SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K
(Mark One)

/X/ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
    of 1934

                 For the fiscal year ended December 31, 2001 or

/ / Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
    Act of 1934

                        Commission file number 000-29829

                          PACIFIC FINANCIAL CORPORATION
             (Exact Name of Registrant as specified in its Charter)

                Washington                              91-1815009
         (State or Other Jurisdiction of       (IRS Employer Identification No.)
         Incorporation or Organization)

                             300 East Market Street
                         Aberdeen, Washington 98520-5244
               (Address of Principal Executive Offices) (Zip Code)

       Registrant's telephone number, including area code: (360) 533-8870

           Securities Registered Pursuant to Section 12(b) of the Act:

                                      None
                                      ----
           Securities Registered Pursuant to Section 12(g) of the Act:

                     Common Stock, par value $1.00 per share

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such shorter  periods that the  Registrant  was
required to file such  reports),  and (2) has been subject to such  requirements
for the past 90 days.
                               Yes       No
                                   -----   -----
Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best  of  the  registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K [   ]
                             ---
The  aggregate  market value of the voting stock held by  non-affiliates  of the
registrant as of February 28, 2002 was $61,044,910.

As of February 28, 2002,  there were issued and outstanding  2,491,629 shares of
the Registrant's Common Stock.

                                       1

<PAGE>


                       DOCUMENTS INCORPORATED BY REFERENCE

PART III of Form 10-K - The definitive Proxy Statement filed with the Securities
and Exchange  Commission in connection  with  Registrant's  annual meeting to be
held April 17, 2002 (only portions of which are incorporated by reference).

                                       2



<PAGE>



                          PACIFIC FINANCIAL CORPORATION
                 ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
                             ENDED DECEMBER 31, 2001

                                TABLE OF CONTENTS
PART I                                                                      Page
     Item  1.    Business                                                     4

     Item  2.    Properties                                                  12

     Item  3.    Legal Proceedings                                           13

     Item  4.    Submission of Matters to a Vote of Security Holders         13

PART  II
     Item 5.     Market for Registrant's Common Equity and Related
                 Stockholder Matters                                         13

     Item  6.    Selected Financial Data                                     14

     Item  7.    Management's Discussion and Analysis of Financial
                 Condition and Results of Operations                         15

     Item  7A.   Quantitative and Qualitative Disclosure About Market Risk   28

     Item  8.    Financial Statements and Supplementary Data                 29

     Item  9.    Changes in and Disagreements with Accountants on
                 Accounting And Financial Disclosure                         29


PART  III
    Item  10.    Directors and Executive Officers of the Registrant          29

    Item  11.    Executive Compensation                                      30

    Item  12.    Security Ownership of Certain Beneficial Owners
                 and Management                                              30

    Item  13.    Certain Relationships and Related Transactions              30

PART  IV
    Item  14.  Exhibits, Financial Statement Schedules, and Reports
               on Form 8-K                                                   30

SIGNATURES                                                                   61


                                       3
<PAGE>




                                     PART I

ITEM 1.  Business

Pacific  Financial  Corporation  (the  Company) is a financial  holding  company
headquartered  in Aberdeen,  Washington.  The Company owns one bank, Bank of the
Pacific  (Pacific  or the Bank),  which is located in  Washington.  The  Company
conducts  its  banking  business  through 10  branches  located  in  communities
throughout  Grays  Harbor  County,  Pacific  County,  and  Wahkiakum  County  in
Southwest  Washington.  At December 31, 2001, the Company had total consolidated
assets of  $243.6  million,  loans of $176.6  million,  and  deposits  of $214.6
million. The Company was incorporated in the State of Washington on February 12,
1997, pursuant to a holding company  reorganization of the Bank. Although an SEC
reporting company, the Company's stock is not listed on any exchange.

Forward Looking Information

Discussions of certain matters  contained in this Annual Report on Form 10-K may
constitute  forward-looking  statements  with the  meaning of Section 27A of the
Securities Act of 1933, as amended,  and Section 21F of the Securities  Exchange
Act of 1934, as amended (the "Exchange Act") and, as such, may involve risks and
uncertainties.  These  forward-looking  statements  may relate to,  among  other
things,  economic conditions in the market areas in which the Bank operates, the
adequacy of the Bank's loan loss reserves,  potential changes in interest rates,
and the competitive  environment  facing the Bank. The Company's actual results,
performance and achievements may differ materially from the results, performance
and achievements expressed or implied in such forward-looking statements.

The Bank

Bank of the Pacific  was  organized  in 1978 and opened for  business in 1979 to
meet the need for a regional  community  bank with local  interests to serve the
small to medium-sized local businesses and professionals in the region. Services
offered by the Bank include  commercial  loans,  installment  loans, real estate
loans, and personal and business deposit products.

The Bank  originates  loans  primarily in its local  markets.  The  underwriting
policies focus on assessment of each borrower's ability to service and repay the
debt, and the  availability  of collateral  that can be used to secure the loan.
Depending  on the nature of the borrower and the purpose and amount of the loan,
the Bank's loans may be secured by a variety of collateral,  including  business
assets, real estate, and personal assets.

The Bank's  commercial  and  agricultural  loans  consist  primarily  of secured
revolving  operating lines of credit and business term loans,  some of which may
be  partially  guaranteed  by the  Small  Business  Administration  or the  U.S.
Department of Agriculture.

Consumer installment loans and other loans represent a small percentage of total
outstanding  loans and include home equity loans,  auto loans,  boat loans,  and
personal lines of credit.

The Bank's primary  sources of deposits are from  individuals  and businesses in
its local markets.  A concerted  effort has been made to attract deposits in the
local market areas through competitive pricing



                                       4
<PAGE>

and  delivery of quality  products.  These  products  include  demand  accounts,
negotiable  order  of  withdrawal  ("NOW")  accounts,  money  market  investment
accounts,  savings accounts,  and time deposits.  The Bank traditionally has not
sought brokered deposits and does not intend to do so in the future.

The Bank  operates  under the banking  laws of the State of  Washington  and the
rules and regulations of the Federal Deposit Insurance Corporation ("FDIC").

Competition

Competition in the banking  industry is significant  and has  intensified as the
regulatory environment has grown more permissive. Banks face a growing number of
competitors  and greater degree of competition  with respect to the provision of
banking  services and the attracting of deposits.  The Company competes in Grays
Harbor County with well-established  thrifts which are headquartered in the area
along with branches of large banks and small community  banks with  headquarters
outside the area. The Company competes with  well-established  branches of large
banks,  thrifts  and credit  unions in Pacific  and  Wahkiakum  Counties.  Other
non-bank and non-depository institutions can be expected to increase competition
further as they offer bank type products.

The  adoption of the  Graham-Leach-Bliley  Act of 1999 (the  Financial  Services
Modernization  Act) in November of that year  eliminated many of the barriers to
affiliation among providers of financial services and further opened the door to
business  combinations  involving  banks,  insurance  companies,  securities  or
brokerage  firms,  and  others.  This  regulatory  change  has  led  to  further
consolidation in the financial  services  industry and the creation of financial
conglomerates  which frequently  offer multiple  financial  services,  including
deposit  services,  brokerage  and  others.  When  combined  with  technological
developments  such as the Internet that have reduced  barriers to entry faced by
companies  physically  located outside the Company's market area, changes in the
market have resulted in increased  competition  and can be expected to result in
further increases in competition in the future.

Although  it cannot  guarantee  that it will  continue to do so, the Company has
been able to  maintain a  competitive  advantage  as a result of its status as a
local  institution,  offering products and services tailored to the needs of the
community.  Further,  because of the  extensive  experience of management in its
market  area  and  the  business  contacts  of  management  and  the  directors,
management believes the Company can continue to compete effectively.

According to the Market  Share Report  compiled by the Federal Home Loan Bank of
Seattle,  as of June 30, 2000,  the Company held a deposit market share of 53.4%
in Pacific County,  45.8% in Wahkiakum  County and a 17.5% share in Grays Harbor
County.

Employees

As of December 31, 2001,  the Bank employed 87 full time  equivalent  employees.
Management believes relations with its employees are good.

                           SUPERVISION AND REGULATION

         The  following  generally  refers to certain  significant  statutes and
regulations  affecting  the  banking  industry.   This  regulation  is  intended
primarily  for the  protection  of  depositors  and not for the  benefit  of the
Company's shareholders.  The following discussion is intended to provide a brief
summary  and,  therefore,  is not  complete and is qualified by the statutes and
regulations  referenced.  Changes in applicable  laws or regulations  may have a
material effect on the business and prospects of the Company.

                                       5
<PAGE>


The operations of the Company may also be affected by changes in the policies of
banking and other government  regulators.  The Company cannot accurately predict
the nature or extent of the effects on its business and earnings  that fiscal or
monetary policies, or new federal or state laws, may have in the future.

                                   THE COMPANY
General

         As a  financial  holding  company,  the  Company is subject to the Bank
Holding Company Act of 1956, as amended, ("BHCA") which places the Company under
the  supervision  of the Board of Governors of the Federal  Reserve  System (the
"Federal  Reserve").  The  Company  must file  annual  reports  with the Federal
Reserve and must provide it with such additional  information as it may require.
In  addition,  the Federal  Reserve  periodically  examines  the Company and its
subsidiaries, including the Bank.

Bank Holding Company Regulation

         In  general,  the BHCA  limits a bank  holding  company  to  owning  or
controlling banks and engaging in other banking-related activities. Bank holding
companies  must obtain the Federal  Resserve  approval  before they: (1) acquire
direct or indirect  ownership  or control of any voting  shares of any bank that
results in total ownership or control,  directly or indirectly,  of more than 5%
of the voting shares of such bank;  (2) merge or  consolidate  with another bank
holding company; or (3) acquire  substantially all of the assets of another bank
or bank holding company.

         Control of Nonbanks.  With certain exceptions,  the BHCA prohibits bank
holding companies from acquiring direct or indirect ownership or control of more
than 5% of the voting shares in any company that is not a bank or a bank holding
company  unless the  Federal  Reserve  determines  that the  activities  of such
company are incidental or closely related to the business of banking.  If a bank
holding company is well-capitalized  and meets certain criteria specified by the
FRB, it may engage de novo in certain permissible  nonbanking activities without
prior Federal Reserve approval.

         Control  Transactions.  The  Change  in Bank  Control  Act of 1978,  as
amended,  requires a person (or group of persons  acting in  concert)  acquiring
"control" of a bank holding company to provide the Federal Reserve with 60 days'
prior  written  notice of the proposed  acquisition.  Following  receipt of this
notice,  the  Federal  Reserve  has 60 days  within  which  to  issue  a  notice
disapproving the proposed  acquisition,  but the Federal Reserve may extend this
time period for up to another 30 days. An  acquisition  may be completed  before
expiration  of the  disapproval  period if the Federal  Reserve  issues  written
notice of its  intent  not to  disapprove  the  transaction.  In  addition,  any
"company" must obtain the Federal Reserve  approval before  acquiring 25% (5% if
the "company" is a bank holding  company) or more of the  outstanding  shares or
otherwise obtaining control over the Company.

Financial Services Modernization Act

On November 12, 1999, the Financial  Services  Modernization Act was signed into
law.  The  Financial  Services  Modernization  Act repeals  the two  affiliation
provisions  of  the  Glass-Steagall   Act:  Section  20,  which  restricted  the
affiliation of Federal Reserve member banks with firms "engaged  principally" in
specified  securities  activities;  and Section  32,  which  restricts  officer,
director, or employee interlocks between a member bank and any company or person
"primarily  engaged"  in  specified  securities  activities.  In  addition,  the
Financial Services  Modernization Act contains provisions that expressly preempt
any state law restricting the establishment of financial affiliations, primarily
related  to  insurance.  The  general  effect  of  the  law  is to  establish  a
comprehensive framework to permit affiliations among commercial banks, insurance


                                       6
<PAGE>

companies,  securities  firms, and other financial service providers by revising
and expanding  the bank holding  company  framework to permit a holding  company
system to engage in a full range of  financial  activities  through a new entity
known as a financial holding company.

The Company received approval to become a financial holding company during 2000.
Bank  holding  companies  that elect to become a financial  holding  company may
affiliate  with  securities  firms and  insurance  companies and engage in other
activities  that are financial in nature or are incidental or  complementary  to
activities that are financial in nature.

"Financial in nature" activities include securities  underwriting,  dealing, and
market  marking,  sponsoring  mutual funds and investment  companies,  insurance
underwriting  and agency,  merchant  banking,  and  activities  that the Federal
Reserve, in consultation with the Secretary of Treasury, determines from time to
time to be so closely related to banking or managing or controlling  banks as to
be a proper incident thereto.

In December  2000,  the Federal  Reserve  approved an interim rule  defining the
three categories of activities  financial in nature or incidental to a financial
activity:

o        lending,   exchanging,   transferring,   investing   for   others,   or
         safeguarding financial assets other than money or securities;

o        providing any device or other instrumentality for transferring money or
         other financial assets; or

o        arranging,  effecting or facilitating  financial  transactions  for the
         account of third parties.

The law also:

o        broadens  the  activities  that may be  conducted  by  national  banks,
         banking  subsidiaries  of bank holding  companies,  and their financial
         subsidiaries;

o        provides an enhanced  framework for  protecting the privacy of consumer
         information;

o        adopts  a  number  of   provisions   related  to  the   capitalization,
         membership,  corporate  governance,  and  other  measures  designed  to
         modernize the Federal Home Loan Bank system;

o        modifies  the  laws  governing  the  implementation  of  the  Community
         Reinvestment Act; and

o        addresses a variety of other legal and regulatory issues affecting both
         day-to-day   operations   and   long-term   activities   of   financial
         institutions.

The Company does not believe that the Financial Services  Modernization Act will
have a material adverse effect on its operations in the near-term.  However,  to
the extent that the legislation  permits banks,  securities firms, and insurance
companies to affiliate,  the financial  services industry may experience further
consolidation.  The Financial Services Modernization Act is intended to grant to
community  banks  certain  powers as a matter of right that larger  institutions
have accumulated on an ad hoc basis. Nevertheless, this legislation may have the
result of  increasing  the amount of  competition  that the  Company  faces from
larger  institutions  and other types of companies  with  substantially  greater
resources  than the Company and offering a wider  variety of financial  products
than the Bank currently offers.

Privacy Rules. The Financial Services Modernization Act required federal banking
regulators to adopt rules that limit the ability of banks and other financial
institutions to disclose non-public information about



                                       7
<PAGE>

consumers to nonaffiliated  third parties.  Regulations were adopted in 2000 and
became effective November 13, 2000,  although compliance was optional until July
1, 2001. Adopted regulations require disclosure of privacy policies to consumers
and, in some  circumstances,  allow consumers to prevent  disclosure of personal
information.  We have  implemented  procedures  to comply  with these  rules and
believe that compliance has not had an adverse effect on operations.

Insurance  products.  In  December  2000  pursuant  to the  requirements  of the
Financial  Services  Modernization  Act, the federal bank and thrift  regulatory
agencies adopted consumer protection rules for the sale of insurance products by
depository institutions. The rule was effective on April 1, 2001. The final rule
applies  to any  depository  institution  or  any  person  selling,  soliciting,
advertising,  or offering  insurance  products or  annuities to a consumer at an
office  of the  institution  or on  behalf of the  institution.  The  regulation
requires  oral and written  disclosure  before the  completion of the sale of an
insurance product that such product:

o        is not a  deposit  or  other  obligation  of,  or  guaranteed  by,  the
         depository institution or its affiliate;

o        is not  insured by the FDIC or any other  agency of the United  States,
         the depository institution or its affiliated; and

o        has certain risks of investment, including the possible loss of value.

The  depository  institution  may not  condition  as  extension of credit on the
consumer's  purchase  of an  insurance  product or annuity  from the  depository
institution or from any of its affiliates, or on the consumer's agreement not to
obtain, or a prohibition on the consumer from obtaining, an insurance product or
annuity from an unaffiliated entity.  Furthermore,  to the extent practicable, a
depository   institution  must  keep  insurance  and  annuity  sales  activities
physically  segregated  from the  areas  where  retail  deposits  are  routinely
accepted from the general  public.  Finally,  the rule addresses cross marketing
and referral fees.

Information  Security.  In January 2000, the banking agencies adopted guidelines
requiring  financial  institutions to establish an information  security program
to:

o        identify and assess the risks that may threaten customer information;

o        develop a written plan containing policies and procedures to manage and
         control these risks;

o        implement and test the plan; and

o        adjust  the  plan on a  continuing  basis to  account  for  changes  in
         technology,  the  sensitivity of customer  information  and internal or
         external threats to information security.

Each  institution may implement a security  program  appropriate to its size and
complexity  and the  nature and scope of its  operations.  The  guidelines  were
effective July 1, 2001. The Company  believes that it is in compliance  with the
guidelines and that they will not adversely affect its operations.

USA Patriot Act of 2001

On October 26, 2001, President Bush signed the Uniting and Strengthening America
by Providing  Appropriate  Tools  Required to Intercept  and Obstruct  Terrorism
("USA  Patriot  Act") of 2001.  Among  other  things,  the USA  Patriot  Act (1)
prohibits banks from providing  correspondent accounts directly to foreign shell
banks;  (2)  imposes  due  diligence  requirements  on banks  opening or holding
accounts for foreign financial  institutions or wealthy foreign  individuals (3)
requires financial institutions to establish


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<PAGE>

an anti-money-laundering  compliance program, and (4) eliminates civil liability
for  persons  who file  suspicious  activity  reports.  The Act  also  increases
governmental  powers to investigate  terrorism,  including  expanded  government
access to account  records.  The  Department  of the  Treasury is  empowered  to
administer and make rules to implement the Act. While we believe the USA Patriot
Act may, to some degree,  affect our recordkeeping and reporting expenses, we do
not believe that the Act will have a material adverse effect on our business and
operations.

Transactions with Affiliates

         The  Company and the Bank are deemed  affiliates  within the meaning of
the Federal  Reserve Act, and  transactions  between  affiliates  are subject to
certain  restrictions.  Accordingly,  the  Company and the Bank must comply with
Sections 23A and 23B of the Federal Reserve Act. Generally, Sections 23A and 23B
(1) limit the extent to which a financial  institution or its  subsidiaries  may
engage in "covered  transactions"  with an affiliate,  as defined,  to an amount
equal to 10% of such institution's capital and surplus and an aggregate limit on
all such  transactions  with all  affiliates  to an amount  equal to 20% of such
capital and surplus, and (2) require all transactions with an affiliate, whether
or not "covered  transactions,"  to be on terms  substantially  the same,  or at
least as favorable to the  institution  or  subsidiary,  as those  provided to a
non-affiliate.  The term  "covered  transaction"  includes  the making of loans,
purchase  of  assets,  issuance  of a  guarantee  and  other  similar  types  of
transactions.

Regulation of Management

         Federal law (1) sets forth the  circumstances  under which  officers or
directors of a financial institution may be removed by the institution's federal
supervisory  agency;  (2) places  restraints on lending by an institution to its
executive  officers,  directors,   principal  stockholders,  and  their  related
interests;  and (3) prohibits management personnel from serving as a director or
in other  management  positions  with another  financial  institution  which has
assets  exceeding a specified  amount or which has an office  within a specified
geographic area.

Tie-In Arrangements

         The Company and the Bank cannot engage in certain  tie-in  arrangements
in  connection  with any  extension  of  credit,  sale or lease of  property  or
furnishing  of services.  For  example,  with  certain  exceptions,  neither the
Company  nor the Bank may  condition  an  extension  of credit to a customer  on
either (1) a requirement that the customer obtain  additional  services provided
by it or (2) an  agreement  by the  customer  to refrain  from  obtaining  other
services from a competitor.

         The Federal  Reserve has adopted  amendments  to its  anti-tying  rules
that:  (1)  removed  Federal  Reserve-imposed  anti-tying  restrictions  on bank
holding  companies  and their  non-bank  subsidiaries;  (2) allow banks  greater
flexibility to package products with their affiliates;  and (3) establish a safe
harbor from the tying  restrictions  for  certain  foreign  transactions.  These
amendments  were  designed  to enhance  competition  in banking  and  nonbanking
products  and to allow banks and their  affiliates  to provide  more  efficient,
lower cost services to their customers.

Source of Strength Requirements

         Under  Federal  Reserve  policy,  the  Company is  expected to act as a
source of financial  and  managerial  strength to the Bank.  This means that the
Company is required to commit, as necessary,  resources to support the Bank. Any
capital loans made by the Company to the Bank would be  subordinate  in priority
to deposits and to certain other indebtedness of the Bank.

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<PAGE>



State Law Restrictions

         As a  Washington  business  corporation,  the Company may be subject to
certain  limitations and  restrictions as provided under  applicable  Washington
corporate law. In addition, Washington banking law restricts and governs certain
activities of the Bank.

                                    The Bank
General

         The Bank, as a non-Fed member FDIC insured  institution,  is subject to
regulation and examination by the FDIC and the State of Washington.  The federal
laws that  apply to the Bank  regulate,  among  other  things,  the scope of its
business,  its  investments,  its reserves against  deposits,  the timing of the
availability  of deposited funds and the nature and amount of and collateral for
loans.

         CRA. The  Community  Reinvestment  Act (the "CRA")  requires  that,  in
connection   with   examinations   of   financial   institutions   within  their
jurisdiction,  the FDIC  evaluate the record of the  financial  institutions  in
meeting the credit needs of their local communities,  including low and moderate
income  neighborhoods,  consistent  with the safe and sound  operation  of those
banks.  These factors are also considered in evaluating  mergers,  acquisitions,
and  applications  to open a branch or facility.  In connection  with the FDIC's
assessment of the record of financial  institutions  under the CRA, it assigns a
rating  of  either,  "outstanding,"   "satisfactory,"  "needs  to  improve,"  or
"substantial  noncompliance"  following an examination.  The Bank received a CRA
rating of "outstanding" during its most recent examination.

         Insider  Credit  Transactions.   Banks  are  also  subject  to  certain
restrictions  imposed by the  Federal  Reserve  Act on  extensions  of credit to
executive officers, directors,  principal shareholders, or any related interests
of such persons. Extensions of credit (i) must be made on substantially the same
terms,  including interest rates and collateral,  and follow credit underwriting
procedures  that are not less  stringent  than those  prevailing at the time for
comparable  transactions  with  persons  not  covered  above  and  who  are  not
employees;  and (ii) must not involve  more than the normal risk of repayment or
present other  unfavorable  features.  Banks are also subject to certain lending
limits and  restrictions  on overdrafts  to such  persons.  A violation of these
restrictions  may  result  in  the  assessment  of  substantial  civil  monetary
penalties on the affected bank or any officer,  director,  employee,  agent,  or
other  person  participating  in the  conduct of the  affairs of that bank,  the
imposition of a cease and desist order, and other regulatory sanctions.

         FDICIA. Under the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA"),  each federal banking agency has prescribed,  by regulation,
noncapital safety and soundness  standards for institutions under its authority.
These standards cover internal controls, information systems, and internal audit
systems, loan documentation,  credit underwriting, interest rate exposure, asset
growth,  compensation,  fees and benefits, such other operational and managerial
standards as the agency  determines to be  appropriate,  and standards for asset
quality,  earnings and stock valuation. An institution which fails to meet these
standards  must develop a plan  acceptable to the agency,  specifying  the steps
that the  institution  will  take to meet the  standards.  Failure  to submit or
implement  such a plan may  subject the  institution  to  regulatory  sanctions.
Management believes that the Bank meets all such standards, and therefore,  does
not believe that these regulatory standards will materially affect the Company's
business operations.

                                       10
<PAGE>


Interstate Banking and Branching

         The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Interstate Act") permits nationwide interstate banking and branching under
certain   circumstances.   This  legislation   generally  authorizes  interstate
branching and relaxes federal law restrictions on interstate banking. Currently,
bank  holding  companies  may  purchase  banks in any state,  and states may not
prohibit such purchases.  Additionally,  banks are permitted to merge with banks
in other  states as long as the home  state of neither  merging  bank has "opted
out."  The  Interstate  Act  requires   regulators  to  consult  with  community
organizations before permitting an interstate institution to close a branch in a
low-income area.

         With regard to interstate  bank mergers,  Washington  has "opted in" to
the Interstate Act and allows  in-state banks to merge with  out-of-state  banks
subject to certain aging requirements.  Washington law generally  authorizes the
acquisition  of an in-state bank by an  out-of-state  bank through merger with a
Washington financial institution that has been in existence for at least 5 years
prior to the acquisition. With regard to interstate bank branching, out-of-state
banks that do not already  operate a branch in  Washington  may not establish de
novo  branches in  Washington  or establish  and operate a branch by acquiring a
branch in Washington.  Under FDIC  regulations,  banks are prohibited from using
their  interstate  branches  primarily  for  deposit  production.  The  FDIC has
accordingly implemented a loan-to-deposit ratio screen to ensure compliance with
this prohibition.

Deposit Insurance

         The deposits of the Bank are currently insured to a maximum of $100,000
per depositor through the Bank Insurance Fund ("BIF")  administered by the FDIC.
All insured  banks are required to pay  semi-annual  deposit  insurance  premium
assessments to the FDIC.

         FDICIA  included  provisions  to reform the Federal  deposit  insurance
system,  including the implementation of risk-based deposit insurance  premiums.
FDICIA also permits the FDIC to make special  assessments on insured  depository
institutions  in  amounts  determined  by the  FDIC to be  necessary  to give it
adequate  assessment income to repay amounts borrowed from the U.S. Treasury and
other sources,  or for any other purpose the FDIC deems necessary.  The FDIC has
implemented a risk-based insurance premium system under which banks are assessed
insurance  premiums  based on how much risk they present to the BIF.  Banks with
higher  levels of capital and a low degree of  supervisory  concern are assessed
lower  premiums  than banks with lower  levels of capital or a higher  degree of
supervisory  concern.  The FDIC has indicated that deposit  premiums will likely
increase in the second half of 2002 or in 2003.

Dividends

         The  principal  source of the  Company's  cash  revenues  is  dividends
received  from the Bank.  The  payment of  dividends  is  subject to  government
regulation,  in that regulatory  authorities may prohibit banks and bank holding
companies from paying  dividends in a manner that would  constitute an unsafe or
unsound banking practice. In addition, a bank may not pay cash dividends if that
payment  could  reduce the amount of its capital  below that  necessary  to meet
minimum  applicable  regulatory  capital  requirements.  Other than the laws and
regulations  noted above,  which apply to all banks and bank holding  companies,
neither  the  Company  nor the  Bank are  currently  subject  to any  regulatory
restrictions on their dividends.  Under applicable restrictions,  as of December
31, 2001, the Bank could declare dividends totaling $3,852,000 without obtaining
prior regulatory approval.

                                       11
<PAGE>


Capital Adequacy

         Federal bank regulatory agencies use capital adequacy guidelines in the
examination and regulation of bank holding companies and banks. If capital falls
below  minimum  guideline  levels,  the  holding  company  or bank may be denied
approval to acquire or establish  additional banks or non-bank  businesses or to
open new facilities.

         The FDIC and Federal  Reserve use  risk-based  capital  guidelines  for
banks and bank  holding  companies.  These  are  designed  to make such  capital
requirements more sensitive to differences in risk profiles among banks and bank
holding  companies,  to account for  off-balance  sheet exposure and to minimize
disincentives for holding liquid assets.  Assets and off-balance sheet items are
assigned to broad risk categories,  each with appropriate weights. The resulting
capital ratios represent capital as a percentage of total  risk-weighted  assets
and  off-balance  sheet items.  The  guidelines  are  minimums,  and the Federal
Reserve  has  noted  that  bank  holding  companies  contemplating   significant
expansion  programs  should not allow expansion to diminish their capital ratios
and should maintain ratios well in excess of the minimum. The current guidelines
require all bank holding companies and  federally-regulated  banks to maintain a
minimum risk-based total capital ratio equal to 8%, of which at least 4% must be
Tier I  capital.  Tier I capital  for bank  holding  companies  includes  common
shareholders' equity,  certain qualifying perpetual preferred stock and minority
interests in equity  accounts of  consolidated  subsidiaries,  less  intangibles
except as described above and accumulated other comprehensive income (loss).

         The Federal  Reserve  also  employs a leverage  ratio,  which is Tier I
capital  as a  percentage  of total  assets  less  intangibles,  to be used as a
supplement to  risk-based  guidelines.  The principal  objective of the leverage
ratio is to constrain  the maximum  degree to which a bank  holding  company may
leverage  its  equity  capital  base.  The  Federal  Reserve  requires a minimum
leverage  ratio of 3%.  However,  for all but the most highly rated bank holding
companies and for bank holding companies seeking to expand,  the Federal Reserve
expects an additional cushion of at least 1% to 2%.

         FDICIA created a statutory  framework of supervisory actions indexed to
the capital level of the individual  institution.  Under regulations  adopted by
the FDIC, an institution is assigned to one of five capital categories depending
on its total  risk-based  capital ratio,  Tier I risk-based  capital ratio,  and
leverage ratio, together with certain subjective factors. Institutions which are
deemed to be  "undercapitalized"  depending  on the  category  to which they are
assigned are subject to certain mandatory  supervisory  corrective actions.  The
Company does not believe that these  regulations have any material effect on its
operations.

Effects of Government Monetary Policy

         The earnings and growth of the Company are affected not only by general
economic conditions, but also by the fiscal and monetary policies of the federal
government,  particularly the Federal Reserve.  The Federal Reserve can and does
implement  national  monetary policy for such purposes as curbing  inflation and
combating  recession,   but  its  open  market  operations  in  U.S.  government
securities,  control of the discount  rate  applicable  to  borrowings  from the
Federal  Reserve,  and  establishment  of reserve  requirements  against certain
deposits, influence the growth of bank loans, investments and deposits, and also
affect  interest  rates  charged  on loans or paid on  deposits.  The nature and
impact of future  changes in monetary  policies  and their impact on the Company
and the Bank cannot be predicted with certainty.

ITEM 2.  Properties

The Company's  administrative offices are located in Aberdeen,  Washington.  The
building  located at 300 East Market  Street is owned by the Bank and houses the
main branch and the  administrative  and



                                       12
<PAGE>

operations offices of the Bank and the Company. The Bank completed  construction
and  occupied  the  building  in December  of 1979.  There are nine  branches in
addition to the main office owned by Pacific.

Pacific  owns the  building  and land  occupied by its  Hoquiam,  Ocean  Shores,
Pacific Beach, and Montesano  branches.  Pacific also owns the land and building
located at 1007 South Pacific Highway, Long Beach, Washington,  which houses the
Long Beach branch and the data  processing  operations of Pacific.  Pacific owns
the  land and  buildings  occupied  by the  Ocean  Park,  Ilwaco,  Naselle,  and
Cathlamet offices.

In addition to the land and buildings owned by Pacific,  it also owns all of its
furniture,  fixtures and  equipment  including  data  processing  equipment.  At
December 31, 2001,  the net book value of the  Company's  premises and equipment
was $4 million.

ITEM 3.  Legal Proceedings

The  Company  and the  Bank  from  time to  time  are  party  to  various  legal
proceedings  arising  in the  ordinary  course  of  their  business.  Management
believes that there are no threatened or pending proceedings against the Company
or the Bank which, if determined adversely,  would have a material effect on its
business or financial position.

ITEM 4.  Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders in the fourth quarter of
2001.

                                     PART II

ITEM 5.  Market for  Registrant's  Common  Equity and Related  Security  Holders
Matters

No broker makes a market in the Company's common stock, and trading has not
otherwise been extensive. The trades that have occurred cannot be characterized
as amounting to an established public trading market. The Company's common stock
is traded by individuals on a personal basis and is not listed on any exchange
or traded on the over-the-counter market, and the prices reported reflect only
the transactions known to Company management. Because only limited information
is available, the following data may not accurately reflect the actual market
value of the Company's common stock. The following data includes trades between
individual investors, as reported to the Company as its own transfer agent.
<TABLE>
<CAPTION>

                                                2001                                  2000
                       Shares Traded      High       Low      Shares Traded       High      Low


<S>                         <C>          <C>         <C>           <C>          <C>          <C>
First Quarter               5,012        $  25       $  23         4,915        $  29        $  26

Second Quarter             12,341        $  25       $  21        12,040        $  28        $  25

Third Quarter              27,166        $  24       $  21         7,575        $  26        $  24

Fourth Quarter              7,691        $  25       $  23         8,359        $  24        $  21
</TABLE>

As of December 31, 2001, there were  approximately 957 stockholders of record of
the Company's common stock.

                                       13
<PAGE>


The  Company's  Board of  Directors  declared  dividends  on its common stock in
December   2001  and  2000  in  the  amounts  per  share  of  $1.32  and  $1.28,
respectively.  The Board of  Directors  has adopted a dividend  policy  which is
reviewed annually.

Payment of dividends is subject to regulatory limitations. Under federal banking
law,  the payment of dividends by the Company and the Bank is subject to capital
adequacy  requirements  established by the Federal  Reserve and the FDIC.  Under
Washington general corporate law as it applies to the Company,  no cash dividend
may be declared or paid if, after giving effect to the dividend,  the Company is
insolvent  or its  liabilities  exceed its assets.  Payment of  dividends on the
Common  Stock is also  affected by  statutory  limitations,  which  restrict the
ability of the Bank to pay upstream  dividends to the Company.  Under Washington
banking law as it applies to the Bank, no dividend may be declared or paid in an
amount greater than net profits then available,  and after a portion of such net
profits have been added to the surplus funds of the Bank.

ITEM 6.  Selected Financial Data

The following table sets forth certain selected  consolidated  financial data of
the Company at and for the years ended December 31:
<TABLE>
<CAPTION>

                                           2001              2000             1999              1998        1997
                                           -----------------------------------------------------------------------
                                                          ($ in thousands, except per share data)
Operations Data
<S>                                    <C>               <C>               <C>              <C>          <C>
Net interest income                    $     11,572      $  11,675         $  11,430        $  11,100    $  10,692

Provision for credit losses                     580            635                60              110          142
Noninterest income                            1,529          1,217             1,255            1,281        1,149

Noninterest expense                           7,193          7,530             7,011            6,687        6,188
Provision for income taxes                    1,521          1,424             1,692            1,590        1,643
Net income                                    3,807          3,303             3,922            3,994        3,868
Net income per share:
Basic                                         1.53           1.33              1.60(1)          1.64(1)      1.59(1)
Diluted                                       1.52           1.31              1.59             1.61         1.58
(1) Restated to reflect the 5 for 1 stock split effected in July 2000.

Dividends declared                            3,289          3,204             3,105            2,379       2,118
Dividends paid ratio                             86%            97%               79%              60%         55%

Performance Ratios
Net interest margin                            5.05%          5.04%             5.10%            5.37%      5.90%
Efficiency ratio                              54.90%         58.41%            55.27%           54.01%     52.26%
Return on average assets                       1.55%          1.34%             1.64%            1.80%      1.99%
Return on average equity                      15.57%         14.95%            17.26%           18.57%     19.70%

Balance Sheet Data
Total assets                                243,617        253,313           242,189          236,364      208,551
Loans, net                                  174,495        175,142           150,734          145,416      141,780
Total deposits                              214,644        213,511           206,139          210,650      178,726
Short-term borrowings                            -0-        11,358             9,675               86        6,625
Shareholders' equity                         23,514         22,743            21,438           21,485       19,657

Book value per share                           9.44           9.09              8.63(1)          8.79(1)     8.07(1)
Equity to assets ratio                         9.65%          8.98%             8.85%            9.09%       9.43%
</TABLE>

(1) Restated to reflect the 5 for 1 stock split effected in July 2000.

                                       14
<PAGE>

<TABLE>
<CAPTION>

Asset Quality Ratios
<S>                                         <C>            <C>              <C>               <C>              <C>
Nonperforming loans to total loans          .71%           1.93%            0.21%             0.01%            0.29%
Allowance for loan losses
  to total loans                           1.19%           1.14%            1.26%             1.27%            1.35%

Allowance for loan losses
  to nonperforming loans                 168.18%          59.24%          612.69%         12426.67%          459.00%
Nonperforming assets to
  total assets                              .51%           1.35%            0.13%             0.06%            0.22%
</TABLE>

ITEM 7. Management's  discussion and analysis of financial condition and results
        of operations

RESULTS OF OPERATIONS

Years ended December 31, 2001, 2000, and 1999

General. The Company's net income for 2001 was $3,807,000, a 15.3% increase
compared to $3,303,000 in 2000, and a decrease of 2.9% from $3,922,000 in 1999.
Basic earnings per share were $1.53, $1.33, and $1.60 for 2001, 2000, and 1999,
respectively. Return on average assets was 1.55%, 1.34%, and 1.64%, in 2001,
2000, and 1999 respectively. Return on average equity was 15.57%, 14.95%, and
17.26%, respectively, in 2001, 2000, and 1999.

The following table presents condensed consolidated statements of income for the
Company for each of the years in the three-year period ended December 31, 2001.
<TABLE>
<CAPTION>
                                                            Increase                           Increase
                                                           (Decrease)                         (Decrease)
(Dollars in thousands)                         2001          Amount      %        2000          Amount     %        1999
---------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>              <C>        <C>      <C>             <C>        <C>       <C>
Interest income                           $  18,102        $(2,170)   (10.7)   $20,272         $1,918     10.4      $18,354
Interest expense                              6,530         (2,067)   (24.0)     8,597          1,673     24.2        6,924
Net interest income                          11,572           (103)     (.9)    11,675            245      2.1       11,430
Provision for credit losses                     580            (55)    (8.7)       635            575    958.3           60
Net interest income after
  provision for credit losses                10,992            (48)     (.4)    11,040           (330)    (2.9)      11,370
Other operating income                        1,529            312     25.6      1,217            (38)    (3.0)       1,255
Other operating expense                       7,193           (337)    (4.5)     7,530            519      7.4        7,011
Income before income taxes                    5,328            601     12.7      4,727           (887)   (15.8)       5,614
Income taxes                                  1,521             97      6.8      1,424           (268)   (15.8)       1,692
Net income                                    3,807            504     15.3      3,303           (619)   (15.8)       3,922
</TABLE>

Net Interest  Income.  The Company derives the majority of its earnings from net
interest  income,  which is the  difference  between  interest  income earned on
interest  earning  assets and  interest  expense  incurred on  interest  bearing
liabilities.  The following table sets forth  information with regard to average
balances of the interest earning assets and interest bearing liabilities and the
resultant yields or cost, net interest income, and the net interest margin.




                                       15
<PAGE>

<TABLE>
<CAPTION>


                                                                       Year Ended December 31,
                                                       2001                           2000                       1999
                                                       ----                           ----                       ----
                                                      Interest                      Interest                       Interest
                                            Average    Income    Avg      Average    Income     Avg      Average    Income     Avg
                                            Balance   (Expense) Rate      Balance   (Expense)  Rate      Balance   (Expense)  Rate
Assets     (dollars in thousands)           -------   --------- ----      -------   ---------  ----      -------   ---------  ----
  Earning assets:
<S>                                      <C>         <C>         <C>      <C>       <C>         <C>     <C>       <C>         <C>
     Loans                               $  170,628  $  15,032*  8.81%    $165,834  $  16,500*  9.95%   $147,689  $  14,129*  9.57%
     Investment Securities:
       Taxable                               27,360      1,638   5.99%      45,857      2,812   6.13%     51,439      2,767   5.81%
       Tax-Exempt                            15,042      1,225*  8.14%      13,187      1,007*  7.64%     14,333      1,114*  7.77%
     Total Investment
       securities                            42,402      2,863   6.75%      59,044      3,819   6.47%     65,772      3,881   6.24%
     Federal funds sold and
       deposits in banks                     11,339        410   3.61%       2,258        148   6.55%     10,476        570   5.44%
Total earning assets/interest
  income                                 $  224,369  $  18,305   8.16%    $227,136   $ 20,467   9.01%   $223,937  $  18,580   8.40%
  Cash and due from banks                     8,448                          8,784                         8,599
  Bank premises and equipment
     (net)                                    4,104                          3,728                         3,596
  Other assets                               10,479                          8,897                         5,303
  Allowance for credit losses                (1,912)                        (1,997)                       (1,922)
  Total assets                           $  245,488                       $246,548                      $239,513

Liabilities and Shareholders' Equity
  Interest bearing liabilities:
     Deposits:
       Savings and interest-
         bearing demand                    $105,846  $  (2,395)  2.26%    $109,266  $  (4,483)  4.10%   $112,452  $  (3,435)  3.05%
           Time                              75,819     (3,945)  5.20%      68,516     (3,537)  5.16%     65,524     (3,277)  5.00%
     Total deposits                         181,665     (6,340)  3.49%     177,782     (8,020)  4.51%    177,976     (6,712)  3.77%
     Other borrowings                         3,065       (190)  6.20%       8,876       (577)  6.50%      4,091       (212)  5.18%
Total interest-bearing liabilities/
  Interest expense                         $184,730  $  (6,530)  3.53%    $186,658  $  (8,597)  4.61%   $182,067  $  (6,924)  3.80%
Demand deposits                              33,419                         34,343                        32,921
Other liabilities                             2,888                          3,457                         1,804
Shareholders' equity                         24,451                         22,090                        22,721
Total liabilities and shareholders'
  equity                                   $245,488                       $246,548                      $239,513
Net interest income                                  $  11,775*                     $  11,870*                    $  11,656*
Net interest income as a percentage of
  average earning assets
         Interest income                                         8.16%                          9.01%                         8.40%
         Interest expense                                        2.91%                          3.78%                         3.10%
         Net interest income                                     5.25%                          5.23%                         5.30%
         * Tax equivalent basis - 34% tax rate used
</TABLE>

Nonaccrual loans are included in "loans."

Interest  income on loans include loan fees of $708,270,  $822,516 and $731,508,
respectively.

Net interest  income  decreased .9% to $11,572,000 in 2001 compared to 2000. The
decrease is primarily the result of a decreased  interest rate environment.  The
Company's   interest  income   decreased  10.7%  to  $18,102,000  in  2001  from
$20,272,000 in 2000. This decrease,  also due to decreasing  interest rates, was
substantially  offset by a 24% decrease in interest  expense from  $8,597,000 in
2000 to $6,530,000 in 2001. Net interest  margins were 5.16%,  5.14%,  and 5.10%
for the years ended December 31, 2001, 2000, and 1999, respectively.


                                       16
<PAGE>



The following table presents changes in net interest income attributable to
changes in volume or rate. Changes not solely due to volume or rate are
allocated to volume and rate based on the absolute values of each.
<TABLE>
<CAPTION>

                                                2001 compared to 2000                  2000 compared to 1999
                                              Increase (decrease) due to             Increase (decrease) due to
(dollars in thousands)                          Volume             Rate          Net      Volume          Rate          Net
                                                ------             ----          ---      ------          ----          ---
Interest earned on:
<S>                                                <C>          <C>          <C>              <C>         <C>           <C>
  Loans                                            $466         $(1,934)     $(1,468)      $1,788         $583          $2,371
Securities:
   Taxable                                       (1,109)            (65)      (1,174)        (336)         161            (175)
   Tax-exempt                                       148              70          218          (88)         (19)           (107)
    Total securities                               (961)              5         (956)        (424)         142            (282)
  Fed funds sold and
  interest bearing deposits
    in other banks                                  354             (93)         261         (520)          98            (422)
Total interest earning assets                      (141)         (2,022)      (2,163)         844          823           1,667

Interest paid on:
  Savings and interest bearing
 demand deposits                                   (136)         (1,952)      (2,088)        (100)       1,148           1,048
  Time deposits                                     380              28          408          152          108             260
  Short term borrowings                            (362)            (25)        (387)         300           65             365
Total interest bearing liabilities                 (118)         (1,949)      (2,067)         352        1,321           1,673
Change in net interest income                       (23)            (73)         (96)         492         (498)             (6)
</TABLE>

Non-Interest Income. Non-interest income was $1,529,000 for 2001, an increase of
$312,000  or 25.6% from 2000 when it totaled  $1,217,000.  The 2000 amount was a
decrease of $38,000 or 3.0% compared to the 1999 total of $1,255,000.

In 2001,  service charges on deposit accounts  increased  $151,000 or 22.3% to a
total of $828,000  compared to $677,000 in 2000. The 2000 total was down $68,000
or 9.1%  compared to the 1999 total of  $745,000.  During  2001,  a new customer
overdraft  protection  program was implemented which contributed to the increase
in service charges on deposit accounts.

Income from sources other than service charges on deposit  accounts and gains on
sale of securities  available for sale totaled  $669,000 in 2001, an increase of
$138,000 from 2000, or 26%. The primary  reason for the increase was income from
foreclosed  real estate,  which  totaled  $139,000.  During  2001,  the Bank was
collecting  operating  revenues  from a motel which was brought into  foreclosed
real estate in July 2001.  Other major  components of  non-interest  income were
credit  card  income and bank owned life  insurance  income.  Income  from other
sources for 2000 was $531,000,  an increase of $66,000 or 14.2% compared to 1999
primarily due to the gain on the sale of foreclosed real estate.

The following table represents the principal  categories of non-interest  income
for each of the years in the three-year period ended December 31, 2001.


                                       17
<PAGE>




<TABLE>
<CAPTION>

                                                          Increase                       Increase
                                                         (Decrease)                      (Decrease)
(Dollars in thousands)                         2001       Amount      %        2000       Amount      %        1999
---------------------------------------------------------------------------------------------------------------------
Service charges on
<S>                                   <C>                  <C>      <C>        <C>        <C>      <C>          <C>
    deposit accounts                  $         828        $151     22.3%      $677       $(68)    (9.1%)       $745
Mortgage broker fees                             32          23    255.0%         9        (27)   (75.0%)         36
Net gain on sale of securities                  ---         ---    ---          ---        ---    ---              9
Other operating income                          669         138     26.0%       531         66     14.2%         465

Total non-interest income             $       1,529         312     25.6%     1,217        (38)    (3.0%)      1,255
</TABLE>

Non-Interest Expense.  Total non-interest expense was $7,193,000,  a decrease of
$337,000 or 4.5% compared to $7,530,000  in 2000. In 2000  non-interest  expense
increased $519,000 or 7.4% compared to $7,011,000 in 1999.

Salary  and  employee  benefits  decreased  by  $77,000,  or  1.9%,  in  2001 to
$4,058,000  and increased by $264,000,  or 6.8%, in 2000. The primary reason for
the  decrease  in 2001  was the  retirement  of the  Company's  Chief  Executive
Officer,  Robert  Worrell.  The increase in 2000 was  primarily due to funding a
defined benefit retirement plan which was terminated on December 31, 2000.

Occupancy  and  equipment  expense  decreased  $176,000  or  15.5%  in 2001  and
increased  $126,000 or 12.5% in 2000.  The decrease in 2001 was due to a decline
in equipment maintenance expense and reduced equipment depreciation expense. The
2000 increase was the result of writing down data processing equipment no longer
in service.

Other  expense  decreased  $84,000 or 3.7% in 2001  compared  to an  increase of
$129,000 or 6.0% in 2000 over 1999. The decrease in 2001 is related primarily to
lower advertising  expense of $20,000,  non-recurring  deferred director fees of
$160,000 paid in 2000, decreased insurance expense of $26,000 and an increase in
foreclosed real estate  expenses of $127,000  primarily due to the operations of
the motel. Non-recurring expenses totaled approximately $117,000 during 2000 and
is the reason for the increase compared to 1999.

The following table represents the principal  categories of non-interest expense
for each of the years in the three-year period ended December 31, 2001.
<TABLE>
<CAPTION>

                                                           Increase                       Increase
                                                          (Decrease)                      (Decrease)
(Dollars in thousands)                         2001        Amount        %        2000    Amount        %          1999
-----------------------------------------------------------------------------------------------------------------------
<S>                                       <C>             <C>          <C>      <C>        <C>         <C>       <C>
Salaries and employee benefits            $   4,058       $    (77)    (1.9)%   $4,135     $  264      6.8%      $3,871
Occupancy and equipment                         963           (176)   (15.5)%    1,139        126     12.5%       1,013
Other expense                                 2,172            (84)    (3.7)%    2,256        129      6.0%       2,127

Total non-interest expense                $   7,193       $   (337)    (4.5)%   $7,530     $  519      7.4%      $7,011
</TABLE>

ASSET AND LIABILITY MANAGEMENT

The largest component of the Company's earnings is net interest income. Interest
income  and  interest  expense  are  affected  by general  economic  conditions,
competition  in the  market  place,  market  interest  rates and  repricing  and
maturity  characteristics  of the Company's assets and liabilities.  Exposure to
interest rate risk is primarily a function of  differences  between the maturity
and repricing schedules of assets (principally loans and investment  securities)
and liabilities (principally deposits).  Assets and



                                       18
<PAGE>

liabilities are described as interest  sensitive for a given period of time when
they mature or can reprice within that period. The difference between the amount
of interest sensitive assets and interest  sensitive  liabilities is referred to
as the interest  sensitive  "GAP" for any given period.  The "GAP" may be either
positive or negative.  If positive,  more assets  reprice than  liabilities.  If
negative, the reverse is true.

Certain  shortcomings are inherent in the interest  sensitivity  "GAP" method of
analysis.  Complexities  such as  prepayment  risk  and  customer  responses  to
interest  rate  changes  are not  taken  into  account  in the  "GAP"  analysis.
Accordingly,  management also utilizes a net interest income simulation model to
measure interest rate sensitivity.  Simulation  modeling gives a broader view of
net  interest  income  variability,  by providing  various  rate shock  exposure
estimates.  Management  regularly  reviews the interest  rate risk  position and
provides measurement reports to the Board of Directors.

The  following  table shows the dollar amount of interest  sensitive  assets and
interest sensitive liabilities at December 31, 2001 and differences between them
for the maturity or repricing periods indicated.
<TABLE>
<CAPTION>

                                                                     Due after
                                                Due in one          one through          Due after
(dollars in thousands)                         year or less         five years          five years         Total
----------------------------------------------------------------------------------------------------------------
Interest earning assets
<S>                                            <C>                  <C>                 <C>             <C>
Loans                                          $    88,042          $  34,490           $  54,072       $ 176,604
Investment securities                               12,820             14,358               9,440          36,618
Fed Funds and interest
  bearing balances with banks                        4,973                 -0-                 -0-          4,973
Federal Home Loan Bank Stock                            -0-                -0-              3,813           3,813
Total interest earning assets                  $   105,835          $  48,848           $  67,325       $ 222,008

Interest bearing liabilities
Interest bearing demand deposits               $    27,120          $      -0-          $      -0-      $  27,120
Savings deposits                                    77,608                 -0-                 -0-         77,608
Time deposits                                       59,037             12,442                  -0-         71,479
Short term borrowings                                   -0-                -0-                 -0-             -0-
Total interest bearing liabilities             $   163,765          $  12,442           $      -0-      $ 176,207

Net interest rate sensitivity GAP              $   (57,930)         $  36,406           $  67,325       $  45,801
</TABLE>

The following table shows the dollar amount of interest sensitive assets and
interest sensitive liabilities at December 31, 2000 and difference between them
for the maturity or repricing periods indicated.
<TABLE>
<CAPTION>
                                                                     Due after
                                                Due in one          one through          Due after
(dollars in thousands)                         year or less         five years          five years       Total
--------------------------------------------------------------------------------------------------------------

Interest earning assets
<S>                                            <C>                   <C>                 <C>           <C>
Loans                                          $    97,464           $  27,174           $  52,530     $ 177,168
Investment securities                               15,506              26,871              12,695        55,072
Fed Funds and interest
  bearing balances with banks                        1,050                  -0-                 -0-        1,050
Federal Home Loan Bank Stock                            -0-                 -0-              3,562         3,562
Total interest earning assets                  $   114,020           $  54,045           $  68,787     $ 236,852

</TABLE>

                                       19
<PAGE>
<TABLE>
<CAPTION>
Interest bearing liabilities
<S>                                            <C>                    <C>                <C>            <C>
Interest bearing demand deposits               $    24,125            $    -0-           $      -0-     $ 24,125
Savings deposits                                    76,018                 -0-                  -0-       76,018
Time deposits                                       75,349              5,509                   -0-       80,858
Short term borrowings                               11,358                 -0-                  -0-       11,358
Total interest bearing liabilities             $   186,850            $ 5,509            $      -0-     $192,359

Net interest rate sensitivity GAP              $   (72,830)           $48,536            $  68,787      $ 44,493
</TABLE>

Effects of Changing Prices.  The results of operations and financial  conditions
presented  in this  report are based on  historical  cost  information,  and are
unadjusted  for the effects of inflation.  Since the assets and  liabilities  of
financial  institutions are primarily monetary in nature, the performance of the
Company  is  affected  more by  changes in  interest  rates  than by  inflation.
Interest rates generally  increase as the rate of inflation  increases,  but the
magnitude of the change in rates may not be the same.

The  effects  of  inflation  on  financial   institutions  is  normally  not  as
significant as its influence on businesses  which have investments in plants and
inventories.  During periods of high inflation there are normally  corresponding
increases  in  the  money  supply,  and  financial  institutions  will  normally
experience  above-average growth in assets,  loans and deposits.  Inflation does
increase  the price of goods and  services,  and  therefore  operating  expenses
increase during inflationary periods.

INVESTMENT PORTFOLIO

The Company's investment  securities portfolio decreased  $18,454,000,  or 33.5%
during 2001 to  $36,618,000 at year end from  $55,072,000  in 2000,  which was a
$2,828,000  decrease  over  1999.  The  changes in 2001 were  primarily  in U.S.
Government agency securities due to call options being exercised by the issuers.
Proceeds from the portfolio decrease were used to decrease short term borrowings
during 2001.

The carrying values of investment  securities at December 31 in each of the last
three years are as follows:
<TABLE>
<CAPTION>


(dollars in thousands)                                        2001                2000              1999
--------------------------------------------------------------------------------------------------------
<S>                                                       <C>                <C>               <C>
Treasury securities                                       $     -0-           $    500          $    997
U.S. Agencies securities                                     6,872              27,613            27,655
Obligations of states and political subdivisions            16,658              13,554            14,291
Other securities                                            13,088              13,405            14,957

     Total                                                $ 36,618            $ 55,072          $ 57,900
</TABLE>

The following table presents the maturities of investment securities at December
31, 2001.  Taxable  equivalent values are used in calculating  yields assuming a
tax rate of 34%.


                                       20
<PAGE>
<TABLE>
<CAPTION>

                                                                Due after           Due after
                                           Due in one          one through        five through       Due after
(dollars in thousands)                    year or less         five years           ten years        ten years      Total
-------------------------------------------------------------------------------------------------------------------------

<S>                                           <C>              <C>               <C>                 <C>         <C>
U.S. Agency securities                        $     505        $   2,775         $        29         $   3,563   $  6,872
  Weighted average yield                           5.33%            6.26%               9.00%             5.62%
Obligations of states and political
  subdivisions                                    1,505            6,712               3,568             4,873     16,658
  Weighted average yield                           6.72%            6.46%               6.61%             9.74%
Other securities                                  6,996            6,092                  -0-               -0-    13,088
  Weighted average yield                           5.02%            5.61%                 -0-               -0-

     Total                                    $  12,721        $  15,174         $     3,519         $   8,399   $ 36,618
</TABLE>

LENDING

General.  The  Company's  policy is to  originate  loans  primarily in its local
markets.  Depending  on the  purpose of the loan,  the loans may be secured by a
variety of collateral,  including  business  assets,  real estate,  and personal
assets.

The following  table sets forth the  composition of the Company's loan portfolio
at December 31 in each of the past five years.
<TABLE>
<CAPTION>

(dollars in thousands)                           2001              2000             1999              1998             1997
---------------------------------------------------------------------------------------------------------------------------

<S>                                          <C>              <C>              <C>               <C>              <C>
Commercial                                   $ 72,427         $  68,827        $  56,198         $  48,455        $  44,815
Real Estate Construction                        6,554             6,118            3,325             4,929            4,258
Real Estate Mortgage                           91,714            96,334           88,905            90,027           90,631
Installment                                     4,941             4,612            3,379             3,104            3,276
Credit cards and overdrafts                       968             1,277              857               764              747
     Total                                   $176,604         $ 177,168        $ 152,664         $ 147,280        $ 143,727
</TABLE>

Loan Maturities and Sensitivity in Interest Rates.  The following table presents
information  related to maturity  distribution  and interest rate sensitivity of
commercial and real estate  construction loans  outstanding,  based on scheduled
repayments at December 31, 2001.
<TABLE>
<CAPTION>
                                                                         Due after
                                                     Due in one         one through          Due after
(dollars in thousands)                              year or less        five years          five years             Total
------------------------------------------------------------------------------------------------------------------------

<S>                                                    <C>               <C>                 <C>                <C>
Commercial                                            $ 47,517           $  1,960            $ 22,950           $ 72,427
Real estate construction                                 4,265                108               2,181              6,554
     Total                                            $ 52,621           $  2,068            $ 25,131           $ 78,981

Total loans maturing after one year with
  Predetermined interest rates (fixed)                $ 22,903           $ 53,723            $ 76,626
  Floating or adjustable rates (variable)                                  10,868                  -0-           10,868
     Total                                                               $ 33,771            $ 53,723          $ 87,494
</TABLE>

                                       21
<PAGE>

At December 31, 2001, 49.8% of the loan portfolio presented above was due in one
year or less.

Risk  Elements.  Risk elements  include  accruing  loans past due ninety days or
more,  non-accrual  loans,  and loans  which have been  restructured  to provide
reduction  or  deferral  of interest  or  principal  for reasons  related to the
debtor's  financial  difficulties.  The  Company's  policy for placing  loans on
non-accrual  status is based upon management's  evaluation of the ability of the
borrower  to meet both  principal  and  interest  payments  as they  become due.
Generally,  loans with interest or principal  payments  which are ninety or more
days past due are placed on non-accrual, unless they are well-secured and in the
process of collection, and the interest accrual is reversed against income.

The following table presents  information  related to the Company's  non-accrual
loans and other  non-performing  assets at  December 31 in each of the last five
years.
<TABLE>
<CAPTION>

(dollars in thousands)                2001           2000           1999          1998          1997
----------------------------------------------------------------------------------------------------

<S>                            <C>               <C>             <C>          <C>           <C>
Non-accrual loans              $     1,254       $  3,128        $   175      $     15      $    422
Accruing loans past due
  90 days or more                       79            292            140             4           184
Restructured loans                      -0-            -0-            -0-           -0-           -0-
</TABLE>

Non-accrual  loans  decreased  approximately  $1.9  million  in 2001  from  2000
primarily due to  foreclosure  involving  several  properties.  During 2001, the
Company foreclosed on properties totaling $1,733,000. The total is net of charge
offs  based on  management's  estimate  of fair  market  value or the  result of
appraisals.  The properties  consist of an agricultural  property and commercial
real estate.  During 2001, sales of other real estate owned totaled $674,000 net
of expenses.  At December 31, 2001,  the balance  remaining in other real estate
owned totaled $1,040,000.  Non-accrual loans increased  $2,953,000 to $3,128,000
at year-end 2000 after increasing to $175,000 in 1999, and decreasing to $15,000
in 1998 from $422,000 in 1997. The increase in non-accrual  loans experienced in
2000 was attributable to the decline in the regional and national  economies and
the local agriculture  economy.  Interest income on non-accrual loans that would
have been recorded had those loans  performed in  accordance  with their initial
terms, as of December 31, was $75,000 for 2001,  $168,000 for 2000,  $10,000 for
1999,  $20,000 for 1998 and  $45,000 for 1997.  Interest  income  recognized  on
impaired loans for 2001 was $2,000, for 2000 was $31,000,  for 1999 was $11,000,
and was none for 1998 and 1997.

There are  $79,000  of loans  which are  ninety  days or more past due and still
accruing  at  year-end  2001.  It is  management's  opinion  that the  loans are
adequately   collateralized  and  if  foreclosure  and  sale  of  collateral  is
necessary, no loss will be incurred.

Loan Concentrations. The Company has credit risk exposure related to real estate
loans.  The Company makes real estate loans for construction and loans for other
purposes,  which are secured by real estate.  At December 31, 2001 loans secured
by real estate totaled  $98,268,000,  which  represents  55.6% of the total loan
portfolio.  Real estate construction loans comprised  $6,554,000 of that amount,
while real estate loans secured by residential  properties totaled  $33,129,000.
As a result of these  concentrations  of loans the loan portfolio is susceptible
to changes in economic and market  conditions in the Company's market areas. The
Company generally requires collateral on all real estate exposures and typically
maintains  loan-to-value  ratios of no greater  than 80%.

Allowance  for  Credit   Losses.

The allowance for credit losses reflects  management's  current  estimate of the
amount  required to absorb losses on existing  loans and  commitments  to extend
credit. Loans deemed uncollectible are charged against and reduce the allowance.
Periodically, a provision for loan losses is charged to current expense.



                                       22
<PAGE>

This  provision  acts to replenish the allowance for loan losses and to maintain
the allowance at a level that  management  deems  adequate.

There is no precise  method of  predicting  specific loan losses or amounts that
ultimately  may  be  charged  off  on  segments  of  the  loan  portfolio.   The
determination  that a loan may become  uncollectible,  in whole or in part, is a
matter of judgment. Similarly, the adequacy of the allowance for loan losses can
be  determined  only on a judgmental  basis,  after full review,  including  (a)
consideration of economic conditions and the effect on particular industries and
specific  borrowers;  (b) a review of borrowers'  financial data,  together with
industry data, the competitive situation, the borrowers' management capabilities
and other factors; (c) a continuing evaluation of the loan portfolio,  including
monitoring by lending officers and staff credit personnel of all loans which are
identified as being of less than acceptable quality;  (d) an in-depth appraisal,
on a monthly basis, of all loans judged to present a possibility of loss (if, as
a  result  of such  monthly  appraisals,  the  loan is  judged  to be not  fully
collectible,  the  carrying  value  of the  loan  is  reduced  to  that  portion
considered collectible);  and (e) an evaluation of the underlying collateral for
secured  lending,  including  the use of  independent  appraisals of real estate
properties securing loans. A formal analysis of the adequacy of the allowance is
conducted  monthly  and is  reviewed  by the Board of  Directors.  Based on this
analysis,  management  considers the allowance for credit losses to be adequate.

Periodic  provisions  for loan losses are made to  maintain  the  allowance  for
credit losses at an appropriate  level.  The provisions are based on an analysis
of various factors  including  historical  loss experience  based on volumes and
types of loans,  volumes  and trends in  delinquencies  and  non-accrual  loans,
trends in portfolio volume,  results of internal and independent external credit
reviews, and anticipated economic conditions.

Transactions  in the  allowance  for  credit  losses  for the five  years  ended
December 31, 2001 are as follows:
<TABLE>
<CAPTION>

(dollars in thousands)                           2001              2000             1999              1998             1997
---------------------------------------------------------------------------------------------------------------------------

<S>                                 <C>                        <C>              <C>               <C>              <C>
Balance at beginning of year        $           2,026          $  1,930         $  1,864          $  1,937         $  1,824
Charge-offs:
  Commercial                                      170               554              114                 9                5
  Real estate loans                               366                 0                0               194                0
  Credit card                                      13                 6               13                18               20
  Installment                                      15                 8                7                 0               16
    Total charge-offs               $             564          $    568         $    134          $    221         $     41

Recoveries:
  Commercial                        $              54          $     15         $     23          $     34         $      7
  Real estate loans                                 0                12              110                 0                0
  Credit card                                       0                 0                6                 3                2
  Installment                                      13                 2                1                 1                3
    Total recoveries                $              67          $     29         $    140          $     38         $     12

Net charge-offs (recoveries)                      497               539               (6)              183               29
Provision for credit losses                       580               635               60               110              142
Balance at end of year              $           2,109          $  2,026         $  1,930          $  1,864         $  1,937
Ratio of net charge-offs (recoveries)
  To average loans outstanding                    .29%              .33%             ---               .13%             .02%
</TABLE>

                                       23
<PAGE>


The allowance for credit losses was $2,109,000 at year-end  2001,  compared with
$2,026,000 at year-end 2000. The aggregate  increase resulted from the provision
of $580,000  and  charge-offs  in 2001.  The  allowance  for credit  losses as a
percentage  of total  loans  outstanding  at year-end  2001 was 1.19%,  which in
management's  opinion is adequate and  reasonable in comparison to the Company's
credit risk experience.

The  allowance  for credit  losses  during 2000  increased  $96,000  compared to
year-end 1999. The total  allowance for credit losses was $2,026,000 at year-end
2000 and $1,930,000 in 1999. The aggregate  increase  during 2000 was the result
of the provision of $635,000 and net  charge-offs.  The  allowance  increased in
1999 from the provision of $60,000 and  recoveries of $6,000.  The allowance for
credit losses as a percentage of total loans  outstanding  was 1.14% at year-end
2000,  1.26% at year-end 1999 and 1.27% in 1998. The allowance for credit losses
at year-end 1997 was $1,937,000.  The net  charge-offs  were $29,000 in 1997 and
provisions  for credit  losses were  $142,000 in 1997.  The allowance for credit
losses as a percentage of total loans outstanding at year-end 1997 was 1.35%.

Charge-offs  during  2001  totaled  $564,000,  which  was  due  primarily  to an
additional write down of $120,000 for an agriculture  cranberry farm loan, which
was  originally  written down by $524,000 in 2000.  In  addition,  during 2001 a
fishing vessel loan was charged-off in the amount of $21,000,  while  commercial
real estate loans were charged off  consisting  of a commercial  building in the
amount of $97,000 and a medical office building in the amount of $222,000. These
charge-offs  were the  primary  reason for the  increased  loan loss  provisions
during  2001  and  2000.  Subsequent  to year  end  2001,  management  performed
additional  analysis  and  obtained  appraisals  for several  credits due to the
current  economic  condition in its market areas and identified  weakness in the
borrower's financial condition.  Based on these events,  further charge-offs are
likely during the 2002 fiscal year, and accordingly,  a significant  addition to
the loan loss reserve during the first quarter of 2002 is likely.

In May 1993,  the Financial  Accounting  Standards  Board (FASB) issued SFAS No.
114,  "Accounting  by Creditors  for  Impairment of a Loan" and in October 1996,
issued SFAS No. 118,  "Accounting  by Creditors for Impairment of a Loan--Income
Recognition  Disclosures,  an amendment to SFAS No. 114".  The Company  measures
impaired  loans  based  on the  present  value of  expected  future  cash  flows
discounted at the loan's effective  interest rate or, as a practical  expedient,
at the loan's observable market price or the fair market value of the collateral
if the  loan is  collateral  dependent.  The  Company  excludes  loans  that are
currently  measured  at fair  value or at the lower of cost or fair  value,  and
certain large groups of smaller balance  homogeneous loans that are collectively
measured for  impairment.  The following  table  summarizes the Bank's  impaired
loans  at  December  31:
<TABLE>
<CAPTION>

 (dollars  in  thousands)                         2001         2000       1999      1998        1997
-----------------------------------------------------------------------------------------------------
<S>                                             <C>            <C>         <C>       <C>       <C>
Total  Impaired Loans                           $ 1,662       $ 3,218     $ 175     $ 15      $ 422
Total Impaired Loans with Valuation  Allowance    1,180         1,114       ---      ---        138
Valuation  Allowance  related to Impaired Loans     143           412       ---      ---          8
</TABLE>

No allocation of the  allowance for credit losses was  considered  necessary for
the remaining  impaired loans. The balance of the allowance for credit losses in
excess of these specific reserves is available to absorb losses from all loans.

It is the Company's  policy to charge-off  any loan or portion of a loan that is
deemed  uncollectible  in the ordinary course of business.  The entire allowance
for credit losses is available to absorb such charge-offs. The Company allocates
its allowance for credit losses primarily on the basis of historical data. Based
on certain characteristics of the portfolio, losses can be anticipated for major
loan categories.

                                       24
<PAGE>

The following  table  presents the allocation of the allowance for credit losses
among the major loan categories  based primarily on their  historical net charge
off experience and other business  considerations  at December 31 in each of the
last five years.
<TABLE>
<CAPTION>
                                    % of                  % of                  % of                  % of                  % of
                         2001       Total      2000       Total      1999       Total      1998       Total      1997       Total
(Dollars in thousands)  Reserve    Reserve    Reserve    Reserve    Reserve    Reserve    Reserve    Reserve    Reserve    Reserve
----------------------  -------    -------    -------    -------    -------    -------    -------    -------    -------    -------
<S>                   <C>          <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>      <C>
Commercial loans        $   548       26%     $   689       34%      $  720       37%      $  710       38%      $  798     41%
Real estate loans         1,413       67%       1,256       62%       1,153       60%       1,091       58%       1,089     56%
Consumer loans              148        7%          81        4%          58        3%          63        4%          50      3%

Total allowance         $ 2,109      100%     $ 2,026      100%      $1,930      100%      $1,864      100%      $1,937    100%

Ratio of allowance for credit
  losses to loans outstanding
  at end of year           1.19%                 1.14%                 1.26%                 1.27%                1.35%
</TABLE>

The table  indicates a decrease of $141,000  from  December 31, 2000 to December
31,  2001 in the  allowance  related to  commercial  loans,  which was offset by
growth of $157,000  during the same period in the  allowance for loan losses for
real estate  loans.  This  growth is due to an increase in past due  balances of
these loans.

DEPOSITS

The Company's primary source of funds has historically been customer deposits. A
variety of deposit  products  are  offered to  attract  customer  deposits.  The
products  include  non-interest  bearing demand  accounts,  negotiable  order of
withdrawal (NOW) accounts, savings accounts, and time deposits. Interest-bearing
accounts earn interest at rates established by management,  based on competitive
market factors and the need to increase or decrease  certain types of maturities
of deposits. The Company has succeeded in growing its deposit base over the last
three years  despite  increasing  competition  for deposits in our markets.  The
Company  believes  that it has  benefited  from its local  identity and superior
customer service. Attracting deposits remains integral to the Company's business
as it is the primary  source of funds for loans and a major  decline in deposits
or failure to attract  deposits  in the future  could have an adverse  effect on
operations.

The following  table sets forth the average  balances for each major category of
deposits  and the  weighted  average  interest  rate paid for  deposits  for the
periods indicated.
<TABLE>
<CAPTION>

(dollars in thousands)                           2001         RATE          2000         RATE         1999         RATE
-----------------------------------------------------------------------------------------------------------------------

<S>                                        <C>               <C>        <C>            <C>        <C>             <C>
Demand deposits                            $   33,419        0.00%      $ 34,343       0.00%      $ 32,921        0.00%
Interest bearing demand deposits               26,949        2.09%        26,416       2.51%        31,980        2.51%
Savings deposits                               78,897        2.32%        82,850       3.65%        80,472        3.67%
Time deposits                                  75,819        5.20%        68,516       5.16%        65,524        5.00%

     Total                                 $  215,084        3.49%      $212,125       3.78%      $210,897        3.18%
</TABLE>



                                       25
<PAGE>

Maturities of time certificates of deposit as of December 31, 2001 are
summarized as follows:
<TABLE>
<CAPTION>

                                              Under                     Over
(dollars in thousands)                      $100,000                  $100,000                     Total
                                            --------                  --------                     -----
<S>                                       <C>                        <C>                       <C>
3 months or less                          $    14,453                $    7,596                $   22,049
Over 3 through 6 months                        12,386                     6,478                    18,864
Over 6 through 12 months                       10,297                     7,192                    17,489
Over 12 months                                  7,890                     5,187                    13,077
     Total                                     45,026                     6,453                    71,479
</TABLE>

SHORT-TERM BORROWINGS

The following is information regarding the Company's short-term borrowings for
the years ended December 31, 2001, 2000 and 1999.
<TABLE>
<CAPTION>

(dollars in thousands)                                                      2001               2000                1999
-----------------------------------------------------------------------------------------------------------------------

<S>                                                                           <C>           <C>                  <C>
Amount outstanding at end of period                                       $    0            $11,358             $ 9,675
Weighted average interest rate thereon                                         0%             6.39%               5.18%
Maximum amount outstanding at any month end during period                 $7,580            $11,358             $11,375
Average amounts outstanding during the period                                963              9,036               4,091
Weighted average interest rate during period                                5.68%              6.39%               5.18%
</TABLE>

KEY FINANCIAL RATIOS
<TABLE>
<CAPTION>

Year ended December 31,                          2001              2000             1999              1998             1997
---------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>              <C>               <C>              <C>               <C>
Return on average assets                        1.55%            1.34%             1.64%            1.80%             1.99%
Return on average equity                       15.57%           14.95%            17.26%           18.57%            19.70%
Average equity to average assets ratio          9.96%            8.96%             9.49%            9.69%            10.09%
Dividend payout ratio                             87%              97%               79%              60%               55%
</TABLE>

LIQUIDITY AND CAPITAL RESOURCES

Liquidity.  The primary  concern of depositors,  creditors and regulators is the
Company's   ability  to  have  sufficient  funds  readily   available  to  repay
liabilities as they mature.  In order to ensure  adequate funds are available at
all times,  the Company  monitors and projects the amount of funds required on a
daily basis. Through the Bank, the Company obtains funds from its customer base,
which provides a stable source of "core" demand and consumer deposits.

Other sources are available with  borrowings from the Federal Home Loan Bank and
correspondent banks.  Liquidity requirements can also be met through disposition
of short-term assets. In management's opinion, the Company maintains an adequate
level of liquid assets,  consisting of cash and due from banks, interest bearing
deposits  with  banks,  and  federal  funds sold to support  the daily cash flow
requirements.

Management  expects to  continue  to rely on  customer  deposits  as the primary
source  of  liquidity,  but may  also  obtain  liquidity  from  maturity  of its
investment  securities,  sale of securities  currently  available for sale,  net
income,  and other  borrowings.  Although deposit balances have shown historical
growth,  deposit  habits  of  customers  may be  influenced  by  changes  in the
financial  services  industry,  interest rates  available on other  investments,
general economic conditions,  consumer confidence,  and competition.  Borrowings
may be used on a short-term basis to compensate for reductions in deposits,  but
are  generally



                                       26
<PAGE>

not considered a long term solution to liquidity issues.  Therefore,  reductions
in deposits could adversely affect the Company's results of operations.

Capital.  The Company  endeavors to maintain equity capital at an adequate level
to support and promote  investor  confidence.  The Company conducts its business
through  the Bank.  Thus,  the Company  needs to be able to provide  capital and
financing to the Bank should the need arise.  The primary  sources for obtaining
capital are  additional  stock sales and retained  earnings.  Total  shareholder
equity  averaged  $24,451,000  in 2001,  compared  to  $22,090,000  in 2000,  an
increase of 10.7%, and $22,721,000 in 1999, a decrease of 2.8% compared to 1999.

The Company's Board of Directors considers financial results,  growth plans, and
anticipated  capital needs in formulating  its dividend  policy.  The payment of
dividends is subject to adequate  financial results of the Bank, and limitations
imposed by law and governmental regulations.

The Federal Reserve has established  guidelines that mandate  risk-based capital
requirements for bank holding companies.  Under the guidelines, one of four risk
weights  is  applied  to  balance  sheet  assets,  each with  different  capital
requirements based on the credit risk of the asset. The Company's capital ratios
include the assets of the Bank on a  consolidated  basis in accordance  with the
requirements of the Federal Reserve.  The Company's capital ratios have exceeded
the minimum  required to be classified  "well  capitalized" for each of the past
three years.

The following table sets forth the minimum required capital ratios and actual
ratios for December 31, 2001, 2000, and 1999.

<TABLE>
<CAPTION>
                                                                                          Capital
                                                                                         Adequacy
                                                Actual                                   Purposes
(dollars in thousands)                          Amount             Ratio         Amount                 Ratio
-------------------------------------------------------------------------------------------------------------
December 31, 2001
<S>                                          <C>                <C>           <C>                    <C>
Tier 1 capital (to average assets)             $23,106             9.49%         $9,738                 4.00%
Tier 1 capital (to risk-weighted                23,106            12.27%          7,459                 4.00%
  assets)
Total capital (to risk-weighted                 25,215            13.39%         14,918                 8.00%
  assets)

December 31, 2000
Tier 1 capital (to average assets)              22,934             9.19%          9,986                 4.00%
Tier 1 capital (to risk-weighted                22,934            12.05%          7,613                 4.00%
  assets)
Total capital (to risk-weighted                 24,960            13.11%         15,226                 8.00%
  assets)

December 31, 1999
Tier 1 capital (to average assets)             $22,390             9.28%         $9,646                 4.00%
Tier 1 capital (to risk-weighted                22,390            12.93%          6,929                 4.00%
  assets)
Total capital (to risk-weighted                 24,320            14.04%         13,857                 8.00%
  assets)
</TABLE>

                                       27
<PAGE>




ITEM 7A.  Quantitative and Qualitative Disclosure About Market Risk

The Company's  results of operations  are largely  dependent upon its ability to
manage  interest  rate risk.  Management  considers  interest  rate risk to be a
significant  market  risk that  could have a  material  effect on the  Company's
financial  condition and results of  operations.  The Company does not currently
use  derivatives to manage market and interest rate risks.  All of the Company's
transactions are denominated in U.S. dollars. Approximately 49% of the Company's
loans have interest rates that float with the Company's  reference  rate.  Fixed
rate loans generally are made with a term of five years or less.

In the Asset and Liability  section of the Management's  Discussion and Analysis
in  Item 7 is a table  presenting  estimated  maturity  or  pricing  information
indicating  the Company's  exposure to interest  changes.  The  assumptions  and
description  of the  process  used to  manage  interest  rate  risk  is  further
discussed in the Asset and Liability  Management  section.  The following  table
discloses the balances of the financial  instruments including the fair value as
of December 31, 2001.

The expected maturities are disclosed based on contractual schedules.  Principal
repayments are not considered. The expected maturities for financial liabilities
with no stated maturity  reflect  estimated  future roll-off rates. The roll-off
rates for non-interest bearing deposits, interest bearing demand deposits, money
market accounts,  and savings deposits are 15%, 25%, 25% and 20%,  respectively.
The interest rates  disclosed are based on rates in effect at December 31, 2001.
Fair values are used in accordance with generally accepted accounting principles
as disclosed in the financial statements.

<TABLE>
<CAPTION>


                                                               Expected Maturity
Year ended December 31, 2001                                                                         there                Fair
(dollars in thousands)                       2002       2003         2004       2005       2006      after      Total    Value
------------------------------------------------------------------------------------------------------------------------------
Financial Assets
  Cash and cash equivalents
<S>                                       <C>                                                                  <C>      <C>
      Non-interest bearing                $10,231       ----         ----       ----       ----       ----     10,231   10,231
      Interest bearing deposits in banks    1,468       ----         ----       ----       ----       ----      1,468    1,468
      Weighted average interest rate         1.87%
  Federal funds sold
      Fixed rate                            3,505       ----         ----       ----       ----       ----      3,505    3,505
      Weighted average interest rate         1.94%
  Securities available for sale
      Fixed rate                            8,889      3,825        5,088      3,535      2,540      6,801     30,678   30,678
      Weighted average interest rate         5.54%      6.15%        5.86%      6.47%      6.31%      6.16%
      Adjustable rate                        ----        995         ----       ----       ----       ----        995      995
      Weighted average interest rate                    2.05%
  Securities held to maturity
      Fixed rate                               14         10          481       ----        116      4,324      4,945    4,942
      Weighted average interest rate         5.88%      5.50%        3.80%                 6.11%      7.03%
  Loans receivable
      Fixed rate                           11,633      4,161        6,658      6,261      6,313     53,645     88,671   91,306
      Weighted average interest rate         8.09%      7.68%        8.76%      8.12%      7.58%      8.02%
      Adjustable rate                      76,866      1,063        7,983        537      1,284        200     87,933   87,933
      Weighted average interest rate         6.20%      7.85%        8.10%      7.77%      7.18%      6.35%
  Federal Home Loan Bank stock              3,813       ----         ----       ----       ----       ----      3,813    3,813
      Weighted average interest rate         7.00%
</TABLE>

                                       28
<PAGE>
<TABLE>
<CAPTION>

                                Expected Maturity
Year ended December 31, 2000                                                                         there                Fair
(dollars in thousands)                       2002       2003         2004       2005       2006      after      Total    Value
------------------------------------------------------------------------------------------------------------------------------
Financial Liabilities
<S>                                        <C>         <C>          <C>        <C>        <C>       <C>        <C>      <C>
  Non-interest bearing deposits          $  5,765      4,901        4,166      3,541      3,010     17,054     38,437   38,437
  Interest bearing checking accounts        6,781      5,086        3,815      2,861      2,145      6,437     27,125   27,125
      Weighted average interest rate          .89%       .89%         .89%       .89%       .89%       .89%
  Money Market accounts                     5,918      4,439        3,329      2,497      1,873      5,619     23,675   23,675
      Weighted average interest rate         1.22%      1.22%        1.22%      1.22%      1.22%      1.22%
  Savings accounts                         10,786      8,628        6,902      5,522      4,418     17,672     53,928   53,928
      Weighted average interest rate         1.17%      1.17%        1.17%      1.17%      1.17%      1.17%
  Certificates of deposit
      Fixed rate                           55,745     10,584        1,325        230        304       ----     68,188   68,458
      Weighted average interest rate         3.84%      4.17%        4.39%      4.82%      4.47%
      Variable rate                         3,291       ----         ----       ----       ----       ----      3,291    3,291
      Weighted average interest rate         3.08%
</TABLE>

As illustrated in the tables above, our balance sheet is currently  sensitive to
declining  interest rates,  meaning that more interest  earning assets mature or
re-price  than  interest  bearing  liabilities.  Therefore,  if  our  asset  and
liability  mix were to remain  unchanged,  and there was an  increase  in market
rates of  interest,  the  Company  would  expect  that its net  income  would be
positively  affected.  In contrast, a decreasing interest rate environment would
adversely  affect  such  income.   While  the  table  presented  above  provides
information about the Company's  interest  sensitivity,  it does not predict the
trends  of future  earnings.  For this  reason,  financial  modeling  is used to
forecast  earnings under varying interest rate  projections.  While this process
assists in managing interest rate risk, it does require significant  assumptions
for the projection of loan prepayments,  loan origination  volumes and liability
funding sources that may prove to be inaccurate.

ITEM 8.  Financial Statements and Supplementary Data

Information required for this item is included in Item 14 of this report.

ITEM  9. Changes  in and  disagreements  with  accountants  on  accounting  and
         financial disclosure

Form 8-K: A report on Form 8-K was filed on  September  6,  2001,  to report the
merger of Knight, Vale & Gregory PLLC, with McGladrey & Pullen LLP. Based on the
recommendation of the Company's Audit Committee, the Board of Directors approved
the engagement of McGladrey & Pullen LLP as its independent accountants.


                                    Part III

ITEM 10.  Directors and Executive Officers of the Registrant

Information  concerning  directors and executive officers requested by this item
is contained in the registrant's  2002 Proxy Statement in the sections  entitled
"MANAGEMENT-Certain   Executive   Officers,"  "Proposal  No.  1  -  Election  of
Directors,"  and  "Compliance  with Section  16(a) of the  Exchange  Act" and is
incorporated by reference herein.



                                       29
<PAGE>



ITEM 11.  Executive Compensation

Information   concerning  executive  compensation  requested  by  this  item  is
contained in the  registrant's  2002 Proxy  Statement  in the sections  entitled
"DIRECTOR'S  COMPENSATION"  and "EXECUTIVE  COMPENSATION"  (not including "Audit
Committee Report," "Report of the Compensation Committee" and "Stock Performance
Graph"), and is incorporated by reference herein.

ITEM 12.  Security Ownership of Certain Beneficial Owners and Management

Information  concerning  security  ownership  of certain  beneficial  owners and
management  requested by this item is contained in the  registrant's  2002 Proxy
Statement in the section  entitled  "MANAGEMENT - Security  Ownership of Certain
Beneficial Owners and Management," and is incorporated by reference herein.

ITEM 13.  Certain Relationships and Related Transactions

Information  concerning certain relationships and related transactions requested
by this item is  contained  in the  registrant's  2002  Proxy  Statement  in the
section entitled  "Compensation  Committee Interlocks and Insider Participation"
and is incorporated by reference herein.

                                     Part IV

ITEM 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) (1)  The following financial statements are filed below:
         Independent Auditors'Reports
         Consolidated Balance Sheets
         Consolidated Statements of Income
         Consolidated Statements of Stockholders' Equity
         Consolidated Statements of Cash Flows
         Notes to Consolidated Financial Statements

(a) (2)  Schedules:  None

(a) (3)  Exhibits:  See Exhibit Index immediately following the signature page.

(b)      Reports on Form 8-K:  None


                                       30

<PAGE>

Contents
--------------------------------------------------------------------------------


Independent Auditors' Reports..............................................32-33


Consolidated Financial Statements

Consolidated Balance Sheets...................................................34

Consolidated Statements of Income.............................................35

Consolidated Statements of Shareholders' Equity...............................36

Consolidated Statements of Cash Flows......................................37-38

Notes to Consolidated Financial Statements.................................39-60


                                       31

<PAGE>
                          Independent Auditor's Report



Board of Directors
Pacific Financial Corporation
Aberdeen, Washington


We have audited the accompanying consolidated balance sheet of Pacific Financial
Corporation and Subsidiary as of December 31, 2001, and the related consolidated
statements  of  income,  shareholders'  equity  and cash flows for the year then
ended.  These  consolidated  financial  statements are the responsibility of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
consolidated financial statements based on our audit.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of Pacific Financial
Corporation  and  Subsidiary  as of December 31, 2001,  and the results of their
operations  and their cash flows for the year then  ended,  in  conformity  with
accounting principles generally accepted in the United States of America.

/s/ McGladrey & Pullen, LLP
MCGLADREY & PULLEN, LLP

Tacoma, Washington
January 31, 2002
                                       32
<PAGE>

                          Independent Auditors' Report


Board of Directors
Pacific Financial Corporation
Aberdeen, Washington

We  have  audited  the  accompanying  consolidated  balance  sheets  of  Pacific
Financial  Corporation  and Subsidiary as of December 31, 2000 and 1999, and the
related consolidated  statements of income,  shareholders' equity and cash flows
for each of the  three  years in the  period  ended  December  31,  2000.  These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of Pacific Financial
Corporation  and Subsidiary as of December 31, 2000 and 1999, and the results of
their  operations and their cash flows for each of the three years in the period
ended  December 31, 2000,  in  conformity  with  generally  accepted  accounting
principles.

/s/ Knight Vale & Gregory PLLC
KNIGHT VALE & GREGORY PLLC
Tacoma, Washington
January 26, 2001

                                       33

<PAGE>



<TABLE>
<CAPTION>

Consolidated Balance Sheets
--------------------------------------------------------------------------------
(Dollars in Thousands)

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000

                                                                                            2001                 2000
Assets
<S>                                                                                        <C>                <C>
     Cash and due from banks                                                               $  10,231            $  8,619
     Interest bearing deposits at other financial institutions                                 1,468                 480
     Federal funds sold                                                                        3,505                 570
     Securities available for sale                                                            31,673              53,696
     Securities held to maturity (market value $4,942 and $1,376)                              4,945               1,376
     Federal Home Loan Bank stock, at cost                                                     3,813               3,562

     Loans                                                                                   176,604             177,168
     Allowance for credit losses                                                               2,109               2,026
                                                                                           ---------           ---------
     Loans - net                                                                             174,495             175,142

     Premises and equipment                                                                    4,014               4,122
     Foreclosed real estate                                                                    1,040                   -
     Accrued interest receivable                                                               1,405               2,302
     Cash surrender value of life insurance                                                    5,579               2,435
     Other assets                                                                              1,449               1,009
                                                                                            --------            --------
     Total assets                                                                           $243,617            $253,313
                                                                                            ========            ========

Liabilities and Shareholders' Equity

Liabilities
     Deposits:
       Demand                                                                              $  38,437           $  32,510
       Savings and interest-bearing demand                                                   104,728             100,143
       Time                                                                                   71,479              80,858
                                                                                            --------            --------
     Total deposits                                                                          214,644             213,511

     Accrued interest payable                                                                    441                 779
     Short-term borrowings                                                                         -              11,358
     Other liabilities                                                                         5,018               4,922
                                                                                            --------            --------
     Total liabilities                                                                       220,103             230,570
                                                                                            --------            --------

Commitments and Contingencies                                                                      -                   -

Shareholders' Equity
     Common stock (par value $1); authorized:  25,000,000 shares;
       issued and outstanding:  2001 - 2,491,629 shares; 2000 - 2,503,130 shares               2,492               2,503
     Additional paid-in capital                                                                9,524               9,859
     Retained earnings                                                                        11,090              10,572
     Accumulated other comprehensive income (loss)                                               408                (191)
                                                                                            --------            --------
     Total shareholders' equity                                                               23,514              22,743
                                                                                            --------            --------

     Total liabilities and shareholders' equity                                             $243,617            $253,313
                                                                                            ========            ========

</TABLE>

See notes to consolidated financial statements.
                                       34

<PAGE>
Consolidated Statements of Income
--------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)

Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
                                                                        2001                 2000                  1999

Interest Income
<S>                                                                     <C>                 <C>                 <C>
     Loans                                                               $14,994             $16,425             $14,062
     Federal funds sold and deposits in banks                                410                 148                 570
     Securities available for sale:
       Taxable                                                             1,638               2,812               2,767
       Tax exempt                                                            545                 567                 675
     Securities held to maturity - tax exempt                                264                  98                 108
     Federal Home Loan Bank stock dividends                                  251                 222                 172
                                                                        --------            --------            --------
     Total interest income                                                18,102              20,272              18,354
                                                                        --------            --------            --------

Interest Expense
     Deposits                                                              6,340               8,020               6,712
     Short-term borrowings                                                   190                 577                 212
                                                                        --------            --------            --------
     Total interest expense                                                6,530               8,597               6,924
                                                                        --------            --------            --------

     Net interest income                                                  11,572              11,675              11,430

Provision for Credit Losses                                                  580                 635                  60
                                                                        --------            --------            --------

     Net interest income after provision for credit losses                10,992              11,040              11,370

Non-Interest Income
     Service charges on deposit accounts                                     828                 677                 745
     Mortgage broker fees                                                     32                   9                  36
     Net gain on sales of securities available for sale                        -                   -                   9
     Other operating income                                                  669                 531                 465
                                                                        --------            --------            --------
     Total non-interest income                                             1,529               1,217               1,255

Non-Interest Expense
     Salaries and employee benefits                                        4,058               4,135               3,871
     Occupancy                                                               409                 388                 367
     Equipment                                                               554                 751                 646
     State taxes                                                             227                 228                 235
     Data processing                                                         214                 229                  97
     Other                                                                 1,731               1,799               1,795
                                                                        --------            --------            --------
     Total non-interest expense                                            7,193               7,530               7,011
                                                                        --------            --------            --------

     Income before income taxes                                            5,328               4,727               5,614

Income Taxes                                                               1,521               1,424               1,692
                                                                        --------            --------            --------

     Net income                                                         $  3,807            $  3,303            $  3,922
                                                                        ========            ========            ========


Earnings Per Share
     Basic                                                                 $1.53               $1.33               $1.60
     Diluted                                                                1.52                1.31                1.59

</TABLE>

See notes to consolidated financial statements.
                                       35

<PAGE>
Consolidated Statements of Shareholders' Equity
--------------------------------------------------------------------------------
(Dollars in Thousands)

Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
                                                                                               Accumulated
                                          Shares of                   Additional               Other
                                          Common       Common         Paid-in     Retained     Comprehensive
                                          Stock        Stock          Capital     Earnings     Income (Loss)
Total

<S>                                          <C>        <C>           <C>        <C>           <C>                 <C>
Balance at December 31, 1998                 488,969    $  489        $10,972    $  9,656      $  368              $21,485

Comprehensive income:
    Net income                                     -         -              -       3,922           -                3,922
    Other comprehensive loss,
       net of tax:
          Change in fair value of
             securities available for sale         -         -              -           -      (1,320)              (1,320)
    Comprehensive income                                                                                             2,602

Stock options exercised                        8,000         8            472           -           -                  480
Repurchase of common stock
    fractional shares                           (199)        -            (24)          -           -                  (24)
Dividends on common stock
    ($1.25 per share)                              -         -              -      (3,105)          -               (3,105)
    ------                                    ------    ------         ------      ------      ------               ------

    Balance at December 31, 1999             496,770       497         11,420      10,473        (952)              21,438

Comprehensive income:
    Net income                                     -         -              -       3,303           -                3,303
    Other comprehensive income,
       net of tax:
          Change in fair value of
             securities available for sale         -         -              -           -         761                  761
    Comprehensive income                                                                                             4,064

5-for-1 stock split                        1,987,110     1,987         (1,987)          -           -                    -
Stock options exercised                        2,750         3             30           -           -                   33
Stock purchase of branch site                 16,500        16            396           -           -                  412
Dividends on common stock
    ($1.28 per share)                              -         -              -      (3,204)          -               (3,204)

    Balance at December 31, 2000           2,503,130     2,503          9,859      10,572        (191)              22,743

Comprehensive income:
    Net income                                    -          -              -       3,807           -                3,807
    Other comprehensive income,
       net of tax:
          Change in fair value of
             securities available for sale        -          -              -           -         599                  599
    Comprehensive income                                                                                             4,406

Stock options exercised                       12,750        13            150           -           -                  163
Repurchase of common stock                   (24,281)      (24)          (486)          -           -                 (510)
Issuance of common stock                          30         -              1           -           -                    1
Dividends on common stock
    ($1.32 per share)                              -         -              -      (3,289)          -               (3,289)
                                           ---------   -------       --------     -------      ------              -------
    Balance at December 31, 2001           2,491,629   $ 2,492       $  9,524     $11,090      $  408              $23,514
                                           =========   =======       ========     =======      ======              =======
</TABLE>
See notes to consolidated financial statements.
                                       36
<PAGE>

Consolidated Statements of Cash Flows
--------------------------------------------------------------------------------
(Dollars in Thousands)

Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
                                                                           2001                2000             1999
Cash Flows from Operating Activities

<S>                                                                        <C>                 <C>              <C>
     Net income                                                            $  3,807            $  3,303         $  3,922
     Adjustments to reconcile net income to net cash
       provided by operating activities:
          Depreciation and amortization                                         423                 568              496
          Provision for credit losses                                           580                 635               60
          Deferred income tax (benefit)                                         225                 (81)             (34)
          Stock dividends received                                             (251)               (222)            (172)
          Gain on sales of securities available for sale                        - -                 - -               (9)
          Gain (loss) on sales of foreclosed real estate                        - -                 (32)               2
          (Increase) decrease in interest receivable                            897                (298)            (140)
          Increase (decrease) in interest payable                              (338)                230               66
          Write down of foreclosed real estate                                   18                 - -              - -
          Other - net                                                          (915)                485             (229)
                                                                               ----                 ---             ----
     Net cash provided by operating activities                                4,446               4,588            3,962
                                                                              -----               -----            -----

Cash Flows from Investing Activities
     Net (increase) decrease in interest bearing deposits in banks             (988)              1,264            4,645
     Net increase in federal funds sold                                      (2,935)               (570)          12,595
     Activity in securities available for sale:
       Sales                                                                 10,694                 - -            1,478
       Maturities, prepayments and calls                                     36,987              12,062           27,560
       Purchases                                                            (24,828)             (2,423)         (43,322)
     Activity in securities held to maturity:
       Maturities                                                               190                 239              210
       Purchases                                                             (1,123)                - -             (100)
     Proceeds from sales of loans                                             1,407               1,293              468
     Increase in loans made to customers, net of principal collections       (5,165)            (26,133)          (5,921)
     Purchases of premises and equipment                                       (509)               (764)            (310)
     Proceeds from sales of premises and equipment                               50                 - -              - -
     Proceeds from sales of foreclosed real estate                              161                 - -               26
     Purchase of bank owned life insurance                                   (3,000)                - -              - -
                                                                             ------              ------           ------
     Net cash provided by (used in) investing activities                     10,941             (15,032)          (2,671)
                                                                             ------             -------           ------

Cash Flows from Financing Activities
     Net increase (decrease) in deposits                                      1,133               7,372           (4,511)
     Net increase (decrease) in short-term borrowings                       (11,358)              1,683            9,589
     Proceeds from issuance of long-term debt                                 3,000                 - -              - -
     Repayments of long-term debt                                            (3,000)                - -              - -
     Common stock issued                                                        164                  33              480
     Cash dividends paid                                                     (3,204)             (3,105)          (2,379)
     Repurchase of common stock and fractional shares                          (510)                - -              (24)
                                                                               ----                ----              ---
     Net cash provided by (used in) financing activities                    (13,775)              5,983            3,155
                                                                            -------               -----            -----

     Net change in cash and due from banks                                    1,612              (4,461)           4,446

Cash and Due from Banks
     Beginning of year                                                        8,619              13,080            8,634
                                                                              -----              ------            -----

     End of year                                                            $10,231            $  8,619          $13,080
                                                                            =======            ========          =======
</TABLE>
(continued)
See notes to consolidated financial statements.
                                       37
<PAGE>
Consolidated Statements of Cash Flows
--------------------------------------------------------------------------------
(concluded) (Dollars in Thousands)

Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
                                                                              2001                2000           1999

Supplemental Disclosures of Cash Flow Information
<S>                                                                            <C>                 <C>            <C>
     Interest paid                                                             $6,868              $8,367         $6,858
     Income taxes paid                                                          1,375               1,247          1,750

Supplemental Disclosures of Non-Cash Investing Activities
     Fair value adjustment of securities available for sale, net of tax       $   599                $761        ($1,320)
     Transfer of loans to foreclosed real estate                                1,733                  26             74
     Stock purchase of branch site                                                - -                 412            - -
     Financed sales of foreclosed real estate                                     514                 235            - -
     Reclassification of loan receivable to securities available for sale       2,636                 - -            - -
</TABLE>
See notes to consolidated financial statements.
                                       38
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 1 - Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated  financial statements include the accounts of Pacific Financial
Corporation  (the  Company)  and its wholly  owned  subsidiary,  The Bank of the
Pacific (the Bank). All significant intercompany  transactions and balances have
been eliminated.

Nature of Operations

The Company is a holding company which operates primarily through its subsidiary
bank.  The Bank  operates  ten  branches  located in Grays  Harbor,  Pacific and
Wahkiakum  Counties in western  Washington.  The Bank  provides loan and deposit
services to customers, who are predominately small- and middle-market businesses
and middle-income individuals in western Washington.

Consolidated Financial Statement Presentation

The  consolidated  financial  statements  have been prepared in accordance  with
generally  accepted  accounting  principles  and  practices  within the  banking
industry.   The  preparation  of  consolidated   financial  statements  requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, and the disclosure of contingent assets and liabilities,
as of the date of the balance  sheet,  and the reported  amounts of revenues and
expenses  during the reporting  period.  Actual  results could differ from those
estimates.  Material estimates that are particularly  susceptible to significant
change in the near term relate to the  determination of the allowance for credit
losses and the valuation of foreclosed real estate and deferred tax assets.

Certain  prior  year  amounts  have been  reclassified  to  conform  to the 2001
presentation.  All dollar amounts,  except per share information,  are stated in
thousands.

Securities Available for Sale

Securities  available  for sale consist of debt  securities,  marketable  equity
securities  and  mutual  funds that the Bank  intends to hold for an  indefinite
period,  but  not  necessarily  to  maturity.  Such  securities  may be  sold to
implement the Bank's  asset/liability  management  strategies and in response to
changes in interest rates and similar  factors,  and certain equity  securities.
Securities  available for sale are reported at fair value.  Unrealized gains and
losses,  net of the related deferred tax effect, are reported as a net amount in
a  separate  component  of  shareholders'  equity  entitled  "accumulated  other
comprehensive  income (loss)." Realized gains and losses on securities available
for sale, determined using the specific  identification  method, are included in
earnings.  Amortization of premiums and accretion of discounts are recognized in
interest income over the period to maturity.

(continued)
                                       39
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 1 - Summary of Significant Accounting Policies (continued)

Securities Held to Maturity

Debt  securities  for which the Company has the  positive  intent and ability to
hold to maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts,  which are recognized in interest income over the period
to maturity.

Declines  in the fair  value  of  individual  securities  held to  maturity  and
available  for sale below  their cost that are other  than  temporary  result in
write-downs of the individual  securities to their fair value.  Such write-downs
are included in earnings as realized losses.

Loans

Loans are stated at the amount of unpaid principal,  reduced by an allowance for
credit losses.  Interest on loans is accrued daily based on the principal amount
outstanding.

Generally the accrual of interest on loans is discontinued when, in management's
opinion,  the borrower may be unable to meet payments as they become due or when
they are past due 90 days as to either  principal or  interest,  unless they are
well  secured  and in the  process  of  collection.  When  interest  accrual  is
discontinued, all unpaid accrued interest is reversed against current income. If
management determines that the ultimate collectibility of principal is in doubt,
cash receipts on nonaccrual  loans are applied to reduce the principal  balance.
The interest on these loans is accounted  for on the  cash-basis  method,  until
qualifying for return to accrual.  Loans are returned to accrual status when all
the principal and interest  amounts  contractually  due are brought  current and
future payments are reasonably assured.

Allowance for Credit Losses

The allowance for credit losses is maintained at a level considered  adequate to
provide for estimated  losses on existing  loans based on  evaluating  known and
inherent risks in the loan portfolio.  The allowance is reduced by loans charged
off, and  increased by  provisions  charged to earnings and  recoveries on loans
previously  charged  off.  The  allowance  is  based on  management's  periodic,
systematic  evaluation of factors  underlying the quality of the loan portfolio,
including  changes  in the  size and  composition  of the  loan  portfolio,  the
estimated  value of any  underlying  collateral,  actual  loan loss  experience,
current economic conditions, and detailed analysis of individual loans for which
full collectibility may not be assured. This evaluation is inherently subjective
as it requires  estimates that are  susceptible to significant  revision as more
information  becomes  available.  While  management  uses the  best  information
available to make its  estimates,  future  adjustments  to the  allowance may be
necessary if there is a significant change in economic conditions.

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

(continued)
                                       40
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000

Note 1 - Summary of Significant Accounting Policies (continued)

Allowance for Credit Losses (concluded)

When management determines that it is probable that a borrower will be unable to
repay all amounts due  according to the terms of the loan  agreement,  including
scheduled interest payments, the loan is considered impaired. Factors considered
by management in  determining  impairment  include  payment  status,  collateral
value,  and the  probability  of  collecting  scheduled  principal  and interest
payments  when due.  Loans  that  experience  insignificant  payment  delays and
payment  shortfalls  are  generally  not  classified  as  impaired.   Management
determines  the  significance  of payment  delays and  payment  shortfalls  on a
case-by-case   basis,   taking  into  consideration  all  of  the  circumstances
surrounding  the loan and the borrower,  including the length of the delay,  the
reasons for the delay,  the borrower's  prior payment record,  and the amount of
shortfall  in  relation  to the  principal  and  interest  owed.  The  amount of
impairment is measured based on the present value of expected  future cash flows
discounted at the loan's effective  interest rate or, when the primary source of
repayment  is  provided  by real  estate  collateral,  at the fair  value of the
collateral less estimated selling costs.

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

Premises and Equipment

Premises and equipment are stated at cost less accumulated  depreciation,  which
is computed on a  straight-line  method over the  estimated  useful lives of the
assets.  Leasehold  improvements  are amortized over the terms of the respective
leases or the  estimated  useful lives of the  improvements,  whichever is less.
Gains or losses on dispositions are reflected in earnings.

Foreclosed Real Estate

Real estate properties  acquired through,  or in lieu of,  foreclosure are to be
sold  and are  initially  recorded  at the  lower  of cost or fair  value of the
properties less estimated costs of disposal. Any write-down to fair value at the
time of  transfer  to other real estate  owned is charged to the  allowance  for
credit losses.  Properties  are evaluated  regularly to ensure that the recorded
amounts  are  supported  by  their  current  fair  values,  and  that  valuation
allowances to reduce the carrying  amounts to fair value less estimated costs to
dispose are recorded as necessary.  Any subsequent reductions in carrying values
are charged to income.

Transfers of Financial Assets

Transfers of financial  assets are  accounted for as sales when control over the
assets has been  surrendered.  Control over  transferred  assets is deemed to be
surrendered  when (1) the  assets  have been  isolated  from the  Bank,  (2) the
transferee  obtains the right (free of conditions  that constrain it from taking
advantage of that right) to pledge or exchange the transferred  assets,  and (3)
the Bank does not maintain effective control over the transferred assets through
an agreement to repurchase them before their maturity.

(continued)
                                       41
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000

Note 1 - Summary of Significant Accounting Policies (continued)

Income Taxes

Deferred  tax  assets  and  liabilities  result  from  differences  between  the
financial   statement   carrying  amounts  and  the  tax  bases  of  assets  and
liabilities,  and are reflected at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be
realized or settled.  The  deferred  tax  provision  represents  the  difference
between the net deferred tax  asset/liability  at the  beginning  and end of the
year.  As  changes  in tax laws or rates are  enacted,  deferred  tax assets and
liabilities are adjusted through the provision for income taxes.

The Bank provides for income taxes  separately and remits to the Company amounts
currently due.

Stock-Based Compensation

The Company  accounts for  stock-based  awards to employees  using the intrinsic
value method,  in  accordance  with APB No. 25,  Accounting  for Stock Issued to
Employees.  Accordingly,  no  compensation  expense has been  recognized  in the
financial statements for employee stock arrangements.  However, the required pro
forma  disclosures of the effects of all options  granted on or after January 1,
1995  have  been  provided  in  accordance  with SFAS No.  123,  Accounting  for
Stock-Based Compensation.

Fair Values of Financial Instruments

The following methods and assumptions were used by the Company in estimating the
fair values of financial instruments disclosed in these financial statements:

          Cash and Short-Term Instruments
          The carrying  amounts of cash and short-term  instruments  approximate
          their fair value.

          Securities  Available  for Sale and Held to  Maturity
          Fair values for securities are based on quoted market prices.

          Federal Home Loan Bank Stock
          The carrying  value of Federal Home Loan Bank stock  approximates  its
          fair value.

          Loans
          For  variable  rate  loans  that  reprice   frequently   and  have  no
          significant  change in credit risk,  fair values are based on carrying
          values.   Fair  values  for  fixed  rate  loans  are  estimated  using
          discounted  cash flow analyses,  using interest rates  currently being
          offered for loans with similar  terms to  borrowers of similar  credit
          quality.  Fair  values  of loans  held  for  sale  are  based on their
          estimated market prices.  Fair values for impaired loans are estimated
          using discounted cash flow analyses or underlying  collateral  values,
          where applicable.

(continued)
                                       42
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000

Note 1 - Summary of Significant Accounting Policies (continued)

Fair Values of Financial Instruments (concluded)

          Deposits
          The fair values  disclosed  for demand  deposits  are, by  definition,
          equal to the amount  payable on demand at the reporting date (that is,
          their carrying amounts).  The carrying amounts of variable rate, fixed
          term money market  accounts and  certificates  of deposit  approximate
          their fair values at the  reporting  date.  Fair values for fixed rate
          certificates  of deposit are  estimated  using a discounted  cash flow
          calculation based on interest rates currently being offered on similar
          certificates.

          Short-Term Borrowings
          The carrying  amounts of federal funds purchased and other  short-term
          borrowings maturing within 90 days approximate their fair values. Fair
          values of other  short-term  borrowings are estimated using discounted
          cash flow analyses based on the Bank's current  incremental  borrowing
          rates for similar types of borrowing arrangements.

          Accrued Interest
          The  carrying  amounts  of  accrued  interest  approximate  their fair
          values.

          Off-balance Sheet Instruments
          The fair value of commitments to extend credit and standby  letters of
          credit was estimated  using the fees  currently  charged to enter into
          similar  agreements,  taking into account the  remaining  terms of the
          agreements and the present creditworthiness of the customers.

Cash and Cash Equivalents

The Company  considers all amounts  included in the balance sheets caption "Cash
and due from banks" to be cash equivalents.

The Company  maintains  balances in depository  institution  accounts  which, at
times, may exceed federally insured limits.  The Company has not experienced any
losses in such accounts.

Earnings Per Share

Basic  earnings  per share  exclude  dilution  and are  computed by dividing net
income by the weighted  average  number of common  shares  outstanding.  Diluted
earnings per share  reflect the  potential  dilution  that could occur if common
shares were issued pursuant to the exercise of options under the Company's stock
option plans.

(continued)
                                       43
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 1 - Summary of Significant Accounting Policies (concluded)

Recent Accounting Pronouncements

In June  2001,  the  Financial  Accounting  Standards  Board  adopted  Financial
Accounting  Standards Nos. 141,  Business  Combinations,  and 142,  Goodwill and
Other Intangible  Assets.  SFAS No. 141 requires that all business  combinations
entered  into after June 30, 2001 be accounted  for under the  purchase  method.
SFAS No. 142  addresses  how  goodwill  and other  intangible  assets  should be
accounted  for  after  they  have  been  initially  recorded  in  the  financial
statements.  Goodwill arising from business  combinations prior to the effective
date of this standard will no longer be amortized, starting in 2002, but will be
subject to annual tests for impairment.  Other  identifiable  intangible assets,
and certain unidentifiable  intangible assets arising from certain acquisitions,
will  continue to be amortized  using the same lives and methods.  In June 2001,
the FASB also issued SFAS No. 143, Accounting for Asset Retirement  Obligations.
This statement  addresses  financial  accounting  and reporting for  obligations
associated with the retirement of tangible  long-lived assets and the associated
asset  retirement  costs.  This  statement  is  effective  for all fiscal  years
beginning  after June 15,  2002.  In August  2001 the FASB  issued SFAS No. 144,
Accounting  for the Impairment or Disposal of Long-Lived  Assets.  The statement
addresses  financial  accounting and reporting for the impairment or disposal of
long-lived assets.  This statement is effective for fiscal years beginning after
December 15, 2001.  The Company  does not  anticipate  that the adoption of SFAS
Nos.  141,  142,  143,  and 144 will have a  material  effect  on its  financial
position or results of operations.


Note 2 - Restricted Assets

Federal  Reserve  Board  regulations  require  that the Bank  maintains  certain
minimum  reserve  balances in cash and on deposit with the Federal Reserve Bank.
The average  amounts of such balances for the years ended  December 31, 2001 and
2000 were approximately $2,878 and $2,575, respectively.


Note 3 - Securities

Investment securities have been classified according to management's intent. The
carrying amounts of securities and their approximate fair value are as follows:
<TABLE>
<CAPTION>
                                                                                  Gross          Gross
                                                               Amortized          Unrealized     Unrealized      Fair
                                                               Cost               Gains          Losses          Value

Securities Available for Sale

December 31, 2001
<S>                                                            <C>                <C>           <C>             <C>
     U.S. Treasury and Government agency securities            $  3,517           $134          $   -           $  3,651
     Obligations of states and political subdivisions            11,359            355              1             11,713
     Mortgage-backed securities                                   3,255             22             56              3,221
     Corporate bonds                                              8,859            170             14              9,015
     Mutual funds                                                 4,065              8              -              4,073
                                                                -------           ----           ----            -------

                                                               $ 31,055           $689            $71            $31,673
                                                                =======           ====            ===            =======
</TABLE>

(continued)
                                       44
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 3 - Securities (concluded)
<TABLE>
<CAPTION>
                                                                                  Gross           Gross
                                                               Amortized          Unrealized      Unrealized     Fair
                                                               Cost               Gains           Losses         Value

December 31, 2000
<S>                                                             <C>              <C>               <C>           <C>
     U.S. Treasury and Government agency securities             $28,324          $  18             $229          $28,113
     Obligations of states and political subdivisions            12,110            122               54           12,178
     Corporate bonds                                             13,552             18              165           13,405
                                                                -------           ----             ----          -------

                                                                $53,986           $158             $448          $53,696
                                                                =======           ====             ====          =======

Securities Held to Maturity

December 31, 2001
     State and municipal securities                              $4,945           $  -             $  3           $4,942

December 31, 2000
     State and municipal securities                              $1,376           $  -             $  -           $1,376
</TABLE>

The  contractual  maturities  of  investment  securities  held to  maturity  and
available for sale at December 31, 2001 are as follows:
<TABLE>
<CAPTION>
                                                     Held to Maturity                       Available for Sale

                                                     Amortized           Fair               Amortized             Fair
                                                     Cost                Value              Cost                  Value

<S>                                                 <C>                 <C>                 <C>                 <C>
Due in one year or less                             $     15            $     15            $  4,829            $  4,919
Due from one year to five years                          613                 610              13,357              13,745
Due from five to ten years                               595                 595               2,897               2,973
Due after ten years                                    3,722               3,722               1,135               1,147
Mortgage-backed securities                               - -                 - -               4,772               4,816
Mutual funds                                             - -                 - -               4,065               4,073
                                                      ------              ------             -------             -------

     Total                                            $4,945              $4,942             $31,055             $31,673
                                                      ======              ======             =======             =======
</TABLE>

Gross gains realized on sales of securities was $9 in 1999. There were no
security sales in 2001 and 2000.

Securities carried at approximately $11,618 at December 31, 2001 and $11,401 at
December 31, 2000 were pledged to secure public deposits and for other purposes
required or permitted by law.

                                       45
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 4 - Loans

Loans at December 31 consist of the following:
<TABLE>
<CAPTION>
                                                                           2001                 2000

<S>                                                                       <C>                 <C>
Commercial and agricultural                                               $  72,427           $  68,827
Real estate:
     Construction                                                             6,554               6,118
     Residential 1-4 family                                                  31,089              31,611
     Multi-family                                                             2,040               3,495
     Commercial                                                              54,894              59,236
     Farmland                                                                 3,691               1,992
Consumer                                                                      5,909               5,889
                                                                           --------            --------
                                                                           $176,604            $177,168
                                                                           ========            ========
</TABLE>

Changes in the allowance for credit losses for the years ended December 31 are
as follows:
<TABLE>
<CAPTION>
                                                                          2001                2000                1999

<S>                                                                       <C>                 <C>                 <C>
Balance at beginning of year                                              $2,026              $1,930              $1,864
Provision for credit losses                                                  580                 635                  60

Charge-offs                                                                 (564)               (568)               (134)
Recoveries                                                                    67                  29                 140
                                                                               -                   -                   -
     Net (charge-offs) recoveries                                           (497)               (539)                  6
                                                                          ------              ------              ------
     Balance at end of year                                               $2,109              $2,026              $1,930
                                                                          ======              ======              ======

Following is a summary of information pertaining to impaired loans:

                                                                          2001                2000                 1999

December 31
     Impaired loans without a valuation allowance                        $   482              $2,014                $175
     Impaired loans with a valuation allowance                             1,180               1,114                 - -
                                                                           -----               -----
     Total impaired loans                                                 $1,662              $3,128                $175
                                                                          ======              ======                ====

     Valuation allowance related to impaired loans                          $143                $412                $- -
                                                                            ====                ====                ====

Years Ended December 31
     Average investment in impaired loans                                 $1,262              $3,425                 $59
     Interest income recognized on a cash basis on impaired loans              2                  31                  11

(continued)
</TABLE>
                                       46
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 4 - Loans (concluded)

At December 31, 2001,  there were no  commitments  to lend  additional  funds to
borrowers  whose loans have been  modified.  Loans 90 days and over past due and
still  accruing  interest  totaled $79 and $292 at  December  31, 2001 and 2000,
respectively.

Certain  related  parties  of  the  Company,  principally  directors  and  their
associates,  were loan customers of the Bank in the ordinary  course of business
during 2001 and 2000.  Total loans  outstanding at December 31, 2001 and 2000 to
key officers and directors  were $2,390 and $2,751,  respectively.  During 2001,
new loans of $1,668 were made, and repayments totaled $2,029.


Note 5 - Premises and Equipment

The components of premises and equipment at December 31 are as follows:
<TABLE>
<CAPTION>
                                                                                             2001                 2000

<S>                                                                                           <C>                 <C>
Land                                                                                          $1,125              $1,125
Premises                                                                                       3,884               3,733
Equipment, furniture and fixtures                                                              4,026               4,297
                                                                                               -----               -----
                                                                                               9,035               9,155
Less accumulated depreciation and amortization                                                 5,021               5,033
                                                                                               -----               -----
     Total premises and equipment                                                             $4,014              $4,122
                                                                                              ======              ======

The Company purchased the property at its Montesano Branch in 2000 for 16,500
shares of the Company's stock.
</TABLE>


Note 6 - Deposits

The composition of deposits at December 31 is as follows:
<TABLE>
<CAPTION>
                                                                                           2001                  2000

<S>                                                                                        <C>                 <C>
Demand deposits, non-interest bearing                                                      $  38,437           $  32,510
NOW and money market accounts                                                                 50,799              46,047
Savings deposits                                                                              53,929              54,112
Time certificates, $100,000 or more                                                           26,453              30,645
Other time certificates                                                                       45,026              50,197
                                                                                            --------            --------
     Total                                                                                  $214,644            $213,511
                                                                                            ========            ========

</TABLE>

(continued)
                                       47
<PAGE>
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 6 - Deposits (concluded)

Scheduled  maturities of certificates of deposit are as follows for future years
ending December 31:

     2002                                               $58,402
     2003                                                11,219
     2004                                                 1,325
     2005                                                   230
     2006                                                   303
     ----                                               -------
                                                        $71,479
                                                        =======


Note 7 - Short-Term Borrowings

Short-term  borrowings  generally  mature  within  one to  four  days  from  the
transaction date.  Information concerning short-term borrowings is summarized as
follows for the years ended December 31:

                                                   2001                2000

Average balance during the year                    $  963             $ 9,036
Average interest rate during the year                5.68%               6.39%
Maximum month-end balance during the year          $7,580             $11,358
Balance outstanding at year-end                    $    -             $11,358
Average interest rate at year-end                       -%               6.39%


Note 8 - Income Taxes

Income taxes are comprised of the following for the years ended December 31:
<TABLE>
<CAPTION>
                                              2001                 2000                1999

<S>                                            <C>                 <C>                 <C>
Current                                        $1,296              $1,505              $1,726
Deferred (benefit)                                225                 (81)                (34)
                                               ------              ------              ------
     Total income taxes                        $1,521              $1,424              $1,692
                                               ======              ======              ======

</TABLE>

(continued)
                                       48
<PAGE>


Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 8 - Income Taxes (concluded)

The tax effects of temporary  differences that give rise to significant portions
of deferred tax assets and liabilities at December 31 are:
<TABLE>
<CAPTION>
                                                                            2001                2000

Deferred Tax Assets
<S>                                                                         <C>                 <C>
     Allowance for credit losses                                            $  626              $  597
     Deferred compensation                                                     230                 247
     Unrealized loss on securities available for sale                          - -                  98
     Other                                                                      70                 164
                                                                                --                 ---
     Total deferred tax assets                                                 926               1,106

Deferred Tax liabilities
     Unrealized gain on securities available for sale                          210                 - -
     Depreciation                                                               68                  37
     Deferred revenue                                                        1,045                 933
                                                                             -----                 ---
     Total deferred tax liabilities                                          1,323                 970
                                                                             -----                 ---

     Net deferred tax assets (liabilities)                                 ($  397)             $  136
                                                                           =======              ======

The following is a reconciliation between the statutory and effective federal
income tax rate for the years ended December 31:
</TABLE>

<TABLE>
<CAPTION>

                                        2001                           2000                       1999
                                                       Percent                       Percent                   Percent
                                                       of Pre-tax                    of Pre-tax                of Pre-tax
                                        Amount         Income          Amount        Income       Amount       Income

<S>                                      <C>            <C>            <C>           <C>           <C>          <C>
Income tax at statutory rate             $1,865         35.0%          $1,654        35.0%         $1,965       35.0%
Adjustments resulting from:
     Tax-exempt income                     (272)        (5.1)            (236)       (5.0)           (261)      (4.6)
     Net earnings on life insurance
       policies                             (26)         (.5)             (36)        (.7)            (35)       (.6)
     Non-deductible merger costs            - -          - -              - -         - -             106        1.9
     Other                                  (46)         (.8)              42          .9             (83)      (1.6)
                                            ---                            --                         ---

     Total income tax expense            $1,521         28.6%          $1,424        30.2%         $1,692       30.1%
                                         ======                        ======                      ======
</TABLE>
                                       49
<PAGE>


Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 9 - Employee Benefits

Incentive Compensation Plan

The Bank has a plan that provides incentive compensation to key employees if the
Bank meets certain performance  criteria  established by the Board of Directors.
The  cost of this  plan  was  $355,  $490  and  $622 in  2001,  2000  and  1999,
respectively.

401(k) Plans

The Bank has  established a 401(k) profit  sharing plan for those  employees who
meet the eligibility  requirements set forth in the plan. Eligible employees may
contribute up to 15% of their compensation.  Matching  contributions by the Bank
are at the discretion of the Board of Directors. Contributions totaled $115, $94
and $95 for 2001, 2000 and 1999, respectively.

Director and Employee Deferred Compensation Plans

The Company has director and employee  deferred  compensation  plans.  Under the
terms of the plans, a director or employee may participate  upon approval by the
Board.  The participant may then elect to defer a portion of his or her earnings
(directors'  fees or salary) as  designated  at the beginning of each plan year.
Payments begin upon retirement, termination, death or permanent disability, sale
of the Company,  the ten-year  anniversary  of the  participant's  participation
date, or at the discretion of the Company.  There are currently two participants
in the plans. Total deferrals plus earnings were $304, $297 and $327 at December
31, 2001,  2000 and 1999,  respectively.  There is no expense to the Company for
this plan.

The  directors  of a bank  acquired by the Company in 1999  adopted two deferred
compensation  plans  for  directors  -- one  plan  providing  retirement  income
benefits for all directors and the other, a deferred compensation plan, covering
only those  directors who have chosen to participate in the plan. At the time of
adopting these plans,  the Bank  purchased life insurance  policies on directors
participating  in both plans  which may be used to fund  payments  to them under
these plans.  Cash surrender  values on these policies were $2,555 and $2,435 at
December  31,  2001 and 2000,  respectively.  In 2001,  2000 and  1999,  the net
(benefit)/cost recorded from these plans, including the cost of the related life
insurance,  was  ($143),  $30 and ($3),  respectively.  Both of these plans were
fully funded and frozen as of September 30, 2000. Plan  participants  were given
the  option to  either  remain in the plan  until  reaching  the age of 70 or to
receive a lump sum  distribution.  Participants  electing  to remain in the plan
will receive  annual  payments over a ten-year  period upon reaching 70 years of
age.

(continued)
                                       50
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 9 - Employee Benefits (concluded)

Qualified Non-Contributory Defined Benefit Plan

The  Company  maintained  a  non-contributory   defined  benefit  plan  covering
substantially all employees of the former Bank of the Pacific,  which was frozen
and terminated on December 31, 2000. The Bank made annual  contributions  to the
plan equal to the amount  accrued for pension  expenses,  which were invested in
shares of  registered  investment  companies.  Final funding of the plan did not
occur  until  2001  upon  receipt  of plan  administrator  distribution  totals.
Contributions  of  $149,  $312  and  $33  were  made in  2001,  2000  and  1999,
respectively.

Non-Qualified Deferred Compensation Plan

The Company has a  non-qualified  deferred  compensation  plan to cover selected
employees. Its annual contributions to the plan totaled $8, $22 and $19 in 2001,
2000 and 1999, respectively.  Covered employees may also contribute to the plan.
The plan was terminated in early 2001.


Note 10 - Commitments and Contingencies

The Bank is party to financial  instruments with  off-balance-sheet  risk in the
normal course of business to meet the financing needs of their customers.  These
financial  instruments  include commitments to extend credit and standby letters
of credit, and involve, to varying degrees, elements of credit risk in excess of
the amount recognized in the balance sheets.

The Bank's exposure to credit loss in the event of  nonperformance  by the other
party to the financial  instrument for  commitments to extend credit and standby
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit  policies in making  commitments  and  conditional
obligations as they do for on-balance-sheet instruments. A summary of the Bank's
commitments at December 31 is as follows:

                                             2001                 2000

Commitments to extend credit                 $23,262             $18,480
Standby letters of credit                      1,688               1,763

Commitments  to extend  credit are  agreements  to lend to a customer as long as
there is no violation of any condition  established in the contract.  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's  experience has been that  approximately 67% of loan commitments is drawn
upon by customers.  The Bank evaluates  each  customer's  creditworthiness  on a
case-by-case  basis. The amount of collateral  obtained,  if deemed necessary by
the Bank upon extension of credit, is based on management's credit evaluation of
the  party.  Collateral  held  varies,  but  may  include  accounts  receivable,
inventory, property and equipment, residential real estate, and income-producing
commercial properties.

(continued)
                                       51
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 10 - Commitments and Contingencies (concluded)

Standby  letters of credit  are  conditional  commitments  issued by the Bank to
guarantee the performance of a customer to a third party.  Those  guarantees are
primarily  issued to support  public and  private  borrowing  arrangements.  The
credit risk  involved in issuing  letters of credit is  essentially  the same as
that involved in extending loan facilities to customers.  Collateral held varies
as specified above, and is required in instances where the Bank deems necessary.

Certain executive officers have entered into employment  contracts with the Bank
which provide for contingent payments subject to future events.

The Bank has  agreements  with  commercial  banks for  lines of credit  totaling
$11,500, none of which was used at December 31, 2001. In addition,  the Bank has
a credit line with the Federal Home Loan Bank of Seattle totaling 10% of assets,
none of which was used at December 31, 2001. These borrowings are collateralized
under blanket pledge agreements.

Because  of the  nature of its  activities,  the  Company  is subject to various
pending and  threatened  legal  actions  which arise in the  ordinary  course of
business.  In the opinion of management,  liabilities arising from these claims,
if any,  will  not have a  material  effect  on the  financial  position  of the
Company.


Note 11 - Significant Concentrations of Credit Risk

Most of the Bank's business activity is with customers and governmental entities
located in the State of Washington, including investments in state and municipal
securities.  Loans are generally limited by state banking  regulations to 20% of
the Bank's  shareholder's  equity,  excluding  accumulated  other  comprehensive
income  (loss).  As of December  31, 2001 the Bank's  loans to  companies in the
hotel\motel  industry totaled $20,956 or 11.87% of total loans.  Standby letters
of credit were granted primarily to commercial borrowers.  The Bank, as a matter
of practice, generally does not extend credit to any single borrower or group of
borrowers in excess of $4 million.

                                       52
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 12 - Stock Options

At December 31, 2001, the Company had options outstanding or available for grant
under three  stock-based  option plans,  which are described  below. The Company
applies APB Opinion No. 25 and related  interpretations  in accounting for these
plans. Accordingly,  no compensation cost has been recognized for the plans. Had
compensation  cost for the Company's stock option plans been determined based on
the fair value at the grant dates for awards  granted  since  December  31, 1994
under these plans, consistent with the method of SFAS No. 123, the Company's net
income  and  earnings  per  share  would  have been  reduced  to these pro forma
amounts:
<TABLE>
<CAPTION>
                                                  2001                 2000                1999

Net income:
<S>                                                <C>                 <C>                 <C>
     As reported                                   $3,807              $3,303              $3,922
     Pro forma                                      3,794               3,280               3,917

Earnings per share:
     Basic:
       As reported                                  $1.53               $1.33               $1.60
       Pro forma                                     1.52                1.32                1.60
     Diluted:
       As reported                                   1.52                1.31                1.59
       Pro forma                                     1.51                1.30                1.58
</TABLE>

The Company's three stock  incentive plans provide for granting  incentive stock
options,  as defined under current tax laws, to key personnel and under the plan
adopted in 2000,  options not  qualified  for  favorable tax treatment and other
types of stock based awards.  Under the first plan,  options are  exercisable 90
days from the date of grant. These options terminate if not exercised within ten
years from the date of grant.  If after six years  from the date of grant  fewer
than 20% of the options have been  exercised,  they will expire at a rate of 20%
annually.  Under the second plan, the options are  exercisable one year from the
date of grant,  at a rate of 10%  annually.  Options  terminate if not exercised
when they become  available,  and no additional  grants will be made under these
two plans. The plan adopted in 2000, authorizes the issuance of up to a total of
500,000  shares,  (374,000 shares are available for grant at December 31, 2001).
Options become  exercisable  ratably over five years.  Under the plan adopted in
2000,  the Company may grant up to 75,000 shares of its common stock to a single
individual in a calendar year.

The fair value of each option granted in 2001 and 1999 was estimated on the date
of  grant,  based on the  Black-Scholes  option  pricing  model  and  using  the
following weighted-average assumptions. There were no options granted in 2000.

                                         2001                    1999

Dividend yield                           5.76%                   4.63%
Expected life                            10 years                10 years
Risk-free interest rate                  4.92 - 5.19%             6.6%

The weighted average fair value of options granted during 2001 and 1999 were $0
and $2.87, respectively.

(continued)
                                       53
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 12 - Stock Option (concluded)

A summary of the status of the  Company's  stock option plans as of December 31,
2001,  2000 and 1999,  and changes  during the years ending on those  dates,  is
presented below:
<TABLE>
<CAPTION>
                                         2001                          2000                         1999
                                                       Weighted                    Weighted                    Weighted
                                                       Average                     Average                     Average
                                                       Exercise                    Exercise                    Exercise
                                        Shares         Price          Shares       Price          Shares       Price

<S>                                       <C>           <C>           <C>          <C>             <C>          <C>
Outstanding at beginning of year          74,550        $18.21        78,550       $18.13          93,550       $13.14
Granted                                  126,000         22.22             -            -          25,000        27.00
Exercised                                (12,750)        12.82        (2,750)       12.00         (40,000)       12.00
Forfeited                                 (3,500)        25.63        (1,250)       27.00             - -         - -
                                          ------                      ------                       ------
     Outstanding at end of year          184,300        $21.19        74,550       $18.21          78,550       $18.13
                                         =======                      ======                       ======
Exercisable at end of year                32,165        $14.40        34,030       $13.65          13,390       $12.00

</TABLE>

The following information summarizes information about stock options outstanding
and exercisable at December 31, 2001:
<TABLE>
<CAPTION>
                                                                         Weighted
                                                                         Average
                                                                         Remaining
                    Exercise              Number                         Contractual                Number
                    Price                 Outstanding                    Life (Years)               Exercisable

<S>                  <C>                     <C>                         <C>                          <C>
                     $12.00                  1,000                       3                            1,000
                      13.00                  9,500                       4                            9,500
                      14.40                  4,000                       5                            4,000
                      15.29                 23,550                       5                           17,665
                      22.22                124,500                       9                              - -
                      23.25                    500                       9                              - -
                      27.00                 21,250                       8                              - -
                                           -------                                                   ------
                                           184,300                                                   32,165
                                           =======                                                   ======
</TABLE>

Note 13 - Stock Transactions

In June 2000, the Board of Directors effected a 5-for-1 stock split. In
addition, Board of Directors approved an increase in the number of authorized
common shares from 5,000,000 to 25,000,000.

Per share information for prior periods has been adjusted to reflect the effect
of the stock split.

                                       54
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 14 - Regulatory Matters

The Company and the Bank are subject to various regulatory capital  requirements
administered  by the 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 on the regulatory  framework for prompt corrective  action,  the Bank
must  meet  specific  capital  adequacy  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
classification is also subject to qualitative  judgments by the regulators about
components, risk weightings and other factors.

Quantitative  measures  established  by  regulation to ensure  capital  adequacy
require the Company  and the Bank to  maintain  minimum  amounts and ratios (set
forth in the table below) of Tier 1 capital (as defined in the  regulations)  to
total  average  assets  (as  defined),  and  minimum  ratios of Tier 1 and total
capital (as defined) to risk-weighted assets (as defined).

As of December 31, 2001, the most recent  notification from the Bank's regulator
categorized  the Bank as well  capitalized  under the  regulatory  framework for
prompt corrective  action. To be categorized as well capitalized,  the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set  forth in the  table.  There  are no  conditions  or  events  since  that
notification that management believes have changed the institution's category.

The Company and the Bank's actual capital  amounts and ratios are also presented
in the table.  Management believes, as of December 31, 2001, the Company and the
Bank meet all capital requirements to which they are subject.
<TABLE>
<CAPTION>
                                                                                                  To be Well Capitalized
                                                                                                  Under Prompt
                                                                         Capital Adequacy         Corrective Action
                                                Actual                   Purposes                 Provisions
                                                Amount       Ratio       Amount        Ratio      Amount            Ratio

December 31, 2001
     Tier 1 capital (to average assets):
<S>                                             <C>           <C>        <C>           <C>         <C>
       Consolidated                             $23,106       9.49%      $  9,738      4.0%            N/A            N/A
       Bank                                      23,077       9.48          9,738      4.0         $12,173           5.0%
     Tier 1 capital (to risk-weighted assets):
       Consolidated                              23,106      12.27          7,459      4.0             N/A            N/A
       Bank                                      23,077      12.02          7,681      4.0          11,521           6.0
     Total capital (to risk-weighted assets):
       Consolidated                              25,215      13.39         14,918      8.0             N/A            N/A
       Bank                                      25,186      13.12         15,362      8.0          19,202          10.0
</TABLE>

(continued)
                                       55
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 14 - Regulatory Matters (concluded)

<TABLE>
<CAPTION>
                                                                                                To be Well Capitalized
                                                                                                Under Prompt
                                                                       Capital Adequacy         Corrective Action
                                                Actual                 Purposes                 Provisions
                                                Amount       Ratio     Amount        Ratio      Amount             Ratio

December 31, 2000
     Tier 1 capital (to average assets):
<S>                                             <C>           <C>     <C>            <C>         <C>             <C>
       Consolidated                             $22,934       9.19%   $  9,986       4.00%           N/A            N/A
       Bank                                      22,895       9.17       9,986       4.00        $12,482           5.00%
     Tier 1 capital (to risk-weighted assets):
       Consolidated                              22,934      12.05       7,613       4.00            N/A            N/A
       Bank                                      22,895      12.35       7,413       4.00         11,120           6.00
     Total capital (to risk-weighted assets):
       Consolidated                              24,960      13.11      15,226       8.00            N/A            N/A
       Bank                                      24,921      13.45      14,827       8.00         18,533          10.00
</TABLE>

Restrictions on Retained Earnings

The Bank is restricted from paying dividends to the Company in an amount that
would violate the most restrictive capital requirement shown above. At December
31, 2001, there were no regulatory dividend restrictions on the Bank's retained
earnings.


Note 15 - Fair Values of Financial Instruments

The estimated fair values of the Company's financial instruments at December 31
are as follows:
<TABLE>
<CAPTION>
                                                   2001                                     2000
                                                   Carrying            Fair                 Carrying         Fair
                                                   Amount              Value                Amount           Value

Financial Assets
     Cash and due from banks,
       interest-bearing deposits with
<S>                                                <C>                 <C>                <C>                 <C>
       banks, and federal funds sold               $  15,204           $  15,204          $    9,669          $    9,669
     Securities available for sale                    31,673              31,673              53,696              53,696
     Securities held to maturity                       4,945               4,942               1,376               1,376
     Federal Home Loan Bank stock                      3,813               3,813               3,562               3,562
     Loans receivable                                174,495             177,569             175,142             175,375
     Accrued interest receivable                       1,405               1,405               2,302               2,302

Financial Liabilities
     Deposits                                       $214,644            $216,096            $213,511            $213,682
     Short-term borrowings                               - -                 - -              11,358              11,358
     Accrued interest payable                            441                 441                 779                 779
</TABLE>

                                       56

<PAGE>


Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 16 - Earnings Per Share Disclosures

Following is information regarding the calculation of basic and diluted earnings
per share for the years indicated.
<TABLE>
<CAPTION>

                                                               Net Income            Shares                   Per Share
                                                               (Numerator)           (Denominator)             Amount

Year Ended December 31, 2001
Basic earnings per share:
<S>                                                             <C>                   <C>                       <C>
       Net income                                               $3,807                2,491,426                 $1.53
     Effect of dilutive securities:
       Options                                                       -                   18,576                  (.01)
     Diluted earnings per share:                                ------                ---------                 -----
       Net income                                               $3,807                2,510,002                 $1.52
                                                                ======                =========                 =====
Year Ended December 31, 2000
Basic earnings per share:
       Net income                                               $3,303                2,492,326                 $1.33
     Effect of dilutive securities:
       Options                                                       -                   20,493                  (.02)
     Diluted earnings per share:                                ------                ---------                 -----
       Net income                                               $3,303                2,512,819                 $1.31
                                                                ======                =========                 =====
Year Ended December 31, 1999
Basic earnings per share:
       Net income                                               $3,922                2,447,729                 $1.60
     Effect of dilutive securities:
       Options                                                       -                   23,783                  (.01)
     Diluted earnings per share:                                ------                ---------                 -----
       Net income                                               $3,922                2,471,512                 $1.59
                                                                ======                =========                 =====

</TABLE>

The number of shares shown for "options" is the number of incrementional  shares
that would  result  from the  exercise  of options  and use of the  proceeds  to
repurchase shares at the average market price during the year.


                                       57
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 17 - Condensed Financial Information - Parent Company Only

Condensed Balance Sheets - December 31
<TABLE>
<CAPTION>
                                                                                             2001                 2000

Assets
<S>                                                                                         <C>                 <C>
     Cash                                                                                   $  3,317            $     66
     Investment in the Bank                                                                   23,485              22,703
     Due from the Bank                                                                             -               3,178
                                                                                            --------            --------
     Total assets                                                                           $ 26,802            $ 25,947
                                                                                            ========            ========

Liabilities and Shareholders' Equity
     Dividends payable                                                                      $  3,288            $  3,204
     Shareholders' equity                                                                     23,514              22,743
                                                                                            --------            --------
     Total liabilities and shareholders' equity                                             $ 26,802            $ 25,947
                                                                                            ========            ========

</TABLE>

Condensed Statements of Income - Years Ended December 31
<TABLE>
<CAPTION>

                                                                          2001                2000                 1999

<S>                                                                       <C>                 <C>                 <C>
Dividend income from the Bank                                             $3,670              $3,275              $3,010

Expenses                                                                     (46)               (151)               (377)

Equity in undistributed income of the Bank                                   183                 179               1,289
                                                                          ------              ------              ------
     Net income                                                           $3,807              $3,303              $3,922
                                                                          ======              ======              ======

</TABLE>

(continued)

                                       58
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 17 - Condensed Financial Information - Parent Company Only (concluded)

Condensed Statements of Cash Flows - Years Ended December 31
<TABLE>
<CAPTION>

                                                                         2001                 2000                 1999

Operating Activities
<S>                                                                       <C>                 <C>                 <C>
     Net income                                                           $3,807              $3,303              $3,922
     Adjustments to reconcile net income to
       net cash provided by operating activities:
          Equity in undistributed income of subsidiary                      (183)               (179)             (1,289)
          Other - net                                                         (1)                 57                  20
                                                                               -                   -                   -
     Net cash provided by operating activities                             3,623               3,181               2,653
                                                                           -----               -----               -----
Investing Activities
     (Increase) decrease in due from the Bank                              3,178              (1,794)                  -
                                                                           -----              ------               -----

Financing Activities
     Common stock issued                                                     164                  33                 480
     Dividends paid                                                       (3,204)             (3,105)             (2,379)
     Repurchase of common stock and fractional shares                       (510)                  -                 (24)
                                                                          ------              ------              ------
     Net cash used in financing activities                                (3,550)             (3,072)             (1,923)
                                                                          ------              ------              ------
     Net increase (decrease) in cash                                       3,251              (1,685)                730

Cash
     Beginning of year                                                        66               1,751               1,021
                                                                          ------             -------              ------
     End of year                                                          $3,317             $    66              $1,751
                                                                          ======             =======              ======
</TABLE>

                                       59
<PAGE>

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

Pacific Financial Corporation and Subsidiary
December 31, 2001 and 2000


Note 18 - Quarterly Data (Unaudited)
<TABLE>
<CAPTION>
                                                     First                Second             Third              Fourth
                                                     Quarter              Quarter            Quarter            Quarter

Year Ended December 31, 2001
<S>                                                   <C>                 <C>                 <C>               <C>
     Interest income                                  $4,985              $4,671              $4,401            $4,045
     Interest expense                                  2,151               1,766               1,539             1,074
                                                       -----               -----               -----             -----
     Net interest income                               2,834               2,905               2,862             2,971

     Provision for credit losses                         102                  98                  98               282

     Noninterest income                                  314                 346                 442               427
     Noninterest expenses                              1,808               1,759               1,761             1,866
                                                       -----               -----               -----             -----
     Income before income taxes                        1,238               1,394               1,445             1,250

     Income taxes                                        361                 429                 399               332
                                                      ------              ------              ------            ------
     Net income                                       $  877              $  965              $1,046            $  918
                                                      ======              ======              ======            ======
     Earnings per common share:
       Basic                                           $0.35               $0.39               $0.42             $0.37
       Diluted                                          0.35                0.38                0.42              0.36


Year Ended December 31, 2000
     Interest income                                  $4,849              $5,099              $5,133            $5,191
     Interest expense                                  1,915               2,096               2,224             2,362
                                                       -----               -----               -----             -----
     Net interest income                               2,934               3,003               2,909             2,829

     Provision for credit losses                          53                  52                  98               432

     Noninterest income                                  356                 305                 304               252
     Noninterest expense                               1,746               1,738               1,723             2,323
                                                       -----               -----               -----             -----

     Income before income taxes                        1,491               1,518               1,392               326

     Income taxes                                        467                 442                 444                71
                                                         ---                 ---                 ---                --
     Net income                                       $1,024              $1,076              $  948            $  255
                                                      ======              ======              ======            ======


     Earnings per common share:
       Basic                                          $  0.41             $ 0.43               $0.38            $ 0.11
       Diluted                                           0.41               0.43                0.38              0.09
</TABLE>

                                       60
<PAGE>


SIGNATURES

Pursuant to the  requirements  of Section 13 or 15(d) of the  Exchange  Act, the
registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereunto duly authorized, on the 21st day of March, 2002.

                                           PACIFIC FINANCIAL CORPORATION
                                                (Registrant)


/s/ Dennis A. Long                         /s/ John Van Dijk
---------------------------------          ---------------------------------
Dennis A. Long, President and CEO          John Van Dijk, Secretary

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the  following  persons on behalf of the  registrant in
the capacities indicated, on the 21st day of March, 2002.

Principal Executive Officer                Principal Financial and Accounting
                                           Officer

/s/ Dennis A. Long                         /s/ John Van Dijk
---------------------------------          ---------------------------------
Dennis A. Long, President and CEO          John Van Dijk, Treasurer (CFO)
                and Director

Remaining Directors

                                           /s/ Sidney R. Snyder
---------------------------------          ---------------------------------
Joseph A. Malik (Chairman of the Board)    Sidney R. Snyder

/s/ Gary C. Forcum                         /s/ Duane E. Hagstrom
---------------------------------          ---------------------------------
Gary C. Forcum                             Duane E. Hagstrom

/s/ Walter L. Westling                     /s/ Robert A. Hall
---------------------------------          ---------------------------------
Walter L. Westling                         Robert A. Hall

/s/ David L. Woodland                      /s/ Robert J. Worrell
---------------------------------          ---------------------------------
David L. Woodland                          Robert J. Worrell

/s/ Susan C. Freese                        /s/ Randy W. Rognlin
---------------------------------          ---------------------------------
Susan C. Freese                            Randy W. Rognlin


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<PAGE>


                                  Exhibit Index

EXHIBIT NO.                EXHIBIT
-----------------          ------------

3.1                        Restated Articles of Incorporation (1)
3.2                        Bylaws (2)
10                         Executive Compensation Plans and Arrangements and
                           Other Management Contracts
10.1                       Employment Agreement for Dennis A. Long (3)
10.2                       Employment Agreement for John Van Dijk (3)
10.3                       Bank of the Pacific Incentive Stock Option Plan (4)
10.4                       The Bank of Grays Harbor Incentive Stock
                           Option Plan (4)
10.5                       2000 Stock Incentive Compensation Plan (5)
10.6                       Bonus Program for Officers (5)
10.7                       The Bank of Grays Harbor Employee Deferred
                           Compensation Plan (6)
21                         Subsidiaries of Registrant - Bank of the Pacific,
                           organized under Washington law
23.1                       Consent of McGladrey & Pullen, LLP, Independent
                           Auditors
23.2                       Consent of Knight Vale & Gregory PLLC, Independent
                           Auditors
99                         Description of common stock of the Company (7)


(1)  Incorporated by reference to Exhibit 3.2 to the Company's  Quarterly Report
on Form 10-Q for the quarter ended June 30, 2000.

(2)  Incorporated  by  reference  to Exhibit 2b to Form 8-A filed by the Company
and declared effective on March 7, 2000 (Registration No. 000-29829)

(3)  Incorporated  by  reference to Exhibits  10.3 and 10.6 of the  Registration
Statement  on Form S-4 filed by the Company and  declared  effective on November
10, 1999 (Registration No. 333-86687).

(4)  Incorporated by reference to Exhibits 10.7 and 10.8 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999.

(5)  Incorporated  by  reference  to  Exhibits  10.1 and  10.2 to the  Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2000.

(6)  Incorporated by  reference to Exhibit 10.10  to the Company's Annual Report
on Form 10-K for the year ended December 31, 2000.

(7)  Incorporated by reference to  Exhibit 99 to the Company's  Quarterly Report
on Form 10-Q for the quarter ended September 30, 2000.


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