<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 8, 1998
REGISTRATION NO. 333-48181
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-4
AMENDMENT NO. 2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
BSM BANCORP
<TABLE>
<S> <C> <C>
CALIFORNIA 6712 77-0442667
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) Number)
</TABLE>
2739 SANTA MARIA WAY
SANTA MARIA, CALIFORNIA
(805) 937-8551
(Address, including zip code and telephone number,
including area code, of registrant's principal office)
WILLIAM A. HARES
PRESIDENT AND CHIEF EXECUTIVE OFFICER
2739 SANTA MARIA WAY
SANTA MARIA, CALIFORNIA, 93401
(805) 937-8551
(Name, address, including zip code, and telephone number
including area code, of agent for service)
------------------------
COPIES TO:
JOHN F. STUART, ESQ. LOREN P. HANSEN, ESQ.
Reitner & Stuart Knecht & Hansen
1730 K Street, N.W., Suite 1100 1301 Dove Street, Suite 900
Washington, D.C. 20006 Newport Beach, CA 92660
(202) 466-2818 (714) 851-8070
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
------------------------
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. / /
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED BE REGISTERED PER UNIT* OFFERING PRICE* REGISTRATION FEE
<S> <C> <C> <C> <C>
Common Stock, no par value........... 7,180,947 shares $27.25/$31.00 $195,718,300 $57,737
</TABLE>
* Estimated solely for the purposes of calculating the registration fee and
calculated pursuant to Rule 457(f) (1) and (i) as to the 7,170,947 shares
originally covered by the Registration Statement, based on the average of
the bid and asked price for Mid-State Bank's common stock on March 13, 1998
and (ii) as to the 10,000 additional shares added by Amendment No. 1, the
average of the bid and asked price for Mid-State Bank's common stock on
April 27, 1998.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
BSM BANCORP PROSPECTUS
CROSS-REFERENCE SHEET
PURSUANT TO ITEM 501(B) OF REGULATION S-K
<TABLE>
<CAPTION>
FORM S-4 ITEM
- ----------------------------------------------------------------
<C> <S> <C>
1. Forepart of Registration Statement and Outside Front
Cover page of Prospectus........................... OUTSIDE FRONT COVER PAGE; FACING PAGE
2. Inside Front and Outside Back Cover Pages of
Prospectus......................................... AVAILABLE INFORMATION; TABLE OF CONTENTS
3. Risk Factors, Ratio of Earnings to Fixed Charges and
Other Information.................................. RISK FACTORS
4. Terms of the Transactions............................ SUMMARY; THE MERGER; DESCRIPTION OF MID-STATE AND
BANCORP STOCK
5. Pro Forma Financial Information...................... UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
6. Material Contracts with the Company Being Acquired... THE MERGER
7. Additional Information Required for Reoffering by
Persons and Parties Deemed to be Underwriters...... *
8. Interests of Named Experts and Counsel............... LEGAL MATTERS; EXPERTS
9. Disclosure of Commission Position on Indemnification
for Securities Act Liabilities..................... *
10. Information with Respect to S-3 Registrants.......... *
11. Incorporation of Certain Information by Reference.... *
12. Information with Respect to S-2 or S-3 Registrants... INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE;
SUMMARY; APPENDIX F
13. Incorporation of Certain Information by Reference.... INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
14. Information with Respect to Registrants Other Than
S-3 or S-2 Registrants............................. *
15. Information with Respect to S-3 Companies............ *
16. Information with Respect to S-2 or S-3 Companies..... INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE;
SUMMARY; APPENDIX E
17. Information with Respect to Companies Other Than S-2
or S-3 Companies................................... *
18. Information if Proxies, Consents or Authorizations
are to be Solicited................................ SUMMARY; THE MID-STATE MEETING; THE BANCORP MEETING;
INFORMATION CONCERNING MID-STATE MEETING ONLY;
INFORMATION CONCERNING BANCORP MEETING ONLY
19. Information if Proxies, Consents or Authorizations
are not to be Solicited, or in an Exchange Offer... *
</TABLE>
- ------------------------
* Not applicable
<PAGE>
[Mid-State Bank Letterhead]
Dear Shareholder:
You are cordially invited to attend the 1998 Annual Meeting of the
Shareholders of Mid-State Bank, a California corporation to be held on
Wednesday, June 17, 1998, at 7:30 PM at the Administrative Headquarters
Building, 991 Bennett Street, Arroyo Grande, California.
At this meeting you will be asked to consider and vote upon a proposal to
approve the principal terms of the amended Agreement to Merge and Plan of
Reorganization dated January 29, 1998 and amended on March 27, 1998 ("the
Agreement") by and among Mid-State Bank, BSM Bancorp, and Bank of Santa Maria
pursuant to which (i) Bank of Santa Maria will merge with and into Mid-State
Bank, with Mid-State Bank continuing as the surviving bank, (ii) BSM Bancorp
will become the bank holding company for Mid-State Bank and change its name to
Mid-State Bancshares and (iii) the shareholders of Mid-State Bank will become
shareholders of the new Mid-State Bancshares in accordance with the exchange
ratio set forth in the Agreement.
Based on the number of shares of BSM Bancorp common stock outstanding as of
the record date for the BSM Bancorp annual meeting, the shares of Mid-State
Bancshares to be issued to Mid-State Bank shareholders pursuant to the agreement
will represent approximately 70% of the shares of Mid-State Bancshares Common
Stock outstanding following the Merger. The enclosed Joint Proxy Statement/
Prospectus more fully describes the proposed merger and related transactions,
including information about the involved entities.
At the annual meeting, the shareholders of Mid-State Bank will be asked to
consider and vote upon the election as directors of the seven (7) individuals
nominated by the Board of Directors as more fully set out herein.
More detailed information about the nominees, specified proposals, and other
matters regarding the Annual Meeting is included in the attached Joint Proxy
Statement/Prospectus.
The Board of Directors of Mid-State Bank has carefully considered the terms
and conditions of the Agreement and the proposed merger with Bank of Santa
Maria. THE BOARD OF DIRECTORS OF MID-STATE BANK HAS CONCLUDED THAT THE MERGER IS
IN THE BEST INTEREST OF MID-STATE AND HOLDERS OF MID-STATE BANK COMMON STOCK,
AND UNANIMOUSLY RECOMMENDS THAT MID-STATE SHAREHOLDERS VOTE "FOR" THE APPROVAL
OF THE PRINCIPAL TERMS OF THE MERGER. Hoefer & Arnett, Mid-State's financial
advisor, has delivered to the Board of Directors its opinion that the terms of
the exchange ratio are fair, from a financial point of view, to Mid-State's
shareholders. A copy of this opinion is attached as Exhibit B to the Joint Proxy
Statement/Prospectus.
It is important that your shares be represented and voted at the Annual
Meeting, regardless of the number of shares you own and whether or not you plan
to attend the Annual Meeting. The affirmative vote of the holders of a majority
of Mid-State's common stock entitled to vote at the Annual Meeting is required
for approval of the principal terms of the Merger. Your failure to vote for
approval of the principal terms of the Merger has the same effect as a vote
against the Merger. Therefore, we urge you to sign, date and mail the enclosed
proxy. If you decide to attend the Annual Meeting and wish to vote in person,
you may withdraw your proxy at that time.
We hope that the Joint Proxy Statement/Prospectus will answer any questions
you may have concerning the Merger and the other items. If you have any further
questions please telephone shareholder relations at Mid-State at (805) 473-6829.
YOU SHOULD NOT SEND IN YOUR CERTIFICATES FOR MID-STATE BANK STOCK AT THIS TIME.
YOU WILL RECEIVE INSTRUCTIONS AT A LATER DATE REGARDING THE
<PAGE>
EXCHANGE OF YOUR STOCK CERTIFICATES REPRESENTING SHARES OF MID-STATE BANCSHARES
STOCK.
Sincerely,
Gracia B. Bello
Clifford H. Clark
Daryl L. Flood
Raymond E. Jones
Albert L. Maguire
Gregory B. Morris
Carrol R. Pruett
<PAGE>
[Bancorp shareholder letter]
May , 1998
To Our Shareholders:
You are cordially invited to attend the 1998 Annual Meeting (the "Bancorp
Annual Meeting") of Shareholders of BSM Bancorp, a California corporation
("Bancorp"), to be held on Thursday, June 18, 1998 at 7:00 p.m. at which you
will be asked to consider and vote on a proposal to approve the principal terms
of the amended Agreement to Merge and Plan of Reorganization dated as of January
29, 1998 and amended on March 27, 1998 (the "Agreement") by and among the
Bancorp, Bank of Santa Maria (the "Bank") and Mid-State Bank ("Mid-State")
pursuant to which (i) the Bank will merge with and into Mid-State and Mid-State
will continue as the surviving bank, (ii) the Bancorp will become the bank
holding company for Mid-State and change its name to "Mid-State Bancshares" and
(iii) the shareholders of Mid-State will become shareholders of the Bancorp in
accordance with the exchange ratio set forth in the Agreement (the "Merger").
Based on the number of shares of Bancorp Common Stock outstanding as of the
record date for the Bancorp Annual Meeting, the shares of Bancorp Common Stock
to be issued to Mid-State shareholders pursuant to the Agreement will represent
approximately 70% of the shares of Bancorp Common Stock outstanding following
the Merger. The enclosed Joint Proxy Statement/Prospectus more fully describes
the proposed merger and related transactions, including information about the
Bancorp, the Bank and Mid-State.
Banking has changed dramatically over the past 20 years since we first
started the Bank. In order to take full advantage of the changes in the banking
environment the Bank and the Bancorp must continue to evolve and grow. We
believe that the Merger with Mid-State will give us a broader range of options
with respect to access to additional capital, possibilities for expansion of the
branch system and expanded abilities in the financial services area, as well as
other business activities.
At the Bancorp Annual Meeting, the shareholders of the Bancorp will also be
asked to consider and vote upon the election as directors the eleven (11)
individuals nominated by the Board of Directors as more fully set out herein. In
addition, the shareholders of the Bancorp will also be asked to consider and
vote upon proposed amendments to the Bancorp's 1996 Stock Option Plan in order
to accommodate certain terms and conditions as provided in the Agreement.
More detailed information about the nominees, specified proposals and other
matters regarding the Bancorp Annual Meeting is included in the attached Joint
Proxy Statement/Prospectus.
The Board of Directors of the Bancorp has carefully considered the terms and
conditions of the Agreement and the proposed Merger with Mid-State. THE BOARD OF
DIRECTORS OF THE BANCORP HAS CONCLUDED THAT THE MERGER IS IN THE BEST INTERESTS
OF THE BANCORP AND HOLDERS OF BANCORP COMMON STOCK (THE "BANCORP SHAREHOLDERS"),
AND UNANIMOUSLY RECOMMENDS THAT THE BANCORP SHAREHOLDERS VOTE "FOR" THE APPROVAL
OF THE PRINCIPAL TERMS OF THE MERGER. Carpenter & Company, the Bancorp's
financial advisor, has delivered to the Board of Directors of the Bancorp its
opinion, dated the date hereof, that the terms of the conversion of Mid-State
stock into Bancorp stock is fair, from a financial point of view, to the Bancorp
Shareholders. A copy of this opinion is attached as Appendix C to the Joint
Proxy Statement/Prospectus.
It is important that your shares be represented and voted at the Bancorp
Annual Meeting regardless of the number of shares you own and whether or not you
plan to attend the Bancorp Annual Meeting. The affirmative vote of the holders
of a majority of the Bancorp Common Stock entitled to vote at the Bancorp Annual
Meeting is required for approval of the principal terms of the Merger. Your
failure to vote for
<PAGE>
approval of the principal terms of the Merger has the same effect as a vote
against the Merger. Therefore, we urge you to sign, date and mail the enclosed
proxy. If you decide to attend the Bancorp Annual Meeting and wish to vote in
person, you may withdraw your proxy at that time.
We hope that the Joint Proxy Statement/Prospectus will answer any questions
you may have concerning the Merger and the other items. If you have any
questions concerning the Joint Proxy statement/ prospectus or the accompanying
proxy or if you need any help voting your shares, please telephone Mr. William
A. Hares or Mr. F. Dean Fletcher of the Bancorp at (805) 937-8551.
YOU SHOULD NOT SEND IN YOUR CERTIFICATES FOR BANCORP COMMON STOCK AT THIS
TIME. YOU WILL RECEIVE INSTRUCTIONS AT A LATER DATE REGARDING THE EXCHANGE OF
YOUR STOCK CERTIFICATES.
Your interest and participation are appreciated.
<TABLE>
<S> <C>
Sincerely,
William A. Hares A. J. Diani
President and Chief Executive Officer Chairman of the Board
Directors:
- ---------------------------- ----------------------------
Armand R. Acosta Toshiharu Nishino
- ---------------------------- ----------------------------
Richard E. Adam Joseph Sesto, Jr.
- ---------------------------- ----------------------------
Fred L. Crandall, Jr. William L. Snelling
- ---------------------------- ----------------------------
Roger A. Ikola Mitsuo Taniguchi
- ----------------------------
Joseph F. Ziemba
</TABLE>
<PAGE>
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
OF
MID-STATE BANK
TO BE HELD JUNE 17, 1998
TO THE SHAREHOLDERS OF MID-STATE BANK:
NOTICE IS HEREBY GIVEN that, pursuant to its Bylaws and the call of its
Board of Directors, the Annual Meeting of Shareholders of Mid-State Bank
("Mid-State") will be held on Wednesday, June 17, 1998, at 7:30 p.m. California
Time at the Administrative Headquarters Building, 991 Bennett Street, Arroyo
Grande, California, (the "Mid-State Meeting") for the following purposes, as set
forth in the attached Joint Proxy Statement/Prospectus:
1. To consider and vote upon a proposal to approve the principal terms of
the amended Agreement to Merge and Plan of Reorganization dated as of January
29, 1998 and amended on March 27, 1998, (the "Agreement") by and among
Mid-State, Bank of Santa Maria (the "Bank") and its parent holding company, BSM
Bancorp ("Bancorp") and the transactions contemplated thereby pursuant to which
(i) the Bank will merge with and into Mid-State and Mid-State will continue as
the surviving bank, (ii) Bancorp will become the bank holding company for
Mid-State and change its name to "Mid-State Bancshares" and (iii) the
shareholders of Mid-State will become shareholders of Bancorp in accordance with
the exchange ratio set forth in the Agreement (the "Merger"). A copy of the
Agreement is included in the Joint Proxy Statement/Prospectus as Appendix A.
2. To consider and vote upon a proposal to elect seven persons to the Board
of Directors of Mid-State to serve until the 1999 Annual Meeting and until their
successors are elected and have qualified. The following persons have been
nominated by Mid-State for election:
<TABLE>
<CAPTION>
<S> <C>
Gracia B. Bello Clifford H. Clark
Daryl L. Flood Raymond E. Jones
Albert L. Maguire Gregory R. Morris
Carrol R. Pruett
</TABLE>
3. To transact any other business which may properly come before the
Mid-State Meeting or any adjournments or postponements thereof.
Only those shareholders of record at the close of business on May 1, 1998
are entitled to notice of and to vote at the Mid-State Meeting or any
adjournments or postponements thereof (the "Mid-State Record Date"). The
affirmative vote of a majority of the outstanding shares of Mid-State's no par
value common stock ("Mid-State Stock") is required to approve the principal
terms of the Agreement and the transactions contemplated thereby.
Section 2.3 of the Mid-State bylaws provide for the nomination of directors
as follows:
"Nominations for election of members of the Board of Directors may be made
by the Board of Directors or by any shareholder of any outstanding class of
voting stock of the Corporation entitled to vote for the election of directors.
Notice of intention to make any nominations, other than by the Board of
Directors, shall be made in writing and shall be received by the president of
the Corporation no more than sixty (60) days prior to any meeting of
shareholders called for the election of directors, and no more than ten (10)
days after the date the notice of such meeting is sent to shareholders pursuant
to Section 2.2 (d) of these bylaws; provided, however, that if only ten (10)
days notice of the meeting is given to shareholders, such notice of intention to
nominate shall be received by the President of the Corporation not later than
the time fixed in the notice of the meeting for the opening of the meeting. Such
notification shall contain the following information to the extent known to the
notifying shareholder: (a) the name and address of
<PAGE>
each proposed nominee; (b) the principal occupation of each proposed nominee;
(c) the number of shares of voting stock of the Corporation owned by each
proposed nominee; (d) the name and residence address of the notifying
shareholder; and (e) the number of shares of voting stock of the Corporation
owned by the notifying shareholder. Nominations not made in accordance herewith
may be disregarded by the chairman of the meeting, and the inspectors of
election shall then disregard all votes cast for each such nominee.
The first paragraph of this Section 2.3 shall be set forth in any notice of
a shareholders' meeting, whether pursuant to Section 2.2 or Section 2.4 of these
Bylaws, at which meeting the election of directors is to be considered."
THE BOARD OF DIRECTORS OF MID-STATE HAS UNANIMOUSLY APPROVED THE AGREEMENT
AND THE TRANSACTIONS CONTEMPLATED BY THE AGREEMENT AND UNANIMOUSLY RECOMMENDS
THAT SHAREHOLDERS VOTE TO APPROVE THE AGREEMENT AND THE TRANSACTIONS
CONTEMPLATED THEREBY AT THE MID-STATE MEETING.
By order of the Board of Directors
Raymond E. Jones
SECRETARY
May , 1998
IT IS VERY IMPORTANT THAT EVERY SHAREHOLDER VOTE. WE URGE YOU TO SIGN AND RETURN
THE ENCLOSED PROXY CARD AS PROMPTLY AS POSSIBLE, WHETHER OR NOT YOU PLAN TO
ATTEND THE MID-STATE MEETING IN PERSON. IF YOU DO ATTEND THE MID-STATE MEETING,
YOU MAY WITHDRAW YOUR PROXY AND VOTE IN PERSON AT THAT TIME. YOU MAY REVOKE YOUR
PROXY AT ANY TIME PRIOR TO ITS EXERCISE.
PLEASE INDICATE ON THE PROXY CARD WHETHER OR NOT YOU EXPECT TO ATTEND THE
MEETING SO WE CAN PROVIDE ADEQUATE ACCOMMODATIONS.
<PAGE>
NOTICE OF ANNUAL MEETING
OF SHAREHOLDERS
TO BE HELD JUNE 18, 1998
NOTICE IS HEREBY GIVEN that, pursuant to its Bylaws and the call of its
Board of Directors, the 1998 Annual Meeting (the "Bancorp Meeting") of
Shareholders of BSM Bancorp, a California corporation (the "Bancorp"), has been
called by the Board of Directors of the Bancorp and will be held at the head
office of Bank of Santa Maria (the "Bank"), 2739 Santa Maria Way, Santa Maria,
California at 7:00 p.m., local time, on Thursday, June 18, 1998 for the
following purposes all as set forth in the attached Joint Proxy
Statement/Prospectus.
(1) APPROVAL OF MERGER AGREEMENT. To consider and vote upon the principal
terms of the amended Agreement to Merge and Plan of Reorganization dated as of
January 29, 1998 and amended on March 27, 1998, (the "Agreement") by and among
the Bancorp, the Bank and Mid-State Bank ("Mid-State") and the transactions
contemplated thereby pursuant to which (i) the Bank will merge with and into
Mid-State and Mid-State will continue as the surviving bank, (ii) the Bancorp
will become the bank holding company for Mid-State and change its name to
"Mid-State Bancshares" and (iii) the shareholders of Mid-State will become
shareholders of the Bancorp in accordance with the exchange ratio set forth in
the Agreement (the "Merger"). A copy of the agreement is included in the Proxy
Statement/Prospectus as Appendix A.
(2) ELECTION OF DIRECTORS. To elect eleven persons to the Board of Directors
to serve until the next Annual Meeting of Shareholders and until their
successors are elected and have qualified. The Board of Directors' nominees are
the following persons:
<TABLE>
<CAPTION>
<S> <C>
Armand R. Acosta* Toshiharu Nishino*
Richard E. Adam* Joseph Sesto, Jr.*
Fred L. Crandall, Jr.* William L. Snelling
A. J. Diani Mitsuo Taniguchi*
William A. Hares Joseph F. Ziemba*
Roger A. Ikola*
</TABLE>
- ------------------------
* In order to assist the Bancorp in complying with the Agreement which
provides, among other things, that the Board of Directors of Mid-State
immediately following the Merger shall consist of three members from the
Board of Directors of the Bancorp and seven (7) members from the Board of
Directors of Mid-State, Directors Armand R. Acosta, Richard E. Adam, Fred L.
Crandall, Jr, Roger A. Ikola, Toshiharu Nishino, Joseph Sesto, Jr., Mitsuo
Taniguchi and Joseph F. Ziemba have agreed to resign as directors of the
Bancorp and the Bank, effective upon the consummation of the Merger. In the
event that the Merger is not consummated, the aforementioned persons will
continue to serve as directors of the Bancorp and the Bank for the period
elected herein.
(3) PROPOSED AMENDMENTS TO 1996 STOCK OPTION PLAN. As required by the
Agreement, to approve proposed amendments to the Bancorp's 1996 Stock Option
Plan that would allow for the granting of substitute stock options to officers
and employees of the Bancorp and the Bank, and to certain directors of the
Bancorp and the Bank that still continue as directors of the Bancorp and
Mid-State, having the same terms and conditions as existing Bancorp options,
except that such substitute options would be completely vested, and such stock
options would not terminate as a result of the Merger, subject to all necessary
approvals of the California Department of Corporations and any other necessary
regulatory agency, as described in the Joint Proxy Statement/Prospectus.
(4) OTHER BUSINESS. To consider and act upon such other business as may
properly come before the Bancorp Meeting or any adjournment or postponement
thereof.
<PAGE>
The Bylaws of the Bancorp provide for the nomination of directors in the
following manner:
"Nominations for election of members of the board of directors may be made
by the board of directors or by any shareholder of any outstanding class of
capital stock of the corporation entitled to vote for the election of directors.
Notice of intention to make any nominations (other than for persons named in the
notice of the meeting at which such nomination is to be made) shall be made in
writing and shall be delivered or mailed to the president of the corporation by
the later of the close of business 21 days prior to any meeting of shareholders
called for the election of directors or 10 days after the date of mailing of
notice of the meeting to shareholders. Such notification shall contain the
following information to the extent known to the notifying shareholder: (a) the
name and address of each proposed nominee; (b) the principal occupation of each
proposed nominee; (c) the number of shares of capital stock of the corporation
owned by each proposed nominee; (d) the name and residence address of the
notifying shareholder; (e) the number of shares of capital stock of the
corporation owned by the notifying shareholder; (f) with the written consent of
the proposed nominee, a copy of which shall be furnished with the notification,
whether the proposed nominee has ever been convicted of or pleaded nolo
contendere to any criminal offense involving dishonesty or breach of trust,
filed a petition in bankruptcy, or been adjudged bankrupt. The notice shall be
signed by the nominating shareholder and by the nominee. Nominations not made in
accordance herewith shall be disregarded by the chairman of the meeting, and
upon his instructions, the inspectors of election shall disregard all votes cast
for each such nominee. The restrictions set forth in this paragraph shall not
apply to nomination of a person to replace a proposed nominee who has died or
otherwise become incapacitated to serve as a director between the last day for
giving notice hereunder and the date of election of directors if the procedure
called for in this paragraph was followed with respect to the nomination of the
proposed nominee."
The terms of the Agreement and the Bancorp Stock to be issued in connection
therewith are described in detail in the accompanying Joint Proxy
Statement/Prospectus. To ensure that your vote will be counted, please complete,
date and sign the enclosed proxy card and return it promptly in the enclosed
postage-paid envelope, whether or not you plan to attend the Bancorp Meeting.
You may revoke your proxy in the manner described in the accompanying Joint
Proxy Statement/Prospectus at any time before it is voted at the Bancorp
Meeting.
Only holders of Bancorp Stock of record at the close of business on May 1,
1998 (the "Bancorp Record Date"), will be entitled to notice of, and to vote at,
the Bancorp Annual Meeting or at any postponements or adjournments thereof. The
affirmative vote of a majority of the shares of Bancorp common stock ("Bancorp
Stock") outstanding as of the Bancorp Record Date is required to approve the
Agreement and the transaction contemplated thereby.
<PAGE>
Shareholders of the Bancorp may be entitled to exercise dissenters' rights
and to receive cash in an amount equal to the fair market value of their shares
of Bancorp Common Stock as of January 28, 1998 by complying with certain
procedures specified by California law. See "The Merger--Dissenters' Rights" in
the accompanying Joint Proxy Statement/Prospectus.
By Order of the Board of Directors,
[SIGNATURE]
William L. Snelling
SECRETARY
Santa Maria, California
May , 1998
YOUR VOTE IS VERY IMPORTANT. PLEASE MARK, SIGN, DATE AND RETURN YOUR PROXY
PROMPTLY, WHETHER OR NOT YOU PLAN TO ATTEND THE BANCORP MEETING. YOUR PROXY WILL
BE REVOCABLE, EITHER IN WRITING OR BY VOTING IN PERSON AT THE BANCORP MEETING,
AT ANY TIME PRIOR TO ITS EXERCISE, BY FOLLOWING THE PROCEDURES DESCRIBED IN THE
ACCOMPANYING JOINT PROXY STATEMENT/PROSPECTUS. YOU SHOULD NOT FORWARD STOCK
CERTIFICATES AT THIS TIME.
<PAGE>
MID-STATE BANK
AND
BSM BANCORP
JOINT PROXY STATEMENT
ANNUAL MEETINGS OF SHAREHOLDERS
BSM BANCORP
PROSPECTUS
This Joint Proxy Statement/Prospectus ("Joint Proxy Statement/Prospectus")
is being furnished to shareholders of Mid-State and Bancorp, in connection with
the solicitation of proxies by the respective Boards of Directors of such
corporations for use at the Mid-State Meeting (including any adjournments
thereof) and the Bancorp Meeting (including any adjournments thereof) to be held
on June 17, 1998 and June 18, 1998, respectively.
This Joint Proxy Statement/Prospectus relates to the proposed Merger of the
Bank with and into Mid-State and the other transactions contemplated by the
Agreement. At each Meeting, shareholders will consider and vote on a proposal to
approve the principal terms of the Agreement and the transactions contemplated
thereby. In addition, at both Meetings the respective corporations will each
elect directors for the upcoming year, subject to adjustment of the compositions
of such Boards of Directors pursuant to the Agreement when the Merger is
effected. Further, at the Bancorp Meeting, the Bancorp shareholders will also be
asked to approve proposed amendments to the Bancorp's 1996 Stock Option Plan to
accommodate the terms of the Agreement.
This Joint Proxy Statement/Prospectus also constitutes a prospectus of
Bancorp with respect to the shares of Bancorp Stock issuable to holders of
Mid-State Stock pursuant to the Merger.
This Joint Proxy Statement/Prospectus is dated May , 1998 and is first
being mailed to shareholders of Mid-State and Bancorp on or about May , 1998.
THE SECURITIES OFFERED HEREBY ARE SUBJECT TO INVESTMENT RISKS, INCLUDING
POSSIBLE LOSS OF THE PRINCIPAL INVESTED.
THE SECURITIES OFFERED HEREBY ARE NOT DEPOSITS AND ARE NOT INSURED BY THE
FEDERAL DEPOSIT INSURANCE CORPORATION.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
EXCHANGE COMMISSION ("SEC"), THE CALIFORNIA COMMISSIONER OF FINANCIAL
INSTITUTIONS ("COMMISSIONER"), THE FEDERAL DEPOSIT INSURANCE
CORPORATION ("FDIC") OR ANY STATE SECURITIES COMMISSIONER NOR
HAS THE SEC, THE COMMISSIONER, THE FDIC OR ANY STATE
COMMISSIONER PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS JOINT PROXY STATEMENT/
PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION............. 3
INCORPORATION OF CERTAIN DOCUMENTS
BY REFERENCE.................... 4
SUMMARY........................... 5
SELECTED CONSOLIDATED FINANCIAL
DATA............................ 15
Mid-State....................... 15
Bancorp......................... 16
SELECTED PRO FORMA COMBINED
FINANCIAL INFORMATION........... 17
RECENT DEVELOPMENTS............... 19
RISK FACTORS...................... 27
THE MID-STATE MEETING............. 29
THE BANCORP MEETING............... 31
THE MERGER........................ 33
Background and Reasons for the
Merger and Management's
Recommendation-- Mid-State.... 33
Background and Reasons for the
Merger and Management's
Recommendation-- Bancorp...... 35
Mid-State Fairness Opinion...... 40
Bancorp Fairness Opinion........ 44
Exchange Ratio.................. 48
Fractional Shares............... 50
Effective Time of Merger........ 51
Management and Operations of
Bancorp and Mid-State After
the Merger.................... 51
Amendment to Bylaws of
Mid-State..................... 51
Regulatory Approvals............ 52
Interests of Certain Persons in
the Merger.................... 52
Additional Agreements........... 53
Federal Income Tax
Consequences.................. 53
Exchange Procedures............. 54
Sales of Bancorp Stock.......... 55
Nasdaq Listing.................. 55
Accounting Treatment............ 55
Conditions to the Merger........ 55
Nonsolicitation................. 57
Expenses........................ 57
Treatment of Stock Options...... 58
Termination..................... 58
Covenants, Conduct of Business
Prior to Effective Time....... 59
Amendment and Waiver............ 60
Dissenting Shareholders'
Rights........................ 60
UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS............ 62
DESCRIPTION OF MID-STATE AND
BANCORP STOCK................... 68
INFORMATION CONCERNING MID-STATE
MEETING ONLY.................... 75
<CAPTION>
PAGE
----
<S> <C>
Election of Directors........... 75
The Board of Directors and
Committees.................... 76
Report of the Compensation
Committee..................... 77
Compensation Committee
Interlocks and Insider
Participation................. 77
Executive Compensation.......... 78
Stock Options................... 79
Profit Sharing/401(k) Plan...... 79
Deferred Compensation Plan...... 80
Change in Control Agreements.... 80
Other Compensation.............. 81
Compensation of Directors....... 81
Performance Graph............... 81
Certain Transactions............ 82
Compliance with Section 16(a) of
the Securities and Exchange
Act of 1934................... 82
Relationship with Independent
Public Accountants............ 82
Proposals of Shareholders....... 82
INFORMATION CONCERNING BANCORP
MEETING ONLY.................... 82
Election of Directors........... 82
The Board of Directors and
Committees.................... 83
Executive Officers.............. 84
Security Ownership of Certain
Beneficial Owners and
Management.................... 85
Director and Executive Officer
Compensation.................. 86
Stock Option Grants in 1997..... 88
Aggregated Option Exercises in
Last Fiscal Year and Fiscal
Year-end Option Values........ 88
Compensation for Non-Employee
Directors..................... 88
Contracts with Executive
Officers...................... 88
Compensation Committee
Interlocks and Insider
Participation................. 89
Compensation Committee Report... 89
Performance Graph............... 90
Certain Relationships and
Related Transactions.......... 90
Relationships with Independent
Public Accountants............ 90
Proposals of Shareholders....... 91
1996 Stock Option Plan and
Proposed Amendments........... 91
LEGAL MATTERS..................... 94
EXPERTS........................... 94
OTHER MATTERS..................... 94
</TABLE>
2
<PAGE>
APPENDICES
A. Agreement to Merge and Plan of Reorganization and First Amendment thereto
B. Hoefer & Arnett Fairness Opinion
C. Carpenter & Co. Fairness Opinion
D. Chapter 13 of the California General Corporation Law
E. Mid-State Bank Form 10-K/A for the year ended December 31, 1997
F. BSM Bancorp Form 10-KA for the year ended December 31, 1997
NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY REPRESENTATION
NOT CONTAINED IN THIS JOINT PROXY STATEMENT/PROSPECTUS. ANY INFORMATION OR
REPRESENTATION NOT CONTAINED HEREIN MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY MID-STATE OR BANCORP. THE DELIVERY OF THIS JOINT PROXY STATEMENT/
PROSPECTUS SHALL NOT, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE
HAS BEEN NO CHANGE IN THE AFFAIRS OF MID-STATE OR BANCORP SINCE THE DATE HEREOF
OR THAT THE INFORMATION IN THIS JOINT PROXY STATEMENT/ PROSPECTUS IS CORRECT AT
ANY TIME SUBSEQUENT TO THE DATE HEREOF.
AVAILABLE INFORMATION
Bancorp has been subject to the informational requirements of Section 15(d)
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in
accordance therewith, has filed reports and other information with the SEC. On
March 18, 1998, Bancorp filed a Form 8-A registering the shares of Bancorp Stock
pursuant to Section 12 of the Exchange Act. As a result of such registration,
Bancorp will file reports, proxy statements and other information with the SEC.
All of such reports, proxy statements and other information can be inspected and
copied at the public facilities maintained by the SEC at 450 Fifth Street, N.W.,
Room 1024, Washington D.C. 20549; 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511; and 7 World Trade Center, Suite 1300, New York, New York
10048. Copies of such material can be obtained from the Public Reference Section
of the SEC at 450 Fifth Street, N.W. Washington D.C. 20549, as prescribed rates.
The SEC maintains a website at http://www.sec.gov that also contains such
reports and other information concerning Bancorp which files information
electronically with the SEC.
This Joint Proxy Statement/Prospectus constitutes a part of a registration
statement on Form S-4 (together with all amendments and exhibits, the
"Registration Statement") filed by Bancorp with the SEC under the Securities Act
of 1933, as amended (the "Securities Act") with respect to the shares of Bancorp
Stock to be issued in the Merger. This Joint Proxy Statement/Prospectus does not
contain all of the information included in the Registration Statement, certain
parts of which are omitted in accordance with the rules and regulations of the
SEC. Statements contained herein concerning the provisions of any document do
not purport to be complete and, in each instance, are qualified in all respects
by reference to the copy of such document filed as an exhibit to the
Registration Statement or otherwise filed with the SEC. Each such statement is
subject to and qualified in its entirety by such reference. Reference is made to
such Registration Statement and to the exhibits relating thereto for further
information with respect to Bancorp and the securities offered hereby. Copies of
all or any part of the Registration Statement, including exhibits thereto, may
be obtained, upon payment of the prescribed fees, or inspected at the offices of
the SEC as set forth above.
Mid-State is subject to the informational requirements of the Exchange Act
and, in accordance therewith, files reports, proxy statements and other
information with the FDIC. Such reports, proxy statements and other information
can be inspected and copied at the public facilities maintained by the FDIC at
550 17th Street, N.W., Washington, D.C. 20429. Copies of such material can be
obtained from the Public Reference Section of the FDIC at 550 17th Street, N.W.,
Washington, D.C. 20429, at prescribed rates. Copies of such materials may also
be obtained by writing to the FDIC's Registration, Disclosure and
3
<PAGE>
Securities Operations Unit at 550 17th Street, N.W., Rm. F-6043, Washington,
D.C. 20429 or calling (202) 898-8913 or by FAX at (202) 898-3909. If the Merger
becomes effective, all the shares of Mid-State Stock will be owned by Bancorp
and, as a result, the Mid-State Stock will be de-registered under the Exchange
Act.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed with the FDIC by Mid-State are hereby
incorporated by reference in this Joint Proxy Statement/Prospectus and made a
part hereof: (1) Current Reports on Form 8-K, filed February 2 and 13, 1998; and
(2) Annual Report on Form 10-K for the fiscal year ended December 31, 1997.
The following documents filed with the SEC by Bancorp are hereby
incorporated by reference in this Joint Proxy Statement/Prospectus and made a
part hereof: (1) Current Reports on Form 8-K, filed March 25, 1997, January 16,
1998 and February 4, 1998; (2) Annual Report on Form 10-K for the fiscal year
ended December 31, 1997; and (3) Registration Statement on Form 8-A filed on
March 18, 1998.
THE FORM 10-K REPORTS OF MID-STATE AND BANCORP FOR THE YEAR ENDED DECEMBER
31, 1997 ARE ATTACHED TO THIS JOINT PROXY STATEMENT/PROSPECTUS AS APPENDICES E
AND F, RESPECTIVELY.
All documents filed by Mid-State or Bancorp pursuant to Section 13(a),
13(c), 14 or 15(d) of the Exchange Act after the date of this Joint Proxy
Statement/Prospectus and prior to the Meetings shall be deemed incorporated by
reference in this Joint Proxy Statement/Prospectus and a part hereof from the
date of filing of such documents. Any statement contained in a document
incorporated or deemed incorporated herein by reference will be deemed to be
modified or superseded for purpose of this Joint Proxy Statement/Prospectus to
the extent that a statement contained herein or in any other subsequently filed
document which also is, or is deemed to be, incorporated herein by reference,
modifies or supersedes such statement. Any such statement so modified or
superseded will not be deemed, except as so modified or superseded, to
constitute a part of this Joint Proxy Statement/Prospectus.
THIS JOINT PROXY STATEMENT/PROSPECTUS INCORPORATES CERTAIN DOCUMENTS BY
REFERENCE WHICH ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH. COPIES OF SUCH
DOCUMENTS (WHICH ARE NOT INCLUDED HEREIN) RELATING TO MID-STATE, OTHER THAN
CERTAIN EXHIBITS TO SUCH DOCUMENTS, ARE AVAILABLE, WITHOUT CHARGE UPON WRITTEN
OR ORAL REQUEST, FROM MR. JAMES STATHOS, EXECUTIVE VICE PRESIDENT, MID-STATE
BANK, 1026 GRAND AVE., ARROYO GRANDE, CALIFORNIA 93421, (805) 473-7700. COPIES
OF SUCH DOCUMENTS (WHICH ARE NOT INCLUDED HEREIN) RELATING TO BANCORP, OTHER
THAN CERTAIN EXHIBITS TO SUCH DOCUMENTS, ARE AVAILABLE, WITHOUT CHARGE UPON
WRITTEN OR ORAL REQUEST, FROM MR. F. DEAN FLETCHER, EXECUTIVE VICE PRESIDENT,
BSM BANCORP, 2739 SANTA MARIA WAY, SANTA MARIA, CALIFORNIA 93455, (805)
937-8551. IN ORDER TO ENSURE TIMELY DELIVERY OF THE DOCUMENTS, ANY REQUEST
SHOULD BE MADE BY MAY , 1998.
4
<PAGE>
SUMMARY
THE FOLLOWING SUMMARY IS NOT INTENDED TO BE COMPLETE AND IS QUALIFIED IN ALL
RESPECTS BY THE MORE DETAILED INFORMATION INCLUDED IN THIS JOINT PROXY
STATEMENT/PROSPECTUS AND THE APPENDICES HERETO. ALL INFORMATION CONCERNING
MID-STATE INCLUDED HEREIN HAS BEEN FURNISHED BY MID-STATE AND ALL INFORMATION
CONCERNING BANCORP AND THE BANK INCLUDED HEREIN HAS BEEN FURNISHED BY THEM.
NEITHER MID-STATE NOR BANCORP WARRANTS THE ACCURACY OR COMPLETENESS OF
INFORMATION RELATING TO THE OTHER PARTY.
MID-STATE, BANCORP AND THE BANK ARE REFERRED TO HEREIN JOINTLY AS THE
"PARTIES" AND EACH OF THEM A "PARTY." UNLESS THE CONTEXT REQUIRES OTHERWISE, THE
TERM "BANCORP" ALSO INCLUDES THE "BANK."
THE PARTIES
MID-STATE. Mid-State is a California state-chartered bank headquartered in
Arroyo Grande, California, which commenced operations on June 12, 1961. At
December 31, 1997, Mid-State had total consolidated assets of $842 million,
consolidated deposits of $757 million, and consolidated shareholders' equity of
$78 million. Mid-State, which currently operates 23 banking offices, has its
headquarters in the City of Arroyo Grande at 1026 Grand Avenue, Arroyo Grande,
California 93420. Its telephone number is (805) 473-7700.
BANCORP. Bancorp is a California corporation incorporated on November 12,
1996 and is registered as a bank holding company under the Bank Holding Company
Act of 1956, as amended. Bancorp operates the Bank which is its wholly-owned
subsidiary. At December 31, 1997, Bancorp had total consolidated assets of $344
million, consolidated deposits of $306 million, and consolidated shareholders'
equity of $36 million. Bancorp is headquartered in the City of Santa Maria at
2739 Santa Maria Way, Santa Maria, California 93455. Its telephone number is
(805) 937-8551.
BANK. The Bank is a California state-chartered bank headquartered in Santa
Maria, California, which commenced operations on March 18, 1978. The Bank, which
currently operates 13 banking offices, has its headquarters in the City of Santa
Maria at 2739 Santa Maria Way, Santa Maria, California 93455. Its telephone
number is (805) 937-8551.
ADDITIONAL INFORMATION. Certain additional information concerning Mid-State
as well as Bancorp and the Bank, their respective businesses, financial
statements, and discussions thereof may be found in the Form 10-K Reports of
Mid-State and Bancorp for the year ended December 31, 1997 which are attached to
this Joint Proxy Statement/Prospectus as Appendices E and F, respectively.
THE MEETINGS
MID-STATE. The Mid-State Meeting will be held on Wednesday, June 17, 1998
at 7:30 p.m. California time, at the Administrative Headquarters Building, 991
Bennett Street in Arroyo Grande, California. Mid-State shareholders will
consider and vote on (i) a proposal to approve the principal terms of the
Agreement and the transactions contemplated thereby and (ii) a proposal to elect
seven persons to the Board of Directors. Only holders of record of Mid-State
Stock at the close of business on the Mid-State Record Date, May 1, 1998, will
be entitled to vote at the Mid-State Meeting. At such date, there were
outstanding and entitled to vote 6,907,800 shares of Mid-State Stock. Each share
of Mid-State Stock is entitled to one vote. See "THE MID-STATE MEETING."
BANCORP. The Bancorp Meeting will be held on Thursday, June 18, 1998 at
7:00 p.m. California time, at the head office of Bank of Santa Maria, 2739 Santa
Maria Way, Santa Maria, California. Bancorp shareholders will consider and vote
on (i) a proposal to approve the principal terms of the Agreement and the
transactions contemplated thereby, (ii) a proposal to elect eleven persons to
the Board of Directors and (iii) a proposal to amend the 1996 Stock Option Plan
in accordance with the Agreement. Only holders of record of Bancorp Stock at the
close of business on the Bancorp Record Date, May 1, 1998, will be entitled to
vote at the Bancorp Meeting. At such date, there were outstanding and entitled
to vote
5
<PAGE>
3,008,639 shares of Bancorp Stock. Each share of Bancorp Stock is entitled to
one vote. See "THE BANCORP MEETING."
THE MERGER
GENERAL. Pursuant to the terms of the Agreement, (i) the Bank will merge
with and into Mid-State and Mid-State will continue as the surviving bank, (ii)
Bancorp will become the bank holding company for Mid-State and change its name
to "Mid-State Bancshares" and (iii) the shareholders of Mid-State will become
shareholders of Bancorp in accordance with the exchange ratio set forth in the
Agreement, all subject to the terms and conditions specified in the Agreement.
The transaction was structured in the foregoing manner in order to preserve and
utilize Bancorp, the newly established holding company for the Bank. Mid-State
considered that operating the combined banks under the ownership of a holding
company would provide increased flexibility in responding to evolving changes in
the banking and financial services industries and meeting the competition of
other financial institutions. See "THE MERGER."
EXCHANGE RATIO. The issued and outstanding shares of Bancorp Stock at the
effective time of the Merger (the "Effective Time") will remain outstanding
(other than shares as to which statutory dissenters' rights are perfected). Each
share of Mid-State Stock issued and outstanding immediately prior to the
Effective Time will automatically, without any action on the part of the holder
thereof, be canceled and converted into the right to receive a number of shares
of Bancorp Stock as determined by the exchange ratio established in the
Agreement (the "Exchange Ratio").
For purposes of the Exchange Ratio, a share of Bancorp Stock was valued at
$29.37, the agreed upon price for a share of Bancorp Stock, which was the result
of negotiation between Mid-State and the Bancorp. In agreeing to this value for
Bancorp Stock, the Board of Directors of Bancorp considered (a) that the value
of $29.37 was the highest value offered for Bancorp Stock by any party solicited
for expressions of interest in a merger with or acquisition of Bancorp, (b) that
the value of $29.37 was immediately accretive to Bancorp earnings per share and
book value per share, (c) that a value of $29.37 per share was higher than the
average price to book, price to earnings, price to assets, and premium to core
deposits paid in comparable transactions and (d) that the value of $29.37 was an
11% premium to the closing price of Bancorp Stock on the day prior to the
announcement of the Merger and a 53% premium to the closing price of Bancorp
Stock as of September 30, 1997, the time at which Bancorp had begun serious
discussions with potential merger partners. For further information on the
factors considered by the Board of Directors of Bancorp and other relevant
elements in arriving at the agreed upon value of $29.37 per share, see "THE
MERGER--Background and Reasons for the Merger and Management's
Recommendation--Bancorp" and "Bancorp Fairness Opinion." The Exchange Ratio will
be determined as follows:
(i) If the Average Closing Price of Mid-State Stock (as defined below)
is not less than $26.25 but not more than $30.50, each share of Mid-State
will be exchanged for the number of shares of Bancorp Stock equal to the
reciprocal of the number determined by dividing $29.37 by the Average
Closing Price. Such formula is expressed as:
1
-------------------
$29.37
-------
Average Closing Price
(ii) If the Average Closing Price is greater than $30.50, each share of
Mid-State Stock will be exchanged for 1.0385 shares of Bancorp Stock.
(iii) If the Average Closing Price is less than $26.25, each share of
Mid-State Stock will be exchanged for .8938 shares of Bancorp Stock;
provided, however, that, if the Average Closing Price is less than $26.25,
Bancorp has the right to terminate the Agreement. If Bancorp elects to so
terminate,
6
<PAGE>
Mid-State has the right, so long as the Average Closing Price exceeds
$22.00, to reinstate the Agreement by adjusting the Exchange Ratio downward
based on the formula in (i), above.
The "Average Closing Price" means the average of the daily closing prices of
a share of Mid-State Stock during the 20 consecutive trading days that
Mid-State's Stock trades ending on the third trading day immediately before the
Effective Day.
The Exchange Ratio will be adjusted upward for certain Significant
Liabilities (as defined in the Agreement) of Bancorp or Bank, if any. See "THE
MERGER--Exchange Ratio."
As described above, the Exchange Ratio (and the number of shares to be
received by shareholders of Mid-State and the value to be attributed to each
outstanding share of Bancorp Stock) depends upon the Average Closing Price of
Mid-State Stock. The following table shows the effective Exchange Ratio based
upon certain Average Closing Prices. No assurance can be given that the market
price of Bancorp Stock on or after consummation of the Merger will approximate
the Average Closing Price of Mid-State Stock prior to the Merger.
<TABLE>
<CAPTION>
ASSUMING A MID-STATE EACH MID-STATE SHARE WILL BE VALUE TO BE ATTRIBUTED TO EACH
AVERAGE CLOSING PRICE EXCHANGED INTO THIS NUMBER OF BANCORP OUTSTANDING SHARE OF BANCORP
OF: STOCK STOCK
- ----------------------- ------------------------------------- --------------------------------
<S> <C> <C>
$ 34.50 1.0385 $ 33.22
33.50 1.0385 32.26
32.50 1.0385 31.30
31.50 1.0385 30.33
30.50 1.0385 29.37
29.50 1.0044 29.37
29.37 1.0000 29.37
28.50 0.9704 29.37
27.50 0.9363 29.37
26.50 0.9023 29.37
26.25* 0.8938 29.37
25.25 0.8597 29.37
24.25 0.8257 29.37
23.25 0.7916 29.37
22.25 0.7576 29.37
22.00 0.7491 29.37
</TABLE>
- ------------------------
* If the Average Closing Price is less than $26.25, Bancorp has the right to
terminate the Agreement. If Bancorp elects to so terminate, Mid-State has
the right, so long as the Average Closing Price exceeds $22.00, to reinstate
the Agreement by adjusting the Exchange Ratio downward based on the formula
described above, as adjusted upwards for any Significant Liabilities.
FRACTIONAL SHARES. No fractional shares of Bancorp Stock will be issued in
the Merger. In lieu thereof, each holder of Mid-State Stock who would otherwise
be entitled to receive a fractional share will receive an amount in cash equal
to the product (calculated to the nearest ten thousandth) obtained by
multiplying (a) the Average Closing Price times (b) the fraction of the shares
of Bancorp Stock to which such holder would otherwise be entitled.
VOTE REQUIRED FOR THE MERGER
Approval of the principal terms of Agreement and the transactions
contemplated thereby requires the affirmative vote of not less than a majority
of the votes entitled to be cast by the holders of both Mid-State Stock and
Bancorp Stock at their respective Meetings.
As of the Mid-State Record Date, Mid-State's directors and executive
officers and their affiliates held approximately 9.1% of the outstanding
Mid-State Stock entitled to vote at the Mid-State Meeting. Each of
7
<PAGE>
the directors of Mid-State has agreed to vote his or her respective shares of
Mid-State Stock in favor of approval of the principal terms of the Agreement and
the transactions contemplated thereby.
As of the Bancorp Record Date, Bancorp's directors and executive officers
and their affiliates held approximately 24.3% of the outstanding Bancorp Stock
entitled to vote at the Bancorp Meeting. Each of the directors of Bancorp has
agreed to vote his or her respective shares of Bancorp Stock in favor of
approval of the principal terms of the Agreement and the transactions
contemplated thereby.
A shareholder's failure to vote for approval of the principal terms of the
Agreement has the same effect as a vote against the Agreement, including, in the
case of Bancorp shareholders only, preserving the status of the shares as
possible "dissenting shares." Therefore, each shareholder of the respective
Parties is urged to sign, date and mail the enclosed proxy as soon as possible.
If a shareholder decides to attend the Meeting and to vote in person, the
shareholder may withdraw his or her proxy at that time.
RECOMMENDATION OF MID-STATE'S AND BANCORP'S BOARDS OF DIRECTORS
The Boards of Directors of both Mid-State and Bancorp (each by a unanimous
vote) approved the Agreement and the related transactions. The respective Boards
believe the Merger is fair to, and in the best interest of, their respective
institutions and shareholders. Each Board of Directors recommends to their
respective shareholders a vote FOR approval of the principal terms of the
Agreement and the matters contemplated thereby.
The conclusions of the Parties are based on a number of factors, including
the respective fairness opinions of their investment banking firms, the expected
increase in the market liquidity of a shareholder's investment and the tax-free
nature of the Merger. It is also anticipated that the Merger will provide the
potential for the combined companies to benefit from revenue enhancement
opportunities, including increased ability to serve the marketplace and
cross-sell products and services; increased loan and fee income by providing
higher lending limits; increased opportunities to expand the loan portfolio; and
increased opportunities to create more efficiencies, thereby reducing overall
operating costs to the combined companies. See "THE MERGER--Background and
Reasons for the Merger and Management's Recommendation--Mid-State,--Background
and Reasons for the Merger and Management's Recommendation--Bancorp."
MID-STATE FAIRNESS OPINION
Mid-State has received a written fairness opinion dated as of January 29,
1998 from the investment banking firm of Hoefer & Arnett ("H&A") that the
consideration to be received in the Merger is fair, from a financial point of
view, to the shareholders of Mid-State. The H&A opinion is attached to this
Joint Proxy Statement/Prospectus as Appendix B. See "THE MERGER--Mid-State
Fairness Opinion."
BANCORP FAIRNESS OPINION
Bancorp has received a written fairness opinion dated as of February 24,
1998 from the investment banking firm of Carpenter & Company ("Carpenter") that
the consideration to be received in the Merger is fair, from a financial point
of view, to the shareholders of Bancorp. The Carpenter opinion is attached to
this Joint Proxy Statement/Prospectus as Appendix C. See "THE MERGER--Bancorp
Fairness Opinion."
MANAGEMENT AND OPERATIONS OF BANCORP AND MID-STATE AFTER THE MERGER
At the Effective Time, the Bank will be merged with and into Mid-State and
its separate corporate existence will terminate. Also at such time and by virtue
of the Merger, Mid-State will become a wholly-owned subsidiary of Bancorp.
Immediately after the Effective Time, the name of Bancorp will be changed to
"Mid-State Bancshares."
The number of directors of Bancorp at the Effective Time will be reduced to
ten and the seven members of Mid-State's Board of Directors and Messrs. A.J.
Diani, William A. Hares and William L. Snelling (each of whom is a currently a
member of the Board of Directors of Bancorp and the Bank) will serve as the
Board of Directors of Bancorp after the Merger until their successors have been
chosen and
8
<PAGE>
qualified in accordance with applicable law. After the Merger, the principal
officers of Bancorp will be Carrol R. Pruett (the current President of
Mid-State) who will serve as Chairman and President, A.J. Diani (the current
Chairman of Bancorp) who will serve as Vice Chairman, William A. Hares (the
current President of Bancorp) who will serve as Executive Vice President,
Raymond E. Jones (the current Secretary of Mid-State) who will serve as
Secretary and James G. Stathos (the current Executive Vice President of
Mid-State) who will serve as Executive Vice President/Chief Financial Officer.
The Articles of Incorporation and Bylaws of Bancorp (except as otherwise noted
above) will continue to govern the business and affairs of Bancorp after the
Merger until amended or repealed in accordance with applicable law.
The seven directors of Mid-State immediately prior to the Effective Time and
Messrs. Diani, Hares and Snelling will be the directors of Mid-State after the
Merger until their successors have been chosen and qualified in accordance with
applicable law. Shareholder approval of the principal terms of the Agreement and
the transactions contemplated thereby includes the approval of an amendment to
the Mid-State bylaws to expand the number of its authorized directors at the
Effective Time. See "THE MERGER--Amendment to Bylaws of Mid-State." The
principal officers of Mid-State immediately prior to the Effective Time will be
the principal officers of Mid-State after the Merger until they resign or are
replaced or terminated by the Board of Directors of Mid-State or otherwise in
accordance with applicable law, except that Mr. Diani will be elected Vice
Chairman of the Board of Directors of Mid-State and Bancorp and Mr. Hares will
be appointed as an Executive Vice President of Mid-State and Bancorp. The
Articles of Incorporation and Bylaws of Mid-State (except as otherwise noted
above) will continue to govern the business and affairs of Mid-State after the
Merger until amended or repealed in accordance with applicable law. See "THE
MERGER--Management and Operations of Bancorp and Mid-State after the Merger."
EFFECTIVE TIME OF THE MERGER
The Effective Time shall occur on the day that the Agreement of Merger
(which is Exhibit A to the Agreement) is filed with the California Department of
Financial Institutions ("DFI") after having been previously filed with the
California Secretary of State ("Secretary") with the DFI's approval endorsed
thereon in accordance with the provisions of the California Financial Code. The
Effective Time shall occur following the last to occur of (i) receipt of all
necessary regulatory approvals with the expiration of any applicable regulatory
waiting periods and (ii) satisfaction of the other conditions precedent set
forth in the Agreement. See "THE MERGER--Conditions to the Merger." It is
anticipated that the Effective Time will occur sometime during the third quarter
of 1998. In no event shall the Effective Time be later than September 30, 1998
unless a later date is agreed to by the Parties.
CONDITIONS TO THE MERGER
The respective obligations of Mid-State and Bancorp to consummate the Merger
are subject to a number of conditions precedent, including, among others, (i)
the receipt of required regulatory approvals, (ii) the approval by the
shareholders of all Parties of the principal terms of the Agreement and the
transaction contemplated thereby by the vote required under applicable law at
the respective Meeting, (iii) the receipt of fairness opinions by the Parties
that the terms of the Merger are fair from a financial point of view, (iv) an
application will be filed for listing Bancorp Stock on the Nasdaq National
Market System at the Effective Time, (v) the receipt of an opinion that the
Merger and the other transactions contemplated by the Agreement will qualify for
pooling of interest accounting treatment, (vi) the receipt of an opinion in
connection with certain tax aspects of the Merger, (vii) certain other
conditions customary in transactions of this nature. See "THE MERGER--Conditions
to the Merger."
9
<PAGE>
REGULATORY APPROVALS
The consummation of the Merger is subject to various conditions, including,
among others, receipt of the prior approvals of the DFI and the Federal Deposit
Insurance Corporation (the "FDIC").
The Agreement provides that the obligations of the Parties to consummate the
Merger are conditioned upon all regulatory approvals having been granted by
September 15, 1998 without the imposition of conditions which, in the opinion of
Mid-State would materially adversely effect the financial condition or
operations of any Party or otherwise would be burdensome.
Applications for regulatory review and approval of the Merger and the
related transactions have been filed. There can be no assurance that the DFI and
the FDIC will approve or take other required action with respect to the Merger
and the related transactions or as to the date of such approvals or action. See
"THE MERGER--Regulatory Approvals."
WAIVER AND AMENDMENT
Prior to the Effective Time, any condition to the Agreement may be waived by
the Party entitled to the benefit of such provision. In addition, the Agreement
may be amended at any time upon the written agreement of the Parties' respective
Boards of Directors without action by their respective shareholders to the
extent permitted by law. See "THE MERGER--Amendment and Waiver."
TERMINATION
The Agreement may be terminated at any time prior to the Effective Time (i)
by mutual consent of Mid-State and Bancorp in writing; (ii) by Mid-State if
Bancorp or the Bank become subject to any regulatory enforcement action; (iii)
by Mid-State or Bancorp if any material breach or default by the other Party is
not cured within 20 business days after notice thereof; (iv) by Mid-State or
Bancorp if any governmental or regulatory consent is not obtained by September
15, 1998 or if any governmental or regulatory authority denies or refuses to
grant any approval, consent or authorization required to be obtained to
consummate the transactions contemplated by the Agreement unless, within 20
business days after such denial or refusal, all parties agree to resubmit the
application to the regulatory authority that has denied or refused to grant the
approval, consent or qualification requested; (v) by Bancorp if any of the
conditions to its performance of the Agreement shall not have been met, or by
Mid-State if any of the conditions to its performance of the Agreement shall not
have been met, by September 30, 1998, or such earlier time as it becomes
apparent that such conditions shall not be met; (vi) by Mid-State if Bancorp
shall have failed to act or refrained from doing any Competing Transaction (as
hereinafter defined); (vii) by Mid-State or Bancorp if it is determined that the
estimated cost of any Bancorp environmental remediation is in excess of
$1,500,000 or is not reasonably determinable; (viii) by Bancorp if it is
determined that the estimated cost of any Mid-State environmental remediation is
in excess of $3,500,000 or is not reasonably determinable; or (ix) by Bancorp if
the Average Closing Price is less than $26.25, provided, however that if Bancorp
elects to so terminate, Mid-State has the right, so long as the Average Closing
Price exceeds $22.00, to reinstate the Agreement by adjusting the Exchange Ratio
downward based on the formula. See "THE MERGER--Termination."
INTERESTS OF CERTAIN PERSONS IN THE MERGER
As a condition to the Merger, each of the directors of Bancorp has entered
into an agreement with Mid-State whereby each has agreed to (i) vote his or her
shares of Bancorp Stock in favor of approving the principal terms of the
Agreement and the transactions contemplated thereby, (ii) recommend, subject to
his or her fiduciary duty, to Bancorp shareholders to vote in favor of the
Agreement, (iii) not dispose, subject to certain exceptions, of his or her
shares of Bancorp Stock, (iv) for a two year period, not to compete with
Mid-State or solicit anyone who was a customer of Mid-State, Bancorp or the Bank
during the last three years and (v) cooperate fully with Mid-State in connection
with the Merger. Each of the
10
<PAGE>
directors of Mid-State has entered into an agreement with Bancorp whereby each
has agreed to take the actions in (i)-(iii) and (v), above, as it relates to his
or her Mid-State Stock and the Mid-State shareholders. See "THE
MERGER--Interests of Certain Persons in the Merger."
Messrs. Diani, Hares and Snelling will continue as directors of Bancorp
after the Effective Time and will be added to the Board of Directors of
Mid-State at the Effective Time. Mr. Diani, the current Chairman of Bancorp and
the Bank, will be elected as Vice Chairman of Bancorp and Mid-State. Mr. Hares,
the current President of Bancorp and the Bank will be appointed as an Executive
Vice President of Mid-State and Bancorp at the Effective Time.
The officers and employees of Bancorp and the Bank at the Effective Time
will become officers and employees of Mid-State subject to the policies of
Mid-State, will be entitled to participate in all employee benefits and benefit
programs of Mid-State on the same basis as similarly situated employees of
Mid-State and will be credited for eligibility, participation and vesting
purposes with their respective years of past service with Bancorp and the Bank.
Mid-State has adopted a severance policy by which all employees of Bancorp, the
Bank or Mid-State who are not offered employment or who are terminated within 12
months following the Effective Time who satisfy the requirement of the severance
plan will receive severance benefits of two weeks for every year of service.
Mid-State has also agreed to honor certain change in control agreements for
James Glines, Dean Fletcher, Susan Forgone and Carol Bradfield, all of whom are
executive officers of Bancorp and the Bank. Severance benefits payable to the
above executive officers under the change of control agreements are determined
by multiplying a base monthly salary by 18 months for the above executive
officers. In addition, the executive officers are entitled to certain fringe
benefits, including health and other medical benefits. If all four executive
officers are terminated following the consummation of the Merger, the Bancorp
estimates that the amounts payable to such four executive officers and the value
of other benefits would total between $650,000 and $675,000. For a description
of such agreements, see "INFORMATION CONCERNING BANCORP MEETING ONLY--Contracts
with Executive Officers." The change of control agreement with Mr. William A.
Hares will terminate at the Effective Time and be replaced with an employment
agreement which provides for, among other things, a two year term at an annual
base salary of $190,000, an automobile, certain medical insurance benefits, five
weeks of vacation and participation in Mid-State compensation, bonus and benefit
plans. In the event Mr. Hares is terminated without cause during the two year
term, he will be entitled to receive his base salary for the remainder of the
two year term as well as the use of an automobile and continuation of medical
insurance benefits.
Subject to the receipt of any required consents, appropriate amendments are
intended to be made to Bancorp's stock option plan in order for Messrs. Diani,
Hares and Snelling and each person who is an officer or employee of Bancorp or
the Bank and who does not exercise his stock option to have the right to receive
a substitute stock option from Bancorp on a fully vested basis.
Policies of directors' and officers' liability insurance (with coverage,
terms and conditions no less advantageous than the insurance presently
maintained) will be maintained by Bancorp and Mid-State for persons currently
serving as officers or directors of Bancorp or the Bank with respect to all
matters arising from facts or events which occurred before the Effective Time
for which Bancorp or the Bank would have had an obligation to indemnify its
directors and officers.
ADDITIONAL AGREEMENTS
In addition to the directors agreements described in "Interests of Certain
Persons in the Merger," the directors and certain other affiliates of each of
the Parties have entered into agreements restricting such persons' ability to
sell shares of Bancorp Stock which such person has acquired or may acquire in
connection with the Merger except in accordance with such agreements.
11
<PAGE>
FEDERAL INCOME TAX CONSEQUENCES
The Parties have received an opinion from Arthur Andersen LLP ("Andersen")
to the effect that the Merger will qualify for non-recognition of gain or loss
treatment such that no gain or loss will be recognized by any of the Parties as
a result of the Merger. Such opinion also concludes that no gain or loss should
be recognized by a shareholder of Mid-State on the receipt solely of Bancorp
Stock in exchange for his shares of Mid-State Stock except, in the case of
Mid-State shareholders to the extent of any cash received in lieu of fractional
shares, such shareholders may recognize gain or loss. Shareholders of Bancorp
may recognize gain or loss pursuant to the exercise of statutory dissenters'
rights. For a more complete description of the federal income tax consequences
of the Merger, see "THE MERGER-- Federal Income Tax Consequences." DUE TO THE
INDIVIDUAL NATURE OF THE TAX CONSEQUENCES OF THE MERGER, IT IS RECOMMENDED THAT
MID-STATE AND BANCORP SHAREHOLDERS CONSULT THEIR OWN TAX ADVISOR CONCERNING THE
TAX CONSEQUENCES OF THE MERGER.
ACCOUNTING TREATMENT
The Parties anticipate that the Merger will be treated as a pooling of
interests for accounting purposes. Prior to the Effective Time and as a
condition precedent to the closing, Andersen will confirm in writing the
accounting treatment of the Merger as a pooling of interest. See "THE MERGER--
Accounting Treatment."
DISSENTERS' RIGHTS
Pursuant to the provisions of the California Financial Code, shareholders of
Mid-State will not be entitled to exercise dissenters' rights in connection with
the Merger.
A holder of Bancorp Stock who, not later than 30 days after the date on
which Bancorp delivers the notice of approval of the Merger by the Bancorp
shareholders, delivers to Bancorp a written demand for dissenters' rights, who
does not vote in favor of the approval of the principal terms of the Agreement
and who complies with all other applicable requirements of Chapter 13 of the
California General Corporation Law, will have the right to receive payment in
cash of the "fair market value" of such holder's shares of Bancorp Stock. The
Bancorp Board of Directors has determined that the "fair market value" of one
share of Bancorp Stock for this purpose is $26.375, which was the closing price
for Bancorp Stock on January 28, 1998, the day before the public announcement of
the Merger. See "THE MERGER--Dissenting Shareholders' Rights" for a further
discussion of dissenters' rights. Chapter 13 of the California General
Corporation Law is attached as Appendix D to his Joint Proxy
Statement/Prospectus.
EXCHANGE OF STOCK CERTIFICATES
As soon as practicable after the Effective Time, shareholders of record of
outstanding shares of Mid-State Stock will receive by mail a letter of
transmittal which is to be used to exchange their Mid-State Stock for a new
certificate bearing the name "Mid-State Bancshares" representing the appropriate
number of shares of Bancorp Stock, together with checks for payment of cash in
lieu of fractional shares. No dividends or other distributions that are declared
on Bancorp Stock will be paid to persons otherwise entitled to receive the same
until the old certificates have been surrendered in exchange for new
certificates, but upon such surrender, such dividends or other distributions,
from and after the Effective Time, will be paid to such persons in accordance
with the terms of Bancorp Stock. No interest will be paid to the Mid-State
shareholders on the cash or the value of the Bancorp Stock into which their
shares of Mid-State Stock will be exchanged. See "THE MERGER--Exchange
Procedures."
As soon as practicable after the Effective Time, shareholders of record of
outstanding shares of Bancorp Stock will also receive by mail a letter of
transmittal which is to be used to exchange their Bancorp Stock for new Bancorp
certificates bearing the name "Mid-State Bancshares" representing the same
number of shares as the exchanged certificates. See "THE MERGER--Exchange
Procedures."
12
<PAGE>
NEITHER MID-STATE NOR BANCORP SHAREHOLDERS SHOULD SEND IN THEIR STOCK
CERTIFICATES UNTIL THEY RECEIVE THE LETTER OF TRANSMITTAL FORM AND INSTRUCTIONS.
MARKETS AND MARKET PRICES
MID-STATE
There is a limited over-the-counter market for the Mid-State Stock. The
Mid-State Stock is not currently listed on any exchange or market, but certain
information concerning the Stock is reported on the Nasdaq electronic bulletin
board under the symbol "MTTB." The information in the following table indicates
the high and low stock sales prices of the Mid-State Stock for each quarterly
period indicated without adjustment for the two 5% stock dividends declared in
the fourth quarter of 1997 and 1996.
<TABLE>
<CAPTION>
SALES PRICES
--------------------
QUARTER ENDED LOW HIGH
- --------------------------------------------------------------- --------- ---------
<S> <C> <C>
1996
March 31....................................................... $ 9.50 $ 12.00
June 30........................................................ $ 11.25 $ 15.00
September 30................................................... $ 11.75 $ 12.75
December 31.................................................... $ 11.88 $ 16.00
1997
March 31....................................................... $ 15.00 $ 21.00
June 30........................................................ $ 16.375 $ 22.00
September 30................................................... $ 19.75 $ 23.75
December 31.................................................... $ 22.75 $ 30.85
1998
March 31....................................................... $ 25.625 $ 29.25
</TABLE>
On January 28, 1998, the last trading day before the announcement of the
Merger, the closing price for a share of Mid-State Stock was $27.50. On May ,
1998, the closing price for a share of Mid-State Stock was $ .
As of March 1, 1998, there were approximately 2,652 holders of Mid-State
Stock. There are no other classes of common equity outstanding.
The following table sets forth information concerning all quarterly cash and
stock dividends paid since January 1, 1996.
<TABLE>
<CAPTION>
PAYABLE DATE DIVIDEND
- ------------------------------------------------------------------- -------------------------
<S> <C>
January 19, 1996................................................... 5%--Stock
January 27, 1997................................................... 5%--Stock
July 25, 1997...................................................... $0.12 per share--Cash
January 23, 1998................................................... 5%--Stock
</TABLE>
In connection with the dividend policy of Bancorp following the Merger, see
"RISK FACTORS--Risk Factors Relating to the Merger--DIVIDEND POLICY."
BANCORP
The common stock of the Bancorp is not listed on any national stock exchange
or with Nasdaq. Trading in the stock has not been extensive and such trades
which have occurred would not constitute an
13
<PAGE>
active trading market. As of March 31, 1998, there were approximately 2,000
shareholders, including those listed in "street name" under various brokers. The
management of Bancorp is aware of three securities dealers who maintain an
inventory and make a market in Bancorp stock. The market makers are Maguire
Investments of Santa Maria, Hoefer & Arnett of San Francisco, and Sutro &
Company, with a local office in Santa Maria.
The following quarterly summary of market activity is furnished by Maguire
Investments, Inc. of Santa Maria and by the OTC Bulletin Board. These quotes do
not necessarily include retail markups, markdowns, or commissions and may not
necessarily represent actual transactions. Additionally, there may have been
transactions at prices other than those shown below:
<TABLE>
<CAPTION>
BANCORP
COMMON STOCK(1)
--------------------
BID ASK
--------- ---------
<S> <C> <C>
1st Quarter 1996................................................. $ 14.00 $ 14.50
2nd Quarter 1996................................................. $ 13.75 $ 14.25
3rd Quarter 1996................................................. $ 15.00 $ 15.75
4th Quarter 1996................................................. $ 15.00 $ 16.00
1st Quarter 1997................................................. $ 15.25 $ 16.75
2nd Quarter 1997................................................. $ 16.13 $ 17.63
3rd Quarter 1997................................................. $ 16.75 $ 18.63
4th Quarter 1997................................................. $ 18.00 $ 27.50
1st Quarter 1998................................................. $ 25.25 $ 28.63
</TABLE>
- ------------------------
(1) Prior to March 12, 1997, Bancorp Stock traded under the Bank's name. On
March 12, 1997, the Bank completed the reorganization of the Bancorp as its
bank holding company.
On January 28, 1998, the last trading day before the announcement of the
Merger, the closing price for a share of Bancorp Stock was $26.375. On May ,
1998, the closing price for a share of Bancorp Stock was $ .
Since 1984, the Bank has consistently declared and paid a cash dividend to
the shareholders of the Bank, with the equivalent of $.06 being paid since
February of 1988. In 1994, the Board of Directors of the Bank increased the per
share dividend to $.10. In 1995, the Board of Directors again increased the per
share dividends to $.11 payable in February, 1995, to the holder of their stock.
In 1996, the Board of Directors increased the cash divided to $.20 payable
in February, 1996. At the 1996 Annual Shareholders Meeting, the Bank announced
that it would begin to pay dividends on a semi-annual basis. In July 1996, a
$.15 dividend was declared to be paid in August, 1996. In January of 1997, the
Board again declared a $.15 cash dividend payable in February, 1997. Following
the formation of the Bancorp, the Directors of the Bancorp continued the
semi-annual dividend policy. In August of 1997, the Bancorp paid a $.20 cash
dividend. In January of 1998, the Bancorp Board again declared a cash dividend
of $.30 per share payable on February 6, 1998. As part of the Agreement with
Mid-State, the Bancorp's mid-year cash dividend, if any, is limited to a maximum
of $.10 per share.
14
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data with respect to
Mid-State's consolidated statement of financial position for the years ended
December 31, 1997 and 1996 and its consolidated statements of income for the
years ended December 31, 1997, 1996, and 1995, have been derived from the
audited consolidated financial statements of Mid-State appearing in Appendix E
of this Joint Proxy Statement/ Prospectus. This information should be read in
conjunction with such consolidated financial statements and the notes thereto.
The summary consolidated financial data with respect to Mid-State's consolidated
statement of financial position as of December 31, 1995, 1994, and 1993 and its
consolidated statements of income for the years ended December 31, 1994 and 1993
have been derived from the audited consolidated financial statements of
Mid-State, which are not presented herein.
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Year Ended December 31:
Interest Income............................................ $ 57,300 $ 52,043 $ 51,675 $ 49,155 $ 52,313
Interest Expense........................................... 17,136 16,158 16,640 14,157 17,685
--------- --------- --------- --------- ---------
Net Interest Income........................................ 40,164 35,885 35,035 34,998 34,628
Provision for Loan Losses.................................. -- -- -- 2,450 16,000
--------- --------- --------- --------- ---------
Net Interest Income after provision for loan losses........ 40,164 35,885 35,035 32,548 18,628
Non-interest income........................................ 12,956 12,722 11,992 10,890 11,120
Non-interest expense....................................... 37,683 41,371 48,051 54,300 38,091
--------- --------- --------- --------- ---------
Income (loss) before income taxes.......................... 15,437 7,236 (1,024) (10,862) (8,343)
Provision (benefit) for income taxes....................... 2,000 2,825 (1,675) -- (620)
--------- --------- --------- --------- ---------
Net Income (Loss).......................................... $ 13,437 $ 4,411 $ 651 $ (10,862) $ (7,723)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Per share:
Net Income (Loss) (adjusted for stock dividends)--basic.... $ 1.95 $ 0.64 $ 0.09 $ (1.57) $ (1.12)
Net Income (Loss) (adjusted for stock
dividends)--diluted...................................... $ 1.94 $ 0.64 $ 0.09 $ (1.57) $ (1.12)
Weighted average shares used in E.P.S. calculation......... 6,905 6,904 6,904 6,904 6,904
Cash dividends............................................. 0.12 -- -- -- 0.12
Stock dividend............................................. 5% 5% 5% 5% 5%
Book value at year-end..................................... 11.29 9.82 9.82 8.46 12.34
Shares outstanding at December 31.......................... 6,905,100 6,576,689 6,264,780 5,967,661 5,678,998
At December 31,
Cash and cash equivalents.................................. $ 73,708 $ 73,392 $ 71,310 $ 76,004 $ 86,889
Investments and Fed Funds Sold............................. 383,171 344,511 304,972 244,396 213,061
Loans, net................................................. 338,281 319,190 302,932 337,513 390,007
Other assets............................................... 47,140 55,338 79,172 100,039 120,189
--------- --------- --------- --------- ---------
Total Assets............................................. $ 842,300 $ 792,431 $ 758,386 $ 757,952 $ 810,146
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Non-interest bearing deposits.............................. $ 137,626 $ 122,396 $ 109,907 $ 112,471 $ 107,825
Interest bearing deposits.................................. 619,429 592,329 575,425 580,877 597,200
Other borrowings........................................... 4,495 7,424 5,589 8,992 26,437
Other liabilities.......................................... 2,784 5,718 5,961 5,115 8,583
Shareholders' equity....................................... 77,966 64,564 61,504 50,497 70,101
--------- --------- --------- --------- ---------
Total Liabilities and Shareholders' equity............... $ 842,300 $ 792,431 $ 758,386 $ 757,952 $ 810,146
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Asset Quality
Non-accrual loans.......................................... 2,677 3,638 13,087 23,969 27,565
Loans past due 90 days or more............................. 632 2,801 1,653 5,412 3,039
Other real estate owned.................................... 2,511 6,160 10,298 13,397 11,793
Total non performing assets................................ 5,820 12,599 25,038 42,778 42,397
Financial Ratios
For the year:
Return on assets......................................... 1.67% 0.58% 0.09% (1.38%) (0.95%)
Return on equity......................................... 18.85% 7.00% 1.16% (18.01%) (7.47%)
Net interest margin...................................... 5.68% 5.58% 5.80% 5.54% 5.24%
Net loan losses (recoveries) to avg. loans............... (0.24%) 0.29% 0.56% 2.51% 1.30%
Efficiency ratio......................................... 70.9% 85.1% 102.2% 118.3% 83.3%
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
At December 31:
Equity to average assets (leverage ratio).................. 9.2% 8.1% 8.1% 7.7% 8.6%
Tier One capital to risk-adjusted assets................... 14.9% 13.6% 12.7% 11.7% 14.7%
Total capital to risk-adjusted assets...................... 16.2% 14.8% 14.0% 13.0% 15.9%
Loan loss reserve to loans, gross.......................... 3.2% 3.2% 3.6% 3.8% 4.9%
</TABLE>
The following summarizes historical financial data for Bancorp and the Bank
for the five years ended December 31, 1997. The data should be read in
conjunction with the consolidated financial statements, related notes, and other
financial information included in Appendix F of this Joint Proxy Statement/
Prospectus.
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Summary of Operations:
Interest Income....................... $ 24,977 $ 23,372 $ 22,367 $ 19,378 $ 18,431
Interest Expense...................... 8,425 7,991 7,045 5,560 5,625
---------- ---------- ---------- ---------- ----------
Net Interest Income................... 16,552 15,381 15,322 13,818 12,806
Provisions for Loan Losses............ 30 227 876 340 712
---------- ---------- ---------- ---------- ----------
Net Interest Income After Provision
for Loan Losses...................... 16,522 15,154 14,446 13,478 12,094
Noninterest Income.................... 3,504 3,098 2,728 2,448 2,550
Noninterest Expense................... 13,205 12,471 12,090 11,723 11,158
---------- ---------- ---------- ---------- ----------
Income Before Income Taxes............ 6,821 5,781 5,084 4,203 3,486
Income Taxes.......................... 2,616 2,313 1,885 1,475 1,146
---------- ---------- ---------- ---------- ----------
Net Income............................ $ 4,205 $ 3,468 $ 3,199 $ 2,728 $ 2,340
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Dividends on Common Stock............. $ 1,402 $ 964 $ 257 $ 219 $ 131
Per Share Data:
Net Income--Basic..................... $ 1.41 $ 1.17 $ 1.10 $ 0.96 $ 0.86
Net Income--Diluted................... $ 1.38 $ 1.16 $ 1.09 $ 0.95 $ 0.83
Dividends on Common Stock............. $ 0.35 $ 0.35 $ 0.11 $ 0.10 $ 0.06
Book Value............................ $ 12.06 $ 10.97 $ 10.16 $ 9.17 $ 8.35
Tangible Book Value................... $ 11.45 $ 10.33 $ 10.16 $ 9.17 $ 8.35
Balance Sheet Summary:
Total Assets.......................... $ 344,046 $ 321,397 $ 284,616 $ 266,987 $ 253,311
Total Deposits........................ 306,292 286,278 252,544 238,954 229,137
Loans Held for Sale................... 1,200 1,400 1,310 958 3,644
Total Loans........................... 191,346 179,391 166,086 164,406 164,004
Allowance for Loan Losses............. 2,115 2,702 2,729 2,413 2,524
Total Shareholders' Equity............ 36,062 32,632 29,978 26,387 22,683
Selected Ratios
Return on Average Assets.............. 1.31% 1.15% 1.17% 1.05% 0.95%
Return on Average Equity.............. 12.15% 11.06% 11.26% 10.99% 10.80%
Average Loans as a Percent of Average
Deposits............................. 62.44% 63.96% 63.04% 64.67% 66.94%
Allowance for Loan Losses to Total
Loans................................ 1.11% 1.51% 1.64% 1.47% 1.54%
Average Capital to Average Assets..... 10.76% 10.41% 10.42% 9.56% 8.79%
Tier 1 Capital to Risk-Weighted
Assets............................... 14.74% 14.10% 13.69% 12.29% 10.89%
Total Capital to Risk-Weighted
Assets............................... 15.66% 15.30% 14.96% 14.71% 12.13%
</TABLE>
16
<PAGE>
SELECTED PRO FORMA COMBINED FINANCIAL INFORMATION
The following selected unaudited pro forma combined financial information
for the years ended December 31, 1997, 1996 and 1995 have been prepared to
reflect the effects of the Merger on the historical results of Mid-State. The
unaudited pro forma combined statement of financial position has been prepared
as if the Merger occured on December 31, 1997. The unaudited pro forma combined
statements of income have been prepared as if the Merger occurred on January 1,
1995. The pro forma financial information set forth below is unaudited and not
necessarily indicative of the results that will occur in the future. Weighted
average shares outstanding of the pro forma combined instution are based on a
1.0000 to 1.0000 Exchange Ratio which assumes that the Average Closing Price is
$29.37 for the 20 consecutive trading days ending at the end of the third day
immediately preceding the Effective Time. THE EXCHANGE RATIO COULD BE HIGHER OR
LOWER THAN 1.0000 TO 1.0000. THE CLOSING PRICE OF A SHARE OF MID-STATE STOCK ON
, 1998 WAS $ .
SELECTED UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C> <C>
Results of operations:
Interest Income................................................... $ 82,277 $ 75,415 $ 74,041
Interest Expense.................................................. 25,560 24,149 23,684
------------ ------------ ------------
Net Interest Income............................................... 56,717 51,266 50,357
Provision for Loan Losses......................................... 30 227 876
------------ ------------ ------------
Net Interest Income after provision for loan losses............... 56,687 51,039 49,481
Non-interest income............................................... 16,459 15,819 14,720
Non-interest expense.............................................. 50,888 53,841 60,141
------------ ------------ ------------
Income before income taxes........................................ 22,258 13,017 4,060
Provision for income taxes........................................ 4,616 5,138 210
------------ ------------ ------------
Net Income........................................................ $ 17,642 $ 7,879 $ 3,850
------------ ------------ ------------
------------ ------------ ------------
Net income per share--Basic....................................... $ 1.79 $ 0.80 $ 0.39
Net income per share--Diluted..................................... $ 1.77 $ 0.80 $ 0.39
Weighted average shares outstanding--Basic........................ 9,882 9,864 9,817
Weighted average shares outstanding--Diluted...................... 9,966 9,905 9,851
Balance at period end:
Total assets...................................................... 1,186,346 1,113,828 1,043,002
Total loans, net.................................................. 527,512 495,880 467,354
Total deposits.................................................... 1,063,347 1,001,003 937,877
Other borrowings.................................................. 4,495 7,424 5,589
Total Shareholders' equity........................................ 111,428 97,196 91,478
Selected statistics:
Return on average total assets.................................... 1.57% 0.74% 0.38%
Return on average common shareholders equity...................... 16.67% 8.35% 4.56%
Average equity to average total assets............................ 9.41% 8.91% 8.35%
Regulatory capital ratios:
Leverage ratio.................................................... 9.3% 8.5% 8.7%
Tier 1 risk based capital ratio................................... 14.5% 13.7% 13.0%
Total risk based capital ratio.................................... 15.7% 14.9% 14.3%
</TABLE>
17
<PAGE>
COMPARATIVE PER SHARE INFORMATION
The following table sets forth certain historical and pro forma combined per
share financial information for Mid-State and Bancorp Stock. The pro forma data
do not purport to be indicative of the results of future operations or the
results that would have occurred had the transaction been consummated at the
beginning of the period presented. The information presented herein should be
read in conjunction with the historical financial information of Mid-State and
Bancorp included in Appendices E and F to this Joint Proxy Statement/Prospectus.
<TABLE>
<CAPTION>
MID-STATE BANCORP PRO FORMA
PER COMMON SHARE HISTORICAL HISTORICAL COMBINED(2)
- ----------------------------------------------------------------------------- ----------- ----------- -------------
<S> <C> <C> <C>
NET INCOME
For the year ended December 31,
1997--basic.............................................................. $ 1.95 $ 1.41 $ 1.79
--primary............................................................ 1.94 1.38 1.77
1996--basic.............................................................. 0.64 1.17 0.80
--primary............................................................ 0.64 1.16 0.80
1995--basic.............................................................. 0.09 1.10 0.39
--primary............................................................ 0.09 1.09 0.39
CASH DIVIDENDS(1)
For the year ended December 31,
1997..................................................................... $ 0.12 $ 0.35 $ 0.19
1996..................................................................... -- 0.35 0.10
1995..................................................................... -- 0.11 0.03
BOOK VALUE
As of December 31, 1997.................................................... $ 11.29 $ 12.06 $ 11.26
As of December 31, 1996.................................................... 9.82 10.97 9.84
</TABLE>
- ------------------------
(1) The pro forma combined cash dividend represents aggregated historical
Mid-State and Bancorp cash dividends divided by the basic pro forma combined
weighted average shares outstanding for each year presented. The pro forma
combined cash dividends presented are not necessarily indicative of the
dividends that may have been declared and paid had the transaction been
effective for all periods presented.
(2) Pro forma amounts represent the equivalent net income and book value per
share for the periods indicated based on historical performance of Mid-State
and Bancorp, assuming that the transaction had been effective for all
periods presented. For purposes of calculating the pro forma combined per
share data, the Merger Exchange Ratio of 1.0000 shares of Mid-State Stock
for each share of Bancorp Stock was used. The Exchange Ratio could be higher
or lower than 1.0000 to 1.0000.
18
<PAGE>
RECENT DEVELOPMENTS
MID-STATE
The following table provides certain selected financial data at March 31,
1998 and March 31, 1997 (both unaudited) and the unaudited results of operations
for the three months ended on those dates. This data should be read in
conjunction with the audited financial statements of Mid-State Bank, the related
notes and other financial information presented in Appendix E of this Joint
Proxy Statement/Prospectus.
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1998 1997
---------- ----------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
YEAR-TO-DATE ENDED:
Interest Income........................................................................... $ 14,892 $ 13,654
Interest Expense.......................................................................... 4,339 4,050
---------- ----------
Net Interest Income....................................................................... 10,553 9,604
Provision for Loan Losses................................................................. -- --
None-interest income...................................................................... 3,209 2,852
Non-interest expense...................................................................... 9,005 9,058
---------- ----------
Income before income taxes................................................................ 4,757 3,400
Provision for income taxes................................................................ 1,700 585
---------- ----------
Net Income................................................................................ $ 3,057 $ 2,815
---------- ----------
---------- ----------
PER SHARE:
Net Income--basic......................................................................... $ 0.44 $ 0.41
Net Income--diluted....................................................................... $ 0.44 $ 0.41
Weighted average shares used in E.P.S. calculation........................................ 6,905 6,904
Cash dividends............................................................................ -- --
Stock dividend............................................................................ -- --
Dividend payout ratio..................................................................... -- --
Book value at period-end (adjusted for stock dividends)................................... 11.80 9.35
Shares outstanding at period end (actual)................................................. 6,905 6,577
AT PERIOD-END:
Cash and cash equivalents................................................................. $ 65,768 $ 64,422
Investments and Fed Funds Sold............................................................ 394,573 336,942
Loans, net................................................................................ 337,706 335,611
Other assets.............................................................................. 47,305 53,633
---------- ----------
Total Assets............................................................................ $ 845,352 $ 790,608
---------- ----------
Non-interest bearing deposits............................................................. $ 133,449 $ 114,706
Interest bearing deposits................................................................. 621,757 599,159
Other borrowings.......................................................................... 4,456 7,175
Other liabilities......................................................................... 4,185 5,034
Shareholders' equity...................................................................... 81,505 64,534
---------- ----------
Total Liabilities and Shareholders' equity.............................................. $ 845,352 $ 790,608
---------- ----------
---------- ----------
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1998 1997
----------- -----------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
ASSET QUALITY:
Non Accrual Loans........................................................................ 1,174 3,988
Loans past due 90 days or more........................................................... 1,066 1,091
Other real estate owned.................................................................. 2,436 5,282
Total non performing assets.............................................................. 4,676 10,361
Ratio of ending non performing assets to ending assets................................... 0.55% 1.31%
FINANCIAL RATIOS
For the period:
Return on assets (1)................................................................... 1.50% 1.47%
Return on equity (1)................................................................... 15.55% 17.69%
Net interest margin (1)................................................................ 5.76% 5.75%
Net loan charge-offs (recoveries) to avg. loans (1).................................... 0.02% (0.03)%
Efficiency ratio....................................................................... 65.4% 72.7%
At Period-End:
Equity to average assets (leverage ratio).............................................. 9.6% 8.5%
Tier One capital to risk-adjusted assets............................................... 15.6% 13.8%
Total capital to risk-adjusted assets.................................................. 16.9% 15.1%
Loan loss reserve to loans, gross...................................................... 3.2% 3.0%
Ending loans (net) to ending deposits.................................................. 44.7% 47.0%
</TABLE>
- ------------------------
(1) Ratio reflects annualized first quarter performance.
QUARTER ENDED MARCH 31, 1998
PERFORMANCE SUMMARY. Mid-State's net income for the first quarter of 1998
was $3,057,000, an increase of 8.6% over the like period in 1997. These earnings
represented an annualized return on assets of 1.50%, up from the 1.47% earned in
the comparable 1997 quarter. The overall growth rate of capital exceeded the
growth rate of earnings. This coupled with an increase in net unrealized
securities gains led to a decline in the annualized return on equity from 17.69%
in the first quarter of 1997 to 15.55% in 1998. Net Income per share was $0.44
(basic and diluted) compared to $0.41 (basic and diluted) after giving effect to
the 5% stock dividend which was effective at the end of 1997.
Net Income for the quarter increased compared to the 1997 period due
primarily to improvements in Mid-State's net interest margin (up $949 thousand)
and non interest income sources (up $357 thousand). During 1997, Mid-State was
able to reduce the size of its tax valuation allowance and correspondingly
reduce the amount of tax expense charged against income. As a result Mid-State
incurred a charge for tax expense which was $1,115,000 higher in the first
quarter of 1998 than the comparable 1997 period.
NET INTEREST INCOME. Mid-State's annualized yield on interest earning
assets was 8.13% in the first quarter of 1998 compared to 8.17% in the like 1997
period. In a similar manner, annualized interest expense as a percent of earning
assets declined from 2.42% in the 1997 first quarter to 2.37% in this year's
first quarter. As a result, Mid-State's annualized Net Interest Income,
expressed as a percent of earning assets, remained virtually unchanged at 5.76%
in 1998 compared to 5.75% in 1997. Interestingly, annualized Net Interest Income
as a percent of average total assets, actually improved from 5.00% in the first
quarter of 1997 to 5.17% in the 1998 period. This was due to a higher proportion
of average earning assets to total assets in the first quarter of 1998 compared
to the previous year.
Earning assets on average were $65 million higher in the first quarter of
1998 which is up nearly 10% from the comparable 1997 period. Average deposits in
the first quarter of 1998 were up $36 million explaining part of the increase in
average assets. The remaining portion of the increase can be explained by
20
<PAGE>
three factors--(1) an increase in he dividend payout ratio, (2) the decline in
non performing assets and (3) a reduction in non earning balances held at the
Federal Reserve Bank (see the Management's Discussion and Analysis section of
Appendix E of this Joint Proxy Statement/Prospectus).
PROVISION AND ALLOWANCE FOR LOAN LOSSES. Mid-State did not make a
contribution to the allowance for loan losses in the first quarter of 1998.
Management continues to believe that the allowance, which stands at 3.2% of
total loans at March 31, 1998, up from 3.0% one year earlier, is adequate to
cover future losses. The $11.2 million allowance is now more than double the
level of non performing assets which have declined to $4.7 million from $10.4
million one year earlier. Non performing assets consist of loans on nonaccrual,
accruing loans 90 days or more past due and Other Real Estate Owned. While
continuing efforts are made to improve overall asset quality, Management is
unable to estimate what and under what exact terms problem assets will be
resolved.
Changes in the allowance for loan losses for the quarters ended March 31,
1998 and 1997 are as follows:
<TABLE>
<CAPTION>
QUARTER ENDED MARCH
31,
--------------------
1998 1997
--------- ---------
(000'S)
<S> <C> <C>
Allowance, beginning of the quarter..................................... $ 11,251 $ 10,438
Provision for loan losses............................................... 0 0
Recoveries of loans previously charged-off.............................. 191 207
Loans charged off....................................................... (205) (185)
--------- ---------
Allowance, end of quarter............................................... $ 11,237 $ 10,460
--------- ---------
--------- ---------
</TABLE>
At March 31, 1998, the recorded investment in loans which have been
identified as impaired loans, in accordance with Statement of Financial
Accounting Standards (SFAS) No. 114, totaled $3,422,515. Of this amount,
$1,592,743 related to loans with no valuation allowance and $1,829,772 related
to loans with a corresponding valuation allowance of $362,402. Impaired loans
totaled $6,690,155 at March 31, 1997. Of that amount, $3,464,823 related to
loans with no valuation allowance and $3,225,332 related to loans with a
corresponding valuation allowance of $617,250. 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 March 31, 1998, the average recorded investment in impaired loans
was $3,825,914 compared to $7,532,406 in the 1997 period.
NONINTEREST INCOME. Noninterest income for the first quarter of 1998 was
$3.2 million, up $357 thousand from the 1997 period, or 12.5%. The major
explanation for the increase was in the amount of recoveries of prior periods
losses. These included recoveries of legal charges, accrued interest write-offs,
operating losses and other losses. Service Charge earnings, which are a major
component of noninterest income, were virtually flat compared to one year ago.
NONINTEREST EXPENSE. Noninterest expense for the first quarter of 1998 at
$9.0 million was virtually unchanged, down just $51 thousand from the comparable
1997 period. There was a reduction of $600 thousand charged to expense for the
allowance for losses on investments in real estate in 1998 compared to the 1997
period. This reduction was offset by an increase of $205 thousand in salaries
and benefits, an increase of $33 thousand in occupancy and furniture, an
increase of $179 thousand in accounting and other professional expenses, and net
increases of $132 thousand across the numerous other categories of noninterest
expense.
21
<PAGE>
BALANCE SHEET. Total assets at March 31, 1998 totaled $845.4 million, up
8.6% from the level one year earlier of $790.6 million. Net loans were a modest
component of this growth, increasing from $335.6 million at the end of March,
1997 to $337.7 in 1998. Investments available for sale and fed funds sold grew
significantly from $336.9 million one year earlier to $394.6 million this year.
Other non earning asset categories declined when comparing the 1998 calendar
quarter to the 1997 period.
Total asset growth was funded through a $41 million increase in deposits and
a $17 million increase in stockholders' equity when comparing 1998 over 1997.
There was also a modest drop in other liabilities of just under $4 million.
comparing the two quarter-ends. Of the $17 million increase in stockholders'
equity, $4.1 million was generated by an increase in the unrealized gain (loss)
on available for sale securities.
Mid-State's loan to deposit ratio of 44.7% at March 31, 1998 is down from
the 47.0% ratio one year earlier. There is ample internal liquidity to fund
improvements in this ratio through Mid-State's investment portfolio which is
categorized 100% as available for sale.
INVESTMENT SECURITIES. Fed funds sold represent $14.0 million of the $394.6
million portfolio noted above. Of the remaining $380.6 million, 42% is invested
in U.S. Treasury securities, 23% is invested in U.S. Government agency
obligations, 31% is invested in securities issued by states and political
subdivisions in the U.S. and 4% is invested in mortgage-backed securities.
$350.3 million, or 92% of all these investment securities have stated maturities
which are due in 5 years or less. Approximately 19% matures in less than one
year. Actual maturities will vary somewhat from stated maturities because
certain issuers, especially in the mortgage-backed securities portfolio, may
have the right to prepay their obligations at a faster rate than that indicated
by their contractual maturity.
CAPITAL RESOURCES. Total stockholders' equity increased from $64.5 million
at March 31, 1997 to $81.5 million at March 31, 1998. Net income over this 12
month time period of $13.7 million less cash dividends of $789 thousand plus a
$4.1 million increase in unrealized gains on available for sale securities
accounted for the $17.0 million increase. Capital continues to be strong with
Mid-State's ratio of equity to average assets ("leverage ratio") at 9.6% up from
8.5% one year earlier. Similarly, Mid-State's ratios of Tier One Capital and
Total Capital to risk-adjusted assets also increased. The Tier One ratio went
from 13.8% one year earlier to 15.6% at March 31, 1998. The Total Capital ratio
went from 15.1% one year earlier to 16.9% at March 31, 1998.
LIQUIDITY. Management is not aware of any future capital expenditures or
other significant demands or commitments which would severely impair liquidity.
BANCORP AND BANK
The following table (unaudited) provides certain selected financial data at
March 31, 1998 and the results of operations for the three months ended March
31, 1998 compared with the prior periods in 1997. The information includes all
adjustments, consisting only of normal recurring adjustments, which the Bancorp
considers necessary for a fair presentation of the financial data and the
results of operations as of and for those periods. The data should be read in
conjunction with the financial statements, related notes,
22
<PAGE>
and other financial information presented elsewhere in Appendix F to this Joint
Proxy Statement/ Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1997
---------- ----------
($ IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
Selected Income Statement Data:
Interest income......................................................................... $ 6,387 $ 6,041
Interest expense........................................................................ 2,173 2,012
---------- ----------
Net interest income..................................................................... 4,214 4,029
Provisions for loan losses.............................................................. 150 30
---------- ----------
Net interest income after provision for loan losses..................................... 4,064 3,999
Noninterest income...................................................................... 959 836
Noninterest expense..................................................................... 3,450 3,367
---------- ----------
Income before income taxes.............................................................. 1,573 1,468
Income taxes............................................................................ 562 553
---------- ----------
Net Income.............................................................................. $ 1,011 $ 915
---------- ----------
---------- ----------
Per Share Data:
Net income-basic........................................................................ $ .34 $ .31
Net income-fully diluted................................................................ $ .33 $ .30
Book value.............................................................................. $ 12.07 $ 11.09
Cash dividends declared................................................................. $ .30 $ .15
Selected Balance Sheet Data:
Loans, net.............................................................................. $ 188,152 $ 171,101
Securities available for sale........................................................... 37,988 29,054
Securities held to maturity............................................................. 59,791 63,645
Total assets............................................................................ 335,871 311,520
Total deposits.......................................................................... 298,405 276,642
Shareholders' equity.................................................................... 36,305 32,998
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1997
---------- ----------
($ IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
Selected Ratios:
ASSET QUALITY:
Loans on non-accrual.................................................................... $ 1,274 $ 1,671
Accruing loans past due 90 day or more.................................................. 0 11
Other real estate owned................................................................. 806 1,293
Total non performing assets............................................................. 2,080 2,975
Non performing assets to ending assets.................................................. .62% .87%
FOR THE PERIOD:
Annualized return on average assets..................................................... 1.22% 1.20%
Annualized return on average equity..................................................... 11.36% 11.28%
Net interest margin..................................................................... 5.69% 5.95%
Net charge-offs to average loans........................................................ .02% .03%
Efficiency Ratio........................................................................ 70.5% 63.7%
AT PERIOD END:
Average equity to average assets........................................................ 10.73% 10.62%
Leverage................................................................................ 10.31% 10.10%
Tier 1 risk-based capital............................................................... 15.07% 14.89%
Total risk-based capital................................................................ 16.04% 16.08%
Allowance for loan loss reserve to gross loans.......................................... 1.16% 1.54%
Average loans to average deposits....................................................... 63.59% 63.65%
</TABLE>
OVERVIEW
For the three months ended March 31, 1998, the Bancorp reported net income
of $1,011,000, or $.34 per share compared to a net income of $915,000, or $.31
per share for the same three month period in 1997. The annualized return on
average assets was 1.22% for 1998, compared to 1.20% for 1997. Annualized return
on average shareholders' equity for 1998 and 1997, was 11.36% and 11.28%
respectively.
FINANCIAL CONDITION
Historically, the Bancorp experiences a first quarter decline in total
assets, loans and deposits primarily due to timing of cash flows from the
Bancorp's agricultural customers. Total assets as of March 31, 1998, decreased
2.4% to $335.9 million in comparison to total assets of $344.0 million as of
December 31, 1997. Comparable asset totals for the first three months of 1997,
recorded a 3.1% decrease. Cash and cash equivalents increased by $5.3 million
with funds provided primarily by the maturation of investment securities. Total
investment dollars decreased by 10.3% to $97.8 million as of March 31, 1998.
Loans declined by $1.0 million during the first three months of 1998, compared
to a $5.6 million decline during the same period in 1997. The percentage of
decline was .5% for 1998, versus a decline of 3.1% for 1997.
There were no material purchases of fixed assets during the first quarter of
1998. The Bank's cash flow continued to benefit from several sales of other real
estate owned properties during the first quarter.
Deposits decreased by $7.9 million during the first three months of 1998, in
comparison to a $9.6 million decline during the same period in 1997. The
percentage of decrease was 2.6% for 1998, versus 3.4% decline in 1997. The
larger 1997 decline appears to be attributable to the runoff of deposit dollars
24
<PAGE>
associated with the acquisition of El Camino National Bank in January of 1997. A
certain level of runoff was anticipated by Bancorp management.
The Bank, prior to its acquisition by the Bancorp, paid semi-annual
dividends, a policy which was first implemented in mid 1996. During the first
quarter of 1996, the Directors of the Bank paid a $.20 per share annual cash
dividend which was augmented in August of 1996, with the first semi-annual
dividend of $.15 per share. In January of 1997, the Bank again paid a $.15 per
share cash dividend. The Bancorp was the beneficiary of two organizational
dividends from the Bank during 1997. A dividend in the amount of $150,000
payable in March, 1997, and a dividend in the amount of $700,000 payable in
August, 1997. With the Bancorp now fully organized, a $.20 per share cash
dividend was declared in July, 1997, payable on August 15, 1997. In January
1998, the Bancorp declared a $.30 per share cash dividend, payable in February
of 1998. The Bank declared a $800,000 cash dividend to provide cash for the
Bancorp's dividend as well as operating capital. In addition, the exercise of
stock options by Bank employees, provided approximately $117,000 in cash to the
Bancorp. Both the Bank and the Bancorp maintain strong liquidity positions.
A provision of the Agreement limits the amount of any mid-year dividend, if
any, by the Bancorp to $.10 per share. This dividend can only be paid if the
Merger has not yet been consummated by July 14, 1998.
RESULTS OF OPERATIONS
Interest income on loans was up by $246,000 in the first three months of
1998, compared with the same period during 1997. The increase in interest income
was primarily attributable to the increase in average outstanding loans, which
were up by $11.7 million. The effective yield on the loan portfolio declined by
approximately .33 basis points. Without any increase in the loans outstanding,
interest income on loans would have declined by approximately $129,000.
Interest income on investments, including Federal funds transactions,
increased by $100,000 during the first three months of 1998, over the comparable
period in 1997. This increase, as with loans, was primarily attributable to the
increase in funds available for investment, which was up by $7.8 million. The
effective yield decreased .15 basis points.
Interest expense on interest-bearing deposits was up by $160,000 in the
first three months of 1998, compared with the first three months of 1997. The
increase in interest expense was attributable to the increase in average
interest-bearing deposits which were up by $10.1 million. The effective rate
increased by 2 basis points. The increase in the rate raised the overall
interest expense cost by only $11,000 or approximately 7% of the total increase.
Net interest margin declined from 5.95% for the first three months of 1997,
to 5.69% for the same period in 1998. The decline in interest income to earning
assets, by 30 basis points, against a modest 4 basis point decline in interest
expense to earning assets, tighten the Bancorp's overall spread. The provision
for loan losses of $150,000 is sufficient to bring the allowance for loan losses
to a balance considered to be adequate to absorb potential losses in the
portfolio. Management's determination of the adequacy of the allowance is based
upon a detailed evaluation of the portfolio, current economic conditions and
trends, historical loan loss experience and other risk factors.
Noninterest income increased $123,000 or 14.7% to $959,000 as of March 31,
1998. This increase is primarily the results of increased activity in the
mortgage banking functions of the Bank. Non interest expenses increased $83,000
or 2.5% to $3,451,000 as of March 31, 1998. While there are some fluctuations in
operating expenses due to the El Camino merger and the opening of the Atascadero
Branch in the first quarter of 1997, the primarily reason for the increase in
1998 is due to increased commissions paid from the aforementioned mortgage
banking function.
25
<PAGE>
CAPITAL RESOURCES
The Bancorp and its bank subsidiary are subject to risk-based capital
regulations adopted by the federal banking regulators. These guidelines are used
to evaluate capital adequacy and are based upon an institution's asset risk
profile and off-balance sheet exposures, such as unused loan commitments and
letters of credit. The following table sets forth the Bancorp's and the Bank's
leverage and risk-based capital ratios at March 31, 1998:
<TABLE>
<CAPTION>
BANCORP BANK
-------------------- --------------------
AMOUNT % AMOUNT %
--------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Leverage ratio........................................................... $ 34,498 10.31% $ 34,220 10.23%
Regulatory minimum....................................................... $ 13,380 4.00% $ 13,377 4.00%
Excess................................................................... $ 21,118 6.31% $ 20,843 6.23%
RISKED-BASED RATIOS
Tier 1 capital........................................................... $ 34,498 15.07% $ 34,220 14.94%
Tier 1 minimum........................................................... $ 9,157 4.00% $ 9,163 4.00%
Excess................................................................... $ 25,341 11.07% $ 25,057 10.94%
Total capital............................................................ $ 36,720 16.04% $ 36,442 15.91%
Total capital minimum.................................................... $ 18,313 8.00% $ 18,325 8.00%
Excess................................................................... $ 18,407 8.04% $ 18,117 7.91%
</TABLE>
The management of the Bancorp is not aware of any trends, events,
uncertainties or recommendations by regulatory authorities that will have or
that are reasonably likely to have material effect on the liquidity, capital
resources or operations of the Bancorp with the exception of the proposed merger
with Mid-State Bank. The effects of this merger will be accretive to earnings in
1999, and should have positive effects to both capital resources and liquidity
during 1998.
26
<PAGE>
RISK FACTORS
IN DECIDING HOW TO VOTE THEIR SHARES AT THE MEETINGS, HOLDERS OF SHARES OF
MID-STATE STOCK AND HOLDERS OF SHARES OF BANCORP STOCK SHOULD CAREFULLY CONSIDER
THE FOLLOWING FACTORS, IN ADDITION TO THE INFORMATION AND OTHER MATTERS SET
FORTH IN THIS JOINT PROXY STATEMENT/PROSPECTUS.
Certain statements contained in this Joint Proxy Statement/Prospectus,
including, without limitation, statements containing the words "believes,"
"anticipates," "intends," "expects" and words of similar import, constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act. Such forward looking statements involve
known and unknown risks, uncertainties and other factors that may cause the
actual results, performance or achievements of Mid-State or Bancorp 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 Mid-State or Bancorp operate; 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 Mid-State's or Bancorp's business; and other
factors referenced in this Joint Proxy Statement/Prospectus, including, without
limitation, under the captions "SUMMARY," "RISK FACTORS" and in Appendices E and
F. Given these uncertainties, shareholders are cautioned not to place undue
reliance on such forward-looking statements. Mid-State and Bancorp disclaim 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.
RISK FACTORS RELATING TO THE MERGER
PROSPECTS OF MID-STATE AND BANCORP AFTER THE MERGER AND ABILITY TO INTEGRATE
OPERATIONS. The earnings, financial condition and prospects of Mid-State and
Bancorp after the Merger will depend in part on Mid-State's ability to
successfully integrate the operations and management of the Bank and to continue
to implement its own business plan. There can be no assurance that Mid-State
will be able to effectively and profitably integrate the operations and
management of the Bank, or that Mid-State will be able to continue to profitably
implement its own business plan. In addition, there can be no assurance that
Mid-State will be able to fully realize the potential revenue enhancement
expected as a result of the Merger. Further, although the Mid-State Board and
the Bancorp Board do anticipate cost savings as a result of the Merger to be
significant (as compared to potential revenue enhancement as a result of the
Merger), there can be no assurance that Mid-State will be able to fully realize
any of the potential cost savings expected. Finally, there can be no assurance
that any cost savings which are realized will not be offset by losses in
revenues or other charges to earnings.
PERFORMANCE OF COMBINED LOAN PORTFOLIOS. Mid-State's performance and
prospects after the Merger also will be dependent to a significant extent on the
performance of the combined loan portfolios of the Bank and Mid-State and
ultimately on the financial condition of the Bank's and Mid-State's borrowers
and other customers. The existing loan portfolios of the Bank and Mid-State
differ to some extent in the types of borrowers, industries and credits
represented. In addition, there are differences in the documentation,
classifications, credit ratings and management of the portfolios. As a result,
Mid-State's overall loan portfolio after the Merger will have a different risk
profile than the loan portfolio of either the Bank or Mid-State before the
Merger. The performance of the combined loan portfolio will be adversely
affected if any of such factors is worse than currently anticipated. In
addition, to the extent that present customers are not retained by the surviving
bank or additional expenses are incurred in retaining them, there could be
adverse effects on future results of operations of Mid-State following the
Merger. Realization of improvement in profitability is dependent, in part, on
the extent to which the revenues of Bancorp and Mid-State are maintained and
enhanced.
27
<PAGE>
MARKET PRICE OF BANCORP STOCK AFTER THE MERGER. The number of shares of
Bancorp Stock which will be issued to Mid-State shareholders in the Merger is
determined by the Average Closing Price of Mid-State Stock. No assurance can be
given that the market price of Bancorp Stock on or after consummation of the
Merger will approximate the Average Closing Price of Mid-State prior to the
Merger.
LIMITED MARKET FOR BANCORP STOCK. There is currently only a limited trading
market for the Mid-State and Bancorp Stocks. An application will be filed for
listing Bancorp Stock on the Nasdaq National Market System which is anticipated
to become effective at the Effective Time or shortly thereafter. However, there
can be no assurance that an active trading market for Bancorp Stock will develop
as a result of the Merger or otherwise, or if developed, will continue, or that
shareholders of Bancorp will be able to resell their securities or otherwise
liquidate their investment without considerable delay, if at all, or
considerable impact on the sale's price. For information concerning the markets
for Mid-State Stock and Bancorp Stock, see "SUMMARY--Markets and Market Prices."
DIVIDEND POLICY. Mid-State has historically paid stock dividends to its
shareholders and recommenced paying an annual cash dividend in 1997. Bancorp has
paid cash dividends since 1984 and semi-annually since 1996. The dividend policy
of Bancorp following the Merger has not yet been precisely determined but it is
currently anticipated that both stock and cash dividends will be paid.
Declarations or payments of dividends by the Board of Directors of Bancorp after
the Merger will depend upon a number of factors, including capital requirements,
regulatory limitations, Bancorp's and Mid-State's financial condition and
results of operations, tax considerations and general economic conditions. No
assurance can be given that any dividends will be declared or, if declared, what
the amount of dividends or their type (cash, stock or both) will be or whether
such dividends, once declared, will continue.
RISK FACTORS RELATING TO THE INDUSTRY
INTEREST RATE RISK. Banking companies' earnings depend largely on the
relationship between the cost of funds, primarily deposits, and the yield on
earning assets. This relationship, known as the interest rate spread, is subject
to fluctuation and is affected by economic and competitive factors which
influence interest rates, the volume and mix of interest-earning assets and
interest-bearing liabilities, and the level of nonperforming assets.
Fluctuations in interest rates affect the demand of customers for Mid-State's
and the Bank's products and services. Mid-State and the Bank are subject to
interest rate risk to the degree that their interest-bearing liabilities reprice
or mature more slowly or more rapidly or on a different basis than their
interest-earning assets. Given Mid-State's and the Bank's current volume and mix
of interest-bearing liabilities and interest-earning assets, Mid-State's and the
Bank's interest rate spread could be expected to increase during times of rising
interest rates and, conversely, to decline during times of falling interest
rates. Therefore, significant fluctuations in interest rates may have an adverse
effect on Mid-State's results of operations.
ECONOMIC CONDITIONS AND GEOGRAPHIC CONCENTRATION. The operations of
Mid-State and Bancorp are located on the California Central Coast and
concentrated in San Luis Obispo and Santa Barbara Counties. As a result of this
geographic concentration, Mid-State's and Bancorp's results depend largely upon
economic conditions in these areas. A deterioration in economic conditions in
these market areas could have a material adverse impact on the quality of
Mid-State's and Bancorp's loan portfolio and the demand for their products and
services and, accordingly, their respective results of operations.
GOVERNMENT REGULATION AND MONETARY POLICY. The banking industry is subject
to extensive federal and state supervision and regulation. Such regulation
limits the manner in which Mid-State, the Bank and Bancorp conduct their
respective businesses, undertake new investments and activities and obtain
financing. This regulation is designed primarily for the protection of the
deposit insurance funds and consumers, and not to benefit holders of Mid-State's
or Bancorp's Stocks. Financial institution regulation has been the subject of
significant legislation in recent years, and may be the subject of further
significant legislation in the future, none of which is in the control of
Mid-State or Bancorp. Significant new laws or changes in, or
28
<PAGE>
repeal of, existing laws may cause Mid-State's or Bancorp's results to differ
materially. Further, federal monetary policy, particularly as implemented
through the Federal Reserve System, significantly affects credit conditions for
financial institutions, primarily through open market operations in United
States government securities, the discount rate for bank borrowings and bank
reserve requirements. Any material change in these conditions would be likely to
have a material impact on Mid-State's and Bancorp's respective results of
operations.
COMPETITION. The banking and financial services business in California
generally, and in Mid-State's and Bancorp's market areas specifically, is highly
competitive. The increasingly competitive environment is a result primarily of
changes in regulation, changes in technology and product delivery systems and
the accelerating pace of consolidation among financial services providers. The
Bank and Mid-State compete for loans, deposits and customers for financial
services with other commercial banks, savings and loan associations, securities
and brokerage companies, mortgage companies, insurance companies, finance
companies, money market funds, credit unions and other nonbank financial service
providers. Many of these competitors are much larger in total assets and
capitalization, have greater access to capital markets and offer a broader array
of financial services than the Bank or Mid-State. There can be no assurance that
Mid-State will be able to compete effectively in its markets, and the results of
operations of Mid-State and Bancorp could be adversely affected if circumstances
affecting the nature or level of competition change.
CREDIT QUALITY. A significant source of risk for financial institutions
such as the Bank and Mid-State arises from the possibility that losses will be
sustained because borrowers, guarantors and related parties may fail to perform
in accordance with the terms of their loans. Mid-State and the Bank have adopted
underwriting and credit monitoring procedures and credit policies, including the
establishment and review of the allowance for credit losses, that each company's
respective management believes are appropriate to minimize this risk by
assessing the likelihood of nonperformance, tracking loan performance and
diversifying the respective credit portfolios. Such policies and procedures,
however, may not prevent unexpected losses that could materially adversely
affect the results of operations.
THE MID-STATE MEETING
DATE, TIME AND PLACE
The Mid-State Meeting will be held on Wednesday, June 17, 1998 at the
Administrative Headquarters Building, located at 991 Bennett Street, Arroyo
Grande, California, at 7:30 p.m., California time, and any adjournment or
adjournments thereof.
PURPOSE
One purpose of the Mid-State Meeting is to consider and vote upon a proposal
to approve the principal terms of the Agreement and the transactions
contemplated thereby. The shareholders of Mid-State will also consider and vote
upon a proposal to elect seven persons to the Board of Directors and such other
matters as may be properly brought before the Mid-State Meeting.
RECORD DATE
The Mid-State Board has fixed the close of business on May 1, 1998, as the
Mid-State Record Date for the determination of shareholders entitled to notice
of, and to vote at, the Mid-State Meeting. Accordingly, only holders of record
of shares of Mid-State Stock at the close of business on the Mid-State Record
Date will be entitled to vote at the Mid-State Meeting and any adjournment
thereof. As of Mid-State Record Date, there were 6,907,800 shares of Mid-State
Stock outstanding, held by approximately 2,650 shareholders of record.
29
<PAGE>
PROXIES AND REVOCABILITY OF PROXIES
A proxy card for voting at the Mid-State Meeting is enclosed with the copy
of this Joint Proxy Statement/Prospectus being mailed to Mid-State shareholders.
(A separate proxy card for Bancorp shareholders voting at the Bancorp Meeting is
being provided to Bancorp shareholders. See THE BANCORP MEETING--Voting of
Proxies and Revocability of Proxies."). When a proxy card is returned, properly
signed and dated, the shares represented thereby will be voted in accordance
with the instructions on the proxy card. If a shareholder does not attend the
Mid-State Meeting and does not return the signed proxy card, such holder's
shares will not be voted and this will have the effect of a vote "AGAINST" the
matters to be voted on at the Mid-State Meeting. Shareholders are urged to mark
the box on the proxy card to indicate how the shares represented by the proxy
card are to be voted. If a shareholder returns a signed proxy card but does not
indicate how his or her shares are to be voted, such shares will be voted "FOR"
all proposals. The proxy card also confers discretionary authority on the
individuals appointed by the Mid-State Board named on the proxy card to vote the
shares represented thereby on any other matter that is properly presented for
action at the Mid-State Meeting. A shareholder who has given a proxy may revoke
it at any time prior to its exercise at the Mid-State Meeting by delivering an
instrument of revocation to the secretary of Mid-State, by duly executing and
submitting a proxy card bearing a later date, or by appearing at the Mid-State
Meeting and voting in person. The mere presence at the Mid-State Meeting of the
person who has given a proxy will not revoke such proxy. In addition, brokers
who hold shares of Mid-State Stock as nominees will not have discretionary
authorization to vote such shares on any of the matters to be voted thereon in
the absence of instructions from the beneficial owners.
COSTS OF SOLICITATIONS OF PROXIES
Mid-State will bear its own costs in connection with this solicitation. It
is contemplated that proxies will be solicited principally through the mails,
but directors, officers and regular employees of Mid-State may solicit proxies
(for no additional compensation) by personal interview, telephone, telex,
telegram, facsimile or similar means of communication. Although there is no
formal agreement to do so, Mid-State may reimburse banks, brokerage houses and
other custodians, nominees and fiduciaries for their reasonable expenses in
forwarding these proxy materials to their principals.
OUTSTANDING SECURITIES; QUORUM
As of the Mid-State Record Date, there were issued and outstanding 6,907,800
shares of Mid-State Stock. The presence, either in person or by properly
executed proxies, of the holders of a majority of the outstanding shares of
Mid-State Stock is necessary to constitute a quorum at the Mid-State Meeting.
Abstentions will be counted for purposes of establishing a quorum.
VOTE REQUIRED
Mid-State shareholders are entitled to one vote at the Mid-State Meeting for
each share of Mid-State Stock held of record by them on the Mid-State Record
Date. The proposal concerning approval of the Agreement and the transactions
contemplated thereby requires the affirmative vote of a majority of the
outstanding shares entitled to vote. In connection with the election of
directors, shares of Mid-State Stock are entitled to be voted cumulatively if a
candidates's or candidates' name(s) have been properly placed in nomination
prior to the voting and a shareholder present at the Mid-State Meeting has given
notice of his or her intention to vote his or her shares cumulatively. If a
shareholder has given such notice, all shareholders may cumulate their votes for
candidates in nomination. Cumulative voting entitles a shareholder to give one
nominee as many votes as is equal to the number of directors to be elected
multiplied by the number of shares of Mid-State Stock owned by such shareholder,
or to distribute his or her votes on the same principle between two or more
nominees as he or she deems appropriate. The seven candidates receiving the
highest number of votes will be elected. If cumulative voting is declared at the
Mid-State Meeting, votes represented by proxies delivered pursuant to this Joint
Proxy Statement/Prospectus may be
30
<PAGE>
cumulated in the discretion of the proxy holders, in accordance with the
recommendations of the Board of Directors.
As of the Mid-State Record Date, directors and executive officers of
Mid-State beneficially owned an aggregate of 631,024 shares of Mid-State Stock
(not including shares issuable upon exercise of stock options), or approximately
9.1% of those outstanding as of the Mid-State Record Date. Abstentions and
broker non-votes with respect to the proposal concerning approval of the
Agreement and the transaction contemplated thereby will have the same effect as
a vote "AGAINST" the proposal.
THE BANCORP MEETING
DATE, TIME AND PLACE
The Bancorp Annual Meeting (the "Bancorp Meeting") is scheduled to be held
at 2739 Santa Maria Way, Santa Maria, California 93455 on Thursday, June 18,
1998 at 7:00 p.m., local time.
BANCORP SHAREHOLDERS ARE REQUESTED TO PROMPTLY SIGN, DATE AND RETURN THE
ACCOMPANYING PROXY CARD IN THE ENCLOSED POSTAGE-PAID PRE-ADDRESSED ENVELOPE.
FAILURE TO RETURN A PROPERLY EXECUTED PROXY CARD OR TO VOTE AT THE MEETING WILL
HAVE THE SAME EFFECT AS A VOTE AGAINST THE PRINCIPAL TERMS OF THE MERGER AND
OTHER MATTERS TO BE VOTED UPON IN CONNECTION WITH THE MERGER.
MATTERS TO BE CONSIDERED AT THE MEETINGS
The purpose of the Bancorp Meeting is to (a) consider and vote upon the
approval of the principal terms of the Agreement and the transactions
contemplated thereby; (b) elect eleven (11) directors until the 1999 Annual
Meeting and until their successors are elected and have qualified, with eight
(8) such nominees resigning upon consummation of the Agreement; (c) as required
by the Agreement, to approve proposed amendments to the Bancorp's 1996 Stock
Option Plan that would allow the granting of substitute stock options to
officers and employees of the Bancorp and the Bank and certain directors of the
Bancorp and the Bank that will continue as directors of the Bancorp and
Mid-State, under specified terms and conditions; and (d) consider and act upon
such other business as may properly come before the Bancorp Meeting or any
adjournments or postponements thereof.
THE BANCORP BOARD HAS, BY UNANIMOUS VOTE, APPROVED THE AGREEMENT AND
RECOMMENDS A VOTE "FOR" APPROVAL OF THE PRINCIPAL TERMS OF THE MERGER. THE
BANCORP BOARD ALSO RECOMMENDS A VOTE "FOR" THE ELECTION OF THE ELEVEN (11)
DIRECTORS UNTIL THE 1999 ANNUAL MEETING, UNTIL THEIR SUCCESSORS ARE ELECTED AND
HAVE QUALIFIED. THE BANCORP BOARD ALSO RECOMMENDS A VOTE "FOR" APPROVAL OF THE
PROPOSED AMENDMENTS TO THE BANCORP'S 1996 STOCK OPTION PLAN.
RECORD DATE; STOCK ENTITLED TO VOTE
The Bancorp Board has fixed the close of business on May 1, 1998, as the
Bancorp Record Date for the determination of shareholders entitled to notice of,
and to vote at, the Bancorp Meeting. Accordingly, only holders of record of
shares of Bancorp Stock at the close of business on the Bancorp Record Date will
be entitled to vote at the Bancorp Meeting and any adjournment thereof. As of
Bancorp Record Date, there were 3,008,639 shares of Bancorp Stock outstanding,
held by approximately 2,000 shareholders of record.
VOTES REQUIRED; QUORUM
The affirmative vote of the holders of at least a majority of the total
number of outstanding shares of Bancorp Stock entitled to vote at the Bancorp
Meeting is required to approve the principal terms of the Agreement and the
proposed amendments to the 1996 Stock Option Plan. In the Election of Directors,
the
31
<PAGE>
eleven (11) nominees receiving the highest number of votes will be elected until
the next annual meeting and until their successors are elected and have
qualified.
Each holder of shares of Bancorp Stock outstanding on the Bancorp Record
Date will be entitled to one vote for each share held of record upon each matter
properly submitted at the Bancorp Meeting and any postponement or adjournment
thereof. In connection with the Election of Directors, shares of Bancorp Stock
are entitled to be voted cumulatively if a candidate's or candidates' names(s)
have been properly placed in nomination prior to the voting and a shareholder
present at the Bancorp Meeting has given notice of his or her intention to vote
his or her shares cumulatively. If a shareholder has given such notice, all
shareholders may cumulate their votes for candidates in nomination. Cumulative
voting entitles a shareholder to give one nominee as many votes as is equal to
the number of directors to be elected multiplied by the number of shares of
Bancorp Stock owned by such shareholders, or to distribute his or her votes on
the same principle between two or more nominees as he or she deems appropriate.
The eleven candidates receiving the highest number of votes will be elected. If
cumulative voting is declared at the Bancorp Meeting, votes represented by
proxies delivered pursuant to this Joint Proxy Statement/ Prospectus may be
cumulated in the discretion of the proxy holders, in accordance with the
recommendations of the Board of Directors.
As of the Bancorp Record Date, directors and executive officers of the
Bancorp held an aggregate of 731,133 shares of Bancorp Stock, or approximately
24.3% of those outstanding as of the Bancorp Record Date. Abstentions and broker
non-votes with respect to the proposed concerning approval of the Agreement and
the transaction contemplated thereby will have the same effect as a vote
"AGAINST" the proposal.
The Bancorp will appoint one or three employees to function as inspectors of
the election in advance of the Bancorp Meeting, to tabulate votes, to ascertain
whether a quorum is present and to determine the voting results on all matters
presented to the Bancorp Shareholders. A majority of all shares of Bancorp Stock
entitled to vote, represented in person or by proxy, constitutes a quorum.
Abstentions and broker non-votes are each included in the determination of the
number of shares present; however, they are not counted as votes in favor of the
principal terms of the Merger. THE FAILURE TO VOTE, AN ABSTENTION OR A BROKER
NON-VOTE THUS HAS THE SAME EFFECT AS A VOTE AGAINST THE PRINCIPAL TERMS OF THE
AGREEMENT.
If a quorum is not obtained, or fewer shares of Bancorp Stock are voted in
favor of the principal terms of the Agreement than the number required for
approval of the principal terms of the Agreement, it is expected that the
Bancorp Meeting will be postponed or adjourned for the purpose of allowing
additional time for obtaining additional proxies or votes, and at any subsequent
reconvening of the Bancorp Meeting, all proxies will be voted in the same manner
as such proxies would have been voted at the original convening of the Bancorp
Meeting (except for any proxies which have theretofore effectively been revoked
or withdrawn).
VOTING OF PROXIES
Shares represented by proxies properly executed and received in time to be
voted at the Meeting will be voted in accordance with the instructions indicated
on the proxies. Proxies which do not contain voting instructions will be voted
"FOR" the proposal to approve the principal terms of the Agreement, "FOR" the
proposed amendments to the 1996 Stock Option Plan, and "FOR" the election of
directors. All proxies voted "FOR" such matters, including proxies on which no
instructions are indicated, may, at the discretion of the proxy holder, be voted
"FOR" a motion to adjourn or postpone the Bancorp Meeting to another time and/or
place for the purpose of soliciting additional proxies or otherwise; provided,
however, that no proxy which is voted against approval of the principal terms of
the Agreement or on which the relevant shareholder specifically abstains from
voting with respect to such approval will be voted in favor of any such
adjournment or postponement.
32
<PAGE>
It is not expected that any matter other than as described herein will be
brought before the Meeting. If, however, other matters are properly brought
before the Meeting, persons appointed as proxies will have discretion to vote or
act thereon in their best judgment.
REVOCABILITY OF PROXIES
The presence of a shareholder at the Bancorp Meeting (or at any postponement
or adjournment thereof) will not automatically revoke such shareholder's proxy.
However, a shareholder may revoke a proxy at any time prior to its exercise by
(a) delivery to the Secretary of the Bancorp of a written notice of revocation
prior to or at the Bancorp Meeting (or, if the Bancorp Meeting is adjourned or
postponed, prior to or at the time the adjourned or postponed meeting is
actually held); (b) submission of a duly executed proxy bearing a later date; or
(c) attending the Bancorp Meeting (or, if such Meeting is adjourned or
postponed, by attending the adjourned or postponed meeting) and voting in person
thereat. Any written revocation of proxy or other related communications should
be addressed to William L. Snelling, Secretary, BSM Bancorp, 2739 Santa Maria
Way, Santa Maria, California 93455.
SOLICITATION OF PROXIES
Directors and officers of the Bancorp and its subsidiary may solicit proxies
from shareholders of Bancorp personally or by telephone or telegram without
additional remuneration therefor. The Bancorp will also provide persons, firms,
banks and corporations holding shares in their names or in the names of
nominees, which in any case are beneficially owned by others, with proxy
materials for transmittal to such beneficial owners and will reimburse such
record owners for their expenses of doing so. The Bancorp will bear the cost of
solicitation of proxies from its own shareholders.
THE MERGER
The Agreement provides for, among other things, (i) the merger of the Bank
with and into Mid-State with Mid-State as the surviving bank, (ii) Bancorp
becoming the bank holding company for Mid-State and changing its name to
"Mid-State Bancshares" and (iii) the shareholders of Mid-State becoming
shareholders of Bancorp in accordance with the Exchange Ratio, all subject to
the terms and conditions specified in the Agreement. The transaction was
structured in the foregoing manner in order to preserve and utilize Bancorp, the
newly established holding company for the Bank. Mid-State considered that
operating the combined banks under the ownership of a holding company would
provide increased flexibility in responding to evolving changes in the banking
and financial services industries and meeting the competition of other financial
institutions.
Certain provisions of the Agreement are summarized below. This summary does
not purport to be complete and is qualified in its entirety by reference to the
complete text of the Agreement, which is reprinted as Appendix A to this Joint
Proxy Statement/Prospectus and is incorporated herein by reference. Shareholders
of Mid-State and Bancorp are urged to read the Agreement in its entirety.
BACKGROUND AND REASONS FOR THE MERGER AND MANAGEMENT'S RECOMMENDATION--MID-STATE
The Board of Directors of Mid-State began to consider the possibility of a
merger or acquisition during the fourth quarter of 1996. In the current
financial services environment, a merger or acquisition would support
Mid-State's strategic objective of remaining a preeminent independent financial
services provider in San Luis Obispo and Santa Barbara Counties, while
strengthening management, growth opportunities and profitability. Furthermore,
it is believed that Mid-State, as a larger independent bank, will be able to
compete with major banks in the communities served, providing superior products
and services to the marketplace.
33
<PAGE>
In early 1997, representatives of Mid-State and the Bank met to discuss
Mid-State's interest in a possible business combination with the Bank.
Thereafter, representatives of Bancorp and Mid-State had further sporadic
discussions reaffirming Mid-State's interest in a potential business
combination.
In September 1997, Mid-State was contacted as one of several potential
acquirors and asked if Mid-State would be interested in making an offer to
acquire Bancorp. In 1997 Mid-State sent a letter of interest to Bancorp
outlining its proposal with information on pricing, organizational structure and
board and mangement alignment. Based upon this proposal, Mid-State was asked to
conduct due diligence and submit an offer.
In November Mid-State conducted extensive due diligence of Bancorp and Bank
including interviews with senior management. Mid-State submitted a revised
proposal to Bancorp in December 1997 and the Parties and their respective
investment bankers thereafter discussed the Mid-State proposal. Mid-State
informed Bancorp that Mid-State would be willing to negotiate subject to a
signed exclusivity agreement and entered into an exclusivity agreement with
Bancorp on December 24, 1997. After further discussions among the advisors and
special committees, Mid-State began drafting a definitive agreement. During this
drafting, Bancorp conducted an extensive due diligence review of Mid-State. Both
Parties' Boards of Directors reviewed the definitive agreement with their
respective lawyers and financial advisors including certain financial analyses
and other data. In addition, on January 27, 1998 both Parties held Board of
Directors meetings where they received oral opinions from their respective
advisors that the proposed business combination was fair from a financial point
of view to their respective shareholders and approved the Agreement and other
ancillary matters. The Agreement was subsequently amended on March 27, 1998 to
correct technical errors prior to submitting it for shareholder approval.
Culturally, it is important to Mid-State's Board of Directors to continue to
offer local management and ongoing support to the communities Mid-State has
served since its founding. That same philosophy is shared by the Bank and, as a
result of that conviction, provides a great opportunity to combine the two
institutions. The Bank possesses an excellent customer and deposit base in
Northern Santa Barbara and San Luis Obispo Counties which compliments
Mid-State's existing customer and deposit base and provides the combined
organization a more competitive share of the market in these Counties.
The Board and management of Mid-State also anticipate that the Merger will
provide the potential to benefit from revenue enhancement opportunities. These
opportunities result from, among other factors; (1) the enhanced ability to
better serve the marketplace; (2) the ability to cross-sell a wider variety of
banking products and services; (3) the ability to generate increased loan and
fee income by providing higher lending limits; (4) the potential to increase
overall market share in the communities served; (5) the opportunity to increase
the loan portfolio; and (6) the ability to create more efficiencies through
staff reductions, facilities closures, and consolidation of data processing,
centralized back office loan and operating functions, thereby reducing overall
operating costs by approximately $2.2 million. Additionally, the Board of
Directors also considered that the larger size of the surviving bank, along with
Mid-State's intention to list the Bancorp Stock on Nasdaq National Market, would
increase shareholder liquidity.
In reaching its conclusion to make an offer, Mid-State's Board of Directors
considered information and advice from several specialists including investment
bankers and legal advisors. After consideration of the financial performance,
business operations, capital levels, and asset quality of the Bank and Bancorp,
it was decided to submit an offer through the investment advisor engaged by
Bancorp's management. It was important that the terms of the Agreement and the
structure of the transaction allowed Mid-State shareholders to retain
approximately 70% of the common equity of the combined institutions, thereby
ensuring the survival of the Mid-State name and franchise, retaining its local
identity and control, with the Board of Directors having the same percentage
representation. It was deemed important that the current directors of the Bank
and Bancorp have some representation on the Board of Mid-State, solidifying the
approval of the transaction, and reinforcing the local ownership and commitment.
34
<PAGE>
The Board of Directors of Mid-State believes that the terms of the Merger
are fair to and in the best interests of Mid-State and its shareholders. All
material factors considered by the Mid-State Board have been disclosed. In
addition to the considerations already described, in unanimously approving the
Agreement, the Board of Directors considered a number of factors, including the
following, without assigning any specific or relative weights to the factors:
(i) The Board of Directors believes that the Exchange Ratio provided for
in the Agreement represents fair consideration. In addition, Mid-State's
investment banking firm for the transaction concluded that the terms of the
Merger are fair to the stockholders of Mid-State from a financial point of
view.
(ii) It is anticipated that the Merger will increase the liquidity of
the stock by expanding the size of the shareholder base.
(iii) Because of the relatively low loan-to-deposit ratio at Mid-State,
it is expected that the Merger will result in better opportunities to lend
to a more diverse customer base.
(iv) The Merger is expected to result in a strong, deep management team
that will allow Mid-State to address more effectively changes in technology,
regulation, competition, products and services.
(v) The capital of the combined institutions will provide an excellent
opportunity to expand and leverage the overall expense structure of the
combined institutions.
Accordingly, the Mid-State's Board of directors has approved the Agreement
and the transactions contemplated thereby and recommends approval of the same by
the shareholders of Mid-State.
BACKGROUND AND REASONS FOR THE MERGER AND MANAGEMENT'S RECOMMENDATION--BANCORP
BSM Bancorp is proud of its community bank roots, and its banking philosophy
is deeply steeped in the independent bank tradition of customer service and
community involvement. In late 1994 and early 1995, the Board of Directors of
the Bank, now the wholly-owned subsidiary of the Bancorp, recognized that it was
becoming increasingly difficult for the Bank to compete with larger banks that
had penetrated the Bank's service area, and that the Bank needed to be larger in
order to compete more effectively. The Bank became actively involved in the
acquisition of other banks located in the central coast area of California.
Following all necessary regulatory and shareholder approvals, on September
8, 1995, the Bank acquired Templeton National Bank ("Templeton") pursuant to an
Agreement and Plan of Reorganization dated March 10, 1995, providing for the
merger of Templeton with and into the Bank. As of the effective date of the
merger, Templeton's deposits were approximately $24 million and loans were
approximately $18 million.
Following all necessary regulatory and shareholder approvals, on May 3,
1996, the Bank acquired Citizens National Bank of Paso Robles, N.A. ("Citizens")
pursuant to an Agreement and Plan of Reorganization dated October 30, 1995,
providing for the merger of Citizens with and into the Bank. As of the effective
date of the merger, Citizens' deposits were approximately $29 million and loans
were approximately $18 million.
Following all necessary regulatory and shareholder approvals, on January 10,
1997, the Bank acquired El Camino National Bank ("El Camino") pursuant to an
Agreement and Plan of Reorganization dated July 16, 1996, providing for the
merger of El Camino with and into the Bank. As of the effective date of the
merger, El Camino's deposits were approximately $16 million and loans were
approximately $12 million.
35
<PAGE>
The Board of Directors and management of the Bank recognized that in order
to continue to evolve and grow, to enhance shareholder value and to provide a
broader range of options with respect to access to additional capital,
possibilities for expansion of the Bank's branch system and expanded abilities
in the financial services area, following all necessary regulatory and
shareholder approvals, on March 12, 1997, the Bank completed the formation of
the Bancorp as its holding company. All of the Bank's shareholders became
shareholders of the Bancorp, with the same Board of Directors and executive
management as the Bank.
From time to time in 1995, 1996 and 1997, and also following the completion
of the formation of the Bancorp, the Bank had meetings and discussions with a
number of central coast-based institutions with respect to potential
acquisitions and business combinations. The institutions contacted were only
those institutions that focused on the community-based approach to banking and
were located in markets that would provide the Bank and the Bancorp with both
strategic and synergistic benefits. However, the diminishing number of potential
acquisition candidates, and the increased competition for available acquisition
targets, caused the Bancorp to begin to review its strategic alternatives.
In early 1997, representatives of Mid-State and the Bank met to discuss
Mid-State's interest in a possible business combination with the Bank.
Thereafter, representatives of the Bancorp and Mid-State had further sporadic
conversations reaffirming Mid-State's interest in a potential business
combination.
In July 1997, the Bancorp engaged Carpenter to assist it in analyzing
strategic alternatives and identifying opportunities for maximizing shareholder
value. In July, 1997, Carpenter made a presentation to the Bancorp as to the
strategic alternatives available to the Bancorp, including staying the present
course, growing through acquisitions and combining the Bancorp and the Bank with
a third party. The Bancorp believed that pursuing acquisitions was the better
strategy in pursuing growth objectives, but all alternatives would be discussed
in order to maximize shareholder value. Carpenter also outlined various
scenarios for acquisitions of the Bancorp by in-state and out-of-state regional
and super-regional financial institutions that were deemed to be likely
acquirors. No decision was made as to the appropriate course of action, although
management was authorized to prepare materials to assist with a discreet inquiry
of potential acquirors in determining the values that might be received by
Bancorp shareholders in a business combination transaction.
Carpenter then reviewed several possible candidates that the Bancorp may
have an interest in acquiring, and Carpenter contacted several would-be
acquirors. The possible candidates that the Bancorp may have an interest in
acquiring were all rejected as either too expensive, time consuming or for other
reasons. However, several would-be acquirors were identified. In August and
September 1997, Carpenter and management of the Bancorp prepared background
materials on the Bancorp for evaluation by prospective acquirors. Mid-State
reviewed such materials and began its preliminary analysis with regard to a
potential transaction to determine the viability of a potential merger, and
thereafter a preliminary non-binding expression of interest was delivered by
Mid-State to the Bancorp in October 1997. Mid-State's preliminary non-binding
indication of interest presented two alternatives. The first alternative
provided for a financial structure of a tax free exchange of stock to be
accounted for on a pooling of interests basis, with the Bancorp shareholders
receiving value equal to $27.25 per share, a 15% reciprocal collar based upon
Mid-State price at the time of closing, Board representation in which Mid-State
would expand its board membership by three members who would be appointed from
the Bancorp Board, with the Chairman of the Bancorp offered the position of Vice
Chairman of the new bank board, and either the exercise of all outstanding
Bancorp options or redemption of such options through a cashless exercise. The
second alternative provided for a financial structure of 50% cash and 50% stock
accounted for as a purchase transaction and allowing for a pro-rata election of
cash or stock by each Bancorp shareholder, value received to be equal to $23.25
per share for each Bancorp share, a 15% reciprocal collar based upon the
Mid-State price at the time of closing, Board representation in which Mid-State
would expand its board membership by two members who would be appointed from the
Bancorp Board, with the Chairman of the
36
<PAGE>
Bancorp offered the position of vice chairman of the new bank board, and either
the exercise of all outstanding Bancorp options or redemption of such options
through a cashless exercise.
Following a review of various preliminary indications of interest submitted
to the Bancorp and a discussion thereof with Carpenter, management proceeded
with further discussions with four prospective purchasers, one of which was
Mid-State, and each of which was afforded the opportunity to conduct expanded
due diligence of the Bancorp. During the due diligence, Mid-State revised its
preliminary analysis. All of the interested parties made presentations and
conducted a review of the books and records of the Bancorp pursuant to the terms
and conditions of various confidentiality agreements. The four interested third
parties made presentations to the Bancorp, outlining the various proposed
transactions and the projected benefits of such transaction. The presentations
by representatives of Mid-State and Carpenter emphasized the complementary
nature of Mid-State's proposal and potential synergies, including the
complementary nature of the two companies' loan, deposit and management styles.
The Mid-State proposal also offered the highest price per share of the four
proposals.
In November, 1997, the principals of the Bancorp and Mid-State met to
preliminarily discuss the possible synergies between the companies. In December,
1997, Carpenter advised the Bancorp that Mid-State had shown the most interest
as a would-be acquiror. Carpenter based that statement on Mid-State's offer
price, which was the highest submitted, and on the other terms of the Mid-State
proposal, including representation for Bancorp shareholders on the Board of
Directors of the combined company and a commitment to list the shares of the
combined company on the Nasdaq. The Bancorp and Mid-State thereafter continued
to discuss a possible combination of the companies. On December 9, 1997,
Mid-State presented a revised offer to the Bancorp that provided for a financial
structure of a tax-free exchange of stock to be accounted for on a
pooling-of-interest basis, with the Bancorp shareholders receiving value equal
to $28.25 per share, a 15% reciprocal collar based upon the Mid-State share
price at the time of closing, Board representation in which Mid-State would
expand its board membership by three members who will be appointed from the
Bancorp Board, with the Chairman of the Bancorp offered the position of
Vice-Chairman of the new bank Board, Mid-State's belief that it is critical that
Mr. William Hares continue in a significant role in the combined bank, and
either the exercise of all outstanding Bancorp options or redemptions of such
options through a cashless exercise.
After an extensive review of the various proposals, which review included,
among other things, an analysis of the financial health, management structure
and future prospects of the four potential acquirors, and after extensive
negotiating, in December 1997, the Bancorp executed a non-binding expression of
interest letter with Mid-State that outlined the general terms and conditions of
a proposed transaction with Mid-State, including the transaction would be a
tax-free exchange of stock to be accounted for as a pooling of interests, the
final structure of the transaction will be determined by the parties in
connection with discussions concerning the definitive agreement; the total value
in Mid-State Common Stock would be equal to $29.37 per share; each holder of a
Bancorp stock option would be provided the opportunity to receive either (i) the
value of Bancorp stock options in Mid-State Stock, or (ii) if permitted,
converting the value of such options into options of Mid-State Stock so that the
value of such options is preserved; the amount of Mid-State Stock to be issued
in the exchange would be determined based upon the Mid-State Stock twenty day
average price per share just prior to the time of closing, subject to a 7.5%
collar; Mid-State would expand its Board of directors and any holding company it
should form to include three (3) members of the Board of Directors of the
Bancorp, and the Chairman of the Bancorp shall be appointed to the position of
Vice Chairman of the Board of Mid-State and any holding company it should form;
William Hares would receive an appropriate employment contract to be agreed upon
by the parties at the time of execution of a definitive agreement; an agreed
upon amount of payment for any layoffs of employees of the Bancorp and the Bank;
an amount of payment to Mid-State if the Bancorp should enter into an
alternative transaction before the definitive agreement is executed; listing of
Mid-State Stock on Nasdaq National Market System; and the payment of a
semi-annual dividend by the Bancorp.
37
<PAGE>
In connection with its analysis of the fairness of the transaction, the
Bancorp retained Carpenter to advise it as to fairness to the Bancorp
shareholders from a financial point of view of the exchange of Bancorp stock to
be received by the Mid-State shareholders when the shareholders of Mid-State
become shareholders of the Bancorp.
On January 27, 1998, the Bancorp Board met to consider the transaction and
to review the Agreement and related documents. At this meeting, Carpenter
discussed with the Bancorp Board its analysis of the Merger and delivered to the
Bancorp Board its opinion that the consideration to be received in the Merger
was fair to the Bancorp shareholders from a financial point of view (see
"Bancorp Fairness Opinion"). Thereafter, the Bancorp Board approved, and
authorized the execution of, the Agreement.
The Bancorp Board unanimously approved the Merger at its Board of Directors
meeting on January 27, 1998. The Bancorp Board believes that the terms of the
Merger are fair to, and in the best interests of, the Bancorp and its
shareholders and recommends that the shareholders of the Bancorp vote FOR
approval of the Merger.
In reaching its conclusion, the Bancorp Board considered information
provided at meetings of its Board of Directors in December 1997 and January
1998, including, among other things, (i) information concerning the financial
performance and condition, business operations, capital levels, asset quality,
loan portfolio breakdown and prospects of Mid-State Bank; (ii) the structure of
the transaction, including the fact that the Bancorp shareholders would retain
approximately 30% of the common equity of the Mid-State on a fully diluted
basis; (iii) the fact that Mr. Diani would serve as Vice Chairman of the Board
of Directors of the Mid-State, and that the Board of Directors of Mid-State
would be comprised of three directors from the Bancorp; (iv) the terms of the
Agreement and other documents to be executed in connection with the Merger,
including the covenant of Mid-State in the Agreement allowing the Bancorp to pay
semi-annual dividends to the shareholders of the Bancorp; (v) the presentation
of Carpenter and the opinion of Carpenter that the Merger is fair to the
shareholders of the Bancorp from a financial point of view; (vi) the results of
its due diligence examination of Mid-State; (vii) the terms of other recent
comparable combinations of banks and bank holding companies; (viii) the Bancorp
Board's review with its legal and financial advisors of alternatives to the
Merger, the range of possible values to Bancorp shareholders obtainable through
implementation of alternatives and the timing and likelihood of the same; (ix)
the current and prospective economic environment and regulatory and competitive
burdens and constraints facing community banks; (x) the pro forma financial
statements of the combined companies and the capitalization of the combined
companies; (xi) the Bancorp Board's review with its legal and financial advisors
of potential merger targets; (xii) the compatibility of the Bancorp with
Mid-State and the complementary lines of business; (xiii) the geographic
distribution of Mid-State offices vis-a-vis the Bancorp's strategic plan; (xiv)
the advantages of being part of a larger entity, including the potential for
operating efficiencies, the effect of a higher lending limit on the Bank's
customers and prospective customers, and the generally higher trading multiples
of larger financial institutions; (xv) the business strategies, the strength and
depth of management of Mid-State and the extent of their interest in continuing
the Bank's significant business relationships in Santa Barbara and San Luis
Obispo counties; (xvi) the ability of a larger institution to compete in the
banking environment and to leverage overhead costs; (xvii) the effect of the
Merger on existing shareholders, employees, officers and customers of the
Bancorp and the Bank; (xviii) the current and prospective economic environment
and regulatory and competitive burdens and constraints facing commercial banks;
(xix) information concerning the ability of Mid-State and the Bancorp to achieve
operating efficiencies; (xx) the impact on the communities served by the Bank
and Mid-State in the Merger, and the increased ability to serve the communities
through the larger branch network; (xxi) the unprecedented consolidation
currently underway in the banking industry and increased competition from larger
independent banks in California; (xxii) the value of the consideration offered
by Mid-State compared to the value of the consideration offered in other
acquisitions of financial institutions in California in 1996 and 1997 and the
prospects for enhanced value of the combined entity in the future; (xxiii) the
tax-free nature of the Mid-State offer; (xxiv) the fact that Bancorp Stock will
38
<PAGE>
be listed on Nasdaq National Market System and the future liquidity of the
Bancorp Stock; (xxv) the prospects and valuation of the Bancorp on a stand alone
basis and on the basis of alternative stand alone strategies, such as dividends,
share repurchases, restructurings and growth through acquisitions; and (xxvi)
the willingness of Mid-State to provide Bancorp shareholders with certain
protections against fluctuations within certain ranges in the Exchange Ratio.
The Board specifically considered the following information in its review of
these factors: (i) the contribution of each of Bancorp and Mid-State to, among
other things, total tangible common equity, assets, LTM net income, and gross
loans of the pro forma combined companies, which showed that based on pro forma
combined balance sheets for Bancorp and Mid-State for 1997, Bancorp would have
contributed 31.6% of shareholders equity, 29.0% of assets, and 35.4% of loans,
(ii) that pro forma income statements indicated that Bancorp would have
contributed 30.6% of the pre-tax net income and 23.8% of the after-tax net
income of the pro forma combined companies based on 1997 earnings (iii) that
Bancorp's contribution to projected 1998 after-tax earnings of the combined
companies would be 23.7%; (iv) that based upon analysis assuming an Average
Closing Price of Mid-State Stock of $30.50 (the highest level provided for in
the Agreement) and, therefore, an Exchange Ratio in the Merger of 1.0385 a share
of Bancorp Stock for each share of Mid-State Stock, holders of Bancorp Stock
would own approximately 31% of the combined companies based on fully diluted
shares outstanding; (v) that return on assets and return on equity of Mid-State
for each of the years ending December 31, 1994 through 1997, were respectively
- -1.4% and -18.0%, 0.09% and 1.16%, 0.58% and 7.2%, and 1.6% and 18.9%; (vi) that
return on assets and return on equity of Bancorp for each of the fiscal years
ending December 31, 1994 through 1997, were 1.1% and 11.6%, 1.3% and 12.9%, 1.3%
and 12.9%; and 1.3% and 12.7%, respectively; (vii) that on a pro-forma basis for
fiscal year 1997 and on a pro-forma basis for projected 1998 the Merger would be
accretive to Bancorp earnings per share by approximately 25% without any
consolidation savings and approximately 35% with consolidation savings equal to
20% of Bancorp non-interest expense: (viii) that the consideration to be
received by the holders of Bancorp Stock in the Merger represented a premium to
core deposits of 20.2%, a multiple of price to book value of 250.4%, a multiple
of price to tangible book value of 263.1%, and a multiple of price to Bancorp's
year end 1997 earnings of 21.5x., as compared to multiples in merger
transactions for all California banks with total assets between $200 million and
$500 million for the period 1996-1997 of median percentage of premium to core
deposits of 10.2%, average multiple of purchase price to book value 195.2%,
average multiple of purchase price to tangible book value of 203.7%, and median
multiple of purchase price to LTM earnings of 16.6x; (ix) that the trading
volumes in calendar 1997 for Mid-State Stock averaged 5,370 shares traded per
day, while trading volume for Bancorp Stock averaged 1,420 shares a day during
1997; (x) that the merged companies would have the largest deposit market share
of any bank in San Luis Obispo County and north Santa Barbara County; and (xi)
at $29.37 per share, the price offered by Mid-State was the highest price
offered per share. These quantitative considerations, in addition to the other
qualitative material factors stated above, led the Board to conclude that the
Merger, as compared to remaining independent, offered substantially better
prospects for shareholder value with respect to earnings per share, liquidity,
and franchise value. The Board further concluded that the Mid-State offer was
superior to the average of prices paid in similar transactions over the last two
years, was superior in price and terms to any other proposals received by
Bancorp, and that acceptance of the offer offered the possibility of
substantially increasing the liquidity of Bancorp Stock. For all of these
reasons, the Board concluded that it was in the best interests of shareholders
to recommend approval of the Merger.
With specific reference to the value of $29.37 placed on Bancorp Stock in
the Exchange Ratio, the Board of Directors of Bancorp considered (a) that the
value of $29.37 was the highest value offered for Bancorp Stock by any party
solicited for expressions of interest in a merger with or acquisition of
Bancorp, (b) that the value of $29.37 was immediately accretive to Bancorp
earnings per share and book value per share, (c) that a value of $29.37 per
share was higher than the average price to book, price to earnings, price to
assets, and premium to core deposits paid in comparable transactions and (d)
that the value of $29.37 was an 11% premium to the closing price of Bancorp
Stock on the day prior to the announcement
39
<PAGE>
of the Merger and a 53% premium to the closing price of Bancorp Stock as of
September 30, 1997, the time at which Bancorp had begun serious discussions with
potential merger partners.
The foregoing discussion of the information and factors considered by the
Bancorp Board is not intended to be exhaustive, but constitutes the material
factors considered by the Bancorp Board. In reaching its determination to
approve and recommend the principal terms of the Merger, the Bancorp Board did
not assign relative or specific weights to the foregoing factors and individual
directors may have weighed such factors differently
FOR THE REASONS SET FORTH ABOVE, THE BANCORP BOARD HAS UNANIMOUSLY APPROVED
THE AGREEMENT AS IN THE BEST INTEREST OF THE BANCORP AND ITS SHAREHOLDERS AND
UNANIMOUSLY RECOMMENDS THAT THE BANCORP SHAREHOLDERS APPROVE THE PRINCIPAL TERMS
OF THE AGREEMENT.
MID-STATE FAIRNESS OPINION
Mid-State retained H&A to render financial advisory and investment banking
services in connection with the proposed merger among Mid-State, Bank and
Bancorp. H&A has rendered a written opinion (the "Opinion") to the Mid-State
Board of Directors to the effect that the Exchange Ratio as defined in section
1.1 of the Agreement, which definition includes certain possible adjustments, is
fair to the holders of Mid-State Stock from a financial point of view. No
limitations were imposed by the Mid-State Board of Directors upon H&A with
respect to the investigations made or procedures followed in rendering the
Opinion.
The text of the Opinion of H&A, dated as of January 29, 1998 which sets
forth certain assumptions made, matters considered and limits on the review
undertaken by H&A, is attached hereto as Appendix B. Mid-State shareholders are
urged to read the Opinion in its entirety. In furnishing such Opinion, H&A does
not admit that it is an expert with respect to the Registration Statement of
which this Joint Proxy Statement/Prospectus is part within the meaning of the
term "experts" as used in the Securities Act and the rules and regulations
promulgated thereunder nor does it admit that its opinion constitutes a report
or valuation within the meaning of Section 11 of the Securities Act. The summary
of the procedures and analysis performed, and assumptions used by H&A set forth
in this Joint Proxy Statement/Prospectus is qualified in its entirety by
reference to the text of such Opinion. H&A's Opinion is directed to the Mid-
State Board of Directors and is directed only to the consideration to be paid by
Mid-State in the Merger and does not constitute a recommendation to any
Mid-State shareholder as to how such shareholder should vote at the Mid-State
Meeting.
In arriving at its opinion, H&A has reviewed and analyzed, among other
things, the following: (i) the Agreement; (ii) certain publicly available
financial and other data with respect to Mid-State, Bank and Bancorp, including
consolidated financial statements for recent years and interim periods to
September 30, 1997; (iii) certain other publicly available financial and other
information concerning Mid-State and Bancorp and the trading markets for the
publicly traded securities of Mid-State and Bancorp; (iv) publicly available
information concerning other banks and holding companies, the trading markets
for their securities and the nature and terms of certain other merger
transactions H&A believed relevant to its inquiry; and (v) evaluations and
analyses prepared and presented to the Board of Directors of Mid-State or a
committee thereof in connection with the Merger. H&A has held discussions with
senior management of Mid-State and of Bancorp concerning their past and current
operations, financial condition and prospects.
H&A reviewed with the senior management of Mid-State earnings projections
for Mid-State as a stand-alone entity, assuming the Merger does not occur. H&A
also reviewed with the senior management of Bancorp earnings projections for
Bancorp as a stand-alone entity, assuming the Merger does not occur. H&A also
reviewed with the senior management of Mid-State the projected operating cost
savings expected by Mid-State to be achieved in each such year resulting from
the Merger with Bancorp. Certain financial projections for the combined
companies and for Mid-State and Bancorp as stand-alone entities
40
<PAGE>
were derived by H&A based partially upon the projections described above, as
well as H&A's own assessment of general economic, market and financial
conditions.
H&A took into account its assessment of general economic, market and
financial conditions and its experience in other transactions, as well as its
experience in securities valuation and its knowledge of the banking industry
generally. H&A considered such financial and other factors as it deemed
appropriate under the circumstances. H&A's Opinion was necessarily based upon
conditions as they existed and could only be evaluated on the date thereof and
the information made available to H&A through the date thereof.
In conducting its review and in arriving at the Opinion, H&A relied upon and
assumed the accuracy and completeness of the financial and other information
provided to it or publicly available and did not attempt independently to verify
the same. H&A relied upon the management of Mid-State and Bancorp as to the
reasonableness of the financial and operating forecasts, projections and
projected operating cost savings. H&A also assumed, without independent
verification, that the aggregate allowances for loan losses for Mid-State and
Bancorp were adequate to cover such losses. H&A did not make or obtain any
evaluations or appraisals of the property of Mid-State or Bancorp, nor did H&A
examine any individual loan credit files. H&A's Opinion is limited to the
fairness, from a financial point of view, to the shareholders of Mid-State of
the consideration to be paid by Mid-State in the Merger which was determined by
arms length negotiations and does not address Mid-State's underlying decision to
proceed with the Merger.
In connection with rendering its Opinion to the Mid-State Board of
Directors, H&A performed certain financial analyses, which are summarized below.
The summary set forth below does not purport to be a complete description of the
presentation by H&A to Mid-State's Board or of the analyses performed by H&A.
H&A believes that its analysis must be considered as a whole and that selecting
portions of such analyses and the factors considered therein, without
considering all factors and analyses, could create an incomplete view of the
analysis and the processes underlying H&A's Opinion. The preparation of a
Opinion is a complex process involving subjective judgments and is not
necessarily susceptible to partial analysis or summary description. In its
analysis, H&A made numerous assumptions with respect to industry performance,
business and economic conditions, and other matters, many of which are beyond
the control of Mid-State and Bancorp. Any estimates contained in H&A's analyses
are not necessarily indicative of future results or values, which may be
significantly more or less favorable than such estimates. Estimates of values of
companies do not purport to be appraisals or necessarily reflect the prices at
which companies or their securities may actually be sold. None of the financial
analyses performed by H&A was assigned a greater significance by H&A than any
other.
Neither Mid-State nor Bancorp publicly discloses internal management
financial forecasts and projections of the type provided to H&A in connection
with its review of the proposed Merger. Such forecasts and projections were not
prepared with a view towards public disclosure. The forecasts, projections, and
projected operating cost savings prepared by H&A were based on numerous
variables and assumptions which are inherently uncertain, including, without
limitation, factors related to general economic and market conditions.
Accordingly, actual results could vary significantly from those set forth in
such forecasts and projections.
Set forth below is a brief summary of the analysis performed by H&A in
reaching the Opinion. H&A assumed for purposes of its opinion that the Merger
will be accounted for as a pooling of interests transaction under generally
accepted accounting principles. Unless otherwise noted in this analysis, H&A
used a Exchange Ratio of 0.8938 shares of Bancorp Stock at time of closing, the
level at which Mid-State Stock would be exchanged if the Closing Date (as
defined in the Agreement) were the same as the date of the Opinion. The Exchange
Ratio and possible adjustments to the Exchange Ratio were developed pursuant to
extensive negotiations between Mid-State and Bancorp. H&A analyzed certain
effects of the Merger assuming an Exchange Ratio, among others, of 1.0385. The
0.8938 Exchange Ratio does not
41
<PAGE>
necessarily reflect the lowest possible Exchange Ratio under the terms of the
Agreement, and there can be no assurance that the Exchange Ratio as finally
determined in accordance with the Agreement will not be lower than 0.8938. The
analysis also focuses on core financial and operating projections and
statistics, which are not specifically adjusted for non-recurring charges,
unless otherwise stated.
(A) PRO FORMA MERGER AND CONTRIBUTION ANALYSIS H&A analyzed the changes in
the amount of earnings, book value and indicated dividends attributable to one
share of Mid-State Stock before the Merger to those attributable to one share of
Mid-State Stock as a result of the proposed Merger. The following assumptions
regarding earnings and dividends underlie the pro forma results. The analysis
assumes a dividend payout ratio consistent with Mid-State's recent historical
dividend payout ratio. The analysis further assumes, unless otherwise stated,
Merger-related operating cost savings to be fully realized during 1999 and each
year thereafter and assumes the Merger is completed during the third quarter of
1998. These projected operating cost savings represent approximately 8.90% of
the combined institutions' projected non-interest expense on a pre-tax basis.
This level of projected operating cost savings, expressed as a percent of the
combined institutions' projected non-interest expense, is within a range of the
level of operating cost savings, expressed as a percent of the combined
institutions' non-interest expense, achieved in other transactions reviewed by
H&A.
H&A performed pro forma merger analyses assuming the stated earnings
projections and the Merger-related operating cost savings projected by
Mid-State. In addition, H&A analyzed certain pro forma merger scenarios in order
to assess the impact on Mid-State of some levels of volatility in Bancorp's and
Mid-State 's projected earnings as well as volatility of the levels of
Merger-related projected operating cost savings. The impact on Mid-State of
volatility in Bancorp's earnings was shown by calculating pro forma results
assuming Bancorp's earnings as projected, as well as 75% and 125% of Bancorp's
projected earnings. In order to measure the impact on Mid-State of volatility of
Mid-State's earnings to the pro forma results, H&A examined the earnings impact
on Mid-State assuming Mid-State achieved earnings as projected, as well as 75%
and 125% of its projected earnings. The impact on Mid-State of volatility in the
level of Merger-related projected operating cost savings was shown by
calculating pro forma results assuming cost savings as projected, as well as
125% and 75% of projected operating cost savings. H&A analyzed the changes in
earnings, dividends and book value for the years 1999, 2000 and 2001 resulting
from various combinations of the stand-alone and pro forma projected earnings
and cost savings volatility assumptions described above. The analyses showed
that for the year 1999 the change in earnings per share ranged from 32.00% to
- -10.34% and the change in book value per share ranged from 0.60% to -7.15%. For
the year 2000 the change in earnings per share ranged from 35.88% to -10.21% and
the change in book value per share ranged from 4.09% to -7.51%. For the year
2001 the change in earnings per share ranged from 39.88% to -10.08% and the
change in book value per share ranged from 7.41% to -7.79%.
(B) ANALYSIS OF OTHER MERGER TRANSACTIONS H&A analyzed other California
bank merger and acquisition transactions where the total target asset size was
over $100 million and less than $500 million for the periods January 1, 1996 to
December 31, 1997. The transactions analyzed were: Pacific Bank, NA and Sterling
West Bancorp, Zions Bancorporation and FP Bancorp, Inc., SierraWest Bancorp and
California Community Bancshares, Greater Bay Bancorp and Peninsula Bank of
Commerce, City National Corporation and Harbor Bancorp, US Bancorp and Business
& Professional Bank, Dartmouth Capital and Eldorado Bancorp, Western Bancorp and
California Commercial Bankshares, Santa Barbara Bancorp and First Valley Bank,
Golden State Bancorp and Transworld Bancorp, City National Corporation and
Riverside National Bank, Bank SinoPac and Far East National Bank, City National
Corporation and Ventura County National Bancorp, Pacific Capital Bancorp and
South Valley Bancorp, FBOP Corporation and SDNB Financial Corp, First Banks, Inc
and Sunrise Bancorp, Western Bancorp and Western Bank, Dartmouth Capital and
Commerce Security Bank. This analysis showed that the Exchange Ratio represented
a multiple of: (i) 2.58X Bancorp's tangible book value compared to a high
multiple of 3.64X, a median multiple of 1.90X and a low multiple of 1.09X for
the comparable transactions; (ii) 21.30X Bancorp's latest twelve months'
earnings per share, compared to a high multiple of 31.79X, a median
42
<PAGE>
multiple of 17.55X, and a low multiple of 14.36X for the comparable
transactions. H&A noted that no transaction reviewed was identical to the Merger
and that, accordingly any analysis of comparable transactions necessarily
involves complex considerations and judgements concerning differences in
financial and operating characteristics of the parties to the transactions being
compared.
(C) DISCOUNTED CASH FLOW ANALYSIS H&A examined the results of a discounted
cash flow analysis designed to compare the present value, under certain
assumptions, that would be attained if Mid-State remained independent through
2002 or was acquired in 2002 by a larger financial institution, with the present
value of the combined institutions at the Exchange Ratio as described in the
Agreement. The results produced in the analysis did not purport to be indicative
of actual values or expected values of Mid-State or the shares of Mid-State
Stock. In calculating the present values through the discounted cash flow
analysis, H&A analyzed the effect of possible earnings volatility and potential
Merger-related operating cost savings volatility, among other items, by assuming
varying levels of projected earnings for Mid-State and Bancorp. The three cases
examined were: Mid-State earnings as projected and Bancorp earnings as
projected; Mid-State earnings 75% of projected earnings and Bancorp earnings
125% of projected earnings; and Mid-State earnings 125% of projected earnings
and Bancorp earnings 75% of projected earnings. Pro forma combined cash flows
were calculated assuming the combinations of the cash flows in each of these
cases, and were compared to the cash flows of Mid-State on a stand-alone basis
as well as to the cash flows of Mid-State acquired in 2002 by a larger financial
institution. All cases were analyzed assuming realization of the operating cost
savings, in the amounts and time periods previously indicated, unless otherwise
stated (see Pro Forma Merger and Contribution Analysis).
The discount rates used ranged from 8.0% to 12.0%. For the Mid-State
stand-alone analyses, the terminal price multiples applied to 2002 estimated
earnings per share ranged from 14.00X to 22.00X. The lower levels of the
price-to-earnings per share multiples range reflected an estimated future
trading range of Mid-State, while the higher levels of the price-to-earnings per
share multiples were more indicative of a future sale of Mid-State's stock to a
larger financial institution. For the pro forma combined analyses, the terminal
price-to-earnings per share multiples also ranged from 14.00X to 22.00X.
For the Mid-State stand-alone analyses, the cash flows were comprised of the
projected stand alone dividends per share in years 1998 through 2002 plus the
terminal value of Mid-State Stock at year-end 2002 (calculated by applying each
one of the assumed terminal price-to-earnings per share multiples as stated
above to 2002 projected Mid-State earnings per share). For the pro forma
combined analyses, the cash flows were comprised of the projected pro forma
combined dividends per share in years 1998 through 2002 plus the terminal value
of the pro forma combined entity's stock at year-end 2002 (calculated by
applying each one of the assumed terminal price-to-earnings per share multiples
as stated above to 2002 projected pro forma combined earnings per share). H&A
also calculated the present values that would be attained in each case if 75% or
125% of projected operating cost savings were realized.
These analyses showed a range of stand-alone present values per share for
Mid-State from $16.03 to $45.81, as compared to a range of pro forma combined
present values per share of $17.23 to $50.52. In comparison to these ranges of
value, the assumed value for Mid-State Stock on January 28, 1998, the last
trading day before the announcement of the Merger, was its closing price of
$27.50 per share. On May , 1998, the closing price for a share of Mid-State
stock was $ . These analyses do not purport to be indicative of actual
values or expected values of the shares of Mid-State Stock. Discounted present
value analysis is a widely used valuation methodology which relies on numerous
assumptions, including asset and earnings growth rates, dividend payout rates,
terminal values and discount rates. The analysis showed that use of a higher
(lower) level of projected Bancorp earnings raised (lowered) the resulting
present value for a given level of Mid-State earnings, on a pro forma combined
basis. The analysis also showed that use of a lower (higher) discount rate or a
higher (lower) terminal price-to-earnings per share multiple raised (lowered)
the calculated present values.
43
<PAGE>
(D) COMPARABLE COMPANY ANALYSIS H&A examined recent historical data on
Mid-State and Bancorp based upon information from Mid-State and Bancorp's 1996
Annual Reports to Shareholders and subsequent quarterly information. H&A
analyzed certain credit and operating statistics for Mid-State and Bancorp,
comparing these statistics to data for a peer group of California banks using
the publicly available Hoefer & Arnett Banking Universe, 1997 Third Quarter
Statistics (the "Universe"). The Universe includes 73 independent California
banking institutions. Both Mid-State and Bancorp are included in the Universe.
The comparisons made are as of or for the period ending June 30, 1996, unless
otherwise noted. In this analysis, for comparison purposes, H&A used the closing
stock prices of Bancorp and Mid-State which coincide with stock prices and
comparative pricing data which appear in the Universe. The analysis necessarily
involved complex considerations and judgements concerning differences in
financial and operating characteristics of the comparable companies.
<TABLE>
<CAPTION>
BANCORP MID-STATE INDEX MEDIAN
---------- ---------- -------------
<S> <C> <C> <C>
Total assets...................................................... $ 335,829 $ 827,817 $ 229,508
Market capitalization(1).......................................... $ 74,523 $ 184,166 $ 40,793
Price to tangible equity per share(1)............................. 2.27X 2.50X 2.13X
Price to latest 12 months earnings(1)............................. 17.99X 19.72X 16.13X
Tangible equity to tangible assets................................ 10.34% 8.89% 8.92%
Nonperforming assets to total assets(2)........................... 0.61% 1.05% 1.37%
Loan loss reserve to nonperforming loans.......................... 263.53% 261.90% 204.43%
Return on assets.................................................. 1.40% 1.51% 1.37%
Return on equity.................................................. 13.36% 17.14% 15.67%
Efficiency ratio(3)............................................... 62.88% 73.98% 61.51%
</TABLE>
- ------------------------
(1) Statistics calculated based on the latest available bid prices prior to
publishing the third quarter 1997 Universe.
(2) Nonperforming assets include loans which are 90 days past due and still
accruing in addition to nonaccrual and restructured loans and other real
estate owned.
(3) Efficiency ratio represents noninterest expense as a percent of total
revenues.
H&A is an investment banking firm continually engaged in the valuation of
businesses and securities, including financial institutions and their
securities, in connection with mergers and acquisitions, negotiated
underwritings, private offerings of securities, secondary distributions of
listed and unlisted securities and valuations for estate, corporate and other
purposes. H&A is a market maker in both Mid-State and Bancorp Stock. H&A has not
previously provided investment banking services to Mid-State or Bancorp.
In consideration for the rendering of financial advice and for the
preparation and rendering of the Opinion, the Mid-State shall pay H&A a fee to
be paid at closing of approximately $740,000. Mid-State will also reimburse H&A
for all reasonable out of pocket expenses which may be incurred in connection
with the rendering of the Opinion. No portion of the fee is contingent upon the
conclusions reached in the Opinion.
BANCORP FAIRNESS OPINION
GENERAL. Pursuant to an engagement letter dated July 9, 1997 (the
"Engagement Letter"), the Bancorp engaged Seapower Carpenter Capital, Inc. dba
Carpenter & Company ("Carpenter") to provide financial advisory services and a
fairness opinion with respect to the Merger. Carpenter is an investment banking
firm specializing in California financial institutions, and, as part of its
investment banking activities, is regularly engaged in the valuation of
businesses and their securities in connection with merger transactions and other
types of acquisitions, underwritings, private placements and valuations for
corporate and other purposes. Bancorp selected Carpenter to render the opinion
on the basis of its experience and expertise in transactions similar to the
Merger and its reputation in the banking and investment
44
<PAGE>
communities. No limitations were imposed by Bancorp on Carpenter with respect to
the investigations made or procedures followed in rendering its opinion.
At a meeting of the Bancorp Board on January 27, 1998, Carpenter delivered
its oral opinion that, as of the date of the opinion and subject to the
limitations and assumptions set forth in the opinion, the merger consideration
pursuant to the Agreement was fair to Bancorp shareholders from a financial
point of view. Carpenter's oral opinion was subsequently confirmed in writing as
of such date.
The full text of Carpenter's written opinion to the Bancorp Board, which
sets forth the assumptions made, matters considered, and limitations of the
review, by Carpenter, is attached hereto and is incorporated herein by
reference. The following summary of Carpenter's opinion is qualified in its
entirety by reference to the full text of the opinion, which should be read
carefully and in its entirety. In furnishing such opinion, Carpenter does not
admit that it is an expert with respect to the Registration Statement of which
this Joint Proxy Statement/Prospectus is part within the meaning of the term
"experts" as used in the Securities Act and the rules and regulations
promulgated thereunder. Nor does Carpenter admit that its opinion constitutes a
report or valuation within the meaning of Section 11 of the Securities Act.
Carpenter's opinion is directed to the Bancorp Board, covers only the fairness
of the consideration to be received by holders of Bancorp Common Stock from a
financial point of view as of the date of the opinion, and does not constitute a
recommendation to any holder of Bancorp Stock as to how such shareholder should
vote at the Bancorp Meeting.
In connection with its Opinion, Carpenter, among other things: (i) reviewed
certain publicly available financial and other data with respect to Bancorp and
Mid-State, including the consolidated financial statements for recent years and
interim periods to December 31, 1997 and certain other relevant financial and
operating data relating to Bancorp and Mid-State made available to Carpenter
from published sources and from the internal records of Bancorp; (ii) reviewed
the Agreement; (iii) reviewed certain publicly available information concerning
the trading of, and the trading market for, Bancorp Stock and Mid-State Stock;
(iv) compared Bancorp and Mid-State from a financial point of view with certain
other companies in the banking industry which Carpenter deemed to be relevant;
(v) considered the financial terms, to the extent publicly available, of
selected recent business combinations of companies in the banking industry which
Carpenter deemed to be comparable, in whole or in part, to the Merger; (vi)
considered the financial and other terms of recent business combinations
proposals made to Bancorp by other companies in 1997, and compared them to the
Merger; (vii) reviewed and discussed with representatives of the management of
Bancorp certain information of a business and financial nature regarding
Bancorp, furnished to Carpenter by them; (viii) made inquiries regarding and
discussed the Merger and the Agreement and other matters related thereto with
Bancorp's counsel; and (ix) performed such other analyses and examinations as
Carpenter deemed appropriate.
In connection with its review, Carpenter did not assume any obligation
independently to verify the foregoing information and relied on such information
being accurate and complete in all material respects. Carpenter also assumed
that there were no material changes in Bancorp's or Mid-State's assets,
financial condition, results of operations, business or prospects since the
respective dates of their last financial statements made available to it.
Carpenter relied on advice of counsel to Bancorp as to all legal matters with
respect to Bancorp, the Merger and the Agreement. Bancorp acknowledged that
Carpenter did not discuss with Bancorp's independent accountants any financial
reporting matters with respect to Bancorp, the Merger or the Agreement. Bancorp
informed Carpenter, and Carpenter assumed that the Merger would be accounted for
as a pooling of interests under generally accepted accounting principles.
Carpenter assumed that the Merger would be consummated in a manner that complies
in all respects with the applicable provisions of the Securities Act, the
Exchange Act and all other applicable Federal and state statutes, rules and
regulations.
Carpenter assumed that the allowance for loan losses for each of Bancorp and
Mid-State are in the aggregate adequate to cover such losses. In addition,
Carpenter did not assume responsibility for reviewing
45
<PAGE>
any individual credit files, or making an independent evaluation, appraisal or
physical inspection of any of the assets or liabilities (contingent or
otherwise) of Bancorp or Mid-State, nor was Carpenter furnished with any such
appraisals. Finally, Carpenter's opinion was based on economic, monetary and
market and other conditions as in effect on, and the information made available
to Carpenter as of the date of the opinion. Accordingly, although subsequent
developments may affect Carpenter's opinion, it has not assumed any obligation
to update, revise or reaffirm such opinion.
Set forth below is a summary of Carpenter's analysis in connection with its
opinion that is complete in all material respects.
ANALYSIS OF SELECTED MERGER TRANSACTIONS. Using publicly available
information, Carpenter reviewed the consideration paid in recently announced
transactions whereby certain banks and bank holding companies ("Banks") of
various sizes were acquired. Specifically, Carpenter reviewed 57 transactions
involving acquisitions of banks based in California announced since January 1,
1996 (the "California Bank Acquisitions"), and 16 acquisitions of banks based in
California with total assets between $200 million and $500 million since the
same date, consisting of the following (acquiror/target): Bay View Capital/CTL
Credit, CU Bancorp/Home Interstate Bancorp, Western Bancorp/Western Bank, Zions
Bancorporation/ FP Bancorp, Mid-Peninsula Bancorp/Cupertino National Bancorp,
Dartmouth Capital/Commerce Security Bank, Greater Bay Bancorp/Peninsula Bank of
Commerce, City National Corp./Harbor Bancorp, Western Bancorp/SC Bancorp, US
Bancorp/Business & Professional Bank, Commerce Security/Eldorado Bancorp,
Western Bancorp/CA Commercial Bancshares, Golden State Bancorp/Transworld
Bancorp, City National Corp./Riverside National Bank, Bank SinoPac of Taiwan/Far
East National Bank, and City National Corp/ Ventura County National
(collectively the "Small Bank Acquisitions"). For each bank acquired or to be
acquired in such transactions, Carpenter analyzed data illustrating, among other
things, the ratio of the premium (i.e., purchase price in excess of tangible
book value) to core deposits, purchase price to book value and to tangible book
value and purchase price to last 12 months' ("LTM") earnings.
The figures for the California Bank Acquisitions, and Small Bank
Acquisitions produced, respectively: (i) median percentage of premium to core
deposits of 8.1%, and 10.2%; (ii) average multiple of purchase price to book
value of 178.9%, and 195.2%; (iii) average multiple of purchase price to
tangible book value of 186.7%, and 203.7%; and (iv) median multiple of purchase
price to LTM earnings of 16.6X, and 16.6X. In comparison, based upon an assumed
value of $29.37 for each share of Bancorp Common Stock, Carpenter determined
that the consideration to be received by the holders of Bancorp Common Stock in
the Merger represented a percentage of premium to core deposits of 20.2%, a
multiple of price to book value of 250.4%, a multiple of price to tangible book
value of 263.1%, and a multiple of price to Bancorp's year end 1997 earnings of
21.5X.
No other company or transaction used in the above analysis, as a comparison
is identical to Bancorp or the Merger. Accordingly, an analysis of the results
of the foregoing is not mathematical rather, it involves complex considerations
and judgments concerning differences in financial and operating characteristics
of the companies and other factors that could affect the public trading value
and the announced acquisition prices of the companies to which Bancorp and the
Merger are being compared.
PRO-FORMA MERGER AND CONTRIBUTION ANALYSIS. Carpenter analyzed the
contribution of each of Bancorp and Mid-State to, among other things, total
tangible common equity, assets, LTM net income, and gross loans of the pro forma
combined companies. For purposes of this analysis, the balance sheets for the
period ending December 31, 1997 were used, and the income statements for the
same period as well as projected figures for 1998 were used for comparative
purposes. This analysis showed, among other things, that based on pro forma
combined balance sheets for Bancorp and Mid-State as defined above, Bancorp
would have contributed 31.6% of shareholders equity, 29.0% of assets, and 35.4%
of loans. Pro forma income statements as defined above indicated that Bancorp
would have contributed 30.6% of the pre-tax net income and 23.8% of the
after-tax net income of the pro forma combined companies based on 1997 earnings.
Based upon Management Plans provided by Bancorp and Mid-State, Bancorp's
contribution to
46
<PAGE>
projected 1998 after-tax earnings would be 23.7% without projected merger
efficiencies. Based upon analysis assuming an Average Closing Price of Mid-State
Stock of $30.50 (the highest level provided for in the Agreement) and,
therefore, an Exchange Ratio in the Merger of 1.0385 a share of Bancorp Stock
for each share of Mid-State Stock, holders of Bancorp Stock would own
approximately 31% of the combined companies based on fully diluted shares
outstanding on the date of the opinion.
REVIEW OF MID-STATE AND BANCORP. Carpenter analyzed the financial results
of both Mid-State and Bancorp for the period from 1994 through 1997 as reported
by both companies in their respective annual reports and public filings.
Specifically, Carpenter reviewed total assets, shareholder equity, net income,
return on assets, and return on equity. Assets of Mid-State grew from $757
million at December 31, 1994 to $842 million at December 31, 1997. Shareholder
equity of Mid-State grew from $50.5 million at December 31, 1994 to $64.6
million at December 31, 1996, and $77.9 million at December 31, 1997. Net income
of Mid-State for the year ending December 31, 1994 was a loss of $10.8 million,
for the year ending December 31, 1996 was $4.4 million, and for the year ending
December 31, 1997 was $13.4 million. Return on assets and return on equity of
Mid-State for each of the years ending December 31, 1994 through 1997, were
respectively -1.4% and -18.0%, 0.09% and 1.16%, 0.58% and 7.2%, and 1.6% and
18.9%. Total assets of Bancorp at the end of each of the fiscal years ending
December 31, 1994 through 1997 were $216.2 million, $263.6 million, $302.4
million, and $344.1 million, respectively. Shareholder equity of Bancorp at the
end of each of the fiscal years ending December 31, 1994 through 1997 was $21.7
million, $27.5 million, $30.4 million, and $36.1 million respectively. Net
income of Bancorp for each of the fiscal years ending December 31, 1994 through
1997 was $2.3 million, $3.1 million, $3.7 million, and $4.2 million,
respectively. Return on assets and return on equity of Bancorp for each of the
fiscal years ending December 31, 1994 through 1997, were 1.1% and 11.6%, 1.3%
and 12.9%, 1.3% and 12.9%, and 1.3% and 12.7%, respectively.
TRADING ACTIVITY AND PRICES. Carpenter reviewed the trading activity and
sales prices in the common stock of both Bancorp and Mid-State, both of which
trade in the Over-the-Counter (OTC) market. As of December 31, 1997, there were
6,905,100 shares of Mid-State Stock outstanding. Sales prices for the Mid-State
Stock in calendar year 1997 ranged from a low of $15.00 to a high of $29.50 per
share. In the period from January 1, 1998 through March 11, 1998, sales prices
for the Mid-State Stock varied from a low of $25.625 to a high of $29.25.
Trading volumes in calendar 1997 averaged 5,370 shares traded per day. Bancorp
common shares traded in a range during calendar year 1997 between $15.375 and
$27.50 per share. Trading volume for Bancorp Stock averaged 1,420 shares a day
during 1997. On December 31, 1997, there were 2,976,533 shares of Bancorp Stock
issued and outstanding.
REGRESSION ANALYSIS. Carpenter undertook an analysis to determine the price
to book multiple at which Bancorp might trade on a stand-alone basis. A
regression analysis of publicly available data on comparable bank holding
companies indicated a high degree of correlation between return on equity and
price to book value. Based on Bancorp's 1997 return on equity of 12.24 percent,
this analysis yielded a price to book at which Bancorp might trade of 2.21X and
an implied value of $26.29 per share for Bancorp.
DISCOUNTED VALUE ANALYSIS. Carpenter estimated the present value (current
share price) based on estimated earnings that Bancorp (a) could produce on a
stand-alone basis through fiscal year 2002 without giving effect to, among other
things, potential cost savings that could be realized in a sale to an in-market
acquiror, and (b) that the combined entity expressed in Bancorp equivalent
shares could produce. Carpenter utilized Bancorp and Mid-State management
projections (the "Management Plans") for 1998 and assumed ten percent annual
earnings growth thereafter. The range of estimated future prices was calculated
by applying market multiples ranging from 14.0X to 22.0X to the projected 2002
EPS of Bancorp alone and of the combined companies. The estimated future share
prices were then discounted to present values using discount rates ranging from
12 percent to 20 percent. This analysis indicated an implied per share price
range today for Bancorp on a stand alone basis of approximately $17.42 to
$33.44.
47
<PAGE>
The corresponding range for the combined companies, including estimated
consolidation savings provided by Bancorp and Mid-State management, is $23.66 to
$45.42 in Bancorp equivalent shares. In comparison to these ranges of value, the
assumed current value for Bancorp Stock is $26.375, which is based on the
closing price for Bancorp Stock on January 28, 1998, the day prior to the public
announcement of the Merger. These analyses do not purport to be indicative of
actual values or expected values of Bancorp Stock.
EXCHANGE RATIO. Carpenter also analyzed the value of $29.37 per share
placed on Bancorp Stock in the Exchange Ratio. In that analysis, Carpenter noted
(a) that the value of $29.37 was the highest value offered for Bancorp Stock by
any party solicited for expressions of interest in a merger with or acquisition
of Bancorp, (b) that the value of $29.37 was immediately accretive to Bancorp
earnings per share and book value per share, (c) that a value of $29.37 per
share was higher than the average price to book, price to earnings, price to
assets, and premium to core deposits paid in the California Bank Acquisitions
and Smaller Bank Acquisitions, and (d) that the value of $29.37 was an 11%
premium to the closing price of Bancorp Stock on the day prior to the
announcement of the Merger and a 53% premium to the closing price of Bancorp
Stock as of September 30, 1997, prior to the time at which Bancorp had begun
serious discussions with potential merger partners or acquirors.
The summary set forth above does not purport to be a complete description of
the presentation by Carpenter to the Bancorp Board or of the analyses performed
by Carpenter. The preparation of a fairness opinion is not necessarily
susceptible to partial analysis or summary description. Carpenter believes that
its analyses and the summary set forth above must be considered as a whole and
that selecting a portion of its analyses and factors, without considering all
analyses and factors, would create an incomplete view of the process underlying
the analyses set forth in its presentation to the Bancorp Board. The ranges of
valuations resulting from any particular analysis described above should not be
taken to be Carpenter's view of the actual value of Bancorp or the combined
companies.
In performing its analyses, Carpenter made numerous assumptions with respect
to industry performance, general business and economic conditions and other
matters, many of which are beyond the control of Bancorp or Mid-State. Material
among those assumptions were that of a reasonably stable economic and interest
rate environment, and no significant changes in the regulatory and statutory
regime governing the businesses of both Mid-State and Bancorp sufficient to
materially impact their results. The analyses performed by Carpenter are not
necessarily indicative of actual values or actual future results, which may be
significantly more or less favorable than suggested by such analyses. Such
analyses were prepared solely as part of Carpenter's analysis of the fairness of
the consideration to be received by the holders of Bancorp Stock in the Merger
and were provided to the Bancorp Board in connection with the delivery of
Carpenter's opinion. The analyses do not purport to be appraisals or to reflect
the prices at which a company might actually be sold or the prices at which any
securities may trade at the present time or any time in the future. The
forecasts utilized by Carpenter in certain of its analyses are based on numerous
variables and assumptions which are inherently unpredictable and must be
considered not certain of occurrence as projected. Accordingly, actual results
could vary significantly from those contemplated in such forecasts.
Pursuant to the Engagement Letter, Bancorp will pay Carpenter & Company a
transaction fee in connection with the merger, a substantial portion of which is
contingent upon the consummation of the merger. Under the terms of the
Engagement Letter, Bancorp will pay Carpenter a transaction fee equal to 1.25%
of the value attributed in the Merger to Bancorp Stock up to $75,000,000, and
1.75% of such value in excess of $75,000,000, less $25,000 previously paid to
Carpenter. The total fee payable to Carpenter in connection with the Merger
pursuant to the Engagement Letter is estimated at $1,190,000. Bancorp has also
agreed to reimburse Carpenter for its reasonable out-of-pocket expenses. Bancorp
has agreed to indemnify Carpenter, its affiliates, and their respective
partners, directors, officers, agents, consultants, employees and controlling
persons against certain liabilities.
48
<PAGE>
EXCHANGE RATIO
The issued and outstanding shares of Bancorp Stock at the Effective Time
will remain outstanding (other than shares as to which statutory dissenters'
rights are perfected). Each share of Mid-State Stock issued and outstanding
immediately prior to the Effective Time will automatically, without any action
on the part of the holder thereof, be canceled and converted into the right to
receive a number of shares of Bancorp Stock as determined by the Exchange Ratio
established in the Agreement.
For purposes of the Exchange Ratio, a share of Bancorp Stock was valued at
$29.37. The Exchange Ratio will be determined as follows:
(i) If the Average Closing Price (as defined below) is not less than
$26.25 but not more than $30.50, each shares of Mid-State will be exchanged
for the number of shares of Bancorp Stock equal to the reciprocal of the
number determined by dividing $29.37 by the Average Closing Price. Such
formula is expressed as:
1
-------------------
$29.37
-------
Average Closing Price
(ii) If the Average Closing Price is greater than $30.50, each share of
Mid-State Stock will be exchanged for 1.0385 shares of Bancorp Stock.
(iii) If the Average Closing Price is less than $26.25, each share of
Mid-State Stock will be exchanged for .8938 shares of Bancorp Stock;
provided, however, that, if the Average Closing Price is less than $26.25,
Bancorp has the right to terminate the Agreement. If Bancorp elects to so
terminate, Mid-State has the right, so long as the Average Closing Price
exceeds $22.00, to reinstate the Agreement by adjusting the exchange ratio
downward based on the formula in (i), above.
The "Average Closing Price" means the average of the daily closing prices of
a share of Mid-State Stock during the 20 consecutive trading days that
Mid-State's Stock trades ending on the third trading day immediately before the
effective day of the transaction.
As described above, the Exchange Ratio (and the number of shares of be
received by shareholders of Mid-State and the value to be attributed to each
outstanding share of Bancorp Stock) depends upon the Average Closing Price of
Mid-State Stock. The following table shows the effective Exchange Ratio based
upon certain Average Closing Price. No assurance can be given that the market
price of Bancorp Stock on
49
<PAGE>
or after consummation of the Merger will approximate the Average Closing Price
of Mid-State Stock prior to the Merger.
<TABLE>
<CAPTION>
ASSUMING A MID-STATE EACH MID-STATE SHARE WILL BE VALUE TO BE ATTRIBUTED TO EACH
AVERAGE CLOSING PRICE EXCHANGED INTO THIS NUMBER OF BANCORP OUTSTANDING SHARE OF BANCORP
OF: STOCK STOCK
- ----------------------- ------------------------------------- --------------------------------
<S> <C> <C>
$ 34.50 1.0385 $ 33.22
33.50 1.0385 32.26
32.50 1.0385 31.30
31.50 1.0385 30.33
30.50 1.0385 29.37
29.37 1.0000 29.37
29.50 1.0044 29.37
28.50 0.9704 29.37
27.50 0.9363 29.37
26.50 0.9023 29.37
26.25* 0.8938 29.37
25.25 0.8597 29.37
24.25 0.8257 29.37
23.25 0.7916 29.37
22.25 0.7576 29.37
22.00 0.7491 29.37
</TABLE>
- ------------------------
* If the Average Closing Price is less than $26.25, Bancorp has the right to
terminate the Agreement. If Bancorp elects to so terminate, Mid-State has
the right, so long as the Average Closing Price exceeds $22.00, to reinstate
the Agreement by adjusting the exchange ratio downward based on the formula
discussed above, as adjusted upwards for any Significant Liabilities.
For information concerning the markets for Mid-State Stock and Bancorp
Stock, see "SUMMARY-- Markets and Market Prices." On May , 1998, the closing
price for a share of Mid-State Stock was $ .
The Exchange Ratio will be adjusted upward for certain Significant
Liabilities (as defined in the Agreement) of Bancorp or the Bank, if any.
"Significant Liabilities," as used in the Agreement, relates to the following
categories or events unless Mid-State has consented in writing to such matter:
(1) new or extended contractual obligations other than those arising in the
ordinary course of Bank's or Bancorp's business; (2) new or extended leases of
real or personal property; (3) acquisition of capital assets (or commitments to
do so) except for assets required in the ordinary course of business; (4) actual
or contingent liabilities based upon threatened or pending litigation, other
proceedings or hazardous materials and legal fees and costs (whether actual or
estimated) related thereto as described in the Agreement (provided, however,
that the amount of such liabilities shall be reduced by the amount of any
insurance proceeds actually received or certain, in the reasonable judgment of
Mid-State, to be received); (5) any unbooked expenses, fines, penalties or
similar obligations except those arising in the ordinary course of the Bank's or
Bancorp's business; (6) any new, expanded or accelerated pension or other
employee benefits including employment contracts and severance payments in
excess of one month's compensation, whether or not vested; (7) an amount which
would equal the amount necessary to bring the Bank's allowance for loan losses
as of the calendar quarter preceding the Effective Time to the amount required
by the Bank's existing policy on allowance for loan and lease losses (provided,
however, that if Mid-State should disagree with the adequacy of the Bank's
allowance for loan losses, then such disagreement shall be resolved through the
independent expert as discussed below); and (8) an amount which would equal the
amount necessary to bring Bancorp's shareholders' equity to the minimum Bancorp
shareholders' equity amount set forth in the Agreement. See "--Conditions to the
Merger." Mid-State and Bancorp are to identify any categories or events
reasonably believed by either of them to be Significant Liabilities commencing
50
<PAGE>
immediately following receipt of the required regulatory approvals. All
calculations of Significant Liabilities, if any, shall be fully taxed affected,
and the after tax cost of any item referenced above shall be the amount of the
Significant Liability. To the extent that the item related to any Significant
Liability shall have already been booked and expensed by the Bancorp and Bank
and is therefore included within the amount of shareholders' equity for purposes
of (8), above, no further adjustment shall be made as a result thereof. Upon
identification of a Significant Liability, the Parties shall attempt to agree
upon the amount of said Significant Liability within seven days. If no mutual
agreement is reached within said period, the Parties shall immediately hire an
independent expert qualified to render an opinion regarding the amount of the
particular Significant Liability. The Parties shall cooperate fully with any
such independent expert and will equally split the cost of such expert. The
opinion of such expert shall be binding on the Parties for purposes of the
Agreement. As a result of any Significant Liabilities through the close of
business on the business day preceding the Effective Time, the Exchange Ratio
shall be calculated (to the nearest ten thousandth) according to the following
formula:
1
-------------------
$29.37-x
---------
Average Closing Price
where "x" represents the dollar amount of any Significant Liabilities divided by
the outstanding shares of Bancorp Stock (determined as of the business day
preceding the Effective Time). Further, if the Average Closing Price is below
$26.25 per share or above $30.50, then for purposes of this calculation $26.25
or $30.50 respectively shall be used as the Average Closing Price unless
otherwise further adjusted.
The amount of Significant Liabilities, if any, cannot currently be
predicted.
FRACTIONAL SHARES
No fractional shares of Bancorp Stock will be issued in the Merger. In lieu
thereof, each holder of Mid-State Stock who would otherwise be entitled to
receive a fractional share will receive an amount in cash equal to the product
(calculated to the nearest ten thousandth) obtained by multiplying (a) the
Average Closing Price times (b) the fraction of the shares of Bancorp Stock to
which such holder would otherwise be entitled. No such holder shall be entitled
to dividends or other rights in respect of any such fraction.
EFFECTIVE TIME OF MERGER
The Effective Time shall occur on the day that the Agreement of Merger
(which is Exhibit A to the Agreement) is filed with the DFI after having been
previously filed with the Secretary with the DFI's approval endorsed thereon in
accordance with the provisions of the California Financial Code. The Effective
Time shall occur following the last to occur of (i) receipt of all necessary
regulatory approvals with the expiration of any applicable regulatory waiting
periods and (ii) satisfaction of the other conditions precedent set forth in the
Agreement. See "Conditions to the Merger." It is anticipated that the Effective
Time will occur sometime during the third quarter of 1998. In no event shall the
Effective Time be later than September 30, 1998 unless a later date is agreed to
by the Parties.
MANAGEMENT AND OPERATIONS OF BANCORP AND MID-STATE AFTER THE MERGER
At the Effective Time, the Bank will be merged with and into Mid-State and
its separate corporate existence will terminate. Also at such time and by virtue
of the Merger, Mid-State will become a wholly-owned subsdiary of Bancorp.
Immediately after the Effective Time, the name of Bancorp will be changed to
"Mid-State Bancshares."
51
<PAGE>
The number of directors of Bancorp at the Effective Time will be reduced to
ten and the seven member of Mid-State's Board of Directors and Messrs. Diani,
Hares and Snelling will serve as the Board of Directors of Bancorp after the
Merger until their successors have been chosen and qualified in accordance with
applicable law. After the Merger, the principal officers of Bancorp will be
Carrol R. Pruett (the current President of Mid-State) who will serve as Chairman
and President, A.J. Diani (the current Chairman of Bancorp) who will serve as
Vice Chairman, William A. Hares (the current President of Bancorp) who will
serve as Executive Vice President, Raymond E. Jones (the current Secretary of
Mid-State) who will serve as Secretary and James G. Stathos (the current
Executive Vice President of Mid-State) who will serve as Executive Vice
President/Chief Financial Officer. The Articles of Incorporation and Bylaws of
Bancorp (except as otherwise noted above) will continue to govern the business
and affairs of Bancorp after the Merger until amended or repealed in accordance
with applicable law.
The seven directors of Mid-State immediately prior to the Effective Time and
Messrs. Diani, Hares and Snelling will be the directors of Mid-State after the
Merger until their successors have been chosen and qualified in accordance with
applicable law. Shareholder approval of the principal terms of the Agreement and
the transactions contemplated thereby includes the approval of an amendment to
the Mid-State bylaws to expand the number of its authorized directors at the
Effective Time. See "-- Amendment to Bylaws of Mid-State." The principal
officers of Mid-State immediately prior to the Effective Time will be the
principal officers of the Mid-State after the Merger until they resign or are
replaced or terminated by the Board of Directors of Mid-State or otherwise in
accordance with applicable law, except that Mr. Diani will be elected Vice
Chairman of the Board of Directors of Mid-State and Bancorp and Mr. Hares will
be appointed as an Executive Vice President of Mid-State. The Articles of
Incorporation and Bylaws of Mid-State (except as otherwise noted above) will
continue to govern the business and affairs of Mid-State after the Merger until
amended or repealed in accordance with applicable law.
AMENDMENT TO BYLAWS OF MID-STATE
Shareholder approval of the principal terms of the Agreement and the
transactions contemplated thereby includes the approval of an amendment to the
Mid-State bylaws to expand the number of its authorized directors at the
Effective Time. The bylaws currently provide for a range of authorized directors
of from five to nine. Pursuant to the Agreement, the board of directors of
Mid-State is to be expanded to 10 members at the Effective Time, including three
of the current directors of Bancorp. See "--Management and Operations of Bancorp
and Mid-State After the Merger." In order to effect such expansion, shareholder
approval of the principal terms of the Agreement and the transactions
contemplated thereby will also include approval of an amendment to Section 3.2
of the Mid-State bylaws to read as follows:
"NUMBER AND QUALIFICATION OF DIRECTORS. The authorized number of
directors of the Corporation shall not be less than six (6) nor more than
eleven (11). The number of directors within such range is hereby
established at ten (10). The range of directors set forth herein may only
be changed in accordance with the provisions of Section 6.1 of these
Bylaws but the exact number of directors may be fixed from time to time
within such range by an amendment duly adopted by the Board of
Directors."
If for any reason the Merger is not carried out, the amendment to the bylaws
will not become effective.
REGULATORY APPROVALS
The consummation of the Merger is subject to various conditions, including,
among others, receipt of the prior approvals of the DFI and the FDIC.
The Agreement provides that the obligations of the Parties to consummate the
Merger are conditioned upon all regulatory approvals having been granted by
September 15, 1998 without the imposition of
52
<PAGE>
conditions which, in the opinion of Mid-State would materially adversely effect
the financial condition or operations of any Party or otherwise would be
burdensome.
Applications for regulatory review and approval of the Merger and the
related transactions have been filed. There can be no assurance that the DFI and
the FDIC will approve or take other required action with respect to the Merger
and the related transactions or as to the date of such approvals or action.
In determining whether to approve the Merger, the DFI will consider factors
such as (i) the effects of the Merger on competition; (ii) the effects of the
Merger on the convenience and needs of the communities to be served; (iii) the
financial condition of Mid-State; (iv) whether the Merger is fair and reasonable
to the depositors, creditors and shareholders of Bancorp, the Bank and
Mid-State; (v) the competence, experience and integrity of Mid-State's
management; and (vi) whether the Merger is fair, just and equitable to Bancorp,
Bank and Mid-State.
In determining whether to approve the Merger, the FDIC will consider factors
such as (i) the financial condition, competence, experience and integrity of
Mid-State's management; and (ii) the effect of the Merger on competition.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
As a condition to the Merger, each of the directors of Bancorp has entered
into an agreement with Mid-State whereby each has agreed to (i) vote his or her
shares of Bancorp Stock in favor of approving the principal terms of the
Agreement and the transactions contemplated thereby, (ii) recommend, subject to
his or her fiduciary duty, to Bancorp shareholders to vote in favor of the
Agreement, (iii) not dispose, subject to certain exceptions, of his or her
shares of Bancorp Stock, (iv) for a two year period, not to compete with
Mid-State or solicit anyone who was a customer of Mid-State, Bancorp or the Bank
during the last three years and (v) cooperate fully with Mid-State in connection
with the Merger. Each of the directors of Mid-State has entered into an
agreement with Bancorp whereby each has agreed to take the actions in (i)-(iii)
and (v), above, as it relates to his or her Mid-State Stock and the Mid-State
shareholders.
Under these agreements the respective directors of Mid-State and Bancorp
have agreed to vote their respective shares (approximately 9.13% of the
outstanding shares in the case of Mid-State Stock and approximately 22.22% of
the outstanding shares in the case of Bancorp Stock) to approve the principal
terms of the Agreement, increasing the likelihood that the Merger will be
approved. The affirmative vote of the holders of an additional 40.48% (in the
case of Mid-State) and 27.78% (in the case of Bancorp) of the respective
outstanding shares voting at the respective Meetings will be required in order
to approve the Agreement.
Messrs. Diani, Hares and Snelling will continue as directors of Bancorp
after the Effective Time and will be added to the Board of Directors of
Mid-State at the Effective Time. Mr. A.J. Diani, the current Chairman of Bancorp
and the Bank, will be elected as Vice Chairman of Bancorp and Mid-State. Mr.
William A. Hares, the current President of Bancorp and the Bank, will be
appointed as an Executive Vice President of Mid-State and Bancorp at the
Effective Time.
The officers and employees of Bancorp and Bank at the Effective Time will
become officers and employees of Mid-State subject to the policies of Mid-State,
will be entitled to participate in all employee benefits and benefit programs of
Mid-State on the same basis as similarly situated employees of Mid-State and
will be credited for eligibility, participation and vesting purposes with their
respective years of past service with Bancorp and the Bank. Mid-State has
adopted a severance policy by which all employees of Bancorp, the Bank or
Mid-State who are not offered employment or who are terminated within 12 months
following the Effective Time who satisfy the requirement of the severance plan
will receive severance benefits of two weeks for every year of service.
53
<PAGE>
Mid-State has also agreed to honor certain change in control agreements for
Messrs. James Glines, Dean Fletcher, Susan Forgone and Carol Bradfield, all of
whom are executive officers of Bancorp and the Bank. Severance benefits payable
to the above executive officers under the change of control agreements are
determined by multiplying a base monthly salary by 18 months for the above
executive officers. In addition, the executive officers are entitled to certain
fringe benefits, including health and other medical benefits. If all four
executive officers are terminated following the consummation of the Merger, the
Bancorp estimates that the amounts payable to such four executive officers and
the value of other benefits would total between $650,000 and $675,000. For a
description of such agreements, see "INFORMATION CONCERNING BANCORP MEETING
ONLY--Contracts with Executive Officers." The change of control agreement with
Mr. William A. Hares will terminate at the Effective Time and be replaced with
an employment agreement which provides for, among other things, a two year term
at an annual base salary of $190,000, an automobile, certain medical insurance
benefits, five weeks of vacation and participation in Mid-State compensation,
bonus and benefit plans. In the event Mr. Hares is terminated without cause
during the two year term, he will be entitled to receive his base salary for the
remainder of the two year term as well as the use of an automobile and
continuation of medical insurance benefits.
Subject to the receipt of any required consents, appropriate amendments are
intended to be made to Bancorp's stock option plan in order for Messrs. Diani,
Hares and Snelling and each person who is an officer or employee of Bancorp or
the Bank and who does not exercise his stock option to have the right to receive
a substitute stock option from Bancorp on a fully vested basis.
Policies of directors' and officers' liability insurance (with coverage,
terms and conditions no less advantageous than the insurance presently
maintained) will be maintained by Bancorp and Mid-State for persons currently
serving as officers or directors of Bancorp or the Bank with respect to all
matters arising from facts or events which occurred before the Effective Time
for which Bancorp or the Bank would have had an obligation to indemnify its
directors and officers.
ADDITIONAL AGREEMENTS
In addition to the directors agreements described in "Interests of Certain
Persons in the Merger," the directors and certain other affiliates of each of
the Parties have entered into agreements restricting such persons' ability to
sell shares of Bancorp Stock which such person has acquired or may acquire in
connection with the Merger except in accordance with such agreements.
FEDERAL INCOME TAX CONSEQUENCES
The Parties have not requested a ruling from the Internal Revenue Service in
connection with the Merger. The following is a summary of the opinion of
Andersen, Mid-State's independent public accountants, that Mid-State and Bancorp
have received concerning the material federal income tax consequences to holders
of Mid-State Stock resulting from the Merger. Consummation of the Merger is
conditioned upon receipt by Mid-State and Bancorp of such opinion prior to the
date of this Joint Proxy Statement/Prospectus. The following is based upon
applicable federal law and judicial and administrative interpretations on the
date hereof, any of which is subject to change at any time and representations
from the management of Mid-State, Bancorp and the Bank.
(i) The Merger will qualify as a reorganization under Section 368 of the
Internal Revenue Code of 1986, as amended (the "Code"), and Mid-State,
Bancorp and the Bank each will be a "party to a reorganization" within the
meaning of Section 368(b) of the Code.
(ii) No gain or loss will be recognized by Mid-State, Bancorp, or Bank
as a result of the Merger.
(iii) No gain or loss will be recognized by a shareholder of Mid-State on
the receipt solely of Bancorp Stock in exchange for his shares of Mid-State
Stock.
54
<PAGE>
(iv) The tax basis of the assets in Mid-State after the Merger will be
the same as the tax basis of the assets held by Mid-State and the Bank
immediately before the Merger.
(v) The holding period of Bancorp Stock to be received by the Mid-State
shareholders pursuant to the Merger will include the holding period of
shares of Mid-State Stock exchanged therefor, provided that the shares of
Mid-State Stock are held as capital assets at the Effective Time.
(vi) The tax basis of Bancorp Stock to be received in the Merger by
Mid-State shareholders will be the same as the basis of the sharers of
Mid-State Stock surrendered in exchange therefor, decreased by the amount of
basis allocated to any cash received in lieu of fractional shares that are
hypothetically received by the Mid-State shareholders and redeemed for cash.
(vii) The payment of cash to shareholders of Mid-State in lieu of
fractional share interest of Bancorp Stock will be treated as if the
fractional shares were distributed as part of the exchange and them redeemed
by Bancorp. These cash payments will be treated as having been received as a
distribution in redemption of that fractional share interest subject to the
conditions and limitations of Section 302 of the Code. If a fractional share
of Bancorp Stock would constitute a capital asset in the hands of a
redeeming shareholder, any resulting gain or loss will be characterized as a
capital gain or loss in accordance with the provisions and limitations of
Subchapter P of Chapter 1 of the Code.
(viii) No gain or loss will be recognized for federal income tax purposes
by the holders of outstanding stock options granted under Mid-State's stock
option plan as a result of the granting, pursuant to the Merger, of
substitute options pursuant to Bancorp's stock option plan.
(ix) The granting of any substitute stock option, under the Bank stock
option plan, to a holder of a Mid-State stock option under the Mid-State
stock option plan, pursuant to the Merger, will not be deemed a modification
of any Mid-State existing incentive stock option.
The opinion of Andersen summarized above is not binding on the Internal
Revenue Service, which could take positions contrary to the conclusions in such
opinion.
The exchange of Bancorp Stock for cash pursuant to the exercise of
dissenters' rights will be a taxable transaction. Holders of Bancorp Stock
electing to exercise dissenters' rights should consult their own tax advisers as
to the tax treatment in their particular circumstances. See "Dissenting
Shareholders' Rights."
As a result of the complexity of the tax laws, and due to the individual
nature of the tax consequences of the Merger, it is recommended that Mid-State
and Bancorp shareholders consult their own tax advisors concerning the tax
consequences of the Merger (including the application and effect of state and
local income and other tax laws).
EXCHANGE PROCEDURES
As soon as practicable after the Effective Time, ChaseMellon Shareholder
Services (the "Exchange Agent") will mail to each holder of record of
outstanding shares of Mid-State Stock a letter of transmittal which is to be
used by each Mid-State shareholder to return to the Exchange Agent the stock
certificates representing the Mid-State Stock owned by him (the "Old
Certificates"), which certificates should be duly endorsed in blank by such
Mid-State shareholder. As soon as practicable after receiving such Old
Certificates from a Mid-State shareholder together with the duly executed letter
of transmittal and any other items specified by the letter of transmittal, the
Exchange Agent will deliver to such Mid-State shareholder new certificates
bearing the name "Mid-State Bancshares" ("New Certificates") representing the
appropriate number of shares of Bancorp Stock, together with checks for payment
of cash in lieu of fractional shares. No dividends or other distributions that
are declared on Bancorp Stock will be paid to persons otherwise entitled to
receive the same until the Old Certificates have been surrendered in exchange
for New Certificates, but upon such surrender, such dividends or other
distributions, from and after the Effective Time, will be paid to such persons
in accordance with the terms of Bancorp Stock. No
55
<PAGE>
interest will be paid to the Mid-State shareholders on the cash or the value of
the Bancorp Stock into which their shares of Mid-State Stock will be exchanged.
The Exchange Agent will also shortly after the Effective Time mail to each
holder of record of outstanding shares of Bancorp Stock a letter of transmittal
which is to be used by each Bancorp shareholder to return to the Exchange Agent
the stock certificates representing the Bancorp Stock owned by him. As soon as
practicable after receiving such certificates from a Bancorp shareholder
together with the duly executed letter of transmittal and any other items
specified by the letter of transmittal, the Exchange Agent will deliver to such
Bancorp shareholder new Bancorp certificates bearing the name "Mid-State
Bancshares" representing the same number of shares as the exchanged
certificates.
NEITHER MID-STATE NOR BANCORP SHAREHOLDERS SHOULD SEND IN THEIR STOCK
CERTIFICATES UNTIL THEY RECEIVE THE LETTER OF TRANSMITTAL FORM AND INSTRUCTIONS.
SALES OF BANCORP STOCK
The shares of Bancorp Stock to be issued to shareholders of Mid-State in the
Merger have been registered under the Securities Act. Such shares will be freely
transferable under the Securities Act, except for shares issued to any person
who may be deemed to be an "affiliate" of Mid-State within the meaning of Rule
145 under the Securities Act.
NASDAQ LISTING
Bancorp will make application to list its shares, including the shares of
Bancorp Stock to be issued to shareholders of Mid-State in the Merger, on the
Nasdaq National Market System. Such application is not expected to be acted on
until at or immediately after the Effective Time. However, no assurance can be
given that such application will be granted or that the shares of Bancorp Stock
will become so listed.
ACCOUNTING TREATMENT
The Parties anticipate that the Merger will be treated as a pooling of
interests for accounting purposes. Prior to the Effective Time and as a
condition precedent to the closing, Andersen will confirm in writing the
accounting treatment of the Merger as a pooling of interest. The unaudited pro
forma financial information contained in this Joint Proxy Statement/Prospectus
has been prepared using the pooling of interest accounting method to account for
the Merger. See "UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS."
CONDITIONS TO THE MERGER
The obligation of each of the Parties to consummate the Merger is subject to
the satisfaction or waiver on or before the Effective Time of, among other
things, the following conditions: (i) the Agreement and the transactions
contemplated thereby will have received all requisite approvals of the
shareholders and Boards of Directors of Mid-State, the Bank and Bancorp; (ii) no
judgment, decree, injunction, order or proceeding will be outstanding or
threatened by any governmental entity which prohibits or restricts the
effectuation of, or threatens to invalidate or set aside the Merger
substantially in the form contemplated by the Agreement unless counsel to the
Party against whom such action or proceeding was instituted or threatened
renders to the other Parties a favorable opinion that such judgment, decree,
injunction, order or proceeding is without merit; (iii) by September 15, 1998,
all approvals or consents of any applicable governmental agency will have been
obtained or granted for the Merger and the transactions contemplated for the
Agreement and the applicable waiting period under all laws will have expired;
(iv) the Registration Statement shall have been declared effective by the SEC
and shall not be the subject of any stop order or proceedings seeking or
threatening a stop order; (v) Bancorp shall have received all state securities
permits and other authorizations necessary to issue the Bancorp Stock to
consummate the Merger; (vi) application
56
<PAGE>
will be filed for listing Bancorp Stock on the Nasdaq National Market System at
the Effective Time; (vii) Mid-State and Bancorp will have received an opinion
reasonably satisfactory to Mid-State and Bancorp from Andersen to the effect
that the Merger will not result in the recognition of gain or loss for federal
income tax purposes, nor will the issuance of Bancorp Stock result in the
recognition of gain or loss to holders of Mid-State Stock who receive Bancorp
Stock in the Merger (see "--Certain Federal Income Tax Consequences"); (viii)
Andersen will have confirmed in writing to Mid-State and Bancorp that the Merger
will quality for pooling of interests accounting treatment (see "--Accounting
Treatment"); and (ix) all third party consent necessary to permit the parties to
consummate the Merger will have been obtained except under certain
circumstances.
The obligations of Mid-State to consummate the Merger are also subject to
fulfillment of certain other conditions, including the following: (i) there will
not have occurred, between January 29, 1998 and the Effective Time, any
materially adverse change in the business, financial condition, results of
operations or properties of Bancorp or the Bank; (ii) Mid-State will have
received satisfactory evidence that all of Bancorp's employee benefit plans,
programs and arrangements have been terminated, merged into Mid-State plans or
as otherwise agreed in the Agreement; (iii) receipt of the H&A Opinion; (iv) all
remediation of environmental contamination or conditions on any Bancorp or Bank
property will have been completed to the satisfaction of Mid-State; (v) all
corporate steps necessary to effect the corporate and management changes
described in "Management and Operations of Bancorp and Mid-State After the
Merger" will have been completed; and (vi) at the close of business on the last
day of the month preceding the Effective Time, Bancorp's consolidated
shareholders' equity, shall not be less than the sum of (i) Bancorp's
consolidated shareholders' equity at December 31, 1997 PLUS (ii) the amount of
"Projected Earnings" LESS the amount of dividends paid as authorized by the
Agreement. The term "Projected Earnings" shall mean (A) $1,228,000, if the month
end immediately preceding the Effective Time is May 31, 1998, (B) $1,504,000, if
the month end immediately preceding the Effective Time is June 30, 1998, (C)
$1,811,000, if the month end immediately preceding the Effective Time is July
31, 1998, or (D) $2,114,000, if the month immediately preceding the Effective
Time is on or after August 31, 1998. The amount of Projected Earnings shall be
increased by any gains from the sale of certain securities and shall be reduced
by the sum of (y) any and all Bancorp and Bank "Expenses" as defined in the
Agreement PLUS (z) all costs accrued by Bancorp and Bank in compliance with the
requirements of environmental remediation prior to the applicable month end
(excluding the costs of the remedial and corrective actions as are actually
related to any hazardous materials), provided, however, that the amount of the
adjustment to the Projected Earnings resulting from (y) and (z) shall, in no
event, exceed $125,000.
The obligations of Bancorp and Bank to consummate the Merger are also
subject to the fulfillment of certain other conditions. including the following:
(i) there will not have occurred, between January 29, 1998 and the Effective
Time, any material adverse change in the business, financial condition, results
of operations or properties of Mid-State; (ii) receipt of the Carpenter Opinion;
(iii) all remediation of environmental contamination or conditions on any
Mid-State property will have been completed to the satisfaction of Bancorp; and
(v) all corporate steps necessary to effect the corporate and management changes
described in "Management and Operations of Bancorp and Mid-State After the
Merger" will have been completed
Additionally, the consummation of the Merger is subject to the performance
of covenants, the execution and delivery of certain ancillary documents, the
accuracy of representations and warranties and the receipt of various legal
opinions, third-party consents, officers' certificates and other documents.
If these and other conditions are not satisfied or waived, the Agreement may
be terminated. The Agreement may also be terminated upon the occurrence of
certain other events. See "--Termination."
57
<PAGE>
NONSOLICITATION
Under the terms of the Agreement, Bancorp and the Bank have agreed not to
solicit, initiate or encourage any "Competing Transaction" (as hereinafter
defined). In addition, each has agreed (unless it determines, with advice of
counsel, that its fiduciary duty requires otherwise) not to participate in any
negotiations or discussions regarding, or furnish any information with respect
to, or otherwise cooperate in any way in connection with, any effort or attempt
to effect any Competing Transaction with or involving any person other than with
Mid-State, unless Bancorp receives a bona fide offer from a person other than
the parties to the Agreement and subject to the fiduciary obligations of the
Bancorp Board. Bancorp has agreed to promptly notify Mid-State of the terms of
any proposal which it may receive in respect of any Competing Transaction. The
term "Competing Transaction" means any of the following involving Bancorp or the
Bank: a merger, consolidation, share exchange or other business combination; a
sale, lease, exchange, mortgage, pledge, transfer or other disposition of assets
representing 10% or more of Bancorp's or of the Bank's assets; a sale of shares
of capital stock (or securities convertible or exchangeable into or otherwise
evidencing, or any agreement or instrument evidencing, the right to acquire
capital stock), representing 10% or more of the voting power of Bancorp or the
Bank; a tender offer or exchange offer for at least 10% of the outstanding
shares of Bancorp; a solicitation of proxies in opposition to approval of the
Merger by Bancorp's shareholders; or a public announcement of an unsolicited
bona fide proposal, plan or intention to do any of the foregoing.
Any violation of these agreements by Bancorp and the Bank will result in
Mid-State having the right to terminate the Agreement. If the Agreement were to
be so terminated by Mid-State and Bancorp, the Bank or both enters into an
agreement for a Competing Transaction prior to the termination of the Agreement
or during the 12 month period immediately following the termination, Bancorp and
the Bank will be obligated to pay Mid-State $4,500,000 which amount represents
(i) Mid-State's direct costs and expenses (including, but not limited to, fees
and expenses of financial or other consultants, printing costs, accountants and
counsel) incurred in negotiating and undertaking to carry out the transactions
contemplated by the Agreement, including Mid-State's management time devoted to
negotiation and preparation for the transactions contemplated by the Agreement;
(ii) Mid-State's indirect costs and expenses incurred in connection with the
transactions contemplated by the Agreement; and (iii) Mid-State's loss as a
result of the transactions contemplated by the Agreement not being consummated
EXPENSES
If the Agreement is terminated by Bancorp or Bank because Mid-State's
shareholders fail to approve the Merger, or because Mid-State fails to satisfy
certain of its obligations under the Agreement, Mid-State will be obligated to
pay all of Bancorp's expenses incurred in connection with the Merger
transaction, not to exceed $500,000.
If the Agreement is terminated by Mid-State because Bancorp's shareholders
fail to approve the Merger, or because Bancorp fails to satisfy certain of its
obligations under the Agreement, Bancorp will be obligated to pay all of
Mid-State's expenses incurred in connection with the Merger transaction, not to
exceed $500,000.
TREATMENT OF STOCK OPTIONS
At the Effective Time, the Mid-State stock option plan will terminate and
the Bancorp stock option plan will continue in effect.
At and as of the Effective Time, Bancorp shall grant substitute stock
options pursuant to the Bancorp stock option plan to each and every officer and
employee of Mid-State who has at the Effective Time an outstanding option to
purchase shares of Mid-State Stock ("Mid-State Stock Options"). Each and every
substitute stock option so granted by Bancorp pursuant to the Bancorp stock
option plan to replace an Mid-State Stock Option shall retain the "vesting"
schedule reflected in each of the respective stock option
58
<PAGE>
agreements and shall be exercisable for that number of whole shares of Bancorp
Stock equal to the product of (A) the number of shares of Mid-State Stock that
were purchasable under such Mid-State Stock Option immediately prior to the
Effective Time multiplied by (B) the Exchange Ratio, rounded down to the nearest
whole number of shares of Bancorp Stock. Further, each and every substitute
stock option so granted shall provide for a per share exercise price which shall
be equal to the quotient determined by dividing (A) the exercise price per share
of Mid-State Stock at which such Mid-State Stock Option was exercisable
immediately prior to the Effective Time by (B) the Exchange Ratio.
The vesting schedules of each and every stock option outstanding on the date
of the Agreement granted pursuant to the Bancorp stock option plan will, as a
result of the transactions contemplated by the Agreement, accelerate in
accordance with the provisions of such plan. Except as provided below, each such
option granted pursuant to the Bancorp stock option plan shall terminate
pursuant to the provisions of such plan on or before the Effective Time. Subject
to the receipt of all required approvals, including the shareholders of Bancorp
(See "THE BANCORP MEETING"), Bancorp shall make appropriate amendments to the
Bancorp stock option plan in order for Messrs. Diani, Hares and Snelling and
each of the other persons, who currently has an outstanding stock option granted
under such plan and who does not exercise such option and who is an officer or
employee of Bancorp or the Bank, to have the right to receive, in their
discretion, a substitute stock option from Bancorp. Any substitute option will
be on a fully vested basis and will contain the same terms and conditions as the
option for which it is substituted.
TERMINATION
The Agreement may be terminated at any time prior to the Effective Time (i)
by mutual consent of Mid-State and Bancorp in writing; (ii) by Mid-State if
Bancorp or the Bank become subject to any regulatory enforcement action; (iii)
by Mid-State or Bancorp if any material breach or default by the other party is
not cured within 20 business days after notice thereof; (iv) by Mid-State or
Bancorp if any governmental or regulatory consent is not obtained by September
15, 1998 or if any governmental or regulatory authority denies or refuses to
grant any approval, consent or authorization required to be obtained to
consummate the transactions contemplated by the Agreement unless, within 20
business days after such denial or refusal, all parties agree to resubmit the
application to the regulatory authority that has denied or refused to grant the
approval, consent or qualification requested; (v) by Bancorp if any of the
conditions to its performance of the Agreement shall not have been met, or by
Mid-State if any of the conditions to its performance of the Agreement shall not
have been met, by September 30, 1998, or such earlier time as it becomes
apparent that such conditions shall not be met; (vi) by Mid-State if Bancorp
shall have failed to act or refrain from doing any Competing Transaction; (vii)
by Mid-State or Bancorp if it is determined that the estimated cost of any
Bancorp environmental remediation is in excess of $1,500,000 or is not
reasonably determinable; (viii) by Bancorp if it is determined that the
estimated cost of any Mid-State environmental remediation is in excess of
$3,500,000 or is not reasonably determinable; or (ix) by Bancorp if the Average
Closing Price is less than $26.25, provided, however that if Bancorp elects to
so terminate, Mid-State has the right, so long as the Average Closing Price
exceeds $22.00, to reinstate the Agreement by adjusting the exchange ratio
downward based on a formula.
COVENANTS; CONDUCT OF BUSINESS PRIOR TO EFFECTIVE TIME
The Agreement provides that, during the period from January 29, 1998 to the
Effective Time, Bancorp will conduct its business only in the normal and
customary manner and in accordance with sound banking practices and will not,
without the prior written consent of Mid-State, which will not be unreasonably
withheld, take any of the following actions, among others: (i) issue any
security except pursuant to the exercise of options outstanding as of the date
of the Agreement; (ii) declare, set aside or pay any dividend (other than a
$0.30 per share cash dividend payable on or about February 6, 1998 and, if the
Effective Time occurs after July 14, 1998, an additional cash dividend in an
amount not to exceed $0.10 per share) or make any other distribution upon, or
purchase or redeem any shares of its stock; (iii) except
59
<PAGE>
as may be required to effect the transactions contemplated by the Agreement,
amend its articles of incorporation or its bylaws; (iv) grant any general or
uniform increase in the rate of pay of employees or employee benefits except in
the ordinary course of business and consistent with past practice; (v) grant any
material increase in salary, incentive compensation or employee benefits or pay
any bonus to any person except in the ordinary course of business and consistent
with past practice; (vi) make any capital expenditure in excess of $100,000,
except for ordinary repairs, renewals and replacements. (vii) compromise, settle
or adjust any assertion or claim of a deficiency in taxes (or interest thereon
or penalties in connection therewith), extend the statute of limitations with
any tax authority or file any pleading in court on any tax litigation or any
appeal from an asserted deficiency, or file or amend any federal, foreign, state
or local tax return, or make any tax election; (viii) grant, renew or commit to
grant or renew any extension of credit or amend the terms of any such credit
outstanding on the date hereof to any executive officer, director or principal
shareholder, or to any corporation, partnership, trust or other entity
controlled by any such person, except under certain circumstances; (ix) make
their credit underwriting policies, standards or practices less stringent than
those in effect on December 31, 1997; (x) enter into or consent to any new
employment agreement or other benefit arrangement, or amend or modify any
employment agreement or other benefit arrangement in effect on the date of the
Agreement to which Bancorp or the Bank is a party or bound; (xi) grant any
person a power of attorney or similar authority; (xii) make any material
investment by purchase of stock or securities, contributions to capital,
property transfers or otherwise in any other person, except for investments made
in the ordinary course of business consistent with past practice: (xiii) amend,
modify or terminate, except in accordance with its terms, any material contract
or enter into any material agreement or contract; (xiv) create or incur or
suffer to exist any mortgage, lien, pledge, security interest, charge,
encumbrance or restraint of any kind against or in any property or right of the
respective party; (xv) sell, lease or otherwise dispose of any assets or release
any claims, except in the ordinary course of business consistent with past
practice; (xvi) except as required by law, knowingly take or cause to be taken
any action which would prevent the transactions contemplated hereby from
qualifying as tax free reorganizations under Section 368 of the Internal Revenue
Code or prevent Mid-State from accounting for the business combination to be
effected by the Merger as a pooling of interests; (xvii) sell any investment
security prior to maturity, except in the ordinary course of business; or
(xviii) grant, renew or commit to grant or renew any extension of credit if such
extension of credit, together with all other credit then outstanding to the same
person and all affiliated persons, would exceed $100,000 on an unsecured basis
and $200,000 on a secured basis subject to certain exceptions.
The Agreement further provides that, during the period from January 29, 1998
to the Effective Time, Mid-State will conduct its business only in the normal
and customary manner and in accordance with sound banking practices and will
not, without the prior written consent of Bancorp, which will not be
unreasonably withheld, take any of the following actions, among others: (i)
issue any security except pursuant to the exercise of options outstanding as of
the date of the Agreement; (ii) declare, set aside or pay any dividend (other
than a $0.15 per share cash dividend payable on or about May 22, 1998) or make
any other distribution upon, or purchase or redeem any shares of its stock;
(iii) except as may be required to effect the transactions contemplated by the
Agreement, amend its articles of incorporation or bylaws; or (iv) except as
required by law, knowingly take or cause to be taken any action which would
prevent the transactions contemplated hereby from qualifying as tax free
reorganizations under Section 368 of the Internal Revenue Code or prevent
Mid-State from accounting for the business combination to be effected by the
Merger as a pooling of interests.
The Agreement also provides that each Party will (i) use its best efforts to
take, or cause to be taken, all actions and to do, or cause to be done, all
things necessary, proper or advisable under applicable laws and regulations to
consummate the transactions contemplated by the Agreement as promptly as
practical; (ii) obtain the consent of the other Party before it issues any press
release or makes any public statement with respect to the Agreement or the
transactions contemplated hereby; and (iii) cause to be prepared one or more
environmental investigations with respect to real property owned or leased.
60
<PAGE>
The Agreement also provides that each Party will: (i) duly and timely file
all required governmental reports; (ii) periodically furnish to the other Party
certain information, loan reports and updates of information previously
provided; (iii) promptly notify the other Party of certain communications from
tax authorities, material litigation and any event which has had or may
reasonably be expected to have a materially adverse effect on the financial
condition, operations, business or properties; (iv) provide access to the other
Party of certain information: and (v) use its reasonable efforts between the
date of the Agreement and the Effective Time to take all actions necessary or
desirable, including the filing of any regulatory applications.
AMENDMENT AND WAIVER
Subject to applicable law: (i) the Agreement may be amended at any time by
the action of the Boards of Directors of Mid-State, the Bank and Bancorp without
action by their shareholders pursuant to a writing signed by all parties to the
Agreement; and (ii) the Parties, by action of their respective Boards of
Directors, may, at any time prior to the Effective Time, extend the performance
of any obligation or action required by the Agreement, waive inaccuracies in
representations and warranties and waive compliance with any agreements or
conditions for their respective benefit contained in the Agreement.
DISSENTING SHAREHOLDERS' RIGHTS
MID-STATE
Pursuant to the provisions of Section 4883 of the California Financial Code,
shareholders of Mid-State will not be entitled to exercise dissenters' rights in
connection with the Merger.
BANCORP
Each holder of shares of Bancorp Stock that were outstanding as of the
Bancorp Record Date and remain outstanding at the Effective Time who does not
vote such shares in favor of the proposal to approve the Merger by complying
with the procedures set forth in Chapter 13 of the California General
Corporation Law ("Chapter 13 of the California Law") will be entitled to receive
an amount equal to the fair market value of his or her shares as of January 28,
1998, the day before the public announcement of the Merger. The closing price
for Bancorp Stock on January 28, 1998 was $26.375. A copy of Chapter 13 of the
California Law is attached hereto as Appendix D and should be read for more
complete information concerning dissenters' rights. THE REQUIRED PROCEDURE SET
FORTH IN CHAPTER 13 OF THE CALIFORNIA LAW MUST BE FOLLOWED EXACTLY OR ANY
DISSENTERS' RIGHTS MAY BE LOST. The information set forth below is a general
summary of dissenters' rights as they apply to Bancorp shareholders and is
qualified in its entirety by reference to Appendix D.
In order to be entitled to exercise dissenters' rights, a shareholder of
Bancorp must not vote "FOR" the Merger. Thus, any shareholder who wishes to
dissent and executes and returns a proxy in the accompanying form must specify
that his or her shares are to be either voted "AGAINST" or "ABSTAIN" on the
proposal to approve the principal terms of the Agreement. If the shareholder
returns a proxy without voting instructions or with instructions to vote "FOR"
the proposal to approve the principal terms of the Agreement, his or her shares
will automatically be voted in favor of the Merger and the shareholder will lose
his or her dissenters' rights.
If the Merger is approved by the shareholders, Bancorp will have 10 days
after such approval to send to those shareholders who did not vote in favor of
the Merger written notice of such approval accompanied by a copy of Chapter 13
of the California Law, a statement of the price determined by Bancorp to
represent the fair market value of the dissenting shares as of January 28, 1998
and a brief description of the procedure to be followed if a shareholder desires
to exercise dissenters' rights. Within 30 days after the date on which the
notice of the approval of the Merger is mailed, the dissenting shareholder must
make written demand upon Bancorp for the purchase of dissenting shares and
payment to such shareholder of
61
<PAGE>
their fair market value, specifying the number of shares held of record by such
shareholder and a statement of what the shareholder claims to be the fair market
value of those shares as of January 28, 1998, and must surrender to Bancorp, at
the office designated in the notice of approval, the certificates representing
the dissenting shares to be stamped or endorsed with a statement that they are
dissenting shares or to be exchanged for certificates of appropriate
denomination so stamped or endorsed. Any shares of Bancorp Stock that are
transferred prior to their submission for endorsement lose their status as
dissenting shares.
If Bancorp and the dissenting shareholder agree that the surrendered shares
are dissenting shares and agree upon the price of the shares, the dissenting
shareholder will be entitled to the agreed price with interest thereon at the
legal rate on judgments from the date of the agreement. Subject to the
restrictions imposed under California law on the ability of Bancorp to purchase
its outstanding shares, payment of the fair value of the dissenting shares shall
be made within 30 days after the amount thereof has been agreed upon or 30 days
after any statutory or contractual conditions to the Merger have been satisfied,
whichever is later, subject to the surrender of the certificates therefor,
unless provided otherwise by agreement.
If Bancorp denies that the shares surrendered are dissenting shares or
Bancorp and the dissenting shareholder fail to agree upon a fair market value of
such shares of Bancorp Stock, then the dissenting shareholder of Bancorp must,
within six months after the notice of approval is mailed, file a complaint in
the Superior Court of the proper county requesting the court to make such
determinations or intervene in any pending action brought by any other
dissenting shareholder. If the complaint is not filed or intervention in a
pending action is not made within the specified six-month period, the
dissenter's rights are lost. If the fair market value of the dissenting shares
is at issue, the court will determine, or will appoint one or more impartial
appraisers to determine, such fair market value.
A dissenting shareholder may not withdraw his or her dissent or demand for
payment unless Bancorp consents to such withdrawal.
The Merger is not directly conditioned upon only a limited number of
shareholders of Bancorp Stock having voted against the Merger or otherwise
having perfected dissenters' rights. Nevertheless, the payment of a significant
amount of cash pursuant to the exercise of dissenters' rights would effect the
ability of the Merger to be accounted for as a "pooling of interest." The Merger
is conditioned upon Andersen confirming in writing that the accounting treatment
for the Merger is a pooling of interest (see "--Accounting Treatment").
62
<PAGE>
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma combined statement of financial position
is based on the historical consolidated statement of financial positions of
Mid-State and Bancorp, using the pooling method of accounting for business
combinations, as of December 31, 1997 after giving effect to Merger-related
adjustments described in the Note herein. It should be read in conjunction with
the historical consolidated financial statements and notes thereto of Mid-State
and Bancorp, which are included in Appendices E and F of this Joint Proxy
Statement/Prospectus.
These pro forma financial statements are presented for illustrative purposes
only and are not indicative of the operating results that would have been
achieved or the financial position that would have existed had the Merger been
consummated on December 31, 1997 nor are they indicative of the future operating
results or finacial position of the combined companies. The pro forma
adjustments made in connection with the development of the pro forma information
are preliminary and have been made solely for purposes of developing such pro
forma information as necessary to comply with the disclosure requirements of the
SEC.
63
<PAGE>
UNAUDITED PRO FORMA COMBINED STATEMENT OF FINANCIAL POSITION
AS OF DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
MID-STATE BANK BSM BANCORP ADJUSTMENTS(1) COMBINED
-------------- ------------- -------------- ------------
<S> <C> <C> <C> <C>
Cash and Due From Banks............................ $ 73,708 $ 18,473 $ -- $ 92,181
Fed Funds Sold..................................... 10,000 7,461 17,461
Investment Securities--Available for Sale.......... 373,171 46,143 419,314
Investment Securities--Held to Maturity............ -- 62,768 62,768
-------------- ------------- ------------
Total Investment Securities........................ 373,171 108,911 482,082
Total Loans........................................ 349,532 191,346 540,878
Loan Loss Allowance................................ (11,251) (2,115) (13,366)
-------------- ------------- ------------
Net Loans.......................................... 338,281 189,231 527,512
Premises and Equipment............................. 20,463 12,709 33,172
Goodwill........................................... -- 1,737 1,737
Other Real Estate Owned............................ 2,511 969 3,480
Investments in Real Estate......................... 8,768 -- 8,768
Other.............................................. 15,398 4,555 19,953
-------------- ------------- ------- ------------
TOTAL ASSETS................................... $ 842,300 $ 344,046 $ -- $ 1,186,346
-------------- ------------- ------- ------------
-------------- ------------- ------- ------------
Non Interest Bearing Demand........................ $ 137,626 $ 74,451 $ -- $ 212,077
Interest Bearing NOW, Savings and Money Market..... 408,677 114,900 523,577
Time Deposits...................................... 210,752 116,941 327,693
-------------- ------------- ------------
Total Deposits..................................... 757,055 306,292 1,063,347
Other Liabilities.................................. 7,279 1,692 2,600 11,571
Capital:
Common Stock and Surplus......................... 29,939 11,636 41,575
Undivided Profits................................ 46,327 24,340 (2,600) 68,067
-------------- ------------- ------- ------------
Unrealized Gain on Available for Sale
Securities..................................... 1,700 86 1,786
Total Equity Capital............................. 77,966 36,062 (2,600) 111,428
-------------- ------------- ------- ------------
TOTAL LIABILITIES AND EQUITY................... $ 842,300 $ 344,046 $ -- $ 1,186,346
-------------- ------------- ------- ------------
-------------- ------------- ------- ------------
</TABLE>
- ------------------------
(1) The following table reflects all nonrecurring Mid-State Bank and BSM Bancorp
estimated Merger-related costs as of December 31, 1997. These costs are not
included on the unaudited pro forma combined income statement but are
included on the unaudited pro form combined balance sheet as a reduction to
equity capital. These costs will be charged to expense immediately following
the consummation of the Merger. Such estimated Merger-related costs are
summarized below (in thousands):
<TABLE>
<CAPTION>
MID-STATE BANK BSM BANCORP COMBINED
--------------- ------------- -----------
<S> <C> <C> <C>
Financial Advisory................................ $ 750 $ 1,250 $ 2,000
Professional Fees................................. 200 200 400
Printing and Other................................ 100 100 200
------ ------ -----------
$ 1,050 $ 1,550 $ 2,600
------ ------ -----------
------ ------ -----------
</TABLE>
64
<PAGE>
The following unaudited pro forma combined statements of income are based on
the historical consolidated statements of income of Mid-State and Bancorp, using
the pooling method of accounting for business combinations, for the years ending
December 31, 1997, 1996, and 1995. It should be read in conjunction with the
historical consolidated financial statements and notes thereto of Mid-State and
Bancorp, which are included in Appendices E and F of this Joint Proxy
Statement/Prospectus. Weighted average shares outstanding of the pro forma
combined institution are based on a 1.0000 to 1.0000 Exchange Ratio which
assumes that the Mid-State Stock share price averages $29.37 for the 20
consecutive trading days ending at the end of the third day immediately
preceding the Effective Time. THE EXCHANGE RATIO COULD BE HIGHER OR LOWER THAN
1.0000 TO 1.0000. THE CLOSING PRICE OF A SHARE OF MID-STATE STOCK ON
, 1998 WAS $ .
These pro forma financial statements are presented for illustrative purposes
only and are not indicative of the operating results that would have been
achieved or the financial position that would have existed had the Merger been
consummated on the dates indicated in the preceding paragraph, nor are they
indicative of the future operating results or financial position of the combined
companies.
65
<PAGE>
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
MID-STATE BANK BSM BANCORP ADJUSTMENTS COMBINED
-------------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Interest Income:
Interest and Fees on Loans and Leases................... $ 34,581 $ 18,802 $ 53,383
Interest on Securities, Fed Funds Sold--Taxable......... 22,719 $ 5,381 28,100
Interest on Securities--Tax-exempt...................... -- 794 794
------- ------------- -----------
TOTAL INTEREST INCOME................................. 57,300 24,977 82,277
------- ------------- -----------
Interest Expense:
Interest on NOW, Money Market and Savings Deposits...... 6,522 2,413 8,935
Interest on Time Deposits--$100,000 and over............ 1,918 1,976 3,894
Interest on Time Deposits--Under $100,000............... 8,496 4,036 12,532
Interest on Mortgages Payable, Other.................... 199 -- 199
------- ------------- -----------
TOTAL INTEREST EXPENSE................................ 17,135 8,425 25,560
------- ------------- -----------
Net Interest Income:
Before Provision for Possible Loan Losses............... 40,165 16,552 56,717
Provision for Possible Loan Losses...................... -- 30 30
------- ------------- -----------
NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN
LOSSES.............................................. 40,165 16,522 56,687
------- ------------- -----------
Other Income:
Service Charges on Deposit Accounts..................... 4,797 2,016 6,813
Other Income and fees................................... 8,158 1,488 9,646
------- ------------- -----------
TOTAL OTHER INCOME.................................... 12,955 3,504 16,459
------- ------------- -----------
Other Expense:
Salaries and Employee Benefits.......................... 19,535 7,162 26,697
Occupancy Expenses...................................... 5,478 2,393 7,871
Other Operating Expenses................................ 12,670 3,650 16,320
------- ------------- -----------
TOTAL OTHER EXPENSES.................................. 37,683 13,205 50,888
------- ------------- -----------
Income Before Income Taxes.............................. 15,437 6,821 22,258
Provision for Income Taxes.............................. 2,000 2,616 4,616
------- ------------- -----------
NET INCOME............................................ $ 13,437 $ 4,205 $ 17,642
------- ------------- -----------
------- ------------- -----------
Earnings Per Share
--Basic............................................... $ 1.95 $ 1.41 $ 1.79
--Diluted............................................. $ 1.94 $ 1.38 $ 1.77
Shares used in Earnings Per Share Calculation
--Basic............................................... 6,905 2,977 9,882
--Diluted............................................. 6,927 3,039 9,966
</TABLE>
66
<PAGE>
MID-STATE BANK
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
MID-STATE BANK BSM BANCORP ADJUSTMENTS COMBINED
-------------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Interest Income:
Interest and Fees on Loans and Leases....................... $ 32,002 $ 17,787 $ 49,789
Interest on Securities, Fed Funds Sold--Taxable............. $ 20,041 $ 5,017 25,058
Interest on Securities--Tax-exempt.......................... -- 568 568
------- ------------- -----------
TOTAL INTEREST INCOME..................................... 52,043 23,372 75,415
------- ------------- -----------
Interest Expense:
Interest on NOW, Money Market and Savings Deposits.......... 6,565 2,547 9,112
Interest on Time Deposits--$100,000 and over................ 2,114 1,797 3,911
Interest on Time Deposits--Under $100,000................... 7,302 3,647 10,949
Interest on Mortgages Payable, Other........................ 177 -- 177
------- ------------- -----------
TOTAL INTEREST EXPENSE.................................... 16,158 7,991 24,149
------- ------------- -----------
Net Interest Income:
Before Provision for Possible Loan Losses................... 35,885 15,381 51,266
Provision for Possible Loan Losses.......................... -- 227 227
------- ------------- -----------
NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN
LOSSES.................................................. 35,885 15,154 51,039
------- ------------- -----------
Other Income:
Service Charges on Deposit Accounts......................... 4,641 1,830 6,471
Other Income and fees....................................... 8,080 1,268 9,348
------- ------------- -----------
TOTAL OTHER INCOME........................................ 12,721 3,098 15,819
------- ------------- -----------
Other Expense:
Salaries and Employee Benefits.............................. 18,227 6,541 24,768
Occupancy Expenses.......................................... 5,403 2,334 7,737
Other Operating Expenses.................................... 17,740 3,596 21,336
------- ------------- -----------
TOTAL OTHER EXPENSES...................................... 41,370 12,471 53,841
------- ------------- -----------
Income Before Income Taxes.................................. 7,236 5,781 13,017
Provision for Income Taxes.................................. 2,825 2,313 5,138
------- ------------- -----------
NET INCOME................................................ $ 4,411 $ 3,468 $ 7,879
------- ------------- -----------
------- ------------- -----------
Earnings Per Share
--Basic................................................... $ 0.64 $ 1.17 $ 0.80
--Diluted................................................. $ 0.64 $ 1.16 $ 0.80
Shares used in Earnings Per Share Calculation
--Basic................................................... 6,904 2,960 9,864
--Diluted................................................. 6,912 2,993 9,905
</TABLE>
67
<PAGE>
MID-STATE BANK
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
MID-STATE BANK BSM BANCORP ADJUSTMENTS COMBINED
-------------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Interest Income:
Interest and Fees on Loans and Leases....................... $ 35,349 $ 17,949 $ 53,298
Interest on Securities, Fed Funds Sold--Taxable............. $ 16,325 $ 3,955 20,280
Interest on Securities--Tax-exempt.......................... -- 463 463
------- ------------- -----------
TOTAL INTEREST INCOME..................................... 51,674 22,367 74,041
------- ------------- -----------
Interest Expense:
Interest on NOW, Money Market and Savings Deposits.......... 7,467 2,954 10,421
Interest on Time Deposits--$100,000 and over................ 1,773 1,263 3,036
Interest on Time Deposits--Under $100,000................... 6,759 2,828 9,587
Interest on Mortgages Payable, Other........................ 640 -- 640
------- ------------- -----------
TOTAL INTEREST EXPENSE.................................... 16,639 7,045 23,684
------- ------------- -----------
Net Interest Income:
Before Provision for Possible Loan Losses................... 35,035 15,322 50,357
Provision for Possible Loan Losses.......................... -- 876 876
------- ------------- -----------
NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN
LOSSES.................................................. 35,035 14,446 49,481
------- ------------- -----------
Other Income:
Service Charges on Deposit Accounts......................... 4,660 1,682 6,342
Other Income and fees....................................... 7,332 1,046 8,378
------- ------------- -----------
TOTAL OTHER INCOME........................................ 11,992 2,728 14,720
------- ------------- -----------
Other Expense:
Salaries and Employee Benefits.............................. 17,317 6,327 23,644
Occupancy Expenses.......................................... 5,401 2,195 7,596
Other Operating Expenses.................................... 25,333 3,568 28,901
------- ------------- -----------
TOTAL OTHER EXPENSES...................................... 48,051 12,090 60,141
------- ------------- -----------
Income (Loss) Before Income Taxes........................... (1,024) 5,084 4,060
Provision (Benefit) for Income Taxes........................ (1,675) 1,885 210
------- ------------- -----------
NET INCOME................................................ $ 651 $ 3,199 $ 3,850
------- ------------- -----------
------- ------------- -----------
Earnings Per Share
--Basic................................................... $ 0.09 $ 1.10 $ 0.39
--Diluted................................................. $ 0.09 $ 1.09 $ 0.39
Shares used in Earnings Per Share Calculation
--Basic................................................... 6,904 2,912 9,817
--Diluted................................................. 6,908 2,943 9,851
</TABLE>
68
<PAGE>
DESCRIPTION OF MID-STATE AND BANCORP COMMON STOCK
Mid-State is a California banking corporation organized under the laws of
the State of California, and the rights of Mid-State Shareholders are governed
by the California Financial Code, the California Corporations Code (the
"Corporations Code"), the Articles of Incorporation of Mid-State (the "Mid-State
Articles"), and the bylaws of Mid-State, as amended (the "Mid-State Bylaws").
Upon consummation of the Agreement, the Mid-State Shareholders will become
shareholders of the Bancorp ("Bancorp Shareholders"). As Bancorp Shareholders,
the rights of the then former Mid-State Shareholders will be governed by
Division 1, Chapters 1-23 of the Corporations Code, other applicable California
statutes, the Articles of Incorporation of the Bancorp (the "Bancorp Articles"),
and the Bylaws of the Bancorp (the "Bancorp Bylaws").
MID-STATE STOCK
Mid-State is authorized by the Mid-State Articles, as amended, to issue
10,125,000 shares of Mid-State Stock, without par value. At the Mid-State Record
Date, 6,905,100 shares of Mid-State Stock were issued and outstanding. Holders
of Mid-State Stock are entitled to one vote, in person or by proxy, for each
share of Mid-State Stock held of record in the shareholder's name on the books
of Mid-State as of the record date on any matter submitted to the vote of the
shareholders, except that in connection with the election of directors, the
shares may be voted cumulatively. Each share of Mid-State Stock has the same
rights, privileges and preferences as every other share and will share equally
in Mid-State's net assets upon liquidation or dissolution. Mid-State Stock has
no conversion, preemptive or redemption rights or sinking fund provisions.
California law prohibits a California state-chartered bank from lending on
the security of its own stock.
Shareholders are entitled to dividends when, as and if declared by
Mid-State's Board of Directors out of funds legally available therefor (and
after satisfaction of the prior rights of holders of outstanding preferred
stock, if any) subject to certain restrictions on payment of dividends imposed
by the California Financial Code and other applicable regulatory limitations.
See "Dividend Restrictions."
The transfer agent and registrar for Mid-State Stock is ChaseMellon
Shareholder Services.
BANCORP STOCK
The Bancorp is authorized by the Bancorp Articles to issue 50,000,000 shares
of Bancorp Stock, without par value, and 25,000,000 shares of Bancorp Preferred
Stock, without par value. As of the date hereof, 6,008,639 shares of Bancorp
Stock were issued and outstanding, and no shares of Bancorp Preferred Stock were
issued and outstanding. Holders of Bancorp Stock are entitled to one vote, in
person or by proxy, for each share of Bancorp Stock held of record in the
shareholder's name on the books of Bancorp as of the record date on any matter
submitted to the vote of the shareholders, except that in connection with the
election of directors, and until the Bancorp is considered to be a "listed
corporation" as provided in Corporations Code Section 310.5, the shares may be
voted cumulatively. However, the Bancorp Articles also provide there will be no
cumulative voting for the election of directors if and when the Bancorp becomes
a "listed corporation" (i.e., outstanding shares listed on the New York or
American Stock Exchange or outstanding securities designated as qualified for
trading as a national market security on the National Association of Securities
Dealers Automatic Quotation System and has at least 800 holders of its equity
securities; Bancorp currently has approximately 2000 holders of its securities).
The Agreement provides that it is a condition of the parties obligation to close
the transaction that an application will be filed for listing Bancorp Stock on
the Nasdaq National Market System, and the parties anticipate that the Bancorp
will become a "listed corporation" at the Effective Time or shortly thereafter.
69
<PAGE>
The Bancorp Articles provide that the Board of Directors will be divided
into three classes, with any class having a term of two or three years, if and
when the Bancorp becomes a "listed corporation" (as defined in the previous
paragraph). Upon the Bancorp becoming a "listed corporation," the Board of
Directors of the Bancorp will be divided into three classes, each of which shall
contain approximately one-third of the whole number of the members of the Board.
The members of each class shall be elected for a term of three years, with the
terms of office of all members of one class expiring each year so that
approximately one-third of the total number of directors are elected each year.
The Bancorp Articles also provide that any vacancy occurring in the Board,
including a vacancy created by an increase in the number of directors, shall be
filled by a vote of two-thirds of the directors then in office and any director
so chosen shall hold office for a term expiring at the annual meeting of
stockholders at which the term of the class to which the director has been
chosen expires. The classified Board is intended to provide for continuity of
the Board of Directors and to make it more difficult and time consuming for a
stockholder group to fully use its voting power to gain control of the Board of
Directors without consent of the incumbent Board of Directors of the Bancorp.
The Bancorp Articles also require the approval of the holders of at least
66 2/3% of the Bancorp's outstanding shares of voting stock to approve certain
"Business Combinations" (as defined therein) involving a "Related Person" (as
defined therein) except in cases where the proposed transaction has been
approved in advance by a majority of those members of the Bancorp's Board of
Directors who are unaffiliated with the Related Person and were directors prior
to the time when the Related Person became a Related Person. The term "Related
Person" is defined to include any individual, corporation, partnership or other
entity (other than the Bancorp or the Bank) which owns beneficially or controls,
directly or indirectly, 10% or more of the outstanding shares of voting stock of
the Bancorp or an affiliate of such person or entity. This provision of the
Bancorp Articles applies to any "Business Combination," which is defined to
include: (i) any merger or consolidation of the Bancorp with or into any Related
Person; (ii) any sale, lease, exchange, mortgage, transfer, or other disposition
of 25% or more of the assets of the Bancorp or combined assets of the Bancorp
and its subsidiaries to a Related Person; (iii) any merger or consolidation of a
Related Person with or into the Bancorp or a subsidiary of the Bancorp; (iv) any
sale, lease, exchange, transfer, or other disposition of 25% or more of the
assets of a Related Person to the Bancorp or a subsidiary of the Bancorp; (v)
the issuance of any securities of the Bancorp or a subsidiary of the Bancorp to
a Related Person; (vi) the acquisition by the Bancorp or a subsidiary of the
Bancorp of any securities of a Related Person; (vii) any reclassification of
common stock of the Bancorp or any recapitalization involving the common stock
of the Bancorp; or (viii) any agreement or other arrangement providing for any
of the foregoing.
Under California law, absent this provision, business combinations,
including mergers, consolidations and sales of substantially all of the assets
of a corporation must, subject to certain exceptions, be approved by the vote of
the holders of a majority of the outstanding shares of common stock of the
Bancorp and any other affected class of stock. The increased stockholder vote
required to approve a business combination may have the effect of foreclosing
mergers and other business combinations which a majority of stockholders deem
desirable and place the power to prevent such a merger or combination in the
hands of a minority of stockholders.
Each share of Bancorp Stock has the same rights, privileges and preferences
as every other share and will share equally in the Bancorp's net assets upon
liquidation of dissolution. Bancorp Stock has no preemptive, conversion or
redemption rights or sinking fund provisions and all of the issued and
outstanding shares of Bancorp Stock, when issued, will be fully paid and
nonassessable. The Bancorp Articles also provide that amendments to the Bancorp
Articles must be approved by a majority vote of its Board of Directors and also
by a majority of the outstanding shares of its voting stock, provided, however,
that an affirmative vote of at least 66 2/3% of the outstanding voting stock
entitled to vote (after giving effect to the provision limiting voting rights)
is required to amend or repeal certain provisions of the Bancorp Articles,
including the provision limiting voting rights, the provisions relating to
approval of certain
70
<PAGE>
business combinations, the number and classification of directors, director and
officer indemnification by the Bancorp and amendment of the Bancorp Bylaws and
the Bancorp Articles. The Bancorp Bylaws may be amended by its Board of
Directors, or by a vote of 66 2/3% of the total votes eligible to be voted at a
duly constituted meeting of stockholders.
Bancorp shareholders are entitled to dividends when, as and if declared by
the Bancorp's Board of Directors out of funds legally available therefor and
after satisfaction of the prior rights of holders of outstanding preferred
stock, if any (subject to certain restrictions on payment of dividends imposed
by the General Corporation Law of California). See "Dividend Restrictions."
DIFFERENCES BETWEEN RIGHTS OF HOLDERS OF BANCORP STOCK AND MID-STATE STOCK
The following subsections discuss in detail the differences between rights
of holders of Bancorp Stock and Mid-State Stock.
CLASSIFICATION OF BOARD OF DIRECTORS
Mid-State's Articles do not permit the Mid-State Board of Directors to be
divided into classes with any class having a term of office of longer than one
year. Each director of Mid-State must be elected annually. However, the
Bancorp's Articles and Bylaws provide for its Board of Directors to be divided
into classes with any class having a term of two or three years, if and when the
Bancorp becomes a "listed corporation."
VOTING RIGHTS
In addition to the description of voting rights contained in "Mid-State
Stock" and "Bancorp Stock", Mid-State may amend its Articles of Incorporation or
Bylaws to eliminate cumulative voting if Mid-State should become a "listed
corporation" as defined above.
NUMBER OF DIRECTORS
Although the Corporations Code does not require the Bancorp or Mid-State to
maintain any specific range of number of directors, the number of directors of
the Bancorp and Mid-State may not be less than a stated minimum nor more than a
stated maximum (which in no case shall be greater than two times the stated
minimum minus one) with the exact number of directors to be fixed, within the
limits specified. The Mid-State Bylaws currently provide that the number of
directors on the Mid-State Board of Directors may not be fewer than five nor
more than nine, and the current number of members on Mid-State's Board of
Directors has been fixed at seven. The Mid-State Bylaws will be amended to
expand the number of authorized directors as contemplated by the Agreement. See
"THE MERGER--Amendment to Bylaws of Mid-State." The Bancorp Bylaws currently
provide that the number of directors on Bancorp Board of Directors may not be
fewer than nine nor more than seventeen, and the current number of members on
the Bancorp's Board of Directors has been fixed at eleven at the present time.
At the Effective Time of the Merger, (i) the number of directors for the
Bancorp will be reduced to ten (10), eight (8) current members of the Bancorp
Board will resign, and the seven (7) Mid-State Board members will be appointed
to the Bancorp Board of Directors; and (ii) the number of directors for Mid-
State will be increased to ten (10), and Messrs. Diani, Hares and Snelling,
members of the Bancorp and the Bank Board, will be appointed to the Mid-State
Board.
DIVIDEND RESTRICTIONS
Since Mid-State is a state-chartered bank, its ability to pay dividends or
make distributions to its shareholders is subject to restrictions set forth in
the California Financial Code. The California Financial Code provides that
neither a bank nor any majority-owned subsidiary of a bank may make a
distribution to
71
<PAGE>
its shareholders in an amount which exceeds the lesser of (i) the bank's
retained earnings; or (ii) 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. Notwithstanding the previous provision, a bank may, with the prior
approval of the Commissioner of Financial Institutions (the "Commissioner"),
make a distribution to the shareholders of the bank in an amount not exceeding
the greatest of (a) its retained earnings; (b) its net income for its last
fiscal year; or (c) the net income of the bank for its current fiscal year. If
the Commissioner finds that the stockholders' equity of a bank is inadequate or
that the making of a distribution by a bank would be unsafe or unsound, the
Commissioner may order the bank to refrain from making a proposed distribution.
The ability of Bancorp to pay cash dividends is limited by the provisions of
Section 500 of the California Corporations Code, which prohibits the payment of
dividends unless (i) the retained earnings of the corporation immediately prior
to the distribution exceeds the amount of the distribution; (ii) the assets of
the corporation exceed 1 1/4 times its liabilities; or (iii) the current assets
of the corporation exceed its current liabilities, but if the average pre-tax
earnings of the corporation before interest expense for the two years preceding
the distribution was less than the average interest expense of the corporation
for those years, the current assets of the corporation must exceed 1 1/4 times
its current liabilities.
DISSENTERS' RIGHTS
Pursuant to the General Corporation Law of California, holders of Bancorp
Stock would be entitled, subject to the provisions of Chapter 13, to dissenters'
rights in connection with any transaction which constitutes a reorganization (as
defined in Section 181 of the California Corporations Code). See "THE
MERGER--Dissenting Shareholders' Rights." However, pursuant to the California
Financial Code, shareholders of Mid-State Stock are not entitled to dissenters'
rights in connection with any transactions between two banking institutions
which constitutes a reorganization (as defined in Section 181 of the California
Corporations Code) where Mid-State is the corporation surviving such
transaction, even if dissenters' rights were otherwise available pursuant to
Chapter 13.
RESTRICTIONS ON ACQUISITION OF BANCORP
The following discussion is a summary of certain provisions of California
and Federal law and regulations and California corporate law, as well as the
Articles of Incorporation and Bylaws of the Bancorp, relating to stock ownership
and transfers, the Board of Directors and business combinations, all of which
may be deemed to have "anti-takeover" effects. The description of these
provisions is necessarily general and reference should be made to the actual law
and regulations and to the Articles of Incorporation and Bylaws of the Bancorp.
See "AVAILABLE INFORMATION" as to how to obtain a copy of these documents.
CALIFORNIA AND FEDERAL BANKING LAW
The Federal Change in Bank Control Act of 1978 prohibits a person or group
of persons "acting in concert" from acquiring "control" of a bank holding
company unless the Federal Reserve Bank (the "FRB") has been given 60 days'
prior written notice of such proposed acquisition and within that time period
the FRB has not issued a notice disapproving the proposed acquisition or
extending for up to another 30 days the period during which such a disapproval
may be issued. An acquisition may be made prior to the expiration of the
disapproval period if the FRB issues written notice of its intent not to
disapprove the action. Under a rebuttable presumption established by the FRB,
the acquisition of more than 10% of a class of voting stock of a bank with a
class of securities registered under Section 12 of the Exchange Act (such as the
Bancorp Stock), would, under the circumstances set forth in the presumption,
constitute the acquisition of control.
72
<PAGE>
Under the California Financial Code, no person shall, directly or
indirectly, acquire control of a California licensed bank or a bank holding
company unless the Commissioner has approved such acquisition of control. A
person would be deemed to have acquired control of the Bancorp under this state
law if such person, directly or indirectly, has the power (i) to vote 25% or
more of the voting power of the Bancorp or (ii) to direct or cause the direction
of the management and policies of the Bancorp. For purposes of this law, a
person who directly or indirectly owns or controls 10% or more of the Bancorp
Stock would be presumed to control the Bancorp.
In addition, any "company" would be required to obtain the approval of the
FRB under the Bank Holding Company Act of 1956, as amended (the "BHC Act"),
before acquiring 25% (5% in the case of an acquiror that is, or is deemed to be,
a bank holding company) or more of the outstanding Bancorp Stock of, or such
lesser number of shares as constitute control over, the Bancorp.
ANTI-TAKEOVER PROVISIONS IN BANCORP'S ARTICLES OF INCORPORATION
Bancorp's Articles contain certain provisions that deal with matters of
corporate governance and certain rights of shareholders. The following
discussion is a general summary of Bancorp's Articles and regulatory provisions
relating to stock ownership and transfer, the Board of Directors and business
combinations, which might be deemed to have a potential "anti-takeover" effect.
These proposed provisions may have the effect of discouraging a future takeover
attempt which is not approved by the Board of Directors but which individual
Bancorp stockholders may deem to be in their best interest or in which
stockholders may receive a substantial premium for their shares over then
current market prices. As a result, Bancorp Shareholders who might desire to
participate in such a transaction may not have an opportunity to do so. Such
provisions will also render the removal of incumbent Board of Directors or
management of Bancorp more difficult. Any provision requiring more than a
majority vote by Bancorp's stockholders may only be effective for a two year
period from its effective time, unless renewed by the Bancorp Board of Directors
and the stockholders. The following description of certain of the amendments to
the Articles of Incorporation of Bancorp is necessarily general, and reference
should be made in each case to such Articles of Incorporation, which is
contained as an exhibit to Bancorp's initial registration statement on Form S-4
dated November 27, 1996. See "AVAILABLE INFORMATION" as to how to obtain a copy
of these documents.
BOARD OF DIRECTORS
When the Bancorp becomes a "listed corporation," as defined above, the Board
of Directors of the Bancorp will be divided into three classes, each of which
contain approximately one-third of the whole number of the members of the Board.
The members of each class shall be elected for a term of three years, with the
terms of office of all members of one class expiring each year so that
approximately one-third of the total number of directors are elected each year.
The classified Board is intended to provide for continuity of the Bancorp Board
of Directors and to make it more difficult and time consuming for a stockholder
group to fully use its voting power to gain control of the Board of Directors
without consent of the incumbent Board of Directors of the Bancorp.
CUMULATIVE VOTING
If the Bancorp becomes a "listed corporation," the Bancorp Articles do not
provide for cumulative voting for any purpose, as described above.
AUTHORIZED SHARES
The Bancorp Articles authorize the issuance of 50,000,000 shares of common
stock and 25,000,000 shares of preferred stock. The shares of common stock and
preferred stock were authorized in an amount greater than that to be issued to
provide the Bancorp's Board of Directors with as much flexibility as
73
<PAGE>
possible to effect, among other transactions, financings, acquisitions, stock
dividends, stock splits and the exercise of employee stock options. However,
these additional authorized shares may also be used by the Board of Directors
consistent with its fiduciary duty to deter future attempts to gain control of
the Bancorp. The Board of Directors also has sole authority to determine the
terms of any one or more series of preferred stock, including voting rights,
conversion rates, and liquidation preferences. As a result of the ability to fix
voting rights for a series of preferred stock, the Board has the power, to the
extent consistent with its fiduciary duties to issue a series of preferred stock
to persons friendly to management in order to attempt to block a tender offer,
merger or other transaction by which a third party seeks control of the Bancorp,
and thereby assist members of management to retain their positions. The
Bancorp's Board has no present plans for the issuance of additional shares,
other than the issuance of shares of Bancorp Stock upon exercise of stock
options and in the Merger.
STOCKHOLDER VOTE REQUIRED TO APPROVE BUSINESS COMBINATION WITH PRINCIPAL
STOCKHOLDERS
The Bancorp Articles require the approval of the holders of at least 66 2/3%
of the Bancorp's outstanding shares of voting stock to approve certain "Business
Combinations" (as defined in therein) involving a "Related Person" (as defined
therein) except in cases where the proposed transaction has been approved in
advance by a majority of those members of the Bancorp's Board of Directors who
are unaffiliated with the Related Person and were directors prior to the time
when the Related Person became a Related Person, as described more fully above.
Under California law, absent this provision, business combinations,
including mergers, consolidations and sales of substantially all of the assets
of a corporation must, subject to certain exceptions, be approved by the vote of
the holders of a majority of the outstanding shares of common stock of the
Bancorp and any other affected class of stock. The increased stockholder vote
required to approve a business combination may have the effect of foreclosing
mergers and other business combinations which a majority of stockholders deem
desirable and place the power to prevent such a merger or combination in the
hands of a minority of stockholders.
AMENDMENT OF ARTICLES OF INCORPORATION AND BYLAWS
Amendments to the Bancorp Articles must be approved by a majority vote of
its Board of Directors and also by a majority of the outstanding shares of its
voting stock, provided, however, that an affirmative vote of at least 66 2/3% of
the outstanding voting stock entitled to vote (after giving effect to the
provision limiting voting rights) is required to amend or repeal certain
provisions of the Articles, including the provision limiting voting rights, the
provisions relating to approval of certain business combinations, the number and
classification of directors, director and officer indemnification by Bancorp and
amendment of the Bancorp's Bylaws and Articles, as described above. The Bancorp
Bylaws may be amended by its Board of Directors, or by a vote of 66 2/3% of the
total votes eligible to be voted at a duly constituted meeting of stockholders.
STOCKHOLDER NOMINATIONS AND PROPOSALS
The Bancorp Bylaws require a stockholder who intends to nominate a candidate
for election to the Board of Directors to give not less than 10 days' advance
notice to the Secretary of the Bancorp. The Bancorp Articles provide that a
stockholder who desires to raise new business to provide certain information to
the Bancorp concerning the nature of the new business, the stockholder and the
stockholder's interest in the business matter. Similarly, a stockholder wishing
to nominate any person for election as a director must provide the Bancorp with
certain information concerning the nominee and the proposing stockholder.
74
<PAGE>
PURPOSE AND TAKEOVER DEFENSIVE EFFECTS OF BANCORP'S ARTICLES OF
INCORPORATION
The Board of Directors of the Bancorp believes that the provisions described
above are prudent and will reduce the Bancorp's vulnerability to takeover
attempts and certain other transactions which have not been negotiated with and
approved by its Board of Directors. The Board of Directors believes these
provisions are in the best interest of the Bancorp and its stockholders. In the
judgment of the Board of Directors, the Bancorp's Board will be in the best
position to determine the true value of the Bancorp and to negotiate more
effectively for what may be in the best interest of its stockholders.
Accordingly, the Board of Directors believes that it is in the best interest of
the Bancorp and its stockholders to encourage potential acquirors to negotiate
directly with the Board of Directors of the Bancorp and that these provisions
will encourage such negotiations and discourage hostile takeover attempts. It is
also the view of the Board of Directors that these provisions should not
discourage persons from proposing a merger or other transaction at a price
reflective of the true value of the Bancorp and which is in the best interest of
all stockholders.
Attempts to acquire control of financial institutions have recently become
increasingly common. Takeover attempts which have not been negotiated with and
approved by the Board of Directors present to stockholders the risks of a
takeover on terms which may be less favorable than might otherwise be available.
A transaction which is negotiated and approved by the Board of Directors, on the
other hand, can be carefully planned and undertaken at an opportune time in
order to obtain maximum value of the Bancorp and its stockholders, with due
consideration given to matters such as the management and business of the
acquiring corporation and maximum strategic development of the Bancorp's assets.
An unsolicited takeover proposal can seriously disrupt the business and
management of a corporation and cause it to incur great expense. Although a
tender offer or other takeover attempt may be made at a price substantially
above the current market prices, such offers are sometimes made for less than
all of the outstanding shares of a target company. As a result, stockholders may
be presented with the alternative of partially liquidating their investment at a
time that may be disadvantageous, or retaining their investment in an enterprise
which is under different management and whose objectives may not be similar to
those of the remaining stockholders. The concentration of control, which could
result from a tender offer or other takeover attempt, could also deprive the
Bancorp's remaining stockholders of benefits of certain protective provisions of
the Exchange Act, if the number of beneficial owners became less than the 300
thereby allowing for Exchange Act deregistration.
Despite the belief of the Bancorp as to the benefits to stockholders of
these provisions of the Bancorp's Articles, these provisions may also have the
effect of discouraging a future takeover attempt which would not be approved by
the Bancorp's Board, but pursuant to which stockholders may receive a
substantial premium for their shares over then current market prices. As a
result, stockholders who might desire to participate in such a transaction may
not have any opportunity to do so. Such provisions will also render the removal
of the Bancorp's Board of Directors and of management more difficult. The Board
of Directors of the Bancorp, however, has concluded that the potential benefits
outweigh the possible disadvantages.
Pursuant to applicable law, at any annual or special meeting of its
stockholders, the Bancorp may adopt additional charter provisions regarding the
acquisition of its equity securities that would be permitted for a California
business corporation. The Bancorp does not presently intend to propose the
adoption of further restrictions on the acquisition of the Bancorp's equity
securities.
The cumulative effect of the restriction on acquisition of the Bancorp
contained in the Bancorp Articles and Bylaws, federal law and California law may
be to discourage potential takeover attempts and perpetuate incumbent
management, even though certain stockholders of the Bancorp may deem a potential
acquisition to be in their best interest, or deem existing management not to be
acting in their best interests.
75
<PAGE>
INFORMATION CONCERNING MID-STATE MEETING ONLY
ELECTION OF DIRECTORS
The persons named below, all of whom are present members of the Board of
Directors of Mid-State, will be nominated for election to serve until the next
Annual Meeting of Shareholders and until their successors are elected and have
qualified. Votes will be cast pursuant to the enclosed Proxy in such a way as to
effect the election of said seven (7) nominees, or as many thereof as possible
under applicable voting rules. In the event that any of the nominees should be
unable to serve as a director, it is intended that the proxy will be voted for
the election of such substitute nominee, if any, as shall be designated by the
Board of Directors. Management has no reason to believe that any nominee will
become unavailable.
Management knows of no person who, as of the Mid-State Record Date, owned
beneficially more than 5% of the outstanding Mid-State Stock.
The following table sets forth certain information, as of January 31, 1998,
with respect to the persons to be nominated by the Board of Directors for
election as directors, and for the directors and principal officers as a group:
<TABLE>
<CAPTION>
COMMON STOCK BENEFICIALLY
OWNED ON JANUARY 31, 1998
YEAR FIRST --------------------------
ELECTED OR PERCENTAGE
PRINCIPAL OCCUPATION APPOINTED NUMBER OF OF SHARES
NAMES AND OFFICES HELD WITH BANK FOR PAST FIVE YEARS AGE DIRECTOR SHARES(1) OUTSTANDING
- ---------------------------------- ---------------------------------- --- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Gracia B. Bello................... Registered Pharmacist 68 1996 5,742 .08%
Director
Clifford H. Clark................. Attorney, 71 1960 57,916 .84%
Director Clifford H. Clark
Daryl L. Flood.................... Executive Vice President/ Credit 63 1978 98,966 1.43%
Director Administration Mid-State Bank
(Retired)
Raymond E. Jones.................. Executive Vice President/ Chief 70 1990 55,847 .81%
Director Financial Officer Mid-State Bank
(Retired)
Albert L. Maguire................. Investment Broker, Chairman of the 81 1960 253,598(3) 3.67%
Chairman of the Board Board, Maguire Investments,
Inc.(2)
Gregory R. Morris................. Insurance Broker, Morris & 57 1987 41,585(4) .60%
Director Garritano Insurance
Carrol R. Pruett.................. President and Chief Executive 60 1967 131,322(5) 1.90%
President/Chief Executive Officer Officer Mid-State Bank
and Director
Directors and Principal Officers as a group (9 persons)......................................... 658,585(6) 9.50%
</TABLE>
- --------------------------
(1) Except as otherwise noted, may include shares held by such person's spouse
(except where legally separated) and minor children; shares held by any
other relative of such person who has the same home; shares held by a family
trust as to which such person is a trustee with sole voting and investment
power (or shared power with a spouse); or shares held in an Individual
Retirement Account as to which such person has pass-through voting rights
and investment power.
(2) Maguire Investments, Inc. is a corporation with securities registered under
Section 12 of the Exchange Act.
76
<PAGE>
(3) Includes 7,735 shares held by Maguire Investments, Inc., which Mr. Maguire
is owner, as to which shares Mr. Maguire has shared voting and investment
power.
(4) Includes 35,076 shares held by Mr. Morris as Trustee for Morris & Garritano
Profit Sharing Trust, as to which Mr. Morris has sole voting and investment
power.
(5) Includes 16,537 shares which Mr. Pruett has the right to acquire by the
exercise of stock options which are vested pursuant to the Mid-State's 1990
Stock Option Plan (see "Stock Options" herein).
(6) Includes 27,561 shares which the principal officers have the right to
acquire by the exercise of stock options which are vested pursuant to the
Mid-State's 1990 Stock Option Plan (see "Stock Options" herein).
THE BOARD OF DIRECTORS AND COMMITTEES
The Board of Directors has, among others, a standing Audit Committee of
which Directors Morris (Chairman), Bello, Clark and Flood are members. During
the year ended December 31, 1997, the Audit Committee held a total of six
meetings. The purpose of the Audit committee is to meet with the outside
auditors of in order to fulfill the legal and technical requirements necessary
to adequately protect the directors, shareholders, employees and depositors of
Mid-State. The Audit committee also meets with Mid-State's internal auditor to
review Mid-State's internal auditing program and supervises and reviews audits
of Mid-State and its departments. In addition, it is the responsibility of the
Audit Committee to recommend to the Board of Directors the selection of
independent accountants and to make certain that the independent accountants
have the necessary freedom and independence to properly examine all Mid-State
records.
Mid-State has no standing nominating committee; however, the procedures for
nominating directors, other than by the Board of Directors itself, are set forth
in Mid-State Bylaws and in the Notice of Annual Meeting of Shareholders.
The Board also has a standing Compensation Committee, of which Executive
Vice President James G. Stathos, an ex-officio member, serves as Chairman, and
Directors Flood, Jones, Morris and Pruett are members. The primary function of
the Compensation Committee, which met 12 times during 1997 is to establish
proper compensation ranges for officers and employees, delegate certain
authority to management regarding salary procedure, and determine salaries for
Mid-State officers depending upon experience, performance and contribution to
the success of Mid-State.
During the fiscal year ended December 31, 1997, the Board of Directors of
Mid-State held a total of 15 meetings. All of the persons who were directors
during 1997 attended at least 75% of the aggregate of, 1) the total number of
such meetings, and 2) the total number of meetings held by all committees of the
Board on which such director served during 1997.
77
<PAGE>
REPORT OF THE COMPENSATION COMMITTEE
Mid-State Bank applies a consistent philosophy to compensation for all
employees, including senior management. This philosophy is based on the premise
that the achievements of Mid-State result from the coordinated efforts of all
individuals working toward common objectives. Mid-State strives to achieve those
objectives through teamwork that is focused on meeting the expectations of
customers and shareholders.
Mid-State Bank has had a long and successful history of using a simple total
compensation program that consists of cash and equity-based compensation. Having
a compensation program that allows Mid-State to successfully attract and retain
key employees permits it to provide useful products and services to customers,
enhance shareholder value, motivate innovation, foster teamwork, and adequately
reward employees.
The goals of the compensation program are to align compensation with
business objectives and performance, and to enable Mid-State to attract and
reward executive officers whose contributions are critical to the long-term
success of Mid-State. Mid-State is committed to maintaining a pay program that
helps attract and retain the best people in the industry. To ensure that pay is
competitive, Mid-State regularly compares its pay practices with those of other
leading independent banks and sets its pay parameters based on this review.
Executive officers are rewarded based upon corporate performance, and
individual performance. Mid-State performance is evaluated by reviewing the
extent to which strategic and business plan goals are met, including such
factors as profitability, performance relative to competitors and achievement of
corporate goals. Individual performance is evaluated by reviewing organizational
and management development progress against set objectives and the degree to
which teamwork and Mid-State values are fostered.
CEO COMPENSATION
Carrol R. Pruett has been President and Chief Executive Officer of Mid-State
since March 20, 1969. The Committee used the same compensation policy described
above for all Executive Officers to determine Mr. Pruett's fiscal 1997
compensation.
In setting Mr. Pruett's compensation, the Compensation Committee made an
overall assessment of Mr. Pruett's leadership in achieving Mid-State's long-term
strategic and business goals. Mr. Pruett's salary reflects a consideration of
both competitive forces and Mid-State's performance. Mid-State does not assign
specific weights to these categories.
<TABLE>
<CAPTION>
<S> <C>
COMPENSATION COMMITTEE:
James. G. Stathos, Chair Daryl L. Flood
Raymond E. Jones Gregory Morris
Carrol R. Pruett
</TABLE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Carrol R. Pruett, the President and Chief Executive Officer of Mid-State,
and James G. Stathos,
Executive Vice President of Mid-State, each served as a member of the
Compensation Committee during 1997. Mr. Stathos also served as Chairman of the
Committee. Neither Mr. Pruett nor Mr. Stathos participated in the discussion of
their respective compensation or performance when such matters were addressed by
the Committee.
78
<PAGE>
EXECUTIVE COMPENSATION
No person serving as a principal officer of Mid-State received aggregate
cash compensation of more than $100,000 during 1997, except Carrol R. Pruett,
President/Chief Executive Officer; Thomas E. Reese, Executive Vice
President/Credit Administration; and James G. Stathos, Executive Vice
President/Chief Financial Officer. The Board of Directors establishes the
compensation awarded to the Executive Officers, and determines the salaries of
those executive officers based upon their experience, performance, and
contribution to the success of Mid-State. The table below sets forth the
aggregate compensation for services in all capacities paid or accrued by
Mid-State to each of these individuals.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION
------------------------------------------------ -------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER RESTRICTED # OF STOCK
NAME OF OFFICER AND ANNUAL STOCK OPTIONS/ LTIP
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDS SAR'S(8) PAYOUTS
- -------------------- --------- -------------- ----------- ------------------- --------------- --------------- ---------
Carrol R. Pruett.... 1997 $253,039.00(10) $ 0 $ 0 $ 0 $ 0 $ 185,000
President 1996 233,614.00(11) 0 0 0 0 210,500
1995 226,591.00(12) 0 0 0 0 185,500
Thomas E. Reese..... 1997 $126,336.00(14) $ 0 $ 0 $ 0 $ 0 0
Executive Vice 1996 119,905.00(15) 0 0 0 0 0
President 1995 113,883.50(16) 0 0 0 0 0
James G. Stathos.... 1997 $126,336.00(18) $ 0 $ 0 $ 0 $ 0 0
Executive Vice 1996 119,905.00(19) 0 0 0 0 0
President 1995 113,883.50(20) 0 0 0 0 0
<CAPTION>
<S> <C>
NAME OF OFFICER AND ALL OTHER
PRINCIPAL POSITION COMPENSATION(9)
- -------------------- ----------------
Carrol R. Pruett.... $206,250.00(13)
President 2,478.31
4,620.00
Thomas E. Reese..... $104,540.00(17)
Executive Vice 1,981.08
President 3,478.50
James G. Stathos.... $104,540.00(21)
Executive Vice 1,981.08
President 3,478.50
</TABLE>
- --------------------------
(8) "Stock option table".
(9) Includes Mid-State contributions to defined contribution plans (qualified
and non-qualified, and whether or not vested.)
(10) Includes $9,500.00 accrued in 1997 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(11) Includes $9,500.00 accrued in 1996 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(12) Includes $9,240.00 accrued in 1995 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(13) Includes 1997 Deferred Compensation Contribution of $201,500.00
(14) Includes $9,500.00 accrued in 1997 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(15) Includes $7,194.30 accrued in 1996 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(16) Includes $6,715.00 accrued in 1995 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(17) Includes 1997 Deferred Compensation Contribution of $100,750.00
(18) Includes $7,580.16 accrued in 1997 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(19) Includes $7,194.30 accrued in 1996 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(20) Includes $6,899.00 accrued in 1995 but deferred pursuant to the Mid-State's
401(k) Plan (see "Profit Sharing 401(k) Plan").
(21) Includes 1997 Deferred Compensation Contribution of $100,750.00
79
<PAGE>
STOCK OPTIONS
Mid-State's 1990 Stock Option Plan (the "Stock Option Plan"), intended to
advance the interests of Mid-State by encouraging stock ownership on the part of
key employees, was adopted by the shareholders on April 11, 1990 and expires on
March 29, 2000. The Stock Option Plan provides for the issuance of both
"incentive" and "non-qualified" stock options to full-time salaried officers and
employees of Mid-State. All options were granted at an exercise price of not
less than one hundred percent (100%) of the fair market value of the stock on
the date of grant. Each option granted under the Stock Option Plan expires not
later than five (5) years from the date the option was granted. Options are
exercisable in installments as provided in individual stock option agreements;
provided, however, that if an optionee may accumulate them and exercise the same
at any time thereafter during the term of the option. As of January 31, 1998,
Mid-State had options outstanding to purchase a total of 72,492 shares of its
Common Stock under the Stock Option Plan. If the Merger is consummated, the
Stock Option Plan will be terminated and each person holding an option granted
pursuant to the Stock Option Plan will receive a substitute stock option granted
pursuant to the Bancorp stock option plan. See "THE MERGER--Treatment of Stock
Options."
The following table furnishes certain information regarding stock options
granted, outstanding and exercised under the Stock Option Plan as well as a
prior stock option plan for (a) Mr. Pruett, (b) Mr. Reese, (c) and Mr. Stathos.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR, AND FISCAL YEAR-END
OPTIONS/SAR VALUE
<TABLE>
<CAPTION>
(D) (E)
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS/SARS
(B) OPTIONS/SARS AT FY-END(4) FY-END(5)
(A) SHARES ACQUIRED (C) ------------------------- --------------------------
NAME ON EXERCISE(3) VALUE REALIZED(5) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE(1)
- --------------------------------- ----------------- ----------------- ------------------------- --------------------------
<S> <C> <C> <C> <C>
Carrol R. Pruett................. 0 0 3,307 Exercisable $ 50,795.52
13,230 Unexercisable 203,212.80
Thomas E. Reese.................. 0 0 1,102 Exercisable $ 16,926.72
4,410 Unexercisable 67,737.60
James G. Stathos................. 0 0 1,102 Exercisable $ 16,926.72
4,410 Unexercisable 67,737.60
</TABLE>
- ------------------------
(1) Unexercisable stock options represent those options granted, but not yet
fully vested. Exercisable stock options represent the fully vested portion.
Stock options vest at the rate of 20% per year from date of grant. Value of
options determined by multiplying number of shares by the difference between
the closing price on January 31, 1998 of $26.25 per share, and the exercise
price of $10.89 per share.
PROFIT SHARING/401(K) PLAN
In 1963, the Board of Directors of Mid-State entered into a Profit Sharing
Retirement Plan and Trust under a group program offered through the California
Bankers Association. The Plan covers substantially all of Mid-State employees,
and was amended in 1985 to be a combination qualified Profit Sharing Plan (the
"Profit Sharing Plan") and Savings and Retirement Plan designed to comply with
Internal Revenue Code Section 401(k) (the "401(k) Plan"). Under the Profit
Sharing Plan, the Board of Directors, in its discretion, decides how much money,
if any, will be contributed by Mid-State to the Profit Sharing Plan depending on
the amount of Mid-State's profits for the year. Employees are not permitted to
contribute to the Profit Sharing Plan. Once an employee has been in service with
Mid-State one full year, his interest begins to vest at the rate of ten percent
(10%) per year for each year of service up to ten (10) years, at which point his
interest is fully vested. Effective January 1, 1989, once an employee has been
in service with Mid-State three full years, his interest begins to vest at a
rate of twenty percent (20%) per year for each year of service up to seven (7)
years, at which point his interest is fully vested. The maximum amount which
80
<PAGE>
can be contributed by Mid-State to the Profit Sharing Plan is equal to fifteen
percent (15%) of the base salary paid to participating employees of Mid-State.
No amounts are accrued or set aside for the account of non-employee directors.
Mid-State contributed approximately $753,789 to the Profit Sharing Plan for the
year ending December 31, 1997. The amounts allocated to individual principal
officers in previous years are set forth in the Cash Compensation Table above
(see "Executive Compensation" above). Under the 401(k) Plan, each covered
employee can make voluntary contributions to his or her account in an amount up
to ten percent (10%) of his or her base salary; such contributions vest
immediately when made. Mid-State makes a contribution to the employee's account
in an amount equal to fifty percent (50%) of the employee's contributions, up to
a maximum of six percent (6%) of the employee's salary. Mid-State's
contributions to the employee's account vest at the rate of twenty percent (20%)
per year, beginning after the third full year of service. For the year ended
December 31, 1997, Mid-State contributed approximately $309,211 to the 401(k)
Plan.
DEFERRED COMPENSATION PLAN
The Board of Directors also adopted a Deferred Compensation Plan in 1983
which was amended in July 1996), in order to provide performance-oriented
deferred compensation for Mid-State's senior management. Pursuant to the
Deferred Compensation Plan, the Board of Directors sets aside a specified amount
for contribution to the Plan, representing between two percent (2%) and four
percent (4%) of Mid-State's net profits, depending upon Mid-State's return on
equity for the previous year. A committee appointed by the Board of Directors
allocates the amount contributed to the Plan among the accounts of the
participants in such proportions as the committee shall determine from time to
time. Contributions pursuant to the Deferred Compensation Plan become vested at
the rate of ten percent (10%) per year for each full year of service up to ten
(10) years. The funds credited to the account of each participant accrue
interest at an annual rate of return equal to ninety percent (90%) of
Mid-State's prime rate, with such interest adjusted and credited to each account
quarterly. Payment of vested amounts may be made either upon retirement or after
the fifth year of participation in the Plan, in certain specified installments,
at the election of the participant. For the year ended December 31, 1997,
Mid-State made a contribution of $403,000 to the Deferred Compensation Plan.
CHANGE IN CONTROL AGREEMENTS
Mid-State entered into "change in control" agreements with Messrs. Pruett,
Reese and Stathos as of November 12, 1997. Each agreement provides that, if a
person who has acquired control of Mid-State terminates the officer within 24
months after such change in control other than for cause, disability or
retirement (as such terms are defined in the agreement) or if, within 24 months
of such a change in control, the officer terminates the agreement for good
reason (as defined in the agreement), the officer will receive (i) a lump sum
severance payment equal to two times his annual salary and bonus (provided that
in no event shall such amount exceed 2.99 times such officer's "annualized
includible compensation for the base period" (as defined in the Internal Revenue
Code)) and (ii) continued benefits under all insured and self-insured employee
welfare benefit plans for a period ending on the earliest of (A) three years,
(B) the commencement date of equivalent benefits from a new employer or (C) the
officer's normal retirement date under the terms of such plans. In general, a
"change in control" includes a change in the majority of directors as a result
of an election contest, an acquisition of 25% of the outstanding shares, a
merger, consolidation, sale of substantially all the assets, a change in the
majority of directors over a two year period as well as any other transfer,
voluntarily or by hostile takeover or proxy contest, operation of law or
otherwise, of control of Mid-State. The Merger does not constitute a "change in
control" for purposes of such agreements.
81
<PAGE>
OTHER COMPENSATION
Mid-State has provided and plans to continue to provide its executive
officers with automobiles, which are not available to all employees of
Mid-State. It is impracticable to estimate the percentage of the total costs of
these benefits attributable to personal use. No amount is stated for the
foregoing, since management has concluded that the amount of any personal
benefits to any principal officer and to the principal officers as a group is
LESS than the lesser of $25,000 per person or ten percent (10%) of the
compensation reported under "Cash Compensation" for each such person and for the
group.
COMPENSATION OF DIRECTORS
Non-officer directors received $600 per month for their service as directors
and attendance at Board meetings. Loan Committee members received $200 per
meeting, and Audit Committee members and Compensation Committee members received
$100 per meeting, for attendance at such committee meetings.
PERFORMANCE GRAPH
The following table and graph display five year comparative total return
performance information for Mid-State Stock, the Standard and Poors 500 index
(S&P 500), and a proxy for Southern California banks published by SNL Securities
(Southern California Proxy). The information is prepared assuming $100.00 is
invested in each of the three potential investments, five years ago. The
performance information takes into account dividends paid and the price
appreciation or depreciation of the stock(s). It should be noted that historical
performance information is no guarantee of future performance.
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
TOTAL RETURN PERFORMANCE
<S> <C> <C> <C>
Period Ending
Mid-State Bank S&P 500 Southern California Proxy
12/31/92 100.00 100.00 100.00
12/31/93 85.32 110.08 122.27
12/31/94 58.73 111.53 139.49
12/31/95 63.07 153.44 176.91
12/31/96 86.19 188.52 267.07
12/31/97 164.78 251.44 510.65
</TABLE>
82
<PAGE>
CERTAIN TRANSACTIONS
Some of the current directors and officers of Mid-State and the companies
with which they are associated have been customers of, and have had banking
transactions with Mid-State, in the ordinary course of Mid-State's business, and
Mid-State expects to continue to have such banking transactions in the future.
All loans and commitments to lend included in such transactions have been made
on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with persons of similar
creditworthiness, and in the opinion of management of Mid-State, have not
involved more than the normal risk of repayment or presented any other
unfavorable features.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Exchange Act requires Mid-State's directors, executive
officers and ten percent or more shareholders of Mid-State's equity securities
to file with the FDIC initial reports of ownership and reports of changes of
ownership of Mid-State's equity securities. Officers, directors and ten percent
(10%) or more shareholders are required by FDIC regulations to furnish Mid-State
with copies of all Section 16(a) forms they file. To Mid-State's knowledge,
based solely on review of the copies of such reports furnished to Mid-State and
written representations that no other reports were required, during the fiscal
year ended December 31, 1997, all Section 16(a) filing requirements applicable
to its executive officers, directors and beneficial owners of ten percent (10%)
or more of Mid-State's equity securities appear to have been met.
RELATIONSHIP WITH INDEPENDENT PUBLIC ACCOUNTANTS
Mid-State has not yet selected its independent public accountants for the
fiscal year ending December 31, 1998, but intends to do so later this year.
Arthur Andersen LLP audited Mid-State's financial statements for the year ended
December 31, 1997, and have been Mid-State's accountants since 1979. It is
anticipated that a representative of Arthur Andersen LLP will be present at the
Mid-State Meeting and will be available to respond to appropriate questions from
shareholders. All professional services rendered by Arthur Andersen LLP during
1997 were furnished at customary rates and terms.
PROPOSALS OF SHAREHOLDERS
Under certain circumstances, shareholders are entitled to present proposals
at shareholder meetings. In the event the Merger is not carried into effect, any
such proposal to be included in the Proxy Statement for Mid-State's 1999 Annual
Meeting of Shareholders must be submitted by a shareholder prior to December 31,
1998, in a form that complies with applicable regulations.
INFORMATION CONCERNING BANCORP MEETING ONLY
ELECTION OF DIRECTORS
The persons named below, all of whom are present members of the Board of
Directors of the Bancorp, will be nominated for election to serve until the next
Annual Meeting of Shareholders and until their successors are elected and have
qualified. Votes will be cast pursuant to the enclosed Proxy in such a way as to
effect the election of said eleven (11) nominees, or as many thereof as possible
under applicable voting rules. In the event that any of the nominees should be
unable to serve as a director, it is intended that the Proxy will be voted for
the election of such substitute nominee, if any, as shall be designated by the
Board of Directors. Management has no reason to believe that any nominee will
become unavailable to serve as a director of the Bancorp.
At the Effective Time and pursuant to the Agreement, the Board of Directors
of the Bancorp will consist of three members of the current Bancorp Board and
the seven (7) members from the Mid-State Board. It is currently contemplated
that the three members of the Bancorp Board who will continue to
83
<PAGE>
serve as directors of the Bancorp following the Effective Time are A. J. Diani,
William A. Hares and William L. Snelling. For information on the members of the
Mid-State Board who will serve on the Bancorp's Board of Directors, see
"INFORMATION CONCERNING MID-STATE MEETING ONLY-- Election of Directors."
Management knows of no person who, as of the Bancorp Record Date, owned
beneficially more than five percent (5%) of the outstanding Bancorp Stock.
The table on the following page sets forth certain information, as of the
Bancorp Record date, with respect to the persons to be nominated by the Board of
Directors for election as directors, and for the directors and executive
officers(1) as a group:
<TABLE>
<CAPTION>
YEAR FIRST
APPOINTED AS YEAR FIRST
BUSINESS EXPERIENCE BANCORP ELECTED AS
NAME AND OFFICE HELD AGE DURING THE PAST FIVE YEARS DIRECTOR BANK DIRECTOR
- ----------------------------------------------- --- --------------------------------- --------------- -------------
<S> <C> <C> <C> <C>
Armand R. Acosta............................... 72 Retailer, Retired 1996 1977
Richard E. Adam................................ 67 Farmer 1996 1977
Fred L. Crandall, Jr., DDS..................... 69 Dentist 1996 1978
A.J. Diani..................................... 76 Construction 1996 1977
Chairman of the Board
Bank of Santa Maria
BSM Bancorp
William A. Hares............................... 63 Commercial Banking 1996 1981
President and CEO
Bank of Santa Maria
BSM Bancorp
Roger A. Ikola, MD............................. 66 Pediatrician 1996 1977
Toshiharu Nishino.............................. 71 Wholesale Produce 1996 1977
Joseph Sesto, Jr............................... 85 Investments, Retired 1996 1977
William L. Snelling............................ 66 Business Manager, Consultant 1996 1977
Secretary
Bank of Santa Maria
BSM Bancorp
Mitsuo Taniguchi............................... 71 Wholesale Produce, Retired 1996 1977
Joseph F. Ziemba, MD........................... 80 Physician, Retired 1996 1978
</TABLE>
THE BOARD OF DIRECTORS AND COMMITTEES
The Board of Directors of the Bancorp held twelve (12) regular meetings and
two (2) special meetings in 1997. The Bancorp has an Executive Committee, but no
standing Audit, Compensation or Nominating Committees. All of the Bancorp's
directors attended at least 75% of all Bancorp Board and Executive Committee
meetings in 1997.
- ------------------------
(1) As used throughout this joint Proxy Statement/Prospectus, the term
"executive officer," as it relates to the Bancorp, means the President and
Chief Executive Officer, the Executive Vice President-- Administration, the
Executive Vice President and Chief Financial Officer, the Executive Vice
President and Loan Administrator, and the Executive Vice President--Branch
Administrator.
84
<PAGE>
The Bancorp's Executive Committee, consisting of Messrs. Diani, Hares,
Ikola, Sesto, and Snelling, held four (4) meetings in 1997. This committee
reviews policies, rules and regulations for the Bancorp and has the authority to
direct the business and affairs of the Bancorp between Board of Director
meetings.
The Board of Directors of the Bank held twelve (12) regular meetings and one
(1) special meeting in 1997. All of the Bank's directors attended at least 75%
of all Board and applicable committee meetings. In addition to meeting as a
group to review the Bank's business, certain members of the Board of Directors
are members of certain standing committees.
The Bank has a standing Executive, Loan, Audit, Asset/Liability Management
and Compensation Committee.
The Bank's Executive Committee, consisting of Messrs. Diani, Hares, Ikola,
Sesto, and Snelling, held twenty-five (25) meetings in 1997. This committee
reviews policies, rules and regulations for the Bank and has the authority to
direct the business and affairs of the Bank between Board of Director meetings.
This committee also acts as the Nominating and Compensation Committee (described
below) for the Bank.
The Bank's Loan Committee, consisting of Messrs. Acosta, Adam, Hares, Ikola,
Taniguchi, and Executive Officer Forgnone, held twelve (12) meetings in 1997.
This committee oversees the Bank's loan policy and reviews certain loans made by
management.
The Bank's Audit Committee, consisting of Messrs. Crandall, Sesto, Nishino,
Snelling, Ziemba and officer Douglas Bradley, held two (2) meetings in 1997.
This committee is responsible for overseeing internal audit functions and
interfaces with the Bank's outside auditors.
The Bank's Asset/Liability Committee, consisting of Messrs. Diani, Hares,
Ikola, Sesto, Snelling and Executive Officer Fletcher, held three (3) meetings
during 1997. This committee is responsible for overseeing the assets and
liability management functions (including investments and capital resource
allocations) of the Bank.
EXECUTIVE OFFICERS
The following table sets forth as to each of the persons who are currently
executive officers of the Bancorp, such person's age as of March 18, 1998,
principal occupation during the past five (5) years, and the period during which
such person has served as a director of the Bancorp and also the Bank, its
wholly-owned subsidiary.
<TABLE>
<CAPTION>
YEAR FIRST
APPOINTED AS
EXECUTIVE
NAME AGE BUSINESS EXPERIENCE DURING PAST FIVE YEARS OFFICER
- --------------------------------- --- ----------------------------------------------------------- ---------------
<S> <C> <C> <C>
William A. Hares................. 63 President and Chief Executive Officer of the Bancorp since
November, 1996. President and Chief Executive Officer of
the Bank since 1981 1996
Carol Bradfield(1)............... 43 Executive Vice President of the Bancorp since November,
1996. Executive Vice President/ Administration of the
Bank since 1996 1996
F. Dean Fletcher................. 50 Executive Vice President and Chief Financial Officer of the
Bancorp since November, 1996. Executive Vice President
and Chief Financial Officer of the Bank since 1991 1996
Susan Forgnone(2)................ 36 Executive Vice President of the Bancorp since November,
1996. Executive Vice President and Loan Administrator of
the Bank since 1994 1996
</TABLE>
85
<PAGE>
<TABLE>
<CAPTION>
YEAR FIRST
APPOINTED AS
EXECUTIVE
NAME AGE BUSINESS EXPERIENCE DURING PAST FIVE YEARS OFFICER
- --------------------------------- --- ----------------------------------------------------------- ---------------
<S> <C> <C> <C>
James D. Glines.................. 55 Executive Vice President of the Bancorp since November,
1996. Executive Vice President-Branch Administrator of
the Bank since 1997
Executive Vice President since 1992
Manager--Santa Maria Way Branch since 1983 1996
</TABLE>
- ------------------------
(1) Ms. Bradfield joined the Bank in April, 1988. She was formally Senior Vice
President--Human Resources prior to her appointment as an executive officer
of the Bank.
(2) Ms. Forgnone joined the Bank in October, 1988. She has worked in various
aspects of lending with the Bank prior to her appointment as an executive
officer.
None of the directors, nominees or executive officers of the Bancorp were
selected pursuant to any arrangement or understanding, other than with the
directors and executive officers of the Bancorp, acting within their capacities
as such. There are no family relationships between the directors and executive
officers of the Bancorp, except between Director Nishino and Director Taniguchi
who are brothers-in-law, and none of the directors or executive officers of the
Bancorp serve as directors of any company which has a class of securities
registered under, or which is subject to the periodic reporting requirements of,
the Securities Exchange Act of 1934 or any investment company registered under
the Investment Company Act of 1940, as amended, although all of the directors
and executive officers hold similar positions with the Bank, which, until
acquired by the Bancorp, was subject to the above periodic reporting
requirements.
None of the directors or executive officers of the Bancorp have, during the
last five years, been involved in any legal proceedings that are material to an
evaluation of the ability or integrity of any director or executive officer of
the Company.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Management of the Bancorp does not know of any person who owns beneficially
or of record more than 5% of the Bancorp's outstanding common stock. The
following table sets forth certain information as of March 18, 1998, concerning
the beneficial ownership of the Bancorp's outstanding common stock by each of
the directors of the Bancorp and by all directors and executive officers of the
Bancorp as a group.
86
<PAGE>
Neither the Chairman of the Board or the Secretary of the Bancorp are
treated as executive officers.
<TABLE>
<CAPTION>
AMOUNT OF
TITLE OF BENEFICIAL PERCENT
CLASS NAME OF BENEFICIAL OWNER AND TITLE OWNERSHIP(1) OF CLASS(2)
- ------------ ------------------------------------------------------------ ---------------------- -----------
<S> <C> <C> <C>
Common Armand R. Acosta, Director.................................. 24,220(3) .8%
Common Richard E. Adam, Director................................... 100,734(3) 3.3%
Common Fred L. Crandall, Jr., Director............................. 82,176(3) 2.7%
Common A. J. Diani, Chairman....................................... 86,588(3) 2.9%
Common William A. Hares, President................................. 50,310(4) 1.7%
Common Roger A. Ikola, Director.................................... 74,408(3) 2.5%
Common Toshiharu Nishino, Director................................. 92,674(3) 3.1%
Common Joseph Sesto, Jr............................................ 14,000(3) .5%
Common William L. Snelling, Secretary.............................. 81,140(3) 2.7%
Common Mitsuo Taniguchi, Director.................................. 74,524(3) 2.5%
Common Joseph F. Ziemba, Director.................................. 46,956(3) 1.6%
Common All Directors and Executive Officers (15 in number)......... 785,133(5) 26.6%
</TABLE>
- ------------------------
(1) Beneficial owner of a security includes any person who, directly or
indirectly, through any contract, arrangement, understanding, relationship,
or otherwise has or shares: (a) voting power, which includes the power to
vote, or to direct the voting of such security; and/or (b) investment power
which includes the power to dispose, or to direct the disposition of such
security. Beneficial owner also includes any person who has the right to
acquire beneficial ownership of such security as defined above within 60
days of the date specified.
(2) Shares subject to options held by directors and executive officers that were
exercisable within 60 days after the Bancorp Record Date ("vested"), are
treated as issued and outstanding for the purpose of computing the
percentage of class owned by such person (or group) but not for the purpose
of computing the percentage of class owned by any other individual person.
(3) Includes 4,000 vested shares from the 1996 Bancorp stock option plan.
(4) Includes 8,000 vested shares from the 1996 Bancorp stock option plan and
7,237 shares over which Mr. Hares has sole investment powers.
(5) Includes 6,000 vested shares and 23,750 shares owned directly and 34,890
shares whose voting powers can be exercised by the executive officers not
listed individually.
DIRECTOR AND EXECUTIVE OFFICER COMPENSATION
During 1997, the Bancorp did not pay any cash compensation to its executive
officers nor were the directors compensated for their attendance at Bancorp
meetings.
The following Summary Compensation Table shows compensation earned from the
Bank for services rendered during fiscal years 1997, 1996, and 1995 to each of
the Bank's executive officers whose salaries and bonuses exceeded $100,000 in
1997.
87
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL AWARDS
COMPENSATION(1) -------------
---------------------- SECURITIES ALL OTHER
SALARY BONUS UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($)(2) ($)(4) OPTIONS(#)(5) ($)(3)
- --------------------------------------------------- --------- ---------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C>
William A. Hares................................... 1997 $ 185,000 $ 190,000 $ 18,285
President and Chief Executive Officer 1996 170,000 165,000 10,000 17,750
1995 160,000 150,000 16,843
Carol Bradfield.................................... 1997 90,000 70,000 17,715
Executive Vice President 1996 68,104 35,000 5,000 11,051
Administration 1995 N/A N/A N/A N/A
F. Dean Fletcher................................... 1997 100,000 80,000 17,135
Executive Vice President 1996 96,000 60,000 -- 13,776
and Chief Financial Officer 1995 93,000 45,000 -- 15,223
Susan Forgnone..................................... 1997 95,000 70,000 15,041
Executive Vice President 1996 85,000 50,000 -- 12,767
and Loan Administrator 1995 80,000 45,000 -- 9,241
James D. Glines.................................... 1997 95,000 70,000 -- 17,311
Executive Vice President 1996 89,000 50,000 -- 14,614
Branch Administrator 1995 85,000 45,000 12,025
</TABLE>
- --------------------------
(1) The column for other annual compensation has been omitted since the only
items reportable thereunder for the named persons are prequisites, which did
not exceed the lessor of $50,000 or 10% of salary and bonus for any of the
named persons.
(2) Includes all contributions to the Bank's 401(k) Plan, and the Bank's
Flexible Spending Account for medical and child care expenditures made
through salary reductions and deferrals.
(3) All employees of the Bank who have at least one year of service having
worked at least 1,000 hours during that year and are at least 18 years of
age are eligible to participate in the Bank's Profit Sharing and the 401(k)
Salary Deferral Plan. The Salary Deferral Plan is a self funded voluntary
plan that offers certain tax savings with tax deferred investment earnings.
The amount contributed by the participants is fully vested from the date of
deposit. The directors of the Bank at their discretion may elect to match an
amount equal to $.50 for every $1.00 the 401(k) participant invests, not to
exceed 2% of their gross compensation. This contribution is made as of June
30th and December 31st of each year. All matching contributions follows a
seven year vesting schedule. Contribution to the Bank's Profit Sharing Plan
are also at the discretion of the Bank's directors. Any amount that is
contributed is allocated to accounts established for each participating
employee, and is based on a percentage of their gross income. These are
subject to a seven year vesting schedule with 100% vesting occurring after
seven years of service. Funding for the plan always occurs in January of
each year. Participants contributions toward the 401(k) are included in
amounts shown as "Salary," above. The Bank's matching contributions are as
well as the Profit Sharing contribution are aggregated and included under
"All Other Compensation," above.
(4) Cash bonuses are reported in the year earned and may be paid in that year or
in January of the following year at the discretion of the officer. Bonuses
are recommended by the Compensation Committee of the Board and are approved
by the full board at the December meeting. Bonuses are discretionary, but
are generally based upon the operating results of the Bank.
(5) Options shown were issued under the Bank's Incentive Stock Option Plans.
These plans are administered by the Compensation Committee. Options granted
have an exercise price equal to the fair market value on the date of grant,
vest over a term of 5 years, and expire 5 years from the date of grant
unless otherwise noted.
88
<PAGE>
STOCK OPTION GRANTS IN 1997
There were no grants of stock option to any of the named persons during
1997.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth the number of shares acquired by any of the
named persons upon exercise of stock options in 1996, the value realized through
the exercise of such options, and the number of unexercised options held by the
such person, including both those which are presently exercisable, and those
which are not presently exercisable.
<TABLE>
<CAPTION>
NUMBER OF SHARE
VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE MONEY OPTIONS
SHARES OPTIONS AT 12-31-97 (#) AT 12-31-97 ($)(1)
ACQUIRED UPON ------------------------ ------------------------
OPTION VALUE NOT NOT
NAME EXERCISE (#) REALIZED($) EXERCISABLE EXERCISABLE EXERCISABLE EXERCISABLE
- ----------------------------------- ------------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
William A. Hares................... 1,000 $ 19,625 19,500 9,500 $ 355,563 $ 139,437
Carol Bradfield.................... 2,500 38,125 1,000 4,000 12,750 51,000
F. Dean Fletcher...................
Susan Forgnone..................... 5,000 2,500 74,750 37,125
James D. Glines.................... 5,000 41,500
</TABLE>
- ------------------------
(1) Potential unrealized value is determined by multiplying the number of shares
by the net of the fair market value at fiscal year end ($26.50) less the
option exercise price.
COMPENSATION FOR NON-EMPLOYEE DIRECTORS
During 1997, each non-officer director received $900 for each Board of
Directors meeting attended. The Chairman of the Board and the Secretary received
an additional $900 and $300 respectively each month. Members of the Executive
Committee received $900 per meeting attended each month but did not receive more
than $900 in any one month. Members of all other committees received $300 for
each committee meeting attended.
CONTRACTS WITH EXECUTIVE OFFICERS
In March, 1997, the Board of Directors of both the Bancorp and the Bank
approved severance pay agreements for their executive officers which would be
triggered by a change in control of either the Bancorp or the Bank, resulting in
the termination without cause or the resignation of these executive officers for
valid reasons as defined in the agreements. The principal purposes of these
agreements are to help assure that key executives give impartial consideration
in evaluating and negotiating a potential business combination which is in the
best interest of BSM Bancorp's shareholders, but which may result in the loss
of, or reduction in, the executive's job.
The benefits under these agreements are triggered if, within one year
following a change in control, the executive officer's employment is terminated
without cause or the executive officer resigns for reasons such as a substantial
reduction in the officer's responsibilities, an assignment of responsibilities
inconsistent with the executive officer's former responsibilities, a reduction
in the executive officer's annual salary or benefits, or a job relocation of
more than 50 miles.
Severance benefits payable to executive officers covered by Agreements are
determined by multiplying base monthly salary by a component of 24 months for
the President and by 18 months for the other four executive officers. The sum is
payable in monthly installments, or at the discretion of the executive officer,
in one lump sum. In addition, the executive officers are entitled certain fringe
benefits including health and other medical benefits for either the 18 or 24
month period.
89
<PAGE>
Generally, a "change in control" will be deemed to have occurred in any of
the following circumstances:
- A merger or consolidation where the Bank and/or the Bancorp is not the
surviving corporation.
- A transfer of all or substantially all of the assets of the Bank and/or
the Bancorp.
- An acquisition of more than 25% of the outstanding stock coupled with or
followed by a change in the majority of the directors of either the Bank
or the Bancorp.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Bank's Compensation Committee is comprised of A. J. Diani, Carol
Bradfield, William A. Hares, Roger A. Ikola, Joseph Sesto, Jr. and William L.
Snelling. Both Mr. Hares and Ms. Bradfield have served as an Executive Officers
of the Bank during 1997. All of the above directors have had loans outstanding
from the Bank during 1997.
Neither Ms. Bradfield nor Mr. Hares participated in the discussion of their
respective compensation or performance when such matters were addressed by the
committee.
COMPENSATION COMMITTEE REPORT
The compensation committee meets annually to review the salaries and bonuses
of all officers of the Bank. Upon their recommendation, the Bank's full board
then approves salary modifications and bonuses, if any, for all Bank officers.
While all officers are reviewed, particular emphasis is placed upon the salaries
paid to executive officers.
The goal of the compensation program is to align compensation with business
objective and performance, and to enable the Bank to attract and reward
executive officers whose contributions are critical to the long-term success of
the Bank. The Bank is committed to maintaining a pay program that helps attract
and retain the best people in the industry. To ensure that pay is competitive,
the Bank regularly compares its pay practices with those of other leading
independent banks and sets its pay parameters based upon this review.
Executive officers are rewarded based upon corporate performance, and
individual contribution. Bank performance is evaluated by reviewing the extent
to which strategic and business plan goals have been met. Individual
contribution is evaluated by reviewing the progress of the Bank against set
objectives in the individuals area of responsibility.
CEO COMPENSATION
William A. Hares has been President and Chief Executive Officer ("CEO") of
the Bank since January 1982, and President and CEO of the Company since it was
formed in November of 1996. In setting Mr. Hares' compensation, the Compensation
Committee made an overall assessment of Mr. Hares' leadership in achieving the
Company's long-term strategic and business goals. During 1997, particular
emphasis was placed on enhancing shareholders' value. The Committee paid
specific attention to variation in budget projections and well as executive
compensation surveys from the California Banking Association, Department of
Financial Institutions and banks headquartered in the Company's local market
area. Mr. Hares' salary reflects a consideration of both competitive forces and
the Company's performance.
COMPENSATION COMMITTEE
A. J. Diani, Chairmen
Carol Bradfield
William A. Hares
Roger A. Ikola
Joseph Sesto, Jr.
William L. Snelling
90
<PAGE>
PERFORMANCE GRAPH
The chart shown below compares Mid-State Bank's cumulative five-year total
shareholder return with both the S&P 500 Index and an index developed by SNL
Securities that represents Southern California banks.
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN
AMONG BSM BANCORP, S&P 500 INDEX AND INDUSTRY INDEX
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
TOTAL RETURN PERFORMANCE
<S> <C> <C> <C>
Period Ending
Index Value BSM Bancorp S&P Southern California Proxy
12/31/92 100.00 100.00 100.00
12/31/93 110.00 110.08 122.27
12/31/94 115.99 111.53 139.49
12/31/95 138.57 153.44 176.91
12/31/96 167.88 188.52 267.07
12/31/97 287.05 251.44 510.65
</TABLE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Some of the Company's Directors and executive officers and their immediate
families, as well as the companies with which they are associated, are customers
of, or have had banking transactions with, the Bank in the ordinary course of
the Bank's business, and the Bank expects to have banking transactions with such
persons in the future. In management's opinion, all loans and commitments to
lend included in such transactions were made in the ordinary course of business,
in compliance with applicable laws on substantially the same terms, including
interest rates and collateral, as those prevailing for comparable transactions
with other persons of similar creditworthiness and, in the opinion of
management, did not involve more than a normal risk of repayment or presented
other unfavorable features.
RELATIONSHIP WITH INDEPENDENT PUBLIC ACCOUNTANTS
The Bancorp has not yet selected its independent public accountants for the
fiscal year ending December 31, 1998, but intends to do so later this year.
Vavrinek, Trine, Day & Co., LLP audited the Bancorp's financial statements for
the year ended December 31, 1997, and have been the Bancorp's accountants since
inception. It is anticipated that a representative of Vavrinek, Trine, Day &
Co., LLP will
91
<PAGE>
be present at the Meeting and will be available to respond to appropriate
questions from shareholders. All professional services rendered by Vavrinek,
Trine, Day & Co., LLP
PROPOSALS OF SHAREHOLDERS
Under certain circumstances, shareholders are entitled to present proposals
at shareholder meetings. Any such proposal to be included in the Bancorp's Proxy
Statement for the 1999 Annual Meeting of Shareholders must be submitted by a
shareholder prior to December 31, 1998 in a form that complies with applicable
regulations.
1996 STOCK OPTION PLAN AND PROPOSED AMENDMENTS
INTRODUCTION
The BSM Bancorp 1996 Stock Option Plan (the "1996 Plan"), was adopted by the
Board of Directors of the Bancorp on November 12, 1996, subject to the approval
of the California Commissioner of Corporations and the holders of a majority of
the issued and outstanding shares of the Bank as prospective shareholders of the
Bancorp. The California Commissioner of Corporations issued an order on December
9, 1996 approving the terms and conditions of the 1996 Plan. The 1996 Plan was
subsequently approved by the shareholders of the Bank as prospective
shareholders of the Bancorp at the time of the approval of the formation of the
Bancorp as the holding company for the Bank.
The Board of Directors subsequently amended the 1996 Plan on March 11 and
May 13, 1997 in order to comply with new regulations of the California
Department of Corporations that became effective on January 15, 1997. The 1996
Plan was amended to exempt officers, directors and consultants, but not other
employees, of the Bancorp and the Bank from the requirement that the option
granted must be exercisable at a minimum of 20% per year over a period of five
years from the date of grant of the option. Further, the 1996 Plan was amended
to provide that options granted to directors, officers and consultants may
become fully exercisable upon the occurrence of a terminating event such as a
merger or change of control of the Bancorp. The 1996 Plan was also amended to
provide for the issuance of substituted options, and if an optionee that is not
a consultant is terminated for cause, then the option would automatically
terminate, subject to possible reinstatement by the Bancorp's Stock Option
Committee. The 1996 Plan was also amended to provide for a total of 892,542
shares that would be reserved for issuance under the 1996 Plan, which was equal
to 30% of the then issued and outstanding shares of the Bancorp. On May 6, 1996,
the Commissioner of Corporations issued an order authorizing the amendments to
the 1996 Plan. On June 13, 1997, the Bancorp registered the 1996 Plan under the
Securities Act of 1933, as amended, by filing a Form S-8 with the SEC.
The purpose of the 1996 Plan is to strengthen the Bancorp and its
wholly-owned subsidiary, the Bank, by providing an additional means of
attracting and retaining competent managerial personnel and by providing to
participating officers, key employees and directors, as well as consultants,
advisors and others having a business relationship with the Bancorp and the
Bank, added incentive for high levels of performance and for unusual efforts to
increase the earnings of the Bancorp and the Bank. The 1996 Plan seeks to
accomplish these purposes and achieve these results by providing a means whereby
such officers, key employees and directors, as well as consultants, advisors and
others having a business relationship with the Bancorp and the Bank, purchase
shares of the Bancorp's Common Stock pursuant to options granted in accordance
with the 1996 Plan. The Board of Directors believes the 1996 Plan is beneficial
to the Bancorp, the Bank and the Bancorp's shareholders.
PROPOSED AMENDMENTS TO 1996 PLAN
On January 29, 1998, the Bancorp, the Bank and Mid-State Bank executed the
Agreement whereby (i) the Bank will merge with and into Mid-State and Mid-State
will continue as the surviving bank, (ii) the Bancorp will become the bank
holding company for Mid-State and change its name to "Mid-State
92
<PAGE>
Bancshares" and (iii) the shareholders of Mid-State will become shareholders of
the Bancorp in accordance with the exchange ratio set forth in the Agreement.
Article 7 of the Agreement requires the Bancorp to amend the 1996 Plan that
would allow for the granting of substitute options to the officers and employees
of the Bancorp and the Bank, and certain directors that would continue as
directors of the Bancorp and Mid-State, that would have the same terms and
conditions as existing Bancorp options, except that such substitute options
would be completely vested and such options would not terminate as a result of
the Merger, subject to all necessary approvals of the California Commissioner of
Corporations and other necessary regulatory agency. The Plan will survive the
Merger and substitute stock options will be granted to Mid-state optionees
pursuant to the 1996 Plan. See "THE MERGER--Treatment of Stock Options."
SUMMARY OF 1996 PLAN
The purpose of the 1996 Plan is to strengthen the Bancorp and the Bank by
providing an additional means of attracting and retaining competent managerial
personnel. The 1996 Plan provides to participants added incentive for high
levels of performance and for unusual efforts to increase the earnings of the
Bancorp and the Bank. The 1996 Plan assists in accomplishing these objectives
and facilitates in achieving these results by providing a means whereby
directors, officers and key employees, as well as consultants, advisors and
others having a business relationship with the Bancorp and the Bank, may
purchase shares of the Common Stock of the Bancorp pursuant to options granted
in accordance with the 1996 Plan. 892,542 unissued shares of the Bancorp are
reserved for issuance to directors, officers and employees, as well as
consultants, advisors and others having a business relationship with the Bancorp
and the Bank ("Eligible Participants"). Options granted pursuant to the 1996
Plan may be non-qualified options or incentive stock options within the meaning
of Section 422A of the Internal Revenue Code.
The 1996 Plan is administered by the Board of Directors of the Bancorp or by
a committee appointed from time to time by the Board. The Board of Directors or
the committee determines the Eligible Participants in the 1996 Plan and the
extent of their participation.
The purchase price of stock subject to each option is not less than one
hundred (100%) of the fair market value of such stock at the time such option is
granted. An Eligible Participant owning more than ten percent (10%) of the total
combined voting power of all classes of stock of the Bancorp may only be granted
an option with an exercise price at least 110% of the fair value of Bancorp
stock at the date of grant. The purchase price of any shares exercised shall be
paid in full in cash or, with the prior written approval of the committee, in
shares of the Bancorp or on a deferred basis evidenced by a promissory note. In
addition, the optionee shall have the right upon exercise of an option to
surrender for cancellation a portion of the option for the number of shares
exercised. Options may be granted pursuant to the 1996 Plan for a term of up to
ten (10) years. Each option shall be exercisable according to the determination
of the Board or committee, except that options granted to employees that are not
directors, officers and consultants shall be exercisable at a minimum of 20% per
year over a five year period.
Options granted under the 1996 Plan shall not be transferable by the
optionee during the optionee's lifetime. In the event of termination of
employment as a result of the optionee's disability or in the event of an
employee's death during the exercise period, to the extent the option is
exercisable on the date employment terminates or the date the employee dies, the
option shall remain exercisable for up to one (1) year (but not beyond the end
of the original option term) by the disabled optionee or, in the event of death
of the optionee, a non-qualified option shall be exercisable by the person or
persons to whom rights under the option shall have passed by will or the laws of
descent and distribution.
If an optionee's employment is terminated, unless termination was by reason
of disability or death, the optionee shall have the right, for a 3-month period
after termination, to exercise that portion of the option which was exercisable
immediately prior to such termination. If an optionee's employment is terminated
for cause, except for options granted to consultants and business advisors, the
option shall terminate,
93
<PAGE>
subject to possible reinstatement within thirty (30) days by the Board of
Directors or the committee. In no event may the option be exercised after the
end of the original option term. However, such termination provisions shall not
apply for options granted to consultants, business associates or other persons
or entities with important business relationships with the Bancorp.
In the event of certain changes in the outstanding Common Stock of the
Bancorp without receipt of consideration by the Bancorp, such as stock
dividends, stock splits, recapitalization, reclassification, reorganization,
merger, stock consolidation, or otherwise, appropriate and proportionate
adjustments shall be made in the number, kind and exercise price of shares
covered by any unexercised or partially unexercised options which were already
granted. Optionees will receive prior notice of any pending dissolution or
liquidation of the Bancorp, or reorganization, merger or dissolution or
liquidations of the Bancorp, or reorganization, merger or consolidation where
the Bancorp is not the surviving corporation or sale of substantially all the
assets of the Bancorp or other form of corporate reorganization in which the
Bancorp is not a surviving entity, or the acquisition of stock representing more
than 50% of the voting power of the stock of the Bancorp then outstanding
("Terminating Event"). Optionees have thirty (30) days from the date of mailing
of such notices to exercise any option in full. After such thirty (30) days, any
option not exercised shall terminate and upon the occurrence of the Terminating
Event, the 1996 Plan shall terminate, unless some other provision is made in
connection with the Terminating Event. As indicated above, the Agreement
provides that the 1996 Plan shall continue following the Effective Time of the
Merger. In addition, the Bancorp is proposing hereby that the 1996 Plan be
amended to provide that the options to all officers and employees, and directors
of the Bancorp and the Bank that continue as directors of the Bancorp and the
Bank following the Merger, be granted substitute options that would have the
same terms and conditions as their existing options except that such options
would be completely vested.
The Board reserves the right to suspend, amend, or terminate the 1996 Plan,
and, with the consent of the optionee, make such modifications, of the terms and
conditions of his or her option as it deems advisable, except that the Board may
not, without further approval of a majority of the shares, increase the maximum
number of shares covered by the 1996 Plan, change the minimum option price,
increase the maximum term of options under the 1996 Plan or permit options to be
granted to any one other than an officer, employee or director, or consultant,
advisor or other person having a business relationship with the Bancorp or the
Bank.
Unless previously terminated by the Board of Directors, the 1996 Plan shall
terminate ten years from the date the 1996 Plan was adopted by the Board of
Directors of the Bancorp, or November 12, 2006.
Shares of the Bancorp's Common Stock to be issued upon exercise of stock
options need not be registered with the SEC. However, the Bancorp has applied
for a permit from the California Commissioner of Corporations for the proposed
amendments, and the Bancorp intends to amend its registration statement with the
SEC with the amendments for the 1996 Plan.
FEDERAL INCOME TAX CONSEQUENCES
To the extent that options granted under the 1996 Plan qualify as incentive
stock options and (i) the optionee does not sell the stock acquired upon
exercise of the options within two (2) years of the date of grant and one (1)
year from the date of exercise and (ii) the optionee was employed by the Bancorp
or a subsidiary for the entire period beginning on the date of grant of option
and ending three (3) months prior to the exercise of the option, then the
optionee will not recognize compensation income to the extent of any "bargain
element" determined as of the time of grant or exercise, and the Bancorp will
not be entitled to a corresponding tax deduction. However, the bargain element
is a time of tax preference for the purpose of determining the employee's
alternative minimum tax.
If the optionee disposes of the stock acquired through the exercise of the
incentive stock option prior to satisfaction of the holding period or fails to
satisfy the employment requirement, the optionee will recognize compensation
income and the Bancorp will be entitled to a corresponding tax deduction to the
94
<PAGE>
extent of the lesser of (i) the excess of the fair market value of the stock at
the date of exercise over the exercise price or (ii) the amount realized in
excess of the tax basis of the stock if disposed in a taxable transaction.
If the options granted under the 1996 Plan are nonqualified, the optionee
will not recognize taxable income, and the Bancorp will not be entitled to a
corresponding tax deduction, at the time of grant or exchange. Upon the exercise
of a non-qualified stock option, however, the optionee will recognize taxable
income equal to the "bargain element" or the "spread", the difference between
the fair market value determined as of the time of exercise of the Bancorp's
Common Stock acquired by the optionee and the option price paid for the stock.
The Bancorp will be entitled to a corresponding tax deduction equal to the
income recognized by the optionee provided that the income tax withholding
attributable to the optionee's recognized income is collected from the optionee.
Approval of the proposed amendments to the 1996 Plan requires the
affirmative vote of a majority of the issued and outstanding shares of the
Bancorp, and the proposed amendments are subject to the approval of the
California Commissioner of Corporations.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE APPROVAL OF THE PROPOSED
AMENDMENTS TO THE BANCORP'S 1996 STOCK OPTION PLAN.
LEGAL MATTERS
Certain legal matters in connection with the Merger will be passed upon for
Mid-State by Reitner & Stuart, San Luis Obispo, California and for Bancorp and
the Bank by Knecht & Hansen, Newport Beach, California.
EXPERTS
The consolidated balance sheets of Mid-State as of December 31, 1997 and
1996 and the related consolidated statements of income, changes in stockholders'
equity, and cash flows for each of the three years in the period ending December
31, 1997 appearing in Appendix E of this Joint Proxy Statement/ Prospectus have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto and are included herein in
reliance upon the authority of said firm as experts in giving said reports.
The consolidated balance sheets of Bancorp as of December 31, 1997 and 1996,
and the related consolidated statements of income, changes in shareholders'
equity, and cash flows for each of the three years in the period ending December
31, 1997 appearing in Appendix F of this Joint Proxy Statement/ Prospectus have
been audited by Vavrinek, Trine, Day & Co., LLP as indicated in their report
with respect thereto and are included herein in reliance upon the authority of
said firm as experts in giving said reports.
OTHER MATTERS
Mid-State and Bancorp do not know of any business other than that described
in this Joint Proxy Statement/Prospectus which will be presented for
consideration at the respective Meetings. If any other business properly comes
before the respective Meetings or any and all adjournments or postponements
thereof, the proxy holders named in the accompanying proxies will vote their
respective shares represented by such proxies in accordance with their best
judgment and, as applicable, in accordance with said proxies.
95
<PAGE>
APPENDIX A
AGREEMENT TO MERGE
AND PLAN OF REORGANIZATION
DATED AS OF JANUARY 29, 1998
AND
FIRST AMENDMENT TO
AGREEMENT TO MERGE AND
PLAN OF REORGANIZATION
DATED AS OF MARCH 18, 1998
BY AND AMONG
BANK OF SANTA MARIA
BSM BANCORP
AND
MID-STATE BANK
A-1
<PAGE>
AGREEMENT TO MERGE
AND PLAN OF REORGANIZATION
THIS AGREEMENT TO MERGE AND PLAN OF REORGANIZATION ("AGREEMENT") is
entered into as of January 29, 1998, among Bank of Santa Maria, a banking
company organized under the laws of California ("BANK"), being located in
Santa Maria, California, BSM Bancorp, a corporation and registered bank
holding company organized under the laws of California ("BANCORP"), and
Mid-State Bank, a banking company organized under the laws of California
("ACQUIROR"), located in Arroyo Grande, California.
R E C I T A L S:
A. Bank is a wholly owned subsidiary of Bancorp.
B. Bancorp, Bank and Acquiror believe that it would be in their
respective best interests and in the best interests of their respective
shareholders for Bank to merge with and into Acquiror (the "Bank Merger"),
for Bancorp to become the bank holding company for Acquiror and for the
shareholders of Acquiror to become shareholders of Bancorp, all in accordance
with the terms set forth in this Agreement and applicable law.
C. The respective Boards of Directors of Bank and Acquiror have
adopted by majority vote resolutions approving and authorizing the Bank
Merger upon the terms and conditions set forth in this Agreement and the
Board of Directors of Bancorp has adopted by majority vote resolutions
approving the Bank Merger, this Agreement and the transactions contemplated
herein.
D. Bancorp, Bank and Acquiror desire to make certain representations,
warranties, covenants and agreements in connection with the transactions
contemplated by this Agreement.
A G R E E M E N T
IN CONSIDERATION of the premises and mutual covenants hereinafter
contained, Bank, Bancorp and Acquiror agree as follows:
1
DEFINITIONS AND DETERMINATIONS
1.1 DEFINITIONS. Capitalized terms used in this Agreement shall
have the meanings set forth below:
"Acquiror" shall have the meaning given such term in the
introductory clause.
A-2
<PAGE>
"Acquiror Benefit Arrangement" shall have the meaning given such
term in Section 4.18(b).
"Acquiror Corporate Governance Changes" shall have the meaning
given such term in Section 2.1(b).
"Acquiror's Directors' Agreement" shall mean an agreement,
substantially in the form attached as Exhibit 2.6(B).
"Acquiror Dissenting Shares" means shares of Acquiror Stock held by
"dissenting shareholders" within the meaning of Chapter 13 of the CGCL.
"Acquiror Perfected Dissenting Shares" means Dissenting Shares
which the holders thereof have not withdrawn or caused to lose their status
as Acquiror Dissenting Shares.
"Acquiror Property" shall have the meaning given such term in
Section 4.25.
"Acquiror Scheduled Contracts" shall have the meaning given such
term in Section 4.30.
"Acquiror Shareholders' Meeting" shall have the meaning given such
term in Section 6.5.
"Acquiror Stock" means the common stock, no par value, of Acquiror.
"Acquiror Stock Options" shall have the meaning given such term in
Section 7.4(a).
"Agreement of Merger" means the Agreement of Merger substantially
in the form attached hereto as Exhibit A.
"Affiliate" means a person that directly, or indirectly through one
or more intermediaries, controls, or is controlled by, or is under common
control with, the person specified.
"Average Closing Price" means the average of the daily closing
prices of a share of Acquiror Stock reported on the OTC Bulletin Board during
the 20 consecutive trading days that Acquiror's Stock trades ending at the
end of the third trading day immediately preceding the Effective Day.
"Bancorp" shall have the meaning given such term in the
introductory clause.
A-3
<PAGE>
"Bancorp Corporate Governance Changes" shall have the meaning given
such term in Section 2.1(d).
"Bancorp Directors' Agreement" shall mean an agreement,
substantially in the form attached as Exhibit 2.6(A).
"Bancorp Dissenting Shares" means shares of Bancorp Stock held by
"dissenting shareholders" within the meaning of Chapter 13 of the CGCL.
"Bancorp Perfected Dissenting Shares" means Dissenting Shares which
the holders thereof have not withdrawn or caused to lose their status as
Bancorp Dissenting Shares.
"Bancorp Property" shall have the meaning given such term in
Section 3.26.
"Bancorp Scheduled Contracts" shall have the meaning given such
term in Section 3.15.
"Bancorp Shareholders' Meeting" shall have the meaning given such
term in Section 5.6.
"Bancorp Stock" means the common stock, no par value, of Bancorp.
"Bancorp Stock Option" means any option issued pursuant to the
Bancorp Stock Option Plan.
"Bancorp Stock Option Plan" means the BSM Bancorp 1996 Stock Option
Plan.
"Bank" shall have the meaning given such term in the introductory
clause.
"Bank Benefit Arrangement" shall have the meaning given such term
in Section 3.19(b).
"Bank Merger" shall have the meaning given such term in the
Recitals.
"Bank Stock" means the common stock, NO PAR value, of Bank.
"Benefit Arrangement" means any plan or arrangement maintained or
contributed to by a Party, including an "employee benefit plan" within the
meaning of ERISA, (but exclusive of base salary and base wages) which
provides for any form of current or deferred compensation, bonus, stock
option, profit sharing, benefit, retirement, incentive, group health or
insurance, welfare or similar plan or arrangement for the benefit of any
employee or class of employee, whether active or retired, of a Party.
A-4
<PAGE>
"BHC Act" means the Bank Holding Company Act of 1956, as amended.
"Business Day" means any day other than a Saturday, Sunday or day
on which commercial banks in California are authorized or required to be
closed.
"CFC" means the California Financial Code.
"CGCL" means the California General Corporation Law.
"Certificates" shall have the meaning given such term in Section
2.5.
"Charter Documents" means, with respect to any business
organization, any certificate or articles of incorporation or articles of
association, and any bylaws, each as amended to date, that regulate the basic
organization of the business organization and its internal relations.
"Closing" means the consummation of the Bank Merger on the
Effective Day at the main office of Acquiror or at such other place as may be
agreed upon by the Parties.
"Code" means the United States Internal Revenue Code of 1986, as
amended, and all regulations thereunder.
"Commissioner" means the Commissioner of Financial Institutions,
State of California.
"Competing Transaction" shall have the meaning given such term in
Section 5.14.
"Confidential Information" means all information exchanged
heretofore or hereafter between Acquiror, its affiliates and agents, on the
one hand, and Bancorp and Bank, their affiliates and agents, on the other
hand, which is information related to the business, financial position or
operations of the Person responsible for furnishing the information or an
Affiliate of such Person (such information to include, by way of example only
and not of limitation, client lists, company manuals, internal memoranda,
strategic plans, budgets, forecasts/ projections, computer models, marketing
plans, files relating to loans originated by such Person, loans and loan
participation purchased by such Person from others, investments, deposits,
leases, contracts, employment records, minutes of board of directors meetings
(and committees thereof) and stockholder meetings, legal proceedings, reports
of examination by any Governmental Entity, and such other records or
documents such Person may supply to the other Party pursuant to the terms of
this Agreement or as contemplated hereby). Notwithstanding the foregoing,
"Confidential Information" shall not include any information that (i) at the
time of disclosure or thereafter is generally available to and known by the
public (other than as a result of a disclosure directly or indirectly by the
recipients or any of their officers, directors, employees or other
representatives or agents), (ii) was available to the
A-5
<PAGE>
recipients on a nonconfidential basis from a source other than Persons
responsible for furnishing the information, PROVIDED that such source is not
and was not bound by a confidentiality agreement with respect to the
information, or (iii) has been independently acquired or developed by the
recipients without violating any obligations under this Agreement.
"Consents" means every required consent, approval, absence of
disapproval, waiver or authorization from, or notice to, or registration or
filing with, any Person.
"Determination Date" shall have the meaning given such term in
Section 10.1(i).
"Disclosure Letter" means a disclosure letter from the Party making
the disclosure and delivered to the other Party.
"DPC Property" means voting securities, other personal property and
real property acquired by foreclosure or otherwise, in the ordinary course of
collecting a debt previously contracted for in good faith, retained with the
object of sale for any applicable statutory holding period, and recorded in
the holder's business records as such.
"Effective Day" means the day on which the Effective Time occurs.
"Effective Time" shall have the meaning given such term in Section
2.2.
"Encumbrances" means any option, pledge, security interest, lien,
charge, encumbrance, mortgage, assessment, claim or restriction (whether on
voting, disposition or otherwise), whether imposed by agreement,
understanding, law or otherwise.
"Environmental Laws" shall have the meaning given such term in
Section 3.26.
"Equity Securities" means capital stock or any options, rights,
warrants or other rights to subscribe for or purchase capital stock, or any
plans, contracts or commitments that are exercisable in such capital stock or
that provide for the issuance of, or grant the right to acquire, or are
convertible into, or exchangeable for, such capital stock.
"ERISA" means the Employee Retirement Income Security Act of 1974,
as amended, and all regulations thereunder.
"Exchange Act" means the Securities Exchange Act of 1934, as
amended.
"Exchange Agent" means ChaseMellon Shareholder Services or such
other financial institution appointed by Acquiror, to effect the exchange
contemplated by Section 2.5 hereof.
"Exchange Fund" shall have the meaning given such term in Section 2.5.
A-6
<PAGE>
"Exchange Ratio" means the number of shares of Bancorp Stock into
which a share of Acquiror Stock shall be converted which shall be equal to
the amount calculated (to the nearest ten thousandth) as set forth
hereinbelow (unless said Exchange Ratio is further adjusted pursuant to
Section 10.1(i)):
(i) If the Average Closing Price is not less than $26.25 and
is not more than $30.50, the Exchange Ratio shall be the reciprocal of the
number determined by dividing $29.37 by the Average Closing Price;
(ii) Subject to Section 10.1(i), if the Average Closing Price
is less than $26.25, the Exchange Ratio shall be .8938; and
(iii) If the Average Closing Price is greater than $30.50, the
Exchange Ratio shall be 1.0385.
The Exchange Ratio shall be adjusted upward for any Significant Liabilities.
"Significant Liabilities", as used in this Agreement, shall relate to the
following categories or events unless Acquiror has consented in writing to
such matter: (1) new or extended contractual obligations other than those
arising in the ordinary course of Bank's or Bancorp's business; (2) new or
extended leases of real or personal property; (3) acquisition of capital
assets (or commitments to do so) except for assets required in the ordinary
course of business; (4) actual or contingent liabilities based upon
threatened or pending litigation, other proceedings or Hazardous Materials
and legal fees and costs (whether actual or estimated) related thereto as
described in Section 5.12 (provided, however, that the amount of such
liabilities shall be reduced by the amount of any insurance proceeds actually
received or certain, in the reasonable judgment of Acquiror, to be received);
(5) any unbooked expenses, fines, penalties or similar obligations except
those arising in the ordinary course of Bank's or Bancorp's business; (6) any
new, expanded or accelerated pension or other employee benefits including
employment contracts and severance payments in excess of one month's
compensation, whether or not vested; (7) an amount which would equal the
amount necessary to bring the Bank's allowance for loan losses as of the
calendar quarter preceding the Effective Time to the amount required by the
Bank's existing policy on allowance for loan and lease losses (provided,
however, that if Acquiror should disagree with the adequacy of Bank's
allowance for loan losses, then such disagreement shall be resolved through
the independent expert as discussed below); and (8) an amount which would
equal the amount necessary to bring Bancorp's shareholders' equity to the
minimum Bancorp shareholders' equity amount as described in Section 8.3(k).
Acquiror and Bancorp shall identify any categories or events reasonably
believed by either of them to be Significant Liabilities commencing
immediately following receipt of the required Consents for the Bank Merger by
the Governmental Entities. All calculations of Significant Liabilities, if
any, shall be fully taxed affected, and the after tax cost of any item
referenced above shall be the amount of the Significant Liability. To the
extent that the item related to any Significant Liability shall have already
been booked and expensed by the Bancorp and Bank
A-7
<PAGE>
and is therefore included within the amount of shareholders' equity for
purposes of (8), above, no further adjustment shall be made as a result
thereof. Upon identification of a Significant Liability, the Parties shall
attempt to agree upon the amount of said Significant Liability within seven
days. If no mutual agreement is reached within said period, the Parties
shall immediately hire an independent expert qualified to render an opinion
regarding the amount of the particular Significant Liability. The Parties
shall cooperate fully with any such independent expert and will equally split
the cost of such expert. The opinion of such expert shall be binding on the
parties for purposes of this Agreement. As a result of any Significant
Liabilities through the close of business on the Business Day preceding the
Effective Day, the Exchange Ratio shall be calculated (to the nearest ten
thousandth) according to the following formula:
1
---------------------
$29.37- x
-----------
Average Closing Price
where "x" represents the dollar amount of any Significant Liabilities divided
by the outstanding shares of Bancorp Stock (determined as of the Business Day
preceding the Effective Day). Further, if the Average Closing Price is below
$26.25 per share or above $30.50, then for purposes of this calculation
$26.25 or $30.50 respectively shall be used as the Average Closing Price
subject to Section 10.1(i).
"Expenses" shall have the meaning given such term in Section 11.1.
"Executive Officer" means with respect to any company a natural
Person who participates or has the authority to participate (other than
solely in the capacity of a director) in major policy making functions of the
company, whether or not such Person has a title or is serving with salary or
compensation.
"FDIC" means the Federal Deposit Insurance Corporation.
"Financial Statements of Bank/Bancorp" means the audited financial
statements and notes thereto of Bank and the related opinions thereon for the
years ended December 31, 1994, 1995 and 1996 and the unaudited consolidated
statements of financial condition and statements of operations and cash flow
of Bancorp for the nine months ended September 30, 1997.
"Financial Statements of Acquiror" means the audited consolidated
financial statements and notes thereto of Acquiror and the related opinions
thereon for the years ended December 31, 1994, 1995 and 1996 and the
unaudited consolidated statements of financial condition and statements of
operations and cash flow of Acquiror for the nine months ended September 30,
1997.
"FRB" shall mean the Board of Governors of the Federal Reserve
System.
A-8
<PAGE>
"GAAP" means generally accepted accounting principles.
"Governmental Entity" means any court or tribunal in any
jurisdiction or any United States federal, state, district, domestic, or
other administrative agency, department, commission, board, bureau or other
governmental authority or instrumentality.
"Hazardous Materials" shall have the meaning given such term in
Section 3.26.
"Immediate Family" shall mean a Person's spouse, parents, in-laws,
children and siblings.
"IRS" shall mean the Internal Revenue Service.
"Investment Securities" means any equity security or debt security
as defined in Statement of Financial Accounting Standard No. 115.
"Minimum Price" shall have the meaning given such term in Section
10.1(i).
"Operating Loss" shall have the meaning given such term in Section
3.25.
"Party" means any of Bancorp, Bank or Acquiror.
"Permit" means any United States federal, foreign, state, local or
other license, permit, franchise, certificate of authority, order of approval
necessary or appropriate under applicable Rules.
"Person" means any natural person, corporation, trust, association,
unincorporated body, partnership, joint venture, Governmental Entity,
statutorily or regulatory sanctioned unit or any other person or organization.
"Projected Earnings" shall have the meaning given such term in
Section 8.3(k).
"Proxy Statement" means the joint proxy statement that is included
as part of the S-4 and used to solicit proxies for the Acquiror Shareholders'
Meeting and the Bancorp Shareholders' Meeting and to offer and sell the
shares of Bancorp Stock to be issued in connection with the Bank Merger.
"Related Group of Persons" means Affiliates, members of an
Immediate Family or Persons the obligation of whom would be attributed to
another Person pursuant to the regulations promulgated by the SEC.
A-9
<PAGE>
"Rule" means any statute or law or any judgment, decree,
injunction, order, regulation or rule of any Governmental Entity.
"S-4" means the registration statement on Form S-4, and such
amendments thereto, that is filed with the SEC to register the shares of
Bancorp Stock to be issued in the Bank Merger under the Securities Act and to
clear use of the Proxy Statement in connection with the Acquiror
Shareholders' Meeting and the Bancorp Shareholders' Meeting pursuant to the
regulations promulgated under the Exchange Act.
"SEC" means the Securities and Exchange Commission.
"SEC Reports" mean all reports filed by a Party hereto pursuant to
the Exchange Act with the SEC or the FDIC.
"Securities Act" means the Securities Act of 1933, as amended.
"Significant Liabilities" shall have the meaning given such term in
the definition of "Exchange Ratio".
"Surviving Bank" means the Acquiror as the California
state-chartered bank surviving the Bank Merger of Bank with and into Acquiror.
"Tank" shall have the meaning given such term in Section 3.26.
"Third Party Consent" shall have the meaning given such term in
subsection (b) of Section 5.7.
"To the knowledge" shall have the meaning given such term in
Section 11.14.
ARTICLE 2
CONSUMMATION OF THE BANK MERGER
2.1 THE MERGER; PLAN OF REORGANIZATION.
(a) Subject to the terms and conditions of this Agreement and
the Agreement of Merger, at the Effective Time, Bank shall merge with and
into Acquiror under the charter of Acquiror.
(b) The Charter Documents of Acquiror as in effect
immediately prior to the Effective Time shall continue in effect after the
Bank Merger until thereafter amended in accordance with applicable law and
the members of the Board of Directors and the Executive
A-10
<PAGE>
Officers of Acquiror immediately prior to the Bank Merger shall continue in
their respective positions after the Bank Merger and be the Board of
Directors and Executive Officers of the Surviving Bank; except that Acquiror
shall have taken prior to the Effective Time all necessary steps so that at
the Effective Time (i) the number of authorized directors of Acquiror shall
be expanded by three, (ii) the three persons set forth on Exhibit 2.1(b)
[which Exhibit shall be delivered by Acquiror to Bancorp within forty-five (45)
days of the date of the Agreement] shall be duly elected and appointed to fill
such three vacancies (or if any of such persons is unable to serve, such other
person designated by Bank and reasonably acceptable to Acquiror) and shall serve
until the earlier of their resignation or removal or until their respective
successors are duly elected and qualified, (iii) the current Chairman of the
Board of the Bank shall be elected and appointed Vice Chairman of the Board of
Directors of Acquiror, and (iv) the current President of the Bank shall be
appointed Executive Vice President of the Acquiror (clauses (i) - (iv) being
hereinafter collectively referred to as the "Acquiror Corporate Governance
Changes").
(c) At the Effective Time, the corporate existence of Bank
shall be merged and continued in the Surviving Bank. All assets, rights,
franchises, titles and interests of Bank and Acquiror, in and to every type
of property (real, personal and mixed) and choses in action shall be
transferred to and vested in the Surviving Bank by virtue of the Bank Merger
without any deed or other transfer, and the Surviving Bank, without any order
or action on the part of any court or otherwise, shall hold and enjoy all
rights of property, franchises and interests, including appointments,
designations and nominations, and all other rights and interests as trustee,
executor, administrator, registrar of stocks and bonds, guardian of estates,
assignee or receiver and in every other fiduciary capacity in the same manner
and to the same extent that such rights, franchises and interests were held
by Bank and Acquiror at the Effective Time. At the Effective Time, the
Surviving Bank shall be liable for all liabilities of Bank and Acquiror and
all deposits, debts, liabilities, obligations and contracts of Bank and
Acquiror, matured or unmatured, whether accrued, absolute, contingent or
otherwise, and whether or not reflected or reserved against on balance
sheets, books of accounts or records of Bank and Acquiror, shall be those of
the Surviving Bank; and all rights of creditors or other obligees and all
liens on property of Bank and Acquiror shall be preserved unimpaired.
(d) The Charter Document of Bancorp as in effect immediately
prior to the Effective Time shall continue in effect after the Bank Merger
until thereafter amended in accordance with applicable law and the operations
of Bancorp shall continue in effect after the Bank Merger; except that
Bancorp shall have taken prior to the Effective Time all necessary steps so
that at the Effective Time (i) the Charter Documents of Bancorp shall be
amended to change its name to "Mid-State Bancshares," (ii) each of the
Executive Officers and officers of Bancorp shall have tendered his
resignation from his position, in form and substance satisfactory to
Acquiror, without incurring any liability on the part of any Party, (iii)
each of the directors of Bancorp (except for the three persons set forth on
Exhibit 2.1(b) [which Exhibit shall be delivered by Acquiror to Bancorp within
forty-five (45) days of the date of the Agreement] or if any of such persons is
unable to serve, such other director of Bancorp designated by Bank and
reasonably acceptable to
A-11
<PAGE>
Acquiror) shall have tendered his resignation as a director of Bancorp, in
form and substance satisfactory to Acquiror, without incurring any liability
on the part of any Party, (iv) the number of authorized directors of Bancorp
shall be reduced to a total of ten (10), (v) each of the then seven directors
of Acquiror shall be duly elected and appointed to the Board of Directors of
Bancorp (or if any of such persons is unable to serve, such other person
designated by Acquiror) and shall serve until the earlier of their
resignation or removal or until their respective successors are duly elected
and qualified, and (vi) the persons set forth on Exhibit 2.1(d) shall be
elected and appointed as the Executive Officers and officers of Bancorp and
shall hold the positions set forth opposite their respective names (clauses
(i) - (vi) being hereinafter collectively referred to as the "Bancorp
Corporate Governance Changes.").
2.2 EFFECTIVE TIME. The Closing shall take place as soon as
practicable following the satisfaction or waiver of the conditions set forth
in Sections 8.1, 8.2 and 8.3, and the parties shall use best efforts to cause
the Closing to occur as soon as possible after receipt of approval of the
Bank Merger from the Commissioner and the FDIC and the expiration of all
required waiting periods, or such later time and date as to which the parties
may agree. The Bank Merger shall be effective upon the filing by the
Commissioner of the Agreement of Merger as specified in the CFC. Such time
is referred to herein as the "Effective Time."
2.3 CONVERSION OF SHARES. At the Effective Time and pursuant to the
Agreement of Merger:
(a) Subject to the exceptions and limitations in Section 2.4,
each outstanding share of Acquiror Stock shall, without any further action on
the part of Acquiror or the holders of any of such shares, be converted into
shares of Bancorp Stock in accordance with the Exchange Ratio.
(b) Each outstanding share of Bank Stock shall, without any
further action on the part of Bank or of the holder of any of such shares, be
converted into shares of the Surviving Bank and each certificate that, prior
to the Effective Time, represented shares of Bank Stock shall evidence
ownership of shares of the Surviving Bank.
(c) Each outstanding share of Bancorp Stock shall remain
outstanding and shall not be converted or otherwise affected by the Bank
Merger, except that any Bancorp Perfected Dissenting Shares shall remain
outstanding subject to the right of the holder of such shares to receive
payment for such shares in an amount determined pursuant to Chapter 13 of the
CGCL.
A-12
<PAGE>
2.4 CERTAIN EXCEPTIONS AND LIMITATIONS. (A) Any shares of Acquiror
Stock held by Bancorp or any subsidiary of Bancorp (other than shares held in
a fiduciary capacity or as DPC Property) will be canceled at the Effective
Time; (B) Acquiror Perfected Dissenting Shares shall not be converted into
shares of Bancorp Stock, but shall, after the Effective Time, be entitled
only to such rights as are granted them by Chapter 13 of the CGCL (each
dissenting shareholder who is entitled to payment for his shares of Acquiror
Stock shall receive such payment in an amount as determined pursuant to
Chapter 13 of CGCL), and (C) no fractional shares of Bancorp Stock shall be
issued in the Bank Merger and, in lieu thereof, each holder of Acquiror Stock
who would otherwise be entitled to receive a fractional share shall receive
an amount in cash equal to the product (calculated to the nearest ten
thousandth) obtained by multiplying (a) the Average Closing Price times (b)
the fraction of the share of Bancorp Stock to which such holder would
otherwise be entitled.
2.5 EXCHANGE PROCEDURES.
(a) As of the Effective Time, Bancorp shall have deposited
with the Exchange Agent for the benefit of the holders of shares of Acquiror
Stock, for exchange in accordance with this Section 2.5 through the Exchange
Agent, certificates representing the shares of Bancorp Stock issuable
pursuant to Section 2.3 in exchange for shares of Acquiror Stock outstanding
immediately prior to the Effective Time, and funds in an amount not less than
the amount of cash payable in lieu of fractional shares of Bancorp Stock
which would otherwise be payable in connection with Section 2.3 hereof, but
for the operation of Section 2.4 of this Agreement (collectively, the
"Exchange Fund").
(b) Bancorp shall direct the Exchange Agent to mail promptly
after the Effective Time, to each holder of record of a certificate or
certificates which immediately prior to the Effective Time represented
outstanding shares of Acquiror Stock (the "Certificates") whose shares were
converted into the right to receive shares of Bancorp Stock pursuant to
Section 2.3 hereof: (i) a letter of transmittal (which shall specify that
delivery shall be effected, and risk of loss and title to the Certificates
shall pass, only upon delivery of the Certificates to the Exchange Agent and
shall be in such form and have such other provisions as Acquiror may
reasonably specify), and (ii) instructions for use in effecting the surrender
of the Certificates in exchange for certificates representing shares of
Bancorp Stock. Upon surrendering of a Certificate for cancellation to the
Exchange Agent or to such other agent or agents as may be appointed by
Acquiror, together with such letters of transmittal, duly executed, the
holder of such Certificate shall be entitled to receive in exchange therefor
that amount of cash and a certificate representing that number of whole
shares of Bancorp Stock which such holder has the right to receive pursuant
to the provisions of Sections 2.3 and 2.4 hereof, and the Certificate so
surrendered shall forthwith be canceled. In the event a Certificate is
surrendered representing Acquiror Stock, the transfer of ownership which is
not registered in the transfer records of Acquiror, a certificate
representing the proper number of shares of Bancorp Stock may be issued to a
transferee if the Certificate representing such Acquiror Stock is presented
to the Exchange Agent, accompanied by all documents required to evidence and
effect
A-13
<PAGE>
such transfer and by evidence that any applicable stock transfer taxes have
been paid. Until surrendered as contemplated by this Section 2.5 and except
as provided in subsection (g) hereof, each Certificate shall be deemed at any
time after the Effective Time to represent only the right to receive upon
such surrender the certificate representing shares of Bancorp Stock and cash
in lieu of any fractional shares of stock as contemplated by this Section
2.5. Notwithstanding anything to the contrary set forth herein, if any holder
of share of Acquiror should be unable to surrender the Certificates for such
shares, because they have been lost or destroyed, such holder may deliver in
lieu thereof, in the discretion of Acquiror, such bond in form and substance
and with surety reasonably satisfactory to Acquiror and shall be entitled to
receive the certificate representing the proper number of shares of Bancorp
Stock and cash in lieu of fractional shares in accordance with Sections 2.3
and 2.4 hereof.
(c) No dividends or other distributions declared or made
after the Effective Time with respect to Bancorp Stock with a record date
after the Effective Time shall be paid to the holder of any unsurrendered
Certificate with respect to the shares of Bancorp Stock represented thereby
and no cash payment in lieu of fractional shares shall be paid to any such
holder pursuant to Section 2.4 until the holder of record of such Certificate
shall surrender such Certificate. Subject to the effect of applicable laws,
following surrender of any such Certificate, there shall be paid to the
record holder of the certificates representing whole shares of Bancorp Stock
issued in exchange thereof, without interest, (i) at the time of such
surrender, the amount of any cash payable in lieu of a fractional share of
Bancorp Stock to which such holder is entitled pursuant to Section 2.4 and
the amount of dividends or other distribution with a record date after the
Effective Time theretofore paid with respect to such whole shares of Bancorp
Stock, and (ii) at the appropriate payment date, the amount of dividends or
other distributions with a record date after the Effective Time but prior to
surrender and a payment date subsequent to surrender payable with respect to
such whole shares of Bancorp Stock.
(d) All shares of Bancorp Stock issued upon the surrender for
exchange of Acquiror Stock in accordance with the terms hereof (including any
cash paid pursuant to Section 2.4) shall be deemed to have been issued in
full satisfaction of all rights pertaining to such shares of Acquiror Stock,
and there shall be no further registration of transfers on the stock transfer
books of the Surviving Bank of the shares of Acquiror Stock which were
outstanding immediately prior to the Effective Time. If after the Effective
Time, Certificates are presented to Bancorp for any reason, they shall be
canceled and exchanged as provided in this Agreement.
(e) Any portion of the Exchange Fund which remains
undistributed to the shareholders of Acquiror following the passage of six
months after the Effective Time shall be delivered to Bancorp, upon demand,
and any shareholders of Acquiror who have not theretofore complied with this
Section 2.5 shall thereafter look only to Bancorp for payment of their claim
for Bancorp Stock, any cash in lieu of fractional shares of Bancorp Stock and
any dividends or distributions with respect Acquiror Stock.
A-14
<PAGE>
(f) Neither Bancorp nor Acquiror shall be liable to any
holder of shares of Acquiror Stock for such shares (or dividends or
distributions with respect thereto) or cash from the Exchange Fund delivered
to a public official pursuant to any applicable abandoned property, escheat
or similar law.
(g) The Exchange Agent shall not be entitled to vote or
exercise any rights of ownership with respect to the shares of Bancorp Stock
held by it from time to time hereunder, except that it shall receive and hold
all dividends or other distributions paid or distributed with respect to such
shares of Bancorp Stock for the account of the Persons entitled thereto.
Former shareholders of record of Acquiror shall be entitled to vote after the
Effective Time at any meeting of Bancorp shareholders the number of whole
shares of Bancorp Stock into which their respective shares of Acquiror Stock
are converted, regardless of whether such holders have exchanged their
Certificates for certificates representing Bancorp Stock in accordance with
the provisions of this Agreement.
2.6 DIRECTORS' AGREEMENTS.
(a) Concurrently with the execution of this Agreement,
Bancorp and Bank shall cause each of its respective directors to enter into a
Bancorp Directors' Agreement.
(b) Concurrently with the execution of this Agreement,
Acquiror shall cause each of its respective directors to enter into an
Acquiror's Directors' Agreement.
ARTICLE 3
REPRESENTATIONS AND WARRANTIES OF BANCORP AND BANK
Bancorp and Bank represent and warrant to Acquiror as follows:
3.1 INCORPORATION, STANDING AND POWER. Bancorp has been duly
incorporated and is validly existing as a corporation in good standing under
the laws of the State of California and is registered as a bank holding
company under the BHC Act. Bank has been duly incorporated and is validly
existing as a banking company under the laws of California and is authorized
by the Commissioner to conduct a general banking business. Bank's deposits
are insured by the FDIC in the manner and to the extent provided by law.
Bancorp and Bank have all requisite corporate power and authority to own,
lease and operate their respective properties and assets and to carry on
their respective businesses as presently conducted. Neither the scope of the
business of Bancorp or Bank nor the location of any of their respective
properties requires that Bancorp or Bank be licensed to do business in any
jurisdiction other than in California where the failure to be so licensed
would, individually or in the aggregate, have a materially adverse effect on
the financial condition, results of operation or business of Bancorp on a
consolidated basis.
A-15
<PAGE>
3.2 CAPITALIZATION. As of the date of this Agreement, the
authorized capital stock of Bancorp consists of 50,000,000 shares of Bancorp
Stock, of which 3,003,439 shares are outstanding and 25,000,000 of Preferred
Stock, of which no shares are outstanding. As of the date of this Agreement,
the authorized capital stock of Bank consists of 25,000,000 shares of Bank
Stock, of which 100 shares are outstanding and are owned by Bancorp without
Encumbrance. All the outstanding shares of Bancorp Stock and Bank Stock are
duly authorized, validly issued, fully paid, nonassessable and without
preemptive rights. Except for Bancorp Stock Options covering 128,700 shares
of Bancorp stock granted pursuant to the Bancorp Stock Option Plan and except
as set forth in Bancorp's Disclosure Letter, there are no outstanding
options, warrants or other rights in or with respect to the unissued shares
of Bancorp Stock or Bank Stock or any other securities convertible into such
stock, and neither Bancorp nor Bank is obligated to issue any additional
shares of its capital stock or any options, warrants or other rights in or
with respect to the unissued shares of its capital stock or any other
securities convertible into such stock.
3.3 SUBSIDIARIES. Except as set forth in Bancorp's Disclosure
Letter, neither Bancorp nor Bank own, directly or indirectly, any outstanding
stock, Equity Securities or other voting interest in any corporation,
partnership, joint venture or other entity or Person, other than DPC Property.
3.4 FINANCIAL STATEMENTS. Bancorp has previously furnished to
Acquiror a copy of the Financial Statements of Bank/Bancorp. The Financial
Statements of Bank/Bancorp: (a) present fairly the consolidated financial
condition of Bank/Bancorp as of the respective dates indicated and their
consolidated results of operations and cash flow for the respective periods
indicated; and (b) have been prepared in accordance with GAAP. The audits of
Bank have been conducted in accordance with generally accepted auditing
standards. The books and records of Bancorp and Bank are being maintained in
material compliance with applicable legal and accounting requirements.
Except to the extent (i) reflected in the Financial Statements of
Bank/Bancorp and (ii) of liabilities incurred since September 30, 1997 in the
ordinary course of business and consistent with past practice, neither
Bancorp nor Bank has any liabilities, whether absolute, accrued, contingent
or otherwise.
3.5 AUTHORITY OF BANCORP AND BANK. The execution and delivery by
Bancorp and Bank of this Agreement and, subject to the requisite approval of
the shareholders of Bancorp and of Bancorp as the sole shareholder of Bank,
the consummation of the transactions contemplated hereby have been duly and
validly authorized by all necessary corporate action on the part of Bancorp
and Bank, and this Agreement is a valid and binding obligation of Bancorp and
Bank enforceable in accordance with its terms, except as the enforceability
thereof may be limited by bankruptcy, liquidation, receivership,
conservatorship, insolvency, moratorium or other similar laws affecting the
rights of creditors generally and by general equitable principles and by
Section 8(b)(6)(D) of the Federal Deposit Insurance Act, 12 U.S.C. Section
1818(b)(6)(D). Except as set forth in Bancorp's Disclosure Letter, neither
the execution and delivery by Bancorp and Bank
A-16
<PAGE>
of this Agreement, the consummation of the Bank Merger or the transactions
contemplated herein, nor compliance by Bancorp and Bank with any of the
provisions hereof, will: (a) violate any provision of their respective
Charter Documents; (b) constitute a breach of or result in a default (or give
rise to any rights of termination, cancellation or acceleration, or any right
to acquire any securities or assets) under any of the terms, conditions or
provisions of any note, bond, mortgage, indenture, franchise, license,
permit, agreement, Encumbrances or other instrument or obligation to which
Bancorp or Bank is a party, or by which Bancorp or Bank or any of their
respective properties or assets is bound, if in any such circumstances, such
event could have consequences materially adverse to Bancorp on a consolidated
basis; or (c) violate any Rule applicable to Bancorp or Bank or any of their
respective properties or assets. No Consent of any Governmental Entity
having jurisdiction over any aspect of the business or assets of Bancorp or
Bank, and no Consent of any Person, is required in connection with the
execution and delivery by Bancorp and Bank of this Agreement or the
consummation by Bancorp and Bank of the Bank Merger and the transactions
contemplated hereby, except (i) the approval of this Agreement and the
transactions contemplated hereby by the shareholders of Bancorp and by
Bancorp as the sole shareholder of Bank; (ii) such approvals or notices as
may be required by the FRB, the Commissioner and the FDIC; (iii) the
declaring effective of the S-4 by the SEC and the approvals of all necessary
blue sky administrators; and (iv) as otherwise set forth in Bancorp's
Disclosure Letter.
3.6 INSURANCE. Bancorp and Bank have policies of insurance and
bonds covering their assets and businesses against such casualties and
contingencies and in such amounts, types and forms as are customary in the
banking industry for their businesses, operations, properties and assets.
All such insurance policies and bonds are in full force and effect. Except
as set forth in Bancorp's Disclosure Letter, neither Bancorp nor Bank has
received notice from any insurer that any such policy or bond has canceled or
indicating an intention to cancel or not to renew any such policy or bond or
generally disclaiming liability thereunder. Except as set forth in Bancorp's
Disclosure Letter, neither Bancorp nor Bank is in default under any such
policy or bond and all material claims thereunder have been filed in a timely
fashion. Bancorp's Disclosure Letter sets forth a list of all policies of
insurance carried and owned by Bancorp or Bank, showing the name of the owner
and the insurance company, the nature of the coverage, the policy limit, the
annual premiums and the expiration dates. There has been delivered to
Acquiror a true and complete copy of each such policy of insurance. The
existing insurance carried by Bancorp and Bank is sufficient for compliance
by Bancorp and Bank with all material requirements of law and regulations and
agreements to which they are subject or are a party.
3.7 TITLE TO ASSETS. Bancorp's Disclosure Letter sets forth a
summary of all items of personal property and equipment with a book value of
$250,000 or more, or having an annual lease payment of $25,000 or more, owned
or leased by Bancorp or Bank. Bancorp and Bank have good and marketable
title to all their respective properties and assets, other than real
property, owned or stated to be owned by Bancorp and Bank, free and clear of
all Encumbrances except: (a) as set forth in the Financial Statements of
Bank/Bancorp; (b) Encumbrances for current taxes not yet due; (c)
Encumbrances incurred in the ordinary course of business, if any, that, to the
A-17
<PAGE>
knowledge of Bancorp and Bank, (i) are not substantial in character, amount
or extent, (ii) do not materially detract from the value, (iii) do not
interfere with present use, of the property subject thereto or affected
thereby, and (iv) do not otherwise materially impair the conduct of business
of Bancorp and Bank; or (d) as set forth in Bancorp's Disclosure Letter.
3.8 REAL ESTATE. Bancorp's Disclosure Letter sets forth a list of
all real property, including leaseholds, owned by Bancorp and Bank, together
with (i) a description of the locations thereof, (ii) a description of each
real property lease, sublease, installment purchase, or similar arrangement
to which either Bancorp or Bank is a party, and (iii) a description of each
contract for the purchase, sale or development of real estate to which
Bancorp or Bank is a party. Bancorp and Bank have good and marketable title
to the respective real property, and valid leasehold interests in the
respective leaseholds, set forth in Bancorp's Disclosure Letter, free and
clear of all Encumbrances, except (a) for rights of lessors, co-lessees or
sublessees in such matters that are reflected in the lease; (b) Encumbrances
for current taxes not yet due and payable; (c) Encumbrances incurred in the
ordinary course of business, if any, that, to the knowledge of Bancorp and
Bank, (i) are not substantial in character, amount or extent, (ii) do not
materially detract from the value, (iii) do not interfere with present use,
of the property subject thereto or affected thereby, and (iv) do not
otherwise materially impair the conduct of business of Bancorp or Bank; or
(d) as set forth in Bancorp's Disclosure Letter. Bancorp or Bank, as the
case may be, as lessee, has the right under valid and subsisting leases to
occupy, use and possess all property leased by it, as identified in Bancorp's
Disclosure Letter, and, to the knowledge of Bancorp and Bank, there has not
occurred under any such lease any breach, violation or default. Except as
set forth in Bancorp's Disclosure Letter and except with respect to
deductibles under insurance policies set forth in Bancorp's Disclosure
Letter, neither Bancorp nor Bank has experienced any uninsured damage or
destruction with respect to the properties identified in Bancorp's Disclosure
Letter. To the knowledge of Bancorp and Bank, all properties and assets used
by Bancorp and Bank are in good operating condition and repair, suitable for
the purposes for which they are currently utilized, and comply with all
applicable Rules related thereto. Bancorp and Bank enjoy peaceful and
undisturbed possession under all leases for the use of real or personal
property under which it is the lessee, and, to the knowledge of Bancorp and
Bank, all leases to which Bancorp or Bank is a party are valid and
enforceable in all material respects in accordance with the terms thereof
except as may be limited by bankruptcy, insolvency, moratorium or other
similar laws affecting creditors' rights and except as may be limited by the
exercise of judicial discretion in applying principles of equity. Neither
Bancorp nor Bank is in default with respect to any such lease, and to the
knowledge of the officers of Bancorp and Bank no event has occurred which
with the lapse of time or the giving of notice, or both, would constitute a
default under any such lease. Copies of each such lease are attached to
Bancorp's Disclosure Letter.
3.9 LITIGATION. Except as set forth in Bancorp's Disclosure
Letter, to the knowledge of Bancorp and Bank, there is no private or
governmental suit, claim, action, investigation or proceeding pending, nor to
Bancorp's or Bank's knowledge threatened, against Bancorp or Bank or against
any of their directors, officers or employees relating to the performance
A-18
<PAGE>
of their duties in such capacities or against or affecting any properties of
Bancorp or Bank. Also, except as disclosed in Bancorp's Disclosure Letter,
there are no judgments, decrees, stipulations or orders against Bancorp or
Bank enjoining either of them or any of their directors, officers or
employees in respect of, or the effect of which is to prohibit, any business
practice or the acquisition of any property or the conduct of business in any
area of Bancorp or Bank. To the knowledge of Bancorp and Bank, neither
Bancorp nor Bank is a party to any pending or, to the knowledge of any of the
officers, threatened legal, administrative or other claim, action, suit,
investigation, arbitration or proceeding challenging the validity or
propriety of any of the transactions contemplated by this Agreement.
3.10 TAXES. Bancorp and Bank had filed all federal and foreign
income tax returns, all state and local franchise and income tax, real and
personal property tax, sales and use tax, premium tax, excise tax and other
tax returns of every character required to be filed by it and have paid all
taxes, together with any interest and penalties owing in connection
therewith, shown on such returns to be due in respect of the periods covered
by such returns, other than taxes which are being contested in good faith and
for which adequate reserves have been established. Bancorp and Bank have
filed all required payroll tax returns, have fulfilled all tax withholding
obligations and have paid over to the appropriate governmental authorities
the proper amounts with respect to the foregoing. The tax and audit
positions taken by Bancorp and Bank in connection with the tax returns
described in the preceding sentence were reasonable and asserted in good
faith. Adequate provision has been made in the books and records of Bancorp
or Bank and, to the extent required by generally accepted accounting
procedures, reflected in the Financial Statements of Bank/Bancorp, for all
tax liabilities, including interest or penalties, whether or not due and
payable and whether or not disputed, with respect to any and all federal,
foreign, state, local and other taxes for the periods covered by such
financial statements and for all prior periods. Bancorp's Disclosure Letter
sets forth (i) the date or dates through which the IRS has examined the
federal tax returns of Bancorp and Bank and the date or dates through which
any foreign, state, local or other taxing authority has examined any other
tax returns of Bancorp and Bank; (ii) a complete list of each year for which
any federal, state, local or foreign tax authority has obtained or has
requested an extension of the statute of limitations from Bancorp or Bank and
lists each tax case of Bancorp or Bank currently pending in audit, at the
administrative appeals level or in litigation; and (iii) the date and issuing
authority of each statutory notice of deficiency, notice of proposed
assessment and revenue agent's report issued to Acquiror within the last
twelve (12) months. Except as set forth in Bancorp's Disclosure Letter, to
the knowledge of Bancorp and Bank, neither the IRS nor any foreign, state,
local or other taxing authority has, during the past three years, examined or
is in the process of examining any federal, foreign, state, local or other
tax returns of Bancorp or Bank. To the knowledge of Bancorp and Bank, neither
the IRS nor any foreign, state, local or other taxing authority is now
asserting or threatening to assert any deficiency or claim for additional
taxes (or interest thereon or penalties in connection therewith) except as
set forth in Bancorp's Disclosure Letter.
A-19
<PAGE>
3.11 COMPLIANCE WITH LAWS AND REGULATIONS. Except as set forth in
Bancorp's Disclosure Letter, neither Bancorp nor Bank is in default under or
in breach of any provision of its Charter Documents or any Rule promulgated
by any Governmental Entity having authority over it, where such default or
breach would have a material adverse effect on the business, financial
condition or results of operations of Bancorp or Bank.
3.12 PERFORMANCE OF OBLIGATIONS. Bancorp and Bank have performed
all of the respective obligations required to be performed by it to date and
neither of them is in material default under or in breach of any term or
provision of any of the Bancorp Scheduled Contracts, and no event has
occurred that, with the giving of notice or the passage of time or both,
would constitute such default or breach. To Bancorp's and Bank's knowledge,
no party with whom either has an agreement that is material to the business
of Bancorp or Bank is in default thereunder.
3.13 EMPLOYEES. Except as set forth in Bancorp's Disclosure
Letter, there are no controversies pending or threatened between Bancorp or
Bank and any of their respective employees that are likely to have a material
adverse effect on the business, financial condition or results of operation
of Bancorp or Bank. Neither Bancorp nor Bank is a party to any collective
bargaining agreement with respect to any of its employees or any labor
organization to which its employees or any of them belong.
3.14 BROKERS AND FINDERS. Except as provided in Bancorp's
Disclosure Letter with copies of any such agreements attached, neither
Bancorp nor Bank is not a party to or obligated under any agreement with any
broker or finder relating to the transactions contemplated hereby, and
neither the execution of this Agreement nor the consummation of the
transactions provided for herein or therein will result in any liability to
any broker or finder.
3.15 MATERIAL CONTRACTS. Except as set forth in Bancorp's
Disclosure Letter (all items listed or required to be listed in Bancorp's
Disclosure Letter as a result of this Section being referred to herein as
"Bancorp Scheduled Contracts"), neither Bancorp nor Bank is a party or
otherwise subject to:
(a) any employment, deferred compensation, bonus or consulting
contract;
(b) any advertising, brokerage, licensing, dealership,
representative or agency relationship or contract;
(c) any contract or agreement that would restrict Bancorp or
Bank after the Effective Time from competing in any line of business with any
Person or using or employing the services of any Person;
A-20
<PAGE>
(d) any collective bargaining agreement or other such
contract or agreement with any labor organization;
(e) any lease of real or personal property providing for
annual lease payments by or to Bancorp or Bank in excess of $25,000 per annum
other than financing leases entered into in the ordinary course of business
in which Bancorp or Bank is lessor and leases of real property presently used
by Bank as banking offices.
(f) any mortgage, pledge, conditional sales contract,
security agreement, option, or any other similar agreement with respect to
any interest of Bancorp or Bank (other than as mortgagor or pledgor in the
ordinary course of their banking business or as mortgagee, secured party or
deed of trust beneficiary in the ordinary course of their business) in
personal property having a value of $25,000 or more;
(g) any stock purchase, stock option, stock bonus, stock
ownership, profit sharing, group insurance, bonus, deferred compensation,
severance pay, pension, retirement, savings or other incentive, welfare or
employment plan or material agreement providing benefits to any present or
former employees, officers or directors of Bancorp or Bank;
(h) any agreement to acquire equipment or any commitment to
make capital expenditures of $25,000 or more;
(i) other than agreements entered into in the ordinary course
of business with respect to DPC Property, any agreement for the sale of any
property or assets in which Bancorp or Bank has an ownership interest or for
the grant of any preferential right to purchase any such property or asset;
(j) any agreement for the borrowing of any money (other than
liabilities or interbank borrowings made in the ordinary course of their
banking business and reflected in the financial records of Bank);
(k) any restrictive covenant contained in any deed to or
lease of real property owned or leased by Bancorp or Bank (as lessee) that
materially restricts the use, transferability or value of such property;
(l) any guarantee or indemnification which involves the sum
of $50,000 or more, other than letters of credit or loan commitments issued
in the normal course of business;
(m) any supply, maintenance or landscape contracts not
terminable by Bancorp or Bank without penalty on 30 days or less notice and
which provides for payments in excess of $25,000 per annum;
A-21
<PAGE>
(n) other than as disclosed with reference to subparagraph
(k) of this Section 3.15, any agreement which would be terminable other than
by Bancorp or Bank or as a result of the consummation of the transactions
contemplated by this Agreement;
(o) any contract of participation with any other bank in any
loan entered into by Bancorp or Bank subsequent to December 31, 1996 in
excess of $50,000 or any sales of assets of Bancorp or Bank with recourse of
any kind to Bancorp or Bank except the sale of mortgage loans, servicing
rights, repurchase or reverse repurchase agreements, securities or other
financial transactions in the ordinary course of business;
(p) any other agreement of any other kind, including for data
processing and similar services, which involves future payments or receipts
or performances of services or delivery of items requiring aggregate payment
of $25,000 or more to or by Bancorp or Bank other than payments made under or
pursuant to loan agreements, participation agreements and other agreements
for the extension of credit in the ordinary course of their business;
(q) any material agreement, arrangement or understanding not
made in the ordinary course of business;
(r) any agreement, arrangement or understanding relating to
the employment, election, retention in office or severance of any present or
former director, officer or employee of Bancorp or Bank;
(s) any agreement, arrangement or understanding pursuant to
which any payment (whether severance pay or otherwise) became or may become
due to any director, officer or employee of Bancorp or Bank upon execution of
this Agreement or upon or following consummation of the transactions
contemplated hereby (either alone or in connection with the occurrence of any
additional acts or events); or
(t) any written agreement, supervisory agreement, memorandum
of understanding, consent order, cease and desist order, capital order, or
condition of any regulatory order or decree with or by the Commissioner or
FDIC or any other regulatory agency.
True copies of all Bancorp Scheduled Contracts, including all amendments and
supplements thereto, are attached to Bancorp's Disclosure Letter.
3.16 ABSENCE OF MATERIAL CHANGE. Since December 31, 1996, the
businesses of Bancorp and Bank have been conducted only in the ordinary
course, in substantially the same manner as theretofore conducted, and,
except as set forth in Bancorp's Disclosure Letter, there has not occurred
since December 31, 1996 any event that has had or may reasonably be expected
to have a material adverse effect on the business, financial condition or
results of operation of Bancorp or Bank.
A-22
<PAGE>
3.17 LICENSES AND PERMITS. Bancorp and Bank have all licenses and
permits that are necessary for the conduct of their respective businesses,
and such licenses are in full force and effect, except for any failure to be
in full force and effect that would not, individually or in the aggregate,
have a material adverse effect on the business, financial condition or
results of operations of Bancorp or Bank. The properties and operations of
Bancorp and Bank are and have been maintained and conducted, in all material
respects, in compliance with all applicable Rules.
3.18 UNDISCLOSED LIABILITIES. Except as set forth in Bancorp's
Disclosure Letter, neither Bancorp nor Bank have any liabilities or
obligations, either accrued or contingent, that are material to Bancorp or
Bank and that have not been: (a) reflected or disclosed in the Financial
Statements of Bank/Bancorp or (b) incurred subsequent to December 31, 1996 in
the ordinary course of business. Neither Bancorp nor Bank knows of any basis
for the assertion against it of any liability, obligation or claim
(including, without limitation, that of any Governmental Entity) that is
likely to result in or cause a material adverse change in the business,
financial condition or results of operations of Bancorp or Bank that is not
fairly reflected in the Financial Statements of Bank/Bancorp or otherwise
disclosed in this Agreement.
3.19 EMPLOYEE BENEFIT PLANS.
(a) Except as set forth in Bancorp's Disclosure Letter,
neither Bancorp nor Bank has an "employee benefit plan," as defined in
Section 3(3) of ERISA.
(b) Bancorp's Disclosure Letter sets forth copies or
descriptions of each Benefit Arrangement maintained or otherwise contributed
to by Bancorp or Bank (such plans and arrangements being collectively
referred to herein as "Bank Benefit Arrangements"). All Bank Benefit
Arrangements which are in effect have been in effect for substantially all of
1997. There has been no material amendment thereof or increase in the cost
thereof or benefits payable thereunder since December 31, 1996. Except as
set forth in Bancorp's Disclosure Letter, there has been no material increase
in the compensation of or benefits payable to any senior executive employee
of Bancorp or Bank since December 31, 1996, nor any employment, severance or
similar contract entered into with any such employee, nor any amendment to
any such contract, since December 31, 1996. Except as set forth in Bancorp's
Disclosure Letter, there is no contract, agreement or benefit arrangement
covering any employee of Bancorp or Bank which individually or collectively
could give rise to the payment of any amount which would constitute an
"excess parachute payment," as such term is defined in Section 280(G) of the
Code.
(c) With respect to all Bank Benefit Arrangements, Bancorp
and Bank are in substantial compliance (other than noncompliance the cost or
liability for which is not material) with the requirements prescribed by any
and all statutes, governmental or court orders, or governmental rules or
regulations currently in effect, applicable to such plans or arrangements.
A-23
<PAGE>
(d) Except for the contracts set forth in Bancorp's
Disclosure Letter, each Bank Benefit Arrangement and each personal services
contract, fringe benefit, consulting contract or similar arrangement with or
for the benefit of any officer, director, employee or other person can be
terminated by Bancorp or Bank within a period of 30 days following the
Effective Time of the Bank Merger, without payment of any amount as a
penalty, bonus, premium, severance pay or other compensation for such
termination.
3.20 CORPORATE RECORDS. The Charter Documents of Bancorp and Bank
and all amendments thereto to the date hereof (true, correct and complete
copies of which are set forth in Bancorp's Disclosure Letter) are in full
force and effect as of the date of this Agreement. The minute books of
Bancorp and Bank, together with the documents and other materials
incorporated therein by reference, reflect all meetings held and contain
complete and accurate records of all corporate actions taken by the boards of
directors of Bancorp and Bank (or any committees thereof) and stockholders.
Except as reflected in such minute books, there are no minutes of meetings or
consents in lieu of meetings of the board of directors (or any committees
thereof) or of the stockholders of Bancorp or Bank.
3.21 ACCOUNTING RECORDS. Bancorp and Bank maintain accounting
records which fairly and validly reflect, in all material respects, their
transactions and accounting controls sufficient to provide reasonable
assurances that such transactions are (i) executed in accordance with their
management's general or specific authorization, and (ii) recorded as
necessary to permit the preparation of financial statements in conformity
with GAAP. Such records, to the extent they contain material information
pertaining to Bancorp or Bank which is not easily and readily available
elsewhere, have been duplicated, and such duplicates are stored safely and
securely.
3.22 OFFICES AND ATMs. Set forth in Bancorp's Disclosure Letter is
a list of the headquarters of Bank (identified as such) and each of the
offices and automated teller machines ("ATMs") maintained and operated (or to
be maintained and operated) by Bank (including, without limitation,
representative and loan production offices and operations centers) and the
location thereof. Except as set forth in Bancorp's Disclosure Letter,
neither Bancorp nor Bank maintains any other office or ATM and conducts
business at any other location, and neither Bancorp nor Bank has applied for
or received permission to open any additional branch nor operate at any other
location.
3.23 LOAN PORTFOLIO. Bancorp's Disclosure Letter sets forth a
description of ; (a) by type and classification, all loans, leases, other
extensions and commitments to extend credit of Bank of $50,000 or more, that
have been classified by itself, its bank examiners or auditors (external or
internal) as "Watch List," "Substandard," "Doubtful," "Loss" or any
comparable classification; and (b) all loans due to Bank as to which any
payment of principal, interest or any other amount is 30 days or more past
due. Bancorp's consolidated allowance for loan losses is and
A-24
<PAGE>
will be at the Effective time adequate and in accordance with GAAP in all
material respects and in accordance with all applicable regulatory
requirements of any Governmental Entity.
3.24 POWER OF ATTORNEY. Except as set forth in Bancorp's
Disclosure Letter, neither Bancorp nor Bank has granted any Person a power of
attorney or similar authorization that is presently in effect or outstanding.
3.25 OPERATING LOSSES. Bancorp's Disclosure Letter sets forth any
Operating Loss (as herein defined) which has occurred at Bancorp or Bank
during the period after December 31, 1996. To the knowledge of Bancorp and
Bank, no action has been taken or omitted to be taken by an employee of
Bancorp or Bank that has resulted in the incurrance by Bancorp or Bank of an
Operating Loss or that might reasonably be expected to result in an Operating
Loss after December 31, 1996, which, net of any insurance proceeds payable in
respect thereof, would exceed $15,000. "Operating Loss" means any loss
resulting from cash shortages, lost or misposted items, disputed clerical and
accounting errors, forged checks, payment of checks over stop payment orders,
counterfeit money, wire transfers made in error, theft, robberies,
defalcations, check kiting, fraudulent use of credit cards or electronic
teller machines or other similar acts or occurrences.
3.26 ENVIRONMENTAL MATTERS. Except as set forth in Bancorp's
Disclosure Letter, to the knowledge of Bancorp and Bank, (i) each of Bancorp
and Bank is in compliance with all Environmental Laws; (ii) there are no
Tanks on or about Bancorp Property; (iii) there are no Hazardous Materials
on, below or above the surface of, or migrating to or from Bancorp Property;
(iv) neither Bancorp nor Bank has loans outstanding secured by real property
that is not in compliance with Environmental Laws or which has a leaking Tank
or upon which there are Hazardous Materials on or migrating to or from; and
(v) without limiting the foregoing representations and warranties contained
in clauses (i) through (iv), as of the date of this Agreement, there is no
claim, action , suit, or proceeding or notice thereof before any Governmental
Entity pending against Bancorp or Bank or concerning property securing
Bancorp and Bank loans and there is no outstanding judgment, order, writ,
injunction, decree, or award against or affecting Bancorp Property or
property securing Bancorp or Bank loans, relating to the foregoing
representations (i) -- (iv), in each case the noncompliance with which, or
the presence of which would have a material adverse effect on the business,
financial condition, results of operations or prospects of Bancorp or Bank.
For purposes of this Agreement, the term "Environmental Laws" shall mean all
applicable statutes, regulations, rules, ordinances, codes, licenses,
permits, orders, approvals, plans, authorizations, concessions, franchises,
and similar items of all Governmental Entities and all applicable judicial,
administrative, and regulatory decrees, judgments, and orders relating to the
protection of human health or the environment, including, without limitation:
all requirements, including, but not limited to those pertaining to
reporting, licensing, permitting, investigation, and remediation of
emissions, discharges, releases, or threatened releases of Hazardous
Materials, chemical substances, pollutants, contaminants, or hazardous or
toxic substances, materials or wastes whether solid, liquid, or gaseous in
nature, into the air, surface water, groundwater, or land, or relating to the
manufacture, processing, distribution, use, treatment,
A-25
<PAGE>
storage, disposal, transport, or handling of chemical substances, pollutants,
contaminates, or hazardous or toxic substances, materials, or wastes, whether
solid, liquid, or gaseous in nature and all requirements pertaining to the
protection of the health and safety of employees or the public. "Bancorp
Property" shall mean real estate currently owned, leased, or otherwise used
by Bancorp or Bank, or in which Bancorp or Bank has an investment or security
interest by mortgage, deed of trust, sale and lease-back or otherwise,
including without limitation, properties under foreclosure and properties
held by Bancorp or Bank in its capacity as a trustee or otherwise. "Tank"
shall mean treatment or storage tanks, sumps, or water, gas or oil wells and
associated piping transportation devices. "Hazardous Materials" shall mean
any substance the presence of which requires investigation or remediation
under any federal, state, or local statute, regulation, ordinance, order,
action, policy or common law, or which is or becomes defined as a hazardous
waste, hazardous substance, hazardous material, used oil, pollutant or
contaminant under any federal, state or local statute, regulation, rule or
ordinance or amendments thereto including without limitation, the
Comprehensive Environmental Response; Compensation and Liability Act (42
U.S.C.Section 9601, ET SEQ.); the Resource Conservation and Recovery Act (42
U.S.C. Section 6901, ET SEQ.); the Clean Air Act, as amended (42 U.S.C.
Section 7401, ET SEQ.); the Federal Water Pollution Control Act, as amended
(33 U.S.C. Section 1251, ET SEQ.); the Toxic Substances Control Act, as
amended (15 U.S.C. Section 9601, et seq.); the Occupational Safety and Health
Act, as amended (29 U.S.C. Section 65); the Emergency Planning and Community
Right-to-Know Act of 1986 (42 U.S.C. Section 11001, ET SEQ.); the Mine Safety
and Health Act of 1977, as amended (30 U.S.C. Section 801, ET SEQ.); the Safe
Drinking Water Act (42 U.S.C. Section 300f, ET SEQ.); and all comparable
state and local laws, including without limitation, the
Carpenter-Presley-Tanner Hazardous Substance Account Act (State Superfund),
the Porter-Cologne Water Quality Control Action, Sections 25140, 25501(j) and
(k); 25501.1.25281 and 25250.1 of the California HEALTH AND SAFETY CODE
and/or Article I of Title 22 of the California CODE OF REGULATIONS, Division
4, Chapter 30; laws of other jurisdictions or orders and regulations; or the
presence of which causes or threatens to cause a nuisance, trespass or other
common law tort upon real property or adjacent properties or poses or
threatens to pose a hazard to the health or safety of persons or without
limitation, which contains gasoline, diesel fuel or other petroleum
hydrocarbons; polychlorinated biphenyls (PCB's), asbestos or urea
formaldehyde foam insulation.
3.27 COMMUNITY REINVESTMENT ACT. Bank received a rating of
"satisfactory" or better in its most recent examination or interim review
with respect to the Community Reinvestment Act. Neither Bancorp nor Bank has
been advised of any concerns regarding compliance with the Community
Reinvestment Act by any Governmental Entity or by any other Person.
3.28 DERIVATIVES. Neither Bancorp nor Bank is currently a party to
any interest rate swap, cap, floor, option agreement, other interest rate
risk management arrangement or agreement or derivative-type security or
derivative arrangement or agreement.
A-26
<PAGE>
3.29 POOLING. It is intended that the Bank Merger be accounted for
on a pooling of interests basis, and no event has occurred or is reasonably
foreseeable (including any transaction contemplated by this Agreement) that
could alter such treatment.
3.30 SEC REPORTS. As of their respective dates, since December 31,
1994, none of Bancorp's nor Bank's SEC Reports contained at the time of
filing any untrue statement of a material fact or omitted to state a material
fact required to be stated therein or necessary to make the statements made
therein, in light of the circumstances under which they were made, not
misleading.
3.31 TRUST ADMINISTRATION. Bancorp and Bank do not presently
exercise trust powers, including, but not limited to, trust administration,
and have not exercised such trust powers for a period of at least 3 years
prior to the date hereof. The term "trusts" as used in this Section 3.31
includes (i) any and all common law or other trusts between an individual,
corporation or other entities and Bancorp or Bank, as trustee or co-trustee,
including, without limitation, pension or other qualified or nonqualified
employee benefit plans, compensation, testamentary, inter vivos, charitable
trust indentures; (ii) any and all decedents' estates where Bancorp or Bank
are serving or have served as a co-executor or sole executor, personal
representative or administrator, administrator de bonis non, administrator de
bonis non with will annexed, or in any similar fiduciary capacity; (iii) any
and all guardianships, conservatorships or similar positions where Bancorp or
Bank are serving or have served as a co-grantor or a sole grantor or a
conservator or a co-conservator of the estate, or any similar fiduciary
capacity; and (iv) any and all agency and/or custodial accounts and/or
similar arrangements, including plan administrator for employee benefit
accounts, under which Bancorp or Bank are serving or have served as an agent
or custodian for the owner or other party establishing the account with or
without investment authority.
3.32 REGULATORY APPROVALS. To the knowledge of Bancorp and Bank,
except as described in Bancorp's Disclosure Letter, Bancorp and Bank have no
reason to believe that they would not receive all required approvals from any
Governmental Entity of any application to consummate the transactions
contemplated by this Agreement without the imposition of a materially
burdensome condition in connection with the approval of any such application.
ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF
ACQUIROR
A-27
<PAGE>
Acquiror represents and warrants to Bancorp and Bank as follows:
4.1 INCORPORATION, STANDING AND POWER. Acquiror has been duly
incorporated and is validly existing as a banking company under the laws of
California and is authorized by the Commissioner to conduct a general banking
business. Acquiror's deposits are insured by the FDIC in the manner and to
the extent provided by law. Acquiror has all requisite corporate power and
authority to own, lease and operate its properties and assets and to carry on
its business as presently conducted. Neither the scope of the business of
Acquiror nor the location of any of its properties requires that Acquiror be
licensed to do business in any jurisdiction other than in California where
the failure to be so licensed would, individually or in the aggregate, have a
materially adverse effect on the financial condition, results of operation or
business of Acquiror.
4.2 CAPITALIZATION. As of the date of this Agreement, the
authorized capital stock of Acquiror consists of 10,125,000 shares of
Acquiror Stock, of which 6,906,230 shares are outstanding. All the
outstanding shares of Acquiror Stock are duly authorized, validly issued,
fully paid, nonassessable and without preemptive rights. Except as set
forth in Acquiror's Disclosure Letter, there are no outstanding options,
warrants or other rights in or with respect to the unissued shares of
Acquiror Stock or any other securities convertible into such stock, and
Acquiror is not obligated to issue any additional shares of its capital stock
or any options, warrants or other rights in or with respect to the unissued
shares of its capital stock or any other securities convertible into such
stock.
4.3 SUBSIDIARIES. Except as set forth in Acquiror's Disclosure
Letter, Acquiror does not own, directly or indirectly, any outstanding stock,
Equity Securities or other voting interest in any corporation, partnership,
joint venture or other entity or Person, other than DPC Property.
4.4 FINANCIAL STATEMENTS. Acquiror has previously furnished to
Bank and Bancorp a copy of the Financial Statements of Acquiror. The
Financial Statements of Acquiror: (a) present fairly the financial condition
of Acquiror as of the respective dates indicated and its results of
operations and cash flow for the respective periods indicated; and (b) have
been prepared in accordance with GAAP. The audits of Acquiror have been
conducted in accordance with generally accepted auditing standards. The
books and records of Acquiror are being maintained in material compliance
with applicable legal and accounting requirements. Except to the extent (i)
reflected in the Financial Statements of Acquiror and (ii) of liabilities
incurred since September 30, 1997 in the ordinary course of business and
consistent with past practice, Acquiror has no liabilities, whether absolute,
accrued, contingent or otherwise.
4.5 AUTHORITY OF ACQUIROR. The execution and delivery by Acquiror
of this Agreement and, subject to the requisite approval of the shareholders
of Acquiror, the consummation of the transactions contemplated hereby have
been duly and validly authorized by all necessary corporate action on the
part of Acquiror, and this Agreement is a valid and binding
A-28
<PAGE>
obligation of Acquiror, enforceable in accordance with its terms, except as
the enforceability thereof may be limited by bankruptcy, liquidation,
receivership, conservatorship, insolvency, moratorium or other similar laws
affecting the rights of creditors generally and by general equitable
principles and by Section 8(b)(6)(D) of the Federal Deposit Insurance Act, 12
U.S.C. Section 1818(b)(6)(D). Except as set forth in Acquiror's Disclosure
Letter, neither the execution and delivery by Acquiror of this Agreement, the
consummation of the Bank Merger or the transactions contemplated herein, nor
compliance by Acquiror with any of the provisions hereof, will: (a) conflict
with or result in a breach of any provision of its Charter Documents; (b)
constitute a breach of or result in a default (or give rise to any rights of
termination, cancellation or acceleration, or any right to acquire any
securities or assets) under any of the terms, conditions or provisions of any
note, bond, mortgage, indenture, franchise, license, permit, agreement,
Encumbrance or other instrument or obligation to which Acquiror is a party,
or by which Acquiror or any of its properties or assets is bound, if in any
such circumstances, such event could have consequences materially adverse to
Acquiror; or (c) violate any Rule applicable to Acquiror or any of its
properties or assets. No Consent of any Governmental Entity having
jurisdiction over any aspect of the business or assets of Acquiror, and no
Consent of any Person, is required in connection with the execution and
delivery by Acquiror of this Agreement or the consummation by Acquiror of the
Bank Merger and the transactions contemplated hereby, except (i) the approval
of this Agreement and the transactions contemplated hereby by the
shareholders of Acquiror; (ii) such approvals or notices as may be required
by the FRB, the Commissioner and the FDIC; and (iii) as otherwise set forth
in Acquiror's Disclosure Letter.
4.6 INSURANCE. Acquiror has policies of insurance and bonds
covering its assets and businesses against such casualties and contingencies
and in such amounts, types and forms as are customary in the banking
industry for its businesses, operations, properties and assets. All such
insurance policies and bonds are in full force and effect. Except as set
forth in Acquiror's Disclosure Letter, Acquiror has not received notice from
any insurer that any such policy or bond has canceled or indicating an
intention to cancel or not to renew any such policy or bond or generally
disclaiming liability thereunder. Except as set forth in Acquiror's
Disclosure Letter, Acquiror is not in default under any such policy or bond
and all material claims thereunder have been filed in a timely fashion.
Acquiror's Disclosure Letter sets forth a list of all policies of insurance
carried and owned by Acquiror, showing the name of the insurance company, the
nature of the coverage, the policy limit, the annual premiums and the
expiration dates. There has been delivered to Bank and Bancorp a true and
complete copy of each such policy of insurance. The existing insurance
carried by Acquiror is sufficient for compliance by Acquiror with all
material requirements of law and regulations and agreements to which Acquiror
is subject or is a party.
4.7 TITLE TO ASSETS. Acquiror's Disclosure Letter sets forth a
summary of all items of personal property and equipment with a book value of
$750,000 or more, or having an annual lease payment of $75,000 or more, owned
or leased by Acquiror. Acquiror has good and marketable title to all its
properties and assets, other than real property, owned or stated to be owned
by Acquiror, free and clear of all Encumbrances except: (a) as set forth in
the Financial
A-29
<PAGE>
Statements of Acquiror; (b) Encumbrances for current taxes not yet due; (c)
Encumbrances incurred in the ordinary course of business, if any, that, to
the knowledge of Acquiror, (i) are not substantial in character, amount or
extent, (ii) do not materially detract from the value, (iii) do not interfere
with present use, of the property subject thereto or affected thereby, and
(iv) do not otherwise materially impair the conduct of business of Acquiror;
or (d) as set forth in Acquiror's Disclosure Letter.
4.8 REAL ESTATE. Acquiror's Disclosure Letter sets forth a list
of all real property, including leaseholds, owned by Acquiror, together with
(i) a description of the locations thereof, (ii) a description of each real
property lease, sublease, installment purchase, or similar arrangement to
which Acquiror is a party, and (iii) a description of each contract for the
purchase, sale or development of real estate to which Acquiror is a party.
Acquiror has good and marketable title to the real property, and valid
leasehold interests in the leaseholds, set forth in Acquiror's Disclosure
Letter, free and clear of all Encumbrances, except (a) for rights of lessors,
co-lessees or sublessees in such matters that are reflected in the lease; (b)
Encumbrances for current taxes not yet due and payable; (c) Encumbrances
incurred in the ordinary course of business, if any, that, to the knowledge
of Acquiror, (i) are not substantial in character, amount or extent, (ii) do
not materially detract from the value, (iii) do not interfere with present
use, of the property subject thereto or affected thereby, and (iv) do not
otherwise materially impair the conduct of business of Acquiror; or (d) as
set forth in Acquiror's Disclosure Letter. Acquiror, as lessee, has the
right under valid and subsisting leases to occupy, use and possess all
property leased by it, as identified in Acquiror's Disclosure Letter, and, to
the knowledge of Acquiror, there has not occurred under any such lease any
breach, violation or default. Except as set forth in Acquiror's Disclosure
Letter and except with respect to deductibles under insurance policies set
forth in Acquiror's Disclosure Letter, Acquiror has not experienced any
uninsured damage or destruction with respect to the properties identified in
Acquiror's Disclosure Letter. To the knowledge of Acquiror, all properties
and assets used by Acquiror are in good operating condition and repair,
suitable for the purposes for which they are currently utilized, and comply
with all applicable Rules related thereto. Acquiror enjoys peaceful and
undisturbed possession under all leases for the use of real or personal
property under which it is the lessee, and, to the knowledge of Acquiror, all
leases to which Acquiror is a party are valid and enforceable in all material
respects in accordance with the terms thereof except as may be limited by
bankruptcy, insolvency, moratorium or other similar laws affecting creditors'
rights and except as may be limited by the exercise of judicial discretion in
applying principles of equity. Acquiror is not in default with respect to
any such lease, and to the knowledge of the officers of Acquiror no event has
occurred which with the lapse of time or the giving of notice, or both, would
constitute a default under any such lease. Copies of each such lease are
attached to Acquiror's Disclosure Letter.
4.9 LITIGATION. Except as set forth in Acquiror's Disclosure
Letter, to the knowledge of Acquiror, there is no private or governmental
suit, claim, action, investigation or proceeding pending, nor to Acquiror's
knowledge threatened, against Acquiror or against any of its directors,
officers or employees relating to the performance of their duties in such
capacities or
A-30
<PAGE>
against or affecting any properties of Acquiror. Also, except as disclosed
in Acquiror's Disclosure Letter, there are no judgments, decrees,
stipulations or orders against Acquiror enjoining it or any of its directors,
officers or employees in respect of, or the effect of which is to prohibit,
any business practice or the acquisition of any property or the conduct of
business in any area of Acquiror. To the knowledge of Acquiror, Acquiror is
not a party to any pending or, to the knowledge of any of the officers,
threatened legal, administrative or other claim, action, suit, investigation,
arbitration or proceeding challenging the validity or propriety of any of the
transactions contemplated by this Agreement.
4.10 TAXES. Acquiror had filed all federal and foreign income tax
returns, all state and local franchise and income tax, real and personal
property tax, sales and use tax, premium tax, excise tax and other tax
returns of every character required to be filed by it and have paid all
taxes, together with any interest and penalties owing in connection
therewith, shown on such returns to be due in respect of the periods covered
by such returns, other than taxes which are being contested in good faith and
for which adequate reserves have been established. Acquiror has filed all
required payroll tax returns, has fulfilled all tax withholding obligations
and have paid over to the appropriate governmental authorities the proper
amounts with respect to the foregoing. The tax and audit positions taken by
Acquiror in connection with the tax returns described in the preceding
sentence were reasonable and asserted in good faith. Adequate provision has
been made in the books and records of Acquiror and, to the extent required by
generally accepted accounting procedures, reflected in the Financial
Statements of Acquiror, for all tax liabilities, including interest or
penalties, whether or not due and payable and whether or not disputed, with
respect to any and all federal, foreign, state, local and other taxes for the
periods covered by such financial statements and for all prior periods.
Acquiror's Disclosure Letter sets forth (i) the date or dates through which
the IRS has examined the federal tax returns of Acquiror and the date or
dates through which any foreign, state, local or other taxing authority has
examined any other tax returns of Acquiror; (ii) a complete list of each year
for which any federal, state, local or foreign tax authority has obtained or
has requested an extension of the statute of limitations from Acquiror and
lists each tax case of Acquiror currently pending in audit, at the
administrative appeals level or in litigation; and (iii) the date and issuing
authority of each statutory notice of deficiency, notice of proposed
assessment and revenue agent's report issued to Acquiror within the last
twelve (12) months. Except as set forth in Acquiror's Disclosure Letter, to
the knowledge of Acquiror, neither the IRS nor any foreign, state, local or
other taxing authority has, during the past three years, examined or is in
the process of examining any federal, foreign, state, local or other tax
returns of Acquiror. To the knowledge of Acquiror, neither the IRS nor any
foreign, state, local or other taxing authority is now asserting or
threatening to assert any deficiency or claim for additional taxes (or
interest thereon or penalties in connection therewith) except as set forth in
Acquiror's Disclosure Letter.
4.11 COMPLIANCE WITH LAWS AND REGULATIONS. Except as set forth in
Acquiror's Disclosure Letter, Acquiror is not in default under or in breach
of any provision of its Charter Documents or any Rule promulgated by any
Governmental Entity having authority over it, where
A-31
<PAGE>
such default or breach would have a material adverse effect on the business,
financial condition or results of operations of Acquiror.
4.12 PERFORMANCE OF OBLIGATIONS. Acquiror has performed all of the
obligations required to be performed by it to date and is not in material
default under or in breach of any term or provision of any material contract
, and no event has occurred that, with the giving of notice or the passage of
time or both, would constitute such default or breach. To Acquiror's
knowledge, no party with whom Acquiror has an agreement that is material to
the business of Acquiror is in default thereunder.
4.13 EMPLOYEES. Except as set forth in Acquiror's Disclosure
Letter, there are no controversies pending or threatened between Acquiror and
any of its employees that are likely to have a material adverse effect on the
business, financial condition or results of operation of Acquiror. Acquiror
is not a party to any collective bargaining agreement with respect to any of
its employees or any labor organization to which its employees or any of them
belong.
4.14 BROKERS AND FINDERS. Except as provided in Acquiror's
Disclosure Letter with copies of any such agreements attached, Acquiror is
not a party to or obligated under any agreement with any broker or finder
relating to the transactions contemplated hereby, and neither the execution
of this Agreement nor the consummation of the transactions provided for
herein or therein will result in any liability to any broker or finder.
4.15 ABSENCE OF MATERIAL CHANGE. Since December 31, 1996, the
business of Acquiror has been conducted only in the ordinary course, in
substantially the same manner as theretofore conducted, and, except as set
forth in Acquiror's Disclosure Letter, there has not occurred since December
31, 1996 any event that has had or may reasonably be expected to have a
material adverse effect on the business, financial condition or results of
operation of Acquiror.
4.16 LICENSES AND PERMITS. Acquiror has all licenses and permits
that are necessary for the conduct of its businesses, and such licenses are
in full force and effect, except for any failure to be in full force and
effect that would not, individually or in the aggregate, have a material
adverse effect on the business, financial condition or results of operations
of Acquiror. The properties and operations of Acquiror are and have been
maintained and conducted, in all material respects, in compliance with all
applicable Rules.
4.17 UNDISCLOSED LIABILITIES. Except as set forth in Acquiror's
Disclosure Letter Acquiror has no liabilities or obligations, either accrued
or contingent, that are material to Acquiror and that have not been:(a)
reflected or disclosed in the Financial Statements of Acquiror or (b)
incurred subsequent to December 31, 1996 in the ordinary course of business.
Acquiror does not know of any basis for the assertion against it of any
liability, obligation or claim (including, without limitation, that of any
Governmental Entity) that is likely to result in or cause a material adverse
change in the business, financial condition or results of operations of
Acquiror that is not fairly reflected in the Financial Statements of Acquiror
or otherwise disclosed in this Agreement.
A-32
<PAGE>
4.18 EMPLOYEE BENEFIT PLANS.
(a) Except as set forth in Acquiror's Disclosure Letter,
Acquiror has no "employee benefit plan," as defined in Section 3(3) of ERISA.
(b) Acquiror's Disclosure Letter sets forth copies or
descriptions of each Benefit Arrangement maintained or otherwise contributed
to by Acquiror (such plans and arrangements being collectively referred to
herein as "Acquiror Benefit Arrangements"). All Acquiror Benefit Arrangements
which are in effect have been in effect for substantially all of 1997. There
has been no material amendment thereof or increase in the cost thereof or
benefits payable thereunder since December 31, 1996. Except as set forth in
Acquiror's Disclosure Letter, there has been no material increase in the
compensation of or benefits payable to any senior executive employee of
Acquiror since December 31, 1996, nor any employment, severance or similar
contract entered into with any such employee, nor any amendment to any such
contract, since December 31, 1996. Except as set forth in Acquiror's
Disclosure Letter, there is no contract, agreement or benefit arrangement
covering any employee of Acquiror which individually or collectively could
give rise to the payment of any amount which would constitute an "excess
parachute payment," as such term is defined in Section 280(G) of the Code.
(c) With respect to all Acquiror Benefit Arrangements,
Acquiror is in substantial compliance (other than noncompliance the cost or
liability for which is not material) with the requirements prescribed by any
and all statutes, governmental or court orders, or governmental rules or
regulations currently in effect, applicable to such plans or arrangements.
(d) Except for the contracts set forth in Acquiror's
Disclosure Letter, each Acquiror Benefit Arrangement and each personal
services contract, fringe benefit, consulting contract or similar arrangement
with or for the benefit of any officer, director, employee or other person
can be terminated by Acquiror within a period of 30 days following the
Effective Time of the Bank Merger, without payment of any amount as a
penalty, bonus, premium, severance pay or other compensation for such
termination.
4.19 CORPORATE RECORDS. The Charter Documents of Acquiror and all
amendments thereto to the date hereof (true, correct and complete copies of
which are set forth in Acquiror's Disclosure Letter) are in full force and
effect as of the date of this Agreement. The minute books of Acquiror,
together with the documents and other materials incorporated therein by
reference, reflect all meetings held and contain complete and accurate
records of all corporate actions taken by the board of directors of Acquiror
(or any committees thereof) and stockholders.
A-33
<PAGE>
Except as reflected in such minute books, there are no minutes of meetings or
consents in lieu of meetings of the board of directors (or any committees
thereof) or of the stockholders of Acquiror.
4.20 ACCOUNTING RECORDS. Acquiror maintains accounting records
which fairly and validly reflect, in all material respects, its transactions
and accounting controls sufficient to provide reasonable assurances that such
transactions are (i) executed in accordance with its management's general or
specific authorization, and (ii) recorded as necessary to permit the
preparation of financial statements in conformity with GAAP. Such records,
to the extent they contain material information pertaining to Acquiror which
is not easily and readily available elsewhere, have been duplicated, and such
duplicates are stored safely and securely.
4.21 OFFICES AND ATMS. Set forth in Acquiror's Disclosure Letter
is a list of the headquarters of Acquiror (identified as such) and each of
the offices and automated teller machines ("ATMs") maintained and operated
(or to be maintained and operated) by Acquiror (including, without
limitation, representative and loan production offices and operations
centers) and the location thereof. Except as set forth in Acquiror's
Disclosure Letter, Acquiror maintains no other office or ATM and conducts
business at no other location, and Acquiror has not applied for nor received
permission to open any additional branch nor operate at any other location.
4.22 LOAN PORTFOLIO. Acquiror's Disclosure Letter sets forth a
description of ; (a) by type and classification, all loans, leases, other
extensions and commitments to extend credit of Acquiror of $150,000 or more,
that have been classified by itself, its bank examiners or auditors (external
or internal) as "Watch List," "Substandard," "Doubtful," "Loss" or any
comparable classification; and (b) all loans due to Acquiror as to which any
payment of principal, interest or any other amount is 30 days or more past
due. Acquiror's allowance for loan losses is and will be at the Effective
Time adequate and in accordance with GAAP in all materials respects and in
accordance with all applicable regulatory requirements of any Governmental
Entity.
4.23 POWER OF ATTORNEY. Except as set forth in Acquiror's
Disclosure Letter, Acquiror has not granted any Person a power of attorney or
similar authorization that is presently in effect or outstanding.
4.24 OPERATING LOSSES. Acquiror's Disclosure Letter sets forth any
Operating Loss which has occurred at Acquiror during the period after
December 31, 1996. To the knowledge of Acquiror, no action has been taken or
omitted to be taken by an employee of Acquiror that has resulted in the
incurrence by Acquiror of an Operating Loss or that might reasonably be
expected to result in an Operating Loss after December 31, 1996, which, net
of any insurance proceeds payable in respect thereof, would exceed $50,000.
4.25 ENVIRONMENTAL MATTERS. Except as set forth in Acquiror's
Disclosure Letter, (i) Acquiror is in compliance with all Environmental Laws;
(ii) there are no Tanks on or about Acquiror Property; (iii) there are no
Hazardous Materials on, below or above the surface of, or
A-34
<PAGE>
migrating to or from Acquiror Property; (iv) Acquiror has no loans
outstanding secured by real property that is not in compliance with
Environmental Laws or which has a leaking Tank or upon which there are
Hazardous Materials on or migrating to or from; and (v) without limiting the
foregoing representations and warranties contained in clauses (i) through
(iv), as of the date of this Agreement, there is no claim, action , suit, or
proceeding or notice thereof before any Governmental Entity pending against
Acquiror or concerning property securing Acquiror loans and there is no
outstanding judgment, order, writ, injunction, decree, or award against or
affecting Acquiror Property or property securing Acquiror loans, relating to
the foregoing representations (i) -- (iv), in each case the noncompliance
with which, or the presence of which would have a material adverse effect on
the business, financial condition, results of operations or prospects of
Acquiror. "Acquiror Property" shall mean real estate currently owned,
leased, or otherwise used by Acquiror, or in which Acquiror has an investment
or security interest by mortgage, deed of trust, sale and lease-back or
otherwise, including without limitation, properties under foreclosure and
properties held by Acquiror in its capacity as a trustee or otherwise.
4.26 COMMUNITY REINVESTMENT ACT. Acquiror received a rating of
"satisfactory" or better in its most recent examination or interim review
with respect to the Community Reinvestment Act. Acquiror has not been
advised of any concerns regarding Acquiror's compliance with the Community
Reinvestment Act by any Governmental Entity or by any other Person.
4.27 DERIVATIVES. Acquiror is not currently a party to any
interest rate swap, cap, floor, option agreement, other interest rate risk
management arrangement or agreement or derivative-type security or derivative
arrangement or agreement.
4.28 POOLING. It is intended that the Bank Merger be accounted for
on a pooling of interests basis, and no event has occurred or is reasonably
foreseeable (including any transaction contemplated by this Agreement) that
could alter such treatment.
4.29 SEC REPORTS. As of their respective dates, since December 31,
1994, none of Acquiror's's SEC Reports contained at the time of filing any
untrue statement of a material fact or omitted to state a material fact
required to be stated therein or necessary to make the statements made
therein, in light of the circumstances under which they were made, not
misleading.
4.30 MATERIAL CONTRACTS. Except as set forth in Acquiror's
Disclosure Letter (all items listed or required to be listed in Acquiror's
Disclosure Letter as a result of this Section being referred to herein as
"Acquiror Scheduled Contracts"), Acquiror is not a party or otherwise subject
to:
(a) any collective bargaining agreement or other such
contract or agreement with any labor organization;
A-35
<PAGE>
(b) any stock purchase, stock option, stock bonus, stock
ownership, profit sharing, group insurance, bonus, deferred compensation,
severance pay, pension, retirement, savings or other incentive, welfare or
employment plan or material agreement providing benefits to any present or
former employees, officers or directors of Acquioror;
(c) any agreement to acquire equipment or any commitment to
make capital expenditures of $75,000 or more;
(d) any agreement which would be terminable other than by
Acquiror or as a result of the consummation of the transactions contemplated
by this Agreement;
(e) any contract of participation with any other bank in any
loan entered into by Acquiror subsequent to December 31, 1996 in excess of
$150,000 or any sales of assets of Acquiror with recourse of any kind to
Acquiror except the sale of mortgage loans, servicing rights, repurchase or
reverse repurchase agreements, securities or other financial transactions in
the ordinary course of business;
(f) any other agreement of any other kind, including for data
processing and similar services, which involves future payments or receipts
or performances of services or delivery of items requiring aggregate payment
of $75,000 or more to or by Acquiror other than payments made under or
pursuant to loan agreements, participation agreements and other agreements
for the extension of credit in the ordinary course of its business;
(g) any material agreement, arrangement or understanding not
made in the ordinary course of business;
(h) any agreement, arrangement or understanding relating to
the employment, election, retention in office or severance of any present or
former director, officer or employee of Acquiror;
(i) any agreement, arrangement or understanding pursuant to
which any payment (whether severance pay or otherwise) became or may become
due to any director, officer or employee of Acquiror upon execution of this
Agreement or upon or following consummation of the transactions contemplated
hereby (either alone or in connection with the occurrence of any additional
acts or events); or
(j) any written agreement, supervisory agreement, memorandum
of understanding, consent order, cease and desist order, capital order, or
condition of any regulatory order or decree with or by the Commissioner or
FDIC or any other regulatory agency.
True copies of all Acquiror Scheduled Contracts, including all amendments and
supplements thereto, are attached to Acquiror's Disclosure Letter.
A-36
<PAGE>
4.31 TRUST ADMINISTRATION. Acquiror does not presently exercise
trust powers, including, but not limited to, trust administration, and has
not exercised such trust powers for a period of at least 3 years prior to the
date hereof. The term "trusts" as used in this Section 4.31 includes (i) any
and all common law or other trusts between an individual, corporation or
other entities and Acquiror, as trustee or co-trustee, including, without
limitation, pension or other qualified or nonqualified employee benefit
plans, compensation, testamentary, inter vivos and charitable trust
indentures; (ii) any and all decedents' estates where Acquiror is serving or
has served as a co-executor or sole executor, personal represetative or
adminstrator, administrator de bonis non, administrator de bonis non with
will annexed, or in any similar fiduciary capacity; (iii) any and all
guardianships, conservatorships or similar positions where Acquiror is
serving or has served as a co-grantor or a sole grantor or a conservator or a
co-conservator of the estate, or any similar fiduciary capacity; and (iv) any
and all agency and/or custodial accounts and/or similar arrangements,
including plan administrator for employee benefit accounts, under which
Acquiror is serving or has served as an agent or custodian for the owner or
other party establishing the account with or without investment authority.
4.32 REGULATORY APPROVALS. To the knowledge of Acquiror, except as
described in Acquiror's Disclosure Letter, Acquiror has no reason to believe
that it would not receive all required approvals from any Governmental Entity
of any application to consummate the transaction contempleted by this
Agreement without the imposition of a materially burdensome condition in
connection with the approval of any such application.
A-37
<PAGE>
ARTICLE 5
AGREEMENTS WITH RESPECT TO CONDUCT OF
BANCORP AND BANK AFTER THE DATE HEREOF
Bancorp and Bank covenant and agree with Acquiror as follows:
5.1 ACCESS.
(a) Bancorp and Bank will authorize and permit Acquiror, its
representatives, accountants and counsel, to have access during normal
business hours, on notice and in such manner as will not unreasonably
interfere with the conduct of the businesses of either Bancorp or Bank, to
all properties, books, records, branch operating reports, branch audit
reports, operating instructions and procedures, tax returns, tax settlement
letters, contracts and documents, and all other information with respect to
their business affairs, financial condition, assets and liabilities as
Acquiror may from time to time request. Bancorp and Bank shall permit
Acquiror, its representatives, accountants and counsel to make copies of such
books, records and other documents and to discuss the business affairs,
condition (financial and otherwise), assets and liabilities of Bancorp and
Bank with such third Persons, including, without limitation, its directors,
officers, employees, accountants, counsel and creditors, as Acquiror
considers necessary or appropriate for the purposes of familiarizing itself
with the businesses and operations of Bancorp and Bank, obtaining any
necessary orders, consents or approvals of the transactions contemplated by
this Agreement by any Governmental Entity and conducting an evaluation of the
assets and liabilities of Bancorp and Bank. Bancorp and Bank will cause
Vavrinick, Trine & Day to make available to Acquiror, its accountants,
counsel and other agents, such personnel, work papers and other documentation
of Vavrinick, Trine & Day relating to its work papers and its audits of the
books and records of Bancorp and Bank as may be requested by Acquiror in
connection with its review of the foregoing matters.
(b) The President of Acquiror or in his absence another
representative of Acquiror selected by him shall be invited by Bancorp and
Bank to attend all regular and special Board of Directors' and Executive
Committee meetings of Bancorp or Bank from the date hereof until the
Effective Time. Bancorp and Bank shall inform Acquiror of each such Board
meeting at least 2 Business Days in advance of each such meeting; provided,
however, that the attendance of such representative of Acquiror shall not be
permitted at any meeting, or portion thereof, for the sole purpose of
discussing the transaction contemplated by this Agreement or the obligations
of either Bancorp or the Bank under this Agreement.
A-38
<PAGE>
5.2 MATERIAL ADVERSE CHANGES; REPORTS; FINANCIAL STATEMENTS; FILINGS.
(a) Bancorp and Bank will promptly notify Acquiror (i) of any
event of which Bancorp or Bank obtains knowledge which may materially and
adversely affect the business, financial condition, or results of operations
of either Bancorp or Bank; (ii) in the event Bancorp or Bank determine that
it is possible that the conditions to the performance of Acquiror set forth
in Sections 8.1 and 8.3 may not be satisfied; (iii) of the opening or closing
of any branch or other office of Bancorp or Bank at which business is
conducted; or (iv) any event, development or circumstance that, to the best
knowledge of Bancorp or Bank, will or, with the passage of time or the giving
of notice or both, is reasonably expected to result in the loss to Bancorp or
Bank of the services of any Executive Officer of Bancorp or Bank.
(b) Bancorp and Bank will furnish to Acquiror as provided in
Section 11.13 of this Agreement, as soon as practicable, and in any event
within 5 Business Days after it is prepared or becomes available to either
Bancorp or Bank, (i) a copy of any report submitted to the board of directors
of either Bancorp or Bank and access to the working papers related thereto
and copies of other operating or financial reports prepared for management of
any of its businesses and access to the working papers related thereto,
PROVIDED, HOWEVER, that Bancorp and Bank need not furnish Acquiror any
privileged communications of or memoranda prepared by its legal counsel in
connection with the transactions contemplated by, and the rights and
obligations of Bancorp and Bank under, this Agreement; (ii) quarterly
unaudited consolidated balance sheets and statements of operations, changes
in stockholders' equity and cash flow for Bancorp and Bank; (iii) monthly
unaudited consolidated balance sheets and, statements of operations for
Bancorp and Bank; (iv) as soon as available, all letters and communications
sent by Bancorp to its shareholders and all reports filed by Bancorp or Bank
with the SEC, the FRB, the FDIC, the Commissioner and any other Person; and
(v) such other reports as Acquiror may reasonably request relating to Bancorp
or Bank.
(c) Each of the financial statements delivered pursuant to
subsection (b) shall be (i) prepared in accordance with GAAP on a basis
consistent with that of the Financial Statements of Bank/Bancorp, except that
such financial statements may omit statements of cash flows and footnote
disclosures required by GAAP; and (ii) accompanied by a certificate of the
chief financial officer to the effect that such consolidated financial
statements fairly present the financial condition and results of operations
of Bancorp and Bank for the period covered, and reflect all adjustments
(which consist only of normal recurring adjustments) necessary for a fair
presentation.
5.3 CONDUCT OF BUSINESS.
(a) Between the date hereof and the Effective Time, except as
contemplated by this Agreement and subject to requirements of law and
regulation generally applicable to bank holding companies and banks, Bancorp
or Bank shall not, without prior written consent of Acquiror (which consent
shall not be unreasonably withheld and which consent [except
A-39
<PAGE>
with respect to subparagraph (30) of this Section 5.3(a)] shall be deemed
granted if within five (5) Business Days of Acquiror's receipt of written
notice of a request for prior written consent, written notice of objection is
not received by Bancorp and Bank):
(1) amend, modify, terminate or fail to renew or
preserve their material Permits;
(2) amend or modify in any material respect, or, except
as they may expire in accordance with their terms, terminate any Bancorp
Scheduled Contract or any other material contract or agreement to which
Bancorp or Bank is a party, or materially default in the performance of any
of its obligations under any such contract or agreement;
(3) enter into any agreement or contract that would be
required to be included as a Bancorp Scheduled Contract.
(4) terminate or unilaterally fail to renew any existing
insurance coverage or bonds;
(5) make any loan or other extension of credit, or enter
into any commitment to make any loan or other extension of credit except for
consumer loans of not more than $50,000 per person, to any director, officer,
employee or shareholder holding 5% or more of the outstanding shares of
Bancorp Stock;
(6) grant any general or uniform increase in the rate of
pay to any employee or employee benefit or profit sharing plan or increase
the salary or employee benefits of any non-exempt employee or agent or pay
any bonus, severance or similar payment to any Person, except in the ordinary
course of business and consistent with past practice or established practices;
(7) grant any promotion or any increase in the rate of
pay to any exempt employee, profit sharing plan or increase in any employee
benefits or pay any bonus, severance or similar payment to any exempt
employee except for prorata bonuses, profit sharing or 401(k) matching
payments which are in the ordinary course of business and consistent with
past practices and which do not exceed the total amount of all such payments
declared in 1997 multiplied by the fraction derived by dividing (a) the
number of full calendar months between January 1, 1998 and the Effective Day
by (b) twelve (12);
(8) sell, transfer, mortgage, encumber or otherwise
dispose of any assets or release or waive any claim, except in the ordinary
course of business and consistent with past practice or as required by any
existing contract or for ordinary repairs, renewals or replacements or as
contemplated in this Agreement;
A-40
<PAGE>
(9) issue, sell, or grant any Equity Securities of
Bancorp or Bank (except pursuant to the exercise of Bancorp options
outstanding as of the date hereof), any other securities (including long term
debt), or any rights, options or securities to acquire any Bancorp Stock
Option or any Equity Securities of Bancorp or any other securities (including
long term debt) of Bancorp;
(10) declare, issue or pay any dividend or other
distribution of assets, whether consisting of money, other personal property,
real property or other things of value, to the shareholders of Bancorp or
Bank, or split, combine or reclassify any shares of its capital stock or
other Equity Securities except (i) for a $0.30 per share cash dividend
payable by Bancorp to its shareholders on or about February 6, 1998 and (ii)
if the Effective Time occurs after July 31, 1998, an additional cash
dividend payable by Bancorp to its shareholders after July 31, 1998 in an
amount not to exceed $.10.
(11) purchase, redeem or otherwise acquire any Equity
Securities, or other securities of Bancorp or Bank or any rights, options, or
securities to acquire any Equity Securities of Bancorp or Bank;
(12) amend or modify its Charter Documents;
(13) make their credit underwriting policies, standards
or practices relating to the making of loans and other extensions of credit,
or commitments to make loans and other extensions of credit, less stringent
than those in effect on December 31, 1997;
(14) make any capital expenditures, or commitments with
respect thereto, in excess of $100,000 except in the ordinary course of
business and consistent with past practice;
(15) make extraordinary payments to any Person other than
as contemplated, or as disclosed, in this Agreement;
(16) make any investment by purchase of stock or
securities (including an Investment Security), contributions to capital,
property transfers or otherwise in any other Person, except for federal funds
or obligations of the United States Treasury or an agency of the United
States Government the obligations of which are entitled to or implied to have
the full faith and credit of the United States government and which have an
original maturity not in excess of one year, or bank qualified investment
grade municipal bonds, in any case, in the ordinary course of business
consistent with the past practices, and which are not designated as trading;
(17) compromise or otherwise settle or adjust any
assertion or claim of a deficiency in taxes (or interest thereon or penalties
in connection therewith); file any appeal from an asserted deficiency except
in a form previously approved by Acquiror in writing;
A-41
<PAGE>
file or amend any United States federal, foreign, state or local tax return
without Acquiror's prior written approval, which approval shall not be
unreasonably withheld; or make any tax election or change any method or
period of accounting unless required by GAAP or applicable law;
(18) enter into or consent to any new employment
agreement or other Benefit Arrangement, or amend or modify any employment
agreement or other Bank Benefit Arrangement in effect on the date of this
Agreement to which either Bancorp or Bank is a party or bound;
(19) grant any Person a power of attorney or similar
authority except in accordance with a written policy previously disclosed to
Acquiror;
(20) agree or make any commitment to take any actions
prohibited by this Section 5.3;
(21) change any of Bank's basic policies and practices
with respect to liquidity management and cash flow planning, marketing,
deposit origination, lending, budgeting, profit and tax planning, personnel
practices or any other material aspect of Bank's business or operations,
except such changes as may be required in the opinion of Bancorp and Banks
management to respond to economic or market conditions or as may be required
by any Governmental Entity;
(22) take any action which would or is reasonably likely
to (i) adversely affect the ability of Bancorp, Bank or Acquiror to obtain
any necessary approval of any Governmental Entity required for the
transactions contemplated hereby; (ii) adversely affect Bancorp or Bank's
ability to perform their covenants and agreements under this Agreement; or
(iii) result in any of the conditions to the performance of Bancorp, Bank or
Acquiror's obligations hereunder, as set forth in Article 8 herein not being
satisfied;
(23) reclassify any Investment Security from
hold-to-maturity or available for sale to trading;
(24) sell any Investment Security prior to maturity,
except in the ordinary course of business. Any gains realized from a sale in
the ordinary course of business shall be excluded on an after tax basis from
Bancorp Projected Earnings as defined in Section 8.3(k);
(25) take title to any real property without obtaining
prior thereto a Phase I environmental report, which report shall disclose the
absence of any suspected environmental contamination;
(26) knowingly take or cause to be taken any action which
would disqualify the Bank Merger as a "reorganization" within the meaning of
Section 368 of the Code or
A-42
<PAGE>
prevent Acquiror from accounting for the business combination to be effected
by the Bank Merger as a pooling-of-interests;
(27) settle any claim, action or proceeding involving any
material liability for monetary damages or enter into any settlement agreement
containing material obligations;
(28) make, acquire a participation in, or reacquire an
interest in a participation sold of, any loan that is not in compliance with
its normal credit underwriting standards, policies and procedures as in
effect as of the date of this Agreement; or renew, extend the maturity of, or
alter any of the material terms of any such loan for a period of greater than
six months;
(29) incur any indebtedness for borrowed money or assume,
guaranty, endorse or otherwise as an accommodation become responsible for the
obligations of any other Person, except for (i) in connection with banking
transactions with banking customers in the ordinary course of business, or
(ii) short-term borrowings made at prevailing market rates and terms;
(30) grant, renew or commit to grant or renew any
extension of credit if such extension of credit, together with all other
credit then outstanding to the same Person and all Affiliated Persons, would
exceed $100,000 on an unsecured basis and $200,000 on a secured basis except
for any loan or loans not to exceed $50,000 per person which is either (i) to
a Person and all Affiliated Persons of up to 10% of the aggregated principal
amount of existing such loans or (ii) a consumer loan. Consent shall be
deemed granted if within two Business Days of written notice delivered to
Acquiror's Chief Credit Officer, written notice of objection is not received
by Bancorp or Bank.
(b) Between the date hereof and the Effective Time, Bancorp
and Bank shall:
(1) duly observe and conform in all material respects to
all lawful requirements applicable to its business;
(2) maintain their assets and properties in good
condition and repair, normal wear and tear excepted;
(3) promptly upon learning of such information, advise
Acquiror in writing of any event or any other transaction within its
knowledge whereby any Person or Related Group of Persons acquires, directly
or indirectly, record or beneficial ownership or control (as defined in Rule
13d-3 promulgated by the SEC under the Exchange Act) of five percent (5%) or
more of the outstanding Bancorp Stock prior to the record date fixed for the
Bancorp Shareholders'
A-43
<PAGE>
Meeting or any adjourned meeting thereof to approve this Agreement and the
transaction contemplated herein;
(4) promptly notify Acquiror regarding receipt from any
tax authority of any notification of the commencement of an audit, any
request to extend the statute of limitations, any statutory notice of
deficiency, any revenue agent's report, any notice of proposed assessment, or
any other similar notification of potential adjustments to the tax
liabilities of Bancorp or Bank, or any actual or threatened collection
enforcement activity by any tax authority with respect to tax liabilities of
Bancorp or Bank; and
(5) maintain an allowance for loan and lease losses
consistent with practices and methodology as in effect on the date of the
execution of this Agreement, and shall not, notwithstanding any recoveries
received with respect to loans previously charged off, reduce the allowance
for loan and lease losses below the amount in effect on the date of the
execution of this Agreement, except as a result of chargeoffs.
5.4 CERTAIN LOANS AND OTHER EXTENSIONS OF BANCORP AND BANK.
Bancorp and Bank will promptly inform Acquiror of the amounts and categories
of any loans, leases or other extensions of credit that have been classified
by any Governmental Entity or by any internal or external loan reviewer of
Bancorp or Bank as "Watch List," "Substandard," "Doubtful," "Loss" or any
comparable classification. Bancorp and Bank will furnish to Acquiror, as
soon as practicable, and in any event within 10 days after the end of each
calendar month, schedules including a listing of the following:
(a) classified credits, showing with respect to each such
credit in amount equal to or exceeding $50,000, the classification category,
credit type, and office, and with respect to all other such credits, by
credit type and office, the aggregate dollar amount;
(b) nonaccrual credits, showing with respect to each such
credit in amount equal to or exceeding $50,000, the credit type and office,
and with respect to all other such credits, by credit type and office, the
aggregate dollar amount;
(c) accrual exception credits that are delinquent 90 or more
days and have not been placed on nonaccrual status, showing with respect to
each such credit in amount equal to or exceeding $50,000, the credit type and
office, and with respect to all other such credits, by credit type and
office, the aggregate dollar amount;
(d) delinquent credits showing with respect to each such
credit in amount equal to or exceeding $50,000, the credit type, office and
an aging schedule broken down into 30-59, 60-89, 90+ day categories, and
with respect to all other such credits, by credit type, office and by aging
category, the aggregate dollar amount;
A-44
<PAGE>
(e) loan and lease participations, stating, with respect to
each, whether it is purchased or sold, the loan or lease type, and the office;
(f) loans or leases (including any commitments) by Bancorp or
Bank except for consumer loans of not more than $50,000 per person to any
director, officer, or employee of Bancorp or Bank, or any shareholder holding
5% or more of the capital stock of Bancorp, including with respect to each
such loan or lease, the identity and, to the best knowledge of Bancorp and
Bank, the relation of the borrower to Bancorp and Bank, the loan or lease
type and the outstanding and undrawn amounts;
(g) letters of credit, showing with respect to each letter of
credit in an amount equal to or exceeding $50,000, the credit type and
office, and showing with respect to all other such letters of credit, by
credit type and office, the aggregate dollar amount;
(h) loans or leases charged off during the previous month,
showing with respect to each such loan or lease, the credit type and office;
(i) loans or leases written down during the previous month,
including with respect to each the original amount, the writeoff amount,
credit type and office;
(j) other real estate or assets owned, stating with respect
to each its credit type;
(k) a reconciliation of the allowance for loan and lease
losses, identifying specifically the amount and sources of all additions and
reductions to the allowance (which may be by reference to specific portions
of another schedule furnished pursuant to this Section 5.4 and, in the case
of unallocated adjustments, shall disclose the methodology and calculations
through which the amount of such adjustment was determined);
(l) extensions of credit whether unsecured or secured in
amount equal to or exceeding $50,000, originated on or after the date of the
schedule previously provided to Acquiror (or if it is the first such
schedule, the date of this Agreement) and before the date of the schedule in
which reported, showing with respect to each, the credit type and the office;
and
(m) renewals or extensions of maturity of outstanding
extensions of credit whether unsecured or secured in amount equal to or
exceeding $50,000, showing with respect to each, the credit type and the
office.
5.5 DISCLOSURE LETTER. Promptly in the case of material matters,
and not less than monthly in the case of all other matters, Bancorp and Bank
shall amend or supplement the Bancorp Disclosure Letter provided for herein
pertaining to Bancorp and Bank as necessary so that the information contained
therein accurately reflects the then current status of Bancorp and Bank
A-45
<PAGE>
and shall transmit copies of such amendments or supplements to Acquiror in
accordance with Section 11.13 of this Agreement.
5.6 SHAREHOLDER APPROVAL.
(a) Bancorp will promptly take action necessary in accordance
with applicable law and its Charter Documents to convene a meeting of its
shareholders (the "Bancorp Shareholders' Meeting") to be held as soon as
practicable, for the purpose of voting on the Bank Merger, this Agreement and
related matters. In connection with the Bancorp Shareholders' Meeting, (i)
the Board of Directors of Bancorp shall, subject to fiduciary duty, recommend
shareholder approval of the Bank Merger, this Agreement and related matters;
and (ii) Bancorp shall use its best efforts to obtain such shareholder
approval by the largest possible percentage.
(b) Bank will promptly take action necessary in accordance
with applicable law and its Charter Documents to convene a meeting of its
shareholder (the "Bank Shareholders' Meeting") to be held as soon as
practicable, for the purpose of voting on the Bank Merger, this Agreement and
related matters. Bancorp shall vote all shares of Bank Stock which it owns
at such meeting in favor of the Bank Merger, this Agreement and related
matters.
5.7 CONSENTS AND APPROVALS.
(a) Bancorp and Bank will cooperate with Acquiror in the
preparation of all filings, applications, notices and requests for waiver for
Consents necessary or desirable for the consummation of the Bank Merger, and
the other transactions contemplated in this Agreement. Bancorp's and Bank's
cooperation hereunder shall include, but not be limited to, providing all
information concerning Bancorp or Bank and their respective shareholders as
may be required for such filings, applications, notices and requests for
Consents and signing, to the extent required, all such filings, applications,
notices and requests.
(b) To the extent that the consent of a third party ("Third
Party Consent") with respect to any contract, agreement, license, franchise,
lease, commitment, arrangement, Permit or release that is material to the
business of Bancorp or Bank or that is contemplated in this Agreement is
required in connection with the Bank Merger or the transactions contemplated
in this Agreement, Bancorp and Bank shall use its best efforts to obtain such
consent prior to the Effective Time.
5.8 PRESERVATION OF EMPLOYMENT RELATIONS PRIOR TO EFFECTIVE TIME.
Bancorp and Bank will use their best efforts consistent with current
employment practices and policies to maintain the services of the officers
and employees of Bancorp and Bank through the Effective Time.
A-46
<PAGE>
5.9 COMPLIANCE WITH RULES. Bancorp and Bank shall comply with
the requirements of all applicable Rules, the noncompliance with which would
materially and adversely affect the assets, liabilities, business, financial
condition or results of operations or prospects of Bancorp or Bank.
5.10 BANK BENEFIT ARRANGEMENTS. Subject to Article 9 hereof and
except for the agreements between the Bancorp, the Bank and its Executive
Officers at or prior to the Effective Time, Bancorp and Bank, as the case may
be, and any effected officers, directors or employees shall mutually
terminate all Bank Benefit Arrangements without the imposition of any
liability therefor to Acquiror or any other Party.
5.11 AGREEMENT OF MERGER. As soon as practicable, Bancorp and
Bank shall execute the Agreement of Merger.
5.12 ENVIRONMENTAL REPORTS. Bancorp and Bank shall provide to
Acquiror, as soon as practical, but not later than 45 days after the date
hereof, a Vista Environmental Report (a sample of which is attached to
Acquiror's Disclosure Letter) containing a preliminary environmental
investigation on all real property owned, leased or operated (including OREO)
by Bancorp or Bank as the date hereof and within ten days after the
acquisition or lease of any real property acquired or leased (including OREO)
by the Bancorp or Bank after the date hereof. If required by said
preliminary investigation in Acquiror's reasonable opinion, Bancorp and Bank
shall provide to Acquiror a phase one and, if necessary in Acquiror's
reasonable opinion, a phase two environmental report of further investigation
on properties requiring such additional study. The expenses of all reports
shall be borne by Bancorp or Bank. Acquiror shall have 15 Business Days from
the receipt of a report pursuant to this Section 5.12 to notify Bancorp and
Bank of any objections to the contents of such report. Should the costs of
taking all remedial and corrective actions and measures (i) required by
applicable law, or (ii) recommended or suggested by such report or reports or
prudent in the light of serious life, health or safety concerns, in the
aggregate, exceed the sum of $25,000 as reasonably estimated by an
environmental expert retained for such purpose by Bancorp or Bank and
reasonably acceptable to Acquiror, or if the cost of such actions and
measures cannot be reasonably estimated by such expert to be $25,000 or less
with any reasonable degree of certainty, then such costs of remedial and
corrective actions and measures shall be deemed to be Significant Liabilities
as defined in this Agreement. Acquiror shall have the right pursuant to
Section 10.1(h) hereof and Bancorp and Bank shall have the right pursuant to
Section 10.1(j) hereto, for a period of 10 Business Days following receipt of
such estimate or indication that the costs of such actions and measures are
reasonably estimated to exceed $1,500,000 on an after tax basis or can not be
reasonably estimated to be less than $1,500,000 on an after tax basis, to
terminate this Agreement, without liability to Bancorp or Bank or Section
5.12.
5.13 ACCRUALS AND RESERVES. Just prior to the Effective Time and
to the extent determined necessary or advisable by Acquiror in its sole
discretion (which shall not be limited by any finding or determination by a
Governmental Entity), Bank shall modify and change its loan,
A-47
<PAGE>
OREO, accrual and reserve policies and practices (including loan
classifications and levels of tax, loan and OREO reserves and accruals) and
increase its reserves for loans losses to reflect Acquiror's judgment and
plans with respect to the conduct of Bancorp and Bank's business following
the Bank Merger.
5.14 NO SHOP. Neither Bancorp nor Bank, nor any of their
Affiliates shall, on or before the earlier of the Effective Time or the date
of termination of this Agreement, initiate, solicit or encourage (including
by way of furnishing information or assistance), or take any other action to
facilitate, any inquiries or the making of any proposal which constitutes, or
may reasonably be expected to lead to any Competing Transaction (as such term
is defined below), or negotiate with any Person in furtherance of such
inquiries or to obtain a Competing Transaction, or agree to or endorse any
Competing Transaction, or authorize or permit any of its officers, directors
or employees or any investment banker, financial advisor, attorney,
accountant or any other representative retained by it or any of its
Affiliates to take any such action, and Bancorp and Bank shall promptly
notify Acquiror (orally and in writing) of all of the relevant details
relating to all inquiries and proposals which they may receive relating to
any of such matters. For purposes of this Agreement, "Competing Transaction"
shall mean any of the following involving Bancorp or Bank: any merger,
consolidation, share exchange or other business combination; a sale, lease,
exchange, mortgage, pledge, transfer or other disposition of assets of
Bancorp or Bank representing ten percent (10%) or more of the asset of
Bancorp or Bank; a sale of shares of capital stock (or securities convertible
or exchangeable into or otherwise evidencing, or any agreement or instrument
evidencing, the right to acquire capital stock), representing ten percent
(10%) or more of the voting power of Bancorp or Bank, a tender offer or
exchange offer for at least ten percent (10%) of the outstanding shares; a
solicitation of proxies in opposition to approval of the Bank Merger by
Bancorp or Bank shareholders; or a public announcement of an unsolicited BONA
FIDE proposal, plan, or intention to do any of the foregoing. Notwithstanding
any other provision in this Section 5.14 or elsewhere in this Agreement, the
obligations of Bancorp and Bank in this Agreement are subject to the
continuing fiduciary duties of their respective Boards of Directors. In the
event the Board of Directors of Bancorp, or Bank, or both, receives a bona
fide offer for a Competing Transaction with another entity, and reasonably
determines, upon written advice of counsel, that as a result of such offer,
any duty to act or to refrain from doing any act pursuant to this Agreement,
is inconsistent with the continuing fiduciary duties of said Board of
Directors to their shareholders, such failure to act or refrain from doing
any act shall not constitute the failure of any condition, breach of any
covenant or otherwise constitute any breach of this Agreement, except that
any such failure to act or refrain from doing any act shall entitle Acquiror
to terminate this Agreement pursuant to Section 10.1(g) hereof, and in no
event shall this sentence or the previous sentence operate to excuse or
modify the obligations of Bancorp and Bank under Section 11.1(c) hereof.
5.15 AFFILIATES AND FIVE PERCENT SHAREHOLDER AGREEMENTS. Within
thirty (30) days of the execution of this Agreement, (a) Bancorp and Bank
shall deliver to Acquiror a letter identifying all persons who are then
"affiliates" of Bancorp or Bank for purposes of Rule 145 under the Securities
Act and (b) Bancorp shall advise the persons identified in such letter of the
resale
A-48
<PAGE>
restrictions imposed by applicable securities laws and shall use reasonable
efforts to obtain from each person identified in such letter a written
agreement substantially in the form attached hereto as Exhibit 5.15. Bancorp
shall use reasonable efforts to obtain from any person who becomes an
affiliate of Bancorp after Bancorp's delivery of the letter referred to
above, and on or prior to the date of the Bancorp Shareholders' Meeting to
approve this Agreement, a written agreement substantially in the form
attached as Exhibit 5.15 hereto as soon as practicable after obtaining such
status. At least 10 Business Days prior to the issuance of the opinion to be
provided for in Section 8.1(h), Bancorp shall use its best efforts to cause
each person or group of persons who holds more than five percent (5%) of the
Bancorp Stock (regardless of whether such person is an "affiliate" under Rule
145) to deliver to both Arthur Andersen, LLP and Reitner & Stuart, a letter
stating that such shareholder(s) has no present plan or intention to dispose
of Bancorp Stock and committing that such shareholder(s) will not dispose of
Bancorp Stock in a manner to cause a violation of the "continuity of
shareholder interest" requirements of Treasury Regulation 1.368-1.
A-49
<PAGE>
ARTICLE 6
AGREEMENTS WITH RESPECT TO CONDUCT OF
ACQUIROR AFTER THE DATE HEREOF
Acquiror covenant and agree with Bancorp and Bank as follows:
6.1 ACCESS.
(a) Acquiror will authorize and permit Bancorp and Bank,
their representatives, accountants and counsel, to have access during normal
business hours, on notice and in such manner as will not unreasonably
interfere with the conduct of the businesses of Acquiror, to all properties,
books, records, branch operating reports, branch audit reports, operating
instructions and procedures, tax returns, tax settlement letters, contracts
and documents, and all other information with respect to its business
affairs, financial condition, assets and liabilities as Bancorp and Bank may
from time to time request. Acquiror shall permit Bancorp and Bank, their
representatives, accountants and counsel to make copies of such books,
records and other documents and to discuss the business affairs, condition
(financial and otherwise), assets and liabilities of Acquiror with such third
Persons, including, without limitation, its directors, officers, employees,
accountants, counsel and creditors, as Bancorp and Bank consider necessary or
appropriate for the purposes of familiarizing themselves with the businesses
and operations of Acquiror, obtaining any necessary orders, consents or
approvals of the transactions contemplated by this Agreement by any
Governmental Entity and conducting an evaluation of the assets and
liabilities of Acquiror. Acquiror will cause Arthur Andersen, LLP, to make
available to Bancorp and Bank, their accountants, counsel and other agents,
such personnel, work papers and other documentation of Arthur Andersen, LLP,
relating to its work papers and its audits of the books and records of
Acquiror as may be requested by Bancorp and Bank in connection with their
review of the foregoing matters.
(b) The President of Bancorp or in his absence another
representative of Bancorp selected by him shall be invited by Acquiror to
attend all regular and special Board of Directors' meetings of Acquiror from
the date hereof until the Effective Time of the Bank Merger. Acquiror shall
inform Bancorp of each such Board meeting at least 2 Business Days in advance
of each such meeting; provided, however, that the attendance of such
representative of Bancorp shall not be permitted at any meeting, or portion
thereof, for the sole purpose of discussing the transactions contemplated by
this Agreement of the obligations of the Acquiror under this Agreement.
A-50
<PAGE>
6.2 MATERIAL ADVERSE CHANGES; REPORTS; FINANCIAL STATEMENTS; FILINGS.
(a) Acquiror will promptly notify Bancorp and Bank (i) of any
event of which Acquiror obtains knowledge which may materially and adversely
affect the business, financial condition, or results of operations of
Acquiror; (ii) in the event Acquiror determines that it is possible that the
conditions to the performance of Bancorp and Bank set forth in Sections 8.1
and 8.2 may not be satisfied; (iii) of the opening or closing of any branch
or other office of Acquiror at which business is conducted; or (iv) any
event, development or circumstance that, to the best knowledge of Acquiror,
will or, with the passage of time or the giving of notice or both, is
reasonably expected to result in the loss to Acquiror of the services of any
Executive Officer of Acquiror.
(b) Acquiror will furnish to Bancorp and Bank as provided in
Section 11.13 of this Agreement, as soon as practicable, and in any event
within 5 Business Days after it is prepared or becomes available to Acquiror,
(i) a copy of any report submitted to the board of directors of Acquiror and
access to the working papers related thereto and copies of other operating or
financial reports prepared for management of any of its businesses and access
to the working papers related thereto, PROVIDED, HOWEVER, that Acquiror need
not furnish Bancorp or Bank any privileged communications of or memoranda
prepared by its legal counsel in connection with the transactions
contemplated by, and the rights and obligations of Acquiror under, this
Agreement; (ii) quarterly unaudited consolidated balance sheets and
statements of operations, changes in stockholders' equity and cash flow for
Acquiror; (iii) monthly unaudited consolidated balance sheets and, statements
of operations for Acquiror; (iv) as soon as available, all letters and
communications sent by Acquiror to its shareholders and all reports filed by
Acquiror with the FDIC, the Commissioner and any other Person; and (v) such
other reports as Bancorp and Bank may reasonably request relating to Acquiror.
(c) Each of the financial statements delivered pursuant to
subsections (b) , shall be (i) prepared in accordance with GAAP on a basis
consistent with that of the Financial Statements of Acquiror, except that
such financial statements may omit statements of cash flows and footnote
disclosures required by GAAP; and (ii) accompanied by a certificate of the
chief financial officer to the effect that such financial statements fairly
present the financial condition and results of operations of Acquiror for the
period covered, and reflect all adjustments (which consist only of normal
recurring adjustments) necessary for a fair presentation.
6.3 CONDUCT OF BUSINESS.
(a) Between the date hereof and the Effective Time, except as
contemplated by this Agreement and subject to requirements of law and
regulation generally applicable to California state chartered banks, Acquiror
shall not, without prior written consent of
A-51
<PAGE>
Bancorp (which consent shall not be unreasonably withheld and which consent
shall be deemed granted if within five (5) Business Days of Bancorp's receipt
of written notice of a request for prior written consent, written notice of
objection is not received by Acquiror):
(1) take any action which would or is reasonably likely
to (i) adversely affect the ability of Acquiror to obtain any necessary
approvals of any Governmental Entity required for the transactions
contemplated hereby; (ii) adversely affect Acquiror's ability to perform its
covenants and agreements under this Agreement; or (iii) result in any of the
conditions to the performance of Acquiror's obligations hereunder, as set
forth in Article 8 herein not being satisfied;
(2) take or cause to be taken any action which would
disqualify the Bank Merger as a "reorganization" within the meaning of
Section 368 of the Code or prevent accounting for the business combination to
be effected by the Bank Merger as a pooling-of-interests;
(3) amend its articles of incorporation in any respect
which would materially and adversely affect the rights and privileges
attendant to the Acquiror Stock except as contemplated by this Agreement; or,
(4) agree or make any commitment to take any actions
prohibited by this Section 6.3.
(5) amend, modify, terminate or fail to renew or
preserve its material Permits;
(6) issue, sell, or grant any Equity Securities of
Acquiror (except pursuant to the exercise of Acquiror options outstanding as
of the date hereof), any other securities (including long term debt), or any
rights, options or securities to acquire any Acquiror Stock Option or any
Equity Securities of Acquiror or any other securities (including long term
debt) of Acquiror;
(7) purchase, redeem or otherwise acquire any Equity
Securities, or other securities of Acquiror or any rights, options, or
securities to acquire any Equity Securities of Acquiror;
(8) amend or modify its Charter Documents;
(9) [Intentionally left blank]
(10) declare, issue or pay any dividend or other
distribution of assets, whether consisting of money, other personal property,
real property or other things of value, to the shareholders of Acquiror, or
split, combine or reclassify any shares of its capital stock or
A-52
<PAGE>
other Equity Securities except for a $.15 per share cash dividend payable by
Acquiror to its shareholders on or about May 22, 1998.
(b) Between the date hereof and the Effective Time, Acquiror
shall:
(1) use its best efforts consistent with this Agreement
to maintain and preserve intact its respective present business organization
and to maintain and preserve the relationships and goodwill with account
customers, employees, and others having business relationships with Acquiror;
(2) duly observe and conform in all material respects to
all lawful requirements applicable to the business of Acquiror;
(3) use its best efforts to obtain any Third Party
Consent with respect to any contract, agreement, lease, license, arrangement,
permit or release that is material to the business of Acquiror on a
consolidated basis or that is contemplated in this Agreement as required in
connection with the Bank Merger;
(4) duly observe and conform in all material respects to
all lawful requirements applicable to its business;
(5) maintain its assets and properties in good condition
and repair, normal wear and tear excepted;
(6) promptly upon learning of such information, advise
Bancorp in writing of any event or any other transaction within its knowledge
whereby any Person or Related Group of Persons acquires, directly or
indirectly, record or beneficial ownership or control (as defined in Rule
13d-3 promulgated by the SEC under the Exchange Act) of five percent (5%) or
more of the outstanding Acquiror Stock prior to the record date fixed for the
Acquiror Shareholders' Meeting or any adjourned meeting thereof to approve
this Agreement and the transaction contemplated herein; and,
(7) provide to Bancorp, as soon as they become
available, drafts of the opinions referred to in Section 8.1(h) and (i) of
this Agreement.
6.4 DISCLOSURE LETTER. Promptly in the case of material matters,
and not less than monthly in the case of all other matters, Acquiror shall
amend or supplement Acquiror's Disclosure Letter provided for herein
pertaining to Acquiror as necessary so that the information contained therein
accurately reflects the then current status of Acquiror and shall transmit
copies of such amendments or supplements to Bancorp and Bank in accordance
with Section 11.13 of this Agreement.
A-53
<PAGE>
6.5 SHAREHOLDER APPROVAL. Acquiror will promptly take action
necessary in accordance with applicable law and its Charter Documents to
convene a meeting of its shareholders (the "Acquiror Shareholders' Meeting")
to be held as soon as practicable, for the purpose of voting on the Bank
Merger, this Agreement and related matters. In connection with the Acquiror
Shareholders' Meeting, (a) the Board of Directors of Acquiror shall, subject
to fiduciary duty, recommend shareholder approval of the Bank Merger, this
Agreement and related matters; and (b) Acquiror shall use its best efforts to
obtain such shareholder approval by the largest possible percentage.
6.6 AFFILIATES AND FIVE PERCENT SHAREHOLDER AGREEMENTS.
Concurrently with the execution of this Agreement, (a) Acquiror shall deliver
to Bancorp and Bank a letter identifying all persons who are then
"affiliates" of Acquiror for purposes of Rule 145 under the Securities Act
and (b) Acquiror shall advise the persons identified in such letter of the
resale restrictions imposed by applicable securities laws and shall use
reasonable efforts to obtain from each person identified in such letter a
written agreement substantially in the form attached hereto as Exhibit 6.6.
Acquiror shall use reasonable efforts to obtain from any person who becomes
an affiliate of Acquiror after Acquiror's delivery of the letter referred to
above, and on or prior to the date of the Acquiror Shareholders' Meeting to
approve this Agreement, a written agreement substantially in the form
attached as Exhibit 6.6 hereto as soon as practicable after obtaining such
status. At least 10 Business Days prior to the issuance of the opinion to be
provided for in Section 8.1(h), Acquiror shall use its best efforts to cause
each person or group of persons who holds more than five percent (5%) of the
Acquiror Stock (regardless of whether such person is an "affiliate" under
Rule 145) to deliver to both Arthur Andersen, LLP and Knecht & Hansen, a
letter stating that such shareholder(s) has no present plan or intention to
dispose of Bancorp Stock that the shareholder(s) will receive in the Bank
Merger, and committing that such shareholder(s) will not dispose of Bancorp
Stock in a manner to cause a violation of the "continuity of shareholder
interest" requirements of Treasury Regulation 1.368-1.
6.7 CONSENTS AND APPROVALS.
(a) Acquiror will cooperate with Bancorp and Bank in the
preparation of all filings, applications, notices, requests for waiver and
Consents necessary or desirable for the consummation of the Bank Merger, and
the other transactions contemplated in this Agreement.
(b) To the extent that the consent of a third party ("Third
Party Consent") with respect to any contract, agreement, license, franchise,
lease, commitment, arrangement, Permit or release that is material to the
business of Acquiror or that is contemplated in this Agreement is required in
connection with the Bank Merger or the transactions contemplated in this
Agreement, Acquiror shall use its best efforts to obtain such consent prior
to the Effective Time.
A-54
<PAGE>
6.8 COMPLIANCE WITH RULES. Acquiror shall comply with the
requirements of all applicable Rules, the noncompliance with which would
materially and adversely affect the assets, liabilities, business, financial
condition or results of operations or prospects of Acquiror.
6.9 AGREEMENT OF MERGER. As soon as practicable, Acquiror shall
execute the Agreement of Merger.
6.10 ENVIRONMENTAL REPORTS. Acquiror shall provide to Bancorp,
as soon as practical, but not later that 45 days after the date hereof, a
Vista Environmental Report (a sample of which is attached to Acquiror's
Disclosure Letter) containing a preliminary environmental investigation on
all real property owned, leased or operated (including OREO) by Acquiror
after the date hereof. If required by said preliminary investigation in
Bancorp's reasonable opinion, Acquiror shall provide to Bancorp a phase one
and if necessary in Bancorp's reasonable opinion, a phase two environmental
report of further investigation on properties requiring such additional
study. The expenses of all reports shall be borne by Acquiror. Bancorp
shall have 15 Business Days from the receipt of a report pursuant to this
Section 6.10 to notify Acquiror of any objections to the contents of such
report. Bancorp shall have the right pursuant to Section 10.1(j) hereof, for
a period of 10 Business Days following receipt of such estimate or indication
that the costs of such actions and measures are reasonably estimated to
exceed $3,500,000 on an after tax basis or can not be reasonably estimated
to be less than $3,500,000 on an after tax basis, to terminate this
Agreement, without liability to Acquiror.
6.11 CERTAIN LOANS AND OTHER EXTENSIONS OF ACQUIROR. Acquiror
will promptly inform Bancorp of the amounts and categories of any loans,
leases or other extensions of credit that have been classified by any
Governmental Entity or by any internal or external loan reviewer of Acquiror
as "Watch List," "Substandard," "Doubtful," "Loss" or any comparable
classification. Acquiror will furnish to Bancorp, as soon as practicable,
and in any event within 10 days after the end of each calendar month,
schedules including a listing of the following:
(a) classified credits, showing with respect to each such
credit in amount equal to or exceeding $150,000, the classification category,
credit type, and office, and with respect to all other such credits, by
credit type and office, the aggregate dollar amount;
(b) nonaccrual credits, showing with respect to each such
credit in amount equal to or exceeding $150,000, the credit type and office,
and with respect to all other such credits, by credit type and office, the
aggregate dollar amount;
(c) accrual exception credits that are delinquent 90 or more
days and have not been placed on nonaccrual status, showing with respect to
each such credit in amount equal to or exceeding $150,000, the credit type
and office, and with respect to all other such credits, by credit type and
office, the aggregate dollar amount;
A-55
<PAGE>
(d) delinquent credits showing with respect to each such
credit in amount equal to or exceeding $150,000, the credit type, office and
an aging schedule broken down into 30-59, 60-89 and 90+ day categories, and
with respect to all other such credits, by credit type, office and by aging
category, the aggregate dollar amount;
(e) loans or leases charged off during the previous month,
showing with respect to each such loan or lease, the credit type and office;
(f) loans or leases written down during the previous month,
including with respect to each the original amount, the writeoff amount,
credit type and office;
(g) other real estate or assets owned, stating with respect
to each its credit type;
(h) a reconciliation of the allowance for loan and lease
losses, identifying specifically the amount and sources of all additions and
reductions to the allowance (which may be by reference to specific portions
of another schedule furnished pursuant to this Section 6.11 and, in the case
of unallocated adjustments, shall disclose the methodology and calculations
through which the amount of such adjustment was determined);
6.12 NEGOTIATIONS WITH OTHER PARTIES PRIOR TO CLOSING. Acquiror
shall not, and will cause each of its officers, directors, employees, agents,
legal and financial advisors and Affiliates not to, directly or indirectly,
make, solicit, encourage, initiate or enter into any agreement or agreement
in principal, or announce any intention to do any of the foregoing,
concerning an acquisition, merger or consolidation with another entity which
transaction any Governmental Entity advises Acquiror in writing or orally
would or might result in the disapproval of the transactions contemplated by
this Agreement or delay until after September 30, 1998 the consummation of
the transactions contemplated by this Agreement.
6.13 INDEMNIFICATION AND INSURANCE.
(a) Bancorp and Acquiror will maintain in effect policies of
directors' and officers' liability insurance (with such coverage, terms and
conditions as are no less advantageous than the insurance presently
maintained by Bancorp and Bank with resepect to its officers and directors)
with respect to all matters arising from facts or events which occurred
before the Effective Time of the Merger for which Bancorp or Bank would have
had an obligation to indemnify its directors and officers.
(b) If Bancorp or Acquiror or any of its successors or assigns
(i) shall consolidate with or merge into any other corporation or entity and
shall not be the continuing or surviving corporation or entity of such
consolidation or merger or (ii) shall transfer all or substantially all of
its properties and assets to any individual, corporation or other entity,
then and
A-56
<PAGE>
in each such case, Bancorp or Acquiror shall take no action to impair the
rights provided in this Section 6.13.
(c) The provisions of this Section are intended to be for the
benefit of, and shall be enforceable by, each director or officer of Bancorp
and Bank and his or her heirs and representatives.
ARTICLE 7
FURTHER COVENANTS OF BANCORP, BANK AND ACQUIROR
7.1 S-4 AND PROXY STATEMENT.
(a) As promptly as practicable, Acquiror and Bancorp shall
cooperate with each other and exercise their best efforts to prepare and file
with the SEC and the FDIC the Proxy Statement and Bancorp shall prepare and
file with the SEC the S-4, in which the Proxy Statement will be included as a
prospectus. The Parties hereto agree to provide the information necessary for
inclusion in the Proxy Statement and S-4. Each of the parties will use its
respective best efforts to have the S-4 declared effective under the
Securities Act as promptly as practicable after it is filed and to satisfy
the requirements of the SEC and FDIC as to the Proxy Statement. Acquiror
shall pay all third party costs associated with the preparation and filing of
the S-4 that are normally paid by the acquiring party in similar
transactions, and shall be responsible for making application to list
Mid-State Bancshares on the Nasdaq National Market System including costs
associated therewith.
(b) After the date of the filing of the S-4 with the SEC and
the Proxy Statement with the FDIC, each of the Parties agrees promptly to
notify the other of and to correct any information furnished by such Party
that shall have become false or misleading in any material respect and to
cooperate with the other to take all steps necessary to file with the SEC or
the FDIC, as appropriate, and have declared effective or cleared by the SEC
or the FDIC, as appropriate, any amendment or supplement to the S-4 or the
Proxy Statement so as to correct such information and to cause the Proxy
Statement as so corrected to be disseminated to the shareholders of Bancorp
and Acquiror to the extent required by applicable Rules. All documents that
the Parties file with the FDIC, SEC or any other Governmental Entity in
connection with this Agreement will comply as to form in all material
respects with the provisions of applicable Rules.
(c) Bancorp shall take all required action with appropriate
Governmental Entities under state securities or blue sky laws in connection
with the issuance of Bancorp Stock pursuant to this Agreement.
A-57
<PAGE>
7.2 FILINGS. The Parties agree that through the Effective Time,
each of its reports, registration, statements and other filings required to
be filed with any applicable Governmental Entity will comply in all material
respects with the applicable statutes, rules and regulations enforced or
promulgated by the Governmental Entity with which it will be filed and none
will contain any untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading. Any financial statement contained in any such report,
registration statement or other filing that is intended to represent the
financial position of the entities or entity to which it relates will fairly
present the financial position of such entities or entity and will be
prepared in accordance with GAAP consistently applied during the periods
involved.
7.3 APPLICATIONS. Acquiror will promptly prepare and file or
cause to be prepared and filed (i) an application for approval of the Bank
Merger with the FDIC; (ii) an application for approval of the Bank Merger
with the Commissioner; (iii) if required, a request for Waiver from the FRB;
and (iv) any other applications or notices necessary to consummate the
transactions contemplated hereby. Acquiror shall afford Bancorp and Bank a
reasonable opportunity to review all such applications and all amendments and
supplements thereto before the filing thereof. The Parties covenant and
agree that the S-4 and the Proxy Statement and all applications to the
appropriate Governmental Entities for approval or consent to the Bank Merger,
with respect to information relating to it, will comply in all material
respects with the provisions of applicable law, and will not contain any
untrue statement of material fact or omit to state any material fact required
to be stated therein or necessary to make the statement contained therein, in
light of the circumstances under which they were made, not misleading.
Acquiror will use its best efforts to obtain all regulatory approvals or
consents necessary to effect the Bank Merger and Bancorp and Bank shall
cooperate with Acquiror in such efforts.
7.4 STOCK OPTIONS.
(a) At and as of the Effective Time and without further
action by any Party, the stock option plan of Acquiror shall terminate. The
Bancorp Stock Option Plan shall not terminate at the Effective Time but shall
continue in effect and, for purposes of such Plan, this provision shall be
deemed to be the making of appropriate provisions for such continuance.
(b) At and as of the Effective Time, Bancorp shall grant
substitute stock options pursuant to the Bancorp Stock Option Plan to each
and every officer and employee of Acquiror who has at the Effective Time an
outstanding option to purchase shares of Acquiror Stock ("Acquiror Stock
Options"). Each and every substitute stock option so granted by Bancorp
pursuant to the Bancorp Stock Option Plan to replace an Acquiror Stock Option
shall retain the "vesting" schedule reflected in each of the respective stock
option agreements evidencing an Acquiror Stock Option and shall be
exercisable for that number of whole shares of Bancorp Stock equal to the
product of (A) the number of shares of Acquiror Stock that were purchasable
under such Acquiror Stock Option immediately prior to the Effective Time
multiplied by (B) the
A-58
<PAGE>
Exchange Ratio, rounded down to the nearest whole number of shares of Bancorp
Stock. Further, each and every substitute stock option so granted by Bancorp
pursuant to the Bancorp Stock Option Plan to replace an Acquiror Stock Option
shall provide for a per share exercise price which shall be equal to the
quotient determined by dividing (A) the exercise price per share of Acquiror
Stock at which such Acquiror Stock Option was exercisable immediately prior
to the Effective Time by (B) the Exchange Ratio. At the Effective Time,
Bancorp shall issue to each holder of an outstanding Acquiror Stock Option a
substitute stock option providing for the terms discussed above.
(c) Bancorp shall use its best effort to assure that each
holder of an Acquiror Stock Option which qualified as an incentive stock
option prior to the Effective Time shall receive a substitute stock option
pursuant to the Bancorp Stock Option Plan which will qualify as an incentive
stock option.
(d) At or prior to the Effective Time, Bancorp shall take all
corporate action necessary to reserve for issuance a sufficient number of
shares of Bancorp Stock for delivery upon exercise of Acquiror Stock Options.
(e) The vesting schedules of each and every stock option
outstanding on the date hereof granted pursuant to the Bancorp Stock Option
Plan shall, as a result of the transaction contemplated by this Agreement,
accelerate in accordance with the provisions of such Plan. Except as
provided in subsection (f), each such option granted pursuant to the Bancorp
Stock Option Plan shall terminate pursuant to the provisions of such Plan on
or before the Effective Time.
(f) Bancorp shall make appropriate amendments to the Bancorp
Stock Option Plan in order for each of the persons, who currently has an
outstanding stock option granted under such Plan and who does not exercise
such option and who is either specified on Exhibit 2.1(b) or is an officer
or employee of Bancorp or Bank, to have the right to receive, in their
discretion, a substitute stock option from Bancorp. Any substitute option
granted pursuant to this subsection shall be on a fully vested basis and
shall contain the same terms and conditions as the option for which it is
substituted except that the number of shares of Bancorp Stock to which such
substitute option pertains and the per share exercise price shall be adjusted
in the same manner as provided in subsection (b) in the case of an Acquiror
Stock Option provided that the reciprocal of the Exchange Ratio shall be used
for purposes of such calculations.
(g) Bancorp shall seek all required Consents to effect the
amendments to the Bancorp Stock Option Plan contemplated by subsection (f).
If, in the course of attempting to obtain such Consents, any Person attempts
to delay unduly in granting such Consents (any delay beyond June 30, 1998
being considered to be undue) or to impose conditions or limitations which
are applicable to the Bancorp Stock Option Plan or to any Party or would
become applicable to Bancorp or the Surviving Bank after the Bank Merger
which delays, conditions or limitations are ones which Acquiror reasonably
and in good faith concludes would be materially burdensome to any Party or
would materially adversely affect the Bancorp Stock Option Plan, its benefits
or any of
A-59
<PAGE>
the transactions contemplated by this Agreement, then, in such event, (A)
Bancorp shall forthwith withdraw its request or application for such Consent
and (B) the provisions of subsection (f) shall not be carried into effect and
such action shall be deemed to be full compliance with subsection (f). No
person shall have any rights or claims against any Party in the event of such
withdrawals in accordance with the preceding sentence.
7.5 FURTHER ASSURANCES. Bancorp/Bank and Acquiror agree that from
time to time, whether before, at or after the Effective Time, they will
execute and deliver such further instruments of conveyance and transfer and
to take such other action as may be reasonable or necessary to consummate the
Bank Merger and the transactions contemplated in this Agreement. Bancorp,
Bank and Acquiror agree to take such further action as may reasonably be
requested to facilitate consummation of the Bank Merger and the transactions
contemplated in this Agreement and that are not inconsistent with the other
provisions of this Agreement.
7.6 REMOVAL OF CONDITIONS. In the event of the imposition of a
condition to any consent of, the Commissioner, the FDIC or other Government
Entity which any Party deems to materially adversely affect it or to be
materially burdensome as provided in Section 8.1(c), the Parties shall use
their respective best efforts to obtain the removal of such condition.
7.7 CORPORATE GOVERNANCE.
(a) Prior to the Effective Time, Acquiror shall take all
necessary steps to effect the Acquiror Corporate Governance Changes at the
Effective Time.
(b) Prior to the Effective Time, Bancorp shall take all
necessary steps to effect the Bancorp Corporate Governance Changes at the
Effective Time.
ARTICLE 8
CONDITIONS TO THE PARTIES' OBLIGATIONS TO CLOSE
8.1 CONDITIONS TO EACH PARTY'S OBLIGATIONS TO CLOSE. The
respective obligations of Bancorp and Bank, on the one hand, and Acquiror, on
the other, to consummate the Bank Merger and the other transactions
contemplated hereby are subject to the satisfaction or waiver at or prior to
the Effective Time of each of the following conditions:
(a) The Agreement and the transactions contemplated hereby
shall have received all requisite approvals of the shareholders of Acquiror,
Bancorp or Bank.
(b) No judgment, decree, injunction, order or proceeding
shall be outstanding or threatened by any Governmental Entity which prohibits
or restricts the effectuation
A-60
<PAGE>
of, or threatens to invalidate or set aside, the Bank Merger substantially in
the form contemplated by this Agreement, unless counsel to the party again
whom such action or proceeding was instituted or threatened renders to the
other Parties hereto a favorable opinion that such judgment, decree,
injunction, order or proceeding is without merit.
(c) On or before September 15, 1998, the Parties shall have
received any required Consent from the FRB, the Commissioner, the FDIC, and,
at or prior to the Effective Time, this Agreement and the transactions
contemplated hereby shall have been approved by any other Governmental Entity
whose Consent is required for consummation of the transactions contemplated
in this Agreement, in each case either unconditionally or without the
imposition of conditions or limitations that are applicable to any Party or
would become applicable to Bancorp or the Surviving Bank after the Bank
Merger that Acquiror reasonably and in good faith concludes would materially
adversely affect the financial condition or operations of any Party or
otherwise would be materially burdensome to any Party and all such Consents
shall be in effect at the Effective Time, which Consents shall permit the
Bank Merger and permit the Surviving Bank to acquire and conduct all direct
and indirect activities as previously conducted by Acquiror and Bank, at or
prior to the Effective Time, and all required waiting periods shall have
expired.
(d) No Rule shall be outstanding or threatened by any
Governmental Entity which prohibits or materially restricts the consummation
of, or threatens to invalidate or set aside, the Bank Merger substantially in
the forms contemplated by this Agreement or which would not permit the
businesses presently carried on by Acquiror, Bancorp or Bank to continue
materially unimpaired following the Effective Time, unless counsel to the
Party or Parties against whom such action or proceeding was instituted or
threatened renders to the other Party or Parties hereto a favorable opinion
that such Rule is without merit and counsel to the other Party concurs with
such opinion.
(e) All Third Party Consents necessary to permit the Parties
to consummate the transactions contemplated in the Agreement shall have been
obtained prior to the Effective Time, unless the failure to obtain any such
Third Party Consent would not have a material adverse effect on the business,
financial condition, or results of operations of Bancorp on a consolidated
basis.
(f) The S-4 shall have been declared effective by the SEC and
shall not be the subject of any stop order or proceedings seeking or
threatening a stop order. Bancorp shall have received all state securities
or "Blue Sky" permits and other authorization necessary to issue the Bancorp
Stock to consummate the Bank Merger.
(g) Application will be filed for listing Bancorp Stock on
the Nasdaq National Market System at the Effective Time.
A-61
<PAGE>
(h) Acquiror and Bancorp shall have received from Arthur
Andersen, LLP, an opinion reasonably satisfactory to Acquiror and Bancorp to
the effect that the Bank Merger shall not result in the recognition of gain
or loss for federal income tax purposes to Acquiror, Bancorp or Bank, nor
shall the issuance of Bancorp Stock result in the recognition of gain or loss
by the holders of Acquiror Stock who receive such stock in connection with
the Bank Merger, nor shall a holder of an outstanding stock option granted
under Acquiror's stock option plan recognize income, gain or loss as a result
of the granting of a substitute option pursuant to Bancorp Stock Option Plan
nor shall the granting of such substitute options be deemed to be a
modification of any incentive stock option granted under Acquiror's stock
option plan, dated prior to the date of the Proxy Statement is first mailed
to the shareholders of Bancorp and Acquiror and such opinions shall not have
been withdrawn or modified in any material respect.
(i) Prior to the Effective Time, Arthur Andersen, LLP, shall
have delivered a written opinion to Acquiror and Bancorp that the Bank Merger
and the other transactions contemplated hereby will qualify for
pooling-of-interest accounting treatment. In making its determination that
the Bank Merger will qualify for such treatment, Arthur Andersen, LLP, shall
be entitled to assume that cash will be paid with respect to all shares held
of record by any holder of Dissenting Shares.
8.2 ADDITIONAL CONDITIONS TO OBLIGATIONS OF BANCORP AND BANK TO
CLOSE. The obligations of Bancorp and Bank to consummate the Bank Merger and
the other transactions contemplated hereby are subject to the satisfaction or
waiver at or prior to the Effective Time of each of the following conditions:
(a) All actions necessary to authorize the execution,
delivery and performance of the Agreement by Acquiror, the consummation of
the Bank Merger by Acquiror and the consummation of the Agreement of Merger
by Acquiror shall have been duly and validly taken by the board of directors
and shareholders of Acquiror, as the case may be.
(b) The representations and warranties of Acquiror contained
in Article 4 of this Agreement shall have been true and correct in all
material respects (i) on the date of this Agreement; and (ii) at and as of
the Effective Time as though all such representations and warranties had been
made on and as of the Effective Time, except with respect to representations
and warranties that, by their terms, speak as of a different time; and
Bancorp and Bank shall have received a certificate to that effect dated the
Effective Time and executed on behalf of Acquiror by its chief executive
officer and chief financial officer. It is understood and acknowledged that
the representations made on and as of the Effective Time shall be made
without giving effect to any update with respect to the Disclosure Letter
pertaining to Acquiror as updated in accordance with Section 6.4.
(c) Each of the covenants and agreements of Acquiror
contained in this Agreement to be performed at or before the Effective Time
shall have been so performed in all
A-62
<PAGE>
material respects; and Bancorp and Bank shall have received a certificate to
that effect dated the Effective Time and executed by the chief executive
officer and chief financial officer of Acquiror.
(d) During the period from the date of this Agreement to the
Effective Time, there shall not have occurred any event related to the
business, condition (financial or otherwise), capitalization or properties
of Acquiror that has had or could reasonably be expected to have a material
adverse effect on the business, financial condition, results of operations or
prospects of Acquiror after consummation of the Bank Merger, whether or not
such event, change or effect is reflected in Acquiror's Disclosure Letter to
this Agreement, as amended or supplemented, after the date of this Agreement;
and Bancorp and Bank shall have received a certificate to that effect dated
the Effective Time and signed by the chief executive officer and chief
financial officer of Acquiror.
(e) Acquiror shall have delivered to Bancorp and Bank a
written opinion of Reitner & Stuart dated as of the Effective Time
substantially in the form attached to this Agreement as Exhibit 8.2(e).
(f) Bancorp shall have received a letter from Carpenter &
Company dated as of a date within five (5) Business Days of the mailing of
the Proxy Statement to the shareholders of Bancorp to the effect that the
transactions contemplated by this Agreement are fair from a financial point
of view to the shareholders of Bancorp.
(g) All necessary action shall have been taken by Acquiror to
effect the Acquiror Corporate Governance Changes.
(h) Concurrently with the execution of this Agreement, each
director of Acquiror shall have executed and delivered to Bancorp an Acquiror
Directors' Agreement substantially in the form of Exhibit 2.6(b).
(i) Within 30 days of the execution of this Agreement,
Bancorp shall have received from each Person named in the letter or otherwise
referred to in Section 6.6 an executed copy of an agreement contemplated by
Section 6.6.
(j) All remediation of environmental contamination or
conditions on any Acquiror property shall have been completed to the
satisfaction of Bancorp subject to the provisions of Section 6.10.
8.3 ADDITIONAL CONDITIONS TO OBLIGATIONS OF ACQUIROR TO CLOSE.
The obligations of Acquiror to consummate the Bank Merger and the other
transactions contemplated herein is subject to the satisfaction or waiver, at
or prior to the Effective Time, of each of the following conditions:
A-63
<PAGE>
(a) All actions necessary to authorize the execution,
delivery and performance of the Agreement, consummation of the Bank Merger by
Bancorp and Bank and the consummation of the Agreement of Merger by Bancorp
and Bank shall have been duly and validly taken by the respective boards of
directors and shareholders of Bancorp and Bank, as the case may be.
(b) The representations and warranties of Bancorp and Bank
contained in Article 3 of this Agreement shall be true and correct in all
material respects (i) on the date of this Agreement; and (ii) at and as of
the Effective Time as though all such representations and warranties had been
made at and as of such time, except with respect to representations and
warranties that, by their terms, speak as of a different time; and Acquiror
shall have received a certificate to that effect dated the Effective Time and
executed on behalf of Bancorp and Bank by their respective chief executive
officers and chief financial officers. It is understood and acknowledged
that the representations made on and as of the Effective Time shall be made
without giving effect to any update with respect to the Disclosure Letters
pertaining to Bancorp and Bank as updated in accordance with Section 5.5.
(c) The covenants and agreements of Bancorp and Bank to be
performed at or before the Effective Time shall have been duly performed in
all material respects; and Acquiror shall have received one or more
certificates to that effect dated the Effective Time and executed by the
respective chief executive officers and chief financial officers of Bancorp
and Bank.
(d) During the period from the date of this Agreement to the
Effective Time, there shall not have occurred any event related to the
business, condition (financial or otherwise), capitalization or properties
of Bancorp or Bank that has had or could reasonably be expected to have a
material adverse effect on the business, financial condition, results of
operations or prospects of the Surviving Bank or Bancorp after consummation
of the Bank Merger, whether or not such event, change or effect is reflected
in Bancorp's Disclosure Letters to this Agreement, as amended or
supplemented, after the date of this Agreement; and Acquiror shall have
received a certificate to that effect dated the Effective Time and signed by
the chief executive officer and chief financial officer of Bancorp and Bank.
(e) Bancorp and Bank shall have delivered to Acquiror a
written opinion of Knecht & Hansen dated the Effective Time substantially in
the form attached to this Agreement as Exhibit 8.3(e).
(f) Acquiror shall have received a letter from Hoefer &
Arnett dated as of a date within five (5) Business Days of the mailing of the
Proxy Statement to the shareholder of Acquiror, to the effect that the
transactions contemplated by this Agreement are fair from a financial point
of view to the shareholders of Acquiror.
A-64
<PAGE>
(g) Concurrently with the execution of this Agreement, each
director of Bancorp and Bank shall have executed and delivered to Acquiror a
Bancorp Directors' Agreement substantially in the form of Exhibit 2.6(a).
(h) Within 30 days of the execution of this Agreement,
Acquiror shall have received from each Person named in the letter or
otherwise referred to in Section 5.15 an executed copy of an agreement
contemplated by Section 5.15.
(i) Acquiror shall have received satisfactory evidence that
all of Bank's Benefit Arrangements have been treated as provided in Articles
5 and 9 of this Agreement.
(j) All remediation of environmental contamination or
conditions on any Bancorp and Bank property shall have been completed to the
satisfaction of Acquiror.
(k) At least five Business Days prior to the Effective Time,
Bancorp shall provide Acquiror with Bancorp's consolidated financial
statements as of the close of business on the last day of the month prior to
the Effective Time. Such financial statements shall have been prepared in
all material respects in accordance with GAAP and other applicable legal and
accounting requirements, and reflect all period-end accruals and other
adjustments. At the close of business on the last day of the month preceding
the Effective Time, Bancorp's consolidated shareholders' equity as
determined in accordance with such financial statements and GAAP, shall not
be less than the sum of (i) Bancorp's consolidated shareholders' equity at
December 31, 1997 PLUS (ii) the amount of "Projected Earnings" LESS the
amount of dividends paid as authorized by Section 5.3(a)(10). The term
"Projected Earnings" shall mean (A) $1,228,000, if the month end immediately
preceding the Effective Time is May 31, 1998, (B) $1,504,000, if the month
end immediately preceding the Effective Time is June 30, 1998 (C) $1,811,000,
if the month end immediately preceding the Effective Time is July 31, 1998,
or (D) $2,114,000, if the month immediately preceding the Effective Time is
on or after August 31, 1998. The amount of Projected Earnings shall be
increased by any gains from the sale of securities pursuant to Section
5.3(a)(24) and shall be reduced by the sum of (y) any and all Bancorp and
Bank "Expenses" as defined in Section 11.1(e) accrued prior to the applicable
month end PLUS (z) all costs accrued by Bancorp and Bank in compliance with
the requirements of Section 5.12 prior to the applicable month end (excluding
the costs of the remedial and corrective actions as are actually related to
any Hazardous Materials), provided, however, that the amount of the
adjustment to the Projected Earnings resulting from (y) and (z) shall, in no
event, exceed $125,000.
(l) All necessary action shall have been taken by Bancorp to
effect the Bancorp Corporate Governance Changes.
A-65
<PAGE>
ARTICLE 9
EMPLOYEE BENEFITS
9.1 EMPLOYEE BENEFITS.
(a) All employees of Bancorp and Bank at the Effective Time
shall be entitled to participate in the Acquiror Benefit Arrangements on the
same basis as other similarly situated employees of Acquiror. Each of these
employees will be credited for eligibility, participation and vesting
purposes (provided that no more than 180 days of sick leave may be carried
over into Acquiror's sick leave program), with such employee's respective
years of past service with Bancorp and Bank (or other prior service so
credited by Bancorp and Bank) as though they had been employees of Acquiror.
(b) Bancorp, Bank and Acquiror have agreed as set forth on
Exhibit 9.1(b) to a severance policy by which all employees of Bancorp, Bank
or Acquiror who are not offered employment or who are terminated within
twelve months following the Effective Time and who satisfy the requirements
of the severance plan currently being considered for adoption by Acquiror
will receive severance benefits otherwise.
(c) Provided such agreement is listed on the Bancorp
Disclosure List and a complete copy of such agreement has been provided to
Acquiror prior to the date hereof, Acquiror hereby agrees to honor, in
accordance with their terms, any existing individual employment, severance,
deferred compensation, and similar agreements between Bancorp or Bank and the
Executive Officers of Bancorp/Bank listed on Exhibit 9.1(c)(1) except for the
Change in Control Agreement between Bancorp, Bank and William Hares, which at
the Effective Time will terminate and be replaced by the Employment Agreement
between William Hares and Acquiror effective as of the Effective Time in
substantially the form attached hereto as Exhibit 9.1(c)(2). Notwithstanding
any other provision of this Agreement, no employee shall receive duplicative
benefits by reason of this Section.
(d) From the date hereof, Bancorp, Bank and Acquiror shall
cooperate to determine the appropriate treatment of the Benefit Arrangements,
such as termination, merger into a plan, etc., and shall take such actions as
shall be reasonably requested by Acquiror with respect to the Benefit
Arrangements, provided that Acquiror, Bancorp and Bank shall not be required
to take any action that would be in breach of the fiduciary duties of the
Plan trustees or administrators.
A-66
<PAGE>
ARTICLE 10
TERMINATION OF AGREEMENT; WAIVER OF CONDITIONS
10.1 TERMINATION OF AGREEMENT. Anything herein to the contrary
notwithstanding, this Agreement and the transactions contemplated hereby
including the Bank Merger may be terminated at any time before the Effective
Time, whether before or after approval by the respective shareholders of
Acquiror and Bancorp as follows, and in no other manner:
(a) By mutual consent of Bancorp and Bank, on the one hand,
and Acquiror, on the other;
(b) By Bancorp, Bank or Acquiror (i) if any conditions set
forth in Section 8.1 shall not have been met by September 30, 1998, or (ii)
upon the expiration of 20 Business Days after any Governmental Entity denies
or refuses to grant any approval, consent or authorization required to be
obtained in order to consummate the transaction contemplated by this
Agreement unless, within said 20 Business Day period after such denial or
refusal, all Parties hereto agree to resubmit the application to the
Governmental Entity that has denied, or refused to grant the approval,
consent or authorization requested;
(c) By Bancorp and Bank if any conditions set forth in
Section 8.2 shall not have been met, or by Acquiror if any conditions set
forth in section 8.3 shall not have been met, by September 30, 1998, or such
earlier time as it becomes apparent that such condition cannot be met;
(d) By Bancorp or Bank, if Acquiror should materially default
in the observance or in the due and timely performance of any of its
covenants and agreements herein contained and such default shall not have
been fully cured within 20 Business Days from the date of delivery of written
notice specifying the alleged default;
(e) By Acquiror, if Bancorp or Bank should materially default
in the observance or in the due and timely performance of any of their
covenants and agreements herein contained and such default shall not have
been fully cured within 20 Business Days from the date of delivery of written
notice specifying the alleged default;
(f) By Acquiror, if Bancorp or Bank is or becomes a party to
any written agreement, memorandum of understanding, cease and desist order,
imposition of civil monetary penalties or other regulatory enforcement action
or proceeding with any federal or state agency charged with the supervision
or regulation of banks;
A-67
<PAGE>
(g) By Acquiror, if Bancorp or Bank shall have failed to act
or refrain from doing any act pursuant to Section 5.14;
(h) By Acquiror or Bancorp, under the circumstances set forth
in Section 5.12;
(i) By Bancorp at any time during the two day period
commencing one day after the Determination Date, if the Average Closing Price
as of the Determination Date is less than $26.25 (the "Minimum Price");
SUBJECT, HOWEVER, to the following three sentences. If Bancorp elects to
exercise its termination right pursuant to the immediately preceding
sentence, it shall give prompt written notice to Acquiror; provided that such
notice of election to terminate may be withdrawn by Bancorp at any time
within the aforementioned two-day period. During the two-day period
commencing on the day after a receipt of such notice, provided that the
Average Closing Price exceeds $22.00, Acquiror shall have the option of
adjusting the Exchange Ratio pursuant to the following calculation rounded to
the nearest ten-thousandth:
1
----------------------------------------
$29.37 - X
---------------------------
Average Closing Price
where "x" represents the amount of any Significant Liabilities determined in
accordance with this Agreement divided by the outstanding shares of Bancorp
Stock (determined as of the Business Day preceding the Effective Day).
If Acquiror makes an election contemplated by the preceding sentence, within
such two-day period, it shall give prompt written notice to Bancorp of such
election and the revised Exchange Ratio, whereupon no termination shall have
occurred pursuant to this subsection and this Agreement shall remain in
effect in accordance with its terms (except as the Exchange Ratio shall have
been modified), and any references in this Agreement to "Exchange Ratio"
shall thereafter be deemed to refer to the Exchange Ratio as adjusted
pursuant to this subsection. For purposes of this subsection, "Determination
Date" shall mean the last day of the 20 trading day period referred to in the
definition of Average Closing Price; or,
(j) By Bancorp, under the circumstances set forth in
section 6.10 or section 5.12.
10.2 EFFECT OF TERMINATION. In the event that this Agreement shall
be terminated pursuant to Section 10.1 hereof, all further obligations of the
Parties hereto under this Agreement shall terminate without further liability
of any Party to another; provided, however, that no termination of this
Agreement under Section 10.1 for any reason or in any manner shall release,
or be construed as so releasing, any Party from its obligations under
Sections 11.1, 11.10 or 11.11, hereof and notwithstanding the foregoing if
such termination shall result from the willful failure of
A-68
<PAGE>
a Party to fulfill a condition to the performance of the obligations of any
other Party or to perform a covenant of such Party in this Agreement, such
Party shall, subject to the provision of Section 11.1, be fully liable for
any and all damages, costs and expenses (including, but not limited to,
reasonable attorneys' fees sustained or incurred by the other Party or
Parties in connection with negotiating and implementing the transactions
contemplated in this Agreement).
10.3 WAIVER OF CONDITIONS. If any of the conditions specified in
Section 8.2 has not been satisfied, Bancorp and Bank may nevertheless, at
their election, proceed with the transactions contemplated in this Agreement.
If any of the conditions specified in Section 8.3 has not been satisfied,
Acquiror may nevertheless, at its election, proceed with the transactions
contemplated in this Agreement. If any Party elects to proceed pursuant to
the provisions hereof, the conditions that are unsatisfied immediately prior
to the Effective Time shall be deemed to be satisfied, as evidence by a
certificate delivered by the electing Party.
ARTICLE 11
GENERAL
11.1 EXPENSES.
(a) Acquiror hereby agrees that if this Agreement is
terminated by Bancorp or Bank pursuant to Section 10.1(c) with respect to the
failure of Acquiror shareholders to approve the Agreement and the
transactions contemplated hereby, or pursuant to Section 10.1(d), Acquiror
shall promptly, and in any event within seven Business Days after such
termination, pay Bancorp and Bank all Expenses (as defined below) of Bancorp
and Bank but not to exceed $500,000.
(b) Bancorp and Bank hereby agree that if this Agreement is
terminated by Acquiror pursuant to Section 10.1(c) with respect to the
failure of Bancorp shareholders to approve the Agreement and transactions
contemplated hereby, or pursuant to Section 10.1(e), Bancorp shall promptly,
and in any event within seven Business Days after such termination, pay (or
cause Bank to pay) Acquiror all Expenses (as defined below) of Acquiror but
not to exceed $500,000.
(c) As an inducement to Acquiror to enter into this
Agreement, in the event this Agreement is terminated by Acquiror pursuant to
Section 10.1(g) and Bancorp or Bank or both enters into an agreement for a
Competing Transaction prior to termination of this Agreement or during the
twelve-month period immediately following termination of this Agreement,
Bancorp and Bank shall promptly, and in any event within seven Business Days
after either or both enters into an agreement for such Competing Transaction,
pay Acquiror Four Million Five Hundred Thousand Dollars ($4,500,000) which
amount represents (i) Acquiror's
A-69
<PAGE>
direct costs and expenses (including, but not limited to, fees and expenses
of financial or other consultants, printing costs, accountants and counsel)
incurred in negotiating and undertaking to carry out the transactions
contemplated by this Agreement, including Acquiror's management time devoted
to negotiation and preparation for the transactions contemplated by this
Agreement; (ii) Acquiror's indirect costs and expenses incurred in connection
with the transactions contemplated by this Agreement; and (iii) Acquiror's
loss as a result of the transactions contemplated by this Agreement not being
consummated. The obligation to make a payment pursuant to this subsection
shall be a joint and several obligation of Bancorp and Bank.
(d) Except as otherwise provided herein, all Expenses
incurred by Bancorp/Bank or Acquiror in connection with or related to the
authorization, preparation and execution of this Agreement, the solicitation
of shareholder approvals and all other matters related to the closing of the
transaction contemplated hereby, including, without limitation of the
generality of the foregoing, all fees and expenses of agents,
representatives, counsel, and accountants employed by either of the Parties
or its affiliates, shall be borne solely and entirely by the Party which has
incurred the same. Notwithstanding the foregoing, Bancorp and Acquiror shall
share the cost of printing the Proxy Statement on a basis proportionate to
the number of shareholders of each Party.
(e) "Expenses" as used in this Agreement shall include all
reasonable out-of-pocket expenses (including all fees and expenses of
attorneys, accountants, investment bankers, experts and consultants to the
Party and its affiliates) incurred by the Party or on its behalf in
connection with or related to the authorization, preparation and execution of
this Agreement, the solicitation of shareholder approvals and all other
matters related to the closing of the transaction contemplated hereby.
11.2 AMENDMENTS. To the fullest extent permitted by law, this
Agreement may be amended by agreement in writing of the Parties hereto at any
time prior to the Effective Time, whether before or after approval of this
Agreement by the shareholders of Acquiror or the shareholders of Bancorp.
11.3 DISCLOSURE LETTER; EXHIBITS; INTEGRATION. Each Disclosure
Letter, exhibit and letter delivered pursuant to this Agreement shall be in
writing and shall constitute a part of the Agreement, although Disclosure
Letters and other letters need not be attached to each copy of this
Agreement. This Agreement, together with such Disclosure Letters, exhibits
and letters, constitutes the entire agreement between the Parties pertaining
to the subject matter hereof and supersedes all prior agreements and
understanding of the Parties in connection therewith.
11.4 BEST EFFORTS. Each Party will use its best efforts to cause
all conditions to the obligations of the Parties to be satisfied.
11.5 [Intentionally left blank]
A-70
<PAGE>
11.6 GOVERNING LAW. This Agreement and the legal relations
between the Parties shall be governed by and construed in accordance with the
laws of California except to the extent that the provisions of federal law
are mandatorily applicable.
11.7 NO ASSIGNMENT. Neither this Agreement nor any rights, duties
or obligations hereunder shall be assignable by Bancorp/Bank or Acquiror, in
whole or in part, without the prior written consent of the other Party. Any
attempted assignment in violation of this prohibition shall be null and void.
Subject to the foregoing, all of the terms and provisions hereof shall be
binding upon, and inure to the benefit of, the successors and assigns of the
Parties hereto.
11.8 HEADINGS. The descriptive headings contained in this
Agreement are inserted for convenience only and do not constitute a part of
this Agreement.
11.9 COUNTERPARTS. This Agreement and any exhibit hereto may be
executed in one or more counterparts, all of which shall be considered one
and the same agreement and shall become effective when one or more
counterparts have been signed by each Party hereto and delivered to each
Party hereto.
11.10 PUBLICITY AND REPORTS. Bancorp and Acquiror shall
coordinate all publicity relating to the transactions contemplated by this
Agreement and no Party shall issue any press release, publicity statement or
other public notice relating to this Agreement or any of the transactions
contemplated hereby without obtaining the prior consent of the other Party,
except to the extent that legal counsel to any Party shall deliver a written
opinion to the other Party to the effect that a particular action is required
by applicable Rules.
11.11 CONFIDENTIALITY. All Confidential Information disclosed
heretofore or hereafter by any Party to this Agreement to any other Party to
this Agreement shall be kept confidential by such other Party and shall not
be used by such other Party otherwise than as herein contemplated, except to
the extent that (a) it is necessary or appropriate to disclose to the
Commissioner, the FDIC or any other Governmental Entity having jurisdiction
over any of the Parties or as may be otherwise be required by Rule (any
disclosure of Confidential Information to a Governmental Entity shall be
accompanied by a request that such Governmental Entity preserve the
confidentiality of such Confidential Information): or (b) to the extent such
duty as to confidentiality is waived by the other Party. Such obligation as
to confidentiality and non-use shall survive the termination of this
Agreement pursuant to Article 10. In the event of such termination and on
request of another Party, each Party shall use all reasonable efforts to (1)
return to the other Parties all documents (and reproductions thereof)
received from such other Parties that contain Confidential Information (and,
in the case of reproductions, all such reproductions made by the receiving
Party); and (2) destroy the originals and all copies of any analyses,
computations, studies or other documents prepared for the internal use of
such Party that included Confidential Information.
A-71
<PAGE>
11.12 SPECIFIC PERFORMANCE. Acquiror, Bank and Bancorp each
acknowledge that, in view of the uniqueness of their respective businesses
and the transactions contemplated in this Agreement, each Party would not
have an adequate remedy at law for money damages in the event that this
Agreement has not been performed in accordance with its terms, and therefore
each Party agrees that the other shall be entitled to specific enforcement of
the terms hereof in addition to any other remedy to which it may be entitled,
at law or in equity.
11.13 NOTICES. Any notice or communication required or permitted
hereunder, including, without limitation, supplemental Disclosure Letters
shall be deemed to have been given if in writing and (a) delivered in person,
(b) telexed, or (c) telecopied (provided that any notice given pursuant to
clauses (b) and (c) is also mailed by certified or registered mail, postage
prepaid), as follows:
If to Bancorp or Bank, addressed to:
BSM Bancorp
2739 Santa Maria Way
Santa Maria, California 93455
Attn: William Hares, President and CEO
Fax No. (805) 937-6582
With a copy addressed to:
Loren P. Hansen, Esq.
Knecht & Hansen
1301 Dove Street, Suite 900
Fax No. (714) 851-1732
If to Acquiror, addressed to:
Mid-State Bank
1026 Grand Avenue
Arroyo Grande, California 93420
Attn: Carrol Pruett, President and CEO
Fax No. (805) 473-7752
With a copy addressed to:
A-72
<PAGE>
Barnet Reitner, Esq.
Reitner & Stuart
1319 Marsh Street
San Luis Obispo, CA 93401
Fax No. (805) 545-8599
or at such other address and to the attention of such other Person as a Party
may notice to the others in accordance with this Section 11.13.
Notwithstanding anything to the contrary contained herein, notice and/or
delivery to Bancorp shall be deemed notice and/or delivery to Bank.
11.14 KNOWLEDGE. Whenever any statement herein or in any
Disclosure Letter, certificate or other document delivered to any Party
pursuant to this Agreement is made "to the knowledge" or "to the best
knowledge" of any Party or other Person such Party or other Person shall make
such statement only after conducting an investigation reasonable under the
circumstances of the subject matter thereof, and each such statement shall
constitute a representation that such investigation has been conducted.
11.15 SEVERABILITY. If any portion of this Agreement shall be
deemed by a court of competent jurisdiction to be unenforceable, the
remaining portions shall be valid and enforceable only if, after excluding
the portion deemed to be unenforceable, the remaining terms hereof shall
provide for the consummation of the transactions contemplated herein in
substantially the same manner as originally set forth at the date this
Agreement was executed.
11.16 ATTORNEYS' FEES. In the event any of the parties to this
Agreement brings an action or suit against any other party by reason of any
breach of any covenant, agreement, representation, warranty or other
provision hereof, or any breach of any duty or obligation created hereunder
by such other party, the prevailing party, as determined by the court or the
body having jurisdiction, shall be entitled to have and recover of and from
the losing party, as determined by the court or other party having
jurisdiction, all reasonable costs and expenses incurred or sustained by such
prevailing party in connection with such prevailing action, including,
without limitation, legal fees and court costs (whether or not taxable as
such).
11.17 TERMINATION OF REPRESENTATIONS, WARRANTIES AND COVENANTS.
The representations, warranties and covenants of each party contained
herein or in any certificate or other writing delivered by such party
pursuant hereto or in connection herewith shall not survive the Effective
Time.
WITNESS, the signature of Bancorp, as of the 29th day of January, 1998,
set by its President and attested to by its Secretary, pursuant to a
resolution of its Board of Directors, acting by a majority:
A-73
<PAGE>
BSM BANCORP
By: /s/ William A. Hares
------------------------------
President
Attest:
By: /s/ F. Dean Fletcher
------------------------------
Secretary
WITNESS, the signature of Bancorp, as of the 29th day of January,
1998, set by its President and attested to by its Secretary, pursuant to a
resolution of its Board of Directors, acting by a majority:
BANK OF SANTA MARIA
By: /s/ WILLIAM A. HARES
------------------------------
President
Attest:
By: /s/ F. DEAN FLETCHER
------------------------------
Secretary
WITNESS, the signature of Acquiror, as of the 29th day of January, 1998,
set by its President and attested to by its Secretary, pursuant to a
resolution of its Board of Directors, acting by a majority:
MID-STATE BANK
By: /s/ CARROL R. PRUETT
------------------------------
President
Attest:
By: /s/ RAYMOND E. JONES
------------------------------
Secretary
A-74
<PAGE>
FIRST AMENDMENT TO
AGREEMENT TO MERGE
AND PLAN OF REORGANIZATION
THIS FIRST AMENDMENT TO THE AGREEMENT TO MERGE AND PLAN OF
REORGANIZATION (the "First Amendment") is entered into as of March 27, 1998,
among Bank of Santa Maria, a banking company organized under the laws of
California ("Bank"), being located in Santa Maria, California, BSM Bancorp, a
corporation and registered bank holding company organized under the laws of
California ("Bancorp"), and Mid-State Bank, a banking company organized under
the laws of California ("Acquiror"), located in Arroyo Grande, California.
WHEREAS, Bank, Bancorp and Acquiror entered into an Agreement to Merge
and Plan of Reorganization dated as of January 29, 1998 (the "Agreement");
WHEREAS, the Parties wish to make certain changes and amendments to the
Agreement before it is submitted to their respective shareholders for
approval;
NOW, THEREFORE, in consideration of the premises and mutual promises of
the parties, the Parties hereto agree as follows:
1. The definitions of "Acquiror Dissenting Shares" and "Acquiror
Perfected Dissenting Shares" are hereby deleted.
2. Section 2.4 of the Agreement is hereby amended in full as follows:
"2.4 CERTAIN EXCEPTIONS AND LIMITATIONS. (A) Any shares of Acquiror
Stock held by Bancorp or any subsidiary of Bancorp (other than shares held in
a fiduciary capacity or as DPC Property) will be canceled at the Effective
Time; and (B) no fractional shares of Bancorp Stock shall be issued in the
Bank Merger and, in lieu thereof, each holder of Acquiror Stock who would
otherwise be entitled to receive a fractional share shall receive an amount
in cash equal to the product (calculated to the nearest ten thousandth)
obtained by multiplying (a) the Average Closing Price times (b) the fraction
of the share of Bancorp Stock to which such holder would otherwise be
entitled."
3. Section 5.3(a)(10) of the Agreement is hereby amended in full as
follows:
"(10) declare, issue or pay any dividend or other distribution of
assets, whether consisting of money, other personal property, real property
or other things of value, to the shareholders of Bancorp or Bank, or split,
combine or reclassify any shares of its capital stock or other Equity
Securities except (i) for a $0.30 per share cash dividend payable by Bancorp
to its shareholders on or about February 6, 1998 and (ii) if the Effective
Time occurs after July 14, 1998, an additional cash dividend payable by
Bancorp to its shareholders after July 14, 1998 in an amount not to exceed
$.10."
A-75
<PAGE>
4. Section 7.4(f) of the Agreement is hereby amended in full as follows:
"(f) Bancorp shall make appropriate amendments to the Bancorp
Stock Option Plan in order for each of the persons, who currently has an
outstanding stock option granted under such Plan and who does not exercise
such option and who is either specified on Exhibit 2.1(b) or is an officer
or employee of Bancorp or Bank, to have the right to receive, in their
discretion, a substitute stock option from Bancorp. Any substitute option
granted pursuant to this subsection shall be on a fully vested basis and
shall contain the same terms and conditions as the option for which it is
substituted."
5. Capitalized terms used herein and not otherwise defined shall have
the same meaning as set forth in the Agreement.
6. This First Amendment may be entered into in one or more
counterparts, all of which shall be considered one and the same instrument,
and it shall become effective when one or more counterparts have been signed
by each of the Parties and delivered to the other Parties, it being
understood that all Parties need not sign the same counterpart.
7. Except as herein amended, the Agreement shall remain in full force
and effect.
8. This First Amendment shall be governed by and construed in
accordance with the laws of the State of California.
WITNESS, the signature of Bancorp, as of the 27th day of March, 1998,
set by its President and attested to by its Secretary, pursuant to a
resolution of its Board of Directors, acting by a majority:
BSM BANCORP
By: /s/ William A. Hares
------------------------------
President
Attest:
By: /s/ F. Dean Fletcher
------------------------------
Secretary
WITNESS, the signature of Bank, as of the 27th day of March, 1998, set
by its President and attested to by its Secretary, pursuant to a resolution
of its Board of Directors, acting by a majority:
A-76
<PAGE>
BANK OF SANTA MARIA
By: /s/ William A. Hares
------------------------------
President
Attest:
By: /s/ F. Dean Fletcher
------------------------------
Secretary
WITNESS, the signature of Acquiror, as of the 27th day of March, 1998,
set by its President and attested to by its Secretary, pursuant to a
resolution of its Board of Directors, acting by a majority:
MID-STATE BANK
By: /s/ Carrol R. Pruett
------------------------------
President
Attest:
By: /s/ Raymond E. Jones
------------------------------
Secretary
A-77
<PAGE>
APPENDIX B
HOEFER & ARNETT
INCORPORATED
353 Sacramento Street, Suite 1000
San Francisco, CA 94111
January 29, 1998
Members of the Board of Directors
Mid-State Bank
1026 Grand Avenue
Arroyo Grande, CA 93448
Members of the Board:
You have requested our opinion as investment bankers as to the fairness, from
a financial point of view, to the shareholders of Mid-State Bank
("Mid-State") of the Exchange Ratio, as defined in Section 1.1 of the
Agreement to Merge and Plan of Reorganization dated as of January 29, 1998
(the "Agreement"), in the proposed merger (the "Merger") among Mid-State, BSM
Bancorp ("Bancorp") and Bank of Santa Maria ("Bank"). Pursuant to the
Agreement (i) the Bank will merge with and into Mid-State and Mid-State will
continue as the surviving bank, (ii) Bancorp will become the bank holding
company for Mid-State and change its name to "Mid-State Bancshares" and (iii)
the shareholders of Mid-State will become shareholders of Bancorp in
accordance with the Exchange Ratio as set forth in the Agreement.
In arriving at our opinion, we have reviewed and analyzed, among other
things, the following: (i) the Agreement; (ii) certain publicly available
financial and other data with respect to Bancorp and Mid-State, including
consolidated financial statements for recent years and interim periods to
September 30, 1997; (iv) certain other publicly available financial and other
information concerning Bancorp and Mid-State and the trading markets for the
publicly traded securities of Bancorp and Mid-State; (v) publicly available
information concerning other banks and holding companies, the trading markets
for their securities and the nature and terms of certain other merger
transactions we believed relevant to our inquiry; and (vi) evaluations and
analyses prepared and presented to the Board of Directors of Mid-State or a
committee thereof in connection with the Merger. We have held discussions
with senior management of Bancorp and of Mid-State concerning their past and
current operations, financial condition and prospects.
We have reviewed with the senior managements of Mid-State and Bancorp
earnings projections for Mid-State and Bancorp, provided by the respective
companies, as stand-alone entities assuming the Merger does not occur. We
also reviewed with the senior management of Mid-State the projected operating
cost savings expected by Mid-State to be achieved in each year resulting from
the Merger with Bancorp. Certain financial projections for the combined
companies and for Mid-State and Bancorp as stand-alone entities were derived
by us based partially upon the projections and information described above,
as well as our own assessment of general economic, market and financial
conditions.
In conducting our review and in arriving at our opinion, we have relied upon
and assumed the accuracy and completeness of the financial and other
information provided to us or publicly available, and we have not assumed any
responsibility for independent verification of the same. We have relied upon
the managements of Mid-State and Bancorp as to the reasonableness of the
financial and operating forecasts, projections and projected operating cost
savings (and the assumptions and bases therefor) provided to us, and we
B-1
<PAGE>
Mid-State Bancorp
January 29, 1998
Page 2
have assumed that such forecasts, projections and projected operating cost
savings reflect the best currently available estimates and judgments of the
applicable managements. We have also assumed, without assuming any
responsibility for the independent verification of same, that the aggregate
allowances for loan losses for Mid-State and Bancorp are adequate to cover
such losses. We have not made or obtained any evaluations or appraisals of
the property of Mid-State or Bancorp, nor have we examined any individual
loan credit files. For purposes of this opinion, we have assumed that the
Merger will have the tax, accounting and legal effects (including, without
limitation, that the Merger will be accounted for as a pooling-of-interests)
described in the Merger Agreement and assumed the accuracy of the disclosures
set forth in the Form S-4 Registration Statement for the Merger. Our opinion
as expressed herein is limited to the fairness, from a financial point of
view, to the holders of the Common Stock of Mid-State of the Exchange Ratio
in the Merger and does not address Mid-State's underlying business decision
to proceed with the Merger.
We have considered such financial and other factors as we have deemed
appropriate under the circumstances, including among others the following:
(i) the historical and current financial position and results of operations
of Mid-State and Bancorp, including interest income, interest expense, net
interest income, net interest margin, provision for loan losses, non-interest
income, non-interest expense, earnings, dividends, internal capital
generation, book value, intangible assets, return on assets, return on
shareholders' equity, capitalization, the amount and type of non-performing
assets, loan losses and the reserve for loan losses, all as set forth in the
financial statements for Mid-State and for Bancorp; (ii) the assets and
liabilities of Mid-State and Bancorp, including the loan, investment and
mortgage portfolios, deposits, other liabilities, historical and current
liability sources and costs and liquidity; and (iii) the nature and terms of
certain other merger transactions involving banks and bank holding companies.
We have also taken into account our assessment of general economic, market
and financial conditions and our experience in other transactions, as well as
our experience in securities valuation and our knowledge of the banking
industry generally. Our opinion is necessarily based upon conditions as they
exist and can be evaluated on the date hereof and the information made
available to us through the date hereof.
It is understood that this letter is for the information of the Board of
Directors of Mid-State and may not be relied upon by any other person or used
for any other purpose without our prior written consent. This letter does not
constitute a recommendation to the Board of Directors or to any shareholder
of Mid-State with respect to any approval of the Merger. We consent to the
filing of this opinion as Appendix B to the Registration Statement and to the
description of this opinion in the Proxy Statement/Prospectus.
Based upon and subject to the foregoing, we are of the opinion as investment
bankers that, as of the date hereof, the Exchange Ratio in the Merger is
fair, from a financial point of view, to the holders of the Common Stock of
Mid-State.
Very truly yours,
HOEFER & ARNETT INCORPORATED
B-2
<PAGE>
APPENDIX C
[LETTERHEAD]
February 24, 1998
Board of Directors
BSM Bancorp
2739 Santa Maria Way
Santa Maria, CA 93455
Members of the Board:
In connection with that certain Acquisition and Merger Agreement dated as of
January 30, 1998 ("the Agreement") between BSM Bancorp (the "Company") and
Mid-State Bank ("Mid-State") pursuant to which Mid-State will merge into and
with the Company (the "Merger"), with the Company to be the surviving party
and the current shareholders of Mid-State to receive Company common stock, in
a transaction in which the exchange ratio is based upon $29.37 per share for
Bancorp common stock, subject to certain adjustments as set forth in the
Agreement, and a minimum of $27.25 and a maximum of $30.50 per share for
Mid-State common stock, based on the Average Closing Price for such stock (as
defined in the agreement), you have asked our opinion as to the fairness from
a financial point of view to the shareholders of the Company of the
consideration to be paid in the Merger ("the Merger Consideration").
In connection with our opinion, we have among other activities: (a) reviewed
certain publicly available financial and other data with respect to the
Company and Mid-State, including the consolidated financial statements for
recent years and for interim periods to December 31, 1997, and certain other
relevant financial and operating data relating to the Company made available
to us from published sources and from the internal records of the Company;
(b) reviewed the terms of the Agreement; (c) reviewed certain historical
market prices and trading volume of common stock of California banking
companies; (d) compared the Company and Mid-State from a financial point of
view with certain other companies in the industry which we deemed to be
relevant; (e) considered the financial terms, to the extent publicly
available, of selected recent transactions which we deem to be comparable, in
whole or in part, to the Merger; (f) reviewed and discussed with
representatives of the management of the Company certain information of a
business and financial nature regarding the Company and Mid-State, including
financial forecasts and related assumptions of the Company and of Mid-State;
(g) made inquiries and held discussions on the Merger and the Agreement and
other matters relating thereto with the Company's counsel; and (h) performed
such other analyses and examinations and considered such other information,
financial analyses, and financial, economic and market criteria as we have
deemed appropriate and relevant.
C-1
<PAGE>
In connection with our review, we have not independently verified any of the
foregoing information with respect to the Company or Mid-State. We have
relied on all such information provided by the Company and have assumed that
all such information is complete and accurate in all material respects. We
have assumed that there have been no material changes in the Company's or
Mid-State's assets, financial condition, results of operations, business or
prospects since the respective dates of their last financial statements made
available to us. We have relied on advice of counsel to the Company as to all
legal matters with respect to the Company, the Merger, and the Agreement. In
addition, we have not made an independent evaluation, appraisal or physical
inspection of the assets or individual properties of the Company or
Mid-State, nor have we been furnished with any such appraisals. We are not
expressing any opinion as to the actual value of the Company's common stock
when issued to the Mid-State shareholders pursuant to the Merger, or the
prices at which the Company common stock will trade subsequent to the Merger.
Further, our opinion is necessarily based upon economic, monetary, and market
conditions existing as of the date hereof. We have acted as financial advisor
to the Company in connection with the Merger and will receive a fee for our
services, a significant portion of which is contingent upon the consummation
of the Merger.
This opinion is furnished pursuant to our engagement letter dated July 9,
1997, and is solely for the benefit of the Board of Directors and
stockholders of the Company. In furnishing this opinion, we do not admit that
we are an expert with respect to any registration statement or other
securities filing within the meaning of the term "experts" as used in the
Securities Act and the rules and regulations promulgated thereunder. Nor do
we admit that this opinion constitutes a report or valuation within the
meaning of Section 11 of the Securities Act. Our opinion is directed to the
Board of the Company, covers only the fairness of the Merger Consideration
from a financial point of view as of the date hereof and does not constitute
a recommendation to any holder of Company Common Stock as to how such
shareholder should vote concerning the Merger. Except as provided in the
engagement letter, this opinion may not be used or referred to by the Company
or quoted or disclosed to any person without our prior written consent.
Based upon and subject to the foregoing, and in reliance thereon, it is our
opinion that, as of today's date, the Merger Consideration is fair to the
shareholders of the Company from a financial point of view.
Very truly yours,
SEAPOWER CARPENTER CAPITAL, INC.
dba CARPENTER & COMPANY
C-2
<PAGE>
APPENDIX D
CALIFORNIA GENERAL CORPORATION LAW
CHAPTER 13
DISSENTERS' RIGHTS
SECTION 1300. RIGHT TO REQUIRE PURCHASE -- "DISSENTING SHARES" AND "DISSENTING
SHAREHOLDER" DEFINED.
(a) If the approval of the outstanding shares (Section 152) of a
corporation is required for a reorganization under subdivisions (a) and (b) or
subdivision (e) or (f) of Section 1201, each shareholder of the corporation
entitled to vote on the transaction and each shareholder of a subsidiary
corporation in a short-term merger may, by complying with this chapter, require
the corporation in which the shareholder holds shares to purchase for cash at
their fair market value the shares owned by the shareholder which are dissenting
shares as defined in subdivision (b). The fair market value shall be determined
as of the day before the first announcement of the terms of the proposed
reorganization or short-term merger, excluding any appreciation or depreciation
in consequence of the proposed action, but adjusted for any stock split, reverse
stocks split or share dividend which becomes effective thereafter.
(b) As used in this chapter, "dissenting shares" means shares which
come within all of the following descriptions:
(1) Which were not immediately prior to the reorganization or
short-form merger either (A) listed on any national securities
exchange certified by the Commissioner of Corporations under
subdivision (o) of Section 25100 or (B) listed on the list of OTC
margin stocks issued by the Board of Governors of the Federal
Reserve System, and the notice of meeting of shareholders to act
upon the reorganization summarizes this section and Sections
1301, 1302, 1303 and 1304; provided, however, that this provision
does apply to any shares with respect to which there exists any
restrictions on transfer imposed by the corporation or by any law
or regulation; and provided, further, that this provision does
not apply to any class of shares described in subparagraph (A) or
(B) if demands for payment are filed with respect to 5 percent or
more of the outstanding shares of that class.
(2) Which were outstanding on the date for the determination of
shareholders entitled to vote on the reorganization and (A) were
not voted in favor of reorganization and (A) were not voted in
favor of the reorganization or, (B) if described in subparagraph
(A)
D-1
<PAGE>
or (B) of paragraph (1) (without regard to the provisos in that
paragraph), were voted against the reorganization, or which were
held of record on the effective date of a short-form merger;
provided, however, that subparagraph (A) rather than subparagraph
(B) of this paragraph applies in any case where the approval
required by Section 1201 is sought by written consent rather than
at a meeting.
(3) Which the dissenting shareholder has demanded that the
corporation purchase at their fair market value, in accordance
with Section 1301.
(4) Which the dissenting shareholder has submitted the endorsement,
in accordance with Section 1302.
(c) As used in this chapter, "dissenting shareholder" means the
recordholder of dissenting shares and includes a transferee of
record.
SECTION 1301. DEMAND FOR PURCHASE.
(a) If, in the case of a reorganization, any shareholders of a
corporation have a right under Section 1300, subject to compliance with
paragraphs (3) and (4) of subdivision (b) thereof, to require the corporation to
purchase their shares of cash, such corporation shall mail to each such
shareholder a notice of the approval of the reorganization by its outstanding
shares (Section 152) within 10 days after the date of such approval, accompanied
by a copy of Sections 1300, 1302, 1303, 1304 and this section, a statement of
the price determined by the corporation to represent the fair market value of
the dissenting shares, and a brief description of the procedure to be followed
if the shareholder desires to exercise the shareholder's rights under such
sections. The statement of price constitutes an offer by the corporation to
purchase at the price stated any dissenting shares as defined in subsection (b)
of Section 1300, unless they lose their status as dissenting shares under
Section 1309.
(b) Any shareholder who has a right to require the corporation to
purchase the shareholder's shares for cash under Section 1300, subject to
compliance with paragraphs (3) and (4) of subdivision (b) thereof, and who
desires the corporation to purchase such shares shall make written demand upon
the corporation for the purchase of such shares and payment to the shareholder
in cash of their fair market value. The demand is not effective for any purpose
unless it is received by the corporation or any transfer agent thereof (1) in
the case of shares described in clause (i) or (ii) of paragraph (1) of
subdivision (b) of Section 1300 (without regard to the provisos in that
paragraph), not later than the date of the shareholders' meeting to vote upon
the reorganization, or (2) in any other case within 30 days after the date on
which the notice of the approval by the outstanding shares
D-2
<PAGE>
pursuant to subdivision (a) or the notice pursuant to subdivision (i) of Section
1110 was mailed to the shareholder.
(c) The demand shall state the number and class of the shares held of
record by the shareholder which the shareholder demands that the corporation
purchase and shall contain a statement of what such shareholder claims to vote
the fair market value of those shares as of the day before the announcement of
the proposed reorganization or short-form merger. The statement of fair market
value constitutes an offer by the shareholder to sell the shares at such price.
SECTION 1302. ENDORSEMENT OF SHARES.
Within 30 days after the date on which notice of the approval by the
outstanding shares or the notice pursuant to subdivision (i) of Section 1110 was
mailed to the shareholder, the shareholder shall submit to the corporation at
its principal office or at the office of any transfer agent thereof, (a) if the
shares are certificated securities, the shareholder's certificates representing
any shares which the shareholder demands that the corporation purchase, to be
stamped or endorsed with a statement that the shares are dissenting shares or to
be exchanged for certificates or appropriate denomination so stamped or endorsed
or (b) if the shares are uncertificated securities, written notice of the number
of shares which the shareholder demands that the corporation purchase. Upon
subsequent transfers of the dissenting shares on the books of the corporation,
the new certificates, initial transaction statement, and other written
statements issued therefor shall bear a like statement, together with the name
of the original dissenting holder of the shares.
SECTION 1303. AGREED PRICE -- TIME FOR PAYMENT.
(a) If the corporation and the shareholder agree that the shares are
dissenting shares and agree upon the price of the shares, the dissenting
shareholder is entitled to the agreed price with interest thereon at the legal
rate on judgments from the date of the agreement. Any agreements fixing the
fair market value of any dissenting shares as between the corporation and the
holders thereof shall be filed with the secretary of the corporation.
(b) Subject to the provisions of Section 1306, payment of the fair
market value of dissenting shares shall be made within 30 days after the amount
thereof has been agreed or within 30 days after any statutory or contractual
conditions to the reorganization are satisfied, whichever is later, and in the
case of certificated securities, subject to surrender of the certificates
therefor, unless provided otherwise by agreement.
SECTION 1304. DISSENTER'S ACTION TO ENFORCE PAYMENT.
(a) If the corporation denies that the shares are dissenting shares,
or the corporation and the shareholder fail to agree upon the fair market value
of the shares, then the shareholder demanding purchase of such shares as
dissenting shares
D-3
<PAGE>
or any interested corporation, within six months after the date on which notice
of the approval by the outstanding shares (Section 152) or notice pursuant to
subdivision (i) of Section 1110 was mailed to the shareholder, but not
thereafter, may file a complaint in the superior court of the proper county
praying the court to determine whether the shares are dissenting shares or the
fair market value of the dissenting shares or both or may intervene in any
action pending on such a complaint.
(b) Two or more dissenting shareholder may join as plaintiffs or be
joined as defendants in any such action and two or more such actions may be
consolidated.
(c) On the trial of the action, the court shall determine the issues.
If the status of the shares as dissenting shares is in issue, the court shall
first determine that issue. If the fair market value of the dissenting shares
is in issue, the court shall determine, or shall appoint one or more impartial
appraisers to determine, the fair market value of the shares.
SECTION 1305. APPRAISERS' REPORT -- PAYMENT -- COSTS.
(a) If the court appoints an appraiser or appraisers, they shall
proceed forthwith to determine the fair market value per share. Within the time
fixed, by the court, the appraisers, or a majority of them, shall make and file
a report in the office of the clerk of the court. Thereupon, on the motion of
any party, the report shall be submitted to the court and considered on such
evidence as the court considers relevant. If the court finds the report
reasonable, the court may confirm it.
(b) If a majority of the appraisers appointed fail to make and file a
report within 10 days from the date of their appointment or within such further
time as may be allowed by the court or the report is not confirmed by the court,
the court shall determine the fair market value of the dissenting shares.
(c) Subject to the provisions of Section 1306, judgment shall be
rendered against the corporation for payment of an amount equal to the fair
market value of each dissenting share multiplied by the number of dissenting
shares which any dissenting shareholder who is a party, or who has intervened,
is entitled to require the corporation to purchase, with interest thereon at the
legal rate from the date on which judgment was entered.
(d) Any such judgment shall be payable forthwith with respect to
uncertificated securities and, with respect to certificated securities, only
upon the endorsement and delivery to the corporation of the certificates for the
shares described in the judgment. Any party may appeal from the judgment.
(e) The costs of the action, including reasonable compensation to the
appraisers to be fixed by the court, shall be assessed or apportioned as the
court considers equitable, but, if the appraisal exceeds the price offered by
the corporation, the corporation shall pay the costs (including in the
discretion of the court attorneys'
D-4
<PAGE>
fees, fees of expert witnesses and interest at the legal rate on judgments from
the date of compliance with Sections 1300, 1301 and 1302 if the value awarded by
the court for the shares is more than 125 percent of the price offered by the
corporation under subdivision (a) of Section 1301).
SECTION 1306. DISSENTING SHAREHOLDER'S STATUS AS CREDITOR.
To the extent that the provisions of Chapter 5 prevent the payment to
any holders of dissenting shares of their fair market value, they shall become
creditors of the corporation for the amount thereof together with interest at
the legal rate on judgments until the date of payment, but subordinate to all
other creditors in any liquidation proceeding, such debt to be payable when
permissible under the provisions of Chapter 5.
SECTION 1307. DIVIDENDS PAID AS CREDIT AGAINST PAYMENT.
Cash dividends declared and paid by the corporation upon the
dissenting shares after the date of approval of the reorganization by the
outstanding shares (Section 152) and prior to payment for the shares by the
corporation shall be credited against the total amount to be paid by the
corporation therefor.
SECTION 1308. CONTINUING RIGHTS AND PRIVILEGES OF DISSENTING SHAREHOLDERS.
Except as expressly limited in this chapter, holders of dissenting
shares continue to have all the rights and privileges incident to their shares,
until the fair market value of their shares is agreed upon or determined. A
dissenting shareholder may not withdraw a demand for payment unless the
corporation consents thereto.
SECTION 1309. TERMINATION OF DISSENTING SHAREHOLDER STATUS.
Dissenting shares lose their status as dissenting shares and the
holders thereof cease to be dissenting shareholders and cease to be entitled to
require the corporation to purchase their shares upon the happening of any of
the following:
(a) The corporation abandons the reorganization. Upon abandonment of
the reorganization, the corporation shall pay on demand to any dissenting
shareholder who has initiated proceedings in good faith under this chapter all
necessary expenses incurred in such proceedings and reasonable attorneys' fees.
(b) The shares are transferred prior to their submission for
endorsement in accordance with Section 1302 or are surrendered for conversion
into shares of another class in accordance with the articles.
(c) The dissenting shareholder and the corporation do not agree upon
the status of the shares as dissenting shares or upon the purchase price of the
shares, and neither files a complaint or intervenes in a pending action as
provided in
D-5
<PAGE>
Section 1304, within six months after the date on which notice of the approval
by the outstanding shares or notice pursuant to subdivision (i) of Section 1110
was mailed to the shareholder.
(d) The dissenting shareholder, with the consent of the corporation,
withdraws the shareholder's demand for purchase of the dissenting shares.
SECTION 1310. SUSPENSION OF PROCEEDINGS FOR PAYMENT OF PENDING LITIGATION.
If litigation is instituted to test the sufficiency or regularity of the
votes of the shareholders in authorizing a reorganization, any proceedings under
Section 1304 and 1305 shall be suspended until final determination of such
litigation.
SECTION 1311. EXEMPT SHARES.
This chapter, except Section 1312, does not apply to classes of shares
whose terms and provisions specifically set forth the amount to be paid in
respect to such shares in the event of a reorganization or merger.
SECTION 1312. ATTACKING VALIDITY OF REORGANIZATION OR MERGER.
(a) No shareholder of a corporation who has a right under this chapter to
demand payment of cash for the shares held by the shareholder shall have any
right at law or in equity to attack the validity of the reorganization or
short-form merger, or to have the reorganization or short-form merger set aside
or rescinded, except in an action to test whether the number of shares required
to authorize or approve the reorganization have been legally voted in favor
thereof; but any holder of shares of a class whose terms and provisions
specifically set forth the amount to be paid in respect to them in the event of
a reorganization or short-form merger is entitled to payment in accordance with
those terms and provisions or, if the principal terms of the reorganization are
approved pursuant to subdivision (b) of Section 1202, is entitled to payment in
accordance with the terms and provisions of the approved reorganization.
(b) If one of the parties to a reorganization or short-form merger is
directly or indirectly controlled by, or under common control with, another
party to the reorganization or short-form merger, subdivision (a) shall not
apply to any shareholder of such party who has not demanded payment of cash for
such shareholder's shares pursuant to this chapter; but if the shareholder
institutes any action to attack the validity of the reorganization or short-form
merger or to have the reorganization or short-form merger set aside or
rescinded, the shareholder shall not thereafter have any right to demand payment
of cash for the shareholder's shares pursuant to this chapter. The court in any
action attacking the validity of the reorganization or short-form merger or to
have the reorganization or short-form merger set aside or rescinded shall not
restrain or enjoin the consummation of transaction except upon 10 days' prior
notice to the corporation and upon a determination by the court that clearly no
other remedy will adequately protect the complaining shareholder or the class of
shareholders of which such shareholder is a member.
(c) If one of the parties to a reorganization or short-form merger is
directly or indirectly controlled by, or under common control with, another
party to the reorganization or short-form merger, in any action to attack the
validity of the reorganization or short-form merger or to have the
reorganization or short-form merger set aside or rescinded, (1) a party to a
reorganization or short-form merger which controls another party to the
reorganization or short-form merger shall have the burden of proving that the
transaction is just and reasonable as to the shareholders of the controlled
party, and (2) a person who controls two or more parties to a reorganization
shall have the burden of proving that the transaction is just and reasonable as
to the shareholders of any party so controlled.
D-6
<PAGE>
FEDERAL DEPOSIT INSURANCE CORPORATION
Washington, D.C. 20429
FORM 10-K/A
/X/ Annual report under Section 13 or 15(d) of the Securities Exchange Act of
1934 for the fiscal year ended December 31, 1997
/ / Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the transition period
from N/A to N/A .
------------------- -----------------------
MID-STATE BANK
(Name of Small Business Issuer in its Charter)
CALIFORNIA 95-2135438
- --------------------------------------- --------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1026 GRAND AVE. ARROYO GRANDE, CA 93420
- --------------------------------------- --------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number: (805) 473-7700
--------------------
Securities to be registered under Section 12(b) of the Act: NONE
Securities to be registered under Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
--------------------------
(Title of class)
Check whether the Bank (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 /X/ No / /
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-K is not contained in this form, and no disclosure will be contained, to the
best of Bank'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/
As of February 28, 1998, the aggregate market value of the common stock held by
non-affiliates of the Bank was: $171,290,405.00
Number of shares of common stock of the Bank outstanding as of February 28,
1998: 6,905,100 shares
Portions of the definitive proxy statement for the 1998 Annual Meeting of the
Bank's Shareholders are incorporated into Item 10-13 of Part III of this Report
by reference.
<PAGE>
TABLE OF CONTENTS
PAGE
----
- --------------------------------------------------------------------------------
PART I
- --------------------------------------------------------------------------------
ITEM 1. DESCRIPTION OF BUSINESS 3
ITEM 2. PROPERTIES 34
ITEM 3. LEGAL PROCEEDINGS 35
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF 35
SECURITY HOLDERS
- --------------------------------------------------------------------------------
PART II
- --------------------------------------------------------------------------------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY 36
AND RELATED SHAREHOLDER MATTERS
ITEM 6. SELECTED FINANCIAL DATA 38
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF 39
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT 60
MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 61
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS 85
ON ACCOUNTING AND FINANCIAL DISCLOSURE
- --------------------------------------------------------------------------------
PART III
- --------------------------------------------------------------------------------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 85
ITEM 11. EXECUTIVE COMPENSATION 85
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS 85
AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 85
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND 86
REPORTS ON FORM 8-K
E-2
<PAGE>
- --------------------------------------------------------------------------------
PART I
- --------------------------------------------------------------------------------
ITEM 1. DESCRIPTION OF BUSINESS
MID-STATE BANK
Mid-State Bank (the "Bank") was incorporated under the laws of the State of
California and commenced operations on June 12, 1961 as a California state
chartered bank. The Bank's accounts are insured by the Federal Deposit
Insurance Corporation ("FDIC"), but it is not a member of the Federal Reserve
System. The Bank's authorized Capital Stock consists of one class of Common
Stock, of which 6,905,100 shares were outstanding as of December 31, 1997, after
taking into account a 5% stock dividend paid to shareholders as of that date.
The Bank operates 23 full service retail banking offices along the central coast
of California throughout Santa Barbara and San Luis Obispo counties. The Bank's
headquarters is located in Arroyo Grande and it also serves the communities of
Paso Robles, Cambria, Atascadero, Cayucos, Morro Bay, Los Osos, San Luis Obispo,
Pismo Beach, Grover Beach, Nipomo, Santa Maria, Orcutt, Buellton, Santa Ynez,
Solvang, Goleta 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.
MID COAST LAND COMPANY
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 California Bank Law. Section 751.3 provided that State chartered
banks were authorized to invest up to ten percent of their assets or 100% of
their capital, whichever is less, in a corporation that engaged in real estate
activities. The Federal Deposit Insurance Corporation (FDIC) Improvement Act
(FDICIA) became law in December 1991. Under FDICIA the Bank, through Mid Coast
Land Company, would have been required to substantially eliminate its real
estate development activities by December 19, 1996. The Bank received an
extension of that deadline to December 31, 1998 and the Regional Director of the
FDIC may, at his sole discretion, extend the deadline to December 31, 2001 for
good cause. The Bank is in the process of completing the divestiture of the
assets held by Mid Coast Land Company which were approximately $8.8 million on
the Bank's consolidated investments in real estate (reflecting $14.8 million in
gross holdings netted against a $6.0 million reserve). Of the $14.8 million in
gross holdings, approximately 83% is centered in one project, - San Luis Bay
Estates in Avila Beach, California. The holdings and results of operations of
Mid Coast Land are included within the consolidated financial statements of the
Bank. Mid Coast Land sustained losses of $2.9 million, $6.6 million and $11.0
million in 1997, 1996 and 1995, respectively. For further information
concerning Mid Coast Land Company, see Footnote number 5 to the Financial
Statements included in Item 8 of this Report and the "Progress Report on
Programs Introduced in Recent Years and the "Subsidiary Activity" portions of
the Management's Discussion and Analysis section of the Financial Condition and
Results of Operations which is included in Item 7 of this Report.
E-3
<PAGE>
MSB PROPERTIES
MSB Properties was incorporated under the laws of the State of California in May
of 1968 allowing for the ownership of property which may be reasonably necessary
for the expansion of the Bank's business, or which is otherwise reasonably
related to the conduct of the Bank's business, pursuant to Section 752 of the
Financial Code of the State of California.
The holdings and results of operations of MSB Properties are included within the
consolidated financial statements of the Bank. Mid Coast Land had earnings of
$1.6 million, $1.3 million and $1.0 million in 1997, 1996 and 1995,
respectively. For further information concerning MSB Properties, see the
"Subsidiary Activity" portions of the Management's Discussion and Analysis
section of the Financial Condition and Results of Operations which is included
in Item 7 of this Report.
ECONOMIC CLIMATE
The economy in the Bank's trade area is based upon agriculture, oil, tourism,
light industry, the aerospace industries and retail trade. Services supporting
those involved in these industries have also developed in the areas of medical,
financial and educational services. Population in the two county area totals
about 625,000 people with slightly over 62% of them in Santa Barbara County and
the balance in San Luis Obispo County. 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 the very stringent
county business regulations), smaller production companies have moved in to
continue the oil industry in the area. The moderate climate allows a year round
growing season for numerous vegetables and fruits. Vineyards and cattle ranches
make large contributions to the local economy. Access to numerous recreational
activities, including both mountains and beaches, provide a fairly stable
tourist industry from larger metropolitan areas such as the Los Angeles/Orange
County basin and the San Francisco Bay area. With the diversity of the various
types of industries in the Bank's service area, the Central Coast, while not
immune from economic fluctuations, does tend to enjoy a more stable level of
economic activity than many other areas of California.
COMPETITION
The banking business in California generally, and in the Bank's primary service
areas specifically, is highly competitive with respect to both loans and
deposits and is dominated by a relatively small number of major banks with many
offices and operations over a wide geographic area. Among the advantages such
major banks have over the Bank are their ability to finance wide-ranging
advertising campaigns and to allocate their investment assets to regions of
higher yield and demand. Such banks offer certain services such as trust
services and international banking which are not offered directly by the Bank;
but which can be offered indirectly by the Bank through correspondent
institutions. In addition, by virtue of their greater total capitalization,
such banks have substantially higher lending limits than the Bank. (Legal
lending limits to an individual customer are based upon a percentage of a bank's
total capital accounts.) 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
E-4
<PAGE>
acquisition of deposits. Banks also compete with money market funds and other
money market instruments which are not subject to interest rate ceilings.
In order to compete with other competitors in their primary service areas, the
Bank attempts to use, to the fullest extent, the flexibility which its
independent status permits. This includes an emphasis on specialized services,
local promotional activity, and personal contacts by its officers, directors and
employees. In particular, the Bank offers highly personalized banking services.
EMPLOYEES
At December 31, 1997, the Bank had a total of 559 employees. A number of these
employees are part-time however. On a full-time equivalent basis, these
employees represent 502 positions. The Bank believes that its employee
relations are satisfactory.
ACQUISITION OF BANK OF SANTA MARIA
On January 29, 1998, the Bank entered into an Agreement to Merge and Plan of
Reorganization (the "Agreement") with BSM Bancorp("Bancorp") and its wholly
owned subsidiary Bank of Santa Maria, Santa Maria, California ("Santa Maria").
The following information insofar as it relates to the Agreement is qualified in
its entirety by reference to the Agreement which was included as an exhibit to a
Current Report dealing with this transaction filed with the FDIC on or about
February 4, 1998.
The transaction is structured as a so-called "reverse triangular merger."
Pursuant to the transaction, among other things, (1) Bank of Santa Maria will
merge with and into the Bank, (2) Bancorp will become the bank holding company
for the Bank and change its name to Mid-State Bancshares and (3) the outstanding
shares of Bancorp at the effective time of the transaction will remain
outstanding and the shareholders of the Bank will become shareholders of Bancorp
in accordance with the exchange ratio set forth in the Agreement. For purposes
of the exchange ratio, a share of Bancorp stock was valued at $29.37. Subject
to the discussion below, each share of the Bank stock outstanding at the
effective time of the transaction will be exchanged for the number of shares of
Bancorp stock equal to the reciprocal of the number determined by dividing
$29.37 by the "Average Closing Price." The Average Closing Price means the
average of the daily closing prices of a share of the Bank's stock during the 20
consecutive trading days that the Bank's stock trades ending on the third
trading day immediately before the effective day of the transaction. If the
Average Closing Price is greater than or equal to $30.50, each share of the
Bank's stock will be exchanged for 1.0385 shares of Bancorp stock. If the
Average Closing Price is less than or equal to $26.25, each share of the Bank's
stock will be exchanged for .8938 shares of Bancorp stock; provided, however,
that, if Bancorp elects to so terminate, the Bank has the right, so long as the
Average Closing Price exceeds $22.00, to reinstate the Agreement by adjusting
the exchange ratio downward based on the formula discussed above. The exchange
ratio will be adjusted upward for certain Significant Liabilities (as defined in
the Agreement) of Bancorp or Santa Maria, if any.
Consummation of the Agreement and the transactions contemplated thereby, is
subject to regulatory and shareholder approval, as well as other conditions set
forth in the Agreement. No assurance can be given that the Agreement and the
transactions contemplated therein will be consummated. Should the transaction
be consummated, current Bank shareholders will hold approximately 70% of the
shares of the newly renamed holding company.
E-5
<PAGE>
SERVICES
The Bank offers a full range of commercial banking services including the
acceptance of checking accounts, NOW accounts, Savings accounts, Money Market
accounts, and various types of time certificates of deposit (including various
maturities and individual retirement accounts). The Bank makes a variety of
construction and land development loans, real estate related loans, home equity
credit lines, installment loans, agricultural and commercial loans, SBA loans,
and credit card lines. Other services offered by the Bank include, but are not
limited to, safe deposit boxes, travelers cheques, notary public, merchant
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 and San Luis
Obispo counties.
DEPOSIT AND LIABILITY MANAGEMENT
Deposits represent the Bank's primary source of funds. As of December 31, 1997
the Bank had approximately 16,900 demand deposit accounts representing $137.6
million, or $8,100 per account. The Bank also had over 48,200 NOW accounts and
Money Market accounts amounting to $291.6 million on deposit, or about $6,000
per account. The average savings account in the Bank was above $3,500 at
year-end and with over 33,000 savings account customers, Mid-State has savings
deposits of $117.1 million. There were over 14,300 time certificates of deposit
outstanding at December 31, 1997 representing $210.8 million on deposit with an
average deposit balance of approximately $14,700. Of the total time
certificates of deposit, only $49.3 million represented holders who carried an
amount on deposit of $100,000 or more - about 23% of the total.
The Bank is not dependent on a single or a few customers for its deposits, most
of which are obtained from individuals and small to medium sized businesses.
This results in the relatively small average balances noted above and allows the
Bank to be less subject to the adverse effects of the loss of a large depositor.
As of December 31, 1997, no individual, corporate, or public depositor accounted
for more than 1% of the Bank's total deposits.
Liquidity is the Bank's ability to meet fluctuations in deposit levels and to
provide for the credit needs of its customers. The objective in liquidity
management is to maintain a balance between the sources and uses of funds.
Principal sources of liquidity include interest and principal payments on loans
and investments, proceeds from the maturity of investments and growth in
deposits. The Bank holds overnight Fed Funds Sold as a cushion for temporary
liquidity needs. For 1997, Fed Funds Sold averaged $23.9 million representing
3.0% of average assets. In addition, the Bank maintains Federal Funds lines of
$20 million with major correspondents, subject to customary terms for such
arrangements.
The Bank's internally calculated liquidity ratio, which measures the percentage
of total liabilities (excluding equity) which are used to fund cash, cash
equivalents and non-pledged marketable securities, was 57.5% - well above the
Bank's policy minimum of 15%.
E-6
<PAGE>
LOANS
The Bank's Loan to Deposit ratio stood at approximately 46% at year-end 1997.
This is below other Banks on the Central Coast which average about 62%. It is
the Bank's goal to increase its Loan to Deposit ratio by growing its Loan
Portfolio without sacrificing 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 operating
expenses. All loans deemed to be uncollectible are charged to the allowance;
subsequent recoveries are credited to the allowance. The amount in the loan
loss allowance is an estimate of the losses inherent in the loan portfolio as
determined by a variety of factors considered by Management. Factors include,
but are not limited to, the current economic climate, type and quality of loans
in the portfolio, trends in delinquencies, trends in losses, trends in
non-accrual totals, diversification of the portfolio, value of available
collateral and the cost of collateral liquidation.
As of December 31, 1997, the Bank's allowance for loan losses stood at $11.3
million or 3.2% of gross loans. It also represents 340% of non performing loans
(non-accrual loans plus loans 90 days or more past due). Outside factors, not
within the Bank's control, such as adverse changes in the economy, can effect
the adequacy of the allowance and there can be no assurance that, in any given
period, the Bank might not suffer losses which are substantial in relation to
the size of the allowance. During the year 1997, the Bank benefited from net
recoveries to the allowance of $812.6 thousand, or 0.24% of average loans.
UNDERWRITING AND CREDIT ADMINISTRATION
The lending activities of Mid-State Bank are guided by the lending policies
established by the Bank's Board of Directors. The credit policy is managed
through periodic reviews and approved annually by the Board.
Each loan must meet minimum underwriting criteria established in the Bank's
lending policy. Lending authority is granted to officers of the Bank on a
limited basis, dependent upon individual knowledge and experience. Loan
requests exceeding individual officer approval limits are approved by the
Administrative Loan Committee. Loan requests exceeding these limits are
submitted to the Executive Loan Committee, which consists of the president and
chief executive officer and three outside directors. Each of these committees
meets on a regular basis in order to provide timely responses to the Bank's
clients.
Mid-State Bank's credit administration function includes an internal review and
the regular use of an outside loan review firm. In addition, the Special Assets
Committee, composed of senior officers meet once a month and review
delinquencies, nonperforming assets, classified assets and other pertinent
information about the loan portfolio. The information reviewed by this
committee is submitted to the Board of Directors on a monthly basis.
LOAN PORTFOLIO
At December 31, 1997, approximately 71.1% of Mid-State Bank's gross loan
portfolio was in real estate related borrowings. Construction and development
loans totaled 6.67%, while real estate borrowings reached 49.43%. Additionally,
15% of the loans were home equity lines of
E-7
<PAGE>
credit. 19.71% of the portfolio was commercial loans, while the remaining 9.2%
was consumer loans.
The interest rates charged for the loans made by the Bank vary with the degree
of risk, size and maturity of the loans. Rates are generally affected by
competition, associated factors stemming from the client's deposit relationship
with the Bank along with the cost of funds.
COMMERCIAL LOANS. Mid-State Bank provides personal financial services to
diverse commercial and professional businesses in the marketplace. Commercial
loans consist primarily of short term loans (normally with a maturity of under
one year) for working capital and business expansion. Commercial loans
typically include revolving lines of credit collateralized by inventory,
accounts receivable and equipment. Emphasis is placed on the borrower's
earnings history, capitalization, secondary sources of repayment, and in some
instances, third-party guarantees or highly liquid collateral (such as time
deposits and investment securities). Commercial loan pricing is generally at a
rate tied to the prime rate (as quoted in the WALL STREET JOURNAL) or the Bank's
reference rates.
Mid-State Bank participates in a Small Business Administration (SBA) loan
guarantee program. Those programs used include both the 504 program, which is
focused toward longer-term financing of buildings and other long-term assets,
and the 7A program, which is primarily used for financing of the equipment,
inventory and working capital needs of eligible businesses, generally over a
three-to-seven year term. Mid-State 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.
REAL ESTATE CONSTRUCTION AND DEVELOPMENT LOANS. Mid-State Bank's real estate
construction loan activity has focused on providing short-term (less than one
year maturity)loans to individuals and developers with whom the Bank has
established relationships for the construction primarily of single family
residences in the Bank's market area.
Residential real estate construction loans are typically secured by first deeds
of trust and require guarantees of the borrower. The economic viability of the
project and the borrower's credit-worthiness are primary considerations in the
loan underwriting decision. The Bank utilizes approved independent local
appraisers as well as in-house staff, and loan-to-value ratios which generally
do not exceed 70% to 80% of the appraised value of the property. The Bank
monitors projects during the construction phase through regular construction
inspections and a disbursement program tied to the percentage of completion of
each project.
Mid-State Bank also occasionally makes land loans to individuals who intend to
construct a single-family residence on the lot, generally within 24 months. In
addition, the Bank has occasionally in the past, and may to a greater extent in
the future, make commercial real estate construction loans to high-net-worth
clients with adequate liquidity for construction of office and warehouse
properties. Such loans are typically secured by first deeds of trust and
require guarantees of borrowers.
COMMERCIAL REAL ESTATE TERM LOANS. Mid-State Bank provides medium-term
commercial real estate loans secured by commercial or industrial buildings where
the properties are either used by the owner for business purposes (owner-used
properties) or have income derived from tenants (investment properties).
Mid-State Bank's loan policies require the principal balance of the loan
E-8
<PAGE>
to be no more than 70% of the stabilized appraised value of the underlying real
estate collateral. The loans, which are typically secured by first deeds of
trust only, generally have terms of no more than ten years and are amortized
over 25 years. Most of these loans have rates tied to the prime rate, with many
adjusting whenever the prime rate changes; the remaining loans adjust every five
years depending upon the term of the loan.
CONSUMER AND OTHER LOANS. The Bank's consumer and other loan portfolio is
divided between installment loans secured by automobiles and other consumer
purposes. Installment loans tend to be fixed rate and longer-term
(one-to-five-year maturity). The Bank also has a minimal portfolio of credit
card and related loans, issued as an additional service to its clients.
INVESTMENT SECURITIES
The Bank maintains a portfolio of investment securities to provide income and to
serve as a secondary source of liquidity for its operations in conjunction with
Federal Funds Sold (see liquidity management above). The Bank's investment
policy provides for the purchase of United States Treasury Securities, United
States Government Agency Securities, Mortgage Backed Securities, Obligations of
State and Political Subdivisions, and Other Securities as permitted by Federal
and State regulation. As of December 31, 1997, the aggregate carrying value of
the Investment Portfolio was $373.2 million. Of this total, $144.1 million was
invested in U.S. Treasury Securities, $102.2 million in U.S. Government
Agencies, $16.7 million in Mortgage Backed Securities, $108.2 million in
Obligations of State and Political Subdivisions and $1.9 million in Other
Securities. The types of securities held are influenced by several factors,
among which are: rate of return, maturity, and risk. Generally, the Bank
endeavors to stagger the maturities of its securities so that it has regular
maturities for liquidity purposes.
Acceptable securities may be pledged to secure public deposits from State and
Public Agencies. As of December 31, 1997, the Bank had public funds totaling
approximately $8.5 million. The Bank has made available $43.3 million of
securities to securitize these funds. Excess collateral can be released as
needed.
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 Bank. The description does not purport to be complete and is qualified
in its entirety by reference to the applicable laws and regulations.
The Bank, as a California state chartered bank, is subject to primary
supervision, periodic examination and regulation by the Commissioner (the
"Commissioner") of the California Department of Financial Institutions ("DFI")
and the Federal Deposit Insurance Corporation ("FDIC").
E-9
<PAGE>
The Bank is insured by the FDIC, which currently insures deposits of each member
bank to a maximum of $100,000 per depositor. For this protection, the Bank, as
is the case with all insured banks, pays a quarterly statutory assessment and is
subject to the rules and regulations of the FDIC. Although the Bank is not a
member of the Federal Reserve System, it is nevertheless subject to certain
regulations of the Federal Reserve Board.
The FDIC also has authority to prohibit the Bank from engaging in activities
that, in the FDIC's opinion, constitutes an unsafe or unsound practice in
conducting its business. It is possible, depending upon the financial condition
of the bank in question and other factors, that the FDIC could assert that the
payment of dividends or other payments might, under some circumstances, be an
unsafe or unsound practice.
Various requirements and restrictions under the laws of the State of California
and the United States affect the operations of the Bank. State and federal
statutes and regulations 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.
There are statutory and regulatory limitations on the amount of dividends which
may be paid to the stockholders by the Bank. California law restricts the
amount available for cash dividends by state-chartered banks to the lesser of
retained earnings or the bank's net income for its last three fiscal years (less
any distributions to stockholders made during such period). In the event a bank
has no retained earnings or net income for its last three fiscal years, cash
dividends may be paid in an amount not exceeding greatest of (a) the retained
earnings of the Bank; (b) the net income for the Bank for the last fiscal year;
and (c) the net income for the current fiscal year, but only after obtaining the
prior approval of the Commissioner.
California law and regulations of the DFI authorize California licensed banks,
subject to applicable limitations and approvals of the DFI to (1) provide real
estate appraisal services, management consulting and advice services, and
electronic data processing services; (2) engage directly in real property
investment or acquire and hold voting stock of one or more corporations, the
primary activities of which are engaging in real property investment; (3)
organize, sponsor, operate or render investment advice to an investment company
or to underwrite, distribute or sell securities in California; and (4) invest in
the capital stock, obligations or other securities of corporations not acting as
insurance companies, insurance agents or insurance brokers. In November 1988,
proposition 103 was adopted by California voters. The DFI has established
certain procedures to be followed by banks desiring to engage in insurance
activities which include filing a report describing (1) a proposed business plan
and information regarding the types of insurance products intended to be
offered; (2) insurance companies with which the banks intend to consuct
business; (3) organization plans; (4) locations at which activities will be
conducted; and (5) proposed operational and compliance procedures and policies.
Banks are subject to certain restrictions imposed by federal law on any
extensions of credit to, or the issuance of a guarantee or letter of credit on
behalf of its affiliates, the purchase of or investments in stock or other
securities thereof, the taking of such securities as collateral for
E-10
<PAGE>
loans and the purchase of assets of such affiliates. Such restrictions prevent
affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts. Further, such secured loans and
investments by the Bank to any other affiliate is limited to 10% of the Bank's
capital and surplus (as defined by federal regulations) and such secured loans
and investments are limited, in the aggregate, to 20% of the Bank's capital and
surplus (as defined by federal regulations). California law also imposes
certain restrictions with respect to transactions involving other controlling
persons of the Bank. Additional restrictions on transactions with affiliates
may be imposed on the Bank under the prompt corrective action provisions of the
FDIC Improvement Act.
The Bank is subject to the periodic reporting requirements of the Securities
Exchange Act of 1934, as amended, including but not limited to, filing annual,
quarterly and other current reports with the FDIC. This annual report Form 10-K
is one such form.
The regulations of these various agencies govern most aspects of the Bank's
business, including required reserves on deposits, investments, loans, certain
of their check clearing activities, issuance of securities, payment of
dividends, opening of branches, and numerous other areas. As a consequence of
the extensive regulation of commercial banking activities in the United States,
the Bank's business is particularly susceptible to changes in California and the
Federal legislation and regulations which may have the effect of increasing the
cost of doing business, limiting permissible activities, or increasing
competition.
ENFORCEMENT ACTIONS
Commercial banking organizations, such as the Bank, may be subject to potential
enforcement actions by the FDIC and the DFI for unsafe or unsound practices in
conducting their businesses or for violations of any law, rule, regulation or
any condition imposed in writing by the agency or any written agreement with the
agency. Enforcement actions may include the imposition of a conservator or
receiver, the issuance of a cease-and-desist order that can be judicially
enforced, the termination of insurance of deposits, the imposition of civil
money penalties, the issuance of directives to increase capital, the issuance of
formal and informal agreements, the issuance of removal and prohibition orders
against institution-affiliated parties and the imposition of restrictions and
sanctions under the prompt corrective action provisions of the FDIC Improvement
Act.
For information concerning the termination of an enforcement action to which the
Bank was previously subject, see Note 15 to the Financial Statements included in
Item 8 of this Report and the "Regulatory Cnsiderations" portion of the
Management's Discussion and Analysis of Financial Condition and Results of
Operations which is included in Item 7 of this Report. In connection with such
termination, the Board of Directors adopted certain resolutions in January 1997
agreeing to certain goals including continued efforts to reduce the level of
classified assets to certain levels, maintenance of an adequate reserve for loan
losses and control of expenses and restoration of profitability, while complying
with the regulations of the FDIC.
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
E-11
<PAGE>
portfolio comprise the major portion of the Bank's earnings. These rates are
highly sensitive to many factors that are beyond the control of the Bank.
Accordingly the earnings and growth of the Bank are subject to the influence of
local, domestic and foreign economic conditions, including recession,
unemployment and inflation.
The commercial banking business is not only affected by general economic
conditions but is also influenced by the monetary and fiscal policies of the
federal government and the policies of regulatory agencies, particularly the
Federal Reserve Board. The Federal Reserve Board implements national monetary
policies (with objectives such as curbing inflation and combating recession) by
its open-market operations in United States Government securities, by adjusting
the required level of reserves for financial intermediaries subject to its
reserve requirements and by varying the discount rates applicable to borrowings
by depository institutions. The actions of the Federal Reserve Board in these
areas influence the growth of bank loans, investments and deposits and also
affect interest rates charged on loans and paid on deposits. The nature and
impact of any future changes in monetary policies cannot be predicted.
From time to time, legislation is enacted which has the effect of increasing the
cost of doing business, limiting or expanding permissible activities or
affecting the competitive balance between banks and other financial
intermediaries. Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and other financial
intermediaries are frequently made in Congress, in the California legislature
and before various bank regulatory and other professional agencies. For
example, legislation has been introduced in Congress that would repeal the
current statutory restrictions on affiliations between commercial banks and
securities firms. See "Financial Modernization Legislation."
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
On December 19, 1991, the FDIC Improvement Act was enacted into law. Set forth
below is a brief discussion of certain portions of this law and implementing
regulations that have been adopted or proposed by the Federal Reserve Board, the
Comptroller of the Currency ("Comptroller"), the Office of Thrift Supervision
("OTS") and the FDIC (collectively, the "federal banking agencies").
STANDARDS FOR SAFETY AND SOUNDNESS
The FDIC Improvement Act requires the federal banking agencies to prescribe, by
regulation, standards for all insured depository institutions and depository
institution holding companies relating to internal controls, loan documentation,
credit underwriting, interest rate exposure and asset growth. Standards must
also be prescribed for classified loans, earnings and the ratio of market value
to book value for publicly traded shares. The FDIC Improvement Act also
requires the federal banking agencies to issue uniform regulations prescribing
standards for real estate lending that are to consider such factors as the risk
to the deposit insurance fund, the need for safe and sound operation of insured
depository institutions and the availability of credit. Further, the FDIC
Improvement Act requires the federal banking agencies to establish standards
prohibiting compensation, fees and benefit arrangements that are excessive or
could lead to financial loss.
E-12
<PAGE>
In July 1992, the federal banking agencies issued a joint advance notice of
proposed rule making requesting public comment on the safety and soundness
standards required to be prescribed by the FDIC Improvement Act. The purpose of
the notice is to assist the federal banking agencies in the development of
proposed regulations. In accordance with the FDIC Improvement Act, final
regulations must become effective no later than December 1, 1993.
In December 1992, the federal banking agency issued final regulations
prescribing uniform guidelines for real estate lending. The regulations require
insured depository institutions to adopt written policies establishing
standards, consistent with such guidelines, for extensions of credit secured by
real estate. The policies must address loan portfolio management, underwriting
standards and loan to value limits that do not exceed the supervisory limits
prescribed by the regulations.
In February 1995, the federal banking agencies adopted final guidelines
establishing standards for safety and soundness, as required by FDICIA. The
guidelines set forth operational and managerial standards relating to internal
controls, information systems and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth and compensation, fees
and benefits. Guidelines for asset quality and earnings standards will be
adopted in the future. The guidelines establish the safety and soundness
standards that the agencies will use to identify and address problems at insured
depository institutions before capital becomes impaired. If an institution
fails to comply with a safety and soundness standard, the appropriate federal
banking agency may require the institution to submit a compliance plan. Failure
to submit a compliance plan or to implement an accepted plan may result in
enforcement action.
Appraisals for "real estate related financial transactions" must be conducted by
either state-certified or state-licensed appraisers for transactions in excess
of certain amounts. State-certified appraisers are required for all
transactions with a transaction value of $1,000,000 or more; for all
non-residential transactions valued at $250,000 or more; and for "complex" 1-4
family residential properties of $250,000 or more. A state-licensed appraiser
is required for all other appraisals. However, appraisals performed in
connection with "federally related transactions" must now comply with the
agencies' appraisal standards. Federally related transactions include the sale,
lease, purchase, investment in, or exchange of, real property or interests in
real property, the financing of real property, and the use of real property or
interests in real property as security for a loan or investment, including
mortgage backed securities.
PROMPT CORRECTIVE REGULATORY ACTION
The FDIC Improvement Act requires each federal banking agency to take prompt
corrective action to resolve the problems of insured depository institutions
that fall below one or more prescribed minimum capital ratios. The purpose of
this law is to resolve the problems of insured depository institutions at the
least possible long-term cost to the appropriate deposit insurance fund.
The law requires each federal banking agency to promulgate regulations defining
the following five categories in which an insured depository institution will be
placed, based on the level of its capital ratios: well capitalized
(significantly exceeding the required minimum capital requirements), adequately
capitalized (meeting the required capital requirements), undercapitalized
(failing to meet any one of the capital requirements), significantly
E-13
<PAGE>
undercapitalized (significantly below any one capital requirement) and
critically undercapitalized (failing to meet all capital requirements).
In September 1992, the federal banking agencies issued uniform final regulations
implementing the prompt corrective action provisions of the FDIC Improvement
Act. Under the regulations, an insured depository institution will be deemed to
be:
- "well capitalized" if it (i) has total risk-based capital of 10% or
greater, Tier 1 risk-based capital of 6% or greater and a leverage
capital ratio of 5% or greater and (ii) is not subject to an order,
written agreement, capital directive or prompt corrective action
directive to meet and maintain a specific capital level for any
capital measure;
- "adequately capitalized" if it has total risk-based capital of 8% or
greater, Tier 1 risk-based capital of 4% or greater and a leverage
capital ratio of 4% or greater (or a leverage capital ratio of 3% or
greater if the institution is rated composite 1 under the applicable
regulatory rating system in its most recent report of examination);
- "undercapitalized" if it has total risk-based capital that is less
than 8%, Tier 1 risk-based capital that is less than 4% or a leverage
capital ratio that is less than 4% (or a leverage capital ratio that
is less than 3% if the institution is rated composite 1 under the
applicable regulatory rating system in its most recent report of
examination);
- "significantly undercapitalized" if it has total risk-based capital
that is less than 6%, Tier 1 risk-based capital that is less than 3%
or a leverage capital ratio that is less than 3%; and
- "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2%.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be reclassified to
the next lower capital category if the appropriate federal banking agency, after
notice and opportunity for hearing, (i) determines that the institution is in an
unsafe or unsound condition or (ii) deems the institution is engaging in an
unsafe or unsound practice and not to have corrected the deficiency. At each
successive lower capital category, an insured depository institution is subject
to more restrictions and federal banking agencies are given less flexibility in
deciding how to deal with it. Additionally, FDIC insurance premiums are
increased resulting in increased expense with each successive lower capital
category.
As of December 31, 1997, the Bank was classified as "Well Capitalized" under the
guidelines discussed above.
The law prohibits insured depository institutions from paying management fees to
any controlling persons or, with certain limited exceptions, making capital
distributions if after such transaction the institution would be
undercapitalized. If an insured depository institution is undercapitalized, it
will be closely monitored by the appropriate federal banking agency, subject to
asset growth restrictions and required to obtain prior regulatory approval for
acquisitions, branching and engaging in new lines of business. Any
undercapitalized depository institution must submit an acceptable capital
restoration plan to the appropriate federal banking agency 45 days after
becoming undercapitalized. The appropriate federal banking agency cannot accept
a
E-14
<PAGE>
capital plan unless, among other things, it determines that the plan (i)
specifies the steps the institution will take to become adequately capitalized,
(ii) is based on realistic assumptions and (iii) is likely to succeed in
restoring the depository institution's capital. In addition, each company
controlling an undercapitalized depository institution must guarantee that the
institution will comply with the capital plan until the depository institution
has been adequately capitalized on an average basis during each of four
consecutive calendar quarters and must otherwise provide adequate assurances of
performance. The aggregate liability of such guarantee is limited to the lesser
of (a) an amount equal to 5% of the depository institution's total assets at the
time the institution became undercapitalized or (b) the amount which is
necessary to bring the institution into compliance with all capital standards
applicable to such institution as of the time the institution fails to comply
with its capital restoration plan. Finally, the appropriate federal banking
agency may impose any of the additional restrictions or sanctions that it may
impose on significantly undercapitalized institutions if it determines that such
action will further the purpose of the prompt correction action provisions.
An insured depository institution that is significantly undercapitalized, or is
undercapitalized and fails to submit, or in a material respect to implement, an
acceptable capital restoration plan, is subject to additional restrictions and
sanctions. These include, among other things: (i) a forced sale of voting
shares to raise capital or, if grounds exist for appointment of a receiver or
conservator, a forced merger; (ii) restrictions on transactions with affiliates;
(iii) further limitations on interest rates paid on deposits; (iv) further
restrictions on growth or required shrinkage; (v) modification or termination of
specified activities; (vi) replacement of directors or senior executive
officers, subject to certain grandfather provisions for those elected prior to
enactment of the FDIC Improvement Act; (vii) prohibitions on the receipt of
deposits from correspondent institutions; (viii) restrictions on capital
distributions by the holding companies of such institutions; (ix) required
divestiture of subsidiaries by the institution; or (x) other restrictions as
determined by the appropriate federal banking agency. Although the appropriate
federal banking agency has discretion to determine which of the foregoing
restrictions or sanctions it will seek to impose, it is required to force a sale
of voting shares or merger, impose restrictions on affiliate transactions and
impose restrictions on rates paid on deposits unless it determines that such
actions would not further the purpose of the prompt corrective action
provisions. In addition, without the prior written approval of the appropriate
federal banking agency, a significantly undercapitalized institution may not pay
any bonus to its senior executive officers or provide compensation to any of
them at a rate that exceeds such officer's average rate of base compensation
during the 12 calendar months preceding the month in which the institution
became undercapitalized.
Further restrictions and sanctions are required to be imposed on insured
depository institutions that are critically undercapitalized. For example, a
critically undercapitalized institution generally would be prohibited from
engaging in any material transaction other than in the ordinary course of
business without prior regulatory approval and could not, with certain
exceptions, make any payment of principal or interest on its subordinated debt
beginning 60 days after becoming critically undercapitalized. Most importantly,
however, except under limited circumstances, the appropriate federal banking
agency, not later than 90 days after an insured depository institution becomes
critically undercapitalized, is required to appoint a conservator or receiver
for the institution. The board of directors of an insured depository
institution would not be liable to the institution's shareholders or creditors
for consenting in good faith to the appointment of a receiver or conservator or
to an acquisition or merger as required by the regulator.
E-15
<PAGE>
OTHER ITEMS
The FDIC Improvement Act also, among other things, (i) limits the percentage of
interest paid on brokered deposits and limits the unrestricted use of such
deposits to only those institutions that are well capitalized; (ii) requires the
FDIC to charge insurance premiums based on the risk profile of each institution;
(iii) eliminates "pass through" deposit insurance for certain employee benefit
accounts unless the depository institution is well capitalized or, under certain
circumstances, adequately capitalized; (iv) prohibits insured state chartered
banks from engaging as principal in any type of activity that is not permissible
for a national bank unless the FDIC permits such activity and the bank meets all
of its regulatory capital requirements; (v) directs the appropriate federal
banking agency to determine the amount of readily marketable purchased mortgage
servicing rights that may be included in calculating such institution's
tangible, core and risk-based capital; and (vi) provides that, subject to
certain limitations, any federal savings association may acquire or be acquired
by any insured depository institution.
In addition, the FDIC has issued final and proposed regulations implementing
provisions of the FDIC Improvement Act relating to powers of insured state
banks. Final regulations issued in October 1992 prohibit insured state banks
from making equity investments of a type, or in an amount, that are not
permissible for national banks. In general, equity investments include equity
securities, partnership interests and equity interests in real estate. Under
the final regulations, non-permissible investments must be divested by no later
than December 19, 1996. As noted above, under FDICIA the Bank, through Mid
Coast Land Company, would have been required to substantially eliminate its real
estate development activities by the December 19, 1996. The Bank received an
extension of that deadline to December 31, 1998 and the Regional Director of the
FDIC may, at his sole discretion, extend the deadline to December 31, 2001 for
good cause. The Bank is in the process of completing the divestiture of the
assets held by Mid Coast Land Company. Regulations issued in December 1993,
prohibit insured state banks from engaging as principal in any activity not
permissible for a national bank, without FDIC approval. The regulations also
provide that subsidiaries of insured state banks may not engage as principal in
any activity that is not permissible for a subsidiary of a national bank,
without FDIC approval.
There is a potential impact of the FDIC Improvement Act on the Bank. Certain
provisions, such as the real estate lending standards and the limitations on
investments and powers of state banks and the rules to be adopted governing
compensation, fees and other operating policies, may affect the way in which the
Bank conducts its business, and other provisions, such as those relating to the
establishment of the risk-based premium system, may adversely affect the Bank's
results of operations. Furthermore, the actual and potential restrictions and
sanctions that apply to or may be imposed on undercapitalized institutions under
the prompt corrective action and other provisions of the FDIC Improvement Act
may significantly adversely affect the operations and liquidity of the Bank, the
value of its Common Stock and its ability to raise funds in the financial
markets.
CAPITAL ADEQUACY GUIDELINES
The FDIC has issued guidelines to implement the risk-based capital requirements.
The guidelines are intended to establish a systematic analytical framework that
makes regulatory capital requirements more sensitive to differences in risk
profiles among banking organizations, takes off-balance sheet items into account
in assessing capital adequacy and minimizes disincentives to holding liquid,
low-risk assets. Under these guidelines, assets and credit
E-16
<PAGE>
equivalent amounts of off-balance sheet items, such as letters of credit and
outstanding loan commitments, are assigned to one of several risk categories,
which range from 0% for risk-free assets, such as cash and certain U.S.
Government securities, to 100% for relatively high-risk assets, such as loans
and investments in fixed assets, premises and other real estate owned. The
aggregated dollar amount of each category is then multiplied by the risk-weight
associated with that category. The resulting weighted values from each of the
risk categories are then added together to determine the total risk-weighted
assets.
A banking organization's qualifying total capital consists of two components:
Tier 1 capital (core capital) and Tier 2 capital (supplementary capital). Tier
1 capital consists primarily of common stock, related surplus and retained
earnings, qualifying non-cumulative perpetual preferred stock and minority
interests in the equity accounts of consolidated subsidiaries. Intangibles,
such as goodwill, are generally deducted from Tier 1 capital; however, purchased
mortgage servicing rights and purchase credit card relationships may be
included, subject to certain limitations. At least 50% of the banking
organization's total regulatory capital must consist of Tier 1 capital.
Tier 2 capital may consist of (i) the allowance for possible loan and lease
losses in an amount up to 1.25% of risk-weighted assets; (ii) perpetual
preferred stock, cumulative perpetual preferred stock and long-term preferred
stock and related surplus; (iii) hybrid capital instruments (instruments with
characteristics of both debt and equity), perpetual debt and mandatory
convertible debt securities; and (iv) eligible term subordinated debt and
intermediate-term preferred stock with an original maturity of five years or
more, including related surplus, in an amount up to 50% of Tier 1 capital. The
inclusion of the foregoing elements of Tier 2 capital are subject to certain
requirements and limitations of the federal banking agencies.
The FDIC has also adopted a minimum leverage capital ratio of Tier 1 capital to
average total assets of 3% for the highest rated banks. This leverage capital
ratio is only a minimum. Institutions experiencing or anticipating significant
growth or those with other than minimum risk profiles are expected to maintain
capital well above the minimum level. Furthermore, higher leverage capital
ratios are required to be considered well capitalized or adequately capitalized
under the prompt corrective action provisions of the FDIC Improvement Act.
Federally supervised banks and savings associations are currently required to
report deferred tax assets in accordance with SFAS No. 109. The federal banking
agencies recently issued final rules governing banks and bank holding companies,
which became effective April 1, 1995, which limit the amount of deferred tax
assets that are allowable in computing an institutions regulatory capital. The
standard has been in effect on an interim basis since March 1993. Deferred tax
assets that can be realized for taxes paid in prior carryback years and from
future reversals of existing taxable temporary differences are generally not
limited. Deferred tax assets that can only be realized through future taxable
earnings are limited for regulatory capital purposes to the lesser of (1) the
amount that can be realized within one year of the quarter-end report date, or
(2) 10% of Tier I Capital. The amount of any deferred tax in excess of this
limit would be excluded from Tier I Capital and total assets and regulatory
capital calculations. The Bank does not have any deferred tax asset excluded
from its regulatory capital calculations.
In August 1995, the federal banking agencies adopted final regulations
specifying that the agencies will include, in their evaluations of a bank's
capital adequacy, an assessment of the exposure to declines in the economic
value of the bank's capital due to changes in interest rates. The final
regulations, however, do not include a measurement framework for assessing the
level
E-17
<PAGE>
of a bank's exposure to interest rate risk, which is the subject of a proposed
policy statement issued by the federal banking agencies concurrently with the
final regulations. The proposal would measure interest rate risk in relation to
the effect of a 200 basis point change in market interest rates on the economic
value of a bank. Banks with high levels of measured exposure or weak management
systems generally will be required to hold additional capital for interest rate
risk. The specific amount of capital that may be needed would be determined on
a case-by-case basis by the examiner and the appropriate federal banking agency.
Because this proposal has only recently been issued, the Bank currently is
unable to predict the impact of the proposal on the Bank if the policy statement
is adopted as proposed.
In January 1995, the federal banking agencies issued a final rule relating to
capital standards and the risks arising from the concentration of credit and
nontraditional activities. Institutions which have significant amounts of their
assets concentrated in high risk loans or nontraditional banking activities and
who fail to adequately manage these risks, will be required to set aside capital
in excess of the regulatory minimums. The federal banking agencies have not
imposed any quantitative assessment for determining when these risks are
significant, but have identified these issues as important factors they will
review in assessing an individual bank's capital adequacy.
In December 1993, the federal banking agencies issued an interagency policy
statement on the allowance for loan and lease losses which, among other things,
establishes certain benchmark ratios of loan loss reserves to classified assets.
The benchmark set forth by such policy statement is the sum of (a) assets
classified "loss"; (b) 50 percent of assets classified "doubtful"; (c) 15
percent of assets classified "substandard"; and (d) estimated credit losses on
other assets over the upcoming 12 months.
For information concerning the capital ratios of the Bank, see the information
which is incorporated into Item 7 of this Report. Future changes in regulations
or practices could reduce the amount of capital recognized for purposes of
capital adequacy. Such changes could affect the ability of the Bank to grow and
could restrict the amount of profits, if any, available for the payment of
dividends.
PREMIUMS FOR DEPOSIT INSURANCE
Federal law has established several mechanisms to increase funds to protect
deposits insured by the Bank Insurance Fund ("BIF") administered by the FDIC.
The FDIC is authorized to borrow up to $30 billion from the United States
Treasury; up to 90% of the fair market value of assets of institutions acquired
by the FDIC as receiver from the Federal Financing Bank; and from depository
institutions that are members of the BIF. Any borrowings not repaid by asset
sales are to be repaid through insurance premiums assessed to member
institutions. Such premiums must be sufficient to repay any borrowed funds
within 15 years and provide insurance fund reserves of $1.25 for each $100 of
insured deposits. The FDIC also has authority to impose special assessments
against insured deposits.
The FDIC implemented a final risk-based assessment system, as required by
FDICIA, effective January 1, 1994, under which an institution's premium
assessment is based on the probability that the deposit insurance fund will
incur a loss with respect to the institution, the likely amount of any such
loss, and the revenue needs of the deposit insurance fund. As long as BIF's
reserve ratio is less than a specified "designated reserve ratio," 1.25%, the
total amount raised from BIF members by the risk-based assessment system may not
be less than the amount that would be
E-18
<PAGE>
raised if the assessment rate for all BIF members were .023% of deposits. The
FDIC, effective September 15, 1995, lowered assessments from their rates of $.23
to $.31 per $100 of insured deposits to rates of $.04 to $.31, depending on the
condition of the bank, as a result of the re-capitalization of the BIF. On
November 15, 1995, the FDIC voted to drop its premiums for well capitalized
banks to zero effective January 1, 1996. Other banks will be charged risk-based
premiums up to $.27 per $100 of deposits.
The Bank pays the minimum required premiums as a result of its "well
capitalized" status.
In 1996, the President signed into law provisions to strengthen the Savings
Association Insurance Fund (the "SAIF") and to repay outstanding bonds that were
issued to re-capitalize the SAIF's successor as result of payments made due to
insolvency of savings and loan associations and other federally insured savings
institutions in the late 1980's and early 1990's. The new law will require
savings and loan associations to bear the cost of re-capitalizing the SAIF and,
after January 1, 1997, banks will contribute towards paying off the financing
bonds, including interest. In 2000, the banking industry will assume the bulk
of the payments. The new law also aims to merge the Bank Insurance Fund and
SAIF by 1999, but not until the bank and savings and loan charters are combined.
The Treasury Department had until March 31, 1997, to deliver to Congress on
combining the charters. Additionally, the new law provides "regulatory relief"
for the banking industry by effecting approximately 30 laws and regulations.
Currently, the costs and benefits of the new law to the Bank can not be
accurately predicted.
RECENT CALIFORNIA LEGISLATION
In 1996, Governor Pete Wilson signed Assembly Bill 3351 (the "Banking
Consolidation Bill"), authored by Assemblyman Ted Weggeland and sponsored by the
California State Banking Department (the "Department"), effective July 1, 1997,
which created the California Department of Financial Institutions ("DFI") to be
headed by a Commissioner of Financial Institutions out of the existing
Department which regulates state chartered commercial banks and trust companies
in California.
The Banking Consolidation Bill, among other provisions, also (i) transfered
regulatory jurisdiction over state chartered savings and loan associations from
the Department of Savings and Loans ("DSL") to the newly-created DFI and
abolishes the DSL; (ii) transfered regulatory jurisdiction over state chartered
industrial loan companies and credit unions from the Department of Corporations
to the newly-created DFI; and (iii) establishes within the DFI separate
divisions for credit unions, commercial banks, industrial loan companies and
savings and loans. As the Banking Consolidation Bill has only recently been
enacted, it is impossible to predict with any degree of certainty, what impact
it will have on the banking industry in general and the Bank in particular.
On January 1, 1998, new legislation became effective which, among other things,
gave the power to the DFI to take possession of the business and properties of a
bank in the event that the tangible shareholders' equity of the bank is less
than the greater of (1) 3% of the bank's total assets or (2) $1,000,000.
E-19
<PAGE>
FINANCIAL MODERNIZATION LEGISLATION
Various proposals to adopt comprehensive financial modernization legislation
have been introduced in Congress which include, among other things, elimination
of the federal thrift charter, creation of a uniform financial institutions
charter, expansion of bank powers, and integration of banking, commerce,
securities activities and insurance. Under the proposed legislation, bank
holding companies would be allowed to control both a commercial bank and a
securities affiliate, which could engage in the full range of investment banking
activities, including corporate underwriting. By the end of 1997 competing
versions of financial modernization legislation had been passed by the House
Banking and the House Commerce Committees. Despite attempts to reach a
compromise on these bills, differences between the bills passed by the two
Committees remain, including the amount of nonfinancial business that bank
holding companies would be permitted to own and limitations on bank operating
subsidiaries. Certain leaders in the Senate have indicated that the Senate will
not take up the matter until a bill is passed by the entire House. It is
currently impossible to predict whether and in what form financial reform
legislation will be passed in 1998 or in the future or what the impact of such
legislation might be on the Bank, its financial condition and business as well
as its result of operations.
INTERSTATE BANKING AND BRANCHING
On September 29, 1994, the President signed into law the Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the "Interstate Act"). Under the
Interstate Act, beginning one year after the date of enactment, a bank holding
company that is adequately capitalized and managed may obtain regulatory
approval to acquire an existing bank located in another state without regard to
state law. A bank holding company would not be permitted to make such an
acquisition if, upon consummation, it would control (a) more than 10% of the
total amount of deposits of insured depository institutions in the United States
or (b) 30% or more of the deposits in the state in which the bank is located. A
state may limit the percentage of total deposits that may be held in that state
by any one bank or bank holding company if application of such limitation does
not discriminate against out-of-state banks. An out-of-state bank holding
company may not acquire a state bank in existence for less than a minimum length
of time that may be prescribed by state law except that a state may not impose
more than a five year existence requirement.
On July 3, 1997, the President signed into law the Reigle-Neal Amendment Act of
1997 providing that branches of state banks that operate in other states are to
be governed by the laws of their home (or chartering) states, not the laws of
the host states. State banks and state bank regulators pushed for the
legislation, believing that without is state banks would switch to national
charters to avoid having to deal with different set of laws in each state where
they have established branches.
State banks did not receive any new powers under the legislation. If a host
state allows banks more powers than a bank's chartering state, the bank is
restricted to the powers granted by its chartering state. However, states are
prohibited from discriminating against branches of banks from other states by
the requirement that states must grant branches out-of-state banks the same
privileges allowed to banks that states have chartered.
E-20
<PAGE>
The Interstate Act also permits mergers of insured banks located in different
states and conversion of the branches of the acquired bank into branches of the
resulting bank. The same concentration limits discussed above apply. The
Interstate Act also permits a national or state bank to establish branches in a
state other than its home state if permitted by the laws of that state, subject
to the same requirement and conditions as for a merger transaction.
The Interstate Act is likely to increase competition in the Bank's market areas
especially from larger financial institutions and their holding companies. It
is difficult to asses the impact such likely increased competition will have on
the Bank' operations.
On September 28, 1995, Governor Wilson signed Assembly Bill No. 1482, the
Caldera, Weggeland, and Killea California Interstate Banking and Branching Act
of 1995 (the "1995 Act"). The 1995 Act, which was filed with the Secretary of
State as Chapter 480 of the Statutes of 1995, became operative on October 2,
1995.
The 1995 Acts opts in early for interstate branching, allowing out-of-state
banks to enter California by merging or purchasing a California bank or
industrial loan company which is at least five years old. Also, the 1995 Act
repeals the California Interstate (National) Banking Act of 1986, which
regulated the acquisition of California banks by out-of-state bank holding
companies. In addition, the 1995 Act permits California state banks, with the
approval of the Department of Financial Institutions, to establish agency
relationships with FDIC-insured banks and savings associations. Finally, the
1995 Act provides for regulatory relief, including (i) authorization for the
Superintendent to exempt banks from the requirement of obtaining approval before
establishing or relocating a branch office or place of business, (ii) repeal of
the requirement of directors' oaths (Financial Code Section 682), and (iii)
repeal of the aggregate limit on real estate loans (Financial Code Section
1230).
COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS
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 financial institutions in meeting the
credit needs of their local community, including low and moderate income
neighborhoods. In addition to substantial penalties and corrective measures
that may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities.
In May 1995, the federal banking agencies issued final regulations which change
the manner in which they measure a bank's compliance with its CRA obligations.
The final regulations adopt a performance-based evaluation system which bases
CRA ratings on an institutions' actual lending service and investment
performance, rather than the extent to which the institution conducts needs
assessments, documents community outreach or complies with other procedural
requirements. In March 1994, the Federal Interagency Tax Force on Fair lending
issued a policy statement on discrimination in lending. The policy statement
describes the three methods that federal agencies will use to prove
discrimination: overt evidence of discrimination, evidence of disparate
treatment and evidence of disparate impact.
E-21
<PAGE>
In connection with its assessment of CRA performance, the appropriate bank
regulatory agency assigns a rating of "Outstanding", "Satisfactory," "Needs to
Improve" or "Substantial Noncompliance." At its last examination by the FDIC,
the Bank received a CRA rating of "Satisfactory."
HAZARDOUS WASTE CLEAN-UP COSTS
Management is aware of recent legislation and cases relating to hazardous waste
clean-up costs and potential liability. Based on a general survey of the loan
portfolio of the Bank, conversations with local authorities and appraisers, and
the type of lending currently and historically done by the Bank (generally, the
Bank has not made the types of loans usually associated with hazardous waste
contamination problems), management is not aware of any potential material
liability for hazardous waste contamination.
OTHER REGULATIONS AND POLICIES
The federal regulatory agencies have adopted regulations that implement Section
304 of FDICIA which requires federal banking agencies to adopt uniform
regulations prescribing standards for real estate lending. Each insured
depository institution must adopt and maintain a comprehensive written real
estate lending policy, developed in conformance with prescribed guidelines, and
each agency has specified loan-to-value limits in guidelines concerning various
categories of real estate loans.
YEAR 2000 SAFETY AND SOUNDNESS
Safety and soundness guidance on the risks posed to financial institutions by
the Year 2000 problem was issued by the Federal Financial Institutions
Examination Council. The guidance underscores that Year 2000 preparation is not
only an information systems issue, according to the FFIEC, but also an
enterprise-wide challenge that must be addressed at the highest level of a
financial institution.
The guidance sets out the responsibilities of senior management and boards of
directors in managing their Year 2000 projects. Among the responsibilities of
institution managers and directors is that of managing the internal and external
risks presented by providers of data-processing products and services, business
partners, counterparties and major loan customers.
Under the guidance, senior management must provide the board of directors with
status reports, at least quarterly, on efforts to reach Year 2000 goals both
internally and by the institution's major vendors. Senior management and
directors must allocate sufficient resources to ensure that high priority is
given to seeing that remediation plans are fulfilled, and that the project
receives the quality personnel and timely support it requires.
The Bank's Plan for addressing Year 2000 issues is documented in the
Management's Discussion and Analysis section on pages 43 and 44 which is
included in Item 7 of this Report.
E-22
<PAGE>
STATISTICAL INFORMATION
Table 1, "Distribution of Average Assets, Liabilities, and Shareholders' Equity
and Related Interest Income. Expense and Rates," sets forth the daily average
balances for the major asset and liability categories, the related income or
expense where applicable, and the resultant yield or cost attributable to the
average earning assets and average interest bearing liabilities.
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------
TABLE 1 - Distribution of Average Assets, Liabilities and Shareholders' Equity
and Related Interest Income, Expense and Rates
- ------------------------------------------------------------------------------------------------------------------------
(dollars in 000's) 1997 1996
-------------------------------- --------------------------------
Balance Interest Rate Balance Interest Rate
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Loans $335,029 $32,473 9.69% $312,431 $30,016 9.61%
Loan Fees $2,108 $1,986
-------- -------- -------- --------
Total Loans $335,029 $34,581 10.32% $312,431 $32,002 10.24%
-------- -------- -------- --------
Investment Securities: (1)
Taxable Securities $348,584 $21,518 6.17% $307,148 $18,858 6.14%
Non-Taxable Securities -- -- -- --
-------- -------- -------- --------
Total Securities $348,584 $21,518 6.17% $307,148 $18,858 6.14%
-------- -------- -------- --------
Money Market Instruments $0 $0 0.00% $0 $0 0.00%
Federal Funds Sold $23,934 $1,201 5.02% $23,558 $1,183 5.02%
-------- -------- -------- --------
Total Money Market Investments $23,934 $1,201 5.02% $23,558 $1,183 5.02%
-------- -------- -------- --------
Total Earning Assets $707,547 $57,300 8.10% $643,137 $52,043 8.09%
-------- --------
Total Non-Earning Assets $95,732 $114,669
-------- --------
TOTAL ASSETS $803,279 $757,806
-------- --------
-------- --------
Liabilities and Shareholders' Equity:
Borrowed Funds:
Federal Funds Purchased $0 $0 0.00% $0 $0 0.00%
Other $3,282 $199 6.06% $3,217 $177 5.50%
-------- -------- -------- --------
Total Borrowed Funds $3,282 $199 6.06% $3,217 $177 5.50%
-------- -------- -------- --------
Interest-Bearing Deposits:
Savings and Interest Bearing
Transaction Accounts $387,807 $6,523 1.68% $385,240 $6,565 1.70%
Time Deposits $202,933 $10,414 5.13% $185,140 $9,416 5.09%
-------- -------- -------- --------
Total Interest-Bearing Deposits $590,740 $16,937 2.87% $570,380 $15,981 2.80%
-------- -------- -------- --------
Total Interest-Bearing Liabilities $594,022 $17,136 2.88% $573,597 $16,158 2.82%
Demand Deposits $126,130 $116,913
Other Liabilities $11,862 $4,262
Shareholders' Equity $71,265 $63,034
-------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $803,279 $757,806
-------- --------
-------- --------
Interest Income / earning assets 8.10% 8.09%
Interest expense / earning assets 2.42% 2.51%
----- -----
Net Interest Margin $40,164 5.68% $35,885 5.58%
Provision for loan losses
charged to operatns/earning assets $0 0.00% $0 0.00%
-------- ----- -------- -----
Net Interest Margin after provision for loan losses $40,164 5.68% $35,885 5.58%
-------- ----- -------- -----
-------- ----- -------- -----
<CAPTION>
1995
--------------------------------
Balance Interest Rate
-------- -------- --------
<S> <C> <C> <C>
Assets:
Loans $333,967 $33,452 10.02%
Loan Fees $1,897
-------- --------
Total Loans $333,967 $35,349 10.58%
-------- --------
Investment Securities: (1)
Taxable Securities $252,978 $15,308 6.05%
Non-Taxable Securities $25 $2 8.08%
-------- --------
Total Securities $253,003 $15,310 6.05%
-------- --------
Money Market Instruments $0 $0 0.00%
Federal Funds Sold $17,584 $1,015 5.77%
-------- --------
Total Money Market Investments $17,584 $1,015 5.77%
-------- --------
Total Earning Assets $604,554 $51,674 8.55%
--------
Total Non-Earning Assets $133,767
--------
TOTAL ASSETS $738,321
--------
--------
Liabilities and Shareholders' Equity:
Borrowed Funds:
Federal Funds Purchased $0 $0 0.00%
Other $7,002 $640 9.14%
-------- --------
Total Borrowed Funds $7,002 $640 9.14%
-------- --------
Interest-Bearing Deposits:
Savings and Interest Bearing
Transaction Accounts $394,836 $7,467 1.89%
Time Deposits $167,094 $8,532 5.11%
-------- --------
Total Interest-Bearing Deposits $561,930 $15,999 2.85%
-------- --------
Total Interest-Bearing Liabilities $568,932 $16,639 2.92%
Demand Deposits $103,225
Other Liabilities $10,164
Shareholders' Equity $56,000
--------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $738,321
--------
--------
Interest Income / earning assets 8.55%
Interest expense / earning assets 2.75%
-----
Net Interest Margin $35,035 5.80%
Provision for loan losses
charged to operatns/earning assets $0 0.00%
-------- -----
Net Interest Margin after provision for loan losses $35,035 5.80%
-------- -----
-------- -----
</TABLE>
(1) Yields have been computed based on actual income.
E-23
<PAGE>
Changes in the dollar amount of interest earned or paid will vary from one year
to the next because of changes in the average balance ("volume") of the various
earning assets and interest-bearing liability accounts and changes in the
interest rates ("rate") applicable to each category. Table 2, "Volume and Rate
Variance Analysis of Net Interest Margin," analyzes the difference in interest
earned and paid on the major categories of assets and liabilities in terms of
the effects of volume and rate changes for the periods indicated.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
TABLE 2 - Volume and Rate Analysis of Net Interest Margin
- --------------------------------------------------------------------------------------------------------------
(dollars in 000's)
1997 OVER 1996 1996 OVER 1995
-------------------------------- --------------------------------
Volume Rate Total Volume Rate Total
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Increase (Decrease) In:
Interest Income
Loans $2,324 $255 $2,579 ($2,243) ($1,104) ($3,347)
-------- -------- -------- -------- -------- --------
Investment Securities: $2,551 $109 $2,660 $3,300 $248 $3,548
-------- -------- -------- -------- -------- --------
Money Market Investments:
Time deposits in other
financial institutions
bankers' acceptances &
commercial paper $0 $0 $0 $0 $0 $0
Federal Funds Sold $19 ($1) $18 $322 ($154) $168
-------- -------- -------- -------- -------- --------
Total Money Market Investments $19 ($1) $18 $322 ($154) $168
-------- -------- -------- -------- -------- --------
Total Earning Assets $4,893 $364 $5,257 $1,380 ($1,011) $369
-------- -------- -------- -------- -------- --------
Interest Expense
Borrowed Funds:
Federal Funds Purchased $0 $0 $0 $0 $0 $0
Other $4 $18 $22 ($277) ($186) ($463)
-------- -------- -------- -------- -------- --------
Total Borrowed Funds $4 $18 $22 ($277) ($186) ($463)
-------- -------- -------- -------- -------- --------
Interest-Bearing Deposits:
Savings and Interest Bearing
Transaction Accounts $43 ($85) ($42) ($173) ($729) ($902)
Time Deposits $909 $89 $998 $920 ($36) $884
-------- -------- -------- -------- -------- --------
Total Interest-Bearing Deposits $952 $4 $956 $747 ($765) ($18)
-------- -------- -------- -------- -------- --------
Total Interest-Bearing Liabilities $956 $22 $978 $470 ($951) ($481)
-------- -------- -------- -------- -------- --------
Increase (decrease) in Net Interest
Margin $3,937 $342 $4,279 $910 ($60) $850
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
</TABLE>
E-24
<PAGE>
Table 3, "Investment Portfolio Maturity Distribution and Yield Analysis," sets
forth the amounts and maturity ranges of the securities at December 31, 1997.
The weighted average yields of the securities are also shown.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
TABLE 3 - Investment Portfolio Maturity Distribution and Yield Analysis
- -----------------------------------------------------------------------------------------------------------------
(dollars in 000's) Market Value
--------------------------------------------------------------------------
As of December 31, 1997 After one After three After five
One Year year to years to years to After
or Less three years five years ten years ten years Total
----------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Maturity Distribution:
U.S. Treasury Securities $37,100 $80,209 $26,787 $0 $0 $144,097
Other U.S. Government Agencies
and Corporations $32,715 $38,297 $31,181 $0 $0 $102,193
Mortgage Backed Securities $0 $3,699 $5,734 $1,320 $5,957 $16,710
State and Municipal Securities $13,674 $27,217 $41,563 $24,549 $1,228 $108,230
Other Securities $504 $1,434 $0 $0 $2 $1,941
----------- ----------- ---------- ----------- ---------- -----------
TOTAL $83,993 $150,857 $105,266 $25,868 $7,187 $373,171
After one After three After five
One Year year to years to years to After
or Less three years five years ten years ten years Total
----------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Weighted Average Yield:
U.S. Treasury Securities 6.01% 6.24% 6.41% -- -- 6.21%
Other U.S. Government Agencies
and Corporations 5.52% 6.21% 6.25% -- -- 6.00%
Mortgage Backed Securities -- 6.20% 6.51% 6.02% 6.92% 6.55%
State and Municipal Securities 6.67% 6.41% 6.57% 6.64% 6.42% 6.56%
Other Securities 6.83% 7.17% -- -- -- 7.07%
TOTAL 5.93% 6.27% 6.43% 6.61% 6.84% 6.27%
</TABLE>
E-25
<PAGE>
Table 4, "Loan Portfolio Analysis by Category," sets forth the distribution of
the Bank's loans at the end of each of the last five years.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
TABLE 4 - Loan Portfolio Analysis By Category
- -------------------------------------------------------------------------------------------------
(dollars in 000's)
December 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
------------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Construction & Development Loans $23,414 $27,719 $27,735 $41,860 $83,337
Real Estate Loans $173,549 $153,566 $139,321 $156,980 $159,641
Home Equity Credit Lines $52,678 $59,048 $66,504 $75,049 $85,179
Installment Loans $20,108 $20,474 $24,730 $21,327 $22,009
Commercial Loans $69,203 $58,923 $51,203 $51,585 $56,136
Credit Cards and related Loans $12,167 $11,088 $5,918 $5,440 $5,667
------------- ---------- ---------- ----------- -----------
Total Loans, Gross $351,119 $330,818 $315,411 $352,241 $411,969
---------- --------- --------- ---------- ----------
</TABLE>
E-26
<PAGE>
Table 5, "Maturities and Sensitivities of Selected Loan Types to Changes in
Interest Rates," shows the maturity distribution of the loan portfolio at
December 31, 1997, and shows the proportion of fixed and floating rate loans for
each type.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
TABLE 5 - Maturities and Sensitivities of Loans to Changes in Interest Rates
- ------------------------------------------------------------------------------------------------------------------------
(dollars in 000's)
Over
As of December 31, 1997 3 Mos Due after one Due after three
3 Mos. through year to years to Due After
or less 12 Mos. three years five years five years Total
---------- ---------- ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Fixed Rate $3,979 $23,557 $33,147 $23,643 $68,180 $152,506
Floating Rate $194,347 $1,589 -- -- -- $195,936
---------- ---------- ----------- ---------- ---------- -----------
TOTAL $198,326 $25,146 $33,147 $23,643 $68,180 $348,442
Non-Accruals $2,677
-----------
TOTAL LOANS, GROSS $351,119
</TABLE>
E-27
<PAGE>
Table 6, "Non-Accrual and Non-Performing Loans," summarizes the Bank's
non-performing loans for the last five years. Non-performing loans consist of
loans that have been placed on non-accrual status and loans that are delinquent
90 days or more. Non-accrual loans are loans where there is reasonable doubt as
to the collectibility of principal or interest on a loan. All non-accrual loans
carry a classified loan grade of either "substandard," "doubtful," or "loss."
The Bank stops recognizing income from the interest on the loan and reverses any
uncollected interest that had been accrued but not received. These loans may or
may not be adequately collateralized, and collection efforts are being pursued.
Troubled debt restructurings are loans which are on accrual status but which
have been restructured and are in compliance with modified terms.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
TABLE 6 - Non-Accrual, Non-Performing Loans and Troubled Debt Restructurings
- --------------------------------------------------------------------------------------------
(dollars in 000's)
December 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------- ------- -------
<S> <C> <C> <C> <C> <C>
Non-Accrual $2,677 $3,638 $13,087 $23,968 $27,565
90 Days or More Past Due 632 2,801 1,653 5,412 3,039
Troubled Debt Restructurings 2,334 2,363 1,451 6,941 -
------ ------ ------- ------- -------
Total $5,643 $8,802 $16,191 $36,321 $30,604
</TABLE>
E-28
<PAGE>
Management reviews all non-performing loans monthly and reports monthly to the
Board's Loan Committee on the status of these loans. Note Three of the Bank's
financial statements discusses the interest income from non-accrual loans in the
portfolio at year-end that was forgone as income because of the non-accrual
status.
From time to time, management has reason to believe that certain borrowers may
not able to repay their loans within the parameters of the present repayment
terms, even though, in some cases, the loans are current at the time. These
loans are graded in the classified loan grades of "substandard," "doubtful," or
"loss" and include non-performing loans. Each classified loan is monitored
monthly. At year-end 1997, classified loans totaled $17,892,000, or 5.1% of the
loan portfolio. The corresponding amounts for 1996 were $36,340,000, or 11.0%
of the portfolio. Except as provided above, there are no loans where known
information about possible credit problems of borrowers causes management to
have serious doubt as to the ability of such borrowers to comply with the
present loan repayment terms and which may result in such loans becoming
non-performing loans.
Other information about the loan portfolio is presented here which may be
helpful to readers of this report.
Foreign Loans: The Bank does not have and does not plan to have foreign loans
in its portfolio.
Participations: Occassionally, the Bank will sell a portion of a loan to
another bank. Banks usually sell a portion of a loan as a means of
accommodating a large borrowing customer and staying within the Bank's maximum
credit limit for loans to any one borrower.
Loan Concentrations: The Bank's concentration profile of the loan portfolio is
discussed in Note Three of the accompanying financial statements. The Bank's
one material concentration of loans is in the real estate category.
E-29
<PAGE>
Table 7, "Summary of Loan Loss Experience," shows the additionals to,
charge-offs against, and recoveries for the Bank's reserve for possible loan
losses over the past five years. Also shown is the ratio of charge-offs to
average loans for each year.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
TABLE 7 - Summary of Loan Loss Experience
- --------------------------------------------------------------------------------------------------------------------
---------------- -------------- -------------- -------------- --------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance of the Reserve for Possible
Loan Losses at Beginning of Year $10,437,972 $11,343,172 $13,216,619 $20,214,348 $9,760,041
Charge-offs:
Construction & Development Loans -- ($73,000) ($1,155,975) ($7,299,242) ($365,673)
Real Estate Loans ($161,940) ($692,245) ($1,113,215) ($1,648,631) ($3,754,143)
Home Equity Credit Lines ($14,772) ($292,636) ($278,112) ($358,492) ($96,549)
Installment Loans ($174,196) ($216,117) ($194,251) ($376,511) ($304,770)
Commercial Loans ($288,154) ($1,118,646) ($1,242,233) ($935,664) ($1,037,097)
Credit Cards and related Loans ($213,392) ($215,178) ($216,351) ($162,416) ($210,399)
----------- ----------- ----------- ----------- -----------
Total Charge-offs ($852,454) ($2,607,822) ($4,200,137) ($10,780,956) ($5,768,631)
----------- ----------- ----------- ----------- -----------
Recoveries:
Construction & Development Loans $43,718 $908,140 $1,616,011 $794,216 --
Real Estate Loans $83,557 $96,060 $148,902 $6,431 $1,300
Home Equity Credit Lines $20,392 $23,027 $49,050 $12,463 --
Installment Loans $96,145 $81,927 $80,654 $257,860 $97,398
Commercial Loans $1,369,624 $545,408 $385,448 $232,384 $114,189
Credit Cards and related Loans $51,666 $48,060 $46,625 $29,873 $10,051
----------- ----------- ----------- ----------- -----------
Total Recoveries $1,665,102 $1,702,622 $2,326,690 $1,333,227 $222,938
----------- ----------- ----------- ----------- -----------
Net Recoveries (Charge-offs) $812,648 ($905,200) ($1,873,447) ($9,447,729) ($5,545,693)
Provision for Possible Loan Losses
Charged to Operations $0 $0 $0 $2,450,000 $16,000,000
----------- ----------- ----------- ----------- -----------
Balance at End of Year $11,250,620 $10,437,972 $11,343,172 $13,216,619 $20,214,348
----------- ----------- ----------- ----------- -----------
Ratio of Net Recoveries/Charge-offs During
the Period to Avg. Loans Outstanding 0.24% -0.27% -0.56% -2.82% -1.66%
During the Period
</TABLE>
E-30
<PAGE>
Table 8, "Average Deposits and Interest Rates," shows the average amount of
deposits for the last three years, the interest paid and the rates.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
TABLE 8 - Average Deposits and Interest Rates
- ----------------------------------------------------------------------------------------------------------------------------------
(dollars in 000's)
1997 1996 1995
------------------------------ ----------------------------- ------------------------------
Balance Interest Rate Balance Interest Rate Balance Interest Rate
----------- --------- -------- ---------- ---------- ------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-Bearing Deposits:
Interest Bearing NOW $148,111 $1,457 0.98% $180,701 $1,840 1.02% $177,295 $2,092 1.18%
Savings, Money Market $239,696 $5,066 2.11% $204,539 $4,725 2.31% $217,541 $5,375 2.47%
Time Deposits $202,933 $10,414 5.13% $185,140 $9,416 5.09% $167,094 $8,532 5.11%
----------- --------- -------- ---------- ---------- ------- ---------- ---------- --------
Total Interest-Bearing Deposits $590,740 $16,937 2.87% $570,380 $15,981 2.80% $561,930 $15,999 2.85%
Non-Interest Bearing Deposits $126,130 $116,913 $103,225
----------- ---------- ----------
Total Deposits $716,870 $687,293 $665,155
----------- ---------- ----------
----------- ---------- ----------
</TABLE>
E-31
<PAGE>
Table 9, "Maturity Distribution of Time Certificates of Deposits of $100,000,"
shows the maturity distribution of time deposits of $100,000 or more and those
under $100,000.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
TABLE 9 - Maturity Distribution of Time Certificates of Deposit
- ---------------------------------------------------------------------------------------------------------
(dollars in 000's)
At December 31, 1997
----------------------------------------------------------------------------------------
Three After three After six After One
Months or Months to Months to Year to After
Size Less six months one year Three Years Three Years Total
- ---------------- --------------- --------------- ------------- --------------- --------------- ----------
<S> <C> <C> <C> <C> <C> <C>
$100,000 or
more $21,624 $13,359 $9,521 $4,133 $675 $49,312
Under
$100,000 $51,491 $45,844 $32,670 $26,045 $5,390 $161,440
--------------- --------------- ------------- --------------- --------------- ----------
Total $73,115 $59,203 $42,191 $30,178 $6,065 $210,752
</TABLE>
E-32
<PAGE>
Table 10, "Financial Ratios," shows certain financial ratios for the last
three years.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
TABLE 10 - Financial Ratios
- --------------------------------------------------------------------------------------------------
Years Ended December 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Return on Average Assets 1.67% 0.58% 0.09% -1.38% -0.95%
Return on Avg. Shareholders' Equity 18.85% 7.00% 1.16% -18.01% -7.47%
Dividend Payout Ratio 6.15% 0.00% 0.00% 0.00% -10.71%
Average Shareholders' Equity
to Average Assets Ratio 8.87% 8.32% 7.58% 7.68% 9.10%
</TABLE>
E-33
<PAGE>
ITEM 2. PROPERTIES
Owned by Bank or Subsidiary
<TABLE>
<CAPTION>
LOCATION OF OFFICES
ENCUMBRANCE
<S> <C> <C>
Arroyo Grande* 991 Bennett Avenue NONE
Arroyo Grande 1026 Grand Avenue NONE
Arroyo Grande* 550 Camino Mercado NONE
Arroyo Grande* 398 Sunrise Terrace NONE
Atascadero 6950 El Camino Real $212,613.00
Buellton West Highway 246 & Central NONE
Cambria 1070 Main Street NONE
Goleta Valley 5956 Calle Real NONE
Grover Beach 899 Grand Avenue NONE
Grover Beach* 140 North Second Street NONE
Lompoc 828 North "H" Street NONE
Los Osos 1001 Los Osos Valley Road NONE
Morro Bay 251 Harbor Street NONE
Nipomo 615 West Tefft NONE
Paso Robles 845 Spring Street NONE
Pismo Beach 801 Price Street NONE
San Luis Obispo 75 Santa Rosa NONE
San Luis Obispo 2276 Broad Street NONE
Santa Maria 1554 South Broadway NONE
Santa Maria 519 E. Main Street NONE
</TABLE>
E-34
<PAGE>
<TABLE>
<CAPTION>
LEASED BY BANK OR SUBSIDIARY
<S> <C> <C>
Cayucos 107 North Ocean Avenue $1,400.00 per month
Expires November, 2002
Paso Robles 705 Golden Hill Road $9,420.00 per month
Expires, August, 2000
Oak Knolls - Orcutt 1110 East Clark, Santa Maria $8,959.00 per month
Expires October, 2000
Oak Park - Pismo Beach 865 Oak Park Boulevard $9,584.00 per month
Expires March, 2008
Santa Barbara 921 Carpinteria $9,195.03 per month
Expires May, 2017
Santa Ynez 3600 Sagunto $2,000.00 per month
Expires May, 2002
Solvang 1600 Copenhagen Drive $8,331.62 per month
Expires April, 1998
</TABLE>
*ALL OFFICES LISTED ABOVE ARE FULL-SERVICE OFFICES, EXCEPT THOSE WITH ASTERISKS
NOTED ABOVE. ASTERISKS REPRESENT NON-BANKING SUPPORT OFFICES (E.G.,
ADMINISTRATION, DATA PROCESSING, SUPPLIES WAREHOUSE, CREDIT SERVICES, ET. AL.).
ITEM 3. LEGAL PROCEEDINGS
The Bank is, from time to time, subject to various pending and threatened legal
actions which arise out of the normal course of its business. The Bank is not a
party to any pending legal or administrative proceedings (other than ordinary
routine litigation incidental to the Bank's business) and no such proceedings
are known to be contemplated.
There are no material proceedings adverse to the Bank to which any director,
officer, affiliate of the Bank or 5% shareholder of the Bank, or any associate
of any such director, officer, affiliate or 5% shareholder of the Bank is a
party, and none of the above persons has a material interest adverse to the
Bank.
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 1997.
E-35
<PAGE>
- --------------------------------------------------------------------------------
PART II
- --------------------------------------------------------------------------------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
There is a limited over-the-counter market for the Common Stock. The Common
Stock is not currently listed on any exchange or market; but certain information
concerning the Stock is reported on the Nasdaq electronic bulletin board under
the symbol "MTTB."
The information in the following table indicates the high and low stock sales
prices of the Bank's Common Stock for each quarterly period during the last two
years without adjustment for the two 5% stock dividends declared in the fourth
quarter of 1997 and 1996.
<TABLE>
<CAPTION>
QUARTER ENDED SALES PRICES
------------- --------------------------------
1996 LOW HIGH
---- --- ----
<S> <C> <C>
March 31 $9.50 $12.00
June 30 $11.25 $15.00
September 30 $11.75 $12.75
December 31 $11.88 $16.00
<CAPTION>
1997 LOW HIGH
---- --- ----
<S> <C> <C>
March 31 $15.00 $21.00
June 30 $16.375 $22.00
September 30 $19.75 $23.75
December 31 $22.75 $30.85
</TABLE>
HOLDERS
As of March 1, 1998, there were approximately 2,652 holders of the Bank's Common
Stock. There are no other classes of common equity outstanding.
DIVIDENDS
The following table sets forth information concerning all quarterly cash and
stock dividends paid since January 1, 1996.
<TABLE>
<CAPTION>
PAYABLE DATE DIVIDEND
------------ --------
<S> <C>
January 19, 1996 5% - Stock
January 27, 1997 5% - Stock
July 25, 1997 $0.12 per share - Cash
January 23, 1998 5% - Stock
</TABLE>
E-36
<PAGE>
Whether or not stock dividends or any cash dividends will be paid in the future
will be determined by the Board of Directors after consideration of various
factors. The Bank's profitability and regulatory capital ratios in addition to
other financial conditions will be key factors considered by the Board of
Directors in making such determinations regarding the payment of dividends by
the Bank.
California law restricts the amount available for cash dividends by California
state banks, such as the Bank, to the lesser of retained earnings or the bank's
net income for its last three years (less any distributions made to shareholders
by the bank during such period). Notwithstanding this restriction, a bank may,
with the prior approval of the DFI, make a distribution to its shareholders in
an amount not exceeding the greater of the retained earnings of the bank, net
income for such bank's last fiscal year or the net income of the bank for its
current year. Additionally, bank regulatory agencies have authority to prohibit
banks from engaging in activities that, in their respective opinions, constitute
unsafe and unsound practices in conducting its business. It is possible,
depending upon the financial condition of the bank in question and other
factors, that the bank regulatory agencies could assert that the payment of
dividends or other payments might, under some circumstances, be such an unsafe
or unsound practice. Further, the bank regulatory agencies have established
guidelines with respect to the maintenance of appropriate levels of capital by
banks or bank holding companies under their jurisdiction. Compliance with the
standards set forth in such guidelines and the restrictions that are or may be
imposed under the prompt corrective action provisions of federal law could limit
the amount of dividends which the Bank may pay.
E-37
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Financial Summary Mid-State Bank
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data) YEAR ENDED DECEMBER 31,
1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest Income $ 57,300 $ 52,043 $ 51,675 $ 49,155 $ 52,313
Interest Expense 17,136 16,158 16,640 14,157 17,685
- ------------------------------------------------------------------------------------------------------------------------------------
Net Interest Income 40,164 35,885 35,035 34,998 34,628
Provision for Loan Losses -- -- -- 2,450 16,000
Non-interest income 12,956 12,722 11,992 10,890 11,120
Non-interest expense 37,683 41,371 48,051 54,300 38,091
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 15,437 7,236 (1,024) (10,862) (8,343)
Provision for income tax expense (benefit) 2,000 2,825 (1,675) -- (620)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 13,437 $ 4,411 $ 651 $ (10,862) $ (7,723)
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Per Share:
Earnings Per Share (adjusted for stock dividends) -- basic $ 1.95 $ 0.64 $ 0.09 $ (1.57) $ (1.12)
Earnings Per Share (adjusted for stock dividends) -- diluted 1.94 0.64 0.09 (1.57) (1.12)
Cash dividends 0.12 -- -- -- 0.12
Dividend payout ratio 6.15% -- -- -- (10.71%)
Stock dividend 5% 5% 5% 5% 5%
Book value at December 31 11.29 9.82 9.82 8.46 12.34
Shares outstanding at December 31 6,905,100 6,576,689 6,264,780 5,967,661 5,678,998
Non-accrual loans 2,677 3,638 13,087 23,969 27,565
Loans past due 90 days or more 632 2,801 1,653 5,412 3,039
Other Real Estate Owned 2,511 6,160 10,298 13,397 11,793
AT DECEMBER 31,
Cash and cash equivalents $ 73,708 $ 73,392 $ 71,310 $ 76,004 $ 86,889
Investments and Fed Funds Sold 383,171 344,511 304,972 244,396 213,061
Loans, net 338,281 319,190 302,932 337,513 390,007
Other assets 47,140 55,338 79,172 100,039 120,189
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 842,300 $ 792,431 $ 758,386 $ 757,952 $ 810,146
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Non-interest bearing deposits $ 137,626 $ 122,396 $ 109,907 $ 112,471 $ 107,825
Interest bearing deposits 619,429 592,329 575,425 580,877 597,200
Other borrowings 4,495 7,424 5,589 8,992 26,437
Other liabilities 2,784 5,718 5,961 5,115 8,583
Shareholders' equity 77,966 64,564 61,504 50,497 70,101
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 842,300 $ 792,431 $ 758,386 $ 757,952 $ 810,146
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
For the year:
Return on assets 1.67% 0.58% 0.09% -1.38% -0.95%
Return on equity 18.85% 7.00% 1.16% -18.01% -7.47%
Net interest margin 5.68% 5.58% 5.80% 5.54% 5.24%
Net loan charge-offs (recoveries) to avg. loans (0.24%) 0.29% 0.56% 2.51% 1.30%
Efficiency ratio 70.9% 85.1% 102.2% 118.3% 83.3%
At December 31:
Equity to average assets (leverage ratio) 9.2% 8.1% 8.1% 7.7% 8.6%
Tier one capital to risk-adjusted assets 14.9% 13.6% 12.7% 11.7% 14.7%
Total capital to risk-adjusted assets 16.2% 14.8% 14.0% 13.0% 15.9%
Loan loss allowance to loans, gross 3.2% 3.2% 3.6% 3.8% 4.9%
Non-accrual loans to total loans 0.79% 1.14% 4.32% 7.10% 7.07%
Non performing assets to total assets 0.69% 1.59% 3.30% 5.64% 5.23%
Allowance for loan losses to non performing loans 340.0% 162.1% 77.0% 45.0% 66.1%
</TABLE>
E-38
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis
INTRODUCTION AND BUSINESS OF THE COMPANY
Mid-State Bank (the Bank or Mid-State) 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 23 offices in
communities throughout San Luis Obispo and Santa Barbara counties. Based on
data supplied by Banks in its trade area, Mid-State is the 2nd largest Bank in
terms of total assets and is one of 13 independent commercial banks operating in
the two county area (the Central Coast banks). Of the 310 banks in the State of
California, only 23 of them were chartered to do business prior to Mid-State.
The following discussion and analysis will provide insight and supplementary
information into the accompanying consolidated financial statements of Mid-State
Bank. It also provides Management's assessment of the operating trends over the
past few years and certain of their expectations for 1998.
Following this section, five areas are reviewed, including; 1) 1997 results and
accomplishments, 2) the environment impacting the Bank, 3) an analysis of the
statement of financial position, 4) an analysis of income and expense, 5) a
review of activity at the Bank's wholly owned subsidiaries (Mid Coast Land
Company and MSB Properties), 6) a review of common stock price, dividend
history, and information concerning the annual meeting of the Bank, and 7)
subsequent event information.
Reference is made to the accompanying consolidated financial statements and
notes to those statements. Comparable data from peer banks in Mid-State's trade
area are based on results from 12 of those institutions' Call Reports which were
supplied to their regulatory agencies as of September 30, 1997 (the 13th Bank
did not commence operations until late December). These data are the latest
available as of the time of this writing.
The Management's Discussion and Analysis (MD&A) includes "forward-looking
statements" within the meaning of Section 27A of the Securities Act. All of the
statements contained in the MD&A, other than statements of historical fact,
should be considered forward-looking statements, including, but not limited to,
those concerning (i) the Bank's strategies, objectives and plans for expansion
of its operations, products and services, and growth of its portfolio of loans,
investments and deposits, (ii) the Bank's beliefs and expectations regarding
actions that may be taken by regulatory authorities having oversight of the
operation, and (iii) the Bank's beliefs as to the adequacy of its existing and
anticipated allowances for loan and real estate losses. Although the Bank
believes the expectations reflected in those forward-looking statements are
reasonable, it can give no assurance that those expectations will prove to have
been correct. All subsequent written and oral forward-looking statements by or
attributable to the Bank or persons acting on its behalf are expressly qualified
in their entirety by this qualification. Investors are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date hereof and are not intended to give any assurance as to future results. The
Bank undertakes no obligation to publicly release any revisions to these
forward-looking
E-39
<PAGE>
statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
1997 RESULTS
FINANCIAL
For 1997, Mid-State Bank on a consolidated basis reported Net Income of $13.4
million compared to $4.4 million in 1996. The diluted Earnings Per Share was
$1.94 compared to a Per Share of $0.64 in the previous year. Consolidated total
assets at December 31, 1997 were $842.3 million compared to $792.4 million at
December 31, 1996, up approximately 6.3%. Total deposits also increased from
$714.7 million as of December 31, 1996 to $757.1 million at year-end 1997.
Shareholders' common equity stood at $78.0 million at period-end up from its
$64.6 million level a year earlier, owing primarily to net income of $13.4
million for 1997. Also impacting shareholders' equity were the unrealized gain
on securities available for sale of $1.7 million which is up from $908 thousand
one year earlier, as well as, cash dividends paid during 1997 of $789 thousand.
As the table below illustrates, net income was generated by both the Bank and
MSB Properties, but was reduced on a consolidated basis by the loss incurred at
Mid Coast Land Company. Mid Coast Land Company's loss is related principally to
1) continued charges to expense for possible losses on investments in real
estate of $2.0 million (down from $5.5 million charged to expense in 1996) and
2) expenses related to San Luis Bay Estates of $1.2 million which consist of net
gains and losses on home sales at San Luis Bay Estates and the direct
administrative expense associated with this project.
INCOME OR (LOSS) BY SUBSIDIARY
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Bank only, pre-tax $16,125,511 $11,779,371 $8,235,903
MSB Properties, pre-tax 2,202,580 2,024,333 1,695,018
Mid Coast Land Co., pre-tax (2,891,383) (6,568,161) (10,955,284)
Tax Expense (credit) 2,000,000 2,825,000 (1,675,000)
- ----------------------------------------------------------------------------------------------------
Consolidated Bank $13,436,708 $4,410,543 $650,637
</TABLE>
Economic vitality has improved significantly from a few years earlier. A good
barometer of economic health is the level of non-accrual loans (which are
symptomatic of economic difficulties) held by Central Coast independent banks.
These had reached a low of 0.40% of total loans at the market peak (December 31,
1990), rising to 2.29% of total loans of the Central Coast Banks at the end of
1995. At the end of September 1997, they had declined to 0.93%. The Central
Coast Banks' net charge-off experience in 1997, representing actual bank losses
net of recoveries, while up slightly from 1996, was much improved over that
experienced a few years earlier. The collective net charge-off experience of
Central Coast banks is as follows:
E-40
<PAGE>
<TABLE>
<S> <C>
1997 (9 months annualized) 0.28%
1996 0.24%
1995 0.88%
1994 0.95%
1993 1.01%
1992 0.52%
1991 0.34%
1990 0.25%
</TABLE>
The Bank's allowance for loan losses, which serves as a "buffer" against loan
losses, experienced losses totaling $852 thousand charged against it.
Recoveries of loans previously charged-off amounted to $1.7 million which were
credited back to the allowance. Management felt that the ending allowance for
loan losses of $11.3 million, or 3.2% of gross consolidated loans, was
sufficient to cover loan losses inherent in the portfolio and therefore did not
make any addition during the year beyond net recoveries.
NEW ACCOMPLISHMENTS IN 1997
In 1997, the Bank continued its efforts aimed at improving bank profitability,
enhancing customer service, expanding the products and services available to the
Bank's customers and improving the Bank's sales of these products and services
to its clientele. These are described below.
As the year began, the Bank became the first community bank on the Central Coast
to offer its customers home banking services. The service allows customers to
verify account balances, review cleared checks, pay bills, view account
activity, initiate stop payments, reconcile accounts, and transfer funds. The
service can be accessed in one of three ways -- by touch-tone telephone, by
screen phone or by personal computer. The system has a sophisticated security
system which assures that communications are confidential and the service is
password protected. By the end of the year, over 1,000 customers were
subscribing to the service. Management feels it is in a unique position to
offer a desirable blend of both person-to-person traditional, independent
banking and the streamlined world of modern day technological conveniences.
On January 15, 1997, the Board of Directors received notification from the
Federal Deposit Insurance Corporation (FDIC) that they had removed the Consent
Agreement under which the Bank had operated since January 1994. The action
removed a number of restrictions placed on the Bank. As reported in last year's
Annual Report, the improved condition of the Bank was anticipated to reduce the
FDIC related assessments, generating an actual savings in 1997 of $778 thousand.
In May, the Bank became the first on the Central Coast to offer the new Medical
Savings Account (MSA) to customers. A MSA is a tax-exempt trust or custodial
account established for the purpose of paying medical expenses accompanying a
high-deductible health plan. Similar rules that apply to IRA's apply to the MSA
account. MSA's were created in response to the rising cost of health care, and
the great number of individuals and families with no health care insurance of
any kind. The intent of Congress in passing this legislation was to provide a
financial incentive for employers (including the self-employed) to purchase
health insurance. Businesses or individuals may contribute money to a MSA for
the purpose of paying health care expenses or certain health insurance premiums.
Mid-State Bank had some 80 MSA accounts totaling over $75 thousand in balances
at the end of 1997. These balances have grown steadily
E-41
<PAGE>
and predictably since the product's introduction. Given the lack of
availability of these accounts from other institutions, Management is hopeful
that this product will become increasingly utilized as its features become more
widely disseminated.
Late in the Spring, the Bank introduced its all-in-one, jumbo construction and
permanent financing loan. This loan allows the customer the ease and
convenience of acquiring a construction loan, as well as a permanent financing
loan, all in one, easy step. With Mid-State's new product, the customer need
only pay a one-time application, documentation and fee process compared to two
sets of fees using traditional methods. The loan was introduced with an 8.5%
fixed interest rate, no interest points, and financing starting at $125
thousand. The new loan product has met with a modest degree of success with 7
loans boarded during the year which totaled $3.2 million.
In June, the Bank also opened its first off-site ATM location at Allan Hancock
College. Located in the bookstore of the Santa Maria based college, customers
and non-customers can perform withdrawal and balance functions during regular
store hours. What is unique about this ATM location and all of Mid-State Bank's
machines is that Management has elected not to charge the customary surcharge
for using a cash machine not owned by their bank. These surcharges are paid to
the bank operating the ATM and supplement the fees many customers pay to their
own banks when they use another bank's machine. Activity at the machine now
equates to about 500 transactions per month.
Many of the Bank's customers were required by July 1, 1997 to begin to pay
federal taxes electronically. This Internal Revenue Service mandate effected
1.2 million taxpayers who paid at least $50,000 in employment taxes during 1995.
Customers were required to enroll in the government's Electronic Funds Tax
Payment System (EFTPS). For those customers who selected a remittance method of
ACH Credit, the Bank began arranging appointments for its representatives to
meet the customer and provide them with information about the Bank's BUSINESS
EXPRE$$product. This software program, which allows for the customer to
initiate ACH transfers, has now been sold to 72 customers of the Bank,
generating about 15,000 ACH transactions per month. The Bank also provides
customers training classes on using the program in its computer lab.
On August 15 1997, the Bank began providing drive-up banking services on
Saturday mornings. This expanded drive-up hours to 8 a.m. to 7 p.m., Monday
through Friday, and 8 a.m. to 12 p.m. on Saturdays. The extra hours were
provided to better accommodate the needs of customers allowing them to make
deposits, cash checks, apply for an ATM card, check balances and transfer funds
from the convenience of their cars. The Saturday opening was an immediate hit
with customers with over 1,000 transactions occurring on the first Saturday!
During the summer, the Bank also introduced a sales training program it has
coined "STP", or "Sales Through Productivity". The theme comes from the
marketing line of the well-known engine additive which advertises that it makes
engines run smoother, more efficiently and with less friction. The training
emphasizes "production" rather than "sales". The focus is on making contacts
rather than necessarily closing sales. The idea is to create a situation in
which employees can feel good about making a customer contact, and at the same
time relieve the pressure on them to "make a sale" on every contact. Over the
long run it is believed that this program will actually increase sales as it
will increase the number of contacts that Bank employees have with prospective
customers. As an adjunct to the introduction of this program, the Bank later
in the year introduced a customer service program called "Back to the Future",
E-42
<PAGE>
after the popular movie of the same name. The program emphasizes the five basic
steps of good customer service including friendly greeting, using the customer's
name, processing an efficient transaction, listening for clues about additional
customer needs, and closing with a friendly good-bye.
On October 1, 1997, the Bank implemented a program to reduce the dollar amount
of required reserves it is required to maintain at the Federal Reserve Bank.
This program allows the Bank to internally reclassify certain of its NOW account
deposits which carry a 10% reserve requirement to a non-transaction account
status which is not subject to any reserve requirement. This allows the Bank to
decrease a non-earning asset (cash) held at the Federal Reserve and invest these
funds in an earning asset such as loans or the investment portfolio. Total
additional earnings generated since implementation is estimated at about $113
thousand compared to one time expenses equal to approximately $80 thousand.
Future periods will continue to benefit (with no on-going expense) from this
improved utilization of assets provided the Federal Reserve Bank does not alter
its current approach to reserve requirement calculations. Management is not
aware of any pending changes to their approach.
AUTOMANIA 97 also began on October 1, 1997, with a Bank goal to book $1.5
million in automobile loans over the two month period of October and November.
All the offices and certain members of the Credit Service Center, Corporate
Banking and the Mortgage Department were divided into teams and competed with
one another for various awards. The Bank offered a special rate on these loans
with an objective of 1) increasing consumer loans, 2) preserving valued customer
relationships, and 3) offering an opportunity to attract non-customers to the
Bank. The Bank boarded 102 loans totaling $2.0 million during the promotion
which is about 2.5 times the average dollar volume generated for similar two
month periods preceding AUTOMANIA.
In addition to the items noted above, the Bank and its employees continue to be
dedicated to a multitude of community involvement activities. For example, the
Bank has raised in the past 14 years some $236 thousand for the March of Dimes
and its efforts to prevent birth defects. Countless hours of volunteerism are
offered to groups such as Special Olympics, the American Cancer Society, local
PTA's, local YMCA's, local United Ways, local Boys and Girls Clubs, youth
activities, senior activities, Hotline, Rotary, Kiwanis and many more.
Donations to these groups by the Bank (excluding employee contributions) totaled
over $51 thousand in 1997. The Bank also launched its first volunteer crew for
the Caltrans Adopt-A-Highway program during the year. The Bank is now
responsible for picking up litter and trash along a two mile stretch of Highway
101 in Arroyo Grande near the Traffic Way on-ramp.
Mid-State Bank, as well as other financial institutions, relies heavily on
effective computer communications between banks, data networks, data processing
centers and customers. Management and the Board of Directors have committed to
a Year 2000 Plan which the Bank has been busy implementing during 1997.
Contracts have been signed and schedules have been set to replace the Bank's
mainframe computer and software with a Year 2000 compliant system. The current
system was due for replacement after serving the Bank for over seven years. The
cost of the new computer system will be capitalized like any fixed asset and
depreciated over its expected useful life. The Bank expects depreciation expense
to increase by approximately $115,000 per month beginning in July 1998. Teams
have been formed to accomplish the
E-43
<PAGE>
conversion in 1998. Personnel have been assigned to assess the Bank's other
systems for Year 2000 compliance. These other systems include, but are not
limited to, in-house applications, outside vendor applications, environmental
systems and parties with whom we exchange information. The Bank's goal is to
modify or replace vulnerable systems, bringing the Bank into Year 2000
compliance by January 1, 1999. Other steps include the commitment of resources
to have a speaker address Year 2000 issues at the Bank's Annual Economic
Symposium, the mailing of Request for Compliance Assessment Letters to certain
of its credit customers, the issuance of Compliance Acknowledgment
Questionnaires to new credit customers, the design and distribution of printed
materials either through mailings or statement stuffers to customers, and
holding informational seminars for the Bank's business customers throughout the
Central Coast. The costs of these activities, which will be charged to expense,
are not expected to have a material affect on the consolidated statement of
financial position and results of operations.
The Bank logged over 700 in-person calls during 1997 under the Community
Reinvestment Act ("CRA") in its efforts to ascertain the financial and
non-financial needs of the community. Through these and other efforts, the Bank
was able to complete a number of CRA related activities. These activities cover
a wide spectrum from programs such as low interest storefront beautification
loans in Grover Beach, to participating with a consortium of local banks in the
purchase of $3.5 million of Certificates of Participation issued by Cuesta
College to construct a new campus in northern San Luis Obispo County.
Management is dedicated to continuing this community involvement in 1998 and
beyond.
PROGRESS REPORT ON PROGRAMS INTRODUCED IN RECENT YEARS
Recent year's Annual Reports outlined different programs introduced to improve
profitability and asset quality. As a follow-up to their introduction,
described below are updates as to how these programs are working during 1997.
One of the most critical goals for the Bank in recent years was to reduce the
level of non-earning, problem assets to acceptable levels. The establishment of
the Special Assets Department in 1994 was a key tactic in accomplishing this
goal. Its effectiveness can be viewed in the trends evident in the levels of
non-accrual loans, Other Real Estate Owned (OREO), and net charge-offs. The
table below outlines some key indicators in the improving quality of Bank
assets.
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Non Accrual Loans $2,677,133 $3,638,320
OREO, net $2,511,259 $6,160,468
Net Charge-offs
(Recoveries) $ (812,648) $ 905,200
</TABLE>
The reduction in non accrual loans and OREO will benefit future periods'
earnings as these balances, which had previously not been generating earnings
for the Bank, are liquidated and the funds reinvested. Net charge-offs
represent actual losses which are charged against the allowance for loan losses
and may often result in charges against earnings to replenish the allowance.
E-44
<PAGE>
The Bank's efforts to liquidate Mid Coast Land and its real estate development
holdings have been extensively documented in recent years. The Bank was able to
either complete development of certain holdings and sell the completed homes to
the general public or sell certain of the development projects in their existing
states of completion to interested third parties. These efforts have brought
forth significant reductions in the level of holdings in these properties, as
evidenced by the following chart:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Investments
in R. E $8,768,095 $14,163,121
Number of
Projects 3 4
</TABLE>
Mid Coast Land has been able to lower its holdings to $8.8 million in
investments in net real estate at year-end compared to more than $70 million at
the end of 1993. There is a reserve of $6.0 million which is netted against the
gross holdings of $14.8 million. Of the $14.8 million in gross holdings, about
83% is centered in one project - San Luis Bay Estates in Avila Beach. The Bank
plans to continue to aggressively market this project in the months ahead as it
completes the process of obtaining all appropriate entitlements to the
development. The project represents one of the last coastal development
projects (consisting of single family residences, planned unit developments,
condominiums and vacant lots) and is considered to be of prime sales potential.
The other 2 properties held by the company are small in comparison and should be
sold in the ordinary course of business. They represent commercial property in
the Five Cities area and some remaining acreage property at Ranchita Estates in
Arroyo Grande.
ENVIRONMENTAL FACTORS
ECONOMIC CONDITIONS
The most comprehensive review of local economic conditions known to Management
comes from the UCSB Economic Forecast Project which provides both annual
forecast information and periodic updates of economic conditions in the Bank's
trade area. The economy continues a steady improvement, as measured by a
variety of data. Perhaps the most important economic criteria is projected job
growth for the area's residents. In San Luis Obispo County, job growth is
expected to increase by 1.9% in 1997 compared to 3.7% in 1996. The unemployment
rate in San Luis Obispo County is expected to be at 4.8% at the end of 1997,
declining further according to the UCSB forecast to 4.5% by the end of 1998.
Santa Barbara County also saw steady job growth, with employment having
increased by some 4,000 jobs, or 2.6% over the 12 months ended in June.
Principal sectors creating this growth were the retail sector, the education
sector, construction and non-durable goods manufacturing. The unemployment rate
in Santa Barbara County was 4.6% at mid year.
Tourism in both counties has continued its steady rise. Hotel/motel occupancy
rates have seen steady improvement with overnight visitor frequency increasing
2.6% and hotel/motel room sales up 5.7% during 1997 in San Luis Obispo County.
Visitor spending has been estimated for 1997 to be up 7.2% to $394 million.
Similarly, in Santa Barbara County on the south coast, hotel/motel room sales
are up 6.4% indicating positive tourism trends there as well. This important
sector to the Bank's trade area appears to be healthy and improving.
E-45
<PAGE>
Solid retail sales figures were noted throughout the Bank's trade area,
especially in San Luis Obispo County, Santa Maria, and Santa Barbara. Retail
sales in San Luis Obispo County jumped a healthy 5.9% in 1997. While figures
for Santa Barbara County were not quite as dramatic, they too exhibited healthy
growth led by Santa Maria with an estimated 8.3% growth rate. Management would
expect retail sales growth, adjusted for inflation, to continue to grow in
excess of 4% in 1998.
Residential real estate sales were particularly strong in San Luis Obispo County
during 1997 and also up in Santa Barbara County. Home sales are estimated to be
up some 6% in San Luis Obispo County and 1.1% in Santa Barbara County (for the
first half of 1997). The median price of homes sold in San Luis Obispo
increased 6.6% (third quarter compared to third quarter) and 5.5% in Santa
Barbara County (based on first half of 1997). The UCSB Economic Forecast
Project is projecting an increase in selling prices for 1998 owing to a lack of
housing inventory going into the new year.
Interest rates are not expected to change dramatically during 1998. In last
year's Annual Report the Bank was anticipating "...that interest rates will
likely remain stable for much, if not all, of the year. There does not appear
to be any clear evidence portending the need to either tighten (raise interest
rates), or to become more accommodative (lower interest rates)....If there is to
be some movement in interest rates, it would appear that the bias would be
toward slightly higher levels." Indeed, the Federal Reserve has only adjusted
its target for the Fed Funds Rate once during 1997 from 5.25% to 5.50% back in
March. The 5.50% target is still being utilized as of the end of the year. The
Prime Rate, which often correlates to Fed Funds Rate movements, also increased
just one time to 8.50% from 8.25% in March. It too has remained unchanged
through the balance of 1997, ending the year at the same level. With these
basic rate monitors being fairly stable over the year, other indicators
displayed somewhat more fluctuation. For example, the 30 year Treasury Bond
which began the year at about 6.65%, rose to the low 7.0% range in March and
then fell in yield through much of the rest of the year to close at 5.92% at the
end of 1997. Similarly, the two year Treasury Note started at 5.88%, rose to
6.4% in March and then fell to 5.64% at the end of the year. While some
fluctuation in market interest rates is to be expected, rates have generally
been fairly stable this past year.
Management's expectations for 1998 would again be for relatively stable interest
rates for much, if not all, of the year. Factors arguing against any upward
movement in rates include; 1) the stable inflation statistics which continue to
be released, and 2) the uncertain conditions in foreign markets which are
negatively impacting the earnings of corporations in the United States. Factors
arguing against any drop in interest rates include; 1) a tight labor market, and
2) both lofty, and fairly volatile, stock market levels. Against this
back-drop, it seems that a more stable, middle of the road course on the part of
the Federal Reserve is most likely. These interest rate conditions, coupled
with the steady momentum developing in the local economy over the past few
years, would appear to indicate another favorable year for the local Central
Coast economy.
COMPETITIVE FACTORS
Competitive pressures from other financial institutions continue to be intense
both in Mid-State Bank's trade area and throughout the Nation. Many banks are
suffering from a lack of loan demand, which is translating into more aggressive
pricing on the good credits available. As noted in previous Annual Reports, in
Mid-State's local trade area, the major banks, absent from the market place in
the late 1980's and early 1990's are marketing loan products again. Various
E-46
<PAGE>
mortgage bankers are blanketing the central coast communities with sales
promotions and are extremely competitive with their rate programs. Brokerage
houses are indeed a factor through their marketing of mutual funds and numerous
banks are now offering these products. Currently, Mid-State Bank continues to
be reluctant to offer these products because of 1) the resultant capital
outflows from San Luis Obispo and Santa Barbara Counties which negatively impact
the local economy, 2) the very real potential for market losses to customers who
would purchase these products (who have not previously experienced losses on
their FDIC insured savings and checking accounts) and 3) the front-end fees
charged by some firms which offer these products. While there are positive
arguments for offering alternative investments, Mid-State Bank continues to
carefully analyze the feasibility of offering these deposit alternatives to its
customers.
It should also be noted that the trend toward consolidation of banking assets
exhibited over the past few years in the Bank's trade area continued in 1997.
Statewide, according to SNL Securities, there were 30 Bank and thrift mergers
announced during 1997, down from 42 in 1996. Locally, First Valley Bank of
Lompoc was acquired by Santa Barbara Bancorp during the year and El Camino
National Bank in Lompoc by the Bank of Santa Maria. With the completion of
these acquisitions, there were just 11 independent banks in the two county area
which Mid-State Bank serves, down from 17 as recently as the end of 1994. This
was short-lived, however, as two banks - Mission Community Bank and Coast
National Bank - both of which would have a presence in San Luis Obispo County,
opened during the year. Coast National began operations in June and Mission
Community opened in late December. These Banks mirror what is happening beyond
the Bank's trade area as 144 state and federally chartered commercial banks
started operating in 1996 and another 91 in 1997.
As more fully discussed in the Subsequent Event section at the end of the MD&A
and in Footnote No. 16 to the consolidated statements of financial position, the
Bank entered into an Agreement to Merge and Plan of Reorganization with BSM
Bancorp and its wholly owned subsidiary Bank of Santa Maria on January 29, 1998.
As mentioned in last year's Annual Report, the other trend in banking in
Mid-State's trade area mirrors what has happened throughout the State of
California. The larger institutions, most notably Bank of America and Wells
Fargo Bank, have closed a number of their traditional brick and mortar branches
in favor of an expanded "kiosk" type presence in local supermarket chains.
Moreover, they have continued to promote their electronic delivery capabilities
to their customer base. It is unclear over the long term how this strategy will
faire, however, and the Bank continues to secure a number of new customers
unhappy with this more de-personalized approach and the mergers of ever larger
institutions.
REGULATORY CONSIDERATIONS
As described in Footnote No. 15 to the Financial Statements, Mid-State Bank
through its Board of Directors operated under a written Consent Agreement with
the Federal Deposit Insurance Corporation pursuant to Section 8(b) of the
Federal Deposit Insurance Act from January 31, 1994 to January 14, 1997. The
Bank was released from that Agreement, effective January 15, 1997. Release from
that agreement was a significant milestone for the Bank in its efforts to reduce
its levels of problem assets and restore profitability. Moreover, it eliminates
some of the operating restrictions previously placed on it by the FDIC.
E-47
<PAGE>
LEGAL MATTERS
The Bank is involved in litigation of a routine nature which is being handled
and defended in the ordinary course of the Bank's business. In the opinion of
Management, based on the advice of legal counsel, the resolution of pending
litigation will have no material impact on the Bank's income or financial
position.
ANALYSIS OF STATEMENT OF FINANCIAL POSITION
LOANS
Mid-State Bank experienced an increase in its net loan portfolio from $319.2
million at the end of 1996 to $338.3 million at the end of 1997. This
represents continued growth of the loan portfolio of $19.1 million following the
$16.3 million increase in 1996. Management is encouraged by this improving
trend after having seen several years of declining totals. The portfolio had
actually been as high as $442.2 million at the end of 1991. Loans now represent
approximately 40% of Mid-State's assets which is down from its peak of 64% of
assets in 1989. Experiences at the independent banks in Mid-State's trade area
are similar. In 1989, loans were 66% of total bank assets among the 17
independent banks. As of September 30, 1997 this figure had declined to 55% of
the remaining 12 independent bank assets. The Investment Portfolio has grown in
absolute dollars, as well as a percentage of assets, over this period of time as
funds are being allocated to this portion of the balance sheet. The section
immediately following provides a more extensive discussion of the Investment
Portfolio.
The composition of the loan portfolio is changing as well. The graph below
displays the trend over the past five years in the various components of the
loan portfolio.
[GRAPH]
E-48
<PAGE>
Construction loans have fallen from their level three years earlier - $41.9
million at December 31, 1994 compared to $23.4 million at year-end 1997. In a
similar manner, Home Equity Credit Lines have also declined from $75.1 million
at the end of 1994 to $52.7 million at the end of 1997. Consumer loans
(installment, credit cards and credit reserve) have exhibited modest growth over
the 3 year period reaching $32.3 million at year-end 1997 compared to $26.8
million at the end of 1994. Commercial loans have especially grown over the
last 18 months having reached $69.2 million at December 31, 1997. Real Estate
loans generally trended down from $160.0 million at the end of 1994 to nearly
$139.3 million at December 31, 1995, but then grew back to $173.5 million by the
end of 1997. The Bank expects to continue to emphasize other types of lending
activity in order to diversify the risk in those categories relative to term
real estate loans. Economic recovery 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.
Recoveries in 1997 of loans previously charged-off totaled $1.7 million which
was actually greater than the charge-offs of $852 thousand taken during the year
resulting in NET RECOVERIES of $813 thousand. This represents a dramatic
turn-around from the actual loan losses (net of recoveries) sustained during
1996 of $905 thousand, $1.9 million in 1995 and $9.4 million in 1994. The Bank
anticipates that charge-offs (actual losses) will continue at the reduced levels
witnessed during 1997. It is unlikely however that recoveries would again
exceed charge-offs in the coming year.
The Bank's allowance for loan losses stands at $11.3 million, or 3.2% of gross
loans, as an accrual for losses inherent in the Loan Portfolio but not yet
realized. This amount is up from the $10.4 million at December 31, 1996. The
year-end 1997 balance now represents 420% of non-accrual loans up from 287% at
the end of 1996. A five year review of activitiy in the allowance for loan
losses and an allocation by loan type of the allowance is shown in the two
tables below.
E-49
<PAGE>
<TABLE>
<CAPTION>
ALLOWANCE FOR LOAN LOSSES 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $10,437,972 $11,343,172 $13,216,619 $20,214,348 $9,760,041
Provision charged to operating expense -- -- -- 2,450,000 16,000,000
Loans charged off:
Construction and development loans -- (73,000) (1,155,975) (7,299,242) (365,673)
Real estate loans (161,940) (692,245) (1,113,215) (1,648,631) (3,754,143)
Home equity credit lines (14,772) (292,636) (278,112) (358,492) (96,549)
Installment loans (174,196) (216,117) (194,251) (376,511) (304,770)
Commercial loans (288,154) (1,118,646) (1,242,233) (935,664) (1,037,097)
Credit cards and related loans (213,392) (215,178) (216,351) (162,416) (210,399)
Recoveries of loans previously charged off:
Construction and development loans 43,718 908,140 1,616,011 794,216 --
Real estate loans 83,557 96,060 148,902 6,431 1,300
Home equity credit lines 20,392 23,027 49,050 12,463 --
Installment loans 96,145 81,927 80,654 257,860 97,398
Commercial loans 1,369,624 545,408 385,448 232,384 114,189
Credit cards and related loans 51,666 48,060 46,625 29,873 10,051
- ------------------------------------------------------------------------------------------------------------------------
BALANCE AT END OF YEAR $11,250,620 $10,437,972 $11,343,172 $13,216,619 $20,214,348
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
AN ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES AT CURRENT AND PRIOR YEAR-ENDS
IS AS FOLLOWS:
<TABLE>
<CAPTION>
Percent Percent Percent Percent Percent
Balance applicable to: 1997 of Total 1996 of Total 1995 of Total 1994 of Total 1993 of Total
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Construction and development loans $ 334 3.0% $ 672 6.4% $ 2,070 18.2% $ 3,068 23.2% $ 6,656 32.9%
Real estate loans 2,474 22.0% 4,911 47.0% 4,536 40.0% 4,124 31.2% 4,246 21.0%
Home equity credit lines 656 5.8% 771 7.4% 1,136 10.0% 1,830 13.8% 2,469 12.2%
Installment loans 402 3.6% 196 1.9% 544 4.8% 892 6.7% 875 4.3%
Commercial loans 1,828 16.2% 1,290 12.4% 2,090 18.4% 3,050 23.1% 5,223 25.8%
Credit cards and related loans 650 5.8% 402 3.9% 486 4.3% 186 1.4% 711 3.5%
Unallocated 4,907 43.6% 2,196 21.0% 481 4.2% 67 0.5% 33 0.2%
BALANCE AT END OF YEAR $ 11,251 100.0% $ 10,438 100.0% $ 11,343 100.0% $ 13,217 100.0% $ 20,214 100.0%
</TABLE>
With the combination of the collateral securing the problem loans and the size
of the allowance for loan losses, Management feels that the allowance is more
than sufficient to cover inherent losses. Management reviews the adequacy of
the allowance and adjusts it as necessary on a regular basis. The allowance is
also examined annually by one or more of the Bank's regulatory bodies including
the FDIC and The State Of California Department of Financial Institutions. The
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.
E-50
<PAGE>
<TABLE>
<CAPTION>
Over Due after Due after
(dollars in 000's) 3 Months one year three years
3 Months through to three to five Due after
or less 12 Months years years five years Total
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
DECEMBER 31,1997
Fixed rate loans $ 3,979 $ 23,557 $ 33,147 $ 23,643 $ 68,180 $152,506
Floating rate loans 194,347 1,589 -- -- -- 195,936
- -----------------------------------------------------------------------------------------------------------------
Sub-total 198,326 25,146 33,147 23,643 68,180 348,442
Non accrual loans 2,677
Total Loans, gross $351,119
DECEMBER 31,1996
Fixed rate loans $ 13,470 $ 18,902 $ 34,327 $ 24,493 $ 52,179 $143,371
Floating rate loans 183,045 764 -- -- -- 183,809
- -----------------------------------------------------------------------------------------------------------------
Sub-total 196,515 19,666 34,327 24,493 52,179 327,180
Non accrual loans 3,638
Total Loans, gross $330,818
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Non-Accrual loans within Mid-State Bank's portfolio stood at $2.7 million as of
December 31, 1997, an improvement from the $3.6 million at the end of 1996.
Loans 90 days or more past due stood at $632 thousand at December 31, 1997 which
is down from the $2.8 million at the end of 1996. The improving level of
non-accrual loans is a reflection of gradually improving economic conditions,
the efforts of the Bank's problem resolution personnel and actual charge-offs of
prior period's problem assets. The vast majority of the loans on non-accrual
($2.4 million) are secured by real estate. There is potential for this
collateral to be liquidated to recover principal and unpaid interest. To the
extent this is not sufficient, a charge-off against the allowance may result.
Loans 90 days or more past due are all secured by real estate. It should be
noted that in certain cases, loans more than 90 days past due will not go into
non-accrual status because they are well secured and in the process of
collection.
A summary of maturities and sensitivities of loans to changes in interest rates
is shown in the table below. A more complete discussion of the Bank's exposure
to changes in interest rates can be found in the MD&A under the section titled
"Net Interest Income and Interest Rate Risk".
INVESTMENT PORTFOLIO
The Bank's Investment Portfolio primarily consists of US Treasury Notes and
Bills, Federal Agency Notes, Mortgage Backed Securities and Municipal Bonds.
See footnote No. 2 to the consolidated financial statements for a detailed
composition of the Investment Portfolio. Most of the growth in the portfolio
was centered in the Municipal Portfolio as it increased from $59.7 million at
the end of 1996 to $108.2 million at the end of 1997. The Bank has focused on
this segment of the portfolio because it generates better returns and there is
already ample liquidity with the Treasury and Agency portion of the portfolio
($246.3 million at year-end 1997). The U.S. Treasury portion of the portfolio
declined by $37 million while Federal Agencies and Mortgage Backed Securities
increased by $19.1 million.
The Bank may segregate its portfolio into three categories - a "Trading
Portfolio" (which requires continual mark to market accounting through the
income statement), a "Held to Maturity" portfolio (which is carried at
historical amortized cost) and an "Available for Sale"
E-51
<PAGE>
portfolio (which requires mark to market adjustments to the Bank's capital
account, but provides for the same income statement treatment as the
Held-to-Maturity portfolio.) The Bank holds no securities that should be
classified as Trading securities. The Bank has determined that since its
securities may be sold prior to maturity because of interest rate changes, to
meet liquidity needs, or to better match the repricing characteristics of
funding sources, its entire portfolio should be classified as Available for
Sale.
The mark to market adjustment on the Available for Sale portfolio resulted in
positive increases in stockholder's equity of $1.7 million and $908 thousand at
the December 31, 1997 and 1996, respectively.
During 1997, management sold certain bonds and had some called prior to their
stated maturities. In total these calls and sales had net gains, amounting to
$90 thousand. Proceeds from these sales and calls amounted to $47.8 million.
Notwithstanding these calls and sales and over $68.3 million in maturing
securities, purchases exceeded maturities/sales over the full year. The total
investment portfolio thus grew by $28.7 million from the end of 1996 to the end
of 1997.
OTHER REAL ESTATE OWNED ("OREO")
As noted in the financial statements, net OREO on the Bank's books stood at $2.5
million at December 31, 1997 compared to $6.2 million at the end of 1996. A
breakdown of year-end 1997 OREO by type shows that $771 thousand is construction
and land development, $74 thousand is residential single family real estate, and
$1.9 million is commercial real estate. The Bank created a real estate
valuation allowance to cover inherent uncertainties in the value of its real
estate holdings, which is netted against these amounts. At year-end 1997, this
allowance stood at $197 thousand compared to $967 thousand at the end of 1996.
OREO is held at the lower of cost or market on the Bank's Consolidated Statement
of Financial Position. However, given the economic circumstances prevalent in
the early 1990's where deteriorating conditions can lead to additional
write-downs on certain properties, Management continues to feel it is prudent to
maintain a valuation allowance. Given the recent stability of real estate
trends and the large decline in the Bank's holdings of OREO properties,
Management has determined that it is not currently necessary to add to this
allowance.
During 1997, the Bank received net proceeds from sale of OREO properties of $6.2
million. Of the proceeds amount, $1.2 million represented the sale of 9 single
family residences, $4.4 million represented the sale of 193 vacant lots, and
$477 thousand represented the sale of two commercial/industrial properties. The
Bank brought a smaller amount into OREO during 1997 ($1.1 million) than it sold
and consequently the year-end 1997 total was smaller than a year ago.
Additionally, the Bank made capitalized advances on OREO properties of $433
thousand in 1997 in order to complete their marketability. The Bank expects
additions to OREO in 1998 as it forecloses on certain loans which are unable to
meet their contractual obligations. Whether the additions to the OREO category
will exceed sales is impossible to predict. This will depend, among other
things, on the strength of the real estate market and general economic activity.
E-52
<PAGE>
DEPOSITS
While the Bank is competitive with major banks in terms of its structure of
interest rates on deposit products offered, it was not overtly aggressive during
1997 in terms of paying higher rates to attract additional deposits. Given the
current modest loan demand and the Bank's excess liquidity at the present time,
management does not feel the need to be especially aggressive on the rates being
paid. As a result, some of the more interest sensitive accounts, in particular
passbook savings, have actually declined in recent years. To be sure, much of
the decline in passbook has migrated to time deposits, however, the combination
of an improving economy and "non-aggressive" pricing on deposits has resulted in
a growth rate over the last few years of about 5% per year.
As mentioned earlier in this report, the Bank implemented a new program during
the year to reclassify certain of its NOW account deposits to the Money Market
category, thereby allowing it to reduce the amount of required reserves (which
are non-earning assets) that it holds at the Federal Reserve Bank. The average
amount of NOW accounts reclassified in the fourth quarter of 1997 has been
approximately 90%. At year end, the percentage was 77%. A summary of deposits
at December 31, 1997 and 1996 is shown in the table below.
<TABLE>
<CAPTION>
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Demand Deposits $137,625,799 $ 122,396,023
NOW Accounts 47,843,528 44,434,301
Money Market
Deposits 243,774,639 237,445,981
Passbook Savings 117,059,033 116,622,761
Individual
Retirement Accts 69,516,710 69,137,402
Other Time
Deposits 141,234,955 124,688,430
- --------------------------------------------------------------------------------
Total
Deposits $757,054,664 $ 714,724,898
</TABLE>
As discussed in the Income Statement Analysis, interest rates were little
changed during 1997 having only modestly affected the Bank's deposit rates.
This is readily seen in a comparison of the rates paid on the Bank's deposit
products at year-end 1997 compared to year-end 1996. Note also that the Wall
Street Journal Prime Rate is higher at year-end 1997 and had risen to this level
on March 26, 1997.
<TABLE>
<CAPTION>
SELECTED QUOTED INTEREST RATES 12/31/97 12/31/96 Change
- ------------------------------ ------------------------------
<S> <C> <C> <C>
Demand Deposits 0% 0% 0%
NOW Account
(50 & Better - over $10,000) 1.00% 1.00% 0%
Money Market Deposits
(over $2,500) 2.40% 2.40% 0%
Passbook Savings Account 2.25% 2.25% 0%
Individual Retirement
Account (2 Year term) 5.30% 5.25% + 0.05%
Time Deposit
($100,000 - 6 month term) 5.25% 5.10% + 0.15%
Wall Street Journal Prime Rate 8.50% 8.25% + 0.25%
</TABLE>
E-53
<PAGE>
OTHER BORROWINGS
While not a significant component of the Bank's structure, other borrowings
decreased from $7.4 million at the end of 1996 to $4.5 million at the end of
1997. These consist primarily of borrowings under the US Treasury Tax and Loan
note account, securities sold under agreements to repurchase and mortgages
payable. The Bank had outstanding borrowings of $2.5 million and $2.6 million
at December 31, 1997 and 1996, respectively, under the US Treasury Tax and Loan
note account program. Securities sold under agreement to repurchase were $1.75
million and $1.85 million at December 31, 1997 and 1996, respectively.
Mortgages payable were $213 thousand and $3.0 million at year-end 1997 and 1996,
respectively.
CAPITAL
Capital ratios for commercial banks in the United States are generally
calculated using 3 different formulas. These calculations are referred to as
the "Leverage Ratio" and two "risk based" calculations known as "Tier One Risk
Based Capital Ratio" and the "Total Risk Based Capital Ratio." The Bank is
subject to certain standards concerning these ratios. These standards were
developed through the joint efforts of banking authorities from 12 different
countries around the world. The standards essentially take into account the
fact that different types of assets have different levels of risk associated
with them. Further, they take into account the off-balance sheet exposures of
banks when assessing capital adequacy.
The Leverage Ratio calculation simply divides common stockholders' equity
(reduced by any goodwill a bank may have) by the total assets of the bank. In
the Tier One Risk Based Capital Ratio, the numerator is the same as the leverage
ratio, but the denominator is the total "risk-weighted assets" of the bank.
Risk weighted assets are determined by segregating all the assets and
off-balance sheet exposures into different risk categories and weighting them by
a percentage ranging from 0% (lowest risk) to 100% (highest risk). The Total
Risk Based Capital Ratio again uses "risk-weighted assets" in the denominator,
but expands the numerator to include other capital items besides equity such as
a limited amount of the allowance for loan losses, long-term capital debt,
preferred stock and other instruments. Summarized below are the Bank's capital
ratios at December 31, 1997 and 1996. Additionally, the standards for a well
capitalized institution, as defined by the federal banking agencies, are
displayed.
<TABLE>
<CAPTION>
Well-Capitalized Mid-State Bank
Regulatory --------------
Standard 1997 1996
-------- ---- ----
<S> <C> <C> <C>
Leverage Ratio 5.00% 9.2% 8.1%
Tier One
Risk Based
Capital Ratio 6.00% 14.9% 13.6%
Total Risk
Based
Capital Ratio 10.00% 16.2% 14.8%
</TABLE>
It is the intent of Management to continue to maintain strong capital ratios.
E-54
<PAGE>
LIQUIDITY
The focus of the Bank's liquidity management is to ensure its ability to meet
cash requirements. Sources of liquidity include Cash, Due From Bank Balances
(net of Federal Reserve requirements to maintain reserves against deposit
liabilities), Fed Funds Sold, Investment Securities (net of pledging
requirements), loan repayments, deposits and Fed Funds Borrowing lines. Typical
demands on liquidity are deposit run-off from demand deposits and savings
accounts, maturing time deposits which are not renewed, and anticipated funding
under credit commitments to customers.
Mid-State Bank has substantial liquidity at the present time. As a comparison,
its loan to deposit ratio at year-end was 44.7% versus 63.1% across all Central
Coast Banks. This means that the Bank has less of its deposits invested in the
loan portfolio which tends to be a less liquid asset than a typical investment
security. 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 57.5% at
December 31, 1997 which is above its normal desired range of between 15% and 30%
and is up slightly from the 56.0% level of one year earlier. Mid-State has a
larger percentage investment in real estate related assets through its Mid Coast
Land Company subsidiary. But even allowing for this difference, Mid-State Bank
has a substantially large liquidity position compared to other banking
institutions.
The Bank strives to make high quality loans to optimize earnings while still
maintaining adequate liquidity. Recent economic conditions have dictated that
the Bank operate with excess liquidity as it has been unable to build its loan
portfolio to the desired range. Management believes that its ability to do so
in the future will at least partly be dependent on the strength of the local
economy.
INCOME STATEMENT ANALYSIS
NET INTEREST INCOME AND INTEREST RATE RISK
Net Interest Income is the difference between interest and fees earned on all
earning assets and interest paid on interest bearing liabilities. Net Interest
Income for 1997 was $40.2 million, up from $35.9 million recorded in 1996 and
$35.0 million in 1995. The components of net interest income change in response
to both changes in rate, average balance and mix of both earning assets and
liabilities. The following table presents an analysis of yields/rates, interest
income and expense, and average balances for 1997, 1996, and 1995.
E-55
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
1997 Compared to 1996
(dollars in 000's) 1997 1996 Interest Income and Expense
- ------------------------------------------------------------------------------------------------------------------------------------
Average Average CHANGES DUE TO: Total
Balance Interest Rate Balance Interest Rate Volume Rate Change
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
EARNING ASSETS
Loans $335,029 $34,581 10.32% $312,431 $32,002 10.24% $2,324 $255 $2,579
Investment Securities $348,584 $21,518 6.17% $307,148 $18,858 6.14% $2,551 $109 $2,660
Fed Funds Sold & Other $23,934 $1,201 5.02% $23,558 $1,183 5.02% $19 ($1) $18
- ------------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets $707,547 $57,300 8.10% $643,137 $52,043 8.09% $4,893 $364 $5,257
INTEREST BEARING LIABILITIES
Savings and Interest Bearing
Transaction Accounts $387,807 $6,523 1.68% $385,240 $6,565 1.70% $43 ($85) ($42)
Time Deposits $202,934 $10,414 5.13% $185,140 $9,416 5.09% $909 $89 $998
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest-Bearing Deposits $590,740 $16,937 2.87% $570,380 $15,981 2.80% $952 $4 $956
Other Borrowed Funds $3,282 $199 6.06% $3,217 $177 5.50% $4 $18 $22
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest-Bearing Liabilities $594,022 $17,136 2.88% $573,597 $16,158 2.82% $956 $22 $978
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME $707,547 $40,164 5.68% $643,137 $35,885 5.58% $3,937 $342 $4,279
<CAPTION>
ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
1996 Compared to 1995
(dollars in 000's) 1995 Interest Income and Expense
- -----------------------------------------------------------------------------------------------------------------
Average CHANGES DUE TO: Total
Balance Interest Rate Volume Rate Change
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS
Loans $333,967 $35,349 10.58% ($2,243) ($1,104) ($3,347)
Investment Securities $253,003 $15,310 6.05% $3,300 $248 $3,548
Fed Funds Sold & Other $17,584 $1,015 5.77% $322 ($154) $168
- -----------------------------------------------------------------------------------------------------------------
Total Earning Assets $604,554 $51,674 8.55% $1,380 ($1,011) $369
INTEREST BEARING LIABILITIES
Savings and Interest Bearing
Transaction Accounts $394,836 $7,467 1.89% ($173) ($729) ($902)
Time Deposits $167,094 $8,532 5.11% $920 ($36) $884
- -----------------------------------------------------------------------------------------------------------------
Total Interest-Bearing Deposits $561,930 $15,999 2.85% $747 ($765) ($18)
Other Borrowed Funds $7,002 $640 9.14% ($277) ($186) ($463)
- -----------------------------------------------------------------------------------------------------------------
Total Interest-Bearing Liabilities $568,932 $16,639 2.92% $470 ($951) ($481)
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME $604,554 $35,035 5.80% $910 ($60) $850
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
During 1997, there was a $5.3 million increase in interest income along with a
smaller $1.0 million increase in interest expense compared to 1996. The
resulting $4.3 million increase in net interest income for 1997 is a result of a
number of dynamics affecting both average balance and interest rate
considerations. First, the Bank actually enjoyed an increase in its average
loan outstandings for the first time in several years. Secondly, the prime rate
on which many of Mid-State Bank's loans are tied was higher in 1997 (8.44%)
compared to 1996 (8.27%). Third, the volume of average earning assets was
higher on average in 1997 than in 1996 by some $64.4 million, while the Bank's
interest bearing liabilities increased by just $20.4 million. Fourth, interest
rates did not significantly impact the Bank's cost of funds during 1997. The
$850 thousand increase in net interest income for 1996 compared to 1995 was the
result of a number of different dynamics in those two years. First, the Bank
had experienced a decline in its average loans outstanding which caused an
increase in the relative percentage of funds placed in the lower yielding
investment portfolio. Secondly, the prime rate was lower on average in 1996
(8.27%) compared to the 1995 level (8.81%). Third, the volume of earning assets
was higher on average in 1996 than in 1995, which more than offset the negative
impact of lower interest rates on loan interest income. Fourth, the volume of
and the rates paid on other borrowings was lower in 1996 compared to 1995 which
substantially contributed to the reduced interest expense in 1996.
The Bank's risk exposure to changes in interest rates is minimal. A recent
review of the potential changes in the Bank's net interest income over the next
12 month time horizon showed that it could fluctuate under very extreme
alternative rate scenarios from between +3.7% and -6.8% of the base case (rates
unchanged) of $44.2 million. The Bank's policy is to maintain a structure of
assets and liabilities which are such that net interest income will not vary
more than plus or minus 15% of the base forecast over the next 12 months.
Management feels that its exposure to interest rate risk is manageable and it
will continue to strive for an optimal trade-off between risk and earnings.
E-56
<PAGE>
The following table presents a summary of the Bank's net interest income
forecasted for the coming 12 months under alternative interest rate scenarios.
<TABLE>
<CAPTION>
Change
From Base
---------
<S> <C>
Rates Down Very Significant -6.8%
(Prime down to 5.50% over 12 months)
Rates Down Significant -4.6%
(Prime down to 6.50% over 12 months)
Rates Down Modestly -3.6%
(Prime down to 7.00% over 12 months)
Base Case - Rates Unchanged --
(Prime unchanged at 8.50% over 12 months)
Rates Up Modestly +2.8%
(Prime up to 10.00% over 12 months)
Rates Up Aggressive +3.3%
(Prime up to 10.50% over 12 months)
Rates Up Very Aggressive +3.7%
(Prime up to 11.50% over 12 months)
</TABLE>
Net interest income under the above scenarios is influenced by the
characteristics of the Bank's assets and liabilities. In the case of savings
and money market deposits (total $408.7 million) interest is based on rates set
at the discretion of Management ranging from 1.00% to 2.40%. This
characteristic is the major reason why it is assumed that a 3% decline in Prime
decreases net interest income by 6.8% while a 3% increase in Prime only improves
net interest income by 3.7%. In a downward rate environment, there is a limit
to how far these deposit instruments can be re-priced and this behavior is
similar to that of fixed rate instruments. In an upward rate environment, the
magnitude and timing of changes in rates on these deposits is assumed to be more
reflective of variable rate instruments.
It is important to note that the above table is a summary of several forecasts
and actual results may vary. The forecasts are based on estimates and
assumptions of Management that may turn out to be different and may change over
time. Factors affecting these estimates and assumptions include, but are not
limited to - competitors' behavior, economic conditions both locally and
nationally, actions taken by the Federal Reserve Bank, customer behavior, and
Management's responses. Historically, the Bank has been able to manage its Net
Interest Income in a fairly narrow range reflecting the Bank's relative
insensitivity to interest rate changes. The impact of prepayment behavior on
mortgages, real estate loans, mortgage backed securities, securities with call
features, etc. is not considered material to the sensitivity analysis. As noted
in the Financial Summary at the beginning of the Management's Discussion and
Analysis, over the last 5 years, the Bank's net interest margin (which is net
interest income divided by average earning assets of the Bank) has ranged from a
low of 5.28% to a high of 5.80%. Based on the scenarios above, the net interest
margin under the alternative scenarios ranges from 5.33% to 5.86%. Management
feels this range of scenarios is reasonable, but no assurances can be given that
actual experience will fall within this range.
E-57
<PAGE>
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.
PROVISION FOR LOAN LOSSES
The Bank did not make a contribution to the allowance for loan losses in 1997,
1996 or 1995. The need for additional provision for loan losses in 1998 will be
dependent upon Management's on-going analysis of the adequacy of the allowance
for loan losses. While Management believes it to be adequate at the present
time, the appropriate value can fluctuate over time in response to economic
conditions and the subjective decisions which must be made in response to those
conditions.
NON-INTEREST INCOME
Non-Interest Income for 1997 totaled $13.0 million compared to $12.7 million in
1996 and $12.0 million in 1995. Service charges on deposit accounts were up
$156 thousand in 1997 over 1996 after having declined by $40 thousand in 1996
compared to 1995. Commissions, fees and other service charges increased by $348
thousand in 1996 over 1995 and by another $280 thousand in 1997. Earnings from
investments in real estate at Mid Coast Land Company continued their decline.
1996 earnings were $477 thousand lower than 1995 and 1997 earnings declined
again by $442 thousand to total just $507 thousand for the year. Prospects for
earnings in 1998 are lower still in light of the phase out of this business by
the Bank. Securities gains, net of losses, were $90 thousand in 1997 versus net
losses in 1996 and 1995 of $4 thousand and $93 thousand, respectively.
Other income increased by $145 thousand in 1997 to over $2.6 million after a
larger $788 thousand increase in 1996 over the $1.7 million earned in 1995. The
1997 increase actually was composed of a $500 thousand increase in recoveries of
prior years losses along with a $143 thousand gain on sale of fixed assets, a
$158 thousand improvement in rental income received on bank property and some
other minor improvements in income. These were partially offset in 1997 by a
$690 thousand reduction in gains on sale of ORE. The increase in other income
in 1996 over 1995 was attributable primarily to an increase in gains on sale of
ORE which were up $528 thousand from the prior year.
NON-INTEREST EXPENSE
Total non-interest expense for 1997 was $37.7 million which was down from $41.4
million in 1996 and $48.1 million in 1995. Employee salary expense over this
three year time frame has been relatively flat having increased 0.2% in 1997
over 1996 and 2.3% in 1996 over 1995. Employee benefits costs have increased at
a faster pace having grown from $3.2 million in 1995 to $3.8 million in 1996 and
$5.0 million in 1997. The increase over these three years is directly
correlated with the improved profits of the Bank and the resulting increasing
profit sharing contributions, increasing incentive reward system bonuses and the
resumption of deferred compensation for senior management (in 1997 only).
Occupancy expense has remained virtually unchanged throughout the last 3 years
at just over $5.4 million in 1995 and 1996 and just under $5.5 million in 1997.
Major capital expenditures for computer equipment and ATM's are planned for
1998. As this equipment comes on stream
E-58
<PAGE>
in the middle of the year, occupancy expense will increase as these items are
depreciated over useful lives of between 5 and 7 years. These items are
expected to cost approximately $7.1 million. No other major expenditures are
planned for 1998.
Expenses incurred from write-downs and provisions for losses on investments in
real estate fell to $2.0 million in 1997 from $5.5 million in 1996 and $9.7
million in 1995. These amounts were determined by reviewing appraisals, updated
annually, for each material investment in real estate. The Bank continues to
work towards divestiture of these activities to conform to the requirements of
the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA).
Management believes additional losses on real estate investments are possible as
it continues with its plans to divest itself of these activities, however, at
current carrying values, potential losses would seem less onerous and less
likely than they may have a few years ago. Management believes that the
allowance for losses on investments in real estate, which stood at $6.0 million
at December 31, 1997, is sufficient to cover these potential losses. However,
many factors, such as the local economy and regulatory timing in requiring
divestiture, over which the Bank has no control, could significantly effect
these activities.
OREO expense decreased from $3.4 million in 1995 to $1.1 million in 1996 and
$355 thousand in 1997. Included in the 1996 and 1995 figures were additional
contributions made to the Bank's real estate valuation allowance of $350
thousand and $2.2 million, respectively. No contributions were made to this
allowance in 1997. The adequacy of the allowance is determined by reviewing
appraisals, updated annually, for each material OREO property. The reduction in
OREO expense reflects lower foreclosures and an improved real estate market.
While the anticipated level of OREO expense for 1998 is unknown at this time, it
is expected that these costs will continue based on the level of additional
foreclosures from 1997. Management is hopeful however that the positive trend
seen in 1996 and 1997 will continue in 1998. The economic recovery underway is
certainly encouraging from this perspective.
Other operating expense decreased from $12.3 million in 1995 to $11.2 million in
1996, and $10.3 million in 1997. The decline in 1997 was primarily attributable
to three expense categories - a $228 thousand reduction in losses and other
special assets loan expense, a reduction of $769 thousand in FDIC insurance
premiums, and a $74 thousand reduction in professional services expenditures.
These reductions in expense from 1996 to 1997 were offset by modest increases in
other categories which in aggregate net to the $842 thousand decline in this
category for 1997. The decline from 1995 to 1996 of $1.1 million was due to two
major factors - a $1.3 million non-recurring charge taken in 1995 on a bank
property which represented capitalized construction costs written-off, and a
reduction of $502 thousand in FDIC insurance premiums. These reductions were
offset by modest increases in other categories which in aggregate net to the
$1.1 million reduction.
TAXES
As described in Footnote No. 8 to the financial statements, the Bank has
deferred tax assets primarily related to the timing difference associated with
the loss resulting from write-downs and provisions for losses on certain loans
and real estate assets. The amount generated for book purposes compared to the
actual loss experience recorded for tax purposes has been significantly
different. Because of regulatory restrictions on the amount of deferred tax
assets which can be recognized for financial reporting purposes, the Bank also
established a valuation allowance for taxes on the Consolidated Statement of
Financial Positions which totaled $3.7 million and $9.1
E-59
<PAGE>
million at December 31, 1997 and 1996, respectively. Specifically, the
limitation on the amount of the deferred tax assets is based on a number of
factors, including the level of projected future taxable income. The recent
reductions to the valuation allowance result primarily from an expectation of
increased future taxable income. The reduction in the valuation allowance
during 1997 directly benefited the tax expense recognized for the year, compared
to normal statutory tax rates. The valuation allowance increased in 1996
compared to 1995 by $1.5 million and thus 1996 tax expense recognized for the
year was actually higher compared to the normal statutory tax rates.
SUBSIDIARY ACTIVITY
MID COAST LAND COMPANY
Investments in real estate shown on the Consolidated Statement of Financial
Position principally represent the assets of the Bank's real estate development
subsidiary, Mid Coast Land Company. Footnote No. 5 to the accompanying
financial statements provides additional information about this wholly owned
subsidiary. As noted earlier, Mid Coast Land Company had a loss during 1997 of
$2.9 million, down from $6.6 million in the prior year, owing principally to a
reduction in the provisions it made for losses on investments in real estate of
$3.5 million.
Because of the progress made to liquidate the real estate development assets,
the FDIC granted an extension of the divestiture date in July 1996 for just over
two years to December 1998. The regional director of the FDIC may, at his sole
discretion, extend the deadline up to December 31, 2001, for good cause.
MSB PROPERTIES, INC.
This wholly owned subsidiary was formed to engage in the specific business of
acquiring, owning, and improving real property and tangible personal property
which may be necessary or convenient for the operation or housing of the
administrative departments and branch offices of Mid-State Bank. Incorporated
under the laws of the State of California in May of 1968, it also allows for the
ownership of property which may be reasonably necessary for future expansion of
the Bank's business, or which is otherwise reasonably related to the conduct of
the Bank's business, pursuant to Section 752 of the Financial Code of the State
of California.
Earnings for this subsidiary consist primarily of rental income from the Bank's
offices and administrative center coupled with a minor amount of rental income
from non-bank tenants and interest earnings on its cash assets. Expenses are
principally interest on mortgages, depreciation of leasehold improvements,
general maintenance and utilities expense. The affairs of the subsidiary are
managed by Bank employees and as such this subsidiary has no paid staff members.
Earnings for MSB Properties have increased over the years with net earnings
after-tax of $1.6 million, $1.3 million, and $961 thousand, in 1997, 1996 and
1995, respectively. The largest contributing factor for the increase in
earnings in 1997 was a one-time gain of $143 thousand on the sale of excess
property in San Luis Obispo. Leases are written with market terms and at market
rates.
E-60
<PAGE>
SUBSEQUENT EVENT
As disclosed in Footnote No. 16 to the accompanying consolidated financial
statements, on January 29, 1998, Mid-State Bank, Bank of Santa Maria, and BSM
Bancorp (parent company to Bank of Santa Maria) entered into a definitive
agreement to merge, subject to the approval of banking regulators and the
shareholders of both banks. The combined entity, Mid-State Bancshares, will have
assets of approximately $1.2 billion, the largest independent bank in San Luis
Obispo and Northern Santa Barbara Counties. The transaction is expected to be
accretive to Mid-State Bancshares earnings during 1999 based upon anticipated
improvements to the efficiency of the operations, resulting in expected
reductions in operating expenses. Additional earnings enhancements will result
from cross marketing efforts, increased lending capacity and increased market
presence.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Certain information concerning market risk is contained in the notes to the
financial statements which are included in Item 8 of this Report and in
Management Discussion and Analysis of Financial Condition and Results of
Operations which is included in Item 7 of this Report.
E-61
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Public Accountants
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF MID-STATE BANK:
We have audited the accompanying consolidated statements of financial position
of MID-STATE BANK (a California chartered state bank) and subsidiaries (the
Bank) as of December 31, 1997 and 1996, and the related consolidated statements
of income, changes in capital accounts and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Bank's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Mid-State Bank and subsidiaries
as of December 31, 1997 and 1996, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1997 in
conformity with generally accepted accounting principles.
Arthur Andersen LLP
Los Angeles, California
January 30, 1998
E-62
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
- ------------------------------------------------------------------------------------------------
DECEMBER 31,
ASSETS 1997 1996
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH AND DUE FROM BANKS $ 73,707,705 $ 73,392,050
FEDERAL FUNDS SOLD 10,000,000
SECURITIES, net:
U.S. Treasury securities 144,096,562 181,046,798
U.S. Government agencies and corporations 102,193,325 90,639,011
Mortgage backed securities 16,709,867 9,188,412
Obligations of states and political subdivisions 108,230,358 59,650,801
Other investments 1,940,735 3,985,840
- ------------------------------------------------------------------------------------------------
TOTAL SECURITIES 373,170,847 344,510,862
- ------------------------------------------------------------------------------------------------
LOANS, net 338,280,695 319,190,078
BANK PREMISES AND EQUIPMENT, net 20,463,227 18,942,856
ACCRUED INTEREST RECEIVABLE 7,221,397 7,286,475
INVESTMENTS IN REAL ESTATE, net 8,768,095 14,163,121
OTHER REAL ESTATE OWNED, net 2,511,259 6,160,468
OTHER ASSETS 8,176,545 8,785,223
- ------------------------------------------------------------------------------------------------
TOTAL ASSETS $842,299,770 $792,431,133
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
LIABILITIES
- ------------------------------------------------------------------------------------------------
DEPOSITS:
Demand deposits $137,625,799 $122,396,023
Savings and money market deposits 408,677,199 398,503,043
Time deposits--$100,000 or more 49,311,540 44,084,380
Time deposits--Under $100,000 161,440,126 149,741,452
- ------------------------------------------------------------------------------------------------
TOTAL DEPOSITS 757,054,664 714,724,898
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
OTHER BORROWINGS 4,494,599 7,424,187
ACCRUED INTEREST PAYABLE & OTHER LIABILITIES 2,784,213 5,717,667
- ------------------------------------------------------------------------------------------------
TOTAL LIABILITIES $764,333,476 $727,866,752
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (NOTE 10) -- --
CAPITAL ACCOUNTS
- ------------------------------------------------------------------------------------------------
Capital stock, no par value:
Authorized--10,125,000 shares
Outstanding--6,905,100 shares in 1997 and
6,576,689 in 1996 $ 29,939,105 $ 20,433,928
Undivided profits 46,327,622 43,222,297
Unrealized gain on securities available for sale, net of tax 1,699,567 908,156
- ------------------------------------------------------------------------------------------------
TOTAL CAPITAL ACCOUNTS 77,966,294 64,564,381
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
TOTAL LIABILITIES & CAPITAL ACCOUNTS $842,299,770 $792,431,133
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED STATEMENTS.
E-63
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
- ------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans and leases $34,581,319 $32,001,851 $35,349,252
Interest on securities:
U.S. Treasury securities 10,922,474 10,753,129 9,427,474
U.S. Government agencies and corporations 5,729,199 5,378,109 4,861,946
Obligations of states and political subdivisions, other 4,866,142 2,726,784 1,020,662
Interest on funds sold 1,200,755 1,183,456 1,014,995
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 57,299,889 52,043,329 51,674,329
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on deposits 16,936,569 15,981,025 15,998,845
Interest on mortgages payable, other 199,015 177,207 640,868
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 17,135,584 16,158,232 16,639,713
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME:
BEFORE PROVISION FOR LOAN LOSSES 40,164,305 35,885,097 35,034,616
Provision for loan losses -- -- --
- ------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 40,164,305 35,885,097 35,034,616
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME:
Service charges on deposit accounts 4,797,069 4,640,599 4,660,194
Commissions, fees and other service charges 4,918,314 4,638,173 4,289,776
Investments in real estate 506,873 948,601 1,425,212
Securities gains, net of (losses) 90,254 (4,210) (92,656)
Other income 2,642,927 2,498,046 1,709,704
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL OTHER INCOME 12,955,437 12,721,209 11,992,230
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
OTHER EXPENSES:
Salaries 14,494,341 14,468,287 14,146,389
Employee benefits 5,041,204 3,758,967 3,170,744
Occupancy expenses 5,477,735 5,403,284 5,400,985
Other real estate owned expense and provision 354,937 1,060,186 3,396,664
Write-downs and provisions for losses on
investments in real estate 1,977,248 5,500,000 9,667,116
Other operating expenses 10,337,569 11,180,039 12,269,311
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL OTHER EXPENSES 37,683,034 41,370,763 48,051,209
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
Income (loss) before taxes 15,436,708 7,235,543 (1,024,363)
Tax expense (benefit) 2,000,000 2,825,000 (1,675,000)
- ------------------------------------------------------------------------------------------------------------------------------
NET INCOME $13,436,708 $ 4,410,543 $ 650,637
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
Earnings per share
-- Basic $ 1.95 $ 0.64 $ 0.09
-- Diluted $ 1.94 $ 0.64 $ 0.09
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED STATEMENTS.
E-64
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF
CHANGES IN CAPITAL ACCOUNTS
- ------------------------------------------------------------------------------------------------------------------------------------
Unrealized Gain (Loss)
On Available
Number of Capital Undivided For Sale
Shares Stock Profits Securities Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1994 5,967,661 $12,632,321 $45,990,274 $(8,125,693) $50,496,902
5% stock dividend 297,119 3,118,022 (3,133,022) -- (15,000)
Over accrual of 1994 cash dividend on
partial shares related to 5% stock dividend -- -- 728 -- 728
Change in unrealized gain (loss)
on available for sale securities -- -- -- 10,370,310 10,370,310
NET INCOME -- -- 650,637 -- 650,637
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1995 6,264,780 $15,750,343 $43,508,617 $ 2,244,617 $61,503,577
5% stock dividend 311,909 4,683,585 (4,698,585) -- (15,000)
Over accrual of 1995 cash dividend on
partial shares related to 5% stock dividend -- -- 1,722 -- 1,722
Change in unrealized gain (loss)
on available for sale securities -- -- -- (1,336,461) (1,336,461)
NET INCOME -- -- 4,410,543 -- 4,410,543
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1996 6,576,689 $20,433,928 $43,222,297 $ 908,156 $64,564,381
5% stock dividend 327,738 9,497,175 (9,537,175) -- (40,000)
Under accrual of 1996 cash dividend on
partial shares related to 5% stock dividend -- -- (4,950) -- (4,950)
Change in unrealized gain (loss)
on available for sale securities -- -- -- 791,411 791,411
Cash Dividend -- .12 per share -- -- (789,258) -- (789,258)
Exercise of stock options 673 8,002 -- -- 8,002
NET INCOME -- -- 13,436,708 -- 13,436,708
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 6,905,100 $29,939,105 $46,327,622 $ 1,699,567 $77,966,294
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED STATEMENTS.
E-65
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net Income $ 13,436,708 $ 4,410,543 $ 650,637
Adjustments to reconcile net income to net
cash provided by operating activities:)
Provision for depreciation and amortization 2,521,335 2,566,960 2,591,994
Amortization of deferred loan fees (1,405,210) (1,296,906) (1,429,973)
Amortization of investment security premiums, net 509,279 729,838 927,981
Provision for OREO valuation allowance -- 350,000 2,200,000
Provision for losses on investments in real estate 1,977,248 5,500,000 8,150,000
Write-downs on bank premises and investments in real estate -- -- 1,517,116
Net gain on sales of other real estate owned (1,032,116) (1,721,727) (1,153,087)
Deferred tax (benefit) charge (4,071,000) 602,000 (3,043,000)
Securities (gains) losses, net (90,255) 4,210 92,656
Decrease (increase) in accrued interest receivable 65,078 (995,972) (386,125)
(Decrease) increase in accrued interest payable and other liabilities (2,933,454) (243,051) 845,460
Decrease (increase) in other assets 608,678 (598,901) (2,344,937)
- ------------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 9,586,291 9,306,994 8,618,722
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Proceeds from sales and maturities of securities 116,101,798 94,365,732 81,159,707
Purchases of securities (144,055,101) (151,915,259) (118,847,541)
Proceeds from sales of other real estate owned 6,196,530 9,169,542 9,478,179
Net (increase) decrease in loans (16,582,986) (17,968,104) 27,599,355
Advances on real estate investments -- (941,959) (13,364,358)
Receipts from real estate investments 4,105,482 14,463,839 21,259,605
Purchases of premises and equipment (5,389,327) (1,533,549) (1,102,203)
Proceeds from sales of premises and equipment 1,734,046 907,940 3,922,106
- ------------------------------------------------------------------------------------------------------------------------------------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (37,889,558) (53,451,818) 10,104,850
- ------------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net increase (decrease) in demand deposits, savings
and money market accounts 25,403,932 14,702,833 (34,699,458)
Net increase in time deposits 16,925,834 14,689,451 26,683,530
Net (decrease) increase in other borrowings (2,929,588) 1,834,957 (3,402,384)
Cash dividend paid (789,258) -- --
Proceeds from exercise of stock options 8,002 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 38,618,922 31,227,241 (11,418,312)
- ------------------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS 10,315,655 (12,917,583) 7,305,260
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 73,392,050 86,309,633 79,004,373
- ------------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 83,707,705 $ 73,392,050 $ 86,309,633
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information
Cash paid during the year for:
Interest (net of amounts capitalized) $ 17,186,434 $ 17,601,684 $ 16,900,269
Taxes on income, net 4,525,000 1,390,000 1,550,000
Non-cash activites--Transfer of loans to other real estate owned 1,102,421 3,007,144 8,411,028
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED STATEMENTS.
E-66
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The accounting and reporting
policies of Mid-State Bank and subsidiaries (the Bank) conform with generally
accepted accounting principles (GAAP) and general practice within the banking
industry. GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and dislosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. The following are descriptions of the more
significant accounting policies of the Bank.
CONSOLIDATION: The consolidated financial statements include the accounts of
Mid-State Bank and its wholly owned subsidiaries. Significant intercompany
accounts and transactions have been eliminated in the consolidated financial
statements.
STATEMENT OF CASH FLOWS: The Bank presents its cash flows using the indirect
method and reports certain cash receipts and payments arising from customer
loans and deposits and deposits placed with other financial institutions on a
net basis. Cash and cash equivalents include short-term, highly liquid
investments that generally have an original maturity of three months or less.
SECURITIES: Securities for which the Bank has the positive intent and ability to
hold until maturity are classified as held-to-maturity securities. Securities
which are purchased principally for the purpose of selling them in the near term
for a gain are classified as trading securities. Securities not classified as
held-to-maturity or trading are classified as available for sale. The Bank holds
no securities that should be classified as trading or held-to-maturity
securities. The Bank has determined that since its securities may be sold prior
to maturity because of interest rate changes, to meet liquidity needs, or to
better match the repricing characteristics of funding sources, its entire
securities portfolio should be classified as available for sale. These
securities are reported on the consolidated statements of financial position as
of December 31, 1997 and 1996 at their market value. The net unrealized gains or
losses for these securities are reported, net of related taxes, in the
statements of financial position as a separate component of the capital accounts
as of December 31, 1997 and 1996. Interest income from the securities portfolio
is accrued as earned including the accretion of discounts and the amortization
of premiums based on the original cost of each security owned.
LOANS: Loans are stated at face amount, less payments collected and deferred
loan fees. The allowance for loan losses, which is based on estimates, is
maintained at a level considered adequate to provide for losses that can be
reasonably anticipated. Ultimate losses may vary from the current estimates.
Management reviews these estimates periodically, considering the borrower's
financial status, current economic conditions, historical loan loss experience
and other factors. As adjustments become necessary, they are reported as
earnings in the periods in which they become known. The allowance is increased
by provisions charged to operating expense and reduced by net charge-offs.
In determining income recognition on loans, generally no interest is recognized
with respect to loans on which a default of interest or principal has occurred
for a period of 90 days or more. Loans are placed on non-accrual status when
management believes that the borrower's financial condition, after giving
consideration to economic and business conditions and collection efforts, is
such that the presumption of collectibility of interest no longer is prudent.
When a loan is placed on non-accrual status, previously accrued and uncollected
interest is reversed from income.
E-67
<PAGE>
OTHER REAL ESTATE OWNED: Other real estate owned (OREO), comprised of real
estate acquired through foreclosure, is carried at the lower of cost or
estimated fair value.
A real estate valuation allowance has been established and is netted against
other real estate owned to provide for fluctuations in the value of these
holdings that can be reasonably anticipated.
INVESTMENTS IN REAL ESTATE: Real estate acquired for sale or development is
stated at cost or market value, whichever is less. Real estate operations from
investments acquired for development are conducted and profits are shared
pursuant to agreements with outside joint venture investors and are accounted
for under the equity method. Gains on sales of such real estate are recognized
when certain criteria relating to the buyer's initial and continuing investment
in the property are met. Under certain circumstances, the gain, or a portion
thereof, may be deferred until the criteria are met. The Bank capitalizes
interest on funds disbursed during the active development phases of real estate
development projects and the construction of Bank premises.
The Bank's real estate development subsidiary, Mid Coast Land Company, has
established a reserve for losses on real estate investment activities. This
amount is netted against investments in real estate in the Consolidated
Statements of Financial Position.
BANK PREMISES AND EQUIPMENT: Bank premises and equipment are carried at cost,
less accumulated depreciation and amortization. Depreciation and amortization
are computed principally on the straight-line method over the lesser of the
estimated useful life of each type of asset or the lease term.
ACCOUNTING FOR INCOME TAXES: Deferred income tax assets or liabilities are
computed based on the difference between the financial statement and income tax
basis of assets and liabilities using the enacted marginal tax rate. Deferred
income tax expenses or benefits are based on the changes in the asset or
liability from period to period.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS
OF LIABILITIES: The Bank adopted Statement of Financial Accounting Standards
(SFAS) No. 125, "ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES," on a prospective basis beginning January 1,
1997. The statement establishes criteria based on legal control to determine
whether a transfer of a financial asset is a sale or a secured borrowing. A sale
is recognized when the Bank relinquishes control over a financial asset and is
compensated accordingly for such asset. The difference between the net proceeds
received and the carrying amount of the financial asset(s) being sold or
securitized is recognized as a gain or loss on sale.
The adoption of this statement did not have a material impact on the
consolidated financial position or results of operations of the Bank.
MORTGAGE SERVICING RIGHTS: The Bank adopted SFAS No. 122, "ACCOUNTING FOR
MORTGAGE SERVICING RIGHTS," on January 1, 1996. This statement amended the prior
accounting rules by requiring originated mortgage servicing rights retained to
be capitalized where the mortgage loans are either sold or securitized, based
upon the allocation of the cost between the loans sold or securitized and the
servicing rights retained based on their relative fair values. Servicing assets
E-68
<PAGE>
and liabilities are subsequently amortized in proportion to and over the period
of estimated net servicing income or loss. The impairment of mortgage serving
rights is evaluated by comparing the carrying amount to the estimate of fair
value. SFAS No. 125 superseded SFAS No. 122 and in general applies the
accounting for mortgage serving rights under SFAS No. 122 to servicing rights of
all assets.
NEW ACCOUNTING PRONOUNCEMENTS: The Financial Accounting Standards Board (FASB)
recently issued SFAS No. 129, "Disclosure of Information about Capital
Structure," SFAS No. 130, "REPORTING COMPREHENSIVE INCOME" and SFAS No. 131,
"DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION." SFAS No.
129 applies to all entities that issue any securities other than ordinary common
stock and continues the existing requirements to disclose the pertinent rights
and privileges of all securities. SFAS No. 130 provides guidance for reporting
and display of comprehensive income and its components in the financial
statements and SFAS No. 131 establishes standards for the way that public
entities report information about operating segments in annual financial
statements and requires that those entities report selected information about
operating segments in interim financial reports issued to shareholders. These
statements are effective for fiscal years beginning after December 15, 1997.
Management does not believe that the adoption of these statements will have a
material impact on the financial position or results of operations of the Bank.
The Bank will incorporate these disclosures at the time these pronouncements are
adopted.
RECLASSIFICATIONS: Certain items in the consolidated financial statements for
1997, 1996, and 1995 were reclassified to conform to the 1997 presentation.
- --------------------------------------------------------------------------------
1. CASH RESERVES
- --------------------------------------------------------------------------------
The average reserve balances required to be maintained by the Federal Reserve
Bank were approximately $10,881,000 and $24,564,000 at December 31, 1997 and
1996, respectively.
E-69
<PAGE>
- --------------------------------------------------------------------------------
2. SECURITIES
- --------------------------------------------------------------------------------
A SUMMARY OF INVESTMENT SECURITIES OWNED AS OF DECEMBER 31, 1997 AND 1996 IS AS
FOLLOWS:
<TABLE>
<CAPTION>
1997
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury securities $142,717,908 $1,453,843 $ 75,189 $144,096,562
Securities of U.S.
government agencies and corporations 101,814,054 503,728 124,457 102,193,325
Mortgage backed securities 16,748,969 24,363 63,465 16,709,867
Obligations of states and political subdivisions 107,157,777 1,166,754 94,173 108,230,358
Other investments 1,899,528 41,207 -- 1,940,735
- ---------------------------------------------------------------------------------------------------------------------
TOTAL $370,338,236 $3,189,895 $ 357,284 $373,170,847
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
<CAPTION>
1996
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury securities $179,923,294 $1,521,559 $ 398,055 $181,046,798
Securities of U.S.
government agencies and corporations 90,644,045 363,817 368,851 90,639,011
Mortgage backed securities 9,185,930 68,943 66,461 9,188,412
Obligations of states and political subdivisions 59,303,608 608,400 261,207 59,650,801
Other investments 3,937,035 48,805 -- 3,985,840
- ---------------------------------------------------------------------------------------------------------------------
TOTAL $342,993,912 $2,611,524 $1,094,574 $344,510,862
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
Securities having an amortized cost of $43,305,469 and $38,699,539 at
December 31, 1997 and 1996, respectively, were pledged to secure public deposits
and for other purposes as required by law.
The market value of securities at December 31, 1997, by contractual maturity,
along with weighted average yields, are shown below. Expected maturities may
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
(dollars in 000's)
After one After three After five
One Year year to years to years to After
or Less three years five years ten years ten years Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Maturity Distribution:
U.S. Treasury Securities $37,100 $ 80,209 $ 26,788 $ -- $ -- $144,097
Other U.S. Government Agencies
and Corporations 32,715 38,297 31,181 -- -- 102,193
Mortgage Backed Securities -- 3,699 5,734 1,320 5,957 16,710
State and Municipal Securities 13,674 27,217 41,563 24,548 1,228 108,230
Other Securities 504 1,435 -- -- 2 1,941
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $83,993 $150,857 $105,266 $25,868 $7,187 $373,171
<CAPTION>
After one After three After five
One Year year to years to years to After
or Less three years five years ten years ten years Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Weighted Average Yield:
U.S. Treasury Securities 6.01% 6.24% 6.41% -- -- 6.21%
Other U.S. Government Agencies
and Corporations 5.52% 6.21% 6.25% -- -- 6.00%
Mortgage Backed Securities -- 6.20% 6.51% 6.02% 6.92% 6.55%
State and Municipal Securities 6.67% 6.41% 6.57% 6.64% 6.42% 6.56%
Other Securities 6.83% 7.17% -- -- -- 7.07%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL 5.93% 6.27% 6.43% 6.61% 6.84% 6.27%
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Proceeds from calls, partial paydowns and/or sales of securities during 1997
were $47,842,053. Gross gains of $152,286 and gross losses of $62,031 were
realized on that activity. Included in U.S. Agency securities are certain
structured notes known as Index Amortization Notes. These notes, which carry
certain call features, had a fair market value of $6,012,656 and amortized cost
of $5,999,135 as of December 31, 1997. The Bank has no derivative financial
instruments as defined by SFAS No. 119, "Disclosure About Derivative Financial
Instruments and Fair Value of Financial Instruments."
E-70
<PAGE>
- --------------------------------------------------------------------------------
3. LOANS AND ALLOWANCE FOR LOAN LOSSES
- --------------------------------------------------------------------------------
THE LOAN PORTFOLIO CONSISTS OF THE FOLLOWING:
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Construction and development loans $ 23,414,140 $ 27,718,825
Real estate loans 173,548,529 153,566,271
Home equity credit lines 52,678,086 59,048,356
Installment loans 20,108,177 20,474,336
Commercial loans 69,202,912 58,922,763
Credit cards & related 12,166,748 11,087,579
- --------------------------------------------------------------------------------
351,118,592 330,818,130
- --------------------------------------------------------------------------------
Less allowance for loan losses (11,250,620) (10,437,972)
Less deferred loan fees (1,587,277) (1,190,080)
- --------------------------------------------------------------------------------
TOTAL LOAN PORTFOLIO $338,280,695 $319,190,078
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, $249,640,755 of the Bank's portfolio was collateralized by
various forms of real estate. The Bank attempts to reduce its concentration of
credit risk by making loans which are diversified by project type and geographic
locations throughout the Central Coast of California. While management of the
Bank believes that the collateral presently securing this portfolio is adequate,
there can be no assurances that a deterioration in the California real estate
market would not expose the Bank to significantly greater credit risk.
Loans on non-accrual status totaled $2,677,133 and $3,638,320 at December 31,
1997 and 1996, respectively. If interest income on non-accrual loans had been
recorded as originally scheduled, approximately $1,426,000, $1,496,000, and
$6,121,000 of additional interest income would have been recorded for the years
ended December 31, 1997, 1996 and 1995. Additionally, interest income which was
recognized for loans on non accrual totaled $313,142, $328,502, and $704,434,
for 1997, 1996, and 1995, respectively.
A loan is identified as impaired when it is probable that interest and principal
will not be collected according to the contractual terms of the loan agreement.
Because this definition is very similar to that used by bank regulators to
determine on which loans interest should not be accrued, the Bank expects that
most impaired loans will be on nonaccrual status. Therefore, in general, the
accrual of interest on impaired loans is discontinued, and any uncollected
interest is written off against interest from other loans in the current period.
No further income is recognized until all recorded amounts of principal are
recovered in full or until circumstances have changed such that the loan is no
longer regarded as impaired. There are some impaired loans about which there is
doubt regarding the collectibility of interest and principal according to the
contractual terms, but which are both fully secured by collateral and which are
current in their interest and principal payments. These impaired loans are not
classified as nonaccrual and $242,731 and $290,009 in interest was recognized
from these loans during 1997 and 1996, respectively. Under GAAP, certain types
of nonaccrual loans may not be included in the amounts reported as impaired.
E-71
<PAGE>
The amount of the valuation allowance for impaired loans is determined by
comparing the recorded investment in each loan with its value measured by one of
three methods: (1) the expected future cash flows discounted at the effective
interest rate; (2) the loan's observable market price, if available from a
secondary market; or (3) by valuing the underlying collateral. A valuation
allowance is computed as any amount by which the recorded investment exceeds the
value of the impaired loan. If the value of the loan as determined by one of the
above methods exceeds the recorded investment in the loan, no valuation
allowance for the loan is established. The following table discloses information
about the impaired loans and the allowance related to them.
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Loans identified as impaired at period end $ 4,229,313 $ 8,374,657
Impaired loans for which a valuation
allowance has been determined $ 2,550,682 $ 3,511,647
Impaired loans for which no valuation
allowance was determined necessary $ 1,678,631 $ 4,863,010
Amount of valuation allowance $ 629,384 $ 659,088
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
The average amount of the recorded investment in impaired loans during the year
ended December 31, 1997 and 1996 was approximately $6,006,000 and $12,333,000,
respectively.
The valuation allowance reported above is determined on a loan-by-loan basis or
by aggregating loans with similar risk characteristics. Because the loans
currently identified as impaired have unique risk characteristics, the valuation
allowance was determined on a loan-by-loan basis.
The Bank also provides an allowance for losses for (1) loans that while not
currently impaired are internally evaluated as having a relatively higher level
of credit risk and (2) losses inherent in the balance of the loan portfolio
which have not been specifically identified as of the period end. The allowance
is based on review of individual loans, historical trends, current economic
conditions, and other factors.
The valuation allowance for impaired loans is included within the overall
allowance for loan losses and netted against loans on the balance sheet for
December 31, 1997, 1996 and 1995. A summary of the changes in the allowance
account is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $10,437,972 $11,343,172 $13,216,619
Loans charged off (852,454) (2,607,821) (4,200,136)
Recoveries of loans previously
charged off 1,665,102 1,702,621 2,326,689
- --------------------------------------------------------------------------------
BALANCE AT END OF YEAR $11,250,620 $10,437,972 $11,343,172
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
AN ANALYSIS OF LOANS TO DIRECTORS AND OFFICERS IS AS FOLLOWS:
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Balance, at beginning of year $ 3,494,845 $ 4,449,471
Additional loans made 210,250 1,144,097
Payments received (1,196,116) (2,098,723)
- --------------------------------------------------------------------------------
BALANCE AT END OF YEAR $ 2,508,979 $ 3,494,845
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
These loans were made in the ordinary course of the Bank's business and, in
management's opinion, were made at prevailing rates and terms.
E-72
<PAGE>
- --------------------------------------------------------------------------------
4. BANK PREMISES AND EQUIPMENT
- --------------------------------------------------------------------------------
BANK PREMISES AND EQUIPMENT CONSISTED OF THE FOLLOWING:
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Land $ 6,719,173 $ 7,997,587
Buildings 11,355,019 11,570,056
Furniture and equipment 17,385,601 15,427,189
Construction in progress 434,316 344,058
- --------------------------------------------------------------------------------
35,894,109 35,338,890
Less--Accumulated depreciation and amortization (15,430,882) (16,396,034)
- --------------------------------------------------------------------------------
TOTAL PREMISES AND EQUIPMENT $20,463,227 $18,942,856
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
Depreciation and amortization included in occupancy expenses was $2,521,335,
$2,566,961, and $2,591,994 in 1997, 1996 and 1995, respectively, based on the
following estimated useful lives:
<TABLE>
<S> <C>
BUILDINGS 20-40 years
FURNITURE AND EQUIPMENT 3-20 years
</TABLE>
Total rental expense for banking premises was $598,307, $591,763, and $586,221,
in 1997, 1996 and 1995, respectively. As of December 31, 1997 the approximate
minimum future lease rentals payable under non-cancellable lease contracts for
bank premises were as follows:
<TABLE>
<CAPTION>
YEAR
- --------------------------------------------------------------------------------
<S> <C>
1998 $ 515,024
1999 486,696
2000 420,412
2001 266,154
2002 249,006
Thereafter 1,767,618
- --------------------------------------------------------------------------------
TOTAL LEASE COMMITMENTS $3,704,910
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
E-73
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
5. INVESTMENTS IN REAL ESTATE
- -----------------------------------------------------------------------------------------------------------------
DECEMBER 31,
REAL ESTATE HELD FOR SALE OR DEVELOPMENT INCLUDES THE FOLLOWING: 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Advances to and investments in real estate joint ventures $ 820,348 $ 933,765
Direct investments in real estate development 13,808,464 18,532,185
Interest capitalized on investments in real estate 183,815 521,455
Allowance for losses on investments in real estate (6,044,532) (5,824,284)
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN REAL ESTATE, NET $8,768,095 $14,163,121
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED INCOME (LOSS) FROM INVESTMENTS
IN REAL ESTATE FOR THE YEAR ENDED DECEMBER 31, 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Equity in gains (losses) of joint ventures $ 4,491 $ (89,063) $ 202,740
Income from direct investments 502,382 1,037,664 1,222,472
- -----------------------------------------------------------------------------------------------------------------
INCOME BEFORE WRITE-DOWNS AND PROVISIONS
FOR LOSSES ON INVESTMENTS IN REAL ESTATE $ 506,873 $ 948,601 $ 1,425,212
- -----------------------------------------------------------------------------------------------------------------
Write-downs charged to expense -- -- (256,000)
Provision for losses on investments in real estate (1,977,248) (5,500,000) (8,150,000)
- -----------------------------------------------------------------------------------------------------------------
NET (LOSS) FROM
INVESTMENTS IN REAL ESTATE $(1,470,375) $(4,551,399) $(6,980,788)
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
The Federal Deposit Insurance Corporation (FDIC) Improvement Act (FDICIA) became
law in December 1991. Under FDICIA the Bank was originally required to
substantially eliminate its real estate development activities by December 19,
1996. In July 1996, the Bank received an extension of the deadline for two years
to December 31, 1998. The Regional Director of the FDIC may, at his sole
discretion, extend the deadline to December 31, 2001, for good cause.
The Bank's real estate operations are significant to the local real estate
market. Based on current estimates of the fair value of the Bank's real estate
operations, management believes that the properties are carried at the lower of
cost or market. However, there can be no assurances that a deterioration in the
local real estate markets would not expose the Bank to the risk of significant
additional losses. Management continues to update the detailed business and
liquidation plans based on current market conditions for its various development
projects. If adjustments become necessary, they will be reported in earnings in
the period in which they become known.
E-74
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
6. OTHER REAL ESTATE OWNED
- -----------------------------------------------------------------------------------------------------------------
THE ANALYSIS OF THE ACTIVITY IN OTHER REAL ESTATE OWNED
IS SUMMARIZED AS FOLLOWS: 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year, gross $7,127,253 $11,276,800
Add: Additions and improvements 1,535,864 3,555,485
Less: Sales proceeds, net of gains (5,124,117) (7,447,815)
Net losses and write downs (830,842) (257,217)
- -----------------------------------------------------------------------------------------------------------------
BALANCE AT END OF YEAR, GROSS $2,708,158 $ 7,127,253
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
AN ANALYSIS OF THE CHANGES IN THE OREO VALUATION
ALLOWANCE IS AS FOLLOWS:
<CAPTION>
1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 966,785 $ 978,884
Current year provision charged to expense -- 350,000
Write downs (769,886) (362,099)
- -----------------------------------------------------------------------------------------------------------------
BALANCE AT END OF YEAR $ 196,899 $ 966,785
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
OREO is presented net of the valuation allowance on the statements of condition.
The OREO valuation allowance is based on estimates of management to account for
possible negative fluctuations in the near term in the value of these holdings.
- --------------------------------------------------------------------------------
7. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
Where applicable, the Bank is required by GAAP to disclose the fair value of
financial instruments and the methods and significant assumptions used to
estimate those fair values. In the case of financial instruments for which it is
not practicable to estimate the fair value, the Bank is required to disclose
information pertinent to estimating the fair value such as interest rates and
maturity, and also state the reasons why it is not practicable to estimate fair
value.
"Fair values of financial instruments depict the market's assessment of the
present value of net future cash flows directly or indirectly embodied in them,
discounted to reflect both current interest rates and the market's assessment of
the risk that the cash flows will not occur." The information about fair value
is said to better enable "investors, creditors, and other users to assess the
consequences of an entity's investment and financing strategies, that is, to
assess its performance."
Nonetheless, there are several factors which users of these financial statements
should keep in mind. First, there are uncertainties inherent in the process of
estimating the fair value of financial instruments. Secondly, the statement
covers financial instruments only, not other assets like premises and equipment,
the fair value of which might differ significantly from the amounts at which
they are carried in an entity's financial statements. Thirdly, the Bank must
exclude from its estimate of the fair value of deposit liabilities any
consideration of its ongoing customer relationships which provide stable sources
of investable funds. Lastly, these disclosures do not address means of
evaluating an entity's performance in areas other than the management of
financial instruments; for example, the ability to generate non-interest income
and the control of non-interest expense. For these reasons, users are advised
not to regard the disclosure of the fair market value of financial instruments
as in any way equivalent to a valuation of the Bank as a whole.
The following methods and assumptions were used to estimate the fair value of
each class of financial
E-75
<PAGE>
instruments for which it is practicable to estimate that value:
CASH AND DUE FROM BANKS AND FED FUNDS SOLD
For those short-term instruments, the carrying amount is a reasonable
estimate of fair value.
INVESTMENT SECURITIES
For securities held as investments, fair value equals quoted market price,
if available. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
LOAN RECEIVABLES
For certain homogeneous categories of loans, such as some residential
mortgages, credit card receivables, and other consumer loans, fair value is
estimated using the quoted market prices for securities backed by similar
loans, adjusted for differences in loan characteristics.
The fair value of other types of loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities.
DEPOSIT LIABILITIES
The fair value of demand deposits is the amount payable on demand. The
fair value of fixed-maturity certificates of deposit, savings accounts and
money market deposits is estimated using the rates currently offered for
deposits of similar remaining maturities.
OTHER BORROWINGS
Rates currently available to the Bank for debt with similar terms and
remaining maturities are used to estimate fair value of existing debt.
COMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT
Commitments to extend credit and letters of credit are written at current
market rates. The Bank does not anticipate any interest rate or credit
factors that would affect the fair value of commitments or letters of
credit outstanding at December 31, 1997.
THE ESTIMATED FAIR VALUES OF THE BANK'S FINANCIAL INSTRUMENTS ARE AS FOLLOWS:
<TABLE>
<CAPTION>
1997 1996
(in 000's) (in 000's)
- --------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $ 73,708 $ 73,708 $ 73,392 $ 73,392
Fed funds sold 10,000 10,000 -- --
Investment securities 373,171 373,171 344,511 344,511
Loans, net 338,281 341,099 319,190 321,417
- --------------------------------------------------------------------------------
Financial liabilities:
Deposits 757,055 751,158 714,725 709,988
Other borrowings 4,495 4,495 7,424 7,424
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
8. INCOME TAXES
- --------------------------------------------------------------------------------
E-76
<PAGE>
THE CURRENT AND DEFERRED AMOUNTS OF THE PROVISION (BENEFIT) FOR TAXES IN THE
YEARS ENDED DECEMBER 31, WERE:
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal:
Current $ 4,728,000 $ 1,187,000 $ 968,000
Deferred (3,694,000) 357,000 (2,194,000)
- -----------------------------------------------------------------------------------------------------
TOTAL FEDERAL TAXES $ 1,034,000 1,544,000 (1,226,000)
- -----------------------------------------------------------------------------------------------------
State:
Current 1,343,000 1,035,000 400,000
Deferred (377,000) 246,000 (849,000)
- -----------------------------------------------------------------------------------------------------
TOTAL STATE TAXES 966,000 1,281,000 (449,000)
- -----------------------------------------------------------------------------------------------------
TOTAL FEDERAL AND STATE TAX EXPENSE (BENEFIT) $ 2,000,000 $ 2,825,000 $ (1,675,000)
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
</TABLE>
THE PROVISION FOR TAXES ON INCOME DIFFERED FROM THE AMOUNTS
COMPUTED USING THE FEDERAL STATUTORY RATE OF 35 PERCENT AS FOLLOWS:
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tax expense (benefit)
at federal statutory tax rate $ 5,403,000 $ 2,460,000 $ (348,000)
Alternative minimum tax (credit) -- (472,000) (674,000)
State income expense 1,043,000 345,000 110,000
Change in valuation allowance (5,443,000) 1,466,000 (999,000)
Other, net 997,000 (974,000) 236,000
- -----------------------------------------------------------------------------------------------------
TOTAL TAX EXPENSE (BENEFIT) $2,000,000 $2,825,000 $(1,675,000)
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
</TABLE>
THE PRINCIPAL ITEMS GIVING RISE TO DEFERRED TAXES WERE:
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Allowance for loan losses $ (189,000) $ 425,000 $ 1,152,000
Provisions for OREO properties 918,000 335,000 126,000
Deferred compensation (69,000) 100,000 124,000
Real estate joint ventures 1,166,000 (331,000) (4,061,000)
Gain on loan workouts (631,000) (997,000) --
Depreciation (319,000) (182,000) (284,000)
Securities - discount accretion 124,000 134,000 110,000
State taxes (234,000) (225,000) 17,000
Change in valuation allowance (5,443,000) 1,466,000 (999,000)
Other, net 606,000 (123,000) 772,000
- -----------------------------------------------------------------------------------------------------
TOTAL DEFERRED TAXES $(4,071,000) $ 602,000 $(3,043,000)
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
AS OF DECEMBER 31, THE DEFERRED TAX ASSETS AND LIABILITIES ARE AS FOLLOWS:
E-77
<PAGE>
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Assets:
Allowance for loan losses $ 4,293,000 $ 4,104,000 $ 4,529,000
Provisions for OREO properties 1,251,000 2,169,000 2,504,000
Deferred compensation 1,105,000 1,036,000 1,136,000
Real estate joint ventures 7,787,000 8,953,000 8,622,000
Gain on loan workouts 1,628,000 997,000 --
All other, net 236,000 842,000 719,000
- -----------------------------------------------------------------------------------------------------
Total Assets 16,300,000 18,101,000 17,510,000
- -----------------------------------------------------------------------------------------------------
Liabilities:
Depreciation (239,000) (558,000) (740,000)
Securities -- discount accretion (388,000) (264,000) (130,000)
State taxes (657,000) (891,000) (1,116,000)
- -----------------------------------------------------------------------------------------------------
Total Liabilities (1,284,000) (1,713,000) (1,986,000)
- -----------------------------------------------------------------------------------------------------
Valuation Allowance (3,668,000) (9,111,000) (7,645,000)
- -----------------------------------------------------------------------------------------------------
Net deferred tax asset before tax effect of
unrealized gain on securities
available for sale $11,348,000 $ 7,277,000 $7,879,000
Tax effect of unrealized
gain on securities available for sale (1,133,000) (609,000) (1,538,000)
- -----------------------------------------------------------------------------------------------------
DEFERRED TAX ASSET, NET $10,215,000 $ 6,668,000 $6,341,000
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
</TABLE>
The valuation allowance primarily represents management's decision to reserve
for deferred taxes that are not anticipated to be offset by taxable income
projected for the next 12 months. The valuation allowance is based on estimates
by management which could change in the near term.
As of December 31, 1997, the Bank has no operating loss and tax credit
carryforwards for financial reporting purposes. There are also no alternative
minimum tax credit carryforwards for tax purposes.
- --------------------------------------------------------------------------------
9. OTHER BORROWINGS
- --------------------------------------------------------------------------------
Mid-State Bank's wholly owned subsidiaries have obtained first trust deed
mortgage financing for several of the properties and investments that they own.
Mortgages payable totaled $212,613 and $2,979,852 at December 31, 1997 and 1996,
respectively. Other borrowings also include borrowings under the Treasury Tax
and Loan note account of $2,531,986 and $2,594,335 at December 31, 1997 and
1996, respectively. Securities sold under agreement to repurchase are also
included in other borrowings of $1,750,000 and $1,850,000 at December 31, 1997
and 1996, respectively.
E-78
<PAGE>
- --------------------------------------------------------------------------------
10. COMMITMENTS AND CONTINGENCIES
- --------------------------------------------------------------------------------
At December 31, 1997 the Bank was contingently liable for letter of credit
accommodations made to its customers totaling $27,729,396. At December 31, 1997,
the Bank also had undisbursed loan commitments in the amount of $190,168,000.
Many of the commitments are expected to expire without being drawn upon.
Accordingly, the total outstanding commitment amount does not necessarily
represent future cash requirements. The Bank does not anticipate any significant
losses as a result of these transactions. Provision has been made for possible
losses which may be sustained in the fulfillment of, or from an inability to
fulfill, any commitments.
The Bank is involved in litigation of a routine nature which is being handled
and defended in the ordinary course of the Bank's business. In the opinion of
management, based on the advice of legal counsel, the resolution of this
litigation will have no material impact on the Bank's financial condition or
results of operations.
- --------------------------------------------------------------------------------
11. EARNINGS PER SHARE
- --------------------------------------------------------------------------------
Earnings per share (EPS) have been computed based on 6,905,100, 6,904,427,
and 6,904,427 shares in 1997, 1996 and 1995, respectively, which is the weighted
average number of shares outstanding each year. Outstanding shares for 1996 and
1995 have been restated to reflect the 5% stock dividends declared in 1997, 1996
and 1995.
The FASB has issued SFAS No. 128, "Earnings per Share". This statement is
effective for both interim and annual reporting periods ending after December
15, 1997. SFAS No. 128 replaces primary EPS with basic EPS, and fully diluted
EPS with diluted EPS. Basic EPS excludes dilution and is computed by dividing
income available to common stockholders by the weighted average number of common
shares outstanding for the period. Diluted EPS is computed in a similar manner
to fully diluted EPS, and reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Bank. All periods presented in the accompanying
consolidated financial statements have been restated to conform with SFAS No.
128. The following is a reconciliation of the numerators and denominators used
in the calculation of basic EPS and diluted EPS for the years ended December 31,
1997, 1996, and 1995.
E-79
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended 1997 Earnings Shares EPS
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Income $13,436,708
Basic Earnings Per Share:
Income available to Common Stockholders 13,436,708 6,905,100 $1.95
Effect of Dilutive Securities:
Stock Options 21,618
Diluted Earnings Per Share:
Income available to Common Stockholders and
assumed conversions 13,436,708 6,926,718 $1.94
For the Year Ended 1996
- -------------------------------------------------------------------------------------------------------
Net Income $4,410,543
Basic Earnings Per Share:
Income available to Common Stockholders 4,410,543 6,904,427 $0.64
Effect of Dilutive Securities:
Stock Options 7,120
Diluted Earnings Per Share:
Income available to Common Stockholders and
assumed conversions 4,410,543 6,911,547 $0.64
For the Year Ended 1995
- -------------------------------------------------------------------------------------------------------
Net Income $650,637
Basic Earnings Per Share:
Income available to Common Stockholders 650,637 6,904,427 $0.09
Effect of Dilutive Securities:
Stock Options 3,117
Diluted Earnings Per Share:
Income available to Common Stockholders and
assumed conversions 650,637 6,907,544 $0.09
</TABLE>
- --------------------------------------------------------------------------------
12. CAPITAL ACCOUNTS
- --------------------------------------------------------------------------------
The California Financial Code provides that a bank may not make a cash
distribution to its shareholders in excess of (1) the bank's undivided profits
or (2) the bank's net income for its last three fiscal years less the amount of
any distributions made by the bank to shareholders during such period. Under
these restrictions, the Bank can make cash dividends totaling $16,388,000 at
December 31, 1997. The Bank declared a 5% stock dividend and a $0.12 per share
cash dividend during 1997.
E-80
<PAGE>
- --------------------------------------------------------------------------------
13. STOCK OPTIONS
- --------------------------------------------------------------------------------
The Bank adopted a new stock option plan in 1990. A previous stock option plan
expired in 1989. The 1990 plan provides for the issuance of common stock to the
Bank's employees. Options are granted at a price not less than the fair market
value of the stock at the grant date. Options are exercisable and expire as
determined by the Board of Directors. However, options expire no later than five
years from the date of grant. The 1990 plan provides for issuance of up to
1,527,660 shares of common stock and is subject to termination as determined by
the Board of Directors. As of December 31, 1997, 72,492 shares are currently
under option. The shares are exercisable at prices ranging from $10.89 to
$13.34. No options were exercised during 1996 and 673 shares were exercised
during 1997.
The Bank applies Accounting Principles Board Opinion No. 25, "ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES," and related Interpretations in accounting for its
Stock Plan. Accordingly, no compensation expense has been recognized for grants
under the Stock Plan.
Consistent with the methods of SFAS No. 123, proforma compensation expense for
the Bank stock option plan had been determined based on the fair value at the
grant date. Fair values were estimated using the Black-Scholes option -pricing
model with the following weighted average assumptions used at August 15, 1996,
the date of the last options granted: 5% dividend yield, expected volatility of
50%, risk-free interest rate of 6.3% and expected lives of five years. The
Bank's net income and earnings per share for the years ended December 31, 1997,
1996 and 1995 would have been reduced to pro forma amounts indicated below:
<TABLE>
<CAPTION>
($in 000's except per share data)
1997 1996 1995
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income to common shareholders:
As reported $13,437 $4,411 $ 651
Pro forma 13,424 4,411 651
Net income per common and common share equivalent:
Basic earnings per share:
As reported $ 1.95 $ 0.64 $0.09
Pro forma $ 1.94 $ 0.64 $0.09
Diluted earnings per share:
As reported $ 1.94 $ 0.64 $0.09
Pro forma $ 1.94 $ 0.64 $0.09
</TABLE>
E-81
<PAGE>
A summary of the Bank's stock options as of December 31, 1997, 1996 and 1995,
and changes during the periods then ended, is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Avg. Exercise Avg. Exercise Avg. Exercise
Shares Price Shares Price Shares Price
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of period 73,581 $11.74 41,276 $17.24 62,500 $20.45
Granted -- -- 53,000 $12.00 -- --
5% Stock Dividend 3,428 (0.55) 3,504 (0.59) 2,064 (0.68)
Exercised/Expired (4,517) (11.60) (24,199) (19.91) (23,288) (24.00)
- --------------------------------------------------------------------------------------------------------------------------
Outstanding at
end of period 72,492 $11.19 73,581 $11.74 41,276 $17.24
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
14. EMPLOYEE BENEFITS
- --------------------------------------------------------------------------------
The Bank offers a combination qualified profit sharing plan (the Profit Sharing
Plan) and a savings and retirement plan designed to comply with Internal Revenue
Service Code Section 401(k) (the 401(k) Plan) to substantially all employees.
The Bank's contributions to the Profit Sharing and 401(k) Plans for the years
ended December 31, 1997, 1996, and 1995 were $1,063,000, $520,000, and $292,131,
respectively.
A Deferred Compensation Plan is also in effect to provide performance oriented
deferred compensation for the Bank's senior management. Allocations to the
participants accounts are made at the discretion of the Board of Directors. The
amount of contributions is determined by the Board of Directors as a function of
net profits and prior year return on equity. No contribution was made in
either 1996 or 1995. In 1997, $403,000 was contributed to the participants.
The Bank began a bonus incentive system in 1996 (the Incentive Reward System)
for many of the Bank's employees. A bonus is paid to selected employees who
exceed certain goals under formulas established at the start of the year.
Included in employee benefits expense for 1997 and 1996 was a charge of $667,850
and $190,750, respectively, which was accrued during those years and paid in the
following year. Approximately 487 employees received bonuses ranging from 1.1%
of their salary to as much as 10.6% of their salary.
- --------------------------------------------------------------------------------
15. REGULATORY MATTERS
- --------------------------------------------------------------------------------
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory--and possibly additional discretionary--actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classifications are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
E-82
<PAGE>
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations), and of Tier
I capital to average assets (as defined). Management believes, as of December
31, 1997, that the Bank meets all capital adequacy requirements to which it is
subject.
<TABLE>
<CAPTION>
To be Considered
Well Capitalized
For Capital For Capital
Actual Adequacy Purposes Adequacy Purposes
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1997:
Total Capital
(to Risk Weighted Assets) $82,708,000 16.2% $40,840,000 8.0% $51,050,000 10.0%
Tier One Capital
(to Risk Weighted Assets) $76,266,000 14.9% $20,420,000 4.0% $30,630,000 6.0%
Tier One Capital
(to Average Assets) $76,266,000 9.2% $33,150,000 4.0% $41,438,000 5.0%
AS OF DECEMBER 31, 1996:
Total Capital
(To Risk Weighted Assests) $69,557,000 14.8% $37,534,000 8.0% $46,917,500 10.0%
Tier One Capital
(to Risk Weighted Assets) $63,636,000 13.6% $18,767,000 4.0% $28,150,500 6.0%
Tier One Capital
(to Average Assets) $63,636,000 8.1% $31,453,040 4.0% $39,316,300 5.0%
</TABLE>
Notwithstanding the figures above, the Bank was required under the terms of a
Consent Agreement to maintain the ratio of tier one captial to average assets
above 7.5% as of December 31, 1996. The Board of Directors and management of the
Bank took various actions over the past few years to improve the condition of
the Bank and to comply with the terms outlined in the Consent Agreement. On
January 15, 1997, the FDIC and the Board of Directors of the Bank executed an
agreement which resulted in the removal of the regulatory order which was in
effect under the terms of the Consent Agreement. This removal eliminated various
restrictions imposed on the Bank by the FDIC.
- --------------------------------------------------------------------------------
16. SUBSEQUENT EVENTS (UNAUDITED)
- --------------------------------------------------------------------------------
On January 29, 1998 the Bank entered into an Agreement to Merge and Plan of
Reorganization (the "agreement") with BSM Bancorp ("Bancorp") and its wholly
owned subsidiary Bank of Santa Maria, Santa Maria, California pursuant to which,
among other things, (i) Bank of Santa Maria will merge with and into the Bank,
(ii) Bancorp will become the bank holding company for the Bank and change its
name to Mid-State Bancshares and (iii) the shareholders of the Bank will become
shareholders of Bancorp in accordance with the exchange ratio set forth in the
agreement, all subject to the terms and conditions specified in the agreement.
The merger is structured to be tax-free and is intended to be accounted for as a
pooling-of-interests. The exact exchange ratio for Bank shareholders will be
dependent upon the average closing price of Mid-State Bank stock during the 20
consecutive trading days ending at the end of the third day immediately
preceding the effective day of the transaction (estimated to be sometime in the
third quarter of 1998). Subject to certain conditions and a range of Mid-State
Bank stock prices, the value received by BSM Bancorp stockholders will be
equivalent to $29.37 per share, or about $90 million in the aggregate. Mid-State
Bank shareholders will own approximately 70% and BSM Bancorp shareholders
approximately 30% of Mid-State Bancshares upon completion of the transaction.
E-83
<PAGE>
Presented below is a condensed pro forma (unaudited) Statement of Financial
Position for the consolidated entity as of December 31, 1997.
<TABLE>
<CAPTION>
Mid-State BSM
Bank Bancorp Consolidated
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash and Due from Banks $73,707,705 $18,472,719 $92,180,424
Fed Funds Sold 10,000,000 7,461,000 17,461,000
Investment Securities
-Available for Sale 373,170,847 46,143,134 419,313,981
-Held to Maturity -- 62,767,464 62,767,464
Net Loans 338,280,695 189,231,140 527,511,835
Other Assets 47,140,523 19,970,159 67,110,682
- ---------------------------------------------------------------------------------------------------------
TOTAL ASSETS $842,299,770 $344,045,616 $1,186,345,386
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
Non-interest bearing Demand $137,625,799 $74,450,817 $212,076,616
Interest bearing NOW, Savings
and Money Market 408,677,199 114,900,337 523,577,536
Time Deposits 210,751,666 116,940,446 327,692,112
- ---------------------------------------------------------------------------------------------------------
Total Deposits 757,054,664 306,291,600 1,063,346,264
Other Liablilities 7,278,812 1,691,788 8,970,600
Total Equity Capital 77,966,294 36,062,228 114,028,522
- ---------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES & CAPITAL $842,299,770 $344,045,616 $1,186,345,386
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
</TABLE>
E-84
<PAGE>
MANAGEMENT STATEMENT
MID-STATE BANK IS RESPONSIBLE FOR THE PREPARATION, INTEGRITY, AND FAIR
PRESENTATION OF ITS PUBLISHED CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER
31, 1997 AND THE YEAR THEN ENDED. THE CONSOLIDATED FINANCIAL STATEMENTS HAVE
BEEN PREPARED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND,
AS SUCH, INCLUDE AMOUNTS, SOME OF WHICH ARE BASED ON JUDGMENTS AND ESTIMATES OF
MANAGEMENT.
INTERNAL CONTROL STRUCTURE OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective internal
control structure over financial reporting. The system contains monitoring
mechanisms, and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any system of internal
control, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control system
can provide only reasonable assurance with respect to financial statement
preparation. Further, because of changes in conditions, the effectiveness of an
internal control system may vary over time.
Management assessed its internal control structure over financial reporting as
of December 31, 1997. This assessment was based on criteria for effective
internal control over financial reporting described in "Internal
Control--Integrated Framework" issued by the Committee of Sponsoring
Organizations (COSO) of the Treadway Commission. Based upon this assessment,
management believes that Mid-State Bank maintained an effective internal control
structure over financial reporting as of December 31, 1997.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for compliance with the federal and state laws
and regulations concerning dividend restrictions and federal laws and
regulations concerning loans to insiders designated by the FDIC as safety and
soundness laws and regulations.
Management assessed its compliance with the designated laws and regulations
relating to safety and soundness. Based on this assessment, management believes
that Mid-State Bank complied, in all significant aspects, with the designated
laws and regulations relating to safety and soundness for the year ended
December 31, 1997.
James G. Stathos Carrol R. Pruett
Executive Vice President President
Chief Financial Officer Chief Executive Officer
E-85
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of Mid-State Bank:
We have examined management's assertions that Mid-State Bank maintained an
effective internal control structure over financial reporting as of December 31,
1997 included in the accompanying Management Statement.
Our examination was made in accordance with standards established by the
American Institute of Certified Public Accountants and accordingly, included
obtaining an understanding of the internal control structure over financial
reporting, testing, and evaluating the design and operating effectiveness of the
internal control structure and such other procedures as we considered necessary
in the circumstances. We believe that our examination provides a reasonable
basis for our opinion.
Because of inherent limitations in any internal control structure, errors or
irregularities may occur and not be detected. Also, projections of any
evaluation of the internal control structure over financial reporting to future
periods are subject to the risk that the internal control structure may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assertion that Mid-State Bank maintained an
effective internal control structure over financial reporting as of December 31,
1997, is fairly stated, in all material respects, based on INTERNAL
CONTROL-INTEGRATED FRAMEWORK issued by the Committee of Sponsoring Organizations
of the Treadway Commission.
Arthur Andersen LLP
Los Angeles, California
January 30, 1998
E-86
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
- --------------------------------------------------------------------------------
PART III
- --------------------------------------------------------------------------------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 of Form 10-K is incorporated by reference
from the information contained in the Bank's Proxy Statement for the 1998 Annual
Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by reference
from the information contained in the Bank's Proxy Statement for the 1998 Annual
Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of Form 10-K is incorporated by reference
from the information contained in the Bank's Proxy Statement for the 1998 Annual
Meeting of Shareholders which will be filed pursuant to Regulation 14A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 of Form 10-K is incorporated by reference
from the information contained in the Bank's Proxy Statement for the 1998 Annual
Meeting of Shareholders which will be filed pursuant to Regulation 14A.
E-87
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) EXHIBITS:
2.1 Agreement to Merge and Plan of Reorganization, dated as of January 29,
1998, filed as an exhibit to the Form 8-K filed February 2, 1998
3.1 Articles of Incorporation, as amended to date
3.2 Bylaws, as amended to date
4.1 Specimen form of Mid-State Bank stock certificate
10.1 1990 Stock Option Plan
10.2 Form of stock option agreement for use pursuant to 1990 Stock Option
Plan
10.3 Deferred Compensation Plan
10.4 Profit Sharing and Salary Deferral 401 (K) Plan
10.5 Change in Control Agreement for Carrol R. Pruett, President/Chief
Executive Officer
10.6 Change in Control Agreement for T. E. Reese, Executive Vice President
10.7 Change in Control Agreement for James G. Stathos, Executive Vice
President
21 All of the subsidiaries of Mid-State Bank are discussed in Item 1 of
this Report
(b) SCHEDULES:
Not Applicable
(c) REPORTS ON FORM 8-K
During the fourth quarter of 1997, the Bank did not file any Reports.
Notice of Annual Meeting and Proxy Statement for the Bank's 1998 Annual Meeting
will be mailed to security holders subsequent to the date of filing of this
Report. Copies of said materials will be furnished to the FDIC in accordance
with applicable rules and regulations.
E-88
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Bank has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MID-STATE BANK
By: /s/ CARROL R. PRUETT
--------------------------------
CARROL R. PRUETT
President and Chief Executive Officer
Dated: March 12, 1998
By /s/ JAMES G. STATHOS
--------------------------------
JAMES G. STATHOS
Executive Vice President
and Chief Financial Officer
Dated: March 12, 1998
E-89
<PAGE>
SIGNATURES
In accordance with the Securities Exchange Act of 1934, this report has
been signed by the following persons on behalf of the Bank and in the capacities
and on the dates indicated.
Dated:
/s/ ALBERT L. MAGUIRE Chairman of the March 12, 1998
- --------------------------- Board
ALBERT L. MAGUIRE
/s/ GRACIA B. BELLO Director March 12, 1998
- ---------------------------
GRACIA B. BELLO
/s/ CLIFFORD H. CLARK Director March 12, 1998
- ---------------------------
CLIFFORD H. CLARK
/s/ DARYL L. FLOOD Director March 12, 1998
- ---------------------------
DARYL L. FLOOD
/s/ RAYMOND E. JONES Director March 12, 1998
- ---------------------------
RAYMOND E. JONES
/s/ GREGORY R. MORRIS Director March 12, 1998
- ---------------------------
GREGORY R. MORRIS
/s/ CARROL R. PRUETT Director March 12, 1998
- ---------------------------
CARROL R. PRUETT
E-90
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT INDEX
Exhibit Sequential
Number Description Page Number
- ------ ----------- -----------
<S> <C> <C>
2.1 Agreement to Merge and Plan of Reorganization 350
3.1 Articles of Incorporation, as amended to date 90
3.2 Bylaws, as amended to date 110
4.1 Specimen form of Mid-State Bank Stock Certificate 145-A
10.1 1990 Stock Option Plan 146
10.2 Form of stock option agreement for use pursuant to 1990 159
Stock Option Plan
10.3 Deferred Compensation Plan 164
10.4 Profit Sharing and Salary Deferral 401 (K) Plan 201
10.5 Change in Control Agreement 315
for Carrol R. Pruett, President/Chief Executive Officer
10.6 Change in Control Agreement 325
for T. E. Reese, Executive Vice President
10.7 Change in Control Agreement 335
for James G. Stathos, Executive Vice President
21 All of the subsidiaries of Mid-State Bank are
discussed in Item 1 of this Report 3-4
</TABLE>
E-91
<PAGE>
APPENDIX F
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20529
FORM 10-KA
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(b) OF THE SECURITIES
FOR THE TRANSITION PERIOD N/A TO N/A
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 333-16951
BSM BANCORP
(Exact name of registrant as specified in its charter)
California 77-0442667
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2739 Santa Maria Way
Santa Maria, CA 93455
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code : (805) 937-8551
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock-No par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the common stock held by non-affiliates of the
registrant as of February 27, 1998 was $61,384,095.
The number of shares of common stock of the registrant outstanding as of
March 18, 1998 was 3,007,639.
F-1
<PAGE>
FORM 10-K
TABLE OF CONTENTS AND CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
PAGE # IN
10-KA
---------
<S> <C>
PART I
- ------
Item 1 Business F-3
Item 2 Properties F-17
Item 3 Legal Proceedings F-18
Item 4 Submission of Matters to a Vote of Security Holders F-18
PART II
- -------
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters F-18
Item 6 Selected Financial Data F-19
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations F-20
Item 8 Financial Statements and Supplementary Data F-33
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure F-55
PART III
- --------
Item 10 Directors and Executive Officers of Registrant F-56
Item 11 Director and Executive Officer Compensation F-58
Item 12 Security Ownership of Certain Beneficial Owners and
Management F-63
Item 13 Certain Relationships and Related Transactions F-64
PART IV
- -------
Item 14 Exhibits, Financial Statement Schedules and Reports on 8-K F-64
</TABLE>
F-2
<PAGE>
PART 1
ITEM 1. BUSINESS
GENERAL
BSM BANCORP
BSM Bancorp (referred to herein on an unconsolidated basis as "BSM" and on a
consolidated basis as the "Company") is a bank holding company incorporated
in California on November 12,1996, and registered under the Bank Holding
Company Act of 1956, as amended. The Company commenced business on March 12,
1997 when, pursuant to a reorganization, it acquired all of the voting stock
of Bank of Santa Maria (the "Bank"). The Bank is the Company's principal
asset.
The Company's principal business is to serve as a holding company for the
Bank and for other banking or bank related subsidiaries which the Company may
establish or acquire. The Company has not engaged in any other activity to
date. As a legal entity separate and distinct from its subsidiaries, BSM's
principal source of funds is, and will continue to be, dividends paid by and
other funds advanced by primarily the Bank. Legal limitations are imposed on
the amount of dividends that may be paid and loans that may be made by the
Bank to BSM. See "Note L-Regulatory Matters" in the Annual Report to
Shareholders. At December 31, 1997, the Company had $344.0 million in total
consolidated assets, $189.2 million in total consolidated net loans and $306.3
million in total consolidated deposits.
BSM's authorized Capital Stock consists of 25,000,000 of Preferred Stock,
none of which is outstanding, and 50,000,000 of Common Stock of which
2,990,939 was outstanding as of December 31, 1997.
The principal executive offices of the Company and the Bank are located at
2739 Santa Maria Way, Santa Maria, California.
MERGER WITH MID-STATE BANK
On January 29, 1998, Mid-State Bank ("Mid-State") entered into an Agreement
to Merge and Plan of Reorganization (the "Agreement") with the Company
pursuant to which, among other things, (i) Bank will merge with and into
Mid-State, (ii) BSM will become the holding company for Mid-State and change
its name to Mid-State Bancshares ("MSB"), and (iii) the shareholders of
Mid-State will become shareholders of MSB in accordance with an exchange
ratio set forth in the Agreement, all subject to the terms and conditions
specified in the Agreement
Consummation of the Agreement and the transactions contemplated therein, is
subject to regulatory and shareholder approval, as well as other conditions
set forth in the Agreement. No assurance can be given that the Agreement and
the transactions contemplated therein will be consummated. Should the
transaction be consummated, current Company shareholders will hold
approximately 30% of the shares of the newly renamed holding company.
BANK OF SANTA MARIA
The Bank was incorporated under the laws of the State of California on June
27, 1977, was licensed by the California State Banking Department and
commenced operations as a California state chartered bank on March 18, 1978.
The Bank's accounts are insured by the Federal Deposit Insurance Corporation
("FDIC"), but like most banks of its size in California, is not a member of
the Federal Reserve Bank. The Bank's authorized Capital Stock consists of one
class of Common Stock, of which there were 100 shares outstanding as of
December 31, 1997, which was held by BSM.
The Bank currently operates 13 retail banking offices along the central coast
of California. The main office and two branch offices are located in the City
of Santa Maria with additional offices located in the communities of
Guadalupe, Oak Knolls, Vandenberg Village, Nipomo, Grover Beach, Pismo Beach,
Paso Robles and Templeton. On January 10, 1997, El Camino National Bank, with
one office in Lompoc, merged into Bank of Santa Maria. On February 3, 1997,
the Bank opened a banking office in Atascadero. The Bank has its headquarters
in the City of Santa Maria at 2739 Santa Maria Way, Santa Maria, California
93455. Its telephone number is (805) 937-8551.
The Bank has expanded from its initial branches in the larger community of
Santa Maria both to the North and to the South, along a corridor following
U.S. Highway 101. The economy in this area of California is based upon
agriculture, oil, tourism, light industry, the aerospace industries and
nuclear energy production. Services to support those employed in these
industries, (including medical, financial, and educational services), have
expanded the two county areas increasing the population of the Bank's service
area to
F-3
<PAGE>
approximately 175,000. Certain economic activities are unique to the area
such as the space launching facility at Vandenberg Air Force Base (which is
now being actively used by large commercial enterprises) and the production
of seeds for numerous flowers grown worldwide. While major oil companies have
elected to do business elsewhere (due to the 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 to the North, South and East.
The commercial space industry will continue to bring "high tech" employment
into the area. Due to the diversity of the industries within the Bank's
market area, the Central Coast, while not immune to economic fluctuations,
tends to enjoy more stability than many areas of both the California
marketplace and the country in general.
ACQUISITION OF TEMPLETON NATIONAL BANK
Following all necessary regulatory approvals, on September 8, 1995, the Bank
acquired Templeton National Bank ("Templeton") pursuant to an Agreement and
Plan of Reorganization dated March 10, 1995, providing for the merger of
Templeton into the Bank. The Agreement provided for Templeton shareholders to
receive shares of the Bank Common Stock based upon the comparative book
values of the banks at the closing plus a premium of $500,000. The Bank
issued 397,561 shares of its Common Stock to the former shareholders of
Templeton. As of the merger date, Templeton's deposits were approximately $24
million and loans were approximately $18 million. Templeton had one office
and two offsite ATM locations. Since the acquisition, one of the offsite ATM
locations was closed and the second has been relocated to the Atascadero
Police Station. This acquisition was treated as a pooling transaction for
accounting purposes.
ACQUISITION OF CITIZENS BANK OF PASO ROBLES, N.A.
Following all necessary regulatory approvals, on May 3, 1996, the Bank
acquired Citizens National Bank of Paso Robles, N.A. ("Citizens") pursuant to
an Agreement and Plan of Reorganization dated October 30, 1995, providing for
the merger of Citizens into the Bank. The Agreement provided for the
shareholders of Citizens to receive cash at the rate of 1.6 times book value
per share of Citizens stock as of the end of the month preceding the closing.
The exchange value used in the merger was $16.94 of each share of Citizens
stock surrendered. The transaction was treated as a purchase for accounting
purposes and approximately $1.9 million of goodwill was recorded. Acquired
deposits were recorded at approximately $29 million and acquired loans at $18
million. Citizens had two offices at the time of the merger. In August 1997,
the Bank closed the former Citizens branch in Templeton.
ACQUISITION OF EL CAMINO NATIONAL BANK
Following all necessary regulatory approvals, on January 10, 1997, the Bank
acquired El Camino National Bank ("El Camino") pursuant to an Agreement and
Plan of Reorganization dated July 16, 1996, providing for the merger of El
Camino into the Bank. The Agreement provided for the shareholders of El
Camino to receive shares of Bank Common Stock based upon the comparative book
values of the banks as of the end of the month preceding the closing. As of
the closing date, El Camino's deposits were approximately $16 million, and
loans were approximately $12 million. This acquisition was treated as a
pooling transaction for accounting purposes. The exchange value used in the
merger was .7332 shares of Bank Common Stock for each share of El Camino
Common Stock. The Bank issued 201,678 shares to complete this transaction. El
Camino had only one office in Lompoc, California, and the Bank continues to
operate from this location.
SERVICES
The Bank offers a full range of commercial banking services including the
acceptance of checking and savings deposits, money market checking and
savings accounts, time certificates of deposit of varying maturities,
individual retirement accounts, the making of commercial loans, various types
of consumer loans and real estate loans and provides safe deposit, travelers
cheques, notary public and other customary non-deposit banking services. The
Bank is a merchant depository for Master Charge and Visa drafts enabling
merchants to deposit both types of drafts with the Bank.
Banks in California have been empowered to conduct certain insurance
activities and to market such services to the public. The Bank did obtain its
Organizational Insurance License in the fall of 1989, but has not elected to
offer products which require this license.
The Bank's organization and operations have been designed to serve the
banking needs of individuals and small to medium sized businesses located in
the Northern Santa Barbara and San Luis Obispo County areas of California.
F-4
<PAGE>
DEPOSIT AND LIABILITY MANAGEMENT
Deposits represent the Bank's primary source of funds. As of December 31,
1997, the Bank had approximately 18,500 demand, money market checking/savings
deposits and NOW accounts representing approximately $157.1 million with an
average balance of approximately $8,500 per account. Of those deposits,
approximately $82.4 million, or 52%, were interest bearing accounts. The Bank
had approximately 11,600 savings accounts representing approximately $32.5
million in total deposits, with an average balance of approximately $2,800
per account. The Bank had approximately 4,800 time certificates of deposit,
representing approximately $116.4 million in total deposits with an average
balance of approximately $24,300 per account. Of the total deposits as of
December 31, 1997, approximately $38.0 million were in the form of
certificates of deposit in denominations of $100,000 or more and all other
time deposits were approximately $79.0 million. During the twelve months
ending December 31, 1997, demand deposits increased approximately $7.4
million, money market and NOW accounts increased approximately $3.4 million,
savings accounts remained essentially flat and time certificates of deposit
increased approximately $9.4 million.
The Bank is not dependent on a single or a few customers for its deposits,
most of which are obtained from individuals and small to medium businesses.
This results in relatively small average balances, but makes the Bank less
subject to adverse effects from the loss of a substantial depositor. As of
December 31, 1997, no individual, corporate, or public depositor accounted
for more than 1.0% of the Bank's total deposits and the five largest deposit
accounts represented only 3.0% of the 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 Federal funds as a cushion for
temporary liquidity needs. During the year ended 1997, Federal funds averaged
$11.9 million, or 3.7% of total average assets. In addition, the Bank
maintains Federal funds credit lines with major correspondents aggregating
$11.1 million, subject to the customary terms for such arrangements.
The Bank's liquidity ratio, which measures the percentage of deposits which
are used to fund cash, cash equivalents and marketable securities, was 42.0%
as of December 31, 1997. This ratio is substantially in excess of the Bank's
minimum percentage of 20%.
LOANS
The Bank makes loans in four main areas, including (1) loans to individuals
for household, family and other consumer expenditures, (2) commercial and
industrial loans, (3) real estate loans and (4) agriculture loans. During
1997, the loan portfolio mix continued to show growth in the percentage of
agricultural loans now representing over 19% of the Bank's portfolio.
Commercial loans have also experienced an increase in the percentage of loans
outstanding constituting over 30% of the portfolio. This change has resulted
from declines in both consumer and real estate loan categories.
The Bank maintains a reserve for possible loan losses in the loan portfolio.
Additions to the reserve are made by charges to operating expenses. All loans
deemed to be uncollectible are charged to the reserve; subsequent recoveries
are credited to the reserve. The loan loss provision is based on current
factors which, in management's judgment, deserve recognition in estimating
possible losses. These factors include the current economic climate, past
loan loss history and management's forecast for the coming year.
As of December 31, 1997, the reserve for loan losses was approximately 1.11%
of loans outstanding, a level believed adequate by management. The reserve
for possible loan losses is maintained on an aggregate basis only and is not
allocated among the various types of loans made by the Bank. Outside factors,
not within the Bank's control, such as adverse changes in the economy, can
effect the adequacy of the reserves 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 reserve. During the year ending December 31,
1997, the Bank sustained net charge-offs of approximately $618,000 or .35% of
the Bank's average 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 funds sold overnight in the Federal funds market. The Bank's Investment
Policy provides for the purchase of United States Treasury Securities, United
States Government Agency Securities, Corporate Securities and State, County
and Municipal Securities. As of December 31, 1997, the aggregate book value
of the Bank's investment securities was approximately $108.8 million. Of this
total, approximately $18.6 million was in U.S. Government Securities,
approximately $57.4 million was in U.S. Government Agency Securities,
approximately $2.6 million was in Corporate Securities and approximately
$30.2 million was in securities issued by State and local subdivisions
thereof. The type of investments held in the Bank's portfolio are influenced
by several factors. Among these are: rate of return, maturity and risk.
F-5
<PAGE>
It is the Bank's policy to stagger the maturities of its securities to
maintain a liquid portfolio and to meet other Bank needs. The sale of
"Federal Funds" (short-term loans to other banks), are also made as alternate
investments for available excess funds. Approximately $658,000 of the Bank's
operating income in 1997, represented interest on Federal Funds sold.
Acceptable securities may be pledged to secure public deposits from state and
public agencies. As of December 31, 1997, the Bank had Public Funds totaling
approximately $2,160,000 secured by approximately $6,006,000 in eligible
securities.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under both federal
and state law. Set forth below, is a summary description of certain laws
which relate to the regulation of BSM and the Bank. The description does not
purport to be complete and is qualified in its entirety by reference to the
applicable laws and regulations.
BSM BANCORP
BSM, as a registered bank holding company, is subject to regulation under the
Bank Holding Company Act of 1956, as amended (the "BHCA"). BSM is required to
file with the Federal Reserve Board quarterly, semi-annual and annual
reports, and such additional information as the Federal Reserve Board may
require pursuant to the BHCA. The Federal Reserve Board may conduct
inspections of the BSM and its subsidiary. The first of such inspections
occurred in September, 1997.
The Federal Reserve Board may require that BSM terminate an activity or
terminate control of or liquidate or divest certain subsidiaries or
affiliates when the Federal Reserve Board believes the activity or the
control of the subsidiary or affiliate 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,
BSM must file written notice and obtain approval from the Federal Reserve
Board prior to purchasing or redeeming its equity securities.
Under the BHCA and regulations adopted by the Federal Reserve Board, a bank
holding company and its non-banking subsidiaries are prohibited from
requiring certain tie-in arrangements in connection with any extension of
credit, lease or sale of property or furnishing of services. Further, BSM is
required by the Federal Reserve Board to maintain certain levels of capital.
See "Item 1 - Prompt Corrective Regulatory Action."
BSM is required to obtain prior approval of the Federal Reserve Board for the
acquisition of more than 5% of the outstanding shares of any class of voting
securities or substantially all of the assets of any bank or bank holding
company. Prior approval of the Federal Reserve Board is also required for the
merger or consolidation of BSM and another bank holding company.
BSM is prohibited by the BHCA, except in certain statutory 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 subsidiary. However, BSM, subject to the prior approval of
the Federal Reserve Board, may engage in, or acquire shares of companies
engaged in, any 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. In making any such determination, the Federal
Reserve Board is required to consider whether the performance of such
activities by BSM or an affiliate can reasonably be expected to produce
benefits to the public, such as greater convenience, increased competition or
gains in efficiency, that outweigh possible adverse effects, such as undue
concentration of resources, decreased or unfair competition, conflicts of
interest or unsound banking practices. The Federal Reserve Board is also
empowered to differentiate between activities commenced DE NOVO and
activities commenced by acquisition, in whole or in part, of a going concern.
In 1996, the Economic Growth and Regulatory Paperwork Reduction Act of 1996
(the "Budget Act"), eliminated the requirement that the bank holding
companies seek Federal Reserve Board approval before engaging DE NOVO in
permissible nonbanking activities listed in Regulation Y, which governs bank
holding companies, if the holding company and its lead depository institution
are well-managed and well-capitalized and certain other criteria specified in
the statute are met. For purposes of determining the capital levels at which a
bank holding company shall be considered "well-capitalized" under this
section of the Budget Act and Regulation Y, the Federal Reserve Board adopted
as an interim rule, risk-based capital ratios (on a consolidated basis) that
are, with the exception of the leverage ratio (which is lower), the same as
the levels set for determining that a state member bank is well-capitalized
under the provisions established under the prompt corrective action
provisions of federal law. See "Item 1 Prompt Corrective Regulatory Action."
Under Federal Reserve Board 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 or 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
F-6
<PAGE>
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 in violation of
the Federal Reserve Board's regulations or both.
BSM is also a bank holding company within the meaning of Section 3700 of the
California Financial Code. As such, BSM and its subsidiary are subject to
examination by, and may be required to file reports with, the Department of
Financial Institutions.
Finally, BSM is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934, as amended, including but not limited to,
filing annual, quarterly and other current reports with the Securities and
Exchange Commission, (the "Commission").
AVAILABLE INFORMATION
Reports filed with the Commission can be viewed on the internet. The
Commission maintains a Web Site that contains reports, proxy and information
statements and other information. The address of the site is http://www.sec.gov.
BANK OF SANTA MARIA
Banks are extensively regulated under both federal and state law. The Bank,
as a California state chartered bank, is subject to primary supervision,
periodic examination and regulation by the Commissioner of Financial Insitutions
and the FDIC.
The Bank is insured by the FDIC, which currently insures deposits of each
member bank to a maximum of $100,000 per depositor. For this protection, the
Bank, as is the case with all insured banks, pays a quarterly statutory
assessment and is subject to the rules and regulations of the FDIC. Although
the Bank is not a member of the Federal Reserve System, it is nevertheless
subject to certain regulations of the Federal Reserve Board.
Various requirements and restrictions under the laws of the State of
California and the United States affect the operations of the Bank. State and
federal statutes and regulations 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.
There are statutory and regulatory limitations on the amount of dividends
which may be paid to the stockholders by the Bank. California law restricts
the amount available for cash dividends by state-chartered banks to the
lesser of retained earnings or the bank's net income for its last three
fiscal years (less any distributions to stockholders made during such
period). In the event a bank has no retained earnings or net income for its
last three fiscal years, cash dividends may be paid in an amount not
exceeding the net income for such bank's last preceding fiscal year only
after obtaining the prior approval of the Commissioner.
The FDIC also has authority to prohibit the Bank from engaging in activities
that, in the FDIC's opinion, constitutes an unsafe or unsound practice in
conducting its business. It is possible, depending upon the financial
condition of the bank in question and other factors, that the FDIC could
assert that the payment of dividends or other payments might, under some
circumstances, be an unsafe or unsound practice.
Banks are subject to certain restrictions imposed by federal law on any
extensions of credit to, or the issuance of a guarantee or letter of credit
on behalf of its affiliates, the purchase of or investments in stock or other
securities thereof, the taking of such securities as collateral for loans and
the purchase of assets of such affiliates. Such restrictions prevent
affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts. Further, such secured loans and
investments by the Bank to any other affiliate is limited to 10% of the
Bank's capital and surplus (as defined by federal regulations) and such
secured loans and investments are limited, in the aggregate, to 20% of the
Bank's capital and surplus (as defined by federal regulations). California
law also imposes certain restrictions with respect to transactions involving
other controlling persons of the Bank. Additional restrictions on
transactions with affiliates may be imposed on the Bank under the prompt
corrective action provisions of the FDIC Improvement Act.
POTENTIAL AND EXISTING ENFORCEMENT ACTIONS
Commercial banking organizations, such as the Bank, may be subject to
potential enforcement actions by the FDIC and the Commissioner 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, the imposition of civil money penalties, the issuance of directives
to increase capital, the issuance of formal
F-7
<PAGE>
and informal agreements, the issuance of removal and prohibition orders
against institution-affiliated parties and the imposition of restrictions and
sanctions under the prompt corrective action provisions of the FDIC
Improvement Act.
The regulations of these various agencies govern most aspects of the Bank's
business, including required reserves on deposits, investments, loans,
certain of their check clearing activities, issuance of securities, payment
of dividends, opening of branches, and numerous other areas. As a consequence
of the extensive regulation of commercial banking activities in the United
States, the Bank's business is particularly susceptible to changes in
California and the Federal legislation and regulations which may have the
effect of increasing the cost of doing business, limiting permissible
activities, or increasing competition.
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, by
adjusting the required level of reserves for financial intermediaries subject
to its reserve requirements and by varying the discount rates applicable to
borrowings by depository institutions. The actions of the Federal Reserve
Board in these areas influence the growth of bank loans, investments and
deposits and also affect interest rates charged on loans and paid on
deposits. The nature and impact of any future changes in monetary policies
cannot be predicted.
From time to time, legislation is enacted which has the effect of increasing
the cost of doing business, limiting or expanding permissible activities or
affecting the competitive balance between banks and other financial
intermediaries. Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and other financial
intermediaries are frequently made in Congress, in the California legislature
and before various bank regulatory and other professional agencies. For
example, legislation has been introduced in Congress that would repeal the
current statutory restrictions on affiliations between commercial banks and
securities firms. The likelihood of any major changes and the impact such
changes might have on the Bank are impossible to predict.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
On December 19, 1991, the FDIC Improvement Act was enacted into law. Set
forth below is a brief discussion of certain portions of this law and
implementing regulations that have been adopted or proposed by the Federal
Reserve Board, the Comptroller of the Currency ("Comptroller"), the Office of
Thrift Supervision ("OTS") and the FDIC (collectively, the "federal banking
agencies").
STANDARDS FOR SAFETY AND SOUNDNESS
The FDIC Improvement Act requires the federal banking agencies to prescribe,
by regulation, standards for all insured depository institutions and
depository institution holding companies relating to internal controls, loan
documentation, credit underwriting, interest rate exposure and asset growth.
Standards must also be prescribed for classified loans, earnings and the
ratio of market value to book value for publicly traded shares. The FDIC
Improvement Act also requires the federal banking agencies to issue uniform
regulations prescribing standards for real estate lending that are to
consider such factors as the risk to the deposit insurance fund, the need for
safe and sound operation of insured depository institutions and the
availability of credit. Further, the FDIC Improvement Act requires the
federal banking agencies to establish standards prohibiting compensation,
fees and benefit arrangements that are excessive or could lead to financial
loss.
In July 1992, the federal banking agencies issued a joint advance notice of
proposed rule making requesting public comment on the safety and soundness
standards required to be prescribed by the FDIC Improvement Act. The purpose
of the notice is to assist the federal banking agencies in the development of
proposed regulations. In accordance with the FDIC Improvement Act, final
regulations must become effective no later than December 1, 1993.
In December 1992, the federal banking agency issued final regulations
prescribing uniform guidelines for real estate lending. The regulations
require insured depository institutions to adopt written policies
establishing standards, consistent with such guidelines,
F-8
<PAGE>
for extensions of credit secured by real estate. The policies must address
loan portfolio management, underwriting standards and loan to value limits
that do not exceed the supervisory limits prescribed by the regulations.
In February 1995, the federal banking agencies adopted final guidelines
establishing standards for safety and soundness, as required by FDICIA. The
guidelines set forth operational and managerial standards relating to
internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth and
compensation, fees and benefits. Guidelines for asset quality and earnings
standards will be adopted in the future. The guidelines establish the safety
and soundness standards that the agencies will use to identify and address
problems at insured depository institutions before capital becomes impaired.
If an institution fails to comply with a safety and soundness standard, the
appropriate federal banking agency may require the institution to submit a
compliance plan. Failure to submit a compliance plan or to implement an
accepted plan may result in enforcement action.
Appraisals for "real estate related financial transactions" must be conducted
by either state-certified or state-licensed appraisers for transactions in
excess of certain amounts. State-certified appraisers are required for all
transactions with a transaction value of $1,000,000 or more; for all
non-residential transactions valued at $250,000 or more; and for "complex"
1-4 family residential properties of $250,000 or more. A state-licensed
appraiser is required for all other appraisals. However, appraisals performed
in connection with "federally related transactions" must now comply with the
agencies' appraisal standards. Federally related transactions include the
sale, lease, purchase, investment in, or exchange of, real property or
interests in real property, the financing of real property, and the use of
real property or interests in real property as security for a loan or
investment, including mortgage backed securities.
PROMPT CORRECTIVE REGULATORY ACTION
The FDIC Improvement Act requires each federal banking agency to take prompt
corrective action to resolve the problems of insured depository institutions
that fall below one or more prescribed minimum capital ratios. The purpose of
this law is to resolve the problems of insured depository institutions at the
least possible long-term cost to the appropriate deposit insurance fund.
The law requires each federal banking agency to promulgate regulations
defining the following five categories in which an insured depository
institution will be placed, based on the level of its capital ratios: well
capitalized (significantly exceeding the required minimum capital
requirements), adequately capitalized (meeting the required capital
requirements), undercapitalized (failing to meet any one of the capital
requirements), significantly undercapitalized (significantly below any one
capital requirement) and critically undercapitalized (failing to meet all
capital requirements).
In September 1992, the federal banking agencies issued uniform final
regulations implementing the prompt corrective action provisions of the FDIC
Improvement Act. Under the regulations, an insured depository institution
will be deemed to be:
- "well capitalized" if it (i) has total risk-based capital of 10% or
greater, Tier 1 risk-based capital of 6% or greater and a leverage
capital ratio of 5% or greater and (ii) is not subject to an order,
written agreement, capital directive or prompt corrective action
directive to meet and maintain a specific capital level for any
capital measure;
- "adequately capitalized" if it has total risk-based capital of 8% or
greater, Tier 1 risk-based capital of 4% or greater and a leverage
capital ratio of 4% or greater (or a leverage capital ratio of 3% or
greater if the institution is rated composite 1 under the applicable
regulatory rating system in its most recent report of examination);
- "undercapitalized" if it has total risk-based capital that is less
than 8%, Tier 1 risk-based capital that is less than 4% or a leverage
capital ratio that is less than 4% (or a leverage capital ratio that
is less than 3% if the institution is rated composite 1 under the
applicable regulatory rating system in its most recent report of
examination);
- "significantly undercapitalized" if it has total risk-based capital
that is less than 6%, Tier 1 risk-based capital that is less than 3%
or a leverage capital ratio that is less than 3%; and
- "critically undercapitalized" if it has a ratio of tangible equity
to total assets that is equal to or less than 2%.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be reclassified
to the next lower capital category if the appropriate federal banking agency,
after notice and opportunity for hearing, (i) determines that the institution
is in an unsafe or unsound condition or (ii) deems the institution is
engaging in an unsafe or unsound practice and not to have corrected the
deficiency. At each successive lower capital category, an insured depository
institution is subject to more restrictions and federal banking agencies are
given less flexibility in deciding how to deal with it.
The law prohibits insured depository institutions from paying management fees
to any controlling persons or, with certain limited exceptions, making
capital distributions if after such transaction the institution would be
undercapitalized. If an insured depository institution is undercapitalized,
it will be closely monitored by the appropriate federal banking agency,
subject to asset growth restrictions and required to obtain prior regulatory
approval for acquisitions, branching and engaging in new lines of business.
Any
F-9
<PAGE>
undercapitalized depository institution must submit an acceptable capital
restoration plan to the appropriate federal banking agency 45 days after
becoming undercapitalized. The appropriate federal banking agency cannot
accept a capital plan unless, among other things, it determines that the plan
(i) specifies the steps the institution will take to become adequately
capitalized, (ii) is based on realistic assumptions and (iii) is likely to
succeed in restoring the depository institution's capital. In addition, each
company controlling an undercapitalized depository institution must guarantee
that the institution will comply with the capital plan until the depository
institution has been adequately capitalized on an average basis during each
of four consecutive calendar quarters and must otherwise provide adequate
assurances of performance. The aggregate liability of such guarantee is
limited to the lesser of (a) an amount equal to 5% of the depository
institution's total assets at the time the institution became
undercapitalized or (b) the amount which is necessary to bring the
institution into compliance with all capital standards applicable to such
institution as of the time the institution fails to comply with its capital
restoration plan. Finally, the appropriate federal banking agency may impose
any of the additional restrictions or sanctions that it may impose on
significantly undercapitalized institutions if it determines that such action
will further the purpose of the prompt correction action provisions.
An insured depository institution that is significantly undercapitalized, or
is undercapitalized and fails to submit, or in a material respect to
implement, an acceptable capital restoration plan, is subject to additional
restrictions and sanctions. These include, among other things: (i) a forced
sale of voting shares to raise capital or, if grounds exist for appointment
of a receiver or conservator, a forced merger; (ii) restrictions on
transactions with affiliates; (iii) further limitations on interest rates
paid on deposits; (iv) further restrictions on growth or required shrinkage;
(v) modification or termination of specified activities; (vi) replacement of
directors or senior executive officers, subject to certain grandfather
provisions for those elected prior to enactment of the FDIC Improvement Act;
(vii) prohibitions on the receipt of deposits from correspondent
institutions; (viii) restrictions on capital distributions by the holding
companies of such institutions; (ix) required divestiture of subsidiaries by
the institution; or (x) other restrictions as determined by the appropriate
federal banking agency. Although the appropriate federal banking agency has
discretion to determine which of the foregoing restrictions or sanctions it
will seek to impose, it is required to force a sale of voting shares or
merger, impose restrictions on affiliate transactions and impose restrictions
on rates paid on deposits unless it determines that such actions would not
further the purpose of the prompt corrective action provisions. In addition,
without the prior written approval of the appropriate federal banking agency,
a significantly undercapitalized institution may not pay any bonus to its
senior executive officers or provide compensation to any of them at a rate
that exceeds such officer's average rate of base compensation during the 12
calendar months preceding the month in which the institution became
undercapitalized.
Further restrictions and sanctions are required to be imposed on insured
depository institutions that are critically undercapitalized. For example, a
critically undercapitalized institution generally would be prohibited from
engaging in any material transaction other than in the ordinary course of
business without prior regulatory approval and could not, with certain
exceptions, make any payment of principal or interest on its subordinated
debt beginning 60 days after becoming critically undercapitalized. Most
importantly, however, except under limited circumstances, the appropriate
federal banking agency, not later than 90 days after an insured depository
institution becomes critically undercapitalized, is required to appoint a
conservator or receiver for the institution. The board of directors of an
insured depository institution would not be liable to the institution's
shareholders or creditors for consenting in good faith to the appointment of
a receiver or conservator or to an acquisition or merger as required by the
regulator.
The FDIC has adopted risk-based minimum capital guidelines intended to
provide a measure of capital that reflects the degree of risk associated with
a banking organization's operations for both transactions reported on the
balance sheet as assets and transactions, such as letters of credit and
recourse arrangements, which are recorded as off-balance sheet items. Under
these guidelines, nominal dollar amounts of assets and credit equivalent
amounts of off-balance sheet items are multiplied by one of several risk
adjustment percentages, which range from 0% for assets with low credit risk,
such as certain U.S. Treasury securities, to 100% for assets with relatively
high credit risk, such as business loans.
In addition to the risk-based guidelines, the FDIC requires banks to maintain
a minimum amount of Tier 1 capital to total assets, referred to as the
leverage ratio. For a bank rated in the highest of the five categories used
by the FDIC to rate banks, the minimum leverage ratio of Tier 1 capital to
total assets is 3%. For all banks not rated in the highest category, the
minimum leverage ratio must be at least 100 to 200 basis points above the 3%
minimum, or 4% to 5%. In addition to these uniform risk-based capital
guidelines and leverage ratios that apply across the industry, the FDIC has
the discretion to set individual minimum capital requirements for specific
institutions at rates significantly above the minimum guidelines and ratios.
In August 1995, the federal banking agencies adopted final regulations
specifying that the agencies will include, in their evaluations of a bank's
capital adequacy, an assessment of the exposure to declines in the economic
value of the bank's capital due to changes in interest rates. The final
regulations, however, do not include a measurement framework for assessing
the level of a bank's exposure to interest rate risk, which is the subject of
a proposed policy statement issued by the federal banking agencies
concurrently with the final regulations. The proposal would measure interest
rate risk in relation to the effect of a 200 basis point change in market
interest rates on the economic value of a bank. Banks with high levels of
measured exposure or weak management systems generally will be required to
hold additional capital for interest rate risk. The specific amount of
capital that
F-10
<PAGE>
may be needed would be determined on a case-by-case basis by the examiner and
the appropriate federal banking agency. Because this proposal has only
recently been issued, the Bank currently is unable to predict the impact of
the proposal on the Bank if the policy statement is adopted as proposed.
In January 1995, the federal banking agencies issued a final rule relating to
capital standards and the risks arising from the concentration of credit and
nontraditional activities. Institutions which have significant amounts of
their assets concentrated in high risk loans or nontraditional banking
activities and who fail to adequately manage these risks, will be required to
set aside capital in excess of the regulatory minimums. The federal banking
agencies have not imposed any quantitative assessment for determining when
these risks are significant, but have identified these issues as important
factors they will review in assessing an individual bank's capital adequacy.
In December 1993, the federal banking agencies issued an interagency policy
statement on the allowance for loan and lease losses which, among other
things, establishes certain benchmark ratios of loan loss reserves to
classified assets. The benchmark set forth by such policy statement is the
sum of (a) assets classified "loss"; (b) 50 percent of assets classified
"doubtful"; (c) 15 percent of assets classified "substandard"; and (d)
estimated credit losses on other assets over the upcoming 12 months.
OTHER ITEMS
The FDIC Improvement Act also, among other things, (i) limits the percentage
of interest paid on brokered deposits and limits the unrestricted use of such
deposits to only those institutions that are well capitalized; (ii) requires
the FDIC to charge insurance premiums based on the risk profile of each
institution; (iii) eliminates "pass through" deposit insurance for certain
employee benefit accounts unless the depository institution is well
capitalized or, under certain circumstances, adequately capitalized; (iv)
prohibits insured state chartered banks from engaging as principal in any
type of activity that is not permissible for a national bank unless the FDIC
permits such activity and the bank meets all of its regulatory capital
requirements; (v) directs the appropriate federal banking agency to determine
the amount of readily marketable purchased mortgage servicing rights that may
be included in calculating such institution's tangible, core and risk-based
capital; and (vi) provides that, subject to certain limitations, any federal
savings association may acquire or be acquired by any insured depository
institution.
In addition, the FDIC has issued final and proposed regulations implementing
provisions of the FDIC Improvement Act relating to powers of insured state
banks. Final regulations issued in October 1992 prohibit insured state banks
from making equity investments of a type, or in an amount, that are not
permissible for national banks. In general, equity investments include equity
securities, partnership interests and equity interests in real estate. Under
the final regulations, non-permissible investments must be divested by no
later than December 19, 1996. The Bank has no such non-permissible
investments.
Regulations issued in December 1993, prohibit insured state banks from
engaging as principal in any activity not permissible for a national bank,
without FDIC approval. The proposal also provides that subsidiaries of
insured state banks may not engage as principal in any activity that is not
permissible for a subsidiary of a national bank, without FDIC approval.
Certain provisions of the FDIC Improvement Act, such as the recently adopted
real estate lending standards and the limitations on investments and powers
of state banks and the rules to be adopted governing compensation, fees and
other operating policies, may affect the way in which the Bank conducts its
business, and other provisions, such as those relating to the establishment
of the risk-based premium system, may adversely affect the Bank's results of
operations. Furthermore, the actual and potential restrictions and sanctions
that apply to or may be imposed on undercapitalized institutions under the
prompt corrective action and other provisions of the FDIC Improvement Act may
significantly adversely affect the operations and liquidity of the Bank, the
value of its Common Stock and its ability to raise funds in the financial
markets.
CAPITAL ADEQUACY GUIDELINES
The FDIC has issued guidelines to implement the risk-based capital
requirements. The guidelines are intended to establish a systematic
analytical framework that makes regulatory capital requirements more
sensitive to differences in risk profiles among banking organizations, takes
off-balance sheet items into account in assessing capital adequacy and
minimizes disincentives to holding liquid, low-risk assets. Under these
guidelines, assets and credit equivalent amounts of off-balance sheet items,
such as letters of credit and outstanding loan commitments, are assigned to
one of several risk categories, which range from 0% for risk-free assets,
such as cash and certain U.S. Government securities, to 100% for relatively
high-risk assets, such as loans and investments in fixed assets, premises and
other real estate owned. The aggregated dollar amount of each category is
then multiplied by the risk-weight associated with that category. The
resulting weighted values from each of the risk categories are then added
together to determine the total risk-weighted assets.
A banking organization's qualifying total capital consists of two components:
Tier 1 capital (core capital) and Tier 2 capital (supplementary capital).
Tier 1 capital consists primarily of common stock, related surplus and
retained earnings, qualifying non-
F-11
<PAGE>
cumulative perpetual preferred stock and minority interests in the equity
accounts of consolidated subsidiaries. Intangibles, such as goodwill, are
generally deducted from Tier 1 capital; however, purchased mortgage servicing
rights and purchase credit card relationships may be included, subject to
certain limitations. At least 50% of the banking organization's total
regulatory capital must consist of Tier 1 capital.
Tier 2 capital may consist of (i) the allowance for possible loan and lease
losses in an amount up to 1.25% of risk-weighted assets; (ii) perpetual
preferred stock, cumulative perpetual preferred stock and long-term preferred
stock and related surplus; (iii) hybrid capital instruments (instruments with
characteristics of both debt and equity), perpetual debt and mandatory
convertible debt securities; and (iv) eligible term subordinated debt and
intermediate-term preferred stock with an original maturity of five years or
more, including related surplus, in an amount up to 50% of Tier 1 capital.
The inclusion of the foregoing elements of Tier 2 capital are subject to
certain requirements and limitations of the federal banking agencies.
The FDIC has also adopted a minimum leverage capital ratio of Tier 1 capital
to average total assets of 3% for the highest rated banks. This leverage
capital ratio is only a minimum. Institutions experiencing or anticipating
significant growth or those with other than minimum risk profiles are
expected to maintain capital well above the minimum level. Furthermore,
higher leverage capital ratios are required to be considered well capitalized
or adequately capitalized under the prompt corrective action provisions of
the FDIC Improvement Act.
PREMIUMS FOR DEPOSIT INSURANCE
Federal law has established several mechanisms to increase funds to protect
deposits insured by the Bank Insurance Fund ("BIF") administered by the FDIC.
The FDIC is authorized to borrow up to $30 billion from the United States
Treasury; up to 90% of the fair market value of assets of institutions
acquired by the FDIC as receiver from the Federal Financing Bank; and from
depository institutions that are members of the BIF. Any borrowings not
repaid by asset sales are to be repaid through insurance premiums assessed to
member institutions. Such premiums must be sufficient to repay any borrowed
funds within 15 years and provide insurance fund reserves of $1.25 for each
$100 of insured deposits. The FDIC also has authority to impose special
assessments against insured deposits.
The FDIC implemented a final risk-based assessment system, as required by
FDICIA, effective January 1, 1994, under which an institution's premium
assessment is based on the probability that the deposit insurance fund will
incur a loss with respect to the institution, the likely amount of any such
loss, and the revenue needs of the deposit insurance fund. As long as BIF's
reserve ratio is less than a specified "designated reserve ratio," 1.25%, the
total amount raised from BIF members by the risk-based assessment system may
not be less than the amount that would be raised if the assessment rate for
all BIF members were .023% of deposits. The FDIC, effective September 15,
1995, lowered assessments from their rates of $.23 to $.31 per $100 of
insured deposits to rates of $.04 to $.31, depending on the condition of the
bank, as a result of the re-capitalization of the BIF. On November 15, 1995,
the FDIC voted to drop its premiums for well capitalized banks to zero
effective January 1, 1996. Other banks will be charged risk-based premiums up
to $.27 per $100 of deposits.
In 1996, Governor Pete Wilson signed Assembly Bill 3351 (the "Banking
Consolidation Bill"), authored by Assemblyman Ted Weggeland and sponsored by
the California State Banking Department (the "Department"), effective July 1,
1997, which creates the California Department of Financial Institutions
("DFI") to be headed by a Commissioner of Financial Institutions out of the
existing Department which regulates state chartered commercial banks and
trust companies in California.
The Banking Consolidation Bill, among other provisions, also (i) transfers
regulatory jurisdiction over state chartered savings and loan associations
from the Department of Savings and Loans ("DSL") to the newly-created DFI and
abolishes the DSL; (ii) transfers regulatory jurisdiction over state
chartered industrial loan companies and credit unions from the Department of
Corporations to the newly-created DFI; and (iii) establishes within the DFI
separate divisions for credit unions, commercial banks, industrial loan
companies and savings and loans. As the Banking Consolidation Bill has only
recently been enacted, it is impossible to predict with any degree of
certainty, what impact it will have on the banking industry in general and
the Bank in particular.
In 1996, the President signed into law provisions to strengthen the Savings
Association Insurance Fund (the "SAIF") and to repay outstanding bonds that
were issued to re-capitalize the SAIF's successor as result of payments made
due to insolvency of savings and loan associations and other federally
insured savings institutions in the late 1980's and early 1990's. The new law
will require savings and loan associations to bear the cost of
re-capitalizing the SAIF and, after January 1, 1997, banks will contribute
towards paying off the financing bonds, including interest. In the year 2000,
the banking industry will assume the bulk of the payments. The new law also
aims to merge the Bank Insurance Fund and SAIF by 1999, but not until the
bank and savings and loan charters are combined. The Treasury Department had
until March 31, 1997, to deliver to Congress on combining the charters.
Additionally, the new law provides "regulatory relief" for the banking
industry by effecting approximately 30 laws and regulations. Currently, the
costs and benefits of the new law to the Bank can not be accurately predicted.
F-12
<PAGE>
INTERSTATE BANKING AND BRANCHING
On September 29, 1994, the President signed into law the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate
Act"). Under the Interstate Act, beginning one year after the date of
enactment, a bank holding company that is adequately capitalized and managed
may obtain regulatory approval to acquire an existing bank located in another
state without regard to state law. A bank holding company would not be
permitted to make such an acquisition if, upon consummation, it would control
(a) more than 10% of the total amount of deposits of insured depository
institutions in the United States or (b) 30% or more of the deposits in the
state in which the bank is located. A state may limit the percentage of total
deposits that may be held in that state by any one bank or bank holding
company if application of such limitation does not discriminate against
out-of-state banks. An out-of-state bank holding company may not acquire a
state bank in existence for less than a minimum length of time that may be
prescribed by state law except that a state may not impose more than a five
year existence requirement.
On July 3, 1997, the President signed into law the Reigle-Neal Amendment Act
of 1997 providing that branches of state banks that operate in other states
are to be governed by the laws of their home (or chartering) states, not the
laws of the host states. State banks and state bank regulators pushed for the
legislation, believing that without it, state banks would switch to national
charters to avoid having to deal with a different a set of laws in each state
where they have established branches.
State banks will not receive any new powers under the legislation. If a host
state allows banks more powers than a bank's chartering state, the bank is
restricted to the powers granted by its chartering state. However, states
will be prohibited from discriminating against branches of banks from other
states by the requirement that states must grant branches out-of-state banks
the same privileges allowed to banks that states have chartered.
The Interstate Act also permits, beginning June 1, 1997, mergers of insured
banks located in different states and conversion of the branches of the
acquired bank into branches of the resulting bank. Each state may permit such
combinations earlier than June 1, 1997, and may adopt legislation to prohibit
interstate mergers after that date in that state or in other states by that
state's banks. The same concentration limits discussed in the preceding
paragraph apply. The Interstate Act also permits a national or state bank to
establish branches in a state other than its home state if permitted by the
laws of that state, subject to the same requirement and conditions as for a
merger transaction. Effective October 2, 1995, California adopted legislation
which "opts California into" the Interstate Act. However, the California
Legislation restricts out of state banks from purchasing branches or starting
a de novo branch to enter the California banking market. Such banks may
proceed only by way of purchases of whole banks.
The Interstate Act is likely to increase competition in the Bank's market
areas especially from larger financial institutions and their holding
companies. It is difficult to access the impact such likely increased
competition will have on the Bank' operations.
In 1986, California adopted an interstate banking law. The law allows
California banks and bank holding companies to be acquired by banking
organizations in other states on a "reciprocal" basis (i.e., provided the
other state's law permit California banking organizations to acquire banking
organizations in that state on substantially the same terms and conditions
applicable to banking organizations solely within that state). The law took
effect in two stages. The first stage allowed acquisitions on a "reciprocal"
basis within a region consisting of 11 western states. The second stage,
which became effective January 1, 1991, allows interstate acquisitions on a
national "reciprocal" basis. California has also adopted similar legislation
applicable to savings associations and their holding companies.
On September 28, 1995, Governor Wilson signed Assembly Bill No. 1482, the
Caldera, Weggeland, and Killea California Interstate Banking and Branching
Act of 1995 (the "1995 Act"). The 1995 Act, which was filed with the
Secretary of State as Chapter 480 of the Statutes of 1995, became operative
on October 2, 1995.
The 1995 Acts opts in early for interstate branching, allowing out-of-state
banks to enter California by merging or purchasing a California bank or
industrial loan company which is at least five years old. Also, the 1995 Act
repeals the California Interstate (National) Banking Act of 1986, which
regulated the acquisition of California banks by out-of-state bank holding
companies. In addition, the 1995 Act permits California state banks, with the
approval of the Commissioner of Financial Insitutions, to establish agency
relationships with FDIC-insured banks and savings associations. Finally, the
1995 Act provides for regulatory relief, including (i) authorization for the
Superintendent to exempt banks from the requirement of obtaining approval
before establishing or relocating a branch office or place of business, (ii)
repeal of the requirement of directors' oaths (Financial Code Section 682),
and (iii) repeal of the aggregate limit on real estate loans (Financial Code
Section 1230).
COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS
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 financial institutions in meeting
the credit needs of their local community, 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
F-13
<PAGE>
federal banking agencies may take compliance with such laws and CRA into
account when regulating and supervising other activities.
In May 1995, the federal banking agencies issued final regulations which
change the manner in which they measure a bank's compliance with its CRA
obligations. The final regulations adopt a performance-based evaluation
system which bases CRA ratings on an institutions' actual lending service and
investment performance, rather than the extent to which the institution
conducts needs assessments, documents community outreach or complies with
other procedural requirements. In March 1994, the Federal Interagency Tax
Force on Fair Lending issued a policy statement on discrimination in lending.
The policy statement describes the three methods that federal agencies will
use to prove discrimination: overt evidence of discrimination, evidence of
disparate treatment and evidence of disparate impact.
CHANGES IN ACCOUNTING PRINCIPLES
In March of 1995, the FASB issued SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT
OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. SFAS No.
121 establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles, and goodwill related to those assets to be
held and used and for long-lived assets and certain identifiable intangibles
to be disposed of. The statement does not apply to financial instruments
long-term customer relationships of a financial institution (core deposits),
mortgage and other servicing rights, and tax deferred assets. SFAS 121
requires the review of long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances include, for
example, a significant decrease in market value of an assets, a significant
change in use of an asset, or an adverse change in a legal factor that could
affect the value of an asset. If such an event occurs and it is determined
that the carrying value of the asset may not be recoverable, an impairment
loss should be recognized and measured by the amount by which the carrying
amount of the asset exceeds the fair value of the asset. Fair value can be
determined by a current transaction, quoted market prices, or present value
of estimated expected future cash flows discounted at the appropriate rate.
The statement is effective for fiscal years beginning after December 15,
1995. The implementation of SFAS No. 121 did not have a material impact on
the Bank's results of operations or financial position.
In May of 1995, the FASB issued SFAS 122, ACCOUNTING FOR MORTGAGE SERVICING
RIGHTS. SFAS No. 122 eliminates distinctions between servicing rights that
were purchased and those that were retained upon the sale of loans. The
statement requires mortgage servicers to recognize as separate assets rights
to service loans, no matter how the rights were acquired. Institutions who
sell loans and retain the servicing rights will be required to allocate the
total cost of the loans to servicing rights and loans based on their relative
fair values if the value can be estimated. SFAS No. 122 is effective for
fiscal years beginning after December 15, 1995. Further, SFAS No. 122
requires that all capitalized mortgage servicing rights be periodically
evaluated for impairment based upon the current fair value of these rights.
This Statement which is superseded by SFAS No. 125, ACCOUNTING FOR TRANSFERS
AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES, did not
have a material effect on the Bank's financial condition and results of
operations.
In October of 1995, the FASB issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, establishing financial accounting and reporting standards for
stock-based employee compensation plans. This statement encourages all
entities to adopt a new method of accounting to measure compensation cost of
all employee stock compensation plans based on the estimated fair value of
the award at the date it is granted. Companies are, however, allowed to
continue to measure compensation cost for those plans using the intrinsic
value based method of accounting, which generally does not result in
compensation expense recognition for most plans. Companies that elect to
remain with the existing accounting are required to disclose in a footnote to
the financial statements pro forma net income and, if presented, earnings per
share, as if this statement had been adopted. The accounting requirements of
this statement are effective for transactions entered into in fiscal years
that begin after December 15, 1995; however, companies are required to
disclose information for awards granted in their first fiscal year beginning
after December 15, 1994. The Bank has elected the pro forma disclosure
requirements as noted in the note to the Financial Statements.
In June of 1996, the FASB issued SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, and in
December, 1996 issued SFAS No. 127, Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125 (an amendment of FASB Statement No. 125)
establishing accounting and reporting standards for transfers and servicing
of financial assets and extinguishments of liabilities based on consistent
application of the financial-components approach. This approach requires the
recognition of financial assets and servicing assets that are controlled by
the reporting entity, the de-recognition of financial assets when control is
surrendered, and the de-recognition of liabilities when they are
extinguished. Specific criteria are established for determining when control
has been surrendered in the transfer of financial assets. Liabilities and
derivatives incurred or obtained by transferors in conjunction with the
transfer of financial assets are required to be measured at fair value, if
practicable. Servicing assets and other retained interests in transferred
assets are required to be measured by allocating the previous carrying amount
between the assets sold, if any, and the interest that is retained, if any,
based on the relative fair values of the assets on the date of the transfer.
Servicing assets retained are subsequently subject to amortization and
assessment for
F-14
<PAGE>
impairment. Management believes the implementation of this statement will not
have a material effect on the Banks financial condition or results of
operations.
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "REPORTING COMPREHENSIVE INCOME". This statement, which is effective for
the year ending December 31, 1998, establishes standards of disclosure and
financial statement display for reporting comprehensive income and its
components.
In June 1997, the Financial Accounting Standards Board issued Statement No.
131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION".
This statement changes current practice under SFAS 14 by establishing a new
framework on which to base segment reporting (referred to as the management
approach), and also requires certain related disclosures about products and
services, geographic areas, and major customers. The disclosures are required
for the year ending December 31, 1998.
HAZARDOUS WASTE CLEAN-UP COSTS
Management is aware of recent legislation and cases relating to hazardous
waste clean-up costs and potential liability. Based on a general survey of
the loan portfolio of the Bank, conversations with local authorities and
appraisers, and the type of lending currently and historically done by the
Bank (generally, the Bank has not made the types of loans usually associated
with hazardous waste contamination problems), management is not aware of any
potential material liability for hazardous waste contamination.
OTHER REGULATIONS AND POLICIES
The federal regulatory agencies have adopted regulations that implement
Section 304 of FDICIA which requires federal banking agencies to adopt
uniform regulations prescribing standards for real estate lending. Each
insured depository institution must adopt and maintain a comprehensive
written real estate lending policy, developed in conformance with prescribed
guidelines, and each agency has specified loan-to-value limits in guidelines
concerning various categories of real estate loans.
Various requirements and restrictions under the laws of the United States and
the State of California affect the operations of the Bank. Federal
regulations include requirements to maintain non-interest bearing reserves
against deposits, limitations on the nature and amount of loans which may be
made, and restrictions on payment of dividends. The California Commissioner
of Financial Institutions approves the number and locations of the branch
offices of a bank. California law exempts banks from the usury laws.
YEAR 2000 SAFETY AND SOUNDNESS
Safety and soundness guidance on the risks posed to financial institutions by
the Year 2000 problem was issued by the Federal Financial Institutions
Examination Council. The guidance underscores that Year 2000 preparation is
not only an information systems issue, according to the FFIEC, but also an
enterprise-wide challenge that must be addressed at the highest level of a
financial institution.
The guidance sets out the responsibilities of senior management and boards of
directors in managing their Year 2000 projects. Among the responsibilities of
institution managers and directors is that of managing the internal and
external risks presented by providers of data-processing products and
services, business partners, counterparties and major loan customers.
Under the guidance, senior management must provide the board of directors
with status reports, at least quarterly, on efforts to reach Year 2000 goals
both internally and by the institution's major vendors. Senior management and
directors must allocate sufficient resources to ensure that high priority is
given to seeing that remediation plans are fulfilled, and that the project
receives the quality personnel and timely support it requires.
A Year 2000 management committee has been formed by the the Company to
identify potential problems associated with the turn of the century and to
develop resolutions to these problems. Renovation activities such as hardware
and software upgrades, system replacements, and vendor certifications are
anticipated to be completed during the fourth quarter of 1998. The Company
was examined by the FDIC in January, 1998 specifically in regards to its
efforts to meet Year 2000 compliance guidelines. The Company's efforts were
judged to be satisfactory. Current costs and estimated future expenditures do
not appear to be material and are expected to have negligible effects on the
Company's results of operations, liquidity and capital resources.
F-15
<PAGE>
MONETARY POLICY
Banking is a business which depends on rate differentials. In general, the
difference between the interest 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 investment portfolios will
comprise the major portion of the Bank's earnings.
The earnings and growth of the Bank will be affected not only by general
economic conditions, both domestic and international, but also by the
monetary and fiscal policies of the United States and its agencies,
particularly the Federal Reserve Board. The Federal Reserve Board can and
does implement national monetary policy, such as seeking to curb inflation
and combat recession, by its open market operations in U.S. Government
securities, limitations upon savings and time deposit interest rates, and
adjustments to the discount rates applicable to borrowings by banks which are
members of the Federal Reserve System. The actions of the Federal Reserve
Board 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 that future changes in fiscal or monetary policies or economic
controls may have on the Bank's businesses and earnings cannot be predicted.
COMPETITION
The banking business in California generally, and in the Bank's primary
service areas specifically, is highly competitive with respect to both loans
and deposits and is dominated by a relatively small number of major banks
with many offices and operations over a wide geographic area. Among the
advantages such major banks have over the Bank are their ability to finance
wide-ranging advertising campaigns and to allocate their investment assets to
regions of higher yield and demand. Such banks offer certain services such as
trust services and international banking which are not offered directly by
the Bank; but which can be offered indirectly by the Bank through
correspondent institutions. In addition, by virtue of their greater total
capitalization, such banks have substantially higher lending limits than the
Bank. (Legal lending limits to an individual customer are based upon a
percentage of a bank's total capital accounts.) Other entities, both
governmental and in private industry, seeking to raise capital through the
issuance and sale of debt or equity securities also provide competition for
the Bank in the acquisition of deposits. Banks also compete with money market
funds and other money market instruments which are not subject to interest
rate ceilings.
In order to compete with other competitors in their primary service areas,
the Bank attempts to use, to the fullest extent, the flexibility which their
independent status permits. This includes an emphasis on specialized
services, local promotional activity, and personal contacts by their
respective officers, directors and employees. In particular, each of the
banks offers highly personalized banking services.
EMPLOYEES
At December 31, 1997, the Company had a total of 155 full-time employees and
63 part-time employees. The Bank believes that its employee relations are
satisfactory.
F-16
<PAGE>
ITEM 2. PROPERTIES
The Bank owns the land and buildings at ten of its thirteen locations. Those
locations include:
<TABLE>
<CAPTION>
OFFICE NAME ADDRESS
----------- -------
<S> <C>
MAIN OFFICE 2739 Santa Maria Way
Santa Maria, California
SOUTH BROADWAY 528 South Broadway
Santa Maria, California
OAK KNOLLS 1070 East Clark Avenue
Santa Maria, California
GUADALUPE 905 Guadalupe Street
Guadalupe, California
VANDENBERG VILLAGE 3745 Constellation
Vandenberg Village, CA
GROVER BEACH 1580 Grand Avenue
Grover Beach, California
PISMO BEACH 790 Price Street
Pismo Beach, California
TEMPLETON 1025 Las Tablas Road
Templeton, California
PASO ROBLES 840 Spring Street
Paso Robles, California
ATASCADERO 5955 E. Mall Street
Atascadero, California
</TABLE>
The Bank also leases the land where the NIPOMO branch has been built and a
portion of the land upon which the NORTH BROADWAY branch building now stands.
Both leases were long-term (25 years with an option to renew for a like
period) and do contain the right of first refusal if the lessor elects to
sell. However, neither lease has any options to purchase and therefore no
ownership is assumed.
With the addition of our LOMPOC BRANCH, the Bank acquired a lease on the
building in which the branch is located. This shopping center lease, which
became in effect on November 1, 1989, is a five year term lease with a five
year option to renew which expires in October, 1999.
In addition, the Bank now leases one off-site ATM location in Atascadero,
California.
OTHER PROPERTIES
When real estate loans are foreclosed, the Bank retains the property and
records the transaction on the Balance Sheet to the Other Real Estate Owned
account. The following is a summary of the changes in Other Real Estate Owned
for the periods ending December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
(In Thousands) 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Balance at beginning of year $ 1,678 $ 1,516 $ 1,398
Additions 630 1,515 838
Provisions charged to income (55) (75) (189)
Sales of other real estate owned (1,284) (1,278) (531)
--------- -------- -------
TOTAL $ 969 $ 1,678 $ 1,516
--------- -------- -------
--------- -------- -------
</TABLE>
F-17
<PAGE>
ITEM 3: LEGAL PROCEEDINGS
Due to the nature of its business, the Bank is a party to claims and legal
proceedings arising in the ordinary course of business. It is management's
opinion that there are no material actions pending against the bank as of
this filing date.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5: MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDERS
MATTERS
The common stock of the Company is not listed on any national stock exchange
or with NASDAQ. Trading in the stock has not been extensive and such trades
which have occurred would not constitute an active trading market. As of
December 31, 1997, there were approximately 2,000 shareholders, including
those listed in "street name" under various brokers. The management of the
Company is aware of three securities dealers who maintain an inventory and
make a market in the Company's common stock. The market makers are Maguire
Investments of Santa Maria, Hoefer & Arnett of San Francisco, and Sutro &
Company, with a local office in Santa Maria.
Since 1984, the Bank has consistently declared and paid a cash dividend to
the then shareholders of Bank of Santa Maria, with the equivalent of $.06
being paid since February of 1988. In 1994, the Board of Directors of the
Bank increased the per share dividend to $.10. In 1995, the Board of
Directors again increased the per share dividends to $.11 payable in
February, 1995, to the holders of their stock.
In 1996, the Board of Directors increased the cash dividend to $.20 payable
in February, 1996. At the 1996 Annual Shareholders Meeting, the Bank
announced that it would begin to pay dividends on a semi-annual basis. In
July 1996, a $.15 dividend was declared to be paid in August, 1996. In
January of 1997, the Board again declared a $.15 cash dividend payable in
February, 1997. Following the formation of the BSM Bancorp, the Directors of
the Company continued the semi-annual dividend policy. In August of 1997, the
Company paid a $.20 cash dividend. In January of 1998, the Company Board
again declared a cash dividend of $.30 per share payable on February 6, 1998.
The California Financial Code provides that a bank may not make a cash
distribution to its shareholders in excess of the lessor of the Company's
undivided profits, or the Company's net income for its last three fiscal
years; less the amount of any distribution made by the Company to
shareholders during the same period. Under these restrictions, approximately
$8,608,000 was available for payment of dividends at December 31, 1997. In
addition, as part of the Agreement with Mid-State, the Company's mid-year
cash dividend, if any, is limited to a maximum of $.10 per share.
The following quarterly summary of market activity is furnished by Maguire
Investments, Inc. of Santa Maria and by the OTC Bulletin Board. These quotes
do not necessarily include retail markups, markdowns, or commissions and may
not necessarily represent actual transactions. Additionally, there may have
been transactions at prices other than those shown below:
<TABLE>
<CAPTION>
Bid Ask
------ ------
<S> <C> <C>
1st Quarter 1996 $14.00 $14.50
2nd Quarter 1996 $13.75 $14.25
3rd Quarter 1996 $15.00 $15.75
4th Quarter 1996 $15.00 $16.00
1st Quarter 1997 $15.25 $16.75
2nd Quarter 1997 $16.13 $17.63
3rd Quarter 1997 $16.75 $18.63
4th Quarter 1997 $18.00 $27.50
</TABLE>
F-18
<PAGE>
ITEM 6: SELECTED FINANCIAL DATA
BSM BANCORP SUMMARY HISTORICAL FINANCIAL DATA
The following summarizes historical financial data for the five years ended
December 31, 1997. The data should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included or incorporated by reference in this Form 10-K.
<TABLE>
<CAPTION>
------------------------------------------------------
(Amounts in thousands, except per share data.) AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS:
Interest Income $ 24,977 $ 23,372 $ 22,367 $ 19,378 $ 18,431
Interest Expense 8,425 7,991 7,045 5,560 5,625
-------- -------- --------- -------- --------
Net Interest Income 16,552 15,381 15,322 13,818 12,806
Provisions for Loan Losses 30 227 876 340 712
-------- -------- --------- -------- --------
Net Interest Income After Provision for Loan Losses 16,522 15,154 14,446 13,478 12,094
Noninterest Income 3,504 3,098 2,728 2,448 2,550
Noninterest Expense 13,205 12,471 12,090 11,723 11,158
-------- -------- --------- -------- --------
Income Before Income Taxes 6,821 5,781 5,084 4,203 3,486
Income Taxes 2,616 2,313 1,885 1,475 1,146
-------- -------- --------- -------- --------
Net Income $ 4,205 $ 3,468 $ 3,199 $ 2,728 $ 2,340
-------- -------- --------- -------- --------
-------- -------- --------- -------- --------
Dividends on Common Stock $ 1,402 $ 964 $ 257 $ 219 $ 131
PER SHARE DATA:
Net Income-Basic $ 1.41 $ 1.17 $ 1.10 $ 0.96 $ 0.86
Net Income-Diluted $ 1.38 $ 1.16 $ 1.09 $ 0.95 $ 0.83
Dividends on Common Stock $ 0.35 $ 0.35 $ 0.11 $ 0.10 $ 0.06
Book Value $ 12.06 $ 10.97 $ 10.16 $ 9.17 $ 8.35
Tangible Book Value $ 11.45 $ 10.33 $ 10.16 $ 9.17 $ 8.35
STATEMENTS OF FINANCIAL CONDITION SUMMARY:
Total Assets $344,046 $321,397 $ 284,616 $266,987 $253,311
Total Deposits 306,292 286,278 252,544 238,954 229,137
Loans Held for Sale 1,200 1,400 1,310 958 3,644
Total Loans 191,346 179,391 166,086 164,406 164,004
Allowance for Loan Losses 2,115 2,702 2,729 2,413 2,524
Total Shareholders' Equity 36,062 32,632 29,978 26,387 22,683
SELECTED RATIOS:
Return on Average Assets 1.31% 1.15% 1.17% 1.05% 0.95%
Return on Average Equity 12.15% 11.06% 11.26% 10.99% 10.80%
Average Loans as a Percent of Average Deposits 62.44% 63.96% 63.04% 64.67% 66.94%
Allowance for Loan Losses to Total Loans 1.11% 1.51% 1.64% 1.47% 1.54%
Average Capital to Average Assets 10.76% 10.41% 10.42% 9.56% 8.79%
Tier 1 Capital to Risk-Weighted Assets 14.74% 14.10% 13.69% 12.29% 10.89%
Total Capital to Risk-Weighted Assets 15.66% 15.30% 14.96% 14.71% 12.13%
</TABLE>
F-19
<PAGE>
ITEM 7: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion is intended to provide information to facilitate the
understanding and assessment of significant changes and trends related to the
results of operations and the financial condition of BSM Bancorp and its
subsidiary, Bank of Santa Maria ("the Company"). This discussion and analysis
should be read in conjunction with the Company's audited financial statements
and the notes thereto.
BSM Bancorp ("the Bancorp") was incorporated on November 12, 1996, for the
sole purpose of becoming a bank holding company for Bank of Santa Maria ("the
Bank"). Following regulatory approval and with the approval of the Bank's
shareholders, the Bank merged with BSM Merger Company, (a wholly-owned
subsidiary of the Bancorp), as of the close of business on March 11, 1997.
The resulting bank assumed the name of Bank of Santa Maria, becoming a
wholly-owned subsidiary of the Bancorp. This acquisition was accounted for
using the pooling of interest method.
Bank of Santa Maria was initially incorporated under the laws of the State of
California on June 27, 1997, and was licensed by the California State Banking
Department. The Bank commenced operations on March 18, 1978, and operated
thirteen retail locations along the central coast of California. The Bank
offers a full range of commercial banking services designed to serve the
banking needs of individuals as well as small to medium sized businesses
located within its primary market area.
As reported in Note B to the Financial Statements, the Bank has been actively
involved in the acquisition of other central coast banks during the periods
under discussion below. During 1997, El Camino National Bank was merged into
the Bank. This acquisition was accounted for by using the pooling of interest
method which requires the restatement of all previously reported numbers to
give effect for this merger. The acquisition of Citizens Bank of Paso Robles
in 1996, on the other hand, was accounted for by using the purchase method of
accounting where no restatement of prior periods numbers was required. During
1995, Templeton National Bank merged into the Bank. Like El Camino, this
acquisition was also accounted for by using the pooling of interest method
which requires the restatement of all previously reported numbers to give
effect for this merger.
RESULTS OF OPERATIONS
The Company reported net earnings of $4,205,000, or $1.41 per share, in 1997.
This represents an increase of 21.3% over 1996 where net earnings were
$3,468,000, or $1.17 per share. Net earnings in 1995 were $3,199,000, or
$1.10 per share.
The increase in profitability during 1997 is the net result of several major
factors. On a pre-tax basis, the difference between the income figures
reported in 1997 over 1996 is approximately $1,040,000. The following recaps
are presented as a preview to a more detailed discussion to follow:
<TABLE>
<CAPTION>
CHANGES BETWEEN THE 1997 AND 1996 OPERATING PERIODS
<S> <C>
Increase in interest income due to increase in the volume of earning assets $1,268,000
(Increase) in interest expenses due to increase in the volume of interest-
bearing liabilities (583,000)
Increase in net interest income due to improved net interest margin 486,000
Reduction in the provision for loan losses 197,000
Increase in non-interest income from service charges 186,000
Increase in non-interest income from mortgage loan fees 168,000
(Increase) in salary & employee benefit costs (621,000)
(Increase) in advertising & promotional expenses (141,000)
Reduction in professional fees 161,000
(Increase) in other costs (net) (81,000)
----------
Change in pretax income between 1997 and 1996 $1,040,000
----------
----------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CHANGES BETWEEN THE 1996 AND 1995 OPERATING PERIODS
<S> <C>
Contribution of former Citizens branches to profitability since merger $ 230,000
(Increase) in advertising & promotional expenses (133,000)
Decline in net interest income due to reduced net interest margin (551,000)
Reduction in the provision for loan losses 649,000
Reduction in regulatory assessments 288,000
Reduction in merger-related expenses 107,000
Reduction in net losses on the sale of other real estate and fixed assets 107,000
----------
Change in pretax income between 1996 and 1995 $ 697,000
----------
----------
</TABLE>
Other key financial ratios are listed below:
TABLE 1 - KEY FINANCIAL RATIOS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Return on average assets 1.31% 1.15% 1.17% 1.05% 0.95%
Return on average equity 12.15% 11.06% 11.26% 10.99% 10.80%
Return on beginning equity 12.89% 11.57% 12.12% 12.03% 11.47%
Dividend payout ratio 24.82% 29.91% 10.00% 10.36% 6.97%
Average equity to average assets 10.76% 10.41% 10.42% 9.56% 8.79%
</TABLE>
NET INTEREST INCOME AND NET INTEREST MARGIN
Table 2, entitled Average Balances and Interest Rates, shows the Company's
average assets, liabilities, and stockholders' equity with the related
interest income, interest expense and rates for the years 1997, 1996, and
1995. Rates for tax preferenced investments are shown on a tax equivalent
basis using a 34% tax rate. Table 3 analyzes the reasons for change in net
interest income resulting from movement in rates and changes in average
outstanding balances. Reference should be made to both Table 2 and Table 3 to
assist in understanding this major component of Company profitability.
Net interest income is the difference between the interest and fees earned on
interest-bearing assets, such as loans and investments, and the interest paid
on interest-bearing liabilities, such as deposits. Net interest income is
similar to "Gross profits on sales" used in the financial statements for
retail sales organizations. Net interest income in 1997 was $16.6 million as
compared to $15.4 million in 1996, and $15.3 million in 1995. Net interest
income, when expressed as a percentage of total average interest-earning
assets, is referred to as net interest margin or "NIM". The Company's NIM was
5.95% in 1997, compared to 5.84% in 1996, and 6.39% in 1995.
NIM is used as a measure of the efficiency of the Company's asset/liability
management. The Company's NIM in 1997 increased by 1.9% compared to the
decrease of 8.6% in 1996. The increase in NIM noted in 1997 is primarily the
result of improved effective yield on the loan portfolio.
There are several reasons for the decline in 1996, which are best explained
by an analysis of the NIM's major components. The two components of NIM are
interest income and interest expense. Loans are the largest interest earning
assets group which contribute to interest income. Loan demand in California
during 1996 was weak. Although the average earning assets (after excluding
the effect of the purchase of Citizens assets) increased by approximately $10
million during 1996. Loans, as a percentage of earning assets, declined from
66.7% to 62.8%. The investment portfolio absorbed these dollars, increasing
their percentage of earning assets from 27.6% to 31.9%. This change in mix
from higher yielding loans to the moderate yields available in low risk
investments would have the effect of lowering interest income by over
$500,000, assuming an average 5.0% differential between the two asset groups.
In addition, the Company's average base rate declined from an average 8.83%
for the year 1996, to an average 8.27% for the year 1997. This 56 basis point
decline had a significant effect on the Company's loan portfolio because
approximately 38% of all Company loans are tied to base rates, which re-price
immediately upon movements in prime rates. Close to 60% of all loan dollars
are subject to repricing within 90 days, and more than 72% of all loan
dollars can be re-priced within any 12 month period. The actual decline in
effective rates on the loan portfolio was 49 basis points during 1997. The
effect on interest loan income of this decline in the effective interest
rates would approximate $800,000.
F-21
<PAGE>
Total interest income on earning assets for the year 1996 was up by $1.0
million, despite the large decline in overall interest rate yields. This can
be primarily attributable to the acquisition of earning assets obtained in
the Citizens merger, although non-acquisition growth also was a contributing
factor.
The funding of earning assets comes primarily from deposits. Between 1995 and
1997, the percentage of average interest bearing deposits remained within the
range of 78% to 79% of all deposits. However, the mix among average
interest-bearing deposits changed with time deposits growing from 40.7% to
50.4% of all average interest-bearing funds. This resulted in an increase in
the cost of interest-bearing funds by 11 basis points and, at the same time,
interest-earning assets were experiencing a decline of 37 basis points.
Within the bank's marketplace, customers appeared to be willing to forego
immediate liquidity to earning a better return on funds normally held in both
savings and money market savings accounts.
Interest expense on interest-bearing deposits increased $434,000 in 1997 over
1996, and by $946,000 in 1996 over 1995, primarily due to the increase in the
volume of time deposits which fully offset the reductions in rates during
this period.
The average interest rate from interest expense used in NIM is based upon
average earning ASSETS rather than average interest-bearing deposits.
Accordingly, fluctuations in earning assets affect the results of the
percentages used in arriving at NIM. In 1997, interest expense, as expressed
as a percentage of earning assets, increased by .7% to 2.96%, in comparison
with 1996, where the percentage was an increase of 3.1% over the previous
year.
Overall, NIM increased to 5.95% in 1997, up 10 basis points from 1996. This
was in contrast to 1996, where NIM declined by 58 basis points as a result of
the decline in interest-earning assets during the same time that increases
were occurring in interest-bearing liabilities. Changes in both the mix of
interest-earning assets and interest-bearing liabilities exacerbated the
anticipated narrowing of the interest margin which would have normally
occurred when general interest rates are on the decline.
F-22
<PAGE>
TABLE 2 - AVERAGE BALANCES AND INTEREST RATES
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------------------------------------------------
1997 1996 1995
-----------------------------------------------------------------------------------------------------
Average Amount Average Amount Average Amount
INTEREST Balance of Average Balance of Average Balance of Average
EARNING ASSETS: (000'S) Interest Rate(2) (000'S) Interest Rate(2) (000'S) Interest Rate(2)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INVESTMENT
SECURITIES
Taxable $78,333 4,723 6.03% $71,046 4,264 6.00% $54,775 $3,180 5.81%
Non-Taxable 19,071 794 6.31% 14,528 568 5.92% 12,324 463 5.70%
-------- ------ ------ ------- ------ ------ -------- ------- -------
TOTAL SECURITIES 97,404 5,517 6.08% 85,574 4,832 5.99% 67,099 3,643 5.79%
-------- ------ ------ ------- ------ ------ -------- ------- -------
Federal Funds Sold 11,865 658 5.55% 14,367 753 5.24% 13,977 775 5.54%
Net Loans (1) 175,660 18,802 10.70% 168,392 17,787 10.56% 162,397 17,949 11.05%
-------- ------ ------ ------- ------ ------ -------- ------- -------
TOTAL EARNING ASSETS 284,929 24,977 8.91% 268,333 23,372 8.82% 243,473 22,367 9.28%
TOTAL NON-EARNING
ASSETS 36,602 32,896 28,986
-------- -------- --------
TOTAL ASSETS $321,531 $301,229 $272,459
-------- -------- --------
-------- -------- --------
LIABILITIES
AND CAPITAL:
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing
demand/savings 110,026 2,413 2.19% 113,022 2,547 2.31% 113,217 2,954 2.61%
Time deposits
under $100,000 75,589 4,036 5.34% 67,516 3,647 5.40% 53,914 2,828 5.25%
Time deposits $100,000
or more 35,995 1,976 5.49% 32,906 1,797 5.46% 23,796 1,263 5.31%
-------- ------ ------ -------- ------ ------ -------- ------- ------
TOTAL INTEREST
BEARING DEPOSITS 221,610 8,425 3.80% 213,444 7,991 3.79% 190,927 7,045 3.69%
-------- ------ ------ -------- ------ ------ -------- ------- ------
Demand deposits 63,636 54,271 51,215
Other liabilities 1,691 2,161 1,915
Capital 34,594 31,353 28,402
-------- -------- --------
TOTAL LIABILITIES
AND CAPITAL $321,531 $301,229 $272,459
--------- -------- --------
--------- -------- --------
Spread on average
interest-bearing funds 5.11% 5.03% 5.59%
Interest income/earning assets 8.91% 8.82% 9.28%
Interest expense/earning assets 2.96% 2.98% 2.89%
Net interest margin 5.95% 5.84% 6.39%
</TABLE>
(1) Non-accrual loans have been included in net loan figures
(2) Yields are calculated on a tax equivalent basis
The impact of changes in the net interest income spread during 1997 and 1996
can also be examined by reference to Table 3, where increases or decreases in
interest income is broken down into two components. Changes due primarily to
increases or decreases in the size of the category are called volume
variances. Changes due primarily to increases or decreases in the rates
associated with each category are called rate variances.
During 1996, net interest income increased by only $59,000. However, the
method of accounting for the acquisition of Citizens tends to overshadow some
of the factors which net to a relatively nominal change in 1996. See the pro
forma analysis below which excludes the effects of net interest income from
the former Citizen's operations subsequent to the acquisition in May of that
year.
F-23
<PAGE>
TABLE 3 - RATE AND VOLUME ANALYSIS
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------
1997 over 1996 1996 over 1995
Increase (Decrease) Increase (Decrease)
due to change in due to change in
------------------------ --------------------------
INTEREST EARNING ASSETS: Volume Rate Total Volume Rate Total
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investment securities
Taxable $ 440 $ 19 $ 459 $ 973 $ 111 $1,084
Non-taxable 189 37 226 86 19 105
------ ----- ------ ------ ------- -------
TOTAL SECURITIES 629 56 685 1,059 130 1,189
Federal funds sold (139) 44 (95) 21 (43) (22)
Net loans 778 237 1,015 649 (811) (162)
------ ----- ------ ------ ------- -------
TOTAL EARNING ASSETS $1,268 $ 337 $1,605 $1,729 $ (724) $1,005
------ ----- ------ ------ ------- -------
------ ----- ------ ------ ------- -------
INTEREST BEARING LIABILITIES:
- ----------------------------------------------------------------------------------------------------------
Interest-bearing demand/savings $ (18) $(116) $ (134) $ (5) $ (402) $ (407)
Time deposits under $100,000 431 (42) 389 733 86 819
Time deposits $100,000 or above 170 9 179 497 37 534
------ ----- ------ ------ ------- -------
TOTAL INTEREST
BEARING DEPOSITS $ 583 $(149) $ 434 $1,225 $ (279) $ 946
------ ----- ------ ------ ------- -------
------ ----- ------ ------ ------- -------
Increase (decrease) in interest
differential $ 685 $ 486 $1,171 $ 504 $ (445) $ 59
</TABLE>
Information is provided in each category with respect to (a) changes
attributable to changes in volume (changes in volume multiplied by prior
rate); (b) changes attributable to changes in rates (changes in rates
multiplied by prior volume); and (c) the net change. The change attributable
to the combined impact of volume and rate has been allotted proportionately
to the change due to volume and the change due to rate.
PRO FORMA 1996 RATE AND VOLUME ANALYSIS
<TABLE>
<CAPTION>
Pro forma Per Table
Volume Rate Total Three
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Earning Assets $ 257 $(724) $(467) $1,005
Total Interest-Bearing Liabilities 363 (279) 84 946
----- ----- ----- ------
Increase (decrease) in interest differential $(106) $(445) $(551) $ 59
----- ----- ----- ------
----- ----- ----- ------
</TABLE>
The level of non-performing loans in the Company's portfolio affects the
amount of interest income. As noted in the notes to the Financial Statements,
when serious doubt exists as to the repayment of a loan, that loan is placed
on non-accrual status, and previously accrued and uncollected interest for
the current year is reversed against income. Had non-performing loans as of
December 31, 1997, complied with original terms, related interest income
would have been approximately $100,000, in which $23,000 was collected. The
difference of approximately $77,000 was not taken into income, which, if
included, would have increased NIM by 3 basis points to 5.98%.
SUMMARY OF CREDIT LOSS EXPERIENCE
The Company maintains an allowance for loan losses, which is reduced by net
loan charge-offs and increased by provisions for loan losses charged against
operating income. It is the Company's practice to maintain the allowance for
loan and lease losses at a level considered by Management to be adequate.
Each quarter, Management calculates an acceptable allowance for loan and
lease losses using an internal rating system based upon the risk associated
with various categories of loans. A portion of the calculation is based upon
the historical loss experience of the preceding five years and in some risk
categories the degree of collateralization. The risk assigned to each loan
is first determined when the loan is originated. It is then reviewed
quarterly and revised as appropriate. In addition, the Bank maintains a
monitoring system for all credits that have been identified either internally
or externally as warranting additional Management attention. These credits
are formally reported to Management by the lending officers on a quarterly
basis and are subsequently reviewed by the Loan Committee of the Board of
Directors. Reserves against these loans are based on the credit risk
assigned to the loans as described above utilizing a schedule of percentages
developed by Management in accordance with historical loss experience,
ranging from .18% to 50% of the present loan balances. These percentages may
be modified, based upon current or prospective local economic conditions.
The comments of bank examiners, the Company's independent auditors and a
third party loan review consultant hired by the Bank on a periodic basis are
also considered in revising risk category assignments. In determining the
actual allowance for loan and lease losses to be maintained, Management
augments this calculation with an analysis of the present and prospective
financial condition of certain borrowers, industry concentrations within the
portfolio, trends in delinquent and nonaccrual loans and general economic
conditions.
The primary risk element considered by Management with respect to each
installment and conventional real estate loan is lack of timely payment and the
value of the collateral. The primary risk elements with respect to real estate
construction loans are fluctuations in real estate values in the Company's
market areas, inaccurate estimates of construction costs, fluctuations in
interest rates, the availability of conventional financing, the demand for
housing in the Company's market area and general economic conditions. The
primary risk elements with respect to commercial loans are the financial
condition of the borrower, general economic conditions in the Company's market
area, the sufficiency of collateral, the timeliness of payment and with respect
to adjustable rate loans, interest rate fluctuations. Management has a policy
of requesting and reviewing annual financial statements from its commercial
loan customers and periodically reviews the existence of collateral and its
value. Management also has a reporting system that monitors all past due loans
and has adopted policies to pursue its creditor's rights in order to preserve
the Company's position.
F-24
<PAGE>
In addition to internal evaluation, the adequacy of the allowance for loan
losses is subject to review by regulators and outside consultants. While no
assurance can be given that economic conditions which adversely affect the
Company's service areas or other unforeseen circum-stances, will not require
increased provisions for loan losses in the future. It is management's
opinion that the allowance for loan losses as of December 31, 1997, of
$2,115,000 or 1.11% of total loans was adequate to absorb losses from any
known or inherent risks in the portfolio. Table 4 shows comparative
statistics and a more detailed breakdown of activity in the loan loss reserve
account. The low amount of the provision for 1997 reflects the overall
stability in the loan portfolio.
TABLE 4 - SUMMARY OF LOAN LOSS EXPERIENCE
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE OF RESERVE AT
BEGINNING OF YEAR $2,703 $2,801 $2,412 $2,524 $2,650
CHARGE OFFS
Consumer 427 269 222 226 480
Commercial 193 302 242 141 171
Agricultural 0 0 0 0 64
Construction and development 0 32 0 0 151
Other real estate 103 49 129 17 134
------ ------- ------- ------ ------
TOTAL CHARGE OFFS 724 652 593 584 1,000
RECOVERIES
Consumer 27 23 41 33 64
Commercial 79 74 65 62 96
Agricultural 0 0 0 36 0
Construction and development 0 0 0 1 0
Other real estate 0 1 0 0 1
------ ------- ------- ------ ------
TOTAL RECOVERIES 106 99 106 132 161
------ ------- ------- ------ ------
NET CHARGE OFFS 618 553 487 452 839
------ ------- ------- ------ ------
Acquired Allowance from Citizens 0 228 0 0 0
------ ------- ------- ------ ------
Provision charged to operations 30 227 876 340 713
------ ------- ------- ------ ------
BALANCE AT YEAR END $2,115 $2,703 $2,801 $2,412 $2,524
------ ------- ------- ------ ------
------ ------- ------- ------ ------
Ratio of net charge-offs to average
net loans during the period 0.35% 0.33% 0.30% 0.27% 0.52%
</TABLE>
F-25
<PAGE>
NON-INTEREST INCOME
Non-interest income increased by $406,000 to $3.5 million in 1997, from $3.1
million in 1996, and $2.7 million in 1995. Service charges related to the
Company's deposit products account for the largest portion of non-interest
income. The increase noted in service charges and fees comes primarily from
increased service charges on many of the bank's deposit products. Merchant
discount fees are obtained in conjunction with the processing of credit card
drafts and related products. Increases in fees are generally offset by
increased costs from the bank's service provider. Other fee income includes
mortgage broker fees, servicing fees on loans sold in the secondary markets,
and other non-deposit related charges, including wires, safe deposit, ATM's,
etc. The increase noted in this category was primarily from increase in
mortgage broker activity. Other non-interest income includes net gains on
sale of fixed assets and other real estate owned, income generated from the
holding of other real estate owned and other non-fee related income. The
decrease noted in this category was from reduced net gains on the sale of
fixed assets and other real-estate owned and reduced income generated from
rents on previously owned other real estate.
NON-INTEREST EXPENSE
The Bank's total non-interest expense amounted to $13.2 million in 1997,
$12.5 million in 1996, and $12.1 million in 1995. Both the increase in 1997
of $773,000, or 5.69%, and the increase in 1996 of $380,000, or 3.1%, were
due primarily to costs associated with the expansion of the bank into San
Luis Obispo County.
Non-interest expense as a percentage of average assets has continued to
decline from 4.44% in 1995, to 4.14% in 1996, and to 4.11% in 1997.
F-26
<PAGE>
BALANCE SHEET ANALYSIS
Total assets as of year end increased by 7.0% in 1997 to $344.0, compared to
an 12.9% increase in 1996. The majority of the growth in assets and in
deposits during 1996 can be attributed to the acquisition of Citizens Bank.
INVESTMENT SECURITIES
The Company maintains a portfolio of investment securities to provide income
and to serve as a secondary source of liquidity for its operations in
conjunction with funds sold overnight in the Federal funds market. The types
of investments held in the portfolio include U.S. Treasury Bills and Notes,
Government Agency issues, short-term municipal issues, and corporate
obligations. The type of investments held in the Company's portfolio are
influenced by several factors among which are; rate of return, maturity and
risk. Note C to the Financial Statements sets forth additional information
regarding our investment portfolio, as well as Table 5 below, which reports
maturity distributions and weighted tax-equivalent rates by types of
investments.
TABLE 5 - INVESTMENT PORTFOLIO
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31, 1997
------------------------------------------------------------------------------------------------------------------
After 1 But After 5 But
Total Securities Within One Year Within 5 Years Within 10 Years After 10 Years
------------------ ------------------ ------------------- ---------------- ------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
BOOK AVERAGE BOOK AVERAGE BOOK AVERAGE BOOK AVERAGE BOOK AVERAGE
VALUE T/E YIELD VALUE T/E YIELD VALUE T/E YIELD VALUE T/E YIELD VALUE T/E YIELD
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Held to Maturity, at
Amortized Cost:
U.S. Treasury $1,000 5.65% $ 1,000 5.65% $ 0 0.00% $ 0 0.00% $ 0 0.00%
U.S. Government
Agencies 28,914 5.96% 10,459 5.73% 18,347 6.10% 108 6.52% 0 0.00%
Municipal Issues 30,238 6.50% 3,288 6.06% 16,376 6.38% 9,235 6.67% 1,339 7.76%
Other Debt Securities 2,615 5.97% 1,007 5.86% 1,608 6.04% 0 0.00% 0 0.00%
-------- ------ ------- ------ ------- ------ ------ ------ ------ ------
62,767 6.22% 15,754 5.80% 36,331 6.22% 9,343 6.67% 1,339 7.76%
Available for
Sale,
at Market:
U.S. Treasury 17,561 5.91% 6,130 5.78% 11,431 5.97% 0 0.00% 0 0.00%
U.S. Government
Agencies 28,439 6.14% 3,003 5.61% 25,436 6.20% 0 0.00% 0 0.00%
-------- ------ ------- ------ ------- ------ ------ ------ ------ ------
TOTAL SECURITIES $108,767 6.15% $24,887 5.77% $73,198 6.18% $9,343 6.67% $1,339 7.76%
-------- ------ ------- ------ ------- ------ ------ ------ ------ ------
-------- ------ ------- ------ ------- ------ ------ ------ ------ ------
</TABLE>
LOANS
Table 6, entitled LOAN PORTFOLIO ANALYSIS BY CATEGORY, sets forth the
distribution of the Company's loan portfolio for the past five years. During
1997, the loan portfolio mix continued to show growth in the percentage of
agricultural loans, now representing over 19% of the Company's portfolio.
Commercial loans also have experienced an increase in the percentage of loans
outstanding making up over 30% of the portfolio. This change has resulted
from declines in both consumer and real estate loan categories.
<PAGE>
TABLE 6 - LOAN PORTFOLIO ANALYSIS BY CATEGORY
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1997 1996 1995 1994 1993
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Consumer $42,856 $45,572 $40,548 $42,140 $41,392
Commercial 58,226 50,903 49,997 46,942 37,566
Agricultural 36,993 32,021 23,633 22,806 21,722
Construction/Development 16,778 13,748 12,619 13,227 20,780
Other Real Estate 36,493 37,147 39,290 39,291 42,543
-------- -------- -------- -------- --------
TOTAL LOANS $191,346 $179,391 $166,087 $164,406 $164,003
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
The vast majority of the loans in the portfolio are either amortizing monthly
or have relatively short maturities. This helps maintain liquidity in the
portfolio. As noted, most of the loans which have floating rates are tied to
the Company's base rate or other market rate indicators. This serves to
lessen the risk to the Company from movement in interest rates, particularly
rate increases. Table 7 shows the maturity of certain loan categories
outstanding as of December 31, 1997, net of deferred fees and deferred costs.
TABLE 7 - MATURITIES AND SENSITIVITIES OF CERTAIN LOAN TYPES TO CHANGES IN
INTEREST RATES
(In thousands)
<TABLE>
<CAPTION>
Due after
Due in one ne year to Due after
year or less five years five years Total
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial and Agricultural
Floating Rate $33,960 $ 8,096 $16,203 $58,259
Fixed Rate 7,390 20,484 9,085 36,959
Real Estate Construction
Floating Rate 3,336 4,161 - 7,497
Fixed Rate 6,275 3,006 - 9,281
------- ------- ------- --------
TOTAL $50,961 $35,747 $25,288 $111,996
------- ------- ------- --------
------- ------- ------- --------
</TABLE>
At December 31, 1997, non-performing assets (non-accrual loans, loans 90 days
or more past due, restructured loans and other real estate loans) totaled
$2.5 million, or .73% of total assets, down from $3.1 million or .95% from
December 31, 1996, as restated for the El Camino merger. Management believes
that these assets are generally well secured and that potential losses have
already been reflected in valuation or allowance accounts. In November of
1996, the FDIC concluded its periodic safety and soundness examination. At
that time, the internal grading system of the Company was tested against the
findings of the FDIC examiners. In July of 1997, the Department of Financial
Institutions performed their periodic review of the Company. Again, the
internal grading system of the Company was tested against their findings.
During both examinations, management was directed to downgrade only one
extension of credit, which reflects positively on management's efforts to
identify and manage credit problems on a timely basis. Management is not
aware of any information where serious doubts exist regarding any significant
borrower's ability to comply with loan repayment terms. Table 8 sets forth
information on non-performing assets for the periods indicated. The market
value of other real estate owned and collateral securing non-performing loans
is regularly monitored for changes.
F-28
<PAGE>
TABLE 8 - NON-ACCRUAL AND NON-PERFORMING ASSETS
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-Accrual $ 790 $ 981 $1,027 $2,120 $2,893
Loans currently accruing which are
past due 90 days or more 31 - 395 119 223
Restructured loans 737 407 190 35 28
Other real estate owned 969 1,678 1,516 1,726 2,225
------ ------ ------ ------ -------
TOTAL NON-PERFORMING
ASSETS $2,527 $3,066 $3,128 $4,000 $5,369
------ ------ ------ ------ -------
------ ------ ------ ------ -------
Percentage of non-performing loans
to total loans 0.81% 0.77% 0.97% 1.38% 1.92%
------ ------ ------ ------ -------
------ ------ ------ ------ -------
Percentage of non-performing
assets to total assets 0.73% 0.95% 1.10% 1.50% 2.12%
------ ------ ------ ------ -------
------ ------ ------ ------ -------
</TABLE>
DEPOSITS
As noted above, deposits have grown steadily over the reporting periods. The
average balances for deposit categories and their associated costs are
presented in Table 9.
TABLE 9 - DETAILED DEPOSIT SUMMARY
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------------------------
1997 1996 1995
--------------------------------------------------------------------
Average Average Average
Balance Rate Balance Rate Balance Rate
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing demand $ 30,324 1.06% $ 28,710 1.21% $ 25,913 1.48%
Savings accounts 32,269 2.20% 32,529 2.41% 35,279 2.50%
Money market savings 47,433 2.91% 49,189 2.88% 52,026 3.24%
TCD less than $100,000 75,589 5.34% 67,516 5.40% 53,914 5.24%
TCD $100,000 or more 35,995 5.49% 32,907 5.46% 23,796 5.31%
-------- ------ -------- ------ -------- ------
TOTAL INTEREST-
BEARING DEPOSITS 221,610 3.80% 210,851 3.79% 190,928 3.78%
Demand 63,636 - 56,864 - 51,215 -
-------- ------ -------- ------ -------- ------
TOTAL DEPOSITS $285,246 2.95% $267,715 2.99% $242,143 2.98%
-------- ------ -------- ------ -------- ------
-------- ------ -------- ------ -------- ------
</TABLE>
F-29
<PAGE>
The effective cost of all funds decreased during 1997, primarily as the
result of the increase in demand deposits as a percentage of total deposits
outstanding. Demand deposits increased by 5.0% and now represents 22% of all
deposits in the Bank. The interest-bearing deposit mix has several notable
changes, modifying the previous trend towards more liquidity and
shorter-termed accounts. Time deposits of less than $100,000, grew by 5.1%,
time deposits of $100,000 or more grew by 2.6%, while money market savings
declined by 9.5% and regular savings by 6.9%.
Table 10 sets forth the remaining maturities of large denominational time
deposits, including public funds, as of December 31, 1997.
TABLE 10 - MATURITY DISTRIBUTION OF TCD'S OF $100,000 OR MORE
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31, 1997
- ---------------------------------------------------------------------------------------
<S> <C>
Three months or less $15,463
After three months to six months 9,596
After six months to one year 7,878
Over one year 5,052
--------
TOTAL $37,989
--------
--------
</TABLE>
LIQUIDITY
Liquidity is the Company's ability to meet fluctuations in deposit levels and
provide for the credit needs of its customers. The objective in liquidity
management is to maintain a balance between the sources and the 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 Company holds overnight Federal funds as a cushion
for temporary liquidity needs. During 1997, Federal funds averaged $11.9
million, or 3.7% of total average assets. In addition, the Company maintains
Federal funds credit lines with major correspondents, aggregating to $11.1
million, subject to the customary terms for such arrangements.
As shown in the consolidated statements of cash flows, cash and cash
equivalents declined by $5.6 million during 1997, to $25.9 million at
December 31, 1997. The decrease reflects $5.2 million in net cash provided
by operating activities, $30.3 million used in investing activities and $19.1
million provided by financing activities. Net cash used by investing
activities is primarily the result of increases in the security purchases and
an equal increase in loan growth. Net cash provided by financing activities
primarily reflect equal increases in both liquid and short-term deposits.
There are several accepted methods of measuring liquidity as utilized by the
regulators. One ratio, which is fairly easy to understand, is referred to as
the liquidity ratio. This ratio measures the percentage of deposits which are
used to fund cash, equivalents and marketable securities. The Company has set
a minimum standard percentage of 20% and, as of December 31, 1997, the
Company's liquidity ratio was 42.0%. The Company appears to be sufficiently
liquid to meet its operational needs.
MARKET RISK MANAGEMENT
Market risk is the possibility that changes in interest rates will impair the
fair value of the Company's financial instruments. The Asset/Liability
Committee measures and reviews the market risk of the Company and established
policies and procedures to limit its exposure to changes in interest rates.
Their policies are reviewed and approved by the Board of Directors of the
Company's subsidiary bank.
Interest rate risk is the most significant market risk regularly undertaken
by the Company. This risk is monitored through the use of three
complementary measurement methods: rate sensitivity gap, rate shocked
interest margin and rate shocked economic value of equity. Rate sensitivity
gap analysis measures interest rate risk due to volume differences, called
the gap, between repricable assets and liabilities over a specific period of
time. Rate shock is a method for stress testing the net interest margin
(NIM) over the next four quarters under several rate change levels. Rate
shock on equity is used to approximate the bank's liquidation value as
interest rates change.
At year end, the average twelve month gap as a percentage of earning assets
was 7.3%. This results in a four basis point difference for each 100 basis
points interest rate movement. Using the rate shock analysis method on NIM
results in seven basis points for each 100 basis points interest rate
movement. The mark-to-market method of rate shocking the economic value of
equity results in a 12% change for every 100 basis points change in interest
rates. All of the above approximation of interest rate risk are within the
guidelines established by the Company.
The interest rate risk position is actively managed and changes on a regular
basis as the interest rate enviroment changes. Accordingly, positions at the
end of any period may not reflect the Company's position in any subsequent
period.
CAPITAL RESOURCES
The primary source of capital for the Company is the retention of operating
profits. The Company reviews its capital needs on an ongoing basis to ensure
an adequate level of capital to support growth and to ensure depositor
protection. Total capital grew by $3.4 million or 10.5%, to $36.0 million as
of December 31, 1997. During 1997 and 1996, the Company's capital was
augmented by the exercise of stock options. During 1996, the Company
purchased land adjacent to the Paso Robles branch for the purpose of building
a permanent building. The cost of the land was approximately $900,000. The
Company had sufficient liquidity and capital to purchase the land without
financing either by debt or equity funding. Comments regarding the
established minimum capital ratios can be found in Footnote L of the
financial statements. The Company can operate safely at its current level of
capital and is positioned to grow within acceptable parameters.
MARKET INFORMATION REGARDING THE COMPANY'S COMMON STOCK
The common stock of the Company is not listed on any national stock exchange
or with NASDAQ. Trading in the stock has not been extensive and such trades
which have occurred would not constitute an active trading market. As of
December 31, 1997, there were approximately 2,000 shareholders, including
those listed in "street name" under various brokers. The management of the
Company is aware of three securities dealers who maintain an inventory and
make a market in the Company's common stock. The market makers are Maguire
Investments of Santa Maria, Hoefer & Arnett of San Francisco, and Sutro &
Company, with a local office in Santa Maria.
Since 1984, the Bank has consistently declared and paid a cash dividend to
the then shareholders of Bank of Santa Maria, with the equivalent of $.06
being paid since February of 1988. In 1994, the Board of Directors of the
Bank increased the per share dividend
F-30
<PAGE>
to $.10. In 1995, the Board of Directors again increased the per share
dividends to $.11 payable in February, 1995, to the holders of their stock.
In 1996, the Board of Directors increased the cash dividend to $.20 payable
in February, 1996. At the 1996 Annual Shareholders Meeting, the Bank
announced that it would begin to pay dividends on a semi-annual basis. In
July 1996, a $.15 dividend was declared to be paid in August, 1996. In
January of 1997, the Board again declared a $.15 cash dividend payable in
February, 1997. Following the formation of the BSM Bancorp, the Directors of
the Company continued the semi-annual dividend policy. In August of 1997, the
Company paid a $.20 cash dividend. In January of 1998, the Company Board
again declared a cash dividend of $.30 per share payable on February 6, 1998.
Restrictions on future dividend payments are outlined in the notes to the
financial statements.
The following quarterly summary of market activity is furnished by Maguire
Investments, Inc. of Santa Maria and by the OTC Bulletin Board. These quotes
do not necessarily include retail markups, markdowns, or commissions and may
not necessarily represent actual transactions. Additionally, there may have
been transactions at prices other than those shown below:
<TABLE>
<CAPTION>
Bid Ask
--- ---
<S> <C> <C>
1st Quarter 1996 $14.00 $14.50
2nd Quarter 1996 $13.75 $14.25
3rd Quarter 1996 $15.00 $15.75
4th Quarter 1996 $15.00 $16.00
1st Quarter 1997 $15.25 $16.75
2nd Quarter 1997 $16.13 $17.63
3rd Quarter 1997 $16.75 $18.63
4th Quarter 1997 $18.00 $27.50
</TABLE>
Selected Financial Data
The following is a summary of operations of Bank of Santa Maria for each of
the last five years ended December 31, 1997. This summary has not been
examined by an independent public accountant. However, in the opinion of
management, this summary reflects all adjustments which would be considered
necessary for a fair presentation of the results of operations for each of
these periods. This summary of operations should be read in conjunction with
the financial statements and notes relating thereto included elsewhere in
this report.
<TABLE>
<CAPTION>
(IN THOUSANDS) 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Total assets $344,046 $321,397 $284,616 $266,989 $253,311
Net interest income $16,552 $15,154 $14,446 $13,818 $12,805
Provision for loan loss $30 $227 $876 $340 $712
Other income $3,504 $3,098 $2,728 $2,448 $2,550
Other expense $13,205 $12,471 $12,090 $11,723 $11,158
Net income $4,205 $3,468 $3,199 $2,728 $2,340
Net income per share $1.41 $1.17 $1.10 $.96 $.86
Cash dividend per share $.35 $.35 $.11 $.10 $.06
</TABLE>
F-31
<PAGE>
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors
of BSM Bancorp and Subsidiary
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheets of
BSM Bancorp and Subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of BSM Bancorp and
Subsidiary as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Vavrinek, Trine, Day & Co.
- ---------------------------------------
Vavrinek, Trine, Day & Co.
January 8, 1998, except for Note O as to which the date is January 29, 1998.
Laguna Hills, California
F-32
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
---------------------------------
ASSETS 1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Cash and Due from Banks $ 18,472,719 $ 17,643,554
Federal Funds Sold 7,461,000 13,920,000
------------ ------------
TOTAL CASH & CASH EQUIVALENTS 25,933,719 31,563,554
------------ ------------
Investment Securities - Note C:
Securities available for sale 46,143,134 23,865,611
Securities held to maturity 62,767,464 68,339,127
------------ ------------
TOTAL INVESTMENT SECURITIES 108,910,598 92,204,738
Loans - Note D:
Commercial 58,225,966 50,902,945
Agricultural 36,992,494 32,020,648
Real Estate 53,271,399 50,895,476
Consumer 42,855,965 45,572,297
------------ ------------
TOTAL LOANS 191,345,824 179,391,366
Allowance for possible credit losses (2,114,684) (2,701,876)
------------ ------------
NET LOANS 189,231,140 176,689,490
Premises and equipment - Note E 12,709,127 12,648,207
Accrued interest and other assets 4,555,235 4,744,483
Goodwill 1,737,220 1,868,500
Other Real Estate Owned 968,577 1,678,313
------------ ------------
TOTAL ASSETS $344,045,616 $321,397,285
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
- -------------------------------------------------------------------------------
Deposits
Noninterest-bearing demand $ 74,450,817 $ 67,181,717
Interest-bearing demand and savings 114,900,337 111,528,482
Time deposits under $100,000 78,951,276 70,229,443
Time deposits of $100,000 or more 37,989,170 37,338,194
------------ ------------
TOTAL DEPOSITS 306,291,600 286,277,836
Accrued interest and other liabilities 1,691,788 2,487,932
------------ ------------
TOTAL LIABILITIES 307,983,388 288,765,768
------------ ------------
Commitments - Note J
Shareholders' Equity - Note F:
Preferred shares - authorized 25,000,000
shares outstanding - none
Common shares - authorized 50,000,000
shares; issued and outstanding
2,990,939 as of December 31, 1997;
2,973,631 as of December 31, 1996 11,636,514 11,460,488
Undivided profits 24,339,778 21,176,801
Net unrealized appreciation (depreciation)
on available for sale securities, net
of taxes of $57,291 in 1997 and $3,819
in 1996 85,936 (5,772)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 36,062,228 32,631,517
------------ ------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $344,045,616 $321,397,285
------------ ------------
------------ ------------
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
F-33
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31,
-----------------------------------------------------
INTEREST INCOME 1997 1996 1995
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest and fees on loans $18,801,501 $17,787,334 $17,948,550
Interest on investment securities-taxable 4,722,703 4,264,162 3,180,013
Interest on investment securities-non
taxable 794,328 567,881 463,366
Other interest income 657,987 752,795 774,828
----------- ----------- -----------
TOTAL INTEREST INCOME 24,976,519 23,372,172 22,366,757
----------- ----------- -----------
INTEREST EXPENSE
- ---------------------------------------------------------------------------------------------------
Interest on demand and savings deposits 2,413,035 2,546,602 2,953,779
Interest on time CD's over $100,000 1,975,827 1,797,494 1,262,855
Interest on time CD's less than $100,000 4,035,997 3,647,378 2,828,677
----------- ----------- -----------
TOTAL INTEREST EXPENSE 8,424,859 7,991,474 7,045,311
----------- ----------- -----------
NET INTEREST INCOME 16,551,660 15,380,698 15,321,446
Provision for credit losses 30,000 227,000 875,500
----------- ----------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 16,521,660 15,153,698 14,445,946
----------- ----------- -----------
NON-INTEREST INCOME
- ---------------------------------------------------------------------------------------------------
Service charges on deposits 2,016,085 1,829,790 1,681,995
Merchant discount fees 587,357 493,031 446,075
Loan and servicing fees 527,693 358,767 243,515
Other fee income 257,564 235,014 228,524
Other non-interest income 115,512 181,197 128,133
----------- ----------- -----------
TOTAL 3,504,211 3,097,799 2,728,242
----------- ----------- -----------
NON-INTEREST EXPENSE
- ---------------------------------------------------------------------------------------------------
Salaries and employee benefits 7,162,366 6,540,602 6,327,466
Occupancy expenses 982,920 952,114 879,116
Furniture and equipment 1,409,854 1,382,105 1,316,207
Advertising and promotion 697,019 556,042 422,655
Professional 308,618 469,984 606,858
General Office 553,781 446,549 444,306
Communications 393,407 378,850 334,879
Regulatory assessments 70,225 43,220 330,739
Merchant processing costs 550,723 501,191 446,108
Other OREO expense 54,742 136,053 39,568
Other expenses 1,021,249 1,064,253 942,722
----------- ----------- -----------
TOTAL 13,204,904 12,470,963 12,090,624
----------- ----------- -----------
INCOME BEFORE TAXES 6,820,967 5,780,534 5,083,564
Income taxes - Note H 2,616,000 2,312,800 1,884,900
----------- ----------- -----------
NET INCOME $4,204,967 $3,467,734 $3,198,664
----------- ----------- -----------
----------- ----------- -----------
Earnings per share data - Note I
Net Income - Basic $1.41 $1.17 $1.10
----------- ----------- -----------
----------- ----------- -----------
Net Income - Diluted $1.38 $1.16 $1.09
----------- ----------- -----------
----------- ----------- -----------
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
F-34
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
----------------------------------------------------------------
OPERATING ACTIVITIES 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $ 4,204,967 $ 3,467,734 $ 3,198,664
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,358,448 1,216,500 1,111,910
Provision for credit losses 30,000 227,000 875,500
Amortization of premium/discounts
on investment securities 278,076 345,514 96,824
Loans originated for sale (4,547,941) (7,839,650) (4,316,600)
Proceeds from loan sales 4,779,279 7,744,846 3,969,394
Net (gain) from sale of fixed assets (14,812) (51,912) (30,450)
Net loss (gain) on sale of other real
estate loans (101,129) 39,212 149,571
Other items- Net (669,854) 263,095 (275,382)
----------- ----------- -----------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 5,245,981 5,412,339 4,779,431
INVESTING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------------------------
Proceeds from maturities of securities held
to maturity 29,940,827 36,380,923 31,385,000
Proceeds from maturities of securities held
for sale 16,073,000 6,702,750 5,582,750
Purchases of held to maturity securities (27,277,773) (34,125,412) (46,118,216)
Purchases of available for sale securities (35,565,324) (25,783,500) (3,619,038)
Net (increase) decrease in loans (13,078,658) 2,889,950 (2,488,647)
Purchases of premises and equipment (1,602,476) (3,146,259) (724,388)
Proceeds from sales of other real estate owned 1,157,587 1,313,618 729,018
Proceeds from sales of fixed assets 55,890 65,706 40,949
Net cash received for purchase of Citizens Bank
of Paso Robles 8,067,071
----------- ----------- -----------
NET CASH USED BY
INVESTING ACTIVITIES (30,296,927) (7,635,153) (15,212,572)
FINANCING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in demand deposits and
savings accounts 10,640,955 (9,596,605) 1,319,523
Net increase in time deposits 9,372,809 14,012,070 12,271,245
Payments for dividends/distributions (1,041,990) (964,191) (256,832)
Proceeds from exercise of stock options 176,026 210,200 580,294
----------- ----------- -----------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 19,147,800 3,661,474 13,914,230
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (5,629,835) 1,438,660 3,481,089
Cash and cash equivalents at beginning of year 31,563,554 30,124,894 26,643,805
----------- ----------- -----------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $25,933,719 $31,563,554 $30,124,894
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 9,089,872 $ 7,824,179 $ 6,587,042
Cash paid during the year for income taxes $ 2,271,032 $ 2,244,705 $ 2,194,780
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
F-35
<PAGE>
CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Net
Unrealized
Appreciation/
Common Shares (Depreciation)
----------------------- in Available
Number of Undivided for Sale
Shares Amount Profits Securities Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1995 2,878,593 $10,669,994 $15,731,426 $(14,409) $26,387,011
Proceeds from exercise of stock options 18,450 165,600 165,600
Proceeds from exercise of stock options
(Templeton only) 53,019 414,058 414,058
Proceeds from exercise of stock options
(El Camino only) 146 2,200 2,200
Partial Distribution-Templeton Merger (127) (1,564) (1,564)
Dividends paid (256,832) (256,832)
Net income 3,198,664 3,198,664
Adjustment in Available for Sale
Securities, Net of Taxes of ($43,753) 65,630 65,630
--------- ----------- ----------- -------- -----------
BALANCE AT DECEMBER 31, 1995 2,950,081 11,250,288 18,673,258 51,221 29,974,767
--------- ----------- ----------- -------- -----------
Proceeds from exercise of stock options 23,400 208,700 208,700
Issuance of organizational stock 150 1,500 1,500
Dividends paid (964,191) (964,191)
Net income 3,467,734 3,467,734
Adjustment in Available for Sale
Securities, Net of Taxes of $37,995 (56,993) (56,993)
--------- ----------- ----------- -------- -----------
BALANCE AT DECEMBER 31, 1996 2,973,631 11,460,488 21,176,801 (5,772) 32,631,517
--------- ----------- ----------- -------- -----------
Retirement of organizational stock (150) (1,500) (1,500)
Proceeds from exercise of stock options 17,600 179,725 179,725
Partial Distribution-El Camino Merger (142) (2,199) (2,199)
Dividends paid (1,041,990) (1,041,990)
Net income 4,204,967 4,204,967
Adjustment in Available for Sale
Securities, Net of Taxes of ($61,139) 91,708 91,708
--------- ----------- ----------- -------- -----------
BALANCE AT DECEMBER 31, 1997 2,990,939 $11,636,514 $24,339,778 $85,936 $36,062,228
--------- ----------- ----------- -------- -----------
--------- ----------- ----------- -------- -----------
</TABLE>
NOTES TO FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of BSM Bancorp and Subsidiary (the
"Company") are in accordance with generally accepted accounting principles
and conform to practices with the banking industry. A summary of the
significant accounting policies consistently applied in the preparation of
the accompanying consolidated financial statements follows:
The accompanying notes are an integral part of these consolidated financial
statements
F-36
<PAGE>
NOTE A (CONTINUED)
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of BSM Bancorp
(the "Bancorp") and its wholly owned subsidiary, Bank of Santa Maria (the
"Bank"). All material intercompany accounts and transactions have been
eliminated in the consolidated financial statements.
NATURE OF OPERATIONS
The Company's primary operations are related to traditional banking
activities, including the acceptance of deposits and the lending and
investing of money through the operations of the Bank. The Bank's customers
are predominantly small and middle-market businesses and individuals who are
located in the central coast area of California. The Bank operates 13
branches, with headquarters in the city of Santa Maria.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities at the date of the financial statements,
and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
CASH AND DUE FROM BANKS
For purposes of reporting cash flows, cash and due from banks includes cash
on hand and amount due from banks. Cash flows from loans originated by the
Company, deposits, and federal funds sold are reported net.
The Company maintains amounts due from banks which exceed federally insured
limits. The Company has not experienced any losses in such accounts.
INVESTMENTS SECURITIES
Securities held to maturity are stated at cost, adjusted for amortization of
premiums and accretion of discounts over the period to maturity, or to an
earlier call, if appropriate, on a straight-line basis. Such securities include
those that management intends and has the ability to hold into the foreseeable
future.
Securities would be considered available for sale if they would be sold under
certain conditions, among these being changes in interest rates, fluctuations
in deposit levels or loan demand, or a need to restructure the portfolio to
better match the maturity or interest rate characteristics of liabilities
with assets. Securities classified as available for sale are accounted for at
their current fair value rather than amortized historical cost. Unrealized
gains or losses are not recognized as current income or expense, but rather
as an increase or decrease of capital through a separate reserve.
LOANS AND LOAN FEES
Loans are recorded at amount advanced less payments collected. Interest on
loans is accrued daily as earned, except where management believes that
serious doubt exists as to the full collectability of interest or principal.
When this occurs, the accrual of income is discontinued and the balance of
accrued interest is reversed against current income. Loans are generally put
on nonaccrual status when interest is ninety days or more past due, unless
the loan is well secured and in the process of collection. Subsequent cash
payments are applied fully to the principal balance. Only after the principal
is reduced to zero is interest income realized. Once a loan is placed on
nonaccrual it generally remains on nonaccrual until the loan is termed
uncollectable or the borrower's capacity and intent to make further payments
is evidenced by keeping the loan current for a period of three to six months.
F-37
<PAGE>
NOTE A - (CONTINUED)
Loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated market value in the aggregate. Net unrealized
losses are recognized through a valuation allowance by charges to income.
Service income is generally recognized on a cash basis over the life of the
loan. If the normal servicing fees are expected to be less than the estimated
servicing costs, a loss would be recognized when the loan was sold. The
Company also acts in a broker capacity assisting customers in obtaining
mortgage loans with other institutions. The Company earns points and
documentation fees but is otherwise not involved in the loan. Fees are
recorded when payment is received.
Loan origination fees offset by certain direct origination costs are deferred
and recognized over the contractual life of the loan as an adjustment to the
yield. The unrecognized fees and costs are reported either as a reduction of
the loan principal outstanding, or, if deferred costs are greater than
deferred fees, as additions to the applicable loan grouping. Commitment fees
are deferred and recognized over the term of the commitment. Most deferred
fees and costs are recognized using the interest method. When a loan is
repaid or sold, an unamortized net deferred balance is credited or charged to
income. Accretion of deferred loan fees is discontinued when loans are placed
on nonaccrual status.
ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS
The determination of the balance in the allowance for possible loan losses is
based on an analysis of the loan portfolio and reflects an amount which, in
management's judgment, is adequate to provide for potential loan losses after
giving consideration to the character of the loan portfolio, current economic
conditions, past loan loss experience and such other factors as warrant
recognition in estimating loan losses. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review the Bank's allowance for loan losses. Such agencies may require the
Bank to record additions to the allowance based upon their judgments on
information available to them at the time of the examination.
The Company also evaluated loans in accordance with guidelines found in SFAS
No. 114 and SFAS No. 118 from the Financial Accounting Standards Board (FASB)
regarding loan impairment, income recognition and related disclosures, which
the Company adopted in the first quarter of 1995. The Company considers a
loan to be impaired when, based upon current information and events, it
believes it is probable that the Company will be unable to collect all
amounts due on a timely basis, according to the contractual terms of the loan
agreement. Impairment of a loan is measured by the present value of the
expected future cash flows discounted at the loan's effective interest rate,
the loan's observable market price, or the fair value of the collateral if
the loan is collateral dependent. If the measure of the impaired loan is less
than the recorded investment in the loan, the Company recognizes impairment
by creating a valuation allowance with a corresponding charge to provision
for loan losses.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation,
which is computed principally on the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized over the
shorter of their economic lives or the term of the lease.
GOODWILL
The Company has classified as goodwill the cost in excess of fair value of
the net assets (including tax attributes) of businesses acquired in purchase
transactions. Goodwill is being amortized on a straight line method over
fifteen years. The Company periodically reviews goodwill to assess
recoverability from projected, undiscounted net cash flows of the related
business unit, and impairments which would be recognized in operating results
if a permanent reduction in value were to occur.
OTHER REAL ESTATE OWNED
Other real estate owned, which represents real estate acquired through
foreclosure, or deed in lieu of foreclosure, is reported at the fair value of
the property at the time of transfer to other real estate owned, reduced by
estimated selling expenses. Any subsequent operating expenses, or income,
reductions in estimated values, and gains or losses on disposition of such
properties are charged to current operations.
INCOME TAXES
Income taxes are accounted for by the asset and liability method as required
by Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes" (SFAS 109). Deferred tax liabilities or assets are established
for temporary differences between financial and tax reporting basis and are
subsequently adjusted to reflect changes in tax rates expected to be in
effect when the temporary differences reverse. A valuation allowance is
established for any deferred tax asset for which realization is not likely.
F-38
<PAGE>
NOTE A - (CONTINUED)
STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include; cash
on hand, amounts due from banks and Federal funds sold. Generally, Federal
funds are purchased and sold for one-day periods.
EARNINGS PER SHARE
Basic EPS (Earnings per Share) excludes dilution and is computed by dividing
income available to common stockholders by the weighted-average number of
common shares outstanding for the period. Diluted EPA reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.
CURRENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income". This statement, which is effective for
the year ending December 31, 1998, establishes standards of disclosure and
financial statement display for reporting comprehensive income and its
components.
In June 1997, the Financial Accounting Standards Board issued Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information".
This statement changes current practice under SFAS 14 by establishing a new
framework on which to base segment reporting (referred to as the management
approach), and also requires certain related disclosures about products and
services, geographic areas, and major customers. The disclosures are required
for the year ending December 31, 1998.
RECLASSIFICATION
Certain reclassifications were made to prior years' presentations to conform
to the current year. These reclassifications are of a normal recurring
nature. All prior years' numbers have been restated to give affect for the
acquisition of El Camino National Bank and Templeton National Bank by Bank of
Santa Maria, and Bank of Santa Maria by BSM Bancorp, on a pooling of interest
basis.
NOTE B - MERGERS AND ACQUISITIONS
On March 11, 1997, BSM Bancorp acquired Bank of Santa Maria by issuing
2,973,539 shares of Bancorp common stock in exchange for the surrender of all
outstanding shares of the Bank's common stock. There was no cash involved in
this transaction. The acquisition was accounted for as a pooling of interest
and the consolidated financial statements contained herein have been restated
to give full affect to this transaction.
Prior to this acquisition, the Bank acquired three other local financial
institutions either through the exchange of stock or by cash payment. Details
regarding these acquisitions can be found below.
MERGER WITH EL CAMINO NATIONAL BANK
At the close of business on January 10, 1997, Bank of Santa Maria consummated
a merger with El Camino National Bank. This merger was accounted for by the
pooling of interest method, whereby the Company's Financial Statements have
been restated as if the two banks were historically one unit. A total of
201,678 common shares were issued to the shareholders of El Camino National
Bank in connection with this merger.
F-39
<PAGE>
NOTE B - (CONTINUED)
The following summarizes the separate revenue and net income of Bank of Santa
Maria and El Camino National Bank that have been reported in the restated
financial statements included herein:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Interest and Nonintest Income:
Bank of Santa Maria $24,627,927 $23,021,319
El Camino National Bank 1,842,044 2,073,680
----------- -----------
$26,469,971 $25,094,999
----------- -----------
----------- -----------
Net Income:
Bank of Santa Maria $ 3,718,740 $ 3,149,392
El Camino National Bank (250,206) 49,272
BSM Merger Company (800) -
----------- -----------
$ 3,467,734 $ 3,198,664
----------- -----------
----------- -----------
</TABLE>
MERGER WITH CITIZENS BANK
On May 3, 1996, the Bank acquired 100% of the outstanding common stock of
Citizens Bank of Paso Robles, N.A. (Citizens) for $4,129,000 in cash.
Citizens had total assets of approximately $31,858,000. The acquisition was
accounted for using the purchase method of accounting in accordance with
Accounting Principles Board Opinion No. 16. "Business Combinations". Under
this method of accounting, the purchase price was allocated to the assets
acquired and deposits and liabilities assumed based on their fair values as
of the acquisition date. The financial statements include the operations of
Citizens from the date of the acquisition. Goodwill arising from the
transaction totaled approximately $1,958,000 and is being amortized over
fifteen years on a straight-line basis.
The following table sets forth selected unaudited pro forma combined
financial information of the Bank and Citizens for the years ended December
31, 1996, and 1995. The pro forma operating data reflects the effect of the
acquisition of Citizens as if it was consummated at the beginning of each
year presented. The pro forma results are not necessarily indicative of the
results that would have occurred had the acquisition been in effect for the
full years presented, nor are they necessarily indicative of the results of
future operations.
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Interest and Noninterest Income:
Bank of Santa Maria restated $26,469,971 $25,094,999
Citizens Bank of Paso Robles 1,024,332 3,187,381
Interest on Purchase Price (218,800) (229,600)
----------- -----------
$27,275,503 $28,052,780
----------- -----------
----------- -----------
Net Income:
Bank of Santa Maria Restated $ 3,467,734 $ 3,198,664
Citizens Bank of Paso Robles 19,134 331,682
----------- -----------
3,486,868 3,530,346
----------- -----------
----------- -----------
Merger Related Adjustments (16,927) (196,332)
----------- -----------
Pro forma Net Income $ 3,469,941 $ 3,334,014
----------- -----------
----------- -----------
Pro forma Net Income Per Share - Basic $ 1.17 $ 1.14
----------- -----------
----------- -----------
Pro forma Net Income Per Share - Diluted $ 1.16 $ 1.13
----------- -----------
----------- -----------
</TABLE>
F-40
<PAGE>
NOTE - B (CONTINUED)
Merger related adjustments include adjustments to interest income from the
payment of the purchase price in cash, goodwill amortization, depreciation,
professional expenses related to the merger, data processing, and other
operating costs and related tax effects.
MERGER WITH TEMPLETON NATIONAL BANK
At the close of business on September 8, 1995, Bank of Santa Maria consummated a
merger with Templeton National Bank. This merger was accounted for by the
pooling of interest method, whereby the Balance Sheets and the Statements of
Income are combined and restated as if the two banks were historically one unit.
A total of 397,561 common shares were issued to the shareholders of Templeton
National Bank in connection with this merger.
The following summarizes the historical separate revenue and net income of Bank
of Santa Maria and Templeton National Bank that have been reported in the
restated financial statements included herein:
<TABLE>
<CAPTION>
Eight month
period ended
August 31, 1995
------------------
<S> <C>
Interest and non-interest income
--------------------------------------
Bank of Santa Maria $13,608,014
Templeton National Bank 1,754,146
--------------
$15,362,160
--------------
--------------
Net Income
--------------------------------------
Bank of Santa Maria $ 2,061,359
Templeton National Bank 199,598
--------------
$ 2,260,957
--------------
--------------
</TABLE>
F-41
<PAGE>
NOTE C - INVESTMENT SECURITIES
Securities have been classified in the Balance Sheets according to management's
intent. The carrying amount of securities and their approximate fair values at
December 31, were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------------- ------------ ------------ --------------
<S> <C> <C> <C> <C>
1997:
Available for Sale Securities:
U.S. Treasury securities $17,560,736 $52,037 $3,009 $17,609,764
U.S. Government and agency
securities 28,439,171 124,560 30,361 28,533,370
--------------- ------------ ------------ --------------
$45,999,907 $176,597 $33,370 $46,143,134
--------------- ------------ ------------ --------------
--------------- ------------ ------------ --------------
1997:
Held to Maturity Securities:
U.S. Treasury securities $999,750 - $69 $999,681
U. S. Government and agency
securities 28,913,811 71,152 86,281 28,898,683
Obligations of states and
political subdivisions 30,238,482 333,100 1,931 30,569,651
Other debt securities 2,615,421 6,773 16,205 2,605,989
--------------- ------------ ------------ --------------
$62,767,464 $411,025 $104,486 $63,074,004
--------------- ------------ ------------ --------------
--------------- ------------ ------------ --------------
1996:
Available for Sale Securities:
U.S. Treasury securities $3,981,598 $26,867 - $4,008,464
U.S. Government and agency
securities 19,893,604 27,101 63,559 19,857,146
--------------- ------------ ------------ --------------
$23,875,202 $53,968 $63,559 $23,865,610
--------------- ------------ ------------ --------------
--------------- ------------ ------------ --------------
1996:
Held to Maturity Securities:
U.S. Treasury securities $4,798,202 $117,139 $2,915 $4,912,426
U.S. Government and agency
securities 45,190,581 84,635 188,581 45,086,635
Obligations of states and
political subdivisions 15,294,241 - 6,278 15,287,963
Other debt securities 3,056,103 10,372 22,604 3,043,870
--------------- ------------ ------------ --------------
$68,339,127 $212,146 $220,378 $68,330,894
--------------- ------------ ------------ --------------
--------------- ------------ ------------ --------------
</TABLE>
There were no gross realized gains or gross realized losses on sales of
available for sale securities. The Company does not expect to realize either
gains or losses shown in the above schedule. The Company fully expects to hold
these securities to maturity/call date at which time the amortized cost and
market value will be the same as the par value of the bond.
The Company has no derivative financial instruments as defined by SFAS No.
119, "Disclosure About Derivative Financial Instruments and Fair Value of
Financial Instruments."
At December 31, 1997, and 1996, investment securities having an amortized cost
of approximately $6,006,000 and $6,224,000 respectively, were pledged to secure
public deposits and for other purposes as required or permitted by law.
F-42
<PAGE>
NOTE C - (CONTINUED)
The amortized cost and estimated market value of all debt securities as of
December 31, 1997, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Held to Maturity Available for Sale
---------------- ------------------
Amortized Estimated Amortized Estimated
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Due in one year or less $15,754,095 $15,756,674 $9,133,101 $9,133,144
Due after one year to five years 36,331,320 36,473,327 36,866,806 37,009,990
Due after five years to ten years 9,342,945 9,490,224 - -
Due after ten years 1,339,104 1,353,779 - -
------------ ------------ ------------ ------------
TOTAL $62,767,464 $63,074,004 $45,999,907 $46,143,134
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
NOTE D - LOANS
The Company's loan portfolio consists primarily of loans to borrowers within
Santa Barbara and San Luis Obispo Counties. Although the Company seeks to avoid
concentrations of loans to a single industry, loans to the agricultural
community are listed separately, as in total they exceed 10% of all loans
outstanding as of December 31, 1997, and 1996. Concentrations also can occur
based upon a single class of collateral. Real estate and real estate associated
businesses are among the principal industries in the Company's market area and,
as a result, the Company's loan and collateral portfolios are to some degree
concentrated in those industries. Real estate related loans, net of deferred
fees and costs at December 31, 1997, and December 31, 1996, were as follows:
Real estate related:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Construction and land development $16,778,000 $13,797,000
Home equity credit lines 18,727,000 20,465,000
Residential properties 14,304,000 17,253,000
Commercial properties 49,099,000 42,057,000
Farmland 11,101,000 6,971,000
------------ ------------
$110,009,000 $100,543,000
------------ ------------
------------ ------------
</TABLE>
F-43
<PAGE>
NOTE D - (CONTINUED)
The Company also originates real estate loans for sale to governmental agencies
and institutional investors. At December 31, 1997, and at December 31, 1996, the
Company had approximately $1,200,000 and $1,400,000 held for sale respectively,
and was servicing approximately $36,900,000 and $39,600,000, respectively, in
loans previously sold.
A summary of the changes in the allowance for possible credit losses follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year $2,701,876 $2,801,396 $2,412,427
Additions to the allowance charged to expense 30,000 227,000 875,500
Recoveries on loans charged off 106,300 97,476 106,149
Allowance on loans acquired from Citizens
Bank - Note B - 228,022 -
------------- ----------- -----------
Subtotal 2,838,176 3,353,894 3,394,076
Less loans charged off 723,692 652,018 592,680
------------- ----------- -----------
TOTAL $2,114,484 $2,701,876 $2,801,396
------------- ----------- -----------
------------- ----------- -----------
</TABLE>
The following is a summary of the investment in impaired loans, the related
allowance for loan losses, and income recognized on a cash basis as of December
31:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Recorded Investment in Impaired Loans $1,572,021 $1,390,561
----------- -----------
----------- -----------
Related Allowance for Loan Losses $ 425,461 $ 351,544
----------- -----------
----------- -----------
Average Recorded Investment in Impaired Loans $1,733,151 $1,506,478
----------- -----------
----------- -----------
Interest Income Recognized for Cash Payments $ 61,569 $ 39,128
----------- -----------
----------- -----------
</TABLE>
Loans having carrying value of $419,669, $1,151,581 and $698,909 were
transferred to other real estate owned in 1997, 1996, and 1995, respectively.
During 1997 and 1996, loans totaling $144,000 and $122,900 respectively, were
made to facilitate the sale of other real estate owned.
NOTE E - PREMISES AND EQUIPMENT
A summary of premises and equipment follows:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Land $3,349,597 $3,225,913
Buildings and improvements 8,721,744 8,598,715
Leasehold improvements 12,210 109,199
Furniture, fixtures, and equipment 7,581,153 7,162,786
------------- -------------
Subtotal 19,664,704 19,096,613
Less accumulated depreciation/amortization 6,955,577 6,448,406
------------- -------------
TOTAL $12,709,127 $12,648,207
------------- -------------
------------- -------------
</TABLE>
F-44
<PAGE>
NOTE F - STOCK OPTION PLAN
In 1996, the Company adopted a stock option plan under which the Company's
common shares may be issued to directors, officers and key employees of the
Company and its subsidiary, as well as consultants and business associates, at
not less than 100% of the fair market value at the date the options were
granted. Of the 892,542 shares available to be issued under the new plan,
159,400 were immediately issued to replace options outstanding under Bank of
Santa Maria's stock option plans.
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions for 1997, 1996
and 1995, respectively: risk-free rates of 5.8%, 6.1%, and 5.4%; dividend yields
of 2.0%, 2.0%, and 2.0%; volatility of 20% for 1997, and 15% for 1996, and 1995.
A summary of the status of the Company's plan and the Bank's two expired fixed
stock option plans as of December 31, 1997, 1996, 1995, and changes during the
years ending on those dates, is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------- ------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------------------- ------------------------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 158,400 $12 153,900 $11 153,300 $10
Granted 4,000 16 31,500 15 23,500 14
Exercised (17,600) 10 (23,400) 9 (18,450) 9
Forfeited (3,600) 15 3,600) 7 (4,450) 10
-------- --------- ---------
Outstanding at end of year 141,200 12 158,400 12 153,900 11
-------- --------- ---------
-------- --------- ---------
Options exercisable at year-end 72,000 59,500 53,400
Weighted-average fair value of
options granted during the year $ 3.79 $ 3.10 $ 2.70
Options available for future grant 733,942 11 86,520 10 118,420 9
</TABLE>
The following table summarizes information about fixed stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------------------------------------------------
Weighted-Average
Exercise Number Remaining Weighted Average Number Weighted
Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$6 14,000 2 years $6 12,500 $6
$10 to $12 72,400 1.3 11 44,600 11
$13 to $17 54,800 3.2 14 14,900 14
--------- --------
$6 to $17 141,200 2.0 12 72,000 11
--------- --------
--------- --------
</TABLE>
F-45
<PAGE>
NOTE G - RETIREMENT PLAN
The Company has a noncontributory retirement plan covering substantially all of
its employees. The plan is a defined contribution plan with annual contributions
established at the discretion of the Board of Directors. The retirement plan
expense was $425,000 for 1997, $380,000 for 1996, and $340,000 for 1995.
In 1988, the Company's subsidiary established a Profit Sharing and Salary
Deferral 401(K) Plan to allow employees to defer a portion of their current
compensation until retirement. Since 1991, the Board of Directors of the Bank,
at their discretion, have elected to make a matching contribution at a
predetermined percentage of deferred dollars up to 2% of the participant's gross
salary. In 1997, the Board increased the percentage to 3%. The expense of the
matching contribution was $111,000 for 1997, $79,000 for 1996, and $74,000 for
1995. As of December 31, 1997, there were $7,366,000 in funds held for the
benefit of Bank employees in the aforementioned plans.
The estimated annual benefit payable upon retirement for any participant is
dependent upon the participant's salary levels for each of the years until
retirement coupled with the election of the Bank's Board to make annual
contributions for any given year, as well as the returns generated by the
investment choices selected by the individual employee over the period prior to
retirement.
NOTE H - INCOME TAXES
The provisions for income taxes included in the Statements of Income consist of
the following:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ------------ -----------
<S> <C> <C> <C>
Current:
Federal $1,617,000 $1,436,000 $1,480,900
State 683,000 607,800 619,000
----------- ------------ -----------
2,300,000 2,043,800 2,099,900
Deferred 316,000 269,000 (215,000)
----------- ------------ -----------
$2,616,000 $2,312,800 $1,884,900
----------- ------------ -----------
----------- ------------ -----------
</TABLE>
A comparison of the federal statutory income tax rates to the Company's
effective income tax rates follow:
<TABLE>
<CAPTION>
1997 1996 1995
Amount Rate Amount Rate Amount Rate
---------- ------- ----------- ------ ----------- -------
<S> <C> <C> <C> <C> <C> <C>
Federal tax rate $2,319,000 34.0% $1,965,000 34.0% $1,728,000 34.0%
California franchise taxes,
net of federal tax benefit 500,000 7.3% 448,000 7.8% 379,000 7.6%
Tax savings from exempt
loan and investment income (273,000) (4.0%) (197,000) (3.4%) (166,000) (3.3%)
Other items - net 70,000 1.0% 96,800 1.6% (56,100) (1.2%)
---------- ------- ----------- ------ ----------- -------
$2,616,000 38.3% $2,312,800 40.0% $1,884,900 37.1%
---------- ------- ----------- ------ ----------- -------
---------- ------- ----------- ------ ----------- -------
</TABLE>
F-46
<PAGE>
NOTE H - (CONTINUED)
The following is a summary of the components of the net deferred tax asset and
liability accounts recognized in the accompanying Balance Sheets:
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
Deferred Tax Assets:
Allowance for Credit Losses Due to Tax Limitations $570,000 $855,000
Other Assets/Liabilities 351,000 437,000
----------- ----------
921,000 1,292,000
Deferred Tax Liability:
Premises and Equipment Due to Depreciation
Difference (496,000) (490,000)
----------- ----------
Net Deferred Taxes $425,000 $802,000
----------- ----------
----------- ----------
</TABLE>
NOTE I - EARNINGS PER SHARE (EPS)
The following is a reconciliation of net income and shares outstanding to the
income and number of shares used to compute EPS.
<TABLE>
<CAPTION>
1997 1996 1995
Income Shares Income Shares Income Shares
------------ ----------- ----------- ----------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Net Income as Reported $4,204,967 $3,467,734 $3,198,664
Shares Outstanding at Year End 2,990,939 2,973,631 2,950,081
Impact of Weighting Shares
Purchased During the Year - (14,406) - (14,047) - (38,007)
------------ ----------- ----------- ----------- ------------- ----------
Used in Basic EPS 4,204,967 2,976,533 3,467,734 2,959,584 3,198,664 2,912,074
Dilutive Effect of Stock Options - 62,296 - 33,590 - 31,066
------------ ----------- ----------- ----------- ------------- ----------
Used in Dilutive EPS $4,204,967 3,038,829 $3,467,734 2,993,174 $3,198,664 2,943,140
------------ ----------- ----------- ----------- ------------- ----------
------------ ----------- ----------- ----------- ------------- ----------
</TABLE>
NOTE J - FINANCIAL COMMITMENTS
In the normal course of business, the Company enters into financial commitments
to meet the financing needs of its customers. These financial commitments
include commitments to extend credit and standby letters of credit. Those
instruments involve, to varying degrees, elements of credit and interest rate
risk not recognized in the Company's financial statements.
The Company's exposure to credit loss in the event of nonperformance on
commitments to extend credit and standby letters of credit is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments as it does for loans reflected in the financial
statements.
F-47
<PAGE>
NOTE J - (CONTINUED)
As of December 31, 1997, the Company had the following outstanding financial
commitments whose contractual amount represents credit risk:
<TABLE>
<CAPTION>
<S> <C>
Commitments to extend credit $ 53,823,796
Standby letters of credit 2,046,426
-------------
$ 55,870,222
-------------
-------------
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Standby
letters of credit are conditional commitments to guarantee the performance of a
Company customer to a third party. Since many of the commitments and standby
letters of credit are expected to expire without being drawn upon, the total
amounts do not necessarily represent future cash requirements. The Company
evaluates each customer's credit worthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company, is based on
management's credit evaluation of the customer. The majority of the Company's
commitments to extend credit and standby letters of credit are secured by real
estate.
NOTE K - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company has granted loans to certain
officers and directors and the companies with which they are associated. In the
Company's opinion, all loans and loan commitments to such parties are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons. An
analysis of the activity with respect to such loans to related parties is as
follows:
<TABLE>
<CAPTION>
1997 1996
----------- -------------
<S> <C> <C>
Balance at Beginning of Year $5,643,829 $5,677,776
Advances 2,815,721 5,993,138
Repayments (3,888,618) (6,027,085)
----------- -------------
Balance at End of Year $4,570,932 $5,643,829
----------- -------------
----------- -------------
</TABLE>
NOTE L - REGULATORY MATTERS
The Company is subject to various regulatory capital requirements administered
by federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory - and possibly additional discretionary - actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines, and the
regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Company's
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Company's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios of total and Tier 1
capital (as defined in the regulations) to risk-weighted assets (as defined);
and of Tier 1 capital (as defined) to average assets (as defined). Management
believes, as of December 31, 1997, that the Company meets all capital adequacy
requirements to which it is subject.
F-48
<PAGE>
NOTE L - (CONTINUED)
The Company's actual capital amounts and ratios are presented in the following
table.
<TABLE>
<CAPTION>
Capital Needed
--------------
To be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Provisions
------------------- ------------------- --------------------
IN THOUSANDS Amount Ratio Amount Ratio Amount Ratio
- ----------------------------- --------- -------- ------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
BANCORP
As of December 31, 1997:
Total Capital to Risk-Weighted Assets $36,366 15.6% $18,630 8.0% $23,287 10.0%
Tier 1 Capital to Risk-Weighted Assets $34,251 14.7% $ 9,315 4.0% $13,972 6.0%
Tier 1 Capital to Average Assets $34,251 10.7% $12,789 4.0% $15,986 5.0%
BANK
As of December 31, 1997:
Total Capital to Risk-Weighted Assets $36,041 15.6% $18,527 8.0% $23,159 10.0%
Tier 1 Capital to Risk-Weighted Assets $33,926 14.6% $ 9,264 4.0% $13,895 6.0%
Tier 1 Capital to Average Assets $33,926 10.2% $13,364 4.0% $16,705 5.0%
BANK
As of December 31, 1996:
Total Capital to Risk-Weighted Assets $33,047 15.3% $17,287 8.0% $21,609 10.0%
Tier 1 Capital to Risk-Weighted Assets $30,537 14.1% $ 8,644 4.0% $12,966 6.0%
Tier 1 Capital to Average Assets $30,537 9.7% $12,581 4.0% $15,726 5.0%
</TABLE>
The California Financial Code provides that a bank may not make a cash
distribution to its shareholders in excess of the lessor of the Company's
undivided profits, or the Company's net income for its last three fiscal years;
less the amount of any distribution made by the Company to shareholders during
the same period. Under these restrictions, approximately $8,608,000 was
available for payment of dividends at December 31, 1997.
Banking regulations require that all banks maintain a percentage of their
deposits as reserves at the Federal Reserve Bank. During the year ended December
31, 1997, required reserves averaged approximately $2,281,000.
NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of Financial Accounting Standards No.
107, "Disclosures About Fair Value of Financial Instruments". For financial
instruments, whether or not recognized in the Balance Sheets, the Company is
required to disclose the fair value of those instruments for which it is
practicable to estimate that value. In addition, the Company is required to
disclose the methods and significant assumptions used to estimate those fair
values.
Considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts the Company could realize in a
current market exchange. This disclosure of the fair value of financial
instruments should not be viewed as equivalent to the valuation of the Company
as a whole.
Fair value estimates, methods, and assumptions are set forth below:
CASH, DUE FROM BANKS, AND FED FUNDS SOLD
For these short-term instruments, the carrying amount approximates fair value.
F-49
<PAGE>
NOTE M - (CONTINUED)
INVESTMENT SECURITIES
For investment securities, fair value equals quoted market prices where
available, or, if unavailable, the fair value is based upon similar securities.
LOANS
For those loans with floating interest rates, it is presumed that estimated fair
value generally approximates the carrying value. The fair value of other types
of loans is estimated by discounting the future cash flows using the current
rates at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
The fair value of non-accrual loans with a recorded book value of $963,000 was
not estimated because it was not practicable to reasonably estimate the amount
or timing of future cash flows for such loans.
DEPOSITS
The fair value of demand deposits, savings, and money market accounts is the
amount payable on demand at the reporting date. The fair value of fixed-maturity
certificates of deposit is estimated using rates currently offered for deposits
of similar remaining maturities.
COMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT
Commitments to extend credit and letters of credit are written at current market
rates. The Company does not anticipate any interest rate or credit factors that
would materially affect the fair value of these commitments or letters of credit
outstanding at December 31, 1997.
The estimated fair values of the Company's financial instruments at December 31,
1997 and December 31, 1996, are as follows (dollar amounts in thousands):
<TABLE>
<CAPTION>
1997 1997 1996 1996
Carrying Carrying
Amount Fair Value Amount Fair Value
---------- -------------- ---------- --------------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and Due from banks $18,473 $18,473 $17,644 $17,644
Fed funds sold 7,461 7,461 13,920 13,920
Investment securities 108,911 109,217 92,205 92,198
Loans 192,136 190,394 180,372 179,037
Less: Non-Accruals (790) (790) (981) (981)
Allowance for losses (2,115) (2,115) (2,702) (2,702)
---------- -------------- ---------- --------------
Net Loans $189,231 $187,489 $176,689 $175,354
Financial Liabilities:
Deposits $306,292 $306,167 $286,278 $286,556
</TABLE>
F-50
<PAGE>
NOTE N - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of BSM Bancorp (parent only) follows:
BSM BANCORP
Condensed Balance Sheet
December 31, 1997, and 1996
<TABLE>
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash in Bank of Santa Maria $ 185,140 $ 17,136
Investment in Bank of Santa Maria 35,739,148 -
Investment in BSM Merger Company - 200
Other assets 151,440 54,106
------------- ------------
Total assets $ 36,075,728 $ 71,442
------------- ------------
------------- ------------
LIABILITIES & SHAREHOLDERS' EQUITY
Short-term note payable $ - $ 40,000
Accrued liabilities 13,500 30,742
------------- ------------
Total liabilities 13,500 70,742
Shareholders' equity 36,062,228 700
------------- ------------
Total liabilities and shareholders' equity $ 36,075,728 $ 71,442
------------- ------------
------------- ------------
</TABLE>
F-51
<PAGE>
NOTE N - (CONTINUED)
BSM BANCORP
Condensed Statements of Income
Years Ended December 31, 1997, and 1996
<TABLE>
1997 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<S> <C> <C>
INCOME:
Cash Dividends from Bank of Santa Maria $ 850,000 $ -
EXPENSES:
Operating Expenses 174,057 -
------------- ------------
Earnings before income taxes and equity in
undistributed net earnings of
Bank of Santa Maria 675,943 -
Provision (Income tax benefit) (67,000) -
------------- ------------
Earnings before equity in undistributed
net earnings of Bank of Santa Maria 742,943 -
Equity in undistributed net earnings of
Bank of Santa Maria 3,462,024 -
Equity in undistributed net loss of BSM Merger
Company - (800)
------------- ------------
Net earnings (loss) $ 4,204,967 $ (800)
------------- ------------
------------- ------------
</TABLE>
F-52
<PAGE>
NOTE N - (CONTINUED)
BSM BANCORP
Condensed Statements of Cash Flows
Years Ended December 31, 1997, and 1996
<TABLE>
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operation activities:
Net income (loss) $ 4,204,967 $ (800)
Adjustments to reconcile net income to net cash
provided by operating activities:
Undistributed net (income) loss of consolidated (3,462,024) 800
subsidiaries
Amortization of organizational expenses 14,829 -
Other (129,405) (23,364)
------------- ------------
Net cash provided by operating activities 628,367 (23,364)
------------- ------------
Cash flows from investing activities:
Decrease (increase) of investment in
subsidiaries 200 (1,000)
------------- ------------
Net cash provided by (used in)
investing activities 200 (1,000)
------------- ------------
Cash flows from financing activities:
Net change in short-term note payable (40,000) 40,000
Proceeds from the issuance of
organizational stock - 1,500
Proceeds from the exercise of stock options 176,925 -
Payment to redeem organizational stock (1,500) -
Dividends paid (595,988) -
------------- ------------
Net cash provided by (used in)
financing activities (460,563) 41,500
------------- ------------
Net increase in cash 168,004 17,136
Cash, beginning of year 17,136 -
------------- ------------
Cash, end of year $ 185,140 $ 17,136
------------- ------------
------------- ------------
</TABLE>
NOTE O - INTENT TO MERGE AND PROPOSED CHANGE OF CONTROL
On January 29, 1998, the Company jointly announced with Mid-State Bank that they
have entered into an Agreement to Merge and Plan of Reorganization dated January
29, 1998, whereby the Bank of Santa Maria and Mid-State Bank would merge
together under BSM Bancorp. Upon consummation, which is anticipated to occur in
the third quarter of 1998, BSM Bancorp is expected to change its name to Mid
State Bancshares and Mid-State Bank would become the surviving bank. Under the
merger terms, existing Mid-State Bank stock would be exchanged for shares of the
Holding Company in a ratio based upon a value of $29.37 for each share of BSM
Bancorp and the fair market value of Mid-State Bank stock just prior to the
close of the merger. It is estimated that Mid-State Bank shareholders will own
approximately 70% and the BSM Bancorp shareholders will own approximately 30% of
the holding company following the consummation of the merger.
F-53
<PAGE>
NOTE O - (CONTINUED)
This transaction is subject to the approval by holders of a majority of the
outstanding shares of the Company's common stock and by regulatory authorities.
All unexercised stock options of BSM Bancorp will become exercisable in full in
the event that this proposed transaction is consummated. In addition, as part of
the Agreement with Mid-State, the Company's mid-year cash dividend, if any, is
limited to a maximum of $.10 per share.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None
F-54
<PAGE>
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following table sets forth as to each of the persons who are currently
directors of the Bancorp, such person's age as of February 17, 1998, principal
occupation during the past five (5) years, and the period during which such
person has served as a director of the Bancorp and also the Bank, its
wholly-owned subsidiary.
<TABLE>
<CAPTION> YEAR FIRST YEAR FIRST
BUSINESS EXPERIENCE APPOINTED AS ELECTED AS BANK
NAME AND OFFICE HELD AGE DURING THE PAST FIVE YEARS BANCORP DIRECTOR DIRECTOR
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Armand R. Acosta 72 Retailer, Retired 1996 1977
Richard E. Adam 67 Farmer 1996 1977
Fred L. Crandall, Jr., DDS 69 Dentist 1996 1978
A J. Diani 76 Construction 1996 1977
Chairman of the Board
Bank of Santa Maria
BSM Bancorp
William A. Hares 63 Commercial Banking 1996 1981
President and CEO
Bank of Santa Maria
BSM Bancorp
Roger A. Ikola, MD 66 Pediatrician 1996 1977
Toshiharu Nishino 71 Wholesale Produce 1996 1977
Joseph Sesto, Jr. 85 Investments, Retired 1996 1977
William L. Snelling 66 Business Manager, Consultant 1996 1977
Secretary
Bank of Santa Maria
BSM Bancorp
Mitsuo Taniguchi 71 Wholesale Produce, Retired 1996 1977
Joseph F. Ziemba, MD 80 Physician, Retired 1996 1978
</TABLE>
F-55
<PAGE>
Upon consummation of the acquisition of Bank of Santa Maria, (see Item
I-Business-Acquisition by Mid-State Bank), all but three of the above directors
have agreed to resign as directors of the Company and its subsidiary. The three
directors who will remain as a part of Mid-State Bancshares are Messieurs Diani,
Hares and Snelling. The seven directors of Mid-State Bank will then be appointed
to fill the vacancies at both the Bank and Company level and the number of
directors of the Company will be reduced to ten. The names of the directors to
be appointed to both the Company and the Bank's Board following the consummation
of the merger are as follows:
Gracia B. Bello
Clifford H. Clark
Daryl L. Flood
Raymond E Jones
Albert L Maguire
Gregory R. Morris
Carrol R Pruett
EXECUTIVE OFFICERS
The following table sets forth as to each of the persons who are currently
executive officers of the Bancorp, such person's age as of February 17, 1998,
principal occupation during the past five (5) years, and the period during which
such person has served as a director of the Bancorp and also the Bank, its
wholly-owned subsidiary.
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE YEAR FIRST APPOINTED
NAME AGE DURING PAST FIVE YEARS AS EXECUTIVE OFFICER
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
William A. Hares 63 President and Chief Executive Officer 1996
of the Bancorp since November, 1996.
President and Chief Executive Officer
of the Bank since 1981
Carol Bradfield(1) 43 Executive Vice President of the 1996
Bancorp since November, 1996
Executive Vice President/Administration
of the Bank since 1996
F. Dean Fletcher 50 Executive Vice President and 1996
Chief Financial Officer of the
Bancorp since November, 1996
Executive Vice President and
Chief Financial Officer of the
Bank since 1991
Susan Forgnone (2) 36 Executive Vice President of the 1996
Bancorp since November, 1996.
Executive Vice President and
Loan Administrator of the
Bank since 1994
James D. Glines 55 Executive Vice President of the 1996
Bancorp since November, 1996.
Executive Vice President-
Branch Administrator of the
Bank since 1997
Executive Vice President since 1992
Manager-Santa Maria Way Branch since 1983
</TABLE>
F-56
<PAGE>
(1) Ms. Bradfield joined the Bank in April, 1988. She was formally Senior
Vice President - Human Resources prior to her appointment as an executive
officer of the Bank.
(2) Ms. Forgnone joined the Bank in October, 1988. She has worked in various
aspects of lending with the Bank prior to her appointment as an executive
officer.
None of the directors, nominees or executive officers of the Bancorp were
selected pursuant to any arrangement or understanding, other than with the
directors and executive officers of the Bancorp, acting within their capacities
as such. There are no family relationships between the directors and executive
officers of the Bancorp, except between Director Nishino and Director Taniguchi
who are brothers-in-law, and none of the directors or executive officers of the
Bancorp serve as directors of any company which has a class of securities
registered under, or which is subject to the periodic reporting requirements of,
the Securities Exchange Act of 1934 or any investment company registered under
the Investment Company Act of 1940, as amended, although all of the directors
and executive officers hold similar positions with the Bank, which, until
acquired by the Bancorp, was subject to the above periodic reporting
requirements.
None of the directors or executive officers of the Bancorp have, during the last
five years, been involved in any legal proceedings that are material to an
evaluation of the ability or integrity of any director or executive officer of
the Company.
ITEM 11: DIRECTORS AND EXECUTIVE OFFICER COMPENSATION
During 1997, the Bancorp did not pay any cash compensation to its executive
officers nor were the directors compensated for their attendance at Bancorp
meetings.
The following Summary Compensation Table shows compensation earned from the Bank
for services rendered during fiscal years 1997, 1996, and 1995 by each of the
Bank's executive officers whose salaries and bonuses exceeded $100,000 in 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long-term
Annual Compensation
Compensation(1) Awards
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Securities All Other
Salary Bonus Underlying Compensation
Name and Principal Position Year ($)(2) ($)(4) Options(#)(5) ($)(3)
- --------------------------------------------------------------------------------------------------------------------------------
William A. Hares 1997 $ 185,000 $ 190,000 $ 18,285
President and Chief 1996 170,000 165,000 17,750
Executive Officer 1995 160,000 150,000 10,000 16,843
Carol Bradfield 1997 90,000 70,000 17,715
Executive Vice President 1996 68,104 35,000 5,000 11,051
Administration 1995 N/A N/A N/A N/A
F. Dean Fletcher 1997 100,000 80,000 17,135
Executive Vice President 1996 96,000 60,000 - 13,776
and Chief Financial Officer 1995 93,000 45,000 - 15,223
Susan Forgnone 1997 95,000 70,000 15,041
Executive Vice President 1996 85,000 50,000 - 12,767
and Loan Administrator 1995 80,000 45,000 - 9,241
James D. Glines 1997 95,000 70,000 17,311
Executive Vice President 1996 89,000 50,000 - 14,614
Branch Administrator 1995 85,000 45,000 - 12,025
</TABLE>
F-57
<PAGE>
(1) The column for other annual compensation has been omitted since the only
items reportable thereunder for the named persons are perquisites, which did
not exceed the lessor of $50,000 or 10% of salary and bonus for any of the
named persons.
(2) Includes all contributions to the Bank's 401(k) Plan, and the Bank's
Flexible Spending Account for medical and child care expenditures made
through salary reductions and deferrals.
(3) All employees of the Bank who have at least one year of service having
worked at least 1,000 hours during that year and are at least 18 years of age
are eligible to participate in the Bank's Profit Sharing and the 401(k)
Salary Deferral Plan. The Salary Deferral Plan is a self funded voluntary
plan that offers certain tax savings with tax deferred investment earnings.
The amount contributed by the participants is fully vested from the date of
deposit. The directors of the Bank at their discretion may elect to match an
amount equal to $.50 for every $1.00 the 401(k) participant invests, not to
exceed 2% of their gross compensation. This contribution is made as of June
30th and December 31st of each year. All matching contributions follows a
seven year vesting schedule. Contribution to the Bank's Profit Sharing Plan
are also at the discretion of the Bank's directors. Any amount that is
contributed is allocated to accounts established for each participating
employee, and is based on a percentage of their gross income. These are
subject to a seven year vesting schedule with 100% vesting occurring after
seven years of service. Funding for the plan always occurs in January of each
year. Participants contributions toward the 401(k) are included in amounts
shown as "Salary," above. The Bank's matching contributions are as well as
the Profit Sharing contribution are aggregated and included under "All Other
Compensation," above.
(4) Cash bonuses are reported in the year earned and may be paid in that year
or in January of the following year at the discretion of the officer. Bonuses
are recommended by the Compensation Committee of the Board and are approved
by the full board at the December meeting. Bonuses are discretionary, but are
generally based upon the operating results of the Bank.
(5) Options shown were issued under the Bank's Incentive Stock Option Plans.
These plans are administered by the Compensation Committee. Options granted
have an exercise price equal to the fair market value on the date of grant,
vest over a term of 5 years, and expire 5 years from the date of grant unless
otherwise noted.
STOCK OPTION GRANTS IN 1997
There were no grants of stock options to any of the named persons during 1997.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth the number of shares acquired by any of the
named persons upon exercise of stock options in 1997, the value realized
through the exercise of such options, and the number of unexercised options
held by the such person, including both those which are presently
exercisable, and those which are not presently exercisable.
<TABLE>
Shares Number of
Acquired Share Underlying Value of Unexercised
Upon Unexercised In-the
Option Value Options Money Options
Name Exercise (#) Realized($) at 12-31-97 (#) at 12-31-97 ($)(1)
- ---- ------------ ----------- --------------------------------- -----------------------------------
<S> <C> <C> <C> <C> <C> <C>
Not Not
Exercisable Exercisable Exercisable Exercisable
------------ ------------ ----------- -----------
William A. Hares 1,000 $ 19,625 19,500 9,500 $ 355,563 $ 139,437
Carol Bradfield 2,500 38,125 1,000 4,000 12,750 51,000
F. Dean Fletcher
Susan Forgnone 5,000 2,500 74,750 37,125
James D. Glines 5,000 41,500
</TABLE>
(1) Potential unrealized value is determined by multiplying the number of shares
by the net of the fair market value at fiscal year end ($26.50) less the option
exercise price.
COMPENSATION FOR NON-EMPLOYEE DIRECTORS There were no fees paid to directors of
the Bancorp.
During 1997, each non-officer director received $900 for each Board of Directors
meeting attended. The Chairman of the Board and the Secretary received an
additional $900 and $300 respectively each month. Members of the Executive
Committee received $900 per month no matter how many meetings held per month.
Members of all other committees received $300 for each committee meeting
attended.
F-58
<PAGE>
CONTRACTS WITH EXECUTIVE OFFICERS
In March, 1997, the Board of Directors of both the Bancorp and the Bank approved
severance pay agreements for their executive officers which would be triggered
by a change in control of either the Bancorp or the Bank, for valid reasons as
defined in the agreements. The principal purposes of these agreements are to
help assure that key executives give impartial consideration in evaluating and
negotiating a potential business combination which is in the best interest of
BSM Bancorp's shareholders, but which may result in the loss of, or reduction
in, the executive's job.
The benefits under these agreements are triggered if, within one year following
a change in control, the executive officer's employment is terminated without
cause or the executive officer resigns for reasons such as a substantial
reduction in the officer's responsibilities, an assignment of responsibilities
inconsistent with the executive officer's former responsibilities, a reduction
in the executive officer's annual salary or benefits, or a job relocation of
more than 50 miles.
Severance benefits payable to executive officers covered by Agreements are
determined by multiplying base monthly salary by a component of 24 months for
the President and by 18 months for the other four executive officers. The sum is
payable in monthly installments, or at the discretion of the executive officer,
in one lump sum. In addition, the executive officers are entitled certain fringe
benefits including health and other medical benefits for either the 18 or 24
month period.
Generally, a "change in control" will be deemed to have occurred in any of the
following circumstances:
- A merger or consolidation where the Bank and/or the Bancorp is not the
surviving corporation.
- A transfer of all or substantially all of the assets of the Bank and/or
the Bancorp.
- An acquisition of more than 25% of the outstanding stock coupled with or
followed by a change in the majority of the directors of either the Bank
or the Bancorp.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Bank's Compensation Committee is comprised of A. J. Diani, Carol Bradfield,
William A. Hares, Roger A. Ikola, Joseph Sesto, Jr. and William L.
Snelling. Both Mr. Hares and Ms. Bradfield served as Executive Officers of the
Bank during 1997. All of the above directors have had loans from the
Bank during 1997.
Neither Ms. Bradfield nor Mr. Hares participated in the discussion of their
respective compensation or performance when such matters were addressed by
the committee.
COMPENSATION COMMITTEE REPORT
The compensation committee meets annually to review the salaries and bonuses of
all officers of the Bank. Upon their recommendation, the Bank's full board then
approves salary modifications and bonuses, if any, for all Bank officers. While
all officers are reviewed, particular emphasis is placed upon the salaries paid
to executive officers.
The goal of the compensation program is to align compensation with business
objective and performance, and to enable the Bank to attract and reward
executive officers whose contributions are critical to the long-term success of
the Bank. The Bank is committed to maintaining a pay program that helps attract
and retain the best people in the industry. To ensure that pay is competitive,
the Bank regularly compares its pay practices with those of other leading
independent banks and sets its pay parameters based upon this review.
Executive officers are rewarded based upon corporate performance, and individual
contribution. Bank performance is evaluated by reviewing the extent to which
strategic and business plan goals have been met. Individual contribution is
evaluated by reviewing the progress of the Bank against set objectives in the
individuals area of responsibility.
F-59
<PAGE>
CEO COMPENSATION
William A. Hares has been President and Chief Executive Officer ("CEO") of the
Bank since January 1982, and President and CEO of the Company since it was
formed in November of 1996. In setting Mr. Hares' compensation, the Compensation
Committee made an overall assessment of Mr. Hares' leadership in achieving the
Company's long-term strategic and business goals. During 1997, particular
emphasis was placed on enhancing shareholders' value. The Committee paid
specific attention to variation in budget projections and well as executive
compensation surveys from the California Banking Association, Department of
Financial Institutions and banks headquartered in the Company's local market
area. Mr. Hares' salary reflects a consideration of both competitive forces and
the Company's performance.
COMPENSATION COMMITTEE
A. J. Diani, Chairmen
Carol Bradfield
William A. Hares
Roger A. Ikola
Joseph Sesto, Jr.
William L. Snelling
F-60
<PAGE>
PERFORMANCE GRAPH
The chart shown below compares Mid-State Bank's cumulative five-year total
shareholder return with both the S & P 500 Index and an index developed by SNL
Securities that represents Southern California banks.
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN
AMONG BSM BANCORP, S & P 500 INDEX AND INDUSTRY INDEX
BSM BANCORP
CHART
<TABLE>
<CAPTION>
Period Ending
Index 12/13/92 12/13/93 12/13/94 12/13/95 12/13/96 12/13/97
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BSM Bancorp/Bank of Santa Maria 100.00 110.00 115.99 138.57 167.88 287.05
S & P 100.00 110.08 111.53 153.44 188.52 251.44
Southern California Proxy 100.00 122.27 139.49 176.91 267.07 510.65
</TABLE>
F-61
<PAGE>
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Management of the Bancorp does not know of any person who owns beneficially or
of record more than 5% of the Bancorp's outstanding common stock. The following
table sets forth certain information as of March 18, 1998, concerning the
beneficial ownership of the Bancorp's outstanding common stock by each of the
directors of the Bancorp and by all directors and executive officers of the
Bancorp as a group. As noted in "Item 1 - Business", the proposed merger with
Mid-State Bank would result in a change of control for the Company.
As used throughout this Form 10-K, the term "executive officer" means the
President and Chief Executive Officer of the Bancorp, and the four Executive
Vice Presidents of the Bancorp.
Neither the Chairman of the Board or the Secretary of the Bancorp are treated as
executive officers.
<TABLE>
<CAPTION>
TITLE OF NAME OF BENEFICIAL AMOUNT OF PERCENT OF
CLASS OWNER AND TITLE BENEFICIAL OWNERSHIP (1) OF CLASS (2)
<S> <C> <C> <C>
Common Armand R. Acosta, Director 24,220(3) .8%
Common Richard E. Adam, Director 100,734(3) 3.3%
Common Fred L. Crandall, Jr., Director 82,176(3) 2.7%
Common A. J. Diani, Chairman 86,588(3) 2.9%
Common William A. Hares, President/CEO 50,310(4) 1.7%
Common Roger A. Ikola, Director 74,408(3) 2.5%
Common Toshiharu Nishino, Director 92,674(3) 3.1%
Common Joseph Sesto, Jr. 14,000(3) .5%
Common William L. Snelling, Secretary 81,140(3) 2.7%
Common Mitsuo Taniguchi, Director 74,524(3) 2.5%
Common Joseph F. Ziemba, Director 46,956(3) 1.6%
Common All Directors and Executive
Officers (15 in number) 785,133(5) 25.6%
</TABLE>
(1) Beneficial owner of a security includes any person who, directly or
indirectly, through any contract, arrangement, understanding, relationship, or
otherwise has or shares: (a) voting power, which includes the power to vote, or
to direct the voting of such security; and/or (b) investment power which
includes the power to dispose, or to direct the disposition of such security.
Beneficial owner also includes any person who has the right to acquire
beneficial ownership of such security as defined above within 60 days of the
date specified.
(2) Shares subject to options held by directors and executive officers that were
exercisable within 60 days after March 18, 1998 ("vested"), are treated as
issued and outstanding for the purpose of computing the percentage of class
owned by such person (or group) but not for the purpose of computing the
percentage of class owned by any other individual person.
(3) Includes 4,000 vested shares from the 1997 Bancorp stock option plan.
F-62
<PAGE>
(4) Includes 8,000 vested shares from the 1997 Bancorp stock option plan and
7,237 shares over which Mr. Hares has sole investment powers.
(5) Includes 6,000 vested shares and 23,750 shares owned directly and 34,890
shares whose voting powers can be exercised by the executive officers not listed
individually.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Some of the Company's Directors and executive officers and their immediate
families, as well as the companies with which they are associated, are customers
of, or have had banking transactions with, the Bank in the ordinary course of
the Bank's business, and the Bank expects to have banking transactions with such
persons in the future. In management's opinion, all loans and commitments to
lend included in such transactions were made in the ordinary course of business,
in compliance with applicable laws on substantially the same terms, including
interest rates and collateral, as those prevailing for comparable transactions
with other persons of similar creditworthiness and, in the opinion of
management, did not involve more than a normal risk of collectibility or present
other unfavorable features.
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K
(A) Financial Statements
See Item # 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, which is
part of this Form 10-K.
(B) Reports on Form 8-K
During the fourth quarter of 1997, the Company did not file any
Current Reports on Form 8-K
During the first quarter of 1998, the Company filed two Current
Reports on Form 8-K, one as of January 16, 1998 and the second as of
February 3, 1998.
(C) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NO.
-----------
<S> <C>
2.1 Plan of Reorganization and Merger Agreement dated
November 20, 1996 - Annex 1 of Written Consent
Statement/Prospectus*
2.2 Plan of Reorganization and Merger Agreement dated
January 29, 1997***
3.1 Articles of Incorporation of Registrant*
3.2 Amendment to Articles of Incorporation of Registrant*
3.3 Amendment to Articles of Incorporation of Registrant*
3.4 Bylaws of the Registrant*
10.1 Form of Indemnification Agreement*
10.2 BSM Bancorp 1996 Stock Option agreement as approved by
California Department of Corporations**
10.3 Form of Written Consent*
10.4 Nipomo Branch Land Lease*
10.5 Lompoc Branch Lease*
10.6 Form of "Change in Control" Employment Contract**
10.7 Plan of Reorganization and Merger Agreement dated
January 29, 1998***
21 Subsidiary of Registrant
Registrant has one subsidiary, Bank of Santa Maria,
a California State Chartered Bank
23 Consent of Independent Accountants
27 Financial Data Schedule (for SEC use only)
27.3 Financial Data Schedule (for SEC use only)
</TABLE>
*Incorporated by reference to the Registration Statement of the Company
filed on Form S-4 (Commission File No 333-16951). The effective date was
January 29, 1997
F-63
<PAGE>
**This exhibit is contained in the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1997. filed with the Commission on May 15,
1997 (Commission File No. 333-16951), and incorporated by reference.
***This exhibit is contained in the Company's Current Report on Form 8-K as of
February 3, 1998 and incorporated by reference.
(D) Financial Statements-Other
All schedules are omitted because they are not required, not
applicable or because the information is included in the financial
statements or notes thereto or is not material.
SIGNATURE
Pursuant to the requirement of Section 13 of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: May 7, 1998 BSM BANCORP
-----------
(Registrant)
By:/s/ F. Dean Fletcher
-----------------------
F. Dean Fletcher
Executive Vice President
Chief Financial Officer
F-64
<PAGE>
Pursuant to the Requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C> <C>
/s/ William A. Hares 5/7/98 /s/ Susan D. Forgnone 5/7/98
- --------------------------------- ------ --------------------------- ------
William A. Hares Date Susan D. Forgnone Date
President/CEO/Director Executive Vice President,
Loan Administrator
/s/ F. Dean Fletcher 5/7/98 /s/ James D. Glines 5/7/98
- --------------------------------- ------ --------------------------- ------
F. Dean Fletcher Date James D. Glines Date
Executive Vice President/CFO Executive Vice President
Branch Administrator
/s/ Carol Bradfield 5/7/98 /s/ Mata L. Landry 5/7/98
- --------------------------------- ------ --------------------------- ------
Carol Bradfield Date Mata L. Landry Date
Executive Vice President, Assistant Vice President,
Administration Controller
/s/ Armand Acosta 5/7/98 /s/ Richard E. Adam 5/7/98
- --------------------------------- ------ --------------------------- ------
Armand Acosta Date Richard E. Adam Date
Director Director
/s/ Fred L. Crandall, Jr., D.D.S. 5/7/98 /s/ A. J. Diani 5/7/98
- --------------------------------- ------ --------------------------- ------
Fred L. Crandall, Jr., D.D.S. Date A. J. Diani Date
Director Chairman, Board of Directors
/s/ Roger A. Ikola, M.D. 5/7/98 /s/ Toshiharu Nishino 5/7/98
- --------------------------------- ------ --------------------------- ------
Roger A. Ikola, M.D. Date Toshiharu Nishino Date
Director Director
/s/ Joseph Sesto, Jr. 5/7/98 /s/ William L. Snelling 5/7/98
- --------------------------------- ------ --------------------------- ------
Joseph Sesto, Jr. Date William L. Snelling Date
Director Director
/s/ Mitsuo Taniguchi 5/7/98 /s/ Joseph F. Ziemba, M.D. 5/7/98
- --------------------------------- ------ --------------------------- ------
Mitsuo Taniguchi Date Joseph F. Ziemba, M.D. Date
Director Director
</TABLE>
F-65
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article V of the Registrant's Articles of Incorporation provides that the
liability of the directors of the corporation for monetary damages shall be
eliminated to the fullest extent permissible under California law. Article VI of
the Registrant's Articles of Incorporation provides that the corporation is
authorized to provide for the indemnification of agents (as defined in Section
317 of the California General Corporation Law) of the corporation in excess of
that expressly permitted by such Section 317 for breach of duty to the
corporation and its shareholders to the fullest extent permissible under
California law.
Article III of the Registrant's Bylaws provides, in pertinent part, that
each person who is or was a director, officer, employee or agent of the
corporation, or is or was serving at the request of the corporation as a
director, officer, employee or agent of another foreign or domestic corporation
or other entity, shall be indemnified by the Registrant to the full extent
permitted by the General Corporation Law of the State of California or any other
applicable laws. Article III also authorizes the registrant to enter into one or
more agreements with any person which provides for indemnification greater or
different than that provided for in that Article.
Both the Registrant and its wholly-owned subsidiary, Bank of Santa Maria,
have entered into indemnification agreements with their respective officers and
directors in the forms incorporated by reference as Exhibit 10.1 to the
Registration Statement on Form S-4 (No. 333-16951) originally filed November 27,
1996.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted pursuant to the foregoing provisions to directors,
officers or persons controlling the Registrant, the Registrant has been informed
that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in said Act and is
therefore unenforceable.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT
- ------ --------------------------------------------------------------------------
<C> <S>
2.1 Plan of Reorganization and Merger Agreement between Bancorp, the Bank, and
BSM Merger Company in connection with the formation of Bancorp as a
holding company for the Bank--Annex I of Written Consent
Statement/Prospectus incorporated by reference*
2.2 Agreement and Plan of Reorganization dated January 29, 1998 and amended on
March 27, 1998 by and between Bancorp, Bank and Mid-State--Appendix A of
Joint Proxy Statement/Prospectus incorporated by reference
3.1 Articles of Incorporation of the Registrant*
3.2 Amendment to Articles of Incorporation of Registrant*
3.3 Bylaws of the Registrant*
4.1 Specimen Certificate evidencing shares of Registrant's Common Stock*
4.2 Stockholder Agreement Covering Issuance and Compulsory Repurchase of
Organizing Shares of Registrant in connection with the formation of
Bancorp as a holding company for Bank--Annex II of Written Consent
Statement/Prospectus incorporated by reference*
</TABLE>
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT
- ------ --------------------------------------------------------------------------
<C> <S>
5.1 Opinion of Knecht & Hansen****
8.1 Tax Opinion of Arthur Andersen LLP
10.1 Form of Indemnification Agreement*
10.2 BSM Bancorp 1996 Stock Option Plan and form of Stock Option Agreement**
10.3 Form of Bancorp Proxy*****
10.4 Form of Mid-State Proxy*****
10.5 Nipomo Branch Land Lease*
10.6 Lompoc Branch Lease*
10.7 Unisys License and Service Agreement*
10.8 Information Technology, Inc.*
10.9 Carpenter Fairness Opinion--Appendix C of Joint Proxy Statement/Prospectus
incorporated by reference
10.10 H & A Fairness Opinion--Appendix B of Joint Proxy Statement/Prospectus
incorporated by reference
10.11 BSM Bancorp 1996 Stock Option Plan, form of Stock Option Agreement and
form of Substitute Stock Option Agreement*****
13.1 Annual Report to Securityholders--Annual Report on Form 10-K at Appendix F
of Joint Proxy Statement/Prospectus incorporated by reference
21.1 Subsidiary of BSM Bancorp--Bank of Santa Maria is the only subsidiary of
BSM Bancorp
23.1 Consent of Vavrinek, Trine, Day & Co., LLP
23.2 Consent of Arthur Andersen LLP (the Consent of Arthur Andersen LLP
relating to the Tax Opinion is included in Exhibit 8.1)
23.3 Consent of Knecht & Hansen (Included in Exhibit 5.1)
23.4 Consent of Carpenter*****
23.5 Consent of Hoefer & Arnett (Included in their fairness opinion, Appendix
B, attached to the Joint Proxy Statement/Prospectus)
23.6 Consent of Persons about to Become Directors*****
27 Financial Data Schedule***
</TABLE>
- ------------------------
* Filed as an exhibit to Registrant's Registration Statement (File No.
333-16952) filed on November 27, 1996, which exhibit is incorporated herein
by this reference.
** Filed as an exhibit to the Registration Statement (File No. 333-29161) filed
on June 13, 1997.
*** Filed as an exhibit to the Form 10-K filed on March 18, 1998.
**** Previously filed as part of Registrant's Initial Registration Statement on
Form S-4 (File No. 333-48181) filed on March 18, 1998.
***** Previously filed as part of Registrant's Registration Statement on Form
S-4, Amendment No. 1 (File No. 333-48181) filed on April 29, 1998.
II-2
<PAGE>
(b) Financial Statement Schedules
All schedules are omitted because the required information is not applicable
or is included in the Financial Statements of the Bank and the related notes.
(c) Not applicable.
ITEM 22. UNDERTAKINGS
(a) The undersigned Registrant hereby undertakes to file, during any period
in which offers or sales are being made, a post-effective amendment to this
Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
Registration Statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the Registration Statement or any
material change to such information in the Registration Statement.
(b) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the foregoing provisions, or otherwise, the Company
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
(c) The undersigned Registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the Joint Proxy
Statement/Prospectus pursuant to Item 4 of this form, within one business day of
receipt of such request, and to send the incorporated documents by first class
mail or other equally prompt means. This includes information contained in
documents filed subsequent to the effective date of the Registration Statement
through the date of responding to the request.
(d) The undersigned Registrant hereby undertakes to supply by mans of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the Registration Statement when it became effective.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this pre-effective amendment to the registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Santa Maria, State of California, on May 8, 1998.
BSM BANCORP
A California Corporation
<TABLE>
<S> <C> <C>
By: /s/ WILLIAM A. HARES
-----------------------------------------
William A. Hares,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this
pre-effective amendment to the registration statement has been signed by the
following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
President and Chief
/s/ WILLIAM A. HARES Executive
- ------------------------------ Officer (Principal May 8, 1998
William A. Hares Executive
Officer and Director)
Executive Vice President
and
/s/ F. DEAN FLETCHER Chief Financial Officer
- ------------------------------ (Principal Financial May 8, 1998
F. Dean Fletcher Officer
and Accounting Officer)
/s/ ARMAND R. ACOSTA
- ------------------------------ Director May 8, 1998
Armand R. Acosta
/s/ RICHARD E. ADAM
- ------------------------------ Director May 8, 1998
Richard E. Adam
/s/ FRED L. CRANDALL, JR.
- ------------------------------ Director May 8, 1998
Fred L. Crandall, Jr.
/s/ A.J. DIANI
- ------------------------------ Director May 8, 1998
A.J. Diani
II-4
<PAGE>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ ROGER A. IKOLA
- ------------------------------ Director May 8, 1998
Roger A. Ikola
/s/ TOSHIHARU NIHINO
- ------------------------------ Director May 8, 1998
Toshiharu Nishino
/s/ JOSEPH SESTO, JR.
- ------------------------------ Director May 8, 1998
Joseph Sesto, Jr.
/s/ WILLIAM L. SNELLING
- ------------------------------ Director May 8, 1998
William L. Snelling
/s/ MITSUO TANIGUCHI
- ------------------------------ Director May 8, 1998
Mitsuo Taniguchi
/s/ JOSEPH F. ZIEMBA
- ------------------------------ Director May 8, 1998
Joseph F. Ziemba
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT
- ------ --------------------------------------------------------------------------
<C> <S>
2.1 Plan of Reorganization and Merger Agreement between Bancorp, the Bank, and
BSM Merger Company in connection with the formation of Bancorp as a
holding company for the Bank--Annex I of Written Consent
Statement/Prospectus incorporated by reference*
2.2 Agreement and Plan of Reorganization dated January 29, 1998 and amended on
March 27, 1998 by and between Bancorp, Bank and Mid-State--Appendix A of
Joint Proxy Statement/Prospectus incorporated by reference
3.1 Articles of Incorporation of the Registrant*
3.2 Amendment to Articles of Incorporation of Registrant*
3.3 Bylaws of the Registrant*
4.1 Specimen Certificate evidencing shares of Registrant's Common Stock*
4.2 Stockholder Agreement Covering Issuance and Compulsory Repurchase of
Organizing Shares of Registrant in connection with the formation of
Bancorp as a holding company for Bank--Annex II of Written Consent
Statement/Prospectus incorporated by reference*
5.1 Opinion of Knecht & Hansen****
8.1 Tax Opinion of Arthur Andersen LLP
10.1 Form of Indemnification Agreement*
10.2 BSM Bancorp 1996 Stock Option Plan and form of Stock Option Agreement**
10.3 Form of Bancorp Proxy*****
10.4 Form of Mid-State Proxy*****
10.5 Nipomo Branch Land Lease*
10.6 Lompoc Branch Lease*
10.7 Unisys License and Service Agreement*
10.8 Information Technology, Inc.*
10.9 Carpenter Fairness Opinion--Appendix C of Joint Proxy Statement/Prospectus
incorporated by reference
10.10 H & A Fairness Opinion--Appendix B of Joint Proxy Statement/Prospectus
incorporated by reference
10.11 BSM Bancorp 1996 Stock Option Plan, form of Stock Option Agreement and
form of Substitute Stock Option Agreement*****
13.1 Annual Report to Securityholders--Annual Report on Form 10-K at Appendix F
of Joint Proxy Statement/Prospectus incorporated by reference
21.1 Subsidiary of BSM Bancorp--Bank of Santa Maria is the only subsidiary of
BSM Bancorp
23.1 Consent of Vavrinek, Trine, Day & Co., LLP
23.2 Consent of Arthur Andersen LLP (the Consent of Arthur Andersen LLP
relating to the Tax Opinion is included in Exhibit 8.1)
23.3 Consent of Knecht & Hansen (Included in Exhibit 5.1)
23.4 Consent of Carpenter*****
23.5 Consent of Hoefer & Arnett (Included in their fairness opinion, Appendix
B, attached to the Joint Proxy Statement/Prospectus)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT
- ------ --------------------------------------------------------------------------
<C> <S>
23.6 Consent of Persons about to Become Directors*****
27 Financial Data Schedule***
</TABLE>
- ------------------------
* Filed as an exhibit to Registrant's Registration Statement (File No.
333-16952) filed on November 27, 1996, which exhibit is incorporated herein
by this reference.
** Filed as an exhibit to the Registration Statement (File No. 333-29161) filed
on June 13, 1997.
*** Filed as an exhibit to the Form 10-K filed on March 18, 1998.
**** Previously filed as part of Registrant's Initial Registration Statement on
Form S-4 (File No. 333-48181) filed on March 18, 1998.
***** Previously filed as part of Registrant's Registration Statement on Form
S-4, Amendment No. 1 (File No. 333-48181) filed on April 29, 1998.
(b) Financial Statement Schedules
All schedules are omitted because the required information is not applicable
or is included in the Financial Statements of the Bank and the related notes.
(c) Not applicable.
<PAGE>
May 7, 1998
Mr. James G. Stathos
Executive Vice President
and Chief Financial Officer
Mid-State Bank
1026 Grand Avenue
Arroyo Grande, California 93420
Mr. F. Dean Fletcher
Executive Vice President
and Chief Financial Officer
2739 Santa Maria Way
Santa Maria, California 93401
Dear Jim and Dean:
This opinion is being furnished to you in connection with the Agreement to
Merge and Plan of Reorganization dated as of January 29, 1998 and First
Amendment thereto ("the Agreement to Merge") among Mid-State Bank, BSM
Bancorp and Bank of Santa Maria, which is expected to be completed in the
third quarter of 1998 ("the Effective Date" and "the Effective Time" as
defined in the Agreement to Merge). Our understanding of the merger (the
"Merger") is as follows:
A. At the Effective Date and Time, Bank of Santa Maria shall be merged with
and into Mid-State Bank and Mid-State Bank will continue as the
surviving bank. All assets, rights, franchises, titles and interests of
Bank of Santa Maria shall be transferred to and vested in Mid-State
Bank. Mid-State Bank shall be liable for all liabilities of Bank of
Santa Maria.
B. At the Effective Date and Time, all shares of the common stock of
Mid-State Bank shall be converted solely into shares of BSM Bancorp
common stock. The shareholders of Mid-State Bank will receive shares of
BSM Bancorp common stock proportionate in value based on the terms
contained in Section 2.3 and 1.1 of the Agreement to Merge. (i) If the
Average Closing Price of Mid-State Bank stock is not less than $26.25
but not more than $30.50, each share of Mid-State Bank stock will be
exchanged for the number of shares of BSM Bancorp stock equal to the
reciprocal of the number determined by dividing $29.37 by the average
closing price. (ii) If the Average Closing Price is greater than
$30.50, each share of Mid-State Bank stock will be exchanged for 1.0385
shares of BSM Bancorp stock. (iii) If the average closing price is less
than $26.25, each share of Mid-State Bank stock will be exchanged for
0.8938 shares of BSM Bancorp stock;
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 2
May 7, 1998
provided, however that, if the Average Closing Price is less than
$26.25, Bancorp has a right to terminate the Agreement. If Bancorp
elects to so terminate, Mid-State has the right, so long as the Average
Closing Price exceeds $22.00, to reinstate the Agreement by adjusting
the Exchange Ratio downward based on the formula in (i) above.
In lieu of issuing fractional shares of BSM Bancorp common stock as a
result of the merger, common shareholders of Mid-State Bank will be
entitled to receive a cash payment equal to the fair market value of any
fraction of a share of BSM Bancorp common stock to which such holder
would be entitled but for this provision.
C. Immediately after the Effective Time, the Charter Documents of BSM
Bancorp shall be amended to change its name to "Mid-State Bancshares."
D. At the Effective Time, the Mid-State Option Plan will terminate and the
BSM Option Plan will continue in effect. BSM Bancorp shall grant
substitute stock options pursuant to the BSM Option Plan to each and
every officer and employee of Mid-State Bank who has at the Effective
Time an outstanding option under the Mid-State Bank Option Plan to
purchase shares of Mid-State Bank stock.
E. Pursuant to the S-4, each and every substitute option so granted by BSM
Bancorp to replace a Mid-State Bank option shall retain the vesting
schedule in the respective option agreement, and shall be exercisable
for that whole number of shares equal to the product of (A) the number
of Mid-State shares that were purchasable under the option prior to the
merger by (B) the exchange ratio as outlined in the S-4, rounded down to
the nearest whole number of shares. Further, the substitute option
shall have an exercise price equal to the quotient determined by
dividing (A) the exercise price of the Mid-State Option by (B) the
exchange ratio.
In addition, no other provisions of the option agreements are to be
changed. Therefore, each employee is not receiving an option, which has
any additional benefits beyond those provided in the original option
agreement.
RELIANCE ON CERTAIN FACTS, ASSUMPTIONS, AND REPRESENTATIONS
You have asked for our opinion on the federal income tax consequences to
Mid-State Bank, BSM Bancorp, Bank of Santa Maria, and the shareholders of
Mid-State Bank. In rendering our opinion, we have relied upon the accuracy
and completeness of the facts, assumptions, and information as contained
herein, in the Agreement to Merge (in each case, except as otherwise
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 3
May 7, 1998
provided, without regard to any limitations based on knowledge or belief),
including all exhibits attached thereto, the Registration Statement on Form
S-4, certain representations attached as Exhibit A, and all other related
documents. You have represented that such facts, assumptions, and
representations are true, correct, and complete. However, we have not
independently audited or otherwise verified any of these facts, assumptions,
or representations. A misstatement or omission of any fact or a change or
amendment in any of the facts, assumptions, or representations upon which we
have relied may require a modification of all or a part of this opinion. In
addition, our opinion is based on such facts, assumptions, and
representations as represented to us as of the date of this letter. Any
changes in the facts, assumptions, or representations upon which we have
relied between the date of this letter and the actual closing of the
transaction may require a modification of all or part of this opinion. If
needed, we will update our opinion as of the date of the Merger. However, we
will require a representation that none of the facts or representations have
changed between the date of this letter and the date of the Merger.
Otherwise, we have no responsibility to update this opinion for events,
transactions, circumstances, or changes in any of such facts, assumptions, or
representations occurring after this date.
PREMISE OF OPINION
Our opinion is based solely on our interpretation of the Internal Revenue
Code of 1986, as amended (the "Code"); U.S. federal income tax regulations
thereunder ("Treasury Regulations"; relevant judicial decisions; guidance
issued by the Internal Revenue Service (the "Service") including revenue
rulings and revenue procedures; and other authorities that we deemed
relevant; in each case as of the date of this opinion.
U.S. federal income tax laws and regulations, and the interpretations
thereof, are subject to change, which changes could adversely affect this
opinion. If there is a change in the Code, the regulations thereunder, the
administrative guidance issued thereunder, or in the prevailing judicial
interpretation of the foregoing, the opinion expressed herein would
necessarily have to be reevaluated in light of any such changes. If
requested, we will update our opinion as of the date of the Merger.
Otherwise, our opinion is as of the date of this letter and we have no
responsibility to update this opinion for changes in applicable law or
authorities occurring after this date.
Our opinion does not address the potential tax consequences of any
transactions, events, or circumstances other than the transaction as
described herein. In addition, our opinion is limited to the U.S. federal
income tax consequences set forth below. Our opinion does not address any
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 4
May 7, 1998
non-income, state, local, or foreign tax consequences of the transaction. We
also express no opinion on non-income tax issues, such as corporate law or
securities matters.
This opinion does not address the U.S. federal income tax consequences of the
transaction to any Mid-State Bank common shareholder that has a special
status, including (without limitation) insurance companies; financial
institutions; broker-dealers; foreign corporations; estates and trusts not
subject to U.S. federal income tax on their income regardless of source;
persons who are not citizens or residents of the United States; and persons
who acquired stock as the result of the exercise of a compensatory stock
option, pursuant to an employee stock purchase plan, or otherwise as
compensation.
Our opinion is not binding on the Service, and there can be no assurance that
the Service will not take positions contrary to such opinion or will not be
successful in sustaining such contrary positions. However, should the
Service challenge the U.S. federal income tax treatment of the matters
discussed below, our opinion reflects our assessment of the probable outcome
of litigation based solely on an analysis of the existing authorities
relating to such matters.
This opinion is solely for the benefit of Mid-State Bank, BSM Bancorp and
Bank of Santa Maria and their respective shareholders and is not intended to
be relied upon by anyone other than Mid-State Bank, BSM Bancorp and Bank of
Santa Maria and their respective shareholders. Due to the individual nature
of the tax consequences of the Merger, it is recommended that Mid-State Bank,
BSM Bancorp, and Bank of Santa Maria shareholders consult their own tax
advisor concerning the individual tax consequences to them. You do hereby
have our express consent to include copies of this letter as an exhibit to
the Agreement to Merge, as an exhibit in the Registration Statement on Form
S-4 for the proposed transaction and by making reference to us and our
opinion in the Proxy Statement-Prospectus forming a part of the Registration
Statement. Except to the extent expressly permitted hereby, and without the
prior written consent of this firm, this letter may not be quoted in whole or
in part or otherwise referred to in any documents or delivered to any other
person or entity.
OPINION
Based upon all of the foregoing, including representations of the management
of Mid-State Bank, BSM Bancorp and Bank of Santa Maria, it is our opinion
with respect to the Merger that:
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 5
May 7, 1998
a) The Merger will qualify as a reorganization under Code Section 368 and
Mid-State Bank, BSM Bancorp and Bank of Santa Maria each will be a
"party to a reorganization" within the meaning of Code Section 368(b).
b) No gain or loss will be recognized by Mid-State Bank, BSM Bancorp, or
Bank of Santa Maria as a result of the Merger.
c) No gain or loss will be recognized by a shareholder of Mid-State Bank on
the receipt solely of BSM Bancorp common stock in exchange for
his/her/its shares of Mid-State Bank common stock.
d) The tax basis of the assets in Mid-State Bank after the Merger will be
the same as the tax basis of the assets held by Mid-State Bank and Bank
of Santa Maria immediately before the Merger.
e) The tax basis of the shares of BSM Bancorp common stock to be received
by shareholders of Mid-State Bank pursuant to the Merger will be the
same as the basis of the shares of Mid-State Bank common stock
surrendered in exchange therefor, decreased by the amount of basis
allocated to any cash received in lieu of fractional shares that are
hypothetically received by the Mid-State Bank shareholders and redeemed
for cash.
f) The holding period of the shares of BSM Bancorp common stock to be
received by shareholders of Mid-State Bank pursuant to the Merger will
include the holding period of shares of Mid-State Bank common stock
exchanged therefor, provided that the shares of Mid-State Bank common
stock are held as capital assets on the effective date of the Merger.
g) The payment of cash to shareholders of Mid-State Bank in lieu of
fractional share interests of BSM Bancorp common stock will be treated
as if the fractional shares were distributed as part of the exchange and
then redeemed by BSM Bancorp. These cash payments will be treated as
having been received as a distribution in redemption of that fractional
share interest subject to the conditions and limitations of Code Section
302. If a fractional share of BSM Bancorp common stock would have
constituted a capital asset in the hands of a redeeming shareholder, and
the actual receipt and redemption of such fractional interest would have
qualified for sale or exchange treatment, any resulting gain or loss
will be characterized as capital gain or loss in accordance with the
provisions and limitations of Subchapter P of Chapter 1 of the Code.
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 6
May 7, 1998
h) No gain or loss will be recognized for federal income tax purposes by
the holders of outstanding stock options granted under Mid-State Bank's
stock option plan as a result of the granting, pursuant to the Merger,
of substitute options pursuant to BSM Bancorp's stock plan.
i) The granting of any substitute stock option, under the BSM Option Plan,
to a holder of a Mid-State Bank stock option, under the Mid-State Option
Plan, pursuant to the Merger under the provisions discussed above, will
not be deemed a "modification" of any Mid-State Bank existing incentive
stock option under Code Section 424(h)(3).
As a result of the complexity of the tax laws, and because the tax
consequences to any particular shareholder may be affected by matters not
discussed herein, it is recommended that each shareholder of Mid-State Bank
consult his/her/its personal tax advisor concerning the applicable federal,
state and local income tax consequences of the Merger.
We express no opinion on the impact, if any, on any other sections of the
Code, other than that as stated immediately above, and neither this opinion
nor any prior statements are intended to imply or to be an opinion on any
other matters.
/s/ Arthur Andersen LLP
May 7, 1998
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 7
May 7, 1998
EXHIBIT A
Representations
Representatives of Mid-State Bank have made the following representations to
us:
a) The fair market value of the BSM Bancorp stock and other consideration
received by each Mid-State Bank shareholder will be approximately equal
to the fair market value of the Mid-State Bank stock surrendered in the
exchange.
b) Following the Merger, Mid-State Bank will hold at least 90 percent of
the fair market value of the net assets and at least 70 percent of the
fair market value of the gross assets held by Mid-State Bank immediately
before the Merger. Following the Merger, Mid-State Bank will hold at
least 90% of the fair market value of the net assets and at least 70% of
the fair market value of the gross assets held by Bank of Santa Maria
immediately prior to the Merger. For purposes of this representation,
amounts paid by Mid-State Bank or Bank of Santa Maria to dissenters,
amounts paid by Mid-State Bank or Bank of Santa Maria to shareholders
who receive cash or other property, amounts used by Mid-State Bank or
Bank of Santa Maria to pay reorganization expenses, and all redemptions
and distributions (except for regular, normal dividends) made by
Mid-State Bank or Bank of Santa Maria immediately preceding the Merger,
will be included as assets of Mid-State Bank or Bank of Santa Maria,
respectively, immediately prior to the Merger.
c) There is no intercorporate indebtedness existing between Mid-State Bank,
on the one hand, and BSM Bancorp and Bank of Santa Maria, on the other
hand (or any member of their respective federal income tax consolidated
groups).
d) The Merger will qualify as a merger under applicable state law.
e) Upon merger of Bank of Santa Maria into Mid-State Bank, all assets,
obligations and liabilities of Bank of Santa Maria will be transferred
to Mid-State Bank. All Mid-State Bank shareholders will become
shareholders of BSM Bancorp.
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 8
May 7, 1998
f) Mid-State Bank intends that the Merger will qualify as a tax-free
reorganization within the meaning of Code Section 368(a)(1)(A) and Code
Section 368(a)(2)(E) and will report it as such in accordance with
Treasury Regulation Section 1.368-3.
g) The payment of cash in lieu of fractional shares of BSM Bancorp stock is
solely for the purpose of avoiding the expense and inconvenience to BSM
Bancorp of issuing fractional shares, and does not represent separately
bargained-for consideration. The total cash consideration that will be
paid in the transaction to the Mid-State Bank shareholders instead of
issuing fractional shares of BSM Bancorp stock will not exceed one
percent of the total consideration that will be issued in the
transaction to the Mid-State Bank shareholders in exchange for their
shares of stock. The fractional share interests of each Mid-State Bank
shareholder will be aggregated, and no Mid-State Bank shareholder will
receive cash in an amount greater than the value of one full share of
BSM Bancorp stock.
h) None of the compensation received by any shareholder-employees of
Mid-State Bank will be separate consideration for, or allocable to, any
of their shares of Mid-State Bank stock; none of the shares of BSM
Bancorp stock received by any shareholder-employees will be separate
consideration for, or allocable to, any employment agreement; and the
compensation paid to any shareholder-employees will be for services
actually rendered and will be commensurate with amounts paid to third
parties bargaining at arm's-length for similar services.
i) Mid-State Bank understands and intends that Arthur Andersen LLP will
rely on these facts and representations and assume them to be accurate
as of the date hereof, without further inquiry on its part, in rendering
its opinion with respect to the Merger and that the inaccuracy of any of
these representations may adversely affect these opinions.
j) BSM Bancorp will issue its stock directly to the Mid-State Bank
shareholders as consideration in the Merger.
k) There is no plan or intention by the shareholders of Mid-State Bank who
own 5 percent or more of Mid-State Bank's stock, and to the best of the
knowledge of the management of Mid-State Bank, there is no plan or
intention on the part of the remaining shareholders of Mid-State Bank,
to sell, exchange, or otherwise dispose of a number of shares of BSM
Bancorp stock received in the Merger that would reduce Mid-State Bank
shareholders' ownership of BSM Bancorp stock to a number of shares
having a value, as of the Effective Date of the Merger, of less than 50
percent of the value of all of the formerly outstanding stock of
Mid-State Bank as of the same date. For purposes of this
representation, shares of
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 9
May 7, 1998
Mid-State Bank stock surrendered by dissenters or exchanged for cash in
lieu of fractional shares of BSM Bancorp stock will be treated as
outstanding Mid-State Bank stock on the date of the transaction.
Moreover, shares of Mid-State Bank stock and shares of BSM Bancorp stock
held by Mid-State Bank shareholders and otherwise sold, redeemed, or
disposed of prior or subsequent to the transaction will be considered in
making this representation. Finally, for purposes of this
representation, extraordinary distributions (i.e., distributions with
respect to stock other than regular, normal dividends), prior to or in
connection with the transaction, will be taken into account. The
preceding representation with respect to Mid-State Bank shareholders who
own 5 percent or more of Mid-State Bank stock is based on
representations that Mid-State Bank has received from such shareholders.
l) Mid-State Bank has no plan or intention to issue additional shares of
its stock that would result in BSM Bancorp losing control of Mid-State
Bank within the meaning of Code Section 368(c).
m) Mid-State Bank and the shareholders of Mid-State Bank will pay their
respective expenses, if any, incurred in connection with the Merger.
n) At the time of the Merger, Mid-State Bank will not have outstanding any
warrants, options, convertible securities, or any other type of right
pursuant to which any person could acquire stock in Mid-State Bank that,
if exercised or converted, would affect BSM Bancorp's acquisition or
retention of control of Mid-State Bank, as defined in Code Section
368(c).
o) Mid-State Bank is not an investment company as defined in Code Section
368(a)(2)(F)(iii) and Code Section 368(a)(2)(F)(iv).
p) On the date of the Merger, the fair market value of the assets of
Mid-State Bank will exceed the sum of its liabilities, plus the amount
of liabilities, if any, to which the assets are subject.
q) Mid-State Bank is not under the jurisdiction of a court in a Title 11 or
similar case within the meaning of Code 368(a)(3)(A).
r) Following the Merger, Mid-State Bank will continue its historic
businesses or use a significant portion of its historic business assets
in a business.
s) In the Merger, shares of Mid-State Bank stock representing control of
Mid-State Bank, as defined in Code Section 368(c), will be exchanged
solely for voting stock of BSM Bancorp. For purposes of this
representation, shares of Mid-State Bank exchanged for cash or other
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 10
May 7, 1998
property originating with BSM Bancorp will be treated as outstanding
Mid-State Bank stock on the date of the transaction.
t) The Merger is being undertaken for reasons germane to the continuance of
the business of BSM Bancorp, Bank of Santa Maria, and Mid-State Bank.
u) BSM Bancorp will change its name to Mid-State Bancshares immediately
after the Effective Time.
v) BSM Bancorp will not change its name to Mid-State Bancshares unless the
Merger is consummated.
Representatives of BSM Bancorp have made the following representations to us:
a) The fair market value of the BSM Bancorp stock and other consideration
received by each Mid-State Bank shareholder will be approximately equal
to the fair market value of the Mid-State Bank stock surrendered in the
exchange.
b) Following the Merger, Mid-State Bank will hold at least 90 percent of
the fair market value of the net assets and at least 70 percent of the
fair market value of the gross assets held by Mid-State Bank immediately
before the Merger. Following the Merger, Mid-State Bank will hold at
least 90% of the fair market value of the net assets and at least 70% of
the fair market value of the gross assets held by Bank of Santa Maria
immediately prior to the Merger. For purposes of this representation,
amounts paid by Mid-State Bank or Bank of Santa Maria to dissenters,
amounts paid by Mid-State Bank or Bank of Santa Maria to shareholders
who receive cash or other property, amounts used by Mid-State Bank or
Bank of Santa Maria to pay reorganization expenses, and all redemptions
and distributions (except for regular, normal dividends) made by
Mid-State Bank or Bank of Santa Maria immediately preceding the Merger,
will be included as assets of Mid-State Bank or Bank of Santa Maria,
respectively, immediately prior to the Merger.
c) There is no intercorporate indebtedness existing between Mid-State Bank,
on the one hand, and BSM Bancorp and Bank of Santa Maria, on the other
hand (or any member of their respective federal income tax consolidated
groups).
d) The Merger will qualify as a merger under applicable state law.
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 11
May 7, 1998
e) Upon merger of Bank of Santa Maria into Mid-State Bank, all assets,
obligations and liabilities of Bank of Santa Maria will be transferred
to Mid-State Bank. All Mid-State Bank shareholders will become
shareholders of BSM Bancorp.
f) BSM Bancorp and Bank of Santa Maria intend that the Merger will qualify
as a tax-free reorganization within the meaning of Code Section
368(a)(1)(A) and Code Section 368(a)(2)(E) and will report it as such in
accordance with Treasury Regulation Section 1.368-3.
g) The payment of cash in lieu of fractional shares of BSM Bancorp stock is
solely for the purpose of avoiding the expense and inconvenience to BSM
Bancorp of issuing fractional shares, and does not represent separately
bargained-for consideration. The total cash consideration that will be
paid in the transaction to the Mid-State Bank shareholders instead of
issuing fractional shares of BSM Bancorp stock will not exceed one
percent of the total consideration that will be issued in the
transaction to the Mid-State Bank shareholders in exchange for their
shares of stock. The fractional share interests of each Mid-State Bank
shareholder will be aggregated, and no Mid-State Bank shareholder will
receive cash in an amount greater than the value of one full share of
BSM Bancorp stock.
h) None of the compensation received by any shareholder-employees of
Mid-State Bank will be separate consideration for, or allocable to, any
of their shares of Mid-State Bank stock; none of the shares of BSM
Bancorp stock received by any shareholder-employees will be separate
consideration for, or allocable to, any employment agreement; and the
compensation paid to any shareholder-employees will be for services
actually rendered and will be commensurate with amounts paid to third
parties bargaining at arm's-length for similar services.
i) BSM Bancorp and Bank of Santa Maria understand and intend that Arthur
Andersen LLP will rely on these facts and representations and assume
them to be accurate as of the date hereof, without further inquiry on
its part, in rendering its opinion with respect to the Merger and that
the inaccuracy of any of these representations may adversely affect
these opinions.
j) BSM Bancorp will issue its stock directly to the Mid-State Bank
shareholders as consideration in the merger.
k) BSM Bancorp and Bank of Santa Maria will pay their respective expenses,
if any, incurred in connection with the Merger.
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 12
May 7, 1998
l) Prior to the Merger, BSM Bancorp will be in control of Bank of Santa
Maria within the meaning of Code Section 368(c) (i.e., own stock
possessing at least 80 percent of the total combined voting power of all
classes of stock entitled to vote, and own at least 80 percent of the
total number of shares of all other classes of stock of the
corporation).
m) Neither BSM Bancorp nor any related party has any plan or intention to
reacquire any of its stock issued in the Merger. For purposes of this
opinion, a "related party" includes any corporation (i) that is a member
of any affiliated group, as defined in Code Section 1504 (determined
without regard to Code Section 1504(b)), of which BSM Bancorp is a
member, or (ii) whose purchase of BSM Bancorp stock would be treated as
a distribution in redemption of stock of BSM Bancorp under Code Section
304(a)(2) (determined without regard to Treasury Regulation Section
1.1502-80).
n) The liabilities of Bank of Santa Maria assumed by Mid-State Bank and the
liabilities to which the transferred assets of Bank of Santa Maria are
subject were incurred by Bank of Santa Maria in the ordinary course of
its business, and the principal purpose of such assumption is not the
avoidance of federal income tax.
o) BSM Bancorp has no plan or intention to liquidate Mid-State Bank; to
merge Mid-State Bank with or into another corporation; to sell or
otherwise dispose of the stock of Mid-State Bank, except for transfers
of stock to corporations controlled by BSM Bancorp; or to cause
Mid-State Bank to sell or otherwise dispose of any of its own assets or
any of the assets acquired from Bank of Santa Maria, except for
disposition made in the ordinary course of business or transfers of
assets to a corporation controlled by Mid-State Bank (within the meaning
of Code Section 368(a)(2)(C)).
p) BSM Bancorp does not own, nor has it owned during the past five years,
any shares of the stock of Mid-State Bank.
q) BSM Bancorp and Bank of Santa Maria are not investment companies as
defined in Code Sections 368(a)(2)(F)(iii) and 368(a)(2)(F)(iv).
r) Except for restrictions imposed by (i) SEC Rule 145 and (ii) agreements
in place that restrict certain current Mid-State Bank shareholders from
selling BSM Bancorp shares received in the Merger, the Mid-State Bank
common shareholders will have unrestricted rights of ownership of BSM
Bancorp stock received in the transaction, and their ability to retain
the BSM Bancorp common stock received in the Merger will not be limited
in any way.
<PAGE>
Mr. James G. Stathos
Mr. F. Dean Fletcher
Page 13
May 7, 1998
s) It is our belief that following the Merger, Mid-State Bank will continue
its historic businesses or use a significant portion of its historic
business assets in a business.
t) In the Merger, shares of Mid-State Bank stock representing control of
Mid-State Bank, as defined in Code Section 368(c), will be exchanged
solely for voting stock of BSM Bancorp. For purposes of determining
whether or not BSM Bancorp has acquired control of Mid-State Bank under
Section 368(c) of the Code, it is necessary to determine the total
number of Mid-State Bank shares outstanding prior to the Merger. In
determining the total number of outstanding shares, any Mid-State Bank
shares that are exchanged for cash or other property will be treated as
outstanding prior to the Merger.
u) The Merger is being undertaken for business reasons relating to the
continuance of the overall banking business of BSM Bancorp, Bank of
Santa Maria, and Mid-State Bank.
v) BSM Bancorp will change its name to Mid-State Bancshares immediately
after the Effective Time.
w) BSM Bancorp will not change its name to Mid-State Bancshares unless the
Merger is consummated.
<PAGE>
[LETTERHEAD]
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the inclusion of our Independent Auditor's Report dated
January 30, 1998 regarding the consolidated balance sheets of BSM Bancorp and
Subsidiary as of December 31, 1997 and 1996, and the related consolidated
statements of income, changes in shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1997, in the Form 10-KA
filed with the Securities and Exchange Commission (SEC) and included as
Appendix F to the Form S-4 filed by BSM Bancorp with the SEC and the
reference to our firm as experts.
/s/ VAVRINEK, TRINE, DAY & CO., LLP
May 8, 1998
Laguna Hills, California
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
report (and to all references to our Firm) included in or made part of this
registration statement.
ARTHUR ANDERSEN LLP
Los Angeles, California
May 7, 1998
