UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

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

For the fiscal year ended          December 31, 2003

For the transition period from                     to                    

Commission file number:  001-12487

FIRST STATE BANCORPORATION

Registrant’s telephone number, including area code:     (505) 241-7500

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value

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 o

Indicate by check mark if disclosure of the delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes x  No o

The aggregate market value of the Common Stock as of June 30, 2003 (the last business day of the registrant’s most recently completed second quarter), based upon the last sale price of the Common Stock at June 30, 2003 as reported by The Nasdaq Stock Market, held by non-affiliates was approximately $188,965,000. Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and the registrant is not bound by this determination for any other purpose.

As of March 10, 2004, there were 7,630,311 shares of common stock issued and outstanding.

Documents Incorporated By Reference

Certain Part III information is incorporated herein by reference, pursuant to Instruction G of Form 10-K, from First State Bancorporation’s Proxy Statement for its 2004 Annual Shareholders’ Meeting, which will be filed with the Commission by April 29, 2004.

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TABLE OF CONTENTS

Forward-Looking Statements

Certain statements in this Form 10-K are forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). The discussions regarding our growth strategy, competition, loan and deposit growth, timing of new branch openings, expansion opportunities, and response to consolidation in the banking industry include forward-looking statements. Other forward-looking statements can be identified by the use of forward-looking words such as “believe,” “expect,” “may,” “will,” “should,” “seek,” “approximately,” “intend,” “plan,” “estimate,” or “anticipate” or the negative of those words or other comparable terminology. Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those in the forward-looking statement. Some factors include changes in interest rates, local business conditions, government regulations, loss of key personnel or inability to hire suitable personnel, faster or slower that anticipated growth, economic conditions, our competitors’ responses to our marketing strategy or new competitive conditions, and competition in the geographic and business areas in which we conduct our operations. We are not undertaking any obligation to update these risks to reflect events or circumstances after the date of this report to reflect the occurrence of unanticipated events.

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PART I

Item 1: Business.

First State Bancorporation

We are a New Mexico-based bank holding company. We provide commercial banking services to businesses through our subsidiary bank, First State Bank N.M. (“First State Bank” or “Bank”). We operate thirty branch offices, including twenty-three in New Mexico (three offices in Taos, nine offices in Albuquerque, three offices in Santa Fe, and one office each in Rio Rancho, Los Lunas, Bernalillo, Questa, Pojoaque, Placitas, Moriarty, and Belen), six in Colorado (Denver, Colorado Springs, Fort Collins, Lakewood, Littleton, and Longmont), and one in Utah (Salt Lake City). We have one new branch under building renovation in Santa Fe scheduled for completion in March 2004 and four branch offices in Colorado and Utah that are in the process of re-location and renovation or construction, which are expected to be operational in the second quarter of 2004. First State Bank’s branches in Colorado and Utah operate under the name First Community Bank. First State Bank began in 1922 in Taos County as a single bank, and is currently the largest bank in that county. At December 31, 2003, we had total assets, total deposits, and total stockholders’ equity of $1.647 billion, $1.196 billion, and $132 million, respectively.

Our management strategy is to provide a business culture in which customers are provided individualized customer service. As part of our operating and growth strategies, we are working to (i) place greater emphasis on attracting core deposits from, and providing financial services to, local businesses and governments; (ii) expand operations in the Albuquerque metropolitan area (which consists of Albuquerque and Rio Rancho), Belen, Los Lunas, Santa Fe, and other strategic areas in New Mexico; (iii) expand operations in the Colorado and Utah markets including the Denver metropolitan area, Colorado Springs, Salt Lake City, and the surrounding areas; (iv) maintain asset quality through strict adherence to credit administration standards; (v) manage interest rate risk; (vi) continue to improve internal operating systems; and (vii) manage non-interest expenses.

We believe that we are well qualified to pursue an aggressive growth strategy throughout New Mexico, Colorado, and Utah due to our responsive customer service, our streamlined management structure, management’s and employees’ strong community involvement in our business locations, and our recent expansion into the Colorado and Utah markets. We believe that expansion opportunities are centered primarily in the Albuquerque metropolitan area, Santa Fe, the Denver metropolitan area, Colorado Springs, Salt Lake City, and the surrounding markets. We continue to add staff to service the additional volume of loans and deposits obtained as a result of expansion in and into these marketplaces. The level of any additional staffing and related expenses will depend on the magnitude of continued growth. In addition, we will consider potential market acquisition targets that complement our existing operations and provide economies of scale when combined with our existing locations. See “Growth Strategy.”

At December 31, 2003, First State Bancorporation and First State Bank were “well capitalized” under regulatory capital guidelines.

Our executive offices are located at 7900 Jefferson NE, Albuquerque, New Mexico 87109, and our telephone number is (505) 241-7500.

History

First State Bank began operations in 1922 in Taos County, New Mexico. First State Bancorporation and an affiliated company, New Mexico Bank Corporation, were organized under the laws of New Mexico in 1988 to acquire banking institutions in New Mexico. In December 1988, we acquired First State Bank, and New Mexico Bank Corporation acquired National Bank of Albuquerque (“NBA”). After a change in

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New Mexico banking laws in 1991, First State Bancorporation and New Mexico Bank Corporation merged, and the operations of NBA were merged into First State Bank in December 1991.

On December 1, 1993, we purchased 94.5% of the outstanding shares of common stock of First State Bank of Santa Fe (“Santa Fe Bank”). Certain members of our current management, our board of directors, and two officers of First State Bank sold their shares of Santa Fe Bank to us. Santa Fe Bank was merged into First State Bank as of June 5, 1994.

During the fourth quarter of 1999, First State Bank opened a mortgage origination division. The mortgage division allows the Bank to generate fee income from our branch network and construction lending activities as well as attract additional customers.

On March 1, 2000, we closed the sale of the assets of First State Bank’s commercial leasing division. Our sale of the leasing division resulted in the sale of approximately $64 million of leases. Our gain on the sale amounted to approximately $879,000, net of transaction costs. We used proceeds from the sale to fund loan demand, purchase investment securities, and reduce borrowings.

On October 1, 2002 we entered the Colorado and Utah markets when we completed our acquisition of First Community Industrial Bank (“First Community”) for approximately $67 million. We financed this acquisition through a public offering of our common stock in August 2002, which netted approximately $51 million and through the issuance of approximately $25 million in trust preferred securities in June of 2002. We acquired approximately $343 million in loans and approximately $242 million in deposits, and recognized goodwill of approximately $43 million related to the transaction. We merged First Community into First State Bank and officially changed the name of the Bank to First State Bank N.M. However, the branches in Colorado and Utah operate under the name of First Community Bank.

Since our initial public offering in 1993, we have made significant investments in expansion and technology. Since 1993, First State Bank has opened sixteen new branches and acquired nine branches. During 2003, we began to strategically reposition the acquired branches and closed two of the branches.

Operating Strategy

Our operating strategies include:

	•		Providing responsive, personal customer service
	•		Fostering a culture in which employees are valued and respected
	•		Attracting new account relationships
	•		Emphasizing community involvement
	•		Developing new business opportunities
	•		Increasing efficiency
	•		Optimizing asset/liability management

Customer service. Our objective is to increase market share in both lending volume and deposits by providing responsive customer service that is tailored to our customers’ needs. By maximizing personal contact with customers, maintaining low employee turnover, and endeavoring to understand the needs and preferences of our customers, we are working to maintain and further enhance our reputation of providing excellent customer service. We have developed a streamlined management structure that allows us to make credit and other banking decisions rapidly. We believe that this structure, when compared to other competing institutions, enables us to provide a higher degree of service and increased flexibility to creditworthy customers.

Employees. We recognize that our individual employees are the core of our overall business strategy. We are committed to providing a workplace environment in which the individual employee is valued and respected. We have strategically hired and promoted within the Bank many talented bankers and have

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provided each region with local decision making ability which allows us to best serve and attract small to medium size businesses.

New account relationships. We emphasize relationship banking with local businesses, local governments, and individual customers across all product lines. We intend to continue to target our marketing efforts to those businesses, governments, and individuals who prefer our personalized customer service, combined with our emphasis on local decision making and the delivery of a state-of-the-art array of products and services.

Community Involvement. First State Bank’s management and other employees participate actively in a wide variety of civic and community activities and organizations in New Mexico, Colorado, and Utah. First State Bank management also sponsors a number of community-oriented events each year. We believe that these activities assist First State Bank through increased visibility and through development and maintenance of customer relationships.

New Business Opportunities. We have and will continue to consider a variety of new banking opportunities, whether through the opening of de novo branches, acquisition of existing commercial banks or bank holding companies, or other opportunities permissible under state and federal banking regulations. We will focus our expansion efforts in areas or markets that are complementary to our existing customer base and areas of operation. See “Growth Strategy.”

Increasing Efficiency. We believe that our investments in technology will allow us to grow revenues faster than expenses over the next few years. Over the last several years a significant investment has been made in the area of internet and telephone banking to provide alternative methods to enhance our ability to service both our retail and commercial customers. For our commercial customers, we also offer an internet based cash management product. We are currently implementing an imaging based document management and archiving system which will provide efficiencies in managing document flow and ensure records retention is managed correctly and efficiently. All of our locations are linked together by a private voice and data network eliminating long distance costs for intralocation phone calls and data transmission. We believe these investments as well as others will allow us to expand our asset base without a commensurate increase in non-interest expenses.

We continue to evaluate and improve our branch locations and facilities. In 2003, we began repositioning several of our facilities in Colorado and Utah to improve the future growth in these markets. These expenses will continue to grow during 2004 before they stabilize; however, we believe our investments in facilities will enable us to provide the convenience and quality of service that our customers deserve.

Asset/Liability Management. Our asset/liability management policy is designed to provide stable net interest income growth by protecting our earnings from undue interest rate risk. We maintain a strategy of keeping the rate adjustment period on the majority of both assets and liabilities to an earning neutral position, with a substantial amount of these assets and liabilities adjustable in 90 days or less. See Item 7: “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Asset/Liability Management.”

Growth Strategy

We expect to continue pursuing a growth strategy through a combination of internal growth, de novo branching, and selective acquisitions. Our total assets have grown from $494 million at December 31, 1998 to $1.6 billion through internal growth, de novo branching, and acquisition activity. Since 1993 large out of state financial institutions have acquired several banks that compete with us. These institutions concentrate on the mass retail customer base and extremely large customers. They also reduce service levels to small to medium size businesses. These institutions’ method of doing business affords us a continuing opportunity to gain profitable new account relationships and to expand existing relationships.

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In addition, we believe that there continues to be attractive opportunities to open new branches. Consolidation in the banking industry and increased regulatory burdens on existing institutions provide a favorable environment for such openings. We consider a variety of criteria when evaluating potential branch expansion, including (i) the short and long term growth prospects for the location, (ii) the management and other resources required to integrate the operations, if desirable, (iii) the degree to which the branch would enhance our geographic diversification, (iv) the degree to which the branch would enhance our presence in an existing market, and (v) the costs of operating the branch.

We believe that the strategy we have employed successfully in the New Mexico market can be successfully employed in other markets in the Southwest. We therefore intend to continue exploring opportunities to expand into markets in the southwestern United States either through acquisition of existing institutions with a branch structure in markets with characteristics similar to those in New Mexico, or through de novo branching into markets that display those characteristics.

Our goal over the next five years is to continue creating a broad-based, well capitalized, customer-focused regional financial institution. To accommodate our anticipated growth, we intend to further develop our existing management and further develop management information systems and other appropriate internal management systems. However, there can be no assurance that we will be able to achieve our growth objectives.

Market Areas and Banks

Markets. First State Bank serves three distinct market areas within New Mexico: Taos County, the Albuquerque metropolitan area (Bernalillo, Sandoval, Torrance, and Valencia counties), and Santa Fe. In 2002, First State Bank entered into the Colorado and Utah markets with the acquisition of First Community. First Community operates in two distinct market areas: the Colorado front range market area, which includes the Denver metropolitan area, and the Salt Lake City, Utah metropolitan area.

Taos County is a popular year-round recreation and tourist area. Ski and golf resorts in the area attract visitors from throughout the southwestern and western United States. Taos also has an active art community catering to the tourist trade.

The Albuquerque metropolitan area is the largest metropolitan area in New Mexico and is the financial center of the state. It has a diverse economy centered around federal and state government, military, service, and technology industries. Military facilities include Kirtland Air Force Base and Sandia National Laboratories. A number of companies, including Intel, General Mills, America Online, and The Gap have initiated or expanded operations in the area in the past several years.

Santa Fe is the state capital of New Mexico. Its principal industries are government and tourism. Santa Fe is widely known for its southwestern art galleries and amenities, including the Santa Fe Opera. Santa Fe is one of the largest art markets in the United States, attracting visitors from all parts of the United States and many foreign countries.

The Colorado front range market area includes the Denver metropolitan area (with branches in Denver, Littleton and Lakewood), and the surrounding communities of Colorado Springs, Longmont and Fort Collins. Denver, the capital of Colorado and the state’s largest city, has a diverse economy including telecommunications, aerospace, financial services, computer software, biomedical and many other high tech sectors. Colorado Springs also plays host to a growing number of high technology industries. Many private sector leaders in their fields are located in the front range area, including Qwest Communications, Intel, Lockheed Martin, Merrill Lynch, and Sun Microsystems. The Colorado front range has emerged as a premier center for high-tech and other businesses providing a blend of quality, affordable lifestyle, cultural and national sports attractions, and desirable climate.

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Salt Lake City is the state capital of Utah and the financial center of the state. The Salt Lake City area has a diverse economy driven by technology companies, telemarketing, engineering, management services, universities, and state and local governments. Many major companies as well as small businesses operate throughout the area. The state of Utah is a recreation minded and livable community catering to year-round recreation with both mountain and desert areas nearby. Effective as of November 30, 2003, we closed the Ogden, Utah branch and one branch in Salt Lake City. The total loans and deposits of the Utah operations did not justify maintaining three separate banking facilities and therefore the Utah operations were consolidated into one branch in Salt Lake City to enhance the efficiency of the Utah operations and allow management to target small to medium size businesses in a more focused manner.

First State Bank’s operations are divided into eight regions: Taos which includes Taos county; Santa Fe which includes Santa Fe county; Albuquerque Metropolitan which includes Bernalillo and Sandoval counties; Los Lunas which includes Valencia and Torrance counties; Northern Colorado which includes Larimer and Boulder counties; Central Colorado which includes Denver, Jefferson, and Arapahoe counties; Southern Colorado which includes El Paso County; and Utah which includes Salt Lake county.

First State Bank. The following table sets forth certain information concerning the banking offices of First State Bank as of December 31, 2003:

First State Bank offers a full range of financial services to commercial and individual customers, including checking accounts, short and medium term loans, revolving credit facilities, inventory and accounts receivable financing, equipment financing, residential and small commercial construction lending, residential mortgage loans, various savings programs, installment and personal loans, safe deposit services, and credit cards.

The Taos locations provide conventional commercial loans to established commercial businesses and businesses that support the tourism and skiing industries. The Taos branches also provide a broad range of consumer banking services, including a full complement of deposit and residential construction and mortgage lending, and other loan services.

The Albuquerque metropolitan area locations primarily serve established commercial businesses and individuals who may require a full range of banking services. In addition to an emphasis on conventional commercial and real estate secured commercial lending, these locations are active in residential construction lending and mortgage lending in the Albuquerque metropolitan area.

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The Santa Fe locations primarily serve a diverse group of small to medium size business and individual customers, including commercial businesses that support the tourism industry, and residential construction and mortgage lending.

The Colorado and Utah locations provide conventional commercial and real estate secured commercial lending to small to medium size business and individual customers in these markets. These locations also provide a full range of banking services, including a full complement of deposit and residential construction and mortgage lending, and other loan services. Prior to its acquisition by First State Bank, First Community primarily made residential mortgage and retail installment loans and was prohibited from accepting transaction deposit accounts (i.e. checking accounts) due to its charter as an industrial bank.

The following is a summary of the percentage of our deposits to total deposits of FDIC insured institutions in the counties in which we do business as of June 30, 2003:

* We closed our branch in Weber County in November of 2003 and the existing loans and deposits were transferred to our branch in Salt Lake County subsequent to that date.

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We believe that our greatest opportunity for growth in our current market area in New Mexico is in increasing our market share in Bernalillo, Sandoval, Valencia, and Santa Fe counties. First State Bank is the largest bank in Taos County, and growth in that market is expected to come from economic growth and not as a result of increased market share.

We also believe that the Colorado and Utah markets represent a great opportunity for growth as the acquired First Community branches have the ability to accept demand deposits and we continue to aggressively seek commercial banking relationships with small to medium size businesses. We expect that the change in deposit and loan products combined with the integration of our individualized customer service will result in increased market share in Colorado and Utah.

Competition

First State Bank competes for loans and deposits with other commercial banks, savings banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking firms, asset-based non-bank lenders, governmental organizations, and other institutions with respect to the scope and type of services offered, interest rates paid on deposits, and pricing of loans, among other things. Many of our competitors have significantly greater financial and other resources than we do. First State Bank also faces significant competition for investors’ funds from sellers of short-term money market securities and other corporate and government securities.

First State Bank competes for loans principally through the range and quality of its services, interest rates, and loan fees. We believe that First State Bank’s personal-service philosophy enables the bank to compete favorably with other financial institutions in its focus market of local businesses. First State Bank actively solicits deposit-related clients and competes for deposits by offering customers competitive interest rates, personal attention and professional service.

Employees

As of December 31, 2003, we had 499 full-time equivalent employees. We place a high priority on staff development, training, and selective hiring. We select new employees on the basis of both technical skills and customer-service capabilities. Our staff development involves training in marketing, customer service, and regulatory compliance. Our employees are not covered by a collective bargaining agreement. We believe that our relationship with our employees is good.

Supervision and Regulation

First State Bancorporation. We are a bank holding company subject to the supervision, examination and regulation of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the Bank Holding Company Act (the “BHCA”). The BHCA and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations. As a bank holding company, our activities and those of our banking subsidiary are limited to the business of banking and activities closely related or incidental to banking, and we may not directly or indirectly acquire the ownership or control of more than 5% of any class of voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Federal Reserve Board.

Supervision and regulation of bank holding companies and their subsidiaries are intended primarily for the protection of depositors, the deposit insurance funds of the Federal Deposit Insurance Corporation (the “FDIC”) and the banking system as a whole, not for the protection of bank holding company stockholders or creditors. The banking agencies have broad enforcement power over bank holding companies and banks, including the power to impose substantial fines and other penalties for violation of laws and regulations.

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First State Bank N.M. As a New Mexico-chartered state member bank of the Federal Reserve System, First State Bank is subject to regulation and supervision by the Federal Reserve Board and the New Mexico Financial Institutions Division and, as a result of the insurance of its deposits, by the FDIC. Almost every aspect of the operations and financial condition of First State Bank is subject to extensive regulation and supervision and to various requirements and restrictions under federal and state law, including requirements governing capital adequacy, liquidity, earnings, dividends, reserves against deposits, management practices, branching, loans, investments, and the provision of services. Various consumer protection laws and regulations also affect the operations of First State Bank. The deposits of First State Bank are insured up to applicable limits by the FDIC.

Holding Company Liability. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to its banking subsidiaries and commit resources to their support. This support may be required by the Federal Reserve Board at times when, absent this Federal Reserve policy, we may not be inclined to provide it. As discussed below under “Prompt Corrective Action,” a bank holding company in certain circumstances also could be required to guarantee the capital plan of an undercapitalized banking subsidiary. In addition, any capital loans by a bank holding company to any of its depository institution subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of the banks.

In the event of a bank holding company’s bankruptcy under Chapter 11 of the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is required to cure immediately any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution, and any claim for breach of such obligation will generally have priority over most other unsecured claims.

Payment of Dividends. The Federal Reserve Board has issued a policy statement with regard to the payment of cash dividends by bank holding companies. The policy statement provides that, as a matter of prudent banking, a bank holding company should not maintain a rate of cash dividends unless its net income available to common stockholders has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears to be consistent with the holding company’s capital needs, asset quality and overall financial condition. Accordingly, a bank holding company should not pay cash dividends that exceed its net income or can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing.

In addition, as noted above, bank holding companies are expected under Federal Reserve Board policy to serve as a source of financial strength for their depository institution subsidiaries. This requirement, and the capital adequacy requirements applicable to bank holding companies, described below under “Capital Adequacy Requirements,” may also limit our ability to pay dividends.

As a bank holding company, we are a legal entity separate and distinct from First State Bank. Our principal asset is the outstanding capital stock of First State Bank. As a result, our ability to pay dividends on our common stock will depend primarily on the ability of First State Bank to pay dividends to us in amounts sufficient to service our obligations. Dividend payments from First State Bank are subject to federal and state limitations, generally based on the capital level and current and retained earnings of the bank. Approval of the Federal Reserve Board is required, for example, for payment of any dividend if the total of all dividends declared by the bank in any calendar year would exceed the total of its net profits (as defined by regulatory agencies) for that year combined with its retained net profits for the preceding two years. First State Bank may not pay a dividend in an amount greater than its net profits. First State Bank is also prohibited under federal law from paying any dividend that would cause it to become undercapitalized. In addition, the Federal regulatory agencies are authorized to prohibit a bank or bank holding company from engaging in an unsafe or unsound banking practice. The payment of dividends could, depending on the financial condition of First State Bank, be deemed to constitute an unsafe or unsound practice.

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Under New Mexico law, First State Bank may not pay a dividend on its common stock unless its remaining surplus after payment of such dividend is equal to at least 20% of its minimum common capital requirement. First State Bank is also prohibited from paying dividends from undivided profits if its reserves against deposits are impaired or will become impaired as a result of such payment.

Capital Adequacy Requirements. We are subject to the Federal Reserve Board’s risk-based capital and leverage guidelines for bank holding companies. The minimum ratio of total capital to risk-weighted assets (which are the credit risk equivalents of balance sheet assets and certain off balance sheet items such as standby letters of credit) is 8%. At least half of the total capital must be composed of common stockholders’ equity (including retained earnings), trust preferred securities, qualifying non-cumulative perpetual preferred stock (and, for bank holding companies only, a limited amount of qualifying cumulative perpetual preferred stock), and minority interests in the equity accounts of consolidated subsidiaries, less goodwill, other disallowed intangibles and disallowed deferred tax assets, among other items (“Tier 1 Capital”). The remainder may consist of a limited amount of subordinated debt, other perpetual preferred stock, hybrid capital instruments, mandatory convertible debt securities that meet certain requirements, as well as a limited amount of reserves for loan losses (“Tier 2 Capital”). The maximum amount of Tier 2 Capital that may be included in an organization’s qualifying total capital is limited to 100% of Tier 1 Capital. The Federal Reserve Board has also adopted a minimum leverage ratio for bank holding companies, requiring Tier 1 Capital of at least 3% of average total consolidated assets.

Our subsidiary, First State Bank, also is subject to risk-based and leverage capital guidelines of the Federal Reserve Board which are similar to those established by the Federal Reserve Board for bank holding companies. As discussed below under “Enforcement Powers of the Federal Regulatory Agencies,” failure to meet the minimum regulatory capital requirements could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including, in most severe cases, the termination of deposit insurance by the FDIC and the placement of the institution into conservatorship or receivership. The capital ratios for First State Bancorporation and First State Bank are provided in the chart below.

Risk-Based Capital and Leverage Ratios

The federal bank regulatory agencies’ risk-based and leverage ratios are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming that they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. In addition, the regulations of the Federal Reserve Board provide that concentration of credit risk, interest rate risk and certain risks arising from nontraditional activities, as well as an institution’s ability to manage these risks, are important factors to be taken into account by regulatory agencies in assessing an organization’s overall capital adequacy. The agencies have also adopted an adjustment to the risk-based capital calculations to cover market risk in trading accounts of certain institutions.

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The federal bank regulatory agencies recently adopted amendments to their risk-based capital regulations to provide for the consideration of interest rate risk in the agencies’ determination of a banking institution’s capital adequacy. The amendments require such institutions to effectively measure and monitor their interest rate risk and to maintain capital adequate for that risk.

Prompt Corrective Action. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, the federal banking agencies must take prompt supervisory and regulatory actions against undercapitalized depository institutions. Depository institutions, such as First State Bank, are assigned one of five capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized,” and are subjected to differential regulation corresponding to the capital category within which the institution falls. Under certain circumstances, a well capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category. A depository institution is generally prohibited from making capital distributions (including paying dividends) or paying management fees to a holding company if the institution would thereafter be undercapitalized. Adequately capitalized institutions cannot accept, renew or roll over brokered deposits except with a waiver from the FDIC, and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or roll over brokered deposits.

The banking regulatory agencies are permitted or, in certain cases, required to take certain actions with respect to institutions falling within one of the three undercapitalized categories. Depending on the level of an institution’s capital, the agency’s corrective powers include, among other things:

	•		prohibiting the payment of principal and interest on subordinated debt;
	•		prohibiting the holding company from making distributions without prior regulatory approval;
	•		placing limits on asset growth and restrictions on activities;
	•		placing additional restrictions on transactions with affiliates;
	•		restricting the interest rate the institution may pay on deposits;
	•		prohibiting the institution from accepting deposits from correspondent banks; and
	•		in the most severe cases, appointing a conservator or receiver for the institution.

A banking institution that is undercapitalized is required to submit a capital restoration plan, and such a plan will not be accepted unless, among other things, the banking institution’s holding company guarantees the plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy. Failure to meet capital guidelines could subject the bank to a variety of enforcement remedies by federal bank regulatory agencies, including termination of deposit insurance by the FDIC, and to certain restrictions on business. As of December 31, 2003, each of First State Bancorporation and First State Bank exceeded the required capital ratios for classification as “well capitalized.”

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Enforcement Powers of the Federal Banking Agencies. The federal banking agencies have broad enforcement powers. Failure to comply with applicable laws, regulations and supervisory agreements could subject First State Bancorporation or First State Bank, as well as officers, directors and other institution-affiliated parties of these organizations, to administrative sanctions and potentially substantial civil money penalties. In addition to the grounds discussed under “Prompt Corrective Action,” the appropriate federal banking agency may appoint the FDIC as conservator or receiver for a banking institution (or the FDIC may appoint itself, under certain circumstances) if any one or more of a number of circumstances exist, including, without limitation:

	•		the fact that the banking institution is undercapitalized and has no reasonable prospect of becoming adequately capitalized;
	•		fails to become adequately capitalized when required to do so;
	•		fails to submit a timely and acceptable capital restoration plan;
	•		or materially fails to implement an accepted capital restoration plan.

Control Acquisitions. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, such as First State Bancorporation, would, under the circumstances set forth in the presumption, constitute acquisition of control of First State Bancorporation.

In addition, any company is required to obtain the approval of the Federal Reserve Board under the BHCA before acquiring 25% (5% in the case of an acquiror that is a bank holding company) or more of the outstanding common stock of First State Bancorporation, or otherwise obtaining control or a “controlling influence” over First State Bancorporation.

Restrictions on Transactions with Affiliates and Insiders. First State Bank is subject to restrictions under federal law that limit certain transactions with us, including loans, other extensions of credit, investments or asset purchases. Such transactions by a banking subsidiary with any one affiliate are limited in amount to 10% of the bank’s capital and surplus and, with all affiliates together, to an aggregate of 20% of the bank’s capital and surplus. Furthermore, such loans and extensions of credit, as well as certain other transactions, are required to be secured in specified amounts. These and certain other transactions, including any payment of money to us, must be on terms and conditions that are or in good faith would be offered to nonaffiliated companies.

The restrictions on loans to directors, executive officers, principal stockholders and their related interests (collectively referred to herein as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all federally insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution’s total unimpaired capital and surplus, and the FDIC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions. Regulation O institutions are not subject to the prohibitions of the Sarbanes-Oxley Act of 2002 on certain loans to insiders.

Anti-Terrorism Legislation. We are subject to the USA Patriot Act of 2001 which contains the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001. That Act contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain financial institutions. The Act requires U.S. financial institutions to adopt new policies and procedures to combat money laundering and grants the Secretary of the Treasury broad authority to establish regulations

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and to impose requirements and restrictions on financial institutions’ operations. We have established policies and procedures to ensure compliance with the Act and the related regulations.

Interstate Banking and Branching. The Riegle-Neal Act enacted in 1994 permits an adequately capitalized and adequately managed bank holding company, with Federal Reserve Board approval, to acquire banking institutions located in states other than the bank holding company’s home state without regard to whether the transaction is prohibited under state law. In addition, national banks and state banks with different home states are permitted to merge across state lines, with the approval of the appropriate federal banking agency, unless the home state of a participating banking institution has passed legislation prior to that date that expressly prohibits interstate mergers. De novo interstate branching is permitted if the laws of the host state so authorizes.

The Gramm-Leach-Bliley Act. The GLBA became law on November 12, 1999, and key provisions affecting bank holding companies became effective March 11, 2000. The GLBA enables bank holding companies to acquire insurance companies and securities firms and effectively repeals depression-era laws which prohibited the affiliation of banks and these other financial services entities under a single holding company. Certain qualified bank holding companies and other types of financial service entities may elect to become financial holding companies under the new law. Financial holding companies are permitted to engage in activities considered financial in nature, as defined in the GLBA, and may engage in a broader range of activities than bank holding companies or banks. The GLBA will enable financial holding companies to offer a wide variety of financial services, or services incident to financial services, including banking, securities underwriting, merchant banking and insurance (both underwriting and agency services). The financial services authorized by the GLBA also may be engaged in by a “financial subsidiary” of a national or state bank, with the exception of insurance or annuity underwriting, insurance company portfolio investments, real estate investment and development, and merchant banking, all of which must be conducted under the financial holding company.

Community Reinvestment Act. First State Bank is subject to the CRA. The CRA and the regulations issued thereunder are intended to encourage banks to help meet the credit needs of their service area, including low and moderate income neighborhoods, consistent with the safe and sound operations of the banks. These regulations also provide for regulatory assessment of a bank’s record in meeting the needs of its service area when considering applications to establish branches, merger applications and applications to acquire the assets and assume the liabilities of another bank. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) requires federal banking agencies to make public a rating of a bank’s performance under the CRA. In the case of a bank holding company, the CRA performance record of its bank subsidiaries are reviewed by federal banking agencies in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or thrift or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction. First State Bank received an “outstanding” CRA rating from the Federal Reserve at its most recent CRA examination.

Consumer Laws and Regulations. In addition to the laws and regulations discussed herein, First State Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the New Mexico Unfair Practices Act and the Settlement Procedures Act among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans to or engaging in other types of transactions with such customers.

Effect on Economic Environment. The policies of regulatory authorities, especially the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. Government securities, changes in the discount rate on member

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bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid for deposits. Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on our business and earnings cannot be predicted.

Future Legislation. Various legislation is from time to time introduced in Congress, and state legislatures with respect to the regulation of financial institutions. Such legislation may change the banking statutes and our operating environment in substantial and unpredictable ways. We cannot determine the ultimate effect that potential legislation, if enacted, or implementing regulations, would have upon our financial condition or our results of operations.

Corporate Governance — Sarbanes-Oxley Act of 2002 and NASD Independence Rules. We are subject to the Sarbanes-Oxley Act of 2002 (“SOX”), which implemented reforms intended to address securities and accounting fraud. Among other things, SOX established a new accounting oversight board to enforce auditing, quality control and independence standards, restricts provision of both auditing and consulting services by accounting firms, and provides audit committee pre-approval of non-audit services to audit clients. To insure auditor independence, any non-audit services being provided to an audit client will require pre-approval by a company’s audit committee members. SOX also requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the Commission, subject to civil and criminal penalties for knowing violations. SOX also requires audit committees to be independent and have at least one financial expert, and enacts other requirements for audit committee operations and selection of auditor. SOX also expands the scope and penalties of the federal criminal code relating to securities and accounting fraud, and afford protection for employees who are “whistle-blowers”.

We are listed on the Nasdaq Stock Market (“Nasdaq”), a subsidiary of the National Association of Securities Dealers (“NASD”). On November 2, 2003, the SEC approved NASD rules for companies listed on Nasdaq as part of their qualitative listing requirements for listing or continued listing relating to audit committee composition, audit committee charters, nominating committee charters, executive sessions of independent directors, and code of conduct requirements. Under the NASD rules, the audit committee must be composed of independent directors without recent affiliation with auditors of the company, must have an audit committee charter, executives must have executive sessions of independent directors, must have a nominating committee charter, and must have a code of conduct applying to all employees, officers, and directors meeting certain minimum standards. As required by the NASD rules, we have certified that we comply with the new rules. In addition, the NASD also requires audit committee approval of all related party transactions and that a majority of the board of directors be independent under the NASD definition of independence.

The board is committed to maintaining a corporate governance structure that meets or exceeds the requirements for the Sarbanes-Oxley Act and the recent NASD rules.

Other

For a discussion of asset/liability management, the investment portfolio, loan portfolio, nonperforming assets, allowance for loan losses, and deposits see Item 7: “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Available Information

Our Internet address is www.fsbnm.com. We make available free of charge through our web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as

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soon as reasonably practicable after we electronically file such material with, or furnish such material to, the SEC. Information contained on the web site is not part of this report.

Item 2: Properties.

With the exception of the Main and Southside facilities in Taos, the Journal Center facility in Albuquerque, and the Bernalillo facility, which are owned by First State Bank, we lease our banking facilities. See Item 13: “Certain Relationships and Related Transactions.” The following table shows the size and age of each of the banking facilities and the building area owned or leased by us:

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Item 3: Legal Proceedings.

From time to time we are involved in legal proceedings. In the ordinary course of our business claims and lawsuits are filed against us or raised by counterclaims. These legal actions arise out of claims to enforce liens, in condemnation proceedings on properties in which we hold security interests, and by claims involving the making and servicing of real property loans, and other issues incident to our business. In the opinion of management, the ultimate liability, if any, resulting from known claims or lawsuits will not have a material adverse effect on our consolidated financial position or results of operations.

Item 4: Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of our security holders during the fourth quarter of 2003.

Executive Officers of the Registrant

First State Bancorporation’s executive officers, their positions, and their respective ages (as of January 1, 2004) are as follows:

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PART II

Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Price Range of Common Stock

Our Common Stock is traded on The NASDAQ Stock Market’s National Market under the symbol “FSNM.” Our Common Stock commenced trading on November 3, 1993. The quotations in the over-the-counter market reflect inter-dealer prices, without retail markup, markdown, or commissions and may not necessarily represent actual transactions.

The last reported sale price of our Common Stock on March 10, 2004, was $31.85 per share. As of March 10, 2004, there were approximately 103 shareholders of record, not including shareholders who beneficially own Common Stock held in nominee or street name.

Dividend Policy

We paid cash dividends of $3.2 million or $0.43 per share in 2003 and $2.2 million or $0.39 per share in 2002, which amounted to 21.62% and 21.61%, of net income in 2003 and 2002, respectively. The declaration and payment of cash dividends are determined by the Board of Directors in light of the earnings, capital requirements, our financial condition, and other relevant factors. Our ability to pay cash dividends depends on the amount of cash dividends paid to us by First State Bank and our capital position. Capital distributions, including dividends, by First State Bank are subject to federal and state regulatory restrictions tied to its earnings and capital. Information regarding dividend restrictions on our banking subsidiary is incorporated herein by reference to Item 1. Business—Supervision and Regulation/Payment of Dividends.

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Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information regarding compensation plans under which shares of Common Stock may be issued upon the exercise of option, warrants and rights under the First State Bancorporation 1993 Stock Option Plan and the 2003 Equity Incentive Plan as of December 31, 2003:

Item 6: Selected Financial Data.

Selected Financial Data are filed as part of this report and appear immediately following the signature page.

Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Management’s Discussion and Analysis of Financial Condition and Results of Operations are filed as part of this report and appear immediately following Selected Financial Data.

Item 7A: Quantitative and Qualitative Disclosures About Market Risk.

Quantitative and Qualitative Disclosures About Market Risk are filed as part of this report and appear within Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption Asset/Liability Management.

Item 8: Financial Statements and Supplementary Data.

Our consolidated financial statements are filed as a part of this report and appear immediately following the Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 9: Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

None.

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Item 9A: Controls and Procedures.

An evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2003 pursuant to Exchange act rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2003, in all material respects, to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required. There was no change in our internal control over financial reporting during the quarter ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART III

Item 10: Directors and Executive Officers of the Registrant.

Information regarding directors appearing under the caption “Election of Directors” in our Proxy Statement for the 2004 Annual Meeting of Shareholders is hereby incorporated by reference. Information relating to disclosure of delinquent Form 3, 4 and 5 filers is incorporated by reference to the information appearing under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement for the 2004 Annual Meeting of Shareholders.

Information regarding our audit committee financial experts appearing under the caption “Information with Respect to Standing Committees of the Board of Directors and Meetings” in our Proxy Statement for the 2004 Annual Meeting of Shareholders is hereby incorporated by reference.

Information regarding our Code of Ethics appearing under the caption “Corporate Governance” in our Proxy Statement for the 2004 Annual Meeting of Shareholders is hereby incorporated by reference. The Code of Ethics has been filed with the Commission and is posted on our website at www.fsbnm.com “Investor Relations.”

Information regarding executive officers is included in Part I of this Form 10-K as permitted by General Instruction G (3).

Item 11: Executive Compensation.

Information appearing under the captions “Compensation of Directors” and “Executive Compensation” in the 2004 Proxy Statement is hereby incorporated by reference.

Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Information setting forth the security ownership of certain beneficial owners and management appearing under the caption “Voting Securities and Principal Holders” in the 2004 Proxy Statement is hereby incorporated by reference.

Item 13: Certain Relationships and Related Transactions.

Information regarding certain related transactions appearing under the caption “Certain Business Relationships” in the 2004 Proxy Statement is hereby incorporated by reference.

Item 14: Principal Accountant Fees and Services.

Information regarding principal accountant fees and services appearing under the caption “Ratification of Independent Auditors” in the 2004 Proxy Statement is incorporated herein by reference.

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PART IV

Item 15: Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a) The following documents are filed as part of this annual report on Form 10-K:

1.

Financial Statements:

	•		Selected Quarterly Financial Data
	•		Independent Auditors’ Report
	•		Consolidated Balance Sheets as of December 31, 2003 and 2002
	•		Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002, and 2001
	•		Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2003, 2002, and 2001
	•		Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2003, 2002, and 2001
	•		Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002, and 2001

2.

Financial Statement Schedules

None

3.

Exhibits

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(b) Reports on Form 8-K.

On October 22, 2003, we filed a current report on Form 8-K announcing our third quarter 2003 financial results.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	FIRST STATE BANCORPORATION
	By:	Michael R. Stanford
		Michael R. Stanford, President and
Dated: March 12, 2004		Chief Executive Officer

Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

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FIRST STATE BANCORPORATION AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001

Basis of Presentation

     The following represents management’s discussion and analysis of First State Bancorporation’s consolidated financial condition as of December 31, 2003 and 2002, and our results of consolidated operations for the years ended December 31, 2003, 2002, and 2001. This discussion should be read in conjunction with the consolidated financial statements and related footnotes and the five-year summary of selected financial data.

Overview and Outlook

     For the year ended December 31, 2003, we reported net income of $14.9 million, or $1.95 per diluted share in 2003, an increase of 49.1% over prior year earnings. Net income for 2002 was $10.0 million, or $1.66 per diluted share. Earnings growth in 2003 was driven primarily by the increase in net interest income combined with a fairly stable net interest margin.

Highlights for 2003 are as follows:

	•		We benefited for the entire year from the acquisition of First Community Industrial Bank (“First Community”) in late 2002.
	•		Strong loan demand throughout our system resulted in total loans growing at a 21.1% rate in 2003. The allowance for loan losses as a percentage of total loans ended the year at 1.15% and loans charged-off as a percentage of total loans was a modest 0.29%.
	•		Total deposits grew 10.8% during the year which included an $81 million increase (42.6%) in non-interest-bearing deposits.
	•		Mortgage loans originated by us were a record $213 million in response to an increase in refinancing activity, as long-term interest rates fell to 40-year lows in 2003.
	•		Two of the six First Community branches in Colorado were relocated or renovated to better serve our customers, the three Utah branches of First Community were consolidated into one branch in Salt Lake City to provide operating efficiencies, and two new branches were added in Santa Fe and Albuquerque, New Mexico as a result of continued growth in those markets. During 2003, we also established a new 50,000 square foot operations center.
	•		Our efficiency ratio decreased to 62.49% in 2003 from 66.44% in the prior year in spite of significant increases in non-interest expenses resulting from investments in new personnel and facilities. The decrease was driven primarily by the growth in total loans during 2003 and the resulting increase in interest income.

     Assuming the economy remains stable and the yield curve remains relatively unchanged in 2004, management expects modest balance sheet growth and strong loan demand. Based on this outlook, we are currently projecting results for 2004 in the range of $2.05 — $2.15 per diluted share.

Business Combination

     We completed the acquisition and merger of First Community on October 1, 2002 for approximately $67 million. We financed this acquisition through a public offering of our common stock in August 2002, which netted approximately $51 million, and through the issuance of approximately $25 million in trust preferred securities in June of 2002. The acquisition was accounted for using the purchase method of accounting, and accordingly, the assets and liabilities of First Community were recorded at their respective fair values on October 1, 2002. First State acquired approximately $343 million in loans and approximately $242 million in deposits, and recognized goodwill of approximately $43 million related to the transaction. The First Community account balances acquired on October 1, 2002 and the results of operations since October 1, 2002 are included in our results.

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Critical Accounting Estimates and Judgments

Allowance for loan loss

     Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain an adequate allowance. Estimating the allowance is a critical accounting policy. Management uses a systematic methodology with subjective elements that require material estimates which are subject to revision as facts and circumstances warrant. In assessing the adequacy of the allowance, management reviews the size, quality, and risks of loans in the portfolio, and considers factors such as specific known risks, past experience, the status and amount of nonperforming assets, and economic conditions. A specific percentage is allocated to total loans in good standing and not specifically allowed for, while additional amounts are added for individual loans considered to have specific loss potential. Loans identified as losses are charged off. Based on total allocations, the provision is recorded to maintain the allowance at a level deemed appropriate by management based on probable losses in the loan portfolio.

Goodwill

     The excess of cost over fair value of the net assets of acquired banks is recorded as goodwill. Prior to 2002, goodwill was amortized over its estimated useful life on a straight-line basis and the recoverability of goodwill assessed by determining whether the amortization can be recovered through projected undiscounted future results of operations. Beginning in 2002, goodwill is no longer amortized. We test goodwill for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that the asset might be impaired. We completed our annual goodwill impairment tests during the fourth quarter in 2003 and 2002, and found no impairment.

Recent Accounting Pronouncements and Developments

     Note 1 to the consolidated financial statements discusses new accounting policies we adopted during 2003 and the expected impact of accounting policies recently issued but not yet required to be adopted. To the extent the adoption of new accounting standards materially affect our financial condition, results of operations or liquidity, the impact is discussed elsewhere in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the notes to the consolidated financial statements.

Results of Operations

Earnings Performance

     An analysis of the major components of net income in 2003, 2002 and 2001 is presented below. Additional data on our performance during the past five years appear in “Financial Highlights”.

Net Interest Income

     The primary component of earnings for most financial institutions is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread, and margin. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

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     During the years ended December 31, our net interest income increased by $19.6 million to $61.1 million or 47.3% in 2003 from $41.5 million in 2002, which was an increase of $8.3 million or 25.1% from $33.2 million in 2001. These increases were due to a $418.5 million or 60.5% increase in average loans to $1.111 billion in 2003 from $692 million in 2002, and a $194.8 million or 39.2% increase from $497 million in 2001. A significant factor in the increase in average loans in 2003 was due to the $343 million of loans acquired on October 1, 2002, in the First Community acquisition. In addition, we experienced growth in the loan portfolio as a result of our efforts to increase market share by taking advantage of market dislocations caused by the acquisition of local competitors and growth in the economy of our market areas. The increase was offset by a decrease in yield on loans to 6.8% in 2003 from 7.3% in 2002 and 9.0% in 2001. This decrease was a direct result of the Federal Reserve Bank cutting rates, which has a like effect on the prime rate to which a significant portion of our loans are tied.

     During 2003, the cost of interest-bearing liabilities decreased to 2.04% from 2.44% in 2002 and 3.76% in 2001 as a result of decreasing interest rates precipitated by the Federal Reserve Bank’s rate cuts.

     During 2001, a significant competitor in our New Mexico market area was acquired by another institution in the market requiring the purchaser to divest of significant deposits to another institution owned by an out-of-state company. We geared many of our activities, including marketing efforts, to capturing market share disrupted by this acquisition. Management believes that a significant amount of its deposit growth in 2001 was a result of this transaction and our efforts to capitalize on it. While management believes that we will continue to increase our market share as a result of this acquisition, we do not expect our market share growth from this acquisition to continue at the same rate as that experienced in 2002 and 2001.

     The decline in interest rates in 2001, 2002, and 2003 had the impact of compressing our net interest margin because of our asset sensitive position. If the decline in rates were to halt, this compression should be abated and any increase in rates by the Federal Reserve would be expected to have the effect of increasing our net interest margin. The decline in rates also had the effect of stimulating demand for one- to four-family residential real estate. That increased demand contributed to the growth in real estate construction loans and originations of mortgage loans available for sale. With interest rates at historically low levels, management expects that increases in rates will occur that will slow the pace of demand for one- to four-family residential real estate, which would have the effect of reducing the rate of growth in construction loans and mortgage loans originated for sale.

     Our net interest margin was 4.59% in 2003, compared in 4.50% in 2002 and 4.93% in 2001. The decrease in the margin from 2001 to 2002 was due to the Federal Reserve Bank rate cuts which has the effect of reducing interest income faster than interest expense given the asset sensitive position of our balance sheet and the significant liquidity maintained in the third quarter of 2002 prior to the acquisition of First Community. The net margin rose from 2002 to 2003 in spite of a Federal Reserve Bank rate cut in the second quarter due to the 2002 margin having been compressed abnormally by the liquidity maintained prior to the acquisition, the 42.6% growth in non-interest-bearing deposits in 2003, and the run off of higher yielding certificates of deposit in the First Community branches. In addition, the 2003 margin benefited from an increased level of short-term borrowings from the Federal Home Loan Bank at an average rate less than the average cost of deposits. The net interest margin includes a reclassification reducing fees associated with originating loans and reducing non-interest expenses. The reclassification represents direct costs incurred to originate successful loans.

     Management believes that any additional interest rate cuts by the Federal Reserve Bank would reduce our net interest margin. The extent of any reduction in net interest margin will depend on the amount and timing of any further Federal Reserve Bank reductions and our ability to manage the cost of interest-bearing liabilities given our competitive position in the markets we serve.

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     The following tables set forth, for the periods indicated, information with respect to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense from interest-bearing liabilities, resultant yields or costs, net interest income, net interest spread, net interest margin, and the ratio of average interest-earning assets to average interest-bearing liabilities. No tax equivalent adjustments were made and all average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.