**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

**ý****Quarterly Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

**for the quarterlyperiod ended June 30, 2004.**

 

**Or**

 

**o****Transition Report Pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934**

**for the transitionperiod from                    to                    **

 

**Commission FileNumber 000-50266**

 

**TRINITY CAPITAL CORPORATION**

(Exact name of registrant asspecified in its charter)

 

| **New Mexico**                                        |   | **85-0242376**                          |
|-------------------------------------------------------|--------|-----------------------------------------|
| (State of incorporation)                              |   | (I.R.S. Employer Identification Number) |
|                                                  |   |                                    |
| **1200 Trinity Drive, Los Alamos, New Mexico  87544** |
| (Address of principal executive offices)              |
|                                                  |
| **(505) 662-5171**                               |
| Telephone number                                      |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes oNo ý

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date: 6,731,318 shares ofcommon stock, no par value, outstanding as of July 15, 2004.

 

 

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**TRINITY CAPITAL CORPORATION AND SUBSIDIARIES**

 
|                                    |                                                                                        | **Page** |
|-----------------------------------------|---------------------------------------------------------------------------------------------|----------|
| **PART I.  FINANCIAL INFORMATION** |                                                                                        |     |
| Item  1.                                | Financial Statements                                                                        |     | 2 |
| Item 2.                                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |     | 10 |
| Item 3.                                 | Quantitative  and Qualitative Disclosures About Market Risk                                 |     | 22 |
| Item 4.                                 | Controls and Procedures                                                                     |     | 25 |
| **PART II.  OTHER INFORMATION**    |                                                                                        | 25       |
| Item 1.                                 | Legal Proceedings                                                                           |     | 25 |
| Item  2.                                | Changes  in securities and use of proceeds and issuer purchases of equity securities        |     | 25 |
| Item 3.                                 | Defaults  upon senior securities                                                            |     | 26 |
| Item 4.                                 | Submission  of matters to a vote of securities holders                                      |     | 26 |
| Item 5.                                 | Other information                                                                           |     | 26 |
| Item 6.                                 | Exhibits  and Reports on Form 8-K                                                           |     | 26 |
|                                    | SIGNATURES                                                                                  |     | 27 |
|                                    | CERTIFICATIONS                                                                              |     | 28 |

 

1

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**PART I – FINANCIAL INFORMATION**

 

**Item 1.****  FinancialStatements**

 

**TRINITY CAPITAL CORPORATION &SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**June 30, 2004 and December 31, 2003**

**(Amounts in thousands, except share data)**

 
|                                                                                                                                                                                                                                                                                                                                         |   | **June 30,  2004** |      | **December 31,  2003** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|-----------------------------|------------|
|                                                                                                                                                                                                                                                                                                                                         |   | **(Unaudited****)**     |      |                        | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                   |   |                    |      |                        |       |
| Cash and due from banks                                                                                                                                                                                                                                                                                                                      |   | $                       | 35,054    |                        | $          | 42,104 |   |
| Interest bearing deposits with banks                                                                                                                                                                                                                                                                                                         |   | 34,213                  |      | 967                         |       |
| Federal funds sold and securities purchased  under resell agreements                                                                                                                                                                                                                                                                         |   | 40                      |      | 40                          |       |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| **Cash and cash  equivalents**                                                                                                                                                                                                                                                                                                               |   | 69,307                  |      | 43,111                      |       |
| Investment securities available for sale                                                                                                                                                                                                                                                                                                     |   | 43,692                  |      | 100,753                     |       |
| Investment securities held to maturity, at  amortized cost (fair value of $73,805 at June 30, 2004 and $75,179 at  December 31, 2003)                                                                                                                                                                                              |   | 73,230                  |      | 73,717                      |       |
| Loans (net of allowance for loan losses of  $8,289 at June 30, 2004 and $7,368 at December 31, 2003)                                                                                                                                                                                                                               |   | 774,894                 |      | 733,155                     |       |
| Loans held for sale                                                                                                                                                                                                                                                                                                                          |   | 10,496                  |      | 9,511                       |       |
| Premises and equipment, net                                                                                                                                                                                                                                                                                                                  |   | 23,990                  |      | 18,939                      |       |
| Accrued interest receivable                                                                                                                                                                                                                                                                                                                  |   | 5,895                   |      | 6,485                       |       |
| Mortgage servicing rights, net                                                                                                                                                                                                                                                                                                               |   | 9,278                   |      | 7,792                       |       |
| Other real estate owned                                                                                                                                                                                                                                                                                                                      |   | 5,829                   |      | 7,383                       |       |
| Other assets                                                                                                                                                                                                                                                                                                                                 |   | 3,447                   |      | 5,904                       |       |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| **Total assets**                                                                                                                                                                                                                                                                                                                             |   | $                       | 1,020,058 |                        | $          | 1,006,750 |   |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                               |   |                    |      |                        |       |
| Liabilities                                                                                                                                                                                                                                                                                                                                  |   |                    |      |                        |       |
| Deposits:                                                                                                                                                                                                                                                                                                                                    |   |                    |      |                        |       |
| Noninterest bearing                                                                                                                                                                                                                                                                                                                          |   | $                       | 67,584    |                        | $          | 60,191 |   |
| Interest bearing                                                                                                                                                                                                                                                                                                                             |   | 781,232                 |      | 776,004                     |       |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| **Total deposits**                                                                                                                                                                                                                                                                                                                           |   | 848,816                 |      | 836,195                     |       |
| Short-term borrowings                                                                                                                                                                                                                                                                                                                        |   | 5,002                   |      | 9,402                       |       |
| Long-term borrowings                                                                                                                                                                                                                                                                                                                         |   | 63,740                  |      | 67,398                      |       |
| Junior subordinated debt owed to  unconsolidated trusts                                                                                                                                                                                                                                                                                      |   | 22,682                  |      | 16,496                      |       |
| Borrowings made by Employee Stock Ownership  Plan (ESOP) to outside parties                                                                                                                                                                                                                                                                  |   | 1,686                   |      | 2,157                       |       |
| Accrued interest payable                                                                                                                                                                                                                                                                                                                     |   | 2,538                   |      | 2,797                       |       |
| Other liabilities                                                                                                                                                                                                                                                                                                                            |   | 5,331                   |      | 6,247                       |       |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| **Total liabilities**                                                                                                                                                                                                                                                                                                                        |   | 949,795                 |      | 940,692                     |       |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| Stock owned by Employee Stock Ownership  Plan (ESOP) participants; 638,660 and 653,381 shares at June 30,  2004 and December 31, 2003, respectively, at fair value; net of unearned  ESOP shares of 99,748 shares and 126,194 shares at June 30, 2004  and December 31, 2003, respectively, at historical cost |   | 18,237                  |      | 18,256                      |       |
| Commitments, contingencies and credit risk  (note 7)                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| Stockholders’ Equity                                                                                                                                                                                                                                                                                                                    |   |                    |      |                        |       |
| Common stock, no par, authorized  20,000,000 shares; issued 6,856,800 shares, outstanding 6,731,318  and 6,701,478 at June 30, 2004 and December 31, 2003, respectively                                                                                                                                                  |   | 6,836                   |      | 6,836                       |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                   |   | 928                     |      | 545                         |       |
| Retained earnings                                                                                                                                                                                                                                                                                                                            |   | 45,061                  |      | 40,845                      |       |
| Accumulated other comprehensive (loss)  income                                                                                                                                                                                                                                                                                               |   | (195                    | )         | 135                         |       |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| Total stockholders’ equity before treasury  stock                                                                                                                                                                                                                                                                                       |   | 52,630                  |      | 48,361                      |       |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| Treasury stock, at cost, 25,734 shares and  29,128 shares at June 30, 2004 and December 31, 2003,  respectively, at historical cost                                                                                                                                                                                           |   | (604                    | )         | (559                        | )          |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| **Total stockholders’  equity**                                                                                                                                                                                                                                                                                                         |   | 52,026                  |      | 47,802                      |       |
|                                                                                                                                                                                                                                                                                                                                         |   |                    |      |                        |       |
| **Total liabilities  and stockholders’ equity**                                                                                                                                                                                                                                                                                         |   | $                       | 1,020,058 |                        | $          | 1,006,750 |   |

 

The accompanying notes are an integral partof these unaudited consolidated financial statements.

 

2

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**TRINITY CAPITAL CORPORATION &SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**For the Three and Six Months EndedJune 30, 2004 and 2003**

**(Amounts in thousands except share and pershare data)**

**(Unaudited)**

 
|                                                     |   | **Three  Months Ended** |   | **Six Months  Ended**   |   |
|----------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                                     |   | **June 30,  2004** |   | **June 30,  2003** |   | **June 30,  2004** |   | **June 30,  2003** |   |
| Interest income:                                         |   |                    |   |                    |   |   |   |   |   |
| Loans, including fees                                    |   | $                       | 11,956 |                    | $      | 12,364 |   | $ | 23,894 |   | $ | 24,856 |   |
| Investment securities:                                   |   |                    |   |                    |   |   |   |   |   |
| Taxable                                                  |   | 709                     |   | 855                     |   | 1,682 |   | 1,739 |   |
| Nontaxable                                               |   | 163                     |   | 122                     |   | 321 |   | 226 |   |
| Federal funds sold                                       |   | —                  |   | 2                       |   | — |   | 2 |   |
| Other interest bearing deposits                          |   | 63                      |   | 67                      |   | 69 |   | 133 |   |
| Investment in unconsolidated trusts                      |   | 14                      |   | 9                       |   | 27 |   | 26 |   |
| **Total interest income**                                |   | 12,905                  |   | 13,419                  |   | 25,993 |   | 26,982 |   |
| Interest expense:                                        |   |                    |   |                    |   |   |   |   |   |
| Deposits                                                 |   | 2,962                   |   | 4,150                   |   | 5,930 |   | 8,403 |   |
| Short-term borrowings                                    |   | 28                      |   | 2                       |   | 95 |   | 2 |   |
| Long-term borrowings                                     |   | 591                     |   | 370                     |   | 1,198 |   | 758 |   |
| Junior subordinated debt owed to unconsolidated  trusts  |   | 472                     |   | 432                     |   | 911 |   | 877 |   |
| **Total interest expense**                               |   | 4,053                   |   | 4,954                   |   | 8,134 |   | 10,040 |   |
| **Net interest income**                                  |   | 8,852                   |   | 8,465                   |   | 17,859 |   | 16,942 |   |
| Provision for loan losses                                |   | 600                     |   | 600                     |   | 1,200 |   | 1,200 |   |
| **Net interest income after  provision for loan losses** |   | 8,252                   |   | 7,865                   |   | 16,659 |   | 15,742 |   |
| Other income:                                            |   |                    |   |                    |   |   |   |   |   |
| Mortgage loan servicing fees                             |   | 585                     |   | 559                     |   | 1,159 |   | 1,040 |   |
| Loan and other fees                                      |   | 682                     |   | 439                     |   | 1,239 |   | 826 |   |
| Service charges on deposits                              |   | 339                     |   | 329                     |   | 670 |   | 628 |   |
| Gain on sale of loans                                    |   | 983                     |   | 3,497                   |   | 1,999 |   | 6,723 |   |
| Gain on sale of securities                               |   | —                  |   | —                  |   | 272 |   | — |   |
| Other operating income                                   |   | 261                     |   | 478                     |   | 528 |   | 848 |   |
|                                                     |   | 2,850                   |   | 5,302                   |   | 5,867 |   | 10,065 |   |
| Other expenses:                                          |   |                    |   |                    |   |   |   |   |   |
| Salaries and employee benefits                           |   | 3,855                   |   | 3,655                   |   | 7,708 |   | 7,217 |   |
| Occupancy                                                |   | 574                     |   | 444                     |   | 1,068 |   | 906 |   |
| Data processing                                          |   | 499                     |   | 348                     |   | 934 |   | 649 |   |
| Marketing                                                |   | 324                     |   | 376                     |   | 550 |   | 664 |   |
| Amortization of mortgage servicing rights                |   | 683                     |   | 540                     |   | 1,307 |   | 1,040 |   |
| Mortgage servicing rights (recovery) impairment          |   | (1,780                  | )      | 1,553                   |   | (1,417 | ) | 1,821 |   |
| Supplies                                                 |   | 209                     |   | 219                     |   | 381 |   | 430 |   |
| Other                                                    |   | 1,086                   |   | 1,376                   |   | 2,448 |   | 2,746 |   |
|                                                     |   | 5,450                   |   | 8,511                   |   | 12,979 |   | 15,473 |   |
| **Income before income taxes**                           |   | 5,652                   |   | 4,656                   |   | 9,547 |   | 10,334 |   |
| Income taxes                                             |   | 2,293                   |   | 1,820                   |   | 3,738 |   | 3,980 |   |
| Net income                                               |   | $                       | 3,359  |                    | $      | 2,836 |   | $ | 5,809 |   | $ | 6,354 |   |
| Basic earnings per common share                          |   | $                       | 0.50   |                    | $      | 0.42 |   | $ | 0.86 |   | $ | 0.95 |   |
| Diluted earnings per common share                        |   | $                       | 0.49   |                    | $      | 0.42 |   | $ | 0.85 |   | $ | 0.95 |   |

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.

 

3

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**TRINITY CAPITAL CORPORATION &SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**For the Six Months Ended June 30, 2004and 2003**

**(Amounts in thousands)**

**(Unaudited)**

 
|                                                                                         |   | **Six Months  Ended**   |   |
|----------------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                                         |   | **June 30,  2004** |   | **June 30,  2003** |   |
|                                                                                         |   |                    |   |   |   |
| Cash Flows From Operating Activities                                                         |   |                    |   |   |   |
| Net income                                                                                   |   | $                       | 5,809  |   | $ | 6,354 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |   |                    |   |   |   |
| Depreciation and amortization                                                                |   | 1,032                   |   | 898 |   |
| Net amortization of:                                                                         |   |                    |   |   |   |
| Mortgage servicing rights                                                                    |   | 1.307                   |   | 1,040 |   |
| Premiums and discounts on investment  securities                                             |   | 725                     |   | 691 |   |
| Junior subordinated debt owed to  unconsolidated trusts issuance costs                       |   | 9                       |   | 9 |   |
| Provision for loan losses                                                                    |   | 1,200                   |   | 1,200 |   |
| (Recovery) impairment of mortgage servicing  rights                                          |   | (1.417                  | )      | 1,821 |   |
| Gain on sale of available for sale  securities                                               |   | (272                    | )      | — |   |
| Federal Home Loan Bank (FHLB) stock  dividends received                                      |   | (41                     | )      | (40 | ) |
| Gain on sale of loans                                                                        |   | (1,999                  | )      | (6,723 | ) |
| Loss (gain) loss on disposal of other real  estate owned                                     |   | 66                      |   | (9 | ) |
| Write-down of value of other real estate  owned                                              |   | 61                      |   | 580 |   |
| Decrease (increase) in other assets                                                          |   | 3.038                   |   | (1,261 | ) |
| Decrease in other liabilities                                                                |   | (974                    | )      | (590 | ) |
| Tax benefit recognized for exercise of  stock options                                        |   | 53                      |   | — |   |
| Release of Employee Stock Ownership Plan  (ESOP) shares                                      |   | 768                     |   | 530 |   |
| **Net cash provided  by operating activities before originations and gross sales of loans**  |   | 9.365                   |   | 4,500 |   |
| Gross sales of loans held for sale                                                           |   | 140,034                 |   | 314,950 |   |
| Origination of loans held for sale                                                           |   | (140,396                | )      | (295,517 | ) |
| **Net cash provided  by operating activities**                                               |   | 9,003                   |   | 23,933 |   |
| Cash Flows From Investing Activities                                                         |   |                    |   |   |   |
| Proceeds from maturities and paydowns of  investment securities available for sale           |   | 30,885                  |   | 9,620 |   |
| Proceeds from maturities and paydowns of  investment securities held to maturity             |   | 133                     |   | 5,680 |   |
| Proceeds from sale of investment  securities, available for sale                             |   | 28,389                  |   | — |   |
| Purchase of investment securities available  for sale                                        |   | (2,804                  | )      | (29,446 | ) |
| Purchase of investment securities held to  maturity                                          |   | —                  |   | (9,650 | ) |
| Proceeds from sale of other real estate  owned                                               |   | 2,551                   |   | 3,009 |   |
| Loans funded, net of repayments                                                              |   | (44,063                 | )      | (38,963 | ) |
| Purchases of premises and equipment                                                          |   | (6,083                  | )      | (1,458 | ) |
| **Net cash provided  by (used in) investing activities**                                     |   | 9,008                   |   | (61,208 | ) |
| Cash Flows From Financing Activities                                                         |   |                    |   |   |   |
| Net increase in demand deposits, NOW  accounts and savings accounts                          |   | 29,978                  |   | 36,649 |   |
| Net (decrease) increase in time deposits                                                     |   | (17,357                 | )      | 23,825 |   |
| Proceeds from issuances of borrowings                                                        |   | 108,700                 |   | 51,194 |   |
| Repayment of borrowings                                                                      |   | (116,758                | )      | (54,705 | ) |
| Repayment of ESOP debt                                                                       |   | (471                    | )      | (531 | ) |
| Proceeds from issuance of trust preferred  securities                                        |   | 6,186                   |   | — |   |
| Purchase of treasury stock                                                                   |   | (117                    | )      | — |   |
| Issuance of common stock for stock option  plan                                              |   | 72                      |   | — |   |
| Dividend payments                                                                            |   | (2,048                  | )      | (1,912 | ) |
| **Net cash provided  by financing activities**                                               |   | 8,185                   |   | 54,520 |   |
| **Net increase in  cash and cash equivalents**                                               |   | 26,196                  |   | 17,245 |   |
| Cash and cash equivalents:                                                                   |   |                    |   |   |   |
| Beginning of year                                                                            |   | 43,111                  |   | 40,979 |   |
| End of period                                                                                |   | $                       | 69,307 |   | $ | 58,224 |   |
|                                                                                         |   |                    |   |   |   |
| Supplemental Disclosures of Cash Flow  Information                                           |   |                    |   |   |   |
| Cash payments for:                                                                           |   |                    |   |   |   |
| Interest                                                                                     |   | $                       | 8,393  |   | $ | 9,298 |   |
| Income taxes                                                                                 |   | 1,024                   |   | 5,064 |   |
| Non-cash investing and financing  activities:                                                |   |                    |   |   |   |
| Transfers from loans to other real estate  owned                                             |   | 1,124                   |   | 2,179 |   |
| Dividends declared, not yet paid                                                             |   | 2,049                   |   | 1,912 |   |
| Change in unrealized gain on investment  securities, net of taxes                            |   | (330                    | )      | 28 |   |

 

The accompanying notes are an integral partof these unaudited consolidated financial statements.

 

4

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**TRINITY CAPITAL CORPORATION &SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1. Basis of Presentation**

 

The accompanying unaudited consolidated financial statements includethe consolidated balances and results of operations of Trinity CapitalCorporation (“Trinity” or the “Company”) and its wholly owned subsidiaries: LosAlamos National Bank (the “Bank”) and Title Guaranty & Insurance Company(“Title Guaranty”), collectively referred to as the “Company.”  Trinity Capital Trust I(“Trust I”), Trinity Capital Trust II (“Trust II”) and TrinityCapital Trust III (“Trust III”), collectively referred to as the “Trusts”,which are also wholly owned subsidiaries of Trinity, are not consolidated inthese financial statements.  Thebusiness activities of the Company consist solely of the operations of itswholly owned subsidiaries.  Allsignificant intercompany balances and transactions have been eliminated inconsolidation.  In the opinion ofmanagement, all adjustments (consisting only of normal recurring adjustments)necessary for a fair presentation of the financial position, results ofoperations and cash flows for the interim periods have been made.  The results of operations for the three andsix months ended June 30, 2004 are not necessarily indicative of theresults to be expected for the entire fiscal year.

 

The unaudited interim consolidated financial statements have beenprepared in conformity with accounting principles generally accepted in theUnited States of America and industry practice.  Certain information in footnote disclosure normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America and industry practice hasbeen condensed or omitted pursuant to rules and regulations of the Securitiesand Exchange Commission.  These financialstatements should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s December 31, 2003audited financial statements filed on Form 10-K.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions which affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesas of the date of the financial statements, as well as the reported amounts ofincome and expenses during the reported periods.  Actual results could differ from those estimates.

 

**Note 2.  Comprehensive Income**

 

Comprehensive income includes net income, as well as the change in netunrealized gain on investment securities available for sale, net of tax.  Comprehensive income was $3.0 million and$3.0 million for the three month periods ended June 30, 2004 and 2003,respectively, and $5.5 million and $6.4 million for the six month periods endedJune 30, 2004 and 2003, respectively.

 

**Note 3.  Earnings Per Share Data**

 

The following table sets forth the computation of basic and dilutedearnings per share for the periods indicated:

 
|                                                                               |   | **Three  Months Ended June 30,**                           |   | **Six Months  Ended June 30,** |   |
|------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                                               |   | **2004**                                                        |   | **2003**                            |   | **2004** |   | **2003** |   |
|                                                                               |   | **(Unaudited; in thousands, except  share and per share data)** |   |
| Net income                                                                         |   | $                                                               | 3,359  |                                | $      | 2,836 |   | $ | 5,809 |   | $ | 6,354 |   |
| Weighted average common shares issued                                              |   | 6,856,800                                                       |   | 6,856,800                           |   | 6,856,800 |   | 6,856,800 |   |
| LESS: Weighted average treasury stock  shares                                      |   | (29,016                                                         | )      | (29,128                             | )      | (29,072 | ) | (29,128 | ) |
| LESS: Weighted average unearned Employee  Stock Ownership Plan (ESOP) stock shares |   | (99,748                                                         | )      | (146,310                            | )      | (102,509 | ) | (150,122 | ) |
| Weighted average common shares outstanding,  net                                   |   | 6,728,036                                                       |   | 6,681,362                           |   | 6,725,219 |   | 6,677,550 |   |
| Basic earnings per common share                                                    |   | $                                                               | 0.50   |                                | $      | 0.42 |   | $ | 0.86 |   | $ | 0.95 |   |
| Weighted average dilutive shares from stock  option plan                           |   | 106,630                                                         |   | 31,134                              |   | 112,206 |   | 31,134 |   |
| Weighted average common shares outstanding  including dilutive shares              |   | 6,834,666                                                       |   | 6,712,496                           |   | 6,837,425 |   | 6,708,684 |   |
| Diluted earnings per common share                                                  |   | $                                                               | 0.49   |                                | $      | 0.42 |   | $ | 0.85 |   | $ | 0.95 |   |

 

5

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**Note 4.  Recent Accounting Pronouncements andRegulatory Developments**

 

InMarch, 2004 the Securities and Exchange Commission (the “SEC”) issued *StaffAccounting Bulletin (“SAB”) 105, “Application of Accounting Principles to LoanCommitments.”*  This SABsummarizes the views of the SEC regarding the application of generally acceptedaccounting principles to loan commitments accounted for as derivativeinstruments.  Under this SAB, banks willno longer be able to record interest rate lock commitments (IRLCs) as assets,but only record any liabilities resulting from these IRLCs.  Through March 31, 2004, the Companyfollowed industry practice in recording these IRLCs as assets or liabilities,depending on the net position the Company had on these IRLCs.  As of April 1, 2004, the Company hasadopted this SAB.  This did not have asignificant effect on the Company’s financial statements.

 

In December 2003 the Financial AccountingStandards Board (the “FASB”) revised *Statement of Financial Accounting Standards*(“*SFAS”)No. 132, “Employers’ Disclosures about Pensions and Other PostretirementBenefits.”*  The provisions ofthis statement do not change the measurement and recognition provisions ofprevious statements, but adds disclosures about retirement plan assets,employer obligations, key assumptions in these measurements and the measurementdate(s) used to determine pensions and other postretirement benefitmeasurements that make up at least the majority of plan assets and benefitobligations.  These provisions areeffective for annual and interim financial statements for periods beginningafter December 15, 2003.  Theadoption of this statement as of January 1, 2004 did not have asignificant impact on the Company’s financial statements.

 

InDecember 2003, the Accounting Standards Executive Committee of theAmerican Institute of Certified Public Accountants (the “AcSEC”) issuedStatement of Position (“SOP”) 03-3, *Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer*. The SOP is effective for loans acquired infiscal years beginning after December 15, 2004, with early adoptionencouraged. A certain transition provision applies for certain aspects of loanscurrently within the scope of Practice Bulletin 6, Amortization of Discounts onCertain Acquired Loans. The SOP addresses accounting for differences betweencontractual cash flows and cash flows expected to be collected from aninvestor’s initial investment in loans or debt securities (loans) acquired in atransfer if those differences are attributable, at least in part, to creditquality. It includes loans acquired in business combinations and applies to allnongovernmental entities, including not-for-profit organizations. The SOP doesnot apply to loans originated by the entity. Adoption of this SOP is not expected to have a significant impact on theCompany’s financial statements.

 

On March 31, 2004, the FASB ratified aconsensus opinion of the Emerging Issues Task Force (EITF), issue 03-1, *The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments*.  A consensus was reached regardingdisclosures about unrealized losses on available-for-sale debt and equitysecurities accounted for under FASB Statements No. 115, *Accounting for Certain Investments in Debt and EquitySecurities,* and No. 124, *Accountingfor Certain Investments Held by Not-for-Profit Organizations.* Theguidance for evaluating whether an investment is other-than-temporarilyimpaired should be applied in other-than-temporary impairment evaluations madein reporting periods beginning after June 15, 2004.  The disclosures are effective in annualfinancial statements for fiscal years ending after December 15, 2003, forinvestments accounted for under Statements 115 and 124.   For all other investments within the scopeof this Issue, the disclosures are effective in annual financial statements forfiscal years ending after June 15, 2004. The additional disclosures for cost method investments are effective forfiscal years ending after June 15, 2004. Adoption of the provisions of this opinion that are effective as of thisreport date did not have a significant impact on the Company’s financialstatements.  Adoption of furtherprovisions when they are effective is not expected to have a significant impacton the Company’s financial statements.

 

OnMay 6, 2004, the Board of Governors of the Federal Reserve System issued aNotice of Proposed Rulemaking in which it proposed to allow the continuedinclusion of trust preferred securities in the tier 1 capital ofbank holding companies, subject to stricter standards.  The Federal Reserve is proposing to limitthe aggregate amount of a bank holding company’s cumulative perpetual preferredstock, trust preferred securities and other minority interests to 25% ofthe company’s core capital elements, net of goodwill.  Current regulations do not require the deduction of goodwill.  The proposal also provides that amountsof qualifying trust preferred securities and certain minority interests inexcess of the 25% limit may be included in tier 2 capital but would be limited,together with subordinated debt and limited-life preferred stock, to 50% oftier 1 capital.  The proposalprovides a three-year transition period for bank holding companies to meetthese quantitative limitations.  At thistime, this proposed rule, if adopted, will have no material effect on theCompany.

 

OnJune 17, 2004, the SEC issued a Proposed Rule in which it described theparameters under which banks may sell securities to their customers withouthaving to register as broker-dealers with the SEC in accordance with Title IIof the Gramm-Leach-Bliley Act of 1999. The proposal, which is designated as Regulation B, clarifies, amongother things: (i) the limitations on the amount that unregistered bankemployees may be compensated for making referrals in connection with a third-partybrokerage arrangement; (ii) the manner by which banks may be compensatedfor effecting securities transactions for its customers in a fiduciarycapacity; and (iii) the extent to which banks may engage in certainsecurities transactions as a custodian. At this time, it appears as though this proposed regulation, if adopted,will have no material effect on the Company’s activities or financial results.

 

6

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**Note 5.  Long Term Borrowings**

 

The Company had Federal Home Loan Bank advances withmaturity dates greater than one year of $63.7 million and $67.4 million as ofJune 30, 2004 and December 31, 2003, respectively.  As of June 30, 2004, the advances havefixed interest rates ranging from 3.22% to 6.34%.

 

**Note 6. Junior Subordinated Debt Owed to Unconsolidated Trusts**

 

The following table presents details on the junior subordinated debt owed to unconsolidated trusts as of June 30, 2004:

 
|                                                        |   | **Trust I**                |   | **Trust II**           |   | **Trust III**          |   |
|-------------------------------------------------------------|--------|----------------------------|--------|------------------------|--------|------------------------|--------|
|                                                        |   | **(Dollars in thousands)** |   |
| Date of issue                                               |   | March 23, 2000        |   | November 28, 2001 |   | May 11, 2004           |   |
| Amount of trust preferred securities issued                 |   | $                          | 10,000 |                   | $      | 6,000                  |   | $ | 6,000 |   |
| Rate on trust preferred securities                          |   | 10.875                     | %      | 9.95                   | %      | 3.88% (variable        | )      |
| Maturity                                                    |   | March 8, 2030         |   | December 8, 2031  |   | September 8, 2034 |   |
| Date of first redemption                                    |   | March 8, 2010         |   | December 8, 2006  |   | September 8, 2009 |   |
| Common equity securities issued                             |   | $                          | 310    |                   | $      | 186                    |   | $ | 186 |   |
| Junior subordinated deferrable interest  debentures issued  |   | $                          | 10,310 |                   | $      | 6,186                  |   | $ | 6,186 |   |
| Rate on junior subordinated deferrable  interest debentures |   | 10.875                     | %      | 9.95                   | %      | 3.88% (variable        | )      |

 

On the dates of issue indicated above, the Trusts, being Delaware statutory business trusts, issued trust preferred securities (the “trust preferred securities”) in the amount and at the rate indicated above.  These securities represent preferred beneficial interests in the assets of the Trusts.  The trust preferred securities will mature on the dates indicated, and are redeemable in whole or in part at the option of the Company at any time after the date of first redemption indicated above, with the approval of the Federal Reserve Board and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment.  The Trusts also issued common equity securities to Trinity in the amounts indicated above.  The Trusts used the proceeds of the offering of the trust preferred securities to purchase junior subordinated deferrable interest debentures (the debentures) issued by the Company, which have terms substantially similar to the trust preferred securities.  The Company has the right to defer payments of interest on the debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods with respect to each interest payment deferred.  Under the terms of the debentures, in the event that under certain circumstances there is an event of default under the debentures or the Company has elected to defer interest on the debentures, the Company may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock.  The Company used the majority of the proceeds from the sale of the debentures to add to Tier 1 capital in order to support its growth.

 

Trinity owns all of the outstanding common stock of the Trusts.  The Trusts are considered variable interest entities (VIEs) under *Financial Accounting Standards Board Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51”*, as revised.  Prior to FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity.  Under FIN 46, a VIE should be consolidated by its primary beneficiary.  The Company implemented FIN 46 during the fourth quarter of 2003.  Because Trinity is not the primary beneficiary of the Trusts, the financial statements of the Trusts are no longer included in the consolidated financial statements of the Company.  The Company’s prior financial statements have been reclassified to de-consolidate the Company’s investment in the Trusts.

 

The trust preferred securities are currently included in the Tier 1 capital of Trinity for regulatory capital purposes.  However, because the Trusts are no longer a part of the Company’s financial statements, the Federal Reserve Board may in the future disallow inclusion of the trust preferred securities in Tier 1 capital for regulatory capital purposes.  The most recent proposed rule issued by the Board of the Federal Reserve System indicated that it will continue to recognize these trust preferred securities as Tier 1 capital (see discussion in Note 4, “Recent Accounting Pronouncements and Regulatory Developments”.)  However, there can be no assurance that the Federal Reserve Board will continue to permit institutions to include trust preferred securities in Tier I capital for regulatory capital purposes.  As of June 30, 2004, assuming the Company was not permitted to include the $22 million in trust preferred securities issued by the Trusts in its Tier 1 capital, the Company would still exceed the regulatory required minimums for capital adequacy purposes.  If the trust preferred securities were no longer permitted to be included in Tier 1 capital, the Company would also be permitted to redeem the capital securities without penalty.

 

7

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Payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities are guaranteed by the Company on a limited basis.  The Company also entered into an agreement as to expenses and liabilities with the Trusts pursuant to which it agreed, on a subordinated basis, to pay any costs, expenses or liabilities of the Trusts other than those arising under the trust preferred securities.  The obligations of the Company under the junior subordinated debentures, the related indenture, the trust agreement establishing the Trusts, the guarantee and the agreement as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by the Company of the Trusts’ obligations under the trust preferred securities.

 

Issuance costs of $615 thousand related to the trust preferredsecurities were deferred and are being amortized over the period untilmandatory redemption of the securities in March 2030, December 2031and September 2034, respectively. During the three months ended June 30, 2004 and 2003, respectively,$5 thousand and $4 thousand of these issuance costs were amortized.  During the six months ended June 30,2004 and 2003, respectively, $9 thousand and $9 thousand of these issuancecosts were amortized.  Unamortizedissuance costs were $549 thousand and $490 thousand at June 30, 2004 and2003, respectively.

 

Dividends accrued and unpaid to securities holders totaled $425thousand and $379 thousand on June 30, 2004 and 2003, respectively.

 

**Note 7. Commitments, Contingencies and Off-Balance Sheet Activities**

 

*Credit-related financial instruments:*  The Company is a party to credit-relatedfinancial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit, standby letters of credit and commercial lettersof credit.  Such commitments involve, tovarying degrees, elements of credit and interest rate risk in excess of theamount recognized in the consolidated balance sheets.

 

The Company’s exposure to credit loss is represented by the contractualamount of these commitments.  TheCompany follows the same credit policies in making commitments as it does foron-balance-sheet instruments.

 

At June 30, 2004 and December 31, 2003, the following financialinstruments were outstanding whose contract amounts represent credit risk:

 
|                                       |   | **Contract  Amount**    |    |
|--------------------------------------------|--------|-------------------------|---------|
|                                       |   | **June 30,  2004** |    | **December 31,  2003** |   |
|                                       |   | **(In  thousands)**     |    |
| Mortgage loans sold with recourse          |   | —                  |    | $ | 17 |   |
| Unfunded commitments under lines of credit |   | $                       | 135,703 |   | 130,868 |   |
| Commercial and standby letters of credit   |   | 23,849                  |    | 27,522 |   |
|                                            |        |                         |         |  |  |  |  |

 

Mortgage loans sold with recourse are loans sold to outside investors,with the Company retaining servicing and responsibility for collection in theevent of a default.  For 2004 and 2003,no such defaults occurred or were expected to occur.

 

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require a paymentof a fee.  The commitments for equitylines of credit may expire without being drawn upon.  Therefore, the total commitment amounts do not necessarilyrepresent future cash requirements.  Theamount of collateral obtained, if it is deemed necessary by the Company, isbased on management’s credit evaluation of the customer.  Unfunded commitments under commercial linesof credit, revolving credit lines and overdraft protection agreements arecommitments for possible future extensions of credit to existingcustomers.  Overdraft protectionagreements are uncollateralized, but most other unfunded commitments havecollateral.  These unfunded lines ofcredit usually do not contain a specified maturity date and may not necessarilybe drawn upon to the total extent to which the Company is committed.

 

8

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Commercial and standby letters of credit are conditional commitmentsissued by the Company to guarantee the performance of a customer to a thirdparty.  Those letters of credit areprimarily issued to support public and private borrowing arrangements.  Essentially all letters of credit issuedhave expiration dates within one year. The credit risk involved in issuingletters of credit is the same as that involved in extending loans tocustomers.  The Company generally holdscollateral supporting those commitments, if deemed necessary. In the event thecustomer does not perform in accordance with the terms of the agreement withthe third party, the Company would be required to fund the commitment.  The maximum potential amount of futurepayments the Company could be required to make is represented by thecontractual amount shown in the summary above. If the commitment is funded, the Company would be entitled to seekrecovery from the customer.  AtJune 30, 2004 and December 31, 2003, no amounts have been recorded asliabilities for the Company’s potential obligations under thesecommitments.  The fair value of thesecommitments is approximately equal to the fees collected when granting theseletters of credit.  These fees collectedwere $23 thousand and $30 thousand as of June 30, 2004 andDecember 31, 2003, respectively, and are included in “other liabilities”on the Company’s balance sheet.

 

*Concentrations of credit risk:*  The majority of the loans, commitments toextend credit, and standby letters of credit have been granted to customers inLos Alamos and surrounding communities. Although the Company has a diversified loan portfolio, a substantialportion of its loans are made to businesses and individuals associated with, oremployed by, Los Alamos National Laboratory (“the Laboratory”).  The ability of such borrowers to honor theircontracts is predominately dependent upon the continued operation and fundingof the Laboratory.  Investments insecurities issued by states and political subdivisions involve governmentalentities within the state of New Mexico. The distribution of commitments to extend credit approximates thedistribution of loans outstanding. Standby letters of credit were granted primarily to commercialborrowers.

 

*Contingencies:*  In the normal course of business, theCompany is involved in various legal proceedings.  In the opinion of management, after consulting with counsel, anyliability resulting from such proceedings would not have a material adverseeffect on the Company’s consolidated financial statements.

 

**Note 8.  Pro Forma Impact of Stock-Based CompensationPlans**

 

Asallowed under SFAS No. 123, *Accounting forStock-Based Compensation*, the Company measures stock-basedcompensation cost in accordance with the methods prescribed in AccountingPrinciples Board (APB) Opinion No. 25, *Accountingfor Stock Issued to Employees*.  As stock options are granted atfair value, there are no charges to earnings associated with stock optionsgranted.  Accordingly, no compensation cost has been recognized for grantsmade to date.  Had compensation cost been determined based on the fairvalue method prescribed in FASB Statement No. 123, reported net income andearnings per common share would have been reduced to the pro forma amountsshown below (dollars in thousands, except earnings per share data):

 
|                                                                                                                                          |   | **Three  Months Ended  June 30,**               |   | **Six Months  Ended  June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                                                                                          |   | **2004**                                             |   | **2003**                             |   | **2004** |   | **2003** |   |
|                                                                                                                                          |   | **(Unaudited; in thousands except per  share data)** |   |
| Net income as reported                                                                                                                        |   | $                                                    | 3,359  |                                 | $      | 2,836 |   | $ | 5,809 |   | $ | 6,354 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | 28                                                   |   | 27                                   |   | 57 |   | 54 |   |
|                                                                                                                                          |   |                                                 |   |                                 |   |   |   |   |   |
| Pro forma net income                                                                                                                          |   | $                                                    | 3,331  |                                 | $      | 2,809 |   | $ | 5,752 |   | 6,300 |   |
|                                                                                                                                          |   |                                                 |   |                                 |   |   |   |   |   |
| Earnings per share:                                                                                                                           |   |                                                 |   |                                 |   |   |   |   |   |
| Basic – as reported                                                                                                                      |   | $                                                    | 0.50   |                                 | $      | 0.42 |   | $ | 0.86 |   | $ | 0.95 |   |
| Basic – pro forma                                                                                                                        |   | $                                                    | 0.50   |                                 | $      | 0.42 |   | $ | 0.86 |   | $ | 0.94 |   |
|                                                                                                                                          |   |                                                 |   |                                 |   |   |   |   |   |
| Diluted – as reported                                                                                                                    |   | $                                                    | 0.49   |                                 | $      | 0.42 |   | $ | 0.85 |   | $ | 0.95 |   |
| Diluted – pro forma                                                                                                                      |   | $                                                    | 0.49   |                                 | $      | 0.42 |   | $ | 0.84 |   | $ | 0.94 |   |

 

9

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**Item 2.****  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

*This discussion is intended to focus oncertain financial information regarding the Company and the Bank and is writtento provide the reader with a more thorough understanding of its financial statements.The following discussion and analysis of the Company’s financial position andresults of operations should be read in conjunction with the information setforth in Item 3, Quantitative and Qualitative Disclosures about MarketRisk and the annual audited consolidated financial statements filed on Form10-K.*

 

**Special Note Concerning Forward-LookingStatements**

 

This Form 10-Q contains, and future oral and written statements ofthe Company may contain, forward-looking statements, within the meaning of suchterm in the Private Securities Litigation Reform Act of 1995, with respect tothe financial condition, results of operations, plans, objectives, futureperformance and business of the Company. Forward-looking statements, which maybe based upon beliefs, expectations and assumptions of our management and oninformation currently available to management, are generally identifiable bythe use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,”“estimate,” “may,” “will,” “would,” “could,” “should” or other similarexpressions. Additionally, all statements in this document, includingforward-looking statements, speak only as of the date they are made, and weundertake no obligation to update any statement in light of new information orfuture events.

 

Our ability to predict results or the actual effect of future plans orstrategies is inherently uncertain. Factors which could have a material adverseeffect on our operations and future prospects include, but are not limited to,the following:

 

•                                          Thestrength of the United States economy in general and the strength of the localeconomies in which we conduct our operations which may be less favorable thanexpected and may result in, among other things, a deterioration in the creditquality and value of our assets.

 

•                                          Theeconomic impact of any future terrorist threats or attacks, and the response ofthe United States to any such threats and attacks.

 

•                                          Theeffects of, and changes in, federal, state and local laws, regulations andpolicies affecting banking, securities, insurance and monetary and financialmatters.

 

•                                          Theeffects of changes in interest rates (including the effects of changes in therate of prepayments of the Company’s assets) and the policies of the Board ofGovernors of the Federal Reserve System.

 

•                                          Ourability to compete with other financial institutions as effectively as wecurrently intend due to increases in competitive pressures in the financialservices sector.

 

•                                          Ourinability to obtain new customers and to retain existing customers.

 

•                                          Thetimely development and acceptance of products and services, including productsand services offered through alternative delivery channels such as theInternet.

 

•                                          Technologicalchanges implemented by us and by other parties, including third party vendors,which may be more difficult or more expensive than anticipated or which mayhave unforeseen consequences to us and its customers.

 

•                                          Ourability to develop and maintain secure and reliable electronic systems.

 

•                                          Ourability to retain key executives and employees and the difficulty that we mayexperience in replacing key executives and employees in an effective manner.

 

•                                          Consumerspending and saving habits which may change in a manner that affects ourbusiness adversely.

 

•                                          Businesscombinations and the integration of acquired businesses which may be moredifficult or expensive than expected.

 

•                                          Thecosts, effects and outcomes of existing or future litigation.

 

10

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•                                          Changesin accounting policies and practices, as may be adopted by state and federalregulatory agencies and the Financial Accounting Standards Board.

 

•                                          Ourability to manage the risks associated with the foregoing as well asanticipated.

 

These risks and uncertainties should be considered in evaluatingforward-looking statements and undue reliance should not be placed on suchstatements. Additional information concerning the Company and our business,including other factors that could materially affect our financial results, willbe included in our filings with the Securities and Exchange Commission.

 

**Critical Accounting Policies**

 

***Allowance for Loan Losses:***  Management believes the allowance for loanlosses accounting policy is critical to the portrayal and understanding of ourfinancial condition and results of operations. As such, selection and application of this “critical accounting policy”involves judgments, estimates, and uncertainties that are susceptible tochange.  In the event that differentassumptions or conditions were to prevail, and depending upon the severity ofsuch changes, the possibility of materially different financial condition orresults of operations is a reasonable likelihood.

 

The allowance for loan losses is maintained at an amount thatmanagement believes will be adequate to absorb probable losses on existingloans, based on an evaluation of the collectibility of loans and prior lossexperience.  This evaluation also takesinto consideration such factors as changes in the nature and volume of the loanportfolio, the value of underlying collateral, overall portfolio quality,review of specific problem loans and current economic conditions that mayaffect the borrower’s ability to pay. While management uses the best information available to make its evaluation,future adjustments to the allowance may be necessary if there are significantchanges in these factors.  In addition,as an integral part of their examination process regulatory agenciesperiodically review our allowance for loan losses and may require us to makeadditions to the allowance based on their evaluation of information availableat the time of their examinations.

 

We maintain our allowance for loan losses at a level that managementbelieves will be adequate to absorb probable losses on existing loans based onan evaluation of the collectibility of loans and prior loss experience.  Three methods are used to evaluate theadequacy of the allowance for loan losses: (1) historical loss experience,based on loss experience by quality classification in the previous twelvecalendar quarters; (2) specific identification, based upon management’sassessment of loans and the probability that a charge off will occur in theupcoming quarter; and (3) loan concentrations, based on current or expectedeconomic factors in the geographic and industry sectors where managementbelieves we may eventually experience some loan losses.

 

***Mortgage Servicing Right (MSR) Assets:***  Servicing residential mortgage loans for third-party investors represents a significant business activity of the Bank.  As of June 30, 2004, mortgage loans serviced for others totaled $905.7 million.  The MSRs on these loans totaled $9.3 million as of June 30, 2004.  The expected and actual rates of mortgage loan prepayments are the most significant factors driving the value of MSRs.  Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.  In determining the fair value of the MSRs, mortgage interest rates, which are used to determine prepayment rates and discount rates, are held constant over the estimated life of the portfolio.  Fair values of the MSRs are provided by an independent third-party broker of MSRs on a monthly basis.  The values given by the broker are based upon current market conditions and assumptions, which incorporate the expected life of the loans, estimated costs to service the loans, servicing fees to be received and other factors.  MSRs are carried at the lower of the initial capitalized amount, net of accumulated amortization, or fair value.

 

The fair value of the MSRs is driven primarily by the effect current mortgage interest rates have on the likelihood borrowers will prepay the underlying mortgages by refinancing at a lower rate.  Accordingly, higher interest rates decrease the likelihood of repayment, extending the life of the MSRs and increasing the value of these assets.  Lower interest rates increase the likelihood of repayment, contracting the life of the MSRs and decreasing the value of these assets.  This can have a significant impact on our income.  In the three months ended June 30, 2004, we recognized income of $1.8 million due to the higher values of these MSRs.  In the six months ended June 30, 2004, we recognized income of $1.4 million.  For the year ending December 31, 2003, we recognized an expense of $754 thousand for these assets.  We can have no certainty on the direction and amount of interest rate changes looking forward, and therefore, we can have no certainty on the amount or direction of the change in valuation.

 

11

 

**Overview**

 

The Company improved its earnings in thesecond quarter of 2004 over the first quarter of 2004, largely due to therecovery of impairment on mortgage servicing rights as interest ratesincreased.  Although mortgage loanrefinance activity (and its associated income) was much lower in 2004 comparedto 2003, the Company managed to increase income 18.4% from the second quarterof 2003 to the second quarter of 2004, also due to the recovery of thisimpairment.  The Company’s balance sheetgrowth remained flat, growing only 1.3% from December 31, 2003 toJune 30, 2004.  However, there wasa shift from lower-yielding assets (investment securities) to higher-yieldingassets (loans), increasing net interest margin on a fully tax-equivalent basisfrom 3.84% for the year ended December 31, 2003 to 3.90% for the sixmonths ended June 30, 2004.  TheCompany also increased its risk-based capital by issuing $6 million in trustpreferred securities during this quarter, enabling us to continue to grow andremain well-capitalized.  Constructionon the second office in Santa Fe neared completion during this quarter, and itis scheduled to open in August, 2004.

 

**Income Statement Analysis**

 

***Net Income-General.***  Net income for the three months endedJune 30, 2004 was $3.4 million, compared to $2.8 million for the sameperiod of 2003.  Diluted earnings pershare increased by $0.07 to $0.49 for the three months ended June 30, 2004from $0.42 for the same period of 2003. This represented an increase in earnings per share of 16.7%.  The increase in net income was primarily theresult of a decrease in other expenses, coupled with an increase in netinterest income.  The decrease in otherexpenses was primarily due to the recovery of impairment on mortgage servicingrights, resulting from an increased market value of these rights in a risinginterest rate environment.

 

Net income for the six months ended June 30, 2004 was $5.8 million,compared to $6.4 million for the same period of 2003.  Diluted earnings per share decreased by $0.10 to $0.85 for thesix months ended June 30, 2004 from $0.95 for the same period of 2003.  This represented a decrease in earnings pershare of 10.5%.  The decrease in netincome was primarily the result of a decrease in non-interest income, which waspartially offset by an increase in net interest income and a decrease in otherexpenses.

 

The profitability of the Company’s operations depends primarily on itsnet interest income, which is the difference between total interest earned oninterest earning assets and total interest paid on interest bearingliabilities. The Company’s net income is affected by its provision for loanlosses as well as other income and other expenses. The provision for loanlosses reflects the amount thought to be adequate to cover probable creditlosses in the loan portfolio. Non-interest income or other income consists ofmortgage loan servicing fees, loan and other fees, service charges on deposits,gain on sale of loans, gain on sale of securities and other operating income.Other expenses include salaries and employee benefits, occupancy expenses, dataprocessing expenses, marketing, amortization and valuation of mortgage servicingrights, supplies expense and other expenses.

 

The amount of net interest income is affected by changes in the volumeand mix of interest earning assets, the level of interest rates earned on thoseassets, the volume and mix of interest bearing liabilities, and the level ofinterest rates paid on those interest bearing liabilities. The provision forloan losses is dependent on changes in the loan portfolio and management’sassessment of the collectibility of the loan portfolio, as well as economic andmarket conditions. Other income and other expenses are impacted by growth ofoperations and growth in the number of accounts through both acquisitions andcore banking business growth. Growth in operations affects other expenses as aresult of additional employees, branch facilities and promotional marketingexpense. Growth in the number of accounts affects other income includingservice fees as well as other expenses such as computer services, supplies,postage, telecommunications and other miscellaneous expenses.

 

12

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***Net Interest Income.***  The following tables present, for theperiods indicated, the total dollar amount of interest income from averageinterest earning assets and the resultant yields, as well as the interestexpense on average interest bearing liabilities, and the resultant costs,expressed both in dollars and rates. Borrowings made by the Company’s EmployeeStock Ownership Plan (“ESOP”) to outside parties are not included in thisanalysis, as the interest expense on this borrowing is born by the ESOP.Funding for the ESOP is recognized as part of compensation expense:

 
|                                                                 |   | **Three  Months Ended June 30,**  |      |
|----------------------------------------------------------------------|--------|----------------------------------------|-----------|
|                                                                 |   | **2004**                               |      | **2003** |   |
|                                                                 |   | **Average  Balance**                   |      | **Interest** |   | **Yield/Rate** |   | **Average  Balance** |   | **Interest** |   | **Yield/Rate** |   |
|                                                                 |   | **(Unaudited;  Dollars in thousands)** |      |
| **Interest Earning  Assets:**                                        |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Loans(1)(2)                                                          |   | $                                      | 787,775   |   | $ | 11,956 |   | 6.10 | % | $ | 739,089 |   | $ | 12,364 |   | 6.71 | % |
| Taxable investment securities                                        |   | 100,984                                |      | 709 |   | 2.82 |   | 108,528 |   | 855 |   | 3.16 |   |
| Investment securities exempt from federal  income taxes(3)           |   | 21,397                                 |      | 264 |   | 4.96 |   | 13,923 |   | 190 |   | 5.47 |   |
| Federal funds sold and securities purchased  under resell agreements |   | 40                                     |      | — |   | 1.02 |   | 1,016 |   | 2 |   | 0.79 |   |
| Other interest bearing deposits                                      |   | 26,919                                 |      | 63 |   | 0.94 |   | 24,155 |   | 67 |   | 1.11 |   |
| Investment in unconsolidated trust  subsidiaries                     |   | 600                                    |      | 14 |   | 9.38 |   | 496 |   | 9 |   | 7.28 |   |
| Total interest earning assets                                        |   | 937,715                                |      | 13,006 |   | 5.58 |   | 887,207 |   | $ | 13,487 |   | 6.10 |   |
| Non-interest earning assets                                          |   | 69,243                                 |      |   |   |   |   | 67,457 |   |   |   |   |   |
| Total assets                                                         |   | $                                      | 1,006,958 |   |   |   |   |   | $ | 954,664 |   |   |   |   |   |
|                                                                 |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| **Interest Bearing  Liabilities:**                                   |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                            |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| NOW and money market deposit                                         |   | $                                      | 102,611   |   | $ | 261 |   | 1.02 | % | $ | 192,513 |   | $ | 637 |   | 1.33 | % |
| Savings deposit                                                      |   | 344,828                                |      | 803 |   | 0.94 |   | 216,706 |   | 836 |   | 1.55 |   |
| Time deposits                                                        |   | 327,537                                |      | 1,898 |   | 2.33 |   | 360,837 |   | 2,677 |   | 2.98 |   |
| Short-term borrowings                                                |   | 5,342                                  |      | 28 |   | 2.11 |   | 565 |   | 2 |   | 1.42 |   |
| Long-term borrowings                                                 |   | 64,428                                 |      | 591 |   | 3.69 |   | 36,667 |   | 370 |   | 4.05 |   |
| Junior subordinated debt owed to unconsolidated  trusts              |   | 19,963                                 |      | 472 |   | 9.51 |   | 16,496 |   | 432 |   | 10.50 |   |
| Total interest bearing liabilities                                   |   | 864,709                                |      | 4,053 |   | 1.89 |   | 823,784 |   | 4,954 |   | 2.41 |   |
| Demand deposits-non-interest bearing                                 |   | 46,159                                 |      |   |   |   |   | 62,872 |   |   |   |   |   |
| Other non-interest bearing liabilities                               |   | 27,535                                 |      |   |   |   |   | 6,276 |   |   |   |   |   |
| Stockholders’ equity, including stock owned  by ESOP            |   | 68,555                                 |      |   |   |   |   | 61,732 |   |   |   |   |   |
| Total liabilities and stockholders equity                            |   | $                                      | 1,006,958 |   |   |   |   |   | $ | 954,664 |   |   |   |   |   |
|                                                                 |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Net interest income/interest rate Spread(4)                          |   |                                   |      | $ | 8,953 |   | 3.69 | % |   |   | $ | 8,533 |   | 3.69 | % |
|                                                                 |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Net interest margin on a fully tax  equivalent basis(5)              |   |                                   |      | 3.84 | % |   |   |   |   |   |   | 3.86 | % |
|                                                                 |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Net interest margin(5)                                               |   |                                   |      | 3.80 | % |   |   |   |   |   |   | 3.83 | % |

 

----

(1)                                  Non-accrual loans areincluded in average loans.

 

(2)                                  Interest incomeincludes loan origination fees of $629 thousand and $801 thousand for the threemonths ended June 30, 2004 and 2003, respectively.

 

(3)                                  Non-taxableinvestment income is presented on a fully tax equivalent basis, adjusting forfederal and state exemption of interest income and certain other permanentincome tax differences.

 

(4)                                  Interest rate spreadrepresents the difference between the average yield on interest earning assetsand the average cost of interest bearing liabilities and is presented on afully tax equivalent basis.

 

(5)                                  Net interest marginrepresents net interest income as a percentage of average interest earningassets.

 

13

----

 

For the second quarter of 2004, net interest income on a fully taxequivalent basis increased $420 thousand (4.9%) to $9.0 million from $8.5million for the second quarter of 2003. The increase in net interest income resulted from a decrease in interestexpense of $901 thousand (18.2%), while interest income on a fully taxequivalent basis decreased $481 thousand (3.6%).  Interest expense decreased due to a decrease in rate on interestbearing liabilities of 52 basis points, which accounted for a decrease in interestexpense of $1.2 million.  This was partiallyoffset by an increase in average interest-bearing liabilities of $40.9 million(5.0%), which accounted for an increase in interest expense of $262thousand.  Interest income on a fullytax equivalent basis decreased due to a decrease in the rate on interestearning assets of 52 basis points, which accounted for a decrease in interestincome on a fully tax equivalent basis of $1.3 million.  This was partially offset by an increase inaverage earning assets of $50.5 million (5.7%), which accounted for an increaseof $829 thousand in interest income on a fully tax equivalent basis.  The net interest margin expressed on a fullytax equivalent basis decreased 2 basis points to 3.84% for 2004 from 3.86% for2003.

 
|                                                       |   | **Six Months  Ended June 30,**    |      |
|------------------------------------------------------------|--------|----------------------------------------|-----------|
|                                                       |   | **2004**                               |      | **2003** |   |
|                                                       |   | **Average  Balance**                   |      | **Interest** |   | **Yield/Rate** |   | **Average  Balance** |   | **Interest** |   | **Yield/Rate** |   |
|                                                       |   | **(Unaudited;  Dollars in thousands)** |      |
| **Interest Earning  Assets:**                              |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Loans(1)(2)                                                |   | $                                      | 775,408   |   | $ | 23,894 |   | 6.20 | % | $ | 728,786 |   | $ | 24,856 |   | 6.88 | % |
| Taxable investment securities                              |   | 119,161                                |      | 1,682 |   | 2.84 |   | 103,845 |   | 1,739 |   | 3.38 |   |
| Investment securities exempt from federal  income taxes(3) |   | 20,915                                 |      | 507 |   | 4.87 |   | 12,371 |   | 353 |   | 5.75 |   |
| Federal funds sold                                         |   | 40                                     |      | — |   | 0.78 |   | 538 |   | 2 |   | 0.75 |   |
| Other interest bearing deposits                            |   | 14,763                                 |      | 69 |   | 0.94 |   | 23,568 |   | 133 |   | 1.14 |   |
| Investment in unconsolidated trust  subsidiaries           |   | 548                                    |      | 27 |   | 9.91 |   | 496 |   | 26 |   | 10.57 |   |
| Total interest earning assets                              |   | 930,835                                |      | 26,179 |   | 5.66 |   | 869,604 |   | 27,109 |   | 6.29 |   |
| Non-interest earning assets                                |   | 73,952                                 |      |   |   |   |   | 68,054 |   |   |   |   |   |
| Total assets                                               |   | $                                      | 1,004,787 |   |   |   |   |   | $ | 937,658 |   |   |   |   |   |
|                                                       |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| **Interest Bearing  Liabilities:**                         |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                  |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| NOW and money market deposit                               |   | $                                      | 154,248   |   | $ | 655 |   | 0.85 | % | $ | 193,014 |   | $ | 1,337 |   | 1.40 | % |
| Savings deposit                                            |   | 286,180                                |      | 1,351 |   | 0.95 |   | 213,098 |   | 1,725 |   | 1.63 |   |
| Time deposits                                              |   | 331,039                                |      | 3,924 |   | 2.38 |   | 351,311 |   | 5,341 |   | 3.07 |   |
| Short-term borrowings                                      |   | 11,590                                 |      | 95 |   | 1.65 |   | 290 |   | 2 |   | 1.39 |   |
| Long-term borrowings                                       |   | 65,387                                 |      | 1,198 |   | 3.68 |   | 37,519 |   | 758 |   | 4.07 |   |
| Junior subordinated debt owed to  unconsolidated trusts    |   | 18,229                                 |      | 911 |   | 10.05 |   | 16,496 |   | 877 |   | 10.72 |   |
| Total interest bearing liabilities                         |   | 866,673                                |      | 8,134 |   | 1.89 |   | 811,728 |   | 10,040 |   | 2.49 |   |
| Demand deposits-non-interest bearing                       |   | 52,070                                 |      |   |   |   |   | 59,341 |   |   |   |   |   |
| Other non-interest bearing liabilities                     |   | 17,707                                 |      |   |   |   |   | 4,274 |   |   |   |   |   |
| Stockholders’ equity, including stock owned  by ESOP  |   | 68,337                                 |      |   |   |   |   | 62,315 |   |   |   |   |   |
| Total liabilities and stockholders equity                  |   | $                                      | 1,004,787 |   |   |   |   |   | $ | 937,658 |   |   |   |   |   |
|                                                       |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Net interest income/interest rate Spread(4)                |   |                                   |      | $ | 18,045 |   | 3.77 | % |   |   | $ | 17,069 |   | 3.80 | % |
|                                                       |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Net interest margin on a fully tax  equivalent basis(5)    |   |                                   |      |   |   | 3.90 | % |   |   |   |   | 3.96 | % |
|                                                       |   |                                   |      |   |   |   |   |   |   |   |   |   |   |
| Net interest margin(5)                                     |   |                                   |      |   |   | 3.86 | % |   |   |   |   | 3.93 | % |

 

----

(1)                                  Non-accrual loans areincluded in average loans.

 

(2)                                  Interest incomeincludes loan origination fees of $1.4 million and $1.8 million for the sixmonths ended June 30, 2004 and 2003, respectively.

 

(3)                                  Non-taxableinvestment income is presented on a fully tax equivalent basis, adjusting forfederal and state exemption of interest income and certain other permanentincome tax differences.

 

(4)                                  Interest rate spreadrepresents the difference between the average yield on interest earning assetsand the average cost of interest bearing liabilities and is presented on afully tax equivalent basis.

 

(5)                                  Net interest marginrepresents net interest income as a percentage of average interest earningassets.

 

14

----

 

For the six months ended June 30, 2004, net interest income on afully tax equivalent basis increased $976 thousand (5.7%) to $18.0 million from$17.1 million for the six months ended June 30, 2003.  The increase in net interest income resultedfrom a decrease in interest expense of $1.9 million (19.0%), while interestincome on a fully tax equivalent basis decreased $930 thousand (3.4%).  Interest expense decreased due to a decreasein rate on interest bearing liabilities of 60 basis points, which accounted fora $2.6 million decrease.  This waspartially offset by an increase in average interest-bearing liabilities of$54.9 million (6.8%), which increased interest expense by $651 thousand.  Interest income on a fully tax equivalentbasis decreased due to a decrease in the rate on interest earning assets of 63basis points, which accounted for a decrease of $2.9 million.  This was offset by an increase in averageearning assets of $61.2 million (7.0%), which accounted for an increase of $1.9million in interest income on a fully tax equivalent basis.  The net interest margin expressed on a fullytax equivalent basis decreased 6 basis points to 3.90% for 2004 from 3.96% for2003.

 

***Volume, Mix and RateAnalysis of Net Interest Income.***  The following tables present the extent towhich changes in volume, changes in interest rates, and changes in the interestrates times the changes in volume of interest earning assets and interestbearing liabilities have affected our interest income and interest expenseduring the periods indicated. Information is provided on changes in eachcategory due to (i) changes attributable to changes in volume (change involume times the prior period interest rate), (ii) changes attributable tochanges in interest rate (changes in rate times the prior period volume) and(iii) changes attributable to changes in rate/volume (changes in interestrate times changes in volume).  Changesattributable to the combined impact of volume and rate have been allocatedproportionally to the changes due to volume and the changes due to rate:

 
|                                                       |   | **Three  Months Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                                       |   | **2004  Compared to 2003**            |   | **2004  Compared to 2003**          |   |
|                                                       |   | **Change Due  to Volume**        |   | **Change Due  to Rate**        |   | **Total  Change** |   | **Change Due  to Volume** |   | **Change Due  to Rate** |   | **Total  Change** |   |
|                                                       |   | **(In thousands)**                    |   |
| **Interest Earning  Assets:**                              |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |
| Loans                                                      |   | $                                     | 783    |                                | $      | (1,191 | ) | $ | (408 | ) | $ | 1,529 |   | $ | (2,491 | ) | $ | (962 | ) |
| Taxable investment securities                              |   | (57                                   | )      | (89                                 | )      | (146 | ) | 237 |   | (294 | ) | (57 | ) |
| Investment securities exempt from federal  income taxes(1) |   | 94                                    |   | (20                                 | )      | 74 |   | 214 |   | (60 | ) | 154 |   |
| Federal funds sold                                         |   | (1                                    | )      | (1                                  | )      | (2 | ) | (1 | ) | (1 | ) | (2 | ) |
| Other interest bearing deposits                            |   | 8                                     |   | (12                                 | )      | (4 | ) | (44 | ) | (20 | ) | (64 | ) |
| Investment in unconsolidated trust  subsidiaries           |   | 2                                     |   | 3                                   |   | 5 |   | 3 |   | (2 | ) | 1 |   |
|                                                       |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |
| Total increase (decrease) in interest  income              |   | 829                                   |   | (1,310                              | )      | (481 | ) | 1,938 |   | (2,868 | ) | (930 | ) |
|                                                       |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |
| **Interest Bearing  Liabilities:**                         |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |
| NOW and money market deposit accounts                      |   | (252                                  | )      | (124                                | )      | (376 | ) | (233 | ) | (449 | ) | (682 | ) |
| Savings deposits                                           |   | 377                                   |   | (410                                | )      | (33 | ) | 480 |   | (854 | ) | (374 | ) |
| Time deposits                                              |   | (231                                  | )      | (548                                | )      | (779 | ) | (294 | ) | (1,123 | ) | (1,417 | ) |
| Short-term borrowings                                      |   | 25                                    |   | 1                                   |   | 26 |   | 93 |   | — |   | 93 |   |
| Long-term borrowings                                       |   | 258                                   |   | (37                                 | )      | 221 |   | 517 |   | (77 | ) | 440 |   |
| Junior subordinated debt owed to unconsolidated  trusts    |   | 85                                    |   | (45                                 | )      | 40 |   | 89 |   | (55 | ) | 34 |   |
|                                                       |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |
| Total increase (decrease) in interest  expense             |   | 262                                   |   | (1,163                              | )      | (901 | ) | 652 |   | (2,558 | ) | (1,906 | ) |
|                                                       |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |
| Increase (decrease) in net interest income                 |   | $                                     | 567    |                                | $      | (147 | ) | $ | 420 |   | $ | 1,286 |   | (310 | ) | $ | 976 |   |
|                                                            |        |                                       |        |                                     |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                                  Non-taxable investment income is presented ona fully tax equivalent basis, adjusting for federal and state exemption ofinterest income and certain other permanent income tax differences.

 

15

----

 

***Other Income.***  Changes in other income between the threemonths ended June 30, 2004 and 2003, and between the six months endedJune 30, 2004 and 2003, were as follows:

 
|                         |   | **Three  Months Ended  June 30,** |   | **Net  difference** |   | **Six Months  Ended  June 30,** |     | **Net  difference** |     |
|------------------------------|--------|----------------------------------------|--------|---------------------|--------|--------------------------------------|----------|---------------------|----------|
|                         |   | **2004**                               |   | **2003**            |   |                                 | **2004** |                | **2003** |   |   |
|                         |   | **(In thousands)**                     |   |
| Other income:                |   |                                   |   |                |   |                                 |     |                |     |   |   |   |   |
| Mortgage loan servicing fees |   | $                                      | 585    |                | $      | 559                                  |     | $                   | 26       |   | $ | 1,159 |   | $ | 1,040 |   | $ | 119 |   |
| Loan and other fees          |   | 682                                    |   | 439                 |   | 243                                  |     | 1,239               |     | 826 |   | 413 |   |
| Service charges on deposits  |   | 339                                    |   | 329                 |   | 10                                   |     | 670                 |     | 628 |   | 42 |   |
| Gain on sale of loans        |   | 983                                    |   | 3,497               |   | (2,514                               | )        | 1,999               |     | 6,723 |   | (4,724 | ) |
| Gain on sale of securities   |   | —                                 |   | —              |   | —                               |     | 272                 |     | — |   | 272 |   |
| Other operating income       |   | 261                                    |   | 478                 |   | (217                                 | )        | 528                 |     | 848 |   | (320 | ) |
|                         |   |                                   |   |                |   |                                 |     |                |     |   |   |   |   |
|                         |   | $                                      | 2,850  |                | $      | 5,302                                |     | $                   | (2,452   | ) | $ | 5,867 |   | $ | 10,065 |   | $ | (4,198 | ) |

 

In the second quarter of 2004, other income decreased by $2.4 million(46.2%) to $2.9 million from $5.3 million in the second quarter of 2003.  Gain on sale of loans decreased $2.5 million(71.9%) due to a drop in mortgage loan refinancing activity from historicallyhigh activity in the second quarter of 2003. This drop in refinancing was expected and was experienced generally inthe financial services industry. Mortgage refinancing activity may continue to diminish during theremainder of 2004 as many mortgage holders have already taken advantage of thelow interest rates favorable for refinancing. Loan and other fees increased $243 thousand (55.4%), mainly due to anincrease in trust fees related to the generation of more trust business.

 

In the first six months of 2004, other income decreased by $4.2 million(41.7%) to $5.9 million from $10.1 million in the first six months of2004.  Gain on sale of loans decreased$4.7 million (70.3%) due to a drop in mortgage loan refinancing activity fromhistorically high activity in the first six months of 2003.  This drop in refinancing was expected as wasexperienced generally in the financial services industry.  Loan and other fees increased $413 thousand(50.0%), mainly due to an increase in trust fees related to the generation ofmore trust business.

 

***Other Expenses.***  Changes in other expenses between the threemonths ended June 30, 2004 and 2003 and the six months ended June 30,2004 and 2003 are as follows:

 
|                                             |   | **Three  Months Ended  June 30,** |   | **Net  difference** |   | **Six Months  Ended  June 30,** |     | **Net  difference** |     |
|--------------------------------------------------|--------|----------------------------------------|--------|---------------------|--------|--------------------------------------|----------|---------------------|----------|
|                                             |   | **2004**                               |   | **2003**            |   |                                 | **2004** |                | **2003** |   |   |
|                                             |   | **(In thousands)**                     |   |
| Other expenses:                                  |   |                                   |   |                |   |                                 |     |                |     |   |   |   |   |
| Salaries and employee benefits                   |   | $                                      | 3,855  |                | $      | 3,655                                |     | $                   | 200      |   | $ | 7,708 |   | $ | 7,217 |   | $ | 491 |   |
| Occupancy                                        |   | 574                                    |   | 444                 |   | 130                                  |     | 1,068               |     | 906 |   | 162 |   |
| Data processing                                  |   | 499                                    |   | 348                 |   | 151                                  |     | 934                 |     | 649 |   | 285 |   |
| Marketing                                        |   | 324                                    |   | 376                 |   | (52                                  | )        | 550                 |     | 664 |   | (114 | ) |
| Amortization of mortgage servicing rights        |   | 683                                    |   | 540                 |   | 143                                  |     | 1,307               |     | 1,040 |   | 267 |   |
| Mortgage servicing rights (recovery)  impairment |   | (1,780                                 | )      | 1,553               |   | (3,333                               | )        | (1,417              | )        | 1,821 |   | (3,238 | ) |
| Supplies                                         |   | 209                                    |   | 219                 |   | (10                                  | )        | 381                 |     | 430 |   | (49 | ) |
| Other                                            |   | 1,086                                  |   | 1,376               |   | (290                                 | )        | 2,448               |     | 2,746 |   | (298 | ) |
|                                             |   |                                   |   |                |   |                                 |     |                |     |   |   |   |   |
|                                             |   | $                                      | 5,450  |                | $      | 8,511                                |     | $                   | (3,061   | ) | $ | 12,979 |   | $ | 15,473 |   | $ | (2,494 | ) |

 

For the second quarter of 2004, other expenses decreased $3.0 million(36.0%) to $5.5 million from $8.5 million in the second quarter of 2003.  This decrease was primarily due to anincrease in the mortgage servicing rights recovery of $3.3 million (214.6%),due to an increase in the valuation of mortgage servicing rights that resultedfrom a higher interest rate environment. Other expenses declined $290 thousand (21.1%) mainly due to a decline inthe loss on sale of other real estate owned (OREO) property of $251thousand.  In the second quarter of 2003there were some large OREO losses that were not repeated in 2004.

 

16

----

 

Forthe six months ended June 30, 2004, other expenses decreased $2.5 million(16.1%) to $13.0 million from $15.5 million in the first six months of2003.  This decrease was primarily dueto an increase in the mortgage servicing rights recovery of $3.2 million(177.8%), due to an increase in the valuation of mortgage servicing rights thatresulted from a higher interest rate environment.  Salaries and employee benefits increased $491 thousand (6.8%),mainly due to an increase in employee stock ownership plan (ESOP) contributionsof $318 thousand (101.2%).  The ESOPcontributions are based on the prior year’s net income before taxes, as well asthe increase in the fair market value of the shares allocated as the ESOP debtis paid down.

 

***Income Taxes.***  In the second quarter of 2004, income taxexpense increased $473 thousand (26.0%) over the second quarter of 2003 to atotal of $2.3 million compared to $1.8 million.  The effective tax rate increased to 40.6% in the second quarterof 2004, compared to 39.1% in the second quarter of 2003.

 

In the six months ended June 30, 2004, income tax expensedecreased $242 thousand (6.1%) over the six months ended June 30, 2003 toa total of $3.7 million compared to $4.0 million.  The effective tax rate increased to 39.2% in the first six monthsof 2004, compared to 38.5% in the first six months of 2003.

 

***BalanceSheet—General.*** Total assets at June 30, 2004 remained at $1.0 billion, a slightincrease of $13.3 million from December 31, 2003.  Premises and equipment, net of depreciation,increased $5.1 million (26.7%) from December 31, 2003 to June 30,2003, due to continuing work on the building of a new office in Santa Fe.  During the same period, total liabilitiesincreased $9.1 million (1.0%) to a total of $949.8 million on June 30,2004, from $940.7 million on December 31, 2003.  The increase in total liabilities was primarily due to anincrease in total deposits of $12.6 million (1.5%), and an increase in juniorsubordinated debt owed to unconsolidated trusts of $6.2 million (37.5%).  These increases were partially offset by adecline in short- and long-term borrowings of $8.1 million (10.5%).  Stockholders’ equity (including stock ownedby the Employee Stock Ownership Plan) increased $4.2 million (6.4%) to $70.3million on June 30, 2004 compared to $66.1 million on December 31,2003.

 

***InvestmentSecurities.*** The primary purposes of the investment portfolio are to provide a sourceof earnings for liquidity management purposes, to provide collateral to pledgeagainst public deposits and to control interest rate risk. In managing theportfolio, we seek to obtain the objectives of safety of principal, liquidity,diversification and maximized return on funds. For an additional discussionwith respect to these matters, see “Liquidity” and “Capital Resources” underItem 2 and “Asset Liability Management” under Item 3 below.

 

The following tables set forth the amortized cost and fair value of oursecurities by accounting classification category and by type of security asindicated:

 
|                                |   | **At  June 30, 2004** |   | **At December 31,  2003** |   | **At  June 30, 2003** |   |
|-------------------------------------|--------|----------------------------|--------|--------------------------------|--------|----------------------------|--------|
|                                |   | **Amortized  Cost**        |   | **Fair Value**                 |   | **Amortized  Cost**        |   | **Fair Value** |   | **Amortized  Cost** |   | **Fair Value** |   |
|                                |   | **(In  thousands)**        |   |
| Securities Available for Sale:      |   |                       |   |                           |   |                       |   |   |   |   |   |   |   |
| U.S. Government agencies            |   | $                          | 36,797 |                           | $      | 36,497                     |   | $ | 94,868 |   | $ | 95,081 |   | $ | 49,718 |   | $ | 50,465 |   |
| States and political subdivisions   |   | 1,132                      |   | 1,113                          |   | —                     |   | — |   | — |   | — |   |
| Equity securities                   |   | 6,076                      |   | 6,082                          |   | 5,666                      |   | 5,672 |   | 4,997 |   | 5,003 |   |
|                                |   |                       |   |                           |   |                       |   |   |   |   |   |   |   |
| Total securities available for sale |   | $                          | 44,005 |                           | $      | 43,692                     |   | $ | 100,534 |   | $ | 100,753 |   | $ | 54,715 |   | $ | 55,468 |   |
|                                |   |                       |   |                           |   |                       |   |   |   |   |   |   |   |
| Securities Held to Maturity:        |   |                       |   |                           |   |                       |   |   |   |   |   |   |   |
| U.S. Government agencies            |   | $                          | 52,897 |                           | $      | 53,395                     |   | $ | 53,246 |   | $ | 54,541 |   | $ | 53,594 |   | $ | 55,862 |   |
| States and political subdivisions   |   | 20,333                     |   | 20,410                         |   | 20,471                     |   | 20,638 |   | 19,946 |   | 20,178 |   |
|                                |   |                       |   |                           |   |                       |   |   |   |   |   |   |   |
| Total securities held to maturity   |   | $                          | 73,230 |                           | $      | 73,805                     |   | $ | 73,717 |   | $ | 75,179 |   | $ | 73,540 |   | $ | 76,040 |   |

 

17

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***Loan Portfolio.***  The following tables set forth thecomposition of the loan portfolio:

 
|                      |   | **At  June 30, 2004**  |    | **At  December 31, 2003** |   | **At  June 30, 2003** |   |
|---------------------------|--------|-----------------------------|---------|--------------------------------|--------|----------------------------|--------|
|                      |   | **Amount**                  |    | **Percent**                    |   | **Amount**                 |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                      |   | **(Dollars in  thousands)** |    |
| Commercial                |   | $                           | 77,473  |                           | 9.87   | %                          | $      | 71,299 |   | 9.61 | % | $ | 70,070 |   | 10.04 | % |
| Commercial real estate    |   | 307,608                     |    | 39.18                          |   | 286,551                    |   | 38.61 |   | 269,367 |   | 38.61 |   |
| Residential real estate   |   | 235,596                     |    | 30.01                          |   | 222,282                    |   | 29.95 |   | 206,110 |   | 29.55 |   |
| Construction real estate  |   | 114,317                     |    | 14.56                          |   | 112,616                    |   | 15.18 |   | 105,035 |   | 15.06 |   |
| Installment and other     |   | 50,052                      |    | 6.38                           |   | 49,349                     |   | 6.65 |   | 47,026 |   | 6.74 |   |
| Total loans               |   | 785,046                     |    | 100.00                         |   | 742,097                    |   | 100.00 |   | 697,608 |   | 100.00 |   |
| Unearned income           |   | 1,863                       |    |                           |   | 1,574                      |   |   |   | 1,324 |   |   |   |
| Gross loans               |   | 783,183                     |    |                           |   | 740,523                    |   |   |   | 696,284 |   |   |   |
| Allowance for loan losses |   | 8,289                       |    |                           |   | 7,368                      |   |   |   | 6,833 |   |   |   |
| Net loans                 |   | $                           | 774,894 |                           |   |                       | $      | 733,155 |   |   |   | $ | 689,451 |   |   |   |

 

Net loans increased $85.4 million (12.4%) to $774.9 million atJune 30, 2004 from $689.5 million at June 30, 2003. The increasewas due primarily to growth in the Company’s commercial and residential realestate and construction loan portfolios as the percentage levels of thecategories of loans within the portfolio remained relatively constant.

 

***Asset Quality.***  The following table sets forth the amountsof non-performing loans and non-performing assets at the dates indicated:

 
|                                                          |   | **At June  30, 2004**      |   | **At  December 31,  2003** |   | **At June  30, 2003** |   |
|---------------------------------------------------------------|--------|----------------------------|--------|---------------------------------|--------|-----------------------|--------|
|                                                          |   | **(Dollars in Thousands)** |   |
| Non-accruing loans                                            |   | $                          | 3,448  |                            | $      | 3,112                 |   | $ | 2,729 |   |
| Loans 90 days or more past due, still  accruing interest |   | 160                        |   | 80                              |   | 145                   |   |
| Total non-performing loans                                    |   | 3,608                      |   | 3,192                           |   | 2,874                 |   |
|                                                          |   |                       |   |                            |   |                  |   |
| Other real estate owned                                       |   | 5,829                      |   | 7,383                           |   | 2,306                 |   |
| Other repossessed assets                                      |   | 39                         |   | 353                             |   | 215                   |   |
| Total non-performing assets                                   |   | $                          | 9,476  |                            | $      | 10,928                |   | $ | 5,395 |   |
|                                                          |   |                       |   |                            |   |                  |   |
| Total non-performing loans to total loans                     |   | 0.46                       | %      | 0.43                            | %      | 0.41                  | %      |
| Allowance for loan losses to non-performing  loans            |   | 229.74                     | %      | 230.83                          | %      | 237.75                | %      |
| Total non-performing assets to total assets                   |   | 0.93                       | %      | 1.09                            | %      | 0.55                  | %      |

 

At June 30, 2004, total non-performing assets increased $4.1million (75.6%) to $9.5 million from $5.4 million at June 30, 2003 due toincreases in other real estate owned of $3.5 million (152.8%).  The increase in other real estate owned wasprimarily due to the acquisition of $5.4 million in residential constructionproperty in December 2003, which was partially offset by the sale of a$1.3 million commercial real estate property in 2004.

 

At June 30, 2004, total non-performing assets decreased $1.4million (13.3%) to $9.5 million from $10.9 million at December 31, 2003primarily due to decreases in other real estate owned of $1.6 million.  The decrease in other real estate owned wasprimarily due to the sale of a $1.3 million commercial real estate property in2004.

 

*Allowance for Loan Losses.*  Management believes the allowance for loanlosses accounting policy is critical to the portrayal and understanding of theCompany’s financial condition and results of operations. As such, selection andapplication of this “critical accounting policy” involves judgments, estimates,and uncertainties that are susceptible to change. In the event that differentassumptions or conditions were to prevail, and depending upon the severity ofsuch changes, the possibility of materially different financial condition orresults of operations is a reasonable likelihood.

 

18

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The allowance for loan losses is maintained at an amount thatmanagement believes will be adequate to absorb probable losses on existingloans, based on an evaluation of the collectibility of loans and prior lossexperience. This evaluation also takes into consideration such factors aschanges in the nature and volume of the loan portfolio, the value of underlyingcollateral, overall portfolio quality, review of specific problem loans andcurrent economic conditions that may affect the borrower’s ability to pay.While management uses the best information available to make its evaluation,future adjustments to the allowance may be necessary if there are significantchanges in economic conditions. In addition, as an integral part of theirexamination process regulatory agencies periodically review the Company’sallowance for loan losses and may require the Company to make additions to theallowance based on their evaluation of information available at the time oftheir examinations.

 

The following table presents an analysis of the allowance for loanlosses for the periods presented:

 
|                                           |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|------------------------------------------------|--------|----------------------------------------|---------|--------------------------------------|--------|
|                                           |   | **2004**                               |    | **2003**                             |   | **2004** |   | **2003** |   |
|                                           |   | **(Dollars in thousands)**             |    |
| Balance at beginning of period                 |   | $                                      | 7,734   |                                 | $      | 6,560 |   | $ | 7,368 |   | $ | 6,581 |   |
| Provision for loan losses                      |   | 600                                    |    | 600                                  |   | 1,200 |   | 1,200 |   |
| Total charge-offs                              |   | (57                                    | )       | (367                                 | )      | (295 | ) | (1,016 | ) |
| Total recoveries                               |   | 12                                     |    | 40                                   |   | 16 |   | 68 |   |
| Net charge-offs                                |   | 45                                     |    | 327                                  |   | 279 |   | 948 |   |
| Balance at end of period                       |   | $                                      | 8,289   |                                 | $      | 6,833 |   | $ | 8,289 |   | $ | 6,833 |   |
|                                           |   |                                   |    |                                 |   |   |   |   |   |
| Gross loans at end of period                   |   | $                                      | 783,183 |                                 | $      | 696,284 |   | $ | 783,183 |   | $ | 696,284 |   |
| Ratio of allowance to total loans              |   | 1.06                                   | %       | 0.98                                 | %      | 1.06 | % | 0.98 | % |
| Ratio of net charge-offs to average loans  (1) |   | 0.02                                   | %       | 0.18                                 | %      | 0.07 | % | 0.26 | % |

 

----

(1)                                  Net charge-offs areannualized for the purposes of this calculation.

 

Net charge-offs for the three months ended June 30, 2004 totaled$45 thousand, a decrease of $282 thousand (86.2%) from $327 thousand from thethree months ended June 30, 2003. The majority of the charge-offs were personal and commercial loans.  The provision for loan losses remained thesame for the three months ended June 30, 2004 and June 30, 2003, due tomanagement’s analysis of current non-performing loans.

 

Net charge-offs for the six months ended June 30, 2004 totaled$279 thousand, a decrease of $669 thousand (70.6%) from $948 thousand from thesix months ended June 30, 2003. The majority of the charge-offs were personal and residential realestate.  The provision for loan lossesremained the same for the six months ended June 30, 2004 and June 30,2003, due to management’s analysis of current non-performing loans.

 

The following table sets forth the allocation of the allowance for loanlosses for the periods presented and the percentage of loans in each categoryto total loans. An allocation for a loan classification is only for internalanalysis of the adequacy of the allowance and is not an indication of expectedor anticipated losses:

 
|                                   |   | **At  June 30, 2004**  |   | **At  December 31, 2003** |   | **At  June 30, 2003** |   |
|----------------------------------------|--------|-----------------------------|--------|--------------------------------|--------|----------------------------|--------|
|                                   |   | **Amount**                  |   | **Percent**                    |   | **Amount**                 |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                                   |   | **(Dollars in  thousands)** |   |
| Commercial                             |   | $                           | 2,143  |                           | 9.87   | %                          | $      | 2,509 |   | 9.61 | % | $ | 1,926 |   | 10.04 | % |
| Commercial and residential real estate |   | 2,861                       |   | 69.19                          |   | 3,192                      |   | 68.56 |   | 2,348 |   | 68.16 |   |
| Construction real estate               |   | 1,493                       |   | 14.56                          |   | 844                        |   | 15.18 |   | 1,627 |   | 15.06 |   |
| Installment and other                  |   | 1,761                       |   | 6.38                           |   | 799                        |   | 6.65 |   | 440 |   | 6.74 |   |
| Unallocated                            |   | 31                          |   | N/A                            |   | 24                         |   | N/A |   | 492 |   | N/A |   |
| Total                                  |   | $                           | 8,289  |                           | 100.00 | %                          | $      | 7,368 |   | 100.00 | % | $ | 6,833 |   | 100.00 | % |

 

----

N/A—not applicable

 

19

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The portion of the allocation that was based upon historical lossexperience increased by $528 thousand (22.9%) in 2004, from $2.3 million inDecember 30, 2003 to $2.8 million in June 30, 2004.  This was largely due to an increase in theallocation for installment and other loans which increased by $734 thousand andan increase in the allocation for construction loans which increased by $439thousand.  This was partially offset bya decrease in the allocation for commercial loans of $659 thousand.  Concentration allocation increased by $1.9million (194.5%) from $963 thousand in June 30, 2003 to $2.8 million inJune 30, 2004.  This was primarilydue to an increase in the allocation for consumer and other loans of $814thousand and an increase in the allocation for construction real estate loansof $461 thousand.  FromDecember 30, 2003 to June 30, 2003, the allocation for specificallyidentified loans increased slightly, from $279 thousand to $604 thousand.  From June 30, 2003 to June 30,2003, the allocation for specifically identified loans decreased $362 thousand(37.5%).

 

Managementanticipates continued growth in the loan portfolio due to a strengthened localeconomy, a stabilized Los Alamos National Laboratory budget of over $2 billionand the expectation of a continued increase in interest rates.  The volume of commercial real estate andconstruction loans is also anticipated to increase as the industry continues tostrengthen and the recovery in capital spending boosts production and profitsinto 2004.  Although record mortgagefinancing peaked in 2003, the housing market for new construction and resale homesis expected to remain strong, especially in the under $500 thousand market,which should remain constant. Residential real estate for property worth greater than $1.5 million isexpected to be as “soft” as during the last several years.  Losses in the first quarter of 2004 wereless than expected due to the absence of substantial commercial charge-offs.

 

Additions to the allowance for loan losses, which are charged toearnings through the provision for loan losses, are determined based on avariety of factors, as indicated above. Although management believes the allowance for loan losses is sufficientto cover probable losses inherent in the loan portfolio, there can be noassurance that the allowance will prove sufficient to cover actual future loan losses.

 

*Potential Problem Loans.*  The Company utilizes an internal assetclassification system as a means of reporting problem and potential problemassets.  At scheduled Board of Directorsmeetings every quarter, a list of total adversely classified assets ispresented, showing other real estate owned, other repossessed assets, and allloans listed as “Substandard,” “Doubtful” and “Loss.”  All non-accrual loans are classed either as “Substandard” or“Doubtful” and are thus included in total adversely classified assets.  A separate watch list of loans classified as“Special Mention” is also presented.  Anasset is classified Substandard if it is inadequately protected by the currentnet worth and paying capacity of the obligor or of the collateral pledged, ifany. Substandard assets include those characterized by the distinct possibilitythat the Company will sustain some loss if the deficiencies are notcorrected.  Assets classified asDoubtful have all the weaknesses inherent in those classified Substandard withthe added characteristic that the weaknesses present make collection orliquidation in full, on the basis of currently existing facts, conditions andvalues, highly questionable and improbable. Assets classified as Loss are those considered uncollectible and viewedas non-bankable assets, worthy of charge-off. Assets that do not currently expose the Company to sufficient risk towarrant classification in one of the aforementioned categories, but possessweaknesses that may or may not be within the control of the customer are deemedto be Special Mention.

 

The Company’s determination as to the classification of its assets andthe amount of its valuation allowances is subject to review by the Bank’sprimary regulators, which can order the establishment of additional general orspecific loss allowances.  TheComptroller of the Currency, in conjunction with the other federal bankingagencies, has adopted an interagency policy statement on the allowance for loanlosses.  The policy statement providesguidance for financial institutions on both the responsibilities of managementfor the assessment and establishment of adequate allowances and guidance forbanking agency examiners to use in determining the adequacy of generalvaluation guidelines.  Generally, thepolicy statement recommends that (i) institutions have effective systemsand controls to identify, monitor and address asset quality problems;(ii) management has analyzed all significant factors that affect thecollectibility of the portfolio in a reasonable manner; and(iii) management has established acceptable allowance evaluation processesthat meet the objectives set forth in the policy statement.  Management believes it has established anadequate allowance for probable loan losses. The Company analyzes its process regularly, with modifications made ifneeded, and reports those results quarterly at Board of Directorsmeetings.  However, there can be noassurance that regulators, in reviewing the Company’s loan portfolio, will notrequest the Company to materially increase its allowance for loan losses at afuture time.  Although managementbelieves that adequate specific and general loan loss allowances have beenestablished, actual losses are dependent upon future events and, as such,further additions to the level of specific and general loan loss allowances maybecome necessary.

 

20

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The following table shows the amounts of adversely classified assetsand special mention loans as of the periods indicated:

 
|                              |   | **At June  30, 2004**      |   | **At  December  31, 2003** |   | **At June  30, 2003** |   |
|-----------------------------------|--------|----------------------------|--------|----------------------------|--------|-----------------------|--------|
|                              |   | **(Dollars in thousands)** |   |
| Loans classified as:              |   |                       |   |                       |   |                  |   |
| Substandard                       |   | $                          | 14,237 |                       | $      | 9,815                 |   | $ | 5,021 |   |
| Doubtful                          |   | 213                        |   | 180                        |   | 10                    |   |
| Total adversely classified loans  |   | 14,450                     |   | 9,995                      |   | 5,031                 |   |
| Other real estate owned           |   | 5,829                      |   | 7,383                      |   | 2,306                 |   |
| Other repossessed assets          |   | 39                         |   | 353                        |   | 215                   |   |
| Total adversely classified assets |   | $                          | 20,318 |                       | $      | 17,731                |   | $ | 7,552 |   |
|                              |   |                       |   |                       |   |                  |   |
| Special mention loans             |   | $                          | 20,769 |                       | $      | 17,507                |   | $ | 14,596 |   |

 

Totaladversely classified assets increased $12.8 million (169.0%) from June 30,2003 to June 30, 2004.  The mainreason for the increase was an increase of $9.1 million in loans classified assubstandard and an increase of $3.5 million in other real estate owned.  The increase in loans classified assubstandard was due to the downgrading of two commercial borrowers, one in theretail business concentration and one in the Office Building / BusinessProperty loan concentration.  Specialmention loans increased $6.2 million (42.3%) from June 30, 2003 toJune 30, 2004.  The increase inspecial mention loans was due to the downgrading of two commercial borrowers,one in the Hotel/Lodging concentration and one in the Office Buildings/Unitsconcentration.

 

**Sources of Funds**

 

***Liquidity andSources of Capital***

 

The Company’s cash flows are comprised of three classifications: cashflows from operating activities, cash flows from investing activities and cashflows from financing activities. Net cash provided by operating activities was$9.0 million and $23.9 million for the six months ended June 30, 2004 and2003, respectively.  Net cash providedby operating activities decreased $14.9 million in the first six months of 2004compared to the first six months of 2003 largely due to a decline in the saleof loans held for sale by $174.9 million over the first six months of 2003,which was partially offset by the origination of loans held for sale thatdecreased $155.1 million in the same period. Net cash provided by (used in) investing activities was $9.0 million and$(61.2) million for the six months ended June 30, 2004 and 2003,respectively.  The $70.2 millionincrease in cash provided by investing activities was largely due to the saleof $28.4 million in investment securities, as well as the increase of cashprovided by maturities and paydowns of securities of $21.3 million.  Cash used in the purchases of investmentsecurities also decreased by $26.6 million between this period in 2004 comparedto this period in 2003.  Net cashprovided by financing activities was $8.2 million and $54.5 million for the sixmonths ended June 30, 2004 and 2003, respectively.  The $46.3 million decrease in cash providedby financing activities was mainly due to a decrease in new deposit growth of$47.9 million from the first six months of 2003 compared to the first sixmonths of 2004.

 

TheCompany expects to have available cash to meet its liquidity needs. Liquidity management is monitored by the Asset/Liability committee of the Bank,which takes into account the marketability of assets, the sources and stabilityof funding and the level of unfunded commitments.  In the event that additional short-term liquidity is needed, theCompany has established relationships with several large regional banks toprovide short-term borrowings in the form of federal funds purchases.  The Company has borrowed, and managementbelieves that the Company could again borrow, up to $84.0 million for ashort time from these banks on a collective basis.  Additionally, the Bank is a member of the Federal Home Loan Bank(“FHLB”) and has the ability to borrow from the FHLB.  As a contingency plan for significant funding needs, theAsset/Liability committee may also consider the sale of investment securities,selling securities under agreement to repurchase, sale of certain loans and/orthe temporary curtailment of lending activities.

 

AtJune 30, 2004, the Company’s total risk-based capital ratio was 12.46%,the Tier 1 capital to risk-weighted assets ratio was 11.43%, and the Tier 1 capitalto average assets ratio was 9.15%.  TheBank was categorized as “well-capitalized” under Federal Deposit InsuranceCorporation regulations at June 30, 2004 and December 31, 2003.  At December 31, 2003, the Company’stotal risk-based capital ratio was 11.61%, the Tier 1 capital to risk-weightedassets ratio was 10.64%, and the Tier 1 capital to average assets ratio was8.05%.

 

AtJune 30, 2004 and December 31, 2003, the Company’s book value percommon share was $10.44 and $9.86, respectively.

 

21

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**Item 3.****  Quantitativeand Qualitative Disclosures About Market Risk**

 

**Asset Liability Management**

 

The Company’s net interest income is subject to “interest rate risk” tothe extent that it can vary based on changes in the general level of interestrates. It is the Company’s policy to maintain an acceptable level of interestrate risk over a range of possible changes in interest rates while remainingresponsive to market demand for loan and deposit products.  The strategy employed by the Company tomanage its interest rate risk is to measure its risk using an asset/liabilitysimulation model and adjust the maturity of securities in its investmentportfolio to manage that risk.

 

Interest rate risk can also be measured by analyzing the extent towhich the repricing of assets and liabilities are mismatched to create aninterest sensitivity “gap”.  An asset orliability is said to be interest rate sensitive within a specific time periodif it will mature or reprice within that time period.  The interest rate sensitivity gap is defined as the differencebetween the amount of interest earning assets maturing or repricing within aspecific time period and the amount of interest bearing liabilities maturing orrepricing within that same time period. A gap is considered positive when the amount of interest rate sensitiveassets exceeds the amount of interest rate sensitive liabilities.  A gap is considered negative when the amountof interest rate sensitive liabilities exceeds the amount of interest ratesensitive assets.  During a period ofrising interest rates, therefore, a negative gap would tend to adversely affectnet interest income.  Conversely, duringa period of falling interest rates, a negative gap position would tend toresult in an increase in net interest income.

 

The following table sets forth the amounts of interest earning assetsand interest bearing liabilities outstanding at June 30, 2004, which areanticipated by the Company, based upon certain assumptions, to reprice ormature in each of the future time periods shown. Except as stated below, theamount of assets and liabilities shown which reprice or mature during aparticular period were determined based on the earlier of the term to repricingor the term to repayment of the asset or liability.  The table is intended to provide an approximation of theprojected repricing of assets and liabilities at June 30, 2004 on thebasis of contractual maturities and scheduled rate adjustments within athree-month period and subsequent selected time intervals.  The loan amounts in the table reflectprincipal balances expected to be reinvested and/or repriced as a result ofcontractual amortization and rate adjustments on adjustable-rate loans. Loanand investment securities contractual maturities and amortization reflectmodest prepayment assumptions.  WhileNOW, money market and savings deposit accounts have adjustable rates, it isassumed that the interest rates on these accounts will not adjust immediatelyto changes in other interest rates. Therefore, the table is calculated assuming that these accounts willreprice based upon an historical analysis of rate changes of these particularaccounts, with repricing assigned to these accounts from six to fourteenmonths.

 

Borrowings made by the Employee Stock Ownership Plan (ESOP) are notincluded below, as the Company does not recognize interest expense on theseborrowings.  The Company makesdiscretionary contributions to the ESOP to service this debt, and thesecontributions are recognized as compensation expense.

 

22

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|                                                    |   | **Time to  Maturity or Repricing** |    |
|---------------------------------------------------------|--------|------------------------------------|---------|
| **As of June 30, 2004:**                           |   | **0-90 Days**                      |    | **91-365  Days** |   | **1-5 Years** |   | **Over 5  Years** |   | **Total** |   |
|                                                    |   | **(In  thousands)**                |    |
| **Interest Earning  Assets:**                           |   |                               |    |   |   |   |   |   |   |   |   |
| Loans                                                   |   | $                                  | 377,831 |   | $ | 358,268 |   | $ | 43,149 |   | $ | 3,935 |   | $ | 783,183 |   |
| Loans held for sale                                     |   | 10,496                             |    | — |   | — |   | — |   | 10,496 |   |
| Investment securities                                   |   | 18,057                             |    | 40,584 |   | 58,231 |   | 50 |   | 116,922 |   |
| Securities purchased under agreements to  resell        |   | 40                                 |    | — |   | — |   | — |   | 40 |   |
| Interest bearing deposits with banks                    |   | 34,213                             |    | — |   | — |   | — |   | 34,213 |   |
| Investment in unconsolidated trusts                     |   | 186                                |    | — |   | — |   | 496 |   | 682 |   |
| Total interest earning assets                           |   | $                                  | 440,823 |   | $ | 398,852 |   | $ | 101,380 |   | $ | 4,481 |   | $ | 945,536 |   |
|                                                    |   |                               |    |   |   |   |   |   |   |   |   |
| **Interest Bearing  Liabilities:**                      |   |                               |    |   |   |   |   |   |   |   |   |
| NOW and money market deposit accounts                   |   | $                                  | 54,649  |   | $ | 59,508 |   | $ | 1,507 |   | — |   | $ | 115,664 |   |
| Savings deposits                                        |   | 106,952                            |    | 238,588 |   | — |   | — |   | 345,540 |   |
| Time deposits                                           |   | 77,136                             |    | 151,111 |   | 89,202 |   | $ | 2,579 |   | 320,028 |   |
| Short- and long-term borrowings                         |   | 1,859                              |    | 10,687 |   | 12,663 |   | 43,533 |   | 68,742 |   |
| Junior subordinated debt owed to  unconsolidated trusts |   | 6,186                              |    | — |   | — |   | 16,496 |   | 22,682 |   |
| Total interest bearing liabilities                      |   | $                                  | 246,782 |   | $ | 459,894 |   | $ | 103,372 |   | $ | 62,608 |   | $ | 872,656 |   |
|                                                    |   |                               |    |   |   |   |   |   |   |   |   |
| Rate sensitive assets (RSA)                             |   | $                                  | 440,823 |   | $ | 839,675 |   | $ | 941,055 |   | $ | 945,536 |   | $ | 945,536 |   |
| Rate sensitive liabilities (RSL)                        |   | 246,782                            |    | 706,676 |   | 810,048 |   | 872,656 |   | 872,656 |   |
| Cumulative GAP (GAP=RSA-RSL)                            |   | 194,041                            |    | 132,999 |   | 131,007 |   | 72,880 |   | 72,880 |   |
| RSA/Total assets                                        |   | 43.22                              | %       | 82.32 | % | 92.26 | % | 92.69 | % | 92.69 | % |
| RSL/Total assets                                        |   | 24.19                              | %       | 69.28 | % | 79.41 | % | 85.55 | % | 85.55 | % |
| GAP/Total assets                                        |   | 19.03                              | %       | 13.04 | % | 12.85 | % | 7.14 | % | 7.14 | % |
| GAP/RSA                                                 |   | 44.02                              | %       | 15.84 | % | 13.92 | % | 7.71 | % | 7.71 | % |

 

Certain shortcomings are inherent in the method of analysis presentedin the foregoing table. For example, although certain assets and liabilitiesmay have similar maturities or periods to repricing, they may react indifferent degrees to changes in market interest rates. Also, the interest rateson certain types of assets and liabilities may fluctuate in advance of changesin market interest rates, while interest rates on other types of assets may lagbehind changes in market rates. Additionally, in the event of a change in interest rates, prepayment andearly withdrawal levels would likely deviate significantly from those assumedin calculating the table.  Therefore,the Company does not rely solely on a gap analysis to manage its interest raterisk, but rather it uses what it believes to be the more reliable simulationmodel relating to changes in net interest income.

 

23

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Based on simulation modeling at June 30, 2004 andDecember 31, 2003, the Company’s net interest income would change over aone-year time period due to changes in interest rates as follows:

 

**Change in Net Interest Income Over One YearHorizon**

 
| **Changes in Levels of** |   | **At  June 30, 2004**  |   | **At  December 31, 2003** |   |
|--------------------------|--------|-----------------------------|--------|--------------------------------|--------|
| **Interest Rates**       |   | **Dollar  Change**          |   | **Percentage  Change**         |   | **Dollar  Change** |   | **Percentage  Change** |   |
|                     |   | **(Dollars  in thousands)** |   |
| + 2.00%                  |   |                        | $      | (3,695                         | )      | (9.96 | )% | $ | (4,461 | ) | (12.17 | )% |
| + 1.00                   |   |                        | (1,521 | )                              | (4.10  | ) | (2,207 | ) | (6.02 | ) |
| (1.00)                   |   |                        | (1,094 | )                              | (2.95  | ) | (1,671 | ) | (4.56 | ) |
| (2.00)                   |   |                        | (2,608 | )                              | (7.03  | ) | (3,566 | ) | (9.73 | ) |
|                          |        |                             |        |                                |        |  |  |  |  |  |  |  |

 

Simulations used by the Company assume the following:

 

1.                                       Changes ininterest rates are immediate.

 

2.                                       It is theCompany’s policy that interest rate exposure due to a 2.00% interest rate riseor fall be limited to 15.0% of the Company’s annual net interest income, asforecasted by the simulation model. As demonstrated by the table above, theCompany’s interest rate risk exposure was within this policy at June 30,2004.

 

Changes in net interest income between the periods above reflectchanges in the composition of interest earning assets and interest bearingliabilities, related interest rates, repricing frequencies, and the fixed orvariable characteristics of the interest earning assets and interest bearingliabilities.  Projections of incomegiven by the model are not actual predictions, but rather show our relativeinterest rate risk.  Actual interestincome may vary from model projections.

 

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**Item4.****  Controls andProcedures.**

 

Anevaluation was performed under the supervision and with the participation ofthe Company’s management, including the Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures (as defined in Rule 13a-15(e)promulgated under the Securities and Exchange Act of 1934, as amended) as ofJune 30, 2004. Based on that evaluation, the Company’s management,including the Chief Executive Officer and Chief Financial Officer, concludedthat the Company’s disclosure controls and procedures were effective. Therehave been no significant changes in the Company’s internal controls or in otherfactors that could significantly affect internal controls.

 

**PART II – OTHERINFORMATION**

 

**Item1.   Legal Proceedings**

 

Themajority of lawsuits the Company and the Bank are involved in are foreclosureand collection proceedings due to loan default which arise in the normal courseof business. However, because the Bank acts as a depository of funds, from timeto time it is named as a defendant in lawsuits (such as garnishmentproceedings) involving claims to the ownership of funds in particular accountsand in other actions arising in the normal course of business. Management doesnot believe that there is currently any pending or threatened proceedingagainst either the Company or the Bank which, if determined adversely, wouldhave a material effect on its business, financial condition or results ofoperations.

 

**Item2.  Changes in Securities, Use ofProceeds and Issuer Purchases of Equity Securities**

 

The following table provides information aboutpurchases by the Company and its affiliates during the quarter endedJune 30, 2004 of equity securities that are registered by the Companypursuant to Section 12 of the Exchange Act:

 

# **ISSUER PURCHASES OF EQUITYSECURITIES**

 
| **Period**         |   | **(a)  Total Number of Shares  Purchased (1)** |   | **(b)  Average Price Paid  per Share** |   | **(c)  Total Number of Shares  Purchased as Part of  Publicly Announced Plans or  Programs (2)** |   | **(d)  Maximum Number (or  Approximate Dollar Value) of  Shares that May Yet Be  Purchased Under the Plans or  Programs(2)** |   |
|--------------------|--------|------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------|--------|
| 04/01/04- 04/31/04 |   | —                                         |   | —                                 |   | —                                                                                           |   | NA                                                                                                                           |   |
| 05/01/04- 05/31/04 |   | —                                         |   | —                                 |   | —                                                                                           |   | NA                                                                                                                           |   |
| 06/01/04- 06/30/04 |   | 3,770                                          |   | $                                      | 31.00  |                                                                                             | — |                                                                                                                         | NA     |   |
| Total:             |   | 3,770                                          |   | $                                      | 31.00  |                                                                                             | — |                                                                                                                         | NA     |   |

 

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(1)                                  In connection with the exercise ofoptions by an executive officer, on June 28, 2004, the executive officerdelivered 3,770 shares of common stock to the Company to pay for a portion ofthe exercise price of the options and the withholding taxes associated with theexercise.

 

(2)                                  The Company’s board of directors has notformally approved a stock repurchase program.

 

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**Item 3.****  Defaults UponSenior Securities**

 

None

 

**Item 4.****  Submission ofMatters to a Vote of Security Holders**

 

Atthe Annual Meeting of Stockholders held on May 20, 2004, William C. Enloe,Deborah U. Johnson, Lewis A. Muir and Charles A. Slocomb were elected to serveas directors of the Company until the 2007 Annual Meeting.  Serving as directors until the 2005 annualmeeting are Jerry Kindsfather, Steve W. Wells and Robert P. Worcester.  Servicing as directors until the 2006 annualmeeting are George A. Cowan, Jeffrey F. Howell, Arhur B. Montoya, Jr. andStanley D. Primak.  In addition, thestockholders ratified the appointment of Neff & Ricci LLP as the Company’sindependent auditors for 2004.

 

Thevoting for each matter was as follows:

 

1.                                       Election of directors:

 

 

| **NOMINEE**        |   | **FOR**   |   | **WITHHOLD** |   |
|--------------------|--------|-----------|--------|--------------|--------|
| William C. Enloe   |   | 5,609,874 |   | 4,234        |   |
| Deborah U. Johnson |   | 5,446,953 |   | 167,155      |   |
| Lewis A. Muir      |   | 5,601,426 |   | 12,682       |   |
| Charles A. Slocomb |   | 5,593,632 |   | 20,476       |   |

 

**2.**                                       Ratifythe appointment of Neff & Ricci LLP as the Company’s independent auditorsfor the fiscal year ending December 31, 2004:

** **

| **For**   |   | **Against** |   | **Abstain** |   |
|-----------|--------|-------------|--------|-------------|--------|
| 5,594,227 |   | 2,160       |   | 17,721      |   |

 

**Item 5.****  Other Information**

 

None

 

**Item 6.****  Exhibits and Reports on Form 8-K**

 

(a)                                       Exhibits

 

31.1                           Certification of Chief Executive Officer Pursuant to Rule13a-14(a)/15d-14(a)

31.2                           Certification of Chief Financial Officer Pursuant to Rule13a-14(a)/15d-14(a)

32.1                           Certification of Chief Executive Officer Pursuant to 18 U.S.C.Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

32.2                           Certification of Chief Financial Officer Pursuant to 18 U.S.C.Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

(b)                                      Reports on Form 8-K

 

Areport on Form 8-K was filed on May 24, 2004, pursuant to Item 9, whichreported, in the form of a press release, the results of the annual meeting ofstockholders

 

Areport on Form 8-K was filed on June 18, 2004, pursuant to Item 5, whichreported, in the form of a press release, the declaration of a dividend.

 

Areport on Form 8-K was filed on July 16, 2004, pursuant to Item 12, whichreported, in the form of a press release, the Company’s financial results forthe quarter ended June 30, 2004.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 12 of the SecuritiesExchange Act of 1934, the registrant has duly caused this registrationstatement to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                      |   | **TRINITY CAPITAL CORPORATION** |
|---------------------------|--------|---------------------------------|
|                      |   |                            |
|                      |   |                            |   |
| Date: August 6, 2004 |   | By:                             | /s/ WILLIAM C. ENLOE |
|                      |   |                            | William C. Enloe |
|                      |   |                            | President and Chief Executive Officer |
| Date: August 6, 2004 |   | By:                             | /s/ DANIEL R. BARTHOLOMEW |
|                      |   |                            | Daniel R. Bartholomew |
|                      |   |                            | Chief Financial Officer |

 

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