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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)

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

For the quarterly period ended March 31, 2009

or



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

For the transition period from              to

Commission File Number: 000-50992





FIRST STATE FINANCIAL CORPORATION

(Exact name of registrant as specified in
its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Florida                                                        |  | 65-0771145                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                         |  |           
|---------------------------------------- |  | ----------
|22 S. Links Avenue, Sarasota, FL         |  | 34236     
|(Address of principal executive offices) |  | (Zip code)

941-929-9000

(Registrants telephone number, including area code)

N/A

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





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

Indicate by check mark whether the registrant has
submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files).    Yes   ̈    No   ̈

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



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈ |  | Accelerated filer         |  |  ̈
|                        |  |   | 
|Non-Accelerated filer   |  |  ̈ |  | Smaller Reporting Company |  | x

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

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date. As of May 14, 2009 the registrant had outstanding 5,920,300 shares of common stock.









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TABLE OF CONTENTS



|                               |  |                                                                      |  |   
|------------------------------ |  | -------------------------------------------------------------------- |  | --
|                               |  | PAGE                                                                
|PART I  FINANCIAL INFORMATION |  |                                                                     
|                               |  |                                                                     
|Item 1 -                       |  | Condensed Consolidated Financial Statements                          |  |   
|                               |  |                                                                     
|                               |  | Condensed Consolidated Balance Sheets                                |  | 1 
|                               |  |                                                                     
|                               |  | Condensed Consolidated Statements of Income                          |  | 2 
|                               |  |                                                                     
|                               |  | Condensed Consolidated Statements of Changes in Stockholders Equity |  | 3 
|                               |  |                                                                     
|                               |  | Condensed Consolidated Statements of Cash Flow                       |  | 4 
|                               |  |                                                                     
|                               |  | Condensed Notes to Condensed Consolidated Financial Statements       |  | 5 
|                               |  |                                                                     
|Item 2 -                       |  | Managements Discussion and Analysis                                 |  | 10
|                               |  |                                                                     
|Item 3 -                       |  | Quantitative and Qualitative Disclosures About Market Risk           |  | 16
|                               |  |                                                                     
|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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FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

March 31, 2009 (unaudited) and December 31, 2008

(Dollar amounts in thousands except per share data)



|                                                                                                  |  |                |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                  |  | March 31, 2009 |         |   | December 31, 2008 |  
|ASSETS                                                                                            | 
|Cash and due from financial institutions                                                          |  | $              | 6,903   |   |                   | $ | 5,195   |  
|Federal funds sold                                                                                |  |                | 12,430  |   |                   |   | 1,524   |  
|                                                                                                  |  |                |         |   |                   |   |         |  
|Cash and cash equivalents                                                                         |  |                | 19,333  |   |                   |   | 6,719   |  
|Interest bearing deposits in other financial institutions                                         |  |                | 1,299   |   |                   |   | 225     |  
|Securities, available-for-sale                                                                    |  |                | 52,925  |   |                   |   | 67,323  |  
|Loans, net of allowance of $16,681 and $20,679                                                    |  |                | 342,737 |   |                   |   | 366,293 |  
|Federal Home Loan Bank stock                                                                      |  |                | 1,791   |   |                   |   | 2,700   |  
|Premise and equipment, net                                                                        |  |                | 12,229  |   |                   |   | 12,351  |  
|Other real estate owned                                                                           |  |                | 3,265   |   |                   |   | 811     |  
|Other assets                                                                                      |  |                | 6,988   |   |                   |   | 6,814   |  
|                                                                                                  |  |                |         |   |                   |   |         |  
|Total Assets                                                                                      |  | $              | 440,567 |   |                   | $ | 463,236 |  
|                                                                                                  |  |                |         |   |                   |   |         |  
|                                                                                                 
|LIABILITIES and STOCKHOLDERS EQUITY                                                              | 
|Deposits                                                                                          |  |                |         |   |                   |   |         |  
|Demand                                                                                            |  | $              | 28,240  |   |                   | $ | 32,555  |  
|Interest-bearing checking                                                                         |  |                | 14,042  |   |                   |   | 13,908  |  
|Money market                                                                                      |  |                | 53,695  |   |                   |   | 45,180  |  
|Savings                                                                                           |  |                | 9,194   |   |                   |   | 8,314   |  
|Time                                                                                              |  |                | 276,485 |   |                   |   | 267,901 |  
|                                                                                                  |  |                |         |   |                   |   |         |  
|Total deposits                                                                                    |  |                | 381,656 |   |                   |   | 367,858 |  
|Accrued interest payable and other liabilities                                                    |  |                | 1,234   |   |                   |   | 1,384   |  
|Repurchase agreements                                                                             |  |                | 25,000  |   |                   |   | 25,000  |  
|Federal Home Loan Bank advances & other borrowings                                                |  |                | 21,001  |   |                   |   | 41,001  |  
|                                                                                                  |  |                |         |   |                   |   |         |  
|Total Liabilities                                                                                 |  |                | 428,891 |   |                   |   | 435,243 |  
|                                                                                                  |  |               
|Commitments and contingent liabilities                                                            |  |                |         |   |                   |   |         |  
|                                                                                                  |  |               
|Stockholders Equity                                                                              |  |                |         |   |                   |   |         |  
|Common stock, $1 par value; 25,000,000 shares authorized; 5,920,300 shares issued and outstanding |  |                | 5,920   |   |                   |   | 5,920   |  
|Additional paid-in capital                                                                        |  |                | 32,663  |   |                   |   | 32,639  |  
|Accumulated deficit                                                                               |  |                | (27,066 | ) |                   |   | (10,723 | )
|Accumulated other comprehensive income                                                            |  |                | 159     |   |                   |   | 157     |  
|                                                                                                  |  |                |         |   |                   |   |         |  
|Total Stockholders Equity                                                                        |  |                | 11,676  |   |                   |   | 27,993  |  
|                                                                                                  |  |                |         |   |                   |   |         |  
|Total Liabilities and Stockholders Equity                                                        |  | $              | 440,567 |   |                   | $ | 463,236 |  
|                                                                                                  |  |                |         |   |                   |   |         |  

See Notes to Condensed Consolidated Financial Statements



1



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FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollar amounts in thousands except per share data)



|                                                           |  |                             |           |   |      |   |           |  
|---------------------------------------------------------- |  | --------------------------- | --------- | - | ---- | - | --------- | -
|                                                           |  | Three Months EndedMarch 31, |          
|                                                           |  | 2009                        |           |   | 2008 |  
|Interest Income                                            |  |                             |           |   |      |   |           |  
|Loans, including fees                                      |  | $                           | 5,085     |   |      | $ | 7,125     |  
|Taxable securities                                         |  |                             | 590       |   |      |   | 624       |  
|Tax exempt securities                                      |  |                             | 99        |   |      |   | 151       |  
|Federal funds sold and other                               |  |                             | 1         |   |      |   | 75        |  
|                                                           |  |                             |           |   |      |   |           |  
|                                                           |  |                             | 5,775     |   |      |   | 7,975     |  
|Interest expense                                           |  |                             |           |   |      |   |           |  
|Deposits                                                   |  |                             | 3,430     |   |      |   | 4,133     |  
|Federal Home Loan Bank advances and other borrowings       |  |                             | 413       |   |      |   | 343       |  
|                                                           |  |                             |           |   |      |   |           |  
|                                                           |  |                             | 3,843     |   |      |   | 4,476     |  
|                                                           |  |                             |           |   |      |   |           |  
|Net interest income                                        |  |                             | 1,932     |   |      |   | 3,499     |  
|Provision for loan losses                                  |  |                             | 15,541    |   |      |   | 2,933     |  
|                                                           |  |                             |           |   |      |   |           |  
|Net interest (loss) income after provision for loan losses |  |                             | (13,609   | ) |      |   | 566       |  
|Non-interest income                                        |  |                             |           |   |      |   |           |  
|Service charges and other fees                             |  |                             | 240       |   |      |   | 328       |  
|Mortgage banking fees                                      |  |                             | 97        |   |      |   | 103       |  
|Net gain on sale of securities                             |  |                             | 394       |   |      |   | 191       |  
|Gain on sale of property                                   |  |                             |          |   |      |   | 49        |  
|Other                                                      |  |                             | 6         |   |      |   | 20        |  
|                                                           |  |                             |           |   |      |   |           |  
|                                                           |  |                             | 737       |   |      |   | 691       |  
|Non-interest expense                                       |  |                             |           |   |      |   |           |  
|Salaries and employee benefits                             |  |                             | 2,063     |   |      |   | 1,845     |  
|Occupancy and equipment                                    |  |                             | 648       |   |      |   | 575       |  
|Data processing                                            |  |                             | 179       |   |      |   | 180       |  
|Professional services                                      |  |                             | 59        |   |      |   | 69        |  
|Stationery and supplies                                    |  |                             | 36        |   |      |   | 48        |  
|Advertising and marketing                                  |  |                             | 41        |   |      |   | 41        |  
|Other                                                      |  |                             | 445       |   |      |   | 376       |  
|                                                           |  |                             |           |   |      |   |           |  
|                                                           |  |                             | 3,471     |   |      |   | 3,134     |  
|                                                           |  |                             |           |   |      |   |           |  
|Loss before income taxes                                   |  |                             | (16,343   | ) |      |   | (1,877    | )
|Income tax benefit                                         |  |                             |          |   |      |   | (739      | )
|                                                           |  |                             |           |   |      |   |           |  
|Net loss                                                   |  | $                           | (16,343   | ) |      | $ | (1,138    | )
|                                                           |  |                             |           |   |      |   |           |  
|Loss per share                                             |  |                             |           |   |      |   |           |  
|Basic                                                      |  | $                           | (2.76     | ) |      | $ | (0.19     | )
|Diluted                                                    |  | $                           | (2.76     | ) |      | $ | (0.19     | )
|Average common shares outstanding                          |  |                             |           |   |      |   |           |  
|Basic                                                      |  |                             | 5,920,300 |   |      |   | 5,920,300 |  
|Diluted                                                    |  |                             | 5,920,300 |   |      |   | 5,920,300 |  
|Dividends per share                                        |  |                             |          |   |      | $ | 0.08      |  

See Notes to Condensed Consolidated Financial Statements



2



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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/(AccumDeficit) |  |   | Accum. OtherComprehensiveIncome (Loss) |   |  | Total |     
|Balance at January 1, 2008                                                                           |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,515                          |  | $ | 11,367                                 |   |  | $     | 331  |   |  | $ | 50,133  |  
|Comprehensive loss:                                                                                  |  |           |  |             |       |                          |   |                                 |  |   |                                        |   |  |       |      |   |  |   |         |  
|Net loss                                                                                             |  |          |  |             |      |                          |   |                                |  |   | (1,138                                 | ) |  |       |     |   |  |   | (1,138  | )
|Change in net unrealized gain (loss) on investment securities available-for-sale, net of tax effects |  |          |  |             |      |                          |   |                                |  |   |                                       |   |  |       | (371 | ) |  |   | (371    | )
|                                                                                                     |  |           |  |             |       |                          |   |                                 |  |   |                                        |   |  |       |      |   |  |   |         |  
|Total Comprehensive Loss                                                                             |  |          |  |             |      |                          |   |                                |  |   |                                       |   |  |       |     |   |  |   | (1,509  | )
|Stock-based compensation                                                                             |  |          |  |             |      |                          |   | 31                              |  |   |                                       |   |  |       |     |   |  |   | 31      |  
|Cash dividend declared, $0.08 per share                                                              |  |          |  |             |      |                          |   |                                |  |   | (474                                   | ) |  |       |     |   |  |   | (474    | )
|                                                                                                     |  |           |  |             |       |                          |   |                                 |  |   |                                        |   |  |       |      |   |  |   |         |  
|Balance at March 31, 2008                                                                            |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,546                          |  | $ | 9,755                                  |   |  | $     | (40  | ) |  | $ | 48,181  |  
|                                                                                                     |  |           |  |             |       |                          |   |                                 |  |   |                                        |   |  |       |      |   |  |   |         |  
|                                                                                                     |  |           |  |             |       |                         
|Balance at January 1, 2009                                                                           |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,639                          |  | $ | (10,723                                | ) |  | $     | 157  |   |  | $ | 27,993  |  
|Comprehensive loss:                                                                                  |  |           |  |             |       |                          |   |                                 |  |   |                                        |   |  |       |      |   |  |   |         |  
|Net loss                                                                                             |  |          |  |             |      |                          |   |                                |  |   | (16,343                                | ) |  |       |     |   |  |   | (16,343 | )
|Change in net unrealized gain on investment securities available-for-sale, net of tax effects        |  |          |  |             |      |                          |   |                                |  |   |                                       |   |  |       | 2    |   |  |   | 2       |  
|                                                                                                     |  |           |  |             |       |                          |   |                                 |  |   |                                        |   |  |       |      |   |  |   |         |  
|Total Comprehensive Loss                                                                             |  |          |  |             |      |                          |   |                                |  |   |                                       |   |  |       |     |   |  |   | (16,341 | )
|Stock-based compensation                                                                             |  |          |  |             |      |                          |   | 24                              |  |   |                                       |   |  |       |     |   |  |   | 24      |  
|                                                                                                     |  |           |  |             |       |                          |   |                                 |  |   |                                        |   |  |       |      |   |  |   |         |  
|Balance at March 31, 2009                                                                            |  | 5,920,300 |  | $           | 5,920 |                          | $ | 32,663                          |  | $ | (27,066                                | ) |  | $     | 159  |   |  | $ | 11,676  |  
|                                                                                                     |  |           |  |             |       |                          |   |                                 |  |   |                                        |   |  |       |      |   |  |   |         |  

See Notes to Condensed Consolidated Financial Statements



3



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FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

Three Months Ended March 31, 2009 and 2008

(Unaudited)

(Dollar amounts in thousands)



|                                                                                  |  |      |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | 2009 |         |   | 2008 |  
|Cash flows (used in) from operating activities:                                   |  |      |         |   |      |   |         |  
|Net loss                                                                          |  | $    | (16,343 | ) |      | $ | (1,138  | )
|Adjustments to reconcile net loss to net cash (used in) from operating activities |  |      |         |   |      |   |         |  
|Provision for loan losses                                                         |  |      | 15,541  |   |      |   | 2,933   |  
|Depreciation                                                                      |  |      | 144     |   |      |   | 133     |  
|Net accretion of securities                                                       |  |      | (59     | ) |      |   | (52     | )
|Stock-based compensation                                                          |  |      | 24      |   |      |   | 31      |  
|Gain on sale of available-for-sale securities                                     |  |      | (394    | ) |      |   |        |  
|Gain on sale of property                                                          |  |      |        |   |      |   | (49     | )
|Net change in:                                                                    |  |      |         |   |      |   |         |  
|Other assets                                                                      |  |      | (176    | ) |      |   | (1,029  | )
|Deferred tax asset                                                                |  |      |        |   |      |   | 490     |  
|Accrued expenses and other liabilities                                            |  |      | (150    | ) |      |   | (612    | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash (used in) from operating activities                                      |  |      | (1,413  | ) |      |   | 707     |  
|Cash flows from (used in) investing activities:                                   |  |      |         |   |      |   |         |  
|Net change in time deposits                                                       |  |      | (1,074  | ) |      |   | 209     |  
|Available-for-sale securities:                                                    |  |      |         |   |      |   |         |  
|Maturities, prepayments and calls                                                 |  |      | 2,754   |   |      |   | (46     | )
|Proceeds from sales                                                               |  |      | 17,826  |   |      |   | 11,813  |  
|Purchases                                                                         |  |      | (5,725  | ) |      |   | (23,089 | )
|Loan originations and payments, net                                               |  |      | 5,561   |   |      |   | 8,391   |  
|Net sale (purchase) of FHLB stock                                                 |  |      | 909     |   |      |   | (669    | )
|Net change in premise and equipment                                               |  |      | (22     | ) |      |   | (233    | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash from (used in) investing activities                                      |  |      | 20,229  |   |      |   | (3,624  | )
|Cash flows used in financing activities:                                          |  |      |         |   |      |   |         |  
|Net change in deposits                                                            |  |      | 13,798  |   |      |   | (17,842 | )
|Net change in short-term borrowing                                                |  |      | (20,000 | ) |      |   | 5,204   |  
|Proceeds from long-term borrowing                                                 |  |      |        |   |      |   | 10,000  |  
|Cash dividend paid                                                                |  |      |        |   |      |   | (474    | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash used in financing activities                                             |  |      | (6,202  | ) |      |   | (3,112  | )
|                                                                                  |  |     
|Net change in cash and cash equivalents                                           |  |      | 12,614  |   |      |   | (6,029  | )
|Beginning cash and cash equivalents                                               |  |      | 6,719   |   |      |   | 10,669  |  
|                                                                                  |  |      |         |   |      |   |         |  
|Ending cash and cash equivalents                                                  |  | $    | 19,333  |   |      | $ | 4,640   |  
|                                                                                  |  |      |         |   |      |   |         |  
|Supplemental cash flow information                                                |  |      |         |   |      |   |         |  
|Interest paid                                                                     |  | $    | 3,820   |   |      | $ | 4,569   |  
|Income taxes paid                                                                 |  | $    |        |   |      | $ |        |  
|Supplemental disclosure of non cash transactions:                                 |  |      |         |   |      |   |         |  
|Loans transferred to other real estate owned                                      |  | $    | 2,454   |   |      | $ |        |  

See Notes to Condensed Consolidated Financial Statements



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FIRST STATE FINANCIAL CORPORATION

CONDENSED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2009

(Unaudited)

NOTE 1  INTERIM FINANCIAL STATEMENTS

The (a) condensed balance sheet as of December 31, 2008, which
has been derived from audited financial statements, and (b) the unaudited interim condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note
disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the company believes that the
disclosures made are adequate to make the information not misleading. It is suggested that these condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the companys latest Form
10-K/A Amendment No. 1. 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 three months ended
March 31, 2009 are not necessarily indicative of the results that may be expected for the full year of 2009.

NOTE 2  NEW ACCOUNTING
STANDARDS

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments.
This FASB Staff Position (FSP) amends Statement of Financial Accounting Standard (SFAS) No. 107, Disclosures About Fair Value of Financial Instruments, to require disclosures about fair value of financial
instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized
financial information at interim reporting periods. This FSP is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The FSP does not require disclosures
for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, this FSP requires comparative disclosures only for periods ending after initial adoption. We intend to include the disclosures required by
this FSP in our second quarter Form 10-Q.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments. This FSP amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt
and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. This FSP is effective for interim and annual reporting periods
ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial
adoption, this FSP requires comparative disclosures only for periods ending after initial adoption. We intend to adopt this FSP in the second quarter; however, we do not expect the adoption to have a material effect on our financial results.

In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly. This FSP provides additional guidance for estimating fair value in accordance with SFAS No. 157, Fair Value Measurements, when the volume and level of
activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. This FSP is effective for interim and annual reporting periods ending after
June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, this
FSP requires comparative disclosures only for periods ending after initial adoption. We intend to adopt this FSP in the second quarter; however, we do not expect the adoption to have a material effect on our financial results.



5



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NOTE 3  STOCK-BASED COMPENSATION

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

During the quarter ended March 31, 2009, the Company did not grant any stock options. During the quarter ended March 31,
2008, the Company granted 71,250 stock options. During the quarter ended March 31, 2009, 20,050 options vested and no options were exercised. During the quarter ended March 31, 2008, 5,800 options vested and no options were exercised.

A summary of share option activity under the plan as of March 31, 2009 is as follows:



|                                     |  |                         |  |                              |       |                                                     |      |                                       |   |  
|------------------------------------ |  | ----------------------- |  | ---------------------------- | ----- | --------------------------------------------------- | ---- | ------------------------------------- | - | -
|                                     |  | StockOptionsOutstanding |  | WeightedAverageExercisePrice |       | Weighted-AverageRemainingContractualLife (in
years) |      | AggregateIntrinsicValue(in thousands)
|Options outstanding, January 1, 2009 |  | 166,590                 |  | $                            | 11.17 |                                                     |      |                                       |   |  
|Granted                              |  |                        |  |                              |      |                                                     |      |                                       |   |  
|Exercised                            |  |                        |  |                              |      |                                                     |      |                                       |   |  
|Forfeited or expired                 |  |                        |  |                              |      |                                                     |      |                                       |   |  
|                                     |  |                         |  |                              |       |                                                     |      |                                       |   |  
|Options outstanding, March 31, 2009  |  | 166,590                 |  | $                            | 11.17 |                                                     | 7.60 |                                       | $ | 
|                                     |  |                         |  |                              |       |                                                     |      |                                       |   |  
|                                     |  |                         |  |                             
|Options exercisable, March 31, 2009  |  | 64,970                  |  | $                            | 12.05 |                                                     | 6.98 |                                       | $ | 
|                                     |  |                         |  |                              |       |                                                     |      |                                       |   |  

For the three months ended March 31, 2009, $24 thousand in compensation cost related to the Companys
stock option plan was recorded in net loss. As of March 31, 2009, $124 thousand in unrecognized compensation costs remained to be recognized over a weighted-average period of 2.3 years. All stock option compensation costs recognized in the
first three months of 2009 were 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):



|                              |  |               |         |   |                  |   |         |  
|----------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                              |  | March 31,2009 |         |   | December 31,2008 |  
|Commercial                    |  | $             | 60,700  |   |                  | $ | 73,301  |  
|Real estate:                  |  |               |         |   |                  |   |         |  
|Residential                   |  |               | 51,682  |   |                  |   | 53,470  |  
|Commercial                    |  |               | 175,005 |   |                  |   | 183,203 |  
|Construction                  |  |               | 60,304  |   |                  |   | 64,799  |  
|Consumer and other            |  |               | 12,432  |   |                  |   | 13,006  |  
|                              |  |               |         |   |                  |   |         |  
|                              |  |               | 360,123 |   |                  |   | 387,779 |  
|Less: Deferred loan fees, net |  |               | (705    | ) |                  |   | (807    | )
|Allowance for loan losses     |  |               | (16,681 | ) |                  |   | (20,679 | )
|                              |  |               |         |   |                  |   |         |  
|Total loans, net              |  | $             | 342,737 |   |                  | $ | 366,293 |  
|                              |  |               |         |   |                  |   |         |  



6



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



|                                |  |                                     |         |   |               |   |        |  
|------------------------------- |  | ----------------------------------- | ------- | - | ------------- | - | ------ | -
|                                |  | Activity for the three months ended |        
|                                |  | March 31,2009                       |         |   | March 31,2008 |  
|Balance, beginning of period    |  | $                                   | 20,679  |   |               | $ | 7,633  |  
|Provision charged to operations |  |                                     | 15,541  |   |               |   | 2,933  |  
|Loans charged off               |  |                                     | (19,543 | ) |               |   | (545   | )
|Recoveries                      |  |                                     | 4       |   |               |   | 22     |  
|                                |  |                                     |         |   |               |   |        |  
|Balance, end of period          |  | $                                   | 16,681  |   |               | $ | 10,043 |  
|                                |  |                                     |         |   |               |   |        |  

Impaired loans were as follows (in thousands):



|                                                  |  |               |        |                  |   |       
|------------------------------------------------- |  | ------------- | ------ | ---------------- | - | ------
|                                                  |  | March 31,2009 |        | December 31,2008
|Loans with no allocated allowance for loan losses |  | $             | 51,243 |                  | $ | 44,839
|Loans with allocated allowance for loan losses    |  |               | 35,806 |                  |   | 53,643
|                                                  |  |               |        |                  |   |       
|                                                  |  | $             | 87,049 |                  | $ | 98,482
|                                                  |  |               |        |                  |   |       
|Amount of the allowance for loan losses allocated |  | $             | 9,161  |                  | $ | 17,812
|                                                  |  |               |        |                  |   |       

NOTE 5  FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS

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



|                                          |  |               |        |                  |   |       
|----------------------------------------- |  | ------------- | ------ | ---------------- | - | ------
|                                          |  | March 31,2009 |        | December 31,2008
|Line of credit, Independent Bankers Bank |  | $             | 1      |                  | $ | 1     
|Federal Home Loan Bank advances           |  |               | 21,000 |                  |   | 41,000
|                                          |  |               |        |                  |   |       
|                                          |  | $             | 21,001 |                  | $ | 41,001
|                                          |  |               |        |                  |   |       

During the quarter ended March 31, 2009, $20.0 million Federal Home Loan Bank advances outstanding at
December 31, 2008 were paid off.

The borrowings were collateralized by $2.8 million and $3.0 million of securities and a blanket pledge of a portion
of the Banks mortgage loan portfolio at March 31, 2009 and December 31, 2008, respectively.

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 March 31, 2009 and December 31, 2008. 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. The line of credit was renewed in May 2009 and is subject to review in May 2010. At March 31,
2009 the Company was not compliant with the debt covenants surrounding the line of credit and thus cannot utilize the remainder of the $4.0 million line of credit and could be required to repay the $1 thousand outstanding.

NOTE 6  FAIR VALUE

SFAS No. 157 establishes a fair value
hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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

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

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



7



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##### Table of Contents

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below. The fair value of securities available-for-sale is determined by matrix pricing, which is a mathematical technique widely used
in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities relationship to other benchmark quoted securities (Level 2 inputs).



|                               |  |                                                                                                           |        |                                                                                                              |   |       
|------------------------------ |  | --------------------------------------------------------------------------------------------------------- | ------ | ------------------------------------------------------------------------------------------------------------ | - | ------
|                               |  | Fair Value Measurement at March 31,2009 Using Significant Other ObservableInputs (level 2) (in thousands) |        | Fair Value Measurement at December 31,2008 Using Significant Other ObservableInputs (level 2) (in thousands)
|Securities, available-for-sale |  | $                                                                                                         | 52,925 |                                                                                                              | $ | 67,323

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below. The fair value of the other real estate owned and impaired loans with
specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.
Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the
inputs for determining fair value. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $35.8 million, with a valuation allowance of $9.2 million, resulting
in an increase of the provision for loan losses of $10.9 million for the period. Other real estate owned, which is measured for impairment using fair value, had a carrying amount of $203 thousand, with a valuation allowance of $85 thousand.



|                        |  |                                                                                                             |        |                                                                                                                |   |       
|----------------------- |  | ----------------------------------------------------------------------------------------------------------- | ------ | -------------------------------------------------------------------------------------------------------------- | - | ------
|                        |  | Fair Value Measurement at March 31,2009 Using Significant Other UnobservableInputs (level 3) (in thousands) |        | Fair Value Measurement at December 31,2008 Using Significant Other UnobservableInputs (level 3) (in thousands)
|Impaired loans          |  | $                                                                                                           | 35,806 |                                                                                                                | $ | 53,643
|Other real estate owned |  |                                                                                                             | 203    |                                                                                                                |   | 203   

NOTE 7  CAPITAL REQUIREMENTS

The Bank is subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory  and possibly additional
discretionary  actions by regulators that, if undertaken, could have a direct material effect on the Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must
meet specific capital guidelines that involve quantitative measures of the Banks assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Banks capital amounts and classification
are also subject to qualitative judgments by the regulators about components, risk-weighting and other factors.

Quantitative measures established by
regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 Capital (as defined by regulations) to Risk-Weighted Assets (as defined) and of Tier I Capital (as
defined) to Average Assets (as defined).

As of March 31, 2009 the Bank was significantly undercapitalized under the regulatory framework for prompt
corrective action. Actual capital amounts (dollars in thousands) and ratios are presented in the table.



|                                          |  |        |  |       |                              |  |        |                                                                     |       |   |      |        |  |       |        |  |      |  
|----------------------------------------- |  | ------ |  | ----- | ---------------------------- |  | ------ | ------------------------------------------------------------------- | ----- | - | ---- | ------ |  | ----- | ------ |  | ---- | -
|                                          |  | Actual |  |       | For CapitalAdequacy Purposes |  |        | To Be AdequatelyCapitalized UnderPrompt CorrectiveAction Provisions |      
|                                          |  | Amount |  | Ratio |                              |  | Amount |                                                                     | Ratio |   |      | Amount |  | Ratio |       
|As of March 31, 2009:                     |  |        |  |       |                              |  |        |                                                                     |       |   |      |        |  |       |        |  |      |  
|Total capital (to risk-weighted assets):  |  | 16,344 |  | 4.25  | %                            |  | 3      | 30,801                                                              |       | 3 | 8.00 | %      |  | $     | 30,801 |  | 8.00 | %
|Tier I capital (to risk weighted assets): |  | 11,385 |  | 2.96  | %                            |  | 3      | 15,401                                                              |       | 3 | 4.00 | %      |  |       | 15,401 |  | 4.00 | %
|Tier I capital (to average assets):       |  | 11,385 |  | 2.50  | %                            |  | 3      | 18,227                                                              |       | 3 | 4.00 | %      |  |       | 18,227 |  | 4.00 | %



|(1) | The regulatory ratios for a well capitalized institution are: Tier I Capital 6%; Total Capital 10%; Leverage 5%. The regulatory ratios for an adequately
capitalized institution are: Tier I Capital 4%; Total Capital 8%; Leverage 4%. The regulatory ratios for an under capitalized institution are: Tier I Capital 3%; Total Capital 6%; Leverage 3%. The regulatory ratio for a
significantly under capitalized institution are: Ratio of tangible equity to total assets greater than 2%.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

On May 12, 2009, the Bank received notification from the FDIC that as of March 31, 2009, it was
undercapitalized. As a result of this classification, the Bank is subject to restrictions on asset growth, dividends, other capital distributions and management fees pursuant to FDIC Rules and Regulations. Further, the Bank is required to file a
written capital restoration plan with the FDIC within 45 days of the receipt of the notification. Lastly, the Banks current capital levels do not allow it to accept new or rollover any brokered deposits or solicit deposits by offering an
effective yield that exceeds by more than 75 basis points over the prevailing effective yields on insured deposits of comparable maturity in the Banks market area.

NOTE 8  GOING CONCERN

The Companys financial statements have been prepared on a going-concern basis,
which contemplates continuity ofoperations, realization of assets and liquidation of liabilities in the ordinary course of business. The Company recorded a loss for the year ended December 31, 2008 of $21.1 million and for the
first quarter of 2009 of $16.3 million. In addition, the Banks capital ratios as of December 31, 2008 and March 31, 2009 severely deteriorated and are expected to continue to deteriorate through the second quarter of 2009 unless the
Company is able to secure new capital or reduce the size of the loan portfolio. Failure to meet regulatory capital requirements may expose the Company and the Bank to additional regulatory sanctions including mandatory asset disposition and seizure.
As previously reported in the Companys 2008 financial statements filed on Form 10-K/A, filed on May 15, 2009, these factors raise substantial doubt about the Companys ability to continue as a going concern.

Managements plans to mitigate the effects of the losses incurred and other matters described above are: 1) to raise additional equity capital; 2) reduce the size
of the loan portfolio; and 3) to pursue its business plan and seek to generate positive operating cash flow. The Companys ability to continue as a going concern is dependent on the implementation and success of these plans and management
believes that these plans can be effectively implemented during 2009. However, there can be no assurance that managements plans can be achieved. The financial statements do not include any adjustments in the event the Company is unable to
continue as a going concern.

NOTE 9  SUBSEQUENT EVENT

During the year ended 2007, the Bank entered into $25.0 million of ten-year repurchase agreements, whereby higher yielding long-term securities were purchased to decrease the duration of earning assets and shorten the duration of
liabilities. At March 31, 2009 the agreements were callable immediately as the Bank did not maintain its well capitalized status with the FDIC. However, upon further review of the associated agreements and discussions with the
counterparty to the agreements in April of 2009, it was determined that there was ambiguity in the agreements pertaining to the rights of the non defaulting party.

In April of 2009, the repurchase agreements were amended. The amendments state that the agreements are callable and a default has occurred if (i) First State Bank ceases to be adequately capitalized at any time before
September 30, 2009, (ii) First State Bank fails to regain and maintain well capitalized status on and after September 30, 2009, (iii) First State Bank is issued a cease and desist order at any time by its
Federal or State regulator, or (iv) First State Bank fails to deliver additional cash margin such that the total amount of the excess cash margin is equal to $2.5 million. Under the terms of the amendment, if a default occurs, the agreements
are callable immediately and the non defaulting party has the right to mark-to-market the underlying interest rate exposure, which was valued at approximately $4.6 million at April 13, 2009. As First State Bank was rated significantly
undercapitalized as of March 31, 2009, the Bank is in default of the amended repurchase agreements and if called, would need to record approximately $4.6 million of additional expense in order to mark-to-market the interest rate exposure.



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##### Table of Contents

|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 months ended March 31, 2009. 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 2008 Form 10-K/A
(Amendment No. 1). 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 2008
Form 10-K/A (Amendment No. 1), which contains important additional information that is necessary to understand the Corporation and its financial condition and results of operations for the periods covered by this report.

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

OVERVIEW

We are the parent of First State Bank, a community bank headquartered in Sarasota, Florida with offices in
Sarasota and Pinellas counties.

Some of the key developments during the first quarter of 2009 include:



| |  |  | The net sale of $12.1 million in securities to decrease the duration of interest earning assets;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | The pay down of $20.0 million of short term borrowings; and
| | - |  | -----------------------------------------------------------



| |  |  | Net loss of $16.3 million primarily due to an increase of the loan loss provision.
| | - |  | ----------------------------------------------------------------------------------

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. As part of our strategic plan, we are reassessing our long term objectives and strategic alternatives to determine the most appropriate business strategy for the Company and its shareholders. In our efforts to continue to improve our
efficiency and profitability, our plan is to focus on recapitalization, improving operating expenses as a percent of total assets and improving our efficiency ratio. We also will seek to improve our profitability by maintaining pricing discipline on
the loans we originate and attracting lower cost core deposits.

FORWARD-LOOKING STATEMENTS

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



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



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



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



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



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



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

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



10



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##### Table of Contents

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 endedMarch 31, |        
|                                           |  |                             |         |   |      |   |        | change | 
|(Dollars in thousands)                     |  | 2009                        |         |   | 2008 |   |        | $      |  |   | %       |  
|Interest income                            |  | $                           | 5,775   |   |      | $ | 7,975  |        |  | $ | (2,200  | ) |  | -28   | % 
|Interest expense                           |  |                             | 3,843   |   |      |   | 4,476  |        |  |   | (633    | ) |  | -14   | % 
|                                           |  |                             |         |   |      |   |        |        |  |   |         |   |  |       |   
|Net interest income                        |  |                             | 1,932   |   |      |   | 3,499  |        |  |   | (1,567  | ) |  | -45   | % 
|Provision for loan losses                  |  |                             | 15,541  |   |      |   | 2,933  |        |  |   | 12,608  |   |  | 430   | % 
|                                           |  |                             |         |   |      |   |        |        |  |   |         |   |  |       |   
|Net interest (loss) income after provision |  |                             | (13,609 | ) |      |   | 566    |        |  |   | (14,175 | ) |  | 2504  | % 
|Non-interest income                        |  |                             | 737     |   |      |   | 691    |        |  |   | 46      |   |  | 7     | % 
|Non-interest expense                       |  |                             | (3,471  | ) |      |   | (3,134 | )      |  |   | 337     |   |  | 11    | % 
|                                           |  |                             |         |   |      |   |        |        |  |   |         |   |  |       |   
|Loss before income taxes                   |  |                             | (16,343 | ) |      |   | (1,877 | )      |  |   | (14,466 | ) |  | -771  | % 
|Income tax benefit                         |  |                             |        |   |      |   | (739   | )      |  |   | 739     |   |  | 100   | % 
|                                           |  |                             |         |   |      |   |        |        |  |   |         |   |  |       |   
|Net loss                                   |  | $                           | (16,343 | ) |      | $ | (1,138 | )      |  | $ | (15,205 | ) |  | (1336 | )%
|                                           |  |                             |         |   |      |   |        |        |  |   |         |   |  |       |   

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



|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|---------------------------------------- |  | ------------------------------------ | ------- | -------------- | ---- | ----- | ------------ |  | ---- | --------------- |  | -------------- | ------- |  | ------------ | ----- | --- |  | ---- | -
|                                         |  | For the three months ended March 31, |        
|                                         |  | 2009                                 |         |                | 2008 |      
|(Dollars in thousands)                   |  | AverageBalances                      |         | Income/Expense |      |       | Yields/Rates |  |      | AverageBalances |  | Income/Expense |         |  | Yields/Rates |      
|Assets:                                  |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Earning assets:                          |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Loans (1)                                |  | $                                    | 363,228 |                | $    | 5,085 | (4)          |  | 5.68 | %               |  | $              | 388,418 |  | $            | 7,125 | (4) |  | 7.36 | %
|Investment securities, taxable           |  |                                      | 44,229  |                |      | 590   |              |  | 5.41 | %               |  |                | 44,437  |  |              | 624   |     |  | 5.63 | %
|Investment securities, non-taxable (2)   |  |                                      | 8,463   |                |      | 135   |              |  | 6.45 | %               |  |                | 11,976  |  |              | 206   |     |  | 6.87 | %
|Federal funds sold and other             |  |                                      | 13,052  |                |      | 1     |              |  | 0.04 | %               |  |                | 8,056   |  |              | 75    |     |  | 3.75 | %
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Total interest earning assets            |  |                                      | 428,972 |                |      | 5,811 |              |  | 5.49 | %               |  |                | 452,887 |  |              | 8,030 |     |  | 7.11 | %
|Non-interest earning assets              |  |                                      | 34,263  |                |      |       |              |  |      |                 |  |                | 20,215  |  |              |       |     |  |      |  
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Total assets                             |  | $                                    | 463,235 |                |      |       |              |  |      |                 |  | $              | 473,102 |  |              |       |     |  |      |  
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Liabilities:                             |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Interest bearing liabilities:            |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|NOW accounts                             |  | $                                    | 14,004  |                | $    | 29    |              |  | 0.84 | %               |  | $              | 14,044  |  | $            | 64    |     |  | 1.83 | %
|Money market                             |  |                                      | 49,953  |                |      | 311   |              |  | 2.53 | %               |  |                | 35,383  |  |              | 296   |     |  | 3.36 | %
|Savings                                  |  |                                      | 8,805   |                |      | 39    |              |  | 1.81 | %               |  |                | 22,929  |  |              | 163   |     |  | 2.85 | %
|Time deposits                            |  |                                      | 276,767 |                |      | 3,051 |              |  | 4.47 | %               |  |                | 280,533 |  |              | 3,610 |     |  | 5.16 | %
|Borrowings                               |  |                                      | 49,784  |                |      | 413   |              |  | 3.36 | %               |  |                | 31,856  |  |              | 343   |     |  | 4.31 | %
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Total interest bearing liabilities       |  |                                      | 399,313 |                |      | 3,843 |              |  | 3.90 | %               |  |                | 384,745 |  |              | 4,476 |     |  | 4.67 | %
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Demand deposits                          |  |                                      | 28,180  |                |      |       |              |  |      |                 |  |                | 36,700  |  |              |       |     |  |      |  
|Other non-interest bearing liabilities   |  |                                      | 1,213   |                |      |       |              |  |      |                 |  |                | 1,665   |  |              |       |     |  |      |  
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Total non-interest bearing liabilities   |  |                                      | 29,393  |                |      |       |              |  |      |                 |  |                | 38,365  |  |              |       |     |  |      |  
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Stockholders equity                     |  |                                      | 34,529  |                |      |       |              |  |      |                 |  |                | 49,992  |  |              |       |     |  |      |  
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Total liabilities & stockholders equity |  | $                                    | 463,235 |                |      |       |              |  |      |                 |  | $              | 473,102 |  |              |       |     |  |      |  
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Net Interest Income                      |  |                                      |         |                | $    | 1,968 |              |  |      |                 |  |                |         |  | $            | 3,554 |     |  |      |  
|                                         |  |                                      |         |                |      |       |              |  |      |                 |  |                |         |  |              |       |     |  |      |  
|Net Interest Margin (3)                  |  |                                      |         |                |      |       |              |  | 1.86 | %               |  |                |         |  |              |       |     |  | 3.15 | %



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

|(4) | Includes $145 and $251 of fees for the three months ended March 31, 2009 and 2008, respectively.
|--- | ------------------------------------------------------------------------------------------------

The table below details the components of the changes in net interest income for the three months ended March 31, 2009 and March 31, 2008. 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 three months ended March 31, 2009Compared to the three months ended March 31, 2008 |     
|                                         |  | Increase (decrease) due to change in                                                       |      |   |             |  
|(Dollars in thousands)                   |  | AverageVolume                                                                              |      |   | AverageRate |   |        | NetIncrease(Decrease) | 
|Increase (decrease) in interest income:  |  |                                                                                            |      |   |             |   |        |                       |  |   |        |  
|Loans                                    |  | $                                                                                          | (439 | ) |             | $ | (1,601 | )                     |  | $ | (2,040 | )
|Investment securities, taxable           |  |                                                                                            | (3   | ) |             |   | (31    | )                     |  |   | (34    | )
|Investment securities, non-taxable (1)   |  |                                                                                            | (57  | ) |             |   | (14    | )                     |  |   | (71    | )
|Federal funds sold and other             |  |                                                                                            | 29   |   |             |   | (103   | )                     |  |   | (74    | )
|                                         |  |                                                                                            |      |   |             |   |        |                       |  |   |        |  
|Total interest income                    |  |                                                                                            | (470 | ) |             |   | (1,749 | )                     |  |   | (2,219 | )
|                                         |  |                                                                                            |      |   |             |   |        |                       |  |   |        |  
|                                         |  |                                                                                            |     
|Increase (decrease) in interest expense: |  |                                                                                            |      |   |             |   |        |                       |  |   |        |  
|NOW accounts                             |  |                                                                                            |     |   |             |   | (35    | )                     |  |   | (35    | )
|Money market                             |  |                                                                                            | 103  |   |             |   | (88    | )                     |  |   | 15     |  
|Savings                                  |  |                                                                                            | (78  | ) |             |   | (46    | )                     |  |   | (124   | )
|Time deposits                            |  |                                                                                            | (48  | ) |             |   | (511   | )                     |  |   | (559   | )
|Borrowings                               |  |                                                                                            | 161  |   |             |   | (91    | )                     |  |   | 70     |  
|                                         |  |                                                                                            |      |   |             |   |        |                       |  |   |        |  
|Total interest expense                   |  |                                                                                            | 138  |   |             |   | (771   | )                     |  |   | (633   | )
|                                         |  |                                                                                            |      |   |             |   |        |                       |  |   |        |  
|                                         |  |                                                                                            |     
|Total change in net interest income      |  | $                                                                                          | (608 | ) |             | $ | (978   | )                     |  | $ | (1,586 | )
|                                         |  |                                                                                            |      |   |             |   |        |                       |  |   |        |  



|(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 THREE MONTHS ENDED MARCH 31, 2009:

NET INTEREST INCOME

Net interest income on a fully tax-equivalent basis for the first quarter of 2009 and for the first quarter of 2008 was $2.0 million and $3.6 million,
respectively. Net interest income on a fully tax-equivalent basis decreased by $1.6 million; $978 thousand was due to a decrease in rates, and $608 thousand of the decrease was due to volume. Average earning assets decreased 5.3% for the first
quarter of 2009 over the first quarter of 2008, from $452.9 million to $429.0 million, with the yield on average earning assets decreasing 162 basis points. Average interest bearing liabilities (deposits and borrowings) increased 3.8% for the first
quarter of 2009 over the first quarter of 2008, from $384.7 million to $399.3 million, with the annualized cost decreasing 77 basis points.

NON-INTEREST INCOME

Non-interest income for the first quarter of 2009 was $737 thousand compared to $691 thousand for the same period of
2008. The increase from 2008 to 2009 was primarily due to the net gain on the sale of securities of $394 thousand during the first quarter of 2009 as compared to $191 thousand for the same period of 2008. The increase was partially offset by a
reduction in service charges and other fees. Service charges and other fees decreased $88 thousand, from $328 thousand in the first quarter of 2008 to $240 thousand in the first quarter of 2009 as a result of a decline in volume of transactions
closed.

NON-INTEREST EXPENSE

For the first quarter of
2009, non-interest expense was $3.5 million compared to $3.1 million for the first quarter of 2008. The increase was primarily attributable to an increase in salaries and employee benefits due to increases in headcount. The increase in full-time
equivalent employees is primarily the result of new branch openings. As of March 31, 2009 there were 135.0 full-time equivalent employees compared to 129.5 at March 31, 2008. Other expenses also contributed to the increase. Other expenses
rose due to an increase in FDIC insurance requirements and an increase in legal and loan costs.

INCOME TAXES

For the quarter ended March 31, 2009 and 2008, the Company recorded income tax benefit of $0 and $739 thousand, respectively. Accordingly, our effective tax rates
were 0% and 39.4% for 2009 and 2008, respectively. The determination of effective rates reflects items which are not taxed for income tax purposes, primarily tax-exempt interest income. Due to our lack of profitability we can no longer assert to the
degree required under generally accepted accounting principles that we will be able to realize the future benefit of our deferred tax asset, so we are continuing to apply a full valuation allowance against this asset.



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##### Table of Contents

FINANCIAL CONDITION ANALYSIS



|                                                          |  |           |         |   |              |   |         |        |  |   |         |   |  |     |  
|--------------------------------------------------------- |  | --------- | ------- | - | ------------ | - | ------- | ------ |  | - | ------- | - |  | --- | -
|                                                          |  | March 31, |         |   | December 31, |   |         | Change | 
|(Dollars in thousands)                                    |  | 2009      |         |   | 2008         |   |         | $      |  |   | %       |  
|Cash                                                      |  | $         | 19,333  |   |              | $ | 6,719   |        |  | $ | 12,614  |   |  | 188 | %
|Interest bearing deposits in other financial institutions |  |           | 1,299   |   |              |   | 225     |        |  |   | 1,074   |   |  | 477 | %
|Investments                                               |  |           | 52,925  |   |              |   | 67,323  |        |  |   | (14,398 | ) |  | -21 | %
|Loans  gross                                             |  |           | 360,123 |   |              |   | 387,779 |        |  |   | (27,656 | ) |  | -7  | %
|Net deferred fees                                         |  |           | (705    | ) |              |   | (807    | )      |  |   | 102     |   |  | 13  | %
|Allowance for loan loss reserve                           |  |           | (16,681 | ) |              |   | (20,679 | )      |  |   | 3,998   |   |  | 19  | %
|Other                                                     |  |           | 24,273  |   |              |   | 22,676  |        |  |   | 1,597   |   |  | 7   | %
|                                                          |  |           |         |   |              |   |         |        |  |   |         |   |  |     |  
|Total Assets                                              |  | $         | 440,567 |   |              | $ | 463,236 |        |  | $ | (22,669 | ) |  | -5  | %
|                                                          |  |           |         |   |              |   |         |        |  |   |         |   |  |     |  
|                                                          |  |           |         |  
|Non-interest bearing deposits                             |  | $         | 28,240  |   |              | $ | 32,555  |        |  | $ | (4,315  | ) |  | -13 | %
|Interest bearing deposits                                 |  |           | 353,416 |   |              |   | 335,303 |        |  |   | 18,113  |   |  | 5   | %
|Borrowings                                                |  |           | 46,001  |   |              |   | 66,001  |        |  |   | (20,000 | ) |  | -30 | %
|Other                                                     |  |           | 1,234   |   |              |   | 1,384   |        |  |   | (150    | ) |  | -11 | %
|Stockholders equity                                      |  |           | 11,676  |   |              |   | 27,993  |        |  |   | (16,317 | ) |  | -58 | %
|                                                          |  |           |         |   |              |   |         |        |  |   |         |   |  |     |  
|Total Liabilities and Stockholders Equity                |  | $         | 440,567 |   |              | $ | 463,236 |        |  | $ | (22,669 | ) |  | -5  | %
|                                                          |  |           |         |   |              |   |         |        |  |   |         |   |  |     |  

Significant changes to our balance sheet include the following:



| |  |  | Gross loans decreased $27.7 million (from $387.8 million at December 31, 2008 to $360.1 million at March 31, 2009);
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | Deposits increased $13.8 million with increases in interest-bearing checking, money markets, savings and time deposits. The increase was offset slightly with
decreases in demand deposits.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our securities portfolio was reduced with the sale of $17.8 million of investments in the first three months partially offset with the purchase of $5.7 million of
investments;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For the three month period ending March 31, 2009, borrowings decreased $20.0 million (from $66.0 million to $46.0 million).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------

LOAN PORTFOLIO AND ADEQUACY OF THE ALLOWANCE FOR LOAN LOSSES

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

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

The Companys allowance for loan losses consists of three elements: (i) homogenous loan pool
valuation allowances determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies, based on the quantitative loan loss experience of the Bank for similar loans with
similar characteristics; (ii) specific valuation allowances determined in accordance with SFAS 114, Accounting by Creditors for Impairment of a Loan, based on probable losses on specific loans; and (iii) general valuation
allowances based upon the best judgment of management on existing regional and local economic factors, including insurance and tax changes and qualitative and market risks that may affect a particular category of loans.

On a monthly basis, management performs an analysis of the adequacy of the loan loss allowance. The analysis uses a nine point grade system to rate the loan portfolio.
The nine categories are 1-Superior, 2-Very Satisfactory, 3-Satisfactory, 4-Acceptable, 5-Adequate, 6-Special Mention, 7-Substandard, 8-Doubtful, 9-Loss. Each loan is assigned a rating at origination and then reviewed periodically. All significant
commercial loans classified as either substandard or doubtful are reviewed at the end of each period to determine if a specific reserve is needed for that credit. A specific reserve is very common for significant credits
classified as either substandard or



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doubtful. The establishment of a specific reserve does not necessarily mean that the credit with the specific reserve will definitely incur loss
at the reserve level. It is only an estimation of incurred loss based upon anticipated events. A general allocation is made for all other commercial loans based on factors including historical loss rate, perceived economic conditions, recent trends
in loan loss history, and concentrations of credit. These factors are reviewed and updated as necessary on a quarterly basis.

Commercial loans entail
certain risks since they usually involve large loan balances to single borrowers or a related group of borrowers, resulting in a more concentrated loan portfolio. Further, since their repayment is usually dependent upon the successful operation of
the commercial enterprise, they are also subject to adverse conditions in the economy. Commercial loans are generally riskier than residential mortgages because they are typically made on the basis of the ability to repay from the cash flow of a
business rather than on the ability of the borrower or guarantor to repay. Further, the collateral underlying commercial loans may depreciate over time, and occasionally cannot be appraised with as much precision as residential real estate, and may
fluctuate in value based on the success of the business.

Generally, construction loans present a higher degree of risk to a lender compared to
conventional residential mortgage loans depending upon, among other things, whether the borrower has permanent financing at the end of the loan period, whether the project is an income producing transaction in the interim, and the nature of changing
economic conditions including changing interest rates and the overall real estate market.

Residential and consumer loans generally are not analyzed
individually. These loans are grouped into pools and assigned risk categories based on their current payment status and managements assessment of risk inherent in the various types of loans. The allocations are based on the same factors as
used for commercial loans. When appropriate, a specific reserve will be established for individual loans. Due to continued market deterioration, the Bank reviewed select residential and consumer loans individually.

The balance in the allowance for loan losses at March 31, 2009 was $16.7 million, or 4.63%, of total loans compared to $20.7 million and 5.33% of total loans at
December 31, 2008. The decrease in the allowance for loan losses was the result $19.5 million in net charge-offs partially offset by the Banks $15.5 million provision in the first quarter of 2009. This is compared to first quarter 2008
activity of a $2.9 million charge to the provision offset by $523 thousand in net charge-offs. $13.7 million of charge-offs during the first quarter of 2009 were related to loans that already had specific reserves at December 31, 2008.
Management determined that it was appropriate to take partial charge-offs on these loans during the first quarter of 2009. The major increases in the provision for loans were as follows; homogenous loan pool ($3.0 million) construction mortgages
($5.2 million), commercial business assets ($2.2 million), unsecured commercial ($1.3 million) and home equity loans ($1.2 million). Although 76% of impaired loans are performing contractually as of March 31, 2009 (compared to 76% as of
December 31, 2008), there are weaknesses that place doubt on the borrowers ability to pay in accordance with the original terms, such as the collateralized value of the property securing the loans, the borrowers paying ability and
the borrowers net worth, all of which may not be sufficient to cover the loan value in case of default. While management believes that the loan loss reserve was adequate as of March 31, 2009, a continued deterioration in the economy could
result in additional losses in the future.

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

All of the Banks nonaccrual loans are considered to be impaired. A loan is considered impaired
when its determined that it is probable that all the principal and interest due under the loan may not be collectible as contractually agreed. Nonaccrual relationships in excess of $50 thousand 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 and entrepreneurial profit or the present value of estimated future cash flows.

The Banks impaired loans were $87.0 million at March 31, 2009, or 24.3% of total gross loans, compared to $98.5 million at December 31, 2008, or 25.4% of
total loans. Of the $87.0 million of impaired loans at March 31, 2009, $56.4 million were commercial and commercial real estate, $27.3 million were construction and $3.3 million were



14



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##### Table of Contents

residential and consumer loans. This compares to $59.4 million commercial and commercial real estate, $34.3 million construction and $4.8 million residential
and consumer loans at December 31, 2008. Management continues to monitor the worth, paying capacity and collateral pledged of the borrowers; however those loans classified as impaired are characterized by the distinct possibility that the Bank
will sustain some loss if the deficiencies are not corrected.

The Banks non-performing assets as a percentage of total assets were 5.58% at
March 31, 2009 and 5.33% at December 31, 2008. There were $21.3 million in non-performing loans and $3.3 million other non-performing assets at March 31, 2009, compared to $23.9 million and $810 thousand at December 31, 2008
respectively.

ASSET / LIABILITY MANAGEMENT AND INTEREST RATE RISKS

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

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

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

LIQUIDITY AND CAPITAL RESOURCES

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. The Company has adopted a board resolution which, among other things, states that the Company will not incur debt without approval of the Federal Reserve Bank. Approval has been obtained for a $4.0 million line of
credit available to the Company from the Federal Reserve Bank. However, at quarter end the Company was not compliant with the debt covenants surrounding the line of credit.

For banks, liquidity represents the ability to meet both loan commitments and withdrawals of deposited funds. Funds to meet these needs can be obtained by converting liquid assets to cash or by attracting new deposits
or other sources of funding. Many factors affect a banks ability to meet liquidity needs. The Banks principal sources of funds are deposits, payments, paydowns, and maturities on loans; payments, maturities, and sales of investments; and
capital contributions by the Company. As additional sources of funds, the Bank has credit availability with the Federal Home Loan Bank amounting to $66.1 million and Federal Funds purchased lines available at correspondent banks amounting to $10.0
million, if secured.

Additionally, we have agreements under which securities can be sold under agreements to repurchase. Currently the Bank has $25.0
million of ten-year repurchase agreements, whereby higher yielding long-term securities were purchased to decrease the duration of earning assets and shorten the duration of liabilities. The securities were then sold under agreements to repurchase.
The agreements are callable immediately as the Bank did not maintain its well capitalized status with the FDIC. The borrowings were collateralized by $35.8 million of securities at March 31, 2009.

In April of 2009, the repurchase agreements were amended. The amendments state that the agreements are callable and a default has occurred if (i) First State Bank
ceases to be adequately capitalized at any time before September 30, 2009, (ii) First State Bank fails to regain and maintain well capitalized status on and after September 30, 2009, (iii) First State Bank
is issued a cease and desist order at any time by its Federal or State regulator, or (iv) First State Bank fails to deliver additional cash margin such that the total amount of the excess cash margin is equal to



15



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##### Table of Contents

$2.5 million. Under the terms of the amendment, if a default occurs, the agreements are callable immediately and the non defaulting party has the right to
mark-to-market the underlying interest rate exposure, which was valued at approximately $4.6 million at April 13, 2009. As First State Bank was rated significantly undercapitalized as of March 31, 2009, the Bank is in default
of the amended repurchase agreements and if called, would need to record approximately $4.6 million of additional expense in order to mark-to-market the interest rate exposure.

CAPITAL RESOURCES

Growth and profitability of the Bank are dependent upon maintenance of adequate levels of capital.
The capital adequacy of the Bank is determined based on the level of capital as well as asset quality, liquidity and earnings history. At March 31, 2009, the Bank was rated significantly undercapitalized by its regulatory agency. As
a result the Bank is subject to certain operating restrictions and requirements. In particular, while the Bank remains below well capitalized, it can no longer accept brokered deposits. The Bank is also required to submit a capital restoration plan
to its primary regulator.

Regulatory capital guidelines divide capital into two tiers. Tier 1 capital consists of stockholders equity less goodwill,
disallowed deferred tax assets and the unrealized gain/loss on available-for-sale securities. Tier 2 capital consists of Tier 1 capital plus an allowable portion of the allowance for loan losses. In addition to Tier 1 and Tier 2 capital ratio
requirements, regulatory capital guidelines set forth certain leverage capital requirements. This ratio is computed by dividing Tier 1 capital by unadjusted total quarterly average assets.

The following table presents the regulatory capital levels and ratios of the Bank at March 31, 2009 (dollar amounts in thousands).



|                                          |  |        |  |       |                              |  |          |                                                                     |       |   |  |        |        |       |      |  
|----------------------------------------- |  | ------ |  | ----- | ---------------------------- |  | -------- | ------------------------------------------------------------------- | ----- | - |  | ------ | ------ | ----- | ---- | -
|                                          |  | Actual |  |       | For CapitalAdequacy Purposes |  |          | To Be AdequatelyCapitalized UnderPrompt CorrectiveAction Provisions |      
|                                          |  | Amount |  | Ratio |                              |  | Amount   |                                                                     | Ratio |   |  | Amount |        | Ratio |     
|As of March 31, 2009:                     |  |        |  |       |                              |  |          |                                                                     |       |   |  |        |        |       |      |  
|Total capital (to risk-weighted assets):  |  | 16,344 |  | 4.25  | %                            |  | > 30,801 |                                                                     | >8.00 | % |  | $      | 30,801 |       | 8.00 | %
|Tier I capital (to risk weighted assets): |  | 11,385 |  | 2.96  | %                            |  | > 15,401 |                                                                     | >4.00 | % |  |        | 15,401 |       | 4.00 | %
|Tier I capital (to average assets):       |  | 11,385 |  | 2.50  | %                            |  | > 18,227 |                                                                     | >4.00 | % |  |        | 18,227 |       | 4.00 | %



|(1) | The regulatory ratios for a well capitalized institution are: Tier I Capital 6%; Total Capital 10%; Leverage 5%. The regulatory ratios for an adequately
capitalized institution are: Tier I Capital 4%; Total Capital 8%; Leverage 4%. The regulatory ratios for an under capitalized institution are: Tier I Capital 3%; Total Capital 6%; Leverage 3%. The regulatory ratio for a
significantly under capitalized institution are: Ratio of tangible equity to total assets greater than 2%.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

On May 12, 2009,
the Bank received notification from the FDIC that as of March 31, 2009, it is subject to restrictions on asset growth, dividends, other capital distributions and management fees pursuant to FDIC Rules and Regulations. Further, the Bank is
required to file a written capital restoration plan with the FDIC within 45 days of the receipt of the notification. Lastly, the Banks current capital levels do not allow it to accept new or rollover any brokered deposits or solicit deposits
by offering an effective yield that exceeds by more than 75 basis points over the prevailing effective yields on insured deposits of comparable maturity in the Banks market area.

DIVIDENDS

Dividends paid by the Bank to the Company are subject to the financial condition of the Bank and practical
business considerations relating to utilization of funds. Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank to the holding company or by the holding company to stockholders without prior
approval of the banks regulatory agency. Dividend payments are generally limited to earnings of the Bank, as defined for regulatory purposes, for the current period and the full two preceding years. Based on projected net income during 2009,
the Company could not, without prior regulatory approval, declare dividends. In addition, we have adopted a board resolution suspending dividends without prior written approval of the Federal Reserve Bank.



|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 March 31, 2009 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



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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. We previously reported that as of December 31, 2008, we had identified a material weakness in our internal control over
financial reporting related to identifying the disallowed portion of the Companys deferred tax asset for regulatory reporting requirements. The error in calculating our capital ratios led to uncertainty whether we can continue as a going
concern and utilize our deferred tax asset. While we have made progress in remediating this deficiency in our internal control over financial reporting, there has been an insufficient period of time to determine whether the implemented processes are
operating effectively. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2009, such disclosure controls and procedures were not effective to ensure that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and accumulated and
communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

We have implemented the following changes to improve our
internal controls over financial reporting:



| |  |  | Maintaining and referring to capital ratio instructions during the Call Report preparation and review;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | Instituting an independent review of the capital ratio calculations.
| | - |  | --------------------------------------------------------------------

We believe that these actions strengthen our internal control over financial reporting and address the previously identified material weakness in our internal control over financial reporting. By their nature, these
actions require a period of time to become fully effective.



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|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 Form 10-K/A (Amendment
No. 1) for the year ended December 31, 2008, which could materially affect our business, financial condition or future results. The risks described in our Form 10-K/A (Amendment No. 1) 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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|         | 
|         |  | On May 6, 2009, the Company held an annual meeting of the stockholders of the Common Stock to vote to elect seven persons to the Companys Board of Directors. The following table sets
forth the votes for and votes withheld with respect to the election of the directors:                                                                                                                                                                                                                                                                                                                                    



|                        |  |                |  |               
|----------------------- |  | -------------- |  | --------------
|Director Nominee:       |  | Votes Cast For |  | Votes Withheld
|Robert Beymer           |  | 4,604,282      |  | 449,986       
|Daniel Harrington       |  | 4,614,005      |  | 440,263       
|Marshall Reynolds       |  | 4,560,965      |  | 493,303       
|Neal Scaggs             |  | 4,629,321      |  | 424,947       
|Robert Shell, Jr.       |  | 4,528,752      |  | 525,516       
|John E. Jed Wilkinson |  | 4,520,862      |  | 533,406       
|Thomas Wright           |  | 4,631,398      |  | 422,870       



|        |  |                                                                                                                                            
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|Item 5. |  | OTHER INFORMATION                                                                                                                          
|        | 
|        |  | None                                                                                                                                       
|        | 
|Item 6. |  | EXHIBITS                                                                                                                                   
|        | 
|        |  | Exhibit 31.1  Chief Executive Officers certification required under Section 302 of Sarbanes-Oxley Act of 2002                            
|        | 
|        |  | Exhibit 31.2  Chief Financial Officers certification required under Section 302 of Sarbanes-Oxley Act of 2002                            
|        | 
|        |  | Exhibit 32  Chief Executive Officers and Chief Financial Officers certification required under Section 906 of Sarbanes-Oxley
Act of 2002



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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: May 19, 2009



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




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