Cowlitz Bancorporation (CWLZ) 10-Q 2008 Q3 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 September 30, 2008

OR

¨ 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, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

¨ Large accelerated filer    ¨ Accelerated filer     ¨ Non-accelerated filer  x Smaller reporting company

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 October 31, 2008: 5,067,379 shares

COWLITZ BANCORPORATION AND SUBSIDIARY

TABLE OF CONTENTS

		PAGE
Part I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Statements of Condition - September 30, 2008 and December 31, 2007	3
	Consolidated Statements of Operations -  Three and nine months ended September 30, 2008 and September 30, 2007	4
	Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Loss) - Nine months ended September 30, 2008 and year ended December 31, 2007	5
	Consolidated Statements of Cash Flows - Nine months ended September 30, 2008 and September 30, 2007	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition And Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4T.	Controls and Procedures	25
Part II	OTHER INFORMATION
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults upon Senior Securities	27
Item 4.	Submission of Matters to a Vote of Security Holders	27
Item 5.	Other Information	27
Item 6.	Exhibits	27
	Signatures	28

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 impact of the current national and regional economy (including real estate values) on loan demand and borrowers’ financial capacity in the Company’s market, 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. Forward looking statements in this document include, without limitation, statements regarding the adequacy of our allowance for loan losses and liquidity. We undertake no obligation to update publicly or revise any forward-looking statements. You should not place undue reliance on forward-looking statements, which speak only as of the date on which they are made.

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Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

COWLITZ BANCORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CONDITION

(UNAUDITED)

	September 30,			December 31,
(dollars in thousands)	2008			2007
Assets
Cash and cash equivalents	$	57,762		$	31,251
Investment securities		40,812			51,578
Federal Home Loan Bank stock, at cost		1,247			1,247
Loans, net of deferred loan fees		436,684			397,325
Allowance for loan losses		(13,859	)		(5,801	)
Total loans, net		422,825			391,524
Cash surrender value of bank-owned life insurance		14,788			14,328
Premises and equipment		6,148			6,515
Goodwill and other intangibles		1,798			1,834
Accrued interest receivable and other assets		19,955			15,903
Total assets	$	565,335		$	514,180
Liabilities
Deposits:
Non-interest-bearing demand	$	82,096		$	91,662
Savings and interest-bearing demand		31,768			35,792
Money market		75,574			86,658
Certificates of deposit		311,920			227,067
Total deposits		501,358			441,179
Federal funds purchased		425			1,050
Junior subordinated debentures and other borrowings		12,441			12,501
Accrued interest payable and other liabilities		4,739			3,910
Total liabilities		518,963			458,640
Commitments and contingencies (Note 8)
Shareholders' equity
Preferred stock, no par value; 5,000,000 shares authorized; no shares issued and outstanding at September 30, 2008 and December 31, 2007		-			-
Common stock, no par value; 25,000,000 shares authorized with 5,067,379 and 5,054,437 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively		29,013			28,936
Additional paid-in capital		2,532			2,484
Retained earnings		12,968			21,753
Accumulated other comprehensive income		1,859			2,367
Total shareholders' equity		46,372			55,540
Total liabilities and shareholders' equity	$	565,335		$	514,180

See accompanying notes

3

COWLITZ BANCORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(dollars in thousands, except per share amounts)	2008			2007			2008			2007
Interest income
Interest and fees on loans	$	8,287		$	8,552		$	24,973		$	24,841
Interest on taxable investment securities		264			451			969			1,394
Interest on non-taxable investment securities		263			222			788			662
Other interest and dividend income		78			139			241			259
Total interest income		8,892			9,364			26,971			27,156
Interest expense
Savings and interest-bearing demand deposits		48			56			149			155
Money market		328			652			1,276			1,353
Certificates of deposit		2,787			2,747			8,310			7,953
Federal funds purchased and other borrowings		7			16			46			79
Junior subordinated debentures		138			220			469			651
Total interest expense		3,308			3,691			10,250			10,191
Net interest income before provision for credit losses		5,584			5,673			16,721			16,965
Provision for credit losses		2,300			725			15,895			1,000
Net interest income after provision for credit losses		3,284			4,948			826			15,965
Non-interest income
Service charges on deposit accounts		221			171			564			508
International trade fees		126			146			461			425
Fiduciary income		143			165			479			529
Increase in cash surrender value of bank-owned life insurance		154			142			460			415
Wire fees		85			93			250			268
Mortgage brokerage fees		50			77			158			210
Securities losses		(1,412	)		-			(1,844	)		-
Other income		113			116			361			370
Total non-interest income		(520	)		910			889			2,725
Non-interest expense
Salaries and employee benefits		2,333			2,391			7,340			7,306
Net occupancy and equipment		641			592			1,888			1,684
Professional services		390			454			861			1,225
Data processing and communications		264			248			710			718
Business taxes		112			115			354			325
Interest rate contracts adjustments		(242	)		(245	)		75			388
Federal deposit insurance		94			11			281			35
Foreclosed asset expense, net		373			-			2,247			422
Other expense		762			626			2,505			2,275
Total non-interest expense		4,727			4,192			16,261			14,378
Income (loss) before provision for income taxes		(1,963	)		1,666			(14,546	)		4,312
Income tax provision (benefit)		(367	)		390			(5,761	)		1,085
Net income (loss)	$	(1,596	)	$	1,276		$	(8,785	)	$	3,227
Earnings (loss) per common share:
Basic	$	(0.31	)	$	0.26		$	(1.74	)	$	0.65
Diluted	$	(0.31	)	$	0.25		$	(1.74	)	$	0.62
Weighted average shares outstanding:
Basic		5,067,379			4,995,073			5,059,188			4,947,019
Diluted		5,067,379			5,161,696			5,059,188			5,172,078

See accompanying notes

4

COWLITZ BANCORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS'

EQUITY AND COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

										Accumulated
					Additional					Other			Total
	Common stock				Paid-in		Retained			Comprehensive			Shareholders’
(dollars in thousands, except shares)	Shares		Amount		Capital		Earnings			Income (Loss)			Equity
Balance, December 31, 2006		4,889,323	$	27,279	$	2,366	$	21,667		$	(587	)	$	50,725
Comprehensive income:
Net income		-		-		-		86			-			86
Net change in unrealized gain on:
Investments available-for-sale, net of taxes of $7		-		-		-		-			14			14
Cash flow hedges, net of taxes of $1,582		-		-		-		-			2,940			2,940
Comprehensive income														3,040
Proceeds from the exercise of stock options and employee stock purchases		165,114		1,657		-		-			-			1,657
Share-based compensation		-		-		118		-			-			118
Balance, December 31, 2007		5,054,437		28,936		2,484		21,753			2,367			55,540
Comprehensive loss:
Net loss		-		-		-		(8,785	)		-			(8,785	)
Net change in unrealized gain (loss) on:
Investments available-for-sale, net of taxes of ($497)		-		-		-		-			(919	)		(919	)
Cash flow hedges, net of taxes of $222		-		-		-		-			411			411
Comprehensive loss														(9,293	)
Proceeds from the exercise of stock options and employee stock purchases		12,942		77		-		-			-			77
Share-based compensation		-		-		48		-			-			48
Balance, September 30, 2008		5,067,379	$	29,013	$	2,532	$	12,968		$	1,859		$	46,372

See accompanying notes

5

COWLITZ BANCORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Nine Months Ended
	September 30,
(dollars in thousands)	2008			2007
Cash flows from operating activities
Net income (loss)	$	(8,785	)	$	3,227
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Deferred tax provision (benefit)		(5,761	)		1,085
Share-based compensation		45			274
Excess tax benefit on stock options exercised		-			(168	)
Depreciation and amortization		1,155			739
Provision for credit losses		15,895			1,000
Increase in cash surrender value of bank-owned life insurance		(460	)		(415	)
Impairment charge on investment securities		1,644			-
Net loss on sales of investment securities		200			-
Interest rate contracts adjustments		(91	)		388
Net (gain) loss on sale of foreclosed assets		(116	)		306
Write-down of foreclosed assets		2,137			-
Net Increase in accrued interest receivable and other assets		(647	)		(896	)
Net Increase in accrued interest payable and other liabilities		612			138
Other		38			35
Net cash provided by operating activities		5,866			5,713
Cash flows from investing activities
Proceeds from maturities and sales of investment securities		11,268			4,644
Purchases of investment securities		(905	)		(4,601	)
Net increase in loans		(51,501	)		(40,793	)
Proceeds from sale of foreclosed assets		2,482			921
Proceeds from termination of cash flow hedging instrument		482			-
Purchases of bank-owned life insurance		-			(267	)
Purchases of premises and equipment		(332	)		(1,031	)
Proceeds from sale of premises and equipment		-			3
Net cash used by investing activities		(38,506	)		(41,124	)
Cash flows from financing activities
Net increase in deposits		59,759			42,207
Net increase (decrease) in federal funds purchased		(625	)		500
Repayment of Federal Home Loan Bank and other borrowings		(60	)		(86	)
Proceeds from the exercise of stock options		77			1,585
Excess tax benefit on stock options exercised		-			168
Net cash provided by financing activities		59,151			44,374
Net increase in cash and cash equivalents		26,511			8,963
Cash and cash equivalents, beginning of period		31,251			26,581
Cash and cash equivalents, end of period	$	57,762		$	35,544
Supplemental disclosure of cash flow information
Cash paid for interest	$	10,146		$	9,880
Supplemental disclosure of investing and financing activities
Loans transferred to foreclosed assets	$	4,525		$	622

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 Bellevue, Seattle, and Vancouver, Washington, and Portland and Wilsonville, Oregon. The Bank also provides mortgage banking services through its Bay Mortgage division with offices in Longview and Vancouver, Washington.

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, consumer lending, international banking services, internet banking, cash management, mortgage 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 Company has one wholly-owned trust, Cowlitz Statutory Trust I (the Trust), for purposes of issuing guaranteed undivided beneficial interests in junior subordinated debentures (Trust Preferred Securities). 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. Certain reclassifications have been made in prior year’s data to conform to the current year’s presentation.

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 nine months ended September 30, 2008 are not necessarily indicative of results to be anticipated for the year ending December 31, 2008. The interim consolidated financial statements should be read in conjunction with the December 31, 2007 consolidated financial statements, including the notes thereto, included in the Company’s 2007 Annual Report on Form 10-K.

Operating Segments – The Company is principally engaged in community banking activities through its branches and corporate offices. Community banking activities include accepting deposits, providing loans and lines of credit to local individuals, businesses and governmental entities, investing in investment securities and money market instruments, international banking services, and holding or managing assets in a fiduciary agency capacity on behalf of its trust customers and their beneficiaries. The Company also provides mortgage lending solutions for its customers, consisting of all facets of residential lending including FHA and VA loans, construction loans, and “bridge” loans. While management monitors the revenue streams of the various products and services, financial performance is being evaluated on a company-wide basis for 2008 as was the case in 2007. Accordingly, operations were 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 real estate owned.

Derivative Financial Instruments – In the ordinary course of business, the Company enters into derivative transactions to manage its interest rate risk. All derivative instruments are recorded as either other assets or other liabilities at fair value. Subsequent changes in a derivative’s fair value are recognized currently in earnings and included in non-interest expense unless specific hedge accounting criteria are met.

7

All derivative instruments that qualify for hedge accounting are recorded at fair value and classified either as a hedge of the fair value of a recognized asset or liability (“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). Changes in the fair value of a derivative that is highly effective and designated as a fair value hedge and the offsetting changes in the fair value of the hedged item are recorded in income. Changes in the fair value of a derivative that is highly effective and designated as a cash flow hedge are recognized in other comprehensive income until income from the cash flows of the hedged item is recognized. The Company performs an assessment, both at the inception of the hedge and on a quarterly basis thereafter, to determine whether these derivatives are expected to continue to be highly effective in offsetting changes in the value of the hedged items. Any change in fair value resulting from hedge ineffectiveness is immediately recorded in non-interest expense.

If a derivative designated as a cash flow hedge is terminated or ceases to be highly effective, the gain or loss is amortized to earnings over the same period(s) that the forecasted hedged transactions impact earnings (cash flow hedge). If the hedged item is disposed of, or the forecasted transaction is no longer probable, the derivative is recorded at fair value with any resulting gain or loss included in the gain or loss from the disposition of the hedged item or, in the case of a forecasted transaction that is no longer probable, included in earnings immediately.

Recently Issued Accounting Standards – In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements,” (SFAS 157). This statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement establishes a fair value hierarchy for the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The Company adopted this statement on January 1, 2008. In February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-2, “Effective Date of FASB Statement No. 157”. This FSP delayed the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The Company’s adoption of FAS 157-2 is not expected to have a material impact on the Company’s financial statements.

In December 2007, FASB issued SFAS No. 141 (revised), Business Combinations. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquired entity and the goodwill acquired. SFAS No. 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. We are currently evaluating the impact of the adoption of SFAS No. 141R.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133,” (SFAS 161). This Statement requires enhanced disclosures about an entity’s derivative and hedging activities and is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company plans to apply the enhanced disclosure provisions of SFAS 161 to all derivative and hedging activities.

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 (original maturities of 90 days or less), and federal funds sold. Federal funds sold generally mature the day following purchase.

3. Earnings (Loss) Per Share

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

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2008		2007		2008		2007
Weighted-average shares outstanding – basic		5,067,379		4,995,073		5,059,188		4,947,019
Effect of assumed conversion of stock options		-		166,623		-		225,059
Weighted-average shares outstanding – diluted		5,067,379		5,161,696		5,059,188		5,172,078

No options to purchase shares were included in the computation of diluted earnings (loss) per share for the three and nine-months ended September 30, 2008, as their inclusion would be anti-dilutive. All options outstanding were included in the computation of diluted earnings (loss) per share for the three and nine-month periods of 2007.

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4. Share-Based Compensation

The Company has a stock option plan, a stock appreciation rights (SAR) plan and an employee stock purchase plan. Compensation costs related to these plans are recognized on a straight-line basis. Compensation cost charged against income for the plans was $45,000 and $274,400 for the first nine-months of 2008 and 2007, respectively. Net compensation credits of $28,400 and $19,400 for the third quarters of 2008 and 2007, respectively were included in compensation expense for the plans. Income tax benefits recognized in the income statement for share-based compensation were $15,800 and $96,300 for the first nine-months of 2008 and 2007, respectively, compared with income tax provisions of $10,000 and $6,800 for the third quarters of 2008 and 2007, respectively. At September 30, 2008, unrecognized estimated compensation cost related to non-vested SARs and stock options was $74,700 and $8,200 respectively, which is expected to be recognized over weighted average periods of 1.9 and 1.0 years, respectively.

The Company generally grants its annual SAR awards in the first quarter of the calendar year. The Company awarded 147,900 and 125,800 SARs in the first quarters of 2008 and 2007, respectively, with grant date fair values of $9.15 and $16.65, respectively. The fair value of the SARs awarded in 2008 was estimated on grant date using the Black-Scholes option pricing model with the following assumptions: expected volatility of 26.85%; expected term of 5.11 years; dividend yield of zero; and risk free rate of return of 3.36%. The fair value of each SAR awarded in 2007 was estimated using the following weighted average assumptions: expected volatility of 26.46%; expected term of 5.11 years; dividend yield of zero; and risk free rate of return of 4.47%. The fair value of all SAR awards outstanding were revalued as of September 30, 2008 with a market close price of $6.30 and the following weighted average assumptions: expected volatility of 31.06%; expected term of 4.04 years; dividend yield of zero; and risk-free rate of return of 2.61%. After revaluation of all SAR awards outstanding at September 30, 2008, the Company recognized a reduction of $41,100 of compensation expense in the third quarter of 2008. The expense reduction in the third quarter of 2007 related to SAR awards outstanding at September 30, 2007 was $35,100.

The fair value of each stock option grant is estimated as of the grant date using the Black-Scholes option-pricing model. There were no stock options granted in the nine months ended September 30, 2008. During the first nine months of 2007, 7,000 stock options were granted with the fair value of the options estimated using the following assumptions: expected volatility of 26.46%; expected term of 5.11 years; dividend yield of zero; and risk free rate of return of 4.47%. Compensation expense related to stock options was $6,700 and $77,900 in the first nine months of 2008 and 2007, respectively. Share-based compensation cost in 2007 also included $49,800 of costs related to the accelerated vesting of stock options granted in prior years for a retiring director. The following table summarizes stock option activity for the nine months ended September 30, 2008:

						Weighted-Avg.		Aggregate
	Options			Weighted-Avg.		Remaining Contractual		Intrinsic Value
(dollars in thousands)	Outstanding			Exercise Price		Term (years)		(in thousands)
Balance, beginning of period		722,136		$	10.92
Granted		-			-
Exercised		(3,070	)		4.53
Forfeited/Expired		(42,000	)		10.70
Balance, end of period		677,066			10.96		4.4	$	44,968
Exercisable, end of period		672,866			10.92		4.4	$	44,968

The total intrinsic value of options exercised was $13,000 and $724,400 in the first nine months of 2008 and 2007, respectively. The amount of cash received from the exercise of stock options was $14,000 and $1,527,900 in the comparable periods of 2008 and 2007, respectively.

Compensation expense related to the employee stock purchase plan was $10,600 and $41,000 in the three and nine-month period ended September 30, 2008, respectively, compared with $7,000 and $21,300 in the same periods in 2007, respectively.

5. Comprehensive Income (Loss)

For the Company, comprehensive income (loss) primarily includes net income (loss) reported on the statements of operations and changes in the fair value of available-for-sale investment securities and interest rate contracts accounted for as cash flow hedges. These amounts are included in “Accumulated Other Comprehensive Income (Loss)” on the consolidated statement of changes in shareholders’ equity.

9

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(dollars in thousands)	2008			2007			2008			2007
Net income (loss) reported	$	(1,596	)	$	1,276		$	(8,785	)	$	3,227
Unrealized gain (loss) from securities:
Net unrealized gain (loss) on available-for-sale securities arising during the period, net of tax		(1,530	)		364			(2,116	)		(173	)
Reclassification adjustment of loss included in income, net of tax		916			-			1,197			-
Net unrealized gain (loss) from securities		(614	)		364			(919	)		(173	)
Unrealized gain (loss) from cash flow hedging instruments:
Net unrealized gain from cash flow hedging instruments arising during the period, net of tax		561			1,753			469			890
Reclassification adjustment of (gain) loss included in income, net of tax		(227	)		(159	)		(58	)		252
Net unrealized gain from cash flow hedging instruments		334			1,594			411			1,142
Total comprehensive income (loss)	$	(1,876	)	$	3,234		$	(9,293	)	$	4,196

6. Investment Securities

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

	September 30,		December 31,
(dollars in thousands)	2008		2007
Mortgage-backed securities		18,407		27,263
Municipal bonds		21,779		22,801
Agency securities		126		1,514
Other investments		500		-
	$	40,812	$	51,578

Due to the extraordinarily unsettled equity market for government-sponsored enterprises, the Company recorded other-than-temporary impairment charges of $1,412,000 and $1,644,000 on 70,000 shares of FNMA investment grade perpetual callable preferred stock in the three and nine-month periods ended September 30, 2008, respectively. 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 September 30, 2008:

	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	$	9,369	$	(648	)	$	1,656	$	(29	)	$	11,025	$	(677	)
Municipal bonds		16,475		(883	)		266		(20	)	$	16,741	$	(903	)
Agency securities		-		-			-		-			-		-
Other investments		-		-			-		-			-		-
	$	25,844	$	(1,531	)	$	1,922	$	(49	)	$	27,766	$	(1,580	)

At September 30, 2008, there were 86 investment securities in an unrealized loss position, of which 4 were in a continuous loss position for 12 months or more. The Company uses an independent third party to determine current market values of the securities it holds. These fair market values are compared to current carrying values to determine if a security is in a gain or loss position. As market rates fluctuate, a security’s fair value can move from a gain or loss position. The Company believes that the unrealized losses on its other securities that were in a loss position as of September 30, 2008, were primarily due to changes in market rates and not credit quality. The Company has the ability and intent to hold these investments until a market price recovery or to maturity, therefore, the unrealized loss on these investments are not considered other-than-temporarily impaired.

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7. Loans and Allowance for Credit Losses

The following table presents the loan portfolio, in accordance with Bank regulatory guidance, as of September 30, 2008 and December 31, 2007:

(dollars in thousands)	September 30, 2008			December 31, 2007
Commercial	$	123,582		$	109,846
Real estate:
Construction		101,420			83,766
Residential 1-4 family		35,014			32,480
Multifamily		3,325			6,298
Commercial		170,954			162,344
Installment and other consumer		3,595			3,785
Total loans, gross		437,890			398,519
Deferred loan fees		(1,206	)		(1,194	)
Loans, net of deferred loan fees	$	436,684		$	397,325

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. An analysis of the change in the allowance for credit losses is as follows for the periods indicated:

	Three Months Ended						Nine Months Ended
(dollars in thousands)	September 30, 2008			September 30, 2007			September 30, 2008			September 30, 2007
Balance at beginning of period	$	14,247		$	5,185		$	5,990		$	4,825
Provision for credit losses		2,300			725			15,895			1,000
Recoveries		35			222			62			394
Charge-offs		(2,314	)		(32	)		(7,679	)		(119	)
Balance at end of period	$	14,268		$	6,100		$	14,268		$	6,100
Components
Allowance for loan losses	$	13,859		$	5,828		$	13,859		$	5,828
Liability for unfunded credit commitments		409			272			409			272
Total allowance for credit losses	$	14,268		$	6,100		$	14,268		$	6,100

Loans on which the accrual of interest has been discontinued totaled $9.3 million and $10.8 million at September 30, 2008 and December 31, 2007, respectively. Loans past due more than 90 days and still accruing interest totaled $3.7 million and $149,000 at September 30, 2008 and December 31, 2007 respectively.

8. Commitments and Contingencies

In the normal course of business, the Bank enters into agreements with customers that give rise to various commitments and contingent liabilities 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 September 30, 2008, was as follows:

(dollars in thousands)	Total
Commitments to extend credit	$	75,987
Credit card commitments		3,535
Standby letters of credit		2,242
	$	81,764

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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 most of 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. Income Taxes

The Company and its subsidiary file income tax returns in the U.S. federal jurisdiction and the state of Oregon. The Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2003. The Company’s policy is to recognize interest related to unrealized tax benefits and penalties as operating expenses. There were no interest or penalties paid during the nine-month period ended September 30, 2008 or the twelve-month period ended December 31, 2007. There were no accrued interest or penalties as of September 30, 2008 or December 31, 2007. The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns, and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter.

10. Derivative Instruments and Hedging Activities

The Company had two interest rate contracts to manage the risk of overall changes in cash flows associated with prime-based variable-rate loans at September 30, 2008. The Company sold an interest rate swap contract in June of 2008 that was entered into in 2006. At the time of sale, the unrealized gain was $312,800, net of taxes of $169,200. Since the forecasted transaction at the inception of the hedging relationship remains probable, this amount will be recognized in earnings over approximately 32 months. All interest rate contracts are reported at their fair value in the Consolidated Statements of Condition. At September 30, 2008, interest rate contracts with a fair value of $4.6 million were included in other assets and $2.8 million of deferred unrealized gains (net of taxes of $1.5 million) were included in accumulated other comprehensive income. At December 31, 2007, interest rate contracts with a fair value of $4.3 million were included in other assets and $2.4 million of deferred unrealized gains (net of taxes of $1.3 million) were included in accumulated other comprehensive income.

11. Fair Value Measurements

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1. Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. An active market is a market in which transactions for the asset or liability occur with significant frequency and volume to provide pricing information on an ongoing basis.

Level 2. Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data by correlation or other means.

Level 3. Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability developed based on the best information available in the circumstances.

The Company used the following methods and significant assumptions to estimate fair value.

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

Interest Rate Contracts: The Company has elected to use the income approach to value the interest rate contracts, using observable Level 2 market expectations at measurement date and standard valuation techniques to convert future amounts to a single present amount assuming that participants are motivated, but not compelled to transact. As such, significant fair value inputs can generally be verified and do not typically involve significant judgments by management.

Impaired Loans: Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. As a practical expedient, fair value may be measured based on a loan’s observable market price or the underlying collateral securing the loan. Collateral may be real estate or business assets including equipment. The value of collateral is determined based on independent appraisals.

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Financial instruments are broken down in the table that follows by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that due to an event or circumstance were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.

	September 30, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring basis:
Available for sale securities	$	40,812	$	-	$	40,812	$	-
Interest rate contracts		4,568		-		4,568		-
Nonrecurring basis:
Impaired loans		11,176		-		-		11,176
Total	$	56,556	$	-	$	45,380	$	11,176

The loans in the table above represent impaired, collateral dependent loans that have been adjusted to fair value. When management determines that the value of the underlying collateral is less than the recorded investment in the loan, the Company recognizes this impairment and adjusts the carrying value of the loan to fair value by charging-off the amount of the impairment to the allowance for loan losses.

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

Critical Accounting Estimates

The Company’s most critical accounting estimate 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,

· the introduction of new loan products or specific marketing efforts,

· large credit exposure and trends, and

· industry segments that are exhibiting stress.

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 loss levels are adjusted on a timely basis. For further discussion of this significant management estimate, see “Allowance for Credit Losses.”

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Another critical accounting estimate of the Company is that related to the carrying value of goodwill. Impairment analysis of the fair value of goodwill involves a substantial amount of judgment. 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 goodwill for impairment.

Results of Operations for the Three and Nine Months Ended September 30, 2008 and 2007

Overview

The Company’s net loss for the quarter ended September 30, 2008 was $1.6 million, or ($0.31) per share, compared with net income of $1.3 million, or $0.25 per diluted share during the same period of 2007. For the first nine months of 2008, the Company’s net loss was $8.8 million, compared with net income of $3.2 million for the same period of 2007.

Net interest income was $5.6 million in the third quarter of 2008, compared with $5.7 million in the same period in 2007. For the first nine months of 2008, net interest income was down $0.2 million from the same period in 2007. Average earning assets were $496.7 million in the third quarter of 2008, compared with $459.3 million in the third quarter of 2007. The increase in average earning assets related primarily to higher loan balances. Average interest-bearing liabilities in the third quarter of 2008 were $403.8 million, compared with $340.1 million in the third quarter of 2007, as deposits were the primary source of funds to support loan growth.

The provision for credit losses was $2.3 million in the third quarter of 2008 compared with $725,000 in the third quarter of 2007. For the nine month period ended September 30, 2008, the provision for credit losses was $15.9 million compared with $1.0 million in the same period of 2007. The higher provision in 2008 reflected primarily unfavorable conditions in the residential real estate market that affected home builders and developers and resulted in an increase in loans charged-off during the period. A slowdown in home buying has resulted in slower sales and rapidly declining real estate valuations, which have significantly affected these borrowers’ liquidity and ability to repay loans.

At September 30, 2008, total assets were $565.3 million, an increase of $51.2 million, or 10%, from December 31, 2007. Total loans increased 10% to $436.7 million, from $397.3 million at December 31, 2007. Loans grew at an annualized rate of 13% in the first nine months of 2008. Total deposits increased 13.6% to $501.4 million at September 30, 2008 from $441.2 million at December 31, 2007.

The Company maintained capital ratios in excess of defined regulatory levels required to be “well-capitalized” as of September 30, 2008. In addition, management believes the Company has adequate amounts of liquidity readily available.

The Emergency Economic Stabilization Act of 2008, signed into law on October 3, 2008, provides authority to the United States Department of the Treasury to, among other things, purchase up to $700 billion of mortgages, mortgage backed securities and certain other financial instruments from financial institutions. On October 14, 2008, the Treasury Department announced it will offer certain selected financial institutions the opportunity to issue and sell preferred stock, along with warrants to purchase common stock, to the US government, acting through the Treasury, on terms specified by the government. This program is known as the Capital Purchase Program, which is part of the larger Troubled Asset Relief Program announced.

In addition, the Federal Deposit Insurance Corporation has initiated the Temporary Liquidity Guarantee Program that will provide a 100 percent guarantee for a limited period of time to newly issued senior unsecured debt and non-interest bearing transaction deposits. Coverage under the Temporary Liquidity Guarantee Program is available for 30 days without charge and thereafter at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing transaction deposits. Management is currently evaluating participation in the Liquidity Guarantee Programs.

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 and 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.

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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.

	For Three Months Ended September 30,
	2008								2007
	Average			Interest					Average			Interest
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
(dollars in thousands)	Balance			Paid		Rate			Balance			Paid		Rate
Assets
Interest-earning assets:
Loans (1) (2) (3)	$	436,770		$	8,341		7.60	%	$	393,133		$	8,564		8.64	%
Taxable securities		19,036			264		5.52	%		32,622			451		5.48	%
Non-taxable securities (2)		23,946			396		6.58	%		21,157			340		6.38	%
Temporary investments		16,938			78		1.83	%		12,435			139		4.43	%
Total interest-earning assets (2)		496,690		$	9,079		7.27	%		459,347		$	9,494		8.20	%
Allowance for loan losses		(13,511	)							(5,076	)
Other assets		56,786								47,785
Total assets	$	539,965							$	502,056
Liabilities and shareholders' equity
Interest-bearing liabilities:
Savings, money market and interest-bearing demand deposits	$	104,718		$	376		1.43	%	$	112,200		$	708		2.50	%
Certificates of deposit		285,733			2,787		3.88	%		214,305			2,747		5.09	%
Federal funds purchased		950			5		2.09	%		1,042			13		4.95	%
Junior subordinated debentures		12,372			138		4.44	%		12,372			220		7.05	%
FHLB and other borrowings		76			2		8.20	%		161			3		7.80	%
Total interest-bearing liabilities		403,849		$	3,308		3.26	%		340,080		$	3,691		4.31	%
Non-interest-bearing deposits		84,111								102,219
Other liabilities		4,128								5,300
Total liabilities		492,088								447,599
Shareholders' equity		47,877								54,457
Total liabilities and shareholders' equity	$	539,965							$	502,056
Net interest income (2)				$	5,771							$	5,803
Net interest spread							4.01	%							3.89	%
Yield on average interest-earning assets							7.27	%							8.20	%
Interest expense to average interest-earning assets							2.65	%							3.19	%
Net interest income to average interest-earning assets (net interest margin)							4.62	%							5.01	%

(1) Loans include loans on which the accrual of interest has been discontinued.

(2) Interest earned on non-taxable securities and loans has been computed on a 34 percent tax-equivalent basis.

(3) Loan interest income includes net loan fee income of $312,300 and $409,700 for 2008 and 2007, respectively.

15

	For Nine Months Ended September 30,
	2008								2007
	Average			Interest					Average			Interest
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
(dollars in thousands)	Balance			Paid		Rate			Balance			Paid		Rate
Assets
Interest-earning assets:
Loans (1) (2) (3)	$	425,177		$	25,051		7.87	%	$	377,579		$	24,880		8.81	%
Taxable securities		23,800			969		5.44	%		34,048			1,394		5.47	%
Non-taxable securities (2)		24,253			1,187		6.54	%		21,327			1,011		6.34	%
Temporary investments		13,999			241		2.30	%		7,901			259		4.38	%
Total interest-earning assets (2)		487,229		$	27,448		7.53	%		440,855		$	27,544		8.35	%
Allowance for loan losses		(9,276	)							(4,919	)
Other assets		55,759								47,228
Total assets	$	533,712							$	483,164
Liabilities and shareholders' equity
Interest-bearing liabilities:
Savings, money market and interest-bearing demand deposits	$	113,908		$	1,425		1.67	%	$	98,759		$	1,508		2.04	%
Certificates of deposit		258,711			8,310		4.29	%		210,858			7,953		5.04	%
Federal funds purchased		1,939			40		2.76	%		1,696			68		5.36	%
Junior subordinated debentures		12,372			469		5.06	%		12,372			651		7.04	%
FHLB and other borrowings		95			6		7.90	%		188			11		7.82	%
Total interest-bearing liabilities		387,025		$	10,250		3.54	%		323,873		$	10,191		4.21	%
Non-interest-bearing deposits		88,932								101,145
Other liabilities		4,016								5,167
Total liabilities		479,973								430,185
Shareholders' equity		53,739								52,979
Total liabilities and shareholders' equity	$	533,712							$	483,164
Net interest income (2)				$	17,198							$	17,353
Net interest spread							3.99	%							4.14	%
Yield on average interest-earning assets							7.53	%							8.35	%
Interest expense to average interest-earning assets							2.81	%							3.09	%
Net interest income to average interest-earning assets (net interest margin)							4.71	%							5.26	%

(1) Loans include loans on which the accrual of interest has been discontinued.

(2) Interest earned on non-taxable securities and loans has been computed on a 34 percent tax-equivalent basis.

(3) Loan interest income includes net loan fee income of $1,201,700 and $1,322,100 for 2008 and 2007, respectively.

The net interest margin as a percentage was 4.62% in the third quarter of 2008, compared with 5.01% in the same quarter last year and 4.71% and 5.26% for the nine months ended September 30, 2008 and 2007, respectively. Tax-equivalent net interest income for the three and nine month periods ended September 30, 2008 were comparable to the respective periods in 2007. Increases in average interest-earning assets of $37.3 million and $46.4 million for the three and nine-month periods, respectively, were funded primarily by increases in interest-bearing deposits. The net interest margin in 2008 relative to the net interest margin in 2007 was affected by several factors, including rate cuts by the Federal Reserve of approximately 300 basis points over the last 12 months, continued competitive market pricing on both sides of the balance sheet, the level of nonperforming loans and a lower level of noninterest-bearing demand deposit accounts year-over-year. Interest reversals on nonaccrual loans of $118,000 and $248,000 for the three and nine-month periods ended September 30, 2008 reduced net interest margin by 10 and 7 bps, respectively

16

The net interest margin for the nine-months ended September 30, 2008 was also affected by the Company’s election to redeem $45.1 million in callable certificates of deposit, with $21.5 million settling in March of 2008 and the balance in the second quarter of 2008. Newly issued certificates of deposit have an approximately 150 basis point lower average cost and a slightly longer duration than the certificates of deposits redeemed. In connection with the redemptions, the Company wrote off all unamortized premiums associated with those deposits of $185,000. The deposit premium write-off increased the average cost of interest-bearing liabilities by approximately 7 basis points and decreased the net interest margin by approximately 5 basis points.

Provision for Credit Losses

The Company recorded a provision for credit losses of $2.3 million and $15.9 million for the three and nine-month periods ended September 30, 2008, compared with $725,000 and $1.0 million in the same periods of 2007. 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 probable 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.

Non-Interest Income

Non-interest income consists of the following components:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(dollars in thousands)	2008			2007		2008			2007
Service charges on deposit accounts	$	221		$	171	$	564		$	508
International trade fees		126			146		461			425
Fiduciary income		143			165		479			529
Increase in cash surrender value of bank-owned life insurance		154			142		460			415
Wire fees		85			93		250			268
Mortgage brokerage fees		50			77		158			210
Securities losses		(1,412	)		-		(1,844	)		-
Other income		113			116		361			370
Total non-interest income	$	(520	)	$	910	$	889		$	2,725

Total non-interest income for the third quarter of 2008 reflected a loss of $520,000 compared with income of $910,000 in the same quarter of last year. Securities losses in the three and nine month periods ended September 30, 2008 were $1.4 million and $1.8 million, respectively, compared to no losses in the same periods in 2007. The loss in the third quarter of 2008 was due to the recognition of an increase in the other-than-temporary impairment (OTTI) charge on 70,000 shares of FNMA investment grade perpetual callable preferred stock, reflecting the extraordinarily unsettled equity market for this government-sponsored enterprise (GSE) following the federal government’s actions to place the GSE under conservatorship and suspend preferred stock dividends. The Company recognized an OTTI charge of $232,000 on its FNMA preferred securities in the second quarter of 2008.

17

Non-Interest Expense

Non-interest expense consists of the following components:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(dollars in thousands)	2008			2007			2008		2007
Salaries and employee benefits	$	2,333		$	2,391		$	7,340	$	7,306
Net occupancy and equipment		641			592			1,888		1,684
Professional services		390			454			861		1,225
Data processing and communications		264			248			710		718
Business taxes		112			115			354		325
Interest rate contracts adjustments		(242	)		(245	)		75		388
Federal deposit insurance		94			11			281		35
Foreclosed asset expense, net		373			-			2,247		422
Other expense		762			626			2,505		2,275
Total non-interest expense	$	4,727		$	4,192		$	16,261	$	14,378

Non-interest expenses in the three and nine month periods ended September 30, 2008 were $4.7 million and $16.3 million, compared with $4.2 million and $14.4 million in the same periods of 2007. The most significant items affecting comparability of the totals were costs related to foreclosed assets and amounts related to interest rate contracts. Foreclosed asset expenses were $373,000 in the third quarter of 2008, compared with none in the third quarter of 2007, and $2.2 million in the first nine months of 2008 compared with $422,000 in the same period of 2007. The Company recorded non-cash credits of $242,000 and $245,000 in the three month periods ended September 30, 2008 and 2007, respectively and non-cash charges of $75,000 and $388,000 in the nine month periods ended September 2008 and 2007, respectively, related to the ineffective portion of the change in fair value of the Company’s cash flow hedges.

Salaries and employee benefits for the three and nine-month periods of 2008 were approximately equal to the amounts in the same periods of 2007. In the first quarter of 2008, the Company substantially completed a planned reduction of approximately 7% in its workforce primarily through attrition and better matching of staffing levels to customer traffic flows, as well as job eliminations. The number of full-time equivalent employees was 130 at September 30, 2008, compared with 137 at September 30, 2007.

On a year-to-date basis, net occupancy and equipment expenses in the first nine months of 2008 were higher than the same period in 2007 primarily due to higher levels of depreciation related to branch remodeling and related asset acquisitions in mid-2007. Professional services were down significantly in the first nine months of 2008 compared with the first nine months of 2007. The Company’s legal costs related to nonperforming loans were higher by approximately $50,000 in 2008 compared with the same period in 2007, while costs associated with Sarbanes-Oxley compliance efforts were lower by approximately $255,000 than in the same period of 2007. Federal deposit insurance premiums were $281,000 in the first nine months of 2008, compared with $35,000 in the first nine months of 2007. In the third quarter of 2007, the Company fully utilized its remaining one-time credits towards FDIC assessments.

Income Taxes

The Company’s effective tax benefit rate for the first nine months of 2008 was 40%, compared with 25% for the first nine months of 2007. The Company’s effective benefit rate for the first six months of 2008 was 43%. The change in the effective tax benefit rate to 40% at September 30, 2008 caused the third quarter 2008 tax benefit rate to be 19%. When the Company incurs a pre-tax loss, its effective tax rate is higher than the Federal statutory rate of 35% primarily due to tax-exempt income related to its municipal securities portfolio and investments in bank-owned life insurance. The Company’s effective tax rate for interim periods is based on projections of taxable income or loss for the full year and is affected by the relative amounts of taxable and non-taxable income and the amount of available tax credits.

18

Financial Condition

Investment Securities

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

	September 30,		December 31,
(dollars in thousands)	2008		2007
Mortgage-backed securities		18,407		27,263
Municipal bonds		21,779		22,801
Agency securities		126		1,514
Other investments		500		-
	$	40,812	$	51,578

Total investment securities as of September 30, 2008 were $40.8 million, compared with $51.6 million at December 31, 2007. The decrease in total securities from year-end 2007 primarily reflected the sale of four non-agency mortgage-backed securities, as well as scheduled principal payments. In addition, an other-than-temporary impairment charge of $1.6 million was recorded on its investment in FNMA preferred stock in 2008. 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.

Loans

Total loans outstanding were $436.7 million and $397.3 million at September 30, 2008 and December 31, 2007, respectively. Unfunded loan commitments were $81.8 million at September 30, 2008 and $96.3 million at December 31, 2007.

The following table presents the composition of the Company's loan portfolio, in accordance with bank regulatory guidelines, at the dates indicated:

	September 30, 2008						December 31, 2007
(dollars in thousands)	Amount			Percent			Amount			Percent
Commercial	$	123,582			28.2	%	$	109,846			27.6	%
Real estate:
Construction		101,420			23.2	%		83,766			21.0	%
Residential 1-4 family		35,014			8.0	%		32,480			8.1	%
Multifamily		3,325			0.8	%		6,298			1.6	%
Commercial		170,954			39.0	%		162,344			40.7	%
Installment and other consumer		3,595			0.8	%		3,785			1.0	%
Total loans, gross		437,890			100.0	%		398,519			100.0	%
Deferred loan fees		(1,206	)					(1,194	)
Loans, net of deferred loan fees	$	436,684					$	397,325

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; general; special; 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.”

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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. Special allowances are established to facilitate changes in the Bank’s strategy and other factors. Special allocations are to take into consideration various factors that include, but are not limited to:

· effectiveness of credit administration;

· adequacy of loan review;

· the adequacy of loan operations personnel and processes;

· the trend in loan growth and the percentage of change;

· the level of geographic and/or industry concentration;

· the effect of competitive issues that impact loan underwriting and structure;

· the impact of economic conditions, including interest rate trends;

· the introduction of new loan products or special marketing efforts;

· large credit exposure and trends; and

· commercial real estate acquisition and development portfolio.

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.

Liability for Unfunded Credit Commitments. Management determines the adequacy of the liability for unfunded credit commitments based upon reviews of individual credit facilities, current economic conditions, the risk characteristics of the various categories of commitments and other relevant factors. The liability is based on estimates, which are evaluated on a regular basis, and, as adjustments become necessary, they are reported in earnings in periods in which they become known.

Loans and other extensions of credit deemed uncollectible are charged to the allowance for loan losses. Subsequent recoveries, if any, are credited to the allowance. Draws on unfunded commitments that are considered uncollectible at the time funds are advanced are charged to the allowance for loan losses. Provisions for unfunded commitment losses are added to the liability for unfunded commitments, which is included in other liabilities in the consolidated balance sheets. 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 credit losses to the level determined through the above process.

The Company’s non-performing loans at September 30, 2008 related primarily to land acquisition and development loans in Oregon and Washington. Collateral values for these loans declined significantly in 2008, and a slowdown in home buying has reduced the borrowers’ cash flows. Consistent with regulatory guidelines and industry trends, the Company has charged-off impairment reserves to the period when expected collection of total principal and contractual interest is doubtful. In the third quarter of 2008, net charge-offs were $2.3 million, compared with a net recovery of $190,000 in the third quarter of 2007.

The provision for loan losses was $2.3 million in the third quarter of 2008, compared with $725,000 in the same quarter last year. Management's evaluation of the loan portfolio resulted in a total allowance for credit losses of $14.3 million at September 30, 2008 and $6.0 million at December 31, 2007. The allowance for credit losses, as a percentage of total loans, increased from 1.50% on December 31, 2007 to 3.27% at September 30, 2008. The allowance for credit losses represented 154% of non-performing loans at September 30, 2008 compared with 50% at September 30, 2007 and 55% at December 31, 2007. Management believes the allowance for credit losses at September 30, 2008 is adequate to absorb current potential or anticipated losses.

20

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

	September 30, 2008					December 31, 2007
(dollars in thousands)	Amount		Percent			Amount		Percent
General	$	4,845		35	%	$	2,733		46	%
Specific		684		5	%		-		-
Special		8,330		60	%		3,167		52	%
Available for other factors		-		-			90		2	%
Total allowance for credit losses	$	13,859		100	%	$	5,990		100	%

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.

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(dollars in thousands)	2008			2007			2008			2007
Loans outstanding at end of period, net of deferred fees	$	436,684		$	398,841		$	436,684		$	398,841
Average loans outstanding during the period		436,770			393,133			425,177			377,579
Allowance for credit losses, beginning of period	$	14,247		$	5,185		$	5,990		$	4,825
Loans charged off:
Commercial		1,144			23			2,156			73
Real estate		1,155			-			5,472			-
Consumer and other		15			9			51			46
Total loans charged-off		2,314			32			7,679			119
Recoveries:
Commercial		9			213			11			319
Real estate		23			1			27			3
Consumer and other		3			8			24			72
Total recoveries		35			222			62			394
Net loans charged off (recovered) during the period		2,279			(190	)		7,617			(275	)
Provision for credit losses		2,300			725			15,895			1,000
Allowance for credit losses, end of period	$	14,268		$	6,100		$	14,268		$	6,100
Components
Allowance for loan losses	$	13,859		$	5,828		$	13,859		$	5,828
Liability for unfunded credit commitments		409			272			409			272
Total allowance for credit losses	$	14,268		$	6,100		$	14,268		$	6,100
Ratio of net loans charged off (recovered) to average loans outstanding (annualized)		2.09	%		-0.19	%		2.39	%		-0.15	%
Allowance for loan losses/total loans		3.17	%		1.46	%		3.17	%		1.46	%
Allowance for credit losses/total loans		3.27	%		1.53	%		3.27	%		1.53	%
Allowance for loan loss/non-performing loans		149	%		48	%		149	%		48	%
Allowance for credit losses/non-performing loans		154	%		50	%		154	%		50	%

Impaired Loans

The Company, 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.

21

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.

At September 30, 2008 the Company’s recorded investment in impaired loans was $17.6 million compared with $10.8 million at December 31, 2007. For these loans, there were specific reserves at September 30, 2008 totaling $684,500 and no specific reserves at December 31, 2007.

Non-Performing Assets

Non-performing assets include repossessed real estate or other assets and loans for which the accrual of interest has been suspended. The following table presents information on the Company’s non-performing assets and loans past due greater than 90 days and still accruing at the dates indicated:

	September 30,			December 31,
(dollars in thousands)	2008			2007
Loans on non-accrual status	$	9,286		$	10,827
Other real estate owned		2,425			2,240
Other repossessed assets		100			10
Total non-performing assets	$	11,811		$	13,077
Total assets	$	565,335		$	514,180
Percentage of non-performing assets to total assets		2.09	%		2.54	%
Percentage of non-accrual loans to total loans		2.13	%		2.72	%
Loans past due greater than 90 days and accruing	$	3,733		$	149

Total nonperforming assets at September 30, 2008 were $11.8 million, down from $13.1 million at December 31, 2007. As a percentage of total assets, non-performing assets were 2.09% at September 20, 2008 compared with 2.54% at December 31, 2007.

Non-accrual loans at September 30, 2008 totaled $9.3 million. Almost all of the Company’s non-accrual loan portfolio related to land acquisition and development loans in Oregon and Washington. During the third quarter of 2008, non-accrual loans were reduced by pay-offs of $3.0 million and charge-offs of $1.0 million. Loans placed on non-accrual during the quarter totaled $4.6 million. Of the loans placed on non-accrual in the third quarter, $3.4 million were real estate construction and development related.

Other real estate owned (OREO) totaled $2.4 million at September 30, 2008, compared with $2.2 million at December 31, 2007. OREO properties at September 30, 2008 consisted primarily of one residential real estate development project and one parcel of land in the Portland, Oregon area. In the third quarter of 2008, one real estate development property was sold for $1.4 million resulting in a loss of $120,000.

Liquidity

Liquidity represents the ability to meet deposit withdrawals and fund loan demand, while retaining the flexibility to take advantage of business opportunities. Daily and short-term liquidity needs are principally met with deposits from customers, payments on loans, maturities and paydowns of investment securities, and wholesale borrowings, including brokered CDs, federal funds purchased, and depending on the availability of collateral, borrowings from the Federal Reserve and FHLB.

Secondary sources of liquidity include sale of investment securities which are not held for pledging purposes and other classes of assets. Securities classified as available for sale which are not pledged may be sold in response to changes in interest rates or liquidity needs. Investments in securities available for sale were $40.8 million at September 30, 2008.

Longer term funding needs can be met through a variety of wholesale sources that have a broader range of maturities than customer deposits and add flexibility in liquidity planning and management. These wholesale sources include advances from the FHLB with longer maturities, brokered CDs and investments that qualify as regulatory capital, including trust preferred securities and subordinated debt. In addition, the Company may also issue equity capital to address liquidity or capital needs.

22

The following table presents the composition of the Company’s deposit liabilities on the dates indicated:

	September 30,		December 31,
(dollars in thousands)	2008		2007
Non-interest-bearing demand deposits	$	82,096	$	91,662
Savings		17,263		17,687
Interest-bearing demand deposits		14,505		18,105
Money market accounts		75,574		86,658
Certificates of deposit under $100,000		77,963		66,137
Certificates of deposit over $100,000		233,957		160,930
Total	$	501,358	$	441,179

Total deposits increased $60.2 million in the first nine months of 2008, or 13.6%, over total deposits at December 31, 2007. At September 30, 2008, the Bank’s brokered deposits totaled $209.7 million, compared with $121.4 million at December 31, 2007. The Company’s loan growth in 2008 and 2007 exceeded its core deposit generation, and the Company has supplemented its core deposits with brokered certificates of deposits and brokered money market deposits. The Company’s brokered deposits have maturities ranging from 90 days to five years. At September 30, 2008, approximately 82% of the Company’s brokered CDs have original maturities of one year or more. The Company’s brokered money market deposits are provided to the Bank under long-term contracts, providing a relatively stable source of funds.

The Company has an agreement with Promontory Interfinancial Network that makes it possible to offer FDIC insured deposits in excess of the current deposit limits. The CDARS network uses a deposit-matching program to match CDARS deposits in other participating banks, dollar for dollar. This product is designed to enhance our ability to attract and retain customers and increase deposits, by providing additional FDIC coverage to customers. CDARS deposits can be reciprocal or one-way, and due to the nature of the placement of funds, CDARS deposits are defined as “brokered deposits” by regulatory agencies. With media focus on the financial sector and customer concern with FDIC insurance limits over the past quarter, customer interest in and demand for CDARS deposits has increased. The Company’s CDARS deposits totaled $13.0 million at September 30, 2008. CDARS deposits might decline due to the recent increase in FDIC insurance limits.

The Bank has overnight federal funds borrowing lines with correspondent banks that provide access to an additional $25.0 million for short-term liquidity needs. The Bank has an established borrowing line with the Federal Home Loan Bank (the “FHLB”). The borrowing line with the FHLB permits it to borrow up to 20% of the Bank's assets, subject to collateral limitations. With the collateral available on September 30, 2008, the Company believes the Bank could borrow approximately $110.0 million. FHLB borrowings in excess of $26.4 million would require the Company to purchase additional FHLB stock. At September 30, 2008, the Company had only minor amounts of borrowings from the FHLB. The Bank also has access to additional liquidity through the Federal Reserve’s primary credit program.

Capital Resources

Capital Ratios

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 result in certain mandatory or discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s operations and 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.

As of September 30, 2008, 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). 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. 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 total core capital elements (as defined). As of September 30, 2008, trust preferred securities accounted for 22% of total core capital elements. 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.

23

The following table presents selected capital information for the Company and the Bank as of September 30, 2008 and December 31, 2007:

											To Be Well-Capitalized
											Under Prompt
						For Capital Adequacy					Corrective Action
	Actual					Purposes					Provisions
(dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2008
Total risk-based capital:
Consolidated	$	57,638		11.63	%	$	39,660		>8.00	%		N/A		N/A
Bank	$	55,246		11.17	%	$	42,784		>8.00	%	$	49,472		>10.00	%
Tier 1 risk-based capital:
Consolidated	$	51,342		10.36	%	$	19,830		>4.00	%		N/A		N/A
Bank	$	48,962		9.90	%	$	19,789		>4.00	%	$	29,683		>6.00	%
Tier 1 (leverage) capital:
Consolidated	$	51,342		9.60	%	$	21,392		>4.00	%		N/A		N/A
Bank	$	48,962		9.14	%	$	21,423		>4.00	%	$	26,779		>5.00	%
December 31, 2007
Total risk-based capital:
Consolidated	$	69,095		14.82	%	$	37,310		>8.00	%		N/A		N/A
Bank	$	65,421		14.06	%	$	37,220		>8.00	%	$	46,525		>10.00	%
Tier 1 risk-based capital:
Consolidated	$	63,260		13.56	%	$	18,655		>4.00	%		N/A		N/A
Bank	$	59,603		12.81	%	$	18,610		>4.00	%	$	27,915		>6.00	%
Tier 1 (leverage) capital:
Consolidated	$	63,260		12.51	%	$	20,233		>4.00	%		N/A		N/A
Bank	$	59,603		11.78	%	$	20,236		>4.00	%	$	25,296		>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 September 30, 2008 and December 31, 2007, the Company and the Bank exceeded all relevant capital adequacy requirements.

Stock Repurchase Program

In September, 2007, the Company announced a stock repurchase program for up to 500,000 shares. The Company intends to use existing funds to finance the repurchases. When evaluating timing and amount of common stock repurchases, management considers a number of factors including, but not limited to, projected earnings generation, risk weighted asset growth, capital ratios relative to regulatory capital guidelines, availability and cost of other capital resources and the market valuation of its stock price. As of September 30, 2008, the Company has not repurchased any of its shares of common stock.

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

24

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 is dependent upon 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. Such structuring includes the use of interest rate derivative contracts. 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.

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 ended December 31, 2007.

Item 4T. Controls and Procedures

As of the end of the period covered by this report, the Company carried out evaluations, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of disclosure controls and procedures pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934. Based upon that evaluation, management, including the Chief Executive Officer and Chief Financial Officer, concluded that the existing disclosure controls and procedures are 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 changes in our internal controls or in other factors that have materially affected or are likely to materially affect our internal controls over financial reporting subsequent to the date of the evaluation.

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

Except as noted below, there were no material changes to the risk factors set forth in the Company’s Form 10-K for the year ended December 31, 2007.

We cannot predict the effect of the national economic situation on our future results of operations or stock trading price.

The national economy, and the financial services sector in particular, is currently facing challenges of a scope unprecedented in recent history. No one can predict the severity or duration of this downturn. We cannot predict whether, or the extent to which, the more severe regional and local economic downturns that have affected other areas of the country may also occur to the same degree in the markets we serve. Any such further deterioration in our markets could have an adverse effect on our business, financial condition, results of operations and prospects, as discussed in the Company’s risk factors, and could also cause the trading price of our stock to decline. The Bank’s ability to assess the creditworthiness of its customers may be affected if the models and approaches the Bank uses to underwrite its loans become less accurate and less predictive of future performance. The process the Bank uses to estimate losses inherent in the loan portfolio could also become affected due to inaccurate economic forecasts.

25

There can be no assurance that recently enacted legislation authorizing the U.S. government to inject capital into financial institutions and purchase assets from financial institutions will help stabilize the U.S. financial system.

On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”). The legislation was the result of a proposal by Treasury Secretary Henry Paulson to the U.S. Congress on September 20, 2008 in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. Pursuant to the EESA, the U.S. Treasury will have the authority to, among other things, invest in preferred stock of financial institutions and purchase mortgages and mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. There can be no assurance, however, as to the actual impact that the EESA will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock. In connection with these recent events, the Bank may face the risks of increased regulation causing increased costs and limits on business opportunities; higher FDIC insurance premiums; downward pressure on the Company’s stock price; the inability to engage in routine funding transactions due to the soundness of other financial institutions and government sponsored entities; and increased competition due to intensified consolidation of the industry.

Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.

Liquidity is essential to our business. The Bank must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market down turn or regulatory action that limits or eliminates our access to alternate national funding sources. Our ability to borrow could also be impaired by factors that are nonspecific to us, such as severe disruption of the financial markets or negative expectations about the prospects for the financial services industry as a whole as evidenced by recent turmoil in the domestic and worldwide credit markets. As a part of its liquidity management, the Bank uses brokered deposits in addition to core deposit growth and repayments and maturities of loans and investments. As the Bank continues to grow, it is likely to become more dependent on these sources. The Company’s financial flexibility will be severely constrained if the Bank is unable to maintain access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If the Bank is required to rely more heavily on more expensive funding sources to support future growth, revenues may not increase proportionately to cover costs, and profitability would be adversely affected.

We may need to raise additional capital which may not be available or may adversely affect existing shareholders.

The Company may need to raise additional capital in the future through financings to maintain desired levels of capital ratios, to improve its financial condition, or to increase liquidity available for operations. Any equity or debt financing, if available at all, may not be available on terms that are favorable to the Company. In the case of equity financings, dilution to the Company’s shareholders could result and, in any case, securities may have rights, preferences and privileges that are senior to those of the Company’s current shareholders. Debt financing could also negatively affect future earnings due to interest charges. In the event additional capital is projected to be or becomes needed and is unavailable on acceptable terms through available financing sources, we may need to take steps to preserve capital, including possibly slowing our lending activities and new loan commitments, selling certain profitable assets, or increasing loan participations.

If the Bank is unable to pay cash dividends to the holding company to meet its cash obligations, the Company’s business, financial condition, results of operations and prospects will be adversely affected.

Dividends paid by the Bank to the Company provide cash flow used to service interest payments on trust preferred securities. Various statutory provisions restrict the amount of dividends the Bank can pay to the Company without regulatory approval. It is possible that depending upon the financial condition of the Bank and other factors, the applicable regulatory authorities could assert that payment of dividends or other payments, including payments to the Company, is an unsafe or unsound practice. If the Bank is unable to pay dividends to the Company, the Company may not be able to service its debt or pay its obligations. The inability to receive dividends from the Bank would adversely affect the business, financial condition, results of operations and prospects.

A significant decline in the Company’s market value could result in an impairment of goodwill.

Recently, the Company’s common stock has been trading at a price below its book value, including goodwill. As a result we evaluated goodwill for impairment during the third quarter of 2008, but no impairment was identified. Our assessment of the fair value of goodwill is based on an evaluation of recent bank acquisition transactions, discounted cash flows from forecasted earnings and our current market capitalization. Our evaluation of the fair value of goodwill involves a substantial amount of judgment. If impairment of goodwill was deemed to exist, we would be required to write down our assets resulting in a charge to earnings. A write-down of goodwill due to impairment would adversely impact our results of operations and financial condition; however, it would have no impact on our regulatory capital.

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The value of certain securities in our investment securities portfolio may be negatively affected by disruptions in the market for these securities.

The market for certain investment securities held within our investment portfolio has over the past year become more volatile. The volatile market may affect the value of these securities, such as through reduced valuations due to the perception of heightened credit and liquidity risks, in addition to interest rate risk typically associated with these securities. There can be no assurance that the declines in market value associated with these disruptions will not result in impairments of these assets, which would lead to accounting charges that could have a material adverse effect on the Company’s net income, equity and capital ratios.

Market and other constraints on our construction loan origination volumes are expected to lead to decreases in the Company’s interest and fee income that are not expected to be offset by reductions in our non-interest expenses.

Due to existing conditions in housing markets in the areas where we operate and other factors, management projects our construction loan originations to be materially constrained for the remainder of 2008 and 2009. This will lower interest income and fees generated from this part of our business. Unless this revenue decline is offset by other areas of our operations, our total revenues may decline relative to our total non-interest expenses. Management expects that it will be difficult to find new revenue sources in the near term to completely offset expected declines in our interest income.

The FDIC has increased insurance premiums to rebuild and maintain the federal deposit insurance fund.

Based on recent events and the state of the economy, the FDIC has increased federal deposit insurance premiums beginning in the first quarter of 2009 to double what we originally paid. The increase of these premiums will add to our cost of operations and could have a significant impact on the Company. Further, depending upon any future losses that the FDIC insurance fund may suffer, there can be no assurance that there will not be additional premium increases in order to replenish the fund

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

Not applicable

Item 5. Other Information

None

Item 6.Exhibits

(a)Exhibits. The following constitutes the exhibit index.

3.1	Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 filed January 15, 1998; File No. 333-44355/Film No. 98507908)
3.2	Amended and Restated Bylaws (incorporated by reference to Exhibit 3(ii) to the Company’s Form 8-K filed October 29, 2007; File No. 000-23881/Film No. 071196564)
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: November 14, 2008

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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