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 strategies. 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 risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs that may be impacted by deterioration in the housing and commercial real estate markets and may lead to increased losses and non-performing assets in the Company's loan portfolio, result in the Company's allowance for loan losses not being adequate to cover actual losses, and require the Company to materially increase its reserves; changes in general economic conditions, either nationally or in the Company's market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, net interest margin, and funding sources; deposit flows; fluctuations in the demand for loans, the number of unsold homes and other properties, and fluctuations in real estate values in the Company's market areas; adverse changes in the securities markets, including changes in the ability of the issuers of trust preferred CDO securities the Company owns to repay their obligations; results of examinations of the Company by the Federal Reserve Board and its bank subsidiary by the Federal Deposit Insurance Corporation, the Washington State Department of Financial Institutions, Division of Banks, or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require the Company to increase its reserve for loan losses, write-down assets, change its regulatory capital position, or affect its ability to borrow funds or maintain or increase deposits, which could adversely affect the Company's liquidity and earnings; the Company's ability to control operating costs and expenses; the use of estimates in determining fair value of certain of the Company's assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on the Company's balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect the Company's work force and potential associated charges; computer systems on which the Company depends could fail or experience a security breach, or the implementation of new technologies may not be successful; the Company's ability to retain key members of its senior management team; costs and effects of litigation, including settlements and judgments; the Company's ability to manage loan delinquency rates; increased competitive pressures among financial services companies; changes in consumer spending, borrowing, and savings habits; legislative or regulatory changes that adversely affect the Company's business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; inability of key third-party providers to perform their obligations to the Company; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting the Company's operations; pricing, products, and services; time to lease excess space in Company-owned buildings; and other risks detailed in the Company's reports filed with the Securities and Exchange Commission, including the Company's 2008 Form 10-K. Any of the forward-looking statements that the Company makes in this Form 10-Q and in the other public statements may turn out to be wrong because of inaccurate assumptions the Company might make, the factors illustrated above, or other factors that the Company cannot foresee. Because of these and other uncertainties, the Company's actual future results may be materially different from those expressed in any forward-looking statements made by or on the Company's behalf. Therefore, 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 statement.

Comparison of Financial Condition at March 31, 2009 and December 31, 2008

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

                                                                  At
                                                               December
                                            At March 31,         31,          $ Increase        % Increase
                                                2009             2008          (Decrease)        (Decrease)

Total assets                               $      858,324     $  847,233     $      11,091                1.3 %
Investment securities (1)                          60,831         48,879            11,952               24.5
Interest-bearing deposits with banks               64,051         29,425            34,626              117.7
Loans, net                                        631,812        658,952           (27,140 )             (4.1 )
Deposits                                          508,609        519,239           (10,630 )             (2.0 )
Borrowed funds                                    299,681        291,217             8,464                2.9
Total shareholders' equity                         39,165         29,294             9,871               33.7

(1) Includes mortgage-backed securities

Total assets increased $11.1 million or 1.3% to $858.3 million at March 31, 2009, compared to $847.2 million at December 31, 2008. Interest-bearing deposits with the Federal Reserve Bank increased by $34.6 million during the quarter and investment securities increased $12.0 million due to a pre-tax fair value increase in our trust preferred CDO securities. Partially offsetting these increases was a net decrease of $27.1 million in the loan portfolio, which was primarily the result of loan sales during the quarter, including the sale of our VISA credit card portfolio. Deposits decreased $10.6 million to $508.6 million from $519.2 million at December 31, 2008, resulting primarily from the reduction of our balance of brokered deposits by $16.6 million during the quarter, which was offset by a $6.0 million increase in retail deposits. Shareholders' equity increased $9.9 million to $39.2 million at March 31, 2009 from $29.3 million at December 31, 2008, primarily as a result of $14.3 million in tax-effected fair value adjustments relating to our trust preferred CDO securities, offset by our net loss of $4.6 million during the three months ended March 31, 2009.

Loans. The following table sets forth the composition of our loan portfolio (including loans held-for-sale), by type of loan, at the dates indicated (dollars in thousands):

                        At March 31, 2009       At December 31, 2008     $ Increase     % Increase
                        Amount     Percent      Amount        Percent     (Decrease)    (Decrease)
Real estate:
One-to four-family
residential              $58,515       9.1%       $56,325         8.4%       $ 2,190          3.9%
Five or more family
residential              149,562       23.4       148,949         22.2           613           0.4
Commercial               256,985       40.1       253,801         37.7         3,184           1.3
Total real estate        465,062       72.6       459,075         68.3         5,987           1.3

Real estate
construction:
One-to four-family
residential               59,263        9.2        71,424         10.6      (12,161)        (17.0)
Five or more family
residential                  491        0.1           483          0.1             8           1.7
Commercial                 9,602        1.5         9,953          1.5         (351)         (3.5)
Total real estate
construction              69,356       10.8        81,860         12.2      (12,504)        (15.3)

Consumer:
Automobile                10,127        1.6        11,818          1.8       (1,691)        (14.3)
Home equity               40,843        6.4        42,442          6.3       (1,599)         (3.8)
Credit cards                   -          -        23,192          3.4      (23,192)       (100.0)
Other                      7,547        1.2         8,132          1.2         (585)         (7.2)
Total consumer            58,517        9.2        85,584         12.7      (27,067)        (31.6)

Commercial business       47,333        7.4        45,762          6.8         1,571           3.4

Total loans              640,268     100.0%       672,281       100.0%      (32,013)         (4.8)

Less allowance for
loan losses              (8,456)                 (13,329)                      4,873        (36.6)

Loans, net              $631,812                 $658,952                  $(27,140)        (4.1)%

Our net loan portfolio decreased $27.1 million or 4.1%, to $631.8 million at March 31, 2009 from the December 31, 2008 balance, primarily due to the sale of our VISA credit card portfolio as of January 31, 2009 and a $12.5 million decline in our construction loan balances, which included a $6.6 million charge-off of non-accrual construction loan balances. We also experienced a $1.7 million decline in automobile loan balances as these loan balances continue to decline since the discontinuation of our indirect auto lending program in February 2008. In addition, home equity loan balances decreased $1.6 million during the quarter as borrowers continued to take advantage of historically low long-term rates by refinancing their existing one-to four-family mortgages and home equity balances into a single mortgage loan. These decreases were partially offset by increases in our real estate loan portfolio, which increased $6.0 million or 1.3%, to $465.1 million at March 31, 2009 compared to $459.1 million at December 31, 2008 and commercial business loans, which increased $1.6 million during the same period. The real estate loan growth included a $2.2 million increase in one-to four-family mortgage loans, despite the sale of $33.9 million of such mortgages due to the strong refinancing market.

Investments. The following table sets forth the composition of our investment securities at the dates indicated. The available-for-sale investments are presented at fair value, 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 December
                                            At March 31,          31,          $ Increase        % Increase
                                                2009             2008          (Decrease)        (Decrease)
Available-for-sale:
Trust preferred CDO securities             $       28,233     $    14,895     $      13,338             89.5 %
Total available-for-sale                           28,233          14,895            13,338             89.5

Held-to-maturity:
Municipal obligations                              11,086          11,085                 1                -
Mortgage-backed securities                         21,512          22,899            (1,387 )           (6.1 )
Total held-to-maturity                             32,598          33,984            (1,386 )           (4.1 )

Total Investment Securities                        60,831          48,879            11,952             24.5

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

 Total                                     $       74,543     $    62,591     $      11,952             19.1 %

Our investment securities portfolio increased by 24.5%, to $60.8 million at March 31, 2009 compared to $48.9 million at December 31, 2008, primarily as a result of an increase in the fair value of our trust preferred CDO securities collateralized by the trust preferred securities issued by 551 FDIC-insured financial institutions and 39 insurance companies. Management adopted the FASB's revised guidance issued on April 9, 2009 changing how the valuation for securities lacking an orderly and liquid market are calculated so they are more representative of fair value under current market conditions. See Note 9 to the Selected Notes to Unaudited Interim Consolidated Financial Statements contained in Part I, Item 1 - "Financial Statements" of this report on Form 10-Q. In connection with adopting these new accounting standards, the Company engaged an independent consulting firm to assist the Company's management in determining the fair value of the Company's trust preferred CDO securities as of March 31, 2009, resulting in a $13.3 million net increase in the fair value of the Company's portfolio of 15 trust preferred CDO securities. Mortgage-backed securities held to maturity decreased $1.4 million as a result of routine principal reductions.

On a quarterly basis, management evaluates each available-for-sale and held-to-maturity investment security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary. Management has determined six of our 15 trust preferred securities were other-than-temporarily impaired at March 31, 2009. Accordingly, the Company recognized non-cash, pre-tax OTTI charges of $8.5 million reflecting the credit loss portion of the change in fair value of these securities, as shown in the Consolidated Statements of Operations. The Company intends to, and believes it will more-likely-than-not be able to hold these securities with OTTI to the earlier of their recovery in value or the maturity of the underlying investment security. The Company recorded the change in the non-credit related factors of the change in fair value for these six securities as a component of shareholders' equity (i.e. accumulated other comprehensive loss).

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

                              At March 31, 2009                 At December 31, 2008             $ 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                 17,490              2.73           24,042                3.58             (6,552 )         (27.3 )
Consumer                        244              0.04              488                0.07               (244 )         (50.0 )
Commercial business           1,596              0.25               14                0.00              1,582        11,300.0
Total non-performing
loans                        19,330              3.02           24,544                3.65             (5,214 )         (21.2 )

Other non-performing
assets
Repossessed assets            6,087                              6,796                                   (709 )         (10.4 )
Real estate owned                25                                 38                                    (13 )         (34.2 )
Total other
non-performing assets         6,112                              6,834                                   (722 )         (10.6 )

Total non-performing
assets                  $    25,442                       $     31,378                          $      (5,936 )         (18.9 )%

Total non-performing
assets as a
percentage
  of total assets              2.96 %                             3.70 %

Loans greater than 30
days delinquent as
percentage of total
loans                          3.13 %                             4.00 %

(1) Percent of total loan portfolio

Our non-performing assets have decreased to $25.4 million at March 31, 2009 from $31.4 million at December 31, 2008. The decrease was primarily the result of $6.6 million in charge-offs in our non-accrual real estate construction loans for which we had previously established a specific allocation of the allowance for loan losses in the third quarter of 2008. As of March 31, 2009, we classified $17.5 million in real estate construction loans (representing 25.5% of our total real estate construction portfolio) as non-performing, which consists of $10.8 million in developed one- to four-family residential lots, $4.7 million in one- to four-family residential construction loans with houses in varying stages of completion (i.e., developed lots to completed homes), and $2.0 million in loans for land development in Pierce and Thurston counties of Washington State. Of the $19.3 million in total non-performing loans at March 31, 2009, a total of $18.7 million ($17.1 million in real estate construction loans and $1.6 million in commercial business loans) related to the remaining balances on loans outstanding to the three previously mentioned residential builder relationships that generated the significant charge-off in the first quarter of 2009. The cumulative interest not accrued during the first three months of 2009 relating to all non-performing loans totaled $340,000. We seek to reach acceptable payment plans on all of our non-performing loan while protecting 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 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, 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 $21.0 million in total impaired loans, $17.7 million in impaired real estate construction loans and $3.3 million in impaired commercial business loans, revealed a specific allocation of the allowance was appropriate. Based on our analysis of these loans, which included the review of either existing or updated appraisals as well as adjustments to those appraisals for deteriorating market conditions, we established a $1.8 million specific allowance for these loans.

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

                                 At March 31, 2009              At December 31, 2008            $ Increase        % Increase
                               Amount         Percent          Amount           Percent         (Decrease)        (Decrease)

Non-interest-bearing
checking                    $    45,166             8.9 %   $     40,331              7.8 %   $       4,835               12.0 %
Interest-bearing checking        35,602             7.0           36,468              7.0              (866 )             (2.4 )
Savings accounts                 31,195             6.1           28,197              5.4             2,998               10.6
Money market accounts           151,118            29.7          145,311             28.0             5,807                4.0
IRA accounts                      5,582             1.1            6,382              1.2              (800 )            (12.5 )
Brokered certificates of
deposit                          70,800            13.9           87,442             16.9           (16,642 )            (19.0 )
Retail certificates of
deposit                         169,146            33.3          175,108             33.7            (5,962 )             (3.4 )
Total deposits              $   508,609           100.0 %   $    519,239            100.0 %   $     (10,630 )             (2.0 )%

Core deposits               $   268,663            52.8 %   $    256,689             49.4 %   $      11,974                4.7 %
Non-core deposits               239,946            47.2          262,550             50.6           (22,604 )             (8.6 )
Total deposits              $   508,609           100.0 %   $    519,239            100.0 %   $     (10,630 )             (2.0 )%

Our deposits decreased $10.6 million, or 2.0%, to $508.6 million at March 31, 2009 from $519.2 million at December 31, 2008. The decrease was primarily the result of maturing brokered deposits during the first quarter of 2009, which were not replaced. Certificates of deposit at March 31, 2009 included $70.8 million of brokered certificates of deposit, representing a decrease of $16.6 million from the $87.4 million of brokered certificates of deposit at December 31, 2008. We are increasing our marketing efforts toward generating core deposits and continue to focus on our local relationship-oriented deposit gathering activities. The result of these efforts was a $6.0 million increase in total retail deposits, with core deposits increasing by $12.0 million during the first quarter of 2009. These core deposits (i.e. checking, savings, money market and individual retirement accounts) represented 52.8% of total deposits and are more valuable for us as they are generally less rate sensitive and represent a more stable source of funds.

Borrowings. Borrowed funds increased $8.5 million, or 2.9%, to $299.7 million at March 31, 2009 from $291.2 million at December 31, 2008. The increase in borrowed funds provided additional short-term liquidity for the Company contributing to the $34.6 million increase in the Company's interest-bearing deposits during the quarter.

Capital. Total shareholders' equity increased $9.9 million, or 33.7%, to $39.2 million at March 31, 2009 from $29.3 million at December 31, 2008. The increase in equity during the quarter was primarily attributable to $14.3 million in tax-effected fair value adjustments relating to our trust preferred CDO securities. Partially offsetting that increase was a $4.6 million net loss for the three months ended March 31, 2009, which included the $8.5 million in credit losses realized on six of our 15 trust preferred CDO securities deemed to involve OTTI, during the same period. As a result of these factors, and the $11.1 million increase in our total assets, our capital-to-assets ratio under accounting principles generally accepted in the United States increased 110 basis points to 4.56% at March 31, 2009, compared to 3.46% at December 31, 2008.

Comparison of Operating Results for the Three Months Ended March 31, 2009 and 2008

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

                                Three Months Ended March 31,        $ Increase     % Increase
                                    2009              2008          (Decrease)     (Decrease)
Net interest income                   $  5,590        $  6,543       $    (953)        (14.6)%
Non-interest income                      5,650           2,821            2,829          100.3
Total revenue                           11,240           9,364            1,876           20.0
Provision for loan losses                2,300             150            2,150        1,433.3
Non-interest expense                     7,389           6,958              431            6.2
Impairment loss on securities          (8,483)               -          (8,483)        (100.0)
Net income (loss)                      (4,613)           1,444          (6,057)        (419.5)

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 March 31,         $ Increase     % Increase
                              2009              2008            (Decrease)     (Decrease)
Interest income:
Loans                           $10,242           $11,277         $ (1,035)         (9.2)%
Securities
available-for-sale                  834             1,857           (1,023)         (55.1)
Securities
held-to-maturity                    353               451              (98)         (21.7)
Interest-bearing
deposits                             19                27               (8)         (29.6)
Federal Home Loan Bank
dividends                             -                34              (34)        (100.0)
Total interest income            11,448            13,646           (2,198)         (16.1)

Interest expense:
Deposits                          2,632             3,587             (955)         (26.6)
Borrowed funds                    3,226             3,516             (290)          (8.2)
Total interest expense            5,858             7,103           (1,245)         (17.5)
Net interest income            $  5,590          $  6,543          $  (953)        (14.6)%

Net interest income was $5.6 million for the three months ended March 31, 2009, compared to $6.5 million for the same period in 2008. Our net interest margin decreased 35 basis points to 2.85% for the three months ended March 31, 2009, from 3.20% for the same period in 2008. The decrease in net interest income and net interest margin were primarily due to $340,000 of unrecognized interest on non-accrual real estate construction loans during the first three months of 2009, the loss of interest income from the relatively higher yielding VISA credit card portfolio that we sold as of January 31, 2009, and the general decline in market interest rates. Additionally, we decided to increase our balance of interest-bearing deposits with the Federal Reserve Bank during the quarter by $34.6 million to $64.1 million at March 31, 2009 to enhance our liquidity position, but at an interest-earning yield of only 18 basis points.

Interest Income. Our interest income decreased $2.2 million or 16.1%, to $11.5 million for the three months ended March 31, 2009 from $13.7 million for the three months ended March 31, 2008. Interest earned on loans for the three . . .