UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

or

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: 7,647,909 shares of common stock, no par value, outstanding as of August 3, 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 and six months ended June 30, 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 and six months ended June 30, 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 and six months ended June 30, 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 and six month periods ended June 30, 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.

On May 6, 2004, the Federal Reserve Board released a notice of proposed rulemaking (NPR) pertaining to the continued inclusion of trust preferred securities in the Tier 1 capital of bank holding companies. This NPR was subject to public comment until July 11, 2004 and therefore may be revised. The NPR proposes two substantive changes in the capital treatment of trust preferred securities that would impact bank holding companies and a number of clarifications of existing policies and guidelines. The substantive changes included in the NPR that effect bank holding companies provide that: 1) As of March 31, 2007, the amount of trust preferred securities that a bank holding company may include as Tier 1 capital will be limited to 25% of the sum of all core capital elements including trust preferred securities, net of goodwill, and 2) After March 31, 2007, amounts of trust preferred securities in excess of the 25% limit will be included in Tier 2 capital, limited to 50% of Tier 1 capital.

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

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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.

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. The adoption of SAB105 on April 1, 2004 did not have a material impact on our 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 and six months ended June 30:

For the three months ended June 30, 2004, approximately 378,000 of our stock options outstanding and 305,000 for the six months ended June 30, 2004 were excluded from the calculation of diluted earnings per share because the exercise prices of the stock options were equal to or greater than the average share price of the common shares, and therefore their inclusion would have been anti-dilutive. These options could be dilutive in the future. For the three and six months ended June 30, 2003 no options were excluded from the calculation as the exercise prices of the stock options were less than the average share price of the common shares.

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 six months ended June 30, 2004, and as of June 30, 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 June 30, 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

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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 increased by $52.3 million from $1.647 billion as of December 31, 2003, to $1.699 billion as of June 30, 2004. The increase was primarily made up of a $38.8 million increase in investment securities and a $38.2 million increase in net loans offset by a $31.7 million decrease in cash and cash equivalents.

At June 30, 2004, we had an unrealized loss in our available for sale investment portfolio of $3.8 million due to fluctuations in market interest rates. We have the ability to hold these investments until a market price recovery, maturity of the securities, or a modification of our investment strategy and therefore we have concluded that these investments are not other than temporarily impaired.

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

During the first quarter of 2004, we completed the sale of 194 mortgage loans with a carrying value of approximately $38 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 $76.5 million from $1.196 billion as of December 31, 2003, to $1.272 billion as of June 30, 2004. Securities sold under agreements to repurchase decreased $11.7 million from $63.7 million at December 31, 2003 to $52.0 million at June 30, 2004. Borrowings decreased $15.9 million from $249.3 million at December 31, 2003 to $233.4 million at June 30, 2004.

The following table represents customer deposits, by category, at the dates indicated.

Consolidated Results of Operations For the Three Months Ended June 30, 2004

Our net income for the three months ended June 30, 2004, was $3.3 million, a decrease of $410,000 or 11% from $3.7 million for the same period of 2003. The decrease in net income resulted from a decrease in non-interest income of $505,000 and an increase in non-interest expenses of $2.2 million partially offset by an increase in net interest income of

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$1.5 million, a decrease in the provision for loan losses of $441,000, and a decrease in income taxes of $371,000. Our annualized return on average assets was 0.80% for the three months ended June 30, 2004, compared to 1.05% for the same period of 2003.

Our net interest income increased $1.5 million to $16.5 million for the second quarter of 2004 compared to $15.0 million for the second quarter of 2003. This increase was composed primarily of a $1.5 million increase in total interest income, as total interest expense remained consistent with the second quarter of prior year. The increase in interest income was composed of an increase of $3.4 million due to increased average interest earning assets of $221.5 million, offset by a $1.9 million decrease due to a 0.53% decrease in the yield on average interest earning assets. The increase in average interest-earning assets primarily occurred in loans and investment securities. The increase in loans was made possible by our successful efforts to increase market share and the increase in our investment securities is driven solely by purchases of new securities to satisfy collateral pledging requirements. The increase in total interest expense was composed of an increase of $670,000 due to increased average interest-bearing liabilities of $172.3 million, offset by a decrease of $660,000 due to a 0.29% 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 $91.0 million and an increase in average borrowings of $82.2 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 of 0.53% reflects the residual impact of the Federal Reserve Bank’s past reduction of the discount rate in the second quarter of 2003 and the sale of $38 million in mortgage loans at the end of the first quarter of 2004. 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. The mortgage loans sold in the first quarter had a higher average rate than the majority of our other loans which further reduced the yield on the loan portfolio. 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. We believe that further decreases in the yield on our loan portfolio will be minimized by the recent Federal Reserve Bank rate increase in the second quarter of 2004.

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. We believe that the recent increase in the discount rate will cause the interest rates that we pay on our customers’ deposits and repurchase agreements to increase slightly in the coming months due to the competitive environment for deposits.

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 increases in rates would cause an increase in out net interest margin, while decreases would cause further compression of our net interest margin.

Our provision for loan losses was $830,000 for the second quarter of 2004, compared to $1.3 million for the second quarter of 2003. Net charge-offs for the second quarter of 2004 were $398,000 compared to $490,000 for the second quarter of 2003. The allowance for loan losses to total loans was 1.15% and the ratio of allowance for loan losses to non-performing loans was 171% at June 30, 2004, compared to the allowance for loan losses to total loans of 1.17% and the ratio of allowance for loan losses to non-performing loans of 130% at June 30, 2003. Total non-performing assets to total assets were 0.58% at June 30, 2004, compared to 0.72% at June 30, 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 $505,000 to $3.5 million for the three months ended June 30, 2004, compared to $4.0 million for the same period of 2003. The decrease was primarily composed of a $627,000 decrease in gain on sale of mortgage loans, reflecting a lower level of loan origination and refinancing activity, which has steadily decreased since the second quarter of 2003, and a $206,000 increase in credit and debit card transaction fees resulting from increased customer activity. In the second quarter of 2004, we reorganized the mortgage lending division of the Bank including a change in management who will be looking to expand our current market share.

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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 unless we can successfully increase our market share.

Our total non-interest expenses increased by $2.2 million to $13.9 million for the second quarter of 2004, compared to $11.7 million for the same period of 2003. This increase was due partially to a $406,000 increase in salaries and employee benefits, a $524,000 increase in occupancy expense, a $202,000 increase in equipment expense, and a $629,000 increase in other non-interest expenses. Other non-interest expenses in the second quarter 2004 include a loss of $215,000 from a robbery, $98,000 from restructuring the bank’s mortgage operation, and $47,000 from the write-off of abandoned lockbox software.

Consolidated Results of Operations For the Six Months Ended June 30, 2004

Our net income for the six months ended June 30, 2004, was $6.9 million, a decrease of $302,000 or 4% from $7.2 million for the same period of 2003. The decrease in net income resulted from a decrease in non-interest income of $584,000 and an increase in non-interest expenses of $4.2 million partially offset by an increase in net interest income of $4.0 million, a decrease in the provision for loan losses of $48,000, and a decrease in income taxes of $405,000. Our annualized return on average assets was 0.84% for the six months ended June 30, 2004, compared to 1.03% for the same period of 2003.

Our net interest income increased $4.0 million to $33.2 million for the six months ended June 30, 2004 compared to $29.2 million for the same period of 2003. This increase was composed of a $3.8 million increase in total interest income and a $158,000 decrease in total interest expense. The increase in interest income was composed of an increase of $7.7 million due to increased average interest earning assets of $229.0 million offset by a $3.9 million decrease due to a 0.48% decrease in the yield on average interest earning assets. The decrease in total interest expense was composed of an increase of $1.4 million due to increased average interest-bearing liabilities of $172.9 million, offset by a decrease of $1.6 million due to a 0.33% 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 $72.1 million and an increase in average borrowings of $100.2 million. The increase in interest-bearing deposits is a result of our success in increasing market share.

Our provision for loan losses was $2.3 million for the first six months of 2004, compared to $2.3 million for the first six months of 2003. Net charge-offs for the six months ended June 30, 2004 were $1.8 million compared to $1.2 million for the six months ended June 30, 2003. The allowance for loan losses to total loans was 1.15% and the ratio of allowance for loan losses to non-performing loans was 171% at June 30, 2004, compared to the allowance for loan losses to total loans of 1.17% and the ratio of allowance for loan losses to non-performing loans of 130% at June 30, 2003. Total non-performing assets to total assets were 0.58% at June 30, 2004, compared to 0.72% at June 30, 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 $584,000 to $7.0 million for the six months ended June 30, 2004, compared to $7.6 million for the same period of 2003. For the first six months of 2004 compared to the first six months of 2003, the gains on sales of mortgage loans decreased $980,000 reflecting a lower level of loan origination and refinancing activity, which has steadily decreased since the second quarter of 2003, and other banking service fees decreased $205,000 offset by credit and debit card transaction fees that increased $201,000. In addition, non-interest income for the first six months of 2004 includes the gain on sale of securities of $236,000 during the first quarter of 2004 as we repositioned a portion of our investment securities portfolio.

Our total non-interest expenses increased by $4.2 million to $27.0 million for the six months ended June 30, 2004, compared to $22.8 million for the same period of 2003. This increase was due partially to an $872,000 increase in salaries and employee benefits, a $1.2 million increase in occupancy expense, and a $377,000 increase in equipment expense. The increases in salary, occupancy, and equipment expense are due primarily to overall expansion of our infrastructure to better serve the needs of our customers. The increase in occupancy expense and equipment expense from 2003 was impacted by repositioning several branch locations in Colorado and opening three additional branches and a new support services facility in New Mexico. We anticipate additional increases in non-interest expenses in the second half of 2004

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due primarily to the relocation of our Salt Lake City branch which is scheduled to be completed in September 2004 and additional costs related to the expansion of our mortgage lending division. In addition, the six months ended 2004 includes the sale of 194 mortgage loans with a carrying value of approximately $38 million obtained in the acquisition of First Community in 2002 to unrelated third parties which 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 factors affecting the amount of the provision in each of the periods presented was growth in the loan portfolio and net charge-offs.

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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