**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549









**FORM
      10-Q**




x
            Quarterly
                report Pursuant to section 13 or 15(d) of the Securities and Exchange
                act
                of 1934


**For
      the quarter ended September 30, 2008**





OR




 ̈
            Transition
                report pursuant to section 13 or 15(d) of the Securities and Exchange
                act
                of 1934


For
      the
      transition period from ________ to ________




**Commission
      file number 0-23881**









**COWLITZ
      BANCORPORATION**


(Exact
      name of registrant as specified in its charter)




**Washington**
            
            **91-1529841**(State
                or other jurisdiction
            
            (I.R.S.
                Employerof
                incorporation or organization)
            
            Identification
                No.)





927
      Commerce Ave., Longview, Washington 98632


(Address
      of principal executive offices) (Zip Code)




(360)
      423-9800


(Registrant's
      telephone number, including area code)




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 period that the registrant was required
      to file such reports) and (2) has been subject to such filing requirements
      for
      the past 90 days.


Yes x No  ̈




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer or a smaller reporting company.
      See
      definition of “large accelerated filer”, “accelerated filer” and “smaller
      reporting company” in Rule 12b-2 of the Exchange Act. (Check one):




 ̈ Large
      accelerated filer  ̈ Accelerated
      filer  ̈ Non-accelerated
      filer  x Smaller
      reporting company




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act).


Yes  ̈ No x




Indicate
      the number of shares outstanding of each of the issuer's classes of common
      stock, as of the latest practicable date.




Common
      Stock, no par value on October 31, 2008: 5,067,379 shares









**COWLITZ
      BANCORPORATION AND SUBSIDIARY**


**TABLE
      OF CONTENTS**




PAGEPart
                I
            FINANCIAL
                INFORMATIONItem
                1.
            Financial
                StatementsConsolidated
                Statements of Condition -
              September
                30, 2008 and December 31, 2007
            
            3Consolidated
                Statements of Operations -
              Three
                and nine months ended September 30, 2008 and September 30,
                2007
            
            4Consolidated
                Statements of Changes in Shareholders' Equity and Comprehensive Income
                (Loss) -
              Nine
                months ended September 30, 2008 and year ended December 31,
                2007
            
            5Consolidated
                Statements of Cash Flows -
              Nine
                months ended September 30, 2008 and September 30, 2007
            
            6Notes
                to Consolidated Financial Statements
            
            7Item
                2.
            Management's
                Discussion and Analysis of Financial ConditionAnd
                Results of Operations
            
            13Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            
            24Item
                4T.
            Controls
                and Procedures
            
            25Part
                II
            OTHER
                INFORMATIONItem
                1.
            Legal
                Proceedings
            
            25Item
                1A.
            Risk
                Factors
            
            25Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            
            27Item
                3.
            Defaults
                upon Senior Securities
            
            27Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            
            27Item
                5.
            Other
                Information
            
            27Item
                6.
            Exhibits
            
            27Signatures
            
            28




Forward-Looking
      Statements




*Management’s
      discussion and the information in this document and the accompanying financial
      statements contain forward-looking statements, within the meaning of the Private
      Securities Litigation Reform Act of 1995. Forward-looking statements, which
      are
      based on certain assumptions and describe future plans, strategies and
      expectations of the Company, are generally identifiable by words such as
      "expect", "believe", "intend", "anticipate", "estimate" or similar expressions,
      and are subject to risks and uncertainties that could cause actual results
      to
      differ materially from those stated. Examples of such risks and uncertainties
      that could have a material adverse effect on the operations and future prospects
      of the Company, and could render actual results different from those expressed
      in the forward-looking statements, include, without limitation: those set forth
      in our most recent Form 10-K and other filings with the SEC, changes in general
      economic conditions, competition for financial services in the market area
      of
      the Company, the impact of the current national and regional economy (including
      real estate values) on loan demand and borrowers’ financial capacity in the
      Company’s market, quality of the loan and investment portfolio, deposit flows,
      legislative and regulatory initiatives, and monetary and fiscal policies of
      the
      U.S. Government affecting interest rates. The reader is advised that this list
      of risks is not exhaustive and should not be construed as any prediction by
      the
      Company as to which risks would cause actual results to differ materially from
      those indicated by the forward-looking statements. Forward looking statements
      in
      this document include, without limitation, statements regarding the adequacy
      of
      our allowance for loan losses and liquidity. We undertake no obligation to
      update publicly or revise any forward-looking statements. You should not place
      undue reliance on forward-looking statements, which speak only as of the date
      on
      which they are made.*




2




**Part
      I. FINANCIAL INFORMATION**




**Item
      1. Financial Statements**




**COWLITZ
      BANCORPORATION AND SUBSIDIARY**


**CONSOLIDATED
      STATEMENTS OF CONDITION**


**(UNAUDITED)**




September 30,
            
            December 31,*(dollars in thousands)*
            
            2008
            
            2007**Assets**Cash
                and cash equivalents
            
            $
            57,762
            
            $
            31,251Investment
                securities
            
            
            40,812
            
            
            51,578Federal
                Home Loan Bank stock, at cost
            
            
            1,247
            
            
            1,247Loans,
                net of deferred loan fees
            
            
            436,684
            
            
            397,325Allowance
                for loan losses
            
            
            (13,859
            )
            
            (5,801
            )Total
                loans, net
            
            
            422,825
            
            
            391,524Cash
                surrender value of bank-owned life insurance
            
            
            14,788
            
            
            14,328Premises
                and equipment
            
            
            6,148
            
            
            6,515Goodwill
                and other intangibles
            
            
            1,798
            
            
            1,834Accrued
                interest receivable and other assets
            
            
            19,955
            
            
            15,903**Total
                assets**
            
            $
            565,335
            
            $
            514,180**Liabilities**Deposits:Non-interest-bearing
                demand
            
            $
            82,096
            
            $
            91,662Savings
                and interest-bearing demand
            
            
            31,768
            
            
            35,792Money
                market
            
            
            75,574
            
            
            86,658Certificates
                of deposit
            
            
            311,920
            
            
            227,067Total
                deposits
            
            
            501,358
            
            
            441,179Federal
                funds purchased
            
            
            425
            
            
            1,050Junior
                subordinated debentures and other borrowings
            
            
            12,441
            
            
            12,501Accrued
                interest payable and other liabilities
            
            
            4,739
            
            
            3,910**Total
                liabilities**
            
            
            518,963
            
            
            458,640**Commitments
                and contingencies**(Note 8)**Shareholders'
                equity**Preferred
                stock, no par value; 5,000,000 shares authorized; no shares issued
                and
                outstanding at September 30, 2008 and December 31, 2007
            
            
            -
            
            
            -Common
                stock, no par value; 25,000,000 shares authorized with
                5,067,379****and****5,054,437 shares
                issued and outstanding at September 30, 2008 and December 31, 2007,
                respectively
            
            
            29,013
            
            
            28,936Additional
                paid-in capital
            
            
            2,532
            
            
            2,484Retained
                earnings
            
            
            12,968
            
            
            21,753Accumulated
                other comprehensive income
            
            
            1,859
            
            
            2,367**Total
                shareholders' equity**
            
            
            46,372
            
            
            55,540**Total
                liabilities and shareholders' equity**
            
            $
            565,335
            
            $
            514,180





*See
      accompanying notes*




3




**COWLITZ
      BANCORPORATION AND SUBSIDIARY**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(UNAUDITED)**




Three Months Ended
            
            Nine Months EndedSeptember 30,
            
            September 30,*(dollars in thousands, except per share amounts)*
            
            2008
            
            2007
            
            2008
            
            2007**Interest
                income**Interest
                and fees on loans
            
            $
            8,287
            
            $
            8,552
            
            $
            24,973
            
            $
            24,841Interest
                on taxable investment securities
            
            
            264
            
            
            451
            
            
            969
            
            
            1,394Interest
                on non-taxable investment securities
            
            
            263
            
            
            222
            
            
            788
            
            
            662Other
                interest and dividend income
            
            
            78
            
            
            139
            
            
            241
            
            
            259Total
                interest income
            
            
            8,892
            
            
            9,364
            
            
            26,971
            
            
            27,156**Interest
                expense**Savings
                and interest-bearing demand deposits
            
            
            48
            
            
            56
            
            
            149
            
            
            155Money
                market
            
            
            328
            
            
            652
            
            
            1,276
            
            
            1,353Certificates
                of deposit
            
            
            2,787
            
            
            2,747
            
            
            8,310
            
            
            7,953Federal
                funds purchased and other borrowings
            
            
            7
            
            
            16
            
            
            46
            
            
            79Junior
                subordinated debentures
            
            
            138
            
            
            220
            
            
            469
            
            
            651Total
                interest expense
            
            
            3,308
            
            
            3,691
            
            
            10,250
            
            
            10,191**Net
                interest income before provision for credit
                losses**
            
            
            5,584
            
            
            5,673
            
            
            16,721
            
            
            16,965Provision
                for credit losses
            
            
            2,300
            
            
            725
            
            
            15,895
            
            
            1,000**Net
                interest income after provision for credit losses**
            
            
            3,284
            
            
            4,948
            
            
            826
            
            
            15,965**Non-interest
                income**Service
                charges on deposit accounts
            
            
            221
            
            
            171
            
            
            564
            
            
            508International
                trade fees
            
            
            126
            
            
            146
            
            
            461
            
            
            425Fiduciary
                income
            
            
            143
            
            
            165
            
            
            479
            
            
            529Increase
                in cash surrender value of bank-owned life insurance
            
            
            154
            
            
            142
            
            
            460
            
            
            415Wire
                fees
            
            
            85
            
            
            93
            
            
            250
            
            
            268Mortgage
                brokerage fees
            
            
            50
            
            
            77
            
            
            158
            
            
            210Securities
                losses
            
            
            (1,412
            )
            
            -
            
            
            (1,844
            )
            
            -Other
                income
            
            
            113
            
            
            116
            
            
            361
            
            
            370Total
                non-interest income
            
            
            (520
            )
            
            910
            
            
            889
            
            
            2,725**Non-interest
                expense**Salaries
                and employee benefits
            
            
            2,333
            
            
            2,391
            
            
            7,340
            
            
            7,306Net
                occupancy and equipment
            
            
            641
            
            
            592
            
            
            1,888
            
            
            1,684Professional
                services
            
            
            390
            
            
            454
            
            
            861
            
            
            1,225Data
                processing and communications
            
            
            264
            
            
            248
            
            
            710
            
            
            718Business
                taxes
            
            
            112
            
            
            115
            
            
            354
            
            
            325Interest
                rate contracts adjustments
            
            
            (242
            )
            
            (245
            )
            
            75
            
            
            388Federal
                deposit insurance
            
            
            94
            
            
            11
            
            
            281
            
            
            35Foreclosed
                asset expense, net
            
            
            373
            
            
            -
            
            
            2,247
            
            
            422Other
                expense
            
            
            762
            
            
            626
            
            
            2,505
            
            
            2,275Total
                non-interest expense
            
            
            4,727
            
            
            4,192
            
            
            16,261
            
            
            14,378**Income
                (loss) before provision for income taxes**
            
            
            (1,963
            )
            
            1,666
            
            
            (14,546
            )
            
            4,312**Income
                tax provision (benefit)**
            
            
            (367
            )
            
            390
            
            
            (5,761
            )
            
            1,085**Net
                income (loss)**
            
            $
            (1,596
            )
            $
            1,276
            
            $
            (8,785
            )
            $
            3,227**Earnings
                (loss) per common share:**Basic
            
            $
            (0.31
            )
            $
            0.26
            
            $
            (1.74
            )
            $
            0.65Diluted
            
            $
            (0.31
            )
            $
            0.25
            
            $
            (1.74
            )
            $
            0.62**Weighted
                average shares outstanding:**Basic
            
            
            5,067,379
            
            
            4,995,073
            
            
            5,059,188
            
            
            4,947,019Diluted
            
            
            5,067,379
            
            
            5,161,696
            
            
            5,059,188
            
            
            5,172,078




*See
      accompanying notes*




4




**COWLITZ
      BANCORPORATION AND SUBSIDIARY**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN SHAREHOLDERS'**


**EQUITY
      AND COMPREHENSIVE INCOME (LOSS)**


**(UNAUDITED)**




**Accumulated****Additional**
            
            
            
            **Other**
            
            **Total****Common stock**
            
            **Paid-in**
            
            **Retained**
            
            **Comprehensive**
            
            **Shareholders’***(dollars in thousands, except shares)*
            
            **Shares**
            
            **Amount**
            
            **Capital**
            
            **Earnings**
            
            **Income (Loss)**
            
            **Equity****Balance,
                December 31, 2006**
            
            
            4,889,323
            
            $
            27,279
            
            $
            2,366
            
            $
            21,667
            
            $
            (587
            )
            $
            50,725Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            86
            
            
            -
            
            
            86Net
                change in unrealized gain on:Investments
                available-for-sale, net of taxes of $7
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            14
            
            
            14Cash
                flow hedges, net of taxes of $1,582
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,940
            
            
            2,940Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,040Proceeds
                from the exercise of stock options and employee stock
                purchases
            
            
            165,114
            
            
            1,657
            
            
            -
            
            
            -
            
            
            -
            
            
            1,657Share-based
                compensation
            
            
            -
            
            
            -
            
            
            118
            
            
            -
            
            
            -
            
            
            118**Balance,
                December 31, 2007**
            
            
            5,054,437
            
            
            28,936
            
            
            2,484
            
            
            21,753
            
            
            2,367
            
            
            55,540Comprehensive
                loss:Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (8,785
            )
            
            -
            
            
            (8,785
            )Net
                change in unrealized gain (loss) on:Investments
                available-for-sale, net of taxes of ($497)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (919
            )
            
            (919
            )Cash
                flow hedges, net of taxes of $222
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            411
            
            
            411Comprehensive
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (9,293
            )Proceeds
                from the exercise of stock options and employee stock
                purchases
            
            
            12,942
            
            
            77
            
            
            -
            
            
            -
            
            
            -
            
            
            77Share-based
                compensation
            
            
            -
            
            
            -
            
            
            48
            
            
            -
            
            
            -
            
            
            48**Balance,
                September 30, 2008**
            
            
            5,067,379
            
            $
            29,013
            
            $
            2,532
            
            $
            12,968
            
            $
            1,859
            
            $
            46,372




*See
      accompanying notes*




5




**COWLITZ
      BANCORPORATION AND SUBSIDIARY**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(UNAUDITED)**




Nine Months EndedSeptember 30,*(dollars in thousands)*
            
            2008
            
            2007**Cash
                flows from operating activities**Net
                income (loss)
            
            $
            (8,785
            )
            $
            3,227Adjustments
                to reconcile net income (loss) to net cash provided by operating
                activities:Deferred
                tax provision (benefit)
            
            
            (5,761
            )
            
            1,085Share-based
                compensation
            
            
            45
            
            
            274Excess
                tax benefit on stock options exercised
            
            
            -
            
            
            (168
            )Depreciation
                and amortization
            
            
            1,155
            
            
            739Provision
                for credit losses
            
            
            15,895
            
            
            1,000Increase
                in cash surrender value of bank-owned life insurance
            
            
            (460
            )
            
            (415
            )Impairment
                charge on investment securities
            
            
            1,644
            
            
            -Net
                loss on sales of investment securities
            
            
            200
            
            
            -Interest
                rate contracts adjustments
            
            
            (91
            )
            
            388Net
                (gain) loss on sale of foreclosed assets
            
            
            (116
            )
            
            306Write-down
                of foreclosed assets
            
            
            2,137
            
            
            -Net
                Increase in accrued interest receivable and other assets
            
            
            (647
            )
            
            (896
            )Net
                Increase in accrued interest payable and other liabilities
            
            
            612
            
            
            138Other
            
            
            38
            
            
            35Net
                cash provided by operating activities
            
            
            5,866
            
            
            5,713**Cash
                flows from investing activities**Proceeds
                from maturities and sales of investment securities
            
            
            11,268
            
            
            4,644Purchases
                of investment securities
            
            
            (905
            )
            
            (4,601
            )Net
                increase in loans
            
            
            (51,501
            )
            
            (40,793
            )Proceeds
                from sale of foreclosed assets
            
            
            2,482
            
            
            921Proceeds
                from termination of cash flow hedging instrument
            
            
            482
            
            
            -Purchases
                of bank-owned life insurance
            
            
            -
            
            
            (267
            )Purchases
                of premises and equipment
            
            
            (332
            )
            
            (1,031
            )Proceeds
                from sale of premises and equipment
            
            
            -
            
            
            3Net
                cash used by investing activities
            
            
            (38,506
            )
            
            (41,124
            )**Cash
                flows from financing activities**Net
                increase in deposits
            
            
            59,759
            
            
            42,207Net
                increase (decrease) in federal funds purchased
            
            
            (625
            )
            
            500Repayment
                of Federal Home Loan Bank and other borrowings
            
            
            (60
            )
            
            (86
            )Proceeds
                from the exercise of stock options
            
            
            77
            
            
            1,585Excess
                tax benefit on stock options exercised
            
            
            -
            
            
            168Net
                cash provided by financing activities
            
            
            59,151
            
            
            44,374**Net
                increase in cash and cash equivalents**
            
            
            26,511
            
            
            8,963**Cash
                and cash equivalents, beginning of period**
            
            
            31,251
            
            
            26,581**Cash
                and cash equivalents, end of period**
            
            $
            57,762
            
            $
            35,544**Supplemental
                disclosure of cash flow information**Cash
                paid for interest
            
            $
            10,146
            
            $
            9,880**Supplemental
                disclosure of investing and financing activities**Loans
                transferred to foreclosed assets
            
            $
            4,525
            
            $
            622




*See
      accompanying notes*




6




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**




**1.**
            **Organization
                and Summary of Significant Accounting
                Policies**




**Organization
      –** Cowlitz
      Bancorporation (the Company) was organized in 1991 under Washington law to
      become the holding company for Cowlitz Bank (the “Bank”), a Washington state
      chartered bank that commenced operations in 1978. The principal executive
      offices of the Company are located in Longview, Washington. The Bank operates
      four branches in Cowlitz County in southwest Washington. Outside of Cowlitz
      County, the Bank does business under the name Bay Bank with branches in
      Bellevue, Seattle, and Vancouver, Washington, and Portland and Wilsonville,
      Oregon. The Bank also provides mortgage banking services through its Bay
      Mortgage division with offices in Longview and Vancouver, Washington.




The
      Company offers or makes available a broad range of financial services to its
      customers, primarily small- and medium-sized businesses, professionals, and
      retail customers. The Bank's commercial and personal banking services include
      commercial and real estate lending, consumer lending, international banking
      services, internet banking, cash management, mortgage banking and trust
      services.




**Principles
      of consolidation** -
      The
      accompanying consolidated financial statements include the accounts of the
      Company and its subsidiary. All significant intercompany transactions and
      balances have been eliminated. The Company has one wholly-owned trust, Cowlitz
      Statutory Trust I (the Trust), for purposes of issuing guaranteed undivided
      beneficial interests in junior subordinated debentures (Trust Preferred
      Securities). In accordance with Financial Accounting Standards Board’s
      Interpretation No. 46 (revised December 2003) “Consolidation of Variable
      Interest Entities,” the Company does not consolidate the Trust. Certain
      reclassifications have been made in prior year’s data to conform to the current
      year’s presentation.




The
      interim financial statements have been prepared without an audit and in
      accordance with the instructions to Form 10-Q, generally accepted accounting
      principles, and banking industry practices. Accordingly, they do not include
      all
      the information and footnotes required by accounting principles generally
      accepted in the United States of America for complete financial statements.
      In
      the opinion of management, all adjustments, including normal recurring accruals
      necessary for a fair presentation of the financial condition and results of
      operations for the interim periods included herein, have been made. The results
      of operations for the three and nine months ended September 30, 2008 are not
      necessarily indicative of results to be anticipated for the year ending December
      31, 2008. The interim consolidated financial statements should be read in
      conjunction with the December 31, 2007 consolidated financial statements,
      including the notes thereto, included in the Company’s 2007 Annual Report on
      Form 10-K.




**Operating
      Segments –** The
      Company is principally engaged in community banking activities through its
      branches and corporate offices. Community banking activities include accepting
      deposits, providing loans and lines of credit to local individuals, businesses
      and governmental entities, investing in investment securities and money market
      instruments, international banking services, and holding or managing assets
      in a
      fiduciary agency capacity on behalf of its trust customers and their
      beneficiaries. The Company also provides mortgage lending solutions for its
      customers, consisting of all facets of residential lending including FHA and
      VA
      loans, construction loans, and “bridge” loans. While management monitors the
      revenue streams of the various products and services, financial performance
      is
      being evaluated on a company-wide basis for 2008 as was the case in 2007.
      Accordingly, operations were considered by management to be aggregated within
      one reportable operating segment.




**Use
      of estimates in preparation of the consolidated financial statements -** Preparation
      of the consolidated financial statements, in conformity with accounting
      principles generally accepted in the United States of America, requires
      management to make certain estimates and assumptions that affect the reported
      amounts of assets and liabilities and disclosure of contingent assets and
      liabilities at the date of the financial statements and the reported amounts
      of
      revenues and expenses during the reporting period. Actual results could differ
      from those estimates. Significant estimates include the allowance for credit
      losses and carrying values of the Company's goodwill and other real estate
      owned.




**Derivative
      Financial Instruments –** In
      the
      ordinary course of business, the Company enters into derivative transactions
      to
      manage its interest rate risk. All derivative instruments are recorded as either
      other assets or other liabilities at fair value. Subsequent changes in a
      derivative’s fair value are recognized currently in earnings and included in
      non-interest expense unless specific hedge accounting criteria are met.




7




All
      derivative instruments that qualify for hedge accounting are recorded at fair
      value and classified either as a hedge of the fair value of a recognized asset
      or liability (“fair value” hedge) or as a hedge of the variability of cash flows
      to be received or paid related to a recognized asset or liability or a
      forecasted transaction (“cash flow” hedge). Changes in the fair value of a
      derivative that is highly effective and designated as a fair value hedge and
      the
      offsetting changes in the fair value of the hedged item are recorded in income.
      Changes in the fair value of a derivative that is highly effective and
      designated as a cash flow hedge are recognized in other comprehensive income
      until income from the cash flows of the hedged item is recognized. The Company
      performs an assessment, both at the inception of the hedge and on a quarterly
      basis thereafter, to determine whether these derivatives are expected to
      continue to be highly effective in offsetting changes in the value of the hedged
      items. Any change in fair value resulting from hedge ineffectiveness is
      immediately recorded in non-interest expense.




If
      a
      derivative designated as a cash flow hedge is terminated or ceases to be highly
      effective, the gain or loss is amortized to earnings over the same period(s)
      that the forecasted hedged transactions impact earnings (cash flow hedge).
      If
      the hedged item is disposed of, or the forecasted transaction is no longer
      probable, the derivative is recorded at fair value with any resulting gain
      or
      loss included in the gain or loss from the disposition of the hedged item or,
      in
      the case of a forecasted transaction that is no longer probable, included in
      earnings immediately.




**Recently
      Issued Accounting Standards –** In
      September 2006, the FASB issued Statement No. 157, “ *Fair
      Value Measurements* ,”
(SFAS
      157). This statement defines fair value, establishes a framework for measuring
      fair value, and expands disclosures about fair value measurements. The statement
      establishes a fair value hierarchy for the assumptions used to measure fair
      value and clarifies assumptions about risk and the effect of a restriction
      on
      the sale or use of an asset. The Company adopted this statement on January
      1,
      2008. In February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-2,
      “ *Effective
      Date of FASB Statement No. 157”.* This FSP
      delayed the effective date of FAS 157 for all nonfinancial assets and
      nonfinancial liabilities, except those that are recognized or disclosed at
      fair
      value on a recurring basis (at least annually) to fiscal years beginning after
      November 15, 2008, and interim periods within those fiscal years. The Company’s
      adoption of FAS 157-2 is not expected to have a material impact on the Company’s
      financial statements.




In
      December 2007, FASB issued SFAS No. 141 (revised), *Business
      Combinations* .
      SFAS
      No. 141R establishes principles and requirements for how an acquirer recognizes
      and measures in its financial statements the identifiable assets acquired,
      the
      liabilities assumed, any non-controlling interest in the acquired entity and
      the
      goodwill acquired. SFAS No. 141R also establishes disclosure requirements to
      enable the evaluation of the nature and financial effects of the business
      combination. This statement applies prospectively to business combinations
      for
      which the acquisition date is on or after January 1, 2009. We are currently
      evaluating the impact of the adoption of SFAS No. 141R.




In
      March
      2008, the FASB issued Statement of Financial Accounting Standards No. 161,
      “ *Disclosures
      about Derivative Instruments and Hedging Activities—an amendment of FASB
      Statement No. 133,”* (SFAS
      161). This Statement requires enhanced disclosures about an entity’s derivative
      and hedging activities and is effective for financial statements issued for
      fiscal years and interim periods beginning after November 15, 2008. The Company
      plans to apply the enhanced disclosure provisions of SFAS 161 to all derivative
      and hedging activities.




**2.**
            **Cash
                and Cash Equivalents**




For
      the
      purpose of presentation in the statements of cash flows, cash and cash
      equivalents include cash on hand, amounts due from banks including short-term
      certificates of deposit (original maturities of 90 days or less), and federal
      funds sold. Federal funds sold generally mature the day following
      purchase.




**3.**
            **Earnings
                (Loss) Per Share**




The
      following table reconciles the denominator of the basic and diluted earnings
      (loss) per share computations:




Three Months Ended
            
            Nine Months EndedSeptember 30,
            
            September 30,2008
            
            2007
            
            2008
            
            2007Weighted-average
                shares outstanding – basic
            
            
            5,067,379
            
            
            4,995,073
            
            
            5,059,188
            
            
            4,947,019Effect
                of assumed conversion of stock options
            
            
            -
            
            
            166,623
            
            
            -
            
            
            225,059Weighted-average
                shares outstanding – diluted
            
            
            5,067,379
            
            
            5,161,696
            
            
            5,059,188
            
            
            5,172,078




No
      options to purchase shares were included in the computation of diluted earnings
      (loss) per share for the three and nine-months ended September 30, 2008, as
      their inclusion would be anti-dilutive. All options outstanding were included
      in
      the computation of diluted earnings (loss) per share for the three and
      nine-month periods of 2007.




8




**4.**
            **Share-Based
                Compensation**




The
      Company has a stock option plan, a stock appreciation rights (SAR) plan and
      an
      employee stock purchase plan. Compensation costs related to these plans are
      recognized on a straight-line basis. Compensation cost charged against income
      for the plans was $45,000 and $274,400 for the first nine-months of 2008 and
      2007, respectively. Net compensation credits of $28,400 and $19,400 for the
      third quarters of 2008 and 2007, respectively were included in compensation
      expense for the plans. Income tax benefits recognized in the income statement
      for share-based compensation were $15,800 and $96,300 for the first nine-months
      of 2008 and 2007, respectively, compared with income tax provisions of $10,000
      and $6,800 for the third quarters of 2008 and 2007, respectively. At September
      30, 2008, unrecognized estimated compensation cost related to non-vested SARs
      and stock options was $74,700 and $8,200 respectively, which is expected to
      be
      recognized over weighted average periods of 1.9 and 1.0 years, respectively.




The
      Company generally grants its annual SAR awards in the first quarter of the
      calendar year. The Company awarded 147,900 and 125,800 SARs in the first
      quarters of 2008 and 2007, respectively, with grant date fair values of $9.15
      and $16.65, respectively. The fair value of the SARs awarded in 2008 was
      estimated on grant date using the Black-Scholes option pricing model with the
      following assumptions: expected volatility of 26.85%; expected term of 5.11
      years; dividend yield of zero; and risk free rate of return of 3.36%. The fair
      value of each SAR awarded in 2007 was estimated using the following weighted
      average assumptions: expected volatility of 26.46%; expected term of 5.11 years;
      dividend yield of zero; and risk free rate of return of 4.47%. The fair value
      of
      all SAR awards outstanding were revalued as of September 30, 2008 with a market
      close price of $6.30 and the following weighted average assumptions: expected
      volatility of 31.06%; expected term of 4.04 years; dividend yield of zero;
      and
      risk-free rate of return of 2.61%. After revaluation of all SAR awards
      outstanding at September 30, 2008, the Company recognized a reduction of $41,100
      of compensation expense in the third quarter of 2008. The expense reduction
      in
      the third quarter of 2007 related to SAR awards outstanding at September 30,
      2007 was $35,100.




The
      fair
      value of each stock option grant is estimated as of the grant date using the
      Black-Scholes option-pricing model. There were no stock options granted in
      the
      nine months ended September 30, 2008. During the first nine months of 2007,
      7,000 stock options were granted with the fair value of the options estimated
      using the following assumptions: expected volatility of 26.46%; expected term
      of
      5.11 years; dividend yield of zero; and risk free rate of return of 4.47%.
      Compensation expense related to stock options was $6,700 and $77,900 in the
      first nine months of 2008 and 2007, respectively. Share-based compensation
      cost
      in 2007 also included $49,800 of costs related to the accelerated vesting of
      stock options granted in prior years for a retiring director. The following
      table summarizes stock option activity for the nine months ended September
      30,
      2008:




Weighted-Avg.
            
            AggregateOptions
            
            Weighted-Avg.
            
            Remaining Contractual
            
            Intrinsic Value(dollars in thousands)
            
            Outstanding
            
            Exercise Price
            
            Term (years)
            
            (in thousands)Balance,
                beginning of period
            
            
            722,136
            
            $
            10.92Granted
            
            
            -
            
            
            -Exercised
            
            
            (3,070
            )
            
            4.53Forfeited/Expired
            
            
            (42,000
            )
            
            10.70Balance,
                end of period
            
            
            677,066
            
            
            10.96
            
            
            4.4
            
            $
            44,968Exercisable,
                end of period
            
            
            672,866
            
            
            10.92
            
            
            4.4
            
            $
            44,968




The
      total
      intrinsic value of options exercised was $13,000 and $724,400 in the first
      nine
      months of 2008 and 2007, respectively. The amount of cash received from the
      exercise of stock options was $14,000 and $1,527,900 in the comparable periods
      of 2008 and 2007, respectively.




Compensation
      expense related to the employee stock purchase plan was $10,600 and $41,000
      in
      the three and nine-month period ended September 30, 2008, respectively, compared
      with $7,000 and $21,300 in the same periods in 2007, respectively.




**5.**
            **Comprehensive
                Income (Loss)**




For
      the
      Company, comprehensive income (loss) primarily includes net income (loss)
      reported on the statements of operations and changes in the fair value of
      available-for-sale investment securities and interest rate contracts accounted
      for as cash flow hedges. These amounts are included in “Accumulated Other
      Comprehensive Income (Loss)” on the consolidated statement of changes in
      shareholders’ equity.




9


Three Months Ended
              
              Nine Months EndedSeptember 30,
              
              September 30,(dollars
                  in thousands)
              
              2008
              
              2007
              
              2008
              
              2007Net
                  income (loss) reported
              
              $
              (1,596
              )
              $
              1,276
              
              $
              (8,785
              )
              $
              3,227Unrealized
                  gain (loss) from securities:Net
                  unrealized gain (loss) on available-for-sale securities arising
                  during the
                  period, net of tax
              
              
              (1,530
              )
              
              364
              
              
              (2,116
              )
              
              (173
              )Reclassification
                  adjustment of loss included in income, net of tax
              
              
              916
              
              
              -
              
              
              1,197
              
              
              -Net
                  unrealized gain (loss) from securities
              
              
              (614
              )
              
              364
              
              
              (919
              )
              
              (173
              )Unrealized
                  gain (loss) from cash flow hedging instruments:Net
                  unrealized gain from cash flow hedging instruments arising during
                  the
                  period, net of tax
              
              
              561
              
              
              1,753
              
              
              469
              
              
              890Reclassification
                  adjustment of (gain) loss included in income, net of tax
              
              
              (227
              )
              
              (159
              )
              
              (58
              )
              
              252Net
                  unrealized gain from cash flow hedging instruments
              
              
              334
              
              
              1,594
              
              
              411
              
              
              1,142Total
                  comprehensive income (loss)
              
              $
              (1,876
              )
              $
              3,234
              
              $
              (9,293
              )
              $
              4,196




**6.**
            **Investment
                Securities**




The
      following table presents the composition and carrying value of the Company’s
      available for sale investment portfolio:




September 30,
            
            December 31,(dollars in thousands)
            
            2008
            
            2007Mortgage-backed
                securities
            
            
            18,407
            
            
            27,263Municipal
                bonds
            
            
            21,779
            
            
            22,801Agency
                securities
            
            
            126
            
            
            1,514Other
                investments
            
            
            500
            
            
            -$
            40,812
            
            $
            51,578




Due
      to
      the extraordinarily unsettled equity market for government-sponsored
      enterprises, the Company recorded other-than-temporary impairment charges of
      $1,412,000 and $1,644,000 on 70,000 shares of FNMA investment grade perpetual
      callable preferred stock in the three and nine-month periods ended September
      30,
      2008, respectively. The following table presents the gross unrealized losses
      and
      fair value of the Company’s investment securities aggregated by investment
      category and length of time that individual securities have been in a continuous
      unrealized loss position at September 30, 2008:


Less Than 12 Months
              
              12 Months or More
              
              TotalFair
              
              Unrealized
              
              Fair
              
              Unrealized
              
              Fair
              
              Unrealized(dollars in thousands)
              
              Value
              
              Losses
              
              Value
              
              Losses
              
              Value
              
              LossesMortgage-backed
                  securities
              
              $
              9,369
              
              $
              (648
              )
              $
              1,656
              
              $
              (29
              )
              $
              11,025
              
              $
              (677
              )Municipal
                  bonds
              
              
              16,475
              
              
              (883
              )
              
              266
              
              
              (20
              )
              $
              16,741
              
              $
              (903
              )Agency
                  securities
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Other
                  investments
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -$
              25,844
              
              $
              (1,531
              )
              $
              1,922
              
              $
              (49
              )
              $
              27,766
              
              $
              (1,580
              )




At
      September 30, 2008, there were 86 investment securities in an unrealized loss
      position, of which 4 were in a continuous loss position for 12 months or more.
      The Company uses an independent third party to determine current market values
      of the securities it holds. These fair market values are compared to current
      carrying values to determine if a security is in a gain or loss position. As
      market rates fluctuate, a security’s fair value can move from a gain or loss
      position. The Company believes that the unrealized losses on its other
      securities that were in a loss position as of September 30, 2008, were primarily
      due to changes in market rates and not credit quality. The Company has the
      ability and intent to hold these investments until a market price recovery
      or to
      maturity, therefore, the unrealized loss on these investments are not considered
      other-than-temporarily impaired.




10




**7.**
            **Loans
                and Allowance for Credit
                Losses**




The
      following table presents the loan portfolio, in accordance with Bank regulatory
      guidance, as of September 30, 2008 and December 31, 2007:




(dollars in thousands)
            
            September 30,
              2008
            
            December 31,
              2007Commercial
            
            $
            123,582
            
            $
            109,846Real
                estate:Construction
            
            
            101,420
            
            
            83,766Residential
                1-4 family
            
            
            35,014
            
            
            32,480Multifamily
            
            
            3,325
            
            
            6,298Commercial
            
            
            170,954
            
            
            162,344Installment
                and other consumer
            
            
            3,595
            
            
            3,785Total
                loans, gross
            
            
            437,890
            
            
            398,519Deferred
                loan fees
            
            
            (1,206
            )
            
            (1,194
            )Loans,
                net of deferred loan fees
            
            $
            436,684
            
            $
            397,325




The allowance
      for credit losses is based upon estimates of probable losses inherent in the
      loan portfolio and the Company’s commitments to extend credit to borrowers. The
      amount of loss ultimately incurred for these loans can vary significantly from
      the estimated amounts. An analysis of the change in the allowance for credit
      losses is as follows for the periods indicated:




Three Months Ended
            
            Nine Months Ended(dollars in thousands)
            
            September 30,
              2008
            
            September 30,
              2007
            
            September 30,
              2008
            
            September 30,
              2007Balance
                at beginning of period
            
            $
            14,247
            
            $
            5,185
            
            $
            5,990
            
            $
            4,825Provision
                for credit losses
            
            
            2,300
            
            
            725
            
            
            15,895
            
            
            1,000Recoveries
            
            
            35
            
            
            222
            
            
            62
            
            
            394Charge-offs
            
            
            (2,314
            )
            
            (32
            )
            
            (7,679
            )
            
            (119
            )Balance
                at end of period
            
            $
            14,268
            
            $
            6,100
            
            $
            14,268
            
            $
            6,100ComponentsAllowance
                for loan losses
            
            $
            13,859
            
            $
            5,828
            
            $
            13,859
            
            $
            5,828Liability
                for unfunded credit commitments
            
            
            409
            
            
            272
            
            
            409
            
            
            272Total
                allowance for credit losses
            
            $
            14,268
            
            $
            6,100
            
            $
            14,268
            
            $
            6,100




Loans
      on
      which the accrual of interest has been discontinued totaled $9.3 million and
      $10.8 million at September 30, 2008 and December 31, 2007, respectively. Loans
      past due more than 90 days and still accruing interest totaled $3.7 million
      and
      $149,000 at September 30, 2008 and December 31, 2007 respectively.




**8.**
            **Commitments
                and Contingencies**




In
      the
      normal course of business, the Bank enters into agreements with customers that
      give rise to various commitments and contingent liabilities that involve
      elements of credit risk, interest rate risk, and liquidity risk. These
      commitments and contingent liabilities are commitments to extend credit, credit
      card arrangements, and standby letters of credit.




A
      summary
      of the Bank’s undisbursed commitments and contingent liabilities at September
      30, 2008, was as follows:




(dollars in thousands)
            
            TotalCommitments
                to extend credit
            
            $
            75,987Credit
                card commitments
            
            
            3,535Standby
                letters of credit
            
            
            2,242$
            81,764




11




Commitments
      to extend credit, credit card arrangements, and standby letters of credit all
      include exposure to some credit loss in the event of non-performance of the
      customer. The Bank’s credit policies and procedures for credit commitments and
      financial guarantees are the same as those for extension of credit that are
      recorded in the consolidated statements of condition. Because most of these
      instruments have fixed maturity dates and many of them expire without being
      drawn upon, they do not generally present a significant liquidity risk to the
      Bank.




**9.**
            **Income
                Taxes**




The
      Company and its subsidiary file income tax returns in the U.S. federal
      jurisdiction and the state of Oregon. The Company is no longer subject to U.S.
      federal, state and local income tax examinations by tax authorities for years
      prior to 2003. The Company’s policy is to recognize interest related to
      unrealized tax benefits and penalties as operating expenses. There were no
      interest or penalties paid during the nine-month period ended September 30,
      2008
      or the twelve-month period ended December 31, 2007. There were no accrued
      interest or penalties as of September 30, 2008 or December 31, 2007. The Company
      believes that it has appropriate support for the income tax positions taken
      and
      to be taken on its tax returns, and that its accruals for tax liabilities are
      adequate for all open years based on an assessment of many factors including
      past experience and interpretations of tax law applied to the facts of each
      matter.




**10.**
            **Derivative
                Instruments and Hedging
                Activities**




The
      Company had two interest rate contracts to manage the risk of overall changes
      in
      cash flows associated with prime-based variable-rate loans at September 30,
      2008. The Company sold an interest rate swap contract in June of 2008 that
      was
      entered into in 2006. At the time of sale, the unrealized gain was $312,800,
      net
      of taxes of $169,200. Since the forecasted transaction at the inception of
      the
      hedging relationship remains probable, this amount will be recognized in
      earnings over approximately 32 months. All interest rate contracts are reported
      at their fair value in the Consolidated Statements of Condition. At September
      30, 2008, interest rate contracts with a fair value of $4.6 million were
      included in other assets and $2.8 million of deferred unrealized gains (net
      of
      taxes of $1.5 million) were included in accumulated other comprehensive income.
      At December 31, 2007, interest rate contracts with a fair value of $4.3 million
      were included in other assets and $2.4 million of deferred unrealized gains
      (net
      of taxes of $1.3 million) were included in accumulated other comprehensive
      income.




**11.**
            **Fair
                Value Measurements**




SFAS
      157
      defines fair value as the exchange price that would be received for an asset
      or
      paid to transfer a liability (an exit price) in the principal or most
      advantageous market for the asset or liability in an orderly transaction between
      market participants on the measurement date. SFAS 157 also establishes a fair
      value hierarchy which requires an entity to maximize the use of observable
      inputs and minimize the use of unobservable inputs when measuring fair value.
      The standard describes three levels of inputs that may be used to measure fair
      value:




*Level
      1.* Quoted
      prices (unadjusted) for identical assets or liabilities in active markets that
      the entity has the ability to access as of the measurement date. An active
      market is a market in which transactions for the asset or liability occur with
      significant frequency and volume to provide pricing information on an ongoing
      basis.




*Level
      2.* Significant other observable inputs other than Level 1 prices, such as quoted
      prices for similar assets or liabilities, quoted prices in markets that are
      not
      active, and other inputs that are observable or can be corroborated by
      observable market data by correlation or other means.




*Level
      3.* Significant unobservable inputs that reflect a company’s own assumptions about
      the assumptions that market participants would use in pricing an asset or
      liability developed based on the best information available in the
      circumstances.




The
      Company used the following methods and significant assumptions to estimate
      fair
      value.




*Securities:* The fair
      values of securities available for sale are determined by obtaining quoted
      prices on nationally recognized securities exchanges or matrix pricing, which
      is
      a mathematical technique used widely in the industry to value debt securities
      without relying exclusively on quoted prices for the specific securities but
      rather by relying on the securities’ relationship to other benchmark quoted
      securities.




*Interest
      Rate Contracts:* The
      Company has elected to use the income approach to value the interest rate
      contracts, using observable Level 2 market expectations at measurement date
      and
      standard valuation techniques to convert future amounts to a single present
      amount assuming that participants are motivated, but not compelled to transact.
      As such, significant fair value inputs can generally be verified and do not
      typically involve significant judgments by management.




*Impaired
      Loans:* Impaired
      loans are evaluated and valued at the time the loan is identified as impaired,
      at the lower of cost or fair value. As a practical expedient, fair value may
      be
      measured based on a loan’s observable market price or the underlying collateral
      securing the loan. Collateral may be real estate or business assets including
      equipment. The value of collateral is determined based on independent
      appraisals.




12




Financial
      instruments are broken down in the table that follows by recurring or
      nonrecurring measurement status. Recurring assets are initially measured at
      fair
      value and are required to be remeasured at fair value in the financial
      statements at each reporting date. Assets measured on a nonrecurring basis
      are
      assets that due to an event or circumstance were required to be remeasured
      at
      fair value after initial recognition in the financial statements at some time
      during the reporting period.




September 30, 2008
            
            Quoted Prices
              in Active
              Markets for
              Identical
              Assets
              (Level 1)
            
            Significant
              Other
              Observable
              Inputs
              (Level 2)
            
            Significant
              Unobservable
              Inputs
              (Level 3)Recurring
                basis:Available
                for sale securities
            
            $
            40,812
            
            $
            -
            
            $
            40,812
            
            $
            -Interest
                rate contracts
            
            
            4,568
            
            
            -
            
            
            4,568
            
            
            -Nonrecurring
                basis:Impaired
                loans
            
            
            11,176
            
            
            -
            
            
            -
            
            
            11,176Total
            
            $
            56,556
            
            $
            -
            
            $
            45,380
            
            $
            11,176




The
      loans
      in the table above represent impaired, collateral dependent loans that have
      been
      adjusted to fair value. When management determines that the value of the
      underlying collateral is less than the recorded investment in the loan, the
      Company recognizes this impairment and adjusts the carrying value of the loan
      to
      fair value by charging-off the amount of the impairment to the allowance for
      loan losses.




**Item
      2.**  **Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations**




**Critical
      Accounting Estimates**




The
      Company’s most critical accounting estimate is related to the allowance for
      credit losses. The Company utilizes both quantitative and qualitative
      considerations in establishing an allowance for credit losses believed to be
      appropriate as of each reporting date.




Quantitative
      factors include:




·
            the
                volume and severity of non-performing loans and adversely classified
                credits,


·
            the
                level of net charge-offs experienced on previously classified loans,


·
            the
                nature and value of collateral securing the loans,


·
            the
                trend in loan growth and the percentage of
                change,


·
            the
                level of geographic and/or industry
                concentration,


·
            the
                relationship and trend over the past several years of recoveries
                in
                relation to charge-offs, and


·
            other
                known factors regarding specific loans.




Qualitative
      factors include:




·
            the
                effectiveness of credit administration,


·
            the
                adequacy of loan review,


·
            the
                adequacy of loan operations personnel and processes,


·
            the
                effect of competitive issues that impact loan underwriting and
                structure,


·
            the
                impact of economic conditions, including interest rate trends,


·
            the
                introduction of new loan products or specific marketing
                efforts,


·
            large
                credit exposure and trends, and


·
            industry
                segments that are exhibiting stress.




Changes
      in the above factors could significantly affect the determination of the
      adequacy of the allowance for credit losses. Management performs a full
      analysis, no less often than quarterly, to ensure that changes in estimated
      loan
      loss levels are adjusted on a timely basis. For further discussion of this
      significant management estimate, see “Allowance for Credit Losses.”




13




Another
      critical accounting estimate of the Company is that related to the carrying
      value of goodwill. Impairment analysis of the fair value of goodwill involves
      a
      substantial amount of judgment. Under Statement of Financial Accounting
      Standards No. 142, “ *Goodwill
      and Other Intangible Assets”* (SFAS
      No.
      142), the Company ceased amortization of goodwill on January 1, 2002 and
      periodically tests goodwill for impairment.




**Results
      of Operations for the Three and Nine Months Ended September 30, 2008 and
      2007**




*Overview*




The
      Company’s net loss for the quarter ended September 30, 2008 was $1.6 million, or
      ($0.31) per share, compared with net income of $1.3 million, or $0.25 per
      diluted share during the same period of 2007. For the first nine months of
      2008,
      the Company’s net loss was $8.8 million, compared with net income of $3.2
      million for the same period of 2007.




Net
      interest income was $5.6 million in the third quarter of 2008, compared with
      $5.7 million in the same period in 2007. For the first nine months of 2008,
      net
      interest income was down $0.2 million from the same period in 2007. Average
      earning assets were $496.7 million in the third quarter of 2008, compared with
      $459.3 million in the third quarter of 2007. The increase in average earning
      assets related primarily to higher loan balances. Average interest-bearing
      liabilities in the third quarter of 2008 were $403.8 million, compared with
      $340.1 million in the third quarter of 2007, as deposits were the primary source
      of funds to support loan growth.




The
      provision for credit losses was $2.3 million in the third quarter of 2008
      compared with $725,000 in the third quarter of 2007. For the nine month period
      ended September 30, 2008, the provision for credit losses was $15.9 million
      compared with $1.0 million in the same period of 2007. The higher provision
      in
      2008 reflected primarily unfavorable conditions in the residential real estate
      market that affected home builders and developers and resulted in an increase
      in
      loans charged-off during the period. A slowdown in home buying has resulted in
      slower sales and rapidly declining real estate valuations, which have
      significantly affected these borrowers’ liquidity and ability to repay
      loans.




At
      September 30, 2008, total assets were $565.3 million, an increase of $51.2
      million, or 10%, from December 31, 2007. Total loans increased 10% to $436.7
      million, from $397.3 million at December 31, 2007. Loans grew at an annualized
      rate of 13% in the first nine months of 2008. Total deposits increased 13.6%
      to
      $501.4 million at September 30, 2008 from $441.2 million at December 31, 2007.




The
      Company maintained capital ratios in excess of defined regulatory levels
      required to be “well-capitalized” as of September 30, 2008. In addition,
      management believes the Company has adequate amounts of liquidity readily
      available.




The
      Emergency Economic Stabilization Act of 2008, signed into law on October 3,
      2008, provides authority to the United States Department of the Treasury to,
      among other things, purchase up to $700 billion of mortgages, mortgage backed
      securities and certain other financial instruments from financial institutions.
      On October 14, 2008, the Treasury Department announced it will offer certain
      selected financial institutions the opportunity to issue and sell preferred
      stock, along with warrants to purchase common stock, to the US government,
      acting through the Treasury, on terms specified by the government. This program
      is known as the Capital Purchase Program, which is part of the larger Troubled
      Asset Relief Program announced.




In
      addition, the Federal Deposit Insurance Corporation has initiated the Temporary
      Liquidity Guarantee Program that will provide a 100 percent guarantee for a
      limited period of time to newly issued senior unsecured debt and non-interest
      bearing transaction deposits. Coverage under the Temporary Liquidity Guarantee
      Program is available for 30 days without charge and thereafter at a cost of
      75
      basis points per annum for senior unsecured debt and 10 basis points per annum
      for non-interest bearing transaction deposits. Management is currently
      evaluating participation in the Liquidity Guarantee Programs.




*Analysis
      of Net Interest Income*




The
      primary component of the Company’s earnings is net interest income. Net interest
      income is the difference between interest income, principally from loans and
      the
      investment securities portfolio, and interest expense, principally on customer
      deposits and borrowings. Changes in net interest income, net interest spread,
      and net interest margin result from changes in asset and liability volume and
      mix, and to rates earned or paid. Net interest spread refers to the difference
      between the yield on interest-earning assets and the cost of interest-bearing
      liabilities. Net interest margin is the ratio of net interest income to total
      interest-earning assets and is influenced by the volume and relative mix of
      interest-earning assets and interest-bearing liabilities. Volume refers to
      the
      dollar level of interest-earning assets and interest-bearing
      liabilities.




14




Interest
      income from certain of the Company’s earning assets is non-taxable. The
      following tables present interest income and expense, including adjustments
      for
      non-taxable interest income, and the resulting tax-adjusted yields earned,
      rates
      paid, interest rate spread, and net interest margin for the periods indicated
      on
      an annualized basis.




For Three Months Ended September 30,2008
            
            2007Average
            
            Interest
            
            
            
            Average
            
            InterestOutstanding
            
            Earned/
            
            Yield/
            
            Outstanding
            
            Earned/
            
            Yield/(dollars in thousands)
            
            Balance
            
            Paid
            
            Rate
            
            Balance
            
            Paid
            
            RateAssetsInterest-earning
                assets:Loans
                (1) (2) (3)
            
            $
            436,770
            
            $
            8,341
            
            
            7.60
            %
            $
            393,133
            
            $
            8,564
            
            
            8.64
            %Taxable
                securities
            
            
            19,036
            
            
            264
            
            
            5.52
            %
            
            32,622
            
            
            451
            
            
            5.48
            %Non-taxable
                securities (2)
            
            
            23,946
            
            
            396
            
            
            6.58
            %
            
            21,157
            
            
            340
            
            
            6.38
            %Temporary
                investments
            
            
            16,938
            
            
            78
            
            
            1.83
            %
            
            12,435
            
            
            139
            
            
            4.43
            %Total
                interest-earning assets (2)
            
            
            496,690
            
            $
            9,079
            
            
            7.27
            %
            
            459,347
            
            $
            9,494
            
            
            8.20
            %Allowance
                for loan losses
            
            
            (13,511
            )
            
            
            
            
            
            
            
            (5,076
            )Other
                assets
            
            
            56,786
            
            
            
            
            
            
            
            
            47,785Total
                assets
            
            $
            539,965
            
            
            
            
            
            
            
            $
            502,056Liabilities
                and shareholders' equityInterest-bearing
                liabilities:Savings,
                money market and interest-bearing demand deposits
            
            $
            104,718
            
            $
            376
            
            
            1.43
            %
            $
            112,200
            
            $
            708
            
            
            2.50
            %Certificates
                of deposit
            
            
            285,733
            
            
            2,787
            
            
            3.88
            %
            
            214,305
            
            
            2,747
            
            
            5.09
            %Federal
                funds purchased
            
            
            950
            
            
            5
            
            
            2.09
            %
            
            1,042
            
            
            13
            
            
            4.95
            %Junior
                subordinated debentures
            
            
            12,372
            
            
            138
            
            
            4.44
            %
            
            12,372
            
            
            220
            
            
            7.05
            %FHLB
                and other borrowings
            
            
            76
            
            
            2
            
            
            8.20
            %
            
            161
            
            
            3
            
            
            7.80
            %Total
                interest-bearing liabilities
            
            
            403,849
            
            $
            3,308
            
            
            3.26
            %
            
            340,080
            
            $
            3,691
            
            
            4.31
            %Non-interest-bearing
                deposits
            
            
            84,111
            
            
            
            
            
            
            
            
            102,219Other
                liabilities
            
            
            4,128
            
            
            
            
            
            
            
            
            5,300Total
                liabilities
            
            
            492,088
            
            
            
            
            
            
            
            
            447,599Shareholders'
                equity
            
            
            47,877
            
            
            
            
            
            
            
            
            54,457Total
                liabilities and shareholders' equity
            
            $
            539,965
            
            
            
            
            
            
            
            $
            502,056Net
                interest income (2)
            
            
            
            
            $
            5,771
            
            
            
            
            
            
            
            $
            5,803Net
                interest spread
            
            
            
            
            
            
            
            
            4.01
            %
            
            
            
            
            
            
            
            3.89
            %Yield
                on average interest-earning assets
            
            
            
            
            7.27
            %
            
            
            
            
            
            
            
            8.20
            %Interest
                expense to average interest-earning assets
            
            
            
            
            
            
            
            
            2.65
            %
            
            
            
            
            
            
            
            3.19
            %Net
                interest income to average interest-earning assets (net interest
                margin)
            
            
            
            
            
            
            
            
            4.62
            %
            
            
            
            
            
            
            
            5.01
            %




(1)
            Loans
                include loans on which the accrual of interest has been
                discontinued.


(2)
            Interest
                earned on non-taxable securities and loans has been computed on a
                34
                percent tax-equivalent basis.


(3)
            Loan
                interest income includes net loan fee income of $312,300 and $409,700
                for
                2008 and 2007, respectively.




15




For Nine Months Ended September 30,2008
            
            2007Average
            
            Interest
            
            
            
            Average
            
            InterestOutstanding
            
            Earned/
            
            Yield/
            
            Outstanding
            
            Earned/
            
            Yield/(dollars in thousands)
            
            Balance
            
            Paid
            
            Rate
            
            Balance
            
            Paid
            
            RateAssetsInterest-earning
                assets:Loans
                (1) (2) (3)
            
            $
            425,177
            
            $
            25,051
            
            
            7.87
            %
            $
            377,579
            
            $
            24,880
            
            
            8.81
            %Taxable
                securities
            
            
            23,800
            
            
            969
            
            
            5.44
            %
            
            34,048
            
            
            1,394
            
            
            5.47
            %Non-taxable
                securities (2)
            
            
            24,253
            
            
            1,187
            
            
            6.54
            %
            
            21,327
            
            
            1,011
            
            
            6.34
            %Temporary
                investments
            
            
            13,999
            
            
            241
            
            
            2.30
            %
            
            7,901
            
            
            259
            
            
            4.38
            %Total
                interest-earning assets (2)
            
            
            487,229
            
            $
            27,448
            
            
            7.53
            %
            
            440,855
            
            $
            27,544
            
            
            8.35
            %Allowance
                for loan losses
            
            
            (9,276
            )
            
            
            
            
            
            
            
            (4,919
            )Other
                assets
            
            
            55,759
            
            
            
            
            
            
            
            
            47,228Total
                assets
            
            $
            533,712
            
            
            
            
            
            
            
            $
            483,164Liabilities
                and shareholders' equityInterest-bearing
                liabilities:Savings,
                money market and interest-bearing demand deposits
            
            $
            113,908
            
            $
            1,425
            
            
            1.67
            %
            $
            98,759
            
            $
            1,508
            
            
            2.04
            %Certificates
                of deposit
            
            
            258,711
            
            
            8,310
            
            
            4.29
            %
            
            210,858
            
            
            7,953
            
            
            5.04
            %Federal
                funds purchased
            
            
            1,939
            
            
            40
            
            
            2.76
            %
            
            1,696
            
            
            68
            
            
            5.36
            %Junior
                subordinated debentures
            
            
            12,372
            
            
            469
            
            
            5.06
            %
            
            12,372
            
            
            651
            
            
            7.04
            %FHLB
                and other borrowings
            
            
            95
            
            
            6
            
            
            7.90
            %
            
            188
            
            
            11
            
            
            7.82
            %Total
                interest-bearing liabilities
            
            
            387,025
            
            $
            10,250
            
            
            3.54
            %
            
            323,873
            
            $
            10,191
            
            
            4.21
            %Non-interest-bearing
                deposits
            
            
            88,932
            
            
            
            
            
            
            
            
            101,145Other
                liabilities
            
            
            4,016
            
            
            
            
            
            
            
            
            5,167Total
                liabilities
            
            
            479,973
            
            
            
            
            
            
            
            
            430,185Shareholders'
                equity
            
            
            53,739
            
            
            
            
            
            
            
            
            52,979Total
                liabilities and shareholders' equity
            
            $
            533,712
            
            
            
            
            
            
            
            $
            483,164Net
                interest income (2)
            
            
            
            
            $
            17,198
            
            
            
            
            
            
            
            $
            17,353Net
                interest spread
            
            
            
            
            
            
            
            
            3.99
            %
            
            
            
            
            
            
            
            4.14
            %Yield
                on average interest-earning assets
            
            
            
            
            7.53
            %
            
            
            
            
            
            
            
            8.35
            %Interest
                expense to average interest-earning assets
            
            
            
            
            
            
            
            
            2.81
            %
            
            
            
            
            
            
            
            3.09
            %Net
                interest income to average interest-earning assets (net interest
                margin)
            
            
            
            
            
            
            
            
            4.71
            %
            
            
            
            
            
            
            
            5.26
            %




(1)
            Loans
                include loans on which the accrual of interest has been
                discontinued.


(2)
            Interest
                earned on non-taxable securities and loans has been computed on a
                34
                percent tax-equivalent basis.


(3)
            Loan
                interest income includes net loan fee income of $1,201,700 and $1,322,100
                for 2008 and 2007, respectively.




The
      net
      interest margin as a percentage was 4.62% in the third quarter of 2008, compared
      with 5.01% in the same quarter last year and 4.71% and 5.26% for the nine months
      ended September 30, 2008 and 2007, respectively. Tax-equivalent net interest
      income for the three and nine month periods ended September 30, 2008 were
      comparable to the respective periods in 2007. Increases in average
      interest-earning assets of $37.3 million and $46.4 million for the three and
      nine-month periods, respectively, were funded primarily by increases in
      interest-bearing deposits. The net interest margin in 2008 relative to the
      net
      interest margin in 2007 was affected by several factors, including rate cuts
      by
      the Federal Reserve of approximately 300 basis points over the last 12 months,
      continued competitive market pricing on both sides of the balance sheet, the
      level of nonperforming loans and a lower level of noninterest-bearing demand
      deposit accounts year-over-year. Interest reversals on nonaccrual loans of
      $118,000 and $248,000 for the three and nine-month periods ended September
      30,
      2008 reduced net interest margin by 10 and 7 bps, respectively




16




The
      net
      interest margin for the nine-months ended September 30, 2008 was also affected
      by the Company’s election to redeem $45.1 million in callable certificates of
      deposit, with $21.5 million settling in March of 2008 and the balance in the
      second quarter of 2008. Newly issued certificates of deposit have an
      approximately 150 basis point lower average cost and a slightly longer duration
      than the certificates of deposits redeemed. In connection with the redemptions,
      the Company wrote off all unamortized premiums associated with those deposits
      of
      $185,000. The deposit premium write-off increased the average cost of
      interest-bearing liabilities by approximately 7 basis points and decreased
      the
      net interest margin by approximately 5 basis points.




*Provision
      for Credit Losses*




The
      Company recorded a provision for credit losses of $2.3 million and $15.9 million
      for the three and nine-month periods ended September 30, 2008, compared with
      $725,000 and $1.0 million in the same periods of 2007. The amount of the
      allowance for credit losses is analyzed by management on a regular basis to
      ensure that it is adequate to absorb losses inherent in the loan portfolio
      as of
      the reporting date. When a provision for credit losses is recorded, the amount
      is based on the current volume of loans and commitments to extend credit,
      anticipated changes in loan volumes, past charge-off experience, management’s
      assessment of the risk of loss on current loans, the level of non-performing
      and
      impaired loans, evaluation of future economic trends in the Company's market
      area, and other factors relevant to the loan portfolio. An internal loan risk
      grading system is used to evaluate probable losses of individual loans. The
      Company does not, as part of its analysis, group loans together by loan type
      to
      assign risk. See "Allowance for Credit Losses" below for a more detailed
      discussion.




*Non-Interest
      Income*




Non-interest
      income consists of the following components:




Three Months Ended
            
            Nine Months EndedSeptember 30,
            
            September 30,(dollars in thousands)
            
            2008
            
            2007
            
            2008
            
            2007Service
                charges on deposit accounts
            
            $
            221
            
            $
            171
            
            $
            564
            
            $
            508International
                trade fees
            
            
            126
            
            
            146
            
            
            461
            
            
            425Fiduciary
                income
            
            
            143
            
            
            165
            
            
            479
            
            
            529Increase
                in cash surrender value of bank-owned life insurance
            
            
            154
            
            
            142
            
            
            460
            
            
            415Wire
                fees
            
            
            85
            
            
            93
            
            
            250
            
            
            268Mortgage
                brokerage fees
            
            
            50
            
            
            77
            
            
            158
            
            
            210Securities
                losses
            
            
            (1,412
            )
            
            -
            
            
            (1,844
            )
            
            -Other
                income
            
            
            113
            
            
            116
            
            
            361
            
            
            370Total
                non-interest income
            
            $
            (520
            )
            $
            910
            
            $
            889
            
            $
            2,725




Total
      non-interest income for the third quarter of 2008 reflected a loss of $520,000
      compared with income of $910,000 in the same quarter of last year. Securities
      losses in the three and nine month periods ended September 30, 2008 were $1.4
      million and $1.8 million, respectively, compared to no losses in the same
      periods in 2007. The loss in the third quarter of 2008 was due to the
      recognition of an increase in the other-than-temporary impairment (OTTI) charge
      on 70,000 shares of FNMA investment grade perpetual callable preferred stock,
      reflecting the extraordinarily unsettled equity market for this
      government-sponsored enterprise (GSE) following the federal government’s actions
      to place the GSE under conservatorship and suspend preferred stock dividends.
      The Company recognized an OTTI charge of $232,000 on its FNMA preferred
      securities in the second quarter of 2008.




17




*Non-Interest
      Expense*




Non-interest
      expense consists of the following components:




Three Months Ended
            
            Nine Months EndedSeptember 30,
            
            September 30,(dollars in thousands)
            
            2008
            
            2007
            
            2008
            
            2007Salaries
                and employee benefits
            
            $
            2,333
            
            $
            2,391
            
            $
            7,340
            
            $
            7,306Net
                occupancy and equipment
            
            
            641
            
            
            592
            
            
            1,888
            
            
            1,684Professional
                services
            
            
            390
            
            
            454
            
            
            861
            
            
            1,225Data
                processing and communications
            
            
            264
            
            
            248
            
            
            710
            
            
            718Business
                taxes
            
            
            112
            
            
            115
            
            
            354
            
            
            325Interest
                rate contracts adjustments
            
            
            (242
            )
            
            (245
            )
            
            75
            
            
            388Federal
                deposit insurance
            
            
            94
            
            
            11
            
            
            281
            
            
            35Foreclosed
                asset expense, net
            
            
            373
            
            
            -
            
            
            2,247
            
            
            422Other
                expense
            
            
            762
            
            
            626
            
            
            2,505
            
            
            2,275Total
                non-interest expense
            
            $
            4,727
            
            $
            4,192
            
            $
            16,261
            
            $
            14,378




Non-interest
      expenses in the three and nine month periods ended September 30, 2008 were
      $4.7
      million and $16.3 million, compared with $4.2 million and $14.4 million in
      the
      same periods of 2007. The most significant items affecting comparability of
      the
      totals were costs related to foreclosed assets and amounts related to interest
      rate contracts. Foreclosed asset expenses were $373,000 in the third quarter
      of
      2008, compared with none in the third quarter of 2007, and $2.2 million in
      the
      first nine months of 2008 compared with $422,000 in the same period of 2007.
      The
      Company recorded non-cash credits of $242,000 and $245,000 in the three month
      periods ended September 30, 2008 and 2007, respectively and non-cash charges
      of
      $75,000 and $388,000 in the nine month periods ended September 2008 and 2007,
      respectively, related to the ineffective portion of the change in fair value
      of
      the Company’s cash flow hedges.




Salaries
      and employee benefits for the three and nine-month periods of 2008 were
      approximately equal to the amounts in the same periods of 2007. In the first
      quarter of 2008, the Company substantially completed a planned reduction of
      approximately 7% in its workforce primarily through attrition and better
      matching of staffing levels to customer traffic flows, as well as job
      eliminations. The number of full-time equivalent employees was 130 at September
      30, 2008, compared with 137 at September 30, 2007.




On
      a
      year-to-date basis, net occupancy and equipment expenses in the first nine
      months of 2008 were higher than the same period in 2007 primarily due to higher
      levels of depreciation related to branch remodeling and related asset
      acquisitions in mid-2007. Professional services were down significantly in
      the
      first nine months of 2008 compared with the first nine months of 2007. The
      Company’s legal costs related to nonperforming loans were higher by
      approximately $50,000 in 2008 compared with the same period in 2007, while
      costs
      associated with Sarbanes-Oxley compliance efforts were lower by approximately
      $255,000 than in the same period of 2007. Federal deposit insurance premiums
      were $281,000 in the first nine months of 2008, compared with $35,000 in the
      first nine months of 2007. In the third quarter of 2007, the Company fully
      utilized its remaining one-time credits towards FDIC assessments.




*Income
      Taxes*




The
      Company’s effective tax benefit rate for the first nine months of 2008 was 40%,
      compared with 25% for the first nine months of 2007. The Company’s effective
      benefit rate for the first six months of 2008 was 43%. The change in the
      effective tax benefit rate to 40% at September 30, 2008 caused the third quarter
      2008 tax benefit rate to be 19%. When the Company incurs a pre-tax loss, its
      effective tax rate is higher than the Federal statutory rate of 35% primarily
      due to tax-exempt income related to its municipal securities portfolio and
      investments in bank-owned life insurance. The Company’s effective tax rate for
      interim periods is based on projections of taxable income or loss for the full
      year and is affected by the relative amounts of taxable and non-taxable income
      and the amount of available tax credits.




18




**Financial
      Condition**




*Investment
      Securities*




The
      following table presents the composition and carrying value of the Company’s
      available for sale investment portfolio:




September 30,
            
            December 31,(dollars in thousands)
            
            2008
            
            2007Mortgage-backed
                securities
            
            
            18,407
            
            
            27,263Municipal
                bonds
            
            
            21,779
            
            
            22,801Agency
                securities
            
            
            126
            
            
            1,514Other
                investments
            
            
            500
            
            
            -$
            40,812
            
            $
            51,578




Total
      investment securities as of September 30, 2008 were $40.8 million, compared
      with
      $51.6 million at December 31, 2007. The decrease in total securities from
      year-end 2007 primarily reflected the sale of four non-agency mortgage-backed
      securities, as well as scheduled principal payments. In addition, an
      other-than-temporary impairment charge of $1.6 million was recorded on its
      investment in FNMA preferred stock in 2008. The Company’s securities, classified
      as available for sale, are used by management as part of its asset/liability
      management strategy and may be sold in response to changes in interest rates
      or
      significant prepayment risk.




*Loans*




Total
      loans outstanding were $436.7 million and $397.3 million at September 30, 2008
      and December 31, 2007, respectively. Unfunded loan commitments were $81.8
      million at September 30, 2008 and $96.3 million at December 31,
      2007.




The
      following table presents the composition of the Company's loan portfolio, in
      accordance with bank regulatory guidelines, at the dates indicated:




September 30, 2008
            
            December 31, 2007(dollars in thousands)
            
            Amount
            
            Percent
            
            Amount
            
            PercentCommercial
            
            $
            123,582
            
            
            28.2
            %
            $
            109,846
            
            
            27.6
            %Real
                estate:Construction
            
            
            101,420
            
            
            23.2
            %
            
            83,766
            
            
            21.0
            %Residential
                1-4 family
            
            
            35,014
            
            
            8.0
            %
            
            32,480
            
            
            8.1
            %Multifamily
            
            
            3,325
            
            
            0.8
            %
            
            6,298
            
            
            1.6
            %Commercial
            
            
            170,954
            
            
            39.0
            %
            
            162,344
            
            
            40.7
            %Installment
                and other consumer
            
            
            3,595
            
            
            0.8
            %
            
            3,785
            
            
            1.0
            %Total
                loans, gross
            
            
            437,890
            
            
            100.0
            %
            
            398,519
            
            
            100.0
            %Deferred
                loan fees
            
            
            (1,206
            )
            
            
            
            
            (1,194
            )Loans,
                net of deferred loan fees
            
            $
            436,684
            
            
            
            
            $
            397,325




*Allowance
      for Credit Losses*




The
      allowance for credit losses represents management's estimate of potential losses
      as of the date of the financial statements. The loan portfolio is regularly
      reviewed to evaluate the adequacy of the allowance for credit losses. In
      determining the level of the allowance, the Company estimates losses inherent
      in
      all loans and commitments to make loans, and evaluates non-performing loans
      to
      determine the amount, if any, necessary for a specific reserve. An important
      element in determining the adequacy of the allowance for credit losses is an
      analysis of loans by loan risk-rating categories. At a loan’s inception and
      periodically throughout the life of the loan, management evaluates the credit
      risk by using a risk-rating system. This grading system currently includes
      eleven levels of risk. Risk ratings range from “1” for the strongest credits to
“10” for the weakest. A “10” rated loan would normally represent a loss. All
      loans rated 7-10 collectively comprise the Company's “Watch List”. The specific
      grades from 7-10 are “watch list” (risk-rating 7), “special mention”
(risk-rating 7.5), “substandard” (risk-rating 8), “doubtful” (risk-rating 9),
      and “loss” (risk-rating 10). When indicators such as operating losses,
      collateral impairment or delinquency problems show that a credit may have
      weakened, the credit will be downgraded as appropriate. Similarly, as borrowers
      bring loans current, show improved cash flows or improve the collateral position
      of a loan, the credits may be upgraded. The result of management’s ongoing
      evaluations and the risk ratings of the portfolio is an allowance with four
      components: specific; general; special; and an amount available for other
      factors.




*Specific
      Allowance* .
      Loans
      on the Bank's Watch List, as described above, are specifically reviewed and
      analyzed. Management considers in its analysis expected future cash flows,
      the
      value of collateral and other factors that may impact the borrower's ability
      to
      pay. When significant conditions or circumstances exist on an individual loan
      indicating greater risk, a specific allowance may be allocated in addition
      to
      the general allowance percentage for that particular risk rating, as outlined
      in
      Statement of Financial Accounting Standards No. 114, “ *Accounting
      by Creditors for Impairment of a Loan.”*




19




*General
      Allowance* .
      All
      loans that do not require a specific allocation are subject to a general
      allocation based upon historic loss factors. Management determines these factors
      by analyzing the volume and mix of the existing loan portfolio, in addition
      to
      other factors. Management also analyzes the following:




·
            the
                volume and severity of non-performing loans and adversely classified
                credits;


·
            the
                level of net charge-offs experienced on previously classified
                loans;


·
            the
                nature and value of collateral securing the loans;
                and


·
            the
                relationship and trend over the past several years of recoveries
                in
                relation to charge-offs.





*Special
      Allowance* .
      Special
      allowances are established to facilitate changes in the Bank’s strategy and
      other factors. Special allocations are to take into consideration various
      factors that include, but are not limited to:




·
            effectiveness
                of credit administration;


·
            adequacy
                of loan review;


·
            the
                adequacy of loan operations personnel and
                processes;


·
            the
                trend in loan growth and the percentage of
                change;


·
            the
                level of geographic and/or industry
                concentration;


·
            the
                effect of competitive issues that impact loan underwriting and
                structure;


·
            the
                impact of economic conditions, including interest rate
                trends;


·
            the
                introduction of new loan products or special marketing
                efforts;


·
            large
                credit exposure and trends; and


·
            commercial
                real estate acquisition and development
                portfolio.





*Amounts
      Available for Other Factors* .
      Management also attempts to ensure that the overall allowance appropriately
      reflects a margin for the imprecision necessarily inherent in estimates of
      expected credit losses. The quarterly analysis of specific, general, and special
      allocations of the allowance is the principal method relied upon by management
      to ensure that changes in estimated credit loss levels are adjusted on a timely
      basis. The inclusion of historical loss factors in the process of determining
      the general component of the allowance also acts as a self-correcting mechanism
      of management's estimation process, as past and more remote loss experience
      is
      replaced by more recent experience. In its analysis of the specific, general,
      and special allocations of the allowance, management also considers regulatory
      guidance in addition to the Company's own experience.




*Liability
      for Unfunded Credit Commitments* .
      Management determines the adequacy of the liability for unfunded credit
      commitments based upon reviews of individual credit facilities, current economic
      conditions, the risk characteristics of the various categories of commitments
      and other relevant factors. The liability is based on estimates, which are
      evaluated on a regular basis, and, as adjustments become necessary, they are
      reported in earnings in periods in which they become known.




Loans
      and
      other extensions of credit deemed uncollectible are charged to the allowance
      for
      loan losses. Subsequent recoveries, if any, are credited to the allowance.
      Draws
      on unfunded commitments that are considered uncollectible at the time funds
      are
      advanced are charged to the allowance for loan losses. Provisions for unfunded
      commitment losses are added to the liability for unfunded commitments, which
      is
      included in other liabilities in the consolidated balance sheets. Actual losses
      may vary from current estimates and the amount of the provision for credit
      losses may be either greater than or less than actual net charge-offs when
      and
      if they occur. The related provision for credit losses that is charged to income
      is the amount necessary to adjust the allowance for credit losses to the level
      determined through the above process.




The
      Company’s non-performing loans at September 30, 2008 related primarily to land
      acquisition and development loans in Oregon and Washington. Collateral values
      for these loans declined significantly in 2008, and a slowdown in home buying
      has reduced the borrowers’ cash flows. Consistent with regulatory guidelines and
      industry trends, the Company has charged-off impairment reserves to the period
      when expected collection of total principal and contractual interest is
      doubtful. In the third quarter of 2008, net charge-offs were $2.3 million,
      compared with a net recovery of $190,000 in the third quarter of 2007.




The
      provision for loan losses was $2.3 million in the third quarter of 2008,
      compared with $725,000 in the same quarter last year. Management's evaluation
      of
      the loan portfolio resulted in a total allowance for credit losses of $14.3
      million at September 30, 2008 and $6.0 million at December 31, 2007. The
      allowance for credit losses, as a percentage of total loans, increased from
      1.50% on December 31, 2007 to 3.27% at September 30, 2008. The allowance for
      credit losses represented 154% of non-performing loans at September 30, 2008
      compared with 50% at September 30, 2007 and 55% at December 31, 2007. Management
      believes the allowance for credit losses at September 30, 2008 is adequate
      to
      absorb current potential or anticipated losses.




20




The
      following table shows the components of the allowance for credit losses for
      the
      periods indicated:




September 30, 2008
            
            December 31, 2007(dollars in thousands)
            
            Amount
            
            Percent
            
            Amount
            
            PercentGeneral
            
            $
            4,845
            
            
            35
            %
            $
            2,733
            
            
            46
            %Specific
            
            
            684
            
            
            5
            %
            
            -
            
            
            -Special
            
            
            8,330
            
            
            60
            %
            
            3,167
            
            
            52
            %Available
                for other factors
            
            
            -
            
            
            -
            
            
            90
            
            
            2
            %Total
                allowance for credit losses
            
            $
            13,859
            
            
            100
            %
            $
            5,990
            
            
            100
            %




The
      allowance for credit losses is based upon estimates of probable losses inherent
      in the loan portfolio and the Company’s commitments to extend credit to
      borrowers. The amount of loss ultimately incurred for these loans can vary
      significantly from the estimated amounts. The following table shows the
      Company’s loan loss performance for the periods indicated.




Three Months Ended
            
            Nine Months EndedSeptember 30,
            
            September 30,(dollars in thousands)
            
            2008
            
            2007
            
            2008
            
            2007Loans
                outstanding at end of period, net of deferred fees
            
            $
            436,684
            
            $
            398,841
            
            $
            436,684
            
            $
            398,841Average
                loans outstanding during the period
            
            
            436,770
            
            
            393,133
            
            
            425,177
            
            
            377,579Allowance
                for credit losses, beginning of period
            
            $
            14,247
            
            $
            5,185
            
            $
            5,990
            
            $
            4,825Loans
                charged off:Commercial
            
            
            1,144
            
            
            23
            
            
            2,156
            
            
            73Real
                estate
            
            
            1,155
            
            
            -
            
            
            5,472
            
            
            -Consumer
                and other
            
            
            15
            
            
            9
            
            
            51
            
            
            46Total
                loans charged-off
            
            
            2,314
            
            
            32
            
            
            7,679
            
            
            119Recoveries:Commercial
            
            
            9
            
            
            213
            
            
            11
            
            
            319Real
                estate
            
            
            23
            
            
            1
            
            
            27
            
            
            3Consumer
                and other
            
            
            3
            
            
            8
            
            
            24
            
            
            72Total
                recoveries
            
            
            35
            
            
            222
            
            
            62
            
            
            394Net
                loans charged off (recovered) during the period
            
            
            2,279
            
            
            (190
            )
            
            7,617
            
            
            (275
            )Provision
                for credit losses
            
            
            2,300
            
            
            725
            
            
            15,895
            
            
            1,000Allowance
                for credit losses, end of period
            
            $
            14,268
            
            $
            6,100
            
            $
            14,268
            
            $
            6,100ComponentsAllowance
                for loan losses
            
            $
            13,859
            
            $
            5,828
            
            $
            13,859
            
            $
            5,828Liability
                for unfunded credit commitments
            
            
            409
            
            
            272
            
            
            409
            
            
            272Total
                allowance for credit losses
            
            $
            14,268
            
            $
            6,100
            
            $
            14,268
            
            $
            6,100Ratio
                of net loans charged off (recovered) to average loans outstanding
                (annualized)
            
            
            2.09
            %
            
            -0.19
            %
            
            2.39
            %
            
            -0.15
            %Allowance
                for loan losses/total loans
            
            
            3.17
            %
            
            1.46
            %
            
            3.17
            %
            
            1.46
            %Allowance
                for credit losses/total loans
            
            
            3.27
            %
            
            1.53
            %
            
            3.27
            %
            
            1.53
            %Allowance
                for loan loss/non-performing loans
            
            
            149
            %
            
            48
            %
            
            149
            %
            
            48
            %Allowance
                for credit losses/non-performing loans
            
            
            154
            %
            
            50
            %
            
            154
            %
            
            50
            %




*Impaired
      Loans*




The
      Company, during its normal loan review procedures, considers a loan to be
      impaired when it is probable that the Bank will be unable to collect all amounts
      due according to the contractual terms of the loan agreement. A loan is not
      considered to be impaired during a period of minimal delay (less than 90 days)
      unless available information strongly suggests impairment. The Bank 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. Impaired loans are charged to the allowance
      when management believes that, after considering economic and business
      conditions, collection efforts, and collateral position, the borrower's
      financial condition indicates that collection of principal is not
      probable.




21




Generally,
      no interest is accrued on loans when factors indicate collection of interest
      is
      doubtful or when principal or interest payments become 90 days past due, unless
      collection of principal and interest are anticipated within a reasonable period
      of time and the loans are well secured. For such loans, previously accrued
      but
      uncollected interest is charged against current earnings, and income is only
      recognized to the extent payments are subsequently received and collection
      of
      the remaining recorded principal balance is considered probable.




At
      September 30, 2008 the Company’s recorded investment in impaired loans was $17.6
      million compared with $10.8 million at December 31, 2007. For these loans,
      there
      were specific reserves at September 30, 2008 totaling $684,500 and no specific
      reserves at December 31, 2007.




*Non-Performing
      Assets*




Non-performing
      assets include repossessed real estate or other assets and loans for which
      the
      accrual of interest has been suspended. The following table presents information
      on the Company’s non-performing assets and loans past due greater than 90 days
      and still accruing at the dates indicated:




September 30,
            
            December 31,(dollars in thousands)
            
            2008
            
            2007Loans
                on non-accrual status
            
            $
            9,286
            
            $
            10,827Other
                real estate owned
            
            
            2,425
            
            
            2,240Other
                repossessed assets
            
            
            100
            
            
            10Total
                non-performing assets
            
            $
            11,811
            
            $
            13,077Total
                assets
            
            $
            565,335
            
            $
            514,180Percentage
                of non-performing assets to total assets
            
            
            2.09
            %
            
            2.54
            %Percentage
                of non-accrual loans to total loans
            
            
            2.13
            %
            
            2.72
            %Loans
                past due greater than 90 days and accruing
            
            $
            3,733
            
            $
            149




Total
      nonperforming assets at September 30, 2008 were $11.8 million, down from $13.1
      million at December 31, 2007. As a percentage of total assets, non-performing
      assets were 2.09% at September 20, 2008 compared with 2.54% at December 31,
      2007.




Non-accrual
      loans at September 30, 2008 totaled $9.3 million. Almost all of the Company’s
      non-accrual loan portfolio related to land acquisition and development loans
      in
      Oregon and Washington. During the third quarter of 2008, non-accrual loans
      were
      reduced by pay-offs of $3.0 million and charge-offs of $1.0 million. Loans
      placed on non-accrual during the quarter totaled $4.6 million. Of the loans
      placed on non-accrual in the third quarter, $3.4 million were real estate
      construction and development related.




Other
      real estate owned (OREO) totaled $2.4 million at September 30, 2008, compared
      with $2.2 million at December 31, 2007. OREO properties at September 30, 2008
      consisted primarily of one residential real estate development project and
      one
      parcel of land in the Portland, Oregon area. In the third quarter of 2008,
      one
      real estate development property was sold for $1.4 million resulting in a loss
      of $120,000.




*Liquidity*




Liquidity
      represents the ability to meet deposit withdrawals and fund loan demand, while
      retaining the flexibility to take advantage of business opportunities. Daily
      and
      short-term liquidity needs are principally met with deposits from customers,
      payments on loans, maturities and paydowns of investment securities, and
      wholesale borrowings, including brokered CDs, federal funds purchased, and
      depending on the availability of collateral, borrowings from the Federal Reserve
      and FHLB.




Secondary
      sources of liquidity include sale of investment securities which are not held
      for pledging purposes and other classes of assets. Securities classified as
      available for sale which are not pledged may be sold in response to changes
      in
      interest rates or liquidity needs. Investments in securities available for
      sale
      were $40.8 million at September 30, 2008.




Longer
      term funding needs can be met through a variety of wholesale sources that have
      a
      broader range of maturities than customer deposits and add flexibility in
      liquidity planning and management. These wholesale sources include advances
      from
      the FHLB with longer maturities, brokered CDs and investments that qualify
      as
      regulatory capital, including trust preferred securities and subordinated debt.
      In addition, the Company may also issue equity capital to address liquidity
      or
      capital needs.




22




The
      following table presents the composition of the Company’s deposit liabilities on
      the dates indicated:




September 30,
            
            December 31,(dollars in thousands)
            
            2008
            
            2007Non-interest-bearing
                demand deposits
            
            $
            82,096
            
            $
            91,662Savings
            
            
            17,263
            
            
            17,687Interest-bearing
                demand deposits
            
            
            14,505
            
            
            18,105Money
                market accounts
            
            
            75,574
            
            
            86,658Certificates
                of deposit under $100,000
            
            
            77,963
            
            
            66,137Certificates
                of deposit over $100,000
            
            
            233,957
            
            
            160,930Total
            
            $
            501,358
            
            $
            441,179




Total
      deposits increased $60.2 million in the first nine months of 2008, or 13.6%,
      over total deposits at December 31, 2007. At September 30, 2008, the Bank’s
      brokered deposits totaled $209.7 million, compared with $121.4 million at
      December 31, 2007. The Company’s loan growth in 2008 and 2007 exceeded its core
      deposit generation, and the Company has supplemented its core deposits with
      brokered certificates of deposits and brokered money market deposits. The
      Company’s brokered deposits have maturities ranging from 90 days to five years.
      At September 30, 2008, approximately 82% of the Company’s brokered CDs have
      original maturities of one year or more. The Company’s brokered money market
      deposits are provided to the Bank under long-term contracts, providing a
      relatively stable source of funds.




The
      Company has an agreement with Promontory Interfinancial Network that makes
      it
      possible to offer FDIC insured deposits in excess of the current deposit limits.
      The CDARS network uses a deposit-matching program to match CDARS deposits in
      other participating banks, dollar for dollar. This product is designed to
      enhance our ability to attract and retain customers and increase deposits,
      by
      providing additional FDIC coverage to customers. CDARS deposits can be
      reciprocal or one-way, and due to the nature of the placement of funds, CDARS
      deposits are defined as “brokered deposits” by regulatory agencies. With media
      focus on the financial sector and customer concern with FDIC insurance limits
      over the past quarter, customer interest in and demand for CDARS deposits has
      increased. The Company’s CDARS deposits totaled $13.0 million at September 30,
      2008. CDARS deposits might decline due to the recent increase in FDIC insurance
      limits.




The
      Bank
      has overnight federal funds borrowing lines with correspondent banks that
      provide access to an additional $25.0 million for short-term liquidity needs.
      The Bank has an established borrowing line with the Federal Home Loan Bank
      (the
“FHLB”). The borrowing line with the FHLB permits it to borrow up to 20% of the
      Bank's assets, subject to collateral limitations. With the collateral available
      on September 30, 2008, the Company believes the Bank could borrow approximately
      $110.0 million. FHLB borrowings in excess of $26.4 million would require the
      Company to purchase additional FHLB stock. At September 30, 2008, the Company
      had only minor amounts of borrowings from the FHLB. The Bank also has access
      to
      additional liquidity through the Federal Reserve’s primary credit
      program.




*Capital
      Resources*




Capital
      Ratios




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




As
      of
      September 30, 2008, the Company had one wholly owned Delaware statutory business
      trust subsidiary, Cowlitz Statutory Trust I (the Trust), which issued
      $12,000,000 of guaranteed undivided beneficial interests in the Company’s Junior
      Subordinated Deferrable Interest Debentures (Trust Preferred Securities). The
      proceeds from the issuance of the common securities and the Trust Preferred
      Securities were used by the Trust to purchase $12,372,000 of junior subordinated
      debentures of the Company. These debentures qualify as Tier 1 capital under
      Federal Reserve Board guidelines. Federal Reserve guidelines limit inclusion
      of
      trust-preferred securities and certain other preferred capital elements to
      25%
      of total core capital elements (as defined). As of September 30, 2008, trust
      preferred securities accounted for 22% of total core capital elements. There
      can
      be no assurance that the Federal Reserve Board will not further limit the amount
      of trust preferred securities permitted to be included in Tier 1 capital for
      regulatory capital purposes.




23




The
      following table presents selected capital information for the Company and the
      Bank as of September 30, 2008 and December 31, 2007:




To Be Well-CapitalizedUnder PromptFor Capital Adequacy
            
            Corrective ActionActual
            
            Purposes
            
            Provisions(dollars in thousands)
            
            Amount
            
            Ratio
            
            Amount
            
            Ratio
            
            Amount
            
            Ratio**September
                30, 2008**Total
                risk-based capital:Consolidated
            
            $
            57,638
            
            
            11.63
            %
            $
            39,660
            
            
            >8.00
            %
            
            N/A
            
            
            N/ABank
            
            $
            55,246
            
            
            11.17
            %
            $
            42,784
            
            
            >8.00
            %
            $
            49,472
            
            
            >10.00
            %Tier
                1 risk-based capital:Consolidated
            
            $
            51,342
            
            
            10.36
            %
            $
            19,830
            
            
            >4.00
            %
            
            N/A
            
            
            N/ABank
            
            $
            48,962
            
            
            9.90
            %
            $
            19,789
            
            
            >4.00
            %
            $
            29,683
            
            
            >6.00
            %Tier
                1 (leverage) capital:Consolidated
            
            $
            51,342
            
            
            9.60
            %
            $
            21,392
            
            
            >4.00
            %
            
            N/A
            
            
            N/ABank
            
            $
            48,962
            
            
            9.14
            %
            $
            21,423
            
            
            >4.00
            %
            $
            26,779
            
            
            >5.00
            %**December
                31, 2007**Total
                risk-based capital:Consolidated
            
            $
            69,095
            
            
            14.82
            %
            $
            37,310
            
            
            >8.00
            %
            
            N/A
            
            
            N/ABank
            
            $
            65,421
            
            
            14.06
            %
            $
            37,220
            
            
            >8.00
            %
            $
            46,525
            
            
            >10.00
            %Tier
                1 risk-based capital:Consolidated
            
            $
            63,260
            
            
            13.56
            %
            $
            18,655
            
            
            >4.00
            %
            
            N/A
            
            
            N/ABank
            
            $
            59,603
            
            
            12.81
            %
            $
            18,610
            
            
            >4.00
            %
            $
            27,915
            
            
            >6.00
            %Tier
                1 (leverage) capital:Consolidated
            
            $
            63,260
            
            
            12.51
            %
            $
            20,233
            
            
            >4.00
            %
            
            N/A
            
            
            N/ABank
            
            $
            59,603
            
            
            11.78
            %
            $
            20,236
            
            
            >4.00
            %
            $
            25,296
            
            
            >5.00
            %




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
      tables above) of Tier 1 capital to average assets, and Tier 1 and total
      risk-based capital to risk-weighted assets (all as defined in the regulations).
      As of September 30, 2008 and December 31, 2007, the Company and the Bank
      exceeded all relevant capital adequacy requirements.




Stock
      Repurchase Program




In
      September, 2007, the Company announced a stock repurchase program for up to
      500,000 shares. The Company intends to use existing funds to finance the
      repurchases. When evaluating timing and amount of common stock repurchases,
      management considers a number of factors including, but not limited to,
      projected earnings generation, risk weighted asset growth, capital ratios
      relative to regulatory capital guidelines, availability and cost of other
      capital resources and the market valuation of its stock price. As of September
      30, 2008, the Company has not repurchased any of its shares of common
      stock.




**Item
      3. Quantitative and Qualitative Disclosures about Market
      Risk**




*Credit
      Risk*




The
      Bank,
      like other lenders, is subject to credit risk, which is the risk of losing
      principal and interest due to customers' failure to repay loans in accordance
      with their terms. The Bank relies on loan reviews, prudent loan underwriting
      standards and an adequate allowance for credit losses to help mitigate credit
      risk. However, a downturn in economic conditions or in the real estate market,
      or a rapid increase in interest rates could have a negative effect on collateral
      values, cash flows, and borrowers' ability to repay. The Bank's targeted
      customers are small to medium-size businesses, professionals and retail
      customers that may have limited capital resources to repay loans during a
      prolonged economic downturn.




24




*Interest
      Rate Risk*




The
      Bank’s earnings are largely derived from net interest income, which is interest
      income and fees earned on loans and investment income, less interest expense
      paid on deposits and other borrowings. Interest rates are highly sensitive
      to
      many factors that are beyond the control of the Bank’s management, including
      general economic conditions, and the policies of various governmental and
      regulatory authorities. As interest rates change, net interest income is
      affected. With fixed rate assets (such as fixed rate loans) and liabilities
      (such as certificates of deposit), the effect on net interest income is
      dependent upon on the maturities of the assets and liabilities. The Bank’s
      primary objective in managing interest rate risk is to minimize the adverse
      impact of changes in interest rates on the Bank’s net interest income and
      capital, while structuring the Bank’s asset/liability position to obtain the
      maximum yield-cost spread on that structure. Such structuring includes the
      use
      of interest rate derivative contracts. Interest rate risk is managed through
      the
      monitoring of the Bank’s gap position and sensitivity to interest rate risk by
      subjecting the Bank’s balance sheet to hypothetical interest rate shocks using a
      computer based model. In a falling rate environment, the spread between interest
      yields earned and interest rates paid may narrow, depending on the relative
      level of fixed and variable rate assets and liabilities. In a stable or
      increasing rate environment the Bank’s variable rate loans will remain steady or
      increase immediately with changes in interest rates, while fixed rate
      liabilities, particularly certificates of deposit, will only re-price as the
      liability matures.




For
      a
      complete description of the Company’s disclosures about market risk, see
“Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A
      of the Annual Report on Form 10-K for the year ended December 31,
      2007.




**Item
      4T. Controls and Procedures**




As
      of the
      end of the period covered by this report, the Company carried out evaluations,
      under the supervision and with the participation of management, including the
      Chief Executive Officer and Chief Financial Officer, of the effectiveness of
      the
      design and operation of disclosure controls and procedures pursuant to Rule
      13a-15(b) of the Securities Exchange Act of 1934. Based upon that evaluation,
      management, including the Chief Executive Officer and Chief Financial Officer,
      concluded that the existing disclosure controls and procedures are effective
      in
      timely alerting them to material information relating to the Company that is
      required to be included in its periodic SEC filings.




There
      have been no changes in our internal controls or in other factors that have
      materially affected or are likely to materially affect our internal controls
      over financial reporting subsequent to the date of the evaluation.




**Part
      II. OTHER INFORMATION**




**Item
      1.**  **Legal
      Proceedings**




The
      Company from time to time enters into routine litigation resulting from the
      collection of secured and unsecured indebtedness as part of its business of
      providing financial services. In some cases, such litigation will involve
      counterclaims or other claims against the Company. Such proceedings against
      financial institutions sometimes also involve claims for punitive damages in
      addition to other specific relief. The Company is not a party to any litigation
      other than in the ordinary course of business. In the opinion of management,
      the
      ultimate outcome of all pending legal proceedings will not individually or
      in
      the aggregate have a material adverse effect on the financial condition or
      the
      results of operations of the Company.




**Item
      1A. Risk Factors**




Except
      as
      noted below, there were no material changes to the risk factors set forth in
      the
      Company’s Form 10-K for the year ended December 31, 2007.




*We
      cannot predict the effect of the national economic situation on our future
      results of operations or stock trading price.*




The
      national economy, and the financial services sector in particular, is currently
      facing challenges of a scope unprecedented in recent history. No one can predict
      the severity or duration of this downturn. We cannot predict whether, or the
      extent to which, the more severe regional and local economic downturns that
      have
      affected other areas of the country may also occur to the same degree in the
      markets we serve. Any such further deterioration in our markets could have
      an
      adverse effect on our business, financial condition, results of operations
      and
      prospects, as discussed in the Company’s risk factors, and could also cause the
      trading price of our stock to decline. The Bank’s ability to assess the
      creditworthiness of its customers may be affected if the models and approaches
      the Bank uses to underwrite its loans become less accurate and less predictive
      of future performance. The process the Bank uses to estimate losses inherent
      in
      the loan portfolio could also become affected due to inaccurate economic
      forecasts.




25




*There
      can be no assurance that recently enacted legislation authorizing the U.S.
      government to inject capital into financial institutions and purchase assets
      from financial institutions will help stabilize the U.S. financial
      system.*




On
      October 3, 2008, President Bush signed into law the Emergency Economic
      Stabilization Act of 2008 (the “EESA”). The legislation was the result of a
      proposal by Treasury Secretary Henry Paulson to the U.S. Congress on September
      20, 2008 in response to the financial crises affecting the banking system and
      financial markets and going concern threats to investment banks and other
      financial institutions. Pursuant to the EESA, the U.S. Treasury will have the
      authority to, among other things, invest in preferred stock of financial
      institutions and purchase mortgages and mortgage-backed securities and certain
      other financial instruments from financial institutions for the purpose of
      stabilizing and providing liquidity to the U.S. financial markets. There can
      be
      no assurance, however, as to the actual impact that the EESA will have on the
      financial markets, including the extreme levels of volatility and limited credit
      availability currently being experienced. The failure of the EESA to help
      stabilize the financial markets and a continuation or worsening of current
      financial market conditions could materially and adversely affect our business,
      financial condition, results of operations, access to credit or the trading
      price of our common stock. In connection with these recent events, the Bank
      may
      face the risks of increased regulation causing increased costs and limits on
      business opportunities; higher FDIC insurance premiums; downward pressure on
      the
      Company’s stock price; the inability to engage in routine funding transactions
      due to the soundness of other financial institutions and government sponsored
      entities; and increased competition due to intensified consolidation of the
      industry.




*Conditions
      in the financial markets may limit our access to additional funding to meet
      our
      liquidity needs.*




Liquidity
      is essential to our business. The Bank must maintain sufficient funds to respond
      to the needs of depositors and borrowers. An inability to raise funds through
      deposits, borrowings, the sale or pledging as collateral of loans and other
      assets could have a substantial negative effect on our liquidity. Our access
      to
      funding sources in amounts adequate to finance our activities could be impaired
      by factors that affect us specifically or the financial services industry in
      general. Factors that could detrimentally impact our access to liquidity sources
      include a decrease in the level of our business activity due to a market down
      turn or regulatory action that limits or eliminates our access to alternate
      national funding sources. Our ability to borrow could also be impaired by
      factors that are nonspecific to us, such as severe disruption of the financial
      markets or negative expectations about the prospects for the financial services
      industry as a whole as evidenced by recent turmoil in the domestic and worldwide
      credit markets. As a part of its liquidity management, the Bank uses brokered
      deposits in addition to core deposit growth and repayments and maturities of
      loans and investments. As the Bank continues to grow, it is likely to become
      more dependent on these sources. The Company’s financial flexibility will be
      severely constrained if the Bank is unable to maintain access to funding or
      if
      adequate financing is not available to accommodate future growth at acceptable
      interest rates. If the Bank is required to rely more heavily on more expensive
      funding sources to support future growth, revenues may not increase
      proportionately to cover costs, and profitability would be adversely
      affected.




*We
      may need to raise additional capital which may not be available or may adversely
      affect existing shareholders.*




The
      Company may need to raise additional capital in the future through financings
      to
      maintain desired levels of capital ratios, to improve its financial condition,
      or to increase liquidity available for operations. Any equity or debt financing,
      if available at all, may not be available on terms that are favorable to the
      Company. In the case of equity financings, dilution to the Company’s
      shareholders could result and, in any case, securities may have rights,
      preferences and privileges that are senior to those of the Company’s current
      shareholders. Debt financing could also negatively affect future earnings due
      to
      interest charges. In the event additional capital is projected to be or becomes
      needed and is unavailable on acceptable terms through available financing
      sources, we may need to take steps to preserve capital, including possibly
      slowing our lending activities and new loan commitments, selling certain
      profitable assets, or increasing loan participations.




*If
      the Bank is unable to pay cash dividends to the holding company to meet its
      cash
      obligations, the Company’s business, financial condition, results of operations
      and prospects will be adversely affected.*




Dividends
      paid by the Bank to the Company provide cash flow used to service interest
      payments on trust preferred securities. Various statutory provisions restrict
      the amount of dividends the Bank can pay to the Company without regulatory
      approval. It is possible that depending upon the financial condition of the
      Bank
      and other factors, the applicable regulatory authorities could assert that
      payment of dividends or other payments, including payments to the Company,
      is an
      unsafe or unsound practice. If the Bank is unable to pay dividends to the
      Company, the Company may not be able to service its debt or pay its obligations.
      The inability to receive dividends from the Bank would adversely affect the
      business, financial condition, results of operations and prospects.




*A
      significant decline in the Company’s market value could result in an impairment
      of goodwill.*




Recently,
      the Company’s common stock has been trading at a price below its book value,
      including goodwill. As a result we evaluated goodwill for impairment during
      the
      third quarter of 2008, but no impairment was identified. Our assessment of
      the
      fair value of goodwill is based on an evaluation of recent bank acquisition
      transactions, discounted cash flows from forecasted earnings and our current
      market capitalization. Our evaluation of the fair value of goodwill involves
      a
      substantial amount of judgment. If impairment of goodwill was deemed to exist,
      we would be required to write down our assets resulting in a charge to earnings.
      A write-down of goodwill due to impairment would adversely impact our results
      of
      operations and financial condition; however, it would have no impact on our
      regulatory capital.




26




*The
      value of certain securities in our investment securities portfolio may be
      negatively affected by disruptions in the market for these
      securities.*




The
      market for certain investment securities held within our investment portfolio
      has over the past year become more volatile. The volatile market may affect
      the
      value of these securities, such as through reduced valuations due to the
      perception of heightened credit and liquidity risks, in addition to interest
      rate risk typically associated with these securities. There can be no assurance
      that the declines in market value associated with these disruptions will not
      result in impairments of these assets, which would lead to accounting charges
      that could have a material adverse effect on the Company’s net income, equity
      and capital ratios.




*Market
      and other constraints on our construction loan origination volumes are expected
      to lead to decreases in the Company’s interest and fee income that are not
      expected to be offset by reductions in our non-interest
      expenses.*




Due
      to
      existing conditions in housing markets in the areas where we operate and other
      factors, management projects our construction loan originations to be materially
      constrained for the remainder of 2008 and 2009. This will lower interest income
      and fees generated from this part of our business. Unless this revenue decline
      is offset by other areas of our operations, our total revenues may decline
      relative to our total non-interest expenses. Management expects that it will
      be
      difficult to find new revenue sources in the near term to completely offset
      expected declines in our interest income.




*The
      FDIC has increased insurance premiums to rebuild and maintain the federal
      deposit insurance fund.*




Based
      on
      recent events and the state of the economy, the FDIC has increased federal
      deposit insurance premiums beginning in the first quarter of 2009 to double
      what
      we originally paid. The increase of these premiums will add to our cost of
      operations and could have a significant impact on the Company. Further,
      depending upon any future losses that the FDIC insurance fund may suffer, there
      can be no assurance that there will not be additional premium increases in
      order
      to replenish the fund




**Item
      2.**  **Unregistered
      Sales of Equity Securities and Use of Proceeds**




Not
      applicable




**Item
      3.**  **Defaults
      upon Senior Securities**




Not
      applicable




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




Not
      applicable




**Item
      5.**  **Other
      Information**




None




**Item
      6.**  **Exhibits**




(a)  Exhibits.
      The following constitutes the exhibit index.




3.1
            Restated
                Articles of Incorporation (incorporated by reference to Exhibit 3.1
                to the
                Company’s Registration Statement on Form S-1 filed January 15, 1998; File
                No. 333-44355/Film No. 98507908)3.2
            Amended
                and Restated Bylaws (incorporated by reference to Exhibit 3(ii) to
                the
                Company’s Form 8-K filed October 29, 2007; File No. 000-23881/Film No.
                071196564)31.1
            Certification
                of Chief Executive Officer31.2
            Certification
                of Chief Financial Officer32
            Certification
                of Chief Executive Officer and Chief Financial
                Officer




27




SIGNATURES





Pursuant
      to the requirements of the Securities and Exchange Act of 1934, the registrant
      has duly caused this report to be signed on its behalf by the undersigned
      thereunto duly authorized.




Date:
      November 14, 2008




Cowlitz
                Bancorporation
              (Registrant)
              By:/s/ Richard J. FitzpatrickRichard J. Fitzpatrick, President and Chief Executive Officer/s/ Gerald L. BrickeyGerald
                L. Brickey, Vice-President and Chief Financial Officer




28