**UNITED STATES**

**SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20529**

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**FORM 10-K**

**(MarkOne)**

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

**For the fiscal yearended December 31, 2005**

**or**

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

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

**Commission file number 000-23925**

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**MID-STATEBANCSHARES**

(Exact name of registrant as specified in its charter)

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

 

**(805) 473-6829**

(Registrant’s telephone number, including area code)

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

None

Securitiesregistered pursuant to Section 12(g) of the Act:

**Common Stock**

**(no par value)**

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Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRole 405 of the Securities Act.   Yes o   No x

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or 15(d) of the Act.   Yes  o   No x

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or shorter period that the Registrant wasrequired to file such reports)   Yes  x    No o, and (2) has been subject to such filing requirementsfor the past 90 days.   Yes  x    No o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

Indicate by check mark whether the registrant is a largeaccelerated filer, accelerated filer, or a non-accelerated filer (as defined inExchange Act Rule 12b-2).  Large accelerated filer o   acceleratedfiler x   non-acceleratedfiler o

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Act.).   Yes  o    No  x

Theaggregate market value of the common stock held by non-affiliates of theregistrant as of June 30, 2005 was $601,176,762.

Thenumber of shares of common stock of the registrant outstanding as of March 3,2006 was 22,431,314.

Thefollowing documents are incorporated by reference herein:  Part III, Items 10 through 14 areincorporated from Registrant’s definitive proxy statement for the 2006 AnnualMeeting of Shareholders.

This annual report on Form 10Kis 103 pages long including the signature pages, certifications andconsent.

 

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**TABLE OF CONTENTS**

|            | ** ** | ** **                                                                                                         | ** **   | **Page** | ** **   |
|------------|------------|--------------------------------------------------------------------------------------------------------------------|--------------|----------|--------------|
| ** ** | ** ** | ** **                                                                                                         | ** **   |     | ** **   | ** ** |   |
| ** ** | ** ** | **PART I**                                                                                                    | ** **   |     | ** **   | ** ** |   |
| ITEM 1.    |       | BUSINESS                                                                                                           |         |     | 1            | ** ** |   |
| ITEM 1A.   |       | RISK FACTORS                                                                                                       |         |     | 18           | ** ** |   |
| ITEM 1B.   |       | UNRESOLVED STAFF COMMENTS                                                                                          |         |     | 24           | ** ** |   |
| ITEM 2.    |       | PROPERTIES                                                                                                         |         |     | 25           | ** ** |   |
| ITEM 3.    |       | LEGAL PROCEEDINGS                                                                                                  |         |     | 27           | ** ** |   |
| ITEM 4.    |       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |         |     | 27           | ** ** |   |
| ** ** | ** ** | **PART II**                                                                                                   | ** **   |     | ** **   | ** ** |   |
| ITEM 5.    |       | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |         |     | 28           | ** ** |   |
| ITEM  6.   |       | SELECTED  FINANCIAL DATA                                                                                           |         |     | 32           | ** ** |   |
| ITEM 7.    |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                        |         |     | 33           | ** ** |   |
| ITEM 7A.   |       | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET  RISK                                                         |         |     | 55           | ** ** |   |
| ITEM 8 .   |       | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                        |         |     | 56           | ** ** |   |
| ITEM 9.    |       | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE                              |         |     | 94           | ** ** |   |
| ITEM 9A.   |       | CONTROLS AND PROCEDURES                                                                                            |         |     | 94           | ** ** |   |
| ITEM  9B.  |       | OTHER  INFORMATION                                                                                                 |         |     | 94           | ** ** |   |
| ** ** | ** ** | **PART III**                                                                                                  | *** *** | * * | *** *** | ** ** |   |
| ITEM 10.   |       | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                 |         |     | 95           | ** ** |   |
| ITEM 11.   |       | EXECUTIVE COMPENSATION                                                                                             |         |     | 95           | ** ** |   |
| ITEM 12.   |       | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS                    |         |     | 95           | ** ** |   |
| ITEM 13.   |       | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                     |         |     | 95           | ** ** |   |
| ITEM 14.   |       | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                             |         |     | 95           | ** ** |   |
| ** ** | ** ** | **PART IV**                                                                                                   | *** *** | * * | *** *** | ** ** |   |
| ITEM 15.   |       | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                         |         |     | 96           | ** ** |   |
| ** ** |       | SIGNATURES                                                                                                         |         |     | 97           | ** ** |   |

 

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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 and allowance for credit losses.They involve known and unknown risks, uncertainties and other factors that maycause the actual results, performance or achievements of the Company to bematerially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements. Such factors include,among others, the following: general economic and business conditions in thoseareas in which the Company operates, competition, natural disasters, growth inloans and deposits, fluctuations in interest rates, changes in businessstrategy or development plans, changes in governmental regulation, creditquality, economic, political and global changes arising from the war onterrorism and the conflict in Iraq, and other factors referenced in thisreport, including in “Item 1A. Risk Factors.” When relying on forward-looking statements to make decisions withrespect to our Company, investors and others are cautioned to consider theseand other risks and uncertainties. The Company disclaims any obligation toupdate any such factors or to publicly announce the results of any revisions toany of the forward-looking statements contained herein to reflect future eventsor 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 federal governmentand of the regulatory authorities that govern financial institutions. See “Supervisionand 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, 2005 the Company had total assetsof approximately $2.4 billion, total deposits of $2.1 billion and totalshareholders’ equity of $273 million.

The Bank operates 40 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, SanLuis Obispo, Pismo Beach, Grover Beach, Guadalupe, Nipomo, Santa Maria, Orcutt,Lompoc, Vandenberg Village, Buellton, Santa Ynez, Solvang, Goleta, Oxnard,Camarillo, Ojai, Oak View, Ventura and Santa Barbara. It also plans to open anew branch office and commercial banking office in 

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Westlake Village in theSpring of 2006. The headquarters’ street address is 1026 Grand Ave., ArroyoGrande, CA 93420. Its mailing address is P.O. Box 6002, Arroyo Grande, CA93421-6002. The telephone number is: (805) 473-6829. The Bank canalso be reached through its internet address at *www.midstatebank.com*.Investors can obtain copies of this Annual Report on Form 10-K orother filings made by the Company with the Securities and Exchange Commission(SEC) filings through this website which provides a link to the SEC internetwebsite. See the section entitled “Where you can Find Additional Information”at the end of this section on page 20.

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—Mid-CoastLand Company and MSB Properties, Inc. Mid-Coast Land Company was foundedin 1984 pursuant to section 751.3 of the Financial Code of the State ofCalifornia. Section 751.3 provided that state-chartered banks wereauthorized to invest in a corporation that engaged in real estate activities. Underthe Federal Deposit Insurance Corporation Improvement Act (FDICIA) which becamelaw in December 1991, the Bank, through Mid-Coast Land Company, wasrequired to divest itself of its real estate development activities. Thatprocess was completed in January 2003. The holdings and results ofoperations of Mid-Coast Land Company are included within the consolidatedfinancial statements of the****Company. On astand-alone basis, Mid-Coast Land Company had after-tax earnings of $409thousand in 2005, $379 thousand in 2004, and $322 thousand in 2003. For furtherinformation concerning Mid-Coast Land Company, see the Subsidiary Activitysection of the Management’s Discussion and Analysis section included in Item 7of this Report.

MSB Properties Inc. was incorporated under the laws ofthe State of California in May of 1968, allowing for the ownership ofproperty which may be reasonably necessary for the expansion of the Bank’sbusiness, or which is otherwise reasonably related to the conduct of the Bank’sbusiness, pursuant to Section 752 of the Financial Code of the State ofCalifornia.

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, $1.2 million, and $1.4 million in 2005, 2004, and 2003,respectively. For further information concerning MSB Properties, see theSubsidiary Activity portions of the Management’s Discussion and Analysissection included 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 expanded Mid-State Bank &Trust’s Ventura County presence with these two additional offices.

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 

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Mid-StateBancshares’ stock traded ending October 24, 2003. The average price ofMid-State Bancshares’ stock over that period was $23.78. The merger wasaccounted for utilizing the purchase method of accounting.

***Services***

The Bank offers a fullrange of commercial banking services including checking accounts, NOW accounts,health savings accounts, savings accounts, money market accounts, and varioustypes of time certificates of deposit (including various maturities andindividual retirement accounts). The Bank makes a variety of construction andland development loans, real estate related loans, home equity credit lines,installment loans, agricultural and commercial loans, business equipment leasesand SBA loans. Other services offered by the Bank include, but are not limitedto, trust services, safe deposit boxes, travelers cheques, notary public,merchant depository services for VISA and Mastercard, cash management, homebanking, telephone voice response system and ATM’s. The Bank’s organization andstructure is designed to serve the banking needs of individuals and small tomedium sized businesses in Santa Barbara, Ventura and San Luis Obispo counties.

***Deposit and Liability Management***

Deposits represent the Bank’s primary source of funds.As of December 31, 2005 the Bank had approximately 32,734 non interestbearing demand deposit accounts representing $567.8 million, or an average of$17,345 per account. The Bank also had approximately 125,926 NOW, Money Marketand Savings accounts amounting to $1,067 million, or about $8,477 average peraccount. There were 16,088 time certificates of deposit outstanding at December 31,2005, representing $434.3 million with an average deposit balance ofapproximately $26,998. Of the total time certificates of deposit, $202.1million represented holders who carried an amount on deposit of $100,000 ormore, approximately 47% 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, 2005, 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 2005, Fed Funds Sold averaged$36.1 million representing 1.5% 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, was29.7%—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.

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***Loans***

The Bank’s loan-to-deposit ratio stood atapproximately 73.6% at year-end 2005. The ratio has increased in recent yearsfrom 60.6% at the end of 2003. It is the Bank’s policy to maintain itsloan-to-deposit ratio in the 60% to 80% 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 charged tothe allowance; subsequent recoveries are credited to the allowance. The amountin the loan loss allowance is an estimate of the losses inherent in the loanportfolio as determined by a variety of factors considered by Management. Factorsinclude, but are not limited to, the current economic climate, type and qualityof loans in the portfolio, trends in delinquencies, historical loss rates,non-accrual totals, diversification of the portfolio, value of availablecollateral and the cost of collateral liquidation.

As of December 31,2005, the Bank’s allowance for loan losses stood at $11.9 million. Additionally,the Bank has an allowance for losses on unfunded commitments totaling $1.8million. Collectively, these allowances for losses represent 554.5% 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 2005, the Bank experienced netcharge-offs after recoveries, of $1.9 million, or 0.13% 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. During 2005, the approval process was revised. Loan requestsexceeding individual limits are now submitted to the Bank’s Loan Committee,which consists of the president, chief credit officer, executive vice presidentof commercial banking, 2 senior credit administrators and one non-managementdirector. The Loan Committee meets on a regular basis in order to providetimely responses to the Bank’s clients. Additionally, a Board Loan Committeeconsisting of the president, chief credit officer and 3 non-management directorsmeet monthly to review all credits made over certain dollar thresholds and toestablish Bank credit policy and monitor adherence to it. The new structure hassatisfied Management’s and the Board’s concern for improved efficiency in theapproval process.

The Bank’s creditadministration function includes an internal review and the regular use of anindependent outside loan review firm.

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***Loan Portfolio***

At December 31,2005 and 2004, the Bank’s gross loan portfolio totaled $1.5 billion and $1.4billion, respectively. The portfolio was distributed as follows:
|                                             | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Construction and  Land Development          |       | 18.4                  | %          | 16.1 | % |
| Real Estate—Farmland                   |       | 3.2                   | %          | 2.3 | % |
| Real Estate —Residential               |       | 13.6                  | %          | 13.7 | % |
| Real Estate—Non  Farm, Non Residential |       | 36.8                  | %          | 37.5 | % |
| Home Equity  Credit Lines                   |       | 12.0                  | %          | 11.2 | % |
| Cash Reserve                                |       | 0.2                   | %          | 0.3 | % |
| Installment                                 |       | 1.2                   | %          | 1.3 | % |
| Agricultural  Production                    |       | 2.3                   | %          | 2.8 | % |
| Commercial, Other                           |       | 12.3                  | %          | 14.8 | % |
|                                        |       | 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.

*CommercialLoans.**  *The Bankprovides financial services to diverse commercial and professional businessesin the marketplace. Commercial loans consist primarily of short term loans(normally with a maturity of one year or less) for working capital and businessexpansion. Commercial loans typically include revolving lines of credit, eitheruncollateralized or collateralized by inventory, loans secured by accountsreceivable and equipment loans. Emphasis is placed on the borrower’s earningshistory, capitalization, secondary sources of repayment, and in some instances,third-party guarantees or highly liquid collateral (such as time deposits andinvestment securities). Commercial loan pricing is generally at a rate tied tothe prime rate (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.

The Bank participates in Small Business Administration(SBA) loan guarantee programs. Those programs used include both the 504program, which is focused toward longer-term financing of buildings and otherlong-term assets, and the 7A program, which is primarily used for financing ofequipment, inventory and working capital needs of eligible businesses,generally over a seven to twenty-five year term. The Bank’s collateral positionin the SBA loans is enhanced by the SBA guarantee in the case of 7A loans, andby lower loan-to-value ratios under the 504 program. The Bank is designated asa preferred lender by the SBA, allowing it to process these loans more quickly.Under the SBA’s Preferred Lending Program, the SBA delegates a substantialdegree of lending authority to participating lenders, such as the Bank. TheBank also participates in other government sponsored loan programs offered byvarious government agencies, such as through the California Coastal RuralDevelopment Corporation, Central Coast Development Companies and others.

*AgriculturalLoans.*   The Bank provides production loans tohelp finance the seasonal needs of farming operations, including crop andlivestock financing, inventory purchases, and receivable financing. The Bankhas very limited vineyard lending exposure (less than $10 million at December 31,2005). Equipment loans are also financed on everything from field equipment tooffice automation systems. Emphasis is placed on the borrower’s earningshistory, capitalization, secondary sources of repayment, and in some instances,third-party guarantees or highly liquid collateral (such as time deposits andinvestment securities). Agricultural loan pricing, like commercial loanpricing, is generally at a rate tied to the prime 

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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.

*RealEstate Construction and Development Loans.**  *The Bank’s real estate construction loan activity hasfocused on providing short-term (maturity of two years or less) loans toindividuals and developers with whom the Bank has established relationships,for the construction primarily of single family residences in the Bank’s marketarea.

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.  The economic viability of the project and theborrower’s credit-worthiness are primary considerations in the loanunderwriting decision. Such loans are typically secured by first deeds oftrust.

*CommercialReal Estate Term Loans and Loans Secured by Farmland.**  *The Bank provides medium-term commercial real estateloans secured by commercial or industrial buildings or farmland where theproperties are either used by the owner for business purposes (owner-userproperties) or have income derived from tenants (investment properties). As ageneral rule, the Bank’s loan policies require the principal balance of theloan to not exceed 75% of the stabilized appraised value of the underlying realestate collateral. The loans, which are typically secured by first deeds of trustonly, generally have terms of no more than ten years and are amortized over 25to 30 years. Some of these loans have rates tied to Wall Street Journal primerate that adjust whenever the prime rate changes. The remaining loans adjustevery three, five or seven years depending upon the index to which the loan istied.

*ResidentialReal Estate Loans.*   The Bank provides a varietyof real estate loans secured by residential real estate. These loans aregenerally secured by first or second trust deeds on individual residentialproperties. Most of these loans are sold, servicing retained, in the secondarymarket. Certain shorter term mortgages, especially jumbo adjustable ratemortgages, may be kept in portfolio and not sold in the secondary marketdepending on the Bank’s appetite for these earning assets. These consist ofadjustable rate loans with a short fixed rate period of 3, 5 or 7 years, thenadjusted annually using an index of the 1 year treasury constant maturity or 1year LIBOR. These loans are originated using FNMA/FHMLC underwriting guidelines.Although the loans are held for investment, they are eligible for sale in thesecondary market.

*HomeEquity Credit Lines.*   The Bank provides lines ofcredit secured by a first or second deed of trust on the borrower’s residentialreal property. The loans have a 15 year draw period followed by a 15 yearamortization of the outstanding principal balance. The loans have an interestrate that adjusts monthly with the Wall Street Journal published prime rate. Thetotal combined percentage of Home Equity Credit Line and first mortgage isdependent on several factors such as credit score, income ratios, stability ofemployment etc, and can go as high as 100%.

*Consumer and Other Loans.**  *The Bank’s consumer and other loan portfolio isdivided between installment loans secured by automobiles, other consumerpurposes and revolving, unsecured consumer debt such as reserve lines of credit.Installment loans tend to be fixed rate and longer-term (one-to-five-

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year maturity). TheBank’s portfolio of revolving credit plans, issued as an additional service toits clients, is minimal at just 0.2% 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, 2005, the aggregate carrying value of the InvestmentPortfolio was $619.3 million. Of this total, $22.6 million was invested in U.S.Treasury Securities, $214.6 million in U.S. Government Agencies, $8.9 millionin Mortgage Backed Securities, $356.7 million in Obligations of State andPolitical Subdivisions and $16.5 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 31,2005, the Bank had public funds totaling approximately $60.7 million. The Bankhas made available $110.0 million of securities to securitize these funds. Excesscollateral can be released as needed.

***Senior Housing Crime Prevention Foundation Investment***

The Bank owns a $30million holding of the Preferred Stock of Senior Housing Crime PreventionFoundation Investment Corporation (SHCPF-I) which is carried under a separatecaption on the Consolidated Statement of Financial Positions. That investmentis secured by a federal agency security issued by FNMA. The Bank has the rightafter five years on April 29, 2010 to require SHCPF to redeem all or apart of the shares of the Preferred Stock. Dividends are paid to the Bank onthe Preferred Stock at a rate which is 1.875% below the interest earned on theunderlying FNMA agency security. This 1.875% differential is used by SHCPF tofund the various programs of the Senior Housing Crime Prevention Foundation at53 nursing home facilities in the Bank’s tri-county service area. Theseinclude, among other things, the senior crime stoppers program which isreducing crimes against the elderly living in those facilities. The benefits tothe Bank of this program include full Community Reinvestment Act (CRA) creditfor our $30 million investment, positive public relations, and significantmarketing opportunities with the operators of the facilities, their owners,Board of Directors, employees, family members and residents.

***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 industries have also developed in the areas of medical,financial and educational services. Population in the Tri-county area,according to the California Department of Finance, is estimated at July 2005to be 1,493,039. Ventura County represents about 54% of this total with SantaBarbara and San Luis Obispo Counties accounting for 28% and 18% respectively. Certaineconomic activities are unique to the area such as the space launchingfacilities at Vandenberg Air Force Base and the production of seeds for variousflowers grown worldwide. While major oil companies have elected to do businesselsewhere (due to very stringent county business regulations), smallerproduction companies have moved in to continue the oil industry in the area. Themoderate climate allows a year round growing season for numerous vegetables andfruits. Vineyards and cattle ranches make large contributions to the localeconomy. There are large 

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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’ssecured and unsecured lending limits at December 31, 2005, wereapproximately $56.1 million and $33.7 million, respectively. These levelscompare to $56.5 million and $33.9 million, respectively, at December 31,2004 (see “Item 7. Management’s Discussion and Analysis of Financial Conditionand Results of Operations—External Factors Impacting the Bank—CompetitiveFactors”).

Other entities, both governmental and 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, insurance companies and other lendinginstitutions.

The financial servicesindustry is undergoing rapid technological changes involving frequentintroductions of new technology-driven products and services that have furtherincreased competition. There can also be no assurance that these technologicalimprovements, if made, will increase the Bank’s operational efficiency or thatthe Bank will be able to effectively implement new technology-driven productsand services or be successful in marketing these products and services to ourcustomers.

The trend toward consolidation of banking assetsexhibited over the past few years in California continued in 2005 but other newinstitutions are coming on line to replace them. Statewide in 2005, there were15 banks which either completed or announced merger into another institution.According to the California State Department of Financial Institutions however,21 applications for new banks were filed in 2005 in California, with 10 ofthose having received approval.

***Employees***

At December 31, 2005,the Bank had a total of 880 employees, a number of which are part-time. On afull-time equivalent basis, employees represent 823 positions. The Bankbelieves that its employee relations are positive.

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***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 inits entirety 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  isrequired to file with the Federal Reserve Board quarterly and annual reportsand such additional information as the Federal Reserve Board may requirepursuant to the Bank Holding Company Act. The Federal Reserve Board may conductexaminations of bank holding companies and their 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 voting shares of such bank. Prior approval of theFederal Reserve Board is also required for the merger or consolidation of theCompany 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 

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services to itssubsidiaries. However, the Company may, subject to the prior approval of theFederal Reserve Board, engage in any, or acquire shares of companies engagedin, activities that are deemed by the Federal Reserve Board to be so closelyrelated to banking or managing or controlling banks as to be a proper incidentthereto.

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 theactivity or the control or the subsidiary or affiliates constitutes asignificant risk to the financial safety, soundness or stability of any of itsbanking subsidiaries. The Federal Reserve Board also has the authority toregulate provisions of certain bank holding company debt, including authorityto impose interest ceilings and reserve requirements on such debt. Undercertain circumstances, the Company must file written notice and obtain approvalfrom the 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 beconsidered by the Federal Reserve Board to be an unsafe and unsound bankingpractice or a violation 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.

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 

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law orregulation, various remedies are available to these regulatory agencies. Suchremedies include 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 term preferred stock, eligible termsubordinated debt and certain other instruments with some characteristics ofequity. The inclusion of elements of Tier 2 capital is subject to certain otherrequirements and limitations of the federal banking agencies. The federalbanking agencies require a minimum ratio of qualifying total capital to risk-adjustedassets of 8% and a minimum ratio of Tier 1 capital to risk-adjustedassets of 4%. Mid-State Bank & Trust’s ratios are 12.0% and 11.3%,respectively, as of December 31, 2005. On a consolidated basis, Mid-StateBancshares’ ratios are 12.3% and 11.6%, respectively, at the same date.

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 allbanking organizations not rated in the highest category, the minimum leverageratio must be at least 100 to 200 basis points above the 3% minimum, or 4% to5%. Mid-State Bank & Trust’s ratio is 8.9% as of December 31,2005. On a consolidated basis, Mid-State Bancshares’ ratio is 9.2% at the samedate. In addition to these uniform risk-based capital guidelines andleverage ratios that apply across the industry, the regulators have thediscretion to set individual minimum capital requirements for specificinstitutions at rates significantly above the minimum guidelines and 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.

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’ equityof the bank is less than the greater of (i) 3% of the bank’s total assetsor (ii) $1.0 million.

For additional information concerning the capitalratios of the Company and the Bank, see, “Item 7—Management’s Discussion andAnalysis of Financial Condition and Results of Operations.”

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Under applicableregulatory guidelines, the Bank was considered “Well Capitalized” as of December 31,2005.

***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, commercialbanking organizations may be subject to potential enforcement actions by thefederal regulators for unsafe or unsound practices in conducting their businessesor for 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*.*

***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 

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supervisory concern areassessed lower premiums than banks with lower levels of capital or a higherdegree of supervisory concern.

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

The FDIC is authorized to terminate a depositoryinstitution’s deposit insurance upon a finding by the FDIC that the institution’sfinancial condition is unsafe or unsound or that the institution has engaged inunsafe or unsound practices or has violated any applicable rule, regulation,order or condition enacted or imposed by the institution’s regulatory agency.

The President signed thebudget reconciliation package (S. 1932) that contains the comprehensive FederalDeposit Insurance Reform Act of 2005. This legislation, among other things, (i) mergesthe Bank Insurance Fund (BIF) and the Savings Associations Insurance Fund(SAIF) into the Deposit Insurance Fund (DIF); (ii) establishes a processfor indexing coverage levels to account for inflation; (iii) sets a cap onthe DIF; (iv) sets up a system of dividends; (v) gives certain bankscredit for past over-payments to the fund; (vi) gives the FDIC addedflexibility should the fund ever face financial difficulty; and (vii) increasesdeposit insurance coverage to $250,000 for certain retirement accounts. Thelegislation will become effective six months after the FDIC completes theirregulations covering the above items.

***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 

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affiliations through aholding company structure or through a financial subsidiary of a bank, subjectto certain limitations. The Financial Services Modernization Act establishes anew type of bank holding company, known as a financial holding company, whichmay engage in an expanded list of activities that 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. There are various measures pending in the U.S.Congress which would extend the provisions of the Act. While the Company andthe Bank believes the Patriot Act affects their recordkeeping and reportingexpenses, they do not believe that it has a material adverse effect on theirbusiness and operations.

***Bank Secrecy Act***

In 1970, Congress passedthe Currency and Foreign Transactions Reporting Act, otherwise known as theBank Secrecy Act (the “BSA”), which established requirements for recordkeepingand reporting by banks and other financial institutions. The BSA was designedto help identify the source, volume and movement of currency and other monetaryinstruments into and out of the United States in order to help detect andprevent money laundering connected with drug trafficking, terrorism and othercriminal activities. The primary tool used to implement BSA requirements is thefiling of Suspicious Activity Reports. Today, the BSA requires that all bankinginstitutions develop and provide for the continued administration of a programreasonably designed to assure and monitor compliance with certain recordkeepingand reporting requirements regarding both domestic and international currency 

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transactions.These programs must, at a minimum, provide for a system of internal controls toassure ongoing compliance, provide for independent testing of such systems andcompliance, designate individuals responsible for such compliance and provideappropriate personnel training.

***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, including low and moderate incomeneighborhoods. In addition to substantial penalties and corrective measuresthat may be required for a violation of certain fair lending laws, the federalbanking agencies may take compliance with such laws and CRA into account whenregulating 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 conditions underwhich they may disclose non-public information to non-affiliated third partiesand affiliates;

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·       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.

A new capital plan ofthe FHLB of San Francisco was approved by the Federal Housing Finance Board andwas implemented on April 1, 2004. The new capital plan incorporates asingle class of stock with a par value of $100 per 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 bringing the total of its holdings to $8.2 million.

***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 scenarios trigger coverageunder the Home Ownership and Equity Protection Act of 1994:

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

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·       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, theregulation bars loan flipping by the same lender or loan servicer within ayear. Lenders also will be presumed to have violated the law—which says loansshouldn’t be made to people unable to repay them—unless they document that theborrower has the ability to repay. Lenders that violate the rules facecancellation of loans and penalties equal to the finance charges paid. TheCompany does not expect these rules and potential state action in thisarea to have a material impact on our financial condition or results ofoperation.

***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.

***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 $40.9 million at December 31,2005 compared to $30.2 million one year earlier. Additionally, the Company hasundisbursed loan commitments, also made in the ordinary course of business,totaling $658.0 million, which compares to $626.4 million outstanding one yearearlier.

There are no Special Purpose Entity (“SPE”) trusts,corporations, or other legal entities established by the Company 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 to related parties(directors and officers) in the ordinary course of business at prevailing ratesand terms. These loans totaled $14.1 million at the end of 2005, compared tothe $8.7 million outstanding one year earlier. While loans to insiders andrelated parties are generally prohibited under SOX, as a bank, the Bank isexempt from this rule.

***Where You Can Find More Information.***

Under the Securities Exchange Act of 1934 Sections 13and 15(d), periodic and current reports must be filed with the SEC. The Companyelectronically files the following reports with the SEC: Form 10-K(Annual Report), Form 10-Q (Quarterly Report), Form 11-K(Annual Report for Employees’ Stock Purchase and Savings Plans), Form 8-K(Current Report), 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 committeecharter, 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), are available free of charge onthe Company’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.

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**ITEM 1A.**        RISKFACTORS

***An investment in our common stock is subject to risksinherent to our business. The material risks and uncertainties that managementbelieves may affect our business are described below. Before making aninvestment decision, you should carefully consider the risks and uncertaintiesdescribed below together with all of the other information included orincorporated by reference in this report. The risks and uncertainties describedbelow are not the only ones facing our business. Additional risks anduncertainties that management is not aware of or focused on or that managementcurrently deems immaterial may also impair our business operations. This reportis qualified in its entirety by these risk factors.***

***If any of thefollowing risks actually occur, our financial condition and results ofoperations could be materially and adversely affected. If this were to happen,the value of our common stock could decline significantly, and you could loseall or part of your investment.***

***Risks Associated with our Business.***

**Weare highly dependent on real estate and a downturn in the real estate marketcould hurt our business.**

A significant portion of our loan portfolio isdependent on real estate. At December 31, 2005, real estate served as theprincipal source of collateral with respect to approximately 84% of our 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 us, as well as ourfinancial condition and results of operations in general and the market valueof our common stock.

Acts of nature, includingearthquakes, floods and fires, which may cause uninsured damage and other lossof value to real estate that secures these loans, may also negatively impactour financial condition.

**Wealso have a concentration in commercial real estate loans.**

We also have a high concentration in commercial realestate or CRE loans. CRE loans generally involve a higher degree of credit riskthan residential mortgage lending due, among other things, to the large amountsloaned to individual borrowers. Losses incurred on loans to a small number ofborrowers could have a material adverse impact on our income and financialcondition. In addition, unlike residential mortgage loans, commercial realestate loans generally depend on the cash flow from the property to service thedebt. Cash flow may be significantly affected by general economic conditions.

Banking regulators haverecently issued proposed guidance regarding institutions that have particularlyhigh concentrations of CRE within their lending portfolios. This guidancesuggests that institutions that exceed certain levels of CRE lending may berequired, in the future, to maintain higher capital ratios than institutionswith lower concentrations in CRE lending*.*If and whenthis proposed guidance becomes final, we may be subject to enhanced regulatoryscrutiny and subject to higher capital requirements.

**Ourreal estate lending also exposes us to the risk of environmental liabilities.**

In the course of ourbusiness, we may foreclose and take title to real estate, and could be subjectto environmental liabilities with respect to these properties. We may be heldliable to a governmental entity or to third persons for property damage,personal injury, investigation and clean-up costs incurred by these parties inconnection with environmental contamination, or may be required to investigateor clean up hazardous or toxic substances, or chemical releases at a property. Thecosts associated with investigation or remediation activities could besubstantial. In addition, as the owner or former owner of a contaminated site,we may be subject to common law claims by third parties based on damages andcosts resulting from environmental contamination emanating from the property. Ifwe ever become subject to significant 

18

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environmentalliabilities, our business, financial condition, liquidity and results ofoperations could be materially and adversely affected.

**Insufficientloan demand could have an adverse impact on our business.**

We are significantlyaffected by the level of loan demand available in our markets. Strong localpressure from competitors to make loans to existing and potential customersalso affects our ability to make sufficient loans. The inability to makesufficient loans directly affects the interest income we earn. Lower loandemand will generally result in lower interest income since funds will beplaced in lower yielding investments.

**Ourbusiness is subject to interest rate risk and changes in interest rates mayadversely affect our performance and financial condition.**

Our earnings are impacted by changing interest rates.Changes in interest rates impact the demand for new loans, the credit profileof our borrowers, the rates received on loans and securities and rates paid ondeposits and borrowings. The difference between the rates received on loans andsecurities and the rates paid on deposits and borrowings is known as interestrate spread. Increasing levels of competition in the banking and financialservices business may decrease our net interest spread by forcing us to offerlower lending interest rates and pay higher deposit interest rates.

A sustained decrease inmarket interest rates could adversely affect our earnings. When interest ratesdecline, borrowers tend to refinance higher-rate, fixed-rate loans at lowerrates, prepaying their existing loans. Under those circumstances, we would notbe able to reinvest those prepayments in assets earning interest rates as highas the rates on the prepaid loans. In addition, our commercial real estate andcommercial loans, which carry interest rates that, in general, adjust inaccordance with changes in the prime rate, will adjust to lower rates. We arealso significantly affected by the level of loan demand available in ourmarket. Given our currentvolume and mix of interest-bearing liabilities and interest-earning assets, ourinterest rate spread can be expected to increase when market interest rates arerising, and to decline when market interest rates are declining. The FederalReserve Board’s decrease in rates during 2001, 2002 and 2003 substantiallyimpacted our interest rate spread, as the spread for 2004 declined to 5.36%(taxable equivalent) from 5.54% (taxable equivalent) in 2003 and from 5.74%(taxable equivalent) in 2002. Increases in short term rates by the FederalReserve Board in the latter half of 2004 through 2005 and into 2006 are havingthe effect of beginning to reverse this trend with our interest spread risingto 5.74% (taxable equivalent) in 2005. Although we believe our current level ofinterest rate sensitivity is reasonable, significant fluctuations in interestrates may have an adverse impact on our business, financial condition andresults of operations.

**Failureto successfully execute our strategy could adversely affect our performance.**

Our financialperformance and profitability depends on our ability to execute our corporategrowth strategy. See “Item 7.—Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Challenges and Opportunities in 2006.”   Continued growth, however, may present operatingand other problems that could adversely affect our business, financialcondition and results of operations.  Accordingly, there can be no assurance that wewill be able to execute our growth strategy or maintain the level ofprofitability that we have recently experienced. Factors that may adverselyaffect our ability to attain our long-term financial performance goals includethose stated elsewhere in this section, as well as:

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

·       Inabilityto increase non-interest income; and

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·       Continuingability to expand, through de novo branching or finding acquisition targets atvaluation levels we find attractive.

Our primary market area isan increasingly competitive and overcrowded banking****market. Our ability to achieve the growth outlined in ourcorporate strategic goals may be dependent in part on an ability to growthrough the successful addition of new branches or the identification andacquisition of potential targets at acceptable pricing levels either inside oroutside of our primary market. If we are unable to attract significant newbusiness through strategic branching, or acquiring new business through ouracquisition of other banks, our growth in loans and deposits and,therefore, our earnings, may be adversely affected.

**Economicconditions on the California Central Coast could adversely affect ouroperations and/or cause us to sustain losses.**

Our retail and commercialbanking operations are concentrated primarily in San Luis Obispo and SantaBarbara Counties. As a result of this geographic concentration, our results ofoperations depend largely upon economic conditions in this area. A significantsource of risk arises from the possibility that losses will be sustained if asignificant number of our borrowers, guarantors and related parties fail toperform in accordance with the terms of their loans. This risk increases whenthe economy is weak. We have adopted underwriting and credit monitoringprocedures and credit policies, including the establishment and review of theallowance for credit losses, that management believes are appropriate tominimize this risk by assessing the likelihood of nonperformance, tracking loanperformance and diversifying our credit portfolio. These policies andprocedures, however, may not prevent unexpected losses that could materiallyadversely affect our results of operations in general and the market value ofour stock.

**Potentialacquisitions may affect our business and shareholder value.**

We are currentlyseeking merger or acquisition partners that are culturally similar and haveexperienced management and possess either significant market presence or havepotential for improved profitability through financial management, economies ofscale or expanded services. We do not currently have any specific plans,arrangements or understandings regarding such expansion. We cannot say with anycertainty that we will be able to consummate such acquisitions. In attempting tomake such acquisitions, we anticipate competing with other financialinstitutions, many of which have greater financial and operational resources. Acquiringother banks, businesses, or branches involves various risks commonly associatedwith acquisitions, including, among other things:

·       Potentialexposure to unknown or contingent liabilities of the target company.

·       Exposureto potential asset quality issues of the target company.

·       Difficultyand expense of integrating the operations and personnel of the target company.

·       Potentialdisruption to our business.

·       Potentialdiversion of management’s time and attention.

·       Thepossible loss of key employees and customers of the target company.

·       Difficultyin estimating the value of the target company.

·       Potentialchanges in banking or tax laws or regulations that may affect the targetcompany.

We regularly evaluate merger and acquisitionopportunities and conduct due diligence activities related to possibletransactions with other financial institutions and financial servicescompanies. As a result, merger or acquisition discussions and, in some cases,negotiations may take place and future 

20

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mergers or acquisitionsinvolving cash, debt or equity securities may occur at any time. Acquisitionstypically involve the payment of a premium over book and market values, and,therefore, some dilution of our stock’s tangible book value and net income percommon share may occur in connection with any future transaction. Furthermore,failure to realize the expected revenue increases, cost savings, increases ingeographic or product presence, and/or other projected benefits from anacquisition could have a material adverse effect on our financial condition andresults of operations.

Likewise, we may expandour branch network through de novo branches in existing or new markets. Thesede novo branches will have expenses in excess of revenues for varying periodsafter opening that could decrease our reported earnings.

**Weface strong competition from financial service companies and other companiesthat offer banking services that could hurt our business.**

The financial services business in our market areas ishighly competitive. It is becoming increasingly competitive due to changes inregulation, technological advances, and the accelerating pace of consolidationamong financial services providers. We face competition both in attractingquality assets and deposits and in making loans. We compete for loansprincipally through the interest rates and loan fees we charge and the efficiencyand quality of services we provide. Increasing levels of competition in thebanking and financial services business may reduce our market share, decreaseloan demand, cause the prices we charge for our services to fall, or decreaseour net interest margin by forcing us to offer lower lending interest rates andpay higher deposit interest rates. Therefore, our results may differ in futureperiods depending upon the nature or level of competition.

Technology and otherchanges are allowing parties to complete financial transactions thathistorically have involved banks through alternative methods. For example,consumers can now maintain funds that would have historically been held as bankdeposits in brokerage accounts or mutual funds. Consumers can also completetransactions such as paying bills and/or transferring funds directly withoutthe assistance of banks. The process of eliminating banks as intermediaries,known as “disintermediation,” could result in the loss of fee income, as wellas the loss of customer deposits and the related income generated from thosedeposits. The loss of these revenue streams and the lower cost deposits as asource of funds could have a material adverse effect on our financial conditionand results of operations.

**Wemay not be able to attract and retain skilled people.**

Our success depends, inlarge part, on our ability to attract and retain key people. Competition forthe best people in most of our activities can be intense and we may not be ableto hire people or to retain them. The unexpected loss of services of one ormore of our key personnel could have a material adverse impact on our businessbecause of their skills, knowledge of our market, years of industry experienceand the difficulty of promptly finding qualified replacement personnel.

**Ourinternal operations are subject to a number of risks.**

We are subject to certain operations risks, including,but not limited to, data processing system failures and errors, customer oremployee fraud and catastrophic failures resulting from terrorist acts ornatural disasters. We maintain a system of internal controls to mitigateagainst such occurrences and maintain insurance coverage for such risks thatare insurable, but should such an event occur that is not prevented or detectedby our internal controls, uninsured or in excess of applicable insurancelimits, it could have a significant adverse impact on our business, financialcondition or results of operations.

*InformationSystems.*   We rely heavily on communications andinformation systems to conduct our business. Any failure, interruption orbreach in security of these systems could result in failures or disruptions inour customer relationship management, general ledger, deposit, loan and othersystems. 

21

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While we have policies andprocedures designed to prevent or limit the effect of the failure, interruptionor security breach of our information systems, there can be no assurance thatany such failures, interruptions or security breaches will not occur or, ifthey do occur, that they will be adequately addressed. The occurrence of anyfailures, interruptions or security breaches of our information systems coulddamage our reputation, result in a loss of customer business, subject us toadditional regulatory scrutiny, or expose us to civil litigation and possiblefinancial liability, any of which could have a material adverse effect on ourfinancial condition and results of operations.

*TechnologicalAdvances.*   The financial services industry iscontinually undergoing rapid technological change with frequent introductionsof new technology-driven products and services. The effective use of technologyincreases efficiency and enables financial institutions to better servecustomers and to reduce costs. Our future success depends, in part, upon ourability to address the needs of our customers by using technology to provideproducts and services that will satisfy customer demands, as well as to createadditional efficiencies in our operations. Many of our competitors havesubstantially greater resources to invest in technological improvements. We maynot be able to effectively implement new technology-driven products andservices or be successful in marketing these products and services to ourcustomers. Failure to successfully keep pace with technological changeaffecting the financial services industry could have a material adverse impacton our business and, in turn, our financial condition and results of operations.

*Severe Weather, NaturalDisasters, Acts Of War Or Terrorism and Other External Events.*   Severeweather, natural disasters, acts of war or terrorism and other adverse externalevents could have a significant impact on our ability to conduct business. Suchevents could affect the stability of our deposit base, impair the ability ofborrowers to repay outstanding loans, impair the value of collateral securingloans, cause significant property damage, result in loss of revenue and/orcause us to incur additional expenses. For example, the Central Coast ofCalifornia is subject to earthquakes and fires. Operations in our market couldbe disrupted by both the evacuation of large portions of the population as wellas damage and or lack of access to our banking and operation facilities. Whilewe have not experienced such an occurrence to date, other severe weather ornatural disasters, acts of war or terrorism or other adverse external eventsmay occur in the future. Although management has established disaster recoverypolicies and procedures, the occurrence of any such event could have a materialadverse effect on our business, which, in turn, could have a material adverseeffect on our financial condition and results of operations.

**Wedepend on cash dividends from our subsidiary bank to meet our cash obligations.**

As a holding company,dividends from our subsidiary bank provide a substantial portion of our cashflow used to service our obligations, including cash dividends. See “Item 5—Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities.”  Variousstatutory provisions restrict the amount of dividends our subsidiary bank canpay to us without regulatory approval.

**Impairmentof goodwill recorded on our balance sheet could lead to a charge against futureperiod’s earnings.**

Pursuant to GenerallyAccepted Accounting Practices (GAAP), we are required to periodically assessour goodwill, intangibles and other long-lived assets to determine if they areimpaired. Disruptions to our business, end market conditions and protractedeconomic weakness, unexpected significant declines in operating results ofreporting units, divestitures and market capitalization declines may result inadditional charges to goodwill and other asset impairments. Future impairmentcharges could substantially affect our reported earnings in the period of suchcharge. In addition, such charges would reduce our consolidated net worth andour shareholders’ equity.

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***Risks Associated with our Industry.***

**Weare subject to government regulation that could limit or restrict ouractivities, which in turn could adversely impact our operations.**

The financial services industry is regulatedextensively. Federal and State regulation is designed primarily to protect thedeposit insurance funds and consumers, and not to benefit our shareholders.These regulations can sometimes impose significant limitations on ouroperations.

New laws and regulations or changes in existing lawsand regulations or repeal of existing laws and regulations may adversely impactour business. We have to comply with all governmental regulations such as theSarbanes Oxley Act of 2002, the Bank Secrecy Act, the Patriot Act, theCommunity Reinvestment Act, and many others. The cumulative cost of compliancewith these regulations could be significant and affect the ability of theCompany to earn an adequate return for its shareholders. For example, operatingexpenses were impacted by the significant cost of compliance with the newSarbanes-Oxley Section 404 provisions in the years ended December 31,2005 and 2004.

Further, federal monetarypolicy, particularly as implemented through the Federal Reserve System,significantly affects economic conditions for us.

**Newlegislative and regulatory proposals may affect our operations and growth.**

Proposals to change thelaws and regulations governing the operations and taxation of, and federalinsurance premiums paid by, banks and other financial institutions andcompanies that control such institutions are frequently raised in theU.S. Congress, state legislatures and before bank regulatory authorities.The likelihood of any major changes in the future and the impact such changesmight have on us or our subsidiaries are impossible to determine. Similarly,proposals to change the accounting treatment applicable to banks and otherdepository institutions are frequently raised by the SEC, the federal bankingagencies, the IRS and other appropriate authorities. The likelihood and impactof any additional future changes in law or regulation and the impact suchchanges might have on us or our subsidiaries are impossible to determine atthis time.

***Risks Associated with our Stock.***

**OurStock Trades Less Frequently Than Others.**

Although our common stockis listed for trading on the NASDAQ National Market, the trading volume in ourcommon stock is less than that of other larger financial services companies. Apublic trading market having the desired characteristics of depth, liquidityand orderliness depends on the presence in the marketplace of willing buyersand sellers of our common stock at any given time. This presence depends on theindividual decisions of investors and general economic and market conditionsover which we have no control. Given the lower trading volume of our commonstock, significant sales of our common stock, or the expectation of thesesales, could cause our stock price to fall.

**OurStock Price Is Affected by a Variety of Factors.**

Stock pricevolatility may make it more difficult for you to resell your common stock whenyou want and at prices you find attractive. Our stock price can fluctuatesignificantly in response to a variety of factors discussed in this section,including, among other things:

·       Actualor anticipated variations in quarterly results of operations.

·       Recommendationsby securities analysts.

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·       Operatingand stock price performance of other companies that investors deem comparableto our company.

·       Newsreports relating to trends, concerns and other issues in the financial servicesindustry.

·       Perceptions in themarketplace regarding our company and/or its competitors.

**OurCommon Stock Is Not An Insured Deposit.**

Our common stock is not abank deposit and, therefore, is not insured against loss by the FDIC, any otherdeposit insurance fund or by any other public or private entity. Investment inour common stock is inherently risky for the reasons described in this “RiskFactors” section and elsewhere in this report and is subject to the same marketforces that affect the price of common stock in any company. As a result, ifyou acquire our common stock, you may lose some or all of your investment.

**OurArticles Of Incorporation and By-Laws, As Well As Certain Banking Laws, May HaveAn Anti-Takeover Effect.**

Provisions of our articlesof incorporation, bylaws and federal banking laws, including regulatoryapproval requirements, could make it more difficult for a third party toacquire us, even if doing so would be perceived to be beneficial to ourshareholders. The combination of these provisions may hinder a non-negotiatedmerger or other business combination, which, in turn, could adversely affectthe market price of our common stock.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS.

The Company does not have any unresolved staffcomments received from the staff of the Securities and Exchange Commission(SEC).

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**ITEM 2.**                PROPERTIES

TheCompany’s principal office is located at 1026 Grand Avenue, Arroyo Grande,California. As of December 31, 2005, the Bank owned 23 of its branchoffices, 4 non-banking support offices and leased 20 other Bank locations(covered by 22 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.
| Ownedby 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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**Leased by Bank orSubsidiary**
| Arroyo Grande                   |   | 1132 West Branch Street     |   | $3,500.00 per  month     |   |
|---------------------------------|--------|-----------------------------|--------|--------------------------|--------|
| West Branch In Store  Office    |   |                        |   | Expires February,  2010  |   |
| Camarillo                       |   | 470 Arneill Road            |   | $7,089.98 per month      |   |
| Camarillo Financial  Center     |   |                        |   | Expires June, 2009       |   |
| Cayucos                         |   | 107 North Ocean  Avenue     |   | $1,782.00 per month      |   |
|                            |   |                        |   | Expires November,  2007  |   |
| Goleta Valley                   |   | 5340 Hollister  Avenue      |   | $5,210.28 per month      |   |
| Hollister Office                |   |                        |   | Expires February,  2007  |   |
| Ojai                            |   | 410 Ventura Avenue          |   | $2,124.27 per month      |   |
| Oak View                        |   |                        |   | Expires December,  2010  |   |
| Ojai                            |   | 1207 Maricopa  Highway      |   | $8,003.00 per month      |   |
| Ojai Valley                     |   |                        |   | Expires December,  2014  |   |
| Orcutt                          |   | 1110 East Clark  Avenue     |   | $11,292.00 per month     |   |
|                            |   |                        |   | Expires October,  2010   |   |
| Oxnard                          |   | 300 Esplanade  Drive,       |   | $14,676.95 per month     |   |
| Esplanade Financial  Center     |   | Suite 101              |   | Expires September,  2012 |   |
| Oxnard*                         |   | 300 Esplanade  Drive,       |   | $12,145.25 per month     |   |
|                            |   | Suite 110              |   | Expires August,  2012    |   |
| Oxnard                          |   | 155 “A” Street    |   | $6,030.42 per month      |   |
| Downtown Oxnard Office          |   |                        |   | Expires July, 2010       |   |
| Oxnard                          |   | 121-125  Gonzales Boulevard |   | $6,907.43 per month      |   |
| Northside Plaza Office***       |   |                        |   | Expires July, 2007       |   |
| Paso Robles                     |   | 705 Golden Hill  Road       |   | $9,585.00 per month      |   |
| Creston Road Office             |   |                        |   | Expires October,  2012   |   |
| Pismo Beach                     |   | 865 Oak Park  Boulevard     |   | $10,683.00 per month     |   |
| Oak Park Office                 |   |                        |   | Expires March,  2008     |   |
| Santa Barbara                   |   | 914 Carpinteria  Street     |   | $10,407.00 per month     |   |
| Milpas Office                   |   |                        |   | Expires May, 2017        |   |
| Santa Maria**                   |   | 720 North Broadway          |   | $2,522.00 per month      |   |
| North Broadway Office—Land |   |                        |   | Expires Dec, 2008        |   |
| Santa Ynez                      |   | 3600 Sagunto  Street        |   | $2,759.00 per month      |   |
|                            |   |                        |   | Expires May, 2012        |   |
| Solvang                         |   | 1600 Copenhagen  Drive      |   | $12,099.16 per month     |   |
|                            |   |                        |   | Expires April,  2008     |   |
| Ventura                         |   | 300 S. Mills Road           |   | $17,306.94 per month     |   |
| Mills Road Financial  Center    |   |                        |   | Expires August,  2012    |   |
| Ventura                         |   | 304 E. Main Street          |   | $10,652.00 per month     |   |
| Downtown Ventura Office         |   |                        |   | Expires November,  2012  |   |
| Ventura                         |   | 6401 E. Telephone  Road     |   | $11,985.56 per month     |   |
| County Center Office            |   |                        |   | Expires September,  2012 |   |
| Westlake Village                |   | 2663 Townsgate  Road        |   | $16,732.00 per month     |   |
|                            |   |                        |   | Expires September,  2015 |   |
| Westlake  VillageCommercial     |   | 2663 Townsgate  Road,       |   | $7,614.81 per month      |   |
| Banking Office*                 |   | Suite 113/119          |   | Expires December, 2011   |   |

 

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**FormerBank Offices Leased by Bank—Which Are Sub-Leased**
| Nipomo       |   | 630  W. Tefft Street |   | $4,156.00 per month    |   |
|--------------|--------|----------------------|--------|------------------------|--------|
| Ground Lease |   |                 |   | Expires February, 2015 |   |

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*                    *The Bank’s rental expense for 2005 was $2,042,000. See note 6 of theCompany’s financial statements included in Item 8 of this Report for certainadditional information concerning the amount of the Bank’s lease commitment. Alloffices listed are full service branch offices, except those with asterisksnoted above. Asterisks represent non-banking support offices (e.g.,Administration, Data Processing, Supplies Warehouse, Credit Services, et. al.)*

**             *Ground leaseon property adjacent to a fully owned facility.*

***      *Office closed June 30, 2005. Remaining rental charges expensed in2005.*

**ITEM 3.**                LEGALPROCEEDINGS

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, 2005 (other than ordinary routinelitigation incidental to the Company’s business) and no such proceedings areknown to be contemplated. The Company does not expect the resolution of theseitems to have a material impact on its financial condition or operatingresults.

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.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of securityholders during the fourth quarter of 2005.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

***Market Information***

TheCompany’s Common Stock trades on the NASDAQ National Market under the symbol “MDST.”The following 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, 2004. The closing sales priceon December 31, 2005 was $26.75 compared to the close one year earlier of$28.65.
|                                  | ** ** | **Closing  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 |   |
|                                  |            |                                |            |  |  |  |  |

 
|                                  | ** ** | **Closing  Sales Prices** | ** **   |
|----------------------------------|------------|--------------------------------|--------------|
| **Quarter Ended 2005** | ** ** | ** **                     | *** *** | **Low** | *** *** | **High** | *** *** |
| March 31                    |       | $25.80                         |         | $28.89 |   |
| June 30                     |       | $24.00                         |         | $28.94 |   |
| September 30                |       | $26.70                         |         | $31.29 |   |
| December 31                 |       | $25.84                         |         | $29.61 |   |
|                                  |            |                                |              |  |  |  |  |

 

There are approximately5,000 holders of Mid-State Bancshares common stock as of December 31,2005.

***Equity Plan Compensation Information***

Thefollowing table summarizes information as of December 31, 2005 relating toequity compensation plans of the Company pursuant to which grants of options,restricted stock or other rights to acquire shares may be granted from time totime.
| 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 approved by Stockholders     |       |       | 2,000,958  |                                                                                                |       |                                                                             | $19.20     |                                                                                        |       |   | 1,027,372 |   |   |
| Equity  compensation  Plans not approved by Stockholders |       |       | -None-     |                                                                                                |       |                                                                             | N/A        |                                                                                        |       |   | N/A |   |   |
| Total                                                    |       |       | 2,000,958  |                                                                                                |       |                                                                             | $19.20     |                                                                                        |       |   | 1,027,372 |   |   |

 

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***Dividends***

Thefollowing table sets forth the per share amount and month of payment for allcash dividends paid since January 1, 2004 by the Company to itsshareholders.
| Payable Date      | ** ** | ** **      | ** ** | ** ** | **Dividend** | ** ** | ** ** |
|------------------------|------------|-----------------|------------|------------|--------------|------------|------------|
| 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 |       |
| April 15,  2005   |       | $0.16 per share |       |
| July 15,  2005    |       | $0.16 per share |       |
| October 14,  2005 |       | $0.16 per share |       |
| January 17, 2006  |       | $0.18 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 availabletherefore, 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. The CorporationLaw also provides that, in the event that sufficient retained earnings are notavailable for the proposed distribution, a corporation may, nevertheless, makea distribution to its shareholders if it meets two conditions, which generallystated are as follows: (i) the corporation’s assets equal at least 1-1/4times its liabilities, and (ii) the corporation’s current assets equal atleast its current liabilities or, if the average of the corporation’s earningsbefore taxes on income and before interest expenses for the two precedingfiscal years was less than the average of the corporation’s interest expensesfor such fiscal years, then the corporation’s current assets must equal atleast 11¤4 timesits 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—PromptCorrective Action and Other Enforcement Mechanisms.”) Additionally, while theFederal Reserve Board has no general restriction with respect to the payment ofcash dividends by an adequately capitalized bank to its parent holding company,the Federal Reserve Board might, under certain circumstances, placerestrictions on the ability of a particular bank to pay dividends based uponpeer group averages and the performance and maturity of the particular bank, orobject to management fees to be paid by a subsidiary bank to its holdingcompany on the basis that such fees cannot be supported by the value of theservices rendered or are not the result of an arm’s length transaction.

29

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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’stransfer agent. Shareholder inquiries regarding holdings of Mid-StateBancshares Common Stock can be directed to:

Mellon Investor Services, LLCP. O. Box 3315South Hackensack, NJ       07606

Or

Mellon Investor Services, LLC480 Washington BoulevardJersey City, NJ 07310-1900

By Phone:1-(888)-540-9878 (U.S. & Canada)1-(201)-329-8660 (Outside U.S.)TDD for Hearing Impaired: (800) 231-5469Foreign Shareowners: (201) 680-6578TDD Foreign Shareowners: (201) 680-6610

Web Site Address: *www.melloninvestor.com/isd*

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 itsregular meeting of June 15, 2005, authorized the purchase of up to 1,141,373additional shares since its prior authorizations in May 2002 and January 2004had expired. The June 2005 authorization does not have an expiration date.The repurchase program seeks to reduce the number of outstanding sharesresulting in an improvement to the Company’s earnings per share and to itsreturn on equity. All of these shares were purchased at current market priceson the date of transaction in compliance with the SEC rules. The total numberof shares repurchased was 845,055, 658,867, and 800,006 in 2005, 2004 and 2003,respectively. The average price paid per share in 2005, 2004, and 2003 was$27.29, $25.26, and $20.27, respectively. As of December 31, 2005, theCompany could repurchase up to an additional 816,675 shares under the June 2005authorization.**

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Duringthe fourth quarter of 2005, share repurchase activity was as follows:
| Period                      | ** ** | ** ** | ** ** | **Total  Number of  Shares Purchased** | ** ** | **Average Price  Paid  Per Share** | ** ** | **Cumulative Shares  Purchased Pursuant  To June 15, 2005  Authorization** | ** ** | **Remaining Shares to  Purchase Pursuant to  June 15, 2005  Authorization** | ** ** |
|-----------------------------|------------|------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|
| October 2005           |       |       | 62,402     |                                             |       |                                         | $26.72     |                                                                                                |       |                                                                                                      | 265,237    |   |   |   | 876,136 |   |   |
| November 2005          |       |       | 59,461     |                                             |       |                                         | $28.29     |                                                                                                |       |                                                                                                      | 324,698    |   |   |   | 816,675 |   |   |
| December 2005          |       |       | —-    |                                             |       |                                         | —     |                                                                                                |       |                                                                                                      | 324,698    |   |   |   | 816,675 |   |   |
| Fourth Quarter 2005  Totals |       |       | 121,863    |                                             |       |                                         | $27.49     |                                                                                                |       |                                                                                                      | 324,698    |   |   |   | 816,675 |   |   |

 

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**ITEM 6.**                SELECTEDFINANCIAL DATA

**SelectedConsolidated Financial Data—Mid-State Bancshares**
| (In thousands—except per share data) | ** ** | ** ** | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**  | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-----------|------------|
| **Year Ended  December 31:**                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest Income (not taxable equivalent)                      |       | $          | 128,326    |       | $          | 109,936    |       | $          | 105,240    |       | $          | 109,332   |       | $ | 114,002 |   |
| Interest Expense                                              |       | 15,503     |       | 8,450      |       | 9,699      |       | 16,381     |       | 26,480     |       |
| Net Interest Income                                           |       | 112,823    |       | 101,486    |       | 95,541     |       | 92,951     |       | 87,522     |       |
| Provision for Loan Losses                                     |       | —     |       | (2,700     | )          | (969       | )          | 600        |       | 4,100      |       |
| Net Interest Income after provision for loan losses           |       | 112,823    |       | 104,186    |       | 96,510     |       | 92,351     |       | 83,422     |       |
| Non-interest income                                           |       | 21,441     |       | 27,764     |       | 29,059     |       | 24,321     |       | 23,254     |       |
| Non-interest expense                                          |       | 77,674     |       | 79,294     |       | 74,691     |       | 70,925     |       | 64,744     |       |
| Income before income taxes                                    |       | 56,590     |       | 52,656     |       | 50,878     |       | 45,747     |       | 41,932     |       |
| Provision for income taxes                                    |       | 19,099     |       | 17,547     |       | 17,714     |       | 15,892     |       | 14,530     |       |
| Net Income                                                    |       | $          | 37,491     |       | $          | 35,109     |       | $          | 33,164     |       | $          | 29,855    |       | $ | 27,402 |   |
| **Per  share:**                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Income—basic                                         |       | $          | 1.65       |       | $          | 1.50       |       | $          | 1.41       |       | $          | 1.25      |       | $ | 1.22 |   |
| Net Income—diluted                                       |       | $          | 1.61       |       | $          | 1.47       |       | $          | 1.40       |       | $          | 1.20      |       | $ | 1.18 |   |
| Weighted avg. shares for Basic E.P.S. calculation        |       | 22,788     |       | 23,422     |       | 23,443     |       | 23,962     |       | 22,452     |       |
| Weighted avg. shares for Diluted E.P.S. calculation           |       | 23,300     |       | 23,897     |       | 23,762     |       | 24,837     |       | 23,252     |       |
| Cash dividends                                                |       | $          | 0.66       |       | $          | 0.58       |       | $          | 0.50       |       | $          | 0.41      |       | $ | 0.37 |   |
| Book value at period-end                                      |       | $          | 12.10      |       | $          | 11.89      |       | $          | 11.56      |       | $          | 10.72     |       | $ | 9.74 |   |
| Tangible book value at period-end                             |       | $          | 9.69       |       | $          | 9.48       |       | $          | 9.15       |       | $          | 8.94      |       | $ | 7.96 |   |
| Ending Shares                                                 |       | 22,520     |       | 23,099     |       | 23,567     |       | 23,697     |       | 24,089     |       |
| **Period Averages:**                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Assets                                                  |       | $          | 2,367,764  |       | $          | 2,269,873  |       | $          | 2,045,252  |       | $          | 1,892,137 |       | $ | 1,570,098 |   |
| Total Tangible Assets                                         |       | 2,312,889  |       | 2,213,639  |       | 2,000,406  |       | 1,850,671  |       | 1,558,507  |       |
| Total Loans & Leases                                 |       | 1,472,885  |       | 1,310,842  |       | 1,131,932  |       | 1,109,245  |       | 999,501    |       |
| Total Earning Assets                                          |       | 2,120,123  |       | 2,050,218  |       | 1,857,241  |       | 1,718,280  |       | 1,444,631  |       |
| Total Deposits                                                |       | 2,049,280  |       | 1,970,248  |       | 1,763,215  |       | 1,623,510  |       | 1,351,256  |       |
| Common Equity                                                 |       | 276,412    |       | 277,054    |       | 261,103    |       | 244,295    |       | 195,955    |       |
| Common Tangible Equity                                        |       | 221,537    |       | 220,820    |       | 217,982    |       | 202,829    |       | 184,364    |       |
| **At December 31,**                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                     |       | $          | 109,791    |       | $          | 112,669    |       | $          | 123,763    |       | $          | 128,036   |       | $ | 102,970 |   |
| Investments and Fed Funds Sold                                |       | 619,332    |       | 650,817    |       | 822,179    |       | 625,483    |       | 524,345    |       |
| Loans held for sale                                           |       | 10,176     |       | 12,988     |       | 13,410     |       | 22,560     |       | 13,604     |       |
| Loans, net of deferred fees, before allowance                 |       | 1,519,014  |       | 1,421,894  |       | 1,154,932  |       | 1,087,551  |       | 1,136,099  |       |
| Allowance for Loan & Lease Losses                    |       | (11,896    | )          | (13,799    | )          | (16,063    | )          | (17,370    | )          | (19,073    | )          |
| Goodwill and Core Deposit Intangibles                         |       | 54,323     |       | 55,572     |       | 56,947     |       | 40,949     |       | 42,021     |       |
| Other assets                                                  |       | 90,759     |       | 55,946     |       | 53,664     |       | 47,531     |       | 53,698     |       |
| Total Assets                                                  |       | $          | 2,391,499  |       | $          | 2,296,087  |       | $          | 2,208,832  |       | $          | 1,934,740 |       | $ | 1,853,664 |   |
| Non-interest bearing deposits                                 |       | $          | 567,782    |       | $          | 517,139    |       | $          | 487,624    |       | $          | 390,212   |       | $ | 367,370 |   |
| Interest bearing deposits                                     |       | 1,501,824  |       | 1,477,406  |       | 1,424,807  |       | 1,262,735  |       | 1,216,796  |       |
| Other borrowings                                              |       | 25,903     |       | 6,582      |       | 7,627      |       | 10,973     |       | 17,714     |       |
| Allowance for losses—unfunded commitments                |       | 1,761      |       | 1,783      |       | 1,941      |       | 1,771      |       | 1,586      |       |
| Other liabilities                                             |       | 21,667     |       | 18,550     |       | 14,279     |       | 14,914     |       | 15,647     |       |
| Shareholders’ equity                                     |       | 272,562    |       | 274,627    |       | 272,554    |       | 254,135    |       | 234,551    |       |
| Total Liabilities and Shareholders’ equity               |       | $          | 2,391,499  |       | $          | 2,296,087  |       | $          | 2,208,832  |       | $          | 1,934,740 |       | $ | 1,853,664 |   |
|                                                               |            |            |            |            |            |            |            |            |            |            |            |           |            |  |  |  |  |  |  |

 

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**Selected Consolidated Financial Data—Mid-StateBancshares (Continued)**
| (In thousands—except per share data) | ** ** | ** ** | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------|------------|
| **Asset  Quality**                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Non-accrual loans                                             |       | $          | 2,463      |       | $          | 10,700     |       | $          | 12,312     |       | $          | 16,748   |       | $ | 2,986 |   |
| Loans past due 90 days or more                                |       | —     |       | —     |       | —     |       | —     |       | 690        |       |
| Other real estate owned                                       |       | —     |       | —     |       | 3,428      |       | —     |       | —     |       |
| Total non performing assets                                   |       | $          | 2,463      |       | $          | 10,700     |       | $          | 15,740     |       | $          | 16,748   |       | $ | 3,676 |   |
| **Financial  Ratios**                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| For  the year:                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Return on assets                                              |       | 1.58       | %          | 1.55       | %          | 1.62       | %          | 1.58       | %          | 1.75       | %          |
| Return on tangible assets                                     |       | 1.62       | %          | 1.59       | %          | 1.66       | %          | 1.61       | %          | 1.76       | %          |
| Return on equity                                              |       | 13.56      | %          | 12.67      | %          | 12.70      | %          | 12.22      | %          | 13.98      | %          |
| Return on tangible equity                                     |       | 16.92      | %          | 15.90      | %          | 15.21      | %          | 14.79      | %          | 14.90      | %          |
| Net interest margin (not  taxable equivalent)                 |       | 5.32       | %          | 4.95       | %          | 5.14       | %          | 5.41       | %          | 6.06       | %          |
| Net interest margin (taxable  equivalent)(2)                  |       | 5.74       | %          | 5.36       | %          | 5.54       | %          | 5.74       | %          | 6.36       | %          |
| Net loan losses (recoveries)  to average loans                |       | 0.13       | %          | (0.03      | %)         | 0.06       | %          | 0.19       | %          | 0.22       | %          |
| Dividend Payout Ratio                                         |       | 40.0       | %          | 38.6       | %          | 35.3       | %          | 32.8       | %          | 30.3       | %          |
| Efficiency ratio                                              |       | 57.9       | %          | 61.3       | %          | 59.9       | %          | 60.5       | %          | 58.4       | %          |
| At  December 31:                                         |       |       |       |       |       |       |       |       |       |       |       |
| Equity to average assets  (leverage ratio)                    |       | 9.2        | %          | 9.3        | %          | 9.6        | %          | 10.6       | %          | 10.2       | %          |
| Tier One capital to  risk-adjusted assets                     |       | 11.6       | %          | 12.1       | %          | 13.8       | %          | 14.7       | %          | 13.8       | %          |
| Total capital to risk-adjusted  assets                        |       | 12.3       | %          | 13.0       | %          | 15.0       | %          | 16.0       | %          | 15.0       | %          |
| Loan loss allowance to loans,  gross(1)                       |       | 0.9        | %          | 1.1        | %          | 1.6        | %          | 1.8        | %          | 1.8        | %          |
| Non-accrual loans to total  loans, gross                      |       | 0.2        | %          | 0.8        | %          | 1.1        | %          | 1.5        | %          | 0.3        | %          |
| Non performing assets to total  assets                        |       | 0.1        | %          | 0.5        | %          | 0.7        | %          | 0.9        | %          | 0.2        | %          |
| Allowance for losses to non performing loans(1)               |       | 554        | %          | 146        | %          | 146        | %          | 114        | %          | 562        | %          |
|                                                               |            |            |            |            |            |            |            |            |            |            |            |          |            |  |  |  |  |  |  |  |  |  |  |

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(1)          Includes allowance forloan losses and allowance for losses-unfunded commitments.

(2)          Taxableequivalent converts tax exempt income as if it were taxable.

**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

***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, Inc. and Mid Coast Land Company(discussed above in Part I of this report and later in this Management’sDiscussion and Analysis). The Bank was founded in 1961 and operates a fullservice commercial banking business serving its customers on the Central Coastof California. Headquartered in Arroyo Grande, it operates 41 offices incommunities throughout San Luis Obispo, Santa Barbara and Ventura Counties andserves nearly 100 thousand households and 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 2006. Unless otherwise noted below, thediscussion and analysis section deals almost exclusively with the CommunityBanking segment of the Company. The other two segments, Mid-Coast Land Companyand Trust Services, contribute a small percentage (less than 3%) to the overallearnings of the Company.

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**2005 RESULTS AND ACCOMPLISHMENTS**

***Financial Summary***

The Company, on a consolidated basis, reported netincome of $37.5 million in 2005, $35.1 million in 2004 and $33.2 million in2003. The diluted Earnings Per Share (EPS) was $1.61 for 2005 compared to $1.47in 2004 and $1.40 in 2003. Consolidated total assets at December 31, 2005were $2.391 billion compared to $2.296 billion at December 31, 2004, up4.1%. Total deposits also increased from $1.995 billion as of December 31,2004 to $2.070 billion as of December 31, 2005. Shareholders’ commonequity stood at $272.6 million at year end down from its $274.6 million levelone year earlier. There were a number of factors working to both increase anddecrease this account which showed a net decline. Those factors working toincrease shareholders’ common equity included; 1) $37.5 million of net incomegenerated for the year and 2) $4.0 million received for the exercise of stockoptions. These were offset however by; 1) $15.0 million in dividends paid outduring 2005, 2) $23.1 million paid for the repurchase of common stockoutstanding, and 3) a $6.5 million reduction in accumulated other comprehensiveincome.

Thetable below illustrates net income by subsidiary unit.
| Income (Loss) by subsidiary (000’s) | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Bank only,  pre-tax                                          |       | $          | 55,097     |     | $          | 50,711   |       | $        | 48,684     |   |
| MSB Properties,  pre-tax                                     |       | 2,041      |       | 2,079    |       | 2,376    |       |
| Mid Coast Land  Co., pre-tax                                 |       | 705        |       | 654      |       | 556      |       |
| Parent only,  pre-tax                                        |       | (1,253     | )          | (788     | )          | (738     | )          |
| Tax (expense)                                                |       | (19,099    | )          | (17,547  | ))         | (17,714  | )          |
| Net Income—Mid-State  Bancshares                        |       | $          | 37,491     |     | $          | 35,109   |       | $        | 33,164     |   |

 

***Executive Summary***

Managementconsiders the following to be the most significant items affecting net incomeduring 2005 compared to 2004.

·       During2005, with the Federal Reserve orchestrating a number of increases in shortterm interest rates, the Prime Rate (to which many of the Company’s loans aretied) increased 8 times over the course of the year from 5.25% at the start ofthe year to 7.25% by the end of the year. Because of its general assetsensitivity, the Company saw an improvement in its net interest margin (from5.36% in 2004 to 5.74% in 2005, taxable equivalent). Coupled with a $69.9million increase in earning assets, this allowed the Company to show a $11.3million increase in net interest income.

·       TheCompany took a benefit to provision for loan losses of $2.7 million in 2004compared to no provision during 2005. 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, animproved outlook for the collection of the Company’s non accrual loans, and animproved outlook for economic activity in general. The Company did not need totake any benefit to the provision for loan losses in 2005. Because of the continuedquality of the portfolio, it also did not have to take a charge to theprovision for loan losses in 2005.

·       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 $88 thousand in 2005 and no OREO gains.

·       Thenet decrease in total non-interest expense amounted to $1.6 million in 2005compared to 2004. Factors contributing to this decrease included 1) decreasesin merchant credit card processing fees of $4.3 million on 2005 compared to2004; 2) increases in salaries and employee benefits of $2.8 

34

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million related primarilyto the Company’s incentive bonus program and 3) all other operating expensesincreasing by $180 thousand from one year to another. The decrease in merchantcredit card processing charges was a result of outsourcing this function to athird party. There was a similar drop in non-interest income.

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, animproved outlook for the collection of the Company’s non accrual loans, and animproved outlook 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 the non-interest expense amounted to $4.6 million in 2004 compared to 2003. Factorscontributing to this increase included 1) increases in outside professional servicesof $913 thousand related to Section 404 Sarbanes-Oxley compliance efforts;2) increases in advertising and promotional expenditures of approximately $1.0million in 2004 compared to 2003; 3) increases in costs reflecting the mergerwith Ojai Valley Bank effective October 31, 2003 which resulted in twomonths of costs in the 2003 figures compared to a full 12 months in 2004,estimated to be an increase of $1.4 million; 4) increase in employee benefitsprimarily related to workers compensation and group insurance increases of $198thousand (excluding the impact of the Ojai employees) and 5) all otheroperating expenses increasing by $11 million, net of declines—the primaryimpact being salary increases of $1.5 million (excluding the impact of Ojai employees).

·       There was a decline in thenet gains realized on mortgage loans sold of $2.8 million in 2004 compared to2003 as a result of the dramatic slowdown in refinance activity during theyear.

***Challenges and Opportunities in 2006***

Managementconsiders the following to be major challenges and opportunities for theCompany in 2006. They should be read in conjunction with the informationcontained in “Item 1A. Risk Factors.”

·       Thenumber of additional increases in short term interest rates that the Board ofGovernors of the Federal Reserve System will cause to occur in 2006. TheCompany’s asset and liability, maturity and rate structure are such that itsnet interest margin should improve in a rising rate environment. However, manypundits expect the number of additional increases in 2006 to be limited. Sincethe Company received benefit to its spread and its net interest margin from therate increases in 2005, the extent to which it may receive additional benefitin 2006 could be limited.

·       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. Loan growth in recentyears has been adequate, however, competition is intense and no assurance canbe given that in future periods the Company will be able to obtain a sufficientshare of the business available.

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·       Theability of the Company to generate new revenue sources either through newcustomers in existing or new markets, increased fees on existing products orthe introduction of new products. Because the Company is well capitalized andits stock price is trading at favorable multiples of book value and earnings,it is well positioned to make strategic acquisitions in selected markets butonly at valuation levels we find attractive.

·       Theability of the Company to contain salary and benefits costs which have risen inrecent years, especially in view of the expensing of stock options (initialestimates for 2006 put the impact at approximately $1.0 million pre-tax, or$0.03 per share—see Note 1 and Note 15 of the Notes to the ConsolidatedFinancial Statements which follows in Item 8 of this report) and the start-upcosts of new banking facilities (a branch office and commercial banking office)in the Westlake Village market.

·       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. The Company believes its expanded presence inVentura County will allow it to take advantage of the large and growingeconomic base in that part of its market area. Expansion into the WestlakeVillage market in the Spring of 2006 should enhance this effort.

·       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.

·       Theability of the Company to continue to be competitive on deposit and loanpricing in the face of intense competition from its competitors. Thesecompetitive pressures could affect both interest income in a downward mannerand deposit costs in an upward manner leading to a compression of the netinterest margin.

·       Theability of the Company to attract and retain qualified personnel.

·       Since the Company has thecapacity, it may increase its Other Borrowings during 2006 in an effort todiversify its funding sources and purchase earning assets which create a positivespread for the income statement, allowing it to more profitably leverage itsstrong capital base.

***Other Events and Items of Note in 2005***

The Company’s stockrepurchase program continued in 2005 with 845,055, shares repurchased, whichcompares to 658,867 and 800,006 shares repurchased in 2004 and 2003,respectively. The average price paid for the stock over this three year periodwas $27.29, $25.26, and $20.27, respectively. As of December 31, 2005, theCompany had 816,675 shares remaining to repurchase under its June 2005authorization approved by the Board of Directors to re-purchase up to 1,141,373additional shares. The authorization does not have an expiration date.

**EXTERNAL FACTORS IMPACTING THE BANK**

***Economic Conditions***

In last year’s annual report we noted that, “Managementis encouraged that 2005 should again be a solid year for the economy in theCompany’s trade area...... our local trade area again appears to be in a solidposition at the start of 2005 to continue the recovery underway and maintainlow unemployment rates. The Board of Governors of the Federal Reserve Systemhave started raising short term interest rates and Management expects thistrend to continue with the target Fed Funds rate reaching the mid 3% range byyear-end. Management also expects that longer term rates will rise much moremodestly, if at all, in-keeping with a continued trend towards a flatter yieldcurve.” We note that this forecast proved reasonably accurate. The FederalReserve increased short term rates throughout 2005 with the bellwether Federal 

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Funds Rate reaching 4.25%at December 31, 2005. While the national unemployment rate dropped from5.4% at the start of 2005 to 4.9% by the end of the year, locally, unemploymentrates also fell with San Luis Obispo County falling to 3.6% at the end of 2005compared to 4.0% at the start of the year and Santa Barbara County falling to4.1% from 4.8% one year earlier. The yield curve also, as expected, flatteneddramatically with the spread between the three month and ten year Treasurydeclining from 202 basis points at the start of 2005 to just 31 basis points atthe end of the year. The ten year Treasury is actually little changed from its4.24% level at the start of the year having closed at 4.39% at the end of 2005.Management is of the opinion that the flattening of the yield curve portrays ageneral belief that future inflation will be in-line with recent historicalexperience (e.g.—the Consumer Price Index was up 3.4% and 3.3% in 2005 and2004, respectively) and we have no reason to change that expectation. Notwithstandingspikes in energy prices, inflation does appear to be in check.

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 $82.0billion in 2005, up 6.9% from the $76.7 level in the prior year. Adjusted forreal dollars, it was up 3.7% following a 3.3% growth rate in 2004 and 3.2% in2003. These rates of growth were down from the double digit increases witnessedin the late 1990’s. For California as a whole, real Gross State Product was+4.5% in 2005, +4.6% in 2004 and +3.4% in 2003, slightly ahead of the TriCounty experience. Expectations by UCSB for 2006 are for further improvementswith the real State Product growing 3.8% and the real Tri County Gross Productgrowing somewhat slower at a 3.5% pace. A survey of business owners across thetri-county area conducted by UCSB in the third quarter of 2005 found generaloptimism with respect to expected business activity over the coming year. Surveyparticipants were queried, “Will you be expanding or downsizing your firm inthe next twelve months?” While 50.5% of the respondents said they did notexpect to expand or contract, fully 27.0% expected to expand 1% to 9% and 14.4%expected to expand 10% or more. In contrast, only 8.1% of respondents expectedto contract. Reflecting similar optimism, when asked, “In six months, do youexpect your firm to be better or worse off?”, over 58% expected to be betteroff or much better off compared to just 7% expecting to be worse off. All ofthis evidence indicates to Management that growth should continue in 2006 inthe local economy at similar levels to 2005 with nominal growth in the 6.5% to7.0% range and real growth in the 3% to 4% range.

Median home prices are at historical highs throughoutthe Bank’s service area. The median price of a home in 2005 is estimated tohave reached $539 thousand in San Luis Obispo County, up 21% from a yearearlier. In Santa Barbara County, that figure is estimated to have reached $685thousand, up 25% from one year earlier. And in Ventura County, the median homeprice is estimated to have grown at a somewhat slower 13% pace from one yearbefore. In spite of numerous residential building projects in the Bank’s tradearea and housing affordability indices falling below 20% in most locales, thelocal real estate market still appears relatively healthy with a combination ofhistorically low interest rate levels and demand ahead of supply. The strongtrends in both residential and non-residential real estate exhibited in recentyears are believed to be slowing somewhat though as we enter 2006. Lenderscontinue to be very prudent in their lending practices having learned thelessons of the early 1990’s and hence building is far less speculative. Collectively,all factors considered, Management does not see significant risk of a dramaticslowdown in real estate in 2006. However, Management would not be surprised tosee flat housing prices in 2006 or even some modest downward pressure onprices, as a correction to the dramatic increases seen over the past severalyears. It is also significant that high real estate prices have created ademographic trend of “aging” home owners replacing “working-class” residentswho find first time home ownership difficult. This is contributing to anout-migration by young families with working-aged heads of households. Theimpact of this demographic trend has implications on the local economy and thetypes of businesses that operate here with service and retail orientedbusinesses likely to be more predominant compared to manufacturing andindustrial type businesses.

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With positive indicatorscontinuing in the national economic statistics and a solid economic baselocally, Management is encouraged that 2006 should again be a positive yearoverall for the economy in the Company’s trade area. As mentioned last year,this optimism must be tempered by the potential for disruption resulting fromgeopolitical issues surrounding homeland security and terrorism. The effects ofepisodes such as the 9/11 terrorist attacks, the wars in Afghanistan and Iraq,and the international tensions surrounding these events, can have a significantimpact on economic activity. In spite of this caveat, our local trade areaagain appears to be in a solid position at the start of 2006 to continue solideconomic growth and maintain low unemployment rates. The Board of Governors ofthe Federal Reserve System are widely believed to be reaching the end of theirdrive to raise short term interest rates and Management expects only modestadditional increases with the target Fed Funds rate reaching the 5% range byyear-end. Management again expects that longer term rates will rise modestly,with a continuing flat yield curve in place through 2006.

***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, 68 financial institutions (banks andsavings institutions) operate 336 offices serving $24.6 billion in depositsbased on data as of June 30, 2005. These figures are up from 66institutions operating 321 offices with $23.1 billion in deposits one yearearlier. Additionally, while Management does not have specific metrics oncompetition from broker dealers, there is significant competition frombrokerage houses providing competing deposit and investment products. Also, “conduitfinancing” from Wall Street is competing with the Bank for larger loantransactions.

It should be noted thatthe trend toward consolidation of banking assets exhibited over the past fewyears in California continued in 2005. Statewide, 15 banks are merging out ofexistence based on announced merger transactions. According to the StateDepartment of Financial Institutions however, 21 new banks have filed in 2005to start a new bank in California, with 10 of those having been alreadyapproved.

**ANALYSISOF STATEMENT OF FINANCIAL POSITION**

***Loans***

The Bank experienced an increase in net loans from$1,408.1 million at the end of 2004, to $1,507.1 million at the end of 2005. Thisrepresents an increase in the loan portfolio of $99.0 million, or 7.0%,following the $269.2 million, or 23.6% increase in 2004. The loan portfoliorepresents approximately 63% of the Bank’s assets. Additionally, loans held forsale (which are single family residential mortgages pending sale) total $10.2million at the end of 2005, down from $13.0 million one year earlier.

 

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The graph above displays the trend over the five yearperiod ended December 31, 2005 in the various components of the loanportfolio, net of deferred loan fees. Construction loans have risen from theirlevel four years earlier—$215.0 million at December 31, 2001 compared to$277.6 million at year-end 2005. Real Estate loans generally trended up from$525.8 million at the end of 2001 to $814.6 million at the end of 2005. Thelarger growth in real estate loans, especially in recent years, reflects anexpanded use of jumbo adjustable rate mortgage loans in the portfolio ($131.0million at the end of 2005) along with the purchase of certain of these sametype of loan assets in the secondary market ($28.9 million at the end of 2005).

Home Equity Credit Lines have generally increased from$68.5 million at the end of 2001 compared to $182.1 million at the end of 2005.Consumer loans (installment and credit reserve) have decreased from $39.3million at December 31, 2001 to $21.4 million at year-end 2005. Commercialand other loans have generally declined to $187.4 million at December 31,2005. Agricultural production loans have remained flat, ending at $35.9 million.The Bank expects to continue to emphasize all types of lending activity inorder to diversify the risk in its portfolio. Economic activity in the CentralCoast will determine the types of credit the Bank will be able to extend andhence its ability to achieve this objective. For a discussion of the Company’sconcentrations in total real estate loans and in commercial real estate loans,see “Item 1A. Risk Factors.”

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TheBank’s allowances for losses collectively stand at $13.7 million, or 0.9% ofgross loans, and represents losses not yet realized, but inherent in the loanportfolio and on unfunded commitments. The allowances for losses was $15.6million at December 31, 2004. The year-end 2005 balance now represents554% of non-performing loans which is up from the 146% level at the end of 2004owing to a drop in non performing loans. A five-year review of activity in theallowance for losses and an allocation by loan type of the allowance is shownin the tables below.
| **Allowances for Losses (in 000’s)**                               | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Allowance for  loan losses beginning of year                                                |       | $          | 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 allowances  for losses                                                                |       | $          | 15,582     |     | $          | 18,004   |       | $        | 19,141     |     | $          | 20,659   |       | $ | 13,280 |   |
| Provision for  loan losses charged to operating expense       |       | —     |       | (2,700   | )          | (969     | )          | 600      |       | 4,100    |       |
| Provision for  losses—unfunded commitments (credited) charged to operating expense     |       | (22        | )          | (158     | )          | 170      |       | —   |       | —   |       |
| Adjustments—acquisition  through merger                                                |       | —     |       | —   |       | 391      |       | —   |       | 5,464    |       |
| Loans charged off:                                                                          |       |       |       |     |       |     |       |     |       |     |       |
| Real estate loans                                                                           |       | (2,234     | )          | (5       | )          | (1,106   | )          | —   |       | (7       | )          |
| Installment loans                                                                           |       | (181       | )          | (148     | )          | (234     | )          | (275     | )          | (275     | )          |
| Commercial loans                                                                            |       | (741       | )          | (746     | )          | (488     | )          | (2,475   | )          | (2,377   | )          |
| Credit cards and related loans                                                              |       | (75        | )          | (41      | )          | (66      | )          | (88      | )          | (255     | )          |
| Recoveries of loans  previously charged off:                                                |       |       |       |     |       |     |       |     |       |     |       |
| Real estate loans                                                                           |       | 34         |       | 41       |       | 45       |       | 24       |       | 149      |       |
| Installment loans                                                                           |       | 70         |       | 111      |       | 96       |       | 196      |       | 186      |       |
| Commercial loans                                                                            |       | 1,200      |       | 1,179    |       | 963      |       | 451      |       | 309      |       |
| Credit cards and related loans                                                              |       | 24         |       | 45       |       | 61       |       | 49       |       | 85       |       |
| ***Total Allowances for Losses***                                                           |       | $          | 13,657     |     | $          | 15,582   |       | $        | 18,004     |     | $          | 19,141   |       | $ | 20,659 |   |
|                                                                                             |            |            |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| Allocation of Allowance for  Losses (in 000’s)                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Allowance for  loan losses                                                     |       | $          | 11,896     |       | $          | 13,799     |       | $          | 16,063     |       | $          | 17,370     |       | $ | 19,073 |   |
| Allowance for  losses—unfunded commitments                                |       | 1,761      |       | 1,783      |       | 1,941      |       | 1,771      |       | 1,586      |       |
| ***Total Allowance for Losses***                                               |       | $          | 13,657     |       | $          | 15,582     |       | $          | 18,004     |       | $          | 19,141     |       | $ | 20,659 |   |
| Ratio of Net Loan Losses  to Average Loans Outstanding     |       | 0.13       | %          | (0.03      | %)         | 0.06       | %          | 0.19       | %          | 0.22       | %          |
|                                                                                |            |            |            |            |            |            |            |            |            |            |            |            |            |  |  |  |  |  |  |  |  |  |

 

Allocation of the allowance for losses compared to loantype as a percent of total at December 31:
| (dollars in 000’s)  Balance applicable to: | ** ** | ** ** | ** ** | **2005** | ** ** | **Type  as a % of  Loans** | ** ** | **2004** | ** ** | **Type  as a % of  Loans** | ** ** | **2003** | ** ** | **Type  as a % of  Loans** | ** ** | **2002** | ** ** | **Type  as a % of  Loans** | ** ** | **2001** | ** ** | **Type  as a % of  Loans** | ** ** |
|---------------------------------------------------------------------|------------|------------|------------|----------|------------|-------------------------------------------|------------|----------|------------|-------------------------------------------|------------|----------|------------|-------------------------------------------|------------|----------|------------|-------------------------------------------|------------|----------|------------|-------------------------------------------|------------|
| Construction and Land                                               |       | $          | 1,655      |     |       | 18.4                                      | %          |     | $          | 5,120                                     |       |     | 16.1       | %                                         |       | $        | 2,680      |                                      |       | 20.8     | %          |                                      | $          | 2,636 |   |   | 19.7 | % |   | $ | 1,969 |   |   | 18.8 | % |   |
| Real Estate                                                         |       | 4,277      |       |     | 53.6       | %                                         |       | 1,757    |       |                                      | 53.5       | %        |       | 2,164                                     |       |     | 49.1       | %                                         |       | 4,047    |       |                                      | 48.4       | % |   | 2,949 |   |   | 46.8 | % |   |
| H.E.C.L.                                                            |       | 735        |       |     | 12.0       | %                                         |       | 308      |       |                                      | 11.2       | %        |       | 250                                       |       |     | 7.8        | %                                         |       | 295      |       |                                      | 6.8        | % |   | 443 |   |   | 6.0 | % |   |
| Installment                                                         |       | 226        |       |     | 1.2        | %                                         |       | 160      |       |                                      | 1.3        | %        |       | 244                                       |       |     | 2.2        | %                                         |       | 254      |       |                                      | 2.5        | % |   | 780 |   |   | 3.1 | % |   |
| Credit Card and Related                                             |       | 76         |       |     | 0.2        | %                                         |       | 86       |       |                                      | 0.3        | %        |       | 229                                       |       |     | 0.6        | %                                         |       | 97       |       |                                      | 0.3        | % |   | 393 |   |   | 0.3 | % |   |
| Commercial, Other                                                   |       | 3,879      |       |     | 14.6       | %                                         |       | 3,237    |       |                                      | 17.6       | %        |       | 6,468                                     |       |     | 19.5       | %                                         |       | 6,296    |       |                                      | 22.3       | % |   | 5,712 |   |   | 25.0 | % |   |
| Unfunded commitments                                                |       | 1,761      |       |     | N/A        |                                      |       | 1,783    |       |                                      | N/A        |     |       | 1,941                                     |       |     | N/A        |                                      |       | 1,771    |       |                                      | N/A        |   |   | 1,586 |   |   | N/A |   |   |
| Unallocated                                                         |       | 1,048      |       |     | N/A        |                                      |       | 3,131    |       |                                      | N/A        |     |       | 4,028                                     |       |     | N/A        |                                      |       | 3,745    |       |                                      | N/A        |   |   | 6,827 |   |   | N/A |   |   |
|                                                                     |            |            |            |          |            |                                           |            |          |            |                                           |            |          |            |                                           |            |          |            |                                           |            |          |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| ***Balance at End of Year*** |   | $ | 13,657 |   |   | 100.0 | % |   | $ | 15,582 |   |   | 100.0 | % |   | $ | 18,004 |   |   | 100.0 | % |   | $ | 19,141 |   |   | 100.0 | % |   | $ | 20,659 |   |   | 100.0 | % |   |
|------------------------------|--------|---|--------|--------|--------|-------|---|--------|---|--------|--------|--------|-------|---|--------|---|--------|--------|--------|-------|---|--------|---|--------|--------|--------|-------|---|--------|---|--------|--------|--------|-------|---|--------|

 

During 2005, we enhanced our methodology fordetermining the appropriate level of allowance for loan and lease losses. Whileour methodology had always consisted of two key components, an individual loanimpairment component and a pool loan analysis component, the enhancement madein 2005 introduced improved methodology incorporating increased analysis ofloss exposure associated with both historical loss rates and known qualitativefactors present in various major segments of the loan portfolio. 

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The prior methodologyrelied on loss factors that provided results not significantly different fromthe results of our enhanced methodology. However, with this enhancement, therewas a reallocation in the unallocated portion of the allowance for loan losseswhich was attributable, at least in part, to the enhanced calculation of lossexposure compared to prior years.

Non-accrual loans within the Bank’s portfoliodecreased from $10.7 million as of December 31, 2004, to $2.5 million, atthe end of 2005. Loans 90 days or more past due, and still accruing, remainedat zero for the periods ending December 31, 2004 and December 31,2005. Additional information on non-accrual loans, past due loans and troubleddebt restructurings can be found in Footnote 5 to the financial statements. Overhalf of the level of non-accrual loans at the end of 2005 is centered in onerelationship (total $1.4 million). Management has established specific reservesthat would offset potential losses, if any, arising from less than fullrecovery of the loan from the supporting collateral. Recoveries in 2005 ofloans previously charged-off totaled $1.3 million compared to charge-offs of$3.2 million taken during the year resulting in net charge-offs of $1.9 million.This figure compares to net recoveries of $0.4 million and net charge-offs of$0.7 million in 2004 and 2003, respectively.

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 quarterly to, among other things, review the reasonableness ofindividual asset classifications. Management, as necessary, adjusts theallowance on a regular basis. The allowance is also examined annually by one ormore of the Bank’s regulatory bodies including the FDIC and DFI. During 2004,Management took a benefit to the provision for loan losses of $2.7 million. Noprovision for loan losses was taken during 2005. These actions reflected strongcredit quality standards, consistent performance of the loan portfolio inrecent years, improving trends in classified loans, improving trends indelinquencies, modest levels of net charge-offs in recent years, a positiveoutlook for the collection of the Company’s non accrual loans, and a positiveoutlook for economic activity in general. The need for additional provision forloan losses or for further benefit to the provision for loan losses in 2006will be dependent upon Management’s on-going analysis of the adequacy of theallowance for loan losses. While Management believes it 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.

The allowance for losses consists of an allocatedportion based on historical average loss experience adjusted for known expectedloss factors 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 “additionalportion” 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 a great deal of discussionsurrounding a possible slow down and/or drop in value of residential realestate in the Bank’s service area. While long term interest rates remainrelatively low and the Bank’s service area is marked by limited supply andhealthy demand, residential projects financed by the Bank are underwritten witha requirement of a percentage of cash equity to the total cost of the projectin addition to prudent exposures to current appraised values. To furthermitigate this risk, individual projects financed are analyzed using direct,current and historical project trends with limitations to production unit startsahead of sales using the projected absorption analysis contained in theappraisal of each project. The Bank believes, based upon past experience, thatthis process helps mitigate against the production of a supply of units thatwould exceed the current market demand.

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Additionally, due to the popularity of our market areato urban retirees and others wanting to enjoy the environment and lifestyle 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.  Management does not see significant risk of adramatic slowdown in real estate in 2006. However, Management would not besurprised to see flat housing prices in 2006 or even some modest downwardpressure on prices, as a correction to the dramatic increases seen over thepast several years.

Asummary of maturities and sensitivities of loans to changes in interest ratesat December 31, 2005 is shown in the table below. A more completediscussion of the Bank’s exposure to changes in interest rates can be found inthe MD&A under the section titled “Net Interest Income and Interest RateRisk”.

***Loan Portfolio asof 12/31/05***
| (dollars in 000’s)  Fixed Rate Loans | ** ** | ** ** | ** ** | **3 Months  or less** | ** ** | **Over  3 through  12 Months** | ** ** | **Due after  After 1 to  3 Years** | ** ** | **Due After  After 3 to   5 Years** | ** ** | **Due After  5 Years** | ** ** | **Total** | ** ** |       |
|---------------------------------------------------------------|------------|------------|------------|---------------------------------|------------|------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------|------------|-----------|------------|------------|
| Construction/Land  Development                                |       |       | 22,210     |                            |       |                                     | 22,693     |                                                   |       | 12,792                                                       |       |                             | 914        |      |       |       | 3,921 |   |   | 62,530 |   |
| Real estate                                                   |       |       | 70         |                            |       |                                     | 17,234     |                                                   |       | 26,167                                                       |       |                             | 44,024     |      |       |       | 219,670 |   |   | 307,165 |   |
| Home equity  credit lines                                     |       |       | —     |                            |       |                                     | —     |                                                   |       | —                                                       |       |                             | —     |      |       |       | 289 |   |   | 289 |   |
| Installment                                                   |       |       | 259        |                            |       |                                     | 661        |                                                   |       | 3,306                                                        |       |                             | 6,832      |      |       |       | 5,719 |   |   | 16,777 |   |
| Cash reserve                                                  |       |       | 19         |                            |       |                                     | —     |                                                   |       | —                                                       |       |                             | —     |      |       |       | — |   |   | 19 |   |
| Agricultural  production                                      |       |       | 147        |                            |       |                                     | 2,283      |                                                   |       | 4,726                                                        |       |                             | —     |      |       |       | — |   |   | 7,156 |   |
| Commercial, other                                             |       |       | 1,089      |                            |       |                                     | 2,351      |                                                   |       | 17,908                                                       |       |                             | 32,547     |      |       |       | 18,357 |   |   | 72,252 |   |
| **Total**                                                     |       | ** ** | **23,794** |                            | ** ** | ** **                               | **45,222** |                                                   | ** ** | **64,899**                                                   |       | ** **                       | **84,317** |      | ** ** | ** ** | **247,956** |   | ** ** | **466,188** | ** ** |
|                                                               |            |            |            |                                 |            |                                          |            |                                                        |            |                                                              |            |                                  |            |           |            |            |  |  |  |  |  |  |  |  |  |  |  |

 
| Variable Rate Loans                                                                                | ** ** | ** ** | ** **  | **3 Months  or less** | ** ** | **Over  3 through  12 Months** | ** ** | **Due after  After 1 to  3 Years** | ** ** | **Due After  After 3 to   5 Years** | ** ** | **Due After  5 Years** | ** **  | **Total** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------|-------------|---------------------------------|------------|------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------|-------------|-----------|------------|
| Construction/Land  Development                                                                               |       |       | 185,907     |                            |       |                                     | 13,144     |                                                   |       | 11,515                                                       |       |                             | 3,592       |      |       |   | 2,728 |   |   | 216,886 |   |
| Real estate                                                                                                  |       |       | 119,345     |                            |       |                                     | 20,960     |                                                   |       | 158,088                                                      |       |                             | 183,131     |      |       |   | 28,265 |   |   | 509,789 |   |
| Home equity  credit lines                                                                                    |       |       | 181,768     |                            |       |                                     | —     |                                                   |       | —                                                       |       |                             | —      |      |       |   | — |   |   | 181,768 |   |
| Installment                                                                                                  |       |       | 1,255       |                            |       |                                     | —     |                                                   |       | —                                                       |       |                             | —      |      |       |   | — |   |   | 1,255 |   |
| Cash reserve                                                                                                 |       |       | 3,348       |                            |       |                                     | —     |                                                   |       | —                                                       |       |                             | —      |      |       |   | — |   |   | 3,348 |   |
| Agricultural  production                                                                                     |       |       | 28,742      |                            |       |                                     | —     |                                                   |       | —                                                       |       |                             | —      |      |       |   | — |   |   | 28,742 |   |
| Commercial, other                                                                                            |       |       | 105,656     |                            |       |                                     | —     |                                                   |       | 69                                                           |       |                             | 8,780       |      |       |   | — |   |   | 114,505 |   |
| **Total**                                                                                                    | ** ** | ** ** | **626,021** |                            | ** ** | ** **                               | **34,104** |                                                   | ** ** | **169,672**                                                  | ** ** | ** **                       | **195,503** |      | ** ** | ** ** | **30,993** |   | ** ** | **1,056,293** | ** ** |
| **Total loans, gross (excludes  allowance for loan losses, net deferred loan fees and loans held for sale)** | ** ** | ** ** | ** **  |                            | ** ** | ** **                               | ** ** |                                                   | ** ** | ** **                                                   | ** ** | ** **                       | ** **  |      | ** ** | ** ** | ** ** |   | ** ** | **1,522,481** | ** ** |

 

***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 of2005 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 theinvestment portfolio declined. The Treasury and Agency portion of the portfoliodecreased by $4.9 million from one year ago. Holdings in the Municipal Bondportfolio were reduced from $377.0 million at the end of 2004 to $356.7 millionat the end of 2005. In total, the Bank decreased its investment portfolio from$644.8 million at the end of 2004 to $619.3 million at the end of 2005, a $25.5million decrease.

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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 $0.4 millionincluded in accumulated other comprehensive income as of December 31, 2005compared to an unrealized gain of $6.9 million at December 31, 2004, netof related taxes. Maturities and sales over the full year exceeded purchasesand the total investment portfolio decreased by $25.5 million from the end of2004 to the end of 2005.

Shownbelow is a summary maturity distribution of the investment portfolio, by typeand weighted taxable equivalent yield as of December 31, 2005. 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.
| (dollars in 000’s) | ** ** | ** ** | ** ** | **One Year  Or Less** | ** ** | **After One  Year to  Five Years** | ** ** | **After Five  Years to  Ten Years** | ** ** | **After  Ten Years** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|------------|------------|---------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------|------------|-----------|------------|
| Maturity  Distribution:           |       |       |       |                            |       |                                              |       |                                               |       |                      |       |      |       |
| U.S. Treasury Securities          |       | $          | 11,867     |                            | $          | 10,279                                            |       | $                                                  | 500        |                      |       | $         | —     |   |   | $ | 22,646 |   |
| U.S. Government Agencies          |       | 114,716    |       | 99,871                          |       | —                                            |       |                                               | —     |                      |       | 214,587   |       |
| Mortgage Backed Securities        |       | 110        |       | 2,385                           |       | 4,394                                             |       |                                               | 2,050      |                      |       | 8,939     |       |
| Municipal Bonds, Other            |       | 38,564     |       | 179,541                         |       | 146,813                                           |       |                                               | 8,242      |                      |       | 373,160   |       |
| Total                             |       | $          | 165,257    |                            | $          | 292,076                                           |       | $                                                  | 151,707    |                      |       | $         | 10,292     |   |   | $ | 619,332 |   |
|                                   |            |            |            |                                 |            |                                                   |            |                                                    |            |                           |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                            | ** ** | **One Year  Or Less** | ** ** | **After One  Year to  Five Years** | ** ** | **After Five  Years to  Ten Years** | ** ** | **After  Ten Years** | ** ** | ** ** | **Total** | ** ** |
|----------------------------|------------|---------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------|------------|------------|-----------|------------|
| Weighted  Average Yield:   |       |                            |       |                                              |       |                                               |       |                      |       |       |      |       |
| U.S. Treasury Securities   |       | 2.42                            | %          | 4.03                                              | %          | 4.22                                               | %          | —                    |       |       | 3.10      | %          |
| U.S. Government Agencies   |       | 2.53                            | %          | 4.27                                              | %          | —                                             |       | —                    |       |       | 3.34      | %          |
| Mortgage Backed Securities |       | 6.16                            | %          | 6.64                                              | %          | 5.74                                               | %          | 5.63                      | %          |       | 5.96      | %          |
| Municipal Bonds, Other     |       | 6.27                            | %          | 5.89                                              | %          | 5.45                                               | %          | 6.00                      | %          |       | 5.76      | %          |
| Total                      |       | 3.40                            | %          | 4.45                                              | %          | 5.46                                               | %          | 5.93                      | %          |       | 4.44      | %          |

 

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

The Company did not holdany OREO from foreclosure as of December 31, 2005 or 2004. Future OREOactivity will depend, among other things, on how many borrowers the Bank mayneed to foreclose upon, and the strength of the real estate market and generaleconomic activity.

***Goodwill and Core Deposit Intangibles***

Goodwill totaled $47.8 million at December 31,2005 and 2004. 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 relates to a May 3,1996 acquisition of Citizens Bank of Paso Robles by BSM Bancorp which theCompany acquired in 1998.

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On an annual basis, the Company tests its Goodwill forimpairment. The Goodwill is entirely attributable to the Company’s communitybanking segment. Results of these tests have indicated that there was noimpairment of Goodwill in any of the past four years (2002 through 2005) sincethe testing commenced.

Core deposit intangiblestotal $6.5 million at December 31, 2005 compared to $7.7 million one yearearlier. Of  the year-end 2005 amounts,$4.4 million represents the net un-amortized value of the core depositintangible created with the American Commercial Bank acquisition and $2.1million represents the net un-amortized value of the core deposit intangiblecreated upon the acquisition of Ojai Valley Bank. In connection with theseacquisitions, the Company recognizes core deposit intangibles that representthe fair value of long-term deposit relationships acquired. Such amounts arethen amortized over expected useful remaining economic lives. During 2005, theCompany adjusted the amortization rate of the Core Deposit Intangibleassociated with the American Commercial Bank acquisition due to a greaterretention rate of the original core deposit base than was originallycontemplated at the time of the acquisition in 2001. No adjustments to the OjaiValley Bank related Core Deposit Intangible have been necessary. Absentadjustments to the amortization schedules in future periods, the core depositintangibles are now scheduled to be fully amortized in September 2013 withrespect to the American Commercial Bank acquisition and October 2012 withrespect to the Ojai Valley Bank acquisition and the total amount of theamortization is projected to be $872 thousand in 2006. This charge to expenseis carried under other operating expense on the consolidated statements ofincome.

***Senior Housing Crime Prevention Foundation Investment***

The Bank owns a $30million holding of the Preferred Stock of Senior Housing Crime PreventionFoundation Investment Corporation (SHCPF-I) which is carried under a separatecaption on the Consolidated Statement of Financial Positions. That investmentis secured by a federal agency security issued by FNMA. The Bank has the rightafter five years on April 29, 2010 to require SHCPF to redeem all or apart of the shares of the Preferred Stock. Dividends are paid to the Bank onthe Preferred Stock at a rate which is 1.875% below the interest earned on theunderlying FNMA agency security. This 1.875% differential is used by SHCPF tofund the various programs of the Senior Housing Crime Prevention Foundation at53 nursing home facilities in the Bank’s tri-county service area. Theseinclude, among other things, the senior crime stoppers program which isreducing crimes against the elderly living in those facilities. The benefits tothe Bank of this program include full Community Reinvestment Act (CRA) creditfor our $30 million investment, positive public relations, and significantmarketing opportunities with the operators of the facilities, their owners,Board of Directors, employees, family members and residents.

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***Deposits***

Whilethe Bank is competitive with major institutions in terms of its structure ofinterest rates on deposit products offered, Management was not aggressiveduring 2005 in terms of pricing to attract additional deposits, a decisionwhich reflected the Bank’s liquidity through the year. As discussed in theIncome Statement Analysis, many of the Bank’s deposit rates have risen invarying degrees in response to the general increase in rates. A comparison ofthe rates paid on the Bank’s deposit products at December 31, 2005 and2004 is as follows:

| **Selected Quoted Interest Rates**    | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|------------|------------|
| Demand Deposits                                      | ** ** | 0          | %          | 0        | %          |     | 0          | %          |       |
| NOW Account  (50 & Better—over $2,500) | ** ** | 0.25       | %          | 0.10     | %          |     | 0.15       | %          |       |
| Money Market  Deposits (over $100,000)               | ** ** | 1.15       | %          | 0.80     | %          |     | 0.35       | %          |       |
| Passbook Savings  Account                            | ** ** | 0.50       | %          | 0.25     | %          |     | 0.25       | %          |       |
| Individual  Retirement  Account (2 Year term)        | ** ** | 3.60       | %          | 2.75     | %          |     | 0.85       | %          |       |
| Time Deposit****($100,000—6 month term)         | ** ** | 3.20       | %          | 1.85     | %          |     | 1.35       | %          |       |
| Wall Street Journal  Prime Rate                      | ** ** | 7.25       | %          | 5.25     | %          |     | 2.00       | %          |       |

 

Averagedeposits have risen steadily over the past three years reflecting growth at theBank’s existing offices and the acquisition of Ojai Valley Bank on October 31,2003 which had deposits of approximately $78.8 million at the time of theacquisition. Below is a summary of the average deposits outstanding and theaverage rate paid by category over the last three years.

| ** **                                                    | ** ** | **Average** | ** ** | **2005**    | ** ** | ** **   | ** ** | **Average** | ** ** | **2004**    | ** ** | ** **   | ** ** | **Average** | ** ** | **2003**    | ** ** | ** **   | ** ** |
|---------------------------------------------------------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|--------------|------------|
| **(dollars in 000’s)**                         | ** ** | ** **  | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Interest Bearing Demand and  Money Market Investment Accounts |       | $           | 765,491    |        |       | $            | 3,271      |        |       |        | 0.43       | %            |       | $           | 741,230    |        |       | $            | 1,712      |   |   |   | 0.23 | % |   | $ | 651,285 |   |   | $ | 1,527 |   |   |   | 0.23 | % |   |
| Savings Accounts                                              |       | 317,370     |       |        | 1,502      |         |       |        | 0.47       | %           |       | 322,665      |       |        | 853        |        |       |         | 0.26       | % |   | 287,435 |   |   | 1,077 |   |   |   | 0.37 | % |   |
| Time Deposits                                                 |       | 414,883     |       |        | 9,837      |         |       |        | 2.37       | %           |       | 399,806      |       |        | 5,691      |        |       |         | 1.42       | % |   | 399,448 |   |   | 6,944 |   |   |   | 1.74 | % |   |
| Total Interest Bearing Deposits                               |       | 1,497,744   |       |        | 14,610     |         |       |        | 0.98       | %           |       | 1,463,701    |       |        | 8,256      |        |       |         | 0.56       | % |   | 1,338,168 |   |   | 9,548 |   |   |   | 0.71 | % |   |
| Non Interest Bearing Demand                                   |       | 551,536     |       |        | —     |         |       |        | —     |        |       | 506,547      |       |        | —     |        |       |         | —     |   |   | 425,047 |   |   | — |   |   |   | — |   |   |
| Total Deposits                                                |       | $           | 2,049,280  |        |       | $            | 14,610     |        |       |        | 0.71       | %            |       | $           | 1,970,248  |        |       | $            | 8,256      |   |   |   | 0.42 | % |   | $ | 1,763,215 |   |   | $ | 9,548 |   |   |   | 0.54 | % |   |
|                                                               |            |             |            |             |            |              |            |             |            |             |            |              |            |             |            |             |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Themajority of the Bank’s time deposits (approximately 53%) have balances that areunder $100,000. While all time deposits are somewhat more rate sensitive thanthe Bank’s other deposit categories, the smaller time deposit balances tend tobe more stable and less sensitive to absolute rate levels than do time depositsof $100,000 or more. Approximately 90% of the Bank’s time deposits maturewithin one year and would be potentially subject to a change in rate on theirmaturity date. The following table as of December 31, 2005, displayssummary size and maturity information on the Bank’s time deposits.

| ** **                            | ** ** | **Three**          | ** ** | **After Three** | ** ** | **After Six**  | ** ** | ** **        | ** ** | ** **        | ** ** |
|---------------------------------------|------------|--------------------|------------|----------------------|------------|---------------------|------------|-------------------|------------|-------------------|------------|
| **(dollars in 000’s)** | ** ** | **Months or** | ** ** | **Months to**   | ** ** | **Months to**  | ** ** | **After**         | ** ** | ** **        | ** ** |
| **Balance by Size**         | ** ** | ** **         | ** ** | **Less**             | ** ** | **Six Months** | ** ** | **One Year** | ** ** | **One Year** | ** ** | **Total** | ** ** |
| Under $100,000                        |       | $                  | 89,028     |                 |       | $                   | 64,935     |              |       |              | $          | 46,156 |   |   |   | $ | 32,156 |   |   | $ | 232,275 |   |
| $100,000 or More                      |       | 109,782            |       |                 | 56,954     |                |       |              | 23,663     |              |       |   | 11,664 |   |   | 202,063 |   |
| Total  Time Deposits                  |       | $                  | 198,810    |                 |       | $                   | 121,889    |              |       |              | $          | 69,819 |   |   |   | $ | 43,820 |   |   | $ | 434,338 |   |
|                                       |            |                    |            |                      |            |                     |            |                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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***Other Borrowings***

Whilenot a significant component of the Bank’s structure, other borrowings were$25.9 million, at the end of 2005 compared to $6.6 million at the end of 2004. Theseconsist of borrowings under the U.S. Treasury Tax and Loan note account andFederal Home Loan Bank (FHLB) borrowings. The Bank had outstanding borrowingsof $3.9 million and $4.6 million at December 31, 2005 and 2004,respectively, under the U.S. Treasury Tax and Loan note account program. TheBank had two borrowings from the FHLB totaling $22.0 million at December 31,2005 and one for $2.0 million at December 31, 2004. The two borrowings atthe end of 2005 were structured as follows:

| **Description**            | ** ** | ** ** | ** ** | **Issue Date** | ** ** | **Rate**   | ** ** | **Maturity** | ** ** | **Principal** | ** ** |
|----------------------------|------------|------------|------------|---------------------|------------|------------|------------|--------------|------------|---------------|------------|
| Fixed Rate Credit  Advance | ** ** |       | 06/25/01   |                |       | 6.16       | %          | 06/27/11     |       | $             | 2,000,000  | ** ** |
| Fixed Rate Credit  Advance |       |       | 01/20/05   |                |       | 3.74       | %          | 01/22/08     | * *   | $             | 20,000,000 | * * |
| Total                      | ** ** |       |       |                | ** ** | ** ** | ** ** | ** **   | ** ** | $             | 22,000,000 | ** ** |

 

While the $2.0 million borrowing above wasspecifically taken down to match fund a particular earning asset, the $20.0million borrowing funded general earning asset growth.

The Company may increaseits Other Borrowings during 2006 in an effort to diversify its funding sourcesand purchase earning assets which create a positive spread for the incomestatement, allowing it to more profitably leverage its strong capital base. Managementhad the ability at December 31, 2005 to borrow up to $110 million ofmostly shorter term borrowings (up to five years) from sources such as the FHLB.Funds raised from these sources may be used to fund earning assets such asinvestment securities or generate additional loans at sufficiently positivespreads to justify the additional leverage. In January of 2006, theCompany added $25.0 million of additional borrowings in the form of a five yearfixed rate credit advance at 4.75%.

***Liquidity and Capital Resources***

The focus of the Bank’s liquidity management is toensure its ability to meet cash requirements. Sources of liquidity includecash, 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.

A review of liquidity provided by operating activitiesfinds that this source has been relatively constant over the past three yearsat $52.3 million, $43.3 million and $49.8 million in 2005, 2004, and 2003,respectively. Net cash used in investing activities has declined from $174.7million in 2003 to $149.3 million in 2004 and $122.5 million in 2005 reflectinga net drop over this period in new loans and investments made. Net cashprovided by financing activities fell from $151.7 million in 2003 to $53.5million in 2004 and $61.3 million in 2005. The Company experienced slowerdeposit growth over the last couple of years compared to 2003.

The Bank has adequate liquidity at the present time. Itsloan to deposit ratio at year-end 2005 was 73.6% versus 71.3% 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 29.7% at December 31,2005 compared to 34.2% one year earlier. These levels are above the Bank’sminimum policy of 15%.

Management is not aware of any trend, demand,commitment or event that would result in a material change in the Bank’sliquidity at the present time.

The Company is dependent on the Bank for dividendpayments to conduct its stock repurchase program and to make dividends to itsshareholders. The Company declared cash dividends during 2005 of 

46

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$14,995,000 andrepurchased stock totaling $23,065,000. 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 $15,827,000 at December 31,2005 to the Company. The Bank can also apply to the (DFI) for the ability topay additional dividends to the Company. The Bank and Company expects to makesuch application during 2006 given the Company’s planned regular dividends andon-going stock repurchase program. Given the Bank’s strong capital position,Management does not expect such approval to be withheld. Indeed, at the Bank’srequest, it received approval to pay $5,000,000 in dividends to the HoldingCompany in the fourth quarter of 2005 so that it would not risk violating theCalifornia Financial Code requirements noted above for 2005.

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 two “riskbased” calculations known as “Tier One Risk Based Capital Ratio” and the “TotalRisk Based Capital Ratio.”  The Companyand the 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.

The Leverage Ratiocalculation simply divides common stockholders’ equity (reduced by goodwill andcertain other intangibles that a bank may have) by the total assets of the bank.In the Tier One Risk Based Capital Ratio, the numerator is the same as theleverage ratio, but the denominator is the total “risk-weighted assets” of thebank. Risk-weighted assets are determined by segregating all the assets andoff-balance sheet exposures into different risk categories and weighting themby a percentage ranging from 0% (lowest risk) to 100% (highest risk). The TotalRisk Based Capital Ratio again uses “risk-weighted assets” in the denominator,but expands the numerator to include other capital items besides equity such asa limited amount of the allowance for loan losses, long-term capital debt,preferred stock and other instruments. Summarized below are the capital ratiosat December 31, 2005 and 2004, for both Mid-State Bancshares and Mid-StateBank & Trust. Additionally, the standards for a well-capitalizedinstitution, as defined by the federal banking agencies, are displayed.

| ** **                        | ** ** | **Minimum**    | ** ** | **Well-Capitalized** | ** ** | **Mid-State**  | ** ** | **Mid-State**                  | ** ** |
|-----------------------------------|------------|----------------|------------|----------------------|------------|----------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **Regulatory** | ** ** | **Regulatory**       | ** ** | **Bancshares** | ** ** | **Bank & Trust** | ** ** |
| ** **                        | ** ** | **Standard**   | ** ** | **Standard**         | ** ** | **2005**       | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Leverage Ratio                    |       |           | 4.0%       |                 |       |           | 5.0%       |                           |       | 9.2% |   | 9.3% |   | 8.9% |   | 9.2% | ** ** |
| Tier One Risk Based Capital Ratio |       |           | 4.0%       |                 |       |           | 6.0%       |                           |       | 11.6% |   | 12.1% |   | 11.3% |   | 12.0% | ** ** |
| Total Risk Based Capital Ratio    | ** ** |           | 8.0%       |                 |       |           | 10.0%      |                           |       | 12.3% |   | 13.0% |   | 12.0% |   | 12.9% | ** ** |

 

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 alsomay 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.

| ** **                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend Payout  Ratio                   |       | 40.0     | %          | 38.6     | %          | 35.3     | %          |
| Average Common Equity to  Average Assets |       | 11.7     | %          | 12.2     | %          | 12.8     | %          |

 

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***Capital Commitments***

As of December 31,2005, neither the Company nor the Bank had any material commitment for capitalexpenditures.

***Contractual Obligations***

As of December 31,2005, the Bank had the following contractual obligations.

| ** **                     | ** ** | **Less Than** | ** ** | **One to Three** | ** ** | **Three to Five** | ** ** | **Over**            | ** ** | ** ** | ** ** |
|--------------------------------|------------|--------------------|------------|----------------------------|------------|-----------------------------|------------|---------------------|------------|------------|------------|
| ** **                     | ** ** | **One Year**  | ** ** | **Years**                  | ** ** | **Years**                   | ** ** | **Five Years** | ** ** | **Total**  | ** ** |
| Long Term Debt                 |       |               | $          | —                     |       |                        |       | $                   | 20,000     |       |       |   | $ | — |   |   |   | $ | 2,000 |   |   | $ | 22,000 |   |
| Operating Leases               |       |               | 2,435      |                       |       |                        | 4,398      |                |       |       | 3,692      |   |   |   | 4,218 |   |   | 14,743 |   |
| Total  Contractual Obligations |       |               | $          | 2,435                      |       |                        |       | $                   | 24,398     |       |       |   | $ | 3,692 |   |   |   | $ | 6,218 |   |   | $ | 36,743 |   |

 

***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 $40.9 million at December 31,2005, up from $30.2 million one year earlier. Additionally, the Company hasun-disbursed loan commitments, also made in the ordinary course of business,totaling $658.0 million, which was up from the $626.4 million outstanding oneyear earlier. The Company has an allowance for losses-unfunded commitmentstotaling $1,761,000 and $1,783,000 at December 31, 2005 and 2004, respectively,to cover losses inherent in its letter of credit accommodations andun-disbursed loan commitments.

There are no Special Purpose Entity (“SPE”) trusts,corporations, or other legal entities established by the Company or the Bankwhich reside off-balance sheet. There are no other off-balance sheet itemsother than the aforementioned items related to letter of credit accommodationsand un-disbursed loan commitments.

As noted in Footnote 5 to the financial statements,the Company does make loans and leases to related parties (directors andofficers) in the ordinary course of business at prevailing rates and terms. Theseloans and leases totaled $14.1 million and $8.7 million at the end of 2005 and2004, respectively. In addition, there were un-funded commitments to loan up toan additional $4,352,000 in extensions of credit to directors and executiveofficers at year-end 2005.

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**INCOME STATEMENT ANALYSIS**

***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 2005 was $112.8million, up from $101.5 million recorded in 2004 and $95.5 million in 2003. 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 2005, 2004, and 2003.

**ANALYSISOF CHANGES IN INTEREST INCOME AND EXPENSE**

| ** **                               | ** ** | ** **  | ** ** | ** **   | ** ** | ** **                          | ** ** | ** **  | ** ** | ** **   | ** ** | ** **       | ** ** | **2005 Compared to 2004** | ** ** |
|------------------------------------------|------------|-------------|------------|--------------|------------|-------------------------------------|------------|-------------|------------|--------------|------------|------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **2005**    | ** ** | **2004**     | ** ** | **Composition of Change** | ** ** |
| ** **                               | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average**                         | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average**      | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield /**                    | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield /** | ** ** | **Change Due To:**             | ** ** | **Total** | ** ** |
| **(dollars in 000’s)**    | ** ** | ** **  | ** ** | **Balance**  | ** ** | **Expense**                         | ** ** | **Rate**    | ** ** | **Balance**  | ** ** | **Expense**      | ** ** | **Rate**                                 | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
| *EARNING  ASSETS:*                       |       |        |       |         |       |                                |       |        |       |         |       |             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                    |       | $           | 1,472,885  |         | $          | 104,401                             |       |        | 7.09       | %            |       | $                | 1,310,842  |                                     | $          | 85,127 |   |   | 6.49 | % |   |   | $ | 11,004 |   |   | $ | 8,270 |   |   | $ | 19,274 |   |   |
| Investment Securities                    |       | 611,130     |       | 22,747       |       |                                | 3.72       | %           |       | 701,996      |       | 24,329           |       |                                     | 3.47       | % |   |   | (3,266 | ) |   | 1,684 |   |   | (1,582 | ) |   |
| Fed Funds, Other                         |       | 36,108      |       | 1,178        |       |                                | 3.26       | %           |       | 37,380       |       | 480              |       |                                     | 1.28       | % |   |   | (28 | ) |   | 726 |   |   | 698 |   |   |
| *TOTAL EARNING ASSETS*                   |       | $           | 2,120,123  |         | $          | 128,326                             |       |        | 6.05       | %            |       | $                | 2,050,218  |                                     | $          | 109,936 |   |   | 5.36 | % |   |   | $ | 7,710 |   |   | $ | 10,680 |   |   | $ | 18,390 |   |   |
| *INTEREST  BEARING LIABILITIES*          |       |        |       |         |       |                                |       |        |       |         |       |             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW, Savings, and Money Market  Accounts |       | $           | 1,082,861  |         | $          | 4,773                               |       |        | 0.44       | %            |       | $                | 1,063,895  |                                     | $          | 2,565 |   |   | 0.24 | % |   |   | $ | 65 |   |   | $ | 2,143 |   |   | $ | 2,208 |   |   |
| Time Deposits                            |       | 414,883     |       | 9,837        |       |                                | 2.37       | %           |       | 399,806      |       | 5,691            |       |                                     | 1.42       | % |   |   | 286 |   |   | 3,860 |   |   | 4,146 |   |   |
| Interest Bearing Deposits                |       | 1,497,744   |       | 14,610       |       |                                | 0.98       | %           |       | 1,463,701    |       | 8,256            |       |                                     | 0.56       | % |   |   | 351 |   |   | 6,003 |   |   | 6,354 |   |   |
| Other Borrowings                         |       | 23,117      |       | 893          |       |                                | 3.86       | %           |       | 4,401        |       | 194              |       |                                     | 4.41       | % |   |   | 774 |   |   | (75 | ) |   | 699 |   |   |
| *TOTAL INTEREST BEARING  LIABILITIES*    |       | 1,520,861   |       | 15,503       |       |                                | 1.02       | %           |       | 1,468,102    |       | 8,450            |       |                                     | 0.58       | % |   |   | 1,125 |   |   | 5,928 |   |   | 7,053 |   |   |
| *NET INTEREST INCOME*                    |       | $           | 2,120,123  |         | $          | 112,823                             |       |        | 5.32       | %            |       | $                | 2,050,218  |                                     | $          | 101,486 |   |   | 4.95 | % |   |   | $ | 6,585 |   |   | $ | 4,752 |   |   | $ | 11,337 |   |   |
|                                          |            |             |            |              |            |                                     |            |             |            |              |            |                  |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                               | ** ** | **2004**    | ** ** | **2003**     | ** ** | **2004 Compared to 2003  Composition of Change** | ** ** |
|------------------------------------------|------------|-------------|------------|--------------|------------|---------------------------------------------------------------------------|------------|
| ** **                               | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average**                                                               | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield /**                                                          | ** ** | **Average** | ** ** | **Income/** | ** ** | **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 | ) |   | (1,249 | ) |   |
| *NET INTEREST INCOME*                    |       | $           | 2,050,218  |         | $          | 101,486                                                                   |       |   | 4.95 | % |   | $ | 1,857,241 |   | $ | 95,541 |   |   | 5.14 | % |   |   | $ | 13,504 |   |   | $ | (7,559 | ) |   | $ | 5,945 |   |   |
|                                          |            |             |            |              |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

During 2005 there was a$18.4 million increase in interest income along with an increase of $7.1million in interest expense compared to 2004. The resulting $11.3 millionincrease in net interest income for 2005 was a result of a number of dynamicsaffecting both average balance and interest rate considerations. First, theCompany experienced an increase in its average earning assets outstanding of 

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$69.9million. The increase was primarily attributable to the net increase in higheryielding average loans, which were up by $162.0 million, offset by declines ininvestments outstanding of $90.9 million and fed funds sold of $1.3 million. Second,****while the Company’s average interest bearing liabilitiesincreased by $52.8 million, earning assets increased by a larger $69.9 million.Third, earning asset yields were higher in 2005 compared to the average for2004, and liability costs, while higher in 2005 also, did not increase asdramatically.

During 2004 there was a$4.7 million increase in interest income along with a decrease of $1.2 millionin interest expense compared to 2003. The resulting $5.9 million increase innet interest income for 2004 was a result of a number of dynamics affectingboth average balance and interest rate considerations. First, the Companyexperienced an increase in its average earning assets outstanding of $193.0million. The increase was primarily attributable to the net increase in averageloans, which were up by $178.9 million, and to a lesser extent to anincrease  in average investments of $61.1million. These increases were partially offset by a decrease in average federalfunds sold of $47.0 million. Second,****while theCompany’s average interest bearing liabilities increased by $125.5 million,earning assets increased by a larger $193.0 million. Third, earning assetyields were somewhat lower in 2004 compared to the average for 2003 andliability costs did not drop as quickly.

The Bank expects its riskexposure to changes in interest rates during 2006 to remain manageable and wellwithin acceptable policy ranges. A recent review as of the end of 2005 of thepotential changes in the Bank’s net interest income over a 12 month timehorizon showed that it could fluctuate under extreme alternative rate scenariosfrom between +3.8% and -7.3% of the base case (rates unchanged) of $126.1million. The Bank’s policy is to maintain a structure of assets and liabilitieswhich are such that net interest income will not vary more than plus or minus15% of the base forecast over the next 12 months. Management expects that itsexposure to interest rate risk is manageable and it will continue to strive foran optimal trade-off between risk and earnings.

Thefollowing table presents a summary of the Bank’s net interest income forecastedfor the coming 12 months under alternative interest rate scenarios.

|                                                  | ** ** | **Change  From Base** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| Rates Down Very Significant                      |       |                       | -7.3       | % |   |
| (Prime down from 7.25% to  4.25% over 11 months) |       |                       |       |   |   |
| Rates Down Significant                           |       |                       | -3.8       | % |   |
| (Prime down from  7.25% to 5.25% over 11 months) |       |                       |       |   |   |
| Rates Down Modestly                              |       |                       | -1.4       | % |   |
| (Prime down from 7.25% to  6.25% over 11 months) |       |                       |       |   |   |
| Base Case—Rates  Unchanged                  |       |                       | —     |   |   |
| (Prime unchanged  at 7.25% over 12 months)       |       |                       |       |   |   |
| Rates Up Modestly                                |       |                       | +1.1       | % |   |
| (Prime up from 7.25% to  8.25% over 11 months)   |       |                       |       |   |   |
| Rates Up  Aggressive                             |       |                       | +1.8       | % |   |
| (Prime up from  7.25% to 9.25% over 11 months)   |       |                       |       |   |   |
| Rates Up Very Aggressive                         |       |                       | +3.8       | % |   |
| (Prime up from 7.25% to  10.25% over 11 months)  |       |                       |       |   |   |

 

Net interest income underthe above scenarios is influenced by the characteristics of the Bank’s assetsand liabilities. In the case of N.O.W., savings and money market deposits(total $1.067 billion) interest is based on rates set at the discretion ofmanagement ranging from 0.25% to 1.15%. In a downward rate environment, thereis a limit to how far these deposit instruments can be re-priced and thisbehavior is similar to that of fixed rate instruments. In an upward rateenvironment, the magnitude and timing of changes in rates on these deposits isassumed to be more reflective of variable rate instruments.

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It is important to notethat the above table is a summary of several forecasts and actual results mayvary. The forecasts are based on estimates and assumptions of management thatmay turn out to be different and may change over time. Factors affecting theseestimates and assumptions include, but are not limited to—competitors’behavior, economic conditions both locally and nationally, actions taken by theFederal Reserve Board, customer behavior, and management’s responses. Changesthat vary significantly from the assumptions and estimates may have significanteffects on the Bank’s net interest income. Therefore the results of thisanalysis should 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 6.06% (not taxable equivalent). TheBank’s net interest margin in 2005 of 5.32% was just below the middle of thisrange by historical standards, coming off the low levels experienced in 2004and 2003 of 4.95% and 5.14%, respectively. The improvement in the net interestmargin in 2005 is a result of both the higher level of interest rates and thechange in mix of earning assets (the Bank now has a higher portion in loansvis-à-vis investment securities compared to 2004 when the margin was at itslowest level). The net interest margin under the alternative scenarios rangesfrom 5.09% to 5.69%. Management feels this range of scenarios is consistentwith current experience and interest rate levels, but no assurances can begiven that actual future experience will fall within this range.

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 LoanLosses***

The Company did not make aprovision to the allowance for loan losses during 2005. In 2004 and 2003however, it reduced the allowance for loan losses by $2.7 million and $969thousand, respectively, through a benefit to the provision for loan losses. Theseactions over the past three years reflected strong credit quality standards,consistent performance of the loan portfolio in recent years, improving trendsin classified loans, improving trends in delinquencies, an improved outlook forthe collection of the Company’s non accrual loans, the reduced absolute levelof non accrual loans and the outlook for economic activity in general. The needfor additional provision for loan losses or for further benefit to theprovision for loan losses in 2006 will be dependent upon Management’s on-goinganalysis of the adequacy of the allowance for loan losses. While Managementbelieves the allowance 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.

***Non-Interest Income***

Non-Interest Income for2005 totaled $21.4 million compared to $27.8 million in 2004 and $29.1 millionin 2003. Service charges on deposit accounts decreased $0.8 million to $9.4million in 2005 compared to 2004 following an increase of $0.9 million to $10.2million in 2004 versus 2003. The decrease in 2005 compared to 2004 reflectsprimarily a decline in account analysis charges collected in the face of higherearnings credits for compensating balances posted to customer accounts in thehigher rate environment compared to the prior year. The increase in 2004compared to 2003 primarily reflects the implementation of a new decision planmodule for handling non-sufficient fund and overdraft accounts and the mergerwith Ojai Valley Bank.

Commissions, fees andother service charges decreased by $4.0 million in 2005 to $8.6 million. Thisfollowed a decrease of $0.5 million in 2004 over 2003. The decrease in 2005 isa result of outsourcing its merchant credit card processing functions(approximately $5.2 million) offset by improvements to other 

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categories,especially debit card fees ($0.4 million), letter of credit commissions ($0.3million) and trust department income ($0.3 million). The Company now receives apayment for merchant credit card processing which is net of expenses, so asimilar decline was experienced in the non interest expense section of theincome statement. The decrease in 2004 compared to 2003 also related primarilyto a drop in merchant credit card processing income as a result of outsourcingthis activity late in the year.

Gains on sales ofsecurities decreased to $88 thousand in 2005 following $475 thousand and $40thousand gains in 2004 and 2003, respectively. The net gains in 2005 wererecognized primarily in the second quarter as the Company liquidated certainsecurities to help fund loan growth during the year. The gain in 2004 reflectedthe acceptance of a tender offer for a $1.0 million block of corporate bondsheld by the Bank resulting in a $352 thousand gain in the first quarter and thesale of an additional security (the put feature of which was no longerapplicable) at a gain of $93 thousand in the third quarter.

The Gain on Sale of loansheld for sale (single family mortgages) was $549 thousand in 2005 compared to$607 thousand in 2004 and $3.4 million in 2003. The modest decline in 2005compared to 2004 reflected a lower volume of jumbo adjustable rate mortgageloans sold as the Company kept a larger amount of these in its regular loanportfolio. The higher levels in 2003 compared to 2004 reflected the largeamount of mortgage refinance activity experienced as a result of thehistorically low mortgage interest rate levels in that year.

All other sources ofincome were $2.8 million in 2005, compared to $3.9 million in 2004 and $3.3million in 2003. The decline in 2005 compared to 2004 related to a $1.1 milliongain on the sale of OREO in 2004 which did not recur in 2005. The increase in2004 over 2003 was a result of the $1.1 million gain on sale of OREO in 2004,partially offset by declines in miscellaneous recoveries from the prior year.

***Non-Interest Expense***

Total non-interest expensefor 2005 was $77.7 million, following $79.3 million in 2004, and $74.7 millionin 2003. Salaries and employee benefits increased to $44.6 million in 2005compared to $41.8 million in 2004 and $39.2 million in 2003. The increase in2005 compared to 2004 reflects: 1) a $1.7 million increase in expense  for the Company’s bonus program due toexceeding goals established at the start of the year by a greater degree in2005 than in 2004, 2) increases in payroll taxes and other benefits of $0.4million and 3) salary expense increases of $0.7 million. The increase in 2004compared to 2003 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. Salary andBenefit levels were higher in the fourth quarter of the year ($11.9 millioncompared to $11.1 million in the third quarter) reflecting higher rates on thebonus payout, the filling of a number of open positions throughout the Bank andthe hiring of individuals in anticipation of its expansion efforts to establisha branch and commercial lending office in Westlake Village in the Spring of2006. Additionally, beginning in late 2005, the Company expanded its complianceefforts and anticipates the possible hiring of additional staff members in 2006to meet the increasing level of compliance legislation and rule making. Managementconsiders containment of salaries and benefits costs in 2006 and beyond to beone of its top challenges. A number of factors are continuing to createunusually strong upward pressure on these costs, especially in the areas ofmedical benefits, workers compensation costs and competitive wages. Also,during the first quarter of 2006, the Company will implement a change inaccounting for stock options which will require it to take a charge tocompensation expense based on the grant date fair value of its stock optionawards and the estimated number of awards that are expected to vest. The costwill be recognized over the period during which the employees are required toprovide service in exchange for the awards—usually the vesting period. Initialestimates for 2006 put the impact at approximately $1.0 million pre-tax or$0.03 per share. See Note 1 and Note 15 of the Notes to the ConsolidatedFinancial Statements which follows in item 8 of this report. The Company is 

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addressingthese cost pressures by focusing on ways of becoming more efficient in itsprocesses and using technology wherever possible to hold down staffingrequirements.

Occupancy expense wasvirtually unchanged in 2005 and 2004 at $12.5 million, having increased from$11.6 million in 2003. The increase in 2004 over 2003 reflects a $533 thousanddollar increase in depreciation expense resulting from new fixed assets put inservice, a $123 thousand increase in rental expense (largely because of the newOjai facilities) and other miscellaneous increases in maintenance, repairs andutilities. Occupancy expense is expected to increase in 2006 as the result ofopening a new bank branch and commercial banking office in Westlake Village inthe Spring, an upgrade planned to the Bank’s computer mainframe, certain branchrenovations and normal rent increases. Management expects these increases incost to be approximately $0.9 million for 2006.

Advertising and promotionexpenditures were $4.4 million in 2005 following charges of $4.0 million in2004 and $2.9 million in 2003. The increase in 2005 over 2004 reflectedincreased business development expenditures of $269 thousand, increaseddonations of $115 thousand and various other smaller increases in individualline items. The increase in 2004 over 2003 reflected a planned increase of $1.0million in the Company’s marketing budget in support of 1) an expanded awarenesscampaign in the relatively new Ventura County market and 2) increased consumerloan sales efforts. The Company does not expect any major increases in its 2006expenditures and anticipates they will show only modest increases over 2005levels.

General officeexpenditures were $3.8 million in 2005 following levels of $4.0 million in 2004and $3.8 million in 2003. While this category of expenditure has beenrelatively flat in recent years, the small increase in 2004 reflects the recentOjai acquisition. This category includes primarily charges for stationery andsupplies, telephone expenses, and postage. Management does not expect anysignificant changes to this category in 2006.

Merchant processing anddata processing charges were $0.9 million in 2005, $5.2 million in 2004, and$6.2 million in 2003. The decline reflects the outsourcing of this function toan outside vendor late in 2004. Management’s expectation for 2006 is that thiscategory of expense will be little changed.

Professional services were$5.0 million in 2005 following $5.5 million in 2004 and $4.3 million in 2003. Thedecrease in 2005 compared to 2004 reflects primarily lower costs incurred withcomplying with the Sarbanes-Oxley Act, Section 404 requirements pertainingto the effectiveness of internal control over financial reporting. The increasein 2004 over 2003 reflects increased costs of $913 thousand for the Company’soutside accounting firm and its outsourced internal audit firm to comply withthe 404 requirements. Management expects costs in 2006 for professionalservices to be little changed from 2005 levels.

Regulatory assessments(charges for FDIC assessments and DFI fees) have been little changed over thepast three years at $0.4 million, $0.5 million and $0.4 million in 2005, 2004,and 2003, respectively. Management does not anticipate any significantincreases in these charges in 2006.

Other operating expensescontinue to be relatively stable in 2005 at $6.0 million compared to $5.8million in 2004 and $6.2 million in 2003. The increase in 2005 compared to 2004reflects especially a decrease in the total credit to the provision for losseson unfunded commitments of $136 thousand. The decrease in 2004 reflects a $328thousand change in the provision for losses on unfunded commitments from adebit position in 2003 to a credit in 2004.

***Taxes***

Book tax expense amountedto $19.1 million in 2005, $17.5 million in 2004, and $15.9 million in 2002. Whilethe statutory tax rate of the Company is 42.05%, the actual rate accrued was33.7%, 33.3%, and 34.8% in 2005, 2004, and 2003, respectively. The primaryreason for the difference compared to the statutory rate relates to the taxexempt income generated by the Company’s municipal bond portfolio. 

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Whilethe 2005 tax rate was little changed from 2004, the small decline in theaccrued rate in 2004 from 2003 reflected a modest increase in municipal taxexempt 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 LandCompany***

Mid-Coast Land Companyrecorded a profit of $409 thousand in 2005, $379 thousand in 2004 and $322thousand in net income in 2003. The gains in each of these years primarilyrelate to the on-going commissions on the sale of property formerly owned byMid-Coast Land Company. Management expects earnings to continue for severalyears as there are 86 lots remaining to be sold at the start of 2006 (down from97 one year earlier) which are subject to the payment of these commissions. Mid-CoastLand Company is no longer engaged in real estate development activity, havingsold its final property which closed during the first quarter of 2003. Itcurrently records residual activity resulting from prior years’ operations.

***MSB Properties, Inc.***

This wholly ownedsubsidiary was formed to engage in the specific business of acquiring, owning,and improving real property and tangible personal property which may benecessary or convenient for the operation or housing of the administrativedepartments and branch offices of the Bank. Incorporated under the laws of theState of California in May of 1968, it also allows for the ownership ofproperty which may be reasonably necessary for future expansion of the Bank’sbusiness, or which is otherwise reasonably related to the conduct of the Bank’sbusiness, pursuant to Section 752 of the Financial Code of the State ofCalifornia.

Earnings for thissubsidiary consist primarily of rental income from the Bank’s offices andadministrative center coupled with a minor amount of rental income fromnon-bank tenants and interest earnings on its cash assets. Leases are writtenwith market terms and at market rates. Expenses are principally rental expense,depreciation of leasehold improvements, general maintenance and utilitiesexpense. The affairs of the subsidiary are managed by Bank employees and assuch this subsidiary has no paid staff members.

Earnings for MSBProperties, Inc. have remained relatively unchanged over the years withnet earnings after-tax of $1.2 million, $1.2 million, and $1.4 million, in2005, 2004 and 2003, respectively. The subsidiary benefited from a one-timepre-tax gain of $273 thousand in 2003 from the sale of a property.

**CRITICALACCOUNTING POLICIES 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 require Managementto make estimates and judgments that affect the reported amounts of assets,liabilities, revenues, expenses and related disclosure of contingencies. Managementbelieves that the most significant subjective judgements that it is required tomake 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 allowance and makerecommendations. Management, as necessary, adjusts the allowance for loanlosses and the allowance for losses—unfunded commitments. These adjustments aremade through 

54

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a charge to expenseor a benefit in the provision for loan losses on the income statement. Theallowance is also examined annually by one or more of the Bank’s regulatorybodies including the FDIC and DFI. The need for additional provision for loanlosses in 2006, or a benefit to the provision for loan losses, will bedependent upon Management’s on-going analysis of the adequacy of the allowancefor losses. While Management believes it to be adequate at the present time,the appropriate value can fluctuate overtime in response to economic conditions and the subjective decisions which mustbe 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. Managementis also required to calculate the fair value of its options issued under itsEquity Based Compensation Plan. See Note 15 to the Consolidated FinancialStatements for a description of the calculation of pro forma compensationexpense based on the fair value of options issued at the grant date.

·       *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 31,2005 and 2004, provides for deferred taxes that are not anticipated to beoffset by taxable income projected for the next 12 months. A valuationallowance is based on estimates by Management which can change over time.**

·       *Goodwill andCore Deposit Intangibles.  *The Company is required by GAAP toperform an annual impairment analysis of the amount of Goodwill showing on itsConsolidated Statement of Financial Position. Additional information can befound under “Goodwill and Core Deposit Intangibles” earlier in this ManagementsDiscussion and Analysis of Financial Condition and Results of Operations.

**ITEM7A.**        QUANTITATIVE ANDQUALITATIVE DISCLOSURE ABOUT MARKET RISK

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’s Discussion and Analysisof Financial Condition and Results of Operations which is included in Item 7 ofthis Report.

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**ITEM8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**TABLE OF CONTENTS**

|                                                          | ** ** | **PAGE** | ** ** |
|----------------------------------------------------------|------------|----------|------------|
| Management Statement                                     |       |     | 57         |   |   |
| Report of Independent Registered Public Accounting  Firm |       |     | 58         |   |   |
| Consolidated Statements of Financial Position            |       |     | 60         |   |   |
| Consolidated Statements of Income                        |       |     | 61         |   |   |
| Consolidated Statements of Comprehensive Income          |       |     | 62         |   |   |
| Consolidated Statements of Changes in Capital Accounts   |       |     | 63         |   |   |
| Consolidated Statements of Cash Flows                    |       |     | 64         |   |   |
| Notes to Consolidated Financial Statements               |       |     | 66         |   |   |

 

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**Management’s Report on Internal Control Over FinancialReporting**

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) tocomply with the reporting requirements of Section 112 of the FederalDeposit Insurance 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, 2005 and2004. Management’s assessment of the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2005 and 2004 has beenaudited by PricewaterhouseCoopers LLP, an independent registered publicaccounting 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  Executive Officer* | * * | *Chief Financial Officer*   |     |     |

 

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**Report of Independent Registered Public AccountingFirm**

**Tothe Board of Directors and Stockholders of Mid-State Bancshares:**

We havecompleted integrated audits of Mid-State Bancshares’ 2005 and 2004 consolidatedfinancial statements and of its internal control over financial reporting as ofDecember 31, 2005 and an audit of its 2003 consolidated financialstatements in accordance with the standards of the Public Company AccountingOversight Board (United States). Our opinions, based on our audits, arepresented below.

*Consolidated financial statements*

In our opinion, the consolidated financial statements listed inthe accompanying index presentfairly, in all material respects, the financial position of Mid-StateBancshares and its subsidiaries****at December 31,2005 and 2004, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2005****in conformity with accounting principles generally acceptedin 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 Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit of financial statements includes examining, ona test basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statement presentation.We believe that our audits 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, 2005 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, 2005 and2004, based on criteria established in *Internal Control—IntegratedFramework* 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 whethereffective internal control over financial reporting was maintained in allmaterial respects. An audit of internal control over financial reportingincludes obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother procedures as we consider necessary in the circumstances. We believe thatour audit 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 reportingrequirements of Section 112 of the Federal Deposit Insurance CorporationImprovement Act (FDICIA). A company’s internal control over financial reportingincludes those policies and procedures that (i) pertain to the maintenanceof records 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.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

PricewaterhouseCoopers LLPLos Angeles, CaliforniaMarch 15, 2006

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**ConsolidatedStatements of Financial Position(amounts in 000’s except share amounts)**

| ** **                                                                               | ** ** | **December 31,** | ** **    |
|------------------------------------------------------------------------------------------|------------|-----------------------|---------------|
| ** **                                                                               | ** ** | **2005**              | ** **    | **2004** | ** ** |
| **Assets**                                                                               |       |                  |          |   |   |
| CASH AND DUE FROM  BANKS                                                                 | ** ** | **$**                 | **109,791**   |   | $ | 112,669 |   |
| FEDERAL FUNDS  SOLD                                                                      | ** ** | **—**            |          | 6,000 |   |
| SECURITIES  AVAILABLE FOR SALE                                                           | ** ** | **619,332**           |          | 644,817 |   |
| LOANS HELD FOR  SALE                                                                     | ** ** | **10,176**            |          | 12,988 |   |
| LOANS, net                                                                               | ** ** | **1,507,118**         |          | 1,408,095 |   |
| PREMISES AND  EQUIPMENT, net                                                             | ** ** | **24,772**            |          | 24,946 |   |
| ACCRUED INTEREST  RECEIVABLE                                                             | ** ** | **13,947**            |          | 11,918 |   |
| GOODWILL                                                                                 | ** ** | **47,840**            |          | 47,840 |   |
| CORE DEPOSIT  INTANGIBLES, net                                                           | ** ** | **6,483**             |          | 7,732 |   |
| SENIOR HOUSING  CRIME PREVENTION FOUNDATION INVESTMENT                                   | ** ** | **30,000**            |          | — |   |
| OTHER ASSETS                                                                             | ** ** | **22,040**            |          | 19,082 |   |
| ***TOTAL ASSETS***                                                                       | ** ** | **$**                 | **2,391,499** |   | $ | 2,296,087 |   |
| **Liabilities**                                                                          |       |                  |          |   |   |
| DEPOSITS:                                                                                |       |                  |          |   |   |
| Demand deposits                                                                          | ** ** | **$**                 | **567,782**   |   | $ | 517,139 |   |
| Savings, money market and NOW accounts                                                   | ** ** | **1,067,486**         |          | 1,083,139 |   |
| Time deposits—$100,000 or more                                                      | ** ** | **202,063**           |          | 166,295 |   |
| Time deposits—Under $100,000                                                        | ** ** | **232,275**           |          | 227,972 |   |
| ***Total Deposits***                                                                     | ** ** | **2,069,606**         |          | 1,994,545 |   |
| OTHER BORROWINGS                                                                         | ** ** | **25,903**            |          | 6,582 |   |
| ALLOWANCE FOR  LOSSES—UNFUNDED COMMITMENTS                                          | ** ** | **1,761**             |          | 1,783 |   |
| ACCRUED INTEREST  PAYABLE & OTHER LIABILITIES                                   | ** ** | **21,667**            |          | 18,550 |   |
| ***TOTAL LIABILITIES***                                                                  | ** ** | **2,118,937**         |          | 2,021,460 |   |
| **Commitments  and Contingencies (Note 12)**                                             |       |                  |          |   |   |
| **Capital Accounts**                                                                     |       |                  |          |   |   |
| CAPITAL STOCK, NO PAR  VALUE:                                                            |       |                  |          |   |   |
| Authorized—100,000,000  shares                                                      |       |                  |          |   |   |
| Outstanding—22,520,434 shares in 2005 and 23,099,159  in 2004                       |       | **42,343**            |          | 61,439 |   |
| UNDIVIDED PROFITS                                                                        | ** ** | **229,824**           |          | 206,328 |   |
| ACCUMULATED OTHER  COMPREHENSIVE INCOME, NET OF TAXES OF $264 IN 2005 AND $4,573 IN 2004 |       | **395**               |          | 6,860 |   |
| ***TOTAL CAPITAL ACCOUNTS***                                                             | ** ** | **272,562**           |          | 274,627 |   |
| ***TOTAL  LIABILITIES & CAPITAL ACCOUNTS***                                     | ** ** | **$**                 | **2,391,499** |   | $ | 2,296,087 |   |

 

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,** | ** **  |
|-------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                  | ** ** | **2005**                                   | ** **  | **2004** | ** ** | **2003** | ** ** |
| **Interest Income:**                                        |       |                                       |        |   |   |   |   |
| Interest and fees  on loans and leases                      | ** ** | **$**                                      | **104,401** |   | $ | 85,127 |   | $ | 80,372 |   |
| Interest on securities:                                     |       |                                       |        |   |   |   |   |
| U.S. Treasury securities                                    | ** ** | **679**                                    |        | 974 |   | 1,012 |   |
| U.S. Government agencies and corporations                   | ** ** | **6,492**                                  |        | 8,553 |   | 8,809 |   |
| Obligations of states and political subdivisions,  other    | ** ** | **15,576**                                 |        | 14,802 |   | 14,219 |   |
| Interest on  federal funds sold                             | ** ** | **1,178**                                  |        | 480 |   | 828 |   |
| ***TOTAL INTEREST INCOME***                                 | ** ** | **128,326**                                |        | 109,936 |   | 105,240 |   |
| **Interest Expense:**                                       |       |                                       |        |   |   |   |   |
| Interest on  deposits                                       | ** ** | **14,610**                                 |        | 8,256 |   | 9,548 |   |
| Interest on other  borrowings                               | ** ** | **893**                                    |        | 194 |   | 151 |   |
| ***TOTAL INTEREST EXPENSE***                                | ** ** | **15,503**                                 |        | 8,450 |   | 9,699 |   |
| **Net  Interest Income**                                    | ** ** | **112,823**                                |        | 101,486 |   | 95,541 |   |
| (Benefit)/Provision  for loan losses                        | ** ** | **—**                                 |        | (2,700 | ) | (969 | ) |
| ***NET INTEREST INCOME AFTER PROVISION  FOR LOAN LOSSES***  | ** ** | **112,823**                                |        | 104,186 |   | 96,510 |   |
| **Other  Income:**                                          |       |                                       |        |   |   |   |   |
| Service charges on  deposit accounts                        | ** ** | **9,384**                                  |        | 10,164 |   | 9,254 |   |
| Commissions, fees  and other service charges                | ** ** | **8,620**                                  |        | 12,577 |   | 13,064 |   |
| Gains on sale of  securities                                | ** ** | **88**                                     |        | 475 |   | 40 |   |
| Gain on sale of  loans held for sale                        | ** ** | **549**                                    |        | 607 |   | 3,385 |   |
| Other income                                                | ** ** | **2,800**                                  |        | 3,941 |   | 3,316 |   |
| ***TOTAL OTHER INCOME***                                    | ** ** | **21,441**                                 |        | 27,764 |   | 29,059 |   |
| **Other  Expenses:**                                        |       |                                       |        |   |   |   |   |
| Salaries &  employee benefits                      | ** ** | **44,635**                                 |        | 41,779 |   | 39,156 |   |
| Occupancy expenses                                          | ** ** | **12,534**                                 |        | 12,509 |   | 11,572 |   |
| Advertising &  promotion                           | ** ** | **4,439**                                  |        | 3,955 |   | 2,938 |   |
| General office                                              | ** ** | **3,809**                                  |        | 4,017 |   | 3,832 |   |
| Merchant  processing and data processing fees               | ** ** | **900**                                    |        | 5,197 |   | 6,207 |   |
| Professional  services                                      | ** ** | **4,955**                                  |        | 5,525 |   | 4,342 |   |
| Regulatory  assessments                                     | ** ** | **445**                                    |        | 498 |   | 407 |   |
| Other operating  expenses                                   | ** ** | **5,957**                                  |        | 5,814 |   | 6,237 |   |
| ***TOTAL OTHER EXPENSES***                                  | ** ** | **77,674**                                 |        | 79,294 |   | 74,691 |   |
| Income before  taxes                                        | ** ** | **56,590**                                 |        | 52,656 |   | 50,878 |   |
| Tax expense                                                 | ** ** | **19,099**                                 |        | 17,547 |   | 17,714 |   |
| ***NET INCOME***                                            | ** ** | **$**                                      | **37,491**  | ** ** | **$** | **35,109** |   | $ | 33,164 |   |
| **Earnings  per share:**                                    |       |                                       |        |   |   |   |   |
| —Basic                                                 | ** ** | **$**                                      | **1.65**    |   | $ | 1.50 |   | $ | 1.41 |   |
| —Diluted                                               | ** ** | **$**                                      | **1.61**    |   | $ | 1.47 |   | $ | 1.40 |   |
| **Average shares used in earnings  per share calculation:** |       |                                       |        |   |   |   |   |
| —Basic                                                 | ** ** | **22,788**                                 |        | 23,422 |   | 23,443 |   |
| —Diluted                                               | ** ** | **23,300**                                 |        | 23,897 |   | 23,762 |   |

 

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

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**ConsolidatedStatements of Comprehensive Income(amounts in 000’s)**

| ** **                                                    | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ***NET INCOME***                                              | ** ** | **$**                                      | **37,491** | ** ** | **$** | **35,109** |   | $ | 33,164 |   |
| **Other  Comprehensive Income Before Taxes:**                 |       |                                       |       |   |   |   |   |
| Unrealized (losses)  gains on securities available for sale:  |       |                                       |       |   |   |   |   |
| Unrealized  holding losses arising during year                | ** ** | **(10,687**                                | **)**      | (8,568 | ) | (1,547 | ) |
| Reclassification  adjustment for gains included in net income | ** ** | **(88**                                    | **)**      | (475 | ) | (40 | ) |
| Other  comprehensive loss, before tax                         | ** ** | **(10,775**                                | **)**      | (9,043 | ) | (1,587 | ) |
| Income tax  benefit                                           | ** ** | **(4,310**                                 | **)**      | (3,626 | ) | (626 | ) |
| ***OTHER COMPREHENSIVE LOSS, NET  OF TAXES***                 | ** ** | **(6,465**                                 | **)**      | (5,417 | ) | (961 | ) |
| ***TOTAL  COMPREHENSIVE INCOME***                             | ** ** | **$**                                      | **31,026** |   | $ | 29,692 |   | $ | 32,203 |   |

 

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

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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, 2002                                                          |       | 23,697,235         |       | 77,588      |       | 163,309       |       |                   | 13,238     |       |       | 254,135 |   |
| Cash dividend—$0.50 per share                                                        |       | —             |       | —      |       | (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—$0.58 per share                                                        |       | —             |       | —      |       | (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 |   |
| Cash dividend—$0.66 per share                                                        |       | —             |       | —      |       | (14,995       | )          |                   | —     |       |       | (14,995 | ) |
| Exercise of stock options                                                                 |       | 266,330            |       | 3,969       |       | —        |       |                   | —     |       |       | 3,969 |   |
| Tax Benefit from exercise of options                                                      |       | —             |       | —      |       | 1,000         |       |                   | —     |       |       | 1,000 |   |
| Net income                                                                                |       | —             |       | —      |       | 37,491        |       |                   | —     |       |       | 37,491 |   |
| Change in net unrealized gain on available for sale  securities, net of taxes of ($4,310) |       | —             |       | —      |       | —        |       |                   | (6,465     | )          |       | (6,465 | ) |
| Stock repurchased                                                                         |       | (845,055           | )          | (23,065     | )          | —        |       |                   | —     |       |       | (23,065 | ) |
| **BALANCE, December 31, 2005**                                                       | ** ** | **22,520,434**     | ** ** | **$**       | **42,343** | ** **    | **$**      | **229,824**            | ** ** | ** ** | **$**      | **395** |   | ** ** | **$** | **272,562** |   |

 

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

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**ConsolidatedStatements of Cash Flows(amounts in 000’s)**

| ** **                                                                         | ** ** | **Year Ended December 31,** | ** **  |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                                         | ** ** | **2005**                                   | ** **  | **2004** | ** ** | **2003** | ** ** |
| **Operating Activities:**                                                          |       |                                       |        |   |   |   |   |
| Net Income                                                                         | ** ** | **$**                                      | **37,491**  |   | $ | 35,109 |   | $ | 33,164 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                       |        |   |   |   |   |
| (Benefit)/Provision for credit losses                                              |       | —                                     |        | (2,700 | ) | (969 | ) |
| Provision for depreciation and amortization                                        | ** ** | **5,249**                                  |        | 5,044 |   | 4,511 |   |
| Amortization of originated mortgage servicing rights                               | ** ** | **458**                                    |        | 459 |   | 804 |   |
| Amortization of net investment security premiums                                   | ** ** | **3,743**                                  |        | 5,120 |   | 4,204 |   |
| Amortization of deferred loan (costs) fees                                         | ** ** | **(525**                                   | **)**       | (163 | ) | 687 |   |
| Amortization of core deposit intangible assets                                     | ** ** | **1,249**                                  |        | 1,375 |   | 1,121 |   |
| Gain on sale of investments                                                        | ** ** | **(88**                                    | **)**       | (475 | ) | (40 | ) |
| Originations of loans held for sale                                                | ** ** | **(70,517**                                | **)**       | (77,218 | ) | (222,486 | ) |
| Proceeds from sales of loans held for sale                                         | ** ** | **73,878**                                 |        | 78,247 |   | 235,021 |   |
| Gain on sale of other real estate owned                                            |       | —                                     |        | (1,084 | ) | — |   |
| Gain on sale of loans held for sale                                                | ** ** | **(549**                                   | **)**       | (607 | ) | (3,385 | ) |
| Deferred tax charge (benefit)                                                      | ** ** | **33**                                     |        | (765 | ) | 1,814 |   |
| (Increase) decrease in accrued interest                                            | ** ** | **(2,029**                                 | **)**       | 256 |   | (485 | ) |
| Decrease (increase) in other assets                                                | ** ** | **860**                                    |        | (4,176 | ) | (2,938 | ) |
| Increase (decrease) in accrued interest payable and  other liabilities             | ** ** | **3,095**                                  |        | 4,882 |   | (1,257 | ) |
| ***Net cash provided by operating  activities***                                   | ** ** | **52,348**                                 |        | 43,304 |   | 49,766 |   |
| **Investing Activities:**                                                          |       |                                       |        |   |   |   |   |
| Proceeds from sales and maturities of securities                                   | ** ** | **140,159**                                |        | 160,631 |   | 137,567 |   |
| Purchases of securities                                                            | ** ** | **(159,104**                               | **)**       | (44,463 | ) | (275,591 | ) |
| Net increase in loans                                                              | ** ** | **(98,498**                                | **)**       | (266,363 | ) | (41,427 | ) |
| Receipts from real estate investments, net of  advances                            |       | —                                     |        | 4,512 |   | — |   |
| Cash acquired in acquisition, net of cash used                                     |       | —                                     |        | — |   | 9,959 |   |
| Purchases of premises and equipment                                                | ** ** | **(5,071**                                 | **)**       | (3,670 | ) | (5,265 | ) |
| Net (loss) gain from proceeds on sales of premises  and equipment                  | ** ** | **(4**                                     | **)**       | 5 |   | 10 |   |
| ***Net cash used in investing  activities***                                       | ** ** | **(122,518**                               | **)**       | (149,348 | ) | (174,747 | ) |
| **Financing Activities:**                                                          |       |                                       |        |   |   |   |   |
| Net increase in deposits                                                           | ** ** | **75,061**                                 |        | 82,114 |   | 180,684 |   |
| Increase in other borrowings—Federal Home Loan Bank                           | ** ** | **20,000**                                 |        | — |   | — |   |
| Net decrease in other borrowings—revolving  T.T. & L. note           | ** ** | **(679**                                   | **)**       | (1,045 | ) | (3,346 | ) |
| Cash dividend paid                                                                 | ** ** | **(14,995**                                | **)**       | (13,552 | ) | (11,702 | ) |
| Proceeds from exercise of stock options                                            | ** ** | **4,970**                                  |        | 2,579 |   | 2,284 |   |
| Purchase of bank stock for retirement                                              | ** ** | **(23,065**                                | **)**       | (16,646 | ) | (16,212 | ) |
| ***Net cash provided by financing  activities***                                   | ** ** | **61,292**                                 |        | 53,450 |   | 151,708 |   |
| ***(DECREASE) INCREASE IN  CASH & CASH EQUIVALENTS***                     | ** ** | **(8,878**                                 | **)**       | (52,594 | ) | 26,727 |   |
| ***CASH AND CASH EQUIVALENTS,  beginning of year***                                | ** ** | **118,669**                                |        | 171,263 |   | 144,536 |   |
| ***CASH AND CASH EQUIVALENTS, end  of year***                                      | ** ** | **$**                                      | **109,791** |   | $ | 118,669 |   | $ | 171,263 |   |

 

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

| ** **                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Supplemental  disclosure of cash flow information                                          |       |                                       |       |   |   |   |   |
| Cash paid during  the year for:                                                            |       |                                       |       |   |   |   |   |
| Interest                                                                                   | ** ** | **$**                                      | **15,112** |   | $ | 8,237 |   | $ | 9,424 |   |
| Taxes on income                                                                            | ** ** | **19,057**                                 |       | 15,006 |   | 19,136 |   |
| Transfers from loans to other real estate owned                                            |       | —                                     |       | — |   | 3,279 |   |
| Supplemental  disclosure of non-cash investing activities:                                 |       |                                       |       |   |   |   |   |
| Transfer of security investment for senior housing  crime prevention foundation investment | ** ** | **30,000**                                 |       | — |   | — |   |
| **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, 2005**

**1.Summary of Significant Accounting Policies**

The accounting and reporting policies of Mid-StateBancshares and subsidiary (the “Company”) conform with accounting principlesgenerally accepted in the United States (GAAP) and general practice within thebanking industry. GAAP requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates. The following aredescriptions of the more significant accounting policies of the Company.

**Consolidation:****  **The consolidated financial statements include the accountsof Mid-State Bancshares and its wholly owned subsidiary, Mid-State Bank &Trust, (the “Bank”) which includes Mid-State Bank & Trust’s whollyowned subsidiaries, Mid-Coast Land Company and MSB Properties, Inc. Allinter-company accounts and transactions have been eliminated in theconsolidated financial statements.

**SignificantGroup Concentrations of Credit Risk:**   Most of theCompany’s activities are with customers located within the three counties ofSan Luis Obispo, Santa Barbara and Ventura in California. Note 4 below reviewsthe types of securities that the Company invests in. Note 5 reviews the typesof lending that the Company engages in. The Company does not have anysignificant concentrations to any one industry or customer, but does have asignificant portion of its loan portfolio (approximately 84%) secured by realestate.

**Cashand Cash Equivalents:**   For purposes of theconsolidated statements of cash flows, cash and cash equivalents include cashand balances due from banks, federal funds sold and securities purchased underagreements to resell, all of which mature within ninety days.

**Securities:****  **Securities for which the Company has the positiveintent and ability to hold until maturity would be classified asheld-to-maturity securities. Securities which are purchased principally for thepurpose of selling them in the near term for a gain would be classified astrading securities. Securities not classified as held-to-maturity or tradingare classified as available for sale. The Company holds no securities thatshould be classified as trading securities or held-to-maturity securities.Securities classified as available for sale are reported on the consolidatedstatements of financial position as of December 31, 2005 and 2004, attheir market value. The net unrealized gains or losses for these securities arereported, net of related taxes, in the statements of comprehensive income forthe years ended December 31, 2005, 2004 and 2003 and as a separatecomponent of the capital accounts for the years ended December 31, 2005and 2004.

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 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**1. Summaryof Significant Accounting Policies (Continued)**

between principal proceedsand this amortized cost. Related income taxes are calculated at current federaland state statutory rates.

**LoansHeld 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 at face amount, less paymentscollected and net deferred loan fees. Income is accrued daily as earned. Loanorigination costs are netted against loan fees collected and the net amount isdeferred in accordance with SFAS No. 91, *“Accountingfor Nonrefundable Fees and Costs Associated with Originating or AcquiringLoans  and Initial Direct Costs ofLeases,”* and amortized into income over the expected life of theloan. The allowance for loan losses, which is based on estimates, is maintainedat a level considered adequate to provide for losses that are considered to beinherent in the portfolio. Ultimate losses may vary from the current estimates.Management reviews these estimates periodically, considers the borrower’sfinancial status, current economic conditions, historical loan loss experienceand other factors. As adjustments become necessary, they are reported inearnings in the periods in which they become known. The allowance is increasedby provisions charged 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 interest or principal has occurredfor a period of 90 days or more. Consumer loans are typically charged-off whenthey are 90 days or more past due. Other types of loans are placed onnon-accrual status when management believes that the borrower’s financialcondition, after giving consideration to economic and business conditions andcollection efforts, is such that the presumption of collectibility of interestno longer is prudent. When a loan is placed on non-accrual status, previouslyaccrued and uncollected interest is reversed from income. Loans on non-accrualare charged off, or partially charged off, when collection of all, or a portionof, principal is considered doubtful. Payments received on non accrual loansare applied to principal unless the loan has had a partial charge off in whichcase payment is applied as a recovery to the allowance for loan losses. Once aloan is on non-accrual, it is generally not returned to accrual status until 1)all past due principal and interest payments have been paid, 2) there has beena demonstrated ability to make payments for 6 to 12 months, and 3) there issufficient collateral supporting the loan.

**Premisesand 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.

**OtherReal Estate Owned:**   Other Real Estate Owned(OREO) is comprised of real estate acquired through foreclosure. It is carriedat the lower of cost or estimated fair value less estimated costs of disposal.

**Goodwill:**   Theamounts presented on the Company’s consolidated statements of financialposition represents the excess of acquisition prices paid over and above thefair market value 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 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**1. Summaryof Significant Accounting Policies (Continued)**

community banking segment,the Company compares its fair market value of equity to its book value. Thisdifference is compared to Goodwill. Provided the excess of fair market value tobook value is above the Goodwill amount, there is no impairment of Goodwill.

**CoreDeposit Intangible:**   The fair market value ofcore deposits acquired are carried at cost, less accumulated amortization. Theamounts carried are included in Core Deposit Intangibles, net, on theconsolidated statements of financial position. The amortization of the CoreDeposit Intangible (CDI) is computed principally on a straight-line basis overits expected useful life. On an annual basis, the Company tests it CDI forimpairment. The amortized CDI is compared to the original amount of CDI bookedat the time of the acquisition. This percentage is then compared to thepercentage of customers acquired in the acquisition who are still banking withthe Bank. Provided the percentage of the CDI does not exceed the percentage ofcustomers who are still banking with the Bank, there is no impairment. Theamortization of the CDI may be adjusted from time to time based on the resultsof this test.

**Allowancefor losses—unfunded commitments:****  **Theallowance for loan losses—unfunded commitments, which is based on estimates, ismaintained at a level considered adequate to provide for losses that areconsidered to be inherent in commitments and contingencies which the Company isobligated under. Ultimate losses may vary from the current estimates.Management reviews these estimates periodically, considers the financial statusof the commitment or contingency, current economic conditions, historicalexperience and other factors. As adjustments become necessary, they arereported in earnings in the periods in which they become known. The allowanceis increased by provisions charged to other operating expense and reduced bycredits to other operating expense.

**Accountingfor Income Taxes:**   Deferred income tax assets orliabilities are computed based on the difference between the financialstatement and income tax basis of assets and liabilities using the enactedmarginal tax rate. Deferred income tax expenses or benefits are based on the changesin the deferred asset or liability from period to period. The Company estimatesits quarterly effective income tax rate based upon a variety of factors,including, but not limited to, the expected revenues for the year and theproduct mix of revenue, and the ratio of permanent differences to total revenue.Any changes to the estimated rate are made prospectively in accordance with APB28 “Interim Financial Reporting”. Additionally, Management makes estimates asto the amount of reserves, if any, that are necessary for known tax exposures.

**StockOption Plan:**   The Company applies AccountingPrinciples Board (APB) Opinion No. 25, *“Accounting for StockIssued to Employees,”* and related Interpretations in accounting forits Plan. Accordingly, no compensation expense has been recognized for grantsunder the Plan. Consistent with the methods of SFAS No. 123, pro-formacompensation expense for the Plan is determined based on the fair value at thegrant date. Fair values were estimated using the Black-Scholes option-pricingmodel and pro forma disclosures of net income and earnings per share, as if thefair value based method of accounting had been applied, are disclosed in Note15.

**RecentAccounting Pronouncements:****  **InJanuary of 2003, the Financial Accounting Standards Board (FASB) issuedFASB Interpretation (FIN) No. 46, “Consolidation of Variable InterestEntities”. FIN No. 46 addresses consolidation by business enterprises ofvariable interest entities, which have one or both of the followingcharacteristics:  i) the equityinvestment at risk is not sufficient to permit the entity to finance itsactivities 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 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**1. Summaryof Significant Accounting Policies (Continued)**

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 subsequently the adoption date was deferred to January 1, 2004. Theadoption of FIN No. 46 did not have a material impact on the Company’sresults of operations and financial position.

In April 2003, the FASB issued Statement ofFinancial Accounting Standards (SFAS) No. 149, “Amendment of Statement 133on Derivative Instruments and Hedging Activities.” SFAS 149 amends andclarifies accounting for derivative instruments, including certain derivativeinstruments embedded in other contracts, and for hedging activities under SFAS No. 133.SFAS 149 was effective for contracts entered into or modified after June 30,2003, and for hedging relationships designated after June 30, 2003. Theguidance should be applied prospectively. The adoption of SFAS 149 did not havea material impact on the Company’s results of operations and financialposition.

The FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity” in May of2003. SFAS No. 150 establishes standards for how an issuer classifies andmeasures certain financial instruments with characteristics of both liabilitiesand equity. It requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances). Many ofthose instruments were previously classified as equity. SFAS No. 150 waseffective for financial instruments entered into or modified after May 31,2003, and otherwise was effective at the beginning of the first interim periodbeginning after June 15, 2003. The adoption of SFAS No. 150 did nothave a material impact on the Company’s results of operations and financialposition.

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, “Accountingfor Certain Loans or Debt Securities Acquired in a Transfer.”  The SOP was effective for loans acquired infiscal years beginning after December 15, 2004. The SOP addressesaccounting for differences between contractual cash flows and cash flowsexpected to be collected from an Investor’s initial investment in loans or debtsecurities acquired in a transfer if those differences are attributable, atleast in part, to credit quality. The adoption of SOP 03-3 did not have amaterial impact on the Company’s results of operations and financial position.

In June 2004, the Emerging Issues Task Force ofthe Financial Accounting Standards Board (FASB) issued guidance on its Issue No. 03-1,“The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments.”  The guidance maderecommendations regarding unrealized losses on available-for-sale debt andequity securities accounted for under Statement of Financial AccountingStandards (SFAS) No. 115, “Accountingfor Certain Investments in Debt and Equity Securities,” and No. 124,“Accounting for Certain Investments Heldby Not-for-Profit Organizations.” The guidance for evaluating whether an investment isother-than-temporarily impaired was to be applied in other-than-temporaryimpairment evaluations made in reporting periods beginning after June 15,2004. The disclosures were to be effective in annual financial statements forfiscal years ending after December 15, 2003, for investments accounted forunder Statements 115 and 124. On September 30, 2004, the FASB 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**1. Summaryof Significant Accounting Policies (Continued)**

Board directed theissuance of FASB Staff Position (FSP) EITF Issue 03-1-a, “ImplementationGuidance for the Application of Paragraph 16 of EITF Issue No. 03-1.”  The proposed FSP would provide implementationguidance with respect to debt securities that are impaired solely due tointerest rates and/or sector spreads and analyzed for other-than-temporaryimpairment under paragraph 16 of issue 03-1. The FASB asked constituentsto comment on whether the application guidance with respect to “minorimpairments” should also be applied to securities analyzed for impairment underparagraphs 10-15 of Issue 03-1. At the June 29, 2005 meeting,the Board decided not to provide additional guidance on the meaning of other-than-temporaryimpairment and directed the staff to finalize proposed FASB Staff Position(FSP) EITF 03-1-a, “Implementation Guidance for the Application ofParagraph 16 of EITF Issue No. 03-1.” The final FSP, retitled as FSPFAS 115-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments,” would:

1.                Replace theguidance in paragraphs 10-18 of EITF Issue 03-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments,”and refer to existing other-than-temporary impairment guidance—for example,FASB Statement No. 115, *Accounting forCertain Investments in Debt and Equity Securities,* APB Opinion No. 18,*The Equity Method of Accounting forInvestments in Common Stock,* and SEC Staff Accounting Bulletin No. 59,“Accounting for Noncurrent Marketable Equity Securities”

2.                Supersede Issue 03-1and EITF Topic No. D-44, “Recognition of Other-Than-TemporaryImpairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value”

3.                Codify the guidanceset forth in Topic D-44 and clarify that an investor should recognize animpairment loss no later than when the impairment is deemed other thantemporary, even if a decision to sell has not been made

4.                Be effective forother-than-temporary impairment analyses conducted in periods beginning after September 15,2005.

At the September 7, 2005 meeting, the Boarddirected the staff to consider transition guidance for the proposed FSP. At theSeptember 14, 2005 meeting, the Board decided to retain the paragraph inthe proposed FSP pertaining to the accounting for debt securities subsequent toan other-than-temporary impairment and add a footnote to clarify that theproposed FSP does not address when a debt security should be designated asnonaccrual or how to subsequently report income on a nonaccrual debt security. Inaddition, the Board decided that (1) transition would be appliedprospectively and (2) the effective date would be reporting periodsbeginning after December 15, 2005. Adoption of EITF Issue 03-1-ais not expected to have a material impact on the Company’s results ofoperations and its financial position.

The FASB issued a revision to SFAS No. 123, “Accountingfor Stock-Based Compensation” in December 2004. The revised Statement isSFAS No. 123R (revised 2004), “Share-Based Payment” and it will supercedeAPB Opinion No. 25, “Accounting for Stock Issued to Employees,” and itsrelated implementation guidance. It is to be effective for the Company as ofthe beginning of the first annual reporting period that begins after June 15,2005. The Statement requires that the Company measures the cost of employeeservices received in exchange for an award of equity instruments (share basedpayment awards) based on the grant date fair value of the award and theestimated number of awards that are expected to vest. The cost will berecognized over the period during which an employee is required to provideservice in exchange for the award—usually the vesting period. Compensation costfor awards that 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**1. Summaryof Significant Accounting Policies (Continued)**

vest would not be reversedif the awards 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 of theCompany’s Annual Report on Form 10K. The Company expects to adopt therevised Statement for the first quarter of 2006. The Company expects thatadoption of SFAS No. 123R would have a significant effect on itsConsolidated Statements of Income, Comprehensive Income and Changes in CapitalAccounts in future years. Initial estimates for 2006 put the impact atapproximately $1.0 million pre-tax, or $0.03 per share.

FASB issued SFAS No. 154, “*Accounting Changes and Error Corrections”* on June 1, 2005, a replacementof APB No. 20 and SFAS No. 3. The Statement applies to all voluntarychanges in accounting principle, and changes the requirements for accountingfor and reporting of a change in accounting principle. SFAS No. 154requires retrospective application to prior periods’ financial statements of avoluntary change in accounting principle unless it is impracticable. APB No. 20previously required that most voluntary changes in accounting principle berecognized by including in net income of the period of the change thecumulative effect of changing to the new accounting principle. SFAS No. 154improves financial reporting because its requirements enhance the consistencyof financial information between periods. SFAS No. 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. The Company expects to adopt the Statement forthe first quarter of 2006 and expects it will not have a material effect on itsconsolidated financial statements.

FASB issued SFAS No. 155,“*Accounting for Certain Hybrid Instruments,*”on February 16, 2006 as an amendment of FASB Statements No. 133 and140. The standard allows financial instruments that have embedded derivativesto be accounted for as a whole (eliminating the need to bifurcate thederivative from its host) if the holder elects to account for the wholeinstrument on a fair value basis. The standard also a) clarifies whichinterest-only strips and principal-only strips are not subject to therequirements of Statement 133, b) establishes a requirement to evaluateinterests in securitized financial assets to identify interests that arefreestanding derivatives or that are hybrid financial instruments that containan embedded derivative requiring bifurcation, c) clarifies that concentrationsof credit risk in the form of subordination are not embedded derivatives, andd) amends Statement 140 to eliminate the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest other than another derivative financialinstrument.

**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 thecommunities of Ojai and Oak View in Ventura County. The merger expanded Mid-StateBank & Trust’s Ventura County presence with these two additionaloffices.

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 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**2. Merger(Continued)**

Mid-State Bancshares’stock traded ending October 24, 2003. The average price of Mid-StateBancshares’ stock over that period was $23.78. The merger was accounted forutilizing the purchase method of accounting.

A pro forma summary of revenue, net income andearnings per share, as if the merger was in effect at the beginning of eachperiod, is presented below. This summary specifically excludes any expensesavings achieved as a result of the merger. Adjustments have been made toreflect the amortization of the core deposit intangible and the loss ofinterest on cash utilized to complete the merger. These results are notincluded in the financial statements included herein. Figures are in thousands.

| ** **                                         | ** ** | **(Unaudited)**                       | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **For the Year Ended** | ** ** |
| ** **                                         | ** ** | **December 31, 2003**       | ** ** |
| **Pro  Forma Interest and Non Interest Income:**   |       |                                  |       |   |   |
| Combined Mid-State Bancshares and Ojai Valley Bank |       |                                  | $          | 138,789 |   |   |
| **Pro  Forma Net Income:**                         |       |                                  |       |   |   |
| Combined Mid-State Bancshares and Ojai Valley Bank |       |                                  | $          | 32,728 |   |   |
| **Pro  Forma Earnings Per Share—Basic**       |       |                                  | $          | 1.37 |   |   |
| **Pro Forma Earnings Per Share—Diluted**      |       |                                  | $          | 1.35 |   |   |

 

The following table summarizes the estimated fairvalues of the assets acquired and liabilities assumed at the date ofacquisition, 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 amount displayedis attributable to a Core Deposit Intangible which is being amortized over itsexpected 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 were approximately$22.3 million and $24.8 million at December 31, 2005 and 2004,respectively.

 

72

----

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**4. Securities**

A summary of investmentsecurities owned is as follows:

**December 31,2005**

| **(amounts in 000’s)  Securities Available For Sale** | ** ** | ** **  | ** **  | **Cost  Basis** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Market  Value** | ** ** |
|----------------------------------------------------------------------|------------|-------------|-------------|-----------------|------------|------------------------------|------------|-------------------------------|------------|-------------------|------------|
| U.S. Treasury  securities                                            | ** ** | **$**       | **22,868**  | ** **      |       | **$**                        | **—** | ** **                    |       |              | **$**      | **(222** | **)** |   | **$** | **22,646** | ** ** |
| Securities of  U.S. government agencies  and corporations            | ** ** | **216,218** | ** **  |            | **171**    | ** **                   |       |                          | **(1,802** | **)**             |       | **214,587** | ** ** |
| Mortgage backed  securities                                          | ** ** | **8,672**   | ** **  |            | **313**    | ** **                   |       |                          | **(46**    | **)**             |       | **8,939** | ** ** |
| Obligations of  states and political subdivisions                    | ** ** | **354,356** | ** **  |            | **4,342**  | ** **                   |       |                          | **(2,047** | **)**             |       | **356,651** | ** ** |
| Other investments                                                    | ** ** | **16,559**  | ** **  |            | **22**     | ** **                   |       |                          | **(72**    | **)**             |       | **16,509** | ** ** |
| ***TOTAL***                                                          | ** ** | **$**       | **618,673** | ** **      |       | **$**                        | **4,848**  | ** **                    |       |              | **$**      | **(4,189** | **)** |   | **$** | **619,332** | ** ** |

 

**December 31,2004**

| **(amounts in 000’s)  Securities Available For Sale** | ** ** | ** ** | ** ** | **Cost  Basis** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Market  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 |   |

 

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 31,2005:

| ** **                                               | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**              | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|------------------------|------------|
| **(amounts in 000’s)**                    | ** ** | ** **                             | ** ** | **Market  Value**                    | ** ** | **Unrealized  Losses** | ** ** | **Market  Value** | ** ** | **Unrealized  Losses** | ** ** | **Market  Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S. Treasury  securities                                |       | $                                      | 10,778     |                                 |       | $                      | (77        | ) |   | $ | 11,868 |   |   | $ | (145 | ) |   | $ | 22,646 |   |   | $ | (222 | ) |   |
| Securities of  U.S. government agencies and corporations |       | 84,827                                 |       |                                 | (787       | )                      |       | 109,604 |   |   | (1,015 | ) |   | 194,431 |   |   | (1,802 | ) |   |
| Mortgage backed  securities                              |       | 2,501                                  |       |                                 | (35        | )                      |       | 599 |   |   | (11 | ) |   | 3,100 |   |   | (46 | ) |   |
| Obligations of  states and political subdivisions        |       | 134,943                                |       |                                 | (1,508     | )                      |       | 20,176 |   |   | (539 | ) |   | 155,119 |   |   | (2,047 | ) |   |
| Other investments                                        |       | 1,973                                  |       |                                 | (25        | )                      |       | 1,962 |   |   | (47 | ) |   | 3,935 |   |   | (72 | ) |   |
| *TOTAL*                                                  |       | $                                      | 235,022    |                                 |       | $                      | (2,432     | ) |   | $ | 144,209 |   |   | $ | (1,757 | ) |   | $ | 379,231 |   |   | $ | (4,189 | ) |   |
|                                                          |            |                                        |            |                                      |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

All of the unrealized losses identified in the tableabove are attributable to changes in general interest rate levels and are notconsidered to be other than temporary impairment. The unrealized losses are not

73

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**4. Securities(Continued)**

the result of anydeteriorating financial conditions or near term prospects of the underlyingissuers and Management believes that it has the intent and ability to eitherretain these investment securities to allow for the eventual recovery in marketvalue or to hold them until maturity.

Securities having a fair value of $109,959,000 and$106,354,000 at December 31, 2005 and 2004, 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 $140,159,000, $160,631,000, and $137,567,000for the years ended 2005, 2004, and 2003, respectively. Gross gains of$145,000, $485,000, and $46,000 and gross losses of $57,000, $10,000, and$6,000 were realized on that activity for the years ended 2005, 2004, and 2003,respectively.

The amortized cost andmarket value of securities at December 31, 2005 and 2004, by contractualmaturity, are shown below. Expected maturities may differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without call or prepayment penalties. Included in the “due after ten yearscategory” below is common stock held in the Federal Home Loan Bank, FederalNational Mortgage Association and Federal Agricultural Mortgage Association. Managementbelieves this maturity category most closely matches the non maturitycharacteristics of these equity investments totaling $8.2 million.

| ** **                                                          | ** ** | **Available For Sale** | ** **  |
|---------------------------------------------------------------------|------------|----------------------------------|-------------|
| **(dollars in 000’s)  December 31, 2005*** | ** ** | ** **                       | ** **  | **Cost  Basis** | ** ** | **Market  Value** | ** ** |
| Due in one year  or less                                            |       | **$**                            | **166,103** | ** ** | **$** | **165,257** |   |
| Due after one  year to five years                                   |       | **289,849**                      | ** **  | **292,076** |   |
| Due after five  years to ten years                                  |       | **152,383**                      | ** **  | **151,675** |   |
| Due after ten  years                                                |       | **2,096**                        | ** **  | **2,082** |   |
| Equity securities                                                   |       | **8,242**                        | ** **  | **8,242** |   |
| ***Total***                                                         |       | **$**                            | **618,673** | ** ** | **$** | **619,332** |   |
| **December 31, 2004***                                    | ** ** | ** **                       | ** **  | **Cost  Basis** | ** ** | **Market  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                                                |       | 2,155                            |        | 2,163 |   |
| Equity securities                                                   |       | 7,743                            |        | 7,743 |   |
| *Total*                                                             |       | $                                | 633,384     |   | $ | 644,817 |   |
|                                                                     |            |                                  |             |  |  |  |  |  |  |  |  |

----

*                    Mortgageback securities are shown at contractual maturity, however, the average life ofthese securities may differ due to principal prepayments.

74

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**5. Loans**

**Theloan portfolio consists of the following:**

| ** **                            | ** ** | **December 31,** | ** **    |
|---------------------------------------|------------|-----------------------|---------------|
| **(dollars in 000’s)** | ** ** | ** **            | ** **    | **2005** | ** ** | **2004** | ** ** |
| Construction and  development loans   | ** ** | **$**                 | **279,417**   |   | $ | 229,569 |   |
| Real estate loans                     | ** ** | **816,953**           |          | 761,947 |   |
| Home equity  credit lines             | ** ** | **182,057**           |          | 160,050 |   |
| Installment loans                     | ** ** | **18,032**            |          | 19,206 |   |
| Cash reserve                          | ** ** | **3,367**             |          | 3,607 |   |
| Agricultural  production              | ** ** | **35,898**            |          | 40,256 |   |
| Commercial, other                     | ** ** | **186,757**           |          | 211,251 |   |
| ** **                            |       | **1,522,481**         |          | 1,425,886 |   |
| Less allowance  for loan losses       | ** ** | **(11,896**           | **)**         | (13,799 | ) |
| Less deferred  loan fees, net         | ** ** | **(3,467**            | **)**         | (3,992 | ) |
| *TOTAL  LOAN PORTFOLIO*               | ** ** | **$**                 | **1,507,118** |   | $ | 1,408,095 |   |
|                                       |            |                       |               |  |  |  |  |  |  |

 

At December 31, 2005, $1,278,427,000 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 $2,463,000 and$10,700,000 at December 31, 2005 and 2004, respectively. The bank had noloans past due 90 days or more and still accruing interest at December 31,2005 and 2004. If interest income on non-accrual loans had been recorded asoriginally scheduled, approximately $1,008,140, $1,308,710, and $1,731,761 ofadditional interest income would have been recorded for the years ended December 31,2005, 2004 and 2003, respectively. Additionally, there was no interest incomewhich was recognized for loans on non-accrual during 2005, 2004, or 2003.

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 $37,930, $73,102 and $629,093 in interest was recognized from these loansduring 2005, 2004 and 2003, respectively.

75

----

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**5. Loans(Continued)**

The amount of thevaluation allowance for impaired loans is determined by comparing the recordedinvestment in each loan with its value measured by one of three methods:(1) the expected future cash flows discounted at the effective interestrate; (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 notestablished. The following table discloses information about impaired loans andtheir related allowance.

| ** **                                                                | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**                                     | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Loans identified  as impaired at year end                                 |       | **$**                 | **2,528**  |   | $ | 10,778 |   |
| Impaired loans  for which a valuation allowance has been determined       |       | **1,972**             |       | 9,381 |   |
| Amount of  valuation allowance                                            |       | **592**               |       | 4,462 |   |
| Impaired loans for which  no valuation allowance was determined necessary |       | **556**               |       | 1,397 |   |
|                                                                           |            |                       |            |  |  |  |  |  |  |

 

The average amount of the recorded investment inimpaired loans during the years ended December 31, 2005,  2004 and 2003 was approximately $6,629,000,$12,914,000 and $19,304,000, respectively.  The valuation allowance reported above is 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 whichcan be reasonably anticipated.

Theallowance for loan losses is netted against loans on the Statements ofFinancial Position for December 31, 2005 and 2004. A summary of thechanges in the allowance for loan losses account and the allowance for losses—unfundedcommitments which shows on the liability side of the Consolidated Statements ofFinancial Position is as follows:

| ** **                                                                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**                                                        | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Balance at  beginning of year:                                                               |       |                  |       |   |   |   |   |
| 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 at beginning of year                                             | ** ** | **15,582**            |       | 18,004 |   | $ | 19,141 |   |
| (Reductions in)  additions to the allowance for loan losses (credited to) charged to expense |       | —                |       | (2,700 | ) | (969 | ) |
| Provision for  losses—unfunded commitments charged to expense                           | ** ** | **(22**               | **)**      | (158 | ) | 170 |   |
| Loans charged off                                                                            | ** ** | **(3,231**            | **)**      | (940 | ) | (1,894 | ) |
| Recoveries of  loans previously charged off                                                  | ** ** | **1,328**             |       | 1,376 |   | 1,165 |   |
| Adjustment—Acquired  through Merger                                                     | ** ** | **—**            |       | — |   | 391 |   |
| ***TOTAL  ALLOWANCE FOR LOSSES—END OF YEAR***                                           | ** ** | **$**                 | **13,657** |   | $ | 15,582 |   | $ | 18,004 |   |
|                                                                                              |            |                       |            |  |  |  |  |  |  |  |  |  |

** **

76

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**5. Loans (Continued)**

| ** **                                         | ** ** | ** ** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|------------|------------|------------------|------------|
| **(dollars in 000’s)**              | ** ** | ** ** | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Allowance for  loan losses                         | ** ** | **$**      | **11,896** |             | $          | 13,799 |   | $ | 16,063 |   |
| Allowance for  losses—unfunded commitments    | ** ** | **1,761**  |       | 1,783            |       | 1,941 |   |
| ***TOTAL  ALLOWANCE FOR LOSSES—END OF YEAR*** | ** ** | **$**      | **13,657** |             | $          | 15,582 |   | $ | 18,004 |   |

 

Ananalysis of loans and leases to directors and executive officers is as follows:

| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**    | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Balance, at  beginning of year           | ** ** | **$**                 | **8,744**  |   | $ | 1,246 |   |
| Additional loans  and leases made        | ** ** | **8,758**             |       | 7,817 |   |
| Payments received  and other adjustments | ** ** | **(3,374**            | **)**      | (319 | ) |
| ***BALANCE  AT END OF YEAR***            | ** ** | **$**                 | **14,128** |   | $ | 8,744 |   |
|                                          |            |                       |            |  |  |  |  |  |  |

 

These loans were made inthe ordinary course of the Bank’s business and, in management’s opinion, were madeat prevailing rates and terms. In addition, there were un-funded commitments toloan up to an additional $4,352,000 in extensions of credit to directors andexecutive officers at year-end.

**6. Premises and Equipment**

*Premises and equipment consisted of the following:*

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**                | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Land                                                 | ** ** | **$**                 | **7,595**  |   | $ | 7,595 |   |
| Buildings                                            | ** ** | **32,694**            |       | 31,307 |   |
| Furniture and  equipment                             | ** ** | **28,345**            |       | 26,890 |   |
| Construction and  equipment purchases in progress    | ** ** | **1,828**             |       | 444 |   |
| ** **                                           |       | **70,462**            |       | 66,236 |   |
| Less—Accumulated  depreciation and amortization | ** ** | **(45,690**           | **)**      | (41,290 | ) |
| ***TOTAL  PREMISES AND EQUIPMENT***                  | ** ** | **$**                 | **24,772** |   | $ | 24,946 |   |
|                                                      |            |                       |            |  |  |  |  |  |  |

 

 

77

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**6.**   Premisesand Equipment (Continued)

Depreciationand amortization included in occupancy expenses was $5,249,000, $5,044,000, and$4,511,000  in 2005, 2004 and 2003,respectively, based on the following estimated useful lives:

| Buildings               |   | 20-40 years |   |
|-------------------------|--------|-------------|--------|
| Furniture and equipment |   | 3-20 years  |   |

 

Totalrental expense for banking premises was $2,042,000, $1,985,000, and $1,864,000,in 2005, 2004 and 2003, respectively. As of December 31, 2005 theapproximate minimum future lease rentals payable under non-cancelable leasecontracts for bank premises were as follows (dollars in 000’s):

| **Year**                       | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|
| 2006                           |       | $          | 2,351      |       |
| 2007                           |       | 2,282      |       |
| 2008                           |       | 2,002      |       |
| 2009                           |       | 1,887      |       |
| 2010                           |       | 1,749      |       |
| Thereafter                     |       | 4,446      |       |
| ***TOTAL  LEASE COMMITMENTS*** |       | $          | 14,717     |       |

 

**7. Goodwill and CoreDeposit Intangible Assets**

Thefollowing table presents net income and basic and diluted earnings per commonshare, adjusted to reflect results as if the non-amortization provisions ofSFAS 142 had not been in effect for the periods presented (dollars in 000’s).

| ** **                                    | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| *Net  Income:*                                |       |       |       |     |       |     |       |
| Reported net  income                          | ** ** | **$**      | **37,491** |     | $          | 35,109   |       | $ | 33,164 |   |
| Less:  Amortization of Goodwill, net of taxes | ** ** | **(3,189** | **)**      | (3,189   | )          | (2,390   | )          |
| Adjusted Net  Income                          | ** ** | **$**      | **34,302** |     | $          | 31,920   |       | 30,774 |   |
| *Basic  earnings per share:*                  |       |       |       |     |       |     |       |
| Reported basic  earnings per share            | ** ** | **$**      | **1.65**   |     | $          | 1.50     |       | $ | 1.41 |   |
| Less:  Amortization of Goodwill, net of taxes | ** ** | **(0.14**  | **)**      | (0.14    | )          | (0.10    | )          |
| Adjusted basic  earnings per share            | ** ** | **$**      | **1.51**   |     | $          | 1.36     |       | $ | 1.31 |   |
| *Diluted  earnings per share:*                |       |       |       |     |       |     |       |
| Reported diluted  earnings per share          | ** ** | **$**      | **1.61**   |     | $          | 1.47     |       | $ | 1.40 |   |
| Less:  Amortization of Goodwill, net of taxes | ** ** | **(0.14**  | **)**      | (0.13    | )          | (0.10    | )          |
| Adjusted diluted  earnings per share          | ** ** | **$**      | **1.47**   |     | $          | 1.34     |       | $ | 1.30 |   |

 

Thefollowing is a summary of the Company’s core deposit intangible assets. Figuresare in thousands.

| ** **               | ** ** | **Dec. 31, 2005** | ** ** | **Dec. 31, 2004**   | ** ** |
|--------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **               | ** ** | **Gross  Amount**           | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** |
| Core Deposit  Intangible | ** ** | **$**                       | **11,597** | ** **                    |       | **$(5,114** | **)** |   |   | **$** | **6,483** |   |   | $ | 11,597 |   |   | $(3,865 | ) |   |   | $ | 7,732 |   |   |
|                          |            |                             |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

78

----

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**7. Goodwilland Core Deposit Intangible Assets (Continued)**

The aggregate amount ofamortization expense of the core deposit intangible assets is as follows($ in 000’s):

| ** **                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Amortization of  Core Deposit Intangible | ** ** | **$**    | **1,249**  |     | $          | 1,375    |       | $ | 1,122 |   |
|                                          |            |          |            |          |            |          |            |  |  |  |

 

The decline in theamortization rate in 2005 compared to 2004 is related to an adjustment madenecessary by a stronger retention of core deposits from one of the Company’sacquisitions than originally anticipated. The projected amortization expensefor the core deposit intangible assets, assuming no further acquisitions ordispositions or adjustments to current amortization rates, is approximately$872 thousand per year over the next six years. Amortization of core depositintangible premiums from prior mergers are currently scheduled to be completedby dates ranging from October 2012 to September 2013 which representoriginal lives ranging from 9.0 years to 12.0 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.

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-term instruments, the carrying amountis a reasonable estimate of fair value.

79

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**8. Disclosuresabout Fair Value of Financial Instruments (Continued)**

*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.

*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 31,2005.

*Accrued InterestPayable*

For accrued interest payable, the carrying amount is areasonable estimate of fair value.

80

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**8. Disclosuresabout Fair Value of Financial Instruments (Continued)**

**The estimated fair values of theCompany’s financial instruments are as follows:**

| ** **                            | ** ** | **2005**      | ** **  | **2004**             | ** ** |
|---------------------------------------|------------|---------------|-------------|----------------------|------------|
| **(dollars in 000’s)** | ** ** | ** **    | ** **  | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| Financial assets:                     |       |          |        |                 |       |   |   |   |   |
| Cash and due from banks               | ** ** | **$**         | **109,791** | ** **           | **$**      | **109,791** |   | $ | 112,669 |   | $ | 112,669 |   |
| Fed funds sold                        |       | **—**    |        | **—**           |       | 6,000 |   | 6,000 |   |
| Investment securities                 | ** ** | **619,332**   | ** **  | **619,332**          |       | 644,817 |   | 644,817 |   |
| Loans held for sale                   | ** ** | **10,177**    | ** **  | **10,278**           |       | 12,988 |   | 13,118 |   |
| Loans, net                            | ** ** | **1,507,118** | ** **  | **1,499,709**        |       | 1,408,095 |   | 1,366,160 |   |
| Accrued interest receivable           | ** ** | **13,947**    | ** **  | **13,947**           |       | 11,918 |   | 11,918 |   |
| Financial  liabilities:               |       |          |        |                 |       |   |   |   |   |
| Deposits                              | ** ** | **2,069,606** | ** **  | **2,063,188**        |       | 1,994,545 |   | 1,991,371 |   |
| Other borrowings                      | ** ** | **25,903**    | ** **  | **25,638**           |       | 6,582 |   | 6,582 |   |
| Accrued interest  payable             | ** ** | **685**       | ** **  | **685**              |       | 293 |   | 293 |   |
|                                       |            |               |             |                      |            |  |  |  |  |  |  |  |  |  |  |

 

**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 31,2005

| **(dollars in 000’s)**   | ** ** | ** ** | ** **    | **No Contractual  Maturity** | ** ** | **Three Months  or Less** | ** **  | **After 3 Months  to 12 Months** | ** **  | **After  One Year** | ** **  | **Total**  | ** ** |
|-----------------------------------------|------------|------------|---------------|-----------------------------------|------------|-------------------------------------|-------------|------------------------------------------------------|-------------|--------------------------|-------------|------------|------------|
| Demand Deposits                         | ** ** |       | **$**         | **567,782**                       | ** ** |                                |        | **$**                                                | **—**  | ** **               |        |       | **$**      | **—** | ** ** |   |   | **$** | **—** | ** ** |   | **$** | **567,782** | ** ** |
| Savings, Money  Market and NOW Accounts | ** ** |       | **1,067,486** | ** **                        |       |                                | **—**  | ** **                                           |        |                     | **—**  | ** ** |       |   | **—** | ** ** |   | **1,067,486** | ** ** |
| Time Deposits—$100,000  or   more  |       |       | **—**    | ** **                        |       |                                | **109,782** | ** **                                           |        |                     | **80,617**  | ** ** |       |   | **11,664** | ** ** |   | **202,063** | ** ** |
| Time Deposits—Under  $100,000      | ** ** |       | **—**    | ** **                        |       |                                | **89,028**  | ** **                                           |        |                     | **111,091** | ** ** |       |   | **32,156** | ** ** |   | **232,275** | ** ** |
| ***Total***                             | ** ** |       | **$**         | **1,635,268**                     | ** ** |                                |        | **$**                                                | **198,810** | ** **               |        |       | **$**      | **191,708** | ** ** |   |   | **$** | **43,820** | ** ** |   | **$** | **2,069,606** | ** ** |

 

December 31,2004

| **(dollars in 000’s)**   | ** ** | ** ** | ** ** | **No Contractual  Maturity** | ** ** | **Three Months  or Less** | ** ** | **After 3 Months  to 12 Months** | ** ** | **After  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 |   |

 

81

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**10. Income Taxes**

Thecurrent and deferred amounts of the provision for taxes in the years ended December 31,were:

| **(dollars in 000’s)**      | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Federal:                                   |       |       |       |     |       |     |       |
| Current                                    | ** ** | **$**      | **13,081** |     | $          | 12,395   |       | $        | 10,942     |   |
| Deferred                                   | ** ** | **(116**   | **)**      | (553     | )          | 1,285    |       |
| ***Total Federal Taxes***                  | ** ** | **12,965** |       | 11,842   |       | 12,227   |       |
| State:                                     |       |       |       |     |       |     |       |
| Current                                    | ** ** | **5,985**  |       | 5,917    |       | 4,958    |       |
| Deferred                                   | ** ** | **149**    |       | (212     | )          | 529      |       |
| ***Total State Taxes***                    | ** ** | **6,134**  |       | 5,705    |       | 5,487    |       |
| ***TOTAL  FEDERAL AND STATE TAX EXPENSE*** | ** ** | **$**      | **19,099** |     | $          | 17,547   |       | $        | 17,714     |   |

 

Theprovision for taxes on income differed from the amounts computed using thefederal statutory rate of 35 percent as follows:

| **(dollars in 000’s)**                             | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Tax expense at  federal statutory tax rate                        | ** ** | **$**      | **19,807** |     | $          | 18,429   |       | $        | 17,807     |   |
| State income tax  expense, net of state benefit on federal return | ** ** | **3,986**  |       | 3,709    |       | 3,567    |       |
| Tax savings from  exempt investment and loan income)              | ** ** | **(4,681** | **)**      | (4,542   | )          | (3,880   | )          |
| Other, net                                                        | ** ** | **(13**    | **)**      | (49      | )          | 220      |       |
| ***TOTAL  TAX EXPENSE***                                          | ** ** | **$**      | **19,099** |     | $          | 17,547   |       | $        | 17,714     |   |

 

**The principal items giving rise to changes in deferredtaxes were:**

| **(dollars in 000’s)** | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Allowance for  loan losses            | ** ** | **$**      | **861**    |     | $          | 826      |       | $        | 409        |   |
| Real estate joint  ventures           | ** ** | **40**     |       | (56      | )          | (53      | )          |
| Deferred  compensation                | ** ** | **(65**    | **)**      | (61      | )          | 5        |       |
| State income  taxes                   | ** ** | **(100**   | **)**      | (256     | )          | 91       |       |
| Depreciation                          | ** ** | **(607**   | **)**      | (1,608   | )          | 1,011    |       |
| Securities—discount  accretion   | ** ** | **(3**     | **)**      | (170     | )          | (153     | )          |
| Accrued liabilities  and other, net   | ** ** | **(120**   | **)**      | 296      |       | 279      |       |
| Accrued  compensation                 | ** ** | **(9**     | **)**      | 167      |       | (9       | )          |
| Credit carryovers                     | ** ** | **96**     |       | 97       |       | 128      |       |
| Lease income                          | ** ** | **(243**   | **)**      | —   |       | —   |       |
| Purchase  accounting adjustments      | ** ** | **183**    | ** ** | —   |       | 2,077    |       |
| ***TOTAL  DEFERRED TAXES***           | ** ** | **$**      | **33**     |     | $          | (765     | )          | $        | 3,785      |   |

 

82

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**10. IncomeTaxes (Continued)**

**As ofDecember 31, the deferred tax assets and liabilities, which include thedeferred tax asset acquired in the Americorp transaction, are as follows:**

| **(dollars in 000’s)**                                                         | ** ** | ** ** | ** ** | **2005** | ** ** | **2004**   | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|------------|------------|----------|------------|
| Assets:                                                                                       |       |       |       |     |       |       |       |
| Allowance for loan losses                                                                     | ** ** | **$**      | **5,738**  |     | $          | 6,618      |       | $        | 7,444      |   |
| Gain on loan workouts                                                                         |       | **—** |       | 167      |       | 167        |       |
| Deferred compensation                                                                         | ** ** | **2,379**  |       | 2,314    |       | 2,253      |       |
| Merger related expenses                                                                       | ** ** | **226**    |       | 226      |       | 226        |       |
| State income taxes                                                                            | ** ** | **1,719**  |       | 1,613    |       | 1,357      |       |
| Depreciation and amortization                                                                 | ** ** | **1,007**  |       | 381      | ** ** | **—** | ** ** |
| Securities—discount accretion                                                            | ** ** | **473**    |       | 470      |       | 299        |       |
| Accrued compensation                                                                          |       | **—** |       | —   |       | 115        |       |
| Lease rental                                                                                  | ** ** | **277**    |       | —   |       | —     |       |
| Credit carryovers                                                                             | ** ** | **835**    |       | 930      |       | 1,027      |       |
| ***Total  Assets***                                                                           | ** ** | **12,654** |       | 12,719   |       | 12,888     |       |
| Liabilities:                                                                                  |       |       |       |     |       |       |       |
| Real estate joint ventures                                                                    | ** ** | **(603**   | **)**      | (563     | )          | (619       | )          |
| Depreciation and amortization                                                                 |       | **—** |       | —   |       | (1,227     | )          |
| Accrued Compensation                                                                          | ** ** | **(84**    | **)**      | (52      | )          | —     |       |
| Mark-to-market adjustment                                                                     | ** ** | **(293**   | **)**      | (293     | )          | (293       | )          |
| Accrued liabilities and other, net                                                            | ** ** | **(705**   | **)**      | (993     | )          | (696       | )          |
| Purchase accounting adjustments                                                               | ** ** | **(2,260** | **)**      | (2,077   | )          | (2,077     | )          |
| ***Total  Liabilities***                                                                      | ** ** | **(3,945** | **)**      | (3,978   | )          | (4,912     | )          |
| Valuation  Allowance                                                                          | ** ** | **—** |       | —   | ** ** | **—** | ** ** |
| Net deferred tax  asset before tax effect of unrealized gain on securities available for sale | ** ** | **8,709**  |       | 8,741    |       | 7,976      |       |
| Tax effect of unrealized gain on securities  available for sale                               | ** ** | **(264**   | **)**      | (4,573   | )          | (8,200     | )          |
| ***DEFERRED  TAX ASSET, NET***                                                                | ** ** | **$**      | **8,445**  |     | $          | 4,168      |       | $        | (224       | ) |

 

The net deferred tax asset above is included in OtherAssets on the Consolidated Statements of Financial Position. As of December 31,2005, the Company has State tax credit carryforwards of $835,000 for financialreporting purposes. There are no alternative minimum tax credit carryforwardsfor tax purposes. As of December 31, 2005, 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.

83

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**11. Other Borrowings**

TheCompany had other borrowings under the Treasury Tax and Loan note account of$3,903,000 and $4,582,000 at December 31, 2005 and 2004, respectively.Federal Home Loan Bank borrowings were at $22,000,000 and $2,000,000 at December 31,2005 and 2004, respectively. A summary of borrowings from the Federal Home LoanBank are as follows:

| **Description**            | ** ** | ** ** | ** ** | **Issue Date** | ** ** | **Rate** | ** ** | **Maturity** | ** ** | **Carrying Amount** | ** ** |
|----------------------------|------------|------------|------------|---------------------|------------|----------|------------|--------------|------------|--------------------------|------------|
| Fixed Rate Credit  Advance |       |       | 06/25/01   |                |       | 6.16     | %          | 06/27/11     |       |                     | $          | 2,000,000 |   |   |
| Fixed Rate Credit  Advance |       |       | 01/20/05   |                |       | 3.74     | %          | 01/22/08     | * *   |                     | $          | 20,000,000 |   |   |
| Total                      |       |       |       |                |       |     |       |         |       |                     | $          | 22,000,000 |   |   |

 

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, 2005and 2004, these combined unused lines amounted to $109,685,000 and$109,791,000, respectively.

**12. Commitments andContingencies**

At December 31, 2005 and 2004, the Company wascontingently liable for letter of credit accommodations made to its customerstotaling $40,914,000 and $30,176,000, respectively. At December 31, 2005and 2004, the Company also had undisbursed loan commitments in the amount of$657,687,000 and $626,353,000, respectively.

Letters of credit are issued in connection with agreementsmade by customers to counterparties. Terms of these letters of credit aregenerally for one year and may or may not be collateralized by receivables orother assets. If the customer fails to comply with the agreement, thecounterparty may enforce the letter of credit as a remedy. Credit risk arisesfrom the possibility that the customer may not be able to repay the Company. Thenotional amount of the letter of credit accommodations represents the maximumamount 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 through a charge to other operating expenses on theConsolidated Statements of Income.

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 PerShare**

Earnings per share (EPS) have been computed in 2005,2004 and 2003, based on the weighted average number of shares outstanding eachyear of 22,788,000, 23,422,000, and 23,443,000, respectively.

84

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**13. EarningsPer 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.

| **(figures in 000’s except per share data)** | ** ** | ** ** | ** ** | **Earnings** | ** ** | **Weighted  Average Shares  Outstanding** | ** ** | **EPS**    | ** ** |
|---------------------------------------------------------------------------------|------------|------------|------------|--------------|------------|------------------------------------------------|------------|------------|------------|
| **2005**                                                                        |       |       |       |         |       |                                           |       |       |       |
| **Basic Earnings Per Share:**                                                   |       |       |       |         |       |                                           |       |       |       |
| **Net Income available to Common Stockholders**                                 | ** ** | **$**      | **37,491** | ** **   | ** ** | **22,788**                                     |       | ** ** | **$**      | **1.65** | ** ** |
| **Effect  of Dilutive Securities:**                                             |       |       |       |         |       |                                           |       |       |       |
| **Stock Options**                                                               | ** ** | ** ** |       | ** **   | **512**    |                                           |       |       |       |
| **Diluted  Earnings Per Share:**                                                |       |       |       |         |       |                                           |       |       |       |
| **Net Income available to Common Stockholders and assumed  conversions**        | ** ** | **$**      | **37,491** | ** **   | ** ** | **23,300**                                     |       | ** ** | **$**      | **1.61** | ** ** |
| **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 |   |

 

**14. Capital Accounts**

The Company declared cashdividends during 2005 of $14,995,000. 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 $15,827,000 at December 31,2005 to the Company. The Bank can also apply to the State of California’sDepartment of Financial Institutions (DFI) for the ability to pay additionaldividends to the Company. The Bank and Company expects to make such applicationduring 2006 given the Company’s planned regular dividends and on-going stockrepurchase program. Given the Bank’s strong capital position, Management doesnot expect such approval to be withheld.

85

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**15. Stock Options**

On May 17, 2005, shareholders of the Companyapproved a new equity based compensation plan, the Mid-State Bancshares 2005Equity Based Compensation Plan (the “2005 Plan”) which reserves an additional1,000,000 common shares for issuance in accordance with the terms of the Plan. The2005 Plan provides for the grant of stock options, stock appreciation rights,restricted shares, restricted share units, performance based cash only awards,or any combination thereof. It replaces the 1996 Stock Option Plan which waslimited in scope to the issuance of Stock Options. Shares available forissuance under the 1996 Plan are now included in the 2005 Plan, resulting in1,027,372 shares currently being available to be issued (4.56% of current andissued outstanding common stock) as of December 31, 2005. All Optionsunder both the 1996 and 2005 Plans have been granted at a price not less than thefair market value of the stock at the grant date. While options are exercisableand expire as determined by the Board of Directors, generally options expire nolater than ten years from the date of grant and vest at the rate of 20% peryear following the date of grant. As of December 31, 2005, 2,000,958shares are currently under option. The shares are exercisable at prices rangingfrom $5.375 to $30.61. There were 266,330 shares exercised in 2005 and 190,548and 172,096 exercised in 2004 and 2003, respectively.

TheBank applies Accounting Principles Board 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 with the followingassumptions in 2005: dividend yields ranging from 2.12% to 2.68%, expectedvolatility of 34.85%, risk-free interest rates ranging from 3.83%****to 4.44% and expected lives of 6.29 years. Assumptionsutilized in prior years for estimating fair values were not materiallydifferent. The Bank’s net income and earnings per share for the years ended December 31,2005, 2004 and 2003 would have been reduced to pro forma amounts indicatedbelow:

| **(dollars in 000’s except per share data)** | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Net income to  common shareholders:                                             |       |       |       |     |       |     |       |
| As reported                                                                     | ** ** | **$**      | **37,492** |     | $          | 35,109   |       | $        | 33,164     |   |
| Pro forma  compensation cost                                                    | ** ** | **$**      | **(2,406** | **)**    | $          | (2,099   | )          | $        | (1,618     | ) |
| Pro forma                                                                       | ** ** | **$**      | **35,086** |     | $          | 33,010   |       | $        | 31,546     |   |
| Net income per  common and common share equivalent:                             |       |       |       |     |       |     |       |
| Basic earnings per share:                                                       |       |       |       |     |       |     |       |
| As reported                                                                     | ** ** | **$**      | **1.65**   |     | $          | 1.50     |       | $        | 1.41       |   |
| Pro forma                                                                       | ** ** | **$**      | **1.54**   |     | $          | 1.41     |       | $        | 1.35       |   |
| Diluted earnings per share:                                                     |       |       |       |     |       |     |       |
| As reported                                                                     | ** ** | **$**      | **1.61**   |     | $          | 1.47     |       | $        | 1.40       |   |
| Pro forma                                                                       | ** ** | **$**      | **1.51**   |     | $          | 1.38     |       | $        | 1.33       |   |

 

86

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**15. StockOptions (Continued)**

A summary of the Company’sstock options as of December 31, 2005, 2004 and 2003, and changes duringthe periods then ended, is presented below:

| ** **                             | ** ** | **Options**                 | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Per Share  Ranges** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|----------------------------|------------|
| **2005**                               |       |                        |       |                                   |       |                       |       |   |   |
| **Outstanding  at Beginning of Year**  | ** ** | **2,086,917**               | ** ** | ** **                             | **$**      | **17.81**                  |       | ** ** | **$** | **5.375-$30.61** | ** ** |
| **Granted  during Year**               | ** ** | **216,371**                 | ** ** | ** **                             | **$**      | **27.73**                  |       | ** ** | **$** | **26.67-$30.24** | ** ** |
| **Exercised/Forfeited  during Year**   | ** ** | **(302,330**                | **)**      | ** **                             | **$**      | **15.75**                  |       | ** ** | **$** | **5.375-$27.60** | ** ** |
| **Outstanding  at End of Year**        | ** ** | **2,000,958**               | ** ** | ** **                             | **$**      | **19.20**                  |       | ** ** | **$** | **5.375-$30.61** | ** ** |
| **Exercisable  at End of Year**        | ** ** | **1,207,218**               | ** ** | ** **                             | **$**      | **16.30**                  |       | ** ** | **$** | **5.375-$30.61** | ** ** |
| **Range  of Expiration Dates**         | ** ** | **7/10/2008 to 12/21/2015** | ** ** |
| **Shares  Available for Future Grant** | ** ** | **1,027,372**               |       |                                   |       |                       |       |   |   |
| **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 |   |
| **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 |   |

 

Asummary of the Company’s stock options outstanding and exercisable as of December 31,2005 by price range is presented below:

| **Range of Exercise  Prices** | ** ** | ** ** | ** ** | **Total  Amount  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Years** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Amount  Exercisable** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|-----------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------|------------|-------------------------------------------|------------|
| $3.061 - $6.122                         |       |       | 33,488     |                           |       |                                                         | 0.5        |                                      |       |                    | $          | 5.375                                     |       |   | 33,488 |   |   | $ | 5.375 |   |   |
| $6.123 - $9.183                         |       |       | —     |                           |       |                                                         | —     |                                      |       |                    | —     |                                      |       | — |   |   | — |   |   |
| $9.184 - $12.244                        |       |       | 12,000     |                           |       |                                                         | 4.3        |                                      |       |                    | $          | 12.125                                    |       |   | 12,000 |   |   | $ | 12.125 |   |   |
| $12.245 - $15.305                       |       |       | 473,543    |                           |       |                                                         | 3.8        |                                      |       |                    | $          | 14.540                                    |       |   | 455,101 |   |   | $ | 14.542 |   |   |
| $15.306 - $18.366                       |       |       | 820,350    |                           |       |                                                         | 5.0        |                                      |       |                    | $          | 16.882                                    |       |   | 606,189 |   |   | $ | 16.845 |   |   |
| $18.367 - $21.427                       |       |       | 18,000     |                           |       |                                                         | 6.7        |                                      |       |                    | $          | 19.372                                    |       |   | 10,000 |   |   | $ | 19.322 |   |   |
| $21.428 - $24.488                       |       |       | 75,200     |                           |       |                                                         | 8.3        |                                      |       |                    | $          | 22.816                                    |       |   | 16,800 |   |   | $ | 22.959 |   |   |
| $24.489 - $27.549                       |       |       | 329,006    |                           |       |                                                         | 8.5        |                                      |       |                    | $          | 25.871                                    |       |   | 62,840 |   |   | $ | 25.825 |   |   |
| $27.550 - $30.610                       |       |       | 239,371    |                           |       |                                                         | 9.1        |                                      |       |                    | $          | 28.320                                    |       |   | 10,800 |   |   | $ | 29.873 |   |   |
| Total                                   |       |       | 2,000,958  |                           |       |                                                         | 5.8        |                                      |       |                    | $          | 19.198                                    |       |   | 1,207,218 |   |   | $ | 16.301 |   |   |

 

87

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**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 31,2005, 2004, and 2003 were $2,985,000, $2,842,000, and $2,665,000, 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 2005, 2004 and 2003 was a charge of $4,050,000,$2,400,000, and $3,400,000, respectively, which was accrued during those yearsand paid in the following year under the Incentive Reward System. Employeesreceiving bonuses under this program in 2005 ranged from 2.2% of their salaryto as much as 95.8% of their salary.

The Company has postretirementobligations to certain of the former employees of acquired institutions. Theliability for these obligations is included within Other Liabilities on theconsolidated statement of financial position and amounted to $1,450,000 and$1,371,000 at December 31, 2005 and 2004, respectively. The amount ofemployee benefit expense accrued under these obligations amounted to $145,000,$145,000 and $61,000 in 2005, 2004, and 2003, respectively. Generally, theseobligations amount to a fixed payment to these individuals for 10 to 15 yearsupon 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.

88

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**17. RegulatoryMatters (Continued)**

As of December 31,2005, the latest regulatory examinations indicated that, Mid-State Bancsharesand Mid-State Bank & Trust were categorized as well capitalized underthe regulatory framework for prompt corrective action. To be categorized aswell capitalized, Mid-State Bancshares and Mid-State Bank & Trust mustmaintain minimum total risk-based, Tier One risk-based and Tier One Leverageratios as set forth in the following table. There are no conditions or eventsthat Management believes have changed Mid-State Bancshares’ and Mid-State Bank &Trust’s category. The actual capital amounts and ratios as of December 31,2005 and 2004 are also presented in the following table:

| ** **                                        | ** ** | **Actual** | ** **  | **To be Considered  Adequately  Capitalized  For Capital  Adequacy Purposes** | ** ** | **To be Considered  Well Capitalized  For Capital  Adequacy Purposes** | ** ** |
|---------------------------------------------------|------------|------------|-------------|---------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| **(dollars in  000’s)**                      | ** ** | ** ** | ** **  | **Amount**                                                                                        | ** ** | **Ratio**                                                                                       | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ***Mid-State  Bancshares—Consolidated:***    |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As of December 31, 2005:                     |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Capital                                     |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Risk Weighted  Assets)                        | ** ** | **$**      | **231,264** | ** **                                                                                        | ** ** | **12.3**                                                                                        | **%**      | ** ** | **$** | **149,824** | ** ** | ** ** | **8.0** | **%** | ** ** | **$** | **187,280** | ** ** | ** ** | **10.0** | **%** | ** ** |
| Tier One Capital                                  |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Risk Weighted  Assets)                        | ** ** | **$**      | **217,607** | ** **                                                                                        | ** ** | **11.6**                                                                                        | **%**      | ** ** | **$** | **74,912** | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **112,368** | ** ** | ** ** | **6.0** | **%** | ** ** |
| Tier One Capital                                  |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Average  Assets)                              | ** ** | **$**      | **217,607** | ** **                                                                                        | ** ** | **9.2**                                                                                         | **%**      | ** ** | **$** | **94,666** | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **118,333** | ** ** | ** ** | **5.0** | **%** | ** ** |
| 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 | % |   |
| ***Mid-State Bank &  Trust—Only:*** |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As of December 31, 2005:                     |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Capital                                     |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Risk Weighted  Assets)                        | ** ** | **$**      | **224,459** | ** **                                                                                        | ** ** | **12.0**                                                                                        | **%**      | ** ** | **$** | **149,824** | ** ** | ** ** | **8.0** | **%** | ** ** | **$** | **187,280** | ** ** | ** ** | **10.0** | **%** | ** ** |
| Tier One Capital                                  |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Risk Weighted  Assets)                        | ** ** | **$**      | **210,802** | ** **                                                                                        | ** ** | **11.3**                                                                                        | **%**      | ** ** | **$** | **74,912** | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **112,368** | ** ** | ** ** | **6.0** | **%** | ** ** |
| Tier One Capital                                  |       |       |        |                                                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Average  Assets)                              | ** ** | **$**      | **210,802** | ** **                                                                                        | ** ** | **8.9**                                                                                         | **%**      | ** ** | **$** | **94,690** | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **118,363** | ** ** | ** ** | **5.0** | **%** | ** ** |
| 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 | % |   |
|                                                   |            |            |             |                                                                                                   |            |                                                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

89

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**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 within the company for makingoperating decisions and assessing performance. Presently, the Company issegregated into three reportable business segments, Community Banking,Mid-Coast 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, 2005. The accounting policies usedin the disclosure of business segments are the same as those described in the summaryof significant accounting policies. Certain assumptions are made concerning theallocations of costs between segments which may influence relative results,most notably, allocations of various types of overhead and administrative costs.Management believes that the allocations utilized below are reasonable andconsistent with the way it manages the business.

| ** **                            | ** ** | **Community Banking** | ** ** | **Mid-Coast  Land Company** | ** ** | **Trust Services** | ** ** |
|---------------------------------------|------------|----------------------------|------------|----------------------------------|------------|-------------------------|------------|
| **(dollars in 000’s)** | ** ** | ** **                 | ** ** | **2005**                         | ** ** | **2004**                | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest Income                       |       | $                          | 128,326    |                             | $          | 109,936                 |       | $ | 105,239 |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 1 |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |
| Interest Expense                      |       | 15,503                     |       | 8,450                            |       | 9,699                   |       |   | — |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | — |   |
| Net Interest Income                   |       | 112,823                    |       | 101,486                          |       | 95,540                  |       |   | — |   |   |   | — |   |   |   | 1 |   |   | — |   |   | — |   |   | — |   |
| (Benefit) Provision                   |       | —                     |       | (2,700                           | )          | (969                    | )          |   | — |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | — |   |
| Non Interest Income                   |       | 19,512                     |       | 26,153                           |       | 27,715                  |       |   | 717 |   |   |   | 682 |   |   |   | 678 |   |   | 1,212 |   |   | 929 |   |   | 666 |   |
| Non Interest Expense                  |       | 76,692                     |       | 78,391                           |       | 73,735                  |       |   | 12 |   |   |   | 27 |   |   |   | 123 |   |   | 970 |   |   | 876 |   |   | 833 |   |
| Pre-Tax Income                        |       | $                          | 55,643     |                             | $          | 51,948                  |       | $ | 50,489 |   |   | $ | 705 |   |   |   | $ | 655 |   |   |   | $ | 556 |   |   | $ | 242 |   |   | $ | 53 |   |   | $ | (167 | ) |
| Ending Total Assets   (in millions)   |       | $                          | 2,380      |                             | $          | 2,285                   |       | $ | 2,199 |   |   | $ | 11 |   |   |   | $ | 11 |   |   |   | $ | 10 |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |
|                                       |            |                            |            |                                  |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                            | ** ** | **Mid-State Bancshares** | ** ** |
|---------------------------------------|------------|-------------------------------|------------|
| **(dollars in 000’s)** | ** ** | ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest Income                       |       | $                             | 128,326    |   | $ | 109,936 |   | $ | 105,240 |   |
| Interest Expense                      |       | 15,503                        |       | 8,450 |   | 9,699 |   |
| Net Interest Income                   |       | 112,823                       |       | 101,486 |   | 95,541 |   |
| (Benefit) Provision                   |       | —                        |       | (2,700 | ) | (969 | ) |
| Non Interest Income                   |       | 21,441                        |       | 27,764 |   | 29,059 |   |
| Non Interest Expense                  |       | 77,674                        |       | 79,294 |   | 74,691 |   |
| Pre-Tax Income                        |       | $                             | 56,590     |   | $ | 52,656 |   | $ |  50,878 |   |
| Ending Assets  (in millions)          |       | $                             | 2,391      |   | $ | 2,296 |   | $ | 2,209 |   |
|                                       |            |                               |            |  |  |  |  |  |  |  |  |  |

 

There were no significantcapital expenditures made in 2005 in any of the above business segments.

90

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**19. Quarterly FinancialData**

Thefollowing table presents condensed consolidated statements of income for eachof the quarters covering the past two years (unaudited—in 000’s):

| ** **                 | ** ** | **2005**             | ** ** |
|----------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** | **Full Year** | ** ** |
| Interest Income            | ** ** |                 | **$**      | **29,482** | ** ** |   |   | **$** | **31,654** | ** ** |   |   | **$** | **32,923** | ** ** |   |   | **$** | **34,267** | ** ** |   | **$** | **128,326** | ** ** |
| Interest Expense           | ** ** |                 | **2,713**  | ** ** |   |   | **3,694** | ** ** |   |   | **4,324** | ** ** |   |   | **4,772** | ** ** |   | **15,503** | ** ** |
| Net Interest  Income       | ** ** |                 | **26,769** | ** ** |   |   | **27,960** | ** ** |   |   | **28,599** | ** ** |   |   | **29,495** | ** ** |   | **112,823** | ** ** |
| Provision for  loan losses |       |                 | **—** | ** ** |   |   | **—** | ** ** |   |   | **—** | ** ** |   |   | **—** | ** ** |   | **—** | ** ** |
| Non-interest  income       | ** ** |                 | **5,395**  | ** ** |   |   | **5,378** | ** ** |   |   | **5,271** | ** ** |   |   | **5,397** | ** ** |   | **21,441** | ** ** |
| Non-interest  expense      | ** ** |                 | **18,335** | ** ** |   |   | **19,211** | ** ** |   |   | **19,473** | ** ** |   |   | **20,655** | ** ** |   | **77,674** | ** ** |
| Income before  taxes       | ** ** |                 | **13,829** | ** ** |   |   | **14,127** | ** ** |   |   | **14,397** | ** ** |   |   | **14,237** | ** ** |   | **56,590** | ** ** |
| **Taxes**                  | ** ** |                 | **4,739**  | ** ** |   |   | **4,615** | ** ** |   |   | **4,905** | ** ** |   |   | **4,840** | ** ** |   | **19,099** | ** ** |
| Net Income                 | ** ** |                 | **$**      | **9,090** | ** ** |   |   | **$** | **9,512** | ** ** |   |   | **$** | **9,492** | ** ** |   |   | **$** | **9,397** | ** ** |   | **$** | **37,491** | ** ** |
| Earnings Per  Share:       |       |                 |       | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   |   |
| —Basic                | ** ** |                 | **$**      | **0.39** | ** ** |   |   | **$** | **0.42** | ** ** |   |   | **$** | **0.42** | ** ** |   |   | **$** | **0.42** | ** ** |   | **$** | **1.65** | ** ** |
| —Diluted              | ** ** |                 | **$**      | **0.39** | ** ** |   |   | **$** | **0.41** | ** ** |   |   | **$** | **0.41** | ** ** |   |   | **$** | **0.41** | ** ** |   | **$** | **1.61** | ** ** |

 

| ** **                 | ** ** | **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 |   |

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**20. Parent CompanyFinancial Information**

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

***Condensed BalanceSheets***

| ** **                                       | ** **   | **December 31,** | ** **  |
|--------------------------------------------------|--------------|-----------------------|-------------|
| **(dollars in  000’s)**                     | ** **   | ** **            | ** **  | **2005** | ** ** | **2004** | ** ** |
| ASSETS                                           | ** **   | ** **            |        |   |   |
| Cash                                             | ** **   | **$**                 | **4,946**   |   | $ | 1,292 |   |
| Investment in Mid-State  Bank & Trust   | ** **   | **269,811**           |        | 276,694 |   |
| Other Assets                                     | *** *** | **1**                 | * *    | *5* | * * |
| Total Assets                                     | ** **   | **$**                 | **274,758** |   | $ | 277,991 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |         |                  |        |   |   |
| Dividend Payable                                 | ** **   | **$**                 | **4,054**   |   | $ | 3,695 |   |
| Accrued  Liabilities                             | *** *** | **(1,858**            | **)**       | (331 | ) |
| Total Liabilities                                | ** **   | **2,196**             |        | 3,364 |   |
| Stockholders’  Equity                       | *** *** | **272,562**           | * *    | 274,627 | * * |
| Total Liabilities  and Stockholders’ Equity | ** **   | **$**                 | **274,758** |   | $ | 277,991 |   |
|                                                  |              |                       |             |  |  |  |  |  |  |

 

***Condensed IncomeStatements***

| ** **                           | ** **   | **December 31,** | ** ** |
|--------------------------------------|--------------|-----------------------|------------|
| ** **                           | ** **   | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Equity in  earnings of subsidiaries: |         |                  |       |   |   |   |   |
| Undistributed                        | ** **   | **$**                 | **(418**   | **)** | $ | 10,345 |   | $ | 7,348 |   |
| Dividends                            | ** **   | **38,637**            |       | 25,222 |   | 26,245 |   |
| Operating  Expenses                  | ** **   | **(1,254**            | **)**      | (789 | ) | (739 | ) |
| Income Tax  Benefit                  | *** *** | **526**               | * *   | 331 | * * | 310 | * * |
| Net Income                           | ** **   | **$**                 | **37,491** |   | $ | 35,109 |   | $ | 33,164 |   |

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2005**

**20. ParentCompany Financial Information (Continued)**

***CondensedStatements of Cash Flows***

| ** **                                                                         | ** **   | **December 31,** | ** ** |
|------------------------------------------------------------------------------------|--------------|-----------------------|------------|
| ** **                                                                         | ** **   | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from  operation activities:                                             |         |                  |       |   |   |   |   |
| Net Income                                                                         | ** **   | **$**                 | **37,491** |   | $ | 35,109 |   | $ | 33,164 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |         |                  |       |   |   |   |   |
| Net undistributed earnings of Bank                                                 | ** **   | **418**               |       | (10,345 | ) | (7,348 | ) |
| Net change in accrued liabilities                                                  | ** **   | **(1,527**            | **)**      | 201 |   | (310 | ) |
| Net change in other assets                                                         | ** **   | **4**                 |       | (5 | ) | *—* | * * |
| Net cash provided by operating activities                                          | ** **   | **36,386**            |       | 24,960 |   | 25,506 |   |
| Net Cash Flow  from Investing Activities                                           | *** *** | **—**            |       | — |   | — | * * |
| Net Cash Flows  from Financing Activities:                                         |         |                  |       |   |   |   |   |
| Proceeds from stock options                                                        | ** **   | **3,969**             |       | 2,579 |   | 2,284 |   |
| Payment to purchase common stock                                                   | ** **   | **(23,065**           | **)**      | (16,646 | ) | (16,212 | ) |
| Dividends paid by parent                                                           | ** **   | **(14,636**           | **)**      | (12,918 | ) | (11,246 | ) |
| Other—non cash item related to tax benefit on stock  options                  | ** **   | **1,000**             | * *   | *—* | * * | *—* | * * |
| Net cash used in financing activities                                              | ** **   | **(32,732**           | **)**      | (26,985 | ) | (25,174 | ) |
| Net Increase  (Decrease) in Cash                                                   | ** **   | **3,654**             |       | (2,025 | ) | 332 |   |
| Cash, beginning  of year                                                           | ** **   | **1,292**             |       | 3,317 |   | 2,985 |   |
| Cash, at end of year                                                               | ** **   | **$**                 | **4,946**  |   | $ | 1,292 |   | $ | 3,317 |   |

 

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

**ITEM 9A.**        CONTROLSAND PROCEDURES

In accordance with Rule 13a-15(b) ofthe Exchange Act, as of the end of the year ended December 31, 2005, 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, 2005, 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 (includinginternal controls) and enhanced monitoring controls. We are committed toongoing assessments of our controls and their effectiveness, the results ofwhich will be 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, 2005 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, 2005. Management’s report on internal controlover financial reporting is set forth in Item 8 of  this report on Form 10-K,and is incorporated herein by reference. Management’s assessment of theeffectiveness of the Company’s internal control over financial reporting hasbeen audited by PricewaterhouseCoopers LLP, an independent, registered publicaccounting firm, as stated in its report, which is also set forth in Item 8 ofthis Form 10-K and is also  incorporated herein by reference.

**ITEM 9B.**       OTHERINFORMATION

Not Applicable.

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

The information requiredby Item 10 of Form 10-K is incorporated by reference from theinformation contained in the Bank’s Proxy Statement for the 2006 Annual Meetingof Shareholders which will be filed pursuant to Regulation 14A.

**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 atwww.midstatebank.com. Any change to or waiver of the code of conduct (otherthan technical, administrative, and other non-substantive changes) will beposted on our website or reported on a Form 8-K filed with the SEC. Whilethe Board may consider a waiver for an executive officer or director, we do notexpect to grant such waivers.

**ITEM 11.**         EXECUTIVECOMPENSATION

The information requiredby Item 11 of Form 10-K is incorporated by reference from theinformation contained in the Bank’s Proxy Statement for the 2006 Annual Meetingof Shareholders which will be filed pursuant to Regulation 14A.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The information requiredby Item 12 of Form 10-K is incorporated by reference from theinformation contained in the Bank’s Proxy Statement for the 2006 Annual Meetingof Shareholders which will be filed pursuant to Regulation 14A.

**ITEM 13.**         CERTAINRELATIONSHIPS 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 2006 Annual Meetingof Shareholders which will be filed pursuant to Regulation 14A.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The information required by Item 14 of Form 10-Kis incorporated by reference from the information contained in the Bank’s ProxyStatement for the 2006 Annual Meeting of Shareholders which will be filedpursuant to Regulation 14A.

 

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

**(a)**          **Documents filed as part of this Report**

**(1)****        **ManagementStatement, Report of Independent Registered Public Accounting Firm,Consolidated Statements of Financial Position, Income, Comprehensive Income,Changes in Capital Accounts, and Cash Flows, and the Notes to the ConsolidatedFinancial Statements.

**(2)****        **Schedules:None

**(3)****        **Exhibits:See Page 99.

**(b)**          **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)                                                                                     |       |   |   |
|        | 10.9       | ** **                      |       | Mid-State Bancshares  2005 Equity Based Compensation Plan(8)                                                                               |       |   |   |
|        | 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)          Filedas an exhibit to Registrant’s Registration Statement (File No. 333-16952) filedon November 27, 1996.

(3)          Filedas part of the Registrant’s Registration Statement on Form S-4 (File No.333-48181) filed on March 18, 1998.

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

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

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

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

(8)          Filedas part of the Registrant’s Registration Statement on Form S-8 (File No. 333-126880)filed on July 26, 2005.

**(c)****           Schedules:**

Not Applicable

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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 BANCSHARES        |
|--------|--------|--------|--------|-----------------------------|
|   |   |   |   | By:                         | * * | /s/  JAMES W. LOKEY |
|   |   |   |   |                        |   | JAMES W. LOKEY |
|   |   |   |   |                        |   | *President  and Chief Executive Officer* |
|   |   |   |   |                        |   | *[Principal  Executive Officer]* |
|   |   |   |   | Dated: March 15,  2006 |
|   |   |   |   | By                          | * * | /s/  JAMES G. STATHOS |
|   |   |   |   |                        |   | JAMES G. STATHOS |
|   |   |   |   |                        |   | *Executive  Vice President* |
|   |   |   |   |                        |   | *and  Chief Financial Officer* |
|   |   |   |   |                        |   | *[Principal  Financial and Accounting Officer]* |
|   |   |   |   | Dated: March 15,  2006 |

 

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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,  2006 |
| CARROL R. PRUETT        |       |                  |
| /s/  GEORGE H. ANDREWS  |       | Director              |       | March 15,  2006 |
| GEORGE H. ANDREWS       |       |                  |
| /s/  TRUDI CAREY        |       | Director              |       | March 15,  2006 |
| TRUDI CAREY             |       |                  |
| /s/  DARYL L. FLOOD     |       | Director              |       | March 15,  2006 |
| DARYL L. FLOOD          |       |                  |
| /s/H. EDWARD HERON      |       | Director              |       | March 15,  2006 |
| H. EDWARD HERON         |       |                  |
| /s/  JAMES W. LOKEY     |       | Director              |       | March 15,  2006 |
| JAMES W. LOKEY          |       |                  |
| /s/  STEPHEN P. MAGUIRE |       | Director              |       | March 15,  2006 |
| STEPHEN P.  MAGUIRE     |       |                  |
| /s/  MICHAEL L. MINER   |       | Director              |       | March 15,  2006 |
| MICHAEL L. MINER        |       |                  |
| /s/  GREGORY R. MORRIS  |       | Director              |       | March 15,  2006 |
| GREGORY R. MORRIS       |       |                  |
| /s/  ALAN RAINS         |       | Director              |       | March 15,  2006 |
| ALAN RAINS              |       |                  |

 

 

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**EXHIBIT INDEX**
| 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 |   |

 

99

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