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Article by DailyStocks_admin    (05-23-08 07:21 AM)

Filed with the SEC from May 8 to May 14:

Cowlitz Bancorp (CWLZ),
Crescent Capital VI intends to purchase additional shares and to seek regulatory approval to permit Crescent to increase its stake to more than 10%. Last year, Crescent proposed taking the bank-holding company private for $15 a share in cash, but Cowlitz rejected the proposal, saying the offer was too low.
Last month, Cowlitz also declined Crescent's request to appoint a Crescent representative to the board, stating that doing that wouldn't be in shareholders' long-term interest. Crescent intends to seek regulatory approval to permit it to buy additional shares and increase its influence on the board. Crescent Capital currently holds 483,000 shares (9.6%).

BUSINESS OVERVIEW

Introduction

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 Company’s goals are to offer exceptional customer service and to invest in the markets it serves through its business practices and community service. 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. The Company’s customers have access to the Bank’s products and services through a variety of convenient channels such as 24 hour—7 days a week automated phone and internet access and ATMs, as well as through branch locations. Beginning in the first quarter of 2008, the Bank began offering its business customers remote deposit capture. This service allows customers to make deposits electronically without leaving their office.

On October 31, 2005, the Company acquired all of the outstanding shares of common stock of AEA Bancshares, Inc. (AEA), the parent company of Asia-Europe-Americas Bank, in an acquisition accounted for as a purchase. The acquisition is consistent with the Company’s business banking expansion strategy in King County, Washington. The former Asia-Europe-Americas Bank office in Seattle operates as a Bay Bank branch. Also based in the Seattle office, in the second quarter of 2006 the Company established its international banking department.

Prior to 2004, the Company also operated Bay Mortgage and Bay Escrow offices in Bellevue and Seattle, Washington. As part of a strategy to consolidate resources into commercial banking and reduce reliance on mortgage lending activities, those offices were closed during the fourth quarter of 2003 and first quarter of 2004.

For the year 2007, the Company recorded net income of $86,000 or $0.02 per diluted share. At December 31, 2007, the Company had total assets of $514.2 million, total liabilities of $458.7 million, and total shareholders’ equity of $55.5 million. Book value per share was $10.99 at year-end 2007. At December 31, 2007, net loans were $391.5 million, approximately 76% of total assets, and total deposits were $441.2 million.

Products and Services

The Company offers a broad portfolio of products and services tailored to meet the financial needs of individuals and small business customers in its market areas. The Company believes this portfolio is generally competitive with the products and services of its competitors, including community banks, major regional and national banks, thrifts and credit unions.

Deposit Products . The Company offers non-interest-bearing and interest-bearing checking accounts, savings accounts, money market accounts, individual retirement accounts, and certificates of deposit. Interest-bearing accounts generally earn interest at rates established by management based on competitive market factors and management's desire to increase certain types or alter maturities of deposit liabilities. During times of asset growth, or as liquidity needs arise, the Company utilizes brokered certificates of deposit as a source of funding. The Company strives to establish customer relationships to attract core deposits in non-interest-bearing transactional accounts to reduce its cost of funds.

Loan Products. The Company offers a broad range of loan products to retail and business customers. The Company maintains loan underwriting standards with written loan policies and individual lending limits. All new loans and renewals are reported monthly to the Company's Board of Directors. The Board of Directors’ Loan Committee approves particularly large loan commitments. Underwriting standards are designed to achieve a high-quality loan portfolio, compliance with lending regulations and an appropriate mix of loan maturities and industry concentrations. Management seeks to minimize credit losses by closely monitoring the financial condition of its borrowers and the value of collateral.

Commercial Loans. Commercial lending is a focus of the Company's lending activities, and a significant portion of its loan portfolio consists of commercial loans. The Company offers specialized loans for its business and commercial customers. These include operating lines of credit that support accounts receivables and inventory, as well as secured term loans to finance machinery and equipment. The Company has historically reported loans in accordance with Bank regulatory guidelines. As a result, a substantial portion of the Company's commercial loans are designated as real estate loans, as the loans are secured by mortgages or trust deeds on real property, although some of these loans were not made to finance real estate nor does the repayment depend on the sale of or income from the real estate. Lending decisions are based on careful evaluation of the financial strength, management and credit history of the borrower, and the quality of the collateral securing the loan. A second category of commercial lending involves construction or term loans on commercial income producing properties and acquisition and development loans for single family residential development. These loans are secured by real property and are generally limited to 75% of the value of collateral. In most cases, the Company requires personal guarantees and secondary sources of repayment. In competing with major regional and national banks, the Company is limited by lower single borrower lending limits imposed by law.

Real Estate Loans. This category supports single family residential lending. The loans are available for construction, purchase, or refinancing of residential properties. Borrowers can choose from a variety of fixed and adjustable rate options and terms. The Company provides customers access to long-term residential real estate loans through Bay Mortgage and its branch network, focusing on all facets of residential lending from single family homes to small multiplexes, including FHA and VA loans, construction and bridge loans. Real estate loans reflected in the loan portfolio also include loans made to commercial customers that are secured by real property.

Consumer Loans. The Company provides loans to individual borrowers for a variety of purposes, including secured and unsecured personal loans, home equity, personal lines of credit and motor vehicle loans. Consumer loans can carry significantly greater risks than other loan products, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles or recreational equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are dependent on borrowers' continuing financial stability, and are sensitive to job loss, illness and other personal factors. The Company attempts to manage the risks inherent in consumer lending by following conservative credit guidelines and underwriting practices. The Company also offers Visa credit cards to its customers.

Trust Services. Cowlitz Bank is the only bank headquartered in Cowlitz County to offer complete in-house trust services. The trust department, located in the offices of the main branch in Longview, Washington provide trust services to individuals, partnerships, corporations and institutions and acts as fiduciary of living trusts, estates, conservatorships and other plans. The Company believes these services add to the value of the Bank as a community bank by providing local access to services that are offered by out of the area financial institutions.

International Banking. Through its Seattle branch, the Company offers a variety of international banking services. To assist customers with import, export and other trade related needs, the Company provides commercial and standby letters of credit, foreign exchange and foreign collection services, international funds transfer capabilities accounts receivable financing and foreign denominated accounts (euro, pounds, yen).

Internet Banking. Internet banking and cash management systems are available to both business and individual customers, providing secure access to information and services from the Company’s website. Business clients can avail themselves of comprehensive cash management program which allows them to easily and securely move money between accounts, wire funds, receive funds, pay bills, and generally manage their financial resources. Retail customers have the ability to access account information, pay bills, and manage their accounts by way of the internet. The Company’s website address is www.cowlitzbancorporation.com and the Bank’s websites are www.cowlitzbank.com, www.bay-bank.com and www.bay-loans.com. The content of these websites is not incorporated into this document or into the Company’s other filings with the SEC.

Other Banking Products and Services. In support of its focus on personalized service, the Company offers additional products and services for the convenience of its customers. These services include a debit card program, automated teller machines at six branches and one off-site location, merchant services and an automated telephone banking service with 24-hour access to accounts that also allows customers to speak directly with a customer service representative during normal banking hours. The Company provides drive-through facilities at three of its branches.

Market Areas and Competition

The Company's primary market areas in which it accepts deposits and makes loans are Cowlitz County, in southwest Washington; King County, Washington; the Portland metropolitan area in Oregon; and the surrounding counties in Washington and northwest Oregon. As a community bank, the Bank has certain competitive advantages due to its local focus, but is also more closely tied to the local community than many of its competitors, which serve a number of geographic markets. Bay Mortgage operations are concentrated in southwestern Washington.

According to the US Department of Labor—Bureau of Labor Statistics website, both Washington (28 th at 4.8%) and Oregon (41 st at 5.6%) were among the states with relatively high unemployment rates during December 2007. Washington’s December 2007 unemployment rate declined 0.2% from a year ago. The Seattle metropolitan area’s unemployment rate (not seasonally adjusted) was 4.0% and ranked 31 out of 367 metropolitan areas. Washington ranked in the top ten states for year-over-year job growth in 2007 and 2006. Oregon’s December 2007 unemployment rate increased 0.2% from a year ago. The Portland –Vancouver metropolitan area’s unemployment rate was 4.9% and ranked 164. The increase in the unemployment rate reflects the decline in the residential real estate construction industry. The Longview area in Cowlitz County, Washington, continues to experience cyclically higher levels of unemployment than the Seattle metropolitan area. In December 2007, unemployment in Cowlitz County was 6.8%, an increase of 0.6% from a year ago. The increase primarily reflected recent workforce reductions in the forest products industry.

In the first quarter of 2008, the Federal Reserve made a series of interest rate cuts to support a softening national economy. Contributing to concerns about a U.S. recession in 2008 are the significant declines in most residential real estate markets and the increase in mortgage loan delinquencies and foreclosures, increasing unemployment rates, higher energy costs and lower consumer confidence. According to Standard & Poor’s S&P/Case-Shiller quarterly index, for the fourth quarter of 2007, Portland, Oregon and Seattle, Washington, were two of the three major metropolitan areas out of 20 to show year-over-year increases in existing single-family home prices. However, the Company expects the economy in the Pacific Northwest to generally follow the direction of the national economy in 2008.

Commercial banking in the state of Washington and northwest Oregon is highly competitive with respect to providing banking services including making loans and attracting deposits. The Company competes with other banks, as well as with savings and loan associations, savings banks, credit unions, mortgage companies, investment banks, insurance companies, securities brokerages and other financial institutions. Banking in Washington and Oregon is dominated by several significant banking institutions which together account for a majority of the total commercial and savings bank loans and deposits in Washington and Oregon. These competitors have significantly greater financial resources and offer a greater number of branch locations (with statewide branch networks), higher lending limits, and a variety of services not offered by the Bank. The Company has attempted to offset some of the advantages of the large competitors by arranging participations with other banks for loans above its legal lending limits, as well as leveraging technology and third party arrangements to deliver financial products and better compete in targeted customer segments. The Company has positioned itself as a local alternative to larger competitors that may be perceived by customers or potential customers to be impersonal, out-of-touch with the community, or simply not interested in providing banking services to some of the target customers, by offering excellent customer service and investing in the markets it services through its business practices and community service.

In addition to larger institutions, other community banks and credit unions have been formed, expanded, or moved into the Company’s market areas and have developed a similar focus to the Company. This growing number of similar financial institutions and an increased focus by larger institutions on the Company’s market segments has led to intensified competition in all aspects of the Company’s business. Increased competitive pressure and changing customer deposit behaviors could adversely affect the Bank’s market share of deposits.

The adoption of the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) led to further competition in the financial services industry. The GLB Act eliminated many of the barriers to affiliation among providers of various types of financial services and permitted business combinations among financial service providers such as banks, insurance companies, securities or brokerage firms and other financial service providers. Additionally, the rapid adoption of financial services through the internet has reduced or even eliminated many barriers to entry by financial services providers physically located outside our market areas. For example, remote deposit services allow depository companies physically located in other geographical markets to service local businesses with minimal cost of entry. Although the Company has been able to compete effectively in the financial services business in its markets to date, there can be no assurance that it will be able to continue to do so in the future.

The financial services industry has experienced widespread consolidation over the last decade. The Company anticipates that consolidation among financial institutions in its market areas will continue. As noted the Company may seek acquisition opportunities in markets of strategic importance to it from time to time. However, other financial institutions aggressively compete against the Company in the acquisition market. Some of these institutions may have greater access to capital markets, larger cash reserves and stock for use in acquisitions that is more liquid and more highly valued by the market.

Employees

As of December 31, 2007, the Company employed a total of 142 full-time equivalent employees. None of the employees are subject to a collective bargaining agreement and the Company considers its relationships with its employees to be favorable.

Regulation and Supervision

The Company and the Bank are subject to extensive federal and state regulations that significantly affect the respective activities of the Company and the Bank and the competitive environment in which they operate. These laws and regulations are intended primarily to protect depositors and the deposit insurance fund, rather than shareholders.

The description of the laws and regulations applicable to the Company and the Bank is not a complete description of the laws and regulations mentioned herein or of all such laws and regulations. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Company and the Bank.

The Bank is a state chartered commercial bank, which is not a member of the Federal Reserve System, and is subject to primary regulation and supervision by the Department of Financial Institutions of the State of Washington (“DFI”) and by the Federal Deposit Insurance Corporation (the “FDIC”), which also insures bank deposits. The Company is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”).

Bank Holding Company Regulation. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (“BHCA”) and, as such, is subject to the regulations of the Federal Reserve. Bank holding companies are required to file periodic reports with, and are subject to periodic examination by, the Federal Reserve. The Federal Reserve has issued regulations under the BHCA requiring bank holding companies to serve as a source of financial and managerial strength to their subsidiary banks. It is the policy of the Federal Reserve that, pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital to fund its subsidiary banks during periods of financial stress or adversity. Additionally, under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” (as defined in the statute) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan. Under the BHCA, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the Federal Reserve's determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

Capital Adequacy Guidelines for Bank Holding Companies. The Federal Reserve has adopted capital adequacy guidelines for bank holding companies. These guidelines are similar to, although not identical with, the guidelines applicable to banks. See “FDICIA and Capital Requirements.”

Bank Regulation. The Bank is organized under the laws of the State of Washington and is subject to the supervision of the DFI, whose examiners conduct periodic examinations of state banks. Cowlitz Bank is not a member of the Federal Reserve System, so its principal federal regulator is the FDIC, which also conducts periodic examinations of the Bank. The Bank's deposits are insured, to the maximum extent permitted by law, by the Deposit Insurance Fund (“DIF”) administered by the FDIC and are subject to the FDIC’s rules and regulations respecting the insurance of deposits. See “Deposit Insurance.”

Both federal and state laws extensively regulate various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Current federal law also requires banks, among other things, to make deposited funds available within specified time periods.

Insured state-chartered banks are generally prohibited under FDICIA from engaging as principal in activities that are not permitted for national banks, unless (i) the FDIC determines that the activity would pose no significant risk to the appropriate deposit insurance fund, and (ii) the bank is, and continues to be, in compliance with all applicable capital standards. The Company believes that these restrictions do not have a material adverse effect on its current operations.

FDICIA. FDICIA requires, among other things, federal bank regulatory authorities to take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.

The FDIC has adopted regulations to implement the prompt corrective action provisions of FDICIA. Among other things, the regulations define the relevant capital measures for the five capital categories. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater, and is not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure. The Federal Reserve Board classifies a bank holding company as “well capitalized” if it has a total risk-based capital ratio of 10% or greater and a Tier 1 risk-based capital ratio of 6% or greater. The Company and the Bank are both “well-capitalized.”

FDICIA further directs that each federal banking agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, management compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value of publicly traded shares and such other standards as the agency deems appropriate.

Capital Requirements. The FDIC has adopted risk-based capital ratio guidelines to which the Bank is subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk.

These guidelines divide a bank’s capital into two tiers. Tier 1 includes common equity, certain non-cumulative perpetual preferred stock (excluding auction rate issues) and minority interest in equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets (except mortgage servicing rights and purchased credit card relationships, subject to certain limitations). Supplementary (Tier 2) capital includes, among other items, preferred stock (cumulative perpetual and long-term, limited-life), mandatory convertible securities, certain hybrid capital instruments, term-subordinated debt and the allowance for loan and lease losses, subject to certain limitations, less required deductions. Banks are required to maintain a total risk-based capital ratio of 8%, of which 4% must be Tier 1 capital. The FDIC may, however, set higher capital requirements when a bank's particular circumstances warrant. Banks experiencing or anticipating significant growth are expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.

In addition, the FDIC has established guidelines prescribing a minimum Tier 1 leverage ratio (Tier 1 capital to adjusted total assets) of 3% for banks that meet certain specified criteria, including that the banks have the highest regulatory rating and are not experiencing or anticipating significant growth. All other banks are required to maintain a Tier 1 leverage ratio of not less than 4%.

Dividends. The principal source of the Company’s cash revenues is dividends from the Bank. Under Washington law, the Bank may not pay dividends in an amount greater than its retained earnings as determined by generally accepted accounting principles. In addition, DFI has the authority to require a state-chartered bank to suspend the payment of dividends. The FDIC has the authority to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the bank or if it would cause a bank to become undercapitalized.

Lending Limits. Under Washington law, the total loans and extensions of credit by a Washington-chartered bank to a borrower outstanding at one time may not exceed 20% of the bank’s Tier 1 capital. However, this limitation does not apply to loans or extensions of credit which are fully secured by readily marketable collateral having market value of at least 115% of the amount of the loan or the extension of credit at all times.

Branches and Affiliates. Establishment of bank branches is subject to approval of the DFI and FDIC and geographic limits established by state laws. Washington's branch banking law permits a bank having its principal place of business in the State of Washington to establish branch offices in any county in Washington without geographic restrictions. A bank may also merge with any national or state chartered bank located anywhere in the State of Washington without geographic restrictions.

Under Oregon law, an out-of-state bank or bank holding company may merge with or acquire an Oregon state chartered bank or bank holding company if the Oregon bank, or in the case of a bank holding company, the subsidiary bank, has been in existence for a minimum of three years, and the law of the state in which the acquiring bank is located permits such merger. Branches may not be acquired or opened separately, but once an out-of-state bank has acquired branches in Oregon, either through a merger with or acquisition of substantially all of the assets of an Oregon bank, the bank may open additional branches.

The Bank is subject to provisions of the Federal Reserve Act that restrict financial transactions between banks and affiliated companies. The statute limits credit transactions between a bank and its executive officers and its affiliates, prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a bank's extension of credit to an affiliate.

Deposit Insurance. The Bank’s deposits are insured by the Deposit Insurance Fund (“DIF”). The Federal Deposit Insurance Reform Act of 2005 (“Reform Act”), enacted in February 2006, increased the deposit insurance limit for certain retirement plan deposit accounts from $100,000 to $250,000. The basic insurance limit for other deposits, including individuals, joint account holders, businesses, government entities, and trusts, remains at $100,000. The Bank’s deposits were previously insured by the Bank Insurance Fund, which was merged with the Savings Association Insurance Fund to form the DIF in March 2006.

As an institution whose deposits are insured by DIF, the Bank is required to pay deposit insurance premiums to DIF. FDIC regulations set deposit insurance premiums based upon the risks a particular bank or savings association poses to the deposit insurance fund. This system bases an institution's risk category partly upon whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. Each insured depository institution is also assigned to one of three “supervisory” categories based on reviews by regulators, statistical analysis of financial statements and other relevant information. An institution's assessment rate depends upon the capital category and supervisory category to which it is assigned.

The Reform Act created a new system and assessment rate schedule to calculate an institution’s assessment. For 2007, the assessment rates ranged from $0.05 to $0.43 per $100 of deposits annually. Assessment rates for well managed, well capitalized institutions ranged from $0.05 to $0.07 per $100 of deposits annually. The Bank’s assessment rate for 2007 fell within this range and is expected to fall within this range for 2008. In 2007, the FDIC issued one-time assessment credits that were used to offset FDIC assessments. The Bank’s credit was fully utilized and covered the majority of the assessment in 2007. The Bank does not have any remaining credit to offset assessments in 2008. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis in order to manage the DIF to prescribed statutory target levels. Further increases in the assessment rate could have a material adverse affect on the Company’s earnings, depending on the amount of the increase.

Under legislation enacted in 1996 to recapitalize the Savings Association Insurance Fund, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation (“FICO”) to service FICO debt incurred in the 1980's. The current FICO assessment rate for DIF insured deposits are $0.0114 per $100 of deposits per year. An increase in deposit or FICO assessments could have an adverse effect on the Bank's earnings, depending upon the amount of the increase.

Gramm-Leach-Bliley Act. On November 12, 1999, the Gramm-Leach-Bliley Act (the “GLB Act”) was signed into law, which significantly reformed various aspects of the financial services business. Among other things, the GLB Act:


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established a new framework under which bank holding companies and banks can own securities firms, insurance companies and other financial companies;


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provided consumers with new protections regarding the transfer and use of their non-public personal information by financial institutions; and •

changed the Federal Home Loan Bank (“FHLB”) system in numerous ways revising the manner of calculating the Resolution Funding Corporation obligations payable by the FHLB and broadening the purposes for which FHLB advances may be used.

The GLB Act also includes provisions to protect consumer privacy by prohibiting financial services providers, whether or not affiliated with a bank, from disclosing non-public personal, financial information to unaffiliated parties without the consent of the customer, and by requiring annual disclosure of the provider’s privacy policy.

Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires financial institutions regulated by the federal financial supervisory agencies to ascertain and help meet the credit needs of their delineated communities, including low-income and moderate-income neighborhoods within those communities, while maintaining safe and sound banking practices. The regulatory agency assigns one of four possible ratings to an institution's CRA performance and is required to make public an institution’s rating and written evaluation. The four possible ratings are “outstanding,” “satisfactory,” “needs to improve” and "substantial non-compliance."

Many factors play a role in assessing a financial institution's CRA performance. The institution’s regulator must consider its financial capacity and size, legal impediments, local economic conditions and demographics and the competitive environment in which it operates. The evaluation does not rely on absolute standards and financial institutions are not required to perform specific activities or to provide specific amounts or types of credit.

The Company’s most recent rating under CRA is “satisfactory.” This rating reflects the Company's commitment to meeting the credit needs of the communities it serves. Although the Company strives to maintain a satisfactory or higher rating, no assurance can be given that the Company will maintain this rating in the future. If the Company’s CRA rating were to fall below “satisfactory” it may inhibit its ability to obtain regulatory approval for acquisitions or expansion.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 addressed public company corporate governance, auditing, accounting, executive compensation, and enhanced and timely disclosure of corporate information. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

The Sarbanes-Oxley Act and related SEC regulations provides for, among other matters:


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a prohibition on personal loans by Cowlitz to its directors and executive officers except loans in the ordinary course of business made by the Bank;


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independence requirements for Board audit committee members and the Company’s auditors;


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certification of Exchange Act reports by the chief executive officer and the chief financial officer;


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disclosure of off-balance sheet transactions;


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expedited reporting of stock transactions by insiders;


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internal and disclosure controls and procedures requirements; and


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increased criminal penalties for violations of securities laws.

The Sarbanes-Oxley Act also requires:


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management to establish, maintain and evaluate disclosure controls and procedures;


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report on its annual assessment of the effectiveness of internal controls over financial reporting; and


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a company’s auditor to attest to management’s assessment of internal controls.

CEO BACKGROUND

Ernie D. Ballou, age 59, has served on the Board of Directors since May 2003. He has served as EVP & Chief Credit Administrator of Cowlitz Bank since January 2003 and has served on the Cowlitz Bank Board of Directors since February 2003. He also serves as VP/Credit Administrator for the Company. Mr. Ballou has over thirty years of lending experience, including twenty-five years with First Interstate Bank (now Wells Fargo Bank), most recently serving as Senior Vice President and Senior Credit Administrator for the Northwest Region. Prior to joining Cowlitz, Mr. Ballou was self-employed, initiating credit training seminars and conducting independent credit reviews for banking institutions.

Richard J. Fitzpatrick, age 58, has served as President/CEO of Cowlitz Bancorporation and Cowlitz Bank since March 2003. He has served on the Boards of Directors of Cowlitz Bancorporation and Cowlitz Bank since March 2003, as well. Prior to joining Cowlitz, Mr. Fitzpatrick spent nine years with Banknorth Group Inc., most recently as Regional President, responsible for operations in Vermont and New York. Other positions he held include Chief Banking Officer responsible for Banknorth Group Inc.’s seven banks, and President and Chief Executive Officer of Howard Bank, a subsidiary of Banknorth Group, Inc.

Brian E. Magnuson, age 51, joined the Board of Directors in December 2005. Mr. Magnuson currently serves on the Audit, Compensation and Corporate Governance Committees. He is President of Cascade Networks, specializing in high-speed wireless and fiber optic Internet, a position he has held since 2003. Mr. Magnuson co-founded Cascade Networks in 2001. Mr. Magnuson is an active member and resident of the Longview, Washington community.

John M. Petersen, age 57, was appointed to the Board of Directors of Cowlitz Bancorporation and Cowlitz Bank in September 2004. Mr. Petersen serves on the Audit and Compensation Committees and chairs the Corporate Governance Committee. He also serves as Chairman of the Cowlitz Bank Trust Committee. Mr. Petersen currently holds the position of Senior Director of CBRE/Melody and Company Capital Markets, a commercial real estate investment-banking firm, where he has worked since 2001. He has also held several senior positions at Bank of America and Security Pacific Bank. Mr. Petersen is an active community leader in the Portland area, currently serving as the First Vice President of the Portland State University Foundation Board, serving on their executive committee and the real estate committee, as well as other board committees.

Phillip S. Rowley, age 61, was appointed to the Cowlitz Bancorporation and Cowlitz Bank Board of Directors in August 2003. Mr. Rowley has served as Chairman of the Cowlitz Bancorporation Board since March 2004. He serves as Chairman of the Audit Committee. Mr. Rowley also serves on the Compensation Committee and on the Cowlitz Bank Trust and Asset/Liability Committees. Mr. Rowley is currently the President and CEO of Treasury Management Services, Inc., providing consulting in asset/liability management, investment portfolio management, and corporate funding strategies, as well as board and executive management training in these associated areas of banking. He founded Treasury Management Services in 1998. He also serves on the faculties of several premier banking schools. Mr. Rowley has held several positions for various banks during his 37-year banking career.

Linda M. Tubbs, age 60, was appointed to the Cowlitz Bancorporation and Cowlitz Bank Board of Directors in September 2004. Ms. Tubbs serves as Chairwoman of the Compensation Committee and of the Cowlitz Bank Board of Directors. She also serves on the Audit and Corporate Governance Committees. Ms. Tubbs is active in the Vancouver, Washington community. She retired from Wells Fargo in 1998, where she was an Executive Vice President, managing commercial banking in Oregon, Washington, Idaho, and Utah. Ms. Tubbs serves on various local non-profit boards and is a former chairwoman of Oregon Public Broadcasting.

The age, position, and experience of the Company’s executive officers, other than Richard J. Fitzpatrick and Ernie D. Ballou, about whom information is provided above, are as follows:

Gerald L. Brickey , 55 , joined the Company in December 2005. Prior to joining the company he held the position of Controller from 1998 to 2005 for Pope & Talbot, Inc., a New York Stock Exchange listed forest products company headquartered in Portland, Oregon. Mr. Brickey has over twenty years of financial services industry experience. He currently holds the positions of Vice President/Chief Financial Officer of the Company and Executive Vice President/Chief Financial Officer of Cowlitz Bank.

Lynda Larrabee , 45 , joined the Company in 1997. Ms. Larrabee has over fifteen years of banking experience. She currently holds the positions of Vice President of Administration and Corporate Secretary of the Company and Senior Vice President/Administration of Cowlitz Bank.

COMPENSATION

Elements of Compensation. The compensation package for executive officers consists of base salary, bonus, equity compensation and retirement benefits.

Base Salary . Base salaries are intended to be competitive relative to similar positions at companies of comparable size in our business, permitting the Company to pay base salaries to help attract and retain high quality employees. The Committee has the discretion to adjust salaries based on skill level of the executive. The Committee has not established a targeted percentile relative to similarly sized financial institutions for base salary or for overall compensation. In 2007, the Committee reviewed the survey data provided and determined that salary levels and total compensation were competitive.

In December 2007, the Committee voted to increase the base salary of each of the named executive officers by 5%. The Committee based its decision on the survey data.

Bonus. The Company adopts an annual bonus plan that provides for a variable cash payment opportunity based on individual and Company performance. The bonus plan compensates executives for obtaining short-term goals and objectives, which the Committee designs to promote long-term growth and enhanced shareholder value. The Committee selects objective criteria, primarily financial results, at the beginning of the year based on the Company’s budgeted targets and also subjective criteria, often based on specific Company business goals for the year. The nonequity incentive plans for 2007 are described below in the narrative following the Summary Compensation Table.

Equity Compensation . In 2003, shareholders approved the Cowlitz Bancorporation 2003 Stock Incentive Plan, under which the Company could issue nonqualified stock options and restricted stock grants to management and directors. The Plan provides an additional form of compensation that focuses on the long-term success of the Company and aligns the interests of shareholders and management. The Company has also issued stock options outside of the 2003 plan, primarily in connection with initial hiring of employees.

The named executive officers did not receive any stock options or restricted stock awards under the 2003 Stock Incentive Plan in 2007, primarily because there were 4,200 shares, or less, available for issuance. At the 2006 annual meeting of shareholders, shareholders did not approve a proposed amendment to the 2003 Stock Incentive Plan, which would have provided additional shares for stock option and restricted stock grants. The Committee analyzed other forms of equity-based compensation plans that would align executives with the interests of shareholders and provide executives with a reward for the Company’s improved performance and growth. The committee recommended to the Board, in the fall of 2006, a Stock Appreciation Rights Plan. The Plan provides for cash-settled stock appreciation rights, or SARs, which do not dilute the interests of existing shareholders but provide a reward to the executive officers as the value of the Company increases. In January 2007, the committee recommended and the Board approved the Plan and the grant of SARs to key executives. The Committee believes that having a portion of total compensation tied to the performance of the Company’s stock is an important component of compensation.

Retirement Benefits . Retirement benefits are an important element of a competitive compensation program for attracting senior executives, especially in the financial services industry. The Company’s executive compensation program includes matching contributions for 401(k) plan, and discretionary profit sharing as an additional non-matching component of the 401(k) plan. The President/CEO and the EVP/Credit Administrator also have Supplemental Executive Retirement Plans, or SERPs. The SERPs provide a benefit based on years of service and final average compensation. The benefits are described in detail below.

Employment Agreements. Richard J. Fitzpatrick entered into an employment agreement with the Company effective on February 10, 2003, which has a five-year term, with the agreement that on the third anniversary and each anniversary thereafter the term shall be extended for an additional one year period unless either party delivers written notice of its intent not to extend the term. No such notice was delivered by February 10, 2008, thus the contract is currently extended to February 11, 2011. The term, however, will end no later than the anniversary following Mr. Fitzpatrick’s sixty-fifth birthday. Under the employment agreement, Mr. Fitzpatrick’s base salary is subject to annual review and appropriate upward adjustments. Under the agreement, Mr. Fitzpatrick is entitled to receive a bonus of at least 30% of salary and additional stock options, provided specific performance goals are met. The agreement contains a covenant not to compete during the employment period and for a period following termination equal to the number of months for which Mr. Fitzpatrick is entitled to severance payment of employment or twelve months, whichever is greater.

Ernie Ballou entered into an employment agreement with the Company on January 13, 2003. Mr. Ballou’s initial base salary was $160,000 per year, subject to annual review and appropriate upward adjustments. Mr. Ballou’s agreement initially entitled him to receive 25% of his base salary as annual bonus and additional stock options, provided specific performance goals are met. The agreement contains a covenant not to compete during the employment period and for a six-month period following termination.

Gerald L. Brickey entered into an employment agreement with the Company on December 28, 2005. Mr. Brickey’s initial base salary was $160,000 per year. Mr. Brickey is entitled to receive 25% of his base salary as incentive compensation if he achieves certain management objectives established on an annual basis. The agreement contains a covenant regarding non-solicitation and non-raiding of employees.

Option Awards and Stock Appreciation Rights. None of the Company’s executive officers received stock option or restricted stock awards in 2007. The following named executive officers received cash- settled stock appreciation right awards in the amounts indicated pursuant to the 2007 Stock Appreciation Right Plan: Richard Fitzpatrick—35,000; Ernie Ballou—21,000; and Gerald Brickey—14,000. Each stock appreciation right represents the right to receive an amount equal to the excess of the fair market value of a share of the Company’s common stock on a valuation date over the fair market value of a share of the Company’s common stock on the award date. On a valuation date, the excess amount is credited to a bookkeeping account and credited with interest on a monthly basis at the 5-year LIBOR swap rate plus one percent with the rate adjusted quarterly. Stock appreciation rights vest 20% on the date of grant and 20% on each anniversary of the grant with accelerated vesting upon death, disability, a change in control and upon retirement after reaching age 62 while employed with at least five years of service. Unvested rights are forfeited upon termination. Stock appreciation rights automatically convert at 10 years from the date of grant and can be converted into the deemed investment account at any time upon election of the recipient. Stock appreciation rights do not have dividend or voting rights or any other rights of the owner of an actual share of common stock. Recipient accounts are distributed upon termination or, if elected by the recipient in advance, a specific distribution date not later than the later of termination or the January following the recipient’s 65 th birthday.

Nonequity Incentive Compensation. For 2007, objective and financial performance criteria included under each executive’s nonequity incentive compensation plan were:


n

net income and earnings per share,
n

return on assets,
n

loan quality (measured by delinquency rates),
n

loan production, and
n

satisfactory regulatory compliance.

In addition, in 2007 the Committee considered subjective goals such as improvements in product offerings, overall process improvements including a data processing conversion, employee relations and morale, community involvement and Board relations. The Committee determines the annual bonus criteria and establishes a targeted bonus as a percentage of salary for each executive. Each executive’s employment agreement established a base level of bonus with Mr. Fitzpatrick originally at 30% and Mr. Ballou and Mr. Brickey at 25%. For 2007, the base level percentages were established for Mr. Fitzpatrick at 40%, Mr. Ballou at 30% and Mr. Brickey at 25%. Increases in the base level are generally made to remain competitive after reviewing survey data. The Committee also sets a threshold, target and maximum level (as a percentage of the base level of bonus), although the Committee retains the discretion to alter these levels and award a bonus below the threshold or above the maximum. In 2007, the threshold level was 80%, target 100% and maximum 150%. The Committee generally pays above the target level up to the maximum only if objective and subjective criteria are met and most targets are exceeded.

MANAGEMENT DISCUSSION FROM LATEST 10K
Results of Operations—Overview

For the year ended December 31, 2007, the Company recorded net income of $86,000, or $0.02 per diluted share. This compares with net income of $4.8 million, or $0.93 per share, and $3.0 million, or $0.66 per share, for the corresponding periods ended December 31, 2006, and 2005, respectively. Average loans in 2007 totaled $383.5 million, an increase of 20% over 2006, and up significantly from $219.9 million in 2005. This loan growth, primarily in commercial and real estate loans, was funded mostly by the growth in deposits, with a significant portion consisting of certificates of deposits.

Net interest income was down slightly compared with 2006 results, and up 51% over 2005 results. The net interest margin (on a fully tax-equivalent basis) was 5.12% in 2007, compared with 5.90% and 5.28% in 2006 and 2005, respectively. The decline in net interest margin in 2007 related to several factors, including recent Federal Reserve rate cuts, competitive loan and deposit pricing, and interest reversals on non-accrual loans, as well as a higher level of non-accrual loans.

The Company’s provision for credit losses was $7.8 million in 2007, compared with $2.6 million in 2006 and $0.9 million in 2005. Net charge-offs of $6.6 million were recorded in 2007, compared with $2.5 million and $1.6 million in 2006 and 2005, respectively. The charge-offs in 2007 primarily related to residential land acquisition and development loans. At December 31, 2007, total non-performing assets were $13.2 million compared with $1.8 million at year-end 2006 and $4.2 million at December 31, 2005. Non-performing assets include nonaccrual loans, loans past due 90 days or more and still accruing, and repossessed assets.

Non-interest income and non-interest expenses in 2007 increased significantly when compared with 2006, reflecting an overall higher level of staffing, occupancy, data processing and branch activities due to loan growth and the expansion of the Company’s international trade finance capabilities. In 2007, the Company incurred higher levels of professional fees related to efforts to comply with Sarbanes-Oxley Act requirements and to higher levels of non-performing assets.

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

Another critical accounting policy of the Company is 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.

Net Interest Income

For financial institutions, the primary component of earnings is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities portfolios, and interest expense, principally on customer deposits and other borrowings. Changes in net interest income result from changes in “volume,” “spread” and “margin.” Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. 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 level and relative mix of interest-earning assets and interest-bearing liabilities.

Interest-Earning Assets. Total average earning assets increased $62.1 million in 2007 to $446.3 million, compared with $384.3 million in 2006. Average loans in 2007 increased $63.9 million, or 20%, reflecting the strength of the economy in the Pacific Northwest throughout much of the year and expansion of the Company’s lending staff. The average yield on earning assets in 2007 was 8.23% compared with 8.31% in 2006. The increase in interest income due to the increase in average loans was partially offset by a decrease in loan yields. The Bank’s prime rate stood at 7.25% at year-end 2007 compared to 8.25% at year-end 2006. Approximately two-thirds of the Company’s loan portfolio was composed of variable-rate loans during 2007.

Comparing 2006 to 2005, total average interest earning assets increased $100.2 million. Average loans increased $99.7 million, reflecting the strong economy in the Pacific Northwest during the period and the acquisition of Asia-Europe-Americas Bank (AEA) in late 2005. Average yields earned on interest-earning assets increased 130 basis points (b.p.—100 b.p. is equal to 1.0%), primarily due to the increase in market interest rates during the first six months of 2006. The Bank’s prime rate stood at 8.25% at year-end 2006, unchanged from late June 2006, as the Federal Reserve had not adjusted its benchmark interest rate since that time. The Bank’s prime rate on January 1, 2006 was 7.25%.

Interest-Bearing Liabilities. The average rate paid on interest-bearing liabilities increased 74 b.p. The average rate paid in 2007 was 4.21%, compared with 3.47% in 2006. The Company’s loan growth in 2007 exceeded its growth in non-interest bearing and low-cost deposits, and the balance of the funding need was met primarily through certificates of deposit. The average rate paid on certificates of deposit in 2007 was 5.04% compared with 4.48% in 2006, an increase of 56 b.p., primarily due to the higher rate environment in 2007.

In 2006, a rising interest rate environment led to higher average rates paid for deposits and other borrowings as compared with 2005. The average cost of interest-bearing liabilities increased to 3.47% in 2006 from 2.40% in 2005. Average rates on savings, money market and interest-bearing demand deposits increased 36 b.p., and average rates on certificates of deposits increased 130 b.p. In addition to the increase in non-interest-bearing deposits, loan growth was funded primarily by an increase in certificates of deposit.

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 the “Allowance for Credit Losses” disclosure for a more detailed discussion.

The Company’s provision for credit losses was $7.8 million for the year ended December 31, 2007, compared with $2.6 million and $870,000 the years ended December 31, 2006 and 2005, respectively. The significant increase in the 2007 provision for credit losses was largely due to the fourth quarter provision for credit losses of $6.8 million. In the fourth quarter of 2007, the Company charged off loans totaling $6.9 million, primarily related to residential land acquisition and development loans in the Portland, Oregon and southwest Washington markets. In addition, a portion of the increase in the provision was consistent with the current credit cycle and reflected the impact of loan growth, loan mix changes and current loan risk ratings of the portfolio. The increase in the provision in 2006 compared with 2005 reflected strong loan growth, but also included the impact of a $1.1 million charge-off due to a loss on a nationally syndicated equipment lease related to an alleged accounting fraud committed by the lessee. In 2006, over 90% of loan and lease charge-offs were non-real estate related.

At December 31, 2007, the allowance for loan losses was 1.46% of total loans compared to 1.25% and 1.73% at December 31, 2006 and 2005, respectively. If loan volumes continue to increase, or if the overall quality of the portfolio were to decline, provisions for credit losses would be expected to increase in future periods.

Non-interest Income

Total non-interest income was $3.5 million for the year ended December 31, 2007 compared with $2.8 million and $2.2 million for the year ended December 31, 2006 and 2005, respectively. Excluding securities transactions, non-interest income was $3.7 million, $3.2 million and $2.4 million for 2007, 2006, and 2005, respectively.

Service charges on deposit accounts were lower in 2007 compared with 2006, primarily due to a decline in overdraft account balances and a resulting decrease in overdraft fees. Service charges on deposit accounts were 26% higher in 2006 compared with 2005, primarily due to the acquisition of AEA in late 2005. Fiduciary income increased from 2006, primarily due to an increase of 21% in assets under management. The increase in income related to bank-owned life insurance was due to additional investments in 2006 and, to a lesser degree, in 2007. Wire fees decreased in 2007 from 2006 primarily due to accounts switching from a direct cash charge for wire transactions to a bundled service charge agreement with their deposit account. The increase from 2005 to 2006 in wire fees and international trade fees was a result of the acquisition of AEA in late 2005 and the establishment of the Company’s international banking department in the second quarter of 2006.

The Company recognized losses on sale of investment securities in 2007, 2006 and 2005, as certain low-yielding securities were sold and the proceeds used to purchase additional securities to improve the overall yield of the portfolio or invest in higher yielding loans.

Non-interest Expense

Most types of non-interest expense were higher in 2007 compared with 2006 and 2005. These increases were primarily a reflection of the overall higher level of staffing, including hiring costs, merit increases and performance-based pay, occupancy, and data processing. In addition to the Seattle branch acquisition in late 2005, the Company opened a full-service branch in Vancouver, Washington in the first quarter of 2006 and added an international trade finance department in the second quarter of 2006. At December 31, 2007, the Company had 146 full-time equivalent employees compared with 135 at December 31, 2006 and 119 at December 31, 2005.

Professional services include audit expenses, consulting costs, legal and other professional fees. In 2007, expenses for professional services increased over prior year levels primarily due to the outsourcing of the company’s internal audit function, which was staffed internally in 2005, and external assistance with the Company’s process to comply with Sarbanes-Oxley Act Section 404 requirements for 2007. Data processing and communications were also significantly higher in 2007 compared with 2006 and 2005. Beginning in August 2006, the Company outsourced its core processing, lending, and internet banking systems to a third party service provider. These system conversions are expected to improve long-term operating and financial reporting efficiencies, as well as provide the infrastructure to support the Company’s plans for growth. The Company expensed approximately $334,000 in costs for the new outsourced core processing systems in 2006 subsequent to the conversion. In addition, prepaid maintenance contracts and computer equipment associated with the Company’s former in-house core processing system of approximately $52,000 were written off at the time of conversion. The higher level of travel and education in the 2006 period was partially attributable to travel for training on the new systems.

Foreclosed asset expenses were $447,000 in 2007 compared with income related to foreclosed assets of $36,000 and $225,000 in 2006 and 2005 respectively. Included in the 2007 expenses was $422,000 of foreclosed asset expenses related to the Company’s share of a nationally syndicated equipment lease foreclosed in the fourth quarter of 2006. In the second quarter of 2007, the Company received revised equipment appraisal valuations and recorded a write-down of $305,600 and its share of certain expenses related to the foreclosed equipment. The equipment was sold in 2007.

Included in the non-interest expense for 2007 was a non-cash charge of $215,000 for the ineffective portion of the Company’s cash flow hedges and the change in fair value of its interest rate floor contract. A non-cash credit of $5,000 was recorded in 2006. The Company’s hedges provide an interest rate floor of 7.5% on a pool of variable rate loans totaling $50 million and fixed rate yields ranging from 7.67% to 7.76% on $75 million of variable rate loans. To reduce the volatility in reported earnings associated with the changes in fair value of these interest rate contracts, the Company began applying cash flow hedge accounting treatment, as prescribed by SFAS No. 133, as amended, as of December 12, 2006 to all of its interest rate contracts. 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. To the extent the Company’s hedges are ineffective in hedging interest income cash flows from variable rate loans, the ineffectiveness is recognized in the income statement and included in non-interest expenses.

The Company has investments in limited partnerships that own and operate affordable housing projects or invest in small businesses. The Company’s allocated share of investment gains or losses are included in non-interest expense as equity valuation adjustments in limited partnership investments. These investments serve as an element of compliance with the Community Reinvestment Act. The Company recognizes its proportionate share of management fees, operating losses and equity valuation adjustments as a component of non-interest expense. Tax credits related to these investments are recorded as a component of the tax provision.

The FDIC has regulations establishing a system for setting deposit insurance premiums based upon the risks a particular bank or savings association poses to the deposit insurance fund. This system bases an institution’s risk category partly upon whether the institution is well-capitalized, adequately capitalized or less than adequately capitalized. Each insured depository institution is also assigned to one of three “supervisory” categories based on reviews by regulators, statistical analysis of financial statements and other relevant information. An institution’s assessment rate depends upon the capital category and supervisory category to which it is assigned. Annual assessment rates in 2007 ranged from $0.05 for the highest rated institution to $0.43 per $100 of domestic deposits for an institution in the lowest category. Assessment rates for well managed, well capitalized institutions ranged from $0.05 to $0.07 per $100 of deposits annually. The Bank’s assessment rate for 2007 fell within this range and is expected to fall within this range for 2008. In 2007, the FDIC issued one-time assessment credits that can be used to offset FDIC assessments. The Bank’s credit was fully utilized and covered the majority of the assessment. The Bank does not have any remaining credit to offset assessments in 2008.

MANAGEMENT DISCUSSION FOR LATEST QUARTER
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.

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.

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 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 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

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.

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