**United StatesSecurities and Exchange Commission**

**Washington, D.C. 20429**

 

**FORM 10-Q**

 

**ý****                                ****Quarterlyreport under Section 13 or 15(d) of the Securities Exchange Act of1934.**

 

**For thequarterly period ended September 30, 2005.**

 

**o****                                ****Transition report under Section 13or 15(d) of the Securities Exchange Act of 1934**

 

**for the transition period from N/Ato N/A.**

 

**Commission File Number 000-23925**

 

**MID-STATE BANCSHARES**

**(**Exact name of registrant asspecified in its charter)

 
| **California**                                                  | ** ** | **77-0442667**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |       | (I.R.S. Employer Identification No.) |

 
| **1026 Grand Ave. Arroyo Grande, CA**    | ** ** | **93420-0580** |
|------------------------------------------|------------|----------------|
| (Address of Principal Executive Offices) |       | (Zip Code)     |

 

Registrant’s Telephone Number:     **(805) 473-7700**

 

Check whether the Company(1) filed all reports required to be filed by Section 13 or 15(d) ofthe Exchange Act during the past 12 months (or such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.          Yes ý   No   o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

Yes ý   No   o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes o  No   ý

 

Number of shares ofcommon stock of the Company outstanding as of October 31, 2005:  22,562,845 shares.

 

 

----

 

**Mid-State Bancshares**

September 30, 2005

Index

 
| **PART I  - FINANCIAL INFORMATION** |                                                                                                     |
|------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                     |                                                                                                     |
|                                     | Item  1                                                                                                  | –Financial  Statements (Unaudited) |   |
|                                     |                                                                                                     |   |   |
|                                     |                                                                                                     | Consolidated  Statements of Financial Position |   |
|                                     |                                                                                                     |   |   |
|                                     |                                                                                                     | Consolidated  Statements of Income |   |
|                                     |                                                                                                     |   |   |
|                                     |                                                                                                     | Consolidated  Statements of Comprehensive Income |   |
|                                     |                                                                                                     |   |   |
|                                     |                                                                                                     | Consolidated  Statements of Changes in Capital Accounts |   |
|                                     |                                                                                                     |   |   |
|                                     |                                                                                                     | Consolidated  Statements of Cash Flows |   |
|                                     |                                                                                                     |   |   |
|                                     |                                                                                                     | Notes to  Consolidated Financial Statements |   |
|                                     |                                                                                                     |   |   |
|                                     | Item 2 –Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                     |                                                                                                     |   |   |
|                                     | Item 3  –Quantitative and Qualitative Disclosures About Market Risk                                 |   |
|                                     |                                                                                                     |   |   |
|                                     | Item  4 –Controls and Procedures                                                                    |   |
|                                     |                                                                                                     |   |   |
| **PART II - OTHER  INFORMATION**    |                                                                                                     |
|                                     |                                                                                                     |   |
|                                     | Item 1  –Legal Proceedings                                                                          |   |
|                                     |                                                                                                     |   |
|                                     | Item 2  –Unregistered Sales of Equity Securities and Use of Proceeds                                |   |
|                                     |                                                                                                     |   |
|                                     | Item 3  –Defaults Upon Senior Securities                                                            |   |
|                                     |                                                                                                     |   |
|                                     | Item 4  –Submission of Matters to a Vote of Security Holders                                        |   |
|                                     |                                                                                                     |   |
|                                     | Item 5  –Other Information                                                                          |   |
|                                     |                                                                                                     |   |
|                                     | Item 6 –Exhibits                                                                                    |   |
|                                     |                                                                                                     |   |
|                                     | Signatures                                                                                               |   |
|                                     |                                                                                                     |   |
|                                     | EX-31  Certifications                                                                                    |   |
|                                     |                                                                                                     |   |
|                                     | EX-32  Certification Pursuant to 18 U.S.C. Sec. 1350                                                     |   |

 

2

----

 

**PART I - FINANCIALINFORMATION**

**Item 1 - Financial Statements**

 

**Mid-State Bancshares**

Consolidated Statementsof Financial Position

(Unaudited - figures in 000’s)

 
| ** **                                                                                     | ** ** | **Sept. 30, 2005** | ** ** | **Dec. 31, 2004** | ** ** | **Sept. 30, 2004** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|--------------------|------------|
| ASSETS                                                                                         |       |               |       |                   |       |               |       |
| Cash and Due From Banks                                                                        |       | $                  | 130,602    |                   | $          | 112,669            |       | $ | 119,104 |   |
| Fed Funds Sold                                                                                 |       | 32,100             |       | 6,000                  |       | —             |       |
| Securities Available For Sale                                                                  |       | 617,715            |       | 644,817                |       | 688,923            |       |
| Loans Held for Sale                                                                            |       | 10,391             |       | 12,988                 |       | 10,001             |       |
| Loans, net of unearned income                                                                  |       | 1,497,704          |       | 1,421,894              |       | 1,394,478          |       |
| Allowance for Loan Losses                                                                      |       | (11,532            | )          | (13,799                | )          | (13,912            | )          |
| Net Loans                                                                                      |       | 1,486,172          |       | 1,408,095              |       | 1,380,566          |       |
|                                                                                           |       |               |       |                   |       |               |       |
| Premises and Equipment, Net                                                                    |       | 24,635             |       | 24,946                 |       | 25,213             |       |
| Accrued Interest Receivable                                                                    |       | 13,935             |       | 11,918                 |       | 13,099             |       |
| Goodwill                                                                                       |       | 47,840             |       | 47,840                 |       | 47,840             |       |
| Core Deposit Intangibles, net                                                                  |       | 6,701              |       | 7,732                  |       | 8,076              |       |
| Other Assets                                                                                   |       | 52,282             |       | 19,082                 |       | 16,721             |       |
| ***Total  Assets***                                                                            |       | $                  | 2,422,373  |                   | $          | 2,296,087          |       | $ | 2,309,543 |   |
|                                                                                           |       |               |       |                   |       |               |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                      |       |               |       |                   |       |               |       |
| Non Interest Bearing Demand                                                                    |       | $                  | 589,601    |                   | $          | 517,139            |       | $ | 524,785 |   |
| NOW Accounts, Money Market and Savings Deposits                                                |       | 1,088,091          |       | 1,083,139              |       | 1,075,583          |       |
| Time Deposits Under $100                                                                       |       | 232,062            |       | 227,972                |       | 231,147            |       |
| Time Deposits $100 or more                                                                     |       | 196,208            |       | 166,295                |       | 168,052            |       |
| *Total  Deposits*                                                                              |       | 2,105,962          |       | 1,994,545              |       | 1,999,567          |       |
| Other Borrowings                                                                               |       | 23,680             |       | 6,582                  |       | 5,843              |       |
| Allowance for Losses – Unfunded Commitments                                               |       | 1,839              |       | 1,783                  |       | 1,682              |       |
| Accrued Interest Payable and Other Liabilities                                                 |       | 19,206             |       | 18,550                 |       | 23,989             |       |
| *Total  Liabilities*                                                                           | * *   | 2,150,687          |       | 2,021,460              |       | 2,031,081          |       |
| Commitments and Contingencies                                                                  |       |               |       |                   |       |               |       |
|                                                                                           |       |               |       |                   |       |               |       |
| Shareholders’ Equity:                                                                     |       |               |       |                   |       |               |       |
| Common Stock and  Surplus (Shares outstanding of 22,623, 23,099 and 23,323, respectively)      |       | 45,384             |       | 61,439                 |       | 68,348             |       |
| Retained Earnings                                                                              |       | 224,349            |       | 206,328                |       | 200,626            |       |
| Accumulated  Other Comprehensive Income net of taxes of $1,302, $4,573 and $6,326 respectively |       | 1,953              |       | 6,860                  |       | 9,488              |       |
| *Total  Equity*                                                                                |       | 271,686            |       | 274,627                |       | 278,462            |       |
| ***Total  Liabilities and Equity***                                                            |       | $                  | 2,422,373  |                   | $          | 2,296,087          |       | $ | 2,309,543 |   |

 

The accompanying notesare an integral part of these consolidated statements.

 

3

----

 

**Mid-State Bancshares**

Consolidated Statementsof Income

(Unaudited - figures in 000’s except earnings per share data)

 
| ** **                                                              | ** ** | **Three Month Period  Ended Sept. 30,** | ** ** | **Nine Month Period  Ended Sept. 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                                | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Interest Income:**                                                    |       |                                    |       |                                   |       |   |   |   |   |
| Interest and  fees on loans                                             |       | $                                       | 26,780     |                                   | $          | 22,106 |   | $ | 76,533 |   | $ | 62,343 |   |
| Interest on investment  securities -                                    |       |                                    |       |                                   |       |   |   |   |   |
| U.S. Treasury  securities                                               |       | 189                                     |       | 178                                    |       | 494 |   | 820 |   |
| U.S. Government  agencies and corporations                              |       | 1,562                                   |       | 2,095                                  |       | 4,569 |   | 6,595 |   |
| Obligations of  states and political sub-divisions and other securities |       | 3,936                                   |       | 3,708                                  |       | 11,661 |   | 11,029 |   |
| Interest on fed  funds sold                                             |       | 456                                     |       | 149                                    |       | 802 |   | 306 |   |
| **Total  Interest Income**                                              |       | 32,923                                  |       | 28,236                                 |       | 94,059 |   | 81,093 |   |
| **Interest Expense:**                                                   |       |                                    |       |                                   |       |   |   |   |   |
| Interest on NOW,  money market and savings                              |       | 1,391                                   |       | 654                                    |       | 3,321 |   | 1,855 |   |
| Interest on time  deposits less than $100                               |       | 1,452                                   |       | 849                                    |       | 3,726 |   | 2,595 |   |
| Interest on time  deposits of $100 or more                              |       | 1,247                                   |       | 546                                    |       | 3,030 |   | 1,548 |   |
| Interest other                                                          |       | 234                                     |       | 34                                     |       | 654 |   | 151 |   |
| **Total  Interest Expense**                                             |       | 4,324                                   |       | 2,083                                  |       | 10,731 |   | 6,149 |   |
| **Net Interest Income before provision for loan  losses**               |       | 28,599                                  |       | 26,153                                 |       | 83,328 |   | 74,944 |   |
| Provision (Benefit) for loan losses                                     |       | —                                  |       | —                                 |       | — |   | (2,700 | ) |
| **Net Interest Income after provision for loan  losses**                |       | 28,599                                  |       | 26,153                                 |       | 83,328 |   | 77,644 |   |
| **Other Operating Income:**                                             |       |                                    |       |                                   |       |   |   |   |   |
| Service charges  and fees                                               |       | 2,374                                   |       | 2,574                                  |       | 7,094 |   | 7,646 |   |
| Commissions,  fees and other service charges                            |       | 2,238                                   |       | 3,545                                  |       | 6,497 |   | 10,146 |   |
| Net gain on sale  of securities                                         |       | —                                  |       | 93                                     |       | 88 |   | 475 |   |
| Net gain on sale  of loans held for sale                                |       | 179                                     |       | 40                                     |       | 417 |   | 414 |   |
| Other non-interest  income                                              |       | 480                                     |       | 998                                    |       | 1,948 |   | 3,479 |   |
| **Total  Other Operating Income**                                       |       | 5,271                                   |       | 7,250                                  |       | 16,044 |   | 22,160 |   |
| **Other Operating Expense:**                                            |       |                                    |       |                                   |       |   |   |   |   |
| Salaries and  employee benefits                                         |       | 11,105                                  |       | 10,579                                 |       | 32,761 |   | 32,478 |   |
| Occupancy and  furniture                                                |       | 3,105                                   |       | 3,153                                  |       | 9,146 |   | 9,361 |   |
| Other operating  expenses                                               |       | 5,263                                   |       | 6,533                                  |       | 15,112 |   | 18,997 |   |
| **Total  Other Operating Expense**                                      |       | 19,473                                  |       | 20,265                                 |       | 57,019 |   | 60,836 |   |
| **Income Before Taxes**                                                 |       | 14,397                                  |       | 13,138                                 |       | 42,353 |   | 38,968 |   |
| Provision for income taxes                                              |       | 4,905                                   |       | 4,465                                  |       | 14,259 |   | 13,257 |   |
| **Net Income**                                                          |       | $                                       | 9,492      |                                   | $          | 8,673 |   | $ | 28,094 |   | $ | 25,711 |   |
| **Earnings per share:**                                                 |       |                                    |       |                                   |       |   |   |   |   |
| **– basic**                                                        |       | $                                       | 0.42       |                                   | $          | 0.37 |   | $ | 1.23 |   | $ | 1.09 |   |
| **–  diluted**                                                     |       | $                                       | 0.41       |                                   | $          | 0.36 |   | $ | 1.20 |   | $ | 1.07 |   |
| **Dividends per share**                                                 |       | $                                       | 0.16       |                                   | $          | 0.14 |   | $ | 0.48 |   | $ | 0.42 |   |
| **Average  shares used in earnings per share calculations:**            |       |                                    |       |                                   |       |   |   |   |   |
| **– basic**                                                        |       | 22,709                                  |       | 23,369                                 |       | 22,869 |   | 23,496 |   |
| **–  diluted**                                                     |       | 23,231                                  |       | 23,842                                 |       | 23,388 |   | 23,949 |   |

 

The accompanying notesare an integral part of these consolidated statements.

 

4

----

 

**Mid-State Bancshares**

Consolidated Statementsof Comprehensive Income

(Unaudited - figures in 000’s)

 
| ** **                                                            | ** ** | **Three Month Period  Ended Sept. 30,** | ** ** | **Nine Month Period  Ended Sept. 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Net  Income**                                                       |       | $                                       | 9,492      |                                   | $          | 8,673 |   | $ | 28,094 |   | $ | 25,711 |   |
| **Other  Comprehensive Income Before Taxes:**                         |       |                                    |       |                                   |       |   |   |   |   |
| Unrealized  (losses) gains on securities available for sale:          |       |                                    |       |                                   |       |   |   |   |   |
| Unrealized  holding (losses) gains arising during period              |       | (5,288                                  | )          | 8,788                                  |       | (8,090 | ) | (4,188 | ) |
| Reclassification  adjustment for (gains) included in net income       |       | —                                  |       | (93                                    | )          | (88 | ) | (475 | ) |
| Other  comprehensive (loss) income, before tax                        |       | (5,288                                  | )          | 8,695                                  |       | (8,178 | ) | (4,663 | ) |
| Income tax  (credit) expense related to items in comprehensive income |       | (2,115                                  | )          | 3,478                                  |       | (3,271 | ) | (1,874 | ) |
| **Other  Comprehensive (Loss) Income, Net of Taxes**                  |       | (3,173                                  | )          | 5,217                                  |       | (4,907 | ) | (2,789 | ) |
| **Comprehensive  Income**                                             |       | $                                       | 6,319      |                                   | $          | 13,890 |   | $ | 23,187 |   | $ | 22,922 |   |

 

The accompanying notesare an integral part of these consolidated statements.

 

5

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**Mid-State Bancshares**

Consolidated Statementsof Changes in Capital Accounts

(Unaudited - figures in 000’s except share amounts)

 
| ** **                                                                                | ** ** | **Number of  Shares** | ** ** | **Capital  Stock** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total**  | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|------------------------|------------|------------------------------------------------------|------------|------------|------------|
|                                                                                      |       |                  |       |               |       |                   |       |                                                 |       |       |       |
| BALANCE, December 31, 2004                                                           |       | 23,099,159            |       | $                  | 61,439     |                   | $          | 206,328                                              |       | $          | 6,860      |   | $ | 274,627 |   |
| Cash dividend                                                                             |       | —                |       | —             |       | (10,941                | )          | —                                               |       | (10,941    | )          |
| Exercise of  stock options                                                                |       | 246,880               |       | 3,660              |       | —                 |       | —                                               |       | 3,660      |       |
| Tax Benefit from  exercise of options                                                     |       | —                |       | —             |       | 868                    |       | —                                               |       | 868        |       |
| Net income                                                                                |       | —                |       | —             |       | 28,094                 |       | —                                               |       | 28,094     |       |
| Change in net  unrealized gain on available for sale securities, net of taxes of ($3,271) |       | —                |       | —             |       | —                 |       | (4,907                                               | )          | (4,907     | )          |
| Stock  repurchased                                                                        |       | (723,192              | )          | (19,715            | )          | —                 |       | —                                               |       | (19,715    | )          |
|                                                                                      |       |                  |       |               |       |                   |       |                                                 |       |       |       |
| **BALANCE, Sept. 30, 2005**                                                               | ** ** | **22,622,847**        | ** ** | **$**              | **45,384** | ** **             | **$**      | **224,349**                                          | ** ** | **$**      | **1,953**  | ** ** | **$** | **271,686** |   |
| ** **                                                                                | ** ** | ** **            | ** ** | ** **         | ** ** | ** **             | ** ** | ** **                                           | ** ** | ** ** |       |
| BALANCE, December 31, 2003                                                           |       | 23,567,478            |       | $                  | 75,506     |                   | $          | 184,771                                              |       | $          | 12,277     |   | $ | 272,554 |   |
| Cash dividend                                                                             |       | —                |       | —             |       | (9,856                 | )          | —                                               |       | (9,856     | )          |
| Exercise of  stock options                                                                |       | 129,008               |       | 1,659              |       | —                 |       | —                                               |       | 1,659      |       |
| Net income                                                                                |       | —                |       | —             |       | 25,711                 |       | —                                               |       | 25,711     |       |
| Change in net  unrealized gain on available for sale securities, net of taxes of ($1,874) |       | —                |       | —             |       | —                 |       | (2,789                                               | )          | (2,789     | )          |
| Stock  repurchased                                                                        |       | (373,819              | )          | (8,817             | )          | —                 |       | —                                               |       | (8,817     | )          |
|                                                                                      |       |                  |       |               |       |                   |       |                                                 |       |       |       |
| BALANCE, Sept. 30, 2004                                                                   |       | 23,322,667            |       | $                  | 68,348     |                   | $          | 200,626                                              |       | $          | 9,488      |   | $ | 278,462 |   |

 

The accompanying notesare an integral part of these consolidated statements.

 

6

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**Mid-State Bancshares**

Consolidated Statementsof Cash Flows

(Unaudited - figures in 000’s)

 
| ** **                                                                         | ** ** | **Nine Month Period  Ended Sept. 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| **OPERATING ACTIVITIES**                                                           |       |                                   |       |   |   |
| Net Income                                                                         |       | $                                      | 28,094     |   | $ | 25,711 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                   |       |   |   |
| Provision for  credit losses                                                       |       | —                                 |       | (2,700 | ) |
| Depreciation and  amortization                                                     |       | 4,044                                  |       | 4,669 |   |
| Net amortization  of prem./discounts-investments                                   |       | 2,799                                  |       | 3,987 |   |
| Gain on sale of  loans held for sale                                               |       | (417                                   | )          | (414 | ) |
| Gain on sale of  other real estate owned                                           |       | —                                 |       | (1,084 | ) |
| Gain on sale of  securities, net                                                   |       | (88                                    | )          | (475 | ) |
| Net decrease in  loans held for sale                                               |       | 3,016                                  |       | 3,823 |   |
| Change in  deferred loan fees                                                      |       | (340                                   | )          | (146 | ) |
| Changes in  assets and liabilities:                                                |       |                                   |       |   |   |
| Accrued interest  receivable                                                       |       | (2,017                                 | )          | (925 | ) |
| Core deposit  intangible                                                           |       | 1,031                                  |       | 1,031 |   |
| Other assets,  net                                                                 |       | 69                                     |       | (4,141 | ) |
| Other  liabilities, net                                                            |       | 1,580                                  |       | 9,451 |   |
| Net cash  provided by operating activities                                         |       | 37,771                                 |       | 38,787 |   |
| **INVESTING ACTIVITIES**                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Proceeds from sales  and maturities of investments                                 |       | 125,265                                |       | 117,541 |   |
| Purchases of  investments                                                          |       | (139,052                               | )          | (39,960 | ) |
| Net increase in  loans                                                             |       | (77,737                                | )          | (238,851 | ) |
| Proceeds from  sale of other real estate owned                                     |       | —                                 |       | 4,512 |   |
| Purchases of  premises and equipment, net                                          |       | (3,733                                 | )          | (2,526 | ) |
| Net cash used in  investing activities                                             |       | (95,257                                | )          | (159,284 | ) |
| **FINANCING ACTIVITIES**                                                           |       |                                   |       |   |   |
| Net increase in  deposits                                                          |       | 111,417                                |       | 87,136 |   |
| Increase  (decrease) in other borrowings                                           |       | 17,098                                 |       | (1,784 | ) |
| Exercise of  stock options                                                         |       | 3,660                                  |       | 1,659 |   |
| Cash dividends  paid                                                               |       | (10,941                                | )          | (9,856 | ) |
| Repurchase of  company stock                                                       |       | (19,715                                | )          | (8,817 | ) |
| Net cash  provided by financing activities                                         |       | 101,519                                |       | 68,338 |   |
| Increase  (decrease) in cash and cash equivalents                                  |       | 44,033                                 |       | (52,159 | ) |
| Cash and cash  equivalents, beginning of period                                    |       | 118,669                                |       | 171,263 |   |
| Cash and cash  equivalents, end of period                                          |       | $                                      | 162,702    |   | $ | 119,104 |   |
| Supplemental disclosure of cash flow information:                                  |       |                                   |       |   |   |
| Cash paid during  the period for interest                                          |       | $                                      | 9,782      |   | $ | 6,138 |   |
| Cash paid during  the period for taxes on income                                   |       | 14,457                                 |       | 9,306 |   |
| Supplemental disclosure of non-cash investing  activities:                         |       |                                   |       |   |   |
| Transfer of  security investment for other assets                                  |       | 30,000                                 |       | — |   |

 

The accompanying notesare an integral part of these consolidated statements.

 

7

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**Mid-State Bancshares**

Notes to ConsolidatedFinancial Statements

(Information with respect to interim periods is unaudited)

 

**NOTE A -BASIS OF PRESENTATION AND MANAGEMENT REPRESENTATION**

 

The accompanying consolidated financial statements include the accountsof Mid-State Bancshares and its wholly owned subsidiary Mid-State Bank &Trust and the Bank’s subsidiaries, MSB Properties and Mid-Coast Land Company(collectively the “Company,” “Bank” or “Mid-State”).  All significant inter-company transactionshave been eliminated in consolidation. These consolidated financial statements should be read in conjunctionwith the Form 10-K Annual Report for the year ended December 31, 2004of Mid-State Bancshares.  A summary ofthe Company’s significant accounting policies is set forth in the Notes toConsolidated Financial Statements contained therein.

 

These consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States on a basis consistent withthe accounting policies reflected in the audited consolidated financialstatements included in the Annual Report on Form 10-K for the year ended December 31,2004.  They do not, however, include allof the information and footnotes required by accounting principles generallyaccepted in the United States for complete financial statements.  In the opinion of management, all adjustmentsincluding normal recurring accruals considered necessary for a fairpresentation have been included. Operating results for the interim periods presented are not necessarilyindicative of the results that may be expected for any other interim period orfor the year as a whole.

 

**NOTE B -EARNINGS PER SHARE**

 

The following is areconciliation of net income and shares outstanding to the income and number ofshares used to compute Earnings Per Share (“EPS”).  Figures are in thousands, except earnings pershare data.

 
| ** **                               | ** ** | **Three Month Period Ended  Sept. 30, 2005** | ** ** | **Three Month Period Ended  Sept. 30, 2004** | ** ** |
|------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                               | ** ** | **Net Income**                               | ** ** | **Shares**                                   | ** ** | **EPS** | ** ** | **Net Income** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Net Income as reported                   |       | $                                            | 9,492      |                                         |       |   |   |   | $ | 8,673 |   |   |   |   |   |
|                                     |       |                                         |       |                                         |       |   |   |   |   |   |   |   |   |
| Basic Earnings Per Share:                |       |                                         |       |                                         |       |   |   |   |   |   |   |   |   |
| Income available  to Common Shareholders |       | $                                            | 9,492      |                                         | 22,709     |   | $ | 0.42 |   | $ | 8,673 |   | 23,369 |   | $ | 0.37 |   |
|                                     |       |                                         |       |                                         |       |   |   |   |   |   |   |   |   |
| Effect of dilutive securities:           |       |                                         |       |                                         |       |   |   |   |   |   |   |   |   |
| Stock Options                            |       |                                         |       | 522                                          |       |   |   |   |   | 473 |   |   |   |
|                                     |       |                                         |       |                                         |       |   |   |   |   |   |   |   |   |
| Diluted Earnings Per Share:              |       |                                         |       |                                         |       |   |   |   |   |   |   |   |   |
| Income available  to Common Shareholders |       | $                                            | 9,492      |                                         | 23,231     |   | $ | 0.41 |   | $ | 8,673 |   | 23,842 |   | $ | 0.36 |   |

 

8

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| ** **                               | ** ** | **Nine Month Period Ended  Sept. 30, 2005** | ** ** | **Nine Month Period Ended  Sept. 30, 2004** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **Net Income**                              | ** ** | **Shares**                                  | ** ** | **EPS** | ** ** | **Net Income** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Net Income as reported                   |       | $                                           | 28,094     |                                        |       |   |   |   | $ | 25,711 |   |   |   |   |   |
|                                     |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic Earnings Per Share:                |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Income available  to Common Shareholders |       | $                                           | 28,094     |                                        | 22,869     |   | $ | 1.23 |   | $ | 25,711 |   | 23,496 |   | $ | 1.09 |   |
|                                     |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Effect of dilutive securities:           |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Stock Options                            |       |                                        |       | 519                                         |       |   |   |   |   | 453 |   |   |   |
|                                     |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Diluted Earnings Per Share:              |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Income available  to Common Shareholders |       | $                                           | 28,094     |                                        | 23,388     |   | $ | 1.20 |   | $ | 25,711 |   | 23,949 |   | $ | 1.07 |   |

 

#### **NOTE C – RECENTACCOUNTING PRONOUNCEMENTS**

 

In December 2003,the Accounting Standards Executive Committee (AcSEC) of the American Instituteof Certified Public Accountants (AICPA) issued Statement of Position (SOP) 03-3,“Accounting for Certain Loans or Debt Securities Acquired in a Transfer.”  The SOP was effective for loans acquired infiscal years beginning after December 15, 2004, with early adoptionencouraged.  The SOP addresses accountingfor differences between contractual cash flows and cash flows expected to becollected from an investor’s initial investment in loans or debt securitiesacquired in a transfer if those differences are attributable, at least in part,to credit quality.  The adoption of SOP 03-3did not have a material impact on the Company’s results of operations andfinancial position.

 

In June 2004, theEmerging Issues Task Force of the Financial Accounting Standards Board (FASB)issued guidance on its Issue No. 03-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments.”  The guidance made recommendations regardingunrealized losses on available-for-sale debt and equity securities accountedfor under Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debtand Equity Securities,” and No. 124, “Accounting for Certain Investments Held by Not-for-ProfitOrganizations.”  The guidance forevaluating whether an investment is other-than-temporarily impaired was to beapplied in other-than-temporary impairment evaluations made in reporting periodsbeginning after June 15, 2004.  Thedisclosures were to be effective in annual financial statements for fiscalyears ending after December 15, 2003, for investments accounted for underStatements 115 and 124.  On September 30,2004, the FASB Board directed the issuance of FASB Staff Position (FSP) EITFIssue 03-1-a, “Implementation Guidance for the Application of Paragraph 16 ofEITF Issue No. 03-1.”  The proposedFSP would provide implementation guidance with respect to debt securities thatare impaired solely due to interest rates and/or sector spreads and analyzedfor other-than-temporary impairment under paragraph 16 of issue 03-1.  The FASB asked constituents to comment onwhether the application guidance with respect to “minor impairments” shouldalso be applied to securities analyzed for impairment under paragraphs 10-15 ofIssue 03-1.  At the June 29, 2005meeting, the Board decided not to provide additional guidance on the meaning ofother-than-temporary impairment and directed the staff to finalize proposedFASB Staff Position (FSP) EITF 03-1-a, “Implementation Guidance for theApplication of Paragraph 16 of EITF Issue No. 03-1.” The final FSP,retitled as FSP FAS 115-1, “The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments,” would:

 

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1.               Replace the guidance in paragraphs 10–18 ofEITF Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments,” and refer to existing other-than-temporaryimpairment guidance—for example, FASB Statement No. 115, *Accounting for Certain Investments in Debt and EquitySecurities,* APB Opinion No. 18, *The Equity Method of Accounting for Investments in Common Stock,*and SEC Staff Accounting Bulletin No. 59, “Accounting for NoncurrentMarketable Equity Securities”

 

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

 

3.               Codify the guidance set forth in Topic D-44and clarify that an investor should recognize an impairment loss no later thanwhen the impairment is deemed other than temporary, even if a decision to sellhas not been made

 

4.               Be effective for other-than-temporary impairmentanalyses conducted in periods beginning after September 15, 2005.

 

Atthe September 7, 2005 meeting, the Board directed the staff to considertransition guidance for the proposed FSP. At the September 14, 2005 meeting, the Board decided to retain the paragraphin the proposed FSP pertaining to the accounting for debt securities subsequentto an other-than-temporary impairment and add a footnote to clarify that theproposed FSP does not address when a debt security should be designated asnonaccrual or how to subsequently report income on a nonaccrual debtsecurity.  In addition, the Board decidedthat (1) transition would be applied prospectively and (2) theeffective date would be reporting periods beginning after December 15,2005.  Adoption of EITF Issue 03-1-a isnot expected to have a material impact on the Company’s results of operationsand its financial position.

 

The FASB issued arevision to SFAS No. 123, “Accounting for Stock-Based Compensation” in December 2004.  The revised Statement is SFAS No. 123R(revised 2004), “Share-Based Payment” and it will supercede APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and its related implementationguidance.  It is to be effective for theCompany as of the beginning of the first annual reporting period that beginsafter June 15, 2005.  The Statementrequires that the Company measures the cost of employee services received inexchange for an award of equity instruments (share based payment awards) basedon the grant date fair value of the award and the estimated number of awardsthat are expected to vest.  The cost willbe recognized over the period during which an employee is required to provideservice in exchange for the award – usually the vesting period.  Compensation cost for awards that vest wouldnot be reversed if the awards expire without being exercised.  The Company currently applies APB Opinion No. 25,in accounting for its Plan.  Accordingly,no compensation expense has been recognized for grants under the Plan.  Pro forma disclosures of net income andearnings per share are however disclosed in Note 15 of the Company’s AnnualReport on Form 10K.  The Companyexpects to adopt the revised Statement for the first quarter of 2006.  The Company is considering several options inimplementing the new accounting treatment, including, among other things, theacceleration of vesting of existing options in 2005 which would result in botha charge to earnings prior to year-end and additional diluted sharesoutstanding.  The exact amount of theimpact, if acceleration is selected, is still being calculated at this time.  Absent the acceleration of vesting in 2005,the Company expects that adoption of SFAS No. 123R would have a materialeffect on its Consolidated Statements of Income, Comprehensive Income andChanges in Capital Accounts in future years.

 

FASB issued SFAS No. 154,“*Accounting Changes and Error Corrections”* on June 1, 2005, a replacementof APB No. 20 and SFAS No. 3.  TheStatement applies to all voluntary changes in accounting principle, and changesthe requirements for accounting for and reporting of a change in accountingprinciple.  SFAS No. 154 requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is impracticable.  APB No. 20 previously required that mostvoluntary changes in accounting

 

10

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principle be recognizedby including in net income of the period of the change the cumulative effect ofchanging to the new accounting principle.  SFAS No. 154 improves financial reportingbecause its requirements enhance the consistency of financial informationbetween periods.  SFAS No. 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. The Company expects to adopt the Statement for the first quarter of 2006and expects it will not have a material effect on its consolidated financialstatements.

 

**NOTE D –CORE DEPOSIT INTANGIBLES, NET**

 

The following is asummary of the Company’s core deposit intangibles.  Figures are in thousands (unaudited).

 
| ** **              | ** ** | **Sept. 30, 2005**     | ** ** | **Sept. 30, 2004**            | ** ** |
|-------------------------|------------|------------------------|------------|-------------------------------|------------|
| ** **              | ** ** | **Gross  Amount**      | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** |
|                    |       |                   |       |                          |       |   |   |   |   |   |   |   |   |
| Core Deposit Intangible |       | $                      | 11,596     |                          | $          | (4,895 | ) | $ | 6,701 |   | $ | 11,596 |   | $ | (3,520 | ) | $ | 8,076 |   |
|                    |       |                   |       |                          |       |   |   |   |   |   |   |   |   |
| ** **              | ** ** | **Dec. 31, 2004** | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Gross  Amount**      | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                    |       |                   |       |                          |       |   |   |   |   |   |   |   |   |
| Core Deposit Intangible |       | $                      | 11,596     |                          | $          | (3,864 | ) | $ | 7,732 |   |   |   |   |   |   |   |
|                         |            |                        |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

AggregateAmortization Expense of Core Deposit Intangibles ($ in 000’s):

 
| ** **                              | ** ** | **Three Month Period  Ended Sept. 30,** | ** ** | **Nine Month Period  Ended Sept. 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                              | ** ** | **2005**                                | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Amortization of Core Deposit Intangible |       | $                                       | 344        |                                   | $          | 344 |   | $ | 1,031 |   | $ | 1,031 |   |
|                                         |            |                                         |            |                                        |            |  |  |  |  |  |  |  |  |

 

The amortization expensefor core deposit intangibles is included within other operating expenses on theconsolidated statements of income.  Basedon a review of the Company’s core deposit intangible at September 30, 2005in relation to the core deposits retained to which the intangible relates, itwas determined that a downward adjustment in the amortization rate wasappropriate under generally accepted accounting principles.  The projected amortization  expense for  core depositintangibles,  assuming no further  acquisitions or dispositions or changes in amortizationrates, is approximately $872 thousand per year over the next five years.

 

**NOTE E –STOCK OPTIONS**

 

On May 17, 2005, shareholders of the Company approved a new equitybased compensation plan, the Mid-State Bancshares 2005 Equity BasedCompensation Plan (the “2005 Plan”) which reserves an additional 1,000,000common shares for issuance in accordance with the terms of the Plan.  The 2005 Plan provides for the grant of stockoptions, stock appreciation rights, restricted shares, restricted share units,performance based cash only awards, or any combination thereof.  It replaces the 1996 Stock Option Plan whichis described more fully in Footnote 15 of the Company’s December 31, 2004Annual Report on Form 10-K.  Shares availablefor issuance under the 1996 Plan are now included in the 2005 Plan, resultingin 1,025,572 shares currently being available to be issued (4.53% of currentand issued outstanding common stock) as of September 30, 2005.

 

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The Company accounts for stock options using the intrinsic value methodunder the provisions of Accounting Principles Board (“APB”) Opinion No. 25and provides proforma net income and proforma earnings per share disclosuresfor employee stock option grants as if the fair-value-based method, defined inSFAS No. 123, “Accounting for Stock-Based Compensation,” had beenapplied.  Had the Company determinedcompensation cost based on the fair value at the grant date for its stockoptions under SFAS No. 123, the Company’s net income would have beenreduced to the pro forma amounts indicated below for the three month and ninemonth periods ended September 30. The assumptions utilized in calculating the stock-based compensationexpense determined under the intrinsic value based method were generally thesame at September 30, 2005 and 2004 as they were at year-end.

 
| ** **                                                                                                                         | ** ** | **Three Month Period  Ended Sept. 30,** | ** ** | **Nine Month Period  Ended Sept. 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| **(dollars in 000’s except per  share amounts)**                                                                              | ** ** | **2005**                                | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income, as reported                                                                                                            |       | $                                       | 9,492      |                                   | $          | 8,673 |   | $ | 28,094 |   | $ | 25,711 |   |
| Deduct: Total  stock-based compensation expense determined under the fair value based method  for all awards, net of related taxes |       | (609                                    | )          | (484                                   | )          | (1,769 | ) | (1,408 | ) |
|                                                                                                                               |       |                                    |       |                                   |       |   |   |   |   |
| Proforma net income                                                                                                                |       | $                                       | 8,883      |                                   | $          | 8,189 |   | $ | 26,325 |   | $ | 24,303 |   |
|                                                                                                                               |       |                                    |       |                                   |       |   |   |   |   |
| Basic income per share, as reported                                                                                                |       | $                                       | 0.42       |                                   | $          | 0.37 |   | $ | 1.23 |   | $ | 1.09 |   |
| Proforma basic income per share                                                                                                    |       | $                                       | 0.39       |                                   | $          | 0.35 |   | $ | 1.15 |   | $ | 1.03 |   |
|                                                                                                                               |       |                                    |       |                                   |       |   |   |   |   |
| Diluted income per share, as reported                                                                                              |       | $                                       | 0.41       |                                   | $          | 0.36 |   | $ | 1.20 |   | $ | 1.07 |   |
| Proforma diluted income per share                                                                                                  |       | $                                       | 0.38       |                                   | $          | 0.34 |   | $ | 1.13 |   | $ | 1.01 |   |

 

**NOTE F - SECURITIES**

 

The following table shows those investmentswith gross unrealized losses and their market value aggregated by investment categoryand length of time that individual securities have been in a continuousunrealized loss position at September 30, 2005.

 
| ** **                                               | ** ** | **Less than 12 months** | ** ** | **12 months or more**  | ** ** | **Total**         | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|-------------------|------------|
| **(amounts in 000’s)**                              | ** ** | **Market  Value**       | ** ** | **Unrealized  Losses** | ** ** | **Market  Value** | ** ** | **Unrealized  Losses** | ** ** | **Market  Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S. Treasury  securities                                |       | $                       | 10,873     |                   | $          | (20               | )          | $ | 12,860 |   | $ | (165 | ) | $ | 23,733 |   | $ | (185 | ) |
|                                                     |       |                    |       |                   |       |              |       |   |   |   |   |   |   |
| Securities of  U.S. government agencies and corporations |       | 82,387                  |       | (493                   | )          | 105,755           |       | (1,196 | ) | 188,142 |   | (1,689 | ) |
| Mortgage backed  securities                              |       | 1,349                   |       | (8                     | )          | 1,754             |       | (46 | ) | 3,103 |   | (54 | ) |
| Obligations of  states and political subdivisions        |       | 101,440                 |       | (877                   | )          | 16,678            |       | (383 | ) | 118,118 |   | (1,260 | ) |
| Other  investments                                       |       | 3,955                   |       | (53                    | )          | —            |       | — |   | 3,955 |   | (53 | ) |
| *TOTAL*                                                  |       | $                       | 200,004    |                   | $          | (1,451            | )          | $ | 137,047 |   | $ | (1,790 | ) | $ | 337,051 |   | $ | (3,241 | ) |

 

All of the unrealizedlosses identified in the table above are primarily attributable to changes ingeneral interest rate levels and are not considered to be other than a temporaryimpairment.  The unrealized losses arenot the result of any deteriorating financial conditions or near term prospectsof the underlying issuers and Management believes that it has the intent andability to retain these investment securities to allow for the eventualrecovery in market value.

 

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**NOTE G – OTHER ASSETS**

 

During the second quarter of 2005, the Company made an investment inthe amount of $30.0 million in a security of a U.S. government agency.  That security was exchanged for an interestbearing investment in the Senior Housing Crime Prevention Foundation InvestmentCorporation (SHCPF-I) with the U.S. government agency held in safekeepingreflecting ownership by SHCPF-I and the pledge of that Security in favor ofMid-State Bank & Trust.  Theinvestment provides funding for the Senior Housing Crime Prevention Foundationin its efforts to prevent elder abuse in nursing homes throughout the Company’sservice area.  This investment isincluded under Other Assets within the Company’s Consolidated Statements ofFinancial Position.

 

**NOTE H –REPORTABLE BUSINESS SEGMENTS**

 

Below is a summarystatement of income for the three months and nine months ended September 30,2005 and 2004 for each reportable business segment.

 

*ThreeMonths Ended September 30,*

 
| **(unaudited –**      | ** ** | **Community Banking** | ** ** | **Mid Coast Land  Company** | ** ** | **Trust Services** | ** ** | **Mid-State Bancshares** | ** ** |
|----------------------------|------------|-----------------------|------------|-----------------------------|------------|--------------------|------------|--------------------------|------------|
| **dollars in 000’s)** | ** ** | **2005**              | ** ** | **2004**                    | ** ** | **2005**           | ** ** | **2004**                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
|                       |       |                  |       |                        |       |               |       |                     |       |   |   |   |   |   |   |   |   |
| Interest Income            |       | $                     | 32,923     |                        | $          | 28,236             |       | $                        | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 32,923 |   | $ | 28,236 |   |
| Interest Expense           |       | 4,324                 |       | 2,083                       |       | —             |       | —                   |       | — |   | — |   | 4,324 |   | 2,083 |   |
| Net Interest Income        |       | 28,599                |       | 26,153                      |       | —             |       | —                   |       | — |   | — |   | 28,599 |   | 26,153 |   |
| Provision for Loan Losses  |       | —                |       | —                      |       | —             |       | —                   |       | — |   | — |   | — |   | — |   |
| Non Interest Income        |       | 4,749                 |       | 6,908                       |       | 179                |       | 106                      |       | 343 |   | 236 |   | 5,271 |   | 7,250 |   |
| Non Interest Expense       |       | 19,229                |       | 20,045                      |       | 3                  |       | 3                        |       | 241 |   | 217 |   | 19,473 |   | 20,265 |   |
| Pre-Tax Income             |       | $                     | 14,119     |                        | $          | 13,016             |       | $                        | 176        |   | $ | 103 |   | $ | 102 |   | $ | 19 |   | $ | 14,397 |   | $ | 13,138 |   |

 

*NineMonths Ended September 30,*

 
| **(unaudited –**      | ** ** | **Community Banking** | ** ** | **Mid Coast Land  Company** | ** ** | **Trust Services** | ** ** | **Mid-State Bancshares** | ** ** |
|----------------------------|------------|-----------------------|------------|-----------------------------|------------|--------------------|------------|--------------------------|------------|
| **dollars in 000’s)** | ** ** | **2005**              | ** ** | **2004**                    | ** ** | **2005**           | ** ** | **2004**                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
|                       |       |                  |       |                        |       |               |       |                     |       |   |   |   |   |   |   |   |   |
| Interest Income            |       | $                     | 94,059     |                        | $          | 81,093             |       | $                        | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 94,059 |   | $ | 81,093 |   |
| Interest Expense           |       | 10,731                |       | 6,149                       |       | —             |       | —                   |       | — |   | — |   | 10,731 |   | 6,149 |   |
| Net Interest Income        |       | 83,328                |       | 74,944                      |       | —             |       | —                   |       | — |   | — |   | 83,328 |   | 74,944 |   |
| Provision for Loan Losses  |       | —                |       | (2,700                      | )          | —             |       | —                   |       | — |   | — |   | — |   | (2,700 | ) |
| Non Interest Income        |       | 14,603                |       | 21,000                      |       | 529                |       | 485                      |       | 912 |   | 675 |   | 16,044 |   | 22,160 |   |
| Non Interest Expense       |       | 56,321                |       | 60,189                      |       | 9                  |       | 24                       |       | 689 |   | 623 |   | 57,019 |   | 60,836 |   |
| Pre-Tax Income             |       | $                     | 41,610     |                        | $          | 38,455             |       | $                        | 520        |   | $ | 461 |   | $ | 223 |   | $ | 52 |   | $ | 42,353 |   | $ | 38,968 |   |

 

**NOTE I – GUARANTEES**

 

The Company has guarantees outstanding underperformance standby letter of credit accommodations made to its customers inthe ordinary course of business totaling $52.0 million at September 30,2005, up from $29.1 million one year earlier.

 

Letters of credit are issued in connection withagreements made by customers to counterparties. Terms of these letters of credit are generally for one year and may ormay not be collateralized by receivables or other assets.  If the customer fails to comply with theagreement, the counterparty may enforce the letter of credit as a

 

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remedy.  Credit risk arises from the possibility thatthe customer may not be able to repay the Company.  The notional amount of the letter of creditaccommodations represents the maximum amount of future cash payments.

 

Many of the commitments are expected to expire withoutbeing drawn upon.  Accordingly, the totaloutstanding commitment amount does not necessarily represent future cashrequirements.  The Company does notanticipate any significant losses as a result of these transactions.  Provision has been made for losses which maybe sustained in the fulfillment of, or from an inability to fulfill, anycommitments.  The provision at September 30,2005 was $1.8 million, compared to $1.7 million one year earlier, and isreflected on the Consolidated Statements of Financial Position as Allowance forLosses – Unfunded Commitments.

 

**Item 2 -Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

The following is management’s discussion and analysisof the major factors that influenced our financial performance for the threemonths and nine months ended September 30, 2005.  This analysis should be read in conjunctionwith our 2004 Annual Report as filed on Form 10-K and with the unauditedfinancial statements and notes as set forth in this report.  *Unless the contextrequires otherwise, the terms “Company,” “us,” “we,” and “our” refers toMid-State Bancshares on a consolidated basis.*

 

Certain statements contained in this Quarterly Report of Form 10-Q(“Report”), including, without limitation, statements containing the words “estimate,”“believes,” “anticipates,” “intends,” “may,” “expects,” “could,” and words ofsimilar import, constitute “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934.  These forward-lookingstatements relate to, among other things, our current expectations regardingfuture operating results, net interest margin, strength of the local economy, therecovery of unrealized losses in the investment portfolio and allowance forcredit losses.  Such forward lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause our actual results, performance or achievements to be materiallydifferent from any future results, performance or achievements expressed orimplied by such forward-looking statements. Such factors include, among others, those concerning (i) theCompany’s strategies, objectives and plans for expansion of its operations,products and services, and growth of its portfolio of loans, investments anddeposits, (ii) the Company’s beliefs and expectations regarding actionsthat may be taken by regulatory authorities having oversight of its operationand interest rates, (iii) the Company’s beliefs as to the adequacy of itsexisting and anticipated allowances for loan and real estate losses and itsexpectations about the loss potential in its non-performing loans, (iv) theCompany’s beliefs and expectations concerning future operating results, (v) thegrowth of its loan portfolio and its net interest margin and (vi) thestrength of the economy and the increasing levels of competition in its servicearea.  Additional information on theseand other factors that could affect financial results may be found in the Company’s2004 Annual Report as filed on form 10-K, including in “Item 1. Business -Factors That May Affect Future Results of Operations.”  When relying on forward-looking statements tomake decisions with respect to our Company, investors and others are cautionedto consider these and other risks and uncertainties.  We disclaim any obligation to update any suchfactors or to publicly announce the results of any revisions to any of theforward-looking statements contained herein to reflect future events or developments.

 

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

 

***CriticalAccounting Policies and Estimates***This “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” aswell as, disclosures included elsewhere in this Form 10-Q, are based uponthe Company’s consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America.  The preparation of thesefinancial statements require Management to make estimates and judgments thataffect the reported amounts of assets, liabilities,

 

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revenues, expenses and relateddisclosure of contingencies.  A summaryof the more significant accounting policies of the Company can be found inFootnote One to the financial statements which is included in Item 8 of theCompany’s Annual Report on Form 10-K and in the Management’s Discussionand Analysis included in Item 7 of that same report entitled “CriticalAccounting Policies and Estimates.”

 

***InternalControls Over Financial Reporting***  There was no change in our internal controlover financial reporting that occurred during the period covered by thisQuarterly Report on Form 10-Q that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.  We continue to enhance ourinternal control over financial reporting, primarily by evaluating andenhancing our processes and control documentation, in connection with ourongoing efforts to meet the requirements of Section 404 of theSarbanes-Oxley Act of 2002.  We discusswith and disclose these matters to the Audit Committee of our Board ofDirectors and our external, independent auditors.  (See “Item 4 – Controls and Procedures.”)

 

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***SelectedFinancial Data - Summary***.    The following table provides certainselected consolidated financial data as of and for the three months ending September 30,2005 and 2004 (unaudited in 000’s, except per share data).

 
| ** **                                                  | ** ** | **Quarter Ended**  | ** ** | **At or for the 9 months ended** | ** ** |
|-------------------------------------------------------------|------------|--------------------|------------|----------------------------------|------------|
| **(In 000’s, except per share  data)**                 | ** ** | **Sept. 30, 2005** | ** ** | **Sept. 30, 2004**               | ** ** | **Sept. 30, 2005** | ** ** | **Sept. 30, 2004** | ** ** |
|                                                        |       |               |       |                             |       |   |   |   |   |
| Interest Income                                             |       | $                  | 32,923     |                             | $          | 28,236 |   | $ | 94,059 |   | $ | 81,093 |   |
| Interest Expense                                            |       | 4,324              |       | 2,083                            |       | 10,731 |   | 6,149 |   |
| Net Interest  Income                                        |       | 28,599             |       | 26,153                           |       | 83,328 |   | 74,944 |   |
| (Benefit)/Provision  for Loan Losses                        |       | —             |       | —                           |       | — |   | (2,700 | ) |
| Net Interest  Income after provision for loan losses        |       | 28,599             |       | 26,153                           |       | 83,328 |   | 77,644 |   |
| Non-interest  income                                        |       | 5,271              |       | 7,250                            |       | 16,044 |   | 22,160 |   |
| Non-interest  expense                                       |       | 19,473             |       | 20,265                           |       | 57,019 |   | 60,836 |   |
| Income before  income taxes                                 |       | 14,397             |       | 13,138                           |       | 42,353 |   | 38,968 |   |
| Provision for  income taxes                                 |       | 4,905              |       | 4,465                            |       | 14,259 |   | 13,257 |   |
| Net Income                                                  |       | $                  | 9,492      |                             | $          | 8,673 |   | $ | 28,094 |   | $ | 25,711 |   |
|                                                        |       |               |       |                             |       |   |   |   |   |
| **Per  share:**                                             |       |               |       |                             |       |   |   |   |   |
| Net Income -  basic                                         |       | $                  | 0.42       |                             | $          | 0.37 |   | $ | 1.23 |   | $ | 1.09 |   |
| Net Income -  diluted                                       |       | $                  | 0.41       |                             | $          | 0.36 |   | $ | 1.20 |   | $ | 1.07 |   |
| Weighted average  shares used in Basic E.P.S. calculation   |       | 22,709             |       | 23,369                           |       | 22,869 |   | 23,496 |   |
| Weighted average  shares used in Diluted E.P.S. calculation |       | 23,231             |       | 23,842                           |       | 23,388 |   | 23,949 |   |
| Cash dividends                                              |       | $                  | 0.16       |                             | $          | 0.14 |   | $ | 0.48 |   | $ | 0.42 |   |
| Book value at  period-end                                   |       |               |       |                             |       | $ | 12.01 |   | $ | 11.94 |   |
| Tangible book  value at period end                          |       |               |       |                             |       | $ | 9.60 |   | $ | 9.54 |   |
| Ending Shares                                               |       |               |       |                             |       | 22,623 |   | 23,323 |   |
|                                                        |       |               |       |                             |       |   |   |   |   |
| **Financial  Ratios**                                       |       |               |       |                             |       |   |   |   |   |
| Return on assets  (annualized)                              |       | 1.57               | %          | 1.50                             | %          | 1.60 | % | 1.53 | % |
| Return on  tangible assets (annualized)                     |       | 1.60               | %          | 1.53                             | %          | 1.64 | % | 1.57 | % |
| Return on equity  (annualized)                              |       | 13.65              | %          | 12.47                            | %          | 13.62 | % | 12.42 | % |
| Return on  tangible equity (annualized)                     |       | 17.03              | %          | 15.64                            | %          | 17.01 | % | 15.61 | % |
| Net interest  margin                                        |       | 5.22               | %          | 5.01                             | %          | 5.27 | % | 4.93 | % |
| Net interest  margin (taxable equivalent yield)             |       | 5.63               | %          | 5.41                             | %          | 5.69 | % | 5.34 | % |
| Net loan losses  (recoveries) to avg. loans                 |       | 0.49               | %          | (0.01                            | )%         | 0.21 | % | (0.06 | )% |
| Efficiency ratio                                            |       | 57.5               | %          | 60.7                             | %          | 57.4 | % | 62.7 | % |
|                                                        |       |               |       |                             |       |   |   |   |   |
| **Period  Averages**                                        |       |               |       |                             |       |   |   |   |   |
| Total Assets                                                |       | $                  | 2,401,998  |                             | $          | 2,306,318 |   | $ | 2,349,750 |   | $ | 2,249,562 |   |
| Total Tangible  Assets                                      |       | 2,347,308          |       | 2,250,254                        |       | 2,294,719 |   | 2,193,155 |   |
| Total Loans  (includes loans held for sale)                 |       | 1,517,357          |       | 1,358,768                        |       | 1,470,976 |   | 1,279,738 |   |
| Total Earning  Assets                                       |       | 2,172,310          |       | 2,077,356                        |       | 2,113,833 |   | 2,031,150 |   |
| Total Deposits                                              |       | 2,082,464          |       | 2,005,694                        |       | 2,032,504 |   | 1,951,211 |   |
| Common Equity                                               |       | 275,854            |       | 276,652                          |       | 275,846 |   | 276,426 |   |
| Common Tangible  Equity                                     |       | 221,164            |       | 220,587                          |       | 220,815 |   | 220,019 |   |

 

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| **(In 000’s, except per share  data)**                    | ** ** | **Sept. 30,2005** | ** ** | **Sept. 30, 2004** | ** ** |
|----------------------------------------------------------------|------------|-------------------|------------|--------------------|------------|
| **Balance Sheet - At Period-End**                              |       |              |       |               |       |
| Cash and due from banks                                        |       | $                 | 130,602    |               | $          | 119,104 |   |
| Investments and Fed Funds Sold                                 |       | 649,815           |       | 688,923            |       |
| Loans held for sale                                            |       | 10,391            |       | 10,001             |       |
| Loans, net of deferred fees, before allowance for  loan losses |       | 1,497,704         |       | 1,394,478          |       |
| Allowance for Loan Losses                                      |       | (11,532           | )          | (13,912            | )          |
| Goodwill and core deposit intangibles                          |       | 54,541            |       | 55,916             |       |
| Other assets                                                   |       | 90,852            |       | 55,033             |       |
| Total Assets                                                   |       | $                 | 2,422,373  |               | $          | 2,309,543 |   |
|                                                           |       |              |       |               |       |
| Non-interest bearing deposits                                  |       | $                 | 589,601    |               | $          | 524,785 |   |
| Interest bearing deposits                                      |       | 1,516,361         |       | 1,474,782          |       |
| Other borrowings                                               |       | 23,680            |       | 5,843              |       |
| Allowance for losses - unfunded commitments                    |       | 1,839             |       | 1,682              |       |
| Other liabilities                                              |       | 19,206            |       | 23,989             |       |
| Shareholders’ equity                                      |       | 271,686           |       | 278,462            |       |
| Total  Liabilities and Shareholders’ equity               |       | $                 | 2,422,373  |               | $          | 2,309,543 |   |
|                                                           |       |              |       |               |       |
| **Asset Quality & Capital - At Period-End**           |       |              |       |               |       |
| Non-accrual loans                                              |       | $                 | 8,323      |               | $          | 10,954 |   |
| Loans past due 90 days or more                                 |       | —            |       | —             |       |
| Other real estate owned                                        |       | —            |       | —             |       |
| Total non performing assets                                    |       | $                 | 8,323      |               | $          | 10,954 |   |
|                                                           |       |              |       |               |       |
| Allowance for losses to loans, gross (1)                       |       | 0.9               | %          | 1.1                | %          |
| Non-accrual loans to total loans, gross                        |       | 0.6               | %          | 0.8                | %          |
| Non performing assets to total assets                          |       | 0.3               | %          | 0.5                | %          |
| Allowance for losses to non performing loans (1)               |       | 160.7             | %          | 142.4              | %          |
|                                                           |       |              |       |               |       |
| Equity to average assets (leverage ratio)                      |       | 9.2               | %          | 9.5                | %          |
| Tier One capital to risk-adjusted assets                       |       | 11.5              | %          | 12.4               | %          |
| Total capital to risk-adjusted assets                          |       | 12.2              | %          | 13.3               | %          |

 

----

(1) Includes allowance for loan losses and allowance for losses -unfunded commitments

 

***PerformanceSummary.* **TheCompany posted net income of $9.5 million for the three months ended September 30,2005 compared to $8.7 million in the like 2004 period.  On a per share basis, diluted earnings pershare were $0.41 in the 2005 period compared to $0.36 in the same quarter of2004.  These earnings represent an annualizedreturn on assets (R.O.A.) of 1.57% and 1.50%, respectively.  The annualized return on equity was 13.65%for the third quarter of 2005 compared to 12.47% in the third quarter of 2004.  The improved return on equity reflects boththe improved R.O.A. noted above and the increased leverage of the Company.  The Company’s leverage ratio was 9.2% at September 30,2005 compared to 9.5% one year earlier. The growth in shareholders’ equity has been below the growth of theassets of the Company because the payment of dividends and the repurchase ofcommon stock has exceeded the retention of the Company’s net income over thepast twelve months.  The improvedprofitability as reflected in the R.O.A. noted above can generally be traced toimproved net interest income in the 2005 period relative to 2004 owing to bothvolume and rate considerations discussed below. This improvement more than offset a decrease in non interest income netof the decrease in non interest expense.

 

For the nine monthsyear-to-date, the Company posted net income of $28.1 million compared to $25.7million earned in the like 2004 period. Diluted earnings per share were $1.20 in the first nine months of 2005compared to $1.07 in the like period one year earlier.  These earnings represent an annualized returnon assets of 1.60% and

 

17

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1.53%, respectively, forthe comparable 2005 and 2004 periods. The annualized return on equity was 13.62% for the first nine months of2005 compared to 12.42% in the first nine months of 2004.  Again, the improvement in return on equityreflects both the improved R.O.A. and the increased leverage of the Company.  The improved profitability as reflected inthe R.O.A. also can be traced to improved net interest income in the 2005period relative to 2004 owing to both volume and rate considerations discussedbelow.  This improvement more than offseta decrease in non interest income net of the decrease in non interest expense.

 

***NetInterest Income.*** The following table delineates the impacts of changes in the volume ofearning assets, changes in the volume of interest bearing liabilities, andchanges in interest rates on net interest income for the three month periodsended September 30, 2005 and 2004.

 
| ** **                              | ** ** | **3 Months Ended  Sept. 30,****2005** | ** ** | **3 Months Ended  Sept. 30,  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                                   |       | $                                     | 1,517,358  |                                | $          | 26,780                                           |       | 7.00 | % | $ | 1,358,768 |   | $ | 22,106 |   | 6.47 | % | $ | 2,693 |   | $ | 1,981 |   | $ | 4,674 |   |
| Investment Securities                   |       | 601,206                               |       | 5,687                               |       | 3.75                                             | %          | 675,237 |   | 5,981 |   | 3.52 | % | (679 | ) | 385 |   | (294 | ) |
| Fed Funds, Other                        |       | 53,746                                |       | 456                                 |       | 3.37                                             | %          | 43,351 |   | 149 |   | 1.37 | % | 62 |   | 245 |   | 307 |   |
| *TOTAL EARNING ASSETS*                  |       | 2,172,310                             |       | 32,923                              |       | 6.01                                             | %          | 2,077,356 |   | 28,236 |   | 5.41 | % | 2,076 |   | 2,611 |   | 4,687 |   |
|                                    |       |                                  |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *INTEREST BEARING LIABILITIES:*         |       |                                  |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW, Savings, and Money Market Accounts |       | 1,085,979                             |       | 1,391                               |       | 0.51                                             | %          | 1,085,220 |   | 654 |   | 0.24 | % | 1 |   | 736 |   | 737 |   |
| Time Deposits                           |       | 419,204                               |       | 2,699                               |       | 2.55                                             | %          | 400,035 |   | 1,395 |   | 1.39 | % | 95 |   | 1,209 |   | 1,304 |   |
| Interest Bearing Deposits               |       | 1,505,183                             |       | 4,090                               |       | 1.08                                             | %          | 1,485,255 |   | 2,049 |   | 0.55 | % | 96 |   | 1,945 |   | 2,041 |   |
|                                    |       |                                  |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Borrowings                        |       | 24,035                                |       | 234                                 |       | 3.86                                             | %          | 3,258 |   | 34 |   | 4.15 | % | 210 |   | (10 | ) | 200 |   |
|                                    |       |                                  |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *TOTAL INTEREST BEARING*LIABILITIES     |       | 1,529,218                             |       | 4,324                               |       | 1.12                                             | %          | 1,488,513 |   | 2,083 |   | 0.56 | % | 306 |   | 1,935 |   | 2.241 |   |
|                                    |       |                                  |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *NET INTEREST INCOME*                   |       | $                                     | 2,172,310  |                                | $          | 28,599                                           |       | 5.22 | % | $ | 2,077,356 |   | $ | 26,153 |   | 5.01 | % | $ | 1,770 |   | $ | 676 |   | $ | 2,446 |   |

 

Mid-State’s annualizedyield on interest earning assets was 6.01% for the third quarter of 2005 (6.42%on a taxable equivalent basis) compared to 5.41% in the like 2004 period (5.81%on a taxable equivalent basis).  ThePrime Rate, to which many of the Bank’s loans are tied, averaged 6.42% in the thirdquarter of 2005 compared to 4.41% in the like 2004 period.  Annualized interest expense as a percent of interestbearing liabilities also increased from 0.56% in the three months ended September 2004to 1.12% in the comparable 2005 period. The higher overall cost of the time deposit portfolio and other interestbearing deposits in response to the general rise in rates was the principalcontributor to this increase.  Overall,Mid-State’s annualized net interest income, expressed as a percent of earningassets, increased from 5.01% for the three month period of 2004 (5.41% on a taxableequivalent basis) to 5.22% in the comparable 2005 period (5.63% on a taxableequivalent basis).  Annualized net interestincome as a percent of average total assets increased from 4.51% in the thirdquarter of 2004 (4.87% taxable equivalent) to 4.72% in the comparable 2005period (5.09% taxable equivalent).  Boththe impact of the increase in interest rates and the increase in volume of earningassets contributed to the $2.4 million increase in net interest income.  As the table above illustrates, approximately72% of the improvement is due to volume considerations and the balance would bedue to higher interest rate considerations. The Company has also altered the mix of its earning asset base in favorof more loans, resulting in fewer investment securities held.  This too is contributing to the improvementin net interest income.  Steps taken inthis direction have included the restructuring of the commercial bankingdivision, focused promotions of certain consumer loan products, and retentionof certain jumbo residential adjustable rate mortgages.  The mix did improve across the comparable

 

18

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quarters with loansaveraging 69.8% of earning assets in the third quarter of 2005 compared to 65.4%in the like 2004 period.

 

Average earnings assets for the three months ended September 30,2005 increased $94.9 million from the like 2004 period ($2,172.3 millioncompared to $2,077.4 million).  Averageinterest bearing deposits in this same time-frame were up $19.9 million, ($1,505.2million compared to $1,485.3 million). The balance of the funding in earning asset growth came from increasesin non interest bearing demand deposits and other borrowings.

 

The following table presents a similar analysis ofchanges in interest income and expense for the nine month period ended September 30,2005 and 2004.

 
| ** **                              | ** ** | **9 months ended  Sept. 30,  2005** | ** ** | **9 months ended  Sept. 30,  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                                   |       | $                                   | 1,470,976  |                                | $          | 76,533                                           |       | 6.96 | % | $ | 1,279,738 |   | $ | 62,343 |   | 6.51 | % | $ | 9,629 |   | $ | 4,561 |   | $ | 14,190 |   |
| Investment Securities                   |       | 607,543                             |       | 16,724                              |       | 3.68                                             | %          | 713,774 |   | 18,444 |   | 3.45 | % | (2,833 | ) | 1,113 |   | (1,720 | ) |
| Fed Funds, Other                        |       | 35,314                              |       | 802                                 |       | 3.04                                             | %          | 37,638 |   | 306 |   | 1.09 | % | (36 | ) | 532 |   | 496 |   |
| *TOTAL EARNING ASSETS*                  |       | 2,113,833                           |       | 94,059                              |       | 5.95                                             | %          | 2,031,150 |   | 81,093 |   | 5.33 | % | 6,760 |   | 6,206 |   | 12,966 |   |
|                                    |       |                                |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *INTEREST BEARING LIABILITIES:*         |       |                                |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW, Savings, and Money Market Accounts |       | 1,079,365                           |       | 3,321                               |       | 0.41                                             | %          | 1,054,537 |   | 1,855 |   | 0.23 | % | 60 |   | 1,406 |   | 1,466 |   |
| Time Deposits                           |       | 408,499                             |       | 6,756                               |       | 2.21                                             | %          | 400,182 |   | 4,143 |   | 1.38 | % | 112 |   | 2,501 |   | 2,613 |   |
| Interest Bearing Deposits               |       | 1,487,864                           |       | 10,077                              |       | 0.91                                             | %          | 1,454,719 |   | 5,998 |   | 0.55 | % | 172 |   | 3,907 |   | 4,079 |   |
|                                    |       |                                |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Borrowings                        |       | 22,801                              |       | 654                                 |       | 3.83                                             | %          | 4,386 |   | 151 |   | 4.60 | % | 581 |   | (78 | ) | 503 |   |
|                                    |       |                                |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *TOTAL INTEREST BEARING*LIABILITIES     |       | 1,510,665                           |       | 10,731                              |       | 0.95                                             | %          | 1,459,105 |   | 6,149 |   | 0.56 | % | 753 |   | 3,829 |   | 4,582 |   |
|                                    |       |                                |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *NET INTEREST INCOME*                   |       | $                                   | 2,113,833  |                                | $          | 83,328                                           |       | 5.27 | % | $ | 2,031,150 |   | $ | 74,944 |   | 4.93 | % | $ | 6,007 |   | $ | 2,377 |   | $ | 8,384 |   |

 

Mid-State’s year-to-date annualizedyield on interest earning assets was 5.95% for the first nine months of 2005 (6.37%on a taxable equivalent basis) compared to 5.33% in the like 2004 period (5.74%on a taxable equivalent basis).  Theincrease in yield is related to the general increase in interest rates.  The Prime Rate, to which many of the Bank’sloans are tied, averaged 5.93% in the first nine months of 2005 compared to4.14% in the like period of 2004. Annualized interest expense as a percent of interest bearing liabilitiesalso increased from 0.56% in the first nine months of 2004 to 0.95% in thecomparable 2005 period.

 

Overall, Mid-State’s annualized net interest income,expressed as a percent of earning assets, increased from 4.93% for the first ninemonth period of 2004 (5.34% on a taxable equivalent basis) to 5.27% in thecomparable 2005 period (5.69% on a taxable equivalent basis).  Annualized net interest income as a percentof average total assets increased from 4.45% in the first nine monthperiod of 2004 (4.82% taxable equivalent) to 4.74% in the comparable 2005period (5.12% taxable equivalent).  Boththe impact of the increase in general interest rates and the increase in volumeof earning assets contributed to the $8.4 million increase in net interestincome.  The Company has altered the mixof its earning asset base in favor of more loans, resulting in fewer investmentsecurities held.  Steps taken in thisdirection have included the restructuring of the commercial banking division,focused promotions of certain consumer loan products, and retention of certainjumbo residential adjustable rate mortgages. The mix did improve across the comparable nine month periods with loansaveraging 69.6% of earning assets for 2005 compared to 63.0% in the like 2004period.

 

19

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Average earnings assets for the nine months ended September 30,2005 increased $82.6 million from the like 2004 period ($2,113.8 millioncompared to $2,031.2 million).  Average interestbearing deposits in this same time-frame were up $33.2 million, ($1,487.9million compared to $1,454.7 million). The balance of the funding in earning asset growth came from increasesin non interest bearing demand deposits and other borrowings.

 

For a discussion of changes in the net interest margincomparing the second and third quarters of 2005, see “Item 3 – Quantitative andQualitative Disclosures About Market Risk.”

 

***Provisionand Allowance for Loan Losses.***  Mid-State did not make a provision for loanlosses in either of the third quarter periods of 2005 or 2004.  For the nine month periods ended September 30th,the Company did not make a provision for loan losses in the 2005 period, but itdid take a benefit to the provision for loan losses of $2.7 million in the 2004period.  Management believes that theallowance for loan losses and allowance for losses - unfunded commitments,which collectively stand at 0.9% of total loans at September 30, 2005, areadequate to cover inherent losses in the portfolio.  Management has determined that the allocatedand unallocated components of the reserve as calculated and required for itsnon performing loans and the general loan loss reserve are sufficient to offsetpotential losses arising from less than full recovery of the loans from thesupporting collateral.  The Companybelieves the unallocated portion of the reserve is necessary as a result of thelosses inherent in those loans where economic factors may have a negativeaffect on their collectibility even though specific reserves have not yet hadto be allocated.  These economic factorsinclude, but are not limited to, cyclical changes in business activity,changing patterns of tourism, changing markets for agricultural products,changing patterns of retail sales activity, residential and commercial realestate price trends, the “housing bubble” discussed in many economicpublications, and others.   Nonperforming loans consist of loans on non-accrual and accruing loans 90 days ormore past due.  The $13.4 million ofcollective allowances for credit losses is approximately 161% of the level ofnon performing loans at September 30, 2005 compared to 142% one yearearlier.

 

Non performing loans were $8.3 million at September 30,2005 compared to $11.0 million one year earlier.  One loan secured by real estate (originallytotaling $8.5 million), received $6.5 million in principal reductions duringthe nine months of 2005.  With unlikelyprospects for collection of the remaining principal balance, the Bank took acharge-off on that loan of $2.0 million in September of this year.  During the third quarter of 2005, $6.0million was added to total non accrual loans increasing the total to $8.3million at the end of the period.  Ofthat amount, $7.2 million is centered in one relationship, $5.8 million ofwhich is secured by real estate.  No lossof principal is anticipated in this relationship.  Except for the non performing loans discussedabove, Management is not aware of any loans as of September 30, 2005 forwhich known credit problems of the borrower would cause serious doubts as tothe ability of such borrower to comply with its present loan repayment terms,or any known events that would result in the loan being designated asnon-performing at some futures date.

 

Specific reserves have been established for potentiallosses inherent in all of the Company’s impaired loans and Management believesthe balance is adequate at the present time. Moreover, there are additional unallocated reserves available to absorbother losses which are inherent in the portfolio as of September 30,2005.  The Company has not held any otherreal estate owned (property acquired through loan foreclosure) over the lasttwelve months.  A combination of loanpayoffs and improvements in the underlying credit quality of certain borrowers hasled to a drop in internally classified assets over this period also.  The improving trend in non performing loans,improvements in the level of internally classified assets, net recoveries fromthe Company’s on-going collection efforts and the positive local economicconditions have improved the Company’s asset quality and contributed to theCompany’s decision to make no provision for loan losses during the quarter andfor the nine months ended, respectively.

 

Changes in the allowances for losses (in thousands)for the periods ended September 30, 2005 and 2004 are as follows:

 

20

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| ** **                                                                                                     | ** ** | **Three Months Ended  Sept. 30,** | ** ** | **Nine Months Ended  Sept. 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                     | ** ** | **2005**                          | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** |
| Balance at beginning of period:                                                                                |       |                              |       |                             |       |   |   |   |   |
| Allowance for loan losses                                                                                      |       | $                                 | 13,403     |                             | $          | 13,895 |   | $ | 13,799 |   | $ | 16,063 |   |
| Allowance for losses-unfunded commitments                                                                      |       | 1,759                             |       | 1,570                            |       | 1,783 |   | 1,941 |   |
| Total allowances for losses at beginning of period                                                             |       | 15,162                            |       | 15,465                           |       | 15,582 |   | 18,004 |   |
|                                                                                                           |       |                              |       |                             |       |   |   |   |   |
| Additions  (reductions) to the allowance for losses – unfunded commitments (credited) charged  to expense |       | 80                                |       | 112                              |       | 56 |   | (259 | ) |
| (Reductions)  additions to the allowance for loan losses (credited) charged to provision                       |       | —                            |       | —                           |       | — |   | (2,700 | ) |
| Loans charged  off                                                                                             |       | (2,310                            | )          | (118                             | )          | (3,004 | ) | (665 | ) |
| Recoveries of  loans previously charged-off                                                                    |       | 439                               |       | 135                              |       | 737 |   | 1,214 |   |
| Total allowances  for losses-end of quarter                                                                    |       | $                                 | 13,371     |                             | $          | 15,594 |   | $ | 13,371 |   | $ | 15,594 |   |
|                                                                                                           |       |                              |       |                             |       |   |   |   |   |
| Allowance for loan  losses                                                                                     |       | $                                 | 11,532     |                             | $          | 13,912 |   | $ | 11,532 |   | $ | 13,912 |   |
| Allowance for  losses-unfunded commitments                                                                     |       | 1,839                             |       | 1,682                            |       | 1,839 |   | 1,682 |   |
| Total allowances  for losses-end of quarter                                                                    |       | $                                 | 13,371     |                             | $          | 15,594 |   | $ | 13,371 |   | $ | 15,594 |   |
|                                                                                                           |       |                              |       |                             |       |   |   |   |   |
| Allowances for  losses to loans, gross                                                                         |       | 0.9                               | %          | 1.1                              | %          | 0.9 | % | 1.1 | % |
| Allowances for  losses to non performing loans                                                                 |       | 160.7                             | %          | 142.4                            | %          | 160.7 | % | 142.4 | % |
| Non-accrual  loans to total loans, gross                                                                       |       | 0.6                               | %          | 0.8                              | %          | 0.6 | % | 0.8 | % |
| Non performing  assets to total assets                                                                         |       | 0.3                               | %          | 0.5                              | %          | 0.3 | % | 0.5 | % |

 

At September 30, 2005, the recorded investments in loans, whichhave been identified as impaired totaled $8,391,000.   Of this amount, $7,096,000 related to loanswith no valuation allowance and $1,295,000 related to loans with acorresponding valuation allowance of $446,000. Impaired loans totaled $11,035,000 at September 30, 2004, of which$1,478,000 related to loans with no valuation allowance and $9,557,000 relatedto loans with a corresponding valuation allowance of $4,413,000.  The valuation allowance for impaired loans isincluded within the general allowance shown above and netted against loans onthe consolidated statements of financial position.  For the quarter ended September 30, 2005,the average recorded investment in impaired loans was $6,537,000 compared to $11,257,000in the 2004 period.  A loan is identifiedas impaired when it is probable that interest and principal will not becollected according to the contractual terms of the loan agreement.  Because this definition is very similar tothat used by bank regulators to determine on which loans interest should not beaccrued, the Company expects that most impaired loans will be on non-accrualstatus.

 

***Non-interestIncome.*** Non-interest income for the third quarter of 2005 was $5.3 million, downfrom the $7.3 million earned in the 2004 period.  There was a decrease of $1.7 million inmerchant processing income as a result of outsourcing that activity late in2004.  In outsourcing this activity, the Companynow receives a payment, net of expenses, which is realized into non-interestincome – the net effect on total earnings is approximately the same, but hasthe effect of reducing both non-interest income and non-interest expense.   There was a decrease in service charges andfees of approximately $200 thousand over the comparable periods, primarily as aresult of a reduction in account analysis charges collected (account analysiscustomers kept larger balances in the 2005 third quarter compared to the like2004 period and the earnings credit rate was higher in 2005 compared to the2004 period thus yielding lower account analysis service charges).

 

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For the nine month periods ended September 30,2005 and 2004, non-interest income declined from $22.2 million to $16.0 millionin the current period.  There was adecrease of $4.7 million in merchant processing income as a result ofoutsourcing that activity late in 2004 as explained above.  The Bank benefited from a $1.1 millionnon-recurring gain on sale of other real estate owned in the 2004 period andhas not experienced a similar benefit during the 2005 period.  There was also a decrease in service chargesand fees of approximately $552 thousand over the comparable periods, primarilyas a result of a reduction in account analysis charges collected (accountanalysis customers kept larger balances in the 2005 third quarter compared tothe like 2004 period and the earnings credit rate was higher in 2005 comparedto the 2004 period thus yielding lower account analysis service charges).  Gains on sale of securities were also $387thousand lower in the 2005 period compared to the like 2004 period.  Various other line items showed modest improvementsand collectively these partially offset the declines noted above.

 

***Non-interestExpense.***  Non-interestexpense for the third quarter of 2005 decreased $792 thousand to $19.5 millionfrom the $20.3 million in the like 2004 period. For the nine months ended September 30, it decreased from $60.8million to $57.0 million.

 

There was an increase in salaries and benefits expenseof $526 thousand in the third quarter of 2005 compared to 2004.  For the nine month period, there was a $283thousand increase in 2005 compared to 2004. Increases between the two periods are primarily related to certain increasesin the Company cost of employee benefits. Staff expense, which had declined from $11.0 million in the firstquarter of 2005 to $10.7 million in the second quarter of the year, increasedto $11.1 million in the third quarter. The third quarter level is 5% above the year ago period and on ayear-to-date basis is up 0.9%. Management expects these figures to continue to increase in futureperiods as the Bank fills a number of open positions throughout the Bank andprepares for expansion efforts.  Theseefforts include a new branch expected to open in the Westlake Village area inearly 2006 and a renewed focus on mortgage banking activities, consumer lendingactivities and small business lending. The exact impact on staffing expense increases will depend upon thespeed with which positions are filled.

 

Occupancy and furniture expense was virtuallyunchanged in the third quarter of 2005 at $3.1 million from the like amount oneyear earlier.  For the nine monthsyear-to-date 2005, the expense was $9.1 million, down slightly from the $9.4million in the same 2004 period.  Lowermaintenance costs were more than offsetting increases in depreciation andrental expense.

 

Other operating expense declined from $6.5 million inthe third quarter of 2004 to $5.3 million in the 2005 period.  The decrease across the comparable quarterswas primarily attributable to the outsourcing of merchant processing, asdiscussed above, which reduced non interest expense by $1.5 million.  For the nine months year-to-date 2005, othernon-interest expense was $15.1 million down $3.9 million from the $19.0 millionexpense in 2004.  The decrease here wasalso primarily attributable to the outsourcing of merchant processing activitywhich reduced non interest expense by $4.4 million.  The merchant processing activity adjustments,along with the increased net interest margin, positively affected the Company’sefficiency ratio which was 57.4% for the first nine months of 2005 compared to62.7% in the like period of 2004.

 

***Provisionfor Income Taxes.*** The provision for income taxes in the third quarter increased modestlyfrom $4.5 million in the 2004 period to $4.9 million in the current year’sthree month period.  The Company’sconsolidated tax rate was approximately 34.1% in the 2005 period, virtuallyunchanged from the 34.0% level in 2004.  Forthe nine months year-to-date, provision for income taxes were $14.3 millioncompared to $13.3 million in the prior year. The corresponding tax rates were again little changed at 33.7% in 2005compared to 34.0% in 2004.  While thenormal combined federal and state statutory tax rate is 42% for Mid-StateBancshares,

 

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the tax-exempt income generated by its municipal bond portfolio is theprimary reason that the effective rate is lower.

 

***BalanceSheet.***  Totalassets at September 30, 2005 totaled $2.422 billion, up 4.9% from thelevel one year earlier of $2.310 billion. Total deposits also rose 5.3% to $2.106 billion, up from $2.000 billionone year earlier.  Time Deposits under$100 thousand increased from $231.1 million one year earlier to $232.1 millionat period end and Time Deposits over $100 thousand increased by $28.2 million.  Management believes that the higher relativelevels of time deposits with balances over $100 thousand is not the result ofany change in pricing methodology on its part, but rather, reflects greaterdepositor sensitivity to today’s interest rate levels with funds from otherdeposit categories flowing into this category. Non Interest Bearing Demand increased from $524.8 million a year ago to$589.6 million in the current year.  Allother core deposit categories of NOW, Money Market and Savings increased to $1.088billion from $1.076 billion one year earlier. Loan activity over the last year has increased, with net loansincreasing by $105 million from $1.381 billion to $1.486 billion at period-end.  Loans held for sale (single family, mortgageoriginations) increased slightly to $10.4 million from $10.0 million one yearearlier.  Stockholders’ equity decreasedby $6.8 million when comparing September, 2005 over September, 2004 (see belowunder Capital Resources for a recap of the components of this change).

 

The Company’s mix of earning assets has improved inrecent quarters with loans now averaging 69.8% of average earning assets in thethird quarter of 2005 compared to 65.4% in the comparable 2004 period.  These higher yielding assets relative toinvestments and fed funds sold helped contribute to the Company’s higher netinterest margin from one year earlier.  Goingforward however, the impact of competitive pricing on new loans resulting fromincreased competition from other local community banks, continued intensecompetition from the major banks, and the expanded influence of “conduit”financing (the making of loans at attractive rates to borrowers which arepooled together, packaged and sold by Wall Street firms as commercial mortgagebacked securities to investors) in the Bank’s trade area by non-banks couldlead to additional pressure on the yield from the loan portfolio.   Thiscould contribute to a possible drag on the net interest margin in futureperiods, notwithstanding the benefit to the Bank of having half of theportfolio tied to Prime in a rising rate environment.  Displayed below is a summary of loansoutstanding by type as of September 30, 2005 and 2004 (excludes loans heldfor sale).

 
| ** **                         | ** ** | **September 30,** | ** **    |
|------------------------------------|------------|------------------------|---------------|
| **(dollars in 000’s)**        | ** ** | **2005**               | ** **    | **2004** | ** ** |
| Construction and development loans | ** ** | **$**                  | **269,483**   |   | $ | 250,112 |   |
| Real estate loans                  | ** ** | **790,588**            |          | 736,127 |   |
| Home equity credit lines           | ** ** | **185,761**            |          | 141,484 |   |
| Installment loans                  | ** ** | **17,906**             |          | 22,222 |   |
| Cash reserve                       | ** ** | **3,406**              |          | 3,594 |   |
| Agricultural production            | ** ** | **29,810**             |          | 31,575 |   |
| Commercial, other                  | ** ** | **204,402**            |          | 213,373 |   |
| ** **                         |       | **1,501,356**          |          | 1,398,487 |   |
| Less allowance for loan losses     | ** ** | **(11,532**            | **)**         | (13,912 | ) |
| Less deferred loan fees, net       | ** ** | **(3,652**             | **)**         | (4,008 | ) |
|                               | ** ** | ** **             | ** **    |   |   |
| *TOTAL  LOAN PORTFOLIO*            | ** ** | **$**                  | **1,486,172** | ** ** | $ | 1,380,566 |   |

 

Mid-State Bancshares’ loan to deposit ratio of 71.1%at September 30, 2005 is up from the 69.7% ratio one year earlier.  There is ample internal liquidity to fundincreases in this ratio through liquidation of Mid-State’s $617.7 million investmentportfolio which is categorized entirely as available for sale, as well asthrough the accumulation of additional deposits or of additional borrowings,such as from the Federal Home Loan Bank.

 

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***InvestmentSecurities and Fed Funds Sold.***  Of the $617.7 million portfolio at September 30,2005, 4% is invested in U.S. treasury securities, 33% is invested in U.S.government agency obligations, 62% is invested in municipal and corporatesecurities and 1% is invested in mortgage-backed securities.  On a combined basis, sixty percent of allinvestment securities and fed funds sold mature within five years.  Approximately 23% of the total portfoliomatures in less than one year.  The Company’sinvestment in mortgage-backed securities consist of investments in FNMA andFHLMC pools which have contractual maturities of up to 15 years.  The actual time of repayment may be shorterdue to prepayments made on the underlying collateral.

 

A summary of investment securities owned is asfollows:

 

### **September 30, 2005**

 
| **(amounts in 000’s)  Securities Available For Sale** | ** ** | **Cost  Basis** | ** **  | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Market  Value** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|-----------------|-------------|------------------------------|------------|-------------------------------|------------|-------------------|------------|------------|------------|
| U.S. Treasury  securities                                  | ** ** | **$**           | **23,918**  | ** **                   | **$**      | **—**                    | ** ** | **$**             | **(185**   | **)**      | **$**      | **23,733** | ** ** |   |   |
| Securities of  U.S. government agencies and corporations   | ** ** | **204,862**     | ** **  | **213**                      | ** ** | **(1,689**                    | **)**      | **203,386**       | ** ** |       |       |
| Mortgage backed  securities                                | ** ** | **8,711**       | ** **  | **391**                      | ** ** | **(54**                       | **)**      | **9,048**         | ** ** |       |       |
| Obligations of  states and political subdivisions          | ** ** | **360,499**     | ** **  | **5,853**                    | ** ** | **(1,260**                    | **)**      | **365,092**       | ** ** |       |       |
| Other  investments                                         | ** ** | **16,471**      | ** **  | **38**                       | ** ** | **(53**                       | **)**      | **16,456**        | ** ** |       |       |
| ***TOTAL***                                                | ** ** | **$**           | **614,461** | ** **                   | **$**      | **6,495**                     | ** ** | **$**             | **(3,241** | **)**      | **$**      | **617,715** | ** ** |   |   |

 

December 31,2004

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

 

The following table shows those investmentswith gross unrealized losses and their market value aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position at September 30, 2005.

 
| ** **                                               | ** ** | **Less than 12 months** | ** ** | **12 months or more**  | ** ** | **Total**         | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|-------------------|------------|
| **(amounts in 000’s)**                              | ** ** | **Market  Value**       | ** ** | **Unrealized  Losses** | ** ** | **Market  Value** | ** ** | **Unrealized  Losses** | ** ** | **Market  Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S. Treasury  securities                                |       | $                       | 10,873     |                   | $          | (20               | )          | $ | 12,860 |   | $ | (165 | ) | $ | 23,733 |   | $ | (185 | ) |
|                                                     |       |                    |       |                   |       |              |       |   |   |   |   |   |   |
| Securities of  U.S. government agencies and corporations |       | 82,387                  |       | (493                   | )          | 105,755           |       | (1,196 | ) | 188,142 |   | (1,689 | ) |
| Mortgage backed  securities                              |       | 1,349                   |       | (8                     | )          | 1,754             |       | (46 | ) | 3,103 |   | (54 | ) |
| Obligations of  states and political subdivisions        |       | 101,440                 |       | (877                   | )          | 16,678            |       | (383 | ) | 118,118 |   | (1,260 | ) |
| Other  investments                                       |       | 3,955                   |       | (53                    | )          | —            |       | — |   | 3,955 |   | (53 | ) |
| *TOTAL*                                                  |       | $                       | 200,004    |                   | $          | (1,451            | )          | $ | 137,047 |   | $ | (1,790 | ) | $ | 337,051 |   | $ | (3,241 | ) |

 

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All of the unrealizedlosses identified in the table above are primarily attributable to changes ingeneral interest rate levels and are not considered to be other than a temporaryimpairment.  The unrealized losses arenot the result of any deteriorating financial conditions or near term prospectsof the underlying issuers and Management believes that it has the intent andability to retain these investment securities to allow for the eventualrecovery in market value.

 

***CapitalResources.***   On June 15, 2005 the Board authorized therepurchase of up to five percent of its outstanding shares, or up to 1,141,373additional shares of the Company’s common stock.  This authorization does not have anexpiration date.  There were 213,635shares of the Company’s common stock repurchased in the third quarter of 2005at an average price of $29.02 per share. Of the shares repurchased in the third quarter, 10,800 were made underan earlier authorization with the balance being made under the June authorization.  For the nine months year-to-date in 2005, theCompany has repurchased 723,192 shares at an average price of $27.26 pershare.  All of these shares werepurchased at current market prices on the date of transaction.  As of September 30, 2005, the Company iscontinuing the program and can repurchase up to 938,538 additional shares underthe June 2005 authorization.  Forthe three months and nine months ended September 30, 2004, 215,607 and373,819 shares were repurchased, respectively, at an average price of $24.38and $23.59, respectively.

 

In other mattersconcerning capital, the Board of Directors declared three quarterly dividendsin 2005 of $0.16 per share, or $0.48 for the nine months, compared to $0.14 pershare in each of the quarters one year earlier, or $0.42 for the nine monthperiod.

 

***Liquidity.***  The focus of the Company’s liquiditymanagement is to ensure its ability to meet cash requirements.  Sources of liquidity include cash, due frombank balances (net of Federal Reserve requirements to maintain reserves againstdeposit liabilities), fed funds sold, investment securities (net of pledgingrequirements), loan repayments, deposits and fed funds borrowing lines.  Typical demands on liquidity are depositrun-off from demand deposits and savings accounts, maturing time deposits,which are not renewed, and anticipated funding under credit commitments tocustomers.

 

The Company has adequate liquidity at the presenttime.  Its loan to deposit ratio at September 30,2005 was 71.1% versus 69.7% one year earlier. The Company normally strives for a loan to deposit ratio in the 65% to75% range.  The Company’s internallycalculated liquidity ratio stands at 32.2% at September 30, 2005, which isabove its minimum policy of 15% and below the 36.4% level of September 30,2004.  Management is not aware of anyfuture capital expenditures or other significant demands or commitments whichwould severely impair liquidity.

 

***ContractualObligations. ***As ofSeptember 30, 2005, the Company had the following contractual obligations.

 
| ** **        | ** ** | **One Year  Or Less** | ** ** | **Over One to  Three Years** | ** ** | **Over Three to  Five Years** | ** ** | **Over  Five Years** | ** ** | **Total** | ** ** |
|-------------------|------------|-----------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------|------------|-----------|------------|
| Long Term Debt    |       | $                     | —     |                         | $          | 20,000                        |       | $                    | —     |      | $          | 2,000 |   | $ | 22,000 |   |
|              |       |                  |       |                         |       |                          |       |                 |       |      |       |
| Operating Leases  |       | 1,546                 |       | 3,849                        |       | 3,100                         |       | 3,734                |       | 12,229    |       |
|              |       |                  |       |                         |       |                          |       |                 |       |      |       |
| Total Obligations |       | $                     | 1,546      |                         | $          | 23,849                        |       | $                    | 3,100      |      | $          | 5,734 |   | $ | 34,229 |   |

 

***OffBalance Sheet Transactions and Other Related Transactions.***   Off-balance sheet arrangements are anycontractual arrangement to which an unconsolidated entity is a party, underwhich the Company has: 1) any obligation under a guarantee contract; 2) aretained or contingent interest in assets transferred to an

 

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unconsolidated entity or similar arrangement that serves as credit,liquidity or market risk support to that entity for such assets; 3) anyobligation under certain derivative instruments; or 4) any obligation under amaterial variable interest held by the Company in an unconsolidated entity thatprovides financing, liquidity, market risk or credit risk support to theCompany, or engages in leasing, hedging or research and development serviceswith the Company.  In the ordinary courseof business, the Company has entered into off-balance sheet financialinstruments consisting of commitments to extend credit, commercial letters ofcredit, and standby letters of credit.

 

The Company is contingently liable for letter ofcredit accommodations made to its customers in the ordinary course of businesstotaling $52.0 million at September 30, 2005, up from $29.1 million oneyear earlier.  Additionally, the Companyhas undisbursed loan commitments, also made in the ordinary course of business,totaling $645.3 million, which was up from the $633.6 million outstanding oneyear earlier.  The Company has anallowance for losses-unfunded commitments totaling $1,839,000 and $1,682,000 atSeptember, 2005 and 2004, respectively, to cover losses inherent in its letterof credit accommodations and undisbursed loan commitments.

 

There are no Special Purpose Entity (“SPE”) trusts,corporations, or other legal entities established by Mid-State which resideoff-balance sheet.  There are no otheroff-balance sheet items other than the aforementioned items related to letterof credit accommodations and un-disbursed loan commitments.

 

The Company does make loans and leases to relatedparties (directors and officers) in the ordinary course of business 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, have not involved more thanthe normal risk of repayment or presented any other unfavorable features.  These loans and leases totaled $12.7 millionand $9.0 million at September 30, 2005 and 2004, respectively.

 

In the ordinary course of business, the Company is aparty to various operating leases.  For afuller discussion of these financial instruments, refer to Note 6 of theCompany’s consolidated financial statements contained in Item 8 of Part IIof the Company’s December 31, 2004 Annual Report on Form 10K.

 

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**Item 3 -Quantitative and Qualitative Disclosures About Market Risk**

 

The Company expects its risk exposure to changes ininterest rates to remain manageable and well within acceptable policyranges.  A recent review as of September 30,2005 of the potential changes in the Company’s net interest income over a 12month time horizon showed that it could fluctuate under extreme alternativerate scenarios from between +4.0% and –5.3% of the base case (rates unchanged)of $120.3 million.  The Company’s policyis to 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.  Managementexpects that its exposure to interest rate risk is manageable and it willcontinue to strive for an optimal trade-off between risk and earnings.

 

The following table presents a summary of the Company’snet interest income forecasted for the coming 12 months under alternativeinterest rate scenarios.

 

| ** **                                                           | ** ** | **Change From Base** | ** ** |
|----------------------------------------------------------------------|------------|----------------------|------------|
| Rates Down Very  Significantly  (Prime down to 4.75% over 10 months) |       | -5.3                 | %          |
| Rates Down Significant  (Prime down to 5.25% over 10 months)         |       | -3.9                 | %          |
| Rates Down  Slightly  (Prime down to 5.75% over 10 months)           |       | -2.1                 | %          |
| Base Case -  Rates Unchanged  (Prime unchanged at 6.75%)             |       | —               |       |
| Rates Up  Slightly  (Prime up to 7.75% over 10 months)               |       | +0.2                 | %          |
| Rates Up Significant  (Prime up to 8.75% over 10 months)             |       | +2.5                 | %          |
| Rates Up Very  Significantly  (Prime up to 9.75% over 10 months)     |       | +4.0                 | %          |

 

Net interest income under the above scenarios isinfluenced by the characteristics of the Company’s assets and liabilities.  In the case of N.O.W., savings and moneymarket deposits (total $1.088 billion) interest is based on rates set at thediscretion of management ranging from 0.25% to 1.15%.  In a downward rate environment, there is alimit to how far these deposit instruments can be re-priced and this behavioris similar to that of fixed rate instruments. In an upward rate environment, the magnitude and timing of changes inrates on these deposits is assumed to be more reflective of variable rateinstruments.

 

It is important to note that the above table is asummary of several forecasts and actual results may vary.  The forecasts are based on estimates andassumptions of management that may turn out to be different and may change overtime.  Factors affecting these estimatesand assumptions include, but are not limited to - competitors’ behavior,economic conditions both locally and nationally, actions taken by the FederalReserve Board, customer behavior, and management’s responses.  Changes that vary significantly from theassumptions and estimates may have significant effects on the Company’s netinterest income.  Therefore the resultsof this analysis should not be relied upon as indicative of actual futureresults.  Historically, the Company hasbeen able to manage its Net Interest Income in a fairly narrow range reflectingthe Company’s relative insensitivity to interest rate changes.  The impact of prepayment behavior onmortgages, real estate loans, mortgage backed securities, securities with callfeatures, etc. is not considered material to the sensitivity analysis.  Over the last 5 calendar years (2000 – 2004),the Company’s net interest margin (which is net interest income divided byaverage earning assets of the

 

27

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Bank) had ranged from a low of 4.95% to a high of 6.44% (not taxableequivalent).  The Company’s net interestmargin in 2004 of 4.95% is at the low end of this range by historicalstandards, coming off the higher levels experienced in 2000 of 6.44%.  Recent increases in interest rates (e.g. – eleven25 basis point increases in the Federal Funds Rate and Prime Rate) which beganat the end of June 2004 have led to an improving net interest margin forthe Company to 5.22% in the third quarter of 2005 (5.27% for the nine monthsended September 30, 2005).  The netinterest margin under the forecasted alternative scenarios ranges from 5.00% to5.49%.  Management believes this range ofscenarios is conservative given current interest rate levels, but no assurancescan be given that actual future experience will fall within this range.

 

The Company’s net interest margin declined in thethird quarter of 2005 to 5.22% (5.63% taxable equivalent) from 5.37% (5.79%taxable equivalent) in the second quarter of 2005.  The drop in the net interest margin is partlyattributable to an increase in the Company’s cost of funds during the thirdquarter compared to the second (annualized interest expense as a percent ofearning assets was 8 basis points higher). Additionally, the impact of competitive pricing on new loans resultingfrom increased competition from other local community banks, continued intensecompetition from the major banks, and the expanded influence of “conduit”financing in the Company’s trade area by non-banks (the making of loans atattractive rates to borrowers which are pooled together, packaged and sold byWall Street firms as commercial mortgage backed securities to investors) morethan offset the benefit received from the higher prime rate during the quarter. The yield from the loan portfolioactually declined slightly (7.00% in Q3-05 versus 7.09% in Q2-05), furthercontributing to the drop in the margin.  While the upward movement in the Prime Rate is generally positive forthe Company’s net interest margin, the influences of competitive pricing andthe refinancing of existing loans at lower rates can, and has to some extent, offsetthese benefits.  The Company experiencedthese influences in the third quarter of 2005 and expects them to continue to bea factor in the near term, though the magnitude and length of time of their futureimpact cannot currently be predicted.

 

The Company’s exposure with respect to interest ratederivatives, exchange rate fluctuations, and/or commodity price movements isnil.  The Company does not own anyinstruments within these markets.

 

#### **Item4 – Controls and Procedures**

 

As of the end of the period covered by this report,Management, including the Company’s Chief Executive Officer and Chief FinancialOfficer, evaluated the effectiveness of the design and operation of the Company’sdisclosure controls and procedures with respect to the information generatedfor use in this Quarterly Report.  Theevaluation was based in part upon reports and affidavits provided by a numberof executives.  Based upon, and as of thedate of that evaluation, the Company’s Chief Executive Officer and ChiefFinancial Officer concluded that the disclosure controls and procedures wereeffective to provide reasonable assurances that information required to be disclosedin the reports the Company files or submits under the Securities Exchange Actof 1934 is recorded, processed, summarized and reported within time periodsspecified in the SEC’s rules and forms.

 

There was no change in the Company’s internal controlsover financial reporting during the quarter ended September 30, 2005 thathas materially affected, or is reasonably likely to materially affect, theCompany’s internal controls over financial reporting.

 

In designing and evaluating disclosure controls andprocedures, the Company’s Management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurances of achieving the desired controlobjectives and Management necessarily was required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

 

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PART II - OTHERINFORMATION

 

**Item 1 - Legal Proceedings**

 

Mid-Stateis not a party to any material legal proceeding.

 

**Item 2 - UnregisteredSale of Equity Securities and Use of Proceeds**

 

On June 15,2005 the Board authorized the repurchase of up to five percent of itsoutstanding shares, or up to 1,141,373 additional shares of the Company’scommon stock.  This authorization doesnot have an expiration date.  There were 213,635shares of the Company’s common stock repurchased in the third quarter of 2005at an average price of $29.02 per share. Of the shares repurchased, 10,800 were made under an earlierauthorization with the balance being made under the June authorization.  All of these shares were purchased in openmarket transactions.  As of September 30,2005, the Company is continuing the program and can repurchase up to 938,538additional shares under the June 2005 authorization.

 

The following table provides the information withrespect to the purchases made under the publicly announced stock repurchaseprograms during the third quarter ended September 30, 2005.  All of these shares were purchased in openmarket transactions or in block purchases or in privately negotiatedtransactions in compliance with Securities and Exchange Commission (SEC) rules.

 
| **Month of**        | ** ** | **Total  Number of  Shares Purchased** | ** ** | **Average Price  Paid  Per Share** | ** ** | **Remaining Shares  That May be Purchased  Under the Authorization** | ** ** | **Dollar Value of Shares  That May be Purchased  Under the Authorization (1)** | ** ** |
|---------------------|------------|----------------------------------------|------------|------------------------------------|------------|---------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
|                |       |                                   |       |                               |       |                                                                      |       |                                                                                |       |
| July 2005      |       | 80,418                                 |       | $                                  | 29.50      |                                                                      | 1,071,755  |                                                                                | $          | 33,095,794 |   |
| August 2005    |       | 81,226                                 |       | $                                  | 29.07      |                                                                      | 990,529    |                                                                                | $          | 28,220,171 |   |
| September 2005 |       | 51,991                                 |       | $                                  | 28.19      |                                                                      | 938,538    |                                                                                | $          | 25,819,180 |   |
|                |       |                                   |       |                               |       |                                                                      |       |                                                                                |       |
| Totals              |       | 213,635                                |       | $                                  | 29.02      |                                                                      | 938,538    |                                                                                | $          | 25,819,180 |   |

 

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(1)  Value is based on the closing price ofthe Company’s stock at month-end multiplied by the number of shares that may bepurchased under the authorization.

 

**Item 3 -Defaults Upon Senior Securities**

 

Notapplicable.

 

**Item 4 -Submission of Matters to a Vote of Security Holders**

 

Therewere no items presented to the security holders during the third quarter of2005.

 

**Item 5 - Other Information**

 

None.

 

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**Item 6 - Exhibits**

 

A)                                  Exhibits

 
| **Exhibit No.** | ** ** | **Exhibit**                                                                    |
|----------------------|------------|--------------------------------------------------------------------------------|
|                 |       |                                                                           |
| 31.1                 |       | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2                 |       | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32                   |       | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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SIGNATURES

 

Pursuant to therequirement of the Securities and Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                         |   | Mid-State  Bancshares |
|------------------------------|--------|-----------------------|
|                         |   |                  |
|                         |   |                  |
| Date:  November 7, 2005 |   |                  | By: | /s/ JAMES W.  LOKEY |   |
|                         |   |                  | JAMES W. LOKEY |
|                         |   |                  | President and |
|                         |   |                  | Chief Executive  Officer |
|                         |   |                  | (Principal  Executive Officer) |
|                         |   |                  |   |
|                         |   |                  |   |
| Date:  November 7, 2005 |   |                  | By: | /s/ JAMES G.  STATHOS |   |
|                         |   |                  | JAMES G. STATHOS |
|                         |   |                  | Executive Vice  President and |
|                         |   |                  | Chief Financial  Officer |
|                         |   |                  | (Principal  Accounting Officer) |
|                              |        |                       |  |  |  |  |

 

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## **EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                | ** ** | ** ** |
|----------------------|------------|--------------------------------------------------------------------------------|------------|------------|
| 31.1                 |       | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |       |       |
| 31.2                 |       | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |       |       |
| 32                   |       | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |       |       |

 

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