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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 September 30, 2006

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: 333-119800

FIRST STATE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Florida                                                        |  | 65-07714145                         
|(State or other jurisdiction or 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, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act. (Check one):

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer  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 November 13, 2006, the registrant had outstanding 5,874,450 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 Consolidated Financial Statements                             |  | 5 
|                               |  |                                                                                 
|Item 2 -                       |  | Managements Discussion and Analysis                                             |  | 7 
|                               |  |                                                                                 
|Item 3 -                       |  | Quantitative and Qualitative Disclosures About Market Risk                       |  | 15
|                               |  |                                                                                 
|Item 4 -                       |  | Controls and Procedures                                                          |  | 15
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                 
|                               |  |                                                                                 
|Item 1 -                       |  | Legal Proceedings                                                                |  | 16
|                               |  |                                                                                 
|Item 1A -                      |  | Risk Factors                                                                     |  | 16
|                               |  |                                                                                 
|Item 2 -                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                      |  | 16
|                               |  |                                                                                 
|Item 3 -                       |  | Defaults Upon Senior Securities                                                  |  | 16
|                               |  |                                                                                 
|Item 4 -                       |  | Submission of Matters to Vote of Securities Holders                              |  | 16
|                               |  |                                                                                 
|Item 5 -                       |  | Other Information                                                                |  | 16
|                               |  |                                                                                 
|Item 6 -                       |  | Exhibits                                                                         |  | 16
|                               | 
|Signatures                     |  | 17                                                                              
|                               |  |                                                                                 
|Exhibit 31.1-                  |  | Section 302 Certification of Chief Executive Officer                             |  |   
|                               |  |                                                                                 
|Exhibit 31.2-                  |  | Section 302 Certification of Chief Financial Officer                             |  |   
|                               |  |                                                                                 
|Exhibit 32-                    |  | Section 906 Certification by Chief Executive Officer and Chief Financial Officer |  |   



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FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

September 30, 2006 (unaudited) and December 31, 2005

(Dollar amounts in thousands except per share data)



|                                                                                              |  |                   |         |   |                  |   |         |  
|--------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                              |  | September 30,2006 |         |   | December 31,2005 |  
|ASSETS                                                                                        |  |                   |         |  
|Cash and due from financial institutions                                                      |  | $                 | 6,499   |   |                  | $ | 5,883   |  
|Federal funds sold                                                                            |  |                   | 24,867  |   |                  |   | 362     |  
|                                                                                              |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                                                                     |  |                   | 31,366  |   |                  |   | 6,245   |  
|Interest bearing deposits in other financial institutions                                     |  |                   | 150     |   |                  |   | 150     |  
|Securities, available for sale                                                                |  |                   | 25,282  |   |                  |   | 20,361  |  
|Loans, net of allowance of $4,154 and $3,397                                                  |  |                   | 369,263 |   |                  |   | 334,594 |  
|Federal Home Loan Bank stock                                                                  |  |                   | 880     |   |                  |   | 1,178   |  
|Premise and equipment, net                                                                    |  |                   | 4,607   |   |                  |   | 4,596   |  
|Accrued interest and other assets                                                             |  |                   | 6,386   |   |                  |   | 5,565   |  
|                                                                                              |  |                   |         |   |                  |   |         |  
|Total Assets                                                                                  |  | $                 | 437,934 |   |                  | $ | 372,689 |  
|                                                                                              |  |                   |         |   |                  |   |         |  
|LIABILITIES and STOCKHOLDERS EQUITY                                                          |  |                   |         |   |                  |   |         |  
|Deposits                                                                                      |  |                   |         |   |                  |   |         |  
|Demand                                                                                        |  | $                 | 43,887  |   |                  | $ | 44,574  |  
|Interest-bearing checking                                                                     |  |                   | 15,796  |   |                  |   | 16,240  |  
|Money market                                                                                  |  |                   | 32,208  |   |                  |   | 48,147  |  
|Savings                                                                                       |  |                   | 22,843  |   |                  |   | 13,548  |  
|Time                                                                                          |  |                   | 270,665 |   |                  |   | 190,116 |  
|                                                                                              |  |                   |         |   |                  |   |         |  
|Total deposits                                                                                |  |                   | 385,399 |   |                  |   | 312,625 |  
|Accrued interest payable and other liabilities                                                |  |                   | 2,030   |   |                  |   | 1,579   |  
|Federal Home Loan Bank advances & other borrowings                                            |  |                   | 3,001   |   |                  |   | 14,001  |  
|                                                                                              |  |                   |         |   |                  |   |         |  
|Total Liabilities                                                                             |  |                   | 390,430 |   |                  |   | 328,205 |  
|Stockholders Equity                                                                          |  |                   |         |   |                  |   |         |  
|Common stock, $1 par value; 25,000,000 shares authorized;                                     |  |                   |         |   |                  |   |         |  
|5,874,050 shares issued at September 30, 2006 and 5,863,265 share issued at December 31, 2005 |  |                   | 5,874   |   |                  |   | 5,863   |  
|Additional paid-in capital                                                                    |  |                   | 31,943  |   |                  |   | 31,763  |  
|Retained earnings                                                                             |  |                   | 9,875   |   |                  |   | 7,231   |  
|Accumulated other comprehensive income (loss)                                                 |  |                   | (188    | ) |                  |   | (373    | )
|                                                                                              |  |                   |         |   |                  |   |         |  
|Total Stockholders Equity                                                                    |  |                   | 47,504  |   |                  |   | 44,484  |  
|                                                                                              |  |                   |         |   |                  |   |         |  
|Total Liabilities and Stockholders Equity                                                    |  | $                 | 437,934 |   |                  | $ | 372,689 |  
|                                                                                              |  |                   |         |   |                  |   |         |  

See Notes to 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 September 30, |           | Nine months ended September 30,
|                                                     |  | 2006                             |           | 2005                            |   | 2006      |  | 2005
|Interest and Dividend Income                         |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Loans, including fees                                |  | $                                | 7,827     |                                 | $ | 5,209     |  | $    | 21,884    |  | $ | 13,740   
|Taxable securities                                   |  |                                  | 186       |                                 |   | 159       |  |      | 532       |  |   | 475      
|Tax exempt securities                                |  |                                  | 77        |                                 |   | 22        |  |      | 207       |  |   | 34       
|Federal funds sold and other                         |  |                                  | 128       |                                 |   | 19        |  |      | 183       |  |   | 264      
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|                                                     |  |                                  | 8,218     |                                 |   | 5,409     |  |      | 22,806    |  |   | 14,513   
|Interest expense                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Deposits                                             |  |                                  | 3,558     |                                 |   | 1,774     |  |      | 9,016     |  |   | 4,704    
|Federal Home Loan Bank advances and other borrowings |  |                                  | 77        |                                 |   | 80        |  |      | 452       |  |   | 268      
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|                                                     |  |                                  | 3,635     |                                 |   | 1,854     |  |      | 9,468     |  |   | 4,972    
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Net Interest Income                                  |  |                                  | 4,583     |                                 |   | 3,555     |  |      | 13,338    |  |   | 9,541    
|Provision for loan losses                            |  |                                  | 305       |                                 |   | 255       |  |      | 985       |  |   | 480      
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Net interest income after provision for loan losses  |  |                                  | 4,278     |                                 |   | 3,300     |  |      | 12,353    |  |   | 9,061    
|Non-interest income                                  |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Service charges and other fees                       |  |                                  | 350       |                                 |   | 268       |  |      | 963       |  |   | 743      
|Mortgage banking fees                                |  |                                  | 396       |                                 |   | 261       |  |      | 1,104     |  |   | 767      
|Other                                                |  |                                  | 38        |                                 |   | 12        |  |      | 114       |  |   | 29       
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|                                                     |  |                                  | 784       |                                 |   | 541       |  |      | 2,181     |  |   | 1,539    
|Non-interest expense                                 |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Salaries and employee benefits                       |  |                                  | 1,841     |                                 |   | 1,432     |  |      | 5,229     |  |   | 3,884    
|Occupancy and equipment                              |  |                                  | 402       |                                 |   | 310       |  |      | 1,161     |  |   | 865      
|Data processing                                      |  |                                  | 136       |                                 |   | 129       |  |      | 417       |  |   | 377      
|Professional services                                |  |                                  | 92        |                                 |   | 49        |  |      | 182       |  |   | 145      
|Stationery and supplies                              |  |                                  | 46        |                                 |   | 46        |  |      | 137       |  |   | 120      
|Advertising and marketing                            |  |                                  | 70        |                                 |   | 86        |  |      | 262       |  |   | 205      
|Other                                                |  |                                  | 344       |                                 |   | 246       |  |      | 960       |  |   | 814      
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|                                                     |  |                                  | 2,931     |                                 |   | 2,298     |  |      | 8,348     |  |   | 6,410    
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Income before income taxes                           |  |                                  | 2,131     |                                 |   | 1,543     |  |      | 6,186     |  |   | 4,190    
|Income tax expense                                   |  |                                  | 752       |                                 |   | 579       |  |      | 2,310     |  |   | 1,575    
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Net Income                                           |  | $                                | 1,379     |                                 | $ | 964       |  | $    | 3,876     |  | $ | 2,615    
|                                                     |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Earnings per share                                   |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Basic                                                |  | $                                | 0.24      |                                 | $ | 0.16      |  | $    | 0.66      |  | $ | 0.44     
|Diluted                                              |  | $                                | 0.23      |                                 | $ | 0.16      |  | $    | 0.66      |  | $ | 0.44     
|Average common shares outstanding                    |  |                                  |           |                                 |   |           |  |      |           |  |   |          
|Basic                                                |  |                                  | 5,870,841 |                                 |   | 5,863,265 |  |      | 5,866,584 |  |   | 5,859,701
|Diluted                                              |  |                                  | 5,920,663 |                                 |   | 5,899,147 |  |      | 5,909,451 |  |   | 5,885,761
|Dividends per share                                  |  | $                                | 0.08      |                                 | $ | 0.05      |  | $    | 0.21      |  | $ | 0.15     

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    |  | Common Stock |       | Additional Paid-in Capital |   |        | Retained Earnings |  |   | Accum. Other Comprehensive Income
(Loss) |   |  | Total |     
|Balance at December 31, 2004                                                                         |  | 5,856,265 |  | $            | 5,856 |                            | $ | 31,860 |                   |  | $ | 4,566                                    |   |  | $     | (129 | ) |  | $ | 42,153 |  
|Comprehensive income:                                                                                |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Net income                                                                                           |  |           |  |              |       |                            |   |        |                   |  |   | 2,615                                    |   |  |       |      |   |  |   | 2,615  |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of tax effects |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       | (149 | ) |  |   | (149   | )
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   | 2,466  |  
|Capitalization of offering costs                                                                     |  |           |  |              |       |                            |   | (109   | )                 |  |   |                                          |   |  |       |      |   |  |   | (109   | )
|Exercise of stock options                                                                            |  | 7,000     |  |              | 7     |                            |   | 12     |                   |  |   |                                          |   |  |       |      |   |  |   | 19     |  
|Cash dividend, $0.15 per share                                                                       |  |           |  |              |       |                            |   |        |                   |  |   | (879                                     | ) |  |       |      |   |  |   | (879   | )
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Balance at September 30, 2005                                                                        |  | 5,863,265 |  | $            | 5,863 |                            | $ | 31,763 |                   |  | $ | 6,302                                    |   |  | $     | (278 | ) |  | $ | 43,650 |  
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Balance at December 31, 2005                                                                         |  | 5,863,265 |  | $            | 5,863 |                            | $ | 31,763 |                   |  | $ | 7,231                                    |   |  | $     | (373 | ) |  | $ | 44,484 |  
|Comprehensive income:                                                                                |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Net income                                                                                           |  |           |  |              |       |                            |   |        |                   |  |   | 3,876                                    |   |  |       |      |   |  |   | 3,876  |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of tax effects |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       | 185  |   |  |   | 185    |  
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   | 4,061  |  
|Stock based compensation                                                                             |  |           |  |              |       |                            |   | 97     |                   |  |   |                                          |   |  |       |      |   |  |   | 97     |  
|Exercise of stock options                                                                            |  | 10,785    |  |              | 11    |                            |   | 83     |                   |  |   |                                          |   |  |       |      |   |  |   | 94     |  
|Cash dividend, $0.21 per share                                                                       |  |           |  |              |       |                            |   |        |                   |  |   | (1,232                                   | ) |  |       |      |   |  |   | (1,232 | )
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Balance at September 30, 2006                                                                        |  | 5,874,050 |  | $            | 5,874 |                            | $ | 31,943 |                   |  | $ | 9,875                                    |   |  | $     | (188 | ) |  | $ | 47,504 |  
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Balance at June 30, 2005                                                                             |  | 5,863,265 |  | $            | 5,863 |                            | $ | 31,763 |                   |  | $ | 5,631                                    |   |  | $     | (148 | ) |  | $ | 43,109 |  
|Comprehensive income:                                                                                |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Net income                                                                                           |  |           |  |              |       |                            |   |        |                   |  |   | 964                                      |   |  |       |      |   |  |   | 964    |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of tax effects |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       | (130 | ) |  |   | (130   | )
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   | 834    |  
|Cash dividend, $0.05 per share                                                                       |  |           |  |              |       |                            |   |        |                   |  |   | (293                                     | ) |  |       |      |   |  |   | (293   | )
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Balance at September 30, 2005                                                                        |  | 5,863,265 |  | $            | 5,863 |                            | $ | 31,763 |                   |  | $ | 6,302                                    |   |  | $     | (278 | ) |  | $ | 43,650 |  
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Balance at June 30, 2006                                                                             |  | 5,866,850 |  | $            | 5,867 |                            | $ | 31,860 |                   |  | $ | 8,966                                    |   |  | $     | (687 | ) |  | $ | 46,006 |  
|Comprehensive income:                                                                                |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Net income                                                                                           |  |           |  |              |       |                            |   |        |                   |  |   | 1,379                                    |   |  |       |      |   |  |   | 1,379  |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of tax effects |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       | 499  |   |  |   | 499    |  
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   | 1,878  |  
|Stock based compensation                                                                             |  |           |  |              |       |                            |   | 29     |                   |  |   |                                          |   |  |       |      |   |  |   | 29     |  
|Exercise of stock options                                                                            |  | 7,200     |  |              | 7     |                            |   | 54     |                   |  |   |                                          |   |  |       |      |   |  |   | 61     |  
|Cash dividend, $0.08 per share                                                                       |  |           |  |              |       |                            |   |        |                   |  |   | (470                                     | ) |  |       |      |   |  |   | (470   | )
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  
|Balance at September 30, 2006                                                                        |  | 5,874,050 |  | $            | 5,874 |                            | $ | 31,943 |                   |  | $ | 9,875                                    |   |  | $     | (188 | ) |  | $ | 47,504 |  
|                                                                                                     |  |           |  |              |       |                            |   |        |                   |  |   |                                          |   |  |       |      |   |  |   |        |  

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

Nine Months Ended September 30, 2006 and 2005

(Unaudited)

(Dollar amounts in thousands)



|                                                                          |  |      |         |   |      |   |         |  
|------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                          |  | 2006 |         |   | 2005 |  
|Cash flows from operating activities:                                     |  |      |         |   |      |   |         |  
|Net income                                                                |  | $    | 3,876   |   |      | $ | 2,615   |  
|Adjustments to reconcile net income to net cash from operating activities |  |      |         |   |      |   |         |  
|Provision for loan losses                                                 |  |      | 985     |   |      |   | 480     |  
|Depreciation                                                              |  |      | 320     |   |      |   | 277     |  
|Net amortization of securities                                            |  |      | 31      |   |      |   | 67      |  
|Stock compensation expense                                                |  |      | 97      |   |      |   |        |  
|Net change in:                                                            |  |      |         |   |      |   |         |  
|Other assets                                                              |  |      | (911    | ) |      |   | (397    | )
|Accrued expenses and other liabilities                                    |  |      | 449     |   |      |   | (38     | )
|                                                                          |  |      |         |   |      |   |         |  
|Net cash from operating activities                                        |  |      | 4,847   |   |      |   | 3,004   |  
|Cash flows from investing activities:                                     |  |      |         |   |      |   |         |  
|Available-for-sale securities:                                            |  |      |         |   |      |   |         |  
|Maturities, prepayments and calls                                         |  |      | 1,726   |   |      |   | 3,431   |  
|Purchases                                                                 |  |      | (6,401  | ) |      |   | (6,036  | )
|Loan originations and payments, net                                       |  |      | (35,654 | ) |      |   | (76,112 | )
|Net sale of FHLB stock                                                    |  |      | 298     |   |      |   | 366     |  
|Net change in premise and equipment                                       |  |      | (331    | ) |      |   | (575    | )
|                                                                          |  |      |         |   |      |   |         |  
|Net cash from investing activities                                        |  |      | (40,362 | ) |      |   | (78,926 | )
|Cash flows from financing activities:                                     |  |      |         |   |      |   |         |  
|Net change in deposits                                                    |  |      | 72,774  |   |      |   | 68,591  |  
|Net change in short-term borrowing                                        |  |      | (11,000 | ) |      |   | 6,100   |  
|Repayment of long-term borrowing                                          |  |      | (10,000 | ) |      |   | (15,000 | )
|Proceeds from long-term borrowing                                         |  |      | 10,000  |   |      |   |        |  
|Proceeds from exercise of stock options                                   |  |      | 94      |   |      |   | 19      |  
|Proceeds from issuance of common stock, net of capitalized costs          |  |      |        |   |      |   | (109    | )
|Cash dividend paid                                                        |  |      | (1,232  | ) |      |   | (879    | )
|                                                                          |  |      |         |   |      |   |         |  
|Net cash from financing activities                                        |  |      | 60,636  |   |      |   | 58,722  |  
|Net change in cash and cash equivalents                                   |  |      | 25,121  |   |      |   | (17,200 | )
|Beginning cash and cash equivalents                                       |  |      | 6,245   |   |      |   | 24,852  |  
|                                                                          |  |      |         |   |      |   |         |  
|Ending cash and cash equivalents                                          |  | $    | 31,366  |   |      | $ | 7,652   |  
|                                                                          |  |      |         |   |      |   |         |  
|Supplemental cash flow information                                        |  |      |         |   |      |   |         |  
|Interest paid                                                             |  | $    | 9,192   |   |      | $ | 4,880   |  
|Income taxes paid                                                         |  |      | 2,827   |   |      |   | 1,471   |  

See Notes to Condensed Consolidated Financial Statements



4



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##### Table of Contents

FIRST STATE FINANCIAL CORPORATION

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2006

(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 principals 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 nine months ended
September 30, 2006 are not necessarily indicative of the results that may be expected for the full year of 2006.

NOTE 2  NEW ACCOUNTING
STANDARDS

In July 2006 the Financial Accounting Standards Board issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes, an Interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48 revises the recognition tests for tax positions taken in tax returns such that a tax benefit is recorded only when it is more likely than not that the
tax position will be allowed upon examination by taxing authorities. The amount of such a tax benefit to record is the largest amount that is more likely than not to be allowed. Any reduction in deferred tax assets or increase in tax liabilities
upon adoption will correspondingly reduce retained earnings. The Bank has not yet determined the effect of adopting this Interpretation, if any. FIN 48 is effective for fiscal years beginning after December 15, 2006.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). Due to diversity in
practice among registrants, SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. The Company has not
yet determined the effect of implementing this pronouncement, which is effective for fiscal years ending after November 15, 2006.

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. Share awards 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).

The fair value of each option award is
estimated on the date of grant using the Black-Scholes option-pricing model. Because the Companys stock has not been traded publicly long enough to produce a reliable volatility estimate, a peer-group index is used. Expected term is based on a
calculation provided for by the Securities and Exchange Commissions Staff Accounting Bulletin 107 which recognizes a lack of historical data and offers a simplified method of computing expected term. The risk-free rate of the award is
based on the U.S. Treasury yield curve in effect at the time of grant.

During the quarter ended September 30, 2006 and the previous quarter ended
June 30, 2006 the Company did not grant stock options. Additionally, the Company did not grant stock options during the third quarter of 2005.

During
the quarter ended September 30, 2006, no options vested and 7,200 options were exercised. During the previous quarter ended June 30, 2006, 22,460 options vested and 3,585 options were exercised. No options vested and no options were
exercised during the quarter ended September 30, 2005.



5



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##### Table of Contents

A summary of share option activity under the Plan as of September 30, 2006 is as follows:



|                                        |  |                         |  |                              |       |                                                    |      |                                       |   |      
|--------------------------------------- |  | ----------------------- |  | ---------------------------- | ----- | -------------------------------------------------- | ---- | ------------------------------------- | - | -----
|                                        |  | StockOptionsOutstanding |  | WeightedAverageExercisePrice |       | Weighted-AverageRemainingContractualLife(in years) |      | AggregateIntrinsicValue(in thousands)
|Options outstanding, December 31, 2005  |  | 160,000                 |  | $                            | 9.68  |                                                    |      |                                       |   |      
|Granted                                 |  | 28,000                  |  |                              | 15.50 |                                                    |      |                                       |   |      
|Exercised                               |  | 10,785                  |  |                              | 3.61  |                                                    |      |                                       |   |      
|Forfeited or expired                    |  |                        |  |                              |      |                                                    |      |                                       |   |      
|                                        |  |                         |  |                              |       |                                                    |      |                                       |   |      
|Options outstanding, September 30, 2006 |  | 177,215                 |  | $                            | 10.93 |                                                    | 8.07 |                                       | $ | 1,208
|                                        |  |                         |  |                              |       |                                                    |      |                                       |   |      
|Options exercisable, September 30, 2006 |  | 51,775                  |  | $                            | 7.92  |                                                    | 6.91 |                                       | $ | 509  
|                                        |  |                         |  |                              |       |                                                    |      |                                       |   |      

Prior to January 1, 2006, the Company reported employee compensation expense under stock options using the
intrinsic value method. No stock-based compensation cost was reflected in net income. All options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. On September 30, 2005,
the Company reported net income of $2,615,000. Stock-based compensation expense determined under the fair value method, net of tax, represented $44,000 resulting in a pro forma net income for the nine months ended September 30, 2005 of
$2,571,000. Reported earnings per share, as well as pro forma earnings per share, were 44 cents. Reported diluted earnings per share, as well as pro forma diluted earnings per share, were also 44 cents.

For the third quarter of 2005, reported net income was $964,000. Stock-based compensation expense determined under the fair value method, net of tax, represented
$21,000, resulting in a pro forma net income for the third quarter of 2005 of $943,000. Reported earnings per share for the quarter, as well as pro forma earnings per share, were 16 cents. Reported diluted earnings per share for the quarter, as well
as pro forma diluted earnings per share, were also 16 cents.

For the nine months ended September 30, 2006, $97,000 in compensation cost related to
the Companys stock option plan was recorded in net income, $29,000 of which was recorded in the third quarter. As of September 30, 2006, $178,000 in unrecognized compensation costs remained to be recognized over a weighted-average period
of 2.5 years. All stock option compensation costs recognized in the first nine months of 2006 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):



|                              |  |                   |         |   |                  |   |         |  
|----------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                              |  | September 30,2006 |         |   | December 31,2005 |  
|Commercial                    |  | $                 | 54,971  |   |                  | $ | 54,923  |  
|Real estate:                  |  |                   |         |   |                  |   |         |  
|Residential                   |  |                   | 60,241  |   |                  |   | 44,106  |  
|Commercial                    |  |                   | 192,067 |   |                  |   | 186,578 |  
|Construction                  |  |                   | 54,447  |   |                  |   | 45,084  |  
|Consumer and other            |  |                   | 13,226  |   |                  |   | 8,849   |  
|                              |  |                   |         |   |                  |   |         |  
|                              |  |                   | 374,952 |   |                  |   | 339,540 |  
|Less: deferred loan fees, net |  |                   | (1,535  | ) |                  |   | (1,549  | )
|allowance for loan losses     |  |                   | (4,154  | ) |                  |   | (3,397  | )
|                              |  |                   |         |   |                  |   |         |  
|Total loans, net              |  | $                 | 369,263 |   |                  | $ | 334,594 |  
|                              |  |                   |         |   |                  |   |         |  



6



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##### Table of Contents

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



|                                |  |                                    |       |   |                   |   |       |  
|------------------------------- |  | ---------------------------------- | ----- | - | ----------------- | - | ----- | -
|                                |  | Activity for the nine months ended |      
|                                |  | September 30,2006                  |       |   | September 30,2005 |  
|Balance, beginning of period    |  | $                                  | 3,397 |   |                   | $ | 2,727 |  
|Provision charged to operations |  |                                    | 985   |   |                   |   | 480   |  
|Loans charged off               |  |                                    | (263  | ) |                   |   | (108  | )
|Recoveries                      |  |                                    | 35    |   |                   |   | 81    |  
|                                |  |                                    |       |   |                   |   |       |  
|Balance, end of period          |  | $                                  | 4,154 |   |                   | $ | 3,180 |  
|                                |  |                                    |       |   |                   |   |       |  

Impaired loans were as follows (in thousands):



|                                                  |  |                                            |       |                  |   |      
|------------------------------------------------- |  | ------------------------------------------ | ----- | ---------------- | - | -----
|                                                  |  | Year-to-date activity for the period ended
|                                                  |  | September 30,2006                          |       | December 31,2005
|Loans with no allocated allowance for loan losses |  | $                                          | 459   |                  | $ | 25   
|Loans with allocated allowance for loan losses    |  |                                            | 7,041 |                  |   | 4,707
|                                                  |  |                                            |       |                  |   |      
|                                                  |  | $                                          | 7,500 |                  | $ | 4,732
|                                                  |  |                                            |       |                  |   |      
|Amount of the allowance for loan losses allocated |  | $                                          | 1,710 |                  | $ | 1,288
|                                                  |  |                                            |       |                  |   |      



|Item 2. | MANAGEMENT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 nine months ended
September 30, 2006. It should be read in conjunction with the unaudited Consolidated Financial Statement and Notes included elsewhere in this report and the audited Consolidated Financial Statements and Notes contained in the Corporations
2005 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 2005 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 is committed to growing by:



| |  |  | 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; and
| | - |  | --------------------------------------------------------------



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



7



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Our success in serving our customers is seen in the following changes since the beginning of 2006:



| |  |  | A 10.4% increase in net loan production (new loans less repayments);
| | - |  | --------------------------------------------------------------------



| |  |  | A 1.5% decrease in non-interest bearing deposits; and
| | - |  | -----------------------------------------------------



| |  |  | A 27.4% increase in interest bearing deposits.
| | - |  | ----------------------------------------------

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 ended September 30, |       |      | Nine months ended September 30, |       
|                                    |  |                                  |       |      |                                 | change |  |   |       |  |      |   | change |  
|(Dollars in thousands)              |  | 2006                             |       | 2005 |                                 | $      |  | % |       |  | 2006 |   | 2005   |   | $      |  | % |       
|Interest income                     |  | $                                | 8,218 |      | $                               | 5,409  |  | $ | 2,809 |  | 52   | % |        | $ | 22,806 |  | $ | 14,513 |  | $ | 8,293 |  | 57  | %
|Interest expense                    |  |                                  | 3,635 |      |                                 | 1,854  |  |   | 1,781 |  | 96   | % |        |   | 9,468  |  |   | 4,972  |  |   | 4,496 |  | 90  | %
|                                    |  |                                  |       |      |                                 |        |  |   |       |  |      |   |        |   |        |  |   |        |  |   |       |  |     |  
|Net interest income                 |  |                                  | 4,583 |      |                                 | 3,555  |  |   | 1,028 |  | 29   | % |        |   | 13,338 |  |   | 9,541  |  |   | 3,797 |  | 40  | %
|Provision for loan losses           |  |                                  | 305   |      |                                 | 255    |  |   | 50    |  | 20   | % |        |   | 985    |  |   | 480    |  |   | 505   |  | 105 | %
|                                    |  |                                  |       |      |                                 |        |  |   |       |  |      |   |        |   |        |  |   |        |  |   |       |  |     |  
|Net interest income after provision |  |                                  | 4,278 |      |                                 | 3,300  |  |   | 978   |  | 30   | % |        |   | 12,353 |  |   | 9,061  |  |   | 3,292 |  | 36  | %
|Non-interest income                 |  |                                  | 784   |      |                                 | 541    |  |   | 243   |  | 45   | % |        |   | 2,181  |  |   | 1,539  |  |   | 642   |  | 42  | %
|Non-interest expense                |  |                                  | 2,931 |      |                                 | 2,298  |  |   | 633   |  | 28   | % |        |   | 8,348  |  |   | 6,410  |  |   | 1,938 |  | 30  | %
|                                    |  |                                  |       |      |                                 |        |  |   |       |  |      |   |        |   |        |  |   |        |  |   |       |  |     |  
|Income before income taxes          |  |                                  | 2,131 |      |                                 | 1,543  |  |   | 588   |  | 38   | % |        |   | 6,186  |  |   | 4,190  |  |   | 1,996 |  | 48  | %
|Income tax expense                  |  |                                  | 752   |      |                                 | 579    |  |   | 173   |  | 30   | % |        |   | 2,310  |  |   | 1,575  |  |   | 735   |  | 47  | %
|                                    |  |                                  |       |      |                                 |        |  |   |       |  |      |   |        |   |        |  |   |        |  |   |       |  |     |  
|Net income                          |  | $                                | 1,379 |      | $                               | 964    |  | $ | 415   |  | 43   | % |        | $ | 3,876  |  | $ | 2,615  |  | $ | 1,261 |  | 48  | %
|                                    |  |                                  |       |      |                                 |        |  |   |       |  |      |   |        |   |        |  |   |        |  |   |       |  |     |  



8



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##### Table of Contents

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 nine months ended September 30, |        
|                                         |  | 2006                                    |         |                | 2005 |             
|(Dollars in thousands)                   |  | AverageBalances                         |         | Income/Expense |      | Yields/Rates |  |      | AverageBalances |  | Income/Expense |         | Yields/Rates |  
|Assets:                                  |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Earnings assets:                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Loans (1)                                |  | $                                       | 358,810 |                | $    | 21,884       |  | 8.15 | %               |  | $              | 258,701 |              | $ | 13,740 |  | 7.10 | %
|Investment securities, taxable           |  |                                         | 16,353  |                |      | 532          |  | 4.35 | %               |  |                | 17,518  |              |   | 475    |  | 3.63 | %
|Investment securities, non-taxable (2)   |  |                                         | 6,631   |                |      | 282          |  | 5.69 | %               |  |                | 1,102   |              |   | 46     |  | 5.58 | %
|Other                                    |  |                                         | 4,851   |                |      | 183          |  | 5.04 | %               |  |                | 12,062  |              |   | 264    |  | 2.93 | %
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total interest earning assets            |  |                                         | 386,645 |                |      | 22,881       |  | 7.91 | %               |  |                | 289,383 |              |   | 14,525 |  | 6.71 | %
|Non-interest earning assets              |  |                                         | 16,674  |                |      |              |  |      |                 |  |                | 12,379  |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total assets                             |  | $                                       | 403,319 |                |      |              |  |      |                 |  | $              | 301,762 |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Liabilities:                             |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Interest bearing liabilities:            |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|NOW accounts                             |  | $                                       | 16,612  |                | $    | 129          |  | 1.03 | %               |  | $              | 14,230  |              | $ | 30     |  | 0.28 | %
|Money market                             |  |                                         | 34,797  |                |      | 835          |  | 3.21 | %               |  |                | 40,184  |              |   | 605    |  | 2.01 | %
|Savings                                  |  |                                         | 22,859  |                |      | 463          |  | 2.71 | %               |  |                | 9,277   |              |   | 51     |  | 0.74 | %
|Time deposits                            |  |                                         | 228,128 |                |      | 7,588        |  | 4.45 | %               |  |                | 151,860 |              |   | 4,018  |  | 3.54 | %
|Borrowings                               |  |                                         | 11,193  |                |      | 453          |  | 5.41 | %               |  |                | 8,241   |              |   | 268    |  | 4.35 | %
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total interest bearing liabilities       |  |                                         | 313,589 |                |      | 9,468        |  | 4.04 | %               |  |                | 223,792 |              |   | 4,972  |  | 2.97 | %
|Demand deposits                          |  |                                         | 41,491  |                |      |              |  |      |                 |  |                | 33,666  |              |   |        |  |      |  
|Other non-interest bearing liabilities   |  |                                         | 2,013   |                |      |              |  |      |                 |  |                | 1,301   |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total non-interest bearing liabilities   |  |                                         | 43,504  |                |      |              |  |      |                 |  |                | 34,967  |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Stockholders equity                     |  |                                         | 46,226  |                |      |              |  |      |                 |  |                | 43,003  |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total liabilities & stockholders equity |  | $                                       | 403,319 |                |      |              |  |      |                 |  | $              | 301,762 |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Net Interest Income                      |  |                                         |         |                | $    | 13,413       |  |      |                 |  |                |         |              | $ | 9,553  |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Net Interest Margin (3)                  |  |                                         |         |                |      |              |  | 4.64 | %               |  |                |         |              |   |        |  | 4.41 | %



|(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
|--- | -------------------------------------------------------------------------------------------



9



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##### Table of Contents

The table below details the components of the changes in net interest income for the nine months ended September 30,
2006 and September 30, 2005. 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 nine months ended September 30, 2006Compared to 2005 |      
|                                         |  | Increase (decrease) due tochange in                          |       |   |            
|(Dollars in thousands)                   |  | AverageVolume                                                |       |   | AverageRate |   | Net Increase(Decrease) | 
|Increase (decrease) in interest income:  |  |                                                              |       |   |             |   |                        |  |   |       |  
|Loans                                    |  | $                                                            | 5,887 |   |             | $ | 2,257                  |  | $ | 8,144 |  
|Investment securities, taxable           |  |                                                              | (33   | ) |             |   | 90                     |  |   | 57    |  
|Investment securities, non-taxable (1)   |  |                                                              | 235   |   |             |   | 1                      |  |   | 236   |  
|Other                                    |  |                                                              | (209  | ) |             |   | 128                    |  |   | (81   | )
|                                         |  |                                                              |       |   |             |   |                        |  |   |       |  
|Total interest income                    |  |                                                              | 5,880 |   |             |   | 2,476                  |  |   | 8,356 |  
|                                         |  |                                                              |       |   |             |   |                        |  |   |       |  
|Increase (decrease) in interest expense: |  |                                                              |       |   |             |   |                        |  |   |       |  
|NOW accounts                             |  |                                                              | 6     |   |             |   | 92                     |  |   | 98    |  
|Money market                             |  |                                                              | (90   | ) |             |   | 320                    |  |   | 230   |  
|Savings                                  |  |                                                              | 145   |   |             |   | 267                    |  |   | 412   |  
|Time deposits                            |  |                                                              | 2,362 |   |             |   | 1,209                  |  |   | 3,571 |  
|Borrowings                               |  |                                                              | 110   |   |             |   | 75                     |  |   | 185   |  
|                                         |  |                                                              |       |   |             |   |                        |  |   |       |  
|Total interest expense                   |  |                                                              | 2,533 |   |             |   | 1,963                  |  |   | 4,496 |  
|                                         |  |                                                              |       |   |             |   |                        |  |   |       |  
|Total change in net interest income      |  | $                                                            | 3,347 |   |             | $ | 513                    |  | $ | 3,860 |  
|                                         |  |                                                              |       |   |             |   |                        |  |   |       |  



|(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 NINE MONTHS ENDED SEPTEMBER 30, 2006:

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 for the first nine months of 2006, was $13.3 million compared to $9.5 million for the comparable period of 2005. This represents a $3.8 million
increase or 40.0%. The increases in interest income and interest expense for the first nine months of 2006 were driven by a combination of volume growth and an increase in yields. Average earning assets grew 33.6% for the first nine months of 2006
over the first nine months of 2005, from $289.4 million to $386.6 million, with the yield on average earning assets increasing 120 basis points. Average interest bearing liabilities (deposits and borrowings) grew 40.1% for the first nine months of
2006 over the first nine months of 2005, from $223.8 million to $313.6 million, with the cost increasing 107 basis points.

NON-INTEREST INCOME

Non-interest income for the first nine months of 2006 was $2.2 million. For the same period of 2005, non-interest income was $1.5 million. Service
charges and other fees increased $220,000, from $743,000 in the first nine months of 2005 to $963,000 in the first nine months of 2006. The majority of this increase was in overdraft fees which were offset by a decrease in service charges on deposit



10



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##### Table of Contents

accounts. The decrease in service fees and charges is due to a change in the portfolio mix from transactional accounts to time deposits, resulting in less
service fees and charges. We also continue our focus on mortgage banking activity, as the dollar volume from the first nine months of the year increased significantly when compared to the same period in 2005, resulting in higher fees. Mortgage
banking fees were $1.1 million for the first nine months of 2006 versus $767,000 in the first nine months of 2005, an increase in fees of 44%.

NON-INTEREST EXPENSE

For the first nine months of 2006, non-interest expense was $8.3 million, an increase of $1.9 million over the first
nine months of 2005. Salaries and Employee Benefits represented the largest increase in non-interest expense. This item increased $1.3 million in the first nine months of the year versus the first nine months of 2005. 60% of that increase was for
salaries and 40% for benefits. This is a result of an increase in staff and officer positions as well as normal salary increases. The number of full-time equivalent employees increased from 93 as of September 30, 2005 to 105 as of the
September 30, 2006. In January 2006, SFAS 123R was adopted and we began to recognize stock-based compensation costs, of which $97,000 was expensed in the first nine months of 2006. Also, in January 2006 we began leasing the second floor of our
headquarters as well as occupying the second floor of the Gateway branch, which is owned. This activity has caused Occupancy and Equipment to increase from $865,000 in the first nine months of 2005 to $1.2 million in the first nine months of 2006.
The remaining change in non-interest expense from the first nine months of 2006 over the same period in 2005 is due to the general growth of the Bank.

INCOME TAXES

For the nine months ended September 30, 2006 and 2005, the Company recorded income tax expense of $2.3 million and $1.6
million, respectively. Accordingly, our effective tax rates were 37.3% and 37.6% for 2006 and 2005, 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 SEPTEMBER 30, 2006:

NET
INTEREST INCOME

The growth in net interest income for the third quarter of 2006 was a result of interest earned on commercial loans and construction
and commercial real estate loans. Average earning assets for the third quarter grew 4.2% while average interest-bearing deposits grew 4.8% when compared to the second quarter averages of 2006. As a result of the increase in funds available
borrowings decreased 77.0% from the second to third quarter of 2006. Annualized yields on average earning assets grew 12 basis points while annualized costs on average interest-bearing liabilities (deposits and borrowings) grew 33 basis points.

NON-INTEREST INCOME

The major contributor to the
increase in non-interest income for the quarter was mortgage banking fees. For the third quarter of 2006, mortgage banking fees were $396,000, representing 51% of non-interest income and an increase of 52% over the third quarter of 2005.

NON-INTEREST EXPENSE

Non-interest expense was impacted by the
growth of Salaries and Employee Benefits. As discussed in the above discussion of our activity year-to-date, Salaries and Employee Benefits have been affected by the expansion of our staff. In January 2006, SFAS 123R was adopted and we began to
recognize stock-based compensation costs, of which $29,000 was expensed in the quarter ended September 30, 2006. The remaining change in non-interest expense from the quarter ended September 30, 2006 over the same quarter in 2005 is due to
the general growth of the Bank.



11



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##### Table of Contents

INCOME TAXES

For the
three months ended September 30, 2006 and 2005, the Company recorded income tax expense of $752,000 and $579,000, respectively. Accordingly, our effective tax rates were 35.3% and 37.5% for 2006 and 2005 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)                                   |  | September 30,2006 |         |   | December 31,2005 |   |         | $      |  |   | %       |  
|Cash                                                     |  | $                 | 31,366  |   |                  | $ | 6,245   |        |  | $ | 25,121  |   |  | 402 | %
|Interest bearing deposit in other financial institutions |  |                   | 150     |   |                  |   | 150     |        |  |   |        |   |  |    |  
|Investments                                              |  |                   | 25,282  |   |                  |   | 20,361  |        |  |   | 4,921   |   |  | 24  | %
|Loans  gross                                            |  |                   | 374,952 |   |                  |   | 339,540 |        |  |   | 35,412  |   |  | 10  | %
|net deferred fees                                        |  |                   | (1,535  | ) |                  |   | (1,549  | )      |  |   | 14      |   |  | 1   | %
|Allowance for loan loss reserve                          |  |                   | (4,154  | ) |                  |   | (3,397  | )      |  |   | (757    | ) |  | -22 | %
|Other                                                    |  |                   | 11,873  |   |                  |   | 11,339  |        |  |   | 534     |   |  | 5   | %
|                                                         |  |                   |         |   |                  |   |         |        |  |   |         |   |  |     |  
|Total Assets                                             |  | $                 | 437,934 |   |                  | $ | 372,689 |        |  | $ | 65,245  |   |  | 18  | %
|                                                         |  |                   |         |   |                  |   |         |        |  |   |         |   |  |     |  
|Non-interest bearing deposits                            |  | $                 | 43,887  |   |                  | $ | 44,574  |        |  |   | ($687   | ) |  | -2  | %
|Interest bearing deposits                                |  |                   | 341,512 |   |                  |   | 268,051 |        |  |   | 73,461  |   |  | 27  | %
|Borrowings                                               |  |                   | 3,001   |   |                  |   | 14,001  |        |  |   | (11,000 | ) |  | -79 | %
|Other                                                    |  |                   | 2,030   |   |                  |   | 1,579   |        |  |   | 451     |   |  | 29  | %
|Stockholders equity                                     |  |                   | 47,504  |   |                  |   | 44,484  |        |  |   | 3,020   |   |  | 7   | %
|                                                         |  |                   |         |   |                  |   |         |        |  |   |         |   |  |     |  
|Total Liabilities and Stockholders equity               |  | $                 | 437,934 |   |                  | $ | 372,689 |        |  | $ | 65,245  |   |  | 18  | %
|                                                         |  |                   |         |   |                  |   |         |        |  |   |         |   |  |     |  

The balance sheet shows our growth in loans and deposits and our commitment to funding a productive mix of assets.



| |  |  | Gross loans grew $35.5 million (from $339.5 million at December 31, 2005 to $375.0 million at September 30, 2006);
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | Deposits grew $72.8 million with decreases in demand, checking and money market deposits, attributed to a shift of funds to time deposits and a competitive market. The decrease was
offset with increases in savings and time deposits due to favorable interest rates (from $312.6 million to $385.4 million);
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | As a result of market conditions, rising interest rates and an aggressive calling effort; deposit generation has outpaced loan production resulting in an increase in cash of $25.1
million from $6.3 million to $31.4 million);
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our securities portfolio grew with the purchase of $6.4 million in new investments (net growth was $4.9 million  from $20.4 million to $25.3 million);
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Borrowings decreased $11 million (from $14.0 million to $3.0 million);
| | - |  | ----------------------------------------------------------------------



| |  |  | The above activity was funded with our increase in deposits.
| | - |  | ------------------------------------------------------------

LOAN
PORTFOLIO and ADEQUACY of the ALLOWANCE FOR LOAN LOSSES

We believe the allowance for loan losses accounting policy is critical to the portrayal and
understanding of our financial condition and results of operations. As such, selection and application of this critical accounting policy involves judgments, estimates, and uncertainties that are susceptible to change. In the event that
different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial conditions or results of operations is a reasonable likelihood.



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##### Table of Contents

We manage the risk characteristics of the entire loan portfolio in an effort to maintain an adequate allowance for loan
losses and identify problem loans so that the risks in the portfolio can be identified on a timely basis. Loans subject to individual review are analyzed and segregated by risk according to our internal risk rating scale. We also consider:



| |  |  | the character of the loan portfolio;
| | - |  | ------------------------------------



| |  |  | changes in nonperforming and past-due loans;
| | - |  | --------------------------------------------



| |  |  | historical loss experience;
| | - |  | ---------------------------



| |  |  | concentrations of loans to specific borrowers and industries;
| | - |  | -------------------------------------------------------------



| |  |  | general and regional economic conditions; and
| | - |  | ---------------------------------------------



| |  |  | other factors existing at the determination date.
| | - |  | -------------------------------------------------

Although credit
policies are designed to minimize risk, we recognize that loan losses will occur and that the amount of these losses will fluctuate depending on the risk characteristics of the loan portfolio.

As of September 30, 2006, the allowance for loan losses was $4.2 million, up $757,000 (or 22.3%) from December 31, 2005. This increase consists of additional
provision of $985,000, of which $305,000 was recorded in the third quarter of 2006, recoveries of $34,000 and charge-offs of $263,000. The increased provision since the end of last year was primarily due to loan growth as well as a charge off of a
$220,000 commercial loan in the first quarter of 2006. The decision to charge off the loan was made as the ability for the borrower to repay the principal was significantly reduced in the first quarter.

The ratio of the allowance for loan loss to total loans outstanding was 1.11% as of September 30, 2006, up eleven basis points from December 31, 2005.
Considering the growth in the loan portfolio, we cautiously manage the level of reserve, by reviewing individual commercial real estate loans of a certain grade for impairment, reviewing delinquency and charge-off trends and taking into
consideration external economic factors such as market conditions and rising interest rates, as well as those factors mentioned above. Based on our review of commercial and construction loans additional impairments of $368,000 were identified during
the quarter ended September 30, 2006. The third quarter impairment is an isolated incident, as the majority of the impairment is the result of the business operations of one customer in the construction industry. We continue to monitor and
review all impaired loans and we believe that our collateral position will secure our interest in the remaining impaired loans identified.

NONPERFORMING ASSETS

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 is well collateralized and in the process of 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.

As of September 30, 2006, total loans on nonaccrual status were $910,000, representing 0.24%
of total loans. There was $1.1 million of loans on nonaccrual status at December 31, 2005. This represented 0.32% of total loans on that date. In addition to loans classified as nonaccrual, the Bank carefully monitors other loans that are
current in terms of principal and interest payments but that we believe may deteriorate in quality if economic conditions change.

Some 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 contractual principal and interest due under the loan may not be collectible. 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 or the present value of estimated future cash flows.



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##### Table of Contents

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. We manage the levels, types, and maturities of earning assets in relation to the sources available to fund current and future needs.

In addition to maintaining a stable core deposit base, we maintain adequate liquidity primarily through the use of investment securities and unused borrowing capacity. The Bank has invested in Federal Home Loan Bank stock for the purposes
of establishing credit lines with the Federal Home Loan Bank. The credit availability to the Bank is equal to 15 percent of the Banks total assets as reported on the most recent quarterly financial information submitted to its regulators. The
credit availability approximated $65.7 million at September 30, 2006, under which $3 million was outstanding. Borrowings against this line of credit are collateralized by investment securities and the Banks residential loan portfolio.

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 strong capital position, which supports
current needs and provides a sound foundation to support future expansion. The Corporations and Banks regulatory capital ratios are consistently above the well-capitalized standards and each has sufficient capital to maintain
a well-capitalized designation. Our capital ratios as of September 30, 2006 and December 31, 2005 are presented below.



|                                  |  |         |   |  |             |   |  |                    |  |       |                   |  |         |  |       |  
|--------------------------------- |  | ------- | - |  | ----------- | - |  | ------------------ |  | ----- | ----------------- |  | ------- |  | ----- | -
|                                  |  |         |   |  | Well-       |   |  | September 30, 2006 |  |       | December 31, 2005 | 
|(Dollars in thousands)            |  | Minimum |   |  | capitalized |   |  | Amount             |  | Ratio |                   |  | Amount  |  | Ratio |  
|First State Financial Corporation |  |         |   |  |             |   |  |                    |  |       |                   |  |         |  |       |  
|Tier 1 capital                    |  | 4.0     | % |  | 6.0         | % |  | $47,692            |  | 12.18 | %                 |  | $44,856 |  | 13.13 | %
|Total capital                     |  | 8.0     | % |  | 10.0        | % |  | 51,845             |  | 13.24 | %                 |  | 48,253  |  | 14.13 | %
|Tier 1 leverage                   |  | 4.0     | % |  | 5.0         | % |  | 47,692             |  | 11.31 | %                 |  | 44,856  |  | 12.54 | %
|First State Bank                  |  |         |   |  |             |   |  |                    |  |       |                   |  |         |  |       |  
|Tier 1 capital                    |  | 4.0     | % |  | 6.0         | % |  | 47,590             |  | 12.16 | %                 |  | 44,818  |  | 13.12 | %
|Total capital                     |  | 8.0     | % |  | 10.0        | % |  | 51,744             |  | 13.22 | %                 |  | 48,215  |  | 14.12 | %
|Tier 1 leverage                   |  | 4.0     | % |  | 5.0         | % |  | 47,590             |  | 11.28 | %                 |  | 44,818  |  | 12.53 | %



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##### Table of Contents

|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 September 30, 2006 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 very prevalent. 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.



|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 adequate. No significant deficiencies or 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 its 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.



15



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##### Table of Contents

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, 2005, 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 know 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
|------- | -------------------------------------------------

On April 10, 2006, the Company held an annual meeting of the stockholders of the Common Stock to vote to elect seven persons to the Companys Board of Directors. The following table sets forth the votes for and votes withheld with
respect to the election of the directors:



|                  |  |                |  |               
|----------------- |  | -------------- |  | --------------
|Director Nominee: |  | Votes Cast For |  | Votes Withheld
|Robert Beymer     |  | 4,964,190      |  | 12,000        
|Corey Coughlin    |  | 4,965,960      |  | 10,230        
|Daniel Harrington |  | 4,966,190      |  | 10,000        
|Marshall Reynolds |  | 4,849,537      |  | 126,653       
|Neal Scaggs       |  | 4,908,590      |  | 67,600        
|Robert Shell, Jr. |  | 4,836,637      |  | 139,553       
|Thomas Wright     |  | 4,966,190      |  | 10,000        



|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 and
Chief Financial Officers certification required under Section 906 of Sarbanes-Oxley Act of 2002



16



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##### Table of Contents

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: November 13, 2006



FIRST STATE FINANCIAL CORPORATION/s/ Corey J. CoughlinPresident and Chief Executive Officer/s/ Dennis GrinsteinerSenior Vice President and Chief Financial Officer




17