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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2002

or

For the transition period from                              to                             

Commission file number 000-23925

MID-STATE BANCSHARES
(Exact name of registrant as specified in its charter)

(805) 473-7700
Registrant's telephone number, including area code

None
Securities registered pursuant to Section 12(b) of the Act:

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) days. 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/

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). days. /X/     Yes     / / No

The aggregate market value of the common stock held by non-affiliates of the registrant as of March 24, 2003 was $386,315,435.

The number of shares of common stock of the registrant outstanding as of March 24, 2003 was 23,515,537.

The following documents are incorporated by reference herein: Part III, Items 10 through 13 are incorporated from Registrant's definitive proxy statement for the 2002 Annual Meeting of Shareholders.

TABLE OF CONTENTS

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PART I

        Certain statements contained in this Annual Report on Form 10-K ("Annual Report"), including, without limitation, statements containing the words "believes", "anticipates", "intends", "expects", and words of similar impact, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions in those areas in which the Company operates, demographic changes, competition, fluctuations in interest rates, changes in business strategy or development plans, changes in governmental regulation, credit quality, the availability of capital to fund the expansion of the Company's business, economic, political and global changes arising from the terrorist attacks of September 11, 2001 and the conflict in Iraq, and other factors referenced in this report, including in "Item 1. Business—Factors that May Affect Future Results of Operations." The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

ITEM 1. BUSINESS

Mid-State Bancshares and Mid-State Bank & Trust

        Mid-State Bancshares (the Company) is the parent company to Mid-State Bank & Trust (the Bank), its 100% owned principal subsidiary. 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 & Trust 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, 2002 the Company had total assets of $1.935 billion, total deposits of $1.653 billion and total shareholders' equity of $254.1 million.

        The Bank operates 39 full service retail banking offices along the central coast of California in 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, Camarillo, Ventura and Santa Barbara. 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 loans and leases, providing trust services, and making other investments. The Bank originates several types of loans, including secured and unsecured commercial and consumer loans, residential real estate mortgage loans, 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 Bank are arranged through correspondent banks.

        The Company, through the Bank, derives its income primarily from interest received on 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 deposit services. The Company's major operating expenses are the interest it pays on deposits and borrowings and general operating expenses. The

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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, the fiscal and regulatory policies of the federal government and of the regulatory authorities that govern financial institutions. See "Supervision and Regulation."

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. Under the Federal Deposit Insurance Corporation Improvement Act (FDICIA) which became law in December 1991, the Bank, through Mid Coast Land Company, was required to divest itself of its real estate development activities. That process has now been substantially completed. The holdings and results of operations of Mid Coast Land Company are included within the consolidated financial statements of the Company. For further information concerning Mid Coast Land Company, see the Subsidiary Activity section of the Management's Discussion and Analysis section included in Item 7. 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 Company. On a stand-alone basis, MSB Properties had earnings of $1.3 million, $1.7 million, and $1.4 million in 2002, 2001, and 2000, respectively. For further information concerning MSB Properties, see the Subsidiary Activity portions of the Management's Discussion and Analysis section included in Item 7. of this Report.

Acquisition of Americorp/American Commercial Bank

        On September 28, 2001, Mid-State Bancshares and its wholly owned subsidiary Mid-State Bank & Trust acquired 100 percent of the outstanding common stock of Americorp. The results of Americorp's operations have been included in the consolidated financial statements since that date. Americorp was the holding company of American Commercial Bank, a community bank that served Ventura County. The merger gave Mid-State Bank & Trust five new offices in Ventura County.

        The aggregate purchase price was $71.5 million, which includes (1) $31.6 million cash paid to Americorp shareholders and for other merger related expenses and (2) $39.9 million in Mid-State Bancshares' common stock and substitute common stock options issued. The value of the 2.45 million shares issued was determined based on the average closing market price of Mid-State Bancshares' common stock over the twenty consecutive trading days that Mid-State Bancshares' stock traded ending September 21, 2001. The average price of Mid-State Bancshares' stock over that period was $15.9853. The merger was accounted for utilizing the purchase method of accounting.

Trust Department

        Mid-State Bank & Trust formally opened its new Trust Department on January 2, 2001, to provide trust, investment management and estate settlement services in San Luis Obispo, Santa Barbara, and Ventura Counties. As of year-end, the Department had approximately $123 million of assets under management of which $98 million represented temporary funds. These funds are not included in the assets of the Company in its Consolidated Statements of Financial Position. The Trust Department offers a variety of financial and trust-related services including: trustee or successor trustee for trust accounts, estate settlement services, guardianships and conservatorships for minors and adults who are no longer able to manage their own affairs. In addition, the Trust Department offers investment

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management services for those who no longer wish to handle the management of their investment portfolios, or who have inherited investments from a family member and need investment management. The department also provides custody services for customers' financial assets. Its main office is located in the Bank's San Luis Obispo branch at 75 Santa Rosa Street.

Leasing Department

        In June of 2001, Mid-State Bank & Trust opened a new leasing department to serve business customers in Ventura, Santa Barbara, and San Luis Obispo Counties. As of year-end, the department has approximately $6.0 million under management and with its very low overhead operation is already turning a monthly profit. The Bank leases business equipment for construction, agriculture, marine, industrial and manufacturing, transportation, medical, and warehouse uses. The Bank also leases office equipment and medium and heavy duty class trucks. Mid-State Bank & Trust offers a number of lease structures with varying tax and accounting advantages to fit most business' needs.

Services

        The Bank offers a full range of commercial banking services including 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, business equipment leases and SBA loans. Other services offered by the Bank include, but are not limited to, trust services, safe deposit boxes, travelers cheques, notary public, merchant 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, 2002 the Bank had approximately 34,624 non interest bearing demand deposit accounts representing $390.2 million, or an average of $11,270 per account. The Bank also had approximately 110,582 NOW, Money Market and Savings accounts amounting to $863.1 million, or about $7,802 average per account. There were 17,568 time certificates of deposit outstanding at December 31, 2002, representing $399.6 million with an average deposit balance of approximately $22,745. Of the total time certificates of deposit, only $149.8 million represented holders who carried an amount on deposit of $100,000 or more, approximately 37% of the total.

        The Bank is not dependent on a single or a few customers for its deposits. Most deposits 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, 2002, no individual, corporate, or public depositor accounted for more than 2% 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 2002, Fed Funds Sold averaged $75.6 million representing 4.0% of average assets. In addition, the Bank maintains Federal Funds lines of credit totaling $70 million with major correspondents, subject to customary terms for such arrangements.

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        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 40.8%—in excess of the Bank's policy minimum of 15%.

Loans

        The Bank's loan-to-deposit ratio stood at approximately 64.7% at year-end 2002. 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 maintains an allowance for loan losses which is netted against loans on the balance sheet. Additions to the allowance are made by charges to expense. All loans deemed to be uncollectable 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, losses, non-accrual totals, diversification of the portfolio, value of available collateral and the cost of collateral liquidation.

        As of December 31, 2002, the Bank's allowance for loan losses stood at $17.4 million. Additionally, the Bank has an allowance for losses on unfunded commitments totaling $1.8 million. Collectively, these allowances for losses represent 114.3% 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 affect the adequacy of the allowances 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 allowances. During 2002, the Bank experienced charge-offs, net of recoveries, of $2.1 million, or 0.19% of average loans.

Underwriting and Credit Administration

        The lending activities of Mid-State Bank & Trust 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 Loan Committee. Loan requests exceeding these limits are submitted to the Board Loan Committee, which consists of the President, Chief Credit Officer and three non-management directors. Each of these committees meets on a regular basis in order to provide timely responses to the Bank's clients.

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

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Loan Portfolio

        At December 31, 2002, Mid-State Bank & Trust's gross loan portfolio totaled $1.1 billion. The portfolio is distributed as follows:

        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, the client's deposit relationship with the Bank, and the Bank's cost of funds.

        Commercial Loans.    The Bank provides 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. Certain equipment loans may be made at fixed rates for short to medium terms.

        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 equipment, inventory and working capital needs of eligible businesses, generally over a three to twenty-five 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.

        The Bank was designated in May 2000 as a preferred lender by the SBA, allowing it to process these loans quicker. Under the SBA's Preferred Lending Program, the SBA delegates a substantial degree of lending authority to participating lenders, such as the Bank.

        Agricultural Loans.    The Bank provides production loans to help finance the seasonal needs of farming operations, including crop and livestock financing, inventory purchases, and receivable financing. Equipment loans are also financed on everything from field equipment to office automation systems. 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). Agricultural loan pricing, like 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. Certain equipment loans may be made at fixed rates for short to medium terms.

        Real Estate Construction and Development Loans.    The Bank's real estate construction loan activity has focused on providing short-term (maturity of two years or less) 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.

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        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 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 makes 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 and Loans Secured by Farmland.    The Bank provides medium-term commercial real estate loans secured by commercial or industrial buildings or farmland where the properties are either used by the owner for business purposes (owner-user 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 to 30 years. Some of these loans have rates tied to the prime rate that adjust whenever the prime rate changes. The remaining loans adjust every three or five years depending upon the index to which the loan is tied.

        Home Equity Credit Lines.    The Bank provides lines of credit secured by a second deed of trust on the borrower's single family residence. These loans have maturities of ten years and have an interest rate that adjusts each month with the one month jumbo C.D. rate. The combination of the Home Equity Credit Line and the first mortgage may not exceed 80% of the value of the residence.

        Consumer and Other Loans.    The Bank's consumer and other loan portfolio is divided between installment loans secured by automobiles, other consumer purposes and revolving, unsecured consumer debt such as reserve lines of credit. Installment loans tend to be fixed rate and longer-term (one-to-five-year maturity). The Bank's portfolio of revolving credit plans, issued as an additional service to its clients, is minimal at just 0.3% of total loans.

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 Deposit and Liability 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, 2002, the aggregate carrying value of the Investment Portfolio was $609.0 million. Of this total, $26.6 million was invested in U.S. Treasury Securities, $235.1 million in U.S. Government Agencies, $5.9 million in Mortgage Backed Securities, $323.5 million in Obligations of State and Political Subdivisions and $17.9 million in Other Securities. The types of securities held are influenced by several factors, which include: 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, 2002, the Bank had public funds totaling approximately $51.4 million. The Bank has made available $100.0 million of securities to securitize these funds. Excess collateral can be released as needed.

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Economic Climate

        The economy in the Bank's trade area is based upon agriculture, oil, tourism, light industry, government services, 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 Tri-county area, according to the California Department of Finance, is estimated at January 2001 to be 1,434,461. 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. Real estate values throughout the Tri-counties have steadily increased in recent years, having continued to increase in value even through the economic slow-down experienced in 2001 and 2002. With the diversity of the various types of industries in the Bank's service area, the Central Coast, while not immune from economic fluctuations, has historically tended 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 international banking which is 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 secured and unsecured lending limits at December 31, 2002, were approximately $53.9 million and $32.4 million, respectively. These levels are up from $50.7 million and $30.4 million, respectively, at December 31, 2001.

        Within the Bank's trade area, there are few companies which 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 providers of money market instruments.

        Commercial banks compete with savings and loan associations, credit unions, other financial institutions, securities brokerage firms and other entities for funds. For instance, yields on corporate and government debt securities and other commercial paper affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for loans with savings and loan associations, credit unions, consumer finance companies, mortgage companies and other lending institutions.

        The financial services industry is undergoing rapid technological changes involving frequent introductions of new technology-driven products and services which have further increased competition. There can also be no assurance that these technological improvements, if made, will increase the Company's operational efficiency or that the Company will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

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        It should also be noted that the trend toward consolidation of banking assets exhibited over the past few years in California continued in 2002. Statewide, 4 banks were merged out of existence or liquidated during the year and 8 new banks commenced operation.

Stock Repurchase Program

        The Board of Directors authorized a stock repurchase program for up to five percent (5%) of its outstanding shares in March of 2000, and upon completing that initial program, authorized the repurchase of up to an additional five percent of its outstanding shares in May 2002. The buyback reduces the number of outstanding shares resulting in an improvement to the Company's earnings per share and to its return on equity. These repurchases are being made from time to time by the Company in the open market or privately negotiated transactions in compliance with the Securities and Exchange Commission (SEC) rules. The total number of shares repurchased was 477,264, 454,126 and 601,312 in 2002, 2001 and 2000, respectively. As of December 31, 2002, the Company could repurchase up to an additional 800,878 shares under the May 2002 authorization.

Employees

        At December 31, 2002, the Bank had a total of 828 employees. A number of these employees are part-time however. On a full-time equivalent basis, employees represent 756 positions. The Bank believes that its employee relations are positive.

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 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 which effect short term rates such as the Fed Funds rate, 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 on the Bank 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, the California legislature and before various bank regulatory and other professional agencies. See "Financial Services Modernization Legislation," and "Sarbanes-Oxley Act of 2002."

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

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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 Bank Holding Company 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.

        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 files reports and proxy statements pursuant to such Act with the Securities and Exchange Commission (SEC).

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The Bank

        The Bank is chartered under the laws of the State of California and its deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The Bank is subject to the supervision of, and is regularly examined by, the California Department of Financial Institutions (DFI) 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 Bank's 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.

        If, as a result of an examination of a bank, the FDIC or the DFI should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank's operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to these regulatory agencies. Such remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the Bank's deposit insurance, which for a California chartered bank would result in a revocation of the bank's charter.

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 certain 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, non-cumulative 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 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

10

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 to the Company.

        On January 1, 1998 legislation became effective which, among other things, gave the DFI power 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 bank's total assets or (ii) $1.0 million.

Prompt Corrective Action and Other Enforcement Mechanisms

        Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios described above. 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 a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment.

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

Safety and Soundness Standards

        The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") imposes certain specific restrictions on transactions and requires federal banking regulators to adopt overall safety and soundness standards for depository institutions related to internal control, loan underwriting and documentation and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, restricts the use of brokered deposits, limits the aggregate extensions of credit by a depository institution to an executive officer, director, principal shareholder or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain employee benefits accounts. The federal banking agencies may require an institution to submit to an acceptable compliance plan as well as have the flexibility to pursue other more appropriate or effective courses of action given the specific circumstances and severity of an institution's noncompliance with one or more standards.

11

Premiums for Deposit Insurance

        Through the Bank Insurance Fund ("BIF"), the FDIC insures the deposits of the Bank up to prescribed limits for each depositor. The amount of FDIC assessments paid by each BIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution's capitalization risk category and supervisory subgroup category. An institution's capitalization risk category is based on the FDIC's determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. An institution's supervisory subgroup category is based on the FDIC's assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required. The assessment rate currently ranges from zero to 27 cents per $100 of domestic deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. An increase in the assessment rate could have a material adverse effect on the Company's earnings, depending on the amount of the increase. Due to continued growth in deposits and some recent bank failures, the bank insurance fund is nearing its minimum ratio of 1.25% on insured deposits as mandated by law. If the ratio drops below 1.25%, it is likely that the FDIC will be required to assess premiums on all banks for the first time since 1996.

        The FDIC is authorized to terminate a depository institution's deposit insurance upon a finding by the FDIC that the institution's financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution's regulatory agency. The termination of deposit insurance for the Bank would have a material adverse effect on the Company's condition since it would result in the revocation of the Bank's charter and the cessation of its operations as a going concern.

Sarbanes-Oxley Act of 2002

        On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the "SOA"). The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.

        The SOA is one of the most far-reaching U.S. securities legislation enacted. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934, (the "Exchange Act"). The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

        The SOA addresses, among other matters:

•

the creation of an independent accounting oversight board to oversee the audit of public companies and auditors who perform such audits;



•

expansion of the power of the audit committee, including the requirements that the audit committee: (i) have direct control of the outside auditor; (ii) be able to hire and replace the auditor; and (iii) approve all non-audit services performed by the outside auditors;



•

auditor independence provisions which restrict non-audit services that independent accountants may provide to their audit clients and pre-approval by the audit committee of non-audit related services;

12

•

certification of financial statements and internal controls over financial reporting by the chief executive officer and the chief financial officer;



•

the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;



•

a prohibition on insider trading during pension plan black out periods;



•

increased protection for whistleblowers and informants;



•

disclosure of off-balance sheet transactions;



•

expedited filing requirements for ownership reports by officers and directors;



•

disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;



•

"real time" filing of periodic reports; and



•

various increased criminal penalties for violations of securities laws.

        The SOA contains provisions which became effective upon enactment on July 30, 2002, and provisions which will become effective within 30 days to one year from enactment. The SEC has been delegated the task of enacting rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. The Company has implemented procedures to comply with the requirements for expanded disclosure of internal controls and the certification of financial statements. A significant portion of the remaining items in the new legislation will become effective during 2003. The Company is currently evaluating what impacts the new legislation and its implementing regulations will have upon its operations, including a likely increase in certain outside professional costs.

Financial Services Modernization Legislation

        On November 12, 1999, the Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization Act") was signed into law. The Financial Services Modernization Act is intended to modernize the banking industry by removing barriers to affiliation among banks, insurance companies, the securities industry and other financial service providers. It provides financial organizations with the flexibility of structuring such affiliations through a holding company structure or through a financial subsidiary of a bank, subject to certain limitations. The Financial Services Modernization Act establishes a new type of bank holding company, known as a financial holding company, that may engage in an expanded list of activities that are "financial in nature," which include securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking.

        The Company currently meets all the requirements for financial holding company status. However, the Company does not expect to elect financial holding company status unless and until it intends to engage in any of the expanded activities under the Financial Services Modernization Act which require such status. Unless and until it elects such status, the Company will only be permitted to engage in non-banking activities that were permissible for bank holding companies as of the date of the enactment of the Financial Services Modernization Act.

        The Financial Services Modernization Act also sets forth a system of functional regulation that makes the Federal Reserve Board the "umbrella supervisor" for holding companies, while providing for the supervision of the holding company's subsidiaries by other federal and state agencies. A bank holding company may not become a financial holding company if any of its subsidiary financial institutions are not well-capitalized or well-managed. Further, each bank subsidiary of the holding company must have received at least a satisfactory Community Reinvestment Financial Services Modernization Act (CRA) rating. The Financial Services Modernization Act also expands the types of

13

financial activities a national bank may conduct through a financial subsidiary, addresses state regulation of insurance, generally prohibits unitary thrift holding companies organized after May 4, 1999 from participating in new financial activities, provides privacy protection for nonpublic customer information of financial institutions, modernizes the Federal Home Loan Bank system and makes miscellaneous regulatory improvements. The Federal Reserve Board and the Secretary of the Treasury must coordinate their supervision regarding approval of new financial activities to be conducted through a financial holding company or through a financial subsidiary of a bank. While the provisions of the Financial Services Modernization Act regarding activities that may be conducted through a financial subsidiary directly apply only to national banks, those provisions indirectly apply to state-chartered banks.

        In addition, the Bank is subject to other provisions of the Financial Services Modernization Act, including those relating to CRA, privacy and safe-guarding confidential customer information, regardless of whether the Company elects to become a financial holding company or to conduct activities through a financial subsidiary of the Bank. The Company does not, however, currently intend to file notice with the Federal Reserve Board to become a financial holding company or to engage in expanded financial activities through a financial subsidiary of the Bank.

        The Company and the Bank do not believe that the Financial Services Modernization Act has had thus far, or will have in the near term, a material adverse effect on their operations. However, to the extent that it permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The Financial Services Modernization Act is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that the Company and the Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and the Bank.

USA Patriot Act of 2001

        In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington D.C. which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcement's and the intelligence communities' abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Transactions between Affiliates

        Transactions between a bank and its "affiliates" are quantitatively and qualitatively restricted under the Federal Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve Board has also recently issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions.

        Regulation W incorporates the exemption from the affiliate transaction rules but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank's holding company and companies that are under common control with the bank. The Company is considered to be an affiliate of the Bank. In general,

14

subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in "covered transactions" with affiliates:

•

to an amount equal to 10% of the bank's capital and surplus, in the case of covered transactions with any one affiliate; and



•

to an amount equal to 20% of the bank's capital and surplus, in the case of covered transactions with all affiliates.

        In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A "covered transaction" includes:

•

a loan or extension of credit to an affiliate;



•

a purchase of, or an investment in, securities issued by an affiliate;



•

a purchase of assets from an affiliate, with some exceptions;



•

the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and



•

the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.

        In addition, under Regulation W:

•

a bank and its subsidiaries may not purchase a low-quality asset from an affiliate;



•

covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and



•

with some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit.

        Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.

Interest on Reserves

        Legislation to permit interest payments on reserves has been pending for several years. Several versions have passed the House Committee on Financial Services and one could be before the House and Senate before the end of the year. The legislation would authorize the Federal Reserve to pay interest on required reserves and excess reserve balances, as well as to pay explicit interest on contractual clearing balances. In addition, a "mark-up" bill implements several provisions:

•

It eliminates current prohibitions that prevent banks and thrifts from paying interest on business checking accounts;



•

It allows depository institutions to permit up to 24 transfers per month rather than six;



•

It gives the Federal Reserve the flexibility to reduce or even eliminate reserve requirements;



•

It requires expanded, permanent reports on retail fees charged by banks, thrifts, and credit unions.

15

        Interest payments on required reserves and clearing balances would begin shortly after legislative approval. Other parts of the bill would be phased in, including interest payments on certain checking accounts and interest payments on excess balances. It is currently impossible to predict accurately whether or in what form the legislation will be passed. Moreover, it is difficult to predict exactly how such legislation will affect the Company. It is likely though that balances with the Federal Reserve would increase. The Company may benefit by holding less cash in its vault because it will earn interest by holding balances with the Federal Reserve. Sweep activity, which is used to minimize reserve requirements, will likely dwindle. Earnings credits would cease with the payment of interest, and depository institutions would have one year to use existing credits. Finally, institutions may contract for higher clearing balances because they will earn interest.

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.

        When a bank holding company applies for approval to acquire a bank or other bank holding company, the Federal Reserve will review the assessment of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. A bank's compliance with its CRA obligations is based on a performance-based evaluation system which bases CRA ratings on an institution's lending service and investment performance, resulting in a rating by the appropriate bank regulatory agency 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 8 of this Report.

Off Balance Sheet and Other Related Party Transactions

        As noted in Footnote 12 to the financial statements, the Company is contingently liable for letter of credit accommodations made to its customers in the ordinary course of business totaling $39.4 million at December 31, 2002, up from $31.8 million one year earlier. Additionally, the Company has undisbursed loan commitments, also made in the ordinary course of business, totaling $436.7 million, which was up from the $368.5 million outstanding one year earlier.

        There are no Special Purpose Entity ("SPE") trusts, corporations, or other legal entities established by the Company which reside off-balance sheet. There are no other off-balance sheet items other than the aforementioned items related to letter of credit accommodations and undisbursed loan commitments.

        As noted in Footnote 5 to the financial statements, the Company does make loans to related parties (directors and officers) in the ordinary course of business at prevailing rates and terms. These loans totaled $1.2 million at the end of 2002 compared to $14.1 million one year earlier.

16

Factors That May Affect Future Results of Operations

        Dependence on Real Estate.    A significant portion of the loan portfolio of the Company is dependent on real estate. At December 31, 2002, real estate served as the principal source of collateral with respect to approximately 74.9% percent of the Company's loan portfolio. A decline in current economic conditions or rising interest rates could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing loans and the value of real estate owned by the Bank, as well as the Company's financial condition and results of operations in general and the market value of the Company's common stock. Acts of nature, including earthquakes and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact the Company's financial condition.

        Operating Strategies.    From time to time, the Company develops long-term financial performance goals to guide and measure the success of our operating strategies. The Company can make no assurance that we will be successful in achieving these long-term goals or that our operating strategies will be successful. Achieving success in these areas is dependent on a number of factors, many of which are beyond the Company's direct control. Factors that may adversely affect the Company's ability to attain its long-term financial performance goals include:

•

Deterioration of asset quality;



•

Inability to control noninterest expense, including, but not limited to, rising employee and healthcare costs;



•

Inability to increase noninterest income;



•

Inability to decrease reliance on revenue generated from assets;



•

Ability to increase loan growth;



•

Ability to find acquisitions targets at valuation levels we find attractive;



•

Regulatory and other impediments associated with making acquisitions;



•

Deterioration in general economic conditions, especially in the Company's core markets;



•

Decreases in the Company's net interest margin;



•

Increases in competition;



•

Adverse regulatory or legislative developments; and



•

Unexpected increase in costs related to acquisitions.

        Interest Rate Changes.    The earnings of the Company and the Bank are substantially affected by changes in prevailing interest rates. Changes in interest rates affect the demand for new loans, the credit profile of existing loans, the rates received on loans and securities and the rates the Bank must pay on deposits and borrowings. The difference between the rates the Bank receives on loans and securities and the rates it must pay on deposits and borrowings is known as the interest rate spread. Given the Bank's current volume and mix of interest-bearing liabilities and interest-earning assets, the Bank's interest rate spread can be expected to increase when market interest rates are rising, and to decline when market interest rates are declining. The Federal Reserve Board's decrease in rates during 2001 and 2002 substantially impacted the Bank's interest rate spread, as its spread for 2002 declined to 5.74% (taxable equivalent) from 6.36% (taxable equivalent) in 2001 and from 6.75% (taxable equivalent) for 2000. Although the Bank believes its current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates may have an adverse impact on its business, financial condition and results of operations.

17

        Competition.    Competition may adversely affect the Bank's performance. The financial services business in the Bank's market area is highly competitive, and becoming more so due to changes in regulation, technological advances and the accelerating pace of consolidation among financial service providers. Mid-State faces competition both in attracting deposits and making loans. Mid-State competes for loans principally through competitive interest rates and the efficiency and quality of the services provided. Increasing levels of competition in the banking and financial services businesses may reduce market share or cause the prices charged for services to fall. Results may differ in future periods depending on the nature or level of competition.

        Regulation.    Both the Company and the Bank are subject to government regulation that could limit or restrict their activities, adversely affecting operations. The financial services industry is heavily regulated. Federal and state regulation is designed to protect the deposits of consumers, not to benefit shareholders. The regulations impose significant limitations on operations, and may be changed at any time, possibly causing results to vary significantly from past results. Government policy and regulation, particularly as implemented through the Federal Reserve System, significantly affects credit conditions.

        In response to several well-publicized corporate and auditing scandals, the President signed the Sarbanes-Oxley Act into law on July 30, 2002. This act calls for increased federal regulation of the accounting profession and imposes new requirements upon boards of directors, audit committees and executive officers of public companies. These requirements will likely increase the accounting and legal costs of the Company. As a public company whose securities on listed on the Nasdaq national market, the Company will be subject to all of these provisions of the Act and implementing regulations as well as additional corporate governance standards which Nasdaq has proposed for adoption.

        Borrowers' Failure to Perform.    A significant number of the Bank's borrowers and guarantors may fail to perform their obligations as required by the terms of their loans, which could result in larger than expected losses. This risk increases when the economy is weak, as it has been recently. The Bank has adopted underwriting and credit policies, and loan monitoring procedures, including the establishment and monitoring of allowances for credit losses. Management believes these provisions are reasonable and adequate, and should keep credit losses within expected limits by assessing the likelihood of nonperformance, tracking loan performance and diversifying the credit portfolio. However, these policies and procedures may not be adequate to prevent unexpected losses that could materially and adversely affect the results of operations.

        Operations Risks.    The Bank is subject to certain operations risks, including, but not limited to, data processing system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. The Bank maintains a system of internal controls to mitigate against such occurrences and maintains insurance coverage for such risks, but should such an event occur that is not prevented or detected by the Bank's internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on the Company's business, financial condition or results of operations.

        Geographic Concentration.    The Company's operations are located almost entirely in the Central Coast region of California. As a result of this geographic concentration, our results depend largely upon economic and business conditions in this region. A deterioration in economic and business conditions in our market area could have a material adverse impact on the quality of our loan portfolio and the demand for our products and services, which in turn may have a material adverse effect on our results of operations.

        War on Terrorism.    The terrorist attacks of September 11, 2001, the ensuing worldwide war on terrorism and the conflict in Iraq, may lead to unexpected shifts in cash flows, deposit levels, and general economic activity. US banking agencies have warned of the possible impact of such events on the capital ratios of banks.

        Company Cash Flow.    As a holding company, all of the Company's cash flow typically comes from dividends from the Bank. Various statutory provisions restrict the amount of dividends the Bank can pay to the Company without regulatory approval.

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ITEM 2. PROPERTIES

        The Company's principal office is located at 1026 Grand Avenue, Arroyo Grande, California. As of December 31, 2002, the Bank owned 23 of its branch offices and leased 16 other Bank locations. The Company believes its present facilities are adequate for its present needs.

19

Leased by Bank or Subsidiary

20

Former Bank Offices Leased by Bank—Which Are Sub-Leased

*

All offices listed are full service branch offices, except those with asterisks noted above. Asterisks represent non-banking support offices (e.g., Administration, Data Processing, Supplies Warehouse, Credit Services, et. al.)

**

Locations not in use as of close of business December 31, 2002.

***

Ground lease on property adjacent to a fully owned facility.

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 as of December 31, 2002 (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, 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 2002.

21

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."

        The following table summarizes those trades of the Company's Common Stock on NASDAQ, setting forth the approximate high and low trade prices for each quarterly period ended since January 1, 2001. The closing price on December 31, 2002 was $16.42 compared to the close one year earlier of $16.28. All prices shown below have been adjusted to reflect the two for one stock split which became effective February 26, 2001.

Equity Plan Compensation Information

        The following table summarizes information as of December 31, 2002 relating to equity compensation plans of the Company pursuant to which grants of options, restricted stock or other rights to acquire shares may be granted from time to time.

Holders

        As of December 31, 2002, 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 declared by its Board of Directors, out of funds legally available

22

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 1¹/4 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 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 1¹/4 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—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, 2001 by the Company to its shareholders.

        Whether or not 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

23

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

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

Mellon Investor Services, LLC
P. O. Box 3315
South Hackensack, NJ 07606-1915

Or

85 Challenger Road
Ridgefield Park, NJ 07660

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

        Alternatively, Mellon Investor Services, LLC can be contacted via the Internet at www.melloninvestor.com.

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ITEM 6. SELECTED FINANCIAL DATA

         Selected Consolidated Financial Data—Mid-State Bancshares

25

(1)

Includes allowance for loan losses and allowance for losses—unfunded commitments

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction and Business of the Company

        The Company has as its single, wholly owned subsidiary, Mid-State Bank & Trust (the Bank). The Bank 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 39 offices in communities throughout San Luis Obispo, Santa Barbara and Ventura Counties and serves over 115,000 households and businesses.

        The following discussion and analysis will provide insight and supplementary information into the accompanying consolidated financial statements of the Company. It also provides Management's assessment of the operating trends over the past few years and certain of their expectations for 2003.

        Certain statements contained in this Management's Discussion and Analysis (MD&A), including, without limitation, statements containing the words "believes", "anticipates", "intends", "expects", and words of similar impact, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions in those areas in which the Company operates, demographic changes, competition, fluctuations in interest rates,

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changes in business strategy or development plans, changes in governmental regulation, credit quality, the availability of capital to fund the expansion of the Company's business, economic, political and global changes arising from the terrorist attacks of September 11, 2001 and the potential conflict in Iraq, and other factors referenced in this report, including in "Item 1. Business-Factors that May Affect Future Results of Operations." The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

2002 RESULTS AND ACCOMPLISHMENTS

Financial

        The Company, on a consolidated basis, reported net income of $29.9 million in 2002 and $27.4 million in 2001 after generating $27.3 million in 2000. The diluted Earnings Per Share (EPS) was $1.20 for 2002 compared to $1.18 in 2001 and $1.20 in 2000. Consolidated total assets at December 31, 2002 were $1.935 billion compared to $1.852 billion at December 31, 2001, up 4.5%. Total deposits also increased from $1.584 billion as of December 31, 2001 to $1.653 billion as of December 31, 2002. Shareholders' common equity stood at $254.1 million at year end up from its $234.6 million level one year earlier. Factors contributing to the increase in shareholders' common equity included; 1) the $29.9 million of net income generated for the year, 2) a $6.8 million after-tax change in the unrealized gain on available for sale securities, and 3) the $1.1 million received for the exercise of stock options. Partially offsetting these increases were $9.8 million in dividends paid out and $8.4 million paid for the repurchase of common stock outstanding.

        The table below illustrates net income by subsidiary unit.

Other Events and Items of Note in 2002

        With the addition of the former American Commercial Bank branches in Ventura County to the Company's service area, much time was spent "blue-printing" a new structure to manage the larger Company with its expanded customer base and geographic reach. Broadly speaking, in terms of customer contact areas, the Company approaches its customer base from three perspectives—retail banking, business banking and corporate banking. Corporate banking will handle the needs of larger companies with annual revenue in excess of five million dollars, large private banking clients, agricultural banking and real estate developers. Business banking will focus on the needs of smaller businesses with annual sales in the one to five million dollar range which typically have borrowing needs under one million dollars. Retail banking focuses more on the needs of the individual consumer and small "Main Street" business through such products as traditional checking and savings accounts, installment loans, mortgage loans, merchant services and cash reserve. Both business and retail banking are broken into three regions. The North/Mid-San Luis Obispo County Region includes the communities of San Luis Obispo, coastal areas from Los Osos north, and cities in northern San Luis Obispo County. The Five Cities/Santa Maria Valley Region includes the five cities area, Nipomo, the Santa Maria Valley and Lompoc. The Santa Barbara/Ventura County Region includes the Santa Ynez Valley, Santa Barbara/Goleta and the communities in Ventura County. Corporate Banking is managed

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by a mid-coast and southern sectional manager. Offices however are maintained in key communities with local corporate bankers in Paso Robles, San Luis Obispo, the Five Cities, Santa Maria (corporate and agricultural), Santa Barbara, Ventura and Oxnard.

        With the early retirement of the Company's former Chief Credit Officer, Mid-State undertook an extensive search for a new Chief Credit Officer in early 2002 involving both external and internal candidates. On March 14, the Company announced the appointment of Mr. Harry Sackrider to the position of Chief Credit Officer, overseeing all credit policy and analysis, risk management, credit administration, and loan review for the Bank. Mr. Sackrider has over 35 years in banking with extensive real estate experience. Mr. Sackrider joined the Bank in 1997 and most recently held the position of Senior Vice President and real estate credit administrator since 2000. In January 2003, Mr. Sackrider was given the additional corporate title of Executive Vice President and Chief Credit Officer.

        The Board of Directors authorized a stock repurchase program for up to five percent (5%) of its outstanding shares in March of 2000, and upon completing that initial program, authorized the repurchase of an additional five percent of its outstanding shares in May 2002. The buyback reduces the number of outstanding shares resulting in an improvement to the Company's earnings per share and to its return on equity. These repurchases are being made from time to time by the Company in the open market or privately negotiated transactions in compliance with the Securities and Exchange Commission (SEC) rules. The total number of shares repurchased was 477,264, 454,126 and 601,312 in 2002, 2001 and 2000, respectively. As of December 31, 2002, the Company could repurchase up to an additional 800,878 shares under the May 2002 authorization.

        There were two changes of note on the Company's Board of Directors during the year. Mr. Raymond Jones, who had served on the Board since 1991 and prior to that had worked for the Bank since 1967 in the capacity of Cashier and later Chief Financial Officer, retired from the Board in May 2002. He will continue to serve the board as a director emeritus. On a sadder note, A.J. Diani, who had served on the Board since the Company's merger with Bank of Santa Maria as Vice Chairman of the Board, passed away on October 31, 2002. His exemplary record of service to the community is held in the highest regard by members of the Company. He will be greatly missed.

        Other milestones for the Bank in 2002, while less significant than those noted above, are certainly notable. Approvals were finally obtained and work commenced on a permanent structure to replace the Bank's office in Cambria. The final property held by Mid Coast Land Company was sold with closing occurring in January 2003. And the Mid-State Bank Foundation, started in 2001, contributed over $215 thousand throughout the tri-county area. Coupled with donations made directly by the Bank, Mid-State contributed over $302 thousand in support of charitable causes throughout its trade area.

EXTERNAL FACTORS IMPACTING THE BANK

Economic Conditions

        At the start of 2002, Management noted in last year's annual report that we expected to "...witness a positive and improving level of economic activity over the course of the year." In spite of the potential lingering effects of the war on terrorism, we expected this improving economic activity to extend beyond Mid-State's trade area and that the Federal Reserve would likely need to raise interest rates in the middle part of the year with Prime raising to somewhere in the 5.5% range by the end of 2002. As the Company enters 2003, we note that our outlook for 2002 was optimistic and was only reasonably accurate with respect to the local economy of the tri-county service area of the Bank. The most comprehensive review of local economic conditions known to Management comes from the University of California at Santa Barbara (UCSB) Economic Forecast Project. According to UCSB, Gross County Product in the tri-county area was estimated at $69.1 billion in 2002, up 6.5% from the $64.9 level in the prior year. Adjusted for real dollars, it was up 3.3% following a 4.3% growth rate in 2001. While these rates of growth were down from the double digit increases witnessed in the late

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1990's, they were nonetheless substantially better than those exhibited by the State as a whole. California's real State Product was flat in 2001 and is estimated to actually have declined in 2002 by 0.7%. On a national level, real gross domestic product was better than the State, but not quite as healthy as the local tri-county area, having increased 2.4% in 2002 following a 0.3% increase in the prior year. Growth in 2002 was centered earlier in the year as it slowed to an annualized rate of just 0.7% in the fourth quarter.

        The Federal Reserve Board, which had lowered interest rates frequently and dramatically during 2001, followed a steady course through most of 2002, hoping that the lower interest rate levels would work to stimulate activity during the year. But as the year progressed, with unemployment hovering near 6.0%, with gross domestic product slowing, with the S&P 500 off some 23% for the first 10 months of the year and with continuing geo-political risk creating a large degree of uncertainty throughout the country, the Federal Reserve Board took the unusual step of lowering rates again by 0.50% in November 2002. Commercial banks quickly followed suit lowering the Prime Rate to 4.25%. Early data suggest that, except in the housing industry, the additional rate cuts are having little effect on stimulating economic activity. Management believes that it is possible that the low rate environment is actually having the opposite of the desired effect. Low interest rate levels, while helping refinancing homeowners realize lower monthly payments, are negatively impacting the disposable incomes of those who are dependent on earnings from their savings. Commercial borrowing is not benefiting as was hoped because lenders can not make sufficient returns in the low rate environment to justify the risk inherent in certain loans. Moreover, potential commercial borrowers would appear to be more concerned about economic activity in general than the absolute level of rates currently.

        Current economic difficulties being experienced by the State are expected to have a negative effect on the local tri-county area. As the State moves to narrow its $26 to $34 billion deficit, the impacts on local cities, counties and schools are inescapable. The public sector, which accounts for 17% of employment in the tri-counties, will see employment decline as funding from the State declines. Non employment related spending will also decrease in the face of tighter budgets. The State is also expected to impose higher vehicle license fees, higher DMV use fees, higher State park fees, higher taxes for farmers on the use of pesticides, public safety surcharges on intrastate telephone calls, increased tuition costs at community colleges and State universities, and more.

        National indicators do not yet show any significant improvement in the outlook for economic activity, though potentially positive impacts are on the horizon. Policymakers in Washington would appear to be considering a number of potential stimulants for the economy which would be of help later this year. It is generally agreed that a quick resolution of the war in Iraq will also have a positive effect on the economy if for no other reason than through improved "psychological" sentiment. A return of lower oil prices and stability of oil supplies would also have a positive impact.

        Local economic conditions, in spite of the problems at the State and National levels, are clearly better than in other parts of the State. Real Gross County Product, as noted above, continues at a positive pace and is expected by UCSB to improve in 2003 by 4.8% across the tri-county area. Unemployment rates are still low relative to the State and the Nation at 3.5% in San Luis Obispo County, 4.6% in Santa Barbara County and 5.7% in Ventura County. The local real estate market continues strong with demand far outpacing supply and median home prices at record highs. Lenders are more prudent in their lending practices having learned the lessons of the early 1990's and building is far less speculative.

        Management is very cautious in its outlook for 2003. While local conditions would appear to be relatively favorable in the near term, the effects of National and State conditions are likely to be negative. Management does not see a return of robust economic conditions until at least 2004 and that will be highly dependent on the outcome of events in the Middle East. Interest rates are not expected to rise until at least late 2003 and more than likely 2004. It is even possible that the Federal Reserve

29

may, with no other effective tools available to it, lower rates again in their efforts to stimulate the 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 insufficient 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.

        It should also be noted that the trend toward consolidation of banking assets exhibited over the past few years in California continued in 2002. Statewide, 4 banks were merged out of existence or liquidated during the year and 8 new banks commenced operation.

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ANALYSIS OF STATEMENT OF FINANCIAL POSITION

Loans

        The Bank experienced a decrease in net loans from $1,117.0 million at the end of 2001, to $1,070.2 million at the end of 2002. This represents a decrease in the loan portfolio of $46.8 million following the $208.0 million increase in 2001, which was primarily attributed to the merger with Americorp. The loan portfolio represents approximately 55% of the Bank's assets. Additionally, loans held for sale (which are single family residential mortgages pending sale) total $22.6 million at the end of 2002, up from $13.6 million one year earlier.

Mid-Sate Bancshares
Trends in Loan Categories

        The graph above displays the trend over the past five years in the various components of the loan portfolio. Construction loans have risen from their level five years earlier—$90.7 million at December 31, 1998 compared to $213.4 million at year-end 2002. Real Estate loans nearly doubled from $285.9 million at the end of 1998 to $525.2 million at the end of 2002. Home Equity Credit Lines have generally increased from $57.4 million at the end of 1998 compared to $74.3 million at the end of 2002. Consumer loans (installment and credit reserve) have decreased from $59.3 million at December 31, 1998 to $30.9 million at year-end 2002 which is due to the sale in December 2001 of Credit Card receivables. Commercial loans, while growing in recent years, declined to $214.0 million at December 31, 2002. Agricultural production loans decreased from $35.1 million at the end of 1998 to $29.9 million at the end of 2002. The Bank expects to continue to emphasize all types of lending activity in order to diversify the risk in its portfolio. 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.

        The Bank's allowance for losses stands at $19.1 million, or 1.8% of gross loans, and represents losses not yet realized, but inherent in the loan portfolio and on unfunded commitments. This amount is down from the $20.7 million at December 31, 2001. The year-end 2002 balance now represents 114%

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of non-performing loans which is down from 562% at the end of 2001. A five-year review of activity in the allowance for losses and an allocation by loan type of the allowance is shown in the tables below.

        Allocation of the allowance for losses at December 31:

        The increase in the unallocated portion of the allowance for losses in 2001 to $6.8 million from $0.7 million in 2000 is related to 1) concerns by Management of a pending recession and its impact on

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the losses inherent in the loan portfolio, 2) refinements to the loss allowance methodology as it relates to historical loss experience and 3) concerns by Management of the losses inherent in the acquisition of American Commercial Bank's loan portfolio. The reduction of the unallocated portion in 2002 to $3.7 million reflects additional specific allocations, especially on the Company's Construction & Land Development and Real Estate loan portfolios.

        Non-accrual loans within the Bank's portfolio increased from $3.0 million as of December 31, 2001, to $16.7 million, at the end of 2002. Loans 90 days or more past due decreased from $690 thousand at December 31, 2001, to zero at the end of 2002. Additional information on non-accrual loans, past due loans and troubled debt restructurings can be found in Footnote 5 to the financial statements. The level of non-accrual loans at the end of 2002 is centered primarily in two real estate secured loans (total $14.4 million). Management has established specific reserves that would offset potential losses, if any, arising from less than full recovery of the loans from the supporting collateral. Recoveries in 2002 of loans previously charged-off totaled $720 thousand compared to charge-offs of $2.8 million taken during the year resulting in net charge-offs of $2.1 million. This compares to net charge-offs incurred during 2001 of $2.2 million and net charge-offs of $525 thousand in 2000. The Bank anticipates that charge-offs (actual losses) will continue during 2003. It is unlikely that recoveries would exceed charge-offs in the coming year.

        With the combination of the collateral securing the problem loans and the size of the allowance for losses, Management feels that the allowance is sufficient to cover inherent losses. Management reviews the adequacy of the allowance and also employs an independent third party loan review group to, among other things, review the adequacy of the allowance and make recommendations. Management, as necessary, adjusts the allowance on a regular basis. The allowance is also examined annually by one or more of the Bank's regulatory bodies including the FDIC and DFI. During the 3^rd quarter of 2001, the effects of an economic slow-down prompted Management to re-evaluate the allowance for loan losses. Accordingly, Management recommended and the Board of Directors authorized an additional $2.9 million provision for loans losses at that time. No additional provision for loan losses was made after June of 2002 in view of the adequacy of the allowance. The need for additional provision for loan losses in 2003 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.

        The allowance for losses as a percentage of total loans stands at 1.8% at the end of 2002. 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, 2002, Management considered the quality of the loan portfolio obtained by acquisition and the slow-down in economic activity and continues to acknowledge the combined high concentration of real estate loans, increases in certain higher risk activities such as construction lending, and higher levels of individually large corporate loans.

        The allowance for losses consists of 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, 2002 and 2001 is shown in the table below. A more complete discussion of the Bank's exposure to

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changes in interest rates can be found in the MD&A under the section titled "Net Interest Income and Interest Rate Risk".