Forward-Looking Statements

This Form 10-Q contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be identified by the use of words such as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." These forward-looking statements relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding the Company's mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. The Company's actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to: the credit risk of lending activities, including changes in the level and trend of loan delinquencies and write-offs; results of examinations by our banking regulators; interest rate fluctuations; economic conditions in the Company's primary market area; demand for residential, commercial real estate, consumer, and other types of loans; success of new products; competitive conditions between banks and non-bank financial service providers; regulatory and accounting changes; technological factors affecting operations; pricing of products and services; and other risks detailed in the Company's reports filed with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the fiscal year ended December 31, 2007. Accordingly, these factors should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. The Company undertakes no responsibility to update or revise any forward-looking statements.

Comparison of Financial Condition at June 30, 2008 and December 31, 2007

The following table sets forth certain information concerning our consolidated
financial condition at the dates indicated (dollars in thousands):

                        At June 30,   At December 31,   $ Increase       % Increase
                           2008            2007         (Decrease)       (Decrease)

 Total assets           $   870,613        $  878,864   $  (8,251)              (0.9)%
 Investment securities
 (1)                        132,002           177,043     (45,041)            (25.4)
 Interest-bearing
 deposits with banks            539                90         449              498.9
 Loans, net                 655,703           628,921      26,782                4.3
 Deposits                   463,725           461,487       2,238                0.5
 Borrowed funds             324,238           320,454       3,784                1.2
 Total shareholders'
 equity                      75,549            86,820     (11,271)            (13.0)

(1) Includes mortgage-backed securities

Total assets decreased $8.3 million, or 0.9%, to $870.6 million at June 30, 2008 from $878.9 million at December 31, 2007. During the six months ended June 30, 2008, our investment securities portfolio declined by $45.0 million, primarily the result of a market value decline of our trust preferred securities; and investment securities sales, maturities, and principal payments on mortgage-backed securities. Partially offsetting the decline in the investment securities portfolio was a $26.8 million increase in the net loan portfolio as a result of $45.4 million of nonresidential commercial real estate loan originations and $42.3 million of single-family residential real estate loan originations. Deposits increased $2.2 million to $463.7 million from $461.5 million at December 31, 2007, resulting primarily from the growth of balances of non-interest business checking and money market accounts that were partially offset by a decline of $9.2 million in the balances of certificates of deposit. Shareholders' equity decreased $11.3 million to $75.5 million at June 30, 2008 from $86.8 million at December 31, 2007, primarily as a result of the decline in the market value of available-for-sale securities during the six months ended June 30, 2008.

Loans. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated (dollars in thousands):

                                  At June 30, 2008          At December 31, 2007     $ Increase   % Increase
                                  Amount     Percent        Amount       Percent     (Decrease)   (Decrease)
Real estate:
One-to four-family residential     $75,879     11.4%      $   76,882        12.1%      $(1,003)       (1.3)%
Five or more family residential    146,050    22.0           149,080        23.4        (3,030)      (2.0)
Commercial                         245,522    37.0           212,901        33.4         32,621       15.3
Total real estate                  467,451    70.4           438,863        68.9         28,588        6.5

Real estate construction:
One-to four-family residential      79,581    12.0            73,114        11.5          6,467        8.8
Five or more family residential          -       -             1,839         0.3        (1,839)     (100.0)
Commercial                           4,032     0.6             3,827         0.6            205         5.4
Total real estate construction      83,613    12.6            78,780        12.4          4,833         6.1

Consumer:
Automobile                          15,621     2.3            20,798         3.3        (5,177)      (24.9)
Home equity                         42,344     6.4            45,293         7.1        (2,949)       (6.5)
Credit cards                        22,063     3.3            23,172         3.6        (1,109)       (4.8)
Other                                7,962     1.2             7,411         1.2            551         7.4
Total consumer                      87,990    13.2            96,674        15.2        (8,684)       (9.0)

Commercial/business                 24,920     3.8            22,683         3.5          2,237         9.9

Total loans                        663,974    100.0%         637,000       100.0%        26,974         4.2

Less allowance for loan losses     (8,271)                   (8,079)                      (192)         2.4

Loans, net                        $655,703                $  628,921                    $26,782         4.3%

Our net loan portfolio increased $26.8 million, or 4.3%, to $655.7 million at June 30, 2008 from $628.9 million at December 31, 2007. This increase was primarily attributable to increases in our real estate secured loans, which increased $30.5 million, or 5.4%, to $593.4 million at June 30, 2008 compared to $562.9 million at December 31, 2007. The real estate loan growth included a $32.6 million, or 15.3% increase in nonresidential commercial real estate loans and a $4.8 million, or 6.1% increase in real estate construction loans. These increases were partially offset by a $3.0 million, or 2.0% decline in five or more family real estate loans as a result of a high level of loan repayments for the six months ended June 30, 2008; a $2.9 million, or 6.5% decline in home equity loans as a result of tighter underwriting standards and borrowers refinancing their home first mortgage and paying off their home equity loans:
and a $1.0 million, or 1.3% decline in our one-to four-family mortgage portfolio, which included $35.6 million in single-family fixed-rate mortgages sold. Additionally, the commercial business loan portfolio increased $2.2 million, or 9.9%. Partially offsetting the increases in loans secured by real estate and commercial business loans was a $5.7 million decrease in consumer loans (excluding home equity loans), including a $5.2 million decline in automobile loan balances primarily attributable to our decision to tighten the underwriting standards for auto loans beginning in 2007 and to discontinue the origination of indirect auto loans on February 1, 2008. During the balance of fiscal 2008, subject to market conditions, we plan to continue to grow our portfolio of real estate secured loans, primarily with loans secured by five or more family and commercial real estate.

Investments. The following table sets forth the composition of our investment securities at the dates indicated. The available-for-sale investments are presented at net book value after a mark-to-market fair value adjustment, while the held-to-maturity securities are presented at amortized cost. Our investment in the FHLB of Seattle's common stock is presented at cost and for reference purposes only (dollars in thousands):

                                        At June 30,   At December 31,    $ Increase     % Increase
                                           2008            2007          (Decrease)     (Decrease)
Available-for-sale:
U. S. Government agencies                 $       -      $      5,705    $  (5,705)        (100.0)%
Corporate securities                              -             5,023       (5,023)       (100.0)
Trust preferred securities                   81,608           102,356      (20,748)        (20.3)
Mortgage-backed securities                   12,448            18,203       (5,755)        (31.6)
Total available-for-sale portfolio           94,056           131,287      (37,231)        (28.4)

Held-to-maturity:
Municipal obligations                        11,789            12,784         (995)         (7.8)
Mortgage-backed securities                   26,157            32,972       (6,815)        (20.7)
Total held-to-maturity portfolio             37,946            45,756       (7,810)        (17.1)

Total Investment Securities                 132,002           177,043      (45,041)        (25.4)

Federal Home Loan Bank of Seattle stock      13,712            13,712             -             -

 Total                                    $ 145,714      $    190,755    $ (45,041)         (23.6)%

Our investment securities portfolio decreased by $45.0 million, or 25.4%, to $132.0 million at June 30, 2008 from $177.0 million at December 31, 2007. The decrease in investments was primarily the result of $19.6 million of sales, maturities, and partial calls of investment securities during the six months ended June 30, 2008 and a $20.2 million market value decline in the Company's portfolio of pooled trust preferred securities issued by FDIC-insured financial institutions and insurance companies. The Company has evaluated the decline in the market value of its trust preferred securities, which is directly related to the credit and liquidity crisis being experienced in the financial services industry over the past three calendar quarters, and believes the impairment in value to be temporary. The trust preferred securities are investment grade securities that are performing and are expected to continue performing. Under U.S. generally accepted accounting principles, the Company has reflected this temporary market value decline in a valuation allowance component of shareholders' equity. All of our trust preferred securities have continued to pay interest as scheduled through June 30, 3008 and are expected to continue paying interest, as scheduled, in the future. Additionally, we received $4.5 million in principal repayments on mortgage-backed securities. Included in the sales of investment securities during the first six months of 2008 was $3.7 million of held-to-maturity ("HTM") securities. These HTM securities were sold when they had remaining book values of less than 15% of original purchase price. In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, when HTM securities with remaining book values of less than 15% of their original purchased price are sold, they are treated the same as maturities and do not taint the HTM investment portfolio or affect the Company's ability to hold securities in the HTM portfolio in the future.

Non-performing Assets. The following table sets forth detailed information concerning our non-performing assets for the periods indicated (dollars in thousands):

                                At June 30, 2008               At December 31, 2007        $ Increase     % Increase
                              Amount       Percent (1)         Amount       Percent (1)    (Decrease)     (Decrease)
Loans 90 days or more past
due or non-accrual loans:
Real estate                  $         -            -%          $       -           -%      $         -            -%
Real estate construction          13,461         2.03                   -          -             13,461       100.0
Consumer                             415         0.06                 497        0.08              (82)       (16.5)
Commercial business                    -           -                    -           -                 -           -
Total non-performing loans        13,876         2.09                 497        0.08            13,379     2,692.0

Other non-performing
assets
Repossessed assets                     -                               49                          (49)      (100.0)
Other real estate owned              446                                -                           446        100.0%
Total other non-performing
assets                               446                               49                           397       810.2

Total non-performing
assets                        $   14,322                        $     546                   $    13,776      2,523.1%

Total non-performing
assets as a percentage of
total assets                       1.65%                            0.06%

(1) Percent of total loan portfolio

Our non-performing assets have increased to $14.3 million at June 30, 2008 from $546,000 at December 31, 2007. The increase was the result of cash flow problems experienced by two local residential builders during the second quarter resulting in their inability to meet the debt service requirements of the loans. As of June 30, 2008, we classified $13.5 million in real estate construction loans associated with these two builders as non-performing, which consists of $6.6 million in loans for land development, $5.5 million in one- to four-family residential construction loans with houses in varying stages of completion, and $1.3 million in developed one- to four-family residential lots. We classified most of our loans to these builders (excluding pre-sold homes and rental properties) as non-performing. The cumulative interest not accrued during the second quarter relating to these non-performing loans totaled $164,000. We intend to work with the builders to reach acceptable payment plans and to further protect our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.

Management performs an impairment analysis on a loan when it determines that it is probable that all contractual amounts of principal and interest will not be paid as scheduled. The analysis usually occurs when a loan has been negatively classified or placed on non-accrual status. If the current value of the impaired loan is less than the recorded investment in the loan, an impairment is recognized by establishing a specific allocation of the allowance for loan losses for the loan or by adjusting an existing allocation. Our analysis of the $6.6 million in loans for land development and the $5.5 million in loans for one- to four-family residential construction in varying stages of completion indicated a specific allocation of the allowance was appropriate. Based on our analysis of these loans, which included the review of existing and updated appraisals as well as adjustments to those appraisals for deteriorating market conditions, we established a $1.7 million specific allowance for these loans. Our analysis of the $1.3 million in loans on the developed one- to four-family residential lots indicated a specific allocation of the allowance for these loans was not required at June 30, 2008.

Deposits. The following table sets forth the composition of our deposits at the dates indicated (dollars in thousands):

                                   At June 30, 2008         At December 31, 2007        $ Increase   % Increase
                                   Amount    Percent         Amount       Percent       (Decrease)   (Decrease)

Non-interest-bearing checking      $40,736      8.8%          $33,924         7.4%          $6,812        20.1%
Interest-bearing checking           37,672     8.1             41,083        8.9           (3,411)       (8.3)
Savings accounts                    29,553     6.4             28,397        6.1             1,156        4.1
Money market accounts              124,444    26.8            117,626       25.5             6,818        5.8
IRA accounts                         5,866     1.3              5,713        1.2               153        2.7
Certificates of deposit            225,454    48.6            234,744       50.9           (9,290)       (4.0)
Total deposits                    $463,725    100.0%         $461,487       100.0%        $  2,238         0.5%

Core deposits                     $238,271     51.4%         $226,743        49.1%         $11,528         5.1%
Non-core deposits                  225,454    48.6            234,744       50.9           (9,290)       (4.0)
Total deposits                    $463,725    100.0%         $461,487       100.0%        $  2,238         0.5%

Our deposits increased $2.2 million, or 0.5%, to $463.7 million at June 30, 2008 from $461.5 million at December 31, 2007. Interest-bearing deposits, primarily certificates of deposit and money market accounts, decreased $4.6 million, while non-interest bearing deposits, primarily checking accounts, increased $6.8 million. Our deposit mix at the end of the second quarter included 51.4% of relatively low-cost checking, savings, money market, and individual retirement accounts (i.e., core deposits). Certificates of deposit at June 30, 2008 included $61.2 million of brokered certificates of deposit, an increase of $321,000 from the $60.9 million of brokered certificates of deposit at December 31, 2007.

Borrowings. Borrowed funds increased $3.7 million, or 1.2%, to $324.2 million at June 30, 2008 from $320.5 million at December 31, 2007. The increase in borrowed funds during the quarter ended June 30, 2008 was primarily attributable to funding short-term liquidity needs. We will continue to utilize borrowings from the FHLB of Seattle to fund attractive loan and investment opportunities and to enhance earnings in connection with leveraging the Company's capital to increase our net interest income.

Capital. Total shareholders' equity decreased $11.3 million, or 13.0%, to $75.5 million at June 30, 2008 from $86.8 million at December 31, 2007. The decrease in equity during the six months ended June 30, 2008 was primarily attributable to a $13.3 million unrealized loss, net of taxes, on the available-for-sale securities portfolio. Additionally, we paid out $904,000 in cash dividends to shareholders and purchased $616,000 of our common stock. Partially offsetting these decreases was $2.5 million in net income and $1.1 million in positive equity adjustments related to stock compensation and benefits. As a result of these factors, and a relatively small change in the balance of our total assets, our capital-to-assets ratio under accounting principles generally accepted in the United States decreased 120 basis points to 8.68% at June 30, 2008, compared to 9.88% at December 31, 2007. As of June 30, 2008, the Bank remained categorized "well capitalized" under regulatory standards.

Comparison of Operating Results for the Three Months Ended June 30, 2008 and 2007

The following table sets forth certain information concerning our results of operations for the periods indicated (dollars in thousands):

                             Three Months Ended June 30,     $ Increase   % Increase
                                2008             2007        (Decrease)   (Decrease)

  Net interest income            $  6,438         $  6,419     $     19         0.3%
  Non-interest income               2,601            2,344          257       11.0
  Total revenue                     9,039            8,763          276        3.1
  Provision for loan losses           550              150          400      266.7
  Non-interest expense              6,900            7,102        (202)       (2.8)
  Net income                        1,017              982           35        3.6

Net Interest Income. The following table sets forth detailed information concerning our net interest income for the periods indicated (dollars in thousands):

                                       Three Months Ended June
                                                 30,               $ Increase   % Increase
                                           2008          2007      (Decrease)   (Decrease)
Interest income:
Loans                                       $11,191     $11,645     $   (454)       (3.9)%
Securities available-for-sale                 1,276       2,032         (756)     (37.2)
Securities held-to-maturity                     420         546         (126)     (23.1)
Interest-bearing deposits                         6          70          (64)     (91.4)
Federal Home Loan Bank stock dividends           48          20            28      140.0
Total interest income                        12,941      14,313       (1,372)      (9.6)

Interest expense:
Deposits                                      2,979       4,053       (1,074)     (26.5)
Borrowed funds                                3,524       3,841         (317)      (8.3)
Total interest expense                        6,503       7,894       (1,391)     (17.6)
Net interest income                         $ 6,438    $  6,419      $     19         0.3%

Net interest income was $6.4 million for the three months ended June 30, 2008, relatively unchanged from the same period in 2007. Our net interest margin increased 12 basis points to 3.13% for the three months ended June 30, 2008, from 3.01% for the same period in 2007, as the market decline in short-term interest rates allowed us to reprice deposits more rapidly than loans as a large portion of our loan portfolio consists of intermediate and long-term fixed-rate loans.

Interest Income. Our interest income decreased $1.4 million, or 9.6%, to $12.9 million for the three months ended June 30, 2008 from $14.3 million for the three months ended June 30, 2007. Interest earned on loans for the three months ended June 30, 2008 and 2007 was $11.2 million and $11.6 million, respectively. The average yield on total loans decreased to 6.80% for the three months ended June 30, 2008 compared to 7.27% for the same period in 2007 reflecting the decrease in short-term interest rates. The yield decrease on our variable-rate loan products was a result of the current lower interest rate environment, and was partially offset by an increase in the average balance of loans, resulting in the decreased interest income on loans. Additionally, during the second quarter of 2008, $13.5 million in construction loans were classified as non-accrual. Interest on these loans not recognized during the second quarter of 2008 was $164,000. The average balance of total loans increased by $17.0 million to $658.7 million for the three months ended June 30, 2008 compared to $641.7 million for the same period in 2007. Although a significant portion of the loan portfolio consists of real estate secured loans that do not immediately re-price when interest rates change, construction loans, home equity lines of credit, credit card loans, and some of our commercial business loans generally re-price when short-term interest rates change.

Interest income on investment securities (including mortgage-backed securities) decreased $882,000, or 34.2%, to $1.7 million for the three months ended June 30, 2008 compared to $2.6 million for the three months ended June 30, 2007 as a result of a lower average balances, as well as lower yields earned. Additionally, 95.4% of our trust preferred securities adjust to a floating LIBOR rate plus a specified margin every three months. Accordingly, a decrease in the LIBOR rate has contributed to the lower yields being earned. The average balances of investment securities, including mortgage-backed securities for the three months ended June 30, 2008 and 2007 were $146.5 million and $193.0 million, respectively. The average yield on investment securities decreased to 4.63% for the three months ended June 30, 2008 from 5.34% for the three months ended June 30, 2007 as a result of the lower interest rate environment.

Interest Expense. Our interest expense decreased $1.4 million, or 17.6%, to $6.5 million for the three months ended June 30, 2008 from $7.9 million for the three months ended June 30, 2007. Declining short-term market interest rates, conservative deposit pricing, as well as a decrease in the average balances of our interest-bearing liabilities helped reduce our deposit and borrowing costs.

Interest expense on deposits decreased $1.1 million, or 26.5%, to $3.0 million for the three months ended June 30, 2008 from $4.1 million for the three months ended June 30, 2007. The average cost of deposits decreased 99 basis points to 2.84% for the three months ended June 30, 2008 from 3.83% for the three months ended June 30, 2007 as a result of the recent decline in short-term interest rates and lower deposit pricing.

Interest expense on borrowed funds decreased $317,000, or 8.3%, to $3.5 million for the three months ended June 30, 2008 from $3.8 million for the three months ended June 30, 2007 primarily attributable to a $21.3 million decline in the average balance of borrowed funds. The average balances of borrowed funds were $324.0 million for the quarter ended June 30, 2008, compared to $345.3 million for the three months ended June 30, 2007. The cost of borrowed funds decreased by only seven basis points to 4.38% for the three months ended June 30, 2008 from 4.45% for the three months ended June 30, 2007, as $245.0 million of our borrowings are intermediate- and long-term structured advances that do not reprice when short-term rates decline.

                                       Three Months Ended June 30,     $ Increase     % Increase
                                         2008              2007        (Decrease)     (Decrease)
Allowance at beginning of period            $7,979            $8,276     $  (297)            (3.6)%
Provision for loan losses                      550               150          400           266.7
Recoveries                                      66                76         (10)          (13.2)
Charge-offs                                  (324)             (267)         (57)            21.3
Allowance at end of period                  $8,271            $8,235      $    36              0.4%

. . .