AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 12,OCTOBER 29, 1997

REGISTRATION NO. 333-
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- -------------------------------------------------------------------------------333-35573
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

----------------

HERITAGE FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

WASHINGTON 6036
APPLIED FOR
(STATE OR OTHER (PRIMARY SICC NO.) 91-1857900
JURISDICTION OF (I.R.S. EMPLOYER
JURISDICTION OFINCORPORATION OR IDENTIFICATION NUMBER)
INCORPORATION OR
ORGANIZATION)

----------------

201 5TH AVENUE S.W.
OLYMPIA, WASHINGTON 98501
(360) 943-1500
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

DONALD V. RHODES
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER
HERITAGE FINANCIAL CORPORATION
201 5TH AVENUE S.W.
OLYMPIA, WASHINGTON 98501
(360) 943-1500
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

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COPIES OF COMMUNICATIONS TO:

J. JAMES GALLAGHER, ESQ.
SANDRA L. GALLAGHER, ESQ.
GORDON, THOMAS, HONEYWELL, MALANCA,
PETERSON & DAHEIM, P.L.L.C.
1201 PACIFIC AVENUE, SUITE 2200
TACOMA, WASHINGTON 98402
(253) 572-5050

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF SECURITIES TO THE
PUBLIC: As soon as practicable after this Registration Statement becomes
effective.

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]

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CALCULATION OF REGISTRATION FEE
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PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT BEING PURCHASE PRICE AGGREGATE AMOUNT OF
SECURITIES BEING REGISTERED REGISTERED(1) PER SHARE OFFERING PRICE(1) REGISTRATION FEE
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Common Stock, no par
value.................. 7,013,8359,748,636 shares $10.00 $70,138,350 $21,254.05
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- -----------------------------------------------------------------------------------------------$97,486,360 $29,541.32
===============================================================================================

(1) Estimated solely for purposes of calculating the registration fee. As
described in the Prospectus, the actual number of shares to be issued and
sold are subject to adjustment based upon the estimated pro forma market
value of the registrant and market and financial conditions.
----------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a)8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a)8(A), MAY DETERMINE.

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HERITAGE FINANCIAL CORPORATION

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CROSS-REFERENCE SHEET

FORM S-1 ITEM NO. AND CAPTION LOCATION OR HEADING IN THE PROSPECTUS
----------------------------- -------------------------------------

1. Forepart of Registration
Statement and Outside Front
Cover Page of Prospectus..... Outside Front Cover Page

2. Inside Front and Outside Back
Cover Pages of Prospectus.... Insider Front Cover Page; Outside Back
Cover Page

3. Summary Information and Risk
Factors...................... Summary; Risk Factors

4. Use of Proceeds............... Summary; Use of Proceeds

5. Determination of Offering
Price........................ Summary--Stock Pricing and Number of
Shares to be Issued in the Conversion;
The Conversion

6. Dilution...................... Not Applicable

7. Selling Security Holders...... Not Applicable

8. Plan of Distribution.......... Front Cover Page; Summary; The Conversion

9. Description of Securities to
be Registered................ Description of Capital Stock

10. Interests of Named Experts and
Counsel...................... Not Applicable

11. Information with Respect to
the Registrant............... Summary; Selected Consolidated Financial
and Other Data; Dividend Policy; Market
for Common Stock; Management's Discussion
of Analysis of Financial Condition and
Results of Operations; Business of the
Company; Business of the Bank; Management;
Consolidated Financial Statements

12. Disclosure of Commission
Position on Indemnification
for Securities Act
Liabilities.................. Part II--Item 14
================================================================================

PROSPECTUS

HERITAGE FINANCIAL CORPORATION [LOGO]

(HOLDING COMPANY FOR HERITAGE SAVINGS BANK)

UP TO 6,098,9988,477,075 SHARES OF COMMON STOCK (ANTICIPATED MAXIMUM)
$10.00 PER SHARE

Heritage Financial Corporation (the "Company"), a Washington corporation, is
offering up to 6,098,9988,477,075 shares (which may be increased to 7,013,8359,748,636 shares
under certain circumstances described below) of its common

(continued on following page)

FOR ADDITIONAL INFORMATION ON HOW TO SUBSCRIBE FOR COMMON STOCK, PLEASE CALL
THE STOCK INFORMATION CENTER AT (360) .705-9190.

FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY EACH
PROSPECTIVE INVESTOR, SEE "RISK FACTORS" BEGINNING ON PAGE 11.14.

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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION ("SEC"), THE FEDERAL DEPOSIT INSURANCE CORPORATION
("FDIC"), THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM ("FEDERAL
RESERVE") OR ANY OTHER FEDERAL AGENCY OR ANY STATE SECURITIES COMMISSION
OR OTHER STATE AGENCY, INCLUDING THE WASHINGTON DEPARTMENT OF FINANCIAL
INSTITUTIONS, DIVISION OF BANKS (THE "DIVISION"), NOR HAS THE SEC, THE
FDIC, THE FEDERAL RESERVE OR ANY OTHER AGENCY OR ANY STATE SECURITIES
COMMISSION OR OTHER STATE AGENCY PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.

THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR DEPOSITS AND
ARE NOT INSURED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY, NOR
ARE THEY INSURED OR GUARANTEED BY THE COMPANY OR THE BANK.

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ESTIMATED FEES,
UNDERWRITING
PURCHASE COMMISSIONS AND OTHER ESTIMATED NET
PRICE(1) EXPENSES(2) PROCEEDS(3)
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Minimum Per Share............ $ 10.00 $ 0.280.25 $ 9.729.75
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Midpoint Per Share........... $ 10.00 $ 0.260.24 $ 9.749.76
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Maximum Per Share............ $ 10.00 $ 0.250.22 $ 9.759.78
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Maximum Per Share, as
adjusted(4)................. $ 10.00 $ 0.230.21 $ 9.779.79
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Minimum Total................ $30,600,000 $ 867,000 $29,733,000$42,500,000 $1,070,000 $41,430,000
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Midpoint Total............... $36,000,000 $ 942,000 $35,058,000$50,000,000 $1,180,000 $48,820,000
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Maximum Total................ $41,400,000 $1,016,000 $40,384,000$57,500,000 $1,290,000 $56,210,000
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Maximum Total, as
adjusted(4)................. $47,610,000 $1,102,000 $46,508,000
$66,125,000 $1,417,000 $64,708,000
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(1) Based upon the minimum, midpoint, maximum and 15% above the maximum of the
Valuation Price Range as hereinafter defined, respectively, determined in
accordance with an independent appraisal prepared by RP Financial, LC.
("RP Financial"). Does not include shares of Common Stock to be issued to
Minority Stockholders in the Exchange.

(2) Consists of the estimated costs to the Company and the Bank to be incurred
in connection with the Conversion, including estimated fixed expenses of
$460,000 and marketing fees to be paid to the Agent in connection with the
Offerings, which are estimated to be $482,000$720,000 at the midpoint of the
Valuation Price Range, as hereinafter defined. See "The Conversion--
Marketing Arrangements." The actual fees and expenses may vary
substantially from the estimates. See "Pro Forma Data." The fees paid to
the Agent may be deemed to be underwriting fees. See "The Conversion--
Marketing Arrangements" for information relating to indemnification of the
Agent.
(3) Actual net proceeds may vary substantially from estimated amounts
depending on the number of shares sold in the Offerings and other factors.
Includes the proposed purchase of shares of Conversion Stock by the ESOP
which will be funded by a loan to the ESOP from the Company. See
"Capitalization" and "Pro Forma Data."
(4) Gives effect to an increase in the number of shares which could occur
without a resolicitation of subscribers or any right of cancellation of
stock orders due to an increase in the Valuation Price Range of up to 15%
above the maximum of the Valuation Price Range to reflect regulatory
considerations and changes in market and financial conditions following
commencement of the Offerings. See "The Conversion--Stock Pricing and
Number of Shares to be Issued."

----------------
RYAN, BECK & CO.
----------------

The date of this Prospectus is , 1997.

(continued from previous page)

stock, no par value per share (the "Common Stock" or "Company Common Stock"),
in connection with the conversion and reorganization (the "Conversion") of
Heritage Financial Corporation, MHC (the "Mutual Holding Company" or "MHC")
from a state chartered mutual holding company to a Washington stock
corporation. Heritage Savings Bank, a Washington stock savings bank ("Heritage
Bank" or the "Bank") is a 66.31% owned subsidiary of the MHC. The Conversion
will cause the Bank to become a wholly owned subsidiary of the Company and
will be effected pursuant to a Plan of Conversion and Reorganization (the
"Plan of Conversion" or "Plan"). At June 30, 1997, the Mutual Holding Company
held $120,000 in assets, in addition to 1,200,000 shares of common stock, par
value $1.00 per share, of the Bank ("Bank Common Stock"). The remaining
609,616 shares, or approximately 33.69% of the Bank Common Stock (the
"Minority Shares"), are owned by members of the public, including the Bank's
employees, directors, and existing Employee Stock Ownership Plan ("ESOP")
(together, the "Minority Stockholders"). The Minority Shares, as of
consummation of the Conversion (the "Effective Time"), will be exchanged for
Company Common Stock.

THE OFFERINGS. Pursuant to the Plan, nontransferable subscription rights to
subscribe for up to 4,140,0005,750,000 shares (subject to adjustment up to 4,761,0006,612,500
shares) of Common Stock (the "Conversion Stock") have been granted to certain
depositors and borrowers of the Bank as of specified record dates (the
"Subscription Offering"). In order of priority, the Subscription Offering is
being made to (i) depositors with $50.00 or more on deposit at the Bank as of
June 30, 1996 ("Eligible Account Holders"); (ii) the Bank's ESOP, a tax
qualified employee benefit plan; (iii) depositors with $50.00 or more on
deposit at the Bank as of ,September 30, 1997 ("Supplemental Eligible Account
Holders"); and (iv) depositors of the Bank as of ,October 24, 1997 ("Voting
Record Date") other than Eligible Account Holders and Supplemental Eligible
Account Holders, and borrowers with loans outstanding on July 21, 1993 which
continue to be outstanding as of ,October 24, 1997 ("Other Members").

Commencing concurrently with the Subscription Offering, the Company is
offering the shares of Conversion Stock not subscribed for in the Subscription
Offering in order of priority to (i) the Minority Stockholders as of October
24, 1997 who are not Eligible Account Holders, Supplemental Eligible Account
Holders or Other Members ("Minority Stockholders' Offering") and (ii) to
certain members of the general public to whom a copy of this Prospectus is
delivered by or on behalf of the Company (the "Community Offering"). The
Mutual Holding Company and the Bank have determined that the Bank's local
community consists of the counties of Thurston, Mason, Pierce, King,
Snohomish, Kitsap and Grays Harbor in the State of Washington (the "Local
Community"). In the Community Offering, a preference may be given to stock
orders from natural persons who are residents of the Local Community. It is
anticipated that shares of Conversion Stock not subscribed for in the
Subscription, Minority Stockholders' and Community Offerings, will be offered
on a best efforts basis by a selling group of broker-dealers to members of the
general public to whom a copy of this Prospectus is delivered by or on behalf
of the Company (the "Syndicated Community Offering"). The Subscription
Offering, Minority Stockholders' Offering, Community Offering and any
Syndicated Community Offering are referred to collectively as the "Offerings."
The Company reserves the right, in its absolute discretion, to accept or
reject, in whole or in part, any or all stock orders in the Minority
Stockholders' Offering, Community Offering or Syndicated Community Offering
either at the time of receipt of an order or as soon as practicable following
the termination of the Offerings. If an order is rejected in part, the
subscriber does not have the right to cancel the remainder of the order.
Purchase of shares of Conversion Stock in the Offerings are subject to
limitations. See "The Conversion--Limitations on Purchases and Ownership of
Shares."

The Company and the Bank have engaged Ryan Beck & Co., Inc. (hereinafter
referred to as "Ryan Beck" or the "Agent") to consult with and advise them in
the Conversion, and the Agent has agreed to use its best efforts to assist in
the sale of Conversion Stock in the Offerings and to manage any Syndicated
Community Offering. The Agent is not obligated to take or purchase any shares
of Common Stock in the Offerings. See "The Conversion--Marketing
Arrangements."

(continued from previous page)

THE SUBSCRIPTION OFFERING WILL EXPIRE AT NOON, PACIFIC TIME, ON , 1997
("EXPIRATION DATE"), UNLESS EXTENDED BY THE COMPANY FOR UP TO DAYS TO
, 1997. THE COMMUNITY OFFERING AND MINORITY STOCKHOLDERS' OFFERING ARE ALSO
EXPECTED TO TERMINATE AT NOON, PACIFIC TIME, ON , 1997, BUT MAY BE
EXTENDED. If the Conversion is not consummated within 45 days after the last
day of the Subscription Offering (which may conclude no later than ,
1997) and the Company elects to extend the Offerings, with the approval of the
Division, if necessary, subscribers will be notified in writing of the time
period within which they must notify the Company of any intention to increase,
decrease or rescind stock orders. If an affirmative response to any such
resolicitation is not received by the Company, a subscriber's stock order will
be rescinded and subscription funds will be returned promptly, together with
interest from the date such funds were received by the Company, and all
withdrawal authorizations from deposit accounts at the Bank will be
terminated. If the Offerings are not extended or, in any event, if the
Conversion is not consummated by , 1997, all stock orders will be
rescinded, funds returned and withdrawal authorizations terminated, as
described above.

THE EXCHANGE. In addition to the Offerings, each share of Bank Common Stock
held by the Mutual Holding Company will be canceled and each share of Bank
Common Stock held by the Minority Stockholders will be converted into shares
of Common Stock (the "Exchange Shares") pursuant to a ratio (the "Exchange
Ratio") that will result in the Minority Stockholders owning in the aggregate
approximately 32.12%32.17% of the Company (the "Exchange"), before giving effect to
certain items, including any shares of Conversion Stock purchased by such
Minority Stockholders in the Offerings. The dilution of Minority Stockholder
ownership interest from the 33.69% current ownership interest in the Bank to
an approximate 32.12%32.17% ownership interest in the Company reflects a policy of
the FDIC requiring the Exchange Ratio to be adjusted downward to reflect the
aggregate amount of Bank Common Stock dividends waived by the MHC and certain
assets held by the MHC. The Exchange Ratio is expected to be between 2.37523.3064
and 3.2135,4.4734, resulting in a range of between 1,447,9592,015,664 and 1,958,9982,727,075 Exchange
Shares to be issued in the Conversion (which may be increased to 2,252,8353,136,136
shares, as described below). THE ACTUAL EXCHANGE RATIO WILL BE BASED ON THE
NUMBER OF SHARES OF CONVERSION STOCK SOLD IN THE OFFERINGS AND THE MINORITY
STOCKHOLDERS' PERCENTAGE OWNERSHIP INTEREST IN THE BANK IMMEDIATELY PRIOR TO
THE EFFECTIVE TIME. THE EXCHANGE RATIO IS NOT DEPENDENT ON THE MARKET VALUE OF
THE MINORITY SHARES. SEE "SUMMARY--THE EXCHANGE RATIO."

INDEPENDENT VALUATION. Pursuant to applicable Washington law and regulations
of the FDIC, the offering of Conversion Stock in the Offerings is required to
be based on an independent valuation of the pro forma market value of the Bank
and the Mutual Holding Company. RP Financial prepared an independent appraisal
which states that the aggregate pro forma market value of the Bank, and the
Mutual Holding Company, inclusive
of the sale in the Offerings of an approximate 67.88%the MHC's ownership interest in the Offerings,Bank was
$53,034,770$73,713,696 at the midpoint as of the October 10, 1997 update of the original
August 15, 1997 and as updated on , 1997appraisal (the "Appraisal"). The Appraisal was multiplied by
67.88%67.83%, which is the Mutual Holding Company's percentage ownership interest in
the Bank as adjusted upward from the actual interest of 66.31% to reflect
$1,230,000 of dividends declared by the Bank and waived by the Mutual Holding
Company and the $120,000 in assets, other than Bank Common Stock, held by the
MHC. The resulting amount, $36,000,000,$50,000,000, is the midpoint of the dollar amount
of Conversion Stock to be offered in the Offerings. The minimum and maximum of
the offering range were set at 15% below and above the midpoint, respectively,
resulting in an offering range of $30,600,000$42,500,000 to $41,400,000$57,500,000 (the "Valuation
Price Range") of Conversion Stock. The Boards of Directors of the Company and
the Bank determined that the Conversion Stock would be sold at $10.00 per
share (the "Purchase Price"), resulting in a range of 3,060,0004,250,000 to 4,140,0005,750,000
shares of Conversion Stock being offered.

THE 6,098,9988,477,075 SHARES OF COMMON STOCK OFFERED HEREBY (SUBJECT TO ADJUSTMENT
UP TO 7,013,8359,748,636 SHARES AS DESCRIBED HEREIN) INCLUDE UP TO 4,140,0005,750,000 SHARES OF
CONVERSION STOCK AND UP TO 1,958,9982,727,075 SHARES OF EXCHANGE SHARES. The Valuation
Price Range, and therefore the number of shares offered, may be increased or
decreased prior to completion of the Conversion to reflect regulatory
considerations and changes in market and economic conditions. In any case,
however, through the Exchange Ratio, the Conversion Stock and the Exchange

(continued from previous page)

Shares will represent approximately 67.88%67.83% and 32.12%32.17%, respectively, of Common
Stock outstanding, unless the Company issues unissued shares to the ESOP
immediately following the Conversion. See "The Conversion--Stock Pricing and
Number of Shares to be Issued."

No resolicitation of subscribers will be made and subscribers will not be
permitted to modify or cancel their subscriptions unless (i) the gross
proceeds from the sale of the Conversion Stock are less than the minimum or
more than 15% above the maximum of the current Valuation Price Range or (ii)
the Offerings are extended beyond .

PURCHASE LIMITATIONS AND OWNERSHIP LIMITATION. The Plan sets forth purchase
limitations applicable to the Offerings. The minimum stock order is 25 shares.
Except for the ESOP, which is expected to purchase 8%2% of the Conversion Stock
sold, no person (or persons through a single subscription right), together
with any associate or group of persons acting in concert, may subscribe for
more than $250,000 in all categories of the Offerings combined. In addition to
these purchase limitations, no person, together with any associate or group of
persons acting in concert may, upon completion of the Conversion, own more
than 2% of the Common Stock outstanding. This ownership limitation pertains to
the aggregate of Conversion Stock purchased and Exchange Shares received by
the subscriber. Notwithstanding the foregoing, no Minority Stockholder will be
required to dispose of Minority Shares if, without purchasing Conversion
Stock, the Exchange will result in ownership of in excess of 2% of the Common
Stock. The purchase limitations and ownership limitation may be changed at the
discretion of the Company, as described herein. See "The Conversion--
Limitations on Purchases and Ownership of Shares."

REQUIRED APPROVALS. The consummation of the Conversion is subject to the
receipt of regulatory approvals from the Division, the FDIC and the Federal
Reserve, the ratification by members of the MHC and the approval of the
Minority Stockholders of the Bank in the manner set forth herein. See "The
Conversion--General."

MARKET FOR COMMON STOCK. The Company has received conditional approval to
have the Common Stock quoted on the National Association of Securities Dealers
Automated Quotation ("Nasdaq") National Market under the symbol "HFWA." ." There
can be no assurance that an active and liquid trading market for the Common
Stock will develop, or, if developed, be maintained. The Minority Shares,
which will be exchanged for Common Stock, are not traded on any exchange and
there is currently no established trading market for them.

[MAP SHOWS LOCATION OF THE COMPANY'S
OFFICES IN THURSTON, MASON AND PIERCE COUNTIES IN
THE STATE OF WASHINGTON]

THE CONVERSION IS CONTINGENT UPON THE RECEIPT OF ALL REQUIRED REGULATORY
APPROVALS, RATIFICATION BY MEMBERS OF THE MHC, APPROVAL BY THE STOCKHOLDERS OF
THE BANK, AND THE SALE OF AT LEAST THE MINIMUM NUMBER OF SHARES OFFERED
PURSUANT TO THE PLAN.

THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR DEPOSITS AND ARE
NOT INSURED OR GUARANTEED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY, NOR ARE
THEY INSURED OR GUARANTEED BY THE COMPANY OR THE BANK.

SUMMARY

The information set forth below should be read in conjunction with and is
qualified in its entirety by, the more detailed information and Consolidated
Financial Statements (including the Notes thereto) presented elsewhere in this
Prospectus. The purchase of Common Stock is subject to certain risks. This
Prospectus contains certain forward-looking statements within the meaning of
the federal securities laws. Actual results and timing of certain events could
differ materially from those projected in the forward-looking statements due to
a number of factors, including those set forth under "Risk Factors" and
elsewhere in this Prospectus.

HERITAGE FINANCIAL CORPORATION

The Company is a Washington corporation organized in August 1997 at the
direction of the Bank to hold all of the capital stock of the Bank upon
consummation of the Conversion. The Company has not engaged in any significant
business to date. Upon completion of the Conversion, the Company will be
regulated by the Federal Reserve. The Company has filed an application with the
Federal Reserve Bank of San Francisco to become a bank holding company and for
approval to acquire the Bank. Immediately following the Conversion, the only
significant assets of the Company will be the capital stock of the Bank, a
portion of the net proceeds of the Offerings and a note receivable from the
ESOP evidencing a loan from the Company to fund the purchase of Conversion
Stock by the Bank's ESOP. See "Use of Proceeds." Management believes that the
holding company structure and proceeds of the Offerings can facilitate possible
future acquisitions of other financial institutions, such as commercial banks
or savings institutions, or branches of other financial institutions and
thereby further expansion in existing and new market areas. The holding company
structure will also provide increased flexibility to the Company to diversify
into a variety of banking-related activities and to repurchase its stock. There
are no present plans, arrangements, agreements, or understandings, written or
oral, regarding any such acquisitions, activities or repurchases.

The main office of the Company is located at 201 5th Avenue S.W., Olympia,
Washington 98501 and its telephone number is (360) 943-1500.

HERITAGE BANK

The Bank was established in 1927 and has maintained its headquarters in
Olympia, Thurston County, Washington (the state capital) continuously since
that date and currently serves Thurston, Pierce and Mason Counties in the South
Puget Sound region of Washington as its primary market area. In 1992, the Bank
converted from a federally chartered mutual savings bank to a state chartered
mutual savings bank. In connection with the organization of the Mutual Holding
Company in 1994 (the "MHC Reorganization"), the Bank merged into an interim
institution formed as a subsidiary of the Mutual Holding Company, thereby
becoming a stock savings bank and a subsidiary of the Mutual Holding Company.
The Bank sold approximately 33.3% of its shares of common stock to the general
public and to an ESOP in connection with the MHC Reorganization. The MHC was
issued the remaining 66.7%. Stock options exercised by Minority Stockholders
have increased total outstanding shares to 1,809,616 at June 30, 1997.

The Bank is regulated by the Division as its primary state regulator and by
the FDIC as its primary federal regulator. The Bank's deposits have been
federally insured since 1935 by the FDIC (under the Savings Association
Insurance Fund ("SAIF")) and its predecessor, the Federal Savings and Loan
Insurance Corporation. The Bank has been a member of the Federal Home Loan Bank
("FHLB") System since 1932. At

June 30, 1997, the Bank had total assets of $242.2 million, total deposits of
$209.8 million and stockholders' equity of $27.7 million, or 11.44% of total
assets, on a consolidated basis.

. Geographic and Product Expansion

. Loan Portfolio Diversification

. Development of Relationship Banking

. Maintenance of Asset Quality

The Bank's strategy to date has resulted in the following changes in the
Bank's operations.

Geographic and Product Expansion. Since the end of fiscal 1994, the Bank has
doubled its number of offices, to ten full service locations. New branches were
opened in the West Olympia and Indian Summer areas of Thurston County in fiscal
1995, and an office was opened in Lakewood, Pierce County, in fiscal 1996. In
October 1996, an office was established in Tacoma, Pierce County, and the tenth
office was opened, in downtown Tacoma, in the spring of 1997. During the last
four years, the Bank has constructed new buildings in Lacey, Thurston County,
and Shelton, Mason County, to replace existing branch buildings and to better
serve customers in these markets. The Bank has installed Automated Teller
Machines at six of its offices. The Bank intends to continue its growth
strategy on a basis it considers prudent. The number and timing of future
branch openings will depend on various factors, including maintaining an
infrastructure to accommodate growth, targeting promising market areas, and, in
the case of acquisitions of financial institutions or branches, identifying
favorable opportunities.

Concurrent with geographic expansion, the Bank has (i) developed business
checking accounts and commercial lending products and other services for
businesses and high net worth individuals; (ii) introduced Visa debit and
credit cards; (iii) installed an automated voice response system for customer
account inquiries and (iv) developed products to assist realtors and potential
borrowers to obtain information about loan programs and qualifications. To
accommodate new products and to improve internal operating and reporting, the
Bank converted to a new data processing system with a data service bureau and
installed a personal computer network.

Loan Portfolio Diversification. Since initiating its expansion activities,
total loans increased to $208.2 million at June 30, 1997 from $130.4 million at
June 30, 1993. During this period, the Bank targeted growth in commercial
loans, taking advantage of market opportunities and the higher interest rates
and shorter terms of such loans relative to residential mortgage loans. As a
result, commercial loans increased to $39.4 million, or 18.95% of total loans,
from $1.2 million, or 0.92% of total loans, at June 30, 1993. One- to four-
family residential loans increased in amounts outstanding but decreased to
49.68% from 56.29% of total loans, and multifamily and commercial real estate
loans similarly increased in amounts outstanding while decreasing to 24.60%
from 30.97% of total loans during that period. Most of the Bank's commercial
business loans are collateralized by real estate, but repayment is expected
from a source other than operation or sale of the real estate. See "Business of
the Bank--Lending Activities."

addition was made for the purpose of enhancing the Bank's relationship banking
capacity and to establish a commercial banking presence in Pierce County. Since
that time, the Bank has also hired six additional lending officers who have
experience lending to small businesses and individuals in the Pierce County
market. While the banking market is very competitive, recent mergers of
regional commercial banks with significant presence in the Bank's principal
market areas have, in management's view, provided a greater opportunity for
community banks to fill a personal service niche which the Bank believes has
been created by the mergers. Management believes that the Bank can develop a
larger market share in the Pierce County market, while continuing to expand in
the Thurston and Mason County markets, by delivering efficient and personalized
banking service and developing relationships with small businesses and high net
worth individuals who are seeking a relationship with a responsive, service
oriented provider of financial services and products.

Maintenance of Asset Quality. While pursuing its growth strategy, the Bank
will continue its policy of seeking to employ consistent underwriting and loan
monitoring procedures, in order to maintain asset quality. The Bank's loan
portfolio grew 59.6% between June 30, 1993 and June 30, 1997. Nonperforming
loans remained less than $436,000 during the four year period, as did total
nonperforming assets. At June 30, 1997, nonperforming loans constituted 0.06%
of the Bank's total loans and the allowance for loan losses to nonperforming
loans was 2069.17%. See "Business of the Bank--Delinquencies and Nonperforming
Assets."

The Bank conducts business from its main office located at 201 5th Avenue
S.W., Olympia, Washington 98501 and its nine branch offices located in
Thurston, Pierce and Mason Counties of Washington. The Bank's telephone number
is (360) 943-1500.

THE MUTUAL HOLDING COMPANY

The MHC is a Washington chartered mutual holding company which was
incorporated in January 1994, in connection with the MHC Reorganization. The
Mutual Holding Company's only significant assets are approximately 66.31% of
the outstanding shares of Bank Common Stock and $120,000 in cash. Subsequent to
the MHC Reorganization, the Mutual Holding Company has engaged in no
significant activity other than holding the Bank Common Stock. Accordingly, the
information set forth in this Prospectus includes the Mutual Holding Company
but relates primarily to the Bank and its subsidiary. The Consolidated
Financial Statements reflect only the financial condition and results of
operations of the Bank and its subsidiaries.

THE CONVERSION AND THE OFFERINGS

On July 1, 1997, the Boards of Directors of the Bank and the Mutual Holding
Company adopted the Plan, which was subsequently amended. In August 1997 the
Bank incorporated the Company under Washington law as a wholly-owned subsidiary
of the Bank. Pursuant to the Plan, (i) the Mutual Holding Company will convert
from the mutual to stock form of organization and simultaneously merge into the
Bank, with the Bank being the surviving institution, and the shares of Bank
Common Stock currently held by the Mutual Holding Company will be canceled and
(ii) the Bank will then merge with an interim bank ("Interim"), with the Bank
being the surviving institution and becoming a wholly-owned subsidiary of the
Company.

Consummation of the Conversion is conditioned upon: (i) approval of the Plan
by the Division; (ii) the nonobjection of the FDIC; (iii) approval by the
Federal Reserve of the Company's acquisition of the Bank; (iv) approval of the
Plan by at least a majority of the total number of votes eligible to be cast by
members of the Mutual Holding Company; (v) approval of the Plan by a majority
of the votes cast by the Minority Stockholders; and (vi) successful completion
of the Offerings. Special Meetings of Members of the Mutual Holding Company and
stockholders of the Bank, called for the purpose of submitting the Plan for
approval, will be held on , 1997 (the "Special Meetings"). It is possible
that there could be a significant delay in the completion of the Conversion as
a result of, among other things, delays in receiving approval by the Division
or

the Federal Reserve, or a notice of nonobjection to the Conversion from the
FDIC, or by difficulty in completing the Offerings due to market conditions.
See "Risk Factors--Risk of Delayed Offering."

The Board of Directors of the Bank believes that the Conversion offers a
number of advantages which will be important to the future growth and
performance of the Bank. The Conversion is intended to: (i) provide
substantially increased capital to expand the operations of the Bank; (ii)
improve future access to capital markets; (iii) enhance the Company's and the
Bank's ability to expand directly or through mergers and acquisitions and to
diversify operations into new business activities (although there are no
specific agreements, arrangements or understandings, written or oral, regarding
any such mergers or diversified activities); and (iv) afford customers and
others the opportunity to become stockholders of the Company and thereby
participate more directly in any future growth of the Company and the Bank.
Additionally, by converting to the stock holding company form of organization,
the Company will be structured in the form used by many commercial banks and
business entities and a growing number of savings institutions.

The Company is offering up to 4,140,0005,750,000 (or 4,761,0006,612,500 if the Valuation Price
Range is increased by 15%) shares of Conversion Stock at $10.00 per share to
holders of subscription rights in the following order of priority: (i) Eligible
Account Holders; (ii) the Bank's ESOP; (iii) Supplemental Eligible Account
Holders; and (iv) Other Members. In the event the number of shares offered in
the Conversion is increased above the maximum of the Valuation Price Range, the
Bank's ESOP shall have a second priority right, after Eligible Account Holders,
to purchase any such shares exceeding the maximum of the Valuation Price Range
up to an aggregate of 8%2% of the Conversion Stock sold in the Offerings.
Concurrently, and subject to the prior rights of holders of subscription
rights, any shares of Conversion Stock not subscribed for in the Subscription
Offering are being offered by the Company, in order of priority, in (i) the
Minority Stockholders' Offering to Minority Stockholders and (ii) in the
Community Offering to certain members of the general public. Preference may be
given in the Community Offering to natural persons who are permanent residents
of the Local Community. The Bank has engaged Ryan Beck to consult with and
advise the Company and the Bank in the Offerings and Ryan Beck has agreed to
use its best efforts to assist the Company in the sale of Conversion Stock in
the Offerings. Ryan Beck is not obligated to take or purchase any shares of
Conversion Stock in the Offerings. If all shares of Conversion Stock are not
sold through the Subscription, Minority Stockholders', and Community Offerings,
then the Company expects to offer the remaining shares to the general public in
a Syndicated Community Offering managed by Ryan Beck. All shares of Conversion
Stock will be sold at the $10.00 Purchase Price per share in the Offerings. See
"Use Of Proceeds," "Pro Forma Data" and "The Conversion--Stock Pricing and
Number of Shares to be Issued."

The Subscription Offering will expire at Noon, Pacific Time, on ,
unless extended by the Bank and the Company. The Minority Stockholders'
Offering, Community Offering and Syndicated Community Offering may terminate on
the same date, however in no event later than , 1997, unless extended
pursuant to regulatory approval. See "The Conversion."

EFFECTS OF THE EXCHANGE ON MINORITY STOCKHOLDERS

The following are effects of the Conversion on Minority Stockholders,
assuming that at the minimum, midpoint, maximum and 15% above the maximum of
the Valuation Price Range, one Minority Share will be exchanged for 2.3752,
2.7943, 3.21353.3064,
3.8899, 4.4734 and 3.69555.1444 shares of Common Stock, respectively. See "Pro Forma
Data."

Effect of the Exchange on Stockholders' Equity Per Share. The Conversion will
increase the stockholders' equity per share of Minority Stockholders. At June
30, 1997, stockholders' equity was $15.31 for each share of the Bank Common
Stock outstanding, including shares held by the Mutual Holding Company. Based
on the pro forma information set forth in "Pro Forma Data" assuming the sale of
3,600,0005,000,000 shares of Conversion Stock at the midpoint of the Valuation Price
Range, at June 30, 1997, the pro forma stockholders' equity per share of Common
Stock was $11.04,$10.20, and the pro forma stockholders' equity for the aggregate
number of Exchange

Shares to be received for each Minority Share was $30.85.$39.68. The pro forma
stockholders' equity at June 30, 1997 for the aggregate number of Exchange
Shares to be received for each Minority Share was $28.41, $33.32$35.87, $43.44 and $36.14$47.79 at
the minimum, maximum, and adjusted maximum of the Valuation Price Range.

Effect of the Exchange on Earnings Per Share. The Conversion will also affect
Minority Stockholders' pro forma earnings per share. For the year ended June
30, 1997, the earnings per share was $1.26 for each share of the Bank Common
Stock outstanding, including shares held by the Mutual Holding Company. Based
on the pro forma information set forth in "Pro Forma Data," assuming the sale
of 3,600,0005,000,000 shares of Common Stock at the midpoint of the Valuation Price
Range, the pro forma earnings per share of Common Stock was $0.66$0.59 for such
period, and the pro forma earnings for the aggregate number of Exchange Shares
to be received for each Minority Share was $1.84.$2.30. For the year ended June 30,
1997, the pro forma earnings per share for the aggregate number of Exchange
Shares to be received for each Minority Share was $1.76, $1.93$2.12, $2.46 and $2.03$2.62 at the
minimum, maximum, and adjusted maximum of the Valuation Price Range.

Effect of the Exchange on Market Value. The aggregate number of Exchange
Shares to be received for each share of Bank Common StockMinority Share will have a calculated estimated
value of $23.75, $27.94, $32.13$33.06, $38.90, $44.73 and $36.95$51.44 at the minimum, midpoint, maximum
and adjusted maximum of the Valuation Price Range based on the $10.00 Purchase
Price of the Conversion Stock. The most recent known stock trade of Minority
Shares preceding the date of this Prospectus was March 12,August 8, 1997 at a price of
$18.00.

PROSPECTUS DELIVERY AND PROCEDURE FOR PURCHASING SHARES

To ensure that each purchaser receives a Prospectus at least 48 hours prior
to the Expiration Date, Prospectuses may not be mailed later than five days
prior to such date or be hand delivered later than two days prior to such date.
Order forms may only be distributed with a Prospectus. Execution of a stock
order form will confirm receipt or delivery of the Prospectus. The Company will
not be required to accept orders submitted on photocopied or telecopied stock
order forms. Payment in full by check, bank draft, money order, or withdrawal
authorization from any existing certificate of deposit or other deposit account
at the Bank must accompany each stock order form. The Bank is prohibited from
lending funds for the purchase of the Conversion Stock. See "The Conversion--
Procedure for Purchasing Shares in Offerings."

To help ensure that each prospective purchaser is properly identified as to
such person's stock purchase priority and to assist in stock allocation in the
event of oversubscription, depositors as of the Eligibility Record Date and
Supplemental Eligibility Record Date must list on the order form all Bank
deposit accounts as of the applicable date, giving all account holders names
for each account number. Failure to list all accounts may result in the
subscriber's loss of subscription rights.

PURCHASE LIMITATIONS AND OWNERSHIP LIMITATION

The Plan sets forth purchase limitations applicable to the Offerings. The
minimum stock order is 25 shares. Except for the ESOP, which is expected to
purchase 8%2% of the Conversion Stock sold, no person (or persons through a
single subscription right), together with any associate or group of persons
acting in concert, may subscribe for more than $250,000 in all categories of
the Offerings combined. In addition to these purchase limitations, no person,
together with any associate or group of persons acting in concert may, upon
completion of the Conversion, own more than 2% of the Common Stock outstanding.
This ownership limitation pertains to the aggregate of Conversion Stock
purchased and Exchange Shares received by the subscriber. Notwithstanding the
foregoing, no Minority Stockholder will be required to dispose of Minority
Shares if, without purchasing Conversion Stock, the Exchange will result in
ownership of in excess of 2% of the Common Stock. The purchase limitations and
ownership limitation may be changed at the discretion of the Company, as
described herein. See "The Conversion--Limitations on Purchases and Ownership
of Shares".

STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED IN THE CONVERSION

Pursuant to applicable Washington law and regulations of the FDIC, the
offering of Conversion Stock in the Offerings is required to be based on an
independent valuation of the pro forma market value of the Bank and the Mutual
Holding Company. RP Financial prepared an independent appraisal, which states
that the aggregate pro forma market value of the Bank and the Mutual Holding
Company, inclusive of the sale of an approximate 67.88%67.83% ownership interest in
the Offerings, was $53,034,770$73,713,696 at the midpoint as of the October 10, 1997
update of the original August 15, 1997 and as
updated on , 1997.Appraisal. The Appraisal was multiplied
by 67.88%67.83%, which is the Mutual Holding Company's percentage ownership interest
in the Bank as adjusted upward from the actual interest of 66.31% to reflect
$1,230,000 of dividends declared by the Bank and waived by the Mutual Holding
Company and the $120,000 in assets held by the MHC. The resulting amount,
$36,000,000,$50,000,000, is the midpoint of the dollar amount of Conversion Stock to be
offered in the Offerings. The minimum and maximum of the offering range were
set at 15% below and above the midpoint, respectively, resulting in an offering
range of $30,600,000$42,500,000 to $41,400,000$57,500,000 of Conversion Stock. The Boards of
Directors of the Company and the Bank determined that the Conversion Stock
would be sold at $10.00 per share Purchase Price, resulting in a range of
3,060,0004,250,000 to 4,140,0005,750,000 shares of Conversion Stock being offered. The $10.00
Purchase Price in the Offerings is a uniform price for all subscribers,
including the Bank's Board of Directors, its management and ESOP. See "The
Conversion--Stock Pricing and Number of Shares to be Issued."

THE APPRAISAL IS BASED ON A NUMBER OF FACTORS AND IS NOT INTENDED AND SHOULD
NOT BE CONSTRUED AS A RECOMMENDATION OF ANY KIND AS TO THE ADVISABILITY OF
PURCHASING CONVERSION STOCK NOR CAN ASSURANCE BE GIVEN THAT PURCHASERS OF THE
CONVERSION STOCK OR RECIPIENTS OF THE EXCHANGE SHARES WILL BE ABLE TO SELL SUCH
SHARES AFTER THE CONVERSION AT A PRICE THAT IS EQUAL TO OR ABOVE THE PURCHASE
PRICE. Further, the pro forma stockholders' equity reflected in "Pro Forma
Data" is not intended to represent the fair market value of the Common Stock
and may be greater than amounts that would be available for distribution to
stockholders in the event of liquidation.

If necessary, depending on regulatory considerations and changes in market
and financial conditions or material changes in the financial condition or
performance of the Bank, the Valuation Price Range may be revised based on an
updated Appraisal prepared by RP Financial and approved by applicable
regulatory agencies. The actual number of shares of Conversion Stock sold must
be supported by a final Appraisal. No resolicitation of subscribers will be
made and subscribers will not be permitted to modify or cancel their
subscriptions unless the gross proceeds from the sale of the Conversion Stock
are less than the minimum or more than 15% above the maximum of the current
Valuation Price Range or the Offerings are extended beyond .

THE EXCHANGE RATIO

The Bank and the Mutual Holding Company must demonstrate to the satisfaction
of the Division and the FDIC that the basis for the Exchange is fair and
reasonable. The Boards of Directors of the Bank and the Company have determined
that each Minority Share will, on the Effective Time, be converted into
Exchange Shares through the Exchange Ratio. The Exchange Ratio ensures that
Minority Stockholders will own approximately the same aggregate percentage of
the outstanding Common Stock (which will consist of Conversion Stock plus
Exchange Shares) as they own of the outstanding Bank Common Stock immediately
prior to the Effective Time. The Minority Stockholders, however, will
experience a dilution in ownership interest, from a 33.69% current ownership
interest in the Bank to an approximately 32.12%32.17% interest in the Company. This
is because the FDIC requires that the Exchange Ratio be adjusted downward to
reflect the aggregate amount of Bank Common Stock dividends waived by the
Mutual Holding Company and the amount of assets other than Bank Common Stock
held by the Mutual Holding Company. See "The Conversion--The Exchange."

Based on the 609,616 Minority Shares outstanding at June 30, 1997, the
Exchange Ratio is expected to be within a range of 1,447,9592,015,664 to 1,958,9982,727,075
Exchange Shares for the Minority Shares outstanding immediately prior to the
Effective Time. See "The Conversion--Stock Pricing and Number of Shares to be
Issued."

The following table sets forth, based upon the minimum, midpoint, maximum and
15% above the maximum of the Valuation Price Range: (i) the total number of
shares of Conversion Stock and Exchange Shares to be issued in the Conversion;
(ii) the percentage of the total Common Stock represented by the Conversion
Stock and the Exchange Shares; and (iii) the Exchange Ratio. The table assumes
that there is no cash paid in lieu of issuing fractional Exchange Shares.

CONVERSION STOCK EXCHANGE SHARES TOTAL SHARES
OF
TO BE ISSUED(1) TO BE ISSUED(1) OF COMMON
----------------- ----------------- STOCK TO
----------------- ----------------- BE EXCHANGE
AMOUNT PERCENT AMOUNT PERCENT OUTSTANDING(2) RATIO
--------- ------- --------- ------- ----------------------------- --------

Minimum................. 3,060,000 67.88% 1,447,959 32.12% 4,507,959 2.37524,250,000 67.83% 2,015,664 32.17% 6,265,664 3.3064
Midpoint................ 3,600,000 67.88 1,703,449 32.12 5,303,449 2.79435,000,000 67.83 2,371,369 32.17 7,371,369 3.8899
Maximum................. 4,140,000 67.88 1,958,998 32.12 6,098,998 3.21355,750,000 67.83 2,727,075 32.17 8,477,075 4.4734
15% above maximum ...... 4,761,000 67.88 2,252,835 32.12 7,013,835 3.69556,612,500 67.83 3,136,136 32.17 9,748,636 5.1444

- --------

(1) Assumes that outstanding options to purchase 42,717 shares of Bank Common
Stock at June 30, 1997 are not exercised prior to consummation of the
Conversion. Assuming that all of such options are exercised prior to such
consummation, the percentages represented by the Conversion Stock and the
Exchange Shares would amount to 66.40% and 33.60% respectively, and the
Exchange Ratio would amount to 2.4838, 2.9233, 3.3628,3.2968, 3.8786, 4.4604 and 3.86825.1294 at the
minimum, midpoint, maximum and 15% above the maximum of the Valuation Price
Range, respectively.
(2) Assumes that the Company does not issue authorized, but unissued shares to
the ESOP immediately following the Conversion.

THE ACTUAL EXCHANGE RATIO IS NOT DEPENDENT ON THE MARKET VALUE OF MINORITY
SHARES. IT WILL BE CALCULATED BASED UPON THE NUMBER OF SHARES OF CONVERSION
STOCK SOLD IN THE OFFERINGS AND THE MINORITY STOCKHOLDERS' PERCENTAGE OWNERSHIP
INTEREST IN THE BANK IMMEDIATELY PRIOR TO THE EFFECTIVE TIME. THE EXCHANGE
RATIO IS NOT DEPENDENT ON THE MARKET VALUE OF THE MINORITY SHARES.

RESTRICTIONS ON TRANSFER OF SUBSCRIPTION RIGHTS AND SHARES

No person may transfer or enter into any agreement or understanding to
transfer the legal or beneficial ownership of the subscription rights issued
under the Plan or to transfer the shares of Conversion Stock to be issued upon
their exercise. Each person exercising subscription rights will be required to
certify that a purchase of Conversion Stock is solely for the purchaser's own
account and that there is no agreement or understanding regarding the sale or
transfer of such shares. The Company and the Bank will pursue any and all legal
and equitable remedies in the event they become aware of the transfer of
subscription rights and will not honor subscriptions known by them to involve
the transfer of such rights.

Following the Conversion there generally will be no restrictions on the
transfer or sale of shares by purchasers other than affiliates of the Company
and the Bank. See "Supervision and Regulation--Federal Securities Laws" and
"The Conversion--Restrictions on Transferability by Directors and Officers and
NASD Members."

BENEFITS OF THE CONVERSION TO MANAGEMENT

ESOP. The Bank currently has an ESOP, a tax-qualified employee benefit plan
for officers and employees of the Company and the Bank, which intends to
purchase 8%2% of the Conversion Shares. The ESOP owned 21,763 shares of Bank
Common Stock at June 30, 1997.1997, all of which were allocated to participants'
accounts. For additional information concerning the ESOP, see "Management--Benefits--Employee"Management--
Benefits--Employee Stock Ownership Plan.Plan" and "Risk Factors--Possible Dilutive
Effects of Benefit Plans."

MRP. The Company intends to seek stockholder approval of a Management
Recognition Plan and Trust ("MRP") at a meeting of stockholders occurring no
earlier than six months following consummation of the

Conversion. The MRP, which will be funded with a number of shares of Common
Stock equal to up to 4%1% of the number of shares of Conversion Stock issued in
the Conversion, is a non-tax-qualified restricted stock plan intended for the
benefit of key employees and directors of the Company and the Bank. If
stockholder approval of the MRP is obtained, it is expected that shares of
Common Stock of the Company will be awarded at no cost to such recipients. For
additional information concerning the MRP and shares intended to be awarded
thereunder, see "Management--Benefits--Management Recognition Plan."

Stock Option Plan. The Company intends to seek stockholder approval of a
stock option plan ("1998 Stock Option Plan"), which will reserve a number of
shares of Common Stock equal to up to 10% of the number of shares of Conversion
Stock in the Conversion, at a meeting of stockholders occurring no earlier than
six months following consummation of the Conversion. If stockholder approval of
the 1998 Stock Option Plan is obtained, it is expected that options to acquire
up to 414,000575,000 shares of Common Stock will be awarded to key employees and
directors of the Company and the Bank (based on the issuance of the maximum of
the Valuation Price Range). The exercise price of such options will be 100% of
the fair market value of the Common Stock on the date the option is granted.
Options granted to officers and directors are valuable only to the extent that
such options are exercisable and the market price for the underlying share of
Common Stock is in excess of the exercise price. An option effectively
eliminates the market risk of holding the underlying security since no
consideration is paid for the option until it is exercised and, therefore, the
recipient may, within the limits of the term of the option wait to exercise the
option until such time as the market price exceeds the exercise price. For
additional information concerning the 1998 Stock Option Plan and options
intended to be granted thereunder, see "Management--Benefits--1998 Stock Option
Plan."

Employment and Severance Agreements. Effective October 1, 1997, the Company
entered into an employment agreement with Mr. Donald V. Rhodes, the Chief
Executive Officer of the Company and the Bank, for a term which initially
expires on March 14, 2001 and renews annually thereafter unless terminated by
either the Company or Mr. Rhodes. The Bank has also entered into severance
agreements with Messrs. John D. Parry and Brian L. Vance, both Executive Vice
Presidents, and with a total of 7 additional key members of management. The
agreement with Mr. Rhodes provides that he will be entitled to compensation for
up to three years in the event of a change in control of the Bank or the
Company and two years in certain other circumstances. The agreements with
Messrs. Parry and Vance provide that each will be entitled to compensation for
up to two years in the event of a change in control of the Bank or the Company.
The agreements with the additional officers provide that each will be entitled
to compensation for one year in the event of a change in control of the Bank or
the Company. See "Management--Executive Compensation--Employment and Severance
Agreements."

For information concerning the possible voting control of officers, directors
and employees following the Conversion, see "Risk Factors--Voting Power of
Directors and Executive Officers."

USE OF PROCEEDS

Depending upon the number of shares sold and the expenses of the Conversion,
net proceeds from the sale of the Conversion Stock are estimated to range from
$29.7$41.4 million to $40.4$56.2 million (or $46.5$64.7 million if the Valuation Price Range
is increased by 15%). See "Pro Forma Data." After giving effect to the proposed
purchase of shares by the ESOP and MRP, the Company plans to contribute to the
Bank 50% of the net proceeds and retain the remaining net proceeds. This would
result in the Company retaining approximately $17.5$24.4 million of net proceeds
(50% of $35.1$48.8 million) based on the issuance of 3,600,0005,000,000 shares at the
midpoint of the Valuation Price Range.

Because shares of Conversion Stock may be purchased in the Offerings by Bank
customers using funds on deposit at the Bank, the net amount of funds available
to the Bank following the Offerings will be reduced to the extent that shares
are purchased with funds on deposit. Net proceeds contributed to the Bank will
increase the Bank's capital. The Bank will use the funds contributed to it for
general corporate purposes, including increased

lending, possible purchase of loan participation, and investment in securities
of the type currently held by the Bank. In addition, depending on the level of
market interest rates following consummation of the Conversion, the Bank may
use a portion of the proceeds to retire any outstanding FHLB advances.

A portion of the net proceeds retained by the Company will be used for a loan
by the Company to the Bank's ESOP to fund the ESOP's purchase of shares in the
Offerings. The remaining net proceeds will initially be invested primarily in
U.S. Government and agency securities and other investment securities of the
type currently held by the Bank. Such proceeds will be available for additional
contributions to the Bank in the form of debt or equity, to support future
internal growth of the Bank and the Company, for possible future acquisitions
of financial institutions or branches, as a source of dividends to the
stockholders of the Company, and for future repurchases of Common Stock to the
extent permitted under applicable law and regulations. Currently, as discussed
below under "Use of Proceeds," there are no specific plans, arrangements,
agreements or understandings, written or oral, regarding any such acquisitions
or repurchases.

8
MARKET FOR COMMON STOCK

The Company has received conditional approval to have the Common Stock listed
on the Nasdaq National Market under the symbol "HFWA." ." Ryan Beck has agreed to
act as a market maker for the Company's Common Stock following consummation of
the Conversion. No assurance can be given that an active and liquid trading
market for the Common Stock will develop, or, if developed, be maintained.
Further, no assurance can be given that purchasers will be able to sell their
shares at or above the Purchase Price after the Conversion. See "Risk Factors--
Absence of Prior Market for the Common Stock" and "Market for Common Stock."

DIVIDENDS

DISSENTERS' RIGHTS

The Plan of Conversion provides that stockholders of the Bank have the right
to dissent from the mergers of the Bank with the MHC and with an interim bank
formed to facilitate the Conversion, with the Bank as the surviving entity in
each merger, and, subject to certain conditions, to receive payment of the
"value" of their shares of Bank Common Stock, as provided in the Washington
Business Corporation Act ("WBCA"), Revised Code of Washington, Chapter 23B.13.
See "The Conversion--The Exchange" and "--Dissenters' Rights."

RISK FACTORS

See "Risk Factors" for a discussion of certain risks that should be
considered by all prospective investors.

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

The following table sets forth selected consolidated financial and other data
of the Bank at the dates and for the periods indicated. This information is
derived from and is qualified in its entirety by reference to the detailed
information and Consolidated Financial Statements and Notes thereto presented
elsewhere in this Prospectus.

SUMMARY CONSOLIDATED FINANCIAL INFORMATION

FOR THE YEARS ENDED JUNE 30
-----------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

OPERATIONS DATA:
Net interest income.... $ 6,363 $ 6,788 $ 8,227 $ 8,332 $ 9,512
Provision for loan
losses................ 926 -- -- -- (270)
Noninterest income..... 4,648 4,019 3,040 4,298 3,347
Noninterest
expense(1)............ 6,178 7,421 7,425 8,422 11,105
Federal income tax
expense (benefit)..... 2,061 1,154 1,308 1,435 (245)
Net income............. 1,846 2,232 2,534 2,773 2,269
Earnings per share(2).. N.A. $ 0.35 $ 1.41 $ 1.54 $ 1.26
PERFORMANCE RATIOS:
Net interest
spread(3)............. 3.35% 3.45% 4.14% 3.84% 4.06%
Net interest
margin(4)............. 3.72 3.83 4.57 4.31 4.50
Efficiency ratio(1).... 56.11 68.67 65.90 66.68 77.89
Return on average
assets................ 1.03 1.18 1.30 1.31 0.99
Return on average
equity................ 15.11 13.05 11.67 11.38 8.62

AT JUNE 30
-----------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

BALANCE SHEET DATA:
Total assets........... $ 179,236 $ 194,102 $ 204,897 $ 222,052 $ 242,164
Loans receivable, net.. 121,356 123,258 150,526 161,744 199,188199,118
Loans held for sale.... 7,435 4,110 5,944 5,286 6,323
Deposits............... 153,266 165,922 174,797 191,119 209,781
FHLB advances.......... -- -- -- -- 890
Other borrowed funds... 7,174 4,100 3,252 -- --
Stockholders' equity... $ 12,863 $ 20,662 $ 23,065 $ 25,633 $ 27,714
Book value per share... N.A. $ 11.48 $ 12.78 $ 14.20 $ 15.31
Equity to assets
ratio................. 7.18% 10.64% 11.26% 11.54% 11.44%
ASSET QUALITY RATIOS:
Nonperforming loans to
loans................. 0.07% 0.07% 0.06% 0.03% 0.06%
Allowance for loan
losses to loans....... 1.27 1.32 1.09 1.11 1.32
Allowance for loan
losses to
nonperforming loans... 1,709.28 1,776.04 1,791.67 3,672.55 2,069.17
Nonperforming assets to
total assets.......... 0.14 0.05 0.05 0.02 0.05
OTHER DATA:
Number of full service
banking offices....... 5 5 7 8 10
Number of full-time
equivalent employees.. 98 119 116 136 145

- --------

(1) The efficiency ratio is recurring noninterest expense divided by the sum of
net interest income and noninterest income. The Bank paid a one-time
deposit assessment of $1.1 million to the FDIC, Savings Association
Insurance Fund in November 1996 which was excluded from the calculation of
the efficiency ratio for 1997.
(2) The Bank became a stock bank as of January 31, 1994. Per share data prior
to 1994 is not applicable. The earnings per share data for 1994 is
calculated using only the earnings for the five months ended June 30, 1994.
Weighted average number of shares of Bank Common Stock outstanding during
the years ended June 30, 1994, 1995, 1996 and 1997 were 1,800,000
1,800,000, 1,805,166 and 1,807,910, respectively.
(3) Net interest spread is the difference between the average yield on interest
earning assets and the average cost of interest bearing liabilities.
(4) Net interest margin is net interest income divided by average interest
earning assets.

RECENT DEVELOPMENTS

The following table sets forth selected consolidated financial and other data
at the dates and for the periods indicated. The data at September 30, 1997, and
for the three months ended September 30, 1997 and 1996, are unaudited and, in
the opinion of management, contain all adjustments (none of which were other
than normal recurring entries) necessary for a fair presentation of the results
for such unaudited periods. The selected operations data for the three months
ended September 30, 1997 are not necessarily indicative of the results of
operations for the entire fiscal year. This information should be read in
conjunction with the Consolidated Financial Statements and Notes thereto
presented elsewhere in this Prospectus.

SUMMARY CONSOLIDATED FINANCIAL INFORMATION

FOR THE THREE
MONTHS
ENDED SEPTEMBER 30,
--------------------
1996 1997
----------- -----------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)

OPERATIONS DATA:
Net interest income.................................... $ 2,213 $ 2,645
Provision for loan losses.............................. -- 30
Noninterest income..................................... 867 893
Noninterest expense.................................... 3,414 2,563
Federal income tax expense (benefit)................... (1,051) 335
Net income............................................. 717 610
Earnings per share..................................... $ 0.40 $ 0.34
PERFORMANCE RATIOS:(1)
Net interest spread(2)................................. 3.83% 4.22%
Net interest margin(3)................................. 4.30% 4.70%
Efficiency ratio(4).................................... 75.49% 72.44%
Return on average assets............................... 1.28% 1.00%
Return on average equity............................... 11.23% 8.87%

AT JUNE 30, AT SEPTEMBER 30,
1997 1997
----------- ----------------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE DATA)

BALANCE SHEET DATA:
Total assets................................. $ 242,164 $248,704
Loans receivable, net........................ 199,188 202,028
Loans held for sale.......................... 6,323 5,451
Deposits..................................... 209,781 216,948
FHLB advances................................ 890 --
Other borrowed funds......................... -- --
Stockholders' Equity......................... 27,714 28,324
Book value per share......................... $ 15.31 $ 15.65
Equity to assets ratio....................... 11.44% 11.39%
ASSET QUALITY RATIO:
Nonperforming loans to loans................. 0.06% 0.23%
Allowance for loan losses to loans........... 1.32 1.32
Allowance for loan losses to nonperforming
loans....................................... 2,069.17 564.37
Nonperforming assets to total assets......... 0.05 0.20
OTHER DATA:
Number of full service banking offices....... 10 10
Number of full-time equivalent employees..... 145 145

- --------

(1) On an annualized basis, except for calculation of the efficiency ratio.

(2) Net interest spread is the difference between the average yield on interest
earning assets and the average cost of interest bearing liabilities.

(3) Net interest margin is net interest income divided by average interest
earning assets.

(4) The efficiency ratio is recurring noninterest expense divided by the sum of
net interest income and noninterest income, excluding nonrecurring items.
The Bank accrued a one-time deposit assessment of $1.1 million to the
Savings Association Insurance Fund in September 1996 which was excluded
from the calculation of the efficiency ratio for the three months ended
September 30, 1996.

NONPERFORMING ASSETS AND DELINQUENCIES

At September 30, 1997, the Bank had $493,000 of loans accounted for on a
nonaccrual basis ($344,000 in single family mortgage loans and $149,000 in an
undeveloped land loan) compared to $133,000 at June 30, 1997. At September 30,
1997 and June 30, 1997, the Bank had no accruing loans which were contractually
past due 90 days or more, no restructured loans and no real estate owned.

The allowance for loan losses was $2.8 million at September 30, 1997 and June
30, 1997. There were no charge-offs and no recoveries for the three months
ended September 30, 1997.

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
AND 1996

Net Income. Net income for the three months ended September 30, 1997, was
$610,000, or $0.34 per share, compared to $717,000, or $0.40 per share, for the
three months ended September 30, 1996. During the quarter ended September 30,
1996, based on recent legislation the Bank accrued $1.1 million for a one-time
special assessment by the FDIC on all SAIF-insured institutions to recapitalize
the SAIF deposit insurance fund. The Bank also reversed a $938,000 deferred tax
liability related to the potential recapture of the pre-1988 additions to the
tax bad debt reserve. Excluding the impact of these two nonrecurring items, net
income for the three months ended September 30, 1996, would have been $498,000,
or $0.28 per share. Thus, on a comparable fully taxed basis, net income in the
first quarter of 1997 increased by $112,000, or $0.06 per share. The increase
in net income on such a comparable basis was primarily attributable to an
increase in net interest income partially offset by an increase in noninterest
expense.

Net Interest Income. Net interest income increased $431,000, or 19.5%, to
$2.6 million for the three months ended September 30, 1997, compared to $2.2
million for the three months ended September 30, 1996. The increase was
primarily due to a $19.4 million, or 9.4%, increase in the average balance of
earning assets resulting from a $37.3 million increase in the average balance
of loans and a decline in other interest earning assets.

Net interest margin for the three months ended September 30, 1997 increased
to 4.70% from 4.30% for the same period in 1996. The increase in margin was
attributable to growth in assets and a shift from lower yielding investments,
interest earning deposits and mortgage-backed securities into higher yielding
loans, particularly commercial loans, coupled with a decrease in the average
cost of interest bearing deposits, particularly certificates of deposit.

Provisions for Loan Losses. The provision for loan losses for the three
months ended September 30, 1997 was $30,000. There was no provision for loan
losses during the same period in 1996. The allowance for loan losses at
September 30, 1997 and June 30, 1997 was $2.8 million, or 1.32% of loans. At
September 30, 1997, management deemed the allowance for loan losses adequate to
cover reasonably foreseeable losses in the Bank's loan portfolio.

Noninterest Income. There was no significant change in total noninterest
income in the period ended September 30, 1997, compared with the same period in
1996. In August 1997, the Bank recognized income of $36,000 from a settlement
with a title company concerning a boundary line adjustment at the Bank's
Spanaway branch. Service charges on deposits increased $12,000, or 10.6%, due
to growth in business and personal checking accounts. Gains on sales of loans
decreased $34,000, or 5.9%, due to a lower volume of mortgage loans sold in the
1997 quarter.

Noninterest Expense. Excluding the impact of the $1.1 million one-time SAIF
assessment which the Bank accrued in September 1996, noninterest expense
increased $238,000, or 10.2%, for the three months ended September 30, 1997,
compared with the same period in 1996. The increase was attributable to the
Bank's expansion of its branch network in Pierce County and the continued
development of the Bank's relationship banking capacity. Salaries and employee
benefits increased $157,000, or 11.9%, $81,000 of which resulted from the
hiring of two additional experienced commercial lending officers in Pierce
County and three branch staff for

the two new Pierce County branches (80th and Pacific Branch opened in October
1996 and Pierce County Business Banking Center opened in April 1997). The
remaining increase in salaries and employee benefits was primarily the result
of lower capitalized loan costs during the three months ended September 30,
1997, due to a lower volume of mortgage loans originated. Occupancy expense
increased $49,000, or 13.2%, as a result of the operating costs of the two
Pierce County branch facilities opened after September 1996. FDIC premiums and
special assessments decreased $851,000, or 97.4%, due to the absence of the
nonrecurring $1.1 million special SAIF assessment mentioned above. Excluding
this special assessment, FDIC premiums decreased $78,000, or 71.4%, as the FDIC
reduced the Bank's federal deposit insurance premiums from 0.23% (on an
annualized basis) of insured deposits for the quarter ended September 30, 1996,
to 0.06% of insured deposits for the quarter ended September 30, 1997.

Income Taxes. Provision for federal income taxes was $335,000 for the three
months ended September 30, 1997, compared to a federal income tax benefit of
$1.1 million for the three months ended September 30, 1996. The federal income
tax benefit for the 1996 quarter reflects the reversal of the $938,000 deferred
tax liability mentioned above and the impact of the $1.1 million special SAIF
assessment.

13
RISK FACTORS

Before investing in shares of the Common Stock offered hereby, prospective
investors should carefully consider the matters presented below, in addition
to matters discussed elsewhere in this Prospectus.

RISKS OF PURSUING GROWTH STRATEGY

The Bank's ability to pursue its growth strategy successfully is
significantly dependent upon generating an increasing volume of loans and
deposits, through internal growth or by acquisitions of banks or branches, at
acceptable risk levels and upon acceptable terms. The Bank has expanded its
loans to $208.2 million at June 30, 1997, from $130.4 million at June 30,
1993, an increase of 59.6%. During that same period, the commercial loan
portfolio increased to $39.4 million from $1.2 million, and the Bank's full
service offices increased to ten from five. Commercial loans generally involve
a higher level of credit risk than do residential loans and many of the
commercial loans, though granted to customers known to officers of the Bank,
are relatively unseasoned since they have been on the books of the Bank for a
short period of time. Although the Bank has not incurred significant credit
losses in recent periods, thereThere can be no assurance that it will not incur
significant credit losses in the future. Heritage Bank is continuing to
emphasize its established mortgage banking business of originating and selling
residential mortgage loans while broadening its products and services to those
more closely related to commercial banking. There can be no assurance of the
Bank's ability to sustain income derived from its mortgage banking business at
recent levels or to increase such income.

Moreover, there can be no assurance that the Bank will be successful in
expanding its asset base and fee income to a level acceptable to management
and in managing the costs and implementation risks associated with its growth
strategy, identifying and acquiring attractive banks or branches on terms
favorable to the Bank, integrating such acquisitions, or preventing deposit
erosion at acquired institutions or branches. Acquisitions and branching by
the Company or the Bank will also be subject to regulatory approvals and there
can be no assurance that the Company or the Bank will succeed in securing such
approvals. The Bank's ability to pursue its growth strategy also may be
adversely affected by general economic conditions. See "Business of the Bank--
General" and "--Competition."

RELIANCE ONIMPORTANCE OF MORTGAGE BANKING OPERATIONS

Mortgage banking activities significantly influence the Bank's results of
operations. The Bank's mortgage banking operations involve the origination and
sale of mortgage loans primarily for the purpose of generating income. The
profitability of mortgage banking operations depends primarily on managing the
volume of loan originations and sales and the expenses associated with loan
originations so that gains on the sale of loans together with any recurring
fee income exceeds the costs of this activity. Changes in the level of
interest rates and the condition of the local and national economies affect
the amount of loans originated by the Bank and demanded by investors to whom
the loans are sold. Generally, the Bank's loan origination and sale activity
and, therefore, its results of operations, may be adversely affected by an
increasing interest rate environment to the extent such environment results in
decreased loan demand by borrowers and/or investors. Accordingly, the volume
of loan originations and the profitability of this activity can vary
significantly from period to period. During the years ended June 30, 1996 and
1997, the Bank's single family mortgage originations totaled $140.1 million
and $104.2 million, respectively. In addition, the Bank's results of
operations are affected by the amount of noninterest expenses associated with
mortgage banking activities, such as compensation and benefits, occupancy and
equipment expenses, and other operating expenses. During periods of reduced
loan demand, the Bank's results of operations may be adversely affected to the
extent that it is unable to reduce expenses commensurate with the decline in
loan originations. During the years ended June 30, 1996 and 1997, the Bank's
net gains on sales of loans were $3.0 million and $2.0 million, respectively.
In comparison, the Bank's pre-tax income for these periods was $4.2 million
and $2.0 million, respectively.

11
HIGH OVERHEAD EXPENSES

Competition in the banking industry has led many banks to focus on expense
reduction as a method of increasing stockholder returns. The Bank, however,
has embarked on a growth strategy as a method of increasing

profitability. That strategy has involved incurring substantial expenses
concentrated in: (i) personnel hired in anticipation of growth and expanded
market share; (ii) maintaining the Bank's mortgage origination capacity while
mortgage origination volumes have fluctuated; (iii) facilities expansion; and
(iv) upgrading of data processing capabilities. As a result of pursuing its
growth strategy and emphasis on personal service, the Bank's expense ratios
are higher than those of many similarly sized banking companies. At June 30,
1997, the Bank's efficiency ratio was 77.89%. While the Bank anticipates that its
efficiency ratio will improve gradually as overhead expenses are allocated
over a larger asset base,, and there can be no assurance
that it will decline to the levels of certain of the Bank's more efficient
competitors, many of whom are following strategies different from those of the
Bank. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations." Failure by the Bank to improve its efficiency ratio
over time could adversely affect the value of the Common Stock.

EXPANSION OF NONRESIDENTIAL LENDING

The Bank has a diversified loan portfolio with a substantial amount of loans
other than traditional one- to four-family permanent (excluding construction)
residential loans.

The Bank has changed the relative concentration of its loan portfolio in
recent years. One- to four-family permanent residential loans decreased to
49.68% of total loans at June 30, 1997 from 56.29% of total loans at June 30,
1993. During that same time commercial business loans increased to 18.95% of
total loans from 0.92% of total loans. At June 30, 1997, $104.7$104.8 million, or
50.3%, of the Bank's total loan portfolio (including loans in process
and deferred loan fees) consisted of loans other than one-
to four-family permanent residential loans. Included among these other loans
are multi-family and commercial real estate, construction, commercial and
consumer loans. Although such loans typically have higher yields than one- to
four-family residential loans, such loans are typically more sensitive to
economic conditions, involve higher concentrations of investment in a single
borrower or project (with the exception of consumer loans) are more difficult
to monitor and carry a higher level of credit risk than do permanent
residential loans. The Bank has attemptedThere can be no assurance that the Bank's attempt to
address these risks by utilizing conservative underwriting procedures,
requiring real estate as collateral for most commercial business loans, and
limiting its out-of-area loans and its multi-
familymulti-family and commercial
construction loans.loans will be successful. See "Business of the Bank--Lending
Activities."

POTENTIAL ADVERSE IMPACT OF CHANGES IN INTEREST RATES

The financial condition and operations of the Bank, and of financial
institutions in general, are influenced significantly by general economic
conditions, by the related monetary and fiscal policies of the federal
government and by the regulations of the Division and the FDIC. Deposit flows
and the cost of funds are influenced by interest rates of competing
investments and general market rates of interest. Lending activities are
affected by the demand for mortgage financing and for consumer and other types
of loans, which in turn is affected by the interest rates at which such
financing may be offered and by other factors affecting the supply of housing
and the availability of funds. The Bank's profitability like that of most
financial institutions, is dependent to a
large extent on its net interest income, which is the difference between the
interest income received from its interest earning assets and the interest
expense incurred in connection with its interest bearing liabilities. The Bank like other savings institutions,
is vulnerable to an increase in interest rates to the extent that its interest
earning assets have longer effective maturities than its interest bearing
liabilities. Under such circumstances, material and prolonged increases in
interest rates generally would adversely affect net interest income, while
material and prolonged decreases in interest rates generally would have a
favorable effect on net interest income. See "Management's Discussion and
Analysis of Financial Condition and Result of Operations--Asset/Liability
Management."

Changes in the level of interest rates also affect the amount of other loans
originated by the Bank and, thus, the amount of loan and commitment fees, as
well as the value of the Bank's investment securities and other 12
interest
earning assets. Decreases in rates may result in borrower prepayments,
subjecting the Bank to reinvestment risk. Moreover, volatility in interest
rates also can result in disintermediation, or the flow of funds away from
savings institutions into direct investments, such as U.S. Government and
corporate securities and other investment vehicles which, because of the
absence of federal insurance premiums and reserve requirements, generally pay
higher rates of return than insured savings institutions.

OTHER POSITIONS OCCUPIED BY CHIEF EXECUTIVE OFFICER

In addition to his position as Chairman, President and Chief Executive
Officer of the Company and the Bank, Mr. Donald V. Rhodes is the Chairman of
the Board and Chief Executive Officer of Washington Independent Bancshares,
Inc. ("WIB"), a closely held bank holding company, and its subsidiary, Central
Valley Bank, N.A. ("CVB"), which is headquartered in Toppenish, Washington.
Mr. Daryl D. Jensen, a director of the Company and the Bank, is also a
director of WIB and CVB. WIB had total assets of $48.6 million at June 30,
1997. CVB serves a market area in central Washington approximately 150 miles
east of Olympia. Mr. Rhodes beneficially owns 7.82% of WIB's common stock and
Mr. Jensen beneficially owns 3.87% of such common stock. While Mr. Rhodes
currently devotes and intends to continue devoting a majority of his time to
Heritage Bank matters, there can be no assurance that this will continue to be
the case. See "Certain Transactions--Transactions With Central Valley Bank."15

COMPETITION

The Bank's strategy involves the significant expansion of the Bank
throughout its principal market areas in the South Puget Sound region of
Washington. During the past several years, substantial consolidation among
financial institutions in Washington has occurred. The Bank anticipates a
continuation of the consolidation trend in Washington. Many other financial
institutions, most of which have greater resources than the Bank, compete with
the Bank for banking business in the Bank's market area. Among the advantages
of some of these institutions are their superior technological resources, and
their ability to make larger loans, finance extensive advertising campaigns,
access international money markets and allocate their investment assets to
regions of highest yield and demand. The Bank does not have a significant
market share of the deposit-taking or lending activities in the areas in which
it conducts operations. AlthoughThere can be no assurance that the Bank has beenwill be able
to compete effectively in its market areas to date, there can be no assurance that it will be able to
continue to do sothis competitive environment in the future. The Bank
also faces deposit competition from securities firms, mortgage bankers,
insurance companies and other investment vehicles such as mutual funds. See
"Business of the Bank--Competition."

ANTI-TAKEOVER PROVISIONS

Provisions in the Company's Governing Instruments and Washington
Law. Certain provisions included in the Company's Articles of Incorporation
and in the Washington Business Corporation Act will assist the Company in
maintaining its independence as a separate, publicly owned corporation. These
provisions may discourage potential takeover attempts, particularly those
which have not been negotiated with the Board of Directors. As a result, these
provisions may preclude takeover attempts which certain stockholders may deem
to be in their interest and perpetuate existing management. These provisions
include, among other things, a provision limiting voting rights of beneficial
owners of more than 10% of the Common Stock. In addition, the Articles of
Incorporation provide for the election of directors to staggered terms of
three years and for their removal without cause only upon the vote of holders
of 66 2/3% of the outstanding voting shares and provisions for approval of
certain business combinations. The Articles of Incorporation also contain
provisions regarding the timing and content of stockholder proposals and
nominations. Certain provisions of the Articles of Incorporation of the
Company cannot be amended by stockholders unless an 66 2/3% stockholder vote
is obtained. The Board of Directors believes that these provisions are in the
best interest of the Company and its stockholders.

Policy of Independence. Potential investors should not invest with the
expectation that the Company or the Bank may be merged into or its assets sold
to another company in the foreseeable future. The Board of 13
Directors of the
Company believes it is in the long-term best interest of the Company and its
stockholders to remain independent and the Board has adopted a statement of
policy that the Company intends to remain independent for the foreseeable
future. See "Restrictions on Acquisition of the Company and the Bank."

GEOGRAPHIC CONCENTRATION

Substantially all of the Bank's loans are collateralized by real estate
located in the Puget Sound region of Washington. The Bank's growth and
profitability are dependent upon economic conditions in the region.
Unfavorable changes in economic conditions affecting the region, such as in
the aerospace, natural resources or software industries, or significant
decline in foreign trade or in the large military base presence in the area
may have an adverse impact on the risk of loss associated with the loan
portfolio and on operations of the Company in general.

VOTING POWER OF DIRECTORS AND EXECUTIVE OFFICERS

Directors and executive officers of the Company (11 persons), at June 30,
1997, beneficially owned 159,103 shares (including 33,216 unexercised stock
options exercisable within 60 days under the existing 1994 and 1997 Stock
Option Plans), or 8.6%, of the outstanding Bank Common Stock on a fully
diluted basis. Based on their anticipated purchases of Conversion Stock at the
midpoint of the Valuation Price Range, they expect to hold approximately
438,760576,682 shares, or 8.3%7.8%, of the shares of Common Stock outstanding upon
consummation of the Conversion (including 92,811(excluding 129,206 unexercised stock options
exercisable within 60 days). See "Conversion Stock

to be Purchased by Management Pursuant to Subscription Rights" and
"Management--Beneficial Ownership of Bank Common Stock."

Directors and officers are also expected to control the voting of
approximately 8%2% of the shares of Common Stock issued in the Conversion
through the ESOP. Under the terms of the ESOP, the unallocated shares will be
voted by the independent ESOP trusteetrustees in the same proportion as the votes cast by
participants with respect to the allocated shares. At a meeting of
stockholders to be held no earlier than six months following the consummation
of the Conversion, the Company intends to seek stockholder approval of the
Company's MRP. Assuming the receipt of stockholder approval, the Company
expects to acquire Common Stock on behalf of the MRP in an amount equal to 4%1%
of the Conversion Stock, or 165,00057,500 shares at the maximum of the Valuation
Price Range. These shares will be acquired either through open market
purchases or from authorized but unissued Common Stock. Under the terms of the
MRP, the MRP committee or the MRP trustees will have the power to vote
unallocated and unvested shares [inin the same proportion as they receive
instructions from recipients with respect to allocated shares which have not
been earned and distributed].distributed. The trustees will not vote allocated shares which
have not been distributed if they do not receive instructions from the
recipient. The Company intends to reserve for future issuance pursuant to the
1998 Stock Option Plan a number of authorized shares of Common Stock equal to
up to 10% of the Conversion Stock issued in the Conversion (414,000(575,000 shares at
the maximum of the Valuation Price Range) and to seek stockholder approval of
the 1998 Stock Option Plan at a meeting of stockholders to be held no earlier
than six months following consummation of the Conversion. Consequently,
assuming (1) the receipt of stockholder approval for the MRP and the 1998
Stock Option Plan, (ii) the open market purchase of shares on behalf of the
MRP, (iii) the purchase by the ESOP of 8%2% of the CommonConversion Stock sold in the
Offerings, and (iv) the exercise of stock options equal to 10% of the number
of shares of Common Stock issued in the Conversion, directors, officers and
employees of the Holding Company and the Bank would have voting control on a
fully diluted basis of 38.9%21.5% of the Common Stock, based on the issuance of the
maximum of the Valuation Price Range. Management's potential voting control
could, together with additional stockholder support, preclude or make more
difficult takeover attempts that certain stockholders deem to be in their best
interest and may tend to perpetuate existing management.

NEW EXPENSES ASSOCIATED WITH ESOP AND MRP

The Company will recognize additional material employee compensation and
benefit expenses as a result of the ESOP's purchase of Conversion Stock in the
Offerings and the expected subsequent implementation of the

14
MRP. The actual
aggregate amount of these new expenses cannot be currently predicted because
applicable accounting practices require that they be based on the fair market
value of the shares of Common Stock when the expenses are recognized, which
would occur when shares are committed to be released in the case of the ESOP
and over the vesting period of awards made to recipients in the case of the
MRP. These expenses have been reflected in the pro forma financial information
under "Pro Forma Data" assuming the Purchase Price ($10.00 per share) as fair
market value. Actual expenses, however, will be based on the fair market value
of the Common Stock at the time of recognition, which may be higher or lower
than the Purchase Price.

EXPECTED LOWER RETURN ON EQUITY AFTER THE CONVERSION

As a result of the Conversion, stockholders' equity will be substantially
increased. The increase in equity is likely to adversely affect the Company's
ability to maintain a return on average equity (net income divided by average
stockholders' equity) at historical levels, absent a corresponding increase in
net income. There can be no assurance that the Company will be able to
increase net income in future periods in amounts commensurate with the
increase in equity resulting from the Conversion. "Management--Benefits--
Employee Stock Ownership Plan" and "--Management Recognition Plan."

POSSIBLE DILUTIVE EFFECTS OF BENEFIT PLANS

Subject to stockholder approval, the MRP intends to acquire an amount of
Common Stock of the Company up to 4%1% of the shares issued in the Conversion.
Such shares of Common Stock of the Company may be acquired

by the Company in the open market or from authorized but unissued shares of
Common Stock of the Company. In the event that the MRP acquires authorized but
unissued shares of Common Stock from the Company, the voting interests of
existing stockholders will be diluted and net income per share and
stockholders' equity per share will be decreased. See "Pro Forma Data" and
"Management--Benefits--Management Recognition Plan."

The 1998 Stock Option Plan, if approved by stockholders, will provide for
options for up to a number of shares of Common Stock of the Company equal to
up to 10% of the shares issued in the Conversion. Such shares will likely be
authorized but unissued shares of Common Stock of the Company; therefore, upon
exercise of the options will result in the dilution of the voting interests of
existing stockholders and will decrease net income per share and stockholders'
equity per share. See "Management--Benefits--1998 Stock Option Plan."

If the ESOP is unable to purchase 8%2% of the Conversion Stock in the
Offerings due to oversubscription by Eligible Account Holders, it may acquire
authorized but unissued shares of Common Stock, which would reduce the voting
interests of stockholders and would decrease net income per share and
stockholders' equity per share.

ABSENCE OF PRIOR MARKET FOR THE COMMON STOCK

The Company has not previously issued capital stock and, consequently, there
is no existing market for the Common Stock. The Company has received
conditional approval to list the Common Stock on the Nasdaq National Market
under the symbol "HFWA." ." One of the listing requirements for initial quotation of the
Common Stock is the presence of three market makers. Ryan Beck has advised the
Company that it intends to make a market in the Common Stock following the
completion of the Conversion so long as the volume of trading activity and
certain other market-making considerations justify it doing so. While the
Company anticipates that it will be able to obtain the commitment from at
least two other broker-dealers to act as market makers for the Common Stock,
there can be no assurance there will be three or more market makers for the
Common Stock. Making a market involves maintaining bid and ask quotations and
being able, as principal, to effect transactions in reasonable quantities at
those prices, subject to securities laws and regulatory constraints.
Additionally, the development of a liquid public market depends on the
existence of willing buyers and sellers, the presence of which is not within
the control of the Company, the Bank or any market maker. The number of active
buyers and sellers of the Common Stock at any particular time may be limited.
Under such circumstances, investors in the Common Stock could 15
have difficulty
disposing of their shares on short notice. Investors should not view the
Common Stock as a short term investment. There can be no assurance that an
active and liquid trading market for the Common Stock will develop or that, if
developed, it will continue, nor is there any assurance that persons
purchasing shares or receiving Exchange Shares will be able to sell them at or
above the Purchase Price. See "Market for Common Stock."

POSSIBLE INCREASE IN VALUATION PRICE RANGE AND NUMBER OF SHARES ISSUED

The number of shares to be sold in the Conversion may be increased as a
result of an increase in the Valuation Price Range of up to 15% to reflect
regulatory considerations and changes in market and financial conditions
following the commencement of the Offerings. In the event that the Valuation
Price Range is so increased, it is expected that the Company will issue up to
4,761,0006,612,500 shares of Common Stock at the Purchase Price for an aggregate price
of up to $47,610,000.$66,125,000. An increase in the number of shares will decrease a
subscriber's proportionate share of the pro forma net income per share and
stockholders' equity per share and will increase the Company's pro forma
consolidated stockholders' equity and net income. Such an increase will also
increase the Purchase Price as a percentage of pro forma stockholders' equity
per share and net income per share. See "Pro Forma Data."

RISK OF DELAYED OFFERING

The Company and the Bank expect to complete the Conversion within the time
periods indicated in this Prospectus. Nevertheless, itIt is possible that there could be a significant delay in the completion of
the Conversion as a result of delays in receiving approval of or non objection
from a necessary regulatory authority, receiving member or stockholder

approval or completing the Offerings. If the Conversion is not completed by
(45 days after the last day of the fully extended Subscription
Offering) and the Division consents to an extension of time to complete the
Conversion, subscribers will be given the right to modify or rescind their
subscriptions. In such event, unless an affirmative indication is received
from subscribers that they wish to continue to subscribe for shares, their
funds will be returned promptly, together with interest at the Bank's passbook
rate, or their withdrawal authorizations will be terminated.

POSSIBLE ADVERSE INCOME TAX CONSEQUENCES OF THE DISTRIBUTION OF SUBSCRIPTION
RIGHTS

If the subscription rights granted to Eligible Account Holders, Supplemental
Eligible Account Holders and Other Members are deemed to have an ascertainable
value, receipt of such rights may result in a taxable gain (either as capital
gain or ordinary income) to those Eligible Account Holders, Supplemental
Eligible Account Holders and Other Members who receive and/or exercise the
subscription rights, in an amount equal to such value. Additionally, the Bank
could be required to recognize a gain for tax purposes on such distribution.
Whether subscription rights are considered to have ascertainable value is an
inherently factual determination. The Bank has been advised by RP Financial
that such rights have no value, however, RP Financial's conclusion is not
binding on the Internal Revenue Service ("IRS"). See "The Conversion--Effects
of Conversion to Stock Form on Depositors and Borrowers of the Bank--Tax
Effects."

1619

USE OF PROCEEDS

Depending upon the number of shares sold and the expenses of the Conversion,
net proceeds from the sale of the Conversion Stock are estimated to range from
$29.7$41.4 million to $40.4$56.2 million (or $46.5$64.7 million if the Valuation Price Range
is increased by 15%). See "Pro Forma Data." The Company plans to contribute to
the Bank 50% of the net proceeds and retain the remaining net proceeds. This
would result in the Company retaining approximately $17.5$24.4 million of net
proceeds (50% of $35.1$48.8 million) based on the issuance of 3,600,0005,000,000 shares at
the midpoint of the Valuation Price Range.

Receipt of the net proceeds of the sale of the Conversion Stock will
increase the Bank's capital. The Bank will use the funds contributed to it for
general corporate purposes, including increased lending, possible purchase of
loan participations or investment in U.S. Government or agency securities and
mortgage backed securities of the type currently held by the Bank. In
addition, depending on the level of market interest rates following
consummation of the Conversion, the Bank may use a portion of the proceeds to
retire any outstanding FHLB advances.

In connection with the Conversion and the establishment of the ESOP, the
Company intends to loan the ESOP the amount necessary for it to acquire 8%2% of
the shares issued in the Conversion. The Company's loan to fund the ESOP may
range from $2,448,000$850,000 to $2,880,000$1,000,000 to $3,312,000$1,150,000 based on the sale of 3,060,0004,250,000
shares (at the minimum of the Valuation Price Range), 3,600,0005,000,000 shares (at the
midpoint of the Valuation Price Range), and 4,140,0005,750,000 shares (at the maximum
of the Valuation Price Range), respectively, at $10.00 per share. If 15% above
the maximum of the Valuation Price Range, or 4,761,0006,612,500 shares, are sold in the
Conversion, the Company's loan to the ESOP would be approximately $3,809,000.$1,323,000.

The remaining net proceeds retained by the Company initially will be
invested primarily in investment securities of the type currently held by the
Bank. Such proceeds will be available for additional contributions to the Bank
in the form of debt or equity, to support future acquisition and
diversification activities, as a source of dividends to the stockholders of
the Company and for future repurchases of Common Stock to the extent permitted
under applicable law and regulations. Currently, there are no specific plans,
arrangements, agreements or understandings, written or oral, regarding any
diversification or acquisition activities. The Conversion will also facilitate
the Company's access to the capital markets.

Upon completion of the Conversion, the Board of Directors will have the
authority to adopt stock repurchase plans, subject to statutory and regulatory
requirements. Since the Company has not yet issued stock, there is currently
insufficient information upon which an intention to repurchase stock could be
based. The facts and circumstances upon which the Board of Directors may
determine to repurchase stock in the future may include but are not limited
to: (i) market and economic factors such as the price at which the stock is
trading in the market, the volume of trading, the attractiveness of other
investment alternatives in terms of the rate of return and risk involved in
the investment, the ability to increase the book value and/or earnings per
share of the remaining outstanding shares, and an improvement in the Company's
return on equity; (ii) the avoidance of dilution to stockholders by not having
to issue additional shares to cover the exercise of stock options or to fund
employee stock benefit plans; (iii) the ability of the Company to utilize
pooling of interests accounting treatment in connection with future mergers
and acquisitions; and (iv) any other circumstances in which repurchases would
be in the best interests of the Company and its stockholders. Any stock
repurchases will be subject to a determination by the Board of Directors that
both the Company and the Bank will be capitalized in excess of all applicable
regulatory requirements after any such repurchases and that capital will be
adequate taking into account, among other things, the level of nonperforming
and other risk assets, the Company's and the Bank's current and projected
results of operations and asset/liability structure, the economic environment
and tax and other regulatory considerations.

1720

DIVIDEND POLICY

GENERAL

The Board of Directors of the Company intends to declare cash dividends on
the Common Stock commencing with the first full quarter following consummation
of the Conversion. The first quarterly dividend is expected to be in an amount
that will be equivalent to $0.40, annually, on existing Minority Shares. Based
upon the Valuation Price Range, the Exchange Ratio is expected to be 2.3752,
2.7943, 3.21353.3064,
3.8899, 4.4734 and 3.69555.1444 at the minimum, midpoint, maximum and 15% above the
maximum of the Valuation Price Range, respectively, resulting in an initial
quarterly dividend of $0.042, $0.036, $0.031$0.030, $0.026, $0.022 and $0.027$0.019 per share,
respectively, on the Exchange Shares following consummation of the Conversion.
In addition, the Board of Directors may determine to pay periodic special cash
or stock dividends in addition to, or in lieu of, regular cash dividends.
Declarations or payments of any future dividends (regular and special) will be
subject to determination by the Company's Board of Directors, which will take
into account the amount of the net proceeds retained by the Company, the
Company's financial condition, results of operations, tax considerations,
capital requirements, industry standards, economic conditions and other
factors, including the regulatory restrictions that affect the payment of
dividends by the Bank to the Company discussed below. Under Washington law,
the Company is prohibited from paying a dividend if, as a result of its
payment, the Company would be unable to pay its debts as they became due in
the normal course of business, or if the Company's total liabilities would
exceed its total assets. In order to pay such cash dividends, however, the
Company must have available cash either from the net proceeds raised in the
Offerings and retained by the Company, dividends received from the Bank or
earnings on Company assets. No assurances can be given that any dividends,
either regular or special, will be declared or, if declared, what the amount
of dividends will be or whether such dividends, if commenced, will continue.

CURRENT REGULATORY RESTRICTIONS

Dividends from the Company will depend, in part, upon receipt of dividends
from the Bank because the Company initially will have no source of income
other than dividends from the Bank and earnings from the investment of the net
proceeds from the Conversion retained by the Company. The Division has the
authority under its supervisory powers to prohibit the payment of dividends by
the Bank to the Company. For a period of ten years after the Conversion, the
Bank may not, without prior approval of the Division, declare or pay a cash
dividend in an amount in excess of one-half of (i) the greater of the Bank's
net income for the current fiscal year or (ii) the average of the Bank's net
income for the current fiscal year and not more than two of the immediately
preceding fiscal years. In addition, the Bank may not declare or pay a cash
dividend on its capital stock if the effect thereof would be to reduce the net
worth of the Bank below the amount required for the liquidation account to be
established pursuant to the Plan of Conversion. See "Supervision and
Regulation--Banking Subsidiary" and "The Conversion--Effects of Conversion to
Stock Form on Depositors and Borrowers of the Bank--Liquidation Account."

TAX CONSIDERATIONS

In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for federal income tax purposes cannot be used by the
Bank to pay cash dividends to the Company without the payment of federal
income taxes by the Bank at the then current income tax rate on the amount
deemed distributed, which would include the amount of any federal income taxes
attributable to the distribution. See "Business of the Bank--Federal Taxation"
and Note 10 of Notes to the Consolidated Financial Statements included
elsewhere herein. The Company does not contemplate any distribution by the
Bank that would result in a recapture of the Bank's bad debt reserve or create
the above-mentioned federal tax liabilities.

1821

MARKET FOR COMMON STOCK

The Company has not previously issued capital stock, and, consequently,
there is no established market for the Common Stock. The Board of Directors of
the Company and the Bank determined that the Common Stock would be sold at
$10.00 per share. The Company has received conditional approval to have its
Common Stock quoted on the Nasdaq National Market under the symbol " ""HFWA" upon
completion of the Conversion. One of the requirements for initial quotation of
the Common Stock on the Nasdaq National Market is that there be at least three
market makers for the Common Stock. Making a market involves maintaining bid
and ask quotations and being able, as principal, to effect transactions in
reasonable quantities at those quoted prices, subject to various securities
laws and other regulatory requirements. Ryan Beck has advised the Company that
it intends to make a market in the Common Stock following the completion of
the Conversion, subject to compliance with applicable laws and regulations.
While the Company anticipates that prior to the completion of the Conversion
it will be able to obtain the commitment from at least two other broker-
dealers to act as market makers for the Common Stock, there can be no
assurance there will be three or more market makers for the Common Stock.
Additionally, the development of a liquid public market depends on the
existence of willing buyers and sellers, the presence of which is not within
the control of the Company, the Bank or any market maker. The number of active
buyers and sellers of the Common Stock at any particular time may be limited.
Under such circumstances, investors in the Common Stock could have difficulty
disposing of their shares on short notice. Investors should not view the
Common Stock as a short term investment. There can be no assurance that an
active and liquid trading market for the Common Stock will develop or that, if
developed, it will continue, nor is there any assurance that persons
purchasing shares will be able to sell them at or above the Purchase Price or
that quotations will be available on the Nasdaq National Market as
contemplated.

1922

CAPITALIZATION

The following table presents the historical consolidated capitalization of
the Bank at June 30, 1997, and the pro forma consolidated capitalization of
the Company after giving effect to the assumptions set forth under "Pro Forma
Data," based on the sale of the number of shares of Conversion Stock set forth
below in the Conversion at the minimum, midpoint, maximum and 15% above the
maximum of the Valuation Price Range.

COMPANY PRO FORMA CONSOLIDATED CAPITALIZATION
BASED UPON THE SALE OF
----------------------------------------------------------
MAXIMUM AS
MINIMUM MIDPOINT MAXIMUM ADJUSTED
3,060,000 3,600,000 4,140,000 4,761,0004,250,000 5,000,000 5,750,000 6,612,500
SHARES AT SHARES AT SHARES AT SHARES AT
PURCHASE PURCHASE PURCHASE PURCHASE
CAPITALIZATION PRICE OF PRICE OF PRICE OF PRICE OF
AS OF JUNE 30, $10.00 $10.00 $10.00 $10.00 PER
1997 PER SHARE PER SHARE PER SHARE SHARE(1)
-------------- --------- --------- --------- ----------
(IN THOUSANDS)

Deposits(2)............. $209,781 $209,781 $209,781 $209,781 $209,781
Borrowings:
FHLB advances.......... 890 890 890 890 890
-------- -------- -------- -------- --------
Total deposits and
borrowings............ $210,671 $210,671 $210,671 $210,671 $210,671
======== ======== ======== ======== ========
Stockholders' equity:(3)
Preferred stock (no par
value per share);
2,500,000 shares
authorized; none
outstanding(4)........ -- -- -- -- --
Common Stock (no par
value per share);
15,000,000 shares
authorized(5)......... 1,810 -- -- -- --
Additional paid-in
capital............... 4,103 35,646 40,971 46,297 52,42147,343 54,733 62,123 70,621
Retained earnings...... 21,801 21,921 21,921 21,921 21,921
Less:
Common Stock acquired
by ESOP(6)........... -- (2,448) (2,880) (3,312) (3,809)(850) (1,000) (1,150) (1,323)
Common Stock acquired
by MRP(6)............ -- (1,224) (1,440) (1,656) (1,904)(425) (500) (575) (661)
-------- -------- -------- -------- --------
Total stockholders'
equity................. $ 27,714 $ 53,89567,989 $ 58,57275,154 $ 63,25082,319 $ 68,62990,558
======== ======== ======== ======== ========

- -------
(1) As adjusted to give effect to an increase in the number of shares which
could occur due to an increase in the Valuation Price Range of up to 15%
to reflect regulatory considerations and changes in market and financial
conditions following the commencement of the Offerings.
(2) Does not reflect withdrawals from deposit accounts for the purchase of
Conversion Stock in the Offerings. Such withdrawals would reduce pro
forma deposits by the amount of such withdrawals.

(3) Assumes (i) that the 609,616 Minority Shares outstanding at June 30, 1997
are converted into 1,447,959, 1,703,449, 1,958,9982,015,664, 2,371,369, 2,727,075 and 2,252,8353,136,136 Exchange
Shares at the minimum, midpoint, maximum and 15% above the maximum of the
Valuation Price Range, respectively, and (ii) that no fractional shares
of Exchange shares will be issued by the Company. Pro forma retained
earnings include $120,000 of assets held by the MHC.
(4) The Bank has 5,000,000 shares of Preferred Stock authorized, $1.00 par
value per share, none of which are outstanding. The Company has 2,500,000
shares of Preferred Stock authorized, no par value per share, none of
which are outstanding or will be outstanding after the completion of the
Conversion.

(5) The Bank has 10,000,000 shares of Common Stock authorized, $1.00 par
value per share.share, of which 1,809,616 were outstanding as of June 30, 1997.
The Company has 15,000,000 shares of Common Stock authorized, no par
value per share.

(6) Assumes that 8%2% and 4%1% of the shares sold in the Offerings will be
purchased by the ESOP and MRP, respectively. No shares actually will be
purchased by the MRP in the Offerings. Such purchases by the MRP would
occur only upon receipt of stockholder approval which is expected no
earlier than six months after completion of the Conversion. A purchase by
the MRP in the Offerings has been included on a pro forma basis to give
an indication of its effect on capitalization. The pro forma presentation
does not show the impact of (a) results of operations after the
Conversion, (b) changing market prices of shares of Common Stock after
the Conversion, (c) a smaller than 4%1% purchase by the MRP, or (d) the
purchase by the MRP or ESOP of Common Stock out of authorized but
unissued shares. Assumes that the funds used to acquire the ESOP shares
will be borrowed from the Company for a 15 year term at the prime rate.
For an estimate of the impact of the loan on earnings, see "Pro Forma
Data." If the ESOP obtained a loan from a third party, other borrowings
would increase by the amount of Common Stock acquired by the ESOP. The
Bank intends to make contributions to the ESOP sufficient to service and
ultimately retire its debt. The amount to be acquired by the ESOP and MRP
is reflected as a reduction of stockholders' equity. There can be no
assurance that stockholder approval of the MRP will be obtained. See
"Management--Benefits--Employee Stock Ownership Plan" and "--Management
Recognition Plan."

20Plan".

HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE

The following table presents the Bank's historical and pro forma capital
position relative to its capital requirements at June 30, 1997. The amount of
capital infused into the Bank for purposes of the following table is 50% of
the net proceeds of the Offerings, plus the $120,000 of MHC assets.assets, less the
ESOP and MRP deductions. For purpose of the table below, the amount expected
to be borrowed by the ESOP and the cost of the shares expected to be acquired
by the MRP are deducted from pro forma regulatory capital. For a discussion of
the assumptions underlying the pro forma capital calculations presented below,
see "Use of Proceeds," "Capitalization" and "Pro Forma Data." The definitions
of the terms used in the table are those provided in the applicable
regulations.

PRO FORMA AT JUNE 30, 1997
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------
MINIMUM OF MIDPOINT OF MAXIMUM OF 15% OF MAXIMUM OF
VALUATION PRICE MIDPOINT OF VALUATION PRICE VALUATION PRICE VALUATION PRICE
RANGE PRICE RANGE RANGE RANGE
------------------ -------------------------- ------------------ ------------------
3,060,000------------------- ----------------------- ------------------- -------------------
4,250,000 SHARES 4,140,000AT 5,000,000 SHARES 4,761,000AT 5,750,000 SHARES AT 6,612,500 SHARES AT
PURCHASE PRICE 3,600,000 SHARES AT AT PURCHASE PRICE ATOF PURCHASE PRICE OF $10.00 PER PURCHASE PRICE OF PURCHASE PRICE OF $10.00 PER OF $10.00 PER
JUNE 30, 1997 $10.00 PER SHARE $10.00 PER SHARE $10.00 PER SHARE $10.00 PER SHARE
------------------ ------------------ -------------------------- ------------------ ----------------------------------------- ------------------- -------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF PERCENT OF
ADJUSTED ADJUSTED ADJUSTED ADJUSTED ADJUSTED
TOTAL TOTAL TOTAL TOTAL TOTAL
AMOUNT ASSETS(1) AMOUNT ASSETS(1) AMOUNT ASSETS(1) AMOUNT ASSETS(1) AMOUNT ASSETS(1)
------- ---------- ------- ---------- ----------------------- ------------- ------------- ---------- ------- ---------------- ------------
(DOLLARS IN THOUSANDS)

Tier 1 (leverage)
capital...........capital............ $27,714 11.68% $39,029 15.55% $ 41,043 16.20% $43,058 16.83% $45,375 17.54%$47,274 18.35% 50,744 19.43% 54,214 20.47% 58.204 21.64%
Tier 1 (leverage)
capital
requirement(2)......... 7,118 3.00 7,5297,728 3.00 7,6027,837 3.00 7,6767,945 3.00 7,7608.070 3.00
------- ----- ------- ----- ----------------------- ---------- ------------- ----- ------------- -----
Excess.............Excess.............. $20,596 8.68% $31,500 12.55% $ 33,441 13.20% $35,382 13.83% $37,615 14.54%39,546 15.35 42,907 16.43 46,269 17.47 50,134 18.64%
======= ===== ======= ===== ======================= ========== ============= ===== ============= =====
Tier 1 risk based
capital...........capital............ $27,714 15.65% $39,029 21.70% $ 41,043 22.75% $43,058 23.81% $45,375 25.01%47,274 26.09 50,744 27.89 54,214 29.68 58,204 31.72%
Tier 1 risk based
capital
requirement.......requirement........ 7,085 4.00 7,1967,249 4.00 7,2157,278 4.00 7,2357,307 4.00 7,2577,340 4.00
------- ----- ------- ----- ----------------------- ---------- ------------- ----- ------------- -----
Excess.............Excess.............. $20,629 11.65% $31,833 17.70% $ 33,828 18.75% $35,823 19.81% $38,118 21.01%40,025 22.09 43,466 23.89 46,907 25.68 50,864 27.72%
======= ===== ======= ===== ======================= ========== ============= ===== ============= =====
Total risk based
capital...........capital............ $29,935 16.90% $41,278 22.95% $ 43,298 24.00% $45,319 25.06% $47,643 26.26%49,539 27.34 53,018 29.14 56,497 30.93 60,498 32.97%
Total risk based
capital
requirement.......requirement........ 14,171 8.00 14,39114,497 8.00 14,43014,555 8.00 14,46914,613 8.00 14,51414,680 8.00
------- ----- ------- ----- ----------------------- ---------- ------------- ----- ------------- -----
Excess.............Excess.............. $15,764 8.90% $26,887 14.95% $ 28,868 16.00% $30,850 17.06% $33,129 18.26%35,042 19.34 38,463 21.14 41,884 22.93 45,818 24.97%
======= ===== ======= ===== ======================= ========== ============= ===== ============= =====

- -------
(1) For the risk-based capital calculations, the portion of the net proceeds
contributed to the Bank (after ESOP and MRP deductions) were assumed to
be invested in U.S. Government Agency debt securities with a weighted
average risk-weighing of 20%.
(2) As a Washington state chartered savings bank, the Bank is subject to the
capital requirements of the FDIC and the Division. The FDIC requires
state-chartered banks, including the Bank, to have a minimum leverage
ratio of Tier 1 capital to total assets of at least 3%, provided,
however, that all institutions, other than those (i) receiving the
highest rating during the examination process and (ii) not anticipating
any significant growth, are required to maintain a ratio of 1% to 2%
above the stated minimum, with an absolute total capital to risk-weighted
assets of at least 8%. The Bank has not been notified by the FDIC of any
leverage capital requirement specifically applicable to it. However, for
the purposes of this table, the Bank has assumed that its leverage
capital requirement is 3% of total average assets.

2124

CONVERSION STOCK TO BE PURCHASED BY MANAGEMENT PURSUANT TO
SUBSCRIPTION RIGHTS

The following table sets forth, for each director and executive officer and
for all of the directors and executive officers as a group, (i) Exchange
Shares to be held upon consummation of the Conversion based upon their
beneficial ownership of Bank Common Stock (excluding options) as of June 30,
1997, (ii) proposed purchase of Conversion Stock, assuming shares are
available to satisfy their subscriptions, and (iii) total shares of Common
Stock to be held upon consummation of the Conversion, in each case assuming
that the Conversion Stock is sold at the midpoint of the Valuation Price
Range. No individual has entered into a binding agreement with respect to such
intended purchases, and, therefore, actual purchases could be more or less
than indicated below. Directors and executive officers and their associates
may not purchase in excess of 20% of the shares sold in the Conversion.
Directors, officers and employees will pay the Purchase Price ($10.00 per
share) for each share for which they subscribe.

PROPOSED PURCHASE
OF CONVERSION TOTAL COMMON STOCK
NUMBER OF STOCK TO BE HELD
EXCHANGE ------------------ ------------------
SHARES TO NUMBER NUMBER
BE HELD NUMBEROF OF PERCENTAGE
(1)(2) AMOUNT OF SHARES SHARES OF TOTAL
--------- -------- --------- ------- ----------

Donald V. Rhodes
Director, Chairman of the
Board, President and Chief
Executive Officer of the
Company; Chairman of the
Board and President of the
Bank......................... 77,625108,061 $250,000 25,000 102,625 1.94%133,061 1.81%
Lynn M. Brunton
Director..................... 41,91458,348 50,000 5,000 46,914 0.8863,348 0.86
John A. Clees
Director..................... 33,53146,678 40,000 4,000 37,531 0.7150,678 0.69
Daryl D. Jensen
Director..................... 50,29770,018 50,000 5,000 55,297 1.0475,018 1.02
H. Edward Odegard
Director..................... 41,91458,348 25,000 2,500 44,414 0.8460,848 0.83
James P. Senna
Director..................... 27,94338,899 75,000 7,500 35,443 0.6746,399 0.63
Philip S. Weigand
Director..................... 49,15768,431 50,000 5,000 54,157 1.0273,431 1.00
John D. Parry
Executive Vice President--
Administration............... 8,94112,447 70,000 7,000 15,941 0.3019,447 0.26
Brian L. Vance
Executive Vice President--
Loan Administration.......... 5,5887,779 150,000 15,000 20,588 0.3922,779 0.31
James Hastings
Senior Vice President and
Treasurer.................... 3,0734,278 50,000 5,000 8,073 0.159,278 0.13
Wendy Gauksheim
Senior Vice President--
Corporate Services Officer... 11,77716,395 60,000 6,000 17,777 0.3422,395 0.30
------- -------- ------ ------- ----
All directors and executive
officers as a group
(11 persons)................. 351,760489,682 $820,000 82,000 435,787 8.27%87,000 576,682 7.82%
======= ======== ====== ======= ====

- --------

(1) Excludes 67,546 shares which may be received upon the exercise of
outstanding stock options granted under the existing 1994 and 1997 Stock
Option Plans. Based upon the Exchange Ratio of 2.79433.8899 Exchange Shares for
each Minority Share at the midpoint of the Valuation Price Range, the
persons named in the table would have options to purchase Common Stock as
follows: Mr. Rhodes, 55,88677,798 shares; Ms. Brunton, 9,31312,965 shares; Mr.
Clees, 9,31312,965 shares; Mr. Jensen, 9,31312,965 shares; Mr. Odegard, 9,31312,965
shares; Mr. Senna, 9,31312,965 shares; Mr. Weigand, 8,05511,215 shares; Mr. Parry,
27,94338,899 shares; Mr. Vance, 27,94338,899 shares; Mr. Hastings, 18,16225,284 shares; Ms.
Gauksheim, 4,1915,835 shares; and all directors and executive officers as a
group, 188,745262,755 shares.
(2) Excludes stock options that may be granted under 1998 Stock Option Plan
and awards that may be granted under the MRP if such plans are approved
by stockholders at an annual or special meeting at least six months
following the Conversion. See "Management--Benefits."

2225

PRO FORMA DATA

Applicable law requires that the aggregate Purchase Price of the Common
Stock to be issued in the Conversion be based upon an independent appraisal of
the estimated pro forma market value of the Common Stock. At August 15,October 10, 1997,
the Valuation Price Range of the Offerings as set forth in the Appraisal is
from a minimum of $30.6$42.5 million to a maximum of $41.4$57.5 million, with a midpoint
of $36.0$50.0 million or, at a price per share of $10.00, a minimum number of
shares of 3,060,000,4,250,000, a maximum number of shares of 4,140,0005,750,000 and a midpoint
number of shares of 3,600,000.5,000,000. The actual net proceeds from the sale of the
CommonConversion Stock cannot be determined until the Conversion is completed.
However, net proceeds are currently based upon the following assumptions: (i)
all of the shares of Conversion Stock will be sold in the Subscription and
Minority Stockholder'sStockholders' Offerings; (ii) Ryan Beck will receive a management and
advisory fee of $50,000 and a marketing fee of 1.5% of the aggregate dollar
amount of CommonConversion Stock sold in the Subscription and Minority StockholderStockholders'
Offerings; (iii) approximately 11.3%4.4%, 10.8%4.0%, 10.4%3.7% and 10.1%3.5% of the Conversion
Stock issued in the Conversion at the minimum, midpoint, maximum, and 15%
above the maximum, of the Valuation Price Range, respectively, will be sold to
the ESOP and to directors, officers and employees or members of such persons'
immediate families, for which no fee will be paid to Ryan Beck, and (iv)
Conversion expenses, excluding the fees paid to Ryan Beck, will be
approximately $460,000. Actual fees and expenses may vary from this estimate,
because the fees paid will depend upon the percentages and total number of
shares sold in the various categories of Offerings and other factors. See "The
Conversion--Marketing Arrangements."

The pro forma consolidated net income of the Company for the year ended June
30, 1997 has been calculated as if the Conversion had been completed at the
beginning of the period and the estimated net proceeds received by the Company
and the Bank had been invested at 6.74%, the arithmetic average of the yield
earned by the Bank on its interest earning assets and the rates paid on its
deposits. As discussed under "Use of Proceeds," the Company expects to retain
50% of the net Conversion proceeds from which it will fund the ESOP loan. A
pro forma after-tax return of 4.45% is used for both the Company and the Bank
for the 12 month period, after giving effect to an incremental tax rate of
34.0%.

Historical and pro forma per share amounts have been calculated by dividing
historical and pro forma amounts by the indicated number of shares of Common
Stock. Per share amounts have been computed as if the Common Stock had been
outstanding at the beginning of the period or at June 30, 1997, but without
any adjustment of per share historical or pro forma stockholders' equity to
reflect the earnings on the estimated net proceeds.

The following table summarizes the historical net income and stockholders'
equity of the Bank and the pro forma consolidated net income and stockholders'
equity of the Company at and for the year ended June 30, 1997, based on the
minimum, midpoint, maximum, and a 15% increase in the maximum of the Valuation
Price Range. No effect has been given to (i) the shares to be reserved for
issuance under the Company's 1998 Stock Option Plan, which is expected to be
adopted by stockholders at a meeting to be held no earlier than six months
following consummation of the Conversion; (ii) withdrawals from deposit
accounts for the purpose of purchasing Conversion Stock in the Conversion;
(iii) the issuance of shares from authorized but unissued shares to the MRP,
which is expected to be adoptedESOP
in the event of over-subscription in the Offering by stockholders at a meeting to be held no
earlier than six months following consummation of the Conversion;Eligible Account Holders;
or (iv) the establishment of a liquidation account for the benefit of Eligible
Account Holders and Supplemental Eligible Account Holders. See "Management--Benefits--
1998"Management--
Benefits--1998 Stock Option Plan" and "The Conversion--Stock Pricing and
Number of Shares to be Issued."

THE FOLLOWING PRO FORMA INFORMATION MAY NOT BE REPRESENTATIVE OF THE
FINANCIAL EFFECTS OF THE CONVERSION AT THE DATE ON WHICH THE CONVERSION
ACTUALLY OCCURS AND SHOULD NOT BE TAKEN AS INDICATIVE OF FUTURE RESULTS OF
OPERATIONS. STOCKHOLDERS' EQUITY REPRESENTS THE DIFFERENCE BETWEEN THE STATED
AMOUNTS OF CONSOLIDATED ASSETS AND LIABILITIES OF THE COMPANY COMPUTED IN
ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. STOCKHOLDERS' EQUITY
HAS NOT BEEN INCREASED OR DECREASED TO REFLECT THE DIFFERENCE BETWEEN THE
CARRYING VALUE OF LOANS AND OTHER ASSETS AND THEIR MARKET VALUE. STOCKHOLDERS'
EQUITY IS NOT INTENDED TO REPRESENT FAIR MARKET VALUE NOR DOES IT REPRESENT
AMOUNTS THAT WOULD BE AVAILABLE FOR DISTRIBUTION TO STOCKHOLDERS IN THE EVENT
OF LIQUIDATION.

2326

AT OR FOR THE YEAR ENDED JUNE 30, 1997
----------------------------------------------
15% ABOVE
MINIMUM OF MIDPOINT OF MAXIMUM OF MAXIMUM OF
VALUATION MIDPOINT OF VALUATION VALUATION PRICE VALUATION PRICE
PRICE RANGE PRICE RANGE PRICE RANGE PRICE RANGE
--------------------- ----------- ----------- ----------
----------
3,060,000 3,600,000 4,140,000 4,761,0004,250,000 5,000,000 5,750,000 6,612,500
SHARES AT SHARES AT SHARES AT SHARES AT
PURCHASE PURCHASE PURCHASE PURCHASE
PRICE OF PRICE OF PRICE OF PRICE OF
$10.00 PER $10.00 PER $10.00 PER $10.00 PER
SHARE SHARE SHARE SHARE
---------- ----------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Gross proceeds................... $30,600 $36,000 $41,400 $47,610
Less expenses.................... (867) (942) (1,016) (1,102)$42,500 $50,000 $57,500 $66,125
Less: expenses................... (1,070) (1,180) (1,290) (1,417)
--------- --------- --------- ---------
Estimated net proceeds.......... $29,733 $35,058 $40,384 $46,508Net Proceeds.......... $41,430 $48,820 $56,210 $64,708
Less: Common Stock purchased by
ESOP(2)......................... (2,448) (2,880) (3,312) (3,809)(850) (1,000) (1,150) (1,323)
Less: Common Stock purchased by
MRP(3).......................... (1,224) (1,440) (1,656) (1,904)(425) (500) (575) (661)
--------- --------- --------- ---------
Estimated Net Proceeds for
Reinvestment................... $26,061 $30,738 $35,416 $40,795$40,155 $47,320 $54,485 $62,724
========= ========= ========= =========
For the 12 Months Ended June 30,
1997
Consolidated Net Income:
Historical(5)................... $ 2,269 $ 2,269 $ 2,269 $ 2,269
Pro forma income on net
proceeds(1).................... 1,159 1,367 1,575 1,8151,786 2,105 2,424 2,790
Earnings on assets at MHC....... 5 5 5 5
Pro forma ESOP Adjustment(2).... (108) (127) (146) (168)(37) (44) (51) (58)
Pro forma MRP Adjustment(3)..... (162) (190) (219) (251)(56) (66) (76) (87)
--------- --------- --------- ---------
Pro forma Net Income............ $ 3,1633,967 $ 3,3244,269 $ 3,4844,571 $ 3,6704,919
========= ========= ========= =========
Earnings Per Share (reflects SOP
93-6)(4):
Historical(5)................... $ 0.530.37 $ 0.450.31 $ 0.390.27 $ 0.340.24
Pro forma income on net proceeds
............................... 0.28 0.28 0.28 0.280.29 0.30 0.30 0.29
Earnings on Capitalassets at Company.. -- -- -- --MHC....... 0.00 0.00 0.00 0.00
Pro forma ESOP Adjustment(2).... (0.03) (0.03) (0.03) (0.03)(0.01) (0.01) (0.01) (0.01)
Pro forma MRP adjustment(3)..... (0.04) (0.04) (0.04) (0.04)(0.01) 0.01) (0.01) (0.01)
--------- --------- --------- ---------
Pro forma earnings per share....Earnings Per Share.... $ 0.740.64 $ 0.660.59 $ 0.600.55 $ 0.550.51
========= ========= ========= =========
Offering price as a multiple of
pro forma earnings per share.... 13.51x 15.15x 16.67x15.63x 16.95x 18.18x 19.61x
At June 30, 1997
Stockholders' Equity:
Historical(5)................... $27,714 $27,714 $27,714 $27,714
Assets at MHC................... 120 120 120 120
Estimated Net Proceeds.......... 29,733 35,058 40,384 46,50841,430 48,820 56,210 64,708
Less: Common Stock purchased by
ESOP(2)........................ (2,448) (2,880) (3,312) (3,809)(850) (1,000) (1,150) (1,323)
Less: Common Stock purchased by
MRP(3)......................... (1,224) (1,440) (1,656) (1,904)(425) (500) (575) (661)
--------- --------- --------- ---------
Pro forma Stockholders' Equity.. $53,895 $58,572 $63,250 $68,629$67,989 $75,154 $82,319 $90,558
========= ========= ========= =========
Stockholders' equity per share
(does not reflect SOP 93-6):
Historical(5)................... $ 6.154.42 $ 5.233.76 $ 4.543.27 $ 3.952.84
Assets at MHC................... 0.03 0.02 0.02 0.020.01 0.01
Estimated net proceeds.......... 6.59 6.60 6.62 6.626.63 6.64 6.65
Less: Common Stock purchased by
ESOP(2)........................ (0.54) (0.54) (0.54) (0.54)(0.14) (0.14) (0.14) (0.14)
Less: Common Stock purchased by
MRP(3)......................... (0.27) (0.27) (0.27) (0.27)(0.07) (0.07) (0.07) (0.07)
--------- --------- --------- ---------
Pro forma Stockholders' Equity
Per Share...................... $ 11.9610.85 $ 11.0410.20 $ 10.379.71 $ 9.789.29
========= ========= ========= =========
Offering price as a percentage
of pro forma stockholders'
equity per share............... 83.61% 90.58% 96.43% 102.25%
Offer92.17% 98.04% 102.99% 107.64%
Offering price as a percentage
of pro forma tangible equity...... 83.61% 90.58% 96.43% 102.25%equity... 92.17% 98.04% 102.99% 107.64%
Number of Sharesshares used in book
value per share calculations... 4,507,955 5,303,476 6,098,998 7,013,8476,265,664 7,371,369 8,477,075 9,748,636

2427

- --------
(1) No effect has been given to withdrawals from deposit accounts for the
purpose of purchasing Conversion Stock. The net amount of funds available
to the Bank for investment following the Offerings will be reduced to the
extent that shares are purchased with funds on deposit.

(2) Assumes that 8%2% of the Conversion Stock issued in the Conversion will be
purchased by the ESOP. The funds used to acquire such shares will be
borrowed by the ESOP (at an interest rate equal to the prime rate as
published in The Wall Street Journal on the closing date of the
Conversion, which rate is currently 8.50%) from the net proceeds of the
Offerings retained by the Company. The amount of this borrowing has been
reflected as a reduction from gross proceeds to determine estimated net
proceeds for reinvestment. The Bank intends to make contributions to the
ESOP at least equal to the principal and interest requirement of the
debt. As the debt is repaid, stockholders' equity will be increased. The
Bank's payment of the ESOP debt is based upon equal installments of
principal over a 15 year period, assuming a federal income tax rate of
34.0%. Interest income earned by the Company on the ESOP debt offsets the
interest paid by the Bank on the ESOP loan. No reinvestment is assumed on
proceeds contributed to fund the ESOP. The ESOP expense reflects adoption
of Statement of Position ("SOP") 93-6, which will require recognition of
compensation expense as shares are committed to be released to employee's
accounts and the exclusion of unallocated shares from earnings per share
computations. The valuation of shares committed to be released would be
based upon the average market value of the shares during the year, which,
for purposes of this calculation, was assumed to be equal to the $10.00
per share Purchase Price. See "Management--Benefits--Employee Stock
Ownership Plan."

(3) Assumes that the required stockholder approval has been received, that
the shares were acquired by the MRP at the beginning of the period
presented in open market purchases at $10.00 per share, that 20% of the
amount contributed was an amortized expense during such period, and that
the federal income tax rate is 34.0%. For purposes of this table,
compensation expense is recognized on a straight-line basis over the five
year term of shares issued under the MRP. In the event the fair market
value per share is greater than $10.00 per share on the date shares are
awarded under the MRP, total MRP expense would increase. See "Risk
Factors--New Expenses Associated with ESOP and MRP." The total of the
estimated MRP purchases was multiplied by 20% (the total percent of
shares for which expense is recognized in the first year) resulting in
pre-tax MRP expense of $244,800, $288,000, $331,200$85,000, $100,000, $115,000 and $380,800$132,200 at the
minimum, midpoint, maximum and 15% above the maximum of the Valuation
Price Range, respectively, for the year ended June 30, 1997. The issuance
of authorized but unissued shares of Common Stock pursuant to the MRP in
the amount of 4%1% of the Conversion Stock issued in the Offerings would
dilute the voting interests of existing stockholders by approximately
2.65%from 32.17% to
31.95%, and under such circumstances pro forma net income per share for
the year ended June 30, 1997 would be $0.72, $0.64, $0.59,$0.58, $0.54 and $0.54$0.51 at
the minimum, midpoint, maximum and 15% above the maximum of the Valuation
Price Range, respectively, and stockholders' equity per share at June 30,
1997 would be $11.64, $10.75, $10.10,$10.78, $10.13, $9.65 and $9.53$9.23 at the minimum, midpoint,
maximum and 15% above the maximum of such range, respectively. No effect
has been given to the shares reserved for issuance under the proposed
1998 Stock Option Plan. If stockholders approve the 1998 Stock Option
Plan following the Conversion, the Company will have reserved for
issuance under the 1998 Stock Option Plan authorized by unissued shares
of Common Stock representing an amount of shares equal to up to 10% of
the Conversion Stock sold in the Offerings. See "Management--Benefits--1998"Management--Benefits--
1998 Stock Option Plan" and "--Benefits--Management Recognition Plan" and
"Risk Factors--Possible Dilutive Effect of Benefit Plans."

(4) Per share amounts are based upon shares outstanding of 4,271,315,
5,025,076, 5,778,8386,183,497,
7,274,702, 8,365,908 and 6,645,663,9,620,794, at the minimum, midpoint, maximum and
15% above the maximum of the Valuation Price Range for the year ended
June 30, 1997, respectively, which includes the Conversion Stock and
Exchange Shares, less the number of shares assumed to be held by the ESOP
not released within the first year following the Conversion.
(5) Historical per share amounts have been computed as if the Conversion
Stock expected to be issued in the Conversion had not been outstanding at
the beginning of the period, and without any adjustment of historical net
income or historical retained earnings to reflect the investment of the
estimated net proceeds of the sale of shares in the Conversion, the
additional ESOP expense or the proposed MRP expense, as described above.

2528

HERITAGE SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

The following Consolidated Statements of Income of Heritage Savings Bank and
Subsidiaries for each of the fiscal years in the three year period ended June
30, 1997 are a part of the consolidated financial statements of Heritage
Savings Bank and subsidiaries, and should be read in conjunction therewith,
which financial statements have been audited by KPMG Peat Marwick LLP,
independent certified public accountants. The Consolidated Financial
Statements as of June 30, 1996 and 1997, and for each of the years in the
three year period ended June 30, 1997, and the report thereon, are included
elsewhere herein.

YEARS ENDED JUNE 30,
-----------------------
1995 1996 1997
------- ------- -------
(IN THOUSANDS)

INTEREST INCOME:
Loans..................... $13,115 $14,894 $16,743
Mortgage backed
securities............... 722 552 464
Investment securities and
FHLB dividends........... 1,118 854 757
Interest bearing
deposits................. 268 575 548
------- ------- -------
Total interest income... 15,223 16,875 18,512
------- ------- -------
INTEREST EXPENSE:
Deposits.................. 6,639 8,528 8,999
Borrowed funds............ 357 15 1
------- ------- -------
Total interest expense.. 6,996 8,543 9,000
------- ------- -------
Net interest income..... 8,227 8,332 9,512
PROVISION FOR LOAN LOSSES... -- -- (270)
------- ------- -------
Net interest income after
provision for loan
losses................... 8,227 8,332 9,782
------- ------- -------
NONINTEREST EXPENSE:
Gains on sales of loans,
net...................... 1,665 3,049 2,006
Commissions on sales of
annuities and
securities............... 241 296 220
Service charges on
deposits................. 207 353 462
Rental income............. 209 221 210
Gain on sale of premises.. 356 -- 84
Other income.............. 362 379 365
------- ------- -------
Total noninterest
income................. 3,040 4,298 3,347
------- ------- -------
NONINTEREST EXPENSE:
Salaries and employee
benefits................. 4,176 4,711 5,468
Building occupancy........ 979 1,254 1,717
FDIC premiums and special
assessment............... 380 407 1,262
Data processing........... 462 493 534
Marketing................. 200 162 257
OfficesOffice supplies &and
printing................. 257 229 243
Other..................... 971 1,166 1,624
------- ------- -------
Total noninterest
expense................ 7,425 8,422 11,105
------- ------- -------
Income before federal
income tax expense..... 3,842 4,208 2,024
Federal income tax expense
(benefit).................. 1,308 1,435 (245)
------- ------- -------
Net income.............. $ 2,534 $ 2,773 $ 2,269
======= ======= =======
Earnings per common share... $1.41 $1.54 $1.26

2629

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following discussion is intended to assist in understanding the
financial condition and results of operations of the Bank. The information
contained in this section should be read in conjunction with the Consolidated
Financial Statements and accompanying Notes thereto and the other sections
contained in this Prospectus. The Mutual Holding Company's only material
activity is to hold Bank Common Stock and invest its available funds in
accounts at the Bank. The MHC has not conducted any operations to date and
therefore has no reported results of operations.

OPERATING STRATEGY

The Bank traditionally has offered a variety of savings products and
originated one- to four-family mortgage loans (principally for sale in the
secondary market) and, to a lesser extent, multi-family, commercial real
estate and construction loans. Beginning in fiscal 1994, the Bank began to
implement a growth strategy which is intended to broaden its products and
services from traditional thrift products and services to those more closely
related to commercial banking. That strategy entails (1) geographic and
product expansion, (2) loan portfolio diversification, (3) development of
relationship banking, and (4) maintenance of asset quality. (See "Business of
the Bank--Implementation of Growth Strategy" and "--Lending Activities") The
Bank intends to continue to fund its assets primarily with retail deposits,
although FHLB advances may be used as a supplemental source of funds, and it
believes that the capital raised in the Offerings will enhance its ability to
continue implementing its growth strategy.

Concurrent with geographic expansion, the Bank has (i) developed business
checking accounts and commercial lending products and other services for
businesses and high net worth individuals; (ii) introduced Visa(TM) debit and
credit cards; (iii) installed an automated voice response system for customer
account inquiries and (iv) developed products to assist realtors and potential
borrowers to obtain information about loan programs and qualifications. To
accommodate new products and to improve internal operating and reporting, the
Bank converted to a new data processing system with a data service bureau and
installed a personal computer network.

The Bank has incurred substantial expenses as it carried out its growth
strategy. Those expenses have been concentrated in (i) personnel hired in
anticipation of growth and expanded market share; (ii) maintaining the Bank's
mortgage origination capacity while mortgage origination volumes have
fluctuated; (iii) facilities expansion and (iv) upgrading of data processing
capabilities.capabilities, and have reduced the Bank's return on average assets and return
on equity for fiscal year 1997. Management believes that those expenditures
will continue to have a negative impact on earnings in the near term, but that
the investments are necessary to produce an expected improvement in earnings
as the Bank seeks to broaden its product mix and expand its market share
throughout its market area.

The Bank's profitability depends primarily on its net interest income, which
is the difference between the income it receives on its loan and investment
portfolio and its cost of funds, which consists of interest paid on deposits
and borrowed funds. The Bank also generates noninterest income through service
charges and fees and income from mortgage banking operations. The Bank's
noninterest expenses consist primarily of compensation and employee benefits,
occupancy, deposit insurance premiums, data processing and other operating
costs. Like most financial institutions, the Bank's interest income and cost
of funds are affected significantly by general economic conditions,
particularly changes in market interest rates, and by government policies and
the actions of regulatory authorities.

NET INTEREST INCOME

Changes in net interest income result from changes in volume, net interest
spread and net interest margin. Volume refers to the average dollar amounts of
interest earning assets and interest bearing liabilities. Net interest spread
refers to the difference between the average yield on interest earning assets
and the average cost of interest bearing liabilities. Net interest margin
refers to net interest income divided by average interest earning assets and

2730

is influenced by the level and relative mix of interest earning assets and
interest bearing liabilities. During the years ended June 30, 1995, 1996 and
1997, average interest earning assets amounted to $180.2 million, $193.5
million and $211.2 million, respectively. During these same periods, average
interest bearing liabilities were $162.5 million, $175.1 million and $191.1
million, respectively, and net interest margins were 4.57%, 4.31% and 4.50%,
respectively.

The following table sets forth for the periods indicated information for the
Bank with respect to average balances of assets and liabilities, as well as
the total dollar amounts of interest income from interest earning assets and
interest expense on interest bearing liabilities, resultant yields or costs,
net interest income, net interest spread, net interest margin and the ratio of
average interest earning assets to average interest bearing liabilities. The
average loan balances presented in the table are net of allowances for loan
losses. Nonaccrual loans have been included in the tables as loans carrying a
zero yield.

YEAR ENDED JUNE 30
-------------------------------------------------------------------------------------
1995 1996 1997
--------------------------- --------------------------- ---------------------------
INTEREST INTEREST INTEREST
AVERAGE EARNED/ AVERAGE AVERAGE EARNED/ AVERAGE AVERAGE EARNED/ AVERAGE
BALANCE(1) PAID RATE BALANCE(1) PAID RATE BALANCE(1) PAID RATE
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
(DOLLARS IN THOUSANDS)

INTEREST EARNING ASSETS:
Loans................... $142,598 $13,115 9.20% $160,823 $14,894 9.26% $182,791 $16,743 9.16%
Mortgage backed
securities............. 9,231 722 7.82 6,715 552 8.22 5,598 464 8.29
Investment securities
and FHLB stock......... 22,516 1,118 4.97 15,096 854 5.66 12,360 757 6.12
Interest earning
deposits............... 5,837 268 4.59 10,820 575 5.31 10,414 548 5.26
-------- ------- ------ -------- ------- ------ -------- ------- ------
Total interest earning
assets................. 180,182 $15,223 8.45% $193,454 $16,875 8.72% $211,163 $18,512 8.77%
Noninterest earning
assets................. 14,818 18,002 18,974
-------- -------- --------
Total assets........... $195,000 $211,456 $230,137
======== ======== ========
INTEREST BEARING
LIABILITIES:
Certificates of
deposit................ $ 89,602 $ 4,415 4.93% $109,559 $ 6,336 5.78% $119,133 $ 6,599 5.54%
Savings accounts........ 28,178 927 3.29 28,407 1,030 3.63 29,703 1,055 3.55
Interest bearing demand
and money market
accounts............... 40,594 1,297 3.19 36,930 1,162 3.15 42,271 1,345 3.18
-------- ------- ------ -------- ------- ------ -------- ------- ------
Total interest bearing
deposits.............. 158,374 6,639 4.19 174,896 8,528 4.88 191,107 8,999 4.71
FHLB advances........... 658 41 6.23 -- -- 27 1 4.99
Other borrowed funds.... 3,453 316 9.15 171 15 8.77 -- -- --
-------- ------- ------ -------- ------- ------ -------- ------- ------
Total interest bearing
liabilities........... 162,485 6,996 4.31% 175,067 8,543 4.88 191,134 9,000 4.71%
Demand and other
noninterest bearing
deposits............... 6,001 6,537 7,955
Other noninterest
bearing liabilities.... 4,797 5,489 4,711
Stockholders' equity.... 21,717 24,363 26,337
-------- -------- --------
Total liabilities and
stockholders' equity.. $195,000 $211,456 $230,137
======== ======== ========
Net interest income..... $ 8,227 $ 8,332 $ 9,512
Net interest spread..... 4.14% 3.84% 4.06%
Net interest margin..... 4.57% 4.31% 4.50%
Average interest earning
assets to average
interest bearing
liabilities............ 110.89% 110.51% 110.48%

2831

The following table sets forth the amounts of the changes in the Bank's net
interest income attributable to changes in volume and changes in interest
rates. Changes attributable to the combined effect of volume and interest
rates have been allocated proportionately to changes due to volume and the
changes due to interest rates.

1995 COMPARED TO 1996 COMPARED TO
1996 INCREASE 1997 INCREASE
(DECREASE) DUE TO (DECREASE) DUE TO
---------------------- ---------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ------ ------ ------ ----- ------
(IN THOUSANDS)

Loans.......................... $1,676 $ 103 $1,779 $2,034 $(185) $1,849
Mortgage backed securities..... (197) 27 (170) (92) -- (88)
Investment securities and FHLB
stock......................... (368) 104 (264) (155) 58 (97)
Interest earning deposits...... 229 78 307 (22) (5) (27)
------ ------ ------ ------ ----- ------
Total interest income........ $1,340 $ 312 $1,652 $1,765 $(128) $1,637
====== ====== ====== ====== ===== ======
Certificates of deposit........ $ 984 $ 937 $1,921 $ 554 $(291) $ 263
Savings accounts............... 8 95 103 47 (22) 25
Interest bearing demand
deposits...................... (118) (17) (135) 168 15 183
------ ------ ------ ------ ----- ------
Total interest on deposits... 874 1,015 1,889 769 (298) 471
FHLB advances.................. (41) -- (41) 1 -- 1
Other borrowed funds........... (300) (1) (301) (15) -- (15)
------ ------ ------ ------ ----- ------
Total interest expense....... $ 533 $1,014 $1,547 $ 755 $(298) $ 457
====== ====== ====== ====== ===== ======

RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1997 AND 1996

Net Income. Net income was $2.3 million, or $1.26 per share, for the year
ended June 30, 1997 compared to $2.8 million, or $1.54 per share, for the year
ended June 30, 1996, an 18.2% decline, primarily as a result of noninterest
expense increasing more rapidly than net interest income, coupled with a
decrease in noninterest income. The increase in noninterest expenses was
attributable to two factors: (1) the expansion in Pierce County of the Bank's
branch office network and development of the Bank's relationship banking
capacity; and (2) the legislatively-mandated, one-time assessment levied by
the FDIC on all SAIF-insured institutions to recapitalize the SAIF deposit
insurance fund. The decrease in noninterest income was principally the result
of lower gains on sales of loans due to a decline in the volume of
originations of residential mortgage loans.

Net Interest Income. Net interest income increased $1.2 million, or 14.2%,
in 1997 compared to 1996 primarily due to a $22.0 million increase in the
average balance of loans. The growth in average loan balances was most
pronounced in commercial loans ($17.7 million of the total $22.0 million
increase). Net interest income increased as a result of an improved net
interest spread coupled with average interest earning assets increasing more
rapidly than average interest bearing liabilities, with the difference funded
by noninterest bearing deposits.

Net interest margin, which is net income divided by average interest earning
assets, for 1997 increased to 4.50% from 4.31% in 1996. The increase was
primarily the result of a growth in earning assets at increased rates coupled
with a decline in the average cost of interest bearing deposits (particularly
for certificates of deposit). Certificates of deposit with scheduled
maturities of one year or less increased to 90% of certificate accounts as of
June 30, 1997 compared to 83% as of June 30, 1996, while average rates on
certificates decreased to 5.54% from 5.78%. The increase in the average yield
on interest earning assets was the result of shifting funds from lower
yielding investments and mortgage backed securities into higher yielding loans
and the overall growth in loans, particularly commercial loans.

Provision for Loan Losses. In 1997, the Bank recorded a $1.2 million
recovery on a multifamily mortgage loan which had been partially charged off
in a prior year. In its most recent evaluation ofreviewing the adequacy of the Bank's allowance for loan
losses as of June 30, 1997, management determined that the allowance balance
was more than adequate to cover any potential losses in the Bank's loan
portfolio and therefore reduced the allowance balance through a $270,000
negative provision for loan losses.

2932

Management considers the allowance for loan losses at June 30, 1997 to be
adequate to cover reasonably foreseeable loan losses based on management's
assessment of various factors affecting the loan portfolio, including the
level of problem loans, business conditions, estimated collateral values, loss
experience and credit concentrations.

Noninterest Income. Total noninterest income decreased $951,000, or 22.1%,
in 1997 compared with 1996. The major component of this category, gains on
sales of loans, decreased $1.0 million, or 34.2% from 1996 to 1997 due to a
lower volume of mortgage loans sold ($87.0 million in 1997 compared to $119.5
million in 1996). The decrease in volume of originations of one- to four-
family residential mortgage loans in 1997 compared with 1996 was due to
weakness in the residential mortgage market and the loss of two key producers
by the end of fiscal 1996. Commissions on sales of annuities and securities
declined $76,000, or 25.7%, as a result of lower sales volume due to staff
turnover. Service charges on deposits increased $109,000, or 30.8%, due to
growth in personal and business checking accounts. In June 1997, the Bank sold
its former branch premises in Shelton, recognizing an $84,000 gain on the
sale.

Noninterest Expense. Total noninterest expense increased $2.7 million, or
31.9%, in 1997 compared with 1996. The increase was attributable to: (i) the
Bank's expansion of its branch network in Pierce County and development of the
Bank's relationship banking capacity; and (ii) a one-time special assessment
of $1.1 million required by legislation enacted in August 1996, to
recapitalize the SAIF fund of the FDIC. Total noninterest expense (less the
nonrecurring SAIF assessment of $1.1 million) was 77.89% of adjusted revenue
(the sum of net interest income plus noninterest income), for the year ended
June 30, 1997 as compared to 66.68% for the same period in 1996. Total
noninterest expense for the Bank is expected to decline in relation to
revenues as the Bank's asset base grows.

Salaries and employee benefits increased $757,000, or 16.1%. The increase
reflects the hiring of a Senior Loan Administrator (in June 1996) and six
commercial lending officers for the Pierce County market (four of which were
hired in June 1996), the staffing additions for the 80th and Pacific branch
(which opened in October 1996) and the full year effect of staffing additions
for the Lakewood branch (which opened in February 1996). Occupancy expense
increased $463,000, or 36.9%, as result of the operating costs of the new
branch facilities opened during 1996 and 1997 and the full year depreciation
impact of the installation of a bank-wide personal computer network in March
1996. FDIC premiums and special assessment increased $855,000, or 210%, due to
the $1.1 million special assessment mentioned above. The Bank's federal
deposit insurance premiums were reduced by the FDIC from 0.23% (on an
annualized basis) of insured deposits for the quarter ended September 30, 1996
to 0.06% of insured deposits for the semi-annual period ended June 30, 1997.

Income Taxes. The Bank recorded a Federal income tax benefit of $245,000 for
the year ended June 30, 1997 as a result of the reversal of $938,000 deferred
tax liability related to the potential recapture of the pre-1988 additions to
the tax bad debt reserve which could have been triggered by the MHC
Reorganization in January 1994. Based on subsequent legislation, the Bank
reversed the $938,000 deferred tax liability as a reduction of Federal income
tax expense during the year ended June 30, 1997.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1996 AND 1995

Net income. Net income increased $239,000, or 9.4%, for the year ended June
30, 1996 to $2.8 million from $2.5 million for the year ended June 30, 1995.
This increase resulted primarily from noninterest income increasing more
rapidly than noninterest expenses, while net interest income rose slightly.

Net Interest Income. Net interest income increased $105,000, or 1.3%, in
1996 compared with 1995 despite growth in average loans of $18.2 million, or
12.8%, due principally to a decrease in net interest spread to 3.84% in 1996
from 4.14% in 1995. Average interest bearing liabilities increased by $16.5
million (concentrated in certificates of deposit), or 10.4%, in 1996, while
average interest earning assets increased by $13.3 million, or 7.4%. The
average rate on interest bearing liabilities rose to 4.88% from 4.31% in 1995,
while the average rate on interest earning assets increased to 8.72% from
8.45%.

3033

The increase in loans resulted from a greater emphasis on commercial lending
coupled with an increase in residential and commercial real estate mortgage
loans. The growth in certificates of deposit reflected rate promotions offered
in concert with the new branch openings in 1995 and 1996 and was accompanied
by a reduction of $3.7 million, or 9.0%, in lower cost interest bearing demand
deposits.

Provision for Loan Losses. There were no provisions for loan losses in 1995
or 1996 as management deemed the allowance for loan losses at June 30, 1995
and 1996 adequate to provide for reasonably foreseeable loan losses at those
dates.

Noninterest Income. Noninterest income increased $1.3 million, or 41.4%, to
$4.3 million for 1996, from $3.0 million for 1995. Gains on sales of loans
increased $1.4 million, or 83.1%, due to a larger volume of mortgage loan
originations ($140.2 million in 1996 versus $93.6 million in 1995) and
mortgage loans sold ($119.5 million in 1996 versus $63.3 million in 1995).
Commissions on sales of annuities and securities increased $55,000, or 23%, as
a result of higher sales volume and a shift in relative mix of sales from
lower fee producing securities sales into variable annuities. Service charges
on deposits increased $146,000, or 71%, due to growth in personal and business
noninterest bearing checking accounts. The gain on sale of premises in 1995
occurred due to the sale of a former branch facility in Lacey.

Noninterest Expense. Noninterest expense for 1996 increased $997,000, or
13.4%, from 1995 due principally to an increase in compensation and occupancy
expense. Salaries, bonuses and employee benefits increased by $535,000, or
12.8%, due to staffing additions related to new branches opened (Indian Summer
in January 1995 and Lakewood in February 1996), increases in mortgage banking
support staff and information systems support, management bonuses and
increases in employee benefit plan contributions. Occupancy expense increased
$275,000, or 28.1%, due to the operating costs of the new branch facilities
opened in 1995 and 1996 and the depreciation impact of the installation of a
personal computer network in March 1996. Federal deposit insurance premiums
increased as a result of higher average deposit levels in 1996, while data
processing expenses increased due to greater transaction processing levels
related to checking accounts (business and personal). Marketing expenses
decreased by $38,000 as a result of one less new branch opening in 1996.
Office supplies and printing decreased by $28,000 due to management's efforts
in controlling the growth of these expenditures. Other noninterest expenses
increased $195,000 as a result of branch expansion and growth in customer
accounts, increased professional services and higher business and occupation
taxes due to increased revenues in 1996.

LIQUIDITY AND CAPITAL RESOURCES

The Bank's primary sources of funds are customer deposits, loan repayments,
loan sales, maturing investment securities and advances from the FHLB of
Seattle. These funds, together with retained earnings, equity and other
borrowed funds, are used to make loans, acquire investment securities and
other assets and to fund continuing operations. While maturities and scheduled
amortization of loans are a predictable source of funds, deposit flows and
mortgage prepayments are greatly influenced by the level of interest rates,
economic conditions and competition.

The Bank must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to fund loan originations and deposit
withdrawals, to satisfy other financial commitments and to fund operations.
The Bank generally maintains sufficient cash and short term investments to
meet short term liquidity needs. At June 30, 1997, cash and cash equivalents
totaled $7.6 million, or 3.1% of total assets, and investment securities
classified as held to maturity with maturities of one year or less amounted to
$3.8 million, or 1.6% of total assets. At June 30, 1997, the Bank maintained a
credit facility with the FHLB of Seattle for up to 20% of assets or $48.4
million (of which only $890,000 was outstanding at that date).

To fund the growth of the Bank, management's strategy has been to build core
deposits (which the Bank defines to include all deposits except public funds)
through the development of its branch office network and commercial banking
relationships. Total deposits increased $18.7 million, or 9.8%, to $209.8
million at June 30,

3134

1997 from $191.1 million at June 30, 1996. Of this increase, $3.6 million was
in the form of a short term public deposit which matured and was withdrawn in
July 1997. Historically, the Bank has been able to retain a significant amount
of its deposits as they mature. Management anticipates that the Bank will
continue to rely on the same sources of funds in the future and will use those
funds primarily to make loans and purchase investment securities.

Heritage Bank is subject to certain regulatory capital requirements. As of
June 30, 1996 and 1997, the Bank was classified as a "well capitalized"
institution under the criteria established by the FDIC Act. See "Historical
and Pro Forma Regulatory Capital Compliance."

ASSET/LIABILITY MANAGEMENT

The Bank's primary financial objective is to achieve long term profitability
while controlling its exposure to fluctuations in market interest rates. To
accomplish this objective, management has formulated an interest rate risk
management policy that attempts to manage the mismatch between asset and
liability maturities while maintaining an acceptable interest rate sensitivity
position. The principal strategies which the Bank employs to control its
interest rate sensitivity are: (i) sale of most long term, fixed rate, one-to
four-family residential mortgage loan originations in the secondary mortgage
market; (ii) retention of some adjustable rate mortgage loans; (iii) the
origination of commercial loans and residential construction loans at variable
interest rates for terms generally one year or less; and (iv) keeping
investment securities with generally short term maturities. Additionally, the
Bank offers noninterest bearing demand deposit accounts to businesses and
individuals. The Bank's longer term objective is to reduce its dependency on
certificates of deposit, which tend to be a higher cost source of funds and
most susceptible to movement from the Bank if market interest rates increase,
by increasing its proportion of noninterest bearing demand deposits, interest
bearing demand deposits and money market accounts and savings deposits.

The Bank's asset and liability management strategies have resulted in a
negative one year "gap" of 9.18% as of June 30, 1997. This one year gap is the
difference between the dollar amount of its interest earning assets and
interest bearing liabilities that mature or reprice within one year as a
percentage of total interest earning amounts, based on certain estimates and
assumptions as discussed below. Although management believes that the
implementation of its operating strategies has reduced the potential effects
of changes in market interest rates on the Bank's results of operations, the
negative gap indicates that increases in market interest rates may adversely
affect the Bank's results.

3235

The following table sets forth the estimated maturity or repricing and the
resulting interest rate sensitivity gap of the Bank's interest earning assets
and interest bearing liabilities at June 30, 1997 based upon estimates of
expected mortgage prepayment rates and deposit decay rates consistent with
national trends. The Bank has adjusted mortgage loan maturities for loans held
for sale by reflecting these loans in the zero to three month category which
is consistent with their sale in the secondary mortgage market. The amounts in
the table are derived from the Bank's internal data, and because certain
assumptions have been utilized in presenting this data, the amounts may not be
consistent with financial information appearing elsewhere in this Prospectus
that have been prepared in accordance with generally accepted accounting
principles. The amounts in the tables also could be significantly affected by
external factors, such as changes in prepayment assumptions, early withdrawal
of deposits and competition.

ESTIMATED MATURITY OR REPRICING WITHIN
----------------------------------------------------------
0-3 4-12 1-5 5-10 MORE THAN
MONTHS MONTHS YEARS YEARS 10 YEARS TOTAL
------- -------- ------- ------- --------- --------
(DOLLARS IN THOUSANDS)

INTEREST EARNING ASSETS:
Loans.................. $45,321 $ 77,607 $57,294 $23,942 $4,029 $208,193
Mortgage backed
securities............ -- 35 23 207 4,894 5,159
Investment securities.. 321 3,496 4,689 -- -- 8,506
FHLB stock............. 1,511 -- -- -- -- 1,511
Interest earning
deposits.............. 175 -- -- -- -- 175
------- -------- ------- ------- ------ --------
Total interest earning
assets............... $47,328 $ 81,138 $62,006 $24,149 $8,923 $223,544
Noninterest earning
assets................ 18,620
--------
Total assets.......... $242,164
========
INTEREST BEARING
LIABILITIES
Deposits
Certificates of
deposit............... $35,412 $ 78,394 $12,866 $ 109 -- $126,781
Savings accounts....... 2,417 6,084 15,074 3,998 801 28,374
Interest bearing demand
and money market
deposits.............. 9,879 15,921 15,889 2,863 585 45,137
------- -------- ------- ------- ------ --------
Total interest bearing
deposits............. 47,708 100,399 43,829 6,970 1,386 200,292
FHLB advances.......... 890 -- -- -- -- 890
------- -------- ------- ------- ------ --------
Total interest bearing
liabilities.......... $48,598 $100,399 $43,829 $ 6,970 $1,386 $201,182
Noninterest bearing
liabilities and
equity................ 40,982
--------
Total liabilities and
equity............... $242,164
========
RATE SENSITIVITY GAP.... $(1,270) $(19,261) $18,177 $17,179 $7,537 $ 22,362
Cumulative rate
sensitivity gap:
Amount................. (1,270) (20,531) (2,354) 14,825 22,362
As a percentage of
interest earning
assets................ (0.57)% (9.18)% (1.05)% 6.63%
======= ======== ======= =======

Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market interest rates. Additionally, certain assets, such as
adjustable rate mortgages, have features which restrict changes in the
interest rates of such assets both on a short term basis and over the lives of
such assets. Further, in the event of a change in market interest rates,
prepayment and early withdrawal levels could deviate significantly from those
assumed in calculating the tables. Finally, the ability of many borrowers to
service their adjustable rate debt may decrease in the event of a substantial
increase in market interest rates.

3336

MARKET RISK DISCLOSURES ON FINANCIAL INSTRUMENTS

The table below provides information as of June 30, 1997 about the Bank's
financial instruments that are sensitive to changes in interest rates. The
table presents principal cash flows and related weighted average interest
rates by expected maturity dates. The data in this table may not be consistent
with the amounts in the preceding table which represents amounts by the
repricing date or maturity date (whichever occurs sooner) adjusted by
estimates such as mortgage prepayments and deposit decay or early withdrawal
rates.

BY EXPECTED MATURITY DATE
------------------------------------------------------------------------
YEAR ENDED JUNE 30
------------------------------------------------------------------------
AFTER FAIR
1998 1999 2000 2001 2002 2002 TOTAL VALUE
-------- ------- ------ ------ ------- -------- -------- --------
(DOLLARS IN THOUSANDS)

INVESTMENT SECURITIES
Amounts maturing:
Fixed rate............. $ 3,817 $ 4,689 $ -- $ -- $ -- $ -- $ 8,506 $ 8,498
Weighted average
interest rate......... 5.87% 5.83% 5.85%
MORTGAGE BACKED
SECURITIES
Amounts maturing:
Fixed rate............. $ -- $ -- $ -- $ 23 $ -- $ 5,101 $ 5,124 $ 5,343
Weighted average
interest rate......... 8.50% 8.30% 8.30%
Adjustable rate........ -- -- -- -- -- 35 35 37
Weighted average
interest rate......... 8.28% 5.85%
-------- ------- ------ ------ ------- -------- -------- --------
Totals................ $ -- $ -- $ -- $ 23 $ -- $ 5,136 $ 5,159 $ 5,380
8.50% 8.30% 8.30%
LOANS
Amounts maturing
Fixed rate............. $ 8,373 $ 1,910 $1,641 $ 930 $ 7,967 $ 86,982 $107,803 $ 98,896
Weighted average
interest rate......... 8.94% 8.93% 9.15% 9.31% 8.90% 8.59% 8.66%
Adjustable rate........ 29,351 5,908 1,001 2,704 3,913 57,513 100,390 110,948
Weighted average
interest rate......... 9.62% 9.05% 9.48% 9.67% 9.01% 8.69% 9.03%
-------- ------- ------ ------ ------- -------- -------- --------
Totals................ $ 37,724 $ 7,818 $2,642 $3,634 $11,880 $144,495 $208,193 $209,845
9.47% 9.02% 9.27% 9.57% 8.94% 8.63% 8.84%
CERTIFICATES OF DEPOSIT
Amounts maturing:
Fixed rate............. $113,806 $10,437 $2,299 $ 61 $ 69 $ 109 $126,781 $126,568
Weighted average
interest rate......... 5.46% 5.56% 5.75% 5.35% 5.14% 6.60% 5.47%

IMPACT OF INFLATION AND CHANGING PRICES

The primary impact of inflation on the Bank's operations is increased
operating costs. Unlike most industrial companies, virtually all the assets
and liabilities of a financial institution are monetary in nature. As a
result, interest rates generally have a more significant impact on a financial
institution's performance than the effects of general levels of inflation.
Although interest rates do not necessarily move in the same direction or to
the same extent as the prices of goods and services, increases in inflation
generally have resulted in increased interest rates.

RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Statements Board ("FASB") issued Statement of
Accounting Standards ("SFAS") No. 128, "Earnings Per Share". SFAS No. 128
establishes standards for computing and presenting earnings per share ("EPS")
and applies to entities with publicly-held common stock or potential common
stock. It replaces the presentation of primary EPS with a presentation of
basis EPS and requires the dual presentation of basic and diluted EPS on the
fact of the income statement. SFAS No. 128 is effective for the financial
statements for the periods ending after December 15, 1997. SFAS No. 128
requires restatement of all prior period EPS data presented. The impact of its
adoption is not expected to be material to the Company.

3437

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". SFAS 130 establishes standards for reporting comprehensive income and
its components (revenues, expenses, gains and losses) in a full set of
financial statements. This Statement requires that the Bank (a) classify items
of other comprehensive income by their nature in its financial statements and
(b) display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the statement of financial condition. This Statement is effective for the year
ending June 30, 1999.

In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information". SFAS 131 requires public companies to
report financial and descriptive information about its operating segments.
Operating segments are components of a business about which separate financial
information is available that is evaluated regularly by the chief operating
decision-maker in deciding how to allocate resources and in assessing
performance. The adoption of SFAS 131 is required for the fiscal year ended
June 30, 1999 and the Bank is currently evaluating the effect of this
Statement.

On January 28, 1997, the SEC amended their rules and regulations to require
public companies to provide enhanced descriptions of accounting policies for
derivative financial instruments and derivative commodity instruments in the
footnotes to their financial statements. The accounting policy requirement
became effective for all filings that include financial statements for periods
ending after June 15, 1997. The Bank had no derivative financial instruments
or derivative commodity instruments at June 30,1997 or at any time during the
three year period then ended. The Bank believes that it is in compliance with
this amended rule.

BUSINESS OF THE COMPANY

GENERAL

The Company was organized as a Washington business corporation at the
direction of the Board of Directors of the Bank in August 1997 for the purpose
of becoming a holding company for the Bank upon completion of the Conversion.
The Company has filed an application with the Federal Reserve Bank of San
Francisco to become a bank holding company and for approval to acquire the
Bank. Immediately following the Conversion, the only significant assets of the
Company will be the capital stock of the Bank, that portion of the net
proceeds of the Offerings to be retained by the Company and a note receivable
from the ESOP evidencing a loan from the Company to fund the Bank's ESOP. See
"Use of Proceeds." Management believes that the holding company structure and
proceeds of the Offerings may facilitate possible future acquisitions of other
financial institutions, such as commercial banks or savings institutions, or
branches of other financial institutions and thereby further expansion into
existing and new market areas. The holding company structure will also provide
increased flexibility to the Company to diversify into a variety of banking-
related activities and to repurchase its stock.

BUSINESS

Prior to the Conversion, the Company will not engage in any significant
operations. Upon completion of the Conversion, the Company's sole business
activity will be the ownership of the stock of the Bank. Following the
Conversion, the Company will be engaged in the business of directing, planning
and coordinating the business activities of the Bank. In the future, the
Company may acquire or organize other operating subsidiaries, including other
financial institutions, although there are no current plans, arrangements,
agreements or understandings, written or oral, to do so.

Initially, the Company will neither own nor lease any property but will
instead use the premises, equipment and furniture of the Bank with the payment
of appropriate rental fees in accordance with applicable laws and regulations.

Since the Company will only hold the capital stock of the Bank, the
competitive conditions applicable to the Company will be the same as those
confronting the Bank. See "Business of the Bank--Competition."

3538

BUSINESS OF THE BANK

GENERAL

The Bank is a state-chartered stock savings bank headquartered in Olympia,
Washington, the state capital of Washington. The Bank was originally chartered
in 1927 and since 1935 its savings accounts have been federally insured. At
June 30, 1997, the Bank had $242.2 million of total assets, $214.5 million of
total liabilities, including $209.8 million of deposits, and $27.7 million of
stockholders' equity. The Bank presently has ten full service offices in its
market areas of Thurston, Pierce and Mason Counties.

IMPLEMENTATION OF GROWTH STRATEGY

Concurrent with geographic expansion, the Bank has (i) developed business
checking accounts and commercial lending products and other services for
businesses and high net worth individuals; (ii) introduced Visa(TM) debit and
credit cards; (iii) installed an automated voice response system for customer
account inquiries and (iv) developed products to assist realtors and potential
borrowers to obtain information about loan programs and qualifications. To
accommodate new products and to improve internal operating and reporting, the
Bank converted to a new data processing system with a data service bureau and
installed a personal computer network.

Loan Portfolio Diversification. Since initiating its expansion activities,
the Bank has supplemented its traditional mortgage loan products with an
increased emphasis on variable interest rate commercial loans. Total loans
increased to $208.2 million at June 30, 1997 from $130.4 million at June 30,
1993, commercial loans increased to $39.4 million, or 18.95% of total loans,
from $1.2 million, or 0.92% of total loans at June 30, 1993. One- to four-
family residential loans increased in amounts outstanding but decreased to
49.68% from 56.29% of total loans, and multi-family and commercial real estate
loans similarly increased in amounts outstanding while decreasing to 24.60%
from 30.97% of total loans during that period. Most of the loans categorized
by the Bank as commercial business loans are collateralized by real estate,
but repayment is expected from a source other than operations or sale of the
real estate. See "--Lending Activities."

Development of Relationship Banking. In fiscal 1994, the Bank initiated
efforts to develop a business banking department under the direction of a
senior officer with commercial banking experience in Thurston County. The new
department concentrated its efforts on development of expanded lending and
deposit relationships with existing and new customers of the Bank in Mason and
Thurston counties. In June 1996, the Bank hired a former south Puget Sound
Regional Manager for a large commercial bank as Senior Vice President--Loan
Administration. The management addition was made for the purpose of enhancing
the Bank's relationship banking capacity and to establish a commercial banking
presence in Pierce County. Since that time, the Bank has also hired six
additional lending officers who have experience lending to small businesses
and individuals in the Pierce County market. While the banking market is very
competitive, recent mergers of regional commercial banks with significant
presence in the Bank's principal market areas have, in management's view,
provided a greater opportunity for community banks to fill a personal service
niche which the Bank believes has been created by the mergers. Management
believes that the Bank can develop a larger market share in the Pierce County
market while continuing to expand in the Thurston and Mason County markets, by
delivering an efficient and personalized banking service and developing
relationships with small businesses and high net worth individuals who are
seeking a relationship with a responsive, service oriented provider of
financial products and services.

3639

Maintenance of Asset Quality. While pursuing its growth strategy, the Bank
will continue its policy of seeking to employ consistent underwriting and loan
monitoring procedures, in order to maintain asset quality. The Bank's loan
portfolio grew 59.6% between June 30, 1993 and June 30, 1997. Nonperforming
loans remained at less than $436,000 during the four year period, as did total
nonperforming assets. At June 30, 1997, nonperforming loans constituted 0.06%
of the Bank's total loans and the allowance for loan losses to nonperforming
loans was 2069.17%.

The Bank's main office is located at 201 5th Avenue S.W., Olympia,
Washington 98501 and its telephone number is (360) 943-1500.

MARKET AREAS

The Bank has been, and intends to continue to be, a community-oriented
financial institution offering financial services to meet the needs of the
communities it serves. Headquartered in Olympia, Thurston County, Washington,
the Bank conducts business from ten full service offices, five in Thurston
County, one in Mason County and four in Pierce County. The Bank has two
mortgage origination offices, one in Thurston and one in Pierce County, both
of which operate within banking offices.

Olympia enjoys a stable economic climate, largely due to government
employment and military personnel, both retired and active. State government
is by far the largest and most important employer in Thurston County,
employing over 40% of the total county work force. Federal, county, and
municipal government comprise nearly 50% of the county's employment base. Fort
Lewis and McChord Air Force Base are both located in the Bank's primary market
area.

Thurston County has a population of 197,600 as of April 1, 1997 and was one
of the fastest growing metropolitan counties in the state of Washington as
reported in the national 1990 census. Thurston County's growth has been
spurred by an increase in government employment in the 1980's and the
expansion of a large retirement population, including many former military
personnel.

Pierce County, where Tacoma is located, has a population of 674,300 as of
April 1, 1997. Its economy is well-diversified, with the principal industry
being aerospace, shipping, military-related government employment, agriculture
and forest products. Pierce County's economy is expected to benefit over the
next few years because of Intel Corporation's decision to build a computer
chip facility in DuPont and the expansion of the Matsushita semiconductor
plant in Puyallup, east of Tacoma. The Puget Sound Economic Forecaster, a
regional publication providing economic forecasts and commentary, predicts
that Pierce County will likely have the strongest economic performance in the
Puget Sound region through 1999. Forbes magazine recently published its
prediction that the Tacoma area would be among the top twenty-five cities in
the United States in terms of job growth, especially in the areas of computers
and semiconductors.

The Bank's market area also includes Shelton and the surrounding Mason
County area. The population of Mason County is approximately 47,900 and its
economy is substantially dependent upon timber and the forest products
industries.

LENDING ACTIVITIES

General. The Bank traditionally has originated one- to four-family mortgage
loans and, to a lesser extent, multifamily, commercial real estate and
construction loans. In fiscal 1994, the Bank implemented a growth strategy
which is intended to broaden its products and services from traditional thrift
products and services to those more closely related to commercial banking. In
this regard, in 1993, the Bank began to emphasize relationship banking, in
order to improve customer loyalty through maximizing the number of lending and
deposit relationships with a customer. The focus also included expanding the
Bank's commercial business lending capabilities. In early fiscal 1997, several
commercial loan officers, experienced in the Puget Sound region, were hired to
continue the expansion. The loan officers, in addition to bringing to the Bank
some previous

3740

customer relationships, have taken advantage of the opportunity to attract
customers of banks that have been acquired in the recent wave of mergers with
out-of-area acquirors. Such customers often perceive that non-local decision
makers do not provide the efficient, personal service they were used to
receiving. It is possible that the large out-of-area acquirors will begin to
better serve small business and professionals. Heritage Bank anticipates,
however, that it will, by then, have more fully developed its reputation as a
commercial lender. As the Bank pursues its strategy, management is continuing
to emphasize strong asset quality.

The Bank's overall lending operations are guided by loan policies which are
reviewed and approved annually by its Board of Directors, and which outline
the basic policies and procedures by which lending operations are conducted.
Generally, the policies address the types of loans, underwriting and
collateral requirements, terms, interest rate and yield considerations, and
compliance with laws and regulations. The Bank supplements its own supervision
of the loan underwriting and approval process with periodic but informal loan
audits by an experienced internal loan quality specialist, who reviews credit
quality, loan documentation and compliance with laws and regulations.

During the loan process, the Bank assesses both the borrower's ability to
repay the loan and the adequacy of the underlying collateral. Potential
residential borrowers complete an application which is submitted to a loan
officer of the Bank. As part of the loan application process, qualified
independent fee appraisers inspect and appraise the property which is offered
to secure the loan. The Bank also obtains information concerning the income,
financial condition, employment, and credit history of the applicant. The
Bank's loan officers and the loan underwriting department analyze the loan
application and the property to be used as collateral. Loans to be sold on the
secondary market are approved or denied based on guidelines established by
secondary market agencies such as the Federal National Mortgage Association
("FNMA"), the Federal Housing Authority (the "FHA") or the Veteran's
Administration (the "VA"). Loans to be placed in the portfolio are approved or
denied by a loan committee consisting of the loan officer and the Chief
Executive Officer. Loan requests for less than $1.5 million and where the
borrower's total bank liability is less than $1.5 million may be approved by
the Chief Executive Officer. Loan requests for over $1.5 million or any
request where the borrower's total bank liabilities exceeds $1.5 million must
be approved by the Chief Executive Officer and either the Board of Directors
or the Board Executive Committee.

3841

The following table sets forth at the dates indicated the Bank's loan
portfolio composition by type of loan. These balances are net of deferred loan
fees and prior to deduction for the allowance for loan losses.

AT JUNE 30
----------------------------------------------------------------------------------------
1993 1994 1995 1996 1997
---------------- ---------------- ---------------- ---------------- ----------------
% OF % OF % OF % OF % OF
TOTAL TOTAL TOTAL TOTAL TOTAL
BALANCE LOANS BALANCE LOANS BALANCE LOANS BALANCE LOANS BALANCE LOANS
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(DOLLARS IN THOUSANDS)

Commercial.............. $ 1,203 0.92% $ 4,902 3.80% $ 9,983 6.31% $ 18,269 10.82% $ 39,445 18.95%
Real estate mortgages
One- to four-family
residential(1)........ 73,431 56.29 70,019 54.25 90,985 57.52 93,157 55.15 103,439 49.68
Five or more family
residential and
commercial
properties............ 40,395 30.97 39,731 30.78 38,494 24.33 42,560 25.20 51,209 24.60
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate
mortgages............. 113,826 87.26 109,750 85.03 129,479 81.85 135,717 80.35 154,648 74.28
Real estate construction
One- to four-family
residential........... 12,115 9.29 13,251 10.26 16,504 10.43 14,509 8.59 12,683 6.09
Five or more family
residential and
commercial
properties............ 2,970 2.28 -- -- 1,538 0.97 393 0.23 1,029 0.50
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate
construction(2)....... 15,085 11.57 13,251 10.26 18,042 11.40 14,902 8.82 13,712 6.59
Consumer................ 997 0.76 1,934 1.50 1,812 1.15 1,105 0.65 1,467 0.70
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Gross loans............. $131,111 100.51% $129,837 100.59% $159,316 100.71% $169,993 100.64% $209,272 100.52%
Less deferred loan
fees................... (662) (0.51) (763) (0.59) (1,126) (0.71) (1,090) (0.64) (1,079) (0.52)
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans............. $130,449 100.00% $129,074 100.00% $158,190 100.00% $168,903 100.00% $208,193 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======

- --------
(1) Includes loans held for sale of $7,435, $4,110, $5,944, $5,286 and $6,322,
respectively.
(2) Balances are net of undisbursed loan proceeds.

The following table presents at June 30, 1997, (i) the aggregate maturities
of loans in the named categories of the Bank's loan portfolio and (ii) the
aggregate amounts of fixed rate and variable or adjustable rate loans in the
named categories that mature after one year:

MATURING
-------------------------------
WITHIN 1-5 AFTER
1 YEAR YEARS 5 YEARS TOTAL
------- ------- ------- -------
(IN THOUSANDS)

Commercial.................................. $17,341 $ 8,791 $13,313 $39,445
Real estate construction.................... 10,718 2,364 630 13,712
------- ------- ------- -------
Total..................................... $28,059 $11,155 $13,943 $53,157
======= ======= ======= =======
Fixed rate loans............................ $ 6,444 $ 5,395 $11,839
Variable or adjustable rate loans........... 4,711 8,548 13,259
------- ------- -------
Total..................................... $11,155 $13,943 $25,098
======= ======= =======

REAL ESTATE LENDING

One- to Four-Family Residential Real Estate Lending. The majority of
residential loans have been originated through the Bank and are secured by
one- to four-family residences located in the Bank's primary market area. The
Bank's underwriting standards require that one- to four-family portfolio loans
generally be owner-occupied and that loan amounts not exceed 80% (90% with
private mortgage insurance) of the current appraised value or cost, whichever
is lower, of the underlying collateral. Terms typically range from 15 to 30
years. The Bank offers both fixed-rate mortgages and adjustable rate mortgages
("ARMs"), with repricing based on a Treasury Bill or other index. The Bank's
ability to generate volume in ARMs however, is largely a function

3942

of consumer preference and the interest rate environment. The Bank's current
policy is not to make ARMs with discounted initial interest rates (i.e.,
"teasers"). The Bank generally sells all government guaranteed mortgages mostboth
fixed rate and adjustable rate. In addition, in connection with management's
strategies to control the Bank's interest rate sensitivity position, the Bank
determines from time to time to what extent it will retain or sell other ARMs
and other fixed rate mortgagesmortgages. See "Management's Discussion and other ARMAnalysis of
Financial Condition and Results of Operations--Asset/Liability Management." At
June 30, 1997, the Bank had $103.4 million, or 49.7%, of the Bank's total
loans receivable, in the secondary market.one-to-four family residential mortgage loans of which
$80.3 million, or 77.6% of this category, are at fixed interest rates.

Multifamily and Commercial Real Estate Lending. The Bank has made, and
anticipates continuing to make, on a selective basis, multifamily and
commercial real estate loans in the Bank's primary market areas. Commercial
real estate loans are made for small shopping centers, warehouses and
professional offices, generally owner occupied. Cash flow coverage to debt
servicing requirements is generally 1.2 times or more. The Bank's underwriting
standards generally require that the loan-to-value ratio for multifamily and
commercial real estate loans not exceed 80% of appraised value or cost,
whichever is lower.

At June 30, 1997, the Bank had $51.2 million, or 24.6% of the Bank's total
loans receivable, secured byin multifamily and commercial real estate loans secured by
properties located primarily in the Bank's primary market area. Of the $51.2
million, $9.9 million, or 19.3% of this category, are at fixed interest rates.

Multifamily and commercial real estate loans generally range in principal
balance from $1.0 million to $2.0 million. At June 30, 1997, the largest such
loan had an outstanding principal balance of $3.1 million and was secured by a
144 unit apartment complex located in the Bank's primary market area. At June
30, 1997, this loan was performing according to its terms.

Multifamily and commercial real estate mortgage lending affords the Bank an
opportunity to receive interest at rates higher than those generally available
from one- to four-family residential lending. However, loans secured by such
properties usually are greater in amount, more difficult to evaluate and
monitor and, therefore, involve a greater degree of risk than one- to four-
family residential mortgage loans. Because payments on loans secured by
multifamily and commercial real estate properties are often dependent on the
successful operation and management of the properties, repayment of such loans
may be affected by adverse conditions in the real estate market or the
economy. The Bank seeks to minimize these risks by strictly scrutinizing the
financial condition of the borrower, the quality of the collateral and the
management of the property securing the loan. The Bank also generally obtains
personal guarantees from financially capable borrowers based on a review of
personal financial statements.

Construction Loans. The Bank originates one- to four-family residential
construction loans for the construction of custom homes (where the home buyer
is the borrower) and provides financing to builders for the construction of
pre-sold homes and speculative residential construction. The Bank loans to
builders who have demonstrated a favorable record of performance and
profitable operations and who are building in markets that management
understands and in which it is comfortable with the economic conditions. The
Bank further endeavors to limit its construction lending risk through
adherence to strict underwriting procedures. Loans to one builder are
generally limited on a case-by-case basis with unsold home limits based on
builder strengths. Heritage Bank's underwriting standards require that the
loan-to-value ratio for pre-sold homes and speculative residential
construction not exceed 80% of appraised value or builder's cost less
overhead, whichever is less. Speculative construction and land development
loans are generally priced with a variable rate of interest using the prime
rate as the index. The Bank generally requires builders to have some tangible
form of equity in each construction project. That objective may be achieved by
restricting draws to less than the acquisition cost of land plus a percentage
of the builder's costs less overhead incurred to date, requiring that loan
fees be paid from outside funds, requiring the builder to place equity funds
in a construction loan account or by not reimbursing fees incurred by the
builder such as legal fees, architectural fees, and building permits. Also,
the Bank generally requires prompt and thorough documentation of all draw
requests and utilizes outside inspectors to inspect the project prior to
paying any draw requests from builders.

43
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its single-
family permanent mortgage lending. Construction lending, however, is generally
considered to involve a higher degree of risk than single-family permanent
mortgage lending because of the inherent difficulty in estimating both a
property's value at completion of the project and the estimated costs of the
project. The nature of these loans is such that they are generally more
difficult to evaluate and

monitor. If the estimate of construction cost proves to be inaccurate, the
Bank may be required to advance funds beyond the amount originally committed
to permit completion of the project. If the estimate of value upon completion
proves to be inaccurate, the Bank may be confronted with a project whose value
is insufficient to assure full repayment. Projects may also be jeopardized by
disagreements between borrowers and builders and by the failure of builders to
pay subcontractors. Loans to builders to construct homes for which no
purchaser has been identified carry more risk because the payoff for the loan
depends on the builder's ability to sell the property prior to the time that
the construction loan is due.

At June 30, 1997, the Bank had $13.7 million, or 6.6% of the Bank's total
loans receivable, in real estate construction loans. The majority of these
construction loans, $12.7 million, are for one-to-four family residential
properties. Of the $13.7 million total, most of these loans have variable
interest rates and only $2.8 million have fixed interest rates.

The Bank has reduced its activity in residential construction lending with
originations of $16.3 million for fiscal 1997, $20.5 million in fiscal 1996
and $21.3 million for fiscal 1995. The reductions reflect changes in market
conditions rather than a decision to deemphasize residential construction
lending.

COMMERCIAL BUSINESS LENDING

The Bank offers commercial loans to sole proprietorships, partnerships and
corporations in real estate related industries and firms in the health care,
legal and other professions. The types of commercial loans offered are
business lines of credit which are secured by real estate or securities,
business term loans secured by real estate for either working capital or lot
acquisition, Small Business Association ("SBA") loans and unsecured business
loans. Unsecured credit is reserved for business customers with impeccable
character and demonstrated capability to repay. All unsecured loans in excess
of $150,000 require the approval of the Chief Executive Officer. All unsecured
loans in excess of $500,000 require approval of the Board of Directors.

Commercial business lending generally involves greater risk than residential
mortgage lending and involves risks that are different from those associated
with residential and commercial real estate lending. Real estate lending is
generally considered to be collateral based lending with loan amounts based on
predetermined loan to collateral values and liquidation of the underlying real
estate collateral is viewed as the primary source of repayment in the event of
borrower default. Although the Bank's commercial business loans are often
collateralized by real estate, the decision to grant a commercial business
loan depends primarily on the creditworthiness and cash flow of the borrower
(and any guarantors), while liquidation of collateral is a secondary source of
repayment.

As of June 30, 1997, the Bank had $39.4 million, or 18.9% of the Bank's
total loans receivable, in commercial business loans. Collateral for these
loans is generally owner occupied business or residential real estate. The
Bank generally limits its exposure to any one borrowing relationship to $1.5
million, though loan relationships up to $4.0 million have been approved.

CONSUMER LENDING

The Bank does not actively solicit consumer loans, which are offered
primarily as a convenience to existing customers. While these types of loans
are primarily secured by real estate, they also include savings and
certificate of deposit loans, vehicle and recreational vehicle loans, stock
secured loans and secured and unsecured lines of credit.

ORIGINATION AND SALES OF LOANS

The Bank originates real estate and other loans at each of the Bank's
offices with approximately two-thirds of the residential mortgage volumes
generated from its two loan origination offices. Walk-in customers and
referrals from real estate brokers are important sources of loan originations.

Consistent with the Bank's asset/liability management strategy, the Bank
sells a majority of its fixed rate and ARM residential mortgage loans into the
secondary market. Commitments to sell mortgage loans generally are made during
the period between the taking of the loan application and the closing of the
mortgage loan. The timing of making these sale commitments is dependent upon
the timing of the borrower's election to lock-in the mortgage interest rate
and fees prior to loan closing. Most of these sale commitments are made on a
"best

efforts" basis whereby the Bank is only obligated to sell the mortgage if the
mortgage loan is approved and closed by the Bank.

When the Bank sells mortgage loans, it typically also sells the servicing of
the loans (i.e., collection of principal and interest payments). The Bank
serviced $23.3 million and $19.2 million in loans for others as of June 30,
1996 and 1997, respectively. The Bank received fee income of $75,000 during
fiscal 1997 for these servicing activities.

The following table presents summary information concerning the Bank's
origination and sale of residential mortgage loans and the gains achieved on
such activities.

YEAR ENDED JUNE 30,
-------------------------
1995 1996 1997
------- -------- --------
(DOLLARS IN THOUSANDS)

One- to four-family residential mortgage loans:
Originated..................................... $93,564 $140,232 $104,145
Sold........................................... 63,261 119,544 87,003
Gains on sales of loans, net..................... $ 1,665 $ 3,049 $ 2,006

The decrease in volume of originations of one- to four-family residential
mortgage loans in 1997 compared with 1996 was due to weakness in the
residential mortgage market and the loss of two key producers by the end of
fiscal 1996. The Bank has a minimal amount of purchased loans and loan
participations.

COMMITMENTS AND CONTINGENT LIABILITIES

In the ordinary course of business, the Bank enters into various types of
transactions that include commitments to extend credit that are not included
in the Consolidated Financial Statements. The Bank applies the same credit
standards to these commitments as it uses in all its lending activities and
has included these commitments in its lending risk evaluations. The Bank's
exposure to credit loss under commitments to extend credit is represented by
the amount of these commitments. At June 30, 1997, the Bank had outstanding
commitments to extend credit, including letters of credit, in the amount of
$17.8 million.

DELINQUENCIES AND NONPERFORMING ASSETS

Delinquency Procedures. When a borrower fails to make a required payment on
a loan, the Bank attempts to cause the delinquency to be cured by contacting
the borrower. In the case of loans other than commercial business loans, a
late notice is sent 15 days after the due date. If the delinquency is not
cured by the 30th day, a second notice is mailed and, if appropriate, the
borrower is contacted by telephone. Additional written and verbal contacts are
made with the borrower between 60 and 90 days after the due date.

In the event a real estate loan payment is past due for 45 days or more,
loan servicing personnel perform an in-depth review of the loan status, the
condition of the property, and the circumstances of the borrower. Based upon
the results of its review, the Bank may negotiate and accept a repayment
program with the borrower, accept a voluntary deed in lieu of foreclosure or,
when deemed necessary, initiate foreclosure proceedings. If foreclosed

45
on, real property is sold at a public sale and the Bank may bid on the
property to protect its interest. A decision as to whether and when to
initiate foreclosure proceedings is made by the loan committee and is based on
such factors as the amount of the outstanding loan in relation to the value of
the property securing the original indebtedness, the extent of the
delinquency, and the borrower's ability and willingness to cooperate in curing
the delinquency.

Real estate acquired by the Bank by deed in lieu of foreclosure or as a
result of foreclosure is classified as real estate owned ("REO") until it is
sold. When property is acquired, it is recorded at the lower of cost or
estimated fair value at the date of acquisition, not to exceed net realizable
value, and any write-down resulting therefrom is charged to the allowance for
loan losses. Upon acquisition, all costs incurred in maintaining the

42
property
are expensed. Costs relating to the development and improvement of the
property, however, are capitalized to the extent of the property's net
realizable value.

The Bank considers loans as in-substance foreclosed if the borrower has
little or no equity in the property based upon its estimated fair value, if
repayment can be expected only to come from operation or sale of the
collateral, and if the borrower has effectively abandoned control of the
collateral or has continued to retain control of the collateral but because of
the borrower's current financial status, it is doubtful that the borrower will
be able to repay the loan in the foreseeable future.

Delinquencies in the commercial business loan portfolio are handled on a
case-by-case basis. Generally, notices are sent and personal contact is made
with the borrower when the loan is 15 days past due. Loan officers are
responsible for collecting loans they originate or which are assigned to them.
Depending on the nature of the loan and the type of collateral securing the
loan, the Bank may negotiate and accept a modified payment program or take
such other actions as the circumstances warrant.

Classification of Assets. Federal regulations require that the Bank classify
its assets on a regular basis. In addition, in connection with examinations of
the Bank, the Division and FDIC examiners have authority to identify problem
assets and, if appropriate, require them to be classified. There are three
classifications for problem assets: Substandard, Doubtful, and Loss.
Substandard assets have one or more defined weaknesses and are characterized
by the distinct possibility that the Bank will sustain some loss if the
deficiencies are not corrected. Doubtful assets have the weaknesses of
Substandard assets, with the additional characteristics that the weaknesses
make collection or liquidation in full on the basis of currently existing
facts, conditions and values questionable, and there is a high possibility of
loss. An asset classified as Loss is considered uncollectible and of such
little value that continuance as an asset of the institution is not warranted.
Assets classified as Substandard or Doubtful require the institution to
establish prudent general allowances for loan losses. If an asset or portion
thereof is classified as Loss, the institution must charge off such amount. In
March 1997, the FDIC performed its most recent examination of the Bank and the
regulators' assessment of the Bank's classified assets is consistent with the
Bank's internal classifications.

46
Nonperforming Assets. Nonperforming assets consist of nonaccrual loans,
restructured loans and real estate owned. The following table sets forth at
the dates indicated information with respect to nonaccrual loans, restructured
loans and real estate owned of the Bank.

AT JUNE 30,
-------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)

Nonaccrual loans................. $ 97 $ 96 $ 96 $ 51 $ 133
Restructured loans............... -- -- -- -- --
------- ------- ------- ------- -------
Total nonperforming loans...... 97 96 96 51 133
Real estate owned................ 157 -- -- -- --
------- ------- ------- ------- -------
Total nonperforming assets..... $ 254 $ 96 $ 96 $ 51 $ 133
======= ======= ======= ======= =======
Accruing loans past due 90 days
or more......................... -- -- -- -- --
Potential problem loans.......... $ 3,662 $ 3,568 $ 3,718 $ 1,613 $ 68
Allowance for loan losses........ 1,658 1,705 1,720 1,873 2,752
Nonperforming loans to loans..... 0.07% 0.07% 0.06% 0.03% 0.06%
Allowance for loan losses to
loans........................... 1.27% 1.32% 1.09% 1.11% 1.32%
Allowance for loan losses to
nonperforming loans............. 1709.28% 1776.04% 1791.67% 3672.55% 2069.17%
Nonperforming assets to total
assets.......................... 0.14% 0.05% 0.05% 0.02% 0.05%

Nonaccrual Loans. The Bank's financial statements are prepared on the
accrual basis of accounting, including the recognition of interest income on
its loan portfolio, unless a loan is placed on a nonaccrual basis. Loans are
placed on nonaccrual status when there are serious doubts about the
collectibility of principal or 43
interest. The Bank's policy is to place a loan
on nonaccrual status when the loan becomes past due for 90 days or more.
Amounts received on nonaccrual loans generally are applied first to principal
and then to interest only after all principal has been collected.

At June 30, 1997, the Bank had $133,000 of nonaccrual loans which represents
one single family mortgage. Interest on nonaccrual loans foregone was
approximately $990 for the year ended June 30, 1997. There was no interest
foregone on nonaccrual loans in fiscal 1995 and 1996.

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is maintained at a level considered adequate
by management to provide for reasonably foreseeable loan losses based on
management's assessment of various factors affecting the loan portfolio,
including a review of problem loans, business conditions and loss experience
and an overall evaluation of the quality of the underlying collateral, holding
and disposal costs and costs of capital. The allowance is increased by
provisions for loan losses charged to operations and reduced by loans charged
off, net of recoveries.

While management believes that it uses the best information available to
determine the allowance for loan losses, unforeseen market conditions could
result in adjustments to the allowance for loan losses, and net income could
be significantly affected, if circumstances differ substantially from the
assumptions used in determining the allowance.

The following table sets forth for the periods indicated information
regarding changes in the Bank's allowance for loan losses:

YEAR ENDED JUNE 30,
-------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)

Total loans outstanding at
end of period(1)........... $130,449 $129,074 $158,190 $168,903 $208,193
Average loans outstanding
during period.............. 125,829 123,800 144,266 161,501 184,617
Allowance balance at
beginning of period........ 2,511 1,658 1,705 1,720 1,873
Provision for loan losses... 926 -- -- -- (270)
Charge-offs:
Real estate(2)............ (1,866) -- -- -- --
Commercial................ -- -- -- -- (3)
Consumer.................. -- -- -- -- --
-------- -------- -------- -------- --------
Total charge-offs....... (1,866) -- -- -- (3)
-------- -------- -------- -------- --------
Recoveries:
Real estate(2)............ 87 47 15 153 1,152
Commercial................ -- -- -- -- --
Consumer.................. -- -- -- -- --
-------- -------- -------- -------- --------
Total recoveries........ 87 47 15 153 1,152
-------- -------- -------- -------- --------
Net (charge-offs)
recoveries........... (1,779) 47 15 153 1,149
-------- -------- -------- -------- --------
Allowance balance at end of
period..................... $ 1,658 $ 1,705 $ 1,720 $ 1,873 $ 2,752
======== ======== ======== ======== ========
Ratio of net (charge-offs)
recoveries during period to
average loans outstanding.. (1.41)% 0.04% 0.01% 0.09% 0.62%
======== ======== ======== ======== ========

- --------
(1) Includes loans held for sale.
(2) During this five year period, all of the charge-offs and recoveries shown
under the real estate category relate to real estate mortgages. None of
the above activity related to real estate construction loans.

The following table shows the allocation of the allowance for loan losses
for the last five years. The allocation is based upon an evaluation of defined
loan problems, historical ratios of loan losses for the Bank and industry wide
and other factors which may affect future loan losses in the categories shown
below:

AT JUNE 30
-------------------------------------------------------------------------------
1993 1994 1995 1996 1997
--------------- --------------- --------------- --------------- ---------------
% OF % OF % OF %OF % OF
TOTAL TOTAL TOTAL TOTAL TOTAL
AMOUNT LOANS(1) AMOUNT LOANS(1) AMOUNT LOANS(1) AMOUNT LOANS(1) AMOUNT LOANS(1)
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
(DOLLARS IN THOUSANDS)

BALANCE APPLICABLE TO:
Commercial.............. $ 34 0.9% $ 144 3.8% $ 200 6.3% $ 446 10.8% $1,094 18.8%
Real estate mortgages:
One- to four-family
residential........... 100 56.0 92 53.9 115 57.1 110 54.8 128 49.4
Five or more family
residential and
commercial
properties............ 1,190 30.8 1,120 30.6 1,136 24.2 959 25.0 748 24.5
Real estate
construction:
One- to four-family
residential........... 175 9.2 248 10.2 182 10.4 239 8.5 197 6.1
Five or more family
residential and
commercial
properties............ 89 2.3 -- 0.0 29 0.9 12 0.2 31 0.5
Consumer................ 6 0.8 13 1.5 10 1.1 3 0.7 7 0.7
Unallocated............. 64 88 48 103 546
------ ------ ------ ------ ------
Total.................. $1,658 100.0% $1,705 100.0% $1,720 100.0% $1,873 100.0% $2,752 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====

- --------
(1) Represents the total of all outstanding loans in each category as a
percent of total loans outstanding.

48
INVESTMENT ACTIVITIES

Investment securities are those securities which the Bank has the ability to
hold to maturity and the intent to hold on a long-term basis or until
maturity. Events which may be reasonably anticipated are considered when
determining the Bank's intent to hold investment securities for the
foreseeable future. Investment securities are carried at cost, adjusted for
amortization of premiums and accretion of discounts. At June 30, 1997, the
Bank had no securities classified as available for sale or trading.

The investment policy of the Bank, which is established by the Board of
Directors and monitored by the Audit and Finance Committee, is designed
primarily to provide and maintain liquidity, to generate a favorable return on
investments without incurring undue interest rate and credit risk, and to
complement the Bank's lending activities. This policy dictates that
investments will be made with the intent of holding them to maturity. The
Bank's policy permits investment in various types of liquid assets permissible
under applicable regulations, which include U.S. Treasury obligations, U.S.
Government agency obligations, certain certificates of deposit of insured
banks, FHLB stock and federal funds. Investment in non-investment grade bonds
is not permitted under this policy.

The following table summarizes the amortized cost, gross unrealized gains
and losses and the resulting fair value of securities held for investment:

GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
(IN THOUSANDS)

June 30, 1995:
U.S. Government and its agencies...... $18,094 $ 24 $ (70) $18,048
Mortgage backed securities............ 7,465 314 (5) 7,774
------- ---- ----- -------
Total held for investment........... 25,559 338 (75) 25,822
June 30, 1996:
U.S. Government and its agencies...... 15,292 5 (127) 15,170
Mortgage backed securities............ 5,979 159 (2) 6,136
------- ---- ----- -------
Total held for investment........... 21,271 164 (129) 21,306
June 30, 1997:
U.S. Government and its agencies...... 8,506 9 (17) 8,498
Mortgage backed securities............ 5,159 224 (3) 5,380
------- ---- ----- -------
Total held for investment........... $13,665 $233 $ (20) $13,878
======= ==== ===== =======

For the above indicated dates, the Bank had no securities available for sale
or trading.

The following table sets forth certain information regarding the carrying
value, weighted average yields and maturities or periods to repricing of the
Bank's investment securities and mortgage backed securities at June 30, 1997.

US GOVERNMENT AND ITS MORTGAGE BACKED
AGENCIES SECURITIES TOTAL
---------------------- ---------------------- -----------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE YIELD COST VALUE YIELD COST VALUE YIELD
--------- ------ ----- --------- ------ ----- --------- ------- -----
(DOLLARS IN THOUSANDS)

Less than one year...... $3,817 $3,820 5.87% $ 35 $ 37 8.28% $ 3,851 $ 3,857 5.90%
One to five years....... 4,689 4,678 5.83 23 24 8.50 4,712 4,702 5.84
Five to ten years....... -- -- -- 207 209 7.92 207 209 7.92
After ten years......... -- -- -- 4,894 5,110 8.32 4,894 5,110 8.32
------ ------ ------ ------ ------- -------
Total................. $8,506 $8,498 $5,159 $5,380 $13,665 $13,878
====== ====== ====== ====== ======= =======

49
The Bank held $1.5 million of FHLB stock at June 30, 1997. The stock has no
contractual maturity and amounts in excess of the required minimum for FHLB
membership may be redeemed at par. At June 30, 1997, the Bank was required to
maintain an investment in the stock of FHLB of Seattle of at least $1.4
million.

DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS

General. The Bank's primary sources of funds are customer deposits and loan
repayments. Scheduled loan repayments are a relatively stable source of funds,
while deposit inflows and outflows and unscheduled loan prepayments, which are
influenced significantly by general interest rate levels, interest rates
available on other investments, competition, economic condition and other
factors, are not. Although the Bank's deposit balances have been increasing,
such balances have been influenced in the past by adverse changes in the
thrift industry and may be affected by such developments in the future.
Borrowings may be used on a short term basis to compensate for reductions in
other sources of funds (such as deposit inflows at less than projected
levels). Borrowings may also be used on a longer term basis to support
expanded lending activities and to match the maturity or repricing intervals
of assets.

Deposit Activities. The Bank offers a variety of accounts for depositors
designed to attract both short term and long term deposits. These accounts
include certificates of deposit ("CDs"), regular savings accounts, money
market accounts, checking and negotiable order of withdrawal ("NOW") accounts,
and individual retirement accounts ("IRAs"). These accounts generally earn
interest at rates established by management based on competitive market
factors and management's desire to increase or decrease certain types or
maturities of deposits. At June 30, 1997, the Bank had no brokered deposits.
The more significant deposit accounts offered by Heritage Bank are described
below.

CERTIFICATES OF DEPOSIT. The Bank offers several types of CDs with
maturities ranging from 30 days to five years and which require a minimum
deposit of $100. In addition, the Bank offers a CD that has a maturity of
four to 11 months and a minimum deposit of $2,500 and permits additional
deposits at the initial rate throughout the certificate term. Interest is
credited quarterly or at maturity. Finally, jumbo CDs are offered in
amounts of $100,000 or more for terms of 30 days to 12 months. The jumbo
CDs pay simple interest and are credited either quarterly or at maturity.

REGULAR SAVINGS ACCOUNTS. The Bank offers savings accounts that allow for
unlimited deposits and withdrawals, provided that a $100 minimum balance is
maintained. Interest is compounded daily and credited quarterly.

MONEY MARKET ACCOUNTS. Money market accounts pay a variable interest rate
that is tiered depending on the balance maintained in the account. Minimum
opening balances vary. Interest is compounded daily and paid monthly.

CHECKING AND NOW ACCOUNTS. Checking and NOW accounts are non-interest and
interest bearing and may be charged service fees based on activity and
balances. NOW accounts pay interest, but require a higher minimum balance
to avoid services charges.

INDIVIDUAL RETIREMENT ACCOUNTS. IRAs permit contributions of up to $2,000
per year and pay interest at fixed rates. Maturities are available from one
to five years and interest is compounded daily and credited quarterly.

50
SOURCES OF FUNDS

Deposit Activities. The following table sets forth for the periods indicated
the average balances outstanding and the weighted average interest rates for
each major category of deposits:

YEAR ENDED JUNE 30
----------------------------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------------ ------------------ ------------------ ------------------ ------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
AVERAGE RATE AVERAGE RATE AVERAGE RATE AVERAGE RATE AVERAGE RATE
BALANCE(1) PAID BALANCE(1) PAID BALANCE(1) PAID BALANCE(1) PAID BALANCE(1) PAID
---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- -------
(DOLLARS IN THOUSANDS)

Interest bearing demand
and money market
Accounts............... $ 27,018 3.26% $ 34,932 2.99% $ 40,594 3.19% $ 36,930 3.15% $ 42,271 3.18%
Savings................. 27,283 3.63 31,520 3.26 28,178 3.29 28,407 3.63 29,703 3.55
Certificates of
deposit................ 95,622 5.32 88,904 4.68 89,602 4.93 109,559 5.78 119,133 5.54
Total interest bearing
deposits.............. 149,923 4.64 155,355 4.02 158,374 4.19 174,895 4.88 191,107 4.71
Demand and other
noninterest bearing
deposits............... 4,256 6,183 6,001 6,537 7,955
-------- -------- -------- -------- --------
Total deposits......... $154,179 4.51% $161,538 3.86% $164,375 4.04% $181,432 4.70% $199,063 4.52%
======== ======== ======== ======== ========

- --------
(1) Average balances were calculated using average daily balances.

The following table sets forth for the periods indicated the change in the
balances of deposits during the year and the impact of interest credited
thereon.

YEAR ENDED JUNE 30
-------------------------
1995 1996 1997
------- ------- -------
(IN THOUSANDS)

Net increase in deposits........................ $ 8,875 $16,322 $18,662
Less: Interest credited....................... (6,639) (8,528) (8,999)
------- ------- -------
Net increase before interest credited........... $ 2,236 $ 7,794 $ 9,663
======= ======= =======

The following table shows the amount and maturity of certificates of deposit
that had balance of $100,000 or more as of June 30, 1997:

JUNE 30, 1997
--------------
(IN THOUSANDS)

Remaining maturity:
Three months or less...................................... $ 8,330
Over three months through six months...................... 1,670
Over six months through 12 months......................... 6,234
Over twelve months........................................ 1,748
-------
Total................................................... $17,982
=======

At June 30, 1996 and 1997 certificates of deposits with balances of $100,000
or more totaled $11.7 million and $18.0 million, respectively.

In the unlikely event the Bank is liquidated after the Conversion,
depositors will be entitled to full payment of their deposit accounts prior to
any payment being made to the Company's stockholders. Substantially all of the
Bank's depositors are residents of the State of Washington.

Borrowings. Savings deposits are the primary source of funds for the Bank's
lending and investment activities and for its general business purposes. The
Bank has in the past, however, relied upon advances from the FHLB of Seattle
to supplement its supply of lendable funds and to meet deposit withdrawal
requirements.

The FHLB of Seattle has served as one of the Bank's secondary sources of
liquidity. Advances from the FHLB of Seattle are typically secured by the
Bank's first mortgage loans, and stock issued by the FHLB of Seattle, which is
held by the Bank. At June 30, 1997, the Bank had advances from the FHLB of
Seattle totaling $890,000.

The FHLB functions as a central reserve bank providing credit for savings
and loan associations and certain other member financial institutions. As a
member, the Bank is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the United States) provided certain
standards related to creditworthiness have been met. Advances are made
pursuant to several different programs. Each credit program has its own
interest rate and range of maturities. Depending on the program, limitations
on the amount of advances are based either on a fixed percentage of an
institution's net worth or on the FHLB's assessment of the institution's
creditworthiness. Under its current credit policies, the FHLB of Seattle
generally limits advances to 20.0% of a member's assets, and short term
borrowings of less than one year may not exceed 10.0% of the institution's
assets. The FHLB of Seattle determines specific lines of credit for each
member institution.
In August 1986, Heritage Capital Corporation ("HCC"), a special purpose
wholly owned finance subsidiary, issued and sold $21.9 million aggregate
principal amount of collateralized mortgage obligations. These bonds,
including interest, were repaid in quarterly installments from principal and
interest payments on the underlying collateral. In August 1995, HCC called and
repaid the then remaining unpaid balance of the bonds in accordance with the
terms of the indenture. HCC was then liquidated.

COMPETITION

The Bank competes for loans and deposits with other thrifts, commercial
banks, credit unions, mortgage bankers and other institutions in the scope and
type of services offered, interest rates paid on deposits, pricing of loans,
and number and locations of branches, among other things. Many of these
competitors have substantially greater resources than the Bank. Particularly
in times of high interest rates, the Bank also faces significant competition
for investors' funds from short term money market securities and other
corporate and government securities.

The Bank competes for loans principally through the range and quality of the
services it provides, interest rates and loan fees, and the locations of its
branches. The Bank actively solicits deposit-related clients and competes for
deposits by offering depositors a variety of savings accounts, checking
accounts and other services.

Competition has intensified as a result of changes in Washington banking
laws that permit (i) statewide branching of Washington-domiciled financial
institutions and (ii) out-of-state holding companies to acquire Washington-
based financial institutions, provided that the laws of the state in which the
out-of-state institutions conduct their principal operations similarly permit
a Washington-based institution to acquire financial institutions domiciled in
their state. During the past several years, substantial consolidation among
financial institutions in Washington has occurred. Management believes that
due to this consolidation, customers in the Bank's market areas will seek a
relationship with smaller, service-oriented institutions like the Bank.

PROPERTIES

The Company's executive offices and the main office of the Bank are located
in approximately 18,000 square feet of the headquarters building and adjacent
office space which is owned and located in downtown Olympia. At June 30, 1997,
the Bank had five offices located in Thurston County, including the main
office, all of which are owned, with one office located on leased land, one
office in Shelton, Mason County, which is owned, and four offices in Tacoma
and surrounding areas of Pierce County, all but one of which is owned.

EMPLOYEES

At June 30, 1997, the Bank had 145 full-time equivalent employees. The Bank
believes that employees play a vital role in the success of a service company.
None of the Bank's employees are covered by a collective bargaining agreement
with the Bank and management believes that they have a good relationship with
the employees.

52
SUBSIDIARIES

At June 30, 1997, the Bank has one wholly-owned subsidiary, Sound Service
Associates, Inc. Sound Service Associates, Inc.'s operations consist of the
sale of tax-deferred annuities, mutual funds and other securities.

LEGAL PROCEEDINGS

Periodically and in the ordinary course of business, various claims and
lawsuits are brought against the Bank, such as claims to enforce liens,
condemnation proceedings on properties in which the Bank holds security
interest, claims involving the making and servicing of real property loans and
other issues incident to the Bank's business. In the opinion of the Bank's
management and outside legal counsel, the ultimate liability, if any,
resulting from such claims or lawsuits will not have a material adverse effect
on the financial position or results of operations of the Bank.

FEDERAL TAXATION

General. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax
rules applicable to the Bank.

The Bank has been permitted under the Internal Revenue Code to deduct an
annual addition to a reserve for bad debts in determining taxable income,
subject to certain limitations. The deduction was based on either specified
experience formulas or a percentage of taxable income before such deduction.
The Bank used the percentage of taxable income method for the years ended June
30, 1995 and 1996. This deduction has historically been greater than the loan
loss provisions recorded for financial accounting purposes. Deferred income
taxes are provided on differences between the bad debt reserve for tax and
financial reporting purposes only to the extent of the tax reserves arising
subsequent to June 30, 1988. Savings institutions were not required to provide
a deferred tax liability for the tax bad debt reserves accumulated as of June
30, 1988 which for the Bank amounted to $938,000. Starting in the fiscal year
ended June 30, 1994, the Bank established and maintained a deferred income tax
liability of $938,000 due to the potential recapture of the pre-1988 tax bad
debt reserve which could have been triggered by the formation of the mutual
holding company; a change to a commercial bank charter (which management had
been contemplating); or possible legislation which was being debated in
Congress.

Legislation enacted in August 1996 eliminated certain conditions under which
recapture of the pre-1988 additions to the tax bad debt reserve would be
required. Such conditions are principally conversion to a commercial bank
charter or merger with a commercial bank. The pre-1988 reserves would be
required to be recaptured under certain other conditions such as payment of
dividends in excess of accumulated earnings and profits or other distributions
made in connection with the dissolution or liquidation of the Bank. Based on
this legislation, the Bank reversed the $938,000 deferred tax liability as a
reduction of Federal income tax expense during the year ended June 30, 1997.

The legislation also repealed the reserve method for determining income tax
deductions described above. Under the legislation, the Bank will be required
to recapture the post-1988 additions to its bad debt reserve as taxable income
over a six to eight year period. The Bank has provided the appropriate
deferred tax liability for these post-1988 additions in the prior years so
this legislation had no adverse impact on the results of operations for the
year ended June 30, 1997.

STATE TAXATION

The State of Washington does not currently have a net income tax. A business
and occupation tax based on a percentage of gross receipts is assessed on the
Bank at 1.6% of gross receipts; however interest received on loans secured by
first mortgages or deeds of trust on residential properties is not subject to
such tax. The Bank was most recently audited in August 1995 by the Washington
State Department of Revenue for the period January 1991 through September
1994.

5053

MANAGEMENT

The following table sets forth certain information with respect to the
directors and executive officers of the Bank. The Board is presently comprised
of seven members who are elected annually and until their successors are
elected and qualified. Executive officers are elected to serve annually at the
discretion of the Board of Directors. All persons listed below are expected to
serve as the directors and executive officers of the Company and the Bank
following the Conversion.

DIRECTORS

DIRECTOR
NAME AGE POSITION WITH BANK SINCE
- ---- --- ------------------ --------

Donald V. Rhodes......... 61 Director, Chairman of the Board, 1989
President and 1989 Chief Executive Officer of
the Company; Chairman of the Board,
President and PresidentChief Executive Officer of
the Bank (1)(2)
Lynn M. Brunton.......... 59 Director (1)(2)(3) 1990
John A. Clees............ 49 Director (1)(2)(3) 1990
Daryl D. Jensen.......... 58 Director (1)(3) 1985
H. Edward Odegard........ 66 Director (2) 1987
James P. Senna........... 62 Director 1976
Philip S. Weigand........ 59 Director (1)(2) 1985

EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS

NAME AGE POSITION WITH BANK
- ---- --- ------------------

John D. Parry............ 51 Executive Vice President--Administration
Brian L. Vance........... 43 Executive Vice President--Loan
Administration
James Hastings........... 45 Senior Vice President and Treasurer
Wendy K. Gauksheim....... 37 Senior Vice President--Corporate
Services Officer and Corporate Secretary
of the Bank

- --------
(1) Serves as a member of the Executive Committee.
(2) Serves as a member of the Audit and Finance Committee.
(3) Serves as a member of the Personnel and Compensation Committee.

The principal occupation during the past five years of each director and
executive officer of the Bank is set forth below. All directors and executive
officers have held their present positions with Heritage Bank for five years
unless otherwise stated.

DONALD V. RHODES has been a director, President and Chief Executive Officer
of the Bank since 1989. He was elected as Chairman of the Board in 1990. Since
1985, Mr. Rhodes has also served as Chairman, President and Chief Executive
Officer of Washington Independent Bancshares, Inc., and as Chairman and Chief
Executive Officer of that company's wholly owned subsidiary, Central Valley
Bank, at June 30, 1997 a $48.6 million in assets commercial bank headquartered
in Toppenish, Washington.

LYNN M. BRUNTON is presently a community volunteer. As a community volunteer
she serves as a member of the St. Peter Hospital Community Board and is
actively involved in several local and community organizations.

JOHN A. CLEES is the President of Clees Miles CPA Group, since October 1995
and was managing partner of Gattis, Clees and Company, an accounting firm
located in Olympia, Washington prior to that time.

DARYL D. JENSEN is the President and a director of Sunset Life Insurance
Company of America, and serves as a director of its parent company, Kansas
City Life Insurance Company.

5154

H. EDWARD ODEGARD is recently retired. Mr. Odegard was the co-owner and
manager of The Valley Athletic Club, Tumwater, Washington, from 1974 to 1993.

JAMES P. SENNA is the President and Chief Executive Officer of Shee Atika,
Incorporated, Sitka, Alaska.

PHILIP S. WEIGAND is a retired Lieutenant Colonel after 20 years of service
with the U.S. Marine Corps and is currently a real estate agent with Virgil
Adams Real Estate, located in Olympia, Washington.

JOHN D. PARRY has been employed by Heritage Bank since 1994, currently
serving as Executive Vice President--Administration. Prior to joining the
Bank, Mr. Parry was Senior Vice President in charge of Washington banking
operations of the Washington Division, Great American First Savings Bank, a
California headquartered thrift institution.

BRIAN L. VANCE has been employed by Heritage Bank since 1996, currently
serving as Executive Vice President--Loan Administration. Prior to joining the
Bank, Mr. Vance was employed for over 20 years with West One Bank, an Idaho
headquartered commercial bank, in both Idaho and Washington. Prior to leaving
West One, he was Senior Vice President and Regional Manager of banking
operations for the South Puget Sound Region.

JAMES HASTINGS has been employed by Heritage Bank since 1985, currently
serving as Senior Vice President and Treasurer. Mr. Hastings is a Certified
Public Accountant with over 20 years of banking and thrift experience either
in public accounting or with financial institutions.

WENDY K. GAUKSHEIM has been employed by Heritage Bank since 1987, currently
serving as Senior Vice President--Corporate Services Officer.

5255

BENEFICIAL OWNERSHIP OF BANK COMMON STOCK

The following table sets forth, as of June 30, 1997, certain information as
to the beneficial ownership of Bank Common Stock by: (i) persons known by the
Bank to beneficially own more than 5% of the outstanding shares of Common
Stock, except for MHC; (ii) the directors of the Bank; (iii) the executive
officers of the Bank; and (iv) by all officers and directors as a group. For
purposes of this table, an individual is considered to beneficially own shares
of Bank Common Stock if he or she has or shares voting power (which includes
the power to vote or direct the voting of the shares) or investment power
(which includes the power to dispose of or direct the disposition of the
shares). Unless otherwise indicated, all shares are owned directly by the
officers and directors or by the officers and directors indirectly through a
trust, corporation or association, or by the officers and directors or their
spouses as custodians or trustees for the shares of minor children. Shares
which are subject to stock options that are exercisable within 60 days of June
30, 1997 are deemed to be beneficially owned. For information regarding
proposed purchases of Conversion Stock by the directors and officers and their
anticipated ownership of Common Stock upon consummation of the Conversion, see
"Conversion Stock to be Purchased by Management Pursuant to Subscription
Rights."

SHARES BENEFICIALLY
OWNED AT JUNE 30, 1997
------------------------------
PERCENT OF OUTSTANDING
NAME NUMBER BANK COMMON STOCK
---- ------- ----------------------

Donald V. Rhodes (1)........................ 37,780 2.1%
Lynn M. Brunton (2)......................... 17,000 0.9
John A. Clees (3)........................... 14,000 0.8
Daryl D. Jensen (4)......................... 20,000 1.1
H. Edward Odegard (5)....................... 17,000 0.9
James P. Senna (6).......................... 12,000 0.7
Philip S. Weigand (7)....................... 19,142 1.11.0
John D. Parry (8)........................... 8,200 0.50.4
Brian L. Vance (9).......................... 3,666 0.2
James Hastings (10)......................... 6,100 0.3
Wendy K. Gauksheim.......................... 4,215 0.2
------- ---
All officers and directors as a group (11
persons)................................... 159,103 8.8%8.6%
======= ===

- --------
(1) Includes 10,000 shares of Bank Common Stock which may be received upon
the exercise of stock options that are exercisable within 60 days of June
30, 1997.
(2) Includes 2,000 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.
(3) Includes 2,000 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.
(4) Includes 2,000 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.
(5) Includes 2,000 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.
(6) Includes 2,000 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.
(7) Includes 1,550 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.
(8) Includes 5,000 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.
(9) Includes 1,666 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.
(10) Includes 5,000 shares of Bank Common Stock which may be received upon the
exercise of stock options that are exercisable within 60 days of June 30,
1997.

5356

MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS

The business of the Bank is conducted through meetings and activities of the
Board of Directors and its committees. During the fiscal year ended June 30,
1997, the Board of Directors held 12 meetings, including one special meeting.
No director attended fewer than 75% of the total meetings of the Board of
Directors or of committees on which such director served.

The Executive Committee of the Board of Directors consists of Donald V.
Rhodes, Chairman of the Board, and directors Jensen, Weigand, Clees and
Brunton. The Executive Committee did not meet during the fiscal year ended
June 30, 1997. The Executive Committee meets as necessary between meetings of
the full Board of Directors.

The Audit and Finance Committee, consists of John Clees, who acts as
Chairman, and directors Rhodes, Weigand, Odegard and Brunton. Mr. Rhodes will
no longer participate as a member of the Audit and Finance Committee
subsequent to completion of the Conversion. The Audit and Finance Committee
met four times during the fiscal year ended June 30, 1997. The Bank's
management and external auditors provide the Committee with reports and
findings regarding compliance policies and procedures, internal controls, and
operating procedures.

The other standing committee of the Board is the Personnel and Compensation
Committee.Committee, which reviews and recommends remuneration arrangements for senior
management. The Committee, which met three times during the fiscal year ended
June 30, 1997, consists of director Daryl Jensen, who acts as Chairman, and
directors Brunton and Clees. The Committee met three times during the fiscal
year ended June 30, 1997.

In addition to the committees described above, the Bank has from time to
time established other committees whose members consist of its directors and
officers. These committees include the Strategic Planning Committee, the
Donations Committee, and the Community Reinvestment Act Committee.

DIRECTORS' COMPENSATION

Directors receive an annual retainer of $6,000 and a monthly fee of $500 for
each meeting attended. Directors also received $100 for each committee meeting
attended with the Chairman of the Committee receiving $150.

5457

EXECUTIVE COMPENSATION

Summary Compensation Table. The following information is furnished for the
Chief Executive Officer of the Bank and for the executive officers of the Bank
who received salary and bonus in excess of $100,000 for the year ended June
30, 1997. No other executive officers of the Bank received salary and bonus in
excess of $100,000 during the year ended June 30, 1997.

LONG-TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
--------------------- -------------------------
RESTRICTED SECURITIES
NAME AND PRINCIPAL STOCK UNDERLYING ALL OTHER
POSITION YEAR SALARY BONUS AWARDS ($)(1) OPTIONS (#) COMPENSATION(2)
- ------------------ ---- -------- ------- ------------- ----------- ---------------

Donald V. Rhodes,....... 1997 $148,906 $$19,470 10,000 $16,350
Chairman, President and 1996 135,385 64,350 -- 15,026
Chief Executive Officer 1995 135,560 47,190 $50,000 -- 13,200
John D. Parry,.......... 1997 95,621 13,644 5,000 13,686
Executive Vice 1996 90,406 28,803 -- 11,634
President-- 1995 85,195 23,459 5,000 --
Administration
Brian L. Vance,......... 1997 91,004 14,994 5,000 --
Executive Vice 1996 -- -- 5,000 --
President--Loan
Administration
James Hastings,......... 1997 87,984 11,680 1,500 10,184
Senior Vice President 1996 87,684 27,070 -- 7,883
and Treasurer 1995 84,916 21,356 -- 7,316

- --------
(1) At June 30, 1997, the value of the aggregate restricted stock holdings
outstanding was estimated at $90,000. Dividends are paid on the
outstanding shares of restricted stock.
(2) Includes the Bank's contribution to its defined contribution retirement
plan and existing ESOP and 401(k) for Messrs. Rhodes, Parry, Vance and
Hastings, respectively.

EMPLOYMENT AGREEMENTS

In connection with the Conversion, the Bank and Company entered into an
employment agreement with Mr. Donald Rhodes effective as of October 1, 1997.
The agreement provides an annual base salary for Mr. Rhodes of $174,000, which
may be increased at the discretion of the Board of Directors of the Bank or
the Company or by an authorized Committee thereof. In addition to base salary,
the agreement provides for Mr. Rhodes' participation in employee benefit plans
and other fringe benefits applicable to senior executives of the Bank. The
term of the agreement will run until Mr. Rhodes attains age 65 (March 14,
2001), and will then be automatically renewed for additional terms of one year
each unless notice is given one year prior to the expiration date of any term
that renewal will not be effected. In the event the employment of Mr. Rhodes
is terminated by the Company at any time for "cause" or by Mr. Rhodes without
"good reason," both as defined in the agreement, no termination benefit will
be payable. If Mr. Rhodes is terminated without cause or he terminates the
agreement for good reason, a severance benefit will be payable in an amount
equal to two times the amount of his then-current annual base salary, or the
amount of such salary which would otherwise have been paid to him during the
then-remaining term of the agreement, whichever is greater.

The agreement also provides for the payment of a severance benefit to Mr.
Rhodes in the event of his termination of employment in certain cases
preceding, and for any reason following by up to two years, a change of
control of the Bank or the Company. Under the terms of the agreement, Mr.
Rhodes is entitled to receive his then-current base salary for three years
following such termination or until the term of the agreement, whichever is
longer. In such circumstances, he is also entitled to all benefits in his
agreement, to be fully vested as to unvested options, and to have restrictions
lapse with regard to any restricted stock or other restricted securities.

The Bank has entered into severance agreements with Messrs. John Parry,
Executive Vice President-Administration, and Brian Vance, Executive Vice
President-Loan Administration. The terms of each of these severance agreements
is five years. The agreements provide that Messrs. Parry and Vance would each
receive a severance benefit in an amount equal to two times the amount of
their then-current annual base salary, if their employment is terminated in
certain cases preceding, and for any reason following by up to two years, a
change of control of the Bank or the Company. The Bank has also entered into
severance agreements with seven additional Executives that provide each
Executive with a severance agreement equal to the Executive's then-current
base salary in the event their employment is terminated for any reason within
up to two years following a change in control of the Bank or the Company.

For purposes of the agreements, "change of control" includes, among other
things, the acquisition by any person of 25% or more of the outstanding
securities of the Bank or the Company; replacement of incumbent directors or
election of newly-elected directors constituting a majority of the Board of
the Company where such replacement or election has not been supported by the
Board; dissolution, or sale of 50% or more in value of the assets, of either
the Company, the Bank or any of their respective subsidiaries; or the merger
of the Company into any corporation, 25% or more of the outstanding common
stock of which is owned by other than owners of the common stock of the
Company prior to such merger.

The employment agreement for Mr. Rhodes and the severance agreements for
Messrs. Parry and Vance provide that in the event any of those Executives
receive an amount under the provisions of the agreements which results in
imposition of a tax on the Executive under the provisions of the Internal
Revenue Code Section 4999 (relating to Golden Parachute payments) the employer
is obligated to reimburse the Executive for that amount, exclusive of any tax
imposed by reason of receipt of reimbursement under the employment agreements.
The agreements restrict the right of Messrs. Rhodes, Parry and Vance to
compete against the Bank or the Company in the State of Washington for a
period of two years in the case of Mr. Rhodes and one year in the case of
Messrs. Parry and Vance following termination of employment, except in the
case of Mr. Rhodes, where such employment is terminated without cause or for
good reason.

BENEFITS

General. Following three months of employment, the Bank provides medical,
dental, life and disability insurance benefits for full-time employees,
subject to certain deductibles and copayments. Dependent medical and dental
coverage are available at the employee's expense.

Pension Plan. The Bank maintains a defined contribution retirement plan. The
plan allows participation to all employees upon completion of one year of
service and the attainment of 21 years of age. It is the Bank's policy to fund
plan costs as accrued. Employee vesting occurs over a period of seven years,
at which time they become fully vested. The Bank accrued a contribution in the
amount of $246,000 to the pension plan in fiscal 1997.

401(k) Plan. The Bank maintains a salary savings 401(k) plan for its
employees. All persons employed as of July 1, 1984 automatically participate
in the plan. All employees hired after that date who are at least 21 years of
age and with one year of service to the Bank may participate in the plan.
Employees who participate may contribute a portion of their salary which is
matched by the employer at 50% up to certain specified limits. Employee
vesting in employer portions is similar to the retirement plan described
above.

Employee Stock Ownership Plan. The Board of Directors has authorized the
amendment of the Bank's existing ESOP for employees of the Bank to become
effective upon the completion of the Conversion. The ESOP is intended to
satisfy the requirements for an employee stock ownership plan under the Code
and the Employee Retirement Income Security Act of 1974, as amended ("ERISA").
The Common Stock owned by the existing

59
ESOP are Minority Shares that will be converted into Exchange Shares on the
Effective Time of the Conversion. Full-
timeFull-time employees of the Company and the
Bank who have been credited with at least 1,000 hours of service 55
during a 12-month12-
month period and who have attained age 21 are eligible to participate in the
ESOP. The ESOP owned 21,763 shares of Bank Common Stock at June 30, 1997.1997, all
of which were allocated to participants' accounts. There was no debt incurred
in connection with the acquisition of those shares.

In order to fund the purchase of up to 8%2% of the Conversion Stock to be
issued in the Offerings, it is anticipated that the ESOP will borrow funds
from the Company. Such loan will equal 100% of the aggregate purchase price of
the Conversion Stock. The loan to the ESOP will be repaid principally from the
Bank's contributions to the ESOP and dividends payable on Common Stock held by
the ESOP over the fifteen-year term of the loan. The interest rate for the
ESOP loan is expected to be the prime rate as published in The Wall Street
Journal on the closing date of the Conversion. See "Pro Forma Data." In the
event of oversubscription by Eligible Account Holders, the Company may issue
shares of Common Stock to the ESOP at the Purchase Price immediately following
the Offerings to satisfy the ESOP's order to purchase 8%2% of Conversion Stock
in the Offerings and/or the ESOP may purchase shares of Common Stock in the
open market. Purchases of additional shares of Common Stock from the Company
would dilute the interests of other stockholders. In any plan year, the Bank
may make additional discretionary contributions to the ESOP for the benefit of
plan participants in either cash or shares of Common Stock, which may be
acquired through the purchase of outstanding shares in the market or from
individual stockholders or which constitute authorized but unissued shares or
shares held in treasury by the Company. The timing, amount, and manner of such
discretionary contributions will be affected by several factors, including
applicable regulatory policies, the requirements of applicable laws and
regulations, and market conditions.

Shares purchased by the ESOP with the proceeds of the loan will be held in a
suspense account and released on a pro rata basis as the loan is repaid.
Discretionary contributions to the ESOP and shares released from the suspense
account will be allocated among participants on the basis of each
participant's proportional share of total compensation. Forfeitures will be
reallocated among the remaining plan participants and may reduce the amount of
the Bank's contributions. Benefits may be payable upon a participant's
retirement, early retirement, death, disability, or termination of employment.
The Bank's contributions to the ESOP are not fixed so benefits payable under
the ESOP cannot be estimated.

A committee appointed by the Board of Directors of the Bank serves as
trustee of the ESOP. Under the ESOP, the trustee must vote all allocated
shares held in the ESOP in accordance with the instructions of plan
participants. Unallocated shares and allocated shares for which no
instructions are received must be voted in the same ratio on any matter as
those shares for which instructions are given. The ESOP is subject to the
requirements of ERISA and the regulations of the IRS and the Department of
Labor issued thereunder.

Pursuant to SOP 93-6, Employers' Accounting for Employee Stock Ownership
Plans, this statement changes the measure of compensation expense recorded by an employer for a
leveraged ESOP from the historical cost of the ESOP shares
tois the fair market value of the ESOP shares when allocated to
participants' accounts. See "Pro Forma Data" for a discussion of the effects
of SOP 93-6 on the reporting of ESOP-related compensation expense.

If the ESOP purchases unissued shares from the Company, total stockholders'
equity would neither increase nor decrease. However, on a per share basis,
stockholders' equity and net earnings would decrease because of the increase
in the number of outstanding shares.

Existing Stock Option Plans. In September 1994, the Bank's stockholders
approved the adoption of the 1994 Stock Option Plan, providing for the award
of a restricted stock award to a key officer, incentive stock options to
employees and nonqualified stock options to directors of the Bank at the
discretion of the Board of Directors. On September 24, 1996, the stockholders
of the Bank approved the adoption of the 1997 Stock Option Plan which is
generally similar to the 1994 plan. The 1997 plan does not affect any options
granted under the 1994 plan.

5660

Under both of these stock option plans, on the date of grant, the exercise
price of the option must at least equal the market value per share of Bank
Common Stock. The 1994 plan provides for the grant of options and stock awards
of up to 67,000 shares. The 1997 plan provides for the granting of options for
up to 50,000 common shares. All shares under the 1994 plan have been awarded
and all shares subject to option are fully vested. A total of 5,000 shares
were issued under the 1994 plan as a restricted stock award subject to lapse
provisions that end in 1999. A total of 5,002 shares remain available for
grant under the 1997 plan. All awards made under the plan require vesting over
a three year period beginning January 31, 1998. Under both existing plans,
options must be exercised within five years of vesting. Outstanding options
will be converted in the Exchange, using the Exchange Ratio, to become options
for Company Common Stock. Set forth below is certain information for Messrs.
Rhodes, Parry, Vance and Hastings concerning options granted in fiscal year
1997.

INDIVIDUAL GRANTS
-----------------------------------------------------
PERCENTAGE
NUMBER OF OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE
OPTIONS EMPLOYEES PRICE PER EXPIRATION GRANT DATE
NAME GRANTED IN 1997 SHARE DATE(1) VALUE(2)
- ---- ---------- ---------- --------- ---------- ----------

Donald V. Rhodes.......... 10,000 19.2% $18.45 1/31/05 $31,900
John D. Parry............. 5,000 9.6 18.45 1/31/05 15,950
Brian L. Vance............ 5,000 9.6 18.45 1/31/05 15,950
James Hastings............ 1,500 2.9 18.45 1/31/05 4,785

- --------
(1) One third of the options vest (become exercisable) on January 31, 1998,
1999 and 2000. These options expire five years after they become
exercisable.
(2) Calculated using the minimum value method.

1998 Stock Option Plan. The Board of Directors of the Company intends to
adopt the Stock Option Plan and to submit the Stock Option Plan to the
stockholders for approval at a meeting held no earlier than six months
following consummation of the Conversion. The approval of a majority vote of
the Company's stockholders is required prior to the implementation of the
Stock Option Plan. The Stock Option Plan will comply with all applicable
regulatory requirements.

The Stock Option Plan will be designed to attract and retain qualified
management personnel and nonemployee directors, to provide such officers, key
employees and nonemployee directors with a proprietary interest in the Company
as an incentive to contribute to the success of the Company and the Bank, and
to reward officers and key employees for outstanding performance and the
attainment of targeted objectives. The Stock Option Plan will provide for the
grant of incentive stock options ("ISOs"), intended to comply with the
requirements of Section 422 of the Code, and nonqualified stock options
("NQOs"). Upon receipt of stockholder approval of the Stock Option Plan, stock
options may be granted to key employees of the Company and its subsidiaries,
including the Bank and to nonemployee directors. The Stock Option Plan will be
administered and interpreted by a committee of the Board of Directors
("Committee") which is "disinterested" pursuant to applicable regulations
under the federal securities laws. Unless sooner terminated, the Stock Option
Plan will continue in effect for a period of ten years from the date the Stock
Option Plan is adopted by the Board of Directors.

A number of authorized shares of Common Stock equal to up to 10% of the
number of shares of Conversion Stock sold in connection with the Conversion
(575,000 shares based on the issuance of 5,750,000 shares at the maximum of
the Valuation Price Range) will be reserved for future issuance under the
Stock Option Plan (414,000 shares based
onPlan; provided that the issuanceaggregate number of 4,140,000 shares atoptions granted under
the maximum1994, 1997 and 1998 Stock Option Plans cannot exceed 10% of the Valuation Price
Range).aggregate
number of Conversion Shares and Exchange Shares issued in the Conversion. Such
shares will be authorized but unissued shares or treasury shares. In the event
of a stock split, reverse stock split, stock dividend, or similar event, the
number of shares of Common Stock under the Stock Option Plan, the number of
shares to which any award relates and the exercise price per share under any
option may be adjusted by the Committee to reflect the increase or decrease in
the total number of shares of Common Stock outstanding.

5761

Under the Stock Option Plan, the Committee will determine which officers and
key employeesnonemployee directors will be granted options, whether such options will be
ISOs or NQOs (provided that nonemployee directors will receive only NQOs), the
number of shares subject to each option, and the exercisability of such
options. The per share exercise price of an option will at least equal 100% of
the fair market value of a share of Common Stock on the date the option is
granted.

The number of options granted to nonemployee directors and the terms thereof
will be determined under a formula set forth in the Stock Option Plan. The
formula will provide that no individual nonemployee director may be awarded an
option covering in excess of 5% of the number of shares of Common Stock
reserved under the Plan. All options granted to nonemployee directors will be
NQOs and such options will be granted at an exercise price equal to 100% of
the fair market value of the Common Stock on the date the option is granted.

Each stock option that is awarded to an officer, or key employee or nonemployee
director will remain exercisable at any time on or after the date it vests
through the earlier to occur of the tenth anniversary of the date of grant or
three months after the date on which the optionee terminates employment or
participation on the Board (one year in the event of the optionee's
termination or death or disability), unless such period is extended by the
Committee. Each stock option that is awarded to a nonemployee director
will remain exercisable through the earlier to occur of the fifth anniversary
of the date of grant or one year (two years in the event of a nonemployee
director's death or disability) following the termination of a nonemployee
director's service on the Board. Options granted upon the effective date of
the Stock Option Plan will become exercisable ratably over a minimum five-year
period following the date of grant. However, unvested options will be immediately exercisable in the
event of the recipient's death, disability, retirement, or a change in control
of the Company. A "change in control" is deemed to occur when (a) a person
other than the Company purchases shares of Common Stock pursuant to a tender
or exchange offer for such shares; (b) any person (as such term is used in
Sections 13(d) and 14(d)(2) of Securities Exchange Act of 1934, as amended
("Exchange Act") who is or becomes the beneficial owner, directly or
indirectly, of securities of the Company representing 25% or more of the
combined voting power of the Company's then outstanding securities; (c) the
membership of the Board of Directors changes as the result of a contested
election; or (d) stockholders of the Company approve a merger, consolidation,
sale or disposition of all or substantially all of the Company assets, or a
plan of partial or complete liquidation. All stock options are nontransferable
except by will or the laws of descent or distribution.

Under current provisions of the Code, the federal tax treatment of ISOs and
NQOs is different. With respect to ISOs, an optionee who satisfies certain
holding period requirements will not recognize income at the time the option
is granted or at the time the option is exercised. If the holding period
requirements are satisfied, the optionee will generally recognize capital gain
or loss upon a subsequent disposition of the shares of Common Stock received
upon the exercise of a stock option. If the holding period requirements are
not satisfied, the difference between the fair market value of the Common
Stock on the date of grant and the option exercise price, if any, will be
taxable to the optionee at ordinary income tax rates. A federal income tax
deduction generally will not be available to the Company as a result of the
grant or exercise of an ISO, unless the optionee fails to satisfy the holding
period requirements. With respect to NQOs the grant of an NQO is generally not
a taxable event for the optionee and no tax deduction will be available to the
Company. However, upon the exercise of an NQO, the difference between the fair
market value of the Common Stock on the date of exercise and the option
exercise price will generally be treated as compensation to the optionee upon
exercise, and the Company will be entitled to a compensation expense deduction
in the amount of income realized by the optionee.

Management Recognition Plan. Following the Conversion, the Board of
Directors of the Company intends to adopt an MRP for officers, employees, and
nonemployee directors of the Company and the Bank. The MRP

58
will enable the
Company and the Bank to provide participants with a proprietary interest in
the Company as an incentive to contribute to the success of the Company and
the Bank.

The MRP will be submitted to stockholders for approval at a meeting no
earlier than six months following the consummation of the Conversion. The
approval of a majority vote of the Company's stockholders is required prior to
implementation of the MRP. The MRP will comply with all applicable regulatory
requirements. The MRP expects to acquire a number of shares of Common Stock
equal to 4%1% of the Conversion Stock sold in connection with the Conversion
(165,600(57,500 shares based on the issuance of 4,140,0005,750,000 shares in the Conversion at
the maximum of the Valuation Price Range). Such shares will be acquired on the
open market with funds contributed by the Company to a trust which the Company
may establish in conjunction with the MRP ("MRP Trust") or may be acquired
from authorized but unissued or treasury shares of the Company.

A committee of the Board of Directors of the Company will administer the
MRP, the members of which will also serve as trustees of the MRP Trust, if
formed. The trustees will be responsible for the investment of all funds
contributed by the Company to the MRP Trust. Shares of Common Stock granted
pursuant to the MRP will be in the form of restricted stock payable ratably
over a minimum five-year period following the date of grant. Compensation
expense in the amount of the fair market value of the Common Stock at the date
of grant will be recognized pro rata over the number of years during which the
shares are payable. An MRP award recipient is entitled to voting, dividend,
and other stockholder rights while the shares are restricted. During the
period of restriction, all shares will be held in escrow by the Company or by
the MRP Trust. If a recipient terminates employment for reasons other than
death, disability, retirement, or a change in control of the Company, the
recipient will forfeit all rights to allocated shares which are then subject
to restriction. In the event of the recipient's death, disability, retirement,
or a change in control of the Company, all restrictions will expire and all
allocated shares will become unrestricted. A "change in control" is deemed to
occur when (a) a person other than the Company purchases shares of Common
Stock pursuant to a tender or exchange offer for such shares; (b) any person
(as such term is used in Sections 13(d) and 14(d)(2) of the Exchange Act) who
is or becomes the beneficial owner, directly or indirectly, of securities of
the Company representing 25% or more of the combined voting power of the
Company's then outstanding securities; (c) the membership of the Board of
Directors changes as the result of a contested election; or (d) stockholders
of the Company approve a merger, consolidation, sale or disposition of all or
substantially all of the Company's assets, or a plan of partial or complete
liquidation.

All unallocated shares may be transferred by the Company to the MRP Trust.
The trustees of the MRP Trust will be authorized to vote such shares in the
same proportion as they receive instructions from award recipients with
respect to allocated shares which have not been earned and distributed.

The Board of Directors of the Company may terminate the MRP at any time and,
upon termination, all unallocated shares of Common Stock will revert to the
Company.

A recipient of an MRP award in the form of restricted stock will generally
not recognize income upon an award of shares of Common Stock, and the Company
will not be entitled to a federal income tax deduction, until the termination
of the restrictions. Upon such termination, the recipient will recognize
ordinary income in an amount equal to the fair market value of the Common
Stock at that time, and the Company will be entitled to a deduction in the
same amount after satisfying federal income tax withholding requirements.
However, the recipient may elect to recognize ordinary income in the year the
restricted stock is granted in an amount equal to the fair market value of the
shares at that time, determined without regard to the restrictions. In that
event, the Company will be entitled to a deduction in such year and in the
same amount. Any gain or loss recognized by the recipient upon subsequent
disposition of the stock will be either a capital gain or capital loss.

Although no specific award determinations have been made at this time, the
Company and the Bank anticipate that if stockholder approval is obtained it
would provide awards to its directors, officers and employees to the extent
and under terms and conditions permitted by applicable regulations. Under
current policy of the FDIC, if the 1997 MRP is implemented within one year of
the consummation of the Conversion, (i) no officer or 59
employees could receive
an award covering in excess of 25%; (ii) no nonemployee director could receive
in excess of 5%; and (iii) nonemployee directors, as a group, could not
receive in excess of 30% of the number of shares reserved for issuance under
the MRP. The size of individual awards will be determined prior to submitting
the MRP for stockholder approval, and disclosure of anticipated awards will be
included in the proxy materials for such meeting.

CERTAIN TRANSACTIONS

LOANS TO DIRECTORS AND EXECUTIVE OFFICERS

Certain of the Bank and Company directors and executive officers and their
immediate families are also customers and depositors of the Bank and it is
anticipated that such individuals will continue to be customers of

63
the Bank in the future. All transactions between the Bank and the Bank's
directors, executive officers and their immediate families were made in the
ordinary course of business on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with other persons, and in the opinion of management did not
involve more than the normal risk of collectibility or present other
unfavorable features. At June 30, 1997, loans to directors and executive
officers represented 3.9% of the Bank's stockholders' equity.

TRANSACTIONS WITH CENTRAL VALLEY BANK

Since June 30, 1995, the Bank has entered into contractual agreements to
purchase loan participations in an aggregate amount of $1.1 million from
Central Valley Bank. The aggregate outstanding balance of such participations
at June 30, 1997 was $531,300, consisting of two loan participations. Both
participations are current and performing as agreed. In the opinion of
management, the participations are on terms no less favorable than could have
been obtained from an unaffiliated party. The agreement to purchase the
participations was approved through the Bank's normal credit approval process,
and Mr. Rhodes is Chairman
and Chief Executive Officer of Central Valley Bank and of Heritage Bank.abstained from any participation in the process.

SUPERVISION AND REGULATION

The Company and the Bank are subject to extensive Federal and Washington
state legislation, regulation and supervision. These laws and regulations are
primarily intended to protect depositors and the FDIC rather than shareholders
of the Company. The laws and regulations affecting banks and bank holding
companies have changed significantly over recent years, and there is reason to
expect that similar changes will continue in the future. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on the business, operations and prospects of the Company. The Company is
unable to predict the nature or the extent of the effects on its business and
earnings that any fiscal or monetary policies or new federal or state
legislation may have in the future. The following information is qualified in
its entirety by reference to the particular statutory and regulatory
provisions described herein.

The Company. The Company is subject to regulation as a bank holding company
within the meaning of the Bank Holding Company Act of 1956, as amended, (the
"BHCA"). As such, the Company is supervised by the Federal Reserve.

The Federal Reserve has the authority to order bank holding companies to
cease and desist from unsound practices and violations of conditions imposed
by it. The Federal Reserve is also empowered to assess civil money penalties
against companies and individuals who violate the BHCA or orders or
regulations thereunder in amounts up to $1.0 million per day or order
termination of non-banking activities of non-banking subsidiaries of bank
holding companies, and to order termination of ownership and control of a non-
banking subsidiary by a bank holding company. Certain violations may also
result in criminal penalties. The FDIC is authorized to exercise comparable
authority under the Federal Deposit Insurance Act and other statutes with
respect to state nonmember banks such as the Bank.

6064

The Federal Reserve takes the position that a bank holding company is
required to serve as a source of financial and managerial strength to its
subsidiary banks and may not conduct its operations in an unsafe or unsound
manner. In addition, it is the Federal Reserve's position that in serving as a
source of strength to its subsidiary banks, bank holding companies should be
prepared to use available resources to provide adequate capital funds to their
subsidiary banks during periods of financial stress or adversity and should
maintain the financial flexibility and capital raising capacity to obtain
additional resources for assisting their subsidiary banks. A bank holding
company's failure to meet its obligations to serve as a source of strength to
its subsidiary banks will generally be considered by the Federal Reserve to be
an unsafe and unsound banking practice, a violation of the Federal Reserve's
regulations or both. The Federal Deposit Insurance Act requires an
undercapitalized institution to submit to the Federal Reserve a capital
restoration plan with a guarantee by each company having control of the bank.

The BHCA prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of any company which is not
a bank or from engaging in any activities other than those of banking,
managing or controlling banks and certain other subsidiaries, or furnishing
services to or performing services for its subsidiaries. One principal
exception to these prohibitions allows a bank holding company to acquire an
interest in companies whose activities are found by the Federal Reserve, by
order or by regulation, to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. The Company must obtain
the approval of the Federal Reserve before it acquires all, or substantially
all, of the assets of any bank, or ownership or control of more than 5% of the
voting shares of a bank.

The Company is required under the BHCA to file an annual report and periodic
reports with the Federal Reserve and such additional information as the
Federal Reserve may require pursuant to the BHCA. The Federal Reserve may
examine a bank holding company and any of its subsidiaries and charge the
company for the cost of such an examination.

The Company and any subsidiaries which it may control are deemed
"affiliates" within the meaning of the Federal Reserve Act, and transactions
between bank subsidiaries of the Company and its affiliates are subject to
certain restrictions. With certain exceptions, the Company and its
subsidiaries are prohibited from tying the provision of certain services, such
as extensions of credit, to other services offered by the Company or its
affiliates.

Banking regulations require bank holding companies and banks to maintain a
minimum "leverage" ratio of core capital to adjusted quarterly average total
assets of at least 3%. In addition, banking regulators have adopted risk-based
capital guidelines under which risk percentages are assigned to various
categories of assets and off-balance sheet items to calculate a risk-adjusted
capital ratio. Tier I capital generally consists of common shareholders'
equity (which does not include unrealized gains and losses on securities),
less goodwill and certain identifiable intangible assets, while Tier II
capital includes the allowance for loan losses and subordinated debt, both
subject to certain limitations. Regulatory risk-based capital guidelines
require a minimum Tier I capital of 4% of risk-adjusted assets and minimum
total capital ratio (combined Tier I and Tier II) of 8%. For a discussion of
the Bank's capital ratios, see "Banking Subsidiary."

Banking Subsidiary. The Bank is a Washington state-chartered savings bank,
the deposits of which are insured by the FDIC. It is subject to regulation by
the FDIC and the Division. Although the Bank is not a member of the Federal
Reserve System, the Federal Reserve supervisory authority over the Company can
also affect the Bank.

Among other things, applicable federal and state statutes and regulations
which govern a bank's operations relate to minimum capital requirements,
required reserves against deposits, investments, loans, legal lending limits,
mergers and consolidations, borrowings, issuance of securities, payment of
dividends, establishment of branches and other aspects of its operations. The
Division and the FDIC also have authority to prohibit banks under their
supervision from engaging in what they consider to be unsafe and unsound
practices.

6165

The Bank is required to file periodic reports with the FDIC and the Division
and is subject to periodic examinations and evaluations by those regulatory
authorities. Based upon such an evaluation, the regulators may revalue the
assets of an institution and require that it establish specific reserves to
compensate for the differences between the regulator-determined value and the
book value of such assets. These examinations must be conducted every 12
months, except that certain well-capitalized banks may be examined every 18
months. The FDIC and the Division may each accept the results of an
examination by the other in lieu of conducting an independent examination.

As a subsidiary of a bank holding company, the Bank is subject to certain
restrictions in its dealings with the Company and with other companies that
may become affiliated with the Company.

Dividends paid by the Bank will provide substantially all of the Company's
cash flow. Applicable federal and Washington state regulations restrict
capital distributions by institutions such as the Bank, including dividends.
Such restrictions are tied to the institution's capital levels after giving
effect to such distributions. At June 30, 1997, the Bank's leverage ratio was
11.7% compared with 11.6% at June 30, 1996. Tier I and total capital ratios
for the Bank at June 30, 1997 were 15.6% and 16.9%, respectively, compared
with 17.7% and 18.9%, respectively, at June 30, 1996. The FDIC has established
the qualifications necessary to be classified as a "well-capitalized" bank,
primarily for assignment of FDIC risk-based insurance premium rates discussed
below. To qualify as "well-capitalized," banks must have a Tier I risk-
adjusted capital ratio of at least 6%, a total risk-adjusted capital ratio of
at least 10%, and a leverage ratio of at least 5%. The Bank qualified as
"well-capitalized" at June 30, 1997.

Federal laws generally bar institutions which are not well capitalized from
accepting brokered deposits. The FDIC has issued rules which prohibit under-
capitalized institutions from soliciting or accepting such deposits.
Adequately capitalized institutions are allowed to solicit such deposits, but
only to accept them if a waiver is obtained from the FDIC.

Other Regulatory Developments. Congress has enacted significant federal
banking legislation in recent years. Included in this legislation have been
the FIRREA and the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA"). FIRREA, among other things, (i) created two deposit insurance
funds administered by the FDIC, the Bank Insurance Fund ("BIF") and the SAIF;
(ii) permitted commercial banks that meet certain housing-related asset
requirements to secure advances and other financial services from local FHLBs;
(iii) restructured the federal regulatory agencies for savings associations;
and (iv) greatly enhanced the regulators' enforcement powers over financial
institutions and their affiliates.

FDICIA went substantially farther than FIRREA in establishing a more
rigorous regulatory environment. Under FDICIA, regulatory authorities are
required to enact a number of new regulations, substantially all of which are
now effective. These regulations include, among other things, (i) a new method
for calculating deposit insurance premiums based on risk, (ii) restrictions on
acceptance of brokered deposits except by well-capitalized institutions, (iii)
additional limitations on loans to executive officers and directors of banks,
(iv) the employment of interest rate risk in the calculation of risk-based
capital, (v) safety and soundness standards that take into consideration,
among other things, management, operations, asset quality, earnings and
compensation, (vi) a five-tiered rating system from well-capitalized to
critically undercapitalized, along with the prompt corrective action the
agencies may take depending on the category, and (vii) new disclosure and
advertising requirements with respect to interest paid on savings accounts.

FDICIA and regulations adopted by the FDIC impose additional requirements
for annual independent audits and reporting when a bank begins a fiscal year
with assets of $500 million or more. Such banks, or their holding companies,
are also required to establish audit committees consisting of directors who
are independent of management. The Bank had less than $500 million in assets
at June 30, 1997.

Also, the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 (the "Interstate Banking Act") provides banks with greater opportunities
to merge with other institutions and to open branches

6266

nationwide. The Interstate Banking Act also allows a bank holding company
whose principal operations are in one state to apply to the Federal Reserve
for approval to acquire a bank that is headquartered in a different state.
States cannot "opt out" but may impose minimum time periods, not to exceed
five years, for the target bank's existence.

The Interstate Banking Act also allows bank subsidiaries of bank holding
companies to establish "agency" relationships with their depository
institution affiliates. In an agency relationship, a bank can accept deposits,
renew time deposits, close and service loans, and receive payments for a
depository institution affiliate. States cannot "opt out."

In addition, the Interstate Banking Act allows banks whose principal
operations are located in different states to apply to federal regulators to
merge. This provision takes effect June 1, 1997, unless states enact laws to
either (i) authorize such transactions at an earlier date or (ii) prohibit
such transactions entirely. The Interstate Banking Act also allows banks to
apply to establish de novo branches in states in which they do not already
have a branch office. This provision took effect June 1, 1997, but (i) states
must enact laws to permit such branching and (ii) a bank's primary federal
regulator must approve any such branch establishment. The Washington
legislature passed legislation that allows, subject to certain conditions,
mergers or other combinations, relocations of banks' main office and branching
across state lines in advance of the June 1, 1997 date established by federal
law.

Further effects on the Company and the Bank may result from the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "Community
Development Act"). The Community Development Act (i) establishes and funds
institutions that are focused on investing in economically distressed areas
and (ii) streamlines the procedures for certain transactions by financial
institutions with federal banking agencies.

Among other things, the Community Development Act requires the federal
banking agencies to (i) consider the burdens that are imposed on financial
institutions when new regulations are issued or new compliance burdens are
created and (ii) coordinate their examinations of financial institutions when
more than one agency is involved. The Community Development Act also
streamlines the procedures for forming certain one-bank holding companies and
engaging in authorized non-banking activities.

The Bank's deposit accounts are insured by the FDIC under the SAIF to the
maximum extent permitted by law. The Bank pays deposit insurance premiums to
the FDIC based on a risk-based assessment system established by the FDIC for
all SAIF-member institutions. Under applicable regulations, institutions are
assigned to one of three capital groups that are based solely on the level of
an institution's capital ("well capitalized", "adequately capitalized" or
"undercapitalized"). The matrix so created results in nine assessment risk
classifications, with rates that until September 30, 1996 ranged from 0.23%
for well capitalized, financially sound institutions with only a few minor
weaknesses to 0.31% for undercapitalized institutions that pose a substantial
risk of loss to the SAIF unless effective corrective action is taken. The
Bank's assessments expensed for the year ended June 30, 1997 equaled $1.3
million, which includes the $1.1 million special SAIF assessment.

Pursuant to recent changes in federal law, the FDIC imposed a special
assessment on each depository institution with SAIF-assessable deposits which
resulted in the SAIF achieving its designated reserve ratio. In connection
therewith, the FDIC reduced the assessment schedule for SAIF members,
effective January 1, 1997, to a range of 0% to 0.27%, with most institutions,
including the Bank, paying 0%. This assessment schedule is the same as that
for the BIF, which reached its designated reserve ratio in 1995. In addition,
since January 1, 1997, SAIF members are charged an assessment of 0.065% of
SAIF-assessable deposits for the purpose of paying interest on the obligations
issued by the Financing Corporation ("FICO") in the 1980s to help fund the
thrift industry cleanup. BIF-assessable deposits will be charged an assessment
to help pay interest on the FICO bonds at a rate of approximately .013% until
the earlier of December 31, 1999 or the date upon which the last savings
association ceases to exist, after which time the assessment will be the same
for all insured deposits.

6367

Recent legislative changes provide for the merger of the BIF and SAIF into
the Deposit Insurance Fund on January 1, 1999, but only if no insured
depository institution is a savings association on that date. The recent
change contemplates the development of a common charter for all federally
chartered depository institutions and the abolition of separate charters for
national banks and federal savings associations. It is not known what form the
common charter may take and what effect, if any, the adoption of a new charter
would have on the operation of the Bank.

In addition to the changes to the BIF and SAIF assessment rates implemented
by the recent legislation, various regulatory relief provisions were enacted.
The new legislation includes, among other things, changes to (i) the Truth in
Lending Act and the Real Estate Settlement Procedures Act to coordinate and
simplify the two laws' disclosure requirements; (ii) eliminate civil liability
for violations of the Truth in Savings Act after five years; (iii) streamline
the application process for a number of bank holding company and bank
applications; (iv) establish a privilege from discovery in any civil or
administrative proceeding or bank examination for any fair lending self-test
results conducted by, or on behalf of, a financial institution in certain
circumstances; (v) repeal the FDICIA requirement that independent public
accountants attest to compliance with designated safety and soundness
regulations; (vi) impose a continuous regulatory review of regulations to
identify and eliminate outdated and unnecessary rules; and (vii) various other
miscellaneous provisions to reduce bank regulatory burden.

FEDERAL SECURITIES LAWS

The Company has filed a Registration Statement with the SEC under the
Securities Act of 1933, as amended ("Securities Act") for the registration of
the Common Stock to be issued in the Conversion. Upon completion of the
Conversion, the Common Stock will be registered with the SEC under the
Exchange Act and generally may not be deregistered for at least three years
thereafter. The Company will then be subject to the information, proxy
solicitation, insider trading restrictions and other requirements of the
Exchange Act.

The registration under the Securities Act of the Common Stock to be issued
in the Conversion does not cover the resale of such shares. Shares of the
Common Stock purchased by persons who are not affiliates of the Company may be
resold without registration. Shares purchased by an affiliate of the Company
may comply with the resale restrictions of Rule 144 under the Securities Act.
If the Company meets the current public information requirements of Rule 144
under the Securities Act, each affiliate of the Company who complies with the
other conditions of Rule 144 (including those that require the affiliate's
sale to be aggregated with those of certain other persons) would be able to
sell in the public market, without registration, a number of shares not to
exceed, in any three-month period, the greater of (i) 1% of the outstanding
shares of the Company or (ii) the average weekly volume of trading in such
shares during the preceding four calendar weeks. Provision may be made in the
future by the Company to permit affiliates to have their shares registered for
sale under the Securities Act under certain circumstances. There are currently
no demand registration rights outstanding. However, in the event the Company,
at some future time, determines to issue additional shares from its authorized
but unissued shares, the Company might offer registration rights to certain of
its affiliates who want to sell their shares.

THE CONVERSION

The Division has given approval to the Plan subject to the satisfaction of
certain conditions imposed by the Division in its approval. In addition, the
Conversion will not be consummated until the Bank receives from the FDIC a
notice of nonobjection to the Conversion and the Federal Reserve approves the
application of the Company to become a bank holding company and to acquire the
Bank. The Division's approval, however, does not constitute a recommendation
or endorsement of the Plan.

GENERAL

On July 1, 1997, the Boards of Directors of the Mutual Holding Company and
the Bank unanimously adopted the Plan of Conversion, which was subsequently
amended, pursuant to which the Bank will reorganize

6468

into the stock holding company form of organization and the Company, a newly
formed Washington corporation, will offer and sell the Common Stock. It is
intended that following the Conversion all of the common stock of the Bank
will be held by the Company. THE FOLLOWING DISCUSSION OF THE PLAN OF
CONVERSION IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE PLAN OF
CONVERSION, WHICH IS AVAILABLE FROM THE BANK UPON REQUEST. The Division has
approved the Plan of Conversion subject to the satisfaction of certain
conditions imposed by the Division in its approval. In addition, completion of
the Conversion is subject to (i) the nonobjection of the FDIC; (ii) approval
by the Federal Reserve of the Company's acquisition of the Bank; (iii)
approval of the Plan by at least a majority of the total number of votes
eligible to be cast by members of the Mutual Holding Company (iv) approval of
the Plan by two-thirds of the outstanding shares of Bank Common Stock and a
majority of the votes castoutstanding shares of Bank Common Stock held by the Minority
Stockholders; and (v) successful completion of the Offerings. It is possible
that there could be a significant delay in the completion of the Conversion as
a result of delays in receiving a notice of nonobjection to the Conversion
from the FDIC or in receiving the approval of the Federal Reserve. See "Risk
Factors--Risk of Delayed Offering."

The Plan of Conversion provides generally that (i) the Mutual Holding
Company, which currently owns 66.31% of the Bank, will convert from mutual to
stock form and simultaneously merge with the Bank, with the Bank being the
surviving entity, and the shares of Bank Common Stock currently held by the
Mutual Holding Company will be canceled; (ii) the Bank will then merge into
Interim, a to be formed wholly-owned subsidiary of the Company, with the Bank
being the surviving entity (and with the 1,200,000 shares of the Company's
Common Stock currently held by the Bank being canceled); and (iii) the
Conversion Stock will be offered by the Company in the Offerings. Applicable
law requires that a minimum number of shares of Conversion Stock offered for
sale in the Conversion be sold in order for the Conversion to become
effective. The Conversion will be effected only upon completion of the sale of
at least $30.6$42.5 million of Conversion Stock to be issued pursuant to the Plan
of Conversion.

As part of the Conversion, the Company is making a Subscription Offering of
its Conversion Stock to holders of subscription rights in the following order
of priority: (i) Eligible Account Holders; (ii) the Bank's ESOP; (iii)
Supplemental Eligible Account Holders; and (iv) Other Members. Commencing
concurrently with the Subscription Offering, the Company is offering the
shares of Conversion Stock not subscribed for in the Subscription Offering in
order of priority to (i) the Minority Stockholders who are not Eligible
Account Holders, Supplemental Eligible Account Holders or Other Members and
(ii) to certain members of the general public to whom a copy of this
Prospectus is delivered by or on behalf of the Company.

Shares of Common Stock not sold in the Subscription, Minority Stockholders'
and Community Offerings may be offered in the Syndicated Community Offering.
If a Syndicated Community Offering is determined not to be feasible, the Board
of Directors of the Bank will consult with the regulatory authorities to
determine an appropriate alternative method for selling the unsubscribed
shares of Conversion Stock. The Plan of Conversion provides that the
Conversion must be completed within 24 months after the date of the approval
of the Plan of Conversion by the members of the Mutual Holding Company. No
sales of Conversion Stock may be completed in the Offerings unless the Plan of
Conversion is approved by the members of the Mutual Holding Company and
Minority Stockholders of the Bank.

The completion of the Offerings is subject to market conditions and other
factors beyond the Bank's control. No assurance can be given as to the length
of time after approval of the Plan of Conversion at the Special Meetings that
will be required to complete the sale of the Conversion Stock or to receive
the required approvals of regulatory authorities. If delays are experienced,
significant changes may occur in the estimated pro forma market value of the
Conversion Stock, together with corresponding changes in the net proceeds
realized by the Company from the sale of the Conversion Stock. In the event
the Conversion is terminated, the Bank would be required to charge all
Conversion expenses against current income.

Orders for shares of Conversion Stock will not be filled until at least
3,060,0004,250,000 shares of Conversion Stock have been sold, the Division and the FDIC
approve the final Appraisal, the Federal Reserve approves the application of
the Company to become a bank holding company and acquire the Bank and the
Conversion closes. If the Conversion is not completed by , 1997 (45 days
after the last day of the fully extended

6569

Subscription Offering) and the Division consents to an extension of time to
complete the Conversion, subscribers will be given the right to increase,
decrease or rescind their subscriptions. Unless an affirmative indication is
received from subscribers that they wish to continue to subscribe for shares,
the funds will be returned promptly, together with accrued interest at the
Bank's passbook rate from the date payment was received by the Company, and
all withdrawal authorizations from deposit accounts of those subscribers will
be terminated. If such period is not extended, or, in any event, if the
Conversion is not completed by , all withdrawal authorizations will be
terminated and all funds held will be promptly returned together with accrued
interest at the Bank's passbook rate from the date payment is received.

PURPOSES OF CONVERSION

The Mutual Holding Company, as a Washington-chartered mutual holding
company, does not have stockholders and has no authority to issue capital
stock. By converting to the stock holding company form of organization, the
Company will be structured in the form used by many commercial banks and
business entities and a growing number of savings institutions. Management of
the Bank believes that the Conversion offers a number of advantages which will
be important to the future growth and performance of the Bank. The Conversion
is intended to: (i) provide substantially increased capital to expand the
operations of the Bank; (ii) to improve future access to capital markets;
(iii) enhance the Company's and the Bank's ability to expand directly or
through mergers and acquisitions and to diversify operations into new business
activities (although there are no specific agreements, arrangements or
understandings, written or oral, regarding any such mergers or diversified
activities); and (iv) afford customers and others the opportunity to become
stockholders of the Company and thereby participate more directly in any
future growth of the Bank. While the Bank, prior to the consummation of the
Conversion, has the ability to raise additional capital through the sale of
additional shares of its common stock, that ability is limited by the mutual
holding company structure which, among other things, requires that the Mutual
Holding Company hold a majority of the outstanding shares of Bank Common
Stock. The Conversion also will result in an increase in the number of shares
of Common Stock to be outstanding as compared to the number of outstanding
shares of Minority Shares, which will increase the likelihood of the
development of an active and liquid trading market. See "Market for Common
Stock." In addition, the Conversion permits the Company to engage in
repurchases of its outstanding stock without adverse federal income tax
consequences, unlike the Bank and MHC. Currently, the Company has no plans to
engage in any stock repurchases.

After completion of the Conversion, there will be a substantial amount of
authorized but unissued Common Stock available for issuance to raise
additional equity capital or to be used in connection with possible
acquisitions. At the present time, the Company has no plans with respect to
specific acquisitions or additional offerings of securities, other than the
issuance of authorized but unissued shares upon exercise of stock options, the
possible issuance of authorized but unissued shares to the MRP. Following the
Conversion, the Company will be able to use stock-based incentive programs to
attract and retain executive and other personnel for itself and its
subsidiaries. For a description of the programs which have been adopted by the
Company, see "Management--Benefits--1998 Stock Option Plan."

EFFECTS OF CONVERSION TO STOCK FORM ON DEPOSITORS AND BORROWERS OF THE BANK

Voting Rights. Depositors and borrowers will have no voting rights in the
Bank or the Company and therefore will not be able to elect directors of the
Bank or the Company or to control their affairs. Subsequent to the Conversion,
voting rights will be vested exclusively in the Company, as the sole
stockholder, with respect to the Bank and the holders of the Common Stock as
to matters pertaining to the Company. Each holder of Common Stock shall be
entitled to vote on any matter to be considered by the stockholders of the
Company. A stockholder will be entitled to one vote for each share of Common
Stock owned.

Savings Accounts and Loans. The Bank's savings accounts, account balances
and existing FDIC insurance coverage of savings accounts will not be affected
by the Conversion. Furthermore, the Conversion will not affect

6670

the loan accounts, loan balances or obligations of borrowers under their
individual contractual arrangements with the Bank.

Tax Effects. The Bank has received an opinion from KPMG Peat Marwick LLP
that for federal income tax purposes: (1) the conversion of the Mutual Holding
Company from mutual to stock form and the simultaneous merger of the Mutual
Holding Company with and into the Bank, with the Bank being the surviving
institution, will qualify as a conversion within the meaning of Section
368(a)(1)(A) of the Code, (2) no gain or loss will be recognized by the Bank
upon the receipt of the assets of the Mutual Holding Company in such merger,
(3) the merger of the Bank with and into Interim, with the Bank being the
surviving institution, will qualify as a conversion within the meaning of
Section 368(a)(1)(A) of the Code, (4) no gain or loss will be recognized by
Interim upon the transfer of its assets to the Bank, (5) no gain or loss will
be recognized by the Bank upon the receipt of the assets of Interim, (6) no
gain or loss will be recognized by the Company upon the sale of shares of
Common Stock in the Offering, (7) the Eligible Account Holders and
Supplemental Eligible Account Holders will recognize gain, if any, upon the
issuance to them of withdrawable savings accounts in the Bank following the
Conversion, interests in the liquidation account and nontransferable
subscription rights to purchase Common Stock, but only to the extent of the
value, if any, of the subscription rights, and (8) the tax basis to the
holders of Common Stock purchased in the Offering will be the amount paid
therefor, and the holding period for the shares of Common Stock will begin on
the date of consummation of the Offerings if purchased through the exercise of
subscription rights and on the day after the date of purchase if purchased in
the Community Offering or Syndicated Community Offering. Unlike a private
letter ruling issued by the IRS, an opinion of a tax advisor is not binding on
the IRS and the IRS could disagree with the conclusions reached therein. In
the event of such disagreement, no assurance can be given that the conclusions
reached in an opinion of a tax advisor would be sustained by a court if
contested by the IRS.

Based upon past rulings issued by the IRS, the opinion provides that the
receipt of subscription rights by Eligible Account Holders, Supplemental
Eligible Account Holders and Other Members under the Plan will be taxable to
the extent, if any, that the subscription rights are deemed to have a fair
market value. RP Financial, whose findings are not binding upon the IRS, has
issued a letter indicating that it believes the subscription rights do not
have any value, based on the fact that such rights are acquired by the
recipients without cost, are nontransferable and of short duration, and afford
the recipients the right only to purchase shares of the Conversion Stock at a
price equal to its estimated fair market value, which will be the same price
paid by purchasers in the Offerings. If the subscription rights are deemed to
have a fair market value, the receipt of such rights may be taxable to those
Eligible Account Holders, Supplemental Eligible Account Holders, and Other
Members who exercise their subscription rights by purchasing Conversion Stock.
The Bank could also recognize a gain on the distribution of such subscription
rights. Eligible Account Holders, Supplemental Eligible Account Holders, and
Other Members are encouraged to consult with their own tax advisers as to the
tax consequences in the event the subscription rights are deemed to have a
fair market value.

The Bank has also received an opinion from Gordon, Thomas, Honeywell,
Malanca, Peterson & Daheim, P.L.L.C. that no gross receipts will be recognized
for Washington business and occupation tax purposes by either the Bank or its
Eligible Account Holders and Supplemental Eligible Account Holders as a result
of the implementation of the Plan of Conversion.

The opinions of KPMG Peat Marwick LLP and Gordon, Thomas, Honeywell,
Malanca, Peterson & Daheim, P.L.L.C. and the letter from RP Financial are
filed as exhibits to the Registration Statement. See "Additional Information."

PROSPECTIVE INVESTORS ARE URGED TO CONSULT WITH THEIR OWN TAX ADVISORS
REGARDING THE TAX CONSEQUENCES OF THE CONVERSION PARTICULAR TO THEM.

Liquidation Account. In the unlikely event of a complete liquidation of the
Mutual Holding Company in its present mutual form, each depositor in the Bank
would receive a pro rata share of any assets of the Mutual Holding Company
remaining after payment of claims of all creditors (including the claims of
all depositors up

6771

to the withdrawal value of their accounts). Each depositor's pro rata share of
such remaining assets would be in the same proportion as the value of his
deposit account to the total value of all deposit accounts in the Bank at the
time of liquidation. After the Conversion, each depositor, in the event of a
complete liquidation of the Bank, would have a claim as a creditor of the same
general priority as the claims of all other general creditors of the Bank.
However, except as described below, his or her claim would be solely in the
amount of the balance in his or her deposit account plus accrued interest.
Each stockholder would not have an interest in the value or assets of the Bank
or the Company above that amount.

The Plan of Conversion provides for the establishment, upon the completion
of the Conversion, of a special "liquidation account" for the benefit of
Eligible Account Holders and Supplemental Eligible Account Holders in an
amount equal to the amount of any dividends waived by the MHC plus the greater
of (1) the Bank's retained earnings of $12.9 million at June 30, 1993, the
date of the latest statement of financial condition contained in the final
offering circular utilized in the MHC Reorganization, or (2) 66.31% of the
Bank's total stockholders' equity as reflected in its latest statement of
financial condition contained in the final Prospectus utilized in the
Offerings. As of the date of this Prospectus, the initial balance of the
liquidation account would be $18.4 million. Each Eligible Account Holder and
Supplemental Eligible Account Holder, if he were to continue to maintain his
deposit account at the Bank, would be entitled, upon a complete liquidation of
the Bank after the Conversion to an interest in the liquidation account prior
to any payment to the Company as the sole stockholder of the Bank. Each
Eligible Account Holder and Supplemental Eligible Account Holder would have an
initial interest in such liquidation account for each deposit account,
including passbook accounts, transaction accounts such as checking accounts,
money market deposit accounts and certificates of deposit, held in the Bank at
the close of business on June 30, 1996 or ,September 30, 1997, as the case may
be. Each Eligible Account Holder and Supplemental Eligible Account Holder will
have a pro rata interest in the total liquidation account for each of his
deposit accounts based on the proportion that the balance of each such deposit
account on the June 30, 1996 Eligibility Record Date or the ,September 30, 1997
Supplemental Eligibility Record Date, as the case may be, bore to the balance
of all deposit accounts in the Bank on such date.

If, however, on any June 30 annual closing date of the Bank, commencing June
30, 1997, the amount in any deposit account is less than the amount in such
deposit account on June 30, 1996 or ,September 30, 1997, as the case may be, or
any other annual closing date, then the interest in the liquidation account
relating to such deposit account would be reduced by the proportion of any
such reduction, and such interest will cease to exist if such deposit account
is closed. In addition, no interest in the liquidation account would ever be
increased despite any subsequent increase in the related deposit account. Any
assets remaining after the above liquidation rights of Eligible Account
Holders and Supplemental Eligible Account Holders are satisfied would be
distributed to the Company as the sole stockholder of the Bank.

THE OFFERINGS

THE OFFERINGS ARE EXPECTED TO EXPIRE ON THE EXPIRATION DATE, UNLESS EXTENDED
OR CONTINUED AS DESCRIBED ON THE COVER PAGE OF THIS PROSPECTUS. ALL PURCHASES
ARE SUBJECT TO THE MAXIMUM PURCHASE LIMITATIONS IN THE OFFERINGS AND THE
OVERALL OWNERSHIP LIMITATIONS DESCRIBED UNDER "THE CONVERSION--LIMITATIONS ON
PURCHASE AND OWNERSHIP OF SHARES". FOR ADDITIONAL INFORMATION ON HOW TO
SUBSCRIBE FOR CONVERSION STOCK, PLEASE CALL THE STOCK INFORMATION CENTER AT
(360) .705-9190.

Subscription Offering. In accordance with the Plan, nontransferable
subscription rights to purchase the Conversion Stock have been granted to all
persons and entities entitled to purchase the Conversion Stock in the
Subscription Offering. The amount of the Conversion Stock which these parties
may purchase will be subject to the availability of the Conversion Stock for
purchase. Subscription priorities have been established for the allocation of
available stock. If all the Conversion Stock offered is subscribed and
purchased in categories of higher priority, no shares will be available for
purchase to prospective purchasers in the remaining categories. These
priorities are as follows:

6872

CATEGORY 1: Eligible Account Holders. Each depositor with $50.00 or more on
deposit at the Bank as of June 30, 1996 will receive nontransferable
subscription rights to subscribe for up to the greater of the purchase
limitation established by the Bank for the Community Offering, one-tenth of
one percent (.10%) of the total offering of shares of Conversion Stock, or 15
times the product (rounded down to the next whole number) obtained by
multiplying the total number of shares of Conversion Stock to be issued by a
fraction of which the numerator is the amount of the qualifying deposit of the
Eligible Account Holder and the denominator is the total amount of qualifying
deposits of all Eligible Account Holders. If the exercise of subscription
rights in this category results in an oversubscription, shares of Conversion
Stock will be allocated among subscribing Eligible Account Holders so as to
permit each Eligible Account Holder, to the extent possible, to purchase a
number of shares sufficient to make his total allocation equal to 100 shares
or the number of shares subscribed for, whichever is less. Thereafter,
unallocated shares will be allocated among subscribing Eligible Account
Holders proportionately, based on the amount of their respective qualifying
deposits, as compared to total qualifying deposits of all subscribing Eligible
Account Holders. Subscription rights received by officers and directors in
this category based on their increased deposits in the Bank in the one year
period preceding June 30, 1996 are subordinated to the subscription rights of
other Eligible Account Holders.

CATEGORY 2: ESOP. The Plan of Conversion provides that the ESOP shall
receive nontransferable subscription rightsSubscription Rights to purchase up to 8%2% of the shares
of Conversion Stock issued in the Conversion. The ESOP intends to purchase 2%
of the shares of Conversion Stock issued in the Conversion. In the event the
number of shares offered in the Conversion is increased above the maximum of
the Estimated Valuation Price Range, the ESOP shall have a second priority right
after Eligible Account Holders to purchase any such shares exceedingavailable additional shares. In
the maximumevent of an oversubscription by Eligible Account Holders and, as a result,
the Valuation Price RangeESOP is unable to fill its order for up to an
aggregate of 8%2% of the Conversion Stock.Stock,
then the Company may issue such shares of Common Stock as are necessary for
the ESOP to acquire a number of shares equal to 2% of the shares of Conversion
Stock issued in the Conversion and/or the ESOP may purchase shares of Common
Stock in the open market.

CATEGORY 3: Supplemental Eligible Account Holders. Each depositor with
$50.00 or more on deposit as of ,September 30, 1997 will receive
nontransferable subscription rights to subscribe for up to the greater of the
purchase limitation established by the Bank for the Community Offering, one-tenthone-
tenth (.10%) of one percent of the total offering of Conversion Stock or
fifteen times the product (rounded down to the next whole number) obtained by
multiplying the total number of shares of Common Stock to be issued by a
fraction of which the numerator is the amount of qualifying deposits of the
Supplemental Eligible Account Holder and the denominator is the total amount
of qualifying deposits of all Supplemental Eligible Account Holders. If the
exercise of subscription rights in this category results in an
oversubscription, shares of Conversion Stock will be allocated among
subscribing Supplemental Eligible Account Holders so as to permit each
Supplemental Eligible Account Holder, to the extent possible, to purchase a
number of shares sufficient to make his total allocation equal 100 shares or
the number of shares actually subscribed for, whichever is less. Thereafter,
unallocated shares will be allocated among subscribing Supplemental Eligible
Account Holders proportionately, based on the amount of their respective
qualifying deposits as compared to total qualifying deposits of all
Supplemental Eligible Account Holders.

CATEGORY 4: Other Members. Each depositor of the Bank as of the Voting
Record Date ( ,(October 24, 1997) and each borrower with a loan outstanding on
July 21, 1993, which continues to be outstanding as of the Voting Record Date,
will receive nontransferable Subscription Rights to purchasesubscribe for up to the
purchase limitation established by the Bank, to the extent shares are
available after filingfilling subscriptions by Eligible Account Holders, the Bank's
ESOP and Supplemental Eligible Account Holders. In the event of an
oversubscription in this category, the available shares will be allocated
proportionately based on the amount of the respective subscriptions.

CATEGORY 5: Minority Stockholders. Minority Stockholders as of the Voting
Record Date will receive nontransferable subscription rights to purchase
shares up to the purchase limitation established by the Bank, to

73
the extent available after filingfilling the Subscription Offering subscriptionsubscriptions. In
the event of an oversubscription, the available shares will be allocated
proportionately on the basis of the amounts of their respective subscriptions.

Subscription rights are nontransferable. Persons selling or otherwise
transferring their rights to subscribe for Conversion Stock in the
Subscription Offering or subscribing for Conversion Stock on behalf of another
person will be subject to forfeiture of such rights and possible further
sanctions and penalties imposed by government 69
agencies. Each person exercising
subscription rights will be required to certify that he or she is purchasing
such shares solely for his or her own account and that he or she has no
agreement or understanding with any other person for the sale or transfer of
such shares. ONCE TENDERED, SUBSCRIPTION
ORDERS CANNOT BE REVOKED WITHOUT THE CONSENT OF THE BANK AND THE COMPANY.

Community Offering. Concurrently with the Subscription Offering and the
Minority Stockholders' Offering, the Company is offering shares of the
Conversion Stock to certain members of the general public in a Community
Offering. Preference may be given first to natural persons residing in the
Local Community (such persons are referred to as "Preferred Subscribers").
Purchasers, in the Community Offering, together with their associates and groups acting in concert, may
order up to $250,000 in aggregate purchase price of Conversion Stock. SubjectStock subject
to maximum purchase limitations in the foregoing, ifOfferings and the overall ownership
limitation. If the amount of available stock is insufficient to fill the
orders of Preferred Subscribers stock will be allocated first to each
Preferred Subscriber whose order is accepted by the
Bank in an amount equal to the lesser of 100 shares or the
number of shares subscribed for by each such Preferred Subscriber, if
possible. Thereafter, unallocated shares will be allocated among the Preferred
Subscribers whose order remains unsatisfied proportionately, on the basis of
the amounts of the respective subscriptions. If the orders of Preferred
Subscribers are completely filled, but there are insufficient shares to fill
the orders of others, available shares will be allocated to the other members
of the general public who purchase in the Community Offering applying the same
allocation described above for Preferred Subscribers. THE RIGHT OF ANY PERSON
TO PURCHASE SHARES IN THE COMMUNITY OFFERING IS SUBJECT TO THE ABSOLUTE RIGHT
OF THE COMPANY AND THE BANK TO ACCEPT OR REJECT SUCH ORDERS IN WHOLE OR IN
PART.

If all of the Common Stock offered in the Subscription Offering and the
Minority Stockholders' Offering is subscribed for, no Conversion Stock will be
available for purchase in the Community Offering and all funds submitted
pursuant to the Community Offering will be promptly refunded with interest.

Syndicated Community Offering. The Plan provides that all shares of
Conversion Stock not purchased in the Subscription, Minority Stockholders' and
Community Offerings may be offered for sale to certain members of the general
public in a Syndicated Community Offering through a syndicate of registered
broker-dealers to be managed by Ryan Beck acting as agent of the Company to
assist the Company and the Bank in the sale of the Common Stock. The Company
and the Bank have the right to reject orders, in whole or part, in their sole
discretion in the Syndicated Community Offering. Neither Ryan Beck nor any
other registered broker-dealer shall have any obligation to take or purchase
any shares of the Conversion Stock in the Syndicated Community Offering;
however, Ryan Beck has agreed to use its best efforts in the sale of shares in
the Syndicated Community Offering.

No person, together with any associate or group of persons acting in
concert, will be permitted to subscribe in the Syndicated Community Offering
for sharesin excess of Common Stock with an aggregate Purchase Price$250,000 of more than
$250,000.Conversion Stock. See "--Marketing Arrangements"
for a description of the commission to be paid to the selected dealers and to
Ryan Beck.

If a syndicate of selected dealers is formed to assist in the Syndicated
Community Offering, a purchaser may pay for his shares with funds held by or
deposited with a selected dealer. Selected dealers are expected to solicit
indications of interest from their customers to place orders for shares. Such
selected dealers shall subsequently contact their customers who indicated an
interest and seek their confirmation as to their intent to purchase. The
selected dealer will then acknowledge confirmation of the order by its
customer in writing on the following business day and will debit such
customer's account on the third business day after the customer has confirmed
his intent to purchase (the "debit date"). On or before noon of the next
business day following the debit date, the selected dealer will send funds to
the Bank for deposit in a segregated account. Although purchasers' funds are
not required to be in their accounts with selected dealers until the debit
date, once a

74
confirmation of an intent to purchase has been given to the selected dealer,
the purchaser has no right to rescind his order.

The Syndicated Community Offering may run concurrent to the Subscription,
Minority Stockholders' and Community Offering or subsequent to such offerings.
The Syndicated Community Offering will terminate no more than 45 days
following the Expiration Date, unless extended by the Company with any
required regulatory approval, but in no case later than .

THE SUBSCRIPTION OFFERING WILL EXPIRE AT NOON, PACIFIC TIME, ON , 1997
("EXPIRATION DATE"), UNLESS EXTENDED BY THE COMPANY FOR UP TO DAYS TO
, 1997. THE MINORITY STOCKHOLDERS' OFFERING AND COMMUNITY OFFERING ARE
ALSO EXPECTED TO TERMINATE AT NOON, PACIFIC TIME, ON , 1997, BUT MAY BE
EXTENDED. Such extensions may be granted without notice to subscribers. If the
Conversion is not consummated within 45 days after the last day of the
Subscription Offering (which may conclude no later than , 1997) and the
Company elects to extend the Offerings, with the approval of the Division, if
necessary, subscribers will be notified in writing of the time period within
which they must notify the Company of any intention to increase, decrease or
rescind stock orders. If an affirmative response to any such resolicitation is
not received by the Company, a subscriber's stock order will be rescinded and
subscription funds will be returned promptly, together with interest from the
date such funds were received by the Company, and all withdrawal
authorizations from deposit accounts at the Bank will be terminated. No single
extension may exceed 90 days. If the Offerings are not extended or, in any
event, if the Conversion is not consummated by , 1997, all stock orders
will be rescinded, funds returned and withdrawal authorizations terminated, as
described above.

In the event the Company is unable to find purchasers from the general
public for an insignificant number of unsubscribed shares, other purchase
arrangements will be made by the Board of Directors of the Bank, if feasible.
Such other arrangements will be subject to the approval of the Division.

Persons in Non-Qualified States. The Company and the Bank will make
reasonable efforts to comply with the securities laws of all states in the
United States in which persons entitled to subscribe for stock pursuant to the
Plan reside. However, the Company and the Bank are not required to offer stock
in the Subscription Offering to any person who resides in a foreign country or
resides in a state of the United States with respect to which (i) a small
number of persons otherwise eligible to subscribe for shares of Conversion
Stock reside in such state; or (ii) the Company or the Bank determines that
compliance with the securities laws of such state would be impracticable for
reasons of cost or otherwise, including but not limited to a request that the
Company and the Bank or their officers, directors or trustees register as a
broker, dealer, salesman or selling agent, under the securities laws of such
state, or a request to register or otherwise qualify the subscription rights
or Conversion Stock for sale or submit any filing with respect thereto in such
state. Where the number of persons eligible to subscribe for shares in one
state is small, the Company and the Bank will base their decision as to
whether or not to offer the Conversion Stock in such state on a number of
factors, including the size of accounts held by account holders in the state,
the cost of registering or qualifying the shares or the need to register the
Company, its officers, directors or employees as brokers, dealers or salesmen.

THE EXCHANGE

General. The regulations and policies governing mutual holding companies
provide that in a conversion of a mutual holding company to the stock holding
company form of organization, the Minority Stockholders will be entitled to
exchange their Minority Shares for Exchange Shares, provided the Bank and the
Mutual Holding Company demonstrate to the satisfaction of the Division and the
FDIC that the basis for the exchange is fair and reasonable. The Boards of
Directors of the Bank and the Company have determined that each Minority Share
will, at the Effective Time of the Conversion, be converted into and become
the right to receive a number of Exchange Shares determined pursuant to the
Exchange Ratio that ensures that after the Conversion and before giving effect
to purchases of Conversion Stock by Minority Stockholders in the Offering, and
receipt by Minority Stockholders of cash in lieu of fractional shares,
Minority Stockholders will own approximately the same

75
aggregate percentage of the Common Stock as they own of the Bank Common Stock
immediately prior to the Effective Time adjusted downward to reflect the
aggregate amount of Bank Common Stock dividends waived by the Mutual Holding
Company and the amount of assets, other than Bank Common Stock, held by the
Mutual 71
Holding Company. The Mutual Holding Company had assets of $120,000 and
waived $1,230,000 in dividends, as of June 30, 1997. No Bank common stock
dividends are expected to be declared after such date.

The adjustments described above decrease the Minority Stockholders'
ownership interest to 32.12%32.17% from 33.69% based on the following calculation:

Bank Stockholders' Equity at 6/30/97--Aggregate Dividends Waived by MHC x
- -------------------------------------------------------------------------
Minority Stockholders' 33.69% Ownership = 32.1925%
- --------------------------------------------------

Bank Stockholders' Equity at 6/30/97

The adjustmentadjustments described above would further adjust the Minority
StockholdersStockholders' ownership interest as follows:

32.1925% x Pro Forma Market Value of the Company--Market Value of Assets of
- ---------------------------------------------------------------------------
MHC Other than Bank Common Stock = 32.12%
- ----------------------------------------
(Rounded)32.17%

Pro Forma Market Value of the Company

To determine the Exchange Ratio, multiply the reciprocal of the adjusted
Minority Stockholders' ownership interest was multiplied by the number of
shares to be issued in the Conversion, and divide the result was divided by the number of
Minority Shares outstanding (609,616) shares as of June 30, 1997. Immediately
prior to consummation of the Conversion, the Bank will recalculate the
Minority Stockholders' ownership interest pursuant to the above formula, which
will take into account changes in stockholders' equity and percentage
ownership at such date.

The following table sets forth, based upon the minimum, midpoint, maximum
and 15% above the maximum of the Valuation Price Range, the following: (i) the
total number of shares of Conversion Stock and Exchange Shares to be issued in
the Conversion, (ii) the percentage of the total Common Stock represented by
the Conversion Stock and the Exchange Shares, and (iii) the Exchange Ratio.
The table assumes that there is no cash paid in lieu of issuing fractional
Exchange Shares.

CONVERSION STOCK EXCHANGE SHARES TOTAL SHARES
TO BE ISSUED(1) TO BE ISSUED(1) OF COMMON
----------------- ----------------- STOCK TO BE EXCHANGE
AMOUNT PERCENT AMOUNT PERCENT OUTSTANDING RATIO
--------- ------- --------- ------- ------------ --------

Minimum.............. 3,060,000 67.88% 1,447,959 32.12% 4,507,959 2.37524,250,000 67.83% 2,015,664 32.17% 6,265,664 3.3064
Midpoint............. 3,600,000 67.88 1,703,449 32.12 5,303,449 2.79435,000,000 67.83 2,371,369 32.17 7,371,369 3.8899
Maximum.............. 4,140,000 67.88 1,958,998 32.12 6,098,998 3.21355,750,000 67.83 2,727,075 32.17 8,477,075 4.4734
15% above maximum.... 4,761,000 67.88 2,252,835 32.12 7,013,835 3.69556,612,500 67.83 3,136,136 32.17 9,748,636 5.1444

- --------

(1) Assumes that outstanding options to purchase 42,717 shares of Bank Common
Stock at June 30, 1997 are not exercised prior to consummation of the
Conversion. Assuming that all of such options are exercised prior to such
consummation, the percentages represented by the Conversion Stock and the
Exchange Shares would amount to 66.40% and 33.60%, respectively, and the
Exchange Ratio would amount to 2.4838, 2.9233, 3.3628,3.2968, 3.8786, 4.4604 and 3.86825.1294 at the
minimum, midpoint, maximum and 15% above the maximum of the Valuation
Price Range, respectively.
(2) Assumes that the Company does not issue authorized but unissued shares to
the ESOP immediately following the Conversion.

The actual Exchange Ratio is not dependent on the market value of the
Minority Shares. It will be determined based upon the number of shares of
CommonConversion Stock issued in the Offerings and the Minority Stockholders'
percentage ownership in the Bank prior to consummation of the Conversion
adjusted downward to take into account the effect of the aggregate amount of
dividends declared by the Bank and waived by the Mutual Holding Company and
the assets of the Mutual Holding Company). At the minimum, midpoint and
maximum of the Valuation Price Range, one Minority Share will be exchanged for
2.3752, 2.79433.3064, 3.8899 and 3.21354.4734

shares of common Stock, respectively (which have calculated equivalent
estimated value of $23.75, $27.94$33.06, $38.90 and $32.13$44.73 based on the Purchase Price of
Conversion Stock in the Offerings and the aforementioned Exchange Ratios).
However, there can be no assurance as to the actual market value of a share of
Common Stock after the

72
Conversion or that such shares can be sole at or above
the $10.00 per share Purchase Price. Any increase or decrease in the number of
shares of Conversion Stock will result in a corresponding change in the number
of Exchange Shares, so that upon consummation of the Conversion, the
Conversion Stock and the Exchange Stock will represent approximately 67.88%67.83%
and 32.12%32.17%, respectively, of the Company's total outstanding shares of Common
Stock. Each holder of a certificate or certificates evidencing issued and
outstanding Minority Shares will be entitled to receive in exchange therefor a
certificate or certificates representing the number of full shares of Common
Stock for which the Minority Shares will have been converted based on the
Exchange Ratio. To effect the Exchange, a duly appointed agent of the Bank
will promptly mail to each such holder of record of an outstanding certificate
which immediately prior to the consummation of the Conversion evidenced
Minority Shares, a letter of transmittal (which will specify that delivery
shall be effected, and risk of loss and title to such certificate shall pass,
only upon delivery of such certificate to the Exchange Agent) advising such
holder of the terms of the Exchange effected by the Conversion and of the
procedure for surrendering to the Exchange Agent such certificate in exchange
for a certificate or certificates evidencing Common Stock. MINORITY
STOCKHOLDERS SHOULD NOT FORWARD TO THE BANK OR THE EXCHANGE AGENT CERTIFICATES
UNTIL THEY HAVE RECEIVED THE TRANSMITTAL LETTER.

No holder of a certificate representing shares of Bank Common Stock will be
entitled to receive any dividends in respect of the Common Stock into which
such shares shall have been converted by virtue of the conversion until the
certificate representing such shares of Bank Common Stock is surrendered in
exchange for certificates representing shares of Common Stock. In the event
that dividends are declared and paid by the Company in respect of Common Stock
after the consummation of the Conversion but prior to surrender of
certificates representing shares of Bank Common Stock, dividends payable in
respect of shares of Common Stock not then issued will accrue (without
interest). Any such dividends will be paid (without interest) upon surrender
of the certificates representing such shares of Bank Common Stock. The Company
will be entitled, after the consummation of the Conversion, to treat
certificates representing shares of Bank Common Stock as evidencing ownership
of the number of full shares of Common Stock into which the shares of Bank
Common Stock represented by such certificates shall have been converted,
notwithstanding the failure on the part of the holder thereof to surrender
such certificates.

The Company shall not be obligated to deliver a certificate or certificates
representing shares of Common Stock to which a holder of Bank Common Stock
would otherwise be entitled as a result of the Conversion until such holder
surrenders the certificate or certificates representing the shares of Bank
Common Stock for exchange as provided above, or, in default thereof, an
appropriate affidavit of loss and indemnity agreement and/or a bond as may be
required in each case by the Company.

DISSENTERS' RIGHTS

The Plan of Conversion provides that stockholders of the Bank have the right
to dissent from the mergers of the Bank with the MHC and with an interim bank
formed to facilitate the Conversion, with the Bank as the surviving entity in
each Merger, and, subject to certain conditions, to receive payment of the
"value" of their shares of Bank Common Stock, as provided in Washington law.

Under Washington state law (RCW 23B.13), a stockholder of the Bank may
exercise "dissenters' rights" and receive the fair value of his or her shares
in cash, if certain procedures are followed. To exercise these rights, a Bank
stockholder must (i) deliver to the Bank, before the vote on approval of the
Conversion is taken, written notice of intent to demand payment for his or her
shares if the Conversion is effected, and (ii) not vote in favor of the
Conversion. Following consummation of the Conversion, the Company will send a
Dissenters' Notice to each Bank stockholder who has properly perfected his or
her dissenters' rights. A dissenting shareholder must also follow the
procedures set forth in the Dissenters' Notice. The Dissenters' Notice will
include instructions to completing the exercise of dissenters' rights,
including that the dissenting stockholder must (1) make written

77
demand for payment of the fair value of his or her shares in the form sent to
the stockholder by the corporation along with the Dissenters' Notice (this
notice will prescribe a time period within which the demand must be made), (2)
certify that the beneficial ownership of his or Bank Common Stock shares was
acquired before the

73
date set forth in the Dissenters' Notice, and (3)
surrender his or her stock certificates representing shares of the Bank Common
Stock in accordance with the Dissenters' Notice. If a stockholder exercises
dissenters' rights, the dissenting stockholder is entitled to receive the fair
value of his or her shares in cash. Such value may be higher or lower than the
value of Exchange Shares issuable pursuant to the Conversion.

A vote against the Conversion will not in and of itself satisfy the
requirements of the Washington statute; a stockholder who does not deliver to
the Bank prior to the Special Meeting a written notice of the stockholder's
intent to demand payment for the fair value of the shares of Bank Common Stock
held will lose the right to exercise dissenters' rights. In addition, any
stockholder electing to exercise dissenters' rights must either vote against
the Conversion or abstain from voting. The failure of a stockholder to comply
strictly with the statutory requirements will result in a loss of dissenters'
rights. A copy of the relevant statutory provisions is attached as Appendix
and Minority Stockholders are urged to refer to this Appendix for a complete
statement concerning dissenters' rights. The foregoing summary of such rights
is qualified in its entirety by reference to such Appendix .

MARKETING ARRANGEMENTS

The Bank and the Company have engaged Ryan Beck, a National Association of
Securities Dealers ("NASD") member firm as a financial and marketing advisor
in connection with the Offerings, and Ryan Beck has agreed to use its best
efforts to assist the Company with the solicitation of subscriptions for
shares of Conversion Stock in the Offerings. The services to be rendered by
Ryan Beck include the following: (i) consulting as to the securities marketing
implications of any aspect of the Plan or related corporate documents; (ii)
reviewing all offering documents, including the Prospectus, stock order forms
and related offering materials; (iii) assisting in the design and
implementation of a marketing strategy for the Offerings; (iv) organizing and
supervising the Stock Information Center, including the proxy solicitation in
connection with the Special Meetings to approve the Conversion; (v) training
Bank personnel with respect to the Conversion and their roles in the process;
(vi) assisting management in scheduling and preparing for meetings with
potential investors and broker-dealers; (vii) soliciting stock orders; and
(viii) providing such other general advice and assistance as may be requested
to promote the successful completion of the Conversion. In addition, Ryan Beck
will manage any Syndicated Community Offering.

The engagement of Ryan Beck and the services performed thereunder, including
any "due diligence" investigation of the operations of the Bank, should not be
construed as an endorsement or recommendation of the suitability of an
investment in the Common Stock or a verification of the accuracy or
completeness of the information contained herein. Ryan Beck has not prepared
any report or opinion constituting a recommendation or advice to the Bank or
to persons who may purchase shares in the Offerings regarding the suitability
of an investment in the Common Stock or as to the prices at which the Common
Stock may trade.

Based upon negotiations between the Bank, the Company and Ryan Beck, Ryan
Beck will receive a management and advisory fee of $50,000, a marketing fee
equal to 1.50% of the aggregate Purchase Price of Conversion Stock sold in the
Subscription and Minority Stockholders' Offerings, and a marketing fee of 2.0%
on such sales in the Community Offering. No fees will be paid to Ryan Beck on
subscriptions by any director, officer or employee of the Bank or the Company
or members of their immediate families or the ESOP. In the event that a
selected dealers agreement is entered into in connection with a Syndicated
Community Offering, the Bank will pay a fee to such selected dealers of up to
7.0% including a management fee to Ryan Beck of 1.50% for shares sold by NASD
member firms, other than Ryan Beck. Fees to Ryan Beck and to any other NASD
member firm may be deemed to be underwriting fees and Ryan Beck and such
broker-dealers may be deemed to be underwriters.

78
Ryan Beck will also be reimbursed for its reasonable out-of-pocket expenses,
including legal fees of its counsel, up to $35,000, and other expenses not to
exceed $15,000 without Company approval. The Bank and the Company have agreed
to indemnity Ryan Beck in connection with certain claims or liabilities,
including certain liabilities under the Securities Act. Ryan Beck has received
advances towards its fees totaling $25,000. Total 74
fees to Ryan Beck, including
the $50,000 management and advisory fee, are estimated to be $407,000$610,000 and
$556,000$830,000 at the minimum and the maximum of the Valuation Price Range,
respectively. See "Pro Forma Data" for the assumptions used to arrive at these
estimates.

The management and employees of the Bank may participate in the Offerings in
clerical capacities, providing administrative support in effecting sales
transactions or answering questions of a mechanical nature, such as the proper
execution of the order form. Management of the Bank may answer questions
regarding the business of the Bank. Other questions of prospective purchasers,
including investment related questions, will be directed to Ryan Beck
registered representatives. The management and employees of the Bank have been
instructed not to solicit offers to purchase Conversion Stock or to provide
advice regarding the purchase of Conversion Stock. None of the Bank's
employees or directors who participate in the Offerings will receive any
special compensation or other remuneration for such activities.

None of the Bank's personnel participating in the Offerings are registered
or licensed as a broker or dealer or an agent of a broker or dealer. The
Bank's personnel will assist in the above-described sales activities pursuant
to an exemption from registration as a broker or dealer provided by Rule 3a4-l
("Rule 3a4-l ") promulgated under the Exchange Act. Rule 3a4-l generally
provides that an "associated person of an issuer" of securities shall not be
deemed a broker solely by reason of participation in the sale of securities of
such issuer if the associated person meets certain conditions. Such conditions
include, but are not limited to, that the associated person participating in
the sale of an issuer's securities not be compensated in connection therewith
at the time of participation, that such person not be associated with a broker
or dealer and that such person observe certain limitations on his
participation in the sale of securities. For purposes of this exemption,
"associated person of an issuer" is defined to include any person who is a
director, officer or employee of the issuer or a company that controls, is
controlled by or is under common control with the issuer.

PROCEDURE FOR PURCHASING SHARES IN OFFERINGS

To ensure that each purchaser receives a Prospectus at least 48 hours before
the Expiration Date in accordance with Rule l5c2-8 of the Exchange Act, no
Prospectus will be mailed any later than five days prior to such date or hand
delivered any later than two days prior to such date. Execution of the stock
order form will confirm receipt or delivery in accordance with Rule 15c2-8.
Stock order forms will only be distributed with a Prospectus.

To purchase shares in the Subscription, Minority Stockholders' and Community
Offerings, an executed stock order form, with the required payment for each
share subscribed for, or with appropriate authorization for withdrawal from
the subscriber's deposit accounts with the Bank must be received by the Bank
at any of its branch offices by Noon, Pacific Time, on the Expiration Date.
Stock order forms which are not received by such time or are executed
defectively or are received without full payment (or appropriate withdrawal
instructions) are not required to be accepted. In addition, the Bank is not
obligated to accept orders submitted on photocopied or facsimilied stock order
forms. Notwithstanding the foregoing, the Company shall have the right, in its
sole discretion, to permit institutional investors to submit irrevocable
orders together with a legally binding commitment for payment and to
thereafter pay for the shares of Conversion Stock for which they subscribe in
the Community Offering at any time prior to 48 hours before the completion of
the Conversion. The Company and the Bank have the right to waive or permit the
correction of incomplete or improperly executed stock order forms, but do not
represent that they will do so. Pursuant to the Plan of Conversion, the
interpretation by the Company and the Bank of the terms and conditions of the
Plan of Conversion and acceptability of the order form will be final. Once
received, an executed stock order form may not be modified, amended or
rescinded without the consent of the Bank unless the Company conducts a
resolicitation of subscribers.

79
In order to help ensure that prospective purchasers are properly identified
as to their stock purchase priorities, depositors as of the Eligibility Record
Date (June 30, 1996) or the Supplemental Eligibility Record Date ( ,(September
30, 1997) must list all accounts on the stock order form, all account holders'
names in each Bank deposit account, and the account number.

Payment for subscriptions may be made (i) in cash if delivered in person at
any branch office of the Bank; (ii) by check, bank draft or money order; or
(iii) by authorization of withdrawal from deposit accounts maintained with the
Bank. Interest will be paid on payments made by cash, check, bank draft or
money order at the Bank's passbook rate of interest from the date payment is
received until the completion or termination of the Conversion. If payment is
made by authorization of withdrawal from deposit accounts, the funds
authorized to be withdrawn will continue to accrue interest at the contractual
rates until completion or termination of the Conversion, but a hold will be
placed on such funds, thereby making them unavailable to the depositor. At the
completion of the Conversion, withdrawals will be made and the funds received
in the Offerings will be used to purchase the shares of Conversion Stock. The
shares issued in the Conversion cannot and will not be insured by the FDIC or
any other governmental agency.

The Bank will waive any applicable penalties for early withdrawal from
certificate accounts at the Bank. If the remaining balance in a certificate
account is reduced below the applicable minimum balance requirement at the
time that the funds actually are transferred under the authorization, the
certificate will be canceled at the time of the withdrawal, without penalty,
and the remaining balance will earn interest at the passbook rate.

The ESOP will not be required to pay for the shares subscribed for at the
time it subscribes, but rather, may pay for such shares of Conversion Stock
subscribed for at the Purchase Price upon consummation of the Offerings;
provided, that there is in force from the time of its subscription until such
time, a loan commitment from an unrelated financial institution or the Company
to lend to the ESOP, at such time, the aggregate Purchase Price of the shares
for which it subscribed.

Owners of self-directed IRAs may use the assets of such IRAs to purchase
shares of Conversion Stock in the Offerings, provided that such IRAs are not
maintained at the Bank. Persons with self-directed IRAs maintained at the Bank
must have their accounts transferred to an unaffiliated institution or broker
to purchase shares of Conversion Stock in the Offerings. In addition, the
provisions of ERISA and IRS regulations require that officers, directors and
ten percent shareholders who use self-directed IRA funds to purchase shares of
Conversion Stock in the Offerings, make such purchases for the exclusive
benefit of IRAs.

Certificates representing, shares of Conversion Stock purchased, and any
refund due, will be mailed to purchasers at such address as may be specified
in properly completed stock order forms as soon as practicable following
consummation of the sale of all shares of Conversion Stock. Any certificates
returned as undeliverable will be disposed of in accordance with applicable
law. Until certificates for the Common Stock are available and delivered to
subscribers and purchasers, subscribers and purchasers may not be able to sell
the shares of Common Stock for which they subscribed or purchased.

STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED

The Plan of Conversion requires that the aggregate purchase price of the
securities sold in connection with the Conversion be based upon an estimated
pro forma value of the Bank and the MHC (i.e., taking into account the
expected receipt of proceeds from the sale of securities in the Conversion) as
determined by an independent appraisal. The Bank and the Company have retained
RP Financial to prepare an appraisal of the pro forma market value of the
common stock and a business plan. A COPY OF THE APPRAISAL IS AVAILABLE FOR
INSPECTION AT EACH OFFICE OF THE BANK. RP Financial will receive a fee
expected to total approximately $35,000 for its appraisal services and
preparation of a business plan, plus reasonable out-of-pocket expenses
incurred in connection with the appraisal. The Bank has agreed to indemnify RP
Financial under certain circumstances against liabilities and expenses
(including legal fees) arising out of, related to, or based upon the
Conversion.

80
RP Financial prepared the Appraisal dated August 15, 1997 and as updated on
,October 10, 1997, which states that the aggregate pro forma market value of
the Bank and the Mutual Holding Company inclusive of the sale of an
approximate 67.88%67.83% ownership interest in the Offerings was $53,034,770 at the
midpoint as of August 15, 1997 and $73,713,696 at the midpoint as updated on
,October 10, 1997. The Appraisal was multiplied by 67.88%67.83%, which is the Mutual
Holding Company's percentage ownership interest in the Bank as adjusted upward
from the 66.31% to reflect $1,230,000

76
of dividends declared by the Bank and
waived by the Mutual Holding Company and the $120,000 in assets held by the
MHC. The resulting amount, $36,000,000,$50,000,000, is the midpoint of the dollar amount
of Conversion Stock to be offered in the Offerings. The minimum and maximum of
the offering range were set at 15% below and above the midpoint, respectively,
resulting in an offering range of $30,600,000$42,500,000 to $41,400,000$57,500,000 of Conversion
Stock. The Boards of Directors of the Company and the Bank determined that the
Conversion Stock would be sold at $10.00 per share, resulting in a range of
3,060,0004,250,000 to 4,140,0005,750,000 shares of Conversion Stock being offered. The Plan of
Conversion requires that all of the shares subscribed for in the Offerings be
sold at the same price per share.

The Appraisal involved a comparative evaluation of the operating and
financial statistics of the Bank with those of other thrift institutions. The
Appraisal also took into account such other factors as the market for thrift
institution stocks generally, prevailing economic conditions, both nationally
and in the State of Washington, which affect the operations of thrift
institutions, the competitive environment within which the Bank operates and
the effect of the Bank becoming a subsidiary of the Company. No detailed
individual analysis of the separate components of the MHC's and the Bank's
assets and liabilities was performed in connection with the evaluation. The
Board of Directors reviewed the appraisal, including the methodology and the
appropriateness of the assumptions utilized by RP Financial, and the Board
accepted the valuation.

Following commencement of the Subscription and Community Offerings, the
maximum of the Valuation Price Range may be increased up to 15% and the number
of shares of Conversion Stock to be issued in the Conversion may be increased
to 4,761,0006,612,500 shares due to regulatory considerations, changes in market
conditions or general financial and economic conditions, without the
resolicitation of subscribers. See "--Limitations on Purchases and Ownership
of Shares" as to the method of distribution and allocation of additional
shares that may be issued in the event of an increase in the Valuation Price
Range to fill unfilled orders in the Offerings.

No sale of the shares will take place until RP Financial confirms to the
Division and the FDIC that, to the best of RP Financial's knowledge and
judgment, nothing of a material nature has occurred which would cause it to
conclude that the aggregate Purchase Price (i.e. gross proceeds) received in
the Offerings is incompatible with its Appraisal. If, however, the facts do
not justify such a statement, the Offerings may be canceled, a new Valuation
Price Range and price per share set and new Subscription, Minority
Stockholders, Community and Syndicated Community Offerings held.

If, based on RP Financial's estimate, the pro forma market value of Common
Stock as of such date is not more than 15% above the maximum and not less than
the minimum of the Valuation Price Range, then (1) with the approval of the
Division and the FDIC, the number of shares of CommonConversion Stock to be issued
Conversion
may be increased or decreased, pro rata to the increase or decrease in value
without resolicitation of subscriptions, to no more than 4,761,0006,612,500 shares or
no less than 3,060,0004,250,000 shares, and (2) all shares purchased in the Offerings
will be purchased for the Purchase Price of $10.00 per share. IfSee "--
Limitations on Purchases and Ownership of Shares" for a description of the
numberdistribution and allocation of additional shares that may be issued in the
Conversion is increased due toevent of an increase of
up to 15% in the Valuation Price Range to reflect Regulatory Considerationfill unfilled orders in
the Subscription, Minority Stockholders' and changes in market and financial conditions. See "--Limitations on Purchases
and Ownership of Shares."Community Offerings.

In formulating the Appraisal, RP Financial relied upon the truthfulness,
accuracy and completeness of all documents the Bank furnished it. RP Financial
also considered financial and other information from regulatory agencies,
other financial institutions and other public sources, as appropriate. While
RP Financial believes this information to be reliable, RP Financial does not
guarantee the accuracy or completeness of such information and did not
independently verify the financial statements and other data provided by the
Bank and the Company or independently value the assets or liabilities of the
Company and the Bank. THE APPRAISAL BY RP

81
FINANCIAL IS NOT INTENDED TO BE, AND MUST NOT BE INTERPRETED AS, A
RECOMMENDATION OF ANY KIND AS TO THE ADVISABILITY OF VOTING TO APPROVE THE
CONVERSION OR OF PURCHASING SHARES OF COMMON STOCK. MOREOVER, BECAUSE THE
APPRAISAL IS NECESSARILY BASED ON MANY FACTORS WHICH CHANGE FROM TIME TO TIME,
THERE IS NO ASSURANCE THAT PERSONS WHO PURCHASE CONVERSION STOCK 77
OR RECEIVE
EXCHANGE SHARES IN THE CONVERSION WILL BE ABLE TO SELL SHARES THEREAFTER AT
PRICES AT OR ABOVE THE PURCHASE PRICE.

LIMITATIONS ON PURCHASES AND OWNERSHIP OF SHARES

The Plan of Conversion sets forth purchase limitations applicable to the
Offerings. The minimum stock order is 25 shares. Except for the ESOP, which is
expected to purchase 8%2% of the Conversion Stock sold, no person (or persons
through a single subscription right), together with any associate or group or
persons acting in concert, may subscribe for more than $250,000 in all
categories of the Offerings combined. In addition to these purchase
limitations, no person, together with any associate or group of persons acting
in concert may, upon completion of the Conversion, own more than 2% of the
Common Stock outstanding. This ownership limitation pertains to the aggregate
of Conversion Stock purchased and Exchange Shares received by the subscriber.
Notwithstanding the foregoing, no Minority Stockholder will be required to
dispose of Minority Shares if, without purchasing Conversion Stock, the
Exchange will result in ownership of in excess of 2% of the Common Stock. The
purchase limitations and ownership limitation may be changed at the discretion
of the Company, as described herein.

The Bank's and the Company's Boards of Directors may, in their sole
discretion, increase the maximum purchase limitation to 9.99% of the shares of
Conversion Stock sold in the Conversion, provided that orders for shares which
exceed 5% of the shares of Conversion Stock sold in the Conversion may not
exceed, in the aggregate, 10% of the shares sold in the Conversion. If the
Board of Directors decides to increase the purchase limitation above $250,000,
all persons who subscribed for the maximum number of shares will be given the
opportunity to increase their subscriptions accordingly, subject to the rights
and preferences of any person who has priority subscription rights.

In the event of an increase in the total number of shares offered in the
Conversion due to an increase in the Valuation Price Range of up to 15% (the
"Adjusted Maximum"), the additional shares will be allocated in the following
priority in accordance with the Plan: (i) to fill the ESOP's subscription of
8% of the Adjusted Maximum number of shares; (ii) in the event that there is an
oversubscription by Eligible Account Holders, to fill their unfulfilled
subscriptions; (ii) to fill the ESOP's subscription of up to 2% of the
Adjusted Maximum number of shares; (iii) in the event that there is an
oversubscription by Supplemental Eligible Account Holders, to fill their
unfulfilled subscriptions; (iv) in the event that there is an oversubscription
by Other Members, to fill their unfulfilled subscriptions; (v) in the event
that there is an oversubscription by Minority Stockholders to fill their
subscriptions; and (iv) to fill unfulfilled subscriptions in the Community
Offering with preference to Preferred Subscribers.

The term "associate" of a person is defined in the Plan to mean (i) any
corporation or organization (other than the Bank or a majority-owned
subsidiary of the Bank or the Company) of which such person is an officer or
partner or is, directly or indirectly, the beneficial owner of 10% or more of
any class of equity securities; (ii) any trust or other estate in which such
person has a substantial beneficial interest or as to which such person serves
as trustee or in a similar fiduciary capacity (excluding tax-qualified
employee plans); and (iii) any relative or spouse of such person, or any
relative of such spouse, who has the same home as such person or who is a
director or officer of the Bank, or any of its subsidiaries, or the Mutual
Holding Company. For example, a corporation of which a person serves as an
officer would be an associate of such person and, therefore, all shares
purchased by such corporation would be included with the number of shares
which such person could purchase individually under the above limitations.

The term "acting in concert" is defined in the Plan to mean (i) knowing
participation in a joint activity or interdependent conscious parallel action
towards a common goal whether or not pursuant to an express

82
agreement; or (ii) a combination or pooling of voting or other interests in
the securities of an issuer for a common purpose pursuant to any contract,
understanding, relationship, agreement or other arrangement, whether written
or otherwise. A person or company which acts in concert with another person or
company ("other party") shall also be deemed to be acting in concert with any
person or company who is also acting in concert with that other party, except
that any tax-qualified employee stock benefit plan will not be deemed to be
acting in concert with its trustee or a person who serves in a similar
capacity solely for the purpose of determining whether stock held 78
by the
trustee and stock held by the plan will be aggregated. The term "officer" is
defined in the Plan to mean an executive officer of the Bank, the Company or
the MHC.

The term "resident" as used herein means any person who, on the date of the
Prospectus, maintained a bona fide residence within the Local Community (i.e.,
the counties of Thurston, Mason, Pierce, King, Snohomish, Kitsap, and Grays
Harbor in the State of Washington) and has manifested an intent to remain
within the Local Community for a period of time. To the extent the person is a
corporation or other business entity, the principal place of business or
headquarters shall be within the Local Community. To the extent the person is
a personal benefit plan, the circumstances of the beneficiary shall apply with
respect to this definition. In the case of all other benefit plans, the
circumstances of the trustee shall be examined for purposes of this
definition. The Bank may utilize deposit or loan records or such other
evidence provided to it to make a determination as to whether a person is bona
fide resident of the Local Community. In all cases, however, such
determination shall be in the sole discretion of the Bank and shall be
determined on a case-by-case basis without regard to prior determination.

Common Stock purchased in the Offerings or received in the Exchange pursuant
to the Conversion will be freely transferable, except for shares purchased by
directors and officers of the Bank and the Company and by NASD members. See
"--Restrictions on Transferability by Directors and Officers and NASD
Members."

RESTRICTIONS ON TRANSFERABILITY BY DIRECTORS AND OFFICERS AND NASD MEMBERS

Shares of Conversion Stock purchased by directors and officers of the
Company may not be sold for a period of one year following completion of the
Conversion, except in the event of the death of the stockholder or in any
exchange of the Common Stock in connection with a merger or acquisition of the
Company. Shares of Common Stock received by directors or officers upon
exercise of options issued pursuant to the Stock Option Plan are not subject
to this restriction. Accordingly, shares of Common Stock issued by the Company
to directors and officers shall bear a legend giving appropriate notice of the
restriction and, in addition, the Company will give appropriate instructions
to the transfer agent for the Common Stock with respect to the restriction on
transfers. Any shares issued to directors and officers as a stock dividend,
stock split or otherwise with respect to restricted Common Stock shall be
subject to the same restrictions.

Purchases of outstanding shares of Common Stock of the Company by directors,
executive officers (or any person who was an executive officer or director of
the Bank after adoption of the Plan of Conversion) and their associates during
the three-year period following Conversion may be made only through a broker
or dealer registered with the SEC, except with the prior written approval of
the Division. This restriction does not apply, however, to negotiated
transactions involving more than 1% of the Company's outstanding Common Stock
or to the purchase of stock pursuant to the Stock Option Plan.

The Company has filed with the SEC a registration statement under the
Securities Act for the registration of the Common Stock to be issued pursuant
to the Conversion. The registration under the Securities Act of shares of the
Common Stock to be issued in the Conversion does not cover the resale of such
shares. Shares of Common Stock purchased by persons who are not affiliates of
the Company may be resold without registration. Shares purchased by an
affiliate of the Company will be subject to the resale restrictions of Rule
144 under the Securities Act. If the Company meets the current public
information requirements of Rule 144 under the Securities Act, each affiliate
of the Company who complies with the other conditions of Rule 144 (including,
those that require the affiliate's sale to be aggregated with those of certain
other persons) would be able to sell in the public market, without
registration, a number of shares not to exceed, in any three-month period, the
greater of (i) 1% of the outstanding shares of the Company or (ii) the average
weekly volume of trading, in such shares during the

83
preceding, four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under
the Securities Act under certain circumstances.

In addition, under guidelines of the NASD, members of the NASD and their
associates are subject to certain restrictions on the transfer of securities
purchased in accordance with subscription rights and to certain reporting
requirements upon purchase of such securities.

RESTRICTIONS ON ACQUISITION OF THE COMPANY AND THE BANK

The following discussion is a summary of certain provisions of Washington
and Federal law and regulations and Washington corporate law, as well as the
Articles of Incorporation and Bylaws of the Company, relating to stock
ownership and transfers, the Board of Directors and business combinations, all
of which may be deemed to have "anti-takeover" effects. The description of
these provisions is necessarily general and reference should be made to the
actual law and regulations and to the Articles of Incorporation and Bylaws of
the Company. See "Additional Information" as to how to obtain a copy of these
documents.

WASHINGTON LAW

As required by Washington law, as soon as practicable following the
Conversion, the Bank will enter into an agreement with the Division which will
provide that for a period of three years following the date of Conversion, any
company significantly engaged in an unrelated business activity (either
directly or through an affiliate thereof) shall not be permitted to acquire
control of the Bank. For purposes of this agreement, a person or company shall
be deemed to have "control" of the Bank if the person directly or indirectly
or acting, in concert with one or more other persons or through one or more
subsidiaries, owns, controls, or holds with power to vote, or holds proxies
representing, more than 25% of the voting shares of the Company, or controls
in any manner the election of a majority of the directors of the Company. A
company shall be deemed to be "significantly engaged" in an unrelated business
activity if such activity represents on either an actual or a pro forma basis
more than 15% of its consolidated net worth at the close of its preceding
fiscal year or of its consolidated net earnings for such fiscal year. The term
"unrelated business activity" means any business activity not authorized for a
savings bank or any subsidiary thereof.

In addition, for a period of three years following completion of the
Conversion, no person or entity may make directly, or indirectly, any offer to
acquire or actually acquire capital stock of the Bank (or the Company) if,
after consummation of such acquisition, such person would be the beneficial
owner of more than 10% of the Bank's (or Company's) capital stock, without the
prior approval of the Division. However, approval is not required for
purchases directly from the Bank or Company or the underwriters or selling
group acting on their behalf with a view towards public resale, or for
purchases not exceeding 1% per annum of the shares outstanding.

FEDERAL BANKING LAW

Federal Change in Bank Control Law. The Change in Bank Control Act requires
any person or group of persons acting in concert who at any time intend to
acquire control of an insured depository institution or its parent holding
company to give 60 days prior written notice to the "appropriate Federal
banking agency." The Federal Reserve is the "appropriate Federal banking
agency" for bank holding companies. Control for these purposes exists when the
acquiring party owns or controls at least 10% of any class of voting
securities of a bank holding company registered under the Exchange Act or has
the power to direct the management or policies of an institution.

Federal Bank Holding Company Law. The BHCA provides that no company may
acquire "control" of a bank or bank holding company) without the prior
approval of the Federal Reserve. Any company that acquires such control
becomes a "bank holding company" subject to registration, examination and
regulation by the Federal Reserve. Pursuant to the BHCA, a company has control
over a bank or bank holding company if it has

84
the power to vote 25% or more of any class of voting stock of the bank or bank
holding company, controls the election of a majority of the directors of the
bank or bank holding company, or exercises a controlling, influence over the
management or policies of the bank or bank holding company. The Federal
Reserve may find that a company controls a bank or bank holding company if the
company owns or controls more than 10% of any class of voting securities of
the bank or bank holding company and certain other relationships exist between
the company and the bank or bank holding company. The Federal Reserve may
prohibit an acquisition of control if it finds, among other things, that (i)
the acquisition would result in a monopoly or substantially, lessen
competition, (ii) the financial condition of the acquiring person might
jeopardize the financial stability of the institution, or (iii) the
competence, experience or integrity of the acquiring person indicates that it
would not be in the interest of the depositors or the public to permit the
acquisition of control by such person.

ANTI-TAKEOVER PROVISIONS

A number of provisions of the Company's Articles of Incorporation and Bylaws
deal with matters of corporate government and certain rights of stockholders.
The following discussion is a general summary of certain provisions of the
Company's Articles of Incorporation and Bylaws and regulatory provisions
relating to stock ownership and transfers, the Board of Directors and business
combinations which might be deemed to have a potential "anti-takeover" effect.
These provisions may have the effect of discouraging a future takeover

80
attempt
which is not approved by the Board of Directors but which individual Company
stockholders may deem to be in their best interests or in which stockholders
may receive a substantial premium for their shares over then current market
prices. As a result, stockholders who might desire to participate in such a
transaction may not have an opportunity to do so. Such provisions will also
render the removal of incumbent Board of Directors or management of the
Company more difficult. The following description of certain of the provisions
of the Articles of Incorporation and Bylaws of the Company is necessarily
general, and reference should be made in each case to such Articles of
Incorporation and Bylaws, which are incorporated herein by reference. See
"Additional Information" as to how to obtain a copy of these documents.

Policy of Independence. In addition to Article and Bylaw provisions which
might be deemed to have potential "anti-takeover" effects, the Company's Board
of Directors has adopted a statement of policy that the Company intends to
remain independent for the foreseeable future. Thus, potential investors
should not invest in Company Common Stock with the expectation that the
Company or the Bank may be merged into or its assets sold to another company
in the foreseeable future.

Restrictions on Acquisitions of Securities. The Articles of Incorporation
provide that for a period of five years from the effective date of the
Conversion, no person may acquire directly or indirectly acquire the
beneficial ownership of more than 10% of any class of equity security of the
Company, unless such offer or acquisition shall have been approved in advance
by a two-thirds vote of the Company's Continuing Directors (as defined in the
Articles of Incorporation). This provision does not apply to any employee
stock benefit plan of the Company. In addition, during such five-year period,
no shares beneficially owned in violation of the foregoing percentage
limitation, as determined by the Company's Board of Directors, shall be
entitled to vote in connection with any matter submitted to stockholders for a
vote. Additionally, the Articles of Incorporation provides for further
restrictions on voting rights of shares owned in excess of 10% of any class of
equity security of the Company beyond five years after the Conversion.
Specifically, the Articles of Incorporation provides that if, at any time
after five years from the Conversion, any person acquires the beneficial
ownership of more than 10% of any class of equity security of the Company,
then, with respect to each vote in excess of 10%, the record holders of voting
stock of the Company beneficially owned by such person shall be entitled to
cast only one-hundredth of-one vote with respect to each vote in excess 10% of
the voting power of the outstanding shares of voting stock of the Company
which such record holders would otherwise be entitled to cast without giving
effect to the provision, and the aggregate voting power of such record holders
shall be allocated proportionately among such record holders. An exception
from the restriction is provided if the acquisition of more than 10% of the
securities received the prior approval by a two-thirds vote of the Company's
"Continuing Directors." Under the Company's Articles of Incorporation, the
restriction on voting shares beneficially owned in violation of the foregoing
limitations is imposed automatically. In order to prevent the imposition of
such restrictions, the Board

85
of Directors must take affirmative action approving in advance a particular
offer to acquire or acquisition. Unless the Board took such affirmative
action, the provision would operate to restrict the voting by beneficial
owners of more than 10% of the Company's Common Stock in a proxy contest.

Board of Directors. The Board of Directors of the Company is divided into
three classes, each of which shall contain approximately one-third of the
whole number of the members of the Board. The members of each class shall be
elected for a term of three years, with the terms of office of all members of
one class expiring each year so that approximately one-third of the total
number of directors are elected each year. The Company's Articles of
Incorporation provides that the size of the Board shall be as set forth in the
Bylaws. The Bylaws currently set the number of directors at eight. The
Articles of Incorporation provides that any vacancy occurring in the Board,
including a vacancy created by an increase in the number of directors, shall
be filled by a vote of two-thirds of the directors then in office and any
director so chosen shall hold office for a term expiring at the annual meeting
of stockholders at which the term of the class to which the director has been
chosen expires. The classified Board is intended to provide for continuity of
the Board of Directors and to make it more difficult and time consuming for a
stockholder group to fully use its voting, power to gain control of the Board
of Directors without the consent of the incumbent Board of Directors of the
Company. The Articles of Incorporation of the Company provide that a director
may be removed from the Board of Directors prior to the expiration of his term

only for cause and only upon the vote of 66.66% of the outstanding shares of
voting stock. In the absence of this provision, the vote of the holders of a
majority of the shares could remove the entire Board, but only with cause, and
replace it with persons of such holders' choice.

Cumulative Voting Special Meetings and Action by Written Consent. The
Articles of Incorporation do not provide for cumulative voting for any
purpose. Moreover, the Articles of Incorporation provides that special
meetings of stockholders of the Company may be called only by the Board of
Directors of the Company and that stockholders may take action only at a
meeting and not by written consent.

Authorized Shares. The Articles of Incorporation authorize the issuance of
15,000,000 shares of Common Stock and 2,500,000 shares of preferred stock. The
shares of Common Stock and preferred stock were authorized in an amount
greater than that to be issued in the Conversion to provide the Company's
Board of Directors with as much flexibility as possible to effect, among other
transactions, financings, acquisitions, stock dividends, stock splits and the
exercise of employee stock options. However, these additional authorized
shares may also be used by the Board of Directors consistent with its
fiduciary duty to deter future attempts to gain control of the Company. The
Board of Directors also has sole authority to determine the terms of any one
or more series of preferred stock, including voting rights, conversion rates,
and liquidation preferences. As a result of the ability to fix voting rights
for a series of preferred stock, the Board has the power to the extent
consistent with its fiduciary duty to issue a series of preferred stock to
persons friendly to management in order to attempt to block a tender offer,
merger or other transaction by which a third party seeks control of the
Company, and thereby assist members of management to retain their positions.
The Company's Board currently has no plans for the issuance of additional
shares, other than the issuance of shares of Common Stock upon exercise of
stock options.

Stockholder Vote Required to Approve Business Combinations with Principal
Stockholders. The Articles of Incorporation require the approval of the
holders of at least 66.66% of the Company's outstanding shares of voting stock
to approve certain "Business Combinations" (as defined therein) involving a
"Related Person" (as defined therein) except in cases where the proposed
transaction has been approved in advance by a majority of those members of the
Company's Board of Directors who are unaffiliated with the Related Person and
were directors prior to the time when the Related Person became an Related
Person. The term "Related Person" is defined to include any individual,
corporation, partnership or other entity (other than the Company or its
subsidiary) which owns beneficially or controls, directly or indirectly, 10%
or more of the outstanding shares of voting stock of the Company or an
affiliate of such person or entity. This provision of the Articles of
Incorporation applies to any "Business Combination" which is defined to
include: (i) any merger or consolidation of the Company with or into any
Related Person; (ii) any sale, lease, exchange, mortgage, transfer, or other
disposition of 25% or more of the assets of the Company or combined assets of
the Company and its subsidiaries to a Related Person; (iii) any, merger or
consolidation of a Related Person with or into the Company

86
or a subsidiary of the Company; (iv) any sale, lease, exchange, transfer, or
other disposition of 25% or more of the assets of a Related Person to the
Company or a subsidiary of the Company; (v) the issuance of any securities of
the Company or a subsidiary of the Company to a Related Person; (vi) the
acquisition by the Company or a subsidiary, of the Company of any securities
of a Related Person; (vii) any reclassification of common stock of the Company
or any recapitalization involving the common stock of the Company; or (viii)
any agreement or other arrangement providing for any of the foregoing.

Under Washington law, absent this provision, business combinations,
including mergers, consolidations and sales of substantially all of the assets
of a corporation must, subject to certain exceptions, be approved by the vote
of the holders of a majority of the outstanding shares of common stock of the
Company and any other affected class of stock. One exception under Washington
law to the majority approval requirement applies to stockholders owning 15% or
more of the common stock of a corporation for a period of less than three
years. Such 15% stockholder, in order to obtain approval of a business
combination, must obtain the approval of two-thirds of the outstanding stock,
excluding the stock owned by such 15% stockholder, or satisfy other
requirements under Washington law relating to board of director approval of
his acquisition of the shares of the Company. The increased stockholder vote
required to approve a business combination may have the effect of

82
foreclosing
mergers and other business combinations which a majority of stockholders deem
desirable and place the power to prevent such a merger or combination in the
hands of a minority of stockholders.

Amendment of Articles of Incorporation and Bylaws. Amendments to the
Company's Articles of Incorporation must be approved by a majority of its
Board of Directors and also by a majority of the outstanding shares of its
voting stock, provided, however, that an affirmative vote of at least 66.66%
of the outstanding voting stock entitled to vote (after giving effect to the
provision limiting voting rights) is required to amend or repeal certain
provisions of the Articles of Incorporation, including the provision limiting
voting rights, the provisions relating to approval of certain business
combinations, calling special meetings, the number and classification of
directors, director and officer indemnification by the Company and amendment
of the Company's Bylaws and Articles of Incorporation. The Company's Bylaws
may, be amended by its Board of Directors, or by a vote of 66.66% of the total
votes eligible to be voted at a duly constituted meeting of stockholders.

Stockholder Nominations and Proposals. The Articles of Incorporation of the
Company requires a stockholder who intends to nominate a candidate for
election to the Board of Directors, or to raise new business at a stockholder
meeting to give not less than 30 nor more than 50 days' advance notice to the
Secretary of the Company. The notice provision requires a stockholder who
desires to raise new business to provide certain information to the Company
concerning the nature of the new business, the stockholder and the
stockholder's interest in the business matter. Similarly, a stockholder
wishing to nominate any person for election as a director must provide the
Company with certain information concerning the nominee and the proposing
stockholder.

DESCRIPTION OF CAPITAL STOCK OF THE COMPANY

GENERAL

The Company is authorized to issue 15,000,000 shares of Common Stock having
no par value per share and 2,500,000 shares of preferred stock having no par
value per share. The Company, currently expects to issue up to 6,098,9988,477,075
shares of Common Stock (at the maximum of the Valuation Price Range) and no
shares of preferred stock in the Conversion. Each share of the Common Stock
will have the same relative rights as, and will be identical in all respects
with, each other share of Common Stock. Upon payment of the Purchase Price for
the Common Stock, in accordance with the Plan of Conversion, all such stock
will be duly authorized, fully paid and nonassessable.

THE COMMON STOCK OF THE COMPANY WILL REPRESENT NONWITHDRAWABLE CAPITAL, WILL
NOT BE AN ACCOUNT OF AN INSURABLE TYPE, AND WILL NOT BE INSURED BY THE FDIC.

COMMON STOCK

Dividends. The Company can pay dividends out of statutory surplus or from
certain net profits if, as and when declared by its Board of Directors. The
payment of dividends by the Company is subject to limitations which are
imposed by law and applicable regulation. See "Dividend Policy" and
"Supervision and Regulation." The holders of Common Stock of the Company will
be entitled to receive and share equally in such dividends as may be declared
by the Board of Directors of the Company out of funds legally available
therefor. If the Company issues preferred stock, the holders thereof may have
a priority over the holders of the Common Stock with respect to dividends.

Voting Rights. Upon Conversion, the holders of Common Stock of the Company
will possess exclusive voting rights in the Company. They will elect the
Company's Board of Directors and act on such other matters as are required to
be presented to them under Washington law or as are otherwise presented to
them by the Board of Directors. Except as discussed in "Restrictions on
Acquisition of the Company and the Bank," each holder of Common Stock will be
entitled to one vote per share and will not have any right to accumulate votes
in the election of directors. If the Company issues preferred stock, holders
of the Company preferred stock may also possess voting rights. Certain matters
require a vote of 66.66% of the outstanding shares entitled to vote thereon.
See "Restrictions on Acquisition of the Company and the Bank."

Liquidation. In the event of any liquidation, dissolution or winding up of
the Bank, the Company, as holder of the Bank's capital stock would be entitled
to receive, after payment or provision for payment of all debts and
liabilities of the Bank (including all deposit accounts and accrued interest
thereon) and after distribution of the balance in the special liquidation
account to Eligible Account Holders and Supplemental Eligible Account Holders
(see "The Conversion"), all assets of the Bank available for distribution. In
the event of liquidation, dissolution or winding up of the Company, the
holders of its Common Stock would be entitled to receive, after payment or
provision for payment of all its debts and liabilities, all of the assets of
the Company available for distribution. If Company preferred stock is issued,
the holders thereof may have a priority over the holders of the Common Stock
in the event of liquidation or dissolution.

Preemptive Rights. Holders of the Common Stock of the Company will not be
entitled to preemptive rights with respect to any shares which may be issued.
The Common Stock is not subject to redemption.

PREFERRED STOCK

None of the shares of the authorized Company preferred stock will be issued
in the Conversion and there are no plans to issue the preferred stock. Such
stock may be issued with such designations, powers, preferences and rights as
the Board of Directors may from time to time determine. The Board of Directors
can, without stockholder approval, issue preferred stock with voting,
dividend, liquidation and conversion rights which could dilute the voting
strength of the holders of the Common Stock and may assist management in
impeding an unfriendly takeover or attempted change in control.

RESTRICTIONS ON ACQUISITION

Acquisitions of the Company are restricted by provisions in its Articles of
Incorporation and Bylaws and by the rules and regulations of various
regulatory agencies. See "Supervision and Regulation" and "Restrictions on
Acquisition of the Company and the Bank."

COMPARISON OF STOCKHOLDERS' RIGHTS

GENERAL. As a result of the Conversion, holders of the Bank Common Stock
will become stockholders of the Company, a Washington corporation. There are
certain differences in stockholder rights arising from distinctions between
the Bank's Washington State Stock Articles and Bylaws and the Company's
Articles of

88
Incorporation and Bylaws and from distinctions between laws with respect to
savings institutions and the Washington Business Corporation Act ("WBCA").

The discussion herein is not intended to be a complete statement of the
differences affecting the rights of stockholders, but rather summarizes the
material differences and similarities affecting the rights of stockholders.
The discussion is qualified in its entirety by reference to the Articles of
Incorporation and Bylaws of the Company and the Bank ("Articles" and "Bylaws")
and the WBCA. See "Additional Information" for procedures for obtaining a copy
of the Company's Articles and Bylaws.

AUTHORIZED CAPITAL STOCK. The Company's authorized capital stock consists of
15,000,000 shares of Common Stock, no par value per share, and 2,500,000
shares of preferred stock, no par value per share ("Preferred Stock"). The
Bank's authorized capital stock consists of 10,000,000 shares of Bank Common
Stock, par value $1.00 per share, and 5,000,000 shares of blank check
preferred stock, par value $1.00 per share. The shares of Common Stock and
Preferred Stock were authorized in an amount greater than that to be issued in
the Conversion to provide the Company's Board of Directors with flexibility to
effect, among other transactions, financings, acquisitions, stock dividends,
stock splits and grants of employee stock options. The Board of Directors has
sole authority to determine the terms of any one or more series of Preferred
Stock, including dividends, voting rights, conversion rates, if any, and
liquidation preferences.

ISSUANCE OF CAPITAL STOCK. Pursuant to applicable laws and regulations, the
MHC is required to own not less than a majority of the outstanding Bank Common
Stock. There will be no such restriction applicable to the Company following
consummation of the Conversion.

Neither the Articles of the Bank or the Company contain restrictions on the
issuance of shares of capital stock to directors, officers or controlling
persons. Thus, stock-related compensation plans such as stock option plans
could be adopted by either Company without stockholder approval and shares of
capital stock could be issued directly to directors or officers without
stockholder approval. Unlike the Bank, the Company will be subject to
jurisdiction of the NASD. The Rules of the NASD generally require corporations
with securities which are quoted on the Nasdaq National Market to obtain
stockholder approval of most stock compensation plans for directors, officers
and key employees of the corporation. Moreover, although generally not
required, stockholder approval of stock related compensation plans may be
sought in certain instances in order to qualify such plans for favorable
federal income tax and securities law treatment under current laws and
regulations. The Company plans to submit the stock compensation plans
discussed herein to its stockholders for approval.

VOTING RIGHTS. Neither the Bank's Articles or Bylaws nor the Company's
Articles or Bylaws currently provide for cumulative voting in elections of
directors. For additional information regarding voting rights, see "--
Limitations on Acquisitions of Voting Stock and Voting Rights" below.

PAYMENT OF DIVIDENDS. The ability of the Bank to pay dividends on its
capital stock is restricted by applicable Washington banking law and by
federal income tax considerations related to savings institutions such as the
Bank. See "Supervision and Regulation--Banking Subsidiary." Although the
Company is not subject to these restrictions as a Washington corporation, such
restrictions will indirectly affect the Company because dividends from the
Bank will be a primary source of funds of the Company for the payment of
dividends to stockholders of the Company.

Certain restrictions generally imposed on Washington corporations may also
have an impact on the Company's ability to pay dividends. The WBCA provides
that dividends may be paid only if, after giving effect to the dividend, the
Company will be able to pay its debts as they become due in the ordinary
course of business and the Company's total assets will not be less than the
sum of its total liabilities plus the amount that would be needed, if the
Company were to be dissolved at the time of the dividend, to satisfy the
preferential rights of persons whose right to payment is superior to those
receiving the dividend.

BOARD OF DIRECTORS. The Company's Articles require the Board of Directors of
the Company to be divided into three classes as nearly equal in number as
possible and that the members of each class shall be elected for a

89
term of three years and until their successors are elected and qualified, with
one class being elected annually. No such provision is contained in the
Articles or Bylaws of the Bank.

Under the Bank's Bylaws, any vacancies in the Board of Directors of the Bank
may be filled by the affirmative vote of a majority of the remaining directors
although less than a quorum of the Board of Directors. Persons elected by the
directors of the Bank to fill vacancies may only serve until the next annual
meeting of stockholders. Under the Company's Articles, any vacancy occurring
in the Board of Directors of the Company, including any vacancy created by
reason of an increase in the number of directors, may be filled by the
remaining directors, and any director so chosen shall hold office for the
remainder of the term to which the director has been elected and until his or
her successor is elected and qualified.

Under the Bank's Bylaws, any director may be removed with or without cause
by the holders of a majority of the outstanding voting shares. The Company's
Articles provide that any director may be removed for cause by a majority of
the directors of the Company or by the holders of at least 66 2/3% of the
outstanding voting shares of the Company.

LIMITATIONS ON LIABILITY. The Company's Articles provide that directors
shall not be personally liable for monetary damages to the Company or Bank for
conduct other than conduct that is adjudged to involve intentional

85
misconduct
and other acts defined in the Articles as "Egregious Conduct." This provision
might, in certain instances, discourage or deter shareholders or management
from bringing a lawsuit against directors for a breach of their duties even
though such an action, if successful, might have benefited the Company.

INDEMNIFICATION OF DIRECTORS AND OFFICERS-DIRECTORS. Directors and persons
who serve as officers and directors of the Bank and the Company are
indemnified with respect to certain actions pursuant to their respective
Articles, which comply with applicable Washington law regarding
indemnification. The WBCA allows the Company to indemnify the aforementioned
persons for expenses, settlements, judgments and fines in suits in which such
person has made a party by reason of the fact that he or she is or was an
agent of the Company. No such indemnification may be given if the acts or
omissions of the person are adjudged to be in violation of law, if such person
is liable to the corporation for an unlawful distribution, or if such person
personally received a benefit to which he or she was not entitled.

SPECIAL MEETINGS OF STOCKHOLDERS. The Company's and the Bank's Articles
provide that special meetings of the stockholders may be called by the
Chairman, President, a majority of the Board of Directors or the holders of
not less than one tenth of the outstanding capital stock of the Company
entitled to vote at the meeting.

STOCKHOLDER NOMINATIONS. The Company's Articles and the Bank's Bylaws
generally provide that any stockholder desiring to make a nomination for the
election of directors at a meeting of stockholders must submit written notice
to the Company at least 14 days and not more than 50 days in advance of the
meeting, together with certain information relating to the nomination. Failure
to comply with these advance notice requirements will preclude such
nominations from being considered at the meeting. Management believes that it
is in the best interests of the Company and its stockholders to provide
sufficient time to enable management to disclose to stockholders information
about a dissident slate of nominations for directors. This advance notice
requirement may also give management time to solicit its own proxies in an
attempt to defeat any dissident slate of nominations, should management
determine that doing so is in the best interest of stockholders generally.
Similarly, adequate advance notice of stockholder proposals will give
management time to study such proposals and to determine whether to recommend
to the stockholders that such proposals be adopted. In certain instances, such
provisions could make it more difficult to oppose management's nominees, even
if stockholders believe such nominees or proposals are in their best
interests.

STOCKHOLDER ACTION WITHOUT A MEETING. The Bylaws of the Company and the Bank
provide that any action to be taken or which may be taken at any annual or
special meeting of stockholders may be taken if a consent in writing, setting
forth the actions so taken, is given by the holders of all outstanding shares
entitled to vote.

90
STOCKHOLDER'S RIGHT TO EXAMINE BOOKS AND RECORDS. The WBCA provides that a
stockholder may inspect books and records upon written demand stating the
purpose of the inspection, if such purpose is reasonably related to such
person's interest as a stockholder.

LIMITATIONS ON ACQUISITIONS OF VOTING STOCK AND VOTING RIGHTS. The Company's
Articles of Incorporation provide that no person shall directly or indirectly
offer to acquire or acquire the beneficial ownership of (i) more than 10% of
the issued and outstanding shares of any class of an equity security of the
Company, or (ii) any securities convertible into, or exercisable for, any
equity securities of the Company if, assuming conversion or exercise by such
person of all securities of which such person is the beneficial owner which
are convertible into, or exercisable for, such equity securities (but of no
securities convertible into, or exercisable for, such equity securities of
which such person is not the beneficial owner), such person would be the
beneficial owner of more than 10% of any class of an equity security of the
Company. The term "person" is broadly defined in the Articles to prevent
circumvention of this restriction.

The foregoing restrictions do not apply to (i) any offer with a view toward
public resale made exclusively to the Company by underwriters or a selling
group acting on its behalf, (ii) any employee benefit plan established by the
Company or the Bank, and (iii) any other offer or acquisition approved in
advance by the affirmative vote

86
of two-thirds of the Company's Board of
Directors. In the event that shares are acquired in violation of this
restriction, all shares beneficially owned by any person in excess of 10%
during the period ending five years from the Effective Time of the Conversion
shall not be counted as shares entitled to vote and shall not be voted by any
person or counted as voting shares in connection with any matters submitted to
stockholders for a vote. If at any time after five years from the Effective
Time of the Conversion shares are acquired in violation of this restriction,
all shares beneficially owned in excess of 10% shall be counted at one
hundredth of a vote.

Neither the Articles nor the Bylaws of the Bank contains a provision which
restricts voting rights of certain stockholders of the Bank in the manner set
forth above.

REGISTRATION REQUIREMENTS

The Company will register the Common Stock with the SEC pursuant to Section
12(g) of the Exchange Act upon the completion of the Conversion and will not
deregister its Common Stock for a period of at least three years following the
completion of the Conversion. Upon such registration, the proxy and tender
offer rules, insider trading reporting and restrictions, annual and periodic
reporting and other requirements of the Exchange Act will be applicable to the
Company and its stockholders.

LEGAL AND TAX OPINIONS

The legality of the Common Stock has been passed upon for the Company by
Gordon, Thomas, Honeywell, Malanca, Peterson & Daheim, P.L.L.C. The federal
tax consequences of the Offerings have been opined upon by KPMG Peat Marwick
LLP and the Washington tax consequences of the Offerings have been opined upon
by Gordon, Thomas, Honeywell, Malanca, Peterson & Daheim, P.L.L.C., Tacoma and
Seattle, Washington, and they have consented to the references herein to their
opinions. Certain legal matters will be passed upon for Ryan Beck by Breyer
and Aguggia, Washington, D.C.

EXPERTS

The consolidated financial statements of Heritage Savings Bank and
Subsidiaries as of June 30, 1996 and 1997, and for each of the years in the
three year period ended June 30, 1997 have been included herein and in the
Registration Statement in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, appearing elsewhere herein, upon the
authority of said firm as experts in accounting and auditing.

91
RP Financial has consented to the publication herein of the summary of its
letter to the Bank setting forth its opinion as to the estimated pro forma
market value of the Common Stock and to the use of its name and statements
with respect to it appearing herein.

87
ADDITIONAL INFORMATION

The Company has filed with the SEC a Registration Statement on Form S-1
(File No. 333- )333-35573) under the Securities Act with respect to the Common Stock
offered in the Conversion. This Prospectus does not contain all the
information set forth in the Registration Statement, certain parts of which
are omitted in accordance with the rules and regulations of the SEC. Such
information may be inspected at the public reference facilities maintained by
the SEC at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549; 500 West
Madison Street, Suite 1400, Room 1100, Chicago, Illinois 60661; and 7 World
Trade Center (13th Floor), New York, New York 10048. Copies may be obtained at
prescribed rates from the Public Reference Section of the SEC at 450 Fifth
Street N.W., Washington, D.C. 20549.

The Bank has filed with the Division an Application for Approval of
Conversion, which includes proxy materials for the Mutual Holding Company's
Special Meeting, the Minority Stockholder Meeting and certain other
information. This Prospectus omits certain information contained in such
Application. The Application, including the proxy materials, exhibits and
certain other information that are a part thereof, may be inspected, without
charge, at the offices of the Division at the General Administration Building,
Third Floor West, 210 11th Avenue West, Olympia, Washington 98504.

8892

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

HERITAGE SAVINGS BANK AND SUBSIDIARIES

PAGES
-----

Independent Auditors' Report............................................ F-2
Consolidated Statements of Financial Condition as of June 30, 1996 and
1997................................................................... F-3
Consolidated Statements of Income for the Years Ended June 30, 1995,
1996 and 1997.......................................................... F-4
Consolidated Statements of Stockholders' Equity for the Years Ended June
30, 1994, 1995, 1996 and 1997.......................................... F-5
Consolidated Statements of Cash Flows for the Years Ended June 30, 1995,
1996 and 1997.......................................................... F-6
Notes to the Consolidated Financial Statements.......................... F-7

Separate financial statements on the Company have not been included since it
will not engage in material transactions until after the Conversion. The
Company, which has been inactive to date, has no significant assets,
liabilities, revenues, expenses or contingent liabilities.

F-1

INDEPENDENT AUDITORS' REPORT

The Board of Directors
Heritage Savings Bank

We have audited the accompanying consolidated statements of financial
condition of Heritage Savings Bank and subsidiaries as of June 30, 1996 and
1997, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the years in the three-year period ended June 30,
1997. These consolidated financial statements are the responsibility of the
Savings Bank's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally acceptable auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Heritage Savings Bank and subsidiaries as of June 30, 1996 and 1997, and
the results of their operations and their cash flows for each of the years in
the three-year period ended June 30, 1997 in conformity with generally
accepted accounting principles.

KPMG Peat Marwick LLP

Seattle, Washington
August 8, 1997

F-2

HERITAGE SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)

JUNE 30
-----------------
1996 1997
-------- -------

ASSETS
Cash on hand and in banks................................... $ 6,308 7,412
Interest earning deposits................................... 11,774 175
Investment securities held to maturity...................... 15,292 8,506
Mortgage backed securities held to maturity................. 5,979 5,159
Loans held for sale......................................... 5,286 6,323
Loans receivable............................................ 163,617 201,870
Less: Allowance for loan losses............................. (1,873) (2,752)
-------- -------
Loans, net.............................................. 161,744 199,118
Premises and equipment, net................................. 11,209 12,202
Federal Home Loan Bank stock................................ 1,400 1,511
Accrued interest receivable................................. 1,385 1,380
Prepaid expenses and other assets........................... 1,675 378
-------- -------
$222,052 242,164
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits.................................................... 191,119 209,781
Advances from Federal Home Loan Bank........................ -- 890
Advance payments by borrowers for taxes and insurance....... 535 473
Accrued expenses and other liabilities...................... 3,515 2,605
Deferred Federal income taxes............................... 1,250 701
-------- -------
196,419 214,450
-------- -------
Stockholders' equity:
Preferred stock, $1 par value per share. 5,000,000 shares
authorized; none outstanding............................. -- --
Common stock, $1 par value per share 10,000,000 shares
authorized; 1,805,666 and 1,809,616 shares outstanding,
respectively............................................. 1,806 1,810
Additional paid-in capital................................ 4,067 4,103
Retained earnings, substantially restricted............... 19,760 21,801
-------- -------
Total stockholders' equity.............................. 25,633 27,714
Commitments and contingencies
-------- -------
$222,052 242,164
======== =======

See accompanying notes to consolidated financial statements.

F-3

HERITAGE SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)

YEAR ENDED
JUNE 30
---------------------
1995 1996 1997
------- ------ ------

Interest income:
Loans................................................. $13,115 14,894 16,743
Mortgage backed securities............................ 722 552 464
Investment securities and Federal Home Loan Bank
dividends............................................ 1,118 854 757
Interest bearing deposits............................. 268 575 548
------- ------ ------
Total interest income............................... 15,223 16,875 18,512
------- ------ ------
Interest expense:
Deposits.............................................. 6,639 8,528 8,999
Borrowed funds........................................ 357 15 1
------- ------ ------
Total interest expense.............................. 6,996 8,543 9,000
------- ------ ------
Net interest income............................... 8,227 8,332 9,512
Provision for loan losses............................... -- -- (270)
------- ------ ------
Net interest income after provision for loan
losses........................................... 8,227 8,332 9,782
------- ------ ------
Noninterest income:
Gains on sales of loans, net.......................... 1,665 3,049 2,006
Commissions on sales of annuities and securities...... 241 296 220
Services charges on deposits.......................... 207 353 462
Rental income......................................... 209 221 210
Gain on sale of premises.............................. 356 -- 84
Other income.......................................... 362 379 365
------- ------ ------
Total noninterest income............................ 3,040 4,298 3,347
------- ------ ------
Noninterest expense:
Salaries and employee benefits........................ 4,176 4,711 5,468
Building occupancy.................................... 979 1,254 1,717
FDIC premiums and special assessment.................. 380 407 1,262
Data processing....................................... 462 493 534
Marketing............................................. 200 162 257
Office supplies and printing.......................... 257 229 243
Other................................................. 971 1,166 1,624
------- ------ ------
Total noninterest expense........................... 7,425 8,422 11,105
------- ------ ------
Income before Federal income tax expense
(benefit)........................................ 3,842 4,208 2,024
Federal income tax expense (benefit).................... 1,308 1,435 (245)
------- ------ ------
Net income........................................ $ 2,534 2,773 2,269
======= ====== ======
Earnings per common share............................... $ 1.41 1.54 1.26
======= ====== ======

See accompanying notes to consolidated financial statements

F-4

HERITAGE SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands)

ADDITIONAL TOTAL
COMMON PAID-IN RETAINED STOCKHOLDERS'
STOCK CAPITAL EARNINGS EQUITY
------ ---------- -------- -------------

Balance at June 30, 1994............... $1,800 4,017 14,845 20,662
Restricted stock award................. 5 45 -- 50
Net income............................. -- -- 2,534 2,534
Cash dividend paid..................... -- -- (181) (181)
------ ----- ------ ------
Balance at June 30, 1995............... $1,805 4,062 17,198 23,065
Exercise of stock options.............. 1 5 -- 6
Net income............................. -- -- 2,773 2,773
Cash dividend paid..................... (211) (211)
------ ----- ------ ------
Balance at June 30, 1996............... 1,806 4,067 19,760 25,633
Exercise of stock options.............. 4 36 -- 40
Net income............................. -- -- 2,269 2,269
Cash dividend paid..................... -- -- (228) (228)
------ ----- ------ ------
Balance at June 30, 1997............... $1,810 4,103 21,801 27,714
====== ===== ====== ======

See accompanying notes to consolidated financial statements.

F-5

HERITAGE SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)

YEAR ENDED JUNE 30
-------------------------
1995 1996 1997
------- ------- -------

Cash flows from operating activities:
Net income........................................ $ 2,534 2,773 2,269
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................... 157 349 996
Deferred loan fees, net of amortization......... 363 35 11
Provision for loan losses....................... -- -- (270)
Net increase in loans held for sale............. (1,816) 615 (1,037)
Deferred Federal income tax expense (benefit)... 41 262 (549)
Federal Home Loan Bank stock dividends.......... (108) (99) (111)
Net change in accrued interest receivable,
prepaid expenses and other assets, and accrued
expenses and other liabilities................. 70 411 392
------- ------- -------
Net cash provided by operating activities..... 1,241 4,346 1,701
------- ------- -------
Cash flows from investing activities:
Loans originated, net of principal payments and
loan sales....................................... (27,649) (11,211) (37,115)
Principal payments of mortgage backed securities.. 2,771 1,493 825
Proceeds from:
Sale of Federal Home Loan Bank Stock............ 860 -- --
Maturities of investment securities held to
maturity....................................... 6,900 13,300 9,160
Purchase of investment securities held to
maturity......................................... (2,132) (10,445) (2,345)
Purchase of premises and equipment................ (2,696) (2,204) (2,023)
------- ------- -------
Net cash used in investing activities......... (21,946) (9,067) (31,498)
------- ------- -------
Cash flows from financing activities:
Net increase in deposits.......................... 8,875 16,322 18,662
Net increase in FHLB advances..................... -- -- 890
Net decrease in other borrowed funds.............. (848) (3,252) --
Net decrease (increase) in advance payments by
borrowers for taxes and insurance................ 100 (100) (62)
Cash dividends paid............................... (181) (211) (228)
Issuance of restricted stock award and exercise of
stock options.................................... 50 6 40
------- ------- -------
Net cash provided by financing activities..... 7,996 12,765 19,302
------- ------- -------
Net increase (decrease) in cash and cash
equivalents.................................. (12,709) 8,044 (10,495)
Cash and cash equivalents at beginning of year...... 22,747 10,038 18,082
------- ------- -------
Cash and cash equivalents at end of year............ $10,038 18,082 7,587
======= ======= =======
Supplemental disclosures of cash flow information:
Cash payments for:
Interest expense................................ $ 6,631 8,527 8,945
Federal income taxes............................ 1,265 1,395 620

See accompanying notes to consolidated financial statements.

F-6

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 AND 1996
(DOLLARS IN THOUSANDS)

(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Description of Business

The business of Heritage Savings Bank (the "Bank"), which is focused in
Thurston, Mason and Pierce counties, consists primarily of attracting deposits
from the general public and originating for sale or investment purposes first
mortgage loans on residential properties located in western Washington. The
Bank also makes residential construction loans, income property loans,
business loans and consumer loans, primarily second mortgage loans. Although
the Bank has a diversified loan portfolio and its market area enjoys a stable
economic climate, a substantial portion of its borrowers ability to repay
these loans is dependent upon the economic stability of the major employers,
Federal, State and local governments.

Loans originated by the Bank that are secured by real estate have loan to
value ratios of generally no more than 80% of the appraised amount. The Bank
currently requires customers to obtain private mortgage insurance on all fixed
and adjustable rate mortgage loans above an 80% loan-to-value ratio.

Heritage Savings Bank, a Washington State stock savings bank, is majority-
owned by Heritage Financial Corporation, M.H.C. (HFC), a Washington State
mutual holding company.

(b) Basis of Presentation

The accounting and reporting policies of the Bank and its subsidiaries conform
to generally accepted accounting principles and to general practices within
the financial institutions industry, where applicable. In preparing the
consolidated financial statements, management makes estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of financial statements and the
reported amounts of income and expense during the reported periods. Actual
results could differ from these estimates. All significant intercompany
balances and transactions among the Bank and its subsidiaries have been
eliminated in consolidation.

The accompanying consolidated financial statements include the accounts of the
Bank and its wholly-owned subsidiaries, Sound Service Associates, Inc. and
Heritage Capital Corporation. Sound Service Associates, Inc. operations
primarily consist of the sale of tax-deferred investment products. Heritage
Capital Corporation was incorporated as a limited purpose financing subsidiary
to issue collateralized mortgage obligations which were retired in August
1995. Certain amounts in the consolidated financial statements for prior years
have been reclassified to conform to the current consolidated financial
statement presentation.

For purposes of reporting cash flows, cash and cash equivalents includes cash
on hand and in banks and interest bearing deposits.

(d) Investment Securities

Investment securities are recorded at cost, adjusted for amortization of
premiums or accretion of discounts using the interest method. These
investments are carried at cost because the Bank has the ability, and it is
management's intent, to hold them to maturity. The Bank has no investment
securities classified available for sale or held for trading purposes.

F-7

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(e) Loans Receivable and Mortgage-Backed Securities

Loans and mortgage backed securities are generally recorded at cost, net of
discounts, unearned fees and deferred fees. Discounts and premiums on
purchased loans and mortgage-backed securities are amortized using the
interest method over the remaining contractual life, adjusted for actual
prepayments. Mortgage loans held for sale are carried at the lower of
amortized cost or market value determined on an aggregate basis. Any loan that
management determines will not be held to maturity is classified as held for
sale at the time of origination, purchase or securitization. Unrealized losses
on such loans are included in the consolidated statements of income. Mortgage
backed securities are carried at amortized cost because the Bank has the
ability, and it is management's intent, to hold them to maturity.

(f) Loan Fees

Loan origination fees and certain direct origination costs are deferred and
amortized as an adjustment of the loans yields over the contractual lives,
adjusted for prepayment of the loans, using the interest method. In the event
loans are sold, the deferred net loan origination fees or costs are recognized
as a component of the gains or losses on the sales of loans.

(g) Allowance for Loan Losses

A valuation allowance for loans is based on management's estimate of the
amount necessary to recognize possible losses inherent in the loan portfolio.
In determining the level to be maintained, management evaluates many factors
including the borrowers ability to repay, economic and market trends and
conditions, holding costs and absorption periods. In the opinion of
management, the present allowance is adequate to absorb reasonably foreseeable
loan losses.

Effective July 1, 1995, the Bank adopted Statement of Financial Accounting
Standards (SFAS) No. 114, Accounting for Creditors for Impairment of a Loan,
and its amendment, SFAS No. 118, Accounting by Creditors for Impairment of a
Loan--Income Recognition and Disclosures. These statements require that
impaired loans are measured based on the present value of expected future cash
flows discounted at the loan's effective interest rate or, as a practical
expedient, based on the loan's observable market price or the fair value of
collateral; if the loan is collateral dependent. In accordance with SFAS No.
114, the Bank excludes smaller balance, homogeneous loans from its impairment
evaluation. The adoption of this statement had no impact on these financial
statements.

While management uses available information to recognize losses on these
loans, future additions to the allowances may be necessary based on changes in
economic conditions, particularly in the western Washington region. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Banks allowance for losses on
loans. Such agencies may require the Bank to make additions to the allowance
based on their judgments about information available to them at the time of
their examinations.

(h) Nonaccrual Loans

The accrual of interest on loans is discontinued and the loan is considered
impaired when, in the opinion of management, the collectibility of principal
or interest is in doubt or generally when the loans are contractually past due
90 days or more with respect to principal or interest. When accrual of
interest is discontinued on a loan, the interest accrued but not collected is
charged against operations. Thereafter, payments received are generally
applied to principal. However, based on management's assessment of the
ultimate collectibility of an impaired or nonaccrual loan, interest income may
be recognized on a cash basis. Impaired loans and other nonaccrual loans
(smaller balance, homogeneous loans) are returned to an accrual status when
management determines that the circumstances have improved to the extent that
there has been a sustained period of repayment performance and both principal
and interest are deemed collectible.

F-8

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(i) Mortgage Banking Operations

The Bank sells mortgage loans primarily on a servicing released basis and
recognizes a cash or a present value gain or loss. A cash gain or loss is
recognized to the extent that the sales proceeds of the mortgage loans sold
exceed or are less than the net book value at the time of sale.

In June 1996, the FASB issued SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, which
provides consistent standards for distinguishing transfers of assets that are
sales from transfers that are secured borrowings. This Standard supersedes
SFAS No. 122, Accounting for Mortgage Servicing Rights, in the measurement and
valuation of mortgage servicing rights. This Standard is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996, and is to be applied prospectively only.
The adoption of this pronouncement did not have a material impact on the
financial statements of the Bank.

Loan servicing income is recorded when earned. Loan servicing costs are
charged to expense as incurred.

(j) Real Estate Owned

Real estate acquired by the Bank in satisfaction of debt is recorded at fair
value at time of foreclosure and is carried at the lower of the new cost basis
or fair value. Subsequently, foreclosed assets are carried at the lower of
cost or fair value less estimated costs to sell. Costs related to the
improvement of the property are capitalized subject to the above limitations;
those related to holding the property, net of rental income, are charged to
expense.

(k) Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation.
Depreciation and amortization are computed using the straight-line method over
the estimated useful lives of the assets. The estimated useful lives used to
compute depreciation and amortization include buildings and building
improvements, 30 to 40 years; and furniture, fixtures and equipment, 3 to 10
years.

During 1995, the FASB issued SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This
pronouncement deals with the measurement and reporting of long-lived assets
that either will be held and used in operations or that will be disposed of.
The adoption did not have a material impact on the results of operations or
financial condition of the Bank.

(l) Federal Income Taxes

Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
the deferred tax assets and liabilities of a change in tax rate is recognized
in income in the period that includes the enactment date.

(m) Recent Financial Accounting Pronouncements

SFAS No. 128, "Earnings Per Share," issued in February 1997, establishes
standards for computing and presenting earnings per share ("EPS") and applies
to entities with publicly-held common stock or potential common stock. It
replaces the presentation of primary EPS with a presentation of basic EPS and
requires the dual presentation of basic and diluted EPS on the fact of the
income statement. SFAS No. 128 is effective for the financial statements for
the periods ending after December 15, 1997. SFAS No. 128 requires restatement
of all prior period EPS data presented. The impact of its adoption is not
expected to be material to the Bank.

F-9

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

In June 1997, the Financial Accounting Standards Board issued Statement of
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes standards for reporting comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of financial
statements. This Statement requires that the Bank (a) classify items of other
comprehensive income by their nature in its financial statements and (b)
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of the
statement of financial condition. This Statement is effective for the year
ending June 30, 1999.

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 requires public
companies to report financial and descriptive information about its operating
segments. Operating segments are components of a business about which separate
financial information is available that is evaluated regularly by the chief
operating decision-maker in deciding how to allocate resources and in
assessing performance. The adoption of SFAS 131 is required for the fiscal
year ended June 30, 1999 and the Bank is currently evaluating the effect of
this Statement.

On January 28, 1997, the Securities and Exchange Commission amended their
rules and regulations to require public companies to provide enhanced
descriptions of accounting policies for derivative financial instruments and
derivative commodity instruments in the footnotes to their financial
statements. The accounting policy requirements become effective for all
filings that include financial statements for periods ending after June 15,
1997. The Bank had no derivative financial instruments or derivative commodity
instruments at June 30, 1997 or at any time during the three year period then
ended. The Bank believes that it is in compliance with this amended rule.

(2) LOANS RECEIVABLE AND LOANS HELD FOR SALE

Loans receivable and loans held for sale at June 30 consist of the following:

1996 1997
-------- --------

Commercial loans........................................... $ 18,269 $ 39,445
-------- --------
Real Estate Mortgages:
One to four family residential........................... 93,157 103,439
Five or more family residential and commercial real
estate.................................................. 42,560 51,209
-------- --------
Total real estate mortgage............................. 135,717 154,648
-------- --------
Real Estate Construction:
One to four family residential........................... 14,509 12,683
Five or more family residential and commercial real
estate.................................................. 393 1,029
-------- --------
Total real estate construction......................... 14,902 13,712
Consumer................................................... 1,105 1,467
-------- --------
Subtotal................................................. 169,993 209,272
Unamortized yield adjustments.............................. (1,090) (1,079)
-------- --------
Total Loans Receivable and Loans Held for Sale......... $168,903 $208,193
======== ========

Loans to directors and officers amounted to $1,534 and $1,087 as of June 30,
1996 and 1997, respectively.

Accrued interest on loans receivable amounted to $1,001 and $1,198 as of June
30, 1996 and 1997, respectively. The Bank had $51 and $133 of impaired loans
which are nonaccruing as of June 30, 1996 and 1997, respectively. The weighted
average interest rate on loans was 8.6% and 8.8% as of June 30, 1996 and 1997,
respectively.

F-10

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Details of certain mortgage banking activities at June 30 are as follows:

1996 1997
------- ------

Loans held for sale at lower of cost or market............ $ 5,286 6,323
Loans serviced for others................................. 23,257 19,162
Commitments to sell mortgage loans........................ 10,170 8,134
Commitments to fund loans (at interest rates approximating
market rates)
Fixed rate.............................................. 5,533 1,902
Variable or adjustable rate............................. 877 193

Servicing fee income from loans serviced for others amounted to $114, $90, and
$75 for the years ended June 30, 1995, 1996 and 1997, respectively.

Commitments to sell mortgage loans are made primarily during the period
between the taking of the loan application and the closing of the mortgage
loan. The timing of making these sale commitments is dependent upon the timing
of the borrowers election to lock-in the mortgage interest rate and fees prior
to loan closing. Most of these sale commitments are made on a best-effort
basis whereby the Bank is only obligated to sell the mortgage if the mortgage
loan is approved and closed by the Bank.

(3) MORTGAGE BACKED SECURITIES

The amortized cost and fair values of mortgage backed securities held to
maturity at June 30 are as follows:

GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -----

1996
Federal Home Loan Mortgage
Corporation....................... $1,290 29 -- 1,319
Federal National Mortgage
Association....................... 1,784 42 (2) 1,824
Government National Mortgage
Association....................... 2,905 88 -- 2,993
------ --- --- -----
$5,979 159 (2) 6,136
====== === === =====
1997
Federal Home Loan Mortgage
Corporation....................... $1,062 47 (1) 1,108
Federal National Mortgage
Association....................... 1,371 51 (2) 1,420
Government National Mortgage
Association....................... 2,726 126 -- 2,852
------ --- --- -----
$5,159 224 (3) 5,380
====== === === =====

The amortized cost and fair values of mortgage backed securities, by
contractual maturity, at June 30, 1997 are shown below:

AMORTIZED FAIR
COST VALUE
--------- -----

Due after three years through five years................... $ 23 24
Due after five years through ten years..................... 207 209
After ten years............................................ 4,929 5,147
------ -----
Totals................................................... $5,159 5,380
====== =====

F-11

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Mortgage backed securities included net unamortized discounts of $77 and $71
as of June 30, 1996 and 1997, respectively. Accrued interest receivable on
mortgage backed securities was $50 and $43 at June 30, 1996 and 1997,
respectively.

(4) ALLOWANCE FOR LOAN LOSSES

Activity in the allowance for loan losses is summarized as follows:

Balance at June 30, 1994.............. $1,705
Recoveries............................ 15
------
Balance at June 30, 1995.............. $1,720
Recoveries............................ 153
------
Balance at June 30, 1996.............. $1,873
Provision............................. (270)
Recovery.............................. 1,152
Chargeoff............................. (3)
------
Balance at June 30, 1997.............. $2,752
======

In May 1996, the Bank sold its interest in two loans which were partially
charged off. This sale resulted in an excess of net proceeds over the book
basis of these loans of $1.3 million. The Bank recorded a recovery of $148 in
1996 which was the pro rata portion of the sale proceeds received in cash
versus the amount the Bank financed for the purchaser. The additional $1,152
was recognized as a recovery in 1997 as the Bank received additional
collateral on this financing.

(5) INVESTMENT SECURITIES

The amortized cost and fair values of investment securities held to maturity
at June 30 are as follows:

GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------

1996
U.S. Government and its agencies... $15,292 5 (127) 15,170
======= === ==== ======
1997
U.S. Government and its agencies... $ 8,506 -- (17) 8,498
======= === ==== ======

The amortized cost and fair value of investment securities, by contractual
maturity, at June 30, 1997 are shown below:

AMORTIZED FAIR
COST VALUE
--------- -----

Due in one year or less.................................... $3,817 3,820
Due after one year through three years..................... 4,689 4,678
------ -----
Totals................................................... $8,506 8,498
====== =====

There were no sales of investment securities during the years ended June 30,
1995, 1996 and 1997.

Accrued interest on investment securities amounted to $111 and $125 as of June
30, 1996 and 1997, respectively.

F-12

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

At June 30, 1996 and 1997, investment securities with amortized cost values of
$897 and $1,244, respectively, were pledged to secure public deposits and for
other purposes as required or permitted by law.

(6) PREMISES AND EQUIPMENT

A summary of premises and equipment at June 30 follows:

1996 1997
------- ------

Land........................................................ $ 2,903 3,371
Buildings and building improvements......................... 7,724 8,029
Furniture, fixtures and equipment........................... 4,478 4,983
------- ------
15,105 16,383
Less accumulated depreciation............................... 3,896 4,181
------- ------
$11,209 12,202
======= ======

The Bank holds property for investment which is recorded at the lower of cost
or fair value of $1,072 and $659 as of June 30, 1996 and 1997, respectively.

(7) DEPOSITS

Deposits at June 30 consist of the following:

WEIGHTED AVERAGE 1996 1997
INTEREST RATE AT ---------------- ----------------
JUNE 30, 1997 AMOUNT PERCENT AMOUNT PERCENT
---------------- -------- ------- -------- -------

Demand deposits.............. -- $ 7,510 3.9% $ 9,489 4.5%
NOW accounts................. 2.38% 17,978 9.4 20,641 9.8
Money market accounts........ 3.91 19,331 10.1 24,496 11.7
Savings accounts............. 3.51 29,543 15.5 28,374 13.6
Certificate accounts:
Below 3%................... -- -- 102 --
3% to 4%................... 404 0.2 366 0.2
4% to 5%................... 12,183 6.4 14,044 6.7
5% to 6%................... 71,575 37.5 103,691 49.4
6% to 7%................... 27,783 14.5 7,806 3.7
7% to 8%................... 4,777 2.5 737 0.4
8% to 10%.................. 35 -- 35 --
---- -------- ----- -------- -----
5.47 116,757 61.1 126,781 60.4
==== ======== ===== ======== =====
4.47% $191,119 100.0% $209,781 100.0%
==== ======== ===== ======== =====

The combined weighted average interest rate of deposits was 4.66% and 4.47% at
June 30, 1996 and 1997, respectively. Accrued interest payable on deposits was
$24 and $78 at June 30, 1996 and 1997, respectively.

F-13

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Interest expense, by category, for the year ended June 30 is as follows:

1995 1996 1997
------ ----- -----

NOW accounts................................................. $ 360 404 490
Money market accounts........................................ 1,522 1,489 1,603
Savings accounts............................................. 342 300 307
Certificate accounts......................................... 4,415 6,335 6,599
------ ----- -----
$6,639 8,528 8,999
====== ===== =====

Scheduled maturities of certificate accounts at June 30 are as follows:

1996 1997
-------- -------

Within one year......................................... $ 96,928 113,806
Between one and two years............................... 12,138 10,437
Between two and three years............................. 5,995 2,299
Between three and four years............................ 1,465 61
Between four and five years............................. 125 69
Over five years......................................... 106 109
-------- -------
$116,757 126,781
======== =======

As of June 30, 1996 and 1997, certificates of deposit issued in denominations
in excess of $100 totaled $9,130 and $15,481, respectively.

(8) FHLB ADVANCES AND STOCK

The Bank is required to maintain an investment in the stock of the Federal
Home Loan Bank of Seattle in an amount equal to at least 1% of the unpaid
principal balances of the Bank's residential mortgage loans or 5% of its
outstanding advances from the FHLB, whichever is greater. Purchases and sales
of stock are made directly with the FHLB at par value.

A summary of FHLB Advances follows:

AT OR FOR THE YEAR ENDED
JUNE 30
-------------------------
1995 1996 1997
-------- ---------------

Balance at June 30........ $ -- $ -- $ 890
Average balance........... 658 -- 27
Maximum amount outstanding
at any month end......... 3,875 -- 1,300
Average interest rate:
During the year......... 6.24% -- 5.41%
At June 30.............. -- -- 6.45%

The $890 outstanding balance of FHLB Advances at June 30, 1997 matured on July
1, 1997.

Advances from the FHLB are collateralized by a blanket pledge on FHLB stock
owned by the Bank, deposits at the FHLB and all mortgages or deeds of trust
securing such properties. In accordance with the pledge agreement, the Bank
must maintain unencumbered collateral in an amount equal to varying
percentages ranging from 100% to 125% of outstanding advances depending on the
type of collateral.

The Bank may borrow from the FHLB in amounts up to 20% of the Bank's total
assets.

F-14

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(9) OTHER BORROWED FUNDS

In August 1986, the Bank issued $21.9 million in collateralized mortgage
obligations. The bonds have been repaid in quarterly installments, including
interest, from principal and interest payments received on the underlying
collateral (Federal National Mortgage Association and Federal Home Loan
Mortgage Corporation mortgage backed securities). Under the terms of the bond
indenture, the Bank may call the bonds when their outstanding balance is equal
to or less than 10% of the original issue amount which amounts to $2.2
million. On August 1, 1995, the Bank called and repaid the then outstanding
balance of the remaining bonds.

(10) FEDERAL INCOME TAXES

Federal income tax expense (benefit) at June 30 consists of the following:

1995 1996 1997
------ ----- ----

Current............................................... $1,267 1,173 304
Deferred.............................................. 41 262 (549)
------ ----- ----
$1,308 1,435 (245)
====== ===== ====

Federal income tax expense differs from that computed by applying the Federal
statutory income tax rate of 34% for the year ended June 30 as follows:

1995 1996 1997
------ ----- ----

Income tax expense at Federal statutory rate........ $1,306 1,431 688
Reversal of provision for base year bad debt
reserve............................................ -- -- (938)
Other, net.......................................... 2 4 5
------ ----- ----
$1,308 1,435 (245)
====== ===== ====

The Bank has been permitted under the Internal Revenue Code to deduct an
annual addition to a reserve for bad debts in determining taxable income,
subject to certain limitations. The deduction was based on either specified
experience formulas or a percentage of taxable income before such deduction.
The Bank used the percentage of taxable income method for the years ended June
30, 1995 and 1996. This deduction was historically greater than the loan loss
provisions recorded for financial accounting purposes. Deferred income taxes
are provided on differences between the bad debt reserve for tax and financial
reporting purposes only to the extent of the tax reserves arising subsequent
to June 30, 1988. Savings institutions were not required to provide a deferred
tax liability for the tax bad debt reserves accumulated as of June 30, 1988
which for the Bank amounted to $938. Starting in the fiscal year ended June
30, 1994, the Bank established and maintained a deferred income tax liability
of $938 due to the potential recapture of the pre-1988 tax bad debt reserve
which could have been triggered by the formation of the mutual holding
company; a change to a commercial bank charter (which management had been
contemplating); or possible legislation which was being debated in Congress.

Legislation enacted in August 1996 eliminated certain conditions under which
recapture of the pre-1988 additions to the tax bad debt reserve would be
required. Such conditions are principally conversion to a commercial bank
charter or merger with a commercial bank. The pre-1988 reserves would be
required to be recaptured under certain other conditions such as payment of
dividends in excess of accumulated earnings and profits or other distributions
made in connection with the dissolution or liquidation of the Bank. Based on
this legislation, the Bank reversed the $938 deferred tax liability as a
reduction of Federal income tax expense during the year ended June 30, 1997.

F-15

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The following table presents major components of the deferred Federal income
tax liability resulting from differences between financial reporting and tax
bases at June 30:

1996 1997
------ -----

Deferred tax liabilities:
Provision for base year tax bad debt reserve.............. $ 938 --
Deferred loan fees........................................ 241 412
Premises and equipment.................................... 236 358
FHLB stock................................................ 287 324
Other..................................................... 37 11
------ -----
Total deferred tax liabilities.......................... 1,739 1,105
====== =====
Deferred tax assets:
Loan loss allowances...................................... (407) (292)
Vacation benefits......................................... (60) (64)
Other..................................................... (22) (48)
------ -----
Total deferred tax assets............................... (489) (404)
------ -----
Deferred taxes payable, net............................. $1,250 701
====== =====

(11) CONTINGENCIES

The Bank is involved in numerous business transactions which, in some cases,
depend on regulatory determination as to compliance with rules and
regulations. Also, the Bank has certain litigation and negotiations in
progress. All such matters are attributable to activities arising from normal
operations. In the opinion of management, after review with legal counsel, the
eventual outcome of the aforementioned matters is unlikely to have a
materially adverse effect on the Bank's consolidated financial statements or
its financial position.

(12) STOCKHOLDERS' EQUITY

(a) Stock Offering and Reorganization

On July 1, 1997, the Board of Directors of Heritage Financial Corporation,
MHC, approved a Plan of Conversion and Reorganization whose purpose is to
convert the current Mutual Holding Company to the stock form of organization.
The Mutual Holding Company currently owns a majority of the common stock of
Heritage Savings Bank. The Holding Company will offer its common stock upon
the terms and conditions set forth in the Plan of Conversion. As a part of the
Conversion, each minority stockholder of the Bank will receive common stock of
the Holding Company in exchange for their shares of common stock of the Bank.

Conversion costs will be deferred and reduce the proceeds from the shares sold
in the conversion. If the conversion is not completed, all costs will be
charged as an expense. As of June 30, 1997, no significant conversion costs
have been incurred.

F-16

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(b) Earnings Per Common Share

Earnings per common share is computed based on the weighted average number of
shares of common stock outstanding during the year which amounted to 1,805,166
and 1,807,910 shares for the years ended June 30, 1996 and 1997, respectively.
Common stock equivalents have not been considered because they do not have a
dilutive impact.

The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. 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.

Pursuant to minimum capital requirements of the Federal Deposit Insurance
Corporation, the Bank is required to maintain a leverage ratio (capital to
assets ratio) of 3% and risk-based capital ratios of Tier 1 capital and total
capital (to total risk-weighted assets) of 4% and 8%, respectively. At June
30, 1997, the Bank exceeded the minimum capital requirements and the
requirements for well capitalized institutions as shown below. As of June 30,
1996 and 1997, the Bank was classified as a "well capitalized" institution
under the criteria established by the FDIC Act.

WELL-
MINIMUM CAPITALIZED
REQUIREMENTS REQUIREMENTS ACTUAL
-----------------------------------------
$ % $ % $ %
------- -------------- ------------- ----

AS OF JUNE 30, 1996:
Leverage ratio...................... $ 6,652 3% $ 11,087 5% $25,633 11.6%
Risk-based capital:
Tier 1............................ 5,799 4% 8,699 6% 25,633 17.7%
Total............................. 11,598 8% 14,498 10% 27,446 18.9%
AS OF JUNE 30, 1997:
Leverage ratio...................... 7,118 3% 11,864 5% 27,714 11.7%
Risk-based capital:
Tier 1............................ 7,085 4% 10,628 6% 27,714 15.6%
Total............................. 14,171 8% 17,714 10% 29,935 16.9%

On September 30, 1996, legislation was signed into law to recapitalize the
Savings Association Insurance Fund (SAIF). The effect of this legislation was
to require a one-time assessment on all federally insured savings
institutions' deposits under SAIF at .657% of insured deposits at March 31,
1995. The Bank's assessment was approximately $1.1 million which was charged
to earnings in the quarter ended September 30, 1996 and paid in November 1996.

(d) Cash Dividend

At the Board of Directors meeting on August 28, 1996, a cash dividend of $.375
per share on the Bank's issued and outstanding common stock was declared. The
dividend was paid in October 1996 to shareholders of record as of September
30, 1996 and was paid only to shareholders other than HFC. The dividend waiver
on the 1,200,000 shares owned by HFC was approved by regulatory agencies. The
Bank's ability to pay dividends is predicated upon its earning capability and
is subject to legal and regulatory restrictions.

F-17

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(13) STOCK OPTION PLANS

In September 1994, the Bank's stockholders approved the adoption of the 1994
stock option plan, providing for the award of a restricted stock award to a
key officer, incentive stock options to employees and nonqualified stock
options to directors of the Bank at the discretion of the Board of Directors.
On September 24, 1996, the stockholders of the Bank approved the adoption of
the 1997 stock option plan which is generally similar to the 1994 plan. The
1997 plan does not affect any options granted under the 1994 plan.

Under both of these stock option plans, on the date of grant, the exercise
price of the option must at least equal the market value per share of the
Bank's common stock. The 1994 plan provides for the grant of options and stock
awards up to 67,000 shares. The 1997 plan provides for the granting of options
for up to 50,000 common shares.

Stock options are generally exercisable ratably over three years and expire
five years after they become exercisable which amounts to an average term of
seven years.

The following table summarizes activity on stock options for the years ended
June 30, 1996 and 1997:

OUTSTANDING OPTIONS EXERCISABLE OPTIONS
-------------------------- -------------------------
SHARES UNDER OPTION SHARES AVG. OPTION PRICE SHARES AVG. OPTION PRICE
- ------------------- ------- ----------------- ------ -----------------

Balance at July 1,
1994................... 50,000 $ 10.20
Options granted......... -- --
Became exercisable...... -- -- 15,000 $ 10.22
Less: Exercised -- --
Expired or
canceled............ (5,000) 10.00
------- ------- ------ -------
Balance at June 30,
1995................... 45,000 $ 10.22 15,000 $ 10.22
======= ======= ====== =======
Options granted......... 7,000 16.00
Became exercisable...... 15,000 10.22
Less: Exercised......... (666) 10.00 (666) 10.00
Expired or
canceled............ -- -- -- --
------- ------- ------ -------
Balance at June 30,
1996................... 51,334 $ 11.01 29,334 $ 10.23
======= ======= ====== =======
Options granted......... 59,998 18.45 -- --
Became exercisable...... -- -- 17,333 11.00
Less: Exercised......... (3,950) 10.00 (3,950) 10.00
Expired or
canceled............ -- -- -- --
------- ------- ------ -------
Balance at June 30,
1997................... 107,382 $ 15.21 42,717 $ 10.56
======= ======= ====== =======

A restricted stock award of 5,000 shares has been awarded to the chairman and
requires five years of continuous employment from the date of award. These
5,000 shares were issued to the Chairman during the year ended June 30, 1995
and recorded as compensation expense using the fair value of the shares on the
date of award.

F-18

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Financial data pertaining to outstanding stock options at June 30, 1997 were
as follows:

WEIGHTED AVERAGE
NUMBER OF REMAINING CONTRACTUAL
EXERCISE PRICE OPTION SHARES LIFE (IN YEARS)
-------------- ------------- ---------------------

$10.00 35,384 3.6
$12.00 5,000 4.0
$16.00 7,000 6.0
$18.45 59,998 6.6
------- ---
107,382 5.4
======= ===

During 1995, the FASB issued the SFAS No. 123, Accounting for Stock-based
Compensation, effective for years beginning after December 15, 1995. The
statement requires expanded disclosures of stock-based compensation
arrangements with employees and encourages (but does not require) application
of the fair value recognition provision in the statement. Under the fair value
recognition method, compensation cost is measured at the grant date of the
option, based on the value of the award and is recognized over the vesting
period. Under existing rules ("intrinsic value based method"), compensation
cost is the excess, if any, of the market value of the stock at grant date
over the amount an employee must pay to acquire the stock. None of the Bank
stock options have any intrinsic value at grant date and, under Accounting
Principles Board Opinion No. 25 (APB No. 25), no compensation cost has been
recognized for them. SFAS No. 123 does not alter the existing accounting rules
for employee stock-based programs. Companies may continue to follow rules
outlined in APB No. 25, but they will now be required to disclose the pro
forma amounts of net income and earnings per share that would have been
reported had they elected to follow the fair value recognition provision of
SFAS No. 123. Effective July 1, 1996, the Bank adopted the disclosure
requirements of SFAS No. 123, but has determined that it will continue to
measure its employee stock-based compensation arrangements under the
provisions of APB Opinion 25. Accordingly, no compensation cost has been
recognized for its stock option plans. Had compensation cost for the Bank's
stock option plans been determined consistent with SFAS 123, the Bank's net
income and earnings per share would have been reduced to the pro forma amounts
indicated below:

YEAR ENDED JUNE 30,
-----------------------
1995 1996 1997
------- ------- -------
(DOLLARS IN THOUSANDS)

Net income:
As reported...................................... $ 2,534 $ 2,773 $ 2,269
Pro forma........................................ 2,534 2,772 2,239
Earnings per share:
As reported...................................... $ 1.41 $ 1.54 $ 1.26
Pro forma........................................ 1.41 1.54 1.24

No options were granted during 1995; therefore, there is no pro forma impact
on net income for the year ended June 30, 1995.

The compensation expense included in the pro forma net income attributable to
fully diluted common stock and fully diluted earnings per share is not likely
to be representative of the effect on reported net income for future years
because options vest over several years and additional awards generally are
made each year.

The fair value of options granted is estimated on the date of grant using the
minimum value method with the following weighted average assumptions used for
grants in 1996 and 1997: annual dividend yield of 3% for both years; risk-free
interest rates of 6.50% for both years; and expected lives of seven years for
both years. The weighted average grant date fair value per share of options
granted during the years ended June 30, 1996 and 1997 was $3.09 and $3.19,
respectively.

F-19

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(14) EMPLOYEE BENEFIT PLANS

The Bank maintains a defined contribution retirement plan. The plan allows
participation to all employees upon completion of one year of service and the
attainment of 21 years of age. It is the Bank's policy to fund plan costs as
accrued. Employee vesting occurs over a period of seven years, at which time
they become fully vested. Charges of approximately $172, $192 and $246 are
included in the consolidated statements of income for the years ended June 30,
1995, 1996 and 1997, respectively.

The Bank also maintains a salary savings 401(k) plan for its employees. All
persons employed as of July 1, 1984 automatically participate in the plan. All
employees hired after that date who are at least 21 years of age and with one
year of service to the Bank may participate in the plan. Employees who
participate may contribute a portion of their salary which is matched by the
employer at 50% up to certain specified limits. Employee vesting in employer
portions is similar to the retirement plan described above. Employer
contributions for the years ended June 30, 1995, 1996 and 1997 were $84, $82
and $87, respectively.

The Bank has established an Employee Stock Ownership Plan (ESOP) effective
July 1, 1993, which allows participation to all employees upon completion of
one year of service and the attainment of 21 years of age. The ESOP is funded
by employer contributions in cash or common stock. Employee vesting occurs
over a period of seven years. The Bank contributed $0 and $44 to the ESOP for
the years ended June 30, 1995 and 1996. The Bank has accrued $75 for its ESOP
contribution for the year ended June 30, 1997.

(15) FAIR VALUE OF FINANCIAL INSTRUMENTS

Because broadly traded markets do not exist for most of the Bank's financial
instruments, the fair value calculations attempt to incorporate the effect of
current market conditions at a specific time. Fair valuations are management's
estimates of values. These calculations are subjective in nature, involve
uncertainties and matters of significant judgment and do not include tax
ramifications; therefore, the results cannot be determined with precision,
substantiated by comparison to independent markets and may not be realized in
an actual sale or immediate settlement of the instruments. There may be
inherent weaknesses in any calculation technique, and changes in the
underlying assumptions used, including discount rates and estimates of future
cash flows, could significantly affect the results. For all of these reasons,
the aggregation of the fair value calculations presented herein do not
represent, and should not be construed to represent, the underlying value of
the Bank.

When possible, quoted market prices are used to determine fair value. In cases
where a quoted market price is not available, the fair value of financial
instruments is estimated using the present value of future cash flows or other
valuation methods.

(a) Financial Instruments With Book Value Equal to Fair Value

The fair value of financial instruments that are short-term or reprice
frequently and that have little or no risk are considered to have a fair value
equal to book value. Assets that are included in this category include cash
and due from banks and interest-bearing deposits. Liabilities included in this
category include deposits with no contractual maturity such as demand
accounts, checking accounts, money market accounts, passbook savings accounts
and FHLB advances which reprice daily.

(b) Investment Securities

The fair value of all investment securities excluding Federal Home Loan Bank
(FHLB) stock was based upon quoted market prices. FHLB stock is not publicly
traded, however it may be redeemed on a dollar-for-dollar basis, for any
amount the Bank is not required to hold. The fair value is therefore equal to
the book value.

F-20

HERITAGE SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The loan portfolio is composed of single family and income property mortgages
(both fixed rate and adjustable rate), construction, business and consumer
loans. For most loans, fair value is estimated using market prices for
mortgage backed securities with similar rates and average maturities adjusted
for servicing costs or calculated by discounting expected cash flows over the
estimated life of the loans using a current market rate reflecting the risk
associated with comparable loans. Construction loans which are variable rate
and short-term are reflected with fair values equal to book value.

(d) Deposits

Deposits are comprised of passbook, commercial and basic checking, money
market and fixed maturity accounts. For deposits with no contractual maturity
such as demand accounts, checking accounts, money market accounts and passbook
savings accounts, SFAS 107 stipulates that the fair value is equal to the book
value. The fair value of fixed maturity deposits is based on discounted cash
flows using the difference between the deposit rate and an alternative cost of
funds rate.

(e) Off-Balance Sheet Financial Instruments

The fair value of off-balance sheet commitments to extend credit is considered
equal to its notional amount.

The table below presents the book value amount of the Bank's financial
instruments and their corresponding fair values at June 30:

1996 1997
--------------------- ---------------------
BOOK VALUE FAIR VALUE BOOK VALUE FAIR VALUE
---------- ---------- ---------- ----------

FINANCIAL ASSETS
Cash on hand and in banks.......... $ 6,308 6,308 7,412 7,412
Interest bearing deposits.......... 11,774 11,774 175 175
Investment securities.............. 15,292 15,170 8,506 8,498
FHLB stock......................... 1,400 1,400 1,511 1,511
Mortgage backed securities......... 5,979 6,136 5,159 5,380
Loans.............................. 167,030 167,237 205,441 207,094
FINANCIAL LIABILITIES
Savings, money market and demand... 74,362 74,362 83,000 83,000
Time certificates.................. 116,757 116,460 126,781 126,568
-------- ------- ------- -------
Total deposits..................... $191,119 190,822 209,781 209,568
-------- ------- ------- -------
FHLB advances...................... $ -- -- 890 890

F-21

===============================================================================

NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PRO-
SPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER
TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEI-
THER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.

----------------

TABLE OF CONTENTS

PAGE
----

Summary.................................................................. 1
Selected Consolidated Financial and Other Data........................... 10
Risk Factors............................................................. 1114
Use of Proceeds.......................................................... 1720
Dividend Policy.......................................................... 1821
Market for Common Stock.................................................. 1922
Capitalization........................................................... 2023
Historical and Pro Forma Regulatory Capital Compliance................... 2124
Conversion Stock to be Purchased by Management Pursuant to Subscription
Rights.................................................................. 2225
Pro Forma Data........................................................... 2326
Heritage Savings Bank and Subsidiaries Consolidated Statements of
Income.................................................................. 2629
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 2730
Business of the Company.................................................. 3538
Business of the Bank..................................................... 3639
Management............................................................... 5154
Certain Transactions..................................................... 6063
Supervision and Regulation............................................... 6064
The Conversion........................................................... 6468
Restrictions on Acquisition of the Company and the Bank.................. 7984
Description of Capital Stock of the Company.............................. 8387
Comparison of Stockholders' Rights....................................... 8488
Registration Requirements................................................ 8791
Legal and Tax Opinions................................................... 8791
Experts.................................................................. 8791
Additional Information................................................... 8892
Index to Consolidated Financial Statements............................... F-1

===============================================================================

6,098,9988,477,075 SHARES

[LOGO]

HERITAGE FINANCIAL CORPORATION

COMMON STOCK

----------------

PROSPECTUS

----------------

RYAN, BECK & CO.LOGO

, 1997

===============================================================================

PART II

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the various expenses in connection with the
sale and distribution of the securities being registered, other than
underwriting discounts and commissions. All of the amounts shown are estimated
except the Securities and Exchange Commission registration fee.

Commission registration fee.................................... $ 21,254
NASD Filing fee................................................ 5,000
Legal.......................................................... 125,000
Accounting Fees and Expenses................................... 75,000
Appraisal and Business Plan Fees and Expenses.................. 35,000
Conversion Agent Fees and Expenses............................. 11,500
Marketing Agent Fixed Fee...................................... 50,000
Marketing Agent Counsel Fees and Expenses...................... 40,000
Printing, Postage and Mailing.................................. 80,000
Transfer Agent and Registrar Fees, Expenses.................... 7,500
Miscellaneous Expenses......................................... 9,746
--------
Total........................................................ $460,000
========

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

The Company's Articles of Incorporation provide, among other things, for the
indemnification of directors, and authorize the Board to pay reasonable
expenses incurred by, or to satisfy a judgment or fine against, a current or
former director in connection with any personal legal liability incurred by
the individual while acting for the Company within the scope of his or her
employment, and which was not the result of conduct finally adjudged to be
"egregious" conduct. "Egregious" conduct is defined as intentional misconduct,
a knowing violation of law, or participation in any transaction from which the
person will personally receive a benefit in money, property, or services to
which that person is not legally entitled. The Articles of Incorporation also
include a provision that limits the liability of directors of the Company from
any personal liability to the Company or its shareholders for conduct not
found to have been egregious.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

Not applicable

II-1

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

The financial statements and exhibits filed as part of this Registration
Statement are as follows:

(a) List of Exhibits

1.1 Form of proposed Agency Agreement among Heritage Financial
Corporation, Heritage Bank and Ryan Beck & Co., Inc.*
1.2 Engagement Letter by and between Heritage Financial Corporation,
Heritage Bank and Ryan Beck & Co., Inc.*
2 Amended and Restated Plan of Conversion and Reorganization of
Heritage Financial Corporation, M.H.C.*
3.1 Articles of Incorporation of the Registrant. (Filed as an exhibit to
the Registration Statement on Form S-1 (Registration No. 333-35573)
and incorporated herein by reference.)
3.2 Bylaws of the Registrant. (Filed as an exhibit to the Registration
Statement on Form S-1 (Registration No. 333-35573) and incorporated
herein by reference.)
4. Form of Certificate for Common Stock.*
5 Opinion of Gordon, Thomas, Honeywell, Malanca, Peterson & Daheim,
P.L.L.C. regarding legality of the Common Stock. (Filed as an
exhibit to the Registration Statement on Form S-1 (Registration No.
333-35573) and incorporated herein by reference.)
8.1 Federal Tax Opinion of KPMG Peat Marwick LLP.*
8.2 State Tax Opinion of Gordon, Thomas, Honeywell, Malanca, Peterson &
Daheim, P.L.L.C.*
8.3 Letter from RP Financial, LC. as to the value of subscription
rights. (Filed as an exhibit to the Registration Statement on Form
S-1 (Registration No. 333-35573) and incorporated herein by
reference.)
10.1 Proposed Form of Stock Option Plan. (Filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-35573) and
incorporated herein by reference.)
10.2 Proposed form of Management Recognition Plan and Trust Agreement.
(Filed as an exhibit to the Registration Statement on Form S-1
(Registration No. 333-35573) and incorporated herein by reference.)
10.3 Employment Agreement between the Registrant and Donald V. Rhodes
effective as of October 1, 1997.*
10.4 Severance Agreement between the Registrant and Brian Vance effective
as of October 1, 1997.*
10.5 Severance Agreement between the Registrant and John Parry effective
as of October 1, 1997.*
10.6 Form of Severance Agreement to be entered into between the
Registrant and seven additional executives effective as of October
1, 1997.*
23.1 Consent of KPMG Peat Marwick LLP. (Filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-35573) and
incorporated herein by reference.)
23.2 Consent of Gordon, Thomas, Honeywell, Malanca, Peterson & Daheim,
P.L.L.C. (included in opinion filed as Exhibit 5 to this
Registration Statement).
23.3 Consent of RP Financial, LC. (Filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-35573) and
incorporated herein by reference.)
24 Power of Attorney. (Filed as an exhibit to the Registration
Statement on Form S-1 (Registration No. 333-35573) and incorporated
herein by reference.)
27 Financial Data Schedule. (Filed as an exhibit to the Registration
Statement on Form S-1 (Registration No. 333-35573) and incorporated
herein by reference.)
99.1 Order and Acknowledgment Form.*
99.2 Solicitation and Marketing Materials.*
99.399.3(a) Appraisal Report of RP Financial, LC. (Filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-35573) and
incorporated herein by reference.)
99.3(b) Updated Appraisal Report of RP Financial, LC.*

- --------

* To be filed by amendment.Filed herewith

II-2

(b) Financial Statement Schedules.

Not applicable.

ITEM 17. UNDERTAKINGS

The undersigned Registrant hereby undertakes:

(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement;

(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933, as amended ("Securities Act");

(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post-
effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement;

II-2

(iii) To include any material information with respect to the plan of
distribution of previously disclosed in the registration statement or any
material change to such information in the registration statement.

(2) That, for the purpose of determining any liability under the Securities
Act, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be the initial bona fide
offering thereof.

(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of
the offering.

Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.

II-3

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE COMPANY HAS
DULY CAUSED THIS AMENDMENT NO. 1 TO THE REGISTRATION STATEMENT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF
OLYMPIA, STATE OF WASHINGTON, ON SEPTEMBER 12,OCTOBER 24, 1997.

HERITAGE FINANCIAL CORPORATION

/s/ Donald V. Rhodes
By: _________________________________
DONALD V. RHODES CHAIRMAN,
PRESIDENT AND CHIEF EXECUTIVE
OFFICER

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NO. 1 TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS
ON SEPTEMBER 12,OCTOBER 24, 1997 IN THE CAPACITIES INDICATED.

SIGNATURE TITLE
--------- -----

PRINCIPAL EXECUTIVE OFFICER:

/s/ Donald V. Rhodes Chairman, President and Chief
- ------------------------------------- Executive Officer
DONALD V. RHODES

PRINCIPAL FINANCIAL OFFICER AND
PRINCIPAL ACCOUNTING OFFICER:

/s/ James Hastings Senior Vice President and Treasurer
- -------------------------------------
JAMES HASTINGS

A MAJORITY OF THE BOARD OF
DIRECTORS:

/s/ Lynn M. Brunton
_____________________________________
LYNN M. BRUNTON

/s/ John A. Clees
_____________________________________
JOHN A. CLEES

/s/ Daryl D. Jensen
_____________________________________
DARYL D. JENSEN

II-4

SIGNATURE
---------

/s/ H. Edward Odegard*
_____________________________________
H. EDWARD ODEGARD

/s/ James P. Senna*
_____________________________________
JAMES P. SENNA

/s/ Philip S. Weigand*
_____________________________________
PHILIP S. WEIGAND

*By: /s/ Donald V. Rhodes
_____________________________________
DONALD V. RHODES
ATTORNEY-IN-FACT

II-5

EXHIBIT INDEX

EXHIBIT
NUMBER PAGE NO.
------- --------

1.1 Form of proposed Agency Agreement among Heritage Financial
Corporation, Heritage Bank and Ryan Beck & Co., Inc.*
1.2 Engagement Letter by and between Heritage Financial
Corporation, Heritage Bank and Ryan Beck & Co., Inc.*
2 Amended and Restated Plan of Conversion and Reorganization
of Heritage Financial Corporation, M.H.C.*
3.1 Articles of Incorporation of the Registrant. (Filed as an
exhibit to the Registration Statement on Form S-1
(Registration No. 333-35573) and incorporated herein by
reference.)
3.2 Bylaws of the Registrant. (Filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-
35573) and incorporated herein by reference.)
4. Form of Certificate for Common Stock.*
5 Opinion of Gordon, Thomas, Honeywell, Malanca, Peterson &
Daheim, P.L.L.C. regarding legality of the Common Stock.
(Filed as an exhibit to the Registration Statement on Form
S-1 (Registration No. 333-35573) and incorporated herein
by reference.)
8.1 Federal Tax Opinion of KPMG Peat Marwick LLP.*
8.2 State Tax Opinion of Gordon, Thomas, Honeywell, Malanca,
Peterson & Daheim, P.L.L.C.*
8.3 Letter from RP Financial, LC. as to the value of
subscription rights. (Filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-
35573) and incorporated herein by reference.)
10.1 Proposed Form of Stock Option Plan. (Filed as an exhibit to
the Registration Statement on Form S-1 (Registration No.
333-35573) and incorporated herein by reference.)
10.2 Proposed form of Management Recognition Plan and Trust
Agreement. (Filed as an exhibit to the Registration
Statement on Form S-1 (Registration No. 333-35573) and
incorporated herein by reference.)
10.3 Employment Agreement between the Registrant and Donald V.
Rhodes effective as of October 1, 1997.*
10.4 Severance Agreement between the Registrant and Brian Vance
effective as of October 1, 1997.*
10.5 Severance Agreement between the Registrant and John Parry
effective as of October 1, 1997.*
10.6 Form of Severance Agreement between the Registrant and
seven additional executives, effective October 1, 1997.*
23.1 Consent of KPMG Peat Marwick LLP. (Filed as an exhibit to
the Registration Statement on Form S-1 (Registration No.
333-35573) and incorporated herein by reference.)
23.2 Consent of Gordon, Thomas, Honeywell, Malanca, Peterson &
Daheim, P.L.L.C. (included in opinion filed as Exhibit 5
to this Registration Statement).
23.3 Consent of RP Financial, LC. (Filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-
35573) and incorporated herein by reference.)
24 Power of Attorney. (Filed as an exhibit to the Registration
Statement on Form S-1 (Registration No. 333-35573) and
incorporated herein by reference.)
27 Financial Data Schedule. (Filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 333-
35573) and incorporated herein by reference.)
99.1 Order and Acknowledgment Form.*
99.2 Solicitation and Marketing Materials.*
99.399.3(a) Appraisal Report of RP Financial, LC. (Filed as an exhibit
to the Registration Statement on Form S-1 (Registration
No. 333-35573) and incorporated herein by reference.)
99.3(b) Updated Appraisal Report of RP Financial, LC.*

- --------

* To be filed by amendment.Filed herewith