SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

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 001-12487

FIRST STATE BANCORPORATION

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

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 an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [  ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 7,632,563 shares of common stock, no par value, outstanding as of May 4, 2004.

FIRST STATE BANCORPORATION AND SUBSIDIARY

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PART I. – FINANCIAL INFORMATION

Item 1. Financial Statements.

First State Bancorporation and Subsidiary
Consolidated Condensed Balance Sheets
(unaudited)
(Dollars in thousands, except share and per share amounts)

See accompanying notes to unaudited consolidated condensed financial statements.

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First State Bancorporation and Subsidiary
Consolidated Condensed Statements of Operations
For the three months ended March 31, 2004 and 2003
(unaudited)
(Dollars in thousands, except per share amounts)

See accompanying notes to unaudited consolidated condensed financial statements.

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First State Bancorporation and Subsidiary
Consolidated Condensed Statements of Comprehensive Income
For the three months ended March 31, 2004 and 2003
(unaudited)
(Dollars in thousands)

See accompanying notes to unaudited consolidated condensed financial statements.

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First State Bancorporation and Subsidiary
Consolidated Condensed Statements of Cash Flows
For the three months ended March 31, 2004 and 2003
(unaudited)
(Dollars in thousands)

See accompanying notes to unaudited consolidated condensed financial statements.

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First State Bancorporation and Subsidiary
Notes to Consolidated Condensed Financial Statements
(unaudited)

1. Consolidated Condensed Financial Statements

The accompanying consolidated condensed financial statements of First State Bancorporation and subsidiary (the “Company”) are unaudited and include our accounts and those of our wholly owned subsidiary, First State Bank N.M. (the “Bank”). All significant intercompany accounts and transactions have been eliminated. Information contained in our consolidated condensed financial statements and notes thereto should be read in conjunction with our consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2003.

Our consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and instructions to Form 10-Q. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In our opinion, all adjustments (consisting only of normally recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

2. New Accounting Standards

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” This interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements, addresses consolidation by business enterprises of variable interest entities (selected entities with related contractual, ownership, voting or other monetary interests, including certain special purpose entities), and requires certain additional disclosure with respect to these entities. The provisions of FIN 46 are immediately applicable to variable interest entities created after January 31, 2003. Initially, FIN 46 was to apply in the first fiscal year or interim period beginning after June 15, 2003 to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. In December 2003, the FASB issued FASB Interpretation No. 46R (“FIN 46R”), “Consolidation of Variable Interest Entities,” which specifically addresses trust preferred securities and determined that these types of trusts should not be consolidated as a variable interest entity. We adopted FIN 46R as of January 1, 2004 and deconsolidated our trust preferred securities issued by Trust I of $7.5 million and Trust II of $25.0 million which were previously included in Borrowings in our consolidated financial statements. As part of the deconsolidation of the trust preferred securities, we recorded the Junior Subordinated Deferrable Interest Debentures — Trust I of approximately $7.7 million in Borrowings, the Junior Subordinated Deferrable Interest Debentures — Trust II of approximately $25.8 million in Borrowings, and the investment in the Capital Securities of Trust I and Trust II of approximately $1.0 million in Other assets, net.

The Federal Reserve Board may in the future disallow inclusion of the trust-preferred securities in Tier 1 capital for regulatory capital purposes. In July 2003, the Federal Reserve Board issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve Board intends to review the regulatory implications of the change in accounting treatment of subsidiary trusts that issue trust preferred securities and, if necessary or warranted, provide further appropriate guidance.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 establishes standards for how a business enterprise classifies, measures and discloses in its financial statements certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that a business enterprise classify financial instruments that are within its scope as liabilities (or as assets in some circumstances). SFAS 150 is effective for contracts entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The FASB has proposed to defer provisions related to mandatorily redeemable financial instruments to periods beginning after December 15, 2004. The adoption of SFAS 150 on July 1, 2003 did not have a material impact on our consolidated financial statements, and the adoption of deferred provisions at January 1, 2005 is not expected to have a material impact on our consolidated financial statements.

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On March 9, 2004, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 105 (“SAB 105”), “Application of Accounting Principles to Loan Commitments.” SAB 105 provides recognition guidance for entities that issue loan commitments that are required to be accounted for as derivative instruments. SAB 105 indicates that the expected future cash flows related to the associated servicing of the loan and any other internally-developed intangible assets should not be considered when recognizing a loan commitment at inception or through its life. SAB 105 also discusses disclosure requirements for loan commitments and is effective for loan commitments accounted for as derivatives and entered into subsequent to March 31, 2004. We currently do not account for loan commitments as derivative instruments. We are currently evaluating the impact of applying the requirements of SAB 105 and at this time it is anticipated that the effect will not be material to our future consolidated financial statements.

3. Stock Based Compensation

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”. This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The adoption of this statement as of December 31, 2002 had no effect on our consolidated financial position or results of operations.

We apply the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees and related interpretations in accounting for its fixed plan stock options.” As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. SFAS No. 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, we have elected to continue to apply the intrinsic value-based method and have included the disclosure required by SFAS No. 148.

Had compensation costs been determined consistent with the fair value method of SFAS No. 123 at the grant dates for awards, net income and earnings per common share would have changed to the pro forma amounts indicated below.

4. Earnings per Common Share

Basic earnings per share are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding during the period (the denominator). Diluted earnings per share are calculated by increasing the basic earnings per share denominator by the number of additional common shares that would have been outstanding if dilutive potential common shares for options had been issued.

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The following is a reconciliation of the numerators and denominators of basic and diluted earnings per share for the three months ended March 31:

5. Treasury Stock

Our Board of Directors has authorized us to purchase up to 525,000 shares of our common stock. We did not purchase any shares during the three months ended March 31, 2004, and as of March 31, 2004, we have purchased 392,050 shares. We may purchase additional shares, the amount of which will be determined by market conditions. We sponsor a deferred compensation plan, which is included in the consolidated financial statements. At March 31, 2004, the assets of the deferred compensation plan included 16,030 shares of Company common stock.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

Certain statements in this Form 10-Q 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.

Consolidated Condensed Balance Sheets

Our total assets decreased by $11.8 million from $1.647 billion as of December 31, 2003, to $1.635 billion as of March 31, 2004. The decrease was primarily made up of a $36.7 million decrease in cash and cash equivalents, offset by a $9.2 million increase in investment securities, and a $12.2 million increase in net loans.

The following table presents the amounts of our loans, by category, at the dates indicated.

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During the first quarter of 2004, we completed the sale of 194 mortgage loans with a carrying value of approximately $38.5 million obtained in the acquisition of First Community in 2002. These loans were sold at a discount resulting in a loss of $435,000, net of deferred loan fees.

Deposits, which are our main source of funds for loans and investments, increased by $45.5 million from $1.196 billion as of December 31, 2003, to $1.241 billion as of March 31, 2004. Securities sold under agreements to repurchase decreased $11.3 million from $63.7 million at December 31, 2003 to $52.4 million at March 31, 2004. Borrowings decreased $52.3 million from $249.3 million at December 31, 2003 to $197.0 million at March 31, 2004. The following table represents customer deposits, by category, at the dates indicated.

Consolidated Results of Operations For the Three Months Ended March 31, 2004

Our net income for the three months ended March 31, 2004, was $3.6 million, an increase of $108,000 or 3.1% from $3.5 million for the same period of 2003. The increase in net income resulted from an increase in net interest income of $2.5 million and a decrease in income taxes of $34,000, partially offset by an increase in non-interest expenses of $2.0 million and a decrease in non-interest income of $79,000. Our annualized return on average assets was 0.88% for the three months ended March 31, 2004, compared to 1.01% for the same period of 2003.

The net interest income increased $2.5 million to $16.6 million for the first quarter of 2004 compared to $14.1 million for the first quarter of 2003. This increase was composed of a $2.3 million increase in total interest income and a $167,000 decrease in total interest expense. The increase in interest income was composed of an increase of $4.4 million due to increased average interest earning assets of $237.6 million, offset by a $2.0 million decrease due to a 0.43% decrease in the yield on average interest earning assets. The increase in average interest-earning assets occurred in loans and investment securities. The increase in loans was made possible by our successful efforts to increase market share. The increase in total interest expense was composed of an increase of $820,000 due to increased average interest-bearing liabilities of $173.4 million, offset by a decrease of $987,000 due to a 0.37% decrease in the cost of interest-bearing liabilities. The increase in average interest-bearing liabilities was due to an increase in average interest-bearing deposits of $53.2 million and an increase in average borrowings of $118.1 million. The increase in interest-bearing deposits is a result of our success in increasing market share.

The decrease in yield on interest earning assets reflects the continued impact of the Federal Reserve Bank’s additional reduction of the discount rate in the second quarter of 2003. The reduction in the discount rate contributed to a corresponding reduction in the prime rate. A substantial portion of our loan portfolio consists of adjustable rate loans whose rates are adjusted based upon the then prevailing prime rate. The decrease in the prime rate has led to a corresponding reduction in the yield on our loan portfolio. Absent further changes in the discount rate by the Federal Reserve Bank, we anticipate that the downward pressure on the yield on the loan portfolio from the previous rate reductions will diminish in the second quarter of 2004. We aim to keep the maturity of our investment securities relatively short. As a result of the current low rate environment, our policy of investing in securities with short maturities has caused us to experience reduced yields on our securities as they mature and are reinvested.

The decrease in our cost of interest bearing liabilities is a result of lower interest payments made to our deposit and repurchase agreement customers. The interest rate that we pay to our deposit and repurchase agreement customers is influenced by the level of the discount rate. As a result of the reduction in the discount rate made by the Federal Reserve Bank in 2003, we reduced the interest rates that we pay on our customers’ deposits and repurchase agreements and reduced the corresponding interest payments to these customers.

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We believe that the competitive environment for deposits will significantly determine the impact on the net interest margin of changes in interest rates. We also believe that additional decreases in rates would cause further compression of our net interest margin, while increases would cause an increase in our net interest margin.

Our provision for loan losses was $1.4 million for the first quarter of 2004, compared to $1.0 million for the first quarter of 2003. Net charge-offs for the first quarter of 2004 were $1.4 million compared to $681,000 for the first quarter of 2003. The allowance for loan losses to total loans was 1.14% and the ratio of allowance for loan losses to non-performing loans was 175% at March 31, 2004, compared to the allowance for loan losses to total loans of 1.16% and the ratio of allowance for loan losses to non-performing loans of 123% at March 31, 2003. Total non-performing assets to total assets were 0.62% at March 31, 2004, compared to 0.74% at March 31, 2003. We provide for loan losses based upon our judgments concerning the adequacy of the allowance for loan losses considering such factors as loan growth, delinquency trends, previous charge-off experience, and local and national economic conditions.

Our total non-interest income decreased by $79,000 to $3.5 million for the three months ended March 31, 2004, compared to $3.6 million for the same period of 2003. The gains on sales of mortgage loans decreased $353,000 from the first quarter of 2003 reflecting a lower level of loan origination and refinancing activity, which has steadily decreased since the second quarter of 2003. Other banking service fees decreased $105,000 over the first quarter of 2003. These decreases in non-interest income were offset by the gain on sale of securities of $236,000 during the first quarter of 2004 as First State repositioned a portion of the investment securities portfolio. Service charges increased $130,000 over the first quarter of 2003.

We believe that if interest rates remain at current levels or begin to increase, the demand for mortgage loans to refinance existing mortgage loans or for new home construction will decrease and we will continue to see lower levels in gains on sales of mortgage loans and other loan fees associated with our mortgage lending operations than that experienced in 2003.

Our total non-interest expenses increased by $2.0 million to $13.1 million for the first quarter of 2004, compared to $11.1 million for the same period of 2003. This increase was due partially to a $466,000 increase in salaries and employee benefits, a $497,000 increase in occupancy expense, a $175,000 increase in equipment expense, and a $190,000 increase in marketing and contributions. In addition, on March 30, 2004, First State completed the sale of 194 mortgage loans with a carrying value of approximately $38.5 million obtained in the acquisition of First Community in 2002. The sale to unrelated third parties resulted in a loss on sale of loans of $435,000 during the first quarter of 2004.

Allowance for Loan Losses

We use a systematic methodology, which is applied monthly, to determine the amount of allowance for loan losses and the resultant provisions for loan losses we consider adequate to provide for anticipated loan losses. The allowance is increased by provisions charged to operations, and reduced by loan charge-offs, net of recoveries. The following table sets forth information regarding changes in our allowance for loan losses for the periods indicated. The principal factor affecting the amount of the provision in each of the periods presented was growth in the loan portfolio.

ALLOWANCE FOR LOAN LOSSES:

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NON-PERFORMING ASSETS:

Potential problem loans are loans not included in non-performing loans that we have doubts as to the ability of the borrowers to comply with present loan repayment terms.

Liquidity and Capital Expenditures

Our primary sources of funds are customer deposits, loan repayments, and maturities of investment securities. We have additional sources of liquidity in the form of borrowings. Borrowings include federal funds purchased, securities sold under repurchase agreements, and borrowings from the Federal Home Loan Bank.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

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 our ratio of average interest-earning assets to average interest-bearing liabilities. No tax equivalent adjustments were made and all average balances are daily average balance. Non-accruing loans have been included in the table as loans carrying a zero yield.

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To effectively measure and manage interest rate risk, we use gap analysis and simulation analysis to determine the impact on net interest income under various interest rate scenarios, balance sheet trends, and strategies. From these analyses, we quantify interest rate risk and we develop and implement appropriate strategies. Additionally, we utilize duration and market value sensitivity measures when these measures provide added value to the overall interest rate risk management process. The overall interest rate risk position and strategies are reviewed by management and the Board of Directors of First State Bank N.M. on an ongoing basis.

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Rising and falling interest rate environments can have various impacts on a bank’s net interest income, depending on the short-term interest rate gap that the bank maintains, the relative changes in interest rates that occur when the bank’s various assets and liabilities reprice, unscheduled repayments of loans, early withdrawals of deposits and other factors. As of March 31, 2004, our cumulative interest rate gap for the period up to three months was a positive $460.6 million and for the period up to one year was a positive $387.0 million. Based solely on our interest rate gap of twelve months or less, our net income could be unfavorably impacted by decreases in interest rates or favorably impacted by increases in interest rates.

The following table sets forth our estimate of maturity or repricing, and the resulting interest rate gap of our interest-earning assets and interest-bearing liabilities at March 31, 2004. The amounts are based upon regulatory reporting formats and, therefore, may not be consistent with financial information appearing elsewhere in this report that has been prepared in accordance with accounting principles generally accepted in the United States of America. The amounts could be significantly affected by external factors such as changes in prepayment assumptions, early withdrawals of deposits, and competition.

Item 4. Controls and Procedures.

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2004 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, 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 have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date of management’s evaluation.

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PART II. – OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K.

     (a) Exhibits

     (b) Reports on Form 8-K.

On January 20, 2004, we filed a current report on Form 8-K announcing our fourth quarter 2003 financial results.

On February 24, 2004, we filed a current report on Form 8-K announcing a Form 425 for Boston Private Financial Holdings was filed which inadvertently used First State Bancorporation’s CIK filing codes in the required submission header tag referencing us as the “subject company”. The subject company of the acquisition by Boston Financial Holdings should have been First State Bancorp (OTC BB: FCAL.OB) headquartered in California and is not affiliated with First State Bancorporation (NASDAQ:FSNM).

On April 1, 2004, we filed a current report on Form 8-K announcing our completed sale of certain residential mortgage loans obtained in the acquisition of First Community Industrial Bank in 2002. The sale to unrelated third parties included 194 loans with a carrying value of approximately $38.5 million at a price of 97.75 percent.

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SIGNATURES

In accordance with 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.

FIRST STATE BANCORPORATION

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EXHIBIT INDEX

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