**UNITED STATES****SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

 

**FORM 10-Q**

 
| **(mark one)**                                    |                                                                                    |
|---------------------------------------------------|-----------------------------------------------------------------------------------------|
| **ý**                                        | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                              |                                                                                    |
| **For the quarterly period ended June 30,  2003** |
|                                              |                                                                                    |
| **OR**                                            |
|                                              |                                                                                    |
| **o**                                             | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

For the transition period from          to         

 

Commission File Number **    0-24024**

 

 

**Venture Financial Group, Inc.**(Exact name of registrant as specified in its charter)

 

 

| **Washington**                    |   | **91-1277503**                       |
|-----------------------------------|--------|--------------------------------------|
| (State or other jurisdiction      |   | (IRS Employer Identification Number) |
| of incorporation or organization) |   |                                 |

 

 

**721 College Street. SE, P.O. Box 3800, Lacey,WA  98509**(Address of principal executive offices)

 

 

Issuer’s telephone number:    **(360)459-1100**

 

 

**First CommunityFinancial Group, Inc.**(Former name, former address and former fiscal year, if changed since lastreport)

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the past 12 months (or for such shorter periods that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days:  ý Yes  o No

 

Indicateby check mark whether the registrant is an accelerated filer (as defined byRule 12b-2 of the Exchange Act)  oYes  ý No

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock as of the latest practicable date.

 

| **Title of Class** |   | **Outstanding at July 22, 2003** |
|--------------------|--------|----------------------------------|
| Common Stock       |   | 4,344,240                        |

 

** **

----

 

**Venture Financial Group, Inc.**

** **

Table of Contents

 

 
| PART I - FINANCIAL INFORMATION |                                                                                        |
|--------------------------------|---------------------------------------------------------------------------------------------|
|                           |                                                                                        |   |
| Item 1                         | Financial Statements                                                                        |   |
|                           | Condensed Consolidated Balance Sheets                                                       |   |
|                           | Condensed Consolidated Statements of Income  and Comprehensive Income                       |   |
|                           | Condensed Consolidated Statement of Stockholders’  Equity                              |   |
|                           | Condensed Consolidated Statements of Cash  Flows                                            |   |
|                           | Notes to Condensed Consolidated Financial  Statements                                       |   |
|                           |                                                                                        |   |
| Item 2                         | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|                           |                                                                                        |   |
| Item 3                         | Quantitative and Qualitative Disclosures  about Market Risk                                 |   |
|                           |                                                                                        |   |
| Item 4                         | Disclosure Controls and Procedures                                                          |   |
|                           |                                                                                        |   |
| PART II - OTHER INFORMATION    |                                                                                        |
|                           |                                                                                        |   |
| Item 4                         | Submission of Matters to a Vote of Security  Holders                                        |   |
|                           |                                                                                        |   |
| Item 6                         | Exhibits and Reports on Form 8-K                                                            |   |
|                           |                                                                                        |   |
| SIGNATURES                     |                                                                                        |

 

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**VENTURE FINANCIAL GROUP, INC. andSUBSIDIARIES**

Condensed Consolidated Balance Sheets (Unaudited)

 
|                                                                                                           |   | **June 30** |        | **December 31** |   |
|----------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|-----------------|--------|
| ***(Dollars in thousands)***                                                                                   |   | **2003**    |        | **2002**        |   |
|                                                                                                           |   |        |        |            |   |
| **Assets**                                                                                                     |   |        |        |            |   |
| Cash and due from banks                                                                                        |   | $           | 31,281      |            | $      | 30,965 |   |
| Interest bearing deposits in banks                                                                             |   | 593         |        | 76              |   |
| Federal funds sold                                                                                             |   | 6,100       |        | 7,000           |   |
| Securities available for sale                                                                                  |   | 32,554      |        | 33,622          |   |
| Securities held to maturity                                                                                    |   | 505         |        | 505             |   |
| FHLB Stock                                                                                                     |   | 1,124       |        | 877             |   |
| Loans held for sale                                                                                            |   | 11,825      |        | 7,432           |   |
|                                                                                                           |   |        |        |            |   |
| Loans                                                                                                          |   | 355,829     |        | 362,132         |   |
| Allowance for credit losses                                                                                    |   | 8,178       |        | 7,947           |   |
| **Net loans**                                                                                                  |   | **347,651** | ** **  | **354,185**     |   |
|                                                                                                           |   |        |        |            |   |
| Premises and equipment                                                                                         |   | 11,614      |        | 11,141          |   |
| Foreclosed real estate                                                                                         |   | 8,520       |        | 4,899           |   |
| Accrued interest receivable                                                                                    |   | 1,766       |        | 1,884           |   |
| Cash surrender value of life insurance                                                                         |   | 9,070       |        | 8,863           |   |
| Intangible assets                                                                                              |   | 11,653      |        | 11,708          |   |
| Other assets                                                                                                   |   | 1,832       |        | 1,293           |   |
|                                                                                                           |   |        |        |            |   |
| **Total assets**                                                                                               |   | **$**       | **476,088** | ** **      | **$**  | **474,450** |   |
|                                                                                                           |   |        |        |            |   |
| Liabilities                                                                                                    |   |        |        |            |   |
| Deposits:                                                                                                      |   |        |        |            |   |
| Demand                                                                                                         |   | $           | 80,824      |            | $      | 82,267 |   |
| Savings and interest bearing demand                                                                            |   | 166,881     |        | 156,031         |   |
| Time deposits                                                                                                  |   | 128,365     |        | 145,909         |   |
| **Total deposits**                                                                                             |   | **376,070** | ** **  | **384,207**     |   |
|                                                                                                           |   |        |        |            |   |
| Short term borrowing                                                                                           |   | 19,135      |        | 16,547          |   |
| Long term debt                                                                                                 |   | 29,000      |        | 24,000          |   |
| Accrued interest payable                                                                                       |   | 472         |        | 315             |   |
| Other liabilities                                                                                              |   | 5,848       |        | 5,172           |   |
| **Total liabilities**                                                                                          |   | **430,525** | ** **  | **430,241**     |   |
|                                                                                                           |   |        |        |            |   |
| **Stockholders’ Equity**                                                                                  |   |        |        |            |   |
| Common stock, (no par value); 10,000,000  shares authorized, shares issued: 2003 - 4,342,002; 2002 - 4,389,236 |   | 26,342      |        | 28,430          |   |
| Retained earnings                                                                                              |   | 18,542      |        | 15,246          |   |
| Accumulated other comprehensive income, net  of tax                                                            |   | 679         |        | 533             |   |
| **Total stockholders’ equity**                                                                            |   | **45,563**  | ** **  | **44,209**      |   |
|                                                                                                           |   |        | ** **  |            |   |
| **Total liabilities and stockholders’ equity**                                                            |   | **$**       | **476,088** | ** **      | **$**  | **474,450** |   |

 

*See notes to condensed consolidated financialstatements*

 

3

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**VENTURE FINANCIAL GROUP, INC. andSUBSIDIARIES**

Condensed Consolidated Statements of Income and Comprehensive Income(Unaudited)

 
|                                                                        |   | **Three months ended** |       | **Six months ended** |       |
|-----------------------------------------------------------------------------|--------|------------------------|------------|----------------------|------------|
|                                                                        |   | **June 30**            |       | **June 30**          |       |
| ***(Dollars in thousands, except per  share amounts)***                     |   | **2003**               |       | **2002**             |       | **2003** |   | **2002** |   |
| **Interest income**                                                         |   |                   |       |                 |       |   |   |   |   |
| Loans                                                                       |   | $                      | 7,788      |                 | $          | 6,689 |   | $ | 15,671 |   | $ | 13,318 |   |
| Federal funds sold and deposits in banks                                    |   | 28                     |       | 2                    |       | 30 |   | 4 |   |
| Investments                                                                 |   | 348                    |       | 304                  |       | 699 |   | 609 |   |
| **Total interest income**                                                   |   | **8,164**              | ** ** | **6,995**            | ** ** | **16,400** | ** ** | **13,931** |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| **Interest Expense**                                                        |   |                   |       |                 |       |   |   |   |   |
| Deposits                                                                    |   | 1,169                  |       | 1,383                |       | 2,429 |   | 3,028 |   |
| Other                                                                       |   | 381                    |       | 81                   |       | 739 |   | 152 |   |
| **Total interest expense**                                                  |   | **1,550**              | ** ** | **1,464**            | ** ** | **3,168** | ** ** | **3,180** |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| **Provision for credit losses**                                             |   | **622**                | ** ** | **364**              | ** ** | **1,199** | ** ** | **985** |   |
| **Net interest income after provision**                                     |   |                   | ** ** |                 | ** ** |   | ** ** |   |   |
| **For credit losses**                                                       |   | **5,992**              | ** ** | **5,167**            | ** ** | **12,033** | ** ** | **9,766** |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| **Non-interest income**                                                     |   |                   |       |                 |       |   |   |   |   |
| Service charges on deposit accounts                                         |   | 935                    |       | 749                  |       | 1,855 |   | 1,472 |   |
| Mortgage loans sold                                                         |   | 990                    |       | 496                  |       | 1,848 |   | 1,053 |   |
| Other operating income                                                      |   | 524                    |       | 583                  |       | 1,312 |   | 1,119 |   |
| **Total non-interest income**                                               |   | **2,449**              | ** ** | **1,828**            | ** ** | **5,015** | ** ** | **3,644** |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| **Non-interest expense**                                                    |   |                   |       |                 |       |   |   |   |   |
| Salaries and employee benefits                                              |   | 3,065                  |       | 2,370                |       | 6,211 |   | 4,635 |   |
| Occupancy and equipment                                                     |   | 915                    |       | 585                  |       | 1,718 |   | 1,227 |   |
| Other expense                                                               |   | 1,671                  |       | 1,636                |       | 3,702 |   | 3,188 |   |
| **Total non-interest expense**                                              |   | **5,651**              | ** ** | **4,591**            | ** ** | **11,631** | ** ** | **9,050** |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| **Operating income before income taxes**                                    |   | **2,790**              | ** ** | **2,404**            | ** ** | **5,417** | ** ** | **4,360** |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| Income Taxes                                                                |   | 836                    |       | 760                  |       | 1,681 |   | 1,370 |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| **Net income**                                                              |   | **$**                  | **1,954**  | ** **           | **$**      | **1,644** | ** ** | **$** | **3,736** | ** ** | **$** | **2,990** |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| **Other comprehensive income, net of tax:**                                 |   |                   |       |                 |       |   |   |   |   |
| Unrealized holding gains (losses) on  securities arising during the period  |   | 179                    |       | (88                  | )          | 146 |   | (352 | ) |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| **Comprehensive Income**                                                    |   | **$**                  | **2,133**  | ** **           | **$**      | **1,556** | ** ** | **$** | **3,882** | ** ** | **$** | **2,638** |   |
|                                                                        |   |                   | ** ** |                 | ** ** |   | ** ** |   |   |
| **Earnings per Share Data**                                                 |   |                   | ** ** |                 | ** ** |   | ** ** |   |   |
| **Basic earnings per share**                                                |   | **$**                  | **.45**    | ** **           | **$**      | **.38** | ** ** | **$** | **.85** | ** ** | **$** | **.68** |   |
| **Diluted earnings per share**                                              |   | **$**                  | **.43**    | ** **           | **$**      | **.37** | ** ** | **$** | **.82** | ** ** | **$** | **.67** |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| Dividends declared per share                                                |   | $                      | 0.05       |                 | $          | 0.05 |   | $ | 0.05 |   | $ | 0.05 |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| Weighted average number of common shares                                    |   | 4,381,335              |       | 4,375,446            |       | 4,380,932 |   | 4,374,824 |   |
| Weighted average number of common shares,  Including dilutive stock options |   | 4,596,864              |       | 4,436,408            |       | 4,574,334 |   | 4,434,086 |   |
|                                                                        |   |                   |       |                 |       |   |   |   |   |
| Return on average assets                                                    |   | 1.66                   | %          | 1.76                 | %          | 1.57 | % | 1.61 | % |

 

*See notes to condensed consolidated financial statements*

* *

4

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**VENTURE FINANCIAL GROUP, INC. andSUBSIDIARIES**

Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)

 
|                                      |   | **Six Months Ended June 30, 2002 and 2003** |       |
|-------------------------------------------|--------|---------------------------------------------|------------|
|                                      |   |                                        |       |   |   | **Accumulated** |   |   |   |   |   |
|                                      |   |                                        |       |   |   | **Other** |   | **Unearned** |   |   |   |
|                                      |   | **Common**                                  |       | **Retained** |   | **Comprehensive** |   | **KSOP** |   |   |   |
| ***(Dollars in thousands)***              |   | **Stock**                                   |       | **Earnings** |   | **Income (Loss)** |   | **Shares** |   | **Total** |   |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Balance, December 31, 2001                |   | $                                           | 28,596     |   | $ | 9,912 |   | $ | 312 |   | $ | (25 | ) | $ | 38,795 |   |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Net income                                |   | —                                      |       | 2,990 |   | — |   | — |   | 2,990 |   |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Stock options exercised                   |   | 618                                         |       | — |   | — |   | — |   | 618 |   |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Stock repurchased                         |   | (950                                        | )          | — |   | — |   | — |   | (950 | ) |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Cash dividend ($0.05 per share)           |   | —                                      |       | (440 | ) | — |   | — |   | (440 | ) |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Other comprehensive loss                  |   | —                                      |       | — |   | (352 | ) | — |   | (352 | ) |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Net decrease in unearned KSOP shares |   | *—*                                    |       | *—* |   | *—* |   | 25 |   | 25 |   |
|                                      |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| **Balance, June 30, 2002**                |   | **$**                                       | **28,264** | ** ** | **$** | **12,462** | ** ** | **$** | **(40** | **)** | **$** | **0** | ** ** | **$** | 40,686 | ** ** |
|                                      |   |                                        | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Balance, December 31, 2002**            |   | **$**                                       | **28,430** | ** ** | **$** | **15,246** | ** ** | **$** | **533** | ** ** | **$** | **0** | ** ** | **$** | **44,209** |   |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Net income                                |   | —                                      |       | 3,736 |   | — |   | — |   | 3,736 |   |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Stock options exercised                   |   | 1,297                                       |       | — |   | — |   | — |   | 1,297 |   |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Stock repurchased                         |   | (3,385                                      | )          | — |   | — |   | — |   | (3,385 | ) |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Cash dividend ($0.05 per share)           |   | —                                      |       | (440 | ) | — |   | — |   | (440 | ) |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| Other comprehensive income                |   | —                                      |       | — |   | 146 |   | — |   | 146 |   |
|                                      |   |                                        |       |   |   |   |   |   |   |   |   |
| **Balance, June 30, 2003**                |   | **$**                                       | **26,342** | ** ** | **$** | **18,542** | ** ** | **$** | **679** | ** ** | **$** | **0** | ** ** | **$** | 45,563 | ** ** |

 

*See notes to condensed consolidated financialstatements*

 

5

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**VENTURE FINANCIAL GROUP, INC. andSUBSIDIARIES**

Condensed Consolidated Statements of Cash Flows (Unaudited)

 
|                                                                               |   | **Six months ended June 30** |       |
|------------------------------------------------------------------------------------|--------|------------------------------|------------|
| ***(Dollars in thousands)***                                                       |   | **2003**                     |       | **2002** |   |
|                                                                               |   |                         |       |   |   |
| **Cash Flows from Operating Activities**                                           |   |                         |       |   |   |
| Net Income                                                                         |   | $                            | 3,736      |   | $ | 2,990 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                         |       |   |   |
|                                                                               |
| Provision for credit losses                                                        |   | 1,199                        |       | 985 |   |
| Depreciation and amortization                                                      |   | 722                          |       | 583 |   |
| Amortization of other intangible assets                                            |   | 55                           |       | 100 |   |
| Increase in cash surrender value of life  insurance                                |   | (207                         | )          | (101 | ) |
| Income from mortgage loans sold                                                    |   | 1,848                        |       | 1,053 |   |
| Other - net                                                                        |   | (63                          | )          | (773 | ) |
| Originations of loans held for sale                                                |   | (77,252                      | )          | (41,701 | ) |
| Proceeds from sales of loans held for sale                                         |   | 71,011                       |       | 42,369 |   |
| **Net cash provided by operating activities**                                      |   | **1,049**                    | ** ** | **5,505** | ** ** |
|                                                                               |   |                         |       |   |   |
| **Cash Flows from Investing Activities**                                           |   |                         |       |   |   |
| Net (increase) decrease in interest bearing  deposits in banks                     |   | (517                         | )          | 2 |   |
| Net (increase) decrease in Federal funds  sold                                     |   | 900                          |       | (900 | ) |
| Proceeds from maturities and prepayments of  available-for-sale securities         |   | 1,226                        |       | 2,479 |   |
| Purchase of securities available for sale                                          |   | —                       |       | (2,424 | ) |
| Net (increase) decrease in loans                                                   |   | 5,335                        |       | (5,607 | ) |
| Proceeds from sale of other real estate                                            |   | (3,405                       | )          | 325 |   |
| Additions to premises and equipment                                                |   | (1,195                       | )          | (226 | ) |
| **Net cash provided (used) by investing  activities**                              |   | **2,344**                    | ** ** | **(6,351** | **)** |
|                                                                               |   |                         |       |   |   |
| **Cash Flows from Financing Activities**                                           |   |                         |       |   |   |
| Net decrease in deposits                                                           |   | (8,137                       | )          | 2,625 |   |
| Net increase in short-term borrowings                                              |   | 2,588                        |       | 1,624 |   |
| Sale of common stock                                                               |   | 1,297                        |       | 618 |   |
| Repurchase of common stock                                                         |   | (3,385                       | )          | (950 | ) |
| Increase in long-term borrowings                                                   |   | 5,000                        |       | 1,000 |   |
| Repayment of long-term borrowings                                                  |   | —                       |       | (25 | ) |
| Payment of cash dividends                                                          |   | (440                         | )          | (440 | ) |
| **Net cash provided (used) by financing  activities**                              |   | **(3,077**                   | **)**      | **4,452** | ** ** |
|                                                                               |   |                         |       |   |   |
| **Net change in cash and due from banks**                                          |   | **316**                      | ** ** | **3,606** | ** ** |
|                                                                               |   |                         |       |   |   |
| **Cash and Due from Banks:**                                                       |   |                         |       |   |   |
| Beginning of period                                                                |   | 30,965                       |       | 21,383 |   |
|                                                                               |   |                         |       |   |   |
| **End of period**                                                                  |   | **$**                        | **31,281** | ** ** | **$** | **24,989** | ** ** |
|                                                                               |   |                         |       |   |   |
| **Supplemental Disclosures of Cash Flow  Information:**                            |   |                         |       |   |   |
| **Cash payments for:**                                                             |   |                         |       |   |   |
| Interest                                                                           |   | $                            | 3,011      |   | $ | 3,301 |   |
| Taxes                                                                              |   | 1,580                        |       | 1,415 |   |
|                                                                               |   |                         |       |   |   |
| **Supplemental Disclosures of Non-Cash  Investing and Financing Activities:**      |   |                         |       |   |   |
| Other real estate acquired in settlement of  loans                                 |   | $                            | 4,474      |   | $ | 727 |   |
| Decrease in unearned KSOP shares                                                   |   | —                       |       | (25 | ) |
| Fair value adjustment of securities  available for sale, net                       |   | 146                          |       | (352 | ) |

 

*See notes to condensed consolidated financialstatements*

 

6

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**VENTURE FINANCIAL GROUP, INC. andSUBSIDIARIES**

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

**1.****                                     ****Basis ofPresentation**

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and withinstructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  In the opinion of management, adjustmentsconsidered necessary for a fair presentation (consisting of normally recurringaccruals) have been included.  Theinterim condensed consolidated financial statements should be read inconjunction with the December 31, 2002 consolidated financial statements,including notes thereto, included in the Company’s 2002 Annual Report to Shareholders.  Operating results for the six months endedJune 30, 2003 are not necessarily indicative of the results anticipated for theyear ending December 31, 2003.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.

 

In December 2002, the Financial Accounting Standards Board issued FASBStatement No. 148, *Accounting forStock-Based Compensation — Transition and Disclosure. *This Statement amends FASB Statement No. 123, *Accounting for Stock-Based Compensation,*andAPB Opinion No. 28, *Interim FinancialReporting,*to provide alternative methods of transition for avoluntary change to the fair value based method of accounting for stock-basedemployee compensation.  This statementdoes not require any change from the method currently used by the Company toaccount for stock-based compensation, but does require more prominentdisclosure in the annual and interim financial statements about the method ofaccounting for such compensation and the effect of the method used on reportedresults.  This statement was effectivefor fiscal years ending after December 15, 2002.  The Company has adopted the disclosure provisions of SFAS No. 148in the accompanying financial statements, and accordingly, the disclosurerequirements are set forth in Note 4 — Stock Based Compensation.

 

**2.****                                     ****Basic andDiluted Earnings per Share**

 

Basic and diluted earnings per share are calculated by dividing netincome by the weighted average number of common shares outstanding during theperiods presented.  Diluted earnings pershare assumes that all dilutive stock options outstanding are issued such thattheir dilutive effect is maximized.

 
|                                                           |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|----------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                           |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Basic EPS computation                                          |   | $                               | 1,954  |                          | $      | 1,644 |   | $ | 3,736 |   | $ | 2,990 |   |
| Numerator — Net Income                                    |   |                            |   |                          |   |   |   |   |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Denominator — Weighted Average common  shares outstanding |   | 4,381,335                       |   | 4,375,446                     |   | 4,380,932 |   | 4,374,824 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Basic EPS                                                      |   | $                               | .45    |                          | $      | .38 |   | $ | .85 |   | $ | .68 |   |

 

7

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|                                                           |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|----------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                           |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| Diluted EPS computation                                        |   | $                               | 1,954  |                          | $      | 1,644 |   | $ | 3,736 |   | $ | 2,990 |   |
| Numerator — Net Income                                    |   |                            |   |                          |   |   |   |   |   |
| Denominator — Weighted average common  shares outstanding |   | 4,381,335                       |   | 4,375,446                     |   | 4,380,932 |   | 4,374,824 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Effect of dilutive stock options                               |   | 215,529                         |   | 60,962                        |   | 193,402 |   | 59,262 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Weighted average common shares and common  stock equivalents   |   | 4,596,864                       |   | 4,436,408                     |   | 4,574,408 |   | 4,434,086 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Diluted EPS                                                    |   | $                               | .43    |                          | $      | .37 |   | $ | .82 |   | $ | .67 |   |

 

 

**3.             Issuanceof Trust Preferred Securities**

 

On April 10, 2003, the Company completed an offering of trust preferredsecurities and received net proceeds of approximately $5,910,000.  The proceeds are expected to be used forgeneral Company purposes, which may include utilization in a stock repurchaseprogram or to provide additional capital to Venture Bank.  Trust preferred securities consist of theissuance of subordinated debt securities to a wholly owned subsidiary businesstrust, which then issues preferred stock to investors.  The wholly owned subsidiary trust isconsolidated in the Consolidated Financial Statements.  The interest payments on the debt securitiesare approximately equal to the dividend payments on the preferred stock of thetrust.  The Company will be able torecognize a deduction of the interest cost for income tax purposes, while thenet proceeds will qualify as Tier 1 capital.

 

**4.             Stock-BasedCompensation**

 

The Company accounts for stock-based awardsto employees and directors using the intrinsic value method, in accordance withAPB No. 25, *Accounting for Stock Issued toEmployees*.  Accordingly, nocompensation expense has been recognized in the consolidated financialstatements for employee and director stock arrangements where the grant priceis equal to market price.  However, therequired pro forma disclosures of the effects of all options granted on orafter January 1, 1995**have beenprovided in accordance with SFAS No. 123, *Accountingfor Stock-Based Compensation*.

 

At June 30, 2003, the Company has twostock-based employee and director compensation plans.  The following illustrates the effect on net income and earningsper share if the Company had applied the fair value recognition provisions ofSFAS No. 123, *Accounting for Stock-BasedCompensation,*to stock-based compensation awards for the effects ofall options granted on or after January 1, 1995 for the periods ended June 30:

 
|                                                                                                      |   | **2003** |   | **2002** |   |
|-----------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                                                                      |   |     |   |     |   |
| Net income, as reported                                                                                   |   | $        | 3,736  |     | $      | 2,990 |   |
| Less total stock-based compensation expense  determined under fair value method for all qualifying awards |   | 144      |   | 143      |   |
|                                                                                                      |   |     |   |     |   |
| Pro forma net income                                                                                      |   | $        | 3,592  |     | $      | 2,847 |   |
|                                                                                                      |   |     |   |     |   |
| **Earnings per Share**                                                                                    |   |     |   |     |   |
| Basic:                                                                                                    |   |     |   |     |   |
| As reported                                                                                               |   | $        | 0.85   |     | $      | 0.68 |   |
| Pro forma                                                                                                 |   | 0.82     |   | 0.65     |   |
| Diluted:                                                                                                  |   |     |   |     |   |
| As reported                                                                                               |   | 0.82     |   | 0.67     |   |
| Pro forma                                                                                                 |   | 0.79     |   | 0.65     |   |

 

8

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**5.****              Recent AccountingPronouncements**

 

During the second quarter of 2003 theFinancial Accounting Standards Board (FASB) issued the following newpronouncements.

 

In April 2003, FASBissued Statement No. 149, *Amendment ofStatement 133 on Derivative Instruments and Hedging Activities*. ThisStatement amends and clarifies financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts (collectively referred to as derivatives) and for hedgingactivities under FASB Statement No. 133, *Accountingfor Derivative Instruments and Hedging Activities.*This Statement iseffective for contracts entered into or modified after June 30, 2003.

 

In May 2003, FASBissued Statement No. 150, *Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity.* This Statement establishes standards for how an issuerclassifies and measures certain financial instruments with characteristics ofboth liabilities and equity. It requires that an issuer classify a financialinstrument that is within its scope as a liability (or an asset in somecircumstances). Many of those instruments were previously classified as equity.This Statement is effective for financial instruments entered into or modifiedafter May 31, 2003, and otherwise is effective at the beginning of the firstinterim period beginning after June 15, 2003, except for mandatory redeemablefinancial instruments of nonpublic entities. Adoption of the Statement did notresult in an impact on the Company’s statement of financial position or resultsof operations.

 

**6.****              Subsequent Events**

 

On July 15, the Company sold property that had beenacquired as a result of a failed loan identified in 1999.  The sale resulted in a $2,100,000 “Gain onSale of Asset” and will be reflected in the Company’s third quarter results as“Other noninterest income”.  The sale ofthis property reduces the Company’s Nonperforming assets from $13,394,000reported at June 30, 2003 to $10,144,000.  This transaction should increase third quarter earnings per share byapproximately $.33.

 

9

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**Item2     Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

The following discussion contains a review of the Company’s and itssubsidiaries operating results and financial condition for the first six monthof and period ended June 30, 2003.  Whenwarranted, comparisons are made to the same period in 2002, and to the previousyear ended December 31, 2002.  Thediscussion should be read in conjunction with the financial statements(unaudited) and related notes contained elsewhere in this report.  The reader is assumed to have access to theCompany’s Form 10-K for the year ended December 31, 2002, which containsadditional statistics and explanations. All numbers in tables, except per share data, are expressed inthousands.

 

**Forward-Looking Information**

 

In addition to historical information,statements appearing in this report which are not historical in nature,including the discussions of the adequacy of the Company’s capital resourcesand allowance for credit losses, are forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995 (“PLSRA”).  Any statements that expressly or implicitlypredict future results, performance, or events should be consideredforward-looking.  Forward-lookingstatements are subject to the risks and uncertainties that may cause actualfuture results to differ materially. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date of this AnnualReport.  The Company does not undertakeany obligation to publicly release any revisions to forward-looking statementscontained in this Quarterly Report, with respect to events or circumstancesafter the date of this Report, or to reflect the occurrence of unanticipatedevents.

 

Such risks and uncertainties with respect tothe Company include, among others, those related to the general economicenvironment, particularly in the region in which the Company operates,competitive products and pricing, that may lead to pricing pressures on ratesthe Bank charges on loans and pays on deposits, loss of customers of greatestvalue to the Bank, or other losses, fiscal and monetary policies of the federalgovernment, changes in government regulations affecting financial institutionsand small loan practices, including regulatory fees and capital requirements,changes in prevailing interest rates that could lead to decreased net interestmargin, acquisitions and the integration of acquired businesses, credit riskmanagement and asset/liability management, the financial and securitiesmarkets, changes in technology or required investments in technology, and theavailability of and costs associated with sources of liquidity.

 

**Financial Condition**

 

General

The Company’s consolidated total assets at June 30, 2003 of$476,088,000 represents a .35% increase from December 31, 2002 assets of$474,450,000.  The increase in assetswas caused by an increase in loans held for sale of $4,393,000 and foreclosedreal estate of $3,621,000, offset by a reduction in the Company’s loanportfolio of $6,303,000.  Other assetswere largely unchanged.   The increasein loans held for sale is largely attributed to the favorable interest rates onone-to-four family residential mortgages while the increase in foreclosed realestate is primarily attributed to the acquisition of one foreclosed property inthe second quarter 2003.

 

Loans

The composition of the loan portfolio is as follows (dollars inthousands):

 

|            |   | **June 30 2003** |        | **December 31 2002** |   |
|-----------------|--------|------------------|-------------|----------------------|--------|
| Commercial      |   | $                | 59,246      |                 | $      | 64,716 |   |
|            |   |             |        |                 |   |
| Real Estate     |   |             |        |                 |   |
|            |   |             |        |                 |   |
| Mortgage        |   | 207,683          |        | 207,346              |   |
|            |   |             |        |                 |   |
| Construction    |   | 71,625           |        | 70,385               |   |
|            |   |             |        |                 |   |
| Consumer        |   | 8,593            |        | 10,718               |   |
|            |   |             |        |                 |   |
| Small Loans     |   | 8,682            |        | 8,967                |   |
|            |   |             |        |                 |   |
| **Total Loans** |   | **$**            | **355,829** | ** **           | **$**  | **362,132** | ** ** |

 

10

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Thetotal non-performing loans, defined as those loans on non-accrual and accruingloans over 90-days past due, decreased since December 31, 2002 by $3,123,000 asshown in the following table of non-performing assets (dollars in thousands):

 
|                                    |   | **June 30** |       | **December 31** |   |
|-----------------------------------------|--------|-------------|------------|-----------------|--------|
|                                    |   | **2003**    |       | **2002**        |   |
|                                    |   |        |       |            |   |
| Non-accrual loans                       |   | $           | 3,450      |            | $      | 6,543 |   |
| Accruing loans past due 90 days or more |   | 1,248       |       | 1,278           |   |
| Foreclosed real estate                  |   | 8,520       |       | 4,899           |   |
| Other assets                            |   | 176         |       | 55              |   |
|                                    |   | **$**       | **13,394** | ** **      | **$**  | **12,775** | ** ** |

 

The percentage of non-performing loans to loans decreased to 1.32% onJune 30, 2003 from 2.16% on December 1, 2002.  Non-accrual loans decreased $3,093,000 during the first sixmonths of 2003, while foreclosed real estate and other assets increased $3,742,000during the same period.  The reductionin non-accrual loans and increase in foreclosed real estate is primarilyattributed to one credit that was transferred to foreclosed real estate in thesecond quarter of 2003.

 

Accruing loans past due 90 days or more are well secured and in theprocess of collection for the accrual of interest to continue.  These loans are monitored and may beclassified as non-accrual as conditions warrant.

 

Allowance for Credit Losses

The allowance for credit losses reflects management’s current estimateof the amount required to absorb losses on existing loans and commitments toextend credit.  Determination of theappropriate level of the allowance is based on an analysis of various factorsincluding historical loss experience based on volumes and types of loans; volumesand trends in delinquencies and non-accrual loans; trends in portfolio volume;results of internal credit reviews; and economic conditions.  All loans in the portfolio are assigned agrade indicating credit quality by the originating loan officer at the time ofloan origination.  These grades arereviewed at regular intervals and, if performance concerns arise on anindividual loan, the grade is lowered to the appropriate level.  Management reviews the composite changes inloan grades within the portfolio in its assessment of the adequacy of theallowance.  If a loan becomes impaired,the Company’s loss exposure on that loan is measured based on expected cashflows or collateral values, and if necessary, a portion of the allowance forcredit losses is allocated to that loan.  After reviewing the composition of the loan portfolio at June 30, 2003,the levels of classified loans, losses experienced during the period, and thechanges in the economy, management has determined the allowance for creditlosses to be adequate to cover the loss exposure in the loan portfolio at thatdate.  An analysis of the adequacy ofthe allowance is subject to quarterly review by the Board of Directors.   Various regulatory agencies, as an integralpart of their examination process, periodically review the Bank’s allowance forloan losses.  Such agencies may requirethe Bank to recognize changes to the allowance based on their judgments ofinformation available at the time of their examination.

 

The allowance for credit losses increased $231,000 for the first sixmonths of 2003, with the ratio of the allowance for credit losses to loans at2.30% on June 30, 2003, compared to 2.19% on December 31, 2002.  During the first six months an additional$1,199,000 was reserved for potential losses, and net charge-offs were$968,000, or .27 % of the loan portfolio. The charge-offs were centered in the Bank’s small loan portfolio.  The allowance for credit losses tononperforming loans was 174.0% on June 30, 2003, compared to 101.61% on December31, 2002.  Management believes theallowance is at an appropriate level.

 

Investment Portfolio

Investment securities decreased by $1,068,000, or 3.2% during the firstsix months of 2003 to a total of $32,554,000.    The decrease in investment balances is due to maturity andprepayments on securities in the portfolio. Although no securities were purchased during the first six months,securities are purchased from time to time as either collateral for various operationalpurposes or for additional income in times of excess liquidity.

 

Deposits and Borrowings

Total deposits decreased $8,137,000, or 2.1% in the six months endedJune 30, 2003 to $376,070,000.  Savingsand interest-bearing deposit accounts reflected a $10,850,000 increase whiletime and demand deposits experienced a $17,544,000 and $1,443,000 decreaserespectively.  Short term borrowingshave also been used as a funding source due to their relatively low cost ascompared to time deposits.  Short termborrowings increased in the first six months by $2,588,000 to $19,135,000.

 

11

----

 

Liquidity

Liquidity management involves the ability to meet cash flowrequirements of customers who may be either depositors wanting to withdrawfunds or borrowers needing assurance that sufficient funds will be available tomeet their credit needs.  Liquidity isgenerated from both internal and external sources.  Internal sources are those assets that can be converted to cashwith little or no risk of loss.  Theseinclude overnight investments in interest bearing deposits in banks and federalfunds sold and investment securities, particularly those of shorter maturity,and are the principal source of asset liquidity.  At June 30, 2003, cash, deposits in banks, federal funds sold andsecurities available for sale totaled $70,528,000.  External sources refer to the ability to attract new liabilitiesand capital.  They include increasingsavings and demand deposits, federal funds purchased, borrowings, and theissuance of capital and debt securities. At June 30, 2003, borrowing lines of credit totaled $48,553,000.  These credit facilities are being usedregularly as a source of funds. At June 30, 2003, $10,000,000 was borrowedagainst these lines of credit in the form of long term advances.

 

Cash flows from operations contributed toliquidity as well as proceeds from maturities of securities, a net decrease inloans outstanding, an increase in short-term and long-term borrowings and saleof common stock.  As indicated on the Company’sCondensed Consolidated Statement of Cash Flows, net cash from operatingactivities for the six months ended June 30, 2003 contributed $1,049,000 toliquidity compared to $5,505,000 for the six months ended June 30, 2002.  Short-term and long-term borrowings provided$7,588,000 for the six months ended June 30, 2003 compared to $2,624,000 forthe six months ended June 30, 2002.  Inthe stock repurchase program, $3,385,000 of the funds provided were used to repurchasecommon stock of the Company.

 

The stock repurchase program authorizes the Companyto make scheduled purchases over time in either privately negotiatedtransactions or through the open market. On June 18, 2003, the Company’s board of directors authorized anadditional 37,420 shares of stock be added to the stock repurchaseprogram.  Under the program the Company expects to buy a total ofapproximately 125,000 shares of the Company’s common stock or approximately 3%of the total common shares currently outstanding.  As of June 30, 2003 theCompany had repurchased 109,144 shares at a cost of $2,212,000.  There are 15,856 shares left for repurchase.

 

Management believes the Bank’s liquidity positionat June 30, 2003, was adequate to meet its short term funding requirements.

 

Capital

Consolidated capital of the Company increased$1,354,000 or 3.1% during the first six months of 2003.  The net income for the first six months andits corresponding increase to retained earnings was the primary component ofthis increase along with the exercising of stock options, which added$1,297,000 and an increase in the**marketvalue of securities available for sale of $146,000 on an after-tax basis.  Capital decreases were the result of$3,385,000 worth of stock being repurchased and retired and the first twoquarterly cash dividends paid to shareholders totaling $440,000

There are regulatory constraints placed uponcapital adequacy, and it is necessary to maintain an appropriate ratio betweencapital and assets.  Regulations requirebanks and holding companies to maintain a minimum “leverage” ratio (primarycapital ratio) of total assets.  For themost highly rated holding companies this ratio must be at least 3%, and forothers it must be 4 to 5%.  At June 30,2003, the Company’s leverage ratio was 11.43%, compared to 11.60% at year-end2002.  In addition, banks and holdingcompanies are required to meet minimum risk-based capital guidelines underwhich risk percentages are assigned to various categories of assets and off-balance-sheetitems to calculate a risk-adjusted capital ratio.  Tier I capital generally consists of common stockholders’ equity,less goodwill, while total capital includes the allowance for possible creditlosses, subject to 1.25% limitation of risk-adjusted assets.  The rules require Tier I capital of 4% ofrisk-adjusted assets and total capital of 8%. At June 30, 2003, the Company’s Tier I capital ratio was 11.93%, andtotal capital was 13.19%.  At December31, 2002 the Company’s Tier I capital ratio was 10.23% and the total capitalratio was 11.49%.

**Issuance of Trust Preferred Securities**

 

On April 10, 2003, the Company completed anoffering of trust preferred securities and received net proceeds ofapproximately $5,910,000.  The proceedsare expected to be used for general Company purposes, which may includeutilization in a stock repurchase program or to provide additional capital toVenture Bank.  Trust preferredsecurities consist of the issuance of subordinated debt securities to a whollyowned subsidiary business trust, which then issues preferred stock toinvestors.  The wholly owned subsidiarytrust is consolidated in the Consolidated Financial Statements.  The interest payments on the debt securitiesare approximately equal to the dividend payments on the preferred stock of thetrust.  The Company will be able torecognize a deduction of the interest cost 

 

12

----

 

for income tax purposes, whilethe net proceeds will qualify as Tier 1 capital.

 

**Resultsof Operations**

 

**General**

 

Net income for the six monthsended June 30, 2003 increased 25% to $3,736,000, compared to $2,990,000 for thesame period in 2002 The increase in net income can be primarily attributed toincreased interest income due to the loans acquired with the purchase of HarborBank in Gig Harbor in October 2002 and increased fees earned on mortgage loanssold.

 

Net interest income increased$2,481,000, an increase of 23.08% for the six months ended June 30, 2003 overthe same period for 2002.  The increasein the Company’s net interest income is primarily the result of increased loanvolumes due to the acquisition of Harbor Bank and a reduction in interest ratescausing a corresponding reduction in cost of funds.  The Company’s small loan product also impacted the growth in netinterest income for the period.    Thisproduct’s contribution to net interest income grew to $2,856,000 in the firstsix months of 2003 from $2,257,000 during the same period in 2002, a $599,000or 27% increase.

 

The average volumes of bothearning assets, primarily loans, and interest bearing liabilities, deposits,increased significantly due to the acquisition of Harbor Bank, N.A. in thefourth quarter of 2002.  The impact ofthis acquisition on average balances is evident in the year to year comparisonsfor the first six months of 2002 and 2003.

 

Interest income for the sixmonths ended June 30, 2003 increased $2,469,000, or 17.7%, from the same periodin the prior year.  Increased volume ofearning assets provided an additional $3,532,000 of interest income for thefirst six months, which was partially offset by a $1,063,000 reduction ininterest income due to the reduced earnings rate of these assets.   Average earning assets for the first sixmonths of 2003 were $91,000,000 or 29.0% higher than in the same period of2002.  The average rate earned on assetsdecreased to 8.12% in the first six months of 2003 from 8.89% for the sameperiod in 2002, a decrease of 77 basis points.

 

Interest income for the threemonths ended June 30, 2003 increased $1,169,000, or 16.7%, from the same periodin the prior year.  Increased volume ofearning assets provided an additional $1,731,000 of interest income for theperiod, which was partially offset by a $562,000 reduction in interest incomedue to the reduced earnings rate of these assets.   Average earning assets for the first six months of 2003 were$91,300,000 or 29.0% higher than in the same period of 2002.  The average rate earned on assets decreasedto 8.00% from 8.82% for the same period in 2002, a decrease of 82 basis points.

 

Total interest expense for thesix months ended June 30, 2003 decreased $12,000, or.38%, from the comparableperiod in the prior year.  The decreasein the interest rate paid on deposits and borrowings, which declined 40 basispoints, to 1.94% in the first six months of 2003 from 2.34% in the first sixmonths of 2002, resulted in a reduction to interest expense of $62,000.  Of this amount, $50,000 was offset by anincrease in the volume of these liabilities, which rose from an average of$274,532,000 in 2002 to $329,406,000 in 2003.

 

Total interest expense for thethree months ended June 30, 2003 decreased $86,000, or 5.9%, from thecomparable period in the prior year. The decrease in the interest rate paid on deposits and borrowings, whichdeclined 22 basis points, to 1.92% for the quarter ended June 30, 2003 from2.14% for the same period in 2002, resulted in a reduction to interest expenseof $115,000.  Of this amount, $201,000was offset by an increase in the volume of these liabilities, which rose froman average of $274,168,000 in 2002 to $324,040,000 in 2003.

 

Net interest margin, defined asnet interest income as a percentage of average earning assets, decreased by 31basis points to 6.55% from 6.86% in the first six months of 2003 compared tothe same period in 2002 and decreased by 49 basis points to 6.48% from 6.97%for the quarter ended June 30, 2003 compared to the same quarter in 2002.

 

13

----

 

The yield and cost of funds forearning assets and interest bearing liabilities were as follows as of and forthe six months ended June 30 (dollars in thousands):

 
|                                                        |   | **2003**            |    | **2002**                      |   |              |
|-------------------------------------------------------------|--------|---------------------|---------|-------------------------------|--------|-------------------|
|                                                        |   | **Average Balance** |    | **Interest Income (Expense)** |   | **Average Rates** |   | **Average Balance** |   | **Interest Income (Expense)** |   | **Average Rates** |   |
|                                                        |   |                |    |                          |   |              |   |   |   |   |   |   |   |
| Earning Assets:                                             |   |                |    |                          |   |              |   |   |   |   |   |   |   |
| Loans (Interest and fees)(a)                                |   | $                   | 386,036 |                          | $      | 15,671            |   | 8.59 | % | $ | 294,994 |   | $ | 13,318 |   | 9.10 | % |
| Federal funds sold                                          |   | 5,941               |    | 30                            |   | .98               | % | 386 |   | 4 |   | 1.57 | % |
| Investment securities(b)                                    |   | 33,392              |    | 699                           |   | 4.23              | % | 20,490 |   | 609 |   | 6.00 | % |
| Total earning assets and interest income                    |   | $                   | 407,369 |                          | $      | 16,400            |   | 8.12 | % | $ | 315,870 |   | $ | 13,931 |   | 8.89 | % |
| Interest bearing liabilities:                               |   |                |    |                          |   |              |   |   |   |   |   |   |   |
| Deposits:                                                   |   |                |    |                          |   |              |   |   |   |   |   |   |   |
| Savings, NOW, and Money Market Deposits                     |   | $                   | 160,235 |                          | $      | (749              | ) | 0.94 | % | $ | 129,873 |   | $ | (827 | ) | 1.28 | % |
| Time deposits                                               |   | 138,194             |    | (1,680                        | )      | 2.45              | % | 129,339 |   | (2,201 | ) | 3.43 | % |
| Total interest bearing deposits                             |   | $                   | 298,249 |                          | $      | (2,429            | ) | 1.64 | % | $ | 259,212 |   | $ | (3,028 | ) | 2.36 | % |
| Other borrowings                                            |   | 30,977              |    | (739                          | )      | 4.81              | % | 15,320 |   | (152 | ) | 2.28 | % |
| Total interest bearing liabilities and interest expense     |   | $                   | 329,406 |                          | $      | (3,168            | ) | 1.94 | % | $ | 274,532 |   | $ | (3,180 | ) | 2.34 | % |
|                                                        |   |                |    |                          |   |              |   |   |   |   |   |   |   |
| Net interest income                                         |   |                |    | $                             | 13,232 |              |   |   |   |   | $ | 10,751 |   |   |   |
| Net interest margin as a percent of average earning assets: |   |                |    |                          |   | 6.55              | % |   |   |   |   | 6.86 | % |
|                                                             |        |                     |         |                               |        |                   |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

An analysis of the change in net interest income is as follows for thesix months ended June 30 (dollars in thousands):

 
|                                     |   | **2003 compared to 2002**      |   |
|------------------------------------------|--------|--------------------------------|--------|
|                                     |   | **Increase (decrease) due to** |   |
|                                     |   | **Volume**                     |   | **Rate** |   | **Net** |   |
| Interest earned on:                      |   |                           |   |   |   |   |   |
| Loans(c)                                 |   | $                              | 3,054  |   | $ | (701 | ) | $ | 2,353 |   |
| Federal funds sold and deposits in banks |   | 27                             |   | (1 | ) | 26 |   |
| Investment securities                    |   | 170                            |   | (80 | ) | 90 |   |
| Total interest income                    |   | 3,532                          |   | (1,063 | ) | 1,300 |   |
| Interest paid on:                        |   |                           |   |   |   |   |   |
| Savings, NOW and MMA                     |   | 567                            |   | (645 | ) | (78 | ) |
| Time deposits                            |   | 164                            |   | (685 | ) | (521 | ) |
| Other borrowings                         |   | 456                            |   | 131 |   | 587 |   |
| Total Interest expense                   |   | (62                            | )      | 50 |   | (12 | ) |
| Net interest income                      |   | $                              | 3,594  |   | $ | (1,113 | ) | $ | 2,481 |   |

 

----

(a)  Average loan balanceincludes nonaccrual loans.  Interestincome on nonaccrual loans has been included.

(b)  The yield on investmentsecurities is calculated using historical cost basis.

(c)  Balances of nonaccrualloans, if any, and related income recognized have been included forcomputational purposes.

 

14

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The yield and cost of funds for earning assets and interest bearingliabilities were as follows as of and for the three months ended June 30(dollars in thousands):

 
|                                                        |   | **2003**            |    | **2002**                      |   |
|-------------------------------------------------------------|--------|---------------------|---------|-------------------------------|--------|
|                                                        |   | **Average Balance** |    | **Interest Income (Expense)** |   | **Average Rates** |   | **Average Balance** |   | **Interest Income (Expense)** |   | **Average Rates** |   |
|                                                        |   |                |    |                          |   |   |   |   |   |   |   |   |   |
| Earning Assets:                                             |   |                |    |                          |   |   |   |   |   |   |   |   |   |
| Loans (Interest and fees)                                   |   | $                   | 365,572 |                          | $      | 7,788 |   | 8.54 | % | $ | 296,925 |   | $ | 6,689 |   | 9.04 | % |
| Federal funds sold                                          |   | 8,847               |    | 28                            |   | 1.27 | % | 547 |   | 2 |   | 1.47 | % |
| Investment securities                                       |   | 34,999              |    | 348                           |   | 3.99 | % | 20,640 |   | 304 |   | 5.91 | % |
| Total earning assets and interest income                    |   | $                   | 409,418 |                          | $      | 8,164 |   | 8.00 | % | $ | 318,111 |   | $ | 6,995 |   | 8.82 | % |
| Interest bearing liabilities:                               |   |                |    |                          |   |   |   |   |   |   |   |   |   |
| Deposits:                                                   |   |                |    |                          |   |   |   |   |   |   |   |   |   |
| Savings, NOW, and Money Market Deposits                     |   | $                   | 162,831 |                          | $      | (368 | ) | 0.91 | % | $ | 130,696 |   | $ | (416 | ) | 1.28 | % |
| Time deposits                                               |   | 133,799             |    | (801                          | )      | 2.40 | % | 128,152 |   | (967 | ) | 3.03 | % |
| Total interest bearing deposits                             |   | $                   | 296,630 |                          | $      | (1,169 | ) | 1.58 | % | $ | 258,848 |   | $ | (1,383 | ) | 2.14 | % |
| Other borrowings                                            |   | 27,410              |    | (381                          | )      | 5.58 | % | 15,320 |   | (81 | ) | 2.12 | % |
| Total interest bearing liabilities and interest expense     |   | $                   | 324,040 |                          | $      | (1,550 | ) | 1.92 | % | $ | 274,168 |   | $ | (1,464 | ) | 2.14 | % |
|                                                        |   |                |    |                          |   |   |   |   |   |   |   |   |   |
| Net interest income                                         |   |                |    | $                             | 6,614  |   |   |   |   |   | $ | 5,531 |   |   |   |
| Net interest margin as a percent of average earning assets: |   |                |    |                          |   | 6.48 | % |   |   |   |   | 6.97 | % |

 

An analysis of the change in net interest income is as follows for thethree months ended June 30 (dollars in thousands):
|                                     |   | **2003 compared to 2002**      |   |
|------------------------------------------|--------|--------------------------------|--------|
|                                     |   | **Increase (decrease) due to** |   |
|                                     |   | **Volume**                     |   | **Rate** |   | **Net** |   |
| Interest earned on:                      |   |                           |   |   |   |   |   |
| Loans                                    |   | $                              | 1,437  |   | $ | (338 | ) | $ | 1,099 |   |
| Federal funds sold and deposits in banks |   | 26                             |   | (1 | ) | 25 |   |
| Investment securities                    |   | 83                             |   | (39 | ) | 44 |   |
| Total interest income                    |   | 1,731                          |   | (562 | ) | 1,169 |   |
| Interest paid on:                        |   |                           |   |   |   |   |   |
| Savings, NOW and MMA                     |   | 268                            |   | (316 | ) | (48 | ) |
| Time deposits                            |   | 45                             |   | (211 | ) | (166 | ) |
| Other borrowings                         |   | 98                             |   | 202 |   | 300 |   |
| Total Interest expense                   |   | 201                            |   | (115 | ) | 86 |   |
| Net interest income                      |   | $                              | 1,529  |   | $ | (446 | ) | $ | 1,083 |   |

 

15

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The change in interest, due to both rate andvolume, has been allocated to volume and rate changes in proportion to therelationship of the absolute dollar amounts of the change in each.

Non-interest income for the six months endedJune 30, 2003 was $1,371,000, or 37.6% greater than the same period for2002.  Service charges increased$383,000, or 26.0%, over the first six months of 2002.  Fees on mortgage loans sold increased by$795,000, or 75.5% over the same period in 2002.

Non-interest income for the quarter endedJune 30, 2003 was $621,000, or 34.0% greater than the same period for2002.  Service charges increased$186,000, or 25.0%, over the same period in 2002.  Fees on mortgage loans sold increased by $494,000, or 100% overthe same period in 2002.  Theyear-to-date and quarter-to-date increase over the same period in 2002 can beattributed to the increased service charges primarily due to the increasedrelationships generated from the addition of Harbor Bank in the fourth quarterof 2002 and a continued a strong performance in fees generated on mortgageloans sold.

Non-interest expense, for the first sixmonths of 2003, increased by $2,581,000 or 29.0% over the same period in2002.  Non-interest expense for thequarter ended June 30 2003 increased by $1,060,000 or 23% over the same periodin 2002.  Salaries and employee benefitsfor the first six months of 2003 increased by $1,576,000, or 34.0% over thesame six month period in 2002 and increased $695,000 or 29% for the quarterended June 30 2003 over the quarter ended June 30, 2002.  Both increases reflect the additionalemployees related to the Harbor Bank acquisition as well as increasedcommission compensation associated with the large increase in mortgage loanoriginations.  The change in occupancyexpense which reflects the operation of two additional Harbor Bank branches notin operation for the same period in 2002 increased $491,000, or 40.0% for thefirst six months of 2003 and $330,000 or 56% for the quarter ended June 30,2003 over the same period in 2002.  Forthe first six months other expense increased by $514,000, or 16.0% compared tothe prior year.  This fluctuation wasdue to increased asset size and costs associated with developing the Company’sbranding strategy, reduced by a business and occupation tax refund received inthe second quarter of 2003.

**Business Segment Reporting**

The Company is managed along two major linesof business; community banking, its core business, and the small loan division,which began operations in the fourth quarter of 2000.  Community banking consists of all lending, deposit andadministrative operations conducted through its 21 offices in Washington State.  The small loan division provides small,short-term consumer loans to customers in Alabama and Arkansas.

Prior to 2001, the Company was managed as awhole, not by discrete operating segments. When the Company began offering small loans, its operating results weresegregated in the General Ledger system to better manage financialperformance.  The financial performanceof the business lines is measured by the Company’s profitability reportingprocess, which utilizes various management accounting techniques to moreaccurately reflect each business line’s financial results.  Revenues and expenses are primarily assigneddirectly to business lines.

The organizational structure of the Companyand its business line financial results are not necessarily comparable acrosscompanies.  As such, the Company’sbusiness line performance may not be directly comparable with similarinformation from other financial institutions.

Selected comparative financial informationfor community banking and the small loan division, which are included in theoverall financial results, as of and for the six months ended June 30, are asfollows (dollars in thousands):
| **Six months ended June 30, 2003**                     |   | **Community  Banking** |    | **Small Loans** |   | **Total** |   |
|--------------------------------------------------------|--------|------------------------|---------|-----------------|--------|-----------|--------|
|                                                   |   |                   |    |            |   |      |   |
| Net Interest income after provision for  credit losses |   | $                      | 10,231  |            | $      | 2,257     |   | $ | 12,488 |   |
| Non-interest income                                    |   | 4,628                  |    | 11              |   | 4,639     |   |
| Non-interest expense                                   |   | 10,866                 |    | 255             |   | 11,121    |   |
| Income taxes                                           |   | 1,180                  |    | 742             |   | 1,922     |   |
| Net Income                                             |   | $                      | 2,814   |            | $      | 1,271     |   | $ | 4,085 |   |
| Total assets                                           |   | $                      | 455,104 |            | $      | 20,564    |   | $ | 475,668 |   |
| Total Loans                                            |   | $                      | 359,066 |            | $      | 8,682     |   | $ | 367,748 |   |

 

16

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| **Six months ended June 30, 2002**                     |   | **Community  Banking** |    | **Small Loans** |   | **Total** |   |
|--------------------------------------------------------|--------|------------------------|---------|-----------------|--------|-----------|--------|
|                                                   |   |                   |    |            |   |      |   |
| Net Interest income after provision for  credit losses |   | $                      | 3,914   |            | $      | 685       |   | $ | 4,599 |   |
| Non-Interest income                                    |   | 1,798                  |    | 18              |   | 1,816     |   |
| Non-Interest expense                                   |   | 4,204                  |    | 205             |   | 4,409     |   |
| Income taxes                                           |   | 477                    |    | 150             |   | 627       |   |
| Net Income                                             |   | $                      | 1,031   |            | $      | 348       |   | $ | 1,379 |   |
| Total assets                                           |   | $                      | 354,221 |            | $      | 17,930    |   | $ | 372,151 |   |
| Total Loans                                            |   | $                      | 282,508 |            | $      | 5,123     |   | $ | 287,631 |   |

 

**Regulatory Developments**

Three recent legislativeand regulatory developments may impact the operations and earnings generated bythe small loan division.

 

The Alabamalegislature recently enacted the Deferred Presentment Services Act.  The Act creates a regulatory frameworkwithin which licensed, non-bank lenders may now make small loans inAlabama.  Among other things, the Actauthorizes such lenders to charge a loan fee of up to 17.5% of the amountadvanced.  Through its relationship withAdvance America, the Bank currently offers loans in Alabama and charges a loanfee of up to 15% of the amount advanced, the maximum amount allowed underWashington law.   Due to changes inAlabama law, the Bank and Advance America terminated the original Marketing andServicing Agreement effective July 11, 2003. The terms of the termination agreement include Advance Americacontinuing to remit to the Bank a portion of the fees earned for the periodJuly 11, 2003 through October 31, 2003, the termination date of the originalagreement.  The fee structure was establishedto keep the Bank financially whole as if the Bank had continued in the smallloan program in Alabama through the original agreement termination date.

 

The WashingtonState legislature recently passed amendments to the Check Cashers and SellersAct, the law that authorizes small loans in Washington.  Among other changes, the amendments increasethe maximum small loan amount from $500 to $700 (with lower fees allowed on anyamounts over $500), allows borrowers to rescind a loan within one business day,and requires lenders to offer payment plans to certain repeat borrowers.  While the amendments may cause an increasein certain administrative expenses, we do not anticipate that they will have amaterial impact on our small loan operations.

 

The Federal DepositInsurance Corporation (FDIC) recently issued Guidelines for state chartered,nonmember banks that participate in small loan programs with third partycontractors.  The Guidelines coversafety and soundness considerations, including loan concentrations, capitaladequacy, allowance for loan and lease losses (ALLL), and loan classificationguidelines.  Compliance considerations,such as Community Reinvestment Act performance, Truth in Lending, and consumerprivacy are also covered.  TheGuidelines allow examiners wide discretion to review and, where necessary,criticize a bank’s loan program based upon these considerations.  Where serious deficiencies exist, the FDICmay order a bank to discontinue its small loan program.

 

The Guidelines willcertainly increase the regulatory scrutiny of the Bank’s small loanprogram.  While we do not believe thatgrounds exist for the FDIC to order the Bank to curtail or discontinue itssmall loan program, it is likely that the increased regulatory scrutiny willadd to the Bank’s compliance burdens and costs.  It may also cause the Bank to evaluate the extent of itscontinued participation in the small loan business.

 

The Company is taking steps to forestall anynegative effect that may occur from these developments, including thediscussions regarding provision of small loan programs with Advance America andother small loan providers in other states and the introduction of replacementprograms.  While the Company believes itwill be able to ameliorate any negative impact on its earnings from thesedevelopments, there can be no assurance that its efforts will be whollysuccessful.  Because of the significanceof the small loan division to the Company’s earnings, unsuccessful or delayedsubstitution of other states, providers or programs could have a materialadverse effect on the Company’s earnings.

 

**Item3     Quantitative and QualitativeDisclosure About Market Risk**

 

The Company’s results of operation aredependent upon its ability to manage interest rate risk. Management considersinterest rate risk to be a risk that could have a material effect on theCompany’s financial condition and results of operations. The Company does notcurrently use derivatives to manage market and interest rate risk.

 

A number of measures are used to monitor andmanage interest rate risk, including income simulations and interest 

 

17

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sensitivity (gap) analyses.  An income simulation model is the primarytool used to assess the direction and magnitude of changes in net interestincome resulting from changes in interest rates.  Key assumptions in the model include repayment speeds on certainassets, cash flows and maturities of other investment securities, loan anddeposit volumes and pricing.  Theseassumptions are inherently uncertain and, as a result, the model cannotprecisely estimate net interest income or precisely predict the impact ofhigher or lower interest rates on net interest income.

 

Actual results will differ from simulatedresults due to timing, magnitude and frequency of interest rate changes andchanges in market conditions and management strategies, among otherfactors.  At June 30, 2003, based on themeasures used to monitor and manage interest rate risk, there has not been amaterial change in the Company’s interest rate risk since December 31,2002.  For additional information, referto the Company’s annual report on Form 10-K for the year ended December 31,2002.

 

**Interest Rate Gap AnalysisJune 30, 2003**

** **
| ***(dollars in thousands)***         |   | **Within  One Year** |    | **After One  But Within  Five Years** |    | **After  Five Years** |   | **Total** |   |
|--------------------------------------|--------|----------------------|---------|---------------------------------------|---------|-----------------------|--------|-----------|--------|
| Loans                                |   | $                    | 187,249 |                                  | $       | 143,327               |   | $         | 33,628 |   | $ | 364,204 |   |
| Securities:                          |   |                 |    |                                  |    |                  |   |      |   |
| Available for sale                   |   | 3,792                |    | 24,073                                |    | 4,647                 |   | 32,512    |   |
| Held to maturity                     |   | —               |    | 505                                   |    | —                |   | 505       |   |
| Federal funds sold                   |   | 6,100                |    | —                                |    | —                |   | 6,100     |   |
| Interest bearing deposits with banks |   | 593                  |    | —                                |    | —                |   | 593       |   |
| Total Earning Assets                 |   | $                    | 197,734 |                                  | $       | 167,905               |   | $         | 38,275 |   | $ | 403,914 |   |
|                                 |   |                 |    |                                  |    |                  |   |      |   |
| Deposits:                            |   |                 |    |                                  |    |                  |   |      |   |
| Savings, NOW and money market        |   | $                    | 166,881 |                                  | $       | —                |   | $         | — |   | $ | 166,881 |   |
| Time deposits                        |   | 91,594               |    | 15,189                                |    | 21,582                |   | 128,365   |   |
| Short-term borrowings                |   | 19,135               |    | —                                |    | —                |   | 19,135    |   |
| Long-term debt                       |   | —               |    | 10,000                                |    | 19,000                |   | 29,000    |   |
|                                 |   |                 |    |                                  |    |                  |   |      |   |
| Total Interest Bearing Liabilities   |   | $                    | 277,610 |                                  | $       | 25,189                |   | 40,582    |   | $ | 343,381 |   |
|                                 |   |                 |    |                                  |    |                  |   |      |   |
| Net Interest Rate Sensitivity Gap    |   | ($79,876             | )       | $                                     | 142,716 |                  | $      | (2,307    | )      | $ | 60,553 |   |

 

 

**Item4     Disclosure Controls andProcedures**

 

(a)           Evaluation ofDisclosure Controls and Procedures.

 

Management of the Company, including the Chief Executive Officer andthe Chief Financial Officer, have conducted an evaluation of the Company’sdisclosure controls and procedures in accordance with Rule 13a-14 under theSecurities Exchange Act of 1934 as of a date (the “evaluation date”) within 90days prior to the filing date of this report. Based on that evaluation, the Chief Executive Officer and the ChiefFinancial Officer have concluded that, as of the evaluation date, the Company’sdisclosure controls and procedures were effective in ensuring that all materialinformation relating to the Company required to be filed in this quarterlyreport has been made known to them in a timely manner.

 

(b)           Changes in InternalControls

 

Since the evaluation date, there have been no changes to the Company’sinternal controls or in other factors that could significantly affect thosecontrols.

 

18

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**Venture Financial Group, Inc.**

 

**PARTII - OTHER INFORMATION**

 

**Item 4     Submission ofMatters to a Vote of Security Holders.**

** **

(a)                                  The Company’sAnnual Shareholders’ Meeting was held on May 22, 2003

 

(b)                                 Not Applicable

 

(c)                                  A brief descriptionof each matter voted upon at the Annual Meeting and number of votes cast for,against or withheld, including a separate tabulation with respect to eachnominee to serve on the Board is presented below:

 
| (1)    | Election of  three Directors for terms expiring in 2006 or until their successors have  been elected and qualified. |
|--------|---------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                |   |   |
|   | Directors:                                                                                                          |   |   |
|   |                                                                                                                |   |   |
|   | Jewell C. Manspeaker —                                                                                         |   |   |
|   | Votes Cast For:                                                                                                     | 3,577,213 |   |
|   | Votes Cast Against:                                                                                                 | — |   |
|   | Votes Withheld:                                                                                                     | 36,716 |   |
|   |                                                                                                                |   |   |
|   | Patrick L. Martin —                                                                                            |   |   |
|   | Votes Cast For:                                                                                                     | 3,588,573 |   |
|   | Votes Cast Against:                                                                                                 | — |   |
|   | Votes Withheld:                                                                                                     | 25,356 |   |
|   |                                                                                                                |   |   |
|   | Ken F. Parsons, Sr. —                                                                                          |   |   |
|   | Votes Cast For:                                                                                                     | 3,594,885 |   |
|   | Votes Cast Against:                                                                                                 | — |   |
|   | Votes Withheld:                                                                                                     | 19,044 |   |
|   |                                                                                                                |   |   |
| (2)    | Amendment to  the Employee Stock Option Plan                                                                        |
|   | Votes Cast For:                                                                                                     | 3,289,448 |   |
|   | Votes Cast Against:                                                                                                 | 133,452 |   |
|   | Abstentions:                                                                                                        | 191,029 |   |
|   |                                                                                                                |   |   |

(d)                                 None

**Item 6     Exhibitsand Reports on Form 8-K**

(a)          Exhibits

The followingexhibit is filed herewith, and this list constitutes the exhibit index:
| 31.1   | Certification of the Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
|--------|---------------------------------------------------------------------------------------------------------|
|   |                                                                                                    |
| 31.2   | Certification of the Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
|   |                                                                                                    |
| 32     | Certification of CEO and Chief Financial Officer under Section 906 of  Sarbanes-Oxley Act of 2002       |

 

19

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(b)         Reportson Form 8-K

Changein Registrant’s Certifying Accountant filed April 1, 2003

 

Hiringof Chief Financial Officer filed May 2, 2003

 

Changeof Corporate Names filed May 29, 2003

 

FirstQuarter 2003 Earnings Release filed May 29, 2003

 

AdditionalShares for Repurchase Added to the Stock Repurchase Program filed June 27, 2003

 

 

 

20

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**Venture Financial Group, Inc.**

 

SIGNATURES

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.
|                  |   | VENTURE FINANCIAL GROUP, INC. |
|-----------------------|--------|-------------------------------|
|                  |   | (Registrant)                  |
|                  |   |                          |   |
|                  |   |                          |   |
| Date: August 13, 2003 |   | By:                           | /s/ Ken F. Parsons |
|                  |   |                          |   |
|                  |   |                          | Ken F. Parsons |
|                  |   |                          |   |
|                  |   |                          | President, Chief Executive Officer |
|                  |   |                          |   |
|                  |   |                          |   |
|                  |   | By:                           | /s/ Catherine M. Reines |
|                  |   |                          |   |
|                  |   |                          | Catherine M. Reines |
|                  |   |                          |   |
|                  |   |                          | Chief Financial Officer |

 

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