Exhibit 13
Management Discussion and Analysis and Consolidated Financial Statements included in 2000 Financial Information distributed to shareholders with the 2000 Annual Report

---

| | 2000 Financial Information
| | --------------------------
| | LOGO                      

---

PACIFIC NORTHWEST BANCORP  2000 FINANCIAL INFORMATION

CONTENTS

|MANAGEMENT DISCUSSION AND ANALYSIS                |  | 1  | )
|------------------------------------------------- |  | -- | -
|REPORT OF MANAGEMENT TO SHAREHOLDERS              |  | 29 | )
|REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS |  | 30 | )
|CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION    |  | 31 | )
|CONSOLIDATED STATEMENTS OF INCOME                 |  | 32 | )
|CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY   |  | 33 | )
|CONSOLIDATED STATEMENTS OF CASH FLOWS             |  | 34 | )
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        |  | 36 | )

---

MANAGEMENT DISCUSSION AND ANALYSIS

The following discussion is provided for the consolidated operations of Pacific Northwest Bancorp (Bancorp), which includes its wholly owned subsidiaries
(collectively PNWB). As of December 31, 2000 Bancorp's wholly owned subsidiaries were Pacific Northwest Bank and InterWest Capital Trust I. The purpose of this discussion is to focus on
significant factors concerning PNWB's financial condition and results of operations. This discussion should be read along with the consolidated financial statements (including notes thereto) for an
understanding of the following discussion and analysis.

On
June 20, 2000 the Board of Directors approved a change of PNWB's fiscal year end from September 30 to December 31, retroactively to January 1, 2000.
Effective September 1, 2000, InterWest Bancorp, Inc. changed its name to Pacific Northwest Bancorp and the company's commercial bank subsidiary, InterWest Bank, changed its name to
Pacific Northwest Bank. In conjunction with the name changes, PNWB relocated its corporate headquarters to Seattle.

The
Year 2000 was a period of significant change and transition for Pacific Northwest Bancorp. PNWB adopted a new corporate name, transitioned to a new executive management team
experienced in commercial banking, converted to a new enhanced operating system, changed to a commercial bank charter, relocated its corporate headquarters and changed its fiscal year end. These
initiatives implemented during 2000 reflect PNWB's commitment to become the premier commercial bank headquartered in the Pacific Northwest.

During
the past year, a number of employees were dedicated to converting PNWB to a single enhanced operating system. The first four phases of the conversion were completed during 2000
and the final phase will be completed early in the second quarter of 2001. The new operating system provides PNWB with the ability to increase the types of products and services offered to business
and retail customers.

Effective
July 1, 2000 PNWB converted its subsidiary bank charter from a state savings bank to a state commercial bank. In conjunction with the charter conversion, PNWB merged
its banking subsidiaries into a single commercial bank. This is an indication of a continued focus on commercial banking. PNWB continues to change the asset and liability structure to reduce its
sensitivity to movements in interest rates by increasing both commercial loans and retail deposits.

Bancorp
is a bank holding company incorporated in Washington state. PNWB is a financial services company providing a variety of products and services for both business and individual
customers. Financial services of PNWB include the banking activities of accepting deposits from businesses and individuals and originating commercial and commercial real estate loans, residential
loans, consumer loans, and agricultural loans. PNWB continues to change the composition of the loan portfolio and the deposit base as part of the migration to a commercial bank. These changes are
designed to have a positive impact on net interest income and service fee revenue while continuing to meet the needs of PNWB's customers.

Bancorp
completed the acquisition of six commercial banking institutions since 1996. The acquisition of Central Bancorporation (Central) on August 31, 1996 was the first of
these acquisitions. Central's commercial banking subsidiaries, Central Washington Bank and North Central Washington Bank, operated ten financial centers in central Washington. At the acquisition date,
Central had total consolidated assets of $206.1 million, total loans receivable of $132.2 million, total deposits of $181.9 million and shareholders' equity of
$17.1 million.

On
January 15, 1998, Bancorp acquired Puget Sound Bancorp, Inc. (Puget), of Port Orchard, Washington. Puget's commercial banking subsidiary, First National Bank of Port
Orchard, operated three financial centers in western Washington. At the acquisition date, Puget had total consolidated assets of $53.1 million, total loans receivable of $38.7 million,
total deposits of $45.6 million, and

1

---

shareholders' equity of $5.9 million. On October 15, 1998, First National Bank of Port Orchard was merged into Pacific Northwest Bank.

On
June 15, 1998, Bancorp acquired Pacific Northwest Bank, of Seattle, Washington. At the acquisition date, Pacific Northwest Bank operated four financial centers in the
metropolitan Seattle area of western Washington and had total assets of $200.2 million, total loans receivable of $150.1 million, total deposits of $170.2 million, and
shareholders' equity of $16.8 million. Effective July 1, 2000, Pacific Northwest Bank was merged into InterWest Bank. Effective September 1, 2000, InterWest Bank's name was
changed to Pacific Northwest Bank.

On
June 16, 1998, Bancorp acquired Pioneer Bancorp, Inc. (Pioneer), of Yakima, Washington. Pioneer's commercial banking subsidiary, Pioneer National Bank operated five
financial centers in central Washington. At the acquisition date, Pioneer had total consolidated assets of $108.4 million, total loans receivable of $63.4 million, total deposits of
$87.2 million, and shareholders' equity of $9.3 million. On January 22, 1999, Pioneer National Bank was merged into Pacific Northwest Bank.

The
acquisitions of Central, Puget, Pacific Northwest Bank and Pioneer were accounted for using the pooling-of-interests method.

On
August 31, 1998, Bancorp acquired Kittitas Valley Bancorp, Inc. (Kittitas), of Ellensburg, Washington. Kittitas' commercial banking subsidiary, Kittitas Valley Bank
N.A. operated three financial centers in central Washington. This acquisition was accounted for using the purchase method and as such the accounts and operations of Kittitas Valley Bank, N.A. are
included in the consolidated financial statements for periods subsequent to August 31, 1998. At the acquisition date, Kittitas had total consolidated assets of $47.4 million, total loans
receivable of $27.9 million, total deposits of $39.2 million and shareholders' equity of $4.3 million. On January 3, 2000, Kittitas Valley Bank, N.A. was merged into
Pacific Northwest Bank.

On
October 1, 1999, Bancorp acquired NBT Northwest Bancorp (NBT) of Tukwila, Washington. NBT's commercial banking subsidiary, The Bank of Tukwila, operated one financial center
in south King County. At the acquisition date, NBT had total consolidated assets of $53.0 million, total loans receivable of $37.8 million, total deposits of $48.0 million and
shareholders' equity of $4.9 million. This acquisition was accounted for using the purchase method and as such the accounts and operations of The Bank of Tukwila are included in consolidated
financial statements for periods subsequent to October 1, 1999. Effective July 1, 2000, The Bank of Tukwila was merged into Pacific Northwest Bank.

The
following table summarizes pertinent information related to the acquisitions completed since 1996:

|Acquisition Date |  | Institution                   |  | Total Assets At Acquisition Date
(dollars in thousands) |         | Common Shares
Issued |          
|---------------- |  | ----------------------------- |  | ------------------------------------------------------- | ------- | -------------------- | ---------
|August 31, 1996  |  | Central Bancorporation        |  | $                                                       | 206,093 |                      | 2,147,391
|January 15, 1998 |  | Puget Sound Bancorp, Inc.     |  |                                                         | 53,109  |                      | 586,420  
|June 15, 1998    |  | Pacific Northwest Bank        |  |                                                         | 200,219 |                      | 2,346,081
|June 16, 1998    |  | Pioneer Bancorp, Inc.         |  |                                                         | 108,399 |                      | 692,846  
|August 31, 1998  |  | Kittitas Valley Bancorp, Inc. |  |                                                         | 47,441  |                      | 229,831  
|October 1, 1999  |  | NBT Northwest Bancorp         |  |                                                         | 53,018  |                      | 677,107  

---

A
source of future growth may be through mergers and acquisitions. PNWB's management believes that many other financial institutions are considering selling their institutions for a
variety of reasons, including lack of shareholder liquidity, management succession issues, technology challenges, increasing competition and pending changes with respect to the method of accounting
used for mergers and acquisitions. PNWB actively reviews proposals for various acquisition opportunities. PNWB has a

2

---

due diligence review process to evaluate potential acquisitions and has established parameters for potential acquisitions relating to market factors, financial performance and certain
non-financial factors. Successful completion of acquisitions by PNWB depends on several factors such as the availability of suitable acquisition candidates, necessary regulatory and
shareholder approval and compliance with applicable capital requirements. No assurance can be made that acquisition activity will continue in the future.

RESULTS OF OPERATIONS

PNWB's net income was $6.3 million for the year ended December 31, 2000 compared to $27.9 million and $22.6 million for the years
ended September 30, 1999 and 1998. Diluted net income per share was $0.40 for the year ended December 31, 2000 compared to $1.74 and $1.40 for the years ended September 30, 1999
and 1998. Return on average assets was 0.22 percent for the year ended December 31, 2000 compared to 1.12 percent and 0.95 percent for the years ended September 30,
1999 and 1998. Return on average shareholders' equity was 3.74 percent for the year ended December 31, 2000 compared to 16.00 percent and 13.58 percent for the years ended
September 30, 1999 and 1998.

During
the year ended December 31, 2000, PNWB incurred losses associated with the sale of securities available for sale; expenses associated with severance and employment
agreements, conversion and integration activities, and asset write-downs. The total of these expenses incurred during the year ended December 31, 2000 was $13.5 million, net of income
taxes. In addition, net income decreased from 1999 due to a decrease in the gain on sale of loans and loan servicing rights, and increases in the provision for losses on loans and
non-interest expense. This decrease in net income was partially offset by an increase in net interest income and the impact of the acquisition of The Bank of Tukwila.

The
following table summarizes financial information for the year ended December 31, 2000 and the years ended September 30, 1999, 1998, 1997 and 1996.

|As of and for the year ended,                           |  | December 31,
2000(1) |         | September 30,
1999 |   | September 30,
1998(2) |  | September 30,
1997 |         | September 30,
1996(3)
|------------------------------------------------------- |  | -------------------- | ------- | ------------------ | - | --------------------- |  | ------------------ | ------- | ---------------------
|
|SUMMARY OF OPERATIONS                                   |  |                      |         |                    |   |                       |  |                    |         |                      
|Interest income                                         |  | $                    | 218,188 |                    | $ | 179,659               |  | $                  | 180,279 |                      
|Interest expense                                        |  |                      | 128,655 |                    |   | 95,480                |  |                    | 101,483 |                      
|                                                        |  |                      |         |                    |   |                       |  |                    |         |                      
|Net interest income                                     |  |                      | 89,533  |                    |   | 84,179                |  |                    | 78,796  |                      
|Provision for losses on loans                           |  |                      | 4,750   |                    |   | 2,000                 |  |                    | 2,807   |                      
|                                                        |  |                      |         |                    |   |                       |  |                    |         |                      
|Net interest income after provision for losses on loans |  |                      | 84,783  |                    |   | 82,179                |  |                    | 75,989  |                      
|Gain (loss) on sale of securities available for sale    |  |                      | (6,113  | )                  |   | 72                    |  |                    | 813     |                      
|Other non-interest income                               |  |                      | 18,506  |                    |   | 28,336                |  |                    | 25,660  |                      
|Non-interest expense                                    |  |                      | 86,545  |                    |   | 68,147                |  |                    | 66,972  |                      
|Income tax expense                                      |  |                      | 4,362   |                    |   | 14,585                |  |                    | 12,848  |                      
|                                                        |  |                      |         |                    |   |                       |  |                    |         |                      
|Net income                                              |  | $                    | 6,269   |                    | $ | 27,855                |  | $                  | 22,642  |                      
|                                                        |  |                      |         |                    |   |                       |  |                    |         |                      
|Basic net income per share                              |  | $                    | 0.40    |                    | $ | 1.78                  |  | $                  | 1.45    |                      
|Diluted net income per share                            |  |                      | 0.40    |                    |   | 1.74                  |  |                    | 1.40    |                      
|Cash dividends declared per share                       |  |                      | 0.56    |                    |   | 0.56                  |  |                    | 0.50    |                      

3

---

|As of and for the year ended,                     |  | December 31,
2000(1) |           | September 30,
1999 |   | September 30,
1998(2) |   | September 30,
1997 |           | September 30,
1996(3) |  
|------------------------------------------------- |  | -------------------- | --------- | ------------------ | - | --------------------- | - | ------------------ | --------- | --------------------- | -
|
|STATEMENT OF FINANCIAL CONDITION                  | 
|Total assets                                      |  | $                    | 2,882,870 |                    | $ | 2,579,539             |   | $                  | 2,448,386 |                       | $
|Loans receivable and loans held for sale          |  |                      | 1,772,734 |                    |   | 1,584,722             |   |                    | 1,452,175 |                       |  
|Deposits                                          |  |                      | 1,717,108 |                    |   | 1,578,949             |   |                    | 1,564,825 |                       |  
|Borrowings                                        |  |                      | 959,873   |                    |   | 817,910               |   |                    | 682,390   |                       |  
|Shareholders' equity                              |  |                      | 178,736   |                    |   | 165,306               |   |                    | 171,652   |                       |  
|Book value per share                              |  | $                    | 11.54     |                    | $ | 10.71                 |   | $                  | 10.97     |                       | $
|KEY OPERATING RATIOS                              |  |                      |           |                    |   |                       |   |                    |           |                       |  
|Return on average assets                          |  |                      | 0.22      | %                  |   | 1.12                  | % |                    | 0.95      | %                     |  
|Return on average shareholders' equity            |  |                      | 3.74      | %                  |   | 16.00                 | % |                    | 13.58     | %                     |  
|Average shareholders' equity to average assets    |  |                      | 5.92      | %                  |   | 7.02                  | % |                    | 6.99      | %                     |  
|Net interest margin                               |  |                      | 3.41      | %                  |   | 3.64                  | % |                    | 3.52      | %                     |  
|Ratio of non-performing assets to total assets(4) |  |                      | 0.83      | %                  |   | 0.56                  | % |                    | 0.64      | %                     |  
|Dividend payout ratio                             |  |                      | 138.76    | %                  |   | 31.62                 | % |                    | 33.98     | %                     |  

---

On June 20, 2000 the Board of Directors approved a change of PNWB's fiscal year end from September 30 to December 31,
retroactively to January 1, 2000.

NET INTEREST INCOMEPNWB's net income is significantly affected by changes in net interest income, which is the difference
between interest income received on loans receivable and other interest-earning assets and interest paid on deposits and borrowings. PNWB's operations are sensitive to changes in interest rates and
the resulting impact on net interest income. During the second half of 1999 and 2000, overall interest rates increased. In periods of rising interest rates, PNWB's net interest income and net interest
margin decreased as a greater amount of interest-bearing liabilities are subject to more rapid repricing than interest-earning assets. PNWB will continue to change the composition of its balance sheet
with a focus on growth in commercial loans and retail deposits to reduce its sensitivity to movement in interest rates.

Net
interest income before the provision for losses on loans was $89.5 million for the year ended December 31, 2000 compared to $84.2 million and
$78.8 million for the years ended September 30, 1999 and 1998. The increase in net interest income from 1999 to 2000 was due to growth in interest-earning assets offset by a decrease in
net interest margin. The increase in net interest income from 1998 to 1999 was due to growth in interest-earning assets and an increase in net interest margin.

4

---

Net interest margin, which is net interest income divided by average interest-earning assets, decreased for the year ended December 31, 2000 compared to the years ended
September 30, 1999 and 1998. Net interest margin was 3.41 percent in 2000, compared to 3.64 percent in 1999 and 3.52 percent in 1998. The decrease in net interest margin
compared to the prior years was primarily the result of an increase in the cost of funds. The cost of funds was 5.33 percent for the year ended December 31, 2000 compared to
4.57 percent and 4.96 percent for the years ended September 30, 1999 and 1998. The cost of funds increased due to overall interest rate increases and the resulting impact on the
interest rate paid on deposits and borrowings. The cost of funds also increased as a result of changes in the composition of the average balances of interest-bearing liabilities. During the year ended
December 31, 2000, asset growth was funded primarily by increased borrowings as PNWB experienced limited interest-bearing
deposit growth. For the year ended December 31, 2000, 42 percent of average interest-bearing liabilities were comprised of borrowings compared to 35 percent for the years ended
September 30, 1999 and 1998. It is PNWB's intention to increase deposit liabilities and reduce borrowings in the future. If successful, this should have a positive impact on net interest
income.

The
effect that the increase in the cost of funds had on net interest margin was partially offset by an increase in the yield earned on loans, securities and other interest-earning
assets as well as an increase in the average balance of non-interest-bearing deposits. The yield on interest-earning assets increased to 8.32 percent for the year ended
December 31, 2000 compared to 7.76 percent and 8.05 percent for the years ended September 30, 1999 and 1998. The yield earned increased both as a result of overall interest
rate increases and growth in higher yielding commercial loans. The average balance of non-interest-bearing deposits increased to $218.9 million for the year ended
December 31, 2000 compared to $191.7 million and $150.4 million for the years ended September 30, 1999 and 1998, respectively.

Interest
income was $218.2 million for the year ended December 31, 2000, compared to $179.7 million and $180.3 million for the years ended
September 30, 1999 and 1998. Interest income increased from 1999 to 2000 due to an increase in the yield earned and an increase in interest-earning assets. Interest income decreased from 1998
to 1999 due to a decrease in the yield earned partially offset by an increase in interest-earning assets.

Interest
expense was $128.7 million for the year ended December 31, 2000, compared to $95.5 million and $101.5 million for the years ended
September 30, 1999 and 1998. Interest expense increased from 1999 to 2000 due to an increase in the cost of funds and an increase in interest-bearing liabilities. Interest expense decreased
from 1998 to 1999 due to a decrease in the cost of funds partially offset by an increase in interest-bearing liabilities.

The
following table presents, for the periods indicated, information regarding average balances of assets and liabilities as well as the total amounts of interest income from average
interest-earning assets

5

---

and interest expense on average interest-bearing liabilities, resulting yield and cost ratios, interest rate spread, ratio of interest-earning assets to interest-bearing liabilities and net interest
margin for PNWB.

|Year ended                                                                         |                                 | December 31,
2000 |           | September 30,
1999 |   | September 30,
1998 |        
|---------------------------------------------------------------------------------- | ------------------------------- | ----------------- | --------- | ------------------ | - | ------------------ | -------
|
|Assets:                                                                            |                                 |                   |           |                    |   |                    |        
|Loans receivable and loans held for sale(1)                                        |                                 | $                 | 1,756,014 |                    | $ | 159,870            |        
|Securities available for sale and securities held to maturity                      |                                 |                   | 841,380   |                    |   | 56,747             |        
|Other interest-earning assets                                                      |                                 |                   | 25,971    |                    |   | 1,571              |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|                                                                                   | Total interest-earning assets   |                   |           | 2,623,365          |   |                    | 218,188
|Non-interest-earning
assets                                                        |                                 |                   | 203,326   |                    |   |                    |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|Total assets                                                                       |                                 | $                 | 2,826,691 |                    |   |                    |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|Liabilities and Shareholders' Equity:                                              |                                 |                   |           |                    |   |                    |        
|Savings accounts and money market accounts                                         |                                 | $                 | 386,869   |                    | $ | 13,285             |        
|Checking accounts                                                                  |                                 |                   | 182,208   |                    |   | 2,017              |        
|Certificates of deposit                                                            |                                 |                   | 823,764   |                    |   | 48,503             |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|                                                                                   | Total interest-bearing deposits |                   |           | 1,392,841          |   |                    | 63,805 
|FHLB advances, securities sold under agreements to repurchase and other borrowings |                                 |                   | 1,019,612 |                    |   | 64,850             |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|Total interest-bearing liabilities                                                 |                                 |                   | 2,412,453 |                    |   | 128,655            |        
|Non-interest-bearing deposits                                                      |                                 |                   | 218,887   |                    |   |                    |        
|Other non-interest-bearing liabilities                                             |                                 |                   | 27,871    |                    |   |                    |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|Total liabilities                                                                  |                                 |                   | 2,659,211 |                    |   |                    |        
|Shareholders' equity                                                               |                                 |                   | 167,480   |                    |   |                    |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|Total liabilities and shareholders' equity                                         |                                 | $                 | 2,826,691 |                    |   |                    |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|Net interest income                                                                |                                 |                   |           |                    | $ | 89,533             |        
|                                                                                   |                                 |                   |           |                    |   |                    |        
|Interest rate spread                                                               |                                 |                   |           |                    |   |                    |        
|Net interest margin                                                                |                                 |                   |           |                    |   |                    |        
|Ratio of average interest-earning assets to average interest-bearing liabilities   |                                 |                   |           |                    |   |                    |        

---

6

---

The following table provides information on changes in net interest income for the periods indicated that are attributable to changes in
interest rates and changes in volume.

|                                                                     |                                                                                              | September 30, 1999 to
December 31, 2000
Increase (Decrease)
Due to Changes in |         | September 30, 1998 to
September 30, 1999
Increase (Decrease)
Due to Changes in |  
|-------------------------------------------------------------------- | -------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------- | ------- | ------------------------------------------------------------------------------ | -
|
|Interest-Earning Assets                                              |                                                                                              |                                                                               |         |                                                                                |  
|                                                                     | Loans receivable and loans held for sale                                                     |                                                                               | $       | 4,021                                                                          |  
|                                                                     | Securities available for sale, securities held to maturity and other interest-earning assets |                                                                               |         | 6,012                                                                          |  
|                                                                     |                                                                                              |                                                                               |         |                                                                                |  
|Total net change in interest income on interest-earning assets       |                                                                                              |                                                                               | 10,033  |                                                                                |  
|                                                                     |                                                                                              |                                                                               |         |                                                                                |  
|Interest-Bearing Liabilities                                         |                                                                                              |                                                                               |         |                                                                                |  
|                                                                     | Interest-bearing deposits                                                                    |                                                                               |         | (6,842                                                                         | )
|                                                                     | FHLB advances, securities sold under agreements to repurchase and other borrowings           |                                                                               |         | (7,426                                                                         | )
|                                                                     |                                                                                              |                                                                               |         |                                                                                |  
|Total net change in interest expense on interest-bearing liabilities |                                                                                              |                                                                               | (14,268 | )                                                                              |  
|                                                                     |                                                                                              |                                                                               |         |                                                                                |  
|Net change in net interest income                                    |                                                                                              | $                                                                             | (4,235  | )                                                                              | $
|                                                                     |                                                                                              |                                                                               |         |                                                                                |  

PROVISION FOR LOSSES ON LOANSThe provision for losses on loans was $4.8 million for the year ended
December 31, 2000 compared to $2.0 million and $2.8 million for the years ended September 30, 1999 and 1998. The provision for losses on loans for 1998 included a
merger-related provision of $1.1 million. Management increased the provision for losses on loans during 2000 as a result of the continuous assessment of known and inherent risk characteristics
in the loan portfolio. These risk characteristics include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions, and
detailed analysis of individual loans for which full collectibility may not be assured. Management believes the allowance for losses on loans was adequate as of December 31, 2000. However,
based on current trends in the loan portfolio, it is anticipated that the provision for losses on loans will remain at higher levels compared to 1999 and 1998.

NON-INTEREST INCOMENon-interest income was $12.4 million for the year ended
December 31, 2000, compared to $28.4 million and $26.5 million for the years ended September 30, 1999 and 1998. The decrease in non-interest income from 1999 to
2000 was primarily due to a decrease in the gain on sale of loans and loan servicing rights and losses on the sale of securities available for sale. The increase in non-interest income
from 1998 to 1999 was primarily due to an increase in service fees and investment product fees and insurance commissions earned by non-bank subsidiaries.

Gains
on the sale of loans were $0.9 million for the year ended December 31, 2000, compared to $8.1 million and $10.4 million for the years ended
September 30, 1999 and 1998. During the first half of 1999, the long-term interest rate environment resulted in increased fixed-rate single-family mortgage loan
refinances and opportunities to sell these loans on the secondary market for a premium. During the second half of 1999 and fiscal year 2000, long-term interest rates increased and
single-family residential
mortgage loan originations decreased, and as a result, sales of single-family mortgage loans declined as compared to the first half of 1999. During 2000, PNWB changed its strategy with regard to

7

---

the origination and retention of single-family residential mortgage loans. Management intends to retain less single-family mortgages in the loan portfolio with the majority of PNWB's single-family
mortgage loan production channeled to the secondary market. Recently, interest rates declined relative to 2000, which should provide increased opportunities for PNWB to originate and sell
single-family residential mortgage loans.

PNWB
sold the servicing rights for $530 million of fixed-rate single-family mortgage loans that resulted in a gain of $2.8 million during the year ended
September 30, 1999. These loan servicing rights were primarily related to loans sold with servicing rights retained by PNWB during 1998 and the first half of 1999. The sale was initiated as a
result of increasing long-term interest rates and decreasing loan prepayment rates, which increased the value of the servicing portfolio.

As
part its strategic plan for commercial banking activities, PNWB partially restructured its investment portfolio by selling approximately $130 million of securities available
for sale during the first half of 2000, which resulted in a $6.8 million loss. During the second half of 2000 PNWB sold approximately $30 million of mortgage-backed securities available
for sale at a gain of $0.7 million. These mortgage-backed securities were PNWB single-family mortgage loans that were securitized in prior periods. The total net loss on the sale of securities
available for sale was $6.1 million for the year ended December 31, 2000 compared to net gains of $0.1 million and $0.8 million for the years ended September 30,
1999 and 1998.

NON-INTEREST EXPENSENon-interest expense was $86.5 million for the year ended
December 31, 2000, compared to $68.1 million and $67.0 million for the years ended September 30, 1999 and 1998. Non-interest expense for the year ended
December 31, 2000 included costs associated with conversion and integration activities, severance and employment agreements and goodwill impairment. The total of these expenses incurred during
the year ended December 31, 2000 was $11.4 million. Non-interest expense for 1998 included $5.5 million of merger-related charges. Excluding non-recurring
expenses in 2000 and 1998, non-interest expense increased $7.0 million, or 10 percent from 1999 to 2000 and $6.6 million, or 11 percent for 1999 compared to
1998.

Compensation
and employee benefits expense was $39.4 million for the year ended December 31, 2000 compared to $37.5 million and $32.6 million for the years
ended September 30, 1999 and 1998. The increase was due to increased focus on commercial banking and the acquisitions of The Bank of Tukwila in 1999 and Kittitas Valley Bank in 1998. Increases
in base compensation from 1999 to 2000
were partially offset by a decrease in variable compensation expense related to performance based bonus plans.

The
increase in general and administrative, occupancy and equipment and data processing expenses for the year ended December 31, 2000 compared to the years ended
September 30, 1999 and 1998 was primarily due to activities to develop the resources and infrastructure for commercial banking growth. Key elements of commercial banking growth were the
development of credit administration and commercial lending support, the addition of commercial lending officers and several experienced commercial banking management personnel. General and
administrative, occupancy and equipment and data processing expenses also increased due to the acquisitions of The Bank of Tukwila in 1999 and Kittitas Valley Bank in 1998.

The
loss from real estate write-downs and operations was $2.5 million for the year ended December 31, 2000 compared to $0.9 million and $2.0 million for
the years ended September 30, 1999 and 1998. PNWB recorded write-downs of approximately $2.2 million related to other real estate during the year ended December 31, 2000. These
write-downs relate primarily to one land development project and new management's intent with regard to the development and sale of the project as well as changing economic conditions.

8

---

The amortization of goodwill and core deposit intangible was $1.3 million for the year ended December 31, 2000 compared to $0.7 million and $0.3 million
for the years ended September 30, 1999 and 1998. This increase is due to the acquisitions of The Bank of Tukwila in 1999 and Kittitas Valley Bank in 1998.

As
discussed previously, PNWB completed acquisitions of four commercial banks during fiscal year 1998 and one during the transition period ended December 31, 1999. However, the
efficiencies available from eliminating duplicate administrative and operational functions have not been fully realized from the acquisitions. During 2000 PNWB began the process of converting to a
single enhanced operating system for the entire company. PNWB contracted with Marshall & Ilsley Corporation to provide data services and processing for the new operating system. The contract
term expires on December 31, 2006. The first four phases of the five-phase conversion process were completed during 2000 with the remaining phase of the conversion to be completed
during the second quarter of 2001. Conversion and integration expenses are expensed as incurred. Total expenses associated with conversion and integration efforts were $7.4 million during the
year ended December 31, 2000. These expenses included the buyout of previous data processing contracts, consultant fees, accelerated depreciation of equipment and other costs incurred in
conjunction with conversion and integration initiatives. Other costs include the preparation and mailing of customer notifications for the conversion of customer accounts and training expenses. Of the
$7.4 million of conversion and integration expenses for the year ended
December 31, 2000, $5.2 million was paid out during the year and $0.4 relates to accelerated depreciation of equipment. The remaining $1.8 million is expected to be paid out
during 2001. Additional conversion and integration expenses will continue to be incurred during the first half of 2001.

In
conjunction with executive management changes, elimination of duplicate administrative functions and consolidating operating systems, PNWB incurred $3.3 million in expenses
associated with severance and employment agreements during the year ended December 31, 2000. There were approximately 40 employees affected by these severance and employment agreements. Of the
$3.3 million of severance and employment agreement expenses for year ended December 31, 2000, $1.1 million was paid out during the year and $2.2 million will be paid out in
subsequent periods in accordance with the terms of the severance and employment agreements.

As
part of the transition to a commercial bank, PNWB consolidated and restructured its mortgage loan origination functions and related processes. This resulted in the impairment of
$0.7 million of goodwill previously recorded for the acquisition of a mortgage brokerage subsidiary in 1996. PNWB consolidated its mortgage brokerage function into its wholesale lending
function and changed its strategy with regard to the origination and retention of single-family mortgage loans. Management intends to retain less single-family mortgages in the loan portfolio and the
majority of PNWB's single-family mortgage loan production is channeled to the secondary market.

INCOME TAX EXPENSEIncome tax expense was $4.4 million for the year ended December 31, 2000, compared to
$14.6 million and $12.8 million for the years ended September 30, 1999 and 1998. The decrease in income tax expense is consistent with a decrease in income before income taxes.
The effective tax rates were 41.0 percent for the year ended December 31, 2000, 34.4 percent for the year ended September 30, 1999 and 36.2 percent for the year
ended September 30, 1998. The higher effective tax rate in 2000 is primarily due to an increase in goodwill amortization that is not deductible for federal income tax purposes and a decrease in
income before income taxes.

REVIEW OF FINANCIAL CONDITION

PNWB's total consolidated assets were $2.883 billion as of December 31, 2000 compared to $2.783 billion as of December 31, 1999.

9

---

SECURITIES AND OTHER INTEREST-EARNING ASSETSSecurities and other interest-earning assets, including securities available
for sale, securities held to maturity, interest-bearing deposits in banks, federal funds sold and securities purchased under agreements to resell were $921.0 million as of December 31,
2000, compared to $870.9 million as of December 31, 1999. As of December 31, 2000, 93 percent of PNWB's securities were classified as available for sale. Management
believes that a higher percentage of securities classified as available for sale provides greater flexibility to respond to interest rate changes and liquidity needs to fund loan growth.

PNWB
maintains liquidity in accordance with an internal liquidity policy. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives,
management's judgment as to the attractiveness of the yields then available in relation to other opportunities and management's expectation of the yield that will be available in the future.
Management's projections as to the short-term demand for funds to be used for loan originations and other activities can also affect liquidity levels.

Securities
are categorized as held to maturity or available for sale, based upon management's intent as to the ultimate disposition of each security when the security is acquired.
PNWB does not currently trade securities. Securities classified as held to maturity are stated at amortized cost. Securities classified as available for sale are reported at estimated fair value, with
unrealized gains and losses (net of income taxes) reported as accumulated other comprehensive income, a separate component of shareholders' equity. As permitted by the provisions of Statement of
Financial Accounting Standards (SFAS) No. 133 "Accounting for Derivative Instruments and Hedging Activities," PNWB reclassified all securities held to maturity to securities available for sale
on January 1, 2001. This reclassification resulted in other comprehensive loss of $0.6 million, net of income taxes of $0.3 million.

The
following table sets forth amortized cost and estimated fair values for PNWB's securities held to maturity as of the dates indicated.

|                                                 |  | December 31, 2000 |        | December 31, 1999 |  
|------------------------------------------------ |  | ----------------- | ------ | ----------------- | -
|
|U.S. government and agency securities            |  | $                 | 22,672 |                   | $
|Obligations of states and political subdivisions |  |                   | 998    |                   |  
|Private mortgage-backed and related securities   |  |                   | 41,071 |                   |  
|                                                 |  |                   |        |                   |  
|Total                                            |  | $                 | 64,741 |                   | $
|                                                 |  |                   |        |                   |  
|                                                 |  |                   |        |                   |  

|                                                 |  | September 30, 1999 |        | September 30, 1998 |  
|------------------------------------------------ |  | ------------------ | ------ | ------------------ | -
|
|U.S. government and agency securities            |  | $                  | 24,878 |                    | $
|Obligations of states and political subdivisions |  |                    | 2,397  |                    |  
|Private mortgage-backed and related securities   |  |                    | 43,417 |                    |  
|                                                 |  |                    |        |                    |  
|Total                                            |  | $                  | 70,692 |                    | $
|                                                 |  |                    |        |                    |  

10

---

The
following table sets forth the contractual maturities and weighted average yields of securities held to maturity as of December 31, 2000.

|                                                 |  | Less Than
One Year |     | One to
Five Years |      | Five to
Ten Years |   | Over Ten
Years | 
|------------------------------------------------ |  | ------------------ | --- | ----------------- | ---- | ----------------- | - | -------------- | 
|
|U.S. government and agency securities            |  | $                  |    |                   |     | %                 | $ |               | 
|Obligations of states and political subdivisions |  |                    | 897 |                   | 4.47 |                   |   | 101            | 
|Private mortgage-backed and related securities   |  |                    |    |                   |     |                   |   |               | 
|                                                 |  |                    |     |                   |      |                   |   |                | 
|Total                                            |  | $                  | 897 |                   | 4.47 | %                 | $ | 101            | 
|                                                 |  |                    |     |                   |      |                   |   |                | 

The
following table sets forth PNWB's securities available for sale as of the dates indicated.

|                                                 |  | December 31, 2000 |         | December 31, 1999 |      | September 30, 1999 |   | September 30, 1998 | 
|------------------------------------------------ |  | ----------------- | ------- | ----------------- | ---- | ------------------ | - | ------------------ | 
|
|U.S. government and agency securities            |  | $                 | 510,916 |                   | 60.8 | %                  | $ | 362,528            | 
|FHLB stock                                       |  |                   | 42,962  |                   | 5.1  |                    |   | 44,346             | 
|Obligations of states and political subdivisions |  |                   | 1,187   |                   | 0.1  |                    |   | 1,107              | 
|Private mortgage-backed and related securities   |  |                   | 242,062 |                   | 28.8 |                    |   | 345,521            | 
|Other securities                                 |  |                   | 43,362  |                   | 5.2  |                    |   | 38,827             | 
|                                                 |  |                   |         |                   |      |                    |   |                    | 
|Total                                            |  | $                 | 840,489 |                   |      |                    | $ | 792,329            | 
|                                                 |  |                   |         |                   |      |                    |   |                    | 

The
following table sets forth the contractual maturities and weighted average yields of PNWB's securities available for sale as of December 31, 2000.

|                                                 |  | Less Than
One Year |        | One to
Five Years |      | Five to
Ten Years |   | Over Ten
Years | 
|------------------------------------------------ |  | ------------------ | ------ | ----------------- | ---- | ----------------- | - | -------------- | 
|
|U.S. government and agency securities            |  | $                  | 29,707 |                   | 6.80 | %                 | $ | 210,059        | 
|Obligations of states and political subdivisions |  |                    | 155    |                   | 4.45 |                   |   | 897            | 
|Private mortgage-backed and related securities   |  |                    |       |                   |     |                   |   |               | 
|Other securities                                 |  |                    |       |                   |     |                   |   |               | 
|                                                 |  |                    |        |                   |      |                   |   |                | 
|Total                                            |  | $                  | 29,862 |                   | 6.79 | %                 | $ | 210,956        | 
|                                                 |  |                    |        |                   |      |                   |   |                | 

LOANS RECEIVABLE AND LOANS HELD FOR SALENet loans receivable were $1.759 billion as of December 31, 2000 an
increase from $1.672 billion as of December 31, 1999. During the year ended December 31, 2000, the principal balances outstanding of commercial, commercial real estate, real
estate construction, consumer and agricultural loans increased. These increases were partially offset by a decrease in single-family mortgage loans outstanding as a result of loan sales and
securitizations during the year.

11

---

The acquisitions of Central, Pacific Northwest Bank, Pioneer, Puget, Kittitas and NBT increased PNWB's ability to originate commercial loans. These acquisitions, as well as the
development of commercial banking at the former InterWest Bank, changed the composition of the PNWB loan portfolio with an emphasis on commercial lending. As part of the emphasis on commercial
lending, PNWB's banking subsidiary changed its charter from a Washington state savings bank to a Washington state commercial bank during 2000. Growth in commercial lending should shorten duration
risk, increase net interest margin, create better protection from interest rate volatility and ultimately meet the needs of PNWB's customers.

Commercial
loans outstanding totaled $430.1 million, or 23.9 percent of total gross loans as of December 31, 2000. Commercial loans have increased by
$82.7 million during 2000, which represents an annual growth rate of 23.8 percent. Increases in commercial lending increased the yield earned on the loan portfolio and net interest
income.

Single-family
mortgage loans outstanding totaled $420.1 million, or 23.4 percent of total gross loans, compared to $462.9 million, or 26.9 percent of total
gross loans, as of December 31, 1999. As part of the transition to a commercial bank, PNWB consolidated and restructured its mortgage loan origination functions and related processes. PNWB
consolidated its mortgage brokerage function into its wholesale lending function and changed its strategy with regards to the origination and retention of single-family mortgage loans. The majority of
PNWB's single-family mortgage loan production is channeled to the secondary market; thus less single-family mortgage loans are retained in the loan portfolio compared to prior years. During the year
ended December 31, 2000, PNWB sold approximately $91 million of single-family mortgage loans and securitized $120 million as mortgage-backed securities.

Commercial
real estate mortgage loans outstanding totaled $428.0 million, or 23.8 percent of total gross loans, as of December 31, 2000 compared to
$427.9 million, or 24.9 percent of total gross loans, as of December 31, 1999. During the year ended December 31, 2000, PNWB sold approximately $66.5 million of
commercial real estate mortgage loans.

Real
estate construction loans outstanding totaled $334.8 million, or 18.6 percent of total gross loans, as of December 31, 2000 compared to
$323.3 million, or 18.8 percent of total gross loans, as of December 31, 1999.

Consumer
loans outstanding totaled $130.2 million, or 7.2 percent of total gross loans, as of December 31, 2000 compared to $104.4 million, or
6.1 percent of total gross loans, as of December 31, 1999.

12

---

The following table sets forth the composition of PNWB's loan portfolio by type of loan as of the dates indicated.

|                                 |                           | December 31,
2000 |           | December 31,
1999 |      | September 30,
1999 |   | September 30,
1998 |           | September 30,
1997 |      | September 30,
1996 |          
|-------------------------------- | ------------------------- | ----------------- | --------- | ----------------- | ---- | ------------------ | - | ------------------ | --------- | ------------------ | ---- | ------------------ | ---------
|
|Commercial loans                 |                           | $                 | 430,147   |                   | 23.9 | %                  | $ | 347,443            |           | 20.2               | %    | $                  | 323,753  
|Real estate mortgage loans:(1)   |                           |                   |           |                   |      |                    |   |                    |           |                    |      |                    |          
|                                 | Single-family residential |                   |           | 420,084           |      | 23.4               |   |                    | 462,853   |                    | 26.9 |                    |          
|                                 | Commercial                |                   |           | 427,958           |      | 23.8               |   |                    | 427,940   |                    | 24.9 |                    |          
|Real estate construction         |                           |                   | 334,789   |                   | 18.6 |                    |   | 323,281            |           | 18.8               |      |                    | 302,178  
|Consumer loans                   |                           |                   | 130,222   |                   | 7.2  |                    |   | 104,446            |           | 6.1                |      |                    | 97,153   
|Agricultural loans               |                           |                   | 55,850    |                   | 3.1  |                    |   | 54,071             |           | 3.1                |      |                    | 51,961   
|                                 |                           |                   |           |                   |      |                    |   |                    |           |                    |      |                    |          
|                                 | Total gross loans         |                   |           | 1,799,050         |      |                    |   |                    | 1,720,034 |                    |      |                    |          
|Less:                            |                           |                   |           |                   |      |                    |   |                    |           |                    |      |                    |          
|                                 | Loans held for sale       |                   |           | (14,187           | )    |                    |   |                    | (22,397   | )                  |      |                    |          
|Allowance for losses on loans    |                           |                   | (17,561   | )                 |      |                    |   | (15,182            | )         |                    |      |                    | (14,123  
|Deferred loan fees and discounts |                           |                   | (8,755    | )                 |      |                    |   | (10,140            | )         |                    |      |                    | (10,015  
|                                 |                           |                   |           |                   |      |                    |   |                    |           |                    |      |                    |          
|Net loans receivable             |                           | $                 | 1,758,547 |                   |      |                    | $ | 1,672,315          |           |                    |      | $                  | 1,561,584
|                                 |                           |                   |           |                   |      |                    |   |                    |           |                    |      |                    |          

---

The following table indicates the contractual maturity of PNWB's gross loans as of December 31, 2000. Loans having no stated schedule of
repayments and no stated maturity are reported as due within one year. Loan balances do not include deferred loan fees and discounts and the allowance for losses on loans. The table does not reflect
any estimate of prepayments, which significantly shorten the average life of all loans and will cause PNWB's actual repayment experience to differ significantly from that indicated below.

Dollars in thousands

Within
One
Year

After One
Through
5 Years

After
5 Years

TotalCommercial loans

$
144,478

$
88,024

$
197,645

$
430,147Real estate mortgage loans:Single-family residential


3,710


20,797


395,577


420,084Commercial


8,852


29,215


389,891


427,958Real estate construction


103,878


81,507


149,404


334,789Consumer loans


58,500


17,875


53,847


130,222Agricultural loans


32,463


3,444


19,943


55,850Total gross loans

$
351,881

$
240,862

$
1,206,307

$
1,799,050


13

---

The
following table sets forth the dollar amount of all loans contractually due after one year as of December 31, 2000 that have fixed interest rates and have floating or
variable interest rates.

Dollars in thousands

Fixed
Rates

Variable
RatesCommercial loans

$
85,237

$
200,432Real estate mortgage loans:Single-family residential


168,031


248,343Commercial


83,590


335,516Real estate construction


98,186


132,725Consumer loans


57,811


13,911Agricultural loans


3,983


19,404Total

$
496,838

$
950,331


The
principal lending activity of Pacific Northwest Bank is the origination of commercial loans, commercial real estate mortgage loans, single-family residential mortgage loans, real
estate construction loans, consumer loans and agricultural loans.

Commercial loansCommercial loans include a wide range of loan types to small and medium-sized businesses. Commercial loans
include commercial lines of credit with variable rates and maturities of one year or less. Commercial loans also include equipment and operational loans. These loans are
primarily secured by liens on real estate, capital assets, accounts receivable and inventory, although certain loans are unsecured. Commercial lending has increased risks as a result of dependence on
income production for future repayment, and in certain circumstances, the lack of tangible collateral. Commercial loans are underwritten based on the financial strength and repayment ability of the
borrower, as well as the value of any collateral securing the loans. Commercial lending operations rely on a strong credit culture that combines prudent credit policies and individual lender
accountability.

Single-family residential mortgage loansPNWB presently originates both fixed-rate loans and
adjustable-rate mortgage loans ("ARMs") secured by single-family residential properties with loan terms of up to 30 years. ARMs have interest rates that adjust based upon
changes in a predetermined index for a period matching the repricing period of the loan. Borrower demand for ARMs versus fixed-rate mortgage loans is a function of the level of
interest rates, the expectations of changes in the level of interest rates and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and the rates
and loan fees for ARMs. As part of the transition to a commercial bank, PNWB consolidated and restructured its mortgage loan origination functions and related processes. PNWB consolidated its
mortgage brokerage function into its wholesale lending function and changed its strategy with regards to the origination and retention of single-family mortgage loans. The majority of PNWB's
single-family mortgage loan production is channeled to the secondary market; thus less single-family mortgage loans are retained in the loan portfolio as compared to prior years.

Commercial real estate mortgage loansPNWB originates mortgage loans on commercial real estate properties with terms of up
to 30 years in its primary market area. These loans are secured by property such as apartment buildings, condominium projects, office buildings, small commercial business properties, churches,
subdivision developments and strip shopping centers.

Commercial
real estate mortgage loans generally have larger balances outstanding and involve greater risks than single-family residential mortgage loans because payments on loans
secured by commercial properties are dependent on the successful operation or management of the properties. As a result, repayment of such loans may be subject to conditions in the real estate market
or the economy to a greater extent than single-family residential mortgage loans. These loans may involve large loan balances to single borrowers or groups of related borrowers.

14

---

Real estate constructionPNWB originates real estate construction loans to residential owner-occupants (custom construction
loans) and to contractors building residential properties for resale, as well as construction loans for condominiums, commercial real estate properties and land development on properties located
within its primary market area. Construction loans to owner-occupants generally are converted to single-family residential mortgage loans.

Real
estate construction loans may involve additional risks because loan funds are collateralized by the project under construction, which is of uncertain value prior to completion.
Delays may arise from labor problems, material shortages may be experienced and other unpredictable contingencies may occur. It is important to evaluate accurately the total loan funds required to
complete a project and related loan-to-value ratios. Because of these factors, the analysis of prospective construction loan projects requires an expertise that is different in
significant respects from the expertise required for real estate mortgage lending. Construction lending is generally considered to involve a higher degree of collateral risk than long-term
financing of residential properties. PNWB's risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value and marketability at completion
of construction or development and the estimated cost (including interest) of construction. If the estimate of construction costs and the marketability of the property upon completion of the project
prove to be inaccurate, PNWB may be required to advance additional funds to complete development of the project. PNWB's underwriting criteria are designed to evaluate and minimize the risks of each
real estate construction loan. Among other things, PNWB considers evidence of the availability of permanent financing for the borrower, the reputation of the borrower, the amount of the borrower's
equity in the project, the independent appraisal and review of cost estimates, the pre-construction sale and leasing information, and the cash flow projections of the borrower.

Consumer loansConsumer loans consist of automobile loans, home equity loans, credit card loans and loans for other
consumer purposes. Consumer loans also include both secured and unsecured personal lines of credit. Consumer lending may involve special risks, including decreases in the value of collateral and
transaction costs associated with foreclosure and repossession.

Agricultural loansAgricultural loans include seasonal production loans secured by crops and equipment. These loans
generally have adjustable rates that are renewed annually. Agricultural loans also include loans secured by farmland. The majority of PNWB's agricultural loans have terms of less than five years and
have variable interest rates.

Loans held for saleLoans held for sale totaled $14.2 million as of December 31, 2000 compared to
$22.4 million as of December 31, 1999. Loans held for sale are carried at the lower of cost or estimated fair value in aggregate. Net unrealized losses are recognized in a valuation
allowance by charges to income. Loans held for sale are generally single-family residential mortgage loans and loans originated under a Small Business Administration program. The loans are typically
sold to FHLMC and other financial institutions. In connection with loan sales to FHLMC and certain other financial institutions, PNWB retains the right to service the loans, for which it generally
receives a fee based on the difference between the rate paid to the investor and that collected from the borrower. PNWB capitalizes loan-servicing rights either through the purchase or
origination of mortgage loans that are subsequently sold or securitized with the servicing rights retained. Loan servicing rights are included in intangible assets and are amortized as an offset to
services fees in proportion to and over the period of servicing income, not to exceed 15 years. Periodically, PNWB has sold loan servicing rights. During
1999, PNWB sold the loan servicing rights for $530 million of single-family mortgage loans resulting in a gain of $2.8 million.

Non-performing loansLoans are generally placed on non-accrual when they become past due over
90 days or when the collection of interest or principal is considered unlikely. PNWB does not return a loan to accrual status until it is brought current with respect to both principal and
interest and future

15

---

principal and interest payments are no longer in doubt. When a loan is placed on non-accrual status, any previously accrued and uncollected interest is reversed from interest income. As of
December 31, 2000, PNWB had $13.9 million of loans on non-accrual status compared to $11.0 million as of December 31, 1999. PNWB performs a review of its loan
portfolio for weaknesses in credit quality on an ongoing basis to identify problem loans. This review results in internal loan classifications based on risk characteristics and loan performance. The
overall objective of this review process is to identify trends in the credit quality of the loan portfolio and to determine the level of loss exposure to evaluate the need for an adjustment to the
allowance for losses on loans.

ALLOWANCE FOR LOSSES ON LOANSPNWB's allowance for losses on loans was $17.6 million or 0.99 percent of loans
receivable as of December 31, 2000, compared to $14.1 million, or 0.90 percent of loans as of September 30, 1999. Net loan charge-offs for the year ended
December 31, 2000, were $2.4 million or 0.14 percent of the average balance of loans outstanding for the year. Net loan charge-offs were $1.1 million and
$0.9 million for the years ended September 30, 1999 and 1998, respectively. The higher amount of net charge-offs during the year ended December 31, 2000 was primarily
due to charge-offs on four specific commercial and commercial real estate loans.

The
allowance for losses on loans is maintained at an amount to sufficiently provide for estimated losses based on evaluating known and inherent risks in the loan portfolio.
Management analyzes certain factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss
experience, current economic conditions, and detailed analysis of individual loans for which full collectibility may not be assured. The appropriate level of the allowance for losses on loans is
estimated based upon factors and trends identified by management.

When
available information confirms that specific loans or portions thereof are uncollectible, these amounts are charged off against the allowance for losses on loans. The existence
of some or all of the following criteria will generally confirm that a loss has been incurred: the loan is significantly delinquent and the borrower has not evidenced the ability or intent to bring
the loan current; there is no recourse to the borrower, or if there is recourse, the borrower has insufficient assets to pay the debt; the fair value of the loan collateral is significantly below the
current loan balance, and there is
little or no near-term prospect for improvement. A provision for losses on loans, which is a charge against income, is added to the allowance for losses on loans based on ongoing
assessments of credit risk in the loan portfolio.

PNWB
believes it has established its allowance for losses on loans in accordance with accounting principles generally accepted in the United States. However, there can be no assurance
that in the future, regulators, when reviewing PNWB's loan portfolio, will not request PNWB to increase its allowance for losses on loans, thereby affecting PNWB's financial condition and results of
operations. Substantial increases may be necessary should the quality of any loans deteriorate as a result of the factors discussed above.

16

---

The following table sets forth activity in the allowance for losses on loans during the periods indicated.

|                                                                                           |                                   | Year Ended December 31, 2000 |        | Year Ended September 30, |  
|------------------------------------------------------------------------------------------ | --------------------------------- | ---------------------------- | ------ | ------------------------ | -
|
|Allowance as of beginning of year                                                          |                                   | $                            | 15,182 |                          | $
|Provision for losses on loans                                                              |                                   |                              | 4,750  |                          |  
|Merger and acquisition activity:                                                           |                                   |                              |        |                          |  
|                                                                                           | Provision pursuant to acquisition |                              |        |                         |  
|                                                                                           | Allowance acquired                |                              |        |                         |  
|                                                                                           | Pooling accounting adjustment     |                              |        |                         |  
|Charge-offs:                                                                               |                                   |                              |        |                          |  
|Commercial loans                                                                           |                                   |                              | 1,300  |                          |  
|Real estate mortgage loans:                                                                |                                   |                              |        |                          |  
|                                                                                           | Single-family residential         |                              |        | 750                      |  
|                                                                                           | Commercial                        |                              |        | 5                        |  
|Real estate construction                                                                   |                                   |                              | 283    |                          |  
|Consumer loans                                                                             |                                   |                              | 464    |                          |  
|Agricultural loans                                                                         |                                   |                              | 154    |                          |  
|                                                                                           |                                   |                              |        |                          |  
|                                                                                           | Total charge-offs                 |                              |        | 2,956                    |  
|Recoveries:                                                                                |                                   |                              |        |                          |  
|Commercial loans                                                                           |                                   |                              | 280    |                          |  
|Real estate mortgage loans:                                                                |                                   |                              |        |                          |  
|                                                                                           | Single-family residential         |                              |        | 175                      |  
|                                                                                           | Commercial                        |                              |        | 29                       |  
|Consumer loans                                                                             |                                   |                              | 100    |                          |  
|Agricultural loans                                                                         |                                   |                              | 1      |                          |  
|                                                                                           |                                   |                              |        |                          |  
|                                                                                           | Total recoveries                  |                              |        | 585                      |  
|                                                                                           |                                   |                              |        |                          |  
|Net charge-offs                                                                            |                                   |                              | (2,371 | )                        |  
|                                                                                           |                                   |                              |        |                          |  
|Allowance as of end of year                                                                |                                   | $                            | 17,561 |                          | $
|                                                                                           |                                   |                              |        |                          |  
|Ratio of allowance for losses on loans to total loans receivable as of the end of the year |                                   |                              | 0.99   | %                        |  
|Ratio of net charge-offs to average loans outstanding during the year                      |                                   |                              | 0.14   | %                        |  

PNWB maintains an estimated allowance for losses on loans based on the analyses conducted by management and credit personnel. The allowance for
losses on loans is allocated to certain loan categories based on the relative risk characteristics, asset classifications and actual loss experience of the loan portfolio. Management has reviewed the
allocations in the various loan categories and believes the allowance for losses on loans was adequate at all times during the five-year period ended December 31, 2000.

During
the year ended December 31, 2000, PNWB updated its methodology for allocating the allowance for losses on loans with a greater emphasis on current risk characteristics
and asset classifications and less emphasis on historical loss experience compared to prior years. Management believes this approach is more appropriate and reflective of the changing nature of the
loan portfolio with a greater emphasis on commercial lending that is also expanding into new markets and products. As such, portfolio risk characteristics and internal asset classification assessments
are more reflective of the current loan portfolio than historical loss experience.

The
allocation of the allowance for losses on loans to commercial and commercial real estate loans increased from prior years primarily due to growth in commercial loans and a greater
emphasis on the current risk characteristics inherent in the commercial and commercial real estate loan portfolio.

17

---

The increased allocation to real estate construction loans and agricultural loans is due to a greater emphasis on risk characteristics inherent in real estate construction lending and
greater emphasis on internal asset classifications. Prior year allocations were based more heavily on historical loss experience and PNWB has not experienced significant losses in the real estate
construction and agricultural loan portfolios. The allocation to agricultural loans has also increased due to an increase in non-performing and adversely classified agricultural loans
based on the state of the agricultural economy in central Washington.

The
decreased allocated to single-family residential mortgage loans is primarily due to a decrease in the balances outstanding in the portfolio compared to prior years.

The
decreased allocation to the consumer portfolio is primarily due to a decrease in the average life of consumer loans outstanding with a greater emphasis on originating
shorter-term consumer loans and a decrease in non-performing consumer loans. The reduction in the allocation also reflects the change in the methodology of allocating the
allowance for losses on loans to the consumer portfolio.

Although
the allocation of the allowance for losses on loans is an important credit management tool, the entire allowance for losses on loans is available for the entire loan
portfolio. The following table sets forth the allocation of the allowance for losses on loans by loan category as of the dates indicated.

|Dollars in thousands        |                           | December 31,
2000 |        | December 31,
1999 |   | September 30,
1999 |       | September 30,
1998 |        | September 30,
1997 |   | September 30,
1996
|--------------------------- | ------------------------- | ----------------- | ------ | ----------------- | - | ------------------ | ----- | ------------------ | ------ | ------------------ | - | ------------------
|Commercial loans            |                           | $                 | 4,448  |                   | $ | 3,632              |       | $                  | 2,785  |                    | $ | 2,454             
|Real estate mortgage loans: |                           |                   |        |                   |   |                    |       |                    |        |                    |   |                   
|                            | Single-family residential |                   |        | 2,076             |   |                    | 3,265 |                    |        | 2,471              |   |                   
|                            | Commercial                |                   |        | 2,862             |   |                    | 1,342 |                    |        | 1,525              |   |                   
|Real estate construction    |                           |                   | 2,804  |                   |   | 301                |       |                    | 302    |                    |   | 424               
|Consumer loans              |                           |                   | 311    |                   |   | 1,376              |       |                    | 1,441  |                    |   | 996               
|Agricultural loans          |                           |                   | 1,921  |                   |   | 394                |       |                    | 334    |                    |   | 285               
|Unallocated                 |                           |                   | 3,139  |                   |   | 4,872              |       |                    | 5,265  |                    |   | 3,899             
|                            |                           |                   |        |                   |   |                    |       |                    |        |                    |   |                   
|Total                       |                           | $                 | 17,561 |                   | $ | 15,182             |       | $                  | 14,123 |                    | $ | 13,224            
|                            |                           |                   |        |                   |   |                    |       |                    |        |                    |   |                   

OTHER REAL ESTATEOther real estate includes property acquired by PNWB through foreclosure and real estate held for
development. Other real estate is carried at the lower of the estimated fair value or the principal balance of the foreclosed loans. The real estate held for development portfolio primarily consists
of one land development project. PNWB had other real estate totaling $9.9 million as of December 31, 2000 compared to $9.0 million as of December 31, 1999.

NON-PERFORMING ASSETSPNWB's non-performing assets as of December 31, 2000, consisting of
non-performing loans and other real estate, totaled $23.8 million or 0.83 percent of total assets. This is an increase from $15.3 million or 0.55 percent of
total assets as of December 31, 1999. Non-performing loans increased to $13.9 million as of December 31, 2000 compared to $11.0 million as of
December 31, 1999, and $10.9 million as of September 30, 1999. The increase in non-performing loans is primarily due to an increase in non-performing real
estate construction, single-family residential and agricultural loans offset by a decrease in non-performing commercial loans. The increase in non-performing real estate
construction loans is primarily due to several individual land development loans. The increase in non-performing agricultural loans is primarily due to the state of the agricultural
economy in central Washington. Management believes that the allowance for losses on loans is adequate to provide for losses that may be incurred on non-performing loans.
Non-performing other real estate was $9.9 million as of December 31, 2000, an increase from $4.3 million as of December 31, 1999. The primary reason for this
increase is due to the foreclosure on one commercial property and

18

---

one land development property and certain reclassifications of amounts previously classified as real estate held for development. Management's intent with respect to real estate held for development
changed during the year ended December 31, 2000, and resulted in the reclassification of $2.6 million to non-performing assets. The following table presents information with
respect to PNWB's non-performing assets and restructured loans as of the dates indicated.

|Dollars in thousands                           |                           | December 31,
2000 |        | December 31,
1999 |   | September 30,
1999 |        | September 30,
1998 |        | September 30,
1997 |   | September 30,
1996 |      
|---------------------------------------------- | ------------------------- | ----------------- | ------ | ----------------- | - | ------------------ | ------ | ------------------ | ------ | ------------------ | - | ------------------ | -----
|Non-performing loans:                          |                           |                   |        |                   |   |                    |        |                    |        |                    |   |                    |      
|Commercial loans                               |                           | $                 | 2,455  |                   | $ | 5,038              |        | $                  | 3,943  |                    | $ | 1,682              |      
|Real estate mortgage loans:                    |                           |                   |        |                   |   |                    |        |                    |        |                    |   |                    |      
|                                               | Single-family residential |                   |        | 5,020             |   |                    | 3,207  |                    |        | 4,125              |   |                    | 5,036
|                                               | Commercial                |                   |        | 991               |   |                    | 1,371  |                    |        | 792                |   |                    | 557  
|Real estate construction                       |                           |                   | 3,920  |                   |   | 880                |        |                    | 880    |                    |   | 634                |      
|Consumer loans                                 |                           |                   | 225    |                   |   | 366                |        |                    | 507    |                    |   | 174                |      
|Agricultural loans                             |                           |                   | 1,272  |                   |   | 88                 |        |                    | 652    |                    |   | 127                |      
|                                               |                           |                   |        |                   |   |                    |        |                    |        |                    |   |                    |      
|                                               | Total                     |                   |        | 13,883            |   |                    | 10,950 |                    |        | 10,899             |   |                    | 8,210
|Other real estate                              |                           |                   | 9,909  |                   |   | 4,313              |        |                    | 3,560  |                    |   | 7,553              |      
|                                               |                           |                   |        |                   |   |                    |        |                    |        |                    |   |                    |      
|Total non-performing assets                    |                           | $                 | 23,792 |                   | $ | 15,263             |        | $                  | 14,459 |                    | $ | 15,763             |      
|                                               |                           |                   |        |                   |   |                    |        |                    |        |                    |   |                    |      
|Restructured loans                             |                           | $                 | 687    |                   | $ | 777                |        | $                  | 798    |                    | $ | 883                |      
|Total non-performing loans to loans receivable |                           |                   | 0.79   | %                 |   | 0.65               | %      |                    | 0.70   | %                  |   | 0.60               | %    
|Total non-performing loans to total assets     |                           |                   | 0.48   | %                 |   | 0.39               | %      |                    | 0.42   | %                  |   | 0.34               | %    
|Total non-performing assets to total assets    |                           |                   | 0.83   | %                 |   | 0.55               | %      |                    | 0.56   | %                  |   | 0.64               | %    

The level of non-performing loans relative to loans receivable has increased since 1995. This trend may continue as PNWB expands
its commercial lending activities and expands into new geographic and product markets. Interest income that would have been recognized as of December 31, 2000, had non-accrual loans
been current in accordance with their contractual terms amounted to $1.4 million.

Goodwill and Other Intangible AssetsGoodwill and other intangible assets totaled $20.7 million, or
0.72 percent of total assets and 11.58 percent of total shareholders' equity as of December 31, 2000. Goodwill and other intangible assets totaled $21.5 million, or
0.77 percent of total assets and 12.55 percent of total shareholders' equity as of December 31, 1999. This decrease is due to amortization during 2000 offset by additions to loan
servicing rights during the year.

Goodwill
arising from acquisitions represents the excess of the purchase price over the estimated fair value of net assets acquired. As part of the change to a commercial bank, PNWB
has consolidated and restructured its mortgage loan origination functions and related processes during 2000. This resulted in the impairment of $0.7 million of goodwill previously recorded for
the acquisition of a mortgage brokerage subsidiary in 1996.

Other
intangible assets consist of core deposit intangibles and loan servicing rights. Loan servicing rights are capitalized when acquired either through the purchase or origination
of loans that are subsequently sold or securitized with the servicing rights retained. The estimated fair value of loan servicing rights at the date of the sale of loans is determined based on the
discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans. The estimated fair value is periodically
evaluated for impairment by comparing actual cash flows and estimated future cash flows from the servicing assets to those estimated at the

19

---

time servicing assets were originated. Loan servicing rights are amortized as an offset to service fees in proportion to and over the period of estimated net servicing income.

Goodwill
and other intangible assets are amortized using the straight-line and accelerated methods over periods not exceeding twenty years.

DEPOSITSPNWB offers various types of deposit accounts, including checking accounts, savings accounts, money market
accounts and certificate of deposit accounts. Deposit accounts vary as to terms, the principal differences are the minimum balance required, the time period the funds must remain on deposit, the
interest rate, and the deposit or withdrawal option. PNWB relies on generating deposits through a marketing strategy that employs a sales staff responsible for generating new customer relationships.
As part of initiatives to improve liquidity and to reduce overall funding costs, PNWB began to use brokered and wholesale certificates of deposits during the year ended December 31, 2000. PNWB
had a total of $58.2 million of brokered and wholesale certificates of deposit as of December 31, 2000.

Non-interest-bearing
deposits were $244.1 million as of December 31, 2000, compared to $212.9 million as of December 31, 1999.
Non-interest-bearing deposits represented 14.2 percent of total deposits as of December 31, 2000, compared to 13.3 percent as of December 31, 1999.
Interest-bearing transaction accounts (which includes interest-bearing checking, money market and savings accounts) totaled $569.7 million as of December 31, 2000 compared to
$571.1 million as of December 31, 1999. Interest-bearing transaction accounts represented 33.2 percent of total deposits as of December 31, 2000, compared to
35.8 percent as of December 31, 1999.

Certificates
of deposit were $903.4 million as of December 31, 2000, compared to $814.3 million as of December 31, 1999. Certificates of deposit
represented 52.6 percent of total deposits as of December 31, 2000, compared to 50.9 percent as of December 31, 1999. The increase in certificates of deposit is primarily
due to growth in brokered and wholesale certificates of deposit of $58.2 million.

Management
is pursuing initiatives to increase the percentage of non-interest-bearing deposits and interest-bearing transaction deposits relative to certificates of
deposit. This should increase net interest income and service fee revenue while building customer relationships. As of December 31, 2000, 47.4 percent of total deposits were transaction
accounts, compared to 49.1 percent as of December 31, 1999.

The
following table indicates the amount of PNWB's certificates of deposit with balances equal to or greater than $100,000 classified by time remaining until maturity as of
December 31, 2000.

Dollars in thousandsMaturity Period

AmountThree months or less

$
232,285Three through six months


105,772Six through twelve months


91,706Greater than twelve months


38,006Total

$
467,769


20

---

The following table sets forth the balances of deposits by account type as of the dates indicated.

|                                   |  | December 31, 2000 |           | December 31, 1999 |      | September 30, 1999 |   | September 30, 1998 | 
|---------------------------------- |  | ----------------- | --------- | ----------------- | ---- | ------------------ | - | ------------------ | 
|
|Non-interest-bearing deposits      |  | $                 | 244,100   |                   | 14.2 | %                  | $ | 212,880            | 
|Interest-bearing checking accounts |  |                   | 201,894   |                   | 11.8 |                    |   | 173,751            | 
|Money market accounts              |  |                   | 266,933   |                   | 15.5 |                    |   | 300,267            | 
|Savings accounts                   |  |                   | 100,831   |                   | 5.9  |                    |   | 97,035             | 
|Certificates of deposit            |  |                   | 903,350   |                   | 52.6 |                    |   | 814,257            | 
|                                   |  |                   |           |                   |      |                    |   |                    | 
|Total                              |  | $                 | 1,717,108 |                   |      |                    | $ | 1,598,190          | 
|                                   |  |                   |           |                   |      |                    |   |                    | 

FHLB ADVANCES AND SECURITIES SOLD UNDER AGREEMENT TO REPURCHASEPNWB borrows through advances from the Federal Home Loan
Bank (FHLB) and securities sold under agreements to repurchase with third parties. These borrowing sources totaled $918.1 million as of December 31, 2000 compared to
$952.9 million as of December 31, 1999. This decrease is a result of the overall increase in deposits. It is management's intention to increase deposits and reduce borrowings in the
future.

The
FHLB provides credit for member financial institutions. As members, financial institutions are required to own capital stock in the FHLB, and are authorized to apply for advances
on the security of such stock, certain home mortgages and other assets (principally securities that are obligations of, or guaranteed by, the United States). Advances are made to member financial
institutions pursuant to several different programs. These programs are generally designed to meet the financial institution's needs while still reflecting market terms and conditions. Pacific
Northwest Bank uses advances from the FHLB to supplement funds available to lend and to meet liquidity guidelines. Interest rates on these advances vary in response to general economic conditions.

PNWB
also uses the securities market for borrowings by utilizing its securities available for sale and securities held to maturity as collateral. These borrowings are collateralized
by securities with an estimated fair value exceeding the face value of the borrowings.

21

---

The following table sets forth certain information with respect to FHLB advances and securities sold under agreements to repurchase during the periods indicated:

|As of or for the period endedDollars in thousands              |                                                | December 31,
2000 |   | December 31,
1999 |   | September 30,
1999 |         | September 30,
1998 |  
|-------------------------------------------------------------- | ---------------------------------------------- | ----------------- | - | ----------------- | - | ------------------ | ------- | ------------------ | -
|Maximum amount outstanding at any month end during the period: |                                                |                   |   |                   |   |                    |         |                    |  
|                                                               | FHLB advances                                  |                   | $ | 787,526           |   | $                  | 696,587 |                    | $
|                                                               | Securities sold under agreements to repurchase |                   |   | 286,807           |   |                    | 282,655 |                    |  
|Approximate average amount outstanding during the period:      |                                                |                   |   |                   |   |                    |         |                    |  
|                                                               | FHLB advances                                  |                   |   | 707,814           |   |                    | 680,928 |                    |  
|                                                               | Securities sold under agreements to repurchase |                   |   | 267,570           |   |                    | 165,612 |                    |  
|Balance outstanding at end of period:                          |                                                |                   |   |                   |   |                    |         |                    |  
|                                                               | FHLB advances                                  |                   |   | 643,200           |   |                    | 670,234 |                    |  
|                                                               | Securities sold under agreements to repurchase |                   |   | 274,920           |   |                    | 282,655 |                    |  
|Weighted average rate paid during the period:                  |                                                |                   |   |                   |   |                    |         |                    |  
|                                                               | FHLB advances                                  |                   |   | 6.07              | % |                    | 5.55    | %                  |  
|                                                               | Securities sold under agreements to repurchase |                   |   | 6.66              |   |                    | 5.86    |                    |  
|Weighted average rate paid at end of period:                   |                                                |                   |   |                   |   |                    |         |                    |  
|                                                               | FHLB advances                                  |                   |   | 6.37              |   |                    | 5.59    |                    |  
|                                                               | Securities sold under agreements to repurchase |                   |   | 6.88              |   |                    | 5.96    |                    |  

GUARANTEED PREFERRED BENEFICIAL INTERESTS IN SUBORDINATED DEBTOn November 15, 1999, $40 million of
9.875 percent Capital Securities were issued by InterWest Capital Trust I (the Trust). The Trust is a business trust organized in November 1999, and Pacific Northwest Bancorp owns
100 percent of the common equity of the Trust.

The
proceeds of the offering were invested by the Trust in junior subordinated debentures of Pacific Northwest Bancorp. The debentures held by the Trust are the sole assets of the
Trust. Distributions on the capital securities issued by the Trust are payable semiannually at 9.875 percent per annum, which is equal to the interest rate being earned by the Trust on the
debentures held by the Trust. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. The debentures will not mature earlier than
November 15, 2009, and not later than November 15, 2029. Pacific Northwest Bancorp entered into agreements which, taken collectively, fully and unconditionally guarantee the capital
securities subject to the terms of each of the guarantees.

PNWB
used the proceeds for general corporate purposes including stock repurchases and investment in the subsidiary bank. The capital securities qualify as Tier I capital under the
capital guidelines of the Federal Reserve Board.

CAPITAL

Pacific Northwest Bancorp is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors and creditors. PNWB
manages various capital levels at both the holding company and subsidiary bank level to maintain adequate capital ratios and levels in

22

---

accordance with external regulations and capital guidelines established by the Board of Directors of each institution. See Note 20 of the Consolidated Financial Statements for detail of
regulatory capital ratios for Pacific Northwest Bancorp and Pacific Northwest Bank.

On
November 16, 1999, the Board of Directors authorized the purchase of an additional 5 percent of Pacific Northwest Bancorp's outstanding shares of common stock in the
open market for the following twelve-month period. The Board of Directors previously approved a stock repurchase plan of 5 percent on January 20, 1999. During the year ended
December 31, 2000, 468,000 shares (3 percent of the total common shares outstanding) at a total price of $7.9 million were repurchased.

PNWB's
total shareholders' equity was $178.7 million and book value per share was $11.54 as of December 31, 2000. PNWB's total shareholders' equity was
$171.7 million and book value per share was $10.87 as of December 31, 1999. The increase in shareholders' equity is due to net income of $6.3 million, other comprehensive income
of $15.1 million, the issuance of $0.9 million of common stock and the ESOP debt repayment of $1.3 million. These increases in shareholders' equity are offset by
$8.7 million in dividends paid to shareholders and $7.9 million of common stock repurchases.

During
fiscal year 2000, Pacific Northwest Bancorp declared cash dividends totaling $0.56 per share, consistent with $0.56 per share for the year ended September 30, 1999.

LIQUIDITY RESOURCES

Liquidity management focuses on the need to meet both short-term funding requirements and PNWB's long-term strategies and goals.
Specifically, the objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors, creditors and borrowers. Management structures the balance
sheet to meet these needs. PNWB desires to attract and retain business and retail customer relationships with a focus on transaction accounts and commercial and consumer lending. PNWB also uses
wholesale funds through advances from the FHLB and the sale of
securities under agreements to repurchase to fund asset growth and meet liquidity needs. Other sources of funds for liquidity include loan repayments, loan sales, security sales and mortgage-backed
and related security repayments. Repayments on loans and mortgage-backed and related securities and deposit inflows and outflows are affected by changes in interest rates.

PNWB
has capacity to borrow additional funds from the FHLB through pre-approved credit lines. These credit lines have pledge requirements whereby PNWB must maintain
unencumbered collateral with a par value at least equal to the outstanding balance. As of December 31, 2000, the additional amount available under credit lines from the FHLB was
$502.8 million. Additionally, PNWB uses the securities market as a vehicle for borrowing by utilizing its securities available for sale and securities held to maturity as collateral. These
borrowings are collateralized by securities with an estimated fair value exceeding the face value of the borrowings. If the estimated fair value of the securities were to decline as a result of an
increase in interest rates or other factors, PNWB would be required to pledge additional securities or cash as collateral. As of December 31, 2000, PNWB had $132.1 million of available
credit from third parties to sell securities under agreements to repurchase.

The
analysis of liquidity also includes a review of PNWB's consolidated statement of cash flows for 2000. The consolidated statement of cash flows details PNWB's operating, investing
and financing activities during the year. The most significant items under operating activities include net income of $6.3 million and an increase in other liabilities of $10.9 million.
Operating activities also include the add back of non-cash depreciation, amortization of intangible assets, impairment of goodwill, provision for losses on loans and loss on other real
estate totaling $15.3 million. Net cash provided by operating activities is also adjusted for the net loss on securities available for sale of $6.1 million. Investing activities included
proceeds from the sale of securities available for sale of $156.5 million, proceeds from maturing and principal repayments on securities available for sale of $87.3 million and purchases
of securities available for sale of $156.9 million. Investing activities also include a $372.8 million

23

---

increase in loans receivable and $160.5 million of proceeds from the sale of loans. During 2000, financing activities included $36.1 million in borrowing repayments, net of borrowing
proceeds, a $29.8 million increase in deposits, a $89.1 million increase in certificates of deposit, $8.8 million paid in cash dividends to shareholders and $7.9 million in
common stock repurchases.

SUPERVISION AND REGULATION

Pacific Northwest Bancorp is a registered bank holding company under the Bank Holding Company Act of 1956 (BHCA) and is subject to the supervision of, and
regulation by, the Board of Governors of the Federal Reserve System (FRB). Under the BHCA, Pacific Northwest Bancorp files with the FRB annual reports of operations and such additional information as
the FRB may require. Under the
BHCA, a bank holding company may engage in banking, managing or controlling banks, furnishing or performing services for banks it controls, and conducting activities that the FRB has determined to be
closely related to banking.

Pacific
Northwest Bank is a member of the Federal Deposit Insurance Corporation (FDIC), and as such, is subject to examination thereby. Pacific Northwest Bank is a state-chartered
commercial bank subject to regulation and supervision by the Washington Department of Financial Institutions Division of Banks. In practice, the primary regulator makes regular examinations of the
subsidiary bank subject to its regulatory review or participates in joint examinations with other regulators. Areas subject to regulation by federal or state authorities include the allowance for
losses on loans, investments, loans, mergers and acquisitions, issuance of securities, payment of dividends, establishment of branches and other aspects of operations.

The
enforcement powers available to banking regulators are substantial and include, among other things, the ability to assess civil monetary penalties, to issue
cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, enforcement
actions must be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions, or inactions, may provide the basis for enforcement action, including misleading or
untimely reports filed with regulatory authorities. Applicable law also requires public disclosure of final enforcement actions.

MARKET RISK

PNWB's results of operations are largely dependent upon its ability to manage interest rate risk. Management considers interest rate risk to be a significant
market risk that could have a material effect on PNWB's financial condition and results of operations.

PNWB
is sensitive to the potential change in interest rates and the resulting impact on net interest income. It has been an objective of management to reduce this sensitivity through
the use of adjustable rate loans and short-term commercial and consumer loans. This enables PNWB to better match the duration of its deposit base with these types of assets.

In
addition to adjustable rate loans, PNWB uses a number of additional strategies to minimize the impact on net income due to significant changes in interest rates. The strategies
utilized by PNWB include sales of long-term, fixed-rate mortgage loans, emphasis on growth in non-interest-bearing deposits and adjustable rate commercial lending.

Management
uses simulation analysis to measure PNWB's interest sensitivity position. This simulation analysis is used to evaluate the effects of potential interest rate movements on
net interest income. The simulation analysis model is dynamic in nature, and incorporates management's current balance sheet strategy. Management develops assumptions regarding interest rate spreads,
projected balances, expected maturities, cash flows and prepayment assumptions under different interest rate scenarios.

24

---

The table on the following page sets forth the balances of PNWB's financial instruments at the expected maturity dates, as well as the estimated fair value of those financial
instruments as of December 31, 2000. The expected maturities take into consideration historical and estimated principal prepayments for loans and mortgage-backed securities. Principal
prepayments are the amounts of principal reduction, over and above normal amortization.

The
expected maturities for financial liabilities with no stated maturity reflect assumptions based on historical and estimated future roll-off rates. The
roll-off rates for non-interest-bearing deposits, interest-bearing checking accounts, money market accounts and savings accounts are 14 percent, 20 percent,
33 percent and 20 percent, respectively. The weighted average interest rates for financial instruments presented are actual as of December 31, 2000.

The
estimated fair value amounts have been determined by PNWB using available market information and appropriate valuation methodologies. However, considerable judgment is necessary
to interpret market data in the development of the estimated fair value amounts. Accordingly, the estimated fair values presented herein are not necessarily indicative of the amounts PNWB could
realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The carrying value of cash
and due from banks, federal funds sold, securities purchased under agreements to resell and interest receivable is a reasonable estimate of the fair value for such financial assets. The estimated fair
values of securities available for sale, securities held to maturity and loans held for sale are based on quoted market rates and dealer quotes. The estimated fair value of loans receivable is based
on discounted cash flows, using interest rates currently offered for loans of similar characteristics. The estimated fair value of deposits with no stated maturity, such as checking accounts, money
market accounts and savings accounts, is equal to the amount payable on demand as of December 31, 2000. The estimated fair value of certificates of deposit is based on the present value of
contractual cash flows using a discount rate based on the current average rate for deposits with similar characteristics. The estimated fair value of FHLB advances and securities sold under agreements
to repurchase is based on the present value of future cash flows using a discount rate equal to the rate offered on similar borrowings with similar maturities as of December 31, 2000. The
estimated fair value of guaranteed preferred beneficial interests in subordinated debt is based on quoted market rates for subordinated debt with similar
interest rates and similar characteristics. The estimated fair values presented are based on information available as of December 31, 2000.

25

---

|Expected maturity date
year ended December 31,Dollars in thousands     |                                | 2001 |         | 2002    |   | 2003    |         | 2004 |         | 2005    |   | Thereafter |        | Total |        | Estimated
Fair
Value
|---------------------------------------------------------------------- | ------------------------------ | ---- | ------- | ------- | - | ------- | ------- | ---- | ------- | ------- | - | ---------- | ------ | ----- | ------ | --------------------
|Financial Assets                                                       |                                |      |         |         |   |         |         |      |         |         |   |            |        |       |        |                     
|Cash and due from banks                                                |                                |      |         |         |   |         |         |      |         |         |   |            |        |       |        |                     
|                                                                       | Non-interest-bearing           |      | $       | 70,566  |   | $       |        |      | $       |        |   | $          |       |       | $      |                    
|                                                                       | Interest-bearing               |      |         | 8,295   |   |         |        |      |         |        |   |            |       |       |        |                    
|                                                                       | Weighted average interest rate |      |         | 5.57    | % |         |        |      |         |        |   |            |       |       |        |                    
|Federal funds sold and securities purchased under agreements to resell |                                |      | 7,467   |         |   |        |         |      |        |         |   |           |        |       |       |                     
|Weighted average rate                                                  |                                |      | 6.78    | %       |   |        |         |      |        |         |   |           |        |       |       |                     
|Securities available for sale                                          |                                |      | 115,352 |         |   | 137,772 |         |      | 110,612 |         |   | 105,131    |        |       | 64,154 |                     
|Weighted average interest rate                                         |                                |      | 6.56    | %       |   | 6.53    | %       |      | 6.24    | %       |   | 6.26       | %      |       | 6.41   | %                   
|Securities held to maturity                                            |                                |      | 9,119   |         |   | 6,746   |         |      | 5,422   |         |   | 4,460      |        |       | 3,694  |                     
|Weighted average interest rate                                         |                                |      | 6.36    | %       |   | 6.44    | %       |      | 6.38    | %       |   | 6.33       | %      |       | 6.29   | %                   
|Loans receivable                                                       |                                |      |         |         |   |         |         |      |         |         |   |            |        |       |        |                     
|                                                                       | Fixed rate                     |      |         | 98,478  |   |         | 85,173  |      |         | 71,190  |   |            | 54,731 |       |        | 41,704              
|                                                                       | Weighted average interest rate |      |         | 8.76    | % |         | 8.61    | %    |         | 8.36    | % |            | 8.25   | %     |        | 8.36                
|                                                                       | Variable rate                  |      |         | 478,310 |   |         | 165,641 |      |         | 116,336 |   |            | 95,787 |       |        | 73,729              
|                                                                       | Weighted average interest rate |      |         | 10.01   | % |         | 9.10    | %    |         | 8.84    | % |            | 8.78   | %     |        | 8.67                
|Loans held for sale                                                    |                                |      | 14,187  |         |   |        |         |      |        |         |   |           |        |       |       |                     
|Weighted average interest rate                                         |                                |      | 8.06    | %       |   |        |         |      |        |         |   |           |        |       |       |                     
|Interest receivable                                                    |                                |      | 19,762  |         |   |        |         |      |        |         |   |           |        |       |       |                     
|Financial Liabilities                                                  |                                |      |         |         |   |         |         |      |         |         |   |            |        |       |        |                     
|Non-interest-bearing deposits                                          |                                | $    | 34,174  |         | $ | 29,390  |         | $    | 25,275  |         | $ | 21,737     |        | $     | 18,693 |                     
|Interest-bearing checking accounts                                     |                                |      | 40,379  |         |   | 32,303  |         |      | 25,842  |         |   | 20,674     |        |       | 16,539 |                     
|Weighted average interest rate                                         |                                |      | 1.50    | %       |   | 1.50    | %       |      | 1.50    | %       |   | 1.50       | %      |       | 1.50   | %                   
|Money market accounts                                                  |                                |      | 88,088  |         |   | 59,019  |         |      | 39,543  |         |   | 26,494     |        |       | 17,751 |                     
|Weighted average interest rate                                         |                                |      | 4.27    | %       |   | 4.27    | %       |      | 4.27    | %       |   | 4.27       | %      |       | 4.27   | %                   
|Savings accounts                                                       |                                |      | 20,166  |         |   | 16,133  |         |      | 12,906  |         |   | 10,325     |        |       | 8,260  |                     
|Weighted average interest rate                                         |                                |      | 1.60    | %       |   | 1.60    | %       |      | 1.60    | %       |   | 1.60       | %      |       | 1.60   | %                   
|Certificates of deposit                                                |                                |      | 785,962 |         |   | 65,575  |         |      | 38,720  |         |   | 4,705      |        |       | 6,558  |                     
|Weighted average interest rate                                         |                                |      | 6.31    | %       |   | 6.07    | %       |      | 6.04    | %       |   | 5.53       | %      |       | 6.24   | %                   
|FHLB advances                                                          |                                |      |         |         |   |         |         |      |         |         |   |            |        |       |        |                     
|                                                                       | Fixed rate                     |      |         | 525,000 |   |         | 25,400  |      |         | 75,000  |   |            |       |       |        |                    
|                                                                       | Weighted average interest rate |      |         | 6.55    | % |         | 5.09    | %    |         | 5.50    | % |            |       |       |        |                    
|                                                                       | Adjustable rate                |      |         | 17,000  |   |         | 800     |      |         |        |   |            |       |       |        |                    
|                                                                       | Weighted average interest rate |      |         | 6.83    | % |         | 6.54    | %    |         |        |   |            |       |       |        |                    
|Securities sold under agreements to repurchase                         |                                |      | 252,720 |         |   | 22,200  |         |      |        |         |   |           |        |       |       |                     
|Weighted average interest rate                                         |                                |      | 6.90    | %       |   | 7.40    | %       |      |        |         |   |           |        |       |       |                     
|Guaranteed preferred beneficial interest in subordinated debt          |                                |      |        |         |   |        |         |      |        |         |   |           |        |       |       |                     
|Weighted average interest rate                                         |                                |      |        |         |   |        |         |      |        |         |   |           |        |       |       |                     

While this table provides some information about PNWB's interest sensitivity, it does not predict the trends of future earnings. For this
reason, PNWB uses financial modeling to forecast earnings under different interest rate projections. While this modeling is helpful in managing interest rate risk, it does require significant
assumptions for the projection of loan prepayment rates, loan origination volumes and liability funding sources that may prove to be inaccurate.

26

---

ACCOUNTING CHANGES

In June 1998, the Financial Accounting and Standards Board (FASB) issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." In June 2000, the FASB issued SFAS No. 138, which amended certain provisions of SFAS No. 133 to clarify certain areas causing difficulties in implementation. This
statement, as amended by SFAS No. 138, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments imbedded in other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at estimated fair value.
In certain defined conditions, a derivative may be specifically designated as a hedge for a particular exposure. The accounting for derivatives depends on the intended use of the derivatives and the
resulting designation. This statement was adopted by PNWB on January 1, 2001. The adoption of this statement did not have a material impact on PNWB's financial condition or results of
operations. As permitted by the provisions of this statement, PNWB reclassified all securities held to maturity to securities available for sale on January 1, 2001. This reclassification
resulted in other comprehensive loss of $0.6 million, net of income taxes of $0.3 million.

In
March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation: an interpretation of APB No. 25." This
interpretation provides clarification of certain issues, such as determination of who is an employee and the criteria for determining whether a plan qualifies as a non-compensatory plan.
This interpretation also clarifies the accounting for various modifications to the terms of a previously fixed stock option and the accounting for an exchange of stock compensation awards in a
business combination. PNWB believes its accounting for stock based compensation is in conformity with this guidance, and therefore this interpretation had no impact on PNWB's financial condition or
results of operations.

In
September 2000, the FASB issued SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," a replacement of SFAS
No. 125. This statement revises the standards for accounting for securitizations and other transfers of financial assets and collateral and
requires certain disclosures; however, it carries over most of SFAS No. 125's provisions without reconsideration. The standards addressed in this statement are based on consistent application
of a financial components approach that focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after March 31, 2001. This statement is effective for recognition and reclassification of collateral and for disclosures relating
to securitization transactions and collateral for the year ended December 31, 2000. The adoption of this statement affects the disclosures in PNWB's consolidated financial statements; however,
management does not expect the adoption of this statement to have a material impact on PNWB's financial condition or results of operations.

FORWARD-LOOKING STATEMENTS

In this Management Discussion and Analysis, PNWB has included certain "forward-looking statements" concerning its future operations. It is PNWB's desire to
take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. This statement is for the express purpose of availing PNWB of the protections of such safe
harbor with respect to all forward-looking statements contained in this Management Discussion and Analysis. Sentences containing words such as "may," "will," "expect," "anticipate," "believe,"
"estimate," "should," "projected," or similar words may constitute forward-looking statements. Although PNWB 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, it is possible that actual results may differ materially

27

---

from these expectations. PNWB has used these statements to describe expectations and estimates in various areas, including, but not limited to: changes in the economy of the markets in which it
operates; interest rate movements; future acquisition and growth strategies; system conversions and integration activities; the impact of competitive products, services and pricing; and legislative,
regulatory and accounting changes affecting the banking and financial services industry. Actual results could vary materially from the future results covered in forward-looking statements. Factors
such as interest rate trends and loan delinquency rates, as well as the general state of the economy in Washington state and the United States as a whole, could also cause actual results to vary
materially from the future results anticipated in such forward-looking statements. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be
placed on such statements.

28

---

REPORT OF MANAGEMENT TO SHAREHOLDERS

Management of Pacific Northwest Bancorp is responsible for the preparation, integrity and fair presentation of its published financial statements. The consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the United States and include judgments and estimates of management. Pacific Northwest Bancorp's management also prepared the
other information included in this report and is responsible for its accuracy and consistency with the consolidated financial statements.

Management
is responsible for establishing and maintaining an effective internal control structure over financial reporting. The internal control system is supported by written
policies and procedures and by audits performed by an internal audit staff that reports to the Audit Committee of the Board of Directors. Internal auditors monitor the operation of the internal
control system and report findings to management and the Audit Committee, and corrective actions are taken to address identified control deficiencies and other opportunities for improving the system.
The Audit Committee provides oversight to the financial reporting process. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human
error and circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. The
concept of reasonable assurance is based on the recognition that the costs of such a system should not exceed the benefits to be received. Management believes the system provides an appropriate
cost/benefit balance.

Management
assesses Pacific Northwest Bancorp's internal control structure over financial reporting. Based on these assessments, management believes that Pacific Northwest Bancorp
maintains an effective internal control system over financial reporting.

|Patrick M. Fahey
President and Chief Executive Officer | Bette J. Floray
Executive Vice President and Chief Financial Officer
|------------------------------------------------------ | --------------------------------------------------------------------

29

---

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

To the Board of Directors and Shareholders
Pacific Northwest Bancorp

We
have audited the accompanying consolidated statements of financial condition of Pacific Northwest Bancorp (formerly InterWest Bancorp, Inc.) and subsidiaries as of
December 31, 2000 and 1999, and the related consolidated statements of income, shareholders' equity, and cash flows for the year ended December 31, 2000, the three-month period ended
December 31, 1999 and for each of the two years in the period ended September 30, 1999. These consolidated financial statements are the responsibility of Pacific Northwest Bancorp's
management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We
conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pacific Northwest Bancorp and
subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for the year ended December 31, 2000, the three-month period ended
December 31, 1999, and for each of the two years in the period ended September 30, 1999, in conformity with accounting principles generally accepted in the United States.

|Seattle, Washington
January 31, 2001 |  | Ernst & Young LLP
|------------------------------------ |  | -----------------

30

---

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

|Dollars in thousandsAs of December 31,                                                                                            |                                                              | 2000 |           | 1999      |  
|--------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------ | ---- | --------- | --------- | -
|Assets                                                                                                                            |                                                              |      |           |           |  
|Cash and due from banks                                                                                                           |                                                              |      |           |           |  
|                                                                                                                                  | Non-interest-bearing                                         |      | $         | 70,566    |  
|                                                                                                                                  | Interest-bearing                                             |      |           | 8,295     |  
|Federal funds sold and securities purchased under agreements to resell                                                            |                                                              |      | 7,467     |           |  
|Securities available for sale, at estimated fair value                                                                            |                                                              |      | 840,489   |           |  
|Securities held to maturity (estimated fair value: 2000$63,823 and 1999$66,477)                                                 |                                                              |      | 64,741    |           |  
|Loans receivable                                                                                                                  |                                                              |      | 1,776,108 |           |  
|                                                                                                                                  | Allowance for losses on loans                                |      |           | (17,561   | )
|                                                                                                                                  |                                                              |      |           |           |  
|                                                                                                                                  | Net loans receivable                                         |      |           | 1,758,547 |  
|Loans held for sale (estimated fair value: 2000$14,385 and 1999$22,718)                                                         |                                                              |      | 14,187    |           |  
|Interest receivable                                                                                                               |                                                              |      | 19,762    |           |  
|Other real estate                                                                                                                 |                                                              |      | 9,909     |           |  
|Premises and equipment                                                                                                            |                                                              |      | 58,466    |           |  
|Goodwill and other intangible assets                                                                                              |                                                              |      | 20,701    |           |  
|Other assets                                                                                                                      |                                                              |      | 9,740     |           |  
|                                                                                                                                  |                                                              |      |           |           |  
|Total assets                                                                                                                      |                                                              | $    | 2,882,870 |           | $
|                                                                                                                                  |                                                              |      |           |           |  
|Liabilities                                                                                                                       |                                                              |      |           |           |  
|Deposits                                                                                                                          |                                                              |      |           |           |  
|                                                                                                                                  | Non-interest-bearing                                         |      | $         | 244,100   |  
|                                                                                                                                  | Interest-bearing                                             |      |           | 1,473,008 |  
|                                                                                                                                  |                                                              |      |           |           |  
|                                                                                                                                  | Total deposits                                               |      |           | 1,717,108 |  
|Federal Home Loan Bank (FHLB) advances                                                                                            |                                                              |      | 643,200   |           |  
|Securities sold under agreements to repurchase                                                                                    |                                                              |      | 274,920   |           |  
|Guaranteed preferred beneficial interests in subordinated debt                                                                    |                                                              |      | 40,000    |           |  
|Other borrowings                                                                                                                  |                                                              |      | 1,753     |           |  
|Other liabilities                                                                                                                 |                                                              |      | 27,153    |           |  
|                                                                                                                                  |                                                              |      |           |           |  
|Total liabilities                                                                                                                 |                                                              |      | 2,704,134 |           |  
|Shareholders' Equity                                                                                                              |                                                              |      |           |           |  
|Common stock, no par value
Authorized shares 30,000,000
Issued and outstanding: 200015,494,357 shares and 199915,800,377 shares |                                                              |      |          |           |  
|Paid-in capital                                                                                                                   |                                                              |      | 26,291    |           |  
|Retained earnings                                                                                                                 |                                                              |      | 159,613   |           |  
|Debt related to employee stock ownership plan (ESOP)                                                                              |                                                              |      | (1,668    | )         |  
|Accumulated other comprehensive loss:                                                                                             |                                                              |      |           |           |  
|                                                                                                                                  | Unrealized loss on securities available for sale, net of tax |      |           | (5,500    | )
|                                                                                                                                  |                                                              |      |           |           |  
|Total shareholders' equity                                                                                                        |                                                              |      | 178,736   |           |  
|                                                                                                                                  |                                                              |      |           |           |  
|Total liabilities and shareholders' equity                                                                                        |                                                              | $    | 2,882,870 |           | $
|                                                                                                                                  |                                                              |      |           |           |  

See Notes to Consolidated Financial Statements

31

---

CONSOLIDATED STATEMENTS OF INCOME

|Dollars in thousands, except per share amounts                 |  | Year Ended
December 31,
2000 |         | Three Months
December 31,
1999 |   | Year Ended
September 30,
1999 |  | Year Ended
September 30,
1998
|-------------------------------------------------------------- |  | ---------------------------- | ------- | ------------------------------ | - | ----------------------------- |  | -----------------------------
|Interest Income                                                |  |                              |         |                                |   |                               |  |                              
|Loans receivable and loans held for sale                       |  | $                            | 159,870 |                                | $ | 36,297                        |  | $                            
|Securities available for sale                                  |  |                              | 52,402  |                                |   | 12,264                        |  |                              
|Securities held to maturity                                    |  |                              | 4,345   |                                |   | 1,096                         |  |                              
|Other                                                          |  |                              | 1,571   |                                |   | 724                           |  |                              
|                                                               |  |                              |         |                                |   |                               |  |                              
|                                                               |  |                              | 218,188 |                                |   | 50,381                        |  |                              
|Interest Expense                                               |  |                              |         |                                |   |                               |  |                              
|Deposits                                                       |  |                              | 63,805  |                                |   | 14,791                        |  |                              
|FHLB advances and other borrowings                             |  |                              | 43,113  |                                |   | 9,553                         |  |                              
|Securities sold under agreements to repurchase                 |  |                              | 17,787  |                                |   | 2,445                         |  |                              
|Guaranteed preferred beneficial interests in subordinated debt |  |                              | 3,950   |                                |   | 494                           |  |                              
|                                                               |  |                              |         |                                |   |                               |  |                              
|                                                               |  |                              | 128,655 |                                |   | 27,283                        |  |                              
|Net interest income                                            |  |                              | 89,533  |                                |   | 23,098                        |  |                              
|Provision for losses on loans                                  |  |                              | 4,750   |                                |   | 550                           |  |                              
|                                                               |  |                              |         |                                |   |                               |  |                              
|Net interest income after provision for losses on loans        |  |                              | 84,783  |                                |   | 22,548                        |  |                              
|Non-Interest Income                                            |  |                              |         |                                |   |                               |  |                              
|Service fees                                                   |  |                              | 11,974  |                                |   | 2,744                         |  |                              
|Investment product fees and insurance commissions              |  |                              | 2,869   |                                |   | 634                           |  |                              
|Gain (loss) on sale of securities available for sale           |  |                              | (6,113  | )                              |   |                              |  |                              
|Gain on sale of loans                                          |  |                              | 905     |                                |   | 71                            |  |                              
|Gain on sale of loan servicing rights                          |  |                              |        |                                |   |                              |  |                              
|Gain on sale of other real estate                              |  |                              | 177     |                                |   | 93                            |  |                              
|Other                                                          |  |                              | 2,581   |                                |   | 748                           |  |                              
|                                                               |  |                              |         |                                |   |                               |  |                              
|                                                               |  |                              | 12,393  |                                |   | 4,290                         |  |                              
|Non-Interest Expense                                           |  |                              |         |                                |   |                               |  |                              
|Compensation and employee benefits                             |  |                              | 39,398  |                                |   | 9,799                         |  |                              
|General and administrative                                     |  |                              | 15,608  |                                |   | 4,064                         |  |                              
|Occupancy and equipment                                        |  |                              | 10,626  |                                |   | 2,516                         |  |                              
|Data processing                                                |  |                              | 5,684   |                                |   | 1,258                         |  |                              
|Loss from real estate write-downs and operations               |  |                              | 2,504   |                                |   | 63                            |  |                              
|Amortization of goodwill and core deposit intangible           |  |                              | 1,290   |                                |   | 323                           |  |                              
|Conversion and integration                                     |  |                              | 7,361   |                                |   |                              |  |                              
|Severance and employment agreements                            |  |                              | 3,325   |                                |   | 420                           |  |                              
|Impairment of goodwill                                         |  |                              | 749     |                                |   |                              |  |                              
|Merger-related charges                                         |  |                              |        |                                |   |                              |  |                              
|                                                               |  |                              |         |                                |   |                               |  |                              
|                                                               |  |                              | 86,545  |                                |   | 18,443                        |  |                              
|Income before income taxes                                     |  |                              | 10,631  |                                |   | 8,395                         |  |                              
|Income tax expense                                             |  |                              | 4,362   |                                |   | 2,933                         |  |                              
|                                                               |  |                              |         |                                |   |                               |  |                              
|Net income                                                     |  | $                            | 6,269   |                                | $ | 5,462                         |  | $                            
|                                                               |  |                              |         |                                |   |                               |  |                              
|Basic net income per share                                     |  | $                            | 0.40    |                                | $ | 0.34                          |  | $                            
|                                                               |  |                              |         |                                |   |                               |  |                              
|Diluted net income per share                                   |  | $                            | 0.40    |                                | $ | 0.34                          |  | $                            
|                                                               |  |                              |         |                                |   |                               |  |                              

See Notes to Consolidated Financial Statements

32

---

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

|                                        |                                       | Common Stock,
No Par Value
Shares                                                     |         | Paid-In
Capital |         | Retained
Earnings |   | Debt
Related
to ESOP |        | Accumulated
Other
Comprehensive
Income (Loss) |        | Total |  
|--------------------------------------- | ------------------------------------- | ------------------------------------------------------------------------------------- | ------- | --------------- | ------- | ----------------- | - | -------------------- | ------ | --------------------------------------------- | ------ | ----- | -
|
|October 1, 1997                         |                                       | 15,664,812                                                                            |         | $               | 35,821  |                   | $ | 126,064              |        | $                                             |       |       | $
|Dividends declared, $0.50 per share     |                                       |                                                                                       |         |                 |         |                   |   | (7,676               | )      |                                               |        |       |  
|Issuance of common stock:               |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        | Stock option and stock purchase plans |                                                                                       | 134,397 |                 |         | 725               |   |                      |        |                                               |        |       |  
|Purchase and retirement of common stock |                                       | (809                                                                                  | )       |                 | (34     | )                 |   |                      |        |                                               |        |       |  
|Debt related to ESOP                    |                                       | (147,055                                                                              | )       |                 |         |                   |   |                      |        |                                               | (3,935 | )     |  
|Pooling accounting adjustment           |                                       |                                                                                       |         |                 |         |                   |   | (1,249               | )      |                                               |        |       |  
|Comprehensive income:                   |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        | Net income                            |                                                                                       |         |                 |         |                   |   |                      | 22,642 |                                               |        |       |  
|                                        | Other comprehensive income (loss)    |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       | Unrealized gain on securities available for sale, net of taxes of $505                |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       | Reclassification adjustment for gains included in net income, net of taxes of $285    |         |                 |         |                   |   |                      |        |                                               |        |       |  
|Total comprehensive income              |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|September 30, 1998                      |                                       | 15,651,345                                                                            |         |                 | 36,512  |                   |   | 139,781              |        |                                               | (3,935 | )     |  
|Dividends declared, $0.56 per share     |                                       |                                                                                       |         |                 |         |                   |   | (8,808               | )      |                                               |        |       |  
|Issuance of common stock:               |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        | Stock option plans                    |                                                                                       | 285,900 |                 |         | 1,525             |   |                      |        |                                               |        |       |  
|Purchase and retirement of common stock |                                       | (521,500                                                                              | )       |                 | (11,910 | )                 |   |                      |        |                                               |        |       |  
|ESOP debt repayment                     |                                       | 18,945                                                                                |         |                 |         |                   |   |                      |        |                                               | 327    |       |  
|Comprehensive income:                   |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        | Net income                            |                                                                                       |         |                 |         |                   |   |                      | 27,855 |                                               |        |       |  
|                                        | Other comprehensive loss             |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       | Unrealized loss on securities available for sale, net of taxes of $8,232              |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       | Reclassification adjustment for gains included in net income, net of taxes of $25     |         |                 |         |                   |   |                      |        |                                               |        |       |  
|Total comprehensive income              |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|September 30, 1999                      |                                       | 15,434,690                                                                            |         |                 | 26,127  |                   |   | 158,828              |        |                                               | (3,608 | )     |  
|Dividends declared, $0.14 per share     |                                       |                                                                                       |         |                 |         |                   |   | (2,247               | )      |                                               |        |       |  
|Issuance of common stock:               |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        | Stock option plans                    |                                                                                       | 55,600  |                 |         | 328               |   |                      |        |                                               |        |       |  
|                                        | Acquisitions                          |                                                                                       | 677,109 |                 |         | 14,463            |   |                      |        |                                               |        |       |  
|Purchase and retirement of common stock |                                       | (392,500                                                                              | )       |                 | (7,621  | )                 |   |                      |        |                                               |        |       |  
|ESOP debt repayment                     |                                       | 25,478                                                                                |         |                 |         |                   |   |                      |        |                                               | 628    |       |  
|Comprehensive income:                   |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        | Net income                            |                                                                                       |         |                 |         |                   |   |                      | 5,462  |                                               |        |       |  
|                                        | Other comprehensive loss             |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       | Unrealized loss on securities available for sale, net of taxes of $2,476              |         |                 |         |                   |   |                      |        |                                               |        |       |  
|Total comprehensive income              |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|December 31, 1999                       |                                       | 15,800,377                                                                            |         |                 | 33,297  |                   |   | 162,043              |        |                                               | (2,980 | )     |  
|Dividends declared, $0.56 per share     |                                       |                                                                                       |         |                 |         |                   |   | (8,699               | )      |                                               |        |       |  
|Issuance of common stock:               |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        | Stock option plans                    |                                                                                       | 111,964 |                 |         | 779               |   |                      |        |                                               |        |       |  
|                                        | Stock grants                          |                                                                                       | 2,455   |                 |         | 75                |   |                      |        |                                               |        |       |  
|Purchase and retirement of common stock |                                       | (468,000                                                                              | )       |                 | (7,860  | )                 |   |                      |        |                                               |        |       |  
|ESOP debt repayment                     |                                       | 47,561                                                                                |         |                 |         |                   |   |                      |        |                                               | 1,312  |       |  
|Comprehensive income:                   |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        | Net income                            |                                                                                       |         |                 |         |                   |   |                      | 6,269  |                                               |        |       |  
|                                        | Other comprehensive income           |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       | Unrealized gain on securities available for sale, net of taxes of $6,013              |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       | Reclassification adjustment for losses included in net income, net of taxes of $2,140 |         |                 |         |                   |   |                      |        |                                               |        |       |  
|Total comprehensive income              |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|                                        |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  
|December 31, 2000                       |                                       | 15,494,357                                                                            |         | $               | 26,291  |                   | $ | 159,613              |        | $                                             | (1,668 | )     | $
|                                        |                                       |                                                                                       |         |                 |         |                   |   |                      |        |                                               |        |       |  

See Notes to Consolidated Financial Statements

33

---

CONSOLIDATED STATEMENTS OF CASH FLOWS

|Dollars in thousands                                                                              |                                                         | Year ended
December 31,
2000 |          | Three months
December 31,
1999 |   | Year ended
September 30,
1999 |        | Year ended
September 30,
1998 |         
|------------------------------------------------------------------------------------------------- | ------------------------------------------------------- | ---------------------------- | -------- | ------------------------------ | - | ----------------------------- | ------ | ----------------------------- | --------
|Operating Activities                                                                              |                                                         |                              |          |                                |   |                               |        |                               |         
|Net income                                                                                        |                                                         | $                            | 6,269    |                                | $ | 5,462                         |        | $                             | 27,855  
|Adjustments to reconcile net income to net cash provided by operating activities:                 |                                                         |                              |          |                                |   |                               |        |                               |         
|                                                                                                  | Depreciation                                            |                              |          | 5,544                          |   |                               | 1,149  |                               |         
|                                                                                                  | Amortization of intangible assets                       |                              |          | 2,042                          |   |                               | 495    |                               |         
|                                                                                                  | Impairment of goodwill                                  |                              |          | 749                            |   |                               |       |                               |         
|                                                                                                  | Provision for losses on loans                           |                              |          | 4,750                          |   |                               | 550    |                               |         
|                                                                                                  | Loss on other real estate                               |                              |          | 2,168                          |   |                               | 10     |                               |         
|                                                                                                  | Amortization (accretion) of premiums and discounts, net |                              |          | (76                            | ) |                               | 270    |                               |         
|                                                                                                  | Gain on sale of loans                                   |                              |          | (905                           | ) |                               | (71    | )                             |         
|                                                                                                  | Gain on sale of loan servicing rights                   |                              |          |                               |   |                               |       |                               |         
|                                                                                                  | Loss (gain) on sale of securities available for sale    |                              |          | 6,113                          |   |                               |       |                               |         
|                                                                                                  | Gain on sale of other real estate                       |                              |          | (177                           | ) |                               | (93    | )                             |         
|                                                                                                  | Loan fees deferred, net of amortization                 |                              |          | 630                            |   |                               | 730    |                               |         
|                                                                                                  | FHLB stock dividends                                    |                              |          | (2,846                         | ) |                               | (777   | )                             |         
|                                                                                                  | Pooling accounting adjustment                           |                              |          |                               |   |                               |       |                               |         
|Changes in operating assets and liabilities:                                                      |                                                         |                              |          |                                |   |                               |        |                               |         
|                                                                                                  | Interest receivable                                     |                              |          | (2,981                         | ) |                               | (565   | )                             |         
|                                                                                                  | Other assets                                            |                              |          | (5,059                         | ) |                               | 383    |                               |         
|                                                                                                  | Other liabilities                                       |                              |          | 10,940                         |   |                               | (1,516 | )                             |         
|                                                                                                  |                                                         |                              |          |                                |   |                               |        |                               |         
|Net cash provided by operating activities                                                         |                                                         | $                            | 27,161   |                                | $ | 6,027                         |        | $                             | 18,036  
|Investing Activities                                                                              |                                                         |                              |          |                                |   |                               |        |                               |         
|Proceeds from sale of securities available for sale                                               |                                                         |                              | 156,540  |                                |   |                              |        |                               | 258,509 
|Purchases of securities available for sale                                                        |                                                         |                              | (156,891 | )                              |   | (14,380                       | )      |                               | (923,893
|Proceeds from maturing and principal repayments on securities available for sale                  |                                                         |                              | 87,320   |                                |   | 20,290                        |        |                               | 552,145 
|Proceeds from maturing and principal repayments on securities held to maturity                    |                                                         |                              | 4,094    |                                |   | 1,780                         |        |                               | 16,340  
|Purchases of securities held to maturity                                                          |                                                         |                              |         |                                |   |                              |        |                               |        
|Proceeds from sale of loans                                                                       |                                                         |                              | 160,524  |                                |   | 2,316                         |        |                               | 419,079 
|Net increase in loans receivable                                                                  |                                                         |                              | (372,826 | )                              |   | (134,868                      | )      |                               | (592,534
|Proceeds from sale of other real estate                                                           |                                                         |                              | 7,654    |                                |   | 1,190                         |        |                               | 8,954   
|Purchases of premises and equipment                                                               |                                                         |                              | (10,452  | )                              |   | (748                          | )      |                               | (9,171  
|Purchases of FHLB stock                                                                           |                                                         |                              | (770     | )                              |   |                              |        |                               | (1,863  
|Redemption of FHLB stock                                                                          |                                                         |                              | 5,000    |                                |   |                              |        |                               |        
|Proceeds from sale of loan servicing rights                                                       |                                                         |                              |         |                                |   |                              |        |                               | 5,622   
|Cash paid for acquisitions, net of cash received                                                  |                                                         |                              |         |                                |   | 9,735                         |        |                               | (589    
|Improvements capitalized to other real estate                                                     |                                                         |                              | (2,081   | )                              |   | (168                          | )      |                               | (1,570  
|Net decrease (increase) in federal funds sold and securities purchased under agreements to resell |                                                         |                              | (7,467   | )                              |   |                              |        |                               | 19,863  
|Federal funds received in acquisition                                                             |                                                         |                              |         |                                |   |                              |        |                               |        
|                                                                                                  |                                                         |                              |          |                                |   |                               |        |                               |         
|Net cash used in investing activities                                                             |                                                         | $                            | (129,355 | )                              | $ | (114,853                      | )      | $                             | (249,108

See Notes to Consolidated Financial Statements

34

---

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

|Dollars in thousands                                                                              |                                                                    | Year ended
December 31,
2000 |            | Three months
December 31,
1999 |   | Year ended
September 30,
1999 |        | Year ended
September 30,
1998 |         
|------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------ | ---------------------------- | ---------- | ------------------------------ | - | ----------------------------- | ------ | ----------------------------- | --------
|Financing Activities                                                                              |                                                                    |                              |            |                                |   |                               |        |                               |         
|Net increase in deposits                                                                          |                                                                    | $                            | 29,825     |                                | $ | 1,494                         |        | $                             | 28,376  
|Net increase (decrease) in certificates of deposit                                                |                                                                    |                              | 89,093     |                                |   | (30,205                       | )      |                               | (14,252 
|Proceeds from FHLB advances, securities sold under agreements to repurchase, and other borrowings |                                                                    |                              | 1,753,541  |                                |   | 559,087                       |        |                               | 960,231 
|Repayment of FHLB advances, securities sold under agreements to repurchase, and other borrowings  |                                                                    |                              | (1,789,615 | )                              |   | (419,111                      | )      |                               | (824,383
|Proceeds from issuance of guaranteed preferred beneficial interests in subordinated debt          |                                                                    |                              |           |                                |   | 40,000                        |        |                               |        
|Dividends paid to shareholders                                                                    |                                                                    |                              | (8,770     | )                              |   | (2,178                        | )      |                               | (8,843  
|Issuance of common stock from exercise of stock options                                           |                                                                    |                              | 779        |                                |   | 328                           |        |                               | 1,525   
|Purchase and retirement of common stock                                                           |                                                                    |                              | (7,860     | )                              |   | (7,621                        | )      |                               | (11,910 
|                                                                                                  |                                                                    |                              |            |                                |   |                               |        |                               |         
|Net cash provided by (used in) financing activities                                               |                                                                    |                              | 66,993     |                                |   | 141,794                       |        |                               | 130,744 
|Net increase (decrease) in cash and cash equivalents                                              |                                                                    |                              | (35,201    | )                              |   | 32,968                        |        |                               | (100,328
|Cash and due from banks:                                                                          |                                                                    |                              |            |                                |   |                               |        |                               |         
|Beginning of period                                                                               |                                                                    |                              | 114,062    |                                |   | 81,094                        |        |                               | 181,422 
|                                                                                                  |                                                                    |                              |            |                                |   |                               |        |                               |         
|End of period                                                                                     |                                                                    | $                            | 78,861     |                                | $ | 114,062                       |        | $                             | 81,094  
|                                                                                                  |                                                                    |                              |            |                                |   |                               |        |                               |         
|Supplemental Disclosures of Cash Flow Information                                                 |                                                                    |                              |            |                                |   |                               |        |                               |         
|Cash paid during the period for:                                                                  |                                                                    |                              |            |                                |   |                               |        |                               |         
|                                                                                                  | Interest                                                           |                              | $          | 122,465                        |   | $                             | 26,321 |                               | $       
|                                                                                                  | Income taxes                                                       |                              |            | 9,630                          |   |                               |       |                               |         
|Non-cash investing and financing activities:                                                      |                                                                    |                              |            |                                |   |                               |        |                               |         
|                                                                                                  | Loans receivable transferred to other real estate                  |                              |            | 8,214                          |   |                               | 1,355  |                               |         
|                                                                                                  | Premises and equipment transferred to other real estate            |                              |            | 279                            |   |                               |       |                               |         
|                                                                                                  | Loans receivable securitized as securities available for sale      |                              |            | 120,169                        |   |                               | 57,018 |                               |         
|                                                                                                  | Transfer of securities from held to maturity to available for sale |                              |            |                               |   |                               |       |                               |         
|                                                                                                  | Debt related to ESOP                                               |                              |            |                               |   |                               |       |                               |         
|                                                                                                  | ESOP debt repayment                                                |                              |            | 1,312                          |   |                               | 628    |                               |         

See Notes to Consolidated Financial Statements

35

---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATIONThe consolidated financial statements include the accounts of Pacific Northwest Bancorp (Bancorp) and
its wholly owned subsidiaries (collectively, PNWB). As of December 31, 2000, Bancorp's wholly owned subsidiaries were Pacific Northwest Bank and InterWest Capital Trust I. All material
intercompany transactions and balances have been eliminated.

On
October 1, 1999, Bancorp acquired NBT Northwest Bancorp (NBT) and its banking subsidiary The Bank of Tukwila of Tukwila, Washington. This acquisition was accounted for using
the purchase method.

On
June 20, 2000 the Board of Directors approved a change of PNWB's fiscal year end from September 30 to December 31, retroactively to January 1, 2000.

Effective
September 1, 2000, InterWest Bancorp, Inc. changed its name to Pacific Northwest Bancorp. In conjunction with this change, the company's commercial bank
subsidiary, InterWest Bank, changed its name to Pacific Northwest Bank.

USE OF ESTIMATESThe preparation of the consolidated financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements. Changes in these estimates and
assumptions are considered reasonably possible and may have a material impact on the consolidated financial statements and thus actual results could differ from the amounts reported and disclosed
herein.

NATURE OF BUSINESSPacific Northwest Bancorp is a bank holding company incorporated in Washington state. Through its
commercial bank subsidiary, Pacific Northwest Bank, a wide range of financial services are offered to individuals and businesses throughout western and central Washington state. Financial services of
PNWB include the banking activities of accepting deposits from businesses and individuals and originating commercial and commercial real estate loans, residential loans, consumer loans, and
agricultural loans.

Investment
products are available through Pacific Northwest Financial Services, Inc. and insurance products are available through Pacific Northwest Insurance
Agency, Inc., subsidiaries of Pacific Northwest Bank.

SECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITYSecurities held to maturity and are carried at amortized
cost. Securities are adjusted to the lower of cost or estimated fair value only when an other than temporary impairment in value occurs.

Those
securities that are not classified as held to maturity are classified as available for sale, and are carried at estimated fair value. Unrealized gains and losses on securities
available for sale are excluded from net income and are reported, net of tax, as accumulated other comprehensive income or loss, a component of shareholders' equity. The cost of securities
subsequently sold is determined by the specific identification method.

The
carrying value of securities held to maturity and securities available for sale is adjusted for unaccreted discounts and unamortized premiums. Discounts are accreted and premiums
are amortized using the effective yield method to maturity of the securities. Such accretion and amortization is included as interest income on securities.

LOANS RECEIVABLELoans receivable are stated at the principal amount outstanding, net of deferred loan fees and discounts.
Commercial loans are secured liens on real estate, capital assets, accounts receivable and inventory, although certain loans are unsecured. Real estate mortgage loans are

36

---

generally secured by first liens on single-family dwellings, land, developed lots or commercial property. Agricultural loans are generally secured by farmland, crops and/or equipment. Consumer loans
consist of automobile loans, home equity loans, credit card loans and loans for other consumer purposes. Consumer loans include both secured and unsecured personal lines of credit.

LOANS HELD FOR SALELoans held for sale are carried at the lower of cost or estimated fair value in aggregate. Net
unrealized losses are recognized in a valuation allowance by charges to income.

LOAN FEE INCOME, INTEREST INCOME ON LOANS RECEIVABLE AND UNEARNED INTERESTLoan origination fees and direct costs related
to loan origination activities are deferred and amortized into interest income over contractual or actual loan lives as an adjustment to the loan yield. Deferred fees and costs related to loans sold
are recognized into income at the time the loans are sold.

Interest
is accrued on loans receivable until the loan is 90 days delinquent or management doubts the collectibility of the loan or the unpaid interest, at which time PNWB
establishes a reserve for any accrued interest. If management determines the ultimate collectibility of principal is in doubt, all cash receipts on non-accrual loans are applied to reduce
the principal balance.

ALLOWANCE FOR LOSSES ON LOANSThe allowance for losses on loans is maintained at an amount to sufficiently provide for
estimated losses based on evaluating known and inherent risks in the loan portfolio. Management analyzes the factors underlying the quality of the loan portfolio. These factors include changes in the
size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectibility may
not be assured. The allowance for losses on loans is allocated to certain loan categories based on the relative risk characteristics, asset classifications and actual loss experience of the loan
portfolio. The appropriateness of the allowance for losses on loans is estimated based upon factors and trends identified by management at the time financial statements are prepared.

When
available information confirms that specific loans or portions thereof are uncollectible, identified amounts are charged off against the allowance for losses on loans. The
existence of some or all of the following criteria will generally confirm that a loss has been incurred: the loan is significantly delinquent and the borrower has not evidenced the ability or intent
to bring the loan current; PNWB has no recourse to the borrower, or if it does, the borrower has insufficient assets to pay the debt; the estimated fair value of the loan collateral is significantly
below the current loan balance, and there is little or no near-term prospect for improvement.

All
loans are periodically evaluated for impairment, except large groups of homogenous loans that are collectively evaluated for impairment, and loans that are measured at estimated
fair value or at the lower of cost or estimated fair value. PNWB considers all single-family residential and consumer loans to be homogenous loans. A loan is impaired when it is probable that a
creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The valuation of impaired loans is based on the present value of expected future cash flows
discounted at the loans effective
interest rate or, as a practical expedient, at the loan's observable market price or the estimated fair value of the collateral if the loan is collateral dependent. Generally, PNWB evaluates a loan
for impairment when it is placed on non-accrual status or if a loan is internally risk rated as substandard or doubtful.

A
provision for losses on loans, which is a charge against income, is added to the allowance for losses on loans based on quarterly assessments of the loan portfolio. While management
has attributed the allowance for losses on loans to various loan portfolio segments, the allowance is general in nature and is available for the loan portfolio in its entirety.

37

---

The ultimate recovery of all loans is susceptible to future market factors beyond PNWB's control. These factors may result in losses or recoveries differing significantly from those
provided in the consolidated financial statements.

OTHER REAL ESTATEOther real estate includes properties acquired through foreclosure and property acquired for development.
Other real estate is initially recorded at the lower of cost or estimated fair value and is subsequently evaluated to determine that the carrying value does not exceed the estimated fair value of the
real estate. Losses that result from ongoing periodic valuation of other real estate is charged to operations in the period in which the losses are identified and are included in loss from real estate
write-downs and operations in the consolidated statements of income.

PREMISES AND EQUIPMENTPremises and equipment are stated at cost less accumulated depreciation. Depreciation expense is
computed using the straight-line method over estimated useful lives of up to forty years for buildings and three to twenty years for furniture and equipment.

GOODWILL AND OTHER INTANGIBLE ASSETSGoodwill arising from acquisitions represent the excess of the purchase price over the
estimated fair value of net assets acquired. PNWB periodically evaluates goodwill for impairment.

Other
intangible assets consist of core deposit intangibles and loan servicing rights. Loan servicing rights are capitalized when acquired either through the purchase or origination
of loans that are subsequently sold or securitized with the servicing rights retained. The value of loan servicing rights at the date of the sale of loans is determined based on the discounted present
value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the
underlying loans. The estimated fair value is periodically evaluated for impairment by comparing actual cash flows and estimated future cash flows from the servicing assets to those estimated at the
time servicing assets were originated. Loan servicing rights are amortized as an offset to service fees in proportion to and over the period of estimated net servicing income.

Goodwill
and other intangible assets are amortized using the straight-line and accelerated methods over periods not exceeding twenty years. The level of goodwill and other
intangible assets as of December 31, 2000, was supported by the value attributed to the operations acquired and loan servicing rights retained.

ADVERTISING COSTSPNWB expenses advertising costs as incurred. Advertising expenses for the year ended December 31,
2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998 were $2,209,000, $565,000, $2,015,000 and $1,658,000, respectively.

INCOME TAXESPNWB accounts for income taxes using the liability method. Under the liability method, a deferred tax asset or
liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities
are expected to be reported in PNWB's income tax returns. The deferred tax expense for the period is equal to the net change in the deferred tax asset and liability accounts from the beginning to the
end of the period. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

NET INCOME PER SHAREBasic net income per share is calculated by dividing net income by the weighted average number of
common shares outstanding during the period. Diluted net income per share is calculated by dividing net income by diluted weighted average shares outstanding, which includes common stock equivalent
shares outstanding using the treasury stock method, unless such shares are anti-dilutive. Common stock equivalents include shares issuable upon exercise of stock options. Unallocated
shares relating to the debt-leveraged money purchase employee stock ownership plan debt obligation are deducted in the calculation of weighted average shares outstanding.

38

---

STOCK OPTIONSPNWB has adopted the disclosure only provisions of Statement of Financial Accounting Standards (SFAS) No 123,
"Accounting for Stock-based Compensation." Accordingly, employee stock options are accounted for under Accounting Principle Board Opinion (APB) No. 25, "Accounting for Stock Issued to
Employees." Stock options are granted at exercise prices not less than the fair value of common stock on the date of grant. Under APB No. 25, no compensation expense is recognized pursuant to
PNWB's stock option plans.

COMPREHENSIVE INCOMEComprehensive income includes net income and other comprehensive income, which refers to unrealized
gains and losses that under accounting principles generally accepted in the United States are excluded from net income.

RECLASSIFICATIONSCertain reclassifications have been made to the 1999 and 1998 consolidated financial statements to
conform to 2000 presentation. The effects of the reclassifications are not considered material.

NOTE 2  ACCOUNTING CHANGES

In June 1998, the Financial Accounting and Standards Board (FASB) issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." In June 2000, the FASB issued SFAS No. 138, which amended certain provisions of SFAS No. 133 to clarify specific areas presenting difficulties in implementation. SFAS
No. 133, as amended by SFAS No. 138, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments imbedded in other contracts, and
for hedging activities. It requires the recognition of all derivatives as either assets or liabilities in the statement of financial condition and the measurement of those instruments at estimated
fair value. In certain defined conditions, a derivative may be specifically designated as a hedge for a particular exposure. The accounting for derivatives depends on the intended use of the
derivatives and the resulting designation. This statement was adopted by PNWB on January 1, 2001. The adoption of this statement did not have a material impact on PNWB's financial condition or
results of operations. As permitted by the provisions of this statement, PNWB reclassified all securities held to maturity to securities available for sale on January 1, 2001. This
reclassification resulted in other comprehensive loss of $597,000, net of income taxes of $321,000.

In
March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation: an interpretation of APB No. 25." This
interpretation provides clarification of certain issues, such as the determination of who is an employee and the criteria for determining whether a plan qualifies as a non-compensatory
plan. This interpretation also clarifies the accounting for various modifications to the terms of a previously fixed stock option and the accounting for an exchange of stock compensation awards in a
business combination. PNWB believes its accounting for stock based compensation is in conformity with this guidance, and therefore this interpretation had no impact on PNWB's financial condition or
results of operations.

In
September 2000, the FASB issued SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," a replacement of SFAS
No. 125. This statement revises the standards for accounting for securitizations and other transfers of financial assets and collateral and
requires certain disclosures; however, it carries over most of SFAS No. 125's provisions without reconsideration. The standards addressed in this statement are based on consistent application
of a financial components approach that focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after March 31, 2001. This statement is effective for recognition and reclassification of collateral and for disclosures relating
to securitization transactions and collateral for the year ended December 31, 2000. The adoption of this statement affects the

39

---

disclosures in PNWB's consolidated financial statements; however, management does not expect the adoption of this statement to have a material impact on PNWB's financial condition or results of
operations.

NOTE 3  BUSINESS COMBINATIONS

On January 15, 1998, Bancorp acquired Puget Sound Bancorp, Inc. (Puget) of Port Orchard, Washington, the holding company of First National Bank
of Port Orchard. At the acquisition date, Puget had total consolidated assets of $53,109,000, total loans receivable of $38,731,000, total deposits of $45,602,000, and shareholders' equity of
$5,928,000. Each share of Puget common stock was exchanged for 2.50 shares of Bancorp common stock. The total number of shares issued was 586,420. Effective October 15, 1998, First National
Bank of Port Orchard was merged into Pacific Northwest Bank.

On
June 15, 1998, Bancorp acquired Pacific Northwest Bank of Seattle, Washington. At the acquisition date, Pacific Northwest Bank operated four offices in the metropolitan
Seattle area of western Washington with total assets of $200,219,000, total loans receivable of $150,125,000, total deposits of $170,210,000, and shareholders' equity of $16,787,000. Each share of
Pacific Northwest Bank common stock was exchanged for 5.93 shares of Bancorp common stock. The total number of shares issued was 2,346,081. Effective July 1, 2000, Pacific Northwest Bank was
merged into InterWest Bank. Effective September 1, 2000, InterWest Bank's name was changed to Pacific Northwest Bank.

On
June 16, 1998, Bancorp acquired Pioneer Bancorp, Inc. (Pioneer), of Yakima, Washington, the holding company of Pioneer National Bank. At the acquisition date, Pioneer
had total consolidated assets of $108,399,000, total loans receivable of $63,377,000, total deposits of $87,213,000, and shareholders' equity of $9,337,000. Each share of Pioneer common stock was
exchanged for 2.01 shares of Bancorp common stock. The total number of shares issued was 692,846. Effective January 22, 1999, Pioneer National Bank was merged into Pacific Northwest Bank.

The
acquisitions of Puget, Pacific Northwest Bank and Pioneer were accounted for using the pooling-of-interests method.

The
consolidated financial statements were adjusted to conform the December 31 fiscal year end of Puget, Pacific Northwest Bank and Pioneer to that of Bancorp's previous
September 30 fiscal year end. In accordance with accounting principles generally accepted in the United States, interest income of $7,185,000, net interest income of $4,535,000 and net income
of $1,249,000 for the period from October 1, 1997 to December 31, 1997, has been included in the consolidated statements of income for the year ended September 30, 1998 and 1997.
Accordingly, $1,249,000 has been deducted from retained earnings in the consolidated statement of shareholders' equity for the year ended September 30, 1998.

On
August 31, 1998, Bancorp acquired Kittitas Valley Bancorp, Inc. (Kittitas) and its commercial banking subsidiary, Kittitas Valley Bank N.A. of Ellensburg, Washington.
At the acquisition date, Kittitas had total consolidated assets of $47,441,000, total loans receivable of $27,945,000, total deposits of $39,239,000 and shareholders' equity of $4,290,000. The
transaction was completed through the payment of $6,436,000 in cash and the issuance of 229,831 shares of Bancorp common stock to Kittitas shareholders. The total acquisition price was $12,284,000 and
resulted in goodwill of $8,341,000 recorded by Bancorp. This goodwill is being amortized using the straight-line method over a period of twenty years. This acquisition was accounted for
using the purchase method and as such the accounts and operations of Kittitas Valley Bank, N.A. are included in the consolidated financial statements for periods subsequent to August 31, 1998.
Effective January 3, 2000, Kittitas Valley Bank, N.A. was merged into Pacific Northwest Bank.

On
October 1, 1999, Bancorp acquired NBT Northwest Bancorp (NBT) of Tukwila, Washington and its commercial banking subsidiary, The Bank of Tukwila. At the acquisition date, NBT
operated

40

---

one financial center in south King County, Washington with total consolidated assets of $53,018,000, total loans receivable of $37,780,000, total deposits of $47,953,000 and shareholders' equity of
$4,908,000. Each share of NBT common stock has been exchanged for 0.88 shares of Bancorp common stock. The total number of shares issued was 677,109. The total acquisition price was $14,752,000 and
resulted in goodwill of $9,844,000 recorded by Bancorp. This goodwill is being amortized using the straight-line method over a period of twenty years. This acquisition was accounted for
using the purchase method and as such the accounts and operations of The Bank of Tukwila are included in the consolidated financial statements for periods subsequent to October 1, 1999.
Effective July 1, 2000, The Bank of Tukwila was merged into Pacific Northwest Bank.

NOTE 4  SECURITIES AVAILABLE FOR SALE

Securities available for sale are carried at estimated fair value. The amortized cost and estimated fair values of securities available for sale are summarized
as follows:

|Dollars in thousands |                                                  | Amortized
Cost |         | Gross
Unrealized
Gains |   | Gross
Unrealized
Losses |       | Estimated
Fair
Value
|-------------------- | ------------------------------------------------ | -------------- | ------- | ---------------------- | - | ----------------------- | ----- | --------------------
|December 31, 2000    |                                                  |                |         |                        |   |                         |       |                     
|                     | U.S. treasury and agency securities              |                | $       | 222,788                |   | $                       | 585   |                     
|                     | Obligations of states and political subdivisions |                |         | 1,175                  |   |                         | 14    |                     
|                     | Mortgage-backed and related securities           |                |         | 535,547                |   |                         | 1,959 |                     
|                     | FHLB stock                                       |                |         | 42,962                 |   |                         |      |                     
|                     | Other securities                                 |                |         | 46,479                 |   |                         |      |                     
|                     |                                                  |                |         |                        |   |                         |       |                     
|Total                |                                                  | $              | 848,951 |                        | $ | 2,558                   |       | $                   
|                     |                                                  |                |         |                        |   |                         |       |                     
|December 31, 1999    |                                                  |                |         |                        |   |                         |       |                     
|                     | U.S. treasury and agency securities              |                | $       | 165,784                |   | $                       | 11    |                     
|                     | Obligations of states and political subdivisions |                |         | 1,106                  |   |                         | 2     |                     
|                     | Mortgage-backed and related securities           |                |         | 573,198                |   |                         | 2     |                     
|                     | FHLB stock                                       |                |         | 44,346                 |   |                         |      |                     
|                     | Other securities                                 |                |         | 39,613                 |   |                         |      |                     
|                     |                                                  |                |         |                        |   |                         |       |                     
|Total                |                                                  | $              | 824,047 |                        | $ | 15                      |       | $                   
|                     |                                                  |                |         |                        |   |                         |       |                     

The
amortized cost and estimated fair value of securities available for sale as of December 31, 2000, by contractual maturity are summarized as follows:

Dollars in thousands

Amortized
Cost

Estimated
Fair
ValueDue in one year or less

$
31,621

$
31,661Due after one year but within five years


194,942


194,820Due after five years but within ten years


129


135Due after ten years


43,750


40,709270,442


267,325FHLB Stock


42,962


42,962Mortgage-backed and related securities


535,547


530,202Total

$
848,951

$
840,489


Proceeds
from the sale of securities available for sale during the years ended December 31, 2000, September 30, 1999 and September 30, 1998 were $156,540,000,
$258,509,000 and $374,572,000, respectively. PNWB realized gains of $663,000, $238,000, and $905,000 and losses of $6,776,000,

41

---

$166,000 and $92,000 on those sales during the years ended December 31, 2000, September 30, 1999 and September 30, 1998, respectively. There were no sales of securities available
for sale during the three-month period ended December 31, 1999.

Securities
available for sale include mortgage-backed and related securities with estimated fair values of $175,935,000 and $89,291,000 as of December 31, 2000 and 1999,
respectively that were securitized from PNWB's single-family residential loan portfolio.

NOTE 5  SECURITIES HELD TO MATURITY

Securities held to maturity are carried at amortized cost. The amortized cost and estimated fair value of securities held to maturity are summarized as
follows:

Dollars in thousands

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair
ValueDecember 31, 2000Obligations of states and political subdivisions

$
998

$
1

$


$
999Mortgage-backed and related securities


63,743





919


62,824Total

$
64,741

$
1

$
919

$
63,823December 31, 1999Obligations of states and political subdivisions

$
1,625

$
1

$



1,626Mortgage-backed and related securities


67,271





2,420


64,851Total

$
68,896

$
1

$
2,420

$
66,477


The
amortized cost and estimated fair value of securities held to maturity as of December 31, 2000, by contractual maturity are summarized as follows:

Dollars in thousands

Amortized
Cost

Estimated
Fair
ValueDue in one year or less

$
897

$
898Due after one year but within five years


101


101998


999Mortgage-backed and related securities


63,743


62,824Total

$
64,741

$
63,823


42

---

NOTE 6  LOANS RECEIVABLE AND LOANS HELD FOR SALE

Loans
receivable and loans held for sale consisted of the following as of December 31:

Dollars in thousands

2000

1999Commercial loans

$
430,147

$
347,443Real estate mortgage loans:Single-family residential


420,084


462,853Commercial


427,958


427,940Real estate construction


334,789


323,281Consumer loans


130,222


104,446Agricultural loans


55,850


54,0711,799,050


1,720,034Less:Loans held for sale


14,187


22,397Allowance for losses on loans


17,561


15,182Deferred loan fees and discounts


8,755


10,140Net loans receivable

$
1,758,547

$
1,672,315


PNWB
serviced loans, owned in whole or in part by others, of $484,110,000, $291,755,000, $260,821,000 and $511,331,000 as of December 31, 2000 and 1999 and September 30,
1999 and 1998, respectively.

As
of December 31, 2000, PNWB had $266,211,000 in real estate loan commitments to extend credit. Other loan commitments to extend credit, which include commercial and consumer
lines of credit, totaled $250,294,000 as of December 31, 2000. Outstanding commitments to extend credit under standby letters of credit and commercial letters of credit totaled $47,512,000 and
$16,614,000, respectively, as of December 31, 2000.

Non-accrual
loans totaled $13,883,000 and $10,950,000 as of December 31, 2000 and 1999, respectively. Interest income not recognized on these loans was $1,429,000
and $853,000 as of December 31, 2000 and 1999, respectively.

PNWB
originates loans primarily in the state of Washington. Although PNWB has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is
affected by the economy in Washington state.

43

---

NOTE 7  ALLOWANCE FOR LOSSES ON LOANS

The activity in the allowance for losses on loans for the year ended December 31, 2000, the three-month period ended December 31, 1999 and the
years ended September 30, 1999 and 1998 is summarized as follows:

|Dollars in thousands         |                                  | Year Ended
December 31,
2000      |        | Three Months
December 31,
1999 |   | Year Ended
September 30,
1999 |      | Year Ended
September 30,
1998 |       
|---------------------------- | -------------------------------- | --------------------------------- | ------ | ------------------------------ | - | ----------------------------- | ---- | ----------------------------- | ------
|Balance, beginning of period |                                  | $                                 | 15,182 |                                | $ | 14,123                        |      | $                             | 13,224
|                             | Provision for losses on loans    |                                   |        | 4,750                          |   |                               | 550  |                               |       
|                             | Merger and acquisition activity: |                                   |        |                                |   |                               |      |                               |       
|                             |                                  | Provision pursuant to acquisition |        |                                |  |                               |      |                              |       
|                             |                                  | Allowance acquired                |        |                                |  |                               |      | 778                           |       
|                             |                                  | Pooling accounting adjustment     |        |                                |  |                               |      |                              |       
|                             | Recoveries                       |                                   |        | 585                            |   |                               | 105  |                               |       
|                             | Charge-offs                      |                                   |        | (2,956                         | ) |                               | (374 | )                             |       
|                             |                                  |                                   |        |                                |   |                               |      |                               |       
|Balance, end of period       |                                  | $                                 | 17,561 |                                | $ | 15,182                        |      | $                             | 14,123
|                             |                                  |                                   |        |                                |   |                               |      |                               |       

The
following is a summary of loans considered impaired and the related interest income as of and for the year ended December 31, 2000, the three-month period ended
December 31, 1999 and the years ended September 30, 1999 and 1998:

|Dollars in thousands                                   |  | Year Ended
December 31,
2000 |       | Three Months
December 31,
1999 |   | Year Ended
September 30,
1999 |  | Year Ended
September 30,
1998
|------------------------------------------------------ |  | ---------------------------- | ----- | ------------------------------ | - | ----------------------------- |  | -----------------------------
|Recorded investment in impaired loans at end of period |  | $                            | 3,819 |                                | $ | 5,205                         |  | $                            
|Average recorded investment in impaired loans          |  |                              | 4,339 |                                |   | 5,119                         |  |                              
|Interest income recognized on impaired loans           |  |                              | 282   |                                |   | 46                            |  |                              

Total
allocated reserves for impaired loans were $583,000 and $649,000 as of December 31, 2000 and 1999, respectively. Interest income on impaired loans is normally recognized
on the accrual basis, unless the loan is more than 90 days past due, in which case interest income is recorded on a cash basis.

NOTE 8  PREMISES AND EQUIPMENT

Premises and equipment consisted of the following as of December 31:

Dollars in thousands

2000

1999Buildings and leasehold improvements

$
41,109

$
39,024Furniture and equipment


42,193


33,83283,302


72,856Less accumulated depreciation


(35,250
)

(29,756
)48,052


43,100Land


10,414


10,747Total

$
58,466

$
53,847


44

---

Depreciation expense for the year ended December 31, 2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998 was
$5,544,000, $1,149,000, $4,832,000, and $4,166,000, respectively.

PNWB
leases certain premises under operating leases. Rental expense for leased premises was $1,582,000, $409,000, $1,453,000, and $1,372,000 for the year ended December 31,
2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998, respectively. Minimum rental commitments under non-cancelable operating
leases having an original or remaining term of more than one year were as follows as of December 31, 2000:

|Dollars in thousandsYear ending December 31: |  | 2001 |       | 2002 |   | 2003  |  | 2004 |       | 2005 |   | Thereafter |  | Total
|-------------------------------------------- |  | ---- | ----- | ---- | - | ----- |  | ---- | ----- | ---- | - | ---------- |  | -----
|Minimum rental commitments                   |  | $    | 1,730 |      | $ | 1,332 |  | $    | 1,076 |      | $ | 770        |  | $    
|                                             |  |      |       |      |   |       |  |      |       |      |   |            |  |      

NOTE 9  GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets consisted of the following as of December 31:

Dollars in thousands

2000

1999Goodwill

$
17,242

$
18,784Core deposit intangible


598


773Loan servicing intangibles


2,861


1,987Total

$
20,701

$
21,544


Accumulated
amortization of goodwill totaled $1,845,000 and $971,000 as of December 31, 2000 and 1999. As part of the transition to a commercial bank, PNWB consolidated and
restructured its mortgage loan origination functions and related processes. This resulted in the impairment of $749,000 of goodwill related to the acquisition of a mortgage brokerage subsidiary in
1996.

The
changes in loan servicing intangible assets for the year ended December 31, 2000, the three-month period ended December 31, 1999 and the years ended
September 30, 1999 and 1998 is summarized as follows:

Dollars in thousands

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Balance, beginning of period

$
1,987

$
1,714

$
3,690

$
1,983Additions


1,659


424


2,637


2,490Less: Basis sold








(3,203
)

Amortization and write-downs


(785
)

(151
)

(1,410
)

(783
)Balance, end of period

$
2,861

$
1,987

$
1,714

$
3,690


The
estimated fair value of loan servicing intangible assets exceeded the net book value as of December 31, 2000 and 1999. The estimated fair value was determined by comparing
actual cash flows and estimated future cash flows from the servicing assets to those estimated at the time servicing assets were originated.

45

---

During the year ended December 31, 2000, PNWB sold $66,543,000 of commercial real estate mortgage loans, securitized $120,169,000 of single-family residential loans and sold
$62,360,000 of single-family residential loans and retained the right to service the respective loans. PNWB does not have any retained interests in the loans sold. Information and weighted average
assumptions pertaining to these sales and securitizations is as follows during the year ended December 31, 2000:

Dollars in thousands

Single
Family
Residential

Commercial
Real EstateServicing asset recognized

$
1,393

$
266Estimated annual servicing income


0.25
%

0.11
%Weighted average life of loans (in years)


3.9


5.1Prepayment rate


14.8
%

7.3
%Cash flow discount rate


8.7
%

8.9
%


NOTE 10  INTEREST-BEARING DEPOSITS

Interest-bearing deposits consisted of the following as of December 31:

Dollars in thousands

Weighted Average
Interest Rate as of
December 31, 2000

2000

1999Interest-bearing checking accounts

1.50
%
$
201,894

$
173,751Money market accounts

4.27
%

266,933


300,267Savings accounts

1.60
%

100,831


97,0352.84
%

569,658


571,053Certificates of deposit:Due within one year




785,962


724,039After one year but within two years




65,575


58,291After two years but within three years




38,720


22,445After three years but within four years




4,705


4,897After four years but within five years




6,558


3,453After five years




1,830


1,132Total certificates of deposit

6.27
%

903,350


814,257Total

4.94
%
$
1,473,008

$
1,385,310


Deposits
as of December 31, 2000 and 1999 included $144,455,000 and $86,421,000, respectively, in public fund deposits. Securities with book values of $24,992,000 and
$13,807,000 were pledged as collateral on these deposits as of December 31, 2000 and 1999, respectively, which exceeds the minimum collateral requirements established by the Washington Public
Deposit Protection Commission.

Certificates
of deposit greater than or equal to $100,000 totaled $467,769,000 and $387,815,000 as of December 31, 2000 and 1999, respectively.

46

---

Deposit interest expense by account type for the year ended December 31, 2000, the three-month period ended December 31, 1999 and the years ended September 30,
1999 and 1998 were as follows:

Dollars in thousands

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Certificates of deposit greater than or equal to $100,000

$
24,897

$
5,700

$
19,126

$
20,486Other certificates of deposit


23,606


5,413


22,959


27,890Money market accounts


11,563


2,707


9,392


7,955Interest-bearing checking accounts


2,017


539


2,102


2,055Savings accounts


1,722


432


1,837


2,455Total

$
63,805

$
14,791

$
55,416

$
60,841


NOTE 11  FEDERAL HOME LOAN BANK ADVANCES

As of December 31, FHLB advances were scheduled to mature as follows:

2000

1999Dollars in thousands

Amount

Interest Rates

Amount

Interest RatesDue within one year

$
517,000

6.20% - 7.23%

$
109,034

4.68% - 6.55%After one year but within two years


1,200

6.54% - 7.70%




%After two years but within three years


25,000

4.92% - 7.70%


51,200

5.62% - 7.70%After three years but within four years




%


100,000

4.69% - 5.43%After four years but within five years


25,000

5.05%


260,000

5.65% - 5.83%After five years but within six years




%


25,000

5.05%After seven year but within eight years


75,000

5.08% - 5.56%




%After eight years but within nine years




%


125,000

5.08% - 5.56%Total

$
643,200



$
670,234




FHLB
advances are collateralized by FHLB stock owned by PNWB, deposits with the FHLB and certain mortgages or deeds of trust securing such properties. As of December 31, 2000,
the minimum book value of eligible collateral pledged for these borrowings was $771,840,000. As of December 31, 2000, the additional amount available under credit lines from the FHLB was
$502,845,000. Certain FHLB advances contractually due beyond one year have an option whereby the FHLB can call the advance due prior to the contractual maturity. The amount of such advances with call
dates within one year was $25,000,000 as of December 31, 2000.

47

---

The maximum and average amount outstanding and weighted average interest rates on FHLB advances were as follows during the year ended December 31, 2000, the three-month period
ended December 31, 1999 and the years ended September 30, 1999 and 1998:

Dollars in thousands

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Maximum outstanding at any month end

$
787,526

$
696,587

$
718,709

$
663,385Average outstanding


707,814


680,928


601,931


559,012Weighted average interest rates:For the period


6.07
%

5.55
%

5.38
%

5.61
%End of period


6.37
%

5.59
%

5.41
%

5.40
%


NOTE 12  SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

PNWB has sold certain securities of the U.S. government and its agencies and other approved investments under agreements to repurchase. The carrying value of
the securities sold was $301,466,000 with an estimated fair value of $299,616,000 as of December 31, 2000. As of December 31, 2000, PNWB had $132,108,000 of available credit from third
parties to sell securities under agreements to repurchase.

As
of December 31, securities sold under agreements to repurchase were scheduled to mature as follows:

2000

1999Dollars in thousands

Amount

Interest Rates

Amount

Interest RatesWithin 30 days

$
27,193

5.57% - 6.63%

$
59,655

3.75% - 5.91%After 30 days but within 90 days


114,800

6.64% - 7.24%


150,000

5.89% - 6.20%After 90 days


132,927

6.47% - 7.40%


73,000

5.66% - 6.43%Total

$
274,920



$
282,655




The
maximum and average amount outstanding and weighted average interest rates on securities sold under agreements to repurchase were as follows during the year ended
December 31, 2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998:

Dollars in thousands

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Maximum outstanding at any month end

$
286,807

$
282,655

$
133,992

$
214,917Average outstanding


267,570


165,612


131,723


157,898Weighted average interest ratesFor the period


6.66
%

5.86
%

5.77
%

5.81
%End of period


6.88
%

5.96
%

5.70
%

5.72
%


NOTE 13  GUARANTEED PREFERRED BENEFICIAL INTEREST IN SUBORDINATED DEBT

On
November 15, 1999, $40,000,000 of 9.875 percent Capital Securities was issued by InterWest Capital Trust I (the Trust). The Trust is a business trust organized in
November 1999, and Bancorp owns 100 percent of the common equity of the Trust.

48

---

The proceeds of the offering were invested by the Trust in junior subordinated debentures of Bancorp. The debentures held by the Trust are the sole assets of the Trust. Distributions
on the capital securities issued by the Trust are payable semiannually at 9.875 percent per annum, which is equal to the interest rate being earned by the Trust on the debentures held by the
Trust. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. Bancorp has entered into agreements which, taken collectively, fully and
unconditionally guarantee the capital securities subject to the terms of each of the guarantees. The capital securities qualify as Tier I capital under the capital guidelines of the Federal Reserve
Board.

At
Bancorp's option, the debentures will not mature earlier than November 15, 2009, and not later than November 15, 2029. After November 15, 2019, the debentures
can be redeemed at par value. If Bancorp elects to redeem the debentures prior to November 15, 2019, an adjusted prepayment price will be paid as follows during each of the respective years
ending November 15:

Year

Price2009

104.938
%2010

104.444
%2011

103.950
%2012

103.457
%2013

102.963
%2014

102.469
%2015

101.975
%2016

101.481
%2017

100.988
%2018

100.494
%


NOTE 14  SHAREHOLDERS' EQUITY

On January 20, 1999, the Board of Directors approved a stock repurchase plan of 5 percent of Bancorp's outstanding shares of common stock. On
November 16, 1999, the Board of Directors authorized the purchase of an additional 5 percent of Bancorp's outstanding shares of common stock for the following twelve-month period. During
the year ended December 31, 2000, 468,000 shares (3 percent of the total common shares outstanding) at a total price of $7,860,000 were repurchased. This represents an average price of
$16.79 per common share repurchased. During the three months ended December 31, 1999, 392,500 shares (2.5 percent of the total common shares outstanding) at a total price of $7,621,000
were repurchased. This represents an average price of $19.42 per common share repurchased. During the year ended September 30, 1999, Bancorp repurchased 521,500 shares (3.3 percent of
the total common shares outstanding) at a total price of $11,910,000. This represents an average price of $22.84 per common share repurchased.

NOTE 15  CONVERSION AND INTEGRATION

During the year ended December 31, 2000, PNWB initiated the process of converting its subsidiary bank to a single enhanced operating system. The first
four phases of the five-phase conversion process were successfully completed during the year ended December 31, 2000. The remaining phase of the conversion will be completed during
the first half of 2001. Conversion and integration costs are expensed as incurred. Total expenses associated with conversion and integration efforts were $7,361,000 during the year ended
December 31, 2000. These expenses included the buyout of previous data processing contracts, outside professional fees, accelerated depreciation for equipment and other costs incurred in
conjunction with conversion and integration initiatives. Other costs include the preparation and mailing of customer notifications for the conversion of customer accounts and training expenses. Of the
$7,361,000 of conversion and integration expenses for the year ended December 31, 2000,

49

---

$5,205,000 was paid out during the year and $358,000 relates to accelerated depreciation of equipment. The remaining $1,798,000 is expected to be paid out during 2001.

NOTE 16  SEVERANCE AND EMPLOYMENT AGREEMENTS

In conjunction with executive management changes and elimination of duplicate administrative functions, PNWB incurred $3,325,000 in expenses associated with
severance and employment
agreements during the year ended December 31, 2000. PNWB incurred $420,000 in severance and employment agreement expenses during the three-month period ended December 31, 1999, which
were paid out during the year ended December 31, 2000. There are approximately 40 employees affected by these severance and employment agreements. Of total $3,3255,000 of severance and
employment agreement expenses for year ended December 31, 2000, $1,154,000 was paid out during the year and $2,171,000 will be paid out in subsequent periods in accordance with the terms of the
severance and employment agreements.

NOTE 17  MERGER-RELATED CHARGES

During the year ended September 30, 1998, PNWB incurred merger-related charges totaling $5,495,000 in connection with the Pacific Northwest Bank,
Pioneer and Puget acquisitions. Merger-related charges consisted of the following: $1,938,000 for professional fees, $1,468,000 for severance and other personnel expenses, $1,382,000 for data and
facilities conversions and $707,000 of other expenses. The following table presents a summary of the activity in the reserve for merger related-charges during the year ended December 31, 2000,
the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998:

Dollars in thousands

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Balance, beginning of period

$
715

$
1,008

$
2,807

$
Merger-related charges











5,495Cash outlays and non-cash write-downs


(715
)

(293
)

(1,799
)

(2,688
)Balance, end of period

$


$
715

$
1,008

$
2,807


NOTE 18  INCOME TAXES

A reconciliation of income tax expense based on the statutory corporate tax rate on pre-tax income and the amount of expense shown in the
accompanying consolidated statements of income for the year

50

---

ended December 31, 2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998 is as follows:

Dollars in thousands

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Federal income taxes at statutory rates

$
3,721

$
2,938

$
14,854

$
12,421Tax effect of:Goodwill amortization


714


180


146


Non-deductible merger-related charges











611Tax-exempt interest


(52
)

(10
)

(105
)

(140
)Other, net


(21
)

(175
)

(310
)

(44
)Total

$
4,362

$
2,933

$
14,585

$
12,848Current income tax expense

$
7,346

$
3,032

$
14,775

$
10,568Deferred income tax expense (benefit)


(2,984
)

(99
)

(190
)

2,280Total

$
4,362

$
2,933

$
14,585

$
12,848


Tax
effects of temporary differences that give rise to elements of deferred tax assets (liabilities) consisted of the following as of December 31:

Dollars in thousands

2000

1999Deferred tax assets:Allowance for losses on loans

$
6,041

$
5,334Deferred compensation


592


695Other real estate


1,167


407Accrued expenses


2,101


592Unrealized loss on securities available for sale


2,962


11,114Other


152


617Total deferred tax assets


13,015


18,759Deferred tax liabilities:Loan fees


(2,584
)

(3,494
)FHLB stock dividends


(5,375
)

(4,233
)Depreciation


(1,676
)

(2,106
)Other


(1,242
)

(1,600
)Total deferred tax liabilities


(10,877
)

(11,433
)Net deferred tax asset

$
2,138

$
7,326


The
realization of deferred tax assets is dependent upon the ability to generate taxable income in future periods. PNWB has evaluated available evidence supporting the realization of
its deferred tax assets and determined it is more likely than not that deferred tax assets will be realized.

NOTE 19  EMPLOYEE BENEFITS

RETIREMENT AND SAVINGS PLANSPNWB has a debt-leveraged money purchase employee stock ownership plan (ESOP) for
employees. The ESOP is a non-contributory stock ownership plan. PNWB contributes 5 percent of qualified participants' compensation to the ESOP on a monthly basis.

During
1998, the ESOP entered into a line of credit agreement with an unrelated third party to borrow up to a total of $4,000,000 for the purpose of acquiring Bancorp common stock.
Interest on the

51

---

line of credit is computed at one-month LIBOR plus 1.8125 percent. Interest paid was $205,000, $66,000, $284,000, and $104,000 for the year ended December 31, 2000, the
three-month period ended December 31, 1999 and the years ended September 30, 1999, and 1998, respectively. The obligation is reduced, and shareholders' equity increased, by the amount of
any principal reduction of the line of credit by the ESOP. During the year ended December 31, 2000, the three-month period ended December 31, 1999 and the year ended September 30,
1999 the ESOP made principal repayments of $1,312,000, $628,000 and $327,000 on the ESOP line of credit. Dividends paid on unallocated shares of stock may be used to make payments on the loan.
Accordingly, $76,000, $21,000, $85,000, and $31,000 of dividends were applied toward loan payments during the year ended December 31, 2000, the three-month period ended December 31, 1999
and the years ended September 30,1999, and 1998, respectively. The compensation of the leveraged shares is calculated by taking the difference between the average fair value of the shares
released and the cost of the shares. Shares are released as the loan payments are made on the ESOP line of credit. Leveraged ESOP shares during the year ended December 31, 2000, the three-month
period ended December 31, 1999 and the years ended September 30, 1999 and 1998 were as follows:

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Unallocated shares, beginning of period

102,632

128,110

147,055

Shares leveraged







147,055Shares released for allocation

(47,561
)
(25,478
)
(18,945
)
Unallocated shares, end of period

55,071

102,632

128,110

147,055


The
fair value of unallocated shares was $760,668, $1,975,666, $2,658,283 and $3,363,883 as of December 31, 2000, December 31, 1999, September 30, 1999 and
September 30, 1998, respectively.

PNWB
has a salary deferral 401(k) plan that is a defined contribution plan. Employees can make contributions to their respective accounts in the 401(k) plan on a pre-tax
basis up to the maximum amount permitted by law. PNWB matches a portion of the salary deferred by each participant according to the schedule in the plan. Expenses of the ESOP and 401(k) plan were
$2,008,000, $573,000, $1,575,000, and $1,302,000 for the year ended December 31, 2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and
1998, respectively.

PNWB
also maintains several non-qualified deferred compensation programs for certain executive officers.

STOCK OPTION PLANSDuring January 1993, the shareholders of Bancorp approved the addition of a qualified employee
stock option plan (1993 incentive plan). The awarding of stock options to certain employees of PNWB is at the discretion of the Board of Directors. The term of the options granted is generally five or
ten years. Substantially all of the options granted under the 1993 incentive plan vest over three to five-year periods.

In
January 1997, the shareholders of Bancorp approved the non-qualified 1996 Outside Directors Stock Options-For-Fees Plan (1996 Director
Plan). Under the 1996 Director Plan, non-employee directors may elect to receive stock options in lieu of fees otherwise due for board services and may exercise those options after one
year. Each option granted under the 1996 Director Plan has a term of five years.

PNWB
had a qualified stock option plan prior to 1993 that provided for the awarding of stock options to certain officers and employees of PNWB at the discretion of the Board of
Directors. The term of the stock options granted ranged from four to ten years from the date of grant. This plan

52

---

expired during 1993; however, there are exercisable options outstanding under the plan during the period.

Central,
Puget, Pacific Northwest Bank, Pioneer, Kittitas and NBT had stock option plans that have been assumed by PNWB. The number of stock option shares and exercise prices were
appropriately adjusted to reflect the common stock exchange ratios for each acquisition. All outstanding Central, Puget, Pacific Northwest Bank, Pioneer, Kittitas and NBT stock options became
100 percent vested and exercisable upon the consummation of the respective acquisitions. No further awards will be granted under any of these plans.

The
exercise price of options granted under most of these plans was equal to the fair value of the common stock on the date of the grant. Average exercise price per share, number of
shares authorized, available for grant, granted, exercised, outstanding and currently exercisable reflect adjustments for common stock splits. Information with respect to options granted under all
stock option plans is as follows:

Average
Exercise Price

Options
Outstanding

Options
ExercisableBalance October 1, 1997

$
7.27

831,807

664,941Options acquired


11.14

46,227

46,227Options granted


25.75

169,050

3,000Options exercised


4.76

(132,971
)
(132,971
)Options rescinded/expired


16.97

(12,086
)
Options vested






89,699Balance September 30, 1998


11.17

902,027

670,896Options granted


20.80

202,610

3,250Options exercised


5.65

(285,881
)
(285,881
)Options rescinded/expired


25.72

(22,880
)
Options vested






69,895Balance September 30, 1999


15.30

795,876

458,160Options granted


17.50

269,350

4,500Options exercised


5.91

(55,600
)
(55,600
)Options rescinded/expired


16.85

(4,002
)
Options vested






83,626Balance December 31, 1999


16.40

1,005,624

490,686Options granted


13.45

152,875

Options exercised


6.97

(111,969
)
(111,969
)Options rescinded/expired


19.02

(114,566
)
Options vested






109,538Balance December 31, 2000

$
16.73

931,964

488,255


53

---

Additional
financial data pertaining to outstanding stock options as of December 31, 2000 is as follows:

Range of
Exercise Prices

Number of
Option Shares

Weighted Average
Remaining
Contractual Life
(in years)

Weighted Average
Exercise Price
of Option Shares

Number of
Exercisable
Option Shares

Weighted Average
Exercise Price
of Exercisable
Option Shares$5.49 - $6.92

74,405

2.08

$
6.89

74,405

$
6.89$7.50 - $9.79

77,791

3.71


8.34

77,791


8.34$10.46 - $14.74

198,553

6.66


12.77

76,803


12.59$15.57 - $17.50

251,225

6.63


17.27

62,272


17.50$20.75 - $27.73

329,990

5.43


22.88

196,984


22.74Total

931,964

5.60

$
16.73

488,255

$
15.76


As
of December 31, 2000, there were a total of 1,711,833 shares authorized under all stock option plans and a total of 30,319 shares available for future stock option grants.

SFAS
No. 123, "Accounting for Stock-based Compensation," requires the disclosure of pro forma net income and net income per share had PNWB adopted the fair value method of
accounting for stock options. Under this statement, the fair value of stock-based awards is calculated through the use of option pricing models. These models require the use of subjective assumptions,
including stock price volatility, dividend yield, risk-free interest rate and expected time to exercise. The fair value of options granted under stock option plans is estimated on the date
of grant using the Black-Scholes option-pricing model. Using the assumptions below, the weighted average estimated fair value of options granted was $4.12, $6.72, $7.06 and $8.04 during the year ended
December 31, 2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998, respectively. The following weighted average assumptions were
used in the computation of the weighted average estimated fair value of stock options for the year ended December 31, 2000, the three-month period ended December 31, 1999 and the years
ended September 30, 1999 and 1998:

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Expected volatility

40.9
%
42.4
%
37.4
%
27.1
%Expected dividend yield

4.1
%
2.9
%
2.4
%
1.6
%Risk-free interest rate

5.5
%
6.3
%
4.5
%
5.7
%Expected life (in years)

5.8

6.6

6.1

6.0


If
compensation expense for PNWB's stock option plans had been determined consistent with SFAS No. 123, net income and net income per share would have been the following pro
forma amounts

54

---

for the year ended December 31, 2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998:

Dollars in thousands, except per share amounts

Year Ended
December 31,
2000

Three Months
December 31,
1999

Year Ended
September 30,
1999

Year Ended
September 30,
1998Net income:As reported

$
6,269

$
5,462

$
27,855

$
22,642Pro forma


5,963


5,302


27,451


22,397Basic net income per share:As reported

$
0.40

$
0.34

$
1.78

$
1.45Pro forma


0.38


0.33


1.76


1.43Diluted net income per share:As reported

$
0.40

$
0.34

$
1.74

$
1.40Pro forma


0.38


0.33


1.73


1.39


The
compensation expense included in the pro forma net income and net income per share is not likely to be representative of the effect on reported net income for future years because
stock options vest over several years and additional option grants generally are made each year.

NOTE 20  REGULATORY CAPITAL

Bancorp and Pacific Northwest Bank are subject to risk-based capital guidelines requiring minimum capital levels based on the credit risk of
assets. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a material effect on
PNWB's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancorp and Pacific Northwest Bank must meet specific capital
guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital classifications are
also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The
regulations define the relevant capital levels for the five categories. In general terms, the capital definitions are as follows:

|                               |  | Total Capital
(to Risk
Weighted Assets) |   | Tier 1
(to Risk
Weighted Assets) |   | Tier 1
(to Average
Assets) |  
|------------------------------ |  | --------------------------------------- | - | -------------------------------- | - | -------------------------- | -
|Well capitalized               |  | 10                                      | % | 6                                | % | 5                          | %
|Adequately capitalized         |  | 8                                       | % | 4                                | % | 4                          | %
|Undercapitalized               |  | Below 8                                 | % | Below 4                          | % | Below 4                    | %
|Significantly undercapitalized |  | Below 6                                 | % | Below 3                          | % | Below 3                    | %
|Critically undercapitalized    |  |                                        |   |                                 |   | 2% or less                 |  

Bancorp
is subject to risk-based capital guidelines issued by the Federal Reserve Board (FRB), which establish a risk-adjusted ratio relating capital to
different categories of assets. Tier I capital is comprised of shareholders' equity and guaranteed preferred beneficial interests in subordinated debt less certain intangibles, and excludes the equity
impact of adjusting securities available for sale to estimated fair value. Total capital is Tier I capital and the allowance for losses on loans. The FRB's risk-based capital rules are
supplemented by a leverage capital ratio, defined as Tier I capital to adjusted quarterly average total assets. As of December 31, 2000 and 1999, under the FRB's capital guidelines, Bancorp's
consolidated regulatory capital exceeded the FRB's minimum requirements.

55

---

The capital amounts and ratios for Pacific Northwest Bancorp and Pacific Northwest Bank as of December 31, 2000 and 1999 are presented in the following table:

|                                         |  | Actual |         | For Capital
Adequacy Purposes |       | To Be Well
Capitalized Under
Prompt Corrective
Action Provisions |  
|---------------------------------------- |  | ------ | ------- | ----------------------------- | ----- | ---------------------------------------------------------------- | -
|
|December 31, 2000                        |  |        |         |                               |       |                                                                  |  
|Pacific Northwest Bancorp:               |  |        |         |                               |       |                                                                  |  
|Total capital (to risk-weighted assets)  |  | $      | 223,657 |                               | 11.05 | %                                                                | $
|Tier I capital (to risk-weighted assets) |  |        | 206,096 |                               | 10.18 | %                                                                |  
|Tier I capital (to average assets)       |  |        | 206,096 |                               | 7.23  | %                                                                |  
|Pacific Northwest Bank:                  |  |        |         |                               |       |                                                                  |  
|Total capital (to risk-weighted assets)  |  | $      | 221,312 |                               | 10.96 | %                                                                | $
|Tier I capital (to risk-weighted assets) |  |        | 203,751 |                               | 10.09 | %                                                                |  
|Tier I capital (to average assets)       |  |        | 203,751 |                               | 7.30  | %                                                                |  
|December 31, 1999                        |  |        |         |                               |       |                                                                  |  
|Pacific Northwest Bancorp:               |  |        |         |                               |       |                                                                  |  
|Total capital (to risk-weighted assets)  |  | $      | 227,787 |                               | 12.39 | %                                                                | $
|Tier I capital (to risk-weighted assets) |  |        | 212,604 |                               | 11.56 | %                                                                |  
|Tier I capital (to average assets)       |  |        | 212,604 |                               | 7.93  | %                                                                |  
|Pacific Northwest Bank:                  |  |        |         |                               |       |                                                                  |  
|Total capital (to risk-weighted assets)  |  | $      | 160,495 |                               | 11.63 | %                                                                | $
|Tier I capital (to risk-weighted assets) |  |        | 150,463 |                               | 10.91 | %                                                                |  
|Tier I capital (to average assets)       |  |        | 150,463 |                               | 6.95  | %                                                                |  

December 31, 1999 capital ratios for Pacific Northwest Bank are the historical ratios as previously reported for InterWest Bank.

As
of December 31, 2000 and 1999, Pacific Northwest Bank was in compliance with well-capitalized capital requirements. Management believes that under the current
regulations Pacific Northwest Bank will continue to meet minimum well-capitalized capital requirements in the foreseeable future. However, events beyond the control of Pacific Northwest
Bank, such as a downturn in the economy in areas where Pacific Northwest Bank has most of its loans, could adversely affect future earnings and, consequently, the ability of Pacific Northwest Bank to
meet future well-capitalized requirements.

Currently,
Bancorp pays quarterly dividends, which it intends to continue to do. The funding source for dividends paid to shareholders is dividends received from Pacific Northwest
Bank. The payment of dividends to Bancorp from Pacific Northwest Bank will be based on earnings and financial condition and is subject to ongoing review by regulatory agencies and various statutory
limitations. Generally, PNWB is precluded from paying dividends on its common stock if capital would be reduced to below regulatory requirements at either the holding company or subsidiary bank level.
As of December 31, 2000, $59,764,000 of retained earnings was available for dividend distribution based on the capital levels and restrictions of Bancorp and Pacific Northwest Bank.

In
addition to regulatory restrictions on the payment of dividends, Pacific Northwest Bank is subject to certain restrictions imposed by federal law on any extensions of credit to
Pacific Northwest Bancorp. As of December 31, 2000, $21,260,000 of credit was available to Pacific Northwest Bancorp from Pacific Northwest Bank under these limitations.

NOTE 21  DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value amounts are determined by PNWB using available market information and appropriate valuation methodologies. However, considerable
judgment is necessary to interpret

56

---

market data in the development of the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts PNWB could realize in a current market
exchange. The use of different market assumptions and/or estimation methodologies may have a material impact on the estimated fair value amounts. The following methods and assumptions were used to
estimate the fair value of each class of PNWB's financial instruments as of December 31, 2000 and 1999:

CASH AND DUE FROM BANKS, FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENTS TO RESELLThe carrying value is a
reasonable estimate of the fair value.

SECURITIES AVAILABLE FOR SALE, SECURITIES HELD TO MATURITY AND LOANS HELD FOR SALEThe estimated fair value of securities
available for sale, securities held to maturity and loans held for sale are based on quoted market rates and dealer quotes.

LOANS RECEIVABLEThe estimated fair value of loans receivable is based on discounted cash flows, using estimated interest
rates currently offered for loans of similar characteristics.

No
adjustment was made to the estimated interest rates for changes in credit of performing loans for which there are no known credit concerns. Management believes that the risk factor
embedded in the estimated interest rates, along with the allowance for losses on loans applicable to the loan portfolio, results in a fair valuation of such loans.

DEPOSITSThe estimated fair value of deposits with no stated maturity, such as checking accounts, money market and savings
accounts, is equal to the amount payable on demand as of December 31, 2000 and 1999, respectively. The estimated fair value of certificates of deposit is based on the discounted value of
contractual cash flows. The discount rate is estimated using the current rate for certificates of deposit with similar characteristics.

FHLB ADVANCES, SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER BORROWINGSThe fair value of FHLB advances,
securities sold under agreements to repurchase and other borrowings are estimated based on the present values using a discount rate equal to the rate currently offered on similar borrowings with
similar maturities.

GUARANTEED PREFERRED BENEFICIAL INTERESTS IN SUBORDINATED DEBTThe estimated fair value is determined based on quoted
market rates for subordinated debt with similar interest rates and similar characteristics.

OFF BALANCE SHEET LOAN COMMITMENTSThe carrying value of off balance sheet loan commitments has been determined to be a
reasonable estimate of their fair value.

57

---

|                                                                       |                              | December 31, 2000 |           | December 31, 1999
|---------------------------------------------------------------------- | ---------------------------- | ----------------- | --------- | -----------------
|
|Assets                                                                 |                              |                   |           |                  
|Cash and due from banks                                                |                              | $                 | 78,861    |                  
|Federal funds sold and securities purchased under agreements to resell |                              |                   | 7,467     |                  
|Securities available for sale                                          |                              |                   | 840,489   |                  
|Securities held to maturity                                            |                              |                   | 64,741    |                  
|Loans receivable                                                       |                              |                   | 1,776,108 |                  
|Loans held for sale                                                    |                              |                   | 14,187    |                  
|Liabilities                                                            |                              |                   |           |                  
|Non-interest-bearing deposits                                          |                              | $                 | 244,100   |                  
|Interest-bearing checking accounts                                     |                              |                   | 201,894   |                  
|Money market accounts                                                  |                              |                   | 266,933   |                  
|Savings accounts                                                       |                              |                   | 100,831   |                  
|Certificates of deposit                                                |                              |                   | 903,350   |                  
|                                                                       |                              |                   |           |                  
|                                                                       | Total deposits               |                   |           | 1,717,108        
|FHLB advances and other borrowings                                     |                              |                   | 644,953   |                  
|Securities sold under agreements to repurchase                         |                              |                   | 274,920   |                  
|Guaranteed preferred beneficial interests in subordinated debt         |                              |                   | 40,000    |                  
|Off balance sheet loan commitments:                                    |                              |                   |           |                  
|                                                                       | Real estate                  |                   | $         | 266,211          
|                                                                       | Other                        |                   |           | 250,294          
|                                                                       | Standby letters of credit    |                   |           | 47,512           
|                                                                       | Commercial letters of credit |                   |           | 16,614           

LIMITATIONSThe estimated fair values presented are based on information available to management as of
December 31, 2000 and 1999. Since December 31, 2000 and 1999, amounts have not been comprehensively revalued for purposes of these consolidated financial statements and, therefore,
current estimates of fair value may differ from the amounts disclosed above.

NOTE 22  CONTINGENCIES

At periodic intervals, the FDIC, the Washington Department of Financial Institutions, Division of Banks, the FRB and other regulatory agencies (collectively
the regulators), examine Bancorp and Pacific Northwest Bank as part of the regulatory oversight of the banking industry. Based on their examinations, the regulators may direct Bancorp or Pacific
Northwest Bank to adjust financial statements in accordance with their findings. A future examination by the regulators could include a review of certain transactions or other amounts reported in
PNWB's 2000 consolidated financial statements. The regulators have not proposed significant adjustments to PNWB's consolidated financial statements in prior years and management is not aware of any
basis for any such adjustments for 2000. In view of the uncertain regulatory environment in which PNWB operates, the extent, if any, to which a forthcoming examination may ultimately result in
regulatory adjustments to the 2000 consolidated financial statements cannot presently be determined.

In
the normal course of business, PNWB has various legal claims and other contingent matters outstanding. Management believes that any ultimate liability arising from these actions
will not have a material adverse impact on PNWB's financial condition or results of operations.

Pacific
Northwest Bank is required to maintain balances with the Federal Reserve Bank based on a percentage of deposit liabilities. The average required reserve as of
December 31, 2000 was $3,347,000.

58

---

During the year ended September 30, 1998, PNWB sold $26,709,000 of single-family residential mortgage loans with recourse. As of December 31, 2000, $15,044,000 of
single-family mortgage loans sold with recourse were outstanding.

NOTE 23  CONDENSED PARENT COMPANY FINANCIAL INFORMATION PACIFIC NORTHWEST BANCORP

Condensed financial information for Pacific Northwest Bancorp (parent company only) as of December 31 2000 and 1999 and for the year ended
December 31, 2000, the three-month period ended December 31, 1999 and the years ended September 30, 1999 and 1998, is as follows:

CONDENSED STATEMENTS OF FINANCIAL CONDITION

|                                                       |  | As of December 31,
|------------------------------------------------------ |  | ------------------
|
|Assets                                                 |  |                   
|Cash and due from banks                                |  | $                 
|Securities available for sale, at estimated fair value |  |                   
|Goodwill                                               |  |                   
|Other assets                                           |  |                   
|Investment in subsidiaries                             |  |                   
|                                                       |  |                   
|Total                                                  |  | $                 
|                                                       |  |                   
|Liabilities and Shareholders' Equity                   |  |                   
|Other liabilities                                      |  | $                 
|Borrowings from subsidiaries                           |  |                   
|Other borrowings                                       |  |                   
|Shareholders' equity                                   |  |                   
|                                                       |  |                   
|Total                                                  |  | $                 
|                                                       |  |                   

CONDENSED STATEMENTS OF INCOME

|Dollars in thousands                                                                                |                | Year Ended
December 31,
2000 |        | Three Months
December 31,
1999 |   | Year Ended
September 30,
1999 |       | Year Ended
September 30,
1998 |       
|--------------------------------------------------------------------------------------------------- | -------------- | ---------------------------- | ------ | ------------------------------ | - | ----------------------------- | ----- | ----------------------------- | ------
|Dividend income received from subsidiaries                                                          |                | $                            | 17,000 |                                | $ | 8,000                         |       | $                             | 25,000
|Interest income                                                                                     |                |                              | 122    |                                |   | 15                            |       |                               |      
|Non-interest income                                                                                 |                |                              | 88     |                                |   | 23                            |       |                               |      
|                                                                                                    |                |                              |        |                                |   |                               |       |                               |       
|                                                                                                    | Total income   |                              |        | 17,210                         |   |                               | 8,038 |                               |       
|Interest expense                                                                                    |                |                              | 4,072  |                                |   | 509                           |       |                               |      
|Non-interest expense                                                                                |                |                              | 11,779 |                                |   | 1,164                         |       |                               | 1,966 
|                                                                                                    |                |                              |        |                                |   |                               |       |                               |       
|                                                                                                    | Total expenses |                              |        | 15,851                         |   |                               | 1,673 |                               |       
|                                                                                                    |                |                              |        |                                |   |                               |       |                               |       
|Income before income tax benefit and equity (deficit) in undistributed net income from subsidiaries |                |                              | 1,359  |                                |   | 6,365                         |       |                               | 23,034
|Income tax benefit                                                                                  |                |                              | (5,039 | )                              |   | (493                          | )     |                               | (691  
|                                                                                                    |                |                              |        |                                |   |                               |       |                               |       
|Net income before equity (deficit) in undistributed net income from subsidiaries                    |                |                              | 6,398  |                                |   | 6,858                         |       |                               | 23,725
|                                                                                                    |                |                              |        |                                |   |                               |       |                               |       
|Equity (deficit) in undistributed net income from subsidiaries                                      |                |                              | (129   | )                              |   | (1,396                        | )     |                               | 4,130 
|                                                                                                    |                |                              |        |                                |   |                               |       |                               |       
|Net income                                                                                          |                | $                            | 6,269  |                                | $ | 5,462                         |       | $                             | 27,855
|                                                                                                    |                |                              |        |                                |   |                               |       |                               |       

59

---

CONDENSED STATEMENTS OF CASH FLOWS

|Dollars in thousands                                 |                                                                                   | Year Ended
December 31,
2000                |         | Three Months
December 31,
1999 |         | Year Ended
September 30,
1999 |         | Year Ended
September 30,
1998 |        
|---------------------------------------------------- | --------------------------------------------------------------------------------- | ------------------------------------------- | ------- | ------------------------------ | ------- | ----------------------------- | ------- | ----------------------------- | -------
|Cash flows from operating activities:                |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|                                                     | Net income                                                                        |                                             | $       | 6,269                          |         | $                             | 5,462   |                               | $      
|                                                     | Adjustments to reconcile net income to net cash provided by operating activities: |                                             |         |                                |         |                               |         |                               |        
|                                                     |                                                                                   | Equity in net income from subsidiaries      |         |                                | (16,871 | )                             |         | (6,604                        | )      
|                                                     |                                                                                   | Cash dividends received from subsidiaries   |         |                                | 17,000  |                               |         | 8,000                         |        
|                                                     |                                                                                   | Change in other assets and liabilities, net |         |                                | (1,634  | )                             |         | (1,273                        | )      
|                                                     |                                                                                   | Amortization of goodwill                    |         |                                | 1,028   |                               |         | 255                           |        
|                                                     |                                                                                   | Pooling accounting adjustment               |         |                                |        |                               |         |                              |        
|                                                     |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|Net cash provided by operating activities            |                                                                                   |                                             | 5,792   |                                |         | 5,840                         |         |                               | 22,007 
|Cash flows from investing activities:                |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|                                                     | Investments in subsidiaries                                                       |                                             |         |                               |         |                               | (26,238 | )                             |        
|                                                     | Purchase of securities available for sale                                         |                                             |         |                               |         |                               |        |                               |        
|                                                     | Cash paid for acquisition                                                         |                                             |         |                               |         |                               |        |                               |        
|                                                     |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|Net cash used in investing activities                |                                                                                   |                                             |        |                                |         | (26,238                       | )       |                               | (2,300 
|Cash flows from financing activities:                |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|                                                     | Payment of dividends                                                              |                                             |         | (8,770                         | )       |                               | (2,178  | )                             |        
|                                                     | Purchase and retirement of treasury stock                                         |                                             |         | (7,860                         | )       |                               | (7,621  | )                             |        
|                                                     | Proceeds from subsidiary borrowings                                               |                                             |         |                               |         |                               | 41,238  |                               |        
|                                                     | Net decrease in other borrowings                                                  |                                             |         |                               |         |                               |        |                               |        
|                                                     | Proceeds from stock option exercises                                              |                                             |         | 779                            |         |                               | 328     |                               |        
|                                                     |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|Net cash provided by (used in) financing activities  |                                                                                   |                                             | (15,851 | )                              |         | 31,767                        |         |                               | (19,228
|                                                     |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|Net increase (decrease) in cash and cash equivalents |                                                                                   |                                             | (10,059 | )                              |         | 11,369                        |         |                               | 479    
|                                                     |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|Cash and due from banks at beginning of period       |                                                                                   |                                             | 12,116  |                                |         | 747                           |         |                               | 268    
|                                                     |                                                                                   |                                             |         |                                |         |                               |         |                               |        
|Cash and due from banks at end of period             |                                                                                   | $                                           | 2,057   |                                | $       | 12,116                        |         | $                             | 747    
|                                                     |                                                                                   |                                             |         |                                |         |                               |         |                               |        

60

---

NOTE 24  NET INCOME PER SHARE

The
following table presents the computation of basic and diluted net income per share for the year ended December 31, 2000, the three-month period ended December 31,
1999 and the years ended September 30, 1999 and 1998:

|Dollars in thousands, except share and per share data |                                                                          | Year Ended
December 31,
2000 |      | Three Months
December 31,
1999 |         | Year Ended
September 30,
1999 |            | Year Ended
September 30,
1998
|----------------------------------------------------- | ------------------------------------------------------------------------ | ---------------------------- | ---- | ------------------------------ | ------- | ----------------------------- | ---------- | -----------------------------
|Numerator                                             |                                                                          |                              |      |                                |         |                               |            |                              
|                                                      | Net income                                                               |                              | $    | 6,269                          |         | $                             | 5,462      |                              
|                                                      |                                                                          |                              |      |                                |         |                               |            |                              
|Denominator                                           |                                                                          |                              |      |                                |         |                               |            |                              
|                                                      | Denominator for basic net income per share
Weighted average shares      |                              |      | 15,504,759                     |         |                               | 16,001,909 |                              
|                                                      | Effect of dilutive securities:                                           |                              |      |                                |         |                               |            |                              
|                                                      |                                                                          | Stock options                |      |                                | 106,323 |                               |            | 208,300                      
|                                                      |                                                                          |                              |      |                                |         |                               |            |                              
|Denominator for diluted net income per share         |                                                                          |                              |      |                                |         |                               |            |                              
|                                                      | Weighted average shares and assumed conversion of dilutive stock options |                              |      | 15,611,082                     |         |                               | 16,210,209 |                              
|                                                      |                                                                          |                              |      |                                |         |                               |            |                              
|Basic net income per share                            |                                                                          | $                            | 0.40 |                                | $       | 0.34                          |            | $                            
|                                                      |                                                                          |                              |      |                                |         |                               |            |                              
|Diluted net income per share                          |                                                                          | $                            | 0.40 |                                | $       | 0.34                          |            | $                            
|                                                      |                                                                          |                              |      |                                |         |                               |            |                              

NOTE 25  BUSINESS SEGMENTS

Between the period August 31, 1996, and October 1999, PNWB acquired six commercial banking institutions. Subsequent to the acquisitions of
Pacific Northwest Bank, First National Bank of Port Orchard, Pioneer Bank and Kittitas Valley Bank in 1998, the company was managed at the subsidiary bank level. Each subsidiary bank had a board of
directors and an executive management team that was responsible for the operation and performance of the respective subsidiary bank.

During
the year ended December 31, 2000, PNWB consolidated its executive management functions and implemented a new organizational structure while consolidating the subsidiary
banks into a single commercial bank using a single operating system. Effective July 1, 2000, Pacific Northwest Bank and The Bank of Tukwila were merged into InterWest Bank. Effective
September 1, 2000 InterWest Bank changed its name to Pacific Northwest Bank. As a result of these organizational changes, the financial information that is used by the chief operating decision
maker in allocating resources and assessing performance is only provided for one reportable segment as of December 31, 2000. Prior periods have been restated to reflect the change in segment
reporting.

61

---

NOTE 26  SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

|Dollars in thousands except per share data |                                                         | Fourth
Quarter |   | Third
Quarter |  | Second
Quarter |        | First
Quarter |  
|------------------------------------------ | ------------------------------------------------------- | -------------- | - | ------------- |  | -------------- | ------ | ------------- | -
|Year ended December 31, 2000               |                                                         |                |   |               |  |                |        |               |  
|                                           | Interest income                                         |                | $ | 55,684        |  | $              | 55,023 |               | $
|                                           | Interest expense                                        |                |   | 34,338        |  |                | 33,075 |               |  
|                                           | Net interest income                                     |                |   | 21,346        |  |                | 21,948 |               |  
|                                           | Provision for losses on loans                           |                |   | 1,400         |  |                | 1,400  |               |  
|                                           | Net interest income after provision for losses on loans |                |   | 19,946        |  |                | 20,548 |               |  
|                                           | Gain (loss) on sale of securities available for sale    |                |   | 658           |  |                | 5      |               |  
|                                           | Other non-interest income                               |                |   | 4,783         |  |                | 4,928  |               |  
|                                           | Non-interest expense                                    |                |   | 20,162        |  |                | 20,412 |               |  
|                                           | Income (loss) before income taxes                       |                |   | 5,225         |  |                | 5,069  |               |  
|                                           | Income tax expense (benefit)                            |                |   | 1,912         |  |                | 1,861  |               |  
|                                           |                                                         |                |   |               |  |                |        |               |  
|                                           | Net income (loss)                                       |                | $ | 3,313         |  | $              | 3,208  |               | $
|                                           |                                                         |                |   |               |  |                |        |               |  
|                                           | Basic net income (loss) per share                       |                | $ | 0.21          |  | $              | 0.21   |               | $
|                                           |                                                         |                |   |               |  |                |        |               |  
|                                           | Diluted net income (loss) per share                     |                | $ | 0.21          |  | $              | 0.21   |               | $
|                                           |                                                         |                |   |               |  |                |        |               |  
|Year ended September 30, 1999              |                                                         |                |   |               |  |                |        |               |  
|                                           | Interest income                                         |                | $ | 46,218        |  | $              | 43,703 |               | $
|                                           | Interest expense                                        |                |   | 24,275        |  |                | 23,059 |               |  
|                                           | Net interest income                                     |                |   | 21,943        |  |                | 20,644 |               |  
|                                           | Provision for losses on loans                           |                |   | 502           |  |                | 500    |               |  
|                                           | Net interest income after provision for losses on loans |                |   | 21,441        |  |                | 20,144 |               |  
|                                           | Gain (loss) on sale of securities available for sale    |                |   |              |  |                | (2     | )             |  
|                                           | Other non-interest income                               |                |   | 4,836         |  |                | 8,146  |               |  
|                                           | Non-interest expense                                    |                |   | 17,546        |  |                | 17,025 |               |  
|                                           | Income before income taxes                              |                |   | 8,731         |  |                | 11,263 |               |  
|                                           | Income tax expense                                      |                |   | 2,941         |  |                | 3,929  |               |  
|                                           |                                                         |                |   |               |  |                |        |               |  
|                                           | Net income                                              |                | $ | 5,790         |  | $              | 7,334  |               | $
|                                           |                                                         |                |   |               |  |                |        |               |  
|                                           | Basic net income per share                              |                | $ | 0.37          |  | $              | 0.47   |               | $
|                                           |                                                         |                |   |               |  |                |        |               |  
|                                           | Diluted net income per share                            |                | $ | 0.37          |  | $              | 0.46   |               | $
|                                           |                                                         |                |   |               |  |                |        |               |  

Non-interest
expense for the quarter ended June 30, 2000 includes conversion and integration expenses of $3,210,000, expenses associated with severance and
employment agreements of $3,205,000 and impairment of goodwill of $749,000. Non-interest expense for the quarter ended September 30, 2000
includes conversion and integration expenses of $1,827,000 and expenses associated with severance and employment agreements of $120,000. Non-interest expense for the quarter ended
December 31, 2000 includes conversion and integration expenses of $2,007,000.

62

---

QuickLinks