Cowlitz Bancorporation (CWLZ) 10-Q 2008 Q1 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 March 31, 2008

¨ 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 of incorporation or organization)	(I.R.S. Employer 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 April 30, 2008: 5,054,507 shares

COWLITZ BANCORPORATION AND SUBSIDIARY

TABLE OF CONTENTS

		PAGE
Part I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Statements of Condition - March 31, 2008 and December 31, 2007	3
	Consolidated Statements of Income - Three months ended March 31, 2008 and March 31, 2007	4
	Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income - Three months ended March 31, 2008 and year ended December 31, 2007	5
	Consolidated Statements of Cash Flows - Three months ended March 31, 2008 and March 31, 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	23
Item 4T.	Controls and Procedures	23
Part II	OTHER INFORMATION
Item 1	Legal Proceedings	24
Item 1A.	Risk Factors	24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3.	Defaults upon Senior Securities	24
Item 4.	Submission of Matters to a Vote of Security Holders	24
Item 5.	Other Information	24
Item 6.	Exhibits	24
	Signatures	25

Forward-Looking Statements

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

2

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

COWLITZ BANCORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CONDITION

(UNAUDITED)

(dollars in thousands)	March 31, 2008			December 31, 2007
Assets
Cash and cash equivalents	$	45,540		$	31,251
Investment securities		50,669			51,578
Federal Home Loan Bank stock, at cost		1,247			1,247
Loans, net of deferred loan fees		415,474			397,325
Allowance for loan losses		(6,235	)		(5,801	)
Total loans, net		409,239			391,524
Cash surrender value of bank-owned life insurance		14,480			14,328
Premises and equipment		6,459			6,515
Goodwill and other intangibles		1,807			1,834
Accrued interest receivable and other assets		19,009			15,903
Total assets	$	548,450		$	514,180
Liabilities
Deposits:
Non-interest-bearing demand	$	87,501		$	91,662
Savings and interest-bearing demand		33,337			35,792
Money market		93,345			86,658
Certificates of deposit		258,126			227,067
Total deposits		472,309			441,179
Federal funds purchased		975			1,050
Junior subordinated debentures and other borrowings		12,478			12,501
Accrued interest payable and other liabilities		3,492			3,910
Total liabilities		489,254			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 March 31, 2008 and December 31, 2007		—			—
Common stock, no par value; 25,000,000 shares authorized with 5,054,507 and 5,054,437 shares issued and outstanding at March 31, 2008 and December 31, 2007, respectively		28,936			28,936
Additional paid-in capital		2,495			2,484
Retained earnings		22,655			21,753
Accumulated other comprehensive income, net of taxes		5,110			2,367
Total shareholders’ equity		59,196			55,540
Total liabilities and shareholders’ equity	$	548,450		$	514,180

See accompanying notes

3

COWLITZ BANCORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Three Months Ended March 31
(dollars in thousands, except per share amounts)	2008			2007
Interest income
Interest and fees on loans	$	8,416		$	7,998
Interest on taxable investment securities		364			486
Interest on non-taxable investment securities		262			220
Other interest and dividend income		105			64
Total interest income		9,147			8,768
Interest expense
Savings and interest-bearing demand deposits		599			307
Certificates of deposit		2,940			2,469
Federal funds purchased and other borrowings		13			27
Junior subordinated debentures		193			213
Total interest expense		3,745			3,016
Net interest income before provision for credit losses		5,402			5,752
Provision for credit losses		593			275
Net interest income after provision for credit losses		4,809			5,477
Non-interest income
Service charges on deposit accounts		164			166
International trade fees		200			146
Fiduciary income		173			190
Increase in cash surrender value of bank-owned life insurance		152			136
Wire fees		81			81
Mortgage brokerage fees		62			52
Other income		130			135
Total non-interest income		962			906
Non-interest expense
Salaries and employee benefits		2,507			2,496
Net occupancy and equipment		617			539
Professional services		263			387
Data processing and communications		215			260
Business taxes		117			93
Interest rate contracts adjustments		228			127
FDIC assessment		91			12
Foreclosed asset expense (income)		(162	)		—
Other expense		734			728
Total non-interest expense		4,610			4,642
Income before provision for income taxes		1,161			1,741
Income tax provision		259			463
Net income	$	902		$	1,278
Earnings per common share:
Basic	$	0.18		$	0.26
Diluted	$	0.18		$	0.25
Weighted average shares outstanding:
Basic		5,054,473			4,900,490
Diluted		5,093,039			5,176,599

See accompanying notes

4

COWLITZ BANCORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’

EQUITY AND COMPREHENSIVE INCOME

(UNAUDITED)

	Common stock			Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
(dollars in thousands, except shares)	Shares	Amount
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 income:
Net income	—		—		—		902		—			902
Net change in unrealized gain on:
Investments available-for-sale, net of taxes of $89	—		—		—		—		165			165
Cash flow hedges, net of taxes of $1,394	—		—		—		—		2,578			2,578
Comprehensive income												3,645
Proceeds from the exercise of stock options and employee stock purchases	70		—		—		—		—			—
Share-based compensation	—		—		11		—		—			11
Balance, March 31, 2008	5,054,507	$	28,936	$	2,495	$	22,655	$	5,110		$	59,196

See accompanying notes

5

COWLITZ BANCORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Three Months Ended March 31,
(dollars in thousands)	2008			2007
Cash flows from operating activities
Net income	$	902		$	1,278
Adjustments to reconcile net income to net cash from operating activities:
Share-based compensation		16			224
Excess tax benefit on stock options exercised		—			(48	)
Depreciation and amortization		446			229
Provision for credit losses		593			275
Increase in cash surrender value of bank-owned life insurance		(152	)		(136	)
Interest rate contracts adjustments		228			127
Net (gain) loss on sales of foreclosed assets		(217	)		—
(Increase) decrease in accrued interest receivable and other assets		66			155
Increase (decrease) in accrued interest payable and other liabilities		(424	)		(576	)
Other		12			12
Net cash from operations		1,470			1,540
Cash flows from investing activities
Proceeds from maturities and sales of investment securities available-for-sale		4,045			1,485
Net increase in loans		(22,545	)		(7,594	)
Proceeds from sale of foreclosed assets		650			17
Purchases of premises and equipment		(171	)		(83	)
Net cash used by investment activities		(18,021	)		(6,175	)
Cash flows from financing activities
Net increase (decrease) in deposits		30,938			(5,444	)
Net increase (decrease) in federal funds purchased		(75	)		400
Repayment of Federal Home Loan Bank and other borrowings		(23	)		(32	)
Proceeds from the exercise of stock options		—			615
Excess tax benefit on stock options exercised		—			48
Net cash from financing activities		30,840			(4,413	)
Net increase (decrease) in cash and cash equivalents		14,289			(9,048	)
Cash and cash equivalents, beginning of period		31,251			26,581
Cash and cash equivalents, end of period	$	45,540		$	17,533
Supplemental disclosure of cash flow information
Cash paid for interest	$	3,969		$	2,734
Supplemental disclosure of investing and financing activities
Loans transferred to foreclosed assets	$	4,240		$	—

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, Oregon, and a limited service branch in a retirement center in 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, 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. In April 2005, the Company formed Cowlitz Statutory Trust I (the Trust), a wholly-owned Delaware statutory business 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 months ended March 31, 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 and 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 intangibles.

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.

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).

7

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, when required, 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 about 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 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, and federal funds sold. Federal funds sold generally mature the day following purchase.

3. Earnings Per Share

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

	Three Months Ended March 31
	2008	2007
Weighted-average shares outstanding – basic	5,054,473	4,900,490
Effect of assumed conversion of stock options	38,566	276,109
Weighted-average shares outstanding – diluted	5,093,039	5,176,599

Options to purchase 559,566 shares with exercise prices ranging from $9.85 to $16.81 were not included in the computation of diluted earnings per share for the quarter ended March 31, 2008 because the exercise price was greater than the average market price for the quarter. Similarly, options to purchase 7,000 shares with an exercise price of $16.81 were not included in diluted earnings per share for the quarter ended March 31, 2007.

4. Share-Based Compensation

The Company has a stock option plan and a stock appreciation rights (SAR) plan. Compensation costs related to these plans are recognized on a straight-line basis. Compensation cost charged against income for the plans was $7,400 and $224,300 in the first quarter of 2008 and 2007, respectively. Income tax benefits recognized in the income statement for share-based compensation were $2,500 and $76,300 for first quarter 2008 and 2007, respectively. At March 31, 2008, unrecognized estimated compensation cost related to non-vested SARs and stock options was $199,000 and $12,300 respectively, which is expected to be recognized over weighted average periods of 2.2 and 0.7 years, respectively.

8

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 March 31, 2008 with the following weighted average assumptions: expected volatility of 26.08%; expected term of 4.54 years; dividend yield of zero; and risk-free rate of return of 2.55%. After revaluation of the 2008 and 2007 SAR awards at March 31, 2008, the Company recognized $80,500 of expense related to the 2008 SAR awards and recorded a reversal of expense related to the 2007 SAR awards of $75,900, for a net expense of $4,600 in the first quarter of 2008. The expense recognized in the first quarter of 2007 related to the 2007 SAR awards was $167,800.

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 three months ended March 31, 2008. During the first quarter of 2007, 7,000 stock options were granted and the fair value of the options was estimated with 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 $2,400 and $56,500 in the first quarter 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 quarter ended March 31, 2008:

(dollars in thousands)	Options Outstanding		Weighted-Avg. Exercise Price		Weighted-Avg. Remaining Contractual Term (years)	Aggregate Intrinsic Value (in thousands)
Balance, beginning of period	722,136		$	10.92
Granted	—			—
Exercised	(70	)		4.94
Forfeited/Expired	(35,000	)		11.25
Balance, end of period	687,066			10.90	4.9	$	202,035
Exercisable, end of period	681,666			10.86	4.9	$	202,035

The total intrinsic value of options exercised was not significant in the first quarter of 2008 and $272,000 in the quarter ended March 31, 2007. During the first quarter of 2008 the amount of cash received from the exercise of stock options was not significant and $614,300 in the comparable period of 2007.

5. Comprehensive Income

For the Company, comprehensive income primarily includes net income reported on the statements of income and changes in the fair value of available-for-sale investment securities 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.

	Three Months Ended March 31
(dollars in thousands)	2008		2007
Net income reported	$	902	$	1,278
Unrealized gain from securities:
Net unrealized gain on available-for-sale securities arising during the period, net of tax		165		71
Net unrealized gain from securities		165		71
Unrealized gain from cash flow hedging instruments:
Net unrealized gain from cash flow hedging instruments arising during the period, net of tax		2,459		167
Reclassification adjustment of loss included in income, net of tax		119		82
Net unrealized gain from cash flow hedging instruments		2,578		249
Total comprehensive income	$	3,645	$	1,598

9

6. Investment Securities

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

(dollars in thousands)	March 31, 2008		December 31, 2007
Agency securities	$	1,575	$	1,514
Mortgage-backed securities		26,241		27,263
Municipal bonds		22,853		22,801
	$	50,669	$	51,578

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 March 31, 2008:

	Less Than 12 Months					12 Months or More					Total
(dollars in thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Agency securities	$	1,575	$	(200	)	$	—	$	—		$	1,575	$	(200	)
Mortgage-backed securities		9,481		(409	)		1,892		(10	)		11,373		(419	)
Municipal bonds		—		—			286		(1	)		286		(1	)
	$	11,056	$	(609	)	$	2,178	$	(11	)	$	13,234	$	(620	)

At March 31, 2008, there were 14 investment securities in an unrealized loss position, of which 5 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 securities that were in a loss position as of March 31, 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.

7. Loans and Allowance for Credit Losses

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

(dollars in thousands)	March 31, 2008			December 31, 2007
Commercial	$	101,520		$	101,662
Real estate:
Construction		103,595			97,447
Residential 1-4 family		44,799			39,200
Multifamily		9,642			9,938
Commercial		153,400			146,348
Installment and other consumer		3,680			3,924
Total loans, gross		416,636			398,519
Deferred loan fees		(1,162	)		(1,194	)
Loans, net of deferred loan fees	$	415,474		$	397,325

10

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:

	Quarter Ending
(dollars in thousands)	March 31, 2008			March 31, 2007
Balance at beginning of period	$	5,990		$	4,825
Provision for credit losses		593			275
Recoveries		12			24
Charge-offs		(170	)		(26	)
Balance at end of period	$	6,425		$	5,098
Components
Allowance for loan losses	$	6,235		$	4,801
Liability for unfunded credit commitments		190			297
Total allowance for credit losses	$	6,425		$	5,098

Loans on which the accrual of interest has been discontinued totaled $8.0 million and $10.8 million at March 31, 2008 and December 31, 2007, respectively. Also at year-end 2007, one loan recorded at $149,000 was past due more than 90 days and still accruing interest.

The following table summarizes the Company’s investment in loans for which impairment has been recognized for the periods presented:

	March 31, 2008		December 31, 2007
(dollars in thousands)
Total impaired loans at period-end	$	10,770	$	13,590
Impaired loans which have specific allowance		3,766		—
Total specific allowance on impaired loans		859		—
Total impaired loans which as a result of write-downs or the fair value of the collateral, did not have a specific allowance		7,004		13,590
	Quarter Ended March 31, 2008		Year Ended December 31, 2007
(dollars in thousands)
Income recognized on impaired loans during period	$	40	$	15

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 March 31, 2008, was as follows:

(dollars in thousands)
Commitments to extend credit	$	89,892
Credit card commitments		3,600
Standby letters of credit		2,058
	$	95,550

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.

11

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 three-month period ending March 31, 2008 or the twelve-month period ending December 31, 2007. There were no accrued interest or penalties as of March 31, 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 holds loans that have variable rates, thus creating exposure to the variability or uncertainty of future cash flows due to changes in interest rates. The Company’s objective and strategy is to reduce its exposure to decreases in cash flows relating to interest receipts on its prime-based variable-rate loans. The Company has entered into interest rate contracts to manage this risk of overall changes in cash flows associated with those prime-based variable-rate loans. Derivative instruments currently utilized by the Company include an interest rate floor and two interest rate swaps. All derivatives are reported at their fair value on the Consolidated Statements of Condition.

The Company accounts for all its interest rate contracts as cash flow hedges as prescribed by SFAS No. 133, as amended. In a cash flow hedge, the effective portion of the change in the fair value of the hedging derivative is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings during the same period in which the hedged item affects earnings. The change in fair value of any ineffective portion of the hedging derivative is recognized immediately in earnings.

At March 31, 2008, interest rate contracts with a fair value of $8.1 million were included in other assets and $5.0 million of deferred unrealized gains (net of taxes of $2.7 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. Non-cash charges of $228,000 and $127,000 were recorded in the first quarters of 2008 and 2007, respectively, for the ineffective portion of the hedges and the change in fair value of its interest rate floor contract.

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.

12

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.

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.

(dollars in thousands)	March 31, 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	$	50,669	$	1,575	$	49,094	$	—
Interest rate contracts		8,071		—		8,071		—
Nonrecurring basis:
Impaired loans		5,691		—		—		5,691
Total	$	64,431	$	1,575	$	57,165	$	5,691

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

Critical Accounting Policies

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

Quantitative factors include:

• the volume and severity of non-performing loans and adversely classified credits,

• the level of net charge-offs experienced on previously classified loans,

• the nature and value of collateral securing the loans,

• the trend in loan growth and the percentage of change,

• the level of geographic and/or industry concentration,

• the relationship and trend over the past several years of recoveries in relation to charge-offs, and

• other known factors regarding specific loans.

Qualitative factors include:

• the effectiveness of credit administration,

• the adequacy of loan review,

• the adequacy of loan operations personnel and processes,

• the effect of competitive issues that impact loan underwriting and structure,

• the impact of economic conditions, including interest rate trends,

• 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.”

13

Another critical accounting policy of the Company is that related to the carrying value of goodwill and other intangibles. Under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142), the Company ceased amortization of goodwill on January 1, 2002 and periodically tests intangibles with indefinite lives for impairment. Impairment analysis of the fair value of goodwill involves a substantial amount of judgment, as does establishing and monitoring estimated amounts and lives of other intangible assets.

Results of Operations for the Three Months Ended March 31, 2008 and 2007

Overview

The Company’s net income for the first quarter of 2008 was $902,000, or $0.18 per diluted share, compared with net income of $1.3 million, or $0.25 per diluted share for the first quarter of 2007. Net interest income of $5.4 million was down 6% from $5.8 million in the first quarter of 2007.

The Company recorded a provision for credit losses of $593,000 in the first quarter of 2008, compared with a provision for credit losses of $275,000 in the first quarter of 2007.

At March 31, 2008, total assets were $548.5 million, compared with $514.2 at December 31, 2007 and $465.1 million at March 31, 2007. Total loans increased 14% to $415.5 million, from $366.0 million at March 31, 2007. Loans grew at an annualized rate of 18% in the first quarter of 2008. Total deposits increased 20% to $472.3 million at March 31, 2008 from $394.0 million at March 31, 2007. The Company continues to be “well-capitalized” under regulatory requirements.

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.

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.

14

	As of and For the Quarter Ended March 31,
	2008							2007
(dollars in thousands)	Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate		Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate
Assets
Interest-Earning Assets:
Loans (1) (2) (3)	$	412,907		$	8,428	8.21	%	$	356,763		$	8,010	9.11	%
Taxable securities		27,188			364	5.38	%		35,621			486	5.53	%
Non-taxable securities (2)		24,322			393	6.50	%		21,471			333	6.29	%
Temporary investments		15,093			105	2.80	%		6,084			64	4.27	%
Total interest-earning assets (2)		479,510			9,290	7.79	%		419,939			8,893	8.59	%
Allowance for loan losses		(5,987	)						(4,726	)
Other assets		53,174							45,059
Total assets	$	526,697						$	460,272
Liabilities and Shareholders Equity
Interest-Bearing Liabilities:
Savings, money market and interest-bearing demand deposits	$	121,473		$	599	1.98	%	$	87,692		$	307	1.42	%
Certificates of deposit		239,378			2,940	4.94	%		200,506			2,469	4.99	%
Federal funds purchased		1,340			11	3.30	%		1,715			23	5.44	%
Junior subordinated debentures		12,372			193	6.27	%		12,372			213	6.98	%
FHLB and other borrowings		114			2	7.06	%		217			4	7.48	%
Total interest-bearing liabilities		374,677			3,745	4.02	%		302,502			3,016	4.04	%
Non-interest-bearing deposits		91,736							101,467
Other liabilities		4,032							5,062
Total liabilities		470,445							409,031
Shareholders’ equity		56,252							51,241
Total liabilities and shareholders’ equity	$	526,697						$	460,272
Net interest income (2)				$	5,545						$	5,877
Net interest spread						3.77	%						4.55	%
Yield on average interest-earning assets						7.79	%						8.59	%
Interest expense to average interest-earning assets						3.14	%						2.91	%
Net interest income to average interest- earning assets (net interest margin)						4.65	%						5.68	%

(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 amortization of $488,000 and $470,000 for 2008 and 2007, respectively.

Net interest margin as a percentage was 4.65% for the first quarter of 2008, compared with 5.68% in the first quarter of 2007. Comparing the first quarter of 2008 to the first quarter of 2007, tax-equivalent interest income was $0.4 million higher, primarily due to an increase of $59.6 million in average interest-earning assets. Interest expense increased $0.7 million, as the volume of average interest-bearing liabilities increased $72.2 million. The first quarter of 2008 net interest margin decreased 103 b.p. compared with the first quarter of 2007. The net interest margin was affected by several factors, including dramatic rate cuts of 300 basis points over the last six months by the Federal Reserve, competitive market pricing on both sides of the balance sheet, the impact of an elevated level of nonperforming loans and a lower level of noninterest-bearing demand deposit accounts year-over-year. The net settlement from interest rate contracts contributed $431,200 to net interest income in the first quarter of 2008, compared with nothing in the first quarter of 2007.

15

In the first quarter of 2008 the Company elected to redeem $38.9 million in callable certificates of deposit, with $21.6 million settling in March of 2008 and the balance in April 2008. The Company pre-funded the redemptions with $35 million of new certificates of deposit issued in March 2008 with a 140 basis point lower average cost and a slightly longer duration. In connection with the March redemption, the Company wrote off $123,000 of unamortized premiums associated with those deposits. The deposit premium write-off increased the average cost of interest-bearing liabilities by approximately 13 basis points and decreased the margin by 10 basis points in the first quarter of 2008.

Provision for Credit Losses

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

The Company recorded a provision for credit losses of $593,000 in the first quarter of 2008, compared with a $275,000 provision in the first quarter of 2007. Net charge-offs of $158,000 and $2,000 were recorded for the three-month periods ended March 31, 2008 and 2007, respectively. The allowance for loan losses was 1.50% as a percentage of loans outstanding at March 31, 2008, compared with 1.31% in the same quarter last year. The allowance for loan losses represented 78% of non-performing loans at March 31, 2008 compared with 422% at March 31, 2007.

Non-Interest Income

Non-interest income consists of the following components:

	Three Months Ended March 31,
(dollars in thousands)	2008		2007
Service charges on deposit accounts	$	164	$	166
International trade fees		200		146
Fiduciary income		173		190
Increase in cash surrender value of bank-owned life insurance		152		136
Wire fees		81		81
Mortgage brokerage fees		62		52
Other income		130		135
Total non-interest income	$	962	$	906

Non-interest income increased $56,000, or 6%, in the first quarter of 2008 over the comparable 2007 quarter. The increase was primarily related to higher revenues from the Company’s international trade department and bank-owned life insurance.

Non-Interest Expense

Non-interest expense consists of the following components:

	Three Months Ended March 31,
(dollars in thousands)	2008			2007
Salaries and employee benefits	$	2,507		$	2,496
Net occupancy and equipment		617			539
Professional services		263			387
Data processing and communications		215			260
Business taxes		117			93
Interest rate contracts adjustments		228			127
FDIC Assessment		91			12
Foreclosed asset expense (income)		(162	)		—
Other expense		734			728
Total non-interest expense	$	4,610		$	4,642

16

Non-interest expenses in the first quarter of 2008 were $4.6 million, down slightly from the first quarter of 2007. Included in the first quarter 2008 and 2007 results were non-cash charges of $228,000 and $127,000, respectively, for the ineffective portion of the Company’s cash flow hedges and the change in fair value of its interest rate floor contract. The first quarter of 2008 also included a gain on sale of other real estate owned of $216,500. Salaries and employee benefits for the first quarter of 2008 were approximately equal to the first quarter of 2007 amount.

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 March 31, 2008, compared with 138 at March 31, 2007.

Net occupancy and equipment expenses in the first quarter of 2008 were higher than the first quarter of 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 quarter of 2008 compared with the first and fourth quarters of 2007. In the first quarter of 2008, the Company experienced $20,100 higher legal costs related to nonperforming loans, and costs associated with Sarbanes-Oxley compliance efforts were $103,900 lower than in the same period in 2007. Deposit premium assessments were $91,000 in the first quarter of 2008, compared with $12,000 in the first quarter of 2007, as one-time assessment credits available to the Company were utilized to offset FDIC assessments for most of 2007.

Income Taxes

The effective tax rate for the first quarter of 2008 was 22.3% compared with 26.6% during the same period of 2007. The effective tax rate was below the federal tax rate of 34 percent principally due to non-taxable income from bank-owned life insurance, income from tax-exempt investment securities and tax credits arising from low income housing investments.

Financial Condition

Investment Securities

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

(dollars in thousands)	March 31, 2008		December 31, 2007
Agency securities	$	1,575	$	1,514
Mortgage-backed securities		26,241		27,263
Municipal bonds		22,853		22,801
	$	50,669	$	51,578

Total investment securities as of March 31, 2008 were $50.7 million, compared with $51.6 million at December 31, 2007. 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 $415.5 million and $397.3 million at March 31, 2008 and December 31, 2007, respectively. Unfunded loan commitments were $188.1 million at March 31, 2008 and $189.1 million at December 31, 2007.

17

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

	March 31, 2008					December 31, 2007
(dollars in thousands)	Amount			Percent		Amount			Percent
Commercial	$	101,520		24.4	%	$	101,662		25.5	%
Real estate:
Construction		103,595		24.9	%		97,447		24.5	%
Residential 1-4 family		44,799		10.8	%		39,200		9.8	%
Multifamily		9,642		2.3	%		9,938		2.5	%
Commercial		153,400		36.7	%		146,348		36.7	%
Installment and other consumer		3,680		0.9	%		3,924		1.0	%
Total loans, gross		416,636		100.0	%		398,519		100.0	%
Deferred loan fees		(1,162	)				(1,194	)
Loans, net of deferred loan fees	$	415,474				$	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.”

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;

18

• 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.

Management’s evaluation of the loan portfolio resulted in a total allowance for credit losses of $6.4 million at March 31, 2008 and $6.0 million December 31, 2007. The allowance for loan losses, as a percentage of total loans, increased from 1.46% on December 31, 2007 to 1.50% at March 31, 2008. Management believes the allowance for credit losses at March 31, 2008 is adequate to absorb current potential or anticipated losses.

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

	March 31, 2008				December 31, 2007
(dollars in thousands)	Amount		Percent		Amount		Percent
General	$	3,283	51	%	$	2,733	46	%
Specific		859	13	%		—	—
Special		2,282	36	%		3,167	52	%
Available for other factors		1	0	%		90	2	%
Total allowance for credit losses	$	6,425	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.

19

	Three Months Ended March 31,
(dollars in thousands)	2008			2007
Loans outstanding at end of period, net of deferred fees	$	415,474		$	366,029
Average loans outstanding during the period	$	412,907		$	356,763
Allowance for credit losses, beginning of period	$	5,990		$	4,825
Loans charged off:
Commercial		163			—
Real estate		—			—
Consumer and other		7			26
Total loans charged-off		170			26
Recoveries:
Commercial		1			11
Real estate		4			1
Consumer and other		7			12
Total recoveries		12			24
Net loans charged off during the period		158			2
Provision for credit losses		593			275
Allowance for credit losses, end of period	$	6,425		$	5,098
Components
Allowance for loan losses	$	6,235		$	4,801
Liability for unfunded credit commitments		190			297
Total allowance for credit losses	$	6,425		$	5,098
Ratio of net loans charged off to average loans outstanding (annualized)		0.15	%		N/M
Allowance for loan losses/total loans		1.50	%		1.31	%
Allowance for credit losses/total loans		1.55	%		1.39	%
Allowance for loan losses/non-performing loans		78	%		422	%
Allowance for credit losses/non-performing loans		80	%		448	%
N/M- Not meaningful

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.

At March 31, 2008 the Company’s recorded investment in impaired loans was $10.8 million compared with $13.6 million at December 31, 2007. For these loans, there were specific reserves of $859,000 at March 31, 2008 and none at December 31, 2007.

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.

20

Non-Performing Assets

Non-performing assets includes 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 at the dates indicated:

(dollars in thousands)	March 31, 2008			December 31, 2007
Loans on non-accrual status	$	7,985		$	10,827
Loans past due greater than 90 days and accruing		—			149
Total non-performing loans		7,985			10,976
Other real estate owned		6,046			2,240
Other repossessed assets		9			10
Total non-performing assets	$	14,040		$	13,226
Total assets	$	548,450		$	514,180
Percentage of non-performing assets to total assets		2.56	%		2.57	%

Total nonperforming assets at March 31, 2008 consisted primarily of four relationships totaling $13.7 million, or 98% of the total. All of these relationships related to land acquisition and development loans. The change in nonaccrual loans during the quarter ended March 31, 2008 related to the sale of one relationship, totaling $2.4 million, the foreclosure and transfer of loans to other real estate owned (OREO) totaling $4.2 million and the addition of one relationship to nonperforming loans of $3.8 million. The new nonaccrual loan relates to a residential real estate project in the Vancouver, Washington area. The change in OREO during the first quarter of 2008 related to the loan foreclosures referred to above and the sale of one property carried at $434,000 for a gain of $216,500. The $6.1 million balance of OREO at March 31, 2008 is almost entirely related to one residential real estate development project in the Portland, Oregon area.

Liquidity

Liquidity represents the ability to meet deposit withdrawals and fund loan demand, while retaining the flexibility to take advantage of business opportunities. The Bank’s primary sources of funds have been customer and brokered deposits, loan payments, sales or maturities of investments, sales of loans or other assets, borrowings, and the use of the federal funds market. Investment in securities available-for-sale was $50.7 million at March 31, 2008 and $51.6 million at December 31, 2007.

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

(dollars in thousands)	March 31, 2008		December 31, 2007
Non-interest-bearing demand deposits	$	87,501	$	91,662
Savings		16,691		17,687
Interest-bearing demand deposits		16,646		18,105
Money market accounts		93,345		86,658
Certificates of deposit under $100,000		68,673		66,137
Certificates of deposit over $100,000		189,453		160,930
Total	$	472,309	$	441,179

Total deposits increased $31.1 million in the first quarter of 2008, or 7%, over total deposits at December 31, 2007. Of the total increase in deposits, $17.3 million related to the pre-funding of callable brokered certificates of deposits that were redeemed in April 2008. The called certificates of deposits were replaced with new brokered certificates of deposits at lower rates. At March 31, 2008, the Bank’s brokered deposits totaled $162.7 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 Bank has overnight federal funds borrowing lines with correspondent banks that provide access to an additional $50.0 million for short-term liquidity needs. In addition, the parent company has a $2 million line of credit with a correspondent bank. The Bank also has an established borrowing line with the Federal Home Loan Bank (the “FHLB”) that permits it to borrow up to 20% of the Bank’s assets, subject to collateral limitations. The line is available for overnight federal funds, or notes with other terms and maturities. With the collateral available on March 31, 2008, the Company believes the Bank could borrow up to approximately $104.9 million. FHLB borrowings in excess of $26.3 million would require the Company to purchase additional FHLB stock. At March 31, 2008, the Company had no overnight federal funds borrowings with FHLB.

21

As disclosed in the accompanying Consolidated Statements of Cash Flows, net cash flows from operations in the first quarters of 2008 and 2007 were approximately $1.5 million each period. These net cash flows were principally from earnings. Net cash used by investing activities of $18.1 million and $6.2 million in the 2008 and 2007 periods, respectively, primarily related to the increase in loans during those periods. In the first three months of 2008, net deposit growth provided $30.9 million of cash to support loan growth and pre-fund the redemption of $17.3 million of callable certificates of deposit in April 2008. Cash used in financing activities in the first three months of 2007 was primarily related to a $5.4 million net decrease in deposits.

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

As of March 31, 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) in 2005. 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 Tier 1 capital. As of March 31, 2008, trust preferred securities accounted for 19% of Tier 1 capital. There can be no assurance that the Federal Reserve Board will not further limit the amount of trust preferred securities permitted to be included in Tier 1 capital for regulatory capital purposes.

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

	Actual				For Capital Adequacy Purposes				To Be Well-Capitalized Under Prompt Corrective Action Provisions
(dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio
March 31, 2008
Total risk-based capital:
Consolidated	$	70,791	14.42	%	$	39,271	>8.00	%		N/A	N/A
Bank	$	66,943	13.66	%	$	39,203	>8.00	%	$	49,004	>10.00	%
Tier 1 risk-based capital:
Consolidated	$	64,279	13.09	%	$	19,636	>4.00	%		N/A	N/A
Bank	$	60,814	12.41	%	$	19,601	>4.00	%	$	29,402	>6.00	%
Tier 1 (leverage) capital:
Consolidated	$	64,279	12.25	%	$	20,996	>4.00	%		N/A	N/A
Bank	$	60,814	11.60	%	$	20,962	>4.00	%	$	26,203	>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 March 31, 2008 and December 31, 2007, the Company and the Bank substantially exceeded all relevant capital adequacy requirements.

22

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 March 31, 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.

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. As of March 31, 2008, the Bank was asset sensitive.

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

23

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

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

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 December 29, 2007; File No. 000-23881/Film No. 071196564)
10.1	First Amendment to Employment Agreement with Gerald L. Brickey
31.1	Certification of Chief Executive Officer
31.2	Certification of Chief Financial Officer
32	Certification of Chief Executive Officer and Chief Financial Officer

24

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: May 15, 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

25