##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended June 30, 2008

or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission File Number: 000-50992





FIRST STATE FINANCIAL CORPORATION

(Exact name of registrant as specified in
its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Florida                                                        |  | 65-0771145                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|22 S. Links Avenue, Sarasota, FL                               |  | 34236                               
|(Address of principal executive offices)                       |  | (Zip code)                          

941-929-9000

(Registrants telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)





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

Indicate by check mark whether the registrant is
a large accelerated filer, an accelerated filer, a non accelerated filer or a smaller reporting company. See definition of large accelerated filer, accelerated filer, non-accelerated filer and smaller reporting
company in Rule 12b-2 of the Exchange Act. (Check one):



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈ |  | Accelerated filer         |  |  ̈
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller reporting company |  | x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act.)    Yes   ̈    No  x

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.

As of August 4, 2008 the registrant had outstanding 5,920,300 shares of common stock.









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##### Table of Contents

TABLE OF CONTENTS



|                                                                     |  |      |  | 
|-------------------------------------------------------------------- |  | ---- |  | 
|                                                                     |  | PAGE
|PART I  FINANCIAL INFORMATION                                       |  |     
|                                                                     | 
|Item 1 - Condensed Consolidated Financial Statements                 |  |     
|                                                                     | 
|Condensed Consolidated Balance Sheets                                |  | 1   
|                                                                     | 
|Condensed Consolidated Statements of Income                          |  | 2   
|                                                                     | 
|Condensed Consolidated Statements of Changes in Stockholders Equity |  | 3   
|                                                                     | 
|Condensed Consolidated Statements of Cash Flow                       |  | 4   
|                                                                     | 
|Condensed Notes to Condensed Consolidated Financial Statements       |  | 5   
|                                                                     | 
|Item 2 - Managements Discussion and Analysis                        |  | 9   
|                                                                     | 
|Item 3 - Quantitative and Qualitative Disclosures About Market Risk  |  | 17  
|                                                                     | 
|Item 4 - Controls and Procedures                                     |  | 18  
|                                                                     | 
|PART II  OTHER INFORMATION                                          |  |     
|                                                                     | 
|Item 1 - Legal Proceedings                                           |  | 18  
|                                                                     | 
|Item 1A - Risk Factors                                               |  | 18  
|                                                                     | 
|Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds |  | 18  
|                                                                     | 
|Item 3 - Defaults Upon Senior Securities                             |  | 18  
|                                                                     | 
|Item 4 - Submission of Matters to Vote of Securities Holders         |  | 18  
|                                                                     | 
|Item 5 - Other Information                                           |  | 19  
|                                                                     | 
|Item 6 - Exhibits                                                    |  | 19  
|                                                                     | 
|Signatures                                                           |  | 19  



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##### Table of Contents

FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

June 30, 2008 (unaudited) and December 31, 2007

(Dollar amounts in thousands except per share data)



|                                                                                                                         |  |               |         |   |                   |   |        
|------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ------- | - | ----------------- | - | -------
|                                                                                                                         |  | June 30, 2008 |         |   | December 31, 2007
|ASSETS                                                                                                                   |  |               |         |   |                   |   |        
|Cash and due from financial institutions                                                                                 |  | $             | 5,264   |   |                   | $ | 5,408  
|Federal funds sold                                                                                                       |  |               |        |   |                   |   | 5,261  
|                                                                                                                         |  |               |         |   |                   |   |        
|Cash and cash equivalents                                                                                                |  |               | 5,264   |   |                   |   | 10,669 
|Interest bearing deposits in other financial institutions                                                                |  |               | 185     |   |                   |   | 423    
|Securities, available-for-sale                                                                                           |  |               | 72,068  |   |                   |   | 52,632 
|Loans, net of allowance of $12,091 and $7,633                                                                            |  |               | 368,840 |   |                   |   | 394,404
|Federal Home Loan Bank stock                                                                                             |  |               | 2,115   |   |                   |   | 951    
|Premise and equipment, net                                                                                               |  |               | 12,582  |   |                   |   | 9,429  
|Other assets                                                                                                             |  |               | 9,435   |   |                   |   | 6,380  
|                                                                                                                         |  |               |         |   |                   |   |        
|Total Assets                                                                                                             |  | $             | 470,489 |   |                   | $ | 474,888
|                                                                                                                         |  |               |         |   |                   |   |        
|                                                                                                                         |  |              
|LIABILITIES and STOCKHOLDERS EQUITY                                                                                     |  |               |         |   |                   |   |        
|                                                                                                                         |  |              
|Deposits                                                                                                                 |  |               |         |   |                   |   |        
|Demand                                                                                                                   |  | $             | 33,568  |   |                   | $ | 36,071 
|Interest-bearing checking                                                                                                |  |               | 13,760  |   |                   |   | 14,711 
|Money market                                                                                                             |  |               | 41,835  |   |                   |   | 32,603 
|Savings                                                                                                                  |  |               | 17,379  |   |                   |   | 26,425 
|Time                                                                                                                     |  |               | 263,988 |   |                   |   | 285,383
|                                                                                                                         |  |               |         |   |                   |   |        
|Total deposits                                                                                                           |  |               | 370,530 |   |                   |   | 395,193
|Accrued interest payable and other liabilities                                                                           |  |               | 170     |   |                   |   | 1,561  
|Repurchase agreements                                                                                                    |  |               | 25,000  |   |                   |   | 25,000 
|Federal funds purchased                                                                                                  |  |               | 2,255   |   |                   |   |       
|Federal Home Loan Bank advances & other borrowings                                                                       |  |               | 28,001  |   |                   |   | 3,001  
|                                                                                                                         |  |               |         |   |                   |   |        
|Total Liabilities                                                                                                        |  |               | 425,956 |   |                   |   | 424,755
|                                                                                                                         |  |              
|Commitments and contingent liabilities                                                                                   |  |               |         |   |                   |   |        
|                                                                                                                         |  |              
|Stockholders Equity                                                                                                     |  |               |         |   |                   |   |        
|Common stock, $1 par value; 25,000,000 shares authorized; 5,920,300 shares issued at June 30, 2008 and December 31,
2007 |  |               | 5,920   |   |                   |   | 5,920  
|Additional paid-in capital                                                                                               |  |               | 32,578  |   |                   |   | 32,515 
|Retained earnings                                                                                                        |  |               | 7,075   |   |                   |   | 11,367 
|Accumulated other comprehensive (loss) gain                                                                              |  |               | (1,040  | ) |                   |   | 331    
|                                                                                                                         |  |               |         |   |                   |   |        
|Total Stockholders Equity                                                                                               |  |               | 44,533  |   |                   |   | 50,133 
|                                                                                                                         |  |               |         |   |                   |   |        
|Total Liabilities and Stockholders Equity                                                                               |  | $             | 470,489 |   |                   | $ | 474,888
|                                                                                                                         |  |               |         |   |                   |   |        

See Notes to Condensed Consolidated Financial Statements



1



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##### Table of Contents

FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollar amounts in thousands except per share data)



|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|---------------------------------------------------------- |  | --------------------------- | --------- | ------------------------- | ---- | - | --------- |  | - | --------- | - |  | - | ---------
|                                                           |  | Three Months Ended June 30, |           | Six Months Ended June 30,
|                                                           |  | 2008                        |           |                           | 2007 |   | 2008      |  |   | 2007     
|Interest Income                                            |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Loans, including fees                                      |  | $                           | 6,413     |                           |      | $ | 8,022     |  | $ | 13,538    |   |  | $ | 16,072   
|Taxable securities                                         |  |                             | 786       |                           |      |   | 237       |  |   | 1,410     |   |  |   | 421      
|Tax exempt securities                                      |  |                             | 121       |                           |      |   | 87        |  |   | 272       |   |  |   | 172      
|Federal funds sold and other                               |  |                             | 33        |                           |      |   | 135       |  |   | 108       |   |  |   | 474      
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|                                                           |  |                             | 7,353     |                           |      |   | 8,481     |  |   | 15,328    |   |  |   | 17,139   
|Interest expense                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Deposits                                                   |  |                             | 3,716     |                           |      |   | 4,095     |  |   | 7,849     |   |  |   | 8,135    
|Federal Home Loan Bank advances and other borrowings       |  |                             | 417       |                           |      |   | 94        |  |   | 760       |   |  |   | 141      
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|                                                           |  |                             | 4,133     |                           |      |   | 4,189     |  |   | 8,609     |   |  |   | 8,276    
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Net interest income                                        |  |                             | 3,220     |                           |      |   | 4,292     |  |   | 6,719     |   |  |   | 8,863    
|Provision for loan losses                                  |  |                             | 3,700     |                           |      |   | 286       |  |   | 6,633     |   |  |   | 477      
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Net interest (loss) income after provision for loan losses |  |                             | (480      | )                         |      |   | 4,006     |  |   | 86        |   |  |   | 8,386    
|Non-interest income                                        |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Service charges and other fees                             |  |                             | 311       |                           |      |   | 358       |  |   | 639       |   |  |   | 670      
|Mortgage banking fees                                      |  |                             | 74        |                           |      |   | 265       |  |   | 177       |   |  |   | 425      
|Gain on sale of securities                                 |  |                             |          |                           |      |   |          |  |   | 191       |   |  |   |         
|Gain on sale of property                                   |  |                             |          |                           |      |   |          |  |   | 49        |   |  |   |         
|Other                                                      |  |                             | 15        |                           |      |   | 21        |  |   | 35        |   |  |   | 45       
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|                                                           |  |                             | 400       |                           |      |   | 644       |  |   | 1,091     |   |  |   | 1,140    
|Non-interest expense                                       |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Salaries and employee benefits                             |  |                             | 1,987     |                           |      |   | 2,263     |  |   | 3,832     |   |  |   | 4,104    
|Occupancy and equipment                                    |  |                             | 662       |                           |      |   | 412       |  |   | 1,237     |   |  |   | 793      
|Data processing                                            |  |                             | 176       |                           |      |   | 156       |  |   | 356       |   |  |   | 312      
|Professional services                                      |  |                             | 76        |                           |      |   | 132       |  |   | 145       |   |  |   | 221      
|Stationery and supplies                                    |  |                             | 63        |                           |      |   | 56        |  |   | 111       |   |  |   | 97       
|Advertising and marketing                                  |  |                             | 85        |                           |      |   | 77        |  |   | 126       |   |  |   | 156      
|Other                                                      |  |                             | 447       |                           |      |   | 303       |  |   | 823       |   |  |   | 584      
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|                                                           |  |                             | 3,496     |                           |      |   | 3,399     |  |   | 6,630     |   |  |   | 6,267    
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|(Loss) income before income taxes                          |  |                             | (3,576    | )                         |      |   | 1,251     |  |   | (5,453    | ) |  |   | 3,259    
|Income tax (benefit) expense                               |  |                             | (1,369    | )                         |      |   | 454       |  |   | (2,108    | ) |  |   | 1,193    
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Net (loss) income                                          |  | $                           | (2,207    | )                         |      | $ | 797       |  | $ | (3,345    | ) |  | $ | 2,066    
|                                                           |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|(Loss) earnings per share                                  |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Basic                                                      |  | $                           | (0.38     | )                         |      | $ | 0.14      |  | $ | (0.57     | ) |  | $ | 0.36     
|Diluted                                                    |  | $                           | (0.38     | )                         |      | $ | 0.14      |  | $ | (0.57     | ) |  | $ | 0.35     
|                                                           |  |                             |           |                          
|Average common shares outstanding                          |  |                             |           |                           |      |   |           |  |   |           |   |  |   |          
|Basic                                                      |  |                             | 5,920,300 |                           |      |   | 5,875,500 |  |   | 5,920,300 |   |  |   | 5,875,251
|Diluted                                                    |  |                             | 5,920,300 |                           |      |   | 5,909,198 |  |   | 5,920,300 |   |  |   | 5,911,432
|Dividends per share                                        |  | $                           | 0.08      |                           |      | $ | 0.08      |  | $ | 0.16      |   |  | $ | 0.16     

See Notes to Condensed Consolidated Financial Statements



2



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##### Table of Contents

FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES

IN STOCKHOLDERS EQUITY

(Unaudited)

(Dollar amounts in thousands except per share data)



|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|---------------------------------------------------------------------------------------------------- |  | --------- |  | ----------- | ----- | ------------------------ | - | ---------------- |  | - | -------------------------------------- | - |  | ----- | ------ | - |  | - | ------ | -
|                                                                                                     |  | Shares    |  | CommonStock |       | AdditionalPaid-inCapital |   | RetainedEarnings |  |   | Accum. OtherComprehensiveIncome (Loss) |   |  | Total |       
|Balance at December 31, 2006                                                                         |  | 5,874,450 |  | $           | 5,874 |                          | $ | 31,974           |  | $ | 10,870                                 |   |  | $     | (192   | ) |  | $ | 48,526 |  
|Comprehensive income:                                                                                |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Net income                                                                                           |  |           |  |             |       |                          |   |                  |  |   | 2,066                                  |   |  |       |        |   |  |   | 2,066  |  
|Change in net unrealized loss on investment securities available-for-sale, net of tax effects        |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       | (323   | ) |  |   | (323   | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   | 1,743  |  
|Stock-based compensation                                                                             |  |           |  |             |       |                          |   | 44               |  |   |                                        |   |  |       |        |   |  |   | 44     |  
|Exercise of stock options                                                                            |  | 1,050     |  |             | 1     |                          |   | 11               |  |   |                                        |   |  |       |        |   |  |   | 12     |  
|Cash dividend declared, $0.16 per share                                                              |  |           |  |             |       |                          |   |                  |  |   | (940                                   | ) |  |       |        |   |  |   | (940   | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Balance at June 30, 2007                                                                             |  | 5,875,500 |  | $           | 5,875 |                          | $ | 32,029           |  | $ | 11,996                                 |   |  | $     | (515   | ) |  | $ | 49,385 |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|                                                                                                     |  |           |  |             |       |                         
|Balance at December 31, 2007                                                                         |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,515           |  | $ | 11,367                                 |   |  | $     | 331    |   |  | $ | 50,133 |  
|Comprehensive loss:                                                                                  |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Net loss                                                                                             |  |           |  |             |       |                          |   |                  |  |   | (3,345                                 | ) |  |       |        |   |  |   | (3,345 | )
|Change in net unrealized gain (loss) on investment securities available-for-sale, net of tax effects |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       | (1,371 | ) |  |   | (1,371 | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Total Comprehensive Loss                                                                             |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   | (4,716 | )
|Stock-based compensation                                                                             |  |           |  |             |       |                          |   | 63               |  |   |                                        |   |  |       |        |   |  |   | 63     |  
|Cash dividend declared, $0.16 per share                                                              |  |           |  |             |       |                          |   |                  |  |   | (947                                   | ) |  |       |        |   |  |   | (947   | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Balance at June 30, 2008                                                                             |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,578           |  | $ | 7,075                                  |   |  | $     | (1,040 | ) |  | $ | 44,533 |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|                                                                                                     |  |           |  |             |       |                         
|Balance at March 31, 2007                                                                            |  | 5,875,500 |  | $           | 5,875 |                          | $ | 32,008           |  | $ | 11,669                                 |   |  | $     | (142   | ) |  | $ | 49,410 |  
|Comprehensive income:                                                                                |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Net income                                                                                           |  |           |  |             |       |                          |   |                  |  |   | 797                                    |   |  |       |        |   |  |   | 797    |  
|Change in net unrealized loss on investment securities available-for-sale, net of tax effects        |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       | (373   | ) |  |   | (373   | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   | 424    |  
|Stock-based compensation                                                                             |  |           |  |             |       |                          |   | 21               |  |   |                                        |   |  |       |        |   |  |   | 21     |  
|Cash dividend declared, $0.08 per share                                                              |  |           |  |             |       |                          |   |                  |  |   | (470                                   | ) |  |       |        |   |  |   | (470   | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Balance at June 30, 2007                                                                             |  | 5,875,500 |  | $           | 5,875 |                          | $ | 32,029           |  | $ | 11,996                                 |   |  | $     | (515   | ) |  | $ | 49,385 |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|                                                                                                     |  |           |  |             |       |                         
|Balance at March 31, 2008                                                                            |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,546           |  | $ | 9,755                                  |   |  | $     | (40    | ) |  | $ | 48,181 |  
|Comprehensive loss:                                                                                  |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Net loss                                                                                             |  |           |  |             |       |                          |   |                  |  |   | (2,207                                 | ) |  |       |        |   |  |   | (2,207 | )
|Change in net unrealized loss on investment securities available-for-sale, net of tax effects        |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       | (1,000 | ) |  |   | (1,000 | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Total Comprehensive Loss                                                                             |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   | (3,207 | )
|Stock-based compensation                                                                             |  |           |  |             |       |                          |   | 32               |  |   |                                        |   |  |       |        |   |  |   | 32     |  
|Cash dividend declared, $0.08 per share                                                              |  |           |  |             |       |                          |   |                  |  |   | (473                                   | ) |  |       |        |   |  |   | (473   | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  
|Balance at June 30, 2008                                                                             |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,578           |  | $ | 7,075                                  |   |  | $     | (1,040 | ) |  | $ | 44,533 |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                        |   |  |       |        |   |  |   |        |  

See Notes to Condensed Consolidated Financial Statements



3



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##### Table of Contents

FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

Six Months Ended June 30, 2008 and 2007

(Unaudited)

(Dollar amounts in thousands)



|                                                                                           |  |      |         |   |      |   |         |  
|------------------------------------------------------------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                                           |  | 2008 |         |   | 2007 |  
|Cash flows (used in) from operating activities:                                            |  |      |         |   |      |   |         |  
|Net (loss) income                                                                          |  | $    | (3,345  | ) |      | $ | 2,066   |  
|Adjustments to reconcile net (loss) income to net cash (used in) from operating activities |  |      |         |   |      |   |         |  
|Provision for loan losses                                                                  |  |      | 6,633   |   |      |   | 477     |  
|Depreciation                                                                               |  |      | 260     |   |      |   | 209     |  
|Net accretion of securities                                                                |  |      | (50     | ) |      |   | (18     | )
|Stock-based compensation                                                                   |  |      | 63      |   |      |   | 44      |  
|Net change in:                                                                             |  |      |         |   |      |   |         |  
|Other assets                                                                               |  |      | (2,228  | ) |      |   | (48     | )
|Accrued expenses and other liabilities                                                     |  |      | (1,391  | ) |      |   | 523     |  
|                                                                                           |  |      |         |   |      |   |         |  
|Net cash (used in) from operating activities                                               |  |      | (58     | ) |      |   | 3,253   |  
|Cash flows used in investing activities:                                                   |  |      |         |   |      |   |         |  
|Net change in time deposits                                                                |  |      | 238     |   |      |   | 66      |  
|Available-for-sale securities:                                                             |  |      |         |   |      |   |         |  
|Maturities, prepayments and calls                                                          |  |      | 225     |   |      |   | 1,157   |  
|Proceeds from sales of securities available-for-sale                                       |  |      | 11,622  |   |      |   |        |  
|Gain on sale of securities                                                                 |  |      | 191     |   |      |   |        |  
|Purchases                                                                                  |  |      | (33,622 | ) |      |   | (10,764 | )
|Loan originations and payments, net                                                        |  |      | 18,931  |   |      |   | (25,252 | )
|Net purchase of FHLB stock                                                                 |  |      | (1,164  | ) |      |   | (296    | )
|Gain on sale of property                                                                   |  |      | 49      |   |      |   |        |  
|Net change in premise and equipment                                                        |  |      | (3,462  | ) |      |   | (3,331  | )
|                                                                                           |  |      |         |   |      |   |         |  
|Net cash used in investing activities                                                      |  |      | (6,992  | ) |      |   | (38,420 | )
|Cash flows from (used in) financing activities:                                            |  |      |         |   |      |   |         |  
|Net change in deposits                                                                     |  |      | (24,663 | ) |      |   | (17,612 | )
|Net change in short-term borrowing                                                         |  |      | 9,255   |   |      |   | 5,000   |  
|Proceeds from long-term borrowing                                                          |  |      | 18,000  |   |      |   | 10,000  |  
|Proceeds from exercise of stock options                                                    |  |      |        |   |      |   | 12      |  
|Cash dividend paid                                                                         |  |      | (947    | ) |      |   | (940    | )
|                                                                                           |  |      |         |   |      |   |         |  
|Net cash from (used in) financing activities                                               |  |      | 1,645   |   |      |   | (3,540  | )
|                                                                                           |  |     
|Net change in cash and cash equivalents                                                    |  |      | (5,405  | ) |      |   | (38,707 | )
|Beginning cash and cash equivalents                                                        |  |      | 10,669  |   |      |   | 44,233  |  
|                                                                                           |  |      |         |   |      |   |         |  
|Ending cash and cash equivalents                                                           |  | $    | 5,264   |   |      | $ | 5,526   |  
|                                                                                           |  |      |         |   |      |   |         |  
|Supplemental cash flow information                                                         |  |      |         |   |      |   |         |  
|Interest paid                                                                              |  | $    | 8,771   |   |      | $ | 8,230   |  
|Income taxes paid                                                                          |  | $    | 325     |   |      | $ | 1,569   |  

See Notes to Condensed Consolidated Financial Statements



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FIRST STATE FINANCIAL CORPORATION

CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)

NOTE 1  INTERIM FINANCIAL STATEMENTS

These unaudited financial statements were prepared in accordance with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. As such they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all
adjustments (consisting only of normal recurring accruals) considered necessary to comply with Regulation S-X were included. The operating results for the six months ended June 30, 2008 are not necessarily indicative of the results that may be
expected for the full year of 2008.

NOTE 2  NEW ACCOUNTING STANDARDS

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, which will require increased disclosures about an entitys strategies and objectives for
using derivative instruments; the location and amounts of derivative instruments in an entitys financial statements; how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. Certain disclosures will also be required with respect to derivative features that are
credit risk-related. SFAS No. 161 is effective for the Company beginning March 1, 2009 on a prospective basis. Based on the Companys current operations, the Company does not expect that the adoption of SFAS No. 161 will
have a material effect on its financial position, results of operations or cash flows.

NOTE 3  STOCK-BASED COMPENSATION

First State Financial Corporations 2004 Stock Plan, which is stockholder approved, permits the grant of share options for up to 500,000 shares of common stock.
Under the terms of the plan, the option price is not less than the fair market value of the common stock on the date of grant. Stock options generally vest over five years and have a ten year contractual term. Certain awards provide for accelerated
vesting if there is a change in control (as defined in the plan).

During the quarter ended June 30, 2008, the Company did not grant any stock
options. During the previous quarter ended March 31, 2008 the Company granted 71,250 stock options. During the quarter and the six months ended June 30, 2007, the Company granted 10,000 and 24,000 stock options, respectively.

During the quarter ended June 30, 2008, 13,410 options vested and no options were exercised. During the previous quarter ended March 31, 2008, 5,800 options
vested and no options were exercised. During the quarter and the six months ended June 30, 2007, 6,400 and 21,110 options vested and 0 and 1,050 options were exercised, respectively.



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A summary of share option activity under the plan as of June 30, 2008 is as follows:



|                                       |  |                         |  |                              |       |                                                     |      |                                       |   |  
|-------------------------------------- |  | ----------------------- |  | ---------------------------- | ----- | --------------------------------------------------- | ---- | ------------------------------------- | - | -
|                                       |  | StockOptionsOutstanding |  | WeightedAverageExercisePrice |       | Weighted-AverageRemainingContractualLife (in
years) |      | AggregateIntrinsicValue(in thousands)
|Options outstanding, December 31, 2007 |  | 97,140                  |  | $                            | 13.54 |                                                     |      |                                       |   |  
|Granted                                |  | 71,250                  |  |                              | 7.78  |                                                     |      |                                       |   |  
|Exercised                              |  |                        |  |                              |      |                                                     |      |                                       |   |  
|Forfeited or expired                   |  |                        |  |                              |      |                                                     |      |                                       |   |  
|                                       |  |                         |  |                              |       |                                                     |      |                                       |   |  
|Options outstanding, June 30, 2008     |  | 168,390                 |  | $                            | 11.10 |                                                     | 8.26 |                                       | $ | 2
|                                       |  |                         |  |                              |       |                                                     |      |                                       |   |  
|Options exercisable, June 30, 2008     |  | 46,720                  |  | $                            | 12.57 |                                                     | 6.82 |                                       | $ | 2
|                                       |  |                         |  |                              |       |                                                     |      |                                       |   |  

For the three and six months ended June 30, 2008, $32 thousand and $63 thousand in compensation cost related
to the Companys stock option plan was recorded in net loss, respectively. As of June 30, 2008, $208 thousand in unrecognized compensation costs remained to be recognized over a weighted-average period of 2.6 years. All stock option
compensation costs recognized in the first six months of 2008 related to incentive stock options. Accordingly, there is no tax benefit to disclose.

NOTE 4  LOANS

Major classifications of loans are as follows (in thousands):



|                              |  |              |         |   |                  |   |         |  
|----------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                              |  | June 30,2008 |         |   | December 31,2007 |  
|Commercial                    |  | $            | 73,457  |   |                  | $ | 76,630  |  
|Real estate:                  |  |              |         |   |                  |   |         |  
|Residential                   |  |              | 49,995  |   |                  |   | 54,058  |  
|Commercial                    |  |              | 188,407 |   |                  |   | 211,516 |  
|Construction                  |  |              | 56,893  |   |                  |   | 47,308  |  
|Consumer and other            |  |              | 13,121  |   |                  |   | 13,651  |  
|                              |  |              |         |   |                  |   |         |  
|                              |  |              | 381,873 |   |                  |   | 403,163 |  
|Less: Deferred loan fees, net |  |              | (942    | ) |                  |   | (1,126  | )
|Allowance for loan losses     |  |              | (12,091 | ) |                  |   | (7,633  | )
|                              |  |              |         |   |                  |   |         |  
|Total loans, net              |  | $            | 368,840 |   |                  | $ | 394,404 |  
|                              |  |              |         |   |                  |   |         |  

Transactions in the allowance for loan losses are as follows (in thousands):



|                                |  |                                   |        |   |              |   |       |  
|------------------------------- |  | --------------------------------- | ------ | - | ------------ | - | ----- | -
|                                |  | Activity for the six months ended |       
|                                |  | June 30,2008                      |        |   | June 30,2007 |  
|Balance, beginning of period    |  | $                                 | 7,633  |   |              | $ | 4,358 |  
|Provision charged to operations |  |                                   | 6,633  |   |              |   | 477   |  
|Loans charged off               |  |                                   | (2,251 | ) |              |   | (251  | )
|Recoveries                      |  |                                   | 76     |   |              |   | 24    |  
|                                |  |                                   |        |   |              |   |       |  
|Balance, end of period          |  | $                                 | 12,091 |   |              | $ | 4,608 |  
|                                |  |                                   |        |   |              |   |       |  



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Impaired loans were as follows (in thousands):



|                                                  |  |              |        |                  |   |       
|------------------------------------------------- |  | ------------ | ------ | ---------------- | - | ------
|                                                  |  | June 30,2008 |        | December 31,2007
|Loans with no allocated allowance for loan losses |  | $            | 31,932 |                  | $ | 13,634
|Loans with allocated allowance for loan losses    |  |              | 36,217 |                  |   | 17,383
|                                                  |  |              |        |                  |   |       
|                                                  |  | $            | 68,149 |                  | $ | 31,017
|                                                  |  |              |        |                  |   |       
|Amount of the allowance for loan losses allocated |  | $            | 9,459  |                  | $ | 5,017 
|                                                  |  |              |        |                  |   |       

NOTE 5  FAIR VALUE

Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three
levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active
markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level
1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entitys own assumptions about the assumptions that market participants would use
in pricing an asset or liability.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis consist of available-for-sale securities. The fair value was derived based on market prices or dealer
quotes on securities with similar characteristics (level 2) and amounted to $72.1 million as of June 30, 2008.

Assets and Liabilities Measured on
a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis consist of impaired loans. The fair value of certain
assets was derived using significant other observable inputs (level 2) and amounted to $34.8 million as of June 30, 2008. The fair value of certain other assets was derived using significant unobservable inputs (level 3) and amounted to $23.9
million as of June 30, 2008. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $68.2 million, with a valuation allowance of $9.5 million.



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NOTE 6  FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS

Federal Home Loan Bank (FHLB) advances and other borrowings were as follows (in thousands):



|                                          |  |              |        |                  |   |      
|----------------------------------------- |  | ------------ | ------ | ---------------- | - | -----
|                                          |  | June 30,2008 |        | December 31,2007
|Line of credit, Independent Bankers Bank |  | $            | 1      |                  | $ | 1    
|Federal Home Loan Bank Advances           |  |              | 28,000 |                  |   | 3,000
|                                          |  |              |        |                  |   |      
|                                          |  | $            | 28,001 |                  | $ | 3,001
|                                          |  |              |        |                  |   |      

During the six months ended June 30, 2008 the Bank initiated several advances from the Federal Home Loan Bank
totaling $20 million with fixed rates ranging from 2.72% and 3.98%. The Bank also initiated an advance of $8 million with a variable interest rate. These advances were used to purchase higher yielding long-term securities to increase the duration of
earning assets and shorten the duration of liabilities and to fund the opening of new branches. In June 2008, the $3 million Federal Home Loan Bank advance outstanding at December 31, 2007 was paid.



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##### Table of Contents

|Item 2. | MANGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | ------------------------------------------------------------------------------------

The following commentary presents managements discussion and analysis of First State Financial Corporations financial condition and results of operations for the three and six months ended June 30,
2008. It should be read in conjunction with the unaudited Consolidated Financial Statements and Notes included elsewhere in this report and the audited Consolidated Financial Statements and Notes contained in the Corporations 2007 Annual
Report on Form 10-K. In addition, the following discussion and analysis should be read together with Managements Discussion and Analysis of Financial Condition and Results of Operations contained in the Corporations 2007
Annual Report on Form 10-K, which contains important additional information that is necessary to understand the Corporation and its financial condition and results of operations for the periods covered by this report.

As used in this report, the terms we, our, First State Financial, company, and corporation mean First State
Financial Corporation and its subsidiary unless the context indicates otherwise. The terms bank and First State Bank mean First State Bank. We intend for this discussion to provide information that will assist in
understanding our financial statements. We will discuss the changes in certain key items in those financial statements and the primary factors that accounted for those changes.

OVERVIEW

We are the parent of First State Bank, a community bank headquartered in Sarasota, Florida with offices in
Sarasota and Pinellas counties. The Banks business strategy encompasses:



| |  |  | Providing customers with access to local executives;
| | - |  | ----------------------------------------------------



| |  |  | Pursuing commercial lending opportunities with small- to mid-sized businesses;
| | - |  | ------------------------------------------------------------------------------



| |  |  | Developing new products and services to generate additional revenue sources;
| | - |  | ----------------------------------------------------------------------------



| |  |  | Cross-selling products and services to existing customers;
| | - |  | ----------------------------------------------------------



| |  |  | Adhering to sound credit standards and maintaining the continued quality of assets; and
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | Acquiring and developing new branches within our geographical area.
| | - |  | -------------------------------------------------------------------

Some of the key developments during the second quarter of 2008 include:



| |  |  | The purchase of $10.5 million in securities to increase the duration of interest earning assets;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | Net loss of $2.2 million primarily due to an increase of the loan loss provision;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Branch openings in Clearwater and Venice; and
| | - |  | ---------------------------------------------



| |  |  | Plans to open one new branch over the next 12 months.
| | - |  | -----------------------------------------------------

We continue to face a variety of challenges and opportunities inherent within the banking industry which are characterized by the uncertainty in the timing of interest rate changes, credit quality and intense competition. The Company
continues to position itself to better serve its customers in the Pinellas and Sarasota markets. As part of our strategic plan, the management team and employees will continue to build upon our past successes by building customer relationships,
monitoring credit quality, monitoring our margin, and expanding our presence within our geographical market.



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FORWARD-LOOKING STATEMENTS

This Managements Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking statements that may be identified by the use of words like believe, expect,
anticipate, and project. Forward-looking statements reflect our good-faith evaluation of information currently available. However, such statements are dependent on and can be influenced by, a number of external variables over
which we have little or no control. These variables include:



| |  |  | the effect of future economic conditions;
| | - |  | -----------------------------------------



| |  |  | governmental monetary and fiscal policies;
| | - |  | ------------------------------------------



| |  |  | legislative and regulatory changes;
| | - |  | -----------------------------------



| |  |  | the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | interest rate risks; and
| | - |  | ------------------------



| |  |  | the effects of competition from other commercial banks, thrifts, consumer financial companies, and other financial institutions operating in our market area and
elsewhere.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Forward-looking statements are not, and should not be relied upon as a guaranty of future performance or results. As a
result, actual outcomes and results may differ materially from those expressed in forward-looking statements. We undertake no obligation to update or revise forward-looking statements.

RESULTS OF OPERATIONS

The table below presents, for the periods indicated, amounts included in our Condensed
Consolidated Statements of Income. The percentage change is calculated using actual amounts rounded to the nearest thousand and rounded to the nearest whole percentage.



|                                           |  |                            |        |   |                          |   |        |        |  |   |        |   |  |       |   |  |        |        |   |   |   |        |   |  |   |        |   |  |       |  
|------------------------------------------ |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ------ |  | - | ------ | - |  | ----- | - |  | ------ | ------ | - | - | - | ------ | - |  | - | ------ | - |  | ----- | -
|                                           |  | Three months endedJune 30, |        |   | Six months endedJune 30, |  
|                                           |  |                            |        |   |                          |   |        | change |  |   |        |   |  |       |   |  | change |       
|(Dollars in thousands)                     |  | 2008                       |        |   | 2007                     |   |        | $      |  |   | %      |   |  | 2008  |   |  | 2007   |        |   | $ |   |        | % | 
|Interest income                            |  | $                          | 7,353  |   |                          | $ | 8,481  |        |  | $ | (1,128 | ) |  | -13   | % |  | $      | 15,328 |   |   | $ | 17,139 |   |  | $ | (1,811 | ) |  | -11   | %
|Interest expense                           |  |                            | 4,133  |   |                          |   | 4,189  |        |  |   | (56    | ) |  | -1    | % |  |        | 8,609  |   |   |   | 8,276  |   |  |   | 333    |   |  | 4     | %
|                                           |  |                            |        |   |                          |   |        |        |  |   |        |   |  |       |   |  |        |        |   |   |   |        |   |  |   |        |   |  |       |  
|Net interest income                        |  |                            | 3,220  |   |                          |   | 4,292  |        |  |   | (1,072 | ) |  | -25   | % |  |        | 6,719  |   |   |   | 8,863  |   |  |   | (2,144 | ) |  | -24   | %
|Provision for loan losses                  |  |                            | 3,700  |   |                          |   | 286    |        |  |   | 3,414  |   |  | 1,194 | % |  |        | 6,633  |   |   |   | 477    |   |  |   | 6,156  |   |  | 1,291 | %
|                                           |  |                            |        |   |                          |   |        |        |  |   |        |   |  |       |   |  |        |        |   |   |   |        |   |  |   |        |   |  |       |  
|Net interest (loss) income after provision |  |                            | (480   | ) |                          |   | 4,006  |        |  |   | (4,486 | ) |  | -112  | % |  |        | 86     |   |   |   | 8,386  |   |  |   | (8,300 | ) |  | -99   | %
|Non-interest income                        |  |                            | 400    |   |                          |   | 644    |        |  |   | (244   | ) |  | -38   | % |  |        | 1,091  |   |   |   | 1,140  |   |  |   | (49    | ) |  | -4    | %
|Non-interest expense                       |  |                            | (3,496 | ) |                          |   | (3,399 | )      |  |   | 97     |   |  | 3     | % |  |        | (6,630 | ) |   |   | (6,267 | ) |  |   | 363    |   |  | 6     | %
|                                           |  |                            |        |   |                          |   |        |        |  |   |        |   |  |       |   |  |        |        |   |   |   |        |   |  |   |        |   |  |       |  
|(Loss) income before income taxes          |  |                            | (3,576 | ) |                          |   | 1,251  |        |  |   | (4,827 | ) |  | -386  | % |  |        | (5,453 | ) |   |   | 3,259  |   |  |   | (8,712 | ) |  | -267  | %
|Income tax (benefit) expense               |  |                            | (1,369 | ) |                          |   | 454    |        |  |   | (1,823 | ) |  | -402  | % |  |        | (2,108 | ) |   |   | 1,193  |   |  |   | (3,301 | ) |  | -277  | %
|                                           |  |                            |        |   |                          |   |        |        |  |   |        |   |  |       |   |  |        |        |   |   |   |        |   |  |   |        |   |  |       |  
|Net (loss) income                          |  | $                          | (2,207 | ) |                          | $ | 797    |        |  | $ | (3,004 | ) |  | -377  | % |  | $      | (3,345 | ) |   | $ | 2,066  |   |  | $ | (5,411 | ) |  | -262  | %
|                                           |  |                            |        |   |                          |   |        |        |  |   |        |   |  |       |   |  |        |        |   |   |   |        |   |  |   |        |   |  |       |  



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The following average balance sheet presents certain information related to our average yields on assets and average cost
of liabilities. Such yields have been derived by dividing income or expenses by the average balance of the corresponding assets or liabilities and the calculated year to date rate is then annualized.



|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|---------------------------------------- |  | --------------------------------- | ------- | -------------- | ---- | ------------ |  | ---- | --------------- |  | -------------- | ------- | ------------ | - | ------ |  | ---- | -
|                                         |  | For the six months ended June 30, |        
|                                         |  | 2008                              |         |                | 2007 |             
|(Dollars in thousands)                   |  | AverageBalances                   |         | Income/Expense |      | Yields/Rates |  |      | AverageBalances |  | Income/Expense |         | Yields/Rates |  
|Assets:                                  |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Earning assets:                          |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Loans (1)                                |  | $                                 | 382,432 |                | $    | 13,538       |  | 7.12 | %               |  | $              | 377,377 |              | $ | 16,072 |  | 8.59 | %
|Investment securities, taxable           |  |                                   | 49,890  |                |      | 1,410        |  | 5.68 | %               |  |                | 17,706  |              |   | 421    |  | 4.79 | %
|Investment securities, non-taxable (2)   |  |                                   | 11,004  |                |      | 371          |  | 6.77 | %               |  |                | 8,523   |              |   | 235    |  | 5.55 | %
|Other                                    |  |                                   | 5,622   |                |      | 108          |  | 3.86 | %               |  |                | 18,479  |              |   | 474    |  | 5.17 | %
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total interest earning assets            |  |                                   | 448,948 |                |      | 15,427       |  | 6.91 | %               |  |                | 422,085 |              |   | 17,202 |  | 8.22 | %
|Non-interest earning assets              |  |                                   | 21,216  |                |      |              |  |      |                 |  |                | 18,344  |              |   |        |  |      |  
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total assets                             |  | $                                 | 470,164 |                |      |              |  |      |                 |  | $              | 440,429 |              |   |        |  |      |  
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Liabilities:                             |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Interest bearing liabilities:            |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|NOW accounts                             |  | $                                 | 14,403  |                | $    | 124          |  | 1.73 | %               |  | $              | 16,081  |              | $ | 114    |  | 1.43 | %
|Money market                             |  |                                   | 36,202  |                |      | 551          |  | 3.06 | %               |  |                | 31,320  |              |   | 576    |  | 3.71 | %
|Savings                                  |  |                                   | 20,584  |                |      | 280          |  | 2.73 | %               |  |                | 22,837  |              |   | 407    |  | 3.60 | %
|Time deposits                            |  |                                   | 272,878 |                |      | 6,894        |  | 5.08 | %               |  |                | 275,749 |              |   | 7,038  |  | 5.15 | %
|Borrowings                               |  |                                   | 39,645  |                |      | 760          |  | 3.86 | %               |  |                | 4,769   |              |   | 141    |  | 5.95 | %
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total interest bearing liabilities       |  |                                   | 383,712 |                |      | 8,609        |  | 4.51 | %               |  |                | 350,756 |              |   | 8,276  |  | 4.76 | %
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Demand deposits                          |  |                                   | 35,997  |                |      |              |  |      |                 |  |                | 36,906  |              |   |        |  |      |  
|Other non-interest bearing liabilities   |  |                                   | 1,414   |                |      |              |  |      |                 |  |                | 2,554   |              |   |        |  |      |  
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total non-interest bearing liabilities   |  |                                   | 37,411  |                |      |              |  |      |                 |  |                | 39,460  |              |   |        |  |      |  
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Stockholders equity                     |  |                                   | 49,041  |                |      |              |  |      |                 |  |                | 50,213  |              |   |        |  |      |  
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total liabilities & stockholders equity |  | $                                 | 470,164 |                |      |              |  |      |                 |  | $              | 440,429 |              |   |        |  |      |  
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Net Interest Income                      |  |                                   |         |                | $    | 6,818        |  |      |                 |  |                |         |              | $ | 8,926  |  |      |  
|                                         |  |                                   |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Net Interest Margin (3)                  |  |                                   |         |                |      |              |  | 3.05 | %               |  |                |         |              |   |        |  | 4.26 | %



|(1) | Average loans include nonperforming loans
|--- | -----------------------------------------

|(2) | On a fully tax-equivalent basis using a 34% rate for Federal income tax purposes, reduced by the non-deductible portion of interest expense
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Net interest margin is net interest income divided by average total interest earning assets
|--- | -------------------------------------------------------------------------------------------



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##### Table of Contents

The table below details the components of the changes in net interest income for the six months ended June 30, 2008
and June 30, 2007. For each major category of interest earning assets and interest bearing liabilities, information is provided with respect to changes due to average volumes, changes due to rates, and with the changes in both volumes and rates
allocated to these two categories based on the proportionate absolute changes in each category.



|                                         |  |                                                                                   |      |   |             |   |        |                       |  |   |        |  
|---------------------------------------- |  | --------------------------------------------------------------------------------- | ---- | - | ----------- | - | ------ | --------------------- |  | - | ------ | -
|                                         |  | For the six months ended June,
2008Compared to the six months ended June 30, 2007 |     
|                                         |  | Increase (decrease) due to change in                                              |      |   |             |  
|(Dollars in thousands)                   |  | AverageVolume                                                                     |      |   | AverageRate |   |        | NetIncrease(Decrease) | 
|Increase (decrease) in interest income:  |  |                                                                                   |      |   |             |   |        |                       |  |   |        |  
|Loans                                    |  | $                                                                                 | 213  |   |             | $ | (2,747 | )                     |  | $ | (2,534 | )
|Investment securities, taxable           |  |                                                                                   | 895  |   |             |   | 94     |                       |  |   | 989    |  
|Investment securities, non-taxable (1)   |  |                                                                                   | 77   |   |             |   | 59     |                       |  |   | 136    |  
|Other                                    |  |                                                                                   | (269 | ) |             |   | (97    | )                     |  |   | (366   | )
|                                         |  |                                                                                   |      |   |             |   |        |                       |  |   |        |  
|Total interest income                    |  |                                                                                   | 916  |   |             |   | (2,691 | )                     |  |   | (1,775 | )
|                                         |  |                                                                                   |      |   |             |   |        |                       |  |   |        |  
|Increase (decrease) in interest expense: |  |                                                                                   |      |   |             |   |        |                       |  |   |        |  
|NOW accounts                             |  |                                                                                   | (13  | ) |             |   | 23     |                       |  |   | 10     |  
|Money market                             |  |                                                                                   | 82   |   |             |   | (107   | )                     |  |   | (25    | )
|Savings                                  |  |                                                                                   | (37  | ) |             |   | (90    | )                     |  |   | (127   | )
|Time deposits                            |  |                                                                                   | (73  | ) |             |   | (71    | )                     |  |   | (144   | )
|Borrowings                               |  |                                                                                   | 685  |   |             |   | (66    | )                     |  |   | 619    |  
|                                         |  |                                                                                   |      |   |             |   |        |                       |  |   |        |  
|Total interest expense                   |  |                                                                                   | 644  |   |             |   | (311   | )                     |  |   | 333    |  
|                                         |  |                                                                                   |      |   |             |   |        |                       |  |   |        |  
|Total change in net interest income      |  | $                                                                                 | 272  |   |             | $ | (2,380 | )                     |  | $ | (2,108 | )
|                                         |  |                                                                                   |      |   |             |   |        |                       |  |   |        |  



|(1) | On a fully tax-equivalent basis using a 34% rate for Federal income tax purposes, reduced by the non-deductible portion of interest expense
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

FOR THE SIX MONTHS ENDED JUNE 30, 2008:

NET INTEREST INCOME

Net interest income is the most significant component of our earnings. Net interest income is comprised of interest income, and loan-related fees, less
interest expense. Net interest income is affected by numerous factors, including the level, pricing, mix and maturity of earning assets and interest-bearing liabilities, as well as interest rate fluctuations. For purposes of this discussion, net
interest income has been adjusted to a fully tax-equivalent basis which restates tax-exempt income to an amount that would yield the same after-tax income had the income been subject to income taxes.

Net interest income on a fully tax-equivalent basis for the first six months of 2008 and for the first six months of 2007 was $6.8 million and $8.9 million,
respectively. Net interest income on a fully tax-equivalent basis decreased by $2.1 million; $2.4 million was due to a decrease in rates, partially offset by a $0.3 million increase due to volume. Average earning assets grew 6.4% for the first six
months of 2008 over the first six months of 2007, from $422.1 million to $448.9 million, with the yield on average earning assets decreasing 131 basis points. Average interest bearing liabilities (deposits and borrowings) grew 9.4% for the first six
months of 2008 over the first six months of 2007, from $350.8 million to $383.7 million, with the annualized cost decreasing 25 basis points.

NON-INTEREST INCOME

Non-interest income for the first six months of 2008 and 2007 was $1.1 million. Mortgage banking fees decreased $248
thousand, from $425 thousand in the first six months of 2007 to $177 thousand in the first six months of 2008 as a result of a decline in volume of transactions closed. This decrease was offset by a $191 thousand gain on the sale of securities and a
$49 thousand gain on the sale of property. Service charges and other fees were $639 thousand in the first six months of 2008 as compared to $670 thousand for the same period of 2007.



12



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##### Table of Contents

NON-INTEREST EXPENSE

For the first six months of 2008, non-interest expense was $6.6 million compared to $6.3 million for the first six months of 2007. Occupancy costs represented the largest increase in non-interest expense. The Bank opened three new branches
and additional office space was obtained to centralize certain operations of the Bank, resulting in increased occupancy costs. As of June 30, 2008 there were 138.5 full-time equivalent employees compared to 112.5 at June 30, 2007. However,
salaries and employee benefits decreased for the first six months of the year versus the first six months of 2007. Salaries and employee benefit expense did not increase in relation to the increase in full-time equivalents as a bonus accrual was not
necessary during the first six months of 2008 and due to a non-recurring charge in the first six months of 2007 related to the departure of the Banks former CEO. The increase in full-time equivalent employees is primarily the result of new
branch openings.

INCOME TAXES

For the six months
ended June 30, 2008 and 2007, the Company recorded income tax (benefit) expense of $(2.1) million and $1.2 million, respectively. Accordingly, our effective tax rates were (38.7)% and 36.6% for 2008 and 2007, respectively. The determination of
effective rates reflects items which are not taxed for income tax purposes, primarily tax-exempt interest income.

FOR THE THREE MONTHS ENDED JUNE 30,
2008:

NET INTEREST INCOME

Net interest income on a
fully tax-equivalent basis for the second quarter of 2008 and for the second quarter of 2007 was $3.3 million and $4.3 million, respectively. Net interest income on a fully tax-equivalent basis decreased by $1.0 million; $1.1 million was due to a
decrease in rates, partially offset by a $0.1 million increase due to volume. Average earning assets grew 7.1% for the second quarter of 2008 over the second quarter of 2007, from $419.0 million to $448.9 million, with the yield on average earning
assets decreasing 152 basis points. Average interest bearing liabilities (deposits and borrowings) grew 10.0% for the second quarter of 2008 over the second quarter of 2007, from $348.7 million to $383.7 million, with the annualized cost decreasing
49 basis points.

NON-INTEREST INCOME

Non-interest
income for the second quarter of 2008 was $400 thousand compared to $644 thousand for the same period of 2007. The decrease from 2007 to 2008 was primarily due to a reduction in mortgage banking fees. Mortgage banking fees decreased $191 thousand,
from $265 thousand in the second quarter of 2007 to $74 thousand in the second quarter of 2008 as a result of a decline in volume of transactions closed. The decrease was also due to a slight decrease in service charges and other fees. Service
charges and other fees were $311 thousand in the second quarter of 2008 as compared to $358 thousand for the same period of 2007.

NON-INTEREST EXPENSE

For the second quarter of 2008, non-interest expense was $3.5 million compared to $3.4 million for the second quarter of 2007. Occupancy costs
represented the largest increase in non-interest expense. The Bank opened three new branches and additional office space was obtained to centralize certain operations of the Bank, resulting in increased occupancy costs. As of June 30, 2008
there were 138.5 full-time equivalent employees compared to 112.5 at June 30, 2007. However, salaries and employee benefits decreased for the second quarter of the year versus the second quarter of 2007. Salaries and employee benefit expense
did not increase in relation to the increase in full-time equivalents as a bonus accrual was not necessary during the second quarter of 2008 and due to a non-recurring charge in the second quarter of 2007 related to the departure of the Banks
former CEO. The increase in full-time equivalent employees is primarily the result of new branch openings.



13



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##### Table of Contents

INCOME TAXES

For the
quarter ended June 30, 2008 and 2007, the Company recorded income tax (benefit) expense of $(1.4) million and $454 thousand, respectively. Accordingly, our effective tax rates were (38.3)% and 36.3% for 2008 and 2007, respectively. The
determination of effective rates reflects items which are not taxed for income tax purposes, primarily tax-exempt interest income.

FINANCIAL CONDITION ANALYSIS



|                                                          |  |               |         |   |                   |   |         |        |  |   |         |   |  |     |  
|--------------------------------------------------------- |  | ------------- | ------- | - | ----------------- | - | ------- | ------ |  | - | ------- | - |  | --- | -
|                                                          |  |               |         |   |                   |   |         | Change | 
|(Dollars in thousands)                                    |  | June 30, 2008 |         |   | December 31, 2007 |   |         | $      |  |   | %       |  
|Cash                                                      |  | $             | 5,264   |   |                   | $ | 10,669  |        |  | $ | (5,405  | ) |  | -51 | %
|Interest bearing deposits in other financial institutions |  |               | 185     |   |                   |   | 423     |        |  |   | (238    | ) |  | -56 | %
|Investments                                               |  |               | 72,068  |   |                   |   | 52,632  |        |  |   | 19,436  |   |  | 37  | %
|Loans  gross                                             |  |               | 381,873 |   |                   |   | 403,163 |        |  |   | (21,290 | ) |  | -5  | %
|Net deferred fees                                         |  |               | (942    | ) |                   |   | (1,126  | )      |  |   | 184     |   |  | 16  | %
|Allowance for loan loss reserve                           |  |               | (12,091 | ) |                   |   | (7,633  | )      |  |   | (4,458  | ) |  | -58 | %
|Other                                                     |  |               | 24,132  |   |                   |   | 16,760  |        |  |   | 7,372   |   |  | 44  | %
|                                                          |  |               |         |   |                   |   |         |        |  |   |         |   |  |     |  
|Total Assets                                              |  | $             | 470,489 |   |                   | $ | 474,888 |        |  | $ | (4,399  | ) |  | -1  | %
|                                                          |  |               |         |   |                   |   |         |        |  |   |         |   |  |     |  
|Non-interest bearing deposits                             |  | $             | 33,568  |   |                   | $ | 36,071  |        |  | $ | (2,503  | ) |  | -7  | %
|Interest bearing deposits                                 |  |               | 336,962 |   |                   |   | 359,122 |        |  |   | (22,160 | ) |  | -6  | %
|Borrowings                                                |  |               | 55,256  |   |                   |   | 28,001  |        |  |   | 27,255  |   |  | 97  | %
|Other                                                     |  |               | 170     |   |                   |   | 1,561   |        |  |   | (1,391  | ) |  | -89 | %
|Stockholders equity                                      |  |               | 44,533  |   |                   |   | 50,133  |        |  |   | (5,600  | ) |  | -11 | %
|                                                          |  |               |         |   |                   |   |         |        |  |   |         |   |  |     |  
|Total Liabilities and Stockholders Equity                |  | $             | 470,489 |   |                   | $ | 474,888 |        |  | $ | (4,399  | ) |  | -1  | %
|                                                          |  |               |         |   |                   |   |         |        |  |   |         |   |  |     |  

Significant changes to our balance sheet include the following:



| |  |  | Gross loans decreased $21.3 million (from $403.2 million at December 31, 2007 to $381.9 million at June 30, 2008);
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | Deposits decreased $24.7 million with decreases in demand deposits, interest-bearing checking, savings and time deposits, attributed to a competitive market. The
decrease was offset slightly with increases in money markets;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our securities portfolio grew with the purchase of $33.6 million in new investments in the first six months partially offset with the sale of $11.8 million of
investments;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For the six month period ending June 30, 2008, borrowings increased $27.3 million (from $28.0 million to $55.3 million).
| | - |  | ------------------------------------------------------------------------------------------------------------------------

LOAN PORTFOLIO AND ADEQUACY OF THE ALLOWANCE FOR LOAN LOSSES

The
allowance for loan losses represents the Companys estimate of probable losses inherent in the loan portfolio, the largest asset category on the consolidated balance sheet. The determination of the allowance for loan losses requires significant
judgment and the evaluation of several factors: the ongoing review and grading of the loan portfolio, consideration of historical loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications
of loans, existing economic conditions, the fair value of underlying collateral and other qualitative and quantitative factors which could affect probable credit losses. Other allowance considerations include the use of estimates related to pools of
homogeneous loans based on historical loan loss experience and an allocation of reserves for current economic trends and conditions.

While management
utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Companys control, including the performance of the Companys loan portfolio, the economy,
changes in interest rates and regulatory guidance.



14



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##### Table of Contents

The Companys allowance for loan losses consists of three elements: (i) homogenous loan pool valuation
allowances determined in accordance with SFAS 5 based on the quantitative loan loss experience of the Bank for similar loans with similar characteristics, with additional qualitative risks based upon the best judgment of management;
(ii) specific valuation allowances determined in accordance with SFAS 114 based on probable losses on specific loans; and (iii) general valuation allowances based on existing regional and local economic factors, including insurance and tax
changes and increased market risks that may affect a particular category of loans.

On a monthly basis, management performs an analysis of the adequacy of
the loan loss allowance. The analysis uses an eight point grade system to rate the loan portfolio. The eight categories are 1-Superior, 2-Very Satisfactory, 3-Satisfactory, 4-Acceptable, 5-Adequate, 6-Special Mention, 7-Substandard, 8-Doubtful. Each
loan is assigned a rating at origination and then reviewed periodically. All significant commercial loans classified as either substandard or doubtful are reviewed at the end of each period to determine if a specific reserve
is needed for that credit. A specific reserve is very common for significant credits classified as either substandard or doubtful. The establishment of a specific reserve does not necessarily mean that the credit with the
specific reserve will definitely incur loss at the reserve level. It is only an estimation of potential loss based upon anticipated events. A general allocation is made for all other commercial loans based on factors including historical loss rate,
perceived economic conditions, recent trends in loan loss history, and concentrations of credit. These factors are reviewed and updated as necessary on a quarterly basis.

Residential and consumer loans generally are not analyzed individually. These loans are grouped into pools and assigned risk categories based on their current payment status and managements assessment of risk
inherent in the various types of loans. The allocations are based on the same factors as used for commercial loans. When appropriate, a specific reserve will be established for individual loans. During 2007, due to continued market deterioration,
the Bank deemed it necessary to begin reviewing select residential and consumer loans individually. In June 2008, a thorough review was conducted of all home equity loans over $100 thousand as the Bank considered that there was an increased risk
potential in this portion of its loan portfolio. Specifically as real estate values have declined in local markets, home equity loan charge-offs have increased over the past twelve months, totaling $1.0 million for the six months ended June 30,
2008. As a result, the Bank has conducted additional reviews of the $19.4 million home equity portfolio and has increased the reserves in that portfolio to cover anticipated losses. Based on our analysis of residential and consumer loans, the
specific allocated reserve was increased from the December 31, 2007 balance of $738 thousand to the June 30, 2008 balance of $1.7 million. A continued deterioration in real estate values could result in additional losses in the future.

The balance in the allowance for loan losses at June 30, 2008 was $12.1 million, or 3.17%, of total loans. This is an increase of $4.5 million from
the December 31, 2007 allowance balance of $7.6 million, or 1.89% of total loans. The increase in the allowance for loan losses as a percentage of total loans is primarily the result of the Banks $6.6 million provision in the first half
of 2008 offset by $2.1 million in net charge-offs. This is compared to the first six months of 2007 activity of a $477 thousand charge to the provision offset by $227 thousand in net charge-offs. The increased provision since the end of last year
was primarily due to increases in the allocation for impaired commercial ($2.3 million), residential and consumer ($.8 million) and construction mortgages ($1.3 million). Although 90% of impaired loans are performing contractually, the
collateralized value of the property securing the loans, the borrowers paying ability and the borrowers net worth may not be sufficient to cover the loan value in case of default. While management believes that the loan loss reserve was
adequate as of June 30, 2008, a continued deterioration in the economy could result in additional losses in the future.

It is our policy to
discontinue the accrual of interest income and classify a loan as nonaccrual when principal and interest is past due 90 days or more unless we determine the principal and interest on the loan are in the process of imminent collection. In all cases,
loans are placed on nonaccrual or charged-off at an earlier date if collection of principal and interest is considered doubtful. Loans are not returned to accrual status until principal and interest payments are brought current and future payments
appear reasonably certain. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is charged against interest income.



15



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##### Table of Contents

All of the Banks nonaccrual loans are considered to be impaired. A loan is considered impaired when its
determined that it is probable that all the principal and interest due under the loan may not be collectible as contractually agreed. Nonaccrual commercial real estate loans are reviewed individually for impairment. The impairment, if any, is based
upon the difference between the carrying value of the investment and the fair value of the collateral less costs to sell or the present value of estimated future cash flows.

The Banks impaired loans were $68.2 million at June 30, 2008, or 17.8% of total gross loans, compared to $31.0 million at December 31, 2007, or 7.7% of total loans. Of the $68.2 million of impaired
loans at June 30, 2008, $44.7 million were commercial and commercial real estate, $20.9 million were construction and $2.6 million were residential and consumer loans. This compares to $25.4 million commercial and commercial real estate, $3.1
million construction and $2.5 million residential and consumer loans at December 31, 2007. At June 30, 2008, $61.1 million of the impaired loans continued on accrual status and the customers are to substantiate future cash flow
projections. Management continues to monitor the worth, paying capacity and collateral pledged of the borrowers; however those loans classified as impaired are characterized by the distinct possibility that the Bank will sustain some loss if the
deficiencies are not corrected. The remaining $7.1 million of the impaired loans have discontinued accruing interest.

The Banks non-performing
assets as a percentage of total assets were 1.50% at June 30, 2008 and 1.03% at December 31, 2007. There was $7.1 million in non-performing assets at June 30, 2008, compared to $4.9 million at December 31, 2007.

ASSET / LIABILITY MANAGEMENT AND INTEREST RATE RISKS

Changes in
interest rates can substantially impact our long-term profitability and current income. An important part of our efforts to maintain long-term profitability is the management of interest rate risk. The goal is to maximize net interest income within
acceptable levels of interest rate risk and liquidity. Interest rate exposure is managed by monitoring the relationship between interest-earning assets and interest-bearing liabilities, focusing on the size, maturity or repricing date, rate of
return and degree of risk. The Banks Asset / Liability Management Committee oversees the interest rate risk management and reviews the Banks asset / liability structure on a monthly basis.

The Bank uses interest rate sensitivity analysis (GAP analysis) to monitor the amount and timing of balances exposed to changes in interest rates. The GAP
analysis is not relied upon solely to determine future reactions to interest rate changes because it is presented at one point in time and could change significantly from day-to-day.

The impact of adjustable rate loans and mortgages has been factored into the allowance for loan loss reserve. To mitigate our future risk associated with the repricing of loans, management adheres to a conservative
underwriting approach to minimize this future risk. Furthermore, management has avoided the use of certain loan products typically associated with speculative real estate financing, such as negative amortization residential real estate loans and
sub-prime lending.

LIQUIDITY AND CAPITAL RESOURCES

LIQUIDITY

The goal of liquidity management is to ensure the availability of an adequate level of funds to meet the loan demand and deposit
withdrawal needs of our customers. The Bank monitors and manages its liquidity position so that funds will be available at a reasonable cost to meet financial commitments, to finance business expansion, and to take advantage of unforeseen
opportunities. The Bank manages the levels, types, and maturities of earning assets in relation to the sources available to fund current and future needs.



16



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##### Table of Contents

For banks, liquidity represents the ability to meet both loan commitments and withdrawals of deposited funds. Funds to
meet these needs can be obtained by converting liquid assets to cash or by attracting new deposits or other sources of funding. Many factors affect a banks ability to meet liquidity needs. The Banks principal sources of funds are
deposits; payments, paydowns, and maturities on loans; payments, maturities, and sales of investments; and capital contributions by the Company. As additional sources of funds, the Bank has credit availability with the Federal Home Loan Bank
amounting to $70.6 million, of which $28.0 million was utilized as of June 30, 2008 and Federal Funds purchased lines available at correspondent banks amounting to $5.0 million, of which $2.3 million was utilized as of June 30, 2008.

CAPITAL RESOURCES

We and the Bank are subject to
various regulatory capital requirements which involve quantitative measures of our assets, liabilities, and certain off-balance sheet items. These capital requirements and classifications are ultimately subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.

Overall we and the Bank continue to maintain a well-capitalized capital position, which
is intended to support current needs and provide a sound foundation to support future expansion. The Corporations and Banks regulatory capital ratios are consistently above the well-capitalized standards. Our capital ratios
as of June 30, 2008 and December 31, 2007 are presented below.



|                                  |  |         |   |  |                  |   |  |               |        |       |                   |   |        |   |        |  |       |  
|--------------------------------- |  | ------- | - |  | ---------------- | - |  | ------------- | ------ | ----- | ----------------- | - | ------ | - | ------ |  | ----- | -
|                                  |  |         |   |  |                  |   |  | June 30, 2008 |        |       | December 31, 2007 |  
|(Dollars in thousands)            |  | Minimum |   |  | Well-capitalized |   |  | Amount        |        | Ratio |                   |   | Amount |   | Ratio  | 
|First State Financial Corporation |  |         |   |  |                  |   |  |               |        |       |                   |   |        |   |        |  |       |  
|Tier 1 capital                    |  | 4.0     | % |  | 6.0              | % |  | $             | 45,520 |       | 11.34             | % |        | $ | 49,802 |  | 11.72 | %
|Total capital                     |  | 8.0     | % |  | 10.0             | % |  |               | 50,624 |       | 12.61             | % |        |   | 54,989 |  | 12.94 | %
|Tier 1 leverage                   |  | 4.0     | % |  | 5.0              | % |  |               | 45,520 |       | 9.74              | % |        |   | 49,802 |  | 10.44 | %
|                                  |  |         |   |  |                  |  
|First State Bank                  |  |         |   |  |                  |   |  |               |        |       |                   |   |        |   |        |  |       |  
|Tier 1 capital                    |  | 4.0     | % |  | 6.0              | % |  |               | 45,063 |       | 11.20             | % |        |   | 49,275 |  | 11.60 | %
|Total capital                     |  | 8.0     | % |  | 10.0             | % |  |               | 50,168 |       | 12.48             | % |        |   | 54,462 |  | 12.82 | %
|Tier 1 leverage                   |  | 4.0     | % |  | 5.0              | % |  |               | 45,063 |       | 9.64              | % |        |   | 49,275 |  | 10.33 | %



|Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

Market
risk is the risk that a financial institutions earnings and capital, or its ability to meet its business objectives, will be adversely affected by movements in market rates or prices such as interest rates, foreign exchange rates, equity
rates, equity prices, credit spreads and/or commodity prices. The Company has assessed its market risk as predominately interest rate risk.

Interest rate
sensitivity as of June 30, 2008 was analyzed using a simulation analysis of the Companys sensitivity to changes in net interest income under varying assumptions for changes in market interest rates. Specifically, the model derives
expected interest income and interest expense resulting from gradual and parallel shifts in the yield curve. Rate changes are matched with known re-pricing intervals. The Bank uses standardized assumptions run against Bank data by an outsourced
provider of Asset/Liability reporting. The analysis indicates that, while a decreasing rate environment would cause our margin to compress, the decrease in net interest income is not as dramatic as the increase we would receive in a rising rate
environment. This is primarily due to the Banks ability to manage its liabilities. Competition for deposits in the Banks market areas is intense. By managing maturities and rates as well as looking to other sources of funding, such as
advances from the Federal Home Loan Bank, we attempt to control the compression on our interest rate margin in such a way as to cushion the effect of a declining rate environment.

The Companys simulation analysis has its limitations, as the assumptions are inherently uncertain and subject to fluctuation and revision in a dynamic environment and as a result the model cannot perfectly
forecast net interest income, nor exactly predict the impact of higher or lower interest rates on net



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interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of balance sheet components and interest rate
changes, market conditions and management strategies, among other factors.



|Item 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

Disclosure Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rule 13a-15 of the Securities
Exchange Act of 1934, that are designed to cause the material information required to be disclosed by the Bank in the reports it files or submits under the Securities Exchange Act of 1934 to be recorded, processed, summarized and reported within the
time periods specified by the Securities and Exchange Commissions rules and forms. In designing and evaluating the disclosure controls and procedures, management recognized that a control design, no matter how well operated, can provide only
reasonable, not absolute, assurance that the objectives of the control design are met. Due to inherent limitations in all control designs, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if
any, within a company have been detected.

Under the supervision and with the participation of management, including the Chief Executive Officer and Chief
Financial Officer our controls and procedures in place as of the end of the period covered by this report were evaluated. They concluded that our disclosure controls and procedures were effective. No significant material weaknesses in the design or
operation of internal controls which could adversely affect our ability to record, process, summarize, and report financial data have been identified. We made no significant changes in our internal disclosure controls and procedures or in other
factors that could significantly affect these controls subsequent to the date of evaluation by management, including the Chief Executive Officer and Chief Financial Officer.

Changes in Internal Control over Financial Reporting

As of the end of the period covered by this report, we
performed an evaluation under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our internal control over financial
reporting pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, enhancements were made to the financial reporting process, however no changes were made that were considered material or reasonably likely to
materially affect, the Banks internal control over financial reporting.

PART II



|Item 1. | LEGAL PROCEEDINGS
|------- | -----------------

None



|Item 1A. | RISK FACTORS
|-------- | ------------

In addition to other information set
forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2007, which could materially affect our business, financial
condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may adversely
affect our business, financial condition and/or operating results.



|Item 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

None



|Item 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------

None



|Item 4. | SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
|------- | -------------------------------------------------

None



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|Item 5. | OTHER INFORMATION
|------- | -----------------

None



|Item 6. | EXHIBITS
|------- | --------

Exhibit 31.1  Chief Executive
Officers certification required under Section 302 of Sarbanes-Oxley Act of 2002

Exhibit 31.2  Chief Financial Officers
certification required under Section 302 of Sarbanes-Oxley Act of 2002

Exhibit 32  Chief Executive Officers and Chief Financial
Officers certification required under Section 906 of Sarbanes-Oxley Act of 2002

SIGNATURES

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

Date: August 4, 2008



FIRST STATE FINANCIAL CORPORATION/s/ John E. Jed WilkinsonJohn E. Jed WilkinsonPresident and Chief Executive Officer/s/ Dennis GrinsteinerDennis GrinsteinerExecutive Vice President and Chief Financial Officer




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