**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-K**

 

| **ý****  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-----------------------------------------------------------------------------------------------------------------|

 

**For the Fiscal Year ended December 31, 2001**

 

| **o****  TRANSITION REPORT UNDER SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---------------------------------------------------------------------------------------------------------|

 

**For the Transition period from                  to                 **

 

**Commission File Number 0 - 24024**

 

**FIRST COMMUNITY FINANCIAL GROUP, INC.**

(Exactname of registrant as specified in its charter)

 

| **Washington**                                                  |   | **91-1277503**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |   | (IRS  Employer Identification Number) |
|                                                            |   |                                  |
| **Principal Executive Offices**                                 |
| 721 College St. S.E., P.O. Box 3800, Lacey, WA  98509      |
|                                                            |
| **(360) 459-1100**                                              |
| Registrant’s telephone number, including area code         |

 

Securities registered pursuant to Section 12(b) of the Act:

**NONE**

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value

 

Indicate by check whetherthe registrant (1) has filed all reports required by Section 13 or 5(d) of theSecurities Exchange Act of 1934 during the preceding 12 months and (2) has beensubject to such filing requirements for the past 90 days. Yes   ý   No  o

 

Indicate by check mark ifdisclosure of delinquent filers in response to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this form 10-K o

 

Indicate the number ofshares outstanding of the issuer’s class of common stock as of the latestpracticable date.

Aggregate market value of the voting stockheld

by non-affiliates of the registrant at, February 28, 2002

$44,761,360

2,186,681 shares of no par value Common Stock outstanding as ofFebruary 28, 2002

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxystatement (the “Proxy Statement”) for use in connection with the Annual Meetingof Shareholders to be held on May 2, 2002, are incorporated by reference intoPart III of this Annual Report on Form 10-K.

** **

** **

**First Community Financial Group, Inc.**

FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2001

INDEX

 
| **PART I**                                          |
|-----------------------------------------------------|
| ITEM  1.                                            | BUSINESS |
| •    General                         |   |
| •   Competition                      |   |
| •    Employees                       |   |
| •   Supervision and Regulation       |   |
|                                                |   |
| ITEM 2.                                        | PROPERTIES |
|                                                |   |
| ITEM 3.                                             | LEGAL PROCEEDINGS |
|                                                |   |
| ITEM 4.                                             | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS |
|                                                |   |
| **PART II**                                         |
|                                                |   |
| ITEM 5.                                             | MARKET FOR REGISTRANT’S COMMON EQUITY AND  RELATED STOCKHOLDER MATTERS |
|                                                |   |
| ITEM 6.                                             | SELECTED FINANCIAL DATA |
| ITEM 7.                                             | MANAGEMENTS DISCUSSION & ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|                                                |   |
| •   Forward-Looking  Information     |   |
| •   Performance Overview             |   |
| •   Results of Operation             |   |
| •   Financial Condition              |   |
|                                                |   |
| ITEM 7A.                                            |  QUANTITATIVE AND QUALITATIVE DISCLOSURERS ABOUT MARKET RISK |
|                                                |   |
| ITEM 8.                                             | FINANCIAL STATEMENTS AND SUPPLEMENTRARY  DATA |
| •   Reports of Independent  Auditors |   |
| •   Financial  Statements            |   |
| •    Notes to Financial Statements   |   |
|                                                |   |
| ITEM 9.                                             | CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
|                                                |   |
| **PART III**                                        |
|                                                |   |
| ITEM 10.                                       | DIRECTORS AND EXECUTIVE OFFICER; COMPLIANCE  WITH SECTION 16(a) OF THE EXCHANGE ACT |
|                                                |   |
| ITEM 11.                                            | EXECUTIVE COMPENSATION |
|                                                |   |
| ITEM 12.                                       | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL  OWNERS AND MANAGEMENT |
|                                                |   |
| ITEM 13.                                       | CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS |
|                                                |   |
| **PART IV**                                         |
|                                                |   |
| ITEM 14.                                            |  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K |
| •   Signatures                       |
| •   Exhibit Index                    |
|                                                     |  |  |  |

 

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**PART I**

 

**ITEM 1 - BUSINESS**

 

**General**

 

First Community FinancialGroup, Inc. (“FCFG” or “the Company”) was incorporated under the laws of theState of Washington in November 1983 as First Community Bancorp, Inc. and is abank holding company.  The company’sname was changed to First Community Financial Group, Inc. in July 1992.  In 1984, pursuant to a plan ofreorganization, FCFG acquired all of the stock of First Community Bank ofWashington (“FCB” or “Bank”), a state banking corporation chartered under thelaws of the State of Washington in 1979. The principal offices of FCFG and FCB are located in Lacey, Washington.

 

The Company expanded solelythrough internal growth until 1993 when it began a series of acquisitions tomore rapidly expand its market area and to achieve greater economies of scale.

 

| **Acquisition**                  |   | **Year  Completed** |   |
|----------------------------------|--------|---------------------|--------|
| Citizens First Bank              |   | 1993                |   |
| Northwest Community Bank         |   | 1995                |   |
| Prairie Security Bank            |   | 1997                |   |
| Wells Fargo Bank - Four Branches |   | 1997                |   |

 

In February 1999, a mortgagelending office was opened in Puyallup, which was expanded to a full servicebranch later that year.  In March 2000,a branch office was opened in the Hawks Prairie area of Lacey, and in January2001, a branch office was opened on the west side of Olympia to serve tworapidly growing areas of Thurston County.  Also in early 2001, offices were opened in downtown Tacoma and in theSouth Hill area of Puyallup.

 

The Bank engages in generalbanking business through nineteen offices in Thurston, Grays Harbor, Lewis andPierce Counties.  A primary focus of theBank is on business and commercial real estate lending and is a market leaderin Thurston County.  The Bank provides afull range of banking services including savings accounts, checking accounts, installment,mortgage and commercial lending, safety deposit facilities, time deposits, andother consumer and business-related financial services including the sale ofnon-deposit investment products.

 

FCB Financial Services, a wholly ownedsubsidiary of First Community Bank provides a broad range of investmentservices including retirement and estate planning, annuities, stocks, bonds,mutual funds and profit sharing plans.

 

In November 2000 and April2001, the Bank entered into Marketing and Servicing Agreements with AdvanceAmerica.  Advance America is a Delawarecompany formed in 1997 and is comprised of a group of “parent-subsidiary”companies whose function is to develop, own, acquire and manage cash advancecenters throughout the United States. Under these agreements, the Bank offers short-term consumer loans(commonly known as “payday loans”) to customers in the states of Alabama andArkansas.  Advance America acts as theBank’s agent in marketing and collecting these loans.  The agreements have terms of three years, and may be terminatedwithout cause upon six months notice, and are immediately terminable in theevent that any bank regulatory agency with jurisdiction over the Bank or theCompany determines that the Bank’s performance of the agreements is unlawful oris an unsafe or unsound practice. Financial highlights on this segment of the Company is found in *Note 20-Business Segment Information,* inthe Company’s consolidated financial statements.  The federal bank regulators’ perspective on payday lending isgenerally described below in the section titled, “Bank Supervision andRegulation-Safety and Soundness Standards.”

 

**Competition**

 

The financial servicesindustry is highly competitive.  TheBank competes actively with national and state banks, mutual savings banks,savings and loan associations, finance companies, credit unions, brokeragehouses and other financial institutions operating in the service area.  Many of these financial institutions havemerged or are in process of merging and many have greater resources than theBank.

 

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**Employees**

 

FCFGand its subsidiaries employed a total of 217 employees, consisting of 170 fulltime and 47 part time employees at December 31, 2001.  Such employees are not represented by a union organization orother collective bargaining group, and management considers their relationswith their employees to be very good.

 

**BANK SUPERVISION AND REGULATION**

 

*General*

 

FCFG is extensively regulated under federaland state law. These laws and regulations are primarily intended to protectdepositors, not shareholders. The discussion below describes and summarizescertain statutes and regulations. These descriptions and summaries arequalified in their entirety by reference to the particular statute orregulation. Changes in applicable laws or regulations may have a materialeffect on FCFG business and prospects. The Company’s operations may also beaffected by changes in the policies of banking and other government regulators.FCFG cannot accurately predict the nature or extent of the possible futureeffects on the Company’s business and earnings of changes in fiscal or monetarypolicies, or new federal or state laws and regulations.

 

*Significant Changes In Banking Laws And Regulations*

 

USA PatriotAct of 2001. On October 26, 2001, President Bush signed the Uniting and StrengtheningAmerica by Providing Appropriate Tools Required to Intercept and ObstructTerrorism (“USA Patriot Act”) of 2001. Among other things, the USA Patriot Act (1) prohibits banks fromproviding correspondent accounts directly to foreign shell banks;  (2) imposes due diligence requirements onbanks opening or holding accounts for foreign financial institutions or wealthyforeign individuals (3) requires financial institutions to establish ananti-money-laundering compliance program, and (4) eliminates civil liabilityfor persons who file suspicious activity reports.  The Act also increases governmental powers to generallyinvestigate terrorism, including expanded government access to accountrecords.  The Department of the Treasuryis empowered to administer and make rules to implement the Act.  While the Company believes the USA PatriotAct may, to some degree, affect it’s record-keeping and reporting expenses, itdoes not believe that the Act will have a material adverse effect on it’sbusiness and operations.

 

*FederalBank Holding Company Regulation*

 

General. The Company isa bank holding company as defined in the Bank Holding Company Act of 1956, asamended, and is therefore subject to regulation, supervision and examination bythe Federal Reserve. In general, the Bank Holding Company Act limits thebusiness of bank holding companies to owning or controlling banks and engagingin other activities closely related to banking. The Company must file reportswith the Federal Reserve and must provide it with such additional informationas it may require.  Under theFinancial Services Modernization Act of 1999, a bank holding company may applyto the Federal Reserve to become a financial holding company, and therebyengage (directly or through a subsidiary) in certain activities deemedfinancial in nature, such as securities brokerage and insurance underwriting.

 

Holding Company BankOwnership. The BankHolding Company Act requires every bank holding company to obtain the priorapproval of the Federal Reserve before (1) acquiring, directly or indirectly,ownership or control of any voting shares of another bank or bank holdingcompany if, after such acquisition, it would own or control more than 5% ofsuch shares, (2) acquiring all or substantially all of the assets of anotherbank or bank holding company, or (3) merging or consolidating with another bankholding company.

 

Holding Company Control ofNon-banks. With someexceptions, the Bank Holding Company Act also prohibits a bank holding companyfrom acquiring or retaining direct or indirect ownership or control of morethan 5% of the voting shares of any company which is not a bank or bank holdingcompany, or from engaging directly or indirectly in activities other than thoseof banking, managing or controlling banks, or providing services for itssubsidiaries. The principal exceptions to these prohibitions involve certainnon-bank activities which, by statute or by Federal Reserve regulation ororder, have been identified as activities closely related to the business ofbanking or of managing or controlling banks.

 

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Transactions with Affiliates. Subsidiary banks of a bank holding companyare subject to restrictions imposed by the Federal Reserve Act on extensions ofcredit to the holding company or its subsidiaries, on investments in theirsecurities and on the use of their securities as collateral for loans to anyborrower. These regulations and restrictions may limit the Company’s ability toobtain funds from the Bank for its cash needs, including funds for payment ofdividends, interest and operational expenses.

 

Tying Arrangements. We are prohibited from engaging in certaintie-in arrangements in connection with any extension of credit, sale or leaseof property or furnishing of services. For example, with certain exceptions,neither the Company nor its subsidiaries may condition an extension of creditto a customer on either (1) a requirement that the customer obtain additionalservices provided by us or (2) an agreement by the customer to refrain fromobtaining other services from a competitor.

 

Support of Subsidiary Banks. Under Federal Reserve policy, the Company isexpected to act as a source of financial and managerial strength to theBank.  This means that the Company isrequired to commit, as necessary, resources to support the Bank. Any capitalloans a bank holding company makes to its subsidiary banks are subordinate todeposits and to certain other indebtedness of those subsidiary banks.

 

State Law Restrictions. As a Washington corporation, the Company issubject to certain limitations and restrictions under applicable Washingtoncorporate law. For example, state law restrictions in Washington includelimitations and restrictions relating to indemnification of directors,distributions to shareholders, transactions involving directors, officers orinterested shareholders, maintenance of books, records, and minutes, andobservance of certain corporate formalities.

 

*Federal andState Regulation of First Community Bank*

 

General. The Bank is a Washington charteredcommercial bank with deposits insured by the FDIC.  As a result, the Bank is subject to supervision and regulation bythe Washington Department of Financial Institutions, Division of Banks and theFDIC. These agencies have the authority to prohibit banks from engaging in whatthey believe constitute unsafe or unsound banking practices.

 

Community Reinvestment.  TheCommunity Reinvestment Act requires that, in connection with examinations offinancial institutions within their jurisdiction, the Federal Reserve or theFDIC evaluate the record of the financial institution in meeting the creditneeds of its local communities, including low and moderate incomeneighborhoods, consistent with the safe and sound operation of the institution.These factors are also considered in evaluating mergers, acquisitions andapplications to open a branch or other facility.

 

Insider Credit Transactions. Banks are also subject to certainrestrictions imposed by the Federal Reserve Act on extensions of credit toexecutive officers, directors, principal shareholders or any related interestsof such persons. Extensions of credit (1) must be made on substantially thesame terms, including interest rates and collateral as, and follow creditunderwriting procedures that are not less stringent than, those prevailing atthe time for comparable transactions with persons not covered above and who arenot employees, and (2) must not involve more than the normal risk of repaymentor present other unfavorable features. Banks are also subject to certainlending limits and restrictions on overdrafts to insiders. A violation of theserestrictions may result in the assessment of substantial civil monetarypenalties, the imposition of a cease and desist order, and other regulatorysanctions.

 

Regulation of Management. Federal law (1) sets forth circumstancesunder which officers or directors of a bank may be removed by the institution’sfederal supervisory agency; (2) places restraints on lending by a bank to itsexecutive officers, directors, principal shareholders, and their relatedinterests; and (3) prohibits management personnel of a bank from serving as adirector or in other management positions of another financial institutionwhose assets exceed a specified amount or which has an office within aspecified geographic area.

 

Safety and SoundnessStandards.  Federal law imposes upon banks certainnon-capital safety and soundness standards. These standards cover internalcontrols, information systems and internal audit systems, loan documentation,credit underwriting, interest rate exposure, asset growth, compensation, feesand benefits, such other operational and managerial standards as the agencydetermines to be appropriate, and standards for asset quality, earnings andstock valuation. An institution that fails to meet these standards must developa plan acceptable to its regulators, specifying the steps that the institutionwill take to meet the standards. Failure to submit or implement such a plan maysubject the institution to regulatory sanctions.

 

Recently federal bankregulators have increased their scrutiny of banks involved in payday lending.  Published regulatory

 

5

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guidance indicates thatregulators are concerned about certain potential risks to banks that partnerwith payday lenders.  Those risksinclude strategic, reputation, compliance, transaction and credit risks.  Management is expected to measure, monitorand establish controls to manage these risks and to avoid taking risks thatthreaten the safety and soundness of the bank. Regulators will enforce these expectations through the examinationprocess and have the power to order a bank to discontinue its participation inpayday lending.  Management believesthat the Bank has taken appropriate steps to manage and control the risks ofits payday lending activities consistent with applicable regulatoryguidance.  However, there can be noassurance that the Bank’s regulators would not seek to restrict or terminatethe Bank’s participation in payday lending.

 

*InterstateBanking And Branching*

 

The Riegle-Neal Interstate Banking and BranchingEfficiency Act of 1994 (“Interstate Act”) permits nationwide interstate bankingand branching under certain circumstances. This legislation generallyauthorizes interstate branching and relaxes federal law restrictions oninterstate banking. Currently, bank holding companies may purchase banks in anystate, and states may not prohibit these purchases. Additionally, banks arepermitted to merge with banks in other states, as long as the home state ofneither merging bank has opted out under the legislation. The Interstate Actrequires regulators to consult with community organizations before permittingan interstate institution to close a branch in a low-income area.

 

FDIC regulations prohibit banks from usingtheir interstate branches primarily for deposit production. The FDIC hasimplemented a loan-to-deposit ratio screen to ensure compliance with thisprohibition.

 

Washington enacted “opting in” legislation inaccordance with the Interstate Act provisions allowing banks to engage ininterstate merger transactions, subject to certain “aging” requirements.Washington restricts an out-of-state bank from opening de novo branches.However, once an out-of-state bank has acquired a bank within the state, eitherthrough merger or acquisition of all or substantially all of the bank’s assets,the out-of-state bank may open additional branches within the state.

 

*DepositInsurance*

 

The Bank’s deposits are currently insured to amaximum of $100,000 per depositor through the Bank Insurance Fund administeredby the FDIC. The Bank is required to pay deposit insurance premiums, which areassessed semiannually and paid quarterly. The premium amount is based upon a risk classification systemestablished by the FDIC.  Banks withhigher levels of capital and a low degree of supervisory concern are assessedlower premiums than banks with lower levels of capital or a higher degree ofsupervisory concern.

 

The FDIC is also empowered to make specialassessments on insured depository institutions in amounts determined by theFDIC to be necessary to give it adequate assessment income to repay amountsborrowed from the U.S. Treasury and other sources or for any other purpose theFDIC deems necessary.

 

*Dividends*

 

The principal source of the Company’s cashreserves is dividends received from the Bank. The payment of dividends issubject to government regulation, in that regulatory authorities may prohibitbanks and bank holding companies from paying dividends in a manner that wouldconstitute an unsafe or unsound banking practice. In addition, a bank may notpay cash dividends if doing so would reduce the amount of its capital belowthat necessary to meet minimum applicable regulatory capital requirements.State laws also limit a bank’s ability to pay dividends.

 

*CapitalAdequacy*

 

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

 

The FDIC and Federal Reserve use risk-basedcapital guidelines for banks and bank holding companies. These are designed tomake such capital requirements more sensitive to differences in risk profilesamong banks and bank holding companies, to account for off-balance sheetexposure and to minimize disincentives for holding liquid assets. Assets andoff-balance sheet items are assigned to broad risk categories, each withappropriate weights. The resulting capital ratios represent capital as apercentage of total risk-weighted assets and off-balance sheet items. Theguidelines are minimums, and the Federal Reserve has noted that bank holdingcompanies contemplating significant expansion programs should not allowexpansion to diminish their capital ratios and should maintain ratios well inexcess of the minimum. The current guidelines require all bank holdingcompanies and federally-regulated banks to maintain a minimum risk-based totalcapital ratio equal to 8%, of which at least 4% must be Tier I capital. Tier Icapital for bank holding companies includes common shareholders’ equity,certain qualifying

 

6

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perpetual preferred stock and minority interestsin equity accounts of consolidated subsidiaries, less intangibles.

 

The Federal Reserve also employs a leverageratio, which is Tier I capital as a percentage of total assets lessintangibles, to be used as a supplement to risk-based guidelines. The principalobjective of the leverage ratio is to constrain the maximum degree to which abank holding company may leverage its equity capital base. The Federal Reserverequires a minimum leverage ratio of 3%. However, for all but the most highly rated bank holding companies andfor bank holding companies seeking to expand, the Federal Reserve expects anadditional cushion of at least 1% to 2%.

 

Under FDIC regulations, an institution isassigned to one of five capital categories depending on its total risk-basedcapital ratio, Tier I risk-based capital ratio, and leverage ratio, togetherwith certain subjective factors. Institutions which are deemed to be “undercapitalized,” depending on thecategory to which they are assigned, are subject to certain mandatorysupervisory corrective actions.

 

*FinancialServices Modernization*

 

Gramm-Leach-BlileyAct of 1999. The Financial Services Modernization Act of 1999, also known as theGramm-Leach-Bliley Act, brought about significant changes to the laws affectingbanks and bank holding companies. Generally, the Act (i) repealed the historical restrictions onpreventing banks from affiliating with securities firms, (ii) provided auniform framework for the activities of banks, savings institutions and theirholding companies, (iii) broadened the activities that may be conducted bynational banks and banking subsidiaries of bank holding companies, (iv)provided an enhanced framework for protecting the privacy of consumerinformation and (v) addressed a variety of other legal and regulatory issuesaffecting both day-to-day operations and long-term activities of financialinstitutions.

 

Bank holding companies thatqualify and elect to become financial holding companies can engage in a widervariety of financial activities than permitted under previous law, particularlywith respect to insurance and securities underwriting activities.  In addition, in a change from previous law,bank holding companies will be in a position to be owned, controlled oracquired by any company engaged in financially related activities, so long asthe company meets certain regulatory requirements.  The act also permits national banks (and, in states with wildcardstatutes, certain state banks), either directly or through operatingsubsidiaries, to engage in certain non-banking financial activities.

 

The Company does not believethat the act will negatively affect it’s operations in the short term.  However, to the extent the legislationpermits banks, securities firms and insurance companies to affiliate, thefinancial services industry may experience further consolidation.  This consolidation could result in a growingnumber of larger financial institutions that offer a wider variety of financialservices than currently offered, and these companies may be able toaggressively compete in the markets FCFG currently serves.

 

*Effects OfGovernment Monetary Policy*

 

The Company’s earnings and growth are affectednot only by general economic conditions, but also by the fiscal and monetarypolicies of the federal government, particularly the Federal Reserve. TheFederal Reserve can and does implement national monetary policy for suchpurposes as curbing inflation and combating recession, but its open marketoperations in U.S. government securities, control of the discount rateapplicable to borrowings from the Federal Reserve, and establishment of reserverequirements against certain deposits, influence the growth of bank loans,investments and deposits, and also affect interest rates charged on loans orpaid on deposits. The nature and impact of future changes in monetary policiesand their impact on the Company cannot be predicted with certainty.

 

**ITEM 2 - PROPERTIES**

 

The Bank owns the propertyand building on which the Aberdeen, Elma, Hoquiam, Lacey, Yelm, Fircrest,downtown Tacoma, Winlock, Toledo, Montesano, Centralia and downtown Olympiabranches are situated.  The Tumwater,Eatonville and Meridian Road branches are operated in buildings owned by FCBthat are situated on leased property. The Hawks Prairie, Panorama City, West Olympia, and Puyallup Canyon Roadbranches are operated in leased space.

 

The Lacey office is a two story building witha basement and a drive-up, which has approximately 17,500 square feet and isfully utilized as a branch bank, administrative offices, customer care centerand data processing facility. The Meridian, Tumwater, Yelm, Eatonville, WestOlympia, Winlock, Centralia, Aberdeen and Hoquiam branches are single storystructures with drive-up facilities. The Elma, Downtown Olympia, Hawks Prairie, Downtown Tacoma and Montesanobranches are two story structures with drive-up facilities.  The Panorama City branch is located on theground floor of a retirement center. The

 

7

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Toledo and Canyon Road branches are singlestory structures with walk up ATMs. The Fircrest facility is an officecondominium, of which the Bank occupies approximately one-half.

 

**ITEM 3 - LEGAL PROCEEDINGS**

 

From time to time in the ordinary course ofbusiness, FCFG or its subsidiaries may be involved in litigation.  At the present time neither FCFG nor any ofits subsidiaries are involved in any material litigation proceeding.

 

**ITEM 4 -SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

During the fourth quarter of the year endedDecember 31, 2001, no matters were submitted to the security holders throughthe solicitation of proxies or otherwise.

 

**PARTII**

 

**ITEM 5 -MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

**MarketInformation**

 

No broker makes a market in FCFG’s commonstock, and trading has not been extensive. Trades that have occurred cannot be characterized as amounting to anactive market.  The stock is traded byindividuals on a personal basis and is not listed on any exchange or traded onthe over-the-counter market.  Due to thelimited information available, the following price information may notaccurately reflect the actual market value of FCFG’s shares.  The following data includes trades betweenindividual investors.  It does notinclude the exercise of stock options nor does it include shares purchased bythe Company as discussed below.

 

| **Period** |   |    |   | **# of  Shares Traded** |   | **Price  Range** |   |
|------------|--------|---------|--------|-------------------------|--------|------------------|--------|
|       |   |    |   |                    |   |             |   |
| **2000**   |   |    |   |                    |   |             |   |
|       |   |    |   |                    |   |             |   |
| 1(st)      |   | Quarter |   | 4,378                   |   | $21.00  - $23.00 |   |
| 2(nd)      |   | Quarter |   | 40,358                  |   | $21.50  - $25.00 |   |
| 3(rd)      |   | Quarter |   | 3,370                   |   | $20.00  - $23.50 |   |
| 4(th)      |   | Quarter |   | 7,372                   |   | $20.00  - $24.00 |   |
|            |        |         |        |                         |        |                  |        |  |

 

| **2001** |   |    | ** ** |   | ** ** |             | ** ** |
|----------|--------|---------|------------|--------|------------|------------------|------------|
|     |   |    |       |   |       |             |       |
| 1(st)    |   | Quarter |       | 4,247  |       | $20.00  - $22.45 |       |
| 2(nd)    |   | Quarter |       | 2,661  |       | $20.00  - $20.75 |       |
| 3(rd)    |   | Quarter |       | 50,688 |       | $18.50  - $23.00 |       |
| 4(th)    |   | Quarter |       | 12,340 |       | $20.00  - $21.00 |       |

 

At December 31, 2001, options for 330,146shares of FCFG common stock were outstanding. See Note 14 of the audited financial statements for additionalinformation.

 

On April 20, 2000, the Board of Directorsannounced a stock repurchase plan in which FCFG would repurchase a maximum of40,000 shares of FCFG stock within a three-month period.  On April 21, 2000 FCFG repurchased 39,998shares of FCFG common stock for a total of $934,000.

 

Number of Equity Holders

 

As of December 31, 2001, there were 1,325holders of record of FCFG’s common stock.

 

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Dividends

FCFG paid cash dividends of $.10 per share onFebruary 16, May 11, August 10, and November 9, 2001.  Cash dividends of $.10 per share were issued on February 11, May5, August 11 and November 10, 2000. Cash dividends of $ .40, $ .09 and $.09 pershare were issued on April 15, 1999, July 30, 1999 and October 30, 1999,respectively.  There were no cashdividends declared in 1998 or 1997. Stock dividends of 5% were issued on May 6, 1998 and April 15, 1997,respectively.

 

Washington law limits the ability of the Bankto pay dividends to the Company.  Underthese restrictions, a bank may not declare or pay any dividend in an amountgreater than its retained earnings without approval of the Division ofBanks.  All of the retained earnings ofFCB are available for the payment of dividends to the Company under theserestrictions, subject to the federal capital regulations discussed above.

 

**ITEM 6 -SELECTED FINANCIAL DATA**

 
|                                                 |   | **2001**                                     |    | **2000** |   | **1999** |   | **1998** |    | **1997** |   |
|------------------------------------------------------|--------|----------------------------------------------|---------|----------|--------|----------|--------|----------|---------|----------|--------|
|                                                 |   | **($ in  thousands, except per share data)** |    |
| For the Year                                         |   |                                         |    |     |   |     |   |     |    |     |   |
| Net interest income after provisionfor credit losses |   | $                                            | 17,682  |     | $      | 16,604   |   | $        | 11,348  |     | $      | 14,302 |   | $ | 12,106 |   |
| Non-interest income                                  |   | 6,324                                        |    | 4,975    |   | 4,619    |   | 4,883    |    | 4,163    |   |
| Non-interest expense and taxes                       |   | 19,569                                       |    | 17,218   |   | 14,607   |   | 15,580   |    | 15,550   |   |
|                                                 |   |                                         |    |     |   |     |   |     |    |     |   |
| Net income                                           |   | $                                            | 4,437   |     | $      | 4,361    |   | $        | 1,360   |     | $      | 3,605 |   | $ | 719 |   |
|                                                 |   |                                         |    |     |   |     |   |     |    |     |   |   |   |   |   |   |
| Per Common Share                                     |   |                                         |    |     |   |     |   |     |    |     |   |
| Basic Earnings Per Share                             |   | $                                            | 2.04    |     | $      | 2.02     |   | $        | .64     |     | $      | 1.74 |   | $ | 0.36 |   |
|                                                 |   |                                         |    |     |   |     |   |     |    |     |   |   |   |   |   |   |
| Stock Dividends declared                             |   | —                                       |    | —   |   | —   |   | 5        | %       | 5        | %      |
| Cash Dividends Paid                                  |   | $                                            | .40     |     | $      | .40      |   | $        | .58     |     | — |   | — |   |
|                                                 |   |                                         |    |     |   |     |   |     |    |     |   |   |   |
| Balance Sheet Data:                                  |   |                                         |    |     |   |     |   |     |    |     |   |   |   |   |   |   |
| Total Assets                                         |   | $                                            | 364,623 |     | $      | 324,235  |   | $        | 293,773 |     | $      | 271,566 |   | $ | 294,474 |   |
| Long-term debt                                       |   | 575                                          |    | 1,303    |   | 2,030    |   | 2,808    |    | 3,818    |   |
| Stockholders’ equity                            |   | 38,795                                       |    | 34,373   |   | 30,618   |   | 30,341   |    | 26,165   |   |

 

**ITEM 7 -MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

Management’sdiscussion and analysis of the Company should be read in conjunction with theaccompanying consolidated financial statements.  This analysis compares2001 results and financial position with that of 2000 and 1999.

 

**Forward-LookingInformation**

 

Statements appearing in this report which arenot historical in nature, including the discussions of the adequacy of theCompany’s capital resources and allowance for credit losses, areforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995 (“PLSRA”).  Forward-looking statements aresubject to the risks and uncertainties that may cause actual future results todiffer materially.  Readers are cautioned not to place undue reliance onthese forward-looking statements, which speak only as of the date of thisAnnual Report.  FCFG does not undertake any obligation to publicly releaseany revisions to forward-looking statements contained in this Annual Report, withrespect to events or circumstances after the date of this Annual Report, or toreflect the occurrence of unanticipated events.

 

Such risks and uncertainties with respect tothe Company include those related to the economic environment, particularly inthe region in which the Company operates, competitive products and pricing,fiscal and monetary policies of the federal government, changes in governmentregulations affecting financial institutions, including regulatory fees andcapital requirements, changes in prevailing interest rates, acquisitions andthe integration of acquired businesses, credit risk

 

9

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management and asset/liability management,the financial and securities markets, and the availability of and costsassociated with sources of liquidity.

 

**PERFORMANCE OVERVIEW**

 

In 2001, the Company completed its mostprofitable year ever, posting earnings of $4,437,000.  Earnings were up $76,000, or 2% over 2000.  Earnings for 2000 were $4,361,000 representingan increase of 221%, or $3,001,000 over 1999 earnings of  $1,360,000. The 1999 earnings were significantly impacted by a special lossprovision related to a single borrower.  Highlights for 2001 include 17% growth in net interest income, 17%growth in the allowance for credit losses, strong credit quality and 27% growthin non-interest income.  In 2001, theCompany experienced robust asset growth. Total assets grew 12%, or $40,388,000 to $364,623,000.  Depositsincreased $42,353,000, or 16% to $313,730,000.  Total loans also increasedby $35,593,000, or 14% to $294,897,000.

 

Basic earnings per share for 2001 were $2.04per share as compared to $2.02 per share for 2000 and $0.64 per share for 1999.

 

The Banks small loan division contributedsignificantly to financial performance in 2001.  The small loan division provides small, short-term consumer loansto customers in Alabama and Arkansas.

 

Financial highlights by line ofbusiness as of, and for the year ended December 31, 2001 were as follows:

 
|                                                   |   | **Community  Banking** |        | **Small Loans** |   | **Total**  |       |
|--------------------------------------------------------|--------|------------------------|-------------|-----------------|--------|------------|------------|
| Net interest income after provision for  credit losses |   | $                      | 15,493      |            | $      | 2,189      |       | $ | 17,682 |   |
| Non-interest income                                    |   | 6,324                  |        | —          |   | 6,324      |       |
| Non-interest expense                                   |   | 17,102                 |        | 599             |   | 17,701     |       |
| Income taxes                                           |   | 1,354                  |        | 514             |   | 1,868      |       |
|                                                   |   |                   |        |            |   |       |       |
| **Net income**                                         |   | **$**                  | **3,361**   | ** **      | **$**  | **1,076**  | ** ** | **$** | **4,437** | ** ** |
|                                                   |   |                   |        |            |   |       |       |
| **Total assets**                                       |   | **$**                  | **346,355** | ** **      | **$**  | **18,268** | ** ** | **$** | **364,623** | ** ** |
|                                                   |   |                   |        |            |   |       |       |
| **Total loans**                                        |   | **$**                  | **281,412** | ** **      | **$**  | **7,289**  | ** ** | **$** | **288,701** | ** ** |

 

The following table sets forth certainoperating and capital ratios for the Company at December 31:

 
|                                   |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
|----------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Return on Average Assets               |   | 1.27     | %      | 1.40     | %      | 0.48     | %      | 1.26     | %      | .29      | %      |
| Return on Average Equity               |   | 12.12    | %      | 13.62    | %      | 4.26     | %      | 12.61    | %      | 2.76     | %      |
| Average Equity to Average Assets Ratio |   | 10.45    | %      | 10.25    | %      | 11.32    | %      | 9.96     | %      | 10.40    | %      |
| Dividend Payout Ratio                  |   | 19.70    | %      | 19.88    | %      | 92.79    | %      | —   |   | —   |   |

 

**RESULTS OF OPERATIONS**

** **

**NetInterest Income**

 

Net interest income is the Company’sprincipal source of revenue, and is comprised of the difference between theinterest earned on interest earning assets, less the interest expense incurredon interest bearing liabilities. Changes in net interest income from year to year are influenced by boththe volume of the assets or liabilities, and the rates earned or paid on them.Net interest income in 2001 increased by $2,844,000, or 17%, over 2000.  Net interest income in 2000 increased$1,476,000, or 10%, over 1999.  These increases were primarily the resultof increased volume of loans.  During2001, interest income increased $2,824,000, or 10%, compared to an increase of$4,394,000, or 19% in 2000.  Interest expense decreased $20,000 in 2001,or 0.2% from 2000.  Interest expense in2000 increased $2,918,000, or 39% over 1999.  During 2001 the netinterest margin increased 53 basis points, from 5.84% in 2000 to 6.37% in 2001.

 

The year 2001 saw dramatic interest rate cutsby the Federal Reserve Bank in an effort to stimulate an economy inrecession.  The prime rate, a benchmarkrate that generally represents the rate at which banks lend to the most creditworthy borrowers, was

 

10

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reduced 11 times during the year and movedfrom 9.5% at the beginning of the year to 4.75% at year end.  The Federal Funds rate, which representsbanks’ overnight borrowing rate was also reduced 11 times during the year andfell from 6.0% to 1.75%.

 

In spite of these rapid rate cuts, totalinterest income earned from loans in 2001 increased by $3,087,000.  Ofthis amount, $2,335,000 resulted from an increase in the average volume ofloans during the year.  The balance of the increase, $752,000, resultedfrom an increase in the average yield on the loans, which increased to 10.18%from the 9.89% earned in 2000.  Thisincrease in yield was due to the Banks small loan program, which began in late 2000.  These short-term loans carry substantiallyhigher yields than those in the Bank’s traditional portfolio.  Partially offsetting the increase in loaninterest, was a decline in the interest earned on investment securities, whichdecreased a total of $287,000.  A 13% decline in the size of the portfolioproduced a decrease of $215,000, and the average yield on the portfolio fellfrom 6.25% to 5.98%, which added $72,000 to the decrease.

 

Interest expense on deposits in 2001increased a total of 7% or $682,000 over the previous year.  Of thisincrease, $1,449,000 resulted from growth in the volume of deposits.  This was partially offset by a $767,000decrease in interest due to a decline in the average rate paid ondeposits.  The average cost of depositsfell from 4.31% in 2000 to 4.02% during 2001.

 

Interest expense on otherborrowings in 2001 decreased by a total of $702,000 from 2000.  Of this decrease, approximately $388,000 isattributed to a decline in the volume of borrowing, and $314,000 is the resultof a decline in the average rate paid on those balances.

 

 

An analysis of the change innet interest income is as follows:

 
|                                     |   | **2001  compared to 2000  Increase (decrease) due to** |   | **2000  compared to 1999  Increase (decrease) due to** |   |
|------------------------------------------|--------|--------------------------------------------------------|--------|--------------------------------------------------------|--------|
|                                     |   | **Volume**                                             |   | **Rate**                                               |   | **Net** |   | **Volume** |   | **Rate** |   | **Net** |   |
|                                     |   | **(thousands)**                                        |   |
| Interest earned on:                      |   |                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |
| Loans                                    |   | $                                                      | 2,335  |                                                   | $      | 752 |   | $ | 3,087 |   | $ | 3,934 |   | $ | 658 |   | $ | 4,592 |   |
| Federal funds sold and deposits in banks |   | 53                                                     |   | (29                                                    | )      | 24 |   | (38 | ) | 24 |   | (14 | ) |
| Investment securities                    |   | (215                                                   | )      | (72                                                    | )      | (287 | ) | (262 | ) | 78 |   | (184 | ) |
| Total interest income                    |   | 2,173                                                  |   | 651                                                    |   | 2,824 |   | 3,634 |   | 760 |   | 4,394 |   |
|                                     |   |                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |
| Interest paid on:                        |   |                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |
| Savings, NOW and MMA                     |   | 274                                                    |   | (238                                                   | )      | 36 |   | (271 | ) | (144 | ) | (415 | ) |
| Time deposits                            |   | 1,175                                                  |   | (529                                                   | )      | 646 |   | 1,920 |   | 844 |   | 2,764 |   |
| Other borrowings                         |   | (388                                                   | )      | (314                                                   | )      | (702 | ) | 527 |   | 42 |   | 569 |   |
| Total Interest expense                   |   | 1,061                                                  |   | (1,081                                                 | )      | (20 | ) | 2,176 |   | 742 |   | 2,918 |   |
|                                     |   |                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |
| Net interest income                      |   | $                                                      | 1,112  |                                                   | $      | 1,732 |   | $ | 2,844 |   | $ | 1,458 |   | $ | 18 |   | $ | 1,476 |   |

 

The change in interest due toboth rate and volume has been allocated to volume and rate changes inproportion to the relationship of the absolute dollar amounts of the change ineach.

 

11

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Average consolidated statements of financialposition and analysis of net interest spread were as follows*:*

 
|                                                                 |   |        | ** ** | **2001**      | ** ** |                        | ** ** |        | ** ** | **2000**      | ** ** |        | ** ** |        | ** ** | **1999**           | ** **      |        | ** ** |
|----------------------------------------------------------------------|--------|-------------|------------|---------------|------------|-----------------------------|------------|-------------|------------|---------------|------------|-------------|------------|-------------|------------|--------------------|-----------------|-------------|------------|
|                                                                 |   |        | ** ** | **Interest**  | ** ** |                        | ** ** |        | ** ** | **Interest**  | ** ** |        | ** ** |        | ** ** | **Interest**       | ** **      |        | ** ** |
|                                                                 |   | **Average** | ** ** | **Income**    | ** ** | **Average**                 | ** ** | **Average** | ** ** | **Income**    | ** ** | **Average** | ** ** | **Average** | ** ** | **Income**         | ** **      | **Average** | ** ** |
|                                                                 |   | **Balance** | ** ** | **(Expense)** |       | **Rates**                   | ** ** | **Balance** | ** ** | **(Expense)** | ** ** | **Rates**   | ** ** | **Balance** | ** ** | ** (Expense** | ** ****)** | **Rates**   | ** ** |
|                                                                 |   |        |       |          |       | **(dollars  in thousands)** |       |        |       |          |       |        |       |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| **Earning Assets:**                                                  |   | ** **  |       | ** **    |       | ** **                  |       | ** **  |       | ** **    |       | ** **  |       | ** **  |       | ** **         |            | ** **  |       |
| Loans(1)                                                             |   | $           | 277,063    |          | $          | 28,197                      |       | 10.18       | %          | $             | 253,963    |        | $          | 25,110      |       | 9.89               | %               | $           | 213,997    |   | $ | 20,518 |   | 9.59 | % |
| Federal funds sold and interest bearing deposits in banks            |   | 2,699       |       | 122           |       | 4.52                        | %          | 1,618       |       | 98            |       | 6.06        | %          | 2,307       |       | 112                |            | 4.85        | %          |
| Investment securities                                                |   | 24,560      |       | 1,469         |       | 5.98                        | %          | 28,118      |       | 1,756         |       | 6.25        | %          | 32,318      |       | 1,940              |            | 6.00        | %          |
| Total earning assets and interest income                             |   | 304,322     |       | 29,788        |       | 9.79                        | %          | 283,699     |       | 26,964        |       | 9.50        | %          | 248,622     |       | 22,570             |            | 9.08        | %          |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Other Assets:                                                        |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Cash and due from banks                                              |   | 19,511      |       |          |       |                        |       | 11,667      |       |          |       |        |       | 13,208      |       |               |            |        |       |
| Bank premises and equipment                                          |   | 10,405      |       |          |       |                        |       | 9,540       |       |          |       |        |       | 9,583       |       |               |            |        |       |
| Other assets                                                         |   | 19,471      |       |          |       |                        |       | 13,655      |       |          |       |        |       | 13,513      |       |               |            |        |       |
| Allowance for credit losses                                          |   | (3,492      | )          |          |       |                        |       | (6,066      | )     |          |       |        |       | (2,471      | )     |               |            |        |       |
| Total Assets                                                         |   | $           | 350,217    |          |       |                        |       |        | $          | 312,495       |       |        |       |        |       | $                  | 282,455         |        |       |   |   |   |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Liabilities and Stockholders’ Equity                            |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Interest bearing liabilities:                                        |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Deposits:                                                            |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Savings, NOW, and Money Market Deposits                              |   | $           | 111,752    |          | $          | (2,423                      | )          | 2.17        | %          | $             | 99,656     |        | $          | (2,387      | )          | 2.40               | %               | $           | 110,746    |   | $ | (2,802 | ) | 2.53 | % |
| Time deposits                                                        |   | 138,957     |       | (7,650        | )          | 5.51                        | %          | 118,085     |       | (7,004        | )          | 5.93        | %          | 84,154      |       | (4,240             | )               | 5.04        | %          |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Total interest bearing deposits                                      |   | 250,709     |       | (10,073       | )          | 4.02                        | %          | 217,741     |       | (9,391        | )          | 4.31        | %          | 194,900     |       | (7,042             | )               | 3.61        | %          |
| Other borrowings                                                     |   | 7,265       |       | (317          | )          | 4.36                        | %          | 14,147      |       | (1,019        | )          | 7.20        | %          | 6,788       |       | (450               | )               | 6.63        | %          |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Total interest bearing liabilities and interest expense              |   | 257,974     |       | (10,390       | )          | 4.03                        | %          | 231,888     |       | (10,410       | )          | 4.49        | %          | 201,688     |       | (7,492             | )               | 3.71        | %          |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Non-interest bearing deposits                                        |   | 52,692      |       |          |       |                        |       | 45,857      |       |          |       |        |       | 46,541      |       |               |            |        |       |
| Other liabilities                                                    |   | 2,957       |       |          |       |                        |       | 2,722       |       |          |       |        |       | 2,264       |       |               |            |        |       |
| Stockholders’ equity                                            |   | 36,594      |       |          |       |                        |       | 32,028      |       |          |       |        |       | 31,962      |       |               |            |        |       |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Total liabilities, stockholders’ equity and net interest income |   | $           | 350,217    |          | $          | 19,398                      |       |        |       | $             | 312,495    |        | $          | 16,554      |       |               |            | $           | 282,455    |   | $ | 15,078 |   |   |   |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Net interest income as an average of earnings assets:                |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Interest Income                                                      |   |        |       |          |       | 9.79                        | %          |        |       |          |       | 9.50        | %          |        |       |               |            | 9.08        | %          |
| Interest Expense                                                     |   |        |       |          |       | 3.41                        | %          |        |       |          |       | 3.67        | %          |        |       |               |            | 3.01        | %          |
|                                                                 |   |        |       |          |       |                        |       |        |       |          |       |        |       |        |       |               |            |        |       |
| Net Interest Income                                                  |   |        |       |          |       | 6.37                        | %          |        |       |          |       | 5.84        | %          |        |       |               |            | 6.06        | %          |
|                                                                      |        |             |            |               |            |                             |            |             |            |               |            |             |            |             |            |                    |                 |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)  For purposes of thesecomputations, non-accrual loans are included in the average loan balanceoutstanding.  Loan fees and late charges of $1,492,000, $1,933,000 and$1,859,000 are included in interest income in 2001, 2000 and 1999,respectively.

 

 

12

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**Non-InterestIncome**

 

Total non-interest income increased$1,349,000 to $6,324,000, a 27% increase over 2001.  The largest single component of the increase resulted from theorigination and sale of mortgage loans. In part, due to the rapidly falling interest rates, mortgage loan volumein 2001 was approximately double that of the year 2000, producing a $1,048,000,or 105% increase in mortgage loan revenues over the previous year.   Mortgage loan revenues in 2000 were$999,000, down approximately 14% from 1999 due to a rising interest rateenvironment in that year.  Service charge income on deposit accountsincreased $540,000, or 28% in 2001, due in part to growth in deposit accounts,and also to the introduction of a new overdraft privilege program in the secondhalf of the year.  Net service chargesand fees on deposit accounts in 2000 declined only slightly from 1999.   Other non-interest income declined in 2001 by$239,000.  Included in othernon-interest income in the year 2000, were a $215,000 increase in the reportedamount of certain equity investments accounted for at fair value, and a$235,000 gain on the sale of assets. These items did not recur in 2001.

** **

**Non-InterestExpense**

 

Total non-interest expense in 2001 increasedby 17% over 2000 and amounted to $17,701,000.  Total non-interest expensein 2000 increased 7% over 1999 to $15,089,000. Salaries and benefits, the largest component of non-interest expense, in2001 increased $1,518,000, or 19%, from 2000 due primarily to two factors.  First, the three branch offices opened earlyin the period required additional staff.  Secondly, since mortgage loan representatives are compensated bycommission, the dramatically increased mortgage loan origination volumeincreased the compensation expense in that department.  Salaries andbenefits increased less than 2% between 1999 and 2000.  Occupancy and equipment expenses increased15% and 8%, respectively, from 2000 also due to the recently openedoffices.  Occupancy and equipmentexpenses increased 2% and decreased 3%, respectively, between 1999 and2000.  Other expenses in 2001 increased $842,000,or 19% over 2000.  Of this increase,$599,000 is the result of costs associated with the Bank’s small loan program,and includes an increase in advertising expense of $250,000 related primarilyto the opening of three branch offices. Other expenses in 2000 increased$880,000 from 1999.  Of this amount,$500,000 represented a loss provision for a property acquired throughforeclosure during the year.

 

**FINANCIAL CONDITION**

 

**Overview**

 

Consolidated total assets increased by 12% to$364,623,000 in 2001.  Asset growth was greatest in the loanportfolio.  Total loans, net of allowancefor credit losses, increased $35,008,000, or 13%, compared to 2000.  Cashflows from the securities portfolio, along with increased deposits, were usedto fund the loan growth.  Total deposits at December 31, 2001 increased$42,353,000, or 16% over the previous year-end.

 

**Investments**

 

In 2001 the Company’s investment portfoliodecreased $6,941,000 to $18,610,000.   Maturing securities and othercash flows from the portfolio were used to fund loan growth.  Included inthe portfolio are securities classified as “held-to-maturity”, which arerecorded at an amortized cost of $506,000, as well as securities classified as“available-for-sale”, which are recorded at their fair value of$18,104,000.  Because the available-for-sale portfolio is carried at fairvalue, its carrying value fluctuates with changes in market factors, primarilyinterest rates.

 

13

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The carrying amount of securities and theapproximate fair values were as follows:

 

|                                              |   | **Amortized  Cost**         |   | **Gross Unrealized    Gains** |   | **Gross  Realized   Losses** |   | **Fair Value** |   |
|---------------------------------------------------|--------|-----------------------------|--------|-------------------------------|--------|------------------------------|--------|----------------|--------|
|                                              |   | **(dollars  in thousands)** |   |
| Available-for-Sale Securities                     |   |                        |   |                          |   |                         |   |           |   |
| December 31, 2001                                 |   |                        |   |                          |   |                         |   |           |   |
| U.S. Government and agency securities             |   | $                           | 3,722  |                          | $      | 51                           |   | $              | 129    |   | $ | 3,644 |   |
| Corporate Securities                              |   | 3,987                       |   | 139                           |   | —                       |   | 4,126          |   |
| Mortgage backed securities                        |   | 2,823                       |   | 89                            |   | —                       |   | 2,912          |   |
| State and municipal securities                    |   | 7,057                       |   | 323                           |   | —                       |   | 7,380          |   |
| Equity Securities                                 |   | 42                          |   | —                        |   | —                       |   | 42             |   |
|                                              |   | $                           | 17,631 |                          | $      | 602                          |   | $              | 129    |   | $ | 18,104 |   |
|                                              |   |                        |   |                          |   |                         |   |           |   |
| December 31, 2000                                 |   |                        |   |                          |   |                         |   |           |   |
| U.S. Government and agency securities             |   | $                           | 7,899  |                          | $      | 17                           |   | $              | 316    |   | $ | 7,600 |   |
| Corporate Securities                              |   | 4,985                       |   | 7                             |   | 54                           |   | 4,938          |   |
| Mortgage backed securities                        |   | 5,053                       |   | 18                            |   | 32                           |   | 5,039          |   |
| State and municipal securities                    |   | 7,402                       |   | 15                            |   | 155                          |   | 7,262          |   |
| Equity Securities                                 |   | 36                          |   | —                        |   | —                       |   | 36             |   |
|                                              |   | $                           | 25,375 |                          | $      | 57                           |   | $              | 557    |   | $ | 24,875 |   |
|                                              |   |                        |   |                          |   |                         |   |           |   |
| December 31, 1999                                 |   |                        |   |                          |   |                         |   |           |   |
| U.S. Government and agency securities             |   | $                           | 7,731  |                          | $      | —                       |   | $              | 530    |   | $ | 7,201 |   |
| Corporate securities                              |   | 5,339                       |   | —                        |   | 137                          |   | 5,202          |   |
| Mortgage backed securities                        |   | 7,154                       |   | 10                            |   | 137                          |   | 7,027          |   |
| State and municipal securities                    |   | 7,544                       |   | 6                             |   | 315                          |   | 7,235          |   |
| Equity Securities                                 |   | 36                          |   | —                        |   | —                       |   | 36             |   |
|                                              |   | $                           | 27,804 |                          | $      | 16                           |   | $              | 1,119  |   | $ | 26,701 |   |
| Held-to-Maturity Securities                       |   |                        |   |                          |   |                         |   |           |   |
|                                              |   |                        |   |                          |   |                         |   |           |   |
| December 31, 2001  State and municipal securities |   | $                           | 506    |                          | $      | 49                           |   | $              | 1      |   | $ | 554 |   |
|                                              |   |                        |   |                          |   |                         |   |           |   |
| December 31, 2000  State and municipal securities |   | $                           | 676    |                          | $      | 27                           |   | $              | 1      |   | $ | 702 |   |
|                                              |   |                        |   |                          |   |                         |   |           |   |
| December 31, 1999  State and municipal securities |   | $                           | 677    |                          | $      | 25                           |   | $              | 1      |   | $ | 701 |   |

 

The stated maturities of debtsecurities were as follows (dollars in thousands):

 
|                                   |   | **Held-to-Maturity  Securities** |   | **Available-For-Sale  Securities** |   |
|----------------------------------------|--------|----------------------------------|--------|------------------------------------|--------|
|                                   |   | **Amortized  Cost**              |   | **Fair Value**                     |   | **Weighted Average Yield** |   | **Amortized  Cost** |   | **Fair Value** |   | **Weighted   Average Yield** |   |
|                                   |   | **(dollars in thousands)**       |   |
| Due in one year or less                |   | $                                | — |                               | $      | — |   | — | % | $ | 1,652 |   | $ | 1,644 |   | 6.33 | % |
| Due after one year through five years  |   | 506                              |   | 554                                |   | 8.91 | % | 6,865 |   | 7,113 |   | 6.45 | % |
| Due after five years through ten years |   | —                           |   | —                             |   | — | % | 3,791 |   | 3,978 |   | 7.01 | % |
| Due after 10 years                     |   | —                           |   | —                             |   | — | % | 5,281 |   | 5,327 |   | 7.00 | % |
|                                   |   | $                                | 506    |                               | $      | 554 |   |   |   | $ | 17,589 |   | $ | 18,062 |   |   |   |

 

14

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Weighted average yield isreported on tax-equivalent basis.  Mortgage backed securities areallocated based on their anticipated principal repayment.

 

There were no gross realizedgains or gross realized losses on sales of securities available for sale in2001, 2000, or 1999.

 

**Loans**

 

Loan balances of portfolioloans increased by $33,518,000 to $288,701,000 in 2001.

 

The composition of the loanportfolio was as follows at December 31:

 
|                     |   | **2001**                    |    | **2000**    |   | **1999**   |   | **1998**    |   | **1997**   |    |
|--------------------------|--------|-----------------------------|---------|-------------|--------|------------|--------|-------------|--------|------------|---------|
|                     |   | **Amount**                  |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                     |   | **(dollars  in thousands)** |    |
| Commercial               |   | $                           | 40,870  |        | 14.2   | %          | $      | 37,989      |   | 14.9       | %       | $ | 34,981 |   | 15.0 | % | $ | 29,446 |   | 15.2 | % | $ | 36,995 |   | 19.0 | % |
| Real estate construction |   | 50,798                      |    | 17.6        | %      | 39,486     |   | 15.5        | %      | 19,169     |    | 8.2 | % | 17,390 |   | 8.9 | % | 24,423 |   | 12.5 | % |
| Real estate mortgage     |   | 185,012                     |    | 64.1        | %      | 167,680    |   | 65.7        | %      | 170,203    |    | 73.1 | % | 141,120 |   | 72.6 | % | 124,954 |   | 64.1 | % |
| Consumer                 |   | 4,732                       |    | 1.6         | %      | 6,792      |   | 2.6         | %      | 8,472      |    | 3.7 | % | 6,405 |   | 3.3 | % | 8,489 |   | 4.4 | % |
| Small loans              |   | 7,289                       |    | 2.5         | %      | 3,236      |   | 1.3         | %      | —     |    | — |   | — |   | — |   | — |   | — |   |
|                     |   |                        |    |        |   |       |   |        |   |       |    |   |   |   |   |   |   |   |   |   |   |
|                     |   | $                           | 288,701 |        | 100.0  |  %    | $      | 255,183     |   | 100.0      | %  | $ | 232,825 |   | 100.0 |  % | $ | 194,361 |   | 100.0 | %  | $ | 194,861 |   | 100.0 |  % |

 

The Bank’s loan portfolio isconcentrated in real estate secured loans. Real estate mortgage loans primarily consist of commercial loans securedby real estate.

 

The following table shows thematurity analysis of commercial and real estate construction loans outstandingas of December 31, 2001:

 

|                     |   | **Within One  Year**        |   | **After One  But Within  Five Years** |   | **After  Five  Years** |   | **Total** |   |
|--------------------------|--------|-----------------------------|--------|---------------------------------------|--------|-----------------------------|--------|-----------|--------|
|                     |   | **(dollars  in thousands)** |   |
| Commercial               |   | $                           | 25,356 |                                  | $      | 11,264                      |   | $         | 4,250  |   | $ | 40,870 |   |
| Real estate construction |   | 48,892                      |   | 969                                   |   | 937                         |   | 50,798    |   |
|                     |   |                        |   |                                  |   |                        |   |      |   |
|                     |   | $                           | 74,248 |                                  | $      | 12,233                      |   | $         | 5,187  |   | $ | 91,668 |   |

 

Of these loans maturing afterone year, $13,551,000 have predetermined or fixed interest rates and $3,869,000have floating or adjustable interest rates.

 

**AssetQuality**

 

Non-performing assets consistof loans on which interest is no longer accrued, accruing loans past due 90days or more and foreclosed real estate and other assets.  Totalnon-performing assets amounted to $6,508,000 at December 31, 2001, an increaseof 5% from December 31, 2000.  Non-accrual loans increased $973,000 during 2001 from the December 31,2000 balance of $857,000.  Totalforeclosed real estate, net of a $250,000 allowance for losses, amounted to$4,387,000 at December 31, 2001.  Ofthis amount, $3,250,000 represents one commercial property that is leased to aWashington State Agency and is currently under a purchase option by a thirdparty.  Accruing loans past due 90 daysor more decreased from $1,264,000 to $284,000.  Any anticipatedlosses on these loans have been fully reserved for in the allowance for creditlosses.

 

Loans will be placed onnonaccrual using the following guidelines: 1) a loan will be placed onnonaccrual when collection of all principal or all interest is deemed unlikely;and 2) a loan will automatically be placed on nonaccrual when principal orinterest is 90 days or more past due unless the loan is both well secured andin the process of being collected.  Placing a loan on nonaccrual does notdiminish in any way the Bank’s claims against the borrower.

 

15

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Non-performing assets were asfollows at December 31:

 

|                                    |   | **2001**        |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
|-----------------------------------------|--------|-----------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
|                                    |   | **(thousands)** |   |
| Non-accrual loans                       |   | $               | 1,830  |     | $      | 857      |   | $        | 1,476  |     | $      | 2,492 |   | $ | 4,381 |   |
| Accruing loans past due 90 days or more |   | 284             |   | 1,264    |   | 28       |   | 471      |   | 319      |   |
| Foreclosed real estate                  |   | 4,387           |   | 4,097    |   | 1,890    |   | 1,996    |   | 2,105    |   |
| Other assets                            |   | 7               |   | 7        |   | 24       |   | —   |   | 132      |   |
|                                    |   | $               | 6,508  |     | $      | 6,225    |   | $        | 3,276  |     | $      | 4,959 |   | $ | 6,937 |   |

 

The gross interest income thatwould have been recorded in 2001 if the loans had been current in accordancewith their original terms and had been outstanding throughout the period orsince origination, if held for part of the period, totaled $226,000.  Nointerest income on these loans was included in net income in 2001.

 

The Company is not aware of anyloans continuing to accrue interest at December 31, 2001 that represent orresult from trends or uncertainties which management reasonably expects willmaterially impact future operating results, liquidity, or capitalresources.  Material credits about which management is aware of anyinformation that would raise serious doubts as to the ability of such borrowersto comply with the loan repayment terms, have been fully reserved in theallowance for credit losses.

 

**Allowancefor Credit Losses**

 

The allowance for credit lossesreflects management’s current estimate of the amount required to absorb losseson existing loans and commitments to extend credit.  Loans deemeduncollectible are charged against and reduce the allowance.  Periodically, a provision for credit lossesis charged to current expense.  Thisprovision acts to replenish the allowance for credit losses and to maintain theallowance at a level that management deems adequate.

 

There is no precise method ofpredicting specific credit losses or amounts that ultimately may be charged offon segments of the loan portfolio.  Thedetermination that a loan may become uncollectible, in whole or in part, is amatter of judgment. Similarly, the adequacy of the allowance for credit lossescan be determined only on a judgmental basis, after full review, including (a)consideration of economic conditions and the effect on particular industriesand specific borrowers; (b) a review of borrowers’ financial data, togetherwith industry data, the competitive situation, the borrowers’ managementcapabilities and other factors; (c) a continuing evaluation of the loanportfolio, including monitoring by lending officers and staff credit personnelof all loans which are identified as being of less than acceptable quality; (d)an in-depth appraisal, on a monthly basis, of all loans judged to present apossibility of loss (if, as a result of such monthly appraisals, the loan isjudged to be not fully collectible, the carrying value of the loan is reducedto that portion considered collectible); and (e) an evaluation of theunderlying collateral for secured lending, including the use of independentappraisals of real estate properties securing loans.  A formal analysis of the adequacy of the allowance is conductedquarterly and is reviewed by the Board of Directors.  Based on thisanalysis, management considers the allowance for credit losses to be adequate.

 

Periodic provisions for loanlosses are made to maintain the allowance for credit losses at an appropriatelevel.   The provisions are based on ananalysis of various factors including historical loss experience for the bankand for the industry as a whole, based on volumes and types of loans, volumesand trends in delinquencies and non-accrual loans, trends in portfolio volume,results of internal and independent external credit reviews, and anticipatedeconomic conditions.  Provisions forloan losses on small loans are made monthly to maintain this segment of theallowance for credit losses at a level sufficient to absorb losses on existingloans.  This portion is of the allowanceis generally maintained at a level sufficient to cover all small loans thathave defaulted, as well as an amount sufficient to absorb the anticipatedlosses on two small loan operating cycles, based on both the bank’s and theindustry’s historical loss experience.

 

16

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Transactions in the allowance forcredit losses for the five years ended December 31, 2001 are as follows:

 
|                                                        |   | **2001**                    |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
|-------------------------------------------------------------|--------|-----------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
|                                                        |   | **(dollars  in thousands)** |   |
| Balance at beginning of year                                |   | $                           | 3,503  |     | $      | 5,825    |   | $        | 2,290  |     | $      | 2,122 |   | $ | 1,420 |   |
|                                                        |   |                        |   |     |   |     |   |     |   |     |   |
| Provision for credit losses                                 |   | 1,716                       |   | (50      | )      | 3,730    |   | 425      |   | 1,015    |   |
|                                                        |   |                        |   |     |   |     |   |     |   |     |   |
| Transfer from acquisition of Prairie  Security Bank         |   | —                      |   | —   |   | —   |   | —   |   | 469      |   |
|                                                        |   |                        |   |     |   |     |   |     |   |     |   |
| Charge offs:                                                |   |                        |   |     |   |     |   |     |   |     |   |
| Commercial                                                  |   | (60                         | )      | (2,217   | )      | (116     | )      | (219     | )      | (627     | )      |
| Real Estate Mortgage                                        |   | —                      |   | (77      | )      | (65      | )      | (98      | )      | (69      | )      |
| Small Loans                                                 |   | (2,051                      | )      | —   |   | —   |   | —   |   | —   |   |
| Consumer                                                    |   | (36                         | )      | (57      | )      | (66      | )      | (94      | )      | (111     | )      |
|                                                        |   | (2,147                      | )      | (2,351   | )      | (247     | )      | (411     | )      | (807     | )      |
|                                                        |   |                        |   |     |   |     |   |     |   |     |   |
| Recoveries:                                                 |   |                        |   |     |   |     |   |     |   |     |   |
| Commercial                                                  |   | 12                          |   | 43       |   | 17       |   | 72       |   | 15       |   |
| Real Estate Mortgage                                        |   | 8                           |   | 8        |   | 12       |   | 61       |   | 1        |   |
| Small Loans                                                 |   | 983                         |   | —   |   | —   |   | —   |   | —   |   |
| Consumer                                                    |   | 13                          |   | 28       |   | 23       |   | 17       |   | 9        |   |
|                                                        |   | 1,016                       |   | 79       |   | 52       |   | 154      |   | 25       |   |
|                                                        |   |                        |   |     |   |     |   |     |   |     |   |
| Net charge-offs                                             |   | (1,131                      | )      | (2,272   | )      | (195     | )      | (257     | )      | (782     | )      |
|                                                        |   |                        |   |     |   |     |   |     |   |     |   |
| Balance at end of year                                      |   | $                           | 4,088  |     | $      | 3,503    |   | $        | 5,825  |     | $      | 2,290 |   | $ | 2,122 |   |
|                                                        |   |                        |   |     |   |     |   |     |   |     |   |
| Ratio of net charge-offs to average  loans outstanding |   | .41                         | %      | .89      | %      | .09      | %      | .13      | %      | .44      | %      |

 

In May 1993, the FinancialAccounting Standards Board (FASB) issued SFAS No. 114, “Accounting by Creditorsfor Impairment of a Loan” and in October 1996, issued SFAS No. 118, “Accountingby Creditors for Impairment of a Loan—Income Recognition Disclosures, anamendment to SFAS No. 114”.  The Company measures impaired loans based onthe present value of expected future cash flows discounted at the loan’seffective interest rate or, as a practical expedient, at the loan’s observablemarket price or the fair market value of the collateral if the loan iscollateral dependent.  The Company excludes loans that are currentlymeasured at fair value or at the lower of cost or fair value, and certain largegroups of smaller balance homogeneous loans that are collectively measured forimpairment.  The following table summarizes the Bank’s impaired loans atDecember 31:

 

|                                           |   | **2001** |      | **2000** |   | **1999** |   | **1998** |      | **1997** |   |
|------------------------------------------------|--------|----------|-----------|----------|--------|----------|--------|----------|-----------|----------|--------|
| Total Impaired Loans                           |   | $        | 1,830,000 |     | $      | 857,000  |   | $        | 4,726,000 |     | $      | 2,492,000 |   | $ | 4,381,000 |   |
| Total Impaired Loans with Valuation  Allowance |   | $        | 928,000   |     | $      | 817,000  |   | $        | 3,680,000 |     | $      | 362,000 |   | $ | 992,000 |   |
| Allocation of Allowance for Credit Losses      |   | $        | 528,000   |     | $      | 308,000  |   | $        | 3,347,000 |     | $      | 227,000 |   | $ | 139,000 |   |

 

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

 

17

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

 

In the following table, theallowance for credit losses at December 31, 2001, 2000, 1999, 1998 and 1997 hasbeen allocated among major loan categories based on a number of factorsincluding quality, volume, economic outlook and other business considerations:

 
|        |   | **2001**                    |   | **2000**              |   | **1999**   |   | **1998**              |   | **1997**   |   |
|-------------|--------|-----------------------------|--------|-----------------------|--------|------------|--------|-----------------------|--------|------------|--------|
|        |   | **Amount**                  |   | **% of Total  Loans** |   | **Amount** |   | **% of Total  Loans** |   | **Amount** |   | **% of Total  Loans** |   | **Amount** |   | **% of Total  Loans** |   | **Amount** |   | **% of Total  Loans** |   |
|        |   | **(dollars  in thousands)** |   |
| Commercial  |   | $                           | 1,581  |                  | 14.2   | %          | $      | 1,626                 |   | 14.9       | %      | $ | 3,616 |   | 15.0 | % | $ | 576 |   | 15.2 | % | $ | 678 |   | 19.0 | % |
| Real Estate |   | 2,132                       |   | 81.7                  | %      | 1,800      |   | 81.2                  | %      | 2,112      |   | 81.3 | % | 1,633 |   | 81.5 | % | 1,200 |   | 76.6 | % |
| Consumer    |   | 375                         |   | 4.1                   | %      | 77         |   | 3.9                   | %      | 97         |   | 3.7 | % | 81 |   | 3.3 | % | 244 |   | 4.4 | % |
|        |   |                        |   |                  |   |       |   |                  |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Total       |   | $                           | 4,088  |                  | 100.0  | %          | $      | 3,503                 |   | 100.0      | %      | $ | 5,825 |   | 100.0 | % | $ | 2,290 |   | 100.0 | % | $ | 2,122 |   | 100.0 | % |

 

**Deposits**

 

Total deposits increased by$42,353,000, or 16% from 2000 to $313,730,000.  Non-interest bearingdeposits increased 13% to $55,013,000 in 2001, from $48,715,000 in 2000. Savings and interest bearing deposits and time deposits increased by$36,055,000, or 16%, to $258,717,000.

 

The Bank’s average deposits forthe year ended December 31, 2001 are summarized as follows:

 
|                    |   | **2001**                    |    | **2000** |   | **1999**                   |   |
|-------------------------|--------|-----------------------------|---------|----------|--------|----------------------------|--------|
|                    |   | **Amount**                  |    | **%**    |   | **Weighted  Average Rate** |   | **Amount** |   | **%** |   | **Weighted  Average Rate** |   | **Amount** |   | **%** |   | **Weighted  Average Rate** |   |
|                    |   | **(dollars  in thousands)** |    |
| Demand Deposits         |   | $                           | 52,692  |     | 17.4   |                       |   |   | $ | 45,857 |   | 17.4 |   |   |   | $ | 46,541 |   | 19.3 |   |   |   |
| Interest bearing demand |   | 87,465                      |    | 28.8     |   | 2.30                       | %      | 75,245 |   | 28.5 |   | 2.47 | % | 85,008 |   | 35.2 |   | 2.69 | % |
| Savings Accounts        |   | 24,287                      |    | 8.0      |   | 1.69                       | %      | 24,411 |   | 9.3 |   | 2.18 | % | 25,738 |   | 10.7 |   | 2.28 | % |
| Other time deposits     |   | 138,957                     |    | 45.8     |   | 5.46                       | %      | 118,085 |   | 44.8 |   | 5.93 | % | 84,155 |   | 34.8 |   | 5.04 | % |
|                    |   |                        |    |     |   |                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| TOTAL                   |   | $                           | 303,401 |     | 100.0  |                       |   |   | $ | 263,598 |   | 100.0 |   |   |   | $ | 241,441 |   | 100.0 |   |   |   |

 

Time deposits at December 31,2001 are scheduled to mature as follows:

 

|         |   | **Under  $100,000**         |   | **$ 100,000  and over** |   | **Total** |   |
|--------------|--------|-----------------------------|--------|-------------------------|--------|-----------|--------|
|         |   | **(dollars  in thousands)** |   |
| 0-90 days    |   | $                           | 42,679 |                    | $      | 30,137    |   | $ | 72,816 |   |
| 91-180 days  |   | 16,757                      |   | 5,801                   |   | 22,558    |   |
| 181-365 days |   | 24,109                      |   | 6,784                   |   | 30,893    |   |
| Over 1 year  |   | 6,251                       |   | 3,106                   |   | 9,357     |   |
|         |   | $                           | 89,796 |                    | $      | 45,828    |   | $ | 135,624 |   |

 

**Capital**

 

Consolidated capital of FCFGincreased $4,422,000 during 2001 to $38,795,000.  In addition to netearnings of $4,437,000, the exercise of stock options added $27,000, increasesin the market value of available for sale securities, net of tax, amounted to$644,000, tax benefits associated with the exercise of stock options provided$10,000 and payments by the KSOP on the debt related to the Company’s KSOPamounted to $178,000.  Decreases to capital came from the payment of cashdividends of $0.40

 

18

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per share, or $874,000. Cash dividends totaling $0.40 per share were paid in 2001 and 2000, anddividends totaling $0.58 per share were paid in 1999.  No cash dividendswere paid in 1998.

 

There are regulatoryconstraints placed upon capital adequacy, however it is necessary to maintainan appropriate ratio between capital and assets.  Regulations requirebanks and holding companies to maintain a minimum “leverage” ratio (primarycapital ratio) of total assets.  For the most highly rated holdingcompanies this ratio must be at least 3%, and for others it must be 4 to5%.  At December 31, 2001, the Company’s leverage ratio was 8.91%,compared to 8.96% at year-end 2000.  For regulatory purposes, any goodwilland other intangible assets are treated as a reduction of capital.  Inaddition, holding companies are required to meet minimum risk-based capitalguidelines under which risk percentages are assigned to various categories ofassets and off-balance-sheet items to calculate a risk-adjusted capitalratio.  Tier I capital generally consists of common stockholders’ equity,less goodwill and other intangible assets, while Tier II capital includes theallowance for credit losses, subject to 1.25% limitation of risk-adjustedassets.  The rules require Tier II capital of 4% of risk-adjusted assetsand total capital (combined Tier I and Tier II) of 8%.  At December 31,2001, the Tier I capital ratio was 9.34%, and total capital was 10.52%. The similar ratios at December 31, 2000 were a Tier I capital ratio of 9.24%and a total capital ratio of 10.39%.

 

Information concerningshort-term borrowings is summarized as follows:

 
|                                      |   | **2001** |   | **2000** |   | **1999** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Average balance during the year           |   | $        | 6,441  |     | $      | 14,050   |   | $ | 6,002 |   |
| Average interest rate during the year     |   | 4.0      | %      | 6.4      | %      | 5.0      | %      |
| Maximum month-end balance during the year |   | $        | 17,202 |     | $      | 20,148   |   | $ | 13,535 |   |
| Weighted average rate at December 31,     |   | 2.0      | %      | 6.8      | %      | 4.6      | %      |
| Balance at end of year                    |   | $        | 7,055  |     | $      | 14,001   |   | $ | 13,535 |   |

 

Borrowings represent federalfunds purchased, generally maturing within one to four days, demand notes from theU.S. Treasury, and advances from the Federal Home Loan Bank of Seattle,normally maturing within one year.

 

**SupplementaryQuarterly Data**

 
|                        |   | **Quarter  Ended**                                    |   |
|-----------------------------|--------|-------------------------------------------------------|--------|
|                        |   | **Dec 2001**                                          |   | **Sept 2001** |   | **June 2001** |   | **March 2001** |   | **Dec 2000** |   | **Sept 2000** |   | **June 2000** |   | **March 2000** |   |
|                        |   | **(Dollars  in thousands, except per share amounts)** |   |
| Interest income             |   | $                                                     | 6,990  |   | $ | 7,968 |   | $ | 7,664 |   | $ | 7,166 |   | $ | 6,690 |   | $ | 6,904 |   | $ | 6,717 |   | $ | 6,653 |   |
| Interest expense            |   | 2,221                                                 |   | 2,580 |   | 2,755 |   | 2,834 |   | 2,768 |   | 2,740 |   | 2,695 |   | 2,207 |   |
| Net interest income         |   | 4,769                                                 |   | 5,388 |   | 4,909 |   | 4,332 |   | 3,922 |   | 4,164 |   | 4,022 |   | 4,446 |   |
|                        |   |                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Provision for credit losses |   | 758                                                   |   | 513 |   | 300 |   | 145 |   | 460 |   | 120 |   | 120 |   | 170 |   |
| Non-interest income         |   | 1,936                                                 |   | 1,601 |   | 1,296 |   | 1,491 |   | 1,133 |   | 1,398 |   | 1,168 |   | 1,276 |   |
| Non-interest expense        |   | 4,445                                                 |   | 4,664 |   | 4,476 |   | 4,119 |   | 3,763 |   | 3,799 |   | 3,720 |   | 3,816 |   |
| Income taxes                |   | 396                                                   |   | 547 |   | 437 |   | 488 |   | 521 |   | 551 |   | 451 |   | 597 |   |
|                        |   |                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                  |   | $                                                     | 1,106  |   | $ | 1,268 |   | $ | 992 |   | $ | 1,071 |   | $ | 1,231 |   | $ | 1,092 |   | $ | 899 |   | $ | 1,139 |   |
|                        |   |                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic earnings per share    |   | $                                                     | 0.51   |   | $ | 0.58 |   | $ | 0.46 |   | $ | 0.49 |   | $ | 0.56 |   | $ | 0.51 |   | $ | 0.42 |   | $ | 0.53 |   |

 

**ITEM7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The Company’s assets andliabilities are managed to maximize long-term shareholder returns by optimizingnet interest income within the constraints of maintaining high credit quality,conservative interest rate risk disciplines and prudent levels ofliquidity.  The Asset/Liability Committee meets regularly to monitor thecomposition of the balance sheet, to assess current and projected interest ratetrends, and to formulate strategies consistent with established objectives forliquidity, interest rate risk and capital adequacy.

 

19

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Liquidity management involvesthe ability to meet cash flow requirements of customers who may be eitherdepositors withdrawing funds or borrowers needing assurance that sufficientfunds will be available to meet their credit needs.  Liquidity isgenerated from both internal and external sources.  Internal sourcesinclude assets that can be converted to cash with little or no risk ofloss.  These include overnight investments in federal funds sold andinvestment securities available for sale, particularly those of shortermaturity, and are the principal source of asset liquidity.  At December31, 2001, cash, deposits in banks, interest-bearing deposits in banks andsecurities available for sale totaled $39,561,000.  External sources referto the ability to attract new liabilities and capital.  They includeincreasing savings and demand deposits, federal funds purchased, and theissuance of capital and debt securities.  At December 31, 2001, overnightand federal funds lines of credit totaled $37,062,000.  These credit lineswere accessed regularly as a source of funding during 2001 and amounted to$7,055,000 at December 31, 2001.

 

Management believes the Bank’sliquidity position at December 31, 2001, was adequate to meet its short termfunding requirements.

 

Interest rate sensitivity isclosely related to liquidity, as each is directly affected by the maturity ofassets and liabilities.  The Company’s net interest margin is affected bychanges in the level of market interest rates.  Management’s objectivesare to monitor and control interest rate risk and ensure predictable andconsistent growth in net interest income.

 

Management considers any assetor liability that matures, or is subject to repricing within one year to beinterest sensitive, although continual monitoring is performed for other timeintervals as well.  The difference between interest sensitive assets andliabilities for a defined period of time is known as the interest sensitivity“gap”, and may be either positive or negative.  If positive, more assetsreprice before liabilities.  If negative, the reverse is true.  Gapanalysis provides a general measure of interest rate risk but does not addresscomplexities such as prepayment risk, interest rate floors and ceilings imposedon financial instruments, interest rate dynamics and customers’ response tointerest rate changes.  Currently the Bank’s interest sensitivity gap isnegative within one year.  Assuming that general market interest ratechanges affect the repricing of assets and liabilities in equal magnitudes, theeffect of rising interest rates on the Company would be a decrease in the netinterest margin, whereas falling interest rates would cause a correspondingincrease in the margin.

 

| **Interest  Rate Gap Analysis**          |   |
|------------------------------------------|--------|
| **December  31, 2001**                   |   |
|                                     |   |
|                                     |   | **Within One  Year** |   | **After  One  But Within Five Years** |   | **After Five  Years** |   | **Total** |   |
|                                     |   | **(thousands)** |   |
| Loans                                    |   | $ | 111,374 |   | $ | 137,665 |   | $ | 39,662 |   | $ | 288,701 |   |
| Securities:                              |   |   |   |   |   |   |   |   |   |
| Available for sale                       |   | 2,937 |   | 7,153 |   | 8,014 |   | 18,104 |   |
| Held to maturity                         |   | — |   | 506 |   | — |   | 506 |   |
| Interest bearing deposits with banks     |   | 74 |   | — |   | — |   | 74 |   |
| Total Earning Assets                     |   | $ | 114,385 |   | $ | 145,324 |   | $ | 47,676 |   | $ | 307,385 |   |
|                                     |   |   |   |   |   |   |   |   |   |
| Deposits:                                |   |   |   |   |   |   |   |   |   |
| Savings, NOW and money market            |   | $ | 123,093 |   | $ | — |   | $ | — |   | $ | 123,093 |   |
| Time deposits                            |   | 126,267 |   | 9,357 |   | — |   | 135,624 |   |
| Short-term borrowings                    |   | 7,055 |   | — |   | — |   | 7,055 |   |
| Long-term debt                           |   | 575 |   | — |   | — |   | 575 |   |
|                                     |   |   |   |   |   |   |   |   |   |
| Total Interest Bearing Liabilities       |   | $ | 256,990 |   | $ | 9,357 |   | $ | — |   | $ | 266,347 |   |
|                                     |   |   |   |   |   |   |   |   |   |
| Net Interest Rate Sensitivity Gap        |   | $ | (142,605 | ) | $ | 135,967 |   | $ | 47,676 |   | $ | 41,038 |   |
| Cumulative Interest Rate Sensitivity Gap |   | $ | (142,605 | ) | $ | (6,638 | ) | $ | 41,038 |   |   |   |
| Cumulative Gap as a Percent of Assets    |   | (46% | ) | (2% | ) | 13 | % |   |   |

 

The Company’s market risk isimpacted by changes in interest rates.  Other types of market risk, suchas foreign currency exchange rate risk and commodity price risk, do not arisein the normal course of the Company’s business.

 

The Company has market risk inthe form of interest rate risk on its financial assets.  In an effort tounderstand the relative impact of this risk on the Company’s current financialsituation, a process known as a rate shock is applied to the current financialassets.

 

20

----

 

Rate shock is a process wherein the characteristics ofthe financial assets of the Company are reviewed in the event they aresubjected to an instantaneous and complete adjustment in the market rate ofinterest.  These results are modeled to determine the effects on interestrate margin for the succeeding twelve months from the repricing of variablerate assets and liabilities where applicable.  The level of impact on thevarious assets and liabilities are also estimated for their sensitivity topricing changes of such a market interest rate change.

 

According to this model and its assumptions, thechange in net interest margin in the event market interest rates were toimmediately rise or fall by 100 basis points is estimated to be $176,000. This amount represents approximately 0.9% of the 2001 net interest income.

 

As discussed in Note 1 of theaudited financial statements, in June 2001, the Financial Accounting StandardsBoard adopted Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets*,which addresses how goodwill and other intangible assets should be accountedfor after they have been initially recorded in the financial statements.  Goodwill arising from business combinationsprior to the effective date of this standard will no longer be amortized,starting in 2001, but will be subject to annual tests for impairment.  At December 31, 2001, The Company has$4,159,000 of goodwill in which amortization will cease effective January 1,2001.  This is anticipated to have theeffect of reducing non-interest expense $207,000 annually.

 

21

----

 

**ITEM 8 -FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**IndependentAuditor’s Report**

 

Board of Directors

**First Community Financial Group, Inc.**

Lacey, Washington

 

We have audited theaccompanying consolidated balance sheet of **First Community Financial Group, Inc. and Subsidiary**as of December 31, 2001, and the related consolidated statements of income,shareholders’ equity and cash flows for the year then ended.  These consolidated financial statements arethe responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audit.

 

We conducted our audit inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether theconsolidated financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditprovides a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of **First Community Financial Group, Inc.and Subsidiary** as of December 31, 2001, and the results of theiroperations and their cash flows for the year then ended, in conformity withaccounting principles generally accepted in the United States of America.

 
| /s/ McGladrey &  Pullen, LLP |   |
|----------------------------------|--------|
|                             |
| Tacoma, Washington               |
| January 11, 2002                 |

 

22

----

 

**Independent Auditor's Report**

** **

Board of Directors

**First Community Financial Group, Inc.**

Lacey, Washington

 

Wehave audited the accompanying consolidated balance sheet of **FirstCommunity Financial Group, Inc. and Subsidiary** as of December 31,2000, and the related consolidated statements of income, shareholders’ equityand cash flows for the years ended December 31, 2000 and 1999.  These consolidated financial statements arethe responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted our audits inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether theconsolidated financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of **First Community Financial Group, Inc.and Subsidiary** as of December 31, 2000, and the results of theiroperations and their cash flows for the years ended December 31, 2000 and 1999,in conformity with accounting principles generally accepted in the UnitedStates of America.

 
| /s/ Knight Vale & Gregory PLLC |   |
|------------------------------------|--------|
|                               |
| Tacoma, Washington                 |
| January 12, 2001                   |

 

23

----

 

**ConsolidatedBalance Sheets**

(Dollars in Thousands)

 

First Community Financial Group, Inc. andSubsidiary

December 31, 2001 and 2000

 
|                                                                                                                           |   | **2001**    |        | **2000**    | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|-------------|------------|
| **Assets**                                                                                                                     |   |        |        |        |       |
| Cash and due from banks                                                                                                        |   | $           | 21,383      |        | $          | 12,640 |   |
| Interest bearing deposits at  other financial institutions                                                                     |   | 74          |        | 172         |       |
| Securities available for sale                                                                                                  |   | 18,104      |        | 24,875      |       |
| Securities held to maturity  (market value:  2001 - $554; 2000 -  $702)                                                   |   | 506         |        | 676         |       |
| Federal  Home Loan Bank stock, at cost                                                                                         |   | 1,985       |        | 1,854       |       |
| Loans held for sale                                                                                                            |   | 6,196       |        | 4,121       |       |
|                                                                                                                           |   |        |        |        |       |
| Loans                                                                                                                          |   | 288,701     |        | 255,183     |       |
| Allowance for credit losses                                                                                                    |   | (4,088      | )           | (3,503      | )          |
| **Net loans**                                                                                                                  |   | **284,613** | ** **  | **251,680** | ** ** |
|                                                                                                                           |   |        |        |        |       |
| Premises and equipment                                                                                                         |   | 10,382      |        | 10,067      |       |
| Foreclosed real estate                                                                                                         |   | 4,387       |        | 4,097       |       |
| Accrued interest receivable                                                                                                    |   | 1,471       |        | 1,817       |       |
| Cash value of life insurance                                                                                                   |   | 8,453       |        | 3,110       |       |
| Goodwill                                                                                                                       |   | 4,159       |        | 4,366       |       |
| Other intangible assets                                                                                                        |   | 2,109       |        | 2,310       |       |
| Other assets                                                                                                                   |   | 801         |        | 2,450       |       |
|                                                                                                                           |   |        |        |        |       |
| **Total assets**                                                                                                               |   | **$**       | **364,623** | ** **  | **$**      | **324,235** | ** ** |
|                                                                                                                           |   |        |        |        |       |
| **Liabilities**                                                                                                                |   |        |        |        |       |
| Deposits:                                                                                                                      |   |        |        |        |       |
| Demand                                                                                                                         |   | $           | 55,013      |        | $          | 48,715 |   |
| Savings and interest-bearing  demand                                                                                           |   | 123,093     |        | 98,036      |       |
| Time                                                                                                                           |   | 135,624     |        | 124,626     |       |
| **Total deposits**                                                                                                             |   | **313,730** | ** **  | **271,377** | ** ** |
|                                                                                                                           |   |        |        |        |       |
| Federal funds purchased                                                                                                        |   | 1,400       |        | 2           |       |
| Short-term borrowings                                                                                                          |   | 5,655       |        | 13,999      |       |
| Long-term debt                                                                                                                 |   | 575         |        | 1,303       |       |
| Accrued interest payable                                                                                                       |   | 364         |        | 450         |       |
| Other liabilities                                                                                                              |   | 4,104       |        | 2,731       |       |
|                                                                                                                           |   |        |        |        |       |
| **Total liabilities**                                                                                                          |   | **325,828** | ** **  | **289,862** | ** ** |
|                                                                                                                           |   |        |        |        |       |
| **Commitments and Contingent Liabilities**                                                                                     |   | **—**  | ** **  | **—**  | ** ** |
|                                                                                                                           |   |        |        |        |       |
| **Stockholders’ Equity**                                                                                                  |   |        |        |        |       |
| Preferred stock (no par  value); 200,000 shares authorized, none issued                                                        |   | —      |        | —      |       |
| Common stock (par value:  $2.50); 10,000,000 shares authorized,  shares issued:  2001 - 2,186,681; 2000  - 2,184,003 |   | 5,467       |        | 5,460       |       |
| Additional paid-in capital                                                                                                     |   | 23,129      |        | 23,099      |       |
| Retained earnings                                                                                                              |   | 9,912       |        | 6,349       |       |
| Accumulated other  comprehensive income (loss)                                                                                 |   | 312         |        | (332        | )          |
| Unearned KSOP shares                                                                                                           |   | (25         | )           | (203        | )          |
| **Total stockholders’ equity**                                                                                            |   | **38,795**  | ** **  | **34,373**  | ** ** |
|                                                                                                                           |   |        |        |        |       |
| **Total liabilities and stockholders’ equity**                                                                            |   | **$**       | **364,623** | ** **  | **$**      | **324,235** | ** ** |

 

*See notes toconsolidated financial statements.*

 

24

----

 

**ConsolidatedStatements of Income**

(Dollars in Thousands, Except Per Share Data)

 

First Community Financial Group, Inc. andSubsidiary

Years Ended December 31, 2001, 2000 and 1999

 
|                                                       |   | **2001**   |       | **2000**   | ** ** | **1999**   | ** ** |
|------------------------------------------------------------|--------|------------|------------|------------|------------|------------|------------|
|                                                       |   |       | ** ** |
| **Interest Income**                                        |   |       |       |       |       |       |       |
| Loans                                                      |   | $          | 28,197     |       | $          | 25,110     |       | $ | 20,518 |   |
| Federal  funds sold and deposits in banks                  |   | 122        |       | 98         |       | 112        |       |
| Investment securities:                                     |   |       |       |       |       |       |       |
| Taxable                                                    |   | 1,091      |       | 1,369      |       | 1,560      |       |
| Non-taxable                                                |   | 378        |       | 387        |       | 380        |       |
| **Total interest income**                                  |   | **29,788** | ** ** | **26,964** | ** ** | **22,570** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Interest Expense**                                       |   |       |       |       |       |       |       |
| Deposits                                                   |   | 10,073     |       | 9,391      |       | 7,042      |       |
| Short-term  borrowings                                     |   | 256        |       | 900        |       | 309        |       |
| Long-term  borrowings                                      |   | 61         |       | 119        |       | 141        |       |
| **Total interest expense**                                 |   | **10,390** | ** ** | **10,410** | ** ** | **7,492**  | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Net interest income**                                    |   | **19,398** | ** ** | **16,554** | ** ** | **15,078** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Provision for Credit Losses**                            |   | 1,716      |       | (50        | )          | 3,730      |       |
|                                                       |   |       |       |       |       |       |       |
| **Net interest income after provision for  credit losses** |   | **17,682** | ** ** | **16,604** | ** ** | **11,348** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Non-Interest Income**                                    |   |       |       |       |       |       |       |
| Service  charges on deposit accounts                       |   | 2,462      |       | 1,922      |       | 1,949      |       |
| Origination  fees and gains on sales of loans              |   | 2,047      |       | 999        |       | 1,160      |       |
| Other operating income                                     |   | 1,815      |       | 2,054      |       | 1,510      |       |
| **Total non-interest income**                              |   | **6,324**  | ** ** | **4,975**  | ** ** | **4,619**  | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Non-Interest Expenses**                                  |   |       |       |       |       |       |       |
| Salaries and  employee benefits                            |   | 9,589      |       | 8,071      |       | 7,945      |       |
| Occupancy                                                  |   | 1,174      |       | 1,023      |       | 1,003      |       |
| Equipment                                                  |   | 1,255      |       | 1,163      |       | 1,200      |       |
| Amortization of goodwill                                   |   | 207        |       | 207        |       | 207        |       |
| Amortization of intangible assets                          |   | 201        |       | 201        |       | 201        |       |
| Other                                                      |   | 5,275      |       | 4,433      |       | 3,553      |       |
| **Total non-interest expenses**                            |   | **17,701** | ** ** | **15,098** | ** ** | **14,109** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Income before income taxes**                             |   | **6,305**  | ** ** | **6,481**  | ** ** | **1,858**  | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Income Taxes**                                           |   | 1,868      |       | 2,120      |       | 498        |       |
|                                                       |   |       |       |       |       |       |       |
| **Net income**                                             |   | **$**      | **4,437**  | ** ** | **$**      | **4,361**  | ** ** | **$** | **1,360** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Earnings Per Share**                                     |   |       |       |       |       |       |       |
| Basic                                                      |   | $          | 2.04       |       | $          | 2.02       |       | $ | .64 |   |
| Diluted                                                    |   | 1.99       |       | 1.96       |       | .60        |       |

 

*See notes toconsolidated financial statements.*

 

25

----

 

**ConsolidatedStatements of Stockholders’ Equity**

(Dollars in Thousands)

First Community Financial Group, Inc. andSubsidiary

Years Ended December 31, 2001, 2000 and 1999

 
|                                                  |   | **Shares of****Common   Stock** |       | **Common Stock** |       | **Additional**** ****Paid-in   Capital** |       | **Retained Earnings** |       | **Accumulated** **Other********Comprehensive    Income  (Loss)** |   | **Unearned****KSOP  Shares** |   | **Total**  |       |
|-------------------------------------------------------|--------|---------------------------------|------------|-----------------------|------------|-----------------------------------------------|------------|----------------------------|------------|-----------------------------------------------------------------------|--------|------------------------------|--------|------------|------------|
| Balance, January 1, 1999                              |   | 2,126,147                       |       | $                     | 5,315      |                                          | $          | 22,849                     |       | $                                                                     | 2,757  |                         | $      | 28         |       | $ | (608 | ) | $ | 30,341 |   |
|                                                  |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| Comprehensive income:                                 |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| Net income                                            |   | —                          |       | —                |       | —                                        |       | 1,360                      |       | —                                                                |   | —                       |   | 1,360      |       |
| Other comprehensive loss, net of tax:                 |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| Change in fair value of securities available for sale |   | —                          |       | —                |       | —                                        |       | —                     |       | (756                                                                  | )      | —                       |   | (756       | )          |
| **Comprehensive  income**                             |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   | **604**    |       |
|                                                  |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| Stock options exercised                               |   | 51,020                          |       | 128                   |       | 402                                           |       | —                     |       | —                                                                |   | —                       |   | 530        |       |
| Cash dividends paid ($.58 per share)                  |   | —                          |       | —                |       | —                                        |       | (1,262                     | )          | —                                                                |   | —                       |   | (1,262     | )          |
| Income tax benefit from exercise of stock options     |   | —                          |       | —                |       | 177                                           |       | —                     |       | —                                                                |   | —                       |   | 177        |       |
| Net decrease in unearned KSOP shares                  |   | —                          |       | —                |       | —                                        |       | —                     |       | —                                                                |   | 228                          |   | 228        |       |
|                                                  |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| **Balance, December 31, 1999**                        |   | **2,177,167**                   | ** ** | **5,443**             | ** ** | **23,428**                                    | ** ** | **2,855**                  | ** ** | **(728**                                                              | **)**  | **(380**                     | **)**  | **30,618** | ** ** |
|                                                  |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| Comprehensive income:                                 |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| Net income                                            |   | —                          |       | —                |       | —                                        |       | 4,361                      |       | —                                                                |   | —                       |   | 4,361      |       |
| Other comprehensive income, net of tax:               |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| Change in fair value of securities available for sale |   | —                          |       | —                |       | —                                        |       | —                     |       | 396                                                                   |   | —                       |   | 396        |       |
| **Comprehensive  income**                             |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   | **4,757**  |       |
|                                                  |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| Stock options exercised                               |   | 46,834                          |       | 117                   |       | 398                                           |       | —                     |       | —                                                                |   | —                       |   | 515        |       |
| Stock repurchased                                     |   | (39,998                         | )          | (100                  | )          | (834                                          | )          | —                     |       | —                                                                |   | —                       |   | (934       | )          |
| Cash dividends paid ($.40 per share)                  |   | —                          |       | —                |       | —                                        |       | (867                       | )          | —                                                                |   | —                       |   | (867       | )          |
| Income tax benefit from exercise of stock options     |   | —                          |       | —                |       | 107                                           |       | —                     |       | —                                                                |   | —                       |   | 107        |       |
| Net decrease in unearned KSOP shares                  |   | —                          |       | —                |       | —                                        |       | —                     |       | —                                                                |   | 177                          |   | 177        |       |
|                                                  |   |                            |       |                  |       |                                          |       |                       |       |                                                                  |   |                         |   |       |       |
| **Balance, December 31, 2000**                        |   | **2,184,003**                   | ** ** | **5,460**             | ** ** | **23,099**                                    | ** ** | **6,349**                  | ** ** | **(332**                                                              | **)**  | **(203**                     | **)**  | **34,373** | ** ** |
|                                                       |        |                                 |            |                       |            |                                               |            |                            |            |                                                                       |        |                              |        |            |            |  |  |  |  |  |  |

 

*See notes to consolidated financialstatements*

 

26

----

 
|                                                  |   | **Shares of****Common  Stock** |       | **Common  Stock** |      | **Additional****Paid-in   Capital** |   | **Retained  Earnings** |       | **Accumulated  Other********Comprehensive    Income  (Loss)** |      | **Unearned****KSOP  Shares** |   | **Total** |       |
|-------------------------------------------------------|--------|--------------------------------|------------|-------------------|-----------|-------------------------------------|--------|------------------------|------------|---------------------------------------------------------------|-----------|------------------------------|--------|-----------|------------|
| Balance, December 31, 2000                            |   | 2,184,003                      |       | $                 | 5,460     |                                | $      | 23,099                 |       | $                                                             | 6,349     |                         | $      | (332      | )          | $ | (203 | ) | $ | 34,373 |   |
|                                                  |   |                           |       |              |      |                                |   |                   |       |                                                          |      |                         |   |      |       |
| Comprehensive income:                                 |   |                           |       |              |      |                                |   |                   |       |                                                          |      |                         |   |      |       |
| Net income                                            |   | —                         |       | —            |      | —                              |   | 4,437                  |       | —                                                        |      | —                       |   | 4,437     |       |
| Other comprehensive income, net of tax:               |   |                           |       |              |      |                                |   |                   |       |                                                          |      |                         |   |      |       |
| Change in fair value of securities available for sale |   | —                         |       | —            |      | —                              |   | —                 |       | 644                                                           |      | —                       |   | 644       |       |
| **Comprehensive  income**                             |   | **5,081**                      |       |              |      |                                |   |                   |       |                                                          |      |                         |   |      |       |
|                                                  |   |                           |       |              |      |                                |   |                   |       |                                                          |      |                         |   |      |       |
| Stock options exercised                               |   | 2,678                          |       | 7                 |      | 20                                  |   | —                 |       | —                                                        |      | —                       |   | 27        |       |
| Cash dividends paid ($.40 per share)                  |   | —                         |       | —            |      | —                              |   | (874                   | )          | —                                                        |      | —                       |   | (874      | )          |
| Income tax benefit from exercise of stock options     |   | —                         |       | —            |      | 10                                  |   | —                 |       | —                                                        |      | —                       |   | 10        |       |
| Net decrease in unearned KSOP shares                  |   | —                         |       | —            |      | —                              |   | —                 |       | —                                                        |      | 178                          |   | 178       |       |
|                                                  |   |                           |       |              |      |                                |   |                   |       |                                                          |      |                         |   |      |       |
| **Balance,  December 31, 2001**                       |   | **2,186,681**                  | ** ** | **$**             | **5,467** | ** **                          | **$**  | **23,129**             | ** ** | **$**                                                         | **9,912** | ** **                   | **$**  | **312**   | ** ** | **$** | **(25** | **)** | **$** | **38,795** | ** ** |
|                                                       |        |                                |            |                   |           |                                     |        |                        |            |                                                               |           |                              |        |           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*See notes toconsolidated financial statements.*

 

27

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**ConsolidatedStatements of Cash Flows**

(Dollars in Thousands)

First Community Financial Group, Inc. and Subsidiary Years EndedDecember 31, 2001, 2000 and 1999

 
|                                                                               |   | **2001**    |       | **2000**    |       | **1999**    |       |
|------------------------------------------------------------------------------------|--------|-------------|------------|-------------|------------|-------------|------------|
| **Cash Flows from Operating Activities**                                           |   |        |       |        |       |        |       |
| Net income                                                                         |   | $           | 4,437      |        | $          | 4,361       |       | $ | 1,360 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |   |        |       |        |       |        |       |
| Provision for credit losses                                                        |   | 1,716       |       | (50         | )          | 3,730       |       |
| Depreciation and amortization                                                      |   | 1,134       |       | 1,085       |       | 1,096       |       |
| Deferred income taxes  (benefit)                                                   |   | (215        | )          | 942         |       | (1,119      | )          |
| Stock dividends received                                                           |   | (131        | )          | (115        | )          | (122        | )          |
| Amortization of goodwill                                                           |   | 207         |       | 207         |       | 207         |       |
| Amortization of other  intangible asset                                            |   | 201         |       | 201         |       | 201         |       |
| Origination of loans held for  sale                                                |   | (99,491     | )          | (44,119     | )          | (48,753     | )          |
| Proceeds from sales of loans held for sale                                         |   | 97,824      |       | 43,154      |       | 50,258      |       |
| (Increase) decrease in cash  value of life insurance                               |   | (264        | )          | (96         | )          | (7          | )          |
| Gain on sales of foreclosed  real estate                                           |   | (22         | )          | (48         | )          | (11         | )          |
| Gain on sale of premises and  equipment                                            |   | —      |       | (198        | )          | —      |       |
| (Increase) decrease in  accrued interest receivable                                |   | 346         |       | (591        | )          | (106        | )          |
| Increase (decrease) in  accrued interest payable                                   |   | (86         | )          | 151         |       | 2           |       |
| Other - net                                                                        |   | 2,640       |       | (510        | )          | 432         |       |
| **Net cash provided by operating activities**                                      |   | **8,296**   | ** ** | **4,374**   | ** ** | **7,168**   | ** ** |
|                                                                               |   |        |       |        |       |        |       |
| **Cash Flows from Investing Activities**                                           |   |        |       |        |       |        |       |
| Net (increase) decrease in  interest bearing deposits in banks                     |   | 98          |       | (36         | )          | (9          | )          |
| Net decrease in federal funds  sold                                                |   | —      |       | —      |       | 2,815       |       |
| Activity in securities  available for sale:                                        |   |        |       |        |       |        |       |
| Maturities, prepayments and  calls                                                 |   | 7,987       |       | 2,602       |       | 19,507      |       |
| Purchases                                                                          |   | (9          | )          | —      |       | (13,764     | )          |
| Activity in securities held  to maturity:                                          |   |        |       |        |       |        |       |
| Maturities, prepayments and  calls                                                 |   | 170         |       | —      |       | —      |       |
| Net increase in loans                                                              |   | (35,544     | )          | (28,167     | )          | (39,345     | )          |
| Purchase of life insurance  policies                                               |   | (5,079      | )          | —      |       | —      |       |
| Proceeds from sales of  foreclosed assets                                          |   | 263         |       | 817         |       | 753         |       |
| Additions to premises and  equipment                                               |   | (1,449      | )          | (2,175      | )          | (1,228      | )          |
| Proceeds from sales of  premises and equipment                                     |   | —      |       | 408         |       | 444         |       |
| Other - net                                                                        |   | —      |       | (12         | )          | —      |       |
| **Net cash used in investing activities**                                          |   | **(33,563** | **)**      | **(26,563** | **)**      | **(30,827** | **)**      |
|                                                                                    |        |             |            |             |            |             |            |  |  |  |

 

28

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|                                                                         |   | **2001**   |       | **2000**   |       | **1999**   |       |
|------------------------------------------------------------------------------|--------|------------|------------|------------|------------|------------|------------|
| **Cash Flows from Financing Activities**                                     |   |       |       |       |       |       |       |
| Net increase in deposits                                                     |   | $          | 42,353     |       | $          | 25,850     |       | $ | 9,940 |   |
| Net increase (decrease) in  short-term borrowings                            |   | (6,946     | )          | 466        |       | 13,035     |       |
| Proceeds from exercise of  stock options                                     |   | 27         |       | 515        |       | 530        |       |
| Repayment of long-term debt                                                  |   | (550       | )          | (550       | )          | (550       | )          |
| Repurchase of common stock                                                   |   | —     |       | (934       | )          | —     |       |
| Payment of cash dividends                                                    |   | (874       | )          | (867       | )          | (1,262     | )          |
| **Net cash provided by financing activities**                                |   | **34,010** | ** ** | **24,480** | ** ** | **21,693** | ** ** |
|                                                                         |   |       |       |       |       |       |       |
| **Net increase (decrease) in cash and due  from banks**                      |   | **8,743**  | ** ** | **2,291**  | ** ** | **(1,966** | **)**      |
|                                                                         |   |       |       |       |       |       |       |
| **Cash and Due from Banks**                                                  |   |       |       |       |       |       |       |
| Beginning of year                                                            |   | 12,640     |       | 10,349     |       | 12,315     |       |
|                                                                         |   |       |       |       |       |       |       |
| **End of year**                                                              |   | **$**      | **21,383** | ** ** | **$**      | **12,640** | ** ** | **$** | 10,349 | ** ** |
|                                                                         |   |       |       |       |       |       |       |
| **Supplemental Disclosures of Cash Flow  Information**                       |   |       |       |       |       |       |       |
| Cash payments for:                                                           |   |       |       |       |       |       |       |
| Interest                                                                     |   | $          | 10,476     |       | $          | 10,259     |       | $ | 7,490 |   |
| Income taxes                                                                 |   | 1,695      |       | 2,127      |       | 1,105      |       |
|                                                                         |   |       |       |       |       |       |       |
| **Supplemental Disclosures of Non-Cash  Investing and Financing Activities** |   |       |       |       |       |       |       |
| Foreclosed real estate  acquired in settlement of loans                      |   | $          | 497        |       | $          | 4,147      |       | $ | 822 |   |
| Financed sale of foreclosed  real estate                                     |   | —     |       | 610        |       | 136        |       |
| Fair value adjustment of  securities available for sale, net                 |   | 644        |       | 396        |       | (756       | )          |
| Net decrease in unearned KSOP  shares                                        |   | (178       | )          | (177       | )          | (228       | )          |
| Income tax benefit from  exercise of stock options                           |   | 10         |       | 107        |       | 177        |       |

 

See notes to consolidated financial statements.

 

29

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**Notes to Consolidated Financial Statements**

 

First Community Financial Group, Inc. and Subsidiary 

December 31, 2001 and 2000

 

**Note 1 - Summary ofSignificant Accounting Policies**

 

**Nature of Operations**

 

First Community Financial Group, Inc. (the Company) provides commercialbanking services in Washington State through 19 offices concentrated in andaround Thurston, Grays Harbor, Pierce and Lewis Counties.  The Company provides loan and depositservices to customers who are predominately small- and middle-market businessesand middle-income individuals in western Washington.  The Company also provides real estate mortgage lending servicesand the sale of non-deposit investment products through its branch network.  In addition, the Company is engaged in thesmall loan business in Alabama and Arkansas, making short-term loans primarilyto individuals in those states.

 

**Principles ofConsolidation**

 

The consolidated financial statements include the accounts of theCompany and its wholly owned subsidiary, First Community Bank of Washington(the Bank).  All significantintercompany transactions and balances have been eliminated.

 

**ConsolidatedFinancial Statement Presentation**

 

The consolidated financial statements have been prepared in accordancewith generally accepted accounting principles and practices within the bankingindustry.  The preparation ofconsolidated financial statements requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities, and thedisclosure of contingent assets and liabilities, as of the date of the balancesheet, and the reported amounts of revenues and expenses during the reportingperiod.  Actual results could differsignificantly from those estimates. Material estimates that are particularly susceptible to significantchange in the near term relate to the determination of the allowance for creditlosses and the valuation of foreclosed real estate, loans held for sale, anddeferred tax assets.

 

Certainprior year amounts have been reclassified to conform to the 2001presentation.  The reclassifications hadno effect on net income or retained earnings as previously reported.  All dollar amounts, except per shareinformation, are stated in thousands.

 

**Securities Availablefor Sale**

 

Securities available for sale consist of debt securities that theCompany intends to hold for an indefinite period, but not necessarily tomaturity, and certain equity securities. Such securities may be sold to implement the Company’s asset/liabilitymanagement strategies and in response to changes in interest rates and similarfactors.  Securities available for saleare reported at fair value.  Unrealizedgains and losses, net of the related deferred tax effect, are reported as a netamount in a separate component of stockholders’ equity entitled “accumulatedother comprehensive income (loss).” Realized gains and losses on securities available for sale, determinedusing the specific identification method, are included in earnings.  Amortization of premiums and accretion ofdiscounts are recognized in interest income over the period to maturity.

 

30

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**SecuritiesHeld to Maturity**

 

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

 

Declines in the fair value ofindividual securities held to maturity and available for sale below their costthat are other than temporary result in write-downs of the individualsecurities to their fair value.  Suchwrite-downs are included in earnings as realized losses.

 

**LoansHeld for Sale**

 

Mortgage and governmentguaranteed loans originated for sale in the foreseeable future in the secondarymarket are carried at the lower of aggregate cost or estimated marketvalue.  Gains and losses on sales ofloans are recognized at settlement date and are determined by the differencebetween the sales proceeds and the carrying value of the loans.  All sales are made without recourse.  Net unrealized losses are recognized througha valuation allowance established by charges to income.

 

**Loans**

 

Loans are stated at the amountof unpaid principal, reduced by an allowance for credit losses.  Interest on loans is accrued daily based onthe principal amount outstanding. Interest on small loans is recognized when the loan is repaid by theborrower.

 

Generally the accrual ofinterest on loans is discontinued when, in management’s opinion, the borrowermay be unable to meet payments as they become due or when they are past due 90days as to either principal or interest, unless they are well secured and inthe process of collection.  Wheninterest accrual is discontinued, all unpaid accrued interest is reversedagainst current income.  If managementdetermines that the ultimate collectibility of principal is in doubt, cashreceipts on nonaccrual loans are applied to reduce the principal balance.

 

**Allowancefor Credit Losses**

 

The allowance for credit lossesis maintained at a level considered adequate to provide for estimated losses onexisting loans based on evaluating known and inherent risks in the loanportfolio.  The allowance is reduced byloans charged off, and increased by provisions charged to earnings andrecoveries on loans previously charged off. The allowance is based on management’s periodic, systematic evaluationof factors underlying the quality of the loan portfolio, including changes inthe size and composition of the loan portfolio, the estimated value of anyunderlying collateral, actual loan loss experience, current economicconditions, and detailed analysis of individual loans for which fullcollectibility may not be assured.  Thisevaluation is inherently subjective as it requires estimates that aresusceptible to significant revision as more information becomes available.  While management uses the best informationavailable to make its estimates, future adjustments to the allowance may benecessary if there is a significant change in economic conditions.

 

When available informationconfirms that specific loans or portions thereof are uncollectible, theseamounts are charged off against the allowance for credit losses.  The existence of some or all of thefollowing criteria will generally confirm that a loss has been incurred:  the loan is significantly delinquent and theborrower has not evidenced the ability or intent to bring the loan current; theBank has no recourse to the borrower, or if it does, the borrower hasinsufficient assets to pay the debt; the estimated fair value of the loancollateral is significantly below the current loan balance, and there is littleor no near-term prospect for improvement. Losses in the small loan portfolio are limited to a percentage ofrevenue earned from the portfolio by a reduction of servicing fees paid to theBank’s agent.

 

31

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When management determines thatit is probable that a borrower will be unable to repay all amounts dueaccording to the terms of the loan agreement, including scheduled interestpayments, the loan is considered impaired. Factors considered by management in determining impairment includepayment status, collateral value, and the probability of collecting scheduledprincipal and interest payments when due. Loans that experience insignificant payment delays and paymentshortfalls are generally not classified as impaired.  Management determines the significance of payment delays andpayment shortfalls on a case-by-case basis, taking into consideration all ofthe circumstances surrounding the loan and the borrower, including the lengthof the delay, the reasons for the delay, the borrower’s prior payment record,and the amount of shortfall in relation to the principal and interestowed.  The amount of impairment ismeasured based on the present value of expected future cash flows discounted atthe loan’s effective interest rate or, when the primary source of repayment isprovided by real estate collateral, at the fair value of the collateral lessestimated selling costs.

 

The ultimate recovery of allloans is susceptible to future market factors beyond the Bank’s control.  These factors may result in losses orrecoveries differing significantly from those provided for in the financialstatements.

 

**Transfersof Financial Assets**

 

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

 

**Premisesand Equipment**

 

Premises and equipment arestated at cost less accumulated depreciation, which is computed on thestraight-line method over the estimated useful lives of the assets.  Leasehold improvements are amortized overthe term of the lease or the estimated useful life of the improvement,whichever is less.  Gains or losses ondispositions are reflected in earnings.

 

**Goodwill**

 

Goodwill represents costs inexcess of net assets acquired, and is amortized on the straight-line methodover a period of 15 to 25 years.  TheCompany periodically evaluates goodwill for impairment.  (See “Recent Accounting Pronouncements” forthe effect of a new accounting standard effective January 1, 2002.)

 

**Other Intangible Assets**

 

Other intangible assetsrepresent deposit premium and other unidentifiable intangible assets acquiredin the purchase of branches from another bank. Other intangible assets are being amortized on the straight-line methodover 15 years.

 

32

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**ForeclosedReal Estate**

 

Real estate properties acquiredthrough, or in lieu of, foreclosure are initially recorded at the lower of costor fair value of the properties less estimated costs of disposal.  Any write-down to fair value at the time oftransfer to foreclosed real estate is charged to the allowance for creditlosses.  Properties are evaluatedregularly to ensure that the recorded amounts are supported by their currentfair values, and that valuation allowances to reduce the recorded amounts tofair value less estimated costs to dispose are recorded as necessary.  Any subsequent reductions in carrying valuesare charged to income.

 

**IncomeTaxes**

 

Deferred tax assets andliabilities result from differences between the financial statement recordedamounts and the tax bases of assets and liabilities, and are reflected atcurrently enacted income tax rates applicable to the period in which thedeferred tax assets or liabilities are expected to be realized or settled.  The deferred tax provision represents thedifference between the net deferred tax asset/liability at the beginning andend of the year.  As changes in tax lawsor rates are enacted, deferred tax assets and liabilities are adjusted throughthe provision for income taxes.

 

The Company files aconsolidated income tax return with the Bank. The Bank provides for tax on a separate company basis and remits to theCompany amounts currently due.

 

**Stock-BasedCompensation**

 

The Company accounts forstock-based awards to employees and directors using the intrinsic value method,in accordance with APB No. 25, *Accounting for Stock Issued to Employees*.  Accordingly, no compensation expense hasbeen recognized in the consolidated financial statements for employee anddirector stock arrangements where the grant price is equal to marketprice.  However, the required pro formadisclosures of the effects of all options granted on or after January 1, 1995**havebeen provided in accordance with SFAS No. 123, *Accounting for Stock-Based Compensation*.

 

**FairValues of Financial Instruments**

 

The following methods andassumptions were used by the Company in estimating the fair values of financialinstruments disclosed in the consolidated balance sheets:

 

**Cash and Short-Term Instruments**

The recordedamounts of cash and short-term instruments approximate their fair value.

 

**Securities Available for Sale and Held toMaturity**

Fair valuesfor securities are based on quoted market prices.

 

**Federal Home Loan Bank Stock**

The carrying value of Federal Home Loan Bank stock approximates itsfair value.

 

**Loans**

For variablerate loans that reprice frequently and have no significant change in creditrisk, fair values are based on recorded values.  Fair values for fixed rate loans are estimated using discountedcash flow analyses, using interest rates currently being offered for loans withsimilar terms to borrowers of similar credit quality.  Fair values of loans held for sale are based on their estimatedmarket prices.  Fair values for impairedloans are estimated using discounted cash flow analyses or underlyingcollateral values, where applicable.

 

33

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**Deposits**

The fairvalues disclosed for demand deposits are, by definition, equal to the amountpayable on demand at the reporting date (that is, their recorded amounts).  The recorded amounts of variable rate, fixedterm money market accounts and certificates of deposit approximate their fairvalues at the reporting date.  Fairvalues for fixed rate certificates of deposit are estimated using a discountedcash flow calculation based on interest rates currently being offered onsimilar certificates.

 

**Short-Term Borrowings**

The recordedamounts of federal funds purchased and short-term borrowings maturing within 90days approximate their fair values. Fair values of other short-term borrowings are estimated usingdiscounted cash flow analyses based on the Company’s current incrementalborrowing rates for similar types of borrowing arrangements.

 

**Long-Term Debt**

The fairvalues of the Company’s long-term debt are estimated using discounted cash flowanalyses based on the Company’s current incremental borrowing rates for similartypes of borrowing arrangements.  Therecorded amounts of variable rate debt approximate their fair value.

 

**Accrued Interest**

The carryingamounts of accrued interest approximate their fair values.

 

**Off-Balance Sheet Instruments**

The fair valueof commitments to extend credit and standby letters of credit was estimatedusing the fees currently charged to enter into similar agreements, taking intoaccount the remaining terms of the agreements and the present creditworthinessof the customers.

 

**CashEquivalents**

 

The Company considers all amountsincluded in the balance sheets caption “Cash and due from banks” to be cashequivalents.

 

**EarningsPer Share**

 

Basic earnings per shareexclude dilution and are computed by dividing net income by the weightedaverage number of common shares outstanding. Diluted earnings per share reflect the potential dilution that couldoccur if common shares were issued pursuant to the exercise of options underthe Company’s stock option plans.

 

34

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**RecentAccounting Pronouncements**

 

SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities*,became effective and was adopted by the Company effective January 1, 2001.  The Company does not engage in hedgingactivities, nor did it have any derivatives at December 31, 2001 or 2000.  The adoption of SFAS No. 133 had no effecton the Company’s financial position or results of operations as of or for theyear ended December 31, 2001.

 

In June 2001, the Financial AccountingStandards Board adopted Financial Accounting Standards Nos. 141, *Business Combinations*, and 142, *Goodwill and Other Intangible Assets*.  SFAS No. 141 requires that all businesscombinations entered into after June 30, 2001 be accounted for under thepurchase method.  SFAS No. 142 addresseshow goodwill and other intangible assets should be accounted for after theyhave been initially recorded in the financial statements.  Goodwill arising from business combinationsprior to the effective date of this standard will no longer be amortized,starting in 2002, but will be subject to annual tests for impairment.  Other identifiable intangible assets, andcertain unidentifiable intangible assets arising from certain acquisitions,will continue to be amortized using the same lives and methods.  The Company, at December 31, 2001, has$4,159 of goodwill in which amortization will cease effective January 1,2002.  The other intangible assets of$2,109 will continue to be amortized.

 

In June 2001, the FASB alsoissued SFAS No. 143, *Accounting for AssetRetirement Obligations*.  Thisstatement addresses financial accounting and reporting for obligationsassociated with the retirement of tangible long-lived assets and the associatedasset retirement costs.  This statementis effective for all fiscal years beginning after June 15, 2002.  In August 2001 the FASB issued SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets*.  Thestatement addresses financial accounting and reporting for the impairment ordisposal of long-lived assets.  Thisstatement is effective for fiscal years beginning after December 15, 2001. TheCompany does not anticipate that the adoption of SFAS Nos. 143 and 144 willhave a material effect on its financial position or results of operations.

 

**Note2 - Restricted Assets**

 

Federal Reserve Boardregulations require that the Bank maintain reserves in the form of cash on handand deposit balances with the Federal Reserve Bank.  The amounts of such balances for the years ended December 31, 2001and 2000 were approximately $4,359 and $4,580, respectively.

 

35

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**Note3 - Securities**

 

Securities have been classifiedaccording to management’s intent.  Therecorded amounts of securities and their fair value at December 31 were asfollows:

 
|                                  |   | **Amortized  Cost** |       | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |       | **Fair  Value** |    |
|---------------------------------------|--------|---------------------|------------|------------------------------|--------|-------------------------------|------------|-----------------|---------|
| **Securities Available for Sale**     |   |                |       |                         |   |                          |       |            |    |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **December 31, 2001**                 |   |                |       |                         |   |                          |       |            |    |
| U.S. Government and agency securities |   | $                   | 3,722      |                         | $      | 51                            |       | $               | 129     |   | $ | 3,644 |   |
| Corporate securities                  |   | 3,987               |       | 139                          |   | —                        |       | 4,126           |    |
| Mortgage backed securities            |   | 2,823               |       | 89                           |   | —                        |       | 2,912           |    |
| State and municipal securities        |   | 7,057               |       | 323                          |   | —                        |       | 7,380           |    |
| Equity securities                     |   | 42                  |       | —                       |   | —                        |       | 42              |    |
|                                  |   |                |       |                         |   |                          |       |            |    |
|                                  |   | **$**               | **17,631** | ** **                   | **$**  | **602**                       | ** ** | **$**           | **129** | ** ** | **$** | **18,104** |   |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **December 31, 2000**                 |   |                |       |                         |   |                          |       |            |    |
| U.S. Government and agency securities |   | $                   | 7,899      |                         | $      | 17                            |       | $               | 316     |   | $ | 7,600 |   |
| Corporate securities                  |   | 4,985               |       | 7                            |   | 54                            |       | 4,938           |    |
| Mortgage backed securities            |   | 5,053               |       | 18                           |   | 32                            |       | 5,039           |    |
| State and municipal securities        |   | 7,402               |       | 15                           |   | 155                           |       | 7,262           |    |
| Equity securities                     |   | 36                  |       | —                       |   | —                        |       | 36              |    |
|                                  |   |                |       |                         |   |                          |       |            |    |
|                                  |   | **$**               | **25,375** | ** **                   | **$**  | **57**                        | ** ** | **$**           | **557** | ** ** | **$** | **24,875** |   |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **Securities Held to Maturity**       |   |                |       |                         |   |                          |       |            |    |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **December 31, 2001**                 |   |                |       |                         |   |                          |       |            |    |
| State and municipal securities        |   | **$**               | **506**    | ** **                   | **$**  | **49**                        | ** ** | **$**           | **1**   | ** ** | **$** | **554** |   |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **December 31, 2000**                 |   |                |       |                         |   |                          |       |            |    |
| State and municipal securities        |   | **$**               | **676**    | ** **                   | **$**  | **27**                        | ** ** | **$**           | **1**   | ** ** | **$** | **702** |   |

 

36

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The contractual maturities ofsecurities held to maturity and available for sale at December 31, 2001 areshown below.  Expected maturities maydiffer from contractual maturities because borrowers may have the right to callor prepay obligations, with or without call or prepayment penalties.

 
|                                    |   | **Held to Maturity** |    | **Available for Sale** |   |
|-----------------------------------------|--------|----------------------|---------|------------------------|--------|
|                                    |   | **Amortized  Cost**  |    | **Fair  Value**        |   | **Amortized  Cost** |   | **Fair  Value** |   |
| Due in one year or less                 |   | $                    | —  |                   | $      | — |   | $ | 1,652 |   | $ | 1,644 |   |
| Due after one year through five  years  |   | 506                  |    | 554                    |   | 6,865 |   | 7,113 |   |
| Due after five years through  ten years |   | —               |    | —                 |   | 3,791 |   | 3,978 |   |
| Due after ten years                     |   | —               |    | —                 |   | 5,281 |   | 5,327 |   |
|                                    |   |                 |    |                   |   |   |   |   |   |
|                                    |   | **$**                | **506** | ** **             | **$**  | **554** | ** ** | **$** | **17,589** | ** ** | **$** | **18,062** | ** ** |

 

Securities recorded atapproximately $4,978 at December 31, 2001 and $9,398 at December 31, 2000 werepledged to secure public deposits and for other purposes required or permittedby law.

 

**Note4 - Loans**

 

Loans at December 31 consist ofthe following:

 
|                   |   | **2001**      |    | **2000**                  |   |
|------------------------|--------|---------------|---------|---------------------------|--------|
|                   |   | **Portfolio** |    | **Percent  of Portfolio** |   | **Portfolio** |   | **Percent ofPortfolio** |   |
| Commercial             |   | $             | 40,870  |                      | 14.16  | % | $ | 37,989 |   | 14.89 | % |
| Real estate:           |   |          |    |                      |   |   |   |   |   |
| Residential 1-4 family |   | 9,993         |    | 3.46                      |   | 4,123 |   | 1.62 |   |
| Commercial             |   | 175,019       |    | 60.62                     |   | 163,557 |   | 64.09 |   |
| Construction           |   | 50,798        |    | 17.60                     |   | 39,486 |   | 15.47 |   |
| Consumer               |   | 4,732         |    | 1.64                      |   | 6,792 |   | 2.66 |   |
| Small loans            |   | 7,289         |    | 2.52                      |   | 3,236 |   | 1.27 |   |
|                   |   |          |    |                      |   |   |   |   |   |
| Total loans            |   | $             | 288,701 |                      | 100.00 | % | $ | 255,183 |   | 100.00 | % |

 

37

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Changes in the allowance forcredit losses for the years ended December 31 are as follows:

 
|                                                   |   | **2001**   |       | **2000**   |       | **1999**  |       |
|--------------------------------------------------------|--------|------------|------------|------------|------------|-----------|------------|
| Balance at beginning of year                           |   | $          | 3,503      |       | $          | 5,825     |       | $ | 2,290 |   |
| Provision charged (credited) to operations             |   | 1,716      |       | (50        | )          | 3,730     |       |
|                                                   |   |       |       |       |       |      |       |
| Charge-offs (community banking)                        |   | (96        | )          | (2,351     | )          | (247      | )          |
| Recoveries (community banking)                         |   | 33         |       | 79         |       | 52        |       |
| Charge-offs (small loans)                              |   | (2,051     | )          | —     |       | —    |       |
| Recoveries (small loans)                               |   | 983        |       | —     |       | —    |       |
|                                                   |   |       |       |       |       |      |       |
| **Net charge-offs**                                    |   | **(1,131** | **)**      | **(2,272** | **)**      | **(195**  | **)**      |
|                                                   |   |       | ** ** |       | ** ** |      | ** ** |
| **Balance at end of year**                             |   | **$**      | **4,088**  | ** ** | **$**      | **3,503** | ** ** | **$** | **5,825** | ** ** |
|                                                   |   |       |       |       |       |      |       |
| Ratio of net charge-offs to  average loans outstanding |   | .41        | %          | .89        | %          | .09       | %          |

 

Following is a summary of informationpertaining to impaired loans:

 
|                                                          |   | **2001** |       | **2000**   |       | **1999** |       |
|---------------------------------------------------------------|--------|----------|------------|------------|------------|----------|------------|
| **December 31**                                               |   |     |       |       |       |     |       |
| Impaired loans without a valuation  allowance                 |   | $        | 902        |       | $          | 40       |       | $ | 1,046 |   |
| Impaired loans with a valuation allowance                     |   | 928      |       | 817        |       | 3,680    |       |
|                                                          |   |     |       |       |       |     |       |
| **Total impaired loans**                                      |   | **$**    | **1,830**  | ** ** | **$**      | **857**  | ** ** | **$** | **4,726** |   |
|                                                          |   |     | ** ** |       | ** ** |     |       |
| **Valuation allowance related to impaired  loans**            |   | **$**    | **528**    | ** ** | **$**      | **308**  | ** ** | **$** | **3,347** |   |
|                                                          |   |     |       |       |       |     |       |
| **Years Ended December 31**                                   |   |     |       |       |       |     |       |
| Average investment in impaired loans                          |   | $        | 1,258      |       | $          | 1,623    |       | $ | 1,495 |   |
| Interest income recognized on a cash basis  on impaired loans |   | —   |       | —     |       | —   |       |

 

At December 31, 2001, therewere no commitments to lend additional funds to borrowers whose loans wereimpaired.  Loans over 90 days past duestill accruing interest were $284 and $1,264 at December 31, 2001 and 2000,respectively.

 

Certain related parties of theCompany, principally Bank directors and their associates, were loan customersof the Bank in the ordinary course of business during 2001 and 2000.  Total loans outstanding at December 31, 2001and 2000 to key officers and directors were $16,412 and $14,069,respectively.  During 2001, advancestotaled $4,260, and repayments totaled $1,917 on these loans.

 

38

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**Note 5 - Premises and Equipment**

 

The components of premises andequipment at December 31 are as follows:

 
|                                            |   | **2001**   |       | **2000**   |       |
|-------------------------------------------------|--------|------------|------------|------------|------------|
| Land                                            |   | $          | 1,445      |       | $          | 1,445 |   |
| Buildings and leasehold improvements            |   | 8,484      |       | 7,684      |       |
| Equipment, furniture and fixtures               |   | 8,633      |       | 7,574      |       |
| Construction in progress                        |   | 66         |       | 475        |       |
| **Total cost**                                  |   | **18,628** | ** ** | **17,178** | ** ** |
| Less accumulated depreciation and  amortization |   | 8,246      |       | 7,111      |       |
|                                            |   |       |       |       |       |
| **Premises and equipment**                      |   | **$**      | **10,382** | ** ** | **$**      | **10,067** | ** ** |

 

The Bank leases premises andequipment under operating leases. Rental expense of leased premises and equipment was $468, $365 and $309for 2001, 2000 and 1999, respectively, which is included in occupancy expense.

 

Minimum net rental commitmentsunder noncancellable leases having an original or remaining term of more thanone year for future years ending December 31 are as follows:

 
| 2002                                |   | $      | 425       |       |
|-------------------------------------|--------|--------|-----------|------------|
| 2003                                |   | 308    |      |
| 2004                                |   | 219    |      |
| 2005                                |   | 128    |      |
| 2006                                |   | 46     |      |
| Thereafter                          |   | 990    |      |
|                                |   |   |      |
| **Total minimum payments required** |   | **$**  | **2,116** | ** ** |

 

Certain leases contain renewaloptions of five years and escalation clauses based on increases in propertytaxes and other costs.

 

**Note6 - Foreclosed Real Estate**

 

Foreclosed real estateconsisted of the following at December 31:

 
|                                     |   | **2001** |      | **2000**   |   |
|------------------------------------------|--------|----------|-----------|------------|--------|
| Real estate acquired through foreclosure |   | $        | 4,637     |       | $      | 4,597 |   |
| Allowance for losses                     |   | (250     | )         | (500       | )      |
|                                     |   |     |      |       |   |
| **Total foreclosed real estate**         |   | **$**    | **4,387** | ** ** | **$**  | **4,097** | ** ** |

 

39

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Changes in the allowance forlosses for the years ended December 31 are as follows:

 
|                       |   | **2001** |    | **2000**   | ** ** |
|----------------------------|--------|----------|---------|------------|------------|
| Balance, beginning of year |   | $        | 500     |       | $          | — |   |
| Provision for losses       |   | (250     | )       | 500        |       |
|                       |   |     |    |       |       |
| **Balance, end of year**   |   | **$**    | **250** | ** ** | **$**      | **500** | ** ** |

 

There was no allowance forlosses at December 31, 1999.

 

**Note7 - Deposits**

 

Thecomposition of deposits at December 31 is as follows:
|                                  |   | **2001** |        | **2000** |   |
|---------------------------------------|--------|----------|-------------|----------|--------|
| Demand deposits, non-interest bearing |   | $        | 55,013      |     | $      | 48,715 |   |
| NOW and money market accounts         |   | 98,250   |        | 74,900   |   |
| Savings deposits                      |   | 24,843   |        | 23,136   |   |
| Time certificates, $100,000 or more   |   | 45,828   |        | 28,942   |   |
| Other time certificates               |   | 89,796   |        | 95,684   |   |
|                                  |   |     |        |     |   |
| **Total**                             |   | **$**    | **313,730** |     | **$**  | **271,377** |   |

 

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

 
| 2002      |   | $      | 126,266     |   |
|-----------|--------|--------|-------------|--------|
| 2003      |   | 8,549  |        |
| 2004      |   | 547    |        |
| 2005      |   | 155    |        |
| 2006      |   | 107    |        |
|      |   |   |        |
| **Total** |   | **$**  | **135,624** |   |

 

40

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** **

**Note 8 - FederalFunds Purchased and Short-Term Borrowings**

 

Federal funds purchased generally mature within one to four days fromthe transaction date.  The balances atDecember 31, 2001 and 2000 represent advances from a line of credit agreementwith KeyBank (agreement had a limit of $7,000 and $6,100 at December 31, 2001and 2000, respectively).

 

Short-term borrowings at December 31 are as follows:

 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |   | **2001** |      | **2000**   |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|----------|-----------|------------|------------|
| Demand note issued to U. S. Treasury, bearing interest at the federal  funds rate less .25% (1.40% and 6.29% at December 31, 2001 and 2000,  respectively), due on demand, secured by securities pledged to the Federal  Reserve Bank of San Francisco in the amount of $1,764.                                                                                                                                                                       |   |   | $        | 655       |       | $          | 1,349 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |   |     |      |       |       |
| Note due to the Federal Home Loan Bank of Seattle, bearing interest  at 2.63%, due March 2002.  The Bank  has entered into an Advances, Security and Deposit Agreement (“Agreement”)  with the Federal Home Loan Bank of Seattle, which allows it to borrow up to  10% of the Bank’s assets.  Under the  Agreement, virtually all the Bank’s assets, not otherwise encumbered, are  pledged as collateral for advances. |   |   | 5,000    |      | 12,650     |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |   |     |      |       | ** ** |
| **Total short-term borrowings**                                                                                                                                                                                                                                                                                                                                                                                                                       |   |   | **$**    | **5,655** | ** ** | **$**      | **13,999** | ** ** |

 

Information concerning short-term borrowings is summarized as follows:

 
|                                       |   | **2001** |   | **2000** |   |
|--------------------------------------------|--------|----------|--------|----------|--------|
| Average  balance during the year           |   | $        | 6,441  |     | $      | 14,050 |   |
| Average  interest rate during the year     |   | 4.0      | %      | 6.4      | %      |
| Maximum  month-end balance during the year |   | $        | 17,202 |     | $      | 20,148 |   |
| Weighted  average rate at December 31      |   | 2.0      | %      | 6.8      | %      |

 

41

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**Note 9 - Long-TermDebt**

 

Long-term debt at December 31 is as follows:

 
|                                                                                                                                                                                                                                                                                                     |   |   | **2001** |    | **2000**   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|----------|---------|------------|--------|
| Note payable on behalf of the Company’s KSOP, maturing March 2002;  due in monthly principal installments of $15, plus interest at 90% of prime  rate (4.275% and 8.55% at December 31, 2001 and 2000, respectively),  collateralized by 10,968 shares of Company stock; guaranteed by the Company. |   |   | $        | 25      |       | $      | 203 |   |
|                                                                                                                                                                                                                                                                                                     |   |   |     |    |       |   |
| Note payable to Key Bank, maturing July 2002; due in annual  installments of $550, plus monthly installments of interest at prime rate  minus 85 basis points (3.90% and 7.65% at December 31, 2001 and 2000,  respectively), collateralized by investment in First Community Bank.                      |   |   | 550      |    | 1,100      |   |
|                                                                                                                                                                                                                                                                                                     |   |   |     |    |       |   |
|                                                                                                                                                                                                                                                                                                     |   |   | **$**    | **575** | ** ** | **$**  | **1,303** |   |

 

Principal reductions of $575 are due on the above indebtedness for theyear ending December 31, 2002.

 

Under the terms of the business loan agreementwith KeyBank, the Company and the Bank must maintain certain financial ratios.

 

### **Note10 - Income Taxes**

 

Income taxes are comprised of the following for the years endedDecember 31:

 
|                   |   | **2001** |      | **2000**   |   | **1999**  |       |
|------------------------|--------|----------|-----------|------------|--------|-----------|------------|
| Current                |   | $        | 2,083     |       | $      | 1,178     |       | $ | 1,617 |   |
| Deferred (benefit)     |   | (215     | )         | 942        |   | (1,119    | )          |
|                   |   |     |      |       |   |      |       |
| **Total income taxes** |   | **$**    | **1,868** | ** ** | **$**  | **2,120** | ** ** | **$** | **498** | ** ** |

 

42

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The following is a reconciliation between the statutory and theeffective federal income tax rate for the years ended December 31:

 
|                               |   | **2001**   |      | **2000**                       |       | **1999** |   |
|------------------------------------|--------|------------|-----------|--------------------------------|------------|----------|--------|
|                               |   |       |      | **Percent  of Pretax  Income** |       |     |   | **Percent  of Pretax**  **Income** |   |   |   | **Percent  of Pretax**  **Income** |   |
|                               |   | **Amount** |      |                           | **Amount** |     |   | **Amount** |   |   |
| Income tax based on statutory rate |   | $          | 2,207     |                           | 35.0       | %        | $      | 2,268 |   | 35.0 | % | $ | 650 |   | 35.0 | % |
| Adjustments resulting from:        |   |       |      |                           |       |     |   |   |   |   |   |   |   |
| Tax-exempt income                  |   | (150       | )         | (2.4                           | )          | (151     | )      | (2.3 | ) | (144 | ) | (7.8 | ) |
| Goodwill amortization              |   | 70         |      | 1.1                            |       | 70       |   | 1.1 |   | 70 |   | 3.8 |   |
| Tax credits                        |   | (115       | )         | (1.8                           | )          | (115     | )      | (1.2 | ) | (129 | ) | (6.9 | ) |
| Other                              |   | (144       | )         | (2.3                           | )          | 48       |   | .1 |   | 51 |   | 2.7 |   |
|                               |   |       |      |                           |       |     |   |   |   |   |   |   |   |
| **Total  income taxes**            |   | **$**      | **1,868** | ** **                     | **29.6**   | **%**    | **$**  | **2,120** | ** ** | **32.7** | **%** | **$** | **498** | ** ** | **26.8** | **%** |

 

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

 
|                                                    |   | **2001**  |       | **2000**   |   |
|---------------------------------------------------------|--------|-----------|------------|------------|--------|
| **Deferred Tax Assets**                                 |   |      |       |       |   |
| Allowance for credit losses,  in excess of tax reserves |   | $         | 1,005      |       | $      | 874 |   |
| Deferred compensation                                   |   | 674       |       | 496        |   |
| Book depreciation taken in  excess of tax depreciation  |   | 30        |       | 48         |   |
| Unrealized loss on securities  available for sale       |   | —    |       | 168        |   |
| Other deferred tax assets                               |   | 46        |       | 20         |   |
| **Total deferred tax assets**                           |   | **1,755** | ** ** | **1,606**  |   |
|                                                    |   |      |       |       |   |
| **Deferred Tax Liabilities**                            |   |      |       |       |   |
| Deferred income                                         |   | 1,933     |       | 1,831      |   |
| Unrealized gain on securities  available for sale       |   | 161       |       | —     |   |
| **Total  deferred tax liabilities**                     |   | **2,094** | ** ** | **1,831**  |   |
|                                                    |   |      |       |       |   |
| **Net deferred tax liabilities**                        |   | **$**     | **339**    | ** ** | **$**  | **225** |   |

 

43

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**Note 11 - Commitmentsand Contingent Liabilities**

 

The Bank is party to financial instruments with off-balance-sheet riskin the normal course of business to meet the financing needs of itscustomers.  The financial instrumentsinclude commitments to extend credit and standby letters of credit.  These instruments involve, to varyingdegrees, elements of credit risk in excess of the amount recognized on theconsolidated balance sheets.

 

The Bank’s exposure to credit loss in the event of nonperformance by theother party to the financial instrument for commitments to extend credit andstandby letters of credit is represented by the contractual amount of thoseinstruments.  The Bank uses the samecredit policies in making commitments and conditional obligations as it doesfor on-balance-sheet instruments.  Asummary of the Bank’s commitments at December 31 is as follows:

 
|                                     |   | **2001** |       | **2000**   |       |
|------------------------------------------|--------|----------|------------|------------|------------|
| Commitments to extend credit:            |   |     |       |       |       |
| Real estate secured                      |   | $        | 19,180     |       | $          | 14,749 |   |
| Credit card lines                        |   | 1,301    |       | 1,338      |       |
| Other                                    |   | 27,805   |       | 23,918     |       |
|                                     |   |     | ** ** |       | ** ** |
| **Total commitments to extended credit** |   | **$**    | **48,286** | ** ** | **$**      | **40,005** | ** ** |
|                                     |   |     |       |       |       |
| Standby letters of credit                |   | $        | 215        |       | $          | 334 |   |

 

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Since many of the commitmentsare expected to expire without being drawn upon, the total commitment amountsdo not necessarily represent future cash requirements.  The Bank’s experience has been thatapproximately 68% of loan commitments are drawn upon by customers.  The Bank evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank uponextension of credit, is based on management’s credit evaluation of theparty.  Collateral held varies, but mayinclude accounts receivable, inventory, property and equipment, residentialreal estate, and income-producing commercial properties.

 

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

 

**Contingencies**

 

Because of the nature of its activities, the Company is subject tovarious pending and threatened legal actions which arise in the ordinary courseof business.  In the opinion ofmanagement, liabilities arising from these claims, if any, will not have amaterial effect on the financial position of the Company.

 

The Company has entered into contracts with certain of its executivesand others, which provide for contingent payments subject to future events.

 

44

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**Note 12 - SignificantConcentrations of Credit Risk**

 

The Bank has credit risk exposure, including off-balance-sheet creditrisk exposure, related to real estate loans as disclosed in Notes 4 and11.  The ultimate collectibility of asubstantial portion of the loan portfolio is susceptible to changes in economicand market conditions in the region.  TheBank generally requires collateral on all real estate lending arrangements andtypically maintains loan-to-value ratios of no greater than 80%.

 

Investments in state and municipal securities generally involvegovernmental entities within Washington State. Loans are generally limited, by state banking regulation, to 20% of theBank’s stockholder’s equity, excluding accumulated other comprehensive income(loss).  The Bank, as a matter ofpractice, generally does not extend credit to any single borrower or group ofrelated borrowers in excess of $6,000.

 

The contractual amounts of credit-related financial instruments such ascommitments to extend credit, credit-card arrangements, and letters of creditrepresent the amounts of potential accounting loss should the contract be fullydrawn upon, the customer defaults, and the value of any existing collateralbecome worthless.

 

**Note 13 - BenefitPlans**

 

**Employee StockOwnership Plan**

 

The Company has a combined employee stock ownership and profit sharingplan with 401(k) provisions (KSOP) which covers substantially all employees whohave completed at least one year of service. The Company accounts for the KSOP in accordance with Statement ofPosition 93-6, *Employers’ Accounting for Employee Stock Ownership Plans*.  Accordingly, the balance of the debt of theKSOP is included in long-term debt on the accompanying consolidated balancesheets, with a corresponding deduction from stockholders’ equity.  KSOP shares were pledged as collateral forthe debt.  As the debt is repaid, sharesare released based on the proportion of debt paid and allocated to activeemployees.  As shares are released fromcollateral, the Company reports compensation expense equal to the currentmarket price of the shares less basis in the shares.  Shares become outstanding for earnings per share computations atthe time of allocation to the active employees.

 

Eligible employees may defer up to 15% of their annual compensation ona pre-tax basis subject to certain IRS limits. The Company contributes to theplan one-half the employees’ contributions up to 3% of the employees’compensation.  Profit sharingcontributions to the plan may also be made at the discretion of the Board ofDirectors.  The Company also makescontributions equal to the amount required to service the plan’s debt under theterms of the KSOP note.  Companycontributions to this plan totaled $450, $350 and $300 in 2001, 2000 and 1999,respectively.  Cash dividends paid onunallocated shares which are collateral for debt are used to reduce theprincipal of the debt.  Dividends paidon allocated shares are distributed to the employee account.

 

The KSOP shares as of December 31 were as follows:

 
|                                        |   | **2001**    |       | **2000**    |       | **1999**    |       |
|---------------------------------------------|--------|-------------|------------|-------------|------------|-------------|------------|
| Allocated shares                            |   | 199,322     |       | 177,276     |       | 162,844     |       |
| Unallocated shares                          |   | 1,359       |       | 10,968      |       | 20,578      |       |
|                                        |   |        |       |        |       |        |       |
| **Total KSOP shares**                       |   | **200,681** | ** ** | **188,244** | ** ** | **183,422** | ** ** |
|                                        |   |        |       |        |       |        |       |
| Estimated fair value of  unallocated shares |   | $           | 27,197     |        | $          | 232,419     |       | $ | 493,872 |   |
|                                             |        |             |            |             |            |             |            |  |  |  |

 

45

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Upon termination from the plan, a participant may choose to have hisaccount distributed in Company stock, to the extent of his investment in stock,or in cash.  Certain participants mayalso be eligible to diversify a certain percentage of their accounts.  A distribution of stock in the event oftermination or diversification requires the Company to issue put options to theparticipant.  This permits theparticipant to sell the stock to the Company at fair value at any time duringthe option periods, which can be as long as 18 months.  At December 31, 2001, 2000 and 1999,outstanding put options were not material.

 

**IncentiveCompensation Plan**

 

Incentive compensation is awarded to officers and qualified employeesbased on the financial performance of the Company.  Awards are payable if the Company and the Bank meet earnings andother performance objectives and are determined as a percentage of their basesalary.  Fees paid to directors are alsoadjusted annually based on the financial performance of the Company.  Awards under the plan for 2001 and 2000totaled $340 and $339, respectively. There were no awards under the plan for 1999.

 

**ExecutiveSupplemental Income Plan**

 

The Company provides an Executive Supplemental Income (ESI) plancovering a select group of management personnel.  The post-retirement benefit provided by the ESI plan is designedto supplement a participating officer’s retirement benefits from socialsecurity, in order to provide the officer with a certain percentage of final averageincome at retirement age.  Expensesrelated to this plan totaled $522, $94 and $409 in 2001, 2000 and 1999,respectively.

 

Benefits to employees are funded by life insurance policies purchasedby the Company, which had cash surrender values of $8,427 and $2,978 atDecember 31, 2001 and 2000, respectively. Liabilities to employees, which are being accrued over their expectedtime to retirement, were $1,552 and $1,067 at December 31, 2001 and 2000,respectively.

 

**Director DeferredIncome Plan**

 

In 1992 the Board of Directors approved a plan under which a directormay elect to defer director fees until retirement, and to provide a deathbenefit.

 

Benefits to directors are funded by life insurance policies purchasedby the Company, which had cash surrender values of $26 and $132 at December 31,2001 and 2000, respectively.  Accruedliabilities to directors at December 31, 2001 and 2000 totaled $326 and $295,respectively.  Expenses associated withthis plan were $36 and $82 in 2001 and 2000, respectively.  No expenses associated with this plan wereincurred in 1999.

 

**Note 14 - StockOption Plans**

 

The Company maintains stock option plans for non-employee members ofthe Board of Directors and incentive stock option plans for key employees.  The exercise price of the stock optionsunder the plans is usually not less than the fair market value of the stock atthe date of grant.  The Company has thefirst right of refusal to purchase any shares issued under the plans prior totheir sale on the open market.

 

46

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The Company applies APB Opinion No. 25 and related interpretations inaccounting for these plans.  Hadcompensation cost for the Company’s stock option plans been determined based onthe fair value at the grant dates for awards granted subsequent to December 31,1994 under these plans, consistent with the method prescribed by SFAS No. 123,the Company’s net income and earnings per share would have been reduced tothese pro forma amounts for the years ended December 31:

 
|                |   | **2001** |   | **2000** |   | **1999** |   |
|---------------------|--------|----------|--------|----------|--------|----------|--------|
| Net income:         |   |     |   |     |   |     |   |
| As reported         |   | $        | 4,437  |     | $      | 4,361    |   | $ | 1,360 |   |
| Pro forma           |   | 4,341    |   | 4,107    |   | 1,081    |   |
|                |   |     |   |     |   |     |   |
| Earnings per share: |   |     |   |     |   |     |   |
| Basic:              |   |     |   |     |   |     |   |
| As reported         |   | $        | 2.04   |     | $      | 2.02     |   | $ | .64 |   |
| Pro forma           |   | 1.99     |   | 1.94     |   | .54      |   |
| Diluted:            |   |     |   |     |   |     |   |
| As reported         |   | 1.99     |   | 1.96     |   | .60      |   |
| Pro forma           |   | 1.99     |   | 1.94     |   | .54      |   |

 

The fair value of each option grant is estimatedon the date of grant, based on the Black-Scholes option pricing model and usingthe following weighted average assumptions:

 
|                    |   | **2001** |   | **2000** |   | **1999**    |   |
|-------------------------|--------|----------|--------|----------|--------|-------------|--------|
| Dividend yield          |   | 2.0      | %      | 1.8      | %      | 1.9         | %      |
| Expected life           |   | 8 years  |   | 8 years  |   | 10 years    |   |
| Risk-free interest rate |   | 4.9      | %      | 6.7      | %      | 4.7% to 5.2 | %      |
| Expected volatility     |   | 12.0     | %      | 2.0      | %      | 3.0         | %      |

 

The weighted average fair value of options granted during 2001, 2000and 1999 was $4.27, $6.44 and $6.67, respectively.  In the opinion of management, the assumptions used in the optionpricing model are subjective and represent only one estimate of possible value,as there is no active market for Company options granted.

 

Options granted during 2001, 2000 and 1999 are 20% vested on each ofthe five subsequent anniversaries of the grant date.

 

47

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Stock option and per share amounts for currentand prior periods have been adjusted to reflect the effect of stock dividends,and are as follows:

 
|                                      |   | **Employee Options** |       | **Director Options** |       | **Total    Options** |       | **Weighted   Average  Exercise Price** |      |
|-------------------------------------------|--------|----------------------|------------|----------------------|------------|----------------------|------------|----------------------------------------|-----------|
| Under option at December 31,  1998        |   | 297,796              |       | 86,830               |       | 384,626              |       | $                                      | 15.43     |   |
| Granted                                   |   | 26,000               |       | —               |       | 26,000               |       | 30.00                                  |      |
| Exercised                                 |   | (23,862              | )          | (27,158              | )          | (51,020              | )          | 10.37                                  |      |
| Forfeited                                 |   | (2,002               | )          | (2                   | )          | (2,004               | )          | 29.96                                  |      |
| **Under option at December 31, 1999**     |   | **297,932**          | ** ** | **59,670**           | ** ** | **357,602**          | ** ** | **17.13**                              |      |
| Granted                                   |   | 24,500               |       | 2,000                |       | 26,500               |       | 23.00                                  |      |
| Exercised                                 |   | (24,443              | )          | (22,391              | )          | (46,834              | )          | 11.00                                  |      |
| Forfeited                                 |   | (10,843              | )          | (1                   | )          | (10,844              | )          | 21.61                                  |      |
| **Under option at December 31, 2000**     |   | **287,146**          | ** ** | **39,278**           | ** ** | **326,424**          | ** ** | **18.35**                              |      |
| Granted                                   |   | 9,000                |       | —               |       | 9,000                |       | 20.00                                  |      |
| Exercised                                 |   | —               |       | (2,678               | )          | (2,678               | )          | 9.80                                   |      |
| Forfeited                                 |   | (2,600               | )          | —               |       | (2,600               | )          | 25.23                                  |      |
|                                      |   |                 |       |                 |       |                 |       |                                   |      |
| **Under option at December 31, 2001**     |   | **293,546**          | ** ** | **36,600**           | ** ** | **330,146**          | ** ** | **$**                                  | **18.40** |   |
|                                      |   |                 |       |                 |       |                 |       |                                   |      |
| Options exercisable at  December 31, 2001 |   | 243,666              |       | 35,000               |       | 278,666              |       | $                                      | 17.32     |   |

 

Options becoming exercisable under both stock option plans in futureyears ending December 31 are as follows:

2002 - 21,380; 2003 - 11,300; 2004 - 10,700; 2005 - 6,300; and 2006 -1,800.

 

Options for 50,246 and 10,500 shares remain available to be grantedunder the director and employee plans, respectively, atDecember 31, 2001.

 

The following summarizes information about stock options outstanding atDecember 31, 2001:

 
| **Options  Outstanding**        |   | **Options  Exercisable** |   |
|---------------------------------|--------|--------------------------|--------|
| **Range of  Exercise   Prices** |   | **Number  Outstanding**  |   | **Weighted   Average   Remaining   Contractual  Life (Years)** |   | **Weighted   Average   Exercise   Price** |   | **Number Exercisable** |   | **Weighted  Average   Exercise   Price** |   |
|                            | $      | Under 10.00              |   | 8,983 |   | 1.2 |   | $ |  9.12 |   | 8,983 |   | $ |  9.12 |   |
|                            | $      | 11.00 - $14.00           |   | 103,797 |   | 2.6 |   | 13.99 |   | 103,797 |   | 13.99 |   |
|                            | $      | 17.28                    |   | 104,765 |   | 4.3 |   | 17.28 |   | 104,765 |   | 17.28 |   |
|                            | $      | 20.00 - $23.00           |   | 83,400 |   | 6.9 |   | 22.30 |   | 46,321 |   | 22.42 |   |
|                            | $      | 30.00                    |   | 29,201 |   | 7.8 |   | 30.00 |   | 14,800 |   | 30.00 |   |
|                            |   |                     |   |   |   |   |   |   |   |   |   |
|                            |   | **330,146**              |   |   |   |   |   | **278,666** |   |   |   |
|                                 |        |                          |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

48

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**Note 15 - CondensedFinancial Information - Parent Company Only**

 

**Condensed BalanceSheets - December 31**

 
|                                                 |   | **2001** |       | **2000**   |       |
|------------------------------------------------------|--------|----------|------------|------------|------------|
| **Assets**                                           |   |     |       |       |       |
| Cash                                                 |   | $        | 44         |       | $          | 286 |   |
| Investment in the Bank                               |   | 39,389   |       | 34,892     |       |
| Other assets                                         |   | 45       |       | 616        |       |
|                                                 |   |     |       |       |       |
| **Total assets**                                     |   | **$**    | **39,478** | ** ** | **$**      | **35,794** | ** ** |
|                                                 |   |     |       |       |       |
| **Liabilities and Stockholders’ Equity**        |   |     |       |       |       |
|                                                 |   |     |       |       |       |
| **Liabilities**                                      |   |     |       |       |       |
| Long-term debt                                       |   | $        | 575        |       | $          | 1,303 |   |
| Other liabilities                                    |   | 108      |       | 118        |       |
| **Total liabilities**                                |   | **683**  | ** ** | **1,421**  | ** ** |
|                                                 |   |     |       |       |       |
| **Stockholders’ Equity**                        |   | 38,795   |       | 34,373     |       |
|                                                 |   |     |       |       |       |
| **Total liabilities and  stockholders’ equity** |   | **$**    | **39,478** | ** ** | **$**      | **35,794** | ** ** |

 

**Condensed Statementsof Income - Years Ended December 31**

 
|                                                                           |   | **2001** |       | **2000**   |       | **1999**  |       |
|--------------------------------------------------------------------------------|--------|----------|------------|------------|------------|-----------|------------|
| **Operating Income**                                                           |   |     |       |       |       |      |       |
| Dividends received from the Bank                                               |   | $        | 695        |       | $          | 1,946     |       | $ | 1,215 |   |
| Interest                                                                       |   | 3        |       | 3          |       | 4         |       |
| **Total operating income**                                                     |   | **698**  | ** ** | **1,949**  | ** ** | **1,219** | ** ** |
|                                                                           |   |     |       |       |       |      |       |
| **Operating Expenses**                                                         |   |     |       |       |       |      |       |
| Interest                                                                       |   | 61       |       | 119        |       | 142       |       |
| Other                                                                          |   | 110      |       | 77         |       | 54        |       |
| **Total operating expenses**                                                   |   | **171**  | ** ** | **196**    | ** ** | **196**   | ** ** |
|                                                                           |   |     |       |       |       |      |       |
|                                                                           |   |     |       |       |       |      |       |
| **Income before income taxes and equity in  undistributed income of the Bank** |   | **527**  | ** ** | **1,753**  | ** ** | **1,023** | ** ** |
|                                                                           |   |     |       |       |       |      |       |
| **Income Tax Benefit**                                                         |   | (58      | )          | (66        | )          | (49       | )          |
|                                                                           |   |     |       |       |       |      |       |
| **Income before equity in undistributed  income of the Bank**                  |   | **585**  | ** ** | **1,819**  | ** ** | **1,072** | ** ** |
|                                                                           |   |     |       |       |       |      |       |
| **Equity in Undistributed Income of the Bank**                                 |   | 3,852    |       | 2,542      |       | 288       |       |
|                                                                           |   |     |       |       |       |      |       |
| **Net income**                                                                 |   | **$**    | **4,437**  | ** ** | **$**      | **4,361** | ** ** | **$** | **1,360** | ** ** |

 

49

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**Condensed Statementsof Cash Flows - Years Ended December 31**

 
|                                                                               |   | **2001**   |       | **2000**   |       | **1999**   |       |
|------------------------------------------------------------------------------------|--------|------------|------------|------------|------------|------------|------------|
| **Cash Flows from Operating Activities**                                           |   |       |       |       |       |       |       |
| Net income                                                                         |   | $          | 4,437      |       | $          | 4,361      |       | $ | 1,360 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |   |       |       |       |       |       |       |
| Equity in undistributed  income of the Bank                                        |   | (3,852     | )          | (2,542     | )          | (288       | )          |
| Depreciation                                                                       |   | —     |       | —     |       | 2          |       |
| Other - net                                                                        |   | 570        |       | 45         |       | 34         |       |
| **Net cash provided by operating activities**                                      |   | **1,155**  | ** ** | **1,864**  | ** ** | **1,108**  | ** ** |
|                                                                               |   |       |       |       |       |       |       |
| **Cash Flows from Financing Activities**                                           |   |       |       |       |       |       |       |
| Proceeds from exercise of  stock options                                           |   | 27         |       | 515        |       | 530        |       |
| Repurchase of common stock                                                         |   | —     |       | (934       | )          | —     |       |
| Payments on long-term debt                                                         |   | (550       | )          | (550       | )          | (550       | )          |
| Payment of dividends                                                               |   | (874       | )          | (867       | )          | (1,262     | )          |
| **Net cash used in financing activities**                                          |   | **(1,397** | **)**      | **(1,836** | **)**      | **(1,282** | **)**      |
|                                                                               |   |       |       |       |       |       |       |
| **Net increase (decrease) in cash**                                                |   | **(242**   | **)**      | **28**     | ** ** | **(174**   | **)**      |
|                                                                               |   |       |       |       |       |       |       |
| **Cash**                                                                           |   |       |       |       |       |       |       |
| Beginning of year                                                                  |   | 286        |       | 258        |       | 432        |       |
|                                                                               |   |       |       |       |       |       |       |
| **End of year**                                                                    |   | **$**      | **44**     | ** ** | **$**      | **286**    | ** ** | **$** | **258** | ** ** |

 

**Note 16 - RegulatoryMatters**

 

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

 

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

 

50

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As of December 31, 2001, the most recent notification from the Bank’sregulator categorized the Bank as well capitalized under the regulatoryframework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimumtotal risk-based, Tier 1 risk-based, Tier 1 leverage ratios as set forth in thetable.  There are no conditions orevents since that notification that management believes have changed theinstitution’s category.

 

The actual capital amounts and ratios are as follows:

 
|                                        |   | **Actual Amount** |   | **Ratio** |   | **Capital  Adequacy Purposes Amount** |   | **Ratio** |   | **To be Well  Capitalized  Under Prompt  Corrective Action Provisions Amount** |   | **Ratio** |   |
|---------------------------------------------|--------|-------------------|--------|-----------|--------|---------------------------------------|--------|-----------|--------|--------------------------------------------------------------------------------|--------|-----------|--------|
| **December 31, 2001**                       |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| *Tier 1 capital (to average assets):*       |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| Consolidated                                |   | $                 | 32,213 |      | 8.91   | %                                     | $      | 14,467    |   | 4.00                                                                           | %      | N/A       |   | N/A |   |
| FCB                                         |   | 32,807            |   | 9.07      |   | 14,467                                |   | 4.00      |   | $                                                                              | 18,083 |      | 5.00   | % |
| *Tier 1 capital (to risk-weighted assets):* |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| Consolidated                                |   | 32,213            |   | 9.34      |   | 13,797                                |   | 4.00      |   | N/A                                                                            |   | N/A       |   |
| FCB                                         |   | 32,807            |   | 9.52      |   | 13,785                                |   | 4.00      |   | 20,678                                                                         |   | 6.00      |   |
| *Total capital (to risk-weighted assets):*  |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| Consolidated                                |   | 36,301            |   | 10.52     |   | 27,594                                |   | 8.00      |   | N/A                                                                            |   | N/A       |   |
| FCB                                         |   | 36,895            |   | 10.71     |   | 27,570                                |   | 8.00      |   | 34,463                                                                         |   | 10.00     |   |
|                                        |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| **December 31, 2000**                       |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| *Tier 1 capital (to average assets):*       |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| Consolidated                                |   | $                 | 28,028 |      | 8.96   | %                                     | $      | 12,514    |   | 4.00                                                                           | %      | N/A       |   | N/A |   |
| FCB                                         |   | 28,547            |   | 9.14      |   | 12,493                                |   | 4.00      |   | $                                                                              | 15,617 |      | 5.00   | % |
| *Tier 1 capital (to risk-weighted assets):* |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| Consolidated                                |   | 28,028            |   | 9.24      |   | 12,139                                |   | 4.00      |   | N/A                                                                            |   | N/A       |   |
| FCB                                         |   | 28,547            |   | 9.43      |   | 12,114                                |   | 4.00      |   | 18,171                                                                         |   | 6.00      |   |
| *Total capital (to risk-weighted assets):*  |   |              |   |      |   |                                  |   |      |   |                                                                           |   |      |   |
| Consolidated                                |   | 31,531            |   | 10.39     |   | 24,278                                |   | 8.00      |   | N/A                                                                            |   | N/A       |   |
| FCB                                         |   | 32,050            |   | 10.58     |   | 24,228                                |   | 8.00      |   | 30,285                                                                         |   | 10.00     |   |

 

**Restrictions onRetained Earnings**

 

The Bank is subject to certain restrictions onthe amount of dividends that it may declare without prior regulatoryapproval.  At December 31, 2001, all ofthe Bank’s retained earnings were available for dividend declaration to itsparent company without prior regulatory approval.

 

51

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**Note 17 - Fair Valuesof Financial Instruments**

 

The estimated fair values of the Company’s financial instruments atDecember 31 were as follows:

 
|                                                                                   |   | **2001**             |    | **2000**        |   |
|----------------------------------------------------------------------------------------|--------|----------------------|---------|-----------------|--------|
|                                                                                   |   | **Recorded  Amount** |    | **Fair  Value** |   | **Recorded  Amount** |   | **Fair  Value** |   |
| **Financial Assets**                                                                   |   |                 |    |            |   |   |   |   |   |
| Cash and due from banks,  interest bearing deposits with banks, and federal funds sold |   | $                    | 21,457  |            | $      | 21,457 |   | $ | 12,812 |   | $ | 12,812 |   |
| Securities available for sale                                                          |   | 18,104               |    | 18,104          |   | 26,729 |   | 26,729 |   |
| Securities held to maturity                                                            |   | 506                  |    | 554             |   | 676 |   | 702 |   |
| Loans held for sale                                                                    |   | 6,196                |    | 6,196           |   | 4,121 |   | 4,121 |   |
| Loans receivable, net                                                                  |   | 284,613              |    | 284,930         |   | 251,680 |   | 250,778 |   |
|                                                                                   |   |                 |    |            |   |   |   |   |   |
| **Financial Liabilities**                                                              |   |                 |    |            |   |   |   |   |   |
| Deposits                                                                               |   | $                    | 313,730 |            | $      | 316,153 |   | $ | 271,377 |   | $ | 271,932 |   |
| Long-term debt                                                                         |   | 575                  |    | 575             |   | 1,303 |   | 1,303 |   |
| Federal funds purchased                                                                |   | 1,400                |    | 1,400           |   | 2 |   | 2 |   |
| Short-term borrowings                                                                  |   | 5,655                |    | 5,655           |   | 13,999 |   | 13,999 |   |

 

### **Note18 - Other Operating Income and Expenses**

 

Other operating income and expenses include thefollowing amounts which are in excess of 1% of the total of interest income andnon-interest income for the years ended December 31:

 
|                                                   |   | **2001** |   | **2000** |   | **1999** |   |
|--------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| **Other Operating Income**                             |   |     |   |     |   |     |   |
| Commission on sale of  non-deposit investment products |   | $        | 605    |     | $      | 741      |   | $ | 640 |   |
|                                                   |   |     |   |     |   |     |   |
| **Other Operating Expense**                            |   |     |   |     |   |     |   |
| State taxes                                            |   | $        | 777    |     | $      | 470      |   | $ | 398 |   |
| Telephone                                              |   | 233      |   | 256      |   | 273      |   |

 

52

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# **Note 19 -Earnings Per Share Disclosures**

 

Following is information regarding the calculation of basic and dilutedearnings per share for the years indicated:

# ** **

|                             |   | **Net Income    (Numerator)** |       | **Shares  (Denominator)** |          | **Per Share  Amount** |       |
|----------------------------------|--------|-------------------------------|------------|---------------------------|---------------|-----------------------|------------|
| **Year Ended December 31, 2001** |   |                          | ** ** |                      | ** **    |                  | ** ** |
| Basic earnings per share:        |   |                          |       |                      |          |                  |       |
| Net income                       |   | $                             | 4,437      |                      | 2,180,129     |                  | $          | 2.04 |   |
| Effect of dilutive  securities:  |   |                          |       |                      |          |                  |       |
| Options                          |   | —                        |       | 54,092                    |          | (.05                  | )          |
| Diluted earnings per share:      |   |                          |       |                      |          |                  |       |
| **Net income**                   |   | **$**                         | **4,437**  | ** **                | **2,234,221** | ** **            | **$**      | **1.99** | ** ** |
|                             |   |                          | ** ** |                      | ** **    |                  | ** ** |
| **Year Ended December 31, 2000** |   |                          | ** ** |                      | ** **    |                  | ** ** |
| Basic earnings per share:        |   |                          |       |                      |          |                  |       |
| Net income                       |   | $                             | 4,361      |                      | 2,158,693     |                  | $          | 2.02 |   |
| Effect of dilutive  securities:  |   |                          |       |                      |          |                  |       |
| Options                          |   | —                        |       | 69,210                    |          | (.06                  | )          |
| Diluted earnings per share:      |   |                          |       |                      |          |                  |       |
| **Net income**                   |   | **$**                         | **4,361**  | ** **                | **2,227,903** | ** **            | **$**      | **1.96** | ** ** |
|                             |   |                          | ** ** |                      | ** **    |                  | ** ** |
| **Year Ended December 31, 1999** |   |                          | ** ** |                      | ** **    |                  | ** ** |
| Basic earnings per share:        |   |                          |       |                      |          |                  |       |
| Net income                       |   | $                             | 1,360      |                      | 2,136,502     |                  | $          | .64 |   |
| Effect of dilutive  securities:  |   |                          |       |                      |          |                  |       |
| Options                          |   | —                        |       | 134,038                   |          | (.04                  | )          |
| Diluted earnings per share:      |   |                          |       |                      |          |                  |       |
| **Net income**                   |   | **$**                         | **1,360**  | ** **                | **2,270,540** | ** **            | **$**      | **.60** | ** ** |

 

Thenumber of shares shown for “options” is the number of incremental shares thatwould result from exercise of options and use of the proceeds to repurchaseshares at the average market price during the year.

 

 

53

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**Note20 - Business Segment Information**

 

The Company is managed alongtwo major lines of business; community banking, its core business, and thesmall loan division, which was entered into late in the fourth quarter of2000.  Community banking consists of alllending, deposit and administrative operations conducted through its 19 officesin Washington State.  The small loandivision provides small, short-term consumer loans to customers in Alabama andArkansas.

 

Prior to 2001, the Company wasmanaged as a whole, not by discrete operating segments.  When the Company began offering small loans,its operating results were segregated in the general ledger system to bettermanage financial performance.  Thefinancial performance of the business lines is measured by the Company’sprofitability reporting process, which utilizes various management accountingtechniques to more accurately reflect each business line’s financialresults.  Revenues and expenses areprimarily assigned directly to business lines. The small loan division was in a start-up phase in 2000.  Revenues and expenses for the period wereimmaterial and disclosure of segment for 2000 information is not consideredmeaningful.

 

The organizational structure ofthe Company and its business line financial results are not necessarilycomparable across companies.  As such,the Company’s business line performance may not be directly comparable withsimilar information from other financial institutions.

 

Financial highlights by line ofbusiness as of and for the year ended December 31, 2001 were as follows:

 
|                                                   |   | **Community  Banking** |        | **Small****Loans** |   | **Total**  |       |
|--------------------------------------------------------|--------|------------------------|-------------|--------------------|--------|------------|------------|
| Net interest income after  provision for credit losses |   | $                      | 15,493      |               | $      | 2,189      |       | $ | 17,682 |   |
| Non-interest income                                    |   | 6,324                  |        | —             |   | 6,324      |       |
| Non-interest expense                                   |   | 17,102                 |        | 599                |   | 17,701     |       |
| Income taxes                                           |   | 1,354                  |        | 514                |   | 1,868      |       |
|                                                   |   |                   |        |               |   |       |       |
| **Net income**                                         |   | **$**                  | **3,361**   | ** **         | **$**  | **1,076**  | ** ** | **$** | **4,437** |   |
|                                                   |   |                   |        |               |   |       |       |
| **Total assets**                                       |   | **$**                  | **346,355** | ** **         | **$**  | **18,268** | ** ** | **$** | **364,623** |   |
|                                                   |   |                   |        |               |   |       |       |
| **Total loans**                                        |   | **$**                  | **281,412** | ** **         | **$**  | **7,289**  | ** ** | **$** | **288,701** |   |

 

**Note 21- Subsequent Event**

 

Subsequent to December 31, 2001, the Company declared a dividend in theamount of $.10 per share to be paid on February 15, 2002 for shareholders ofrecord as of January 31, 2002.

 

54

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**Note 22 - Selected QuarterlyFinancial Data (Unaudited)**

 

Thefollowing selected financial data are presented for the quarters ended:(dollars in thousands, except per share amounts):

 
|                             |   | **December 31** |       | **September 30** |       | **June 30** |       | **March 31** |       |
|----------------------------------|--------|-----------------|------------|------------------|------------|-------------|------------|--------------|------------|
|                             |   |            |       |
|                             |   |            |       |
| **Year Ended December 31, 2001** |   |            |       |             |       |        |       |         |       |
| Interest and dividend income     |   | $               | 6,990      |             | $          | 7,968       |       | $            | 7,664      |   | $ | 7,166 |   |
| Interest expense                 |   | (2,221          | )          | (2,580           | )          | (2,755      | )          | (2,834       | )          |
| **Net interest income**          |   | **4,769**       | ** ** | **5,388**        | ** ** | **4,909**   | ** ** | **4,332**    | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Provision for loan losses        |   | (758            | )          | (513             | )          | (300        | )          | (145         | )          |
| Noninterest income               |   | 1,936           |       | 1,601            |       | 1,296       |       | 1,491        |       |
| Noninterest expenses             |   | (4,445          | )          | (4,661           | )          | (4,476      | )          | (4,119       | )          |
|                             |   |            |       |             |       |        |       |         |       |
| **Income before income taxes**   |   | **1,502**       | ** ** | **1,815**        | ** ** | **1,429**   | ** ** | **1,559**    | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Income taxes                     |   | 396             |       | 547              |       | 437         |       | 488          |       |
|                             |   |            |       |             |       |        |       |         |       |
| **Net income**                   |   | **$**           | **1,106**  | ** **       | **$**      | **1,268**   | ** ** | **$**        | **992**    | ** ** | **$** | **1,071** | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Earnings per share:              |   |            |       |             |       |        |       |         |       |
| Basic                            |   | $               | .51        |             | $          | .58         |       | $            | .46        |   | $ | .49 |   |
| Diluted                          |   | .50             |       | .57              |       | .44         |       | .48          |       |
|                             |   |            |       |             |       |        |       |         |       |
| **Year Ended December 31, 2000** |   |            |       |             |       |        |       |         |       |
| Interest and dividend income     |   | $               | 6,690      |             | $          | 6,904       |       | $            | 6,717      |   | $ | 6,653 |   |
| Interest expense                 |   | (2,768          | )          | (2,740           | )          | (2,695      | )          | (2,207       | )          |
| **Net interest income**          |   | **3,922**       | ** ** | **4,164**        | ** ** | **4,022**   | ** ** | **4,446**    | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Provision for loan losses        |   | 460             |       | (120             | )          | (120        | )          | (170         | )          |
| Noninterest income               |   | 1,133           |       | 1,398            |       | 1,168       |       | 1,276        |       |
| Noninterest expenses             |   | (3,763          | )          | (3,799           | )          | (3,720      | )          | (3,816       | )          |
|                             |   |            |       |             |       |        |       |         |       |
| **Income before income taxes**   |   | **1,752**       | ** ** | **1,643**        | ** ** | **1,350**   | ** ** | **1,736**    | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Income taxes                     |   | 521             |       | 551              |       | 451         |       | 597          |       |
|                             |   |            |       |             |       |        |       |         |       |
| **Net income**                   |   | **$**           | **1,231**  | ** **       | **$**      | **1,092**   | ** ** | **$**        | **899**    | ** ** | **$** | **1,139** | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Earnings per common share:       |   |            |       |             |       |        |       |         |       |
| Basic                            |   | $               | .56        |             | $          | .51         |       | $            | .42        |   | $ | .53 |   |
| Diluted                          |   | .52             |       | .49              |       | .40         |       | .50          |       |

 

55

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**ITEM 9 -CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

There was a change in the Company’sindependent accountants during the third quarter of 2001 as reported on Form8-K filed with the SEC on September 7, 2001.  This change was a result ofthe acquisition by another accounting firm of the attest assets of theaccounting firm the Company has used for several years.

 

**PART III**

 

**ITEM 10 -DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGEACT**

 

Incorporated by reference to the sectionsentitled ***Election ofDirectors - Information with Respect to Nominees and Directors whose TermsContinue, Management, and Section 16(a) Beneficial Ownership ReportingCompliance*,** as set forth in the Proxy Statement.

 

**ITEM 11 -EXECUTIVE COMPENSATION**

 

Incorporated by reference to the sectionsentitled ***InformationRegarding the Board of Directors and its Committees - Director Compensation andExecutive Compensation***, as set forth in the Proxy Statement.

 

**ITEM 12 -SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

Incorporated by reference to the sectionsentitled***Election ofDirectors - Information with Respect to Nominees and Directors whose TermsContinue, and Security Ownership of Certain Beneficial Owners and Management***,as set forth in the Proxy Statement.

 

**ITEM 13 -CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

Incorporated by reference to the sectionentitled ***CertainRelationships and Related Transactions***, as set forth in theProxy Statement.

 

56

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**PART IV**

 

**ITEM 14 -EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K**

 

The following exhibits are filed as part ofthis report:

 

(a)(1) Financial Statements.

 

Index to Consolidated FinancialReport

 

Report of McGladrey Pullen LLP,Independent Auditors

 

Report of Knight Vale &Gregory PLLC, Independent Auditors

 

Consolidated balance sheets asof December 31, 2001 and 2000

 

Consolidated statements ofincome for the years endedDecember 31, 2001, 2000 and 1999

 

Consolidated statements ofstockholders’ equity for the years ended December 31, 2001, 2000 and 1999

 

Consolidated statements of cashflows for the years endedDecember 31, 2001, 2000 and 1999

 

Notes to Consolidated FinancialStatements

 

(a)(2) Financial StatementSchedules.

 

Schedules are omitted for thereason that they are not required or are not applicable, or the requiredinformation is shown in the Consolidated Financial Statements or notes thereto.

 
| (a)(3) | Exhibits:                      | See separate Exhibit Index |
|--------|--------------------------------|----------------------------|
|   |                           |                       |
| (2)    | Reports on Form 8-K:           | None                       |
|   |                           |                       |
| (3)    | Exhibits:                      | See separate Exhibit Index |
|   |                           |                       |
| (4)    | Financial Statement Schedules: | None                       |

 

57

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SIGNATURES

 

Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized, on the 15th day of March, 2002.

 
|   | FIRST  COMMUNITY FINANCIAL GROUP, INC. |
|--------|----------------------------------------|
|   | (Registrant)                           |
|   |                                   |
|   | By:                                    | /s/ Ken F.  Parsons, Sr. |   |
|   | Ken F.  Parsons, Sr.                   |
|   | President  and Chief Executive Officer |

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities indicatedon the 15th day of March, 2002.

 
| **Signatures**               |                                                           | **Title** |   |
|------------------------------|----------------------------------------------------------------|-----------|--------|
|                         |                                                           |
| Principal  Executive Officer |                                                           |
|                         |                                                           |
| /s/ Ken F.  Parsons, Sr.     | President,  Chief Executive Officer, and Chairman of the Board |
| Ken F.  Parsons, Sr.         |                                                           |
|                              |                                                                |           |        |  |

 
| Chief  Financial and Accounting Officer |                                                  |
|-----------------------------------------|-------------------------------------------------------|
|                                    |                                                  |
| /s/ James F.  Arneson                   | Executive  Vice President and Chief Financial Officer |
| James F.  Arneson                       |                                                  |
|                                    |                                                  |
| /s/ E. Paul  DeTray                     | Director                                              |
| E. Paul  DeTray                         |                                                  |
|                                    |                                                  |
| /s/ A.  Richard Panowicz                | Director                                              |
| A. Richard  Panowicz                    |                                                  |
|                                    |                                                  |
| /s/ Patrick  L. Martin                  | Director                                              |
| Patrick L.  Martin                      |                                                  |
|                                    |                                                  |
| /s/ Michael  N. Murphy                  | Director                                              |
| Michael N.  Murphy                      |                                                  |
|                                         |                                                       |  |

 

58

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**EXHIBITINDEX**

 
| **Exhibit No.** |   | **Exhibit Description**                                                                   |
|-----------------|--------|-------------------------------------------------------------------------------------------|
| 3 (a)           |   | Amended and Restated  Articles of Incorporation.                                          |
|            |   |                                                                                      |
| 3 (b)           |   | Registrant’s Amended and  Restated Bylaws.                                           |
|            |   |                                                                                      |
| 10 (a)          |   | Employment contract for  Ken F. Parsons.(1)                                               |
|            |   |                                                                                      |
| 10 (b)          |   | 1992 Stock Option Plan for  Non-Employee Directors.(2)                                    |
|            |   |                                                                                      |
| 10 (c)          |   | Executive Supplemental  Income Plan.(2)                                                   |
|            |   |                                                                                      |
| 10 (d)          |   | Employee Stock Option and  Restricted Stock Award Plan dated April 19, 1989.(2)           |
|            |   |                                                                                      |
| 10 (e)          |   | 1994 Stock Option Plan for  Non-employee Directors.(3)                                    |
|            |   |                                                                                      |
| 10 (f)          |   | Employment contract for  James F. Arneson.(4)                                             |
|            |   |                                                                                      |
| 10 (g)          |   | 1999 Employee Stock Option  and Restricted Award Plan and form of agreements.(5)          |
|            |   |                                                                                      |
| 10 (h)          |   | Marketing and Service  Agreement with Advance America.(6)                                 |
|            |   |                                                                                      |
| 10 (i)          |   | Marketing and Service  Agreement with Advance America dated March 21, 2001.               |
|            |   |                                                                                      |
| 10 (j)          |   | Employment contract for  Jon M. Jones.(7)                                                 |
|            |   |                                                                                      |
| 10 (k)          |   | Amended and Restated First  Community Financial Group, Inc. Employee Stock Ownership Plan |
|            |   | with 401(k) Provisions.                                                                   |
|            |   |                                                                                      |
| 10 (l)          |   | Form of Long Term Care  Agreement.                                                        |
|            |   |                                                                                      |
| 21              |   | Subsidiaries of  Registrant.                                                              |

 

----

| (1)    |   | Incorporated by reference  to Exhibit 10 of the Registrant’s Quarterly Report on form 10-QSB for the  quarter ended                    |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | September 30, 1996.                                                                                                                         |
|   |   |                                                                                                                                        |
| (2)    |   | Incorporated by reference  from Exhibit 10 of Registrant’s Annual Report on Form 10-KSB for the fiscal  year ending December 31, 1992. |
|   |   |                                                                                                                                        |
| (3)    |   | Incorporated by reference  to Exhibit 10 of Registrant’s Annual Report on Form 10-KSB for the fiscal  year ending December 31, 1994.   |
|   |   |                                                                                                                                        |
| (4)    |   | Incorporated by reference  to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the fiscal year  ending December 31, 1998.     |
|   |   |                                                                                                                                        |
| (5)    |   | Incorporated by reference  to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the fiscal year  ending December 31, 1999.     |
|   |   |                                                                                                                                        |
| (6)    |   | Incorporated by reference  to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the fiscal year  ending December 31, 2000.     |
|   |   |                                                                                                                                        |
| (7)    |   | Incorporated by reference  to Exhibit 10 to Registrant’s Quarterly Report on Form 10-Q for the quarter  ended September 30, 2001.      |
|   |   |                                                                                                                                        |

 

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