================================================================================

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    FORM 10-K


[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

     For the Fiscal Year Ended December 31, 2004

                                       OR

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

                        Commission File Number: 005-57091




                          FIRST MUTUAL BANCSHARES, INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


State of Washington                                              91-2005970
-------------------------------                              -------------------
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                               Identification No.)


400 108th Avenue N.E., Bellevue, Washington                         98004
-------------------------------------------                  -------------------
(Address of principal executive offices)                          (Zip Code)


Registrant's telephone number, including area code             (425) 455-7300
                                                             -------------------

Securities registered pursuant to Section 12(b) of the Act:  None
                                                             ----

Securities registered pursuant to Section 12(g) of the Act:

                     Common Stock, par value $1.00 per share
                     ---------------------------------------
                                (Title of Class)



     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.   YES [X]   NO [_]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K(229.405 of this chapter) is not contained herein, and will
not be contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [X]

     Indicate by a check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).   YES [X]   NO [_]

     As of June 30, 2004, there were issued and outstanding 5,276,662 shares of
the registrant's common stock. The aggregate market value of the voting stock
held by non-affiliates of 3,113,059 shares of the registrant was $78,604,740
based on the closing sales price of the registrant's common stock as quoted on
the Nasdaq Market System which on June 30, 2004 was $25.25.

================================================================================
<PAGE>
     As of March 8, 2005, there were issued and outstanding 5,308,294 shares of
the registrant's common stock.


                       DOCUMENTS INCORPORATED BY REFERENCE

     1.   Certain information required by Parts I, III, and IV is incorporated
          by reference to the Registrant's Annual Report to Shareholders for the
          fiscal year ended December 31, 2004.

     2.   Certain information required by Parts I, III, and IV is incorporated
          by reference to the Registrant's Proxy Statement dated March 18, 2005
          for the 2005 Annual Meeting of Shareholders.


FORWARD-LOOKING STATEMENTS
--------------------------

     This Form 10-K Report and the other Securities and Exchange Commission
filings made by the Company, which are incorporated by reference, contain
statements concerning future operations, trends, expectations, plans,
capabilities, and prospects of the Company that are forward-looking statements
for purposes of the safe harbor provisions under the Private Securities
Litigation Reform Act of 1995. Statements containing words such as "anticipate,"
"believe," "intend," "expect," "objective," "plan," "should," or similar words
may constitute forward-looking statements. Information regarding our Simulation
and GAP Models and our hedging strategies may also constitute forward-looking
statements. Although the Company believes that the expectations expressed in
these forward-looking statements are based on reasonable assumptions within the
bounds of its knowledge of its business and operations, actual events, results,
or developments may differ materially from those expressed or implied in
forward-looking statements due to a number of risks and uncertainties. Factors
which could affect actual results include economic conditions in the Bank's
market area, interest rate fluctuations, the impact of competitive products,
services and pricing, loan delinquency rates, and the legislative and regulatory
changes affecting the banking industry. There are other risks and uncertainties
which could affect the Company which are discussed from time to time in the
filings made by the Company with the Securities and Exchange Commission,
including cautionary statements regarding the forward-looking information in
such filings. These risks and uncertainties should be considered in evaluating
the forward-looking statements, and undue reliance should not be placed on such
statements. The Company shall not be responsible to update any such
forward-looking statements.


TABLE OF CONTENTS
-----------------
                                                                            PAGE
                                                                            ----
PART I
          Item 1.   Business
                        Overview of Business Lines ........................   4
                        Yields Earned and Rates Paid ......................   5
                        Rate Volume Analysis ..............................   8
                        Lending Activities ................................   8
                        Reserve for Loan Losses ...........................  16
                        Securities ........................................  17
                        Investment Activities .............................  20
                        Deposit Activities and Other Sources of Funds .....  24
                        Critical Accounting Policies ......................  26
                        Recently Issued Accounting Standards ..............  29


                                        2
<PAGE>
                        Regulation and Supervision ........................  30
                        Federal and State Taxation ........................  34
          Item 2.   Properties ............................................  36
          Item 3.   Legal Proceedings .....................................  38
          Item 4.   Submission of Matters to a Vote of Security Holders ...  38


PART II
          Item 5.   Market for Registrant's Common Equity and Related
                    Stockholder Matters ...................................  38
          Item 6.   Selected Financial Data ...............................  38
          Item 7.   Management's Discussion and Analysis of Financial
                    Condition and Results of Operations ...................  38
          Item 7A.  Quantitative and Qualitative Disclosures About
                    Market Risk ...........................................  38
          Item 8.   Financial Statements and Supplementary Data ...........  38
          Item 9.   Changes in and Disagreements with Accountants on
                    Accounting and Financial Disclosure ...................  39
          Item 9A.  Controls and Procedures ...............................  39
          Item 9B.  Other Information .....................................  40


PART III
          Item 10.  Directors and Executive Officers of the Registrant ....  40
          Item 11.  Executive Compensation ................................  42
          Item 12.  Security Ownership of Certain Beneficial Owners and
                    Management and Related Stockholder Matters ............  42
          Item 13.  Certain Relationships and Related Transactions ........  42
          Item 14.  Principal Accountant Fees and Services ................  42


PART IV
          Item 15.  Exhibits and Financial Statement Schedules ............  42




                                     PART I
ITEM 1.   BUSINESS
------------------

(a)  General
     -------

     First Mutual Bancshares, Inc. (the "Company") is a Washington corporation,
which was formed for the purpose of becoming the bank holding company for First
Mutual Bank (the "Bank"). The Bank's reorganization was completed on October 26,
1999, on which date the Bank became the wholly-owned banking subsidiary of the
Company, and the stockholders of the Bank became stockholders of the Company.
The Company's only significant activity is holding the stock of the Bank and
engaging in certain passive investment activities. This discussion refers to the
consolidated statements of the Company and the Bank, and therefore the
references to "Bank" in this discussion refer to both entities.

     First Mutual Bank was incorporated as a Washington state-chartered mutual
savings bank in 1968 known as First Mutual Savings Bank and was the successor to
Eastside Savings and Loan Association, which was organized in 1952 and commenced
operations in 1953. The Bank converted from mutual to stock form through the
sale and issuance of 966,000 shares of Common Stock in December 1985. In
connection with the holding company reorganization, the Bank changed its name to
First Mutual Bank. Effective in June 2000, the Federal Reserve Bank approved the
election for the Company to become a financial holding company. The Bank is
subject to regulation by the State of Washington Department of Financial
Institutions and the Federal Deposit Insurance Corporation ("FDIC"). The Company
is subject to regulation by the Federal Reserve Board.

     Our business consists of attracting deposits from the general public as
well as obtaining funds from wholesale funding sources and investing those funds
primarily in commercial and residential real estate loans, business loans,

                                        3
<PAGE>
construction loans, and consumer loans. We also invest in federal government and
agency obligations, structured notes, real estate mortgage investment conduits
("REMICs"), mortgage-backed securities, and municipal securities. In addition to
portfolio lending, we participate in mortgage banking activities that encompass
the selling of primarily fixed-rate loans into the secondary mortgage market.

     The principal sources of funds for lending and investment activities are
deposits, repayment of loans, loan sales and Federal Home Loan Bank ("FHLB") of
Seattle advances. The primary sources of income are interest on loans, gains on
sales of loans and investments, servicing fees on loans, service-charge income
on deposit accounts and interest and dividends on investment securities.
Principal expenses are interest paid on deposits and borrowings, and general and
administrative costs.

     The savings and lending operations are conducted through twelve
full-service banking centers located in Bellevue (3), Issaquah, Kirkland (2),
Monroe, Redmond, Sammamish, Seattle (2), and Woodinville. We also have income
property loan production offices located in Bellingham and Tacoma, Washington,
and a consumer loan office located in Jacksonville, Florida. Our main office is
located at 400 108th Avenue N.E., Bellevue, Washington 98004. See "Item 2. -
Properties" herein for additional information regarding our facilities.

     We post our annual report, Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and press releases on our investor relations page
at www.firstmutual.com. These reports are posted as soon as reasonably
practicable after they are electronically filed with the Securities and Exchange
Commission (the "SEC"). All SEC filings of the Company are also available free
of charge at the SEC's website, www.sec.gov. or by calling the SEC at
1-800-SEC-0330.


OVERVIEW OF BUSINESS LINES
--------------------------

     Beginning January 1, 2004, we changed the presentation of our Business
Segments to more accurately reflect the way these segments are managed within
the Bank. Prior to 2004, we had three segments: 1) Consumer Lending, 2)
Commercial Lending, and 3) Investment Securities. We have made some changes to
the original three segments by:

     o    Separating Residential lending from the Consumer lending segment;

     o    Splitting the Commercial lending segment into two separate segments:
          Business Banking lending and Income Property lending

     o    Allocating the income and expenses from the Investment Securities
          segment to the new segments based upon asset size.

The management reporting process measures the performance of the operating
segments based on the management structure of the Bank and is not necessarily
comparable with similar information for any other financial institution.

The reportable segments include the following:

     o    Consumer Lending - Consumer lending includes home equity lending,
          direct consumer loans, and indirect home improvement loans (sales
          finance). These loans include lines of credit and loans for primarily
          consumer purposes.

     o    Residential Lending - Residential lending offers loans to borrowers to
          purchase, refinance, or build homes secured by one-to-four-unit family
          dwellings. They also finance the purchase or refinance of buildable
          residential lots.


                                        4
<PAGE>
     o    Business Banking Lending - Business Banking lending offers a full
          range of banking services to small and medium size businesses
          including deposit and cash management products, loans for financing
          receivables, inventory, and equipment as well as permanent and interim
          construction loans for owner-occupied commercial real estate. The
          underlying real estate collateral or business asset being financed
          typically secures these loans.

     o    Income Property Lending - Income Property lending offers permanent and
          interim construction loans for multifamily housing (over four units),
          manufactured housing communities, commercial real estate properties,
          and singe-family spec construction. The underlying real estate
          collateral being financed typically secures these loans.

Each of these business segments also sells loans into the secondary market. We
may choose to retain or sell the right to service the loans sold (i.e.,
collection of principal and interest payments) depending upon market conditions.

These segments are managed separately because each business unit requires
different processes and different marketing strategies to reach the customer
base that purchases the products and services. The segments derive a majority of
their revenue from interest income, and we rely primarily on net interest
revenue in managing these segments. No single customer provides more than 10% of
the Bank's revenues. Please refer to the section titled "Business Segments" in
the "Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A")" portion of our 2004 Annual Report and Note 22 in the "Notes
to Consolidated Financial Statements" in the annual report for more information.


YIELDS EARNED AND RATES PAID
----------------------------

     Pretax earnings depend significantly upon net interest income, which is the
difference between the income we receive on our loan portfolio and other
investments and our cost of money, consisting primarily of interest paid on
deposits and borrowings. Net interest income is affected by: (i) the difference
between rates of interest earned on our interest-earning assets and rates paid
on our interest-bearing liabilities ("interest rate spread") and (ii) the
relative amounts of our interest-earning assets and interest-bearing
liabilities. When interest-earning assets approximate or exceed interest-bearing
liabilities, any positive interest rate spread will generate net interest
income.

     At December 31, 2004, our portfolio of loans consisted of 90%
adjustable-rate and 10% fixed-rate loans. We have employed various measures
designed to make yields on our loan portfolio and investments interest-rate
sensitive. They have included: (i) adoption of a policy under which we generally
originate and sell long-term, fixed-rate mortgage loans which have been
underwritten to specifications of secondary market investors and qualify for
sale in the secondary market, (ii) emphasis on origination of adjustable-rate
mortgage loans on residential and commercial properties, (iii) origination of
construction loans secured by residential and commercial properties, at interest
rates subject to periodic adjustment based upon the prevailing market rates,
(iv) origination of business loans at interest rates subject to periodic
adjustment based on prevailing market rates, and (v) origination of direct
consumer loans at interest rates subject to periodic adjustment based upon the
prevailing rates. See "Lending Activities" in this Form 10-K and "Market Risk
Sensitive Instruments" in the "MD&A" section of the 2004 Annual Report.


                                        5
<PAGE>
                              AVERAGE BALANCE SHEET
                              ---------------------

     The following table presents for the periods indicated, information
regarding average balances of assets and liabilities as well as the total dollar
amounts of interest income from average interest-earning assets and interest
expense on average interest-bearing liabilities, resulting interest rate spread,
and ratios of interest-earning assets to interest-bearing liabilities. Averages
are calculated using monthly averages. We follow the practice of stopping
interest accruals on loans past due 90-days and over unless it is reasonably
believed that all principal and interest due on the loan will be fully
recovered. Interest income on tax-free municipal bonds is not shown on a
tax-equivalent basis.
<TABLE><CAPTION>
                                            AT DECEMBER 31,
                                                 2004                               2004
                                      -------------------------------------------------------------------
                                                      AVERAGE        AVERAGE                    AVERAGE
                                         BALANCE     YIELD/COST      BALANCE      INTEREST    YIELD/COST
                                      -------------------------   --------------------------------------
<S>                                   <C>            <C>          <C>            <C>          <C>
Interest earning assets:
    Loans receivable                  $    809,406      6.42%     $    782,566   $   50,195      6.41%
    Mortgage-backed securities             112,702      4.23%          100,116        3,865      3.86%
    Municipal securities                     1,217      6.10%            1,252           80      6.39%
    FHLB stock                              12,919      2.80%           12,200          339      2.78%
    US securities                           18,025      4.05%           14,585          504      3.46%
    Short-term investments and other           309      2.09%            1,703          144      0.70%
                                      ------------                ------------   ----------
Total interest-earning assets              954,578      6.07%          912,422       55,127      6.04%

Noninterest earning assets                  49,205                      19,892
                                      ------------                ------------
Total assets                          $  1,003,783                $    932,314
                                      ============                ============

Interest-earning liabilities:
    Deposits                          $    640,061      2.00%     $    606,036   $   12,292      2.03%
    Long-term debentures (TPS)              17,000      5.89%           17,000        1,002      5.89%
    FHLB advances and other                235,807      2.34%          230,021        5,799      2.52%
                                      ------------                ------------   ----------
Total interest-bearing liabilities         892,868      2.17%          853,057       19,093      2.24%

Noninterest-bearing liabilities -
    deposits and other                      51,468                      24,120
                                      ------------                ------------
Total liabilities                          944,336                     877,177
Shareholders' equity                        59,447                      55,137
                                      ------------                ------------
Total liabilities and shareholders'
    equity                            $  1,003,783                $    932,314
                                      ============                ============


Net interest income                                                              $   36,034
                                                                                 ==========
Ratio of average interest-earning
    assets to average interest-
    bearing liabilities                                                  1.06x
Interest rate spread                                                                             3.80%
Net yield (net interest income as a
    percentage of average interest-
    earning assets)                                                                   3.95%
Amortized loan fees included in loan
    receivable interest income                                                   $      516





                                        6
<PAGE>
                                                        2003                                     2002
                                      --------------------------------------   --------------------------------------
                                         AVERAGE                    AVERAGE       AVERAGE                    AVERAGE
                                         BALANCE      INTEREST    YIELD/COST      BALANCE      INTEREST    YIELD/COST
                                      --------------------------------------   --------------------------------------
Interest earning assets:
    Loans receivable                  $    683,249   $   45,487      6.66%     $    588,213   $   42,925      7.30%
    Mortgage-backed securities              68,841        2,902      4.22%           80,523        4,514      5.61%
    Municipal securities                     1,330           81      6.09%            1,342           80      5.96%
    FHLB stock                              10,728          707      6.59%           10,095          707      7.00%
    US securities                           11,425          473      4.14%            1,666           49      2.94%
    Short-term investments and other         1,568           11      0.70%            4,673           50      1.07%
                                      ------------   ----------                ------------   ----------
Total interest-earning assets              775,573       49,650      6.39%     $    681,839       48,275      7.04%

Noninterest earning assets                  25,929                                   25,310
                                      ------------                             ------------
Total assets                          $    801,502                             $    707,149
                                      ============                             ============

Interest-earning liabilities:
    Deposits                          $    531,674   $   11,984      2.25%     $    467,702   $   13,995      2.99%
    Long-term debentures (TPS)              13,333          716      5.37%            9,000          251      2.79%
    FHLB advances and other                202,266        6,223      3.08%          167,954        7,441      4.43%
                                      ------------   ----------                ------------   ----------
Total interest-bearing liabilities         747,273       18,923      2.53%          644,656       21,687      3.36%

Noninterest-bearing liabilities -
    deposits and other                       8,241                                   19,038
                                      ------------                             ------------
Total liabilities                          755,514                                  663,694
Shareholders' equity                        47,556                                   48,128
                                      ------------                             ------------
Total liabilities and shareholders'
    equity                            $    803,070                             $    711,822
                                      ============                             ============


Net interest income                                  $   30,727                               $   26,588
                                                     ==========                               ==========
Ratio of average interest-earning
    assets to average interest-
    bearing liabilities                      1.05x                                    1.17x
Interest rate spread                                                 3.86%                                    3.68%
Net yield (net interest income as a
    percentage of average interest-
    earning assets)                                       3.96%                                    3.88%
Amortized loan fees included in loan
    receivable interest income                       $    1,040                               $      474
</TABLE>

                                        7
<PAGE>
RATE VOLUME ANALYSIS
--------------------

     The "Rate Volume Analysis" table is contained in the section captioned
"MD&A" in the Annual Report, which is incorporated herein by reference.


LENDING ACTIVITIES
------------------

     GENERAL. Our loan portfolio totaled $809.4 million at December 31, 2004
(loans held-for-sale totaled $10.1 million of this amount). On that date before
deductions (see Note 5 to the Consolidated Financial Statements for additional
information), $177.3 million, or 20%, of total outstanding loans, including
loans held-for-sale, consisted of loans secured by one-to-four-unit residential
properties; $176.4 million, or 20%, consisted of loans secured by mortgages on
over-four-unit residential properties; construction loans constituted $184.1
million, or 21%; $205.4 million, or 23%, consisted of commercial real estate
loans; $94.8 million, or 10%, consisted of consumer loans; and $53.0 million, or
6%, consisted of business loans.

     Our principal lending activities have focused on the origination of
residential, commercial real estate, business banking, and consumer loans. Total
loans originated were $342.2 million and $424.4 million for the years ended
December 31, 2002 and 2003, respectively, and $469.7 million for the year ended
December 31, 2004.

     In order to maintain the interest rate sensitivity of our loan portfolio
and investments, we place an emphasis on the origination of adjustable-rate
mortgage loans on residential and commercial properties, and construction,
business, and consumer loans at interest rates subject to periodic adjustment
based upon the prevailing market rates. At December 31, 2004, $734.2 million, or
90%, of net loans receivable, including loans held-for-sale, were comprised of
loans that were other than long-term, fixed-rate loans. This amount consists of
$175.4 million in residential mortgage loans with rates adjustable at periods
ranging from one to five years, $423.7 million in business loans and loans
secured by income-producing and multifamily residential properties, $112.3
million in net construction loans, and $22.8 million in consumer loans.

     The following tables provide selected data relating to the composition of
our loan portfolio by type of loan and type of security on the dates indicated.


                                        8
<PAGE>
<TABLE><CAPTION>
                                                                         AS OF DECEMBER 31,
                                 --------------------------------------------------------------------------------------------------
                                        2004                2003                2002                2001                2000
                                 ------------------  ------------------  ------------------  ------------------  ------------------
                                  AMOUNT    PERCENT   AMOUNT    PERCENT   AMOUNT    PERCENT   AMOUNT    PERCENT   AMOUNT    PERCENT
                                 --------  --------  --------  --------  --------  --------  --------  --------  --------  --------
                                                                       (Dollars in Thousands)
<S>                              <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>
Type of loan:
   Real estate loans:
      Interim construction loans $184,064    22.74%  $163,309    22.52%  $107,266    17.10%  $ 84,245    14.84%  $103,727    21.19%
      Loans on existing property  379,054    46.83%   299,401    41.26%   270,947    43.18%   250,038    44.05%   198,240    40.49%
      Loans refinanced            180,115    22.26%   228,726    31.53%   219,125    34.93%   208,383    36.72%   196,089    40.05%
   Insured or guaranteed real
      estate loans                     --     0.00%        --     0.00%       103     0.02%       244     0.04%       257     0.05%
   Consumer loans and other        94,776    11.71%    85,243    11.75%    57,627     9.19%    42,488     7.49%    34,219     6.99%
   Business lines of credit        52,963     6.54%    20,089     2.77%    14,683     2.34%    11,995     2.11%     5,033     1.03%
   Less:
      Undisbursed loan proceeds   (73,423)   (9.07%)  (64,140)   (8.84%)  (34,528)   (5.50%)  (22,270)   (3.92%)  (40,087)   (8.19%)
      Reserve for loan losses      (9,301)   (1.15%)   (8,406)   (1.16%)   (7,754)   (1.24%)   (7,032)   (1.24%)   (6,729)   (1.37%)
      Net deferred loan
       (fees)/costs                 1,158     0.14%     1,226     0.17%      (150)   (0.02%)     (537)   (0.09%)   (1,198)   (0.24%)
                                 --------  --------  --------  --------  --------  --------  --------  --------  --------  --------
Total                            $809,406   100.00%  $725,448   100.00%  $627,319   100.00%  $567,554   100.00%  $489,551   100.00%
                                 ========  ========  ========  ========  ========  ========  ========  ========  ========  ========


                                                                         AS OF DECEMBER 31,
                                 --------------------------------------------------------------------------------------------------
                                        2004                2003                2002                2001                2000
                                 ------------------  ------------------  ------------------  ------------------  ------------------
                                  AMOUNT    PERCENT   AMOUNT    PERCENT   AMOUNT    PERCENT   AMOUNT    PERCENT   AMOUNT    PERCENT
                                 --------  --------  --------  --------  --------  --------  --------  --------  --------  --------
                                                                       (Dollars in Thousands)
Type of security:
   Residential:
      One-to-four family         $177,322    21.91%  $131,682    18.15%  $ 93,208    14.86%  $ 83,887    14.78%  $ 74,359    15.19%
      Multifamily                 176,429    21.80%   184,919    25.49%   177,621    28.31%   174,062    30.67%   160,297    32.74%
   Construction                   184,064    22.74%   163,309    22.51%   107,266    17.10%    84,245    14.84%   103,727    21.19%
   Commercial real estate         205,418    25.38%   211,526    29.16%   219,346    34.97%   200,716    35.37%   159,930    32.67%
   Consumer loans and other        94,776    11.71%    85,243    11.75%    57,627     9.19%    42,488     7.49%    34,219     6.99%
   Business lines of credit        52,963     6.54%    20,089     2.77%    14,683     2.34%    11,995     2.11%     5,033     1.03%
   Less:
      Undisbursed loan proceeds   (73,423)   (9.07%)  (64,140)   (8.84%)  (34,528)   (5.50%)  (22,270)   (3.92%)  (40,087)   (8.19%)
      Reserve for loan losses      (9,301)   (1.15%)   (8,406)   (1.16%)   (7,754)   (1.24%)   (7,032)   (1.24%)   (6,729)   (1.37%)
      Net deferred loan
       (fees)/costs                 1,158     0.14%     1,226     0.17%      (150)   (0.02%)     (537)   (0.09%)   (1,198)   (0.24%)
                                 --------  --------  --------  --------  --------  --------  --------  --------  --------  --------
Total                            $809,406   100.00%  $725,448   100.00%  $627,319   100.00%  $567,554   100.00%  $489,551   100.00%
                                 ========  ========  ========  ========  ========  ========  ========  ========  ========  ========
</TABLE>

     LOAN MATURITY. The following table sets forth certain information at
December 31, 2004, regarding the dollar amount of loans maturing based on their
contractual terms to maturity or repricing. Demand loans, loans having no stated
schedule of repayments and no stated maturity, are reported as due in one year
or less. Loan balances exclude unearned discounts, deferred loan origination
fees, and allowance for loan losses.

                                        9
<PAGE>
<TABLE><CAPTION>
                                DUE WITHIN    TWO TO     THREE TO    FIVE TO      BEYOND
                                 ONE YEAR   THREE YEARS FIVE YEARS   TEN YEARS   TEN YEARS     TOTAL
                                ----------  ----------  ----------  ----------  ----------  ----------
                                                        (Dollars in Thousands)
<S>                             <C>         <C>         <C>         <C>         <C>         <C>
Real estate loans:
    Interim construction loans  $  110,641  $       --  $       --  $       --  $       --  $  110,641
    Loans on existing property     236,898      64,065      47,427      27,059       3,605     379,054
    Loans refinanced               112,523      30,485      22,536      12,858       1,713     180,115
    Consumer loans and other        29,050       2,142       4,784      34,326      24,474      94,776
Business loans                      37,196       1,830      13,567         368           2      52,963
                                ----------  ----------  ----------  ----------  ----------  ----------
Total loans                     $  526,308  $   98,522  $   88,314  $   74,611  $   29,794  $  817,549
                                ==========  ==========  ==========  ==========  ==========  ==========
</TABLE>


     The following table sets forth the dollar amount of all loans, categorized
by fixed interest rates and floating or adjustable interest rates. Loan balances
exclude unearned discounts, deferred loan origination fees, and allowance for
loan losses.
<TABLE><CAPTION>
                                        Due Within One-Year                   Due after One-Year
                                ----------------------------------    ----------------------------------
                                            Adjustable                            Adjustable
                                Fixed Rate     Rate        Total      Fixed Rate     Rate        Total
                                ----------  ----------  ----------    ----------  ----------  ----------
                                                         (Dollars in Thousands)
<S>                             <C>         <C>         <C>           <C>         <C>         <C>
Mortgage loans                  $      266  $  459,796  $  460,062    $    9,627  $  200,121  $  209,748
Consumer loans                       6,558      22,492      29,050        65,626         100      65,726
Business loans                          --      37,196      37,196        11,410       4,357      15,767
                                ----------  ----------  ----------    ----------  ----------  ----------
Total                           $    6,824  $  519,484  $  526,308    $   86,663  $  204,578  $  291,241
                                ==========  ==========  ==========    ==========  ==========  ==========
</TABLE>


     RESIDENTIAL LOANS. At December 31, 2004, approximately 32% of the total
loan portfolio, including loans held-for-sale and single-family construction
loans, consisted of loans secured by one-to-four-unit family dwellings
principally located within the states of Washington, Oregon, and Idaho.

     Our lending policies generally limit the maximum loan-to-value ratio on
residential mortgage loans to 97% of the appraised value as determined by an
independent appraiser, with the condition that private mortgage insurance is
required on home loans with loan-to-value ratios in excess of 80%.

     The loan-to-value ratio, maturity, and other provisions of the loans
originated generally have reflected the policy of making less than the maximum
loan permissible in accordance with sound lending practices, market conditions,
and underwriting standards established by management. Mortgage loan originations
are generally long-term loans, amortized on a monthly basis, with principal and
interest due each month. The initial contractual loan payment period for
residential loans typically ranges from five to 30 years. Our past experience
indicates that real estate loans remain outstanding for significantly shorter
periods than their contractual terms. Borrowers may refinance or prepay loans at
their option, subject to prepayment penalty provisions when included in the
note.

     We offer loans that adjust every one or two years and that have initial
fixed-rate periods between one and 10 years. These loans generally have a
maximum rate adjustment of two percent in any one year with a maximum lifetime
interest rate adjustment of between four and six percent. We also offer fixed
rate 15- or 30-year loans that we sell into the secondary market. At times, we
may choose to portfolio some of these loans that are underwritten to certain
criteria.

                                       10
<PAGE>
     All improved real estate which serves as security for a loan must be
insured by companies we have approved against fire, extended coverage,
vandalism, malicious mischief, and other hazards. Such insurance must be
maintained throughout the term of the loan and in an amount not less than that
amount necessary to meet the replacement cost of the property structures,
subject to insurance carrier limits.

     Included in our residential portfolio are single-family construction loans.
These loans are further designated into two categories -- speculative and
custom. Speculative ("spec") construction loans, which represent 2% of the loan
portfolio, are approved for builder-developers who generally first build the
residence and then sell the property to the end buyer. Those loans typically are
made for a 12-month period, which may be extended subject to negotiation and the
payment of an extension fee. Interest rates on spec loans are tied to the prime
rate and are adjusted when the prime rate changes. At the present time, rates
quoted range from 1.0% to 2.0% above the prevailing prime rate and are dependent
upon the type of loan and its terms.

     Custom construction loans, which represent 9% of the loan portfolio, are
originated directly to the borrower. The builder, with whom the borrower has
contracted to build the residence, must be acceptable to the Bank. We oversee
the disbursement of construction funds to the borrower and builder. These loans
generally have 15- or 30-year terms with the construction period ranging from
six to 12 months, with interest collected monthly based upon the disbursed
balance of the loan. At the end of the construction period the terms of payment
are modified to fully amortize the loan balance over the subsequent 15- or
30-year term.

     The loan programs and interest rates offered for custom construction loans
are typically the same as those offered for other one-to-four-family residential
loans. The fee and interest rate structure for custom construction loans are
typically higher than those assessed on non-construction single-family loans
with similar terms and conditions. The additional loan fee and interest rate
compensate us for the extra cost and interest rate risk associated with this
type of lending.

     INCOME PROPERTY LOANS. Income property loans, consisting of multifamily,
construction, and commercial real estate loans, totaled $347 million at December
31, 2004. That figure compares to $364 million at year-end 2003.

     At December 31, 2004, commercial real estate loans (excluding multifamily
and construction loans) constituted $141 million of the loan portfolio as
compared to $153 million at the end of 2003. These loans are typically secured
by office buildings, warehouses, commercial and retail centers located in our
primary lending area of Washington State and Western Oregon. Permanent
commercial real estate loans are normally made up to 75% of the appraised value
of the property and generally have interest rates that are adjusted annually
based on the short-term FHLB advance rate plus a spread ranging from 3.00% to
4.00%.

     Income property real estate financing is generally considered to involve a
somewhat higher degree of credit risk than financing of residential properties.
The risk of loss on an income property construction loan is dependent largely
upon the accuracy of the initial estimate of the property's value at completion
of construction or development and the estimated cost (including interest) of
construction. If the estimate of the construction cost of the property upon
completion of the project proves to be inaccurate, we may be required to advance
funds beyond the amount originally committed to permit completion of the
development. If the estimate of value proves to be inaccurate, we may be
confronted, at or prior to the maturity of the loan, with collateral that is
insufficient to assure full repayment. On permanent income property real estate
loans, the risk is primarily attributable to the cash flow from the property
being financed. If the cash flow from the property is reduced (e.g., if leases
are not obtained or renewed), the borrower's ability to repay the loan may be
impaired.

     Our underwriting criteria are designed to evaluate and minimize the risk of
income property real estate lending. Among other things, we consider the credit
history and reputation of the borrower, the borrower's net worth and liquidity,
the amount of the borrower's equity in the project, independent appraisal and
review of cost estimates, pre-

                                       11
<PAGE>
construction sale and leasing information, and cash flow projections of the
borrower. In addition our loan policy limits the maximum loan(s) to any one
borrower, at any time, to not exceed the maximum allowed under state
regulations.

     Multifamily loans are generally made in amounts between $500,000 and $2.0
million and at December 31, 2004, the largest multifamily loan was for $4.2
million. As of December 31, 2004, multifamily loans were $181 million of the
loan portfolio as compared to $193 million in 2003.

     BUSINESS BANKING. The Business Banking Department makes loans for
"owner-occupied" commercial real estate properties, construction loans and
non-real-estate-based business loans. At year-end 2004, total business banking
loans grew to $110 million compared to $77 million the previous year.
Non-real-estate business loans included in those totals were $55 million and $23
million at December 31, 2004 and 2003, respectively.

     Business banking commercial real estate loans are typically made on
"owner-occupied" properties. The Business Banking Department analyzes the
owner's business that occupies the property and looks at the business' cash flow
as the primary source of repayment. The real estate collateral provides
secondary security to the loan. Non-real-estate business loans are typically
extended to medium-sized businesses for the purpose of financing inventory,
accounts receivable, equipment, etc.

     Interest rates on business loans are generally tied to the prime rate, plus
a spread ranging from 0% to 3%, or to the short-term FHLB advance rate, plus a
spread ranging from 3% to 4%. The rates are adjusted when the index rate
changes. Most prime-based loans reprice immediately while the loans tied to
other indexes reprice based on set schedules, generally annually and after a
fixed period of time. Annual fees are also usually assessed to line-of-credit
business loans.

     Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential, commercial, and multifamily real estate lending.
Real estate lending is generally considered to be collateral-based lending with
loan amounts based on predetermined loan-to-collateral values, and liquidation
of the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default. Although commercial business loans
are often collateralized by equipment, inventory, accounts receivable or other
business assets, the liquidation of collateral in the event of a borrower
default is often not a sufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete or
of limited use, among other reasons. Accordingly, the repayment of a commercial
business loan depends primarily on the creditworthiness and cash flow of the
borrower (and any guarantors), while liquidation of collateral is a secondary
source of repayment.

     CONSUMER LOANS. We originate consumer loans through two principal methods:
sales finance lending (indirect lending) and direct consumer lending (consumer
and home equity loans). Consumer loans totaled $96 million at December 31, 2004,
compared to $86 million the previous year. Included in that total are sales
finance loans totaling $69 million and $62 million at year-end 2004 and 2003,
respectively.

     The Sales Finance Department purchases consumer financing contracts from
approved dealers in over 40 states. The purchases are generally without recourse
to the dealers. Typical collateral for these contracts includes retrofitted
windows, siding, roofs, spas, and other home improvements. Dealers must be
acceptable to the Bank prior to the purchase of contracts. Before a contract is
purchased, Bank personnel make independent credit decisions on the borrowers by
checking the creditworthiness of the borrower using various underwriting
criteria.

     We have a satellite sales finance office located in Jacksonville, Florida.
Our employees based out of this office work with contractors in the eastern
portion of the United States to generate home improvement contracts for
assignment to the Bank.

     The Sales Finance Department originates loans both for portfolio and for
sale in the secondary market. Loans

                                       12
<PAGE>
originated for portfolio can either be unsecured or secured by the use of a
financing statement filed against the real property where the goods were
installed. The terms of the contracts are fixed rate and vary in term from two
to 12 years. Loans originated for sale in the secondary market are unsecured.
The loans are sold non-recourse to various institutional purchasers.

     To mitigate future losses, we have entered into an agreement with a
national insurance company to provide credit default insurance on a portion of
the sales finance loans. The default insurance pays 100% of the loss on any
given loan up to an overall liability cap as defined in the insurance policy.
The insurance coverage, when applicable, is typically purchased for loans that
fall below a cutoff credit score. That cutoff credit score is currently at 720.

     The Direct Consumer Lending Department processes and closes consumer loan
requests generated within the banking centers and from lending officers. The
lending products offered fall into two categories: collateral-based loans
(automobiles, boats, recreational vehicles, home improvement, etc.) and
unsecured lines-of-credit. The underwriting criteria for collateral-based loans
are similar to that of the sales finance loans noted above. Primary
consideration is given to the borrower's capacity to repay the obligation. A
secondary consideration on secured consumer loans is the value of the loan
collateral as a source of repayment. The underwriting criteria on the unsecured
lines-of-credit call for a higher level of borrower creditworthiness because of
the unsecured nature of these loans. The terms on the collateral- based loans
are fixed rates with terms up to 10 years. The unsecured lines-of-credit are
variable and tied to the prime rate plus a margin.

     Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Furthermore, the application of various federal and state laws, including
federal and state bankruptcy and insolvency laws, may limit the amount which can
be recovered on such loans. Such loans may also give rise to claims and defenses
by a consumer loan borrower against an assignee of such loans such as the Bank,
and a borrower may be able to assert against such assignee claims and defenses
that it has against the seller of the underlying collateral. At December 31,
2004, consumer loans past due 90 days or more totaled $299,000 as compared to
$346,000 at year-end 2003.

     LOAN SOLICITATION AND PROCESSING. We rely upon our employees to solicit
and/or originate business, consumer, income property, and residential loans. We
also utilize the services of mortgage brokers and home improvement dealers.
Residential mortgage brokers take applications from borrowers, process the
credit information, obtain property appraisals, and then submit the loan to us
for approval. If approved, the loan is funded by and closed in the name of the
Bank. Income property brokers are generally limited to taking the initial
application from borrowers. Mortgage brokers provide us with a cost-effective
method of originating loans in a broader geographic area than our primary
lending areas. Approximately 86% of all residential loans closed during the year
ended December 31, 2004, were obtained through mortgage brokers as compared to
83% during 2003. We also purchase retail installment contracts (contracts) from
home improvement contractors in 43 states. In the process of selling home
improvement products, the contractors have the borrower complete an application
for credit to finance the purchase and installation of those products. The
application is forwarded to the Bank where the decision is made to purchase the
contract. Once the goods are installed to the satisfaction of the customer, the
Bank purchases the contract from the contractor and the Bank assumes
responsibility for collecting the borrower's monthly payments. The contracts are
purchased by the Bank without recourse except in instances of fraud or
misrepresentation of the work performed or the goods installed.

     Our lending policy is reviewed annually and approved by the Board of
Directors. Residential loans up to specified limits may be approved by a
designated underwriter or member of the Consumer Loan Committee, which is
comprised of officers Boudreau, Boyd, Harlan, Young and Zavaglia. Commercial
real estate loans can be approved by

                                       13
<PAGE>
the Chief Credit Officer up to $1.0 million or by a designated member of the
Commercial Loan Committee up to $500,000. The entire Commercial Loan Committee
can approve these loans up to $3.5 million. This committee can also approve
other secured or unsecured business loans up to $2 million; its members are
officers Collette, Boudreau, Everett, Harlan, Kasanders, Smeby, Valaas, Young,
and Zavaglia. Larger loans are further reviewed and approved by the Investment
Committee of the Board, which is comprised of Directors Doud, Florence, Parker,
Rowley, Valaas, and Wallace. Except for small consumer or community business
loans, the Investment Committee must also approve loans where the cumulative
debt exceeds $3.5 million for residential and consumer loans or $5.0 million for
income property or business loans.

     LOAN ORIGINATIONS AND SALE OF LOANS INTO THE SECONDARY MARKET. Loan
originations increased in 2004 to $470 million from $424 million in 2003, and
the comparable figure for 2002 was $342 million. The increase in originations
came largely from business banking loan closings which increased from $13
million in 2003 to $47 million in 2004.

     Selling loans in the secondary mortgage market reduces the risk that
interest rates will escalate while holding long-term, fixed-rate loans in the
portfolio. The sale of loans into the secondary market also allows us to
continue to make loans during periods when savings inflows decline or funds are
not otherwise available for lending purposes. In connection with such sales, we
have the option of selling the servicing rights (i.e., collection of principal
and interest payments). As of December 31, 2004, we serviced loans for others
aggregating approximately $118 million as compared to $76 million in 2003. Net
loan servicing fees totaled $314,000 for the year ended December 31, 2004, and
$69,000 for the year ended December 31, 2003.

     Currently, long-term mortgage loans and some sales finance loans are being
originated for sale and sold to investors. During the year ended December 31,
2004, we sold $36 million in both residential and sales finance loans and $33
million in commercial loans as compared to $58 million in residential loans, $13
million in sales finance loans and $25 million in commercial loans during 2003.

     Set forth below is a table showing our loan origination and sales activity
for the periods indicated.





                                       14
<PAGE>
                                              YEARS ENDED DECEMBER 31,
                                       --------------------------------------
                                          2004          2003          2002
                                       ----------    ----------    ----------
                                               (Dollars in Thousands)
Total loans at beginning of period
  (net of undisbursed loan proceeds)   $  732,628    $  635,223    $  575,123
Loans originated:
  Real estate loans:
     Construction loans                   170,824       138,238        85,059
     Loans on existing property            87,519       133,341       128,445
     Loans refinanced                      62,021        75,385        78,301
     Insured and guaranteed loans              --            --           103
     Consumer and other loans             149,353        77,400        50,293
                                       ----------    ----------    ----------

     Total loans originated               469,717       424,364       342,201
                                       ----------    ----------    ----------

Principal reductions                     (280,831)     (231,131)     (192,698)
Loans sold:
  Whole loans                             (35,787)      (71,299)      (72,197)
  Participation loans                     (68,178)      (24,529)      (17,206)
                                       ----------    ----------    ----------

     Total loans sold                    (103,965)      (95,828)      (89,403)
                                       ----------    ----------    ----------
Total loans at end of period (net
  of undisbursed loan proceeds)        $  817,549    $  732,628    $  635,223
                                       ==========    ==========    ==========


     LOAN COMMITMENTS. Our commitments to make conventional mortgage loans on
existing residential dwellings are generally made for periods of 30 to 60 days.
The borrower may reserve ("lock-in") an interest rate and loan fee for a period
of 10 to 60 days from the date of application. This reservation is conditioned
upon loan approval and closing within this time frame. Interest rates and loan
fees committed at the time of the lock-in are based upon the prevailing market
rate at the time of approval. Outstanding commitments to borrowers totaled
$239.3 million at December 31, 2004 and $230.4 million at year-end 2003.

     LOAN ORIGINATION FEES AND OTHER FEES. In addition to interest earned on
loans and servicing fees on loans sold and securitized, we receive loan
origination fees for originating mortgage loans. See Note 1 of "Notes to
Consolidated Financial Statements" in the Annual Report for information as to
the recognition of loan fee income.

     Loan origination fees vary with the volume and type of loans made and with
competitive conditions in mortgage markets. Loan demand and availability of
money affect these market conditions. Recent trends have kept loan origination
fees in the 1% to 2% range for permanent real estate loans. Construction loan
fees at the present time range from 1.50% to 3% of the loan amount. We also
receive other fees and charges relating to existing loans, which include late
charges, prepayment fees, and fees collected in connection with a change in
borrower or other loan modifications, including construction loan extensions.

     REAL ESTATE HELD-FOR-SALE AND NON-PERFORMING LOANS. Loans are defined as
non-performing when payment of principal and/or interest is 90 days past due
unless we are reasonably assured that all principal and interest due on the loan
will be fully recovered. Generally we are able to work out a satisfactory
repayment schedule with a delinquent borrower; however, the Bank will undertake
foreclosure proceedings if the delinquency is not otherwise resolved. Property
we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is
classified as "held-for-sale" until such time as it is sold or otherwise
disposed. At December 31, 2004, the total of non-performing loans, repossessed
assets,

                                       15
<PAGE>
and real estate acquired through foreclosure was $1.0 million as compared to
$538,000 at year-end 2003.

     The following table sets forth information regarding non-performing assets
at the dates indicated.

                                                   AS OF DECEMBER 31,
                                         --------------------------------------
                                            2004          2003          2002
                                         ----------    ----------    ----------
                                                 (Dollars in Thousands)

Nonaccrual loans                         $    1,004    $      527    $    2,074
Other assets and real estate acquired
  through foreclosure                             3            11            45
                                         ----------    ----------    ----------
     Total non-performing assets         $    1,007    $      538    $    2,119
                                         ==========    ==========    ==========

As a percentage of loans                       0.12%         0.07%         0.34%
As a percentage of total assets                0.10%         0.06%         0.28%

Gross interest income that would have
  been recorded in the period if loans
  had been current with original terms   $       81    $      104    $      156

Interest income on loans included in
  net income for the period              $       44    $       87    $      117


     There were three impaired loans totaling $139,833 (net of impairment
allowances) at year end 2004 and two impaired loans totaling $16,445 (net of
impairment allowances) at year end 2003, respectively. The amount of impairment
totaled $177,000 for 2004 and $4,600 for 2003.

RESERVE FOR LOAN LOSSES
-----------------------

     The reserve for loan losses is maintained at a level sufficient to provide
for estimated losses based on known and inherent risks in the loan portfolio.
This reserve is based upon management's continuing analysis of the factors
underlying the quality of the loan portfolio. These factors include changes in
the size and composition of the loan portfolio; actual loan loss experience;
current and anticipated economic conditions; detailed analysis of individual
loans for which full collection may not be assured and for which impairment may
be present; and determination of the existence and fair value of the collateral
and guarantees securing the loans. The reserve is based upon factors and trends
identified by management at the time the financial statements are prepared. The
ultimate recovery of loans is susceptible to future market factors beyond our
control, which may result in losses or recoveries differing significantly from
those provided in the financial statements. At December 31, 2004, the reserve
for loan losses totaled $9.3 million which compares to $8.4 million at December
31, 2003.

     While we believe we have established our existing reserve for loan losses
in accordance with generally accepted accounting principles as of December 31,
2004, there can be no assurance that regulators, when reviewing our loan
portfolio in the future, will not request us to increase our reserve for loan
losses, thereby adversely affecting our financial condition and earnings. See
the Consolidated Financial Statements contained in the Annual Report.

     The following table sets forth an analysis of the allowance for loan losses
for the periods indicated.


                                       16
<PAGE>
<TABLE><CAPTION>
                                                       YEARS ENDED DECEMBER 31,
                                     ------------------------------------------------------------
                                       2004         2003         2002         2001         2000
                                     --------     --------     --------     --------     --------
                                                        (Dollars in Thousands)
<S>                                  <C>          <C>          <C>          <C>          <C>
Balance at beginning of period       $  8,406     $  7,754     $  7,032     $  6,729     $  6,309

    Charge-offs:
        Residential real estate          (172)          --           --           --           --
        Commercial and multifamily
           real estate                     (1)          --           (6)          --           --
        Business                         (101)        (174)         (42)         (14)          --
        Consumer and other               (640)        (466)        (223)        (130)        (112)
                                     --------     --------     --------     --------     --------
           Total charge-offs             (914)        (640)        (271)        (144)        (112)
                                     --------     --------     --------     --------     --------

    Recoveries:
        Business                           25           --            8            3           --
        Consumer and other                218          142           75           79            2
                                     --------     --------     --------     --------     --------
           Total recoveries               243          142           83           82            2
                                     --------     --------     --------     --------     --------

    Provision                           1,565        1,150          910          365          530
                                     --------     --------     --------     --------     --------

Balance at end of period             $  9,300     $  8,406     $  7,754     $  7,032     $  6,729
                                     ========     ========     ========     ========     ========

Ratio of net charge-offs to
    average loans outstanding            0.08%        0.07%        0.03%        0.01%        0.02%
</TABLE>



SECURITIES
----------

     The following table sets forth certain information regarding carrying
values and percentage of total carrying values of the consolidated portfolio of
securities classified as available-for-sale and held-to-maturity.



                                       17
<PAGE>
<TABLE><CAPTION>
                                                                         AT DECEMBER 31,
                                                   ----------------------------------------------------------
                                                              2004                           2003
                                                   ---------------------------    ---------------------------
                                                     CARRYING       PERCENT         CARRYING       PERCENT
AVAILABLE FOR SALE:                                    VALUE        OF TOTAL          VALUE        OF TOTAL
-------------------                                ------------   ------------    ------------   ------------
                                                                      (Dollars in Thousands)
<S>                                                <C>            <C>             <C>            <C>
   US government treasury and agency obligations   $     17,954             14%   $     11,053             14%
   Mortgage-backed securities:
       Freddie Mac                                       18,888             15%         15,546             21%
       Ginnie Mae                                        48,608             39%          7,986             10%
       Fannie Mae                                        38,775             32%         43,038             55%
                                                   ------------   ------------    ------------   ------------
   Total mortgage-backed securities                     106,271             86%         66,570             86%

   Total available for sale securities             $    124,225            100%   $     77,623            100%
                                                   ============   ============    ============   ============






                                                                         AT DECEMBER 31,
                                                   ----------------------------------------------------------
                                                              2004                           2003
                                                   ---------------------------    ---------------------------
                                                     CARRYING       PERCENT         CARRYING       PERCENT
HELD TO MATURITY:                                      VALUE        OF TOTAL          VALUE        OF TOTAL
-----------------                                  ------------   ------------    ------------   ------------
                                                                      (Dollars in Thousands)

   Municipal bonds                                 $      1,217             16%   $      1,324             15%
   Mortgage-backed securities:
       Freddie Mac                                          493              6%            550              6%
       Fannie Mae                                         6,010             78%          7,029             79%
                                                   ------------   ------------    ------------   ------------
   Total mortgage-backed securities                       6,503             84%          7,579             85%
   CMOs                                                      --              0%              1              0%
                                                   ------------   ------------    ------------   ------------

   Total held to maturity securities               $      7,720            100%   $      8,904            100%
                                                   ============   ============    ============   ============

   Estimated market value                          $      7,827                   $      9,110
                                                   ============                   ============

</TABLE>





                                       18
<PAGE>
The following table shows the maturity or period to repricing of the Bank's
consolidated portfolio of securities available-for-sale and held-to-maturity at
December 31, 2004.
<TABLE><CAPTION>
                                     ----------------------------------------------------------------------------------------------
                                       ONE YEAR OR LESS        ONE TO THREE YEARS      THREE TO FIVE YEARS       FIVE TO TEN YEARS
                                     -------------------      -------------------      -------------------      -------------------
                                                WEIGHTED                 WEIGHTED                 WEIGHTED                 WEIGHTED
                                     CARRYING   AVERAGE       CARRYING   AVERAGE       CARRYING   AVERAGE       CARRYING   AVERAGE
                                      VALUE      YIELD         VALUE      YIELD         VALUE      YIELD         VALUE      YIELD
                                     --------   --------      --------   --------      --------   --------      --------   --------
                                                                         (Dollars in Thousands)
<S>                                  <C>        <C>           <C>        <C>           <C>        <C>           <C>        <C>
AVAILABLE FOR SALE:
   US government treasury and
     agency obligations              $     --       0.00%     $  6,957       1.88%     $  6,042       4.08%     $     --       0.00%
   Mortgage-backed securities:
       Ginnie Mae                          --       0.00%        7,415       3.75%           --       0.00%           --       0.00%
       Freddie Mac                        298       4.10%           --       0.00%          676       5.50%        4,013       3.50%
       Fannie Mae                         526       4.01%           --       0.00%          992       5.50%           --       0.00%
                                     --------   --------      --------   --------      --------   --------      --------   --------
   Total mortgage-backed securities       824       4.04%        7,415       3.75%        1,668       5.50%        4,013       3.50%

   Total carrying value              $    824       4.04%     $ 14,372       2.84%     $  7,710       4.39%     $  4,013       3.50%
                                     ========   ========      ========   ========      ========   ========      ========   ========

   Total amortized cost              $    799       4.05%     $ 14,457       2.85%     $  7,583       4.38%     $  4,128       3.50%
                                     ========   ========      ========   ========      ========   ========      ========   ========


                                     ---------------------------------------------------------------------
                                     TEN TO TWENTY YEARS       OVER TWENTY YEARS              TOTAL
                                     -------------------      -------------------      -------------------
                                                WEIGHTED                 WEIGHTED                 WEIGHTED
                                     CARRYING   AVERAGE       CARRYING   AVERAGE       CARRYING   AVERAGE
                                      VALUE      YIELD         VALUE      YIELD         VALUE      YIELD
                                     --------   --------      --------   --------      --------   --------
                                                             (Dollars in Thousands)
AVAILABLE FOR SALE:
   US government treasury and
     agency obligations              $  4,955       4.00%     $     --       0.00%     $ 17,954       3.20%
   Mortgage-backed securities:
       Ginnie Mae                          --       0.00%       41,193       4.14%       48,608       4.08%
       Freddie Mac                      8,316       4.50%        5,585       4.32%       18,888       4.26%
       Fannie Mae                      32,663       4.30%        4,594       4.13%       38,775       4.31%
                                     --------   --------      --------   --------      --------   --------
   Total mortgage-backed securities    40,979       4.31%       51,372       4.16%      106,271       4.18%

   Total carrying value              $ 45,934       4.31%     $ 51,372       4.16%     $124,225       4.06%
                                     ========   ========      ========   ========      ========   ========

   Total amortized cost              $ 46,476       4.30%     $ 51,566       4.16%     $125,009       4.05%
                                     ========   ========      ========   ========      ========   ========


                                     ----------------------------------------------------------------------------------------------
                                       ONE YEAR OR LESS        ONE TO THREE YEARS      THREE TO FIVE YEARS       FIVE TO TEN YEARS
                                     -------------------      -------------------      -------------------      -------------------
                                                WEIGHTED                 WEIGHTED                 WEIGHTED                 WEIGHTED
                                     CARRYING   AVERAGE       CARRYING   AVERAGE       CARRYING   AVERAGE       CARRYING   AVERAGE
                                      VALUE      YIELD         VALUE      YIELD         VALUE      YIELD         VALUE      YIELD
                                     --------   --------      --------   --------      --------   --------      --------   --------
                                     (Dollars in Thousands)
HELD TO MATURITY:
   Municipal bonds                   $     --       0.00%     $     --       0.00%     $     --       0.00%     $     --       0.00%
   Mortgage-backed securities:
       Freddie Mac                        493       3.48%           --       0.00%           --       0.00%           --       0.00%
       Fannie Mae                       2,350       4.52%          968       5.67%        1,825       4.58%           --       0.00%
                                     --------   --------      --------   --------      --------   --------      --------   --------
   Total mortgage-backed securities     2,843       4.34%          968       5.67%        1,825       4.58%           --       0.00%

   Total carrying value              $  2,843       4.34%     $    968       5.67%     $  1,825       4.58%     $     --       0.00%
                                     ========   ========      ========   ========      ========   ========      ========   ========

   Total amortized cost              $  2,928       4.34%     $    992       5.67%     $  1,834       4.61%     $     --       0.00%
                                     ========   ========      ========   ========      ========   ========      ========   ========


                                     ---------------------------------------------------------------------
                                     TEN TO TWENTY YEARS       OVER TWENTY YEARS              TOTAL
                                     -------------------      -------------------      -------------------
                                                WEIGHTED                 WEIGHTED                 WEIGHTED
                                     CARRYING   AVERAGE       CARRYING   AVERAGE       CARRYING   AVERAGE
                                      VALUE      YIELD         VALUE      YIELD         VALUE      YIELD
                                     --------   --------      --------   --------      --------   --------

HELD TO MATURITY:
   Municipal bonds                   $    220       5.38%     $    997       6.26%     $  1,217       6.10%
   Mortgage-backed securities:
       Freddie Mac                         --       0.00%           --       0.00%          493       3.48%
       Fannie Mae                         867       4.50%           --       0.00%        6,010       4.72%
                                     --------   --------      --------   --------      --------   --------
   Total mortgage-backed securities       867       4.50%           --       0.00%        6,503       4.63%

   Total carrying value              $  1,087       4.67%     $    997       6.26%     $  7,720       4.86%
                                     ========   ========      ========   ========      ========   ========

   Total amortized cost              $  1,081       4.68%     $    993       6.26%     $  7,827       4.86%
                                     ========   ========      ========   ========      ========   ========
</TABLE>


                                       19
<PAGE>
INVESTMENT ACTIVITIES
---------------------

     Under Washington law, savings banks are permitted to own government and
government agency obligations, commercial paper, corporate bonds, mutual fund
shares, debt and equity obligations issued by creditworthy entities, whether
traded on public securities exchanges or placed privately for investment
purposes. We retain a portfolio of mortgage-backed securities, US treasury and
agency securities, and municipal bonds. Subject to certain exceptions, we are
prohibited by FDIC regulations from making equity investments of a type, or in
an amount, that is not permissible for national banks.

     The Chief Financial Officer determines appropriate investments in
accordance with approved policies of the Investment Committee of the Board of
Directors. The policy generally limits investments to US government and agency
securities and mortgage-backed securities issued and guaranteed by Freddie Mac,
Fannie Mae, and Ginnie Mae. Investments are made based on certain
considerations, which include the interest rate, yield, settlement date and
maturity of the investment, our liquidity position, and anticipated cash needs
and sources. In addition, the effect on our credit and interest rate risk and
risk-based capital is also included in the evaluation.

     At December 31, 2004, the book value of the investment securities portfolio
totaled $132.7 million, while the estimated fair market value amounted to $132.0
million as compared to $86.5 million and $86.7 million, respectively, for 2003.
Securities with stated maturities greater than 10 years comprised 85% of the
investment portfolio in 2004. Mortgage-backed securities guaranteed by Fannie
Mae, Freddie Mac, and Ginnie Mae totaled $112.8 million including those held as
available-for-sale. From time to time, investment levels may be increased or
decreased depending upon a number of factors. These factors include the yields
on investment alternatives and upon management's judgment as to the
attractiveness of the yields then available in relation to other opportunities
and its expectations of the level of yield that will be available in the future.
In addition, management's projections as to the short-term demand for funds to
be used in origination of loans and other activities are also a consideration.
During the past year the investment portfolio increased 52%.

     MORTGAGE-BACKED SECURITIES. We purchase mortgage-backed securities to: (i)
generate positive interest rate spreads on large principal balances with minimal
administrative expense, (ii) lower our credit risk as a result of the guarantees
provided by Freddie Mac, Fannie Mae, and Ginnie Mae, (iii) enable the use of
mortgage-backed securities as collateral for financing, and (iv) invest excess
funds during periods of reduced loan demand. Included in the mortgage-backed
securities portfolio are Fannie Mae, Freddie Mac, and Ginnie Mae mortgage-backed
obligations with a book value of $113.6 million and a market value totaling
$112.9 million. In comparison, the related figures for 2003 totaled a book value
of $74.1 million and a market value of $74.4 million.

     Mortgage-backed securities typically represent a participation interest in
a pool of single-family or multifamily mortgages. The principal and interest
payments on these mortgages are passed from the mortgage originators, through
intermediaries (generally US government agencies and government-sponsored
enterprises) that pool and resell the participation interests in the form of
securities to investors such as the Bank. These US government agencies and
government-sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include Freddie Mac, Fannie Mae, and Ginnie
Mae. Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that fall within a specified range and have varying
maturities. Mortgage-backed securities generally yield less than loans that
underlie such securities because of the cost of payment guarantees and credit
enhancements. In addition, mortgage-backed securities are usually more liquid
than individual mortgage loans and may be used to collateralize certain
liabilities and obligations of the Bank. These types of securities also permit
us to optimize our regulatory capital because they have a low risk weighting.

     The actual maturity of a mortgage-backed security may be less than its
stated maturity due to prepayments of the underlying mortgages. Prepayments that
are faster than anticipated shorten the life of the security, may result in a
loss of

                                       20
<PAGE>
any premiums paid, and thereby reduce the net yield on such securities. Although
prepayments of underlying mortgages depend on many factors, including the type
of mortgages, the coupon rate, the age of mortgages, the geographical location
of the underlying real estate collateralizing the mortgages and general levels
of market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most significant determinant of the rate of prepayments. During periods of
declining mortgage interest rates, if the coupon rate of the underlying
mortgages exceeds the prevailing market interest rates offered for mortgage
loans, refinancing generally increases and accelerates the prepayment of the
underlying mortgages and the related security. Under such circumstances, we may
be subject to reinvestment risk because, to the extent that the mortgage-backed
securities amortize or prepay faster than anticipated, we may not be able to
reinvest the proceeds of such repayments and prepayments at a comparable rate.

     At December 31, 2004, municipal bonds included seven Washington State
municipal bonds that are rated AA or better.

     For further information concerning the investment portfolio, reference is
made to Note 3 and 4 of the "Notes to Consolidated Financial Statements" in the
Annual Report.

     The following table sets forth information regarding the mortgage-backed
securities (including REMICs) activity for the periods indicated.

                                                YEARS ENDED DECEMBER 31,
                                       ----------------------------------------
                                           2004          2003          2002
                                       ------------  ------------  ------------
                                               (Dollars in Thousands)

Beginning balance                      $     74,150  $     60,320  $     71,234

Mortgage-backed securities purchased         55,179        69,104        39,477

Amortization of premiums and discounts         (622)       (1,865)        2,093
Principal repayments                        (15,934)      (53,409)      (52,484)
                                       ------------  ------------  ------------
Ending balance                         $    112,773  $     74,150  $     60,320
                                       ============  ============  ============

     The following table sets forth the composition of the mortgage-backed
securities portfolio at the dates indicated.
<TABLE><CAPTION>
                                                   YEARS ENDED DECEMBER 31,
                              -----------------------------------------------------------------
                                     2004                   2003                   2002
                              -------------------    -------------------    -------------------
                                          PERCENT                PERCENT                PERCENT
                               AMOUNT    OF TOTAL     AMOUNT    OF TOTAL     AMOUNT    OF TOTAL
                              --------   --------    --------   --------    --------   --------
                                                   (Dollars in Thousands)
<S>                           <C>        <C>         <C>        <C>         <C>        <C>
Mortgage-backed securities:
       Freddie Mac            $ 19,380       17.2%   $ 16,096       21.7%   $  4,989        8.3%
       Fannie Mae               44,785       39.7%     50,067       67.5%     55,305       91.7%
       Ginnie Mae               48,608       43.1%      7,986       10.8%         --        0.0%
       REMICs                       --        0.0%          1        0.0%         26        0.0%
                              --------   --------    --------   --------    --------   --------
Total                         $112,773      100.0%   $ 74,150      100.0%   $ 60,320      100.0%
                              ========   ========    ========   ========    ========   ========
</TABLE>


     The following table presents the carrying value of the investment
securities portfolio. The market value of the investments in the table at
December 31, 2004, was approximately $132 million.

                                       21
<PAGE>
     The following table provides the scheduled maturities, carrying values,
market values, and average yields for the investment securities at December 31,
2004.

                                                         AS OF DECEMBER 31,
                                                 -------------------------------
                                                   2004        2003       2002
                                                 --------    --------   --------
                                                      (Dollars in Thousands)
Investment securities:
   US government and agency obligations          $ 17,954    $ 11,053   $ 13,081
   Corporate and municipal securities               1,217       1,324      1,337
   Mortgage-backed securities                     112,773      74,150     60,320
                                                 --------    --------   --------
Total                                            $131,944    $ 86,527   $ 74,738
                                                 ========    ========   ========













                                       22
<PAGE>
The following table provides the scheduled maturities, carrying values, market
values, and average yields for the investment securities at December 31, 2004.


<TABLE><CAPTION>
                 ONE YEAR          ONE TO FIVE YEARS     FIVE TO TEN YEARS      OVER TEN YEARS
            ------------------    ------------------    ------------------    ------------------      TOTAL      TOTAL
              BOOK      YIELD       BOOK      YIELD       BOOK      YIELD       BOOK      YIELD       BOOK       MARKET       YIELD
            --------  --------    --------  --------    --------  --------    --------  --------    --------    --------    --------
                                                      (Dollars in Thousands)
<S>         <C>       <C>         <C>       <C>         <C>       <C>         <C>       <C>         <C>         <C>         <C>
Municipals* $     --     0.00%    $     --     0.00%    $     --     0.00%    $  1,217     8.88%    $  1,217    $  1,215       8.88%
US agencies       --     0.00%      12,946     2.90%          --     0.00%       5,000     4.00%      17,946      17,954       3.20%
Freddie Mac       --     0.00%         652     5.50%       4,128     3.50%      14,840     4.39%      19,620      19,393       4.24%
Fannie Mae       129     5.50%       2,627     5.56%          --     0.00%      42,349     4.28%      45,105      44,881       4.36%
Ginnie Mae        --     0.00%          --     0.00%          --     0.00%      48,840     4.08%      48,840      48,608       4.08%
            --------  --------    --------  --------    --------  --------    --------  --------    --------    --------    --------
Total       $    129     5.50%    $ 16,225     3.43%    $  4,128     3.50%    $112,246     4.25%    $132,728    $132,051
            ========  ========    ========  ========    ========  ========    ========  ========    ========    ========
</TABLE>

* Municipal bond yields are not shown on a tax equivalent basis.
















                                       23
<PAGE>
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
---------------------------------------------

     GENERAL. Savings accounts and other deposits are important sources of our
funds for use in lending, security investments, and for other general business
purposes. In addition to deposit accounts, we derive funds from loan repayments,
interest payments, loan sales, FHLB advances and other borrowings, and
operations. The availability of funds from loan sales is influenced by general
interest rates and other market conditions. Loan repayments and interest
payments are a relatively stable source of funds, while deposit inflows and
outflows vary widely and are influenced by prevailing interest rates and money
market conditions. Borrowings are used to complement deposit inflows. Although
the use of borrowed funds changes from year to year, our internal policy is a
maximum funding position of 30% of assets. At year-end 2004 and 2003, borrowings
represented 23.5% and 22.6% of assets, respectively.

     DEPOSITS. We offer a number of deposit accounts, including savings
accounts, NOW checking, business checking accounts, money market accounts, and
time deposit accounts, ranging in maturity from 30 days to 10 years. Deposit
account terms vary with the principal differences being the minimum balance
required, the time period the funds must remain on deposit and the interest
rate.

     JUMBO TIME DEPOSITS. We offer jumbo, mini-jumbo and public funds mini-jumbo
time deposits, and these accounts are offered for minimum terms of 30 days and
in minimum amounts of $100,000, $50,000, and $20,000, respectively.

     The following table indicates the amount of the jumbo time deposits by time
remaining until maturity as of December 31, 2004. Rates paid on jumbo time
deposits are negotiable.

                                            JUMBO TIME
     MATURITY PERIOD                         DEPOSITS
     ---------------                       ------------
                                      (Dollars in Thousands)

     Three months or less                  $     45,800
     Four through six months                     32,710
     Six through 12 months                       32,969
     Over 12 months                              54,887
                                           ------------
     Total                                 $    166,366
                                           ============


     IRA ACCOUNTS. We offer tax-deferred individual retirement accounts ("IRA").
IRA accounts are offered on the same terms as the time deposits. In addition, we
offer a money market account to IRA customers. The money market IRA requires a
minimum balance of $100.

                                       24
<PAGE>
     DEPOSIT FLOWS. The following table sets forth the balance of savings
deposits in the various types of accounts that we offered at the dates
indicated.

<TABLE><CAPTION>
                                     BALANCE AT                           BALANCE AT                          BALANCE AT
                                     DECEMBER 31,   % OF     INCREASE /   DECEMBER 31,   % OF     INCREASE /  DECEMBER 31,   % OF
                                        2004      DEPOSITS   (DECREASE)      2003      DEPOSITS   (DECREASE)     2002      DEPOSITS
                                     ----------  ----------  ----------   ----------  ----------  ----------  ----------  ----------
                                                                           (Dollars in Thousands)
<S>                                  <C>         <C>         <C>          <C>         <C>         <C>         <C>         <C>
NOW and business checking accounts   $   60,269        8.9%  $   12,573   $   47,696        8.2%  $    9,462  $   38,234        7.7%
Jumbo time deposits                     166,366       24.6%      17,458      148,908       25.5%      24,300     124,608       25.1%
Extreme checking accounts                30,370        4.5%      16,867       13,503        2.3%       7,661       5,842        1.2%
Savings accounts                          8,434        1.2%        (277)       8,711        1.5%         324       8,387        1.7%
Money market deposit accounts           163,797       24.3%      33,047      130,750       22.4%      40,579      90,171       18.1%
Three month or less time deposits         1,287        0.2%      (2,147)       3,434        0.6%       1,534       1,900        0.4%
Four to six month time deposits          23,041        3.4%      12,876       10,165        1.7%       2,160       8,005        1.6%
Seven month to one-year time deposits    92,775       13.7%     (39,796)     132,571       22.7%       5,305     127,266       25.6%
13 month to five year time deposits     128,580       19.1%      41,225       87,355       15.0%      (4,808)     92,163       18.5%
Six to 10 year time deposits                450        0.1%        (348)         798        0.1%           4         794        0.2%
                                     ----------  ----------  ----------   ----------  ----------  ----------  ----------  ----------
Total deposits                       $  675,369      100.0%  $   91,478   $  583,891      100.0%  $   86,521  $  497,370      100.0%
                                     ==========  ==========  ==========   ==========  ==========  ==========  ==========  ==========

IRA accounts                         $   28,121        4.2%  $      800   $   27,321        4.7%  $    1,622  $   25,699        5.2%
</TABLE>


The following table represents an analysis of the deposit accounts by interest
rate and maturity ranges at December 31, 2004.

<TABLE><CAPTION>
                               LESS THAN     ONE TO       TWO TO       OVER
                               ONE YEAR    TWO YEARS    FIVE YEARS   FIVE YEARS     TOTAL
                              ----------   ----------   ----------   ----------   ----------
                                                 (Dollars in Thousands)
<S>                           <C>          <C>          <C>          <C>          <C>
Less than 2.01%               $  416,745   $      177   $      153   $       37   $  417,112
2.01 to 3.00%                    130,740       52,402        1,148            3      184,293
3.01 to 4.00%                      2,774        4,410       22,749           26       29,959
4.01 to 5.00%                      7,001        9,143       21,556            8       37,708
5.01 to 6.00%                        648           10        2,002            2        2,662
6.01 to 8.00%                      1,114        2,301          220           --        3,635
                              ----------   ----------   ----------   ----------   ----------
Total                         $  559,022   $   68,443   $   47,828   $       76   $  675,369
                              ==========   ==========   ==========   ==========   ==========
</TABLE>


The following table provides the deposit activity for the periods indicated.


                                       25
<PAGE>
                                                 YEARS ENDED DECEMBER 31,
                                           ------------------------------------
                                              2004         2003         2002
                                           ----------   ----------   ----------
                                                   (Dollars in Thousands)

Deposits                                   $2,089,551   $1,421,920   $1,170,547
Withdrawals                                 2,009,494    1,346,744    1,115,618
                                           ----------   ----------   ----------
Net deposits/(withdrawals)
   before interest credited                    80,057       75,176       54,928
Interest credited                              11,421       11,345       13,544
                                           ----------   ----------   ----------
Net increase/(decrease) in deposits        $   91,478   $   86,521   $   68,472
                                           ==========   ==========   ==========


     For further information concerning deposits, reference is made to Note 9 of
the "Notes to Consolidated Financial Statements" in the Annual Report.

     BORROWINGS. The FHLB serves as our primary borrowing source. Advances from
the FHLB are typically secured by a portion of our residential mortgage loans,
multifamily permanent loans, home equity loans, and securities. At December 31,
2004, we had advances totaling $234.2 million from the FHLB, which mature in
2005 through 2011 at interest rates ranging from 1.18% to 5.19%.

     In 2004, the Bank also purchased land in West Seattle for construction of
the permanent location of the West Seattle banking center. In connection with
that purchase, a $600,000 note payable was negotiated with the current owner of
the property. The rate on the note is 6.00% with a maturity date of November 1,
2009.

     At the Company level we borrow from other banks. Those borrowings totaled
$1.0 million at the end of 2004.

     The FHLB functions as a central reserve bank providing credit for
commercial banks, savings banks, savings and loan associations and certain other
member financial institutions. As a member, we are required to own capital stock
in the FHLB and are authorized to apply for advances on the security of our home
mortgages and other assets such as securities which are obligations of, or
guaranteed by, the United States government provided certain standards related
to creditworthiness have been met. Advances are made pursuant to several
different programs. Each credit program has its own interest rate and range of
maturities. Limitations on the amount of advances are based on the FHLB's
assessment of the institution's creditworthiness. Under its current credit
policies, the FHLB has limited advances to 40% of our assets. At December 31,
2004, the percentage of assets represented by FHLB borrowings was 23%. For
further information regarding borrowings and the FHLB see Note 10 of the "Notes
to Consolidated Financial Statements" in the Annual Report and "Regulation and
Supervision - Federal Home Loan Bank System" below.

CRITICAL ACCOUNTING POLICIES

     We prepare our Consolidated Financial Statements in conformity with
accounting principles generally accepted in the United States of America
("GAAP"). In accordance with GAAP, management is required to make a number of
judgments, estimates, and assumptions that affect the reported amounts of
assets, liabilities, income, and expenses in our Consolidated Financial
Statements and accompanying footnotes. We have identified four policies as being
critical because they require management to make particularly difficult,
subjective and/or complex judgments about matters that are inherently uncertain
and because the likelihood that materially different amounts would be reported
under different conditions or using different assumptions. The four critical
accounting policies that we have identified are related to the allowance for
loan losses, determining the fair value of servicing assets, estimating the
premiums for credit loss insurance, and determining the value and amortization
methods regarding loan origination fees and costs. We believe that the
judgments, estimates, and assumptions used in the preparation of our
Consolidated Financial Statements are

                                       26
<PAGE>
appropriate given the factual circumstances as of December 31, 2004. However,
given the sensitivity of our Consolidated Financial Statements to these critical
accounting policies, the use of other judgments, estimates, and assumptions
could result in material differences in our results of operations or financial
condition. Management has discussed these critical accounting policies with the
Audit Committee of our Board of Directors.

     The table below represents information about the nature of and rational for
our critical accounting policies.
<TABLE><CAPTION>
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
                              CONSOLIDATED
        CRITICAL                 BALANCE        CONSOLIDATED INCOME             NATURE OF
    ACCOUNTING POLICY         SHEET CAPTION      STATEMENT CAPTION         ESTIMATES REQUIRED                    REFERENCE
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
<S>                        <C>                  <C>                  <C>                                <C>
Allowance for loan         Reserve for loan     Provision for        The allowance for loan losses      The estimates and judgments
losses                     losses               loan losses          represents management's estimate   are described in further
                                                                     of credit losses inherent in the   detail in the Management's
                                                                     Bank's loan portfolio as of the    Discussion and Analysis -
                                                                     balance sheet date. The            "Reserve and Provision for
                                                                     estimation of the allowance is     Loan Losses" and in Note 1
                                                                     based on a variety of factors,     to the Consolidated
                                                                     including the profile of the loan  Financial Statements -
                                                                     portfolio, the local and national  "Summary of Significant
                                                                     economic outlook, and the current  Accounting Policies."
                                                                     and historical performance of the
                                                                     loan portfolio. The Bank's
                                                                     methodology for assessing the
                                                                     adequacy of the allowance
                                                                     includes the evaluation of three
                                                                     distinct elements: the formula
                                                                     allowance, the specific allowance
                                                                     and the unallocated allowance.
                                                                     The ultimate recovery of all
                                                                     loans is susceptible to future
                                                                     market factors beyond the Bank's
                                                                     control.


-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
Fair value of              Servicing assets     Noninterest income,  Determining the fair value of      See further discussion in
servicing assets                                servicing fees, net  servicing assets requires us to    the Management's Discussion
                                                of amortization      formulate conclusions about        and Analysis section of the
                                                                     anticipated changes in future      Annual Report - "Review of
                                                                     market conditions, including       Financial Condition",
                                                                     interest rates. Our servicing      "Servicing Assets", as well
                                                                     portfolio is subject to            as Note 1 to the
                                                                     prepayment risk, which subjects    Consolidated Financial
                                                                     our servicing assets to            Statements in the Annual
                                                                     impairment risk. We use a          Report - "Servicing Assets."
                                                                     valuation model to calculate the
                                                                     present value of the future cash
                                                                     flows to determine the value of
                                                                     our servicing assets. Assumptions
                                                                     used in the valuation model
                                                                     include market discount rates and
                                                                     anticipated prepayment speeds.
                                                                     The prepayment speeds are based
                                                                     upon loan prepayment forecasts
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
</TABLE>

                                       27
<PAGE>
<TABLE><CAPTION>
<S>                        <C>                  <C>                  <C>                                <C>
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
                                                                     derived from the consensus of
                                                                     investment banking firms as
                                                                     reported by online quotation
                                                                     systems for the income property
                                                                     participations; for the sales
                                                                     finance loans the actual previous
                                                                     three-month prepayment history is
                                                                     utilized. Additionally, estimates
                                                                     of the cost of servicing a loan,
                                                                     an inflation rate, ancillary
                                                                     income per loan, and default
                                                                     rates are used in the valuation
                                                                     process. We assess impairment of
                                                                     the capitalized servicing assets
                                                                     based on recalculations of the
                                                                     present value of the remaining
                                                                     future cash flows using updated
                                                                     prepayment speeds. Impairment is
                                                                     assessed on a stratum-by-stratum
                                                                     basis with any impairment
                                                                     recognized through a valuation
                                                                     for each impaired stratum.
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
Credit insurance           Accounts payable     Noninterest          Credit insurance is purchased to   See further discussion in
premiums                   and other            expense              cover credit losses on certain     the Management's Discussion
                           liabilities                               pools of sales finance loans on a  and Analysis section under
                                                                     yearly basis. The cost of the      "Results of Operations,
                                                                     credit insurance is based upon     Noninterest Expense."
                                                                     various factors such as actual
                                                                     loss experience, the size of the
                                                                     pool, etc. The contract with the
                                                                     credit insurer also includes a
                                                                     maximum exposure limit to the
                                                                     insurer of 10% of the loan
                                                                     balances. As a result, the
                                                                     monthly premiums paid are based
                                                                     on an estimate at the beginning
                                                                     of the contract year and any
                                                                     additional premiums are not due
                                                                     until the end of the contract
                                                                     year. We have analyzed the
                                                                     contract and accrue on a monthly
                                                                     basis the estimated amount
                                                                     payable at the end of the
                                                                     contract year.
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
Loan origination           Loans receivable     Interest income,     Loan origination fees and costs    See further discussion in
fees and costs                                  loans receivable     are netted and deferred over the   Note 1 to the Consolidated
                                                                     life of each loan. These net fees  Financial Statements, in the
                                                                     and costs are amortized into       annual report - "Loans" as
                                                                     income over the life of the        well as Note 5 - "Loans
                                                                     underlying loan using one of two   Receivable, Net and Loans
                                                                     methods: the straight-line method  Receivable Held-for-Sale."
                                                                     or the constant-level-yield
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
</TABLE>

                                       28
<PAGE>
<TABLE><CAPTION>
<S>                        <C>                  <C>                  <C>                                <C>
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
                                                                     method. If the loan is prepaid
                                                                     prior to maturity, the remaining
                                                                     net fees/costs are recognized
                                                                     when the loan is paid off.
                                                                     Included in these deferred
                                                                     fees/costs is a standard loan
                                                                     cost. The standard loan cost is
                                                                     calculated for each loan class
                                                                     using a model that incorporates
                                                                     the costs associated with
                                                                     originating and processing a
                                                                     loan. This cost is netted against
                                                                     the qualifying fees received from
                                                                     the borrower to determine the net
                                                                     deferred fee or cost associated
                                                                     with each loan. The amortization
                                                                     of these net fees/costs is then
                                                                     recognized into income as the
                                                                     loan matures. Estimates and
                                                                     assumptions are used to determine
                                                                     the cost of each process that is
                                                                     essential to process the loan
                                                                     request and originate it on our
                                                                     books. These estimates mainly
                                                                     include the number of hours and
                                                                     rate of compensation paid to all
                                                                     parties involved in the
                                                                     origination process of a loan.
                                                                     These estimates are updated on a
                                                                     yearly basis to ensure that any
                                                                     new loan classes have been added
                                                                     and any new processes have been
                                                                     incorporated as well as
                                                                     incorporating any changes in the
                                                                     average compensation rates. These
                                                                     estimates can vary significantly
                                                                     from year to year depending upon
                                                                     demand and overall mix of the
                                                                     varying loan types from year to
                                                                     year as well as the changes in
                                                                     the processes involved in the
                                                                     various kinds of loans.
-------------------------  -------------------  -------------------  ---------------------------------  ----------------------------
</TABLE>

RECENTLY ISSUED ACCOUNTING STANDARDS

     On December 16, 2004, the Financial Accounting Standards Board ("FASB")
issued FASB Statement No. 123(R), ACCOUNTING FOR STOCK-BASED COMPENSATION.
Statement 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income statement based
on their fair values. Pro forma disclosure is no longer an alternative. We
expect to adopt Statement 123(R) on July 1, 2005.

                                       29
<PAGE>
Statement 123(R) permits public companies to adopt its requirements using one of
two methods:

     1.   A "modified prospective" method in which compensation cost is
          recognized beginning with the effective date (a) based on the
          requirements of Statement 123(R) for all share-based payments granted
          after the effective date and (b) based on the requirements of
          Statement 123 for all awards granted to employees prior to the
          effective date of Statement 123(R) that remain unvested on the
          effective date.

     2.   A "modified retrospective" method which includes the requirements of
          the modified prospective method described above, but also permits
          entities to restate based on the amounts previously recognized under
          Statement 123 for purposes of pro forma disclosures either (a) all
          prior periods presented or (b) prior interim periods of the year of
          adoption.

We intend to adopt Statement 123(R) using the modified retrospective method,
restating all prior periods.

As permitted by Statement 123, we currently account for share-based payments to
employees using the intrinsic value method allowed under FASB Opinion No. 25
and, as such, recognize no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have a
significant impact on our results of operations, although it will have no impact
on our overall financial position. The impact of adoption of Statement 123(R)
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. However, had we adopted Statement 123(R) in
prior periods, the impact of that standard would have approximated the impact of
Statement 123 as described in the disclosure of pro forma net income and
earnings per share in Note 1 to our consolidated financial statements. Statement
123(R) also requires the benefit of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net operating cash flows and increase net financing cash flows in periods
after adoption. While we cannot estimate what those amounts will be in the
future (because they depend on, among other things, when employees exercise
stock options), the amount of operating cash flows recognized in prior periods
for such excess tax deductions were $0, $13,000, and $123,000 in 2004, 2003, and
2002, respectively.


REGULATION AND SUPERVISION

     GENERAL. As a state-chartered, federally-insured financial institution, the
Bank is subject to extensive federal and state regulation. Lending activities
and other investments must comply with various statutory and regulatory
requirements, including prescribed minimum capital standards. The Bank is
examined by the Federal Deposit Insurance Corporation (FDIC) and the Department
of Financial Institutions of the State of Washington and files periodic reports
concerning the Bank's activities and financial condition with its federal and
state regulators. Our relationship with depositors and borrowers also is
regulated to a great extent by both federal and state law, especially in such
matters as the ownership of savings accounts and the form and content of
mortgage documents.

     Federal and state banking laws and regulations govern all areas of the
operation of banks, including reserves, loans, mortgages, capital, issuance of
securities, payment of dividends and establishment of banking centers. Federal
and state bank regulatory agencies also have the general authority to limit the
dividends paid by insured banks and bank holding companies if such payments
should be deemed to constitute an unsafe and unsound practice. The respective
primary federal regulators of the Company and the Bank have authority to impose
penalties, initiate civil and administrative actions and take other steps
intended to prevent banks from engaging in unsafe or unsound practices.

     DEPOSIT INSURANCE. The FDIC is an independent federal agency that insures
the deposits, up to prescribed statutory limits, of depository institutions. The
FDIC administers two separate deposit insurance funds: the Bank Insurance Fund
("BIF") and the Savings Association Insurance Fund ("SAIF"). The BIF is a
deposit insurance fund for commercial banks and some state-chartered savings
banks, such as the Bank. The SAIF is a deposit insurance fund for most savings
associations. As an insurer of our deposits, the FDIC has examination,
supervisory, and enforcement authority over us.

                                       30
<PAGE>
     The FDIC has established a risk-based system for setting deposit insurance
assessments. Under the risk-based assessment system, an institution's insurance
assessment varies according to the level of capital the institution holds and
the degree to which it is the subject of supervisory concern. In addition,
regardless of the potential risk to the insurance fund, federal law requires the
ratio of reserves to insured deposits to be no less than $1.25 per $100. Both
funds currently meet this reserve ratio. During 2004, the assessment rate for
both SAIF and BIF deposits ranged from zero to 0.27% of covered deposits. As a
well-capitalized bank, we qualified for the lowest rate on our deposits for
2004.

     In addition to deposit insurance assessments, the FDIC is authorized to
collect assessments against insured deposits to be paid to the Finance
Corporation ("FICO") to service FICO debt incurred in the 1980's to help fund
the thrift industry cleanup. The FICO assessment rate is adjusted quarterly.
During 2004 the FICO assessment rates ranged from 1.46 cents to 1.54 cents per
$100 of insured deposits.

     Any insured bank which does not operate in accordance with or conform to
supervisory regulations, policies and directives may be sanctioned for
non-compliance. For example, proceedings may be instituted against any insured
bank or any director, officer, or employee of such bank who engages in unsafe
and unsound practices, including the violation of applicable laws and
regulations. The FDIC has the authority to terminate deposit insurance pursuant
to procedures established for that purpose. Management is not aware of any
existing circumstances that could result in termination of the deposit insurance
or any sanctions for the Bank.

     CAPITAL REQUIREMENTS. FDIC regulations recognize two types or tiers of
capital: core ("Tier 1") capital and supplementary ("Tier 2") capital. Tier 1
capital generally includes common stockholders' equity, non-cumulative perpetual
preferred stock, and hybrid capital instruments designated by the FDIC less most
intangible assets. Tier 2 capital, which is limited to 100 percent of Tier 1
capital, includes such items as qualifying general loan loss reserves,
cumulative perpetual preferred stock, mandatory convertible debt, term
subordinated debt and limited life preferred stock; however, the amount of term
subordinated debt and intermediate term preferred stock (original maturity of at
least five years but less than 20 years) that may be included in Tier 2 capital
is limited to 50 percent of Tier 1 capital.

     The FDIC currently measures an institution's capital using a leverage limit
together with certain risk-based ratios. The FDIC's minimum leverage capital
requirement specifies a minimum ratio of Tier 1 capital to average total assets.
Most banks are required to maintain a minimum leverage ratio of at least 4% to
5% of total assets.

     FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in one
of four categories and given a percentage weight -- 0%, 20%, 50% or 100% --
based on the relative risk of that category. In addition, certain
off-balance-sheet items are converted to balance sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories. Under
the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital)
to risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to
risk-weighted assets must be at least 4%. We have calculated the Bank's total
risk-based ratio to be 11.6% as of December 31, 2004, and our Tier 1 risk-based
capital ratio to be 10.4% for the Bank.

     Federal statutes establish a supervisory framework based on five capital
categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. An institution's
category depends upon where its capital levels are in relation to relevant
capital measures, which include a risk-based capital measure, a leverage ratio
capital measure, and certain other factors. The federal banking agencies have
adopted regulations that implement this statutory framework. Under these
regulations, an institution is treated as well capitalized if its ratio of total
capital to risk-weighted assets is 10% or more, its ratio of Tier I capital to
risk-weighted assets is 6% or more, its ratio of Tier I capital to adjusted
total assets is 5% or more, and it is not subject to any federal supervisory
order or directive to meet a specific capital level.

     During 2002 and 2003, in addition to capital provided through retained
earnings, we augmented our regulatory capital with trust preferred securities
("TPS"). These securities have a maturity of 30 years and are redeemable by the

                                       31
<PAGE>
Company at par after five years, with certain exceptions. The TPS securities
have been deconsolidated from our financial statements in accordance with FASB
Interpretation No. 46 as amended but qualify as capital for regulatory capital
limits. They are eligible for Tier I leverage capital treatment up to 25% of
Tier I capital and for risk-weighted capital up to 50% of Tier I capital. We
issued $17 million in securities ($9 million in 2002 and $8 million in 2003).
There are no present plans to issue additional TPS securities, and we believe
that our current capital, plus retained earnings for year 2005, will meet our
budgeted growth in assets for the forthcoming year.

     Management believes that, under the current regulations, we will continue
to meet our minimum capital requirements as a well capitalized institution in
the foreseeable future. However, events beyond our control, such as a downturn
in the economy in areas where we have most of our loans, could adversely affect
future earnings and, consequently, the ability to meet our capital requirements.

     FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT ("FDICIA"). The Bank
has surpassed the $500 million asset threshold and as such is required to be
compliant with the FDICIA originally enacted in 1991 and with enhanced
provisions adopted in 1993. In general, FDICIA requires us to conduct an annual
independent audit of our financial statements, appoint an independent audit
committee of outside directors, report on and assess management's
responsibilities for preparing financial statements, and establish an internal
control structure.

     An independent accountant must attest to and report on the assertions in
management's report concerning these internal controls, with the desired outcome
of efficient and effective operations; the safeguarding of assets; reliable
financial reporting; and compliance with applicable laws and regulations.

     The FDIC, our primary regulator, has outlined, in general, the requirements
for compliance with FDICIA but does not provide specific guidance on the
internal control structure, documentation, or procedures to test the
effectiveness. It is up to each bank to establish, document and design
procedures to evaluate and test the internal control structure over financial
reporting and compliance with designated laws and regulations that minimally
include loans to insiders and dividend restrictions.

     We have identified and documented existing controls with consideration
given to the control environment, risk assessment, control activities,
information and communication systems, and monitoring activities to ensure
compliance with the regulatory requirements. These systems and controls are
reviewed, at a minimum, on a yearly basis to comply with the FDICIA
requirements.

     Under FDICIA, the Audit Committee of the Board of Directors has several
responsibilities that include but are not limited to overseeing the internal
audit function; conducting periodic meetings with management, the independent
public accountants, and the internal auditors; review of significant accounting
policies and audit conclusions regarding significant accounting estimates;
review of the assessments prepared by management and the independent auditors on
the adequacy of internal controls and the resolution of identified material
weaknesses and reportable conditions in internal controls; and the review of
compliance with laws and regulations.

     FEDERAL HOME LOAN BANK SYSTEM. The FHLB serves as a reserve or central bank
for the member institutions within its assigned region. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLBs. It
makes loans (I.E., advances) to members in accordance with policies and
procedures established by the Federal Housing Finance Board and the Board of
Directors of the FHLB of Seattle. As a member, we are required to purchase and
hold Class B(1) stock in the FHLB of Seattle. The amount of stock a member
institution is required to hold is based on the cumulative value of three
criteria:

     o    Advance Stock Purchase - Under this requirement, a member must
          currently hold stock with a par value equal to 3.5% of the outstanding
          principal balance of advances extended to the member.

                                       32
<PAGE>
     o    Mortgage Purchase Program - Under this requirement, a member must
          currently hold stock with a par value equal to 5.0% of the outstanding
          principal balance of the loans sold to the FHLB, by the member, under
          the Mortgage Purchase Program, minus the Membership Stock Purchase
          requirement.
     o    Membership Stock Purchase - Under this requirement, a member must
          currently hold stock with a par value equal to the greater of $500 or
          0.75% of the member's home mortgage loans outstanding as of the most
          recent calendar year end.

     As of December 31, 2004, we held stock in the FHLB in the amount of $12.9
million.

     FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires (under
"Regulation D") that all depository institutions, including savings banks,
maintain reserves on transaction accounts or non-personal time deposits. These
reserves may be in the form of cash or non-interest bearing deposits with the
regional Federal Reserve Bank. NOW accounts and other types of accounts that
permit payments or transfers to third parties fall within the definition of
transaction accounts and are subject to Regulation D reserve requirements, as
are any non-personal time deposits at a savings bank. Under Regulation D, we
must maintain reserves against net transaction accounts in the amount of 3% on
amounts of $45.4 million (will increase to $47.6 million in 2005) or less, plus
10% on amounts in excess of $45.4 million (will increase to $47.6 million in
2005). We may designate and exempt $6.6 million (will increase to $7.0 million
in 2005) of certain reservable liabilities from these reserve requirements.
These amounts and percentages are subject to adjustment by the Federal Reserve
Board. The reserve requirement on non-personal time deposits with original
maturities of less than 1.5 years is 0%. As of December 31, 2004, our deposit
with the Federal Reserve Bank and vault cash exceeded the reserve requirements.

     CONTROL ACQUISITIONS. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company unless the
Federal Reserve Board has been notified and has not objected to the transaction.
Under a rebuttable presumption established by the Federal Reserve Board, the
acquisition of 10% or more of a class of voting stock of a bank holding company
with a class of securities registered under Section 12 of the Exchange Act, such
as the Company, would, under the circumstances set forth in the presumption,
constitute acquisition of control of the Company.

     In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the
case of an acquirer that is a bank holding company) or more of the outstanding
Common Stock of the Company or otherwise obtaining control or a "controlling
influence" over the Company.

     REGULATORY RESTRICTIONS ON DIVIDENDS. It is the policy of the Federal
Reserve Board that bank holding companies should pay cash dividends on common
stock only out of income available over the past year and only if prospective
earnings retention is consistent with the organization's expected future needs
and financial condition. The policy provides that bank holding companies should
not maintain a level of cash dividends that undermines the bank holding
company's ability to serve as a source of strength to its banking subsidiaries.

     SCOPE OF PERMISSIBLE ACTIVITIES. Except as provided below, the Company is
prohibited from acquiring a direct or indirect interest in or control of more
than 5% of the voting shares of any company which is not a bank or bank holding
company and from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks or furnishing services to its
subsidiary banks, except the Company may engage in or own shares of companies
engaged in certain activities found by the Federal Reserve Board to be so
closely related to banking or managing and controlling banks as to be a proper
incident thereto. These activities include, among others, operating a mortgage,
finance, credit card or factoring company; performing certain data processing
operations; providing investment and financial advice; acting as an insurance
agent for certain types of credit-related insurance; and providing certain stock
brokerage and investment advisory services. In approving acquisitions or the
addition of activities, the Federal Reserve considers whether the acquisition or
the additional activities can reasonably be expected to produce benefits to the
public, such as greater convenience, increased competition, or gains in
efficiency, that outweigh possible adverse effects such as undue concentration
of resources, decreased or unfair competition or unsound banking practices.

                                       33
<PAGE>
     In 2001, the Gramm-Leach-Bliley Act granted certain expanded powers to bank
holding companies and allowed them to become financial holding companies and
thereby affiliate with securities firms and insurance companies and engage in
other activities that are financial in nature. The Gramm-Leach-Bliley Act
defines "financial in nature" to include securities underwriting, dealing and
market making; sponsoring mutual funds and investment companies; insurance
underwriting and agency; merchant banking activities; and activities that the
Federal Reserve has determined to be closely related to banking. No regulatory
approval will be required for a financial holding company to acquire a company,
other than a bank or savings association, engaged in activities that are
financial in nature or incidental to activities that are financial in nature, as
determined by the Federal Reserve.

     STOCK REPURCHASES. Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, such as the Company,
are required to give the Federal Reserve prior written notice of any purchase or
redemption of its outstanding equity securities if the gross consideration for
the purchase or redemption, when combined with the net consideration paid for
all such purchases or redemptions during the preceding 12 months, is equal to
10% or more of their consolidated net worth. The Federal Reserve may disapprove
such a purchase or redemption if it determines that the proposal would
constitute an unsafe or unsound practice or would violate any law, regulation,
Federal Reserve order, or any condition imposed by, or written agreement with,
the Federal Reserve.

     CAPITAL REQUIREMENTS. The Federal Reserve has established capital adequacy
guidelines for bank holding companies that generally parallel the capital
requirements of the FDIC for the Bank.

     The Company's total risk-based capital must equal 8% of risk-weighted
assets. As of December 31, 2004, the Company's total risk-based capital was
11.9% of risk-weighted assets and its risk-based capital of Tier 1 capital was
10.6% of risk-weighted assets.


FEDERAL AND STATE TAXATION

FEDERAL TAXATION

     GENERAL. The Company and its subsidiaries report their income on a fiscal
year basis using the accrual method of accounting and are subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank.

     The current thrift bad debt rules were passed by Congress as part of "The
Small Business Job Protection Act of 1996." The rules adopted a method for
deducting additions to the tax bad debt reserves for all financial institutions
for tax years beginning after December 31, 1995. These rules also require that
all institutions recapture all or a portion of their bad debt reserves added
since the base year (last taxable year beginning before January 1, 1988). We
have previously recorded a deferred tax liability equal to the bad debt
recapture and as such the rules will have no effect on the net income or federal
income tax expense. For taxable years since 1995, the Bank's bad debt deduction
is determined on the basis of net charge-offs during the taxable year.

     MINIMUM TAX. In addition to regular corporate income tax, corporations are
subject to an alternative minimum tax which generally is equal to 20% of
alternative minimum taxable income (taxable income, increased by tax preference
items and adjusted for certain regular tax items). The preference items which
are generally applicable include an amount equal to 75% of the amount by which a
financial institution's adjusted current earnings (generally alternative minimum
taxable income computed without regard to this preference and prior to reduction
for net operating losses) exceed its alternative minimum taxable income without
regard to this preference and the excess of the institution's bad debt deduction
over the amount deductible under the experience method. Alternative minimum tax
paid can be credited against regular tax due in later years.

                                       34
<PAGE>
     Our federal income tax returns have been audited by the Internal Revenue
Service through year-end 1991.


STATE TAXATION

     We are subject to a business and occupation tax, which is imposed under
Washington law at the rate of 1.5% of gross receipts. However, interest received
on loans secured by first lien mortgages or deeds of trust on residential
properties is not subject to such tax.

     Reference is made to Note 12, of the "Notes to Consolidated Financial
Statements" in the Annual Report for additional information regarding income
taxes payable by the Company.


COMPETITION

     Competition for deposits comes from securities brokerage firms and other
financial institutions, many of which have greater resources than we do. In
addition, during times of low interest rates we experience significant
competition for investors' funds from bond mutual funds.

     We compete for deposits principally by offering depositors a wide variety
of savings programs, convenient banking center locations, pre-authorized payment
and withdrawal systems, on line banking services, tax deferred retirement
programs, and other miscellaneous services.

     Our competition for real estate and other loans comes principally from
mortgage banking companies, savings banks, savings and loan associations,
commercial banks, insurance companies and other institutional lenders. We
compete for loan originations primarily through the interest rates and loan fees
we charge and the efficiency and quality of services we provide borrowers,
business owners, real estate brokers and builders. The competition for loans we
encounter, as well as the types of institutions with which we compete, varies
from time to time depending upon certain factors. The conditions that affect
competition include, among others, the general availability of funds and credit,
general and local economic conditions, current interest rate levels, volatility
in the mortgage markets and other factors which are not readily predictable.


EMPLOYEES

     At December 31, 2004, we employed 211 full-time and 12 part-time employees.
Our employees are not represented by any collective bargaining agreement.
Management considers relations with our employees to be good.


                                       35
<PAGE>
ITEM 2.  PROPERTIES
-------------------

     The following table provides the location of the banking centers and loan
offices, as well as certain information relating to these offices.
<TABLE><CAPTION>
                                                                                               LEASE INFORMATION
                                                                                     ----------------------------------------
                                   YEAR        NET BOOK       SQUARE      OWNED/      INITIAL       DATE OF         RENEWAL
LOCATION                          OPENED        VALUE          FEET       LEASED       LEASE      TERMINATION        TERMS
--------                          ------       --------       ------      ------     ---------     ----------     -----------
<S>                               <C>          <C>            <C>         <C>        <C>           <C>            <C>
                                        (Dollars in Thousands)

Bellevue Banking Center &          1985        $ 12,816       73,049       Owned        --            --               --
       Administrative Offices
       400 108th Avenue NE
       Bellevue, WA 98004
       (Originally opened 1953)

Issaquah Banking Center            1977             631        2,860       Owned        --            --               --
       855 Rainier Blvd. N
       Issaquah, WA 98027
       (Originally opened 1965)

Monroe Banking Center              1993           1,087        5,415       Owned        --            --               --
       19265 State Route 2
       Monroe, WA 98272
       (Originally opened 1968)

Crossroads Banking Center          1969             220        2,860       Owned        --            --               --
       15635 NE 8th Street
       Bellevue, WA 98008

Redmond Banking Center             1977             461        6,474       Owned        --            --               --
       16900 Redmond Way
       Redmond, WA 98052

Ballard Banking Center             2002           2,000        2,400       Owned        --            --               --
       6301 15th Avenue NW
       Seattle, WA 98107
       (Originally opened 1994)

West Seattle Banking Center        1996           1,064        2,200       Leased    March 1,      February       One five-
       4520 California Ave. SW                       (2)                             1996          28, 2006       year option
       Seattle, WA 98116

Bellevue West Banking Center       1997           2,942        8,259       Owned        --            --               --
       10001 NE 8th Street
       Bellevue, WA 98004

Kirkland Banking Center            2000             242        3,692      Leased     September     September      Two five-
       278 Central Way                                                               16, 1999      16, 2009       year options
       Kirkland, WA 98033

Juanita Banking Center             2001           1,278        4,118       Owned        --            --               --
       13633 100th Avenue NE
       Kirkland, WA 98034
</TABLE>


                                       36
<PAGE>
<TABLE><CAPTION>
                                                                                               LEASE INFORMATION
                                                                                     ----------------------------------------
                                   YEAR        NET BOOK       SQUARE      OWNED/      INITIAL       DATE OF         RENEWAL
LOCATION                          OPENED        VALUE          FEET       LEASED       LEASE      TERMINATION        TERMS
--------                          ------       --------       ------      ------     ---------     ----------     -----------
<S>                               <C>          <C>            <C>         <C>        <C>           <C>            <C>
                                        (Dollars in Thousands)

Woodinville Banking Center         2003        $  1,772        2,893       Owned        --            --               --
       13415 NE 175th Street
       Woodinville, WA 98072

Sammamish Banking Center           2003             526        3,250      Leased     December      December       Two five-
       336 - 228th Avenue NE                                                         23, 2002      23, 2012       year options
       Suite 100
       Sammamish, WA 98074


Loan Production Offices
-----------------------

Tacoma Loan Office                 1999             (1)          300      Leased     January 1,    December            --
       2323 N 31st Street                                                            1999          31, 2005
       Suite 200
       Tacoma, WA 98403
       (Originally opened 1996)

Bellingham Loan Office             2003             (1)          898      Leased     February      February            --
       1200 Tenth Street                                                             28, 2003      28, 2006
       Suite 103
       Bellingham, WA 98225
       (Originally opened 1998)

Florida Loan Office                2001             (1)          416      Leased     July 6,       July 31,       Year-to-year
       3015 Hartley Road                                                             2001          2005
       #12B/12C
       Jacksonville, FL 32257
</TABLE>

(1) Net book values of assets are included with Bellevue Administrative offices.
(2) Purchase of land for construction of new West Seattle Banking Center.



     In 2004 we completed the interior remodel of one banking center and began
the construction of an entire new facility for another existing banking center.
We will continue this process with the remodeling of two additional banking
centers in 2005. Once those are complete, we do not anticipate the need for any
further banking center remodels. In 2004 we also completed two land
acquisitions, one in West Seattle for $1,000,000 and one in Canyon Park for
$1,038,000. We anticipate construction of new banking centers to begin on both
sites in 2005. In 2004 we also began a maintenance and upgrade plan for our
seven-story corporate headquarters, and we anticipate these plans will be
completed in 2005.

     We review the utilization of our properties on a regular basis and believe
that we have adequate facilities for current operations. We may open new banking
centers from time-to-time, depending on the availability of capital resources
and the locations' potential for growth and profitability.

     We regularly analyze demographic and geographic data as well as information
regarding our competitors and our current loan and deposit customers in order to
locate potential future bank sites.

                                       37
<PAGE>
ITEM 3.  LEGAL PROCEEDINGS
--------------------------

     At December 31, 2004, the Bank was not engaged in any litigation, which in
the opinion of management, after consultation with its counsel, would be
material to the Company.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
------------------------------------------------------------

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2004.



                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
------------------------------------------------------------------------------

     The information contained under the caption "Stock Information" in the
Annual Report is incorporated herein by reference.

     The following table provides the cash dividends declared by the Company
during the last five fiscal years.


Quarter Ending  Fiscal 2004  Fiscal 2003  Fiscal 2002  Fiscal 2001  Fiscal 2000
--------------  -----------  -----------  -----------  -----------  -----------
Fiscal year       $ 0.32       $ 0.28       $ 0.28       $ 0.22       $ 0.20

March 31            0.07         0.07         0.07         0.05         0.05
June 30             0.07         0.07         0.07         0.05         0.05
September 30        0.09         0.07         0.07         0.05         0.05
December 31         0.09         0.07         0.07         0.07         0.05


ITEM 6.  SELECTED FINANCIAL DATA
--------------------------------

     The information contained in the section captioned "Selected Financial
Data" in the Annual Report is incorporated herein by reference.


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
------------------------------------------------------------------------
         RESULTS OF OPERATIONS
         ---------------------

     The information contained under the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report is incorporated herein by reference.


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------------

     The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Market Risk
Sensitive Instruments" in the Annual Report is incorporated herein by reference.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
----------------------------------------------------

     The financial statements contained in the Annual Report, which are listed
under Item 15 herein, are incorporated herein by reference.

     The following table provides the equity compensation plan information.


                                       38
<PAGE>
<TABLE><CAPTION>
                                                                                    NUMBER OF
                                                                                   SECURITIES
                                                                                    REMAINING
                                                                                  AVAILABLE FOR
                                              NUMBER OF                          FUTURE ISSUANCE
                                          SECURITIES TO BE       WEIGHTED-        UNDER EQUITY
                                             ISSUED UPON          AVERAGE         COMPENSATION
                                             EXERCISE OF      EXERCISE PRICE    PLANS (EXCLUDING
                                             OUTSTANDING      OF OUTSTANDING       SECURITIES
                                               OPTIONS            OPTIONS       REFLECTED IN (A))
                                            ------------       ------------       ------------
                                             (column a)
<S>                                         <C>                <C>                <C>
Equity compensation plans approved
    by security holders                          599,131       $      13.81            546,336

Equity compensation plans not
    approved by security holders                     N/A                N/A                N/A
                                            ------------       ------------       ------------
Total                                            599,131       $      13.81            546,336
                                            ============       ============       ============
</TABLE>



ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
------------------------------------------------------------------------
         FINANCIAL DISCLOSURE
         --------------------

         Not applicable.


ITEM 9A. CONTROLS AND PROCEDURES
--------------------------------

     The Bank's Chief Executive Officer and Chief Financial Officer and other
appropriate officers have evaluated the Bank's disclosure controls and
procedures designed to ensure that information required to be disclosed in our
filings under the Securities and Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms, and have concluded that, although there
are inherent limitations in all control systems and although we apply certain
reasonable cost/benefit considerations to the design of our disclosure controls
and procedures, as of December 31, 2004, those disclosure controls and
procedures are effective.

     There have been no changes in the Bank's internal controls or in other
factors known to the Bank that could significantly affect these controls
subsequent to their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

     While we believe that our existing disclosure controls and procedures have
been effective to accomplish these objectives, we intend to continue to examine,
refine and formalize our disclosure controls and procedures and to monitor
ongoing developments in this area.

     Effective with this annual report, Section 404 of the Sarbanes-Oxley Act
requires management, with the participation of our CEO and CFO, to report
annually on their responsibilities for establishing and maintaining internal
control over financial reporting, the framework used to evaluate such internal
controls and the effectiveness of these internal controls. Section 404 also
requires that our independent public accountants attest to management's report.
The Securities and Exchange Commission has issued an exemptive order allowing
eligible companies of a certain size to utilize a 45-day extension of time to
file this report and the attestation. We have elected to utilize this extension
and, therefore, this 10-K does not include this report or the attestation. The
report and the attestation for this 10-K will be


                                       39
<PAGE>
filed in an amended Form 10-K in April 2005. We have spent considerable time and
resources analyzing documents and testing our internal controls and we are
currently not aware of any material weaknesses in our internal controls over
financial reporting and related disclosures.


ITEM 9B. OTHER INFORMATION
--------------------------

     Not applicable.




                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
-----------------------------------------------------------

     The information contained under the section captioned "Election of
Directors" and "Board of Directors Committees and Reports; Certain Relationships
and Director and Executive Compensation" in the Company's Proxy Statement is
incorporated herein by reference. Reference is made to the cover page of this
report for information regarding compliance with Section 16(a) of the Exchange
Act.

     The following table sets forth certain information with respect to the
executive officers of the Company and the Bank.















                                       40
<PAGE>
<TABLE><CAPTION>
                     AGE AT                                     POSITION
                  DECEMBER 31,-------------------------------------------------------------------------------
NAME                  2004                 COMPANY                                  BANK
-------------------  ------   ---------------------------------    ------------------------------------------
<S>                  <C>      <C>                                  <C>
John R. Valaas         60     President and Chief Executive        President and Chief Executive Officer
                              Officer

Roger A. Mandery       62     Executive Vice President, Chief      Executive Vice President - Chief Financial
                              Financial Officer, and Treasurer     Officer, and Treasurer

Richard J. Collette    57                                          Executive Vice President - Commercial
                                                                   Banking Group

James R. Boudreau      57     Executive Vice President and         Executive Vice President - Chief Credit
                              Assistant Secretary                  Officer

Joseph P. Zavaglia     56                                          Executive Vice President - Retail Banking
                                                                   Group

Scott B. Harlan        43                                          Executive Vice President - Residential and
                                                                   Consumer Lending

Robin R. Carey         47                                          Executive Vice President - Operations and
                                                                   Administration and Assistant Secretary

Kari A. Stenslie       40     Senior Vice President, Controller    Senior Vice President - Controller and
                              and Assistant Treasurer              Assistant Treasurer
</TABLE>



     The following is a description of the principal occupation and employment
of the executive officers of the Bank during at least the past five years:

     JOHN R. VALAAS is the President and Chief Executive Officer for the Bank
and the Company. Prior to his appointment as President of the Bank in 1992, Mr.
Valaas was Senior Vice President and manager of the Commercial Financial
Services Division at Seafirst Bank where he was employed from 1983 to 1992. Mr.
Valaas has over 30 years of experience in commercial banking.

     ROGER A. MANDERY, CPA, is Executive Vice President for the Bank and the
Company. Prior to serving in that capacity, from March 1984 to 1989, he was
Senior Vice President of Finance. Mr. Mandery serves as the Bank's Chief
Financial Officer and in this capacity is responsible for the Bank's treasury,
accounting, internal audit, and asset/liability functions.

     RICHARD J. COLLETTE is the Bank's Executive Vice President and Manager of
its Commercial Banking Group. His responsibilities include overseeing commercial
real estate lending and business banking. Prior to joining the Bank in December
of 2001, he was the Northwest Region's Senior Credit Risk Management Executive
for Bank of America where he was employed from 1973 to 2001. Mr. Collette has
over 31 years of experience in commercial banking.

     JAMES R. BOUDREAU is the Bank's Executive Vice President and Chief Credit
Officer and the Company's Executive Vice President and has been employed by the
Bank since 1975. He is responsible for overseeing lending

                                       41
<PAGE>
policies for all lending areas of the Bank. He chairs the Bank's loan committees
and supervises the asset management and credit administration departments.

     JOSEPH P. ZAVAGLIA is the Bank's Executive Vice President of the Retail and
Community Business Banking Groups. His responsibilities include overseeing the
banking center distribution network and the community business banking
department. Prior to joining the Bank in February 2003, Mr. Zavaglia was Senior
Vice President and Consumer Market Executive for Bank of America where he was
employed from 1975 to 2003. Mr. Zavaglia has over 29 years of commercial and
retail banking experience.

     SCOTT B. HARLAN is the Bank's Executive Vice President of Consumer and
Residential Lending and has been employed by the Bank since 1985. He is
responsible for consumer and residential lending as well as the information
systems department.

     ROBIN R. CAREY is the Bank's Executive Vice President of Operations and
Administration and has been employed by the Bank since 1979. She is responsible
for overseeing facilities and security, human resources and customer service and
support, which includes lending and deposit support functions.

     KARI A. STENSLIE, CPA, CMA, is Senior Vice President and Controller for the
Bank and the Company and has been employed by the Bank since 1988. She is
responsible for the Bank's accounting systems, financial reporting, tax
accounting functions, financial analysis, and workflow analysis.


ITEM 11. EXECUTIVE COMPENSATION
-------------------------------

     The information required by this item is incorporated by reference to the
section captioned - "Board of Directors Committees and Reports; Certain
Relationships and Director and Executive Compensation" in the Proxy Statement
for the Company's 2005 Annual Meeting of Shareholders.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
---------------------------------------------------------------------------
         RELATED STOCKHOLDER MATTERS
         ---------------------------

     The information required by this item is incorporated herein by reference
to the sections captioned "Election of Directors" and "Principal Holders of
Voting Securities and Management" in the Company's Proxy Statement for the
Company's 2005 Annual Meeting of Shareholders.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
-------------------------------------------------------

     The information required by this item is incorporated by reference to the
sections captioned "Election of Directors" and "Board of Directors Committees
and Reports; Certain Relationships and Director and Executive Compensation" in
the Company's Proxy Statement for the Company's 2005 Annual Meeting of
Shareholders.


ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
-----------------------------------------------

     The information required by this item is incorporated by reference to the
section captioned "Board of Directors Committees and Reports; Certain
Relationships and Director and Executive Compensation-Report of the Audit
Committee and Audit Fees" in the Company's Proxy Statement for the Company's
2005 Annual Meeting of Shareholders.


                                     PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
---------------------------------------------------

                                       42
<PAGE>
(a) (1)  Consolidated Financial Statements (*)
         ---------------------------------

         Report of Independent Registered Public Accounting Firm
         Consolidated Statements of Financial Condition at December 31, 2004
            and 2003
         Consolidated Statements of Income for the three years ended December
            31, 2004
         Consolidated Statements of Stockholders' Equity and Comprehensive
            Income for the three years ended December 31, 2004
         Consolidated Statements of Cash Flows for the three years ended
            December 31, 2004
         Notes to Consolidated Financial Statements

    (2)  All required financial statement schedules are included in the Notes to
         Consolidated Financial Statements.

    (3)  Exhibits
         --------

         (3)     a. Articles of Incorporation (a)
                 b. Bylaws (a)
                 We are parties to certain debt instruments under which the
                 total amount of securities authorized does not exceed 10
                 percent of our total consolidated assets.  Pursuant to
                 paragraph 4(iii)(A) of Item 601(b) of Regulation S-K, we agree
                 to furnish a copy of those instruments to the Securities and
                 Exchange Commission upon request.
         (10.1)  Agreement for purchase of company headquarters building
         (11)    Statement regarding computation of per share earnings.
                 Reference is made to the Company's Consolidated Statements of
                 Income attached hereto as part of Exhibit 13, which are
                 incorporated herein by reference.
         (13)    2004 Annual Report to Shareholders
         (14)    Code of Business Conduct and Ethics adopted February 26, 2004
         (21)    Subsidiaries
         (23.1)  Consent of Moss Adams LLP, Independent Registered Public
                 Accounting Firm
         (31.1)  Certification of Chief Executive Officer Pursuant to Section
                 302 of the Sarbanes-Oxley Act of 2002
         (31.2)  Certification of Chief Financial Officer Pursuant to Section
                 302 of the Sarbanes-Oxley Act of 2002
         (32.0)  Certification of Chief Executive Officer and Chief Financial
                 Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
                 2002


(*)  Incorporated by reference from 2004 Annual Report to Shareholders attached
     hereto as Exhibit 13.

(a)  Incorporated by reference to the Current Report on Form 8-K filed with the
     SEC on September 21, 2000.


                                       43
<PAGE>
                                   SIGNATURES
                                   ----------

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                               FIRST MUTUAL BANCSHARES, INC.


DATE:  March 15, 2005          BY: /s/ John R. Valaas
                                   ---------------------------------------------
                                   John R. Valaas, President and Chief Executive
                                   Officer and Duly Authorized Representative


     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

By:  /s/ Roger A. Mandery                 By:  /s/ Victor E. Parker
     ------------------------------            ------------------------------
     Roger A. Mandery                          Victor E. Parker
     Principal Financial Officer               Director

Date:  March 15, 2005                     Date:  March 15, 2005


By:  /s/ Kari A. Stenslie                 By:  /s/ George W. Rowley, Jr.
     ------------------------------            ------------------------------
     Kari A. Stenslie                          George W. Rowley, Jr.
     Principal Accounting Officer              Director

Date:  March 15, 2005                     Date:  March 15, 2005


By:  /s/ F. Kemper Freeman, Jr.           By:  /s/ Richard S. Sprague
     ------------------------------            ------------------------------
     F. Kemper Freeman, Jr.                    Richard S. Sprague
     Chairman of the Board                     Director

Date:  March 15, 2005                     Date:  March 15, 2005


By:  /s/ James J. Doud, Jr.               By:  /s/ John R. Valaas
     ------------------------------            ------------------------------
     James J. Doud, Jr.                        John R. Valaas
     Director                                  Director

Date:  March 15, 2005                     Date:  March 15, 2005


By:  /s/ Mary Case Dunnam                 By:  /s/ Robert C. Wallace
     ------------------------------            ------------------------------
     Mary Case Dunnam                          Robert C. Wallace
     Director                                  Director

Date:  March 15, 2005                     Date:  March 15, 2005


By:  /s/ Janine Florence                  By:  /s/ Robert J. Herbold
     ------------------------------            ------------------------------
     Janine Florence                           Robert J. Herbold
     Director                                  Director

Date:  March 15, 2005                     Date:  March 15, 2005

                                       44