-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VnoUSLnFRGBXc8uXjx/EssD0o1FLWCEZLGHoMzDW6jyNFF8okbKMBXarxgJPqIz1 zlFnZzHoxXZHgk2DdT9BpQ== 0000912057-00-014108.txt : 20000329 0000912057-00-014108.hdr.sgml : 20000329 ACCESSION NUMBER: 0000912057-00-014108 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MID-STATE BANCSHARES CENTRAL INDEX KEY: 0001027324 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 770442667 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-23925 FILM NUMBER: 581589 BUSINESS ADDRESS: STREET 1: 1026 GRAND AVE CITY: ARROYO GRANDE STATE: CA ZIP: 93420 BUSINESS PHONE: 8054737700 MAIL ADDRESS: STREET 1: 1026 GRAND AVE CITY: ARROYO GRANDE STATE: CA ZIP: 93420 FORMER COMPANY: FORMER CONFORMED NAME: MID STATE BANCSHARES DATE OF NAME CHANGE: 19980820 FORMER COMPANY: FORMER CONFORMED NAME: BSM BANCORP DATE OF NAME CHANGE: 19961121 10-K405 1 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20529 ------------------------ FORM 10-K (MARK ONE) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(b) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD N/A TO N/A COMMISSION FILE NUMBER 000-23925 ------------------------ MID-STATE BANCSHARES (Exact name of registrant as specified in its charter) CALIFORNIA 77-0442667 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1026 GRAND AVE., ARROYO GRANDE, 93420 CA (Zip Code) (Address of principal executive offices)
Registrant's telephone number, including area code: (805) 473-7700 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK (NO PAR VALUE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or shorter period that the Registrant was required to file such reports) Yes /X/ No / / , and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K./X/ The aggregate market value of the common stock held by non-affiliates of the registrant as of March 20, 2000 was $262,533,257. The number of shares of common stock of the registrant outstanding as of March 20, 2000 was 11,300,033. The following documents are incorporated by reference herein: Part III, Items 10 through 13 are incorporated from Registrant's definitive proxy statement for the 2000 Annual Meeting of Shareholders. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TABLE OF CONTENTS
PAGE -------- - -------------------------------------------------------------------------------- PART I - -------------------------------------------------------------------------------- ITEM 1. DESCRIPTION OF BUSINESS..................................... 3 ITEM 2. PROPERTIES.................................................. 16 ITEM 3. LEGAL PROCEEDINGS........................................... 17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 17 - -------------------------------------------------------------------------------- PART II - -------------------------------------------------------------------------------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS......................................... 18 ITEM 6. SELECTED FINANCIAL DATA..................................... 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................... 21 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK... 36 ITEM 7B. DISCLOSURE ABOUT RISKS ASSOCIATED WITH YEAR 2000 ISSUES..... 36 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 38 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.................................... 70 - -------------------------------------------------------------------------------- PART III - -------------------------------------------------------------------------------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 70 ITEM 11. EXECUTIVE COMPENSATION...................................... 70 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................................. 70 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 70 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K......................................................... 70
2 - -------------------------------------------------------------------------------- PART I - -------------------------------------------------------------------------------- ITEM 1. DESCRIPTION OF BUSINESS MID-STATE BANCSHARES AND MID-STATE BANK Mid-State Bancshares (the Company) is the parent company to Mid-State Bank (the Bank), its 100% owned principal subsidiary. Mid-State Bancshares (formerly BSM Bancorp) was formed on July 10, 1998, the effective date of the merger of Bank of Santa Maria with and into Mid-State Bank. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (BHC Act) and is subject to the supervision and regulation of the Board of Governors of the Federal Reserve System (Federal Reserve Board). Mid-State Bank was incorporated under the laws of the State of California and commenced operations on June 12, 1961 as a California state chartered bank. The Bank's accounts are insured by the Federal Deposit Insurance Corporation (FDIC), but it is not a member of the Federal Reserve System. At December 31, 1999 the Company had total assets of $1.4 billion, total deposits of $1.2 billion and total shareholders' equity of $160.3 million. The Bank operates 32 full service retail banking offices along the central coast of California throughout Santa Barbara, San Luis Obispo and Ventura counties. The Bank's headquarters is located in Arroyo Grande and it also serves the communities of Paso Robles, Cambria, Templeton, Atascadero, Cayucos, Morro Bay, Los Osos, San Luis Obispo, Pismo Beach, Grover Beach, Guadalupe, Nipomo, Santa Maria, Orcutt, Lompoc, Vandenberg Village, Buellton, Santa Ynez, Solvang, Goleta, Oxnard and Santa Barbara. In the first quarter of 2000, the Bank plans to open a supermarket office in Arroyo Grande. The headquarters' mailing address is 1026 Grand Ave., Arroyo Grande, CA 93420, Telephone: (805) 473-7700. The Bank can also be reached through its internet address at WWW.MIDSTATEBANK.COM. The Bank is a full-service community bank offering a broad range of banking products and services, including accepting time and demand deposits, originating commercial loans, consumer loans and real estate loans, providing escrow services, and making other investments. The Bank originates several types of loans, including secured and unsecured commercial and consumer loans, commercial and residential real estate mortgage loans, and commercial and residential construction loans. The Bank's loans are primarily short-term and adjustable rate. Special services and requests beyond the lending limits of the Banks are arranged through correspondent banks. The Company, through the Bank, derives its income primarily from interest received on real estate loans, commercial loans and consumer loans and, to a lesser extent, from interest on investment securities, fees received in connection with loans and other services offered, including loan servicing and escrow and deposit services. The Company's major operating expenses are the interest it pays on deposits and borrowings and its general operating expenses. The Bank relies on a foundation of locally generated deposits, and management believes it has a relatively low cost of funds due to a high percentage of low cost and non-interest bearing deposits. The Company's operations, like those of other financial institutions operating in California, are significantly influenced by economic conditions in California, including the strength of the real estate market, and the fiscal and regulatory policies of the federal government and of the regulatory authorities that govern financial institutions. See "Supervision and Regulation." When the Company uses or incorporates by reference in this Annual Report on Form 10-K (the Annual Report) the words "anticipate," "estimate," "expect," "project," "intend," "commit," "believe" and similar expressions, the Company intends to identify forward-looking statements. Such statements are subject to certain risks, uncertainties and assumptions, including those described in this Annual Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove 3 incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. BANK SUBSIDIARIES The Bank operates two wholly owned subsidiaries--Mid-Coast Land Company and MSB Properties. Mid-Coast Land Company was founded in 1984 pursuant to section 751.3 of the Financial Code of the State of California. Section 751.3 provided that State chartered banks were authorized to invest in a corporation that engaged in real estate activities. The Federal Deposit Insurance Corporation (FDIC) Improvement Act (FDICIA) became law in December 1991. Under FDICIA the Bank, through Mid-Coast Land Company, would have been required to substantially eliminate its real estate development activities. The Bank received an extension of that deadline to December 31, 2000 for good cause. The Bank is in the process of completing the divestiture of the assets held by Mid-Coast Land Company which were approximately $1.5 million on the Bank's consolidated investments in real estate (reflecting $1.8 million in gross holdings netted against a $0.3 million reserve). The holdings and results of operations of Mid- Coast Land are included within the consolidated financial statements of the Bank. For further information concerning Mid-Coast Land Company, see the Subsidiary Activity section of the Management's Discussion and Analysis section and Footnote number 7 to the Financial Statements included in Item 8 of this Report. MSB Properties was incorporated under the laws of the State of California in May of 1968 allowing for the ownership of property which may be reasonably necessary for the expansion of the Bank's business, or which is otherwise reasonably related to the conduct of the Bank's business, pursuant to Section 752 of the Financial Code of the State of California. The holdings and results of operations of MSB Properties are included within the consolidated financial statements of the Bank. On a stand-alone basis, MSB Properties had earnings of $1.5 million, $1.4 million, and $1.6 million in 1999, 1998 and 1997, respectively. For further information concerning MSB Properties, see the Subsidiary Activity portions of the Management's Discussion and Analysis section of the Financial Condition and Results of Operations which is included in Item 7 of this Report. ACQUISITION OF BANK OF SANTA MARIA On January 29, 1998, the Bank entered into an Agreement to Merge and Plan of Reorganization (the Agreement) with BSM Bancorp (Bancorp) and its wholly owned subsidiary Bank of Santa Maria, Santa Maria, California (Santa Maria). The merger was completed after obtaining all requisite approvals on July 10, 1998. The transaction was structured as a so-called "reverse triangular merger." Pursuant to the transaction, among other things, (1) Bank of Santa Maria was merged with and into Mid-State Bank, (2) BSM Bancorp became the bank holding company for Mid-State Bank and changed its name to Mid-State Bancshares and (3) the outstanding shares of BSM Bancorp at the effective date of the transaction remained outstanding and the shareholders of Mid-State Bank became shareholders of BSM Bancorp in accordance with the exchange ratio set forth in the Agreement. The merger was accounted for as a pooling of interests and as a result the financial statements for all periods presented herein have been restated to include the accounts of BSM Bancorp and Subsidiary. As a result, prior periods are combined and restated as if the two organizations were historically one unit. ACQUISITION OF CITY COMMERCE BANK On April 19, 1999, the Company and City Commerce Bank signed a definitive agreement to merge, subject to the approval of banking regulators and City Commerce Bank shareholders. The merger became effective at the close of business on August 31, 1999. The Agreement provided for the exchange of common stock at an exchange ratio of .6775 shares of Mid-State Bancshares common stock for each share of City Commerce common stock, based on the price of Mid-State Bancshares stock preceding the 4 effective date of the transaction. The merger was structured to be tax-free, and was accounted for as a pooling-of-interests. As a result of this accounting treatment the financial statements for all periods presented herein have been restated to include the accounts of City Commerce Bank. SELECTION OF NEW BANK PRESIDENT On February 4, 2000, the Board of Directors of Mid-State Bank announced that they had selected Mr. James W. Lokey to be President and Chief Executive Officer of Mid-State Bank. Mr. Carrol R. Pruett, formerly President, will remain active as Chairman of the Board of Mid-State Bank and Chairman, President and Chief Executive Officer of Mid-State Bancshares, the parent company. Mr. Lokey has been in banking for over 25 years. He began his banking career with First Interstate Bank in 1973, after receiving his Bachelor of Science in Finance from California State University-Long Beach. While with First Interstate Bank, he rose through various assignments, achieving the position of Executive Vice President. Mr. Lokey has had extensive experience in most areas of banking, including retail banking, branch management, commercial lending, small business lending, agricultural lending, commercial real estate lending, and credit policy and administration. With the 1996 merger of First Interstate Bank into Wells Fargo Bank, Lokey was responsible for the integration of the Southern California commercial divisions of the two banks, with consolidated assets of $3.6 billion and deposits of $1.3 billion. In 1997, Lokey left Wells Fargo Bank to become President and Chief Executive Officer of Downey Savings, a $5.2 billion financial institution with 73 offices, headquartered in Newport Beach. During Lokey's tenure, Downey posted record earnings, record loan production, and by year-end 1998, had increased its assets to $6.3 billion with 91 offices. Mr. Lokey, who officially joined the organization on March 1, 2000, will be responsible for the day-to-day operations. It is contemplated that this will allow Mr. Pruett to devote more of his time and energy to developing strategies and exploring opportunities that will contribute to the Company's future success. Mr. Pruett has served in the capacity of President since 1967 when, at the age of 29, he became the youngest Bank President in the State of California. His continued involvement will be important to the Company, while assuring a smooth transition to a new Chief Executive Officer for the Bank. NEW APPOINTEE TO THE BOARD OF DIRECTORS In connection with the merger with City Commerce Bank, an additional board seat was created on the Mid-State Bancshares Board of Directors. Mr. H. Edward Heron was appointed to this position. Mr. Heron had served on the Board of Directors for City Commerce Bank for three years and has been a Santa Barbara resident since 1948. Active in the community, Mr. Heron has been a Director of the Santa Barbara Chamber of Commerce and the Santa Barbara Industry Education Council. He is an honorary Director for life for the California Association or Realtors, a current member of the Fighting Back Task Force, and a past member of the Calfiornia Department of Real Estate Advisory Commission. With the increased presence in southern Santa Barbara and Venura counties following the acquisition of City Commerce Bank, the addition of Mr. Heron will help expand the Bank's involvement in these communities. SERVICES The Bank offers a full range of commercial banking services including the acceptance of checking accounts, NOW accounts, Savings accounts, Money Market accounts, and various types of time certificates of deposit (including various maturities and individual retirement accounts). The Bank makes a variety of construction and land development loans, real estate related loans, home equity credit lines, installment loans, agricultural and commercial loans, SBA loans, and credit card lines. Other services offered by the Bank include, but are not limited to, safe deposit boxes, travelers cheques, notary public, merchant 5 depository services for VISA and Mastercard, cash management, home banking, telephone voice response system and ATM's. The Bank's organization and structure is designed to serve the banking needs of individuals and small to medium sized businesses in Santa Barbara, Ventura and San Luis Obispo counties. DEPOSIT AND LIABILITY MANAGEMENT Deposits represent the Bank's primary source of funds. As of December 31, 1999 the Bank had approximately 28,278 non interest bearing demand deposit accounts representing $230.3 million, or $8,144 per account. The Bank also had over 101,288 NOW, Money Market and Savings accounts amounting to $611.1 million on deposit, or about $6,033 per account. There were over 17,653 time certificates of deposit outstanding at December 31, 1999 representing $327.1 million on deposit with an average deposit balance of approximately $18,530. Of the total time certificates of deposit, only $99.5 million represented holders who carried an amount on deposit of $100,000 or more--about 30% of the total. The Bank is not dependent on a single or a few customers for its deposits, most of which are obtained from individuals and small to medium sized businesses. This results in the relatively small average balances noted above and allows the Bank to be less subject to the adverse effects of the loss of a large depositor. As of December 31, 1999, no individual, corporate, or public depositor accounted for more than 1% of the Bank's total deposits. Liquidity is the Bank's ability to meet fluctuations in deposit levels and to provide for the credit needs of its customers. The objective in liquidity management is to maintain a balance between the sources and uses of funds. Principal sources of liquidity include interest and principal payments on loans and investments, proceeds from the maturity of investments and growth in deposits. The Bank holds overnight Fed Funds Sold as a cushion for temporary liquidity needs. For 1999, Fed Funds Sold averaged $49.1 million representing 3.5% of average assets. In addition, the Bank maintains Federal Funds lines of $30 million with major correspondents, subject to customary terms for such arrangements. The Bank's internally calculated liquidity ratio, which measures the percentage of total liabilities (excluding equity) which are used to fund cash, cash equivalents and non-pledged marketable securities, was 42.3%--well above the Bank's policy minimum of 15%. LOANS The Bank's Loan to Deposit ratio stood at approximately 65.8% at year-end 1999. It is the Bank's goal to maintain its Loan to Deposit ratio in the 65% to 75% range while maintaining credit quality. The Bank has been able to improve this ratio in 1999. The Bank maintains an allowance for loan losses which is netted against loans on the balance sheet. Additions to the allowance are made by charges to operating expenses. All loans deemed to be uncollectible are charged to the allowance; subsequent recoveries are credited to the allowance. The amount in the loan loss allowance is an estimate of the losses inherent in the loan portfolio as determined by a variety of factors considered by Management. Factors include, but are not limited to, the current economic climate, type and quality of loans in the portfolio, trends in delinquencies, trends in losses, trends in non-accrual totals, diversification of the portfolio, value of available collateral and the cost of collateral liquidation. As of December 31, 1999, the Bank's allowance for loan losses stood at $13.1 million or 1.7% of gross loans. It also represents 229% of non performing loans (non-accrual loans plus loans 90 days or more past due). Outside factors, not within the Bank's control, such as adverse changes in the economy, can effect the adequacy of the allowance and there can be no assurance that, in any given period, the Bank might not suffer losses which are substantial in relation to the size of the allowance. During the year 1999, the Bank experienced charge-offs, net of recoveries, of $1.4 million, or 0.20% of average loans. 6 UNDERWRITING AND CREDIT ADMINISTRATION The lending activities of Mid-State Bank are guided by the lending policies established by the Bank's Board of Directors. The credit policy is managed through periodic reviews and approved annually by the Board. Each loan must meet minimum underwriting criteria established in the Bank's lending policy. Lending authority is granted to officers of the Bank on a limited basis, dependent upon individual knowledge and experience. Loan requests exceeding individual officer approval limits are approved by the Administrative Loan Committee. Loan requests exceeding these limits are submitted to the Executive Loan Committee, which consists of the President and Chief Executive Officer and three outside directors. Each of these committees meets on a regular basis in order to provide timely responses to the Bank's clients. Mid-State Bank's credit administration function includes an internal review and the regular use of an outside loan review firm. LOAN PORTFOLIO At December 31, 1999, Mid-State Bank's gross loan portfolio totaled $768.8 million. By portfolio segment, this is distributed as follows: Construction and Land Development........................... 15.3% Real Estate--Farmland....................................... 3.0% Real Estate--Residential.................................... 11.7% Real Estate--Non Farm, Non Residential...................... 34.2% Home Equity Credit Lines.................................... 6.9% Credit Card and Related..................................... 1.6% Installment................................................. 3.9% Agricultural Production..................................... 5.4% Commercial, Other........................................... 18.0% ----- 100.0% =====
The interest rates charged for the loans made by the Bank vary with the degree of risk, size and maturity of the loans. Rates are generally affected by competition, associated factors stemming from the client's deposit relationship with the Bank along with the cost of funds. COMMERCIAL LOANS. The Bank provides personal financial services to diverse commercial and professional businesses in the marketplace. Commercial loans consist primarily of short term loans (normally with a maturity of under one year) for working capital and business expansion. Commercial loans typically include revolving lines of credit collateralized by inventory, accounts receivable and equipment. Emphasis is placed on the borrower's earnings history, capitalization, secondary sources of repayment, and in some instances, third-party guarantees or highly liquid collateral (such as time deposits and investment securities). Commercial loan pricing is generally at a rate tied to the prime rate (as quoted in the WALL STREET JOURNAL) or the Bank's reference rates. The Bank participates in a Small Business Administration (SBA) loan guarantee program. Those programs used include both the 504 program, which is focused toward longer-term financing of buildings and other long-term assets, and the 7A program, which is primarily used for financing of the equipment, inventory and working capital needs of eligible businesses, generally over a three-to-seven year term. The Bank's collateral position in the SBA loans is enhanced by the SBA guarantee in the case of 7A loans, and by lower loan-to-value ratios under the 504 program. 7 REAL ESTATE CONSTRUCTION AND DEVELOPMENT LOANS. The Bank's real estate construction loan activity has focused on providing short-term (less than one year maturity) loans to individuals and developers with whom the Bank has established relationships for the construction primarily of single family residences in the Bank's market area. Residential real estate construction loans are typically secured by first deeds of trust and require guarantees of the borrower. The economic viability of the project and the borrower's credit-worthiness are primary considerations in the loan underwriting decision. The Bank utilizes approved independent local appraisers as well as in-house staff, and loan-to-value ratios which generally do not exceed 70% to 80% of the appraised value of the property. The Bank monitors projects during the construction phase through regular construction inspections and a disbursement program tied to the percentage of completion of each project. The Bank also occasionally makes land loans to individuals who intend to construct a single-family residence on the lot, generally within 24 months. In addition, the Bank has occasionally in the past, and may to a greater extent in the future, make commercial real estate construction loans to high-net-worth clients with adequate liquidity for construction of office and warehouse properties. Such loans are typically secured by first deeds of trust and require guarantees of borrowers. COMMERCIAL REAL ESTATE TERM LOANS. The Bank provides medium-term commercial real estate loans secured by commercial or industrial buildings where the properties are either used by the owner for business purposes (owner-used properties) or have income derived from tenants (investment properties). The Bank's loan policies require the principal balance of the loan to be no more than 70% of the stabilized appraised value of the underlying real estate collateral. The loans, which are typically secured by first deeds of trust only, generally have terms of no more than ten years and are amortized over 25 years. Most of these loans have rates tied to the prime rate, with many adjusting whenever the prime rate changes; the remaining loans adjust every five years depending upon the term of the loan. CONSUMER AND OTHER LOANS. The Bank's consumer and other loan portfolio is divided between installment loans secured by automobiles and other consumer purposes. Installment loans tend to be fixed rate and longer-term (one-to-five-year maturity). The Bank also has a minimal portfolio of credit card and related loans, issued as an additional service to its clients. INVESTMENT SECURITIES The Bank maintains a portfolio of investment securities to provide income and to serve as a secondary source of liquidity for its operations in conjunction with Federal Funds Sold (see liquidity management above). The Bank's investment policy provides for the purchase of United States Treasury Securities, United States Government Agency Securities, Mortgage Backed Securities, Obligations of State and Political Subdivisions, and Other Securities as permitted by Federal and State regulation. As of December 31, 1999, the aggregate carrying value of the Investment Portfolio was $465.3 million. Of this total, $115.1 million was invested in U.S. Treasury Securities, $104.4 million in U.S. Government Agencies, $6.6 million in Mortgage Backed Securities, $236.4 million in Obligations of State and Political Subdivisions and $2.8 million in Other Securities. The types of securities held are influenced by several factors, among which are: rate of return, maturity, and risk. Generally, the Bank endeavors to stagger the maturities of its securities so that it has regular maturities for liquidity purposes. Acceptable securities may be pledged to secure public deposits from State and Public Agencies. As of December 31, 1999, the Bank had public funds totaling approximately $8.2 million. The Bank has made available $42.4 million of securities to securitize these funds. Excess collateral can be released as needed. 8 ECONOMIC CLIMATE The economy in the Bank's trade area is based upon agriculture, oil, tourism, light industry, the aerospace industries and retail trade. Services supporting those involved in these industries have also developed in the areas of medical, financial and educational services. Population in the three county area, according to the U.S. Bureau of the Census, is estimated at July 1998 to be 1.4 million. Ventura County represents about 54% of this total with Santa Barbara and San Luis Obispo counties accounting for 29% and 17% respectively. Certain economic activities are unique to the area such as the space launching facilities at Vandenberg Air Force Base (which is now also being used by private commercial enterprises) and the production of seeds for various flowers grown worldwide. While major oil companies have elected to do business elsewhere (due to very stringent county business regulations), smaller production companies have moved in to continue the oil industry in the area. The moderate climate allows a year round growing season for numerous vegetables and fruits. Vineyards and cattle ranches make large contributions to the local economy. Access to numerous recreational activities, including both mountains and beaches, provide a fairly stable tourist industry from larger metropolitan areas such as the Los Angeles/Orange County basin and the San Francisco Bay area. With the diversity of the various types of industries in the Bank's service area, the Central Coast, while not immune from economic fluctuations, does tend to enjoy a more stable level of economic activity than many other areas of California. COMPETITION The banking business in California generally, and in the Bank's primary service areas specifically, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major banks with many offices and operations over a wide geographic area. Among the advantages such major banks have over the Bank are their ability to finance wide-ranging advertising campaigns and to allocate their investment assets to regions of higher yield and demand. Such banks offer certain services such as trust services and international banking which are not offered directly by the Bank; but which can be offered indirectly by the Bank through correspondent institutions. In addition, by virtue of their greater total capitalization, such banks have substantially higher lending limits than the Bank. (Legal lending limits to an individual customer are based upon a percentage of a bank's total capital accounts.) The Bank's unsecured and secured lending limits were approximately $26.0 million and $43.3 million, respectively, at December 31, 1999. Although within the Bank's trade area, there are few companies who would require more funds than the Bank can legally lend. Other entities, both governmental and in private industry, seeking to raise capital through the issuance and sale of debt or equity securities also provide competition for the Bank in the acquisition of deposits. Banks also compete with money market funds and other money market instruments which are not subject to interest rate ceilings. In order to compete with other competitors in their primary service areas, the Bank attempts to use, to the fullest extent, the flexibility which its independent status permits. This includes an emphasis on specialized services, local promotional activity, and personal contacts by its officers, directors and employees. In particular, the Bank offers highly personalized banking services. EMPLOYEES At December 31, 1999, the Bank had a total of 779 employees. A number of these employees are part-time however. On a full-time equivalent basis, these employees represent 711 positions. The Bank believes that its employee relations are satisfactory. EFFECT OF GOVERNMENTAL POLICIES AND LEGISLATION Banking is a business that depends on rate differentials. In general, the difference between the interest rate paid by the Bank on its deposits and its other borrowings and the interest rate received by the 9 Bank on loans extended to its customers and securities held in the Bank's portfolio comprise the major portion of the Bank's earnings. These rates are highly sensitive to many factors that are beyond the control of the Bank. Accordingly the earnings and growth of the Bank are subject to the influence of local, domestic and foreign economic conditions, including recession, unemployment and inflation. The commercial banking business is not only affected by general economic conditions but is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve Board. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted. From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial intermediaries. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial intermediaries are frequently made in Congress, in the California legislature and before various bank regulatory and other professional agencies. For example, legislation was recently passed in Congress that would repeal the current statutory restrictions on affiliations between commercial banks and securities firms. See "Financial Modernization Legislation." SUPERVISION AND REGULATION The Bank is extensively regulated under both federal and state law. Set forth below, is a summary description of certain laws which relate to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. THE COMPANY The Company is a bank holding company within the meaning of the BHC Act and is registered as such with, and subject to the supervision of, the Federal Reserve Board. The Company is required to file with the Federal Reserve Board quarterly and annual reports and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may conduct examinations of bank holding companies and their subsidiaries. The Company is required to obtain the approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of the voting shares of such bank. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company. The Company is prohibited by the Bank Holding Company Act, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging, directly or indirectly, in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company may, subject to the prior approval of the Federal Reserve Board, engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. 10 The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest subsidiaries or affiliates when the Federal Reserve Board determines that the activity or the control or the subsidiary or affiliates constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the Federal Reserve Board's regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe and unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, and filed reports and proxy statements pursuant to such Act with the Securities and Exchange Commission ("SEC"). THE BANK The Bank is chartered under the laws of the State of California and its deposits are insured by the FDIC to the extent provided by law. The Bank is subject to the supervision of, and is regularly examined by, the State Department of Financial Institutions and the FDIC. Such supervision and regulation include comprehensive reviews of all major aspects of the Bank's business and condition. Various requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes relate to many aspects of the Banks operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. Further, the Bank is required to maintain certain levels of capital. CAPITAL STANDARDS The Federal Reserve Board and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans. A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, noncumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for loan and lease losses, cumulative preferred stock, long term preferred stock, eligible 11 term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banking organizations not rated in the highest category, the minimum leverage ratio must be at least 100 to 200 basis points above the 3% minimum, or 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. Future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends.The following table presents the amounts of regulatory capital and the capital ratios for the Company, compared to its minimum regulatory capital requirements as of December 31, 1999.
DECEMBER 31, 1999 ------------------------------------ MINIMUM CAPITAL WELL ACTUAL REQUIREMENT CAPITALIZED -------- ----------- ----------- Leverage ratio......................................... 11.6% 4.0% 5.0% Tier 1 risk-based ratio................................ 16.0% 4.0% 6.0% Total risk-based ratio................................. 17.2% 8.0% 10.0%
Under applicable regulatory guidelines, the Bank was also considered "Well Capitalized" at December 31, 1999. On January 1, 1998 new legislation became effective which, among other things, gave the power to the DFI to take possession of the business and properties of a bank in the event that the tangible shareholders' equity of the bank is less than the greater of (i) 3% of the banks total assets or (ii) $1.0 million. PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. 12 An insured depository institution generally will be classified in the following categories based on capital measures indicated below: "WELL CAPITALIZED" "ADEQUATELY CAPITALIZED" Total risk-based capital of 10%; Total risk-based capital of 8%; Tier 1 risk-based capital of 6%; Tier 1 risk-based capital of 4%; and and Leverage ratio of 5%. Leverage ratio of 4%. "UNDERCAPITALIZED" "SIGNIFICANTLY UNDERCAPITALIZED" Total risk-based capital less than Total risk-based capital less than 8%; 6%; Tier 1 risk-based capital less than Tier 1 risk-based capital less than 4%; or Leverage ratio less than 4%. 3%; or Leverage ratio less than 3%. "CRITICALLY UNDERCAPITALIZED" Tangible equity to total assets less than 2%.
An institution that, based upon its capital levels, is classified as "well capitalized," "adequately capitalized" or undercapitalized" may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat an institution as "critically undercapitalized" unless its capital ratio actually warrants such treatment. The law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institution's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt correction action provisions. An insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is subject to additional restrictions and sanctions. These include, among other things: (i) a forced sale of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced merger; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors or senior executive officers; (vii) prohibitions on the receipt of 13 deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of subsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency. Although the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized. Further restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 90 days after an insured depository institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the regulator. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. PREMIUMS FOR DEPOSIT INSURANCE All deposits of the Bank are insured by the FDIC through the Bank Insurance Fund ("BIF") which are subject to FDIC insurance assessment. The amount of FDIC assessment paid by individual insured depository institutions is based upon their relative risk as measured by regulatory capital ratios and certain other factors. During 1995, the FDIC significantly reduced premium rates assessed on deposits insured by the BIF. As a result of its "Well Capitalized" status, the Bank paid the minimum required premium in 1999. FINANCIAL MODERNIZATION LEGISLATION Various proposals to adopt comprehensive financial modernization legislation have been introduced in Congress which include, among other things, elimination of the federal thrift charter, creation of a uniform financial institutions charter, expansion of bank powers, and integration of banking, commerce, securities activities and insurance. In 1999, Congress enacted legislation to modernize the nation's financial services system through S.900 known as the Gramm-Leach-Bliley Act of 1999. The bill allows the affiliation of financially-related firms such as banking, insurance and securities; allows banks to offer any service of a financial nature; protects the Community Reinvestment Act while at the same time extending the examination period for banks with satisfactory or outstanding CRA ratings; restricts the ability of unitary 14 thrift institutions to be sold to commercial firms; protects banks' ability to sell title insurance and generally is viewed as ensuring healthy competition among financial institutions and more choices at lower prices of services for consumers. COMMUNITY REINVESTMENT ACT The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. In connection with its assessment of CRA performance, the appropriate bank regulatory agency assigns a rating of "outstanding," "satisfactory," "needs to improve" or "substantial noncompliance." At its last examination by the FDIC, the Bank received a CRA rating of "Satisfactory." ACCOUNTING CHANGES From time to time the Financial Accounting Standards Board ("FASB") issues pronouncements which govern the accounting treatment for the Company's financial statements. For a description of the recent pronouncements applicable to the Company (see the Notes to the Financial Statements included in Item 7 of this Report). The FASB recently agreed to solicit comments by means of an Invitation to Comment as part of its business combinations project. Through this process, the FASB has determined to make certain changes to the methods of accounting for business combinations. Most notably, the "pooling method" of accounting will be eliminated, effective January 2001. Financial institutions often prefer to account for mergers using this method and many of the mergers in the financial institutions industry in the last several years have been accounted for using the pooling method. The impact of this accounting change, if adopted, on mergers and acquisitions involving financial institutions and upon the Company and the value of its Common Stock cannot presently be predicted. POTENTIAL ENFORCEMENT ACTIONS Commercial banking organizations, such as the Company and the Bank, may be subject to potential enforcement actions by the FDIC and the DFI for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the imposition of restrictions and sanctions under the prompt corrective action provisions of the FDIC Improvement Act. 15 ITEM 2. PROPERTIES The Company's principal office is located at 1026 Grand Avenue, Arroyo Grande, California. As of December 31, 1999, the Bank owned 23 of its offices and leased 9 other Bank locations. Information regarding offices of Bank of Santa Maria consolidated and discontinued is set forth below.
OWNED BY BANK OR SUBSIDIARY: LOCATION OF OFFICES ENCUMBRANCE - ---------------------------- -------------------------- ------------- Arroyo Grande*.................................... 991 Bennett Avenue NONE Arroyo Grande..................................... 1026 Grand Avenue NONE Arroyo Grande*.................................... 550 Camino Mercado NONE Arroyo Grande*.................................... 398 Sunrise Terrace NONE Atascadero........................................ 6950 El Camino Real $163,763.16 Buellton.......................................... West Highway 246 & Central NONE Cambria........................................... 1070 Main Street NONE Goleta Valley..................................... 5956 Calle Real NONE Grover Beach...................................... 899 Grand Avenue NONE Grover Beach*..................................... 140 North Second Street NONE Guadalupe......................................... 905 Guadalupe Street NONE Lompoc............................................ 828 North "H" Street NONE Los Osos.......................................... 1001 Los Osos Valley Road NONE Morro Bay......................................... 251 Harbor Street NONE Nipomo............................................ 615 West Tefft Street NONE Paso Robles....................................... 845 Spring Street NONE Pismo Beach....................................... 801 Price Street NONE San Luis Obispo................................... 75 Santa Rosa NONE San Luis Obispo................................... 2276 Broad Street NONE Santa Barbara..................................... 33 East Carrillo Street NONE Santa Barbara..................................... 2222 Bath Street NONE Santa Maria....................................... 720 North Broadway NONE Santa Maria....................................... 2739 Santa Maria Way NONE Santa Maria....................................... 1554 South Broadway NONE Santa Maria....................................... 519 E. Main Street NONE Templeton......................................... 1025 Las Tablas Road NONE Vandenberg Village................................ 3745 Constellation Road NONE FORMER BANK OF SANTA MARIA OFFICES WHICH HAVE BEEN CONSOLIDATED AND ARE BEING SOLD: OWNED BY BANK OR SUBSIDIARY: LOCATION OF OFFICES ENCUMBRANCE - ---------------------------- -------------------------- ------------- Orcutt Oak Knolls 1070 East Clark NONE Santa Maria 528 South Broadway NONE
16 LEASED BY BANK OR SUBSIDIARY Cayucos..................... 107 North Ocean Avenue $1,455.50 per month Expires November, 2002 Paso Robles................. 705 Golden Hill Road $9,463.00 per month Expires October, 2002 Orcutt...................... 1110 East Clark, Santa Maria $8,959.00 per month Expires October, 2000 Oak Park--Pismo Beach....... 865 Oak Park Boulevard $10,098.00 per month Expires March, 2008 Oxnard...................... 445 Esplanade Drive, Ste 110 $2,947.12 per month Expires June, 2000 Oxnard*..................... 300 Esplanade Drive, Ste 470/480 $3,360.00 per month Expires December, 2002 Milpas--Santa Barbara....... 914 Carpinteria Street $9,562.94 per month Expires May, 2017 Hollister--Goleta Valley.... 5340 Hollister Avenue $5,907.38 per month Expires February, 2002 Santa Barbara*.............. 911 Olive Street $10,280.49 per month Expires December, 2003 Santa Maria*................ 2801--B Santa Maria Way $1,313.90 per month Expires April, 2000 Santa Ynez.................. 3600 Sagunto Street $2,000.00 per month Expires May, 2002 Solvang..................... 1600 Copenhagen Drive $9,688.69 per month Expires April, 2003 FORMER BANK OFFICES LEASED BY BANK--WHICH ARE SUB-LEASED Nipomo...................... 630 W. Tefft Street $3,460.80 per month Expires February, 2015
* ALL OFFICES LISTED ABOVE (EXCLUDING THOSE FORMER BANK OF SANTA MARIA OFFICES BEING SOLD OR SUB-LEASED) ARE FULL-SERVICE OFFICES, EXCEPT THOSE WITH ASTERISKS NOTED ABOVE. ASTERISKS REPRESENT NON-BANKING SUPPORT OFFICES (E.G., ADMINISTRATION, DATA PROCESSING, SUPPLIES WAREHOUSE, CREDIT SERVICES, TRAINING FACILITIES, ET. AL.). ITEM 3. LEGAL PROCEEDINGS The Company is, from time to time, subject to various pending and threatened legal actions which arise out of the normal course of its business. The Company is not a party to any pending legal or administrative proceedings (other than ordinary routine litigation incidental to the Company's business) and no such proceedings are known to be contemplated. There are no material proceedings adverse to the Company to which any director, officer, affiliate of the Company or 5% shareholder of the Company, or any associate of any such director, officer, affiliate or 5% shareholder of the Company is a party, and none of the above persons has a material interest adverse to the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1999. 17 - -------------------------------------------------------------------------------- PART II - -------------------------------------------------------------------------------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS MARKET INFORMATION The Company's Common Stock trades on the Nasdaq National Market under the symbol "MDST." Prior to July 10, 1998, trading of the Company's Common Stock occurred solely "over the counter," and was limited. Consequently, the prices listed before that date represent quotations by dealers making a market in the Company's Common Stock and reflect inter-dealer prices, without adjustments for mark-ups, mark-downs or commissions and may not necessarily represent actual transactions. On July 10, 1998, the Company's Common Stock was designated for quotation on the Nasdaq National Market. The prices listed below for periods subsequent to July 10, 1998 are as reported by the Nasdaq National Market. The following table summarizes those trades of the Company's Common Stock of which Management is aware, setting forth the approximate high and low trade prices for each quarterly period ended since January 1, 1998.
QUARTER SALES PRICES ENDED ------------------- 1998 LOW HIGH ------- -------- -------- March 31.................................................... $25.63 $29.25 June 30..................................................... $28.75 $32.00 September 30................................................ $24.00 $31.25 December 31................................................. $22.88 $28.88 QUARTER SALES PRICES ENDED ------------------- 1999 LOW HIGH ------- -------- -------- March 31.................................................... $27.88 $28.38 June 30..................................................... $33.63 $35.50 September 30................................................ $29.63 $30.63 December 31................................................. $30.38 $31.88
HOLDERS As of December 31, 1999, there were approximately 3,800 holders of the Company's Common Stock. There are no other classes of common equity outstanding. DIVIDENDS The Company is a legal entity separate and distinct from the Bank. The Company's shareholders are entitled to receive dividends when and as declared by its Board of Directors, out of funds legally available therefor, subject to the restrictions set forth in the California General Corporation Law (the "Corporation Law"). The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. The Corporation Law also provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may nevertheless make a distribution to its shareholders if it meets two conditions, which generally stated are as follows: (i) the corporation's assets equal at least 1 1/4 times its liabilities, and (ii) the corporation's current assets equal at least its current liabilities or, if the average of the corporation's earnings before taxes on income and before interest expenses for the two preceding fiscal 18 years was less than the average of the corporation's interest expenses for such fiscal years, then the corporation's current assets must equal at least 1 1/4 times its current liabilities. The ability of the Company to pay a cash dividend depends largely on the Bank's ability to pay a cash dividend to the Company. The payment of cash dividends by the Bank is subject to restrictions set forth in the California Financial Code (the "Financial Code"). The Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of (a) the bank's retained earnings; or (b) the bank's net income for its last three fiscal years, less the amount of any distributions made by the bank or by any majority-owned subsidiary of the bank to the shareholders of the bank during such period. However, a bank may, with the approval of the DFI, make a distribution to its shareholders in an amount not exceeding the greater of (x) its retained earnings; (y) its net income for its last fiscal year; or (z) its net income for its current fiscal year. In the event that the DFI determines that the shareholders' equity of a bank is inadequate or that the making of a distribution by the bank would be unsafe or unsound, the DFI may order the bank to refrain from making a proposed distribution. The FDIC may also restrict the payment of dividends if such payment would be deemed unsafe or unsound or if after the payment of such dividends, the Bank would be included in one of the "undercapitalized" categories for capital adequacy purposes pursuant to federal law. (See, "Item 1--Description of Business--Prompt Corrective Action and Other Enforcement Mechanisms.") Additionally, while the Federal Reserve Board has no general restriction with respect to the payment of cash dividends by an adequately capitalized bank to its parent holding company, the Federal Reserve Board might, under certain circumstances, place restrictions on the ability of a particular bank to pay dividends based upon peer group averages and the performance and maturity of the particular bank, or object to management fees to be paid by a subsidiary bank to its holding company on the basis that such fees cannot be supported by the value of the services rendered or are not the result of an arm's length transaction. The following table sets forth the per share amount and month of payment for all cash dividends paid since January 1, 1998.
PAYABLE DATE DIVIDEND - ------------ ---------------------------- January 23, 1998 Mid-State Bank................... 5%--Stock June 26, 1998 Mid-State Bank................... $0.15 per share--Cash January 22, 1999 Mid-State Bancshares............. $0.12 per share--Cash April 22, 1999 Mid-State Bancshares............. $0.12 per share--Cash July 22, 1999 Mid-State Bancshares............. $0.12 per share--Cash October 22, 1999 Mid-State Bancshares............. $0.14 per share--Cash January 18, 2000 Mid-State Bancshares............. $0.14 per share--Cash
Whether or not stock dividends or any cash dividends will be paid in the future will be determined by the Board of Directors after consideration of various factors. The Company's profitability and regulatory capital ratios in addition to other financial conditions will be key factors considered by the Board of Directors in making such determinations regarding the payment of dividends by the Company. TRANSFER AGENT ChaseMellon Shareholder Services serves as the Company's transfer agent. Shareholder inquiries regarding holdings of Mid-State Bancshares Common Stock can be directed to: ChaseMellon Shareholder Services, LLC P.O. Box 3315 South Hackensack, NJ 07606-1915 1-(888)-540-9878 (U.S. & Canada) 1-(201)-329-8660 (Outside U.S.) Alternatively, ChaseMellon can be contacted via the Internet at www.chasemellon.com. 19 ITEM 6. SELECTED FINANCIAL DATA SELECTED CONSOLIDATED FINANCIAL DATA--MID-STATE BANCSHARES
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS) 1999 1998 1997 1996 1995 - --------------------------------------- ---------- ---------- ---------- ---------- ---------- YEAR ENDED DECEMBER 31: Interest Income (not taxable equivalent)........................ $ 99,627 $ 98,882 $ 93,091 $ 85,217 $ 84,340 Interest Expense..................... 26,071 29,441 29,060 27,068 26,693 ---------- ---------- ---------- ---------- ---------- Net Interest Income.................. 73,556 69,441 64,031 58,149 57,647 Provision for Loan Losses............ 50 300 105 7 1,025 ---------- ---------- ---------- ---------- ---------- Net Interest Income after provision for loan losses........................ 73,506 69,141 63,926 58,142 56,622 Non-interest income.................. 17,465 24,736 17,834 17,303 16,469 Non-interest expense................. 57,488 62,306 57,674 60,596 67,271 ---------- ---------- ---------- ---------- ---------- Income before income taxes........... 33,483 31,571 24,086 14,849 5,820 Provision for income taxes........... 11,430 10,576 5,220 5,668 692 ---------- ---------- ---------- ---------- ---------- Net Income........................... $ 22,053 $ 20,995 $ 18,866 $ 9,181 $ 5,128 ========== ========== ========== ========== ========== PER SHARE: Net Income--basic.................... $ 1.96 $ 1.88 $ 1.70 $ 0.83 $ 0.47 Net Income--diluted.................. $ 1.94 $ 1.86 $ 1.68 $ 0.82 $ 0.46 Weighted average shares for Basic E.P.S. calculation................. 11,230 11,176 11,097 11,058 10,991 Weighted average shares for Diluted E.P.S. calculation................. 11,364 11,273 11,262 11,131 11,050 Cash dividends....................... $ 0.49 $ 0.28 $ 0.16 $ 0.09 $ 0.02 Book value at year-end............... $ 14.20 $ 13.48 $ 11.71 $ 10.11 $ 9.50 Ending Shares........................ 11,287 11,206 11,104 11,084 11,041 AT DECEMBER 31, Cash and cash equivalents............ $ 56,080 $ 84,557 $ 102,060 $ 99,883 $ 97,227 Investments and Fed Funds Sold....... 482,781 578,034 518,739 473,826 415,367 Loans, net of deferred fees, before allowance.......................... 768,814 675,481 643,675 600,418 561,605 Allowance for Loan & Lease Losses.... (13,105) (14,441) (15,065) (14,561) (15,798) Other assets......................... 60,648 65,694 73,796 81,104 100,119 ---------- ---------- ---------- ---------- ---------- Total Assets....................... $1,355,218 $1,389,325 $1,323,205 $1,240,670 $1,158,520 ========== ========== ========== ========== ========== Non-interest bearing deposits........ $ 230,271 $ 258,629 $ 243,315 $ 220,850 $ 198,823 Interest bearing deposits............ 938,183 965,850 938,663 891,613 840,549 Other borrowings..................... 15,357 3,049 4,494 7,424 5,589 Other liabilities.................... 11,076 10,706 6,646 8,757 8,659 Capital Accounts..................... 160,331 151,091 130,087 112,026 104,900 ---------- ---------- ---------- ---------- ---------- Total Liabilities and Shareholders' equity........................... $1,355,218 $1,389,325 $1,323,205 $1,240,670 $1,158,520 ========== ========== ========== ========== ==========
20 SELECTED CONSOLIDATED FINANCIAL DATA--MID-STATE BANCSHARES (CONTINUED)
(IN THOUSANDS) 1999 1998 1997 1996 1995 - -------------- --------- --------- --------- --------- --------- PERIOD AVERAGES: Total Assets............................ 1,391,279 1,331,954 1,254,686 1,177,624 1,120,956 Total Loans............................. 685,566 633,324 605,688 561,375 571,846 Total Earning Assets.................... 1,269,656 1,194,352 1,110,560 1,018,546 946,539 Total Deposits.......................... 1,220,340 1,184,293 1,107,842 1,058,743 1,003,763 Common Equity........................... 155,419 140,989 121,450 108,614 97,798 ASSET QUALITY Non-accrual loans..................... 1,520 2,019 3,939 5,336 14,692 Loans past due 90 days or more........ 4,199 4,408 663 2,803 2,048 Other real estate owned............... -- 259 5,188 7,838 11,814 --------- --------- --------- --------- --------- Total non performing assets........... 5,719 6,686 9,790 15,977 28,554 FINANCIAL RATIOS For the year: Return on assets...................... 1.59% 1.58% 1.50% 0.78% 0.46% Return on equity...................... 14.19% 14.89% 15.53% 8.45% 5.24% Net interest margin (not taxable equivalent)......................... 5.79% 5.81% 5.77% 5.71% 6.09% Net interest margin (taxable equivalent)........................... 6.02% 5.91% 5.83% 5.78% 6.16% Net loan losses (recoveries) to avg. loans................................. 0.20% 0.15% -0.07% 0.26% 0.35% Efficiency ratio...................... 63.2% 66.2% 70.5% 80.3% 90.8% At December 31: Equity to average assets (leverage ratio)................................ 11.6% 10.7% 9.7% 8.9% 8.9% Tier One capital to risk-adjusted assets................................ 16.0% 16.1% 14.7% 13.7% 13.2% Total capital to risk-adjusted assets................................ 17.2% 17.4% 15.8% 15.0% 14.4% Loan loss allowance to loans, gross... 1.7% 2.1% 2.3% 2.4% 2.8% Non-accrual loans to total loans, gross................................. 0.2% 0.3% 0.6% 0.9% 2.6% Non performing assets to total assets................................ 0.4% 0.5% 0.7% 1.3% 2.5% Allowance for loan losses to non performing loans.................... 229% 225% 327% 179% 94%
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT'S DISCUSSION AND ANALYSIS INTRODUCTION AND BUSINESS OF THE COMPANY The Company has as its single, wholly owned subsidiary, Mid-State Bank (the Bank). The Bank itself has two wholly owned subsidiaries--MSB Properties and Mid-Coast Land Company (discussed above in Part I of this report and later in this Management's Discussion and Analysis). The Bank was founded in 1961 and operates a full service commercial banking business serving its customers on the Central Coast of California. Headquartered in Arroyo Grande, it operates 32 offices in communities throughout San Luis Obispo, Santa Barbara and Ventura counties. Based on data supplied by Banks in its trade area, Mid-State is the second largest Bank in terms of total assets. Of the 300 banks in the State of California, only 23 of them were chartered prior to the Bank. An Agreement to Merge and Plan of Reorganization by and among Mid-State Bank and City Commerce Bank was effective at close of business August 31, 1999. The acquisition of City Commerce 21 Bank increases the Bank's market presence along the south coast of Santa Barbara County and provides an important entree into the Ventura County marketplace. The merger was accounted for on a pooling of interests basis and as a result, the financial statements for all periods presented have been restated to include the accounts of City Commerce Bank. The following discussion and analysis will provide insight and supplementary information into the accompanying consolidated financial statements of the Bank. It also provides Management's assessment of the operating trends over the past few years and certain of their expectations for 2000. Management's Discussion and Analysis (MD&A) includes "forward-looking statements" within the meaning of Section 27A of the Securities Act. All of the statements contained in the MD&A, other than statements of historical fact, should be considered forward-looking statements, including, but not limited to, those concerning (i) the Company's strategies, objectives and plans for expansion of its operations, products and services, and growth of its portfolio of loans, investments and deposits, (ii) the Company's beliefs and expectations regarding actions that may be taken by regulatory authorities having oversight of the operation, and (iii) the Company's beliefs as to the adequacy of its existing and anticipated allowances for loan and real estate losses. Although the Company believes the expectations reflected in those forward-looking statements are reasonable, it can give no assurance that those expectations will prove to have been correct. All subsequent written and oral forward-looking statements by or attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by this qualification. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof and are not intended to give any assurance as to future results. The Company undertakes no obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. 1999 RESULTS AND ACCOMPLISHMENTS FINANCIAL For 1999, the Company on a consolidated basis reported net income of $22.1 million compared to $21.0 million in 1998 and $18.9 million in 1997. The diluted Earnings Per Share was $1.94 compared to $1.86 in 1998 and $1.68 in 1997. Consolidated total assets at December 31, 1999 were $1.355 billion compared to $1.389 billion at December 31, 1998, down 2.5%. Total deposits also decreased slightly from $1.224 billion as of December 31, 1998 to $1.168 billion at year-end 1999. Shareholders' common equity stood at $160.3 million at year end up from its $151.1 million level a year earlier, owing primarily to net income of $22.1 million for 1999. Also impacting shareholders' equity were the unrealized loss on securities available for sale of $3.7 million compared to a gain of $4.4 million one year earlier, as well as, cash dividends paid during 1999 of $5.6 million. The table below illustrates net income by subsidiary unit. Significant items affecting the income statement in 1999 include: 1) non-recurring merger charges of $2.1 million after-tax, and 2) tax deductions not previously benefited in prior years of $1.4 million. These items are discussed more fully below in the analysis of income and expense.
INCOME (LOSS) BY SUBSIDIARY (000'S) 1999 1998 1997 - ----------------------------------- -------- -------- -------- Bank only, pre-tax....................................... $32,340) $24,320) $24,948) MSB Properties, pre-tax.................................. 2,175) 2,165) 2,203) Mid Coast Land Co., pre-tax.............................. 349 5,410 (2,891) Parent only, pre-tax..................................... (1,381) (324) (174) Tax expense.............................................. 11,430 10,576 5,220 ------- ------- ------- Consolidated Mid-State Bancshares........................ $22,053 $20,995 $18,866
22 OTHER ACCOMPLISHMENTS IN 1999 The most significant accomplishment during the year, was the successful completion of the merger of City Commerce Bank with the Bank. Prior to the announcement of the merger in the first quarter of 1999, Mid-State Bank had $1.222 billion in assets, 28 office locations and 644 full time equivalent employees. City Commerce Bank, which operated in the southern portion of Mid-State Bank's geographical territory, maintained $150 million in assets and 75 full time equivalent employees. The integration of these two entities was complex and involved significant management effort. The goal of this in-market merger was to attain the synergy's available to benefit the stockholders of both organizations, while minimizing the disruption to customers and employees alike. City Commerce Bank had four branches- two in Santa Barbara, one in Goleta and one in Oxnard. All four branches became new offices of Mid-State Bank and will complement the Bank's two existing offices in Santa Barbara and Goleta. Also during 1999, the Bank completed implementation of its Year 2000 Plan begun in 1997. (See item 7.b. below--"Disclosure about risks associated with Year 2000 issues)." Activities completed included testing of various "Mission Critical" systems, development and testing of contingency plans, reviews of customer readiness status and public information awareness campaigns. No meaningful Year 2000 issues have arisen with the century date change rollover. ENVIRONMENTAL FACTORS IMPACTING THE BANK ECONOMIC CONDITIONS The most comprehensive review of local economic conditions known to Management comes from the UCSB Economic Forecast Project which provides both annual forecast information and periodic updates of economic conditions in the Company's trade area. The economy continues a steady improvement, as measured by a variety of data. In San Luis Obispo County, job growth increased by 1.2% in 1999 compared to 3.6% in 1998. The slowdown in job creation in 1999 could in large part, be attributed to the decline in the labor force availability. The unemployment rate in San Luis Obispo County remained approximately the same with 3.5% in 1999 compared to 3.6% one year earlier. The County rate is now less than the national rate of 4.1%, a rare occurrence in recent years. According to UCSB estimates, if the unemployment rate drops much further, the existing labor force will not be able to accommodate new job demand, thus placing pressure for additional population growth pursuing employment opportunities. Santa Barbara County is seeing a similar situation with an exceptionally low unemployment rate of 3.8% in 1999 compared to 4.7% in 1998. Ventura County employment remained strong in 1999 also. Tourism in San Luis Obispo and Santa Barbata counties remained solid in 1999. Hotel/motel occupancy rates have seen steady improvement with hotel/motel room sales up 5.0% during 1999 in San Luis Obispo County over 1998. Visitor spending in San Luis Obispo County has been estimated for 1999 to be up 9.8% to $431 million. Similarly, in Santa Barbara County on the south coast, hotel/motel room sales are estimated to be up 9.2% in 1999 indicating positive tourism trends there as well. This important sector to the Company's trade area appears to be healthy and improving. With a wealthier population contributing to increases in travel dollars being spent and with prospects for drier weather, tourism in 2000 should enjoy another robust year. Solid retail sales figures were noted throughout the Company's trade area, especially in the larger cities of Paso Robles, Arroyo Grande, San Luis Obispo, Santa Maria, and Santa Barbara. Retail sales in San Luis Obispo County jumped a healthy 8% in 1998 followed by an estimated 9% in 1999. Rates in Santa Barbara County were estimated to be in excess of 5%. Management would expect retail sales growth, adjusted for inflation, to continue to grow in 2000. Growth rates in excess of 5% are likely in view of the strong economic conditions throughout the tri-counties. Residential real estate sales were strong in 1999 throughout the Company's trade area. Home sales are estimated to be up some 18.6% in San Luis Obispo County and 14.3% in Santa Barbara County. The 23 median price of homes sold in San Luis Obispo increased 13.2% (third quarter compared to third quarter) and 4.4% in Santa Barbara County. The UCSB Economic Forecast Project is projecting an increase in selling prices of about 6.7% for 2000 owing to a lack of housing inventory of both new and existing homes. In last year's Annual Report the Bank was anticipating "...Interest rates are not expected to change dramatically during 1999." This was indeed the case for the first six months of the year. The Prime Rate began the year at 7.75% and remained at that level until the start of the third quarter. Three 25 basis point increases on July 1(st), August 24(th) and November 17(th) saw the Prime Rate finish the year at 8.50%. On average for the full year 1999, Prime was 8.00% compared to 8.36% in 1998. Other key interest rates followed similar patterns. The closely watched Fed Funds Rate began the year at 4.75% and rose to 5.50% by December 31(st). Similarly, the thirty year Treasury Bond which had started the year at 5.09 was 6.48% by the end of 1999. Management's expectations for 2000 are for continued strong growth rates throughout the Bank's trade area. Projections would be for 2 or 3 modest increases in the Prime Rate. The willingness by the Federal Reserve Bank and Chairman Greenspan to raise rates in an effort to curb inflation would appear to be the likely course for some months to come. Other factors also arguing against any drop in interest rates include; 1) a tight labor market, and 2) both lofty, and fairly volatile, stock market levels. These interest rate conditions, coupled with the steady momentum developed in the local economy over the past few years, would appear to indicate another favorable year overall for the local Central Coast economy. COMPETITIVE FACTORS Competitive pressures from other financial institutions continue to be intense both in the Company's trade area and throughout the Nation. Many banks are suffering from sufficient loan volumes and have become very aggressive on the pricing of those good credits available. Various mortgage bankers are blanketing the central coast communities with sales promotions and are extremely competitive with their rate programs. Brokerage houses are indeed a factor through their marketing of mutual funds and numerous banks are now offering these products. It should also be noted that the trend toward consolidation of banking assets exhibited over the past few years in California continued in 1999. Statewide, 16 banks were merged out of existence during the year. Locally, the only Bank merger in the tri-county area was Mid-State Bank's merger with City Commerce Bank. While no new banks were started in Mid-State Bank's trade area during 1999, 8 were established throughout the State during the year (with another 4 approved pending start-up). Two new banks began operating locally in 1997 and a savings bank began operation in San Luis Obispo during early 1999. LEGAL MATTERS The Bank is involved in litigation of a routine nature which is being handled and defended in the ordinary course of the Bank's business. In the opinion of Management, based on the advice of legal counsel, the resolution of pending litigation will have no material impact on the Bank's income or financial position. ANALYSIS OF STATEMENT OF FINANCIAL POSITION LOANS The Bank experienced an increase in its net loan portfolio from $661.0 million at the end of 1998 to $755.7 million at the end of 1999. This represents continued growth of the loan portfolio of $94.7 million following the $32.4 million increase in 1998. Loans now represent approximately 56% of the Bank's assets which is below the level at which Management would prefer to operate. The Investment Portfolio has decreased by $60.9 million, over this period of time as funds are being allocated to the loan portion of the 24 balance sheet. The section immediately following provides a more extensive discussion of the Investment Portfolio. The composition of the loan portfolio is also changing. The graph below displays the trend over the past five years in the various components of the loan portfolio. Construction loans have risen from their level three years earlier--$46.6 million at December 31, 1996 compared to $118.4 million at year-end 1999. Real Estate loans generally trended up from $270.6 million at the end of 1996 to nearly $285.9 million at December 31, 1998, and $379.8 million at the end of 1999. Home Equity Credit Lines have steadily declined from $83.6 million at the end of 1996 to $52.7 million at the end of 1999. Consumer loans (installment, credit cards and credit reserve) have generally exhibited declines over the last 3 years reaching $42.0 million at year-end 1999 compared to $56.2 million at the end of 1996. Commercial loans have grown in recent years having reached $138.1 million at December 31, 1999. Agricultural production loans have also grown from $26.6 million at the end of 1996 to $41.3 million at the end of 1999. The Bank expects to continue to emphasize other types of lending activity in order to diversify the risk in those categories relative to term real estate loans. Economic activity in the Central Coast will determine the types of credit the Bank will be able to extend and hence its ability to achieve this objective. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
CONSTRUCTION AND REAL ESTATE HECL'S INSTALLMENT CREDIT CARD AGRICULTURE COMMERCIAL, OTHER Land Development & Related 1995 $43,564 $253,154 $89,673 $39,899 $12,009 $19,588 $104,852 1996 $46,596 $270,559 $83,624 $38,553 $17,688 $26,632 $117,891 1997 $46,415 $307,065 $74,850 $35,611 $18,469 $35,523 $127,374 1998 $90,689 $287,440 $57,428 $47,210 $12,153 $35,128 $147,396 1999 $117,340 $377,435 $52,681 $29,652 $12,308 $41,303 $138,095
The Bank's allowance for loan losses stands at $13.1 million, or 1.7% of gross loans, representing losses inherent in the Loan Portfolio but not yet realized. This amount is down from the $14.4 million at December 31, 1998. The year-end 1999 balance now represents 229% of non-performing loans slightly up 25 from 225% at the end of 1998. A five year review of activitiy in the allowance for loan losses and an allocation by loan type of the allowance is shown in the two tables below.
ALLOWANCE FOR LOAN LOSSES (IN 000'S) 1999 1998 1997 1996 1995 - ------------------------------------ -------- -------- -------- -------- -------- Balance at beginning of year................... $14,441 $15,065 $14,561 $15,798 $17,256 Provision charged to operating expense......... 50 300 105 7 1,025 After Adjustments--Merger -- -- -- 228 -- Loans charged off: Construction and development loans........... (14) -- -- (73) (1,156) Real estate loans............................ (15) (151) (265) (785) (1,273) Home equity credit lines..................... (178) (94) (15) (293) (278) Installment loans............................ (132) (405) (477) (355) (407) Commercial loans............................. (1,852) (674) (462) (1,422) (1,509) Credit cards and related loans............... (331) (397) (443) (409) (435) Recoveries of loans previously charged off: Construction and development loans........... 198 32 44 908 1,616 Real estate loans............................ 180 188 84 96 161 Home equity credit lines..................... 111 17 20 23 49 Installment loans............................ 115 122 111 113 100 Commercial loans............................. 425 362 1,721 661 566 Credit cards and related loans............... 107 76 81 64 83 ------- ------- ------- ------- ------- BALANCE AT END OF YEAR....................... $13,105 $14,441 $15,065 $14,561 $15,798 ======= ======= ======= ======= ======= Ratio of Net Loan Losses (Recoveries) to Average Loans Outstanding.................... 0.20% 0.15% -0.07% 0.26% 0.43%
Allocation of the allowance for loan losses at December 31, is as follows:
PERCENT PERCENT PERCENT PERCENT (DOLLARS IN 000'S) OF OF OF OF BALANCE APPLICABLE TO: 1999 LOANS 1998 LOANS 1997 LOANS 1996 LOANS 1995 - -------------------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Construction and Land Dev..................... $ 1,979 15.3% $ 946 13.4% $ 617 7.2% $ 958 7.3% $ 2,344 Real Estate............... 2,291 49.1% 3,798 42.4% 4,243 47.5% 6,693 48.2% 6,605 H.E.C.L................... 344 6.9% 753 8.5% 922 11.6% 1,143 15.1% 1,546 Installment............... 283 3.9% 1,092 7.0% 591 5.5% 470 5.6% 808 Credit Card and Related... 770 1.6% 1,170 1.8% 736 2.9% 503 3.4% 599 Commercial, Other......... 4,448 23.2% 4,973 26.9% 3,049 25.3% 2,598 20.4% 3,415 Contingency............... 2,990 N/A 1,709 N/A 4,907 N/A 2,196 N/A 481 ------- ----- ------- ----- ------- ----- ------- ----- ------- BALANCE AT END OF YEAR.................. $13,105 100.0% $14,441 100.0% $15,065 100.0% $14,561 100.0% $15,798 ======= ===== ======= ===== ======= ===== ======= ===== ======= PERCENT (DOLLARS IN 000'S) OF BALANCE APPLICABLE TO: LOANS - -------------------------- -------- Construction and Land Dev..................... 7.5% Real Estate............... 46.4% H.E.C.L................... 18.2% Installment............... 6.8% Credit Card and Related... 2.3% Commercial, Other......... 18.8% Contingency............... N/A ----- BALANCE AT END OF YEAR.................. 100.0% =====
Non-Accrual loans within the Bank's portfolio stood at $1.5 million as of December 31, 1999, an improvement from the $2.0 million at the end of 1998. Loans 90 days or more past due stood at $4.2 million at December 31, 1999, which is slightly down from the $4.4 million at the end of 1998. The vast majority of the loans on non-accrual ($1.4 million) are secured by real estate. There is potential for this collateral to be liquidated to recover principal and unpaid interest. To the extent this is insufficient, a charge-off to the allowance may result. $0.8 million of 90 days or more past due loans are secured by real estate and $3.2 million is secured by loans to finance agricultural production. Recoveries in 1999 of loans previously charged-off totaled $1.1 million compared to charge-offs of $2.5 million taken during the year resulting in NET CHARGE-OFFS of $1.4 million. This compares to net charge-offs incurred during 1998 of $924 thousand and net recoveries of $399 thousand in 1997. The Bank anticipates that charge-offs (actual losses) will continue during 2000. It is unlikely that recoveries would exceed charge-offs in the coming year. 26 With the combination of the collateral securing the problem loans and the size of the allowance for loan losses, Management feels that the allowance is sufficient to cover inherent losses. Management reviews the adequacy of the allowance and adjusts it as necessary on a regular basis. The allowance is also examined annually by one or more of the Bank's regulatory bodies including the FDIC and The State Of California Department of Financial Institutions. The allowance for loan losses as a percentage of total loans has gradually decreased from 2.8% in 1995 to 1.7% in 1999, reflecting an improvement in asset quality during this period. This is evident in the reduction of non-performing assets from $28.6 million in 1995 to $5.7 million by the end of 1999. The adequacy of the allowance is determined by considering the type and quality of loans in the loan portfolio, trends in non-accrual loans, trends in delinquencies, trends in actual losses, geographical distribution of loans, management expertise, economic outlook, diversification of the loan portfolio, value of available collateral, and the costs of collateral liquidation. In establishing the allowance at December 31, 1999, Management acknowledged the combined high concentration of real estate loans, increases in certain higher risk activities such as construction lending, concern with respect to the Year 2000 readiness of borrowers, and higher levels of individually large corporate loans. These factors directly offset the beneficial trends in non-performing loans. The allowance for loan losses consists of an amount allocated to loans which are impaired, a statistically allocated portion and a specifically allocated portion. The total of these components is considered adequate to provide for losses which can be reasonably anticipated. However, since these amounts are based on estimates, ultimate losses relating to these loans may vary. A summary of maturities and sensitivities of loans to changes in interest rates at December 31, is shown in the table below. A more complete discussion of the Bank's exposure to changes in interest rates can be found in the MD&A under the section titled "Net Interest Income and Interest Rate Risk".
OVER DUE AFTER DUE AFTER 3 MONTHS ONE YEAR THREE YEARS (DOLLARS IN 000'S) 3 MONTHS THROUGH TO THREE TO FIVE DUE AFTER 1999 OR LESS 12 MONTHS YEARS YEARS FIVE YEARS TOTAL - ----------------------------------------- -------- --------- --------- ----------- ---------- -------- Fixed rate loans......................... $18,877 $63,241 $66,639 $41,109 $176,611 $366,477 Floating rate loans...................... 364,063 5,602 19,393 8,043 3,715 400,816 ------- ------- ------- ------- -------- -------- Sub-total.............................. 382,940 68,843 86,032 49,152 180,326 767,293 Non accrual loans........................ 1,520 -------- Total Loans, gross..................... $768,813 ========
OVER DUE AFTER DUE AFTER 3 MONTHS ONE YEAR THREE YEARS (DOLLARS IN 000'S) 3 MONTHS THROUGH TO THREE TO FIVE DUE AFTER 1998 OR LESS 12 MONTHS YEARS YEARS FIVE YEARS TOTAL - ----------------------------------------- -------- --------- --------- ----------- ---------- -------- Fixed rate loans......................... $ 9,462 $67,255 $80,598 $52,812 $154,952 $365,079 Floating rate loans...................... 305,007 3,376 -- -- -- 308,383 ------- ------- ------- ------- -------- -------- Sub-total.............................. 314,469 70,631 80,598 52,812 154,952 673,462 Non accrual loans........................ 2,019 -------- Total Loans, gross..................... $675,481 ========
27 INVESTMENT PORTFOLIO The Bank's Investment Portfolio primarily consists of US Treasury Notes and Bills, Federal Agency Notes, Mortgage Backed Securities and Municipal Bonds. See footnote No. 4 to the consolidated financial statements for a detailed composition of the Investment Portfolio. Most of the growth in the portfolio was centered in the Municipal Portfolio as it increased from $193.3 million at the end of 1998 to $236.4 million at the end of 1999. The Bank has focused on this segment of the portfolio because it generates better returns and there is already ample liquidity with the Treasury and Agency portion of the portfolio ($219.5 million at year-end 1999). The U.S. Treasury portion of the portfolio decreased by $60.1 million while Federal Agencies and Mortgage Backed Securities decreased by $43.7 million from December 31, 1998 to December 31, 1999. The Bank may segregate its portfolio into three categories--a "Trading Portfolio" (which is carried at market value, with changes reflected in the income statement), a "Held to Maturity" portfolio (which is carried at historical amortized cost) and an "Available for Sale" portfolio (which is carried at market value, with changes reflected in comprehensive income, but provides for the same income statement treatment as the Held-to-Maturity portfolio.) The Bank holds no securities that should be classified as Trading securities. The Bank has determined that since its securities may be sold prior to maturity because of interest rate changes, to meet liquidity needs, or to better match the repricing characteristics of funding sources, the majority of the portfolio ($433.9 million) should be classified as Available for Sale. The remaining $31.4 million in the held-to-maturity portion of the portfolio will likely be allowed to mature with the funds re-invested either in the loan portfolio or the Available for Sale portion of the Investment Portfolio. The mark to market adjustment on the Available for Sale portfolio resulted in a loss in the equity section of $3.7 million as of December 31, 1999 compared to an unrealized gain of $4.4 million at December 31, 1998. Maturities/sales exceeded Purchases over the full year and the total investment portfolio thus decreased by $60.9 million from the end of 1998 to the end of 1999. Shown below is a summary maturity distribution of the investment portfolio by type and weighted taxable equivalent yield as of December 31, 1999. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Maturity information for Mortgage Backed securities shown below is based on contractual maturities.
AFTER ONE AFTER FIVE AVAILABLE FOR SALE (AT MARKET VALUE): ONE YEAR YEAR TO YEARS TO AFTER (DOLLARS IN 000'S) OR LESS FIVE YEARS TEN YEARS TEN YEARS TOTAL - -------------------------------------------- -------- ---------- ---------- --------- -------- Maturity Distribution: U.S. Treasury Securities.................. $ 63,118 $ 52,025 $ -- $ -- $115,143 U.S. Government Agencies.................. 45,398 54,462 -- -- 99,860 Mortgage Backed Securities................ 511 3,199 526 1,937 6,173 Municipals, Other Securities.............. 26,825 115,308 70,242 347 212,722 -------- -------- ------- ------ -------- Total................................... $135,852 $224,994 $70,768 $2,284 $433,898 ======== ======== ======= ====== ========
AFTER ONE AFTER FIVE ONE YEAR YEAR TO YEARS TO AFTER OR LESS FIVE YEARS TEN YEARS TEN YEARS TOTAL -------- ---------- ---------- --------- -------- Weighted Average Yield: U.S. Treasury Securities....................... 5.85% 6.05% -- -- 5.92% U.S. Government Agencies....................... 6.00% 6.70% -- -- 6.37% Mortgage Backed Securities..................... 5.98% 6.64% 6.02% 6.79% 6.58% Municipals, Other Securities................... 6.13% 6.47% 6.09% 6.22% 6.27% ---- ---- ---- ---- ---- Total........................................ 6.03% 6.13% 6.05% 6.30% 6.11% ==== ==== ==== ==== ====
28
AFTER ONE AFTER FIVE HELD TO MATURITY (AT AMORTIZED COST): ONE YEAR YEAR TO YEARS TO AFTER (DOLLARS IN 000'S) OR LESS FIVE YEARS TEN YEARS TEN YEARS TOTAL - ---------------------------------------------- -------- ---------- ---------- --------- -------- Maturity Distribution: U.S. Government Agencies.................... $2,000 $ 2,501 $ -- $ -- $ 4,501 Mortgage Backed Securities.................. -- 437 -- -- 437 Municipals, Other Securities................ 4,662 9,963 11,450 370 26,445 ------ ------- ------- ---- ------- Total..................................... $6,662 $12,901 $11,450 $370 $31,383 ====== ======= ======= ==== =======
AFTER ONE AFTER FIVE ONE YEAR YEAR TO YEARS TO AFTER OR LESS FIVE YEARS TEN YEARS TEN YEARS TOTAL -------- ---------- ---------- --------- -------- Weighted Average Yield: U.S. Government Agencies....................... 6.42% 6.33% -- -- 6.37% Mortgage Backed Securities..................... -- 6.77% -- -- 6.77% Municipals, Other Securities................... 6.53% 6.64% 6.74% 8.20% 6.60% ---- ---- ---- ---- ---- Total........................................ 6.50% 6.54% 6.74% 8.20% 6.57% ==== ==== ==== ==== ====
OTHER REAL ESTATE OWNED ("OREO") As noted in the financial statements, the Company held no OREO at December 31, 1999 compared to holdings of $0.3 million at the end of 1998. During 1999, the Bank received net proceeds from sale of OREO properties of $0.4 million. Future OREO activity will depend, among other things, on how many borrowers that the Bank may need to foreclose on and on the strength of the real estate market and general economic activity. In general however, Management does not anticipate substantial additions of OREO holdings. DEPOSITS While the Bank is competitive with major banks in terms of its structure of interest rates on deposit products offered, Management was not overly aggressive during 1999 in terms of pricing to attract additional deposits, a decision which reflects the Bank's strong liquidity at the present time. As a result, the balances on some of the more interest sensitive accounts, in particular passbook savings, have remained the same in recent years. As discussed in the Income Statement Analysis, interest rates were little changed during the first half of 1999, having risen modestly during the latter part of the year. A comparison of the rates paid on the Bank's deposit products at year-end 1999 compared to year-end 1998 is as follows:.
SELECTED QUOTED INTEREST RATES 1999 1998 * CHANGE - ------------------------------ -------- -------- -------- Demand Deposits............................................. 0% 0% -- NOW Account (50 & Better--over $10,000)..................... 0.50% 0.75% -0.25% Money Market Deposits (over $2,500)......................... 2.00% 2.00% -- Passbook Savings Account.................................... 2.00% 2.00% -- Individual Retirement Account (2 Year term)................. 5.15% 4.15% +1.00% Time Deposit ($100,000--6 month term)....................... 5.30% 4.40% +0.90% Wall Street Journal Prime Rate.............................. 8.50% 7.75% +0.75%
*Rates shown for 1998 are Mid-State Bank rates. Average deposits have grown steadily over the last few years. The rates paid on these deposits have provided a relatively stable cost of funds to the Bank with a modest drop occurring during 1999. Below is a 29 summary of the average deposits outstanding and the average rate paid by category over the last three years.
1999 1998 1997 (DOLLARS IN 000'S) BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST - ------------------ ---------- -------- -------- ---------- -------- -------- ---------- -------- Interest Bearing Demand......... $ 428,739 $ 5,133 1.20% $ 406,312 $ 6,223 1.53% $ 381,280 $ 6,332 Savings Accounts................ 195,128 4,668 2.39% 189,088 4,819 2.55% 181,831 4,846 Time Deposits................... 346,659 15,941 4.60% 346,187 18,059 5.22% 340,467 17,680 ---------- ------- ---- ---------- ------- ---- ---------- ------- Total Interest Bearing Deposits...................... 970,526 25,742 2.65% 941,587 29,101 3.09% 903,578 28,858 Non Interest Bearing Demand..... 249,814 -- -- 242,706 -- -- 204,264 -- ---------- ------- ---- ---------- ------- ---- ---------- ------- Total Deposits................ $1,220,340 $25,742 2.11% $1,184,293 $29,101 2.46% $1,107,842 $28,858 ========== ======= ==== ========== ======= ==== ========== ======= (DOLLARS IN 000'S) RATE - ------------------ -------- Interest Bearing Demand......... 1.66% Savings Accounts................ 2.67% Time Deposits................... 5.22% ---- Total Interest Bearing Deposits...................... 3.19% Non Interest Bearing Demand..... -- ---- Total Deposits................ 2.60% ====
The majority of the Bank's time deposits (approximately 70%) have balances which are under $100,000 in size. While all time deposits are somewhat more rate sensitive than the Bank's other deposit categories, the smaller balance time deposits do tend to be more stable and less sensitive to absolute rate levels than do time deposits of $100,000 or more. Approximately 88% of the Bank's time deposits mature within one year and would be subject to a change in rate at that time. The following table as of December 31, 1999, displays summary size and maturity information on the Bank's time deposits.
AFTER THREE AFTER SIX THREE MONTHS TO MONTHS (DOLLARS IN 000'S) MONTHS OR SIX TO AFTER BALANCE BY SIZE LESS MONTHS ONE YEAR ONE YEAR TOTAL - -------------------------------------------------- --------- ----------- --------- -------- -------- Under $100,000.................................... $ 82,771 $69,783 $47,992 $27,000 $227,546 $100,000 or More.................................. 45,075 24,095 20,162 10,186 99,518 -------- ------- ------- ------- -------- Total Time Deposits............................... $127,846 $93,878 $68,154 $37,186 $327,064 ======== ======= ======= ======= ========
OTHER BORROWINGS While not a significant component of the Bank's structure, other borrowings increased from $3.0 million at the end of 1998 to $15.4 million at the end of 1999. These consist primarily of borrowings under the U.S. Treasury Tax and Loan note account, securities sold under agreements to repurchase and mortgages payable. The Bank had outstanding borrowings of $12.3 million and $1.6 million at December 31, 1999 and 1998, respectively, under the US Treasury Tax and Loan note account program. Securities sold under agreement to repurchase were $2.9 million and $1.2 million at December 31, 1999 and 1998, respectively. Mortgages payable were $164 thousand and $189 thousand at year-end 1999 and 1998, respectively. CAPITAL Capital ratios for commercial banks and their holding companies in the United States are generally calculated using 3 different formulas. These calculations are referred to as the "Leverage Ratio" and two "risk based" calculations known as "Tier One Risk Based Capital Ratio" and the "Total Risk Based Capital Ratio." The Company and the Bank are subject to certain standards concerning these ratios. These standards were developed through the joint efforts of banking authorities from 12 different countries around the world. The standards essentially take into account the fact that different types of assets have different levels of risk associated with them. Further, they take into account the off-balance sheet exposures of banks when assessing capital adequacy. The Leverage Ratio calculation simply divides common stockholders' equity (reduced by any goodwill a bank may have) by the total assets of the bank. In the Tier One Risk Based Capital Ratio, the numerator is the same as the leverage ratio, but the denominator is the total "risk-weighted assets" of the bank. Risk weighted assets are determined by segregating all the assets and off-balance sheet exposures into different risk categories and weighting them by a percentage ranging from 0% (lowest risk) to 100% (highest risk). The Total Risk Based Capital Ratio again uses "risk-weighted assets" in the denominator, but expands the numerator to include other capital 30 items besides equity such as a limited amount of the allowance for loan losses, long-term capital debt, preferred stock and other instruments. Summarized below are the capital ratios at December 31, 1999 and 1998, for both Mid-State Bancshares and Mid-State Bank. Additionally, the standards for a well capitalized institution, as defined by the federal banking agencies, are displayed.
MID-STATE MID-STATE MINIMUM WELL-CAPITALIZED BANCSHARES BANK REGULATORY REGULATORY ---------------------- ---------------------- STANDARD STANDARD 1999 1998 1999 1998 ---------- ---------------- -------- -------- -------- -------- Leverage Ratio............................ 4.0% 5.0% 11.6% 10.7% 11.6% 9.7% Tier One Risk Based.............................. Capital Ratio........................... 4.0% 6.0% 16.0% 16.1% 16.0% 14.3% Total Risk Based................................... Capital Ratio........................... 8.0% 10.0% 17.2% 17.4% 17.2% 17.2%
It is the intent of Management to continue to maintain strong capital ratios. This has meant that the Company's dividend payout ratio is relatively modest and the ratio of average equity to average assets is high as displayed in the following table for the years ended December 31,
1999 1998 1997 -------- -------- -------- Dividend Payout Ratio....................................... 25.0% 14.9% 9.4% Average Common Equity to Average Assets..................... 11.1% 10.6% 9.7%
LIQUIDITY The focus of the Bank's liquidity management is to ensure its ability to meet cash requirements. Sources of liquidity include Cash, Due From Bank Balances (net of Federal Reserve requirements to maintain reserves against deposit liabilities), Fed Funds Sold, Investment Securities (net of pledging requirements), loan repayments, deposits and Fed Funds Borrowing lines. Typical demands on liquidity are deposit run-off from demand deposits and savings accounts, maturing time deposits which are not renewed, and anticipated funding under credit commitments to customers. The Bank has adequate liquidity at the present time. Its loan to deposit ratio at year-end was 64.7% versus 54.0% one year earlier. The Bank normally strives for a loan to deposit ratio in the 65% to 75% range. The Bank's internally calculated liquidity ratio stands at 42.3% at December 31, 1999, which is above its normal desired range of between 15% and 30%, but is down from one year earlier. The Bank strives to make high quality loans to optimize earnings while still maintaining adequate liquidity. Until recently, the Bank operated with excess liquidity. It was able to use some of that excess in the fourth quarter of 1999 and increase its loan totals closer to its desired target range. Management's ability to maintain its loan portfolio in the desired target range will be partly dependent on the strength of the local economy. INCOME STATEMENT ANALYSIS NET INTEREST INCOME AND INTEREST RATE RISK Net Interest Income is the difference between interest and fees earned on all earning assets and interest paid on interest bearing liabilities. Net Interest Income for 1999 was $73.6 million, up from $69.4 million recorded in 1998 and $64.0 million in 1997. The components of net interest income change in response to both changes in rate, average balance and mix of both earning assets and liabilities. The following tables present an analysis of yields/rates, interest income and expense, and average balances for 1999, 1998, and 1997. 31 ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
1999 COMPARED TO 1998 1999 1998 COMPOSITION OF CHANGE -------------------------------- -------------------------------- ------------------------------ INTEREST AVERAGE INTEREST AVERAGE CHANGE DUE TO AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ ------------------- TOTAL (DOLLARS IN 000'S) BALANCE EXPENSE RATE BALANCE EXPENSE RATE VOLUME RATE CHANGE - ------------------ ---------- -------- -------- ---------- -------- -------- -------- -------- -------- EARNING ASSETS: Loans...................... $ 685,566 $67,372 9.83% $ 633,324 $65,758 10.38% $5,279 $(3,665) $ 1,614 Investment Securities...... 534,666 29,899 5.59% 508,260 30,200 5.94% 1,523 (1,824) (301) Fed Funds, Other........... 49,424 2,356 4.77% 52,768 2,924 5.54% (172) (396) (568) ---------- ------- ---- ---------- ------- ----- ------ ------- ------- TOTAL EARNING ASSETS..... $1,269,656 $99,627 7.85% $1,194,352 $98,882 8.28% $6,630 $(5,885) $ 745 ---------- ------- ---- ---------- ------- ----- ------ ------- ------- INTEREST BEARING LIABILITIES: NOW, Savings, and Money Market Accounts.......... $ 623,867 $ 9,801 1.57% $ 595,400 $11,042 1.85% $ 488 $(1,729) $(1,241) Time Deposits.............. 346,659 15,941 4.60% 346,187 18,059 5.22% 23 (2,140) (2,117) ---------- ------- ---- ---------- ------- ----- ------ ------- ------- Interest Bearing Deposits................. 970,526 25,742 2.65% 941,587 29,101 3.09% 511 (3,869) (3,358) Other Borrowings........... 6,235 329 5.28% 6,437 340 5.28% (11) 0 (11) ---------- ------- ---- ---------- ------- ----- ------ ------- ------- TOTAL INTEREST BEARING LIABILITIES............ 976,761 26,071 2.67% 948,024 29,441 3.11% 500 (3,869) (3,369) ---------- ------- ---- ---------- ------- ----- ------ ------- ------- NET INTEREST INCOME........ $1,269,656 $73,556 5.79% $1,194,352 $69,441 5.81% $6,130 $(2,016) $ 4,114 ========== ======= ==== ========== ======= ===== ====== ======= =======
1998 COMPARED TO 1997 1998 1997 COMPOSITION OF CHANGE -------------------------------- -------------------------------- ------------------------------ INTEREST AVERAGE INTEREST AVERAGE CHANGE DUE TO AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ ------------------- TOTAL (DOLLARS IN 000'S) BALANCE EXPENSE RATE BALANCE EXPENSE RATE VOLUME RATE CHANGE - ------------------ ---------- -------- -------- ---------- -------- -------- -------- -------- -------- EARNING ASSETS: Loans...................... $ 633,324 $65,758 10.38% $ 605,688 $62,892 10.38% $2,870 $ (4) $ 2,866 Investment Securities...... 508,260 30,200 5.94% 460,871 27,951 6.06% 2,845 (596) 2,249 Fed Funds, Other........... 52,768 2,924 5.54% 44,001 2,248 5.11% 467 209 676 ---------- ------- ----- ---------- ------- ----- ------ ------- ------- TOTAL EARNING ASSETS..... $1,194,352 $98,882 8.28% $1,110,560 $93,091 8.38% $6,182 $ (391) $ 5,791 ========== ======= ===== ========== ======= ===== ====== ======= ======= INTEREST BEARING LIABILITIES: NOW, Savings, and Money Market Accounts.......... $ 595,400 $11,042 1.85% $ 563,111 $11,179 1.99% $ 620 $ (757) $ (137) Time Deposits.............. 346,187 18,059 5.22% 340,467 17,679 5.19% 298 81 379 ---------- ------- ----- ---------- ------- ----- ------ ------- ------- Interest Bearing Deposits................. 941,587 29,101 3.09% 903,578 28,858 3.19% 918 (676) 242 Other Borrowings........... 6,437 340 5.28% 3,282 202 6.15% 180 (42) 138 ---------- ------- ----- ---------- ------- ----- ------ ------- ------- TOTAL INTEREST BEARING LIABILITIES............ 948,024 29,441 3.11% 906,860 29,060 3.20% 1,098 (718) 380 ---------- ------- ----- ---------- ------- ----- ------ ------- ------- NET INTEREST INCOME........ $1,194,352 $69,441 5.81% $1,110,560 $64,031 5.77% $5,084 $ 327 $ 5,411 ========== ======= ===== ========== ======= ===== ====== ======= =======
During 1999, there was a $745 thousand increase in interest income along with a decrease of $3.4 million in interest expense compared to 1998. The resulting $4.1 million increase in net interest income for 1999 is a result of a number of dynamics affecting both average balance and interest rate considerations. First, the Company experienced an increase in its average earning assets outstanding of $75.3 million. The increase in interest income was primarily attributable to the net increase in outstanding loans, which were up by $52.2 million, despite the fact that the effective yield on the loan portfolio declined by approximately 55 basis points. Secondly, the Company's interest bearing liabilities increased by just $28.9 million compared to the $75.3 million increase in average earning assets. Third, while interest rates were slightly lower in 1999 than 1998, the Company's cost of funds declined more dramatically than its interest earnings due to the growth and mix of its earning assets. 32 The $5.4 million increase in net interest income for 1998 compared to 1997 was the result of similar, yet slightly different dynamics. First, the Company experienced an increase in its average earning assets outstanding in all categories (loans, investments and fed funds) of $83.8 million. Secondly, the prime rate on which many of Company's loans are tied was lower in 1998 (8.36%) compared to 1997 (8.44%). Third, the volume of average earning assets was higher on average in 1998 than in 1997 while the Company's interest bearing liabilities increased by just $41.2 million. Fourth, while interest rates were slightly lower in 1998 than 1997, they had a positive impact on interest income as well as that on the Company's cost of funds. The Company's risk exposure to changes in interest rates is minimal and is centered in the Bank. A recent review of the potential changes in the Bank's net interest income over the next 12 month time horizon indicated possible fluctuations under very extreme alternative rate scenarios from between +2.3% and -4.8% of the base case (Prime rate unchanged at 8.50%) of $78.0 million. The Bank's policy is to maintain a structure of assets and liabilities which are such that net interest income will not vary more than plus or minus 15% of the base forecast over the next 12 months. Management feels that its exposure to interest rate risk is manageable and it will continue to strive for an optimal trade-off between risk and earnings. The following table presents a summary of the Bank's net interest income forecasted for the coming 12 months under alternative interest rate scenarios.
CHANGE FROM BASE ------------- Rates Down Very Significant................................. -4.8% (Prime down incrementally to 4.50% by Nov. 2000) Rates Down Significant...................................... -3.4% (Prime down incrementally to 6.00% by Oct. 2000) Rates Down Modestly......................................... -2.2% (Prime down incrementally to 7.50% by Oct. 2000) Base Case--Rates Unchanged.................................. -- (Prime unchanged at 8.50% over 12 months) Rates Up Modestly........................................... +2.2% (Prime up incrementally to 9.50% by Oct. 2000) Rates Up Aggressive......................................... +2.1% (Prime up incrementally to 11.00% by Oct. 2000) Rates Up Very Aggressive.................................... +2.3% (Prime up incrementally to 12.50% by Nov. 2000)
Net interest income under the above scenarios is influenced by the characteristics of the Bank's assets and liabilities. In the case of NOW, savings and money market deposits (total $595.4 million) interest is based on rates set at the discretion of Management ranging from 0.50% to 2.38%. This characteristic is the major reason why it is assumed that a 4% decline in Prime decreases net interest income by 4.8% while a 4% increase in Prime only improves net interest income by 2.3%. In a downward rate environment, there is a limit to how far these deposit instruments can be re-priced and this behavior is similar to that of fixed rate instruments. In an upward rate environment, the magnitude and timing of changes in rates on these deposits is assumed to be more reflective of variable rate instruments. It is important to note that the above table is a summary of several forecasts and actual results may vary. The forecasts are based on estimates and assumptions of Management that may turn out to be different and may change over time. Factors affecting these estimates and assumptions include, but are not limited to, competitors' behavior, economic conditions both locally and nationally, actions taken by the Federal Reserve Bank, customer behavior, and Management's responses. Historically, the Bank has been able to manage its Net Interest Income in a fairly narrow range reflecting the Bank's relative insensitivity to interest rate changes. The impact of prepayment behavior on mortgages, real estate loans, mortgage backed securities, securities with call features, etc. is not considered material to the sensitivity analysis. As 33 noted in the Financial Summary at the beginning of the Management's Discussion and Analysis, over the last 5 years, the Company's net interest margin (which is net interest income divided by average earning assets of the Company) has ranged from a low of 5.71% to a high of 6.09% (not taxable equivalent). Based on the scenarios above, the net interest margin under the alternative scenarios ranges from 5.56% to 5.97%. Management feels this range of scenarios is conservative, but no assurances can be given that actual experience will fall within this range. The Company has no exposure with respect to interest rate derivatives, exchange rate fluctuations, and/or commodity price movements. The Company does not own any instruments within these markets. PROVISION FOR LOAN LOSSES The Company made contributions to the allowance for loan losses of $50 thousand, $300 thousand and $105 thousand in 1999, 1998 and 1997, respectively. This reflects management's assessment of the level of inherent losses identified in the portfolio which has been supplemented by higher than expected recoveries of loans previously charged off, amounting to $1.1 million, $.8 million and $2.1 million, in 1999, 1998, and 1997, respectively. The need for additional provision for loan losses in 2000 will be dependent upon Management's on-going analysis of the adequacy of the allowance for loan losses. While Management believes it to be adequate at the present time, the appropriate value can fluctuate over time in response to economic conditions and the subjective decisions which must be made in response to those conditions. NON-INTEREST INCOME Non-Interest Income for 1999 totaled $17.5 million compared to $24.7 million in 1998 and $17.8 million in 1997. The major reason for the increase in 1998 was the reversal into income of $5.3 million of the reserve for losses on investments in real estate which Management felt was no longer required at Mid-Coast Land Company. This decision came about because of the improved real estate market and the higher than anticipated sales prices being received on certain of the subsidiary's real estate development projects--most notably San Luis Bay Estates. A more detailed description of this activity follows in the section below about subsidiary activity. Service charges on deposit accounts were down $209 thousand to $6.8 million in 1999 versus 1998. This followed a decrease of $253 thousand in 1998 over 1997. The decline in 1999 was related to certain waivers of accounts during the merger of City Commerce Bank and Mid-State Bank. Commissions, fees and other service charges decreased by $635 thousand in 1999 over 1998 after a $891 thousand increase in 1998. The decrease in 1999 was primarily related to the drop in refinance activity affecting the Bank's mortgage banking operation which had experienced a robust period of activity in 1998. Earnings from investments in real estate at Mid-Coast Land Company were down $97 thousand in 1999 after a $420 thousand increase in 1998. Securities gains, net of losses, were modest throughout the three years ended in 1999 and other categories of non-interest income were $2.4, $3.9 and $2.8 million, respectively, in 1999, 1998 and 1997. The larger amount in 1998 reflects a one-time gain of sale of Other Real Estate at City Commerce Bank. NON-INTEREST EXPENSE Total non-interest expense for 1999 was $57.5 million, which was down from $62.3 million in 1998 and $57.7 million in 1997. The most dramatic impact in this category which caused the decrease in 1999 was the charge of $2.9 million of non-recurring, merger related costs for the City Commerce merger compared to $7.4 million in 1998 for the Bank of Santa Maria merger. The $2.9 million charge in 1999 was comprised of $0.8 million in severance charges for displaced personnel, $0.7 million of losses on surplus computer equipment, furniture and fixtures of City Commerce Bank, $427 thousand of investment bank fees, and $1.0 million of various charges for legal fees, accounting fees, filings and other miscellaneous charges incurred. 34 Salaries and employee benefits decreased by $13 thousand in 1999 over 1998 after having decreased by $472 thousand in 1998 over 1997. The relatively flat staff expense level in 1999 compared to 1998 reflects both wage increases to employees and fewer staff members due to the merger with City Commerce Bank. The decrease in 1998 over 1997 represented certain savings generated in the latter part of the year through synergies and the reduced staffing requirements of the merged Mid-State Bank and Bank of Santa Maria. Occupancy expense has remained virtually unchanged throughout the last 3 years at $8.5 million in 1999 and $8.5 and $8.9 million in 1998 and 1997, respectively. Major capital expenditures for computer equipment and ATM's were completed in 1998. This equipment came on stream in the middle of the year and occupancy expense increased as these items are depreciated over useful lives of between 5 and 7 years. These items cost approximately $7.2 million and are being depreciated at a total rate of $119 thousand per month. The decline in occupancy expense was due to the consolidation of the eight former offices of the Bank of Santa Maria despite the additional costs related to the computer equipment and ATM's. No other major expenditures are planned for 2000. Expenses from write-downs and provisions for losses on investments in real estate were nil in 1999 and 1998, down from $2.0 million in 1997. These amounts were determined by reviewing appraisals, updated annually, for each material investment in real estate. The Bank continues to work towards divestiture of these activities by its current deadline of December 31, 2000 to conform to the requirements of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Management believes that the allowance for losses on investments in real estate, which stood at $0.3 million at December 31, 1999, is sufficient to cover any remaining potential losses as the divestiture winds down. OREO expense decreased from $0.4 million in 1997 to $0.2 million in 1998 and nil in 1999. The reduction in OREO expense reflects lower foreclosures and an improved real estate market. While the anticipated level of OREO expense for 2000 is unknown at this time, it is expected that some costs, albeit minor, will continue. Management is hopeful however that the positive trend seen in 1998 and 1999 will continue in 2000. Other operating expense remained relatively unchanged in 1999 at $16.2 million compared to $16.3 million in 1998 and $16.1 million in 1997. Management expects that this category should decline in 2000 as the synergies from the merger begin to benefit the income statement. The Company has already begun to note savings at the end of the year in the areas of advertising, auditing charges, insurance premiums, printing, supplies, professional fees, dues & memberships and others. TAXES As described in Footnote No. 9 to the financial statements, the Company has deferred tax assets primarily related to the timing difference associated with charge-offs and provisions for losses on certain loans. The amount generated for book purposes compared to the actual loss experience recorded for tax purposes has been different. Because of regulatory restrictions on the amount of deferred tax assets which can be recognized for regulatory capital purposes, the Company had previously established a valuation allowance for taxes on the Consolidated Statement of Financial Position. This allowance was reduced to $183 thousand at the end of 1998 resulting in a reversal of $3.5 million of the valuation allowance that existed at December 31, 1997. The limitation on the amount of the deferred tax assets was based on a number of factors, including the level of projected future taxable income. The reduction of the valuation allowance results from a decrease in the level of deferred tax assets and an expectation of increased future taxable income. The remaining $183 thousand valuation allowance at December 31, 1999 and 1998 relates to the uncertain realizability of capital loss carryforwards acquired through the City Commerce Bank merger. The reduction in the valuation allowance during 1998 directly benefited the tax expense recognized for the year, compared to normal statutory tax rates. The valuation allowance decreased in 1997 35 compared to 1996 by $5.5 million and thus 1997 tax expense recognized for the year was also lower compared to the normal statutory tax rates. No such benefit to tax expense was received in 1999. SUBSIDIARY ACTIVITY MID-COAST LAND COMPANY Investments in real estate shown on the Consolidated Statement of Financial Position principally represent the assets of the Bank's real estate development subsidiary, Mid-Coast Land Company. Footnote No. 7 to the accompanying financial statements provides additional information about this wholly owned subsidiary. Mid-Coast Land Company recorded earnings during 1999 of $349 thousand compared to earnings during 1998 of $3.1 million and a $2.9 million loss in 1997. The gain in 1999 was related to certain remaining parcels sold on its San Luis Bay Estates project. The profit in 1998 was principally because of the reversal of $5.3 million of its reserve for losses on investments in real estate, which was no longer necessary given the sales of most of the remaining parcels. The remaining $262 thousand in Mid-Coast Land's reserve is sufficient to cover any losses on its remaining two parcels to be sold. It is anticipated that these will be sold by the end of 2000. Because of the progress made to liquidate the real estate development assets, the FDIC granted an extension of the original required divestiture date in July 1996 until December 1998. The regional director of the FDIC, extended the deadline to December 31, 2000. MSB PROPERTIES, INC. This wholly owned subsidiary was formed to engage in the specific business of acquiring, owning, and improving real property and tangible personal property which may be necessary or convenient for the operation or housing of the administrative departments and branch offices of the Bank. Incorporated under the laws of the State of California in May of 1968, it also allows for the ownership of property which may be reasonably necessary for future expansion of the Bank's business, or which is otherwise reasonably related to the conduct of the Bank's business, pursuant to Section 752 of the Financial Code of the State of California. Earnings for this subsidiary consist primarily of rental income from the Bank's offices and administrative center coupled with a minor amount of rental income from non-bank tenants and interest earnings on its cash assets. Expenses are principally interest on mortgages, depreciation of leasehold improvements, general maintenance and utilities expense. The affairs of the subsidiary are managed by Bank employees and as such this subsidiary has no paid staff members. Earnings for MSB Properties have increased over the years with net earnings after-tax of $1.5 million, $1.4 million, and $1.6 million, in 1999, 1998 and 1997, respectively. Leases are written with market terms and at market rates. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Certain information concerning market risk is contained in the notes to the financial statements which are included in Item 8 of this Report and in Management Discussion and Analysis of Financial Condition and Results of Operations which is included in Item 7 of this Report. ITEM 7B. DISCLOSURE ABOUT RISKS ASSOCIATED WITH YEAR 2000 ISSUES "YEAR 2000 READINESS DISCLOSURE" STATE OF READINESS. The Company began implementation of its Year 2000 Plan in 1997. It complied with all time-frames associated with that Plan. The most significant component of that plan was the replacement of the Bank's mainframe computer and software system with a Year 2000 compliant system. 36 That task was completed in July 1998 with the installation of the Information Technology Incorporated software on new Unisys equipment. Testing of "Mission Critical" systems and implementations of compliant systems was substantially complete by early 1999 with all testing completed by year end. The Company also spent a great deal of time assessing the state of readiness of its customers, especially those to whom it had extended credit, and conducting various public awareness campaigns. There were no significant withdrawals experienced by the Bank as a result of concerns surrounding the Y2K issue. There were no disruptions of service experienced by Bank customers because of Y2K related problems. There have been no unusual losses experienced by the Bank as a result of extensions of credit to Bank customers. In summary, there was nothing unusual in the Bank's operations either during the century date change rollover, or since that time. Management does not expect any future Y2K related disruptions either. COSTS TO ADDRESS YEAR 2000 ISSUES. It is important to note that the Company's current computer system had been fully depreciated after serving the Bank for over 7 years. It was due for replacement irrespective of the Year 2000 issue. The total capital cost of the new mainframe, software, terminals and ATM's associated with the Bank's conversion to date have totaled approximately $7.2 million, all of which has been capitalized and will be amortized over their expected useful lives. There were some modest additional purchases of certain equipment, and the Company spent approximately $7.5 million in total for all of these items. The costs associated with the mailings, questionnaires, seminars and other public awareness campaign activities, which the Company conducted, did not have a material effect on the financial position or results of operations of the Company. RISKS FOR THE COMPANY FROM YEAR 2000 ISSUES. No major concerns exist at this point. THE COMPANY'S CONTINGENCY PLANS. The Company completed development of contingency plans in preparation for the Y2K event during 1999. While these plans were not needed, they have served as a catalyst to update and complete the Company's disaster recovery plans. 37 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TABLE OF CONTENTS
PAGE -------- Report of Independent Public Accountants--Arthur Andersen LLP....................................................... 39 Report of Independent Public Accountants--Vavrinek, Trine, Day & Co. LLP............................................. 40 Independent Auditors' Report--KPMG LLP...................... 41 Consolidated Statements of Financial Position............... 42 Consolidated Statements of Income........................... 43 Consolidated Statements of Comprehensive Income............. 44 Consolidated Statements of Changes in Capital Accounts...... 45 Consolidated Statements of Cash Flows....................... 46 Notes to Consolidated Financial Statements.................. 47 Management Statement........................................ 68 Report of Independent Public Accountants.................... 69
38 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of Mid-State Bancshares: We have audited the accompanying consolidated statements of financial position of Mid-State Bancshares and Subsidiary (the Company) as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, changes in capital accounts and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of City Commerce Bank, a company acquired during 1999 in a transaction accounted for as a pooling of interests, as discussed in Note 2. Such statements are included in the related consolidated statement of financial position of Mid-State Bancshares and Subsidiary and reflect total assets of 11.1% of the related consolidated totals for 1998. Such statements are included in the related consolidated statements of income of Mid-State Bancshares and Subsidiary and reflect net interest income and net income of 12.3% and 9.4%, respectively, of the related consolidated totals for 1998, and net interest income and net income of 11.3% and 6.5%, respectively, of the related consolidated totals for 1997. We did not audit the financial statements of BSM Bancorp, a company acquired during 1998 in a transaction accounted for as a pooling of interests, as discussed in Note 2. Such statements are included in the related consolidated statement of income of Mid-State Bancshares and Subsidiary and reflect net interest income and net income of 25.9% and 22.3%, respectively, of the related consolidated totals for 1997. These statements were audited by other auditors whose reports have been furnished to us and our opinion, insofar as it relates to amounts included for City Commerce Bank and BSM Bancorp, is based solely upon the reports of the other auditors. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits, and the reports of other auditors, provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of the other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Mid-State Bancshares and Subsidiary as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP -------------------------------------------------------------------- ARTHUR ANDERSEN LLP Los Angeles, California January 28, 2000 39 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF BSM BANCORP AND SUBSIDIARY: We have audited the related consolidated statements of income, changes in shareholders' equity and cash flows of BSM Bancorp and Subsidiary for the year ended December 31, 1997. These financial statements, which are not presented separately herein, are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows for the year ended December 31, 1997 of BSM Bancorp and Subsidiary in conformity with generally accepted accounting principles. /s/ Vavrinek, Trine, Day & Co., LLP - -------------------------------------------------------------------------------- VAVRINEK, TRINE, DAY & CO., LLP Laguna Hills, California January 8, 1998 40 INDEPENDENT AUDITORS' REPORT TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF CITY COMMERCE BANK: We have audited the balance sheet of City Commerce Bank (the Bank) as of December 31, 1998 and the related statements of operations, changes in stockholders' equity and comprehensive income and cash flows for each of the years in the two-year period ended December 31, 1999. These financial statements, which are not included herein, are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of City Commerce Bank as of December 31, 1998 and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 1999 in conformity with generally accepted accounting principles. /s/ KPMG LLP - -------------------------------------------------------------------------------- KPMG LLP Los Angeles, California January 20, 1999 (except as to note 17, which is as of April 19, 1999) 41 CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (DOLLARS IN 000'S EXCEPT SHARE AMOUNTS)
DECEMBER 31, ----------------------- 1999 1998 ASSETS ---------- ---------- CASH AND DUE FROM BANKS..................................... $ 56,080 $ 84,557 FEDERAL FUNDS SOLD.......................................... 17,500 51,865 SECURITIES, net: Securities available for sale............................. 433,898 484,253 Securities held to maturity (market value of $31,075 and $42,704, respectively).................................. 31,383 41,916 ---------- ---------- TOTAL SECURITIES........................................ 465,281 526,169 ---------- ---------- LOANS, net.................................................. 755,709 661,040 BANK PREMISES AND EQUIPMENT, net............................ 29,282 32,603 ACCRUED INTEREST RECEIVABLE................................. 12,014 11,640 INVESTMENTS IN REAL ESTATE, net............................. 1,517 6,769 OTHER REAL ESTATE OWNED, net................................ 0 259 OTHER ASSETS................................................ 17,835 14,423 ---------- ---------- TOTAL ASSETS.......................................... $1,355,218 $1,389,325 ========== ========== LIABILITIES DEPOSITS: Demand deposits........................................... $ 230,271 $ 258,629 Savings, money market and NOW accounts.................... 611,119 615,836 Time deposits--$100,000 or more........................... 99,518 96,160 Time deposits--Under $100,000 227,546 253,854 ---------- ---------- TOTAL DEPOSITS.......................................... 1,168,454 1,224,479 ---------- ---------- OTHER BORROWINGS............................................ 15,357 3,049 ACCRUED INTEREST PAYABLE & OTHER LIABILITIES................ 11,076 10,706 TOTAL LIABILITIES..................................... $1,194,887 $1,238,234 ---------- ---------- COMMITMENTS AND CONTINGENCIES (NOTE 11) CAPITAL ACCOUNTS CAPITAL STOCK, NO PAR VALUE: Authorized--at 50,000,000 shares Outstanding--11,286,943 shares in 1999 and 11,205,637 in 1998.................................................... $ 59,681 $ 58,821 UNDIVIDED PROFITS........................................... 104,357 87,887 ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX... (3,707) 4,383 TOTAL CAPITAL ACCOUNTS.................................... 160,331 151,091 ---------- ---------- TOTAL LIABILITIES & CAPITAL ACCOUNTS.................. $1,355,218 $1,389,325 ========== ==========
The accompanying notes are an integral part of these consolidated statements. 42 CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (CONTINUED) (DOLLARS IN 000'S EXCEPT SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- INTEREST INCOME: Interest and fees on loans and leases....................... $67,372 $65,758 $62,892 Interest on securities: U.S. Treasury securities.................................. 9,797 10,705 11,741 U.S. Government agencies and corporations................. 7,514 9,333 9,732 Obligations of states and political subdivisions, other... 12,588 10,162 6,478 Interest on funds sold...................................... 2,356 2,924 2,248 ------- ------- ------- TOTAL INTEREST INCOME................................... 99,627 98,882 93,091 ------- ------- ------- Interest Expense: Interest on deposits........................................ 25,742 29,101 28,858 Interest on mortgages payable, other........................ 329 340 202 ------- ------- ------- TOTAL INTEREST EXPENSE.................................. 26,071 29,441 29,060 ------- ------- ------- Net Interest Income......................................... 73,556 69,441 64,031 Provision for loan losses................................... 50 300 105 ------- ------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES..... 73,506 69,141 63,926 ------- ------- ------- OTHER INCOME: Service charges on deposit accounts....................... 6,798 7,007 7,260 Commissions, fees and other service charges............... 7,412 8,047 7,156 Investments in real estate................................ 830 927 507 Reversal of reserve for losses on investments in real estate.................................................. -- 5,300 -- Securities gains, net of (losses)......................... (5) (407) 96 Other income.............................................. 2,430 3,862 2,815 ------- ------- ------- TOTAL OTHER INCOME...................................... 17,465 24,736 17,834 ------- ------- ------- OTHER EXPENSES: Salaries & employee benefits.............................. 29,827 29,840 30,312 Occupancy expenses........................................ 8,495 8,514 8,873 Provision for losses and expenses on real estate.......... -- 177 2,387 Merger related charges.................................... 2,930 7,440 -- Other operating expenses.................................. 16,236 16,335 16,102 ------- ------- ------- TOTAL OTHER EXPENSES.................................... 57,488 62,306 57,674 ------- ------- ------- Income before taxes......................................... 33,483 31,571 24,086 Tax expense................................................. 11,430 10,576 5,220 ------- ------- ------- NET INCOME.............................................. $22,053 $20,995 $18,866 ------- ------- ------- Earnings per share: --Basic................................................... $ 1.96 $ 1.88 $ 1.70 --Diluted................................................. $ 1.94 $ 1.86 $ 1.68 ======= ======= =======
The accompanying notes are an integral part of these consolidated statements. 43 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (DOLLARS IN 000'S)
YEAR ENDED DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- NET INCOME................................................ $22,053 $20,995 $18,866 Other Comprehensive (loss) Income Before Taxes: Unrealized (losses) gains on securities available for sale: Unrealized holding (losses) gains arising during year....... (13,489) 4,565 1,447 Less: reclassification adjustment for losses (gains) included in net income.................................... 5 407 (96) ------- ------- ------- Other comprehensive (loss) income, before tax............... (13,484) 4,972 1,351 Income tax (benefit) expense related to items in comprehensive income...................................... (5,394) 2,238 481 ------- ------- ------- OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAXES........... (8,090) 2,734 870 ------- ------- ------- COMPREHENSIVE INCOME...................................... $13,963 $23,729 $19,736 ======= ======= =======
The accompanying notes are an integral part of these consolidated statements. 44 CONSOLIDATED STATEMENTS OF CHANGES IN CAPITAL ACCOUNTS (DOLLARS IN 000'S EXCEPT SHARE AMOUNTS)
ACCUMULATED OTHER NUMBER OF CAPITAL UNDIVIDED COMPREHENSIVE SHARES STOCK PROFITS INCOME (LOSS) TOTAL ---------- -------- --------- ------------- -------- BALANCE, December 31, 1996............. 11,084,160 $44,517 $ 66,729 $ 779 $112,025 Stock dividend....................... -- 10,749 (10,792) -- (43) Cash dividend........................ -- -- (1,831) -- (1,831) Over accrual of 1996 cash dividend on partial shares related to stock dividend........................... -- -- (5) -- (5) Exercise of stock options............ 20,267 204 -- -- 204 Net income........................... -- -- 18,866 -- 18,866 Change in unrealized gain on available for sale securities...... -- -- -- 870 870 ---------- ------- -------- ------- -------- BALANCE, December 31, 1997............. 11,104,427 $55,470 $ 72,967 $ 1,649 $130,086 Stock dividend....................... -- 2,933 (2,936) -- (3) Cash dividend........................ -- -- (3,147) -- (3,147) Over accrual of 1997 cash dividend on partial shares related to stock dividend........................... -- -- 8 -- 8 Exercise of stock options............ 156,260 1,883 -- -- 1,883 Net income........................... -- -- 20,995 -- 20,995 Change in unrealized gain on available for sale securities...... -- -- -- 2,734 2,734 Stock repurchased.................... (55,050) (1,465) -- -- (1,465) ---------- ------- -------- ------- -------- BALANCE, December 31, 1998............. 11,205,637 $58,821 $ 87,887 $ 4,383 $151,091 Cash dividend........................ -- -- (5,583) -- (5,583) Exercise of stock options............ 100,810 1,349 -- -- 1,349 Net income........................... -- -- 22,053 -- 22,053 Change in unrealized (loss) on available for sale securities...... -- -- -- (8,090) (8,090) Stock repurchased.................... (19,504) (489) -- -- (489) ---------- ------- -------- ------- -------- BALANCE, December 31, 1999............. 11,286,943 $59,681 $104,357 $(3,707) $160,331 ========== ======= ======== ======= ========
The accompanying notes are an integral part of these consolidated statements. 45 CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN 000'S)
YEAR ENDED DECEMBER 31, --------------------------------- 1999 1998 1997 --------- --------- --------- OPERATING ACTIVITIES: Net Income.................................................. $ 22,053 $ 20,995 $ 18,866 Adjustments to reconcile net income to net cash provided by operating activities: Provision for depreciation and amortization............... 3,857 4,005 4,373 Amortization of investment security premiums, net......... 2,663 1,268 823 Merger related losses on sale of bank premises and equipment............................................... 2,371 2,500 -- Provision for losses on investments in real estate........ -- (5,300) 1,997 Provision for credit losses............................... 50 300 105 Net gain on sales of other real estate owned.............. (125) (2,338) (1,032) Deferred tax charge (benefit)............................. 1,960 1,656 (3,828) (Increase) decrease in accrued interest and other assets.................................................. (3,786) (2,280) 341 Increase (decrease) in accrued interest payable and other liabilities............................................. 370 4,060 (3,583) Other changes, net........................................ 2,001 (2,643) (1,819) --------- --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES................. 31,414 22,223 16,243 --------- --------- --------- Investing Activities: Proceeds from sales and maturities of securities............ 248,548 179,018 166,601 Purchases of securities..................................... (203,817) (204,522) (211,819) Proceeds from sales of other real estate owned.............. 444 6,619 7,368 Net increase in loans....................................... (94,336) (31,983) (40,782) Receipts from real estate investments, net of advances...... 5,903 8,142 4,105 Purchases of premises and equipment......................... (2,625) (8,974) (7,247) Proceeds from sales of premises and equipment............... 67 6,052 1,790 --------- --------- --------- NET CASH USED IN INVESTING ACTIVITIES..................... (45,816) (45,648) (79,984) --------- --------- --------- FINANCING ACTIVITIES: Net (decrease) increase in demand deposits, savings and money market accounts..................................... (33,075) 44,078 42,438 Net (decrease) increase in time deposits.................... (22,950) (1,577) 27,078 Net increase (decrease) in other borrowings................. 12,308 (1,446) (2,930) Cash dividend paid.......................................... (5,583) (3,147) (1,831) Proceeds from exercise of stock options..................... 1,349 1,883 204 Purchase of bank stock for retirement....................... (489) (1,465) -- --------- --------- --------- NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES....... (48,440) 38,326 64,959 --------- --------- --------- (DECREASE) INCREASE USED IN CASH & CASH EQUIVALENTS............................................... (62,842) 14,901 1,218 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 136,422 121,521 120,303 --------- --------- --------- CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 73,580 $ 136,422 $ 121,521 ========= ========= ========= Supplemental disclosure of cash flow information Cash paid during the year for: Interest (net of amounts capitalized)..................... $ 25,698 $ 28,957 $ 29,760 Taxes on income, net...................................... 10,710 8,090 7,403 ========= ========= =========
The accompanying notes are an integral part of these consolidated statements. 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Mid-State Bancshares and Subsidiary (the "Company") conform with accounting principles generally accepted in the United States (GAAP) and general practice within the banking industry. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following are descriptions of the more significant accounting policies of the Company. CONSOLIDATION: The consolidated financial statements include the accounts of Mid-State Bancshares and its wholly owned Subsidiary, Mid-State Bank, which includes Mid-State Bank's wholly owned subsidiaries, Mid-Coast Land Company and MSB Properties. All inter-company accounts and transactions have been eliminated in the consolidated financial statements. STATEMENT OF CASH FLOWS: The Company presents its cash flows using the indirect method and reports certain cash receipts and payments arising from customer loans and deposits and deposits placed with other financial institutions on a net basis. Cash and cash equivalents include short-term, highly liquid investments that generally have an original maturity of three months or less. SECURITIES: Securities for which the Company has the positive intent and ability to hold until maturity are classified as held-to-maturity securities. Securities which are purchased principally for the purpose of selling them in the near term for a gain are classified as trading securities. Securities not classified as held-to-maturity or trading are classified as available for sale. The Company holds no securities that should be classified as trading securities. Securities classified as available for sale are reported on the consolidated statements of financial position as of December 31, 1999 and 1998, at their market value. The net unrealized gains or losses for these securities are reported, net of related taxes, in the statements of comprehensive income for the years ended December 31, 1999, 1998 and 1997 and as a separate component of the capital accounts for the years ended December 31, 1999 and 1998. Securities classified as held-to-maturity are reported on the consolidated statements of financial position as of December 31, 1999 and 1998 at their amortized cost basis. Interest income from the securities portfolio is accrued as earned including the accretion of discounts and the amortization of premiums based on the original cost of each security owned. LOANS: Loans are stated at face amount, less payments collected and deferred loan fees. The allowance for loan losses, which is based on estimates, is maintained at a level considered adequate to provide for losses that are considered to be inherent in the portfolio. Ultimate losses may vary from the current estimates. Management reviews these estimates periodically, considering the borrower's financial status, current economic conditions, historical loan loss experience and other factors. As adjustments become necessary, they are reported in earnings in the periods in which they become known. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. In determining income recognition on loans, generally no interest is recognized with respect to loans on which a default of interest or principal has occurred for a period of 90 days or more. Loans are placed on non-accrual status when management believes that the borrower's financial condition, after giving consideration to economic and business conditions and collection efforts, is such that the presumption of collectibility of interest no longer is prudent. When a loan is placed on non-accrual status, previously accrued and uncollected interest is reversed from income. 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) OTHER REAL ESTATE OWNED: Other real estate owned (OREO), comprised of real estate acquired through foreclosure, is carried at the lower of cost or estimated fair value less estimated costs of disposal. INVESTMENTS IN REAL ESTATE: Real estate acquired for sale or development is stated at cost or market value, whichever is less. Real estate operations from investments acquired for development are conducted and profits are shared pursuant to agreements with outside joint venture investors and are accounted for under the equity method. Gains on sales of such real estate are recognized when certain criteria relating to the buyer's initial and continuing investment in the property are met. Under certain circumstances, the gain, or a portion thereof, may be deferred until the criteria are met. The Company capitalizes interest on funds disbursed during the active development phases of real estate development projects and the construction of Bank premises. The Bank's real estate development subsidiary, Mid-Coast Land Company, has established a reserve for losses on real estate investment activities. This amount is netted against investments in real estate in the Consolidated Statements of Financial Position. BANK PREMISES AND EQUIPMENT: Bank premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed principally on the straight-line method over the lesser of the estimated useful life of each type of asset or the lease term. ACCOUNTING FOR INCOME TAXES: Deferred income tax assets or liabilities are computed based on the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or benefits are based on the changes in the deferred asset or liability from period to period. RECENT ACCOUNTING PRONOUNCEMENTS: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES." SFAS NO. 133 requires companies to record derivatives on the balance sheet as assets or liabilities measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for in income depending on the purpose of the derivative and whether or not it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. SFAS No. 133, which was amended by SFAS No. 137, is effective in fiscal years beginning after June 15, 2000. Management believes that the adoption of SFAS No. 133 will not have a material impact on the Company's results of operations or financial condition. RECLASSIFICATIONS: Certain items in the consolidated financial statements for 1998 and 1997 were reclassified to conform to the 1999 presentation. 2. MERGERS The Company entered into an "Agreement to Merge and Plan of Reorganization" dated January 29, 1998 and amended on March 27, 1998 by and among Mid-State Bank, BSM Bancorp and Bank of Santa Maria. This matter was submitted to a vote of the shareholders of Mid-State Bank at its Annual Meeting on June 17, 1998. The matter was also submitted to a vote of the shareholders of BSM Bancorp, the parent company of Bank of Santa Maria, on June 18, 1998. The shareholders of both organizations approved the merger. Co-terminus with the completion of the merger on July 10, 1998, BSM Bancorp changed its name to Mid-State Bancshares and remained the parent company to the merged bank, which retained the 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 2. MERGERS (CONTINUED) Mid-State Bank name. The merger was accounted for on a pooling of interests basis and as a result, prior periods are combined and restated as if the two banks were historically one unit. The Company also signed a definitive agreement to merge on April 19, 1999, subject to the approval of banking regulators and City Commerce Bank shareholders. The merger became effective at close of business on August 31, 1999. The agreement provided for the exchange of common stock at an exchange ratio of .6775 shares of Mid-State Bancshares common stock for each share of City Commerce common stock, based on the price of Mid-State Bancshares stock preceding the effective date of the transaction. The merger was structured to be tax-free, and was accounted for as a pooling of interests. As a result of this accounting treatment, all financial statements presented, including prior periods, are combined and restated as if the two banks were historically one unit. The following summarizes the separate revenue and net income of BSM Bancorp, City Commerce Bank and Mid-State Bank that have been reported in the restated financial statements of Mid-State Bancshares for the years ending December 31:
(DOLLARS IN 000'S) 1999 1998 1997 - ------------------ -------- -------- -------- Interest and non-interest income: BSM Bancorp*.............................................. $ -- $ 14,721 $ 28,481 City Commerce Bank**...................................... 8,999 13,776 12,189 Mid-State................................................. 108,093 95,121 70,255 -------- -------- -------- Mid-State Bancshares.................................... $117,092 $123,618 $110,925 Net income: BSM Bancorp*.............................................. $ -- $ 2,306 $ 4,205 City Commerce Bank**...................................... 1,349 1,975 1,224 Mid-State................................................. 20,704 16,714 13,437 -------- -------- -------- Mid-State Bancshares.................................... $ 22,053 $ 20,995 $ 18,866
* For the year ended December 31, 1998, results for BSM Bancorp reflect the six month period ended June 30, 1998. Results from July 1, 1998 through July 10, 1998, the date of the merger, have not been separately identified and were not considered material to the financial statements. ** For the year ended December 31, 1999, results for City Commerce Bank reflect the eight month period ended August 31, 1999, the date of the merger. 49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 2. MERGERS (CONTINUED) The shares outstanding for Mid-State Bancshares at December 31, 1998, result from the following activity in 1998:
BSM MID-STATE MID-STATE BANCORP BANK BANCSHARES --------- --------- ---------- Shares Outstanding December 31, 1997:...................... 2,990,939 6,905,100 Stock Options Exercised Prior to Merger.................... 71,400 2,700 Additional Shares Issued in Connection with the Exchange for Mid-State Bancshares stock........................... 83,813 3,062,339 6,991,613 10,053,952 ========= ========= Stock Options Exercised After the Merger................... 24,464 ---------- Shares Outstanding December 31, 1998, before giving rise to City Commerce Bank....................................... 10,078,416 Retroactive impact of City Commerce Bank acquisition....... 1,127,221 ---------- Reported Shares Outstanding December 31, 1998:............. 11,205,637 ==========
The shares outstanding for Mid-State Bancshares at December 31, 1999, result from the following activity in 1999:
CITY MID-STATE MID-STATE COMMERCE BANCSHARES BANCSHARES BANK PRE-MERGER POST-MERGER --------- ---------- ----------- Shares Outstanding December 31, 1998:..................... 1,663,795 10,078,416 Stock Options Exercised Prior to Merger................... 101,108 30,386 Stock Repurchased and Retired Prior to Merger............. (28,570) Reduction in Shares Issued in Connection with the Exchange for Mid-State Bancshares stock.......................... (560,115) 1,176,218 10,108,802 11,285,020 ========= ========== Stock Options Exercised After the Merger.................. 1,923 ---------- Shares Outstanding December 31, 1999:..................... 11,286,943 ==========
3. CASH RESERVES The average reserve balances required to be maintained by the Federal Reserve Bank were approximately $19.7 million and $20.0 million at December 31, 1999 and 1998, respectively. 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 4. SECURITIES A summary of investment securities owned as of December 31, 1999 and 1998 is as follows:
1999 ---------------------------------------------- GROSS GROSS (DOLLARS IN 000'S) AMORTIZED UNREALIZED UNREALIZED MARKET SECURITIES AVAILABLE FOR SALE COST GAINS LOSSES VALUE - ---------------------------------------------------- --------- ---------- ---------- -------- U.S. Treasury securities............................ $115,254 $195 $ 306 $115,143 Securities of U.S. government agencies and corporations...................................... 101,040 32 1,212 99,860 Mortgage backed securities.......................... 6,282 2 111 6,173 Obligations of states and political subdivisions.... 215,250 152 4,852 210,550 Other investments................................... 2,251 -- 79 2,172 -------- ---- ------ -------- TOTAL............................................. $440,077 $381 $6,560 $433,898 ======== ==== ====== ========
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET SECURITIES HELD TO MATURITY COST GAINS LOSSES VALUE - --------------------------- --------- ---------- ---------- -------- Securities of U.S. government agencies and corporations....................................... $ 4,501 $ 5 $ 5 $ 4,501 Mortgage backed securities........................... 437 -- 2 435 Obligations of states and political subdivisions..... 25,844 22 328 25,538 Other investments.................................... 601 -- -- 601 ------- --- ---- ------- TOTAL.............................................. $31,383 $27 $335 $31,075 ======= === ==== =======
1998 ---------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET SECURITIES AVAILABLE FOR SALE COST GAINS LOSSES VALUE - ----------------------------- --------- ---------- ---------- -------- U.S. Treasury securities............................ $172,604 $2,680 $-- $175,284 Securities of U.S. government agencies and corporations...................................... 131,435 1,277 5 132,707 Mortgage backed securities.......................... 12,505 20 31 12,494 Obligations of states and political subdivisions.... 159,063 3,421 59 162,425 Other investments................................... 1,336 8 1 1,343 -------- ------ --- -------- TOTAL............................................. $476,943 $7,406 $96 $484,253 ======== ====== === ========
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET SECURITIES HELD TO MATURITY COST GAINS LOSSES VALUE - --------------------------- --------- ---------- ---------- -------- Securities of U.S. government agencies and corporations....................................... $ 8,754 $107 $-- $ 8,861 Mortgage backed securities........................... 706 9 -- 715 Obligations of states and political subdivisions..... 30,852 673 -- 31,525 Other investments.................................... 1,604 2 3 1,603 ------- ---- --- ------- TOTAL.............................................. $41,916 $791 $ 3 $42,704 ======= ==== === =======
Securities having an amortized cost of $42,403,000 and $46,351,000 at December 31, 1999 and 1998, respectively, were pledged to secure public deposits and for other purposes as required by law. 51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 4. SECURITIES (CONTINUED) Proceeds from calls, partial paydowns and/or sales of securities during 1999 were $42,970,492. Gross gains of $3,030 and gross losses of $8,213 were realized on that activity. The amortized cost and market value of securities at December 31, 1999 and 1998, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
AVAILABLE FOR SALE HELD-TO-MATURITY -------------------- -------------------- AMORTIZED MARKET AMORTIZED MARKET 1999 (DOLLARS IN 000'S) COST VALUE COST VALUE - ----------------------- --------- -------- --------- -------- Due in one year or less.............................. $136,058 $135,852 $ 6,662 $ 6,656 Due after one year to five years..................... 227,778 224,993 12,901 12,870 Due after five years to ten years.................... 73,866 70,769 11,450 11,202 Due after ten years.................................. 2,375 2,284 370 347 -------- -------- ------- ------- Total.............................................. $440,077 $433,898 $31,383 $31,075 ======== ======== ======= =======
AVAILABLE FOR SALE HELD-TO-MATURITY -------------------- -------------------- AMORTIZED MARKET AMORTIZED MARKET 1998 (DOLLARS IN 000'S) COST VALUE COST VALUE - ----------------------- --------- -------- --------- -------- Due in one year or less.............................. $163,369 $164,354 $10,037 $10,075 Due after one year to five years..................... 279,196 285,099 20,860 21,275 Due after five years to ten years.................... 29,913 30,314 11,019 11,354 Due after ten years.................................. 4,465 4,486 -- -- -------- -------- ------- ------- Total.............................................. $476,943 $484,253 $41,916 $42,704 ======== ======== ======= =======
5. LOANS AND ALLOWANCE FOR LOAN LOSSES THE LOAN PORTFOLIO CONSISTS OF THE FOLLOWING:
DECEMBER 31, ------------------- (DOLLARS IN 000'S) 1999 1998 - ------------------ -------- -------- Construction and development loans.......................... $118,418 $ 89,844 Real estate loans........................................... 379,781 285,859 Home equity credit lines.................................... 52,681 57,425 Installment loans........................................... 29,680 47,513 Credit cards & related...................................... 12,308 12,134 Agricultural production..................................... 41,314 35,128 Commercial, other........................................... 138,095 150,036 -------- -------- 772,277 677,939 -------- -------- Less allowance for loan losses.............................. (13,105) (14,441) Less deferred loan fees..................................... (3,463) (2,458) -------- -------- TOTAL LOAN PORTFOLIO...................................... $755,709 $661,040 ======== ========
52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED) At December 31, 1999, $550,883,000 of the Bank's portfolio was collateralized by various forms of real estate. The Bank attempts to reduce its concentration of credit risk by making loans which are diversified by project type and geographic locations throughout the Central Coast of California. While management of the Bank believes that the collateral presently securing this portfolio is adequate, there can be no assurances that a deterioration in the California real estate market would not expose the Bank to significantly greater credit risk. Loans on non-accrual status totaled $1,520,000 and $2,019,000 at December 31, 1999 and 1998, respectively. If interest income on non-accrual loans had been recorded as originally scheduled, approximately $231,000, $254,000, and $1,613,000 of additional interest income would have been recorded for the years ended December 31, 1999, 1998 and 1997. Additionally, interest income which was recognized for loans on non accrual totaled $243,000, $47,000, and $135,000, for 1999, 1998, and 1997, respectively. A loan is identified as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Because this definition is very similar to that used by bank regulators to determine on which loans interest should not be accrued, the Bank expects that most impaired loans will be on non-accrual status. Therefore, in general, the accrual of interest on impaired loans is discontinued, and any uncollected interest is written off against interest from other loans in the current period. No further income is recognized until all recorded amounts of principal are recovered in full or until circumstances have changed such that the loan is no longer regarded as impaired. Certain impaired loans are both fully secured by collateral and are current in their interest and principal payments. These impaired loans are not classified as non accrual and $620,000, $321,000 and $313,000 in interest was recognized from these loans during 1999, 1998 and 1997, respectively. The amount of the valuation allowance for impaired loans is determined by comparing the recorded investment in each loan with its value measured by one of three methods: (1) the expected future cash flows discounted at the effective interest rate; (2) the loan's observable market price, if available from a secondary market; or (3) by valuing the underlying collateral if the loan is collateral dependent. A valuation allowance is computed as any amount by which the recorded investment exceeds the value of the impaired loan. If the value of the loan, as determined by one of the above methods, exceeds the recorded investment in the loan, a valuation allowance for the loan is not established. The following table discloses information about impaired loans and their related allowance.
(DOLLARS IN 000'S) 1999 1998 - ------------------ -------- -------- Loans identified as impaired at year end.................... $9,136 $4,105 Impaired loans for which a valuation allowance has been determined................................................ 6,566 2,693 Impaired loans for which no valuation allowance was determined necessary...................................... 2,570 1,412 Amount of valuation allowance............................... $3,113 $1,012 ====== ======
The average amount of the recorded investment in impaired loans during the year ended December 31, 1999 and 1998, was approximately $6,621,000 and $4,243,000, respectively. The valuation allowance reported above is determined on a loan-by-loan basis or by aggregating loans with similar risk characteristics. Because the loans currently identified as impaired have unique risk characteristics, the valuation allowance was determined on a loan-by-loan basis. 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 5. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED) The Bank also provides an allowance for losses for (1) loans that while not individually identified as being currently impaired, are internally evaluated as having a relatively higher level of credit risk and (2) losses inherent in the balance of the loan portfolio which have not been specifically identified as of the year-end. The allowance is based on review of individual loans, historical trends, current economic conditions, and other factors. The allowance for loan losses consists of an amount allocated to loans which are impaired, a statistically allocated portion and a specifically allocated portion. The total of these components is considered adequate to provide for losses which can be reasonably anticipated. The allowance for loan losses is netted against loans on the statement of financial position for December 31, 1999 and 1998. A summary of the changes in the allowance account is as follows:
DECEMBER 31, ------------------------------ (DOLLARS IN 000'S) 1999 1998 1997 - ------------------ -------- -------- -------- Balance at beginning of year................................ $14,441 $15,065 $14,561 Additions to the allowance charged to expense............... 50 300 105 Loans charged off........................................... (2,522) (1,721) (1,662) Recoveries of loans previously charged off.................. 1,136 797 2,061 ------- ------- ------- BALANCE AT END OF YEAR.................................... $13,105 $14,441 $15,065 ======= ======= =======
An analysis of loans to directors and officers is as follows:
DECEMBER 31, ------------------- (DOLLARS IN 000'S) 1999 1998 - ------------------ -------- -------- Balance, at beginning of year............................... $6,196 $7,080 Additional loans made....................................... 109 1,000 Payments received........................................... (2,823) (1,884) ------ ------ BALANCE AT END OF YEAR.................................... $3,482 $6,196 ====== ======
These loans were made in the ordinary course of the Bank's business and, in management's opinion, were made at prevailing rates and terms. 6. BANK PREMISES AND EQUIPMENT BANK PREMISES AND EQUIPMENT CONSISTED OF THE FOLLOWING:
DECEMBER 31, ------------------- (DOLLARS IN 000'S) 1999 1998 - ------------------ -------- -------- Land........................................................ $ 8,859 $ 10,059 Buildings................................................... 24,672 22,592 Furniture and equipment..................................... 16,179 23,934 Construction in progress.................................... 674 217 -------- -------- 50,384 56,802 Less--Accumulated depreciation and amortization............. (21,102) (24,199) -------- -------- TOTAL PREMISES AND EQUIPMENT.............................. $ 29,282 $ 32,603 ======== ========
54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 6. BANK PREMISES AND EQUIPMENT (CONTINUED) Depreciation and amortization included in occupancy expenses was $3,457,000, $4,005,000, and $4,373,000 in 1999, 1998 and 1997, respectively, based on the following estimated useful lives: Buildings................................................... 20-40 years Furniture and equipment..................................... 3-20 years
Total rental expense for banking premises was $1,027,000, $1,112,000, and $999,000, in 1999, 1998 and 1997, respectively. As of December 31, 1999 the approximate minimum future lease rentals payable under non-cancelable lease contracts for bank premises were as follows:
YEAR (DOLLARS IN 000'S) - ---- ------------------ 2000........................................................ $ 766 2001........................................................ 743 2002........................................................ 650 2003........................................................ 440 2004........................................................ 277 Thereafter.................................................. 2,241 ------ TOTAL LEASE COMMITMENTS..................................... $5,117 ======
7. INVESTMENTS IN REAL ESTATE Real estate held for sale or development includes the following:
DECEMBER 31, ------------------- (DOLLARS IN 000'S) 1999 1998 - ------------------ -------- -------- Advances to and investments in real estate joint ventures... $ 406 $ 699 Direct investments in real estate development............... 1,373 6,332 Allowance for losses on investments in real estate.......... (262) (262) ------ ------ TOTAL INVESTMENTS IN REAL ESTATE, NET..................... $1,517 $6,769 ====== ======
The Federal Deposit Insurance Corporation (FDIC) Improvement Act (FDICIA) became law in December 1991. Under FDICIA the Bank was originally required to substantially eliminate its real estate development activities by December 19, 1996. In July 1996, the Bank received an extension of the deadline for two years to December 31, 1998. On December 15, 1998, the Regional Director of the FDIC extended the deadline to December 31, 2000. Management fully expects to achieve the December 31, 2000 deadline. The Bank's real estate operations are significant to the local real estate market. Based on current estimates of the fair value of the Bank's real estate operations, management believes that the properties are carried at the lower of cost or market. However, there can be no assurances that a deterioration in the local real estate markets would not expose the Bank to the risk of significant additional losses. Management continues with its liquidation plans for its various development projects. If adjustments become necessary, they will be reported in earnings in the period in which they become known. 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 8. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS Where applicable, the Bank is required by GAAP to disclose the fair value of financial instruments and the methods and significant assumptions used to estimate those fair values. In the case of financial instruments for which it is not practicable to estimate the fair value, the Bank is required to disclose information pertinent to estimating the fair value such as interest rates and maturity, and also state the reasons why it is not practicable to estimate fair value. "Fair values of financial instruments depict the market's assessment of the present value of net future cash flows directly or indirectly embodied in them, discounted to reflect both current interest rates and the market's assessment of the risk that the cash flows will not occur." The information about fair value is said to better enable "investors, creditors, and other users to assess the consequences of an entity's investment and financing strategies, that is, to assess its performance." Nonetheless, there are several factors which users of these financial statements should consider. First, there are uncertainties inherent in the process of estimating the fair value of financial instruments. Secondly, the statement covers financial instruments only, not other assets like premises and equipment, the fair value of which might differ significantly from the amounts at which they are carried in an entity's financial statements. Thirdly, the Bank must exclude from its estimate of the fair value of deposit liabilities any consideration of its ongoing customer relationships which provide stable sources of investable funds. Lastly, these disclosures do not address means of evaluating an entity's performance in areas other than the management of financial instruments; for example, the ability to generate non-interest income and the control of non-interest expense. For these reasons, users are advised not to regard the disclosure of the fair market value of financial instruments as in any way equivalent to a valuation of the Bank as a whole. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: CASH AND DUE FROM BANKS AND FED FUNDS SOLD For those short-term instruments, the carrying amount is a reasonable estimate of fair value. INVESTMENT SECURITIES For securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. LOANS, NET For certain homogeneous categories of loans, such as some residential mortgages, credit card receivables, and other consumer loans, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 8. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) DEPOSITS The fair value of demand deposits is the amount payable on demand. The fair value of fixed-maturity certificates of deposit, savings accounts and money market deposits is estimated using the rates currently offered for deposits of similar remaining maturities. OTHER BORROWINGS Rates currently available to the Bank for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. COMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT Commitments to extend credit and letters of credit are written at current market rates. The Bank does not anticipate any interest rate or credit factors that would affect the fair value of commitments or letters of credit outstanding at December 31, 1999. The estimated fair values of the Bank's financial instruments are as follows:
1999 1998 ----------------------- ----------------------- CARRYING FAIR CARRYING FAIR (DOLLARS IN 000'S) AMOUNT VALUE AMOUNT VALUE - ------------------ ---------- ---------- ---------- ---------- Financial assets: Cash and due from banks..................... $ 56,080 $ 56,080 $ 84,557 $ 84,557 Fed funds sold.............................. 17,500 17,500 51,865 51,865 Investment securities....................... 465,281 464,973 526,169 526,957 Loans, net.................................. 755,709 770,537 661,040 658,577 Financial liabilities: Deposits.................................... 1,168,454 1,184,851 1,224,479 1,193,625 Other borrowings............................ 15,357 15,357 3,049 3,049
9. INCOME TAXES The current and deferred amounts of the provision for taxes in the years ended December 31, were:
(DOLLARS IN 000'S) 1999 1998 1997 - ------------------ -------- -------- -------- Federal: Current................................................... $ 6,565 $ 6,440 $ 6,783 Deferred.................................................. 1,483 1,853 (3,502) ------- ------- ------- TOTAL FEDERAL TAXES..................................... $ 8,048 $ 8,293 $ 3,281 ------- ------- ------- State: Current................................................... $ 2,905 $ 2,480 $ 2,265 Deferred.................................................. 477 (197) (326) ------- ------- ------- TOTAL STATE TAXES....................................... $ 3,382 $ 2,283 $ 1,939 ------- ------- ------- TOTAL FEDERAL AND STATE TAX EXPENSE......................... $11,430 $10,576 $ 5,220 ======= ======= =======
57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 9. INCOME TAXES The provision for taxes on income differed from the amounts computed using the federal statutory rate of 35 percent as follows:
(DOLLARS IN 000'S) 1999 1998 1997 - ------------------ -------- -------- -------- Tax expense at federal statutory tax rate................... $11,719 $11,014 $ 8,412 State income tax expense.................................... 1,986 2,426 1,674 Tax savings from exempt investment and loan income)......... (1,391) (580) (379) Merger related expenses..................................... 328 921 -- Other, net.................................................. (1,212) 280 1,011 ------- ------- ------- Total before change in valuation allowance................ $11,430 $14,061 $10,718 Change in valuation allowance............................... -- (3,485) (5,498) ------- ------- ------- TOTAL TAX EXPENSE......................................... $11,430 $10,576 $ 5,220 ======= ======= =======
The principal items giving rise to deferred taxes were:
(DOLLARS IN 000'S) 1999 1998 1997 - ------------------ -------- -------- -------- Allowance for loan losses................................... $ 358 $ (32) $ 36 Gain on loan workouts....................................... 95 (25) (581) Real estate joint ventures.................................. 1,480 5,852 1,047 Deferred compensation....................................... (344) (139) (66) Merger related expenses..................................... 336 (1,016) -- State income taxes.......................................... (516) 40 (67) Provisions for OREO properties.............................. 137 991 857 Capital loss carryforward................................... -- (183) -- AMT credit carryforward..................................... -- -- 155 Depreciation................................................ 482 (212) (342) Securities--discount accretion (68) (286) 114 Prepaid expenses............................................ (145) 49 (72) Change in valuation allowance............................... -- (3,485) (5,498) Other, net.................................................. 145 102 589 ------ ------- ------- TOTAL DEFERRED TAXES...................................... $1,960 $ 1,656 $(3,828) ====== ======= =======
58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 9. INCOME TAXES (CONTINUED) AS OF DECEMBER 31, THE DEFERRED TAX ASSETS AND LIABILITIES ARE AS FOLLOWS:
(DOLLARS IN 000'S) 1999 1998 1997 - ------------------ -------- -------- -------- ASSETS: Allowance for loan losses................................. $ 4,593 $ 4,951 $ 4,919 Gain on loan workouts..................................... 1,424 1,519 1,494 Real estate joint ventures................................ -- 1,293 7,145 Deferred compensation..................................... 1,497 1,153 1,014 Merger related expenses................................... 680 1,016 -- State income taxes........................................ 1,187 671 711 Provisions for OREO properties............................ 155 292 1,283 Capital loss carryforward................................. 183 183 -- All other, net............................................ 55 200 302 ------- ------- ------- TOTAL ASSETS................................................ 9,774 11,278 16,868 ------- ------- ------- Liabilities: Prepaid expenses.......................................... -- (145) (96) Real estate joint ventures................................ (187) -- -- Depreciation and amortization............................. (1,207) (725) (937) Securities--discount accretion............................ (2) (70) (356) ------- ------- ------- TOTAL LIABILITIES........................................... (1,396) (940) (1,389) ------- ------- ------- Valuation Allowance......................................... (183) (183) (3,668) ------- ------- ------- Net deferred tax asset before tax effect of unrealized gain on securities available for sale.......................... $ 8,195 $10,155 $11,811 Tax effect of unrealized gain on securities available for sale...................................................... 2,472 (2,926) (1,096) ------- ------- ------- DEFERRED TAX ASSET, NET..................................... $10,667 $ 7,229 $10,715 ======= ======= =======
The valuation allowance provides for deferred taxes that are not anticipated to be offset by taxable income projected for the next 12 months. The valuation allowance is based on estimates by management which could change in the near term. As of December 31, 1999, the Bank has no operating loss and tax credit carryforwards for financial reporting purposes, however, a capital loss carryforward exists that is scheduled to expire in 2002. There are also no alternative minimum tax credit carryforwards for tax purposes. 10. OTHER BORROWINGS Mid-State Bank's wholly owned subsidiaries have obtained first trust deed mortgage financing for several of the properties and investments that they own. Mortgages payable totaled $164,000 and $189,000 at December 31, 1999 and 1998, respectively. Other borrowings also include borrowings under the Treasury Tax and Loan note account of $12,263,000 and $1,659,000 at December 31, 1999 and 1998, respectively. Securities sold under agreement to repurchase are also included in other borrowings of $2,930,000 and $1,200,000 at December 31, 1999 and 1998, respectively. 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 11. COMMITMENTS AND CONTINGENCIES At December 31, 1999 and 1998, the Bank was contingently liable for letter of credit accommodations made to its customers totaling $21,546,000 and $20,734,000, respectively. At December 31, 1999 and 1998, the Bank also had undisbursed loan commitments in the amount of $369,753,000 and $280,685,000, respectively. Many of the commitments are expected to expire without being drawn upon. Accordingly, the total outstanding commitment amount does not necessarily represent future cash requirements. The Bank does not anticipate any significant losses as a result of these transactions. Provision has been made for losses which may be sustained in the fulfillment of, or from an inability to fulfill, any commitments. The Bank is involved in litigation of a routine nature which is being handled and defended in the ordinary course of the Bank's business. In the opinion of management, based on the advice of legal counsel, the resolution of this litigation will have no material impact on the Bank's financial condition or results of operations. 12. EARNINGS PER SHARE Earnings per share (EPS) have been computed in 1999, 1998 and 1997, based on the weighted average number of shares outstanding each year of 11,230,000, 11,176,000, and 11,097,000, respectively. Average outstanding shares in prior years have been restated to reflect stock dividends paid to former shareholders of Mid-State Bank, as well as, additional shares issued in connection with the mergers. The following is a reconciliation of the numerators and denominators used in the calculation of basic EPS and diluted EPS for the years ended December 31. 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 12. EARNINGS PER SHARE (CONTINUED) (figures in 000's except per share data)
1999 EARNINGS SHARES EPS - ---- -------- -------- -------- Basic Earnings Per Share: Net Income available to Common Stockholders............... $22,053 11,230 $1.96 Effect of Dilutive Securities: Stock Options............................................. 134 Diluted Earnings Per Share: Net Income available to Common Stockholders and assumed conversions............................................. $22,053 11,364 $1.94 1998 - ------------------------------------------------------------ Basic Earnings Per Share: Net Income available to Common Stockholders............... $20,995 11,176 $1.88 Effect of Dilutive Securities: Stock Options............................................. 97 Diluted Earnings Per Share: Net Income available to Common Stockholders and assumed conversions............................................. $20,995 11,273 $1.86 1997 - ------------------------------------------------------------ Basic Earnings Per Share: Net Income available to Common Stockholders............... $18,866 11,097 $1.70 Effect of Dilutive Securities: Stock Options............................................. 165 Diluted Earnings Per Share: Net Income available to Common Stockholders and assumed conversions............................................. $18,866 11,262 $1.68
13. CAPITAL ACCOUNTS The California Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of (1) the company's undivided profits or (2) the company's net income for its last three fiscal years less the amount of any distributions made by the company to shareholders during such period. Under these restrictions, the Bank can make cash dividends totaling $43,080,000 at December 31, 1999. The Company declared cash dividends during 1999 of $5,583,000. 14. STOCK OPTIONS The Bank adopted a new stock option plan, the "Plan", in 1998. The Plan replaced earlier plans granted by the former BSM Bancorp, the former City Commerce Bank and the former Mid-State Bank. Options are granted at a price not less than the fair market value of the stock at the grant date. Options are exercisable and expire as determined by the Board of Directors. However, options expire no later than ten years from the date of grant. The Plan provides for issuance of up to 892,542 shares of common stock and is subject to termination as determined by the Board of Directors. As of December 31, 1999, 655,967 shares are currently under option. The shares are exercisable at prices ranging from $7.93 to $36.00. During 1998, 98,564 shares were exercised and 38,133 shares were exercised in 1999. 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 14. STOCK OPTIONS (CONTINUED) The Bank applies Accounting Principles Board Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," and related Interpretations in accounting for its Plan. Accordingly, no compensation expense has been recognized for grants under the Plan. Consistent with the methods of SFAS No. 123, proforma compensation expense for the Plan had been determined based on the fair value at the grant date. Fair values were estimated using the Black-Scholes option--pricing model with the following assumptions: dividend yields (dividend per share divided by earnings per share) ranging from 14% to 27%, expected volatility of 25%, risk-free interest rates ranging from 4.23% to 6.06% and expected lives of five years. The Bank's net income and earnings per share for the years ended December 31, 1999, 1998 and 1997 would have been reduced to pro forma amounts indicated below:
(DOLLARS IN 000'S EXCEPT PER SHARE DATA) 1999 1998 1997 - ---------------------------------------- -------- -------- -------- Net income to common shareholders: As reported................................................. $22,053 $20,995 $18,866 Pro forma................................................... $21,232 $20,461 $18,844 Net income per common and common share equivalent: Basic earnings per share: As reported............................................. $ 1.96 $ 1.88 $ 1.70 Pro forma............................................... $ 1.89 $ 1.83 $ 1.70 Diluted earnings per share: As reported............................................. $ 1.94 $ 1.86 $ 1.68 Pro forma............................................... $ 1.87 $ 1.81 $ 1.68
A summary of the Bank's stock options as of December 31, 1999, 1998 and 1997, and changes during the periods then ended, is presented below:
1999 1998 1997 ------------------- ------------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE -------- -------- -------- -------- -------- -------- Outstanding at beginning of period.... 515,622 $26.31 215,077 $12.57 236,794 $12.27 Granted............................... 195,148 33.31 414,500 30.05 4,000 16.00 Exercised/Forfeited................... (54,803) 17.38 (113,955) 13.84 (25,717) 10.28 ------- ------ -------- ------ ------- ------ Outstanding at end of period.......... 655,967 $29.14 515,622 $26.31 215,077 $12.57 ======= ====== ======== ====== ======= ======
62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 15. EMPLOYEE BENEFITS The Company offers a combination qualified profit sharing plan (the Profit Sharing Plan) and a savings and retirement plan designed to comply with Internal Revenue Service Code Section 401(k) (the 401(k) Plan) to substantially all employees. The Company's contributions to the Profit Sharing and 401(k) Plans for the years ended December 31, 1999, 1998, and 1997 were $1,814,000, $1,738,000, and $1,642,000, respectively. A deferred compensation plan is also in effect to provide performance oriented deferred compensation for the Company's senior management. Allocations to the participants accounts are made at the discretion of the Board of Directors. The amount of contributions is determined by the Board of Directors as a function of net profits and prior year return on equity. In 1998, $571,000 was contributed to participants with $662,000 contributed for 1999. Prior to the merger, Mid-State Bank began a bonus incentive system in 1996 (the Incentive Reward System) for many of the Bank's employees. A bonus is paid to selected employees who exceed certain goals under formulas established at the start of the year. Included in employee benefits expense for 1999, 1998 and 1997 was a charge of $1,214,000, $504,000 and $667,850, respectively, which was accrued during those years and paid in the following year under the Incentive Reward System. Approximately 741 employees received bonuses under this program in 1999 ranging from 0.8% of their salary to as much as 17.6% of their salary. Prior to the merger, BSM Bancorp through its wholly owned subsidiary, Bank of Santa Maria paid bonuses to employees amounting to $285,000 and $570,000 for the years 1998 and 1997, respectively. Also prior to the merger, City Commerce Bank paid bonuses to employees amounting to $98,038, $439,000 and $348,000 for the years 1999, 1998, and 1997, respectively. 16. REGULATORY MATTERS The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. As of December 31, 1999, based on the regulations, Mid-State Bancshares and Mid-State Bank are categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, Mid-State Bancshares and Mid-State Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events that Management believes have changed Mid-State Bancshares' and Mid-State Bank's category. 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 16. REGULATORY MATTERS (CONTINUED) The actual capital amounts and ratios as of December 31, 1999 and 1998 are presented in the following table:
TO BE CONSIDERED FOR CAPITAL WELL CAPITALIZED ADEQUACY FOR CAPITAL ACTUAL PURPOSES ADEQUACY PURPOSES ------------------- ------------------- ------------------- (DOLLARS IN 000'S) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - ------------------ -------- -------- -------- -------- -------- -------- MID-STATE BANCSHARES--CONSOLIDATED: As of December 31, 1999: - ----------------------------------------- Total Capital (to Risk Weighted Assets)................................ $175,151 17.2% $81,257 8.0% $101,572 10.0% Tier One Capital (to Risk Weighted Assets)................................ $162,450 16.0% $40,629 4.0% $ 60,943 6.0% Tier One Capital (to Average Assets)..... $162,450 11.6% $55,846 4.0% $ 69,807 5.0% As of December 31, 1998: - ----------------------------------------- Total Capital (To Risk Weighted Assets)................................ $156,227 17.4% $71,980 8.0% $ 89,988 10.0% Tier One Capital (to Risk Weighted Assets)................................ $145,062 16.1% $35,996 4.0% $ 53,992 6.0% Tier One Capital (to Average Assets)..... $145,062 10.7% $54,318 4.0% $ 67,897 5.0% MID-STATE BANK--ONLY: As of December 31, 1999: - ----------------------------------------- Total Capital (to Risk Weighted Assets)................................ $175,023 17.2% $81,074 8.0% $101,572 10.0% Tier One Capital (to Risk Weighted Assets)................................ $162,321 16.0% $40,537 4.0% $ 60,943 6.0% Tier One Capital (to Average Assets)..... $162,321 11.6% $55,826 4.0% $ 69,783 5.0% As of December 31, 1998: - ----------------------------------------- Total Capital (To Risk Weighted Assets)................................ $154,953 17.2% $71,958 8.0% $ 89,948 10.0% Tier One Capital (to Risk Weighted Assets)................................ $143,793 14.3% $35,980 4.0% $ 53,968 6.0% Tier One Capital (to Average Assets)..... $143,793 9.7% $54,302 4.0% $ 67,878 5.0%
17. REPORTABLE BUSINESS SEGMENTS SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," is a new model for segment reporting, referred to as the "management approach." The management approach is intended to present reportable segments consistent with how the chief operating decision maker organizes segments within a company for making operating decisions and assessing performance. Presently, the Company is segregated into Community Banking, Mid Coast Land Company, and "All Other". The Community Banking business segment consists of commercial and retail banking. This segment is managed as a single strategic unit which derives its revenues from a wide range of banking services, including lending and investing activities, acceptance of demand, savings, and time deposits, and mortgage servicing. As previously noted, Mid-Coast Land Company engages in real estate investment activities. There is no major customer and the Company operates within a single geographic area. Non reportable operating segments of the Company's operations which do not have similar characteristics to any other banking operations and do not meet the quantitative thresholds requiring disclosure, are included in the "All Other" category. "All Other" includes the activities of the Parent Company (excluding 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 17. REPORTABLE BUSINESS SEGMENTS (CONTINUED) equity in earnings of subsidiaries) and certain non-recurring items such as merger related expenses of $2.9 and $7.4 million in 1999 and 1998, respectively, and the reversal of the reserve for losses on investments in real estate of $5.3 million in 1998. These items are not considered attributable to the assessment of performance of the business segments to which they relate. Below is a summary statement of income and certain selected financial data for the three years ended December 31, 1999. The accounting policies used in the disclosure of business segments are the same as those described in the summary of significant accounting policies. Certain assumptions are made concerning the allocations of costs between segments which may influence relative results, most notably, allocations of various types of overhead and administrative costs. Management believes that the allocations utilized below are reasonable and consistent with the way it manages the business.
MID-COAST LAND COMMUNITY BANKING COMPANY ALL OTHER ------------------------------ ------------------------------ ------------------------------ (DOLLARS IN 000'S) 1999 1998 1997 1999 1998 1997 1999 1998 1997 - ------------------ -------- -------- -------- -------- -------- -------- -------- -------- -------- Interest Income................. $99,565 $98,783 $92,998 $ 62 $ 99 $ 93 $ -- $ -- $ -- Interest Expense................ 26,071 29,441 29,060 -- -- -- -- -- -- ------- ------- ------- ---- ---- ------- ------- ------- ----- Net Interest Income............. 73,494 69,342 63,938 62 99 93 -- -- -- Provision....................... 50 300 105 -- -- -- -- -- -- Non Interest Income............. 16,680 18,509 17,327 785 727 507 -- 5,500 -- Non Interest Expense............ 53,614 53,626 54,009 498 916 3,491 3,376 7,764 174 ------- ------- ------- ---- ---- ------- ------- ------- ----- Pre-Tax Income.................. $36,510 $33,925 $27,151 $349 $(90) $(2,891) $(3,376) $(2,264) $(174) ======= ======= ======= ==== ==== ======= ======= ======= ===== Average Assets (in millions).... $ 1,385 $ 1,323 $ 1,237 $ 5 $ 8 $ 18 $ 1 $ 1 $ 1 MID STATE BANCSHARES ------------------------------ (DOLLARS IN 000'S) 1999 1998 1997 - ------------------ -------- -------- -------- Interest Income................. $99,627 $98,882 $93,091 Interest Expense................ 26,071 29,441 29,060 ------- ------- ------- Net Interest Income............. 73,556 69,441 64,031 Provision....................... 50 300 105 Non Interest Income............. 17,465 24,736 17,834 Non Interest Expense............ 57,488 62,306 57,674 ------- ------- ------- Pre-Tax Income.................. $33,483 $31,571 $24,086 ======= ======= ======= Average Assets (in millions).... $ 1,391 $ 1,332 $ 1,255
18. PARENT COMPANY FINANCIAL INFORMATION Condensed financial information of Mid-State Bancshares (parent only) follows: (dollars in 000's) CONDENSED BALANCE SHEETS
DECEMBER 31, ------------------- ASSETS 1999 1998 - ------ -------- -------- Cash........................................................ $ 158 $ 2,112 Investment in Mid-State Bank................................ 160,158 149,822 Other Assets................................................ 1,624 394 -------- -------- Total Assets.............................................. $161,940 $152,328 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------------------------------ Dividend Payable............................................ $ 1,580 $ 1,209 Accrued Liabilities......................................... 29 28 -------- -------- Total Liabilities......................................... 1,609 1,237 Shareholders' Equity........................................ 160,331 151,091 -------- -------- Total Liabilities and Shareholders' Equity.............. $161,940 $152,328 ======== ========
65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 18. PARENT COMPANY FINANCIAL INFORMATION (CONTINUED) CONDENSED INCOME STATEMENTS
DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Equity in earnings of subsidiaries: Undistributed............................................. $17,851 $19,221 $18,123 Dividends................................................. 5,583 2,000 850 Operating Expenses.......................................... (1,381) (324) (174) Income Tax Benefit.......................................... -- 98 67 ------- ------- ------- Net Income.................................................. $22,053 $20,995 $18,866 ======= ======= =======
66 CONDENSED STATEMENTS OF CASH FLOWS
DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Cash flows from operating activities: Net Income (loss)........................................... $ 22,053 $ 20,995 $ 18,866 Adjustments to reconcile net income to net cash provided by operating activities: Net earnings of Bank.................................... (17,851) (19,221) (18,123) Amortization of organizational expenses................. (43) 15 15 Other................................................... (1,186) (243) (129) -------- -------- -------- Net cash provided by (used in) operating activities... 2,973 1,546 629 -------- -------- -------- Net Cash Flow from Investing Activities................... -- -- -- Net Cash Flows from Financing Activities: Net change in short term note payable................... -- -- (40) (Redemption) issuance of organizational stock........... -- -- (1) Proceeds from stock options............................. 286 1,282 176 Dividends paid by parent................................ (5,213) (901) (596) -------- -------- -------- Net cash (used in) provided by financing activities... (4,927) 381 (461) -------- -------- -------- Net (Decrease) Increase in Cash............................. (1,954) 1,927 168 Cash, beginning of year..................................... 2,112 185 17 -------- -------- -------- Cash, at end of year........................................ $ 158 $ 2,112 $ 185 ======== ======== ========
67 MANAGEMENT STATEMENT MID-STATE BANK IS RESPONSIBLE FOR THE PREPARATION, INTEGRITY, AND FAIR PRESENTATION OF ITS PUBLISHED CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1999 AND THE YEAR THEN ENDED. THE CONSOLIDATED FINANCIAL STATEMENTS HAVE BEEN PREPARED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND, AS SUCH, INCLUDE AMOUNTS, SOME OF WHICH ARE BASED ON JUDGMENTS AND ESTIMATES OF MANAGEMENT. INTERNAL CONTROL STRUCTURE OVER FINANCIAL REPORTING Management is responsible for establishing and maintaining an effective internal control structure over financial reporting. The system contains monitoring mechanisms, and actions are taken to correct deficiencies identified. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of an internal control system may vary over time. Management assessed its internal control structure over financial reporting as of December 31, 1999. This assessment was based on criteria for effective internal control over financial reporting described in "Internal Control--Integrated Framework" issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based upon this assessment, management believes that Mid-State Bank maintained an effective internal control structure over financial reporting as of December 31, 1999. COMPLIANCE WITH LAWS AND REGULATIONS Management is also responsible for compliance with the federal and state laws and regulations concerning dividend restrictions and federal laws and regulations concerning loans to insiders designated by the FDIC as safety and soundness laws and regulations. Management assessed its compliance with the designated laws and regulations relating to safety and soundness. Based on this assessment, management believes that Mid-State Bank complied, in all significant aspects, with the designated laws and regulations relating to safety and soundness for the year ended December 31, 1999.
/s/ JAMES G. STATHOS /s/ CARROL R. PRUETT - ------------------------ ------------------------ James G. Stathos Carrol R. Pruett EXECUTIVE VICE PRESIDENT PRESIDENT CHIEF FINANCIAL OFFICER CHIEF EXECUTIVE OFFICER
68 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of Mid-State Bancshares: We have examined management's assertions that Mid-State Bancshares maintained an effective internal control structure over financial reporting as of December 31, 1999 included in the accompanying Management Statement. Our examination was made in accordance with standards established by the American Institute of Certified Public Accountants and accordingly, included obtaining an understanding of the internal control structure over financial reporting, testing, and evaluating the design and operating effectiveness of the internal control structure and such other procedures as we considered necessary in the circumstances. We believe that our examination provides a reasonable basis for our opinion. Because of inherent limitations in any internal control structure, errors or irregularities may occur and not be detected. Also, projections of any evaluation of the internal control structure over financial reporting to future periods are subject to the risk that the internal control structure may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assertion that Mid-State Bancshares maintained an effective internal control structure over financial reporting as of December 31, 1999, is fairly stated, in all material respects, based on criteria established in the INTERNAL CONTROL-INTEGRATED FRAMEwork issued by the Committee of Sponsoring Organizations of the Treadway Commission. /s/ ARTHUR ANDERSEN LLP -------------------------------------------------------------------- ARTHUR ANDERSEN LLP Los Angeles, California January 28, 2000 69 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 of Form 10-K is incorporated by reference from the information contained in the Bank's Proxy Statement for the 2000 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 of Form 10-K is incorporated by reference from the information contained in the Bank's Proxy Statement for the 2000 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 of Form 10-K is incorporated by reference from the information contained in the Bank's Proxy Statement for the 2000 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 of Form 10-K is incorporated by reference from the information contained in the Bank's Proxy Statement for the 2000 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Exhibits: 2.1 Agreement to Merge dated April 19,1999 by and between Mid-State Bancshares and City Commerce Bank.** 3.1 Articles of Incorporation, as amended 3.2 Bylaws of Registrant* 27 Financial Data Schedule
- ------------------------ * Filed as an exhibit to Registrant's Registration Statement (File No. 333-16952) filed on November 27, 1996. ** Filed as part of Registrant's Registration Statement on Form S-4 (File No. 333-81531) filed on July 9, 1999. (b) Schedules: Not Applicable (c) Reports on Form 8-K During the fourth quarter of 1999, the Company did not file any Reports. Notice of Annual Meeting and Proxy Statement for the Bank's 2000 Annual Meeting will be mailed to shareholders subsequent to the date of filing of this Report. Copies of said materials will be furnished to the FDIC in accordance with applicable rules and regulations. 70 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Bank has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MID-STATE BANK By: /s/ CARROL R. PRUETT ------------------------------- CARROL R. PRUETT PRESIDENT AND CHIEF EXECUTIVE OFFICER Dated: March 27, 2000 By: /s/ JAMES G. STATHOS ------------------------------- JAMES G. STATHOS EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER Dated: March 27, 2000
71 SIGNATURES In accordance with the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Bank and in the capacities and on the dates indicated.
DATED: /s/ CARROL R. PRUETT President and Chairman March 27, 2000 - --------------------------- of the Board CARROL R. PRUETT /s/ GRACIA B. BELLO Director March 27, 2000 - --------------------------- GRACIA B. BELLO /s/ CLIFFORD H. CLARK Director March 27, 2000 - --------------------------- CLIFFORD H. CLARK /s/ A. J. DIANI Director March 27, 2000 - --------------------------- A. J. DIANI /s/ DARYL L. FLOOD Director March 27, 2000 - --------------------------- DARYL L. FLOOD /s/ WILLIAM A. HARES Director March 27, 2000 - --------------------------- WILLIAM A. HARES /s/ H. EDWARD HERON Director March 27, 2000 - --------------------------- H. EDWARD HERON /s/ RAYMOND E. JONES Director March 27, 2000 - --------------------------- RAYMOND E. JONES /s/ STEPHEN P. MAGUIRE Director March 27, 2000 - --------------------------- STEPHEN P. MAGUIRE /s/ GREGORY R. MORRIS Director March 27, 2000 - --------------------------- GREGORY R. MORRIS /s/ WILLIAM L. SNELLING Director March 27, 2000 - --------------------------- WILLIAM L. SNELLING
72 EXHIBIT INDEX
EXHIBIT SEQUENTIAL NUMBER DESCRIPTION PAGE NUMBER --------------------- ----------- ----------- 27........ Financial Data Schedule
73 EX-27 2 EXHIBIT 27
9 0001027324 MID-STATE BANCSHARES 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 56,080 0 17,500 0 433,898 31,383 31,075 768,814 13,105 1,355,218 1,168,454 15,357 11,076 0 0 0 59,681 100,650 1,355,218 67,372 29,899 2,356 99,627 25,742 26,071 73,556 50 (5) 57,488 33,483 22,053 0 0 22,053 1.96 1.94 7.85 1,520 4,199 2,527 0 14,441 2,522 1,136 13,105 13,105 0 2,990
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