United States
Securities and Exchange Commission

Washington, D.C. 20429

 

FORM 10-Q

 

 

MID-STATE BANCSHARES

(Exact name of registrant as specified in its charter)

 

 

Check whether the Company (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý   No  o

 

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

Yes  ý   No  o

 

As of November 5, 2003, the aggregate market value of the common stock held by non-affiliates of the Company was: $562,070,832.

 

Number of shares of common stock of the Company outstanding as of November 5, 2003: 23,635,333 shares.

 

 

Mid-State Bancshares

September 30, 2003

Index

 

PART I - FINANCIAL INFORMATION
	Item 1 –Financial Statements
		Consolidated Statements of  Financial Position (Unaudited)
		Consolidated Statements of Income (Unaudited)
		Consolidated Statements of Comprehensive Income (Unaudited)
		Consolidated Statements of Cash Flows (Unaudited)
		Notes to Consolidated Financial Statements (Unaudited)
	Item 2 –Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3 –Quantitative and Qualitative Disclosure About Market Risk
	Item 4 –Controls and Procedures
PART II - OTHER INFORMATION
	Item 1 –Legal Proceedings
	Item 2 –Changes in Securities and Use of Proceeds
	Item 3 –Defaults Upon Senior Securities
	Item 4 –Submission of Matters to a Vote of Security Holders
	Item 5 –Other Information
	Item 6 –Exhibits and Reports on Form 8-K
	Signatures
	Certifications
	EX-99.1 Certification Pursuant to 18 U.S.C. Sec. 1350

 

2

 

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

 

Mid-State Bancshares
Consolidated Statements of Financial Position
(Interim Periods Unaudited - figures in 000’s)

 

		Sept. 30, 2003			Dec. 31, 2002			Sept. 30, 2002
ASSETS
Cash and Due From Banks		$	109,469		$	128,036		$	110,454
Fed Funds Sold		85,300			16,500			5,000
Securities Available For Sale		682,441			608,983			632,124
Loans Held for Sale		42,075			22,560			3,760
Loans, net of unearned income		1,091,113			1,087,551			1,106,184
Allowance for Loan Losses		(16,871		)	(17,370		)	(17,465		)
Net Loans		1,074,242			1,070,181			1,088,719
Premises and Equipment, Net		25,709			25,342			24,555
Accrued Interest Receivable		12,254			11,689			13,700
Other Real Estate Owned		3,279			—			—
Goodwill		33,448			33,448			33,448
Other Intangibles		8,769			8,816			8,806
Other Assets		9,163			9,185			7,456
Total Assets		$	2,086,149		$	1,934,740		$	1,928,022
LIABILITIES AND EQUITY
Non Interest Bearing Demand		$	436,565		$	390,212		$	391,350
NOW Accounts, Money Market and Savings Deposits		965,821			863,142			842,791
Time Deposits Under $100		236,275			249,792			253,391
Time Deposits $100 or more		156,131			149,801			151,805
Total Deposits		1,794,792			1,652,947			1,639,337
Other Borrowings		7,907			10,973			11,573
Allowance for Losses – Unfunded Commitments		1,862			1,771			1,687
Accrued Interest Payable and Other Liabilities		20,767			14,914			23,515
Total Liabilities		1,825,328			1,680,605			1,676,112
Commitments and Contingencies
Shareholders’ Equity:
Common Stock and Surplus (Shares Outstanding of 23,191,  23,697 and 23,839, respectively)		67,424			77,588			80,098
Retained Earnings		179,448			163,309			157,200
Accumulated Other Comprehensive Income, Net		13,949			13,238			14,612
Total Equity		260,821			254,135			251,910
Total Liabilities and Equity		$	2,086,149		$	1,934,740		$	1,928,022

 

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Mid-State Bancshares
Consolidated Statements of Income
(Unaudited - figures in 000’s except earnings per share data)

 

		Three Month Period Ended Sept. 30,						Nine Month Period Ended Sept. 30,
		2003			2002			2003			2002
Interest Income:
Interest and fees on loans		$	20,574		$	20,771		$	60,461		$	64,307
Interest on investment securities -
U.S. Treasury securities		253			296			612			1,068
U.S. Government agencies and corporations		2,062			2,579			6,453			6,383
Obligations of states and political sub-divisions and other securities		3,491			3,175			10,585			9,454
Interest on fed funds sold and other		263			343			604			1,013
Total Interest Income		26,643			27,164			78,715			82,225
Interest Expense:
Interest on NOW, money market and savings		497			1,364			1,997			3,867
Interest on time deposits less than $100		1,034			1,694			3,540			5,811
Interest on time deposits of $100 or more		585			907			1,908			3,137
Interest other		41			56			114			163
Total Interest Expense		2,157			4,021			7,559			12,978
Net Interest Income before provision		24,486			23,143			71,156			69,247
Less: Provision for loan losses		—			—-			260			600
Net Interest Income after provision		24,486			23,143			70,896			68,647
Other Operating Income:
Service charges and fees		2,271			2,155			6,835			6,584
Commissions, fees and other service charges		3,511			3,203			9,996			8,970
Gains on sale of securities		14			21			43			12
Gain on sale of loans held for sale		1,032			243			2,992			390
Other non-interest income		1,010			172			2,370			1,566
Total Other Operating Income		7,838			5,794			22,236			17,522
Other Operating Expense:
Salaries and employee benefits		9,606			9,122			28,465			27,634
Occupancy and furniture		3,017			2,873			8,649			8,277
Other operating expenses		5,966			5,891			17,876			17,193
Total Other Operating Expense		18,589			17,886			54,990			53,104
Income Before Taxes		13,735			11,051			38,142			33,065
Provision for income taxes		4,760			3,965			13,364			11,925
Net Income		$	8,975		$	7,086		$	24,778		$	21,140
Earnings per share:
– basic		$	0.39		$	0.30		$	1.06		$	0.88
– diluted		$	0.37		$	0.29		$	1.01		$	0.85
Dividends per share		$	0.13		$	0.10		$	0.37		$	0.30
Average shares used in earnings per share calculations:
– basic		23,287			23,924			23,441			24,026
– diluted		24,350			24,815			24,487			24,860

 

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Mid-State Bancshares
Consolidated Statements of Comprehensive Income
(Unaudited - figures in 000’s)

 

		Three Month Period Ended Sept. 30,						Nine Month Period Ended Sept. 30,
		2003			2002			2003			2002
Net Income		$	8,975		$	7,086		$	24,778		$	21,140
Other Comprehensive (Loss) Income Before Taxes:
Unrealized (losses) gains on securities available for sale:
Unrealized holding (losses) gains arising during period		(5,579		)	9,301			1,228			13,662
Reclassification adjustment for gains included in net income		(14		)	(21		)	(43		)	(12		)
Other comprehensive (loss) income, before tax		(5,593		)	9,280			1,185			13,650
Income tax (credit) expense related to items in comprehensive income		(2,237		)	3,712			474			5,460
Other Comprehensive (Loss) Income, Net of Taxes		(3,356		)	5,568			711			8,190
Comprehensive Income		$	5,619		$	12,654		$	25,489		$	29,330

 

5

 

Mid-State Bancshares
Consolidated Statements of Cash Flows
(Unaudited - figures in 000’s)

 

		Nine Month Period Ended Sept. 30,
		2003			2002
OPERATING ACTIVITIES
Net Income		$	24,778		$	21,140
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses		260			600
Depreciation and amortization		3,376			3,277
Net amortization of prem./discounts-investments		2,891			2,863
Impairment of investment in real estate		91			—
Gain on sale of loans held for sale		(2,992		)	(390		)
Net (increase) decrease in loans held for sale		(16,523		)	9,844
Change in deferred loan fees		197			(32		)
Changes in assets and liabilities:
Accrued interest receivable		(565		)	(2,640		)
Other intangibles, net		47			488
Other assets, net		(691		)	(6,337		)
Other liabilities		5,944			7,969
Net cash provided by operating activities		16,813			36,782
INVESTING ACTIVITIES
Proceeds from sales and maturities of investments		128,074			73,280
Purchases of investments		(203,238		)	(243,272		)
Net (Increase) decrease in loans		(7,797		)	37,583
Receipt from investments in real estate		148			33
Purchases of premises and equipment, net		(3,743		)	(1,981		)
Net cash used in investing activities		(86,556		)	(134,357		)
FINANCING ACTIVITIES
Increase in deposits		141,845			55,171
Decrease in other borrowings		(3,066		)	(6,141		)
Exercise of stock options		1,686			792
Cash dividends paid		(8,639		)	(7,197		)
Retirement of company stock		(11,850		)	(5,566		)
Net cash provided by financing activities		119,976			37,059
Increase (decrease) in cash and cash equivalents		50,233			(60,516		)
Cash and cash equivalents, beginning of period		144,536			175,970
Cash and cash equivalents, end of period		$	194,769		$	115,454
Supplemental  disclosure of cash flow information:
Cash paid during the period for interest		$	7,671		$	13,364
Cash paid during the period for taxes on income		13,636			9,500
Non-cash disclosure of Investing Activities:
Transfer of Loans to Other Real Estate Owned		3,279			0

 

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Mid-State Bancshares
Notes to Consolidated Financial Statements
(Information with respect to interim periods is unaudited)

 

NOTE A - BASIS OF PRESENTATION AND MANAGEMENT REPRESENTATION

 

The accompanying consolidated financial statements include the accounts of Mid-State Bancshares and its wholly owned subsidiary Mid-State Bank & Trust and the Bank’s subsidiaries, MSB Properties and Mid Coast Land Company (collectively the “Company,” “Bank” or “Mid-State”).  All significant inter-company transactions have been eliminated in consolidation.  These consolidated financial statements should be read in conjunction with the Form 10-K Annual Report for the year ended December 31, 2002 of Mid-State Bancshares.  A summary of the Company’s significant accounting policies is set forth in the Notes to Consolidated Financial Statements contained therein.

 

These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States on a basis consistent with the accounting policies reflected in the audited consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2002.  They do not, however, include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments including normal recurring accruals considered necessary for a fair presentation have been included.  Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole.

 

 NOTE B - EARNINGS PER SHARE

 

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

 

		Three Month Period Ended Sept. 30, 2003								Three Month Period Ended Sept. 30, 2002
		Earnings			Shares		EPS			Earnings			Shares		EPS
Basic Earnings Per Share:
Income available to Common Shareholders		$	8,975		23,287		$	0.39		$	7,086		23,924		$	0.30
Effect of dilutive securities:
Stock Options					1,063								891
Diluted Earnings Per Share:
Income available to Common Shareholders		$	8,975		24,350		$	0.37		$	7,086		24,815		$	0.29

 

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		Nine Month Period Ended Sept. 30, 2003								Nine Month Period Ended Sept. 30, 2002
		Earnings			Shares		EPS			Earnings			Shares		EPS
Basic Earnings Per Share:
Income available to Common Shareholders		$	24,778		23,441		$	1.06		$	21,140		24,026		$	0.88
Effect of dilutive securities:
Stock Options					1,046								834
Diluted Earnings Per Share:
Income available to Common Shareholders		$	24,778		24,487		$	1.01		$	21,140		24,860		$	0.85

 

NOTE C – RECENT ACCOUNTING PRONOUNCEMENTS

 

In January of 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities”.  FIN No. 46 addresses consolidation by business enterprises of variable interest entities, which have one or both of the following characteristics:  i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and ii) the equity investors lack an essential characteristic of a controlling financial interest.  FIN No. 46 was initially effective for all financial statements issued on or after February 1, 2003, but subsequently the adoption date was deferred to January 1, 2004.  The adoption of FIN No. 46 is not expected to have a material impact on the Company’s results of operations and financial position.

 

The FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” in May of 2003.  SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances).  Many of those instruments were previously classified as equity.  SFAS No. 150 was effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  The adoption of SFAS No. 150 did not have a material impact on the Company’s results of operations and financial position.

 

The Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” in June of 2002.  SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities.  SFAS No. 146 was effective for exit or disposal activities initiated after December 31, 2002, with early adoption permitted.  The adoption of SFAS No. 146 did not have a material impact on the Company’s results of operations and financial position.

 

In November of 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”.  FIN No. 45 clarifies the requirements relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees.  The disclosure provisions of FIN No. 45 were effective for financial statements of periods

 

8

 

ended after December 15, 2002.  The provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002.  Adoption did not have a material impact on the Company’s results of operations and financial position.

 

The FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” in December of 2002.  SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123.  SFAS No. 148 was effective for fiscal years ending after December 15, 2002.  The Company adopted SFAS No. 148 on December 15, 2002 and adoption did not have a material impact on its results of operations and financial position.  The effect of SFAS No. 148 is displayed in Note E below.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133.  SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The guidance should be applied prospectively. The adoption of SFAS 149 did not have a material impact on the Company’s results of operations and financial position.

 

NOTE D – OTHER INTANGIBLE ASSETS

 

The following is a summary of the Company’s other intangible assets.  Figures are in thousands.

 

		Sept. 30, 2003									Sept. 30, 2002
		Gross Amount			Accumulated Amortization			Net Carrying Amount			Gross Amount			Accumulated Amortization			Net Carrying Amount
Core Deposit Intangible		$	8,869		$	(2,171	)	$	6,698		$	8,869		$	(1,100	)	$	7,769
Originated Mortgage Servicing Rights		3,425			(1,354		)	2,071			1,633			(596		)	1,037
Total Other Intangible Assets		$	12,294		$	(3,525	)	$	8,769		$	10,502		$	(1,696	)	$	8,806

 

		Dec. 31, 2002
		Gross Amount			Accumulated Amortization			Net Carrying Amount
Core Deposit Intangible		$	8,869		$	(1,368	)	$	7,501
Originated Mortgage Servicing Rights		2,063			(748		)	1,315
Total Other Intangible Assets		$	10,932		$	(2,116	)	$	8,816

 

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Aggregate Amortization Expense of Other Intangible Assets ($ in 000’s):

 

		Three Month Period Ended Sept. 30,						Nine Month Period Ended Sept. 30,
		2003			2002			2003			2002
Amortization of Core Deposit Intangible		$	268		$	268		$	804		$	804
Amortization of Originated Mortgage Servicing Rights		317			77			606			156
Total aggregate amortization expense		$	585		$	345		$	1,410		$	960

 

The projected  amortization  expense  for  intangible  assets,  including the acquisition highlighted in Note F below, is approximately $2.2 million per year over the next five years.  These charges are included in other operating expense on the Consolidated Statements of Income.

 

NOTE E – STOCK OPTIONS

 

At September 30, 2003, the Company had one stock option plan which is described more fully in Note 15 in the Company’s 2002 Annual Report on form 10-K.  The Company accounts for stock options using the intrinsic value method under the provisions of Accounting Principles Board (“APB”) Opinion No. 25 and provides proforma net income and proforma earnings per share disclosures for employee stock option grants as if the fair-value-based method, defined in SFAS No. 123, “Accounting for Stock-Based Compensation,” had been applied.  Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company’s net income would have been reduced to the pro forma amounts indicated below for the three and nine month periods ended September 30:

 

(dollars in 000’s except per share amounts)		Three Month Period Ended Sept. 30,						Nine Month Period Ended Sept. 30,
		2003			2002			2003			2002
Net income, as reported		$	8,975		$	7,086		$	24,778		$	21,140
Deduct:  Total stock-based compensation expense determined under the fair value based method for all awards, net of related taxes		(395		)	(356		)	(1,186		)	(1,068		)
Proforma net income		$	8,580		$	6,730		$	23,592		$	20,072
Basic income per share, as reported		$	0.39		$	0.30		$	1.06		$	0.88
Proforma basic income per share		$	0.37		$	0.28		$	1.01		$	0.84
Diluted income per share, as reported		$	0.37		$	0.29		$	1.01		$	0.85
Proforma diluted income per share		$	0.35		$	0.27		$	0.96		$	0.81

 

NOTE F – SUBSEQUENT EVENT: MERGER OF MID-STATE BANCSHARES AND OJAI VALLEY BANK

 

On June 30, 2003, the Company signed a definitive agreement (“the Agreement”) to acquire Ojai Valley Bank through merger, subject to the approval of banking regulators and shareholders of Ojai Valley Bank.  The Agreement provided Ojai Valley Bank shareholders with an election to choose Mid-State Bancshares common

 

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stock, cash, or a combination of Mid-State Bancshares common stock and cash that was subject to potential adjustments.  Adjustments were then made based on changes in the price of Mid-State Bancshares stock preceding the effective date of the transaction and the necessary pro ration of the stock selections made by Ojai Valley Bank shareholders.  Half of the consideration provided was in the form of Mid-State Bancshares stock with the balance being in cash.  The transaction closed on October 31, 2003 and is expected to be accretive to earnings in the year 2004.  The total consideration was valued at approximately $23.7 million.  The merger was structured to be tax-free for the stock portion of the consideration.

 

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

 

Selected Financial Data - Summary.    The following table provides certain selected consolidated financial data as of and for the three and nine month periods ended September 30, 2003 and 2002 (unaudited).

 

Consolidated Financial Data  -  Mid-State Bancshares

 

		Quarter Ended						Year-to-Date
(Unaudited in thousands, except per share data)		Sept. 30, 2003			Sept. 30, 2002			Sept. 30, 2003			Sept. 30, 2002
Interest Income (not taxable equivalent)		$	26,643		$	27,164		$	78,715		$	82,225
Interest Expense		2,157			4,021			7,559			12,978
Net Interest Income		24,486			23,143			71,156			69,247
Provision for Loan Losses		—			—			260			600
Net Interest Income after provision for loan losses		24,486			23,143			70,896			68,647
Non-interest income		7,838			5,794			22,236			17,522
Non-interest expense		18,589			17,886			54,990			53,104
Income before income taxes		13,735			11,051			38,142			33,065
Provision for income taxes		4,760			3,965			13,364			11,925
Net Income		$	8,975		$	7,086		$	24,778		$	21,140
Per share:
Net Income - basic		$	0.39		$	0.30		$	1.06		$	0.88
Net Income - diluted		$	0.37		$	0.29		$	1.01		$	0.85
Weighted avg. shares used in Basic E.P.S. calculation		23,287			23,924			23,441			24,026
Weighted avg. shares used in Diluted E.P.S. calculation		24,350			24,815			24,487			24,860
Cash dividends		$	0.13		$	0.10		$	0.37		$	0.30
Book value at period-end								$	11.25		$	10.57
Tangible book value at period end								$	9.43		$	8.79
Ending Shares								23,191			23,839
Financial Ratios
Return on assets		1.72		%	1.47		%	1.65		%	1.51		%
Return on tangible assets		1.76		%	1.50		%	1.69		%	1.54		%
Return on equity		13.61		%	11.31		%	12.77		%	11.69		%
Return on tangible equity		16.22		%	13.63		%	15.25		%	14.18		%
Net interest margin (not taxable equivalent)		5.14		%	5.28		%	5.23		%	5.43		%
Net interest margin (taxable equivalent yield)		5.53		%	5.61		%	5.63		%	5.74		%
Net loan losses to avg. loans		0.38		%	0.62		%	0.09		%	0.25		%
Efficiency ratio		57.5		%	62.3		%	58.9		%	61.4		%
Period Averages
Total Assets		$	2,069,078		$	1,914,466		$	2,002,806		$	1,877,434
Total Tangible Assets		2,026,932			1,872,173			1,960,666			1,834,976
Total Loans (includes loans held for sale)		1,140,493			1,081,936			1,129,684			1,112,715
Total Earning Assets		1,889,499			1,739,554			1,818,879			1,705,685
Total Deposits		1,787,933			1,641,953			1,724,251			1,610,677
Common Equity		261,692			248,608			259,408			241,725
Common Tangible Equity		219,546			206,315			217,268			199,267

 

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(Unaudited in thousands)		Sept. 30, 2003			Sept. 30, 2002
Balance Sheet - At Period-End
Cash and due from banks		$	109,469		$	110,454
Investments and Fed Funds Sold		767,741			637,124
Loans held for sale		42,075			3,760
Loans, net of deferred fees, before allowance for loan losses		1,091,113			1,106,184
Allowance for Loan Losses		(16,871		)	(17,465		)
Goodwill and other intangibles		42,217			42,254
Other assets		50,405			45,711
Total Assets		$	2,086,149		$	1,928,022
Non-interest bearing deposits		$	436,565		$	391,350
Interest bearing deposits		1,358,227			1,247,987
Other borrowings		7,907			11,573
Allowance for losses - unfunded commitments		1,862			1,687
Other liabilities		20,767			23,515
Shareholders’ equity		260,821			251,910
Total Liabilities and Shareholders’ equity		$	2,086,149		$	1,928,022
Asset Quality & Capital - At Period-End
Non-accrual loans		$	12,562		$	10,729
Loans past due 90 days or more		—			4
Other real estate owned		3,279			—
Total non-performing assets		$	15,841		$	10,733
Allowance for losses to loans, gross (1)		1.7		%	1.7		%
Non-accrual loans to total loans, gross		1.2		%	1.0		%
Non-performing assets to total assets		0.8		%	0.6		%
Allowance for losses to non performing loans (1)		149.1		%	178.4		%
Equity to average assets (leverage ratio)		10.2		%	10.5		%
Tier One capital to risk-adjusted assets		14.7		%	14.5		%
Total capital to risk-adjusted assets		16.0		%	15.7		%

 

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

 

 

Performance Summary.  The Company posted net income of $9.0 million for the three months ended September 30, 2003 compared to $7.1 million in the like 2002 period.  These earnings represent an annualized return on assets of 1.72% and 1.47%, respectively.  The annualized return on equity was 13.61% for the third quarter of 2003 compared to 11.31% in the third quarter of 2002.  On a per share basis, diluted earnings per share were $0.37 in the 2003 period compared to $0.29 in the like quarter of 2002.

 

For the nine months year-to-date, the Company posted net income of $24.8 million compared to $21.1 million earned in the like 2002 period.  Diluted earnings per share were $1.01 in the first nine months of 2003 compared to $0.85 in the like period one year earlier.  These earnings represent an annualized return on assets of 1.65% and 1.51%, respectively, for the comparable 2003 and 2002 periods.  The annualized return on equity was 12.77% for the first nine months of 2003 compared to 11.69% in the first nine months of 2002.

 

Both the three month and nine month results benefited from increases in its mortgage banking operation compared to the results in 2002.  The decline in interest rates helped to increase the volume of loans originated and corresponding fees earned from the sale of those loans into the secondary market.  Additionally, the Company began selling late in 2002 those mortgage loans for forward delivery on longer terms (up to 90 days), thereby

 

13

 

earning interest on those assets for a longer period of time than what it had done historically.  These two factors, coupled with normal growth of the balance sheet, explain the majority of the increase in the Company’s 2003 earnings for both the quarter and year-to-date compared to 2002.

 

Net Interest Income.  The following table delineates the impacts of changes in the volume of earning assets, changes in the volume of interest bearing liabilities, and changes in interest rates on net interest income for the three month period ended September 30, 2003 and 2002.

 

 

		3 Months Ended Sept. 30, 2003								3 Months Ended Sept. 30, 2002								2003 Compared to 2002 Composition of Change
					Interest Income / Expense			Average Yield / Rate					Interest Income / Expense			Average Yield / Rate
		Average Balance								Average Balance								Change Due To:						Total Change
Dollars in 000’s																		Volume			Rate
EARNING ASSETS:
Loans		$	1,140,493		$	20,574		7.16	%	$	1,081,936		$	20,771		7.62	%	$	1,090		$	(1,287	)	$	(197	)
Investment Securities		626,614			5,806			3.68	%	573,403			6,050			4.19	%	527			(771		)	(244		)
Fed Funds, Other		122,392			263			0.85	%	84,215			343			1.62	%	119			(199		)	(80		)
TOTAL EARNING ASSETS		1,889,499			26,643			5.59	%	1,739,554			27,164			6.20	%	1,736			(2,257		)	(521		)
INTEREST BEARING LIABILITIES:
NOW, Savings, and Money Market Accounts		951,724			497			0.21	%	840,885			1,364			0.64	%	119			(986		)	(867		)
Time Deposits		396,014			1,619			1.62	%	410,557			2,601			2.51	%	(76		)	(906		)	(982		)
Interest Bearing Deposits		1,347,738			2,116			0.62	%	1,251,442			3,965			1.27	%	43			(1,892		)	(1,849		)
Other Borrowings		5,596			41			2.84	%	8,035			56			2.77	%	(16		)	1			(15		)
TOTAL INTEREST BEARING LIABILITIES		1,353,334			2,157			0.63	%	1,259,477			4,021			1.27	%	27			(1,891		)	(1,864		)
NET INTEREST INCOME		$	1,889,499		$	24,486		5.14	%	$	1,739,554		$	23,143		5.28	%	$	1,709		$	(366	)	$	1,343

 

Mid-State’s annualized yield on interest earning assets was 5.59% for the third quarter of 2003 (5.99% on a taxable equivalent basis) compared to 6.20% in the like 2002 period (6.52% on a taxable equivalent basis).  The decrease in yield is related to the general decline in interest rates.  The Prime Rate, to which many of the Bank’s loans are tied, averaged 4.00% in the third quarter of 2003 compared to 4.75% in the like period of 2002.  Annualized interest expense also decreased from 1.27% in the three months ended September 2002 to 0.63% in the comparable 2003 period.  This too reflected the general decline in interest rates.

 

Overall, Mid-State’s annualized Net Interest Income, expressed as a percent of earning assets, decreased from 5.28% for the third quarter of 2002 (5.61% on a taxable equivalent basis) to 5.14% in the comparable 2003 period (5.53% on a taxable equivalent basis).  Annualized Net Interest Income as a percent of average total assets declined from 4.80% in the third quarter of 2002 (5.08% taxable equivalent) to 4.70% in the comparable 2003 period (5.05% taxable equivalent).  In comparing the third quarter of 2003 to the third quarter of 2002, average earnings assets increased from $1,739.6 million one year ago to $1,889.5 million and average deposits increased from $1,251.4 million one year ago to $1,347.7 million.  The combination of the increase in earning assets and the impact of the decline in interest rates on deposits offset the negative impact of the decline in interest rates on interest income and allowed the Company to show a modest increase in net interest income of $1.3 million over the comparable quarters.

 

The following table presents a similar analysis of changes in interest income and expense for the nine month period ended September 30, 2003 and 2002.

 

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		9 months ended Sept. 30, 2003								9 months ended Sept. 30 2002								2003 Compared to 2002 Composition of Change
					Interest Income / Expense			Average Yield / Rate					Interest Income / Expense			Average Yield / Rate
		Average Balance								Average Balance								Change Due To:						Total Change
Dollars in 000’s																		Volume			Rate
EARNING ASSETS:
Loans		$	1,129,684		$	60,461		7.16	%	$	1,112,715		$	64,307		7.73	%	$	626		$	(4,472	)	$	(3,846	)
Investment Securities		608,510			17,650			3.88	%	507,699			16,905			4.45	%	2,082			(1,337		)	745
Fed Funds, Other		80,685			604			1.00	%	85,271			1,013			1.59	%	(29		)	(380		)	(409		)
TOTAL EARNING ASSETS		1,818,879			78,715			5.79	%	1,705,685			82,225			6.45	%	2,679			(6,188		)	(3,510		)
INTEREST BEARING LIABILITIES:
NOW, Savings, and Money Market Accounts		915,261			1,997			0.29	%	813,211			3,867			0.64	%	235			(2,105		)	(1,870		)
Time Deposits		398,312			5,448			1.83	%	424,193			8,948			2.82	%	(298		)	(3,202		)	(3,500		)
Interest Bearing Deposits		1,313,573			7,445			0.76	%	1,237,404			12,815			1.38	%	(64		)	(5,306		)	(5,370		)
Other Borrowings		4,422			114			3.42	%	8,086			163			2.70	%	(55		)	6			(49		)
TOTAL INTEREST BEARING LIABILITIES		1,317,995			7,559			0.77	%	1,245,490			12,978			1.39	%	(118		)	(5,301		)	(5,419		)
NET INTEREST INCOME		$	1,818,878		$	71,156		5.23	%	$	1,705,685		$	69,247		5.43	%	$	2,797		$	(888	)	$	1,909

 

Mid-State’s year-to-date annualized yield on interest earning assets was 5.79% for the first nine months of 2003 (6.18% on a taxable equivalent basis) compared to 6.45% in the like 2002 period (6.76% on a taxable equivalent basis).  The decrease in yield is related to the general decline in interest rates.  The Prime Rate, to which many of the Bank’s loans are tied, averaged 4.16% in the first nine months of 2003 compared to 4.75% in the like period of 2002.  Annualized interest expense also decreased from 1.38% in the first nine months of 2002 to 0.76% in the comparable 2003 period.

 

Overall, Mid-State’s annualized Net Interest Income, expressed as a percent of earning assets, decreased from 5.43% for the first nine month period of 2002 (5.74% on a taxable equivalent basis) to 5.23% in the comparable 2003 period (5.63% on a taxable equivalent basis).  Annualized Net Interest Income as a percent of average total assets declined from 4.93% in the first nine months of 2002 (5.21% taxable equivalent) to 4.75% in the comparable 2003 period (5.11% taxable equivalent).  Average earnings assets for the nine months ended September 30, 2003 increased from the like 2002 period ($1,818.9 million compared to $1,705.7 million). The combination of the increase in earning assets and the impact of the decline in interest rates on deposits offset the negative impact of the decline in interest rates on interest income and allowed the Company to show a modest increase in net interest income of $1.9 million over the comparable nine month periods.

 

It should also be noted that for both the three month and nine month periods ended September 30, 2003, while there was growth in net interest income over 2002, the mix of earning assets had changed somewhat from the same periods of 2002.  Lower yielding investments and fed funds sold had a larger growth rate than loans across the comparable periods, thus also tending to reduce the net interest margins for the 2003 periods compared to the 2002 periods.

 

Provision and Allowance for Loan Losses.  Mid-State did not make a provision for loan losses in the third quarter of either 2003 and 2002.  During the nine months ended September 30, 2003 provision for loan losses totaled $260 thousand, declining from $600 thousand in the like 2002 period.

 

Management continues to believe that the allowances for loan losses and the allowance for losses - unfunded commitments, which collectively stand at 1.7% of total loans at September 30, 2003, are adequate to cover

 

15

 

inherent losses.  The $18.7 million total allowance for credit losses is approximately 149% of the level of non performing loans which stands at $12.6 million compared to $10.7 million one year earlier.  The level of non performing loans is centered in two lending relationships secured by real estate which total $10.1 million at September 30, 2003.  One year earlier, just one of those two relationships were on non accrual totaling $8.0 million.  The two troubled lending relationships described above had totaled $14.5 million at June 30, 2003.  During the third quarter, the Company incurred a partial charge-off totaling $1.1 million as it initiated foreclosure on the property securing one of these loans and the remaining balance of $3.3 million on that loan was transferred to Other Real Estate Owned.  In this way, the non performing loans represented by these two lending relationships was reduced to $10.1 million from the $14.5 million level of June 30, 2003, although the Bank’s overall exposure only decreased by the $1.1 million charge-off.  Management believes that the Other Real Estate Owned now held on the balance sheet is appropriately stated given its fair value and allowing for costs of sale.

 

Management has determined that its reserve requirement allocated to its troubled loans, and held in the general loan loss reserve, are sufficient to offset potential losses, if any, arising from less than full recovery of the loans from the supporting collateral.  Non performing loans consist of loans on non-accrual and accruing loans 90 days or more past due.  While continuing efforts are made to improve overall asset quality, Management is unable to estimate with certainty, how and under what terms, problem assets will be resolved.

 

Changes in the allowance for loan losses (in thousands) for the periods ended September 30, 2003 and 2002 are as follows:

 

		Three Months Ended Sept. 30,						Nine Months Ended Sept. 30,
		2003			2002			2003			2002
Balance at beginning of period:
Allowance for loan losses		$	17,963		$	19,160		$	17,370		$	19,073
Allowance for losses-unfunded commitments		1,812			1,687			1,771			1,586
Total allowances for losses at beginning of period		19,775			20,847			19,141			$	20,659
Additions to the allowances charged to expense		50			—			91			—
Additions to the allowances charged to provision		—			—			260			600
Loans charged off		(1,404		)	(1,882		)	(1,645		)	(2,669		)
Recoveries of loans previously charged-off		312			187			886			562
Total allowances for losses at end of period		$	18,733		$	19,152		$	18,733		$	19,152
Allowance for loan losses		$	16,871		$	17,465		$	16,871		$	17,465
Allowance for losses-unfunded commitments		1,862			1,687			1,862			1,687
Total allowance for credit losses		$	18,733		$	19,152		$	18,733		$	19,152

 

At September 30, 2003, the recorded investments in loans, which have been identified as impaired loans, totaled $23,219,000.   Of this amount, $12,893,000 related to loans with no valuation allowance and $10,326,000 related to loans with a corresponding valuation allowance of $2,217,000.  Impaired loans totaled $11,843,000 at September 30, 2002.  Of that amount, $9,814,000 related to loans with no valuation allowance and $2,029,000 related to loans with a corresponding valuation allowance of $431,000.  The valuation allowance for impaired loans is included within the general allowance shown above and netted against loans on the consolidated statements of financial position.  For the quarter ended September, 2003, the average recorded investment in impaired loans was $19,131,000 compared to $12,959,000 in the 2002 period.  A loan is identified as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.

 

16

 

Non-interest Income.  Non-interest income for the first nine months of 2003 was $22.2 million, up from $17.5 million earned in the 2002 period, an increase of 26.9%.  An increase in the Company’s gain on sale of loans of $2.6 million accounted for the largest portion of the increase, reflecting an increase in the volume of loans originated in response to an increase in refinance activity in its mortgage banking operation.  Other commissions, fees and service charges increased by $1.0 million which was primarily the result of increases in ATM and Debit card fees collected along with increases from trust department fee income and letters of credit commissions.  Other non-interest income increased $0.8 million reflecting a one-time gain on the sale of Bank property of $273 thousand and $470 thousand of on-going commissions on the sale of property formerly owned by Mid Coast Land Company.  Service charge income also increased $251 thousand across the comparable periods.

 

For the three months ended September 30, 2003, non-interest income rose $2.0 million from $5.8 million in the third quarter of 2002 to $7.8 million in the comparable 2003 period.  An increase in the Company’s gain on sale of loans of $0.8 million accounted for a portion of the increase, reflecting an increase in the volume of loans originated in response to an increase in refinance activity in its mortgage banking operation.  Other commissions, fees and service charges increased by $0.3 million, the result of increases in ATM and Debit card fees collected along with increases from trust department fee income and letters of credit commissions.  Other non-interest income increased $0.8 million reflecting a one-time gain on the sale of Bank property of $273 thousand and $280 thousand of on-going commissions on the sale of property formerly owned by Mid Coast Land Company.

 

It should be noted that the increase in the gain on sale of loans held for sale throughout 2003 is in large part a result of the increased loan demand for single family residential mortgages which the Company has originated and sold.  This activity represents predominantly refinance activity in the low interest rate environment prevalent in 2003.  If rates rise into 2004, this source of income may diminish in the coming quarters.

 

Non-interest Expense.  Non-interest expense for the first nine months of 2003 was $55.0 million.  This compares to $53.1 million in the comparable 2002 period, an increase of $1.9 million.  Increases in salaries and benefits accounted for $831 thousand of the increase (salary expense increased by $237 thousand while benefit costs, especially for health care, workers compensation premiums and incentive compensation, increased $594 thousand, a trend being experienced by most employers).  Occupancy costs increased $372 thousand reflecting normal operating expense increases.  All other operating expenses increased $684 thousand.  Included in other operating expenses were increases of $771 thousand in professional services, $545 thousand of amortization of originated mortgage servicing rights, $121 thousand of increases in general insurance costs and $91 thousand of provision for losses on unfunded commitments.  These increases were offset by a decrease in merchant service processing fees of $829 thousand.

 

In comparing the third quarter of 2003 with the third quarter of 2002, non-interest expense increased $703 thousand from $17.9 million to $18.6 million.  This increase was primarily the result of increases in salaries and benefits of $484 thousand.  Occupancy and furniture accounted for $144 thousand of the increase.  And all other categories of expense showed a net $75 thousand increase.

 

Efficiency Ratio.  The Company’s efficiency ratio (defined as the ratio of non-interest expense to the sum of net interest income plus non interest income) has improved in 2003 to the comparable 2002 periods.  For the three months ended September 30, 2003, the ratio was 57.5% compared to 61.8% in the year ago period.  Similarly, for the nine month period of 2003, the efficiency ratio was 58.9% compared to 61.2% in the like 2002 period.  The growth in non interest income and net interest income grew at a faster rate than did non interest expense in comparing the 2003 periods with 2002 thus creating the improvements in this ratio.

 

Provision for Income Taxes.  The year-to-date provision for income taxes was $13.4 million, which is up from the same period in 2002 when it was $11.9 million.  For the third quarter of 2003 the provision for income

 

17

 

taxes rose $795 thousand, up from $4.0 million in the 2002 period to $4.8 million.   The effective tax rate for the nine months year-to-date in 2003 was 35.0% compared to 35.9% in 2002.   While the normal combined federal and state statutory tax rate is 42% for Mid-State Bancshares, the tax exempt income generated by its municipal bond portfolio is the primary reason that the effective rate is lower.

 

Balance Sheet. Total assets of the Company were up 8.2% to $2.086 billion from $1.928 billion at September 30, 2002.  This growth was fueled by an increase in deposits of 9.5% to $1.795 billion, up from $1.639 billion one year earlier.  The growth in deposits was centered in core deposits.  While Time Deposits decreased to $392.4 million from one year earlier of $405.2 million, all other categories of Demand, NOW, Money Market and Savings increased to $1.402 billion from $1.234 billion one year earlier.  In an ongoing effort to improve earnings, the Company continues to focus its attention on attracting lower cost core deposits while trying to remain competitive in retaining Time Deposits.  Loan activity over the last year has been slow with the loan portfolio decreasing to $1.091 billion at September 30, 2003 from $1.106 billion one year earlier.  Consequently, the growth in deposits has funded a $130.6 million increase in Investments and Fed Funds Sold along with a $38.3 million increase in the total of Mortgage Loans Available for Sale.  Management expects to promote more heavily its consumer lending products over the next several quarters.  It is difficult to predict what impact this will have in increasing the size of the loan portfolio going forward.

 

Mid-State Bank & Trust’s loan to deposit ratio of 60.8% at September 30, 2003 is down from the 67.5% ratio one year earlier.  The decrease in the loan to deposit ratio is a reflection of the decline in loans coupled with an increase in deposits.  There is ample internal liquidity to fund increases in this ratio through liquidation of Mid-State’s investment portfolio which is categorized as available for sale.

 

Investment Securities and Fed Funds Sold.  Of the $767.7 million portfolio at September 30, 2003, 11% is invested in overnight fed funds sold, 9% is invested in U.S. Treasury securities, 33% is invested in U.S. Government agency obligations, 46% is invested in securities issued by states and political subdivisions and 1% is invested in mortgage-backed and other securities.  The mix of the portfolio is little changed from one year earlier when 50% of the portfolio was invested in securities issued by states and political sub-divisions and 46% was invested in Treasury and Agency securities.  Sixty-nine percent of all investment securities and fed funds sold combined mature within five years.  Approximately 21% of the total portfolio matures in less than one year.  The Bank’s investment in mortgage-backed securities consist of investments in FNMA and FHLMC pools which have contractual maturities of up to 17 years.  The actual time of repayment may be shorter due to prepayments made on the underlying collateral.

 

Capital Resources.   The Company has continued its stock repurchase program, repurchasing a total of 207,541 and 625,830 shares, respectively, for the three month and nine month periods ending September 30, 2003.  In the comparable 2002 period, the Company repurchased 215,120 shares in the third quarter and 315,058 for the 9 month period.  The average price paid per share under this program was $20.95 and $18.93 for the three month and 9 month periods in 2003, respectively.  For 2002, the average price paid was $17.38 in the third quarter and $17.67 for the 9 months year to date.  Management estimates that the effect of the stock repurchase program in 2003 has been to increase earnings per share by approximately one cent per share in the third quarter compared to what it would have been had no program been in place this year.  The Company has the ability to repurchase an additional 175,048 shares under its current stock repurchase program authorization.  In other matters concerning capital, the dividend declared during the third quarter of 2003 was increased to $0.13 per share up from $0.10 per share one year earlier.

 

Total stockholders’ equity increased from $251.9 million at September 30, 2002 to $260.8 million at September 30, 2003.  Changes in stockholders’ equity over this 12 month period includes activity outlined in the following table (dollars in 000’s):

 

18

 

		Common Stock & Surplus			Retained Earnings			Accumulated Other Comprehensive Income			Total
Ending Equity at Sept. 30, 2002		$	80,098		$	157,200		$	14,612		$	251,910
Net Income 3 Mos 2002 (Oct. - Dec.)					8,715						8,715
Common Stock Repurchased 3 Mos. 2002 (Oct. - Dec.)		(2,820		)							(2,820		)
Stock Options Exercised - 3 Mos. 2002 (Oct. - Dec.)		310									310
Regular Dividends 3 Mos. 2002 (Oct. - Dec.)					(2,606		)				(2,606		)
Chg. Accumulated Other Comprehensive Income (FAS 115)								(1,374		)	(1,374		)
Ending Equity at December 31, 2002		77,588			163,309			13,238			254,135
Net Income 9 Mos. Y-T-D 2003					24,778						24,778
Common Stock Repurchased 9 Mos. Y-T-D 2003		(11,850		)							(11,850		)
Stock Options Exercised 9 Mos Y-T-D 2003		1,686									1,686
Regular Dividends 9 Mos. 2003					(8,639		)				(8,639		)
Chg. Accumulated Other Comprehensive Income (FAS 115)								711			711
Ending Equity at Sept. 30, 2003		$	67,424		$	179,448		$	13,949		$	260,821

 

Liquidity.  The Company maintains a certain amount of liquidity to ensure its ability to meet cash requirements.  Sources of liquidity include cash, due from bank balances (net of Federal Reserve requirements to maintain reserves against deposit liabilities), fed funds sold, investment securities (net of pledging requirements), loan repayments, deposits and fed funds borrowing lines.  Typical demands on liquidity are deposit run-off from demand deposits and savings accounts, maturing time deposits, which are not renewed, and anticipated funding under credit commitments to customers.

 

The Bank has adequate liquidity at the present time.  The loan to deposit ratio at September 30, 2003 was 60.8% versus 67.5% one year earlier.  The decrease in the loan to deposit ratio is a reflection of the decline in loans coupled with an increase in deposits.  The Bank normally strives for a loan to deposit ratio in the 65% to 75% range.  The Bank’s internally calculated liquidity ratio stands at 44.3% at September 30, 2003, which is above its minimum policy of 15% and above the 40.6% level of September 30, 2002.  Management is not aware of any future capital expenditures or other significant demands or commitments which would severely impair liquidity.

 

19

 

Off Balance Sheet Transactions.  The Company is contingently liable for letter of credit accommodations made to its customers in the ordinary course of business totaling $30.7 million at September 30, 2003, down from $35.7 million one year earlier.  Additionally, the Company has undisbursed loan commitments, also made in the ordinary course of business, totaling $478.1 million, which was down from the $556.5 million outstanding one year earlier.

 

There are no Special Purpose Entity (“SPE”) trusts, corporations, or other legal entities established by Mid-State 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.

 

Critical Accounting Policies and Estimates This “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as, disclosures included elsewhere in this Form 10-Q, are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements require Management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingencies.  A summary of the more significant accounting policies of the Company can be found in Footnote One to the financial statements which is included in Item 8 of the Company’s Annual Report on Form 10-K and in the Management’s Discussion and Analysis included in Item 7 of that same report entitled “Critical Accounting Policies and Estimates.”

 

Important Factors Relating to Forward-Looking Statements.  The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in such statements.  All of the statements contained in this Quarterly Report on Form 10-Q, including those in Items 2 and 3, which are not identified as historical should be considered forward-looking.  In connection with certain forward-looking statements contained in this Quarterly Report on Form 10-Q and those that may be made in the future by or on behalf of the Company which are identified as forward-looking, the Company notes that there are various factors that could cause actual results to differ materially from those set forth in any such forward-looking statements.  Such factors include, but are not limited to, the real estate market, the availability of loans at acceptable prices, the general level of economic activity both locally and nationally, interest rates, the actions by the Company’s regulatory agencies, actions by competitors of the Company, the ability of the company to assimilate Ojai Valley Bank into its operation and other factors referenced in the Company’s 10-K report for December 31, 2002 on file with the Securities and Exchange Commission, included in “Item 1. BUSINESS – Factors That May Affect Future Results of Operations.”  Accordingly, there can be no assurance that the forward-looking statements contained in this Quarterly Report on Form 10-Q will be realized or that actual results will not be significantly higher or lower.  The forward-looking statements have not been audited by, examined by or subjected to agreed-upon procedures by independent accountants, and no third-party has independently verified or reviewed such statements.  Readers of this Quarterly Report on Form 10-Q should consider these facts in evaluating the information contained herein.  The inclusion of the forward-looking statements contained in this Quarterly Report on Form 10-Q should not be regarded as a representation by the Company or any other person that the forward-looking statements contained in this Quarterly Report on Form 10-Q will be achieved.  In light of the foregoing, readers of this Quarterly Report on Form 10-Q are cautioned not to place undue reliance on the forward-looking statements contained herein.  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.

 

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Item 3 - Quantitative and Qualitative Disclosure About Market Risk

 

The Bank expects its risk exposure to changes in interest rates to remain manageable and well within acceptable policy ranges.  A recent review as of August 31, 2003 of the potential changes in the Bank’s net interest income over a 12 month time horizon showed that it could fluctuate under extreme alternative rate scenarios from between +4.7% and —10.0% of the base case (rates unchanged) of $96.0 million.  The Bank’s policy is to maintain a structure of assets and liabilities which are such that net interest income will not vary more than plus or minus 15% of the base forecast over the next 12 months.  Management expects that its exposure to interest rate risk is manageable and it will continue to strive for an optimal trade-off between risk and earnings.

 

The following table presents a summary of the Bank’s net interest income forecasted for the coming 12 months under alternative interest rate scenarios.

 

 

Net interest income under the above scenarios is influenced by the characteristics of the Bank’s assets and liabilities.  In the case of N.O.W., savings and money market deposits (total $965.8 million) interest is based on rates set at the discretion of management ranging from 0.05% to 0.75%.  In a downward rate environment, there is a limit to how far these deposit instruments can be re-priced and this behavior is similar to that of fixed rate instruments.  In an upward rate environment, the magnitude and timing of changes in rates on these deposits is assumed to be more reflective of variable rate instruments.

 

It is important to note that the above table is a summary of several forecasts and actual results may vary.  The forecasts are based on estimates and assumptions of management that may turn out to be different and may change over time.  Factors affecting these estimates and assumptions include, but are not limited to - competitors’ behavior, economic conditions both locally and nationally, actions taken by the Federal Reserve Board, customer behavior, and management’s responses.  Changes that vary significantly from the assumptions and estimates may have significant effects on the Bank’s net interest income.  Therefore the results of this analysis should not be relied upon as indicative of actual future results.  Historically, the Bank has been able to manage its Net Interest Income in a fairly narrow range reflecting the Bank’s relative insensitivity to interest rate changes.  The impact of prepayment behavior on mortgages, real estate loans, mortgage backed securities, securities with call features, etc. is not considered material to the sensitivity analysis.  Over the last 5 calendar years (1998 – 2002), the Bank’s net interest margin (which is net interest income divided by average earning assets of the Bank) had ranged from a low of 5.41% to a high of 6.44% (not taxable equivalent).  The Bank’s net interest margin in 2002 of 5.41% was at the low end of this range by historical standards, coming off the higher levels experienced in 2000 of 6.44%.

 

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In the third quarter of 2003, the net interest margin fell further to 5.14%.  This is a result of both the lower level of interest rates and the change in mix of earning assets (the Bank now has a smaller portion in loans vis-à-vis investment securities compared to 2000 when the margin was at its widest level).  The net interest margin under the forecasted alternative scenarios ranges from 4.44% to 5.17%.  Management feels this range of scenarios, while lower than historical standards, is consistent with current experience and interest rate levels, but no assurances can be given that actual future experience will fall within this range.

 

The Bank’s exposure with respect to interest rate derivatives, exchange rate fluctuations, and/or commodity price movements is nil.  The Bank does not own any instruments within these markets.

 

Item 4 – Controls and Procedures

 

As of the end of the period covered by this report, Management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures with respect to the information generated for use in this Quarterly Report.  The evaluation was based in part upon reports and affidavits provided by a number of executives.  Based upon, and as of the date of that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective to provide reasonable assurances that information required to be disclosed in the reports the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within time periods specified in the SEC’s rules and forms.

 

There was no change in the Company’s internal controls over financial reporting during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

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

 

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PART II - OTHER INFORMATION

 

Item 1 - Legal Proceedings

 

Mid-State is not a party to any material legal proceeding.

 

Item 2 - Changes in Securities and Use of Proceeds

 

There were no material changes in securities and uses of proceeds during the period covered by this report.

 

Item 3 - Defaults Upon Senior Securities

 

Not applicable.

 

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

 

Not applicable.

 

Item 5 - Other Information

 

Not applicable.

 

Item 6 - Exhibits and Reports on Form 8-K

 

A)           Exhibits

 

Exhibit No.		Exhibit
31.1		Rule 13a-14(a) Certification
31.2		Rule 13a-14(a) Certification
32		Section 1350 Certifications

 

B)            Reports on Form 8-K

 

On July 2, 2003, the Company filed a report under Item 5 of Form 8-K.  That report disclosed that on June 30, 2003, the Company entered into an Agreement to Merge and Plan of Reorganization with Ojai Valley Bank pursuant to which Ojai will merge with and into Mid-State Bank & Trust.  A full copy of the Agreement to Merge and Plan of Reorganization and the June 30 Press Release was attached thereto and made a part thereof.

 

On September 24, 2003, the Company filed a report under Item 5 of Form 8-K.  That report disclosed that on September 17, 2003, at its regular meeting of the Board of Directors of Mid-State Bancshares, the Board declared a thirteen cents per share quarterly cash dividend for all shareholders of record on September 30, 2003, payable on October 15, 2003.  A full copy of the Press Release dated September 19, 2003 was attached thereto and made a part thereof.

 

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SIGNATURES

 

Pursuant to the requirement of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	Mid-State Bancshares
	(registrant)
Date: November 10, 2003		By:	/s/ JAMES W. LOKEY
		JAMES W. LOKEY
		President Chief Executive Officer
Date: November 10, 2003		By:	/s/ JAMES G. STATHOS
		JAMES G. STATHOS
		Executive Vice President Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit No.		Description
31.1		Rule 13a-14(a) Certification
31.2		Rule 13a-14(a) Cerfitication
32		Section 1350 Certification

 

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