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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the quarterly period ended March 31, 2006

or



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

For the transition period from  to

Commission File Number: 333-119800



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FIRST STATE FINANCIAL
CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Florida                                                        |  | 65-07714145                         
|(State or other jurisdiction or incorporation or organization) |  | (I.R.S. Employer Identification No.)



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

941-929-9000

(Registrants telephone number, including area code)

N/A

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



---

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

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



|Large | accelerated filer ̈Accelerated
filer ̈Non-accelerated filer  x
|----- | ------------------------------------------------------------

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

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

As of May 10, 2006, the registrant had outstanding 5,863,265 shares of common stock.



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##### Table of Contents

TABLE OF CONTENTS



|                               |  |                                                                      |  |   
|------------------------------ |  | -------------------------------------------------------------------- |  | --
|                               |  | PAGE                                                                
|PART I  FINANCIAL INFORMATION |  |                                                                     
|                               |  |                                                                     
|Item 1 -                       |  | Condensed Consolidated Financial Statements                          |  |   
|                               |  |                                                                     
|                               |  | Condensed Consolidated Balance Sheets                                |  | 1 
|                               |  |                                                                     
|                               |  | Condensed Consolidated Statements of Income                          |  | 2 
|                               |  |                                                                     
|                               |  | Condensed Consolidated Statements of Changes in Stockholders Equity |  | 3 
|                               |  |                                                                     
|                               |  | Condensed Consolidated Statements of Cash Flows                      |  | 4 
|                               |  |                                                                     
|                               |  | Condensed Notes to Consolidated Financial Statements                 |  | 5 
|                               |  |                                                                     
|Item 2 -                       |  | Managements Discussion and Analysis                                 |  | 7 
|                               |  |                                                                     
|Item 3 -                       |  | Quantitative and Qualitative Disclosures About Market Risk           |  | 13
|                               |  |                                                                     
|Item 4 -                       |  | Controls and Procedures                                              |  | 13
|                               | 
|PART II 
OTHER INFORMATION    |  |                                                                     
|                               |  |                                                                     
|Item 1 -                       |  | Legal Proceedings                                                    |  | 14
|                               |  |                                                                     
|Item 1A                       |  | Risk Factors                                                         |  | 14
|                               |  |                                                                     
|Item 2 -                       |  | Unregistered Sales of Equity Securities and Use of Proceeds          |  | 14
|                               |  |                                                                     
|Item 3 -                       |  | Defaults Upon Senior Securities                                      |  | 14
|                               |  |                                                                     
|Item 4 -                       |  | Submission of Matters to Vote of Securities Holders                  |  | 14
|                               |  |                                                                     
|Item 5 -                       |  | Other Information                                                    |  | 14
|                               |  |                                                                     
|Item 6 -                       |  | Exhibits                                                             |  | 14
|                               | 
|Signatures                     |  | 15                                                                  
|                               | 
|Exhibit 31.1                   |  | 16                                                                  
|                               | 
|Exhibit 31.2                   |  | 17                                                                  
|                               | 
|Exhibit 32                     |  | 18                                                                  



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##### Table of Contents

FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

March 31, 2006 (unaudited) and December 31, 2005

(Dollar amounts in thousands except per share data)



|                                                                                  |  |               |         |   |                  |   |         |  
|--------------------------------------------------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                  |  | March 31,2006 |         |   | December 31,2005 |  
|ASSETS                                                                            | 
|Cash and due from financial institutions                                          |  | $             | 6,269   |   |                  | $ | 5,883   |  
|Federal funds sold                                                                |  |               |        |   |                  |   | 362     |  
|                                                                                  |  |               |         |   |                  |   |         |  
|Cash and cash equivalents                                                         |  |               | 6,269   |   |                  |   | 6,245   |  
|Interest bearing deposits in other financial institutions                         |  |               | 150     |   |                  |   | 150     |  
|Securities, available for sale                                                    |  |               | 23,482  |   |                  |   | 20,361  |  
|Loans, net of allowance of $3,552 and $3,397                                      |  |               | 358,017 |   |                  |   | 334,594 |  
|Federal Home Loan Bank stock                                                      |  |               | 1,330   |   |                  |   | 1,178   |  
|Premise and equipment, net                                                        |  |               | 4,634   |   |                  |   | 4,596   |  
|Accrued interest and other assets                                                 |  |               | 7,789   |   |                  |   | 5,565   |  
|                                                                                  |  |               |         |   |                  |   |         |  
|Total Assets                                                                      |  | $             | 401,671 |   |                  | $ | 372,689 |  
|                                                                                  |  |               |         |   |                  |   |         |  
|LIABILITIES and STOCKHOLDERS EQUITY                                              |  |               |         |   |                  |   |         |  
|Deposits                                                                          |  |               |         |   |                  |   |         |  
|Demand                                                                            |  | $             | 47,465  |   |                  | $ | 44,574  |  
|Interest-bearing checking                                                         |  |               | 15,622  |   |                  |   | 16,240  |  
|Money market                                                                      |  |               | 36,300  |   |                  |   | 48,147  |  
|Savings                                                                           |  |               | 26,803  |   |                  |   | 13,548  |  
|Time                                                                              |  |               | 211,561 |   |                  |   | 190,116 |  
|                                                                                  |  |               |         |   |                  |   |         |  
|Total deposits                                                                    |  |               | 337,751 |   |                  |   | 312,625 |  
|Accrued interest payable and other liabilities                                    |  |               | 1,989   |   |                  |   | 1,579   |  
|Federal Home Loan Bank advances & other borrowings                                |  |               | 16,624  |   |                  |   | 14,001  |  
|                                                                                  |  |               |         |   |                  |   |         |  
|Total Liabilities                                                                 |  |               | 356,364 |   |                  |   | 328,205 |  
|                                                                                  |  |              
|Stockholders Equity                                                              |  |               |         |   |                  |   |         |  
|Common stock, $1 par value; 25,000,000 shares authorized; 5,863,265 shares issued |  |               | 5,863   |   |                  |   | 5,863   |  
|Additional paid-in capital                                                        |  |               | 31,802  |   |                  |   | 31,763  |  
|Retained earnings                                                                 |  |               | 8,037   |   |                  |   | 7,231   |  
|Accumulated other comprehensive income (loss)                                     |  |               | (395    | ) |                  |   | (373    | )
|                                                                                  |  |               |         |   |                  |   |         |  
|Total Stockholders Equity                                                        |  |               | 45,307  |   |                  |   | 44,484  |  
|                                                                                  |  |               |         |   |                  |   |         |  
|Total Liabilities and Stockholders Equity                                        |  | $             | 401,671 |   |                  | $ | 372,689 |  
|                                                                                  |  |               |         |   |                  |   |         |  

See Notes to Consolidated Financial Statements



1



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FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

For the Three Months Ended March 31, 2006 and 2005

(Unaudited)

(Dollar amounts in thousands except per share data)



|                                                     |  |      |           |      |   |          
|---------------------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                                     |  | 2006 |           | 2005
|Interest and Dividend Income                         |  |      |           |      |   |          
|Loans, including fees                                |  | $    | 6,654     |      | $ | 3,935    
|Taxable securities                                   |  |      | 163       |      |   | 153      
|Tax exempt securities                                |  |      | 59        |      |   | 3        
|Federal funds sold and other                         |  |      | 23        |      |   | 130      
|                                                     |  |      |           |      |   |          
|                                                     |  |      | 6,899     |      |   | 4,221    
|Interest expense                                     |  |      |           |      |   |          
|Deposits                                             |  |      | 2,523     |      |   | 1,269    
|Federal Home Loan Bank advances and other borrowings |  |      | 132       |      |   | 134      
|                                                     |  |      |           |      |   |          
|                                                     |  |      | 2,655     |      |   | 1,403    
|                                                     |  |      |           |      |   |          
|Net Interest Income                                  |  |      | 4,244     |      |   | 2,818    
|Provision for loan losses                            |  |      | 375       |      |   |         
|                                                     |  |      |           |      |   |          
|Net interest income after provision for loan losses  |  |      | 3,869     |      |   | 2,818    
|Non-interest income                                  |  |      |           |      |   |          
|Service charges and other fees                       |  |      | 296       |      |   | 229      
|Mortgage banking fees                                |  |      | 322       |      |   | 252      
|Other                                                |  |      | 38        |      |   | 7        
|                                                     |  |      |           |      |   |          
|                                                     |  |      | 656       |      |   | 488      
|Non-interest expense                                 |  |      |           |      |   |          
|Salaries and employee benefits                       |  |      | 1,639     |      |   | 1,226    
|Occupancy and equipment                              |  |      | 370       |      |   | 266      
|Data processing                                      |  |      | 139       |      |   | 122      
|Professional services                                |  |      | 50        |      |   | 36       
|Stationery and supplies                              |  |      | 40        |      |   | 37       
|Advertising and marketing                            |  |      | 98        |      |   | 76       
|Other                                                |  |      | 334       |      |   | 250      
|                                                     |  |      |           |      |   |          
|                                                     |  |      | 2,670     |      |   | 2,013    
|                                                     |  |      |           |      |   |          
|Income before income taxes                           |  |      | 1,855     |      |   | 1,293    
|Income tax expense                                   |  |      | 697       |      |   | 496      
|                                                     |  |      |           |      |   |          
|Net Income                                           |  | $    | 1,158     |      | $ | 797      
|                                                     |  |      |           |      |   |          
|Earnings per share                                   |  |      |           |      |   |          
|Basic                                                |  | $    | 0.20      |      | $ | 0.14     
|Diluted                                              |  | $    | 0.20      |      | $ | 0.14     
|Average common shares outstanding                    |  |      |           |      |   |          
|Basic                                                |  |      | 5,863,265 |      |   | 5,856,265
|Diluted                                              |  |      | 5,910,472 |      |   | 5,878,387
|Dividends per share                                  |  | $    | 0.06      |      | $ | 0.05     

See Notes to Condensed Consolidated Financial Statements



2



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FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

Three Months Ended March 31, 2006 and 2005

(Unaudited)

(Dollar amounts in thousands except per share data)



|                                                                                                     |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  
|---------------------------------------------------------------------------------------------------- |  | --------- |  | ----------- | ----- | ------------------------ | - | ------ | ---------------- |  | - | ----------------------------------------- | - |  | ----- | ---- | - |  | - | ------ | -
|                                                                                                     |  | Shares    |  | CommonStock |       | AdditionalPaid-inCapital |   |        | RetainedEarnings |  |   | AccumulatedOtherComprehensiveIncome(Loss) |   |  | Total |     
|Balance at December 31, 2004:                                                                        |  | 5,856,265 |  | $           | 5,856 |                          | $ | 31,860 |                  |  | $ | 4,566                                     |   |  | $     | (129 | ) |  | $ | 42,153 |  
|Comprehensive income:                                                                                |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  
|Net income                                                                                           |  |           |  |             |       |                          |   |        |                  |  |   | 797                                       |   |  |       |      |   |  |   | 797    |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of tax effects |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       | (181 | ) |  |   | (181   | )
|                                                                                                     |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   | 616    |  
|Capitalization of offering costs                                                                     |  |           |  |             |       |                          |   | (109   | )                |  |   |                                           |   |  |       |      |   |  |   | (109   | )
|Cash dividend declared, $.05 per share                                                               |  |           |  |             |       |                          |   |        |                  |  |   | (293                                      | ) |  |       |      |   |  |   | (293   | )
|                                                                                                     |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  
|Balance at March 31, 2005                                                                            |  | 5,856,265 |  | $           | 5,856 |                          | $ | 31,751 |                  |  | $ | 5,070                                     |   |  | $     | (310 | ) |  | $ | 42,367 |  
|                                                                                                     |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  
|Balance at December 31, 2005:                                                                        |  | 5,863,265 |  | $           | 5,863 |                          | $ | 31,763 |                  |  | $ | 7,231                                     |   |  | $     | (373 | ) |  | $ | 44,484 |  
|Comprehensive income:                                                                                |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  
|Net income                                                                                           |  |           |  |             |       |                          |   |        |                  |  |   | 1,158                                     |   |  |       |      |   |  |   | 1,158  |  
|Change in net unrealized gain (loss) on investment securities available for sale, net of tax effects |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       | (22  | ) |  |   | (22    | )
|                                                                                                     |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  
|Total Comprehensive Income                                                                           |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   | 1,136  |  
|Compensation costs under SFAS 123R                                                                   |  |           |  |             |       |                          |   | 39     |                  |  |   |                                           |   |  |       |      |   |  |   | 39     |  
|Cash dividend declared, $.06 per share                                                               |  |           |  |             |       |                          |   |        |                  |  |   | (352                                      | ) |  |       |      |   |  |   | (352   | )
|                                                                                                     |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  
|Balance at March 31, 2006                                                                            |  | 5,863,265 |  | $           | 5,863 |                          | $ | 31,802 |                  |  | $ | 8,037                                     |   |  | $     | (395 | ) |  | $ | 45,307 |  
|                                                                                                     |  |           |  |             |       |                          |   |        |                  |  |   |                                           |   |  |       |      |   |  |   |        |  

See Notes to Condensed Consolidated Financial Statements



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FIRST STATE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

Three Months Ended March 31, 2006 and 2005

(Unaudited)

(Dollar amounts in thousands)



|                                                                          |  |      |         |   |      |   |         |  
|------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                          |  | 2006 |         |   | 2005 |  
|Cash flows from operating activities:                                     |  |      |         |   |      |   |         |  
|Net income                                                                |  | $    | 1,158   |   |      | $ | 797     |  
|Adjustments to reconcile net income to net cash from operating activities |  |      |         |   |      |   |         |  
|Provision for loan losses                                                 |  |      | 375     |   |      |   |        |  
|Depreciation                                                              |  |      | 60      |   |      |   | 88      |  
|Net amortization of securities                                            |  |      | 15      |   |      |   | 22      |  
|Net change in:                                                            |  |      |         |   |      |   |         |  
|Other assets                                                              |  |      | (2,211  | ) |      |   | (240    | )
|Accrued expenses and other liabilities                                    |  |      | 449     |   |      |   | (67     | )
|                                                                          |  |      |         |   |      |   |         |  
|Net cash from operating activities                                        |  |      | (154    | ) |      |   | 600     |  
|                                                                          |  |     
|Cash flows from investing activities:                                     |  |      |         |   |      |   |         |  
|Available-for-sale securities:                                            |  |      |         |   |      |   |         |  
|Maturities, prepayments and calls                                         |  |      | 553     |   |      |   | 1,415   |  
|Purchases                                                                 |  |      | (3,724  | ) |      |   | (2,201  | )
|Loan originations and payments, net                                       |  |      | (23,798 | ) |      |   | (24,095 | )
|Net (purchase) sale of FHLB stock                                         |  |      | (152    | ) |      |   | 326     |  
|Net change in premise and equipment                                       |  |      | (98     | ) |      |   | (117    | )
|                                                                          |  |      |         |   |      |   |         |  
|Net cash from investing activities                                        |  |      | (27,219 | ) |      |   | (24,672 | )
|                                                                          |  |     
|Cash flows from financing activities:                                     |  |      |         |   |      |   |         |  
|Net change in deposits                                                    |  |      | 25,126  |   |      |   | 32,713  |  
|Net change in short-term borrowing                                        |  |      | 2,623   |   |      |   |        |  
|Repayment of long-term borrowing                                          |  |      |        |   |      |   | (10,000 | )
|Proceeds from issuance of common stock, net of capitalized costs          |  |      |        |   |      |   | (109    | )
|Cash dividend paid                                                        |  |      | (352    | ) |      |   | (293    | )
|                                                                          |  |      |         |   |      |   |         |  
|Net cash from financing activities                                        |  |      | 27,397  |   |      |   | 22,311  |  
|                                                                          |  |     
|Net change in cash and cash equivalents                                   |  |      | 24      |   |      |   | (1,761  | )
|Beginning cash and cash equivalents                                       |  |      | 6,245   |   |      |   | 24,852  |  
|                                                                          |  |      |         |   |      |   |         |  
|Ending cash and cash equivalents                                          |  | $    | 6,269   |   |      | $ | 23,091  |  
|                                                                          |  |      |         |   |      |   |         |  
|Supplemental cash flow information                                        |  |      |         |   |      |   |         |  
|Interest paid                                                             |  | $    | 2,628   |   |      | $ | 1,361   |  
|Income taxes paid                                                         |  |      | 230     |   |      |   | 496     |  

See Notes to Condensed Consolidated Financial Statements



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FIRST STATE FINANCIAL CORPORATION

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2006

(Unaudited)

NOTE 1  INTERIM FINANCIAL STATEMENTS

These
unaudited financial statements were prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. As such they do not include all of the information and footnotes required by generally accepted accounting principals for
complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary to comply with Regulation S-X were included. The operating results for the three months ended
March 31, 2006 are not necessarily indicative of the results that may be expected for the full year of 2006.

NOTE 2  STOCK-BASED
COMPENSATION

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

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

During the quarter ended March 31, 2006, the Company granted 28,000 stock options. The fair
value of the options granted in the first quarter of 2006 was $3.17 per option. This value was estimated as of the date of the grant using the following assumptions: dividend yield 1.29%, expected volatility 10.809%, risk-free interest rate 4.61%,
and expected life of 6.5 years. No options were granted during the first quarter of 2005.

A summary of share option
activity under the Plan as of March 31, 2006 is as follows:



|                                       |  |                         |  |                              |       |                                                     |     |                                        |   |      
|-------------------------------------- |  | ----------------------- |  | ---------------------------- | ----- | --------------------------------------------------- | --- | -------------------------------------- | - | -----
|                                       |  | StockOptionsOutstanding |  | WeightedAverageExercisePrice |       | Weighted-AverageRemainingContractual Life(in years) |     | AggregateIntrinsicValue (in thousands)
|Options outstanding, December 31, 2005 |  | 160,000                 |  | $                            | 9.68  |                                                     |     |                                        |   |      
|Granted                                |  | 28,000                  |  |                              | 15.50 |                                                     |     |                                        |   |      
|Exercised                              |  | 0                       |  |                              |       |                                                     |     |                                        |   |      
|Forfeited or expired                   |  | 0                       |  |                              |       |                                                     |     |                                        |   |      
|                                       |  |                         |  |                              |       |                                                     |     |                                        |   |      
|Options outstanding, March 31, 2006    |  | 188,000                 |  | $                            | 10.51 |                                                     | 8.3 |                                        | $ | 452  
|                                       |  |                         |  |                              |       |                                                     |     |                                        |   |      
|Options exercisable, March 31, 2006    |  | 40,100                  |  | $                            | 4.62  |                                                     | 5.6 |                                        | $ | 1,011
|                                       |  |                         |  |                              |       |                                                     |     |                                        |   |      



5



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##### Table of Contents

A summary of the status of the Companys nonvested shares as of March 31, 2006 and changes during the first
quarter of 2006 is as follows:



|                               |  |                |   |  |                                           |      
|------------------------------ |  | -------------- | - |  | ----------------------------------------- | -----
|                               |  | NumberOfShares |   |  | Weighted-averageGrant date Fair Value ($)
|Nonvested at December 31, 2005 |  | 121,500        |   |  | $                                         | 9.68 
|Granted                        |  | 28,000         |   |  |                                           | 15.50
|Vested                         |  | (1,600         | ) |  |                                           | 4.00 
|Forfeited or expired           |  | 0              |   |  |                                           |     
|                               |  |                |   |  |                                           |      
|Nonvested at March 31, 2006    |  | 147,900        |   |  | $                                         | 12.11
|                               |  |                |   |  |                                           |      

Total fair value of the shares vested during the first quarter of 2006 was
$25,000.

Prior to January 1, 2006, the Company reported employee compensation expense under stock options using the intrinsic value method. No
stock-based compensation cost was reflected in net income. All options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. On March 31, 2005, the Company reported net income
of $797,000. Stock-based compensation expense determined under the fair value method, net of tax, represented $1,000, resulting in a pro forma net income for the first quarter of 2005 of $796,000. Reported earnings per share, as well as pro forma
earnings per share, were 14 cents. Reported diluted earnings per share, as well as pro forma diluted earnings per share, were also 14 cents.

For the first
quarter of 2006, $39,000 in compensation cost related to the Companys stock option plan was recorded in net income. As of March 31, 2006, $236,000 in unrecognized compensation costs remained to be recognized over a weighted-average period
of 2.8 years. All stock option compensation costs recognized in the first quarter of 2006 related to incentive stock options. Accordingly, there is no tax benefit to disclose.



6



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##### Table of Contents

NOTE 3  LOANS

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



|                              |  |               |         |   |                  |   |         |  
|----------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                              |  | March 31,2006 |         |   | December 31,2005 |  
|Commercial                    |  | $             | 51,268  |   |                  | $ | 54,923  |  
|Real estate:                  |  |               |         |   |                  |   |         |  
|Residential                   |  |               | 44,035  |   |                  |   | 44,106  |  
|Commercial                    |  |               | 208,218 |   |                  |   | 186,578 |  
|Construction                  |  |               | 48,159  |   |                  |   | 45,084  |  
|Consumer and other            |  |               | 11,596  |   |                  |   | 8,849   |  
|                              |  |               |         |   |                  |   |         |  
|                              |  |               | 363,276 |   |                  |   | 339,540 |  
|Less: deferred loan fees, net |  |               | (1,707  | ) |                  |   | (1,549  | )
|allowance for loan losses     |  |               | (3,552  | ) |                  |   | (3,397  | )
|                              |  |               |         |   |                  |   |         |  
|Total loans, net              |  | $             | 358,017 |   |                  | $ | 334,594 |  
|                              |  |               |         |   |                  |   |         |  

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



|                                |  |                                  |       |   |               |   |       |  
|------------------------------- |  | -------------------------------- | ----- | - | ------------- | - | ----- | -
|                                |  | Activity for the quarters ending |      
|                                |  | March 31,2006                    |       |   | March 31,2005 |  
|Balance, beginning of period    |  | $                                | 3,397 |   |               | $ | 2,727 |  
|Provision charged to operations |  |                                  | 375   |   |               |   |      |  
|Loans charged off               |  |                                  | (228  | ) |               |   | (12   | )
|Recoveries                      |  |                                  | 8     |   |               |   | 24    |  
|                                |  |                                  |       |   |               |   |       |  
|Balance, end of period          |  | $                                | 3,552 |   |               | $ | 2,739 |  
|                                |  |                                  |       |   |               |   |       |  

Impaired loans were as follows (in thousands):



|                                                  |  |               |       |                  |   |      
|------------------------------------------------- |  | ------------- | ----- | ---------------- | - | -----
|                                                  |  | March 31,2006 |       | December 31,2005
|Loans with no allocated allowance for loan losses |  | $             | 304   |                  | $ | 25   
|Loans with allocated allowance for loan losses    |  |               | 4,785 |                  |   | 4,707
|                                                  |  |               |       |                  |   |      
|                                                  |  | $             | 5,089 |                  | $ | 4,732
|                                                  |  |               |       |                  |   |      
|Amount of the allowance for loan losses allocated |  | $             | 1,240 |                  | $ | 1,288
|                                                  |  |               |       |                  |   |      

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

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 another meaning. The terms
bank and First State Bank mean First State Bank. We intend for this discussion to provide you, the reader, with 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.



7



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##### Table of Contents

OVERVIEW

We are the
parent of First State Bank, a community bank headquartered in Sarasota, Florida with offices in Sarasota and Pinellas counties. The bank is committed to growing by:



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



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



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



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



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

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



| |  |  | A 7.0% increase in net loan production (new loans less repayments);
| | - |  | -------------------------------------------------------------------



| |  |  | A 6.5% increase in non-interest bearing deposits; and
| | - |  | -----------------------------------------------------



| |  |  | A 8.3% increase in interest bearing deposits.
| | - |  | ---------------------------------------------

FORWARD-LOOKING
STATEMENTS

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



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



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



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



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



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



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

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



8



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##### Table of Contents

RESULTS OF OPERATIONS for the THREE MONTHS ENDED MARCH 31, 2006

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



|                                    |  |                              |       |        |   |       |  |   |       |  |     |  
|----------------------------------- |  | ---------------------------- | ----- | ------ | - | ----- |  | - | ----- |  | --- | -
|                                    |  | Three months ended March 31, |      
|                                    |  |                              |       | change |  
|(Dollars in thousands)              |  | 2006                         |       | 2005   |   | $     |  | % |      
|Interest income                     |  | $                            | 6,899 |        | $ | 4,221 |  | $ | 2,678 |  | 63  | %
|Interest expense                    |  |                              | 2,655 |        |   | 1,403 |  |   | 1,252 |  | 89  | %
|                                    |  |                              |       |        |   |       |  |   |       |  |     |  
|Net interest income                 |  |                              | 4,244 |        |   | 2,818 |  |   | 1,426 |  | 51  | %
|Provision for loan losses           |  |                              | 375   |        |   |      |  |   | 375   |  | n/a |  
|                                    |  |                              |       |        |   |       |  |   |       |  |     |  
|Net interest income after provision |  |                              | 3,869 |        |   | 2,818 |  |   | 1,051 |  | 37  | %
|Non-interest income                 |  |                              | 656   |        |   | 488   |  |   | 168   |  | 34  | %
|Non-interest expense                |  |                              | 2,670 |        |   | 2,013 |  |   | 657   |  | 33  | %
|                                    |  |                              |       |        |   |       |  |   |       |  |     |  
|Income before income taxes          |  |                              | 1,855 |        |   | 1,293 |  |   | 562   |  | 43  | %
|Income tax expense                  |  |                              | 697   |        |   | 496   |  |   | 201   |  | 41  | %
|                                    |  |                              |       |        |   |       |  |   |       |  |     |  
|Net income                          |  | $                            | 1,158 |        | $ | 797   |  | $ | 361   |  | 45  | %
|                                    |  |                              |       |        |   |       |  |   |       |  |     |  

To aid in our discussion, the following average balance sheet is presented. This table 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.



|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|---------------------------------------- |  | ------------------------------------ | ------- | -------------- | ---- | ------------ |  | ---- | --------------- |  | -------------- | ------- | ------------ | - | ----- |  | ---- | -
|                                         |  | For the three months ended March 31, |        
|                                         |  | 2006                                 |         |                | 2005 |             
|(Dollars in thousands)                   |  | AverageBalances                      |         | Income/Expense |      | Yields/Rates |  |      | AverageBalances |  | Income/Expense |         | Yields/Rates |  
|Assets:                                  |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Earnings assets:                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Loans (1)                                |  | $                                    | 342,473 |                | $    | 6,654        |  | 7.88 | %               |  | $              | 229,427 |              | $ | 3,935 |  | 6.96 | %
|Investment securities, taxable           |  |                                      | 15,747  |                |      | 163          |  | 4.19 | %               |  |                | 17,676  |              |   | 153   |  | 3.51 | %
|Investment securities, non-taxable (2)   |  |                                      | 5,611   |                |      | 81           |  | 5.83 | %               |  |                | 330     |              |   | 4     |  | 5.03 | %
|Other                                    |  |                                      | 2,078   |                |      | 23           |  | 4.40 | %               |  |                | 19,971  |              |   | 130   |  | 2.64 | %
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Total interest earning assets            |  |                                      | 365,909 |                |      | 6,920        |  | 7.67 | %               |  |                | 267,404 |              |   | 4,221 |  | 6.40 | %
|Non-interest earning assets              |  |                                      | 15,541  |                |      |              |  |      |                 |  |                | 12,118  |              |   |       |  |      |  
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Total assets                             |  | $                                    | 381,450 |                |      |              |  |      |                 |  | $              | 279,522 |              |   |       |  |      |  
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Liabilities:                             |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Interest bearing liabilities:            |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|NOW accounts                             |  | $                                    | 16,415  |                | $    | 34           |  | 0.83 | %               |  | $              | 14,017  |              | $ | 9     |  | 0.26 | %
|Money market                             |  |                                      | 40,851  |                |      | 301          |  | 2.99 | %               |  |                | 37,034  |              |   | 179   |  | 1.96 | %
|Savings                                  |  |                                      | 21,145  |                |      | 125          |  | 2.39 | %               |  |                | 8,609   |              |   | 10    |  | 0.47 | %
|Time deposits                            |  |                                      | 205,186 |                |      | 2,063        |  | 4.08 | %               |  |                | 131,426 |              |   | 1,071 |  | 3.30 | %
|Borrowings                               |  |                                      | 10,697  |                |      | 132          |  | 5.02 | %               |  |                | 13,444  |              |   | 134   |  | 4.04 | %
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Total interest bearing liabilities       |  |                                      | 294,294 |                |      | 2,655        |  | 3.66 | %               |  |                | 204,530 |              |   | 1,403 |  | 2.78 | %
|Demand deposits                          |  |                                      | 40,057  |                |      |              |  |      |                 |  |                | 30,981  |              |   |       |  |      |  
|Other non-interest bearing liabilities   |  |                                      | 1,984   |                |      |              |  |      |                 |  |                | 1,594   |              |   |       |  |      |  
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Total non-interest bearing liabilities   |  |                                      | 42,041  |                |      |              |  |      |                 |  |                | 32,575  |              |   |       |  |      |  
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Stockholders equity                     |  |                                      | 45,115  |                |      |              |  |      |                 |  |                | 42,417  |              |   |       |  |      |  
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Total liabilities & stockholders equity |  | $                                    | 381,450 |                |      |              |  |      |                 |  | $              | 279,522 |              |   |       |  |      |  
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Net Interest Income                      |  |                                      |         |                | $    | 4,266        |  |      |                 |  |                |         |              | $ | 2,818 |  |      |  
|                                         |  |                                      |         |                |      |              |  |      |                 |  |                |         |              |   |       |  |      |  
|Net Interest Margin (3)                  |  |                                      |         |                |      |              |  | 4.73 | %               |  |                |         |              |   |       |  | 4.28 | %

---

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

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

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



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##### Table of Contents

The table below details the components of the changes in net interest income for the three months ended March 31,
2006 and March 31, 2005. For each major category of interest earning assets and interest bearing liabilities, information is provided with respect to changes due to average volumes, changes due to rates, and with the changes in both volumes and
rates allocated to these two categories based on the proportionate absolute changes in each category.



|
|
|
|
|



|                                         |  |                                                           |       |                       |             |   |     |  |   |       |  
|---------------------------------------- |  | --------------------------------------------------------- | ----- | --------------------- | ----------- | - | --- |  | - | ----- | -
|                                         |  | For the three months endedMarch 31,
2006 compared to 2005 |      
|                                         |  | Increase (decrease)due to change in                       |       | NetIncrease(Decrease) |            
|(Dollars in thousands)                   |  | AverageVolume                                             |       |                       | AverageRate |  
|Increase (decrease) in interest income:  |  |                                                           |       |                       |             |   |     |  |   |       |  
|Loans                                    |  | $                                                         | 2,142 |                       |             | $ | 577 |  | $ | 2,719 |  
|Investment securities, taxable           |  |                                                           | (18   | )                     |             |   | 28  |  |   | 10    |  
|Investment securities, non-taxable (1)   |  |                                                           | 76    |                       |             |   | 1   |  |   | 77    |  
|Other                                    |  |                                                           | (161  | )                     |             |   | 54  |  |   | (107  | )
|                                         |  |                                                           |       |                       |             |   |     |  |   |       |  
|Total interest income                    |  |                                                           | 2,039 |                       |             |   | 660 |  |   | 2,699 |  
|                                         |  |                                                           |       |                       |             |   |     |  |   |       |  
|Increase (decrease) in interest expense: |  |                                                           |       |                       |             |   |     |  |   |       |  
|NOW accounts                             |  |                                                           | 2     |                       |             |   | 23  |  |   | 25    |  
|Money market                             |  |                                                           | 20    |                       |             |   | 102 |  |   | 122   |  
|Savings                                  |  |                                                           | 30    |                       |             |   | 85  |  |   | 115   |  
|Time deposits                            |  |                                                           | 700   |                       |             |   | 292 |  |   | 992   |  
|Borrowings                               |  |                                                           | (30   | )                     |             |   | 28  |  |   | (2    | )
|                                         |  |                                                           |       |                       |             |   |     |  |   |       |  
|Total interest expense                   |  |                                                           | 722   |                       |             |   | 530 |  |   | 1,252 |  
|                                         |  |                                                           |       |                       |             |   |     |  |   |       |  
|Total change in net interest income      |  | $                                                         | 1,317 |                       |             | $ | 130 |  | $ | 1,447 |  
|                                         |  |                                                           |       |                       |             |   |     |  |   |       |  

---

|(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.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------

NET INTEREST INCOME

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

Net interest income for the first quarter of 2006, was $4.3 million compared to $2.8 million
for the comparable period of 2005. This represents a $1.4 million increase or 51.4%. The increases in interest income and interest expense for the first quarter of 2006 were primarily driven by volume growth. Average earning assets grew 36.8% for
the first quarter of 2006 over the first quarter of 2005, from $267.4 million to $365.9 million, with the yield on average earning assets increasing 127 basis points. Average interest bearing liabilities (deposits and borrowings) grew 43.9% for the
first quarter of 2006 over 2005, from $204.5 million to $294.3 million, with the yield increasing 88 basis points.

NON-INTEREST INCOME

Non-interest income for the first quarter of 2006 was $656,000. For the same period of 2005, non-interest income was $488,000. Service charges and other fees increased
$67,000, from $229,000 in the first quarter of 2005 to $296,000 in the first quarter of 2006. The majority of this increase was in overdraft fees and consumer loan fees. We also continue our focus on mortgage banking fees. These fees were $322,000
for the first quarter of 2006 versus $252,000 in the comparable quarter of 2005.



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NON-INTEREST EXPENSE

For the first quarter of 2006, non-interest expense was $2.7 million, an increase of $657,000 over the first quarter of 2005. Salaries and Employee Benefits represented the largest increase in first quarter non-interest expense. This item
increased $413,000 in the first quarter versus the first quarter of 2005. 65.6% of that increase was for salaries and 34.4% for benefits. This is a result of an increase of twelve staff positions as well as normal salary increases. In January 2006
we began leasing the second floor of our headquarters as well as occupying the second floor of the Gateway branch, which is owned. This activity has caused Occupancy and Equipment to increase from $266,000 in the first quarter of 2005 to $370,000 in
the first quarter of 2006.

INCOME TAXES

For the
quarter ended March 31, 2006 and 2005, the Company recorded income tax expense of $697,000 and $496,000, respectively. Accordingly, our effective tax rates were 37.6% and 38.4% for 2006 and 2005 respectively. The determination of effective
rates reflects items which are not taxed for income tax purposes, primarily tax-exempt interest income.

FINANCIAL CONDITION ANALYSIS



|                                           |  |               |         |   |                  |   |         |   |  |   |        |   |  |    |  
|------------------------------------------ |  | ------------- | ------- | - | ---------------- | - | ------- | - |  | - | ------ | - |  | -- | -
|                                           |  |               | change  |  
|(Dollars in thousands)                     |  | March 31,2006 |         |   | December 31,2005 |   |         | $ |  |   | %      |  
|Cash                                       |  | $             | 6,419   |   |                  | $ | 6,395   |   |  | $ | 24     |   |  | 1  | %
|Investments                                |  |               | 23,482  |   |                  |   | 20,361  |   |  |   | 3,121  |   |  | 15 | %
|Loans  gross                              |  |               | 363,276 |   |                  |   | 339,540 |   |  |   | 23,736 |   |  | 7  | %
|net deferred fees                          |  |               | (1,707  | ) |                  |   | (1,549  | ) |  |   | (158   | ) |  | 10 | %
|Allowance for loan loss reserve            |  |               | (3,552  | ) |                  |   | (3,397  | ) |  |   | (155   | ) |  | 5  | %
|Other                                      |  |               | 13,753  |   |                  |   | 11,339  |   |  |   | 2,414  |   |  | 21 | %
|                                           |  |               |         |   |                  |   |         |   |  |   |        |   |  |    |  
|Total Assets                               |  | $             | 401,671 |   |                  | $ | 372,689 |   |  | $ | 28,982 |   |  | 8  | %
|                                           |  |               |         |   |                  |   |         |   |  |   |        |   |  |    |  
|Non-interest bearing deposits              |  | $             | 47,465  |   |                  | $ | 44,574  |   |  | $ | 2,891  |   |  | 6  | %
|Interest bearing deposits                  |  |               | 290,286 |   |                  |   | 268,051 |   |  |   | 22,235 |   |  | 8  | %
|Borrowings                                 |  |               | 16,624  |   |                  |   | 14,001  |   |  |   | 2,623  |   |  | 19 | %
|Other                                      |  |               | 1,989   |   |                  |   | 1,579   |   |  |   | 410    |   |  | 26 | %
|Stockholders equity                       |  |               | 45,307  |   |                  |   | 44,484  |   |  |   | 823    |   |  | 2  | %
|                                           |  |               |         |   |                  |   |         |   |  |   |        |   |  |    |  
|Total Liabilities and Stockholders equity |  | $             | 401,671 |   |                  | $ | 372,689 |   |  | $ | 28,982 |   |  | 8  | %
|                                           |  |               |         |   |                  |   |         |   |  |   |        |   |  |    |  

The balance sheet shows our growth in loans and deposits and our commitment to funding a productive mix of assets.
Gross loans grew $23.7 million (from $339.5 million at December 31, 2005 to $363.3 million at March 31, 2006) as deposits grew $25.1 million (from $312.6 million to $337.8 million). We continued to expand our securities portfolio with the
purchase of $3.7 million in new investments during the first quarter of 2006. To fund the above activity, we increased short-term borrowings by $2.6 million.

LOAN PORTFOLIO and ADEQUACY of the ALLOWANCE FOR LOAN LOSSES

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



11



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##### Table of Contents

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



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



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



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



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



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



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

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

As of March 31, 2006, the allowance for loan losses was $3.6 million, up $154,000 (4.5%) from December 31, 2005. This increase consists of additional
provision of $375,000, recoveries of $8,000 and charge-offs of $228,000. The increased provision over the first quarter of the prior year was primarily due to loan growth as well as a charge off of a $220,000 commercial loan in the first quarter of
2006. The decision to charge off the loan was made as the ability for the borrower to repay the principal was significantly reduced in the first quarter.

The ratio of the loan loss allowance to total loans outstanding of 0.98% was down two basis points from December 31, 2005. Considering the tremendous growth in the loan portfolio, both in size and quality, we cautiously manage the
level of reserve, taking into consideration external economic factors as well as those factors mentioned above.

NONPERFORMING ASSETS

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

As of March 31, 2006, total loans on nonaccrual status were $1.0 million, representing 0.29% of total loans. There was $1.1 million
of loans on nonaccrual status at December 31, 2005. This represented 0.32% of total loans on that date.

LIQUIDITY AND CAPITAL
RESOURCES

LIQUIDITY

The goal of liquidity
management is to ensure the availability of an adequate level of funds to meet the loan demand and deposit withdrawal needs of our customers. We manage the levels, types, and maturities of earning assets in relation to the sources available to fund
current and future needs.

In addition to maintaining a stable core deposit base, we maintain adequate liquidity primarily through the use of investment
securities and unused borrowing capacity. The Bank has invested in Federal Home Loan Bank stock for the purposes of establishing credit lines with the Federal Home Loan Bank. The credit availability to the Bank is equal to 15 percent of the
Banks total assets as reported on the most



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recent quarterly financial information submitted to its regulators. The credit availability approximated $60.2 million at
March 31, 2006, under which $13 million was outstanding. Borrowings against this line of credit are collateralized by investment securities and the Banks residential loan portfolio.

CAPITAL RESOURCES

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



|                                  |  |         |   |              |                  |   |              |                |        |  |                   |   |  |   |        |  |       |  
|--------------------------------- |  | ------- | - | ------------ | ---------------- | - | ------------ | -------------- | ------ |  | ----------------- | - |  | - | ------ |  | ----- | -
|                                  |  | Minimum |   |              | Well-capitalized |   |              | March 31, 2006 |        |  | December 31, 2005 |  
|(Dollars in thousands)            |  |         |   | Amount Ratio |                  |   | Amount Ratio |               
|First State Financial Corporation |  |         |   |              |                  |   |              |                |        |  |                   |   |  |   |        |  |       |  
|Tier 1 capital                    |  | 4.0     | % |              | 6.0              | % |              | $              | 45,701 |  | 12.39             | % |  | $ | 44,856 |  | 13.13 | %
|Total capital                     |  | 8.0     | % |              | 10.0             | % |              |                | 49,252 |  | 13.36             | % |  |   | 48,253 |  | 14.13 | %
|Tier 1 leverage                   |  | 4.0     | % |              | 5.0              | % |              |                |        |  | 11.98             | % |  |   |        |  | 12.54 | %
|                                  |  |         |   |              |                  |  
|First State Bank                  |  |         |   |              |                  |   |              |                |        |  |                   |   |  |   |        |  |       |  
|Tier 1 capital                    |  | 4.0     | % |              | 6.0              | % |              |                | 45,645 |  | 12.38             | % |  |   | 44,818 |  | 13.12 | %
|Total capital                     |  | 8.0     | % |              | 10.0             | % |              |                | 49,196 |  | 13.34             | % |  |   | 48,215 |  | 14.12 | %
|Tier 1 leverage                   |  | 4.0     | % |              | 5.0              | % |              |                |        |  | 11.97             | % |  |   |        |  | 12.53 | %

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, 2006
was analyzed using a simulation analysis of the Companys sensitivity to changes in net interest income under varying assumptions for changes in market interest rates. Specifically, the model derives expected interest income and interest
expense resulting from gradual and parallel shifts in the yield curve. Rate changes are matched with known re-pricing intervals. The Bank uses standardized assumptions run against Bank data by an outsourced provider of Asset/Liability reporting. The
analysis indicates that, while a decreasing rate environment would cause our margin to compress, the decrease in net interest income is not as dramatic as the increase we would receive in a rising rate environment. This is primarily due to the
Banks ability to manage its liabilities. Competition for deposits in the Banks market areas is very active. By managing maturities and rates as well as looking to other sources of funding, such as advances from the Federal Home Loan
Bank, we can control the compression on our interest rate margin in such a way as to cushion the effect of a declining rate environment.

Item 4. CONTROLS AND PROCEDURES

We maintain controls and procedures designed to ensure that information required to be
disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission. Our Chief Executive Officer and
Chief Financial Officer evaluated those controls and procedures in place



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

PART II

Item 1. LEGAL PROCEEDINGS

None

Item 1A. RISK FACTORS

None

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

None

Item 3. DEFAULTS UPON SENIOR SECURITIES

None

Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

None

Item 5. OTHER INFORMATION

None

Item 6. EXHIBITS

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

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

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



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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 4, 2006



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




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