##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(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, 2007

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



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FIRST STATE FINANCIAL
CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Florida                                                       |  | 65-0771145                         
|(State or other jurisdiction orincorporation or organization) |  | (I.R.S. EmployerIdentification 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  x    Non-accelerated filer ̈

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, 2007, the registrant had outstanding 5,920,300 shares of common stock.



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##### Table of Contents

TABLE OF CONTENTS



|                               |  |                                                                      |  |                                                                      |  |     
|------------------------------ |  | -------------------------------------------------------------------- |  | -------------------------------------------------------------------- |  | ----
|                               |  |                                                                      |  |                                                                      |  | PAGE
|PART I  FINANCIAL INFORMATION |  |                                                                     
|                               |  |                                                                     
|                               |  | Item 1 - Condensed Consolidated Financial Statements                 |  |                                                                     
|                               |  |                                                                      | 
|                               |  |                                                                      |  | Condensed Consolidated Balance Sheets                                |  | 1   
|                               |  |                                                                      | 
|                               |  |                                                                      |  | Condensed Consolidated Statements of Income                          |  | 2   
|                               |  |                                                                      | 
|                               |  |                                                                      |  | Condensed Consolidated Statements of Changes in Stockholders Equity |  | 3   
|                               |  |                                                                      | 
|                               |  |                                                                      |  | Condensed Consolidated Statements of Cash Flow                       |  | 4   
|                               |  |                                                                      | 
|                               |  |                                                                      |  | Condensed Notes to Consolidated Financial Statements                 |  | 5   
|                               |  |                                                                     
|                               |  | Item 2 - Managements Discussion and Analysis                        |  | 7                                                                   
|                               |  |                                                                     
|                               |  | Item 3 - Quantitative and Qualitative Disclosures About Market Risk  |  | 17                                                                  
|                               |  |                                                                     
|                               |  | Item 4 - Controls and Procedures                                     |  | 17                                                                  
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                     
|                               |  |                                                                     
|                               |  | Item 1 - Legal Proceedings                                           |  | 18                                                                  
|                               |  |                                                                     
|                               |  | Item 1A - Risk Factors                                               |  | 18                                                                  
|                               |  |                                                                     
|                               |  | Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds |  | 18                                                                  
|                               |  |                                                                     
|                               |  | Item 3 - Defaults Upon Senior Securities                             |  | 18                                                                  
|                               |  |                                                                     
|                               |  | Item 4 - Submission of Matters to Vote of Securities Holders         |  | 18                                                                  
|                               |  |                                                                     
|                               |  | Item 5 - Other Information                                           |  | 18                                                                  
|                               |  |                                                                     
|                               |  | Item 6 - Exhibits                                                    |  | 18                                                                  
|                               |  |                                                                     
|                               |  | Signatures                                                           |  | 19                                                                  



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##### Table of Contents

FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

September 30, 2007 (unaudited) and December 31, 2006

(Dollar amounts in thousands except per share data)



|                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                         |  | September 30,2007 |         |   | December 31,2006 |  
|ASSETS                                                                                                                                                   |  |                   |         |   |                  |   |         |  
|Cash and due from financial institutions                                                                                                                 |  | $                 | 5,855   |   |                  | $ | 6,427   |  
|Federal funds sold                                                                                                                                       |  |                   | 2,327   |   |                  |   | 37,806  |  
|                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                |  |                   | 8,182   |   |                  |   | 44,233  |  
|Interest bearing deposits in other financial institutions                                                                                                |  |                   | 283     |   |                  |   | 299     |  
|Securities, available for sale                                                                                                                           |  |                   | 50,694  |   |                  |   | 24,860  |  
|Loans, net of allowance of $4,764 and $4,358                                                                                                             |  |                   | 401,489 |   |                  |   | 372,747 |  
|Federal Home Loan Bank stock                                                                                                                             |  |                   | 1,302   |   |                  |   | 880     |  
|Premise and equipment, net                                                                                                                               |  |                   | 7,844   |   |                  |   | 4,558   |  
|Accrued interest and other assets                                                                                                                        |  |                   | 6,247   |   |                  |   | 5,871   |  
|                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total Assets                                                                                                                                             |  | $                 | 476,041 |   |                  | $ | 453,448 |  
|                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|LIABILITIES and STOCKHOLDERS EQUITY                                                                                                                     |  |                   |         |   |                  |   |         |  
|Deposits                                                                                                                                                 |  |                   |         |   |                  |   |         |  
|Demand                                                                                                                                                   |  | $                 | 37,947  |   |                  | $ | 44,383  |  
|Interest-bearing checking                                                                                                                                |  |                   | 13,636  |   |                  |   | 19,409  |  
|Money market                                                                                                                                             |  |                   | 36,028  |   |                  |   | 30,508  |  
|Savings                                                                                                                                                  |  |                   | 22,767  |   |                  |   | 22,625  |  
|Time                                                                                                                                                     |  |                   | 277,419 |   |                  |   | 283,394 |  
|                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total deposits                                                                                                                                           |  |                   | 387,797 |   |                  |   | 400,319 |  
|Accrued interest payable and other liabilities                                                                                                           |  |                   | 1,814   |   |                  |   | 1,602   |  
|Federal Home Loan Bank advances & other borrowings                                                                                                       |  |                   | 35,801  |   |                  |   | 3,001   |  
|                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total Liabilities                                                                                                                                        |  |                   | 425,412 |   |                  |   | 404,922 |  
|                                                                                                                                                         |  |                  
|Stockholders Equity                                                                                                                                     |  |                   |         |   |                  |   |         |  
|Common stock, $1 par value; 25,000,000 shares authorized; 5,920,300 shares issued at September 30, 2007 and 5,874,450 shares issued at
December 31, 2006 |  |                   | 5,920   |   |                  |   | 5,874   |  
|Additional paid-in capital                                                                                                                               |  |                   | 32,494  |   |                  |   | 31,974  |  
|Retained earnings                                                                                                                                        |  |                   | 12,497  |   |                  |   | 10,870  |  
|Accumulated other comprehensive loss                                                                                                                     |  |                   | (282    | ) |                  |   | (192    | )
|                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total Stockholders Equity                                                                                                                               |  |                   | 50,629  |   |                  |   | 48,526  |  
|                                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total Liabilities and Stockholders Equity                                                                                                               |  | $                 | 476,041 |   |                  | $ | 453,448 |  
|                                                                                                                                                         |  |                   |         |   |                  |   |         |  

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 endedSeptember 30, |           | Nine months endedSeptember 30,
|                                                     |  | 2007                            |           | 2006                           |   | 2007      |  | 2006
|Interest Income                                      |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Loans, including fees                                |  | $                               | 8,485     |                                | $ | 7,827     |  | $    | 24,557    |  | $ | 21,884   
|Taxable securities                                   |  |                                 | 379       |                                |   | 186       |  |      | 800       |  |   | 532      
|Tax exempt securities                                |  |                                 | 90        |                                |   | 77        |  |      | 262       |  |   | 207      
|Federal funds sold and other                         |  |                                 | 33        |                                |   | 128       |  |      | 507       |  |   | 183      
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|                                                     |  |                                 | 8,987     |                                |   | 8,218     |  |      | 26,126    |  |   | 22,806   
|Interest expense                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Deposits                                             |  |                                 | 4,255     |                                |   | 3,558     |  |      | 12,390    |  |   | 9,016    
|Federal Home Loan Bank advances and other borrowings |  |                                 | 270       |                                |   | 77        |  |      | 411       |  |   | 452      
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|                                                     |  |                                 | 4,525     |                                |   | 3,635     |  |      | 12,801    |  |   | 9,468    
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Net interest income                                  |  |                                 | 4,462     |                                |   | 4,583     |  |      | 13,325    |  |   | 13,338   
|Provision for loan losses                            |  |                                 | 345       |                                |   | 305       |  |      | 822       |  |   | 985      
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Net interest income after provision for loan losses  |  |                                 | 4,117     |                                |   | 4,278     |  |      | 12,503    |  |   | 12,353   
|Non-interest income                                  |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Service charges and other fees                       |  |                                 | 386       |                                |   | 350       |  |      | 1,056     |  |   | 963      
|Mortgage banking fees                                |  |                                 | 107       |                                |   | 396       |  |      | 532       |  |   | 1,104    
|Other                                                |  |                                 | 15        |                                |   | 38        |  |      | 60        |  |   | 114      
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|                                                     |  |                                 | 508       |                                |   | 784       |  |      | 1,648     |  |   | 2,181    
|Non-interest expense                                 |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Salaries and employee benefits                       |  |                                 | 1,977     |                                |   | 1,841     |  |      | 6,081     |  |   | 5,229    
|Occupancy and equipment                              |  |                                 | 507       |                                |   | 402       |  |      | 1,300     |  |   | 1,161    
|Data processing                                      |  |                                 | 142       |                                |   | 136       |  |      | 454       |  |   | 417      
|Professional services                                |  |                                 | 76        |                                |   | 92        |  |      | 297       |  |   | 182      
|Stationery and supplies                              |  |                                 | 61        |                                |   | 46        |  |      | 158       |  |   | 137      
|Advertising and marketing                            |  |                                 | 27        |                                |   | 70        |  |      | 183       |  |   | 262      
|Other                                                |  |                                 | 296       |                                |   | 344       |  |      | 880       |  |   | 960      
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|                                                     |  |                                 | 3,086     |                                |   | 2,931     |  |      | 9,353     |  |   | 8,348    
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Income before income taxes                           |  |                                 | 1,539     |                                |   | 2,131     |  |      | 4,798     |  |   | 6,186    
|Income tax expense                                   |  |                                 | 564       |                                |   | 752       |  |      | 1,757     |  |   | 2,310    
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Net income                                           |  | $                               | 975       |                                | $ | 1,379     |  | $    | 3,041     |  | $ | 3,876    
|                                                     |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Earnings per share                                   |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Basic                                                |  | $                               | 0.16      |                                | $ | 0.24      |  | $    | 0.52      |  | $ | 0.66     
|Diluted                                              |  | $                               | 0.16      |                                | $ | 0.23      |  | $    | 0.51      |  | $ | 0.66     
|Average common shares outstanding                    |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Basic                                                |  |                                 | 5,915,483 |                                |   | 5,870,841 |  |      | 5,888,809 |  |   | 5,866,584
|Diluted                                              |  |                                 | 5,927,967 |                                |   | 5,920,663 |  |      | 5,917,685 |  |   | 5,909,451
|Dividends per share                                  |  | $                               | 0.08      |                                | $ | 0.08      |  | $    | 0.24      |  | $ | 0.21     

See Notes to Condensed Consolidated Financial Statements



2



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##### Table of Contents

FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES

IN STOCKHOLDERS EQUITY

(Unaudited)

(Dollar amounts in thousands except per share data)



|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|---------------------------------------------------------------------------------------------------- |  | --------- |  | ----------- | ----- | ------------------------ | - | ---------------- |  | - | ------------------------------------- | - |  | ----- | ---- | - |  | - | ------ | -
|                                                                                                     |  | Shares    |  | CommonStock |       | AdditionalPaid-inCapital |   | RetainedEarnings |  |   | Accum. OtherComprehensiveIncome(Loss) |   |  | Total |     
|Balance at December 31, 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 December 31, 2006                                                                         |  | 5,874,450 |  | $           | 5,874 |                          | $ | 31,974           |  | $ | 10,870                                |   |  | $     | (192 | ) |  | $ | 48,526 |  
|Comprehensive income:                                                                                |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|Net income                                                                                           |  |           |  |             |       |                          |   |                  |  |   | 3,041                                 |   |  |       |      |   |  |   | 3,041  |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of tax effects |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       | (90  | ) |  |   | (90    | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   | 2,951  |  
|Stock-based compensation                                                                             |  |           |  |             |       |                          |   | 70               |  |   |                                       |   |  |       |      |   |  |   | 70     |  
|Exercise of stock options                                                                            |  | 45,850    |  |             | 46    |                          |   | 450              |  |   |                                       |   |  |       |      |   |  |   | 496    |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|Cash dividend, $0.24 per share                                                                       |  |           |  |             |       |                          |   |                  |  |   | (1,414                                | ) |  |       |      |   |  |   | (1,414 | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|Balance at September 30, 2007                                                                        |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,494           |  | $ | 12,497                                |   |  | $     | (282 | ) |  | $ | 50,629 |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|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 |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|Balance at June 30, 2007                                                                             |  | 5,875,500 |  | $           | 5,875 |                          | $ | 32,029           |  | $ | 11,996                                |   |  | $     | (515 | ) |  | $ | 49,385 |  
|Comprehensive income:                                                                                |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|Net income                                                                                           |  |           |  |             |       |                          |   |                  |  |   | 975                                   |   |  |       |      |   |  |   | 975    |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of tax effects |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       | 233  |   |  |   | 233    |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   | 1,208  |  
|Stock-based compensation                                                                             |  |           |  |             |       |                          |   | 26               |  |   |                                       |   |  |       |      |   |  |   | 26     |  
|Exercise of stock options                                                                            |  | 44,800    |  |             | 45    |                          |   | 439              |  |   |                                       |   |  |       |      |   |  |   | 484    |  
|Cash dividend, $0.08 per share                                                                       |  |           |  |             |       |                          |   |                  |  |   | (474                                  | ) |  |       |      |   |  |   | (474   | )
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  
|Balance at September 30, 2007                                                                        |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,494           |  | $ | 12,497                                |   |  | $     | (282 | ) |  | $ | 50,629 |  
|                                                                                                     |  |           |  |             |       |                          |   |                  |  |   |                                       |   |  |       |      |   |  |   |        |  

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, 2007 and 2006

(Unaudited)

(Dollar amounts in thousands)



|                                                                          |  |      |         |   |      |   |         |  
|------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                          |  | 2007 |         |   | 2006 |  
|Cash flows from operating activities:                                     |  |      |         |   |      |   |         |  
|Net income                                                                |  | $    | 3,041   |   |      | $ | 3,876   |  
|Adjustments to reconcile net income to net cash from operating activities |  |      |         |   |      |   |         |  
|Provision for loan losses                                                 |  |      | 822     |   |      |   | 985     |  
|Depreciation                                                              |  |      | 316     |   |      |   | 320     |  
|Net amortization of securities                                            |  |      | (68     | ) |      |   | 31      |  
|Stock compensation expense                                                |  |      | 70      |   |      |   | 97      |  
|Net change in:                                                            |  |      |         |   |      |   |         |  
|Other assets                                                              |  |      | (172    | ) |      |   | (911    | )
|Accrued expenses and other liabilities                                    |  |      | 211     |   |      |   | 449     |  
|                                                                          |  |      |         |   |      |   |         |  
|Net cash from operating activities                                        |  |      | 4,220   |   |      |   | 4,847   |  
|                                                                          |  |     
|Cash flows from investing activities:                                     |  |      |         |   |      |   |         |  
|Net change in interest bearing deposits in other financial institutions   |  |      | 16      |   |      |   |        |  
|Available-for-sale securities:                                            |  |      |         |   |      |   |         |  
|Maturities, prepayments and calls                                         |  |      | 2,286   |   |      |   | 1,726   |  
|Purchases                                                                 |  |      | (28,195 | ) |      |   | (6,401  | )
|Loan originations and payments, net                                       |  |      | (29,564 | ) |      |   | (35,654 | )
|Net sale of FHLB stock                                                    |  |      | (422    | ) |      |   | 298     |  
|Net change in premise and equipment                                       |  |      | (3,602  | ) |      |   | (331    | )
|                                                                          |  |      |         |   |      |   |         |  
|Net cash used in investing activities                                     |  |      | (59,481 | ) |      |   | (40,362 | )
|                                                                          |  |     
|Cash flows from financing activities:                                     |  |      |         |   |      |   |         |  
|Net change in deposits                                                    |  |      | (12,522 | ) |      |   | 72,774  |  
|Net change in short-term borrowing                                        |  |      | 7,800   |   |      |   | (11,000 | )
|Repayment of long-term borrowing                                          |  |      |        |   |      |   | (10,000 | )
|Proceeds from long-term borrowing                                         |  |      | 25,000  |   |      |   | 10,000  |  
|Proceeds from exercise of stock options                                   |  |      | 346     |   |      |   | 94      |  
|Cash dividend paid                                                        |  |      | (1,414  | ) |      |   | (1,232  | )
|                                                                          |  |      |         |   |      |   |         |  
|Net cash from financing activities                                        |  |      | 19,210  |   |      |   | 60,636  |  
|                                                                          |  |     
|Net change in cash and cash equivalents                                   |  |      | (36,051 | ) |      |   | 25,121  |  
|Beginning cash and cash equivalents                                       |  |      | 44,233  |   |      |   | 6,245   |  
|                                                                          |  |      |         |   |      |   |         |  
|Ending cash and cash equivalents                                          |  | $    | 8,182   |   |      | $ | 31,366  |  
|                                                                          |  |      |         |   |      |   |         |  
|Supplemental cash flow information                                        |  |      |         |   |      |   |         |  
|Interest paid                                                             |  | $    | 12,646  |   |      | $ | 9,192   |  
|Income taxes paid                                                         |  | $    | 2,201   |   |      | $ | 2,827   |  

See Notes to Condensed Consolidated Financial Statements



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FIRST STATE FINANCIAL CORPORATION

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007

(Unaudited)

NOTE 1  INTERIM FINANCIAL STATEMENTS

These
unaudited financial statements were prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. As such they do not include all of the information and footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary to comply with Regulation S-X were included. The operating results for the nine months ended
September 30, 2007 are not necessarily indicative of the results that may be expected for the full year of 2007.

NOTE 2  NEW ACCOUNTING
STANDARDS

In February 2007 the Financial Accounting Standards Board issued FAS 159, The Fair Value Option for Financial Assets and Financial
Liabilities, which expands the scope of what companies may carry at fair value. Statement 159 offers an irrevocable option to carry the vast majority of financial assets and liabilities at fair value, (the fair value option, or FVO). The
adoption of the fair value option is recorded as a cumulative-effect adjustment to the opening balance of retained earnings. Upon adoption, the difference between the carrying amount and the fair value of the items chosen is removed from the balance
sheet and included in the cumulative-effect adjustment. Subsequent changes in fair value are recorded through the income statement. The new statement is effective for fiscal years beginning after November 15, 2007. The Company has not yet
determined the effect of implementing this pronouncement.

On September 15, 2006, the FASB issued a statement to address fair value measurements.
Statement 157, Fair Value Measurements, which requires changes to how certain instruments are measured, both those for which fair value is elected and those where generally accepted accounting principles (GAAP) requires use of fair
value. The Company has not yet determined the effect of implementing this pronouncement, which is effective for fiscal years ending after January 1, 2008.

The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (FIN 48), as of January 1, 2007. A tax position is recognized as a benefit only if it is more likely than not
that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax
positions not meeting the more likely than not test, no tax benefit is recorded. The adoption did not have a material impact on the Companys financial statements.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the state of Florida. The Company is no longer subject to examination by taxing authorities for years before 2002. The
Company does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.

The Company recognizes interest
related to income tax matters as interest expense and penalties related to income tax matters as other expense. The Company did not have any amounts accrued for interest and penalties at September 30, 2007.

NOTE 3  STOCK-BASED COMPENSATION

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



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During the quarters ended September 30, 2007 and 2006, the Company did not grant any stock options.

During the quarter ended September 30, 2007, no options vested and 44,800 options were exercised. During the quarter ended September 30, 2006, no options
vested and 7,200 options were exercised.

A summary of share option activity under the plan as of September 30, 2007 is as follows:



|                                        |  |                         |   |  |                              |       |                                                      |      |                                        |   |    
|--------------------------------------- |  | ----------------------- | - |  | ---------------------------- | ----- | ---------------------------------------------------- | ---- | -------------------------------------- | - | ---
|                                        |  | StockOptionsOutstanding |   |  | WeightedAverageExercisePrice |       | Weighted-AverageRemainingContractual Life (in years) |      | AggregateIntrinsicValue (in thousands)
|Options outstanding, December 31, 2006  |  | 171,615                 |   |  | $                            | 10.92 |                                                      |      |                                        |   |    
|Granted                                 |  | 34,000                  |   |  |                              | 17.23 |                                                      |      |                                        |   |    
|Exercised                               |  | (45,850                 | ) |  |                              | 7.45  |                                                      |      |                                        |   |    
|Forfeited or expired                    |  | (41,125                 | ) |  |                              | 12.99 |                                                      |      |                                        |   |    
|                                        |  |                         |   |  |                              |       |                                                      |      |                                        |   |    
|Options outstanding, September 30, 2007 |  | 118,640                 |   |  | $                            | 13.35 |                                                      | 7.95 |                                        | $ | 190
|                                        |  |                         |   |  |                              |       |                                                      |      |                                        |   |    
|Options exercisable, September 30, 2007 |  | 34,910                  |   |  | $                            | 11.78 |                                                      | 7.26 |                                        | $ | 111
|                                        |  |                         |   |  |                              |       |                                                      |      |                                        |   |    

For the nine months ended September 30, 2007, $70 thousand in compensation cost related to the Companys
stock option plan was recorded in net income, $26 thousand of which was recorded in the third quarter. As of September 30, 2007, $159 thousand 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 2007 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 30,2007 |         |   | December 31,2006 |  
|Commercial                    |  | $                 | 80,373  |   |                  | $ | 59,506  |  
|Real estate:                  |  |                   |         |   |                  |   |         |  
|Residential                   |  |                   | 55,521  |   |                  |   | 58,863  |  
|Commercial                    |  |                   | 212,206 |   |                  |   | 194,992 |  
|Construction                  |  |                   | 45,768  |   |                  |   | 51,426  |  
|Consumer and other            |  |                   | 13,605  |   |                  |   | 13,724  |  
|                              |  |                   |         |   |                  |   |         |  
|                              |  |                   | 407,473 |   |                  |   | 378,511 |  
|Less: deferred loan fees, net |  |                   | (1,220  | ) |                  |   | (1,406  | )
|allowance for loan losses     |  |                   | (4,764  | ) |                  |   | (4,358  | )
|                              |  |                   |         |   |                  |   |         |  
|Total loans, net              |  | $                 | 401,489 |   |                  | $ | 372,747 |  
|                              |  |                   |         |   |                  |   |         |  

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



|                                |  |                                    |       |   |                   |   |       |  
|------------------------------- |  | ---------------------------------- | ----- | - | ----------------- | - | ----- | -
|                                |  | Activity for the nine months ended |      
|                                |  | September 30,2007                  |       |   | September 30,2006 |  
|Balance, beginning of period    |  | $                                  | 4,358 |   |                   | $ | 3,397 |  
|Provision charged to operations |  |                                    | 822   |   |                   |   | 985   |  
|Loans charged off               |  |                                    | (455  | ) |                   |   | (263  | )
|Recoveries                      |  |                                    | 39    |   |                   |   | 35    |  
|                                |  |                                    |       |   |                   |   |       |  
|Balance, end of period          |  | $                                  | 4,764 |   |                   | $ | 4,154 |  
|                                |  |                                    |       |   |                   |   |       |  



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Impaired loans were as follows (in thousands):



|                                                  |  |                                            |        |                  |   |       
|------------------------------------------------- |  | ------------------------------------------ | ------ | ---------------- | - | ------
|                                                  |  | Year-to-date activity for the period ended
|                                                  |  | September 30,2007                          |        | December 31,2006
|Loans with no allocated allowance for loan losses |  | $                                          | 637    |                  | $ | 8,295 
|Loans with allocated allowance for loan losses    |  |                                            | 13,057 |                  |   | 2,403 
|                                                  |  |                                            |        |                  |   |       
|                                                  |  | $                                          | 13,694 |                  | $ | 10,698
|                                                  |  |                                            |        |                  |   |       
|Amount of the allowance for loan losses allocated |  | $                                          | 2,997  |                  | $ | 1,348 
|                                                  |  |                                            |        |                  |   |       

NOTE 5  FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS

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



|                                                                       |  |                   |        |                  |   |      
|---------------------------------------------------------------------- |  | ----------------- | ------ | ---------------- | - | -----
|                                                                       |  | September 30,2007 |        | December 31,2006
|Line of credit, Independent Bankers Bank, 6.75% at September 30, 2007 |  | $                 | 1      |                  | $ | 1    
|Fixed rate FHLB advance, 5.51%, due June 2008                          |  |                   | 3,000  |                  |   | 3,000
|Daily rate FHLB advance, 5.44% at September 30, 2007, no maturity date |  |                   | 7,800  |                  |   |     
|Repurchase agreements                                                  |  |                   | 25,000 |                  |   |     
|                                                                       |  |                   |        |                  |   |      
|                                                                       |  | $                 | 35,801 |                  | $ | 3,001
|                                                                       |  |                   |        |                  |   |      

The Company has a $4.0 million line of credit with another financial institution. Borrowings outstanding on this
line of credit totaled $1 thousand at September 30, 2007 and December 31, 2006. Interest on this line of credit adjusts daily at the Prime Rate published in The Wall Street Journal less 1%. The line of credit is secured by all of the
preferred and common stock of the Companys bank subsidiary, First State Bank.

Each FHLB advance is payable at its maturity date, with a prepayment
penalty on the fixed rate advance. The borrowings were collateralized by $5.3 million and $6.0 million of securities at September 30, 2007 and year-end 2006 and a blanket pledge of the Banks residential mortgage loan portfolio at
September 30, 2007 and year-end 2006.

During the nine months ended September 30, 2007 the Bank entered into $25.0 million of ten-year repurchase
agreements, whereby higher yielding long-term securities were purchased to increase the duration of earning assets and shorten the duration of liabilities. The agreements have interest rates ranging from 4.51% to 4.97% at September 30, 2007 and
are callable quarterly after a three year period.



|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, 2007. It should be read in conjunction with the unaudited Consolidated Financial Statements and Notes included elsewhere in this report and the audited Consolidated Financial Statements and Notes contained in the
Corporations 2006 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 2006 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.



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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;
| | - |  | ----------------------------------------------------------



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



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

Some of the key developments and achievements during the third quarter of 2007 include:



| |  |  | A $4.0 million or 1.0% increase in net loan production (new loans less repayments);
| | - |  | -----------------------------------------------------------------------------------



| |  |  | The purchase of $17.4 million in securities to increase the duration of interest earning assets;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | The third quarter annualized net interest margin on a fully tax equivalent basis was 4.05%;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | Opening of our 7thbranch
in Largo, Florida;
| | - |  | -------------------------------------------



| |  |  | Plans to open three new branches over the next 12 months: A branch opening in Clearwater is scheduled for December 2007
and new branches are planned for Venice and Sarasota in the 2ndand 3rdquarters of 2008, respectively.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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)              |  | 2007                             |       | 2006 |                                 | $      |  |   | %    |   |  | 2007 |        | 2006 |   | $      |  |   | %      | 
|Interest income                     |  | $                                | 8,987 |      | $                               | 8,218  |  | $ | 769  |   |  | 9    | %      |      | $ | 26,126 |  | $ | 22,806 |  | $ | 3,320  |   |  | 15  | %
|Interest expense                    |  |                                  | 4,525 |      |                                 | 3,635  |  |   | 890  |   |  | 24   | %      |      |   | 12,801 |  |   | 9,468  |  |   | 3,333  |   |  | 35  | %
|                                    |  |                                  |       |      |                                 |        |  |   |      |   |  |      |        |      |   |        |  |   |        |  |   |        |   |  |     |  
|Net interest income                 |  |                                  | 4,462 |      |                                 | 4,583  |  |   | (121 | ) |  | -3   | %      |      |   | 13,325 |  |   | 13,338 |  |   | (13    | ) |  | 0   | %
|Provision for loan losses           |  |                                  | 345   |      |                                 | 305    |  |   | 40   |   |  | 13   | %      |      |   | 822    |  |   | 985    |  |   | (163   | ) |  | -17 | %
|                                    |  |                                  |       |      |                                 |        |  |   |      |   |  |      |        |      |   |        |  |   |        |  |   |        |   |  |     |  
|Net interest income after provision |  |                                  | 4,117 |      |                                 | 4,278  |  |   | (161 | ) |  | -4   | %      |      |   | 12,503 |  |   | 12,353 |  |   | 150    |   |  | 1   | %
|Non-interest income                 |  |                                  | 508   |      |                                 | 784    |  |   | (276 | ) |  | -35  | %      |      |   | 1,648  |  |   | 2,181  |  |   | (533   | ) |  | -24 | %
|Non-interest expense                |  |                                  | 3,086 |      |                                 | 2,931  |  |   | 155  |   |  | 5    | %      |      |   | 9,353  |  |   | 8,348  |  |   | 1,005  |   |  | 12  | %
|                                    |  |                                  |       |      |                                 |        |  |   |      |   |  |      |        |      |   |        |  |   |        |  |   |        |   |  |     |  
|Income before income taxes          |  |                                  | 1,539 |      |                                 | 2,131  |  |   | (592 | ) |  | -28  | %      |      |   | 4,798  |  |   | 6,186  |  |   | (1,388 | ) |  | -22 | %
|Income tax expense                  |  |                                  | 564   |      |                                 | 752    |  |   | (188 | ) |  | -25  | %      |      |   | 1,757  |  |   | 2,310  |  |   | (553   | ) |  | -24 | %
|                                    |  |                                  |       |      |                                 |        |  |   |      |   |  |      |        |      |   |        |  |   |        |  |   |        |   |  |     |  
|Net income                          |  | $                                | 975   |      | $                               | 1,379  |  | $ | (404 | ) |  | -29  | %      |      | $ | 3,041  |  | $ | 3,876  |  | $ | (835   | ) |  | -22 | %
|                                    |  |                                  |       |      |                                 |        |  |   |      |   |  |      |        |      |   |        |  |   |        |  |   |        |   |  |     |  

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.



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|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|---------------------------------------- |  | --------------------------------------- | ------- | -------------- | ---- | ------------ |  | ---- | --------------- |  | -------------- | ------- | ------------ | - | ------ |  | ---- | -
|                                         |  | For the nine months ended September 30, |        
|                                         |  | 2007                                    |         |                | 2006 |             
|(Dollars in thousands)                   |  | AverageBalances                         |         | Income/Expense |      | Yields/Rates |  |      | AverageBalances |  | Income/Expense |         | Yields/Rates |  
|Assets:                                  |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Earning assets:                          |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Loans (1)                                |  | $                                       | 385,692 |                | $    | 24,557       |  | 8.51 | %               |  | $              | 358,810 |              | $ | 21,884 |  | 8.15 | %
|Investment securities, taxable           |  |                                         | 20,765  |                |      | 800          |  | 5.15 | %               |  |                | 16,353  |              |   | 532    |  | 4.35 | %
|Investment securities, non-taxable (2)   |  |                                         | 8,489   |                |      | 357          |  | 5.63 | %               |  |                | 6,631   |              |   | 282    |  | 5.69 | %
|Other                                    |  |                                         | 13,127  |                |      | 507          |  | 5.16 | %               |  |                | 4,851   |              |   | 183    |  | 5.04 | %
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total interest earning assets            |  |                                         | 428,073 |                |      | 26,221       |  | 8.19 | %               |  |                | 386,645 |              |   | 22,881 |  | 7.91 | %
|Non-interest earning assets              |  |                                         | 21,006  |                |      |              |  |      |                 |  |                | 16,674  |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total assets                             |  | $                                       | 449,079 |                |      |              |  |      |                 |  | $              | 403,319 |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Liabilities:                             |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Interest bearing liabilities:            |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|NOW accounts                             |  | $                                       | 15,376  |                | $    | 175          |  | 1.51 | %               |  | $              | 16,612  |              | $ | 129    |  | 1.03 | %
|Money market                             |  |                                         | 32,094  |                |      | 905          |  | 3.77 | %               |  |                | 34,797  |              |   | 835    |  | 3.21 | %
|Savings                                  |  |                                         | 23,180  |                |      | 637          |  | 3.67 | %               |  |                | 22,859  |              |   | 463    |  | 2.71 | %
|Time deposits                            |  |                                         | 275,660 |                |      | 10,673       |  | 5.18 | %               |  |                | 228,128 |              |   | 7,588  |  | 4.45 | %
|Borrowings                               |  |                                         | 10,159  |                |      | 411          |  | 5.42 | %               |  |                | 11,193  |              |   | 453    |  | 5.41 | %
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total interest bearing liabilities       |  |                                         | 356,469 |                |      | 12,801       |  | 4.80 | %               |  |                | 313,589 |              |   | 9,468  |  | 4.04 | %
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Demand deposits                          |  |                                         | 37,419  |                |      |              |  |      |                 |  |                | 41,491  |              |   |        |  |      |  
|Other non-interest bearing liabilities   |  |                                         | 2,390   |                |      |              |  |      |                 |  |                | 2,013   |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total non-interest bearing liabilities   |  |                                         | 39,809  |                |      |              |  |      |                 |  |                | 43,504  |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Stockholders equity                     |  |                                         | 52,801  |                |      |              |  |      |                 |  |                | 46,226  |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Total liabilities & stockholders equity |  | $                                       | 449,079 |                |      |              |  |      |                 |  | $              | 403,319 |              |   |        |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Net Interest Income                      |  |                                         |         |                | $    | 13,420       |  |      |                 |  |                |         |              | $ | 13,413 |  |      |  
|                                         |  |                                         |         |                |      |              |  |      |                 |  |                |         |              |   |        |  |      |  
|Net Interest Margin (3)                  |  |                                         |         |                |      |              |  | 4.19 | %               |  |                |         |              |   |        |  | 4.64 | %

---

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

The table below details the components of the changes in net interest income for the nine months ended September 30, 2007 and September 30, 2006. 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.



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|                                         |  |                                                                                                  |       |   |              |   |       |                        |  |   |       |  
|---------------------------------------- |  | ------------------------------------------------------------------------------------------------ | ----- | - | ------------ | - | ----- | ---------------------- |  | - | ----- | -
|                                         |  | For the nine months ended September 30, 2007Compared to the nine months ended September 30, 2006 |      
|                                         |  | Increase (decrease) due to change in                                                             |       |   |              |  
|(Dollars in thousands)                   |  | Average Volume                                                                                   |       |   | Average Rate |   |       | Net Increase(Decrease) | 
|Increase (decrease) in interest income:  |  |                                                                                                  |       |   |              |   |       |                        |  |   |       |  
|Loans                                    |  | $                                                                                                | 1,685 |   |              | $ | 988   |                        |  | $ | 2,673 |  
|Investment securities, taxable           |  |                                                                                                  | 159   |   |              |   | 109   |                        |  |   | 268   |  
|Investment securities, non-taxable (1)   |  |                                                                                                  | 78    |   |              |   | (3    | )                      |  |   | 75    |  
|Other                                    |  |                                                                                                  | 320   |   |              |   | 4     |                        |  |   | 324   |  
|                                         |  |                                                                                                  |       |   |              |   |       |                        |  |   |       |  
|Total interest income                    |  |                                                                                                  | 2,242 |   |              |   | 1,098 |                        |  |   | 3,340 |  
|                                         |  |                                                                                                  |       |   |              |   |       |                        |  |   |       |  
|Increase (decrease) in interest expense: |  |                                                                                                  |       |   |              |   |       |                        |  |   |       |  
|NOW accounts                             |  |                                                                                                  | (9    | ) |              |   | 55    |                        |  |   | 46    |  
|Money market                             |  |                                                                                                  | (68   | ) |              |   | 138   |                        |  |   | 70    |  
|Savings                                  |  |                                                                                                  | 7     |   |              |   | 167   |                        |  |   | 174   |  
|Time deposits                            |  |                                                                                                  | 1,725 |   |              |   | 1,360 |                        |  |   | 3,085 |  
|Borrowings                               |  |                                                                                                  | (42   | ) |              |   |      |                        |  |   | (42   | )
|                                         |  |                                                                                                  |       |   |              |   |       |                        |  |   |       |  
|Total interest expense                   |  |                                                                                                  | 1,613 |   |              |   | 1,720 |                        |  |   | 3,333 |  
|                                         |  |                                                                                                  |       |   |              |   |       |                        |  |   |       |  
|Total change in net interest income      |  | $                                                                                                | 629   |   |              | $ | (622  | )                      |  | $ | 7     |  
|                                         |  |                                                                                                  |       |   |              |   |       |                        |  |   |       |  

---

|(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, 2007:

NET INTEREST INCOME

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

Net interest income on a fully tax-equivalent basis for the first nine months of 2007 and for the first nine months of 2006 was $13.4 million. Net interest income on a
fully tax-equivalent basis increased by $2.7 million, of which $1.7 million was due to an increase in volume. Average earning assets grew 10.7% for the first nine months of 2007 over the first nine months of 2006, from $386.6 million to $428.1
million, with the yield on average earning assets increasing 28 basis points. Average interest bearing liabilities (deposits and borrowings) grew 13.7% for the first nine months of 2007 over the first nine months of 2006, from $313.6 million to
$356.5 million, with the annualized cost increasing 76 basis points.

NON-INTEREST INCOME

Non-interest income for the first nine months of 2007 was $1.6 million compared to $2.2 million for the same period of 2006. The decrease from 2006 to 2007 was primarily
due to a reduction in mortgage banking fees. Mortgage banking fees decreased $572 thousand, from $1.1 million in the first nine months of 2006 to $532 thousand in the first nine months of 2007 as a result of a decline in volume of transactions
closed. The decrease in mortgage banking fees was offset slightly with an increase in service charges and other fees. Service charges and other fees were $1.1 million in the first nine months of 2007 from $963 thousand for the same period of 2006.

NON-INTEREST EXPENSE

For the first nine months of
2007, non-interest expense was $9.4 million, an increase of $1.0 million over the first nine months of 2006. Salaries and employee benefits combined with occupancy costs represented the largest increase in non-interest expense. Salaries and employee
benefits increased



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$852 thousand in the first nine months of the year versus the first nine months of 2006. 83% of that increase was for salaries and 17% was for benefits. The
increase is a result of the departure of the Companys former CEO, annual salary and bonus increases and, to further position the Bank for continued growth and to staff branch openings, new staff and several officer positions were added over
the past year. As of September 30, 2007 there were 122 full-time equivalent employees compared to 105 at September 30, 2006. In January 2006, SFAS 123R was adopted and we began to recognize stock-based compensation costs, of which $70
thousand was expensed in the first nine months of 2007. New office space was completed to centralize certain operations and departments of the Bank, resulting in increased occupancy costs. Professional fees have increased as the Company sought
possible expansion opportunities.

INCOME TAXES

For
the nine months ended September 30, 2007 and 2006, the Company recorded income tax expense of $1.8 million and $2.3 million, respectively. Accordingly, our effective tax rates were 36.6% and 37.3% for 2007 and 2006, 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, 2007:

NET INTEREST INCOME

Net
interest income decreased 2.7% to $4.5 million for the third quarter of 2007 from $4.6 million for the third quarter of 2006. The decrease in net interest income from the prior year quarterly results is primarily attributed to an overall increase in
funding costs, which was partially offset by volume and rate growth in the loan portfolio. Average earning assets for the third quarter grew 8.6% while average interest-bearing deposits grew 11.3% when compared to the third quarter averages of 2006.
Annualized yields on average earning assets grew 6 basis points while annualized costs on average interest-bearing liabilities (deposits and borrowings) grew 52 basis points.

NON-INTEREST INCOME

Non-interest income for the third quarter of 2007 was $508 thousand compared to $784 thousand
for the third quarter of 2006. The major contributor to the decrease in non-interest income for the quarter was due to a reduction in mortgage banking fees. For the third quarter of 2007, mortgage banking fees were $107 thousand representing 21% of
non-interest income and decreased 73.0% over the third quarter of 2006. This decrease is due to the decrease in the volume of transactions closed, as the result of changes in the marketplace, as the activity in the residential real estate market has
reduced from the third quarter of 2006. Management does not expect mortgage banking fees to increase until there is an improvement in the residential mortgage environment.

NON-INTEREST EXPENSE

Non-interest expense for the third quarter of 2007 increased by approximately $155 thousand to
$3.1 million, compared with $2.9 million for the third quarter of 2006, an increase of 5.3%. Approximately $136 thousand of this increase was attributable to an increase in the number of employees, as discussed above. In January 2006, SFAS 123R was
adopted and we began to recognize stock-based compensation costs, of which $26 thousand was expensed in the quarter ended September 30, 2007. The remaining change in non-interest expense from the quarter ended September 30, 2007 over the
same quarter in 2006 is due to the general growth of the Bank.

INCOME TAXES

For the three months ended September 30, 2007 and 2006, the Company recorded income tax expense of $564 thousand and $752 thousand, respectively. Accordingly, our effective tax rates were 36.7% and 35.3% for 2007
and 2006 respectively. The determination of effective rates reflects items which are not taxed for income tax purposes, primarily tax-exempt interest income.



12



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FINANCIAL CONDITION ANALYSIS



|                                                          |  |                    |         |   |                   |   |         |        |  |   |         |   |  |      |  
|--------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | ------ |  | - | ------- | - |  | ---- | -
|                                                          |  |                    |         |   |                   |   |         | change | 
|(Dollars in thousands)                                    |  | September 30, 2007 |         |   | December 31, 2006 |   |         | $      |  |   | %       |  
|Cash                                                      |  | $                  | 8,182   |   |                   | $ | 44,233  |        |  | $ | (36,051 | ) |  | -82  | %
|Interest bearing deposits in other financial institutions |  |                    | 283     |   |                   |   | 299     |        |  |   | (16     | ) |  | -5   | %
|Investments                                               |  |                    | 50,694  |   |                   |   | 24,860  |        |  |   | 25,834  |   |  | 104  | %
|Loans  gross                                             |  |                    | 407,472 |   |                   |   | 378,511 |        |  |   | 28,961  |   |  | 8    | %
|Net deferred fees                                         |  |                    | (1,219  | ) |                   |   | (1,406  | )      |  |   | 187     |   |  | 13   | %
|Allowance for loan loss reserve                           |  |                    | (4,764  | ) |                   |   | (4,358  | )      |  |   | (406    | ) |  | -9   | %
|Other                                                     |  |                    | 15,393  |   |                   |   | 11,309  |        |  |   | 4,084   |   |  | 36   | %
|                                                          |  |                    |         |   |                   |   |         |        |  |   |         |   |  |      |  
|Total Assets                                              |  | $                  | 476,041 |   |                   | $ | 453,448 |        |  | $ | 22,593  |   |  | 5    | %
|                                                          |  |                    |         |   |                   |   |         |        |  |   |         |   |  |      |  
|Non-interest bearing deposits                             |  | $                  | 37,947  |   |                   | $ | 44,383  |        |  | $ | (6,436  | ) |  | -15  | %
|Interest bearing deposits                                 |  |                    | 349,850 |   |                   |   | 355,936 |        |  |   | (6,086  | ) |  | -2   | %
|Borrowings                                                |  |                    | 35,801  |   |                   |   | 3,001   |        |  |   | 32,800  |   |  | 1093 | %
|Other                                                     |  |                    | 1,814   |   |                   |   | 1,602   |        |  |   | 212     |   |  | 13   | %
|Stockholders equity                                      |  |                    | 50,629  |   |                   |   | 48,526  |        |  |   | 2,103   |   |  | 4    | %
|                                                          |  |                    |         |   |                   |   |         |        |  |   |         |   |  |      |  
|Total Liabilities and Stockholders equity                |  | $                  | 476,041 |   |                   | $ | 453,448 |        |  | $ | 22,593  |   |  | 5    | %
|                                                          |  |                    |         |   |                   |   |         |        |  |   |         |   |  |      |  

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



| |  |  | Gross loans grew $29.0 million (from $378.5 million at December 31, 2006 to $407.5 million at September 30, 2007);
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | Deposits decreased $12.5 million with decreases in demand, checking and time deposits, attributed to a competitive market. The decrease was offset slightly with
increases in savings and money markets due to increased interest rates (from $53.1 million to $58.8 million);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Other assets grew $4.1 million, which includes the purchase of land in Venice for a future branch;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | Our securities portfolio grew with the purchase of $17.4 million in new investments in the third quarter (net growth for the first nine months of 2007 was $25.8
million  from $24.9 million to $50.7 million);
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For the nine month period ending September 30, 2007, borrowings increased $32.8 million (from $3.0 million to $35.8 million), $27.8 million was used to
purchase long-term securities as part of a repurchase agreement and the remaining $5 million was used to fund the increase in loans;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The above activity was funded with our decrease in cash and increase in borrowings.
| | - |  | -----------------------------------------------------------------------------------

LOAN PORTFOLIO AND ADEQUACY OF THE ALLOWANCE FOR LOAN LOSSES

We believe the allowance for loan losses accounting
policy is important to the portrayal and understanding of our financial condition and results of operations. As such, selection and application of this 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 possible.

We monitor 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 risk characteristics 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.
| | - |  | -------------------------------------------------



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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.

Management has made allocations to the allowance for specific
environmental influences on the loan portfolio. These environmental variables include allocations for (i) rising interest rates, (ii) insurance and tax increases, and (iii) increased risk in the commercial real estate
portfolio. During managements review of the qualitative factors related to its portfolio, the Bank noted that insurance and property taxes have begun to stabilize, thus reducing the risk of loan defaults resulting from increased tax and
insurance assessments. These allocations have been made as a result of the increase in the cited asset portfolio (which includes special mention and adversely classified assets) and managements experience within the banking industry.

Overall, management believes the allowance for loan losses accurately estimates the losses present in our portfolio. Although the level of impaired
and cited assets has increased, this increase primarily relates to very specific and identified issues. Specifically, as the margined collateral value adequately supports our exposure, six of our impaired loans (totaling $7.8 million) do not
carry a specific reserve. We continue to closely monitor the portfolio for any deterioration in credit quality and are proactive in grading our credit exposure.

As of September 30, 2007, the allowance for loan losses was $4.8 million, up $406 thousand (or 9.3%) from December 31, 2006. This increase consists of an additional provision of $822 thousand, of which $345
thousand was recorded in the third quarter of 2007, recoveries of $39 thousand and charge-offs of $455 thousand. The increased provision since the end of last year was primarily due to loan growth as well as increased reserves related to impaired
loans. The provision was offset by the reassignment of $1.5 million of the allowance reserved for economic conditions to impaired loans, as well as the overall positive trends for the remaining loan portfolio.

Between December 31, 2005 and December 31, 2006, the allowance rose from 1.02% to 1.15% of our loan portfolio. Fluctuating a small amount over the first three
quarters of 2007, the ratio of the allowance for loan loss to total loans outstanding was 1.17% as of September 30, 2007. Over the same period, our cited assets rose from 4% at December 31, 2006 to 13% of the portfolio at
September 30, 2007. Cited loans also rose as a percent of the allowance, from 421% ($18.4 million) at December 31, 2006 to 1,077% ($51.3 million) at September 30, 2007. Although the overall level of cited assets increased
significantly during the first three quarters of 2007, a majority of the increase is attributable to five specific credits. These credits account for $25.8 million of the total cited assets. Excluding these credits, the cited assets totaled
$25.5 million at September 30, 2007 (6.3% of the portfolio and 535% of the allowance).

During 2007 management implemented additional measures to
evaluate the Banks loan portfolio, including the development of standardized risk rating methodologies, the introduction of quarterly formalized portfolio-wide rating reviews by account officers, and increased levels of loan review.
Specifically, in the second quarter of 2007, the Bank improved the loan grading process by developing a grading system based on matrix guidelines for specific credit characteristics. These guidelines are designed to enhance the accuracy and
consistency of the grading process. In the third quarter of 2007, the Bank initiated improved monitoring controls to ensure that all credits currently in the portfolio are timely graded by loan officers. On a quarterly basis all loan officers
formally review their portfolio and submit grade changes for credits that have improved or deteriorated. These additional measures have increased managements ability to identify impaired loans and decreased the volatility related to
unidentified factors in the environment. As such, the allocation of the reserve to the impaired loans has increased with an offsetting decrease to the environmental risk reserve. Based on managements review of commercial and construction
loans, impaired assets increased $3.0 million during the first nine months of 2007. The increase was primarily due to the downgrading of several loans including, one relationship



14



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##### Table of Contents

which accounted for $4.5 million. Management continues to monitor and review all impaired loans and believes that the collateral position, along with a
specific allocation of the allowance, sufficiently protects the Bank from further loss. However these loans classified as impaired are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not
corrected.

Also, it is important to note that our portfolio (unlike many peer banks) has limited exposure to sub-prime residential real estate loans as
our policy is to originate residential real estate loans for sale. Our portfolio has a very limited number of residential loans.

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, 2007, total loans on nonaccrual status were $1.1 million, representing 0.27% of total loans.
There was $889 thousand of loans on nonaccrual status at December 31, 2006. This represented 0.23% of total loans on that date. In addition to loans classified as nonaccrual, the Bank carefully monitors other credits that are current in terms
of principal and interest payments but that it believes may deteriorate in quality.

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 less costs to sell or the present value of estimated future cash flows.

ASSET / LIABILITY MANAGEMENT AND INTEREST RATE RISKS

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

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

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

In response to the changing operating environment, management continues to
monitor the net interest margin through controls and effective balance sheet and risk management practices. During the third



15



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##### Table of Contents

quarter of 2007 the Bank entered into a $15 million debt repurchase agreement, whereby higher yielding long-term securities were purchased to increase the
duration of earning assets and shorten the duration of liabilities. The Bank is currently in an asset-sensitive position, therefore the debt repurchase agreement and managements focus on fixed rate loans is intended to lessen the impact of a
downward movement in interest rates.

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, the Bank seeks to 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 $71.4 million at September 30, 2007, under which $10.8 million was outstanding. Borrowings against this line of credit are collateralized by investment securities and the Banks residential
and commercial real estate 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
well-capitalized capital position, which is intended to support current needs and provide a sound foundation to support future expansion. The Corporations and Banks regulatory capital ratios are consistently above the
well-capitalized standards. Our capital ratios as of September 30, 2007 and December 31, 2006 are presented below.



|                                  |  |         |   |  |             |   |  |                    |        |       |                   |   |        |   |        |  |       |  
|--------------------------------- |  | ------- | - |  | ----------- | - |  | ------------------ | ------ | ----- | ----------------- | - | ------ | - | ------ |  | ----- | -
|                                  |  |         |   |  | Well-       |   |  | September 30, 2007 |        |       | December 31, 2006 |  
|(Dollars in thousands)            |  | Minimum |   |  | capitalized |   |  | Amount             |        | Ratio |                   |   | Amount |   | Ratio  | 
|First State Financial Corporation |  |         |   |  |             |   |  |                    |        |       |                   |   |        |   |        |  |       |  
|Tier 1 capital                    |  | 4.0     | % |  | 6.0         | % |  | $                  | 50,911 |       | 12.21             | % |        | $ | 48,718 |  | 12.17 | %
|Total capital                     |  | 8.0     | % |  | 10.0        | % |  |                    | 55,675 |       | 13.35             | % |        |   | 53,076 |  | 13.26 | %
|Tier 1 leverage                   |  | 4.0     | % |  | 5.0         | % |  |                    | 50,911 |       | 10.92             | % |        |   | 48,718 |  | 10.89 | %
|                                  |  |         |   |  |             |  
|First State Bank                  |  |         |   |  |             |   |  |                    |        |       |                   |   |        |   |        |  |       |  
|Tier 1 capital                    |  | 4.0     | % |  | 6.0         | % |  |                    | 50,356 |       | 12.07             | % |        |   | 48,670 |  | 12.16 | %
|Total capital                     |  | 8.0     | % |  | 10.0        | % |  |                    | 55,120 |       | 13.22             | % |        |   | 53,028 |  | 13.25 | %
|Tier 1 leverage                   |  | 4.0     | % |  | 5.0         | % |  |                    | 50,356 |       | 10.99             | % |        |   | 48,670 |  | 10.96 | %



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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, 2007 was analyzed using a simulation analysis of the Companys sensitivity to changes in net interest income under varying assumptions for changes in market interest rates. Specifically, the model derives
expected interest income and interest expense resulting from gradual and parallel shifts in the yield curve. Rate changes are matched with known re-pricing intervals. The Bank uses standardized assumptions run against Bank data by an outsourced
provider of Asset/Liability reporting. The analysis indicates that, while a decreasing rate environment would cause our margin to compress, the decrease in net interest income is not as dramatic as the increase we would receive in a rising rate
environment. This is primarily due to the Banks ability to manage its liabilities. Competition for deposits in the Banks market areas is intense. By managing maturities and rates as well as looking to other sources of funding, such as
advances from the Federal Home Loan Bank, we attempt to control the compression on our interest rate margin in such a way as to cushion the effect of a declining rate environment.

The Companys simulation analysis has its limitations, as the assumptions are inherently uncertain and subject to fluctuation and revision in a dynamic environment and as a result the model cannot perfectly
forecast net interest income, nor exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of balance sheet components and interest
rate changes, market conditions and management strategies, among other factors.



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

Disclosure Controls and Procedures

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

Under the supervision and with the participation of management, including the Chief Executive Officer and Chief
Financial Officer our controls and procedures in place as of the end of the period covered by this report were evaluated. They concluded that our disclosure controls and procedures were effective. No significant 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 our internal control over financial
reporting pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, enhancements were made to the financial reporting process, however no changes were made that were considered material or reasonably likely to
materially affect, the Banks internal control over financial reporting.



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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, 2006, which could materially affect our business, financial
condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may adversely
affect our business, financial condition and/or operating results.



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

None



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

None



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

None



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

None



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

Exhibit 10.7  Lease between Oasis
Largo, LLC and First State Bank, dated May 10, 2007

Exhibit 10.8  Lease agreement between PBC Associates, L.L.C. and First State
Bank, dated December 11, 2006

Exhibit 10.9  Lease agreement between Winkal Holdings, L.L.C. and First State Financial Corp,
dated July, 2007

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

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

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



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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, 2007



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




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