**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20529**

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**FORM 10-K**

| (Mark One) |                                                                               |
|------------|------------------------------------------------------------------------------------|
| **x**      | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES**     |
| ** ** | **EXCHANGE ACT OF 1934**                                                           |
| ** ** | **For the fiscal year ended December 31, 2006**                               |
| ** ** | **or**                                                                             |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(b) OF THE SECURITIES** |
| ** ** | **EXCHANGE ACT OF 1934**                                                           |

 

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

**Commissionfile number 000-23925**

**MID-STATE BANCSHARES**(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)           |

 

Registrant’s telephonenumber, including area code : **(805) 473-6829**

Securities registeredpursuant to Section 12(b) of the Act: **None**

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

**Common Stock**

(no par value)

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Role 405 of theSecurities Act. Yes o  Nox

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or15(d) of the Act. Yes  o  No x

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

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

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 |   | accelerated filer x |   | non-accelerated filer o |
|---------------------------|--------|---------------------|--------|-------------------------|

 

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

The aggregate market valueof the common stock held by non-affiliates of the registrant as of June 30,2006 was $619,383,016.

The number of shares ofcommon stock of the registrant outstanding as of March 2, 2007 was22,251,545.

Thisannual report on Form 10K is 117 pages long including the signaturepages, certifications and consent.

 

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**TABLEOF CONTENTS**
|            | ** ** | ** **                                                                                                         | ** ** | **Page**   | ** ** |
|------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** ** | ** ** | ** **                                                                                                         | ** ** | ** ** | ** ** |
| ** ** | ** ** | **PART I**                                                                                                    |       |       |       |   |   |
| ITEM 1.    |       | BUSINESS                                                                                                           |       |       | 1          |   |   |
| ITEM 1A.   |       | RISK FACTORS                                                                                                       |       |       | 19         |   |   |
| 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                                                                                           |       |       | 31         |   |   |
| ITEM 7.    |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                        |       |       | 33         |   |   |
| ITEM 7A.   |       | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET  RISK                      |       |       | 52         |   |   |
| ITEM 8.    |       | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                        |       |       | 53         |   |   |
| ITEM 9.    |       | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE                              |       |       | 91         |   |   |
| ITEM 9A.   |       | CONTROLS AND PROCEDURES                                                                                            |       |       | 91         |   |   |
| ITEM  9B.  |       | OTHER  INFORMATION                                                                                                 |       |       | 91         |   |   |
| ** ** | ** ** | **PART III**                                                                                                  |       |       |       |   |   |
| ITEM 10.   |       | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                             |       |       | 92         |   |   |
| ITEM 11.   |       | EXECUTIVE COMPENSATION                                                                                             |       |       | 96         |   |   |
| ITEM 12.   |       | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS                    |       |       | 107        |   |   |
| ITEM 13.   |       | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND  DIRECTOR INDEPENDENCE                                         |       |       | 107        |   |   |
| ITEM 14.   |       | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                             |       |       | 109        |   |   |
| ** ** | ** ** | **PART IV**                                                                                                   |       |       |       |   |   |
| ITEM 15.   |       | EXHIBITS, FINANCIAL STATEMENT SCHEDULES                                                                            |       |       | 110        |   |   |
|       |       | SIGNATURES                                                                                                         |       |       | 111        |   |   |

 

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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, the occurrence of any event, change orother circumstances that could give rise to the termination of the agreementand plan of merger with Rabobank, the outcome of any legal proceedings thathave been or may be instituted against the Company and others related to theagreement and plan of merger and the transactions contemplated thereby, failureto obtain shareholder approval or any other failure to satisfy other conditionsrequired to complete the proposed merger, including required regulatoryapprovals, the amount of the costs, fees, expenses and charges related to theproposed merger and other factors referenced in this report, including in “Item1A. Risk Factors.”  We can make noassurances regarding the likelihood of consummation of the merger described inthis report. 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 (theCompany) is the parent company to Mid-State Bank & Trust (the Bank),its 100% owned principal subsidiary. The Company is registered as a bankholding company under the Bank Holding Company Act of 1956, as amended (BHCAct) and is subject to the supervision and regulation of the Board of Governorsof the Federal Reserve System (Federal Reserve Board).

***Rabobank Merger***

On November 2, 2006, the Company and Rabobankannounced that they had entered into an agreement and plan of merger throughwhich Mid-State Bank & Trust will become part of the Rabobank Group. Uponcompletion, Mid-State Bank & Trust will be merged into Rabobank, N.A.,Rabobank’s community banking subsidiary in California.

Under terms of the agreement and plan of merger,Rabobank will acquire all of the shares of Mid-State Bancshares, through amerger with a Rabobank subsidiary, for a purchase price of $37.00 per share incash, or a total purchase price of approximately $851 million. This representeda 23% premium over the average share price of Mid-State Bancshares common stockin October of 2006. The transaction is expected to close in the secondquarter of 2007, subject to approval by Mid-State Bancshares shareholders andthe receipt of all required regulatory approvals. It is currently anticipatedthat the special meeting of shareholders to vote on the acquisition will beheld on or about April 25, 2007 and a proxy statement 

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containing informationabout the transaction will be sent out approximately 30 days in advance of suchmeeting to shareholders of record. If the transaction does not close on orbefore April 30, 2007, the Company may pay an additional cash dividend, ordividends, to shareholders as more fully described in Part II, Item 5 ofthis report.

Please see our Report on Form 8-K filedwith the Securities and Exchange Commission on November 3, 2006. Attachedto that Report is a copy of the definitive agreement for the acquisition towhich you are referred and by which this discussion is qualified in itsentirety. See the section entitled “Where you can Find Additional Information”at the end of this Item 1 for how to get a copy of that Report. See also, Item3 of this Report on Form 10-K entitled Legal Proceedings forinformation regarding a lawsuit filed in connection with the acquisition.

In reviewing this AnnualReport on Form 10-K, please understand that the entire discussion ofthe Company, its business and all related disclosures herein is influenced tosome extent by the acquisition by Rabobank which is expected to be consummatedin the second quarter of 2007. Thus, the Company has focused its discussion onhistorical information and has omitted discussion of the future independentoperations or prospects of the Company during this year or in the future unlessotherwise required under SEC rules.

***General***

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

Mid-State Bank & Trust was incorporated underthe laws of the State of California and commenced operations on June 12,1961 as a California state chartered bank. The Bank’s accounts are insured bythe Federal Deposit Insurance Corporation (FDIC), but it is not a member of theFederal Reserve System. At December 31, 2006 the Company had total assetsof approximately $2.4 billion, total deposits of $2.0 billion and totalshareholders’ equity of $282 million.

The Bank operates 41 full service retail-bankingoffices along the central coast of California in Santa Barbara, San Luis Obispoand Ventura counties. The Bank’s headquarters is located in Arroyo Grande andit also serves the communities of Paso Robles, Cambria, Templeton,  Atascadero, Cayucos, Morro Bay, Los Osos, 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, Westlake Village and Santa Barbara. Theheadquarters’ street address is 1026 Grand Ave., Arroyo Grande, CA 93420. Itsmailing address is P.O. Box 6002, Arroyo Grande, CA 93421-6002. Thetelephone number is: (805) 473-6829. The Bank can also be reached throughits 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) through this website which provides a link to the SEC internet website. Seethe section entitled “Where you can Find Additional Information” at the end ofthis Item 1.

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. 

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The Bank’sloans are both short-term and intermediate term in length and consist of bothfixed and adjustable rate contracts. Special services and requests beyond thelending limits of the Bank are arranged through correspondent 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 $195thousand in 2006, $409 thousand in 2005, and $379 thousand in 2004. 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 of California.

The holdings and resultsof operations of MSB Properties are included within the consolidated financialstatements of the Company. On a stand-alone basis, MSB Properties had earningsof $1.1 million, $1.2 million, and $1.2 million in 2006, 2005, and 2004,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.

***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 equipmentleases, Small Business Administration (SBA) and other government agency loans. Otherservices offered by the Bank include, but are not limited to, trust services,safe deposit boxes, travelers cheques, notary public, merchant depositoryservices for VISA and Mastercard, cash management, home banking, telephonevoice response system and ATM’s. The Bank’s organization and structure isdesigned to serve the banking needs of individuals and small to medium sizedbusinesses 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, 2006 the Bank had approximately 42,809 non-interestbearing demand deposit accounts representing $523.1 million, or an average of$12,220 per account. The Bank also had approximately 105,026 NOW, Money Marketand Savings accounts amounting to $994.6 million, or about $9,470 average peraccount. There were 17,513 time certificates of deposit outstanding at December 31,2006, representing $487.1 million with an average deposit balance ofapproximately $27,811. Of the total time certificates of deposit, $229.4million represented holders who carried an amount on deposit of $100,000 ormore, approximately 47% of the total.

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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, 2006, 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 2006, Fed Funds Sold averaged$39.9 million representing 1.7% 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, was24.7%, greater than 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 demands requiring additionalliquidity in the near term. Currently, the liquidity needs of the HoldingCompany are funded by dividends it receives from the Bank.

***Loans***

The Bank’s loan-to-deposit ratio stood atapproximately 78.7% at year-end 2006 up from 73.6% at the end of 2005. It isthe Bank’s policy to maintain its loan-to-deposit ratio in the 60% to 80% rangewhile 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.Factors include, but are not limited to, the current economic climate, type andquality of loans in the portfolio, trends in delinquencies, historical lossrates, non-accrual totals, diversification of the portfolio, value of availablecollateral and the cost of collateral liquidation.

As of December 31,2006, the Bank’s allowance for loan losses stood at $11.9 million.Additionally, the Bank has an allowance for losses on unfunded commitmentstotaling $1.8 million. Collectively, these allowances for losses represent2,605% of non-performing loans (non-accrual loans plus loans 90 days or morepast due). Outside factors, not within the Bank’s control, such as adversechanges in the economy, can affect the adequacy of the allowances and there canbe no assurance that in any given period, the Bank might not suffer losses whichare substantial in relation to the size of the allowances. During 2006, theBank experienced net charge-offs after recoveries, of $26 thousand.

***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 

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now submitted to the Bank’sLoan Committee, which consists of the chief executive officer, chief creditofficer, the presidents of community banking for the bank’s three regions, thecredit operations manager, the 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-managementdirectors meet monthly to review all credits made over certain dollarthresholds and to establish Bank credit policy and monitor adherence to it. Thenew structure has satisfied Management’s and the Board’s concern for improvedefficiency in the approval process.

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

***Loan Portfolio***

At December 31,2006 and 2005, the Bank’s gross loan portfolio totaled $1.6 billion and $1.5billion, respectively. The portfolio was distributed as follows:

| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Construction and  Land Development          |       | 18.5                  | %          | 18.4 | % |
| Real Estate—Farmland                   |       | 3.4                   | %          | 3.2 | % |
| Real Estate—Residential                |       | 12.2                  | %          | 13.6 | % |
| Real Estate—Non  Farm, Non Residential |       | 38.3                  | %          | 36.8 | % |
| Home Equity  Credit Lines                   |       | 9.6                   | %          | 12.0 | % |
| Cash Reserve                                |       | 0.2                   | %          | 0.2 | % |
| Installment                                 |       | 1.2                   | %          | 1.2 | % |
| Agricultural  Production                    |       | 2.5                   | %          | 2.3 | % |
| Commercial, Other                           |       | 14.1                  | %          | 12.3 | % |
|                                        |       | 100.0                 | %          | 100.0 | % |

 

The interest ratescharged for the loans made by the Bank vary with the degree of risk, size andmaturity of the loans. Rates are generally affected by competition, the client’sdeposit relationship with the Bank, and the Bank’s cost of funds.

*Commercial Loans.  *TheBank provides financial services to diverse commercial and professionalbusinesses in the marketplace. Commercial loans consist primarily of short termloans (normally with a maturity of one year or less) for working capital andbusiness expansion. Commercial loans typically include revolving lines ofcredit, either uncollateralized or collateralized by inventory, loans securedby accounts receivable and equipment loans. Emphasis is placed on the borrower’searnings history, capitalization, secondary sources of repayment, and in someinstances, third-party guarantees or highly liquid collateral (such as timedeposits and investment securities). Commercial loan pricing is generally at arate tied to the prime rate (as quoted in the *Wall StreetJournal*) or the Bank’s reference rates. Certain equipment loans maybe made at fixed rates for short to medium terms.

The Bank has developed a streamlined underwritingprocess for small business loans up to $250,000. This process includes, but isnot limited to, automated approval on loans using a business scoring model,combined with requiring only limited financial information for loans over$100,000. This process was implemented in January, 2006.

The Bankparticipates in Small Business Administration (SBA) loan guarantee programs.The programs used include: 1) SBA Express, which is scored and underwrittenusing the Bank’s small business loan guidelines and products described above inaddition to SBA criteria; 2) the 504 program, which is focused towardlonger-term financing of buildings and other long-term assets; and 3) the 7Aprogram, 

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whichis primarily used for financing of equipment, inventory and working capitalneeds of eligible businesses, generally over a seven to twenty-five year term. TheBank’s collateral position in the SBA loans is enhanced by the SBA guarantee inthe case of SBA Express and 7A loans, and by lower loan-to-value ratios underthe 504 program. The Bank is designated as a preferred lender by the SBA,allowing it to process these loans more quickly. Under the SBA’s PreferredLending Program, the SBA delegates a substantial degree of lending authority toparticipating lenders, such as the Bank. The Bank also participates in othergovernment sponsored loan programs offered by various government agencies, suchas through the California Coastal Rural Development Corporation, Central CoastDevelopment 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 $15 million at December 31,2006). 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 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.

*Real EstateConstruction 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 alsooccasionally makes land loans to individuals and developers who intend toconstruct a single-family residence(s) on the lot, generally within 24months. In addition, the Bank makes commercial real estate construction loansfor construction of office and warehouse properties, generally tohigh-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.

*Commercial Real Estate Term Loans and Loans Securedby Farmland.     *TheBank provides medium-term commercial real estate loans secured by commercial orindustrial buildings or farmland where the properties are either used by theowner for business purposes (owner-user properties) or have income derived fromtenants (investment properties). As a general rule, the Bank’s loan policiesrequire the principal balance of the loan to not exceed 75% of the stabilizedappraised value of the underlying real estate collateral. The loans, which aretypically secured by first deeds of trust only, generally have terms of no morethan ten years and are amortized over 25 to 30 years. Some of these loans haverates tied to Wall Street Journal prime rate that adjust whenever the primerate changes. The remaining loans adjust every three, five or seven yearsdepending upon the index to which the loan is tied.

*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 

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secondary market dependingon the Bank’s desire to retain 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.

*Home EquityCredit Lines.*   The Bank provides lines of creditsecured by a first or second deed of trust on the borrower’s residential realproperty. 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%.

*Consumerand Other Loans.**  *The Bank’sconsumer and other loan portfolio is divided between installment loans securedby automobiles, other consumer purposes and revolving, unsecured consumer debtsuch as reserve lines of credit. Installment loans tend to be fixed rate andlonger-term (one-to-five-year maturity). The Bank’s portfolio of revolvingcredit plans, issued as an additional service to its clients, is minimal atjust 0.2% of total loans.

The Bank does notparticipate in “sub-prime” lending, whereby loans are made to borrowers who donot qualify for conventional loan programs. These loans typically have muchlower credit requirements, allowing higher loan to value and debt to incomeratios, require reduced documentation, accept property types/condition ascollateral that would not otherwise qualify, and carry higher interest rates.

***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, 2006, the aggregate carrying value of the InvestmentPortfolio was $487.7 million. Of this total, $15.6 million was invested in U.S.Treasury Securities, $129.8 million in U.S. Government Agencies, $6.6 millionin Mortgage Backed Securities, $320.7 million in Obligations of State andPolitical Subdivisions and $14.9 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 31,2006, the Bank had public funds totaling approximately $51.5 million. The Bankhas made available $111.9 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 Position. That investment issecured 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 

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Foundationat 53 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 2006to be 1,507,178. Ventura County represents about 54.5% of this total with SantaBarbara and San Luis Obispo Counties accounting for 28.0% and 17.5%,respectively. Certain economic activities are unique to the area such as thespace launching facilities at Vandenberg Air Force Base and the production ofseeds for various flowers grown worldwide. While major oil companies haveelected to do business elsewhere (due to very stringent county businessregulations), smaller production companies have moved in to continue the oilindustry in the area. The moderate climate allows a year round growing seasonfor numerous vegetables and fruits. Vineyards and cattle ranches make largecontributions to the local economy. There are large numbers of retailbusinesses and light manufacturers with only limited numbers of high tech firmsthroughout the service area. Access to numerous recreational activities,including both mountains and beaches, provide a fairly stable tourist industryfrom larger metropolitan areas such as the Los Angeles/Orange County basin andthe San Francisco Bay area. Real estate values throughout the Tri-counties havesteadily increased in recent years. Management does foresee the risk of aslowdown in real estate in 2007, which could potentially create some modestdownward pressure on prices as a correction to the dramatic increases seen overthe past several years. With the diversity of the various types of industriesin the Bank’s service area, the Central Coast, while not immune from economicfluctuations, has historically tended to enjoy a more stable level of economicactivity than many other parts 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 abank’s total capital accounts.)  TheBank’s secured and unsecured lending limits at December 31, 2006, wereapproximately $57.9 million and $34.7 million, respectively. These levelscompare to $56.1 million and $33.7 million, respectively, at December 31,2005 (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 and 

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government debt securitiesand other commercial paper affect the ability of commercial banks to attractand hold deposits. Commercial banks also compete for loans with savings andloan associations, credit unions, consumer finance companies, mortgagecompanies, insurance companies and other lending institutions.

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

The trend towardconsolidation of banking assets exhibited over the past few years in Californiacontinued in 2006 but other new institutions are coming on line to replacethem. Statewide in 2006, there were 12 banks which announced merger intoanother institution including the pending merger between the Company andRabobank, discussed earlier. According to the California State Department ofFinancial Institutions 13 applications for new banks were approved in 2006 inCalifornia and an additional one was approved in San Luis Obispo County inearly 2007.

***Employees***

At December 31, 2006,the Bank had a total of 886 employees, a number of which are part-time. On afull-time equivalent basis, employees represent 834 positions. The Bankbelieves that its employee relations are positive.

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

Banking is a business that is largely dependent onrate differentials. In general, the difference between the interest rate paidby the Bank on its deposits and its other borrowings and the interest ratereceived by the Bank on loans extended to its customers and securities held inthe Bank’s portfolio comprise the major portion of the Bank’s earnings. Theserates are highly sensitive to many factors that are beyond the control of theBank. Accordingly, the earnings and growth of the Bank are subject to theinfluence of local, domestic and foreign economic conditions, includingrecession, unemployment and inflation.

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.

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***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 require pursuantto 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 any class of the outstanding voting shares of such bank.Prior approval of the Federal Reserve Board is also required for the merger orconsolidation of the Company and another bank holding company.

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

The Federal Reserve Board may require that the Companyterminate an activity or terminate control of or liquidate or divestsubsidiaries or affiliates when the Federal Reserve Board determines that 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 provide adequatecapital funds to its subsidiary banks during periods of financial stress oradversity and should maintain the financial flexibility and capital-raisingcapacity to obtain additional resources for assisting its subsidiary banks. Abank holding company’s failure to meet its obligations to serve as a source ofstrength to its subsidiary banks will generally be considered by the FederalReserve Board to be an unsafe and unsound banking practice or a violation ofthe 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, 

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with certain exceptions,neither the Company nor the Bank may condition an extension of credit to acustomer on either (1) a requirement that the customer obtain additionalservices provided by the Company and the Bank or (2) an agreement by thecustomer to refrain from obtaining other services from a competitor.

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 that 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 law or regulation,various remedies are available to these regulatory agencies. Such remediesinclude the power to enjoin “unsafe or unsound” practices, to requireaffirmative action to correct any conditions resulting from any violation orpractice, to issue an administrative order that can be judicially enforced, todirect an increase in capital, to restrict the growth of the Bank, to assesscivil monetary penalties, to remove officers and directors, and ultimately toterminate the Bank’s deposit insurance, which for a California chartered bankwould result in a revocation of the bank’s charter.

***Capital Standards***

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

A banking organization’s risk-based capitalratios are obtained by dividing its qualifying capital by its total risk ­adjustedassets. The regulators measure risk-adjusted assets, which includes offbalance sheet items, against both total qualifying capital (the sum of Tier 1capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1capital consists primarily of common stock, retained earnings, non-cumulativeperpetual preferred stock (cumulative perpetual preferred stock for bankholding companies) and minority interests in certain subsidiaries, less mostintangible assets. Tier 2 capital may consist of a limited amount of theallowance for loan and lease losses, cumulative preferred stock,  long 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 

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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 12.2% and 11.5%,respectively, as of December 31, 2006. On a consolidated basis, Mid-StateBancshares’ ratios are 12.8% and 12.1%, 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 9.4% as of December 31,2006. On a consolidated basis, Mid-State Bancshares’ ratio is 9.9% 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’equity of the bank is less than the greater of (i) 3% of the bank’s totalassets or (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.”

Under applicableregulatory guidelines, the Bank was considered “Well Capitalized” as of December 31,2006.

***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;

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·       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 such persons(i.e., insiders). Extensions of credit (1) must be made on substantiallythe same terms and pursuant to the same credit underwriting procedures as thosefor comparable transactions with persons who are neither insiders noremployees, and (2) must not involve more than the normal risk of repaymentor present other unfavorable features. Banks are also subject to certainlending limits and restrictions on overdrafts to insiders. A violation of theserestrictions may result in regulatory sanctions on the bank or its insiders*.*

***Premiums for Deposit Insurance***

The Bank’s deposits are currently insured to a maximumof $100,000 per depositor through the Deposit Insurance Fund (“DIF”)administered by the FDIC. The Bank is required to pay deposit insurance premiums,which are assessed semiannually and paid quarterly. In November, 2006 the FDICadopted a new risk-based insurance assessment system effective January 1,2007 designed to tie what banks pay for deposit insurance more closely to therisks they pose. The FDIC also adopted a new base schedule of rates that theFDIC can adjust up or down, depending on the needs of the DIF, and set initialpremiums for 2007 that range from 5 cents per $100 of domestic deposits in thelowest risk category to 43 cents per $100 of domestic deposits for banks in thehighest risk category. The new assessment system is expected to result inincreased annual assessments on the deposits of our Bank of 5 to 7 cents per$100 of domestic deposits. An FDIC credit available of $1.8 million forprior contributions is expected to offset the assessments for 2007. Significantincreases in the insurance assessments of our Bank will increase our costs oncethe credit is fully utilized.

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

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

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

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senior financial officersand whether the audit committee includes at least one “audit committeefinancial expert.”

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

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

***Financial Services Modernization Legislation***

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

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shellbanks; (ii) imposes due diligence requirements on banks opening or holdingaccounts for foreign financial 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. On March 9, 2006, the President signed the USAPatriot Improvement and Reauthorization Act, which extended and modified theoriginal Act. While the Company and the Bank believes the Patriot Act, asamended and reauthorized, affects their recordkeeping and reporting expenses,they do not believe that it has a material adverse effect on their business andoperations.

***Bank Secrecy Act***

In 1970, Congress passedthe Currency and Foreign Transactions Reporting Act, otherwise known as the BankSecrecy Act (the “BSA”), which established requirements for recordkeeping andreporting by banks and other financial institutions. The BSA was designed tohelp 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 currencytransactions. These programs must, at a minimum, provide for a system ofinternal controls to assure ongoing compliance, provide for independent testingof such systems and compliance, designate individuals responsible for suchcompliance and provide appropriate personnel training.

***Commercial Real Estate Lending***

Federal banking regulatorsrecently issued final guidance regarding commercial real estate lending toaddress a concern that rising commercial real estate lending concentrations mayexpose institutions to unanticipated earnings and capital volatility in theevent of adverse changes in the general commercial real estate market. Thisguidance suggests that institutions that are potentially exposed to significantcommercial real estate concentration risk will be subject to increasedregulatory scrutiny. Institutions that have experienced rapid growth incommercial real estate lending, have notable exposure to specific types ofcommercial real estate lending, or are approaching or exceed certainsupervisory criteria that measure an institution’s commercial real estateportfolio against its capital levels, may be subject to such increasedregulatory scrutiny. Our commercial real estate portfolio may be viewed asfalling within one or more of the foregoing categories, and accordingly we maybecome subject to increased regulatory scrutiny because of our commercial realestate portfolio. If it is determined by our regulator that we have an undueconcentration in commercial real estate lending, we may be required to maintainincreased levels of capital and/or be required to reduce our concentration incommercial real estate loans.

***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 a depositoryinstitution to its affiliates, asset purchases by a depository institution fromits affiliates, and other transactions between a depository institution and itsaffiliates. Regulation W unifies in one public document the Federal ReserveBoard’s interpretations of Section 23A and 23B. Regulation W had aneffective date of April 1, 2003.

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***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“substantial noncompliance.” At its last examination by the FDIC, the Bankreceived a CRA rating 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 effective coursesof action given the specific circumstances and severity of an institution’snoncompliance with one or more standards.

***Privacy***

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

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

·       annualnotices of their privacy policies to current customers; and

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

These privacy provisions affect how consumer informationis transmitted through diversified financial companies and conveyed to outsidevendors. We have implemented our privacy policies in accordance with the 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.

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***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 planof the FHLB of San Francisco was approved by the Federal Housing Finance Boardand was implemented on April 1, 2004. The new capital plan incorporates asingle class of stock with a par value of $100 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. Totalholdings of  FHLB stock by the Companyamounted to $8.6 million at December 31, 2006.

***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,

·       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.

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***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 $39.8 million at December 31,2006 compared to $40.9 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 $657.7 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 $20.8 million at the end of 2006, compared tothe $14.1 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 governancecommittee charter, corporate governance guidelines, and corporate code ofconduct (which includes the code of ethics required by the SEC and applicableto senior executive officers of the Company and Bank), are available free ofcharge on the 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.

18

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**ITEM1.A.**  RISK FACTORS

***An investment inour common stock is subject to risks inherent to our business. The materialrisks and uncertainties that management believes may affect our business aredescribed below. Before making an investment decision, you should carefullyconsider the risks and uncertainties described below together with all of theother information included or incorporated by reference in this report. Therisks and uncertainties described below are not the only ones facing ourbusiness. Additional risks and uncertainties that management is not aware of orfocused on or that management currently deems immaterial may also impair ourbusiness operations. This report is qualified in its entirety by these riskfactors.***

***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.***

***This item 1A hasbeen updated from prior years’ filings to reflect the fact that the Company hasentered into an agreement and plan of merger with Rabobank with the acquisitionexpected to be consummated in the second quarter of 2007.***

***Risks Associatedwith our Business.***

**We are highly dependent on real estate and a downturnin the real estate market could hurt our business.**

A significant portion ofour loan portfolio is dependent on real estate. At December 31, 2006, realestate served as the principal source of collateral with respect to approximately83% of our loan portfolio. A decline in current economic conditions or risinginterest rates could have an adverse effect on the demand for new loans, theability of borrowers to repay outstanding loans, the value of real estate andother collateral securing loans and the value of real estate owned by us, aswell as our financial condition and results of operations in general and themarket value of our common stock. As more fully discussed in Item 7 of thisReport under “External Factors Impacting the Bank, Economic Conditions,” realestate prices have continued to rise in the Bank’s service area but increasesin sales activity have slowed in 2006 compared to 2005. Slower sales and higherinventories of homes for sale could, potentially cause some downward pressureon prices as well as impact real estate developers ability to repay theirdevelopment loans according to their original terms

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.

**We also have a concentration in commercial real estateloans.**

We also have a highconcentration in commercial real estate or CRE loans. CRE loans generallyinvolve a higher degree of credit risk than residential mortgage lending due,among other things, to the large amounts loaned to individual borrowers. Lossesincurred on loans to a small number of borrowers could have a material adverseimpact on our income and financial condition. Unlike residential mortgageloans, commercial real estate loans generally depend on the cash flow from theproperty to service the debt. Cash flow may be significantly affected bygeneral economic conditions.

In addition, federalbanking regulators recently issued final guidance regarding commercial realestate lending. This guidance suggests that institutions that are potentiallyexposed to significant commercial real estate concentration risk will besubject to increased regulatory scrutiny. Institutions that have experiencedrapid growth in commercial real estate lending, have notable exposure tospecific types of commercial real estate lending, or are approaching or exceedcertain supervisory criteria that measure an institution’s commercial realestate portfolio against its capital levels, may be subject to such increasedregulatory scrutiny. Our commercial real estate portfolio may be viewed asfalling within one or more of the foregoing categories, and accordingly we maybecome subject to increased regulatory scrutiny because of our commercial realestate portfolio. If it is determined by our regulator that we have an undueconcentration 

19

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incommercial real estate lending, we may be required to maintain increased levelsof capital and/or be required to reduce our concentration in commercial realestate loans.

**Our real estatelending 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 investigate orclean 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 environmental liabilities, our business,financial condition, liquidity and results of operations could be materiallyand adversely affected.

**Insufficient loandemand 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.

**Our business is subject to interest rate risk andchanges in interest rates may adversely affect our performance and financialcondition.**

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, which we are currently experiencing in our market, maydecrease our net interest spread by forcing us to offer lower lending interestrates 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 5.38%(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 2006 are having the effect ofbeginning to reverse this trend with our interest spread rising to 6.00%(taxable equivalent) in 2006. Although we believe our current level of interestrate sensitivity is reasonable, significant fluctuations in interest rates mayhave an adverse impact on our business, financial condition and results of operations.

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**Economic conditions on the California Central Coastcould adversely affect our operations and/or cause us to sustain losses.**

Our retail and commercialbanking operations are concentrated primarily in San Luis Obispo, Ventura andSanta Barbara Counties. As a result of this geographic concentration, ourresults of operations depend largely upon economic conditions in this area. Asignificant source of risk arises from the possibility that losses will besustained if a significant number of our borrowers, guarantors and relatedparties fail to perform in accordance with the terms of their loans. This riskincreases when the economy is weak. We have adopted underwriting and creditmonitoring procedures and credit policies, including the establishment andreview of the allowance for credit losses, that management believes areappropriate to minimize this risk by assessing the likelihood ofnonperformance, tracking loan performance and diversifying our creditportfolio. These policies and procedures, however, may not prevent unexpectedlosses that could materially adversely affect our results of operations ingeneral and the market value of our stock.

**We face strong competition from financial servicecompanies and other companies that offer banking services that could hurt ourbusiness.**

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 loans principallythrough the interest rates and loan fees we charge and the efficiency andquality of services we provide. Increasing levels of competition in the bankingand financial services business may reduce our market share, decrease loandemand, cause the prices we charge for our services to fall, or decrease ournet interest margin by forcing us to offer lower lending interest rates and payhigher 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.

**We may not be ableto attract and retain skilled people.**

Our success depends, in large part, on our ability toattract and retain key people. Competition for the best people in most of ouractivities can be intense and we may not be able to hire people or to retainthem. The unexpected loss of services of one or more of our key personnel couldhave a material adverse impact on our business because of their skills,knowledge of our market, years of industry experience and the difficulty ofpromptly finding qualified replacement personnel.

21

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**Our internaloperations are subject to a number of risks.**

We are subject tocertain operations risks, including, but not limited to, data processing systemfailures and errors, customer or employee fraud and catastrophic failuresresulting from terrorist acts or natural disasters. We maintain a system ofinternal controls to mitigate against such occurrences and maintain insurancecoverage for such risks that are insurable, but should such an event occur thatis not prevented or detected by our internal controls, uninsured or in excessof applicable insurance limits, it could have a significant adverse impact onour business, financial condition or results of operations.

*Information Systems*.   Werely heavily on communications and information systems to conduct our business.Any failure, interruption or breach in security of these systems could resultin failures or disruptions in our customer relationship management, generalledger, deposit, loan and other systems. While we have policies and proceduresdesigned to prevent or limit the effect of the failure, interruption orsecurity breach of our information systems, there can be no assurance that anysuch failures, interruptions or security breaches will not occur or, if they dooccur, that they will be adequately addressed. The occurrence of any failures,interruptions or security breaches of our information systems could damage ourreputation, result in a loss of customer business, subject us to additionalregulatory scrutiny, or expose us to civil litigation and possible financialliability, any of which could have a material adverse effect on our financialcondition and results of operations.

*Technological Advances*.   Thefinancial services industry is continually undergoing rapid technologicalchange with frequent introductions of new technology-driven products andservices. The effective use of technology increases efficiency and enablesfinancial institutions to better serve customers and to reduce costs. Ourfuture success depends, in part, upon our ability to address the needs of ourcustomers by using technology to provide products and services that willsatisfy customer demands, as well as to create additional efficiencies in ouroperations. Many of our competitors have substantially greater resources toinvest in technological improvements. We may not be able to effectivelyimplement new technology-driven products and services or be successful inmarketing these products and services to our customers. Failure to successfullykeep pace with technological change affecting the financial services industrycould have a material adverse impact on our business and, in turn, ourfinancial condition and results of operations.

*SevereWeather, Natural Disasters, 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.

**We depend on cashdividends 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.” Various statutory provisions restrict theamount of dividends our subsidiary bank can pay to us without regulatoryapproval.

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***Risks Associatedwith our Industry.***

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

The financial servicesindustry is regulated extensively. Federal and State regulation is designedprimarily to protect the deposit insurance funds and consumers, and not tobenefit our shareholders. These regulations can sometimes impose significantlimitations on our operations.

New laws and regulationsor changes in existing laws and regulations or repeal of existing laws andregulations may adversely impact our business. We have to comply with allgovernmental regulations such as the Sarbanes Oxley Act of 2002, the BankSecrecy Act, the Patriot Act, the Community Reinvestment Act, and many others. Thecumulative cost of compliance with these regulations could be significant andaffect the ability of the Company to earn an adequate return for itsshareholders. For example, operating expenses were impacted by the significantcost of compliance with the new Sarbanes-Oxley Section 404 provisions inthe years ended December 31, 2006 and 2005.

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

***New legislative and regulatory proposals may affect ouroperations 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 Associatedwith our Stock.***

**Our currentCommon Stock value is heavily influenced by the acquisition price to be paid byRabobank. If the acquisition is not consummated, the price of the Company’sCommon Stock is likely to fall.**

The price of our CommonStock rose immediately following the public announcement of the signing of theagreement and plan of merger with Rabobank and has risen slightly since then tonearly the acquisition price of $37.00 per share. The acquisition is subject toseveral conditions, including but not limited to, shareholder and regulatoryapprovals, which have not yet been obtained and we cannot provide any assuranceas to when, or if, they will be obtained. The shareholders will be asked toapprove the acquisition at a special meeting anticipated to be held on or aboutApril 25, 2007. The required regulatory approvals have not yet beenreceived. See the agreement and plan of merger attached to Form 8-Kfiled with the Securities and Exchange Commission on November 3, 2006 foradditional conditions to the consummation of the acquisition. See also Item 3,Legal Proceedings of this Annual Report on Form 10-K for furtherinformation regarding a lawsuit which has been filed in connection with theacquisition.

**Our Common Stock.**

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.

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***Risks Relating to the Proposed Merger***

Consummation of theproposed merger is subject to the satisfaction of various closing conditions,including approval of the merger by a vote of a majority of the outstandingshares of our common stock, approval of certain regulatory authorities andother customary closing conditions described in the agreement and plan ofmerger. We expect the merger to be closed during the second quarter. However, wecannot guarantee that these closing conditions will be satisfied or that theproposed merger will be successfully completed. In the event that the proposedmerger is not completed:

·       management’sand employees’ attention from the Company’s day-to-day business may bediverted;

·       theCompany may lose key employees;

·       theCompany’s relationships with customers may be disrupted as a result ofuncertainties with regard to its business and prospects;

·       certaincosts related to the proposed merger, including the fees and/or expenses of ourlegal, accounting and financial advisors, would have to be paid even if theproposed merger is not completed;

·       undercircumstances defined in the agreement and plan of merger, the Company may berequired to pay a termination (break-up) fee up to $27.5 million and expensesincurred by the acquirer, up to a maximum of $2 million if the Company were toaccept a competing offer;

·       additionalshareholder lawsuits may be filed against us in connection with the agreementand plan of merger;

·       themarket price of shares of the Company’s common stock should be expected to declinesince the current market price of those shares reflects a market assumptionthat the proposed merger will be completed; and

·       afailed merger may result in negative publicity and/or a negative impression ofus in the investment community.

Any such events would likely have a material negativeimpact on the Company’s results of operations and financial condition and couldfurther adversely affect the Company’s stock price.

The announcement of theproposed merger may have had a negative impact on the Company’s ability toattract and retain key management and maintain and attract new third-partyrelationships. Any such events could have a material negative impact on theCompany’s results of operations and financial condition.

**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, 2006, the Bank owned 25 of its branchoffices, 4 non-banking support offices and leased 18 other Bank locations(covered by 20 leases). The Company believes its present facilities are in goodcondition and are adequate for its present needs. The Company does notanticipate difficulty in renewing existing leases as they expire or in findingalternative facilities. See Note 6 to the Consolidated Financial Statements fora further description of the Company’s lease obligations.
| Owned by Bank or Subsidiary: | ** ** | ** **                           | ** ** | **Location of Offices** | ** ** | ** ** | ** ** | ** ** | **Encumbrance** | ** ** |
|------------------------------|------------|--------------------------------------|------------|-------------------------|------------|------------|------------|------------|-----------------|------------|
| Arroyo Grande*               |       | 991 Bennett Avenue                   |       | NONE                    |
| Arroyo Grande                |       | 1026 Grand Avenue                    |       | NONE                    |
| Arroyo Grande*               |       | 550 Camino  Mercado                  |       | NONE                    |
| Arroyo Grande*               |       | 398 Sunrise  Terrace                 |       | NONE                    |
| Atascadero                   |       | 6950 El Camino  Real                 |       | NONE                    |
| Buellton                     |       | West Highway  246 & Central |       | NONE                    |
| Cambria                      |       | 1070 Main Street                     |       | NONE                    |
| Goleta Valley                |       | 5956 Calle Real                      |       | NONE                    |
| Grover Beach                 |       | 899 Grand Avenue                     |       | NONE                    |
| Grover Beach*                |       | 140 North Second  Street             |       | NONE                    |
| Guadalupe                    |       | 905 Guadalupe  Street                |       | NONE                    |
| Lompoc                       |       | 828 North “H”  Street      |       | NONE                    |
| Los Osos                     |       | 1001 Los Osos  Valley Road           |       | NONE                    |
| Morro Bay                    |       | 251 Harbor Street                    |       | NONE                    |
| Nipomo                       |       | 615 West Tefft  Street               |       | NONE                    |
| Oak View                     |       | 410  No. Ventura Avenue         |       | 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                |       | 914 Carpinteria  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 or  Subsidiary: | ** ** | ** **               | ** ** | **Location of Offices** | ** ** | ** ** | ** ** | **Rent/Lease Term** | ** ** | ** ** |
|--------------------------------|------------|--------------------------|------------|-------------------------|------------|------------|------------|---------------------|------------|------------|
| Arroyo Grande                  |       | 1132 West Branch Street  |       | $3,500.00 per month     |
| West Branch In Store Office    |       |                     |       | Expires February, 2010  |
| Camarillo                      |       | 470 Arneill Road         |       | $7,442.69 per month     |
| Camarillo Financial Center     |       |                     |       | Expires June, 2009      |
| Cayucos                        |       | 107 North Ocean Avenue   |       | $1,859.00 per month     |
|                                |       |                     |       | Expires November, 2007  |
| Goleta Valley                  |       | 5340 Hollister Avenue    |       | $5,210.28 per month     |
| Hollister Office               |       |                     |       | Expires February, 2008  |
| Ojai                           |       | 1207 Maricopa Highway    |       | $8,823.31 per month     |
| Ojai Valley                    |       |                     |       | Expires December, 2014  |
| Orcutt                         |       | 1110 East Clark Avenue   |       | $11,292.00 per month    |
|                           |       |                     |       | Expires October, 2010   |
| Oxnard                         |       | 300 Esplanade Drive,     |       | $15,806.75 per month    |
| Esplanade Financial Center     |       | Suite 101           |       | Expires September, 2012 |
| Oxnard *                       |       | 300 Esplanade Drive,     |       | $12,570.36 per month    |
|                           |       | Suite 110           |       | Expires August, 2012    |
| Oxnard                         |       | 155 “A” Street |       | $6,030.42 per month     |
| Downtown Oxnard Office         |       |                     |       | Expires June, 2010      |
| Paso Robles                    |       | 705 Golden Hill Road     |       | $10,477.00 per month    |
| Creston Road Office            |       |                     |       | Expires October, 2012   |
| Pismo Beach                    |       | 865 Oak Park Boulevard   |       | $11,003.00 per month    |
| Oak Park Office                |       |                     |       | Expires March, 2008     |
| Santa Maria **                 |       | 720 North Broadway       |       | $2,749.00 per month     |
| North Broadway Office-Land     |       |                     |       | Expires Dec, 2008       |
| Santa Ynez                     |       | 3600 Sagunto Street      |       | $2,887.00 per month     |
|                                |       |                     |       | Expires April, 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       |       | $12,051.00 per month    |
| Downtown Ventura Office        |       |                     |       | Expires November, 2012  |
| Ventura                        |       | 6401 E. Telephone Road   |       | $12,307.32 per month    |
| County Center Office           |       |                     |       | Expires September, 2012 |
| Westlake Village               |       | 2663 Townsgate Road      |       | $17,233.96 per month    |
|                           |       |                     |       | Expires September, 2015 |
| Westlake Village Commercial    |       | 2663 Townsgate Road,     |       | $7,843.25 per month     |
| Banking Office *               |       | Suite 113/119       |       | Expires December, 2011  |

 

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**FormerBank Offices Leased by Bank—Which Are Sub-Leased**
| Nipomo  Ground Lease | 630 W. Tefft Street | $4,341.00 per month  Expires February, 2015 |
|----------------------|---------------------|---------------------------------------------|

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*                    *The Bank’s rental expense for 2006 was $2.5 million. See Note 6 ofthe Company’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.*

**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, 2006 (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.

On November 15, 2006, David Fuerstenberg, apurported shareholder of Mid-State, filed a complaint seeking class actionstatus in the Superior Court of the State of California, County of San LuisObispo against Mid-State and each of its directors entitled *Fuerstenberg v Mid-State Bancshares et al* (Case No. CV060976).The complaint contains a single cause of action for breach of fiduciary dutyalleging that the Mid-State directors breached their fiduciary duties withregard to the proposed merger. The alleged breaches of fiduciary duty arenon-specific. Among other things, the complaint seeks class action status, acourt order enjoining Mid-State and its directors from proceeding with orconsummating the merger and the payment of attorneys’ and experts fees. TheCompany intends to defend this lawsuit vigorously.

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 2006.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASESOF 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, 2005. The closing sales priceon December 31, 2006 was $36.39 (reflective of the purchase price pershare to be paid in the pending Rabobank transaction) compared to the close oneyear earlier of $26.75.

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

 

| ** **                       | ** ** | **Closing  Sales Prices** | ** ** |
|----------------------------------|------------|--------------------------------|------------|
| **Quarter Ended 2006** | ** ** | ** **                     | ** ** | **Low** | ** ** | **High** | ** ** |
| March 31                    |       | $                              | 27.12      |   | $ | 29.80 |   |
| June 30                     |       | $                              | 25.85      |   | $ | 29.74 |   |
| September 30                |       | $                              | 26.07      |   | $ | 28.36 |   |
| December 31                 |       | $                              | 26.72      |   | $ | 36.61 |   |
|                                  |            |                                |            |  |  |  |  |  |  |

 

There are approximately5,000 holders of Mid-State Bancshares common stock as of December 31,2006.

***Dividends***

Thefollowing table sets forth the per share amount and month of payment for allcash dividends paid since January 1, 2005 by the Company to itsshareholders.

| **Payable Date**  | ** ** | ** ** | ** **     | **Dividend** | ** ** |
|------------------------|------------|------------|----------------|--------------|------------|
| January 17,  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 |         |
| April 17,  2006   |       | $          | 0.18 per share |         |
| July 17, 2006     |       | $          | 0.18 per share |         |
| October 16,  2006 |       | $          | 0.18 per share |         |
| January 16, 2007  |       | $          | 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. TheCorporation Law also provides that, in the event that sufficient retainedearnings are not available for the proposed 

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distribution, acorporation may, nevertheless, make a distribution to its shareholders if itmeets two conditions, which generally stated are as follows: (i) thecorporation’s assets equal at least 1-1/4 times its liabilities, and (ii) thecorporation’s current assets equal at least its current liabilities or, if theaverage of the corporation’s earnings before taxes on income and beforeinterest expenses for the two preceding fiscal years was less than the averageof the corporation’s interest expenses for such fiscal years, then thecorporation’s current assets must equal at least 1-1/4 times its currentliabilities.

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.

Whether or not dividends will be paid in the futurewill be determined by the Board of Directors after consideration of various factors.The Company’s profitability and regulatory capital ratios in addition to otherfinancial conditions will be key factors considered by the Board of Directorsin making such determinations regarding the payment of dividends by theCompany.

The agreement and plan ofmerger with Rabobank provides that the Company may pay regular quarterlydividends in accordance with its prior practices up to the close of thetransaction, not to exceed $.18 per share per quarter. Again, any decision todo so will be made by the Board of Directors as described above. In addition toany regular quarterly dividend paid for the first quarter, the Company may paya special cash dividend of an additional $.18 per share if the transaction hasnot been consummated on or before April 30, 2007. Similarly, if thetransaction has not been consummated on or before July 31, 2007, theCompany may pay a special cash dividend of an additional $.18 per share overany regularly declared dividend for the second quarter.

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***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 to1,141,373 additional shares since its prior authorizations in May 2002 andJanuary 2004 had expired. The June 2005 authorization does not havean expiration date. The repurchase program seeks to reduce the number ofoutstanding shares resulting in an improvement to the Company’s earnings pershare and to its return on equity. All of these shares were purchased atcurrent market prices on the date of transaction in compliance with the SECrules. The total number of shares repurchased was 608,876, 845,055, and 658,867in 2006, 2005 and 2004, respectively. The average price paid per share in 2006,2005, and 2004 was $27.79, $27.29, and $25.26, respectively. As of December 31,2006, the Company could repurchase up to an additional 207,799 shares under theJune 2005 authorization. There was no repurchase activity in the fourthquarter of 2006 and no further repurchase activity is anticipated prior to theconsummation of the pending merger with Rabobank.**

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**ITEM 6.**                SELECTEDFINANCIAL DATA

**Selected Consolidated Financial Data—Mid-StateBancshares**

| **(In thousands—except per share data)** | ** ** | ** ** | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**  | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-----------|------------|
| **Year  Ended December 31:**                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest Income (not taxable equivalent)                          |       | $          | 145,796    |       | $          | 128,326    |       | $          | 109,936    |       | $          | 105,240   |       | $ | 109,332 |   |
| Interest Expense                                                  |       | 27,405     |       | 15,503     |       | 8,450      |       | 9,699      |       | 16,381     |       |
| Net Interest Income                                               |       | 118,391    |       | 112,823    |       | 101,486    |       | 95,541     |       | 92,951     |       |
| Provision for Loan Losses                                         |       | —     |       | —     |       | (2,700     | )          | (969       | )          | 600        |       |
| Net Interest Income after provision for loan losses               |       | 118,391    |       | 112,823    |       | 104,186    |       | 96,510     |       | 92,351     |       |
| Non-interest income                                               |       | 21,865     |       | 21,441     |       | 27,764     |       | 29,059     |       | 24,321     |       |
| Non-interest expense                                              |       | 85,731     |       | 77,674     |       | 79,294     |       | 74,691     |       | 70,925     |       |
| Income before income taxes                                        |       | 54,525     |       | 56,590     |       | 52,656     |       | 50,878     |       | 45,747     |       |
| Provision for income taxes                                        |       | 19,246     |       | 19,099     |       | 17,547     |       | 17,714     |       | 15,892     |       |
| Net Income                                                        |       | $          | 35,279     |       | $          | 37,491     |       | $          | 35,109     |       | $          | 33,164    |       | $ | 29,855 |   |
| **Per share:**                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Income—basic                                             |       | $          | 1.59       |       | $          | 1.65       |       | $          | 1.50       |       | $          | 1.41      |       | $ | 1.25 |   |
| Net Income—diluted                                           |       | $          | 1.55       |       | $          | 1.61       |       | $          | 1.47       |       | $          | 1.40      |       | $ | 1.20 |   |
| Weighted avg. shares for Basic E.P.S. calculation                 |       | 22,211     |       | 22,788     |       | 23,422     |       | 23,443     |       | 23,962     |       |
| Weighted avg. shares for Diluted E.P.S.  calculation              |       | 22,711     |       | 23,300     |       | 23,897     |       | 23,762     |       | 24,837     |       |
| Cash dividends                                                    |       | $          | 0.72       |       | $          | 0.66       |       | $          | 0.58       |       | $          | 0.50      |       | $ | 0.41 |   |
| Book value at period-end                                          |       | $          | 12.73      |       | $          | 12.10      |       | $          | 11.89      |       | $          | 11.56     |       | $ | 10.72 |   |
| Tangible book value at period-end                                 |       | $          | 10.32      |       | $          | 9.69       |       | $          | 9.48       |       | $          | 9.15      |       | $ | 8.94 |   |
| Ending Shares                                                     |       | 22,188     |       | 22,520     |       | 23,099     |       | 23,567     |       | 23,697     |       |
| **Period Averages:**                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Assets                                                      |       | $          | 2,358,789  |       | $          | 2,367,764  |       | $          | 2,269,873  |       | $          | 2,045,252 |       | $ | 1,892,137 |   |
| Total Tangible Assets                                             |       | 2,304,919  |       | 2,312,889  |       | 2,213,639  |       | 2,000,406  |       | 1,850,671  |       |
| Total Loans & Leases                                     |       | 1,554,271  |       | 1,472,885  |       | 1,310,842  |       | 1,131,932  |       | 1,109,245  |       |
| Total Earning Assets                                              |       | 2,117,216  |       | 2,120,123  |       | 2,050,218  |       | 1,857,241  |       | 1,718,280  |       |
| Total Deposits                                                    |       | 2,011,845  |       | 2,049,280  |       | 1,970,248  |       | 1,763,215  |       | 1,623,510  |       |
| Common Equity                                                     |       | 275,650    |       | 276,412    |       | 277,054    |       | 261,103    |       | 244,295    |       |
| Common Tangible Equity                                            |       | 221,780    |       | 221,537    |       | 220,820    |       | 217,982    |       | 202,829    |       |
| **At December 31,**                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                         |       | $          | 99,675     |       | $          | 109,791    |       | $          | 112,669    |       | $          | 123,763   |       | $ | 128,036 |   |
| Investments and Fed Funds Sold                                    |       | 526,282    |       | 619,332    |       | 650,817    |       | 822,179    |       | 625,483    |       |
| Loans held for sale                                               |       | 12,840     |       | 10,176     |       | 12,988     |       | 13,410     |       | 22,560     |       |
| Loans, net of deferred fees, before allowance                     |       | 1,574,688  |       | 1,519,014  |       | 1,421,894  |       | 1,154,932  |       | 1,087,551  |       |
| Allowance for Loan & Lease Losses                        |       | (11,870    | )          | (11,896    | )          | (13,799    | )          | (16,063    | )          | (17,370    | )          |
| Goodwill and Core Deposit Intangibles                             |       | 53,451     |       | 54,323     |       | 55,572     |       | 56,947     |       | 40,949     |       |
| Other assets                                                      |       | 100,388    |       | 90,759     |       | 55,946     |       | 53,664     |       | 47,531     |       |
| Total Assets                                                      |       | $          | 2,355,454  |       | $          | 2,391,499  |       | $          | 2,296,087  |       | $          | 2,208,832 |       | $ | 1,934,740 |   |
| Non-interest bearing deposits                                     |       | $          | 523,139    |       | $          | 567,782    |       | $          | 517,139    |       | $          | 487,624   |       | $ | 390,212 |   |
| Interest bearing deposits                                         |       | 1,481,642  |       | 1,501,824  |       | 1,477,406  |       | 1,424,807  |       | 1,262,735  |       |
| Other borrowings                                                  |       | 49,400     |       | 25,903     |       | 6,582      |       | 7,627      |       | 10,973     |       |
| Allowance for losses—unfunded commitments                    |       | 1,830      |       | 1,761      |       | 1,783      |       | 1,941      |       | 1,771      |       |
| Other liabilities                                                 |       | 17,006     |       | 21,667     |       | 18,550     |       | 14,279     |       | 14,914     |       |
| Shareholders’ equity                                         |       | 282,437    |       | 272,562    |       | 274,627    |       | 272,554    |       | 254,135    |       |
| Total Liabilities and  Shareholders’ equity                  |       | $          | 2,355,454  |       | $          | 2,391,499  |       | $          | 2,296,087  |       | $          | 2,208,832 |       | $ | 1,934,740 |   |

 

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**Selected Consolidated Financial Data—Mid-StateBancshares (Continued)**

| **(In thousands—except per share data)** | ** ** | ** ** | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------|------------|
| **Asset  Quality**                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Non-accrual  loans                                                |       | $          | 526        |       | $          | 2,463      |       | $          | 10,700     |       | $          | 12,312   |       | $ | 16,748 |   |
| Loans  past due 90 days or more                                   |       | —     |       | —     |       | —     |       | —     |       | —     |       |
| Other real estate owned                                           |       | —     |       | —     |       | —     |       | 3,428      |       | —     |       |
| Total non performing assets                                       |       | $          | 526        |       | $          | 2,463      |       | $          | 10,700     |       | $          | 15,740   |       | $ | 16,748 |   |
| **Financial Ratios**                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| For the year:                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Return on assets                                                  |       | 1.50       | %          | 1.58       | %          | 1.55       | %          | 1.62       | %          | 1.58       | %          |
| Return on tangible assets                                         |       | 1.53       | %          | 1.62       | %          | 1.59       | %          | 1.66       | %          | 1.61       | %          |
| Return on equity                                                  |       | 12.80      | %          | 13.56      | %          | 12.67      | %          | 12.70      | %          | 12.22      | %          |
| Return on tangible equity                                         |       | 15.91      | %          | 16.92      | %          | 15.90      | %          | 15.21      | %          | 14.79      | %          |
| Net interest margin (not  taxable equivalent)                     |       | 5.59       | %          | 5.32       | %          | 4.95       | %          | 5.14       | %          | 5.41       | %          |
| Net interest margin (taxable  equivalent)(2)                      |       | 6.00       | %          | 5.76       | %          | 5.38       | %          | 5.54       | %          | 5.74       | %          |
| Net loan losses (recoveries)  to average loans                    |       | 0.00       | %          | 0.13       | %          | (0.03      | )%         | 0.06       | %          | 0.19       | %          |
| Dividend Payout Ratio                                             |       | 45.3       | %          | 40.0       | %          | 38.6       | %          | 35.3       | %          | 32.8       | %          |
| Efficiency ratio                                                  |       | 61.1       | %          | 57.9       | %          | 61.3       | %          | 59.9       | %          | 60.5       | %          |
| At December 31:                                              |       |       |       |       |       |       |       |       |       |       |       |
| Equity to average assets  (leverage ratio)                        |       | 9.9        | %          | 9.2        | %          | 9.3        | %          | 9.6        | %          | 10.6       | %          |
| Tier One capital to  risk-adjusted assets                         |       | 12.1       | %          | 11.6       | %          | 12.1       | %          | 13.8       | %          | 14.7       | %          |
| Total capital to risk-adjusted  assets                            |       | 12.8       | %          | 12.3       | %          | 13.0       | %          | 15.0       | %          | 16.0       | %          |
| Loan loss allowance to loans,  gross(1)                           |       | 0.9        | %          | 0.9        | %          | 1.1        | %          | 1.6        | %          | 1.8        | %          |
| Non-accrual loans to total  loans, gross                          |       | 0.0        | %          | 0.2        | %          | 0.8        | %          | 1.1        | %          | 1.5        | %          |
| Non performing assets to total  assets                            |       | 0.0        | %          | 0.1        | %          | 0.5        | %          | 0.7        | %          | 0.9        | %          |
| Allowance for losses to non performing loans(1)                   |       | 2605       | %          | 554        | %          | 146        | %          | 146        | %          | 114        | %          |

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

(2)          Taxable equivalentconverts tax exempt income as if it were taxable.

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**ITEM7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

***Introduction andBusiness of the Company***

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. Unlessotherwise noted below, the discussion and analysis section deals almostexclusively with the Community Banking segment of the Company. The other twosegments, Mid-Coast Land Company and Trust Services, contribute a smallpercentage (less than 4%) to the overall earnings of the Company.

***2006 RESULTS AND ACCOMPLISHMENTS***

***Financial Summary***

The Company, on aconsolidated basis, reported net income of $35.3 million in 2006, $37.5 millionin 2005 and $35.1 million in 2004. The diluted Earnings Per Share (EPS) was$1.55 for 2006 compared to $1.61 in 2005 and $1.47 in 2004. Consolidated totalassets at December 31, 2006 were $2.355 billion compared to $2.391 billionat December 31, 2005, down 1.5%. Total deposits also decreased from $2.070 billionas of December 31, 2005 to $2.005 billion as of December 31, 2006. Shareholders’common equity stood at $282.4 million at year end up from its $272.6 millionlevel one year earlier. There were a number of factors working to both increaseand decrease this account which showed a net increase. The primary factorsworking to increase shareholders’ common equity included: 1) $35.3 million ofnet income generated for the year; and 2) $4.4 million received for theexercise of stock options. These were offset by: 1) $16.0 million in dividendspaid out during 2006; and 2) $16.9 million paid for the repurchase of commonstock outstanding.

Thetable below illustrates net income by subsidiary unit.

| **Income (Loss) by subsidiary (000’s)** | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Bank only,  pre-tax                                              |       | $          | 55,523     |     | $          | 55,097   |       | $        | 50,711     |   |
| MSB Properties,  pre-tax                                         |       | 1,866      |       | 2,041    |       | 2,079    |       |
| Mid Coast Land  Co., pre-tax                                     |       | 338        |       | 705      |       | 654      |       |
| Parent only,  pre-tax                                            |       | (3,202     | )          | (1,253   | )          | (788     | )          |
| Tax (expense)                                                    |       | (19,246    | )          | (19,099  | )          | (17,547  | )          |
| Net Income—Mid-State  Bancshares                            |       | $          | 35,279     |     | $          | 37,491   |       | $        | 35,109     |   |

 

***Executive Summary***

***Management considers the following to be the mostsignificant items affecting net income during 2006 compared to 2005.***

·       During2006, the Federal Reserve continued making a number of increases in short terminterest rates, the Prime Rate (to which many of the Company’s loans are tied)increased 4 times over the course of the year from 7.25% at the start of theyear to 8.25% by the end of the year. Because of its general asset sensitivity,the Company saw an improvement in its net interest margin (from 5.76% in 2005to 6.00% in 2006, taxable equivalent). This allowed the Company to show a $5.6 millionincrease in net interest income.

·       TheCompany realized non-recurring, pre-tax gains in 2006 of $581 thousand relatedto the sale of its share of the Western States Bancard Association (WSBA)merchant processing activity to a third party. The Company was a foundingmember of the WSBA.

·       Thenet increase in total non-interest expense amounted to $8.1 million in 2006compared to 2005. Factors contributing to this increase included: 1) theadoption of SFAS 123(R), “Share-Based 

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Payments”, whichaccounted for approximately $1.9 million in additional salary expense; 2) othersalary and benefit increases of approximately $2.2 million related toadditional staffing for the new Westlake Village branch, regulatory compliance,particularly the Bank Secrecy Act and U.S.A. Patriot Act, and for regularsalary increases across the Company; 3) increases in professional services ofapproximately $1.4 million for consulting, outsourcing and accounting services;and 4) charges incurred in connection with the pending merger withRabobank, of approximately $0.5 million, primarily made up of attorneys’and accountants’ fees.

***Management considers the following to be the mostsignificant items affecting net income during 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 an $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 thecontinued quality of the portfolio, it also did not have to take a charge tothe provision 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.

·       The net decrease in totalnon-interest expense amounted to $1.6 million in 2005 compared to 2004. Factorscontributing to this decrease included 1) decreases in merchant credit cardprocessing fees of $4.3 million on 2005 compared to 2004; 2) increases insalaries and employee benefits of $2.8 million related primarily to theCompany’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.

**EXTERNAL FACTORS IMPACTING THE BANK**

***Economic Conditions***

The Board of Governors ofthe Federal Reserve System continued raising short term interest rates and thetarget Fed Funds rate reached 5.25% by mid-year 2006. The national unemploymentrate dropped from 4.9% at the start of 2006 to 4.5% by the end of the year. Locally,unemployment rates continue to be at low levels in San Luis Obispo County at3.6% at the end of 2006 and in Santa Barbara County at 4.1%. The yield curveinverted with the spread between the three month and ten year Treasurydeclining from a positive 31 basis points at the start of 2006 to negative 31basis points at the end of the year. The ten year Treasury is actually little changedfrom its 4.39% level at the start of the year having closed at 4.71% at the endof 2006. Management is of the opinion that the flattening of the yield curveportrays a general belief that future inflation will be in-line with recenthistorical experience (e.g.—the Consumer Price Index was up 2.5% and 3.4% in2006 and 2005, respectively) and we have no reason to change that expectation. Notwithstandingspikes in energy prices, inflation does appear to be in check.

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The most comprehensivereview of local economic conditions in our market known to Management comesfrom the University of California at Santa Barbara (UCSB) Economic ForecastProject. According to UCSB, Gross County Product in the tri-county area wasestimated at $87.3 billion in 2006, up 6.1% from the $82.3 level in the prioryear. Adjusted for real dollars, it was up 3.3% following a 3.8% growth rate in2005 and 3.5% in 2004. These rates of growth were down from the double digitincreases witnessed in the late 1990’s. For California as a whole, real GrossState Product was up 4.0% in 2006, up 4.4% in 2005 and up 5.1% in 2004,slightly ahead of the Tri County experience. Expectations by UCSB for 2007 arefor further improvements with the real State Product growing 3.5% and the realTri County Gross Product growing somewhat slower at a 3.1% pace.

Median home pricescontinue near historical highs throughout the Bank’s service area. The medianprice of a home in 2006 is estimated to have reached $604 thousand in San LuisObispo County, up 12% from a year earlier. Sales volume was up 4% over thatperiod, which is a much slower increase than the 13% in 2005. Sales volume wasoff in Santa Barbara County having fallen by an estimated 10% and was up byonly 2% in Ventura County. Median home prices continue to be quite high inthese counties, as well, ending at an estimated $768 thousand in Santa BarbaraCounty and $750 thousand in Ventura County. Management believes that the slowersales and higher inventories of homes for sale could potentially put downwardpressure on prices throughout the Tri-County area.

With positive indicatorscontinuing in the national economic statistics and a solid economic baselocally, Management is encouraged that 2007 should again be a positive yearoverall for the economy in the Company’s trade area, in spite of a generallysofter real estate market. As mentioned last year, this optimism must betempered by the potential for disruption resulting from geopolitical issuessurrounding homeland security and terrorism. The effects of episodes such asthe 9/11 terrorist attacks, the wars in Afghanistan and Iraq, and theinternational tensions surrounding these events, can have a significant impacton economic activity. In spite of this caveat, our local trade area againappears to be in a solid position at the start of 2007 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 does not expectadditional increases in the target Fed Funds rate. Management expects thatlonger term rates will remain stable, with a continued flat yield curve inplace throughout 2007.

***Competitive Factors***

Competitive pressures fromother financial institutions continue to be intense both in the Company’s tradearea and throughout the nation. Many banks are suffering from insufficient loanvolumes and have become very aggressive on the pricing of those good creditsavailable. In the Company’s tri-counties service area, 45 financialinstitutions (banks and savings institutions) operate 343 offices serving $25.5billion in deposits based on data as of June 30, 2006. These figures areup from 43 institutions operating 336 offices with $24.6 billion in depositsone year earlier. Additionally, while Management does not have specific metricson competition 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 2006. Statewide, in 2006, there were 12 bankswhich announced merger into another institution including the pending mergerbetween the Company and Rabobank. According to the California State Departmentof Financial Institutions 13 applications for new banks were approved in 2006in California. In addition, an application for a new bank in San Luis ObispoCounty was filed in early 2007.

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**ANALYSIS OFSTATEMENT OF FINANCIAL POSITION**

***Loans***

The Bank experienced an increase in net loans from$1,507.1 million at the end of 2005, to $1,562.8 million at the end of2006. This represents an increase in the loan portfolio of $55.7 million, or3.7%, following the $99.0 million, or 7.0% increase in 2005. The loan portfoliorepresents approximately 66% of the Bank’s assets. Additionally, loans held forsale (which are single family residential mortgages pending sale) total $12.8million at the end of 2006, up from $10.2 million one year earlier.

****

The graph above displays the trend over the five yearperiod ended December 31, 2006 in the various components of the loanportfolio, net of deferred loan fees. Construction loans have risen from theirlevel four years earlier—$213.4 million at December 31, 2002 compared to$290.1 million at year-end 2006. Real Estate loans generally trended up from$525.2 million at the end of 2002 to $848.4 million at the end of 2006. Thelarger growth in real estate loans, especially in recent years, reflects anexpanded use of jumbo adjustable rate mortgage loans in the portfolio ($131.9million at the end of 2006) along with the purchase of certain of these sametype of loan assets in the secondary market ($22.1 million at the end of 2006).

Home Equity Credit Lines, although declining in 2006compared to 2005, have generally increased from $74.3 million at the end of2002 compared to $152.1 million at the end of 2006. Consumer loans (installmentand credit reserve) have decreased from $30.9 million at December 31, 2002to $21.6 million at year-end 2006. Commercial and other loans have rebounded to$222.5 million at December 31, 2006, just slightly ahead of 2002 levels. Agriculturalproduction loans have remained relatively flat, ending at $39.9 million in 2006.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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The Bank’s allowances for loan and lease lossescollectively stand at $13.7 million, or 0.9% of gross loans, and representslosses not yet realized, but inherent in the loan portfolio and on unfundedcommitments. The allowance for losses was $13.7 million at December 31,2005. The year-end 2006 balance now represents 2,605% of non-performing loanswhich is up from the 554% level at the end of 2005 owing to a drop in nonperforming loans.

Afive-year review of activity in the allowance for losses and an allocation byloan type of the allowance is shown in the tables below.

| **Allowances for Losses (in 000’s)**                           | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Allowance for  loan losses beginning of year                                            |       | $          | 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 allowances  for losses                                                            |       | $          | 13,657     |     | $          | 15,582   |       | $        | 18,004     |     | $          | 19,141   |       | $ | 20,659 |   |
| Provision for  loan losses charged to operating expense                                 |       | —     |       | —   |       | (2,700   | )          | (969     | )          | 600      |       |
| Provision for  losses—unfunded commitments (credited) charged to operating expense |       | 69         |       | (22      | )          | (158     | )          | 170      |       | —   |       |
| Adjustments—acquisition  through merger                                            |       | —     |       | —   |       | —   |       | 391      |       | —   |       |
| Loans charged off:                                                                      |       |       |       |     |       |     |       |     |       |     |       |
| Real estate loans                                                                       |       | (54        | )          | (2,234   | )          | (5       | )          | (1,106   | )          | —   |       |
| Installment loans                                                                       |       | (72        | )          | (181     | )          | (148     | )          | (234     | )          | (275     | )          |
| Commercial loans                                                                        |       | (372       | )          | (741     | )          | (746     | )          | (488     | )          | (2,475   | )          |
| Credit cards and related loans                                                          |       | (52        | )          | (75      | )          | (41      | )          | (66      | )          | (88      | )          |
| Recoveries of loans  previously charged off:                                            |       |       |       |     |       |     |       |     |       |     |       |
| Real estate loans                                                                       |       | 11         |       | 34       |       | 41       |       | 45       |       | 24       |       |
| Installment loans                                                                       |       | 70         |       | 70       |       | 111      |       | 96       |       | 196      |       |
| Commercial loans                                                                        |       | 427        |       | 1,200    |       | 1,179    |       | 963      |       | 451      |       |
| Credit cards and related loans                                                          |       | 16         |       | 24       |       | 45       |       | 61       |       | 49       |       |
| ***Total Allowances for Losses***                                                       |       | $          | 13,700     |     | $          | 13,657   |       | $        | 15,582     |     | $          | 18,004   |       | $19,141 |   |

 

| **Allocation of  Allowance for Losses (in 000’s)** | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Allowance for  loan losses                              |       | $          | 11,870     |     | $          | 11,896   |       | $        | 13,799     |     | $          | 16,063   |       | $ | 17,370 |   |
| Allowance for  losses—unfunded commitments         |       | 1,830      |       | 1,761    |       | 1,783    |       | 1,941    |       | 1,771    |       |
| ***Total Allowance for Losses***                        |       | $          | 13,700     |     | $          | 13,657   |       | $        | 15,582     |     | $          | 18,004   |       | $19,141 |   |
| Ratio of Net Loan Losses  to Average Loans Outstanding  |       | 0.00       | %          | 0.13     | %          | (0.03    | )%         | 0.06     | %          | 0.19     | %          |
|                                                         |            |            |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

**Allocation of the allowance for losses compared toloan type as a percent of total at December 31:**

| **(dollars in 000’s)  Balance applicable to:** | ** ** | **2006** | ** ** | **Type  as a % of  Loans** | ** ** | **2005** | ** ** | **Type  as a % of  Loans** | ** ** | **2004** | ** ** | **Type  as a % of  Loans** | ** ** | **2003** | ** ** | **Type  as a % of  Loans** | ** ** | **2002** | ** ** | **Type  as a % of  Loans** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|-------------------------------------------|------------|----------|------------|-------------------------------------------|------------|----------|------------|-------------------------------------------|------------|----------|------------|-------------------------------------------|------------|----------|------------|-------------------------------------------|------------|
| Construction and Land                                                   |       | $        | 2,279      |                                      |       | 18.5     | %          |                                      | $          | 1,655    |       |                                      | 18.4       | %        |       | $                                         | 5,120      |     |       | 16.1                                      | %          |   | $ | 2,680 |   |   | 20.8 | % |   | $ | 2,636 |   |   | 19.7 | % |   |
| Real Estate                                                             |       | 5,137    |       |                                      | 53.9       | %        |       | 4,277                                     |       |     | 53.6       | %                                         |       | 1,757    |       |                                      | 53.5       | %        |       | 2,164                                     |       |   | 49.1 | % |   | 4,047 |   |   | 48.4 | % |   |
| H.E.C.L.                                                                |       | 582      |       |                                      | 9.6        | %        |       | 735                                       |       |     | 12.0       | %                                         |       | 308      |       |                                      | 11.2       | %        |       | 250                                       |       |   | 7.8 | % |   | 295 |   |   | 6.8 | % |   |
| Installment                                                             |       | 238      |       |                                      | 1.2        | %        |       | 226                                       |       |     | 1.2        | %                                         |       | 160      |       |                                      | 1.3        | %        |       | 244                                       |       |   | 2.2 | % |   | 254 |   |   | 2.5 | % |   |
| Credit Card and Related                                                 |       | 65       |       |                                      | 0.2        | %        |       | 76                                        |       |     | 0.2        | %                                         |       | 86       |       |                                      | 0.3        | %        |       | 229                                       |       |   | 0.6 | % |   | 97 |   |   | 0.3 | % |   |
| Commercial, Other                                                       |       | 2,934    |       |                                      | 16.6       | %        |       | 3,879                                     |       |     | 14.6       | %                                         |       | 3,237    |       |                                      | 17.6       | %        |       | 6,468                                     |       |   | 19.5 | % |   | 6,296 |   |   | 22.3 | % |   |
| Unfunded commitments                                                    |       | 1,830    |       |                                      | N/A        |     |       | 1,761                                     |       |     | N/A        |                                      |       | 1,783    |       |                                      | N/A        |     |       | 1,941                                     |       |   | N/A |   |   | 1,771 |   |   | N/A |   |   |
| Unallocated                                                             |       | 635      |       |                                      | N/A        |     |       | 1,048                                     |       |     | N/A        |                                      |       | 3,131    |       |                                      | N/A        |     |       | 4,028                                     |       |   | N/A |   |   | 3,745 |   |   | N/A |   |   |
| ***Balance at End of Year***                                            |       | $        | 13,700     |                                      |       | 100.0    | %          |                                      | $          | 13,657   |       |                                      | 100.0      | %        |       | $                                         | 15,582     |     |       | 100.0                                     | %          |   | $ | 18,004 |   |   | 100.0 | % |   | $ | 19,141 |   |   | 100.0 | % |   |

 

 

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During 2005, the Company enhanced its 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. The priormethodology relied on loss factors that provided results not significantlydifferent from the results of our enhanced methodology. However, with thisenhancement, there was a reallocation in the unallocated portion of theallowance for loan losses which was attributable, at least in part, to theenhanced calculation of loss exposure compared to prior years.

Non-accrual loans within the Bank’s portfoliodecreased from $2.5 million as of December 31, 2005, to $0.5 million, atthe end of 2006. Loans 90 days or more past due, and still accruing, remainedat zero for the periods ending December 31, 2006 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. Recoveriesin 2006 of loans previously charged-off totaled $.5 million nearly offset bycharge-offs of $.5 million taken during the year. This figure compares to netcharge-offs of $1.9 million  in 2005 andnet recoveries of $0.4 million in 2004.

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 reviews the allowance on a regularbasis and adjusts it as necessary. The allowance is also examined annually byone or more of the Bank’s regulatory bodies including the FDIC and DFI. During2004, Management took a benefit to the provision for loan losses of $2.7million. No provision for loan losses was taken during 2005 or 2006. Theseactions reflected strong credit quality standards, consistent performance ofthe loan portfolio in recent years, improving trends in classified loans,improving trends in delinquencies, levels of collateral securing the problemloans, modest levels of net charge-offs in recent years, a positive outlook forthe collection of the Company’s non-accrual loans, and a positive outlook foreconomic activity in general. The need for additional provision for loan lossesor for further benefit to the provision for loan losses in 2007 will bedependent upon Management’s on-going analysis of the adequacy of the allowancefor loan losses. While Management believes it to be adequate at the presenttime, the appropriate value can fluctuateover time in response to economic conditions and the subjective decisions whichmust 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 slow down and/or drop in value of residential real estate in theBank’s service area. While long term interest rates remain relatively low andthe Bank’s service area is marked by limited supply and healthy demand,residential projects financed by the Bank are underwritten with a requirementof a percentage of cash equity to the total cost of the project in addition toprudent 

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exposures to currentappraised values. To further mitigate this risk, individual projects financedare analyzed using direct, current and historical project trends withlimitations to production unit starts ahead of sales using the projectedabsorption analysis contained in the appraisal of each project. The Bankbelieves, based upon past experience, that this process helps prevent theproduction of a supply of units that would exceed the current market demand.

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 mortgages hasan average loan to value ratio of less than 60% along with average creditscores substantially exceeding industry standards with low delinquency ratios.  Management does foresee the risk of a slowdownin real estate in 2007, which could potentially create some modest downwardpressure on prices as a correction to the dramatic increases seen over the pastseveral years. With the factors noted above and the diversity of the varioustypes of industries in the Bank’s service area, the Central Coast, while not immunefrom economic fluctuations, has historically tended to enjoy a more stablelevel of economic activity than many other parts of California.

Asummary of maturities and sensitivities of loans to changes in interest ratesat December 31, 2006 is shown in the table below. A more complete discussionof the Bank’s exposure to changes in interest rates can be found in theMD&A under the section titled “Net Interest Income and Interest Rate Risk”.

***Loan Portfolio asof 12/31/06***

| **(dollars in 000’s)  Fixed Rate Loans** | ** ** | ** ** | ** ** | **3 Months  or less** | ** ** | **Over  3 through  12 Months** | ** ** | **Due   After 1 to  3 Years** | ** ** | **Due  After 3 to  5 Years** | ** ** | **Due After  5 Years** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|---------------------------------|------------|------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------|------------|-----------|------------|
| Construction/Land  Development                                    |       |       | 4,074      |                            |       |                                     | 10,690     |                                              |       | —                                      |       |                             | —     |      |       |   | 3,397 |   |   | 18,161 |   |
| Real estate                                                       |       |       | 9,587      |                            |       |                                     | 19,538     |                                              |       | 43,007                                      |       |                             | 30,416     |      |       |   | 179,102 |   |   | 281,650 |   |
| Home equity credit  lines                                         |       |       | —     |                            |       |                                     | —     |                                              |       | 15                                          |       |                             | —     |      |       |   | — |   |   | 15 |   |
| Installment                                                       |       |       | 182        |                            |       |                                     | 666        |                                              |       | 3,114                                       |       |                             | 6,733      |      |       |   | 6,800 |   |   | 17,495 |   |
| Cash reserve                                                      |       |       | —     |                            |       |                                     | —     |                                              |       | —                                      |       |                             | —     |      |       |   | — |   |   | — |   |
| Agricultural  production                                          |       |       | 539        |                            |       |                                     | 476        |                                              |       | 2,541                                       |       |                             | 3,533      |      |       |   | — |   |   | 7,089 |   |
| Commercial, other                                                 |       |       | 565        |                            |       |                                     | 3,802      |                                              |       | 30,485                                      |       |                             | 35,734     |      |       |   | 15,623 |   |   | 86,209 |   |
| **Total**                                                         | ** ** | ** ** | **14,947** |                            | ** ** | ** **                               | **35,172** |                                              | ** ** | **79,162**                                  | ** ** | ** **                       | **76,416** |      | ** ** | ** ** | **204,922** |   | ** ** | **410,619** | ** ** |

 

| **Variable Rate Loans**                                                                            | ** ** | ** ** | ** **  | **3 Months  or less** | ** ** | **Over  3 through  12 Months** | ** ** | **Due   After 1 to  3 Years** | ** ** | **Due  After 3 to  5 Years** | ** ** | **Due After  5 Years** | ** **  | **Total** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------|-------------|---------------------------------|------------|------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------|-------------|-----------|------------|
| Construction/Land  Development                                                                               |       |       | 249,122     |                            |       |                                     | —     |                                              |       | —                                      |       |                             | 20,393      |      |       |   | 4,365 |   |   | 273,880 |   |
| Real estate                                                                                                  |       |       | 62,230      |                            |       |                                     | 44,130     |                                              |       | 218,711                                     |       |                             | 222,571     |      |       |   | 21,539 |   |   | 569,181 |   |
| Home equity  credit lines                                                                                    |       |       | 152,110     |                            |       |                                     | —     |                                              |       | —                                      |       |                             | —      |      |       |   | — |   |   | 152,110 |   |
| Installment                                                                                                  |       |       | 1,168       |                            |       |                                     | —     |                                              |       | —                                      |       |                             | —      |      |       |   | — |   |   | 1,168 |   |
| Cash reserve                                                                                                 |       |       | 2,881       |                            |       |                                     | —     |                                              |       | —                                      |       |                             | —      |      |       |   | — |   |   | 2,881 |   |
| Agricultural  production                                                                                     |       |       | 32,800      |                            |       |                                     | —     |                                              |       | —                                      |       |                             | —      |      |       |   | — |   |   | 32,800 |   |
| Commercial, other                                                                                            |       |       | 121,098     |                            |       |                                     | 6,552      |                                              |       | 4,063                                       |       |                             | 4,101       |      |       |   | — |   |   | 135,814 |   |
| **Total**                                                                                                    | ** ** | ** ** | **621,409** |                            | ** ** | ** **                               | **50,682** |                                              | ** ** | **222,774**                                 | ** ** | ** **                       | **247,065** |      | ** ** | ** ** | **25,904** |   | ** ** | **1,167,834** | ** ** |
| **Total loans, gross (excludes  allowance for loan losses, net deferred loan fees and loans held for sale)** | ** ** | ** ** | ** **  |                            | ** ** | ** **                               | ** ** |                                              | ** ** | ** **                                  | ** ** | ** **                       | ** **  |      | ** ** | ** ** | ** ** |   | ** ** | **1,578,453** | ** ** |

 

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***InvestmentPortfolio***

The Bank’s investmentportfolio primarily consists of U.S. Treasury Notes and Bills, Federal AgencyNotes, Mortgage Backed Securities, and Municipal Bonds. See Footnote No. 4to the consolidated financial statements for a detailed composition of theinvestment portfolio. Overall, the portfolio showed a net reduction inoutstanding balances over the course of 2006 as 1) the Bank redirected theseearning assets into the loan portfolio and 2) to a lesser extent the marketvalue relative to amortized cost of the investment portfolio declined. TheTreasury and Agency portion of the portfolio decreased by $91.8 millionfrom one year ago. Holdings in the Municipal Bond portfolio were reduced from$356.7 million at the end of 2005 to $335.7 million at the end of 2006. Intotal, the Bank decreased its investment portfolio from $619.3 million at theend of 2005 to $487.7 million at the end of 2006, a $131.6 milliondecrease.

The Bank may segregate itsportfolio into three categories—a “Trading Portfolio” (which is carried atmarket value, with changes in market value reflected in the income statement),a “Held to Maturity” portfolio (which is carried at amortized cost, withchanges in market value having no impact on the financial statements) and an “Availablefor Sale” portfolio (which is carried at market value, with changes in marketvalue reflected in comprehensive income). The Bank holds no securities thatshould be classified as Trading or Held to Maturity securities. The Bank hasdetermined that since its securities may be sold prior to maturity because ofinterest rate changes, to meet liquidity needs, or to better match there-pricing characteristics of funding sources, that the entire portfolio shouldbe classified as “Available for Sale.”

Adjustments to the “Availablefor Sale” portfolio for changes in market values resulted in an unrealized lossof $94 thousand included in accumulated other comprehensive income as of December 31,2006 compared to an unrealized gain of $0.4 million at December 31, 2005,net of related taxes. Maturities and sales over the full year exceededpurchases and the total investment portfolio decreased by $131.6 millionfrom the end of 2005 to the end of 2006. The Company determines cost for eachsecurity on a specific identification basis for calculation of both realizedand unrealized gains and losses.

Shownbelow is a summary maturity distribution of the investment portfolio, by typeand weighted taxable equivalent yield as of December 31, 2006. 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              |       | $          | 5,006      |                            | $          | 10,587                                            |       |                                               | $          | —                    |       |      |       | $ | — |   |   | $ | 15,593 |   |
| U.S. Government Agencies              |       | 92,370     |       | 37,469                          |       |                                              | —     |                                               |       |                      | —     |      |       | 129,839 |   |
| Mortgage Backed Securities            |       | 89         |       | 3,220                           |       |                                              | 1,883      |                                               |       |                      | 1,421      |      |       | 6,613 |   |
| Municipal Bonds, Other                |       | 49,927     |       | 231,292                         |       |                                              | 45,769     |                                               |       |                      | 8,667      |      |       | 335,655 |   |
| Total                                 |       | $          | 147,392    |                            | $          | 282,568                                           |       |                                               | $          | 47,652                    |       |      |       | $ | 10,088 |   |   | $ | 487,700 |   |

 

| ** **                 | ** ** | **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   |       | 5.01                            | %          | 4.04                                              | %          |                                               | —     |                      |       |      | —     |   |   | 4.35 | % |
| U.S. Government Agencies   |       | 4.63                            | %          | 4.13                                              | %          |                                               | —     |                      |       |      | —     |   |   | 4.48 | % |
| Mortgage Backed Securities |       | 5.67                            | %          | 6.10                                              | %          |                                               | 5.28       | %                         |       |      | 5.36       | % |   | 5.70 | % |
| Municipal Bonds, Other     |       | 5.71                            | %          | 5.73                                              | %          |                                               | 5.51       | %                         |       |      | 6.00       | % |   | 5.70 | % |
| Total                      |       | 5.01                            | %          | 5.46                                              | %          |                                               | 5.50       | %                         |       |      | 5.91       | % |   | 5.34 | % |

 

40

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

The Company did not holdany OREO from foreclosure as of December 31, 2006 or 2005. 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 31,2006 and 2005. 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.

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 2006) sincethe testing commenced.

Core deposit intangiblestotal $5.6 million at December 31, 2006 compared to $6.5 million one yearearlier. Of the year-end 2006 amounts, $3.8 million represents the netun-amortized value of the core deposit intangible created with the AmericanCommercial Bank acquisition and $1.8 million represents the net un-amortizedvalue of the core deposit intangible created upon the acquisition of OjaiValley Bank. In connection with these acquisitions, the Company recognizes coredeposit intangibles that represent the fair value of long-term depositrelationships acquired. Such amounts are then amortized over expected usefulremaining economic lives. During 2005, the Company adjusted the amortizationrate of the Core Deposit Intangible associated with the American CommercialBank acquisition due to a greater retention rate of the original core depositbase than was originally contemplated at the time of the acquisition in 2001. Noadjustments to the Ojai Valley Bank related Core Deposit Intangible have beennecessary. Absent adjustments to the amortization schedules in future periods,the core deposit intangibles are now scheduled to be fully amortized in September 2013with respect to the American Commercial Bank acquisition and October 2012with respect to the Ojai Valley Bank acquisition and the total amount of theamortization is projected to be $872 thousand in 2007. This charge to expenseis carried under other operating expense on the consolidated statements ofincome.

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

The Bank owns a $30 million holding of the PreferredStock of Senior Housing Crime Prevention Foundation Investment Corporation(SHCPF-I) which is carried under a separate caption on the ConsolidatedStatement of Financial Positions. That investment is secured by a federalagency security issued by FNMA. The Bank has the right after five years on April 29,2010 to require SHCPF to redeem all or a part of the shares of the PreferredStock. Dividends are paid to the Bank on the Preferred Stock at a rate which is1.875% below the interest earned on the underlying FNMA agency security. This1.875% differential is used by SHCPF to fund the various programs of the SeniorHousing Crime Prevention Foundation at 53 nursing home facilities in the Bank’stri-county service area. These include, among other things, the senior crimestoppers program which is reducing crimes against the elderly living in thosefacilities. The benefits to the Bank of this program include full CommunityReinvestment Act (CRA) credit for our $30 million investment, positive publicrelations, and significant marketing opportunities with the operators of thefacilities, their owners, Board of Directors, employees, family members andresidents.

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***Deposits***

Whilethe Bank is competitive with major institutions in terms of its structure ofinterest rates on deposit products offered, Management determined not to paythe highest rates to avoid further pressure on income while maintainingacceptable levels of liquidity. As discussed in the Income Statement Analysis,many of the Bank’s deposit rates have risen in varying degrees in response tothe general increase in rates. A comparison of the rates paid on the Bank’sdeposit products at December 31, 2006 and 2005 is as follows:

| **Selected Quoted Interest Rates**    | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|------------|------------|
| Demand Deposits                                      |       | 0          | %          | 0        | %          |     | 0          | %          |       |
| NOW Account  (50 & Better—over $2,500) |       | 0.25       | %          | 0.25     | %          |     | 0          | %          |       |
| Money Market  Deposits (over $100,000)               |       | 2.00       | %          | 1.15     | %          |     | 0.85       | %          |       |
| Passbook Savings  Account                            |       | 1.00       | %          | 0.50     | %          |     | 0.50       | %          |       |
| Individual  Retirement Account (2 Year term)         |       | 4.50       | %          | 3.60     | %          |     | 0.90       | %          |       |
| Time Deposit ($100,000—6  month term)           |       | 4.50       | %          | 3.20     | %          |     | 1.30       | %          |       |
| Wall Street Journal  Prime Rate                      |       | 8.25       | %          | 7.25     | %          |     | 1.00       | %          |       |

 

As wasexperienced by many financial institutions, average deposits declined slightlyin 2006 after several years of steady growth. Below is a summary of the averagedeposits outstanding and the average rate paid by category over the last threeyears.

| **(dollars in 000’s)**                          | ** ** | ** ** | ** ** | **Average  Balance** | ** ** | **2006  Interest** | ** ** | **Rate** | ** ** | **Average  Balance** | ** ** | **2005  Interest** | ** ** | **Rate** | ** ** | **Average  Balance** | ** ** | **2004  Interest** | ** ** | **Rate** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|----------------------|------------|--------------------|------------|----------|------------|----------------------|------------|--------------------|------------|----------|------------|----------------------|------------|--------------------|------------|----------|------------|
| Interest Bearing Demand and  Money  Market Investment Accounts |       | $          | 733,917    |                 |       | $                  | 5,239      |     |       |                 | 0.71       | %                  |       | $        | 765,491    |                 |       | $                  | 3,271      |     |       |   | 0.43 | % |   | $ | 741,230 |   |   | $ | 1,712 |   |   |   | 0.23 | % |   |
| Savings Accounts                                               |       | 287,658    |       |                 | 2,485      |               |       |     | 0.86       | %                    |       | 317,370            |       |     | 1,502      |                 |       |               | 0.47       | %        |       | 322,665 |   |   | 853 |   |   |   | 0.26 | % |   |
| Time Deposits                                                  |       | 464,669    |       |                 | 17,540     |               |       |     | 3.77       | %                    |       | 414,883            |       |     | 9,837      |                 |       |               | 2.37       | %        |       | 399,806 |   |   | 5,691 |   |   |   | 1.42 | % |   |
| Total Interest Bearing  Deposits                               |       | 1,486,244  |       |                 | 25,264     |               |       |     | 1.70       | %                    |       | 1,497,744          |       |     | 14,610     |                 |       |               | 0.98       | %        |       | 1,463,701 |   |   | 8,256 |   |   |   | 0.56 | % |   |
| Non Interest Bearing  Demand                                   |       | 525,602    |       |                 | —     |               |       |     | —     |                 |       | 551,536            |       |     | —     |                 |       |               | —     |     |       | 506,547 |   |   | — |   |   |   | — |   |   |
| Total Deposits                                                 |       | $          | 2,011,846  |                 |       | $                  | 25,264     |     |       |                 | 1.26       | %                  |       | $        | 2,049,280  |                 |       | $                  | 14,610     |     |       |   | 0.71 | % |   | $ | 1,970,248 |   |   | $ | 8,256 |   |   |   | 0.42 | % |   |

 

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 88.7% 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, 2006, displayssummary size and maturity information on the Bank’s time deposits.

| **(dollars in 000’s)  Balance by Size** | ** ** | ** ** | ** ** | **Three  Months or  Less** | ** ** | **After Three  Months to  Six Months** | ** ** | **After Six  Months to  One Year** | ** ** | **After  One Year** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|---------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------|------------|-----------|------------|
| Under $100,000                                                   |       | $          | 96,997     |                            |       | $                                                     | 68,635     |                                              |       |                     | $          | 50,971    |       |   |   | $ | 41,061 |   |   | $ | 257,664 |   |
| $100,000 or More                                                 |       | 110,513    |       |                            | 60,994     |                                                  |       |                                              | 43,702     |                     |       |      | 14,183     |   |   | 229,392 |   |
| Total  Time Deposits                                             |       | $          | 207,510    |                            |       | $                                                     | 129,629    |                                              |       |                     | $          | 94,673    |       |   |   | $ | 55,244 |   |   | $ | 487,056 |   |

 

***Other Borrowings***

While not a significant component of the Bank’sstructure, other borrowings were $49.4 million, at the end of 2006 compared to$25.9 million at the end of 2005. These consist of borrowings under the U.S.Treasury Tax and Loan note account and Federal Home Loan Bank (FHLB). The Bankhad outstanding 

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borrowings of $2.4 millionand $3.9 million at December 31, 2006 and 2005, respectively, under theU.S. Treasury Tax and Loan note account program. The Bank had three borrowingsfrom the FHLB totaling $47.0 million at December 31, 2006 and two for$22.0 million at December 31, 2005. The three borrowings at the end of2006 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 |   |
| Fixed Rate Credit  Advance |       |       | 01/24/06   |                |       | 4.75     | %          | 01/24/11     |       | $             | 25,000,000 |   |
| Total                      |       |       |       |                |       |     |       |         |       | $             | 47,000,000 |   |

 

While the $2.0 million borrowing above wasspecifically taken down to match fund a particular earning asset, the other$45.0 million in borrowing funded general earning asset growth.

Management had the abilityat December 31, 2006 to borrow up to $70.0 million in short term Fed Fundsand an additional $37.6 million from the FHLB, which can have maturities up to30 years. Funds raised from these sources may be used to fund earning assetssuch as investment securities or generate additional loans at sufficientlypositive spreads to justify the additional leverage.

***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 $36.8 million, $52.3 million and $43.3 million in 2006, 2005, and 2004,respectively. Net cash used in investing activities has declined from $149.3million in 2004 to $122.5 million in 2005 and went to $59.5 million of cashprovided in 2006 reflecting a net drop over this period in new loans andinvestments made. Net cash provided by financing activities rose from $53.5million in 2004 to $61.3 million in 2005 and dropped to $67.9 million of cashused in 2006. The Company experienced slower deposit growth over the lastcouple of years compared to 2004.

The Bank has adequate liquidity at the present time. Itsloan to deposit ratio at year-end 2006 was 78.7% versus 73.6% one year earlier.The Bank’s policy calls for a loan to deposit ratio from 60% to 80%. The higherratio this year is illustrative of the Bank’s shift to higher yielding loans asopposed to securities and the lack of deposit growth in 2006. The Bank’sinternally calculated liquidity ratio stands at 24.7% at December 31, 2006compared to 29.7% one year earlier. These levels are well 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 2006 of $15,990,000and repurchased stock totaling $16,921,000. The California Financial Codeprovides that a bank may not make a cash distribution to its shareholders inexcess of (1) the bank’s undivided profits or (2) the bank’s netincome for its last three fiscal years less the amount of any distributionsmade by the bank during such period. Based on these restrictions in the CaliforniaFinancial Code, the Bank can make additional cash dividends totaling$12,088,000 at December 31, 2006 to the Company. The Bank can also 

43

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apply to the (DFI) for theability to pay additional dividends to the Company. The Bank and Company do noexpect to make such application during 2007 given the Company’s pending merger,as discussed above.

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.

TheLeverage Ratio calculation simply divides common stockholders’ equity (reducedby goodwill and certain other intangibles that a bank may have) by the totalassets of the bank. In the Tier One Risk Based Capital Ratio, the numerator isthe same as the leverage ratio, but the denominator is the total “risk-weightedassets” of the bank. Risk-weighted assets are determined by segregating all theassets and off-balance sheet exposures into different risk categories andweighting them by a percentage ranging from 0% (lowest risk) to 100% (highestrisk). The Total Risk Based Capital Ratio again uses “risk-weighted assets” inthe denominator, but expands the numerator to include other capital itemsbesides equity such as a limited amount of the allowance for loan losses,long-term capital debt, preferred stock and other instruments. Summarized beloware the capital ratios at December 31, 2006 and 2005, for both Mid-StateBancshares and Mid-State Bank & Trust. Additionally, the standards fora well-capitalized institution, as defined by the federal banking agencies, aredisplayed.

| ** **                        | ** ** | **Minimum  Regulatory** | ** ** | **Well-Capitalized  Regulatory** | ** ** | **Mid-State  Bancshares** | ** ** | **Mid-State  Bank & Trust** | ** ** |
|-----------------------------------|------------|-------------------------|------------|----------------------------------|------------|---------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **Standard**            | ** ** | **Standard**                     | ** ** | **2006**                  | ** ** | **2005**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Leverage Ratio                    |       |                    | 4.0        | %                                |       |                      | 5.0        | %                                         |       | 9.9 | % | 9.2 | % | 9.4 | % | 8.9 | % |
| Tier One Risk Based Capital Ratio |       |                    | 4.0        | %                                |       |                      | 6.0        | %                                         |       | 12.1 | % | 11.6 | % | 11.5 | % | 11.3 | % |
| Total Risk Based  Capital Ratio   |       |                    | 8.0        | %                                |       |                      | 10.0       | %                                         |       | 12.8 | % | 12.3 | % | 12.2 | % | 12.0 | % |

 

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.

| ** **                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend Payout  Ratio                   |       | 45.3     | %          | 40.0     | %          | 38.6     | %          |
| Average Common Equity to  Average Assets |       | 11.7     | %          | 11.7     | %          | 12.2     | %          |

 

***Capital Commitments***

As of December 31, 2006, neither the Company northe Bank had any material commitment for capital expenditures.

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***Contractual Obligations***

As of December 31,2006, the Bank had the following contractual obligations.

| ** **                     | ** ** | **Less Than  One Year** | ** ** | **One to Three  Years** | ** ** | **Three to Five  Years** | ** ** | **Over  Five Years** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|---------------------------|------------|-----------|------------|
| Long Term Debt                 |       |                              | $          | —                            |       |                               |       | $                         | 20,000     |      |       |   | $ | 27,000 |   |   |   | $ | — |   |   | $ | 47,000 |   |
| Operating Leases               |       |                              | 2,144      |                              |       |                               | 3,734      |                      |       |      | 3,214      |   |   |   | 2,199 |   |   | 11,291 |   |
| Total  Contractual Obligations |       |                              | $          | 2,144                             |       |                               |       | $                         | 23,734     |      |       |   | $ | 30,214 |   |   |   | $ | 2,199 |   |   | $ | 58,291 |   |

 

***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 $39.8 million at December 31,2006, down from $40.9 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 $657.7 million outstanding oneyear earlier. The Company has an allowance for losses-unfunded commitmentstotaling $1.8 million at both December 31, 2006 and 2005 to cover lossesinherent in its letter of credit accommodations and un-disbursed loancommitments.

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 $20.8 million and $14.1 million at the end of 2006 and2005, respectively. In addition, there were un-funded commitments to loan up toan additional $12.8 million in extensions of credit to directors and executiveofficers at year-end 2006.

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**INCOME STATEMENTANALYSIS**

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

Net Interest Income is thedifference between interest and fees earned on all earning assets and interestpaid on interest bearing liabilities. Net Interest Income for 2006 was $118.4million, up from $112.8 million recorded in 2005 and $101.5 million in 2004. 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 2006, 2005, and 2004.

**ANALYSIS OF CHANGES IN INTERESTINCOME AND EXPENSE**

| ** **                               | ** ** | **2006**         | ** ** | **2005**              | ** ** | **2006 Compared to 2005  Composition of Change** | ** ** |
|------------------------------------------|------------|------------------|------------|-----------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Average**      | ** ** | **Interest  Income/** | ** ** | **Average  Yield/**                                                       | ** ** | **Average** | ** ** | **Interest  Income/** | ** ** | **Average  Yield/** | ** ** | **Change Due To:** | ** ** | **Total** | ** ** |
| **(dollars in 000’s)**    | ** ** | ** **       | ** ** | **Balance**           | ** ** | **Expense**                                                               | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
| *EARNING  ASSETS:*                       |       |             |       |                  |       | ** **                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                    |       | $ 1,554,271 |       | $ 122,354        |       | 7.87                                                                      | %          | $ 1,472,885 |   | $ 104,401 |   |   | 7.09 | % |   | $ 6,088 |   |   | $ 11,865 |   |   | $ 17,953 |   |
| Taxable Investment Securities            |       | 193,583          |       | 8,997                 |       | 4.65                                                                      | %          | 255,385 |   | 9,492 |   |   | 3.72 | % |   | (2,585 | ) |   | 2,090 |   |   | (495 | ) |
| Non-taxable Investment  Securities       |       | 329,426          |       | 12,418                |       | 3.77                                                                      | %          | 355,745 |   | 13,255 |   |   | 3.73 | % |   | (986 | ) |   | 149 |   |   | (837 | ) |
| Fed Funds, Other                         |       | 39,936           |       | 2,027                 |       | 5.08                                                                      | %          | 36,108 |   | 1,178 |   |   | 3.26 | % |   | 160 |   |   | 689 |   |   | 849 |   |
| *TOTAL EARNING ASSETS*                   |       | $ 2,117,216 |       | $ 145,796        |       | 6.89                                                                      | %          | $ 2,120,123 |   | $ 128,326 |   |   | 6.05 | % |   | $ 2,677 |   |   | $ 14,793 |   |   | $ 17,470 |   |
| *INTEREST BEARING LIABILITIES:*          |       |             |       |                  |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW, Savings, and Money Market  Accounts |       | $ 1,021,575 |       | $ 7,724          |       | 0.76                                                                      | %          | $ 1,082,861 |   | $ 4,773 |   |   | 0.44 | % |   | $ (367 | ) |   | $ 3,318 |   |   | $ 2,951 |   |
| Time Deposits                            |       | 464,669          |       | 17,540                |       | 3.77                                                                      | %          | 414,883 |   | 9,837 |   |   | 2.37 | % |   | 1,530 |   |   | 6,173 |   |   | 7,703 |   |
| Interest Bearing Deposits                |       | 1,486,244        |       | 25,264                |       | 1.70                                                                      | %          | 1,497,744 |   | 14,610 |   |   | 0.98 | % |   | 1,163 |   |   | 9,491 |   |   | 10,654 |   |
| Other Borrowings                         |       | 49,491           |       | 2,141                 |       | 4.33                                                                      | %          | 23,117 |   | 893 |   |   | 3.86 | % |   | 1,080 |   |   | 168 |   |   | 1,248 |   |
| *TOTAL INTEREST BEARING LIABILITIES*     |       | 1,535,735        |       | 27,405                |       | 1.78                                                                      | %          | 1,520,861 |   | 15,503 |   |   | 1.02 | % |   | 2,243 |   |   | 9,659 |   |   | 11,902 |   |
| *NET INTEREST INCOME*                    |       | $ 2,117,216 |       | $ 118,391        |       | 5.59                                                                      | %          | $ 2,120,123 |   | $ 112,823 |   |   | 5.32 | % |   | $   434 |   |   | $ 5,134 |   |   | $ 5,568 |   |
|                                          |            |                  |            |                       |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                               | ** ** | **2005**         | ** ** | **2004**              | ** ** | **2005 Compared to 2004  Composition of Change** | ** ** |
|------------------------------------------|------------|------------------|------------|-----------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Average**      | ** ** | **Interest  Income/** | ** ** | **Average  Yield/**                                                       | ** ** | **Average** | ** ** | **Interest  Income/** | ** ** | **Average  Yield/** | ** ** | **Change Due To:** | ** ** | **Total** | ** ** |
| **(dollars in 000’s)**    | ** ** | ** **       | ** ** | **Balance**           | ** ** | **Expense**                                                               | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
| *EARNING ASSETS:*                        |       |             |       |                  |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                    |       | $ 1,472,885 |       | $ 104,401        |       | 7.09                                                                      | %          | $ 1,310,842 |   | $ 85,127 |   |   | 6.49 | % |   | $ 11,004 |   |   | $ 8,270 |   |   | $ 19,274 |   |
| Taxable Investment Securities            |       | 255,385          |       | 9,492                 |       | 3.72                                                                      | %          | 359,668 |   | 11,683 |   |   | 3.25 | % |   | (3,632 | ) |   | 1,441 |   |   | (2,191 | ) |
| Non-taxable Investment  Securities       |       | 355,745          |       | 13,255                |       | 3.73                                                                      | %          | 342,328 |   | 12,646 |   |   | 3.69 | % |   | 498 |   |   | 111 |   |   | 609 |   |
| 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 | % |   | $ 7,842 |   |   | $ 10,548 |   |   | $ 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 | % |   | $ 6,717 |   |   | $ 4,620 |   |   | $ 11,337 |   |
|                                          |            |                  |            |                       |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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During 2006 there was a $17.5 million increase ininterest income along with an increase of $11.9 million in interestexpense compared to 2005. The resulting $5.6 million increase in net interestincome for 2006 was a result of a number of dynamics affecting both averagebalances and interest rates. First, the Company experienced a decrease in itsaverage earning assets outstanding of $2.9 million. The decrease was primarilyattributable to the runoff of investment securities which dropped $88.1 million.This was offset by increases in higher yielding average loans, which were up by$81.4 million, and fed funds sold of $3.8 million. Second,****theCompany’s average interest bearing liabilities increased by $14.9 million. Third,earning asset yields were higher in 2006 compared to the average for 2005, andliability costs, while higher in 2006, did not increase as dramatically.

During 2005 there was an $18.4 million increase ininterest income along with an increase of $7.1 million in interest expensecompared to 2004. The resulting $11.3 million increase in net interest incomefor 2005 was a result of similar dynamics to 2006 with an increase in itsaverage earning assets outstanding of $69.9 million, primarily attributable tothe net increase in average loans of $162.0 million, offset by declines ininvestments of $90.9 million and fed funds sold of $1.3 million. While theCompany’s average interest bearing liabilities increased by $52.8 million,earning assets increased by a larger amount. Finally, earning asset yields werehigher in 2005 compared to the average for 2004 and liability costs did notincrease as dramatically.

The Bank expects its risk exposure to changes ininterest rates during 2007 to remain manageable and well within acceptablepolicy ranges. A recent review as of the end of 2006 of the potential changesin the Bank’s net interest income over a 12 month time horizon showed that itcould fluctuate under extreme alternative rate scenarios from between +2.6% and-5.7%of the base case (rates unchanged) of $125.7 million. The Bank’s policy isto maintain a structure of assets and liabilities which are such that netinterest income will not vary more than plus or minus 15% of the base forecastover the next 12 months. Management expects that its exposure to interest raterisk is manageable and it will continue to strive for an optimal trade-offbetween 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                     |       |                       | -5.7       | % |   |
| (Prime down from  8.25% to 5.25% over 10 months) |       |                       |       |   |   |
| Rates Down  Significant                          |       |                       | -3.5       | % |   |
| (Prime down from  8.25% to 6.25% over 11 months) |       |                       |       |   |   |
| Rates Down  Modestly                             |       |                       | -1.1       | % |   |
| (Prime down from  8.25% to 7.25% over 11 months) |       |                       |       |   |   |
| Base Case—Rates  Unchanged                  |       |                       | —     |   |   |
| (Prime unchanged  at 8.25% over 12 months)       |       |                       |       |   |   |
| Rates Up Modestly                                |       |                       | +0.7       | % |   |
| (Prime up from  8.25% to 9.25% over 11 months)   |       |                       |       |   |   |
| Rates Up  Aggressive                             |       |                       | +0.9       | % |   |
| (Prime up from  8.25% to 10.25% over 11 months)  |       |                       |       |   |   |
| Rates Up Very  Aggressive                        |       |                       | +2.6       | % |   |
| (Prime up from 8.25% to  11.25% over 10 months)  |       |                       |       |   |   |

 

Net interest income under the above scenarios isinfluenced by the characteristics of the Bank’s assets and liabilities. In thecase of N.O.W., savings and money market deposits (total $994.6 million)interest is based on rates generally set at the discretion of managementranging from 0.25% to 2.00%. In a downward rate environment, there is a limitto how far these deposit instruments can be re-priced and this behavior is 

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

It is important to note that the above table is asummary of several forecasts and actual results may vary. The forecasts arebased on estimates and assumptions of management that may turn out to bedifferent and may change over time. Factors affecting these estimates andassumptions include, but are not limited to—competitors’ behavior, economicconditions both locally and nationally, actions taken by the Federal ReserveBoard, customer behavior, and management’s responses. Changes that varysignificantly from the assumptions and estimates may have significant effectson the Bank’s net interest income. Therefore the results of this analysisshould not be relied upon as indicative of actual future results. Historically,the Bank has been able to manage its Net Interest Income in a fairly narrowrange reflecting the Bank’s relative insensitivity to interest rate changes. Theimpact of prepayment behavior on mortgages, real estate loans, mortgage-backedsecurities, securities with call features, etc. is not considered material tothe sensitivity analysis. Over the last 5 years, the Bank’s net interest margin(which is net interest income divided by average earning assets of the Bank)has ranged from a low of 4.95% to a high of 5.59% (not taxable equivalent). TheBank’s net interest margin in 2006 of 5.59% was at the high end of this rangeby historical standards, coming off the low levels experienced in 2004 and 2003of 4.95% and 5.14%, respectively. The improvement in the net interest margin in2006 is a result of both the higher level of interest rates and the change inmix of earning assets (the Bank now has a higher portion in loans vis-à-visinvestment securities compared to earlier years when the margin was at lowerlevels). The net interest margin under the alternative scenarios ranges from5.25% to 5.70%. Management feels this range of scenarios is consistent withcurrent experience and interest rate levels, but no assurances can be giventhat 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 Loan Losses***

The Company did not make aprovision to the allowance for loan losses during 2006 or 2005. In 2004, however,it reduced the allowance for loan losses by $2.7 million through a benefit tothe provision for loan losses. These actions over the past three yearsreflected strong credit quality standards, consistent performance of the loanportfolio in recent years, improving trends in classified loans, improvingtrends in delinquencies, an improved outlook for the collection of the Company’snon accrual loans, the reduced absolute level of non accrual loans and theoutlook for economic activity in general. The need for additional provision forloan losses or for further benefit to the provision for loan losses in 2007will be dependent upon Management’s on-going analysis of the adequacy of theallowance for loan losses. While Management believes the allowance to beadequate at the present time, the appropriatevalue can fluctuate over time in response to economic conditions and thesubjective decisions which must be made in response to those conditions.

***Non-Interest Income***

Non-Interest Income for 2006 totaled $21.9 millioncompared to $21.4 million in 2005 and $27.8 million in 2004. Servicecharges on deposit accounts increased $0.8 million to $10.2 million in 2006compared to 2005 following a decrease of $0.8 million to $9.4 million in 2005versus 2004. The increase in 2006 compared to 2005 reflects primarily anincrease in overdraft fees. The decrease in 2005 compared to 2004 primarilyreflects a decline in account analysis charges collected in the face of higherearnings credits for compensating balances posted to customer accounts in thehigher rate environment.

Commissions, fees and other service charges increasedby $.2 million in 2006 to $8.8 million. This followed a decrease of $4.0million to $8.6 million in 2005 over 2004. The increase in 2006 was primarily 

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due to an increase indebit card fees. The decrease in 2005 was a result of outsourcing its merchantcredit card processing functions (approximately $5.2 million) offset byimprovements to other categories, especially debit card fees ($0.4 million),letter of credit commissions ($0.3 million) and trust department income ($0.3million). The Company now receives a payment for merchant credit cardprocessing which is net of expenses, so a similar decline was experienced inthe non-interest expense section of the income statement in 2005.

Losses on sales of securities were at $32 thousand in2006 following gains of $88 thousand and $475 thousand gains in 2005 and2004, respectively. Activity in both 2006 and 2005 reflects primarily calls ofdebt securities as opposed to disposals by the Company. The larger gain in 2004reflected the acceptance of a tender offer for a $1.0 million block ofcorporate bonds held by the Bank resulting in a $352 thousand gain in the firstquarter and the sale of an additional security (the put feature of which was nolonger applicable) at a gain of $93 thousand in the third quarter.

The Gain on Sale of loans held for sale (single familymortgages) was $414 thousand in 2006 compared to $549 thousand in 2005 and $607thousand in 2004. The modest decline in 2006 compared to 2005 reflected a lowervolume of jumbo adjustable rate mortgage loans sold as the Company kept alarger amount of these in its regular loan portfolio. The higher levels in 2004compared to 2005 reflected the large amount of mortgage refinance activityexperienced as a result of the historically low mortgage interest rate levelsin that year.

All other sources ofincome were $2.5 million in 2006, compared to $2.8 million in 2005 and $3.9 millionin 2004. The decline in 2006 compared to 2005 related primarily to a decline inmiscellaneous recoveries. The decline in 2005 compared to 2004 related to a$1.1 million gain on the sale of OREO in 2004 which did not recur in 2005.

***Non-Interest Expense***

Total non-interest expense for 2006 was $85.7 million,following $77.7 million in 2005, and $79.3 million in 2004. Salaries andemployee benefits increased to $48.7 million in 2006 compared to $44.6 millionin 2005 and $41.8 million in 2004. The increase in 2006 compared to 2005 reflects:1) $1.9 million of stock based compensation expense related to theadoption of SFAS 123(R); 2) $1.9 million in salary increases; and 3)$.3 million increase in employee benefits due to higher group insurance costs. Theincrease in 2005 compared to 2004 was a result of: 1) a $1.7 million increasein expense for the Company’s bonus program due to exceeding goals establishedat the start of the year by a greater degree in 2005 than in 2004, 2) increasesin payroll taxes and other benefits of $0.4 million and 3) salary expenseincreases of $0.7 million. A number of factors are continuing to createunusually strong upward pressure on these costs, especially the cost of medicalbenefits, workers compensation, competitive wages and the increasing need forinfrastructure for regulatory compliance. The Company is addressing these costpressures by focusing on ways of becoming more efficient in its processes andusing technology wherever possible to hold down staffing requirements.

Occupancy expense increased slightly to $12.9 millionin 2006 after being virtually unchanged in 2005 and 2004 at $12.5 million. Theincrease in 2006 reflects increased rent due to the opening of the newcommercial banking facility in Westlake Village and normal rent increases.

Advertising and promotion expenditures were $4.6million in 2006 following charges of $4.4 million in 2005 and $4.0 million in2004. The increase in 2006 over 2005 reflected increased business developmentexpenditures of $200 thousand. 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 Company does not expect any major increases in its 2007expenditures.

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General office expenditures have been relatively flatwith $4.0 million in 2006 following levels of $3.8 million in 2005 and$4.0 million in 2004. This category includes primarily charges for stationeryand supplies, telephone expenses, and postage. Management does not expect anysignificant changes to this category in 2007.

Merchant processing and data processing charges were$1.6 million in 2006, $0.9 million in 2005, and $5.2 million in 2004. Thedecline from 2004 reflects the outsourcing of this function to an outsidevendor late in that year. The increase in 2006 reflects higher debit card usagewhich generated $725 thousand more in fees paid to our outsourced vendor. Thesecosts were offset by higher fee income noted above in Non-interest Income. Management’sexpectation for 2007 is that this category of expense will be little changed.

Professional services were $6.3 million in 2006following $5.0 million in 2005 and $5.5 million in 2004. The increase in 2006over 2005 reflects continued costs of compliance with the Sarbanes-Oxley Actand regulatory requirements. The decrease in 2005 compared to 2004 reflectsslightly lower costs incurred after the intensive, initial compliance effortsfor Sarbanes-Oxley. Management expects costs in 2007 for professional servicesto be little changed from 2006 levels.

Regulatory assessments (charges for FDIC assessmentsand DFI fees) have been little changed over the past three years at $0.4million, $0.4 million and $0.5 million in 2006, 2005, and 2004, respectively. Managementdoes not anticipate any significant increases in these charges in 2007.

Other operating expensesincreased in 2006 to $7.1 million compared to $6.0 million in 2005 and $5.8 millionin 2004. The increase in 2006 compared to 2005 was primarily due to increasedcorrespondent bank fees of $226 thousand, additional provision for losses onunfunded commitments of $91 thousand and $496 thousand of expenses incurredrelated to the pending merger with Rabobank. The increase in 2005 compared to2004 reflects a smaller credit to the provision for losses on unfundedcommitments in 2005 of $136 thousand.

***Taxes***

Book tax expense amounted to $19.2 million in 2006,$19.1 million in 2005, and $17.5 million in 2004. While the statutory tax rateof the Company is 42.05%, the actual rate accrued was 35.3%, 33.7%, and 33.3%in 2006, 2005, and 2004, respectively. The primary reason for the differencecompared to the statutory rate relates to the tax exempt income generated bythe Company’s municipal bond portfolio. The higher effective tax rate in 2006was primarily due to the fact that compensation costs associated with incentivestock options are now recognized against income, along with all other sharebased awards, in accordance with SFAS 123(R), as described in Note 15 to these financialstatements. This additional book expense, however, does not generate a taxdeduction for the Company and, thus creates a higher effective tax rate againstbook income. If, in the future, there are disqualifying dispositions of theshares issued in the exercise of those incentive stock options, the Companywill receive a tax deduction and show a benefit in it’s effective tax rate inthat period.

As described in Note 10 to the financial statements,the Company has deferred tax assets primarily related to the timing differenceassociated with charge-offs and provisions for losses on certain loans and withthe timing difference on deferred compensation.

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**SUBSIDIARY ACTIVITY**

***Mid-Coast Land Company***

Mid-Coast Land Companyrecorded a profit of $195 thousand in 2006, $409 thousand in 2005 and $379thousand in net income in 2004. 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 81 lots remaining to be sold at the start of 2007 (down from86 one year earlier) which are subject to the payment of these commissions.

***MSB Properties, Inc.***

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

Earnings for this subsidiary consist primarily ofrental income from the Bank’s offices and administrative center coupled with aminor amount of rental income from non-bank tenants and interest earnings onits cash assets. Leases are written with market terms and at market rates. Expensesare principally rental expense, depreciation of leasehold improvements, generalmaintenance and utilities expense. The affairs of the subsidiary are managed byBank employees and as such this subsidiary has no paid staff members.

Earnings for MSBProperties, Inc. have remained relatively unchanged over the years with netearnings after-tax of $1.1 million, $1.2 million, and $1.2 million, in 2006,2005 and 2004, respectively.

**CRITICAL ACCOUNTINGPOLICIES AND ESTIMATES**

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

·       *Allowance for losses.  *Management reviews the adequacyof the allowance and also employs an independent third party loan review groupto, among other things, review the adequacy of the allowance and makerecommendations. Management, as necessary, adjusts the allowance for loanlosses and the allowance for losses—unfunded commitments. These adjustments aremade through a charge to expense or a benefit in the provision for loan losseson the income statement. The allowance is also examined annually by one or moreof the Bank’s regulatory bodies including the FDIC and DFI. The need foradditional provision for loan losses in 2006, or a benefit to the provision forloan losses, will be dependent upon Management’s on-going analysis of theadequacy of the allowance for losses. While Management believes it to beadequate at the present time, the appropriatevalue can fluctuate over time in response to economic conditions and thesubjective decisions which must be made in response to those conditions.

·       *Fair Value.*   Where applicable, the Company is requiredby Generally Accepted Accounting Principles (“GAAP”) to disclose the fair valueof financial instruments and the methods and 

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significant assumptionsused to estimate those fair values. Also, the fair value calculated oncollateral supporting the Bank’s extensions of credit (e.g.—appraisals on theproperty securing real estate loans) can have a significant effect on thedetermination of the adequacy of the allowance for losses noted above. Whereverpossible, fair value used by the Company equals quoted market price, as forexample with its investment securities portfolio, if available. If it is notavailable, fair value is estimated by the Company using quoted market pricesfor similar assets. Fair value of other instruments involves discounting futurecash flows using current market rates for instruments with similar maturity andcredit characteristics. 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 31,2006 and 2005, 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.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE 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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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**TABLEOF CONTENTS**

|                                                          | ** ** | **PAGE** | ** ** |
|----------------------------------------------------------|------------|----------|------------|
| Management Statement                                     |       |     | 54         |   |   |
| Report of Independent Registered Public Accounting  Firm |       |     | 55         |   |   |
| Consolidated Statements of Financial Position            |       |     | 57         |   |   |
| Consolidated Statements of Income                        |       |     | 58         |   |   |
| Consolidated Statements of Comprehensive Income          |       |     | 59         |   |   |
| Consolidated  Statements of Changes in Capital Accounts  |       |     | 60         |   |   |
| Consolidated Statements of Cash Flows                    |       |     | 61         |   |   |
| Notes to Consolidated Financial Statements               |       |     | 62         |   |   |

 

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**Management’s Reporton Internal Control Over Financial Reporting**

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

Management conducted an evaluation of theeffectiveness of internal control over financial reporting based on theframework in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission. Based on this evaluation,Management concluded that the Company’s internal control over financialreporting was effective as of December 31, 2006 and 2005. Management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2006 and 2005 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which is included herein.

Management is also responsible for compliance with thefederal and state laws and regulations concerning dividend restrictions andfederal laws and regulations concerning loans to insiders designated by theFDIC as safety and soundness laws and regulations.

Managementassessed its compliance with the designated laws and regulations relating tosafety and soundness. Based on this assessment, Management believes thatMid-State Bancshares complied, in all significant aspects, with the designatedlaws and regulations relating to safety and soundness for the years ended December 31,2006 and 2005.
| /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 ofIndependent Registered Public Accounting Firm**

**To the Board ofDirectors and Stockholders of Mid-State Bancshares:**

We have completedintegrated audits of Mid-State Bancshares’ consolidated financial statementsand of its internal control over financial reporting as of December 31,2006, in accordance with the standards of the Public Company AccountingOversight Board (United States). Our opinions, based on our audits, are presentedbelow.

*Consolidated financial statements*

In our opinion, theconsolidated financial statements listed in the accompanying index present fairly, in all material respects,the financial position of Mid-State Bancshares and its subsidiaries****at December 31, 2006 and 2005, and the results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2006****in conformitywith accounting principles generally accepted in the United States of America.These financial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits. We conducted our audits of these statements in accordance with thestandards of the PublicCompany Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An audit offinancial statements includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

As discussed inNote 1 to the consolidated financial statements, the Company changed themanner in which it accounts for share-based compensation in 2006.

*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, 2006 based on criteriaestablished in *Internal Control*—*Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), is fairly stated, in allmaterial respects, based on those criteria. Furthermore, in our opinion, theCompany maintained, in all material respects, effective internal control overfinancial reporting as of December 31, 2006, based on criteria establishedin *Internal Control—Integrated Framework*issued by the COSO. The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express opinions on management’s assessment and onthe effectiveness of the Company’s internal control over financial reportingbased on our audit. We conducted our audit of internal control over financialreporting in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. An audit of internal control over financial reporting includesobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we consider necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Management’sassessment 

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

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.

PricewaterhouseCoopersLLP

SanFrancisco, California

March 15, 2007

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**ConsolidatedStatements of Financial Position**

**(amountsin 000’s except share amounts)**

| ** **                                                                                            | ** ** | **December 31,** | ** **    |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------|---------------|
| ** **                                                                                            | ** ** | **2006**              | ** **    | **2005** | ** ** |
| **Assets**                                                                                            | ** ** | ** **            | ** **    | ** ** | ** ** |
| CASH AND DUE FROM  BANKS                                                                              | ** ** | **$**                 | **99,675**    |   | $ | 109,791 |   |
| FEDERAL FUNDS  SOLD                                                                                   | ** ** | **38,582**            |          | — |   |
| SECURITIES  AVAILABLE FOR SALE                                                                        | ** ** | **487,700**           |          | 619,332 |   |
| LOANS HELD FOR  SALE                                                                                  | ** ** | **12,840**            |          | 10,176 |   |
| LOANS, net                                                                                            | ** ** | **1,562,817**         |          | 1,507,118 |   |
| PREMISES AND  EQUIPMENT, net                                                                          | ** ** | **32,131**            |          | 24,772 |   |
| ACCRUED INTEREST  RECEIVABLE                                                                          | ** ** | **13,128**            |          | 13,947 |   |
| GOODWILL                                                                                              | ** ** | **47,840**            |          | 47,840 |   |
| CORE DEPOSIT  INTANGIBLES, net                                                                        | ** ** | **5,611**             |          | 6,483 |   |
| SENIOR HOUSING  CRIME PREVENTION FOUNDATION INVESTMENT                                                | ** ** | **30,000**            |          | 30,000 |   |
| OTHER ASSETS                                                                                          | ** ** | **25,130**            |          | 22,040 |   |
| ***TOTAL ASSETS***                                                                                    | ** ** | **$**                 | **2,355,454** |   | $ | 2,391,499 |   |
| **Liabilities**                                                                                       |       |                  |          |   |   |
| DEPOSITS:                                                                                             |       |                  |          |   |   |
| Demand deposits                                                                                       | ** ** | **$**                 | **523,139**   |   | $ | 567,782 |   |
| Savings, money market and NOW accounts                                                                | ** ** | **994,586**           |          | 1,067,486 |   |
| Time deposits—$100,000 or more                                                                   | ** ** | **229,392**           |          | 202,063 |   |
| Time deposits—Under $100,000                                                                     | ** ** | **257,664**           |          | 232,275 |   |
| ***Total Deposits***                                                                                  | ** ** | **2,004,781**         |          | 2,069,606 |   |
| OTHER BORROWINGS                                                                                      | ** ** | **49,400**            |          | 25,903 |   |
| ALLOWANCE FOR  LOSSES - UNFUNDED COMMITMENTS                                                          | ** ** | **1,830**             |          | 1,761 |   |
| ACCRUED INTEREST  PAYABLE & OTHER LIABILITIES                                                | ** ** | **17,006**            |          | 21,667 |   |
| ***TOTAL LIABILITIES***                                                                               | ** ** | **2,073,017**         |          | 2,118,937 |   |
| **Commitments  and Contingencies (Note 12)**                                                          |       |                  |          |   |   |
| **Capital Accounts**                                                                                  |       |                  |          |   |   |
| CAPITAL STOCK, NO PAR  VALUE:                                                                         |       |                  |          |   |   |
| Authorized—100,000,000 shares  Outstanding—22,188,488 shares in 2006 and 22,520,434 in 2005 | ** ** | **33,418**            |          | 42,343 |   |
| UNDIVIDED PROFITS                                                                                     | ** ** | **249,113**           |          | 229,824 |   |
| ACCUMULATED OTHER  COMPREHENSIVE INCOME, NET OF TAXES OF ($62) IN 2006 AND $264 IN 2005               | ** ** | **(94**               | **)**         | 395 |   |
| ***TOTAL CAPITAL ACCOUNTS***                                                                          | ** ** | **282,437**           |          | 272,562 |   |
| ***TOTAL  LIABILITIES & CAPITAL ACCOUNTS***                                                  | ** ** | **$**                 | **2,355,454** |   | $ | 2,391,499 |   |

 

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

57

----

**ConsolidatedStatements of Income**

**(amountsin 000’s except per share amounts)**

| ** **                                                  | ** ** | **Year Ended December 31,** | ** **  |
|-------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                  | ** ** | **2006**                                   | ** **  | **2005** | ** ** | **2004** | ** ** |
| **Interest  Income:**                                       |       |                                       |        |   |   |   |   |
| Interest and fees on loans and leases                       | ** ** | **$**                                      | **122,354** |   | $ | 104,401 |   | $ | 85,127 |   |
| Interest on  securities:                                    |       |                                       |        |   |   |   |   |
| U.S. Treasury securities                                    | ** ** | **734**                                    |        | 679 |   | 974 |   |
| U.S. Government agencies  and corporations                  | ** ** | **5,919**                                  |        | 6,492 |   | 8,553 |   |
| Obligations of states  and political subdivisions, other    | ** ** | **14,762**                                 |        | 15,576 |   | 14,802 |   |
| Interest on federal funds sold                              | ** ** | **2,027**                                  |        | 1,178 |   | 480 |   |
| ***TOTAL  INTEREST INCOME***                                | ** ** | **145,796**                                |        | 128,326 |   | 109,936 |   |
| **Interest  Expense:**                                      |       |                                       |        |   |   |   |   |
| Interest on deposits                                        | ** ** | **25,264**                                 |        | 14,610 |   | 8,256 |   |
| Interest on other borrowings                                | ** ** | **2,141**                                  |        | 893 |   | 194 |   |
| ***TOTAL  INTEREST EXPENSE***                               | ** ** | **27,405**                                 |        | 15,503 |   | 8,450 |   |
| **Net Interest Income**                                     | ** ** | **118,391**                                |        | 112,823 |   | 101,486 |   |
| (Benefit)/Provision for loan losses                         | ** ** | **—**                                 |        | — |   | (2,700 | ) |
| ***NET  INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES***  | ** ** | **118,391**                                |        | 112,823 |   | 104,186 |   |
| **Other Income:**                                           |       |                                       |        |   |   |   |   |
| Service charges on deposit accounts                         | ** ** | **10,168**                                 |        | 9,384 |   | 10,164 |   |
| Commissions, fees and other service charges                 | ** ** | **8,823**                                  |        | 8,620 |   | 12,577 |   |
| Gains on sale of securities                                 | ** ** | **(32**                                    | **)**       | 88 |   | 475 |   |
| Gain on sale of loans held for sale                         | ** ** | **414**                                    |        | 549 |   | 607 |   |
| Other income                                                | ** ** | **2,492**                                  |        | 2,800 |   | 3,941 |   |
| ***TOTAL  OTHER INCOME***                                   | ** ** | **21,865**                                 |        | 21,441 |   | 27,764 |   |
| **Other Expenses:**                                         |       |                                       |        |   |   |   |   |
| Salaries & employee benefits                       | ** ** | **48,746**                                 |        | 44,635 |   | 41,779 |   |
| Occupancy expenses                                          | ** ** | **12,938**                                 |        | 12,534 |   | 12,509 |   |
| Advertising & promotion                            | ** ** | **4,582**                                  |        | 4,439 |   | 3,955 |   |
| General office                                              | ** ** | **3,961**                                  |        | 3,809 |   | 4,017 |   |
| Merchant processing and data processing fees                | ** ** | **1,620**                                  |        | 900 |   | 5,197 |   |
| Professional services                                       | ** ** | **6,343**                                  |        | 4,955 |   | 5,525 |   |
| Regulatory assessments                                      | ** ** | **418**                                    |        | 445 |   | 498 |   |
| Other operating expenses                                    | ** ** | **7,123**                                  |        | 5,957 |   | 5,814 |   |
| ***TOTAL  OTHER EXPENSES***                                 | ** ** | **85,731**                                 |        | 77,674 |   | 79,294 |   |
| Income before taxes                                         | ** ** | **54,525**                                 |        | 56,590 |   | 52,656 |   |
| Tax expense                                                 | ** ** | **19,246**                                 |        | 19,099 |   | 17,547 |   |
| ***NET  INCOME***                                           | ** ** | **$**                                      | **35,279**  |   | $ | 37,491 | ** ** | **$** | **35,109** | ** ** |
| **Earnings per share:**                                     |       |                                       |        |   |   |   |   |
| —Basic                                                 | ** ** | **$**                                      | **1.59**    |   | $ | 1.65 |   | $ | 1.50 |   |
| —Diluted                                               | ** ** | **$**                                      | **1.55**    |   | $ | 1.61 |   | $ | 1.47 |   |
| **Average  shares used in earnings per share calculation:** |       |                                       |        |   |   |   |   |
| —Basic                                                 | ** ** | **22,211**                                 |        | 22,788 |   | 23,422 |   |
| —Diluted                                               | ** ** | **22,711**                                 |        | 23,300 |   | 23,897 |   |

 

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

58

----

**ConsolidatedStatements of Comprehensive Income**

**(amountsin 000’s)**

| ** **                                                             | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ***NET INCOME***                                                       |       | **$**                                      | **35,279** |   | $ | 37,491 |   | $ | 35,109 |   |
| **Other Comprehensive Income  Before Taxes:**                          |       |                                       |       |   |   |   |   |
| Unrealized (losses)  gains on securities available for sale:           |       |                                       |       |   |   |   |   |
| Unrealized  holding losses arising during year                         | ** ** | **(846**                                   | **)**      | (10,687 | ) | (8,568 | ) |
| Reclassification  adjustment for losses (gains) included in net income | ** ** | **32**                                     |       | (88 | ) | (475 | ) |
| Other  comprehensive loss, before tax                                  | ** ** | **(814**                                   | **)**      | (10,775 | ) | (9,043 | ) |
| Income tax  benefit                                                    | ** ** | **(325**                                   | **)**      | (4,310 | ) | (3,626 | ) |
| ***OTHER  COMPREHENSIVE***                                             |       |                                       |       |   |   |   |   |
| ***LOSS, NET OF TAXES***                                               | ** ** | **(489**                                   | **)**      | (6,465 | ) | (5,417 | ) |
| ***TOTAL  COMPREHENSIVE INCOME***                                      | ** ** | **$**                                      | **34,790** |   | $ | 31,026 |   | $ | 29,692 |   |

 

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

59

----

**ConsolidatedStatements of**

**Changes in CapitalAccounts**

**(amountsin 000’s except share amounts)**

| ** **                                                                                | ** ** | **Number of  Shares** | ** ** | **Capital  Stock** | ** ** | **Undivided  Profits** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total**  | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------|------------|------------------------|------------|-----------------------------------------------------------|------------|------------|------------|
| 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 |   |
| Cash dividend—$0.72 per share                                                        | ** ** | **—**                 | ** ** | **—**         | ** ** | **(15,990**            | **)**      | ** **                                                | **—** | ** ** | ** ** | **(15,990** | **)** |
| Exercise of stock options                                                                 | ** ** | **276,930**                | ** ** | **4,414**          | ** ** | **—**             | ** ** | ** **                                                | **—** | ** ** | ** ** | **4,414** | ** ** |
| Tax Benefit from exercise of options                                                      | ** ** | **—**                 | ** ** | **1,667**          | ** ** | **—**             | ** ** | ** **                                                | **—** | ** ** | ** ** | **1,667** | ** ** |
| Net income                                                                                | ** ** | **—**                 | ** ** | **—**         | ** ** | **35,279**             | ** ** | ** **                                                | **—** | ** ** | ** ** | **35,279** | ** ** |
| Change in net unrealized gain on available for sale  securities, net of taxes of ($325)   | ** ** | **—**                 | ** ** | **—**         | ** ** | **—**             | ** ** | ** **                                                | **(489**   | **)**      | ** ** | **(489** | **)** |
| Common stock issued under employee Plans and related  tax benefits                        | ** ** | **—**                 | ** ** | **1,915**          | ** ** | **—**             | ** ** | ** **                                                | **—** | ** ** | ** ** | **1,915** | ** ** |
| Stock repurchased                                                                         | ** ** | **(608,876**               | **)**      | **(16,921**        | **)**      | **—**             | ** ** | ** **                                                | **—** | ** ** | ** ** | **(16,921** | **)** |
| **BALANCE, December 31, 2006**                                                       | ** ** | **22,188,488**             | ** ** | **$**              | **33,418** | ** **             | **$**      | **249,113**                                               | ** ** | ** ** | **$**      | **(94** | **)** | ** ** | **$** | **282,437** | ** ** |

 

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

60

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**ConsolidatedStatements of Cash Flows**

**(amountsin 000’s)**

| ** **                                                                                 | ** ** | **Year Ended December 31,** | ** **  |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                                                 | ** ** | **2006**                                   | ** **  | **2005** | ** ** | **2004** | ** ** |
| **Operating Activities:**                                                                  |       |                                       |        |   |   |   |   |
| Net Income                                                                                 | ** ** | **$**                                      | **35,279**  |   | $ | 37,491 |   | $ | 35,109 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:         |       |                                       |        |   |   |   |   |
| (Benefit)/Provision for credit losses                                                      |       | **—**                                 | ** **  | — |   | (2,700 | ) |
| Provision for depreciation and amortization                                                | ** ** | **5,278**                                  |        | 5,249 |   | 5,044 |   |
| Amortization of originated mortgage servicing rights                                       | ** ** | **442**                                    |        | 458 |   | 459 |   |
| Amortization of net investment security premiums                                           | ** ** | **2,626**                                  |        | 3,743 |   | 5,120 |   |
| Amortization of deferred loan (costs) fees                                                 | ** ** | **299**                                    |        | (525 | ) | (163 | ) |
| Amortization of core deposit intangible assets                                             | ** ** | **872**                                    |        | 1,249 |   | 1,375 |   |
| Share-based compensation, net of taxes                                                     | ** ** | **1,654**                                  | ** **  | — |   | — | ** ** |
| Excess tax benefit from share-based payments                                               | ** ** | **(10**                                    | **)**       | — |   | — | ** ** |
| Loss (Gain) on sale of investments                                                         | ** ** | **32**                                     |        | (88 | ) | (475 | ) |
| Originations of loans held for sale                                                        | ** ** | **(73,357**                                | **)**       | (70,517 | ) | (77,218 | ) |
| Proceeds from sales of loans held for sale                                                 | ** ** | **71,109**                                 |        | 73,878 |   | 78,247 |   |
| Gain on sale of other real estate owned                                                    |       | **—**                                 |        | — |   | (1,084 | ) |
| Gain on sale of loans held for sale                                                        | ** ** | **(415**                                   | **)**       | (549 | ) | (607 | ) |
| Deferred tax charge (benefit)                                                              | ** ** | **(1,921**                                 | **)**       | 33 |   | (765 | ) |
| (Increase) decrease in accrued interest                                                    | ** ** | **819**                                    |        | (2,029 | ) | 256 |   |
| Decrease (increase) in other assets                                                        | ** ** | **(1,287**                                 | **)**       | 860 |   | (4,176 | ) |
| Increase (decrease) in accrued interest payable and  other liabilities                     | ** ** | **(4,591**                                 | **)**       | 3,095 |   | 4,882 |   |
| ***Net cash provided by operating  activities***                                           | ** ** | **36,829**                                 |        | 52,348 |   | 43,304 |   |
| **Investing Activities:**                                                                  |       |                                       |        |   |   |   |   |
| Proceeds from sales and maturities of securities                                           | ** ** | **187,266**                                |        | 140,159 |   | 160,631 |   |
| Purchases of securities                                                                    | ** ** | **(59,106**                                | **)**       | (159,104 | ) | (44,463 | ) |
| Net increase in loans                                                                      | ** ** | **(55,998**                                | **)**       | (98,498 | ) | (266,363 | ) |
| Receipts from real estate investments, net of  advances                                    | ** ** | **—**                                 |        | — |   | 4,512 |   |
| Purchases of premises and equipment                                                        | ** ** | **(12,637**                                | **)**       | (5,075 | ) | (3,665 | ) |
| ***Net cash provided(used) by  investing activities***                                     | ** ** | **59,525**                                 |        | (122,518 | ) | (149,348 | ) |
| **Financing Activities:**                                                                  |       |                                       |        |   |   |   |   |
| Net increase in deposits                                                                   | ** ** | **(64,825**                                | **)**       | 75,061 |   | 82,114 |   |
| Increase in other borrowings—Federal Home Loan Bank                                   | ** ** | **25,000**                                 |        | 20,000 |   | — |   |
| Net decrease in other borrowings—revolving  T.T. & L. note                   | ** ** | **(1,504**                                 | **)**       | (679 | ) | (1,045 | ) |
| Cash dividend paid                                                                         | ** ** | **(15,990**                                | **)**       | (14,995 | ) | (13,552 | ) |
| Proceeds from exercise of share-based awards                                               | ** ** | **6,342**                                  |        | 4,970 |   | 2,579 |   |
| Excess tax benefit from share-based payments                                               | ** ** | **10**                                     |        | — |   | — |   |
| Stock repurchase for retirement                                                            | ** ** | **(16,921**                                | **)**       | (23,065 | ) | (16,646 | ) |
| ***Net cash provided (used) by  financing activities***                                    | ** ** | **(67,888**                                | **)**       | 61,292 |   | 53,450 |   |
| ***(DECREASE) INCREASE IN  CASH & CASH EQUIVALENTS***                             | ** ** | **28,466**                                 |        | (8,878 | ) | (52,594 | ) |
| ***CASH AND CASH EQUIVALENTS,  beginning of year***                                        | ** ** | **109,791**                                |        | 118,669 |   | 171,263 |   |
| ***CASH AND CASH EQUIVALENTS, end  of year***                                              | ** ** | **$**                                      | **138,257** |   | $ | 109,791 |   | $ | 118,669 |   |
| Supplemental disclosure  of cash flow information:                                         |       |                                       |        |   |   |   |   |
| Cash paid during the year  for:                                                            |       |                                       |        |   |   |   |   |
| Interest                                                                                   | ** ** | **$**                                      | **26,869**  |   | $ | 15,112 |   | $ | 8,237 |   |
| Taxes on income                                                                            | ** ** | **19,950**                                 |        | 19,057 |   | 15,006 |   |
| Supplemental  disclosure of non-cash investing activities:                                 |       |                                       |        |   |   |   |   |
| Transfer of  security investment for senior housing crime prevention foundation investment | ** ** | **—**                                 |        | 30,000 | ** ** | **—** | ** ** |

 

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

61

 

----

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2006**

**1. Summary of SignificantAccounting 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 83%) 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, 2006 and 2005, 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, 2006, 2005 and 2004 and as a separatecomponent of the capital accounts for the years ended December 31, 2006and 2005.

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

**LoansHeld for Sale:**   Loans held for sale are carriedat the lower of cost or market, which is determined on an aggregate basis. Theyare stated at the amount of unpaid principal, reduced by market valuationadjustments and increased or reduced by net deferred loan origination fees andcosts. Interest on loans is recognized over the terms of the loans and iscalculated on principal amounts outstanding. Direct loan origination fees andcosts are deferred until the related loan is sold.

62

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

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

**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 Acquiring Loansand Initial Direct Costs of Leases,”* and amortized into income overthe expected life of the loan. The allowance for loan losses, which is based onestimates, is maintained at a level considered adequate to provide for lossesthat are considered to be inherent in the portfolio. Ultimate losses may varyfrom the current estimates. Management reviews these estimates periodically,considers the borrower’s financial status, current economic conditions,historical loan loss experience and other factors. As adjustments becomenecessary, they are reported in earnings in the periods in which they becomeknown. The allowance is increased by provisions charged to operating expenseand reduced by net charge-offs.

In determining income recognition on loans, generallyno interest is recognized with respect to loans on which a default of interestor principal has occurred for a period of 90 days or more. Consumer loans aretypically charged-off when they are 90 days or more past due. Other types ofloans are placed on non-accrual status when management believes that theborrower’s financial condition, after giving consideration to economic andbusiness conditions and collection efforts, is such that the presumption ofcollectibility of interest no longer is prudent. When a loan is placed onnon-accrual status, previously accrued and uncollected interest is reversedfrom income. Loans on non-accrual are charged off, or partially charged off,when collection of all, or a portion of, principal is considered doubtful. Paymentsreceived on non accrual loans are applied to principal unless the loan has hada partial charge off in which case payment is applied as a recovery to theallowance for loan losses. Once a loan is on non-accrual, it is generally notreturned to accrual status until 1) all past due principal and interestpayments have been paid, 2) there has been a demonstrated ability to makepayments for 6 to 12 months, and 3) there is sufficient collateral supportingthe 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 community banking segment, the Company compares itsfair market value of equity to its book value. This difference is compared toGoodwill. Provided the excess of fair market value to book value is above theGoodwill amount, there is no impairment of Goodwill.

63

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**1. Summary of SignificantAccounting Policies (Continued)**

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

**StockOption Plan:**   Through December 31, 2005, theCompany accounted for its stock-based compensation in accordance with SFAS No. 123,“Accounting for Stock Based Compensation.” SFAS No. 123 allowed stockoptions to be valued using the intrinsic value method in accordance with APB No. 25,“Accounting for Stock Issued to Employees.” and provided for presentation ofproforma net income and proforma earnings per share disclosures for employeestock option grants as if the fair-value-based method, defined in SFAS 123(R) hadbeen applied. Effective January 1, 2006, the Company adopted SFAS 123(R), “ShareBased Payment.”  This standard requiresthat all share-based compensation awards be measured at fair value at the dateof grant and expensed over their vesting or service periods.

**RecentAccounting Pronouncements:****  **InJune 2004, the Emerging Issues Task Force of the Financial AccountingStandards Board (FASB) issued guidance on its Issue No. 03-1, “TheMeaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments.” The guidance made recommendations regarding unrealized losses onavailable-for-sale debt and equity securities accounted for under Statement ofFinancial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,”and No. 124, “Accounting forCertain Investments Held by Not-for-Profit Organizations.”  The guidance for evaluating whether aninvestment is other-than-temporarily impaired was to be applied inother-than-temporary impairment evaluations made in reporting 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

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

periods beginningafter June 15, 2004. The disclosures were to be effective in annualfinancial statements for fiscal years ending after December 15, 2003, forinvestments accounted for under Statements 115 and 124. On September 30,2004, the FASB Board directed the issuance of FASB Staff Position (FSP) EITFIssue 03-1-a, “Implementation Guidance for the Application ofParagraph 16 of EITF Issue No. 03-1.” The proposed FSP would provideimplementation guidance with respect to debt securities that are impairedsolely due to interest rates and/or sector spreads and analyzed forother-than-temporary impairment under paragraph 16 of issue 03-1. TheFASB asked constituents to comment on whether the application guidance withrespect to “minor impairments” should also be applied to securities analyzedfor impairment under paragraphs 10-15 of Issue 03-1. At the June 29,2005 meeting, the Board decided not to provide additional guidance on themeaning of other-than-temporary impairment and directed the staff to finalizeproposed FASB Staff Position (FSP) EITF 03-1-a, “ImplementationGuidance for the Application of Paragraph 16 of EITF Issue No. 03-1.”The final FSP, retitled as FSP FAS 115-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application 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 theguidance set forth in Topic D-44 and clarify that an investor shouldrecognize an impairment loss no later than when the impairment is deemed otherthan temporary, 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 as non-accrualor how to subsequently report income on a non-accrual 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-adid not have a material impact on the Company’s results of operations or itsfinancial position.

The FASB issued a revision to SFAS No. 123, “Accountingfor Stock-Based Compensation” in December 2004. The revised Statement isSFAS No. 123(R) (revised 2004), “Share-Based Payment” and itsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,”and its related implementation guidance. It is effective for the Company as of January 1,2006. The Statement requires that the Company measure 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 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

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

which an employee isrequired to provide service in exchange for the award—usually the vestingperiod. Compensation cost for awards that vest would not be reversed if theawards expire without being exercised. The Company previously applied APBOpinion No. 25, in accounting for its share based payment awards. Accordingly,no compensation expense was recognized for grants of these types of awardsprior to 2006. Pro forma disclosures of net income and earnings per share weredisclosed in Note 15 of the Company’s Annual Report on Form 10K. TheCompany adopted the revised Statement for the first quarter of 2006. The impactof adopting the accounting treatment was to reduce earnings by approximately$429 thousand, after-tax, for the three months ended December 31, 2006. Forthe year ended December 31, 2006, earnings were reduced by approximately$1.7 million, after-tax.

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. Adoption of the Statement did not have a materialeffect on the Company’s consolidated 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. The Company expects to adopt the Statement for the first quarter of2007 and expects it will not have a material effect on its consolidatedfinancial statements.

The FASB issued SFAS No. 156, “*Accounting for Servicing of Financial Assets”*on March 17, 2006 as an amendment to SFAS No. 140. The standard willsimplify the accounting for servicing assets and liabilities, such as thosecommon with mortgage securitization activities. Specifically, the new Standardaddresses the recognition and measurement of separately recognized servicingassets and liabilities and provides an approach to simplify efforts to obtainhedge-like (offset) accounting. The standard also clarifies when an obligationto service financial assets should be separately recognized as a servicingasset or a servicing liability, requires that a separately recognized servicingasset or servicing liability be initially measured at fair value, ifpracticable, permits an entity with a separately recognized servicing asset orservicing liability to choose either the amortization method or fair valuemethod for subsequent 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

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

measurement. SFAS No. 156permits a servicer that uses derivative financial instruments to offset riskson servicing to report both the derivative financial instrument and relatedservicing asset or liability by using a consistent measurement attribute—fairvalue. The Company expects to adopt the Statement for the first quarter of 2007and expects it will not have a material effect on its consolidated financialstatements.

On July 13, 2006 the FASB released FinancialInterpretation Number (FIN) 48, “*Accounting for Uncertaintyin Income Taxes-an interpretation of FASB Statement 109”.*TheInterpretation provides definitive guidance and disclosure requirements relatedto income tax uncertainties. FIN 48 prescribes a comprehensive model for how acompany should recognize, measure, present, and disclose in its financialstatements uncertain tax positions that the company has taken or expects totake on a tax return. Under the Interpretation, the financial statements willreflect expected future tax consequences of such positions presuming the taxingauthorities’ full knowledge of the position and all relevant facts, but withoutconsidering time values. The Interpretation also revises disclosurerequirements to include a tabular roll-forward of any unrecognized tax benefits.The Interpretation is effective for annual periods beginning after December 15,2006. The Company does not expect it will have a material effect on itsconsolidated financial statements.

The FASB issued Statement of Financial AccountingStandards No. 157, “*Fair ValueMeasurements”*(FAS 157)*,*on September 15, 2006, whichdefines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles (GAAP) and expands disclosures aboutfair value measurement. FAS 157 will apply whenever another standard requires(or permits) assets or liabilities to be measured at fair value. The standarddoes not expand the use of fair value to any new circumstances. FAS 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. The Company does notexpect it will have a material effect on its consolidated financial statements.

On September 29,2006, the FASB issued Statement of Financial Accounting Standards No. 158,“*Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans”*(FAS158). This Statement requiresemployers to recognize the over funded or under funded status of asingle-employer defined benefit postretirement plan as an asset or liability inits statement of financial position and recognize any changes in that status incomprehensive income in the year in which it occurs. It also requires thatemployers measure the funded status of a plan as of the date of its year-endstatement of financial position. The Statement does not change how plans areaccounted for and reported in the income statement. For publicly tradedcompanies, FAS158 is effective for fiscal years ending after December 15,2006. The Company does not expect that it will have a material effect on itsconsolidated financial statements.

**2. Merger**

On November 2, 2006, the Company and Rabobankannounced that they had entered into an agreement and plan of merger throughwhich Mid-State Bank & Trust will become part of the Rabobank Group. Uponcompletion, Mid-State Bank & Trust will be merged into Rabobank, N.A.,Rabobank’s community banking subsidiary in California.

Under terms of the agreement and plan of merger,Rabobank will acquire all of the shares of Mid-State Bancshares, through amerger with a Rabobank subsidiary, for a purchase price of $37.00 per share incash, or a total purchase price of approximately $851 million. The transactionis expected to close in the 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**2. Merger(Continued)**

second quarter of 2007,subject to approval by Mid-State Bancshares shareholders and the receipt of allrequired regulatory approvals. A copy of the definitive agreement for theacquisition is attached to our Report on Form 8-K filed with theSecurities and Exchange Commission on November 3, 2006. See also, Note 12,Commitments and Contingencies and Item 3 of this Report on Form 10-Kentitled Legal Proceedings for information regarding a lawsuit filed inconnection with the acquisition.

The agreement and plan ofmerger includes terms and conditions which affect the conduct of the Company’sbusiness until the merger is completed or the agreement is terminated. Amongother items, it generally requires the Company to carry on business in itsordinary course consistent with past practice and in accordance with soundbanking practices, and to observe in all material respects its legal andcontractual obligations. The merger agreement generally restricts the abilityof the Company to make material changes in any aspect of the conduct of itsbusiness without the consent of Rabobank, including significant capitalexpenditures, new material lines of business, the disposition of assets or theincurring of obligations outside the ordinary course of business. The Companyis in compliance with its obligations under the agreement and plan of merger.

**3. Cash Reserves**

The average reserve balances required to be maintainedby the Federal Reserve Bank were approximately $18.5 million and $22.3 millionat December 31, 2006 and 2005, respectively.

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**4. Securities**

A summary of investmentsecurities owned is as follows:

**December 31, 2006**

| **(amounts in 000’s)  Securities Available For Sale** | ** ** | ** **  | ** **  | **Cost  Basis** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Market  Value** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------|-------------|-----------------|------------|------------------------------|------------|-------------------------------|------------|-------------------|------------|
| U.S. Treasury  securities                                                           | ** ** | **$**       | **15,714**  | ** **      |       | **$**                        | **—** | ** **                    |       |              | **$**      | **(121** | **)** |   | **$** | **15,593** | ** ** |
| Securities of  U.S. government agencies and corporations                            | ** ** | **130,488** | ** **  |            | **38**     | ** **                   |       |                          | **(687**   | **)**             |       | **129,839** | ** ** |
| Mortgage backed  securities                                                         | ** ** | **6,604**   | ** **  |            | **135**    | ** **                   |       |                          | **(126**   | **)**             |       | **6,613** | ** ** |
| Obligations of  states and political subdivisions                                   | ** ** | **320,079** | ** **  |            | **2,423**  | ** **                   |       |                          | **(1,772** | **)**             |       | **320,730** | ** ** |
| Other investments                                                                   | ** ** | **14,971**  | ** **  |            | **6**      | ** **                   |       |                          | **(52**    | **)**             |       | **14,925** | ** ** |
| ***TOTAL***                                                                         | ** ** | **$**       | **487,856** | ** **      |       | **$**                        | **2,602**  | ** **                    |       |              | **$**      | **(2,758** | **)** |   | **$** | **487,700** | ** ** |

 

**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 |   |

 

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 31,2006:

| ** **                                               | ** ** | **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                                |       | $                                      | —     |                                 |       | $                      | —     |   |   | $ | 10,587 |   |   | $ | (121 | ) |   | $ | 10,587 |   |   | $ | (121 | ) |   |
| Securities of  U.S. government agencies and corporations |       | —                                 |       |                                 | —     |                   |       | 94,029 |   |   | (687 | ) |   | 94,029 |   |   | (687 | ) |   |
| Mortgage backed  securities                              |       | —                                 |       |                                 | —     |                   |       | 2,971 |   |   | (126 | ) |   | 2,971 |   |   | (126 | ) |   |
| Obligations of  states and political subdivisions        |       | 54,731                                 |       |                                 | (242       | )                      |       | 102,318 |   |   | (1,530 | ) |   | 157,049 |   |   | (1,772 | ) |   |
| Other investments                                        |       | —                                 |       |                                 | —     |                   |       | 3,951 |   |   | (52 | ) |   | 3,951 |   |   | (52 | ) |   |
| *TOTAL*                                                  |       | $                                      | 54,731     |                                 |       | $                      | (242       | ) |   | $ | 213,856 |   |   | $ | (2,516 | ) |   | $ | 268,587 |   |   | $ | (2,758 | ) |   |
|                                                          |            |                                        |            |                                      |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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 notthe result of any deteriorating financial conditions or near term prospects ofthe underlying issuers and 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**4.Securities (Continued)**

Management believes thatit has the intent and ability to either retain these investment securities toallow for the eventual recovery in market value or to hold them until maturity.

Securities having a fair value of $111.9 million and$110.0 million at December 31, 2006 and 2005, respectively, were pledgedto secure public deposits and for other purposes as required by law.

Proceeds from maturities, calls, partial pay-downsand/or sales of securities were $187.3 million, $140.2 million, and $160.6million for the years ended 2006, 2005, and 2004, respectively. Gross gains of$140 thousand, $145 thousand, and $485 thousand and gross losses of $172thousand, $57 thousand, and $10 thousand were realized on that activity for theyears ended 2006, 2005, and 2004, respectively.

Theamortized cost and market value of securities at December 31, 2006 and2005, by contractual maturity, are shown below. Expected maturities may differfrom contractual maturities because borrowers may have the right to call orprepay obligations with or without call or prepayment penalties. Included in the “Equity securities”category below is common stock held in the Federal Home Loan Bank, FederalNational Mortgage Association and Federal Agricultural Mortgage Association.

| ** **                                                          | ** ** | **Available For Sale** | ** **  |
|---------------------------------------------------------------------|------------|----------------------------------|-------------|
| **(dollars in 000’s)  December 31, 2006*** | ** ** | ** **                       | ** **  | **Cost  Basis** | ** ** | **Market  Value** | ** ** |
| Due in one year  or less                                            | ** ** | **$**                            | **147,535** | ** ** | **$** | **147,392** | ** ** |
| Due after one  year to five years                                   | ** ** | **282,340**                      | ** **  | **282,568** | ** ** |
| Due after five  years to ten years                                  | ** ** | **47,813**                       | ** **  | **47,652** | ** ** |
| Due after ten  years                                                | ** ** | **1,501**                        | ** **  | **1,421** | ** ** |
| Equity securities                                                   | ** ** | **8,667**                        | ** **  | **8,667** | ** ** |
| ***Total***                                                         | ** ** | **$**                            | **487,856** | ** ** | **$** | **487,700** | ** ** |
|                                                                     |            |                                  |             |  |  |  |  |  |  |

 

| **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           |       |

----

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

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**5.Loans**

The loan portfolioconsists of the following:

| ** **                            | ** ** | **December 31,** | ** **  |
|---------------------------------------|------------|-----------------------|-------------|
| **(dollars in 000’s)** | ** ** | ** **            | ** **  | **2006** | ** ** | **2005** | ** ** |
| Construction and  development loans   | ** ** | **$**                 | **292,041** | ** ** | $ | 279,417 | ** ** |
| Real estate loans                     | ** ** | **850,831**           | ** **  | 816,953 | ** ** |
| Home equity  credit lines             | ** ** | **152,125**           | ** **  | 182,057 | ** ** |
| Installment loans                     | ** ** | **18,663**            | ** **  | 18,032 | ** ** |
| Cash reserve                          | ** ** | **2,881**             | ** **  | 3,367 | ** ** |
| Agricultural  production              | ** ** | **39,889**            | ** **  | 35,898 | ** ** |
| Commercial, other                     | ** ** | **222,023**           | ** **  | 186,757 | ** ** |
|                                  | ** ** | **1,578,453**         | ** **  | 1,522,481 | ** ** |
| Less allowance  for loan losses       | ** ** | **(11,870**           | **)**       | (11,896 | **)** |
| Less deferred  loan fees, net         | ** ** | **(3,766**            | **)**       | (3,467 | **)** |
| ***TOTAL  LOAN PORTFOLIO***           | * *   | ***$1,562,817***      | * *    | $ | 1,507,118 |   |
|                                       |            |                       |             |  |  |  |  |  |  |

 

At December 31, 2006,approximately $1.3 billion of the Bank’s portfolio was collateralized byvarious forms of real estate. The Company attempts to reduce its concentrationof credit risk by making loans, which are diversified by project type andgeographic locations throughout the Central Coast of California. Whilemanagement of the Company believes that the collateral presently securing thisportfolio is adequate, there can be no assurances that deterioration in theCalifornia real estate market would not expose the Bank to significantlygreater credit risk.

Loans on non-accrualstatus totaled $526 thousand and $2.5 million at December 31, 2006 and2005, respectively. The bank had no loans past due 90 days or more and stillaccruing interest at December 31, 2006 and 2005. If interest income onnon-accrual loans had been recorded as originally scheduled, approximately $142thousand, $1.0 million, and $1.3 million of additional interest income wouldhave been recorded for the years ended December 31, 2006, 2005 and 2004,respectively. Additionally, there was $70 thousand, $59 thousand and nointerest income recognized for loans on non-accrual during 2006, 2005, and2004, respectively.

A loan is identified asimpaired when it is probable that interest and principal will not be collectedaccording to the contractual terms of the loan agreement. Because thisdefinition is very similar to that used by bank regulators to determine onwhich loans interest should not be accrued, the Company expects that mostimpaired loans will be on non-accrual status. Therefore, in general, theaccrual of interest on impaired loans is discontinued, and any uncollectedinterest is written off against interest from other loans in the currentperiod. No further income is recognized until all recorded amounts of principalare recovered in full or until circumstances have changed such that the loan isno longer regarded as impaired. Certain impaired loans are both fully securedby collateral and are current in their interest and principal payments. Theseimpaired loans are not classified as non-accrual and $21 thousand, $38 thousandand $73 thousand in interest was recognized from these loans during 2006,2005 and 2004, respectively.

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) theexpected future cash flows discounted at the effective interest rate; (2) theloan’s observable market price, if available from a secondary market; or (3) byvaluing the underlying collateral if the loan is collateral dependent. Avaluation allowance is computed as any amount by which the recorded investmentexceeds the value of the 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**5. Loans(Continued)**

impairedloan. If the value of the loan, as determined by one of the above methods,exceeds the recorded investment in the loan, a valuation allowance for the loanis not established. The following table discloses information about impairedloans and their related allowance.

| ** **                                                                | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**                                     | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Loans identified  as impaired at year end                                 |       | $                     | 526        |   | $ | 2,528 |   |
| Impaired loans for which  a valuation                                     |       |                  |       |   |   |
| allowance has  been determined                                            |       | —                |       | 1,972 |   |
| Amount of  valuation allowance                                            |       | —                |       | 592 |   |
| Impaired loans for which  no valuation allowance was determined necessary |       | 526                   |       | 556 |   |
|                                                                           |            |                       |            |  |  |  |  |  |  |

 

The average amount of the recorded investment inimpaired loans during the years ended December 31, 2006, 2005 and 2004 wasapproximately $1.0 million, $6.6 million and $12.9 million, respectively. The valuation allowance reported above isdetermined on a loan-by-loan basis.

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, 2006 and 2005. 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)**                                                        | ** **   | ** **            | ** **   | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Balance at beginning of  year:                                                               |         |                  |         |   |   |   |   |
| 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 at beginning of year                                             | ** **   | **13,657**            | ** **   | 15,582 |   | 18,004 |   |
| (Reductions in)  additions to the allowance for loan losses (credited to) charged to expense |         | **—**            |         | — |   | (2,700 | ) |
| Provision for  losses—unfunded commitments charged to expense                           | ** **   | **69**                | ** **   | (22 | ) | (158 | ) |
| Loans charged off                                                                            | ** **   | **(550**              | **)**        | (3,231 | ) | (940 | ) |
| Recoveries of  loans previously charged off                                                  | ** **   | **524**               | ** **   | 1,328 |   | 1,376 |   |
| ***TOTAL ALLOWANCE FOR LOSSES—END OF YEAR***                                            | *** *** | ***$13,700***         | *** *** | ***$*** | 13,657 |   | $ | 15,582 |   |
|                                                                                              |              |                       |              |  |  |  |  |  |  |  |  |  |

 

| **(dollars in 000’s)**             | ** **   | ** **    | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------|--------------|---------------|--------------|------------|------------|------------|------------|------------|------------|
| Allowance for  loan losses                        | ** **   | **$**         | **11,870**   |       | $          | 11,896     |       | $          | 13,799     |   |
| Allowance for  losses—unfunded commitments   | ** **   | **1,830**     |         | 1,761      |       | 1,783      |       |
| ***TOTAL ALLOWANCE FOR LOSSES—END OF YEAR*** | *** *** | ***$13,700*** | *** *** | ***$***    | 13,657     |       | $          | 15,582     |       |
|                                                   |              |               |              |            |            |            |            |            |            |  |  |  |

 

72

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**5. Loans(Continued)**

An analysis of loans andleases to directors and executive officers is as follows:

| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| **(dollars in 000’s)**    | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Balance, at  beginning of year           | ** ** | **$**                 | **14,128** |   | $ | 8,744 |   |
| Additional loans  and leases made        | ** ** | **7,721**             |       | 8,758 |   |
| Payments received  and other adjustments | ** ** | **(1,001**            | **)**      | (3,374 | ) |
| ***BALANCE AT END OF YEAR***             | ** ** | **$**                 | **20,848** |   | $ | 14,128 |   |
|                                          |            |                       |            |  |  |  |  |  |  |

 

These loans were made inthe ordinary course of the Bank’s business and, in management’s opinion, weremade at prevailing rates and terms. In addition, there were un-fundedcommitments to loan up to an additional $12.8 million in extensions of creditto directors and executive officers at December 31, 2006.

**6. Premises and Equipment**

*Premises and equipment consisted of the following:*

| ** **                                           | ** **   | **December 31,** | ** ** |
|------------------------------------------------------|--------------|-----------------------|------------|
| **(dollars in 000’s)**                | ** **   | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Land                                                 | ** **   | **$**                 | **11,135** |   | $ | 7,595 |   |
| Buildings                                            | ** **   | **38,264**            |       | 32,694 |   |
| Furniture and  equipment                             | ** **   | **30,633**            |       | 28,345 |   |
| Construction and  equipment purchases in progress    | ** **   | **867**               | ** ** | 1,828 | ** ** |
| ** **                                           | ** **   | **80,899**            |       | 70,462 |   |
| Less—Accumulated  depreciation and amortization | ** **   | **(48,768**           | **)**      | (45,690 | ) |
| ***TOTAL PREMISES AND EQUIPMENT***                   | *** *** | ***$32,131***         |       | $ | 24,772 |   |
|                                                      |              |                       |            |  |  |  |  |  |  |

 

Depreciationand amortization included in occupancy expenses was $5.3 million, $5.2 million,and $5.0 million in 2006, 2005 and 2004, respectively, based on thefollowing estimated useful lives:

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

 

Total rental expense forbanking premises was $2.5 million, $2.0 million, and $2.0 million, in 2006, 2005and 2004, respectively. As of December 31, 2006 the approximate minimumfuture lease rentals payable under non-cancelable lease contracts for bankpremises were as follows (dollars in 000’s):

| **Year**                      | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|
| 2007                          |       | $          | 2,144      |       |
| 2008                          |       | 1,937      |       |
| 2009                          |       | 1,797      |       |
| 2010                          |       | 1,677      |       |
| 2011                          |       | 1,537      |       |
| Thereafter                    |       | 2,199      |       |
| ***TOTAL LEASE COMMITMENTS*** |       | $          | 11,291     |       |

 

73

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**7. Core DepositIntangible Assets**

The following is a summaryof the Company’s core deposit intangible assets. Figures are in thousands.

| ** **               | ** ** | ** ** | ** ** | **Dec. 31, 2005** | ** ** | ** **            | ** ** | ** ** | ** ** | **Dec. 31, 2006** | ** ** | ** **            | ** ** |
|--------------------------|------------|------------|------------|-----------------------------|------------|-----------------------|------------|------------|------------|-----------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **Gross**  | ** ** | **Accumulated**             | ** ** | **Net Carrying** | ** ** | **Gross**  | ** ** | **Accumulated**             | ** ** | **Net Carrying** | ** ** |
| ** **               | ** ** | **Amount** | ** ** | **Amortization**            | ** ** | **Amount**            | ** ** | **Amount** | ** ** | **Amortization**            | ** ** | **Amount**            | ** ** |
| Core Deposit  Intangible | ** ** | **$**      | **11,597** | ** **                  |       | **($5,986**           | **)**      |       |       | **$**                       | **5,611**  |                  |       | $ | 11,597 |   |   | ($5,114 | ) |   |   | $ | 6,483 |   |   |
|                          |            |            |            |                             |            |                       |            |            |            |                             |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theaggregate amount of amortization expense of the core deposit intangible assetsis as follows ($ in 000’s):

| ** **                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Amortization of  Core Deposit Intangible |       | **$**    | **872**    |     | $          | 1,249    |       | $ | 1,375 |   |
|                                          |            |          |            |          |            |          |            |  |  |  |

 

The decline in theamortization rate in 2006 and 2005 compared to 2004 is the result of anadjustment made necessary by a stronger retention of core deposits thanoriginally anticipated related to one of the Company’s acquisitions. Theprojected amortization expense for the core deposit intangible assets, assumingno further acquisitions, dispositions or adjustments to current amortizationrates, is approximately $872 thousand per year over the next six years. Amortizationof core deposit intangible premiums from prior mergers are currently scheduledto be completed by dates ranging from October 2012 to September 2013which represent original 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 the managementof financial instruments; for example, the ability to generate non-interestincome and the control of non-interest expense. For these reasons, users areadvised not to regard the disclosure of the fair market value of financialinstruments as in any way equivalent to a valuation of the Company as a whole.

74

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

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

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.

*InvestmentSecurities*

For securities held as investments, fair value equalsquoted market price, if available. If a quoted market price is not available,fair value is estimated using quoted market prices 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 other types of loans is estimated bydiscounting the future cash flows using the current rates at which similarloans would be made to borrowers with similar credit ratings and for the sameremaining maturities.

*Accrued InterestReceivable*

For accrued interest receivable, the carrying amountis a reasonable estimate of fair value.

*Deposits*

The fair value of demand deposits is the amountpayable on demand. The fair value of fixed-maturity certificates of deposit,savings accounts and money market deposits is estimated using the rates currentlyoffered for deposits of similar remaining maturities.

*Other Borrowings*

Rates currently available to the Company for debt withsimilar terms and remaining maturities are used to estimate fair value ofexisting debt.

*Commitments toExtend Credit and Letters of Credit*

Commitments to extend credit and letters of credit arewritten at current market rates. The Company does not anticipate any interestrate or credit factors that would affect the fair value of commitments orletters of credit outstanding at December 31, 2006.

*Accrued InterestPayable*

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

75

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

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

**The**estimatedfair values of the Company’s financial instruments are as follows:

| ** **                            | ** ** | **2006**      | ** ** | **2005**      | ** ** |
|---------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                            | ** ** | **Carrying**  | ** ** | **Fair**      | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(dollars in 000’s)** | ** ** | ** **    | ** ** | **Amount**    | ** ** | **Value** | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial assets:                     |       |          |       |          |       |   |   |   |   |
| Cash and due from banks               | ** ** | **$**         | **99,675** | ** **    | **$**      | **99,675** |   | $ | 109,791 |   | $ | 109,791 |   |
| Fed funds sold                        | ** ** | **38,582**    | ** ** | **38,582**    |       | — |   | — |   |
| Investment securities                 | ** ** | **487,700**   | ** ** | **487,700**   |       | 619,332 |   | 619,332 |   |
| Loans held for sale                   | ** ** | **12,840**    | ** ** | **12,840**    |       | 10,177 |   | 10,278 |   |
| Loans, net                            | ** ** | **1,562,817** | ** ** | **1,544,521** |       | 1,507,118 |   | 1,499,709 |   |
| Accrued interest receivable           | ** ** | **13,128**    | ** ** | **13,128**    |       | 13,947 |   | 13,947 |   |
| Financial liabilities:                |       |          |       |          |       |   |   |   |   |
| Deposits                              | ** ** | **2,004,781** | ** ** | **1,986,554** |       | 2,069,606 |   | 2,063,188 |   |
| Other borrowings                      | ** ** | **49,400**    | ** ** | **48,749**    |       | 25,906 |   | 25,638 |   |
| Accrued interest  payable             | ** ** | **1,220**     | ** ** | **1,220**     |       | 685 |   | 685 |   |
|                                       |            |               |            |               |            |  |  |  |  |  |  |  |  |  |  |

 

**9. Deposits**

Individual RetirementAccount balances are now insured up to $250,000 and all other deposits areinsured up to $100,000 per member by the Federal Deposit Insurance Corporation(FDIC). The following is a breakdown by type and maturity at year-end of theBank’s deposits:

**December 31,2006**

| ** **                              | ** **   | **No Contractual** | ** **       | **Three Months** | ** **   | **After 3 Months,** | ** **     | **After**                  | ** **   | ** **        | ** **     |
|-----------------------------------------|--------------|-------------------------|------------------|-----------------------|--------------|-------------------------------|----------------|----------------------------|--------------|-------------------|----------------|
| **(dollars in 000’s)**   | ** **   | ** **              | ** **       | **Maturity**          | ** **   | **or Less**              | ** **     | **to 12 Months** | ** **   | **One Year** | ** **     | **Total** | ** ** |
| Demand Deposits                         |         |                    | **$**            | **523,139**           | ** **   |                          |           | **$**                      | **—**   | ** **        |           |   | **$** | **—** | ** ** |   |   | **$** | **—** | ** ** |   | **$** | **523,139** | ** ** |
| Savings, Money  Market and NOW Accounts | ** **   | ** **              | **994,586**      | ** **            |         |                          | **—**     | ** **                 |         |              | **—**     | ** ** |   |   | **—** | ** ** |   | **994,586** | ** ** |
| Time Deposits—$100,000  or more    | ** **   | ** **              | **—**       | ** **            |         |                          | **110,513**    | ** **                 |         |              | **104,696**    | ** ** |   |   | **14,183** | ** ** |   | **229,392** | ** ** |
| Time  Deposits—Under $100,000      | ** **   | ** **              | **—**       | ** **            |         |                          | **96,997**     | ** **                 |         |              | **119,606**    | ** ** |   |   | **41,061** | ** ** |   | **257,664** | ** ** |
| ***Total***                             | *** *** | *** ***            | ***$1,517,725*** | *** ***          | *** *** | *** ***                  | ***$207,510*** | *** ***               | *** *** | *** ***      | ***$224,302*** | *** *** | *** *** | *** *** | ***$55,244*** | *** *** | *** *** | ***$2,004,781*** | *** *** |
|                                         |              |                         |                  |                       |              |                               |                |                            |              |                   |                |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**December 31,2005**

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

 

76

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**10. Income Taxes**

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

| **(dollars in 000’s)**      | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Federal:                                   |       |       |       |     |       |     |       |
| Current                                    | ** ** | **$**      | **14,858** |     | $          | 13,081   |       | $        | 12,395     |   |
| Deferred                                   | ** ** | **(1,891** | **)**      | (116     | )          | (553     | )          |
| ***Total Federal Taxes***                  | ** ** | **12,967** |       | 12,965   |       | 11,842   |       |
| State:                                     |       |       |       |     |       |     |       |
| Current                                    | ** ** | **6,309**  |       | 5,985    |       | 5,917    |       |
| Deferred                                   | ** ** | **(30**    | **)**      | 149      |       | (212     | )          |
| ***Total State Taxes***                    | ** ** | **6,279**  |       | 6,134    |       | 5,705    |       |
| ***TOTAL  FEDERAL AND STATE TAX EXPENSE*** | ** ** | **$**      | **19,246** |     | $          | 19,099   |       | $        | 17,547     |   |

 

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

| **(dollars in 000’s)**                             | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Tax expense at  federal statutory tax rate                        | ** ** | **$**      | **19,084** |     | $          | 19,807   |       | $        | 18,429     |   |
| State income tax  expense, net of state benefit on federal return | ** ** | **4,081**  |       | 3,986    |       | 3,709    |       |
| Tax savings from  exempt investment and loan income)              | ** ** | **(4,286** | **)**      | (4,681   | )          | (4,542   | )          |
| Other, net                                                        | ** ** | **367**    |       | (13      | )          | (49      | )          |
| ***TOTAL  TAX EXPENSE***                                          | ** ** | **$**      | **19,246** |     | $          | 19,099   |       | $        | 17,547     |   |

 

Theprincipal items giving rise to changes in deferred taxes were:

| **(dollars in 000’s)** | ** ** | ** ** | ** ** | **2006** | ** ** | **2005**   | ** ** | **2004** | ** ** |
|---------------------------------------|------------|------------|------------|----------|------------|------------|------------|----------|------------|
| Allowance for  loan losses            | ** ** | **$**      | **(137**   | **)**    | $          | 880        |       | $        | 826        |   |
| Deferred  compensation                | ** ** | **(386**   | **)**      | (65      | )          | (61        | )          |
| Stock Based  Compensation             | ** ** | **(253**   | **)**      | —   | ** ** | **—** | ** ** |
| State income  taxes                   | ** ** | **(376**   | **)**      | (106     | )          | (256       | )          |
| Depreciation                          | ** ** | **686**    |       | (626     | )          | (1,608     | )          |
| Accrued  liabilities and other, net   | ** ** | **(865**   | **)**      | 165      |       | 271        |       |
| Credit carryovers                     | ** ** | **64**     |       | 62       |       | 63         |       |
| Lease income                          | ** ** | **(654**   | **)**      | (277     | )          | **—** | ** ** |
| ***TOTAL  DEFERRED TAXES***           | ** ** | **$**      | **(1,921** | **)**    | $          | 33         |       | $        | (765       | ) |

 

77

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**10. Income Taxes (Continued)**

As of December 31,the deferred tax assets and liabilities are as follows:

| **(dollars in 000’s)**                                                        | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Assets:                                                                                      |       |       |       |     |       |     |       |
| Allowance for loan losses                                                                    | ** ** | **$**      | **5,761**  |     | $          | 5,624    |       | $        | 6,504      |   |
| Deferred compensation                                                                        | ** ** | **2,765**  |       | 2,379    |       | 2,314    |       |
| Stock Based Compensation                                                                     | ** ** | **253**    |       | —   |       | —   |       |
| State income taxes                                                                           | ** ** | **2,095**  |       | 1,719    |       | 1,613    |       |
| Lease rental                                                                                 | ** ** | **931**    |       | 277      |       | —   |       |
| Credit carryovers                                                                            | ** ** | **479**    |       | 543      |       | 605      |       |
| ***Total  Assets***                                                                          | ** ** | **12,284** |       | 10,542   |       | 11,036   |       |
| Liabilities:                                                                                 |       |       |       |     |       |     |       |
| Depreciation and amortization                                                                | ** ** | **(826**   | **)**      | (140     | )          | (766     | )          |
| Mark-to-market adjustment                                                                    | ** ** | **(268**   | **)**      | (882     | )          | (882     | )          |
| Accrued liabilities and other, net                                                           | ** ** | **(548**   | **)**      | (811     | )          | (647     | )          |
| ***Total  Liabilities***                                                                     | ** ** | **(1,642** | **)**      | (1,833   | )          | (2,295   | )          |
| Net deferred tax  asset before tax effect ofunrealized gain on securities available for sale | ** ** | **10,642** |       | 8,709    |       | 8,741    |       |
| Tax effect of unrealized gain on securities  available for sale                              | ** ** | **62**     |       | (264     | )          | (4,573   | )          |
| ***DEFERRED  TAX ASSET, NET***                                                               | ** ** | **$**      | **10,704** |     | $          | 8,445    |       | $        | 4,168      |   |

 

The net deferred tax assetabove is included in Other Assets on the Consolidated Statements of FinancialPosition. As of December 31, 2006, the Company has State tax creditcarryforwards of $738 thousand for financial reporting purposes. There are noalternative minimum tax credit carryforwards for tax purposes. As of December 31,2006, Management of the Company has determined that the net deferred tax assetmeets the realizability standards of SFAS No. 109 and as such, novaluation allowance is required as of that date.

**11. OtherBorrowings**

TheCompany had other borrowings under the Treasury Tax and Loan note account of$2.4 million and $3.9 million at December 31, 2006 and 2005, respectively.Federal Home Loan Bank borrowings were at $47 million and $22 million at December 31,2006 and 2005, 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 |   |   |
| Fixed Rate Credit  Advance |       |       | 01/24/06   |                |       | 4.75     | %          | 01/24/11     |       |                     | $          | 25,000,000 |   |   |
| Total                      |       |       |       |                |       |     |       |         |       |                     | $          | 47,000,000 |   |   |

 

The Company has unused commitments to borrow FederalFunds from certain correspondent banks and unused borrowing lines from theFederal Home Loan Bank. As of December 31, 2006 and 2005, these combinedunused lines amounted to $107.6 million and $109.7 million, respectively.

78

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**12. Commitments andContingencies**

At December 31, 2006 and 2005, the Company wascontingently liable for letter of credit accommodations made to its customerstotaling $39.8 million and $40.9 million, respectively. At December 31,2006 and 2005, the Company also had undisbursed loan commitments in the amountof $658.0 million and $657.7 million, respectively.

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

Many of the commitments are expected to expire withoutbeing drawn upon. Accordingly, the total outstanding commitment amount does notnecessarily represent future cash requirements. The Company does not anticipateany significant losses as a result of these transactions. Provision has beenmade for losses which may be sustained in the fulfillment of, or from an inabilityto fulfill, any commitments. This provision is included in the Allowance forLosses—Unfunded Commitments on the Consolidated Statements of FinancialPosition through a charge to other operating expenses on the ConsolidatedStatements of Income.

The Company is involved in litigation of a routinenature which is being handled and defended in the ordinary course of theCompany’s business. In the opinion of management, based in part on the adviceof legal counsel, the resolution of this litigation will not have a materialimpact on the Company’s financial condition or results of operations.

On November 15, 2006,David Fuerstenberg, a purported shareholder of Mid-State, filed a complaintseeking class action status in the Superior Court of the State of California,County of San Luis Obispo against Mid-State and each of its directors entitled *Fuerstenberg v Mid-State Bancshares et al* (Case No. CV060976).The complaint contains a single cause of action for breach of fiduciary dutyalleging that the Mid-State directors breached their fiduciary duties withregard to the proposed merger. The alleged breaches of fiduciary duty arenon-specific. Among other things, the complaint seeks class action status, acourt order enjoining Mid-State and its directors from proceeding with orconsummating the merger and the payment of attorneys’ and experts fees. TheCompany intends to defend this lawsuit vigorously.

79

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**13. Earnings PerShare**

The following is a reconciliation of the numeratorsand denominators used in the calculation of basic EPS and diluted EPS for theyears ended December 31.

| **in 000’s except per share data)**        | ** ** | ** ** | ** ** | **Earnings** | ** ** | **Weighted  Average Shares  Outstanding** | ** ** | **EPS**    | ** ** |
|--------------------------------------------------------------------------|------------|------------|------------|--------------|------------|------------------------------------------------|------------|------------|------------|
| **2006**                                                       |       |       |       |         |       |                                           |       |       |       |
| **Basic Earnings Per Share:**                                            | ** ** | ** ** | ** ** | ** **   | ** ** |                                           | ** ** | ** ** | ** ** |
| **Net Income available to Common Stockholders**                          | ** ** | **$**      | **35,279** | ** **   | ** ** | **22,211**                                     |       | ** ** | **$**      | **1.59** | ** ** |
| **Effect of Dilutive Securities:**                                       | ** ** | ** ** | ** ** | ** **   | ** ** |                                           | ** ** | ** ** | ** ** |
| **Stock Options**                                                        | ** ** | ** ** | ** ** | ** **   | **500**    |                                           | ** ** | ** ** | ** ** |
| **Diluted Earnings Per Share:**                                          | ** ** | ** ** | ** ** | ** **   | ** ** |                                           | ** ** | ** ** | ** ** |
| **Net Income available to Common Stockholders and assumed  conversions** | ** ** | **$**      | **35,279** | ** **   | ** ** | **22,711**                                     |       | ** ** | **$**      | **1.55** | ** ** |
| **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 |   |

 

**14. Capital Accounts**

The Company declared cashdividends during 2006 of $15,990,000. 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 Bankcould make additional cash dividends totaling $12,088,000 at December 31,2006 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 beyond that amount. The Bank and Company do not expectto make such application during 2007 given the Company’s pending merger, asdiscussed earlier.

80

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**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 reserved 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 replaced 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 in924,961 shares currently being available to be issued (4.17% of current andissued outstanding common stock) as of December 31, 2006. All Optionsunder both the 1996 and 2006 Plans have been granted at a price not less thanthe fair 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, 2006, 1,784,269shares are currently under option. The shares are exercisable at prices rangingfrom $9.183 to $30.61. There were 276,930 shares exercised in 2006 and 266,330and 190,548 exercised in 2005 and 2004, respectively.

Through December 31, 2005, the Company accountedfor its stock-based compensation in accordance with SFAS No. 123, “Accountingfor Stock Based Compensation.”  SFAS No. 123allowed stock options to be valued using the intrinsic value method inaccordance with APB No. 25, “Accounting for Stock Issued to Employees.”  Effective January 1, 2006, the Companyadopted SFAS 123(R), “Share Based Payment.” This standard requires that all share-based compensation awards bemeasured at fair value at the date of grant and expensed over their vesting orservice periods. The impact of adopting the new accounting treatment was toreduce income before tax and net income by approximately $512 and $429thousand, respectively, for the three months ended December 31, 2006. On aper share basis, this amounted to two cents per share on both a basic anddiluted basis. For the year ended December 31, 2006, the impact was toreduce income before tax and net income by approximately $1.9 million and $1.7million, respectively. This amounted to approximately seven cents per share onboth a basic and diluted basis.

Prior to 2006, theCompany accounted for stock options under the provisions of AccountingPrinciples Board (“APB”) Opinion No. 25 and provided proforma net incomeand proforma earnings per share disclosures for employee stock option grants asif the fair-value-based method, defined in SFAS 123(R) had been applied. Asummary of the proforma disclosure for the years ended 2005 and 2004 was asfollows:

| **(dollars in 000’s except per share data)**                                              | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Net income to common  shareholders:                                                                                          |       |       |       |     |       |
| As reported                                                                                                                  |       | $          | 37,492     |     | $          | 35,109   |       |
| Deduct: Total  stock-based compensation expense determined under the fair value method for  all awards, net of related taxes |       | ($2,406    | )          | ($2,099  | )          |
| Pro forma net  income                                                                                                        |       | $          | 35,086     |     | $          | 33,010   |       |
| Net income per common  and common share equivalent:                                                                          |       |       |       |     |       |
| Basic earnings  per share:                                                                                                   |       |       |       |     |       |
| As reported                                                                                                                  |       | $          | 1.65       |     | $          | 1.50     |       |
| Pro forma                                                                                                                    |       | $          | 1.54       |     | $          | 1.41     |       |
| Diluted earnings  per share:                                                                                                 |       |       |       |     |       |
| As reported                                                                                                                  |       | $          | 1.61       |     | $          | 1.47     |       |
| Pro forma                                                                                                                    |       | $          | 1.51       |     | $          | 1.38     |       |

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**15. StockOptions (Continued)**

In determining the pro forma disclosures in theprevious table, the fair value of options granted was estimated on the date ofgrant using the Black-Scholes option pricing model and appropriate assumptions.For options granted during 2006, the weighted average grant date fair valueswere based on the following assumptions:

·       RiskFree Interest Rate = 4.6%

·       DividendYield = 2.5%

·       StockPrice Volatility = 34.9%

·       WeightedAvg. Expected Lives of Option Grants = 8.5 years

Option awards are granted with an exercise price equalto the market price of the Company’s common stock on the date of grant. Whileoptions are exercisable and expire as determined by the Board of Directors,they generally become exercisable over a five year period vesting 20% eachyear, and have a term of ten years. For purposes of determining the fair valueof stock option awards, the Company uses the Black-Scholes option pricing modelapplied on a grant by grant basis. Risk free rates of interest were applied inthe model as of the grant date based on data provided by the Federal ReserveBank on its H.15 release. The dividend yield applied in the model was thedividend yield of the Company at time of grant. The expected volatility of theCompany’s stock price applied in the model was based on historical informationfrom 1998 (when the Company was first listed on NASDAQ) through March 31,2006. The expected average life applied in the model was estimated fromhistorical information from 1998 through March 31, 2006 and was calculatedby major employee groups. Compensation cost is recognized using a straight-linemethod over the vesting or service period and is net of estimated forfeitures.

Asummary of the Company’s stock options as of December 31, 2006, 2005 and2004, and changes during the periods then ended, is presented below:

| ** **                             | ** ** | ** **                  | ** ** | **Weighted** | ** ** | ** **                                | ** ** |
|----------------------------------------|------------|-----------------------------|------------|--------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | ** **                  | ** ** | **Average**  | ** ** | ** **                                | ** ** |
| ** **                             | ** ** | ** **                  | ** ** | **Exercise** | ** ** | ** **                                | ** ** |
| ** **                             | ** ** | **Options**                 | ** ** | **Price**    | ** ** | **Per Share Price Ranges** | ** ** |
| **2006**                               | ** ** | ** **                  | ** ** |         | ** ** | ** **                                |       |   | ** ** | ** ** |   |
| **Outstanding  at Beginning of Year**  | ** ** | **2,000,958**               | ** ** |         | **$**      | **19.20**                                 | ** ** |   |   | **$** | **5.375—$30.61** | ** ** |   |
| **Granted  during Year**               | ** ** | **77,503**                  | ** ** |         | **$**      | **29.00**                                 | ** ** |   |   | **$** | **29.00—$29.00** | ** ** |   |
| **Exercised  during Year**             | ** ** | **(276,930**                | **)**      |         | **$**      | **15.94**                                 | ** ** |   |   | **$** | **5.375—$29.44** | ** ** |   |
| **Forfeited  during Year**             | ** ** | **(17,262**                 | **)**      |         | **$**      | **20.93**                                 | ** ** |   |   | **$** | **15.50—$25.71** | ** ** |   |
| **Outstanding  at End of Year**        | ** ** | **1,784,269**               | ** ** |         | **$**      | **20.11**                                 | ** ** |   |   | **$** | **9.183—$30.61** | ** ** |   |
| **Exercisable  at End of Year**        | ** ** | **1,180,326**               | ** ** |         | **$**      | **17.52**                                 | ** ** |   |   | **$** | **12.125—$30.61** | ** ** |   |
| **Range  of Expiration Dates**         | ** ** | **8/12/2008 to 02/15/2016** |       |         | ** ** | ** **                                |       |
| **Shares  Available for Future Grant** | ** ** | **924,961**                 | ** ** |         | ** ** | ** **                                |       |   | ** ** | ** ** |   |

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**15. StockOptions (Continued)**

| ** **                        | ** ** | ** **  | ** ** | **Weighted** | ** ** | ** **                                | ** ** |
|-----------------------------------|------------|-------------|------------|--------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | ** **  | ** ** | **Average**  | ** ** | ** **                                | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **Exercise** | ** ** | ** **                                | ** ** |
| ** **                        | ** ** | **Options** | ** ** | **Price**    | ** ** | **Per Share Price 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 |   |   |
| 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 |   |   |

 

Asummary of the Company’s stock options outstanding and exercisable as of December 31,2006 by price range is presented below:

| ** **                            | ** ** | **Total**  | ** ** | **Weighted Average** | ** ** | **Weighted Average**  | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
|---------------------------------------|------------|------------|------------|---------------------------|------------|----------------------------|------------|------------|------------|---------------------------|------------|
| ** **                            | ** ** | **Amount** | ** ** | **Remaining**             | ** ** | **Exercise**               | ** ** | **Amount** | ** ** | **Exercise**              | ** ** |
| **Range of ExercisePrices** | ** ** | ** ** | ** ** | **Outstanding**           | ** ** | **Contractual Years** | ** ** | **Price**  | ** ** | **Exercisable**           | ** ** | **Price** | ** ** |
| $  9.183 - $12.244          |       |       | 12,000     |                      |       |                       | 3.3        |       |       |                      | $          | 12.125 |   |   | 12,000 |   |   | $ | 12.125 |   |   |
| $12.245 - $15.305                     |       |       | 386,188    |                      |       |                       | 2.8        |       |       |                      | $          | 14.515 |   |   | 386,188 |   |   | $ | 14.515 |   |   |
| $15.306 - $18.366                     |       |       | 697,999    |                      |       |                       | 3.9        |       |       |                      | $          | 16.840 |   |   | 588,826 |   |   | $ | 16.800 |   |   |
| $18.367 - $21.427                     |       |       | 8,800      |                      |       |                       | 5.6        |       |       |                      | $          | 19.534 |   |   | 6,400 |   |   | $ | 19.488 |   |   |
| $21.428 - $24.488                     |       |       | 61,200     |                      |       |                       | 7.2        |       |       |                      | $          | 22.645 |   |   | 24,600 |   |   | $ | 22.638 |   |   |
| $24.489 - $27.549                     |       |       | 304,981    |                      |       |                       | 7.5        |       |       |                      | $          | 25.911 |   |   | 107,417 |   |   | $ | 25.946 |   |   |
| $27.550 - $30.610                     |       |       | 313,101    |                      |       |                       | 8.4        |       |       |                      | $          | 28.492 |   |   | 54,895 |   |   | $ | 28.649 |   |   |
| Total                                 |       |       | 1,784,269  |                      |       |                       | 5.2        |       |       |                      | $          | 20.113 |   |   | 1,180,326 |   |   | $ | 17.524 |   |   |
|                                       |            |            |            |                           |            |                            |            |            |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The weighted average fair value of grants issued in2006 was $10.45 per option share. The weighted average fair value of all grantsoutstanding as of December 31, 2006 was $7.04 per option share. Theaggregate intrinsic value for vested options exercisable at December 31,2006 was $22.3 million and the aggregate intrinsic value of unvested optionsnot yet exercisable at December 31, 2006 was $6.8 million.

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**15. Stock Options(Continued)**

TheCompany issued 42,729 restricted stock shares during 2006. These restrictedshares will vest three years from the date of grant and vesting is subject tocontinued employment at the Company through the vesting date. Holders ofrestricted shares will have the right to receive dividends and vote the shares,but may not sell, assign, transfer, pledge or otherwise encumber the stockuntil after the shares are fully vested. The aggregate intrinsic value of theseawards was $1.5 million as of December 31, 2006. A summary of restrictedshares outstanding is as follows:

| ** **                                        | ** ** | **Number of** | ** ** | **Weighted  Average**         | ** ** |
|---------------------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| ** **                                        | ** ** | **Restricted**     | ** ** | **Fair**                      | ** ** |
| ** **                                        | ** ** | **Shares**         | ** ** | **Value Per Share** | ** ** |
| Outstanding at  December 31, 2005            |       |               | 0          |                          |       |   | — |   |   |
| Granted from  Jan. 1 to Dec. 31, 2006   |       |               | 42,729     |                          |       |   | $ | 28.41 |   |   |
| Vested from  Jan. 1 to Dec. 31, 2006    |       |               | 0          |                          |       |   | — |   |   |
| Forfeited from  Jan. 1 to Dec. 31, 2006 |       |               | (559       | )                             |       |   | $ | 28.53 |   |   |
| Outstanding at  December 31, 2006            |       |               | 42,170     |                          |       |   | $ | 28.41 |   |   |

 

Compensation expense on restricted stock shares isaccounted for using the straight-line method over the vesting or service periodand is net of estimated forfeitures. The amount recognized was $98 thousand and$220 thousand, pre-tax, for the three months and year ended December 31,2006, respectively.

Unamortized compensationexpense at December 31, 2006 amounted to approximately $3.6 millionrelated to stock options outstanding and $0.9 million on restricted stockawards. The expense associated with stock options is expected to be recognizedover a weighted average life of 1.42 years, assuming an estimated 5% forfeiturerate. The expense associated with restricted stock awards is expected to berecognized over a weighted average life of 1.23 years, assuming an estimated 2%forfeiture rate.

**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 31,2006, 2005, and 2004 were $2.9 million, $3.0 million, and $2.8 million,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 2006 was a charge of $2.6 million which was paidout prior to year end. In 2005 and 2004 the charge was $4.1 million, and $2.4million, respectively, which was accrued during those years and paid in thefollowing year under the Incentive Reward System. Employees receiving bonusesunder this program in 2006 ranged from 0.2% of their salary to as much as 70.8%of their salary.

The Company haspostretirement obligations to certain of the former employees of acquiredinstitutions. The liability for these obligations is included within OtherLiabilities on the Consolidated Statement of Financial Position and amounted to$1.5 million and $1.5 million at December 31, 2006 and 2005, respectively.The amount of employee benefit expense accrued under these obligations amountedto $138 thousand, $145 thousand and $145 thousand in 2006, 2005, and 2004,respectively. Generally, these 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**16.Employee Benefits (Continued)**

obligationsamount to a fixed payment to these individuals for 10 to 15 years upon reachingtheir 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,Mid-State Bank & Trust (“the Bank”) must meet specific capitalguidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance sheet items as calculated under regulatoryaccounting practices. The Bank’s and the Company’s capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**17.Regulatory Matters (Continued)**

As of December 31,2006, the latest regulatory examinations indicated that Mid-State Bank &Trust was categorized as well capitalized under the regulatory framework forprompt corrective action. Mid-State Bancshares was also considered wellcapitalized. To be categorized as well capitalized, Mid-State Bancshares andMid-State Bank & Trust must maintain minimum total risk-based, TierOne risk-based and Tier One Leverage ratios as set forth in the following table.There are no conditions or events that Management believes have changed Mid-StateBancshares’ and Mid-State Bank & Trust’s category. The actual capitalamounts and ratios as of December 31, 2006 and 2005 are also presented inthe following table:

| ** **                                       | ** ** | ** ** | ** **  | **To be Considered** | ** ** | ** **                     | ** ** |
|--------------------------------------------------|------------|------------|-------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | ** ** | ** **  | **Adequately**                 | ** ** | **To be Considered** | ** ** |
| ** **                                       | ** ** | ** ** | ** **  | **Capitalized**                | ** ** | **Well Capitalized**      | ** ** |
| ** **                                       | ** ** | ** ** | ** **  | **For Capital**           | ** ** | **For Capital**           | ** ** |
| ** **                                       | ** ** | **Actual** | ** **  | **Adequacy Purposes**     | ** ** | **Adequacy Purposes**     | ** ** |
| **(dollars in 000’s)**            | ** ** | ** ** | ** **  | **Amount**                     | ** ** | **Ratio**                      | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ***Mid-State  Bancshares—Consolidated:***   |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As of December 31, 2006:                    |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Capital                                    |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Risk Weighted  Assets)                       | ** ** | **$**      | **242,535** | ** **                     | ** ** | **12.8**                       | **%**      | ** ** | **$** | **151,720** | ** ** | ** ** | **8.0** | **%** | ** ** | **$** | **189,649** | ** ** | ** ** | **10.0** | **%** | ** ** |
| Tier One Capital                                 |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Risk Weighted  Assets)                       | ** ** | **$**      | **228,835** | ** **                     | ** ** | **12.1**                       | **%**      | ** ** | **$** | **75,860** | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **113,790** | ** ** | ** ** | **6.0** | **%** | ** ** |
| Tier One Capital                                 |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Average  Assets)                             | ** ** | **$**      | **228,835** | ** **                     | ** ** | **9.9**                        | **%**      | ** ** | **$** | **92,450** | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **115,563** | ** ** | ** ** | **5.0** | **%** | ** ** |
| 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 | % |   |
| ***Mid-State Bank & Trust—Only:*** |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As of December 31, 2006:                    |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Capital                                    |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Risk Weighted  Assets)                       | ** ** | **$**      | **231,583** | ** **                     | ** ** | **12.2**                       | **%**      | ** ** | **$** | **151,399** | ** ** | ** ** | **8.0** | **%** | ** ** | **$** | **189,249** | ** ** | ** ** | **10.0** | **%** | ** ** |
| Tier One Capital                                 |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Risk Weighted  Assets)                       | ** ** | **$**      | **217,883** | ** **                     | ** ** | **11.5**                       | **%**      | ** ** | **$** | **75,700** | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **113,550** | ** ** | ** ** | **6.0** | **%** | ** ** |
| Tier One Capital                                 |       |       |        |                           |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| (to Average  Assets)                             | ** ** | **$**      | **217,883** | ** **                     | ** ** | **9.4**                        | **%**      | ** ** | **$** | **92,432** | ** ** | ** ** | **4.0** | **%** | ** ** | **$** | **115,541** | ** ** | ** ** | **5.0** | **%** | ** ** |
| 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 | % |   |
|                                                  |            |            |             |                                |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

86

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**18. ReportableBusiness Segments**

Reportable businesssegments are determined using the “management approach” and are intended topresent reportable segments consistent with how the chief operating decisionmaker organizes segments within the company for making operating decisions andassessing performance. Presently, the Company is segregated into threereportable business segments, Community Banking, Mid-Coast Land Company andTrust Services.

The Community Bankingbusiness segment consists of commercial and retail banking. This segment ismanaged as a single strategic unit that derives its revenues from a wide rangeof banking services, including lending and investing activities, acceptance ofdemand, savings, and time deposits, and mortgage servicing. As previouslynoted, Mid-Coast Land Company engages in real estate investment activities. TrustServices provides custody services, investment management and trust-relatedservices such as trustee for trust 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, 2006. The accounting policies usedin the disclosure of business segments are the same as those described in thesummary of significant accounting policies. Certain assumptions are madeconcerning the allocations of costs between segments which may influencerelative results, most notably, allocations of various types of overhead andadministrative costs. Management believes that the allocations utilized beloware reasonable and consistent with the way it manages the business.

| ** **                            | ** ** | **Community Banking** | ** ** | **Mid-Coast  Land Company** | ** ** | **Trust Services** | ** ** |
|---------------------------------------|------------|----------------------------|------------|----------------------------------|------------|-------------------------|------------|
| **(dollars in 000’s)** | ** ** | ** **                 | ** ** | **2006**                         | ** ** | **2005**                | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest Income                       |       | $                          | 145,796    |                             | $          | 128,326                 |       | $ | 109,936 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Interest Expense                      |       | 27,405                     |       | 15,503                           |       | 8,450                   |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Net Interest Income                   |       | 118,391                    |       | 112,823                          |       | 101,486                 |       | — |   | — |   | — |   | — |   | — |   | — |   |
| (Benefit) Provision                   |       | —                     |       | —                           |       | (2,700                  | )          | — |   | — |   | — |   | — |   | — |   | — |   |
| Non-interest Income                   |       | 20,024                     |       | 19,512                           |       | 26,153                  |       | 357 |   | 717 |   | 682 |   | 1,484 |   | 1,212 |   | 929 |   |
| Non-interest Expense                  |       | 84,410                     |       | 76,692                           |       | 78,391                  |       | 19 |   | 12 |   | 27 |   | 1,302 |   | 970 |   | 876 |   |
| Pre-Tax Income                        |       | $                          | 54,005     |                             | $          | 55,643                  |       | $ | 51,948 |   | $ | 338 |   | $ | 705 |   | $ | 655 |   | $ | 182 |   | $ | 242 |   | $ | 53 |   |
| Ending Total Assets  (in millions)    |       | $                          | 2,343      |                             | $          | 2,380                   |       | $ | 2,285 |   | $ | 12 |   | $ | 11 |   | $ | 11 |   | $ | — |   | $ | — |   | $ | — |   |
|                                       |            |                            |            |                                  |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                   | ** ** | **Mid-State Bancshares** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|--------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **(dollars in 000’s)**  | ** ** | ** **               | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest Income              |       | $                        | 145,796    |       | $          | 128,326    |       | $          | 109,936    |       |       |       |       |       |       |   |   |   |   |   |   |   |
| Interest Expense             |       | 27,405                   |       | 15,503     |       | 8,450      |       |       |       |       |       |       |       |       |       |   |   |   |   |
| Net Interest Income          |       | 118,391                  |       | 112,823    |       | 101,486    |       |       |       |       |       |       |       |       |       |   |   |   |   |
| (Benefit) Provision          |       | —                   |       | —     |       | (2,700     | )          |       |       |       |       |       |       |       |       |   |   |   |   |
| Non-interest Income          |       | 21,865                   |       | 21,441     |       | 27,764     |       |       |       |       |       |       |       |       |       |   |   |   |   |
| Non-interest Expense         |       | 85,731                   |       | 77,674     |       | 79,294     |       |       |       |       |       |       |       |       |       |   |   |   |   |
| Pre-Tax Income               |       | $                        | 54,525     |       | $          | 56,590     |       | $          | 52,656     |       |       |       |       |       |       |   |   |   |   |   |   |   |
| Ending Assets  (in millions) |       | $                        | 2,355      |       | $          | 2,391      |       | $          | 2,296      |       |       |       |       |       |       |   |   |   |   |   |   |   |
|                              |            |                          |            |            |            |            |            |            |            |            |            |            |            |            |            |  |  |  |  |  |  |  |  |  |

 

There were no significant capital expenditures made in2006 in any of the above business segments.

87

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

**19. Quarterly FinancialData**

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

| ** **                 | ** ** | **2006**             | ** ** |
|----------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **1**st Quarter | ** ** | **2**nd Quarter | ** ** | **3**rd Quarter | ** ** | **4**th Quarter | ** ** | **Full Year** | ** ** |
| Interest Income            | ** ** |                 | **$**      | **34,735** | ** ** |   |   | **$** | **36,030** | ** ** |   |   | **$** | **37,223** | ** ** |   |   | **$** | **37,808** | ** ** |   | **$** | **145,796** | ** ** |
| Interest Expense           | ** ** |                 | **5,266**  | ** ** |   |   | **6,578** | ** ** |   |   | **7,472** | ** ** |   |   | **8,089** | ** ** |   | **27,405** | ** ** |
| Net Interest  Income       | ** ** |                 | **29,469** | ** ** |   |   | **29,452** | ** ** |   |   | **29,751** | ** ** |   |   | **29,719** | ** ** |   | **118,391** | ** ** |
| Provision for  loan losses | ** ** |                 | **—** | ** ** |   |   | **—** | ** ** |   |   | **—** | ** ** |   |   | **—** | ** ** |   | **—** | ** ** |
| Non-interest  income       | ** ** |                 | **4,980**  | ** ** |   |   | **5,959** | ** ** |   |   | **5,467** | ** ** |   |   | **5,459** | ** ** |   | **21,865** | ** ** |
| Non-interest  expense      | ** ** |                 | **20,962** | ** ** |   |   | **21,589** | ** ** |   |   | **21,276** | ** ** |   |   | **21,904** | ** ** |   | **85,731** | ** ** |
| Income before  taxes       | ** ** |                 | **13,487** | ** ** |   |   | **13,822** | ** ** |   |   | **13,942** | ** ** |   |   | **13,274** | ** ** |   | **54,525** | ** ** |
| **Taxes**                  | ** ** |                 | **4,713**  | ** ** |   |   | **4,899** | ** ** |   |   | **5,085** | ** ** |   |   | **4,549** | ** ** |   | **19,246** | ** ** |
| Net Income                 | ** ** |                 | **$**      | **8,774** | ** ** |   |   | **$** | **8,923** | ** ** |   |   | **$** | **8,857** | ** ** |   |   | **$** | **8,725** | ** ** |   | **$** | **35,279** | ** ** |
| Earnings Per Share:        |       |                 | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   |   |
| —Basic                | ** ** |                 | **$**      | **0.39** | ** ** |   |   | **$** | **0.40** | ** ** |   |   | **$** | **0.40** | ** ** |   |   | **$** | **0.39** | ** ** |   | **$** | **1.59** | ** ** |
| —Diluted              | ** ** |                 | **$**      | **0.38** | ** ** |   |   | **$** | **0.39** | ** ** |   |   | **$** | **0.39** | ** ** |   |   | **$** | **0.38** | ** ** |   | **$** | **1.55** | ** ** |

 

| ** **                 | ** ** | **2005**             | ** ** |
|----------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **1**st Quarter | ** ** | **2**nd Quarter | ** ** | **3**rd Quarter | ** ** | **4**th 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 |   |

 

**20. Parent CompanyFinancial Information**

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

88

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

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

***Condensed BalanceSheets***

| ** **                                       | ** ** | **December 31,** | ** **  |
|--------------------------------------------------|------------|-----------------------|-------------|
| **(dollars in 000’s)**            | ** ** | **2006**              | ** **  | **2005** | ** ** |
| ASSETS                                           |       |                  |        |   |   |
| Cash                                             | ** ** | **$**                 | **6,151**   |   | $ | 4,946 |   |
| Investment in  Mid-State Bank & Trust   | ** ** | **271,485**           |        | 269,811 |   |
| Other Assets                                     | ** ** | **4,001**             |        | 1 |   |
| Total Assets                                     | ** ** | **$**                 | **281,637** |   | $ | 274,758 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |       |                  |        |   |   |
| Dividend Payable                                 | ** ** | **$**                 | **4,001**   |   | $ | 4,054 |   |
| Accrued  Liabilities                             | ** ** | **(4,801**            | **)**       | (1,858 | ) |
| Total Liabilities                                |       | **(800**              | **)**       | 2,196 |   |
| Stockholders’  Equity                       | ** ** | **282,437**           |        | 272,562 |   |
| Total Liabilities  and Stockholders’ Equity | ** ** | **$**                 | **281,637** |   | $ | 274,758 |   |

 

***Condensed IncomeStatements***

| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Equity in earnings of  subsidiaries: |       |                  |       |   |   |   |   |
| Undistributed                        | ** ** | **$**                 | **2,162**  |   | $ | (418 | ) | $ | 10,345 |   |
| Dividends                            | ** ** | **35,044**            |       | 38,637 |   | 25,222 |   |
| Operating  Expenses                  | ** ** | **(3,204**            | **)**      | (1,254 | ) | (789 | ) |
| Income Tax  Benefit                  | ** ** | **1,277**             |       | 526 |   | 331 |   |
| Net Income                           | ** ** | **$**                 | **35,279** |   | $ | 37,491 |   | $ | 35,109 |   |

 

89

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2006**

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

***CondensedStatements of Cash Flows***

| ** **                                                        | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                        | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from  operation activities:                            |       |                  |       |   |   |   |   |
| Net Income                                                        | ** ** | **$**                 | **35,279** |   | $ | 37,491 |   | $ | 35,109 |   |
| Adjustments to reconcile  net income to net cash                  |       |                  |       |   |   |   |   |
| provided by operating  activities:                                |       |                  |       |   |   |   |   |
| Net undistributed earnings of Bank                                | ** ** | **(2,162**            | **)**      | 418 |   | (10,345 | ) |
| Net change in accrued liabilities                                 | ** ** | **(2,996**            | **)**      | (1,527 | ) | 201 |   |
| Net change in other assets                                        | ** ** | **(4,000**            | **)**      | 4 |   | (5 | ) |
| Net cash provided by operating activities                         | ** ** | **26,121**            |       | 36,386 |   | 24,960 |   |
| Net Cash Flow  from Investing Activities                          | ** ** | **—**            |       | — |   | — |   |
| Net Cash Flows from  Financing Activities:                        |       |                  |       |   |   |   |   |
| Proceeds from stock options                                       | ** ** | **4,414**             |       | 3,969 |   | 2,579 |   |
| Payment to purchase common stock                                  | ** ** | **(16,921**           | **)**      | (23,065 | ) | (16,646 | ) |
| Dividends paid by parent                                          | ** ** | **(15,990**           | **)**      | (14,636 | ) | (12,918 | ) |
| Other—non cash item related to tax benefit on stock  options | ** ** | **3,581**             |       | 1,000 |   | — |   |
| Net cash used in financing activities                             | ** ** | **(24,916**           | **)**      | (32,732 | ) | (26,985 | ) |
| Net Increase  (Decrease) in Cash                                  | ** ** | **1,205**             |       | 3,654 |   | (2,025 | ) |
| Cash, beginning  of year                                          | ** ** | **4,946**             |       | 1,292 |   | 3,317 |   |
| Cash, at end of year                                              | ** ** | **$**                 | **6,151**  |   | $ | 4,946 |   | $ | 1,292 |   |

 

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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, 2006, 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, 2006, 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, 2006 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, 2006. 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 AND CORPORATE GOVERNANCE

**CorporateGovernance Guidelines**

We have formalized ourcorporate governance practices into a set of Corporate Governance Guidelines,which include guidelines for determining director independence and reportingconcerns to non-employee directors. All of our corporate governance materials,including the Corporate Governance Guidelines and committee charters, arepublished on the Investor Information section of our website atwww.midstatebank.com. The Board regularly reviews corporate governancedevelopments and modifies these Guidelines and charters as warranted. Anymodifications are reflected on our website.

**Board of Directors**

Mid-State is governed by aBoard of Directors (the “Board”) and various committees of the Board that meetthroughout the year. Directors discharge their responsibilities throughout theyear at Board and committee meetings and also through telephone contact andother communications with the Chairman, the Chief Executive Officer and otherofficers regarding matters of concern and interest to Mid-State as well as byreviewing materials provided to them. During 2006, there were fifteen (15)meetings of the Board.

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**The table below lists biographical information on allcurrent Directors and Executive Officers.**

| Name, Address(1) and                                                                                                       | ** ** | ** **                                                                                                                                                                                         | ** ** | ** **                                                        | ** ** | ** ** | ** ** | **Common Stock Beneficially  Owned on December 31, 2006** | ** **      |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------|-----------------|
| **Relationship with the  Company of Beneficial  Owner**                                                          | ** ** | ** **                                                                                                                                                                                         | ** ** | **Principal Occupation for  Past Five Years** | ** ** | **Age**    | ** ** | **Year First(2) Elected or  Appointed Director  Bancshares/Bank**   | ** **      | **Number of  Shares(4)** | ** ** | **Percentage of  Shares  Outstanding(5)** | ** ** |
| George H. Andrews                                                                                                                    |       | Certified Public                                                                                                                                                                                   |       |                                                              | 60         |       |       |                                                                                    | 2004/Bancshares |   |   |   | 71,566 | (6) |   |   | .32 | % |   |
| Director                                                                                                                             |       | Accountant, Andrews  Galloway and Associates,  Certified Public  Accountants                                                                                                                       |       |                                                              |       |       |       |                                                                                    | 2004/Bank       |   |   |   |   |   |   |   |   |   |   |
| Trudi G. Carey                                                                                                                       |       | Architect, Contractor,                                                                                                                                                                             |       |                                                              | 50         |       |       |                                                                                    | 2000/Bancshares |   |   |   | 33,140 | (7) |   |   | .15 | % |   |
| Director                                                                                                                             |       | Real Estate Broker, The  Carey Group, Inc.                                                                                                                                                    |       |                                                              |       |       |       |                                                                                    | 2000/Bank       |   |   |   |   |   |   |   |   |   |   |
| Daryl L. Flood                                                                                                                       |       | Retired                                                                                                                                                                                            |       |                                                              | 73         |       |       |                                                                                    | 1998/Bancshares |   |   |   | 182,939 | (8) |   |   | .82 | % |   |
| Director                                                                                                                             |       |                                                                                                                                                                                               |       |                                                              |       |       |       |                                                                                    | 1978/Bank       |   |   |   |   |   |   |   |   |   |   |
| H. Edward Heron                                                                                                                      |       | Vice President,                                                                                                                                                                                    |       |                                                              | 66         |       |       |                                                                                    | 1999/Bancshares |   |   |   | 55,609 | (9) |   |   | .25 | % |   |
| Director                                                                                                                             |       | Coldwell Banker                                                                                                                                                                                    |       |                                                              |       |       |       |                                                                                    | 1996/Bank       |   |   |   |   |   |   |   |   |   |   |
| James W. Lokey                                                                                                                       |       | President/CEO, Mid-State                                                                                                                                                                           |       |                                                              | 59         |       |       |                                                                                    | 2000/Bancshares |   |   |   | 271,064 | (10) |   |   | 1.22 | % |   |
| President/Chief Executive  Officer, Mid-State Bancshares and Mid-State Bank & Trust                                         |       | Bank & Trust 3/1/00 to  present and Mid-State  Bancshares 6/1/01 to  present; President,  Downey Savings in 1997  and 1998                                                                |       |                                                              |       |       |       |                                                                                    | 2000/Bank       |   |   |   |   |   |   |   |   |   |   |
| Stephen P. Maguire                                                                                                                   |       | President, Maguire                                                                                                                                                                                 |       |                                                              | 56         |       |       |                                                                                    | 1999/Bancshares |   |   |   | 335,243 | (11) |   |   | 1.51 | % |   |
| Director                                                                                                                             |       | Investments, Inc.  (Investment Firm)                                                                                                                                                          |       |                                                              |       |       |       |                                                                                    | 1999/Bank       |   |   |   |   |   |   |   |   |   |   |
| Michael Miner                                                                                                                        |       | Chief Executive Officer,                                                                                                                                                                           |       |                                                              | 54         |       |       |                                                                                    | 2004/Bancshares |   |   |   | 10,528 | (12) |   |   | .05 | % |   |
| Director                                                                                                                             |       | Miner’s Ace Hardware                                                                                                                                                                          |       |                                                              |       |       |       |                                                                                    | 2004/Bank       |   |   |   |   |   |   |   |   |   |   |
| Gregory R. Morris                                                                                                                    |       | President, Morris &                                                                                                                                                                       |       |                                                              | 66         |       |       |                                                                                    | 1998/Bancshares |   |   |   | 116,758 | (13) |   |   | .53 | % |   |
| Director                                                                                                                             |       | Garritano Insurance  Agency                                                                                                                                                                        |       |                                                              |       |       |       |                                                                                    | 1987/Bank       |   |   |   |   |   |   |   |   |   |   |
| Carrol R. Pruett                                                                                                                     |       | Chairman of the Board,                                                                                                                                                                             |       |                                                              | 69         |       |       |                                                                                    | 1998/Bancshares |   |   |   | 410,016 | (14) |   |   | 1.84 | % |   |
| Chairman of the Board                                                                                                                |       | Mid-State Bancshares and  Mid-State Bank & Trust,  President/Chief Executive  Officer of Mid-State  Bancshares Retired in  2001) and, Mid-State  Bank & Trust (Retired in  2000) |       |                                                              |       |       |       |                                                                                    | 1967/Bank       |   |   |   |   |   |   |   |   |   |   |
| Alan Rains                                                                                                                           |       | Chairman of the Board,                                                                                                                                                                             |       |                                                              | 76         |       |       |                                                                                    | 2003/Bancshares |   |   |   | 92,577 | (15) |   |   | .42 | % |   |
| Director                                                                                                                             |       | A. Rains Inc., dba Rains  Department Store                                                                                                                                                         |       |                                                              |       |       |       |                                                                                    | 2003/Bank       |   |   |   |   |   |   |   |   |   |   |
| Harry H. Sackrider                                                                                                                   |       | Chief Credit Officer, Mid-                                                                                                                                                                         |       |                                                              | 62         |       |       |                                                                                    | —          |   |   |   | 72,470 | (16) |   |   | .33 | % |   |
| Executive Vice President,  Mid-State Bancshares and Executive Vice President/ Chief Credit Officer,  Mid-State Bank & Trust |       | State Bank & Trust 2002  to present and prior to that  was a lender with the  Bank                                                                                                        |       |                                                              |       |       |       |                                                                                    |            |   |   |   |   |   |   |   |   |   |   |
| James G. Stathos                                                                                                                     |       | Chief Financial Officer,                                                                                                                                                                           |       |                                                              | 61         |       |       |                                                                                    | —          |   |   |   | 154,136 | (17) |   |   | .69 | % |   |
| Executive Vice President/ Chief  Financial Officer, Mid-State Bancshares and Mid-State Bank & Trust                         |       | Mid-State Bank & Trust  and Mid-State Bancshares  1998 to present.  Appointed Executive Vice  President/Chief Financial  Officer of the Bank in  April of 1991                       |       |                                                              |       |       |       |                                                                                    |            |   |   |   |   |   |   |   |   |   |   |
| Directors and Executive                                                                                                              |       |                                                                                                                                                                                               |       |                                                              |       |       |       |                                                                                    |            |   |   |   | 1,806,046 | (18) |   |   | 8.12 | % |   |
| Officers as a group  (12 persons)                                                                                               |       |                                                                                                                                                                                               |       |                                                              |       |       |       |                                                                                    |            |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                      |            |                                                                                                                                                                                                    |            |                                                                   |            |            |            |                                                                                         |                 |  |  |  |  |  |  |  |  |  |  |  |  |

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          (1) The address for all persons listed is c/oMid-State Bancshares, 1026 East Grand Avenue, Arroyo Grande, California 93420.

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          (2) Servicewith Mid-State Bancshares, Mid-State Bank & Trust, or a bank which wasacquired by merger by Mid-State Bank & Trust.

          (3) NotUsed.

          (4) Exceptas otherwise noted, includes shares held by each person’s spouse (except wherelegally separated) and minor children; shares held by any other relative ofsuch person who has the same home; shares held by a family trust as to whichsuch person is a trustee with sole voting and investment power (or shares powerwith a spouse); or shares held in an Individual Retirement Account as to whichsuch person has pass-through voting rights and investment power.

          (5) Includesshares of common stock subject to stock option exercisable within 60 days.

          (6) Includes8,000 shares of common stock subject to stock option exercisable within 60days.

          (7) Includes24,000 shares of common stock subject to stock option exercisable within 60days.

          (8) Includes18,000 shares of common stock subject to stock option exercisable within 60days.

          (9) Includes28,000 shares of common stock subject to stock option exercisable within 60days.

    (10) Includes237,620 shares of common stock subject to stock option exercisable within 60days.

    (11) Includes28,000 shares of common stock subject to stock option exercisable within 60days.

    (12) Includes8,000 shares of common stock subject to stock option exercisable within 60days.

    (13) Includes68,508 shares held by Mr. Morris as Trustee for Morris &Garritano Profit Sharing Trust, as to which Mr. Morris has sole voting andinvestment power; and 28,000 shares of common stock subject to stock optionexercisable within 60 days.

    (14) Includes228,000 shares of common stock subject to stock option exercisable within 60days.

    (15) Includes4,000 shares of common stock subject to stock option exercisable within 60days.

    (16) Includes16,001 shares of common stock subject to stock option exercisable within 60days.

    (17) Includes88,400 shares of common stock subject to stock option exercisable within 60days.

    (18) Includes226,606 shares of common stock owned by the executive officers and sharessubject to stock options exercisable within 60 days.

**DirectorIndependence**

It is the Board’s objective that at least the majorityof the Board consists of independent directors. For a director to be consideredindependent, the Board must determine that the director does not have anymaterial relationship with the Company and is otherwise an “independentdirector” within the meaning of the Nasdaq rules. The Board has determined thatthe following eight (8) directors (constituting 80% of the entire Board)satisfy Nasdaq’s independence requirements: Andrews, Carey, Flood, Heron,Maguire, Miner, Morris, and Rains.

Subject to limitedexceptions in the case of the Nominating and Corporate Governance Committee andthe Compensation Committee, the Nasdaq rules require all members of theAudit, the Compensation, and the Nominating and Corporate Governance Committeesto be independent directors. Members of the Audit Committee must also satisfyan additional SEC requirement, which provides that they may not accept directlyor indirectly, any consulting, advisory, or other compensatory fee from us orany of our subsidiaries other than their director’s compensation. The Board hasdetermined that all members of the Nominating and Corporate GovernanceCommittee, Audit, and Compensation Committees satisfy the relevant independencerequirements.

**Communication withthe Board of Directors**

The ability ofshareholders to communicate directly with the Board is an important feature ofcorporate governance and assists in the transparency of the Board’s operations.In furtherance of this interest, the Board has included in the CorporateGovernance Guidelines a process by which a shareholder may communicate directlyin writing to the Board. Please refer to *“ShareholderCommunications with the Board of Directors”* of the Guidelines forfurther information. Because communications to the Board can be junk mail orspam, or relate to products and services, be solicitations, advertisements orjob inquiries or otherwise relate to improper or irrelevant topics, a processhas been approved by not less than a majority of the independent directors forscreening communications.

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**Director Nomination Process**

The Nominating andCorporate Governance Committee is responsible for recommending for the Board’sselection the slate of director nominees for election to our Board and forfilling vacancies occurring between annual meetings of shareholders.

This Committee willconsider shareholder recommendations for candidates for the Board. Recommendationscan be made in accordance with the *“Selection of Directors—ShareholderRecommendations”* of the Guidelines. The committee’s non-exclusivelist of criteria for Board members is set forth in *“Selectionof Directors—Criteria”* of the Corporate Governance Guidelines foundon the Investor Relations section of the Company’s website at *www.midstatebank.com*. The Committee screens all potentialcandidates in the same manner regardless of the source of the recommendation. Therehave been no changes in these procedures in the past year.

**Code of Conduct**

We expect all of ourdirectors, officers (including our Chief Executive Officer, Chief FinancialOfficer and Principal Accounting Officer) and employees to adhere to thehighest standards of ethics and business conduct with each other, customers,shareholders and communities we serve and to comply with all applicable laws, rules andregulations that govern our business. These principles have long been embodiedin our various policies relating to director, officer and employee conductincluding such subjects as employment policies, conflicts of interest,professional conduct, and protection of confidential information. The Boardadopted a comprehensive code of conduct in 2003 reflecting these policies. Ourcode of conduct is published on the Investor Information section of our websiteat *www.midstatebank.com*. Any change to orwaiver of the code of conduct (other than technical, administrative, and othernon-substantive changes) will be posted on our website or reported on a Form 8-Kfiled with the SEC. While the Board may consider a waiver for an executiveofficer or director, they do not expect to grant such waivers.

**Audit Committee of the Board**

Among other committees,the Company Board has an audit committee composed of directors Andrews(Chairman), Flood, Heron, and Miner.

This Committee met six (6) timesin 2006. Each member is an “independent director,” as defined by the Nasdaq rules andsatisfies the additional SEC requirements for independence of audit committeemembers. Nasdaq rules further require each member be able to read andunderstand fundamental financial statements. In addition, our Board hasdetermined that George H. Andrews is an “audit committee financial expert,” asdefined by the SEC rules.

Pursuant to its Charter,the Audit Committee is a standing committee appointed annually by the Board. TheCommittee assists the Board of Directors in fulfilling its responsibility tothe shareholders and depositors relating to the quality and integrity of ouraccounting systems, internal controls, financial-reporting processes, theidentification, and assessment of business risks and the adequacy of overallcontrol environment within Mid-State.

**Section 16(a) of the Securities Exchange Actof 1934**

Section 16(a) ofthe Exchange Act requires Mid-State’s directors, executive officers and tenpercent (10%) or more shareholders of Mid-State’s equity securities to filewith the SEC initial reports of ownership and reports of changes of ownershipof Mid-State’s equity securities. Officers, directors and ten percent (10%) ormore shareholders are required by SEC regulations to furnish Mid-State withcopies of all Section 16(a) forms they file. To Mid-State’sknowledge, based solely on review of the copies of such reports furnished toMid-State and written representations that no other reports were required,during the fiscal year ended December 31, 2006 all Section 16(a) filingrequirements applicable to its executive officers, directors and beneficialowners of ten percent (10%) or more of Mid-State’s equity securities have beenmet.

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**ITEM 11.**         EXECUTIVECOMPENSATION

**CompensationDiscussion and Analysis**

The goals of the Mid-State Executive CompensationProgram (the “Program”) are to attract and retain higher caliber executives,provide compensation in a cost efficient manner, encourage executive ownershipof Mid-State Bancshares (“Mid-State”) common stock and motivate executives tomaximize returns to shareholders, both annually and over the long term.

The philosophy of the Program is to provide a totalreward program that supports achievement of Mid-State’s goals and objectivesand provides total compensation that is competitive in relation to thatprovided by comparable financial institutions. The compensation philosophy putsa strong emphasis on pay for performance, with all elements of the programgeared toward aligning the executive’s interest with the interest of theshareholders and foster an environment for long-term growth of shareholdervalue.

The CompensationCommittee retains consultants to provide expertise regarding compensationpractices. The following compensation surveys are used to assess thecompetitive market’s salary and incentive practices:

1.                FinancialInstitutions Benchmark Compensation Report produced by Watson Wyatt. 53 bankswith assets between $2 and $4 billion participated.

2.                California BankersAssociation Compensation & Benefits Survey prepared by Moss—Adams,LLP, Los Angeles, California. This report contains information on thecompensation and benefit plans of 145 member banks. 19 banks with assets inexcess of $1 billion participated.

3.                CompensationPlanning Survey conducted by William M. Mercer and covers all incentivepractices for the banking industry.

4.                State ofCalifornia Department of Financial Institutions:  Executive Officer and Director Compensation.

In addition to these surveys, the CompensationCommittee reviewed compensation data on several peer group banks. All peergroup data is based upon annual bank survey information and publicly availabledata. The custom peer group includes 14 publicly traded banks. The peer groupwas selected based on asset size and geographic location.

Components of thecompensation program are as follows.

**Salaries**

Base salaries for all employees are targeted at themarket median for employees performing at expected levels, with the principalobjective of the program to maintain salaries that are targeted at the medianof the market for comparable positions in similarly sized financialinstitutions.

Regarding executive compensation, the strategy has beendeveloped to ensure that the executive officers, including the CEO and CFO arerewarded appropriately for their contributions to Company growth andprofitability. The executive compensation strategy is designed to support theCompany’s business strategy and is aligned in a manner that is in the bestinterest of shareholders.

Fundamental changescontinue to occur in the banking industry. Not only is there an expansion offinancial services offered, there is continuing merger and acquisition activity.In addition, there is increased responsibilities and workload as a result of aheightened focus on regulatory issues and corporate governance. There areincreased complex regulations such as the Sarbanes-Oxley Act, and as a result,compensation for bank executives tend to be higher.

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**Incentives**

Annual cash incentives (cash bonuses) are paidaccording to the level of achievement of budgeted goals employees reach asapproved by the Board of Directors.  Incentives are based on the achievement ofannual financial objectives consistent with the Bank’s long-term goals. Theincentives are a way to provide an opportunity to the executive team to improvethe Bank’s financial performance, and to provide a vehicle for rewardingexceptional performance and retaining senior management staff. Variances fromthese guidelines for officers of executive vice president level to CEO will bereviewed and approved by the compensation committee on a case-by-case basis.

The annual executive incentive compensation plan isdesigned to be consistent with all other elements of the Company’s compensationstrategy. The plan includes a defined target for annual incentive rewards thatare tied to the Corporate financial goals. Award levels are approved by theCompensation Committee.

In 2006, theCompensation Committee approved bonuses for the executive officers based on thefollowing performance objectives.

1.                Return On Assets.

2.                ConsolidatedDiluted Earnings per Share.

3.                AverageYear-to-Date Core Deposits

4.                For certainexecutive officers, direct results of branches, line units and/or departmentswere also considered.

5.                Non-FinancialConsiderations:

a.                  Results ofregulatory examinations

b.                 Results ofinternal and external audits

c.                  Results ofoutside rating services.

d.                 Communityinvolvement.

e.                  Public relationsactivities.

f.                    Strategicinitiatives

g.                  Mergerand acquisition activity.

**Long-termincentives**

The principal objective of the long-term stock-basedincentive program is to align the financial interests of executives with thoseof the shareholders, provide incentive for executive ownership of Mid-Statecommon stock, support the achievement of long-term financial objectives, andprovide for long-term incentive reward and capital accumulation opportunities.

Specifically, thepurpose of the stock-based plan is:

1.                To enable keymanagement employees to acquire stock and become owners of the Company.

2.                To incentivisesustained long-term performance of the bank executives and to tie their rewardto that of shareholders.

3.                To provide a toolto attract high caliber employees.

4.                To serve as aretention device.

5.                To keep theCompany’s compensation program balanced and competitive.

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6.                To foster pride ofownership and improve morale.

7.                To enablelong-term accumulation of wealth for executives.

8.                To reward keyemployees.

The method used todetermine the amount of long-term incentives is based on a multiple of basesalary. The CEO is eligible for stock grants reaching a value of three timesthe base salary, using the price of the stock on the day of grant. Otherexecutive officers (CFO and CCO) are eligible for share-based awards totalingtwo times base salary.

**Benefits**

The principal objective of the benefits programprovided for executives are to provide competitive attractive benefits toretain key executives and provide financial planning opportunities tofacilitate tax and estate planning.

Mid-State Bank &Trust recognizes that its continued growth and success depends on attractingand retaining the most qualified and dedicated individuals. A comprehensivebenefit package including medical, dental and vision insurance, medicalreimbursement, dependent care plan, 401(k) Plan, including profit sharing,disability plans, paid vacations, personal holidays, paid sick leave, andemployee assistance program is provided to all employees including theexecutive team.

**PotentialPost-Employment Payments**

In an effort to preserve the management team in theevent of a change in control of the company, Mid-State provides change-in-controlagreements to key management personnel in an effort to retain their expertiseduring a transition period and protect the assets of the company.

The agreements provide for payment to individualofficers of amounts ranging from six months to three years’ salary and bonus. Thesepayments would be paid to the executive, should the Bank be acquired, and theaffected individuals are terminated from employment, or if their position iseliminated.

In those cases where thechange-in-control results in an excess payment under the Internal RevenueService guidelines, the amount paid will be grossed-up to cover the cost of theassociated taxes.

**NonqualifiedDeferred Compensation**

The Company provides a nonqualified DeferredCompensation Plan to its senior management team, wherein a participant maydefer up to 50% of his or her base salary and up to 100% of his or her othercompensation for a plan year.  Uponretirement, the employee elects to begin withdrawing the compensation in asingle amount or in equal monthly installments over a specified number ofyears, not to exceed ten (10) years.

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**Director Compensation **

Directors who are also officersof the Company do not receive additional compensation for their services asdirectors. During 2006, the Company’s non-employee directors received a $14,400annual retainer and $1,250 for each regular and special meeting attended. TheChairman of the Board received $1,800 for meetings attended. Members of theCommittees received $400 for each committee meeting attended, while committeechairpersons received $600 per meeting attended. Members of the Audit Committeereceived $500 for meetings attended, while the committee chairperson received$1,000 for each meeting attended. Directors are also reimbursed for anyout-of-pocket expenses incurred during their duties as directors.

The following table contains information regarding thecompensation awarded or paid to, or earned by, The Company’s directors duringthe 2006 fiscal year.

| **Name(1)**        | ** ** | ** ** | ** ** | **Fees Earned or  Paid in Cash  ($)** | ** ** | **Share  Based  Awards  ($)** | ** ** | **Non-Equity  Incentive Plan  Compensation  ($)** | ** ** | **All Other  Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
|--------------------|------------|------------|------------|-----------------------------------------------------------|------------|-------------------------------|------------|--------------------------------------------------------|------------|---------------------------------------|------------|----------------|------------|
| George H. Andrews  |       |       | 39,150     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 39,150 |   |
| Trudi G. Carey     |       |       | 38,950     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 38,950 |   |
| Daryl L. Flood     |       |       | 52,850     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 52,850 |   |
| H. Edward Heron    |       |       | 43,350     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 43,350 |   |
| Stephen P. Maguire |       |       | 38,300     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 38,300 |   |
| Michael L. Miner   |       |       | 41,150     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 41,150 |   |
| Gregory R. Morris  |       |       | 34,100     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 34,100 |   |
| Carrol R. Pruett   |       |       | 53,800     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 53,800 |   |
| Alan  Rains        |       |       | 42,300     |                                                      |       |                          | 0          |                                                   |       |                                  | 0          |           |       |   | 0 |   |   | 42,300 |   |

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(1)          JamesLokey is not included in this table because he served as an executive officerof the Company during the 2006 fiscal year and, therefore, all amounts paid to Mr. Lokeyare fully reflected in the Summary Compensation Table on page 100 of this Form 10-K.

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**Executive Compensation**

The Compensation Committeerecommends for Board approval the executive compensation awarded to theexecutive officers, and determines the salaries of those executive officersbased upon their experience, performance, and contribution to the success ofMid-State. The following table sets forth the aggregate compensation forservices in all capacities paid or accrued by Mid-State or its bankingsubsidiary to individuals who served as Chief Executive Officer, ChiefFinancial Officer and each of the other three most highly compensated executiveofficers (collectively, the “Named Officers”) during 2006.

**SummaryCompensation Table**

| Name and Principal Position | ** ** | ** ** | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)(1)** | ** ** | **Stock Awards  ($)*** | ** ** | **Option  Awards  ($)*** | ** ** | **All Other  Comp ($)(2)** | ** ** | **Total  ($)** | ** ** |
|--------------------------------------------|------------|------------|------------|----------|------------|-----------------|------------|-------------------|------------|-----------------------------|------------|--------------------------|------------|--------------------------------------|------------|----------------|------------|
|                                       |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
| James W. Lokey                             |       | 2006       |       | 444,761  | (3)        | 197,363         |       |              | —     |                        |       | 385,537                  |       |                                 | 25,893     |           |       | 1,053,554 |   |
| President and Chief                        |       | 2005       |       | 420,319  | (4)        | 402,876         |       |              |       |                        |       |                     |       |                                 | 33,916     |           |       | 857,111 |   |
| Executive Officer                          |       | 2004       |       | 397,067  | (5)        | 159,582         |       |              |       |                        |       |                     |       |                                 | 26,125     |           |       | 582,774 |   |
|                                            |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
|                                       |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
| James G. Stathos                           |       | 2006       |       | 275,221  | (6)        | 84,286          |       |              | —     |                        |       | 134,863                  |       |                                 | 53,105     |           |       | 547,475 |   |
| Executive Vice President/                  |       | 2005       |       | 260,098  | (7)        | 156,579         |       |              |       |                        |       |                     |       |                                 | 27,292     |           |       | 443,969 |   |
| Chief Financial Officer                    |       | 2004       |       | 246,174  | (8)        | 62,501          |       |              |       |                        |       |                     |       |                                 | 26,688     |           |       | 335,363 |   |
|                                       |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
|                                       |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
| Harry H. Sackrider                         |       | 2006       |       | 235,904  | (9)        | 72,246          |       |              | —     |                        |       | 111,293                  |       |                                 | 44,148     |           |       | 463,591 |   |
| Executive Vice President/                  |       | 2005       |       | 221,155  | (10)       | 152,597         |       |              |       |                        |       |                     |       |                                 | 26,735     |           |       | 400,487 |   |
| Chief Credit Officer                       |       | 2004       |       | 201,639  | (11)       | 51,251          |       |              |       |                        |       |                     |       |                                 | 24,062     |           |       | 276,952 |   |
|                                            |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
|                                       |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
| Steven L. Harding                          |       | 2006       |       | 176,865  | (12)       | 74,947          |       |              | 2,242      |                        |       | 42,657                   |       |                                 | 21,969     |           |       | 318,680 |   |
| Executive Vice President/                  |       | 2005       |       | 167,019  | (13)       | 94,867          |       |              |       |                        |       |                     |       |                                 | 20,979     |           |       | 282,865 |   |
| President Community Banking                |       | 2004       |       | 151,967  | (14)       | 24,411          |       |              |       |                        |       |                     |       |                                 | 23,799     |           |       | 200,177 |   |
|                                       |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
|                                       |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |
| Eldon Shiffman                             |       | 2006       |       | 163,861  | (15)       | 115,931         |       |              | —     |                        |       | 4,798                    |       |                                 | 23,302     |           |       | 307,892 |   |
| Senior Vice President/                     |       | 2005       |       | 156,058  | (16)       | 111,737         |       |              |       |                        |       |                     |       |                                 | 24,318     |           |       | 292,113 |   |
| Director of Trust and                      |       | 2004       |       | 148,159  | (17)       | 37,500          |       |              |       |                        |       |                     |       |                                 | 22,667     |           |       | 208,326 |   |
| Investment Mngt. Div.                      |       |       |       |     |       |            |       |              |       |                        |       |                     |       |                                 |       |           |       |   |   |

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                 * Represents the compensation expense recognizedby the Company under SFAS 123(R) in the year noted.

       (1) Amounts shown as bonus payments were earned in the year indicatedbut not paid until the first quarter of the next fiscal year, with theexception of the bonus earned in 2006 which was paid in December 2006.

       (2) No executive officer received perquisites or other personal benefitsin excess of the lesser of $50,000 or 10% of each officer’s total annual salaryand bonus.

       (3) Includes $20,000 accrued in 2006 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

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       (4) Includes $18,000 accrued in 2005 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

       (5) Includes $16,000 accrued in 2004 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

       (6) Includes $20,000 accrued in 2006 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

       (7) Includes $18,000 accrued in 2005 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

       (8) Includes $16,000 accrued in 2004 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

       (9) Includes $20,000 accrued in 2006 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

(10) Includes $18,000 accrued in 2005 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

(11) Includes $16,000 accrued in 2004 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

(12) Includes $15,000 accrued in 2006 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

(13) Includes $14,000 accrued in 2005 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

(14) Includes $9,225 accrued in 2004 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

(15) Includes $17,395 accrued in 2006 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

(16) Includes $15,936 accrued in 2005 but deferred pursuant to Mid-State’s401(k) Plan (see “Profit Sharing 401(k) Plan”).

(17) Includes $14,859 accrued in 2004 but deferredpursuant to Mid-State’s 401(k) Plan (see “Profit Sharing 401(k) Plan”).

**Stock Options**

Mid-State currently has two active stock option plans,the 1996 Stock Option Plan (the “1996 Plan”) and the 2005 Equity BasedCompensation Plan (the “2005 Plan”). Both plans are intended to advance ourinterests by encouraging stock ownership on the part of key employees andnon-employee directors.

The 1996 Plan commenced in November 1996 andexpired in May 2005. Under the 1996 Plan, there were options outstandingto purchase a total of 1,173,726 shares of common stock as of December 31,2006. With the approval of the 2005 Plan in May of 2005, no additionalgrants have been made under the 1996 Plan.

The 2005 Plan was approved by shareholders on May 17,2005, authorizing a maximum of 1,000,000 shares. The Company intends to use the2005 Plan primarily to motivate senior management and senior producers thateffectively influence shareholders’ value. The 2005 Plan authorizes thegranting of incentive stock options, non-qualified stock options, stockappreciation rights (“SARs”), restricted stock awards (“Restricted Stock”), andperformance share cash only awards. Subject to Board ratification, the 

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Compensation Committeewill determine the vesting and, where applicable, the expiration date ofAwards, but Awards that provide for the right to acquire stock may not remainoutstanding more than ten (10) years after the grant date, and any ISOAward granted to any eligible employee owning more than 10% of the Company’sstock must be granted at 110% of the Fair Market Value of the stock. Unless theCommittee determines otherwise, Awards do not vest or become exercisable untilsix (6) month after the date of grant.

Pursuant to the 2005 Plan, outstanding options andrestricted stock awards were granted to directors and to key, full-timesalaried officers and employees of Mid-State and its subsidiaries. As of December 31,2006 there are 924,961 shares available for grant. The Incentive Stock Options(“ISO”) or Non-Qualified Stock Options (“NSO”) or restricted stock granted todate become exercisable in accordance with a vesting schedule established atthe time of grant.

All options granted in the years indicated below tothe named executive officers were incentive stock options and have an exerciseprice equal to the fair market value Mid-State’s Common Stock on the date ofgrant.

The following tables furnish certain informationregarding stock options granted under the Stock Option Plan for James W. Lokey,James G. Stathos, Harry H. Sackrider, Steven L. Harding, and Eldon Shiffman.

Thefollowing table shows all grants of plan-based awards to the Named Officers in2006.

| **Name**                    | ** ** | ** ** | ** ** | **Grant Date** | ** ** | **All Other  Stock Awards:  # Shares  of Stock** | ** ** | **All Other  Options:  # of  Share O/S  in Options  12/31/06** | ** ** | **Exercise  or Base  Price of  Options  ($ /share)** | ** ** |
|-----------------------------|------------|------------|------------|---------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| James W. Lokey,  C.E.O.     |       | 2/15/2006  |       |                | —     |                                                                 |       |                                                                               | 43,883     |                                                                |       |   | $ | 29.00 |   |   |
| James G. Stathos,  C.F.O.   |       | 2/15/2006  |       |                | —     |                                                                 |       |                                                                               | 18,103     |                                                                |       |   | $ | 29.00 |   |   |
| Harry H.  Sackrider, C.C.O. |       | 2/15/2006  |       |                | —     |                                                                 |       |                                                                               | 15,517     |                                                                |       |   | $ | 29.00 |   |   |
| Steven L. Harding           |       | 10/2/2006  |       |                | 1,000      |                                                                 |       |                                                                               | —     |                                                                |       |   | $ | — |   |   |
| Eldon Shiffman              |       | None       |       |                | —     |                                                                 |       |                                                                               | —     |                                                                |       |   | $ | — |   |   |

 

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Thefollowing table lists all outstanding equity awards for the Named Officers asof December 31, 2006.

| ** **                  | ** ** | ** ** | ** ** | **Option Awards** | ** ** | ** **                                                | ** ** | **Stock Awards**                                       | ** ** |
|-----------------------------|------------|------------|------------|------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| **Name**                    | ** ** | ** ** | ** ** | **Grant Date**    | ** ** | **Shares  Underlying  Unexercised  Options  Exercisable** | ** ** | **Shares  Underlying  Unexercised  Options  Unexercisable** | ** ** | **Options  Exercise  Price** | ** ** | **Option  Expiration  Date** | ** ** | **# of  Shares  that  are not  vested** | ** ** | **Market  Value of  Shares  that  are not  vested at  12/31/06** | ** ** |
| James W. Lokey,  C.E.O.     |       | 2/9/2000   |       |                   | 28,635     |                                                      |       |                                                        | —     |   |   |   | $ | 14.00 |   |   | 2/9/2010 |   |   | — |   |   | $ | — |   |
| James W. Lokey,  C.E.O.     |       | 3/21/2001  |       |                   | 62,069     |                                                      |       |                                                        | —     |   |   |   | $ | 14.50 |   |   | 3/21/2011 |   |   | — |   |   | $ | — |   |
| James W. Lokey,  C.E.O.     |       | 3/13/2002  |       |                   | 42,352     |                                                      |       |                                                        | 10,589     |   |   |   | $ | 17.40 |   |   | 3/13/2012 |   |   | — |   |   | $ | — |   |
| James W. Lokey,  C.E.O.     |       | 2/19/2003  |       |                   | 37,770     |                                                      |       |                                                        | 25,180     |   |   |   | $ | 17.10 |   |   | 2/19/2013 |   |   | — |   |   | $ | — |   |
| James W. Lokey,  C.E.O.     |       | 2/18/2004  |       |                   | 18,566     |                                                      |       |                                                        | 27,851     |   |   |   | $ | 24.64 |   |   | 2/18/2014 |   |   | — |   |   | $ | — |   |
| James W. Lokey,  C.E.O.     |       | 2/16/2005  |       |                   | 8,789      |                                                      |       |                                                        | 35,156     |   |   |   | $ | 27.58 |   |   | 2/16/2015 |   |   | — |   |   | $ | — |   |
| James W. Lokey,  C.E.O.     |       | 2/15/2006  |       |                   | —     |                                                      |       |                                                        | 43,883     |   |   |   | $ | 29.00 |   |   | 2/15/2016 |   |   | — |   |   | $ | — |   |
| Total James W. Lokey        |       |       |       |                   | 198,181    |                                                      |       |                                                        | 142,659    |   |   |   | $ | 20.32 |   |   |   |   |   | — |   |   | $ | — |   |
| James G. Stathos, C.F.O.    |       | 8/12/1998  |       |                   | 20,000     |                                                      |       |                                                        | —     |   |   |   | $ | 15.50 |   |   | 8/12/2008 |   |   | — |   |   | $ | — |   |
| James G. Stathos,  C.F.O.   |       | 7/14/1999  |       |                   | 13,859     |                                                      |       |                                                        | —     |   |   |   | $ | 17.94 |   |   | 7/14/2009 |   |   | — |   |   | $ | — |   |
| James G. Stathos,  C.F.O.   |       | 3/21/2001  |       |                   | 9,658      |                                                      |       |                                                        | —     |   |   |   | $ | 14.50 |   |   | 3/21/2011 |   |   | — |   |   | $ | — |   |
| James G. Stathos,  C.F.O.   |       | 3/13/2002  |       |                   | 16,470     |                                                      |       |                                                        | 4,118      |   |   |   | $ | 17.40 |   |   | 3/13/2012 |   |   | — |   |   | $ | — |   |
| James G. Stathos,  C.F.O.   |       | 2/19/2003  |       |                   | 692        |                                                      |       |                                                        | 10,792     |   |   |   | $ | 17.10 |   |   | 2/19/2013 |   |   | — |   |   | $ | — |   |
| James G. Stathos,  C.F.O.   |       | 2/18/2004  |       |                   | 7,636      |                                                      |       |                                                        | 11,455     |   |   |   | $ | 24.64 |   |   | 2/18/2014 |   |   | — |   |   | $ | — |   |
| James G. Stathos,  C.F.O.   |       | 2/16/2005  |       |                   | 3,625      |                                                      |       |                                                        | 14,504     |   |   |   | $ | 27.58 |   |   | 2/16/2015 |   |   | — |   |   | $ | — |   |
| James G. Stathos,  C.F.O.   |       | 2/15/2006  |       |                   | —     |                                                      |       |                                                        | 18,103     |   |   |   | $ | 29.00 |   |   | 2/15/2016 |   |   | — |   |   | $ | — |   |
| Total James G.  Stathos     |       |       |       |                   | 71,940     |                                                      |       |                                                        | 58,972     |   |   |   | $ | 21.00 |   |   |   |   |   | — |   |   | $ | — |   |
| Harry H. Sackrider, C.C.O.  |       | 3/13/2002  |       |                   | —     |                                                      |       |                                                        | 1,000      |   |   |   | $ | 17.40 |   |   | 3/13/2012 |   |   | — |   |   | $ | — |   |
| Harry H.  Sackrider, C.C.O. |       | 12/11/2002 |       |                   | 3,000      |                                                      |       |                                                        | 3,000      |   |   |   | $ | 17.00 |   |   | 12/11/2012 |   |   | — |   |   | $ | — |   |
| Harry H.  Sackrider, C.C.O. |       | 2/19/2003  |       |                   | —     |                                                      |       |                                                        | 7,194      |   |   |   | $ | 17.10 |   |   | 2/19/2013 |   |   | — |   |   | $ | — |   |
| Harry H.  Sackrider, C.C.O. |       | 2/18/2004  |       |                   | —     |                                                      |       |                                                        | 9,984      |   |   |   | $ | 24.64 |   |   | 2/18/2014 |   |   | — |   |   | $ | — |   |
| Harry H.  Sackrider, C.C.O. |       | 2/16/2005  |       |                   | —     |                                                      |       |                                                        | 11,893     |   |   |   | $ | 27.58 |   |   | 2/16/2015 |   |   | — |   |   | $ | — |   |
| Harry H. Sackrider,  C.C.O. |       | 2/15/2006  |       |                   | —     |                                                      |       |                                                        | 15,517     |   |   |   | $ | 29.00 |   |   | 2/15/2016 |   |   | — |   |   | $ | — |   |
| Total Harry H.  Sackrider   |       |       |       |                   | 3,000      |                                                      |       |                                                        | 48,588     |   |   |   | $ | 24.55 |   |   |   |   |   | — |   |   | $ | — |   |
| Steven L. Harding           |       | 9/9/1998   |       |                   | 10,000     |                                                      |       |                                                        | —     |   |   |   | $ | 15.00 |   |   | 9/9/2008 |   |   | — |   |   | $ | — |   |
| Steven L. Harding           |       | 2/19/2003  |       |                   | 6,000      |                                                      |       |                                                        | 4,000      |   |   |   | $ | 17.10 |   |   | 2/19/2013 |   |   | — |   |   | $ | — |   |
| Steven L. Harding           |       | 2/18/2004  |       |                   | 2,435      |                                                      |       |                                                        | 3,653      |   |   |   | $ | 24.64 |   |   | 2/18/2014 |   |   | — |   |   | $ | — |   |
| Steven L. Harding           |       | 2/16/2005  |       |                   | 3,000      |                                                      |       |                                                        | 12,000     |   |   |   | $ | 27.58 |   |   | 2/16/2015 |   |   | — |   |   | $ | — |   |
| Steven L. Harding           |       | 10/2/2006  |       |                   | —     |                                                      |       |                                                        | —     |   |   |   | — |   |   | — |   |   | 1,000 |   |   | $ | 36,390.00 |   |
| Total Steven L.  Harding    |       |       |       |                   | 21,435     |                                                      |       |                                                        | 19,653     |   |   |   | $ | 21.53 |   |   |   |   |   | 1,000 |   |   | $ | 36,390.00 |   |
| Eldon Shiffman              |       | 7/12/2000  |       |                   | 13,900     |                                                      |       |                                                        | —     |   |   |   | $ | 14.25 |   |   | 7/12/2010 |   |   | — |   |   | $ | — |   |
| Eldon Shiffman              |       | 2/19/2003  |       |                   | 1,518      |                                                      |       |                                                        | 2,000      |   |   |   | $ | 17.10 |   |   | 2/19/2013 |   |   | — |   |   | $ | — |   |
| Totals Eldon Shiffman       |       |       |       |                   | 15,418     |                                                      |       |                                                        | 2,000      |   |   |   | $ | 14.83 |   |   |   |   |   | — |   |   | $ | — |   |
|                             |            |            |            |                        |            |                                                           |            |                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Thefollowing table shows all stock options exercised and restricted shares vestedby the Named Officers in 2006. 

| ** **                  | ** ** | **Option Awards** | ** ** | **Stock Awards**                                  | ** ** |
|-----------------------------|------------|------------------------|------------|--------------------------------------------------------|------------|
| **Name**                    | ** ** | ** **             | ** ** | **Number of  Shares  Acquired  on Exercise** | ** ** | **Value  Realized  on Exercise** | ** ** | **Number of  Shares  Acquired  on Vesting** | ** ** | **Value  Realized  on Vesting** | ** ** |
| James W. Lokey,  C.E.O.     |       |                   | —     |                                                   |       | $ | — |   |   | — |   |   |   | $ | — |   |   |
| James G. Stathos,  C.F.O.   |       |                   | 51,635     |                                                   |       | $ | 960,821.84 |   |   | — |   |   |   | $ | — |   |   |
| Harry H.  Sackrider, C.C.O. |       |                   | 49,420     |                                                   |       | $ | 899,726.52 |   |   | — |   |   |   | $ | — |   |   |
| Steven L. Harding           |       |                   | —     |                                                   |       | $ | — |   |   | — |   |   |   | $ | — |   |   |
| Eldon Shiffman              |       |                   | 11,000     |                                                   |       | $ | 145,570.00 |   |   | — |   |   |   | $ | — |   |   |
| Total 5 Named Officers      |       |                   | 112,055    |                                                   |       | $ | 2,006,118.36 |   |   | — |   |   |   | $ | — |   |   |
|                             |            |                        |            |                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Profit Sharing/401(k) Plan**

Mid-State offers a combined Profit Sharing and 401(k) Planto all of its eligible employees, and those of its banking subsidiary (the “Plan”).Eligible employees may participate in the Plan on the first of the monthfollowing 30 days of service. Employer contributions to the Profit Sharing and401(k) Plan are vested on a five-year vesting schedule at 20% per year.

Contributions to the Profit Sharing portion of thePlan (the “Profit Sharing Plan”) are made entirely by Mid-State. Each year theBoard of Directors, in its discretion, decides how much money, if any, will becontributed to the Plan depending on the amount of Mid-State’s profits for theyear. Mid-State’s contribution to the Profit Sharing Plan is allocated amongall eligible employees based on eligible pay. Employees must be activelyemployed at the end of the calendar year in order to receive the profit sharingcontribution. No amounts are accrued or set aside for the account ofnon-employee directors. Mid-State contributed approximately $1.8 million to theProfit Sharing Plan for the year ending December 31, 2006.

Under the 401(k) portionof the Plan (the “401(k) Plan”), each covered employee can make voluntarycontributions to his or her account in an amount up to thirty percent (30%) ofhis or her base salary; such contributions vest immediately when made. Mid-Statemakes a contribution to the employee’s account in an amount equal to theemployee’s contribution up to 3% of their salary, fifty percent (50%) of theemployee’s contribution on the next 2% of their salary and twenty-five percent (25%)of the employee’s contribution on the next 4% of their salary, for a maximummatch of five percent (5%) of the employee’s salary. For the year ended December 31,2006, Mid-State contributed approximately $1.1 million to the 401(k) Plan.

**Change in ControlAgreements, Employment Agreements and Retention Agreements**

***Mid-State entered into “change in control”agreements with Messrs. Lokey, Sackrider, and Stathos as of January 9,2002. Each agreement provided that, if a person who has acquired control ofMid-State terminates the officer within 36 months after such change in controlother than for cause, disability or retirement (as such terms are defined inthe agreement) or if, within 36 months of such a change in control, the officerterminates the agreement for good reason (as defined in the agreement), the officer will receive (i) a lumpsum severance payment equal to three times his annual salary and bonus and (ii) continuedbenefits under all insured and self-insured employee welfare benefit plans fora period ending on the earliest of (A) three (3) years, (B) thecommencement date of equivalent benefits from a new employer or (C) theofficer’s normal retirement date under the terms of such plans. In general, a “changein control” includes a change in the majority of directors as a result of anelection contest, an acquisition of 25% of the outstanding shares, a merger, consolidation,sale of substantially all the assets, a***

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***change in the majority of directors over a two (2) yearperiod as well as any other transfer, voluntarily or by hostile takeover orproxy contest, operation of law or otherwise, of control of Mid-State.***

Messrs. Harding and Shiffman also had “change incontrol” agreements which were substantially identical to the ones describedabove except that the triggering event must occur within 24 months after achange in control and the amount of the lump sum payment was limited to twotimes their annual salary and bonus.

As a replacement for his change in control agreement,generally discussed above, Mid-State Bank & Trust, at Rabobank’s request,has entered into an employment agreement with James Lokey, the President andChief Executive Officer of Mid-State and Mid-State Bank & Trust. Theemployment agreement provides that Mr. Lokey will serve as the president ofRabobank, N.A., commencing on the closing date of the merger, until andincluding December 31, 2009. The employment agreement provides that Mr. Lokeywill be paid an annual salary of $500,000 per year. This represents an increaseof 11.20% over Mr. Lokey’s current employment arrangement which provides for anannual salary of $449,656. If Mr. Lokey’s employment is terminated by Rabobankwithout cause prior to the expiration of the term, Mr. Lokey will be entitledto receive $2,265,000 plus continued health and life insurance benefits for aperiod of two years. If Mr. Lokey remains employed for the entire term of theemployment agreement, he will be entitled to receive a lump sum of $15,000,payable upon termination of his employment, and a sum of $2,500,000, payableover 10 years, starting upon termination of his employment. The foregoingpayments to Mr. Lokey in the event he is terminated without cause by Rabobank,or if he remains employed for the entire term of his employment agreement, aresubstantially the same as the amount of the payment Mr. Lokey would havereceived as a result of the proposed merger pursuant to the change-in-controlagreement he agreed to cancel. In addition, Mr. Lokey has signed a SupportAgreement agreeing to refrain from soliciting employees of Mid-State and/or VIBCorp or their subsidiaries for a period of two years after the termination ofMr. Lokey’s employment agreement described above. The Support Agreement alsoprohibits Mr. Lokey from soliciting customers of Mid-State and/or VIB Corp ortheir subsidiaries for a similar two year period.

Also in connection with the merger with Rabobank,several executive officers and senior officers of the Bank, including Messrs.Harding and Shiffman, entered into “retention” agreements with the Bank on November 1,2006. In exchange for their willingness to waive and cancel the terms undertheir respective change in control agreements, the retention agreement allowsfor, among other things, the payment of a retention bonus at time of closing. Inthe case of Messrs. Harding and Shiffman, this retention bonus is equal to oneyear’s salary. Additionally, if the officer is employed by Rabobank one yearafter the closing, they will be entitled to a single lump sum payment which, inthe case of Messrs. Harding and Shiffman, is equal to one year’s salary.

Messrs. Stathos andSackrider will be paid out in connection with the terms of their change incontrol agreements and will not continue with Rabobank after the merger. It isalso expected that Messrs. Stathos and Sackrider will each enter intothree year non-compete agreements with Rabobank providing for yearly paymentsof $133,333.

**IncentiveCompensation Plan**

The Board of Directorsapproved an annual Incentive Plan for the executive officers. The objective ofthe plan is to provide competitive compensation, warranted by performance, andaid in motivating and retaining key executives. Awards under the Plan are basedon achievement of annual Bank objectives and individual objectives. Objectivesare established in advance of the Plan year and approved by the Chairman, CEO,and the Board, in conjunction with the annual budget. For purposes ofcalculating performance against the objectives for any year, profit (or income)is after-tax net income, as shown in the 

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ConsolidatedStatement of Income for such year, as presented to the Board of Directors.Messrs. Lokey, Stathos, Sackrider, Harding and Shiffman are eligible forparticipation in the Plan.

**Other Compensation**

We have provided and planto continue to provide our executive officers with automobiles, which are notavailable to all our employees. It is impracticable to estimate the percentageof the total costs of these benefits attributable to personal use. No amount isstated for the foregoing in the compensation table on page 100, sincemanagement has concluded that the amount of any personal benefits to anyexecutive officer and to the principal officers as a group is *less* than the lesser of $50,000.00 per person or ten percent(10%) of the compensation reported under “Cash Compensation” for each suchperson and for the group.

**CompensationCommittee Interlocks and Insider Participation**

No member of theCompensation Committee was a current or former officer or employee of Mid-Stateor its subsidiary during the year. The Chairman of the Compensation Committeeduring 2006, Director Gregory R. Morris, is the president and principal owner/shareholderof Morris & Garritano Insurance Agency. Morris & Garritanoreceived broker commissions during 2006 in connection with the placement ofinsurance for Mid-State and its subsidiary. Such broker commissions were lessthan 5% of Morris & Garritano’s gross revenues for 2006.

**Report of theCompensation Committee on Executive Compensation**

The Compensation Committeehas reviewed the Compensation Discussion and Analysis included herein withmanagement and has recommended to the Board of Directors that the CompensationDiscussion and Analysis be included in the Company’s annual report on Form 10-K.

Respectfully submitted,

Gregory R. Morris(Chairman)Stephen P. MaguireAlan Rains

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

***Security Ownership of Certain Beneficial Owners***

To the Company’sknowledge, based on the absence of filings which beneficial owners of more thanfive percent of the outstanding shares of the Company’s common stock arerequired to make with the SEC, there are no other beneficial owners of morethan five percent of the outstanding shares of the Company’s common stock.

***Security Ownership of Management***

All shares owned byDirectors and Executive Officers are reflected in the table in Item 10 of thisreport on page 95. None of the shares were pledged as of December 31,2006.

***Equity Plan Compensation Information***

The following tablesummarizes information as of December 31, 2006 relating to equitycompensation plans of the Company pursuant to which grants of options,restricted stock or other rights to acquire shares may be granted from time totime.

| ** **                                              | ** ** | **Number of Securities**   | ** ** | **Weighted Average**         | ** ** | **Number of Securities** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| ** **                                              | ** ** | **To be issued upon** | ** ** | **Exercise Price of**   | ** ** | **Remaining Available**       | ** ** |
| **Plan Category**                                  | ** ** | ** **                           | ** ** | **Exercise of Options** | ** ** | **Outstanding Options**       | ** ** | **for Future Issuance** | ** ** |
| Equity  compensation Plans approved by Stockholders     |       |                                 | 1,826,439  |                              |       |                               | $          | 20.11 |   |   |   | 924,961 |   |   |
| Equity  compensation Plans not approved by Stockholders |       |                                 | -None-     |                              |       |                               | N/A        |   |   |   | N/A |   |   |
| Total                                                   |       |                                 | 1,826,439  |                              |       |                               | $          | 20.11 |   |   |   | 924,961 |   |   |
|                                                         |            |                                      |            |                                   |            |                                    |            |  |  |  |  |  |  |  |  |  |

 

The number of securitiesto be issued upon exercise of options in the table above, includes 42,170restricted shares as described more fully in the notes to the financialstatements in Item 8 of this report.

***Change in Control***

As more fully discussed inItem 1 of this report under “Rabobank Merger”, the Company has entered into anagreement and plan of merger with Rabobank whereby Rabobank will acquire all ofthe shares of Mid-State Bancshares, through a merger with a Rabobank subsidiary.The transaction is expected to close in the second quarter of 2007, subject toapproval by Mid-State Bancshares shareholders and the receipt of all requiredregulatory approvals.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

***Director Independence***

The Board has determinedthat the following eight (8) directors (constituting 80% of the entireBoard) satisfy Nasdaq’s independence requirements: Andrews, Carey, Flood,Heron, Maguire, Miner, Morris, and Rains.

***Transactions with Management and Others***

There have been notransactions, or series of similar transactions, during 2006, or any currentlyproposed transaction, or series of similar transactions, to which Mid-State orits wholly owned bank subsidiary was or is to be a party, in which the amountinvolved exceeded or will exceed $120,000.00 and in 

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whichany director (or nominee for director) of Mid-State, executive officer ofMid-State, any shareholder owning of record or beneficially 5% or more ofMid-State Stock, or any member of the immediate family of any of the foregoingpersons, had, or will have, a direct or indirect material interest.

***Certain Business Relationships***

No director was related toany entity, either through ownership of more than 10% or as an executiveofficer, with which the Company had any relationship other than payments madeto Morris &Garritano Insurance Agency for insurance placement broker commissionswhich constituted less than 5% of their total revenue. Director Gregory R. Morris, is the president and principalowner/shareholder of Morris & Garritano Insurance Agency.

***Indebtedness of Management.***

Some of the currentdirectors and executive officers of Mid-State and the companies with which theyare associated have been customers of, and have had banking transactions withMid-State, in the ordinary course of Mid-State’s business, and Mid-Stateexpects to continue to have such banking transactions in the future. All loansand commitments to lend included in such transactions have been made onsubstantially the same terms, including interest rates and collateral, as thoseprevailing at the time for comparable transactions with persons of similarcreditworthiness, and in the opinion of management of Mid-State, have notinvolved more than the normal risk of repayment or presented any otherunfavorable features.

***Review of Related Party Transactions***

The Company has written procedures for reviewingtransactions between it and its directors and executive officers, theirimmediate family members and entities with which they have a position orrelationship. These procedures are intended to determine whether any suchrelated party transaction impairs the independence of a director or presents aconflict of interest on the part of a director or executive officer.

On an annual basis, alldirectors and executive officers are required to complete a questionnaire thatrequests information about related party transactions. Additionally, allofficers, employees and directors are required to review and sign a CorporateCode of Conduct which prohibits related party transactions that create aconflict of interest or the appearance of a conflict of interest betweenpersonal and professional relationships. The Audit Committee is responsible forapproving all related party transactions to which the Company is a party.

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**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

PricewaterhouseCoopers,LLP (“PWC”) audited Mid-State’s financial statements for the year ended December 31,2006 and have been Mid-State’s accountants since July 2002. Allprofessional services rendered by PWC during 2006 were furnished at customaryrates and terms. A representative of PWC is expected to attend the shareholdersmeeting at which the Rabobank transaction will be considered. Suchrepresentative will have the opportunity to make a statement, if he or she sochooses, and will be available to respond to appropriate questions. Thefollowing table presents fees for professional audit services rendered by PWCfor the fiscal years ended December 31, 2006 and 2005.

| ** **                                                                                      | ** ** | **2006** | ** **  | **2005**   | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------|-------------|------------|------------|
| **Audit Fees:**                                                                                 |       |     |        |       |       |
| Consolidated financial statements quarterly reviews,  and Report on Internal Controls           |       | $        | 905,600     |       | $          | 902,185 |   |
| **Audit-Related Fees:**                                                                         |       |     |        |       |       |
| Other-Professional services rendered in connection  with an acquisition or proposed acquisition |       | 23,900   |        | 0          |       |
| **Tax Fees:**                                                                                   |       |     |        |       |       |
| Compliance                                                                                      |       | 16,200   |        | 57,875     |       |
| Planning                                                                                        |       | 48,315   |        | 0          |       |
| Advice                                                                                          |       | 0        |        | 23,775     |       |
| Total tax service fees                                                                          |       | 64,515   |        | 81,650     |       |
| **Total Fees:**                                                                                 | ** ** | **$**    | **994,015** | ** ** | **$**      | **983,835** | ** ** |

 

In the above table, in accordance with the SEC’sdefinitions and rules, “audit fees” are fees Mid-State paid PWC forprofessional services for the audit of Mid-State’s consolidated financialstatements included in the Form 10-K and review of financialstatements included in Form 10-Q’s, and for services that arenormally provided by the accountant in connection with statutory and regulatoryfilings and engagements; “audit related fees” are fees for assurance andrelated services that are reasonably related to the performance of the audit orreview of Mid-State’s financial statements; “tax fees” are fees for taxcompliance, tax advice and tax planning; and “all other fees” are fees for anyservices not included in the first three categories. There were no “all other”fees paid during 2005 or 2006.

For the fiscal year 2006 the Audit Committeeconsidered and deemed the services provided by PWC compatible with maintainingthe principal accountant’s independence. The Charter for the Audit Committee ofthe Board contains policies and procedures for pre-approval of audit andnon-audit services from our independent public accountant and all fees in 2005and 2006 were pre-approved. TheCharter is published on the Investor Information section of the Company’swebsite at www.midstatebank.com.

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**PART IV**

**ITEM15.**         EXHIBITS AND FINANCIALSTATEMENT SCHEDULES

**(a)****          Documentsfiled 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 113.

**(b)****          Exhibits:**

|             | ** ** | ** **                      | ** ** | **Sequentially**                                                                                                                           | ** ** |
|-------------|------------|---------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Exhibit** | ** ** | ** **                      | ** ** | **Numbered**                                                                                                                               | ** ** |
| **Number**  | ** ** | **Index to Exhibits** | ** ** | **Pages**                                                                                                                                  | ** ** |
|        | 2.1        |                            |       | Agreement  and Plan of Merger with Rabobank(9)                                                                                             |       |   |   |   |   |
|        | 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                                                                  |       |   |   |   |   |

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(1)           Filed as part of the Registrant’s Form 10-Kfor the year ended December 31, 1998.

(2)           Filed as an exhibit to Registrant’sRegistration Statement (File No. 333-16952) filed on November 27,1996.

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

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

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

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

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

(8)           Filed as part of the Registrant’sRegistration Statement on Form S-8 (File No. 333-126880)filed on July 26, 2005.

(9)           Filed as part of the Registrant’s Form 8-Kfiled on November 3, 2006.

**(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,  2007 |
|   |   |   |   | By                          | * * | /s/  JAMES G. STATHOS |
|   |   |   |   |                        |   | JAMES G. STATHOS |
|   |   |   |   |                        |   | *Executive  Vice President* |
|   |   |   |   |                        |   | *and  Chief Financial Officer* |
|   |   |   |   |                        |   | *[Principal  Financial and Accounting Officer]* |
|   |   |   |   | Dated: March 15,  2007 |

 

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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,  2007 |
| CARROL R. PRUETT        |       |                  |
| /s/  GEORGE H. ANDREWS  |       | Director              |       | March 15,  2007 |
| GEORGE H. ANDREWS       |       |                  |
| /s/  TRUDI CAREY        |       | Director              |       | March 15,  2007 |
| TRUDI CAREY             |       |                  |
| /s/  DARYL L. FLOOD     |       | Director              |       | March 15,  2007 |
| DARYL L. FLOOD          |       |                  |
| /s/H. EDWARD HERON      |       | Director              |       | March 15,  2007 |
| H. EDWARD HERON         |       |                  |
| /s/  JAMES W. LOKEY     |       | Director              |       | March 15,  2007 |
| JAMES W. LOKEY          |       |                  |
| /s/  STEPHEN P. MAGUIRE |       | Director              |       | March 15,  2007 |
| STEPHEN P.  MAGUIRE     |       |                  |
| /s/  MICHAEL L. MINER   |       | Director              |       | March 15,  2007 |
| MICHAEL L. MINER        |       |                  |
| /s/  GREGORY R. MORRIS  |       | Director              |       | March 15,  2007 |
| GREGORY R. MORRIS       |       |                  |
| /s/  ALAN RAINS         |       | Director              |       | March 15,  2007 |
| ALAN RAINS              |       |                  |

 

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

 

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