UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 - Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

Commission File Number 000-51548

STATE NATIONAL BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Texas		75-2641879
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


4500 Mercantile Plaza Drive
Suite 300
Fort Worth, Texas 76137
(Address of principal executive offices, including zip code)

(817) 547-1150
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (i) 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 (ii) has been subject to such filing requirements for the past 90 days.

Yes x No o

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

Large Accelerated Filer o Accelerated Filer o Non-Accelerated Filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)

Yeso No x

The number of shares outstanding of the issuer’s Common Stock as of August 10, 2006, was 12,027,583 shares.

STATE NATIONAL BANCSHARES, INC.

INDEX

		PAGE

PART I - FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
	Consolidated Balance Sheets	1
	Consolidated Statements of Operations	2
	Consolidated Statements of Changes in Shareholders' Equity	3
	Consolidated Statements of Cash Flows	4
	Notes to Interim Consolidated Financial Statements	5

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
	RESULTS OF OPERATIONS	10

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	27

ITEM 4.	CONTROLS AND PROCEDURES	27

PART II - OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	27

ITEM 1A.	RISK FACTORS	27

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	28

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	28

ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	28

ITEM 5.	OTHER INFOMATION	29

ITEM 6.	EXHIBITS	29

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements

STATE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

June 30, 2006 and December 31, 2005

(Unaudited)

		June 30, 2006			December 31, 2005
Assets:		(Dollars in thousands, except share data)
Cash and cash equivalents:
Cash and due from banks	$	77,228		$	72,922
Federal funds sold		—			36,950
Interest-bearing deposits in other banks		3,301			44,763
Total cash and cash equivalents		80,529			154,635
Securities available-for-sale, at fair value (amortized cost of $236,127 and $208,797 at June 30, 2006 and December 31, 2005, respectively)		231,660			206,787
Federal Reserve Bank stock and other investments, at cost		7,619			8,094
Loans held-for-sale		6,949			11,584
Loans held for investment:
Total loans held for investment		1,098,559			1,074,611
Less allowance for loan losses		13,122			12,591
Net loans held for investment		1,085,437			1,062,020
Premises and equipment, net		51,897			48,769
Goodwill		99,354			100,486
Other intangible assets, net		16,332			17,936
Accrued interest receivable		9,018			8,919
Other real estate and other repossessed assets		601			935
Other assets		45,206			42,712
Total assets	$	1,634,602		$	1,662,877
Liabilities and shareholders' equity:
Deposits:
Noninterest bearing deposits	$	479,610		$	487,369
Interest-bearing demand deposits		492,570			523,857
Interest-bearing time deposits		339,269			345,852
Total deposits		1,311,449			1,357,078
Federal funds purchased and securities sold under agreement to repurchase		43,150			28,597
Accrued interest payable		1,781			1,645
Other liabilities		10,191			10,459
Junior subordinated debentures		47,000			47,000
Notes payable		1,270			5,841
Total liabilities		1,414,841			1,450,620

Minority interest in consolidated subsidiary		1,186			—

Shareholders' equity:
Common stock, $1 par value;
Authorized shares—40,000,000;
Issued and outstanding shares—12,014,083 and 11,971,107, respectively		12,014			11,971
Additional paid-in capital		178,560			177,428
Retained earnings		30,904			24,164
Accumulated other comprehensive loss		(2,903	)		(1,306	)
Total shareholders' equity		218,575			212,257
Total liabilities and shareholders' equity	$	1,634,602		$	1,662,877

See Accompanying Notes to Consolidated Financial Statements.

STATE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

Three Months and Six Months Ended June 30, 2006 and 2005

(Unaudited)

		Three Months Ended June 30,					Six Months Ended June 30,
		2006			2005		2006			2005
Interest income:	(In thousands, except per share data)
Loans, including fees	$	22,170		$	16,989	$	42,955		$	32,791
Securities		2,632			1,342		4,952			2,823
Deposits in other banks		111			57		537			110
Federal funds sold		350			184		705			284
Total interest income		25,263			18,572		49,149			36,008
Interest expense:
Deposits		4,631			2,471		8,846			4,405
Federal funds purchased and securities sold under agreement to repurchase		367			124		671			209
Subordinated notes payable		1,010			780		1,952			1,482
Notes payable		23			10		74			21
Total interest expense		6,031			3,385		11,543			6,117
Net interest income		19,232			15,187		37,606			29,891
Provision for loan losses		320			300		800			600
Net interest income after provision for loan losses		18,912			14,887		36,806			29,291
Non-interest income:
Service charges on deposit accounts		2,799			2,435		5,494			4,815
Gain on sale of loans		651			776		1,284			1,349
Bank owned life insurance		326			319		653			634
Net realized (loss)/gain on sale of investment securities		(79	)		—		(79	)		1
Other		1,302			978		2,344			2,073
Total non-interest income		4,999			4,508		9,696			8,872
Non-interest expenses:
Salaries and employee benefits		8,054			7,248		16,305			14,317
Net occupancy and equipment expense		2,461			2,139		5,005			4,307
Amortization of intangibles		997			823		2,019			1,647
Communication expense		325			276		645			556
Data processing expense		235			199		456			419
Advertising		423			312		722			533
Professional fees		587			336		1,091			691
Supplies		195			219		380			421
Net costs applicable to other real estate and other repossessed assets		135			27		204			43
Merger expenses		755			40		758			40
Other		2,594			2,050		4,960			4,120
Total noninterest expenses		16,761			13,669		32,545			27,094
Income before income taxes and minority interest in subsidiaries		7,150			5,726		13,957			11,069
Income tax expense		2,586			1,866		4,866			3,772
Minority interest in consolidated subsidiary’s net (income)/loss		(12	)		—		48			—
Net income	$	4,552		$	3,860	$	9,139		$	7,297
Basic income per share	$	0.38		$	0.38	$	0.76		$	0.73
Diluted income per share		0.37			0.37		0.75			0.71
Dividends per share		0.10			—		0.20			—

See Accompanying Notes to Consolidated Financial Statements.

STATE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Change in Shareholders’ Equity

(Unaudited)

	Common Stock					Additional Paid-In		Retained			Accumulated Other Comprehensive
		Shares		Amount		Capital		Earnings			Income (Loss)			Total
	(Dollars in thousands, except number of shares)
Balance, January 1, 2005		10,054,582	$	10,055	$	133,519	$	7,482		$	304		$	151,360
Comprehensive income:
Net income		—		—		—		16,682			—			16,682
Change in unrealized gain on available-for-sale securities, net of deferred income taxes		—		—		—		—			(1,609	)		(1,609	)
Reclassification adjustment for gains included in net income		—		—		—		—			(1	)		(1	)
Total comprehensive income														15,072
Issuance of new stock		1,907,692		1,907		43,279		—			—			45,186
Stock option award expense		—		—		486		—			—			486
Stock options exercised		8,833		9		144		—			—			153

Balance, December 31, 2005		11,971,107		11,971		177,428		24,164			(1,306	)		212,257
Comprehensive income:
Net income		—		—		—		9,139			—			9,139
Change in unrealized gain on available-for-sale securities, net of deferred income taxes		—		—		—		—			(1,676	)		(1,676	)
Reclassification adjustment for losses included in net income		—		—		—		—			79			79
Total comprehensive income														7,542
Dividends - $0.20 per share		—		—		—		(2,399	)		—			(2,399	)
Stock option award expense		—		—		251		—			—			251
Stock issued for directors fees		7,576		8		182		—			—			190
Stock options exercised		35,400		35		699		—			—			734

Balance, June 30, 2006		12,014,083	$	12,014	$	178,560	$	30,904		$	(2,903	)	$	218,575

See Accompanying Notes to Consolidated Financial Statements.

STATE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

	Six Months Ended June 30,
		2006			2005
	(Dollars in thousands)
Operating Activities:
Net income	$	9,139		$	7,297
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		800			600
Depreciation and amortization		3,796			3,158
Stock compensation expense		251			241
Loans originated for sale		(53,285	)		(61,830	)
Proceeds from sales of loans held-for-sale		59,204			62,796
Gain on sale of loans		(1,284	)		(1,349	)
Gain on sale of premises and equipment		(7	)		—
Net loss (gain) on sale of investment securities		79			(1	)
Net loss (gain) on sale of other real estate and repossessed assets		30			(28	)
Deferred income tax benefit		(689	)		(577	)
Minority interest in consolidated subsidiary’s net loss		(48	)		—
Write-down of premises and equipment		2			23
Net amortization of premium on securities		39			355
Net change in other assets and liabilities		(1,180	)		4,825
Net cash provided by operating activities		16,847			15,510
Investing Activities:
Purchase Price adjustment for Heritage acquisition		720			—
Purchases of securities available-for-sale		(98,211	)		(7,966	)
Purchases of Federal Reserve Bank stock and other investments		(1,007	)		(47	)
Proceeds from sales, maturities and calls of securities available-for-sale		71,769			31,447
Proceeds from maturities and calls of Federal Reserve Bank Stock & other investments		476			417
Net increase in loans		(24,213	)		(20,667	)
Proceeds from sale of premises and equipment		349			—
Proceeds from sales of other real estate and other repossessed assets		300			686
Purchase of premises and equipment		(5,248	)		(2,755	)
Net cash (used in) provided by investing activities	$	(55,065	)	$	1,115
Financing Activities:
Net (decrease) increase in deposits		(45,629	)		1,188
Stock issued through exercise of stock options & warrants		734			95
Stock issued for directors fees		190			—
Net increase in federal funds purchased and securities sold under agreement to repurchase		14,553			2,743
Principal payments on FHLB note		(4,682	)		(59	)
Proceeds from Note		111			—
Proceeds from minority interest		1,234			—
Payment of cash dividends		(2,399	)		—
Net cash (used in) provided by financing activities		(35,888	)		3,967
Net (decrease) increase in cash and cash equivalents		(74,106	)		20,592
Cash and cash equivalents, beginning of period		154,635			89,467
Cash and cash equivalents, end of period	$	80,529		$	110,059

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	11,407		$	5,861
Income taxes paid, net of refunds		4,462			2,656
Noncash transactions:
Transfer of loans to other real estate owned, net		101			905

See Accompanying Notes to Consolidated Financial Statements.

STATE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements

(Unaudited)

1. Nature of Operations and Basis of Presentation

State National Bancshares, Inc. (the “Company” or “SNBI”) is a bank holding company headquartered in Fort Worth, Texas, offering a broad range of financial products and services primarily through the Company’s main subsidiary, State National Bank (the “Bank”), a national banking association. At June 30, 2006, the Bank operated 43 banking centers located in three distinct geographic markets throughout Texas and New Mexico: the greater Tarrant County area (Fort Worth, Texas); West Texas (Lubbock, Abilene and Odessa), and Rio Grande (El Paso, Texas and Southern New Mexico). As a bank holding company, the Company is subject to the provisions of the Bank Holding Company Act, and to supervision and regulation by the Board of Governors of the Federal Reserve System.

The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. These statements are, in the opinion of management, a fair presentation of the financial position and results for the periods presented. These financial statements are unaudited but, in the opinion of management, reflect all necessary adjustments, including usual recurring adjustments, for a fair presentation of such financial statements.

The presentation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenue and expenses during the reporting periods. These estimates are based on information available as of the date of the consolidated financial statements. Therefore, actual results could differ from those estimates.

Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted from these statements pursuant to rules and regulations of the Securities and Exchange Commission (the “SEC”) and, accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended December 31, 2005, which we included in our Annual Report on Form 10-K filed on March 29, 2006. The results of operations for the six-month period ended June 30, 2006 are not necessarily indicative of the results to be expected for the full year.

2. Merger Announcement

On June 12, 2006, SNBI and Banco Bilbao Vizcaya Argentaria, S.A., a bank organized under the laws of Spain (“BBVA”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which, among other things, BBVA will acquire all of the issued and outstanding shares of capital stock of SNBI and all of the outstanding and unexercised options of SNBI by virtue of the merger of a wholly-owned subsidiary of BBVA, with and into SNBI, with SNBI as the surviving corporation (the “Merger”).

Under the terms and subject to the conditions of the Merger Agreement, which has been approved by the Board of Directors of SNBI and the appropriate corporate body of BBVA, at the effective time of the Merger (the “Effective Time”), all of the outstanding common stock of SNBI will be cancelled in exchange for $38.50 per share. All of the outstanding and unexercised options to acquire shares of common stock of SNBI will be cancelled at the Effective Time in exchange for an amount in cash per outstanding and unexercised option equal to the difference between (i) the mean between the highest and lowest selling prices quoted on The Nasdaq National Market for a share of SNBI’s common stock on the last trading day prior to the Effective Time and (ii) the per share exercise price of the stock option. The Merger Agreement contains representations, warranties and covenants of SNBI and BBVA. In addition, SNBI has agreed (i) to conduct its businesses in the ordinary course during the period between the execution of the Merger Agreement and consummation of the Merger and (ii) not to engage in certain kinds of transactions during such period without the consent of BBVA. The Board of Directors of SNBI has adopted a resolution recommending the approval and adoption of the Merger Agreement by SNBI’s shareholders, and has agreed to hold a shareholder meeting to put these matters before SNBI’s shareholders for their consideration. SNBI has further agreed not to (i) solicit proposals relating to alternative business combination transactions or (ii) subject to certain exceptions, enter into discussions or negotiations or provide confidential information in connection with any proposals for alternative business combination transactions.

Consummation of the Merger is subject to various conditions, including (i) requisite approvals of the holders of SNBI common stock and (ii) receipt of regulatory approvals. In addition, each party’s obligation to consummate the Merger is subject to certain other conditions, including (i) the other party’s representations and warranties in the Merger Agreement being true and correct at the Effective Time, subject to the materiality standards contained in the Merger Agreement, (ii) material compliance of the other party with its covenants and (iii) the absence of any law or order prohibiting the consummation of the Merger.

On July 25, 2006, SNBI filed with the SEC its preliminary proxy statement seeking shareholder approval for the Merger. Following the SEC’s review of the preliminary proxy statement, SNBI will file a definitive proxy statement scheduling a special meeting of its shareholders to vote on the merger. SNBI anticipates the transaction will be completed in the first quarter of 2007, assuming that shareholder approval is obtained. For additional information, refer to the Form 8-K filed with the SEC on June 16, 2006 and the preliminary proxy statement on Schedule 14A filed with SEC on July 25, 2006.

3. Earnings Per Share

Basic earnings per share represent income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.

The computation of earnings per share is presented below:

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
	(Dollars in thousands, except per share data)
Reported net income	$	4,552		$	3,860		$	9,139		$	7,297
Add: Stock-based employee compensation expense included in reported net income, net of tax		81			79			163			157
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of tax		(81	)		(82	)		(163	)		(164	)
Pro forma net income	$	4,552		$	3,857		$	9,139		$	7,290
Earnings per share:
Basic—as reported	$	0.38		$	0.38		$	0.76		$	0.73
Basic—pro forma		0.38			0.38			0.76			0.72
Diluted—as reported		0.37			0.37			0.75			0.71
Diluted—pro forma		0.37			0.37			0.75			0.71

4. Adoption of Accounting Standards

SFAS No. 123, "Share-Based Payment (Revised 2004)" ("SFAS 123R") establishes standards for the accounting for transactions in which an entity (i) exchanges its equity instruments for goods or services, or (ii) incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of the equity instruments. SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the date of the grant. SFAS 123R is mandatory for all entities with fiscal periods starting after June 15, 2005. As a public entity we implemented SFAS 123R on January 1, 2006 and its adoption did not have a material impact on our consolidated financial position, results of operations or cash flows including our first quarter stock-based compensation expense.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109”. FIN 48 clarifies the accounting for uncertainty in income taxes and provides greater consistency in criteria used to recognize, derecognize and measure benefits related to income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on classification, interest and penalties, accounting in interim periods, disclosure and transition. The effective date of FIN 48 is for fiscal years beginning after December 15, 2006. We have not yet assessed the impact of the implementation of FIN 48 on our financial condition or results of operations.

In March 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 156, “Accounting for Servicing of Financial Assets” (“FAS 156”), an amendment of FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” FAS 156 was issued to simplify the accounting for servicing assets and servicing liabilities and reduce the volatility that results from the use of different measurement attributes for servicing rights and the related financial instruments used to hedge risks associated with those servicing rights. SFAS 156 requires all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable, and permits for subsequent measurement using either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement No. 140. The subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value eliminates the necessity for entities that manage the risks inherent in servicing assets and servicing liabilities with derivatives to qualify for hedge accounting treatment and eliminates the characterization of declines in fair value as impairments or direct write-downs. The effective date of FAS 156 is for fiscal years beginning after September 15, 2006. Early adoption is permitted in a period if financial statements have not yet been issued. We adopted SFAS 156 effective January 1, 2006 and elected to not apply the fair value method.

5. Initial Public Offering

On September 29, 2005, we completed an initial public offering of 1,907,692 shares of common stock at the initial offering price of $26 per share. The proceeds received after the underwriters’ discounts and commissions but before expenses related to the offering were $46.1 million. All of the proceeds from the offering, net of issuance costs of approximately $1.0 million, were used to fund a portion of the purchase price of Heritage Financial Corporation, which we acquired on October 6, 2005.

6. Recent Acquisitions

On October 6, 2005, SNBI purchased all of the outstanding common stock of Heritage Financial Corporation ("Heritage") for $53.5 million in cash in order to further expand in the Fort Worth Metroplex (Tarrant County) area. To fund the acquisition, SNBI issued, through an initial public offering, 1,907,692 shares of SNBI common stock at $26 per share. The acquisition was accounted for under the purchase method of accounting for business combinations. Core deposit intangibles related to this transaction amounted to $5,953,000 and are amortized on an accelerated basis using a ten year life. Goodwill associated with the transaction amounted to approximately $28.5 million and is subject to change as transactions associated with the merger are finalized. At the date of acquisition, SNBI acquired assets of $226,252,000, net loans of $103,402,000, and deposits of $197,296,000 before purchase accounting adjustments.

7. Regulatory Matters

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. The Bank, as a national bank, is subject to the dividend restrictions set forth in the National Bank Act of 1864 and the regulations and policies of the Office of the Comptroller of the Currency, or the OCC. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 Capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 Capital (as defined) to average assets (Leverage) (as defined). Management believes, as of June 30, 2006, that the Company and the Bank met all capital adequacy requirements to which they are subject.

The most recent notification from the OCC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 Leverage ratios as set forth in the following tables. There are no conditions or events since the most recent notification that management believes have changed the institution’s capital category. The Company’s and the Bank’s actual capital amounts and ratios as of June 30, 2006 are also presented in the table.

At June 30, 2006 and December 31, 2005, required and actual regulatory capital amounts and ratios for SNBI were as follows:

		June 30,			December 31,		Minimum Capital		Well- Capitalized
		2006			2005		Ratios		Ratios
	(Dollars in thousands)
Tier 1 capital	$	152,100		$	142,690
Total capital		165,222			155,281
Total risk-weighted assets		1,222,740			1,191,030
Adjusted quarterly average assets		1,535,491			1,525,043
Capital ratios:
Leverage ratio		9.91	%		9.36	%	4.00	%	5.00	%
Tier 1 capital to risk-weighted assets		12.44			11.98		4.00		6.00
Total capital to risk-weighted assets		13.51			13.04		8.00		10.00

The minimum capital ratios as determined by the regulators for well-capitalized banks and the Bank’s actual capital ratios at June 30, 2006 were as follows:

	Minimum Ratios for Well-Capitalized Banks		Actual Ratios at June 30, 2006
Leverage ratio	5.00	%	8.51	%
Tier 1 capital to risk-weighted assets	6.00		10.70
Total capital to risk-weighted assets	10.00		11.78

8.	Stock-Based Compensation

SNBI has a nonqualified stock option plan to provide an incentive for key employees to remain in service, to extend to them the opportunity to acquire a proprietary interest in SNBI so that they will apply their best efforts for the benefits of SNBI, and to aid SNBI in attracting and retaining key personnel. Prior to 2003, we had applied the recognition and measurement provisions of Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for our plan. APB 25 required compensation cost to be recognized only when the option exercise price is less than the fair market value of the underlying stock on the date of grant. Effective January 1, 2003, we adopted the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") under the prospective transition method. At that time, SNBI began to recognize the cost of stock-based employee compensation calculated under the fair-value-based method of accounting. The compensation cost is calculated by using the Black-Scholes option-pricing model to value the options on the measurement date, which is generally the date of the grant. This model requires the input of assumptions such as volatility, expected terminations and expected forfeitures. Changes to the assumptions can materially affect the fair value estimate. Additionally, there may be other factors that would otherwise affect the value of the employee stock options granted but that are not considered by the model. Accordingly, while management believes that the Black-Scholes option-pricing model provides a reasonable estimate of fair value, the model does not necessarily provide the best single measure of fair value for the Company’s employee stock options. Under the prospective transition method, this cost was recognized only on awards granted after January 1, 2003.

As stated in Note 3 - Adoption of Accounting Standards, SNBI adopted the provisions of SFAS 123R on January 1, 2006. SFAS 123R requires stock-based compensation transactions to be recognized as compensation cost in the income statement based on their fair values on the measurement date, which is generally the date of the grant. We transitioned to SFAS 123R for stock-based compensation using the modified prospective application. Under the modified prospective application, SFAS 123R applies to new awards granted after the implementation date, as well as unvested awards granted prior to the implementation date. As of January 1, 2006, SNBI had no unvested awards for options granted prior to January 1, 2003. For the six months ended June 30, 2006, we recorded stock option expense totaling $251,000.

In the fourth quarter of 2005, as a publicly traded company, we began measuring volatility in our stock when calculating stock option expense. As public trading of SNBI stock began on September 30, 2005, it was most appropriate to use implied volatility when calculating the fair value of the stock options. As we had been a privately held company prior to the IPO, our stock volatility had been minimal. This change increased our stock option expense on the options granted in 2005 by approximately 64.4%. In the first six months of 2006, we granted 27,000 shares of new stock options.

9.	Minority Interest

The Bank entered into a limited partnership with a third party to construct and own a four story building that will provide a permanent location for our downtown Fort Worth banking center and additional non-bank office space that will be available for lease. The Bank has a controlling interest in this entity and the third party is a significant tenant of the building and owns the remaining interest in the entity. This has created a minority interest in the consolidated subsidiary on our consolidated balance sheet of $1.2 million and a minority interest in the loss of the consolidated subsidiary on our consolidated income statement of operations of $48,000 as of and for the six month period ending June 30, 2006.

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

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis presents management’s analysis of our results of operations for the three months and six months ended June 30, 2006 and 2005 and our financial condition as of June 30, 2006 and December 31, 2005. The discussion should be read in conjunction with our financial statements and the notes related thereto which appear elsewhere in this Quarterly Report on Form 10-Q.

Statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, including our expectations, intentions, beliefs, or strategies regarding the future. Any statements in this document about expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” and similar expressions. Accordingly, these statements involve estimates, assumptions and uncertainties, which could cause actual results to differ materially from those expressed in them. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this document. All forward-looking statements concerning economic conditions, rates of growth, rates of income or values as may be included in this document are based on information available to us on the dates noted, and we assume no obligation to update any such forward-looking statements. It is important to note that our actual results may differ materially from those in such forward-looking statements due to fluctuations in interest rates, inflation, government regulations, economic conditions, customer disintermediation and competitive product and pricing pressures in the geographic and business areas in which we conduct operations, including our plans, objectives, expectations and intentions and other factors discussed in this report and our Annual Report on Form 10-K for the year ended December 31, 2005, including the following:

·	we may be unable to satisfy the shareholder approval, regulatory approval and other conditions to closing the planned merger with BBVA;

·	contingencies related to the announcement and pendency of the Merger may impact our employees and customers;

·	any termination of the Merger Agreement may result in costs and disruptions to our business and relationships with employees and customers;

·	if a significant number of our customers fail to perform under their loans, our business, profitability, and financial condition would be adversely affected;

·	our current level of interest rate spread may decline in the future, and any material reduction in our interest spread could have a material impact on our business and profitability;

·	the modification of the Federal Reserve Board’s current position on the capital treatment of our junior subordinated debt and trust preferred securities could have a material adverse effect on our financial condition and results of operations;

·	adverse changes in domestic or global economic conditions could have a material adverse effect on our business, growth, and profitability;

·	we could be liable for breaches of security in our online banking services, and fear of security breaches could limit the growth of our online services;

·	maintaining or increasing our market share depends on market acceptance and regulatory approval of new products and services;

·	significant reliance on loans secured by real estate may increase our vulnerability to downturns in the real estate market and other variables impacting the value of real estate;

·	if we fail to retain our key employees, growth and profitability could be adversely affected;

·	we may be unable to manage our future growth;

·	increases in our allowance for loan and lease losses could materially adversely affect our earnings;

●	our directors and executive officers beneficially own a significant portion of our outstanding common stock; and

●	we face substantial competition in our primary market area.

These factors and the risk factors identified in this report and our Annual Report on Form 10-K for the year ended December 31, 2005, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us, and you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made and we do not undertake any obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Executive Overview

Introduction

We are a registered bank holding company headquartered in Fort Worth, Texas, offering a broad array of financial services through our wholly owned banking subsidiary, State National Bank (“SNB” or the “Bank”). As of June 30, 2006, we had, on a consolidated basis, total assets of $1.6 billion, net loans of $1.1 billion, total deposits of $1.3 billion, and shareholders' equity of $218.6 million. We currently operate through a network of 43 banking centers located in three distinct geographic markets throughout Texas and New Mexico: the greater Tarrant County area (Fort Worth, Texas); West Texas (Lubbock, Abilene and Odessa); and Rio Grande (El Paso, Texas and Southern New Mexico). Our headquarters are located at 4500 Mercantile Plaza Drive, Suite 300, Fort Worth, TX 76137 and our telephone number is (817) 547-1150. Our website address is www.statenationalbank.com.

As a bank holding company, we generate most of our revenue from interest on loans and investments, service charges, and gains on the sale of loans. Our primary source of funding for our loans is deposits we hold in the Bank. Our largest expenses are interest on these deposits and salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk-based capital ratios. We also measure our performance by our efficiency ratio, which is calculated by dividing noninterest expense less amortization of core deposit intangibles by the sum of net interest income on a tax equivalent basis and noninterest income.

Our consolidated financial statements for the three and six-month period ended June 30, 2006 and 2005 and the fiscal year ended December 31, 2005 include financial results for each of our wholly owned subsidiaries: State National Bank, TWOENC, Inc., State National Properties, LLC, and State National Bancshares of Delaware and in 2006 our majority owned subsidiary SNB-WP, LP. Our statutory trust subsidiaries which are special purpose vehicles that were used to issue trust preferred securities, are not consolidated with us or State National Bank.

Merger Agreement

On June 12, 2006, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Banco Bilbao Vizcaya Argentaria, S.A., a bank organized under the laws of Spain (“BBVA”). Pursuant to the Merger Agreement, among other things, BBVA will acquire all of our issued and outstanding shares of capital stock and all of our outstanding and unexercised options by virtue of the merger of a wholly-owned subsidiary of BBVA, with and into the Company, with the Company as the surviving corporation (the “Merger”).

Under the terms and subject to the conditions of the Merger Agreement, which has been approved by our Board of Directors and the appropriate corporate body of BBVA, at the effective time of the Merger (the “Effective Time”), all of our outstanding common stock will be cancelled in exchange for $38.50 per share. All of the outstanding and unexercised options to acquire shares of our common stock will be cancelled at the Effective Time in exchange for an amount in cash per outstanding and unexercised option equal to the difference between (i) the mean between the highest and lowest selling prices quoted on The Nasdaq National Market for a share of our common stock on the last trading day prior to the Effective Time and (ii) the per share exercise price of the stock option.

The Merger Agreement contains representations, warranties and covenants of BBVA and us. In addition, we have agreed (i) to conduct its business in the ordinary course during the period between the execution of the Merger Agreement and consummation of the Merger and (ii) not to engage in certain kinds of transactions during such period without the consent of BBVA. Our Board of Directors has adopted a resolution recommending the approval and adoption of the Merger Agreement by our shareholders, and has agreed to hold a shareholder meeting to put these matters before our shareholders for their consideration. We have further agreed not to (i) solicit proposals relating to alternative business combination transactions or (ii) subject to certain exceptions, enter into discussions or negotiations or provide confidential information in connection with any proposals for alternative business

ombination transactions.

Consummation of the Merger is subject to various conditions, including (i) requisite approvals of the holders of our common stock and (ii) receipt of regulatory approvals. In addition, each party’s obligation to consummate the Merger is subject to certain other conditions, including (i) the other party’s representations and warranties in the Merger Agreement being true and correct at the Effective Time, subject to the materiality standards contained in the Merger Agreement, (ii) material compliance of the other party with its covenants and (iii) the absence of any law or order prohibiting the consummation of the Merger.

On July 25, 2006, we filed with the SEC our preliminary proxy statement seeking shareholder approval for the Merger. Following the SEC’s review of the preliminary proxy statement, we will file a definitive proxy statement scheduling a special meeting of our shareholders to vote on the merger. We anticipate that the transaction will be completed in the first quarter of 2007, assuming that shareholder approval is obtained. For additional information, refer to the Form 8-K filed with the SEC on June 16, 2006 and the preliminary proxy statement on Schedule 14A filed with SEC on July 25, 2006.

Critical Accounting Policies

We prepare our consolidated financial statements based on the selection of certain accounting policies, generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions. Our accounting policies are described in detail in the notes to our consolidated financial statements included in our most recent Annual Report on Form 10-K.

We deem an accounting policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on our financial statements.

Loans and Allowance for Loan Losses

Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding unpaid principal balances adjusted by any charge-offs, unearned finance charges, allowance for loan and lease losses, and net deferred nonrefundable fees or costs on origination. The allowance for loan and lease losses is an estimate to provide for probable collection losses in our loan portfolio. Losses are charged and recoveries are credited to the allowance account at the time a loss is incurred or a recovery is received. The allowance for loan losses amounted to $13.1 million and $12.6 million as of June 30, 2006 and December 31, 2005, respectively. Losses charged to the allowance amounted to $646,000 for the six months ended June 30, 2006 compared to $1.2 million for the same period in 2005. Recoveries were credited to the allowance in the amounts of $377,000 and $712,000 for those same periods, respectively.

We follow a consistent procedural discipline and account for loan loss contingencies in accordance with Statement of Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies,” and SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS No. 118, ”Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosures.”

To mitigate any difference between estimates and actual results relative to the calculation of the allowance for loan losses, our loan review department is specifically charged with reviewing monthly delinquency reports to determine if additional reserves are necessary. Delinquency reports and analysis of the allowance for loan losses are also provided to senior management and the Board of Directors on a monthly basis.

The loan review department evaluates significant changes in delinquency with regard to a particular loan portfolio to determine the potential for continuing trends, and loss projections are estimated and adjustments are made to the historical loss factor applied to that portfolio in connection with the calculation of loss reserves. Portfolio performance is also monitored through the monthly calculation of the percentage of non-performing loans to the total portfolio outstanding. A significant change in this percentage may trigger a review of the portfolio and eventually lead to additional reserves. We also track the ratio of net charge-offs to total portfolio outstanding.

We classify loans as nonperforming when they become 90 days past due. Nonperforming loans amounted to $8.7 million as of June 30, 2006 and December 31, 2005.

Other Real Estate Owned and Repossessed Assets

Other real estate owned (“OREO”) and repossessed assets, normally obtained through foreclosure or other workout situations, are initially recorded at the lower of fair value or book value at the date of foreclosure, establishing a new cost basis. Any resulting loss is charged to the allowance for loan losses. An appraisal of other real estate properties and valuations of repossessed assets is made periodically after acquisition, and comparison between the appraised value and the carrying value is performed. Additional declines in value after acquisition, if any, are charged to current operations. OREO and repossessed assets amounted to $601,000 and $935,000 as of June 30, 2006 and December 31, 2005, respectively.

Results of Operations for the Three Months and Six Months Ended June 30, 2006 and 2005

Net Interest Income and Net Interest Margin

Net interest income is the difference between interest income, principally from loans and investment securities portfolio, and interest expense, principally on customer deposits and borrowings. Net interest income is our principal source of earnings. 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.

Net interest income increased 26.6%, or $4.0 million, to $19.2 million and by 25.8%, or $7.7 million, to $37.6 million in the second quarter and six months ended June 30, 2006, respectively, from $15.2 million and $29.9 million in the same periods of 2005. These increases resulted primarily from higher volumes in our loan portfolio due to our acquisition of Heritage Financial Corporation, and, to a lesser extent, organic growth and the increase in market interest rates.

Total interest income for the second quarter of 2006 was $25.3 million, compared to $18.6 million for the same period in 2005, representing a 36.0% increase. Total interest income for the six months ended June 30, 2006 was $49.1 million compared to total interest income of $36.0 million for the same period in 2005, representing a 36.5% increase. The increases were due to the combined effect of increases in average interest-earning assets due to the Heritage acquisition, organic growth and increased yields resulting from higher interest rates during 2006. Average interest-earning assets for the three months and six months ended June 30, 2006 increased 21.0%, or $238.2 million, to $1.375 billion and 21.5%, or $243.3 million, to $1.374 billion, respectively, compared to $1.137 billion and $1.131 billion for the same period in 2005.

Total interest expense was $6.0 million for the second quarter ended June 30, 2006, compared to $3.4 million for the same quarter in 2005. Total interest expense for the six months ended June 30, 2006 was $11.5 million, compared to total interest expense of $6.1 million for the same period in 2005. These increases resulted primarily from the combination of increased deposit balances due to our acquisition of Heritage, higher rates paid on interest-bearing deposits and higher rates on subordinated notes payable during 2006. Average interest-bearing liabilities for the quarter ended June 30, 2006 increased to $941.3 million compared to $786.8 million for the same period of 2005. Average interest-bearing liabilities increased to $943.7 million for the six months ended June 30, 2006, as compared to $788.9 million for the same period in 2005.

Net interest margin on a fully taxable equivalent basis increased to 5.64% and 5.52% for the second quarter and six months ended June 30, 2006, respectively, as compared to 5.35% and 5.29% for the same periods in 2005. Net interest spread on a fully taxable equivalent basis was 4.83% for the quarter ended June 30, 2006, as compared to 4.82% for the same period in 2005. For the six months ended June 30, 2006, net interest spread on a fully taxable equivalent basis decreased to 4.75%, as compared to 4.82% for the same period in 2005.

The following tables, for the periods indicated, present our average balance sheets and indicate the interest earned or paid on each major category of interest-earning assets and interest-bearing liabilities on a fully taxable equivalent basis, and the average rates earned or paid on each major category. This analysis details the contribution of our interest-earning assets and the overall impact of the cost of funds on our net interest income.

	Three Months Ended June 30,
		2006							2005
		Average Balance			Interest Income/ Expense	Yield/ Rate₍₁₎	₎		Average Balance			Interest Income/ Expense	Yield/ Rate₍₁₎	₎
	(Dollars in thousands)
ASSETS:
Interest earning assets:
Loans, net of unearned income	$	1,097,418		$	22,199	8.09	%	$	964,792		$	16,989	7.04	%
Securities		238,968			2,749	4.60			137,497			1,355	3.94
Time deposits in other banks		9,297			111	4.78			8,985			57	2.54
Fed funds sold		29,449			350	4.75			25,626			184	2.87
Total interest-earning assets		1,375,132			25,409	7.39			1,136,900			18,585	6.54
Noninterest-earning assets:
Cash and due from banks		67,390							61,063
Intangible assets		116,107							85,009
Premises and equipment, net		51,497							34,994
Accrued interest receivable and other assets		53,100							46,470
Allowance for loan losses		(13,303	)						(11,438	)
Total noninterest-earning assets		274,791							216,098
TOTAL ASSETS	$	1,649,923						$	1,352,998
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Interest-bearing liabilities:
Demand, savings and money market deposits	$	521,286		$	1,796	1.38	%	$	443,461		$	982	0.89	%
Time deposits		337,065			2,836	3.37			274,642			1,489	2.17
Fed funds purchased and securities under agreement to repurchase		33,905			366	4.32			20,871			124	2.38
Junior subordinated debentures		47,000			1,010	8.60			47,000			780	6.64
Note payable		2,071			23	4.44			850			10	4.71
Total interest-bearing liabilities		941,327			6,031	2.56			786,824			3,385	1.72
Noninterest-bearing liabilities:
Demand deposits		476,571							397,852
Accrued interest payable and other liabilities		12,409							9,141
Total noninterest-bearing liabilities, net		488,980							406,993
TOTAL LIABILITIES		1,430,307							1,193,817
Minority interest in unconsolidated subsidiary		975							—
SHAREHOLDERS' EQUITY		218,641							159,181
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	1,649,923						$	1,352,998
Net interest income				$	19,378						$	15,200
Net interest spread₍₂₎						4.83	%						4.82	%

Net interest margin₍₃₎						5.64	%						5.35	%

(1)	Yields on tax-exempt loans and securities are calculated on a fully taxable equivalent basis assuming a 35% tax rate.

(2)	Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

(3)	Represents net interest income on a fully taxable equivalent basis as a percentage of average interest-earning assets.

		Six Months Ended June 30,
		2006							2005
		Average Balance			Interest Income/ Expense	Yield/ Rate₍₁₎	₎		Average Balance			Interest Income/ Expense	Yield/ Rate₍₁₎	₎
	(Dollars in thousands)
ASSETS:
Interest earning assets:
Loans, net of unearned income	$	1,090,394		$	43,015	7.89	%	$	956,056		$	32,791	6.86	%
Securities		227,907			5,192	4.56			144,107			2,851	3.96
Time deposits in other banks		24,712			537	4.35			9,415			110	2.34
Fed funds sold		30,902			705	4.56			21,060			284	2.70
Total interest-earning assets		1,373,915			49,449	7.20			1,130,638			36,036	6.37
Noninterest-earning assets:
Cash and due from banks		68,755							61,080
Intangible assets		116,894							85,423
Premises and equipment, net		50,474							34,464
Accrued interest receivable and other assets		52,730							45,993
Allowance for loan losses		(13,058	)						(11,453	)
Total noninterest-earning assets		275,795							215,507
TOTAL ASSETS	$	1,649,710						$	1,346,145
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Interest-bearing liabilities:
Demand, savings and money market deposits	$	520,483		$	3,365	1.29	%	$	445,009		$	1,664	0.75	%
Time deposits		340,311			5,481	3.22			276,630			2,741	1.98
Fed funds purchased and securities under agreement to repurchase		32,777			671	4.09			19,444			209	2.15
Junior subordinated debentures		47,000			1,952	8.31			47,000			1,482	6.31
Note payable		3,137			74	4.72			865			21	4.86
Total interest-bearing liabilities		943,708			11,543	2.45			788,948			6,117	1.55
Noninterest-bearing liabilities:
Demand deposits		476,319							392,854
Accrued interest payable and other liabilities		12,364							8,110
Total noninterest-bearing liabilities, net		488,683							400,964
TOTAL LIABILITIES		1,432,391							1,189,912
Minority interest in unconsolidated subsidiary		632							—
SHAREHOLDERS' EQUITY		216,687							156,233
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	1,649,710						$	1,346,145
Net interest income				$	37,906						$	29,919
Net interest spread₍₂₎						4.75	%						4.82	%
Net interest margin₍₃₎						5.52	%						5.29	%

(1)	Yields on tax-exempt loans and securities are calculated on a fully taxable equivalent basis assuming a 35% tax rate.

(2)	Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

(3)	Represents net interest income on a fully taxable equivalent basis as a percentage of average interest-earning assets.

The following table sets forth, for the periods indicated, the dollar amount of changes in interest earned and paid for interest-earning assets and interest-bearing liabilities and the amount of change attributable to changes in average daily balances (volume) or changes in average daily interest rates (rate) on a fully taxable equivalent basis. All changes in interest owed and paid for interest-earning assets and interest-bearing liabilities are attributable to either volume or rate. The impact of changes in the mix of interest-earning assets and interest-bearing liabilities is reflected in our net interest income.

	Three Months Ended June 30,							Six Months Ended June 30,
	2006 Over 2005							2006 Over 2005
	Increase Due To Changes In:							Increase Due To Changes In:
		Volume		Rate			Total		Volume		Rate			Total
	(In thousands)
Interest-earning assets:
Loans, net of unearned income	$	2,335	$	2,875		$	5,210	$	4,607	$	5,617		$	10,224
Securities		1,000		394			1,394		1,658		683			2,341
Time deposits in other banks		2		52			54		179		248			427
Federal funds sold		27		139			166		133		288			421
Total interest income		3,364		3,460			6,824		6,577		6,836			13,413
Interest-bearing liabilities:
Demand, savings and money market deposits		172		642			814		282		1,419			1,701
Time deposits		338		1,009			1,347		631		2,109			2,740
Federal funds purchased and securities sold under agreement to repurchase		77		165			242		143		319			462
Junior subordinated debentures		—		230			230		—		470			470
Notes payable		14		(1	)		13		55		(2	)		53
Total interest expense		601		2,045			2,646		1,111		4,315			5,426
Increase in net interest income	$	2,763	$	1,415		$	4,178	$	5,466	$	2,521		$	7,987

Provision for Loan Losses

The amount of our provision for loan losses is based on periodic (not less than quarterly) evaluations of the loan portfolio, especially nonperforming and other potential problem loans. As discussed above, during these evaluations, we consider various factors. For additional information concerning the factors considered in these evaluations, see “Critical Accounting Policies—Loans and Allowance for Loan Losses.”

Our provisions for loan losses for the six months ended June 30, 2006 and 2005 were $800,000 and $600,000, respectively. Management calculated a provision for loan losses for the first six months of 2006 to provide amounts slightly above the long term average net charge offs and to increase the overall loan loss reserve percentage to approximate peer ratios.

Noninterest Income

Our noninterest income for the second quarter and six months ended June 30, 2006 was $5.0 million and $9.7 million, respectively, representing a 10.9% and 9.3% increase, respectively, from $4.5 million and $8.9 million for the same periods in 2005. Annualized noninterest income for the six months ended June 30, 2006 and 2005 represented approximately 1.2% and 1.3%, respectively, of our average assets for the same periods. Additionally, noninterest income represented approximately 16.5% and 19.8% of our total revenues for the six months ended June 30, 2006 and 2005, respectively. The decrease in ratio of noninterest income to total revenues is primarily due to the acquisition of Heritage, which provided a greater portion of interest income than noninterest income, and higher market interest rates.

As a result of our efforts to diversify our revenue sources, we currently earn noninterest income from various sources. Our largest noninterest income source is service charges, primarily on deposit accounts, representing 56.0% and 54.0% of our total noninterest income for the second quarter of 2006 and 2005, respectively. This income source increased to $2.8 million in the second quarter of 2006 from $2.4 million in the second quarter of 2005 and to $5.5 million in the six months ended June 30, 2006 from $4.8 million in the six months ended June 30, 2005. These increases were primarily due to an increase in our number of transactional and savings accounts resulting from our acquisition of Heritage. We periodically review service charge rates in an effort to maximize service charge income while maintaining a competitive position.

Gain on sale of loans was the second largest source of our noninterest income for the six months ended June 30, 2006 and 2005, respectively. For the second quarter and six months ended June 30, 2006, gain on sale of loans was $651,000 and $1.3 million, respectively, as compared to $776,000 and $1.3 million for the same period in 2005. Income from gain on sale of loans as a percentage of total noninterest income was 13.2% and 15.2% for the first six months of 2006 and 2005, respectively. This source of noninterest income is derived primarily from the origination and subsequent sale of mortgage loans. The origination of these loans is primarily from two sources, the purchase of new homes as well as the refinancing of existing home loans. We hedge our interest rate risk by selling our mortgage loans on a "best efforts" basis to secondary mortgage buyers at the time the rate is locked, which in effect eliminates most of the risk at the time of the sale.

Other income for the second quarter and six months ended June 30, 2006 was $1.3 million and $2.3 million, respectively, representing a 33.1% and 13.1% increase, respectively, from $978,000 and $2.1 million for the same periods in 2005. The $324,000 increase in other income for the quarter ended June 30, 2006 compared to the same period in 2005 was primarily due to increases in factoring income, debit card income, and brokerage services. In the second quarter of 2006 our factoring income increased $108,000, debit card income increased $89,000 and brokerage service fees increased $66,000 compared to the second quarter of 2005. The relatively small percentage increase for the six month period ended June 30, 2006 compared to the same period in 2005 was due, in part, to a non-reoccurring item in the first quarter of 2005. In the first quarter of 2005 we recorded a $241,475 gain due to the sale of Pulse Network to Discover Financial Services on January 31, 2005 in which we had a shared interest based on network usage. In the first six months of 2006 our factoring income increased $200,000, debit card income increased $171,000, brokerage service fees increased $60,000 and trust fees increased $50,000 compared to the first six months of 2005.

The following tables set forth the various components of our noninterest income for the periods indicated:

		Three Months Ended June 30,									Six Months Ended June 30,
		2006					2005				2006					2005
		Amount		%			Amount	%			Amount		%			Amount	%
	(Dollars in thousands)
Service charges on deposit accounts	$	2,799		56.0	%	$	2,435	54.0	%	$	5,494		56.7	%	$	4,815	54.3	%
Gain on sale of loans		651		13.0			776	17.2			1,284		13.2			1,349	15.2
Bank owned life insurance		326		6.5			319	7.1			653		6.7			634	7.1
Net realized gain on sale of securities		(79	)	(1.6	)		—	—			(79	)	(0.8	)		1	—
Other		1,302		26.1			978	21.7			2,344		24.2			2,073	23.4
Total noninterest income	$	4,999		100.0	%	$	4,508	100.0	%	$	9,696		100.0	%	$	8,872	100.0	%

Noninterest Expense

The following tables set forth a summary of noninterest expenses for the periods indicated:

		Three Months Ended June 30,
		2006				2005
		Amount	%			Amount	%
	(Dollars in thousands)
Salaries and employee benefits:
Salaries	$	6,699	40.0	%	$	6,001	43.9	%
Medical and other benefits		565	3.4			560	4.1
Pension		335	2.0			272	2.0
Payroll taxes		455	2.7			415	3.0
Total salaries and employee benefits		8,054	48.1			7,248	53.0
Net occupancy and equipment expense		2,461	14.7			2,139	15.6
Amortization of intangibles		997	5.9			823	6.0
Professional fees		587	3.5			336	2.5
Communication expense		325	1.9			276	2.0
Advertising		423	2.5			312	2.3
Supplies		195	1.2			219	1.6
Data processing		235	1.4			199	1.5
Courier		223	1.3			210	1.5
Postage		199	1.2			166	1.2
Merger and one-time expenses		755	4.5			40	0.3
OREO		135	0.8			27	0.2
Other		2,172	13.0			1,674	12.3
Total noninterest expense	$	16,761	100.0	%	$	13,669	100.0	%

		Six Months Ended June 30,
		2006				2005
		Amount	%			Amount	%
	(Dollars in thousands)
Salaries and employee benefits:
Salaries	$	13,420	41.2	%	$	11,769	43.4	%
Medical and other benefits		1,217	3.7			1,115	4.1
Pension		665	2.0			527	2.0
Payroll taxes		1,003	3.1			906	3.3
Total salaries and employee benefits		16,305	50.0			14,317	52.8
Net occupancy and equipment expense		5,005	15.4			4,307	15.9
Amortization of intangibles		2,019	6.2			1,647	6.1
Professional fees		1,091	3.4			691	2.6
Communication expense		645	2.0			556	2.1
Advertising		722	2.2			533	2.0
Supplies		380	1.2			421	1.6
Data processing		456	1.4			419	1.5
Courier		440	1.4			399	1.5
Postage		375	1.2			332	1.2
Merger and one-time expenses		758	2.3			40	0.1
OREO		204	0.6			43	0.1
Other		4,145	12.7			3,389	12.5
Total noninterest expense	$	32,545	100.0	%	$	27,094	100.0	%

Our total noninterest expense increased to $16.8 million and $32.5 million in the second quarter and six months ended June 30, 2006, compared to $13.7 million and $27.1 million for the same periods in 2005, representing an increase of 22.6% and 20.1%, respectively. Included in the 2006 second quarter expenses are $755,000 in transaction costs related to the pending merger with BBVA. The remaining increases can be attributed to expanded personnel, occupancy costs, and other operating expense associated with our acquisition of Heritage in October 2005. The efficiency ratio improved to 64.67% for the second quarter of 2006, as compared to 65.18% for the same quarter in 2005, and 64.13% for the six months ended June 30, 2006, as compared to 65.60% for same period in 2005. The efficiency ratio is determined by dividing total noninterest expense, less amortization of intangibles, by an amount equal to net interest income (fully taxable equivalent) plus noninterest income.

Salaries and employee benefits totaled $8.1 million and $16.3 million for the second quarter and six months ended June 30, 2006, compared to $7.2 million and $14.3 million for the same periods in 2005, representing an increase of $806,000, or 11.1%, and $2.0 million, or 13.9%, for the comparable periods. Of the $2.0 million increase in the six months ended June 30, 2006, $1.2 million is attributable to Heritage, $635,000 is attributable to increase in bonus accrual, and $119,000 is related to benefits.

Occupancy and equipment expenses totaled $2.5 million and $5.0 million for the second quarter and six months ended June 30, 2006, respectively, compared to $2.1 million and $4.3 million for the same periods in 2005. This represented an increase of $322,000, or 15.1%, and $698,000, or 16.2%, for the second quarter and six months ended June 30, 2006, respectively, from the comparable prior year periods. Of the $698,000 increase for the six months ended June 30, 2006, $529,000 was attributable to the acquisition of Heritage.

Professional fees were $587,000 and $336,000, or 3.5% and 2.5% of total noninterest expenses, for the second quarter of 2006 and 2005, respectively. For the six months ended June 30, 2006, these expenses increased to $1.1 million from $691,000 for the same period in 2005. The increase is attributable primarily to audit and legal fees associated with public company reporting.

Net costs applicable to OREO and other repossessed assets consist of expense associated with holding and maintaining repossessed assets, the net gain or loss on the sales of such assets and the write-down of the carrying value of the assets. We recorded net costs of $135,000 for the second quarter in 2006 compared to $27,000 for the same period in 2005. These expenses increased to $204,000 for the six months ended June 30, 2006 from $43,000 for the comparable period in 2005. Repossessed assets are initially recorded at the lower of fair value or book value upon repossession and resulting losses are charged to the allowance for loan losses. These assets are then periodically evaluated and recorded at fair value. Any subsequent decline in the fair value is charged to current operations.

Other noninterest expenses increased to $2.2 million and $4.1 million for the second quarter and six months ended June 30, 2006 compared to $1.7 million and $3.4 million for the same periods in 2005. This increase was primarily due to our asset growth.

Provision for Income Taxes

Income tax expense increased $720,000 to $2.6 million for the quarter ended June 30, 2006 compared with $1.9 million for the same period in 2005. For the six months ended June 30, 2006, income tax expense totaled $4.9 million, an increase of $1.1 million, or 29.0%, compared with $3.8 million for the same period in 2005. The increase was primarily attributable to higher pretax earnings for the quarter ended June 30, 2006 when compared to the respective period in 2005. Our effective tax rate for the six months ended June 30, 2006 was 34.9% compared to 34.1% for the same period in 2005.

Financial Condition as of June 30, 2006 and December 31, 2005

Our total assets as of June 30, 2006 were $1.635 billion, a decrease of $28.2 million, or 1.7%, from $1.663 billion as of December 31, 2005. Total loans were $1.106 billion at June 30, 2006 compared to $1.086 billion as of December 31, 2005. Total deposits increased to $1.311 billion as of June 30, 2006, compared to $1.357 billion as of December 31, 2005. As of June 30, 2006, our shareholders’ equity was $218.6 million, compared to $212.3 million as of December 31, 2005.

Investment Securities

Our investment portfolio primarily serves as a source of interest income and, secondarily, as a source of liquidity and a management tool for our interest rate sensitivity. We manage our investment portfolio according to a written investment policy implemented by our Asset/Liability Management Committee. Our investment policy is reviewed annually by our Board of Directors. Investment balances, including cash equivalents and interest-bearing deposits in other financial institutions, are subject to change over time based on our asset/liability funding needs and our interest rate risk management objectives. Our liquidity levels take into consideration anticipated future cash flows and all available sources of credits and are maintained at levels management believes are appropriate to assure future flexibility in meeting our anticipated funding needs.

Our investment portfolio consists of securities that are classified as “available-for-sale” and securities we intend to hold until maturity, or “held-to-maturity securities.” The carrying values of our available-for-sale securities are adjusted for unrealized gain or loss as a valuation allowance, and any gain or loss is reported on an after-tax basis as a component of other comprehensive income (loss).

The following table presents the composition, book value and fair value of our investment portfolio by major category as of the dates indicated:

		Available-for-Sale				Held-to-Maturity				Total
		Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
	(In thousands)
June 30, 2006:
U.S. treasury securities	$	6,986	$	6,909	$	—	$	—	$	6,986	$	6,909
U.S. government agencies obligations		145,644		143,637		—		—		145,644		143,637
Collateralized mortgage obligations		143		142		—		—		143		142
Mortgage-backed securities		57,002		55,004		—		—		57,002		55,004
State and municipal obligations		23,904		23,591		—		—		23,904		23,591
Federal Reserve Bank stock and other investments		2,448		2,377		7,619		7,619		10,067		9,996
Total	$	236,127	$	231,660	$	7,619	$	7,619	$	243,746	$	239,279
December 31, 2005:
U.S. treasury securities	$	7,051	$	6,969	$	—	$	—	$	7,051	$	6,969
U.S. government agencies obligations		109,516		108,622		—		—		109,516		108,622
Collateralized mortgage obligations		165		166		—		—		165		166
Mortgage-backed securities		64,357		63,292		—		—		64,357		63,292
State and municipal obligations		26,294		26,348		—		—		26,294		26,348
Federal Reserve Bank stock and other investments		1,414		1,390		8,094		8,094		9,508		9,484
Total	$	208,797	$	206,787	$	8,094	$	8,094	$	216,891	$	214,881

Our investment portfolio increased by approximately $24.4 million to $239.3 million as of June 30, 2006 from $214.9 million as of December 31, 2005. This increase was primarily due to additional investing because of higher market yields on securities.

Investment Portfolio — Maturity and Yields

The estimated fair value of our securities portfolio as of June 30, 2006 is presented below by contractual maturity:

		As of June 30, 2006
		Within One Year				After One but Within Five Years				After Five but Within Ten Years				After Ten Years				Total
		Amount	Yield			Amount	Yield			Amount	Yield			Amount	Yield			Amount	Yield
	(Dollars in thousands)
Investments available-for-sale₍₁₎₍₂₎:
U.S. treasury obligations	$	3,992	2.31	%	$	2,917	3.77	%	$	—	—	%	$	—	—	%	$	6,909	2.93	%
U.S. government agencies obligations		36,624	3.65			107,013	4.93			—	—			—	—			143,637	4.60
Mortgage backed securities and collateralized mortgage obligations₍₃₎		688	4.49			53,627	4.52			828	4.89			3	6.75			55,146	4.52
State and municipal obligations		3,080	3.27			13,675	3.40			5,922	3.90			914	5.32			23,591	3.62
Other securities		—	—			—	—			—	—			2,377	4.60			2,377	4.60
Total investments available-for-sale		44,384	3.52			177,232	4.67			6,750	4.02			3,294	4.80			231,660	4.43
Other investments:
FHLB stock and other investments		—	—			—	—			—	—			7,619	5.25			7,619	5.25
Total other investments		—	—			—	—			—	—			7,619	5.25			7,619	5.25
Total investments	$	44,384	3.52	%	$	177,232	4.67	%	$	6,750	4.02	%	$	10,913	5.11	%	$	239,279	4.46	%

(1) Based on estimated fair value.

(2) The yields shown in the above table are not calculated on a fully taxable equivalent basis.

(3) Maturities of mortgage-backed securities and collateralized mortgage obligations, or CMOs, are based on anticipated lives of the underlying mortgages, not contractual maturities. CMO maturities are based on cash flow (or payment) windows derived from broker market consensus.

Securities with carrying values of approximately $122.2 million and $133.6 million were pledged to secure certain deposits at June 30, 2006 and December 31, 2005, respectively.

The following table discloses gross unrealized losses and the related fair value of our investment category and length of time that individual available-for-sale securities have been in a continuous unrealized loss position at June 30, 2006:

		Available-For-Sale Securities
		Less than 12 months				12 months or longer				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In thousands)
Treasury/Agency₍₁₎	$	89,628	$	1,365	$	47,654	$	839	$	137,282	$	2,204
Mortgage-backed securities ₍₂₎		23,699		700		30,789		1,303		54,488		2,003
Other		23,771		416		502		6		24,273		422
Total temporarily impaired securities	$	137,098	$	2,481	$	78,945	$	2,148	$	216,043	$	4,629

(1) U.S. Treasury/Agency Debt Securities - The unrealized losses on investments in U.S. treasury and agency debt securities were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because we have the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

(2) Mortgage-Backed Securities - The unrealized losses on investments in mortgage-backed securities were caused by interest rate increases. The contractual cash flows of these securities are guaranteed by Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC). It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because we have the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

Loans

Our loan portfolio consists of loans made to businesses, individuals, and farm and ranch operations located in our primary trade areas. Real estate loans represent loans primarily for residential construction, commercial non-owner-occupied and owner-occupied real estate.

The following table presents our loans held for investment by category as of the dates indicated:

		June 30, 2006					December 31, 2005
		Amount		Loan Category to Total Loans			Amount		Loan Category to Total Loans
		(Dollars in thousands)
Real estate—construction	$	189,369		17.2	%	$	144,721		13.5	%
Real estate—1-4 family		119,091		10.9			125,901		11.7
Real estate—other		415,447		37.8			415,047		38.6
Lease financing		2,142		0.2			—		—
Commercial		257,163		23.4			263,975		24.6
Agricultural and other		74,487		6.8			84,646		7.9
Consumer		40,860		3.7			40,321		3.7
Total loans held for investment	$	1,098,559		100.0	%	$	1,074,611		100.0	%
Allowance for loan losses		(13,122	)				(12,591	)
Loans held for investment, net	$	1,085,437				$	1,062,020

At June 30, 2006 our total loans held for investment, net of unearned income, was $1.099 billion, an increase of $23.9 million, as compared to $1.075 billion at December 31, 2005. At June 30, 2006, our real estate loans increased $38.2 million, lease financing increased $2.1 million, consumer loans increased $539,000, commercial loans decreased $6.8 million and agriculture and other loans decreased $10.2 million. The increase in our loan portfolio is primarily attributable to increased loan demand but was offset due to the seasonality of our agriculture loans. Our total loans held for investment, net of unearned income as a percentage of total assets, was 67.2% at June 30, 2006, compared with 64.6% at December 31, 2005.

Real estate loans, the largest component of our loan portfolio, consist primarily of commercial real estate loans or commercial lines of credit that are extended to finance the purchase or improvement of commercial real estate. Real estate loans equaled $723.9 million and $685.7 million at June 30, 2006 and December 31, 2005, respectively. The percentage of our real estate secured loans in relation to our total loan portfolio, increased to 65.9% as of June 30, 2006, as compared to 63.8% at December 31, 2005.

Our commercial loans, the second largest component of our loan portfolio, typically have floating rates of interest, are for varying terms (generally not exceeding five years), are personally guaranteed by the principal owners and are collateralized by real estate, accounts receivable, inventory or other business assets. Commercial loans decreased to $257.2 million as of June 30, 2006 from $264.0 million as of December 31, 2005. Commercial loans as a percentage of total loans were 23.4% as of June 30, 2006, and 24.6% at the end of 2005.

Consumer loans have historically represented a small part of our total loan portfolio. Consumer loans increased to $40.9 million as of June 30, 2006 from $40.3 million as of December 31, 2005. Consumer loans as a percentage of total loans were 3.7% and 3.7% at June 30, 2006 and December 31, 2005, respectively.

Agriculture and other loans decreased to $74.5 million as of June 30, 2006 from $84.7 million as of December 31, 2005. The decrease in loan balance is primarily due to seasonality within our agriculture portfolio. Agriculture and other loans as a percentage of total loans were 6.8% and 7.9% at June 30, 2006 and December 31, 2005, respectively.

The following table presents the distribution of the maturity of our loans as of June 30, 2006. The table also presents the portion of our loans that have fixed interest rates or interest rates that fluctuate over the life of the loans in accordance with changes in the interest rate environment as represented by the prime rate.

	As of June 30, 2006
		One Year and Less		One to Five Years		Over Five Years		Total Carrying Value
		(In thousands)
Real estate—construction	$	136,711	$	36,524	$	16,134	$	189,369
Real estate—1-4 family		24,103		47,304		47,684		119,091
Real estate—other		52,092		231,334		132,021		415,447
Lease financing		—		—		2,142		2,142
Commercial loans		133,961		91,350		31,852		257,163
Consumer loans		19,174		17,573		4,113		40,860
Agriculture and other loans		64,900		6,611		2,976		74,487
Total loans held for investment	$	430,941	$	430,696	$	236,922	$	1,098,559
With fixed interest rates	$	99,483	$	223,403	$	72,538	$	395,424
With variable interest rates		331,458		207,293		164,384		703,135
Total loans held for investment	$	430,941	$	430,696	$	236,922	$	1,098,559

Nonperforming Assets

Nonperforming assets consist of loans on nonaccrual status, loans 90 days or more past due and still accruing interest, loans that have been restructured resulting in a reduction or deferral of interest or principal, OREO, and other repossessed assets.

The following table lists nonaccrual, past due and restructured loans, OREO and other repossessed assets as of the dates indicated:

		June 30,			December 31,
		2006			2005
		(Dollars in thousands)
Nonaccrual loans	$	8,658		$	8,654
Accruing loans past due over 90 days		13			—
Restructured loans		74			88
OREO		593			927
Other repossessed assets		8			8
Total nonperforming assets	$	9,346		$	9,677
Total nonperforming assets to total loans and other real estate		0.85	%		0.90	%

The nonperforming assets decreased $331,000 to $9.3 million as of June 30, 2006 from $9.7 million as of December 31, 2005. The ratio of nonperforming assets over total loans and OREO decreased to 0.85% as of June 30, 2006, from 0.90% as of December 31, 2005.

At June 30, 2006, loans identified as being impaired consisted of nonhomogeneous loans placed on nonaccrual status. We generally place a loan on nonaccrual status and cease accruing interest when the payment of principal or interest is delinquent for 90 days, or earlier in some cases, unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan.

As of June 30, 2006 and December 31, 2005, the average investment in loans that are considered to be impaired under SFAS No. 114 was approximately $8.7 million and $7.8 million, respectively. Included in these amounts at June 30, 2006 and December 31, 2005 was $8.7 million and $8.6 million, respectively, of impaired loans for which our related specific reserve for loan losses was approximately $2.4 million and $2.0 million, respectively. We had $28,000 of impaired loans as of December 31, 2005 that did not have a specific related reserve for loan losses.

Allowance for Loan Losses

Management actively monitors the Company’s asset quality and provides specific loss allowances when necessary. Loans are charged-off against the allowance for loan losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the allowance for loan loss, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of our allowance for loan and lease losses. Such agencies may recommend us to make additional provisions to the allowance based upon their judgments about information available to them at the time of their examinations. As of June 30, 2006, the allowance for loan losses amounted to $13.1 million, or 1.19% of total loans held for investment, compared with $12.6 million, or 1.17% of total loans held for investment, as of December 31, 2005.

The following table presents the activity in our allowance for loan losses for the six months ended June 30, 2006 and the year ended December 31, 2005. The table also presents our average loan balances and certain pertinent ratios for the six months ended June 30, 2006 and the year ended December 31, 2005.

		Six months ended June 30,			Year Ended December 31,
		2006			2005
		(Dollars in thousands)
Analysis of allowance for loan losses:
Balance, beginning of period	$	12,591		$	11,383
Provision for loan losses		800			900
Loan loss reserves of acquired banks		—			1,670
Loans charged-off:
Real estate—construction		18			72
Real estate—1-4 family		102			96
Commercial loans		267			1,067
Consumer loans		240			820
Agriculture and other loans		19			500
Total charge-offs		646			2,555

Recoveries of loans previously charged-off:
Real estate—construction		—			45
Real estate—1-4 family		3			18
Real estate—other		6			12
Commercial loans		196			535
Consumer loans		108			573
Agriculture and other loans		64			10
Total recoveries		377			1,193
Net loans charged-off		269			1,362
Balance, end of period	$	13,122		$	12,591
Average loans outstanding, net of unearned income, for the period ended	$	1,090,394		$	989,406
Ratio of net loan charge-offs to average loans, net of unearned income ₍₁₎		0.05	%		0.14	%
Ratio of allowance for loan losses to total loans, net of unearned income		1.19	%		1.17	%

(1) Annualized as of June 30, 2006.

Nonearning Assets

Premises, leasehold improvements and equipment, net of accumulated depreciation and amortization, totaled $51.9 million at June 30, 2006 and $48.8 million at December 31, 2005, an increase of $3.1 million. This increase is primarily attributable our new Whisperwood banking center in Lubbock, Texas and the purchase of a building for expansion of our back office operations before consummation of acquisition by BBVA.

Deposits

Deposits are our primary source of funds. The following table sets forth, for the periods indicated, the distribution of our average deposit account balances and average cost of funds on each category of deposits:

	Six Months Ended						Year Ended
	June 30, 2006						December 31, 2005
		Average Balance	Percent of Deposits		Average Rate			Average Balance	Percent of Deposits		Average Rate
	(Dollars in thousands)
Noninterest-bearing demand deposits	$	476,319	35.6	%	—	%	$	416,168	35.4	%	—	%
Interest-bearing demand, savings and money market deposits		520,896	38.9		1.29			463,836	39.4		0.91
Time deposits of less than $100,000		189,504	14.2		3.02			167,646	14.3		2.18
Time deposits of $100,000 or more		150,807	11.3		3.48			127,973	10.9		2.65
Total deposits	$	1,337,526	100.0	%	1.32	%	$	1,175,623	100.0	%	0.96	%

Total deposits as of June 30, 2006 and December 31, 2005 were $1.311 billion and $1.357 billion, respectively, representing a decrease of $45.6 million, or 3.3%, for the six months ended June 30, 2006. The decline in deposits is due to increased competition within our markets and seasonality within our deposit base. Average deposits for the six months ended June 30, 2006 were $1.338 billion, as compared to $1.114 billion for the same period in 2005. The increase in average deposits during the six months ended June 30, 2006 as compared with the six months ended June 30, 2005 was primarily attributable to Heritage.

Total deposits as of June 30, 2006 and December 31, 2005 consisted of the following:

		June 30, 2006		December 31, 2005
	(In thousands)
Noninterest-bearing demand deposits	$	479,610	$	487,369
Interest-bearing deposits:
NOW and Money Market		415,828		448,762
Savings		76,742		75,095
Time deposits		339,269		345,852
Total interest-bearing deposits:		831,839		869,709
Total Deposit	$	1,311,449	$	1,357,078

The following table sets forth the amount and maturities of the time deposits of $100,000 or more as of the dates indicated:

		June 30, 2006		December 31, 2005
	(In thousands)
Three months or less	$	30,847	$	37,958
Over three through six months		20,747		24,918
Over six through 12 months		45,157		36,452
Over 12 months		59,284		55,266
Total time deposits of $100,000 or more	$	156,035	$	154,594

Borrowings

Long-Term Debt

Deposits are the primary source of funds for our lending and investment activities. Occasionally, we obtain funding from the Federal Home Loan Bank (“FHLB”). As of June 30, 2006, we had $1.3 million in FHLB borrowings, compared to $5.8 million at December 31, 2005. The decrease in FHLB borrowings is due to two notes maturing in February with a combined balance of $4.6 million. The maturity dates on the FHLB notes range from 2008 to 2018 and have interest rates from 2.65% to 5.45%.

Other Borrowings

Borrowings, including funds purchased and securities sold under agreement to repurchase, totaled $43.2 million at June 30, 2006, an increase of $14.6 million from December 31, 2005. Securities sold under agreement to repurchase totaled $29.3 million at June 30, 2006, an increase of $653,000 from December 31, 2005. Federal funds purchased at June 30, 2006 totaled $13.9 million. We did not purchase federal funds as of December 31, 2005. The increase in borrowings was due to a higher level of funds purchased to satisfy liquidity needs as a result of growth in loans, additional purchases of investment securities and lower deposit balances.

Junior Subordinated Debentures

As of June 30, 2006 and December 31, 2005, we had $48.5 million (amount net of investments in trusts is $47.0 million) in outstanding junior subordinated debentures. See our Annual Report on Form 10-K, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations- Borrowings” which was filed on March 29, 2006, for further discussion.

Capital Resources and Capital Adequacy Requirements

Total shareholders’ equity was $218.6 million as of June 30, 2006 compared with $212.3 million as of December 31, 2005, an increase of $6.3 million, or 3.0%. The increase was due primarily to our net earnings of $9.1 million, offset by our dividend payment of $2.4 million.

Both the Board of Governors of the Federal Reserve System, with respect to the Company, and the OCC, with respect to the Bank, has established certain minimum risk-based capital standards that apply to bank holding companies and national banks. As of June 30, 2006, our Tier 1 risk based capital, total risk-based capital and leverage capital ratios were 12.44%, 13.51% and 9.91%, respectively. As of June 30, 2006, the Bank’s risk-based capital ratios were above the levels required for the Bank to be designated as “well capitalized” by the FDIC, with Tier 1 risk-based capital, total risk-based capital and leverage capital ratios of 10.70%, 11.78% and 8.51%, respectively.

Liquidity Management

Liquidity involves our ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate on an ongoing basis. Our liquidity needs have primarily been met by growth in core deposits and the issuance of junior subordinated debentures. Although access to purchased funds from correspondent banks is available, we do not generally rely on these external funding sources. The cash and federal funds sold position, supplemented by amortizing investment and loan portfolios, have generally created an adequate liquidity position.

Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. As of June 30, 2006, our cash and due from bank balance was $77.2 million compared with $72.9 million as of December 31, 2005.

Aggregate Contractual Obligations

The following table represents our on and off-balance sheet aggregate contractual obligations, other than deposit liabilities, to make future payments to third parties as of the date specified:

	As of June 30, 2006
		Less than One Year		One Year to Three Years		Over Three Years to Five Years		Over Five Years		Total
	(In thousands)
FHLB advances	$	209	$	367	$	537	$	156	$	1,269
Junior subordinated debentures		—		—		—		47,000		47,000
Operating leases		1,454		2,654		1,566		587		6,261
Total	$	1,663	$	3,021	$	2,103	$	47,743	$	54,530

Aggregate contractual obligations above exclude the interest on our Federal Home Loan Bank advances and guaranteed preferred beneficial interests in our junior subordinated debentures. See footnote 7, “Borrowing Arrangements,” and footnote 8, “Guaranteed Preferred Beneficial Interest in the Company’s Subordinated Debentures,” to our audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, for additional information.

Off-Balance Sheet Arrangements

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters-of-credit, which involve varying degrees of credit risk in excess of the amount recognized in the consolidated statement of financial position. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

	As of June 30, 2006
		Total Notional Amounts Committed		Less than 1 year		1-3 years		4-5 years		Over 5 years
	(In thousands)
Commitments to extend credit	$	319,337	$	240,867	$	64,015	$	2,960	$	11,495
Standby letters of credit		17,100		11,970		5,130		—		—
Total commercial commitments	$	336,437	$	252,837	$	69,145	$	2,960	$	11,495

As of June 30, 2006 and December 31, 2005, we had commitments to extend credit of $319.3 million and $253.9 million, respectively. We also had standby letters of credit of $17.1 million and $15.7 million as of June 30, 2006 and December 31, 2005, respectively.

The effect on our revenues, expenses, cash flows and liquidity of the unused portions of these commitments cannot reasonably be predicted because there is no guarantee that the lines of credit will be used.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

The Company manages market risk, which is primarily interest rate risk, through its Asset/Liability Committee which is composed of senior officers of the Company and members from our Board of Directors, in accordance with policies approved by the Company’s Board of Directors.

The Company uses shock and simulation analysis to examine the potential effects of market changes on net interest income and market value. We consider macroeconomic variables, Company strategy, liquidity and other factors as it quantifies market risk. See our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations- Quantitative and Qualitative Disclosure about Market Risks,” for further discussion.

ITEM 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, we carried out an evaluation, 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 such term is defined under Exchange Act Rule 13a-15(e).

Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of the end of the fiscal quarter covered by this report, such disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is: (a) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and (b) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

There were no changes in our internal controls over financial reporting during the quarter ended June 30, 2006 that materially affected, or were reasonably likely to materially affect, our internal controls over financial reporting.

PART II -

OTHER INFORMATION

ITEM 1. Legal Proceedings

On July 28, 2006, a suit was filed against State National Bank by Monte Hasie in the 72^nd District Court of Lubbock County, Texas alleging malicious prosecution, abuse of legal process, negligence and intentional infliction of emotional distress in connection with the criminal prosecution of the Plaintiff by the U.S. Government beginning in 2004. The suit seeks compensatory or actual damages in excess of $10 million related to, among other things, loss of earnings, emotional distress, damage to reputation, and costs to defend the criminal prosecution. The suit also seeks exemplary damages and attorneys’ fees and costs. Our management, after discussion with legal counsel, believes the ultimate result of this litigation will not have a material adverse effect on the Company's financial position, results of operations or cash flows. However, events could occur that could cause any estimate of ultimate loss to differ materially.

In addition to the foregoing, the Company is involved as plaintiff or defendant in a variety of routine litigation incidental to the normal course of business. Management believes, based on the opinion of legal counsel, that it has adequate defense or insurance protection with respect to such litigation and that any losses there from, whether or not insured, would not have a material adverse effect on the results of operations, financial position, or cash flows of the Company.

ITEM 1A. Risk Factors

Risks Related to the Proposed Merger

In connection with our proposed Merger with BBVA, we have filed a preliminary proxy statement on Schedule 14A with the SEC. After the SEC reviews the preliminary proxy statement, we will file a definitive proxy statement on Schedule 14A. The proxy statement contains important information about the Company, the proposed Merger and other related matters. We urge all of our shareholders to read the proxy statement.

In relation to the proposed Merger, we are subject to certain risks including, but not limited to, those set forth below.

Failure to consummate the Merger could negatively impact our stock price and our future business and financial results.

·	being required, under certain circumstances, including if the Merger Agreement is terminated in favor of an alternative offer from another potential buyer, to pay a termination fee of $19.2 million;

being required, under certain circumstances, including if our Board does not recommend in the proxy statement that our shareholders vote in favor of the merger or if an alternative proposal has been announced and the Merger Agreement is not approved by our shareholders, to reimburse BBVA for its costs and expenses in connection with the Merger Agreement;

·	having incurred certain costs relating to the proposed Merger that are payable whether or not the Merger is completed, including legal, accounting, financial advisor and printing fees;

·	having had the focus of management directed toward the proposed Merger and integration planning instead of on our core business and other opportunities that could have been beneficial to us; and

·	the market price of our common stock may decline to the extent that the current market price reflects a market belief that the Merger will be completed.

In addition, we will not realize any of the expected benefits of having completed the proposed Merger. If the proposed Merger is not completed, we cannot assure our shareholders that these risks will not materialize or materially adversely affect our business, financial results, financial condition and stock price.

Provisions of the Merger Agreement may deter alternative business combinations that could be more advantageous to our shareholders than the Proposed Merger.

Restrictions in the Merger Agreement on solicitation generally prohibit us from soliciting any acquisition proposal or offer for a merger or business combination with any other party, including a proposal that might be advantageous to our shareholders when compared to the terms and conditions of the proposed Merger. If the Merger is not completed, we may not be able to conclude another merger, sale or combination on as favorable terms, in a timely manner, or at all. If the Merger Agreement is terminated, we, in certain specified circumstances, may be required to pay a termination fee of $19.2 million to BBVA. In addition, under certain circumstances, we may be required to pay BBVA’s costs and expenses in connection with the Merger Agreement. These provisions may deter third parties from proposing or pursuing alternative business combinations that might result in greater value to our shareholders than the proposed Merger.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

ITEM 3. Defaults Upon Senior Securities

None.

ITEM 4. Submission of Matters to a vote of Security Holders

At the Company’s Annual Meeting of Shareholders held on May 24, 2006, shareholders voted on the following matters:

(1) To elect directors to serve until the 2007 Annual Meeting of Shareholders. Each director nominee was elected.

Name of Nominee	Total Votes For	Total Votes Withheld
Larry G. Autrey	10,603,727	43,560
Rick Calhoon	10,549,847	97,440
James Cardwell	10,612,540	34,747
Don E. Cosby	10,043,616	603,671
Gary Fletcher	10,611,817	35,470
Mark Merlo	10,613,537	33,750
H. Gil Moutray	10,611,817	35,470
Tom C. Nichols	10,581,160	66,127
Ben Stribling	10,611,817	35,470
Lucinda Vargas	10,611,817	35,470
F. James Volk	10,617,455	29,832

ITEM 5. Other Information

Not applicable.

ITEM 6. Exhibits

Exhibit Number		Description of Exhibit
2.1		Agreement and Plan of Merger, dated as of June 12, 2006, by and between Banco Bilbao Vizcaya Argentania, S.A. and State National Bancshares, Inc. is incorporated by reference from Exhibit 2.1 to the Registrant’s Form 8-K filed with the SEC on June 16, 2006.⁽¹⁾
10.1		Employment Agreement for Tom C. Nichols, dated as of June 12, 2006, with State National Bancshares, Inc. is incorporated by reference from Exhibit 10.1 to the Registrant’s Form 8-K filed with the SEC on June 16, 2006.
10.2		Employment Agreement for Don E. Cosby, dated as of June 12, 2006, with State National Bancshares, Inc. is incorporated by reference from Exhibit 10.2 to the Registrant’s Form 8-K filed with the SEC on June 16, 2006.
10.3		Employment Agreement for F. James Volk, dated as of June 12, 2006, with State National Bancshares, Inc. is incorporated by reference from Exhibit 10.3 to the Registrant’s Form 8-K filed with the SEC on June 16, 2006.
10.4		Tax Gross Up Agreement for Tom C. Nichols, dated as of June 12, 2006, with State National Bancshares, Inc. is incorporated by reference from Exhibit 10.4 to the Registrant’s Form 8-K filed with the SEC on June 16, 2006.
10.5		Tax Gross Up Agreement for Don E. Cosby, dated as of June 12, 2006, with State National Bancshares, Inc. is incorporated by reference from Exhibit 10.5 to the Registrant’s Form 8-K filed with the SEC on June 16, 2006.
10.6		Tax Gross Up Agreement for F. James Volk, dated as of June 12, 2006, with State National Bancshares, Inc. is incorporated by reference from Exhibit 10.6 to the Registrant’s Form 8-K filed with the SEC on June 16, 2006.
31.1		Rule 13a-14(a) Certification of Chief Executive Officer.
31.2		Rule 13a-14(a) Certification of Chief Financial Officer.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Pursuant to Regulation S-K Item 601(b)(2), the Registrant will furnish supplementally to the SEC a copy of any omitted schedule to this exhibit upon request.

SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.


	STATE NATIONAL BANCSHARES, INC.

Date: August 11, 2006	By:
		Don E. Cosby Executive Vice President, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer)

State National Bancshares, Inc. 10-Q