Cowlitz Bancorporation (CWLZ) 10-Q 2006 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

___________________

FORM 10-Q

[X] Quarterly report Pursuant to section 13 or 15(d) of the Securities and Exchange act of 1934 
 For the quarter ended June 30, 2006 

[  ] Transition report pursuant to section 13 or 15(d) of the Securities and Exchange act of 1934 

                                                               For the transition period from  _____to _____

Commission file number 0-23881

___________________

 

COWLITZ BANCORPORATION
(Exact name of registrant as specified in its charter)
Washington	91-1529841
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)
927 Commerce Ave., Longview, Washington 98632
(Address of principal executive offices) (Zip Code)
(360) 423-9800
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

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

[ ] Large accelerated filer                      [ ] Accelerated filer                      [X] Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes[ ] No [X]

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 on July 31, 2006: 4,879,998 shares

1

COWLITZ BANCORPORATION AND SUBSIDIARY
TABLE OF CONTENTS
			PAGE
Part I		FINANCIAL INFORMATION
Item	1.	Financial Statements
		Consolidated Statements of Condition -	3
		June 30, 2006, and December 31, 2005
		Consolidated Statements of Income -	4
		Three and six months ended June 30, 2006 and June 30, 2005
		Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income -	5
		Six months ended June 30, 2006 and year ended December 31, 2005
		Consolidated Statements of Cash Flows -	6
		Six months ended June 30, 2006 and June 30, 2005
		Notes to Consolidated Financial Statements	7
Item	2.	Management's Discussion and Analysis of Financial Condition	11
		And Results of Operations
Item	3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item	4.	Controls and Procedures	21
Part II		OTHER INFORMATION
Item	1.	Legal Proceedings	22
Item	1A.	Risk Factors	22
Item	2.	Unregistered Sales of Equity Securities and Use of Proceeds	22
Item	3.	Defaults upon Senior Securities	22
Item	4.	Submission of Matters to a Vote of Security Holders	22
Item	5.	Other Information	22
Item	6.	Exhibits	23
		Signatures	24

Forward-Looking Statements

Management’s discussion and the information in this document and the accompanying financial statements contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by words such as "expect", "believe", "intend", "anticipate", "estimate" or similar expressions, and are subject to risks and uncertainties that could cause actual results to differ materially from those stated. Examples of such risks and uncertainties that could have a material adverse effect on the operations and future prospects of the Company, and could render actual results different from those expressed in the forward-looking statements, include, without limitation: those set forth in our most recent Form 10-K and other filings with the SEC, changes in general economic conditions, competition for financial services in the market area of the Company, the level of demand for loans, quality of the loan and investment portfolio, deposit flows, legislative and regulatory initiatives, and monetary and fiscal policies of the U.S. Government affecting interest rates. The reader is advised that this list of risks is not exhaustive and should not be construed as any prediction by the Company as to which risks would cause actual results to differ materially from those indicated by the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements.

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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
COWLITZ BANCORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CONDITION
(UNAUDITED)
	June 30,		December 31,
(dollars in thousands)	2006		2005
Assets
Cash and cash equivalents	$	13,938	$	23,457
Securities available for sale at fair value
(amortized cost: $56,473 and $52,880)		54,955		52,462
Federal Home Loan Bank stock, at cost		1,247		1,247
Loans, net of deferred loan fees		329,123		270,247
Allowance for loan losses		(5,039)		(4,417)
Total loans, net		324,084		265,830
Cash surrender value of bank-owned life insurance		13,224		11,475
Premises and equipment, net		5,166		4,269
Goodwill and other intangibles		1,896		2,135
Accrued interest receivable and other assets		9,267		9,471
Total assets	$	423,777	$	370,346
Liabilities
Deposits:
Non-interest-bearing demand	$	99,203	$	97,327
Savings, interest-bearing demand and money market		93,814		98,360
Certificates of deposit		149,236		113,508
Total deposits		342,253		309,195
Federal funds purchased and other borrowings		16,132		817
Junior subordinated debentures		12,372		12,372
Accrued interest payable and other liabilities		5,539		3,021
Total liabilities		376,296		325,405
Commitments and contingent liabilities(Note 8)
Shareholders' equity
Preferred stock, no par value; 5,000,000 shares authorized; no shares
issued and outstanding at June 30, 2006 and December 31, 2005		-		-
Common stock, no par value; 25,000,000 shares authorized
with 4,879,998 and 4,772,251 shares issued and outstanding
at June 30, 2006 and December 31, 2005, respectively		27,195		26,266
Additional paid-in capital		2,209		2,043
Retained earnings		19,081		16,908
Accumulated other comprehensive loss, net of taxes		(1,004)		(276)
Total shareholders' equity		47,481		44,941
Total liabilities and shareholders' equity	$	423,777	$	370,346
See accompanying notes

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COWLITZ BANCORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
	Three Months Ended				Six Months Ended
		June 30,			June 30,
(dollars in thousands, except per share amounts)	2006			2005	2006		2005
Interest income
Interest and fees on loans	$	6,794	$	3,821	$ 12,433	$	7,242
Interest on taxable investment securities		507		493	964		1,011
Interest on non-taxable investment securities		205		135	392		270
Other interest and dividend income		53		52	166		90
Total interest income		7,559		4,501	13,955		8,613
Interest expense
Savings and interest-bearing demand		331		185	638		370
Certificates of deposit		1,601		790	2,732		1,542
Federal funds purchased and other borrowings		46		26	60		39
Junior subordinated debentures		204		109	385		110
Total interest expense		2,182		1,110	3,815		2,061
Net interest income before provision for credit losses		5,377		3,391	10,140		6,552
Provision for credit losses		285		60	690		60
Net interest income after provision for credit losses		5,092		3,331	9,450		6,492
Non-interest income
Service charges on deposit accounts		169		144	313		281
Mortgage brokerage fees		68		55	103		134
Credit card income		85		79	169		204
Fiduciary income		121		150	302		297
Increase in cash surrender value of bank-owned life insurance		138		83	248		165
Wire fees		129		3	244		6
Net loss on sales of investment securities		(164)		-	(164)		-
Net gain on sale of repossessed assets		41		21	41		21
Other income		55		27	147		72
Total non-interest income		642		562	1,403		1,180
Non-interest expense
Salaries and employee benefits		2,063		1,667	4,150		3,364
Net occupancy and equipment expense		526		346	976		694
Professional fees		269		191	516		384
Business taxes		93		55	174		106
Advertising		111		73	174		133
Credit card expense		66		57	132		193
Data processing and communications		166		65	281		138
Postage and freight		85		62	164		127
Travel and education		125		78	199		103
Stationery and supplies		50		42	100		74
Amortization of intangible assets		26		-	52		-
Interest rate floor valuation adjustment		182		-	182		-
Insurance premiums		36		44	84		86
Other expenses		433		279	701		472
Total non-interest expense		4,231		2,959	7,885		5,874
Income before provision for income taxes		1,503		934	2,968		1,798
Income tax provision		390		247	795		469
Net income	$	1,113	$	687	$ 2,173	$	1,329
Earnings per common share:
Basic	$	0.23	$	0.16	$ 0.45	$	0.32
Diluted	$	0.22	$	0.16	$ 0.43	$	0.31
Weighted average shares outstanding:
Basic	4,842,911			4,176,724	4,807,776		4,175,440
Diluted	5,102,201			4,321,444	5,033,143		4,324,594
See accompanying notes

4

COWLITZ BANCORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS'
EQUITY AND COMPREHENSIVE INCOME
(UNAUDITED)
							Accumulated
	Common stock			Additional			Other		Total
				Paid-in		Retained	Comprehensive		Shareholders’	Comprehensive
(dollars in thousands)	Shares	Amount		Capital		Earnings	Income(Loss)		Equity	Income
Balance, December 31, 2004	4,173,552	$	19,511	$	2,022	$        13,951	$	214	$            35,698
Comprehensive income:
Net income	-		-		-	2,957		-	2,957	$	2,957
Net change in unrealized gain on
investments available-for-sale,
net of deferred taxes of $343	-		-		-	-		(490)	(490)		(490)
Comprehensive income										$	2,467
Issuance of common stock in
connection with acquisition	569,970		6,463		-	-		-	6,463
Proceeds from the exercise of
stock options and employee stock
purchases	28,729		292		-	-		-	292
Tax benefit from the exercise
of stock options	-		-		21	-		-	21
Balance, December 31, 2005	4,772,251		26,266		2,043	16,908		(276)	44,941
Comprehensive income:
Net income	-		-		-	2,173		-	2,173	$	2,173
Net change in unrealized gain on
investments available-for-sale,
net of deferred taxes of $223	-		-		-	-		(728)	(728)		(728)
Comprehensive income										$	1,445
Proceeds from the exercise of
stock options and employee stock
purchases	107,747		929		-	-		-	929
Tax benefit from the exercise
of stock options	-		-		90	-		-	90
Recognition of
stock-based compensation	-		-		76	-		-	76
Balance, June 30, 2006	4,879,998	$	27,195	$	2,209	$       19,081	$	(1,004)	$           47,481
See accompanying notes

5

COWLITZ BANCORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
	Six Months Ended
	June 30,
(dollars in thousands)	2006		2005
Cash flows from operating activities
Net income from operations	$         2,173	$	1,329
Adjustments to reconcile net income to net cash from operating activities:
Stock-based compensation	76		-
Tax benefit of stock options exercised	90		-
Depreciation and amortization	273		162
Provision for credit losses	690		60
Increase in cash surrender value of bank-owned life insurance	(248)		(165)
Federal Home Loan Bank stock dividends	-		(4)
Net loss on sales of investment securities availiable for sale	164		-
Net gain on sales of foreclosed assets	(41)		(21)
Net amortization of investment security premiums and accretion of discounts	184		199
Interest rate floor valuation adjustment	182		-
Increase (decrease) in accrued interest receivable and other assets	581		(443)
Increase in accrued interest payable and other liabilities	2,517		357
Net cash from operating activities	6,641		1,474
Cash flows used by investing activities
Proceeds from maturities and sales of investment securities available-for-sale	6,514		4,371
Purchases of available-for-sale investment securities	(10,456)		-
Investment in statutory trust subsidiary	-		(372)
Net increase in loans	(58,944)		(19,246)
Proceeds from sale of foreclosed assets	41		90
Purchases in bank-owned life insurance	(1,500)		(2,500)
Purchases of premises and equipment	(1,118)		(99)
Net cash used by investment activities	(65,463)		(17,756)
Cash flows from financing activities
Net increase (decrease) in savings, noninterest-bearing and interest-bearing demand deposits	(2,724)		12,181
Net increase (decrease) in certificates of deposit	35,783		2,283
Net increase (decrease) in federal funds purchased and other borrowings	15,318		(98)
Proceeds from issuance of junior subordinated debentures	-		12,372
Repayment of other borrowings	(3)		(3)
Proceeds from the exercise of stock options	929		113
Net cash from financing activities	49,303		26,848
Net (decrease) increase in cash and cash equivalents	(9,519)		10,566
Cash and cash equivalents, beginning of period	23,457		8,332
Cash and cash equivalents, end of period	$         13,938	$	18,898
See accompanying notes

6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.Organization and Summary of Significant Accounting Policies

Organization-Cowlitz Bancorporation (the Company) was organized in 1991 under Washington law to become the holding company for Cowlitz Bank (the Bank), a Washington state-chartered bank that commenced operations in 1978. The principal executive offices of the Company are located in Longview, Washington. The Bank operates four branches in Cowlitz County in southwest Washington. Outside of Cowlitz County, the Bank does business under the name Bay Bank with branches in Seattle, Bellevue and Vancouver, Washington. In Oregon, the Company operates a full service branch in Portland and a limited service branch in a retirement center in Wilsonville. The Bank also provides mortgage-banking services through its Bay Mortgage division with offices in Longview and Vancouver. The Company offers or makes available a broad range of financial services to its customers, primarily small and medium-sized businesses, professionals, and retail customers. The Bank's commercial and personal banking services include commercial and real estate lending, international banking services, consumer lending, internet banking and trust services.

Principles of consolidation- The accompanying consolidated financial statements include the accounts of the Company and its subsidiary. All significant intercompany transactions and balances have been eliminated. The interim financial statements have been prepared without an audit and in accordance with the instructions to Form 10-Q, generally accepted accounting principles, and banking industry practices. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, including normal recurring accruals necessary for a fair presentation of the financial condition and results of operations for the interim periods included herein, have been made. The results of operations for the three and six months ended June 30, 2006 are not necessarily indicative of results to be anticipated for the year ending December 31, 2006. The interim consolidated financial statements should be read in conjunction with the December 31, 2005 consolidated financial statements, including the notes thereto, included in the Company’s 2005 Form 10-K.

Operating segments-Internal financial information is primarily recorded and aggregated in three lines of business: commercial banking, mortgage banking, and trust services. While management monitors the revenue streams of the various products and services, the mortgage banking and trust segments are not individually material and operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, all financial service operations are considered by management to be aggregated within one reportable operating segment.

Use of estimates in preparation of the consolidated financial statements-Preparation of the consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities 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. Significant estimates include the allowance for credit losses and carrying values of the Company's goodwill and other intangibles.

Hedging activities-In the ordinary course of business, the Company may enter into derivative transactions to manage its exposure to interest rate fluctuations. Derivatives that may be used for interest rate risk management include interest rate swaps, futures, forward and option structures with indices that relate to the pricing of specific on-balance sheet assets. Under the guidance of Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, all derivative instruments that qualify for hedge accounting are recorded on the balance sheet at fair value and classified either as a hedge of the fair value of a recognized asset, liability or firm commitment (fair value hedge) or as a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability or a forecasted transaction (cash flow hedge). The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy, at the inception of each hedge transaction. The Company performs an assessment, both at inception of the hedge and on a quarterly basis thereafter, when required, to determine whether these derivatives are highly effective in offsetting changes in the value of the hedged items.

In March 2006, the Company entered into an interest rate floor agreement to hedge the variability of expected interest income related to loans priced with a floating rate index. The notional amount of this agreement is $50 million, and the agreement expires in March 2011. The effective portion of the change in the fair value of the derivative instrument is recorded as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. For the purpose of this hedge, the

7

Company elected to exclude the time value portion of the interest rate floor agreement. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in other non-interest expenses during the period of change.

Recently Issued Accounting Standards-In July 2006, the Financial Accounting Standards Board (FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” This interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 31, 2006. The Company is currently evaluating the impact of the adoption of FIN 48.

2.Cash and Cash Equivalents

For the purpose of presentation in the statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks including short-term certificates of deposit, and federal funds sold. Federal funds sold generally mature the day following purchase.

3.Earnings Per Share

The following table reconciles the denominator of the basic and diluted earnings per share computations:

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2006	2005	2006	2005
Weighted-average shares – basic	4,842,911	4,176,724	4,807,776	4,175,440
Effect of assumed conversion of stock options	259,290	144,720	225,367	149,154
Weighted-average shares – diluted	5,102,201	4,321,444	5,033,143	4,324,594

 

4. Stock-Based Compensation 

At June 30, 2006, the Company had one stock-based compensation plan available for issuing option grants and an Employee Stock Purchase Plan (“ESPP”). In 2003, the Company adopted the 2003 Stock Incentive Plan (“2003 Plan”) under which it is authorized to issue up to 500,000 shares of common stock in the form of nonqualified stock options or restricted stock grants. The 2003 Plan replaced the Company’s 1997 Stock Option Plan. Under the 2003 Plan, options may be granted to the Company’s employees, non-employee directors and others whom management believes contribute to the long-term financial success of the Company. The 2003 Plan permits the grant of stock options and restricted stock grants for up to 500,000 shares, of which 4,000 share grants remained available for issue at June 30, 2006. The exercise price of nonqualified stock options under the 2003 Plan must be at least equal to the fair value of the common stock on the date of grant, and the vesting schedule is set at the discretion of the Board of Directors’ Compensation Committee.

The Company adopted SFAS No. 123(R) on January 1, 2006 using the modified prospective method, and, accordingly, did not restate consolidated net income for prior interim periods or fiscal years. Compensation cost recognized in the first quarter of 2006 included: (1) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with SFAS 123; and (2) compensation cost for all share-based awards granted on or after January 1, 2006. Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows. SFAS No. 123(R) requires the cash flows from the tax benefits resulting from tax deductions in excess of the compensation costs recognized for those options (excess tax benefits) to be classified as financing cash flows.

As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company’s income before income taxes was lower by $24,000 and $33,000 in the second quarter and first six months of 2006, respectively. Net income was lower by $9,900 for the second quarter and $15,700 for the first six months of 2006 than if the Company had continued to account for share-based compensation under APB No. 25. There was no significant impact on basic and diluted earnings per share, cash flows from operations or financing activities for the second quarter or first six months of 2006. In the first six months of 2006, the Company recognized expense of $43,000 related to the accelerated vesting of stock options for one former employee and one former director whose services ceased during the quarter. As of June 30, 2006, there was approximately $41,000 of unrecognized compensation costs related to stock options, expected to be recognized over a weighted-average period of 0.7 years.

8

The following table summarizes information about stock option activity for the six months ended June 30, 2006:

				Weighted-Avg.	Aggregate
	Options	Weighted-Avg.		Remaining Contractual	Intrinsic Value
	Outstanding	Exercise Price		Term (years)	(in thousands)
Balance, beginning of period	984,236	$	10.42
Granted	-		-
Exercised	(104,750)		8.55
Forfeited/expired	(150)		4.94
Balance, end of period	879,336		10.65	6.6	$	4,751
Exercisable, end of period	761,936		10.71	6.5	$	4,066

The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing model based on the following assumptions. Expected volatility is based on the historical volatility of the price of the Company’s stock for a period consistent with the expected life of the options. The Company uses historical data to estimate option exercise and employee termination rates within the valuation model. The expected term of options represents the period of time that stock options are expected to be outstanding and is estimated based on historical exercise and forfeiture activity. Expected dividends are estimated to be zero due to the Company’s recent historical practice of not paying dividends. The risk-free rate of return for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

Under SFAS No. 123, the Black-Scholes option pricing model was used to estimate the fair value of options granted in the first six months of 2005 using weighted average assumptions as follows: expected volatility of 35.12%; expected term of 4.26 years; dividend yield of zero; and risk-free interest rate of 2.95% . Pro forma net income and earnings per share information are provided in the following table as if the Company accounted for employee stock option plans under the fair value method of SFAS No. 123 in the first six months of 2005.

	Three Months Ended				Six Months Ended
	June 30, 2005				June 30, 2005
	As		Pro		As		Pro
(dollars in thousands, except per share amounts)	Reported		Forma		Reported		Forma
Net income	$	687	$	645	$	1,329	$	1,113
Basic earnings per share	$	0.16	$	0.15	$	0.32	$	0.27
Diluted earnings per share	$	0.16	$	0.15	$	0.31	$	0.26

Stock options granted in the first six months of 2005 were fully vested upon grant, resulting in full recognition of stock-based compensation expense under the fair value method in the pro forma amounts in the table above. In 2003, the Company amended its ESPP to allow eligible employees to defer from 1% to 10% of their salaries over a period of six months in order to purchase shares of company stock. The purchase price is set at 85% of the lowest market price on either the first or last day of the six-month deferral period. The Company is authorized to issue up to 175,000 shares of common stock under the ESPP. The Company issued 2,997 shares on June 30, 2006 under the ESPP, and there were 108,257 shares remaining for issuance. In the year 2005, 5,925 shares were issued under the ESPP. Under SFAS No.123(R), the plan is considered compensatory, however, compensation expense related to the ESPP for the first six months of 2006 and 2005 was not significant.

5. Comprehensive Income

For the Company, comprehensive income primarily includes net income reported on the statements of income and changes in the fair value of available-for-sale investment securities. These amounts are included in “Other Comprehensive Income (Loss)” on the consolidated statement of changes in shareholders’ equity.

9

	Three Months Ended			Six Months Ended
	June 30,			June 30,
(dollars in thousands)	2006	2005		2006	2005
Unrealized holding gains (losses) arising during the period, net of tax	$           (412)	$	255	$           (835)	$	11
Less reclassification adjustment for net realized (gains) losses
on securities available-for-sale included in net
income during the period, net of tax	107		-	107		-
Net unrealized holding gains (losses) included in
other comprehensive income (loss)	$            (305)	$	255	$           (728)	$	11

6. Investment Securities 

The following table presents the composition and carrying value of the Company’s available for sale investment portfolio:

	June 30,		December 31,
(dollars in thousands)	2006		2005
Mortgage-backed securities	$	35,526	$	34,316
Municipal bonds		19,429		18,146
	$	54,955	$	52,462

The following table presents the gross unrealized losses and fair value of the Company’s investment securities aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2006:

		Less Than 12 Months		12 Months or More		Total
	Fair		Unrealized	Fair	Unrealized	Fair	Unrealized
(dollars in thousands)	Value		Losses	Value	Losses	Value	Losses
Mortgage-backed securities	$	28,539	$         (805)	$        6,379	$          (351)	$         34,918	$	(1,156)
Municipal bonds		15,249	(375)	593	(33)	15,842		(408)
	$	43,788	$      (1,180)	$        6,972	$          (384)	$         50,760	$	(1,564)

At June 30, 2006, there were 113 investment securities in an unrealized loss position, of which 11 were in a continuous loss position for 12 months or more. The Company believes these unrealized losses were due to changes in market interest rates and not credit quality. The Company has the ability and intent to hold these securities until a market price recovery or to maturity, and, therefore, the unrealized losses on these securities are not considered other-than-temporarily impaired.

7.Allowance for Credit Losses

As of March 31, 2006, the Company reclassified the portion of its allowance for credit losses related to unfunded lending commitments ($234,000) to a separate liability account included in other liabilities in the consolidated balance sheet. The amount at December 31, 2005 ($251,000) was also reclassified. The reclassifications had no effect on the provision for credit losses as reported.

8.Commitments and Contingent Liabilities

The Company’s consolidated financial statements do not reflect various commitments and contingent liabilities of the Bank that arise in the normal course of business and that involve elements of credit risk, interest rate risk, and liquidity risk. These commitments and contingent liabilities are commitments to extend credit, credit card arrangements, and standby letters of credit.

A summary of the Bank’s undisbursed commitments and contingent liabilities at June 30, 2006, was as follows:

10

(dollars in thousands)	Total
Commitments to extend credit	$	91,465
Credit card commitments		4,411
Standby letters of credit		1,414
	$	97,290

 

Commitments to extend credit, credit card arrangements, and standby letters of credit all include exposure to some credit loss in the event of non-performance of the customer. The Bank’s credit policies and procedures for credit commitments and financial guarantees are the same as those for extension of credit that are recorded in the consolidated statements of condition. Because these instruments have fixed maturity dates and many of them expire without being drawn upon, they do not generally present a significant liquidity risk to the Bank.

9. Junior Subordinated Debentures

As of June 30, 2006, the Company had one wholly owned Delaware statutory business trust subsidiary, Cowlitz Statutory Trust I (the Trust), which issued $12,000,000 of guaranteed undivided beneficial interests in the Company’s Junior Subordinated Deferrable Interest Debentures (Trust Preferred Securities) in 2005. The Company owns all of the common securities of the Trust. The proceeds from the issuance of the common securities and the Trust Preferred Securities were used by the Trust to purchase $12,372,000 of junior subordinated debentures of the Company. In accordance with Financial Accounting Standards Board’s Interpretation No. 46 (revised December 2003) “Consolidation of Variable Interest Entities,” the Company does not consolidate the Trust because it isn’t the primary beneficiary.

The debentures, which represent the sole asset of the Trust, accrue and pay distributions quarterly at a variable rate of 90-day LIBOR plus 1.75% per annum of the stated liquidation value of $1,000 per capital security. These debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. Federal Reserve guidelines limit inclusion of trust-preferred securities and certain other preferred capital elements to 25% of Tier 1 capital. As of June 30, 2006, trust preferred securities accounted for 21% of Tier 1 capital. There can be no assurance that the Federal Reserve Board will not further limit the amount of trust preferred securities permitted to be included in Tier 1 capital for regulatory capital purposes.

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

Critical Accounting Policies

The Company’s most critical accounting policy is related to the allowance for credit losses. The Company utilizes both quantitative and qualitative considerations in establishing an allowance for credit losses believed to be appropriate as of each reporting date.

Quantitative factors include:

• the volume and severity of non-performing loans and adversely classified credits,
• the level of net charge-offs experienced on previously classified loans,
• the nature and value of collateral securing the loans,
• the trend in loan growth and the percentage of change,
• the level of geographic and/or industry concentration,
• the relationship and trend over the past several years of recoveries in relation to charge-offs, and
• other known factors regarding specific loans.

Qualitative factors include:

• the effectiveness of credit administration,
• the adequacy of loan review,
• the adequacy of loan operations personnel and processes,
• the effect of competitive issues that impact loan underwriting and structure,
• the impact of economic conditions, including interest rate trends, and
• the introduction of new loan products or specific marketing efforts.

Changes in the above factors could significantly affect the determination of the adequacy of the allowance for credit losses. Management performs a full analysis, no less often than quarterly, to ensure that changes in estimated loan

11

loss levels are adjusted on a timely basis. For further discussion of this significant management estimate, see “Allowance for Credit Losses.” Another critical accounting policy of the Company is related to the carrying value of goodwill and other intangibles. Under Statement of Financial Accounting Standards No. 142,"Goodwill and Other Intangible Assets" (SFAS No. 142), the Company ceased amortization of goodwill on January 1, 2002 and periodically tests intangibles with indefinite lives for impairment. Impairment analysis of the fair value of goodwill involves a substantial amount of judgment, as does establishing and monitoring estimated amounts and lives of other intangible assets.

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

Overview

The Company’s net income for the second quarter of 2006 was $1.1 million, or $0.22 per diluted share, compared with net income of $687,000, or $0.16 per diluted share for the second quarter of 2005. Net income was $426,000, or 62%, higher in the second quarter of 2006 compared with the same period of 2005. Net income for the first six months of 2006 was $2.2 million, or $0.43 per diluted share, compared with $1.3 million, or $0.31 per diluted share, in the same period of 2005. The Company’s increase in net income was primarily due to higher average loans outstanding and a higher net interest spread. A significant portion of the loan increase relates to the acquisition of Asia-Europe-Americas Bancshares, Inc. in the fourth quarter of 2005.

Net interest income was $2.0 million higher in the second quarter of 2006, compared with the same period in 2005. Through June 30, 2006, net interest income was $3.5 million higher than the first six months of 2005. Average earning assets were $368.9 million in the second quarter of 2006, compared with $267.6 million in the second quarter of 2005. Average interest-bearing liabilities in the second quarter of 2006 were $261.1 million, compared with $194.7 million in the second quarter of 2005.

The Company recorded a provision for credit losses of $285,000 in the second quarter of 2006 and $690,000 for the first six months of 2006. This compares with a provision for credit losses of $60,000 in the second quarter and first six months of 2005. The 2006 provision increased the allowance for credit losses to primarily support loan growth as the Company has realized only a small net recovery of loan losses in the first six months of 2006.

At June 30, 2006, total assets were $423.8 million, an increase of $53.4 million, or 15%, from December 31, 2005. Interest-bearing liabilities increased to $271.6 million as of June 30, 2006 from $225.1 million as of year-end 2005. Non-interest-bearing demand deposits increased $1.9 million during the same period. Total loans were up $58.9 million, or 22%, from year-end 2005. Loan growth was funded by an increase in deposits, primarily certificates of deposits, and a decrease in cash and cash equivalents from year-end 2005.

Analysis of Net Interest Income

The primary component of the Company’s earnings is net interest income. Net interest income is the difference between interest income, principally from loans and the investment securities portfolio, and interest expense, principally on customer deposits and borrowings. Changes in net interest income, net interest spread, and net interest margin result from changes in asset and liability volume, mix, and to rates earned or paid. Net interest spread refers to the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Net interest margin is the ratio of net interest income to total interest-earning assets and is influenced by the volume and relative mix of interest-earning assets and interest-bearing liabilities. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities.

Interest income from certain of the Company’s earning assets is non-taxable. The following tables present interest income and expense, including adjustments for non-taxable interest income, and the resulting tax-adjusted yields earned, rates paid, interest rate spread, and net interest margin for the periods indicated on an annualized basis.

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	Three Months Ended
	June 30,
					Increase
(dollars in thousands)	2006		2005		(Decrease)			Change
Interest income	$	7,559	$	4,501	$	3,058		68%
Tax effect of non-taxable interest income		77		55		22		40%
Tax equivalent interest income		7,636		4,556		3,080		68%
Interest expense		2,182		1,110		1,072		97%
Net interest income	$	5,454	$	3,446	$	2,008		58%
Average interest-earning assets	$	368,861	$	267,564	$	101,297		38%
Average interest-bearing liabilities	$	261,126	$	194,663	$	66,463		34%
Average yields earned (1)		8.28%		6.81%		147	b.p.	(3)
Average rates paid (1)		3.34%		2.28%		106	b.p.	(3)
Net interest spread (1)		4.94%		4.53%		41	b.p.	(3)
Net interest margin (1) (2)		5.91%		5.15%		76	b.p.	(3)

 

(1)	Ratios have been annualized. Tax exempt interest income has been adjusted to a taxable equivalent basis using a 34% tax rate
(2)	Computed by dividing net interest income by average interest-earning assets
(3)	b.p. stands for "basis points" (100 b.p. is equal to 1.0%)

	Six Months Ended
	June 30,
					Increase
(dollars in thousands)	2006		2005		(Decrease)			Change
Interest income	$	13,955	$	8,613	$	5,342		62%
Tax effect of non-taxable interest income		150		110		40		36%
Tax equivalent interest income		14,105		8,723		5,382		62%
Interest expense		3,815		2,061		1,754		85%
Net interest income	$	10,290	$	6,662	$	3,628		54%
Average interest-earning assets	$	355,021	$	263,390	$	91,631		35%
Average interest-bearing liabilities	$	248,350	$	192,085	$	56,265		29%
Average yields earned (1)		7.95%		6.62%		133	b.p.	(3)
Average rates paid (1)		3.07%		2.15%		92	b.p.	(3)
Net interest spread (1)		4.88%		4.47%		41	b.p.	(3)
Net interest margin (1) (2)		5.80%		5.06%		74	b.p.	(3)

 

(1)	Ratios have been annualized. Tax exempt interest income has been adjusted to a taxable equivalent basis using a 34% tax rate
(2)	Computed by dividing net interest income by average interest-earning assets
(3)	b.p. stands for "basis points" (100 b.p. is equal to 1.0%)

Comparing the second quarter of 2006 to the second quarter of 2005, tax-equivalent net interest income was $2.0 million higher, primarily due to an increase of $101.3 million in average interest-earning assets and an increase in the net interest spread. Interest expense increased $1.1 million, as the volume of average interest-bearing liabilities increased $66.5 million, and average rates paid increased 106 b.p. The second quarter of 2006 net interest margin increased 76 b.p. over the second quarter of 2005, due to a higher net interest spread and an increase in the value of non-interest-bearing deposits in a higher rate environment. The higher spread was primarily due to steadily increasing market interest rates since the second quarter of 2005. The Company’s margin in the second quarter of 2006 included $157,000 of interest income previously unrecognized on non-accrual loans paid off in the quarter. On a year-to-date basis, the net interest margin in 2006 increased 74 b.p. over the same period of 2005 for similar reasons. The Company estimates the second quarter and year-to-date 2006 impact on its net interest margin of this recovery of previously unrecognized nonaccrued interest to be an increase of 17 b.p. and 7 b.p., respectively.

13

Provision for Credit Losses

The amount of the allowance for credit losses is analyzed by management on a regular basis to ensure that it is adequate to absorb losses inherent in the loan portfolio as of the reporting date. When a provision for credit losses is recorded, the amount is based on the current volume of loans and commitments to extend credit, anticipated changes in loan volumes, past charge-off experience, management’s assessment of the risk of loss on current loans, the level of non-performing and impaired loans, evaluation of future economic trends in the Company's market area, and other factors relevant to the loan portfolio. An internal loan risk grading system is used to evaluate potential losses of individual loans. The Company does not, as part of its analysis, group loans together by loan type to assign risk. See "Allowance for Credit Losses" below for a more detailed discussion.

The Company recorded a provision for credit losses of $285,000 in the second quarter and $690,000 year-to-date in 2006, compared with a $60,000 provision in the second quarter and first six months of 2005. Loan charge-off and recovery activity in the 2006 and 2005 periods was not significant. The 2006 provision increased the allowance for credit losses primarily to support loan growth. The low level of provision for credit losses in 2005 was due to the overall improvement in credit quality of the loan portfolio during that period.

Non-Interest Income
Non-interest income consists of the following components:
	Three Months Ended			Six Months Ended
	June 30,			June 30,
(dollars in thousands)	2006	2005		2006	2005
Service charges on deposit accounts	$             169	$	144	$             313	$	281
Mortgage brokerage fees	68		55	103		134
Credit card income	85		79	169		204
Fiduciary income	121		150	302		297
Increase in cash surrender value of bank-owned life insurance	138		83	248		165
Wire fees	129		3	244		6
Net gain (loss) on sales of investment securities	(164)		-	(164)		-
Net gain (loss) on sale of repossessed assets	41		21	41		21
Other income	55		27	147		72
Total non-interest income	$             642	$	562	$           1,403	$	1,180

Total non-interest income, including securities transactions, increased $80,000 when comparing the quarters ending June 30, 2006 and 2005, and $223,000 when comparing the first six months of 2006 with the same period of 2005. Wire fee revenues increased in 2006 as compared with 2005, primarily due to customer services available in the Company’s Seattle branch, which was acquired in the fourth quarter of 2005. In addition, the Company expanded its international trade finance capabilities in the second quarter of 2006 resulting in higher fees associated with foreign exchange and letter of credit services, which are included in other income. In the second quarter of 2006, the Company sold three securities with a par value of $3.8 million at a loss of $164,000 and replaced them with higher yielding loans.

Non-Interest Expense

Non-interest expense consists of the following components:

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	Three Months Ended				Six Months Ended
	June 30,				June 30,
(dollars in thousands)	2006		2005		2006		2005
Salaries and employee benefits	$	2,063	$	1,667	$	4,150	$	3,364
Net occupancy and equipment		526		346		976		694
Professional fees		269		191		516		384
Business taxes		93		55		174		106
Advertising		111		73		174		133
Credit card expense		66		57		132		193
Data processing and communications		166		65		281		138
Postage and freight		85		62		164		127
Travel and education		125		78		199		103
Stationery and supplies		50		42		100		74
Amortization of intangible assets		26		-		52		-
Interest rate floor valuation adjustment		182		-		182		-
Insurance premiums		36		44		84		86
Other expenses		433		279		701		472
Total non-interest expense	$	4,231	$	2,959	$	7,885	$	5,874

Almost every type of non-interest expense was higher in the 2006 periods compared with the 2005 periods. These increases primarily reflected an overall higher level of staffing, occupancy, data processing and branch activities due to loan growth and two additional branches. In addition to the Seattle branch acquisition, the Company opened a full-service branch in Vancouver, Washington and added an international trade finance department in mid-March 2006. As of the end of the second quarter of 2006, the Company had 131 full-time equivalent employees compared with 114 at June 30, 2005.

In March 2006, the Company entered into a five-year interest rate floor agreement to hedge the variability of expected interest income related to loans priced with a floating rate index. The notional amount of this agreement was $50 million, the deferred transaction fee was $880,000 and the threshold price was 7.50% . The interest rate floor assists the Company in managing the impact of declining interest rates on earnings. In the second quarter of 2006, the Company recorded a decrease in the carrying value of the interest rate floor contract totaling $206,000 ($182,000 recorded in non-interest expense and $24,000 as a reduction of non-interest revenue related to the valuation adjustment recorded at March 31, 2006). The non-cash valuation adjustment in the second quarter of 2006 related primarily to increases in market interest rates subsequent to the acquisition of the contract.

Income Taxes

The effective tax rate for the first six months of 2006 was 26.8% compared with 26.1% during the same period of 2005. The higher effective rate was primarily due to the higher level of earnings and the decrease in the relative proportion of nontaxable interest income.

Financial Condition
Investment Securities

The following table presents the composition and carrying value of the Company’s available for sale investment portfolio:

	June 30,		December 31,
(dollars in thousands)	2006		2005
Mortgage-backed securities	$	35,526	$	34,316
Municipal bonds		19,429		18,146
	$	54,955	$	52,462

Total investment securities as of June 30, 2006 were $55.0 million, compared with $52.5 million at December 31, 2005. The increase was primarily due to the purchase of $10.5 million of securities, and $3.8 million of securities were sold for a realized loss of $164,000. The Company’s securities, classified as available for sale, are used by management as part of its asset/liability management strategy and may be sold in response to changes in interest rates or significant prepayment risk.

15

Loans

Total loans outstanding were $330.0 million and $270.5 million at June 30, 2006 and December 31, 2005, respectively. Unfunded loan commitments, such as home equity and other lines of credit, unused available credit on credit cards and letters of credit, were $95.9 million at June 30, 2006 and $87.6 million at December 31, 2005. The following table presents the composition of the Bank's loan portfolio at the dates indicated:

		June 30, 2006			December 31, 2005
(dollars in thousands)		Amount	Percent		Amount	Percent
Real estate secured:
One-to-four family residential	$	34,197	10%	$	25,189	9%
Multifamily		13,293	4%		11,999	5%
Construction		65,849	20%		46,281	17%
Commercial real estate		118,837	36%		108,189	40%
Total real estate		232,176	70%		191,658	71%
Commercial and industrial		94,772	29%		75,600	28%
Consumer and other		3,100	1%		3,194	1%
		330,048	100%		270,452	100%
Deferred loan fees		(925)			(205)
Loans, net of deferred loan fees	$	329,123		$	270,247

Allowance for Credit Losses

The allowance for credit losses represents management's estimate of potential losses as of the date of the financial statements. The loan portfolio is regularly reviewed to evaluate the adequacy of the allowance for credit losses. In determining the level of the allowance, the Company estimates losses inherent in all loans and commitments to make loans, and evaluates non-performing loans to determine the amount, if any, necessary for a specific reserve. An important element in determining the adequacy of the allowance for credit losses is an analysis of loans by loan risk-rating categories. At a loan’s inception and periodically throughout the life of the loan, management evaluates the credit risk by using a risk-rating system. This grading system currently includes eleven levels of risk. Risk ratings range from “1” for the strongest credits to “10” for the weakest. A “10” rated loan would normally represent a loss. All loans rated 7-10 collectively comprise the Company's “Watch List”. The specific grades from 7-10 are “watch list” (risk-rating 7), “special mention” (risk-rating 7.5), “substandard” (risk-rating 8), “doubtful” (risk-rating 9), and “loss” (risk-rating 10). When indicators such as operating losses, collateral impairment or delinquency problems show that a credit may have weakened, the credit will be downgraded as appropriate. Similarly, as borrowers bring loans current, show improved cash flows or improve the collateral position of a loan, the credits may be upgraded. The result of management’s ongoing evaluations and the risk ratings of the portfolio is an allowance with four components: specific reserves; general reserves; special reserves; and an amount available for other factors.

Specific Allowance. Loans on the Bank's Watch List, as described above, are specifically reviewed and analyzed. Management considers in its analysis expected future cash flows, the value of collateral and other factors that may impact the borrower's ability to pay. When significant conditions or circumstances exist on an individual loan indicating greater risk, a specific allowance may be allocated in addition to the general allowance percentage for that particular risk rating, as outlined in Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan.” General Allowance. All loans that do not require a specific allocation are subject to a general allocation based upon historic loss factors. Management determines these factors by analyzing the volume and mix of the existing loan portfolio, in addition to other factors. Management also analyzes the following:

• the volume and severity of non-performing loans and adversely classified credits;
• the level of net charge-offs experienced on previously classified loans;
• the nature and value of collateral securing the loans; and
• the relationship and trend over the past several years of recoveries in relation to charge-offs.

Special Allowance. From time to time, special allowances will be established to facilitate a change in the Bank’s strategy and other factors. Special allocations are to take into consideration various factors that include, but are not limited to:

16

• Effectiveness of credit administration;
• Adequacy of loan review;
• Loan operations;
• The trend in loan growth and the percentage of change;
• Concentrations both geographic and industry-specific;
• Competitive issues that impact loan underwriting/structure;
• Economic conditions, including interest rate trends; and
• Introduction of various loan products and/or special marketing.

Amounts Available for Other Factors. Management also attempts to ensure that the overall allowance appropriately reflects a margin for the imprecision necessarily inherent in estimates of expected credit losses.

The quarterly analysis of specific, general, and special allocations of the allowance is the principal method relied upon by management to ensure that changes in estimated credit loss levels are adjusted on a timely basis. The inclusion of historical loss factors in the process of determining the general component of the allowance also acts as a self-correcting mechanism of management's estimation process, as past and more remote loss experience is replaced by more recent experience. In its analysis of the specific, general, and special allocations of the allowance, management also considers regulatory guidance in addition to the Company's own experience.

Loans and other extensions of credit deemed uncollectable are charged to the allowance. Subsequent recoveries, if any, are credited to the allowance. Actual losses may vary from current estimates and the amount of the provision for credit losses may be either greater than or less than actual net charge-offs when and if they occur. The related provision for credit losses that is charged to income is the amount necessary to adjust the allowance for loan losses and the liability for unfunded credit commitments to the level determined through the above process.

Management's evaluation of the loan portfolio resulted in a total allowance for credit losses of $5.4 million at June 30, 2006 and $4.7 million December 31, 2005. The increase in the allowance for credit losses primarily related to growth of the loan portfolio. The allowance for credit losses, as a percentage of total loans, decreased from 1.73% on December 31, 2005 to 1.63% on June 30, 2006. Management believes the allowance for credit losses at June 30, 2006 is adequate to absorb current potential or anticipated losses.

The following table shows the components of the allowance for credit loss for the periods indicated:

		June 30, 2006			December 31, 2005
(dollars in thousands)		Amount	Percent		Amount	Percent
Allowance for loan losses-
General	$	3,025	60%	$	3,139	71%
Specific		679	14%		-	- %
Special		1,210	24%		1,187	27%
Available for other factors		125	2%		91	2%
Total allowance for loan losses		5,039	100%		4,417	100%
Liability for unfunded credit commitments		328			251
Total allowance for credit losses	$	5,367		$	4,668

The Company established a specific reserve of $500,000 in the first quarter of 2006 concurrent with the downgrading of a single commercial loan. The specific reserve of $179,000 added in the second quarter of 2006 related to one commercial real estate loan. Also in the first quarter of 2006, the Company reclassified a portion of the allowance for loan losses related to unfunded credit commitments to other liabilities on the balance sheet in accordance with GAAP and bank regulatory requirements. Amounts for 2005 were also reclassified.

The allowance for credit losses is based upon estimates of probable losses inherent in the loan portfolio and the Company’s commitments to extend credit to borrowers. The amount of loss ultimately incurred for these loans can vary significantly from the estimated amounts. The following table shows the Company’s loan loss performance for the periods indicated.

17

	Three Months Ended			Six Months Ended
	June 30,			June 30,
(dollars in thousands)	2006		2005	2006		2005
Allowance for credit losses, beginning of period	$           5,094	$	3,840	$           4,668	$	3,796
Loans charged off:
Commercial	-		-	1		-
Real estate	-		-	-		-
Consumer and other	38		28	49		38
Total loans charged-off	38		28	50		38
Recoveries:
Commercial	17		52	43		64
Real estate	1		3	2		38
Consumer and other	8		8	14		15
Total recoveries	26		63	59		117
Net loans charged off (recovered) during the period	12		(35)	(9)		(79)
Provision for credit losses	285		60	690		60
Allowance for credit losses, end of period	$           5,367	$	3,935	$           5,367	$	3,935
Components
Allowance for loan losses				$           5,039	$	3,764
Liability for unfunded credit commitments				328		171
Total allowance for credit losses				$           5,367	$	3,935
Loans outstanding at end of period, net of deferred fees				$      330,048	$	208,731
Average loans outstanding during the period	$      306,319	$	202,541	$      290,878	$	198,200
Ratio of net loans charged off to average loans outstanding	0.02%		N/M	N/M		N/M
Allowance for loan losses/total loans				1.53%		1.80%
Allowance for credit losses/total loans				1.63%		1.89%
Allowance for credit losses/non-performing loans				218%		404%
N/M- Not meaningful

Impaired Loans

The Bank, during its normal loan review procedures, considers a loan to be impaired when it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is not considered to be impaired during a period of minimal delay (less than 90 days) unless available information strongly suggests impairment. The Bank measures impaired loans based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair market value of the collateral if the loan is collateral dependent. Impaired loans are charged to the allowance when management believes that, after considering economic and business conditions, collection efforts, and collateral position, the borrower's financial condition indicates that collection of principal is not probable. Generally, no interest is accrued on loans when factors indicate collection of interest is doubtful or when principal or interest payments become 90 days past due, unless collection of principal and interest are anticipated within a reasonable period of time and the loans are well secured. For such loans, previously accrued but uncollected interest is charged against current earnings, and income is only recognized to the extent payments are subsequently received and collection of the remaining recorded principal balance is considered probable.

Non-Performing Assets

Non-performing loans will generally include all loans greater than 90 days past due with respect to either principal or interest, and all loans to which the accrual of interest has been suspended. These loans, combined with repossessed real estate and other repossessed assets, are collectively considered to be non-performing assets. The following table presents information on all non-performing assets:

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		June 30,	December 31,
(dollars in thousands)		2006		2005
Loans on non-accrual status	$	2,459	$	4,156
Loans past due greater than 90 days but not on non-accrual status		-		-
Other real estate owned		-		-
Total non-performing assets	$	2,459	$	4,156
Total assets	$	423,777	$	370,346
Percentage of non-performing assets to total assets		0.58%		1.12%
Allowance for loan losses as a % of non-performing loans		205%		106%

Total non-performing assets at June 30, 2006 decreased to $2.5 million from $4.2 million at December 31, 2005. Of the total non-performing loans at June 30, 2006, $1.4 million is fully guaranteed by an agency of the U.S. government, and the workout period for this loan is currently expected to extend to late-2007. The Company has not identified any other potential problem loans that were not classified as non-performing but for which known information about the borrowers’ financial condition caused management to have concern about the ability of the borrowers to comply with the repayment terms of their loans.

Liquidity

Liquidity represents the ability to meet deposit withdrawals and fund loan demand, while retaining the flexibility to take advantage of business opportunities. The Bank's primary sources of funds have been customer and brokered deposits, loan payments, sales or maturities of investments, sales of loans or other assets, borrowings, and the use of the federal funds market. Investment in securities available-for-sale was $55.0 million at June 30, 2006 compared with $52.5 million at December 31, 2005. The following table presents the composition of the Company’s deposit liabilities on the dates indicated:

		June 30,	December 31,
(dollars in thousands)		2006		2005
Non-interest-bearing demand deposits	$	99,203	$	97,327
Savings		17,588		17,112
Interest-bearing demand deposits		16,187		19,063
Money market accounts		60,039		62,185
Certificates of deposit under $100,000		42,517		36,511
Certificates of deposit over $100,000		106,720		76,997
Total	$	342,254	$	309,195

The Company’s loan growth in the first six months of 2006 exceeded its core deposit generation, and the Company has supplemented its core deposits with brokered certificates of deposits. At June 30, 2006, the Bank’s brokered certificate of deposit balance was $43.4 million compared with $33.0 million at December 31, 2005. The Bank has overnight federal funds borrowing lines with correspondent banks that provide access to an additional $45.0 million for short-term liquidity needs. In addition, the parent company has a $2 million line of credit with a correspondent bank. The Bank also has an established borrowing line with the Federal Home Loan Bank (the “FHLB”) that permits it to borrow up to 20% of the Bank's assets, or a maximum of $57.2 million, subject to collateral limitations. With the collateral available on June 30, 2006, the Bank could borrow up to $56.5 million. FHLB borrowings in excess of $37.1 million would require the Company to purchase additional FHLB stock. The line is available for overnight federal funds, or notes with other terms and maturities. At June 30, 2006, the Company had $10.0 million of overnight federal funds borrowings with FHLB and an additional $5.5 million of overnight borrowings with a correspondent bank. These overnight borrowings were repaid in July 2006 with proceeds from certificates of deposit.

As disclosed in the accompanying Consolidated Statements of Cash Flows, net cash from operating activities was $6.6 million for the first six months of 2006, principally from earnings and an increase in accrued interest payable and other liabilities. The increase in accrued interest and other liabilities primarily related to income tax refunds received in the second quarter of 2006 and applied to net taxes payable. Net cash from operating activities in the first quarter of 2005 was principally from earnings. Net cash used by investing activities in the 2006 and 2005 periods was due primarily to loan growth. In the 2006 period, the Company invested an additional net $3.9 million in investment securities. Cash provided by financing activities in the first six months of 2006 was primarily related

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to a $35.8 million increase in certificates of deposits, which more than offset the decline in other deposit categories, and a net $15.3 million increase in short-term federal funds purchases. In the first six months of 2005, net deposit growth (excluding certificates of deposit) provided $12.2 million of cash. In addition, in April 2005, the Company received $12.4 million form the issuance of junior subordinated debentures.

Regulatory Capital

The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory or discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

The following table presents selected capital information for the Company and the Bank as of June 30, 2006 and December 31, 2005:

							To Be Well-Capitalized
							Under Prompt
				For Capital Adequacy			Corrective Action
	Actual			Purposes			Provision
	Amount	Ratio			Amount	Ratio		Amount	Ratio
June 30, 2006
Total risk-based capital:
Consolidated	$     63,024	17.12%	$		29,448	>8.00%		N/A	N/A
Bank	$      60,153	16.39%	$		29,369	>8.00%	$	36,712	>10.00%
Tier 1 risk-based capital:
Consolidated	$      58,417	15.87%	$		14,724	>4.00%		N/A	N/A
Bank	$      55,554	15.13%	$		14,685	>4.00%	$	22,027	>6.00%
Tier 1 (leverage) capital:
Consolidated	$      58,417	14.47%	$		16,146	>4.00%		N/A	N/A
Bank	$      55,554	13.77%	$		16,134	>4.00%	$	20,167	>5.00%
December 31, 2005
Total risk-based capital:
Consolidated	$      58,839	18.89%	$		24,922	>8.00%		N/A	N/A
Bank	$      56,664	18.28%	$		24,804	>8.00%	$	31,005	>10.00%
Tier 1 risk-based capital:
Consolidated	$      54,935	17.63%	$		12,461	>4.00%		N/A	N/A
Bank	$      52,779	17.02%	$		12,402	>4.00%	$	18,603	>6.00%
Tier 1 (leverage) capital:
Consolidated	$      54,935	15.92%	$		13,804	>4.00%		N/A	N/A
Bank	$      52,779	15.38%	$		13,730	>4.00%	$	17,163	>5.00%

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the tables above) of Tier 1 capital to average assets, and Tier 1 and total risk-based capital to risk-weighted assets (all as defined in the regulations). As of June 30, 2006 and December 31, 2005, the Company and the Bank substantially exceeded all relevant capital adequacy requirements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Credit Risk

The Bank, like other lenders, is subject to credit risk, which is the risk of losing principal and interest due to customers' failure to repay loans in accordance with their terms. The Bank relies on loan reviews, prudent loan underwriting standards and an adequate allowance for credit losses to help mitigate credit risk. However, a downturn in economic conditions or in the real estate market, or a rapid increase in interest rates could have a negative effect on collateral values, cash flows, and borrowers' ability to repay. The Bank's targeted customers are small to medium-

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size businesses, professionals and retail customers that may have limited capital resources to repay loans during a prolonged economic downturn.

Interest Rate Risk

The Bank’s earnings are largely derived from net interest income, which is interest income and fees earned on loans and investment income, less interest expense paid on deposits and other borrowings. Interest rates are highly sensitive to many factors that are beyond the control of the Bank’s management, including general economic conditions, and the policies of various governmental and regulatory authorities. As interest rates change, net interest income is affected. With fixed rate assets (such as fixed rate loans) and liabilities (such as certificates of deposit), the effect on net interest income depends on the maturities of the assets and liabilities. The Bank’s primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Bank’s net interest income and capital, while structuring the Bank’s asset/liability position to obtain the maximum yield-cost spread on that structure. Interest rate risk is managed through the monitoring of the Bank’s gap position and sensitivity to interest rate risk by subjecting the Bank’s balance sheet to hypothetical interest rate shocks using a computer based model. In a falling rate environment, the spread between interest yields earned and interest rates paid may narrow, depending on the relative level of fixed and variable rate assets and liabilities. In a stable or increasing rate environment the Bank’s variable rate loans will remain steady or increase immediately with changes in interest rates, while fixed rate liabilities, particularly certificates of deposit will only re-price as the liability matures. As of June 30, 2006, the Bank was asset sensitive.

For a complete description of the Company’s disclosures about market risk, see “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A of the Annual Report on Form 10-K for the year end December 31, 2005.

Item 4. Controls and Procedures

As of June 30, 2006, the Company evaluated, under the supervision and the participation of management, including the Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of disclosure controls and procedures. Based on that evaluation, management, including the Chief Executive Officer and Chief Financial Officer, concluded that disclosure controls and procedures were effective in timely alerting them to material information relating to the Company that is required to be included in its periodic SEC filings.

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation.

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Part II. OTHER INFORMATION
Item 1. Legal Proceedings

The Company from time to time enters into routine litigation resulting from the collection of secured and unsecured indebtedness as part of its business of providing financial services. In some cases, such litigation will involve counterclaims or other claims against the Company. Such proceedings against financial institutions sometimes also involve claims for punitive damages in addition to other specific relief. The Company is not a party to any litigation other than in the ordinary course of business. In the opinion of management, the ultimate outcome of all pending legal proceedings will not individually or in the aggregate have a material adverse effect on the financial condition or the results of operations of the Company.

Item 1A. Risk Factors
There were no material changes to the risk factors set forth in the Company’s Form 10-K for the year ended December 31, 2005.
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	Not applicable
Item 3.	Defaults upon Senior Securities
	Not applicable
Item 4.	Submission of Matters to a Vote of Security Holders
	(a)	Cowlitz Bancorporation Annual Shareholder’s Meeting was held on May 26, 2006.
	(c) (1)	The number of votes cast for, against, or withheld, including a separate tabulations with respect to
		each nominee is presented below:
	Nominee		Votes For	Percentage of Voted	Withheld	Percentage of Voted
	Ernie D. Ballou		2,526,753	65	1,345,489	35
	Richard J. Fitzpatrick		2,526,753	65	1,345,489	35
	Brian E. Maguson		2,526,953	65	1,345,289	35
	John S. Maring		2,524,408	65	1,347,834	35
	John M. Petersen		2,526,753	65	1,345,489	35
	Phill S. Rowley		2,526,953	65	1,345,289	35
	Linda M. Tubbs		2,526,953	65	1,345,289	35
	(2)	The number of votes for, against, abstained and broker non-votes regarding amendment of the
		2003 Stock Incentive Plan is presented below:
				Percentage of For and
			Votes	Against on this Proposal
		For	805,088	26
		Against	2,344,472	74
		Abstain	32,838	- -
		Broker non-votes	689,844	- -
Item 5.	Other Information
	None

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Item 6. Exhibits

(a)	Exhibits. The following constitutes the exhibit index.
	3.1	Restated and Amended Articles of Incorporation (incorporated by reference to the Company’s Registration Statement on Form S-1, Reg. No. 333-44355)
	3.2	Bylaws (incorporated by reference to the Company’s Registration Statement on Form S-1, Reg. No. 333-44355)
	10.1	Employment Agreement with Donna Gardner (incorporated by reference to Exhibit 99.1 to the Company’s Current Report on 8-K filed June 21, 2006, SEC Accession No.0000896595-06-000211)
	10.2	Terms of Employment and Change in Control Agreements with Lynda Larrabee and Sue Rodgers (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on 8-K filed June 21, 2006, SEC Accession No. 0000896595-06-000211)
	31.1	Certification of Chief Executive Officer
	31.2	Certification of Chief Financial Officer
	32	Certification of Chief Executive Officer and Chief Financial Officer

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SIGNATURES

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

Date: August 11, 2006
	Cowlitz Bancorporation
	(Registrant)
	By:
	/s/ Richard J. Fitzpatrick
	Richard J. Fitzpatrick, President and Chief Executive Officer
	/s/ Gerald L. Brickey
	Gerald L. Brickey, Vice-President and Chief Financial Officer

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