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

                                    FORM 10-K
(Mark One)
/X/ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
    of 1934

                 For the fiscal year ended December 31, 2002 or

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

                        Commission file number 000-29829

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

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

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

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

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

                                      None

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

                     Common Stock, par value $1.00 per share

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such shorter  periods that the  Registrant  was
required to file such  reports),  and (2) has been subject to such  requirements
for the past 90 days.

                               Yes__X___ No______

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

Indicate  by check mark  whether  the  Registrant  is an  accelerated  filer (as
defined by Exchange Act Rule 12b-2). Yes [ ] No [X ]


                                      -1-
<PAGE>


The  aggregate  market value of the common stock held by  non-affiliates  of the
registrant  at June 28, 2002 (the last  business  day of the most recent  second
quarter), was $59,176,189. (based on the closing price on that date)

The number of shares  outstanding of each of the registrant's  classes of common
stock as of February 28, 2003, was:

      Title of Class                              Number of Shares Outstanding
      --------------                              ----------------------------

 Common Stock, $1.00 Par Value                           2,512,659 shares

                       DOCUMENTS INCORPORATED BY REFERENCE

PART III of Form 10-K - The definitive Proxy Statement filed with the Securities
and Exchange  Commission in connection  with  Registrant's  annual meeting to be
held April 16, 2003 (only portions of which are incorporated by reference).

                                      -2-

<PAGE>


                          PACIFIC FINANCIAL CORPORATION
                 ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
                             ENDED DECEMBER 31, 2002

                                TABLE OF CONTENTS
PART I
                                                                            Page
            Item  1.    Business                                               4

            Item  2.    Properties                                            14

            Item  3.    Legal Proceedings                                     14

            Item  4.    Submission of Matters to a Vote of Security Holders   14

PART  II
            Item  5.    Market for Registrant's Common Equity
                        and Related Stockholder Matters                       14

            Item  6.    Selected Financial Data                               15

            Item  7.    Management's Discussion and Analysis of Financial     16
                            Condition and Results of
Operations

            Item  7A. Quantitative and Qualitative Disclosures About
                      Market Risk                                             30

            Item  8.    Financial Statements and Supplementary Data           31

            Item  9.    Changes in and Disagreements with Accountants
                        on Accounting and Financial Disclosure                31

PART  III
            Item  10.  Directors and Executive Officers of the Registrant     31

            Item  11.  Executive Compensation                                 31

            Item  12.  Security Ownership of Certain Beneficial Owners
                       and Management And Related Stockholder Matters         32

            Item  13.  Certain Relationships and Related Transactions         32

            Item  14.  Controls and Procedures                                32

PART  IV
            Item  15.  Exhibits, Financial Statement Schedules,
                       and Reports on Form 8-K                                33

SIGNATURES AND CERTIFICATIONS                                                 65

                                      -3-
<PAGE>

                                     PART I

ITEM 1.  Business

Pacific  Financial  Corporation  (the  Company) is a financial  holding  company
headquartered  in Aberdeen,  Washington.  The Company owns one bank, Bank of the
Pacific  (Pacific  or the Bank),  which is located in  Washington.  The  Company
conducts  its  banking  business  through 10  branches  located  in  communities
throughout  Grays  Harbor  County,  Pacific  County,  and  Wahkiakum  County  in
Southwest  Washington.  At December 31, 2002, the Company had total consolidated
assets of  $268.5  million,  loans of $185.5  million,  and  deposits  of $225.2
million. The Company was incorporated in the State of Washington on February 12,
1997, pursuant to a holding company  reorganization of the Bank. Although an SEC
reporting company, the Company's stock is not listed on any exchange.

FORWARD LOOKING INFORMATION

This document contains forward-looking  statements that are subject to risks and
uncertainties.  These statements are based on the beliefs and assumptions of our
management,  and on  information  currently  available to them.  Forward-looking
statements  include the  information  concerning our possible  future results of
operations  set forth under  "Management's  Discussion and Analysis of Financial
Condition and Results of Operations" and statements  preceded by, followed by or
that include the words "believes," "expects," "anticipates," "intends," "plans,"
"estimates" or similar expressions.

Any  forward-looking  statements in this document are subject to risks  relating
to, among other things, the following:

               1.  competitive  pressures  among  depository and other financial
          institutions  which may  impede  our  ability  to  attract  and retain
          borrowers, depositors and other customers;

               2. changes in the interest rate environment  resulting in reduced
          margins;

               3. general economic or business conditions,  either nationally or
          in the state or regions in which we do business, may be less favorable
          than expected,  resulting in, among other things,  a deterioration  in
          credit  quality,  including  as a result  of lower  prices in the real
          estate market, or a reduced demand for credit;

               4.  legislative  or regulatory  changes may adversely  affect the
          businesses in which we are engaged; and

               5. continued downturns in the securities markets.

Our management believes the forward-looking statements are reasonable;  however,
you should not place undue reliance on them.  Forward-looking statements are not
guarantees of performance.  They involve risks,  uncertainties  and assumptions.
Many of the factors that will  determine our future  results and share value are
beyond our ability to control or predict.  We undertake no  obligation to update
forward-looking statements.

THE BANK

Bank of the Pacific  was  organized  in 1978 and opened for  business in 1979 to
meet the need for a regional  community  bank with local  interests to serve the
small to medium-sized local businesses and

                                      -4-
<PAGE>

professionals  in the region.  Services  offered by the Bank include  commercial
loans,  installment  loans,  real estate loans,  residential  mortgage loans and
personal and business deposit products.

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

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

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

The Bank's primary  sources of deposits are from  individuals  and businesses in
its local markets.  A concerted  effort has been made to attract deposits in the
local market areas through competitive pricing and delivery of quality products.
These products include demand accounts,  negotiable order of withdrawal  ("NOW")
accounts, money market investment accounts, savings accounts, and time deposits.
The Bank  traditionally  has not sought brokered deposits and does not intend to
do so in the future.

The Bank provides 24 hour online banking to its customers with access to account
balances and transaction  histories,  plus an electronic  check register to make
account  management  and  reconciliation  simple.  The online  banking system is
compatible with budgeting  software like Intuit's Quicken or Microsoft's  Money.
In addition,  the online banking system  includes the ability to transfer funds,
make loan payments,  reorder checks,  request statement reprints,  provides loan
calculators  and allows for e-mail  exchanges with The Bank.  Also for a nominal
fee,  customers can request stop  payments and pay an unlimited  number of bills
online.  These services along with rate information and stock information can be
accessed through the Bank's website at www.thebankofpacific.com.

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

COMPETITION

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

The  adoption  of the  Gramm-Leach-Bliley  Act of 1999 (the  Financial  Services
Modernization  Act) in November of that year  eliminated many of the barriers to
affiliation among providers of financial services and further opened the door to
business  combinations  involving  banks,  insurance  companies,  securities  or
brokerage  firms,  and  others.  This  regulatory  change  has  led  to  further
consolidation in the financial  services  industry and the creation of financial
conglomerates  which frequently  offer multiple  financial  services,  including
deposit  services,  brokerage  and  others.  When  combined  with  technological

                                      -5-
<PAGE>

developments  such as the Internet that have reduced  barriers to entry faced by
companies  physically  located outside the Company's market area, changes in the
market have resulted in increased  competition  and can be expected to result in
further increases in competition in the future.

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

According to the Market Share Report  compiled by the FDIC, as of June 30, 2002,
the  Company  held a deposit  market  share of 30% in Pacific  County,  43.9% in
Wahkiakum County and a 15.7% share in Grays Harbor County.

EMPLOYEES

As of December 31, 2002,  the Bank employed 92 full time  equivalent  employees.
Management believes relations with its employees are good.

                           SUPERVISION AND REGULATION

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

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

                                   THE COMPANY
GENERAL

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

BANK HOLDING COMPANY REGULATION

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

                                      -6-
<PAGE>


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

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

FINANCIAL SERVICES MODERNIZATION ACT

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

The Company received approval to become a financial holding company during 2000.
Bank  holding  companies  that elect to become a financial  holding  company may
affiliate  with  securities  firms and  insurance  companies and engage in other
activities  that are financial in nature or are incidental or  complementary  to
activities  that are  financial  in nature.  "Financial  in  nature"  activities
include securities underwriting,  dealing, and market marking, sponsoring mutual
funds and investment  companies,  insurance  underwriting  and agency,  merchant
banking,  and activities  that the Federal  Reserve,  in  consultation  with the
Secretary of Treasury,  determines from time to time to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.

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

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

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

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

                                      -7-
<PAGE>



The law also:

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

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

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

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

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

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

PRIVACY RULES. The Financial Services Modernization Act required federal banking
regulators  to adopt rules that limit the  ability of banks and other  financial
institutions to disclose non-public information about consumers to nonaffiliated
third parties.  Regulations were adopted in 2000 and became  effective  November
13,  2000,  although  compliance  was  optional  until  July  1,  2001.  Adopted
regulations  require  disclosure of privacy  policies to consumers  and, in some
circumstances, allow consumers to prevent disclosure of personal information. We
have  implemented  procedures  to  comply  with  these  rules and  believe  that
compliance has not had an adverse effect on operations.

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

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

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

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

The  depository  institution  may not  condition  as  extension of credit on the
consumer's  purchase  of an  insurance  product or annuity  from the  depository
institution or from any of its affiliates, or on the consumer's agreement not to
obtain, or a prohibition on the consumer from obtaining, an insurance product or
annuity from an unaffiliated entity.  Furthermore,  to the extent practicable, a
depository   institution  must  keep

                                      -8-
<PAGE>


insurance  and annuity sales  activities  physically  segregated  from the areas
where retail deposits are routinely  accepted from the general public.  Finally,
the rule addresses cross marketing and referral fees.

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

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

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

     o implement and test the plan; and

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

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

USA PATRIOT ACT OF 2001

On October 26, 2001, President Bush signed the Uniting and Strengthening America
by Providing  Appropriate  Tools  Required to Intercept  and Obstruct  Terrorism
("USA  Patriot  Act") of 2001.  Among  other  things,  the USA  Patriot  Act (1)
prohibits banks from providing  correspondent accounts directly to foreign shell
banks;  (2)  imposes  due  diligence  requirements  on banks  opening or holding
accounts for foreign financial institutions or wealthy foreign individuals;  (3)
requires financial institutions to establish an anti-money-laundering compliance
program,  and (4)  eliminates  civil  liability for persons who file  suspicious
activity  reports.  The Act also  increases  governmental  powers to investigate
terrorism,   including  expanded  government  access  to  account  records.  The
Department  of the  Treasury  is  empowered  to  administer  and  make  rules to
implement  the Act. We do not believe that  compliance  with the USA Patriot Act
has had a material effect on our business and operations.

SARBANES-OXLEY ACT OF 2002

     The  Sarbanes-Oxley  Act of 2002 was signed into law by  President  Bush on
July 30, 2002 in response to public concerns regarding corporate  accountability
in connection  with the recent  accounting  scandals at various  large  publicly
traded  companies.  The  stated  goals  of the  act  are to  increase  corporate
responsibility,  to provide for enhanced  penalties for  accounting and auditing
improprieties at publicly traded companies and to protect investors by improving
the accuracy and reliability of corporate disclosures pursuant to the securities
laws. The Sarbanes-Oxley  Act generally applies to all companies,  both U.S. and
non-U.S., that file or are required to file periodic reports with the Securities
and  Exchange  Commission  ("SEC"),  under the  Securities  Exchange Act of 1934
("Exchange Act").

     The  Sarbanes-Oxley  Act  includes  very  specific  additional   disclosure
requirements and new corporate governance rules, requires the SEC and securities
exchanges to adopt extensive  additional  disclosure,  corporate  governance and
other related rules and mandates  further  studies of certain  issues by the SEC
and the  Comptroller  General.  The  Sarbanes-Oxley  Act represents  significant
federal  involvement in matters  traditionally left to state regulatory systems,
such as the regulation of the accounting profession, and to state corporate law,
such as the relationship between a board of directors and management and between
a board of directors and its committees.



                                      -9-
<PAGE>


     The  Sarbanes-Oxley  Act addresses,  among other  matters,  (1) board audit
committees;  (2)  certification  of Exchange Act reports by the chief  executive
officer and the chief financial officer;  (3) the forfeiture of bonuses or other
incentive-based  compensation  and securities  trading  profits by directors and
executive officers in the twelve-month  period following initial  publication of
any financial  statements  that later  require  restatement;  (4)  disclosure of
off-balance sheet transactions; (5) expedited reporting of stock transactions by
insiders;  (6) disclosure of a code of ethics, if any, and changes or waivers of
such code; (7) the formation of a Public Company Accounting Oversight Board; (8)
auditor  independence;  and (9) increased  criminal  penalties for violations of
securities laws.

     Provisions  of the  Sarbanes-Oxley  Act become  effective at various  times
during the 18 months  beginning  July 30, 2002.  The SEC has been  delegated the
task of adopting rules to implement various provisions,  including disclosure in
periodic   filings   pursuant  to  the  Exchange  Act.   While  we  believe  the
Sarbanes-Oxley Act may, to some degree, affect our reporting expenses, we do not
believe  that the Act will have a material  adverse  effect on our  business and
operations.

TRANSACTIONS WITH AFFILIATES

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

REGULATION OF MANAGEMENT

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

TIE-IN ARRANGEMENTS

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

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


                                      -10-
<PAGE>

in banking and  nonbanking  products and to allow banks and their  affiliates to
provide more efficient, lower cost services to their customers.

SOURCE OF STRENGTH REQUIREMENTS

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

STATE LAW RESTRICTIONS

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

                                    THE BANK
GENERAL

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

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

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

     FDICIA. Under the Federal Deposit Insurance Corporation  Improvement Act of
1991  ("FDICIA"),  each federal  banking agency has  prescribed,  by regulation,
noncapital safety and soundness  standards for institutions under its authority.
These standards cover internal controls, information systems, and internal audit
systems, loan documentation,  credit underwriting, interest rate exposure, asset
growth,  compensation,  fees and benefits, such other operational and managerial
standards as the agency



                                      -11-
<PAGE>

determines to be  appropriate,  and standards  for asset  quality,  earnings and
stock valuation. An institution which fails to meet these standards must develop
a plan acceptable to the agency,  specifying the steps that the institution will
take to meet the  standards.  Failure  to  submit or  implement  such a plan may
subject the institution to regulatory  sanctions.  Management  believes that the
Bank  meets all such  standards,  and  therefore,  does not  believe  that these
regulatory standards will materially affect the Company's business operations.

INTERSTATE BANKING AND BRANCHING

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

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

DEPOSIT INSURANCE

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

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

DIVIDENDS

     The principal  source of the Company's cash revenues is dividends  received
from the Bank. The payment of dividends is subject to government regulation,  in
that regulatory  authorities may prohibit banks and bank holding  companies from
paying  dividends in a manner that would constitute an unsafe or unsound banking
practice.  In addition,  a bank may not pay cash dividends if that payment could
reduce the amount of its capital below that necessary to meet minimum applicable
regulatory  capital


                                      -12-

<PAGE>


requirements.  Other than the laws and regulations  noted above,  which apply to
all banks and bank  holding  companies,  neither  the  Company  nor the Bank are
currently  subject to any  regulatory  restrictions  on their  dividends.  Under
applicable  restrictions,  as of  December  31,  2002,  the Bank  could  declare
dividends totaling $3,955,000 without obtaining prior regulatory approval.

CAPITAL ADEQUACY

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

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

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

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

EFFECTS OF GOVERNMENT MONETARY POLICY

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

                                      -13-
<PAGE>

ITEM 2.  PROPERTIES

The Company's  administrative offices are located in Aberdeen,  Washington.  The
building  located at 300 East Market  Street is owned by the Bank and houses the
main branch and the  administrative  and operations  offices of the Bank and the
Company.  The Bank completed  construction and occupied the building in December
of 1979.  There  are nine  branches  in  addition  to the main  office  owned by
Pacific.

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

In addition to the land and buildings owned by Pacific,  it also owns all of its
furniture,  fixtures and  equipment  including  data  processing  equipment.  At
December 31, 2002,  the net book value of the  Company's  premises and equipment
was $3.8 million.

ITEM 3.  LEGAL PROCEEDINGS

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

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

No matters were submitted to a vote of security holders in the fourth quarter of
2002.

                                     PART II

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

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

                                                        2002                                          2001
                       Shares Traded           High             Low         Shares Traded        High       Low

<S>                         <C>               <C>              <C>              <C>             <C>         <C>
First Quarter               7,399             $  25            $  23            5,012           $  25       $  23

Second Quarter              9,265             $  24            $  22           12,341           $  25       $  21

Third Quarter              36,554             $  24            $  21           27,166           $  24       $  23

Fourth Quarter             10,106             $  25            $  24            7,691           $  25       $  23
</TABLE>


                                      -14-

<PAGE>


As of December 31, 2002, there were  approximately  1,024 stockholders of record
of the Company's common stock.

The  Company's  Board of  Directors  declared  dividends  on its common stock in
December   2002  and  2001  in  the  amounts  per  share  of  $1.35  and  $1.32,
respectively.  The Board of  Directors  has adopted a dividend  policy  which is
reviewed annually.

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

ITEM 6.  SELECTED FINANCIAL DATA

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

                                           2002              2001             2000           1999         1998
                                           -------------------------------------------------------------------
                                                 ($ in thousands, except per share data)
OPERATIONS DATA
<S>                                    <C>                <C>              <C>             <C>        <C>
Net interest income                    $   11,788         $  11,572        $  11,675       $  11,430  $  11,100
Provision for credit losses                   954               580              635              60        110
Noninterest income                          2,059             1,529            1,217           1,255      1,281
Noninterest expense                         7,414             7,193            7,530           7,011      6,687
Provision for income taxes                  1,563             1,521            1,424           1,692      1,590
Net income                                  3,916             3,807            3,303           3,922      3,994
Net income per share:
Basic                                        1.57              1.53             1.33            1.60(1)    1.64(1)
Diluted                                      1.56              1.52             1.31            1.59(1)    1.61(1)

Dividends declared                          3,392             3,289            3,204           3,105      2,379
Dividends declared per share                 1.35              1.32             1.28            1.25(1)     .97(1)
Dividends paid ratio                          87%               86%              97%             79%        60%
   (1)      Restated to reflect the 5 for 1 stock split effected in July 2000.

PERFORMANCE RATIOS
Net interest margin                         5.05%             5.16%            5.14%           5.10%      5.37%
Efficiency ratio                           53.54%            54.90%           58.41%          55.27%     54.01%
Return on average assets                    1.54%             1.55%            1.34%           1.64%      1.80%
Return on average equity                   15.81%            15.57%           14.95%          17.26%     18.57%

BALANCE SHEET DATA
Total assets                           $ 268,534           243,617          253,313         242,189    236,364
Loans, net                               183,031           174,495          175,142         150,734    145,416
Total deposits                           225,254           214,644          213,511         206,139    210,650
Other borrowings                          12,800              -0-            11,358           9,675         86
</TABLE>



                                      -15-
<PAGE>
<TABLE>
<CAPTION>

<S>                                       <C>               <C>              <C>             <C>        <C>
Shareholders' equity                      24,683            23,514           22,743          21,438     21,485

Book value per share                       9.82              9.44              9.09            8.63(1)    8.79(1)
Equity to assets ratio                     9.19%             9.65%             8.98%           8.85%      9.09%
(1)      Restated to reflect the 5 for 1 stock split effected in July 2000.

ASSET QUALITY RATIOS
Nonperforming loans to total loans         1.00%              .71%             1.93%           0.21%      0.01%
Allowance for loan losses
  to total loans                           1.33%             1.19%             1.14%           1.26%      1.27%

Allowance for loan losses
  to nonperforming loans                 132.67%           168.18%            59.24%         612.69%  12426.67%
Nonperforming assets to
  total assets                              .69%              .51%             1.35%           0.13%      0.06%
</TABLE>

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

RESULTS OF OPERATIONS

Years ended December 31, 2002, 2001, and 2000

General.  The  Company's  net income for 2002 was  $3,916,000,  a 2.9%  increase
compared to  $3,807,000  in 2001,  and an increase of 18.6% from  $3,303,000  in
2000. Basic earnings per share were $1.57,  $1.53, and $1.33 for 2002, 2001, and
2000,  respectively.  Return on average  assets was 1.54%,  1.55%,  and 1.34% in
2002, 2001, and 2000 respectively.  Return on average equity was 15.81%, 15.57%,
and 14.95%, respectively, in 2002, 2001, and 2000.

The following table presents condensed consolidated statements of income for the
Company for each of the years in the three-year period ended December 31, 2002.
<TABLE>
<CAPTION>

                                                            Increase                           Increase
                                                           (Decrease)                         (Decrease)
(Dollars in thousands)                         2002        Amount        %        2001        Amount        %          2000
---------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>              <C>        <C>      <C>            <C>        <C>        <C>
Interest income                           $  15,779        $(2,323)   (12.8)   $18,102        $(2,170)   (10.7)     $20,272
Interest expense                              3,991         (2,539)   (38.9)     6,530         (2,067)   (24.0)       8,597
Net interest income                          11,788            216      1.9     11,572           (103)     (.9)      11,675
Provision for credit losses                     954            374     64.5        580            (55)    (8.7)         635
Net interest income after
  provision for credit losses                10,834           (158)    (1.4)    10,992            (48)     (.4)      11,040
Other operating income                        2,059            530     34.7      1,529            312     25.6        1,217
Other operating expense                       7,414            221      3.1      7,193           (337)    (4.5)       7,530
Income before income taxes                    5,479            151      2.8      5,328            601     12.7        4,727
Income taxes                                  1,563             42      2.8      1,521             97      6.8        1,424
Net income                                    3,916            109      2.9      3,807            504     15.3        3,303
</TABLE>

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

                                      -16-

<PAGE>

<TABLE>
<CAPTION>

                                                         Year Ended December 31,
                                                  2002                           2001                           2000
                                                  ----                           ----                           ----
                                                 Interest                      Interest                       Interest
                                       Average    Income    Avg      Average    Income     Avg      Average    Income     Avg
                                       Balance   (Expense) Rate      Balance   (Expense)  Rate      Balance   (Expense)  Rate
                                       -------   --------------      -------   ---------  ----      -------   ---------  ----
Assets     (dollars in thousands)
  Earning assets:
<S>                                 <C>          <C>        <C>      <C>       <C>        <C>       <C>       <C>         <C>
     Loans                          $  178,765   $  13,212* 6.95%    $170,628  $  15,032* 8.81%     $165,834  $  16,500*  9.95%
     Investment Securities:
       Taxable                          32,991       1,541  4.67%      27,360      1,638  5.99%       45,857      2,812   6.13%
       Tax-Exempt                       14,510       1,165* 8.03%      15,042      1,225* 8.14%       13,187      1,007*  7.64%
     Total investment
       securities                       47,501       2,706  5.70%      42,402      2,863  6.75%       59,044      3,819   6.47%
     Federal Home Loan Bank Stock        3,102         186  6.01%       3,657        251  6.86%        3,450        223   6.43%
     Federal funds sold and
       deposits in banks                 5,644         107  1.90%      11,339        410  3.61%        2,258        148   6.55%
Total earning assets/interest
  income                            $  235,013   $  16,211  6.90%    $228,026  $  18,556  8.14%     $230,586  $  20,690   8.97%
  Cash and due from banks                8,331                          8,448                          8,599
  Bank premises and equipment
     (net)                               3,930                          4,104                          3,728
  Other assets                           9,552                          6,822                          5,447
  Allowance for credit losses           (2,515)                        (1,912)                        (1,997)
  Total assets                        $254,310                       $245,488                       $246,548


Liabilities and Shareholders' Equity
  Interest bearing liabilities:
     Deposits:
       Savings and interest-
         bearing demand               $104,111  $  (1,080)  1.04%    $105,846  $  (2,395)  2.26%   $109,266  $  (4,483)     4.10%
           Time                         79,664     (2,667)  3.35%      75,819     (3,945)  5.20%     68,516     (3,537)     5.16%
     Total deposits                    183,775     (3,747)  2.04%     181,665     (6,340)  3.49%    177,782     (8,020)     4.51%
     Short-term  borrowings                174         (4)  2.48%       3,065       (190)  6.20%      8,876       (577)     6.50%
     Long-term borrowings                6,548       (240)  3.67%        ----       ----   ----        ----       ----      ----
Total interest-bearing liabilities/
  Interest expense                    $190,497  $  (3,991)  2.10%    $184,730  $  (6,530)  3.53%   $186,658  $  (8,597)     4.61%
Demand deposits                         36,180                         33,419                        34,343
Other liabilities                        2,867                          2,888                         3,457
Shareholders' equity                    24,766                         24,451                        22,090
Total liabilities and shareholders'
  equity                              $254,310                       $245,488                      $239,513
Net interest income                             $  12,220*                     $  12,026*                    $  12,093*
Net interest income as a percentage of
  average earning assets
         Interest income                                    6.90%                          8.14%                            8.97%
         Interest expense                                   1.72%                          2.86%                            3.73%
         Net interest income                                5.18%                          5.28%                            5.24%
         * Tax equivalent basis - 34% tax rate used
</TABLE>

Nonaccrual loans are included in "loans."

Interest income on loans include loan fees of $778,605,  $708,270,  and $822,516
in 2002, 2001, and 2000, respectively.

For purposes of computing the average yield,  the Company used  historical  cost
balances which do not give effect to changes in fair value that are reflected as
a component of shareholders' equity.

Net interest income  increased 1.9% to $11,788,000 in 2002 compared to 2001. The
increase is primarily the result of a decreased  interest rate environment.  The
Company's   interest  income   decreased  12.8%  to  $15,779,000  in  2002  from
$18,102,000 in 2001. This decrease,  also due to declining  interest rates,  was


                                      -17-
<PAGE>

substantially  offset by a 38.9% decrease in interest expense from $6,530,000 in
2001 to $3,991,000 in 2002. Net interest income  decreased .9% to $11,572,000 in
2001 compared to 2000.  The decrease is also primarily the result of a decreased
interest rate  environment.  The Company's  interest  income  decreased 10.7% to
$18,102,000  in 2001  from  $20,272,000  in  2000.  This  decrease,  also due to
decreasing  interest  rates,  was  substantially  offset  by a 24%  decrease  in
interest expense from $8,597,000 in 2000 to $6,530,000 in 2001.

The Company's average loan portfolio increased  $8,137,000,  or 4.8%, from 2001,
and  increased  $4,794,000  or 2.9% in 2001 from  2000.  A large  portion of the
Company's  loan  portfolio  rates are tied to variable rate  indexes.  Given the
unprecedented  drop in rates  experienced in 2001 and the 50 basis point drop in
prime  rate in 2002,  the  decrease  in rates  overshadowed  the  growth  in the
portfolio, causing a decline in interest income earned.

The Company's  average  investment  portfolio  increased  $5,099,000 or 12% from
2001.  These  investments,  along with the proceeds  from  long-term  borrowings
during the third quarter of 2002, were invested in various long-term  investment
products.  This resulted in an increase in earnings on the investment  portfolio
due to the  change  in yield  earned on  long-term  products  versus  short-term
products. The Company's average investment portfolio decreased  $16,642,000,  or
28.2%  during  2001  from  2000.  The  changes  in 2001 were  primarily  in U.S.
Government agency securities due to call options being exercised by the issuers.
Proceeds from the portfolio decrease were used to decrease short term borrowings
during 2001.

The Company's  average  deposits  increased  $2,110,000  or 1.2% from 2001,  and
increased  $3,883,000  or 2.2% in 2001 from  2000.  Along with the  increase  in
average  deposits,  the Company was able to reprice  its  deposit  offerings  to
current  market rates more quickly than loans  repriced,  yielding a decrease in
interest expense.

The Company  increased  its average  borrowings  during  2002 by  $3,657,000  or
119.3%.  These borrowings consist of advances from the Federal Home Loan Bank of
Seattle. The proceeds were used to fund loan growth and for investment purposes.
The Company decreased its average borrowings during 2001 by $5,811,000 or 65.5%.

Net interest  margins were 5.05%,  5.16%, and 5.14% for the years ended December
31, 2002, 2001, and 2000, respectively.

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

                                                     2002 compared to 2001                  2001 compared to 2000
                                                    Increase (decrease) due to             Increase (decrease) due to
(dollars in thousands)                           Volume             Rate          Net      Volume          Rate          Net
                                                 ------             ----          ---      ------          ----          ---
Interest earned on:
<S>                                                <C>          <C>          <C>              <C>      <C>             <C>
  Loans                                            $690         $(2,510)     $(1,820)        $466      $(1,934)        $(1,468)
Securities:
   Taxable                                          301            (398)         (97)      (1,109)         (65)         (1,174)
   Tax-exempt                                       (43)            (17)         (60)         148           70             218
    Total securities                                258            (415)        (157)        (961)           5            (956)
Federal Home Loan Bank Stock                        (35)            (30)         (65)          14           15              29
</TABLE>



                                      -18-
<PAGE>
<TABLE>
<CAPTION>

  Fed funds sold and
  interest bearing deposits
<S>                                                <C>             <C>          <C>           <C>          <C>             <C>
    in other banks                                 (156)           (147)        (303)         354          (93)            261
Total interest earning assets                       757          (3,102)      (2,345)        (127)      (2,007)         (2,134)

Interest paid on:
  Savings and interest bearing
 demand deposits                                     39           1,276        1,315         (136)      (1,952)         (2,088)
  Time deposits                                    (191)          1,469        1,278          380           28             408
  Other borrowings                                 (157)            103          (54)        (362)         (25)           (387)
Total interest bearing liabilities                 (309)          2,848        2,539         (118)      (1,949)         (2,067)
Change in net interest income                       448            (254)        (194)          (9)         (58)            (67)
</TABLE>

Non-Interest Income. Non-interest income was $2,059,000 for 2002, an increase of
$530,000 or 34.7% from 2001 when it totaled  $1,529,000.  The 2001 amount was an
increase of $312,000 or 25.6% compared to the 2000 total of $1,217,000.

In 2002,  service charges on deposit accounts  increased  $241,000 or 29.1% to a
total of $1,069,000 compared to $828,000 in 2001. The 2001 total was up $151,000
or 22.3% compared to the 2000 total of $677,000. During the second half of 2001,
a new customer overdraft protection program was implemented which contributed to
the increase in service charges on deposit accounts during both 2001 and 2002.

Income from  sources  other than  service  charges on deposit  accounts  totaled
$987,000  in 2002,  an increase of  $318,000  from 2001,  or 47.4%.  The primary
reason for the increase was income from  foreclosed  real estate,  which totaled
$132,000. In addition, during 2002, the Bank sold two parcels of foreclosed real
estate and realized a profit on sale of $160,000.  The properties consisted of a
motel and a medical care facility. Other major components of non-interest income
were credit card income and bank owned life insurance  income.  Additional  bank
owned life insurance was purchased  during fourth quarter 2001 which resulted in
higher earnings during 2002. Income from other sources for 2001 was $669,000, an
increase of  $138,000  or 26%  compared  to 2000,  primarily  due to  collecting
operating revenues from a motel that was brought into foreclosed real estate.

The following table represents the principal  categories of non-interest  income
for each of the years in the three-year period ended December 31, 2002.
<TABLE>
<CAPTION>

                                                            Increase                           Increase
                                                           (Decrease)                         (Decrease)
(Dollars in thousands)                         2002         Amount        %        2001        Amount        %       2000
---------------------------------------------------------------------------------------------------------------------------
Service charges on
<S>                                          <C>              <C>      <C>        <C>            <C>      <C>          <C>
    deposit accounts                         $1,069           $241     29.1%      $828           $151     22.3%        $677
Mortgage broker fees                              3            (29)   (90.6)%       32             23    255.0%           9
Net gain on sale of securities                  ---            ---    ---          ---            ---    ---            ---
Other operating income                          987            318     47.5%       669            138     26.0%         531

Total non-interest income                     2,059            530     34.7%     1,529            312     25.6%       1,217
</TABLE>

Non-Interest Expense. Total non-interest expense was $7,414,000,  an increase of
$221,000 or 3.1% compared to $7,193,000  in 2001. In 2001  non-interest  expense
decreased $337,000 or 4.5% compared to $7,530,000 in 2000.

Salary  and  employee  benefits  increased  by  $138,000,  or  3.4%,  in 2002 to
$4,196,000 and decreased by $77,000,  or 1.9%, in 2001. The increase in 2002 was
primarily  due to  addition  of staff and normal  merit

                                      -19-
<PAGE>

increases. The primary reason for the decrease in 2001 was the retirement of the
Company's Chief Executive Officer, Robert Worrell.

Occupancy and equipment  expense increased $21,000 or 2.2% in 2002 and decreased
$176,000 or 15.5% in 2001. The increase in 2002 was due to costs associated with
maintenance  of buildings,  equipment,  utilities and property  taxes.  The 2001
decrease  was the  result of a decline  in  equipment  maintenance  expense  and
reduced equipment depreciation expense.

Other  expense  increased  $62,000 or 2.9% in 2002  compared  to a  decrease  of
$84,000 or 3.7% in 2001 over 2000. The increase in 2002 is due to an increase in
advertising expense of $30,000, professional fees of $35,000 and data processing
cost of $47,000,  which  offset  decreases in legal  expense of $33,000,  travel
expenses $10,000 and loan collection expense of $22,000. The decrease in 2001 is
related  primarily  to  lower  advertising  expense  of  $20,000,  non-recurring
deferred director fees of $160,000 paid in 2000,  decreased insurance expense of
$26,000 and an increase in foreclosed real estate expenses of $127,000 primarily
due to the operations of a motel.

The following table represents the principal  categories of non-interest expense
for each of the years in the three-year period ended December 31, 2002.
<TABLE>
<CAPTION>

                                                            Increase                           Increase
                                                           (Decrease)                         (Decrease)
(Dollars in thousands)                         2002          Amount        %        2001        Amount        %       2000
---------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>             <C>           <C>     <C>            <C>        <C>        <C>
Salaries and employee benefits            $   4,196       $    138      3.4%    $4,058         $  (77)    (1.9%)     $4,135
Occupancy and equipment                         984             21      2.2%       963           (176)   (15.5%)      1,139
Other expense                                 2,234             62      2.9%     2,172            (84)    (3.7%)      2,256

Total non-interest expense                $   7,414         $  221      3.1%    $7,193        $  (337)    (4.5%)     $7,530
</TABLE>

CRITICAL ACCOUNTING POLICY:

The Company's  consolidated financial statements are prepared in accordance with
accounting  principles  generally accepted in the United States of America.  The
financial  information  contained  within these  statements is, to a significant
extent,  financial  information  that is based on  approximate  measures  of the
financial effects of transactions and events that have already  occurred.  Based
on its  evaluation  of  accounting  policies  that  involve the most complex and
subjective  decisions  and  assessments,  management  has  identified  its  most
critical  accounting  policy as related to the  allowance  for loan losses.  The
Company's  allowance for credit loss methodology  incorporates a variety of risk
considerations,  both quantitative and qualitative, in establishing an allowance
for loan losses that management  believes is appropriate at each reporting date.
Quantitative   factors  include  the  Company's   historical  loss   experience,
delinquency and charge-off trends,  collateral values,  changes in nonperforming
loans,  and  other  factors.   Quantitative   factors  also  incorporate   known
information about individual loans, including borrowers' sensitivity to interest
rate movements.  Qualitative factors include the general economic environment in
the Company's  markets,  including economic  conditions and, in particular,  the
state of  certain  industries.  Size and  complexity  of  individual  credits in
relation to loan structure,  existing loan policies and pace of portfolio growth
are other  qualitative  factors that are considered in the  methodology.  As the
Company adds new products and increases the complexity of its loan portfolio, it
intends to enhance its methodology  accordingly.  A materially  different amount
could  be  reported  for the  provision  for loan  losses  in the  statement  of
operations to change the allowance for loan losses if management's assessment of
the above factors were different. This discussion and analysis should be read in
conjunction with the Company's  financial  statements and the accompanying notes
presented  elsewhere  herein,  as  well  as the  portion  of  this  Management's
Discussion and Analysis section entitled  "Lending - Allowance and

                                      -20-
<PAGE>

Provision for Credit  Losses".  Although  management  believes the levels of the
allowance as of both  December 31, 2002 and 2001 were  adequate to absorb losses
inherent in the loan portfolio, a decline in local economic conditions, or other
factors,  could result in increasing  losses that cannot reasonably be predicted
at this time.

ASSET AND LIABILITY MANAGEMENT

The largest component of the Company's earnings is net interest income. Interest
income  and  interest  expense  are  affected  by general  economic  conditions,
competition  in the  market  place,  market  interest  rates and  repricing  and
maturity  characteristics  of the Company's assets and liabilities.  Exposure to
interest rate risk is primarily a function of  differences  between the maturity
and repricing schedules of assets (principally loans and investment  securities)
and liabilities (principally deposits).  Assets and liabilities are described as
interest  sensitive  for a given  period of time when they mature or can reprice
within that  period.  The  difference  between the amount of interest  sensitive
assets  and  interest  sensitive  liabilities  is  referred  to as the  interest
sensitive  "GAP" for any given  period.  The  "GAP"  may be either  positive  or
negative. If positive,  more assets reprice than liabilities.  If negative,  the
reverse is true.

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

The  following  table shows the dollar amount of interest  sensitive  assets and
interest sensitive liabilities at December 31, 2002 and differences between them
for the maturity or repricing periods indicated.
<TABLE>
<CAPTION>

                                                                     Due after
                                                Due in one          one through          Due after
(dollars in thousands)                         year or less         five years          five years                 Total
------------------------------------------------------------------------------------------------------------------------
Interest earning assets
<S>                                            <C>                   <C>                <C>                     <C>
Loans                                          $    70,081           $ 45,383           $  70,326               $ 185,790
Investment securities                               23,856             18,445              20,291                  62,592
Fed Funds and interest
  bearing balances with banks                          373                 -0-                 -0-                    373
Federal Home Loan Bank Stock                            -0-                -0-                866                     866
Total interest earning assets                  $    94,310          $  63,828           $  91,483               $ 249,621

Interest bearing liabilities
Interest bearing demand deposits               $    31,030          $      -0-          $      -0-              $  31,030
Savings deposits                                    72,163                 -0-                 -0-                 72,163
Time deposits                                       71,441             10,536                  -0-                 81,977
Short term borrowings                                1,800                 -0-                 -0-                  1,800
Long term borrowings                                  ----              5,000               6,000                  11,000
Total interest bearing liabilities             $   176,434          $  15,536           $   6,000               $ 197,970


Net interest rate sensitivity GAP              $   (82,124)         $  48,292           $  85,483               $  51,651
Cumulative interest rate sensitivity GAP                            $ (33,832)          $  51,651                  51,651
Cumulative interest rate sensitivity GAP
as a % of earning assets                                               (13.6%)              20.7%                   20.7%
</TABLE>


                                      -21-
<PAGE>

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

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

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

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

Net interest rate sensitivity GAP              $   (57,930)         $  36,406           $  67,325               $  45,801
Cumulative interest rate sensitivity GAP                            $ (21,524)          $  45,801               $  45,801
Cumulative interest rate sensitivity GAP
as a % of earning assets                                                (9.7%)               20.6%                   20.6%
</TABLE>

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

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

INVESTMENT PORTFOLIO

The Company's investment  securities portfolio increased  $25,974,000,  or 70.9%
during 2002 to  $62,592,000 at year end from  $36,618,000  in 2001,  which was a
$18,454,000  decrease  over 2000.  The  changes in 2002 were  primarily  in U.S.
Government agency mortgaged backed securities and in other securities which grew
primarily in short term mutual fund  securities.  Based on the low interest rate
environment during 2002, the Bank borrowed long term funds from the Federal Home
Loan Bank of Seattle totaling  $7,000,000 and purchased U.S.  Government  agency
mortgage backed  securities.  The transaction  resulted in a yield spread of 195
basis points.

The carrying values of investment  securities at December 31 in each of the last

                                      -22-
<PAGE>

three years are as follows:
<TABLE>
<CAPTION>

(dollars in thousands)                                        2002                       2001                      2000
-----------------------------------------------------------------------------------------------------------------------
<S>                                                       <C>                      <C>                      <C>
Treasury securities                                       $    -0-                  $    -0-                  $     500
U.S. Agencies securities                                    25,775                      6,872                    27,613
Obligations of states and political subdivisions            15,849                     16,658                    13,554
Other securities                                            20,968                     13,088                    13,405

     Total                                                $ 62,592                  $  36,618                   $55,072
</TABLE>

The following table presents the maturities of investment securities at December
31, 2002.  Taxable  equivalent values are used in calculating  yields assuming a
tax rate of 34%.
<TABLE>
<CAPTION>
                                                                     Due after           Due after
                                                Due in one          one through        five through       Due after
(dollars in thousands)                         year or less         five years           ten years        ten years      Total
------------------------------------------------------------------------------------------------------------------------------

<S>                                               <C>              <C>                 <C>               <C>        <C>
U.S. Agency securities                            $   4,527        $   1,684           $   5,871         $ 13,693   $  25,775
  Weighted average yield                               4.64%            6.29%               3.74%            4.75%
Obligations of states and political
  subdivisions                                          896            7,818               4,395            2,740      15,849
  Weighted average yield                               6.30%            6.15%               6.58%            6.60%
Other securities                                     18,371            2,597                  -0-              -0-     20,968
  Weighted average yield                               3.40%            6.22%                 -0-              -0-

     Total                                        $  23,794        $  12,099           $  10,266         $ 16,433   $  62,592
</TABLE>

LENDING

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

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

(dollars in thousands)                           2002              2001             2000              1999             1998
---------------------------------------------------------------------------------------------------------------------------

<S>                                          <C>              <C>              <C>               <C>              <C>
Commercial                                   $ 69,794         $  72,427        $  68,827         $  56,198        $  48,455
Real Estate Construction                        9,697             6,554            6,118             3,325            4,929
Real Estate Mortgage                          101,151            91,714           96,334            88,905           90,027
Installment                                     4,114             4,941            4,612             3,379            3,104
Credit cards and overdrafts                     1,034               968            1,277               857              764
     Total                                   $185,790         $ 176,604        $ 177,168         $ 152,664         $147,280
</TABLE>

Loan Maturities and Sensitivity in Interest Rates.  The following table presents
information  related to maturity  distribution  and interest rate sensitivity of
commercial and real estate  construction loans  outstanding,  based on scheduled
repayments at December 31, 2002.


                                      -23-
<PAGE>
<TABLE>
<CAPTION>


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

<S>                                               <C>                    <C>                 <C>               <C>
Commercial                                        $     39,141           $  18,648           $ 12,005          $ 69,794
Real estate construction                                 5,596                 915              3,186             9,697
     Total                                        $     44,737           $  19,563           $ 15,191          $ 79,491

Total loans maturing after one year with
  Predetermined interest rates (fixed)                                   $  37,290           $ 76,008         $ 113,298
  Floating or adjustable rates (variable)                                    9,897                511            10,408
     Total                                                               $  47,187           $ 76,519         $ 123,706
</TABLE>

At December 31, 2002, 37.7% of the loan portfolio presented above was due in one
year or less.

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

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

(dollars in thousands)                2002                2001                2000               1999                1998
-------------------------------------------------------------------------------------------------------------------------

<S>                            <C>                    <C>                <C>                <C>                   <C>
Non-accrual loans              $     1,864            $  1,254           $   3,128          $     175             $    15
Accruing loans past due
  90 days or more                        2                  79                 292                140                   4
Restructured loans                       0                   0                   0                  0                   0
Foreclosed real estate owned           686               1,040                ----                177                ----
</TABLE>

Non-accrual  loans increased  approximately  $610,000 to $1,864,000 in 2002 from
2001. The total is net of  charge-offs  based on  management's  estimate of fair
market value or the result of appraisals.  The properties consist of real estate
and commercial  real estate  properties.  During 2002,  sales of foreclosed real
estate owned totaled $1,421,000.  At December 31, 2002, the balance remaining in
foreclosed  real estate owned  totaled  $686,000.  Non-accrual  loans  decreased
$1,874,000  to  $1,254,000  at year-end  2001 after  increasing to $3,128,000 in
2000,  and  increasing to $175,000 in 1999 from $15,000 in 1998. The increase in
non-accrual  loans  experienced in 2000 was  attributable  to the decline in the
regional and national  economies  and the local  agriculture  economy.  Interest
income on  non-accrual  loans  that  would have been  recorded  had those  loans
performed  in  accordance  with their  initial  terms,  as of  December  31, was
$118,000 for 2002,  $75,000 for 2001,  $168,000  for 2000,  $10,000 for 1999 and
$20,000 for 1998.  Interest  income  recognized  on impaired  loans for 2002 was
$13,000,  for 2001 was $2,000, for 2000 was $31,000,  for 1999 was $11,000,  and
was none for 1998.

There are  $2,000  of loans  which  are  ninety  days or more past due and still
accruing at year-end  2002.  The loans in  management's  opinion are  adequately
collateralized and, if foreclosure and sale of collateral is necessary,  no loss
will be incurred.
                                      -24-
<PAGE>


Loan Concentrations. The Company has credit risk exposure related to real estate
loans.  The Company makes real estate loans for construction and loans for other
purposes which are secured by real estate. At December 31, 2002 loans secured by
real  estate  totaled  $110,848,000,  which  represents  59.6% of the total loan
portfolio.  Real estate construction loans comprised  $9,697,000 of that amount,
while real estate loans secured by residential  properties totaled  $29,945,000.
As a result of these  concentrations of loans, the loan portfolio is susceptible
to changes in economic and market  conditions in the Company's market areas. The
Company generally requires collateral on all real estate exposures and typically
maintains loan-to-value ratios of no greater than 80%.

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

Periodic  provisions  for loan losses are made to  maintain  the  allowance  for
credit losses at an appropriate  level.  The provisions are based on an analysis
of various factors  including  historical  loss experience  based on volumes and
types of loans,  volumes  and trends in  delinquencies  and  non-accrual  loans,
trends in portfolio volume,  results of internal and independent external credit
reviews, and anticipated economic conditions.  Transactions in the allowance for
credit losses for the five years ended December 31, 2002 are as follows:
<TABLE>
<CAPTION>

(dollars in thousands)                           2002              2001             2000              1999             1998
---------------------------------------------------------------------------------------------------------------------------

<S>                                        <C>                 <C>              <C>               <C>              <C>
Balance at beginning of year               $    2,109          $  2,026         $  1,930          $  1,864         $  1,937
Charge-offs:
  Commercial                                      131               170              554               114                9
  Real estate loans                               461               366                0                 0              194
</TABLE>

                                      -25-
<PAGE>

<TABLE>
<CAPTION>

<S>                                                <C>               <C>               <C>              <C>              <C>
  Credit card                                      16                13                6                13               18
  Installment                                      24                15                8                 7                0
    Total charge-offs                      $      632          $    564         $    568          $    134         $    221

Recoveries:
  Commercial                               $       11          $     54         $     15          $     23         $     34
  Real estate loans                                28                 0               12               110                0
  Credit card                                       2                 0                0                 6                3
  Installment                                       1                13                2                 1                1
    Total recoveries                       $       42          $     67         $     29          $    140         $     38

Net charge-offs (recoveries)                      590               497              539                (6)             183
Provision for credit losses                       954               580              635                60              110
Balance at end of year                     $    2,473          $  2,109         $  2,026          $  1,930         $  1,864
Ratio of net charge-offs (recoveries)
  To average loans outstanding                    .33%              .29%             .33%             ---               .13%
</TABLE>

The allowance for credit losses was $2,473,000 at year-end  2002,  compared with
$2,109,000  at year-end  2001,  an increase of $364,000 or 17.3%.  The aggregate
increase  resulted from the provision of $954,000 and net  charge-offs  totaling
$590,000  in 2002.  The  increased  level of  allowance  for  credit  losses was
primarily due to changes in the  composition of the loan portfolio and increased
loss factors  utilized in the allowance for loan loss  analysis.  Changes in the
composition of the loan portfolio  included a 3.6% decrease in commercial loans,
while real estate  construction  and real estate mortgage loans increased 12.8%.
Estimated  loss  factors  used in the  allowance  for credit loss  analysis  are
established  based in part on  historic  charge-off  data by loan  category  and
economic conditions. Based on the trends in historical charge-offs analysis, the
loss factors used in the allowance for credit loss analysis for commercial loans
and real estate loans were increased during the year ended December 31, 2002.

Based on the methodology  used for credit loss analysis,  management  deemed the
allowance  for credit  losses of $2.47  million at  December  31, 2002 (1.33% of
loans  receivable and 132.67% of  non-performing  loans) adequate to provide for
estimated  losses based on an evaluation of known and inherent risks in the loan
portfolio at that date.

The  allowance  for credit  losses  during 2001  increased  $83,000  compared to
year-end 2000. The total  allowance for credit losses was $2,109,000 at year-end
2001 and $2,026,000 in 2000. The aggregate  increase  during 2001 was the result
of the provision of $580,000 and net  charge-offs.  The  allowance  increased in
2000 from the  provision  of $635,000 and net  charge-offs.  The  allowance  for
credit losses as a percentage of total loans  outstanding  was 1.19% at year-end
2001,  1.14% at year-end 2000 and 1.26% in 1999. The allowance for credit losses
at year-end 1999 was $1,930,000 and $1,864,000 in 1998. The net recoveries  were
$6,000  in  1999  and  provisions  for  credit  losses  were  $60,000.  The  net
charge-offs  for 1998  were  $183,00  and  provisions  for  credit  losses  were
$110,000.  The  allowance  for  credit  losses as a  percentage  of total  loans
outstanding at year-end 1998 was 1.27%.

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

(dollars in thousands)                                    2002             2001              2000           1999         1998
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>               <C>            <C>              <C>          <C>
Total Impaired Loans                                     $2,314          $  1,662       $    3,128       $    175     $   15
Total Impaired Loans with Valuation Allowance                18             1,180            1,114            ---        ---
Valuation Allowance related to Impaired Loans                 2               143              412            ---        ---
</TABLE>

                                      -26-
<PAGE>

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

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

The following  table  presents the allocation of the allowance for credit losses
among  the  major  loan  categories  based  primarily  on their  historical  net
charge-off  experience and other business  considerations at December 31 in each
of the last five years.
<TABLE>
<CAPTION>

                                    % of                  % of                  % of                  % of               % of
                         2002       Total      2001       Total      2000       Total      1999       Total      1998    Total
(Dollars in thousands)  Reserve     Loans     Reserve     Loans     Reserve     Loans     Reserve     Loans     Reserve  Loans
------------------------------------------------------------------------------------------------------------------------------

<S>                   <C>             <C>         <C>       <C>        <C>        <C>        <C>        <C>        <C>      <C>
Commercial loans        $   967       37%         548       41%        $689       39%        $720       37%        $710     33%
Real estate loans         1,406       60%       1,413       56%       1,256       58%       1,153       60%       1,091     64%
Consumer loans              100        3%         148        3%          81        3%          58        3%          63      3%

Total allowance         $ 2,473      100%     $ 2,109      100%      $2,026      100%      $1,930      100%      $1,864    100%

Ratio of allowance for credit
  losses to loans outstanding
  at end of year           1.33%                 1.19%                 1.14%                 1.26%                1.27%
</TABLE>

The table  indicates an increase of $419,000  from December 31, 2001 to December
31,  2002 in the  allowance  related to  commercial  loans,  which was offset by
decreases  of $7,000 in real estate  loans and $48,000 in consumer  loans during
the same period ended December 31, 2002.

DEPOSITS

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

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

(dollars in thousands)                           2002         RATE          2001         RATE         2000         RATE
-----------------------------------------------------------------------------------------------------------------------

<S>                                        <C>               <C>        <C>            <C>        <C>             <C>
Demand deposits                            $   36,180        0.00%      $ 33,419       0.00%      $ 34,343        0.00%
Interest bearing demand deposits               29,137         .76%        26,949       2.09%        26,416        2.51%
</TABLE>


                                      -27-
<PAGE>
<TABLE>
<CAPTION>

<S>                                            <C>           <C>          <C>          <C>          <C>           <C>
Savings deposits                               74,974        1.15%        78,897       2.32%        82,850        3.65%
Time deposits                                  79,664        3.35%        75,819       5.20%        68,516        5.16%

     Total                                 $  219,955        1.70%      $215,084       3.49%      $212,125        3.78%
</TABLE>

Maturities of time certificates of deposit as of December 31, 2002 are
summarized as follows:
<TABLE>
<CAPTION>
                                                              Under                     Over
(dollars in thousands)                                      $100,000                  $100,000                 Total
                                                            --------                  --------                 -----
<C>                                                       <C>                       <C>                    <C>
3 months or less                                          $    20,784               $    15,820            $   36,604
Over 3 through 6 months                                         6,662                     7,961                14,623
Over 6 through 12 months                                       13,237                     6,977                20,214
Over 12 months                                                  5,786                     4,750                10,536
     Total                                                     46,469                    35,508                81,977
</TABLE>

SHORT-TERM BORROWINGS

The following is information  regarding the Company's short-term  borrowings for
the years ended December 31, 2002, 2001 and 2000.
<TABLE>
<CAPTION>

(dollars in thousands)                                                      2002               2001                2000
-----------------------------------------------------------------------------------------------------------------------

<S>                                                                       <C>                    <C>            <C>
Amount outstanding at end of period                                       $1,800             $    0             $11,358
Weighted average interest rate thereon                                      1.35%                 0%               6.39%
Maximum amount outstanding at any month end during period                 $2,790             $7,580             $11,358
Average amounts outstanding during the period                                174                963               9,036
Weighted average interest rate during period                                2.48%              5.68%               6.39%
</TABLE>

KEY FINANCIAL RATIOS
<TABLE>
<CAPTION>

Year ended December 31,                          2002              2001             2000              1999             1998
---------------------------------------------------------------------------------------------------------------------------

<S>                                             <C>              <C>               <C>              <C>               <C>
Return on average assets                        1.54%            1.55%             1.34%            1.64%             1.80%
Return on average equity                       15.81%           15.57%            14.95%           17.26%            18.57%
Average equity to average assets ratio          9.74%            9.96%             8.96%            9.49%             9.69%
Dividend payout ratio                             87%              86%               97%              79%               60%
</TABLE>

LIQUIDITY AND CAPITAL RESOURCES

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

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

                                      -28-
<PAGE>

Management  expects to  continue  to rely on  customer  deposits  as the primary
source  of  liquidity,  but may  also  obtain  liquidity  from  maturity  of its
investment  securities,  sale of securities  currently  available for sale,  net
income,  and other  borrowings.  Although deposit balances have shown historical
growth,  deposit  habits  of  customers  may be  influenced  by  changes  in the
financial  services  industry,  interest rates  available on other  investments,
general economic conditions,  consumer confidence,  and competition.  Borrowings
may be used on a short-term basis to compensate for reductions in deposits,  but
are  generally  not  considered  a  long  term  solution  to  liquidity  issues.
Therefore,  reductions in deposits could adversely affect the Company's  results
of operations.

Capital.  The Company  endeavors to maintain equity capital at an adequate level
to support and promote  investor  confidence.  The Company conducts its business
through  the Bank.  Thus,  the Company  needs to be able to provide  capital and
financing to the Bank should the need arise.  The primary  sources for obtaining
capital are additional stock sales and retained  earnings.  Total  shareholders'
equity  averaged  $24,766,000  in 2002,  compared  to  $24,451,000  in 2001,  an
increase of 1.3%, and $22,090,000 in 2000, a decrease of 2.8% compared to 1999.

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

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

The following table sets forth the minimum required capital ratios and actual
ratios for December 31, 2002 and 2001.
<TABLE>
<CAPTION>
                                                                                          Capital
                                                                                         Adequacy
                                                Actual                                   Purposes
(dollars in thousands)                          Amount             Ratio         Amount                 Ratio
----------------------                          ------             -----         ------                 -----
December 31, 2002
<S>                                           <C>                <C>           <C>                    <C>
Tier 1 capital (to average assets)              $23,966            9.42%         $10,172                4.00%
Tier 1 capital (to risk-weighted                 23,966           11.73%           8,172                4.00%
  assets)
Total capital (to risk-weighted                  26,457           12.95%          16,344                8.00%
  assets)

December 31, 2001
Tier 1 capital (to average assets)              $23,106            9.49%         $ 9,738                4.00%
Tier 1 capital (to risk-weighted                 23,106           12.27%           7,459                4.00%
  assets)
Total capital (to risk-weighted                  25,215           13.39%          14,918                8.00%
  assets)
</TABLE>
                                      -29-

<PAGE>

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's  results of operations  are largely  dependent upon its ability to
manage  interest  rate risk.  Management  considers  interest  rate risk to be a
significant  market  risk that  could have a  material  effect on the  Company's
financial  condition and results of  operations.  The Company does not currently
use  derivatives to manage market and interest rate risks.  All of the Company's
transactions are denominated in U.S. dollars. Approximately 38% of the Company's
loans have interest rates that float with the Company's  reference  rate.  Fixed
rate loans generally are made with a term of five years or less.

In the Asset and Liability  section of the Management's  Discussion and Analysis
in  Item 7 is a table  presenting  estimated  maturity  or  pricing  information
indicating  the Company's  exposure to interest  changes.  The  assumptions  and
description  of the  process  used to  manage  interest  rate  risk  is  further
discussed in the Asset and Liability  Management  section.  The following  table
discloses the balances of the financial  instruments including the fair value as
of December 31, 2002.

The expected maturities are disclosed based on contractual schedules.  Principal
repayments are not considered. The expected maturities for financial liabilities
with no stated maturity  reflect  estimated  future roll-off rates. The roll-off
rates for non-interest bearing deposits, interest bearing demand deposits, money
market accounts,  and savings deposits are 15%, 25%, 25% and 20%,  respectively.
The interest rates  disclosed are based on rates in effect at December 31, 2002.
Fair values are used in accordance with generally accepted accounting principles
as disclosed in the financial statements.
<TABLE>
<CAPTION>

                                                        Expected Maturity
Year ended December 31, 2002                                                                         there                Fair
(dollars in thousands)                       2003       2004         2005       2006       2007      after      Total    Value
------------------------------------------------------------------------------------------------------------------------------
Financial Assets
<S>                                         <C>        <C>          <C>        <C>          <C>     <C>        <C>      <C>
  Cash and cash equivalents
      Non-interest bearing                 $8,473       ----         ----       ----       ----       ----      8,473    8,473
      Interest bearing deposits in banks      373       ----         ----       ----       ----       ----        373      373
      Weighted average interest rate         1.30%
  Federal funds sold
      Fixed rate                             ----       ----         ----       ----       ----       ----       ----     ----
      Weighted average interest rate
  Securities available for sale
      Fixed rate                            3,913      3,796        3,186      2,601        703     18,157     32,356   32,356
      Weighted average interest rate         5.17%      5.81%        6.00%      4.93%      4.63%      4.65%
      Adjustable rate                      15,863         35         ----       ----       ----      3,976     19,874   19,874
      Weighted average interest rate         2.95%      2.76%                                         2.93%
  Securities held to maturity
      Fixed rate                                5        468         ----         84        295      9,510     10,362   10,362
      Weighted average interest rate         6.50%      3.01%                   6.03%      6.75%      4.92%
  Loans receivable
      Fixed rate                           30,941      6,504        7,126     10,768     11,071     69,345    135,755  138,212
      Weighted average interest rate         6.75%      8.35%        7.96%      6.92%      7.17%      7.55%
      Adjustable rate                      39,627      6,387          525      1,524      1,972       ----     50,035   50,035
      Weighted average interest rate         5.55%      8.29%        7.62%      6.88%      6.75%
  Federal Home Loan Bank stock                866       ----         ----       ----       ----       ----        866      866
      Weighted average interest rate         6.50%
</TABLE>

                                      -30-
<PAGE>
<TABLE>
<CAPTION>

                                                     Expected Maturity
Year ended December 31, 2002                                                                         there                Fair
(dollars in thousands)                       2003       2004         2005       2006       2007      after      Total    Value
------------------------------------------------------------------------------------------------------------------------------
Financial Liabilities
<S>                                        <C>         <C>          <C>        <C>        <C>       <C>        <C>      <C>
  Non-interest bearing deposits            $6,013      5,111        4,344      3,692      3,138     17,786     40,084   40,084
  Interest bearing checking accounts        7,757      5,818        4,363      3,273      2,455      7,364     31,030   31,030
      Weighted average interest rate          .58%       .58%         .58%       .58%       .58%       .58%
  Money Market accounts                     5,405      4,054        3,041      2,280      1,710      5,131     21,621   21,621
      Weighted average interest rate         1.13%      1.13%        1.13%      1.13%      1.13%      1.13%
  Savings accounts                         10,108      8,087        6,469      5,176      4,140     16,562     50,542   50,542
      Weighted average interest rate          .96%       .96%         .96%       .96%       .96%       .96%
  Certificates of deposit
      Fixed rate                           61,061      5,710        1,163        537      3,098       ----     71,569   72,461
      Weighted average interest rate         2.32%      3.24%        3.56%      4.42%      4.80%
      Variable rate                        10,408       ----         ----       ----       ----       ----     10,408   10,408
      Weighted average interest rate         3.39%
  Borrowings
      Fixed rate                            1,800      2,000        2,000      1,000       ----      6,000     12,800   12,905
      Weighted average interest rate         1.35%      3.20%        4.41%      3.48%                 3.48%

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

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Information required for this item is included in Item 15 of this report.

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

Not Applicable.

                                    Part III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information  concerning  directors and executive officers requested by this item
is contained in the registrant's  2003 Proxy Statement in the sections  entitled
"MANAGEMENT-Certain   Executive   Officers,"  "Proposal  No.  1  -  Election  of
Directors,"  and  "Compliance  with Section  16(a) of the  Exchange  Act" and is
incorporated by reference herein.

ITEM 11.  EXECUTIVE COMPENSATION

Information   concerning  executive  compensation  requested  by  this  item  is
contained in the  registrant's  2003 Proxy  Statement  in the sections  entitled
"DIRECTOR  COMPENSATION"  and "EXECUTIVE


                                      -31-
<PAGE>

COMPENSATION"   (not  including  "Audit   Committee   Report,"  "Report  of  the
Compensation  Committee" and "Stock Performance  Graph"), and is incorporated by
reference herein.

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

Information  concerning  security  ownership  of certain  beneficial  owners and
management  requested by this item is contained in the  registrant's  2003 Proxy
Statement in the section  entitled  "MANAGEMENT - Security  Ownership of Certain
Beneficial Owners and Management," and is incorporated by reference herein.

Equity  Compensation Plan Information.  The following table summarizes share and
exercise price information about the Company's equity  compensation  plans as of
December 31, 2002.
<TABLE>
<CAPTION>

                                                     (a)                       (b)                       (c)
                                             Number of securities        Weighted-average             Number remaining
                                              to be issued upon           exercise price         available for future
                                                  exercise of              of outstanding         issuance under equity
                                             outstanding options,         options, warrants        compensation plans
                                              warrants and rights            and rights           (excluding securities
                                                                                                 reflected in column (a)
              Plan Category                     ---------------             -------------        ----------------------
              -------------
Equity compensation plans approved
<S>                                                 <C>                        <C>                     <C>
by security holders:                                141,496                    $22.41                  358,504

Equity compensation plans not approved
by security holders:                                -------                    -------                 -------
                                                ---------------             ------------            -------------
Total                                               141,496                    $22.41                  358,504
</TABLE>

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information  concerning certain relationships and related transactions requested
by this item is  contained  in the  registrant's  2003  Proxy  Statement  in the
section entitled  "Compensation  Committee Interlocks and Insider Participation"
and is incorporated by reference herein.

ITEM 14.  CONTROLS AND PROCEDURES

Our disclosure  controls and procedures are designed to ensure that  information
the Company must disclose in its reports filed or submitted under the Securities
Exchange Act of 1934, as amended (the "Exchange  Act"), is recorded,  processed,
summarized,  and reported on a timely basis.  Within 90 days prior to the filing
of this report, we carried out an evaluation, under the supervision and with the
participation of our chief executive officer ("CEO") and chief financial officer
("CFO"), of the effectiveness of our disclosure  controls and procedures.  Based
on that evaluation, the CEO and CFO have concluded that the Company's disclosure
controls and procedures are effective in bringing to their attention on a timely
basis  information  required to be  disclosed  by the Company in reports that it
files or submits  under the Exchange  Act.  Also,  since the date of their prior
evaluation,  there  have not  been  any  significant  changes  in the  Company's
internal  controls or in other  factors  that could  significantly  affect those
controls,   including  any   corrective   actions  with  regard  to  significant
deficiencies and material weaknesses.


                                      -32-
<PAGE>


                                     Part IV

ITEM 15.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

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

(a)                   (2) Schedules: None

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

(b)                   Reports on Form 8-K: None


                                      -33-
<PAGE>


                          Independent Auditor's Report



Board of Directors
Pacific Financial Corporation
Aberdeen, Washington


We  have  audited  the  accompanying  consolidated  balance  sheets  of  Pacific
Financial  Corporation  and Subsidiary as of December 31, 2002 and 2001, and the
related consolidated  statements of income,  shareholders' equity and cash flows
for the years then ended.  These financial  statements are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of Pacific Financial
Corporation  and Subsidiary as of December 31, 2002 and 2001, and the results of
their  operations  and their cash flows for the years then ended,  in conformity
with accounting principles generally accepted in the United States of America.



/s/McGladrey & Pullen, LLP


Tacoma, Washington
January 24, 2003


                                      -34-
<PAGE>


                          Independent Auditor's Report



Board of Directors
Pacific Financial Corporation
Aberdeen, Washington


We  have   audited  the   accompanying   consolidated   statements   of  income,
shareholders'  equity  and cash  flows for  Pacific  Financial  Corporation  and
Subsidiary for the year ended December 31, 2000. These financial  statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects,  the results of Pacific Financial  Corporation
and  Subsidiary  operations and cash flows for the year ended December 31, 2000,
in conformity with accounting principles generally accepted in the United States
of America.



/s/ Knight, Vale & Gregory PLLC


Tacoma, Washington
January 26, 2001

                                      -35-
<PAGE>


<TABLE>
<CAPTION>

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

Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001

                                                                                               2002                2001

Assets
<S>                                                                                       <C>                  <C>
     Cash and due from banks                                                              $    8,473           $  10,231
     Interest bearing deposits in banks                                                          373               1,468
     Federal funds sold                                                                          - -               3,505
     Securities available for sale                                                            52,230              31,673
     Securities held to maturity (market value $10,414 and $4,942)                            10,362               4,945
     Federal Home Loan Bank stock, at cost                                                       866               3,813
     Loans held for sale                                                                         286                 - -

     Loans                                                                                   185,504             176,604
     Allowance for credit losses                                                               2,473               2,109
                                                                                             -------             -------
     Loans - net                                                                             183,031             174,495

     Premises and equipment                                                                    3,850               4,014
     Foreclosed real estate                                                                      686               1,040
     Accrued interest receivable                                                               1,493               1,405
     Cash surrender value of life insurance                                                    5,898               5,579
     Other assets                                                                                986               1,449
                                                                                             -------             -------
     Total assets                                                                           $268,534            $243,617
                                                                                            ========            ========


Liabilities and Shareholders' Equity

Liabilities
     Deposits:
       Demand deposits, non-interest bearing                                               $  40,084           $  38,437
       Savings and interest-bearing demand                                                   103,193             104,728
       Time, interest-bearing                                                                 81,977              71,479
                                                                                             -------             -------
     Total deposits                                                                          225,254             214,644

     Accrued interest payable                                                                    318                 441
     Short-term borrowings                                                                     1,800                 - -
     Long-term borrowings                                                                     11,000                 - -
     Other liabilities                                                                         5,479               5,018
                                                                                             -------             -------
     Total liabilities                                                                       243,851             220,103
                                                                                             -------             -------

Commitments and Contingencies                                                                    - -                 - -

Shareholders' Equity
     Common stock (par value $1); authorized:  25,000,000 shares;
       issued and outstanding:  2002 - 2,512,659 shares; 2001 - 2,491,629 shares               2,513               2,492
     Additional paid-in capital                                                                9,839               9,524
     Retained earnings                                                                        11,614              11,090
     Accumulated other comprehensive income                                                      717                 408
                                                                                             -------             -------
     Total shareholders' equity                                                               24,683              23,514
                                                                                             -------             -------
     Total liabilities and shareholders' equity                                             $268,534            $243,617
                                                                                            ========            ========
</TABLE>


See notes to consolidated financial statements.

                                      -36-

<PAGE>


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

Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2002, 2001 and 2000


<TABLE>
<CAPTION>
                                                                           2002               2001                 2000

Interest Income
<S>                                                                      <C>                 <C>                 <C>
     Loans                                                               $13,175             $14,994             $16,425
     Federal funds sold and deposits in banks                                107                 410                 148
     Securities available for sale:
       Taxable                                                             1,401               1,638               2,812
       Tax-exempt                                                            501                 545                 567
     Securities held to maturity:
       Taxable                                                               139                 - -                 - -
       Tax-exempt                                                            270                 264                  98
     Federal Home Loan Bank stock dividends                                  186                 251                 222
                                                                          ------              ------              ------
     Total interest income                                                15,779              18,102              20,272
                                                                          ------              ------              ------

Interest Expense
     Deposits                                                              3,747               6,340               8,020
     Short-term borrowings                                                     4                 190                 577
     Long-term borrowings                                                    240                 - -                 - -
                                                                          ------              ------              ------
     Total interest expense                                                3,991               6,530               8,597
                                                                          ------              ------              ------
     Net interest income                                                  11,788              11,572              11,675

Provision for Credit Losses                                                  954                 580                 635
                                                                          ------              ------              ------
     Net interest income after provision for credit losses                10,834              10,992              11,040

Non-Interest Income
     Service charges on deposit accounts                                   1,069                 828                 677
     Mortgage broker fees                                                      3                  32                   9
     Income from and gains on sale of foreclosed real estate                 292                 139                  32
     Earnings on bank owned life insurance                                   350                 167                 129
     Other operating income                                                  345                 363                 370
     Total non-interest income                                             2,059               1,529               1,217

Non-Interest Expense
     Salaries and employee benefits                                        4,196               4,058               4,135
     Occupancy                                                               419                 409                 388
     Equipment                                                               565                 554                 751
     State taxes                                                             206                 227                 228
     Data processing                                                         268                 214                 229
     Other                                                                 1,760               1,731               1,799
                                                                          ------              ------              ------
     Total non-interest expense                                            7,414               7,193               7,530
                                                                          ------              ------              ------
     Income before income taxes                                            5,479               5,328               4,727

Income Taxes                                                               1,563               1,521               1,424
                                                                          ------              ------              ------
     Net income                                                         $  3,916            $  3,807            $  3,303
                                                                        ========            ========            ========


Earnings Per Share
     Basic                                                              $   1.57               $1.53               $1.33
     Diluted                                                                1.56                1.52                1.31

</TABLE>

See notes to consolidated financial statements.

                                      -37-

<PAGE>


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

Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2002, 2001 and 2000
<TABLE>
<CAPTION>

                                                                                                     Accumulated
                                              Shares of                   Additional                 Other
                                              Common       Common         Paid-in     Retained       Comprehensive
                                              Stock        Stock          Capital     Earnings       Income (Loss)       Total

<S>                                          <C>       <C>                <C>         <C>           <C>                <C>
Balance at December 31, 1999                 496,770   $   497            $11,420     $10,473       ($952)             $21,438

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

5-for-1 stock split                        1,987,110     1,987             (1,987)        - -         - -                  - -
Stock options exercised                        2,750         3                 30         - -         - -                   33
Stock purchase of branch site                 16,500        16                396         - -         - -                  412
Cash dividends declared
    ($1.28 per share)                            - -       - -                - -      (3,204)        - -               (3,204)
                                           ---------     -----              -----      ------        ----               ------
    Balance at December 31, 2000           2,503,130     2,503              9,859      10,572        (191)              22,743


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

Stock options exercised                       12,750        13                150         - -         - -                  163
Repurchase of common stock                   (24,281)      (24)              (486)        - -         - -                 (510)
Issuance of common stock                          30       - -                  1         - -         - -                    1
Cash dividends declared
    ($1.32 per share)                            - -       - -                - -      (3,289)        - -               (3,289)
                                           ---------     -----              -----      ------        ----               ------
    Balance at December 31, 2001           2,491,629     2,492              9,524      11,090         408               23,514

Comprehensive income:
    Net income                                  - -        - -                - -       3,916         - -                3,916
    Other comprehensive income,
       net of tax:
          Change in fair value of
             securities available for sale      - -        - -                - -         - -         309                  309
    Comprehensive income                                                                                                 4,225

Stock options exercised                       21,000        21                275         - -         - -                  296
Issuance of common stock                          30       - -                  1         - -         - -                    1
Cash dividends declared
    ($1.35 per share)                            - -       - -                - -      (3,392)        - -               (3,392)
Tax benefit from exercise of
    stock options                                - -       - -                 39         - -         - -                   39
                                           ---------    ------           --------     -------        ----              -------
    Balance at December 31, 2002           2,512,659    $2,513           $  9,839     $11,614        $717              $24,683
                                           =========    ======           ========     =======        ====              =======

</TABLE>

See notes to consolidated financial statements.
                                      -38-
<PAGE>



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

Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2002, 2001 and 2000
<TABLE>
<CAPTION>

                                                                             2002                 2001             2000

Cash Flows from Operating Activities
<S>                                                                        <C>                 <C>              <C>
     Net income                                                            $  3,916            $  3,807         $  3,303
     Adjustments to reconcile net income to net cash
       provided by operating activities:
          Depreciation and amortization                                         433                 423              568
          Provision for credit losses                                           954                 580              635
          Deferred income tax (benefit)                                         (82)                225              (81)
          Originations of loans held for sale                                  (548)                - -              - -
          Proceeds from loans held for sale                                     262                 - -              - -
          Stock dividends received                                             (186)               (251)            (222)
          Gain on sales of foreclosed real estate                              (178)                - -              (32)
          Earnings on bank owned life insurance                                (350)               (167)            (129)
          (Increase) decrease in interest receivable                            (88)                897             (298)
          Increase (decrease) in interest payable                              (123)               (338)             230
          Write-down of foreclosed real estate                                  420                  18              - -
          Other - net                                                           929                (748)             614
                                                                              -----               -----            -----
     Net cash provided by operating activities                                5,359               4,446            4,588
                                                                              -----               -----            -----

Cash Flows from Investing Activities
     Net (increase) decrease in interest bearing deposits in banks            1,095                (988)           1,264
     Net (increase) decrease in federal funds sold                            3,505              (2,935)            (570)
     Activity in securities available for sale:
       Sales - -                                                             10,694                 - -
       Maturities, prepayments and calls                                     14,109              36,987           12,062
       Purchases                                                            (34,338)            (24,828)          (2,423)
     Activity in securities held to maturity:
       Maturities                                                             3,481                 190              239
       Purchases                                                             (8,920)             (1,123)             - -
     Federal Home Loan Bank stock redemption                                  3,133                 - -              - -
     Proceeds from sales of loans                                               - -               1,407            1,293
     Increase in loans made to customers, net of principal collections      (10,046)             (5,165)         (26,133)
     Purchases of premises and equipment                                       (261)               (509)            (764)
     Proceeds from sales of premises and equipment                              - -                  50              - -
     Proceeds from sales of foreclosed real estate                              707                 161              - -
     Purchase of bank owned life insurance                                      - -              (3,000)             - -
                                                                            -------              ------           ------
     Net cash provided by (used in) investing activities                    (27,535)             10,941          (15,032)
                                                                            -------              ------          -------
</TABLE>

(continued)


See notes to consolidated financial statements.
                                       -39-
<PAGE>



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

Pacific Financial Corporation and Subsidiary
Years Ended December 31, 2002, 2001 and 2000
<TABLE>
<CAPTION>

                                                                             2002                2001              2000

Cash Flows from Financing Activities
<S>                                                                         <C>                <C>              <C>
     Net increase in deposits                                               $10,610            $  1,133         $  7,372
     Net increase (decrease) in short-term borrowings                         1,800             (11,358)           1,683
     Proceeds from issuance of long-term debt                                11,000               3,000              - -
     Repayments of long-term debt                                               - -              (3,000)             - -
     Common stock issued                                                        297                 164               33
     Cash dividends paid                                                     (3,289)             (3,204)          (3,105)
     Repurchase of common stock and fractional shares                           - -                (510)             - -
                                                                             ------              ------            -----
     Net cash provided by (used in) financing activities                     20,418             (13,775)           5,983
                                                                             ------             -------            -----

     Net change in cash and due from banks                                   (1,758)              1,612           (4,461)

Cash and Due from Banks
     Beginning of year                                                       10,231               8,619           13,080
                                                                             ------               -----           ------

     End of year                                                           $  8,473             $10,231         $  8,619
                                                                           ========             =======         ========


Supplemental Disclosures of Cash Flow Information
     Interest paid                                                           $4,114              $6,868           $8,367
     Income taxes paid                                                        1,260               1,375            1,247

Supplemental Disclosures of Non-Cash Investing Activities
     Fair value adjustment of securities available for sale, net of tax      $  309             $   599             $761
     Transfer of loans to foreclosed real estate                              1,198               1,733               26
     Stock purchase of branch site                                              - -                 - -              412
     Financed sales of foreclosed real estate                                   629                 514              235
     Reclassification of loan receivable to securities available for sale       - -               2,636              - -
</TABLE>



See notes to consolidated financial statements.
                                      -40-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

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

NATURE OF OPERATIONS

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

CONSOLIDATED FINANCIAL STATEMENT PRESENTATION

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

Certain prior year amounts have been reclassified,  with no change to net income
or  shareholders'  equity,  to  conform  to the 2002  presentation.  All  dollar
amounts, except per share information, are stated in thousands.

SECURITIES AVAILABLE FOR SALE

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


(continued)

                                      -41-

<PAGE>

--------------------------------------------------------------------------------

Notes to Consolidated Financial Statements


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

SECURITIES HELD TO MATURITY

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

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

FEDERAL HOME LOAN BANK STOCK

The  Company,  as a member  of the  Federal  Home Loan Bank  (FHLB)  system,  is
required  to maintain an  investment  in capital  stock of the FHLB in an amount
equal to the greater of 1% of its outstanding  home loans or 5% of advances from
the FHLB. No ready market exists for the FHLB stock, and it has no quoted market
value.

LOANS HELD FOR SALE

Mortgage loans  originated for sale in the  foreseeable  future in the secondary
market are carried at the lower of  aggregate  cost or estimated  market  value.
Gains and losses on sales of loans are  recognized  at  settlement  date and are
determined by the  difference  between the sales proceeds and the carrying value
of the loans.  All sales are made without  recourse.  Net unrealized  losses are
recognized through a valuation allowance established by charges to income.

LOANS

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

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

(continued)
                                      -42-

<PAGE>


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

Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

ALLOWANCE FOR CREDIT LOSSES

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

The allowance  consists of specific,  general and  unallocated  components.  The
specific  component  relates to loans that are  classified  as either  doubtful,
substandard  or special  mention.  For such loans  that are also  classified  as
impaired,  an  allowance  is  established  when the  discounted  cash  flows (or
collateral value or observable  market price) of the impaired loan is lower than
the carrying value of that loan.  The general  component  covers  non-classified
loans  and is based on  historical  loss  experience  adjusted  for  qualitative
factors.  An  unallocated  component is maintained to cover  uncertainties  that
could affect management's estimate of probable losses. The unallocated component
of the allowance  reflects the margin of imprecision  inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.

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

When management determines that it is probable that a borrower will be unable to
repay all amounts due  according to the terms of the loan  agreement,  including
scheduled interest payments, the loan is considered impaired. Factors considered
by management in  determining  impairment  include  payment  status,  collateral
value,  and the  probability  of  collecting  scheduled  principal  and interest
payments  when due.  Loans  that  experience  insignificant  payment  delays and
payment  shortfalls  are  generally  not  classified  as  impaired.   Management
determines  the  significance  of payment  delays and  payment  shortfalls  on a
case-by-case   basis,   taking  into  consideration  all  of  the  circumstances
surrounding  the loan and the borrower,  including the length of the delay,  the
reasons for the delay,  the borrower's  prior payment record,  and the amount of
shortfall  in  relation  to the  principal  and  interest  owed.  The  amount of
impairment is measured based on the present value of expected  future cash flows
discounted at the loan's effective  interest rate or, when the primary source of
repayment  is  provided  by real  estate  collateral,  at the fair  value of the
collateral  less  estimated  selling  costs.  Large  groups of  smaller  balance
homogenous loans are  collectively  evaluated for impairment.  Accordingly,  the
Bank does not separately  identify individual consumer and residential loans for
impairment disclosures. In addition, regulatory agencies, as an integral part of
their examination  process,  periodically review the Bank's allowance for credit
losses,  and may require the Bank to make  additions to the  allowance  based on
their  judgment  about  information  available  to  them at the  time  of  their
examinations.

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


(continued)
                                      -43-
<PAGE>



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

Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

PREMISES AND EQUIPMENT

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

FORECLOSED REAL ESTATE

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

TRANSFERS OF FINANCIAL ASSETS

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

INCOME TAXES

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

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


(continued)

                                       -44-
<PAGE>




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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

STOCK-BASED COMPENSATION

At December 31, 2002, the Company has three  stock-based  employee  compensation
plans, which are described more fully in Note 13. The Company accounts for those
plans under the recognition and measurement principles of APB No. 25, Accounting
for Stock Issued to  Employees,  and related  interpretations.  Accordingly,  no
stock-based compensation cost is reflected in net income, as all options granted
under  those  plans  had an  exercise  price  equal to the  market  value of the
underlying  common stock on the date of grant.  The  following  illustrates  the
effect on net income and  earnings per share if the Company had applied the fair
value  recognition  provisions  of SFAS  No.  123,  Accounting  for  Stock-Based
Compensation,  to stock-based compensation awards for the effects of all options
granted on or after January 1, 1995 for the years ended December 31:
<TABLE>
<CAPTION>

                                                              2002                2001            2000

<S>                                                           <C>                 <C>             <C>
Net income, as reported                                       $3,916              $3,807          $3,303
Less total stock-based compensation expense determined
     under fair value method for all qualifying awards            95                  13              23

     Pro forma net income                                     $3,821              $3,794          $3,280

Earnings Per Share
     Basic:
       As reported                                             $1.57               $1.53           $1.33
       Pro forma                                                1.53                1.52            1.32
     Diluted:
       As reported                                              1.56                1.52            1.31
       Pro forma                                                1.53                1.50            1.30

Fair Values of Financial Instruments
</TABLE>

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

          Cash, Interest Bearing Deposits at Other Financial  Institutions,  and
          Federal Funds Sold

          The  carrying  amounts of cash,  interest  bearing  deposits  at other
          financial institutions,  and federal funds sold approximate their fair
          value.

          Securities Available for Sale and Held to Maturity

          Fair values for securities are based on quoted market prices.

          Federal Home Loan Bank Stock

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


(continued)
                                      -45-

<PAGE>


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

Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Fair Values of Financial Instruments (concluded)

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

         DEPOSITS
         The fair value of deposits with no stated  maturity date is included at
         the amount  payable on  demand.  The fair value of fixed rate  maturity
         certificates  of deposit is estimated by discounting  future cash flows
         using  rates  currently  offered  by the Bank for  deposits  of similar
         remaining  maturities.  Fair  values  for fixed  rate  certificates  of
         deposit are estimated using a discounted cash flow calculation based on
         interest rates currently being offered on similar certificates.

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

         LONG-TERM BORROWINGS
         The fair values of the Bank's long-term  borrowings are estimated using
         discounted cash flow analyses based on the Bank's incremental borrowing
         rates for similar types of borrowing arrangements.

         ACCRUED INTEREST
         The carrying amounts of accrued interest approximate their fair values.

         OFF-BALANCE-SHEET INSTRUMENTS
         The fair value of commitments  to extend credit and standby  letters of
         credit was  estimated  using the fees  currently  charged to enter into
         similar  agreements,  taking into  account the  remaining  terms of the
         agreements and the present creditworthiness of the customers. Since the
         majority of the Bank's off-balance-sheet instruments consist of non-fee
         producing,  variable-rate commitments,  the Bank has determined they do
         not have a distinguishable fair value.

CASH EQUIVALENTS AND CASH FLOWS

The Company  considers  all amounts  included in the balance sheet caption "Cash
and due from  banks" to be cash  equivalents.  Cash flows from  loans,  interest
bearing  deposits  in  banks,  federal  funds  purchased  and  sold,  short-term
borrowings, and deposits are reported net.

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

(continued)
                                      -46-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

EARNINGS PER SHARE

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

COMPREHENSIVE INCOME

Accounting principles generally require that recognized revenue, expenses, gains
and losses be  included in net income.  Although  certain  changes in assets and
liabilities,  such as unrealized  gains and losses on  securities  available for
sale,  are  reported  as a  separate  component  of the  equity  section  of the
consolidated  balance sheets,  such items, along with net income, are components
of comprehensive  income.  Gains and losses on securities available for sale are
reclassified  to net income as the gains or losses are realized upon sale of the
securities.  Other-than-temporary  impairment  charges are  reclassified  to net
income at the time of the charge.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial  Accounting  Standards  Board (FASB) issued SFAS No.
143,  Accounting for Asset  Retirement  Obligations.  This  Statement  addresses
financial   accounting  and  reporting  for  obligations   associated  with  the
retirement of tangible  long-lived  assets and the associated  asset  retirement
costs. This Statement is effective for all fiscal years beginning after June 15,
2002.  The Company  does not  anticipate  that the adoption of SFAS No. 143 will
have a material effect on its financial position or results of operations.

In April 2002,  the FASB issued SFAS No. 145,  Rescission of FASB Statement Nos.
4, 44, and 64,  Amendment of FASB  Statement No. 13, and Technical  Corrections.
This Statement  rescinds FASB  Statement No. 4, Reporting  Gains and Losses from
Extinguishment  of Debt, and an amendment of that Statement,  FASB Statement No.
64,  Extinguishments  of Debt Made to Satisfy  Sinking-Fund  Requirements.  This
Statement also rescinds FASB Statement No. 44,  Accounting for Intangible Assets
of Motor Carriers.  This Statement amends FASB Statement No. 13,  Accounting for
Leases,  to  eliminate   inconsistency   between  the  required  accounting  for
sale-leaseback  transactions  and the  required  accounting  for  certain  lease
modifications  that have  economic  effects  that are similar to  sale-leaseback
transactions.   This  Statement   also  amends  other   existing   authoritative
pronouncements  to make various  technical  corrections,  clarify  meanings,  or
describe  the  applicability  under  changed  conditions.  The Company  does not
anticipate  the  adoption  of SFAS  No.  145 to have a  material  effect  on its
financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal  Activities.  This Statement addresses financial accounting and
reporting for costs associated with exit or disposal  activities,  and nullifies
Emerging  Issues Task Force  (EITF) Issue No. 94-3,  Liability  Recognition  for
Certain  Employee  Termination  Benefits  and  Other  Costs to Exit an  Activity
(including  Certain  Costs  Incurred  in a  Restructuring).  This  Statement  is
effective for exit or disposal  activities that are initiated after December 31,
2002. The Company does not expect the Statement to have a material effect on its
financial position and results of operations.

(continued)
                                      -47-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)

RECENT ACCOUNTING PRONOUNCEMENTS (concluded)

In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions,  an  amendment  of  FASB  Statement  Nos.  72 and  144,  and  FASB
Interpretation  No. 9. The  provisions  of this  Statement,  that  relate to the
application of the purchase method of accounting,  apply to all  acquisitions of
financial   institutions,   except  transactions  between  two  or  more  mutual
enterprises.  This Statement removes acquisitions of financial institutions from
the scope of both Statement No. 72 and  Interpretation  No. 9, and requires that
those  transactions be accounted for in accordance with FASB Statements No. 141,
Business  Combinations,  and No. 142,  Goodwill and Other Intangible  Assets. In
addition,   this  Statement  amends  FASB  Statement  No.  144,  Accounting  for
Impairment or Disposal of Long-Lived  Assets,  to include in its scope long-term
customer-relationship  intangible  assets  of  financial  institutions  such  as
depositor- and  borrower-relationship  intangible  assets and credit  cardholder
intangible  assets.  This Statement is effective for  acquisitions for which the
date of the  transaction  is on or after  October 1, 2002.  The Company does not
expect the  Statement to have a material  effect on its  financial  position and
results of operations.

In December 2002, the Financial Accounting Standards Board issued FASB Statement
No. 148,  Accounting for  Stock-Based  Compensation - Transition and Disclosure.
This  Statement  amends FASB  Statement  No.  123,  Accounting  for  Stock-Based
Compensation,  and APB Opinion No. 28, Interim Financial  Reporting,  to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation.  This Statement does
not require any change from the method  currently used by the Company to account
for stock-based compensation,  but does require more prominent disclosure in the
annual and interim financial  statements about the method of accounting for such
compensation  and the  effect  of the  method  used on  reported  results.  This
Statement was effective  for years ending after  December 15, 2002.  The Company
has  adopted  the  disclosure  provisions  of SFAS No.  148 in the  accompanying
consolidated financial statements;  the disclosure requirements are set forth in
the Stock-Based Compensation section.

The  Financial  Accounting  Standards  Board has issued  Interpretation  No. 45,
Guarantor's  Accounting and Disclosure  Requirements  for Guarantees,  Including
Indirect  Guarantees  of  Indebtedness  of  Others,  an  interpretation  of FASB
Statement Nos. 5, 57 and 107 and rescission of FASB  Interpretation No. 34. This
Interpretation  elaborates on the  disclosures  to be made by a guarantor in its
interim and annual  financial  statements  about its  obligations  under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize,  at the  inception of a guarantee,  a liability for the fair value of
the obligation undertaken in issuing the guarantee.  The initial recognition and
measurement  provisions of this  Interpretation  are applicable on a prospective
basis to guarantees  issued or modified after December 31, 2002.  Implementation
of these  provisions  of the  Interpretation  is not expected to have a material
impact  on  the  Bank's  consolidated   financial  statements.   The  disclosure
requirements  of the  Interpretation  are effective for financial  statements of
interim or annual  periods ending after December 15, 2002, and have been adopted
in the  consolidated  financial  statements  for  December  31,  2002,  with  no
additional disclosure required.

Note 2 - RESTRICTED ASSETS

Federal  Reserve  Board  regulations  require  that the Bank  maintains  certain
minimum  reserve  balances in cash and on deposit with the Federal Reserve Bank.
The average  amounts of such balances for the years ended  December 31, 2002 and
2001 were approximately $650 and $2,878, respectively.


                                      -48-

<PAGE>


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

Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 3 - SECURITIES

Investment securities have been classified according to management's intent. The
carrying amounts of securities and their approximate fair values are as follows:
<TABLE>
<CAPTION>

                                                                                Gross             Gross
                                                               Amortized        Unrealized        Unrealized     Fair
                                                               Cost             Gains             Losses         Value

SECURITIES AVAILABLE FOR SALE

DECEMBER 31, 2002
<S>                                                            <C>             <C>              <C>             <C>
     U.S. Treasury and Government agency securities            $  2,165        $   142          $ - -           $  2,307
     Obligations of states and political subdivisions            11,502            609             13             12,098
     Mortgage-backed securities                                  16,669            215             27             16,857
     Corporate bonds                                              5,979            127              7              6,099
     Mutual funds                                                14,828             47              6             14,869
                                                                 ------          -----            ---             ------

                                                                $51,143         $1,140            $53            $52,230
                                                                =======         ======            ===            =======

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

                                                                $31,055           $689            $71            $31,673
                                                                =======           ====            ===            =======


SECURITIES HELD TO MATURITY

DECEMBER 31, 2002
     State and municipal securities                             $ 3,751            $39            $28            $ 3,762
     Mortgage-backed securities                                   6,611             41            - -              6,652
                                                                -------            ----           ----           -------

                                                                $10,362            $80            $28            $10,414
                                                                =======            ====           ====           =======

DECEMBER 31, 2001
     State and municipal securities                             $ 4,945            $- -           $ 3            $ 4,942
                                                                =======            ====           ====           =======
</TABLE>

(continued)
                                      -49-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 3 - Securities (concluded)

The contractual maturities of investment securities held to maturity and
available for sale at December 31, 2002 are as follows:

<TABLE>
<CAPTION>

                                                    Held to Maturity                         Available for Sale
                                                    Amortized            Fair                Amortized             Fair
                                                    Cost                 Value               Cost                  Value

<S>                                              <C>                  <C>                   <C>                 <C>
Due in one year or less                          $         5          $        5            $  4,829            $  4,908
Due from one year to five years                          848                 857               8,699               9,166
Due from five to ten years                               967                 996               3,741               3,930
Due after ten years                                    1,931               1,904               2,377               2,500
Mortgage-backed securities                             6,611               6,652              16,669              16,857
Mutual funds                                             - -                 - -              14,828              14,869
                                                      ------              ------              ------              ------
     Total                                           $10,362             $10,414             $51,143             $52,230
                                                     =======             =======             =======             =======
</TABLE>

There were no sales of securities in 2002, 2001 and 2000.

Securities carried at approximately  $25,622 at December 31, 2002 and $11,618 at
December  31, 2001 were pledged to secure  public  deposits,  borrowings  at the
Federal Home Loan Bank, and for other purposes required or permitted by law.


Note 4 - Loans

Loans at December 31 consist of the following:

                                                      2002                 2001

Commercial and agricultural                        $  69,794           $  72,427
Real estate:
   Construction                                        9,697               6,554
   Residential 1-4 family                             28,085              31,089
   Multi-family                                        1,574               2,040
   Commercial                                         65,336              54,894
   Farmland                                            5,870               3,691
Consumer                                               5,148               5,909
                                                     -------             -------

                                                    $185,504            $176,604
                                                    ========            ========

(continued)
                                      -50-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 4 - Loans (concluded)

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

                                                                           2002                2001                2000

<S>                                                                       <C>                 <C>                 <C>
Balance at beginning of year                                              $2,109              $2,026              $1,930
Provision for credit losses                                                  954                 580                 635

Charge-offs                                                                 (632)               (564)               (568)
Recoveries                                                                    42                  67                  29
                                                                           -----               -----               -----
     Net charge-offs                                                        (590)               (497)               (539)
                                                                           -----               -----               -----

     Balance at end of year                                               $2,473              $2,109              $2,026
                                                                          ======              ======              ======

Following is a summary of information pertaining to impaired loans:
</TABLE>


<TABLE>
<CAPTION>

                                                                           2002                2001                2000

December 31
<S>                                                                       <C>                <C>                  <C>
     Impaired loans without a valuation allowance                         $2,296              $  482              $2,014
     Impaired loans with a valuation allowance                                18               1,180               1,114
                                                                          ------              ------              ------
     Total impaired loans                                                 $2,314              $1,662              $3,128
                                                                          ======              ======              ======
     Valuation allowance related to impaired loans                        $    2              $  143              $  412
                                                                          ======              ======              ======
Years Ended December 31
     Average investment in impaired loans                                 $2,390              $1,262              $3,425
     Interest income recognized on a cash basis on impaired loans             13                   2                  31

</TABLE>

At December 31, 2002,  there were no  commitments  to lend  additional  funds to
borrowers  whose loans have been  modified.  Loans 90 days and over past due and
still accruing interest totaled $79 at December 31, 2001. There were no loans 90
days and over past due and still accruing interest at December 31, 2002.

Certain  related  parties  of  the  Company,  principally  directors  and  their
associates,  were loan customers of the Bank in the ordinary  course of business
during 2002 and 2001.  Total loans  outstanding at December 31, 2002 and 2001 to
key officers and directors  were $3,233 and $3,748,  respectively.  During 2002,
new loans of $1,490 were made, and repayments  totaled  $2,005.  In management's
opinion,  these  loans  and  transactions  were on the same  terms as those  for
comparable loans and transactions with non-related  parties. No loans to related
parties were on non-accrual, past due or restructured at December 31, 2002.


                                      -51-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 5 - PREMISES AND EQUIPMENT

The components of premises and equipment at December 31 are as follows:

                                                         2002            2001

Land                                                    $1,125         $1,125
Premises                                                 3,992          3,884
Equipment, furniture and fixtures                        4,074          4,026
                                                         -----          -----
                                                         9,191          9,035
Less accumulated depreciation and amortization           5,341          5,021
                                                         -----          -----

     Total premises and equipment                       $3,850         $4,014
                                                        ======         ======


Note 6 - DEPOSITS

The composition of deposits at December 31 is as follows:

                                                            2002         2001

Demand deposits, non-interest bearing                   $  40,084    $  38,437
NOW and money market accounts                              52,651       50,799
Savings deposits                                           50,542       53,929
Time certificates, $100,000 or more                        35,086       26,453
Other time certificates                                    46,891       45,026
                                                           ------       ------

     Total                                               $225,254     $214,644
                                                         ========     ========

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

     2003                                                              $63,749
     2004                                                                6,525
     2005                                                                8,014
     2006                                                                  537
     2007                                                                3,152
     ----                                                               ------
                                                                       $81,977
                                                                       =======

                                      -52-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 7 - SHORT-TERM BORROWINGS

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

                                                         2002             2001

Average balance during the year                           $174            $963
Average interest rate during the year                     2.48%           5.68%
Maximum month-end balance during the year               $2,790          $7,580
Balance outstanding at year-end                         $1,800            $- -
Average interest rate at year-end                         1.35%            - -%


Note 8 - LONG-TERM BORROWINGS

Long-term  borrowings at December 31, 2002  represent  advances from the Federal
Home Loan Bank bearing interest at 3.20% to 4.41% and maturing at 2004 - $2,000;
2005 - $2,000; 2006 - $1,000; and 2009 - $6,000. The Bank has pledged $41,127 of
securities  and  loans  as  collateral  for  these   borrowings  and  short-term
borrowings at December 31, 2002.


Note 9 - INCOME TAXES

Income taxes are comprised of the following for the years ended December 31:

                                2002               2001                2000

Current                       $1,645              $1,296              $1,505
Deferred (benefit)               (82)                225                 (81)
                               -----               -----               -----

     Total income taxes       $1,563              $1,521              $1,424
                              ======              ======              ======

The tax effects of temporary  differences that give rise to significant portions
of deferred tax assets and liabilities at December 31 are:

                                              2002                 2001

Deferred Tax Assets
     Allowance for credit losses             $  730              $  626
     Deferred compensation                      161                 230
     Other                                        8                  70
                                                ---                 ---
     Total deferred tax assets                  899                 926



(continued)
                                      -53-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 9 - INCOME TAXES (concluded)
<TABLE>
<CAPTION>

                                                                                 2002                2001

Deferred Tax liabilities
<S>                                                                              <C>                 <C>
     Unrealized gain on securities available for sale                            $  369              $  210
     Depreciation                                                                   119                  68
     Deferred revenue                                                               884               1,045
                                                                                  -----               -----
     Total deferred tax liabilities                                               1,372               1,323
                                                                                  -----               -----

     Net deferred tax liabilities                                               ($  473)            ($  397)
                                                                                 =======             =======
</TABLE>

Net deferred tax liabilities are included in other liabilities on the
consolidated balance sheets.

The following is a reconciliation between the statutory and effective federal
income tax rate for the years ended December 31:
<TABLE>
<CAPTION>
                                         2002                           2001                       2000
                                                       Percent                       Percent                 Percent
                                                       of Pre-tax                    of Pre-tax              of Pre-tax
                                        Amount         Income          Amount        Income       Amount     Income

<S>                                      <C>            <C>            <C>           <C>           <C>          <C>
Income tax at statutory rate             $1,918         35.0%          $1,865        35.0%         $1,654       35.0%
Adjustments resulting from:
     Tax-exempt income                     (276)        (5.0)            (272)       (5.1)           (236)      (5.0)
     Net earnings on life insurance
       policies                            (111)        (2.0)             (26)        (.5)            (36)       (.7)
     Other                                   32           .5              (46)        (.8)             42         .9
                                          -----                         -----                       -----
     Total income tax expense            $1,563         28.5%          $1,521        28.6%         $1,424       30.2%
                                         ======                        ======                      ======
</TABLE>

Note 10 - EMPLOYEE BENEFITS

Incentive Compensation Plan

The Bank has a plan that provides incentive compensation to key employees if the
Bank meets certain performance  criteria  established by the Board of Directors.
The  cost of this  plan  was  $435,  $355  and  $490 in  2002,  2001  and  2000,
respectively.

(continued)
                                      -54-
<PAGE>



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

Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 10 - EMPLOYEE BENEFITS (concluded)

401(k) Plans

The Bank has  established a 401(k) profit  sharing plan for those  employees who
meet the eligibility  requirements set forth in the plan. Eligible employees may
contribute up to 15% of their compensation.  Matching  contributions by the Bank
are at the  discretion  of the Board of Directors.  Contributions  totaled $126,
$115 and $94 for 2002, 2001 and 2000, respectively.

DIRECTOR AND EMPLOYEE DEFERRED COMPENSATION PLANS

The Company has director and employee  deferred  compensation  plans.  Under the
terms of the plans, a director or employee may participate  upon approval by the
Board.  The participant may then elect to defer a portion of his or her earnings
(directors'  fees or salary) as  designated  at the beginning of each plan year.
Payments begin upon retirement, termination, death or permanent disability, sale
of the Company,  the ten-year  anniversary  of the  participant's  participation
date, or at the discretion of the Company.  There are currently two participants
in the plans. Total deferrals plus earnings were $110, $304 and $297 at December
31, 2002,  2001 and 2000,  respectively.  There is no expense to the Company for
this plan.

The  directors  of a bank  acquired by the Company in 1999  adopted two deferred
compensation plans for directors - one plan providing retirement income benefits
for all directors and the other,  a deferred  compensation  plan,  covering only
those  directors  who have  chosen to  participate  in the plan.  At the time of
adopting these plans,  the Bank  purchased life insurance  policies on directors
participating  in both plans  which may be used to fund  payments  to them under
these plans.  Cash surrender  values on these policies were $2,700 and $2,555 at
December  31,  2002 and 2001,  respectively.  In 2002,  2001 and  2000,  the net
(benefit)/cost recorded from these plans, including the cost of the related life
insurance,  was ($315), ($104) and $30,  respectively.  Both of these plans were
fully funded and frozen as of September 30, 2000. Plan  participants  were given
the  option to  either  remain in the plan  until  reaching  the age of 70 or to
receive a lump sum  distribution.  Participants  electing  to remain in the plan
will receive  annual  payments over a ten-year  period upon reaching 70 years of
age.

QUALIFIED NON-CONTRIBUTORY DEFINED BENEFIT PLAN

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

NON-QUALIFIED DEFERRED COMPENSATION PLAN

The Company has a non-qualified deferred compensation plan to cover selected
employees. Its annual contributions to the plan totaled $6, $8 and $22 in 2002,
2001 and 2000, respectively. Covered employees may also contribute to the plan.

                                      -55-


<PAGE>

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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 11 - COMMITMENTS AND CONTINGENCIES

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

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

                                                   2002                  2001

Commitments to extend credit                       $23,638             $23,262
Standby letters of credit                            2,326               1,688

Commitments  to extend  credit are  agreements  to lend to a customer as long as
there is no violation of any condition  established in the contract.  Since many
of the  commitments  are expected to expire  without being drawn upon, the total
commitment amounts do not necessarily  represent future cash  requirements.  The
Bank's  experience has been that  approximately 67% of loan commitments is drawn
upon by customers.  The Bank evaluates  each  customer's  creditworthiness  on a
case-by-case  basis. The amount of collateral  obtained,  if deemed necessary by
the Bank upon extension of credit, is based on management's credit evaluation of
the  party.  Collateral  held  varies,  but  may  include  accounts  receivable,
inventory, property and equipment, residential real estate, and income-producing
commercial properties.

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

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

The Bank has  agreements  with  commercial  banks for  lines of credit  totaling
$14,700, none of which was used at December 31, 2002. In addition,  the Bank has
a credit line with the Federal Home Loan Bank of Seattle totaling 20% of assets,
$12,800  of  which  was  used  at  December  31,  2002.   These  borrowings  are
collateralized under blanket pledge and custody agreements.

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

                                      -56-


<PAGE>

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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 12 - SIGNIFICANT CONCENTRATIONS OF CREDIT RISK

Most of the Bank's business activity is with customers and governmental entities
located in the state of Washington, including investments in state and municipal
securities.  Loans are generally limited by state banking  regulations to 20% of
the Bank's  shareholder's  equity,  excluding  accumulated  other  comprehensive
income  (loss).  As of December  31, 2002 the Bank's  loans to  companies in the
hotel\motel  industry totaled $26,082 or 14% of total loans.  Standby letters of
credit were granted primarily to commercial borrowers.  The Bank, as a matter of
practice,  generally  does not extend credit to any single  borrower or group of
borrowers in excess of $4 million.


Note 13 - STOCK OPTIONS

The Company's three stock  incentive plans provide for granting  incentive stock
options,  as defined under current tax laws, to key personnel and under the plan
adopted in 2000,  options not  qualified  for  favorable tax treatment and other
types of stock based awards.  Under the first plan,  options are  exercisable 90
days from the date of grant. These options terminate if not exercised within ten
years from the date of grant.  If after six years  from the date of grant  fewer
than 20% of the options have been  exercised,  they will expire at a rate of 20%
annually.  Under the second plan, the options are  exercisable one year from the
date of grant,  at a rate of 10%  annually.  Options  terminate if not exercised
when they become  available,  and no additional  grants will be made under these
two plans. The plan adopted in 2000, authorizes the issuance of up to a total of
500,000  shares,  (358,504 shares are available for grant at December 31, 2002).
Under the 2000 plan, options become  exercisable  ratably over five years. Under
the 2000 plan,  the Company may grant up to 75,000 shares of its common stock to
a single individual in a calendar year.

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

                                             2002                 2001

Dividend yield                               5.67%                5.51% - 5.76%
Volatility                                   18.99%               19.13%
Expected life                                10 years             10 years
Risk-free interest rate                      4.64% - 5.59%        4.92% - 5.19%

The  weighted  average  fair value of options  granted  during 2002 and 2001 was
$3.03 and $2.59,  respectively.  The Black-Scholes  model used by the Company to
calculate  option values,  as well as other currently  accepted option valuation
models,  were  developed  to estimate the fair value of freely  tradable,  fully
transferable  options without vesting  restrictions,  which significantly differ
from the  Company's  stock  option  awards.  These  models also  require  highly
subjective  assumptions,  including  future stock price  volatility and expected
time until exercise,  which greatly affect the calculated  values.  Accordingly,
management  believes  that this  model does not  necessarily  provide a reliable
single measure of the fair value of the Company's option awards.

(continued)
                                      -57-
<PAGE>



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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 13 - STOCK OPTIONS (concluded)

A summary of the status of the  Company's  stock option plans as of December 31,
2002,  2001 and 2000,  and changes  during the years ending on those  dates,  is
presented below:
<TABLE>
<CAPTION>

                                        2002                         2001                         2000
                                                       Weighted                    Weighted                   Weighted
                                                       Average                     Average                    Average
                                                       Exercise                    Exercise                   Exercise
                                        Shares         Price         Shares        Price          Shares      Price

<S>                                      <C>            <C>           <C>          <C>             <C>          <C>
Outstanding at beginning of year         184,300        $21.19        74,550       $18.21          78,550       $18.13
Granted                                   23,996         23.34       126,000        22.22             - -         - -
Exercised                                (21,000)        14.09       (12,750)       12.82          (2,750)       12.00
Forfeited                                 (7,500)        22.22        (3,500)       25.63          (1,250)       27.00
                                          ------                      ------                       ------

     Outstanding at end of year          179,796        $22.26       184,300       $21.19          74,550       $18.21
                                         =======                     =======                       ======

Exercisable at end of year                53,300        $21.08        32,165       $14.40          34,030       $13.65
</TABLE>

The following information summarizes information about stock options outstanding
and exercisable at December 31, 2002:
<TABLE>
<CAPTION>

                                                     Weighted
                                                     Average               Weighted                             Weighted
                                                     Remaining             Average                              Average
           Exercise              Number              Contractual           Exercise         Number              Exercise
           Price                 Outstanding         Life (Years)          Price            Exercisable         Price


<S>         <C>                    <C>               <C>                   <C>              <C>                <C>
            $15.29                 17,550            4                     $15.29           17,550             $15.29
             22.22 - 24.00        140,996            8                      22.41           23,000              22.22
             27.00                 21,250            7                      27.00           12,750              27.00
                                  -------                                                   ------
                                  179,796                                                   53,300
                                  =======                                                   ======
</TABLE>


Note 14 - STOCK TRANSACTIONS

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



                                      -58-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 15 - REGULATORY MATTERS

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

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

As of December 31, 2002, the most recent  notification from the Bank's regulator
categorized  the Bank as well  capitalized  under the  regulatory  framework for
prompt corrective  action. To be categorized as well capitalized,  the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set  forth in the  table.  There  are no  conditions  or  events  since  that
notification that management believes have changed the institution's category.

The Company and the Bank's actual capital  amounts and ratios are also presented
in the table.  Management believes, as of December 31, 2002, the Company and the
Bank meet all capital requirements to which they are subject.
<TABLE>
<CAPTION>

                                                                                                  To be Well Capitalized
                                                                                                  Under Prompt
                                                                         Capital Adequacy         Corrective Action
                                                Actual                   Purposes                 Provisions
                                                Amount       Ratio       Amount        Ratio      Amount             Ratio

December 31, 2002
<S>       <C>
     Tier 1 capital (to average assets):
       Consolidated                             $23,966       8.92%       $10,753      4.00%           N/A            N/A
       Bank                                      23,832       8.87         10,753      4.00        $13,441           5.00%
     Tier 1 capital (to risk-weighted assets):
       Consolidated                              23,966      11.73          8,172      4.00            N/A            N/A
       Bank                                      23,832      11.67          8,171      4.00         12,257           6.00
     Total capital (to risk-weighted assets):
       Consolidated                              26,457      12.95         16,344      8.00            N/A            N/A
       Bank                                      26,323      12.89         16,342      8.00         20,428          10.00
</TABLE>


(continued)

                                      -59-
<PAGE>



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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 15 - REGULATORY MATTERS (concluded)

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

December 31, 2001
     Tier 1 capital (to average assets):
<S>                                             <C>           <C>        <C>           <C>       <C>
       Consolidated                             $23,106       9.49%      $  9,738      4.00%           N/A            N/A
       Bank                                      23,077       9.48          9,738      4.00        $12,173           5.00%
     Tier 1 capital (to risk-weighted assets):
       Consolidated                              23,106      12.27          7,459      4.00            N/A            N/A
       Bank                                      23,077      12.02          7,681      4.00         11,521           6.00
     Total capital (to risk-weighted assets):
       Consolidated                              25,215      13.39         14,918      8.00            N/A            N/A
       Bank                                      25,186      13.12         15,362      8.00         19,202          10.00

</TABLE>

Note 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS

The estimated fair values of the Company's financial  instruments at December 31
are as follows:
<TABLE>
<CAPTION>

                                                   2002                                     2001
                                                   Carrying            Fair                 Carrying              Fair
                                                   Amount              Value                Amount                Value

Financial Assets
     Cash and due from banks,
       interest-bearing deposits with
<S>                                               <C>                 <C>                  <C>                 <C>
       banks, and federal funds sold              $    8,846          $    8,846           $  15,204           $  15,204
     Securities available for sale                    52,230              52,230              31,673              31,673
     Securities held to maturity                      10,362              10,414               4,945               4,942
     Federal Home Loan Bank stock                        866                 866               3,813               3,813
     Loans receivable, net                           183,031             188,247             174,495             177,569
     Loans held for sale                                 286                 286                 - -                 - -
     Accrued interest receivable                       1,493               1,493               1,405               1,405

Financial Liabilities
     Deposits                                       $225,254            $226,146            $214,644            $214,914
     Short-term borrowings                             1,800               1,800                 - -                 - -
     Long-term borrowings                             11,000              11,105                 - -                 - -
     Accrued interest payable                            318                 318                 441                 441
</TABLE>

(continued)
                                      -60-

<PAGE>


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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS (concluded)

The Bank assumes  interest rate risk (the risk that general interest rate levels
will change) as a result of its normal operations.  As a result, the fair values
of the Bank's financial instruments will change when interest rate levels change
and that change may either be favorable or unfavorable  to the Bank.  Management
attempts to match  maturities of assets and  liabilities to the extent  believed
necessary to minimize  interest rate risk.  However,  borrowers  with fixed rate
obligations  are less  likely to prepay in a rising  rate  environment  and more
likely to prepay in a falling rate environment.  Conversely,  depositors who are
receiving  fixed rates are more likely to withdraw  funds  before  maturity in a
rising rate environment and less likely to do so in a falling rate  environment.
Management monitors rates and maturities of assets and liabilities, and attempts
to minimize interest rate risk by adjusting terms of new loans, and deposits and
by investing in securities with terms that mitigate the Bank's overall  interest
rate risk.


Note 17 - EARNINGS PER SHARE DISCLOSURES

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

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

Year Ended December 31, 2002
   Basic earnings per share:
<S>                                                             <C>                   <C>                       <C>
       Net income                                               $3,916                2,492,526                 $1.57
     Effect of dilutive securities:
       Options                                                     - -                   17,869                  (.01)
     Diluted earnings per share:                                ------                ---------                 -----
       Net income                                               $3,916                2,510,395                 $1.56
                                                                ======                =========                 =====

Year Ended December 31, 2001
   Basic earnings per share:
       Net income                                               $3,807                2,491,426                 $1.53
     Effect of dilutive securities:
       Options                                                     - -                   19,736                  (.01)
     Diluted earnings per share:                                ------                ---------                 -----
       Net income                                               $3,807                2,511,162                 $1.52
                                                                ======                =========                 =====

Year Ended December 31, 2000
   Basic earnings per share:
       Net income                                               $3,303                2,492,326                 $1.33
     Effect of dilutive securities:
       Options                                                     - -                   20,493                  (.02)
     Diluted earnings per share:                                ------                ---------                 -----
       Net income                                               $3,303                2,512,819                 $1.31
                                                                ======                =========                 =====
</TABLE>


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


                                      -61-


<PAGE>

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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 18 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY

CONDENSED BALANCE SHEETS - DECEMBER 31

<TABLE>
<CAPTION>
                                                                              2002                  2001

Assets
<S>                                                                          <C>                 <C>
     Cash                                                                     $ 3,467             $ 3,317
     Investment in the Bank                                                    24,549              23,485
     Due from the Bank                                                             59                 - -
                                                                              -------             -------
     Total assets                                                             $28,075             $26,802
                                                                              =======             =======

Liabilities and Shareholders' Equity
     Dividends payable                                                        $ 3,392             $ 3,288
     Shareholders' equity                                                      24,683              23,514
                                                                              -------             -------
     Total liabilities and shareholders' equity                               $28,075             $26,802
                                                                              =======             =======

</TABLE>

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

                                                                          2002                2001                 2000

<S>                                                                       <C>                 <C>                 <C>
Dividend Income from the Bank                                             $3,200              $3,670              $3,275

Expenses                                                                     (59)                (69)               (169)
                                                                          ------              ------             -------
     Income before income taxes                                            3,141               3,601               3,106

Income Tax Benefit                                                            20                  23                  18
                                                                          ------              ------             -------
     Income before equity in undistributed income of the Bank              3,161               3,624               3,124

Equity in Undistributed Income of the Bank                                   755                 183                 179
                                                                          ------              ------             -------
     Net income                                                           $3,916              $3,807              $3,303
                                                                          ======              ======              ======

</TABLE>

(continued)


                                      -62-
<PAGE>



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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 18 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY (concluded)

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

                                                                         2002                 2001                 2000

Operating Activities
<S>                                                                       <C>                 <C>                 <C>
     Net income                                                           $3,916              $3,807              $3,303
     Adjustments to reconcile net income to
       net cash provided by operating activities:
          Equity in undistributed income of subsidiary                      (755)               (183)               (179)
          Other - net                                                        (19)                 (1)                 57
     Net cash provided by operating activities                             3,142               3,623               3,181
                                                                           -----               -----               -----

Investing Activities
     (Increase) decrease in due from the Bank                                - -               3,178              (1,794)
                                                                           -----               -----               -----
Financing Activities
     Common stock issued                                                     297                 164                  33
     Dividends paid                                                       (3,289)             (3,204)             (3,105)
     Repurchase of common stock and fractional shares                        - -                (510)                - -
                                                                           -----               -----               -----
     Net cash used in financing activities                                (2,992)             (3,550)             (3,072)
                                                                           -----               -----               -----
     Net increase (decrease) in cash                                         150               3,251              (1,685)


Cash
     Beginning of year                                                     3,317                  66               1,751
                                                                           -----               -----               -----
     End of year                                                          $3,467              $3,317             $    66
                                                                          ======              ======             =======

</TABLE>
                                      -63-



<PAGE>

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


Pacific Financial Corporation and Subsidiary
December 31, 2002 and 2001


Note 19 - QUARTERLY DATA (Unaudited)
<TABLE>
<CAPTION>

                                                     First                Second              Third             Fourth
                                                     Quarter              Quarter             Quarter           Quarter

Year Ended December 31, 2002

<S>                                                   <C>                 <C>                 <C>               <C>
Interest income                                       $3,880              $3,930              $3,942            $4,027
Interest expense                                         971                 981               1,046               993
                                                       -----               -----               -----             -----
     Net interest income                               2,909               2,949               2,896             3,034

Provision for credit losses                              954                 - -                 - -               - -

Non-interest income                                      454                 704                 477               424

Non-interest expenses                                  1,819               1,873               1,848             1,874
                                                       -----               -----               -----             -----

     Income before income taxes                          590               1,780               1,525             1,584

Income taxes                                             182                 534                 452               395
                                                         ---                 ---                 ---               ---

     Net income                                       $  408              $1,246              $1,073            $1,189
                                                      ======              ======              ======            ======

Earnings per common share:
   Basic                                              $  .16              $  .50              $  .43              $.48
   Diluted                                               .16                 .50                 .43               .47

Year Ended December 31, 2001

Interest income                                       $4,985              $4,671              $4,401            $4,045
Interest expense                                       2,151               1,766               1,539             1,074
                                                       -----               -----               -----             -----
     Net interest income                               2,834               2,905               2,862             2,971

Provision for credit losses                              102                  98                  98               282

Non-interest income                                      314                 346                 442               427

Non-interest expenses                                  1,808               1,759               1,761             1,865
                                                       -----               -----               -----             -----

     Income before income taxes                        1,238               1,394               1,445             1,251

Income taxes                                             361                 429                 399               332
                                                       -----               -----               -----             -----
     Net income                                       $  877              $  965              $1,046            $  919
                                                      ======              ======              ======            ======
Earnings per common share:
   Basic                                              $  .35              $  .39              $  .42              $.37
   Diluted                                               .35                 .38                 .42               .36


</TABLE>
                                      -64-



<PAGE>


                                   SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  registrant  has duly  caused  this report to be signed on its
behalf by the undersigned,  thereunto duly authorized, on the 19th day of March,
2003.

                                              PACIFIC FINANCIAL CORPORATION
                                                  (Registrant)


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

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities indicated, on the 19th day of March, 2003.

Principal Executive Officer and Director      Principal Financial and
                                              Accounting Officer


/s/ Dennis A. Long                            /s/ John Van Dijk
--------------------------------              -------------------------------
Dennis A. Long, President and CEO             John Van Dijk, Treasurer (CFO)
and Director                                  Principal Financial and
Principal Executive Officer                   Accounting Officer


Remaining Directors

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

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

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

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

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

/s/ Edward Ketel
--------------------------------              -------------------------------
Edward Ketel                                  Douglas M. Schermer


                                      -65-
<PAGE>


                     CERTIFICATIONS UNDER 18 U.S.C. ss. 1350

The undersigned certify,  pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to
ss. 906 of the  Sarbanes-Oxley  Act of 2002, that the preceding Annual Report on
Form 10-K fully complies with the  requirements of Section 13(a) or 15(d) of the
Securities  Exchange Act of 1934, and the information  contained  therein fairly
presents,  in all material  respects,  the  financial  condition  and results of
operations of Pacific Financial Corporation.


/s/ Dennis A. Long                                   /s/ John Van Dijk
------------------------                             ---------------------------
Dennis A. Long                                        John Van Dijk
President                                             Secretary/Treasurer
Chief Executive Officer                               Chief Financial Officer
March 19, 2003                                        March 19, 2003


                    CERTIFICATION OF CHIEF EXECUTIVE OFFICER
               UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Dennis A. Long, certify that:

         1. I have reviewed this annual report on Form 10-K of Pacific Financial
Corporation;

         2. Based on my  knowledge,  this  annual  report  does not  contain any
untrue  statement of a material fact or omit to state a material fact  necessary
to make the  statements  made,  in light of the  circumstances  under which such
statements  were made, not misleading with respect to the period covered by this
annual report;

         3. Based on my knowledge, the financial statements, and other financial
information  included  in this annual  report,  fairly  present in all  material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report;

         4. The registrant's  other certifying officer and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

         (a) Designed  such  disclosure  controls and  procedures to ensure that
material  information  relating to the  registrant,  including its  consolidated
subsidiaries, is made known to us by others within those entities,  particularly
during the period in which this annual report is being prepared;

         (b) Evaluated the effectiveness of the registrant's disclosure controls
and  procedures  as of a date  within 90 days prior to the  filing  date of this
annual report (the "Evaluation Date"); and


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<PAGE>


         (c)  Presented  in  this  annual  report  our  conclusions   about  the
effectiveness of the disclosure  controls and procedures based on our evaluation
as of the Evaluation Date;

         5. The  registrant's  other  certifying  officer and I have  disclosed,
based on our most recent evaluation,  to the registrant's auditors and the audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent functions):

         (a) All significant deficiencies in the design or operation of internal
controls  which  could  adversely  affect  the  registrant's  ability to record,
process,  summarize  and  report  financial  data  and have  identified  for the
registrant's auditors any material weaknesses in internal controls; and

         (b) Any fraud,  whether or not material,  that  involves  management or
other  employees  who  have a  significant  role  in the  registrant's  internal
controls; and

         6. The registrant's  other  certifying  officer and I have indicated in
this annual  report  whether or not there were  significant  changes in internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant deficiencies and material weaknesses.



Date:  March 19, 2003                      /s/ Dennis A. Long
                                           --------------------------------
                                           Dennis A. Long
                                           President and Chief Executive Officer


                                      -67-
<PAGE>



                    CERTIFICATION OF CHIEF FINANCIAL OFFICER
               UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, John Van Dijk, certify that:

         1. I have reviewed this annual report on Form 10-K of Pacific Financial
Corporation;

         2. Based on my  knowledge,  this  annual  report  does not  contain any
untrue  statement of a material fact or omit to state a material fact  necessary
to make the  statements  made,  in light of the  circumstances  under which such
statements  were made, not misleading with respect to the period covered by this
annual report;

         3. Based on my knowledge, the financial statements, and other financial
information  included  in this annual  report,  fairly  present in all  material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report;

         4. The registrant's  other certifying officer and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

         (a) Designed  such  disclosure  controls and  procedures to ensure that
material  information  relating to the  registrant,  including its  consolidated
subsidiaries, is made known to us by others within those entities,  particularly
during the period in which this annual report is being prepared;

         (b) Evaluated the effectiveness of the registrant's disclosure controls
and  procedures  as of a date  within 90 days prior to the  filing  date of this
annual report (the "Evaluation Date"); and

         (c)  Presented  in  this  annual  report  our  conclusions   about  the
effectiveness of the disclosure  controls and procedures based on our evaluation
as of the Evaluation Date;

         5. The  registrant's  other  certifying  officer and I have  disclosed,
based on our most recent evaluation,  to the registrant's auditors and the audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent functions):

         (a) All significant deficiencies in the design or operation of internal
controls  which  could  adversely  affect  the  registrant's  ability to record,
process,  summarize  and  report  financial  data  and have  identified  for the
registrant's auditors any material weaknesses in internal controls; and

         (b) Any fraud,  whether or not material,  that  involves  management or
other  employees  who  have a  significant  role  in the  registrant's  internal
controls; and

                                      -68-
<PAGE>

         6. The registrant's  other  certifying  officer and I have indicated in
this annual  report  whether or not there were  significant  changes in internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant deficiencies and material weaknesses.



Date:  March 19, 2003                      /s/ John Van Dijk
                                           --------------------------------
                                           John Van Dijk
                                           Treasurer



                                      -69-
<PAGE>


                                  Exhibit Index

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

3.1      Restated Articles of Incorporation (1)
3.2      Bylaws (2)
10       Executive Compensation Plans and Arrangements and Other Management
         Contracts
10.1     Employment Agreement with Dennis A. Long dated January 2, 2003
10.2     Employment Agreement with John Van Dijk dated January 2, 2003
10.3     Bank of the Pacific Incentive Stock Option Plan (3)
10.4     The Bank of Grays Harbor Incentive Stock Option Plan (3)
10.5     2000 Stock Incentive Compensation Plan (4)
10.6     Bonus Program for Officers (5)
10.7     The Bank of Grays Harbor Employee Deferred Compensation Plan (5)
10.8     Employment Agreement with Bruce D. MacNaughton dated January 2, 2003
21       Subsidiaries of Registrant - Bank of the Pacific, organized
         under Washington Law
23       Consents of McGladrey & Pullen, LLP, and Knight, Vale & Gregory PLLC,
         Independent Auditors
99       Description of common stock of the Company (6)

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

(2) Incorporated by reference to Exhibit 2b to Form 8-A filed by the Company and
declared effective on March 7, 2000 (Registration No. 000-29329)

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

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

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

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


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