First Mutual Bancshares 10Q 2005 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the quarterly period ended June 30, 2005

Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the transition period from __________ to ___________

Commission File Number 005-57091

FIRST MUTUAL BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

WASHINGTON	91-2005970
(State or other jurisdiction of incorporation	(I.R.S. Employer
or organization)	Identification Number)

400 108th Avenue N.E., Bellevue, WA	98004
(Address of principal executive offices)	(Zip code)

Registrant's telephone number, including area code: (425) 453-5301

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes x No o

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. August 4, 2005 5,346,003

FIRST MUTUAL BANCSHARES, INC.

QUARTERLY REPORT ON FORM 10-Q

June 30, 2005

TABLE OF CONTENTS

		Page

PART I:	FINANCIAL INFORMATION	1
	Forward-Looking Statements Disclaimer	1
ITEM 1.	Financial Statements	2
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and
	Results of Operations	15
	General	15
	Overview	15
	Results of Operations	15
	Net Income	15
	Net Interest Income	15
	Noninterest Income	19
	Noninterest Expense	22
	Review of Financial Condition	25
	Asset Quality	28
	Portfolio Information	29
	Commercial Real Estate Loans	29
	Sales Finance (Home Improvement) Loans	29
	Residential Lending	31
	Portfolio Distribution	32
	Deposit Information	32
	Business Segments	32
	Consumer Lending	33
	Residential Lending	36
	Business Banking Lending	37
	Income Property Lending	38
	Liquidity	39
	Planned Expenditures for Plant and Equipment	42
	Capital	42
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	43
ITEM 4.	Controls and Procedures	50
PART II:	OTHER INFORMATION	50
ITEM 1.	Legal Proceedings	50
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	50
ITEM 3.	Defaults Upon Senior Securities	50
ITEM 4.	Submission of Matters to a Vote of Security Holders	50
ITEM 5.	Other Information	52
ITEM 6.	Exhibits	52
SIGNATURES		53
CERTIFICATIONS

PART I : FINANCIAL INFORMATION

FORWARD-LOOKING STATEMENTS DISCLAIMER

Our Form 10-Q contains statements concerning future operations, trends, expectations, plans, capabilities, and prospects of First Mutual Bancshares, Inc. and First Mutual Bank (together, the “Bank”) that are forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include statements regarding our goals and expectations regarding earnings growth and return on equity; as well as references to potential changes in interest income and interest rate margins, anticipated growth in loan production and modifications of our program to sell loans, trends in income and expenses and expenditures on our headquarters remodel, expectations regarding our Business Banking segment, observations pertaining to the potential disparate movement and repricing of assets and liabilities, and information based on our market risk models, simulations and analysis. Although we believe that the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bounds of our knowledge of our business, operations, and prospects, these forward-looking statements are subject to numerous uncertainties and risks, and actual events, results, and developments will ultimately differ from the expectations and may differ materially from those expressed or implied in such forward-looking statements. Factors which could affect actual results include economic conditions in our market area and the nation as a whole, interest rate fluctuations, the impact of competitive products, services, and pricing, our credit risk management, our ability to control our costs and expenses, loan delinquency rates, and the legislative and regulatory changes affecting the banking industry. There are other risks and uncertainties that could affect us which are discussed from time to time in our filings with the Securities and Exchange Commission. These risks and uncertainties should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. We are not responsible for updating any such forward-looking statements.

ITEM 1. Financial Statements

In the opinion of management, the accompanying consolidated statements of financial condition and related interim consolidated statements of income, comprehensive income, stockholders’ equity and cash flows reflect all adjustments (which include reclassifications and normal recurring adjustments) that are necessary for a fair presentation in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the financial statements.

Certain reclassifications have been made to the 2004 financial statements to conform to the 2005 presentation. All significant inter-company transactions and balances have been eliminated.

The information included in this Form 10-Q should be read in conjunction with the First Mutual Bancshares, Inc. Year 2004 Annual Report on Form 10-K to the Securities and Exchange Commission. Interim results are not necessarily indicative of results for a full year.

Consolidated Financial Statements of the Company begin on page 2.

Item 1. Financial Statements

FIRST MUTUAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION


	June 30,			December 31,
	2005			2004
ASSETS:	(Unaudited)

CASH AND CASH EQUIVALENTS:
Interest-earning deposits	$	1,817,226		$	309,125
Noninterest-earning demand deposits
and cash on hand		15,905,252			13,536,316

		17,722,478			13,845,441

MORTGAGE-BACKED AND OTHER SECURITIES
AVAILABLE-FOR-SALE		121,429,527			124,224,683

LOANS RECEIVABLE, HELD-FOR-SALE		13,408,051			10,064,155

MORTGAGE-BACKED AND OTHER SECURITIES HELD-TO-MATURITY
fair value of $7,754,447 and $7,826,994		7,663,048			7,719,542

LOANS RECEIVABLE		841,581,851			808,642,531
RESERVE FOR LOAN LOSSES		(9,708,806	)		(9,300,854	)

LOANS RECEIVABLE, net		831,873,045			799,341,677

ACCRUED INTEREST RECEIVABLE		4,811,218			4,300,131

LAND, BUILDINGS AND EQUIPMENT, net		31,127,877			27,994,532

FEDERAL HOME LOAN BANK (FHLB) STOCK,		13,122,300			12,918,700
at cost

SERVICING ASSETS		2,081,571			1,525,085

OTHER ASSETS		2,230,847			1,849,401

TOTAL	$	1,045,469,962		$	1,003,783,347

FIRST MUTUAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Continued)


	June 30,			December 31,
	2005			2004
	(Unaudited)
LIABILITIES:
Deposits:
Money market deposit and
checking accounts	$	253,054,408		$	254,435,583
Savings		7,914,360			8,434,423
Time deposits		458,718,154			412,498,902

Total deposits		719,686,922			675,368,908

Drafts payable		541,115			377,814
Accounts payable and other liabilities		12,015,248			14,106,402
Advance payments by borrowers for
taxes and insurance		1,899,938			1,676,175
FHLB advances		228,118,672			234,206,775
Other advances		1,600,000			1,600,000
Long-term debentures payable		17,000,000			17,000,000

Total liabilities		980,861,895			944,336,074

STOCKHOLDERS’ EQUITY:
Common stock, $1 par value-
Authorized, 30,000,000 shares
Issued and outstanding, 5,342,191
and 5,288,489 shares, respectively	$	5,342,191		$	5,288,489
Additional paid-in capital		46,320,662			45,595,319
Retained earnings		13,363,994			9,220,450
Accumulated other comprehensive income(loss):
Unrealized (loss) on securities available-for-sale
and interest rate swap, net of federal income tax		(418,780	)		(656,985	)

Total stockholders’ equity		64,608,067			59,447,273

TOTAL	$	1,045,469,962		$	1,003,783,347

FIRST MUTUAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME


	Quarter ended June 30,				Six months ended June 30,
	2005		2004		2005		2004

	(Unaudited)
INTEREST INCOME:
Loans Receivable	$	14,823,403	$	12,322,025	$	28,755,603	$	24,202,951
Interest on Available For Sale Securities		1,266,563		885,339		2,537,644		1,662,287
Interest on Held To Maturity Securities		102,513		107,718		196,659		216,359
Interest Other		93,968		146,942		195,737		284,067

		16,286,447		13,462,024		31,685,643		26,365,664

INTEREST EXPENSE:
Deposits		4,253,965		2,977,822		7,825,379		5,858,845
FHLB advances and other		2,205,743		1,627,415		4,233,279		3,159,967

		6,459,708		4,605,237		12,058,658		9,018,812

Net interest income		9,826,739		8,856,787		19,626,985		17,346,852

PROVISION FOR LOAN LOSSES		450,000		440,000		850,000		690,000

Net interest income, after provision
for loan losses		9,376,739		8,416,787		18,776,985		16,656,852

NONINTEREST INCOME:
Gain on sales of loans		419,956		321,884		944,493		667,263
Servicing fees, net of amortization		369,259		80,767		695,553		113,641
Gain on sales of investments		—		—		—		70,870
Fees on deposits		170,561		147,551		305,889		291,165
Other		612,127		378,149		995,731		683,100

Total noninterest income		1,571,903		928,351		2,941,666		1,826,039

FIRST MUTUAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Continued)


	Quarter ended June 30,				Six months ended June 30,
	2005		2004		2005		2004
	(Unaudited)



NONINTEREST EXPENSE:
Salaries and employee benefits	$	4,331,748	$	3,392,481	$	8,278,180	$	6,655,193
Occupancy		848,828		648,804		1,632,287		1,344,513
Other		1,962,323		1,998,988		4,095,340		3,680,594

Total noninterest expense		7,142,899		6,040,273		14,005,807		11,680,300

Income before federal income taxes		3,805,743		3,304,865		7,712,844		6,802,591

FEDERAL INCOME TAXES		1,288,398		1,118,014		2,611,239		2,301,599


NET INCOME	$	2,517,345	$	2,186,851	$	5,101,605	$	4,500,992

PER SHARE DATA:

Basic earnings per common share	$	0.47	$	0.42	$	0.96	$	0.86


Earnings per common share, assuming dilution	$	0.45	$	0.40	$	0.92	$	0.82


WEIGHTED AVERAGE SHARES OUTSTANDING		5,319,017		5,268,108		5,310,175		5,245,374

WEIGHTED AVERAGE SHARES OUTSTANDING
INCLUDING DILUTIVE STOCK OPTIONS		5,554,215		5,511,304		5,553,308		5,493,889

First Mutual Bancshares, Inc, and Subsidiaries

Consolidated Statements of Stockholders' Equity and Comprehensive Income


										Accumulated
					Additional					Comprehensive
	Common Stock				Paid-in		Retained			Income
	Shares		Amount		Capital		Earnings			(Loss)			Total


BALANCE, December 31, 2002		4,247,166	$	4,247,166	$	24,028,610	$	15,214,220		$	793,841		$	44,283,837

Comprehensive income:
Net income								8,395,738						8,395,738
Other comprehensive income (loss), net of tax:
Unrealized (loss) on securities available-for-sale											(1,294,797	)		(1,294,797	)
Unrealized gain on interest rate swap											87,186			87,186
Total comprehensive income														7,188,127
Options exercised, including tax benefit of $219,124		53,040		53,040		571,618								624,658
Issuance of stock through employees' stock plans		1,386		1,386		23,617								25,003
10% stock dividend		428,101		428,101		9,054,336		(9,482,437	)					—
Cash dividend declared ($0.28 per share)								(1,294,869	)					(1,294,869	)

BALANCE, December 31, 2003		4,729,693	$	4,729,693	$	33,678,181	$	12,832,652		$	(413,770	)	$	50,826,756


Comprehensive income:
Net income								9,287,813						9,287,813
Other comprehensive income (loss), net of tax:
Unrealized (loss) on securities available-for-sale											(414,879	)		(414,879	)
Unrealized gain on interest rate swap											171,664			171,664
Total comprehensive income														9,044,598
Options exercised, including tax benefit of $337,052		80,697		80,697		1,138,303								1,219,000
Issuance of stock through employees' stock plans		2,019		2,019		47,992								50,011
10% stock dividend		476,080		476,080		10,730,843		(11,206,923	)					—
Cash dividend declared ($0.32 per share)								(1,693,092	)					(1,693,092	)

BALANCE, December 31, 2004		5,288,489	$	5,288,489	$	45,595,319	$	9,220,450		$	(656,985	)	$	59,447,273

Comprehensive income:
Net income								5,101,605						5,101,605
Other comprehensive income (loss), net of tax:
Unrealized gain on securities available-for-sale											161,273			161,273
Unrealized gain on interest rate swap											76,932			76,932
Total comprehensive income														5,339,810
Options exercised, including tax benefit of $176,520		49,856		49,856		629,193								679,049
Issuance of stock through employees' stock plans		3,846		3,846		96,150								99,996
Cash dividend declared ($0.18 per share)								(958,061	)					(958,061	)
-
BALANCE, June 30, 2005		5,342,191	$	5,342,191	$	46,320,662	$	13,363,994		$	(418,780	)	$	64,608,067

FIRST MUTUAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Six months ended June 30,
	2005			2004
	(Unaudited)
OPERATING ACTIVITIES:
Net income	$	5,101,605		$	4,500,992
Adjustments to reconcile net income to net cash
from operating activities:
Provision for loan losses		850,000			690,000
Depreciation and amortization		773,219			642,563
Deferred loan origination fees, net of accretion		(125,792	)		(99,833	)
Amortization of servicing assets		454,005			312,003
Gain on sales of loans		(944,493	)		(667,263	)
(Gain) loss on sale of repossessed real estate and other assets		(2,205	)		7,200
Gain on sale of securities available-for-sale		—			(70,870	)
FHLB stock dividends		(52,900	)		(228,200	)
Changes in operating assets & liabilities:
Loans receivable held-for-sale		(3,343,896	)		7,203,460
Accrued interest receivable		(511,087	)		(266,116	)
Other assets		(381,446	)		368,318
Drafts payable		163,301			184,204
Accounts payable and other liabilities		(2,095,505	)		(5,096,976	)
Advance payments by borrowers for taxes and insurance		223,763			190,817

Net cash provided by operating activities		108,569			7,670,299

INVESTING ACTIVITIES:
Loan originations		(221,601,789	)		(183,350,623	)
Loan principal repayments		177,067,006			119,422,652
Increase (decrease) in undisbursed loan proceeds		11,330,860			(5,148,958	)
Principal repayments & redemptions on
mortgage-backed and other securities		9,154,203			5,979,602
Purchase of securities held-to-maturity		(1,015,435	)		(1,126,983	)
Purchase of securities available-for-sale		(4,991,406	)		(43,282,952	)
Purchases of premises and equipment		(3,902,997	)		(1,110,551	)
Purchase of FHLB stock		(150,700	)		(1,269,400	)
Proceeds from sale of securities		—			2,228,958

Net cash (used) by investing activities		(34,110,258	)		(107,658,255	)

FIRST MUTUAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Continued)


	Six months ended June 30,
	2005			2004

	(Unaudited)
FINANCING ACTIVITIES:
Net increase in deposit accounts	$	36,950,365		$	47,397,620
Interest credited to deposit accounts		7,367,649			5,531,197
Issuance of stock through employees's stock plans		99,996			50,011
Proceeds from advances		576,770,500			436,328,196
Repayment of advances		(582,858,603	)		(385,657,855	)
Dividends paid		(953,710	)		(703,153	)
Proceeds from exercise of stock options		502,529			895,703

Net cash provided by financing activities		37,878,726			103,841,719

NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS	$	3,877,037		$	3,853,763

CASH & CASH EQUIVALENTS:
Beginning of year		13,845,441			7,427,055

End of quarter	$	17,722,478		$	11,280,818

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Loans originated for mortgage banking activities	$	33,679,880		$	42,262,903

Loans originated for investment activities	$	221,601,789		$	183,350,623


Proceeds from sales of loans held-for-sale	$	30,335,984		$	49,466,363

Cash paid during the year for:
Interest	$	12,180,884		$	9,004,628

Income taxes	$	1,667,000		$	1,457,000


SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING ACTIVITIES:

Loans securitized into securities available-for-sale	$	—		$	—

Loans transferred to real estate
held-for-sale, net	$	—		$	—

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for the fiscal year. In the opinion of management, the information contained herein reflects all adjustments necessary to make the results of operations for the interim periods a fair statement of such operations.

The Bank has three stock-based employee/director compensation plans, which are described more fully in the 2004 annual report. The plans are accounted for under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee or director compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, had been adopted.


	Quarters Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004

Net Income, as reported	$	2,517,345		$	2,186,851		$	5,101,605		$	4,500,992
Deduct: Total stock-based employee/
director compensation expense
determined under fair value based
method for all awards, net of related
tax effects		(116,621	)		(98,984	)		(222,508	)		(197,135	)
Pro forma net income	$	2,400,724		$	2,087,867		$	4,879,097		$	4,303,857

Earnings per share:

Basic - as reported	$	0.47		$	0.42		$	0.96		$	0.86
Basic - pro forma	$	0.45		$	0.40		$	0.92		$	0.82

Diluted - as reported	$	0.45		$	0.40		$	0.92		$	0.82
Diluted - pro forma	$	0.43		$	0.38		$	0.88		$	0.78

Weighted average shares outstanding:

Basic		5,319,017			5,268,108			5,310,175			5,245,374
Diluted		5,554,215			5,511,304			5,553,308			5,493,889

The compensation expense included in the pro forma net income and net income per share figures in the previous table 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.

On April 14, 2005 the Securities and Exchange Commission announced a change in the compliance date for Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (Statement 123R). The compliance date has been changed to first quarter of 2006 from July of 2005. We expect to adopt Statement 123R on January 1, 2006.

Note 2.

Mortgage-Backed and Other Securities Available-for-Sale

The amortized cost and estimated fair value of securities available-for-sale at June 30, 2005, and December 31, 2004 are summarized as follows:


					Gross		Gross
			Gross		Unrealized		Unrealized		Estimated
	Amortized		Unrealized		Losses		Losses		Fair
	Cost		Gains		<1 Year		>1 Year		Value
June 30, 2005
Freddie Mac securities	$	17,962,715	$	38,355	$	19,695	$	176,703	$	17,804,672
Fannie Mae securities		36,285,038		57,052		57,111		240,986		36,043,993
Ginnie Mae securities		49,733,071		71,611		94,479		104,614		49,605,589
US agency securities		17,977,037		44,268		46,032		—		17,975,273
	$	121,957,861	$	211,286	$	217,317	$	522,303	$	121,429,527

December 31, 2004
Freddie Mac securities	$	19,127,613	$	48,719	$	173,913	$	115,062	$	18,887,357
Fannie Mae securities		39,095,463		75,726		87,354		308,837		38,774,998
Ginnie Mae securities		48,839,639		38,712		270,022		—		48,608,329
US agency securities		17,946,544		57,761		50,306		—		17,953,999
	$	125,009,259	$	220,918	$	581,595	$	423,899	$	124,224,683

Certain investment securities shown above currently have fair values less than amortized cost and therefore contain unrealized losses. The Bank has evaluated these securities and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase. The decline in value is not related to any company or industry specific event. At June 30, 2005 and December 31, 2004 there were 21 and 23 investment securities with unrealized losses, respectively. The Bank anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment.

Note 3.

Mortgage-Backed and Other Securities Held-to-Maturity

The amortized cost and estimated fair value of mortgage-backed and other securities are summarized as follows:

					Gross		Gross
			Gross		Unrealized		Unrealized		Estimated
	Amortized		Unrealized		Losses		Losses		Fair
	Cost		Gains		<1 Year		>1 Year		Value
June 30, 2005
Fannie Mae securities	$	5,981,632	$	93,940	$	—	$	19,427	$	6,056,145
Freddie Mac securities		481,445		7,816		—		—		489,261
Municipal bonds		1,199,971		9,070		—		—		1,209,041
	$	7,663,048	$	110,826	$	—	$	19,427	$	7,754,447
December 31, 2004
Fannie Mae securities	$	6,010,318	$	125,722	$	30,472	$	—	$	6,105,568
Freddie Mac securities		492,607		13,408		—		—		506,015
Municipal bonds		1,216,617		2,622		—		3,828		1,215,411
	$	7,719,542	$	141,752	$	30,472	$	3,828	$	7,826,994

Certain investment securities shown above currently have fair values less than amortized cost and therefore contain unrealized losses. The Bank has evaluated these securities and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase. The decline in value is not related to any company or industry specific event. At June 30, 2005 and December 31, 2004 there were 2 and 3 investment securities with unrealized losses, respectively. The Bank anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment.

Note 4.

Nonperforming Assets

Non-performing loans are summarized as follows:


	June 30, 2005		December 31, 2004

Impaired loans with a valuation allowance	$	308,810	$	317,023
Valuation allowance related to impaired loans		172,475		177,190
Total non-accrual loans		656,828		864,464
Total loans past due 90-days or more and still accruing interest		15,000		34,000
Interest income recognized on impaired loans		451		1,108

Subsequent to June 30, one of the impaired loans with an impaired balance of $5,012 paid off in April 2005.

Note 5.

Earnings Per Share

Basic Earnings Per Share is computed by dividing net income by the weighted-average number of shares outstanding during the year. Diluted EPS reflects the potential dilutive effect of stock options and is computed by dividing net income by the weighted-average number of shares outstanding during the year, plus the dilutive common shares that would have been outstanding had the stock options been exercised.

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for quarters ending June 30, 2005 and June 30, 2004:


	Income		Shares		Per share
	(numerator)		(denominator)		amount
Quarter ended June 30, 2005
Basic EPS:
Income available to common shareholders	$	2,517,345		5,319,017	$	0.47

Effect of dilutive stock options		—		235,198
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised	$	2,517,345		5,554,215	$	0.45

Six months ended June 30, 2005
Basic EPS:
Income available to common shareholders	$	5,101,605		5,310,175	$	0.96

Effect of dilutive stock options		—		243,133
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised	$	5,101,605		5,553,308	$	0.92

Quarter ended June 30, 2004
Basic EPS:
Income available to common shareholders	$	2,186,851		5,268,108	$	0.42

Effect of dilutive stock options		—		243,196
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised	$	2,186,851		5,511,304	$	0.40

Six months ended June 30, 2004
Basic EPS:
Income available to common shareholders	$	4,500,992		5,245,374	$	0.86

Effect of dilutive stock options		—		248,515
Diluted EPS:
Income available to common shareholders
plus assumed stock options exercised	$	4,500,992		5,493,889	$	0.82

Note 6.


Rate Volume Analysis	SECOND QUARTER 2005									SIX MONTHS ENDED 2005
(Dollars in thousands)	VS									VS
	SECOND QUARTER 2004									SIX MONTHS ENDED 2004
	INCREASE (DECREASE) DUE TO									INCREASE (DECREASE) DUE TO
							TOTAL									TOTAL
	VOLUME			RATE			CHANGE			VOLUME			RATE			CHANGE
INTEREST INCOME
Investments:
Available-for-sale securities	$	218		$	164		$	382		$	631		$	245		$	876
Held-to-maturity securities		(7	)		2			(5	)		(14	)		(6	)		(20	)
Other equity investments		31			(84	)		(53	)		45			(133	)		(88	)
Total investments		242			82			324			662			106			768

Loans:
Residential		588			232			820			1,207			283			1,490
Residential construction		173			346			519			379			588			967
Multifamily		(120	)		292			172			(174	)		443			269
Multifamily construction		(84	)		25			(59	)		(167	)		48			(119	)
Commercial real estate and business		194			573			767			446			951			1,397
Commercial real estate construction		62			19			81			123			66			189
Consumer & other		159			43			202			333			27			360
Total loans		972			1,530			2,502			2,147			2,406			4,553


Total interest income		1,214			1,612			2,826			2,809			2,512			5,321

INTEREST EXPENSE
Deposits:
Money market deposit and checking		95			244			339			243			357			600
Savings		(1	)		—			(1	)		(2	)		(1	)		(3	)
Time deposits		271			668			939			560			810			1,370
Total deposits		365			912			1,277			801			1,166			1,967

FHLB advances and other		127			452			579			399			675			1,074
Total interest expense		492			1,364			1,856			1,200			1,841			3,041


Net interest income	$	722		$	248		$	970		$	1,609		$	671		$	2,280

Note 7.

Business Segments

The management reporting process measures the performance of the operating segments based on the management structure of the Bank and is not necessarily comparable with similar information for any other financial institution.

The reportable segments include the following:

Consumer Lending - Consumer lending includes home equity lending, direct consumer loans, and indirect home improvement loans (Sales Finance). These loans include lines of credit and loans for primarily consumer purposes.

Residential Lending - Residential lending offers loans to borrowers to purchase, refinance, or build homes secured by one-to-four-unit family dwellings. They also finance the purchase or refinance of buildable residential lots.

Business Banking Lending- Business banking lending offers a full range of banking services to small and medium size businesses including deposit and cash management products, loans for financing receivables, inventory, equipment as well as permanent and interim construction loans for commercial real estate. The underlying real estate collateral or business asset being financed typically secures these loans.

Income Property Lending - Income property lending offers permanent and interim construction loans for multifamily housing (over four units), manufactured housing communities, commercial real estate properties, and spec single-family construction. The underlying real estate collateral being financed typically secures these loans.

Each of these business segments also sells loans into the secondary market. We may choose to retain or sell the right to service the loans sold (i.e., collection of principal and interest payments) depending upon market conditions.

These segments are managed separately because each business unit requires different processes and different marketing strategies to reach the customer base that purchases the products and services. The segments derive a majority of their revenue from interest income, and we rely primarily on net interest revenue in managing these segments. No single customer provides more than 10% of the Bank's revenues.

Financial information for the Bank's segments is shown below for June 30, 2005, 2004, and 2003:


		Consumer			Residential		Business Banking			Income Property
Quarter ended June 30:		Lending			Lending		Lending			Lending		Totals

Interest income	2005	$	2,324,663		$	5,137,589	$	2,122,272		$	6,701,923	$	16,286,447
	2004		2,059,604			3,951,681		1,295,871			6,154,868		13,462,024
	2003		1,507,423			2,673,307		1,398,463			6,697,847		12,277,040

Interest Expense	2005		861,286			2,201,985		650,473			2,745,964		6,459,708
	2004		546,897			1,532,006		303,382			2,222,952		4,605,237
	2003		595,946			1,131,325		467,886			2,644,939		4,840,096

Net Interest Income	2005		1,463,377			2,935,604		1,471,799			3,955,959		9,826,739
	2004		1,512,707			2,419,675		992,489			3,931,916		8,856,787
	2003		911,477			1,541,982		930,577			4,052,908		7,436,944

Provision for loan losses	2005		154,500			57,070		73,115			165,315		450,000
	2004		156,535			47,125		55,935			180,405		440,000
	2003		83,068			36,062		44,693			161,177		325,000

Net interest income, after provision for loan losses	2005		1,308,877			2,878,534		1,398,684			3,790,644		9,376,739
	2004		1,356,172			2,372,550		936,554			3,751,511		8,416,787
	2003		828,409			1,505,920		885,884			3,891,731		7,111,944

Noninterest income	2005		610,822			311,280		277,945			371,856		1,571,903
	2004		377,095			190,428		84,624			276,204		928,351
	2003		84,382			323,539		97,742			377,526		883,189

Noninterest expense	2005		1,727,721			1,874,550		1,589,714			1,950,914		7,142,899
	2004		1,429,173			1,429,456		1,283,620			1,898,024		6,040,273
	2003		982,727			1,140,533		983,335			1,821,954		4,928,549

Income before federal income taxes	2005		191,978			1,315,264		86,915			2,211,586		3,805,743
	2004		304,094			1,133,522		(262,442	)		2,129,691		3,304,865
	2003		(69,936	)		688,926		291			2,447,303		3,066,584

Federal income taxes	2005		64,596			445,268		28,782			749,752		1,288,398
	2004		102,766			383,672		(89,781	)		721,357		1,118,014
	2003		(24,422	)		232,875		(574	)		829,088		1,036,967

Net income	2005		127,382			869,996		58,133			1,461,834		2,517,345
	2004		201,328			749,850		(172,661	)		1,408,334		2,186,851
	2003		(45,514	)		456,051		865			1,618,215		2,029,617


Total Interest Earning assets (ending period balances)	2005		116,559,900			327,186,650		131,570,274			419,257,639		994,574,463
	2004		106,368,450			273,980,679		99,436,965			447,499,013		927,285,107
	2003		82,619,989			180,249,319		89,418,052			430,892,240		783,179,600

Note 7.

Segments (continued)



Year-to-date ended June 30:
		Consumer			Residential		Business Banking			Income Property
		Lending			Lending		Lending			Lending		Totals

Interest income	2005	$	4,570,151		$	9,682,525	$	4,075,418		$	13,357,549	$	31,685,643
	2004		4,085,733			7,534,509		2,607,009			12,138,413		26,365,664
	2003		2,752,513			5,316,185		2,730,613			13,485,791		24,285,102

Interest Expense	2005		1,599,534			4,084,545		1,141,186			5,233,393		12,058,658
	2004		1,097,506			2,912,392		632,151			4,376,763		9,018,812
	2003		1,135,390			2,246,725		903,927			5,486,868		9,772,910

Net Interest Income	2005		2,970,617			5,597,980		2,934,232			8,124,156		19,626,985
	2004		2,988,227			4,622,117		1,974,858			7,761,650		17,346,852
	2003		1,617,123			3,069,460		1,826,686			7,998,923		14,512,192

Provision for loan losses	2005		290,215			105,775		132,240			321,770		850,000
	2004		249,634			69,404		81,394			289,568		690,000
	2003		115,495			50,059		59,289			235,157		460,000

Net interest income, after provision for loan losses	2005		2,680,402			5,492,205		2,801,992			7,802,386		18,776,985
	2004		2,738,593			4,552,713		1,893,464			7,472,082		16,656,852
	2003		1,501,628			3,019,401		1,767,397			7,763,766		14,052,192

Non interest income	2005		1,473,077			524,434		380,777			563,378		2,941,666
	2004		747,002			362,513		173,588			542,936		1,826,039
	2003		206,896			629,761		205,916			826,319		1,868,892

Non interest expense	2005		3,376,936			3,572,091		3,180,234			3,876,546		14,005,807
	2004		2,625,406			2,822,546		2,386,135			3,846,213		11,680,300
	2003		1,892,865			2,288,440		1,952,486			3,566,991		9,700,782

Income before federal income taxes	2005		776,543			2,444,548		2,535			4,489,218		7,712,844
	2004		860,189			2,092,680		(319,083	)		4,168,805		6,802,591
	2003		(184,341	)		1,360,722		20,827			5,023,094		6,220,302

Federal income taxes	2005		262,720			827,486		(610	)		1,521,643		2,611,239
	2004		291,159			708,211		(109,668	)		1,411,897		2,301,599
	2003		(63,854	)		460,052		5,759			1,701,570		2,103,527

Net income	2005		513,823			1,617,062		3,145			2,967,575		5,101,605
	2004		569,030			1,384,469		(209,415	)		2,756,908		4,500,992
	2003		(120,487	)		900,670		15,068			3,321,524		4,116,775

Total Interest Earning assets (Ending period balances)	2005		113,352,359			316,231,162		127,556,812			429,190,920		986,331,253
	2004		102,336,690			259,761,399		97,826,002			439,899,861		899,823,952
	2003		77,036,185			173,371,863		88,051,444			434,960,693		773,420,185

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

GENERAL

First Mutual Bancshares, Inc. (the "Company"), a Washington corporation, is a bank holding company owning all of the equity of its wholly owned subsidiary, First Mutual Bank. The Company is subject to regulation by the Federal Reserve Bank of San Francisco. This discussion refers to the consolidated statements of the Company and the Bank, and therefore the references to “Bank” in this discussion refer to both entities.

First Mutual Bank is a Washington-chartered savings bank subject to regulation by the State of Washington Department of Financial Institutions and the Federal Deposit Insurance Corporation ("FDIC"). The Bank conducts business from its headquarters in Bellevue, Washington, and has 12 full-service retail banking centers located in Bellevue (3), Issaquah, Kirkland (2), Monroe, Redmond, Sammamish, Seattle (2), and Woodinville. We also have an income property loan production office located in Vancouver, Washington and a consumer loan office located in Jacksonville, Florida. The Bank's business consists mainly of attracting deposits from the general public as well as wholesale funding sources, and investing those funds primarily in real estate loans, small and mid-sized business loans, and consumer loans.

OVERVIEW

The second quarter of 2005 marked our fifty-first consecutive quarter of year-over-year quarterly earnings growth, as net income increased 15% for the quarter ended June 30, 2005, to $2.5 million, or $0.45 per diluted share, compared to $2.2 million, or $0.40 per diluted share in the same quarter a year ago. Through the first six months of the year, net income increased 13% to $5.1 million, or $0.92 per diluted share, compared to $4.5 million, or $0.82 per diluted share in the first half of 2004.

As general corporate goals, we seek to obtain a 15% or better return on equity (ROE) and year-over-year net income growth in the range of 10% to 12%. This net income growth goal was established in the first quarter of 2005, and represented a reduction from our previous target of a 15% year-over-year increase. We elected to reduce our target in response to a number of factors including general economic conditions and trends, the current competitive environment for loan and deposit products in our local market, and the continued investment required in our Business Banking division. We consider these targets to be our corporate goals, and not indicative of current forecasts or expected future operating results.

While our return on equity has typically met or exceeded our corporate objective, our net income growth has generally fallen short of our target. Over the last several years, we have utilized part of our earnings for the purpose of investing in new business lines. We realized that in order to continue to achieve our goal of consistent earnings, we needed to expand our business lines from two to four. At that time, our operations consisted of residential and income property (commercial real estate) lending. Those business lines were, and continue to be, solid operations. However, for the Bank to continue to produce consistent earnings, we needed to broaden the operating base with two new lines, Business Banking and Consumer Lending. The process of developing these lines has been expensive and has added to both our staff and other operating costs. The encouraging news is that the Consumer Lending business line has been contributing to the Bank’s profit goals for some time. Although the Business Banking division has not yet achieved its objectives, we remain committed to developing this business line, based upon its ability to attract low-cost core deposits, which help reduce our overall cost of funds, the diversification it brings to our portfolio of earning assets, and the potential it offers for generating longer-term relationship-banking opportunities and additional sources of noninterest income. Please refer to the “Business Segments” and “Noninterest Expense” sections for a further discussion of this topic.

The primary source of revenue for each of our business lines is net interest income, which is generally measured with the net interest margin ratio. Our overall net interest margin declined to 4.01% in the second quarter of this year compared to 4.08% in the previous quarter, but exceeded the top of our 3.90% to 4.00% forecast by one basis point and remained above the 3.97% level achieved in the second quarter last year. Reflecting the recent increases in short-term interest rates, the yield on our earning assets grew to 6.39% in the second quarter of 2005, compared to 6.16% in the first quarter, and 5.82% in the second quarter of 2004. Similarly, the cost of interest-bearing liabilities increased to 2.62% in the second quarter, from 2.36% in the first quarter and 2.05% in the second quarter of 2004.

Another key driver of net interest income is the growth of the business lines’ earning assets. On a second quarter 2005 versus 2004 comparison, the growth in earning assets contributed an additional $722,000 to net interest income, while the improvement in the margin added $248,000. The results on a year-to-date basis were comparable, with earning asset growth contributing $1.6 million and the improvement in the margin adding $671,000. Please see the “Net Interest Income” and “Asset and Liability Management” sections for a further discussion of net interest income and the processes by which we manage that source of revenue.

A secondary source of revenue is our noninterest income, which grew 69% from the level earned in the second quarter of 2004. As was the case in the second quarter of last year, the miscellaneous income category was the largest contributor to our quarter’s noninterest income, accounting for 39% of the total. While an increase in loan fee income made the largest single contribution, significant improvements were also observed in late charge fees received on our loan portfolio, as well as Visa and ATM fees, which are expected to continue rising as checking accounts become a greater piece of our overall deposit mix. Please refer to the “Noninterest Income” section for a further discussion of this subject.

A critical factor in achieving our goal of consistent earnings is the credit quality of our loan portfolio. Fortunately, for many years we have enjoyed credit quality that has exceeded the national average. Credit quality remained strong in the second quarter of 2005, with total non-performing assets (NPAs) declining to $797,000, or 0.08% of total assets as of the quarter-end. Our provision for loan losses totaled $450,000 for the second quarter of 2005, while net charge-offs amounted to $231,000. As a result, the loan loss reserve grew to $9.7 million, or 1.14% of gross loans, from $8.9 million, or 1.11% of gross loans at the end of the second quarter of last year. For additional information regarding our credit quality please refer to the “Asset Quality” section.

RESULTS OF OPERATIONS

Net Income

Net income increased approximately 15%, from $2.2 million in the second quarter of 2004 to $2.5 million in the same period of 2005. Net interest income, after provision, rose $960,000, and noninterest income increased $644,000 on a second quarter comparison. Partially offsetting the growth in revenue was a rise of $1.1 million in noninterest expense.

Net Interest Income

For the quarter and six months ended June 30, 2005, our net interest income, after provision, increased $960,000 and $2.1 million, respectively, or 11% and 13%, relative to the same periods last year. This improvement resulted from both the growth in our earning assets, which accounted for the majority of the improvement, as well as the net effects of asset and liability repricing. The following table illustrates the impact to our net interest income of balance sheet growth, and rate changes on our assets and liabilities, with the results attributable to the level of earning assets classified as “volume” and the effect of asset and liability repricing labeled “rate.”

Rate/Volume Analysis
	Quarter Ended						Six Months Ended
	June 30, 2005 vs. June 30, 2004						June 30, 2005 vs. June 30, 2004
	Increase/(Decrease) due to						Increase/(Decrease) due to
	Volume		Rate		Total		Volume		Rate		Total
Interest Income	(Dollars in thousands)
Total Investments	$	242	$	82	$	324	$	662	$	106	$	768
Total Loans		972		1,530		2,502		2,147		2,406		4,553
Total Interest Income	$	1,214	$	1,612	$	2,826	$	2,809	$	2,512	$	5,321

Interest Expense
Total Deposits	$	365	$	912	$	1,277	$	801	$	1,166	$	1,967
FHLB and Other		127		452		579		399		675		1,074
Total Interest Expense	$	492	$	1,364	$	1,856	$	1,200	$	1,841	$	3,041

Net Interest Income	$	722	$	248	$	970	$	1,609	$	671	$	2,280

Earning Asset Growth (Volume)

For the second quarter of 2005, the growth in our earning assets contributed an additional $1.2 million in interest income relative to the second quarter of last year, which was partially offset by additional interest expense incurred from the funding sources used to accommodate the asset growth. The additional expense associated with these funding sources totaled $492,000 for the quarter. Consequently, the net impact of asset growth was an improvement in net interest income of $722,000, or 74% of the total increase in net interest income compared to the second quarter of last year.

Similar results were observed for the first six months of 2005, as asset growth over the prior year resulted in $2.8 million in additional interest income, partially offset by a $1.2 million increase in interest expense for the corresponding funding sources. This resulted in a $1.6 million net impact from asset growth, or 71% of the overall improvement in net interest income.

Quarter Ended	Average Earning Assets		Average Net Loans		Average Deposits
	(Dollars in thousands)
June 30, 2004	$	893,451	$	773,561	$	620,606
September 30, 2004	$	929,335	$	790,319	$	647,560
December 31, 2004	$	945,684	$	801,235	$	666,835
March 31, 2005	$	962,613	$	816,127	$	683,521
June 30, 2005	$	979,981	$	834,064	$	705,680

Our average earning assets totaled $980 million during the second quarter, an increase of nearly $87 million, or 10% over the second quarter of 2004, with approximately 70% of the growth attributable to additional balances in our loan portfolio.

Most of our asset growth was funded with additional deposits, including certificates issued in institutional markets through deposit brokerage services. To the extent that deposit growth was not sufficient to fully support our asset growth, we also utilized advances from the Federal Home Loan Bank of Seattle (FHLB) as an alternative funding source. For the second quarter, our deposits averaged nearly $706 million, representing growth of $85 million over the average level of second quarter 2004. At June 30, 2005, total deposits were up by $83 million from the end of the second quarter last year, with checking and money market balances accounting for $37 million, or 45% of the growth.

Between the 2004 year-end and the March 31, 2005 quarter-end, however, our checking and money market balances declined by $12 million. This represented a significant departure from the previous couple of years, in which growth of checking and money market balances accounted for the majority of all deposit growth. By June 30, 2005, however, the run-off in checking and money market balances reversed and balances had risen to $253 million, approximately $1 million below the 2004 year-end level.

The shift in balances from money market accounts to certificates of deposit occurred as the rate differential between the two product types began to widen. In 2004, with short-term interest rates at historically low levels, the rates offered on time deposits were only modestly higher than those on money market accounts, and thus viewed as unattractive by many investors. As a result, these depositors often chose to keep their balances in money market accounts, accepting slightly lower yields in exchange for greater liquidity. Earlier this year, as the increases in short-term market interest rates that began in the second quarter of 2004 started affecting the yields on retail deposits, the rates paid on time deposits rose to a greater extent than those paid on money market accounts. As a result, time deposits became more attractive, making it more difficult to retain or grow checking and money market balances without incurring exorbitant marginal expense to do so, as any rate increases would apply not only to any newly opened accounts but all existing balances as well. With checking and money market balances showing signs of recovery over the last couple months, we are not currently anticipating significant future migration from checking and money market accounts to time deposits.

Asset Yields and Funding Costs (Rate)

For the quarter and six months ended June 30, 2005, the net effects of repricing on our assets and liabilities contributed an additional $248,000 and $671,000 to our net interest income, or 26% and 29% of the total differences relative to first quarter and half of 2004.

On the asset side, our loan portfolio accounted for $1.5 million and $2.4 million in additional interest income for the three and six month periods, or the vast majority of the total rate-related increase in interest income. As adjustable-rate loans account for approximately 90% of our loan portfolio, almost all loan types benefited from increases in short-term interest rates.

By comparison, very little impact from repricing was observed in our securities portfolio due to the percentage of the portfolio invested in fixed-rate and hybrid ARM securities, which have not yet benefited from rising rate indices. Additionally, the rate-related benefits that were recognized from the repricing of adjustable-rate securities in our portfolio were largely offset by a reduction in the dividend on our holdings of stock in the FHLB.

As a member of the FHLB and to utilize FHLB advances as a funding source for our lending and investment activities, we maintain a position in FHLB stock. Our position in this stock, which totaled $13 million for both the first and second quarters, has historically paid dividends on a quarterly basis. Based on events at the FHLB, however, the dividend rate for the first quarter of 2005 was well below the rate paid in the first quarter of last year, and no dividend was received from the FHLB in the second quarter. At this time, we do not anticipate receiving any dividend income on our FHLB stock in the foreseeable future.

On the liability side of the balance sheet, repricing increased our interest expense on both deposits and FHLB advances for both the quarter and six-month period ended June 30 relative to the prior year. The interest rate increases that drove loan and wholesale funding rates higher over the last year began to influence the deposit rates offered by our competitors in our local market earlier this year, resulting in rate-related increases in interest expense on both our non-maturity and time deposit accounts.

Net Interest Margin

Quarter Ended	Net Interest Margin
June 30, 2004	3.97%
September 30, 2004	3.99%
December 31, 2004	3.99%
March 31, 2005	4.08%
June 30, 2005	4.01%

Our net interest margin totaled 4.01% for the second quarter of 2005. While this represented a decline from the first quarter level, it exceeded the top of our 3.90% to 4.00% forecast by one basis point. A reduction in the margin had been expected based on a combination of fixed-rate securities in our portfolio, the non-payment of dividends on our FHLB stock, and a shifting customer preference from lower-rate money market accounts to higher-rate time deposits observed in the first quarter.

As noted above, adjustable-rate loans, which reprice according to terms specified in our loan agreements with the borrowers, accounted for approximately 90% of our loan portfolio as of June 30, 2005. For the majority of these loans, repricing occurs on an annual basis. A notable exception to this would be those loans tied to the prime rate (about 15% of our portfolio), which typically reprice within one or two days of any increase in the Federal Funds target rate by the Federal Reserve. Consequently, most of the loans in our portfolio benefited from increases in short-term market interest rate indices over the last 15 months and earned additional interest income relative to the quarter and six months ended June 30, 2004.

By comparison, rates on our retail deposits are managed internally and not typically subject to any sort of systematic adjustments based on movements in market rate indices. Instead, retail deposit rates tend to lag major interest rate indices. Retail deposit rates then typically continue to move for some time after the market rates stabilize or plateau at a given level. Consequently, while loan rates systematically repriced upwards, we postponed raising our retail deposit rates for as long as practical given our funding requirements and the rates offered by other institutions in our local market. By the end of the first quarter, however, the deposit rates offered by our competitors had begun moving upwards in response to increases in market interest rates and were rising at a faster rate than most major indices used for pricing in our loan portfolio. If short-term rates were to stabilize, we could potentially see additional compression in our net interest margin in subsequent quarters as the effects of systematic loan repricing diminish, while deposit rates continue to trend upward for some time afterwards based on the lagging nature of retail deposit rate movements. However, given that intense competition earlier this year drove deposit rates higher with what seemed to be faster than historically typical velocity, it is also possible that these rates would not continue to trend upwards as long or as far as in previous rate cycles.

Additionally, the migration of checking and money market balances to time deposit accounts could potentially contribute to future compression of our net interest margin. Our checking and money market account balances typically represent a lower-cost source of funding for us, and time deposits a higher-cost source, becoming progressively more so as rates rise. Although we have grown our checking and money market deposits over their June 30, 2004 levels, these balances declined in the first quarter of this year, then began to recover over the last couple months. While we do not anticipate further migration from checking and money market accounts to time deposits, in the event that movement were to resume in a manner similar to that observed earlier this year, our net interest margin could be subject to further compression.

Our net interest margin represents our net interest income for a given period, divided by the average level of earning assets during that same period. For our year-to-date net interest margin ratios prior to the second quarter of 2005, we calculated our average level of earning assets using an arithmetic average calculation of our balance sheets as of the quarter-end focal date and the previous year-end. As a result, to the extent that assets grew early within a given year or that growth slowed or assets declined later in the year, this methodology would have resulted in a higher margin than a daily average calculation, as assets will be on our balance sheet and earning income for a longer time than implied by the averaging calculation. The opposite would have

occurred if the majority of asset growth occurred near the end of the year, or if assets were to decline early in the year.

Beginning with the second quarter of 2005, we changed this methodology to use an arithmetic average calculation of each quarter-end balance sheet within the subject timeframe, along with the prior year-end. For the six months ended June 30, this translates to a year-to-date average calculation based on three points in time (December 31, 2004, March 31, 2005, and June 30, 2005) as opposed to two points (December 31, 2004 and June 30, 2005) using the previous method. Year-to-date calculations for prior periods have been recalculated using the new method to facilitate comparisons. We believe that this change will better reflect the evolution of our balance sheet and margin over the course of each year and improve the overall accuracy of our margin calculation.

Noninterest Income

Noninterest income increased by $644,000 for the quarter and $1.1 million for the six months ended June 30, 2005, compared to the same periods in 2004. The 69% and 61% improvement, respectively, was attributable to higher net servicing income, gains on loan sales, and loan fees.

Gain on Sales of Loans

Gain on Loan Sales	2Q 2005		2Q 2004		YTD 2005		YTD 2004
Consumer Loan Sale Gains	$	201,000	$	258,000	$	702,000	$	532,000
Residential Loan Sale Gains		38,000		36,000		62,000		64,000
Commercial Loan Sale Gains		181,000		28,000		181,000		71,000
Total Gains on Loan Sales	$	420,000	$	322,000	$	945,000	$	667,000

Loans Sold
Consumer Loans Sold	$	5,038,000	$	7,592,000	$	15,676,000	$	15,264,000
Residential Loans Sold		4,938,000		8,336,000		12,090,000		16,656,000
Commercial Loans Sold*		2,570,000		6,718,000		2,570,000		17,546,000
Total Loans Sold	$	12,546,000	$	22,646,000	$	30,336,000	$	49,466,000

* The commercial loans sold for second quarter 2005 of $2,570,000 represents 2 loans. The first loan for $1,920,000 is fully disbursed. The second loan is a construction loan for $7,500,000 of which $650,000 was disbursed at origination.

For the second quarter of 2005, gains on loan sales significantly exceeded those of the prior year, attributable primarily to a large commercial loan transaction in June. Gains for the quarter and six months totaled $420,000 and $945,000, representing increases of 30% and 42% over the same periods last year.

Historically, the commercial real estate loans we originate have been retained in our portfolio, and sales of participations in these loans have been utilized to limit our aggregate credit exposure to specific borrowers. During the second quarter, however, we experienced increased interest in, and opportunities for, sales of participations in commercial real estate loans. Consequently, we are currently considering the merits of expanding our commercial real estate loan sales and potentially originating credits with the intent to sell, rather than portfolio the loans. In the event we determine that such a strategy would be more favorable than our historical practice, we would likely increase our sales of commercial real estate loans, which could potentially lead to a reduction in the size of our Income Property Segment’s loan portfolio. We do not anticipate that these potential sales would impact the other three segments, where we would

expect the loan portfolios to continue to grow.

With gains of $201,000 in the second quarter, consumer loan sales remained the largest contributor to our loan sale gains, though only modestly greater than the commercial category. While this represented a 22% decline from the gains realized in the second quarter of 2004, our pricing and execution improved, as the volume of loans sold declined 34% to $5.0 million, versus $7.6 million in the second quarter of last year. Similarly, through the first six months of 2005, gains on consumer loan sales increased $170,000, or 32%, despite the volume of loans sold increasing less than 3%.

As with the commercial real estate loans, we reconsidered our strategy on the sales of consumer loans during the second quarter. Previously, our plan had been to sell approximately $6 million to $8 million in sales finance loans each quarter, though actual sales in a given quarter could fall above or below this range depending on loan production, market conditions, and other factors. In the second quarter, we revised our plan such that we now expect to substantially reduce our sales of these loans, selling only sufficient volumes to ensure the continuity of the market. This strategy may be reevaluated and subject to further modification based on factors including, but not limited to future loan production and/or market conditions.

In contrast, residential loan sale gains were little changed from the prior year, up 5% for the quarter and down 4% for the six months ended June 30, 2005, as the volume of loans sold declined 41% and 28% compared to the same periods last year. While production volumes for residential loans exceeded those for the second quarter and first half of last year, a greater percentage of this year’s production was in custom construction loans, which have been retained within our portfolio.

Service Fee Income

	2Q 2005		2Q 2004		YTD 2005		YTD 2004
Consumer Loans	$	341,000	$	65,000	$	641,000	$	88,000
Commercial Loans		26,000		16,000		50,000		28,000
Residential Loans		2,000		0		4,000		(2,000	)
Service Fee Income	$	369,000	$	81,000	$	695,000	$	114,000

For the quarter and six months ended June 30, 2005, our total servicing fee income rose 357% and 512% over the levels earned in the same periods of 2004, based on substantial increases in fees earned on consumer loans serviced for others. The growth in consumer loan service fees this year is primarily attributable to a change in the amortization period assumed for the underlying servicing asset, though additional loan sales over the last several quarters, and corresponding growth in our portfolio of consumer loans serviced for others, also contributed to the additional servicing income.

Servicing assets are recorded when we sell loans to other investors and continue to service those loans following the sale. To determine the fair value of the servicing assets, we utilize a valuation model that calculates the present value of future cash flows for the loans sold, based on assumptions including market discount rates, anticipated prepayment speeds, estimated servicing cost per loan, and other relevant factors. These factors are subject to significant fluctuations, and the estimates used in the models are subject to review and revision based on actual experience and changes in expectations for the future. The calculated value of the servicing rights is then capitalized and amortized in proportion to, and over the period of, estimated future net servicing income.

Based on a review of our assumptions in the first quarter of 2005, we determined that the amortization period for the servicing rights on our consumer loan servicing portfolio was significantly shorter than the term over which these loans would be expected to provide net servicing income. Consequently, we revised the amortization period such that the average life of the amortization schedule would correspond with the average life we are currently observing for the underlying loan portfolio. This resulted in a significant increase in our net servicing income. Note that any projection of servicing asset amortization in future periods is limited by the conditions that exist at the time the calculations are performed, and may not be indicative of actual amortization expense that will be recorded in future periods.

The income received for servicing consumer loans grew as a result of the sales finance loan sales over the last several quarters, and the corresponding growth in our portfolio of consumer loans serviced for others. Based on our decision to reduce sales of consumer loans in the future and instead retain a greater percentage of these loans within our portfolio, the rapid growth in fee income earned on the portfolio of serviced consumer loans in recent quarters is not expected to continue in future quarters.

An increase was also observed in service fee income earned on our commercial loans serviced for others based on participations sold in the last half of 2004. In the event we elect to expand our sales of commercial real estate loans, we would expect this income to continue to grow in the future. In contrast, residential loans are typically sold servicing released, which means we no longer service those loans once they are sold. Consequently, we do not view these loans as a significant source of servicing fee income.

Other Noninterest Income

	2Q 2005		2Q 2004		YTD 2005		YTD 2004
Rental Income	$	144,000	$	167,000	$	310,000	$	335,000
Loan Fees		288,000		86,000		358,000		108,000
ATM/Wires/Safe Deposit		62,000		49,000		119,000		87,000
Late Charges		46,000		38,000		94,000		74,000
Miscellaneous		72,000		38,000		115,000		79,000
Total Other Noninterest Income	$	612,000	$	378,000	$	996,000	$	683,000

Our noninterest income from sources other than those described above rose $234,000, or 62% over the second quarter of last year, and $313,000, or 46% over the first six months of 2004. While an increase in loan fee income made the largest single contribution, significant improvements were also observed in late charge fees received on our loan portfolio, as well as Visa and ATM fees, which are expected to continue rising as checking accounts become a greater piece of our overall deposit mix.

Loan fees increased by $202,000 compared to the second quarter of 2004, as prepayment fees were $248,000, up from $84,000 last year. On a year-to-date basis, loan fees rose $250,000 with prepayment fees increasing $212,000. In recent quarters, short-term interest rates have risen, while longer-term interest rates, such as the 10-year U.S. Treasury rate, which are more indicative of fixed-rate mortgage rates, have tended to move within a range and without any discernible upward or downward tendency. Combined, these movements have resulted in a flattening of the yield curve. We believe that this flattening, and expectations that rates could move upwards in the foreseeable future, have contributed to the higher level of loan payoffs and prepayment fees observed over the last few quarters. As this flattening of the yield curve reduces the rate differential between short- and long-term financing costs, the financial incentive for borrowers to use shorter-term, adjustable-rate financing rather than longer-term, fixed-rate loans diminishes. This, in turn, provides borrowers with short-term or adjustable-rate loans an incentive to refinance with long-term fixed rates. Given the uncertainties in interest rates and borrower expectations, we do not know if the higher level of prepayment fees is likely to continue.

Noninterest Expense

Salaries and Employee Benefits Expense

Salaries and employee benefits expense increased by $940,000, or 28%, from $3.4 million in the second quarter of 2004, to more than $4.3 million for the same period in 2005, accounting for approximately 85% of the increase in total noninterest expense. On a year-to-date basis the increase was $1.6 million, or 24%, over the six-month period ended June 30, 2004.

	2Q 2005		2Q 2004		YTD 2005		YTD 2004
Salaries	$	2,526,000	$	2,239,000	$	5,147,000	$	4,438,000
Commissions & Incentive Bonuses		927,000		441,000		1,438,000		774,000
Employment Taxes & Insurance		272,000		221,000		562,000		481,000
Temporary Office Help		70,000		48,000		112,000		83,000
Benefits		537,000		443,000		1,019,000		879,000
Total Salary & Benefit Expenses	$	4,332,000	$	3,392,000	$	8,278,000	$	6,655,000

Over half of the increase in salary and benefit expense relative to the second quarter of last year was the result of higher incentive compensation accrued for administrative and support personnel. Earlier in the year, incentive compensation had increased relative to the prior year due to our Business Banking and Residential lending divisions returning to a normal level of incentive compensation this year, compared to a below average level of expense in 2004. The incentive compensation plans for loan production tend to vary directly with the production of the business lines.

Also contributing to the increase in salary and benefit expense were our annual salary increases for existing staff, which took place in April 2005. In addition, expenses rose as our full-time-equivalent (FTE) employee count grew from 201 FTE’s to 218 FTE’s over the past 12 months. These additions consisted primarily of positions pertaining to the origination and/or servicing of our loan portfolio or retail deposits. While incentive compensation expenses tend to be variable, base salary represents more of a fixed cost, subject to increases during times of operational expansion.

Our salary expense declined between the first and second quarters of 2005, despite the annual salary increases in April, due to the deferral of certain salary expenses related to loan originations. In accordance with current accounting standards, certain loan origination costs, including some salary expenses tied to loan origination, are deferred and amortized over the life of each loan originated, rather than expensed in the current period. Expenses are then reported in the financial statements net of these deferrals. The amount of expense subject to deferral and amortization can vary from one period to the next based upon the number of loans originated, the mix of loan types, and year-to-year changes in “standard loan costs”. In this instance, the number of loans originated by our Business Banking, Residential, and Sales Finance lending areas in the second quarter of 2005 exceeded the number of loans originated in the first quarter. Consequently, the amount of salary expense to be deferred and amortized increased between the two quarters, reducing our second quarter salary expense. Also contributing to the reduction between quarters was the departure of a senior vice president-level manager in one of our support departments at the end of the first quarter. As we are actively recruiting for a replacement for this position, this cost reduction is expected to be temporary.

Quarter Ended	FTE at Quarter End		Salaries		Commissions & Incentive Bonuses
June 30, 2004		201	$	2,239,000	$	441,000
September 30, 2004		214	$	2,276,000	$	541,000
December 31, 2004		220	$	2,481,000	$	855,000
March 31, 2005		219	$	2,621,000	$	511,000
June 30, 2005		218	$	2,526,000	$	927,000

Occupancy Expense

Occupancy expense increased $200,000, or 31% relative to the second quarter of last year, based primarily on higher software licensing costs and depreciation expense. For the six months ended June 30, 2005, occupancy expenses increased $288,000, or 21%, from the same period in 2004.

	2Q 2005		2Q 2004		YTD 2005		YTD 2004
Rent Expense	$	81,000	$	78,000	$	159,000	$	161,000
Utilities & Maintenance		140,000		138,000		329,000		313,000
Depreciation Expense		395,000		319,000		734,000		634,000
Other Occupancy Costs		233,000		114,000		411,000		237,000
Total Occupancy Expenses	$	849,000	$	649,000	$	1,633,000	$	1,345,000

Depreciation expense rose by $76,000 compared to the second quarter of last year, due to capital expenditures made over the last 12 months for banking center remodel projects, growth in our information systems infrastructure, and investment in enterprise software. We expect these costs to continue to rise in the second half of 2005 as we complete the remodeling projects on our First

Mutual Center headquarters building and additional banking centers and begin depreciating those new assets.

The majority of the increase in occupancy expense occurred in “other occupancy costs,” which includes items such as real estate and personal property taxes, the purchase of non-capitalized equipment, and software licensing. For the second quarter of 2005, our computer equipment costs accounted for most of this category’s increase, rising $95,000 over the prior year, primarily as a result of non-capitalized equipment expenditures associated with the relocation of several departments to recently remodeled areas of the First Mutual Center. Another factor that increased expenses this quarter was higher software licensing fees due to our new licensing agreement with Microsoft.

Other Noninterest Expense

Other noninterest expense declined by $37,000, or 2%, and was driven by lower expenditures for legal fees, data processing, and business and occupation taxes. Largely offsetting these reductions were increased marketing, loan processing and charitable contributions expenses. For the six-month period ending June 30, 2005, other noninterest expense increased by $415,000, or 11%, over the same six-month period in 2004.

	2Q 2005		2Q 2004		YTD 2005		YTD 2004
Marketing & Public Relations	$	350,000	$	302,000	$	704,000	$	588,000
Credit Insurance		346,000		346,000		679,000		503,000
Outside Services		154,000		168,000		352,000		317,000
Taxes		84,000		108,000		225,000		235,000
Information Systems		226,000		283,000		473,000		499,000
Other		802,000		792,000		1,662,000		1,538,000
Total Other Noninterest Expenses	$	1,962,000	$	1,999,000	$	4,095,000	$	3,680,000

The most significant growth in the second quarter’s other noninterest expense came from loan processing costs. These costs which are included in the other noninterest expense category above, increased $64,000 relative to the second quarter of 2004. As with salaries, loan processing costs are another category of expense subject to deferral and capitalization of loan origination costs, and the majority of the increase was attributable to a reduction in the amount of expenses deferred compared to 2004. The amount of processing expense subject to deferral for several loan types, most notably custom construction loans, declined relative to last year. This caused our net expenses to rise substantially as we were unable to defer and amortize as many of these costs as we did in the second quarter of 2004. On a year-to-date basis, our loan processing expenses were up $78,000 over last year.

Another component of our other noninterest expense category, charitable contributions, also increased markedly during the second quarter. The increase can be attributed to a number of donations that were made to various Eastside non-profit organizations. On a year to-date-basis, donations rose $43,000 from last year.

Advertising expenses, which represent the majority of our marketing and public relations expenses above, rose $40,000, or 18%, in the second quarter over the same period in 2004. The growth in these expenses can be attributed to an increase in both our radio and local newspaper

advertising. On a year-to-date basis, marketing expenses rose $103,000, or nearly 22%, from the same period last year.

Additionally, although there was no change in our credit insurance expense for the quarter, it should be noted that in the second quarter of 2004 we incurred an additional accrual of $162,000, which greatly increased our credit insurance expenses during that period. For the year-to-date period, our credit insurance expenses have risen $176,000, or 35%, based on growth in the balances of insured sales finance loans, including both the loans in our portfolio as well as those serviced for other institutions.

Significant decreases in a number of expense categories included our legal expense, which declined $68,000, or 49%, from the same quarter last year. In addition to lower legal fees, our expenses were further reduced as a result of receiving refunds for legal expenses from several borrowers.

Another area where other noninterest expense declined considerably was our information systems expenses. In the second quarter these expenses fell $57,000, or over 20%, compared to the same period last year. We received a $25,000 credit from our primary services provider due to a change in pricing, in addition to submitting fewer work orders during the second quarter. For the year-to-date period, our information systems expenses declined $26,000, or 5%, compared to last year.

Our tax expenses were also much lower in the second quarter, declining $24,000 or nearly 22%, from their second quarter 2004 level. The reduction in these expenses was largely attributable to an adjustment of $27,000 in B&O taxes and a $10,000 refund of taxes from the State of Oregon. For year-to-date 2005, our tax expenses decreased $10,000, or 4%, compared to the first six months of 2004. These adjustments reflected lower actual payments compared to estimated accruals.

REVIEW OF FINANCIAL CONDITION

Assets

Assets increased 4% in the first six months of 2005, totaling $1,045 million at June 30, 2005, up from $1,004 million at the 2004 year-end, based primarily on growth in our loan portfolio.

Securities

We classify investment securities in one of the following categories: 1) trading, 2) available-for-sale, or 3) held-to-maturity. Securities classified as available-for-sale are reviewed regularly, and any unrealized gains or losses are recorded in the shareholders’ equity account. As of June 30, 2005, the balance of the unrealized loss, net of federal income taxes, was $349,000, compared to an unrealized loss at year-end 2004 of $510,000. Generally, falling interest rates will increase the amount recorded as unrealized gain, and rising rates will decrease any unrealized gains, as the market value of securities inversely adjusts to the change in interest rates.

	Securities		Assets		Percentage of Assets
	(Dollars in thousands)
December 31, 2004	$	131,944	$	1,003,783		13	%
June 30, 2005	$	129,093	$	1,045,470		12	%

Security investments (available-for-sale and held-to-maturity) declined from their level as of the 2004 year-end, decreasing slightly less than $3 million over the last six months. With the securities purchased in 2004, we still believe the current size of our portfolio to be adequate, and do not anticipate additional securities purchases, other than the amount necessary to maintain the current portfolio level.

Loans

Loans receivable, excluding loans held-for-sale, increased by $33 million from $809 million at the 2004 year-end to $842 million at the end of the second quarter, as loan originations increased 11% over the second quarter of last year to $137 million. Income property loans accounted for 37% of our loan portfolio at the end of the second quarter, down 3% relative to the 2004 year-end and down from 43% as of June 2004. Business banking loans totaled 13% of the loan portfolio, unchanged compared to the 2004 year-end and 2% higher than a year ago, while commercial construction loans remained unchanged at 3% of loans. Single-family mortgage loans, generally non-conforming and including loans held-for-sale, increased to 24% of the portfolio at quarter-end, compared to 21% at the end of the second quarter last year and 22% as of the 2004 year-end. Single-family construction loans remained relatively consistent and accounted for 11% of total loans for this quarter and for the second quarter last year. Construction loans at year end 2004, however, were slightly lower at 10%. Consumer loans, largely home-improvement loans originated on a national scale through the Sales Finance Division, remained at 12% of the loan portfolio for the quarter which was unchanged compared to the 2004 year end but slightly higher than the 11% that was recorded for the first six months of 2004.

When taking into account our expected production volumes, payoffs, and loan sales for all lending divisions, we expect loan growth in the range of $0-$5 million for the third quarter of 2005. The anticipated increase in commercial loan sales is projected to offset the loan growth in the other business lines.

Servicing Assets

Servicing assets grew by $557,000 or 36%, in the six-month period ending June 30, 2005. Earlier this year, most of the growth in our servicing assets was attributable to sales of consumer loans originated by our Sales Finance lending area, as illustrated by the “Consumer” servicing assets line in the table below. For the quarter-ended June 30, 2005, however, sales of these loans were minimal relative to prior quarters, after we revised our loan sales strategy and decided to substantially reduce our loan sales, selling only sufficient volumes to ensure the continuity of the market. This strategy may be reevaluated and subject to further modification based on factors including, but not limited to future loan production and/or market conditions.

For the second quarter of 2005, the majority of the growth in our servicing assets was attributable to commercial loan sales, in particular, the sale of a large commercial real estate credit in June 2005 that included both the construction financing as well as the permanent mortgage to refinance that loan following the completion of construction.

	2Q 2005		1Q 2005		4Q 2004		3Q 2004
Servicing Assets:
Commercial	$	311,000	$	151,000	$	173,000	$	134,000
Residential		11,000		12,000		13,000		17,000
Consumer		1,760,000		1,730,000		1,339,000		1,085,000
Total	$	2,082,000	$	1,893,000	$	1,525,000	$	1,236,000

Loan Balances Serviced for Others	$	122,154,000	$	120,898,000	$	117,852,000	$	109,226,000

Servicing assets represent the deferred servicing rights generated from sales of loans that are sold servicing retained, offset by the amortization and prepayments of loans serviced, as well as any impairment charges that may occur. Although the increases in servicing assets have not been a major factor in our overall asset growth, this area is expected to continue increasing with the anticipated future sales of commercial loans.

Liabilities

In the first six months of this year, our total deposit balances rose 7% from their year-end levels, totaling $720 million at the end of the second quarter. Our checking and money market balances, however, declined $1 million from their 2004 year-end level as balances migrated from these accounts to time deposits earlier this year. This migration represented a departure from the trend observed over the last few years, in which growth of checking and money market balances accounted for the majority of all deposit growth. In the second quarter of 2005, however, the migration appears to have abated, as checking and money market balances grew $11 million, or 5%, between the ends of the first and second quarters.

The shift in balances in the first quarter from money market accounts to certificates of deposit occurred as the rate differential between the two product types began to widen. In 2004, while short-term interest rates remained at historically low levels, the rates offered on time deposits were only modestly higher than those on money market accounts, and consequently viewed by many investors as unattractive. As a result, these depositors often chose to keep their balances in money market accounts, accepting slightly lower yields in exchange for the greater liquidity offered by these accounts. Earlier this year, as the increases in short-term market interest rates that began in the second quarter of 2004 started affecting the yields on retail deposits, the rates paid on time deposits rose at a faster pace than those paid on money market accounts. This

resulted in time deposits becoming more attractive, making it more difficult to retain or grow checking and money market balances without incurring exorbitant marginal expense to do so, as any rate increases would apply not only to any newly opened accounts, but all existing balances as well. With checking and money market balances showing signs of recovery over the last couple months, we are not currently anticipating significant future migration from checking and money market accounts to time deposits.

Utilization of FHLB advances, our preferred supplemental funding mechanism, declined $6 million to $228 million for the six-month period ending June 30, 2005 as the deposit growth described above, along with retained earnings supported our asset growth. As of June 30, 2005, we had the authority to borrow up to a total of nearly $418 million in FHLB advances, subject to sufficient collateral to support those advances.

ASSET QUALITY

Provision and Reserve for Loan Loss

This quarter’s provision for reserve for loan losses, which was approved by the Audit Committee of the Board of Directors, was little changed from the second quarter 2004 level, increasing from $440,000 last year to $450,000 for the current quarter. The provision in the two previous quarters, the fourth quarter of 2004 and first quarter of 2005 were $350,000 and $400,000, respectively. The provision for loan losses reflects the amount deemed appropriate to produce an adequate reserve for possible loan losses inherent in the risk characteristics of the loan portfolio. In determining the appropriate reserve balance, we consider the amount and type of new loans added to the portfolio, our level of non-performing loans, the amount of loans charged-off, and the economic conditions in which we currently operate.

The provision for the second quarter is largely due to the inherent risks identified in the portfolio. Net portfolio loans totaled $832 million as of June 30, 2005, an increase of 6% from $785 million at the end of June last year. Also affecting the level of our reserve for loan losses were our net loan charge-offs, which totaled $231,000 for the quarter ended June 30, 2005, up substantially from the $161,000 level for the same quarter last year. On a sequential quarterly basis, the net charge-offs totaled $211,000 in the previous quarter and $206,000 in the fourth quarter of 2004. Due to their unique characteristics, our sales finance loans comprise the bulk of our loan write-offs, though they only constitute approximately 9% of the total loan portfolio. This pattern of sales finance loans representing the largest category of charge-offs is generally consistent with the trends that we have experienced in prior years. Please see the section, “Sales Finance (Home Improvement) Loans” for a further discussion of this business line.

Non-Performing Assets

Our non-performing assets declined from $1,154,000 at June 30, 2004 to $797,000 at the end of the second quarter of 2005. The current level of non-performing assets also improved relative to the year-end 2004 level of $1,007,000. The ratio of non-performing assets to total assets was 0.08% as of June 30, 2005, which compares to 0.10% at the end of 2004 and 0.12% as of June 30, 2004. By comparison, the ratio for all FDIC-insured institutions as of March 31, 2005 totaled 0.50%.*

* FDIC Quarterly Banking Profile, First Quarter 2005

Noted below is a summary of our exposure to non-performing loans and repossessed assets as of June 30, 2005:

Three single-family residences, one in Oregon, one in Idaho, and one in Washington. No anticipated loss.	$	461,000
Sixty-two consumer loans. Full recovery anticipated from insurance claims.		290,000
One consumer loan. No anticipated loss.		8,000
Six consumer loans. Possible loss of $34,000.		34,000

TOTAL NON-PERFORMING LOANS	$	793,000
TOTAL REAL ESTATE OWNED AND REPOSSESSED ASSETS		4,000
TOTAL NON-PERFORMING ASSETS	$	797,000

PORTFOLIO INFORMATION

Commercial Real Estate Loans

The average loan size (excluding construction loans) in the Commercial Real Estate portfolio was $753,000 as of June 30, 2005, with an average loan-to-value ratio of 63% (based upon the appraised value at origination or subsequent appraisal, if applicable). At quarter-end, none of these commercial loans were delinquent for 30 days or more. Small individual investors or their limited liability companies and business owners typically own the properties securing these loans. At quarter-end, the portfolio was 44% residential (multi-family or mobile home parks) and 56% commercial.

The loans in our commercial real estate portfolio are well diversified, secured by small retail shopping centers, office buildings, warehouses, mini-storage facilities, restaurants and gas stations, as well as other properties classified as general commercial use. To diversify our risk and to continue serving our customers, we sell participation interests in some loans to other financial institutions. About 14% of commercial real estate loan balances originated by the Bank have been sold in this manner. We continue to service the customer’s loan and are paid a servicing fee by the participant. Likewise, we occasionally buy an interest in loans originated by other lenders. About $12 million of the portfolio, or 3%, has been purchased in this manner.

Sales Finance (Home Improvement) Loans

Loan production for both the second quarter and first six months of 2005 was essentially unchanged over the same periods a year earlier, at $20 million and $36 million, respectively. However, due to a reduced level of loan sales during the second quarter, the portfolio increased by $7 million to $74 million. Prepayment speeds continue to remain in a range of between 30% and 40%, annually.

	Bank Portfolio Balance	Servicing Balance	Insured Balance (Bank Portfolio and Servicing Balance)
June 30, 2004	$67 million	$22 million	$39 million
September 30, 2004	$68 million	$31 million	$45 million
December 31, 2004	$69 million	$37 million	$48 million
March 31, 2005	$67 million	$44 million	$50 million
June 30, 2005	$74 million	$45 million	$53 million

During the second quarter 2005, the average new loan amount was $10,600. The average loan balance in the entire portfolio is $9,300. The yield on this portfolio is 9.94%, which has a net interest margin of 6.78%. Loans with principal balances representing 40% of the Bank’s portfolio balance have credit insurance in place, and 35% (by balance) of the loans originated in the second quarter were insured.

Noted below is the charge-off table for the uninsured portfolio and the claims experience table for the insured portfolio:

UNINSURED PORTFOLIO
	FMB Balance	Net Charge-Offs	Charge-offs as a Percent (%) of Portfolio	Delinquent Loans (% of FMB Portfolio)
June 30, 2004	$41 million	$136,000	0.33%	0.51%
September 30, 2004	$40 million	$ 71,000	0.18%	0.75%
December 31, 2004	$41 million	$100,000	0.24%	0.66%
March 31, 2005	$40 million	$141,000	0.35%	0.62%
June 30, 2005	$44 million	$147,000	0.33%	0.77%

INSURED PORTFOLIO
	Claims Paid	Claims as a Percent (%) of Insured Balance	Delinquent Loans (% of FMB Portfolio)
June 30, 2004	$315,000	0.89%	1.51%
September 30, 2004	$265,000	0.64%	2.11%
December 31, 2004	$492,000	1.06%	2.58%
March 31, 2005	$516,000	1.05%	2.75%
June 30, 2005	$359,000	0.70%	3.23%

Our portfolio at June 30, 2005, totaled $74 million, of which $30 million was insured. The $44 million of uninsured loans with an average credit score of 735 has performed at a fairly consistent level in terms of loan losses as a percent of the portfolio over the last five quarters, ranging from 0.18% to 0.35% during that time. The lower credit score insured portfolio, which has an average credit score of 669, has performed much differently. Losses incurred in that portfolio are submitted to our credit insurer for reimbursement. The claims experience in the last 12 months has ranged between 0.64% and 1.06% of insured balances. The delinquency ratios on the insured portfolio have ranged between 1.51% and 3.23% over the last five quarters.

Our contract with the credit insurer provides for a maximum exposure limit of 10% of the loan balances. Each year’s loan production that is insured is treated as a separate portfolio in terms of the 10% limit. The following table shows the June 30, 2005 standing of each policy year.

		Current	Original		Remaining	Limit as % of	Current
Policy	Loans	Loan	Loss	Claims	Loss	Remaining	Delinquency
Year	Insured	Balance	Limit	Paid	Limit	Balance	Rate
2002/03	$21,850,000	$11,500,000	$2,185,000	$1,547,000	$638,000	5.5%	4.30%
2003/04	$35,000,000	$23,700,000	$3,500,000	$880,000	$2,620,000	11.1%	5.12%
2004/05*	$19,850,000	$17,660,000	NA*	$9,000	NA*	NA*	1.37%
* Policy year closes on 9/30/2005

Our preference is that the remaining lifetime loss limit be at least 10% of the remaining balance of the loans from that policy year. Levels below 10% indicate a higher possibility that the remaining lifetime loss limit for that policy year could be extinguished, resulting in credit risk to the Bank on the loans remaining from that policy year. The first policy year has not performed to expectations. The underwriting approval criteria were tightened in 2004 in reaction to these trends, and the results for both the second and third policy year appear to reflect these changes positively. We are currently in discussions with an insurer about extending the insurance coverage on the first policy year beyond the 10% limit stated above.

Residential Lending

The residential lending portfolio totaled $283 million on June 30, 2005, and consisted of $162 million of adjustable-rate permanent loans (57% of the total), $4.4 million of fixed-rate permanent loans (2% of the total), $76 million of disbursed balances on custom construction loans (27% of the total), $34.7 million of loans on residential building lots (12% of the total), and $5 million of loans that are held for immediate sale in the secondary market (2% of the total). The portfolio has performed in an exceptional manner, and currently has only three loans, or 0.23% of loan balances, that are delinquent more than one payment.

The average loan balance in the permanent-loan portfolio is $189,000, and the average balance in the building lot portfolio is $113,000. Owner-occupied properties constitute 69% of the loan balances. Our portfolio program underwriting is typically described as non-conforming. The portfolio generally consists of loans that, for a variety of reasons, are not readily salable on the secondary market at the time of origination. The yield earned on the portfolio is generally much higher than the yield earned on a more typical “conforming underwriting” portfolio. We underwrite the permanent portfolio loans by focusing primarily on the borrower’s good or excellent credit and our overall exposure on the loan. We manually underwrite all loans and assess the loans for compensating factors to offset the non-conforming elements of those loans.

On June 30, 2005, we had $11 million of loans in the portfolio where the borrowers are making “interest only” payments on the loans until their first interest rate change date (at which time the loan converts to normal amortizing payments). This represents about 7% of the permanent residential lending portfolio. The loans with the interest-only feature are underwritten using a payment of full principal and interest in the calculation of monthly debts. This insures that loans are not made to borrowers who only qualify due to the interest-only payment feature on the loan. Although we believe that those loans are well underwritten, and to date our experience with those loans has been favorable, we recently made the decision to sell a majority of the interest-only loans to other investors. We are seeking buyers for the pool of loans currently on the books and for new originations. We do not originate the “Option ARM” product, where borrowers are given a variety of monthly payment options, which include the possibility of negative amortization.

As of June 30, 2005, we held about $1.7 million of low-documentation loans on our books (or approximately 1% of the permanent-loan portfolio). These loans allow lower levels of documentation to verify a borrower’s income or assets. Through a combination of the borrower’s equity in the property and the purchase of mortgage insurance on each individual loan, all low-documentation loans have a less than 70% loan-to-value exposure to the Bank. Until such time as we have an established track record with the performance of low-documentation residential mortgages, we have established a limit of 1% of the Bank’s loan portfolio for them.

Portfolio Distribution

The loan portfolio distribution at the end of the second quarter was as follows:

	Single Family (including loans held-for-sale)	24%
	Income Property	37%
	Business Banking	13%
	Commercial Construction	3%
	Single Family Construction:
	Spec	2%
	Custom	9%
	Consumer	12%

Adjustable-rate loans accounted for 90% of our total portfolio.

DEPOSIT INFORMATION

The number of business checking accounts increased by 19%, from 1,750 at June 30, 2004, to 2,088 as of June 30, 2005, a gain of 338 accounts. The deposit balances for those accounts grew 62%. Consumer checking accounts also increased, from 6,244 in the second quarter of 2004 to 7,183 this year, an increase of 939 accounts, or 15%. Our total balances for consumer checking accounts rose 16%.

The following table shows the distribution of our deposits.

	Time Deposits	Checking	Money Market Accounts	Savings
June 30, 2004	65%	12%	22%	1%
September 30, 2004	63%	13%	23%	1%
December 31, 2004	61%	14%	24%	1%
March 31, 2005	64%	13%	22%	1%
June 30, 2005	64%	14%	21%	1%

BUSINESS SEGMENTS

The reportable segments include the following:

·	Consumer Lending - Consumer lending includes home equity lending, direct consumer loans, and indirect home improvement loans (Sales Finance). These loans include lines of credit and loans for primarily consumer purposes.

·	Residential Lending - Residential lending offers loans to borrowers to purchase, refinance, or build homes secured by one-to-four-unit family dwellings. They also finance the purchase or refinance of buildable residential lots.

Business Banking Lending - Business Banking offers a full range of banking services to small and medium size businesses including deposit and cash management products, loans for financing receivables, inventory, equipment as well as permanent and interim construction loans for commercial real estate. The underlying real estate collateral or business asset being financed typically secures these loans.

Income Property Lending - Income Property Lending offers permanent and interim construction loans for multifamily housing (over four units), manufactured housing communities, commercial real estate properties, and spec single-family construction. The underlying real estate collateral being financed typically secures these loans.

Each of these business segments also sells loans into the secondary market. We may choose to retain or sell the right to service the loans sold (i.e. collection of principle and interest payments) depending upon market conditions.

Consumer Lending

	Quarter Ended						Six Months Ended
	Net Income			Return on Equity			Net Income			Return on Equity
June 30, 2005	$	127,000			5.40	%	$	514,000			11.45	%
June 30, 2004		201,000			10.29	%		569,000			14.40	%
June 30, 2003		(46,000	)		(3.15	%)		(120,000	)		(4.49	%)

Net income for the Consumer Lending segment totaled $127,000 and $514,000 for the quarter and six months ended June 30, 2005, representing declines of 37% and 10% relative to the comparable 2004 results. These declines were attributable to reductions in the segment’s net interest income combined with growth in noninterest expense. The impact of these changes was partially offset by additional noninterest income relative to the prior year.

The Consumer segment’s earning assets totaled nearly $117 million as of June 30, 2005, an increase of almost 10% over the prior year level. This represented a significant reduction from

the 29% earning asset growth achieved between June 30, 2003 and 2004. The decline in asset growth can be attributed to a combination of a slow down in the growth rate for originations of our sales finance (home improvement) loans and the increased sales of these loans from our portfolio.

Between late 2002 and late 2003, the vast majority of sales finance loans were retained within our portfolio. As loan production increased and the portfolio gained in size, we elected to utilize loan sales to manage that growth, with sales resuming in late 2003 and continuing through the present time. This resulted in a significant deceleration in earning asset growth in 2004 and 2005. In the second quarter of 2005, after evaluating the yields and credit history of these loans, we revised our plan such that we now expect to substantially reduce our sales of these loans, selling only sufficient volumes to ensure the continuity of the market. As a result, we expect these loans, which represented about 9% of our total loans at the quarter-end, will slowly grow as a percentage of total loans, and that our interest income will increase accordingly. This strategy may be reevaluated and subject to further modification based on factors including, but not limited to future loan production and/or market conditions.

With the slowdown in earning asset growth and the primarily fixed-rate nature of the loans in the portfolio, the Consumer Lending segment’s interest income only increased approximately 13% and 12% from the quarter and six months ended June 30, 2004.

By comparison, interest expense rose 58% and 46% relative to the quarter and six months ended June 30, 2004, based on increases in the retail deposit and wholesale funding rates, as well as the cost of the additional funds required to support the growth in earning assets. Funding costs bank-wide had declined over the 2002 to 2004 timeframe as rates on our time deposits gradually repriced at lower levels after market interest rate indexes fell between 2001 and 2003. Near the end of 2004, however, the rates paid on our deposits began to trend upwards. This upward movement accelerated earlier this year, as competition for deposits in our local market increased significantly, pushing time-deposit rates substantially higher. These effects were then compounded as we observed balances moving from our lower cost checking and money market accounts to higher rate certificates.

As a result of these conditions the Consumer segment’s net interest income declined approximately $49,000 and $18,000 from the levels in the second quarter and first half of 2004. Following a reduction in the provision for loan loss of $2,000 for the second quarter, and an increase of $41,000 for the first half, the segment’s net interest income after provision declined $47,000 and $58,000 relative to the same periods in 2004.

The segment’s noninterest income rose 62% for the second quarter and 97% on a year-to-date basis, due primarily to a significant increase in service fee income. Servicing fees earned on the consumer loans serviced for others totaled $341,000 and $641,000 for the quarter and six months ended June 30, 2005, up from $65,000 and $88,000 for the same periods in 2004. This increase in consumer loan service fees was attributable in large part to a change in the amortization period assumed for the underlying servicing asset.

Servicing assets are recorded when we sell loans from our portfolio to other investors, and continue to service those loans for the investors following the sale. To determine the fair value of the servicing assets, we utilize a valuation model that calculates the present value of future cash flows for the loans sold based on assumptions including market discount rates, anticipated prepayment speeds, estimated servicing cost per loan, and other relevant factors. These factors

are subject to significant fluctuations, and the estimates used in the models are subject to review and revision based on actual experience and changes in expectations for the future. The calculated value of the servicing rights is then capitalized and amortized in proportion to, and over the period of, estimated future net servicing income.

Any projection of servicing asset amortization in future periods is limited by the conditions that existed at the time the calculations were performed, and may not be indicative of actual amortization expense that will be recorded in future periods.

In addition to the effects of this change, the income received for servicing consumer loans has grown as a result of the increased level of sales finance loan sales over the last several quarters, and corresponding growth in our portfolio of consumer loans serviced for others. Based on our decision to reduce sales of consumer loans in the future and instead retain a greater percentage of these loans within our portfolio, the rapid growth in fee income earned on the portfolio of serviced consumer loans in recent quarters is not expected to continue in future quarters.

With gains of $201,000 in the second quarter, consumer loan sales remained a major contributor to the Consumer segment’s profitability. While this represented a 22% decline from the gains realized in the second quarter of 2004, our pricing and execution improved, as the volume of loans sold declined 34% to $5.0 million, versus $7.6 million in the second quarter of last year. Similarly, through the first six months of 2005, gains on consumer loan sales increased $170,000, or 32%, despite the volume of loans sold increasing less than 3%. As noted above, in the second quarter of this year, we revised our plan such that we now expect to substantially reduce our sales of these loans.

The Consumer Lending segment’s noninterest expense increased $299,000, or 21% in the second quarter of 2005 compared to the prior year, attributable primarily to higher administrative and support costs allocated to this segment. Included in these allocated costs are expenses related to our Consumer Loan Administration and Asset Management departments. The Consumer Loan Administration and Asset Management expenses allocated to this segment have risen based on the increased efforts required to manage the growing sales finance portfolio, including those loans serviced for others.

For the six months ended June 30, 2005, noninterest expense increased $752,000, or 29% relative to the prior year. In addition to the allocated expenses described above, credit insurance premium expense on the insured part of our sales finance portfolio contributed significantly to the increase. The insurance premium expense pertains to a credit insurance policy which insures us against default risk on sales finance loans to borrowers with credit scores below 720, and has risen as our portfolio of insured loans has increased in size. This insurance contract contains a variable premium that ranges between a low of 0.60% and a ceiling of 2.70% (as an annualized percentage of the outstanding insured balances). We expect a premium of 2.70%, though the final premium will be determined at a later date based on our actual loan loss history. While

there is the possibility that our loss experience in the future will be more favorable, in which case we could receive a rebate on premiums paid, we do not at this time anticipate any future rebates.

Residential Lending

	Quarter Ended					Six Months Ended
	Net Income		Return on Equity			Net Income		Return on Equity
June 30, 2005	$	870,000		25.07	%	$	1,617,000		24.57	%
June 30, 2004		750,000		28.80	%		1,384,000		27.35	%
June 30, 2003		456,000		26.49	%		901,000		27.42	%

Net income for the Residential Lending segment totaled $870,000 for the second quarter of 2005, representing a 16% increase over the second quarter of 2004. Through the first six months of this year, net income of $1.6 million exceeded the prior year’s mark by nearly 17%. The increase in net income resulted from growth in both net interest and noninterest income, which was partly offset by rising operating expenses.

Earning assets for the Residential segment totaled $327 million as of June 30, 2005, a 19% increase over the June 30, 2004 level. With these additional assets, interest income earned on the portfolio totaled $5.1 million and $9.7 million for the three and six months ended June 30, 2005, representing increases of 30% and 29% over the same periods last year. Interest expense, however, rose 44% and 40% relative to the second quarter and first half of last year due to the rising funding rates described above and the cost of the additional funds required to support the earning asset growth. The increase in funding costs, combined with $10,000 and $36,000 increases in the quarterly and year-to-date provisions for loan losses, reduced the overall increase in the Residential segment’s net interest income after provision to approximately 21% over both the second quarter and first half 2004 levels.

The Residential Lending segment’s noninterest income increased $121,000 and $161,000, or 64% and 45%, relative to the second quarter and first half of 2004, based largely on higher loan fees, particularly prepayment fees. In recent quarters, short-term interest rates have continued to rise, while longer-term interest rates, such as the 10-year U.S. Treasury rate, which are more indicative of mortgage rates, have tended to move within a range and without any discernible upward or downward tendency. Combined, these movements have resulted in a flattening of the yield curve. We believe that this flattening, and expectations that rates could move upwards in the foreseeable future, have contributed to the higher level of loan payoffs and prepayment fees observed over the last several quarters. As this flattening of the yield curve reduces the rate differential between short- and long-term financing costs, the financial incentive for borrowers to use shorter-term, adjustable-rate financing rather than longer-term, fixed-rate loans diminishes. This, in turn, provides borrowers with short-term or adjustable-rate loans with an incentive to refinance with long-term fixed rates. Given the uncertainties in interest rates and borrower expectations, we do not know if the higher level of prepayment fee income is likely to continue.

Partially offsetting this year’s income growth were increases of $445,000 and $750,000, or 31% and 27% in the Residential segment’s noninterest expense. Among the segment’s direct expenses, the most significant contribution to the increase was additional compensation expense, particularly incentive compensation, driven by higher loan officer commissions resulting from increased loan production volumes, along with incentive compensation accrued for

administrative and support personnel in the second quarter. Also contributing to the additional expense in 2005 were rising administrative and other allocated costs. The administrative costs include expenses for both general corporate activities, which are allocated to all the business segments, as well as loan servicing and administration costs attributable to the Residential Lending segment’s originations and portfolio management. Other allocated expenses included expenses incurred at the banking centers and allocated to the Residential Lending segment. These allocations have increased with the growth of the Residential segment.

Business Banking Lending

	Quarter Ended						Six Months Ended
	Net Income			Return on Equity			Net Income			Return on Equity
June 30, 2005	$	58,000			2.15	%	$	3,000			0.06	%
June 30, 2004		(173,000	)		(9.55	%)		(209,000	)		(5.63	%)
June 30, 2003		1,000			0.05	%		15,000			0.46	%

Our Business Banking segment is one of the newer business lines in which we have invested, and continue to invest our resources with the eventual goal of achieving our targeted 15% return on equity and consistent year-over-year earnings growth. At this time, these results have not yet been achieved, nor do we anticipate reaching these goals in 2005. We continue to invest in this segment, however, based upon its ability to attract low-cost core deposits, which help reduce our overall cost of funds, the diversification it brings to our portfolio of earning assets, and the potential it offers for generating longer-term relationship-banking opportunities and additional sources of noninterest income.

For the quarter and six months ended June 30, 2005, the Business Banking segment’s net interest income after provision for loan losses rose $462,000 and $909,000, or 49% and 48%, relative to the same periods in 2004. These were the highest percentage net interest income increases among our four business lines, and the second highest dollar increases behind the Residential Lending segment. Like the Consumer and Residential segments, the Business Banking segment succeeded in building incremental assets over the second quarter of last year, with earning assets totaling nearly $132 million as of June 30, 2005, an increase of 32% over the level one year earlier.

Also contributing to the increase in interest income was the prevalence of prime-based loans in the business banking portfolio. Most of the adjustable-rate loans in our portfolio reprice according to contractually defined schedules, most commonly on an annual basis. The rates on prime-based loans, on the other hand, typically adjust in response to any change in the prime rate. Consequently, these loans reprice within days of any change to the index, rather than at a specified reset date potentially months into the future, and may reprice on several occasions over the course of the year, as has been the case over the last 12 months.

Noninterest income for the Business Banking segment increased dramatically, up $193,000 for the quarter and $207,000 for the first half of 2005 relative to the prior year, driven by a $151,000 gain on the sale of a commercial real estate credit that included both the construction financing as well as the permanent mortgage to refinance that loan following the completion of construction. Given the unique nature of this transaction, we cannot predict the probability that similar deals could occur in the future. Also contributing to the segment’s noninterest income

growth has been the expansion of the Business Banking segment’s deposit base, measured by both total deposit balances as well as the number of open accounts. Fee income earned on these additional deposits has contributed to the improvement in noninterest income, and is expected to generate additional noninterest income for the segment in the future.

Partially offsetting the additional net interest and noninterest income, however, were an additional $306,000 in noninterest expense for the quarter and $794,000 for the six-month period relative the prior year. The primary drivers of the additional noninterest expense were increases in compensation expense, particularly loan officer commissions and other incentive compensation, as well as expenses from our retail banking centers allocated to the Business Banking segment. The additional compensation expense was due to a combination of a return to a normal level of loan officer commissions this year, compared to a below average level of expense in early 2004, along with incentive compensation accrued for administrative and support personnel in the second quarter. The expenses from our retail banking centers allocated to the Business Banking segment have increased largely as a result of the strong growth of our business checking and other commercial deposit accounts.

Income Property Lending

	Quarter Ended					Six Months Ended
	Net Income		Return on Equity			Net Income		Return on Equity
June 30, 2005	$	1,462,000		19.17	%	$	2,968,000		19.53	%
June 30, 2004		1,408,000		19.23	%		2,757,000		19.06	%
June 30, 2003		1,618,000		22.65	%		3,322,000		23.32	%

For the second quarter and first six months of 2005, the Income Property segment’s net income rose 4% and 8% from its respective 2004 levels following relatively modest increases in net interest and noninterest income and operating expenses.

The segment’s net interest income after provision for loan loss rose $39,000, or 1%, for the quarter and $330,000, or 4% for the year-to-date period relative to 2004, based on 9% and 10% interest income growth and offsetting 24% and 20% increases in interest expense. The Income Property segment has not benefited from the sort of year-over-year earning asset growth exhibited by the other segments, and instead saw its earning assets fall to $419 million as of June 30, 2005, a decline of 6% relative to June 30 of last year. The decline was largely attributable to higher than expected prepayments on the loan portfolio, likely motivated by the same factors described above in the Residential segment section, though the segment did conduct some loan sale activity in the second quarter, following no loan sales in the first quarter of this year.

Historically, the commercial loans we originate have been retained in our portfolio, and sales of participations in these loans have been utilized for the purpose of limiting our aggregate credit exposure to specific borrowers. During the second quarter, however, we experienced increased interest in, and opportunities for, sales of commercial loan participations. Consequently, we are currently considering the merits of expanding our commercial loan sales and potentially originating credits with the intent to sell, rather than portfolio the loans. Specifically, we would continue to portfolio those income property loans that meet our credit standards and our pricing hurdles, while seeking opportunities to earn fees by selling those income property loans we choose not to portfolio. In the event we determine that such a strategy would be more favorable

than our historical practice, we would likely increase our sales of commercial loans, which could potentially lead to a further reduction in the size of our Income Property segment’s loan portfolio. We do not anticipate that these potential sales would impact the other three segments, where we would expect the loan portfolios to continue to grow.

Noninterest income for the Income Property segment increased $96,000 and $20,000, or 35% and 4%, relative to the second quarter and first half of 2004. As with the Residential segment, higher loan fees, and specifically prepayment fees, were responsible for much of the increase relative to the prior year levels.

In contrast to the other business segments, noninterest expense for the Income Property segment exhibited little change compared to the same timeframe last year, increasing $53,000, or 3% for the quarter and $30,000, or less than 1% for the first six months of the year. As noted above, the asset growth exhibited by the other business lines was not observed with the Income Property segment. Instead, the Income Property segment remained relatively static as the other business lines grew their operations and became larger components of our overall asset mix.

Consequently, for a number of different expenses that we allocate out to the business segments, such as banking center and administrative costs, the percentages allocated to other business lines increased with their activity and asset balances, and reduced the percentage allocated to the Income Property segment relative to last year.

For the remainder of 2005, we expect to see the Income Property segment’s noninterest expenses increase relative to the levels for the same periods in 2004 based on recent investment in the business line. In recent months, we successfully recruited experienced lending officers to replace personnel that left the Bank over the course of 2004. Additionally, in April 2005, we hired a new manager for this business line. This hiring will allow a senior-level officer, who previously divided his time between loan production and managing the segment, to focus entirely on loan production and growing the segment’s earning assets. We anticipate that these changes will result in higher noninterest expense for the segment beginning in the near future.

LIQUIDITY

Our primary sources of liquidity are loan and security sales and repayments, deposits, and wholesale funds. A secondary source of liquidity is cash from operations, which, though not a significant source of liquidity, is a consistent source based upon the quality of our earnings. Our principal uses of liquidity are the origination and acquisition of loans and securities. Liquidity is also used to purchase facilities and equipment.

During the second quarter of 2005, we originated $137 million in loans and purchased no securities.

	2Q 2005		2Q 2004		YTD 2005		YTD 2004
	(Dollars in thousands)
Loan Originations (disbursed)	$	137,000	$	123,000	$	255,000	$	226,000
Security Purchases		0		33,000		6,000		43,000
Draws on Lines of Credit		4,000		1,000		11,000		5,000
Total Originations and Purchases		141,000		157,000		272,000		274,000

Loan and Security Repayments	$	103,000	$	78,000	$	186,000	$	125,000
Sales of Securities		0		0		0		2,000
Sales of Loans		12,000		23,000		30,000		49,000
Total Repayments and Sales		115,000		101,000		216,000		176,000

Net Difference	$	26,000	$	56,000	$	56,000	$	98,000

Loan and security sales and repayments, our primary sources of funding, are heavily influenced by trends in mortgage rates. When rates trend downward, our prepayment speeds typically increase as borrowers refinance their loans at lower interest rates. Conversely, as rates move upwards, prepayments will generally tend to slow, as fewer borrowers will have a financial incentive to refinance their loans. The loan portfolio, excluding loans sold into the secondary market and spec construction loans, experienced an annualized prepayment rate of 34% in the first six months of 2005, compared to 30% for the same period one year earlier.

Movements in rates and the resulting shape of the yield curve have likely contributed to the sustained high prepayment levels. As short-term rates continued to rise in the second half of 2004 and the first half of 2005, longer-term rates initially declined and then tended to move within a fairly narrow range, with no discernible upward or downward tendency. This increase in short-term rates and decline in longer-term rates resulted in a flattening of the yield curve, which continued into the second quarter of 2005. With this flattening, the rate differential between short- and long-term financing diminished, thus reducing the financial incentive for borrowers to use shorter-term, adjustable-rate financing rather than longer-term, fixed-rate loans. This, in turn, provides borrowers with short-term or adjustable-rate loans with an incentive to refinance with long-term fixed rates. We believe this situation contributed to the acceleration in prepayments observed in the second half of 2004 and sustained the higher prepayment rates observed in the first half of 2005.

Our preferred method of funding the net difference between originations/purchases and repayments/sales is with deposits. To the extent that deposit growth is insufficient to fully fund the difference, we may rely on wholesale funding sources including, but not limited to FHLB advances, brokered certificates of deposit, and reverse repurchase agreements. During the second quarters of 2004 and 2005, growth in funds from deposits and borrowings were as follows:

	2Q 2005			2Q 2004		YTD 2005			YTD 2004
	(Dollars in thousands)
Deposits	$	28,000		$	30,000	$	44,000		$	47,000
Advances		(5,000	)	$	20,000		(6,000	)	$	51,000
Total	$	23,000		$	50,000	$	38,000		$	98,000

The inflow of deposits varies from period to period, and our ability to raise liquidity from this source is dependent on our effectiveness in competing with other financial institutions in our local market. That competition tends to focus on rate and service. Although we control the quality of service that we provide, we have no control over the prevailing rates in our marketplace.

Our other major source of liquidity is wholesale funds, which include borrowings from the FHLB, brokered deposits, reverse repurchase agreements, and a revolving line of credit at the Holding Company level. We rely significantly upon these wholesale funds as sources of liquidity, as doing so allows us to avoid maintaining balances of lower-yielding assets for liquidity requirements.

Our most utilized wholesale funding source is FHLB advances, which totaled $228 million at June 30, 2005 and $234 million at December 31, 2004. Our credit line with the FHLB is reviewed annually, and our maximum allowable borrowing level is currently set at 40% of assets or $418 million. As a percentage of period-ending assets, our FHLB borrowings totaled 22% on June 30, 2005 and 23% at the end of 2004. Potential risks associated with this funding source include the reduction or non-renewal of the line and insufficient collateral to utilize the line. We try to mitigate the risk of non-renewal of the line by maintaining the credit quality of our loans and securities and attending to the quality and consistency of our earnings. We presently have sufficient collateral to meet our anticipated 2005 funding needs.

Brokered deposits, which are included in the deposit totals, amounted to $40 million at the 2004 year-end and $41 million as of June 30, 2005. Internal policies limit our total usage of these deposits to no more than 10% of all deposits, and we currently have no plans to substantially increase our use of these deposits.

Reverse repurchase lines are lines of credit collateralized by securities. We have lines totaling $60 million, of which the full amount is currently available. There has been no usage of these lines in the previous three years. The risks associated with these lines are the withdrawal of the line based on credit standing of the Bank and the potential lack of sufficient collateral to support the lines.

An additional source of liquidity has been our cash from operations, which, though not a significant source of liquidity, is a consistent source based upon the quality of our earnings. On a very limited basis it can be viewed as cash from operations adjusted for items such as the provision for loan loss and depreciation. See the “Consolidated Statements of Cash Flows” in the financial statements section of this filing for a calculation of net cash provided by operating activities.

In addition to using liquidity to fund loans and securities, we routinely invest in facilities and equipment. In the first half of 2005, we invested $3.9 million in these assets, up from $1.1 million in the first half of 2004.

In July 2005, based on our consistent earnings growth, we determined that we could increase our quarterly cash dividend payout and still retain sufficient liquidity and capital to fund further growth. Consequently, on August 1, 2005, we announced an 11% increase in our quarterly cash dividend to $0.10 per share. The dividend is payable on October 5, 2005, to shareholders of record September 14, 2005.

PLANNED EXPENDITURES FORPLANT AND EQUIPMENT

In 2005 we have completed the interior remodel of one banking center, completed the construction of another, and in third quarter will complete an exterior and interior remodel on a third banking center. With the completion of these, we do not anticipate the need for any further banking center remodels. In 2004 we also completed two land acquisitions, one in West Seattle for $1,046,000 and one in Canyon Park for $1,356,000. We anticipate construction of our new West Seattle banking center to begin in third quarter, 2005. It is possible that construction on our Canyon Park banking center can begin as early as fourth quarter, 2005, but more likely will begin in first quarter, 2006. In 2004 we also began a maintenance and upgrade plan for our seven-story corporate headquarters, and we anticipate these plans will be completed by fourth quarter, 2005. We estimate that the expenditures in the next two quarters will range from $3.0 million to $4.5 million depending on what projects are initiated this year and the extent to which the existing facilities are remodeled.

We review the utilization of our properties on a regular basis and believe that we have adequate facilities for current operations. We may open new banking centers from time-to-time, depending on the availability of capital resources and the locations potential for growth and profitability.

We regularly analyze demographic and geographic data as well as information regarding our competitors and our current loan and deposit customers in order to locate potential future Bank sites.

CAPITAL

The FDIC’s statutory framework for capital requirements establishes five categories of capital strength, ranging from a high of well capitalized to a low of critically under-capitalized. An institution’s category depends upon its capital level in relation to relevant capital measures, including a risk-based capital measure, a leverage capital measure, and certain other factors. At June 30, 2005, we exceeded the capital levels required to meet the definition of a well-capitalized institution:

			Minimum to be
			Categorized as “Well
		Minimum for	Capitalized” Under
		Capital	Prompt Corrective
	Actual	Adequacy Purposes	Action Provisions
Total capital (to risk-weighted
assets):
First Mutual Bancshares, Inc.	12.12%	8.00%	N/A
First Mutual Bank	11.75	8.00	10.00

Tier I capital (to risk-weighted
assets):
First Mutual Bancshares, Inc.	10.87	4.00	N/A
First Mutual Bank	10.50	4.00	6.00

Tier I capital (to average assets):
First Mutual Bancshares, Inc.	7.53	4.00	N/A
First Mutual Bank	7.40	4.00	5.00

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is defined as the sensitivity of income and capital to changes in interest rates, and other relevant market rates or prices. Our profitability is largely dependent on our net interest income. Consequently, our primary exposure to market risk arises from the interest rate risk inherent in our lending, mortgage banking, deposit, and borrowing activities. Interest rate risk is the risk to earnings or capital resulting from adverse movements in interest rates. To that end, we actively monitor and manage our exposure to interest rate risk.

A number of measures are utilized to monitor and manage interest rate risk, including net interest income and economic value of equity simulation models, as well as traditional “gap” models. We prepare these models on a monthly basis for review by our Asset Liability Committee (ALCO), senior management, and Board of Directors. The use of these models requires us to formulate and apply assumptions to various balance sheet items. Assumptions regarding interest rate risk are inherent in all financial institutions, and may include, but are not limited to, prepayment speeds on loans and mortgage-backed securities, cash flows and maturities of financial instruments held for purposes other than trading, changes in market conditions, loan volumes and pricing, deposit sensitivities, consumer preferences, and management’s capital leverage plans. We believe that the data and assumptions used for our models are reasonable representations of our portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, these assumptions are inherently uncertain; therefore, the models cannot precisely estimate net interest income or predict the impact of higher or lower interest rates on net interest income. Actual results may differ significantly from simulated results due to timing, magnitude, and frequency of interest rate changes, and changes in market conditions and specific strategies, among other factors.

Asset and Liability Management

Our primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on our net interest income and capital, while structuring the asset and liability components to maximize net interest margin, utilize capital effectively, and provide adequate liquidity. We rely primarily on our asset and liability structure to control interest rate risk.

Asset and liability management is the responsibility of the Asset Liability Committee, which acts within policy directives established by the Board of Directors. This committee meets regularly to monitor the composition of the balance sheet, to assess projected earnings trends, and to formulate strategies consistent with the objectives for liquidity, interest rate risk, and capital adequacy. The objective of asset/liability management is to maximize long-term shareholder returns by optimizing net interest income within the constraints of credit quality, interest rate risk policies, levels of capital leverage, and adequate liquidity. Assets and liabilities are managed by matching maturities and repricing characteristics in a systematic manner.

Hedging Techniques

We review interest rate trends on a monthly basis and employ hedging techniques where appropriate. These techniques may include financial futures, options on financial futures, interest rate caps and floors, interest rate swaps, and extended commitments on future lending activities. Typically, the extent of our off-balance-sheet derivative agreements has been the use of forward loan commitments, which are used to hedge our loans held-for-sale.

Additionally, in 2002 we entered into an interest rate swap with the FHLB. The purpose of the swap was to protect against potential adverse interest rate volatility that could be realized from the Trust Preferred Securities (TPS) issued in June 2002. The swap accomplished this by fixing the interest rate payable for the first five years of the TPS’ life.

Net Interest Income (NII) and Economic Value of Equity (EVE) Simulation Model Results

	June 30, 2005		December 31, 2004
	Percentage Change		Percentage Change
Change in Interest Rates	Net Interest	Economic Value	Net Interest	Economic Value
(in basis points)	Income	Of Equity	Income	Of Equity
+200	(0.87%)	0.70%	0.89%	(2.51%)
+100	n/a	1.38%	n/a	(0.40%)
-100	n/a	(3.65%)	(1.26%)	(1.26%)
-200	(0.48%)	(9.45%)	*	*

* Because a large percentage of our loan portfolio is tied to indexes that were at very low levels as of December 31, 2004, the downward 200 bps scenario was not computed at that time.

Net Interest Income Simulation

The results of our income simulation model constructed using data as of June 30, 2005 project modest declines in our net interest income from its “base case” level in scenarios in which interest rates are assumed to gradually increase or decline by 200 bps over a 12-month period. The magnitudes of the changes, however, suggest that there is little sensitivity in net interest income from the “base case” level over a 12-month horizon, as an impact of 0.48% was indicated in the falling rate scenario, and 0.87% in the rising rate environment.

The changes indicated by the simulation model represent variances from a “base case” scenario, which is a projection of net interest income assuming interest rates remain unchanged from their current levels over the life of the forecast, and that the size of the balance sheet remains stable over the forecast timeframe, with no growth or contraction regardless of interest rate movements. The base model will, however, illustrate the future effects of rate changes that have already occurred but have not yet flowed through to all the assets and liabilities on our balance sheet. These changes can either increase or decrease net interest income, depending on the timing and magnitudes of those changes. Additionally, the tendencies for loan and investment prepayments to accelerate in falling interest rate scenarios and slow when interest rates rise have been incorporated into the model assumptions. Implicit in these assumptions are additional assumptions for increased securities purchases and loan originations at lower interest rate levels to offset accelerated prepayments, and conversely, reduced securities purchases and loan production when rates increase and prepayments slow.

The rising and falling rate ramp scenarios then indicate that if the slope of the yield curve remains the same, and customer loan and deposit preferences do not change in response to additional parallel movements of the yield curve, then a parallel 200 basis point increase or decrease in rates will not significantly degrade net interest income from what is presently expected in the “base case.” In the event the simulation model indicated that the increase or decrease in interest rates over the following 12 months would adversely affect our net interest income over the same period by more than 10% relative to the “base case” scenario, we would consider the indicated risk to have exceeded our internal policy limit.

Economic Value of Equity (EVE) Simulation

The EVE analysis goes beyond simulating net interest income for a specified period to estimating the present value of all financial instruments in our portfolio and then analyzing how the economic value of the portfolio would be affected by various alternative interest rate scenarios. The portfolio’s economic value is calculated by generating principal and interest cash flows for the entire life of all assets and liabilities, then discounting these cash flows back to their present values. The assumed discount rate used for each projected cash flow is based on a current market rate, such as a LIBOR, FHLB, or swap curve rate, and from alternative instruments of comparable risk and duration. In the event the simulation model demonstrates that a 200 basis point increase or decrease in rates would adversely affect our EVE by more than 25%, we consider the indicated risk to have exceeded our internal policy limit. Again, as illustrated in the above results, we are operating within the 25% internal policy limit in both the rising and falling rate scenarios.

In the simulated 200 bps upward shift of the yield curve, the discount rates used to calculate the present values of assets and liabilities will increase, causing the present values of both assets and liabilities to fall, with more prominent effects on longer-term, fixed-rate instruments. Additionally, when interest rates rise, the cash flows on our assets are typically expected to decelerate as borrowers become less likely to prepay their loans. As the cash flows on these assets are shifted further into the future, their present values are further reduced. Our EVE simulation model results as of June 30, 2005 indicate that our assets would be expected to exhibit less sensitivity to the effects of rising rates than would liabilities, with the economic value of assets declining by an estimated 2.39%, compared to a decline of 2.77% for our liabilities. Given the lesser sensitivity, the reduction in the economic value of liabilities was greater than the impact on assets. Consequently, the economic value of our equity was positively impacted in this scenario, increasing 0.70%.

The opposite occurs when rates decline, as the discount rates used to calculate the present values of assets and liabilities will decrease, causing the present values of both assets and liabilities to rise. Counteracting this effect for assets, however, is the tendency for cash flows from assets to accelerate in a falling rate scenario, as borrowers refinance their existing loans at lower interest rates. These loan prepayments prevent the present values of these assets from increasing in a declining rate scenario, illustrating an effect referred to as negative convexity. Taking this negative convexity into account, the simulation results indicated a negative impact to EVE in the falling rate scenario. In this case, the economic values of both assets and liabilities at June 30, 2005 were positively impacted when rates were assumed to fall by 200 bps, assets by 1.71% and liabilities by 3.07%. As a result, with the value of liabilities rising more than asset values, our economic value of equity was negatively impacted in this scenario, declining 9.45%.

The Net Interest Income and Economic Value of Equity sensitivity analyses do not necessarily represent forecasts. As previously noted, there are numerous assumptions inherent in the simulation models as well as in the gap report, including the nature and timing of interest levels, the shape of the yield curve, loan and deposit growth, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, customer preferences, and competitor and economic influences.

Gap Model

In addition to the above simulation models, an interest “gap” analysis is used to measure the matching of our assets and liabilities and exposure to changes in interest rates. This model, which represents a traditional view of interest rate sensitivity, quantifies the mismatch between assets maturing, repricing, or prepaying within a period, and liabilities maturing or repricing within the same period. A gap is considered positive when the amount of interest-rate-sensitive assets exceeds the amount of interest-rate-sensitive liabilities within a given period. A gap is considered negative in the reverse situation.

Certain shortcomings are inherent in gap analysis. For example, some assets and liabilities may have similar maturities or repricing characteristics, but they may react differently to changes in interest rates. This illustrates a facet of interest rate exposure referred to as “basis risk.” Additionally, assets such as adjustable-rate mortgage loans may have features that limit the effect that changes in interest rates have on the asset in the short-term and/or over the life of the loan, for example a limit on the amount by which the interest rate on the loan is allowed to adjust each year. This illustrates another area of interest rate exposure referred to as “option risk.” Due to the limitations of the gap analysis, these features are not taken into consideration. Additionally, in the event of a change in interest rates, prepayment and early withdrawal penalties could deviate significantly from those assumed in the gap calculation. As a result, we utilize the gap report as a complement to our income simulation and economic value of equity models.

Our 12-month interest rate sensitivity gap, expressed as a percentage of assets, fell from a positive, or asset sensitive 2.6% at December 31, 2004 to a negative, or liability sensitive 3.9% at the end of the second quarter. These results indicated that more liabilities than assets were expected to mature, reprice, or prepay within the 12 months, whereas the opposite was true at the year-end.

One Year Interest Rate Sensitivity Gap

(Dollars in thousands)

	June 30, 2005			December 31, 2004

One-Year Repricing/Maturing Assets	$	696,013		$	665,665
One-Year Repricing/Maturing Liabilities		736,713			639,430

One-Year Gap		(40,700	)		26,235

Total Assets	$	1,045,469		$	1,012,783
(Dec. 31, 2004 figure includes a $9 million off-balance-sheet item)

One-Year Interest Rate Gap as a Percentage of Assets		(3.9	%)		2.6	%

The significant factors contributing to the reduction in our 12-month gap ratio since the year-end have been the continued popularity of our 13-month time deposit and 15-month “bump” certificate with our deposit customers, and the rolling of existing time deposits and FHLB advances from expected terms to maturity or repricing of more than 12 months to within the 12-month timeframe.

Through the first half of 2005, the most significant growth among time deposit maturities was observed in our 13-month product, balances of which increased from little more than $3 million at the 2004 year-end to over $70 million at June 30, 2005. Based on the term of these certificates, all balances except those originated in the most recent month will mature within the gap report’s 12-month horizon. Additionally, our 15-month “bump” time deposit has remained a popular option with our deposit customers, as balances in this product increased from $61 million at December 31, 2004 to $80 million at June 30, 2005. While these certificates are issued with a 15-month term to maturity, the depositor is granted an option to reprice the certificate to the prevailing 15-month certificate rate on one occasion at any time during those 15 months. For the purposes of the gap report, we assume that the majority of depositors will reprice their certificates within one year of issue. Consequently, the majority of these certificates are considered to be less than one-year instruments for gap purposes.

Also contributing significantly to the reduction in our gap ratio was the rolling of existing time deposits and FHLB advances from expected terms to maturity or repricing of more than 12 months to within the 12-month timeframe. While total FHLB advances declined modestly from the December 31, 2004 year-end, the volume of advances scheduled to mature or reprice within the following 12 months increased $36 million between the year-end and the end of the second quarter. A similar situation was observed with some of our time deposit products, as the balances of outstanding 13-month, 15-month “bump,” and 24-month certificates scheduled to mature within the next 12 months increased relative to the year-end levels.

A change in modeling procedure impacted the total asset base used for the gap ratio calculation by $9 million. As previously noted, in 2002 we entered into an interest rate swap agreement to fix the interest rate on our first trust preferred security issue for a period of five years. As of the December 2004 year-end, we classified the TPS as a variable rate liability, offset by the asset side of the swap, under which the Bank receives payments tied to the same quarterly adjustable-rate as the TPS issue. The other side of the swap, under which the Bank makes payments based on a fixed interest rate, was applied to the liability side of the gap report based on the remaining life of the swap. For the June 30, 2005 model, the fixed-payment side of the swap, formerly a $9 million liability, was moved to the asset side as a $9 million contra-asset. As a result of this modification, our asset base for gap purposes now corresponds to the level of total assets reflected on our financial statements, rather than exceeding that amount by the $9 million notional principal of the swap.

The greater increase of liabilities maturing or repricing in the next 12 months versus assets resulted in a net $67 million reduction in our dollar gap, which led to the decline in the one-year gap ratio from 2.6% to (3.9%) of total assets.

ITEM 3

The following table sets forth certain information regarding carrying values and percentage of total carrying values of the Bank's consolidated portfolio of securities classified as available-for-sale and held-to-maturity (dollars in thousands).



	June 30,
	2005					2004
Available-for-Sale:	Carrying Value		Percent of Total			Carrying Value		Percent of Total

US Government Treasury and agency obligations	$	17,975		15	%	$	10,816		10	%
Mortgage backed securities:
Freddie Mac		17,805		14	%		16,013		14	%
Ginnie Mae		49,605		41	%		44,227		39	%
Fannie Mae		36,044		30	%		41,344		37	%
Total mortgage-backed securities		103,454		85	%		101,584		90	%


Total securities available-for-sale	$	121,429		100	%	$	112,400		100	%



	June 30,
	2005					2004
Held-to-Maturity:		Carrying Value		Percent of Total			Carrying Value		Percent of Total
				��
Municipal Bonds	$	1,200		16	%	$	1,278		15	%
Mortgage backed securities:
Freddie Mac		481		6	%		503		6	%
Fannie Mae		5,982		78	%		6,950		79	%
Total mortgage-backed securities		6,463		84	%		7,453		85	%

Total securities held-to-maturity	$	7,663		100	%	$	8,731		100	%

Estimated Market Value	$	7,754				$	8,818

ITEM 3A

The following table shows the maturity or period to repricing of the Bank's consolidated portfolio of securities available-for-sale and held-to-maturity (dollars in thousands):




	Available-for-sale at June 30, 2005
	One Year or Less					Over One to Three Years					Over Three to Five Years					Over Five to Ten Years					Over Ten to Twenty Years					Over Twenty Years					Total
	Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield
Available-for-Sale:

US Government Treasury and agency obligations	$	6,964		1.88	%	$	—		0.00	%	$	6,030		4.08	%	$	—		0.00	%	$	4,981		4.00	%	$	—		0.00	%	$	17,975		3.20	%
Mortgage backed securities:
Ginnie Mae		—		0.00	%		49,606		4.07	%		—		0.00	%		—		0.00	%		—		0.00	%							49,606		4.07	%
Freddie Mac		291		4.10	%		—		0.00	%		6,003		3.74	%		3,531		4.60	%		7,980		4.50	%		—		0.00	%		17,805		4.26	%
Fannie Mae		518		4.47	%		—		0.00	%		692		5.50	%		4,143		4.12	%		30,691		4.30	%		—		0.00	%		36,044		4.30	%
Total mortgage-backed securities		809		4.34	%		49,606		4.07	%		6,695		4.23	%		7,674		4.34	%		38,671		4.34	%		—		0.00	%		103,455		4.20	%


Total securities available-for-sale -- Carrying Value	$	7,773		2.13	%	$	49,606		4.07	%	$	12,725		4.00	%	$	7,674		4.34	%	$	43,652		4.30	%	$	—		0.00	%	$	121,430		4.04	%

Total securities available-for-sale -- Amortized Cost	$	7,777		2.12	%	$	49,733		4.07	%	$	12,773		3.99	%	$	7,703		4.34	%	$	43,972		4.30	%						$	121,957		4.04	%



	Held-to-Maturity at June 30, 2005
	One Year or Less					Over One to Three Years					Over Three to Five Years					Over Five to Ten Years					Over Ten to Twenty Years					Over Twenty Years					Total
		Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield			Carrying Value		Weighted Average Yield
Held-to-Maturity:

Municipal Bonds	$	—		0.00	%	$	—		0.00	%	$	—		0.00	%	$	—		0.00	%	$	220		5.38	%	$	980		6.27	%	$	1,200		6.11	%
Mortgage backed securities:
Freddie Mac		481		5.21	%		—		0.00	%		—		0.00	%		—		0.00	%		—		0.00	%		—		0.00	%		481		5.21	%
Fannie Mae		2,502		5.39	%		—		0.00	%		1,638		4.49	%		—		0.00	%		1,842		4.77	%		—		0.00	%		5,982		4.95	%
Total mortgage-backed securities		2,983		5.36	%		—		0.00	%		1,638		4.49	%		—		0.00	%		1,842		4.77	%		—		0.00	%		6,463		4.97	%



Total securities held-to-maturity -- Carrying Value	$	2,983		5.36	%	$	—		0.00	%	$	1,638		4.49	%	$	—		0.00	%	$	2,062		4.84	%	$	980		6.27	%	$	7,663		5.15	%

Total securities held-to-maturity -- Fair Market Value	$	3,065		5.36	%	$	—		0.00	%	$	1,643		4.50	%	$	—		0.00	%	$	2,061		4.84	%	$	986		6.26	%	$	7,754		5.16	%

ITEM 4. Controls and Procedures

An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Act”)) was carried out under the supervision and with the participation of the Chief Executive Officer, Chief Financial Officer, and other members of the Company’s senior management, as of the end of the period covered by this report (the "Evaluation Date"). Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective in providing reasonable assurance that the material information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

PART II: OTHER INFORMATION

ITEM 1. Legal Proceedings

At June 30, 2005, the Company was not engaged in any litigation, which in the opinion of management, after consultation with its legal counsel, would be material to the Company.

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

None.

ITEM 3. Defaults Upon Senior Securities

None.

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

The Annual Meeting of Shareholders of First Mutual Bancshares, Inc. was held on April 28, 2005. The results of votes on the matters presented at the Meeting are as follows:

The following individuals were elected as directors for the term noted:

CLASS I DIRECTORS	VOTES FOR	VOTES WITHHELD	TERM

Janine Florence	4,987,326	127,473	3 Years
F. Kemper Freeman, Jr.	5,003,028	111,771	3 Years
Robert J. Herbold	4,991,245	123,554	3 Years
Victor E. Parker	5,003,039	111,760	3 Years

The terms of the Class II and III directors expire at the Annual Meeting of Shareholders for 2006 and 2007, respectively.

CLASS II DIRECTORS, term expires in 2006

James J. Doud, Jr.

Richard S. Sprague

Robert C. Wallace

CLASS III DIRECTORS, term expires in 2007

Mary Case Dunnam

George W. Rowley, Jr.

John R. Valaas

The proposal to amend the Company’s Articles of Incorporation with respect to the quorum for a shareholders meeting, received the following votes:

	VOTED	PERCENT OF OUTSTANDING
For	4,241,343	79.90
Against	149,660	2.82
Abstain	4,687	0.09
Broker non votes	912,604	—

The foregoing proposal was approved.

The proposal to amend the Company’s Articles of Incorporation with respect to increase the number of authorized shares as described in the proxy statement, received the following votes:

	VOTED	PERCENT OF OUTSTANDING
For	4,353,021	82.00
Against	844,836	15.92
Abstain	5,213	0.10
Broker non votes	105,224	—

The foregoing proposal was approved.

The proposal to amend the Company’s 2005 Stock Option and Incentive Plan as described in the proxy statement, received the following votes:

	VOTED	PERCENT OF FOR, AGAINST, ABSTAIN
For	3,121,991	71.79
Against	1,198,012	27.55
Abstain	28,701	0.66
Broker non votes	959,590	—

The foregoing proposal was approved.

ITEM 5. Other Information

None.

ITEM 6. Exhibits

(3.1)	Amended and Restated Articles of Incorporation, attached as an exhibit to this Report on Form 10Q.

(3.3)	Bylaws (as amended and restated), incorporated by reference on Form 10-Q filed with the SEC on August 13, 2004.

(11)	Statement regarding computation of per share earnings. Reference is made to the Company’s Consolidated Statements of Income attached hereto as part of Item I Financial Statements, which are incorporated herein by reference.

(31.1)	Certification by President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.

(31.2)	Certification by Executive Vice President and Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

(32)	Certification by Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.

SIGNATURES

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


	FIRST MUTUAL BANCSHARES, INC.

Date: August 8, 2005	By:	/s/ John R. Valaas
		John R. Valaas
		President and Chief Executive Officer




Date: August 8, 2005	By:	/s/ Roger A. Mandery
		Roger A. Mandery
		Executive Vice President (Principal Financial Officer)

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First Mutual Bancshares (FMSB) Inactive 10-Q2005 Q2 Quarterly report

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