<PAGE>
United States
Securities and Exchange Commission
Washington, D.C. 20429
FORM 10-Q
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended March 31, 1999.
[ ] 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 .
------------- --------------
Commission File Number 333-16951
MID-STATE BANCSHARES
--------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 77-0442667
- -------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1026 GRAND AVE. ARROYO GRANDE, 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 [ ]
As of May 4, 1999, the aggregate market value of the common stock held by
non-affiliates of the Company was: $260,480,379.
Number of shares of common stock of the Company outstanding as of May 4, 1999:
10,097,045 shares.
<PAGE>
MID-STATE BANCSHARES
March 31, 1999
Index
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Statements of Financial Position as of
March 31, 1999, December 31, 1998, and March 31, 1998 3
Consolidated Statements of Income and Comprehensive
Income for the three month period ended March 31,
1999 and March 31, 1998 4
Consolidated Statements of Cash Flows for the three month
period ended March 31, 1999 and March 31, 1998 5
Notes to Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3 - Quantitative and Qualitative Disclosure
About Market Risk 14
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 16
Item 2 - Changes in Securities and Use of Proceeds 16
Item 3 - Defaults Upon Senior Securities 16
Item 4 - Submission of Matters to a Vote of Security Holders 16
Item 5 - Other Information 16
Item 6 - Exhibits and Reports on Form 8-K 16
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
MID-STATE BANCSHARES
Consolidated Statements of Financial Position
(Interim Periods Unaudited - figures in 000's)
<TABLE>
<CAPTION>
ASSETS Mar. 31, 1999 Dec. 31, 1998 Mar. 31, 1998
------------- ------------- -------------
<S> <C> <C> <C>
Cash and Due From Banks $ 60,343 $ 66,761 $ 82,839
Fed Funds Sold 64,865 51,865 28,193
Investment Securities:
Available For Sale 459,482 474,754 418,561
Held-to-Maturity (Market value of 36,486 41,916 59,791
$37,091, $42,704 and $60,083,
respectively)
Loans, net of unearned income 551,438 551,780 539,315
Allowance for Loan Losses (12,435) (12,901) (13,459)
----------- ----------- -----------
Net Loans 539,003 538,879 525,856
Premises and Equipment, net 29,656 29,736 33,023
Accrued Interest Receivable 10,866 10,869 9,522
Investments in Real Estate, Net 6,755 6,769 8,662
Other Real Estate Owned, Net 206 259 3,242
Other Assets 14,273 13,148 11,534
----------- ----------- -----------
TOTAL ASSETS $1,221,935 $1,234,956 $1,181,223
=========== =========== ===========
LIABILITIES AND EQUITY
Non Interest Bearing Demand $ 201,476 $ 224,516 $ 199,841
NOW Accounts, Money Market
and Savings Deposits 540,192 539,394 519,025
Time Deposits Under $100 233,905 236,022 243,950
Time Deposits $100 or more 91,681 88,743 90,795
----------- ----------- -----------
TOTAL DEPOSITS 1,067,254 1,088,675 1,053,611
Accrued Interest Payable and
Other Liabilities 18,448 12,557 9,802
----------- ----------- -----------
TOTAL LIABILITIES 1,085,702 1,101,232 1,063,413
----------- ----------- -----------
Shareholders' Equity:
Common Stock and Surplus (Shares 43,069 42,894 41,695
Outstanding of 10,096, 10,078 and
9,997, respectively)
Retained Earnings 90,517 86,548 73,841
Unrealized Gain
on Available for Sale Securities 2,647 4,282 2,274
----------- ----------- -----------
TOTAL EQUITY 136,233 133,724 117,810
----------- ----------- -----------
TOTAL LIABILITIES AND EQUITY $ 1,221,935 $ 1,234,956 $ 1,181,223
=========== =========== ===========
</TABLE>
3
<PAGE>
MID-STATE BANCSHARES
Consolidated Statements of Income and Comprehensive
Income (Unaudited - figures in 000's except earnings per share data)
<TABLE>
<CAPTION> Three Month Period
Ended March 31,
1999 1998
-------- --------
<S> <C> <C>
INTEREST INCOME:
Interest and fees on loans $ 13,400 $ 13,676
Interest on investment securities - taxable 6,565 6,789
Interest on investment securities - tax exempt 650 342
Interest on fed funds sold, other 700 472
-------- --------
TOTAL INTEREST INCOME 21,315 21,279
-------- --------
INTEREST EXPENSE:
Interest on NOW, money market and savings 1,858 2,181
Interest on time deposits less than $100 2,727 3,101
Interest on time deposits of $100 or more 1,057 1,162
Interest on mortgages, other 70 67
-------- --------
TOTAL INTEREST EXPENSE 5,712 6,511
-------- --------
NET INTEREST INCOME BEFORE PROVISION 15,603 14,768
Less: Provision for loan losses -- 150
-------- --------
NET INTEREST INCOME AFTER PROVISION 15,603 14,618
-------- --------
OTHER OPERATING INCOME:
Service charges and fees 1,505 1,655
Other non interest income 2,205 2,513
-------- --------
TOTAL OTHER OPERATING INCOME 3,710 4,168
-------- --------
OTHER OPERATING EXPENSE:
Salaries and employee benefits 6,725 6,836
Occupancy and furniture 1,787 1,905
Other operating expenses 3,352 3,715
-------- --------
TOTAL OTHER OPERATING EXPENSE 11,864 12,456
-------- --------
Income before taxes 7,449 6,330
Provision for income taxes 2,270 2,262
-------- --------
NET INCOME $ 5,179 $ 4,068
======== ========
OTHER COMPREHENSIVE INCOME BEFORE TAXES:
Unrealized (losses) gains on securities available for sale:
Unrealized holding (losses) gains arising during period (2,727) 815
Less: reclassification adjustment for (gains) losses
included in net income 0 0
-------- --------
Other comprehensive (loss) income, before tax (2,727) 815
Income tax (benefit) provision related to items in
comprehensive income (1,092) 326
-------- --------
OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAXES (1,635) 489
-------- --------
COMPREHENSIVE INCOME $ 3,544 $ 4,557
======== ========
EARNINGS PER SHARE - BASIC $ 0.51 $ 0.41
- DILUTED $ 0.51 $ 0.40
</TABLE>
4
<PAGE>
MID-STATE BANCSHARES
Consolidated Statements of Cash Flows
(Unaudited - figures in 000's)
<TABLE>
<CAPTION>
Three Month Period
Ended March 31,
1999 1998
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net (Loss) Income $ 5,179 $ 4,068
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Provision for credit losses -- 150
Depreciation and amortization 797 894
Net amortization of prem./discounts-investments 586 213
Decrease (Increase) in accrued interest receivable 3 (264)
Increase in other liabilities 4,226 1,401
(Increase) Decrease in other assets (1,125) 700
Other changes, net (856) (452)
-------- --------
Net cash provided by operating activities 8,810 6,710
-------- --------
INVESTING ACTIVITIES
Net cash from proceeds of real estate 67 300
Proceeds from sales and maturities of investments 82,084 52,467
Purchases of investments (63,296) (48,052)
Decrease in loans 423 1,266
Purchases of premises and equipment, net (717) (744)
-------- --------
Net cash provided by investing activities 18,561 5,237
-------- --------
FINANCING ACTIVITIES
Decrease in deposits (21,421) (9,735)
Increase (decrease) in short-term borrowings 1,665 (39)
Exercise of stock options 176 119
Cash dividends paid (1,209) (901)
-------- --------
Net cash used by financing activities (20,789) (10,556)
-------- --------
Increase (decrease) in cash and cash equivalents 6,582 1,391
Cash and cash equivalents at beginning of period 118,626 109,641
-------- --------
Cash and cash equivalents at end of period $ 125,208 $ 111,032
========= =========
</TABLE>
5
<PAGE>
MID-STATE BANCSHARES
Notes to Consolidated Financial Statements
(Information with respect to interim periods is unaudited)
NOTE A - BASIS OF PRESENTATION AND MANAGEMENT REPRESENTATION
The accompanying consolidated financial statements include the accounts of
Mid-State Bancshares and its wholly owned subsidiary Mid-State Bank which
includes the Bank and the Bank's subsidiaries, MSB Properties and Mid Coast
Land Company (collectively the "Company" or "Bank" or "Mid-State"). All
significant intercompany transactions have been eliminated in consolidation.
These consolidated financial statements should be read in conjunction with
the Form 10-K Annual Report for the year ended December 31, 1998 of Mid-State
Bancshares. A summary of the Company's significant accounting policies is set
forth in the Notes to Consolidated Financial Statements contained therein.
These consolidated financial statements have been prepared in accordance with
generally accepted accounting principles on a basis consistent with the
accounting policies reflected in the audited consolidated financial statements
included in the Annual Report on Form 10-K for the year ended December 31, 1998.
They do not, however, include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments including normal recurring accruals
considered necessary for a fair presentation have been included. Operating
results for the interim periods presented are not necessarily indicative of the
results that may be expected for any other interim period or for the year as a
whole.
NOTE B - EARNINGS PER SHARE
The following is a reconciliation of net income and shares outstanding to the
income and number of shares used to compute Earnings Per Share ("EPS"). Figures
are in thousands, except earnings per share data.
<TABLE>
<CAPTION>
Three Month Period Ended Three Month Period Ended
March 31, 1999 March 31, 1998
Earnings Shares EPS Earnings Shares EPS
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net Income as reported $ 5,179 $ 4,068
Basic Earnings Per Share:
Income available to
Common Shareholders $ 5,179 10,082 $ 0.51 $ 4,068 9,994 $ 0.41
Effect of dilutive securities:
Stock Options 47 84
Diluted Earnings Per Share:
Income available to
Common Shareholders $ 5,179 10,129 $ 0.51 $ 4,068 10,078 $ 0.40
</TABLE>
6
<PAGE>
NOTE C - SUBSEQUENT EVENT: MERGER OF MID-STATE BANCSHARES AND CITY COMMERCE BANK
On April 19, 1999, the Company signed a definitive agreement to merge, subject
to the approval of banking regulators and City Commerce Bank shareholders. The
agreement provides for an exchange of common stock at a fixed exchange ratio of
.7791 shares of Mid-State Bancshares common stock for each one share of City
Commerce common stock, subject to potential adjustments based on changes in the
price of Mid-State Bancshares stock preceding the effective date of the
transaction. The merger is structured to be tax-free, and is intended to be
accounted for as a pooling-of-interests.
As of March 31, 1999, City Commerce Bank had total assets of $149.5 million,
total deposits of $130.9 million, and stockholders' equity of $17.3 million.
Before giving rise to any merger related charges, the pro forma combined
Mid-State Bancshares and City Commerce Bank would have total assets of
approximately $1.371 billion, total deposits of approximately $1.198 billion and
stockholders' equity of $153.5 million.
7
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SELECTED FINANCIAL DATA - SUMMARY. The following table provides certain
selected financial data at March 31, 1999 and 1998 and the results of operations
for the year-to-date ended on those dates (unaudited).
<TABLE>
<CAPTION>
CONSOLIDATED FINANCIAL DATA - MID-STATE BANCSHARES
(Unaudited) Year-to-Date
-----------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) MAR. 31, 1999 MAR. 31, 1998
------------- --------------
<S> <C> <C>
Interest Income (not taxable equivalent) $ 21,315 $ 21,279
Interest Expense 5,712 6,511
------------- ------------
Net Interest Income 15,603 14,768
Provision for Loan Losses - 150
------------- ------------
Net Interest Income after provision for loan losses 15,603 14,618
Non-interest income 3,710 4,168
Non-interest expense 11,864 12,456
------------- ------------
Income before income taxes 7,449 6,330
Provision for income taxes 2,270 2,262
------------- ------------
Net Income $ 5,179 $ 4,068
------------- ------------
Year-to-Date
-----------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) MAR. 31, 1999 MAR. 31, 1998
------------- --------------
PER SHARE:
Net Income (adjusted for stock dividends) - basic $ 0.51 $ 0.41
Net Income (adjusted for stock dividends) - diluted $ 0.51 $ 0.40
Weighted average shares used in Basic E.P.S. calculation 10,082 9,994
Weighted average shares used in Diluted E.P.S. calculation 10,129 10,078
Cash dividends 0.12 0.09
Book value at period-end 13.49 11.78
Ending Shares 10,096 9,997
FINANCIAL RATIOS
Return on assets 1.71% 1.42%
Return on equity 15.56% 14.35%
Net interest margin (not taxable equivalent) 5.68% 5.74%
Net interest margin (taxable equivalent yield) 5.84% 5.82%
Net loan losses to avg. loans 0.35% 0.01%
Efficiency ratio 61.4% 65.8%
PERIOD AVERAGES
Total Assets $ 1,224,850 $ 1,162,094
Total Loans 541,431 531,784
Total Earning Assets 1,114,257 1,044,129
Total Deposits 1,076,640 1,038,344
Common Equity 134,979 114,968
BALANCE SHEET - AT PERIOD-END
Cash and due from banks $ 60,343 $ 82,839
Investments and Fed Funds Sold 560,833 506,545
Loans, net of deferred fees, before allowance for loan 551,438 539,317
Allowance for Loan Losses (12,435) (13,459)
Other assets 61,756 65,981
------------- ------------
Total Assets $ 1,221,935 $ 1,181,223
============= ============
Non-interest bearing deposits $ 201,476 $ 199,841
Interest bearing deposits 865,778 853,770
Other borrowings 4,715 4,456
Other liabilities 13,733 5,346
Shareholders' equity 136,233 117,810
------------- ------------
Total Liabilities and Shareholders' equity $ 1,221,935 $ 1,181,223
============= ============
</TABLE>
8
<PAGE>
<TABLE>
ASSET QUALITY & CAPITAL - AT PERIOD-END
<S> <C> <C>
Non-accrual loans $ 1,450 $ 1,681
Loans past due 90 days or more 1,686 1,066
Other real estate owned 206 3,242
------------- ------------
Total non performing assets $ 3,342 $ 5,989
Loan loss allowance to loans, gross 2.3% 2.5%
Non-accrual loans to total loans, gross 0.3% 0.3%
Non performing assets to total assets 0.3% 0.5%
Allowance for loan losses to non performing loans 396.5% 490.0%
Equity to average assets (leverage ratio) 10.8% 9.8%
Tier One capital to risk-adjusted assets 17.2% 15.4%
Total capital to risk-adjusted assets 18.5% 16.6%
</TABLE>
PERFORMANCE SUMMARY. The Company posted net income of $5.2 million for the
three months ended March 31, 1999 compared to $4.1 million in the like 1998
period. These earnings represent an annualized return on assets of 1.71% and
1.42%, respectively, for the comparable periods. The annualized return on equity
was 15.56% for the first quarter of 1999 compared to 14.35% in the first quarter
of 1998. On a per share basis, diluted earnings were $0.51 in the 1999 period
compared to $0.40 in the like quarter of 1998.
NET INTEREST INCOME. Mid-State's year-to-date annualized yield on interest
earning assets was 7.76% for the first three months of 1999 (7.92% on a taxable
equivalent basis) compared to 8.27% in the like 1998 period (8.35% on a taxable
equivalent basis). This decline in yield is related primarily to the drop in
interest rates when comparing the first quarter of 1999 with the 1998 period.
The Prime Rate, to which many of the Bank's loans are tied, averaged 7.75% in
the 1999 period compared to 8.50% in the 1998 period. In a similar manner,
annualized interest expense as a percent of earning assets declined from 2.53%
in the first three months of 1998 to 2.08% in this year's first three months.
This also reflected the general decline in market interest rates as the Bank
lowered rates paid on various deposit products. Overall, the Bank was able to
drop its interest cost on deposits by an approximately comparable amount to the
decline in interest income from earning assets. As a result, Mid-State's
annualized Net Interest Income, expressed as a percent of earning assets,
remained virtually the same at 5.68% for the three month period of 1999 (5.84%
on a taxable equivalent basis) compared to 5.74% in the comparable 1998 period
(5.82% on a taxable equivalent basis). Annualized Net Interest Income as a
percent of average total assets improved slightly from 5.15% in the first three
months of 1998 (5.23% taxable equivalent) to 5.17% in the 1999 period (5.31%
taxable equivalent).
Earning assets on average were $70 million higher in the three month
1999 period ($1,114 million compared to $1,044 million) which is up about
6.7% from the like 1998 period. Average deposits in this same time-frame were
up $38 million, or 3.7% ($1,076 million compared to $1,038 million),
explaining part of the increase in average assets. The remaining portion of
the increase is a result of a combination of three factors - (1) the
retention of earnings in the Bank, (2) the decline in non performing assets
and investments in real estate and (3) a reduction in non earning balances
held at the Federal Reserve Bank.
PROVISION AND ALLOWANCE FOR LOAN LOSSES. Mid-State did not make a
provision to the allowance for loan losses in the first quarter of 1999. The
Bank provided $150 thousand in the comparable 1998 quarter. Management
continues to believe that the allowance, which stands at 2.3% of total loans
at March 31, 1999, down from 2.5% one year earlier, is adequate to cover
future losses. The $12.4 million allowance is just under four times the level
of non performing assets which stand at $3.3 million compared to $6.0 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. Other
Real Estate Owned reflects property acquired through foreclosure which had
secured
9
<PAGE>
Bank loans on which the borrower defaulted. While continuing efforts are made
to improve overall asset quality, Management is unable to estimate with
certainty, how and under what terms, problem assets will be resolved.
Changes in the allowance for loan losses for the periods ended March 31,
1999 and 1998 are as follows:
<TABLE>
<CAPTION>
March 31,
1999 1998
-------- --------
<S> <C> <C>
Balance at beginning of period $ 12,901 $ 13,366
Provision for loan losses -- 150
Loans charged off (642) (297)
Recoveries of loans previously
Charged-off 176 240
-------- --------
Balance at end of period $ 12,435 $ 13,459
======== ========
</TABLE>
At March 31, 1999, the recorded investment in loans which have been identified
as impaired loans, totaled $6,346,000. Of this amount, $1,236,000 related to
loans with no valuation allowance and $5,110,000 related to loans with a
corresponding valuation allowance of $1,187,000. Impaired loans totaled
$3,423,000 at March 31, 1998. Of that amount, $1,593,000 related to loans with
no valuation allowance and $1,830,000 related to loans with a corresponding
valuation allowance of $362,000. The valuation allowance for impaired loans is
included within the general allowance shown above and netted against loans on
the consolidated statements of financial position. For the quarter ended March
31, 1999, the average recorded investment in impaired loans was $5,554,000
compared to $4,075,000 in the 1998 period. A loan is identified as impaired when
it is probable that interest and principal will not be collected according to
the contractual terms of the loan agreement. Because this definition is very
similar to that used by bank regulators to determine on which loans interest
should not be accrued, the Bank expects that most impaired loans will be on
non-accrual status. However, during the first quarter of 1999, one large credit
totaling $3.4 million was classified as impaired, even though it continues to be
on accrual status. Its classification as impaired stems from the potential
inadequacy of collateral value relative to the size of the loan. This one credit
explains the apparent anomaly between the fact that total impaired loans have
increased from one year ago, while total non-accrual loans have decreased.
NONINTEREST INCOME. Noninterest income for the first three months of 1999
was $3.7 million, down from $4.2 million earned in the 1998 period, a decline of
11.0%. One major explanation for the decrease was a drop in service charge
income of some $150 thousand over the comparable periods. This was primarily
related to the fact that the merger of the two banks resulted in the
consolidation of deposit products, which represented the lowest cost to
customers of the two products being brought together. Gains on sale of Other
Real Estate Owned were also $202 thousand less than the like quarter of 1998.
Income from mortgage origination and loan servicing was off some $82 thousand
from the levels in the first quarter of 1998. Miscellaneous recoveries were off
$100 thousand in the first quarter compared to one year ago.
NONINTEREST EXPENSE. Non-interest expense for the first three months of
1999 was $11.9 million. This compares to $12.5 million in the comparable 1998
period. There was an overall reduction of $111 thousand charged to expense for
salaries and benefits in 1999 compared to the 1998 period, in spite of certain
non recurring expenses totaling $239 thousand. There were reductions in expense
in a variety of categories related to the
10
<PAGE>
synergies resulting from the merger of the two banks in 1998. The first
quarter of 1999 compared to the 1998 quarter saw reductions of $118 thousand
in occupancy and furniture costs, $114 thousand in insurance costs, $66
thousand in directors' fees, and $50 thousand in FDIC/State Banking
Department charges. While other categories of expense showed minor declines,
others showed minor increases, all of which in total were expense neutral.
PROVISION FOR INCOME TAXES. The year-to-date provision for income taxes was
$2.3 million, compared to a like amount for the same period in 1998. The
effective tax rate in 1999 was 30.5% compared to 35.7% in 1998. The effective
tax rate in 1999 is somewhat lower than the prior year's first quarter due to an
increase in tax exempt income recognized by the Company, and the realization of
certain tax benefits available to Mid-State, both of which should continue to
benefit tax expense through the balance of 1999.
BALANCE SHEET. Total assets at March 31, 1999 totaled $1,221.9 million, up
3.4% from the level one year earlier of $1,181.2 million. Net loans were a
component of this growth, increasing from $539.3 million at the end of March,
1998 to $551.4 million in 1999. Investments and fed funds sold grew
significantly from $506.5 million one year earlier to $560.8 million this year.
Other non earning asset categories declined when comparing 1998 to 1997.
Total asset growth was funded through a $13.6 million increase in deposits
and an $18.4 million increase in stockholders' equity when comparing 1999 over
1998. There was a modest increase in other borrowing and liabilities of $8.6
million, comparing the quarter-end periods. Of the $18.4 million increase in
stockholders' equity, only $0.4 million was generated by an increase in the
unrealized gain on available for sale securities.
Mid-State's loan to deposit ratio of 51.7% at March 31, 1999 is up slightly
from the 51.2% ratio one year earlier. There is ample internal liquidity to fund
improvements in this ratio through Mid-State's investment portfolio which has
over 90% of it categorized as available for sale.
INVESTMENT SECURITIES. Fed funds sold represent $64.9 million of the $560.8
million portfolio noted above. Of the remaining $495.9 million, 38% is invested
in U.S. Treasury securities, 18% is invested in U.S. Government agency
obligations, 40% is invested in securities issued by states and political
subdivisions in the U.S. and 4% is invested in mortgage-backed securities and
other securities. 88% of all these investment securities have stated maturities
which are due prior to December 31, 2003. Approximately 35% 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 $117.8 million
at March 31, 1998 to $136.2 million at March 31, 1999. Net income over this 12
month time period of $20.1 million less cash dividends of $3.5 million plus a
$0.4 million increase in unrealized gains on available for sale securities plus
$1.4 million in stock options exercised accounted for the $18.4 million
increase. Capital continues to be strong with Mid-State Bancshare's ratio of
tier one equity capital to average assets ("leverage ratio") at 10.8% up from
9.8% 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 15.4% one year earlier to 17.2% at March 31, 1999. The Total Capital ratio
went from 16.6% one year earlier to 18.5% at March 31, 1999.
LIQUIDITY. Management is not aware of any future capital expenditures or
other significant demands or commitments which would severely impair liquidity.
11
<PAGE>
DISCLOSURES CONCERNING YEAR 2000 ISSUES - YEAR 2000 READINESS DISCLOSURE.
STATE OF READINESS. The Company began implementation of its Year 2000 Plan
in 1997. It has complied with all time-frames associated with that Plan and is
on schedule to meet all remaining deadlines. The most significant component of
that plan was the replacement of the Bank's mainframe computer and software
system with a Year 2000 compliant system. That task was completed in July 1998
with the installation of the Information Technology Incorporated software on new
Unisys equipment. This system is believed to be Year 2000 compliant and other
banking organizations have completed Year 2000 testing with favorable results.
The Company is also completing its own testing. The system is installed
nationwide at some 1,500 data processing sites for over 3,000 banks. Other
systems are also being assessed including in-house applications, outside vendor
applications, environmental systems and parties with whom the Company exchanges
information. This process has been actively underway for some time, and while no
assurance can be given that all systems will be addressed, the Management feels
that it has addressed all "Mission Critical" processes in a timely matter.
Testing of "Mission Critical" systems and implementations of compliant systems
was substantially complete by early 1999.
Additionally, the Bank has been mailing, and received a number of positive
responses to, its Request for Compliance Assessment Letters to certain of its
credit customers. The Company has also issued Compliance Acknowledgement
Questionaires to new credit customers. No assurance can be given that the Year
2000 problem could not negatively effect certain of the Bank's credit customers.
This in turn could negatively affect the Bank. Management feels that it has
proactively addressed the Year 2000 issue as it may affect its customers and
potential customers. 307 credit relationships meet the Bank's criteria for an
assessment and questionaire. These relationships represent approximately 70% of
the total loan portfolio. At this point, no relationships are believed to have a
high Year 2000 related risk. This is down from December 31, 1998 when it was
believed that four relationships represented a high risk totaling approximately
$2.0 million. New information has allowed the Bank to reduce risk on these
credits to the moderate category. Approximately 92 credit relationships are
considered to be of moderate risk, 209 are considered to be low risk and 6 are
pending analysis (awaiting additional information). The Bank has established
reserves within the allowance for loan losses to provide for Year 2000 related
losses. This reserve stood at $582 thousand at March 31, 1999.
The Company has been designing and distributing printed materials through
mailings and statement stuffers, holding informational seminars for the Bank's
business customers, and engaged a speaker at its October 1997 Annual Economic
Symposium who addressed this issue. Year 2000 seminars were conducted in March
1999 in Santa Maria and San Luis Obispo with over 300 residents in attendance.
Moreover, the Bank has proactively participated in numerous community meetings
dealing with this topic. Examples of this participation include working with the
San Luis Obispo Y2K Action Alliance, an exhibit at the Y2K expo held February 7,
1999 in San Luis Obispo, a television interview and tour for a local television
station showcasing the Bank's level of Y2K readiness, participating in local
radio panel discussions on the topic, and presentations to local community
groups on Year 2000 readiness and the specific accomplishments of the Bank.
COSTS TO ADDRESS YEAR 2000 ISSUES. It is important to note that the
Company's former computer system had been fully depreciated after serving the
Bank for over 7 years. It was due for replacement irrespective of the Year 2000
issue. The total capital cost of the new mainframe, software, terminals and
ATM's associated with the Bank's conversion to date have totaled approximately
$7.2 million, all of which has been capitalized and will be amortized over their
expected useful lives. It is expected that additional purchases of certain
equipment will be necessary, but the Company does not expect that the total
cost, when allowing for additional charges, will exceed $7.5 million. Amortizing
these capitalized costs over their expected useful lives, Management would
expect monthly depreciation expense of approximately $125 thousand. A majority
of this expected amount did begin impacting the income statement in August of
1998. The costs associated with the mailings, questionnaires,
12
<PAGE>
seminars and other activities noted above is not expected to have a material
effect on the financial position or results of operations of the Company.
RISKS FOR THE COMPANY FROM YEAR 2000 ISSUES. Like all financial
institutions, Mid-State Bank relies heavily on its computer and software
programs to accurately process and keep track of customer financial records and
transactions. Year 2000 related failure of this hardware or software, especially
if for an extended period of time, could pose a significant risk to the
viability of the Company. Management believes that its Year 2000 plan,
especially as it relates to its recent computer hardware and software conversion
noted above, fully mitigates this direct risk from the Year 2000 problem. While
the Company has back-up generating capacity for its main-frame computer system
and a contingency plan for its implementation, an extensive and protracted power
outage throughout the Bank's system could prove difficult to mitigate.
Credit risks associated with the difficulties incurred by the Bank's
customers which have problems resulting from Year 2000 issues are considered low
to moderate. Factors considered include, but are not limited to, 1) the review
of the Request for Compliance Assessment Letters and Compliance Acknowledgment
Questionaires received to date, 2) the knowledge of the customer's business,
which the Bank possesses, 3) underlying secondary sources of collateral
available to the Bank in the event of default by the customer, 4) the Bank's
allowance for loan losses, 5) the potential effects of general economic
disruptions (e.g. - transportation, communications, electrical) on the customer
and 6) the "ripple effects" from problems elsewhere in the economy which end up
effecting the customer.
Risks associated with the Year 2000 readiness status of the Company's
vendors have also been reviewed. A due diligence process has been initially
completed with the 313 initially identified vendors serving the Bank. Responses
from these vendors have been reviewed and assessed. Alternate arrangements will
be made where appropriate, but no major concerns exist at this point. The
Company has since reduced the number of vendors it is tracking to 222.
THE COMPANY'S CONTINGENCY PLAN. The Company had set a goal to complete its
Contingency Plans for all Mission Critical processes in early 1999. The Company
has completed these plans and has established an independent panel to review and
approve them by mid 1999. The independent panel is comprised of Bank employees
working in departments unrelated to the Mission Critical Processes. Should
additional contingency planning be needed, or revisions to developed plans be
appropriate, Management believes it will still have time to make adjustments
prior to the end of 1999. The independent panel reports that as of early May
1999, it had reviewed and approved 53 of 55 of the Mission Critical Processes'
Contingency Plans.
CURRENT TARGET DATES. All projects associated with prior target dates
included in the Company's Year 2000 Plan have been completed, including more
recently the completion of all organizational planning guidelines and business
impact analysis. While there can be no guarantee that the Company will be able
to continue to meet all future target dates associated with its Year 2000 Plan,
there are no outstanding exceptions to either its previous or future target
dates. By June 30, 1999, business resumption contingency plans will be complete,
the method of validating those business resumption contingency plans will be
complete, and the testing of all mission critical systems and implementation of
compliant systems should be substantially complete.
It should be noted that the Company will be progressively heightening its
customer awareness efforts in the communities it serves between now and year-end
1999.
IMPORTANT FACTORS RELATING TO FORWARD-LOOKING STATEMENTS. The Private
Securities Litigation Reform Act of 1995 provides a "safe harbor" for
forward-looking statements so long as those statements are identified as
forward-looking and are accompanied by meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those projected in such statements. All of the statements
13
<PAGE>
contained in this Quarterly Report on Form 10-Q which are not identified as
historical should be considered forward-looking. In connection with certain
forward-looking statements contained in this Quarterly Report on Form 10-Q and
those that may be made in the future by or on behalf of the Company which are
identified as forward-looking, the Company notes that there are various factors
that could cause actual results to differ materially from those set forth in any
such forward-looking statements. Such factors include, but are not limited to,
the real estate market, the availability of loans at acceptable prices, the
general level of economic activity both locally and nationally, interest rates,
the actions by the Company's regulatory agencies, and actions by competitors of
the Company. Accordingly, there can be no assurance that the forward-looking
statements contained in this Quarterly Report on Form 10-Q will be realized or
that actual results will not be significantly higher or lower. The
forward-looking statements have not been audited by, examined by or subjected to
agreed-upon procedures by independent accountants, and no third-party has
independently verified or reviewed such statements. Readers of this Quarterly
Report on Form 10-Q should consider these facts in evaluating the information
contained herein. The inclusion of the forward-looking statements contained in
this Quarterly Report on Form 10-Q should not be regarded as a representation by
the Company or any other person that the forward-looking statements contained in
this Quarterly Report on Form 10-Q will be achieved. In light of the foregoing,
readers of this Quarterly Report on Form 10-Q are cautioned not to place undue
reliance on the forward-looking statements contained herein.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
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 a 12
month time horizon showed that it could fluctuate under very extreme alternative
rate scenarios from between +3.9% and -5.0% of the base case (rates unchanged)
of $60.8 million. The Bank's policy is to maintain a structure of assets and
liabilities which are such that net interest income will not vary more than plus
or minus 15% of the base forecast over the next 12 months. Management feels that
its exposure to interest rate risk is manageable and it will continue to strive
for an optimal trade-off between risk and earnings.
The following table presents a summary of the Bank's net interest income
forecasted for the coming 12 months under alternative interest rate scenarios.
<TABLE>
<CAPTION>
Change
From Base
---------
<S> <C>
Rates Down Very Significant -5.0%
(Prime down to 3.75% over 12 months)
Rates Down Significant -2.5%
(Prime down to 5.25% over 12 months)
Rates Down Modestly -0.7%
(Prime down to 6.75% over 12 months)
Base Case - Rates Unchanged --
(Prime unchanged at 7.75% over 12 months)
Rates Up Modestly +3.3%
(Prime up to 8.75% over 12 months)
Rates Up Aggressive +3.9%
(Prime up to 10.25% over 12 months)
Rates Up Very Aggressive +2.8%
(Prime up to 11.75% over 12 months)
</TABLE>
14
<PAGE>
Net interest income under the above scenarios is influenced by the
characteristics of the Bank's assets and liabilities. In the case of N.O.W.,
savings and money market deposits (total $540.2 million) interest is based on
rates set at the discretion of Management ranging from 0.75% to 2.00%. 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.
These characteristics are the main reasons that a 4% decline in Prime decreases
net interest income by 5.0% while a 4% increase in Prime increases net interest
income just 2.8%. Management believes that under current market conditions,
deposit rates would be increased more aggressively in order to maintain the
Bank's deposit base.
It is important to note that the above table is a summary of several forecasts
and actual results may vary. The forecasts are based on estimates and
assumptions of Management that may turn out to be different and may change over
time. Factors affecting these estimates and assumptions include, but are not
limited to - competitors' behavior, economic conditions both locally and
nationally, actions taken by the Federal Reserve Board, customer behavior, and
Management's responses. Historically, the Bank has been able to manage its Net
Interest Income in a fairly narrow range reflecting the Bank's relative
insensitivity to interest rate changes. The impact of prepayment behavior on
mortgages, real estate loans, mortgage backed securities, securities with call
features, etc. is not considered material to the sensitivity analysis. Over the
last 5 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 5.62% to
a high of 5.94% (not taxable equivalent). Based on the scenarios above, the net
interest margin under the alternative scenarios ranges from 5.00% to 5.46%.
Management feels this range of scenarios is conservative in view of its
historical performance, but no assurances can be given that actual experience
will fall within this range.
The Bank's exposure with respect to interest rate derivatives, exchange rate
fluctuations, and/or commodity price movements is nil. The Bank does not own any
instruments within these markets.
15
<PAGE>
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Mid-State is not a party to any material legal proceeding.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
There were no material changes in securities and uses of proceeds
during the period covered by this report.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the Shareholders for a vote during the
first quarter of 1999.
ITEM 5 - OTHER INFORMATION
Not applicable.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
A) Exhibits
Exhibit No. Exhibit
----------- -------
<S> <C>
27 Financial Data Schedule (for SEC use only)
B) Reports on Form 8-K
On a year-to-date basis in 1999, the Company filed
two reports on Form 8-K, one as an amendment to a
November 17, 1998 filing on February 18, 1999
concerning the Company's dividend policy and one on
April 27, 1999 concerning the City Commerce Bank
merger.
</TABLE>
16
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Mid-State Bancshares
(registrant)
Date: May 10, 1999 By: /s/ CARROL R. PRUETT
-----------------------------------
CARROL R. PRUETT
President and Chief
Executive Officer
Date: May 10, 1999 By /s/ JAMES G. STATHOS
-----------------------------------
JAMES G. STATHOS
Executive Vice President
and Chief Financial Officer
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<CIK> 0001027324
<NAME> MID-STATE BANCSHARES
<S> <C>
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<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
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0
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