Evergreenbancorp (EVGGQ) 10-Q 2006 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2006

o Transition Report Under Section 13 or 15(d) of the Exchange Act

For the transition period from                    to                    

Commission File No. 000-32915

EVERGREENBANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter)

WASHINGTON	91-2097262
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification Number)

301 Eastlake Avenue East
Seattle, Washington 98109-5407
(Address of Principal Executive Offices) (Zip Code)

(206) 628-4250
(Registrant’s Telephone Number, Including Area Code)

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

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

Large accelerated filero       Accelerated filero       Non-accelerated filerþ

     Indicate by check mark whether the Registrant is a shell company (as identified in Rule 12b-2 of the Act). Yeso Noþ

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common Stock, no par value, outstanding as of November 9, 2006:2,011,002
No Preferred Stock was issued or outstanding.

 EXHIBIT 31.1

 EXHIBIT 31.2

 EXHIBIT 32.1

 EXHIBIT 32.2

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PART I – FINANCIAL INFORMATION

ITEM 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

EVERGREENBANCORP, INC.

UNAUDITED CONSOLIDATED BALANCE SHEETS

September 30, 2006 and December 31, 2005

(in thousands, except share and per share data)

	September 30,			December 31,
	2006			2005
Assets
Cash and due from banks	$	4,591		$	12,379
Federal funds sold		5,869			2,112
Interest-bearing deposits in financial institutions		4,127			2,811
Total cash and cash equivalents		14,587			17,302
Securities available for sale		32,022			33,550
Loans		253,279			189,188
Allowance for loan losses		(2,631	)		(2,056	)
Net loans		250,648			187,132
Premises and equipment		2,720			3,179
Cash surrender value of bank owned life insurance		5,259			5,090
Accrued interest and other assets		2,948			2,939
Total assets	$	308,184		$	249,192
Liabilities
Deposits
Noninterest-bearing	$	54,647		$	64,635
Interest-bearing		180,387			135,255
Total deposits		235,034			199,890
Federal Home Loan Bank advances		46,721			23,849
Junior subordinated debt		5,000			5,000
Accrued expenses and other liabilities		2,586			2,717
Total liabilities	$	289,341		$	231,456
Stockholders’ equity
Preferred stock; no par value; 100,000 shares authorized; none issued		—			—
Common stock and surplus; no par value; 15,000,000 shares authorized; 2,011,002 shares issued at September 30, 2006; 2,000,467 shares at December 31, 2005		16,218			16,005
Retained earnings		3,052			2,187
Accumulated other comprehensive loss		(427	)		(456	)
Total stockholders’ equity		18,843			17,736
Total liabilities and stockholders’ equity	$	308,184		$	249,192

See accompanying notes to unaudited consolidated financial statements.

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EVERGREENBANCORP, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

Three month and nine month periods ended September 30, 2006 and 2005

(in thousands, except per share data)

	Three months ended September 30,				Nine months ended September 30,
	2006		2005		2006		2005
Interest income
Loans, including fees	$	5,170	$	3,164	$	13,570	$	8,967
Taxable securities		302		265		868		772
Tax exempt securities		35		35		103		91
Federal funds sold and other		33		49		86		149
Total interest income		5,540		3,513		14,627		9,979
Interest expense
Deposits		1,636		676		3,857		1,786
Federal funds purchased		15		4		50		8
Federal Home Loan Bank advances		516		135		1,357		369
Junior subordinated debt		115		90		323		249
Total interest expense		2,282		905		5,587		2,412
Net interest income		3,258		2,608		9,040		7,567
Provision for loan losses		230		144		578		291
Net interest income after provision for loan losses		3,028		2,464		8,462		7,276
Noninterest income
Service charges on deposit accounts		292		280		847		921
Merchant credit card processing		42		37		112		115
Other commissions and fees		23		32		119		94
Net earnings on bank owned life insurance		57		35		169		35
Other noninterest income		29		26		96		115
Total noninterest income		443		410		1,343		1,280
Noninterest expense
Salaries and employee benefits		1,303		1,224		3,916		3,492
Occupancy and equipment		418		449		1,299		1,260
Data processing		208		182		619		566
Professional fees		82		64		225		292
Marketing		159		152		349		355
State revenue and sales tax expense		98		70		254		237
Other noninterest expense		451		457		1,399		1,297
Total noninterest expense		2,719		2,598		8,061		7,499
Income before income taxes		752		276		1,744		1,057
Income tax expense		235		75		518		343
Net income	$	517	$	201	$	1,226	$	714
Basic earnings per share	$	0.26	$	0.10	$	0.61	$	0.36
Diluted earnings per share	$	0.25	$	0.10	$	0.60	$	0.35

See accompanying notes to unaudited consolidated financial statements.

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EVERGREENBANCORP, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Nine months ended September 30, 2006, and 2005 (in thousands, except share and per share data):

								Accumulated
			Common					other
	Common		stock					comprehen-			Total stock-
	stock		and		Retained			sive			holders’
	shares		surplus		earnings			income			equity
Balance at January 1, 2005		1,992,428	$	15,927	$	1,678		$	(120	)	$	17,485
Comprehensive income
Net income		—		—		714			—			714
Change in net unrealized gain (loss) on securities available for sale, net of reclassification and tax effects		—		—		—			(240	)		(240	)
Total comprehensive income												474
Cash dividends ($.169 per share)		—		—		(337	)		—			(337	)
Exercise of stock options and related tax benefit		8,231		81		—			—			81
Balance at September 30, 2005		2,000,659	$	16,008	$	2,055		$	(360	)	$	17,703

								Accumulated
			Common					other
	Common		stock					comprehen-			Total stock-
	stock		and		Retained			sive			holders’
	shares		surplus		earnings			income (loss)			equity
Balance at January 1, 2006		2,000,467	$	16,005	$	2,187		$	(456	)	$	17,736
Comprehensive income
Net income		—		—		1,226			—			1,226
Change in net unrealized gain (loss) on securities available for sale, net of reclassification and tax effects		—		—		—			29			29
Total comprehensive income												1,255
Cash dividends ($.180 per share)		—		—		(361	)		—			(361	)
Exercise of stock options and related tax benefit		10,535		118		—			—			118
Stock options earned		—		95		—			—			95
Balance at September 30, 2006		2,011,002	$	16,218	$	3,052		$	(427	)	$	18,843

See accompanying notes to unaudited consolidated financial statements.

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EVERGREENBANCORP, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three month and nine month periods ended September 30, 2006 and 2005

(in thousands)

	Three months ended September 30,						Nine months ended September 30,
	2006			2005			2006			2005
Net income	$	517		$	201		$	1,226		$	714
Other comprehensive income (loss):
Change in unrealized gain (loss) on securities available for sale		194			(80	)		44			(364	)
Reclassification adjustment for gains included in net income		—			—			—			—
Net unrealized gains (losses)		194			(80	)		44			(364	)
Tax effect		(66	)		27			(15	)		124
Total other comprehensive income (loss)		128			(53	)		29			(240	)
Total comprehensive income	$	645		$	148		$	1,255		$	474

See accompanying notes to unaudited consolidated financial statements.

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EVERGREENBANCORP, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine months ended September 30, 2006, and 2005

(in thousands, except share and per share data)

	September 30,			September 30,
	2006			2005
Cash flows from operating activities
Net income	$	1,226		$	714
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		636			579
Provision for loan losses		578			291
Amortization of premiums and discounts on securities		33			45
Federal Home Loan Bank stock dividends		—			(6	)
Dividends reinvested		—			(190	)
Net earnings on bank owned life insurance		(169	)		(35	)
Stock option compensation expense		95			—
Other changes, net		(155	)		(672	)
Net cash provided by operating activities		2,244			726
Cash flows from investing activities
Proceeds from sales, maturities and principal payments on securities available for sale		1,672			1,158
Net increase in loans		(64,094	)		(5,682	)
Purchase of bank owned life insurance		—			(5,000	)
Purchases of securities available for sale		(133	)		(1,124	)
Purchases of premises and equipment		(177	)		(1,246	)
Net cash provided by (used in) investing activities		(62,732	)		(11,894	)
Cash flows from financing activities
Net increase in deposits		35,144			19,375
Proceeds from Federal Home Loan Bank advances		26,900			6,000
Repayments of Federal Home Loan Bank advances		(4,028	)		(4,002	)
Proceeds from exercise of stock options		118			67
Dividends paid		(361	)		(337	)
Net cash provided by financing activities		57,773			21,103
Net increase (decrease) in cash and cash equivalents		(2,715	)		9,935
Cash and cash equivalents at beginning of year		17,302			12,145
Cash and cash equivalents at end of period	$	14,587		$	22,080

See accompanying notes to unaudited consolidated financial statements.

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EVERGREENBANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL INFORMATION

Note 1: Summary of Significant Accounting Policies

Organization.EvergreenBancorp, Inc. (“Bancorp”) was formed February 9, 2001 and is a Washington corporation chartered as a bank holding company. Bancorp holds all of the issued and outstanding shares of EvergreenBank (“the Bank”). The Bank is a Washington state chartered financial institution established in 1971 that engages in general commercial and consumer banking operations. Deposits in the Bank are insured to a maximum of $100,000 per depositor (in some instances up to $250,000 per deposit account, depending on the ownership category of the account) by the Federal Deposit Insurance Corporation (“the FDIC”).

Bancorp and the Bank are collectively referred to as “the Company.” EvergreenBancorp Capital Trust I (“the Trust”), a special purpose business trust formed by Bancorp in May 2002 to raise capital through a trust preferred securities offering, had previously been consolidated with the Company and is now reported separately.

The Bank offers a broad spectrum of personal and business banking services, including commercial, consumer, and real estate lending. The Bank’s offices are centered in the Puget Sound region in the Seattle, Lynnwood, Bellevue, and Federal Way communities.

Operating Segments. While the Company’s management monitors the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company’s banking operations are considered by management to be aggregated in one reportable segment.

Principles of consolidation.The accompanying condensed consolidated financial statements include the combined accounts of Bancorp and the Bank for all periods reported. All significant intercompany balances and transactions have been eliminated.

Critical accounting policies and use of estimates.The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities, including contingent amounts, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management has identified certain policies as being particularly sensitive in terms of judgments and the extent to which estimates are used. These policies relate to the determination of the allowance for loan losses on loans, other real estate owned, and the fair value of financial instruments and are described in greater detail in subsequent sections of Management’s Discussion and Analysis and in the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity of the financial statements to these critical accounting policies, estimates and assumptions, material differences in the results of operations or financial condition could result.

Newly issued accounting pronouncements.In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which was issued to require that all tax positions be evaluated using consistent criteria and measurement and further supplemented by enhanced disclosure. FIN 48, an interpretation of FASB Statement No. 109, “Accounting for Income Taxes,” prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. This interpretation provides clear criteria for subsequently recognizing, derecognizing, and measuring such tax positions for financial statement purposes, as well as provides guidance on accrual of interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 or January 1, 2007 for calendar year-end companies. Differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption would be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. The cumulative-effect adjustment would not apply to those items that would not have been recognized in earnings, such as the effect of adopting FIN 48 on tax positions related to business combinations. The Company is currently evaluating the impact of this interpretation on its financial position and results of operations.

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In September 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” that requires companies to recognize the funded status of its defined benefit pension and postretirement plans as an asset or liability on the balance sheet rather than being disclosed in the notes to the financial statements. The over-funded or under-funded status (asset or liability) would be measured as the difference between the fair value of plan assets and the projected benefit obligation for pensions and the accumulated post-retirement benefit obligation for other post-retirement benefits. Actuarial gains and losses and prior service costs and credits that arise subsequent to the effective date would be recognized, net of tax, as a component of other comprehensive income and would continue to be amortized into earnings in future periods as a component of net periodic benefit cost. Any remaining unrecognized net transition asset or obligation from the initial adoption of FASB Statements No. 87 and 106, net of tax, would be recognized in other comprehensive income rather than expense, and as such, this is the only change, if applicable, that would alter the amount of expense recognized by an entity. In addition, employers are required to set the measurement date as of the balance sheet date, rather than having the option of any date up to three months prior to the fiscal year-end. Plan assets and obligations would not be required to be remeasured for interim period reporting. The requirement to recognize the funded status in the balance sheet is effective for fiscal years ending after December 15, 2006 and the requirement to measure plan assets and benefit obligations as of the balance sheet date is not effective until fiscal years ending after December 15, 2008. The Company will adopt the balance sheet recognition requirement for its fiscal year ending December 31, 2006 and the measurement date requirement for its fiscal year ending December 31, 2008. The Company is currently evaluating the impact of the statement on its financial position.

In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements,” to provide guidance on how to measure fair value, which would apply broadly to financial and non-financial assets and liabilities that are measured at fair value under other authoritative accounting pronouncements. The statement defines fair value, provides a hierarchy that prioritizes inputs that should be used in valuation techniques used to measure fair value, and expands current disclosures about the use of fair value to measure assets and liabilities. The disclosures focus on the methods used for the measurements and their effect on earnings and would apply whether the assets were measured at fair value in all periods, such as trading securities, or in only some periods, such as for impaired assets. A transition adjustment would be recognized as a cumulative-effect adjustment to beginning retained earnings for the fiscal year in which statement is initially adopted. This adjustment is measured as the difference between the carrying amounts and the fair values of those financial instruments at the date of adoption. The statement is effective for fiscal years beginning after November 15, 2007 (or January 1, 2008 for calendar-year companies) and interim periods within those fiscal years. The Company will adopt the statement on January 1, 2008. The fair value disclosures required by this statement will be effective for the first interim period in which the statement is adopted. The Company is currently evaluating the impact of the statement on its financial position, results of operations, and liquidity.

In September 2006, the Securities Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 108, which was issued to address diversity in practice in quantifying financial statement misstatements and the potential under current practice for the build up of improper amounts on the balance sheet. The Company is in process evaluating the potential impact of the standard for future periods.

Under EITF 06-4 : Accounting for deferred compensation and postretirement benefit aspects of endorsement split dollar life insurance arrangements, the EITF reached a consensus that requires the recognition of a liability related to the postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The consensus highlights that the employer who is the policy holder has a liability for the benefit it is providing to the employee. The employer has agreed to maintain the insurance policy in force for the employee’s benefit during his retirement, then the liability recognized during the employee’s active service period should be based on the future cost of insurance to be incurred during the employee’s retirement. Also, if the employer has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized under SFAS 106. As of September 20, 2006, the FASB board ratified the above. It is applicable for fiscal years beginning after December 15, 2006. The Company has evaluated the impact of the pronouncement and believes there would be no impact to the Company’s financial position and results of operations.

Under EITF 06-5: Accounting for Purchases of Life Insurance — Determining the Amount That Could be Realized in Accordance with FASB Technical Bulletin No. 85-4, “Accounting for Purchases of Life Insurance”, the task force reached a consensus that a policyholder should consider any additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract. The task forces agreed that contractual limitations should be considered when determining the realizable amounts. Those amounts that are recoverable by the policyholder at the discretion of the insurance company should be excluded from the amount that could be realized. The task force also agreed that fixed amounts that are recoverable by the policyholder in future periods in excess of one year from the

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surrender of the policy should be recognized at their present value. The task force also reached a consensus that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual life by individual life policy. The Task force also noted that any amount that is ultimately realized by the policyholder upon the assumed surrender of the final policy shall be included in the amount that could be realized under the insurance contract. The issue should be effective for fiscal years beginning after December 15, 2006, but early adoption is permitted. The Company is currently evaluating the impact of this interpretation on its financial condition and results of operations.

Note 2: Stock Offering

On September 15, 2006, the Company commenced an offering of common stock to existing shareholders and the public to raise an additional $10 million of capital. The offering will close on November 14, 2006, unless terminated earlier, or extended at the Company’s discretion. As soon as practicable following completion of the offering, the Company will issue the shares purchased and the funds received by the Company will be recognized as common stock and surplus. The Company expects to use the funds raised in the offering for anticipated market expansion and general corporate purposes.

Note 3: Stock options

Stock option and equity compensation plan.In April of 2000, the shareholders of the Bank adopted the 2000 Stock Option Plan that was subsequently adopted by Bancorp as a result of the holding company formation. In April of 2003, the shareholders of Bancorp approved an amendment to the 2000 Stock Option Plan to increase the number of shares available under the plan by 66,000. In April of 2006, the shareholders adopted the Second Amended 2000 Stock Option and Equity Compensation Plan (the “Second Amended 2000 Plan”) which allows greater flexibility in the type of equity compensation to be awarded and to the terms of such awards. Up to 329,724 shares of common stock may be awarded under the Second Amended 2000 Plan. Awards available under the Second Amended Plan are subject to adjustment for all stock dividends and stock splits paid by the Company. As of September 30, 2006, approximately 47,243 shares of common stock were available for future grant under the Second Amended 2000 Plan.

In addition to stock options, the Second Amended 2000 Plan provides for the granting of restricted stock, stock appreciation rights, and restricted stock units. All employees, officers, and directors of the Company or a related corporation, and independent contractors who perform services for the Company or a related corporation, are eligible to be granted awards. The terms of each award are set forth in individual award agreements. To date, only nonqualified stock options have been awarded to employees and directors. All outstanding nonqualified stock options awarded to date to employees vest over a five-year period and expire after ten years from the date of grant. All outstanding nonqualified stock options awarded to date to directors vest over a three-year period and expire after three years, three months from the date of grant.

Stock option transactions were as follows:

	Nine Months Ended					Twelve Months Ended
	September 30, 2006					December 31, 2005
				Weighted-					Weighted-
				Average					Average
				Exercise					Exercise
	Shares			Price		Shares			Price
Outstanding at the beginning of the period		228,250		$	9.32		191,440		$	8.15
Granted		38,500			14.31		45,334			13.72
Exercised		(10,535	)		8.33		(8,524	)		6.29
Forfeited		(17,068	)		8.66		—			—
Outstanding at the end of the period		239,147		$	10.21		228,250		$	9.32

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Outstanding and exercisable stock options at September 30, 2006 were as follows:

		Outstanding					Exercisable
				Weighted-					Weighted-
				Average			Weighted-		Average
	Year of			Remaining			Average		Remaining
Exercise Price	Grant	Number		Contractual Life	Number		Exercise Price		Contractual Life
$14.31	2006		37,500	8.40 years		—	$	14.31		—
13.72	2005		41,772	6.15 years		13,352		13.72	4.20 years
10.65	2004		27,497	6.01 years		14,451		10.65	4.66 years
8.90	2003		26,578	5.19 years		18,160		8.90	4.59 years
8.02	2002		28,454	4.56 years		23,822		8.02	4.37 years
7.01	2001		42,664	3.88 years		42,664		7.01	3.88 years
6.84	2000		34,682	3.53 years		34,682		6.84	3.53 years
Outstanding at end of period			239,147	5.41 years		147,131	$	8.33	4.07 years

The total intrinsic value of options outstanding at September 30, 2006 was $1,172,000. The total intrinsic value of exercisable options at September 30, 2006 was $974,000.

Stock based compensation.Statement of Financial Accounting Standards 123R (SFAS 123R), Accounting for Stock Based Compensation, requires all public companies to record compensation costs for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employee service period, which is normally the vesting period of the options. This applies to awards granted or modified after the first fiscal year beginning after December 15, 2005. Compensation cost will also be recorded for prior option grants that vest after the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. The Company adopted the modified prospective method and has assumed a forfeiture rate of 5 percent. For the three and nine months ended September 30, 2006 stock option compensation expense of $22,000 and $95,000, respectively, was recorded in the income statement and a tax benefit of $7,000 and $32,000, respectively, was recognized. The year-to-date compensation expense of $95,000 includes compensation expense of $24,000 recorded in the second quarter due to a material definitive agreement entered into by the Bank with the Company’s former Chief Financial Officer (CFO) on June 8, 2006 that called for acceleration of the CFO’s unvested options to be fully vested by June 16, 2006. Existing options that will vest after the adoption date are expected to result in additional compensation expense of approximately $25,000 in the remainder of 2006, $92,000 in 2007, $77,000 in 2008, $55,000 in 2009, $35,000 in 2010, and $10,000 in 2011. There will be no significant effect on the Company’s financial position as total equity will not change.

Prior to the implementation of SFAS 123R, the Company accounted for employee compensation expense under stock options using the intrinsic value method. No stock-based compensation cost was reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of SFAS 123R for the three months and nine months ended September 30, 2005. Earnings and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements.

	Three Months		Nine Months
	Ended		Ended
	September 30,		September 30,
(in thousands, except per share data)	2005		2005
Net income as reported	$	201	$	714
Deduct: Stock-based compensation expense determined under fair value based method		17		62
		184		652
Pro forma net income
Basic earnings per share as reported	$	0.10	$	0.36
Pro forma basic earnings per share		0.09		0.33
Diluted earnings per share as reported		0.10		0.35
Pro forma diluted earnings per share		0.09		0.32

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During the third quarter of 2006, 3,000 nonqualified stock options were granted, none were exercised, and 5,207 were forfeited or canceled. During the third quarter of 2005, 17,333 nonqualified stock options were granted, 3,449 options were exercised, and none were forfeited. The weighted average fair value of individual options granted during the third quarter of 2006 and 2005 was $4.78 and $3.74, respectively.

During the first nine months of 2006, 38,500 nonqualified options were granted, 10,535 options were exercised, and 17,068 options were forfeited. During the first nine months of 2005, 45,333 nonqualified options were granted, 8,231 options were exercised, and none were forfeited. The weighted average fair value of individual options granted during the first nine months of 2006 and 2005 was $4.50 and $3.68, respectively.

The income statement and pro forma effects were computed using option pricing models, using the following weighted-average assumptions as of grant date.

	Three months ended
	September 30,
	2006			2005
Risk-free interest rate		4.74	%		4.08	%
Expected option life	7.5 years			7.5 years
Expected stock price volatility		25	%		22	%
Dividend yield		1.6	%		1.6	%

	Nine months ended
	September 30,
	2006			2005
Risk-free interest rate		4.94	%		3.94	%
Expected option life	7.5 years			7.5 years
Expected stock price volatility		24	%		22	%
Dividend yield		1.7	%		1.6	%

The Company’s calculation of fair market value of the options is made using the Black-Scholes option pricing model. The assumptions used are as follows: the expected term of options granted is based on historical experience and represents the period of time that options granted are expected to be outstanding; the risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury constant maturity interest rate with the term consistent with the expected life of the option, and stock volatility is based on historical volatility of the Company’s stock. Each grant’s dividend yield is calculated by annualizing the year-to-date cash dividend and dividing that amount by the market price of the Company’s common stock as of grant date.

The total stock options outstanding were 239,147 at September 30, 2006 with exercise prices ranging between $6.84 and $15.05 and expiration dates between December 26, 2006 and September 11, 2016. All options are granted at market value as of date of grant.

Note 4: Securities available for sale

Investment securities available for sale include $4,756,000 in mortgage-backed securities at September 30, 2006. This investment by the Bank in mortgage-backed securities qualifies as collateral for advances from Federal Home Loan Bank of Seattle. Investment securities available for sale also include the AMF Ultra Short Mortgage Fund (“USM Fund,” formerly the AMF Adjustable Rate Mortgage Fund or ARM Fund) with a fair market value of $14,823,000 at September 30, 2006.

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Securities with unrealized losses at September 30, 2006, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (in thousands):

	Less than 12 Months					12 Months or More					Total
(in thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securities	Value		Loss			Value		Loss			Value		Loss
US agencies	$	—	$	—		$	6,453	$	(53	)	$	6,453	$	(53	)
State and political subdivisions		477		(2	)		3,962		(57	)		4,439		(59	)
Mortgage-backed securities		—		—			4,515		(153	)		4,515		(153	)
AMF Ultra Short Mortgage Fund		—		—			14,823		(383	)		14,823		(383	)
Total temporarily impaired	$	477	$	(2	)	$	29,753	$	(646	)	$	30,230	$	(648	)

At September 30, 2006, securities with unrealized losses have an aggregate depreciation of 2.1 percent from the Company’s amortized cost basis. The unrealized losses are predominately the result of changing market values due to increasing short-term (less than two years) market interest rates, and are expected to regain the lost value with stable or declining interest rates and, accordingly, are considered as temporary. No credit issues have been identified that cause management to believe the declines in market value are other than temporary. The Company has the ability and intent to hold these securities until maturity or for the foreseeable future.

The net asset value (“NAV”) of the USM Fund has declined with recent increases in short term interest rates. With respect to the USM Fund investment, the historical performance of the fund shows that as interest rates slow their rate of ascent, are stable, or as rates decline, the fund recovers its value (that is, the degree of impairment reverses) through increases in its market NAV. Management expects the USM Fund to recover value following a decline due to a rising interest rate environment once rates stabilize and the underlying adjustable rate mortgages reprice to market. The NAV of the USM Fund was $9.69 at December 31, 2005 and fell to $9.65 at June 30, 2006. During the quarter ended September 30, 2006, the interest rates stabilized and long term rates declined slightly, thus impacting the USM Fund’s NAV positively, which increased to $9.69 at September 30, 2006. The Company has the ability and intent to hold the investment for a sufficient period of time for any anticipated recovery in fair value.

At December 31, 2005, securities with unrealized losses have an aggregate depreciation of 2.2 percent from the Company’s amortized cost basis. The unrealized losses are predominately the result of changing market values due to increasing short-term (less than two years) market interest rates, are expected to regain the lost value with stable or declining interest rates and, accordingly, are considered as temporary. No credit issues have been identified that cause management to believe the declines in market value are other than temporary.

Securities with unrealized losses at December 31, 2005, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (in thousands):

	Less than 12 Months					12 Months or More					Total
(in thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securities	Value		Loss			Value		Loss			Value		Loss
US agencies	$	496	$	(4	)	$	6,898	$	(112	)	$	7,394	$	(116	)
State and political subdivisions		3,278		(41	)		694		(11	)		3,972		(52	)
Mortgage-backed securities		436		(3	)		4,755		(141	)		5,191		(144	)
AMF Ultra Short Mortgage Fund		188		(2	)		14,635		(381	)		14,823		(383	)
Total temporarily impaired	$	4,398	$	(50	)	$	26,982	$	(645	)	$	31,380	$	(695	)

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Note 5: Earnings per share

Basic earnings per share of common stock is computed on the basis of the weighted average number of common stock shares outstanding. Diluted earnings per share of common stock is computed on the basis of the weighted average number of common shares outstanding plus the effect of the assumed conversion of outstanding stock options.

A reconciliation of the numerator and denominator used in the calculation of basic and diluted earnings per share of common stock is as follows:

	Three months ended September 30,
(in thousands, except share and per share data):	2006		2005
Income (numerator):
Net income	$	517	$	201
Income (denominator):
Weighted average number of common stock shares outstanding - basic		2,011,002		1,999,487
Dilutive effect of outstanding employee and director stock options		41,711		56,687
Weighted average number of common stock shares outstanding and assumed conversion – diluted		2,052,713		2,056,174
Basic earnings per share of common stock	$	0.26	$	0.10
Diluted earnings per share of common stock	$	0.25	$	0.10

	Nine months ended September 30,
(in thousands, except share and per share data):	2006		2005
Income (numerator):
Net income	$	1,226	$	714
Income (denominator):
Weighted average number of common stock shares outstanding - basic		2,007,153		1,998,206
Dilutive effect of outstanding employee and director stock options		33,454		44,854
Weighted average number of common stock shares outstanding and assumed conversion – diluted		2,040,607		2,043,060
Basic earnings per share of common stock	$	0.61	$	0.36
Diluted earnings per share of common stock	$	0.60	$	0.35

In the calculation of dilutive earnings per share, 38,500 options were considered anti-dilutive for the three and nine months ended September 30, 2006.

Note 6: Retirement Benefits

The Company participates in a defined contribution retirement plan. The 401(k) plan permits all salaried employees to contribute up to a maximum of 15 percent of gross salary per month. For the first 6 percent, the Company contributes two dollars for each dollar the employee contributes. Partial vesting of Company contributions to the plan begins at 20 percent after two years of employment, and such contributions are 100 percent vested with five years of employment. The Company’s contributions to the plan for the quarters ended September 30, 2006 and 2005 were $91,000 and $87,000, respectively. Contributions to the plan for the first nine months of 2006 were $270,000 and $242,000 for the same period in 2005.

The Company also participates in multiple-employer defined benefit postretirement health care plans that provide medical and dental coverage to directors and surviving spouses and to employees who retire after age 62

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and 15 years of full-time service and their dependents. Effective January 1, 2005, new medical plans and a new dental plan were implemented, and a separate vision plan, previously included as part of the former medical plans, was added. Under the new plans, employees reimburse the Company for a portion of the premiums. The medical, dental, and vision plans are nonfunded.

Components of net periodic benefit cost:

	Three months					Nine months
	ended					ended
	September 30,					September 30,
(in thousands)	2006			2005		2006			2005
Service cost	$	41		$	22	$	123		$	66
Interest cost		28			23		84			69
Amortization of transition obligation		—			10		—			30
Amortization of prior service cost		(1	)		—		(4	)		—
Recognized actuarial (gain) loss		8			0		24			0
Net periodic benefit cost	$	76		$	55	$	227		$	165

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

The Bank’s results of operations primarily depend on net interest income, which is the difference between interest income on loans and investments and interest expense on deposits and borrowed funds. The Bank’s operating results are also affected by loan fees, service charges on deposit accounts, net merchant credit card processing fees, gains (losses) from sales of investments, and other noninterest income. Operating expenses of the Bank include employee compensation and benefits, occupancy and equipment costs, data processing costs, professional fees, marketing, state and local taxes, federal deposit insurance premiums and other administrative expenses.

The Bank’s results of operations are further affected by economic and competitive conditions, particularly changes in market interest rates and real estate values. Results are also affected by monetary and fiscal policies of federal agencies, and actions of regulatory and taxing authorities.

The following discussion contains a review of the consolidated operating results and financial condition of the Company for the three and nine month periods ended September 30, 2006. This discussion should be read in conjunction with the unaudited consolidated financial statements and accompanying notes contained elsewhere in this report. When warranted, comparisons are made to the same periods in 2005 and to the previous year ended December 31, 2005. For additional information, refer to the audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

RESULTS OF OPERATIONS

Net Income

Three months and nine months ended September 30, 2006 and 2005

For the third quarter of 2006, the Company reported net income of $517,000 compared to $201,000 for the third quarter of 2005, an increase of 157.21 percent. The primary reason for the increase in net income was higher net interest income due to growth in average interest-bearing assets. For the third quarter of 2006, average interest-bearing assets increased by approximately $77,000,000, as compared with the same quarter in the prior year. This increase was offset by higher provision for loan losses expense of $230,000 for the third quarter of 2006, as compared to $144,000 in the third quarter of 2005 and higher noninterest expense.

Basic and diluted earnings per common share for the third quarter of 2006 were $0.26 and $0.25, respectively, compared with $0.10 and $0.10, respectively, for the same period one year ago.

For the third quarter of 2006, return on average common equity and return on average assets was 11.11 percent and 0.69 percent respectively, compared to 4.55 percent and .36 percent, respectively, for the same period one year ago.

For the first nine months of 2006, net income was $1,226,000, compared with $714,000 for the first nine months of 2005, an increase of 71.71 percent. Basic and diluted earnings per common share were $0.61 and $0.60, respectively, for the first nine months of 2006 and $0.36 and $0.35, respectively, for the same period in 2005. Return on average assets was 0.60 percent for 2006 and 0.45 percent for 2005. Return on average common equity was 9.08 percent for the first nine months of 2006 and 5.43 percent for the same period of 2005. Additional analysis of financial components is contained in the discussion that follows. Unless otherwise stated, comparisons are between the third quarter 2006 and 2005.

Net Interest Income and Net Interest Margin

The Company’s principal source of earnings is net interest income, which is the difference between interest income on loans and investments and interest expense on deposits and borrowed funds. Several factors can contribute to changes in net interest income, such as changes in average balances or in the rates on earning assets and rates paid for interest-bearing liabilities, the level of noninterest-bearing deposits, and the level of nonaccrual loans.

Net interest income before the provision for loan losses was $3,258,000 for the third quarter of 2006, compared to $2,608,000 for the same period in 2005, an increase of 24.92 percent. Average interest earning assets increased

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approximately $77,000,000, or 37.75 percent for the three months ended September 30, 2006 as compared with the third quarter of 2005. Partially offsetting the increase in average interest-bearing assets was an increase of approximately $72,900,000, or 49.59% in average interest-bearing liabilities for the quarter ended September 30, 2006, compared to the same period in the prior year.

Net interest income before the provision for loan losses was $9,040,000 for the first nine months of 2006, compared with $7,567,000 for the first nine months of 2005, an increase of 19.47 percent. Average interest earning assets increased approximately $58,500,000, or 29.32 percent for the nine months ended September 30, 2006. Partially offsetting the increase in average interest-bearing assets was an increase of approximately $57,500,000, or 40.74% in average interest-bearing liabilities for the nine months ended September 30, 2006, compared to the same period in the prior year.

The net interest margin, which is the ratio of taxable-equivalent net interest income to average earning assets, was 4.72 percent for the first nine months of 2006 compared to 5.11 percent for the same period one year ago. The weighted average yield on interest earning assets was 7.61 percent for the first nine months of 2006 compared to 6.73 percent during the first nine months of 2005. Interest expense as a percentage of average earning assets was 2.90 percent for the first nine months of 2006, compared to 1.62 percent during the same period in 2005. In the fourth quarter of 2005 and the first quarter of 2006, the Company purchased $19,635,000 in 1-4 family loans from a mortgage broker. The Company acquired brokered deposits and advances from the Federal Home Loan Bank to fund the purchased loans. These transactions caused funding costs to increase and decreased the Company’s net interest margin while increasing net interest income. The brokered deposit transactions account for the majority of the Company’s time deposit growth, rising approximately $28,100,000, or 48.86 percent for the nine month period ended September 30, 2006 as compared with the same period in 2005; this increased the cost of these funds by 156 basis points to 4.37 percent for the nine months ended September 30, 2006.

Yields on certain asset categories and the net interest margin of the Company and its banking subsidiaries are reviewed on a fully taxable-equivalent basis (“FTE”). In this non-GAAP presentation, net interest income is adjusted to reflect tax-exempt interest income on an equivalent before-tax basis. This measure ensures comparability of net interest income arising from both taxable and tax-exempt sources. The following table shows the reconciliation between net interest income and the taxable-equivalent net interest income as of September 30, 2006 and September 30, 2005:

	Three Months Ended						Year to Date
	September 30,						September 30,
(in thousands, except ratio data)	2006			2005			2006			2005
Net Interest Margin
Interest income (GAAP)	$	5,540		$	3,513		$	14,627		$	9,979
Taxable-equivalent adjustment:
Loans		3			3			9			9
Investments		17			18			53			47
Interest income — FTE		5,560			3,534			14,689			10,035
Interest expense (GAAP)		2,282			905			5,587			2,412
Net interest income — FTE	$	3,278		$	2,629		$	9,102		$	7,623
Net interest income - (GAAP)	$	3,258		$	2,608		$	9,040		$	7,567
Average interest earning assets	$	280,791		$	203,835		$	257,933		$	199,450
Net interest margin (GAAP)		4.60	%		5.08	%		4.69	%		5.07	%
Net interest margin — FTE		4.63	%		5.12	%		4.72	%		5.11	%

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Interest income for the three months ended September 30, 2006 was $5,540,000 compared to $3,513,000 for the three months ended September 30, 2005, an increase of $2,027,000 or 57.70 percent. This increase was primarily attributable to an increase in the average loan balance of $82,900,000 and an increase of 63 basis points in the average yield on loans for the third quarter of 2006, ending at 8.37 percent at September 30, 2006.

Interest income for the nine months ended September 30, 2006 was $14,627,000 compared to $9,979,000 for the nine months ended September 30, 2005, an increase of $4,648,000 or 46.58 percent. The increase is due primarily to a rise in average loan balances of $64,900,000 for the nine months ended September 30, 2006 as compared with the nine months ended September 30, 2005, and an increase of 0.55 percent in the average yield on total loans.

Interest expense for the three months ended September 30, 2006 was $2,282,000 compared to $905,000 for the three months ended September 30, 2005, an increase of $1,377,000 or 152.15 percent. This was largely due to an increase in the average rate paid on interest-bearing liabilities and an increase of $72,800,000 in the average balance of interest-bearing liabilities for the three months ended September 30, 2006, as compared with the same period one year ago. The average rate paid on interest-bearing liabilities increased by 167 basis points for the three months ended September 30, 2006 in comparison with the same period in the prior year. The increase in interest-bearing liabilities is primarily due to a rise in the average borrowings balances of $28,000,000 and an increase in the average time deposit balance of $36,900,000 for the three months ended September 30, 2006 as compared with the three months ended the same period in 2005. The rise in these two balances is mainly due to fulfilling funding needs for the Company’s substantial loan growth.

Interest expense for the nine months ended September 30, 2006 was $5,587,000 compared with $2,412,000 for the same period a year ago, an increase of $3,175,000 or 131.63 percent. This was largely due to an increase in the average rate paid on interest-bearing liabilities and an increase of $57,500,000 in the average balance of interest-bearing liabilities for the nine months ended September 30, 2006, as compared with the same period one year ago. The average rate paid on interest-bearing liabilities increased by 148 basis points for the nine months ended September 30, 2006 in comparison with the same period in the prior year. The increase in interest-bearing liabilities is primarily due to a rise in the average borrowings balances of $25,800,000 and an increase in the average time deposit balance of $28,100,000 for the nine months ended September 30, 2006 as compared with the nine months ended the same period in 2005.

Noninterest Income/Expense

Noninterest income in the third quarter of 2006 was $443,000 compared to $410,000 in the same quarter of 2005, an increase of $33,000 or 0.80 percent. The increase was primarily due to income from bank owned life insurance (“BOLI”), which was purchased in August 2005. Net earnings on BOLI totaled $57,000 in the three months ended September 30, 2006 as compared with $35,000 for the three months ended September 30, 2005. The increase in BOLI income was due to the fact that the asset was purchased in the middle of the third quarter of 2005, earning only two months’ income in 2005, as compared with a full three months’ income earned in the third quarter of 2006. The increase in noninterest income for the third quarter of 2006 as compared to the third quarter of 2005 was also attributable to a $12,000 increase in service charges on deposit accounts primarily due to an increase in NSF fees. The increases in noninterest income was partially offset by a decline in ACH revenue as the Company changed its ACH policy in 2005 to meet the needs of the ACH customers and position itself to attract new ACH customers.

Noninterest income for the nine months ended September 30, 2006 was $1,343,000 compared with $1,280,000 for the same period of 2005, an increase of $63,000 or 0.49 percent. This increase was primarily due to income from BOLI which was $169,000 for the nine months ended September 30, 2006, as compared with $35,000 for the nine months ended September 30, 2005. As the asset was purchased in August of 2005, earnings for the period ended September 30, 2005 only included two months’ income, compared to year-to-date 2006 included a full nine months’ income. Other commissions and fees also increased noninterest income approximately $25,000 due to a rise in investment service commission income. This increase in noninterest income was partially offset by a decrease in service charges on deposit accounts of approximately $74,000 due to a change in the Company’s ACH policy as the Company changed its ACH policy in 2005 to meet the needs of the ACH customers and position itself to attract new ACH customers.

Noninterest expense was $2,719,000 in the third quarter of 2006, compared to $2,598,000 in the same quarter of 2005, an increase of $121,000, or 4.66 percent. The increase was due primarily to a $79,000 rise in salaries and benefits expense for the third quarter of 2006 as compared with the same quarter of 2005, resulting from branch

18

network expansions which increased the number of full time equivalent employees (“FTE”) by approximately 5 FTE from September 30, 2005 to September 30, 2006. State revenue and sales tax expense increased $28,000 for the third quarter of 2006 as compared with the third quarter of 2005 due to an increase in total revenue. Data processing increased approximately $26,000 for the three months ended September 30, 2006, as compared with the three months ended September 30, 2005 due to an increase in contract fees paid for data processing services in 2006. Professional fees for the third quarter of 2006 increased by $18,000 over the same period in 2005 due loan growth during 2006, which increased the Company’s loan legal fees; this increase was mostly offset by a decrease in accounting fees. The increases in noninterest expense for the third quarter of 2006 were partially offset by a reduction in occupancy expense of $31,000 for the quarter ended September 30, 2006 as compared to the same quarter of 2005.

Noninterest expense increased for the nine months ended September 30, 2006, ending at $8,061,000 compared with $7,499,000 for the same period of 2005, an increase of $562,000 or 7.49 percent. The increase was primarily due to a rise of $424,000 in salaries and benefits expense for the nine months ended September 30, 2006 as compared with the same period in 2005, as the Company added staffing due to growth and branch expansions in 2005. Other noninterest expense grew $102,000 for the nine months ended September 30, 2006 compared with the nine months ended September 30, 2005. This increase was mainly due stock option compensation expense of $95,000 for the nine months ended September 30, 2006 related to the implementation of SFAS 123R on January 1, 2006. Occupancy expense increased by $39,000 for the nine months ended September 30, 2006 as compared with the nine months ended September 30, 2005, due to increased rent expense for the Third and Seneca office, which opened in June of 2005. These increases were offset slightly by a decline in professional fees of $67,000 for the nine months ended September 30, 2006, as compared with the same period in 2005, as in 2005 the Company incurred additional costs for a state audit and engaged outside consultants to assist in complying with Section 404 of the Sarbanes-Oxley Act of 2002, which, at the time, the Company believed would apply in 2006. The Company expects the cost of complying with Section 404 of Sarbanes-Oxley to increase again in the year it applies.

Income tax expense

The Company recognized income tax expense of $235,000 during the third quarter of 2006, up 213.33 percent from $75,000 in the same quarter of 2005. Income tax expense for the nine months ended September 30, 2006 was $518,000, compared to $343,000 for the same period of 2005, an increase of $175,000 or 51.02 percent. The effective tax rate for nine months ended September 30, 2006 was 29.70 percent as compared to 32.45 percent for the same period in 2005. The decrease in the effective tax rate is due primarily to the income received from non-taxable bank owned life insurance.

Provision and Allowance for Loan Losses

Included in the results of operations for the quarters ending September 30, 2006 and 2005 is expense of $230,000 and $144,000, respectively, related to the provision for loan losses. The provision for loan losses for the nine months ended September 30, 2006 was $578,000 compared to $291,000 for the same period of 2005. This increase in the provision is due largely to a change in the loan portfolio mix, as a result of loan growth.

At September 30, 2006, the allowance for loan losses was $2,631,000 compared to $2,056,000 at December 31, 2005. The ratio of the allowance to total loans outstanding was 1.04 percent at September 30, 2006, and 1.09 percent at December 31, 2005.

Management evaluates the adequacy of the allowance for loan losses on a quarterly basis after consideration of a number of factors, including the volume and composition of the loan portfolio, potential impairment of individual loans, concentrations of credit, past loss experience, current delinquencies, information about specific borrowers, current economic conditions, and other factors. Although management believes the allowance for loan losses was at a level adequate to absorb probable incurred losses on existing loans at September 30, 2006, there can be no assurance that such losses will not exceed estimated amounts.

While management is encouraged by recent trends and the current health of the national and regional economy, local economic conditions could still adversely affect cash flows for both commercial and individual borrowers, as a result of which the Company could experience increases in problem assets, delinquencies, and losses on loans.

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FINANCIAL CONDITION

Loans

At September 30, 2006, loans totaled $253,279,000 compared to $189,188,000 at December 31, 2005, an increase of $64,091,000 or 33.88 percent and compared with $165,091,000 at September 30, 2005, an increase of $88,188,000 or 53.42 percent.

At September 30, 2006, the Bank had $164,383,000 in loans secured by real estate, which includes loans primarily for a commercial purpose, secured by real estate. The collectibility of a substantial portion of the loan portfolio is susceptible to changes in economic and market conditions in the region. The Bank generally requires collateral on all real estate exposures and typically maintains loan-to-value ratios of no greater than 80 percent.

The following tables set out the composition of the types of loans, the allocation of the allowance for loan losses and the analysis of the allowance for loan losses as of September 30, 2006 and December 31, 2005:

Types of Loans

	September 30,		December 31,
(in thousands)	2006		2005
Commercial	$	71,946	$	61,921
Real estate:
Commercial		100,145		76,902
Construction		28,283		6,953
Residential 1-4 family*		35,955		28,195
Consumer and other		16,950		15,217
Total	$	253,279	$	189,188

* Residential 1-4 family includes loans purchased from a mortgage broker of $5,753,000 in the first quarter of 2006 and $13,882,000 in the fourth quarter of 2005.

Allocation of the Allowance for Loan Losses

In the following table, the allowance for loan losses at September 30, 2006 and December 31, 2005 has been allocated among major loan categories based on a number of factors including quality, volume, current economic outlook and other business considerations.

	September 30,			% of loans in			December 31,			% of loans in
	2006			each category			2005			each category
(in thousands)	Amount			to total loans			Amount			to Total Loans
Commercial	$	1,133			28	%	$	987			33	%
Real estate:
Commercial		866			40			651			40
Construction		245			11			72			4
Residential 1-4 family		129			14			106			15
Consumer and other		258			7			240			8
Total	$	2,631			100	%	$	2,056			100	%
% of Loan portfolio		1.04	%					1.09	%

The analysis of the allowance for loan losses should not be interpreted as an indication that chargeoffs will occur in these amounts or proportions, or that the allocation indicates future chargeoff trends. Furthermore, the portion allocated to each category is not the total amount available for future losses that might occur within each category.

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Analysis of Allowance for Loan Losses

The following table summarizes transactions in the allowance for loan losses and details the chargeoffs, recoveries and net loan losses by loan category.

	Nine months ended		Nine months ended
(in thousands)	September 30, 2006		September 30, 2005
Beginning Balance	$	2,056	$	1,887
Chargeoffs
Commercial		—		252
Real estate:
Commercial		—		1
Construction		—		—
Residential 1-4 family		—		—
Consumer and other		19		23
Total chargeoffs	$	19	$	276
Recoveries
Commercial	$	8	$	17
Real estate:
Commercial		—		—
Construction		—		—
Residential 1-4 family		—		—
Consumer and other		8		12
Total Recoveries	$	16	$	29
Net chargeoffs/(recoveries)	$	3	$	247
Provision		578		291
Ending balance	$	2,631	$	1,931

Investments

At September 30, 2006, investments totaled $32,022,000, a decrease of $1,528,000 or 4.55 percent from $33,550,000 at December 31, 2005. The decrease in investments was primarily due to maturities and prepayments of securities.

For more information regarding securities, see Note 4, “Securities Available for Sale” to the unaudited consolidated financial statements.

Deposits

At September 30, 2006, total deposits were $235,034,000, compared to $199,890,000 at December 31, 2005. This represents a 17.58 percent increase from December 31, 2005. Non-interest-bearing deposits totaled $54,647,000 at September 30, 2006 compared to $64,635,000 at December 31, 2005, a decrease of $9,988,000 or 15.45 percent, partially due to a seasonally high in-flow of dollars on December 31, 2005. Interest-bearing deposits totaled $180,387,000 at September 30, 2006, compared to $135,255,000 at December 31, 2005, an increase of $45,132,000 or 33.37 percent.

Borrowings and Junior Subordinated Debt

At September 30, 2006, the Bank’s Federal Home Loan Bank borrowings were $46,721,000 compared to $23,849,000 at December 31, 2005. This represents a 95.90 percent increase from December 31, 2005 and is

21

primarily due to the use of advances to fund internal loan growth and purchases of loans totaling approximately $5,800,000 from a mortgage broker in the first quarter of 2006.

At September 30, 2006 and December 31, 2005 the Company had junior subordinated debt totaling $5,000,000.

For discussion of Federal Home Loan Bank advances and junior subordinated debt, see Note 8, “Borrowings and Junior Subordinated Debt” to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K as of December 31, 2005.

Stockholders’ Equity and Capital Resources

Stockholders’ equity totaled $18,843,000 at September 30, 2006, an increase of $1,107,000 or 6.24 percent over December 31, 2005. Current net earnings were $1,226,000 and dividends paid were $361,000 for the nine months ended September 30, 2006. The change in unrealized losses on securities available for sale, net of deferred taxes, increased stockholders’ equity by $29,000. Equity increased by $95,000 in surplus due to the recognition of stock option compensation costs as a result of the adoption of SFAS 123R, and by $118,000 in surplus from the exercise of 10,535 stock options in the second quarter of 2006.

Book value per share was $9.37 at September 30, 2006 compared to $8.87 at December 31, 2005. Book value per share is calculated by dividing total equity by total shares outstanding.

The following table displays the capital ratios at September 30, 2006 and December 31, 2005 for the Company and the Bank. As the table illustrates, the capital ratios exceed those required to be considered well-capitalized.

											Minimum to Be
											Well Capitalized
						Minimum for					Under the Prompt
						Capital Adequacy					Corrective Action
	Actual					Purposes					Provisions
(in thousands, except ratio data)	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2006
Total capital (to risk-weighted assets)
Consolidated	$	26,649		10.01	%	$	21,297		8.00	%		N/A		N/A
Bank		26,331		10.10			20,862		8.00		$	26,077		10.00	%
Tier 1 capital (to risk-weighted assets)
Consolidated		24,018		9.02			10,648		4.00			N/A		N/A
Bank		23,700		9.09			10,431		4.00			15,646		6.00
Tier 1 capital (to average assets) (1)
Consolidated		24,018		8.14			11,808		4.00			N/A		N/A
Bank		23,700		8.03			11,808		4.00			14,761		5.00
December 31, 2005
Total capital (to risk-weighted assets)
Consolidated	$	24,997		12.55	%	$	15,939		8.00	%		N/A		N/A
Bank		24,626		12.39			15,898		8.00		$	19,873		10.00	%
Tier 1 capital (to risk-weighted assets)
Consolidated		22,941		11.51			7,953		4.00			N/A		N/A
Bank		22,570		11.36			7,949		4.00			11,924		6.00
Tier 1 capital (to average assets) (1)
Consolidated		22,941		10.25			8,952		4.00			N/A		N/A
Bank		22,570		10.10			8,935		4.00			11,169		5.00

(1) Also referred to as the leverage ratio

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Contractual Obligations and Commitments

In the normal course of business, to meet the financing needs of its customers, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit, lines of credit, and standby letters of credit. Such off-balance sheet items are recognized in the financial statements when they are funded or related fees are received. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The off-balance sheet items do not represent unusual elements of credit risk in excess of the amounts recognized in the balance sheets.

At September 30, 2006, the Company had commitments to extend credit and contingent liabilities under lines of credit, standby letters of credit and similar arrangements totaling $79,754,000. Since many lines of credit do not fully disburse, or expire without being drawn upon, the total amount does not necessarily reflect future cash requirements.

For additional information regarding off-balance sheet items, refer to Note 16 “Commitments and Contingencies” to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K as of December 31, 2005.

The following table summarizes the Company’s significant contractual obligations and commitments at September 30, 2006:

	Within						After
(in thousands)	1 Year		1-3 Years		3-5 Years		5 Years		Total
Federal Home Loan Bank advances	$	26,736	$	4,985	$	5,000	$	10,000	$	46,721
Junior subordinated debt		—		—		—		5,000		5,000
Time Deposits		77,756		17,187		4,499		—		99,442
Operating leases		599		920		662		888		3,069
Purchase obligations *		183		—		—		—		183
Total	$	105,274	$	23,092	$	10,161	$	15,888	$	154,415

* Purchase obligations include approximately $86,000 and $97,000 for a new telephone system and office remodel, respectively, both of which the Company anticipates will be completed in the fourth quarter of 2006.

Liquidity

Liquidity is defined as the ability to provide sufficient cash to fund operations and meet obligations and commitments on a timely basis. Through asset and liability management, the Company controls its liquidity position to ensure that sufficient funds are available to meet the needs of depositors, borrowers, and creditors.

In addition to cash and cash equivalents, asset liquidity is provided by the available-for-sale securities portfolio. Approximately eleven percent of the investment balances within this portfolio mature within one year. Liquidity is further enhanced by deposit growth, federal funds purchased and securities sold under agreements to repurchase, borrowings, and planned cash flows, maturities and sales of investments and loans.

The consolidated statement of cash flows contained in this report provides information on the sources and uses of cash for the respective year-to-date periods ended September 30, 2006 and 2005. See the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 for additional information.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There were no material changes in information about market risk from that provided in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The latest available analysis of the potential impact of rate on net interest income is indicated in the tables below.

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Net interest income analysis as of September 30, 2006:

     In thousands; rate changes in basis points (bp) = 1/100 of 1%.

	ANNUALIZED DOLLAR CHANGE
IMMEDIATE RATE CHANGE	IN NET INTEREST INCOME			PERCENT CHANGE
+200bp		816			7.02
+100bp		425			3.66
+ 50bp		213			1.83
- 50bp		(201	)		(1.73	)
-100bp		(402	)		(3.45	)
-200bp		(804	)		(6.91	)

The table above indicates, for example, that the estimated effect of an immediate 100 basis point increase in interest rates would increase the Company’s net interest income by an estimated 3.66 percent or approximately $425,000. An immediate 100 basis point decrease in rates indicates a potential reduction of net interest income by 3.45 percent or approximately $402,000.

While net interest income or “rate shock” analysis is a useful tool to assess interest rate risk, the methodology has inherent limitations. For example, certain assets and liabilities may have similar maturities or periods to repricing, but may react in different degrees to changes in market interest rates. Prepayment and early withdrawal levels could vary significantly from assumptions made in calculating the tables. In addition, the ability of borrowers to service their debt may decrease in the event of significant interest rate increases. Finally, actual results may vary as management may not adjust rates equally as general levels of interest rates rise or fall.

The Company does not use interest rate risk management products, such as interest rate swaps, hedges, or derivatives.

ITEM 4. CONTROLS AND PROCEDURES

Gordon D. Browning began his role as the Company’s Chief Financial Officer on September 11, 2006. Prior to his start date, Mr. Browning spent time with the Company’s Chief Executive and former Interim Chief Financial Officer to become familiar with the Company’s processes. An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of September 30, 2006. Based upon, and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, in all material respects, in timely alerting them to material information relating to the Company (and its consolidated subsidiaries) required to be included in the periodic reports the Company is required to file and submit to the SEC under the Exchange Act.

We have not experienced any significant difficulties to date during the transition to a new Chief Financial Officer. Except as referred to above, there were no significant changes to the Company’s internal controls over financial reporting or in other factors that could significantly affect these internal controls subsequent to the date the Company carried out its evaluation of those internal controls. There were no significant deficiencies or material weaknesses identified in the evaluation and, therefore, no corrective actions were taken.

Forward-Looking Information Statement

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. EvergreenBancorp, Inc. (the “Company”) intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the Company, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Important factors which could cause actual results to differ materially from the Company’s expectation include, but are not limited to: fluctuation in interest rates and loan and deposit pricing, which could reduce the Company’s net interest margins, asset valuations and expense expectations; a deterioration in the economy or business conditions, either nationally or in the Company’s market areas, that could increase credit-related losses and expenses; a national or local disaster,

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including acts of terrorism; challenges the Company may experience in retaining or replacing key executives or employees in an effective manner; increases in defaults by borrowers and other loan delinquencies resulting in increases in the Company’s provision for loan losses and related expenses; higher than anticipated costs related to business combinations and the integration of acquired businesses which may be more difficult or expensive than expected, or slower than expected earning assets growth which could extend anticipated breakeven periods relating to such strategic expansion; significant increases in competition; legislative or regulatory changes applicable to bank holding companies or the Company’s banking or other subsidiaries; and possible changes in tax rates, tax laws, or tax law interpretation. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission, including its Annual Report for 2005 on Form 10-K.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Bancorp and the Bank from time to time may be parties to various legal actions arising in the normal course of business. Management believes that there is no proceeding threatened or pending against Bancorp or the Bank which, if determined adversely, would have a material adverse effect on the consolidated financial conditions or results of operations of the Company.

ITEM 1A. RISK FACTORS

There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

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

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

(a) Exhibits

Exhibit 31.1 — Certification of Chief Executive Officer Pursuant to Rule 13a-15(e)/15d-15(e)

Exhibit 31.2 — Certification of Chief Financial Officer Pursuant to Rule 13a-15(e)/15d-15(e)

Exhibit 32.1 — Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32.2 — Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

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

Dated: November 10, 2006

EVERGREENBANCORP, INC.

/s/ Gordon D. BrowningGordon D. Browning

Executive Vice President and Chief Financial Officer

(Authorized Officer and Principal Financial Officer)

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