|Alaska Pacific Bancshares, Inc.
|-------------------------------



|Annual Report
|-------------



|2005
|----

---

|Contents                                                                                        
|------------------------------------------------------------------------------------------------
|                                                                                                
|Message to
      Shareholders                                                                   
|Business of the
      Company                                                                   
|Common Stock
      Information                                                                  
|Selected Consolidated Financial
      Information                                               
|Managements Discussion and Analysis
      ofFinancial Condition and Results
      of Operations
|Independent Auditors
      Report                                                              
|Consolidated Financial
      Statements                                                         
|Notes to Consolidated FinancialStatements                                                       
|Corporate
      Information                                                                     

---

Message to Shareholders

It is my pleasure to present the 2005 annual
report to shareholders of Alaska Pacific Bancshares, Inc., parent company of
Alaska Pacific Bank. The bank made good progress in 2005 with record pretax
income of $1.219 million and total assets of $177.2 million. The improvement in
earnings and asset size relates directly to the increase in loans of $14.3
million, which pushed total loans to an all-time high of $152.8 million. The
growth in loans was funded by increased borrowings from the Federal Home Loan
Bank and a healthy increase in deposits of $8.9 million, which brought total
deposits to $146.7 million.

Total loan production within our defined
market was $89.6 million, which was actually down by $22.4 million from last
year. Half of that decline is directly associated with single-family mortgage
loan production and the other half with commercial real estate loan volume, both
reflecting the upward trend in interest rates and the end of refinancing
activity. However, commercial business lending was up by more than $7.9 million,
one-to-four-family construction lending increased by $6.0 million, and consumer
loan production showed a slight increase of $.7 million. In addition, the bank
participated with other banks in Alaska and the Pacific Northwest for an
additional $3.2 million in loan business. It is important to note the progress
the bank has made to change the makeup of the asset side of the balance sheet.
It has been our mission for a number of years to reduce the percentage of 1-4
family fixed-rate home loans (typical of the savings and loan business model of
decades past), to a more diversified mix of loans comprised of floating rate
business and commercial real estate loans, shorter term consumer and
construction loans, and an appropriate level of home loans. The transition was
well underway before interest rates started back up after what has been a
twenty-year downward trend. The loan portfolio is now welldiversified and has a
low interest rate risk profile as planned for a rising interest rate market.

As always, I urge you to refer to
Managements Discussion and Analysis of Financial Condition and
Results of Operations,in addition to the financial statements and
footnotes. It is important that you take the time to read this
information.

Operationally, the decision was made to close
the banks two smallest offices in Hoonah and Yakutat. This was a difficult
decision, but the relative cost of operations, remote location, and size of
market gave us little choice. The offices did not actually close until January
of 2006, so there was little impact on 2005.

The remodel of the banks headquarters
building in Juneau finally got underway after several years of review and
design. The remodel addresses heating, cooling and electrical systems as well as
providing employees and customers with space more conducive to todays
lifestyle. The project is to be completed in late summer of 2006.

All considered, the bank continues to make
steady progress in line with our business plan, improving overall financial
results and our position in the market. We have done this in a regional market
that has had minimal, and in some cases negative, growth over the last few
years. Our officers and employees are committed to serving this unique market
and take pride in what has been accomplished. We thank you for your investment
and confidence in our company.

I would like to close by thanking retiring
director Avrum Gross for his 24 years of service to the bank. Av has been a
valuable resource to the board and management over all these years. His
experience, wisdom, and humor will be missed and we wish him well as he moves on
to enjoy retirement.

Respectfully,

3

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|Business of the
  Company
|-------------------------

Alaska Pacific Bancshares, Inc. (the Company) was
organized on March 19, 1999 for the purpose of becoming the holding company for
Alaska Pacific Bank (formerly Alaska Federal Savings Bank) (the Bank), upon
its conversion from a federal mutual savings bank to a federal stock savings
bank. The conversion was completed on July 1, 1999 with the issuance of 655,415
shares of common stock at $10.00 per share. The Company is not engaged in any
significant business activity other than holding the stock of the Bank.
Accordingly, the information in this report, including the consolidated
financial statements and related data, applies primarily to the Bank.

The Bank is a federal stock savings bank originally
organized in 1935. The Bank is regulated by the Office of Thrift Supervision
(OTS), and its deposits are insured up to applicable limits by the Savings
Association Insurance Fund of the Federal Deposit Insurance Corporation
(FDIC). The Bank has been a member of the Federal Home Loan Bank System since
1937.

The Bank operates as a community-oriented financial
institution and is devoted to serving the needs of its customers, primarily in
Southeast Alaska. The Banks business consists primarily of attracting deposits
from the general public and using those funds to originate residential real
estate loans, commercial real estate loans, commercial business loans, and a
variety of consumer loans.



|Common Stock
  Information
|--------------------------

The Companys common stock is traded on the
over-the-counter market through the OTC Electronic Bulletin Board under the
symbol AKPB. As of December 31, 2005, there were approximately 560
stockholders of record and 627,754 shares outstanding (including 13,062 unearned
Employee Stock Ownership Plan (ESOP) shares).

Generally, if the Bank satisfies its regulatory capital
requirements, it may make dividend payments up to the limits prescribed in the
OTS regulations. However, an institution that has converted to the stock form of
ownership may not declare or pay a dividend on, or repurchase any of, its common
stock if the effect thereof would cause the regulatory capital of the
institution to be reduced below the amount required for the liquidation account
which was established in connection with the institutions mutual-to-stock
conversion.

The following table sets forth market price information of
the Companys stock for 2004 and 2005.

|                         |  |   |  |       |  | Market Price |  |   |  |       |  |   |  |          
|------------------------ |  | - |  | ----- |  | ------------ |  | - |  | ----- |  | - |  | ---------
|                         |  |   |  |      
|Years Ended December 31, |  |   |  | High  |  |              |  |   |  | Low   |  |   |  | Dividends
|                        
|                        
|2004:                    |  |   |  |       |  |              |  |   |  |       |  |   |  |          
|First Quarter            |  | $ |  | 26.00 |  |              |  | $ |  | 20.00 |  | $ |  | 0.07     
|Second Quarter           |  |   |  | 23.26 |  |              |  |   |  | 18.30 |  |   |  | 0.07     
|Third Quarter            |  |   |  | 22.00 |  |              |  |   |  | 18.50 |  |   |  | 0.07     
|Fourth Quarter           |  |   |  | 22.25 |  |              |  |   |  | 20.00 |  |   |  | 0.07     
|                        
|2005:                    |  |   |  |       |  |              |  |   |  |       |  |   |  |          
|First Quarter            |  |   |  | 22.20 |  |              |  |   |  | 20.36 |  |   |  | 0.07     
|Second Quarter           |  |   |  | 20.36 |  |              |  |   |  | 18.50 |  |   |  | 0.08     
|Third Quarter            |  |   |  | 20.98 |  |              |  |   |  | 19.10 |  |   |  | 0.08     
|Fourth Quarter           |  |   |  | 20.25 |  |              |  |   |  | 19.65 |  |   |  | 0.08     

4

---

Selected Consolidated Financial
Information

This information should be read in conjunction with the
Consolidated Financial Statements and related Notes thereto included elsewhere
in this report.

|Financial Condition
      Data:                    |  |   |  |         |  |   |  |         |  |   |  |         |  |   |  |         |   |  |   |  |        
|-------------------------------------------------- |  | - |  | ------- |  | - |  | ------- |  | - |  | ------- |  | - |  | ------- | - |  | - |  | -------
|                                                  
|(in thousands, except per
      share)December 31, |  |   |  | 2005    |  |   |  | 2004    |  |   |  | 2003    |  |   |  | 2002    |   |  |   |  | 2001   
|                                                  
|Total assets                                       |  | $ |  | 177,157 |  | $ |  | 163,786 |  | $ |  | 164,559 |  | $ |  | 154,339 |   |  | $ |  | 154,572
|Loans                                              |  |   |  | 152,722 |  |   |  | 138,433 |  |   |  | 125,282 |  |   |  | 107,274 |   |  |   |  | 111,192
|Allowance for loan losses                          |  |   |  | 1,448   |  |   |  | 1,380   |  |   |  | 1,159   |  |   |  | 1,152   |   |  |   |  | 939    
|                                                  
|Loans, net                                         |  |   |  | 151,274 |  |   |  | 137,053 |  |   |  | 124,123 |  |   |  | 106,122 |   |  |   |  | 110,253
|Loans held for sale                                |  |   |  | 2,531   |  |   |  | 1,137   |  |   |  | 2,938   |  |   |  | 4,590   |   |  |   |  | 995    
|Investment securities available for
      sale     |  |   |  | 7,464   |  |   |  | 7,897   |  |   |  | 11,292  |  |   |  | 8,076   |   |  |   |  | 12,351 
|Cash, due from banks, and
      interest-earning   |  |   |  |         |  |   |  |         |  |   |  |         |  |   |  |         |   |  |   |  |        
|deposits in
      banks                            |  |   |  | 9,913   |  |   |  | 11,628  |  |   |  | 19,126  |  |   |  | 28,229  |   |  |   |  | 23,886 
|Deposits                                           |  |   |  | 146,650 |  |   |  | 137,784 |  |   |  | 138,612 |  |   |  | 132,681 |   |  |   |  | 126,309
|Federal Home Loan Bank advances                    |  |   |  | 12,048  |  |   |  | 8,333   |  |   |  | 9,219   |  |   |  | 5,000   |   |  |   |  | 13,000 
|Shareholders equity                               |  |   |  | 16,638  |  |   |  | 16,005  |  |   |  | 15,257  |  |   |  | 14,967  |   |  |   |  | 12,991 
|                                                  
|Book value per share                               |  | $ |  | 26.50   |  | $ |  | 25.49   |  | $ |  | 24.37   |  | $ |  | 24.02   |   |  | $ |  | 20.85  
|                                                  
|Operating Data:                                    |  |   |  |         |  |   |  |         |  |   |  |         |  |   |  |         |   |  |   |  |        
|                                                  
|(in thousands, except per
      share)             |  |   |  |         |  |   |  |         |  |   |  |         |  |   |  |         |   |  |   |  |        
|Year ended December 31,                            |  |   |  | 2005    |  |   |  | 2004    |  |   |  | 2003    |  |   |  | 2002    |   |  |   |  | 2001   
|                                                  
|Interest income                                    |  | $ |  | 10,184  |  | $ |  | 9,201   |  | $ |  | 8,628   |  | $ |  | 9,315   |   |  | $ |  | 10,582 
|Interest expense                                   |  |   |  | 2,109   |  |   |  | 1,625   |  |   |  | 1,921   |  |   |  | 2,453   |   |  |   |  | 4,441  
|                                                  
|Net interest income                                |  |   |  | 8,075   |  |   |  | 7,576   |  |   |  | 6,707   |  |   |  | 6,862   |   |  |   |  | 6,141  
|Provision for loan losses                          |  |   |  | 120     |  |   |  | 360     |  |   |  | 195     |  |   |  | 370     |   |  |   |  | 210    
|                                                  
|Net interest income after provision for
      loan |  |   |  |         |  |   |  |         |  |   |  |         |  |   |  |         |   |  |   |  |        
|losses                                             |  |   |  | 7,955   |  |   |  | 7,216   |  |   |  | 6,512   |  |   |  | 6,492   |   |  |   |  | 5,931  
|Noninterest income                                 |  |   |  | 1,129   |  |   |  | 1,386   |  |   |  | 1,388   |  |   |  | 1,272   |   |  |   |  | 1,212  
|Noninterest expense                                |  |   |  | 7,865   |  |   |  | 7,422   |  |   |  | 7,062   |  |   |  | 6,579   |   |  |   |  | 6,683  
|                                                  
|Income before income tax                           |  |   |  | 1,219   |  |   |  | 1,180   |  |   |  | 838     |  |   |  | 1,185   |   |  |   |  | 460    
|Provision for income tax (benefit)                 |  |   |  | 488     |  |   |  | 472     |  |   |  | 335     |  |   |  | (592    | ) |  |   |  | -      
|                                                  
|Net income                                         |  | $ |  | 731     |  | $ |  | 708     |  | $ |  | 503     |  | $ |  | 1,777   |   |  | $ |  | 460    
|                                                   |  |  
|                                                  
|Net income per share:                              |  |   |  |         |  |   |  |         |  |   |  |         |  |   |  |         |   |  |   |  |        
|Basic                                              |  | $ |  | 1.20    |  | $ |  | 1.18    |  | $ |  | 0.86    |  | $ |  | 3.10    |   |  | $ |  | 0.82   
|Diluted                                            |  |   |  | 1.15    |  |   |  | 1.12    |  |   |  | 0.81    |  |   |  | 2.98    |   |  |   |  | 0.80   
|                                                   |  |  

5

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|Other Data:                                       |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|------------------------------------------------- |  | ------ | - |  | ------ | - |  | ------ | - |  | ------ | - |  | ------ | -
|                                                 
|December 31,                                      |  | 2005   |   |  | 2004   |   |  | 2003   |   |  | 2002   |   |  | 2001   |  
|                                                 
|Number of:                                        |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|Real estate loans outstanding                     |  | 895    |   |  | 704    |   |  | 842    |   |  | 854    |   |  | 924    |  
|Deposit accounts                                  |  | 13,053 |   |  | 12,863 |   |  | 12,842 |   |  | 13,369 |   |  | 13,735 |  
|Full service offices                              |  | 7      |   |  | 7      |   |  | 7      |   |  | 7      |   |  | 7      |  
|                                                 
|                                                 
|Key Financial Ratios:                             |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|                                                 
|At and for Year ended December 31,                |  | 2005   |   |  | 2004   |   |  | 2003   |   |  | 2002   |   |  | 2001   |  
|                                                 
|Performance ratios:                               |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|Return on average assets                          |  | 0.43   | % |  | 0.42   | % |  | 0.32   | % |  | 1.21   | % |  | 0.32   | %
|Return on average equity                          |  | 4.50   |   |  | 4.54   |   |  | 3.34   |   |  | 12.93  |   |  | 3.63   |  
|Interest rate spread(1)                           |  | 4.73   |   |  | 4.60   |   |  | 4.25   |   |  | 4.66   |   |  | 4.04   |  
|Net interest margin:                              |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|On average earning
      assets                   |  | 5.08   |   |  | 4.84   |   |  | 4.50   |   |  | 4.97   |   |  | 4.51   |  
|On average total
      assets                     |  | 4.79   |   |  | 4.54   |   |  | 4.20   |   |  | 4.66   |   |  | 4.23   |  
|Average interest-earning assets to
      average  |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|interest-bearing
      liabilities                |  | 126.89 |   |  | 123.59 |   |  | 120.05 |   |  | 117.50 |   |  | 114.49 |  
|Noninterest expense as a percent of
      average |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|total assets                                      |  | 4.66   |   |  | 4.45   |   |  | 4.42   |   |  | 4.47   |   |  | 4.60   |  
|Efficiency ratio(2)                               |  | 86.34  |   |  | 85.91  |   |  | 91.11  |   |  | 84.29  |   |  | 95.73  |  
|                                                 
|Asset Quality Ratios:                             |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|Nonaccrual loans as a percent of net
      loans  |  | 0.86   |   |  | 1.07   |   |  | 0.25   |   |  | 1.67   |   |  | 1.23   |  
|Nonperforming assets as a percent of
      total  |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|assets                                            |  | 0.79   |   |  | 0.93   |   |  | 0.37   |   |  | 1.27   |   |  | 0.99   |  
|Allowance for losses as a percent of
      total  |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|loans                                             |  | 0.95   |   |  | 1.00   |   |  | 0.93   |   |  | 1.07   |   |  | 0.84   |  
|Allowance for losses as a percent
      of        |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|nonperforming
      loans                         |  | 111.47 |   |  | 93.69  |   |  | 370.29 |   |  | 64.83  |   |  | 69.09  |  
|Net chargeoffs to average
      loans             |  | 0.04   |   |  | 0.10   |   |  | 0.17   |   |  | 0.14   |   |  | 0.05   |  
|                                                 
|Equity Ratios:                                    |  |        |   |  |        |   |  |        |   |  |        |   |  |        |  
|Total equity to assets                            |  | 9.39   |   |  | 9.77   |   |  | 9.27   |   |  | 9.70   |   |  | 8.40   |  
|Average equity to average
      assets            |  | 9.64   |   |  | 9.36   |   |  | 9.42   |   |  | 9.34   |   |  | 8.73   |  

|(1) | Difference between weighted average yield on interest-earning
      assets and weighted average rate on interest- bearing liabilities                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) | Noninterest expense as a percent of the sum of net interest
      income and noninterest income, excluding gains on sale of loans and
      investments.
|   

6

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Managements Discussion and Analysis of Financial Condition and
Results of Operations



|General
|-------

The following discussion is intended to assist in understanding the
consolidated financial condition and results of operations of the Company. The
Company is not engaged in any significant business activity other than holding
the stock of the Bank. Accordingly, the information in this discussion applies
primarily to the Bank. The information contained in this section should be read
in conjunction with the consolidated financial statements and the accompanying
notes elsewhere in this annual report. In the following discussion, except as
otherwise noted, references to 2005 or 2004 indicate the year ended December
31, 2005 or 2004.

The Banks results of operations depend primarily on its net
interest income, which is the difference between the income earned on its
interest-earning assets, consisting of loans and investments, and the cost of
its interest-bearing liabilities, consisting of deposits and Federal Home Loan
Bank (FHLB) borrowings. Among other things, fee income, provisions for loan
losses, operating expenses and income tax provisions also affect the Banks net
income. General economic and competitive conditions, particularly changes in
market interest rates, government legislation and policies concerning monetary
and fiscal affairs, housing and financial institutions and the attendant actions
of the regulatory authorities also significantly affect the Banks results of
operations.



|Forward-Looking
Statements
|--------------------------

This annual report contains forward-looking statements, which are
based on assumptions and describe future plans, strategies and expectations of
the Company. Management desires to take advantage of the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995 and is
including this statement for the express purpose of availing the Company of the
protections of the safe harbor with respect to all forward-looking statements
contained in this annual report. These forward-looking statements are generally
identified by use of the word believe, expect, intend, anticipate,
estimate, project, or similar words. The Companys ability to predict
results or the actual effect of future plans or strategies is uncertain. Factors
which could have a material adverse effect on our operations include, but are
not limited to, changes in interest rates, general economic conditions,
legislative or regulatory changes, monetary and fiscal policies of the U.S.
Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
our market areas, and accounting principles and guidelines. You should consider
these risks and uncertainties in evaluating forward-looking statements and you
should not rely too much on these statements.



|Operating Strategy
|------------------

The Companys strategy is to operate a community-oriented financial
institution devoted to serving the needs of its customers. The Companys
business consists primarily of attracting retail deposits from the general
public and using those funds to originate residential real estate loans,
commercial real estate loans, commercial business loans, and a variety of
consumer loans.

Financial Condition

Total assets were $177.2 million at December 31, 2005, compared
with $163.8 million at December 31, 2004. The increase was the result of growth
in loans, partly offset by decreases in investments and cash
equivalents.

Loans increased $14.3 million, or 10.3%, to $152.7 million at
December 31, 2005 from $138.4 million atDecember 31, 2004. The increase is largely
attributable to continued marketing efforts to small businesses, builders, and
consumers, as well as the purchase of participations in loans from other banks.

7

---

Following is a comparison of the composition of the portfolio
(excluding loans held for sale) at both dates:

|(dollars in thousands)December
      31, |  |   |  | 2005    |  |         |   |  |   |  | 2004    |  |         |  
|---------------------------------------- |  | - |  | ------- |  | ------- | - |  | - |  | ------- |  | ------- | -
|                                        
|                                         |  |   |  | Amount  |  | Percent |   |  |   |  | Amount  |  | Percent |  
|                                         |  |  
|Real estate:                             |  |   |  |         |  |         |   |  |   |  |         |  |         |  
|Permanent:                               |  |   |  |         |  |         |   |  |   |  |         |  |         |  
|One- to
      four-family                |  | $ |  | 49,425  |  | 32.36   |   |  | $ |  | 45,198  |  | 32.65   | %
|Multifamily                              |  |   |  | 1,261   |  | 0.83    |   |  |   |  | 782     |  | 0.56    |  
|Commercial
      nonresidential          |  |   |  | 45,874  |  | 30.04   |   |  |   |  | 44,150  |  | 31.89   |  
|Land                                     |  |   |  | 3,952   |  | 2.59    |   |  |   |  | 4,499   |  | 3.25    |  
|Construction:                            |  |   |  |         |  |         |   |  |   |  |         |  |         |  
|One- to
      four-family                |  |   |  | 9,174   |  | 6.01    |   |  |   |  | 3,759   |  | 2.72    |  
|Multifamily                              |  |   |  | 1,415   |  | 0.93    |   |  |   |  | -       |  | -       |  
|Commercial
      nonresidential          |  |   |  | 3,284   |  | 2.15    |   |  |   |  | 4,453   |  | 3.22    |  
|Commercial
      business                |  |   |  | 19,134  |  | 12.53   |   |  |   |  | 17,670  |  | 12.76   |  
|Consumer:                                |  |   |  |         |  |         |   |  |   |  |         |  |         |  
|Home equity                              |  |   |  | 13,454  |  | 8.81    |   |  |   |  | 12,287  |  | 8.88    |  
|Boat                                     |  |   |  | 3,914   |  | 2.56    |   |  |   |  | 4,174   |  | 3.02    |  
|Automobile                               |  |   |  | 696     |  | 0.46    |   |  |   |  | 514     |  | 0.37    |  
|Other                                    |  |   |  | 1,139   |  | 0.75    |   |  |   |  | 947     |  | 0.68    |  
|                                        
|Total
      loans                        |  |   |  | 152,722 |  | 100.00  | % |  |   |  | 138,433 |  | 100.00  | %
|Less:                                    |  |   |  |         |  |         |   |  |   |  |         |  |         |  
|Allowance for loan
      losses          |  |   |  | 1,448   |  |         |   |  |   |  | 1,380   |  |         |  
|                                        
|Loans,
      net                         |  | $ |  | 151,274 |  |         |   |  | $ |  | 137,053 |  |         |  
|                                         |  |  

Loan demand continued to be strong in 2005, and further growth is
expected in 2006. The mix of loans in the portfolio at December 31, 2005 was
similar to December 31, 2004, with both one-to-four-family mortgages and
commercial nonresidential real estate loans each representing nearly a third of
the total. One-to-four-family construction loans grew significantly during 2005,
growing from 2.7% to over 6.0% of the portfolio.

Production of one-to-four-family mortgage loans declined for the
second straight year following the refinance boom of the preceding years.
Following a 37.5% decline in 2004, mortgage production further decreased $9.8
million, or 32.3%, to $20.6 million in 2005 compared with $30.4 million in 2004.
Fewer loans were sold in the secondary market in 2005, allowing net growth of
$4.2 million in the mortgage portfolio. Following is a summary of loans
originated and purchased:

|                                          
|------------------------------------------
|(in thousands)Year ended December 31,     
|                                          
|Loans originated:                         
|Real
      estate:                        
|Permanent:                                
|One- to
      four-family                 
|Multifamily                               
|Commercial
      nonresidential           
|Land                                      
|Construction:                             
|One- to
      four-family                 
|Multifamily                               
|Commercial
      nonresidential           
|Commercial
      business                 
|Consumer:                                 
|Home equity                               
|Boat                                      
|Automobile                                
|Other                                     
|                                          
|Total
      loans originated              
|Loans purchased                           
|                                          
|Total loans originated and
      purchased
|                                          

8

---

Cash and cash equivalents decreased $1.7 million to $9.9
million at December 31, 2005, compared to $11.6 million at December 31, 2004.
The decrease cash equivalents was enabled by loan growth.

Available-for-sale securities decreased $0.4 million to
$7.5 million at December 31, 2005, compared to $7.9 million at December 31,
2004. The net decrease was the result of principal reductions on mortgage-backed
securities, partially replenished by the purchase of $3.0 million in securities
during 2005. Premises and equipment at December 31, 2005 was $2.1
million at December 31, 2005, a small decrease from the end of 2004. Some net
growth in fixed assets is expected in 2006 as the Bank completes a major remodel
of its largest office and administrative offices in Juneau at a cost exceeding
$1.5 million. Total deposits increased 6.4% to $146.7 million at
December 31, 2005 from $137.8 million at December 31, 2004. As a result of
continuing efforts to increase noninterest checking accounts of both businesses
and consumers, noninterest-bearing demand deposits increased by $3.1 million, or
13.8%, to $25.8 million at December 31, 2005 from $22.7 million at December 31,
2004. Certificates of deposit increased $8.4 million, or 24.6%, to $42.7 million
at December 31, 2005. Of this total increase, $6.2 million is in brokered CDs
through the Certificate of Deposit Account Registry Service (CDARS); the
remaining net growth of $2.2 million is at least partly the result of more
aggressive pricing in 2005 compared with 2004.

FHLB advances increased a net $3.7 million to $12.0
million at December 31, 2005 from $8.3 million at December 31, 2004. This
increase in borrowings, along with CDARS and other deposits, was used to fund
the growth in loans during 2005. **Results of
Operations**Net Income.Net income increased by $23,000, or 3.2%, to
$731,000 for 2005, compared with $708,000 for 2004. Income for 2005 was affected
by $25,000 of nonrecurring expense ($15,000 net of tax) related to the
subsequent closure of two branches in the first quarter of 2006, as discussed
elsewhere in this section. Excluding this expense, net income would have been
$746,000, a 5.4% increase from 2004. The increase is attributable primarily to
increased net interest income and decreased provision for loan losses, partly
offset by a decrease in gains on sale of loans and an increase in noninterest
expense. For purposes of comparison, pre-tax income may be separated into major
components as follows:

|                                                         |  |   |  |        |   |  |   |  |        |   |  |   |  | Income     |  
|-------------------------------------------------------- |  | - |  | ------ | - |  | - |  | ------ | - |  | - |  | ---------- | -
|                                                         |  |   |  |        |   |  |   |  |        |   |  |   |  | Increase   |  
|(in thousands)Year ended December 31,                    |  |   |  | 2005   |   |  |   |  | 2004   |   |  |   |  | (Decrease) |  
|                                                        
|Net interest income                                      |  | $ |  | 8,075  |   |  | $ |  | 7,576  |   |  | $ |  | 499        |  
|Gain on sale of mortgage
      loans                     |  |   |  | 95     |   |  |   |  | 323    |   |  |   |  | (228       | )
|Other noninterest income                                 |  |   |  | 1,034  |   |  |   |  | 1,063  |   |  |   |  | (29        | )
|                                                        
|Net
      revenues                                       |  |   |  | 9,204  |   |  |   |  | 8,962  |   |  |   |  | 242        |  
|Noniterest expense, excluding branch
      closure costs |  |   |  | (7,840 | ) |  |   |  | (7,422 | ) |  |   |  | (418       | )
|                                                        
|Subtotal                                                 |  |   |  | 1,364  |   |  |   |  | 1,540  |   |  |   |  | (176       | )
|Provision for loan losses                                |  |   |  | (120   | ) |  |   |  | (360   | ) |  |   |  | 240        |  
|                                                        
|Pre-tax income,
      excluding branch closure costs     |  |   |  | 1,244  |   |  |   |  | 1,180  |   |  |   |  | 64         |  
|Branch closure costs                                     |  |   |  | (25    | ) |  |   |  | -      |   |  |   |  | (25        | )
|                                                        
|Income before income
      tax                           |  | $ |  | 1,219  |   |  | $ |  | 1,180  |   |  | $ |  | 39         |  
|                                                         |  |  

Net Interest Income.Net interest income increased
$499,000, or 6.6%, to $8.1 million in 2005 from $7.6 million in 2004. The
increase is due to a combination of factors. See the tables in Average
Balances, Interest and Average Yields/Cost and in Rate/Volume Analysis
elsewhere in this discussion.

A
primary factor contributing to the increase in net interest income was growth in
the loan portfolio. Average loans (including held for sale) increased $8.0
million, or 5.7%, to $147.2 million in 2005 from $139.2 million in 2004.
Negatively affecting income from investment securities were FHLB dividends,
which decreased to zero in 2005 compared with $56,000 in 2004, due to the
suspension of dividends by FHLB beginning in the first quarter of 2005.
The increase in net interest income is also attributable to an increase
in margins. While market interest rates generally increased in 2005, average
rates on the Banks interest-bearing liabilities raised relatively less than the
average yields on interest-earning assets. The spread between the two increased
by 13 basis points (bp) to 4.73% in 2005 from 4.60% in 2004. As a result, the
net interest margin on average interest-earning assets increased 24 bp to 5.08%
in 2005 from 4.84% in 2004. Similarly, the net interest margin on average total
assets increased 25 bp to 4.79% in 2005 from 4.54% in 2004.

9

---

Noninterest Income.Total noninterest income decreased $257,000
to $1,129,000 in 2005 from $1,386,000 in 2004, primarily due to a decline in
gains on sale of loans.

Gains on sale of loans decreased $228,000, or 70.6%, to $95,000 in
2005 from $323,000 in 2004. The decrease is primarily the result of reduced
demand for mortgage loans. The Banks mortgage production declined by 32.3% in
2005 compared with 2004, while a relatively higher proportion of production was
added to the loan portfolio rather than sold.

Excluding gains on sale of mortgage loans, noninterest income
decreased $29,000, or 2.7%, to $1,034,000 in 2005 compared with $1,063,000 in
2004. The small net decrease is primarily attributable to service charges other
than those directly related to deposit accounts such loan-related fees and other
fees which may vary from year to year.Noninterest Expense.Noninterest expense,
excluding nonrecurring branch closure costs, increased $418,000, or 5.6%, to
$7.8 million in 2005 from $7.4 million in 2004. Compensation and benefits
expense increased a net of $201,000, or 4.8%, but $179,000 of this increase was
attributable to increased costs of employee medical benefits resulting from
increased costs as well as improved benefits required to compete in the
Companys labor markets. Excluding medical benefits, compensation and all other
benefits increased less than 1% for the year.

Subsequent Branch Closures.Subsequent to year end, at the end of January
2006, the Bank closed its offices in Hoonah and Yakutat, Alaska. The two offices
are the Banks smallest, with deposits at December 31, 2005 of $3.8 million and
$7.7 million, respectively. No other financial institution has a facility in
either of these small communities, each with a population less than 1,000. The
Bank intends to continue to serve its customers in Hoonah and Yakutat through
online banking and other remote services. By closing these offices, management
expects to save the cost of operating the two facilities, amounting to over
$350,000 annually. The effect on future pre-tax income ultimately depends on the
amount of business that is retained after the closures.

The costs of closing the offices are expensed as incurred. These
costs, including estimated lease settlement costs and severance pay, have not
yet been determined, but are estimated to amount to approximately $150,000, of
which $25,000 has been recorded in the accompanying consolidated income
statement for the year ended December 31, 2005. The remainder of such costs will
be recorded primarily in the first quarter of 2006.



|Provision and Allowance for Loan
  Losses
|-----------------------------------------

Provisions for loan losses are charges to earnings to bring the
total allowance for loan losses to a level considered by management to be
adequate to provide for known and inherent risks in the loan portfolio,
including management's continuing analysis of factors underlying the quality of
the loan portfolio.

The provision for loan losses decreased $240,000 to $120,000 for
2005 compared to $360,000 for 2004. The provisions for both years were
considered appropriate in order for the allowance for loan losses to reflect
management's best estimate of losses inherent in the loan portfolio. The
allowance for loan losses increased $68,000, or 4.9%, to $1,448,000 at December
31, 2005 from $1,380,000 at December 31, 2004. The provisions and the resulting
allowance are reflective of numerous factors, including the following:

- Loan
  losses. Net loan chargeoffs were $52,000 (0.03% of total loans) in 2005
  compared with $139,000 (0.10% of total loans) in 2004.
- Growth
  and composition of the portfolio. Total loans increased $14.3 million to
  $152.7 million atDecember 31, 2005 compared with $138.4 million at December 31,
  2004. Growth in recent years reflects gradual changes in composition away from
  single-family mortgages, moving to a greater proportion of loans to businesses.
  Management considered the higher relative risk of these loans in assessing the
  adequacy of the allowance.
- Management analysis of potential problem loans. As part of an
  assessment of the adequacy of the allowance, management performed a detailed
  review of individual loans for which full collectibility may not be
  assured. Such
  loans were $1.3 million (0.9% of total loans) at December 31, 2005, compared
  with $1.1 million (0.8% of total loans) at December 31, 2004. Of
  these, estimated loan impairments of approximately $365,000 and $182,000 were
  specifically considered in the assessment at December 31, 2005 and 2004,
  respectively.
- Past-due Loans. At December 31, 2005, 0.32% of all loan
  balances were past due 30 days or more, compared with 0.53% at December 31,
  2004.
- Nonperforming and classified loans. Nonaccrual loans
  were $1.3 million (0.9% of total loans) at December 31, 2005, compared with $1.5
  million (1.1% of total loans) at December 31, 2004. Loans classified as
  substandard or doubtful increased to $3.4 million (2.2% of total loans) at
  December 31, 2005, from $1.4 million (1.0% of total loans) at December 31,
  2004.

10

---



|For further information on the Banks accounting for the allowance for loan losses as well as how loan impairment isdetermined, see Note 1 of Notes to Consolidated Financial Statements.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

Average Balances, Interest and Average Yields/Cost

The earnings of the Company depend largely on the spread between
the yield on interest-earning assets, which consist primarily of loans and
investments, and the cost of interest-bearing liabilities, which consist
primarily of deposit accounts and borrowings, as well as the relative size of
the Companys interest-earning assets and interest-bearing liabilities.

The following table sets forth, for the periods indicated,
information regarding average balances of assets and liabilities as well as the
total dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities, resultant yields,
interest rate spread, net interest margin, and ratio of average interest-earning
assets to average interest-bearing liabilities. Average balances are generally
daily averages for the period.

|(dollars in thousands)                     |  |   |  |         |   |  |   |  |          |  |         |   |  |   |  |         |   |  |   |  |          |  |         |  
|------------------------------------------ |  | - |  | ------- | - |  | - |  | -------- |  | ------- | - |  | - |  | ------- | - |  | - |  | -------- |  | ------- | -
|Year ended December 31,                    |  |   |  |         |   |  |   |  | 2005     |  |         |   |  |   |  |         |   |  |   |  | 2004     |  |         |  
|                                          
|                                           |  |   |  |         |   |  |   |  |          |  | Average |   |  |   |  |         |   |  |   |  |          |  | Average |  
|                                           |  |   |  | Average |   |  |   |  |          |  | Yield/  |   |  |   |  | Average |   |  |   |  |          |  | Yield/  |  
|                                           |  |   |  | Balance |   |  |   |  | Interest |  | Cost    |   |  |   |  | Balance |   |  |   |  | Interest |  | Cost    |  
|                                          
|Interest-earning assets:                   |  |   |  |         |   |  |   |  |          |  |         |   |  |   |  |         |   |  |   |  |          |  |         |  
|Loans(1)                                   |  | $ |  | 147,218 |   |  | $ |  | 9,861    |  | 6.70    | % |  | $ |  | 139,247 |   |  | $ |  | 8,798    |  | 6.32    | %
|Investment securities(1)                   |  |   |  | 9,704   |   |  |   |  | 262      |  | 2.70    |   |  |   |  | 11,403  |   |  |   |  | 336      |  | 2.95    |  
|Interest-earning deposits in
      banks   |  |   |  | 2,075   |   |  |   |  | 61       |  | 2.94    |   |  |   |  | 5,788   |   |  |   |  | 67       |  | 1.16    |  
|                                          
|Total interest-earning assets              |  |   |  | 158,997 |   |  |   |  | 10,184   |  | 6.41    |   |  |   |  | 156,438 |   |  |   |  | 9,201    |  | 5.88    |  
|Allowance for loan losses                  |  |   |  | (1,413  | ) |  |   |  |          |  |         |   |  |   |  | (1,318  | ) |  |   |  |          |  |         |  
|Cash and due from banks                    |  |   |  | 6,576   |   |  |   |  |          |  |         |   |  |   |  | 6,018   |   |  |   |  |          |  |         |  
|Other assets                               |  |   |  | 4,519   |   |  |   |  |          |  |         |   |  |   |  | 5,584   |   |  |   |  |          |  |         |  
|                                          
|Total assets                               |  | $ |  | 168,679 |   |  |   |  |          |  |         |   |  | $ |  | 166,722 |   |  |   |  |          |  |         |  
|                                           |  |  
|                                          
|Interest-bearing liabilities:              |  |   |  |         |   |  |   |  |          |  |         |   |  |   |  |         |   |  |   |  |          |  |         |  
|Deposits:                                  |  |   |  |         |   |  |   |  |          |  |         |   |  |   |  |         |   |  |   |  |          |  |         |  
|Interest-bearing
      demand              |  | $ |  | 31,087  |   |  | $ |  | 110      |  | 0.35    | % |  | $ |  | 32,000  |   |  | $ |  | 97       |  | 0.30    | %
|Money market                               |  |   |  | 25,904  |   |  |   |  | 399      |  | 1.54    |   |  |   |  | 25,634  |   |  |   |  | 211      |  | 0.82    |  
|Savings                                    |  |   |  | 22,298  |   |  |   |  | 132      |  | 0.59    |   |  |   |  | 24,062  |   |  |   |  | 132      |  | 0.55    |  
|Certificates of
      deposit              |  |   |  | 35,621  |   |  |   |  | 965      |  | 2.71    |   |  |   |  | 35,658  |   |  |   |  | 741      |  | 2.08    |  
|                                          
|Total interest-bearing
      deposits      |  |   |  | 114,910 |   |  |   |  | 1,606    |  | 1.40    |   |  |   |  | 117,354 |   |  |   |  | 1,181    |  | 1.01    |  
|Borrowings                                 |  |   |  | 10,393  |   |  |   |  | 503      |  | 4.84    |   |  |   |  | 9,229   |   |  |   |  | 444      |  | 4.81    |  
|                                          
|Total interest-bearing
      liabilities   |  |   |  | 125,303 |   |  |   |  | 2,109    |  | 1.68    |   |  |   |  | 126,583 |   |  |   |  | 1,625    |  | 1.28    |  
|Noninterest-bearing demand deposits        |  |   |  | 24,761  |   |  |   |  |          |  |         |   |  |   |  | 22,373  |   |  |   |  |          |  |         |  
|Mortgage escrows                           |  |   |  | 1,395   |   |  |   |  |          |  |         |   |  |   |  | 1,255   |   |  |   |  |          |  |         |  
|Other liabilities                          |  |   |  | 967     |   |  |   |  |          |  |         |   |  |   |  | 909     |   |  |   |  |          |  |         |  
|Shareholders equity                       |  |   |  | 16,253  |   |  |   |  |          |  |         |   |  |   |  | 15,602  |   |  |   |  |          |  |         |  
|                                          
|Total liabilities and shareholders equity |  | $ |  | 168,679 |   |  |   |  |          |  |         |   |  | $ |  | 166,722 |   |  |   |  |          |  |         |  
|                                           |  |  
|Net interest income                        |  |   |  |         |   |  | $ |  | 8,075    |  |         |   |  |   |  |         |   |  | $ |  | 7,576    |  |         |  
|                                           |  |  
|Interest rate spread                       |  |   |  |         |   |  |   |  |          |  | 4.73    | % |  |   |  |         |   |  |   |  |          |  | 4.60    | %
|                                           |  |  
|Net interest margin:                       |  |   |  |         |   |  |   |  |          |  |         |   |  |   |  |         |   |  |   |  |          |  |         |  
|On average interest-earning assets         |  |   |  |         |   |  |   |  |          |  | 5.08    | % |  |   |  |         |   |  |   |  |          |  | 4.84    | %
|On average total assets                    |  |   |  |         |   |  |   |  |          |  | 4.79    |   |  |   |  |         |   |  |   |  |          |  | 4.54    |  
|                                           |  |  
|Ratio of average interest-earning assets   |  |   |  |         |   |  |   |  |          |  |         |   |  |   |  |         |   |  |   |  |          |  |         |  
|to average interest-bearing liabilities    |  |   |  | 126.89  | % |  |   |  |          |  |         |   |  |   |  | 123.59  | % |  |   |  |          |  |         |  
|                                           |  |  

|(1) | Average loans include nonperforming loans and loans held for
      sale. Interest income does not include interest on nonaccrual loans.
      Average investment securities include FHLB stock.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   

12

---



|Rate/Volume
Analysis
|--------------------

The following table sets forth the effects of changing
rates and volumes on net interest income of the Company. Information is provided
with respect to effects on interest income attributable to changes in volume,
which are changes in volume multiplied by prior rate; effects on interest income
attributable to changes in rate, which are changes in rate multiplied by prior
volume; and changes in rate/volume, which is a change in rate multiplied by
change in volume.

|(in
      thousands)                                  |  |   |  |      |   |  |   |  |        |   |  |   |  | Rate/  |   |  |   |  |       |  
|----------------------------------------------------- |  | - |  | ---- | - |  | - |  | ------ | - |  | - |  | ------ | - |  | - |  | ----- | -
|Year ended December 31, 2005 compared
      with 2004 |  |   |  | Rate |   |  |   |  | Volume |   |  |   |  | Volume |   |  |   |  | Total |  
|                                                     
|Interest-earning assets:                              |  |   |  |      |   |  |   |  |        |   |  |   |  |        |   |  |   |  |       |  
|Loans                                                 |  | $ |  | 528  |   |  | $ |  | 505    |   |  | $ |  | 30     |   |  | $ |  | 1,063 |  
|Investment
      securities                           |  |   |  | (28  | ) |  |   |  | (50    | ) |  |   |  | 4      |   |  |   |  | (74   | )
|Interest-earning
      deposits in banks              |  |   |  | 103  |   |  |   |  | (43    | ) |  |   |  | (66    | ) |  |   |  | (6    | )
|                                                     
|Total net change
      in interest income             |  |   |  | 603  |   |  |   |  | 412    |   |  |   |  | (32    | ) |  |   |  | 983   |  
|                                                     
|Interest-bearing
      liabilities:                   |  |   |  |      |   |  |   |  |        |   |  |   |  |        |   |  |   |  |       |  
|Interest-bearing
      demand accounts                |  |   |  | 16   |   |  |   |  | (3     | ) |  |   |  | -      |   |  |   |  | 13    |  
|Money market
      accounts                           |  |   |  | 184  |   |  |   |  | 2      |   |  |   |  | 2      |   |  |   |  | 188   |  
|Savings
      accounts                                |  |   |  | 10   |   |  |   |  | (10    | ) |  |   |  | -      |   |  |   |  | -     |  
|Certificates of
      deposit                         |  |   |  | 225  |   |  |   |  | (1     | ) |  |   |  | -      |   |  |   |  | 224   |  
|Borrowings                                            |  |   |  | 3    |   |  |   |  | 56     |   |  |   |  | -      |   |  |   |  | 59    |  
|                                                     
|Total net change
      in interest expense            |  |   |  | 438  |   |  |   |  | 44     |   |  |   |  | 2      |   |  |   |  | 484   |  
|                                                     
|                                                     
|Net change in net interest
      income               |  | $ |  | 165  |   |  | $ |  | 368    |   |  | $ |  | (34    | ) |  | $ |  | 499   |  
|                                                      |  |  



|Yields Earned and Rates
  Paid
|------------------------------

The following table sets forth, at the date and for the
periods indicated, the weighted average yields earned on the Companys assets
and the weighted average interest rates paid on the Companys liabilities,
together with the net yield on interest-earning assets.

|                                         |  | At           |   |  |                                       |   |  |      |  
|---------------------------------------- |  | ------------ | - |  | ------------------------------------- | - |  | ---- | -
|                                         |  | December 31, |   |  | For the Year
      Ended December 31, |  
|                                         |  | 2005         |   |  | 2005                                  |   |  | 2004 |  
|                                        
|                                        
|Weighted average yield on:               |  |              |   |  |                                       |   |  |      |  
|Loans                                    |  | 6.99         | % |  | 6.70                                  | % |  | 6.32 | %
|Investment
      securities              |  | 4.25         |   |  | 2.70                                  |   |  | 2.95 |  
|Interest-earning
      deposits in banks |  | 3.90         |   |  | 2.94                                  |   |  | 1.16 |  
|Total
      interest-earning assets      |  | 6.83         |   |  | 6.41                                  |   |  | 5.88 |  
|                                        
|Weighted average rate paid
      on:     |  |              |   |  |                                       |   |  |      |  
|Interest-bearing
      demand accounts   |  | 0.34         |   |  | 0.35                                  |   |  | 0.30 |  
|Money market
      accounts              |  | 2.12         |   |  | 1.54                                  |   |  | 0.82 |  
|Savings
      accounts                   |  | 0.65         |   |  | 0.59                                  |   |  | 0.55 |  
|Certificates of
      deposit            |  | 3.07         |   |  | 2.71                                  |   |  | 2.08 |  
|Total
      interest-bearing deposits    |  | 1.76         |   |  | 1.40                                  |   |  | 1.01 |  
|Borrowings                               |  | 4.87         |   |  | 4.84                                  |   |  | 4.81 |  
|Total
      interest-bearing liabilities |  | 2.04         |   |  | 1.68                                  |   |  | 1.28 |  
|                                        
|Interest rate spread                     |  | 4.79         |   |  | 4.73                                  |   |  | 4.60 |  
|                                        
|Net interest margin on:                  |  |              |   |  |                                       |   |  |      |  
|Average
      interest-earning assets    |  | 5.04         |   |  | 5.08                                  |   |  | 4.84 |  
|Average total
      assets               |  | 4.71         |   |  | 4.79                                  |   |  | 4.54 |  

13

---

Asset and Liability Management and Market Risk

Qualitative Analysis - Risks When Interest Rates Change.The
Banks profitability depends primarily on its net interest income, which is the
difference between the income it receives on its loan and investment portfolios
and its cost of funds, which consists of interest paid on deposits and
borrowings. The relative amounts of interest-earning assets and interest-bearing
liabilities also affect net interest income. When interest-earning assets equal
or exceed interest-bearing liabilities, any positive interest rate spread will
generate net interest income. The Banks profitability is also affected by the
level of noninterest income and expenses. Noninterest income includes service
charges and fees and gain on sale of loans and investments. Noninterest expenses
primarily include compensation and benefits, occupancy and equipment expenses,
deposit insurance premiums and data processing expenses. General economic and
competitive conditions, particularly changes in market interest rates,
government legislation and regulation, and monetary and fiscal policies also
significantly affect the Banks results of operations. Quantitative
Analysis - How the Bank Measures Its Risk of Interest Rate Changes.The
Bank does not maintain a trading account for any class of financial instrument
nor does it engage in hedging activities or purchase high-risk derivative
instruments. Furthermore, the Bank has no significant foreign currency exchange
rate risk or commodity price risk.

The Bank has sought to reduce the exposure of its earnings
to changes in market interest rates by attempting to manage the mismatch between
asset and liability maturities and interest rates. Principal elements in
achieving this objective include increasing the interest-rate sensitivity of the
Banks interest-earning assets by originating for its portfolio loans with
interest rates that periodically adjust to market conditions, as well as
continuing decisions to sell fixed-rate mortgage production versus keeping them
in the portfolio. The Bank relies on retail deposits as its primary source of
funds. Historically, retail deposits, compared to brokered deposits and borrowed
funds, tend to reduce the effects of interest rate fluctuations because they
generally represent a more stable source of funds.

In
order to encourage institutions to reduce interest rate risk, the OTS adopted a
rule incorporating an interest rate risk component into its risk-based capital
rules. Using data compiled by the OTS, the Bank receives a report that measures
interest rate risk by modeling the change in net portfolio value over a variety
of interest rate scenarios. The OTS developed this procedure for measuring
interest rate risk to replace the gap analysis, which is the difference
between interest-earning assets and interest-bearing liabilities that mature or
reprice within a specific time period. Net portfolio value is the present value
of expected cash flows from assets, liabilities and off-balance-sheet contracts.
The calculation is intended to illustrate the change in net portfolio value that
will occur upon an immediate change in interest rates of at least 200 basis
points with no effect given to any steps that management might take to counter
the effect of that interest rate movement. Under OTS regulations, an institution
with a greater than normal level of interest rate risk takes a deduction from
total capital for purposes of calculating its risk-based capital. The OTS,
however, has delayed the implementation of this regulation. An institution with
a normal level of interest rate risk is defined as one whose measured
interest rate risk is less than 2.0% . Institutions with assets of less than
$300 million and a risk-based capital ratio of more than 12.0% are exempt. The
Bank is exempt because of its asset size and risk-based capital ratio. Based on
the Banks regulatory capital levels at December 31, 2005, the Bank believes
that, if the proposed regulation had been implemented at that date, the Banks
level of interest rate risk would not have caused it to be treated as an
institution with greater than normal interest rate risk.

The following table illustrates the change in net
portfolio value at December 31, 2005, based on OTS assumptions, that would occur
in the event of an immediate change in interest rates, with no effect given to
any steps which management might take to counter the effect of that interest
rate movement.

|                               |    |  |   |  |        |  |   |  |                     |   |  |         |    |  |  |  |                                                       |  
|------------------------------ | -- |  | - |  | ------ |  | - |  | ------------------- | - |  | ------- | -- |  |  |  | ----------------------------------------------------- | -
|*(dollars in
      thousands)* |    |  |   |  |        |  |   |  | Net Portfolio Value |   |  |         |    |  |  |  | Net Portfolio as % of Portfolio Value of
      Assets |  
|                              
|                               |    |  |   |  |        |  |   |  |                     |   |  |         |    |  |  |  | Net                                                   |  
|Basis Point (bp)             |    |  |   |  | Dollar |  |   |  | Dollar              |   |  | Percent |    |  |  |  | Portfolio Value                                       |  
|Change in Rates                |    |  |   |  | Amount |  |   |  | Change(1)           |   |  | Change  |    |  |  |  | Ratio (2)                                             |  
|                              
|300                            | bp |  | $ |  | 21,149 |  | $ |  | (4,339              | ) |  | (17     | )% |  |  |  | 11.80                                                 | %
|200                            |    |  |   |  | 22,717 |  |   |  | (2,771              | ) |  | (11     | )  |  |  |  | 12.54                                                 |  
|100                            |    |  |   |  | 24,240 |  |   |  | (1,248              | ) |  | (5      | )  |  |  |  | 13.24                                                 |  
|0                              |    |  |   |  | 25,488 |  |   |  | -                   |   |  | -       |    |  |  |  | 13.80                                                 |  
|(100                           | )  |  |   |  | 25,714 |  |   |  | 227                 |   |  | 1       |    |  |  |  | 13.87                                                 |  
|(200                           | )  |  |   |  | 24,864 |  |   |  | (624                | ) |  | (2      | )  |  |  |  | 13.43                                                 |  

|(1) | Represents the increase (decrease) of the estimated
      net portfolio value at the indicated change in interest rates compared to
      the net portfolio value assuming no change in interest rates.                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) | Calculated as the estimated net portfolio value
      divided by the portfolio value of total assets.                                                                                                                      
|   
|(3) | Calculated as the increase (decrease) of the net
      portfolio value ratio assuming the indicated change in interest rates over
      the estimated net portfolio value ratio assuming no change in interest
      rates.
|   

14

---

The above table illustrates, for example, that at December 31, 2005
an instantaneous 200 basis point increase in market interest rates would reduce
the Banks net portfolio value by $2.8 million, or 11%, and an instantaneous 200
basis point decrease in market interest rates would reduce the Banks net
portfolio value by $624,000, or 2%. The following table summarizes key
exposure measures for the dates indicated. They measure the change in net
portfolio value ratio for an adverse change in interest rates of 200 basis
points upward or 200 basis points downward (100 basis points downward for
December 31, 2004).

|                         |  | December 31, |    |  | September 30, |    |  | December 31, |   
|------------------------ |  | ------------ | -- |  | ------------- | -- |  | ------------ | --
|                         |  | 2005         |    |  | 2005          |    |  | 2004         |   
|                        
|Pre-shock net portfolio  |  |              |    |  |               |    |  |              |   
|value
      ratio        |  | 13.80        | %  |  | 13.47         | %  |  | 13.33        | % 
|Post-shock net portfolio |  |              |    |  |               |    |  |              |   
|value
      ratio        |  | 12.54        | %  |  | 12.44         | %  |  | 12.90        | % 
|Decline in net portfolio |  |              |    |  |               |    |  |              |   
|value
      ratio        |  | 125          | bp |  | 103           | bp |  | 43           | bp

These measures indicate a relatively low level of interest-rate
risk at the present time. Among other factors, this is due to management
decisions in recent years to effect a relative decrease in fixed-rate mortgages
and a gradual shift to earning assets that tend to reprice with greater
frequency.

The OTS uses certain assumptions in assessing the interest rate
risk of thrift institutions. These assumptions relate to interest rates, loan
prepayment rates, deposit decay rates, and the market values of certain assets
under differing interest rate scenarios, among others. As with any method of
measuring interest rate risk, certain shortcomings are inherent in the method of
analysis presented in the foregoing table. For example, although certain assets
and liabilities may have similar maturities or periods to repricing, they may
react in different degrees to changes in market interest rates. Also, the
interest rates on certain types of assets and liabilities may fluctuate in
advance of changes in market interest rates, while interest rates on other types
may lag behind changes in market rates. Additionally, certain assets, such as
adjustable rate mortgage loans, have features that restrict changes in interest
rates on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates, expected rates of prepayments on loans and
early withdrawals from certificates of deposit could deviate significantly from
those assumed in calculating the table.



|Liquidity and Capital
Resources
|-------------------------------

The Banks primary sources of funds are deposits, proceeds from
principal and interest payments on loans and mortgage-backed securities, and
FHLB advances. While maturities and scheduled amortization of loans and
mortgage-backed securities are a predictable source of funds, deposit flows and
mortgage prepayments are greatly influenced by general interest rates, economic
conditions and competition.

The primary investing activity of the Bank has been the origination
of loans, including one- to four-family mortgages, commercial real estate loans,
commercial business loans, and consumer loans. Deposits, FHLB borrowings, and
principal repayments on loans and mortgage-backed securities were the primary
means for funding these activities. The Bank must maintain an adequate
level of liquidity to ensure the availability of sufficient funds to support
loan growth and deposit withdrawals, to satisfy financial commitments and to
take advantage of investment opportunities. The Banks sources of funds include
deposits, principal and interest payments from loans and investments, and FHLB
advances. During 2005 and 2004, the Company used its sources of funds primarily
to fund new loans and to pay maturing certificates and other deposit
withdrawals. At December 31, 2005, the Bank had loan commitments including
unused portions of lines of credit and undisbursed construction loans, of $12.8
million. At December 31, 2005, the Bank had $36,000 of net unrealized
losses on investment securities classified as available for sale, which
represented 0.5% of the amortized cost ($7.5 million) of the securities. This
represented a decline of $56,000 compared with $20,000 of unrealized gains at
December 31, 2004, primarily due to changes in market demand. Movements in
market interest rates will continue to affect the unrealized gains and losses in
these securities. However, assuming that the securities are held to their
individual dates of maturity, even in periods of increasing market interest
rates, as the securities approach their dates of maturity, any unrealized gains
or losses will begin to decrease and will eventually be eliminated.

15

---

At
December 31, 2005, certificates of deposit amounted to $42.7 million, or 29.1%
of the Banks total deposits, including $31.6 million scheduled to mature by
December 31, 2006. Historically, the Bank has been able to retain a significant
amount of its deposits as they mature. Management believes it has adequate
resources to fund all loan commitments with deposits and, as needed, FHLB
advances and sale of mortgage loans and that it can adjust the offering rates of
certificates of deposits to retain deposits in changing interest rate
environments. In addition, the Bank has available a line of credit with the FHLB
generally equal to 25% of the Banks total assets, or approximately $44.3
million at December 31, 2005, of which $32.3 million was unused. The
Bank is required to maintain specific amounts of capital pursuant to OTS
requirements. As of December 31, 2005, the Bank was in compliance with all
regulatory capital requirements that were effective as of this date with
tangible, core, and risk-based capital ratios of 9.08%, 9.08% and 13.01%,
respectively. For further information, see Note 2 of the Notes to Consolidated
Financial Statements.



|Recent Accounting
Pronouncements
|--------------------------------

In
December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123(R),Share-Based
Payments. This Statement replaces SFAS 123, Accounting for Stock-Based
Compensation and supersedes APB Opinion No. 25,Accounting for Stock Issued to
Employees. SFAS 123(R) requires that compensation cost relating to
share-based payment transactions (for example, stock options granted to
employees of the Company) be recognized in financial statements. That cost will
be measured based on the fair value of the equity or liability instruments used.
SFAS 123(R) covers a wide range of share-based compensation arrangements
including share options, restricted share plans, performance-based awards, share
appreciation rights, and employee share purchase plans. The statement is
effective for the Company on January 1, 2006. We have not determined the
effects, if any, that this Statement will have on the Companys financial
statements.

SFAS No. 154,Accounting Changes and Error Corrections, a
Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS 154
establishes, unless impracticable, retrospective application as the required
method for reporting a change in accounting principle in the absence of explicit
transition requirements specific to a newly adopted accounting principle.
Previously, most changes in accounting principle were recognized by including
the cumulative effect of changing to the new accounting principle in net income
of the period of the change. Under SFAS 154, retrospective application requires
(i) the cumulative effect of the change to the new accounting principle on
periods prior to those presented to be reflected in the carrying amounts of
assets and liabilities as of the beginning of the first period presented, (ii)
an offsetting adjustment, if any, to be made to the opening balance of retained
earnings (or other appropriate components of equity) for that period, and (iii)
financial statements for each individual prior period presented to be adjusted
to reflect the direct period-specific effects of applying the new accounting
principle. Special retroactive application rules apply in situations where it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. Indirect effects of a change in accounting principle are
required to be reported in the period in which the accounting change is made.
SFAS 154 carries forward the guidance in APB Opinion 20 Accounting Changes,
requiring justification of a change in accounting principle on the basis of
preferability. SFAS 154 also carries forward without change the guidance
contained in APB Opinion 20, for reporting the correction of an error in
previously issued financial statements and for a change in an accounting
estimate. SFAS 154 is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005. The Corporation does not
expect SFAS 154 will significantly impact its financial statements upon its
adoption on January 1, 2006.

FASB Staff Position (FSP) No. 115-1,The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments. FSP 115-1 provides guidance for determining when an investment is
considered impaired, whether impairment is other-than-temporary, and measurement
of an impairment loss. An investment is considered impaired if the fair value of
the investment is less than its cost. If, after consideration of all available
evidence to evaluate the realizable value of its investment, impairment is
determined to be other-than-temporary, then an impairment loss should be
recognized equal to the difference between the investments cost and its fair
value. FSP 115-1 nullifies certain provisions of Emerging Issues Task Force
(EITF) Issue No. 03-1,The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments, while retaining the
disclosure requirements of EITF 03-1, which were adopted in 2003. FSP 115-1 is
effective for reporting periods beginning after December 15, 2005. The
Corporation does not expect FSP 115-1 will significantly impact its financial
statements upon its adoption on January 1, 2006.

16

---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM



|To the Board of DirectorsAlaska Pacific
      Bancshares, Inc.Juneau, Alaska
|----------------------------------------------------------------------------

We
have audited the accompanying consolidated statements of financial condition of
Alaska Pacific Bancshares, Inc. and Subsidiary (the Company) as of December
31, 2005 and 2004, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
consolidated 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 Alaska
Pacific Bancshares, Inc. and subsidiary as of December 31, 2005 and 2004, and
the results of their operations and their cash flows for the years then ended,
in conformity with accounting principles generally accepted in the United States
of America.



/s/Moss Adams LLP



|Spokane, WashingtonMarch 27,
  2006
|-----------------------------------

17

---

|Alaska
      Pacific Bancshares, Inc. and Subsidiary                           |  |              |   |  |  |  |                |     |  
|------------------------------------------------------------------------------ |  | ------------ | - |  |  |  | -------------- | --- | -
|Consolidated
      Balance Sheets                                              |  |              |   |  |  |  |                |     |  
|                                                                              
|(dollars in thousands)December
      31,                                       |  |              |   |  |  |  |                |     |  
|                                                                              
|Assets                                                                         |  |              |   |  |  |  |                |     |  
|Cash and due from banks                                                        |  |              |   |  |  |  | $              |     |  
|Interest-earning deposits in banks                                             |  |              |   |  |  |  |                |     |  
|                                                                              
|Total cash and cash
      equivalents                                          |  |              |   |  |  |  |                |     |  
|Investment securities available for sale, at fair
      value (amortized cost: |  |              |   |  |  |  |                |     |  
|2005 - $7,500; 2004 -
      $7,877)                                            |  |              |   |  |  |  |                |     |  
|Federal Home Loan Bank stock                                                   |  |              |   |  |  |  |                |     |  
|Loans held for sale                                                            |  |              |   |  |  |  |                |     |  
|Loans                                                                          |  |              |   |  |  |  | 152,722        |     |  
|Less allowance for loan
      losses                                           |  |              |   |  |  |  |                |     |  
|                                                                              
|Loans,
      net                                                               |  |              |   |  |  |  | 151,274        |     |  
|Accrued interest receivable                                                    |  |              |   |  |  |  |                |     |  
|Premises and equipment                                                         |  |              |   |  |  |  |                |     |  
|Repossessed assets                                                             |  |              |   |  |  |  |                |     |  
|Other assets                                                                   |  |              |   |  |  |  |                |     |  
|                                                                              
|Total Assets                                                                   |  |              |   |  |  |  | $     177,157  |     |  
|                                                                               |  |             
|                                                                              
|Liabilities and Shareholders
      Equity                                     |  |              |   |  |  |  |                |     |  
|Deposits:                                                                      |  |              |   |  |  |  |                |     |  
|Noninterest-bearing
      demand                                               |  |              |   |  |  |  | $       25,816 |     |  
|Interest-bearing
      demand                                                  |  |              |   |  |  |  |                |     |  
|Money market                                                                   |  |              |   |  |  |  |                |     |  
|Savings                                                                        |  |              |   |  |  |  |                |     |  
|Certificates of
      deposit                                                  |  |              |   |  |  |  |                |     |  
|                                                                              
|Total
      deposits                                                           |  |              |   |  |  |  | 146,650        |     |  
|Federal Home Loan Bank advances                                                |  |              |   |  |  |  |                |     |  
|Advance payments by borrowers for taxes and
      insurance                    |  |              |   |  |  |  |                | 890 |  
|Accounts payable and accrued expenses                                          |  |              |   |  |  |  |                |     |  
|Accrued interest payable                                                       |  |              |   |  |  |  |                |     |  
|Other liabilities                                                              |  |              |   |  |  |  |                |     |  
|                                                                              
|Total liabilities                                                              |  |              |   |  |  |  | 160,519        |     |  
|Commitments and contingencies (Notes 12 and
      13)                          |  |              |   |  |  |  |                |     |  
|Shareholders Equity:                                                          |  |              |   |  |  |  |                |     |  
|                                                                               |  | December 31, |   |  |  |  |                |     |  
|Common stock ($0.01 par
      value):                                          |  | 2005         |   |  |  |  | 2004           |     |  
|                                                                               |  |              |   | 
|Authorized
      shares                                                        |  | 20,000,000   |   |  |  |  | 20,000,000     |     |  
|Issued                                                                         |  | 655,415      |   |  |  |  | 655,415        |     |  
|Outstanding                                                                    |  | 627,754      |   |  |  |  | 627,754        |     |  
|Additional paid-in
      capital                                               |  |              |   |  |  |  |                |     |  
|Treasury stock                                                                 |  | (27,661      | ) |  |  |  | (27,661        | )   |  
|Unearned ESOP shares                                                           |  | (13,062      | ) |  |  |  | (18,007        | )   |  
|Unvested shares in stock award
      plan                                      |  | -            |   |  |  |  | (3,034         | )   |  
|Retained earnings                                                              |  |              |   |  |  |  |                |     |  
|Accumulated other comprehensive
      income (loss)                            |  |              |   |  |  |  |                | (21 | )
|                                                                              
|Total
      shareholders equity                                               |  |              |   |  |  |  |                |     |  
|                                                                              
|Total Liabilities and Shareholders
      Equity                               |  |              |   |  |  |  | $     177,157  |     |  
|                                                                              
|See notes to
      consolidated financial statements.                          |  |              |   |  |  |  |                |     |  

18

---

|Alaska Pacific Bancshares, Inc. and
      Subsidiary          |  |   |  |        |  |   |  |       |  
|------------------------------------------------------------- |  | - |  | ------ |  | - |  | ----- | -
|Consolidated Statements of Income                             |  |   |  |        |  |   |  |       |  
|                                                             
|                                                             
|                                                             
|(in thousands,
      except per share)Year ended December 31, |  |   |  | 2005   |  |   |  | 2004  |  
|                                                             
|Interest
      Income                                         |  |   |  |        |  |   |  |       |  
|Loans                                                         |  | $ |  | 9,861  |  | $ |  | 8,798 |  
|Investment
      securities                                   |  |   |  | 262    |  |   |  | 336   |  
|Interest-earning
      deposits in banks                      |  |   |  | 61     |  |   |  | 67    |  
|                                                             
|Total interest
      income                                   |  |   |  | 10,184 |  |   |  | 9,201 |  
|Interest
      Expense                                        |  |   |  |        |  |   |  |       |  
|Deposits                                                      |  |   |  | 1,606  |  |   |  | 1,181 |  
|Federal Home Loan
      Bank advances                         |  |   |  | 503    |  |   |  | 444   |  
|                                                             
|Total interest
      expense                                  |  |   |  | 2,109  |  |   |  | 1,625 |  
|                                                             
|**Net Interest
      Income**                                 |  |   |  | 8,075  |  |   |  | 7,576 |  
|Provision for loan losses                                     |  |   |  | 120    |  |   |  | 360   |  
|                                                             
|Net interest income
      after provision for loan losses     |  |   |  | 7,955  |  |   |  | 7,216 |  
|Noninterest
      Income                                      |  |   |  |        |  |   |  |       |  
|Mortgage servicing
      income                               |  |   |  | 150    |  |   |  | 151   |  
|Service charges on
      deposit accounts                     |  |   |  | 660    |  |   |  | 660   |  
|Other service charges
      and fees                          |  |   |  | 224    |  |   |  | 252   |  
|Gain on sale of
      mortgage loans                          |  |   |  | 95     |  |   |  | 323   |  
|                                                             
|Total noninterest
      income                                |  |   |  | 1,129  |  |   |  | 1,386 |  
|Noninterest
      Expense                                     |  |   |  |        |  |   |  |       |  
|Compensation and
      benefits                               |  |   |  | 4,363  |  |   |  | 4,162 |  
|Occupancy and
      equipment                                 |  |   |  | 1,548  |  |   |  | 1,499 |  
|Data
      processing                                         |  |   |  | 252    |  |   |  | 269   |  
|Professional and
      consulting fees                        |  |   |  | 268    |  |   |  | 241   |  
|Marketing and public
      relations                          |  |   |  | 282    |  |   |  | 275   |  
|Real estate owned
      expense, net                          |  |   |  | 33     |  |   |  | (60   | )
|Other                                                         |  |   |  | 1,119  |  |   |  | 1,036 |  
|                                                             
|Total noninterest
      expense                               |  |   |  | 7,865  |  |   |  | 7,422 |  
|                                                             
|Income
      before income tax                                |  |   |  | 1,219  |  |   |  | 1,180 |  
|Provision for income tax                                      |  |   |  | 488    |  |   |  | 472   |  
|                                                             
|**Net Income**                                                |  | $ |  | 731    |  | $ |  | 708   |  
|                                                              |  |  
|                                                             
|Net income per share:                                         |  |   |  |        |  |   |  |       |  
|Basic                                                         |  | $ |  | 1.20   |  | $ |  | 1.18  |  
|Diluted                                                       |  |   |  | 1.15   |  |   |  | 1.12  |  
|                                                              |  |  
|See notes to
      consolidated financial statements.         |  |   |  |        |  |   |  |       |  

19

---

AlaskaPacificBancshares,Inc. andSubsidiary

ConsolidatedStatementsofChangesinShareholdersEquity andComprehensiveIncome

|                                                      |  |        |  |  |            |   |  |          |   |  |          |   |  | Unvested   |   |  |          |   |  | Accumulated   |   |  | Total   
|----------------------------------------------------- |  | ------ |  |  | ---------- | - |  | -------- | - |  | -------- | - |  | ---------- | - |  | -------- | - |  | ------------- | - |  | --------
|                                                      |  |        |  |  | Additional |   |  |          |   |  | Unearned |   |  | Shares in  |   |  |          |   |  | Other         |   |  | Share-  
|                                                      |  | Common |  |  | Paid-In    |   |  | Treasury |   |  | ESOP     |   |  | Stock      |   |  | Retained |   |  | Comprehensive |   |  | holders
|(in
      thousands)                                  |  | Stock  |  |  | Capital    |   |  | Stock    |   |  | Shares   |   |  | Award Plan |   |  | Earnings |   |  | Income (Loss) |   |  | Equity  
|                                                     
|Balance, January 1, 2004                              |  | $7     |  |  | $5,857     |   |  | $(362    | ) |  | $(233    | ) |  | $(80       | ) |  | $10,092  |   |  | $(24          | ) |  | $15,257 
|                                                     
|Net income                                            |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  | 708      |   |  |               |   |  | 708     
|Other comprehensive
      income:                     |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  |         
|Change in net
      unrealized gains and              |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  |         
|losses on
      securities available                  |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  |         
|for sale (net
      of income tax of $24)             |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  | 36            |   |  | 36      
|                                                     
|Comprehensive
      income                            |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  | 744     
|Exercise of stock options                             |  |        |  |  | (4         | ) |  | 20       |   |  |          |   |  |            |   |  |          |   |  |               |   |  | 16      
|ESOP shares earned                                    |  |        |  |  | 58         |   |  |          |   |  | 53       |   |  |            |   |  |          |   |  |               |   |  | 111     
|Accrued vesting of restricted
      stock             |  |        |  |  |            |   |  |          |   |  |          |   |  | 50         |   |  |          |   |  |               |   |  | 50      
|Cash dividends ($.28 per
      share)                 |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  | (173     | ) |  |               |   |  | (173    
|                                                     
|Balance, December 31, 2004                            |  | 7      |  |  | 5,911      |   |  | (342     | ) |  | (180     | ) |  | (30        | ) |  | 10,627   |   |  | 12            |   |  | 16,005  
|                                                     
|Net income                                            |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  | 731      |   |  |               |   |  | 731     
|Other comprehensive
      income:                     |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  |         
|Change in net unrealized gains
      and              |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  |         
|losses on
      securities available for              |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  |         
|sale (net of
      income tax benefit of              |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  |         
|$22)                                                  |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  | (33           | ) |  | (33     
|                                                     
|Comprehensive
      income                            |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |   |  | 698     
|ESOP shares earned                                    |  |        |  |  | 47         |   |  |          |   |  | 49       |   |  |            |   |  |          |   |  |               |   |  | 96      
|Accrued vesting of restricted
      stock             |  |        |  |  |            |   |  |          |   |  |          |   |  | 30         |   |  |          |   |  |               |   |  | 30      
|Cash dividends ($.31 per
      share)                 |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  | (191     | ) |  |               |   |  | (191    
|                                                     
|Balance, December 31, 2005                            |  | $7     |  |  | $5,958     |   |  | $(342    | ) |  | $(131    | ) |  | $ -        |   |  | $11,167  |   |  | $(21          | ) |  | $16,638 
|                                                     
|See notes to consolidated financial
      statements. |  |        |  |  |            |   |  |          |   |  |          |   |  |            |   |  |          |   |  |               |  

20

---

|Alaska Pacific Bancshares, Inc. and
      Subsidiary                             |  |   |  |         |   |  |   |  |         |  
|-------------------------------------------------------------------------------- |  | - |  | ------- | - |  | - |  | ------- | -
|Consolidated Statements of Cash Flows                                            |  |   |  |         |   |  |   |  |         |  
|                                                                                
|                                                                                
|(in thousands)Year ended December 31,                                            |  |   |  | 2005    |   |  |   |  | 2004    |  
|                                                                                
|Operating
      Activities                                                       |  |   |  |         |   |  |   |  |         |  
|Net income                                                                       |  | $ |  | 731     |   |  | $ |  | 708     |  
|Adjustments to reconcile net income to
      net cash provided by                |  |   |  |         |   |  |   |  |         |  
|operating
      activities:                                                      |  |   |  |         |   |  |   |  |         |  
|Provision for
      loan losses                                                  |  |   |  | 120     |   |  |   |  | 360     |  
|Depreciation and
      amortization                                              |  |   |  | 391     |   |  |   |  | 362     |  
|Deferred income
      tax expense                                                |  |   |  | 54      |   |  |   |  | 381     |  
|Gain on sale of
      mortgage loans                                             |  |   |  | (95     | ) |  |   |  | (323    | )
|Federal Home
      Loan Bank stock dividends                                     |  |   |  | (7      | ) |  |   |  | (45     | )
|Amortization of
      fees, discounts, and premiums, net                         |  |   |  | (166    | ) |  |   |  | (95     | )
|ESOP
      expense                                                               |  |   |  | 96      |   |  |   |  | 111     |  
|Stock award
      expense                                                        |  |   |  | 30      |   |  |   |  | 50      |  
|Loss on sale of
      repossessed assets                                         |  |   |  | 4       |   |  |   |  | 45      |  
|Cash provided by
      changes in operating assets and liabilities:              |  |   |  |         |   |  |   |  |         |  
|Loans
      held for sale                                                        |  |   |  | (1,394  | ) |  |   |  | 1,801   |  
|Accrued
      interest receivable                                                |  |   |  | 67      |   |  |   |  | (165    | )
|Other
      assets                                                               |  |   |  | 59      |   |  |   |  | 663     |  
|Advance
      payments by borrowers for taxes and insurance                      |  |   |  | 141     |   |  |   |  | 63      |  
|Accrued
      interest payable                                                   |  |   |  | 140     |   |  |   |  | (22     | )
|Accounts
      payable and accrued expenses                                      |  |   |  | (21     | ) |  |   |  | 163     |  
|Other
      liabilities                                                          |  |   |  | (157    | ) |  |   |  | (11     | )
|                                                                                
|Net
      cash provided by (used in) operating activities                        |  |   |  | (7      | ) |  |   |  | 4,046   |  
|Investing
      Activities                                                       |  |   |  |         |   |  |   |  |         |  
|Purchase of
      investment securities available for sale                       |  |   |  | (2,957  | ) |  |   |  | -       |  
|Maturities and
      principal repayments of investment securities               |  |   |  |         |   |  |   |  |         |  
|available for
      sale                                                         |  |   |  | 3,232   |   |  |   |  | 3,277   |  
|Loan originations,
      net of principal repayments                             |  |   |  | (14,078 | ) |  |   |  | (12,749 | )
|Purchase of premises
      and equipment                                         |  |   |  | (338    | ) |  |   |  | (466    | )
|Proceeds from sale of
      repossessed assets                                   |  |   |  | 43      |   |  |   |  | 265     |  
|                                                                                
|Net
      cash used in investing activities                                      |  |   |  | (14,098 | ) |  |   |  | (9,673  | )
|Financing
      Activities                                                       |  |   |  |         |   |  |   |  |         |  
|Cash dividends
      paid                                                        |  |   |  | (191    | ) |  |   |  | (173    | )
|Net increase
      (decrease) in Federal Home Loan Bank advances                 |  |   |  | 3,715   |   |  |   |  | (886    | )
|Net increase in
      demand and savings deposits                                |  |   |  | 444     |   |  |   |  | 2,092   |  
|Net increase
      (decrease) in certificates of deposit                         |  |   |  | 8,422   |   |  |   |  | (2,920  | )
|Proceeds from
      exercise of stock options                                    |  |   |  | -       |   |  |   |  | 16      |  
|                                                                                
|Net
      cash provided by (used in) financing activities                        |  |   |  | 12,390  |   |  |   |  | (1,871  | )
|                                                                                
|Decrease in cash
      and cash equivalents                                      |  |   |  | (1,715  | ) |  |   |  | (7,498  | )
|Cash and cash equivalents at beginning
      of year                             |  |   |  | 11,628  |   |  |   |  | 19,126  |  
|                                                                                
|Cash and cash
      equivalents at end of year                                   |  | $ |  | 9,913   |   |  | $ |  | 11,628  |  
|                                                                                 |  |  
|                                                                                
|Supplemental information:                                                        |  |   |  |         |   |  |   |  |         |  
|Cash paid for
      interest                                                     |  | $ |  | 1,969   |   |  | $ |  | 1,647   |  
|Cash paid for income
      taxes                                                 |  |   |  | 79      |   |  |   |  | 15      |  
|Loans repossessed and
      transferred to repossessed assets                    |  |   |  | 101     |   |  |   |  | 54      |  
|Net change in
      unrealized gains and losses on securities available for sale |  |   |  | (33     | ) |  |   |  | 36      |  
|                                                                                 |  |  
|See notes to
      consolidated financial statements.                            |  |   |  |         |   |  |   |  |         |  

21

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Alaska Pacific Bancshares, Inc. and
SubsidiaryNotes
to Consolidated Financial StatementsDecember 31, 2005 and 2004

Note 1  Summary of
Significant Accounting Policies

GENERAL: The accompanying consolidated financial statements
include the accounts of Alaska Pacific Bancshares, Inc. (the Holding Company)
and its wholly owned subsidiary, Alaska Pacific Bank (the Bank). The Holding
Company and the Bank are collectively referred to as the Company. All
significant intercompany transactions have been eliminated in consolidation.

The Holding Company was formed in 1999 when the Bank
converted from a federally chartered mutual savings bank to a federally
chartered stock savings bank, issuing 655,415 shares in a subscription and
community offering. Concurrent with the conversion, the Bank changed its name
from Alaska Federal Savings Bank to Alaska Pacific Bank.

The Bank provides a range of financial services to
individuals and small businesses in Southeast Alaska. The Banks financial
services include accepting deposits from the general public and making
residential and commercial real estate loans, consumer loans, and commercial
loans. The Bank also originates, sells, and services residential mortgage loans
under several federal and state mortgage-lending programs.

INVESTMENTSECURITIES: Securities available for sale, including mortgage-backed
and related securities, are carried at fair value with unrealized gains and
losses excluded from earnings and reported in a separate component of equity.
Any security that management determines may not be held to maturity is
classified as available for sale at the time the security is acquired. Any gains
and losses realized on the sale of these securities are based on the specific
identification method and included in earnings.

Purchase discounts and premiums on investment securities
are amortized using the level yield method. LOANS: Loans are reported
at the principal amount outstanding, adjusted for net deferred loan fees and
costs and other unamortized premiums or discounts.

Interest is accrued as earned unless management doubts the
collectibility of the loan or the unpaid interest. Interest accrual is generally
discontinued and loans are transferred to nonaccrual status when they become 90
days past due or earlier if the loan is impaired and collection is considered
doubtful. All previously accrued but uncollected interest is deducted from
interest income upon transfer to nonaccrual status. Income from nonaccrual loans
is recorded only when interest payments are received.

Loans or portions of loans are charged off against the
allowance for loan losses when considered uncollectible. Prior to charging a
loan off, a loss allowance may be recognized on impaired loans for an estimated
possible loss.

Loan origination fees and direct loan origination costs
are deferred and recognized as an adjustment to interest income over the
contractual life of the loan using the level yield method. When loans are sold,
the related net unamortized loan fees and costs are included in the
determination of the gain on sale of loans. LOANSHELD FORSALE: Loans held for sale
consist primarily of residential mortgage loans and are individually valued at
the lower of cost or market. Loans are recorded as sold when the loan documents
are sent to the investor.

ALLOWANCE FORLOANLOSSES: The allowance for loan losses is maintained
at a level believed to be sufficient to absorb losses probable and inherent in
the loan portfolio. Managements determination of the adequacy of the allowance
is based on a number of factors, including the level of nonperforming loans,
loan loss experience, collateral values, a review of the credit quality of the
loan portfolio, and current economic conditions. Loans are categorized as either
pass-graded or problem-graded based on periodic reviews of the loan portfolio.
The allowance is evaluated quarterly based on an estimated range of probable
loss comprised of two elements:- General
component:The general allowance component is calculated by loan
category as a range of estimated loss by applying various loss factors to
pass-graded outstanding loans. The loss factors are based primarily on
industry loss statistics, adjusted for the Banks historical loss experience and
other significant**factors that, in managements judgment,
affect the collectibility of the portfolio as of the evaluation date.

22

---

- Specific component:The
specific allowance component is established in cases where management has
identified conditions or circumstances related to a problem-graded loan that
management believes indicate a probable loss. A range of estimated loss is
established for each such loan.

Loan impairment
is measured in accordance with Statement of Financial Accounting Standards
(SFAS) No. 114,Accounting by Creditors for Impairment of a
Loanand SFAS No. 118,Accounting by Creditors for Impairment of a Loan  Income
Recognition and Disclosures.Under these standards, loans are deemed to be
impaired when management determines that it is probable that all amounts due
under the contractual terms of the loan agreements will not be collectible in
accordance with the original loan agreement. All problem-graded loans are
evaluated for impairment. Impairment is measured by comparing the fair value of
the collateral or present value of future cash flows to the recorded investment
in the loan.

MORTGAGESERVICINGRIGHTS: Mortgage servicing rights are stated at amortized cost.
Cost is amortized in proportion to, and over the period of, future expected net
servicing income. Mortgage servicing rights are assessed for impairment based on
the fair value of those rights and any impairment is recognized through a
valuation allowance. In assessing impairment, the mortgage servicing rights are
stratified based on the nature and risk characteristics, including coupon rates,
of the underlying loans which, at December 31, 2005 and 2004, consisted
primarily of one- to four-family residential mortgage loans.

PREMISES ANDEQUIPMENT: Bank premises and equipment are stated at
cost less accumulated depreciation and amortization. Depreciation is computed on
the straight-line method over the estimated useful lives of the assets: 20 to 50
years for buildings, five to 10 years for leasehold improvements, and three to
10 years for furniture and equipment. Expenditures for improvements and major
renewals are capitalized and ordinary maintenance and repairs are charged to
operations as incurred.

Long-lived assets are assessed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. In performing the review for recoverability, estimated
future cash flows expected to result from the use of the asset and its eventual
disposition are compared with the carrying value, and a direct writedown is
recorded for the amount of impairment, if any. REPOSSESSEDASSETS: Real estate or other collateral acquired in satisfaction
of a loan is initially recorded in repossessed assets at the lower of cost or
estimated fair value less estimated selling costs, with any difference from the
loan balance charged to the allowance for loan losses. Subsequent changes in
estimated fair value result in writing down the properties, directly or through
valuation accounts. Such writedowns and gains and losses on disposal, as well as
operating income and costs incurred during the period of ownership, are
recognized currently in noninterest expense.

FEDERALHOMELOANBANKSTOCK: The Banks investment in Federal Home Loan Bank of
Seattle (FHLB) stock is carried at cost because there is no active market for
the stock. As a member of the FHLB system, the Bank is required to maintain a
minimum level of investment in FHLB stock based on specified percentages of its
outstanding mortgages, total assets or FHLB advances. At December 31, 2005, the
Banks minimum investment requirement was approximately $504,000. The Bank may
request redemption at par value on any stock in excess of the amount the Bank is
required to hold. Stock redemptions are granted at the discretion of the FHLB.

ADVERTISINGEXPENSE: Advertising costs are expensed as incurred.
Advertising expense was $191,000 and $188,000 for the years ended December 31,
2005 and 2004, respectively.

INCOMETAX: The Company accounts for income tax using the asset and
liability method. The asset and liability method recognizes the amount of tax
payable at the date of the financial statements as a result of all events that
have been recognized in the financial statements, as measured by the provisions
of current enacted tax laws and rates. Net deferred tax assets are evaluated and
reduced through a valuation allowance to the extent that it is more likely than
not those assets will not be fully recovered in the future.
TREASURYSTOCK: Treasury stock is accounted for on the basis of average
cost, or $12.375 per share at December 31, 2005 and 2004.

EMPLOYEESTOCKOWNERSHIPPLAN: Compensation expense under the Companys Employee Stock
Ownership Plan (ESOP) is based upon the number of shares allocated to
employees each year multiplied by the average share price for the year. Expense
is reduced by the amount of dividends paid on unallocated shares. In computing
earnings per share, shares outstanding are reduced by shares held by the ESOP
that have not yet been allocated to employees.

23

---

STOCKOPTIONPLAN: The Company has adopted SFAS No. 148,Accounting for
Stock-Based Compensation  Transition and Disclosure  an amendment of FASB
Statement No. 123. This statement amends SFAS 123 to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, that Statement requires
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. We have elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosure as
required by SFAS 148.

For purposes of pro forma disclosures, the estimated fair value of
options at the time they are granted is amortized to expense over the options
vesting period of five years. The fair value of options granted, primarily in
2000, was estimated using the Black-Scholes option pricing model, assuming a
risk-free interest rate of 6.17%, a dividend yield of 2%, a stock price
volatility factor of 0.19, and a weighted-average expected life of seven years.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of SFAS 123 to
its stock option plan.

|Year ended December 31                                     |  |   |  | 2005    |   |  |   |  | 2004    |  
|---------------------------------------------------------- |  | - |  | ------- | - |  | - |  | ------- | -
|                                                          
|Net income, as reported                                    |  | $ |  | 731,000 |   |  | $ |  | 708,000 |  
|Total stock option employee
      compensation expense     |  |   |  |         |   |  |   |  |         |  
|determined under fair
      value based method, net of tax |  |   |  |         |   |  |   |  |         |  
|effect                                                     |  |   |  | (15,000 | ) |  |   |  | (24,000 | )
|                                                          
|Pro forma net income                                       |  | $ |  | 716,000 |   |  | $ |  | 684,000 |  
|                                                           |  |  
|Earnings per share:                                        |  |   |  |         |   |  |   |  |         |  
|Basic  as
      reported                                  |  | $ |  | 1.20    |   |  | $ |  | 1.18    |  
|Basic  pro
      forma                                    |  |   |  | 1.18    |   |  |   |  | 1.14    |  
|Diluted  as
      reported                                |  |   |  | 1.15    |   |  |   |  | 1.12    |  
|Diluted  pro
      forma                                  |  |   |  | 1.12    |   |  |   |  | 1.08    |  
|                                                           |  |  

STATEMENT OFCASHFLOWS: The statement of cash flows has been
prepared using the indirect method for presenting cash flows from operating
activities. For purposes of this statement, cash and cash equivalents include
cash and due from banks and interest-bearing deposits with banks.

SEGMENTREPORTING: The Company has identified a single segment at the entity-wide
level used by senior management to make operating decisions.

RECENTACCOUNTINGPRONOUNCEMENTS: Significant recent accounting
pronouncements are described below. In December 2004, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 123(R),Share-Based Payments. This Statement
replaces SFAS 123, Accounting for Stock-Based Compensation and supersedes APB
Opinion No. 25,Accounting for Stock Issued to Employees. SFAS 123(R) requires
that compensation cost relating to share-based payment transactions (for
example, stock options granted to employees of the Company) be recognized in
financial statements. That cost will be measured based on the fair value of the
equity or liability instruments used. SFAS 123(R) covers a wide range of
share-based compensation arrangements including share options, restricted share
plans, performance-based awards, share appreciation rights, and employee share
purchase plans. The statement is effective for the Company on January 1, 2006.
We have not determined the effects, if any, that this Statement will have on the
Companys financial statements.

24

---

SFAS No. 154,Accounting Changes and Error Corrections, a
Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS 154
establishes, unless impracticable, retrospective application as the required
method for reporting a change in accounting principle in the absence of explicit
transition requirements specific to a newly adopted accounting principle.
Previously, most changes in accounting principle were recognized by including
the cumulative effect of changing to the new accounting principle in net income
of the period of the change. Under SFAS 154, retrospective application requires
(i) the cumulative effect of the change to the new accounting principle on
periods prior to those presented to be reflected in the carrying amounts of
assets and liabilities as of the beginning of the first period presented, (ii)
an offsetting adjustment, if any, to be made to the opening balance of retained
earnings (or other appropriate components of equity) for that period, and (iii)
financial statements for each individual prior period presented to be adjusted
to reflect the direct period-specific effects of applying the new accounting
principle. Special retroactive application rules apply in situations where it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. Indirect effects of a change in accounting principle are
required to be reported in the period in which the accounting change is made.
SFAS 154 carries forward the guidance in APB Opinion 20Accounting
Changes, requiring justification of a change in accounting principle on
the basis of preferability. SFAS 154 also carries forward without change the
guidance contained in APB Opinion 20, for reporting the correction of an error
in previously issued financial statements and for a change in an accounting
estimate. SFAS 154 is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005. The Corporation does not
expect SFAS 154 will significantly impact its financial statements upon its
adoption on January 1, 2006. FASB Staff Position (FSP) No. 115-1,The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments. FSP 115-1 provides guidance for determining when an investment is
considered impaired, whether impairment is other-than-temporary, and measurement
of an impairment loss. An investment is considered impaired if the fair value of
the investment is less than its cost. If, after consideration of all available
evidence to evaluate the realizable value of its investment, impairment is
determined to be other-than-temporary, then an impairment loss should be
recognized equal to the difference between the investments cost and its fair
value. FSP 115-1 nullifies certain provisions of Emerging Issues Task Force
(EITF) Issue No. 03-1,The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments, while retaining the
disclosure requirements of EITF 03-1, which were adopted in 2003. FSP 115-1 is
effective for reporting periods beginning after December 15, 2005. The
Corporation does not expect FSP 115-1 will significantly impact its financial
statements upon its adoption on January 1, 2006.

FAIRVALUE OFFINANCIALINSTRUMENTS: The fair value of cash and cash equivalents and accrued interest
receivable is estimated to be equal to the carrying value, due to their
short-term nature. The fair value of investment securities is based upon
estimated market prices obtained from independent safekeeping agents. The fair
value of FHLB stock is considered to be equal to its carrying value, since it
may be redeemed at that value. The fair value of loans is estimated using
present value methods which discount the estimated cash flows, including
prepayments as well as contractual principal and interest, using current
interest rates appropriate for the type and maturity of the loans.

For demand and savings deposits and accrued interest payable, fair
value is considered to be carrying value. The fair values of fixed-rate
certificates of deposit and FHLB advances are estimated using present value
methods and current offering rates for such deposits and advances.

USE OFESTIMATES: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Material estimates that are
particularly susceptible to change in the near term relate to the determination
of the allowance for loan losses, deferred income taxes, and useful lives for
depreciation of premises and equipment. Actual results could differ from these
estimates.

Note 2  Regulatory
Capital Requirements and Restrictions

The Bank is restricted on the amount of dividends it may pay to the
Company. It is generally limited to the net income of the current fiscal year
and that of the two previous fiscal years, less dividends already paid during
those periods. At December 31, 2005, the Banks retained earnings available for
dividends to the Company were approximately $1,272,000. However, payment of
dividends may be further restricted by the Banks regulatory agency if such
payment would reduce the Banks capital ratios below required minimums or would
otherwise be considered to adversely affect the safety and soundness of the
institution.

25

---

The Bank is subject to various regulatory capital
requirements administered by federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Companys financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action (PCA),
the Bank must meet specific capital guidelines that involve quantitative
measures of the Banks assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Banks capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.

Quantitative measures have been established by regulation
to ensure capital adequacy and require the Bank to maintain minimum capital
amounts and ratios (set forth in the following table). The Banks primary
regulatory agency, the Office of Thrift Supervision (OTS), requires that the
Bank maintain minimum amounts and ratios (as defined in the regulations) of
tangible capital of 1.5%, core capital of 4%, and total risk-based capital of
8%. The Bank is also subject to PCA capital requirement regulations set forth by
the Federal Deposit Insurance Corporation (FDIC). The FDIC requires the Bank
to maintain minimum amounts and ratios (as defined in the regulations) of total
and Tier I capital to risk-weighted assets.

Management believes that, as of December 31, 2005 and
2004, the Bank meets all capital adequacy requirements to which it is subject.
The Bank was categorized as well capitalized in the most recent notification
by the Office of Thrift Supervision. There have been no events or conditions
since that notification that management believes would change the Banks capital
category.

|Following is a
      summary of the Banks capital ratios: |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|---------------------------------------------------------- |  | - |  | ------ |  | ----- | - |  | -------- |  | -------------------------- |  | ------------------------------ | ---------- | 
|                                                          
|                                                           |  |   |  |        |  |       |   |  |          |  |                            |  | Minimum Capital
      Required |            | 
|                                                           |  |  
|                                                           |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|                                                           |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|                                                           |  |   |  |        |  |       |   |  |          |  | For Capital
      Adequacy |  |                                |            | 
|(dollars in
      thousands)                               |  |   |  | Actual |  |       |   |  | Purposes |  |                            |  |                                | Provisions | 
|                                                          
|                                                           |  |   |  | Amount |  | Ratio |   |  |          |  | Amount                     |  | Ratio                          |            | 
|                                                          
|December 31,
      2005:                                   |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|Tangible capital (to
      total                           |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|assets)                                                    |  | $ |  | 15,928 |  | 9.08  | % |  | $        |  | 2,630                      |  | 1.50                           | %          | 
|Core capital (to
      total assets)                       |  |   |  | 15,928 |  | 9.08  |   |  |          |  | 7,014                      |  | 4.00                           |            | 
|Total risk-based
      capital (to                         |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|risk weighted
      assets)                                |  |   |  | 17,176 |  | 13.01 |   |  |          |  | 10,560                     |  | 8.00                           |            | 
|Tier I risk-based
      capital (to                        |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|risk weighted
      assets)                                |  |   |  | 15,928 |  | 12.07 |   |  |          |  | N/A                        |  | N/A                            |            | 
|                                                          
|December 31,
      2004:                                   |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|Tangible capital (to
      total                           |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|assets)                                                    |  | $ |  | 15,091 |  | 9.29  | % |  | $        |  | 2,436                      |  | 1.50                           | %          | 
|Core capital (to
      total assets)                       |  |   |  | 15,091 |  | 9.29  |   |  |          |  | 6,496                      |  | 4.00                           |            | 
|Total risk-based
      capital (to                         |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|risk weighted
      assets)                                |  |   |  | 16,271 |  | 13.42 |   |  |          |  | 9,697                      |  | 8.00                           |            | 
|Tier I risk-based
      capital (to                        |  |   |  |        |  |       |   |  |          |  |                            |  |                                |            | 
|risk weighted
      assets)                                |  |   |  | 15,091 |  | 12.45 |   |  |          |  | N/A                        |  | N/A                            |            | 

26

---

Note 3  Investment
Securities Available for Sale

Amortized cost and fair values of investment securities available
for sale, including mortgage-backed securities, are summarized as follows:

|                                      |  |   |  |           |  |  |   | Gross      |  |   |  | Gross      |   |  |   |  |      
|------------------------------------- |  | - |  | --------- |  |  | - | ---------- |  | - |  | ---------- | - |  | - |  | -----
|                                      |  |   |  | Amortized |  |  |   | Unrealized |  |   |  | Unrealized |   |  |   |  | Fair 
|(in
      thousands)                  |  |   |  | Cost      |  |  |   | Gains      |  |   |  | Losses     |   |  |   |  | Value
|                                     
|December 31,
      2005:              |  |   |  |           |  |  |   |            |  |   |  |            |   |  |   |  |      
|Mortgage-backed
      securities:     |  |   |  |           |  |  |   |            |  |   |  |            |   |  |   |  |      
|Fannie Mae                            |  | $ |  | 6,079     |  |  | $ | 5          |  |   |  | (104       | ) |  | $ |  | 5,980
|Freddie Mac                           |  |   |  | 641       |  |  |   | -          |  |   |  | (29        | ) |  |   |  | 613  
|Ginnie Mae                            |  |   |  | 639       |  |  |   | 95         |  |   |  | (2         | ) |  |   |  | 731  
|U.S. agencies and
      corporations: |  |   |  |           |  |  |   |            |  |   |  |            |   |  |   |  |      
|SBA
      pools                       |  |   |  |           |  |  |   |            |  |   |  |            |   |  |   |  |      
|                                      |  |   |  | 141       |  |  |   | -          |  |   |  | (1         | ) |  |   |  | 140  
|                                     
|Total                                 |  | $ |  | 7,500     |  |  | $ | 100        |  | $ |  | (136       | ) |  | $ |  | 7,464
|                                      |  |  
|                                     
|December 31,
      2004:              |  |   |  |           |  |  |   |            |  |   |  |            |   |  |   |  |      
|Mortgage-backed
      securities:     |  |   |  |           |  |  |   |            |  |   |  |            |   |  |   |  |      
|Fannie Mae                            |  | $ |  | 5,788     |  |  | $ | -          |  |   |  | (81        | ) |  | $ |  | 5,707
|Freddie Mac                           |  |   |  | 908       |  |  |   | -          |  |   |  | (39        | ) |  |   |  | 869  
|Ginnie Mae                            |  |   |  | 1,034     |  |  |   | 142        |  |   |  | (4         | ) |  |   |  | 1,172
|U.S. agencies and
      corporations: |  |   |  |           |  |  |   |            |  |   |  |            |   |  |   |  |      
|SBA
      pools                       |  |   |  | 147       |  |  |   | 2          |  |   |  | -          |   |  |   |  | 149  
|                                     
|Total                                 |  | $ |  | 7,877     |  |  | $ | 144        |  | $ |  | (124       | ) |  | $ |  | 7,897
|                                      |  |  

Impaired securities (those with unrealized losses) at December 31,
2005 are summarized as follows:

|                        |  |   |  | Impaired less
      than |  |   |  | Impaired 12
      months |  |   |  |            |  |   |  |           
|----------------------- |  | - |  | ------------------------ |  | - |  | ------------------------ |  | - |  | ---------- |  | - |  | ----------
|                        |  |   |  | 12
      months          |  |   |  | or
      more            |  |   |  | Total     
|                        |  |  
|                        |  |   |  |                          |  |   |  | Unrealized               |  |   |  |            |  |   |  | Unrealized
|(in
      thousands)    |  |   |  | Fair Value               |  |   |  | Losses                   |  |   |  | Fair Value |  |   |  | Losses    
|                       
|Mortgage-backed         |  |   |  |                          |  |   |  |                          |  |   |  |            |  |   |  |           
|securities:             |  |   |  |                          |  |   |  |                          |  |   |  |            |  |   |  |           
|Fannie Mae              |  | $ |  | 1,408                    |  | $ |  | 26                       |  | $ |  | 2,814      |  | $ |  | 78        
|Freddie Mac             |  |   |  | -                        |  |   |  | -                        |  |   |  | 613        |  |   |  | 29        
|Ginnie Mae              |  |   |  | -                        |  |   |  | -                        |  |   |  | 56         |  |   |  | 2         
|U.S. agencies
      and |  |   |  |                          |  |   |  |                          |  |   |  |            |  |   |  |           
|corporations:           |  |   |  |                          |  |   |  |                          |  |   |  |            |  |   |  |           
|SBA
      pools         |  |   |  | 140                      |  |   |  | 1                        |  |   |  |            |  |   |  |           
|                       
|Total                   |  | $ |  | 1,548                    |  | $ |  | 27                       |  | $ |  | 3,483      |  | $ |  | 109       
|                        |  |  

All securities with unrealized losses at December 31, 2005 were
mortgage-backed or other securities issued by the U.S. government and agencies;
collectibility of principal and interest is considered to be reasonably assured.
The fair values of individual securities fluctuate significantly with interest
rates and with market demand for securities with specific structures and
characteristics. Management does not consider these unrealized losses to be
other than temporary.

No
securities were designated as held to maturity at December 31, 2005 or 2004.

All investment securities at December 31, 2005 have final
contractual maturities of more than ten years. Actual maturities may vary due to
prepayment of the underlying loans.

At
December 31, 2005, investment securities with amortized cost of $6,659,000 and
market value of $6,638,000 were pledged to secure public funds deposited with
the Bank.

There were no sales of securities during 2005 or 2004. The Bank
does not have a securities trading portfolio.

27

---

|Note 4  Loans                         |  |   |  |         |  |   |  |        
|-------------------------------------- |  | - |  | ------- |  | - |  | -------
|                                      
|Loans are summarized as
      follows: |  |   |  |         |  |   |  |        
|                                      
|(in thousands)December 31,             |  |   |  | 2005    |  |   |  | 2004   
|                                      
|Real estate:                           |  |   |  |         |  |   |  |        
|Permanent:                             |  |   |  |         |  |   |  |        
|One- to
      four-family              |  | $ |  | 49,425  |  | $ |  | 45,198 
|Multifamily                            |  |   |  | 1,261   |  |   |  | 782    
|Commercial
      nonresidential        |  |   |  | 45,874  |  |   |  | 44,150 
|Land                                   |  |   |  | 3,952   |  |   |  | 4,499  
|Construction:                          |  |   |  |         |  |   |  |        
|One- to
      four-family              |  |   |  | 9,174   |  |   |  | 3,759  
|Multifamily                            |  |   |  | 1,415   |  |   |  | -      
|Commercial
      nonresidential        |  |   |  | 3,284   |  |   |  | 4,453  
|Commercial business                    |  |   |  | 19,134  |  |   |  | 17,670 
|Consumer:                              |  |   |  |         |  |   |  |        
|Home
      equity                      |  |   |  | 13,454  |  |   |  | 12,287 
|Boat                                   |  |   |  | 3,914   |  |   |  | 4,174  
|Automobile                             |  |   |  | 696     |  |   |  | 514    
|Other                                  |  |   |  | 1,139   |  |   |  | 947    
|                                      
|Loans                                  |  | $ |  | 152,722 |  | $ |  | 138,433
|                                       |  |  
|Loans held for sale                    |  | $ |  | 2,531   |  | $ |  | 1,137  
|                                       |  |  

Loans are net of deferred loan fees and other discounts amounting
to $835,000 and $808,000 at December 31, 2005 and 2004, respectively.

Loans include overdrawn balances of deposit accounts of $29,000 and
$86,000 at December 31, 2005 and 2004, respectively.

Interest income from tax-exempt loans was $1,000 and $7,000 in 2005
and 2004, respectively.

Real estate loans are secured primarily by properties located in
Southeast Alaska. Commercial real estate loans are generally secured by
warehouse, retail, and other improved commercial properties. Commercial business
loans are generally secured by equipment, inventory, accounts receivable, or
other business assets.

|Impaired loans are summarized as
      follows:    |  |   |  |       |  |   |  |      
|-------------------------------------------------- |  | - |  | ----- |  | - |  | -----
|                                                  
|(in thousands)Year ended December 31,              |  |   |  | 2005  |  |   |  | 2004 
|                                                  
|Impaired loans at end of
      year                |  | $ |  | 1,299 |  | $ |  | 1,074
|Impaired loans at end of year for
      which      |  |   |  |       |  |   |  |      
|allowances have been
      provided                |  |   |  | 1,299 |  |   |  | 1,074
|Amount of allowances at end of
      year          |  |   |  | 365   |  |   |  | 182  
|Average impaired loans                             |  |   |  | 1,187 |  |   |  | 837  
|Interest income recognized on impaired
      loans |  |   |  | -     |  |   |  | 15   

Nonaccrual loans were $1,299,000 and $1,473,000 at December 31,
2005 and 2004, respectively. For the year ended December 31, 2005, approximately
$78,000 of interest would have been recorded if these loans had been current
according to their original terms and had been outstanding throughout the year;
no interest income on these loans was included in income for the year.

MORTGAGELOANSERVICING: The Bank services residential and other real estate loans for
Alaska Housing Finance Corporation (AHFC), U.S. Government agencies, and
institutional and private investors totaling $100,024,000 and $104,411,000 as of
December 31, 2005 and 2004, respectively. These loans are the assets of the
investors and, accordingly, are not included in the accompanying balance sheets.
Related servicing income, net of amortization of mortgage servicing rights,
amounted to $150,000 and $151,000 for 2005 and 2004, respectively.

28

---

The amortized cost of mortgage servicing rights, which
approximates fair value, was $689,000 and $752,000 at December 31, 2005 and
2004, respectively. The amount of servicing assets recognized during 2005 was
$51,000 and amortization was $114,000 for the year. The amount of servicing
assets recognized during 2004 was $199,000 and amortization was $100,000 for the
year. Management has determined that a valuation allowance for impairment is not
required at December 31, 2005 or 2004.

RELATEDPARTYLOANS: In the ordinary course of business, the Bank makes loans
to executive officers and directors of the Bank and to their affiliates. These
loans are made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions. The
aggregate dollar amount of these loans was $2,738,000 and $1,595,000 at December
31, 2005 and 2004, respectively. During the year ended December 31, 2005 and
2004, new loans of this type were $1,593,000 and $375,000, respectively, and
repayments were $450,000 and $422,000, respectively.

|Note 5  Allowance for Loan
      Losses                                        |  |   |  |        |   |  |   |  |        |  
|------------------------------------------------------------------------------- |  | - |  | ------ | - |  | - |  | ------ | -
|                                                                               
|Following is an analysis of the changes
      in the allowance for loan losses: |  |   |  |        |   |  |   |  |        |  
|                                                                               
|(in thousands)Year ended December 31,                                           |  |   |  | 2005   |   |  |   |  | 2004   |  
|                                                                               
|Balance at beginning of
      year                                              |  | $ |  | 1,380  |   |  | $ |  | 1,159  |  
|Provision for loan losses                                                       |  |   |  | 120    |   |  |   |  | 360    |  
|Loans charged off                                                               |  |   |  | (64    | ) |  |   |  | (230   | )
|Recoveries                                                                      |  |   |  | 12     |   |  |   |  | 91     |  
|                                                                               
|Balance at end of year                                                          |  | $ |  | 1,448  |   |  | $ |  | 1,380  |  
|                                                                                |  |  
|                                                                               
|                                                                               
|Note 6  Premises and
      Equipment                                           |  |   |  |        |   |  |   |  |        |  
|                                                                               
|Following is a summary of premises and
      equipment:                         |  |   |  |        |   |  |   |  |        |  
|                                                                               
|(in thousands)December 31,                                                      |  |   |  | 2005   |   |  |   |  | 2004   |  
|                                                                               
|Land                                                                            |  | $ |  | 424    |   |  | $ |  | 424    |  
|Buildings                                                                       |  |   |  | 2,122  |   |  |   |  | 2,049  |  
|Leasehold improvements                                                          |  |   |  | 2,163  |   |  |   |  | 2,068  |  
|Furniture, fixtures and
      equipment                                         |  |   |  | 2,614  |   |  |   |  | 2,493  |  
|                                                                               
|                                                                                |  |   |  | 7,323  |   |  |   |  | 7,034  |  
|Less accumulated
      depreciation                                             |  |   |  | (5,177 | ) |  |   |  | (4,855 | )
|                                                                               
|                                                                                |  | $ |  | 2,146  |   |  | $ |  | 2,199  |  
|                                                                               

Depreciation and amortization expense for the years ended
December 31, 2005 and 2004 amounted to $391,000 and $362,000,
respectively.



|Note 7 
      Deposits
|-----------------------

Deposits in excess of $100,000 are not federally insured.
Certificates of deposit exceeding $100,000 at December 31, 2005 and 2004 were
$8,045,000 and $6,787,000, respectively, and the uninsured excess over $100,000
amounted to $3,045,000 and $2,933,000, respectively.

The scheduled maturities of certificates of deposit as of
December 31, 2005, are as follows:

|*(in
      thousands)*Year ending December 31,                |   |  |       |  |   |       
|------------------------------------------------------------- | - |  | ----- |  | - | ------
|                                                             
|2006                                                          |   |  |       |  | $ | 31,604
|2007                                                          |   |  |       |  |   | 5,732 
|2008                                                          |   |  |       |  |   | 2,792 
|2009                                                          |   |  |       |  |   | 1,366 
|2010
      and thereafter                                     |   |  |       |  |   | 1,159 
|                                                             
|                                                              |   |  |       |  | $ | 42,653
|                                                              |  
|                                                             
|Interest expense on deposits consists
      of the following: |   |  |       |  |   |       
|                                                             
|*(in
      thousands)*Year ended December 31,                 |   |  | 2005  |  |   | 2004  
|                                                             
|Interest-bearing
      demand                                 | $ |  | 110   |  | $ | 97    
|Money
      market                                            |   |  | 399   |  |   | 211   
|Savings                                                       |   |  | 132   |  |   | 132   
|Certificates
      of deposit                                 |   |  | 965   |  |   | 741   
|                                                             
|                                                              | $ |  | 1,606 |  | $ | 1,818 

29

---

|                                                                           
|---------------------------------------------------------------------------
|The weighted
      averages interest rates paid on deposits are as follows:
|                                                                           
|Year
      ended December 31,                                              
|                                                                           
|Interest-bearing
      demand                                              
|Money
      market                                                         
|Savings                                                                    
|Certificates
      of deposit                                              

Deposits from the Companys executive officers, directors, and
their related companies were $1,363,000 and $2,701,000 at December 31, 2005
and 2004, respectively.

|Note 8  Federal Home Loan Bank Advances                   |  |  |   |  |        |  |   |  |      
|---------------------------------------------------------- |  |  | - |  | ------ |  | - |  | -----
|                                                          
|FHLB advances consist of the following:                    |  |  |   |  |        |  |   |  |      
|                                                          
|(dollars
      in thousands)December 31,                   |  |  |   |  | 2005   |  |   |  | 2004 
|                                                          
|**Overnight
      advances, 4.325%                         |  |  | $ |  | 4,600  |  | $ |  | -    
|**Five-year
      amortizing advance, final maturity in    |  |  |   |  |        |  |   |  |      
|**2008,
      3.03%                                        |  |  |   |  | 1,271  |  |   |  | 1,872
|**Seven-year
      amortizing advance, final maturity in   |  |  |   |  |        |  |   |  |      
|**2010,
      3.62%                                        |  |  |   |  | 1,177  |  |   |  | 1,461
|**Putable
      advance, maturing in 2009, putable earlier |  |  |   |  |        |  |   |  |      
|**at
      discretion of FHLB, 6.13%                       |  |  |   |  | 5,000  |  |   |  | 5,000
|                                                          
|                                                           |  |  | $ |  | 12,048 |  | $ |  | 8,333
|                                                          

FHLB advances at December 31, 2005 with final maturities of more
than one year have scheduled maturities as follows:

|(in
      thousands)           |  |   |  |      
|------------------------------ |  | - |  | -----
|Year ending December
      31, |  |   |  |      
|                              
|2006                           |  | $ |  | 886  
|2007                           |  |   |  | 886  
|2008                           |  |   |  | 356  
|2009                           |  |   |  | 5,286
|2010                           |  |   |  | 34   
|                              
|Total                          |  | $ |  | 7,448
|                               |  |  

The average balance of FHLB advances outstanding during 2005 and
2004 was $10,393,000 and $9,229,000, respectively. The maximum amount of
advances outstanding at any month end during 2005 and 2004 was $14,095,000 and
$14,105,000, respectively. Under a blanket pledge agreement, all funds on
deposit at FHLB, as well as all unencumbered qualifying loans and investment
securities, are available to collateralize FHLB advances.

The Bank has available a line of credit with the FHLB generally
equal to 25% of the Banks total assets, or approximately $44.3 million at
December 31, 2005, of which $32.3 million was unused.



|Note 9 
      Retirement Plans
|-------------------------------

The Bank has a salary deferral 401(k) plan. Employees who are at
least 18 years of age and have completed three months of service are eligible to
participate in the plan. Employees may contribute on a pretax basis up to 17% of
their annual salary up to a maximum limit under the law. Under the plan, the
Bank has matched 75% of the first $2,667 of employee contribution. Beginning in
2006, the Bank will match 100% of employee contributions of up to 4% of
compensation. For the years ended December 31, 2005 and 2004, the Bank
contributed $84,000 and $74,000, respectively, to the plan, including
administrative expenses.

30

---

The Company has an Employee Stock Ownership Plan (ESOP)
established in connection with the conversion to stock ownership. Eight percent
of the shares issued in the conversion, or 52,433 shares, were purchased by the
ESOP in exchange for a note payable to the Holding Company. The shares are
allocated to employees over a ten-year period in proportion to the principal and
interest paid on the note at the end of each year. All employees who have
completed one years service automatically participate in the plan, and each
years allocation is distributed in proportion to total compensation of
employees. Employees are vested in the plan over a seven-year period. Dividends
paid on allocated shares are credited to employees accounts, but dividends on
unallocated shares are used to reduce the expense of the plan. At December 31,
2005 and 2004, 39,371 and 34,426 shares, respectively, were allocated to
employees. The Companys expense for the plan, including administrative
expenses, amounted to $106,000 and $116,000 for the years ended December 31,
2005 and 2004, respectively. Unallocated shares had a market value of $261,000
and $400,000 at December 31, 2005 and 2004, respectively.

Note 10 
Stock-Based Compensation

STOCKOPTIONPLAN: In 2000, the Companys shareholders approved the 2000 Stock
Option Plan, providing for the granting of options to directors and officers on
up to 65,542 shares of the Companys stock. Options on 65,542 shares were
granted in 2000, with an exercise price equal to the market price of the stock
at the date of grant, or $9.75. Options on 3,400 shares were granted in 2003,
replacing forfeitures, with an exercise price of $17.50. Options become
exercisable in five equal annual installments commencing one year after the date
of grant, and unexercised options expire ten years after the date of
grant.

In
2003, the Companys shareholders approved the 2003 Stock Option Plan, providing
for the granting of options on up to 32,000 shares. No options have been granted
under the 2003 plan.

Following is a summary of the changes in stock options:

|(in
      thousands)                                                            |  |   |  |           |  |   |  |                |  |                  |  |   |  |               
|------------------------------------------------------------------------------- |  | - |  | --------- |  | - |  | -------------- |  | ---------------- |  | - |  | --------------
|Year ended December 31,                                                         |  |   |  |           |  |   |  | 2005           |  |                  |  |   |  | 2004          
|                                                                               
|                                                                                |  |   |  | Number of |  |   |  |                |  | Number of        |  |   |  |               
|                                                                                |  |   |  | Options   |  |   |  | Exercise Price |  | Options          |  |   |  | Exercise Price
|                                                                               
|Stock options outstanding
      at                                              |  |   |  |           |  |   |  |                |  |                  |  |   |  |               
|beginning of
      year                                                         |  |   |  | 60,320    |  | $ |  | 9.75 - $17.50  |  | 61,942           |  | $ |  | 9.75 - $17.50 
|Granted                                                                         |  |   |  | -         |  |   |  |                |  | -                |  |   |  |               
|Exercised                                                                       |  |   |  | -         |  |   |  |                |  | (1,622)          |  |   |  | 9.75          
|Forfeited                                                                       |  |   |  | -         |  |   |  |                |  | -                |  |   |  |               
|                                                                               
|Stock options outstanding
      at                                              |  |   |  |           |  |   |  |                |  |                  |  |   |  |               
|end of
      year                                                               |  |   |  | 60,320    |  | $ |  | 9.75 - $17.50  |  | 60,320           |  | $ |  | 9.75 - $17.50 
|                                                                                |  |  
|                                                                               
|Options exercisable at end
      of                                             |  |   |  |           |  |   |  |                |  |                  |  |   |  |               
|year                                                                            |  |   |  | 58,280    |  | $ |  | 9.75 - $17.50  |  | 45,694           |  | $ |  | 9.75 - $17.50 
|                                                                                |  |  
|                                                                               
|Stock options
      outstanding at December 31, 2005 are summarized as follows: |  |   |  |          
|                                                                               
|                                                                                |  |   |  |           |  |   |  |                |  | Weighted-        |  |   |  |               
|                                                                                |  |   |  | Weighted- |  |   |  |                |  | Average          |  |   |  |               
|                                                                                |  |   |  | Average   |  |   |  | Number         |  | Remaining        |  |   |  |               
|                                                                                |  |   |  | Exercise  |  |   |  | Outstanding at |  | Contractual Life |  |   |  | Number        
|December 31, 2005                                                               |  |   |  | Price     |  |   |  | End of Year    |  | (Years)          |  |   |  | Exercisable   
|                                                                               
|                                                                                |  | $ |  | 9.75      |  |   |  | 56,920         |  | 4.6              |  |   |  | 56,920        
|                                                                                |  |   |  | 17.50     |  |   |  | 3,400          |  | 7.2              |  |   |  | 1,360         
|                                                                               
|Total                                                                           |  | $ |  | 10.19     |  |   |  | 60,320         |  | 4.7              |  |   |  | 58,280        
|                                                                                |  |  

MANAGEMENTRECOGNITIONPLAN: In 2000, the Companys shareholders
approved the 2000 Management Recognition Plan, providing for the issuance of up
to 26,217 shares of stock in the form of restricted stock awards. On July 20,
2000, 26,217 shares were granted with a total cost of $256,000, based on the
market price of $9.75 per share. The shares vested in five equal annual
installments in 2001 through 2005. No shares remained restricted at December 31,
2005. Compensation expense related to the plan was $30,000 and $53,000 for the
years ended December 31, 2005 and 2004, respectively, including dividends on
restricted shares.

31

---



|Note 11 
      Operating Leases
|--------------------------------

The Bank leases certain of its premises and equipment under
noncancelable operating leases with terms in excess of one year. Future minimum
lease payments under these leases at December 31, 2005, are summarized as
follows:

|(in thousands)Year ending December 31, |  |   |  |      
|-------------------------------------- |  | - |  | -----
|                                      
|2006                                   |  | $ |  | 484  
|2007                                   |  |   |  | 485  
|2008                                   |  |   |  | 390  
|2009                                   |  |   |  | 74   
|2010                                   |  |   |  | 52   
|2011
      and thereafter              |  |   |  | 150  
|                                      
|                                       |  | $ |  | 1,635
|                                       |  |  

Rent expense was $518,000 and $501,000 for the years ended December
31, 2005 and 2004, respectively. Rental income on owned premises amounted to
$8,000 and $6,000 for the years ended December 31, 2005 and 2004, respectively.

|Note 12  Income Tax                                           |   |  |      |  |   |  |     
|-------------------------------------------------------------- | - |  | ---- |  | - |  | ----
|                                                              
|The provision for income tax consisted
      of the following: |   |  |      |  |   |  |     
|                                                              
|(in thousands)Year ended December 31,                          |   |  | 2005 |  |   |  | 2004
|                                                              
|Taxes paid or currently
      payable                          | $ |  | 434  |  | $ |  | 91  
|Change in deferred taxes                                       |   |  | 54   |  |   |  | 381 
|                                                              
|Income
      tax expense                                       | $ |  | 488  |  | $ |  | 472 
|                                                               |  

A
reconciliation of taxes computed at federal statutory corporate tax rates (34%
in 2005 and 2004) to tax expense, as shown in the accompanying statements of
income and changes in shareholders equity, is as follows:

|(in thousands)Year ended December 31,      |  |   |  | 2005 |   |  |   |  | 2004 |  
|------------------------------------------ |  | - |  | ---- | - |  | - |  | ---- | -
|                                          
|Income tax expense at statutory
      rate |  | $ |  | 414  |   |  | $ |  | 401  |  
|Income tax effect of:                      |  |   |  |      |   |  |   |  |      |  
|Effect of
      permanent differences      |  |   |  | 12   |   |  |   |  | (2   | )
|Effect of
      state income tax           |  |   |  | 75   |   |  |   |  | 73   |  
|Other                                      |  |   |  | (13  | ) |  |   |  | -    |  
|                                          
|Income
      tax expense                   |  | $ |  | 488  |   |  | $ |  | 472  |  
|                                          
|                                          
|Effective tax rate                         |  |   |  | 40   | % |  |   |  | 40   | %
|                                           |  |  

Deferred federal income tax is provided for the temporary
differences between the tax basis and financial statement carrying amounts of
assets and liabilities. Components of the Companys net deferred tax assets
consisted of the following:

|(in thousands)December 31,           |  |   |  | 2005 |   |  |   |  | 2004 |  
|------------------------------------ |  | - |  | ---- | - |  | - |  | ---- | -
|                                    
|Deferred tax assets:                 |  |   |  |      |   |  |   |  |      |  
|Bad debt
      reserves              |  | $ |  | 580  |   |  | $ |  | 639  |  
|Property,
      plant and equipment  |  |   |  | 75   |   |  |   |  | 148  |  
|Accrued
      vacation               |  |   |  | 54   |   |  |   |  | 52   |  
|Other                                |  |   |  | 73   |   |  |   |  | 41   |  
|                                    
|Gross
      deferred tax assets      |  |   |  | 782  |   |  |   |  | 880  |  
|Deferred tax liabilities:            |  |   |  |      |   |  |   |  |      |  
|Deferred
      loan fees, net        |  |   |  | (52  | ) |  |   |  | (64  | )
|FHLB
      stock dividends           |  |   |  | (570 | ) |  |   |  | (571 | )
|Other                                |  |   |  | -    |   |  |   |  | (53  | )
|                                    
|Gross
      deferred tax liabilities |  |   |  | (622 | ) |  |   |  | (688 | )
|                                    
|Net deferred
      tax assets        |  | $ |  | 160  |   |  | $ |  | 192  |  
|                                     |  |  

32

---

In
August 1996, the Small Business Job Protection Act of 1996 (the Act) was
signed into law. Under the Act, the percentage of taxable income method of
accounting for tax basis bad debts is no longer available effective for the
years ending after December 31, 1995. As a result, the Bank is required to use
the experience method of accounting for tax basis bad debts for 1998 and later
years. In addition, the Act requires the recapture of post-1987 (the base year)
additions to the tax bad debt reserves made pursuant to the percentage of
taxable income method. The Bank is not subject to this recapture in 2005 or
2004, as its tax bad debt reserves do not exceed its base year reserve. As a
result of the bad debt deductions, shareholders equity as of December 31, 2005,
includes accumulated earnings of approximately $1,759,000 for which federal
income tax has not been provided. If, in the future, this portion of retained
earnings is used for any purpose other than to absorb losses on loans or on
property acquired through foreclosure, federal income tax may be imposed at
then-applicable rates.

Note 13 
Commitments and Contingencies

COMMITMENTS: Commitments to extend credit, including lines of credit,
totaled $8,122,000 and $9,347,000 at December 31, 2005 and 2004, respectively.
Commitments to extend credit, generally at a variable interest rate, are
arrangements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee
by the customer. Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The Bank evaluates creditworthiness for commitments on
an individual customer basis. Undisbursed loan proceeds, primarily for
real estate construction loans, totaled $4,636,000 and $4,057,000 at December
31, 2005 and 2004, respectively. These amounts are excluded from the balance of
loans at year end.

The Bank has deposits in other institutions in excess of
$100,000 insured by the FDIC.

CONCENTRATIONS: More than 75% of all loans in the Banks
portfolio are secured by real estate located in communities of Southeast Alaska.



|Note 14 
      Earnings per Share
|----------------------------------

Basic earnings per share (EPS) is computed by dividing
net income by the weighted-average number of common shares outstanding during
the period less treasury stock, unvested stock awards under the Management
Recognition Plan (unvested stock awards), and unallocated and not yet
committed to be released Employee Stock Ownership Plan shares (unearned ESOP
shares). Diluted EPS is calculated by dividing net income by the
weighted-average number of common shares used to compute basic EPS plus the
incremental amount of potential common stock from unvested stock awards and
stock options, determined by the treasury stock method. The following table
shows the calculation of basic and diluted EPS.

|Year ended               |  |   |  |         |  |         |   |  |   |  |           |  |   |  |         |  |         |   |  |   |  |          
|------------------------ |  | - |  | ------- |  | ------- | - |  | - |  | --------- |  | - |  | ------- |  | ------- | - |  | - |  | ---------
|December 31,             |  |   |  |         |  | 2005    |   |  |   |  |           |  |   |  |         |  | 2004    |   |  |   |  |          
|                        
|                         |  |   |  | Net     |  | Average |   |  |   |  | Earnings  |  |   |  | Net     |  | Average |   |  |   |  | Earnings 
|                         |  |   |  | Income  |  | Shares  |   |  |   |  | Per Share |  |   |  | Income  |  | Shares  |   |  |   |  | Per Share
|                        
|Net income/average       |  |   |  |         |  |         |   |  |   |  |           |  |   |  |         |  |         |   |  |   |  |          
|shares
      issued      |  | $ |  | 731,000 |  | 655,415 |   |  |   |  |           |  | $ |  | 708,000 |  | 655,415 |   |  |   |  |          
|Treasury stock           |  |   |  |         |  | (27,661 | ) |  |   |  |           |  |   |  |         |  | (28,675 | ) |  |   |  |          
|Unvested stock awards    |  |   |  |         |  | (921    | ) |  |   |  |           |  |   |  |         |  | (5,643  | ) |  |   |  |          
|Unearned ESOP shares     |  |   |  |         |  | (18,007 | ) |  |   |  |           |  |   |  |         |  | (23,252 | ) |  |   |  |          
|                        
|Basic
      EPS          |  |   |  | 731,000 |  | 608,826 |   |  | $ |  | 1.20      |  |   |  | 708,000 |  | 597,845 |   |  | $ |  | 1.18     
|Incremental shares under |  |   |  |         |  |         |   |  |   |  |           |  |   |  |         |  |         |   |  |   |  |          
|stock
      plans:       |  |   |  |         |  |         |   |  |   |  |           |  |   |  |         |  |         |   |  |   |  |          
|Stock
      awards       |  |   |  |         |  | 475     |   |  |   |  |           |  |   |  |         |  | 3,032   |   |  |   |  |          
|Stock
      options      |  |   |  |         |  | 29,767  |   |  |   |  |           |  |   |  |         |  | 31,739  |   |  |   |  |          
|                        
|Diluted
      EPS        |  | $ |  | 731,000 |  | 639,068 |   |  | $ |  | 1.15      |  | $ |  | 708,000 |  | 632,616 |   |  | $ |  | 1.12     
|                         |  |  

33

---

Note 15  Fair
Value of Financial Instruments

The following information is presented in accordance with the
requirements of SFAS No. 107,Disclosures about Fair Value of Financial
Instruments. The estimated fair value amounts have been determined by the Bank
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessarily required to interpret market data
to develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Bank 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.

|(in thousands)December 31,                     |  |   |  |          |  | 2005 |  |   |  |           |  |   |  |          |  | 2004 |  |   |  |          
|---------------------------------------------- |  | - |  | -------- |  | ---- |  | - |  | --------- |  | - |  | -------- |  | ---- |  | - |  | ---------
|                                              
|                                               |  |   |  |          |  |      |  |   |  | Estimated |  |   |  |          |  |      |  |   |  | Estimated
|                                               |  |   |  | Carrying |  |      |  |   |  | Fair      |  |   |  | Carrying |  |      |  |   |  | Fair     
|                                               |  |   |  | Amount   |  |      |  |   |  | Value     |  |   |  | Amount   |  |      |  |   |  | Value    
|                                               |  |  
|Financial
      Assets                         |  |   |  |          |  |      |  |   |  |           |  |   |  |          |  |      |  |   |  |          
|Cash and cash equivalents                      |  | $ |  | 9,913    |  |      |  | $ |  | 9,913     |  | $ |  | 11,628   |  |      |  | $ |  | 11,628   
|Investment securities available for
      sale |  |   |  | 7,464    |  |      |  |   |  | 7,464     |  |   |  | 7,897    |  |      |  |   |  | 7,897    
|FHLB stock                                     |  |   |  | 1,784    |  |      |  |   |  | 1,784     |  |   |  | 1,777    |  |      |  |   |  | 1,777    
|Loans, including held for
      sale           |  |   |  | 155,253  |  |      |  |   |  | 155,940   |  |   |  | 139,570  |  |      |  |   |  | 142,207  
|Accrued interest
      receivable              |  |   |  | 674      |  |      |  |   |  | 674       |  |   |  | 741      |  |      |  |   |  | 741      
|                                              
|Financial
      Liabilities                    |  |   |  |          |  |      |  |   |  |           |  |   |  |          |  |      |  |   |  |          
|Demand and savings
      deposits              |  |   |  | 103,997  |  |      |  |   |  | 103,997   |  |   |  | 103,553  |  |      |  |   |  | 103,553  
|Certificates of deposit                        |  |   |  | 42,653   |  |      |  |   |  | 42,267    |  |   |  | 34,231   |  |      |  |   |  | 34,158   
|FHLB Advances                                  |  |   |  | 12,048   |  |      |  |   |  | 12,255    |  |   |  | 8,333    |  |      |  |   |  | 8,839    
|Accrued interest payable                       |  |   |  | 345      |  |      |  |   |  | 345       |  |   |  | 205      |  |      |  |   |  | 205      

The estimated fair value of loan commitments is $11,000 and $14,000
at December 31, 2005 and 2004, respectively. Although management is not aware of
any subsequent events that would significantly affect the estimated fair value
amounts as of December 31, 2005, such amounts have not been comprehensively
revalued since that date and, therefore, current estimates of fair value may
differ significantly from the amounts presented herein.

Note 16  Parent
Company Financial Information

Summarized financial information for Alaska Pacific Bancshares,
Inc. (parent company only) is presented below:

|PARENT COMPANY CONDENSED BALANCE
      SHEET     |  |   |  |        |  |   |  |       
|------------------------------------------------ |  | - |  | ------ |  | - |  | ------
|                                                
|(in thousands)December
      31,                 |  |   |  | 2005   |  |   |  | 2004  
|                                                
|Assets                                           |  |   |  |        |  |   |  |       
|Cash                                             |  | $ |  | 639    |  | $ |  | 855   
|Investment in subsidiary                         |  |   |  | 15,999 |  |   |  | 15,150
|Other assets                                     |  |   |  | -      |  |   |  | -     
|                                                
|Total Assets                                     |  | $ |  | 16,638 |  | $ |  | 16,005
|                                                 |  |  
|                                                
|Liabilities and Shareholders
      Equity       |  |   |  |        |  |   |  |       
|Shareholders equity                             |  | $ |  | 16,638 |  | $ |  | 16,005
|                                                
|Total Liabilities and Shareholders
      Equity |  | $ |  | 16,638 |  | $ |  | 16,005
|                                                 |  |  
|                                                
|PARENT COMPANY CONDENSED INCOME
      STATEMENT  |  |   |  |        |  |   |  |       
|                                                
|(in thousands)Year ended
      December 31,      |  |   |  | 2005   |  |   |  | 2004  
|                                                
|Equity in earnings of subsidiary                 |  | $ |  | 836    |  | $ |  | 805   
|                                                
|Total income                                     |  |   |  | 836    |  |   |  | 805   
|Operating expenses                               |  |   |  | 105    |  |   |  | 97    
|                                                
|Income before income tax                         |  |   |  | 731    |  |   |  | 708   
|Income tax                                       |  |   |  | -      |  |   |  | -     
|                                                
|Net income                                       |  | $ |  | 731    |  | $ |  | 708   
|                                                 |  |  

34

---

|PARENTCOMPANYCONDENSEDSTATEMENT OFCASHFLOWS                   |  |   |  |      |   | 
|------------------------------------------------------------- |  | - |  | ---- | - | 
|                                                             
|(in thousands)Year ended
      December 31,                   |  |   |  | 2005 |   | 
|                                                             
|Cash flows from operating activities:                         |  |   |  |      |   | 
|Net income                                                    |  | $ |  | 731  |   | 
|Adjustments to reconcile net income to net
      cash used in |  |   |  |      |   | 
|operating
      activities:                                   |  |   |  |      |   | 
|Equity
      in earnings of subsidiary                        |  |   |  | (836 | ) | 
|Increase
      (decrease) in other assets                     |  |   |  | -    |   | 
|                                                             
|Net
      cash used in operating activities                   |  |   |  | (105 | ) | 
|                                                             
|Cash flows from investing activities:                         |  |   |  |      |   | 
|Distributions received from
      subsidiary                  |  |   |  | 80   |   | 
|                                                             
|Net cash provided by
      investing activities               |  |   |  | 80   |   | 
|                                                             
|Cash flows from financing activities:                         |  |   |  |      |   | 
|Issuance of common stock                                      |  |   |  | -    |   | 
|Cash dividends paid                                           |  |   |  | (191 | ) | 
|                                                             
|Net cash used in
      financing activities                   |  |   |  | (191 | ) | 
|                                                             
|                                                             
|Net increase (decrease) in cash                               |  |   |  | (216 | ) | 
|Cash at beginning of year                                     |  |   |  | 855  |   | 
|                                                             
|Cash at end of year                                           |  | $ |  | 639  |   | 
|                                                              |  |  

Note 17 
Subsequent Event  Branch Closures

On
January 26, 2006, the Bank closed its offices in Hoonah and Yakutat, Alaska. The
two offices are the Banks smallest, with deposits at December 31, 2005 of $3.9
million and $7.7 million, respectively. No other financial institution has a
facility in either of these small communities, each with a population less than
1,000. The Bank intends to continue to serve its customers in Hoonah and Yakutat
through online banking and other remote services. By closing these offices,
management expects to save the cost of operating the two facilities, amounting
to over $350,000 annually. The effect on future pre-tax income ultimately
depends on the amount of business that is retained after the closures.

The costs of closing the offices are expensed as incurred. These
costs, including estimated lease settlement costs and severance pay, have not
yet been determined, but are estimated to amount to approximately $150,000, of
which $25,000 has been recorded in the accompanying consolidated income
statement for the year ended December 31, 2005. The remainder of such costs will
be recorded primarily in the first quarter of 2006.

35

---



|Form
  10-KSB
|-------------

Acopy of the Form 10-KSB, including consolidated financial
statements, as filed with the Securities and Exchange Commission, will be
furnished without charge to stockholders as of the record date for voting at the
annual meeting of shareholders upon written request to Roger K. White,
Secretary, Alaska Pacific Bancshares, Inc., 2094 Jordan Avenue, Juneau, Alaska
99801.

36

---

Directors and
Executive Officers

Roger Grummett, Chairman of the Board Retired PartnerShattuck & Grummett, Inc.Hugh N. Grant Real
estate and retailingCraig E. Dahl President
andChief Executive Officer Alaska Pacific Bancshares, Inc.
     and Alaska Pacific Bank

Avrum M. Gross Retired Partner Gross & Burke

Deborah R. MarshallCEOMcDunnahs Ltd.Scott C. MilnerPresidentMilner Howard
Mortensen & Palmer PC, CPA's

Eric McDowellPresidentMcDowell Group,
Inc.Marta RymanDirector and Former Chairman Shee Atika,
Inc.William J. SchmitzPartner*Schmitz & Buck*EXECUTIVEOFFICERSCraig E. Dahl *President and
Chief Executive Officer of Alaska Pacific
Bancshares, Inc. and Alaska Pacific Bank*

Lisa
J. Corrigan*Executive Vice
President and Chief Operating Officer
of Alaska Pacific Bancshares, Inc. and Alaska
Pacific Bank*

Roger K. White*Senior Vice
President, Chief Financial Officer and Secretary of
Alaska Pacific Bancshares, Inc. and Senior Vice
President and Chief Financial Officer of
Alaska
Pacific Bank*

John E. Robertson*Senior Vice
President and Chief Lending Officer of Alaska
Pacific Bank*

Corporate Information

CORPORATEHEADQUARTERS2094 Jordan
Avenue Juneau, AK
99801 907-789-4844
INDEPENDENTAUDITORSMoss Adams LLP 601
West Riverside Suite 1800 Spokane, WA 99201

STOCKREGISTRAR ANDTRANSFERAGENTComputershare Trust Company, Inc.350
Indiana Street, Suite 350 Golden, CO 80401

COMMONSTOCKTraded on the OTC Electronic Bulletin
Board under the symbol: AKPB

SPECIALCOUNSELBreyer & Associates PC 8180
Greensboro Drive Suite 785 McLean, VA 22102

GENERALCOUNSELBaxter Bruce & Sullivan PC
P.O. Box 32819 Juneau, AK 99803

ANNUALMEETING OFSHAREHOLDERSMay 16, 2006 11:00 a.m. Treadwell
Ballroom Westmark Baranof Hotel 127 North Franklin Street Juneau, AK
99801





37

---