11-K (Annual Report for Employees’ StockPurchase and Savings Plans), Form 8-K (Current Report of UnscheduledMaterial Events), Forms 3, 4, and 5 (Changes in Beneficial Ownership) and Form DEF14A (Proxy Statement). The Company may file additional forms. The SEC maintainsan Internet site, *www.sec.gov*, in which all formsfiled electronically may be accessed. Additionally, all forms filed with theSEC and additional shareholder information, such as certain corporategovernance documents including the Company’s and Bank’s audit committee charter,compensation committee charter, nominating/corporate governance committeecharter, corporate governance guidelines, and corporate code of conduct (whichincludes the code of ethics required by the SEC and applicable to seniorexecutive officers of the Company and Bank), is available free of charge on theCompany’s website: *www.midstatebank.com*.The Company posts these reports to its website as soon as reasonablypracticable after filing them with the SEC. None of the information on orhyperlinked from the Company’s website is incorporated into this Annual Reporton Form 10-K.

19

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**ITEM2**. PROPERTIES

TheCompany’s principal office is located at 1026 Grand Avenue, Arroyo Grande,California. As of December 31, 2004, the Bank owned 23 of its branchoffices, 4 non-banking support offices and leased 18 other Bank locations(covered by 20 leases). The Company believes its present facilities are in goodcondition and are adequate for its present needs. The Company does notanticipate difficulty in renewing existing leases as they expire or in findingalternative facilities. See Note 6 to the Consolidated Financial Statements fora further description of the Company’s lease obligations.
| **Owned by Bank or Subsidiary:** | ** ** | ** **                           | ** ** | **Location of Offices** | ** ** | ** ** | ** ** | ** ** | **Encumbrance** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|-------------------------|------------|------------|------------|------------|-----------------|------------|
| Arroyo Grande*                   |       | 991 Bennett Avenue                   |       | NONE                    |
| Arroyo Grande                    |       | 1026 Grand Avenue                    |       | NONE                    |
| Arroyo Grande*                   |       | 550 Camino  Mercado                  |       | NONE                    |
| Arroyo Grande*                   |       | 398 Sunrise  Terrace                 |       | NONE                    |
| Atascadero                       |       | 6950 El Camino  Real                 |       | NONE                    |
| Buellton                         |       | West Highway  246 & Central |       | NONE                    |
| Cambria                          |       | 1070 Main Street                     |       | NONE                    |
| Goleta Valley                    |       | 5956 Calle Real                      |       | NONE                    |
| Grover Beach                     |       | 899 Grand Avenue                     |       | NONE                    |
| Grover Beach*                    |       | 140 North Second  Street             |       | NONE                    |
| Guadalupe                        |       | 905 Guadalupe  Street                |       | NONE                    |
| Lompoc                           |       | 828 North “H”  Street      |       | NONE                    |
| Los Osos                         |       | 1001 Los Osos  Valley Road           |       | NONE                    |
| Morro Bay                        |       | 251 Harbor Street                    |       | NONE                    |
| Nipomo                           |       | 615 West Tefft  Street               |       | NONE                    |
| Paso Robles                      |       | 845 Spring Street                    |       | NONE                    |
| Pismo Beach                      |       | 801 Price Street                     |       | NONE                    |
| San Luis Obispo                  |       | 75 Santa Rosa                        |       | NONE                    |
| San Luis Obispo                  |       | 2276 Broad Street                    |       | NONE                    |
| Santa Barbara                    |       | 33 East Carrillo  Street             |       | NONE                    |
| Santa Barbara                    |       | 2222 Bath Street                     |       | NONE                    |
| Santa Maria                      |       | 720 North  Broadway                  |       | NONE                    |
| Santa Maria                      |       | 2739 Santa Maria  Way                |       | NONE                    |
| Santa Maria                      |       | 1554 South  Broadway                 |       | NONE                    |
| Santa Maria                      |       | 519 E. Main  Street                  |       | NONE                    |
| Templeton                        |       | 1025 Las Tablas  Road                |       | NONE                    |
| Vandenberg Village               |       | 3745 Constellation Road              |       | NONE                    |

 

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**Leasedby Bank or Subsidiary**
| Arroyo Grande  West Branch In Store Office     |   | 1132 West Branch Street              |   | $3,100.00 per month  Expires February, 2005    |
|------------------------------------------------|--------|--------------------------------------|--------|------------------------------------------------|
| Camarillo  Camarillo Financial Center          |   | 470 Arneill Road                     |   | $6,808.76 per  month  Expires June, 2009       |
| Cayucos                                        |   | 107 North Ocean  Avenue              |   | $1,694.00 per  month  Expires November, 2007   |
| Goleta Valley  Hollister Office                |   | 5340 Hollister  Avenue               |   | $4,824.00 per  month  Expires February, 2007   |
| Ojai  Oak View                                 |   | 410 Ventura  Avenue                  |   | $2,124.27 per  month  Expires December, 2005   |
| Ojai  Ojai Valley                              |   | 1207 Maricopa  Highway               |   | $7,622.00 per  month  Expires December, 2014   |
| Orcutt                                         |   | 1110 East Clark  Avenue              |   | $11,292.00 per  month  Expires October, 2010   |
| Oxnard  Esplanade Financial Center             |   | 300 Esplanade  Drive, Suite 101 |   | $14,040.90 per  month  Expires September, 2012 |
| Oxnard*                                        |   | 300 Esplanade  Drive, Suite 110 |   | $11,734.57 per  month  Expires August, 2012    |
| Oxnard  Downtown Oxnard Office                 |   | 155 “A” Street             |   | $6,030.42 per  month  Expires July, 2005       |
| Oxnard  Northside Plaza Office                 |   | 121-125 Gonzales  Boulevard          |   | $6,666.76 per month  Expires July, 2007        |
| Paso Robles  Creston Road Office               |   | 705 Golden Hill  Road                |   | $9,585.00 per  month  Expires October, 2012    |
| Pismo Beach  Oak Park Office                   |   | 865 Oak Park  Boulevard              |   | $10,372.00 per  month  Expires March, 2008     |
| Santa Barbara  Milpas Office                   |   | 914 Carpinteria  Street              |   | $10,117.53 per  month  Expires May, 2017       |
| Santa Maria**  North Broadway Office—Land |   | 720 North  Broadway                  |   | $2,522.00 per  month  Expires Dec, 2008        |
| Santa Ynez                                     |   | 3600 Sagunto  Street                 |   | $2,632.00 per  month  Expires May, 2012        |
| Solvang                                        |   | 1600 Copenhagen  Drive               |   | $9,688.69 per  month  Expires April, 2008      |
| Ventura  Mills Road Financial Center           |   | 300 S. Mills Road                    |   | $17,306.94 per  month  Expires August, 2012    |
| Ventura  Downtown Ventura Office               |   | 304 E. Main  Street                  |   | $10,652.00 per  month  Expires November, 2012  |
| Ventura  County Center Office                  |   | 6401 E. Telephone Road               |   | $10,939.84 per month  Expires September, 2012  |

 

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**FormerBank Offices Leased by Bank—Which Are Sub-Leased**
| Nipomo  Ground Lease |   | 630 W. Tefft Street |   | $3,982.00 per  month

Expires February, 2015 |
|----------------------|--------|---------------------|--------|----------------------------------------------|

 

****                    TheBank’s rental expense for 2004 was $1,985,000. See note 6 of the Company’sfinancial statements included in Item 8 of this Report for certain additionalinformation concerning the amount of the Bank’s lease commitment. All officeslisted are full service branch offices, except those with asterisks noted above.Asterisks represent non-banking support offices (e.g., Administration, DataProcessing, Supplies Warehouse, Credit Services, et. al.)*

*****             Groundlease on property adjacent to a fully owned facility.*

**ITEM3**. LEGAL PROCEEDINGS

The Company is, from time to time, subject to variouspending and threatened legal actions which arise out of the normal course ofits business. The Company is not a party to any pending legal or administrativeproceedings as of December 31, 2004 (other than ordinary routinelitigation incidental to the Company’s business) and no such proceedings areknown to be contemplated.

There are no materialproceedings adverse to the Company to which any director, officer, affiliate ofthe Company, 5% shareholder of the Company, or any associate of any suchdirector, officer, affiliate or 5% shareholder of the Company is a party, andnone of the above persons has a material interest adverse to the Company.

**ITEM4**. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of securityholders during the fourth quarter of 2004.

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**PART II**

**ITEM 5**.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

***Market Information***

The Company’s Common Stock trades on the NasdaqNational Market under the symbol “MDST.”

Thefollowing table summarizes those trades of the Company’s Common Stock onNASDAQ, setting forth the approximate high and low closing sales prices foreach quarterly period ended since January 1, 2003. The closing salesprice on December 31, 2004 was $28.65 compared to the close one yearearlier of $25.44.
| ** **                       | ** ** | **Sales Prices** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| **Quarter Ended 2003** | ** ** | ** **            | ** ** | **Low** | ** ** | **High** | ** ** |
| March 31                    |       | $                     | 16.20      |   | $ | 17.85 |   |
| June 30                     |       | $                     | 16.62      |   | $ | 20.49 |   |
| September 30                |       | $                     | 19.15      |   | $ | 23.40 |   |
| December 31                 |       | $                     | 22.45      |   | $ | 26.99 |   |
|                                  |            |                       |            |  |  |  |  |  |  |

 
| ** **                       | ** ** | **Sales Prices** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| **Quarter Ended 2004** | ** ** | ** **            | ** ** | **Low** | ** ** | **High** | ** ** |
| March 31                    |       | $                     | 23.00      |   | $ | 26.99 |   |
| June 30                     |       | $                     | 21.03      |   | $ | 24.50 |   |
| September 30                |       | $                     | 23.00      |   | $ | 26.13 |   |
| December 31                 |       | $                     | 25.45      |   | $ | 30.61 |   |
|                                  |            |                       |            |  |  |  |  |  |  |

 

***Equity Plan Compensation Information***

The following tablesummarizes information as of December 31, 2004 relating to equity compensationplans of the Company pursuant to which grants of options, restricted stock orother rights to acquire shares may be granted from time to time.
| **Plan Category**                                  | ** ** | ** ** | ** ** | **Number of Securities  To be issued upon  Exercise of Options** | ** ** | **Weighted Average  Exercise Price of  Outstanding Options** | ** ** | **Number of Securities  Remaining Available  for Future Issuance** | ** ** |
|---------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| Equity  compensation Plans not approved by Stockholders |       |       | 1,191,986  |                                                                                                |       |                                                                             | $          | 15.36                                                                                       |       |   |   | 207,743 |   |   |
| Equity compensation Plans approved by Stockholders      |       |       | -None-     |                                                                                                |       |                                                                             | N/A        |                                                                                        |       |   | N/A |   |   |
| Total                                                   |       |       | 1,191,986  |                                                                                                |       |                                                                             | $          | 15.36                                                                                       |       |   |   | 207,743 |   |   |

 

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***Dividends***

Thefollowing table sets forth the per share amount and month of payment for allcash dividends paid since January 1, 2003 by the Company to itsshareholders.
| **Payable Date**  | ** ** | ** ** | ** **     | ** ** | **Dividend** | ** ** | ** ** |
|------------------------|------------|------------|----------------|------------|--------------|------------|------------|
| January 15,  2003 |       | $          | 0.11 per share |       |
| April 15,  2003   |       | $          | 0.11 per share |       |
| July 15,  2003    |       | $          | 0.13 per share |       |
| October 15,  2003 |       | $          | 0.13 per share |       |
| January 15,  2004 |       | $          | 0.13 per share |       |
| April 15,  2004   |       | $          | 0.14 per share |       |
| July 15,  2004    |       | $          | 0.14 per share |       |
| October 15,  2004 |       | $          | 0.14 per share |       |
| January 14, 2005  |       | $          | 0.16 per share |       |
|                        |            |            |                |            |              |            |            |  |

 

The Company is a legal entity separate and distinctfrom the Bank. The Company’s shareholders are entitled to receive dividendswhen declared by its Board of Directors, out of funds legally availabletherefor, subject to the restrictions set forth in the California GeneralCorporation Law (the Corporation Law). The Corporation Law provides that acorporation may make a distribution to its shareholders if the corporation’sretained earnings equal at least the amount of the proposed distribution. TheCorporation Law also provides that, in the event that sufficient retainedearnings are not available for the proposed distribution, a corporation may,nevertheless, make a distribution to its shareholders if it meets twoconditions, which generally stated are as follows: (i) the corporation’sassets equal at least 1-1/4 times its liabilities, and (ii) thecorporation’s current assets equal at least its current liabilities or, if theaverage of the corporation’s earnings before taxes on income and beforeinterest expenses for the two preceding fiscal years was less than the averageof the corporation’s interest expenses for such fiscal years, then thecorporation’s current assets  must equalat least 1-1/4 times its current liabilities.

The ability of the Company to pay a cash dividenddepends largely on the Bank’s ability to pay a cash dividend to the Company. Thepayment of cash dividends by the Bank is subject to restrictions set forth inthe California Financial Code (the Financial Code). The Financial Code providesthat a bank may not make a cash distribution to its shareholders in excess ofthe lesser of (a) the bank’s retained earnings; or (b) the bank’s netincome for its last three fiscal years, less the amount of any distributionsmade by the bank or by any majority-owned subsidiary of the bank to theshareholders of the bank during such period. However, a bank may, with theapproval of the DFI, make a distribution to its shareholders in an amount notexceeding the greater of (x) its retained earnings; (y) its netincome for its last fiscal year; or (z) its net income for its currentfiscal year. In the event that the DFI determines that the shareholders’ equityof a bank is inadequate or that the making of a distribution by the bank wouldbe unsafe or unsound, the DFI may order the bank to refrain from making aproposed distribution. The FDIC may also restrict the payment of dividends ifsuch payment would be deemed unsafe or unsound or if after the payment of suchdividends, the Bank would be included in one of the “undercapitalized”categories for capital adequacy purposes pursuant to federal law. (See,  “Item 1—Prompt Corrective Action and OtherEnforcement Mechanisms.”)  Additionally,while the Federal Reserve Board has no general restriction with respect to thepayment of cash dividends by an adequately capitalized bank to its parentholding company, the Federal Reserve Board might, under certain circumstances,place restrictions on the ability of a particular bank to pay dividends basedupon peer group averages and the performance and maturity of the particularbank, or object to management fees to be paid by a subsidiary bank to itsholding company on the basis that such fees cannot be supported by the value ofthe services rendered or are not the result of an arm’s length transaction.

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Whether or not dividendswill be paid in the future will be determined by the Board of Directors afterconsideration of various factors. The Company’s profitability and regulatorycapital ratios in addition to other financial conditions will be key factorsconsidered by the Board of Directors in making such determinations regardingthe payment of dividends by the Company.

***Transfer Agent***

Mellon Investor Services,LLC serves as the Company’s transfer agent. Shareholder inquiries regardingholdings of Mid-State Bancshares Common Stock can be directed to:

**MellonInvestor Services, LLCP. O. Box 3315South Hackensack, NJ 07606-1915**

**Or**

**MellonInvestor Services, LLCOverpeck Center85 Challenger RoadRidgefield Park, NJ 07660-2108**

**By Phone:1-(888)-540-9878 (U.S. & Canada)1-(201)-329-8660 (Outside U.S.)**

Mellon Investor Servicesmaintains the records for registered Mid-State Bancshares shareholders and canhelp with such services as change of name or address, consolidation ofaccounts, duplicate mailings, dividend reinvestment enrollment, lost stockcertificates, transfer of stock to another person, and additionaladministrative services. For more information, they can be contacted via theInternet at *www.melloninvestor.com*.

***Stock Repurchase Program***

The Board of Directors at its regular meeting of January 21,2004, authorized the purchase of up to 1,178,352 additional shares as its priorauthorizations in March 2000 and May 2002 had been completed. The January 2004authorization does not have an expiration date. The repurchase program seeks toreduce the number of outstanding shares resulting in an improvement to theCompany’s earnings per share and to its return on equity. These repurchases arebeing made from time to time by the Company in the open market or privatelynegotiated transactions in compliance with the SEC rules. The total number ofshares repurchased was 658,867, 800,006, and 477,264 in 2004, 2003 and 2002,respectively. The average price paid per share in 2004, 2003, and 2002 was$25.26, $20.27, and $17.57, respectively. As of December 31, 2004, theCompany could repurchase up to an additional 520,357 shares under the January 2004authorization.

Duringthe fourth quarter of 2004, share repurchase activity was as follows:
| ** **             | ** ** | **Total**          | ** ** | **Average Price**    | ** ** | **Remaining Shares**                | ** ** | **Dollar Value of Shares** | ** ** |
|------------------------|------------|--------------------|------------|---------------------------|------------|------------------------------------------|------------|-------------------------------------------|------------|
| ** **             | ** ** | **Number of** | ** ** | **Paid**                  | ** ** | **That May be Purchased** | ** ** | **That May be Purchased**  | ** ** |
| **Period**             | ** ** | ** **         | ** ** | **Shares Purchased** | ** ** | **Per Share**                       | ** ** | **Under the Authorization**     | ** ** | **Under the Authorization** | ** ** |
| October 2004      |       |               | 80,258     |                      |       |                                     | $          | 26.34                                     |       |   |   | 725,147 |   |   |   | $ | 19,455,694 |   |   |
| November 2004     |       |               | 116,168    |                      |       |                                     | $          | 27.18                                     |       |   |   | 608,979 |   |   |   | $ | 18,171,933 |   |   |
| December 2004     |       |               | 88,622     |                      |       |                                     | $          | 28.86                                     |       |   |   | 520,357 |   |   |   | $ | 14,908,228 |   |   |
| Fourth Quarter  Totals |       |               | 285,048    |                      |       |                                     | $          | 27.47                                     |       |   |   | 520,357 |   |   |   | $ | 14,908,228 |   |   |
|                        |            |                    |            |                           |            |                                          |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 6**. SELECTED FINANCIAL DATA

**SelectedConsolidated Financial Data––Mid-State Bancshares**
| **(In thousands––except per share data)** | ** ** | ** ** | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** | **2000**  | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-----------|------------|
| **Year Ended  December 31:**                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest Income (not taxable equivalent)                                |       | $          | 109,936    |       | $          | 105,240    |       | $          | 109,332    |       | $          | 114,002   |       | $ | 109,967 |   |
| Interest Expense                                                        |       | 8,450      |       | 9,699      |       | 16,381     |       | 26,480     |       | 27,599     |       |
| Net Interest Income                                                     |       | 101,486    |       | 95,541     |       | 92,951     |       | 87,522     |       | 82,368     |       |
| Provision for Loan Losses                                               |       | (2,700     | )          | (969       | )          | 600        |       | 4,100      |       | 700        |       |
| Net Interest Income after provision for loan losses                     |       | 104,186    |       | 96,510     |       | 92,351     |       | 83,422     |       | 81,668     |       |
| Non-interest income                                                     |       | 27,764     |       | 29,059     |       | 24,321     |       | 23,254     |       | 17,805     |       |
| Non-interest expense                                                    |       | 79,294     |       | 74,691     |       | 70,925     |       | 64,744     |       | 57,982     |       |
| Income before income taxes                                              |       | 52,656     |       | 50,878     |       | 45,747     |       | 41,932     |       | 41,491     |       |
| Provision for income taxes                                              |       | 17,547     |       | 17,714     |       | 15,892     |       | 14,530     |       | 14,142     |       |
| Net Income                                                              |       | $          | 35,109     |       | $          | 33,164     |       | $          | 29,855     |       | $          | 27,402    |       | $ | 27,349 |   |
| **Per share: ***                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Income—basic                                                   |       | $          | 1.50       |       | $          | 1.41       |       | $          | 1.25       |       | $          | 1.22      |       | $ | 1.23 |   |
| Net Income—diluted                                                 |       | $          | 1.47       |       | $          | 1.40       |       | $          | 1.20       |       | $          | 1.18      |       | $ | 1.20 |   |
| Weighted avg. shares for Basic E.P.S. calculation                       |       | 23,422     |       | 23,443     |       | 23,962     |       | 22,452     |       | 22,257     |       |
| Weighted avg. shares for Diluted E.P.S. calculation                     |       | 23,897     |       | 23,762     |       | 24,837     |       | 23,252     |       | 22,722     |       |
| Cash dividends                                                          |       | $          | 0.58       |       | $          | 0.50       |       | $          | 0.41       |       | $          | 0.37      |       | $ | 0.34 |   |
| Book value at period-end                                                |       | $          | 11.89      |       | $          | 11.56      |       | $          | 10.72      |       | $          | 9.74      |       | $ | 8.05 |   |
| Tangible book value at period-end                                       |       | $          | 9.48       |       | $          | 9.15       |       | $          | 8.94       |       | $          | 7.96      |       | $ | 7.96 |   |
| Ending Shares                                                           |       | 23,099     |       | 23,567     |       | 23,697     |       | 24,089     |       | 22,019     |       |
| **Period Averages:**                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Assets                                                            |       | $          | 2,269,873  |       | $          | 2,045,252  |       | $          | 1,892,137  |       | $          | 1,570,098 |       | $ | 1,389,625 |   |
| Total Tangible Assets                                                   |       | 2,213,639  |       | 2,000,406  |       | 1,850,671  |       | 1,558,507  |       | 1,388,210  |       |
| Total Loans & Leases                                           |       | 1,310,842  |       | 1,131,932  |       | 1,109,245  |       | 999,501    |       | 847,797    |       |
| Total Earning Assets                                                    |       | 2,050,218  |       | 1,857,241  |       | 1,718,280  |       | 1,444,631  |       | 1,279,119  |       |
| Total Deposits                                                          |       | 1,970,248  |       | 1,763,215  |       | 1,623,510  |       | 1,351,256  |       | 1,205,826  |       |
| Common Equity                                                           |       | 277,054    |       | 261,103    |       | 244,295    |       | 195,955    |       | 166,402    |       |
| Common Tangible Equity                                                  |       | 220,820    |       | 217,982    |       | 202,829    |       | 184,364    |       | 164,987    |       |
| **At December 31,**                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                               |       | $          | 112,669    |       | $          | 123,763    |       | $          | 128,036    |       | $          | 102,970   |       | $ | 88,988 |   |
| Investments and Fed Funds Sold                                          |       | 650,817    |       | 822,179    |       | 625,483    |       | 524,345    |       | 407,462    |       |
| Loans held for sale                                                     |       | 12,988     |       | 13,410     |       | 22,560     |       | 13,604     |       | —     |       |
| Loans, net of deferred fees, before allowance                           |       | 1,421,894  |       | 1,154,932  |       | 1,087,551  |       | 1,136,099  |       | 919,967    |       |
| Allowance for Loan & Lease Losses                              |       | (13,799    | )          | (16,063    | )          | (17,370    | )          | (19,073    | )          | (10,920    | )          |
| Goodwill and Core Deposit Intangibles                                   |       | 55,572     |       | 56,947     |       | 40,949     |       | 42,021     |       | 1,347      |       |
| Other assets                                                            |       | 88,946     |       | 53,664     |       | 47,531     |       | 53,698     |       | 51,394     |       |
| Total  Assets                                                           |       | $          | 2,296,087  |       | $          | 2,208,832  |       | $          | 1,934,740  |       | $          | 1,853,664 |       | $ | 1,458,238 |   |
| Non-interest bearing deposits                                           |       | $          | 517,139    |       | $          | 487,624    |       | $          | 390,212    |       | $          | 367,370   |       | $ | 275,624 |   |
| Interest bearing deposits                                               |       | 1,477,406  |       | 1,424,807  |       | 1,262,735  |       | 1,216,796  |       | 955,538    |       |
| Other borrowings                                                        |       | 6,582      |       | 7,627      |       | 10,973     |       | 17,714     |       | 30,240     |       |
| Allowance for losses––unfunded  commitments                   |       | 1,783      |       | 1,941      |       | 1,771      |       | 1,586      |       | 2,360      |       |
| Other liabilities                                                       |       | 18,550     |       | 14,279     |       | 14,914     |       | 15,647     |       | 17,334     |       |
| Shareholders’ equity                                               |       | 274,627    |       | 272,554    |       | 254,135    |       | 234,551    |       | 177,142    |       |
| Total Liabilities and  Shareholders’ equity                        |       | $          | 2,296,087  |       | $          | 2,208,832  |       | $          | 1,934,740  |       | $          | 1,853,664 |       | $ | 1,458,238 |   |

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*       All historical share information has beenadjusted to reflect the two for one stock split which took place in February2001.

26

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**Selected Consolidated Financial Data––Mid-StateBancshares (Continued)**
| **(In thousands––except per share data)** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| **Asset Quality**                                                       |       |       |       |     |       |     |       |     |       |     |       |
| Non-accrual loans                                                       |       | $          | 10,700     |     | $          | 12,312   |       | $        | 16,748     |     | $          | 2,986    |       | $ | 4,510 |   |
| Loans past due 90 days or more                                          |       | —     |       | —   |       | —   |       | 690      |       | 222      |       |
| Other real estate owned                                                 |       | —     |       | 3,428    |       | —   |       | —   |       | —   |       |
| Total non performing assets                                             |       | $          | 10,700     |     | $          | 15,740   |       | $        | 16,748     |     | $          | 3,676    |       | $ | 4,732 |   |
| **Financial Ratios**                                                    |       |       |       |     |       |     |       |     |       |     |       |
| For the year:                                                           |       |       |       |     |       |     |       |     |       |     |       |
| Return on assets                                                        |       | 1.55       | %          | 1.62     | %          | 1.58     | %          | 1.75     | %          | 1.97     | %          |
| Return on tangible assets                                               |       | 1.59       | %          | 1.66     | %          | 1.61     | %          | 1.76     | %          | 1.97     | %          |
| Return on equity                                                        |       | 12.67      | %          | 12.70    | %          | 12.22    | %          | 13.98    | %          | 16.44    | %          |
| Return on tangible equity                                               |       | 15.90      | %          | 15.21    | %          | 14.79    | %          | 14.90    | %          | 16.62    | %          |
| Net interest margin (not  taxable equivalent)                           |       | 4.95       | %          | 5.14     | %          | 5.41     | %          | 6.06     | %          | 6.44     | %          |
| Net interest margin (taxable  equivalent)(2)                            |       | 5.36       | %          | 5.54     | %          | 5.74     | %          | 6.36     | %          | 6.75     | %          |
| Net loan (recoveries) losses to  avg. loans                             |       | (0.03      | )%         | 0.06     | %          | 0.19     | %          | 0.22     | %          | 0.06     | %          |
| Dividend Payout Ratio                                                   |       | 38.6       | %          | 35.3     | %          | 32.8     | %          | 30.3     | %          | 27.6     | %          |
| Efficiency ratio                                                        |       | 61.3       | %          | 59.9     | %          | 60.5     | %          | 58.4     | %          | 57.9     | %          |
| At December 31:                                                    |       |       |       |     |       |     |       |     |       |     |       |
| Equity to average assets  (leverage ratio)                              |       | 9.3        | %          | 9.6      | %          | 10.6     | %          | 10.2     | %          | 12.3     | %          |
| Tier One capital to  risk-adjusted assets                               |       | 12.1       | %          | 13.8     | %          | 14.7     | %          | 13.8     | %          | 15.5     | %          |
| Total capital to risk-adjusted  assets                                  |       | 13.0       | %          | 15.0     | %          | 16.0     | %          | 15.0     | %          | 16.7     | %          |
| Loan loss allowance to loans,  gross(1)                                 |       | 1.1        | %          | 1.6      | %          | 1.8      | %          | 1.8      | %          | 1.4      | %          |
| Non-accrual loans to total  loans, gross                                |       | 0.8        | %          | 1.1      | %          | 1.5      | %          | 0.3      | %          | 0.5      | %          |
| Non performing assets to total  assets                                  |       | 0.5        | %          | 0.7      | %          | 0.9      | %          | 0.2      | %          | 0.3      | %          |
| Allowance for losses to non performing loans(1)                         |       | 146        | %          | 146      | %          | 114      | %          | 562      | %          | 281      | %          |

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(1)   Includes allowance for loan losses and allowancefor losses—unfundedcommitments

(2)   Taxable equivalent converts tax exempt income as if it weretaxable

**ITEM 7**.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS

***Introduction and Business of the Company***

The Company has as its single, wholly ownedsubsidiary, Mid-State Bank & Trust (the Bank). The Bank has two whollyowned subsidiaries—MSB Properties and Mid Coast Land Company (discussed abovein Part I of this report and later in this Management’s Discussion andAnalysis). The Bank was founded in 1961 and operates a full service commercialbanking business serving its customers on the Central Coast of California. Headquarteredin Arroyo Grande, it operates 41 offices in communities throughout San LuisObispo, Santa Barbara and Ventura Counties and serves over 101,000 householdsand businesses.

The following discussionand analysis will provide insight and supplementary information into theaccompanying consolidated financial statements of the Company. It also providesManagement’s assessment of the operating trends over the past few years andcertain of their expectations for 2005.

27

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**2004 RESULTS ANDACCOMPLISHMENTS**

***Financial Summary***

The Company, on a consolidated basis, reported netincome of $35.1 million in 2004 and $33.2 million in 2003 after generating$29.9 million in 2002. The diluted Earnings Per Share (EPS) was $1.47 for 2004compared to $1.40 in 2003 and $1.20 in 2002. Consolidated total assets at December 31,2004 were $2.296 billion compared to $2.209 billion at December 31, 2003,up 3.8%. Total deposits also increased from $1.912 billion as of December 31,2003 to $1.995 billion as of December 31, 2004. Shareholders’ commonequity stood at $274.6 million at year end up from its $272.6 million level oneyear earlier. Factors contributing to the increase in shareholders’ commonequity included; 1) the $35.1 million of net income generated for the year and2) the $2.6 million received for the exercise of stock options. Partiallyoffsetting these increases were; 1) $13.6 million in dividends paid out during2004, 2) $16.6 million paid for the repurchase of common stock outstanding, and3) a $5.4 million reduction in accumulated other comprehensive income.

Thetable below illustrates net income by subsidiary unit.
| **Income (Loss) by subsidiary (000’s)** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Bank only,  pre-tax                                              |       | $          | 50,711     |     | $          | 48,684   |       | $        | 44,292     |   |
| MSB Properties,  pre-tax                                         |       | 2,079      |       | 2,376    |       | 2,142    |       |
| Mid Coast Land  Co., pre-tax                                     |       | 654        |       | 556      |       | (153     | )          |
| Parent only,  pre-tax                                            |       | (788       | )          | (738     | )          | (563     | )          |
| Tax (expense)                                                    |       | (17,547    | )          | (17,714  | )          | (15,892  | )          |
| Net Income––Mid-State  Bancshares                      |       | $          | 35,109     |     | $          | 33,164   |       | $        | 29,855     |   |

 

***Executive Summary***

Managementconsiders the following to be the most significant items affecting net incomeduring 2004 compared to 2003.

·       TheCompany took a benefit to provision for loan losses of $2.7 million in 2004compared to a benefit of $969 thousand in 2003 resulting in a positive pre-taximprovement in earnings of $1.7 million. The benefit taken to the provision forloan losses in 2004 reflected strong credit quality standards, consistentperformance of the loan portfolio in recent years, improving trends inclassified loans, improving trends in delinquencies and charge-offs, an improvedoutlook for the collection of the Company’s non accrual loans, and an improvedoutlook for economic activity in general..

·       Averageearning assets increased by $193.0 million in 2004 compared to 2003 more thanoffsetting the decline in the net interest margin (from 5.54% in 2003 to 5.36%in 2004, taxable equivalent) thereby allowing the Company to show a $5.9million increase in net interest income.

·       TheCompany realized non-recurring gains in 2004 of $1.1 million on the sale ofOREO and $475 thousand in securities gains. The Company had only minorsecurities gains of $40 thousand in 2003.

·       Increasesin non-interest expense amounted to $4.6 million in 2004 compared to 2003. Factorscontributing to this increase included 1) increases in outside professionalservices of $913 thousand related to Section 404 Sarbanes-Oxley complianceefforts; 2) increases in advertising and promotional expenditures ofapproximately $1.0 million in 2004 compared to 2003; 3) increases in costsreflecting the merger with Ojai Valley Bank effective October 31, 2003which resulted in two months of costs in the 2003 figures compared to a full 12months in 2004 estimated to be an increase of $1.4 million; 4) increases inemployee benefits primarily related to workers compensation and group insuranceincreases of $198 thousand (excluding the impact of the Ojai 

28

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employees) and 5) allother operating expenses increasing by $1.1 million, net of declines—theprimary impact being salary increases of $1.5 million (excluding the impact ofOjai employees).

·       Therewas a decline in the net gains realized on mortgage loans sold of $2.8 millionin 2004 compared to 2003 as a result of the dramatic slowdown in refinanceactivity during the year.

Managementconsiders the following to be the most significant items affecting net incomeduring 2003 compared to 2002.

·       Thegain on sale of loans held for sale increased by $2.4 million resulting from tothe low interest rate environment and the surge in refinance activity on singlefamily residential mortgage loans.

·       TheCompany took a benefit to provision for loan losses of $969 thousand in 2003compared to a provision expense of $600 thousand in 2002 creating a positivepre-tax improvement to earnings of $1.6 million between the two years. Thebenefit taken to the provision for loan losses in 2003 reflected strong creditquality standards, consistent performance of the loan portfolio in recentyears, improving trends in classified loans, improving trends in delinquenciesand charge-offs, an improved outlook for the collection of the Company’s nonaccrual loans, and an improved outlook for economic activity in general.

·       Theimpact of the lower interest rate environment in 2003 led to a decline in theCompany’s net interest margin to 5.54% (taxable equivalent) from 5.74% in 2002.This was offset by an increase in average earning assets of approximately $139million, thereby allowing it to show a $2.6 million increase in net interestincome from the prior year.

·       Variousother non interest income and expense items showed variances which collectivelyreduced pre-tax income by $1.5 million.

Managementconsiders the following to be the most significant items affecting net incomeduring 2002 compared to 2001.

·       Theimpact of the lower interest rate environment in 2002 led to a decline in theCompany’s net interest margin to 5.74% (taxable equivalent) from 6.36% in 2001which was offset by an increase in average earning assets of approximately $274million, thereby allowing it to show a $5.4 million increase in net interestincome from 2001 to 2002.

·       Becauseof concerns of a pending economic slowdown in 2001, the Company added to itsloan loss allowance through a charge to provision for loan loss expense of $4.1million. This provision was reduced in 2002 to just $600 thousand, thuscontributing a $3.5 million improvement to earnings in 2002.

·       TheCompany recorded a non-recurring gain on sale of its credit card portfolio of$1.7 million in 2001.

·       Salariesand benefits during 2002 were $3.1 million above the 2001 levels reflectingespecially the Company’s merger with Americorp in September 2001 resultingin additional staff expense for 2001 involving 3 months of activity compared to12 months in 2002.

·       Occupancyexpense during 2002 was $1.6 million above the 2001 levels reflectingespecially the Company’s merger with Americorp in September 2001 resultingin additional occupancy expense for 2001 involving 3 months of activitycompared to 12 months in 2002.

·       Variousother non interest income and expense items showed variances which collectivelyincreased pre-tax income by $1.3 million. These are discussed in more detail inthe Income Statement Analysis section below.

29

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Management believesthat the primary challenges and risks to the Company in 2005 are as follows:

·       Thedegree and speed with which the Board of Governors of the Federal ReserveSystem will continue to raise short term interest rates thereby allowing theCompany to show improvements in its net interest margin.

·       Theability of the economy to continue its recovery and enhance the Company’sability to grow its loan portfolio either through loan originations orpurchases consistent with the Company’s credit standards.

·       Theability of the Company to generate new revenue to replace some of thenon-recurring benefits to the income statement in 2004.

·       Theability of the Company to contain salary and benefits costs which have risenrapidly in recent years.

·       Theability of the Company to fully integrate its relatively new Ventura Countyoffices and presence into the Company and take advantage of the expanded marketopportunities it sees there.

·       Theability of the Company to overcome the charge to expense that will result froma change in accounting for stock options which is scheduled to be implementedin the third quarter of 2005. See Note 1 and Note 15 of the Notes to theConsolidated Financial Statements which follows in item 8 of this report.

·       Theability of the Company to make its internal support functions more efficient byexploring, and then implementing, a plan to consolidate their operations in onelocation in a cost effective manner.

Management believesthat some of the significant opportunities it has are as follows:

·       Theability the Company has to fund additional loans due to its strong liquidity atthe present time.

·       TheCompany’s asset and liability, maturity and rate structure are such that itsnet interest margin should improve in a rising rate environment.

·       TheCompany’s expanded presence in Ventura County will allow it to take advantageof the large and growing economic base in that part of our market area.

·       Becausethe Company is well capitalized and its stock price has performed well, it iswell positioned to continue to make strategic acquisitions in selected marketsas it has in recent years.

·       Theability of the Company to make its internal support functions more efficient byexploring, and then implementing, a plan to consolidate their operations in onelocation in a cost effective manner.

***Other Events and Items of Note in 2004***

The Company celebrated the one year anniversary of thesuccessful integration of its merger with the former Ojai Valley Bank on October 31,2004. Core deposits (total deposits excluding certificates of deposit) at thetwo locations in Ojai and Oak View have increased from $57.8 million at thetime of the merger to $59.6 million at year-end 2004. Total deposits which were$78.8 million at time of merger were $76.1 million at December 31, 2004. Thisshift away from more rate sensitive deposit liabilities to core, relationshiporiented deposits is expected to benefit the Bank going forward. It should benoted that some of the principal employees in the former Ojai Valley Bank areinvolved with the start-up of the new Ojai Community Bank, which receivedregulatory approval July 21, 2004, raised the necessary equity capital andis expected to open in early 2005. The impact of the opening of this newcommunity bank on the Company is unknown at this time.

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The Company’s stock repurchase program continued in2004 with 658,867 shares repurchased, which compares to 800,006 and 477,264shares repurchased in 2003 and 2002, respectively. The average price paid forthe stock over this three year period was $25.26, $20.27 and $17.57,respectively. As of December 31, 2004, the Company had 520,357 sharesremaining to repurchase on its January 2004 authorization approved by theBoard of Directors to re-purchase up to 1,178,352 additional shares. Theauthorization does not have an expiration date.

Also during 2004, theCompany streamlined its corporate banking and business banking efforts underone umbrella internally known as the commercial banking group. Eight regionalcommercial banking groups under the direction of Senior Vice President, StevenHarding are responsible for the Company’s commercial, commercial real estateand construction lending. The new alignment of this group has createdefficiencies, cost savings and a more focused sales effort.

**EXTERNAL FACTORSIMPACTING THE BANK**

***Economic Conditions***

At the start of 2004, in last year’s annual report wenoted that, “Entering 2004, Management believes that the economy is entering asustained recovery which will lead to lower unemployment rates, increases ininflation and eventually, a need to raise interest rates to combat fears ofexcessive growth and inflationary pressures. Management further believes thatincreases in interest rates will likely take place in the fourth quarter of2004 and/or first quarter of 2005 amounting to a roughly 50 basis pointincrease in short term interest rates. Long term interest rates will rise also,albeit at reduced levels compared to short term rates, reflecting a flatteryield curve.”  We note that this forecastproved reasonably accurate. The Federal Reserve increased short term rates inthe second half of 2004 by 125 basis points, unemployment rates nationally havedeclined from 5.7% at the start of the year to 5.4% at the end of November, andinflation has averaged 2.6% for the first 11 months of the year compared to2.3% in 2003. The yield curve, as expected, has flattened dramatically with thespread between the three month and ten year Treasury declining from 332 basispoints at the start of 2004 to approximately 202 basis points at the end of theyear. The ten year Treasury is actually little changed from its 4.27% level atthe start of the year having closed at 4.24% at the end of 2004.

The most comprehensive review of local economicconditions in our market known to Management comes from the University ofCalifornia at Santa Barbara (UCSB) Economic Forecast Project. According toUCSB, Gross County Product in the tri-county area was estimated at $75.5billion in 2004, up 5.9% from the $71.3 level in the prior year. Adjusted forreal dollars, it was up 2.7% following a 2.8% growth rate in 2003 and 2.1% in2002. While these rates of growth were down from the double digit increaseswitnessed in the late 1990’s, they have been running better than thoseexhibited by the State as a whole. California’s real State Product was -0.9%in 2002, +0.2% in 2003 and is estimated to grow at +1.4% in 2004. Expectationsfor 2005 are for further improvements with the real State Product growing 1.8%and the real Tri County Gross Product growing 3.1%. The difficultiesexperienced at the State level have certainly had a negative effect on thelocal tri-county area. It is estimated by UCSB that the public sector has lostsome 3,892 jobs in the tri-county area over the last two years, a 3.7% decline,at a time when the private sector added some 15,567 jobs, a 3.2% increase. Thisdrag clearly contributed to the slower growth rate in economic activityexperienced locally over the past few years. This notwithstanding, the tricounties continue to be fortunate in experiencing significantly lowerunemployment rates compared to the 5.4% level experienced nationally. The SanLuis Obispo Metropolitan Statistical Area (MSA) was estimated by the Bureau ofLabor Statistics to have an unemployment rate of 3.0% at the end of November 2004with the Santa Barbara MSA at 3.8% and the Ventura MSA at 4.7%. Managementexpects these levels to remain little changed in 2005 as their low absolutelevels would generally be difficult to improve upon.

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Median home prices are at historical highs throughoutthe Bank’s service area. The median price of a home as of November 2004totaled $476 thousand in San Luis Obispo County, up 23.5% from a year earlier. InSanta Barbara County, that figure reached $669 thousand, up 72.3% from one yearearlier. And in Ventura County, the median home price was $507 thousand, up25.8% from one year before. In spite of numerous residential building projectsin the Bank’s trade area and housing affordability indices falling below 20% inmost locales, the local real estate market continues strong with a combinationof favorable interest rate levels and demand far outpacing supply. The strongtrends in both residential and non-residential real estate continue with nosigns of abating. Lenders are more prudent in their lending practices havinglearned the lessons of the early 1990’s and hence building is far lessspeculative. Management does not see significant risk of a slowdown in realestate in 2005. However, it should be noted that high real estate prices arecreating a demographic trend of “aging” home owners replacing “working-class”residents who find first time home ownership difficult. This is contributing toan out-migration by young families with working-aged heads of households. Theimpact of this demographic trend on the local economy and the types ofbusinesses that operate here is unclear at the present time.

With positive indicatorsbeing revealed in the national economic statistics and a solid economic baselocally, Management is encouraged that 2005 should again be a solid year forthe economy in the Company’s trade area. This optimism, however, must betempered by the potential for disruption resulting from geopolitical issuessurrounding homeland security and terrorism. As we noted last year, the effectsof episodes such as the 9/11 terrorist attacks, the wars in Afghanistan andIraq, and the international tensions surrounding these events, can have asignificant on economic activity. In spite of this caveat, our local trade areaagain appears to be in a solid position at the start of 2005 to continue therecovery underway and maintain low unemployment rates. The Board of Governorsof the Federal Reserve System have started raising short term interest ratesand Management expects this trend to continue with the target Fed Funds ratereaching the mid 3% range by year-end. Management also expects that longer termrates will rise much more modestly, if at all, in-keeping with a continue trendtowards a flatter yield curve.

***Competitive Factors***

Competitive pressures from other financialinstitutions continue to be intense both in the Company’s trade area andthroughout the nation. Many banks are suffering from insufficient loan volumesand have become very aggressive on the pricing of those good credits available.In the Company’s tri-counties service area, 66 financial institutions (banksand savings institutions) operate 321 offices serving $23.1 billion in depositsbased on data as of June 30, 2004.

It should be noted thatthe trend toward consolidation of banking assets exhibited over the past fewyears in California continued in 2004. Statewide, through November 2004,21 banks are merging out of existence based on announced merger transactions. Accordingto the State Department of Financial Institutions however, 14 new banks havefiled in 2004 to start a new bank in California, through November.

**ANALYSIS OFSTATEMENT OF FINANCIAL POSITION**

***Loans***

The Bank experienced an increase in net loans from$1,138.9 million at the end of 2003, to $1,408.1 million at the end of 2004. Thisrepresents an increase in the loan portfolio of $269.2 million following the$68.7 million increase in 2002. The loan portfolio represents approximately61.4% of the Bank’s assets. Additionally, loans held for sale (which are singlefamily residential mortgages pending sale) total $13.0 million at the end of2004, down from $13.4 million one year earlier.

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**Mid-StateBancsharesTrends in Loan Categories**

 

The graph above displays the trend over the five yearperiod ended December 31, 2004 in the various components of the loanportfolio. Construction loans have risen from their level five years earlier—$167.5million at December 31, 2000 compared to $227.6 million at year-end 2004. RealEstate loans generally trended up from $445.2 million at the end of 2000 to$759.2 million at the end of 2004. Home Equity Credit Lines have generallyincreased from $55.6 million at the end of 2000 compared to $160.0 million atthe end of 2004. Consumer loans (installment and credit reserve) have decreasedfrom $40.3 million at December 31, 2000 to $22.9 million at year-end 2004which is in part due to the sale in December 2001 of the Company’s CreditCard receivables. Commercial and other loans have grown in recent years through2002, with a decrease in 2003, but grew to $212.0 million at December 31,2004. Agricultural production loans have remained flat until 2004, ending at$40.3 million in December. The Bank expects to continue to emphasize all typesof lending activity in order to diversify the risk in its portfolio. The largergrowth in real estate loans, especially in 2004, reflects an expanded use ofjumbo adjustable rate mortgage loans in the portfolio ($96.4 million at the endof the year) along with the purchase of certain of these same type of loanassets in the secondary market ($43.0 million at the end of the year). Economicactivity in the Central Coast will determine the types of credit the Bank willbe able to extend and hence its ability to achieve this objective.

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TheBank’s allowance for losses stands at $15.6 million, or 1.1% of gross loans,and represents losses not yet realized, but inherent in the loan portfolio andon unfunded commitments. The allowance for losses is down from the $18.0million at December 31, 2003. The year-end 2004 balance now represents146% of non-performing loans identical to the level at the end of 2003. Afive-year review of activity in the allowance for losses and an allocation byloan type of the allowance is shown in the tables below.
| **Allowance for Losses (in 000’s)**                 | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Allowance for  loan losses beginning of year                                 |       | $          | 16,063     |     | $          | 17,370   |       | $        | 19,073     |     | $          | 10,920   |       | $ | 10,905 |   |
| Allowance for  losses—unfunded commitments                              |       | 1,941      |       | 1,771    |       | 1,586    |       | 2,360    |       | 2,200    |       |
| Total allowance  for losses                                                  |       | $          | 18,004     |     | $          | 19,141   |       | $        | 20,659     |     | $          | 13,280   |       | $ | 13,105 |   |
| Provision for loan losses charged to operating  expense                      |       | (2,700     | )          | (969     | )          | 600      |       | 4,100    |       | 700      |       |
| Provision for losses—unfunded commitments charged to  operating expense |       | (158       | )          | 170      |       | —   |       | —   |       | —   |       |
| Adjustments—acquisition through merger                                  |       | —     |       | 391      |       | —   |       | 5,464    |       | —   |       |
| Loans charged  off:                                                          |       |       |       |     |       |     |       |     |       |     |       |
| Real estate loans                                                            |       | (5         | )          | (1,106   | )          | —   |       | (7       | )          | (163     | )          |
| Installment loans                                                            |       | (148       | )          | (234     | )          | (275     | )          | (275     | )          | (278     | )          |
| Commercial loans                                                             |       | (746       | )          | (488     | )          | (2,475   | )          | (2,377   | )          | (512     | )          |
| Credit cards and related loans                                               |       | (41        | )          | (66      | )          | (88      | )          | (255     | )          | (239     | )          |
| Recoveries of  loans previously charged off:                                 |       |       |       |     |       |     |       |     |       |     |       |
| Real estate loans                                                            |       | 41         |       | 45       |       | 24       |       | 149      |       | 102      |       |
| Installment loans                                                            |       | 111        |       | 96       |       | 196      |       | 186      |       | 134      |       |
| Commercial loans                                                             |       | 1,179      |       | 963      |       | 451      |       | 309      |       | 330      |       |
| Credit cards and related loans                                               |       | 45         |       | 61       |       | 49       |       | 85       |       | 101      |       |
| ***Total Allowance for Losses***                                             |       | $          | 15,582     |     | $          | 18,004   |       | $        | 19,141     |     | $          | 20,659   |       | $ | 13,280 |   |

 
| **Allocation of  Allowance for Losses (in 000’s)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Allowance for  loan losses                              |       | $          | 13,799     |       | $          | 16,063     |       | $          | 17,370     |       | $          | 19,073     |       | $ | 10,920 |   |
| Allowance for  losses—unfunded commitments         |       | 1,783      |       | 1,941      |       | 1,771      |       | 1,586      |       | 2,360      |       |
| ***Total Allowance for Losses***                        |       | $          | 15,582     |       | $          | 18,004     |       | $          | 19,141     |       | $          | 20,659     |       | $ | 13,280 |   |
| Ratio of Net Loan  Losses to Average Loans Outstanding  |       | (0.03      | )%         | 0.06       | %          | 0.19       | %          | 0.22       | %          | 0.06       | %          |

 

Allocation of the allowance for losses compared to loantype as a percent of total at December 31:
| ** **                                                              | ** ** | ** ** | ** ** | **Type** | ** ** | ** **                          | ** ** | **Type** | ** ** | ** **                          | ** ** | **Type** | ** ** | ** **                          | ** ** | **Type** | ** ** | ** **                          | ** ** | **Type** | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|----------|------------|-------------------------------------|------------|----------|------------|-------------------------------------|------------|----------|------------|-------------------------------------|------------|----------|------------|-------------------------------------|------------|----------|------------|
| **(dollars in 000’s)  Balance applicable to:** | ** ** | ** ** | ** ** | **2004** | ** ** | **as a % of  Loans** | ** ** | **2003** | ** ** | **as a % of  Loans** | ** ** | **2002** | ** ** | **as a % of  Loans** | ** ** | **2001** | ** ** | **as a % of  Loans** | ** ** | **2000** | ** ** | **as a % of  Loans** | ** ** |
| Construction and Land                                                   |       | $          | 5,120      |     |       | 16.1                                | %          |     | $          | 2,680                               |       |     | 20.8       | %                                   |       | $        | 2,636      |                                |       | 19.7     | %          |   | $ | 1,969 |   |   | 18.8 | % |   | $ | 2,095 |   |   | 18.3 | % |   |
| Real Estate                                                             |       | 1,757      |       |     | 53.5       | %                                   |       | 2,164    |       |                                | 49.1       | %        |       | 4,047                               |       |     | 48.4       | %                                   |       | 2,949    |       |   | 46.8 | % |   | 3,993 |   |   | 48.4 | % |   |
| H.E.C.L.                                                                |       | 308        |       |     | 11.2       | %                                   |       | 250      |       |                                | 7.8        | %        |       | 295                                 |       |     | 6.8        | %                                   |       | 443      |       |   | 6.0 | % |   | 390 |   |   | 6.0 | % |   |
| Installment                                                             |       | 160        |       |     | 1.3        | %                                   |       | 244      |       |                                | 2.2        | %        |       | 254                                 |       |     | 2.5        | %                                   |       | 780      |       |   | 3.1 | % |   | 292 |   |   | 3.4 | % |   |
| Credit Card and Related                                                 |       | 86         |       |     | 0.3        | %                                   |       | 229      |       |                                | 0.6        | %        |       | 97                                  |       |     | 0.3        | %                                   |       | 393      |       |   | 0.3 | % |   | 1,203 |   |   | 1.0 | % |   |
| Commercial, Other                                                       |       | 3,237      |       |     | 17.6       | %                                   |       | 6,468    |       |                                | 19.5       | %        |       | 6,296                               |       |     | 22.3       | %                                   |       | 5,712    |       |   | 25.0 | % |   | 2,247 |   |   | 22.9 | % |   |
| Unfunded commitments                                                    |       | 1,783      |       |     | N/A        |                                |       | 1,941    |       |                                | N/A        |     |       | 1,771                               |       |     | N/A        |                                |       | 1,586    |       |   | N/A |   |   | 2,360 |   |   | N/A |   |   |
| Unallocated                                                             |       | 3,131      |       |     | N/A        |                                |       | 4,028    |       |                                | N/A        |     |       | 3,745                               |       |     | N/A        |                                |       | 6,827    |       |   | N/A |   |   | 700 |   |   | N/A |   |   |
| ***Balance at End of Year***                                            |       | $          | 15,582     |     |       | 100.0                               | %          |     | $          | 18,004                              |       |     | 100.0      | %                                   |       | $        | 19,141     |                                |       | 100.0    | %          |   | $ | 20,659 |   |   | 100.0 | % |   | $ | 13,280 |   |   | 100.0 | % |   |
|                                                                         |            |            |            |          |            |                                     |            |          |            |                                     |            |          |            |                                     |            |          |            |                                     |            |          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Non-accrual loans within the Bank’s portfoliodecreased from $12.3 million as of December 31, 2003, to $10.7 million, atthe end of 2004. Loans 90 days or more past due, and still accruing, remainedat zero 

34

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for the periods ending December 31,2003 and December 31, 2004. Additional information on non-accrual loans,past due loans and troubled debt restructurings can be found in Footnote 5 tothe financial statements. The level of non-accrual loans at the end of 2004 iscentered primarily in one real estate secured loan (total $8.5 million). Managementhas established specific reserves that would offset potential losses, if any,arising from less than full recovery of the loan from the supporting collateral.Recoveries in 2004 of loans previously charged-off totaled $1.4 millioncompared to charge-offs of $0.9 million taken during the year resulting in netrecoveries of $436 thousand. This net recoveries figure compares to netcharge-offs incurred of $0.7 million and $2.1 million in 2003 and 2002,respectively. The Bank anticipates that charge-offs (actual losses) willcontinue during 2005. Management does not anticipate that recoveries wouldagain exceed charge-offs in the coming year.

With the combination of the collateral securing theproblem loans and the size of the allowance for losses, Management feels thatthe allowance is sufficient to cover inherent losses. Management reviews theadequacy of the allowance and also employs an independent third party loanreview group to, among other things, review the reasonableness of individualasset classifications. Management, as necessary, adjusts the allowance on aregular basis. The allowance is also examined annually by one or more of theBank’s regulatory bodies including the FDIC and DFI. During the fourth quarterof 2003, based on its review of the allowance, Management took a benefit to theprovision for loan losses of $1.2 million resulting in a net benefit to theprovision for loan losses of just under $1.0 million for the full year. Againduring the second quarter of 2004, Management took a further benefit to theprovision for loan losses of $2.7 million. These actions reflected strongcredit quality standards, consistent performance of the loan portfolio inrecent years, improving trends in classified loans, improving trends indelinquencies and charge-offs, an improved outlook for the collection of theCompany’s non accrual loans, and an improved outlook for economic activity ingeneral. The need for additional provision for loan losses or for furtherbenefit to the provision for loan losses in 2005 will be dependent uponManagement’s on-going analysis of the adequacy of the allowance for loan losses.While Management believes it to be adequate at the present time, the appropriate value can fluctuate over time inresponse to economic conditions and the subjective decisions which must be madein response to those conditions.

The allowance for losses consists of a statisticallyallocated portion and a specifically allocated portion. The total of thesecomponents is considered adequate to provide for losses, which can bereasonably anticipated. However, since these amounts are based on estimates,ultimate losses relating to these loans may vary and Management believes thatqualitative factors make it prudent to carry a reasonable level of an “unallocatedportion” to absorb losses in excess of the allocated portion. Qualitativefactors considered include, but are not limited to, portfolio composition,concentrations, off balance sheet risks, delinquencies and non-accruals,criticized and classified loans, non performing loans, gross and net loanlosses, changes in lending function, changes in management, the Bank’sorganizational structure, the special assets group, lending and credit approvalauthorities, loan officer training, the credit review function, and real estateappraisal policies.

Management continuously monitors residential realestate reports and markets, and is aware of press articles that have discusseda possible slow down and/or drop in value of residential real estate in theBank’s service area. While long term interest rates remain historically low andthe Bank’s service area is marked by limited supply and strong demand,residential projects financed by the Bank are underwritten with a requirementof a percentage of cash equity to the total cost of the project in addition toprudent exposures to current appraised values. To further mitigate this risk,individual projects financed are analyzed using direct, current and historicalproject trends with limitations to production unit starts ahead of sales usingthe projected absorption analysis contained in the appraisal of each project. TheBank believes, based upon past experience, that this process helps mitigateagainst the production of a supply of units that would exceed the currentmarket demand.

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Additionally, due to the popularity of our market areato urban retirees and others wanting to enjoy the environment and life style itprovides, we have seen and continue to see a migration of wealthier individualsand families absorb the residential housing production with greater cashequities than is typical of other areas throughout the country. This assumptionis supported by the fact that the Bank’s portfolio of residential mortgageshave an average loan to value ratio of less than 60% along with average creditscores substantially exceeding industry standards with low delinquency ratios.

A summary of maturitiesand sensitivities of loans to changes in interest rates at December 31,2004 is shown in the table below. A more complete discussion of the Bank’sexposure to changes in interest rates can be found in the MD&A under thesection titled “Net Interest Income and Interest Rate Risk”.

***Loan Portfolio asof 12/31/04***
| ** **                            | ** ** | ** **                                | ** ** | **Over**                                   | ** ** | **Due after**                               | ** ** | **Due After**                               | ** ** | ** **         | ** ** | ** **       | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------|------------|------------------|------------|
| **(dollars in 000’s)** | ** ** | **  3 Months  ** | ** ** | **  3 through  ** | ** ** | **  After 1 to  ** | ** ** | **  After 3 to  ** | ** ** | **Due After** | ** ** | ** **       | ** ** |
| **Fixed Rate Loans**        | ** ** | ** **                                | ** ** | **or less**                           | ** ** | **12 Months**                               | ** ** | **3 Years**                                 | ** ** | **5 Years**   | ** ** | **5 Years** | ** ** | **    Total    ** | ** ** |
| Construction/Land  Development        |       |                                      | 11,021     |                                       |       |                                             | 29,723     |                                             |       |               | 14,766     |             |       |   | 788 |   |   | — |   | 56,298 |   |
| Real estate                           |       |                                      | 3,746      |                                       |       |                                             | 2,584      |                                             |       |               | 40,886     |             |       |   | 50,253 |   |   | 220,937 |   | 318,406 |   |
| Home equity  credit lines             |       |                                      | 3          |                                       |       |                                             | 23         |                                             |       |               | 1          |             |       |   | 412 |   |   | 792 |   | 1,231 |   |
| Installment                           |       |                                      | 217        |                                       |       |                                             | 920        |                                             |       |               | 4,251      |             |       |   | 6,000 |   |   | 5,638 |   | 17,026 |   |
| Cash reserve                          |       |                                      | 31         |                                       |       |                                             | —     |                                             |       |               | 3          |             |       |   | — |   |   | — |   | 34 |   |
| Agricultural  production              |       |                                      | 197        |                                       |       |                                             | 666        |                                             |       |               | 1,261      |             |       |   | 3,098 |   |   | 197 |   | 5,419 |   |
| Commercial, other                     |       |                                      | 2,054      |                                       |       |                                             | 6,469      |                                             |       |               | 14,655     |             |       |   | 25,750 |   |   | 15,909 |   | 64,837 |   |
| **Total**                             | ** ** | ** **                                | **17,269** |                                       | ** ** | ** **                                       | **40,385** |                                             | ** ** | ** **         | **75,823** |             | ** ** | ** ** | **86,301** |   | ** ** | **243,473** | ** ** | **463,251** | ** ** |
|                                       |            |                                           |            |                                            |            |                                                  |            |                                                  |            |                    |            |                  |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                                                    | ** ** | ** **                                | ** **  | **Over**                                   | ** ** | **Due after**                               | ** ** | **Due After**                               | ** ** | ** **         | ** **  | ** **       | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|-------------|--------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------|-------------|------------------|------------|
| ** **                                                                                                    | ** ** | **  3 Months  ** | ** **  | **  3 through  ** | ** ** | **  After 1 to  ** | ** ** | **  After 3 to  ** | ** ** | **Due After** | ** **  | ** **       | ** ** |
| **Variable Rate Loans**                                                                             | ** ** | ** **                                | ** **  | **or less**                           | ** ** | **12 Months**                               | ** ** | **3 Years**                                 | ** ** | **5 Years**   | ** **  | **5 Years** | ** ** | **    Total    ** | ** ** |
| Construction/Land  Development                                                                                |       |                                      | 163,104     |                                       |       |                                             | 2,196      |                                             |       |               | 5,921       |             |       |   | 200 |   |   |   | 1,850 |   |   | 173,271 |   |
| Real estate                                                                                                   |       |                                      | 95,549      |                                       |       |                                             | 16,919     |                                             |       |               | 154,731     |             |       |   | 161,177 |   |   |   | 15,165 |   |   | 443,541 |   |
| Home equity  credit lines                                                                                     |       |                                      | 158,819     |                                       |       |                                             | —     |                                             |       |               | —      |             |       |   | — |   |   |   | — |   |   | 158,819 |   |
| Installment                                                                                                   |       |                                      | 2,180       |                                       |       |                                             | —     |                                             |       |               | —      |             |       |   | — |   |   |   | — |   |   | 2,180 |   |
| Cash reserve                                                                                                  |       |                                      | 3,573       |                                       |       |                                             | —     |                                             |       |               | —      |             |       |   | — |   |   |   | — |   |   | 3,573 |   |
| Agricultural  production                                                                                      |       |                                      | 34,837      |                                       |       |                                             | —     |                                             |       |               | —      |             |       |   | — |   |   |   | — |   |   | 34,837 |   |
| Commercial, other                                                                                             |       |                                      | 144,631     |                                       |       |                                             | 1,071      |                                             |       |               | 109         |             |       |   | 603 |   |   |   | — |   |   | 146,414 |   |
| **Total**                                                                                                     | ** ** | ** **                                | **602,693** |                                       | ** ** | ** **                                       | **20,186** |                                             | ** ** | ** **         | **160,761** |             | ** ** | ** ** | **161,980** |   | ** ** | ** ** | **17,015** |   | ** ** | **962,635** | ** ** |
| **Total  loans, gross (excludes allowance for loan losses, net deferred loan fees and  loans held for sale)** | ** ** | ** **                                | ** **  |                                       | ** ** | ** **                                       | ** ** |                                             | ** ** | ** **         | ** **  |             | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** |   | ** ** | **1,425,886** | ** ** |
|                                                                                                               |            |                                           |             |                                            |            |                                                  |            |                                                  |            |                    |             |                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Investment Portfolio***

The Bank’s investment portfolio primarily consists ofU.S. Treasury Notes and Bills, Federal Agency Notes, Mortgage BackedSecurities, and Municipal Bonds. See Footnote No. 4 to the consolidatedfinancial statements for a detailed composition of the investment portfolio. Overall,the portfolio showed a net reduction in outstanding balances over the course of2004 as 1) the Bank redirected these earning assets into the loan portfolio and2) to a lesser extent the market value relative to amortized cost of the 100%available for sale the investment portfolio declined. The Treasury and Agencyportion of the portfolio decreased by $132.9 million from one year ago. TheBank maintained its holdings in the Municipal Bond portfolio fairly steady froma market value of $377.1 million at the end of 2003, to a 

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market value of $377.0million at the end of 2004. Mortgage Back Securities increased somewhat by $1.7million. In total however, the Bank decreased its investment portfolio from amarket value of $774.7 million at the end of 2003 to a market value of $644.8million at the end of 2004, a $129.9 million decrease.

The Bank may segregate its portfolio into threecategories—a “Trading Portfolio” (which is carried at market value, withchanges in market value reflected in the income statement), a “Held to Maturity”portfolio (which is carried at amortized cost, with changes in market valuehaving no impact on the financial statements) and an “Available for Sale”portfolio (which is carried at market value, with changes in market valuereflected in comprehensive income). The Bank holds no securities that should beclassified as Trading or Held to Maturity securities. The Bank has determinedthat since its securities may be sold prior to maturity because of interestrate changes, to meet liquidity needs, or to better match the re-pricingcharacteristics of funding sources, that the entire portfolio should beclassified as Available for Sale.

Adjustments to the Available for Sale portfolio forchanges in market values resulted in an unrealized gain of $6.9 millionincluded in accumulated other comprehensive income as of December 31, 2004compared to an unrealized gain of $12.3 million at December 31, 2003, netof related taxes. Maturities and sales over the full year exceeded purchasesand the total investment portfolio decreased by $129.9 million from the end of2003 to the end of 2004.

Shownbelow is a summary maturity distribution of the investment portfolio, by typeand weighted taxable equivalent yield as of December 31, 2004. Expectedmaturities may differ from contractual maturities because borrowers may havethe right to call or prepay obligations with or without call or prepaymentpenalties. Maturity information for Mortgage Backed securities shown below isbased on contractual maturities.
| ** **                            | ** ** | ** **        | ** ** | **After One** | ** ** | **After Five** | ** ** | ** **         | ** ** | ** **         | ** ** |
|---------------------------------------|------------|-------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|--------------------|------------|
| ** **                            | ** ** | **One Year** | ** ** | **Year to**   | ** ** | **Years to**   | ** ** | **After**          | ** ** | ** **         | ** ** |
| **(dollars in 000’s)** | ** ** | ** **        | ** ** | **Or Less**   | ** ** | **Five Years** | ** ** | **Ten Years** | ** ** | **Ten Years** | ** ** | **Total** | ** ** |
| Maturity  Distribution:               |       |              |       |               |       |                |       |               |       |               |       |   |   |
| U.S. Treasury Securities              |       | $                 | 13,047     |               | $          | 11,931              |       | $                  | 510        |               |       | $ | — |   |   | $ | 25,488 |   |
| U.S. Government Agencies              |       | 86,538            |       | 130,123            |       | —              |       |               | —     |               |       | 216,661 |   |
| Mortgage Backed Securities            |       | 145               |       | 570                |       | 6,539               |       |               | 2,163      |               |       | 9,417 |   |
| Municipal Bonds, Other                |       | 28,295            |       | 167,762            |       | 189,451             |       |               | 7,743      |               |       | 393,251 |   |
| Total                                 |       | $                 | 128,025    |               | $          | 310,386             |       | $                  | 196,500    |               |       | $ | 9,906 |   |   | $ | 644,817 |   |
|                                       |            |                   |            |                    |            |                     |            |                    |            |                    |            |  |  |  |  |  |  |  |  |  |

 
| ** **                 | ** ** | ** **        | ** ** | **After One**  | ** ** | **After Five** | ** ** | ** **         | ** ** | ** ** | ** ** |
|----------------------------|------------|-------------------|------------|---------------------|------------|---------------------|------------|--------------------|------------|------------|------------|
| ** **                 | ** ** | **One Year** | ** ** | **Year to**    | ** ** | **Years to**   | ** ** | **After**          | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **Or Less**  | ** ** | **Five Years** | ** ** | **Ten Years**  | ** ** | **Ten Years** | ** ** | **Total**  | ** ** |
| Weighted  Average Yield:   |       |              |       |                |       |                |       |               |       |       |       |   |   |
| U.S. Treasury Securities   |       | 1.58              | %          | 2.42                | %          | 4.22                | %          |               | —     |       |       | 1.94 | % |
| U.S. Government Agencies   |       | 3.47              | %          | 2.77                | %          | —              |       |               | —     |       |       | 3.05 | % |
| Mortgage Backed Securities |       | 6.17              | %          | 6.14                | %          | 6.04                | %          |               | 5.56       | %          |       | 5.94 | % |
| Municipal Bonds, Other     |       | 5.68              | %          | 5.89                | %          | 5.63                | %          |               | 6.00       | %          |       | 5.75 | % |
| Total                      |       | 3.77              | %          | 4.45                | %          | 5.64                | %          |               | 5.90       | %          |       | 4.70 | % |

 

***Other Real Estate Owned (“OREO”)***

The Company did not holdany OREO from foreclosure as of December 31, 2004 compared to $3.4 millionheld as of December 31, 2003. Future OREO activity will depend, amongother things, on how many borrowers the Bank may need to foreclose upon, andthe strength of the real estate market and general economic activity.

37

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***Goodwill and Core Deposit Intangibles***

Goodwill totaled $47.8 million at December 31,2004 and 2003. Of this total, $14.4 million was the result of the acquisitionof Ojai Valley Bank that was completed on October 31, 2003, $32.2 millionwas the result of the acquisition of American Commercial Bank that wascompleted on September 28, 2001 and $1.2 million dates to a May 3,1996 acquisition of Citizens Bank of Paso Robles by BSM Bancorp which theCompany acquired in 1998.

On an annual basis, the Company tests its Goodwill forimpairment. The Goodwill is entirely attributable to the Company’s communitybanking segment. Results of this test have indicated that there was noimpairment of Goodwill in any of the past three years (2002 through 2004) sincethe testing commenced.

Core deposit intangiblestotal $7.7 million at December 31, 2004 compared to $9.1 million one yearearlier. Of  the year-end 2004 amounts,$5.4 million represents the net un-amortized value of the core depositintangible created with the American Commercial Bank acquisition and $2.3 millionrepresents the net un-amortized value of the core deposit intangible createdupon the acquisition of Ojai Valley Bank. In connection with theseacquisitions, the Company recognizes core deposit intangibles which representthe fair value of long-term deposit relationships acquired. Such amounts arethen amortized over originally expected useful economic lives of 8.25 and 9.00years, respectively. Absent adjustments to the amortization schedules in futureperiods, the core deposit intangibles will be fully amortized in December 2009with respect to the American Commercial Bank acquisition and October 2012with respect to the Ojai Valley Bank acquisition

***Deposits***

While the Bank is competitive with major institutionsin terms of its structure of interest rates on deposit products offered,Management was not overly aggressive during 2004 in terms of pricing to attractadditional deposits, a decision which reflects the Bank’s strong liquidity atthe present time.

Asdiscussed in the Income Statement Analysis, many of the Bank’s deposit rateshave risen in concert with the general increase in rates. A comparison of therates paid on the Bank’s deposit products at December 31, 2004 and 2003 isas follows:
| **Selected Quoted Interest Rates**    | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **Change** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|------------|------------|
| Demand Deposits                                      |       | 0          | %          | 0        | %          |     | 0          | %          |       |
| NOW Account  (50 & Better—over $2,500) |       | 0.10       | %          | 0.05     | %          |     | 0.05       | %          |       |
| Money Market  Deposits (over $100,000)               |       | 0.80       | %          | 0.75     | %          |     | 0.05       | %          |       |
| Passbook Savings  Account                            |       | 0.25       | %          | 0.25     | %          |     | 0.00       | %          |       |
| Individual  Retirement Account (2 Year term)         |       | 2.75       | %          | 1.75     | %          |     | 1.00       | %          |       |
| Time Deposit ($100,000—6  month term)           |       | 1.85       | %          | 1.05     | %          |     | 0.75       | %          |       |
| Wall Street Journal  Prime Rate                      |       | 5.25       | %          | 4.00     | %          |     | 1.25       | %          |       |

 

38

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Averagedeposits have risen steadily over the past three years reflecting growth atMid-State Bank & Trusts’ existing offices and the acquisition of OjaiValley Bank on October 31, 2003 which had deposits of approximately $78.8million at the time of the acquisition. Below is a summary of the averagedeposits outstanding and the average rate paid by category over the last threeyears.
| ** **                                                         | ** ** | **Average** | ** ** | **2004**    | ** ** | ** **   | ** ** | **Average** | ** ** | **2003**    | ** ** | ** **   | ** ** | **Average** | ** ** | **2002**    | ** ** | ** **   | ** ** |
|--------------------------------------------------------------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|--------------|------------|
| **(dollars in 000’s)**                              | ** ** | ** **  | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Interest Bearing Demand and Money  Market Investment Accounts | ** ** | $           | 741,230    |        |       | $            | 1,712      |        |       | 0.23        | %          | $            | 651,285    |        |       | $           | 1,527      |         |       | 0.23 | % | $ | 581,439 |   | $ | 2,639 |   | 0.45 | % |
| Savings Accounts                                                   |       | 322,665     |       |        | 853        |         |       | 0.26        | %          | 287,435     |       |         | 1,077      |        |       | 0.37        | %          | 245,615      |       | 2,255 |   | 0.92 | % |
| Time Deposits                                                      |       | 399,806     |       |        | 5,691      |         |       | 1.42        | %          | 399,448     |       |         | 6,944      |        |       | 1.74        | %          | 418,536      |       | 11,275 |   | 2.69 | % |
| Total Interest Bearing Deposits                                    |       | 1,463,701   |       |        | 8,256      |         |       | 0.56        | %          | 1,338,168   |       |         | 9,548      |        |       | 0.71        | %          | 1,245,590    |       | 16,169 |   | 1.30 | % |
| Non Interest Bearing Demand                                        |       | 506,547     |       |        |       |         |       |        |       | 425,047     |       |         |       |        |       |        |       | 377,920      |       |   |   |   |   |
| Total Deposits                                                     |       | $           | 1,970,248  |        |       | $            | 8,256      |        |       | 0.42        | %          | $            | 1,763,215  |        |       | $           | 9,548      |         |       | 0.54 | % | $ | 1,623,510 |   | $ | 16,169 |   | 0.99 | % |
|                                                                    |            |             |            |             |            |              |            |             |            |             |            |              |            |             |            |             |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Themajority of the Bank’s time deposits (approximately 58%) have balances that areunder $100,000 in size. While all time deposits are somewhat more ratesensitive than the Bank’s other deposit categories, the smaller time depositbalances tend to be more stable and less sensitive to absolute rate levels thando time deposits of $100,000 or more. Approximately 86% of the Bank’s timedeposits mature within one year and would be potentially subject to a change inrate on their maturity date. The following table as of December 31, 2004,displays summary size and maturity information on the Bank’s time deposits.
| ** **                            | ** ** | ** **         | ** ** | ** After Three ** | ** ** | **After Six** | ** **        | ** ** | ** **        | ** ** | ** ** |
|---------------------------------------|------------|--------------------|------------|----------------------------------|------------|--------------------|-------------------|------------|-------------------|------------|------------|
| ** **                            | ** ** | **Three**          | ** ** | **Months to**               | ** ** | **Months **   | ** **        | ** ** | ** **        | ** ** | ** ** |
| **(dollars in 000’s)** | ** ** | **Months or** | ** ** | **Six**                          | ** ** | **to**             | ** **        | **After**  | ** **        | ** ** | ** ** |
| **Balance by Size**         | ** ** | ** **         | **Less**   | ** **                       | **Months** | ** **         | **One Year** | ** ** | **One Year** | ** ** | **Total**  | ** ** |
| Under $100,000                        |       | $                  | 84,477     |                             |       | $                  | 58,462            |       |              | $          | 44,543     |   | $ | 40,490 |   | $ | 227,972 |   |
| $100,000 or More                      |       | 83,331             |       |                             | 48,741     |               |              | 20,276     |              | 13,947     |       | 166,295 |   |
| Total Time Deposits                   |       | $                  | 167,808    |                             |       | $                  | 107,203           |       |              | $          | 64,819     |   | $ | 54,437 |   | $ | 394,267 |   |
|                                       |            |                    |            |                                  |            |                    |                   |            |                   |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Other Borrowings***

While not a significant component of the Bank’sstructure, other borrowings were $7.6 million, at the end of 2003 compared to$6.6 million at the end of 2004. These consist of borrowings under the U.S.Treasury Tax and Loan note account, Federal Home Loan Bank borrowings andmortgages payable. The Bank had outstanding borrowings of $4.6 million and $5.6million at December 31, 2004 and 2003, respectively, under the U.S.Treasury Tax and Loan note account program. The Bank had one borrowing from theFederal Home Loan Bank for $2.0 million at December 31, 2004 and 2003. Mortgagespayable were zero and $31 thousand at year-end 2004 and 2003, respectively.

The Company may increaseits Other Borrowings during 2005 in an effort to purchase earning assets whichcreate a positive spread for the income statement and allow it to moreprofitably leverage its strong capital base. Management could borrow up to $100million of mostly shorter term borrowings (up to five years) from sources suchas the Federal Home Loan Bank. Funds raised this way would be used to purchaseearning assets such as investment securities or generate additional loans atsufficiently positive spreads to justify the additional leverage.

***Capital***

Capital ratios for commercial banks and their holdingcompanies in the United States are generally calculated using three differentformulas. These calculations are referred to as the “Leverage Ratio” and 

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two “risk based”calculations known as “Tier One Risk Based Capital Ratio” and the “Total RiskBased Capital Ratio.”  The Company andthe Bank are subject to certain standards concerning these ratios. Thesestandards were developed through the joint efforts of banking authorities from12 different countries around the world. The standards essentially take intoaccount the fact that different types of assets have different levels of riskassociated with them. Further, they take into account the off-balance sheetexposures of banks when assessing capital adequacy.

TheLeverage Ratio calculation simply divides common stockholders’ equity (reducedby goodwill and certain other intangibles that a bank may have) by the totalassets of the bank. In the Tier One Risk Based Capital Ratio, the numerator isthe same as the leverage ratio, but the denominator is the total “risk-weightedassets” of the bank. Risk-weighted assets are determined by segregating all theassets and off-balance sheet exposures into different risk categories andweighting them by a percentage ranging from 0% (lowest risk) to 100% (highestrisk). The Total Risk Based Capital Ratio again uses “risk-weighted assets” inthe denominator, but expands the numerator to include other capital itemsbesides equity such as a limited amount of the allowance for loan losses, long-termcapital debt, preferred stock and other instruments. Summarized below are thecapital ratios at December 31, 2004 and 2003, for both Mid-StateBancshares and Mid-State Bank & Trust. Additionally, the standards fora well-capitalized institution, as defined by the federal banking agencies, aredisplayed.
| ** **                        | ** ** | **Minimum**    | ** ** | **Well-Capitalized** | ** ** | **Mid-State**  | ** ** | **Mid-State**                  | ** ** |
|-----------------------------------|------------|----------------|------------|----------------------|------------|----------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **Regulatory** | ** ** | **Regulatory**       | ** ** | **Bancshares** | ** ** | **Bank & Trust** | ** ** |
| ** **                        | ** ** | **Standard**   | ** ** | **Standard**         | ** ** | **2004**       | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Leverage Ratio                    |       |           | 4.0        | %                    |       |           | 5.0        | %                              |       | 9.3 | % | 9.6 | % | 9.2 | % | 9.4 | % |
| Tier One Risk Based Capital Ratio |       |           | 4.0        | **%**                |       |           | 6.0        | **%**                          |       | 12.1 | **%** | 13.8 | **%** | 12.0 | **%** | 13.5 | **%** |
| Total Risk Based Capital  Ratio   |       |           | 8.0        | **%**                |       |           | 10.0       | **%**                          |       | 13.0 | **%** | 15.0 | **%** | 12.9 | **%** | 14.7 | **%** |

 

While it is the intent of management to continue tomaintain strong capital ratios, the Board of Directors has initiated a stockrepurchase program and increased the quarterly dividend payments in an effortto further leverage its equity and enhance shareholder value. The Company alsoexpects to modestly increase its other borrowings as noted above under OtherBorrowings and increase its capital leverage.

Withoutdeducting for goodwill and other intangibles from equity, two other commonlyfollowed ratios related to capital have trended as follows over the past threeyears.
| ** **                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend Payout  Ratio                   |       | 38.6     | %          | 35.3     | %          | 32.8     | %          |
| Average Common Equity to  Average Assets |       | 12.2     | %          | 12.8     | %          | 12.9     | %          |

 

***Liquidity***

The focus of the Bank’s liquidity management is toensure its ability to meet cash requirements. Sources of liquidity include cash,due from bank balances (net of Federal Reserve requirements to maintainreserves against deposit liabilities), fed funds sold, investment securities(net of pledging requirements), loan repayments, deposits and fed fundsborrowing lines. Typical demands on liquidity are deposit run-off from demanddeposits and savings accounts, maturing time deposits, which are not renewed,and anticipated funding under credit commitments to customers.

The Bank has adequate liquidity at the present time. Itsloan to deposit ratio at year-end 2004 was 71.3% versus 60.4% one year earlier.The Bank normally strives for a loan to deposit ratio in the 65% to 75% range. TheBank’s internally calculated liquidity ratio stands at 34.2% at December 31,2004 compared to 45.2% one year earlier. These levels are above the Bank’sminimum policy of 15%.

Management is not aware ofany trend, demand, commitment or event that would result in a material changein the Bank’s liquidity at the present time.

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***Capital Commitments***

As of December 31,2004, neither the Company or the Bank have any material commitment for capitalexpenditures.

***Contractual Obligations***

As of December 31, 2004, the Bank had thefollowing contractual obligations.
| ** **                    | ** ** | **Less Than** | ** ** | **One to Three** | ** ** | **Three to Five** | ** ** | **Over**            | ** ** | ** ** | ** ** |
|-------------------------------|------------|--------------------|------------|----------------------------|------------|-----------------------------|------------|---------------------|------------|------------|------------|
| ** **                    | ** ** | **One Year**  | ** ** | **Years**                  | ** ** | **Years**                   | ** ** | **Five Years** | ** ** | **Total**  | ** ** |
| Long Term Debt                |       |               | $          | —                     |       |                        |       | $                   | —     |       |       |   | $ | — |   |   |   | $ | 2,000 |   |   | $ | 2,000 |   |
| Operating Leases              |       |               | 1,892      |                       |       |                        | 3,563      |                |       |       | 2,831      |   |   |   | 4,137 |   |   | 12,423 |   |
| Total Contractual Obligations |       |               | $          | 1,892                      |       |                        |       | $                   | 3,563      |       |       |   | $ | 2,831 |   |   |   | $ | 6,137 |   |   | $ | 14,423 |   |

 

***Off Balance Sheet and Other Related Party Transactions***

As noted in Footnote 12 to the financial statements,the Company is contingently liable for letter of credit accommodations made toits customers in the ordinary course of business totaling $30.2 million at December 31,2004, down from $31.0 million one year earlier. Additionally, the Company hasundisbursed loan commitments, also made in the ordinary course of business,totaling $626.4 million, which was up from the $523.4 million outstanding oneyear earlier. The Company has an allowance for losses-unfunded commitmentstotaling $1,783,000 and $1,941,000 at December 31, 2004 and 2003,respectively, to cover losses inherent in its letter of credit accommodationsand undisbursed loan commitments.

There are no Special Purpose Entity (“SPE”) trusts,corporations, or other legal entities established by Mid-State which resideoff-balance sheet. There are no other off-balance sheet items other than theaforementioned items related to letter of credit accommodations and undisbursedloan commitments.

As noted in Footnote 5 tothe financial statements, the Company does make loans and leases to relatedparties (directors and officers) in the ordinary course of business atprevailing rates and terms. These loans and leases totaled $8.7 million and$1.2 million at the end of 2004 and 2003, respectively.

**INCOME STATEMENTANALYSIS**

***Net Interest Income and Interest Rate Risk***

Net Interest Income is thedifference between interest and fees earned on all earning assets and interestpaid on interest bearing liabilities. Net Interest Income for 2004 was $101.5million, up from $95.5 million recorded in 2003 and $93.0 million in 2002. Thecomponents of net interest income change in response to both changes in rate,average balance and mix of both earning assets and liabilities. The followingtables present an analysis of yields/rates, interest income and expense, andaverage balances for 2004, 2003, and 2002.

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**ANALYSIS OF CHANGES IN INTERESTINCOME AND EXPENSE**
| ** **                               | ** ** | **2004**    | ** ** | **2003**              | ** ** | **2004 Compared to 2003  Composition of Change** | ** ** |
|------------------------------------------|------------|-------------|------------|-----------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Average** | ** ** | **Interest  Income/** | ** ** | **Average  Yield /**                                                 | ** ** | **Average** | ** ** | **Interest  Income/** | ** ** | **Average  Yield /** | ** ** | **Change Due To:** | ** ** | **Total** | ** ** |
| **(dollars in 000's)**         | ** ** | ** **  | ** ** | **Balance**           | ** ** | **Expense**                                                               | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
| *EARNING  ASSETS:*                       |       |        |       |                  |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                    |       | $           | 1,310,842  |                  | $          | 85,127                                                                    |       |   | 6.49 | % |   | $ | 1,131,932 |   | $ | 80,372 |   |   | 7.10 | % |   | $ | 12,161 |   | $ | (7,406 | ) | $ | 4,755 |   |
| Investment Securities                    |       | 701,996     |       | 24,329                |       |                                                                      | 3.47       | % |   | 640,888 |   | 24,040 |   |   | 3.75 | % |   | 2,205 |   | (1,916 | ) | 289 |   |
| Fed Funds, Other                         |       | 37,380      |       | 480                   |       |                                                                      | 1.28       | % |   | 84,421 |   | 828 |   |   | 0.98 | % |   | (533 | ) | 185 |   | (348 | ) |
| *TOTAL EARNING ASSETS*                   |       | $           | 2,050,218  |                  | $          | 109,936                                                                   |       |   | 5.36 | % |   | $ | 1,857,241 |   | $ | 105,240 |   |   | 5.67 | % |   | $ | 13,833 |   | $ | (9,137 | ) | $ | 4,696 |   |
| *INTEREST BEARING LIABILITIES:*          |       |        |       |                  |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW, Savings, and Money Market  Accounts |       | $           | 1,063,895  |                  | $          | 2,565                                                                     |       |   | 0.24 | % |   | $ | 938,720 |   | $ | 2,604 |   |   | 0.28 | % |   | $ | 325 |   | $ | (364 | ) | $ | (39 | ) |
| Time Deposits                            |       | 399,806     |       | 5,691                 |       |                                                                      | 1.42       | % |   | 399,448 |   | 6,944 |   |   | 1.74 | % |   | 5 |   | (1,258 | ) | (1,253 | ) |
| Interest Bearing  Deposits               |       | 1,463,701   |       | 8,256                 |       |                                                                      | 0.56       | % |   | 1,338,168 |   | 9,548 |   |   | 0.71 | % |   | 330 |   | (1,622 | ) | (1,292 | ) |
| Other Borrowings                         |       | 4,401       |       | 194                   |       |                                                                      | 4.41       | % |   | 4,423 |   | 151 |   |   | 3.41 | % |   | (1 | ) | 44 |   | 43 |   |
| *TOTAL INTEREST BEARING  LIABILITIES*    |       | 1,468,102   |       | 8,450                 |       |                                                                      | 0.58       | % |   | 1,342,591 |   | 9,699 |   |   | 0.72 | % |   | 329 |   | (1,578 | ) | (1,259 | ) |
| *NET INTEREST  INCOME*                   |       | $           | 2,050,218  |                  | $          | 101,486                                                                   |       |   | 4.95 | % |   | $ | 1,857,241 |   | $ | 95,541 |   |   | 5.14 | % |   | $ | 13,504 |   | $ | (7,559 | ) | $ | 5,945 |   |
|                                          |            |             |            |                       |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **2003**    | ** ** | **2002**              | ** ** | **2003 Compared to 2002  Composition of Change** | ** ** |
|------------------------------------------|------------|-------------|------------|-----------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Average** | ** ** | **Interest  Income/** | ** ** | **Average  Yield /**                                                 | ** ** | **Average** | ** ** | **Interest  Income/** | ** ** | **Average  Yield /** | ** ** | **Change Due To:** | ** ** | **Total** | ** ** |
| **(dollars in 000's)**         | ** ** | ** **  | ** ** | **Balance**           | ** ** | **Expense**                                                               | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
| *EARNING  ASSETS:*                       |       |        |       |                  |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                    |       | $           | 1,131,932  |                  | $          | 80,372                                                                    |       |   | 7.10 | % |   | $ | 1,109,245 |   | $ | 84,962 |   |   | 7.66 | % |   | $ | 1,674 |   | $ | (6,264 | ) | $ | (4,590 | ) |
| Investment Securities                    |       | 640,888     |       | 24,040                |       |                                                                      | 3.75       | % |   | 533,427 |   | 23,201 |   |   | 4.35 | % |   | 4,352 |   | (3,513 | ) | 839 |   |
| Fed Funds, Other                         |       | 84,421      |       | 828                   |       |                                                                      | 0.98       | % |   | 75,608 |   | 1,169 |   |   | 1.55 | % |   | 111 |   | (452 | ) | (341 | ) |
| *TOTAL EARNING ASSETS*                   |       | $           | 1,857,241  |                  | $          | 105,240                                                                   |       |   | 5.67 | % |   | $ | 1,718,280 |   | $ | 109,332 |   |   | 6.36 | % |   | $ | 6,138 |   | $ | (10,230 | ) | $ | (4,092 | ) |
| *INTEREST BEARING LIABILITIES:*          |       |        |       |                  |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW, Savings, and Money Market  Accounts |       | $           | 938,720    |                  | $          | 2,604                                                                     |       |   | 0.28 | % |   | $ | 827,054 |   | $ | 4,894 |   |   | 0.59 | % |   | $ | 485 |   | $ | (2,775 | ) | $ | (2,290 | ) |
| Time Deposits                            |       | 399,448     |       | 6,944                 |       |                                                                      | 1.74       | % |   | 418,536 |   | 11,275 |   |   | 2.69 | % |   | (423 | ) | (3,908 | ) | (4,331 | ) |
| Interest Bearing  Deposits               |       | 1,338,168   |       | 9,548                 |       |                                                                      | 0.71       | % |   | 1,245,590 |   | 16,169 |   |   | 1.30 | % |   | 62 |   | (6,683 | ) | (6,621 | ) |
| Other Borrowings                         |       | 4,423       |       | 151                   |       |                                                                      | 3.41       | % |   | 7,595 |   | 212 |   |   | 2.79 | % |   | (98 | ) | 37 |   | (61 | ) |
| *TOTAL INTEREST BEARING LIABILITIES*     |       | 1,342,591   |       | 9,699                 |       |                                                                      | 0.72       | % |   | 1,253,185 |   | 16,381 |   |   | 1.31 | % |   | (36 | ) | (6,646 | ) | (6,682 | ) |
| *NET INTEREST  INCOME*                   |       | $           | 1,857,241  |                  | $          | 95,541                                                                    |       |   | 5.14 | % |   | $ | 1,718,280 |   | $ | 92,951 |   |   | 5.41 | % |   | $ | 6,174 |   | $ | (3,584 | ) | $ | 2,590 |   |
|                                          |            |             |            |                       |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

During 2004 there was a $4.7 million increase ininterest income along with a decrease of $1.2 million in interest expensecompared to 2003. The resulting $5.9 million increase in net interest incomefor 2004 was a result of a number of dynamics affecting both average balanceand interest rate considerations. First, the Company experienced an increase inits average earning assets outstanding of $193.0 million. The increase wasprimarily attributable to the net increase in average loans, which were up by$178.9 million, and to a lesser extent to an increase in average investments of$61.1 million. These increases were partially offset by a decrease in averagefederal funds sold of $47.0 million. Second,****whilethe Company’s average 

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interest bearingliabilities increased by $125.5 million, earning assets increased by a larger$193.0 million. Third, earning asset yields were somewhat lower in 2004compared to the average for 2003 and liability costs did not drop as quickly.

During 2003 there was a $4.1 million decrease ininterest income along with a decrease of $6.7 million in interest expensecompared to 2002. The resulting $2.6 million increase in net interest incomefor 2003 was a result of a number of dynamics affecting both average balanceand interest rate considerations. First, the Company experienced an increase inits average earning assets outstanding of $139.0 million. The increase wasdivided amongst a net increase in average loans of $22.7 million, an increasein average investments of $107.5 million and an increase in average federalfunds sold of $8.8 million. Second,****while theCompany’s average interest bearing liabilities increased by $89.4 million,earning assets increased by a larger $139.0 million. The increases in earningassets and interest bearing liabilities are partly attributable to theacquisition of Ojai Valley Bank on October 31, 2003 which affected theaverages of these categories (through the influence of their balances for thelast two months of the year) in 2003 with no corresponding influence in 2002. Third,interest rates were lower in 2003 compared to the average for 2002. Forexample, the Prime Rate averaged 4.12% in 2003 compared to 4.68% in 2002.

The Bank expects its risk exposure to changes ininterest rates to remain manageable and well within acceptable policy ranges. Arecent review as of the end of 2004 of the potential changes in the Bank’s netinterest income over a 12 month time horizon showed that it could fluctuateunder extreme alternative rate scenarios from between +4.0% and -8.5% of thebase case (rates unchanged) of $110.8 million. The Bank’s policy is to maintaina structure of assets and liabilities which are such that net interest incomewill not vary more than plus or minus 15% of the base forecast over the next 12months. Management expects that its exposure to interest rate risk ismanageable and it will continue to strive for an optimal trade-off between riskand earnings.

The following table presents a summary of the Bank’snet interest income forecasted for the coming 12 months under alternativeinterest rate scenarios.
| ** **                                 | ** ** | **Change  From Base** | ** ** |
|--------------------------------------------|------------|----------------------------|------------|
| Rates Down Very  Significant               |       |                       | -8.5       | % |   |
| (Prime down to  3.50% over 6 months)       |       |                       |       |   |   |
| Rates Down Significant                     |       |                       | -4.0       | % |   |
| (Prime down to  4.00% over 7 months)       |       |                       |       |   |   |
| Rates Down Modestly                        |       |                       | -2.2       | % |   |
| (Prime down to  4.50% over 7 months)       |       |                       |       |   |   |
| Base Case—Rates Unchanged             |       |                       | —     |   |   |
| (Prime unchanged  at 5.25% over 12 months) |       |                       |       |   |   |
| Rates Up Modestly                          |       |                       | +0.        | 7% |   |
| (Prime up to  6.25% over 10 months)        |       |                       |       |   |   |
| Rates Up Aggressive                        |       |                       | +2.        | 3% |   |
| (Prime up to  7.25% over 10 months)        |       |                       |       |   |   |
| Rates Up Very Aggressive                   |       |                       | +4.        | 0% |   |
| (Prime up to 8.25% over  10 months)        |       |                       |       |   |   |

 

Net interest income under the above scenarios isinfluenced by the characteristics of the Bank’s assets and liabilities. In thecase of N.O.W., savings and money market deposits (total $1.083 billion)interest is based on rates set at the discretion of management ranging from0.10% to 0.80%. In a downward rate environment, there is a limit to how farthese deposit instruments can be re-priced and this behavior is 

43

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similar to that of fixedrate instruments. In an upward rate environment, the magnitude and timing ofchanges in rates on these deposits is assumed to be more reflective of variablerate instruments.

It is important to note that the above table is asummary of several forecasts and actual results may vary. The forecasts arebased on estimates and assumptions of management that may turn out to bedifferent and may change over time. Factors affecting these estimates andassumptions include, but are not limited to—competitors’ behavior, economicconditions both locally and nationally, actions taken by the Federal ReserveBoard, customer behavior, and management’s responses. Changes that varysignificantly from the assumptions and estimates may have significant effectson the Bank’s net interest income. Therefore the results of this analysisshould not be relied upon as indicative of actual future results. Historically,the Bank has been able to manage its Net Interest Income in a fairly narrowrange reflecting the Bank’s relative insensitivity to interest rate changes. Theimpact of prepayment behavior on mortgages, real estate loans, mortgage backedsecurities, securities with call features, etc. is not considered material tothe sensitivity analysis. Over the last 5 years, the Bank’s net interest margin(which is net interest income divided by average earning assets of the Bank)has ranged from a low of 4.95% to a high of 6.44% (not taxable equivalent). TheBank’s net interest margin in 2004 of 4.95% is at the low end of this range byhistorical standards, coming off the higher levels experienced in 2000 of 6.44%.This is a result of both the lower level of interest rates and the change inmix of earning assets (the Bank now has a smaller portion in loans vis-à-visinvestment securities compared to 2000 when the margin was at its widest level).The net interest margin under the alternative scenarios ranges from 4.57% to5.20%. Management feels this range of scenarios, while lower than historicalstandards, is consistent with current experience and interest rate levels, butno assurances can be given that actual future experience will fall within thisrange.

The Bank’s exposure withrespect to interest rate derivatives, exchange rate fluctuations, and/orcommodity price movements is nil. The Bank does not own any instruments withinthese markets.

***Provision for Loan Losses***

The Company made aprovision to the allowance for loan losses of $600 thousand in 2002. In 2004and 2003 however, it reduced the allowance for loan losses by $2.7 million and$969 thousand, respectively, through a benefit to the provision for loan losses.These actions reflected strong credit quality standards, consistent performanceof the loan portfolio in recent years, improving trends in classified loans,improving trends in delinquencies and charge-offs, an improved outlook for thecollection of the Company’s non accrual loans, and an improved outlook foreconomic activity in general. The need for additional provision for loan lossesor for further benefit to the provision for loan losses in 2005 will bedependent upon Management’s on-going analysis of the adequacy of the allowancefor loan losses. While Management believes the allowance to be adequate at thepresent time, the appropriate value canfluctuate over time in response to economic conditions and the subjectivedecisions which must be made in response to those conditions.

***Non-Interest Income***

Non-Interest Income for 2004 totaled $27.8 millioncompared to $29.1 million in 2003 and $24.3 million in 2002. Service charges ondeposit accounts increased $0.9 million to $10.2 million in 2004 compared to2003 following an increase of $0.3 million to $9.3 million in 2003 versus 2002.The increase in 2004 compared to 2003 primarily reflects the implementation ofa new decision plan module for handling non-sufficient fund and overdraftaccounts and the merger with Ojai Valley Bank. The increase in 2003 over 2002reflects an increase in accounts and the merger with Ojai Valley Bank, but nosignificant increases in service charge rates.

Commissions, fees and other service charges decreasedby $0.5 million in 2004 to $12.6 million. This followed an increase of $1.0million in 2003 over 2002. The decrease in 2004 compared to 2003 related 

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primarily to a drop inmerchant processing income as a result of outsourcing this activity late in theyear. The increase in 2003 related to several items including a $285 thousandincrease in income from the Trust and Investment Division, a $228 thousandincrease in mortgage loan processing fees, a $182 thousand increase in realestate loan servicing fees, a $173 thousand increase in debit card fees and a$114 thousand increase in ATM fees and surcharges. Management expects thiscategory to decrease in 2005 as a result of outsourcing its Merchant Processingfunctions and receiving a payment which is net of expenses.

Gains on sales of securities increased to $475thousand in 2004 following $40 thousand and $17 thousand gains in 2003 and2002, respectively. The gain in 2004 reflected the acceptance of a tender offerfor a $1.0 million block of corporate bonds held by the Bank resulting in a$352 thousand gain in the first quarter and the sale of an additional security(the put feature of which was no longer applicable) at a gain of $93 thousandin the third quarter.

The Gain on Sale of loans held for sale (single familymortgages) was $607 thousand in 2004 compared to $3.4 million in 2003 and $1.0million in 2002. The higher levels in late 2002 and through much of 2003reflected the large amount of mortgage refinance activity experienced as aresult of the historically low mortgage interest rate levels.

All other sources ofincome were $3.9 million in 2004, compared to $3.3 million in 2003 and $2.4million in 2002. The increase in 2004 is related to a $1.1 million gain on saleof OREO which was partially offset by declines in miscellaneous recoveries. Theincrease in 2003 was a one-time gain on the sale of bank property of $273thousand and $578 thousand realized from the on-going commissions on the saleof property formerly owned by Mid Coast Land Company.

***Non-Interest Expense***

Total non-interest expense for 2004 was $79.3 million,following $74.7 million in 2003, and $70.9 million in 2002. Results in 2003reflect two months of overhead created by the acquisition of Ojai Valley Bankfollowed by a full year in 2004. For the combined Mid-State and Ojai operation,expenses are estimated to be approximately $0.7 million annually lower than thesum of the two institutions on a stand alone basis. Savings have been realizeddue to reduced data processing costs, reduced salary and benefit costs, reduceddirectors fees, reduced insurance costs, and other similar savings.

Salaries and employee benefits increased to $41.8million in 2004 compared to $39.2 million in 2003 and $36.5 million in 2002. Theincrease in 2004 was a result of including: 1) the addition of employees fromthe acquisition of Ojai Valley Bank resulting in approximately $0.9 millionmore salaries and benefits expense, 2) increases in the Company cost of healthcare coverage for employees and workers compensation premiums of approximately198 thousand, and 3) the balance being regular salary increases. The increasein 2003 over 2002 reflected a $506 thousand increase in total salaries paid,along with a $2.1 million increase in employee benefit incentive expensereflecting both the improved performance of the Bank and enhancements made tothe plan to remain competitive in recruiting, hiring and retaining the mostqualified staff possible. Management considers containment of salaries andbenefits costs in 2005 and beyond to be one of its top challenges. A number offactors are continuing to create unusually strong upward pressure on thesecosts, especially in the areas of medical benefits, workers compensation costsand competitive wages. Also, during the third quarter of 2005, the Company willimplement a change in accounting for stock options which will require it totake a charge to benefits expense based on the grant date fair value of itsstock option awards and the estimated number of awards that are expected tovest. The cost will be recognized over the period during which the employeesare required to provide service in exchange for the awards—usually the vestingperiod. See Note 1 and Note 15 of the Notes to the Consolidated FinancialStatements which follows in item 8 of this report. The Company is addressingthese cost pressures by focusing on ways of becoming more efficient in itsprocesses and using technology wherever possible to hold down staffingrequirements.

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Occupancy expense increased to $12.5 million in 2004from $11.6 million in 2003 and $11.0 million in 2002. The increase in 2004 over2003 reflects a $533 thousand dollar increase in depreciation expense resultingfrom new fixed assets put in service, a $123 thousand increase in rentalexpense (largely because of the new Ojai facilities) and other miscellaneousincreases in maintenance, repairs and utilities. The increase in 2003 reflectsprimarily increases in facilities maintenance of $375 thousand, increases infacilities rents of $84 thousand and increases in depreciation expense of $139thousand. The purchase of a new mainframe computer system during the middle of2003 did not have a significant impact on depreciation costs because of theparallel reduction in depreciation expense from the retirement of the oldsystem. The purchase of new item imaging equipment which is improving checkingaccount processing and research capabilities for customers, along withimproving the efficiency of the Bank, did have a modest impact on depreciationexpense for the year.

Advertising and promotion expenditures were $4.0million in 2004 following charges of $2.9 million in 2003 and $3.0 million in2002. The increase in 2004 reflects a planned increase of $1.0 million in theCompany’s marketing budget in support of 1) an expanded awareness campaign inthe relatively new Ventura County market and 2) increased consumer loan salesefforts. The Company does not expect any major increases in its 2005expenditures and anticipates they will approximate the 2004 levels.

General office expenditures were $4.0 million in 2004following levels of $3.8 million in 2003 and $4.1 million in 2002. While thiscategory of expenditure has been relatively flat in recent years, the smallincrease in 2004 reflects the recent Ojai acquisition. This category includesprimarily charges for stationery and supplies, telephone expenses, and postage.Management does not expect any significant changes to this category in 2005.

Merchant processing and data processing charges were$5.2 million in 2004, $6.2 million in 2003 and $6.6 million in 2002. Thedecline in 2004 reflects the outsourcing of this function to an outside vendorlate in the year. Management’s expectation for 2005 is that merchant processingand data processing expense will decrease as a result of outsourcing thisfunction.

Professional services were $5.5 million in 2004following $4.3 million in 2003 and $4.1 million in 2002. The increase in 2004over 2003 reflects increased costs of $913 thousand for the Company’s outsideaccounting firm and its outsourced internal audit firm to comply with theSarbanes-Oxley Act, Section 404 requirements pertaining to theeffectiveness of internal control over financial reporting. The increase in2003 over 2002 relates primarily to the utilization of outside consultants todevelop enhancements to the Company’s retail banking sales efforts. Managementexpects that there will be a reduction of a portion of the Sarbanes-Oxleyrelated costs in 2005, but that on an on-going basis there will be a permanentincrease in these costs which is approximately half of the one-time costs in2004.

Regulatory assessments (charges for FDIC assessmentsand DFI fees) have grown with the size of the Bank over the past three years at$498, $407, and $368 thousand in 2004, 2003, and 2002, respectively. This trendis likely to continue as the Bank grows.

Other operating expensesdecreased to $5.8 million in 2004 from $6.2 million in 2003 and $5.3 million in2002. The decrease in 2004 reflects a $328 thousand decrease in the provisionfor losses on unfunded commitments. The increase in 2003 compared to 2002reflects an increase in the provision for losses on unfunded commitments, anincrease in Other Real Estate Owned expense and an increase in interest chargedoff from prior periods on special assets.

***Taxes***

Book tax expense amounted to $17.5 million in 2004,$17.7 million in 2003, and $15.9 million in 2002. While the statutory tax rateof the Company is 42.05%, the actual rate accrued was 33.3%, 34.8%, and 34.7%in 2004, 2003, and 2002, respectively. The primary reason for the differencerelates to the tax 

46

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exempt income generated bythe Company’s municipal bond portfolio. The small decline in the accrued ratein 2004 reflects a modest increase in municipal tax exempt income.

As described in Footnote No. 10to the financial statements, the Company has deferred tax assets primarilyrelated to the timing difference associated with charge-offs and provisions forlosses on certain loans and with the timing difference on deferredcompensation.

**SUBSIDIARY ACTIVITY**

***Mid Coast Land Company***

Mid Coast Land Companyrecorded a profit of $379 thousand in 2004 following $322 thousand in netincome in 2003 and a loss of $72 thousand in 2002. The gain in 2004 and 2003primarily relates to the on-going commissions on the sale of property formerlyowned by Mid Coast Land Company. Management expects earnings to continue forseveral years as there are 97 lots remaining to be sold at the start of 2005which are subject to the payment of these commissions. The loss in 2002 wasrelated to the write-off of a note carried by the subsidiary to a developer forwhich no allowance had been provided based on the conditions of the loan priorto 2002. Mid Coast Land Company is no longer engaged in real estate developmentactivity, having sold its final property which closed during the first quarterof 2003. It currently records residual activity resulting from prior years’operations.

***MSB Properties, Inc.***

This wholly owned subsidiary was formed to engage inthe specific business of acquiring, owning, and improving real property andtangible personal property which may be necessary or convenient for theoperation or housing of the administrative departments and branch offices ofthe Bank. Incorporated under the laws of the State of California in May of1968, it also allows for the ownership of property which may be reasonably necessaryfor future expansion of the Bank’s business, or which is otherwise reasonablyrelated to the conduct of the Bank’s business, pursuant to Section 752 ofthe Financial Code of the State of California.

Earnings for this subsidiary consist primarily of rentalincome from the Bank’s offices and administrative center coupled with a minoramount of rental income from non-bank tenants and interest earnings on its cashassets. Leases are written with market terms and at market rates. Expenses areprincipally interest on mortgages, depreciation of leasehold improvements,general maintenance and utilities expense. The affairs of the subsidiary aremanaged by Bank employees and as such this subsidiary has no paid staffmembers.

Earnings for MSBProperties have remained relatively unchanged over the years with net earningsafter-tax of $1.2 million, $1.4 million, and $1.3 million, in 2004, 2003 and2002, respectively. The subsidiary benefited from a one-time pre-tax gain of$273 thousand in 2003 from the sale of a property.

**CRITICAL ACCOUNTINGPOLICIES AND ESTIMATES**

This “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” aswell as, disclosures included elsewhere in this Form 10-K, are basedupon the Company’s consolidated financial statements, which have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America. The preparation of these financial statements requireManagement to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues, expenses and related disclosure of contingencies.Management believes that the most significant subjective judgements that it isrequired to make include the following:

·       *Allowance for losses.  *Management reviews the adequacyof the allowance and also employs an independent third party loan review groupto, among other things, review the adequacy of the 

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allowance and makerecommendations. Management, as necessary, adjusts the allowance for loan lossesand the allowance for losses—unfunded commitments, on a regular basis. Theseadjustments are made through a charge to expense or a benefit in the provisionfor loan losses on the income statement. The allowance is also examinedannually by one or more of the Bank’s regulatory bodies including the FDIC andDFI. The need for additional provision for loan losses in 2005, or a benefit tothe provision for loan losses, will be dependent upon Management’s on-goinganalysis of the adequacy of the allowance for losses. While Management believesit to be adequate at the present time, the appropriatevalue can fluctuate over time in response to economic conditions and thesubjective decisions which must be made in response to those conditions.

·       *Fair Value.*   Where applicable, the Company is requiredby Generally Accepted Accounting Principles (“GAAP”) to disclose the fair valueof financial instruments and the methods and significant assumptions used toestimate those fair values. Also, the fair value calculated on collateralsupporting the Bank’s extensions of credit (e.g.—appraisals on the propertysecuring real estate loans) can have a significant effect on the determinationof the adequacy of the allowance for losses noted above. Wherever possible,fair value used by the Company equals quoted market price, as for example withits investment securities portfolio, if available. If it is not available, fairvalue is estimated by the Company using quoted market prices for similar assets.Fair value of other instruments involves discounting future cash flows usingcurrent market rates for instruments with similar maturity and creditcharacteristics. Declines in the fair value of held-to-maturity andavailable-for-sale securities below their cost that are deemed to be other thantemporary are reflected in earnings as realized losses. In estimatingother-than-temporary impairment losses, management considers 1) the length oftime and the extent to which the fair value has been less than cost, 2) thefinancial condition and near-term prospects of the issuer, and 3) the intentand ability of the Corporation to retain its investment in the issuer for aperiod of time sufficient to allow for any anticipated recovery in fair value.

·       *Taxes.  *The Company estimates its quarterly effectiveincome tax rate based upon a variety of factors, including, but not limited to,the expected revenues for the year and the product mix of revenue, and theratio of permanent differences to total revenue. Any changes to the estimatedrate are made prospectively in accordance with APB 28 “Interim FinancialReporting”. Additionally, a valuation allowance, which was zero at December 31,2004 and 2003, provides for deferred taxes that are not anticipated to be offsetby taxable income projected for the next 12 months. A valuation allowance isbased on estimates by Management which can change over time.**

·       *Goodwill and Core Deposit Intangibles.  *The Company isrequired by GAAP to perform an annual impairment analysis of the amount ofGoodwill showing on its Consolidated Statement of Financial Position. Themethodology utilized in this analysis is described under “Goodwill and CoreDeposit Intangibles” earlier in this Managements Discussion and Analysis ofFinancial Condition and Results of Operations.

**ITEM7A**. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKETRISK

Certain information concerning market risk iscontained in the Notes to the Consolidated Financial Statements which areincluded in Item 8 of this Report and in Management Discussion and Analysis ofFinancial Condition and Results of Operations which is included in Item 7 ofthis Report.

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**ITEM 8**. FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA

**TABLEOF CONTENTS**
|                                                          | ** ** | **PAGE** | ** ** |
|----------------------------------------------------------|------------|----------|------------|
| Management Statement                                     |       |     | 50         |   |   |
| Report of Independent Registered  Public Accounting Firm |       |     | 51         |   |   |
| Consolidated Statements of  Financial Position           |       |     | 53         |   |   |
| Consolidated Statements of Income                        |       |     | 54         |   |   |
| Consolidated Statements of  Comprehensive Income         |       |     | 55         |   |   |
| Consolidated Statements of  Changes in Capital Accounts  |       |     | 56         |   |   |
| Consolidated Statements of Cash  Flows                   |       |     | 57         |   |   |
| Notes  to Consolidated Financial Statements              |       |     | 59         |   |   |

 

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**Management’s**Report on Internal Control Over Financial Reporting

Management is responsible for establishing andmaintaining adequate internal control over financial reporting of the Company. Internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with accountingprinciples generally accepted in the United States of America. Internal controlover financial reporting also includes controls over the preparation offinancial statements in accordance with the instructions to the ConsolidatedFinancial Statements for Bank Holding Companies (Form FR Y-9C) to complywith the reporting requirements of Section 112 of the Federal DepositInsurance Corporation Improvement Act.

The Company’s internal control over financialreporting includes those policies and procedures that (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with accounting principlesgenerally accepted in the United States of America, and that receipts andexpenditures of the Company are being made only in accordance withauthorizations of management and directors of the Company; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the Company’s assets that could have amaterial effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures may deteriorate.

Managementconducted an evaluation of the effectiveness of internal control over financialreporting based on the framework in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.Based on this evaluation, management concluded that the Company’s internalcontrol over financial reporting was effective as of December 31, 2004.Management’s assessment of the effectiveness of the Company’s internal controlover financial reporting as of December 31, 2004 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which is included herein.
| /s/ JAMES  W. LOKEY |                       | /s/ JAMES G.  STATHOS |   |
|---------------------|----------------------------|-----------------------|--------|
| James W. Lokey      | James G. Stathos           |
| *President*         | *Executive Vice President* |
|                | *Chief Financial Officer*  |

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**Report**of Independent Registered Public Accounting Firm

**To the Board of Directors andStockholders of Mid-State Bancshares:**

We have completed anintegrated audit of Mid-State Bancshares’ 2004 consolidated financialstatements and of its internal control over financial reporting as of December 31,2004 and audits of its 2003 and 2002 consolidated financial statements inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Our opinions, based on our audits, are presented below.

*Consolidated financial statements*

In our opinion, theconsolidated financial statements listed in the accompanying index presentfairly, in all material respects, the financial position of Mid-StateBancshares and its subsidiaries at December 31, 2004 and 2003, and the resultsof their operations and their cash flows for each of the three years in theperiod ended December 31, 2004 in conformity with accounting principles generallyaccepted in the United States of America. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits. We conducted ouraudits of these statements in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit offinancial statements includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

*Internal controlover financial reporting*

Also, in our opinion, management’s assessment,included in the accompanying Management’s Report on Internal Control OverFinancial Reporting, that the Company maintained effective internal controlover financial reporting as of December 31, 2004 based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), is fairly stated, in all material respects, based on those criteria. Furthermore,in our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2004, basedon criteria established in *Internal Control—Integrated Framework* issued by the COSO. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessmentand on the effectiveness of the Company’s internal control over financialreporting based on our audit. We conducted our audit of internal control overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. An audit of internal control over financial reporting includesobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we consider necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Management’sassessment and our audit of Mid-State Bancshares’ internal control overfinancial reporting also included controls over the preparation of financialstatements in accordance with the instructions to the Consolidated 

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Financial Statements forBank Holding Companies (Form FR Y-9C) to comply with the reporting requirementsof Section 112 of the Federal Deposit Insurance Corporation ImprovementAct (FDICIA). A company’s internal control over financial reporting includesthose policies and procedures that (i) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.
| PricewaterhouseCoopers LLP |   |
|----------------------------|--------|
| Los Angeles, California    |   |
| March 15, 2005        |   |

 

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**ConsolidatedStatements of Financial Position(amounts in 000’s except share amounts)**
| ** **                                                                                            | ** ** | **December 31,** | ** **    |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------|---------------|
| ** **                                                                                            | ** ** | **2004**              | ** **    | **2003** | ** ** |
| **Assets**                                                                                            |       |                  |          |   |   |
| CASH AND DUE FROM  BANKS                                                                              | ** ** | **$**                 | **112,669**   |   | $ | 123,763 |   |
| FEDERAL FUNDS  SOLD                                                                                   | ** ** | **6,000**             |          | 47,500 |   |
| SECURITIES  AVAILABLE FOR SALE                                                                        | ** ** | **644,817**           |          | 774,679 |   |
| LOANS HELD FOR  SALE                                                                                  | ** ** | **12,988**            |          | 13,410 |   |
| LOANS, net                                                                                            | ** ** | **1,408,095**         |          | 1,138,869 |   |
| PREMISES AND  EQUIPMENT, net                                                                          | ** ** | **24,946**            |          | 26,325 |   |
| ACCRUED INTEREST  RECEIVABLE                                                                          | ** ** | **11,918**            |          | 12,174 |   |
| OTHER REAL ESTATE  OWNED                                                                              | ** ** | **—**            |          | 3,428 |   |
| GOODWILL                                                                                              | ** ** | **47,840**            |          | 47,840 |   |
| CORE DEPOSIT  INTANGIBLES, net                                                                        | ** ** | **7,732**             |          | 9,107 |   |
| OTHER ASSETS                                                                                          | ** ** | **19,082**            |          | 11,737 |   |
| ***TOTAL ASSETS***                                                                                    | ** ** | **$**                 | **2,296,087** |   | $ | 2,208,832 |   |
| **Liabilities**                                                                                       |       |                  |          |   |   |
| DEPOSITS:                                                                                             |       |                  |          |   |   |
| Demand deposits                                                                                       | ** ** | **$**                 | **517,139**   |   | $ | 487,624 |   |
| Savings, money market and NOW accounts                                                                | ** ** | **1,083,139**         |          | 1,024,207 |   |
| Time deposits—$100,000 or more                                                                   | ** ** | **166,295**           |          | 155,548 |   |
| Time deposits—Under $100,000                                                                     | ** ** | **227,972**           |          | 245,052 |   |
| ***Total Deposits***                                                                                  | ** ** | **1,994,545**         |          | 1,912,431 |   |
| OTHER BORROWINGS                                                                                      | ** ** | **6,582**             |          | 7,627 |   |
| ALLOWANCE FOR  LOSSES—UNFUNDED COMMITMENTS                                                       | ** ** | **1,783**             |          | 1,941 |   |
| ACCRUED INTEREST  PAYABLE & OTHER LIABILITIES                                                | ** ** | **18,550**            |          | 14,279 |   |
| ***TOTAL LIABILITIES***                                                                               | ** ** | **2,021,460**         |          | 1,936,278 |   |
| **Commitments  and Contingencies (Note 12)**                                                          |       |                  |          |   |   |
| **Capital Accounts**                                                                                  |       |                  |          |   |   |
| CAPITAL STOCK, NO PAR  VALUE:                                                                         |       |                  |          |   |   |
| Authorized—100,000,000 shares  Outstanding—23,099,159 shares in 2004 and 23,567,478 in 2003 | ** ** | **61,439**            |          | 75,506 |   |
| UNDIVIDED PROFITS                                                                                     | ** ** | **206,328**           |          | 184,771 |   |
| ACCUMULATED OTHER  COMPREHENSIVE INCOME, NET OF TAXES OF $4,573 IN 2004 AND $8,200 IN 2003            | ** ** | **6,860**             |          | 12,277 |   |
| ***TOTAL CAPITAL ACCOUNTS***                                                                          | ** ** | **274,627**           |          | 272,554 |   |
| ***TOTAL  LIABILITIES & CAPITAL ACCOUNTS***                                                  | ** ** | **$**                 | **2,296,087** |   | $ | 2,208,832 |   |

 

The accompanying notes are an integral part of these consolidated statements.

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**ConsolidatedStatements of Income(amounts in 000’s except per share amounts)**
| ** **                                                 | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Interest Income:**                                       | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  and fees on loans and leases                     | ** ** | **$**                                      | **85,127** | ** ** | $ | 80,372 | ** ** | $ | 84,962 |   |
| Interest on securities:                                    |       | ** **                                 |       |   |   |   |   |
| U.S.  Treasury securities                                  | ** ** | **974**                                    | ** ** | 1,012 | ** ** | 1,281 |   |
| U.S.  Government agencies and corporations                 | ** ** | **8,553**                                  | ** ** | 8,809 | ** ** | 8,888 |   |
| Obligations  of states and political subdivisions, other   | ** ** | **14,802**                                 | ** ** | 14,219 | ** ** | 13,032 |   |
| Interest  on federal funds sold                            | ** ** | **480**                                    | ** ** | 828 | ** ** | 1,169 |   |
| ***TOTAL INTEREST INCOME***                                |       | **109,936**                                |       | 105,240 |   | 109,332 |   |
| **Interest Expense:**                                      | ** ** | ** **                                 | ** ** |   | ** ** |   |   |
| Interest  on deposits                                      | ** ** | **8,256**                                  | ** ** | 9,548 | ** ** | 16,169 |   |
| Interest  on other borrowings                              | ** ** | **194**                                    | ** ** | 151 | ** ** | 212 |   |
| ***TOTAL INTEREST EXPENSE***                               |       | **8,450**                                  |       | 9,699 |   | 16,381 |   |
| **Net Interest Income**                                    |       | **101,486**                                |       | 95,541 |   | 92,951 |   |
| (Benefit)/Provision  for loan losses                       | ** ** | **(2,700**                                 | **)**      | (969 | ) | 600 |   |
| ***NET INTEREST INCOME AFTER PROVISION FOR LOAN  LOSSES*** |       | **104,186**                                |       | 96,510 |   | 92,351 |   |
| **Other Income:**                                          | ** ** | ** **                                 | ** ** |   | ** ** |   |   |
| Service  charges on deposit accounts                       | ** ** | **10,164**                                 | ** ** | 9,254 | ** ** | 8,909 |   |
| Commissions,  fees and other service charges               | ** ** | **12,577**                                 | ** ** | 13,064 | ** ** | 12,031 |   |
| Gains  on sale of securities                               | ** ** | **475**                                    | ** ** | 40 | ** ** | 17 |   |
| Gain  on sale of loans held for sale                       | ** ** | **607**                                    | ** ** | 3,385 | ** ** | 1,011 |   |
| Other  income                                              | ** ** | **3,941**                                  | ** ** | 3,316 | ** ** | 2,353 |   |
| ***TOTAL OTHER INCOME***                                   |       | **27,764**                                 |       | 29,059 |   | 24,321 |   |
| **Other Expenses:**                                        | ** ** | ** **                                 | ** ** |   | ** ** |   |   |
| Salaries &  employee benefits                     | ** ** | **41,779**                                 | ** ** | 39,156 | ** ** | 36,537 |   |
| Occupancy  expenses                                        | ** ** | **12,509**                                 | ** ** | 11,572 | ** ** | 10,954 |   |
| Advertising &  promotion                          | ** ** | **3,955**                                  | ** ** | 2,938 | ** ** | 2,989 |   |
| General  office                                            | ** ** | **4,017**                                  | ** ** | 3,832 | ** ** | 4,141 |   |
| Merchant  processing and data processing fees              | ** ** | **5,197**                                  | ** ** | 6,207 | ** ** | 6,554 |   |
| Professional  services                                     | ** ** | **5,525**                                  | ** ** | 4,342 | ** ** | 4,114 |   |
| Regulatory  assessments                                    | ** ** | **498**                                    | ** ** | 407 | ** ** | 368 |   |
| Other  operating expenses                                  | ** ** | **5,814**                                  | ** ** | 6,237 | ** ** | 5,268 |   |
| ***TOTAL OTHER EXPENSES***                                 |       | **79,294**                                 |       | 74,691 |   | 70,925 |   |
| Income  before taxes                                       | ** ** | **52,656**                                 | ** ** | 50,878 | ** ** | 45,747 |   |
| Tax  expense                                               | ** ** | **17,547**                                 | ** ** | 17,714 | ** ** | 15,892 |   |
| ***NET INCOME***                                           |       | **35,109**                                 |       | $ | 33,164 |   | $ | 29,855 |   |
| **Earnings per share:**                                    | ** ** | ** **                                 | ** ** |   | ** ** |   |   |
| —Basic                                                |       | **$**                                      | **1.50**   | ** ** | $ | 1.41 |   | $ | 1.25 |   |
| —Diluted                                              |       | **$**                                      | **1.47**   | ** ** | $ | 1.40 |   | $ | 1.20 |   |
| **Average shares used in earnings per share calculation:** | ** ** | ** **                                 | ** ** |   | ** ** |   |   |
| —Basic                                                |       | **23,422**                                 | ** ** | 23,443 |   | 23,962 |   |
| —Diluted                                              |       | **23,897**                                 | ** ** | 23,762 |   | 24,837 |   |

 

The accompanying notes are an integral part of these consolidated statements.

54

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**ConsolidatedStatements of Comprehensive Income(amounts in 000’s)**
| ** **                                                    | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ***NET INCOME***                                              | ** ** | **$**                                      | **35,109** | ** ** | $ | 33,164 |   | $ | 29,855 |   |
| **Other  Comprehensive Income Before Taxes:**                 |       |                                       |       |   |   |   |   |
| Unrealized (losses)  gains on securities available for sale:  |       |                                       |       |   |   |   |   |
| Unrealized  holding (losses) gains arising during year        | ** ** | **(8,568**                                 | **)**      | (1,547 | ) | 11,378 |   |
| Reclassification  adjustment for gains included in net income | ** ** | **(475**                                   | **)**      | (40 | ) | (17 | ) |
| Other  comprehensive (loss) income, before tax                | ** ** | **(9,043**                                 | **)**      | (1,587 | ) | 11,361 |   |
| Income tax  (benefit) expense                                 | ** ** | **(3,626**                                 | **)**      | (626 | ) | 4,545 |   |
| ***OTHER COMPREHENSIVE (LOSS) INCOME,  NET OF TAXES***        | ** ** | **(5,417**                                 | **)**      | (961 | ) | 6,816 |   |
| ***TOTAL  COMPREHENSIVE INCOME***                             | ** ** | **$**                                      | **29,692** |   | $ | 32,203 |   | $ | 36,671 |   |

 

The accompanying notes are an integral part of these consolidated statements.

55

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**ConsolidatedStatements ofChanges in Capital Accounts(amounts in 000’s except share amounts)**
| ** **                                                                                | ** ** | ** **         | ** ** | ** **  | ** ** | ** **    | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------|------------|---------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                | ** ** | ** **         | ** ** | ** **  | ** ** | ** **    | ** ** | **Other**              | ** ** | ** ** | ** ** |
| ** **                                                                                | ** ** | **Number of** | ** ** | **Capital** | ** ** | **Undivided** | ** ** | **Comprehensive**      | ** ** | ** ** | ** ** |
| ** **                                                                                | ** ** | **Shares**         | ** ** | **Stock**   | ** ** | **Profits**   | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** |
| BALANCE,  December 31, 2001                                                          |       | 24,088,633         |       | 84,872      |       | 143,257       |       |                   | 6,422      |       |       | 234,551 |   |
| Cash dividend                                                                             |       | —             |       | —      |       | (9,803        | )          |                   | —     |       |       | (9,803 | ) |
| Exercise of stock options                                                                 |       | 85,866             |       | 1,102       |       | —        |       |                   | —     |       |       | 1,102 |   |
| Net income                                                                                |       | —             |       | —      |       | 29,855        |       |                   | —     |       |       | 29,855 |   |
| Change in net unrealized gain on available for sale securities,  net of taxes of $4,545   |       | —             |       | —      |       | —        |       |                   | 6,816      |       |       | 6,816 |   |
| Stock repurchased                                                                         |       | (477,264           | )          | (8,386      | )          | —        |       |                   | —     |       |       | (8,386 | ) |
| BALANCE, December 31, 2002                                                           |       | 23,697,235         |       | $           | 77,588     |          | $          | 163,309                |       |       | $          | 13,238 |   |   | $ | 254,135 |   |
| Cash dividend                                                                             |       | —             |       | —      |       | (11,702       | )          |                   | —     |       |       | (11,702 | ) |
| Exercise of stock options                                                                 |       | 172,096            |       | 2,284       |       | —        |       |                   | —     |       |       | 2,284 |   |
| Shares issued in connection with merger                                                   |       | 498,153            |       | 11,846      |       | —        |       |                   | —     |       |       | 11,846 |   |
| Net income                                                                                |       | —             |       | —      |       | 33,164        |       |                   | —     |       |       | 33,164 |   |
| Change in net unrealized gain on available for sale  securities, net of taxes of $(626)   |       | —             |       | —      |       | —        |       |                   | (961       | )          |       | (961 | ) |
| Stock repurchased                                                                         |       | (800,006           | )          | (16,212     | )          | —        |       |                   | —     |       |       | (16,212 | ) |
| BALANCE, December 31, 2003                                                           |       | 23,567,478         |       | $           | 75,506     |          | $          | 184,771                |       |       | $          | 12,277 |   |   | $ | 272,554 |   |
| Cash dividend                                                                             |       | —             |       | —      |       | (13,552       | )          |                   | —     |       |       | (13,552 | ) |
| Exercise of stock options                                                                 |       | 190,548            |       | 2,579       |       | —        |       |                   | —     |       |       | 2,579 |   |
| Net income                                                                                |       | —             |       | —      |       | 35,109        |       |                   | —     |       |       | 35,109 |   |
| Change in net unrealized gain on available for sale  securities, net of taxes of $(3,626) |       | —             |       | —      |       | —        |       |                   | (5,417     | )          |       | (5,417 | ) |
| Stock repurchased                                                                         |       | (658,867           | )          | (16,646     | )          | —        |       |                   | —     |       |       | (16,646 | ) |
| **BALANCE,  December 31, 2004**                                                      | ** ** | **23,099,159**     | ** ** | **$**       | **61,439** | ** **    | **$**      | **206,328**            | ** ** | ** ** | **$**      | **6,860** |   | ** ** | **$** | **274,627** |   |

 

The accompanying notes are an integral part of these consolidated statements.

56

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**Consolidated Statements of Cash Flows (amounts in 000’s)**
| ** **                                                                         | ** ** | **Year Ended December 31,** | ** **  |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                                         | ** ** | **2004**                                   | ** **  | **2003** | ** ** | **2002** | ** ** |
| **Operating  Activities:**                                                         |       |                                       |        |   |   |   |   |
| Net Income                                                                         | ** ** | **$**                                      | **35,109**  |   | $ | 33,164 |   | $ | 29,855 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                       |        |   |   |   |   |
| Provision for depreciation and amortization                                        | ** ** | **5,044**                                  |        | 4,511 |   | 4,372 |   |
| Amortization of originated mortgage servicing rights                               | ** ** | **459**                                    |        | 804 |   | 307 |   |
| Amortization of investment security premiums, net                                  | ** ** | **5,120**                                  |        | 4,204 |   | 4,019 |   |
| Amortization of deferred loan fees                                                 | ** ** | **(163**                                   | **)**       | 687 |   | (78 | ) |
| Amortization of intangible assets                                                  | ** ** | **1,375**                                  |        | 1,121 |   | 1,072 |   |
| (Gain) loss on sale of investments                                                 | ** ** | **(475**                                   | **)**       | (40 | ) | (17 | ) |
| Originations of loans held for sale                                                | ** ** | **(77,218**                                | **)**       | (222,486 | ) | (156,606 | ) |
| Proceeds from sales of loans held for sale                                         | ** ** | **78,247**                                 |        | 235,021 |   | 148,661 |   |
| Gain on sale of other real estate owned                                            | ** ** | **(1,084**                                 | **)**       | — |   | — |   |
| Gain on sale of loans held for sale                                                | ** ** | **(607**                                   | **)**       | (3,385 | ) | (1,011 | ) |
| (Benefit)/Provision for credit losses                                              | ** ** | **(2,700**                                 | **)**       | (969 | ) | 600 |   |
| Deferred tax (benefit) charge                                                      | ** ** | **(765**                                   | **)**       | 1,814 |   | (738 | ) |
| Increase in other intangibles                                                      |       | **—**                                 |        | — |   | (901 | ) |
| Decrease (increase) in accrued interest                                            | ** ** | **256**                                    |        | (485 | ) | (636 | ) |
| (Increase) decrease in other assets                                                | ** ** | **(4,176**                                 | **)**       | (2,938 | ) | 3,845 |   |
| Increase (decrease) in accrued interest payable and  other liabilities        | ** ** | **4,882**                                  |        | (1,257 | ) | (1,307 | ) |
| ***Net cash provided by operating  activities***                                   | ** ** | **43,304**                                 |        | 49,766 |   | 31,437 |   |
| **Investing  Activities:**                                                         |       |                                       |        |   |   |   |   |
| Proceeds from  sales and maturities of securities                                  | ** ** | **160,631**                                |        | 137,567 |   | 112,811 |   |
| Purchases of  securities                                                           | ** ** | **(44,463**                                | **)**       | (275,591 | ) | (263,089 | ) |
| Net (increase)  decrease in loans                                                  | ** ** | **(266,363**                               | **)**       | (41,427 | ) | 46,323 |   |
| Receipts from  real estate investments, net of advances                            | ** ** | **4,512**                                  | **)**       | — |   | (6 | ) |
| Cash acquired in  acquisition, net of cash used                                    |       | **—**                                 |        | 9,959 |   | — |   |
| Purchases of  premises and equipment                                               | ** ** | **(3,670**                                 | **)**       | (5,265 | ) | (3,878 | ) |
| Proceeds from  sales of premises and equipment                                     | ** ** | **5**                                      |        | 10 |   | 15 |   |
| ***Net cash used in investing  activities***                                       | ** ** | **(149,348**                               | **)**       | (174,747 | ) | (107,824 | ) |
| **Financing  Activities:**                                                         |       |                                       |        |   |   |   |   |
| Net increase in  deposits                                                          | ** ** | **82,114**                                 |        | 180,684 |   | 68,781 |   |
| Net decrease in  other borrowings                                                  | ** ** | **(1,045**                                 | **)**       | (3,346 | ) | (6,741 | ) |
| Cash dividend paid                                                                 | ** ** | **(13,552**                                | **)**       | (11,702 | ) | (9,803 | ) |
| Proceeds from  exercise of stock options                                           | ** ** | **2,579**                                  |        | 2,284 |   | 1,102 |   |
| Purchase of bank  stock for retirement                                             | ** ** | **(16,646**                                | **)**       | (16,212 | ) | (8,386 | ) |
| ***Net cash provided by financing  activities***                                   | ** ** | **53,450**                                 |        | 151,708 |   | 44,953 | ) |
| ***(DECREASE)  INCREASE IN CASH & CASH EQUIVALENTS***                     | ** ** | **(52,594**                                | **)**       | 26,727 |   | (31,434 | ) |
| ***CASH  AND CASH EQUIVALENTS, beginning of year***                                | ** ** | **171,263**                                |        | 144,536 |   | 175,970 |   |
| ***CASH  AND CASH EQUIVALENTS, end of year***                                      | ** ** | **$**                                      | **118,669** |   | $ | 171,263 |   | $ | 144,536 |   |

 

57

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**Consolidated Statements of Cash Flows (Continued) (amounts in 000’s)**

 
| ** **                                         | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                         | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Supplemental disclosure  of cash flow information  |       |                                       |       |   |   |   |   |
| Cash paid during  the year for:                    |       |                                       |       |   |   |   |   |
| Interest (net of amounts capitalized)              | ** ** | **$**                                      | **8,237**  |   | $ | 9,424 |   | $ | 16,678 |   |
| Taxes on income, net                               | ** ** | **15,006**                                 |       | 19,136 |   | 15,265 |   |
| Transfers from loans to other real estate owned    | ** ** | **—**                                 |       | 3,279 |   | — |   |
| **ACQUISITIONS**                                   |       |                                       |       |   |   |   |   |
| Fair value of  tangible assets acquired            |       | **$**                                      | **—** |   | $ | 87,484 |   | $ | — |   |
| Fair value of core deposit intangible acquired     |       | **—**                                 |       | 2,727 |   | — |   |
| Goodwill created in acquisition                    |       | **—**                                 |       | 14,392 |   | — |   |
| Liabilities assumed                                |       | **—**                                 |       | (79,592 | ) | — |   |
| Acquisition price, including direct costs          |       | **—**                                 |       | 25,011 |   | — |   |
| Less:                                              |       | ** **                                 |       |   |   |   |   |
| Common stock issued                                |       | **—**                                 |       | (11,846 | ) | — |   |
| Amounts payable to shareholders and other accruals |       | **—**                                 |       | (203 | ) | — |   |
| Cash paid                                          |       | **—**                                 |       | (12,962 | ) | — |   |
| Cash acquired                                      |       | **—**                                 |       | 22,921 |   | — |   |
| Cash acquired,  net of cash paid                   |       | **$**                                      | **—** |   | $ | 9,959 |   | $ | — |   |

 

The accompanying notes are an integral part of these consolidated statements.

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2004**

**1. Summaryof Significant Accounting Policies**

The accounting andreporting policies of Mid-State Bancshares and subsidiary (the “Company”)conform with accounting principles generally accepted in the United States(GAAP) and general practice within the banking industry. GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates. The following are descriptions of the more significantaccounting policies of the Company.

**Consolidation:  **Theconsolidated financial statements include the accounts of Mid-State Bancsharesand its wholly owned subsidiary, Mid-State Bank & Trust, (the “Bank”)which includes Mid-State Bank & Trust’s wholly owned subsidiaries, MidCoast Land Company and MSB Properties. All inter-company accounts andtransactions have been eliminated in the consolidated financial statements.

**Significant Group Concentrations of Credit Risk:  **Mostof the Company’s activities are with customers located within the threecounties of San Luis Obispo, Santa Barbara and Ventura in California. Note 4below discusses the types of securities that the Company invests in. Note 5discusses the types of lending that the Company engages in. The Company doesnot have any significant concentrations to any one industry or customer.

**Cash and Cash Equivalents:  **Forpurposes of the consolidated statements of cash flows, cash and cashequivalents include cash and balances due from banks, federal funds sold andsecurities purchased under agreements to resell, all of which mature withinninety days.

**Securities:  **Securities forwhich the Company has the positive intent and ability to hold until maturityare classified as held-to-maturity securities. Securities which are purchasedprincipally for the purpose of selling them in the near term for a gain areclassified as trading securities. Securities not classified as held-to-maturityor trading are classified as available for sale. The Company holds nosecurities that should be classified as trading securities or held-to-maturitysecurities. Securities classified as available for sale are reported on theconsolidated statements of financial position as of December 31, 2004 and2003, at their market value. The net unrealized gains or losses for thesesecurities are reported, net of related taxes, in the statements ofcomprehensive income for the years ended December 31, 2004, 2003 and 2002and as a separate component of the capital accounts for the years ended December 31,2004 and 2003.

In connection with the merger with Ojai Valley Bank(see Note 2 below), Mid-State Bancshares’ classified approximately $28.7million of securities as Available for Sale which were previously categorizedas Held to Maturity on Ojai Valley Bank’s Statement of Financial Position. Theseactions were taken in conformance with Mid-State Bancshares’ overallasset/liability and investment management policy and are permitted underStatement of Financial Accounting Standards (SFAS) No. 115, *“Accounting for Certain Investments in Debt and Equity Securities.”*

Interest income from the securities portfolio isaccrued as earned including the accretion of discounts and the amortization ofpremiums based on the original cost of each security owned. The accretion ofdiscounts and the amortization of premiums are on a straight-line basis to theexpected maturity date of the bond. The gain or loss recognized on any securitysold prior to maturity is based on the difference between principal proceedsand this amortized cost. Related income taxes are calculated at current federaland state statutory rates.

59

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**1.Summary of Significant Accounting Policies (Continued)**

**Loans Held for Sale:  **Loansheld for sale are carried at the lower of cost or market, which is determinedon an aggregate basis. They are stated at the amount of unpaid principal,reduced by market valuation adjustments and increased or reduced by netdeferred loan origination fees and costs. Interest on loans is recognized overthe terms of the loans and is calculated on principal amounts outstanding. Directloan origination fees and costs are deferred until the related loan is sold.

**Loans:  **Loans are stated atface amount, less payments collected and net deferred loan fees. Income isaccrued daily as earned. Loan origination costs are netted against loan feescollected and the net amount is deferred in accordance with SFAS No. 91, *“Accounting for Nonrefundable Fees and Costs Associated withOriginating or Acquiring Loans and Initial Direct Costs of Leases,”*and amortized into income over the expected life of the loan. The allowance forloan losses, which is based on estimates, is maintained at a level consideredadequate to provide for losses that are considered to be inherent in theportfolio. Ultimate losses may vary from the current estimates. Managementreviews these estimates periodically, considers the borrower’s financialstatus, current economic conditions, historical loan loss experience and otherfactors. As adjustments become necessary, they are reported in earnings in theperiods in which they become known. The allowance is increased by provisionscharged to operating expense and reduced by net charge-offs.

In determining income recognition on loans, generallyno interest is recognized with respect to loans on which a default of interestor principal has occurred for a period of 90 days or more. Consumer loans aretypically charged-off when they are 90 days or more past due. Other types ofloans are placed on non-accrual status when management believes that theborrower’s financial condition, after giving consideration to economic andbusiness conditions and collection efforts, is such that the presumption of collectibilityof interest no longer is prudent. When a loan is placed on non-accrual status,previously accrued and uncollected interest is reversed from income. Loans onnon-accrual are charged off, or partially charged off, when collection of all,or a portion of, principal is considered doubtful. Payments received on nonaccrual loans are applied to principal unless the loan has had a partial chargeoff in which case payment is applied as a recovery to the allowance for loanlosses. Once a loan is on non-accrual, it is generally not returned to accrualstatus until 1) all past due principal and interest payments have been paid, 2)there has been a demonstrated ability to make payments for 6 to 12 months, and3) there is sufficient collateral supporting the loan.

**Premises and Equipment:  **Premisesand equipment are carried at cost, less accumulated depreciation andamortization. Depreciation and amortization are computed principally on thestraight-line method over the lesser of the estimated useful life of each typeof asset or the lease term.

**Other Real Estate Owned:  **OtherReal Estate Owned (OREO) is comprised of real estate acquired throughforeclosure. It is carried at the lower of cost or estimated fair value lessestimated costs of disposal.

**Goodwill:  **The amountspresented on the Company’s consolidated statements of financial positionrepresents the excess of acquisition prices paid over and above the fair marketvalue of net assets acquired. In accordance with the terms of SFAS No. 142,on an annual basis, the Company tests its Goodwill for impairment. Goodwill isentirely attributable to the Company’s community banking segment, and becausethe fair market value of Mid-State Bancshares’ equity is a safe proxy for thefair market value of the community banking segment, the Company compares itsfair market value of equity to its book value. This 

60

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**1.Summary of Significant Accounting Policies (Continued)**

difference is compared toGoodwill. Provided the excess of fair market value to book value is above theGoodwill amount, there is no impairment of Goodwill.

**Core Deposit Intangible:  **Thefair market value of core deposits acquired are carried at cost, lessaccumulated amortization. The amounts carried are included in Core DepositIntangibles, net, on the consolidated statements of financial position. Theamortization of the Core Deposit Intangible (CDI) is computed principally on astraight-line basis over its expected useful life. On an annual basis, theCompany tests it CDI for impairment. The amortized CDI is compared to theoriginal amount of CDI booked at the time of the acquisition. This percentageis then compared to the percentage of customers acquired in the acquisition whoare still banking with the Bank. Provided the percentage of the CDI does notexceed the percentage of customers who are still banking with the Bank, there isno impairment. The amortization of the CDI may be adjusted from time to timebased on the results of this test.

**Accounting for Income Taxes:  **Deferredincome tax assets or liabilities are computed based on the difference betweenthe financial statement and income tax basis of assets and liabilities usingthe enacted marginal tax rate. Deferred income tax expenses or benefits arebased on the changes in the deferred asset or liability from period to period. TheCompany estimates its quarterly effective income tax rate based upon a varietyof factors, including, but not limited to, the expected revenues for the yearand the product mix of revenue, and the ratio of permanent differences to totalrevenue. Any changes to the estimated rate are made prospectively in accordancewith APB 28 “Interim Financial Reporting”. Additionally, Management makesestimates as to the amount of reserves, if any, that are necessary for knowntax exposures.

**Stock Option Plan:  **TheCompany applies Accounting Principles Board (APB) Opinion No. 25, *“Accounting for Stock Issued to Employees,”* and relatedInterpretations in accounting for its Plan. Accordingly, no compensationexpense has been recognized for grants under the Plan. Consistent with themethods of SFAS No. 123, pro-forma compensation expense for the Plan isdetermined based on the fair value at the grant date. Fair values wereestimated using the Black-Scholes option-pricing model and pro formadisclosures of net income and earnings per share, as if the fair value basedmethod of accounting had been applied, are disclosed in Note 15.

**Recent Accounting Pronouncements:  **TheFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 146, “Accounting for Costs Associated withExit or Disposal Activities” in June of 2002. SFAS No. 146 addressesfinancial accounting and reporting for costs associated with exit or disposalactivities. SFAS No. 146 is effective for exit or disposal activitiesinitiated after December 31, 2002, with early adoption permitted. Theadoption of SFAS No. 146 did not have a material impact on the Company’sresults of operations and financial position.

In January of 2003, the FASB issued FASBInterpretation (FIN) No. 46, “Consolidation of Variable Interest Entities”.FIN No. 46 addresses consolidation by business enterprises of variableinterest entities, which have one or both of the following characteristics: i)the equity investment at risk is not sufficient to permit the entity to financeits activities without additional subordinated financial support from otherparties, which is provided through other interests that will absorb some or allof the expected losses of the entity; and ii) the equity investors lack anessential characteristic of a controlling financial interest. FIN No. 46was initially effective for all financial statements issued on or after February 1,2003, but 

61

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**1.Summary of Significant Accounting Policies (Continued)**

subsequently the adoptiondate was deferred to January 1, 2004. The adoption of FIN No. 46 didnot have a material impact on the Company’s results of operations and financialposition.

In April 2003, the FASB issued SFAS No. 149,“Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”SFAS 149 amends and clarifies accounting for derivative instruments, includingcertain derivative instruments embedded in other contracts, and for hedgingactivities under SFAS No. 133. SFAS 149 was effective for contractsentered into or modified after June 30, 2003, and for hedgingrelationships designated after June 30, 2003. The guidance should beapplied prospectively. The adoption of SFAS 149 did not have a material impacton the Company’s results of operations and financial position.

The FASB issued SFAS No. 150, “Accounting forCertain Financial Instruments with Characteristics of Both Liabilities andEquity” in May of 2003. SFAS No. 150 establishes standards for how anissuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. It requires that an issuerclassify a financial instrument that is within its scope as a liability (or anasset in some circumstances). Many of those instruments were previouslyclassified as equity. SFAS No. 150 was effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise was effectiveat the beginning of the first interim period beginning after June 15, 2003.The adoption of SFAS No. 150 did not have a material impact on the Company’sresults of operations and financial position.

The FASB issued SFAS No. 132 (revised 2003), “Employers’Disclosures about Pensions and Postretirement Benefits” in December of2003. SFAS No. 132 requires additional disclosures about the assets,obligations and cash flows of defined benefit pension and postretirement plans,as well as the expense recorded for such plans. As of December 31, 2003,the Company has disclosed the required elements related to its defined benefitpension plan in Note 16 to these consolidated financial statements.

In December 2003, the Accounting StandardsExecutive Committee (AcSEC) of the American Institute of Certified PublicAccountants (AICPA) issued Statement of Position (SOP) 03-3, “Accounting forCertain Loans or Debt Securities Acquired in a Transfer.” The SOP is effectivefor loans acquired in fiscal years beginning after December 15, 2004, withearly adoption encouraged. The SOP addresses accounting for differences betweencontractual cash flows and cash flows expected to be collected from an Investor’sinitial investment in loans or debt securities acquired in a transfer if thosedifferences are attributable, at least in part, to credit quality. The adoptionof SOP 03-3 is not expected to have a material impact on the Company’s resultsof operations and financial position.

In June 2004, the Emerging Issues Task Force ofthe FASB issued guidance on its Issue No. 03-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments.”The guidance made recommendations regarding unrealized losses onavailable-for-sale debt and equity securities accounted for under FASBStatements No. 115, “Accountingfor Certain Investments in Debt and Equity Securities,” .” and No. 124, “Accounting for Certain Investments Held byNot-for-Profit Organizations.” The guidance for evaluating whether aninvestment is other-than-temporarily impaired was to be applied inother-than-temporary impairment evaluations made in reporting periods beginningafter June 15, 2004. The disclosures were to be effective in annualfinancial statements for fiscal years ending after December 15, 2003, forinvestments accounted for under Statements 115 and 124. On September 30,2004, the FASB Board directed the issuance of FASB Staff Position (FSP) EITFIssue 03-1-a, “Implementation Guidance for the Application of Paragraph 16 ofEITF Issue No. 03-1.” The proposed 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**1.Summary of Significant Accounting Policies (Continued)**

FSP would provideimplementation guidance with respect to debt securities that are impairedsolely due to interest rates and/or sector spreads and analyzed forother-than-temporary impairment under paragraph 16 of issue Issue 03-1. TheFASB asked constituents to comment on whether the application guidance withrespect to “minor impairments” should also be applied to securities analyzedfor impairment under paragraphs 10-15 of Issue 03-1. Based on comment lettersreceived, the FASB decided to delay the effective date for the measurement andrecognition guidance contained in paragraphs 10-20 of Issue 03-1 as it furtherconsiders whether application guidance is necessary for all securities analyzedfor impairment. The delay of the effective date for paragraphs 10-20 of Issue03-1 will be superseded concurrent with the final issuance of FSP EITF Issue03-1-a. The adoption of EITF Issue No. 03-1 is not expected to have amaterial impact on the Company’s results of operations and financial position.

The FASB issued a revisionto SFAS No. 123, “Accounting for Stock-Based Compensation” in December 2004.The revised Statement is SFAS No. 123R (revised 2004), “Share-BasedPayment” and it will supercede APB Opinion No. 25, “Accounting for StockIssued to Employees,” and its related implementation guidance. It is effectivefor the Company as of the beginning of the first interim reporting period thatbegins after June 15, 2005. The Statement requires that the Companymeasures the cost of employee services received in exchange for an award ofequity instruments (share based payment awards) based on the grant date fairvalue of the award and the estimated number of awards that are expected to vest.The cost will be recognized over the period during which an employee isrequired to provide service in exchange for the award—usually the vestingperiod. Compensation cost for awards that vest would not be reversed if theawards expire without being exercised. The Company currently applies APBOpinion No. 25, in accounting for its Plan. Accordingly, no compensationexpense has been recognized for grants under the Plan. Pro forma disclosures ofnet income and earnings per share are however disclosed in Note 15. TheCompany expects to adopt the revised Statement for the third quarter of 2005 andexpects it will have a material effect on its Consolidated Statements ofIncome, Comprehensive Income and Changes in Capital Accounts.

**2. Merger**

***Ojai Valley Bank***

On October 31, 2003, Mid-State Bancshares and itswholly owned subsidiary Mid-State Bank & Trust acquired 100 percent ofthe outstanding common stock of Ojai Valley Bank. The results of Ojai ValleyBank’s operations have been included in the consolidated financial statementssince that date. Ojai Valley Bank was a community bank that served the communitiesof Ojai and Oak View in Ventura County. The merger gives Mid-State Bank &Trust two new offices in Ventura County.

The aggregate purchase price was $25.0 million,including $11.8 million in cash paid to Ojai Valley Bank shareholders, $11.8million in Mid-State Bancshares’ common stock issued and $1.3 million for othermerger related expenses. The value of the 498,153 shares issued was determinedbased on the average closing market price of Mid-State Bancshares’ common stockover the twenty consecutive trading days that Mid-State Bancshares’ stocktraded ending October 24, 2003. The average price of Mid-State Bancshares’stock over that period was $23.78. The merger was accounted for utilizing thepurchase method of accounting.

63

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**2. Merger(Continued)**

A pro forma summary ofrevenue, net income and earnings per share, as if the merger was in effect atthe beginning of each period, is presented below. This summary specificallyexcludes any expense savings achieved as a result of the merger. Adjustmentshave been made to reflect the amortization of the core deposit intangible andthe loss of interest on cash utilized to complete the merger. These results arenot included in the financial statements included herein. Figures are inthousands.
| ** **                                         | ** ** | **(Unaudited)  For the Year Ended  December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **2003**                                                              | ** ** | **2002** | ** ** |
| **Pro Forma Interest and Non  Interest Income:**   | ** ** | ** **                                                            | ** ** | ** ** | ** ** |
| Combined Mid-State Bancshares and Ojai Valley Bank |       | $                                                                     | 138,789    |   | $ | 139,043 |   |
| **Pro Forma Net Income:**                          | ** ** | ** **                                                            | ** ** | ** ** | ** ** |
| Combined Mid-State Bancshares and Ojai Valley Bank |       | $                                                                     | 32,728     |   | $ | 30,637 |   |
| **Pro  Forma Earnings Per Share—Basic**       |       | $                                                                     | 1.37       |   | $ | 1.25 |   |
| **Pro Forma Earnings Per  Share—Diluted**     |       | $                                                                     | 1.35       |   | $ | 1.21 |   |

 

The following tablesummarizes the estimated fair values of the assets acquired and liabilitiesassumed at the date of acquisition, October 31, 2003 (in 000’s).
| Cash and Due From  Banks  |     | $       | 4,731  |   |
|---------------------------|----------|---------|--------|--------|
| Federal Funds  Sold       |     | 18,190  |   |
| Securities, net           |     | 33,423  |   |
| Loans, Net                |     | 30,407  |   |
| Goodwill (A)              |     | 14,392  |   |
| Other Intangibles  (B)    |     | 2,727   |   |
| Other Assets              | * * | 733     |   |
| Total Assets Acquired     | * * | 104,603 |   |
| Total Deposits            |     | (78,800 | )      |
| Other Liabilities         | * * | (792    | )      |
| Total Liabilities Assumed | * * | (79,592 | )      |
| Net Assets  Acquired      |     | $       | 25,011 |   |

----

(A)       Goodwill is completelyattributable to the Community Banking segment of the Company and is notdeductible for tax purposes.

The entire amountdisplayed is attributable to a Core Deposit Intangible which is being amortizedover its expected useful life of 9.00 years, i.e. through October 31,2012.

**3. Cash Reserves**

The average reservebalances required to be maintained by the Federal Reserve Bank wereapproximately $24.8 million and $13.1 million at December 31, 2004 and2003, respectively.

64

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**4. Securities**

A summary of investmentsecurities owned is as follows:

**December 31, 2004**
| ** **                                               | ** ** | ** **  | ** **                  | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|-------------|-----------------------------|----------------|------------|----------------|------------|------------|------------|
| **(amounts in 000’s)**                    | ** ** | **Cost**    | ** **                  | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market** | ** ** |
| **Securities Available For Sale**         | ** ** | ** **  | ** **                  | **Basis**      | ** ** | **Gains**      | ** ** | **Losses** | ** ** | **Value** | ** ** |
| U.S. Treasury  securities                                |       | **$**       | **25,630**                  | ** **     |       | **$**          | **5**      | ** ** |       |   | **$** | **(148** | **)** |   | **$** | **25,487** | ** ** |
| Securities of  U.S. government agencies and corporations |       | **217,028** | ** **                  |           | **796**    | ** **     |       |       | **(1,170** | **)** |   | **216,654** | ** ** |
| Mortgage backed  securities                              | ** ** | **8,824**   | ** **                  |           | **650**    | ** **     |       |       | **(57**    | **)** |   | **9,417** | ** ** |
| Obligations of  states and political subdivisions        |       | **365,821** | ** **                  |           | **11,604** | ** **     |       |       | **(387**   | **)** |   | **377,038** | ** ** |
| Other investments                                        |       | **16,081**  | ** **                  |           | **141**    | ** **     |       |       | **(1**     | **)** |   | **16,221** | ** ** |
| ***TOTAL***                                              |       | **$**       | **633,384****  ** | ** **     |       | **$**          | **13,196** | ** ** |       |   | **$** | **(1,763** | **)** |   | **$** | **644,817** | ** ** |
|                                                          |            |             |                             |                |            |                |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

**December 31, 2003**
| ** **                                               | ** ** | ** ** | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|------------|------------|----------------|------------|----------------|------------|------------|------------|
| **(amounts in 000’s)**                    | ** ** | **Cost**   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market** | ** ** |
| **Securities Available For Sale**         | ** ** | ** ** | ** ** | **Basis**      | ** ** | **Gains**      | ** ** | **Losses** | ** ** | **Value** | ** ** |
| U.S. Treasury  securities                                |       | $          | 83,397     |           |       | $              | 289        |       |       |   | $ | (84 | ) |   | $ | 83,602 |   |
| Securities of  U.S. government agencies and corporations |       | 287,224    |       |           | 4,716      |           |       |       | (503       | ) |   | 291,437 |   |
| Mortgage backed  securities                              |       | 7,126      |       |           | 620        |           |       |       | —     |   |   | 7,746 |   |
| Obligations of  states and political subdivisions        |       | 362,332    |       |           | 15,333     |           |       |       | (559       | ) |   | 377,106 |   |
| Other investments                                        |       | 14,123     |       |           | 665        |           |       |       | —     |   |   | 14,788 |   |
| *TOTAL*                                                  |       | $          | 754,202    |           |       | $              | 21,623     |       |       |   | $ | (1,146 | ) |   | $ | 774,679 |   |
|                                                          |            |            |            |                |            |                |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table shows those investments with gross unrealized losses and theirmarket value aggregated by investment category and length of time thatindividual securities have been in a continuous unrealized loss position at December 31,2004:
| ** **                                               | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|------------|------------|
| ** **                                               | ** ** | **Market**                             | ** ** | **Unrealized**                       | ** ** | **Market** | ** ** | **Unrealized** | ** ** | **Market** | ** ** | **Unrealized** | ** ** |
| **(amounts in 000’s)**                    | ** ** | ** **                             | ** ** | **Value**                            | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| U.S. Treasury  securities                                |       | $                                      | 24,978     |                                 |       | $          | (148       | ) |   | $ | — |   |   | $ | — |   |   | $ | 24,978 |   |   | $ | (148 | ) |   |
| Securities of  U.S. government agencies and corporations |       | 130,049                                |       |                                 | (1,170     | )          |       | — |   |   | — |   |   | 130,049 |   |   | (1,170 | ) |   |
| Mortgage backed  securities                              |       | 1,763                                  |       |                                 | (57        | )          |       | — |   |   | — |   |   | 1,763 |   |   | (57 | ) |   |
| Obligations of  states and political subdivisions        |       | 35,693                                 |       |                                 | (142       | )          |       | 3,830 |   |   | (245 | ) |   | 39,523 |   |   | (387 | ) |   |
| Other investments                                        |       | 2,012                                  |       |                                 | (1         | )          |       | — |   |   | — |   |   | 2,012 |   |   | (1 | ) |   |
| *TOTAL*                                                  |       | $                                      | 194,495    |                                 |       | $          | (1,518     | ) |   | $ | 3,830 |   |   | $ | (245 | ) |   | $ | 198,325 |   |   | $ | (1,763 | ) |   |
|                                                          |            |                                        |            |                                      |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

All of the unrealized losses identified in the tableabove are primarily attributable to changes in general interest rate levels andare not considered to be other than temporary impairment. The unrealized lossesare not the result of any deteriorating financial conditions or near termprospects of the underlying issuers and Management believes that it has theintent and ability to either retain these investment securities to allow forthe eventual recovery in market value or to hold them until maturity.

65

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**4.Securities (Continued)**

Securities having a fair value of $106,354,000 and$102,828,000 at December 31, 2004 and 2003, respectively, were pledged tosecure public deposits and for other purposes as required by law.

Proceeds from maturities, calls, partial pay-downsand/or sales of securities were $160,631,000, $137,567,000, and $112,811,000for the years ended 2004, 2003, and 2002, respectively. Gross gains of$485,000, $46,000, and $27,000 and gross losses of $10,000, $6,000, and $10,000were realized on that activity for the years ended 2004, 2003, and 2002,respectively.

Theamortized cost and market value of securities at December 31, 2004 and2003, by contractual maturity, are shown below. Expected maturities may differfrom contractual maturities because borrowers may have the right to call orprepay obligations with or without call or prepayment penalties.
| ** **                            | *** *** | **Available For Sale** | ** **  |
|---------------------------------------|--------------|----------------------------------|-------------|
| **(dollars in 000’s)** | ** **   | **Cost**                         | ** **  | **Market** | ** ** |
| **December 31, 2004**       | ** **   | ** **                       | ** **  | **Basis** | ** ** | **Value** | ** ** |
| Due in one year  or less              | ** **   | **$**                            | **127,629** | ** ** | **$** | **128,025** | ** ** |
| Due after one  year to five years     |         | **304,579**                      | ** **  | **310,386** | ** ** |
| Due after five  years to ten years    |         | **191,278**                      | ** **  | **196,500** | ** ** |
| Due after ten  years                  |         | **9,898**                        | ** **  | **9,906** | ** ** |
| ***Total***                           |         | **$**                            | **633,384** | ** ** | **$** | **644,817** | ** ** |
|                                       |              |                                  |             |  |  |  |  |  |  |

 
| ** **                         | ** ** | **Cost**   | ** ** | **Market** | ** ** |
|------------------------------------|------------|------------|------------|------------|------------|
| **December 31, 2003**    | ** ** | ** ** | ** ** | **Basis**  | ** ** | **Value** | ** ** |
| Due in one year  or less           | ** ** | $          | 121,094    |       | $          | 123,056 |   |
| Due after one  year to five years  | ** ** | 422,199    |       | 479,947    |       |
| Due after five  years to ten years | ** ** | 208,102    |       | 169,315    |       |
| Due after ten  years               | ** ** | 2,807      |       | 2,361      |       |
| *Total*                            |       | $          | 754,202    |       | $          | 774,679 |   |
|                                    |            |            |            |            |            |  |  |  |  |

 

**5. Loans andAllowance for Loan Losses**

**The loan portfolio consists of the following:**
| ** **                            | ** ** | **December 31,** | ** **    |
|---------------------------------------|------------|-----------------------|---------------|
| **(dollars in 000’s)** | ** ** | ** **            | ** **    | **2004** | ** ** | **2003** | ** ** |
| Construction and  development loans   | ** ** | **$**                 | **229,569**   | ** ** | $ | 241,238 |   |
| Real estate loans                     | ** ** | **761,947**           | ** **    | 568,486 |   |
| Home equity  credit lines             | ** ** | **160,050**           | ** **    | 91,016 |   |
| Installment loans                     | ** ** | **19,206**            | ** **    | 25,635 |   |
| Cash reserve                          | ** ** | **3,607**             | ** **    | 7,492 |   |
| Agricultural  production              | ** ** | **40,256**            | ** **    | 33,313 |   |
| Commercial, other                     | ** ** | **211,251**           | ** **    | 191,907 |   |
| ** **                            |       | **1,425,886**         | ** **    | 1,159,087 |   |
| Less allowance  for loan losses       | ** ** | **(13,799**           | **)**         | (16,063 | ) |
| Less deferred  loan fees, net         | ** ** | **(3,992**            | **)**         | (4,155 | ) |
| *TOTAL  LOAN PORTFOLIO*               | ** ** | **$**                 | **1,408,095** | ** ** | $ | 1,138,869 |   |
|                                       |            |                       |               |  |  |  |  |  |  |

 

66

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**5. Loansand Allowance for Loan Losses (Continued)**

At December 31, 2004, $1,151,566,000 of the Bank’sportfolio was collateralized by various forms of real estate. The Companyattempts to reduce its concentration of credit risk by making loans, which arediversified by project type and geographic locations throughout the CentralCoast of California. While management of the Company believes that thecollateral presently securing this portfolio is adequate, there can be noassurances that a deterioration in the California real estate market would notexpose the Bank to significantly greater credit risk.

Loans on non-accrual status totaled $10,700,000 and$12,312,000 at December 31, 2004 and 2003, respectively. The bank had noloans past due 90 days or more and still accruing interest at December 31,2004 and 2003. If interest income on non-accrual loans had been recorded asoriginally scheduled, approximately $1,308,710, $1,731,761, and $1,103,794 ofadditional interest income would have been recorded for the years ended December 31,2004, 2003 and 2002, respectively. Additionally, there was no interest incomewhich was recognized for loans on non-accrual during 2004, 2003, or 2002.

A loan is identified as impaired when it is probablethat interest and principal will not be collected according to the contractualterms of the loan agreement. Because this definition is very similar to thatused by bank regulators to determine on which loans interest should not beaccrued, the Company expects that most impaired loans will be on non-accrualstatus. Therefore, in general, the accrual of interest on impaired loans isdiscontinued, and any uncollected interest is written off against interest fromother loans in the current period. No further income is recognized until allrecorded amounts of principal are recovered in full or until circumstances havechanged such that the loan is no longer regarded as impaired. Certain impairedloans are both fully secured by collateral and are current in their interestand principal payments. These impaired loans are not classified as non-accrualand $73,102, $629,093 and $401,277 in interest was recognized from these loansduring 2004, 2003 and 2002, respectively.

Theamount of the valuation allowance for impaired loans is determined by comparingthe recorded investment in each loan with its value measured by one of threemethods: (1) the expected future cash flows discounted at the effectiveinterest rate; (2) the loan’s observable market price, if available from asecondary market; or (3) by valuing the underlying collateral if the loanis collateral dependent. A valuation allowance is computed as any amount bywhich the recorded investment exceeds the value of the impaired loan. If thevalue of the loan, as determined by one of the above methods, exceeds therecorded investment in the loan, a valuation allowance for the loan is not established.The following table discloses information about impaired loans and theirrelated allowance.
| ** **                                                                | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**                                     | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Loans identified  as impaired at year end                                 | ** ** | **$**                 | **10,778** | ** ** | $ | 20,107 |   |
| Impaired loans  for which a valuation allowance has been determined       | ** ** | **9,381**             | ** ** | 10,490 |   |
| Amount of  valuation allowance                                            | ** ** | **4,462**             | ** ** | 2,164 |   |
| Impaired loans for which  no valuation allowance was determined necessary | ** ** | **1,398**             | ** ** | 9,617 |   |
|                                                                           |            |                       |            |  |  |  |  |  |  |

 

The average amount of the recorded investment inimpaired loans during the years ended December 31, 2004, 2003 and 2002 wasapproximately $12,914,000, $19,304,000 and $10,937,000, respectively.

67

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**5. Loans and Allowance forLoan Losses (Continued)**

The valuation allowance reported above is determinedon a loan-by-loan basis or by aggregating loans with similar riskcharacteristics. Because the loans currently identified as impaired have uniquerisk characteristics, the valuation allowance was determined on a loan-by-loanbasis.

The Company also provides an allowance for losses for (1) loansthat while not individually identified as being currently impaired, areinternally evaluated as having a relatively higher level of credit risk and (2) lossesinherent in the balance of the loan portfolio which have not been specificallyidentified as of the year-end. The allowance is based on review of individualloans, historical trends, current economic conditions, and other factors. Theallowance for loan losses consists of an amount allocated to loans which areimpaired, a statistically allocated portion and an unallocated portion. Thetotal of these components is considered adequate to provide for losses which canbe reasonably anticipated.

Theallowance for loan losses is netted against loans on the Statements ofFinancial Position for December 31, 2004 and 2003. A summary of thechanges in the allowance account is as follows:
| ** **                                                                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**                                                        | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Balance at beginning of  year:                                                               |       |                  |       |   |   |   |   |
| Allowance for  loan losses                                                                   | ** ** | **$**                 | **16,063** |   | $ | 17,370 |   | $ | 19,073 |   |
| Allowance for  losses—unfunded commitments                                              | ** ** | **1,941**             |       | 1,771 |   | 1,586 |   |
| Total allowance  for losses at beginning of year                                             | ** ** | **18,004**            |       | 19,141 |   | $ | 20,659 |   |
| (Reductions in)  additions to the allowance for loan losses (credited to) charged to expense | ** ** | **(2,700**            | **)**      | (969 | ) | 600 |   |
| Provision for  losses—unfunded commitments charged to expense                           | ** ** | **(158**              | **)**      | 170 |   | — |   |
| Loans charged off                                                                            | ** ** | **(940**              | **)**      | (1,894 | ) | (2,838 | ) |
| Recoveries of  loans previously charged off                                                  | ** ** | **1,376**             |       | 1,165 |   | 720 |   |
| Adjustment—Acquired  through Merger                                                     | ** ** | **—**            |       | 391 |   | — |   |
| ***TOTAL  ALLOWANCE FOR LOSSES—END OF YEAR***                                           | ** ** | **$**                 | **15,582** |   | $ | 18,004 |   | $ | 19,141 |   |
|                                                                                              |            |                       |            |  |  |  |  |  |  |  |  |  |

 
| **(dollars in  000’s)**                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Allowance for  loan losses                         | ** ** | **$**      | **13,799** |       | $          | 16,063     |       | $          | 17,370     |   |
| Allowance for  losses—unfunded commitments    | ** ** | **1,783**  |       | 1,941      |       | 1,771      |       |
| ***TOTAL  ALLOWANCE FOR LOSSES—END OF YEAR*** | ** ** | **$**      | **15,582** |       | $          | 18,004     |       | $          | 19,141     |   |

 

Ananalysis of loans and leases to directors and executive officers is as follows:
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**    | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Balance, at  beginning of year           | ** ** | **$**                 | **1,246**  |   | $ | 1,189 |   |
| Additional loans  and leases made        | ** ** | **7,817**             |       | 180 |   |
| Payments received  and other adjustments | ** ** | **(319**              | **)**      | (123 | ) |
| ***BALANCE  AT END OF YEAR***            | ** ** | **$**                 | **8,744**  |   | $ | 1,246 |   |
|                                          |            |                       |            |  |  |  |  |  |  |

 

68

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**5. Loansand Allowance for Loan Losses (Continued)**

These loans were made inthe ordinary course of the Bank’s business and, in management’s opinion, weremade at prevailing rates and terms. In addition, there were un-fundedcommitments to loan up to an additional $5,395,000 in extensions of credit todirectors and executive officers at year-end.

**6. Premises and Equipment**

*Premises and equipment consisted of the following:*
| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**                | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Land                                                 | ** ** | **$**                 | **7,595**  |   | $ | 7,035 |   |
| Buildings                                            | ** ** | **31,307**            |       | 29,097 |   |
| Furniture and  equipment                             | ** ** | **26,890**            |       | 24,877 |   |
| Construction and  equipment purchases in progress    | ** ** | **444**               |       | 2,560 |   |
| ** **                                           |       | **66,236**            |       | 63,569 |   |
| Less—Accumulated  depreciation and amortization | ** ** | **(41,290**           | **)**      | (37,244 | ) |
| ***TOTAL  PREMISES AND EQUIPMENT***                  | ** ** | **$**                 | **24,946** |   | $ | 26,325 |   |
|                                                      |            |                       |            |  |  |  |  |  |  |

 

Depreciation andamortization included in occupancy expenses was $5,044,000, $4,511,000, and$4,372,000 in 2004, 2003 and 2002, respectively, based on the followingestimated useful lives:
| Buildings               |   | 20-40 years |   |
|-------------------------|--------|-------------|--------|
| Furniture and equipment |   | 3-20 years  |   |

 

Totalrental expense for banking premises was $1,985,000, $1,864,000, and $1,548,000,in 2004, 2003 and 2002, respectively. As of December 31, 2004 theapproximate minimum future lease rentals payable under non-cancelable leasecontracts for bank premises were as follows (dollars in 000’s):
| **Year**                       | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|
| 2005                           |       | $          | 1,892      |       |
| 2006                           |       | 1,830      |       |
| 2007                           |       | 1,733      |       |
| 2008                           |       | 1,478      |       |
| 2009                           |       | 1,353      |       |
| Thereafter                     |       | 4,137      |       |
| ***TOTAL  LEASE COMMITMENTS*** |       | $          | 12,423     |       |

 

**7. Goodwill and CoreDeposit Intangible Assets**

In 2003, additional Goodwill in the amount of $14.4million was created as a result of the merger with Ojai Valley Bank.

69

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**7.Goodwill and Core Deposit Intangible Assets (Continued)**

The following table presentsnet income and basic and diluted earnings per common share, adjusted to reflectresults as if the non-amortization provisions of SFAS 142 had not been ineffect for the periods presented (dollars in 000’s).
| ** **                                    | ** ** | **2004**   | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| *Net Income:*                                 |       |       |       |     |       |     |       |
| Reported net  income                          | ** ** | **$**      | **35,109** |     | $          | 33,164   |       | $ | 29,855 |   |
| Less:  Amortization of Goodwill, net of taxes | ** ** | **(3,189** | **)**      | (2,390   | )          | (2,279   | )          |
| Adjusted Net  Income                          | ** ** | **$**      | **31,920** |     | $          | 30,774   |       | 27,576 |   |
| *Basic  earnings per share:*                  |       |       |       |     |       |     |       |
| Reported basic  earnings per share            | ** ** | **$**      | **1.50**   |     | $          | 1.41     |       | $ | 1.25 |   |
| Less:  Amortization of Goodwill, net of taxes | ** ** | **(0.14**  | **)**      | (0.10    | )          | (0.10    | )          |
| Adjusted basic  earnings per share            | ** ** | **$**      | **1.36**   |     | $          | 1.31     |       | $ | 1.15 |   |
| *Diluted  earnings per share:*                |       |       |       |     |       |     |       |
| Reported diluted  earnings per share          | ** ** | **$**      | **1.47**   |     | $          | 1.40     |       | $ | 1.20 |   |
| Less:  Amortization of Goodwill, net of taxes | ** ** | **(0.13**  | **)**      | (0.10    | )          | (0.09    | )          |
| Adjusted diluted  earnings per share          | ** ** | **$**      | **1.34**   |     | $          | 1.30     |       | $ | 1.11 |   |

 

The following is a summaryof the Company’s core deposit intangible assets. Figures are in thousands.
| ** **               | ** ** | **Dec. 31, 2004** | ** ** | **Dec. 31, 2003** | ** ** |
|--------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **               | ** ** | **Gross**                   | ** ** | **Accumulated**             | ** ** | **Net Carrying** | ** ** | **Gross** | ** ** | **Accumulated** | ** ** | **Net Carrying** | ** ** |
| ** **               | ** ** | **Amount**                  | ** ** | **Amortization**            | ** ** | **Amount** | ** ** | **Amount ** | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
| Core Deposit  Intangible | ** ** | **$**                       | **11,596** | ** **                  |       | **($3,864** | **)** |   |   | **$** | **7,732** |   |   | $ | 11,596 |   |   | ($2,489 | ) |   |   | $ | 9,107 |   |   |
|                          |            |                             |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theaggregate amount of amortization expense of the core deposit intangible assetsis as follows ($ in 000’s):
| ** **                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Amortization of  Core Deposit Intangible | ** ** | **$**    | **1,375**  |     | $          | 1,122    |       | $ | 1,072 |   |
|                                          |            |          |            |          |            |          |            |  |  |  |

 

The projected amortizationexpense for the core deposit intangible assets, assuming no furtheracquisitions or dispositions, or adjustments to current amortization rates, isapproximately $1.4 million per year over the next five years.

**8. Disclosures aboutFair Value of Financial Instruments**

Where applicable, the Company is required by GAAP todisclose the fair value of financial instruments and the methods andsignificant assumptions used to estimate those fair values. In the case offinancial instruments for which it is not practicable to estimate the fairvalue, the Company is required to disclose information pertinent to estimatingthe fair value such as interest rates and maturity, and also state the reasonswhy it is not practicable to estimate fair value.

70

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**8.Disclosures about Fair Value of Financial Instruments (Continued)**

Fair values of financial instruments depict the market’sassessment of the present value of net future cash flows directly or indirectlyembodied in them, discounted to reflect both current interest rates and themarket’s assessment of the risk that the cash flows will not occur. Theinformation about fair value is said to better enable investors, creditors, andother users to assess the consequences of an entity’s investment and financingstrategies, that is, to assess its performance.

There are several factors which users of thesefinancial statements should consider. First, there are uncertainties inherentin the process of estimating the fair value of financial instruments. Secondly,the statement covers financial instruments only, not other assets like premisesand equipment, the fair value of which might differ significantly from theamounts at which they are carried in an entity’s financial statements. Thirdly,the Company must exclude from its estimate of the fair value of depositliabilities any consideration of its ongoing customer relationships whichprovide stable sources of investable funds. Lastly, these disclosures do notaddress means of evaluating an entity’s performance in areas other than themanagement of financial instruments; for example, the ability to generatenon-interest income and the control of non-interest expense. For these reasons,users are advised not to regard the disclosure of the fair market value offinancial instruments as in any way equivalent to a valuation of the Company asa whole.

The following methods andassumptions were used to estimate the fair value of each class of financialinstruments for which it is practicable to estimate that value:

*Cash and Due fromBanks and Fed Funds Sold*

For those short-terminstruments, the carrying amount is a reasonable estimate of fair value.

*InvestmentSecurities*

For securities held asinvestments, fair value equals quoted market price, if available. If a quotedmarket price is not available, fair value is estimated using quoted marketprices for similar securities.

*Loans Held for Saleand Loans, net*

For certain homogeneous categories of loans, such assome residential mortgages, credit card receivables, and other consumer loans,fair value is estimated using the quoted market prices for securities backed bysimilar loans, adjusted for differences in loan characteristics.

The fair value of othertypes of loans is estimated by discounting the future cash flows using thecurrent rates at which similar loans would be made to borrowers with similarcredit ratings and for the same remaining maturities.

*Accrued InterestReceivable*

For accrued interestreceivable, the carrying amount is a reasonable estimate of fair value.

71

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**8.Disclosures about Fair Value of Financial Instruments (Continued)**

*Deposits*

The fair value of demanddeposits is the amount payable on demand. The fair value of fixed-maturitycertificates of deposit, savings accounts and money market deposits isestimated using the rates currently offered for deposits of similar remainingmaturities.

*Other Borrowings*

Rates currently availableto the Company for debt with similar terms and remaining maturities are used toestimate fair value of existing debt.

*Commitments toExtend Credit and Letters of Credit*

Commitments to extendcredit and letters of credit are written at current market rates. The Companydoes not anticipate any interest rate or credit factors that would affect thefair value of commitments or letters of credit outstanding at December 31,2004.

*Accrued InterestPayable*

Foraccrued interest payable, the carrying amount is a reasonable estimate of fairvalue.

Theestimated fair values of the Company’s financial instruments are as follows:
| ** **                            | ** ** | **2004**      | ** **  | **2003**      | ** ** |
|---------------------------------------|------------|---------------|-------------|---------------|------------|
| ** **                            | ** ** | **Carrying**  | ** **  | **Fair**      | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(dollars in 000’s)** | ** ** | ** **    | ** **  | **Amount**    | ** ** | **Value** | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial assets:                     |       |          |        |          |       |   |   |   |   |
| Cash and due from banks               | ** ** | **$**         | **112,669** | ** **    | **$**      | **112,669** |   | $ | 123,763 |   | $ | 123,763 |   |
| Fed funds sold                        | ** ** | **6,000**     | ** **  | **6,000**     |       | 47,500 |   | 47,500 |   |
| Investment securities                 | ** ** | **644,817**   | ** **  | **644,817**   |       | 774,679 |   | 774,679 |   |
| Loans held for sale                   | ** ** | **12,988**    | ** **  | **13,118**    |       | 13,410 |   | 13,545 |   |
| Loans, net                            | ** ** | **1,408,095** | ** **  | **1,366,160** |       | 1,138,869 |   | 1,153,972 |   |
| Accrued interest receivable           | ** ** | **11,918**    | ** **  | **11,918**    |       | 12,174 |   | 12,174 |   |
| Financial liabilities:                |       |          |        |          |       |   |   |   |   |
| Deposits                              | ** ** | **1,994,545** | ** **  | **1,991,371** |       | 1,912,431 |   | 1,908,307 |   |
| Other borrowings                      | ** ** | **6,582**     | ** **  | **6,582**     |       | 7,627 |   | 7,627 |   |
| Accrued interest  payable             | ** ** | **293**       | ** **  | **293**       |       | 274 |   | 274 |   |
|                                       |            |               |             |               |            |  |  |  |  |  |  |  |  |  |  |

 

72

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**9. Deposits**

Deposits are insured up to $100,000 per member by theFederal Deposit Insurance Corporation (FDIC). The following is a breakdown bytype and maturity at year-end of the Bank’s deposits:

December 31, 2004
| ** **                              | ** ** | **No Contractual** | ** **    | **Three Months** | ** ** | **After 3 Months,** | ** ** | **After**                  | ** **  | ** **        | ** **  |
|-----------------------------------------|------------|-------------------------|---------------|-----------------------|------------|-------------------------------|------------|----------------------------|-------------|-------------------|-------------|
| **(dollars in 000’s)**   | ** ** | ** **              | ** **    | **Maturity**          | ** ** | **or Less**              | ** ** | **to 12 Months** | ** **  | **One Year** | ** **  | **Total** | ** ** |
| Demand Deposits                         | ** ** |                    | **$**         | **517,139**           | ** ** |                          |       | **$**                      | **—**  | ** **        |        |   | **$** | **—** | ** ** |   | **$** | **—** | ** ** | **$** | **517,139** | ** ** |
| Savings, Money  Market and NOW Accounts | ** ** |                    | **1,083,139** | ** **            |       |                          | **—** | ** **                 |        |              | **—**  | ** ** |   | **—** | ** ** | **1,083,139** | ** ** |
| Time Deposits—$100,000  or more    |       |                    | **—**    | ** **            |       |                          | **83,331** | ** **                 |        |              | **69,017**  | ** ** |   | **13,947** | ** ** | **166,295** | ** ** |
| Time  Deposits—Under $100,000      |       |                    | **—**    | ** **            |       |                          | **84,477** | ** **                 |        |              | **103,005** | ** ** |   | **40,490** | ** ** | **227,972** | ** ** |
| ***Total***                             | ** ** |                    | **$**         | **1,600,278**         | ** ** |                          |       | **$**                      | **167,808** | ** **        |        |   | **$** | **172,022** | ** ** |   | **$** | **54,437** | ** ** | **$** | **1,994,545** | ** ** |
|                                         |            |                         |               |                       |            |                               |            |                            |             |                   |             |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

December 31, 2003
| ** **                              | ** ** | **No Contractual** | ** ** | **Three Months** | ** ** | **After 3 Months** | ** ** | **After**                  | ** ** | ** **        | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-----------------------|------------|------------------------------|------------|----------------------------|------------|-------------------|------------|
| **(dollars in 000’s)**   | ** ** | ** **              | ** ** | **Maturity**          | ** ** | **or Less**             | ** ** | **to 12 Months** | ** ** | **One Year** | ** ** | **Total** | ** ** |
| Demand Deposits                         |       |                    | $          | 487,624               |       |                         |       | $                          | —     |              |       |   | $ | — |   |   | $ | — |   | $ | 487,624 |   |
| Savings, Money  Market and NOW Accounts |       |                    | 1,024,207  |                  |       |                         | —     |                       |       |              | —     |   |   | — |   | 1,024,207 |   |
| Time Deposits—$100,000  or more    |       |                    | —     |                  |       |                         | 81,167     |                       |       |              | 63,161     |   |   | 11,220 |   | 155,548 |   |
| Time  Deposits—Under $100,000      |       |                    | —     |                  |       |                         | 91,818     |                       |       |              | 114,936    |   |   | 38,298 |   | 245,052 |   |
| *Total*                                 |       |                    | $          | 1,511,831             |       |                         |       | $                          | 172,985    |              |       |   | $ | 178,097 |   |   | $ | 49,518 |   | $ | 1,912,431 |   |
|                                         |            |                         |            |                       |            |                              |            |                            |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**10. Income Taxes**

The current and deferredamounts of the provision for taxes in the years ended December 31, were:
| **(dollars in 000’s)**      | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Federal:                                   |       |       |       |     |       |     |       |
| Current                                    | ** ** | **$**      | **12,395** |     | $          | 10,942   |       | $        | 10,937     |   |
| Deferred                                   | ** ** | **(553**   | **)**      | 1,285    |       | 613      |       |
| ***Total Federal Taxes***                  | ** ** | **11,842** |       | 12,227   |       | 11,550   |       |
| State:                                     |       |       |       |     |       |     |       |
| Current                                    | ** ** | **5,917**  |       | 4,958    |       | 5,693    |       |
| Deferred                                   | ** ** | **(212**   | **)**      | 529      |       | (1,351   | )          |
| ***Total State Taxes***                    | ** ** | **5,705**  |       | 5,487    |       | 4,342    |       |
| ***TOTAL  FEDERAL AND STATE TAX EXPENSE*** | ** ** | **$**      | **17,547** |     | $          | 17,714   |       | $        | 15,892     |   |

 

73

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**10.Income Taxes (Continued)**

The provision for taxes onincome differed from the amounts computed using the federal statutory rate of35 percent as follows:
| **(dollars in 000’s)**               | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Tax expense at  federal statutory tax rate          | ** ** | **$**      | **18,429** |     | $          | 17,807   |       | $        | 16,012     |   |
| State income tax  expense, net of federal benefit   | ** ** | **3,709**  |       | 3,567    |       | 2,791    |       |
| Tax savings from exempt  investment and loan income | ** ** | **(4,542** | **)**      | (3,880   | )          | (3,030   | )          |
| Other, net                                          | ** ** | **(49**    | **)**      | 220      |       | 119      |       |
| ***TOTAL  TAX EXPENSE***                            | ** ** | **$**      | **17,547** |     | $          | 17,714   |       | $        | 15,892     |   |

 

**Theprincipal items giving rise to changes in deferred taxes were:**
| **(dollars in 000’s)** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Allowance for  loan losses            | ** ** | **$**      | **826**    |     | $          | 409      |       | $        | 86         |   |
| Real estate joint  ventures           | ** ** | **(56**    | **)**      | (53      | )          | 20       |       |
| Deferred  compensation                | ** ** | **(61**    | **)**      | 5        |       | 153      |       |
| State income  taxes                   | ** ** | **(256**   | **)**      | 91       |       | (1,503   | )          |
| Capital loss  carryforward            | ** ** | **—** | ** ** | —   |       | 248      |       |
| Reversal of  valuation allowance      | ** ** | **—** | ** ** | —   |       | (248     | )          |
| Depreciation                          | ** ** | **(1,608** | **)**      | 1,011    |       | (611     | )          |
| Securities—discount  accretion   | ** ** | **(170**   | **)**      | (153     | )          | (136     | )          |
| Accrued  liabilities and other, net   | ** ** | **296**    |       | 279      |       | 1,063    |       |
| Accrued  compensation                 | ** ** | **167**    |       | (9       | )          | 125      |       |
| Credit carryovers                     | ** ** | **97**     |       | 128      |       | 65       |       |
| Purchase  accounting adjustments      | ** ** | **—** |       | 2,077    | ** ** | —   | ** ** |
| ***TOTAL  DEFERRED TAXES***           | ** ** | **$**      | **(765**   | **)**    | $          | 3,785    |       | $        | (738       | ) |

 

74

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**10.Income Taxes (Continued)**

**As of December 31, thedeferred tax assets and liabilities, which include the deferred tax asset acquiredin the Americorp transaction, are as follows:**
| **(dollars in 000’s)**                                                         | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Assets:                                                                                       |       |       |       |     |       |     |       |
| Allowance for loan losses                                                                     | ** ** | **$**      | **6,618**  |     | $          | 7,444    |       | $        | 7,853      |   |
| Gain on loan workouts                                                                         | ** ** | **167**    |       | 167      |       | 167      |       |
| Deferred compensation                                                                         | ** ** | **2,314**  |       | 2,253    |       | 2,257    |       |
| Merger related expenses                                                                       | ** ** | **226**    |       | 226      |       | 226      |       |
| State income taxes                                                                            | ** ** | **1,613**  |       | 1,357    |       | 1,449    |       |
| Depreciation and amortization                                                                 | ** ** | **381**    |       | —   | ** ** | —   | ** ** |
| Securities—discount accretion                                                            | ** ** | **470**    |       | 299      |       | 147      |       |
| Accrued compensation                                                                          |       | **—** |       | 115      |       | 107      |       |
| Credit carryovers                                                                             | ** ** | **930**    |       | 1,027    |       | 1,155    |       |
| ***Total  Assets***                                                                           | ** ** | **12,719** |       | 12,888   |       | 13,361   |       |
| Liabilities:                                                                                  |       |       |       |     |       |     |       |
| Real estate joint ventures                                                                    | ** ** | **(563**   | **)**      | (619     | )          | (672     | )          |
| Depreciation and amortization                                                                 |       | —     |       | (1,227   | )          | (216     | )          |
| Accrued Compensation                                                                          | ** ** | **(52**    | **)**      | —   |       | —   |       |
| Mark-to-market adjustment                                                                     | ** ** | **(293**   | **)**      | (293     | )          | (293     | )          |
| Accrued liabilities and other, net                                                            | ** ** | **(993**   | **)**      | (696     | )          | (419     | )          |
| Purchase accounting adjustments                                                               | ** ** | **(2,077** | **)**      | (2,077   | )          | —   |       |
| ***Total  Liabilities***                                                                      | ** ** | **(3,978** | **)**      | (4,912   | )          | (1,600   | )          |
| Valuation  Allowance                                                                          |       | **—** |       | —   | ** ** | —   | ** ** |
| Net deferred tax  asset before tax effect of unrealized gain on securities available for sale | ** ** | **8,741**  |       | 7,976    |       | 11,761   |       |
| Tax effect of  unrealized gain on securities available for sale                               | ** ** | **(4,573** | **)**      | (8,200   | )          | (8,826   | )          |
| ***DEFERRED  TAX ASSET, NET***                                                                | ** ** | **$**      | **4,168**  |     | $          | (224     | )          | $        | 2,935      |   |

 

The net deferred tax asset above is included in OtherAssets on the Consolidated Statements of Financial Position. As of December 31,2004, the Company has State tax credit carryforwards of $930,000 for financialreporting purposes. There are no alternative minimum tax credit carryforwardsfor tax purposes. As of December 31, 2004, Management of the Company hasdetermined that the net deferred tax asset meets the realizability standards ofSFAS No. 109 and as such, no valuation allowance is required as of thatdate.

75

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**11. Other Borrowings**

The Company had obtained first trust deed mortgagefinancing for properties and investments that they own. Mortgages payabletotaled $0 and $31,000 at December 31, 2004 and 2003, respectively. Otherborrowings also include borrowings under the Treasury Tax and Loan note accountof $4,582,000 and $5,595,000 at December 31, 2004 and 2003, respectively.Federal Home Loan borrowings remained at $2,000,000 for both 2004 and 2003.

The Company has unusedcommitments to borrow Federal Funds from certain correspondent banks and unusedborrowing lines from the Federal Home Loan Bank. As of December 31, 2004and 2003, these combined unused lines amounted to $109,791,000 and$103,669,000, respectively. The Company has not had to borrow under any of thesecommitments in either 2004 or 2003.

**12. Commitments andContingencies**

At December 31, 2004 and 2003, the Company wascontingently liable for letter of credit accommodations made to its customerstotaling $30,176,000 and $31,022,000, respectively. At December 31, 2004and 2003, the Company also had undisbursed loan commitments in the amount of$626,353,000 and $523,444,000, respectively.

Letters of credit are issued in connection withagreements made by customers to counterparties. Terms of these letters ofcredit are generally for one year and may or may not be collateralized byreceivables or other assets. If the customer fails to comply with theagreement, the counterparty may enforce the letter of credit as a remedy. Creditrisk arises from the possibility that the customer may not be able to repay theCompany. The notional amount of the letter of credit accommodations representsthe maximum amount of future cash payments.

Many of the commitments are expected to expire withoutbeing drawn upon. Accordingly, the total outstanding commitment amount does notnecessarily represent future cash requirements. The Company does not anticipateany significant losses as a result of these transactions. Provision has beenmade for losses which may be sustained in the fulfillment of, or from aninability to fulfill, any commitments. This provision is included in theAllowance for Losses—Unfunded Commitments on the Consolidated Statements ofFinancial Position.

The Company is involved inlitigation of a routine nature which is being handled and defended in theordinary course of the Company’s business. In the opinion of management, basedin part on the advice of legal counsel, the resolution of this litigation willnot have a material impact on the Company’s financial condition or results ofoperations.

**13. Earnings Per Share**

Earnings per share (EPS) have been computed in 2004,2003 and 2002, based on the weighted average number of shares outstanding eachyear of 23,422,000, 23,443,000, and 23,962,000, respectively.

76

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**13.Earnings Per Share (Continued)**

The following is areconciliation of the numerators and denominators used in the calculation ofbasic EPS and diluted EPS for the years ended December 31.
| ** **                                                                      | ** ** | ** ** | ** ** | **Weighted**            | ** ** | ** **      | ** ** |
|---------------------------------------------------------------------------------|------------|------------|------------|-------------------------|------------|-----------------|------------|
| ** **                                                                      | ** ** | ** ** | ** ** | **Average Shares** | ** ** | ** **      | ** ** |
| **(figures in 000’s except per share data)** | ** ** | ** ** | ** ** | **Earnings**            | ** ** | **Outstanding** | ** ** | **EPS** | ** ** |
| **2004**                                                                        | ** ** | ** ** | ** ** | ** **              | ** ** | ** **      | ** ** |
| **Basic  Earnings Per Share:**                                                  |       |       |       |                    |       |            |       |   |   |
| **Net Income available to Common Stockholders**                                 | ** ** | **$**      | **35,109** | ** **              | ** ** | **23,422**      |       | ** ** | **$** | **1.50** | ** ** |
| **Effect of Dilutive Securities:**                                              |       |       |       |                    |       |            |       |   |   |
| **Stock Options**                                                               | ** ** | ** ** |       |                    | **475**    |            |       |   |   |
| **Diluted Earnings Per Share:**                                                 |       |       |       |                    |       |            |       |   |   |
| **Net Income available to Common Stockholders and assumed  conversions**        | ** ** | **$**      | **35,109** | ** **              | ** ** | **23,897**      |       | ** ** | **$** | **1.47** | ** ** |
| **2003**                                                                        | ** ** | ** ** | ** ** | ** **              | ** ** | ** **      | ** ** | ** ** | ** ** |
| Basic Earnings  Per Share:                                                      |       |       |       |                    |       |            |       |   |   |
| Net Income available to Common Stockholders                                     |       | $          | 33,164     |                    |       | 23,443          |       |   | $ | 1.41 |   |
| Effect of Dilutive Securities:                                                  |       |       |       |                    |       |            |       |   |   |
| Stock Options                                                                   |       |       |       |                    | 319        |            |       |   |   |
| Diluted Earnings Per Share:                                                     |       |       |       |                    |       |            |       |   |   |
| Net Income available to Common Stockholders and assumed  conversions            |       | $          | 33,164     |                    |       | 23,762          |       |   | $ | 1.40 |   |
| **2002**                                                                        | ** ** |       |       |                    |       |            |       |   |   |
| Basic Earnings  Per Share:                                                      |       |       |       |                    |       |            |       |   |   |
| Net Income available to Common Stockholders                                     |       | $          | 29,855     |                    |       | 23,962          |       |   | $ | 1.25 |   |
| Effect of Dilutive Securities:                                                  |       |       |       |                    |       |            |       |   |   |
| Stock Options                                                                   |       |       |       |                    | 875        |            |       |   |   |
| Diluted Earnings Per Share:                                                     |       |       |       |                    |       |            |       |   |   |
| Net Income  available to Common Stockholders and assumed conversions            |       | $          | 29,855     |                    |       | 24,837          |       |   | $ | 1.20 |   |
|                                                                                 |            |            |            |                         |            |                 |            |  |  |  |  |  |  |

 

**14. Capital Accounts**

The Company declared cashdividends during 2004 of $13,552,000. The California Financial Code providesthat a bank may not make a cash distribution to its shareholders in excess of (1) thebank’s undivided profits or (2) the bank’s net income for its last threefiscal years less the amount of any distributions made by the bank during suchperiod. Based on these restrictions in the California Financial Code, the Bankcan make additional cash dividends totaling $29,995,000 at December 31,2004 to the Company.

**15. Stock Options**

Options are granted at a price not less than the fairmarket value of the stock at the grant date. Options are exercisable and expireas determined by the Board of Directors. However, options expire no 

77

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**15. StockOptions (Continued)**

later than ten years fromthe date of grant. The Plan provides for issuance of up to 3,000,000 shares ofcommon stock and is subject to termination as determined by the Board ofDirectors. As of December 31, 2004, 2,086,917 shares are currently underoption. The shares are exercisable at prices ranging from $5.38 to $30.61. Therewere 190,548 shares exercised during 2004 and 172,096 and 85,866 sharesexercised in 2003 and 2002, respectively.

TheBank applies Accounting Principles Board Opinion No. 25, *“Accounting for Stock Issued to Employees,”* and relatedInterpretations in accounting for its Plan. Accordingly, no compensation expensehas been recognized for grants under the Plan. Consistent with the methods ofSFAS No. 123, pro-forma compensation expense for the Plan is determinedbased on the fair value at the grant date. Fair values were estimated using theBlack-Scholes option-pricing model with the following assumptions: dividendyields ranging from 1.83% to 2.58%, expected volatility of 25%, risk-freeinterest rates ranging from 2.66%****to 3.93% andexpected lives of five years. The Bank’s net income and earnings per share forthe years ended December 31, 2004, 2003 and 2002 would have been reducedto pro forma amounts indicated below:
| **(dollars in 000’s except per share data)** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Net income to common  shareholders:                                             |       |       |       |     |       |     |       |
| As reported                                                                     | ** ** | **$**      | **35,109** |     | $          | 33,164   |       | $        | 29,855     |   |
| Pro forma                                                                       | ** ** | **$**      | **33,010** |     | $          | 31,546   |       | $        | 28,432     |   |
| Net income per common  and common share equivalent:                             |       |       |       |     |       |     |       |
| Basic earnings  per share:                                                      |       |       |       |     |       |     |       |
| As reported                                                                     | ** ** | **$**      | **1.50**   |     | $          | 1.41     |       | $        | 1.25       |   |
| Pro forma                                                                       | ** ** | **$**      | **1.41**   |     | $          | 1.35     |       | $        | 1.19       |   |
| Diluted earnings  per share:                                                    |       |       |       |     |       |     |       |
| As reported                                                                     | ** ** | **$**      | **1.47**   |     | $          | 1.40     |       | $        | 1.20       |   |
| Pro forma                                                                       | ** ** | **$**      | **1.38**   |     | $          | 1.33     |       | $        | 1.14       |   |

 

78

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**15. StockOptions (Continued)**

A summary of the Company’sstock options as of December 31, 2004, 2003 and 2002, and changes duringthe periods then ended, is presented below:
| ** **                             | ** ** | ** **                 | ** ** | **Weighted** | ** ** | ** **               | ** ** |
|----------------------------------------|------------|----------------------------|------------|--------------|------------|--------------------------|------------|
| ** **                             | ** ** | ** **                 | ** ** | **Average**  | ** ** | ** **               | ** ** |
| ** **                             | ** ** | ** **                 | ** ** | **Exercise** | ** ** | **Per Share ** | ** ** |
| ** **                             | ** ** | **Options**                | ** ** | **Price**    | ** ** | **Price Ranges**    | ** ** |
| **2004**                               |       |                       |       |         |       |                     |       |   |   |
| **Outstanding  at Beginning of Year**  | ** ** | **1,900,267**              | ** ** | ** **   | **$**      | **15.65**                |       | ** ** | **$** | **5.375-$25.79** | ** ** |
| **Granted  during Year**               | ** ** | **423,652**                | ** ** | ** **   | **$**      | **25.87**                |       | ** ** | **$** | **21.73-$30.61** | ** ** |
| **Exercised/Forfeited  during Year**   | ** ** | **(237,002**               | **)**      | ** **   | **$**      | **14.91**                |       | ** ** | **$** | **5.375-$25.71** | ** ** |
| **Outstanding  at End of Year**        | ** ** | **2,086,917**              | ** ** | ** **   | **$**      | **17.81**                |       | ** ** | **$** | **5.375-$30.61** | ** ** |
| **Exercisable  at End of Year**        | ** ** | **1,191,986**              | ** ** | ** **   | **$**      | **15.36**                |       | ** ** | **$** | **5.375-$25.79** | ** ** |
| **Range  of Expiration Dates**         | ** ** | **7/10/2008 to12/15/2014** |       |
| **Shares  Available for Future Grant** | ** ** | **207,743**                |       |         |       |                     |       |   |   |
| **2003**                               |       |                       |       |         |       |                     |       |   |   |
| Outstanding at  Beginning of Year      |       | 1,877,866                  |       |         | $          | 15.03                    |       |   | $ | 5.375-$20.05 |   |
| Granted during  Year                   |       | 257,413                    |       |         | $          | 18.61                    |       |   | $ | 16.90-$25.79 |   |
| Exercised/Forfeited  during Year       |       | (235,012                   | )          |         | $          | 13.94                    |       |   | $ | 5.375-$18.21 |   |
| Outstanding at  End of Year            |       | 1,900,267                  |       |         | $          | 15.65                    |       |   | $ | 5.375-$25.79 |   |
| Exercisable at  End of Year            |       | 1,120,705                  |       |         | $          | 14.82                    |       |   | $ | 5.375-$20.05 |   |
| **2002**                               |       |                       |       |         |       |                     |       |   |   |
| Outstanding at  Beginning of Year      |       | 1,871,514                  |       |         | $          | 14.69                    |       |   | $ | 5.375-$18.00 |   |
| Granted during  Year                   |       | 238,529                    |       |         | $          | 17.19                    |       |   | $ | 14.50-$20.05 |   |
| Exercised/Forfeited  during Year       |       | (232,177                   | )          |         | $          | 14.53                    |       |   | $ | 5.375-$18.00 |   |
| Outstanding at  End of Year            |       | 1,877,866                  |       |         | $          | 15.03                    |       |   | $ | 5.375-$20.05 |   |
| Exercisable at End of  Year            |       | 982,570                    |       |         | $          | 14.31                    |       |   | $ | 5.375-$18.00 |   |

 

A summary of the Company’sstock options outstanding and exercisable as of December 31, 2004 by pricerange is presented below:
| ** **                                  | ** ** | **Total**  | ** ** | **Weighted Average** | ** ** | ** **                 | ** ** | ** **              | ** ** | ** **                | ** ** |
|---------------------------------------------|------------|------------|------------|---------------------------|------------|----------------------------|------------|-------------------------|------------|---------------------------|------------|
| ** **                                  | ** ** | **Amount** | ** ** | **Remaining**             | ** ** | **Weighted Average**  | ** ** | **Amount**              | ** ** | **Weighted Average** | ** ** |
| **Range of Exercise Prices** | ** ** | ** ** | ** ** | **Outstanding**           | ** ** | **Contractual Years** | ** ** | **Exercise Price** | ** ** | **Exercisable**           | ** ** | **Exercise Price** | ** ** |
| $3.061 - $6.122                             |       | 38,568     |       |                      | 1.5        |                       |       |                    | $          | 5.375                     |       |   | 38,568 |   |   | $ | 5.375 |   |   |
| $6.123 - $9.183                             |       | —     |       |                      | —     |                       |       |                    | —     |                      |       | — |   |   | — |   |   |
| $9.184 - $12.244                            |       | 12,000     |       |                      | 5.3        |                       |       |                    | $          | 12.125                    |       |   | 9,600 |   |   | $ | 12.125 |   |   |
| $12.245 - $15.305                           |       | 673,069    |       |                      | 4.7        |                       |       |                    | $          | 14.477                    |       |   | 571,785 |   |   | $ | 14.514 |   |   |
| $15.306 - $18.366                           |       | 879,782    |       |                      | 6.0        |                       |       |                    | $          | 16.856                    |       |   | 555,033 |   |   | $ | 16.796 |   |   |
| $18.367 - $21.427                           |       | 28,800     |       |                      | 7.8        |                       |       |                    | $          | 19.314                    |       |   | 8,800 |   |   | $ | 19.159 |   |   |
| $21.428 - $24.488                           |       | 81,000     |       |                      | 9.2        |                       |       |                    | $          | 22.752                    |       |   | 5,200 |   |   | $ | 22.749 |   |   |
| $24.489 - $27.549                           |       | 319,698    |       |                      | 9.4        |                       |       |                    | $          | 25.767                    |       |   | 3,000 |   |   | $ | 25.731 |   |   |
| $27.550 - $30.610                           |       | 54,000     |       |                      | 9.9        |                       |       |                    | $          | 29.873                    |       |   | — |   |   | — |   |   |
| Total                                       |       | 2,086,917  |       |                      | 6.3        |                       |       |                    | $          | 17.814                    |       |   | 1,191,986 |   |   | $ | 15.360 |   |   |
|                                             |            |            |            |                           |            |                            |            |                         |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

79

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**16. Employee Benefits**

The Company offers a combination qualified profitsharing plan (the “Profit Sharing Plan”) and a savings and retirement plandesigned to comply with Internal Revenue Service Code Section 401(k) (the“401(k) Plan”) to substantially all employees. The Company’s contributionsto the Profit Sharing and 401(k) Plans for the years ended December 31,2004, 2003, and 2002 were $2,842,000, $2,665,000, and $2,291,000, respectively.

A bonus is paid to selected employees who exceedcertain goals under formulas established at the start of the year. Included inemployee benefits expense for 2004, 2003 and 2002 was a charge of $2,400,000,$3,400,000, and $1,772,000, respectively, which was accrued during those yearsand paid in the following year under the Incentive Reward System. Employeesreceiving bonuses under this program in 2004 ranged from 0.70% of their salaryto as much as 31.6% of their salary.

The Company haspostretirement obligations to certain of the former employees of acquiredinstitutions. The liability for these obligations is included within OtherLiabilities on the consolidated statement of financial position and amounted to$1,371,000 and $1,319,000 at December 31, 2004 and 2003, respectively. Theamount of employee benefit expense accrued under these obligations amounted to$145,000, $61,000 and $44,000 in 2004, 2003, and 2002, respectively. Generally,these obligations amount to a fixed payment to these individuals for 10 to 15years upon reaching their defined retirement age.

**17. Regulatory Matters**

The Company is subject to various regulatory capitalrequirements administered by the federal banking agencies. Failure to meetminimum capital requirements can initiate certain mandatory—and possiblyadditional discretionary—actions by regulators that, if undertaken, could havea direct material effect on the Company’s financial statements. Under capitaladequacy guidelines and the regulatory framework for prompt corrective action,the Company must meet specific capital guidelines that involve quantitativemeasures of the Company’s assets, liabilities, and certain off-balance sheetitems as calculated under regulatory accounting practices. The Company’scapital amounts and classifications are also subject to qualitative judgmentsby the regulators about components, risk weightings, and other factors.

As of December 31, 2004, the latest regulatoryexaminations indicated that, Mid-State Bancshares and Mid-State Bank &Trust were categorized as well capitalized under the regulatory framework forprompt corrective action. To be categorized as well capitalized, Mid-StateBancshares and Mid-State Bank & Trust must maintain minimum totalrisk-based, Tier One risk-based and Tier One Leverage ratios as set forth inthe following table. There are no conditions or events that Management believeshave changed Mid-State

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**17.Regulatory Matters (Continued)**

Bancshares’ and Mid-State Bank & Trust’scategory. The actual capital amounts and ratios as of December 31, 2004and 2003 are also presented in the following table:
| ** **                                       | ** ** | ** ** | ** **  | ** **                 | ** ** | **To be Considered**  | ** ** | **To be Considered**                 | ** ** |
|--------------------------------------------------|------------|------------|-------------|----------------------------|------------|---------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | ** ** | ** **  | ** **                 | ** ** | **Adequately Capitalized** | ** ** | **Well Capitalized**                      | ** ** |
| ** **                                       | ** ** | ** ** | ** **  | ** **                 | ** ** | **For Capital**            | ** ** | **For Capital**                           | ** ** |
| ** **                                       | ** ** | **Actual** | ** **  | **Adequacy Purposes** | ** ** | **Adequacy Purposes**      | ** ** |
| **(dollars in 000’s)**            | ** ** | ** ** | ** **  | **Amount**                 | ** ** | **Ratio**                       | ** ** | **   Amount   ** | ** ** | **   Ratio   ** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ***Mid-State  Bancshares—Consolidated:***   |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| As of December 31, 2004:                    |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| Total Capital                                    |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Risk Weighted  Assets)                       | ** ** | **$**      | **227,549** | ** **                 | **13.0**   | **%**                           | **$**      | **140,209**                                    | ** ** | ** ** | **8.0** | **%** | ** ** | **$** | **175,261** | ** ** | **10.0** | **%** |
| Tier One Capital                                 |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Risk Weighted  Assets)                       | ** ** | **$**      | **211,967** | ** **                 | **12.1**   | **%**                           | **$**      | **70,105**                                     | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **105,157** | ** ** | **6.0** | **%** |
| Tier One Capital                                 |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Average  Assets)                             | ** ** | **$**      | **211,967** | ** **                 | **9.3**    | **%**                           | **$**      | **90,983**                                     | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **113,728** | ** ** | **5.0** | **%** |
| As of December 31, 2003:                    |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| Total Capital                                    |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Risk Weighted  Assets)                       |       | $          | 221,118     |                       | 15.0       | %                               | $          | 118,119                                        |       |   | 8.0 | **%** |   | $ | 147,648 |   | 10.0 | % |
| Tier One Capital                                 |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Risk Weighted  Assets)                       |       | $          | 203,114     |                       | 13.8       | %                               | $          | 59,059                                         |       |   | 4.0 | **%** |   | $ | 88,589 |   | 6.0 | % |
| Tier One Capital                                 |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Average Assets)                              |       | $          | 203,114     |                       | 9.6        | %                               | $          | 84,562                                         |       |   | 4.0 | **%** |   | $ | 105,702 |   | 5.0 | % |
| ***Mid-State Bank & Trust—Only:*** |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| As of December 31, 2004:                    |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| Total Capital                                    |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Risk Weighted  Assets)                       | ** ** | **$**      | **225,921** | ** **                 | **12.9**   | **%**                           | **$**      | **140,209**                                    | ** ** | ** ** | **8.0** | **%** | ** ** | **$** | **175,261** | ** ** | **10.0** | **%** |
| Tier One Capital                                 |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Risk Weighted  Assets)                       | ** ** | **$**      | **210,339** | ** **                 | **12.0**   | **%**                           | **$**      | **70,104**                                     | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **105,157** | ** ** | **6.0** | **%** |
| Tier One Capital                                 |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Average  Assets)                             | ** ** | **$**      | **210,339** | ** **                 | **9.2**    | **%**                           | **$**      | **91,018**                                     | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **113,772** | ** ** | **5.0** | **%** |
| As of December 31, 2003:                    |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| Total Capital                                    |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Risk Weighted  Assets)                       |       | $          | 217,268     |                       | 14.7       | %                               | $          | 118,119                                        |       |   | 8.0 | **%** |   | $ | 147,648 |   | 10.0 | % |
| Tier One Capital                                 |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Risk Weighted  Assets)                       |       | $          | 199,264     |                       | 13.5       | %                               | $          | 59,059                                         |       |   | 4.0 | **%** |   | $ | 88,589 |   | 6.0 | % |
| Tier One Capital                                 |       |       |        |                       |       |                            |       |                                           |       | ** ** |   |   |   |   |   |
| (to Average Assets)                              |       | $          | 199,264     |                       | 9.4        | %                               | $          | 84,578                                         |       |   | 4.0 | **%** |   | $ | 105,723 |   | 5.0 | % |
|                                                  |            |            |             |                            |            |                                 |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |

 

**18. Reportable BusinessSegments**

Reportable business segments are determined using the “managementapproach” and are intended to present reportable segments consistent with howthe chief operating decision maker organizes segments

81

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**18.Reportable Business Segments (Continued)**

within the company formaking operating decisions and assessing performance. Presently, the Company issegregated into three reportable business segments, Community Banking, MidCoast Land Company and Trust Services.

The Community Banking business segment consists ofcommercial and retail banking. This segment is managed as a single strategicunit that derives its revenues from a wide range of banking services, includinglending and investing activities, acceptance of demand, savings, and timedeposits, and mortgage servicing. As previously noted, Mid Coast Land Companyengages in real estate investment activities. Trust Services provides custodyservices, investment management and trust-related services such as trustee fortrust accounts, estate settlement services, guardianships and conservatorships.

Belowis a summary statement of income and certain selected financial data for eachof the three years ended December 31, 2004. The accounting policies usedin the disclosure of business segments are the same as those described in thesummary of significant accounting policies. Certain assumptions are madeconcerning the allocations of costs between segments which may influencerelative results, most notably, allocations of various types of overhead andadministrative costs. Management believes that the allocations utilized beloware reasonable and consistent with the way it manages the business.
| ** **                            | ** ** | **Community Banking** | ** ** | **Mid Coast Land Company** | ** ** | **Trust Services** | ** ** |
|---------------------------------------|------------|----------------------------|------------|-------------------------------------------|------------|-------------------------|------------|
| **(dollars in 000’s)** | ** ** | ** **                 | ** ** | **2004**                                  | ** ** | **2003**                | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Interest Income                       |       | $                          | 109,936    |                                      | $          | 105,239                 |       | $ | 109,318 |   | $ | — |   | $ | 1 |   | $ | 14 |   | $ | — |   | $ | — |   | $ | — |   |
| Interest Expense                      |       | 8,450                      |       | 9,699                                     |       | 16,381                  |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Net Interest Income                   |       | 101,486                    |       | 95,540                                    |       | 92,937                  |       | — |   | 1 |   | 14 |   | — |   | — |   | — |   |
| (Benefit) Provision                   |       | (2,700                     | )          | (969                                      | )          | 600                     |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Non Interest Income                   |       | 26,153                     |       | 27,715                                    |       | 23,872                  |       | 682 |   | 678 |   | 68 |   | 929 |   | 666 |   | 381 |   |
| Non Interest Expense                  |       | 78,391                     |       | 73,735                                    |       | 70,110                  |       | 27 |   | 123 |   | 206 |   | 876 |   | 833 |   | 609 |   |
| Pre-Tax Income                        |       | $                          | 51,948     |                                      | $          | 50,489                  |       | $ | 46,099 |   | $ | 655 |   | $ | 556 |   | $ | (124 | ) | $ | 53 |   | $ | (167 | ) | $ | (228 | ) |
| Ending  Total Assets                  |       |                       |       |                                      |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (in millions)                         |       | $                          | 2,285      |                                      | $          | 2,199                   |       | $ | 1,925 |   | $ | 11 |   | $ | 10 |   | $ | 10 |   | $ | — |   | $ | — |   | $ | — |   |
|                                       |            |                            |            |                                           |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                    | ** ** | **Mid-State Bancshares** | ** ** |
|-------------------------------|------------|--------------------------|------------|
| ** **                    | ** ** | **2004**                 | ** ** | **2003** | ** ** | **2002** | ** ** |
| Interest Income               |       | $                        | 109,936    |   | $ | 105,240 |   | $ | 109,332 |   |
| Interest Expense              |       | 8,450                    |       | 9,699 |   | 16,381 |   |
| Net Interest Income           |       | 101,486                  |       | 95,541 |   | 92,951 |   |
| (Benefit) Provision           |       | (2,700                   | )          | (969 | ) | 600 |   |
| Non Interest Income           |       | 27,764                   |       | 29,059 |   | 24,321 |   |
| Non Interest Expense          |       | 79,294                   |       | 74,691 |   | 70,925 |   |
| Pre-Tax Income                |       | $                        | 52,656     |   | $ | 50,878 |   | $ | 45,747 |   |
| Ending  Assets  (in millions) |       | $                        | 2,296      |   | $ | 2,209 |   | $ | 1,935 |   |

 

82

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**19. Quarterly FinancialData**

Thefollowing table presents condensed consolidated statements of income for eachof the quarters covering the past two years (unaudited—in 000’s):
| ** **                 | ** ** | **2004**             | ** ** |
|----------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** | **Full Year** | ** ** |
| Interest Income            | ** ** |                 | **$**      | **26,237** | ** ** |   |   | **$** | **26,620** | ** ** |   |   | **$** | **28,236** | ** ** |   |   | **$** | **28,843** | ** ** |   | **$** | **109,936** | ** ** |
| Interest Expense           | ** ** |                 | **2,076**  | ** ** |   |   | **1,990** | ** ** |   |   | **2,083** | ** ** |   |   | **2,301** | ** ** |   | **8,450** | ** ** |
| Net Interest Income        | ** ** |                 | **24,161** | ** ** |   |   | **24,630** | ** ** |   |   | **26,153** | ** ** |   |   | **26,542** | ** ** |   | **101,486** | ** ** |
| Provision for  loan losses |       |                 | **—** | ** ** |   |   | **(2,700** | **)** |   |   | **—** | ** ** |   |   | **—** | ** ** |   | **(2,700** | **)** |
| Non-interest  income       | ** ** |                 | **7,000**  | ** ** |   |   | **7,910** | ** ** |   |   | **7,250** | ** ** |   |   | **5,604** | ** ** |   | **27,764** | ** ** |
| Non-interest  expense      | ** ** |                 | **19,694** | ** ** |   |   | **20,877** | ** ** |   |   | **20,265** | ** ** |   |   | **18,458** | ** ** |   | **79,294** | ** ** |
| Income before taxes        | ** ** |                 | **11,467** | ** ** |   |   | **14,363** | ** ** |   |   | **13,138** | ** ** |   |   | **13,688** | ** ** |   | **52,656** | ** ** |
| **Taxes**                  | ** ** |                 | **3,802**  | ** ** |   |   | **4,990** | ** ** |   |   | **4,465** | ** ** |   |   | **4,290** | ** ** |   | **17,547** | ** ** |
| Net Income                 | ** ** |                 | **$**      | **7,665** | ** ** |   |   | **$** | **9,373** | ** ** |   |   | **$** | **8,673** | ** ** |   |   | **$** | **9,398** | ** ** |   | **$** | **35,109** | ** ** |
| Earnings Per  Share:       |       |                 |       | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   |   |
| —Basic                | ** ** |                 | **$**      | **0.33** | ** ** |   |   | **$** | **0.40** | ** ** |   |   | **$** | **0.37** | ** ** |   |   | **$** | **0.41** | ** ** |   | **$** | **1.50** | ** ** |
| —Diluted              | ** ** |                 | **$**      | **0.32** | ** ** |   |   | **$** | **0.39** | ** ** |   |   | **$** | **0.36** | ** ** |   |   | **$** | **0.40** | ** ** |   | **$** | **1.47** | ** ** |

 
| ** **                 | ** ** | **2003**             | ** ** |
|----------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** | **Full Year** | ** ** |
| Interest Income            |       |                 | $          | 25,865 |   |   |   | $ | 26,207 |   |   |   | $ | 26,643 |   |   |   | $ | 26,525 |   |   | $ | 105,240 |   |
| Interest Expense           |       |                 | 2,834      |   |   |   | 2,568 |   |   |   | 2,157 |   |   |   | 2,140 |   |   | 9,699 |   |
| Net Interest Income        |       |                 | 23,031     |   |   |   | 23,639 |   |   |   | 24,486 |   |   |   | 24,385 |   |   | 95,541 |   |
| Provision for  loan losses |       |                 | 110        |   |   |   | 150 |   |   |   | — |   |   |   | (1,229 | ) |   | (969 | ) |
| Non-interest  income       |       |                 | 6,914      |   |   |   | 7,484 |   |   |   | 7,838 |   |   |   | 6,823 |   |   | 29,059 |   |
| Non-interest  expense      |       |                 | 18,375     |   |   |   | 18,026 |   |   |   | 18,589 |   |   |   | 19,701 |   |   | 74,691 |   |
| Income before taxes        |       |                 | 11,460     |   |   |   | 12,947 |   |   |   | 13,735 |   |   |   | 12,736 |   |   | 50,878 |   |
| Taxes                      |       |                 | 4,017      |   |   |   | 4,587 |   |   |   | 4,760 |   |   |   | 4,350 |   |   | 17,714 |   |
| Net Income                 |       |                 | $          | 7,443 |   |   |   | $ | 8,360 |   |   |   | $ | 8,975 |   |   |   | $ | 8,386 |   |   | $ | 33,164 |   |
| Earnings Per  Share:       |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| —Basic                |       |                 | $          | 0.32 |   |   |   | $ | 0.36 |   |   |   | $ | 0.39 |   |   |   | $ | 0.36 |   |   | $ | 1.41 |   |
| —Diluted              |       |                 | $          | 0.30 |   |   |   | $ | 0.34 |   |   |   | $ | 0.37 |   |   |   | $ | 0.35 |   |   | $ | 1.40 |   |

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**20. Parent CompanyFinancial Information**

Condensed financialinformation of Mid-State Bancshares (parent only) follows:

***Condensed BalanceSheets***
| ** **                                       | ** ** | **December 31,** | ** **  |
|--------------------------------------------------|------------|-----------------------|-------------|
| **(dollars in 000’s)**            | ** ** | ** **            | ** **  | **2004** | ** ** | **2003** | ** ** |
| ASSETS                                           |       |                  |        |   |   |
| Cash                                             | ** ** | **$**                 | **1,292**   |   | $ | 3,317 |   |
| Investment in  Mid-State Bank & Trust   | ** ** | **276,694**           |        | 271,767 |   |
| Other Assets                                     | ** ** | **5**                 |        | — |   |
| Total Assets                                     | ** ** | **$**                 | **277,991** |   | $ | 275,084 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY        |       |                  |        |   |   |
| Dividend Payable                                 | ** ** | **$**                 | **3,696**   |   | $ | 3,062 |   |
| Accrued  Liabilities                             | ** ** | **(331**              | **)**       | (532 | ) |
| Total Liabilities                                | ** ** | **3,365**             |        | 2,530 |   |
| Stockholders’ Equity                        | ** ** | **274,626**           |        | 272,554 |   |
| Total Liabilities  and Stockholders’ Equity | ** ** | **$**                 | **277,991** |   | $ | 275,084 |   |
|                                                  |            |                       |             |  |  |  |  |  |  |

 

***Condensed IncomeStatements***
| ** **                           | ** ** | **December 31,**                                    | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                           | ** ** | **    2004    ** | ** ** | **    2003    ** | ** ** | **    2002    ** | ** ** |
| Equity in earnings of  subsidiaries: |       |                                                     |       |   |   |   |   |
| Undistributed                        | ** ** | **$**                                                    | **10,345** |   | $ | 7,348 |   | $ | 13,589 |   |
| Dividends                            | ** ** | **25,222**                                               |       | 26,245 |   | 16,607 |   |
| Operating Expenses                   | ** ** | **(789**                                                 | **)**      | (739 | ) | (563 | ) |
| Income Tax Benefit                   | ** ** | **331**                                                  |       | 310 |   | 222 |   |
| Net Income                           | ** ** | **$**                                                    | **35,109** |   | $ | 33,164 |   | $ | 29,855 |   |

                                                                                                

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004**

**20.Parent Company Financial Information (Continued)**

***CondensedStatements of Cash Flows***
| ** **                                                                         | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from  operation activities:                                             |       |                  |       |   |   |   |   |
| Net Income                                                                         | ** ** | **$**                 | **35,109** |   | $ | 33,164 |   | $ | 29,855 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                  |       |   |   |   |   |
| Net undistributed earnings of Bank                                                 | ** ** | **(10,345**           | **)**      | (7,348 | ) | (13,589 | ) |
| Net change in accrued liabilities                                                  | ** ** | **201**               |       | (310 | ) | (48 | ) |
| Net change in other assets                                                         | ** ** | **(5**                | **)**      | — |   | 5 |   |
| Net cash provided by operating activities                                          | ** ** | **24,960**            |       | 25,506 |   | 16,223 |   |
| Net Cash Flow from Investing Activities                                            | ** ** | **—**            | ** ** | — | ** ** | — | ** ** |
| Net Cash Flows  from Financing Activities:                                         |       |                  |       |   |   |   |   |
| Proceeds from stock options                                                        | ** ** | **2,579**             |       | 2,284 |   | 1,102 |   |
| Payment to purchase common stock                                                   | ** ** | **(16,646**           | **)**      | (16,212 | ) | (8,386 | ) |
| Dividends paid by parent                                                           | ** ** | **(12,918**           | **)**      | (11,246 | ) | (9,607 | ) |
| Other                                                                              | ** ** | **—**            | ** ** | — | ** ** | — | ** ** |
| Net cash used in financing activities                                              | ** ** | **(26,985**           | **)**      | (25,174 | ) | (16,891 | ) |
| Net Increase (Decrease) in Cash                                                    | ** ** | **(2,025**            | **)**      | 332 |   | (668 | ) |
| Cash, beginning  of year                                                           | ** ** | **3,317**             |       | 2,985 |   | 3,653 |   |
| Cash, at end of  year                                                              | ** ** | **$**                 | **1,292**  |   | $ | 3,317 |   | $ | 2,985 |   |

 

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**ITEM 9**.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE

Not applicable.

**ITEM 9A**.CONTROLS AND PROCEDURES

In accordance with Rule 13a-15(b) ofthe Exchange Act, as of the end of the year ended December 31, 2004, wecarried out an evaluation under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures as defined in Rule 13a-15 (e) and 15d-15(e) underthe Exchange Act. Based on that evaluation, our Chief Executive Officer andChief Financial Officer have concluded that our disclosure controls andprocedures are effective.

During the quarter ended December 31, 2004, therehave been no changes in our internal controls over financial reporting that hasmaterially affected, or are reasonably likely to materially affect, thesecontrols.

There are inherent limitations in the effectiveness ofany system of internal control, including the possibility of human error andthe circumvention or overriding of controls. Accordingly, even an effectiveinternal control system can provide only reasonable assurance with respect tofinancial statement preparation. Further, because of changes in conditions, theeffectiveness of an internal control system may vary over time.

In connection with our SOX 404 compliance efforts, wehave invested significant resources in documenting, analyzing and testing ourinternal controls. As necessary, we have taken, and currently continue to takeactions to remediate control gaps identified including additional informationtechnology controls, improved segregation of duties, predominantly in oursmaller departments, further formalization of our controllership guide,extensive training on generally accepted accounting principles and internalcontrols and enhanced monitoring controls. We are committed to ongoingassessments of our controls and their effectiveness, the results of which willbe reported to our shareholders.

Additionally, under thesupervision and with the participation of management, including the Company’sChief Executive Officer and Chief Financial Officer, the Company conducted anevaluation of the effectiveness of our internal control over financialreporting as of December 31, 2004 based on the framework in “InternalControl—Integrated Framework” issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based upon that evaluation,management concluded that our internal control over financial reporting waseffective as of December 31, 2004. Management’s report on internal controlover financial reporting is set forth on page 50 of Item 8 of  thisreport on Form 10-K, and is incorporated herein by reference. Management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting has been audited by PricewaterhouseCoopers LLP, anindependent, registered public accounting firm, as stated in its report, whichis set forth on page 51 of Item 8 of this Form 10-K and is also incorporated herein by reference.

**ITEM 9B**.OTHER INFORMATION

Not Applicable.

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**PART III**

**ITEM 10**.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Theinformation required by Item 10 of Form 10-K is incorporated byreference from the information contained in the Bank’s Proxy Statement for the2005 Annual Meeting of Shareholders which will be filed pursuant to Regulation14A.

**Code of Conduct**

The Board has adopted acomprehensive code of conduct reflecting its policies. Our code of conduct ispublished on the Investor Information section of our website at *www.midstatebank.com*. Any change to or waiver of the code ofconduct (other than technical, administrative, and other non-substantivechanges) will be posted on our website or reported on a Form 8-Kfiled with the Securities and Exchange Commission. While the Board may considera waiver for an executive officer or director, we do not expect to grant suchwaivers.

**ITEM 11**.EXECUTIVE COMPENSATION

The information requiredby Item 11 of Form 10-K is incorporated by reference from theinformation contained in the Bank’s Proxy Statement for the 2005 Annual Meetingof Shareholders which will be filed pursuant to Regulation 14A.

**ITEM 12**.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information requiredby Item 12 of Form 10-K is incorporated by reference from theinformation contained in the Bank’s Proxy Statement for the 2005 Annual Meetingof Shareholders which will be filed pursuant to Regulation 14A.

**ITEM 13**.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information requiredby Item 13 of Form 10-K is incorporated by reference from theinformation contained in the Bank’s Proxy Statement for the 2005 Annual Meetingof Shareholders which will be filed pursuant to Regulation 14A.

**ITEM 14**.PRINCIPAL ACCOUNTING FEES AND SERVICES

The information requiredby Item 14 of Form 10-K is incorporated by reference from theinformation contained in the Bank’s Proxy Statement for the 2005 Annual Meetingof Shareholders which will be filed pursuant to Regulation 14A.

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**PART IV**

**ITEM 15**.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

**(a)****          Exhibits:**
|             | ** ** | ** **            | ** **                                                                                                                                 | **Sequentially** |
|-------------|------------|-----------------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------------|
| **Exhibit** | ** ** | ** **            | ** **                                                                                                                                 | **Numbered**     |
| **Number**  | ** ** | **Index to Exhibits** | ** **                                                                                                                                 | **Pages**        |
| 3.1         |       |                  | Articles of Incorporation, as amended(1)                                                                                                   |             |   |
| 3.2         |       |                  | Bylaws of Registrant(2)                                                                                                                    |             |   |
| 4.1         |       |                  | Specimen Certificate evidencing shares of Mid-State  Bancshares Common Stock(3)                                                            |             |   |
| 10.1        |       |                  | Mid-State Bancshares 1996 Stock Option Plan, form of  Stock Option Agreement and form of Substitute Stock Option Agreement, as  amended(4) |             |   |
| 10.2        |       |                  | Deferred Compensation Plan, and as further amended  on January 9, 2002(6)                                                             |             |   |
| 10.3        |       |                  | Profit Sharing and Salary Deferral 401(K) Plan(5)                                                                                     |             |   |
| 10.4        |       |                  | Change in Control Agreement for Carrol R. Pruett, as  amended(6)                                                                           |             |   |
| 10.5        |       |                  | Change in Control Agreement for James G. Stathos(6)                                                                                        |             |   |
| 10.6        |       |                  | Change in Control Agreement for James W. Lokey(6)                                                                                          |             |   |
| 10.7        |       |                  | 2001 Deferred Compensation Plan(6)                                                                                                         |             |   |
| 10.8        |       |                  | Change in Control Agreement for Harry H. Sackrider(7)                                                                                      |             |   |
| 21          |       |                  | Subsidiary of Mid-State Bancshares—Mid-State  Bank & Trust is the only subsidiary                                            |             |   |
| 23.1        |       |                  | Consent of Accountants—PricewaterhouseCoopers LLP                                                                                     |             |   |
| 31.1        |       |                  | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a)                                                                  |             |   |
| 31.2        |       |                  | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a)                                                                  |             |   |
| 32          |       |                  | Certification Pursuant to Section 906 of  Sarbanes-Oxley Act of 2002                                                                  |             |   |

----

(1)          Filedas part of the Registrant’s Form 10-K for the year ended December 31, 1998.

(2)          Filed as an exhibit toRegistrant’s Registration Statement (File No. 333-16952) filed on November 27,1996.

(3)          Filed as part of theRegistrant’s Registration Statement on Form S-4 (File No. 333-48181) filed onMarch 18, 1998.

(4)          As filed by Registranton Form S-8 (File No. 333-38584) on June 5, 2000.

(6)**         **Filedas part of the Registrant’s Form 10-K for the year ended December 31, 2001.

(5)          Filed as part of theRegistrant’s Form 10-K for the year ended December 31, 1998.

(6)          Filed as part of theRegistrant’s Form 10-K for the year ended December 31, 2001.

(7)          Filed as part of theRegistrant’s Form 10-K for the year ended December 31, 2002.

**(b)****          Schedules:**

Not Applicable

88

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**SIGNATURES**

Inaccordance with Section 13 or 15(d) of the Securities Exchange Act of1934, the Bank has caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|        | MID-STATE BANCHSARES                     |
|--------|------------------------------------------|
|   | By:                                      | /s/  JAMES W. LOKEY |
|   |                                     | JAMES W. LOKEY |
|   | *President  and Chief Executive Officer* |
|   | *[Principal  Executive Officer]*         |
|   | Dated:                                   | March 15, 2005 |
|        |                                          |  |  |

 
|        | By                                              | /s/  JAMES G. STATHOS |
|--------|-------------------------------------------------|-----------------------|
|   |                                            | JAMES G. STATHOS      |
|   | *Executive  Vice President*                     |
|   | *and  Chief Financial Officer*                  |
|   | *[Principal  Financial and Accounting Officer]* |
|   | Dated:                                          | March 15, 2005   |
|        |                                                 |                       |  |

 

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**SIGNATURES**

Inaccordance with the Securities Exchange Act of 1934, this report has beensigned by the following persons on behalf of the Bank and in the capacities andon the dates indicated.
|                            | ** ** | ** **            | ** ** | ** **           | **Dated:** | ** ** |
|----------------------------|------------|-----------------------|------------|----------------------|------------|------------|
| /s/ CARROL R. PRUETT       |       | Chairman of the Board |       | March 15,  2005 |
| CARROL R. PRUETT           |       |                  |
| /s/  GEORGE H. ANDREWS     |       | Director              |       | March 15,  2005 |
| GEORGE H. ANDREWS          |       |                  |
| /s/  TRUDI CAREY           |       | Director              |       | March 15,  2005 |
| TRUDI CAREY                |       |                  |
| /s/  DARYL L. FLOOD        |       | Director              |       | March 15,  2005 |
| DARYL L. FLOOD             |       |                  |
| /s/  H. EDWARD HERON       |       | Director              |       | March 15,  2005 |
| H. EDWARD HERON            |       |                  |
| /s/  ROBERT J. LAGOMARSINO |       | Director              |       | March 15,  2005 |
| ROBERT J.  LAGOMARSINO     |       |                  |
| /s/ JAMES  W. LOKEY        |       | Director              |       | March 15,  2005 |
| JAMES W. LOKEY             |       |                  |
| /s/  STEPHEN P. MAGUIRE    |       | Director              |       | March 15,  2005 |
| STEPHEN P.  MAGUIRE        |       |                  |
| /s/  MICHAEL L. MINER      |       | Director              |       | March 15,  2005 |
| MICHAEL L. MINER           |       |                  |
| /s/  GREGORY R. MORRIS     |       | Director              |       | March 15,  2005 |
| GREGORY R. MORRIS          |       |                  |
| /s/  ALAN RAINS            |       | Director              |       | March 15,  2005 |
| ALAN RAINS                 |       |                  |
| /s/  WILLIAM L. SNELLING   |       | Director              |       | March 15,  2005 |
| WILLIAM L.  SNELLING       |       |                  |

 

90

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**EXHIBITINDEX**
| Exhibit  Number | ** ** | ** **                                                                                                                         | ** ** | **Description** |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 23.1            |       | Consent of  Accountants—PricewaterhouseCoopers LLP                                                                            |
| 31.1            |       | Certification of Chief  Executive Officer pursuant to Rule 13a-14(a)                                                          |
| 31.2            |       | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a)                                                          |
| 32              |       | Certification Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 |

 

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