**UNITED STATESSECURITIES 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**                                               |
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|                                                                                                                                                 |   |   |
| **For the Fiscal Year ended December 31, 2002**                                                                                                      |
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| **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.**                                                   |
|---------------------------------------------------------------------------------------------|
| (Exact  name 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**                             |
|                                                                                        |   |   |
| Registrant’s  telephone number, including area code **(360)  459-1100**                |
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| Securities  registered pursuant to Section 12(b) of the Act: **NONE**                       |
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| Securities  registered pursuant to Section 12(g) of the Act: **Common Stock, no par value** |

 

Indicate by check mark whether the registrant(1) has filed all reports required by Section 13 or 5(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months and (2) has been subject tosuch filing requirements for the past 90 days. Yes ý No o

 

Indicate by check mark if disclosure ofdelinquent filers in response to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this form 10-K ý

 

Indicate by check mark whetherthe Registrant is an accelerated filer (as defined by Exchange Act Rule 12b-2).

Yes o                    No ý

 

There is no active trading market for theRegistrant’s voting common equity.  TheRegistrant’s voting common stock is not listed on any exchange or quoted onNasdaq.  The aggregate market value ofthe voting common equity held by non-affiliates as of June 28, 2002 (the lastbusiness day of the most recent second quarter),was $41,488,757 (based on thelast sale of $11.50 per share on June 28, 2002).

 

Thenumber of shares of no par value Common Stock outstanding as of March 19, 2003,was 4,387,248.

 

DOCUMENTSINCORPORATED BY REFERENCE

Portions of the proxy statement (the “ProxyStatement”) for use in connection with the Annual Meeting of Shareholders to beheld on May 22, 2003, are incorporated by reference into Part III of thisAnnual Report on

Form 10-K.

 

 

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**FirstCommunity Financial Group, Inc.**

FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2002

TABLE OF CONTENTS

 
| **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.                                                  | MANAGEMENT’S DISCUSSION & ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
| •  Forward-Looking Information                 |
| •  Critical Accounting Policies  and Estimates |
| •  Performance Overview                        |
| •  Results of Operations                       |
| •  Liquidity and Financial Condition           |
| •  Capital Resources                           |
|                                                     |   |
| ITEM 7A.                                                 | QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK |
|                                                     |   |
| ITEM 8.                                                  | FINANCIAL STATEMENTS AND SUPPLEMENTARY 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 OFFICERS;  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 |
|                                                     |   |
| ITEM 14                                                  | CONTROLS AND PROCEDURES |
|                                                     |   |
| ITEM 15.                                                 | EXHIBITS, FINANCIAL STATEMENT SCHEDULES,  AND REPORTS ON FORM 8-K |
| •   Signatures and Certifications              |
| •   Exhibit Index                              |

 

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**PART I**

 

**ITEM 1** - BUSINESS

 

**General**

 

First Community Financial Group, Inc. (“FCFG”or “the Company”) was incorporated under the laws of the State of Washington inNovember 1983 as First Community Bancorp, Inc. and is a bank holdingcompany.  The Company’s name was changedto 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.   References to “we”, “us”,or “our” refers to FCFG.

 

The Company expanded solely through internalgrowth until 1993 when it began a series of acquisitions to more rapidly expandits 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               |
| Harbor Bank, N.A.                 |   | 2002               |

 

On October 1, 2002, the Company completed theacquisition of Harbor Bank, National Association (“Harbor Bank”) pursuant to anAgreement and Plan of Merger under the terms of which Harbor Bank merged withand into the Bank.  Harbor Bankshareholders received $10.75 in cash for each share of Harbor Bank common stockoutstanding as of the effective date of the merger.  The total estimated value of the acquisition was approximately $7million.  The acquisition was financedout of existing capital, including the proceeds of a $13 million offering oftrust preferred securities completed in July 2002.  For additional information, see “Item 7. Management’s Discussion &Analysis of Financial Condition and Results of Operations – Liquidity andFinancial Condition.”

 

In February 1999, a mortgage lending officewas opened in Puyallup, which was expanded to a full service branch later thatyear.  In March 2000, a branch officewas opened in the Hawks Prairie area of Lacey, and in January 2001, a branchoffice was opened on the west side of Olympia to serve two rapidly growingareas of Thurston County.   Also inearly 2001, offices were opened in downtown Tacoma and in the South Hill areaof Puyallup.  In October 2002, twobranches in Gig Harbor were acquired in the purchase of Harbor Bank, NA.

 

The Bank engages in general banking businessthrough twenty-one offices in Thurston, Grays Harbor, Lewis and PierceCounties.  A primary focus of the Bankis on business and commercial real estate lending and is a market leader inThurston County.  The Bank provides afull range of banking services including savings accounts, checking accounts,installment, mortgage and commercial lending, safety deposit facilities, timedeposits, and other consumer and business-related financial services includingthe sale of non-deposit investment products.

 

FCB Financial Services, a wholly ownedsubsidiary of the Bank provides a broad range of investment services includingretirement and estate planning, annuities, stocks, bonds, mutual funds andprofit sharing plans.

 

In November 2000 and April 2001, the Bankentered into Marketing and Servicing Agreements with Advance America.  Advance America is a Delaware company formedin 1997 and is comprised of a group of “parent-subsidiary” companies whosefunction is to develop, own, acquire and manage cash advance centers throughoutthe United States.  Under theseagreements, the Bank offers short-term consumer loans (commonly known as“payday loans”) to customers in the states of Alabama and Arkansas.  Payday loans are small dollar ($500 orless), short-term unsecured loans that borrowers promise to repay out of theirnext paycheck.  The Bank charges a fixeddollar fee, rather than simple interest. In a typical payday loan transaction, the borrower provides the Bankwith a post-dated check for the loan amount plus the fee.  The Bank agrees to defer deposit of thecheck until the check date, usually two weeks or less.  Advance America acts as the Bank’s agent inmarketing and collecting these loans. The agreements have terms of three years, and may be terminated withoutcause upon six months notice.  Theagreements are immediately terminable if any bank regulatory agency withjurisdiction over the Bank or the Company determines that the Bank’sperformance of the agreements is unlawful or an unsafe or unsoundpractice.  Financial highlights on thissegment of the Company is found in *Note20-Business Segment Information,* in the Company’s consolidatedfinancial

 

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statements. The federal bank regulators’ perspective on payday lending is generallydescribed below in the section titled, “Business - Supervision andRegulation-Safety and Soundness Standards.”

 

**Competition**

 

Commercial banking in the state of Washingtonis highly competitive with respect to providing banking services, includingmaking loans and attracting deposits. The Bank competes with other banks, as well as with savings and loanassociations, savings banks, credit unions, mortgage companies, investmentbanks, insurance companies, securities brokerages, and other financialinstitutions.  Banking in Washington issignificantly affected by several large banking institutions, including U.S.Bank, Wells Fargo Bank, Bank of America, and Washington Mutual Bank, whichtogether account for a majority of the total commercial and savings bankdeposits in Washington.  Thesecompetitors have significantly greater financial resources and offer a greaternumber of branch locations (with statewide branch networks), higher lendinglimits, and a variety of services not offered by the Bank.  The Bank has positioned itself successfullyas a local alternative to banking conglomerates that may be perceived bycustomers or potential customers, to be impersonal, out-of-touch with thecommunity, or simply not interested in providing banking services to some ofthe Bank’s target customers.  Over thepast few years, numerous “community” banks have been formed or moved into theBank’s market areas and have developed a similar focus. This growing number ofsimilar banks and an increased focus by larger institutions on the Bank’smarket segments in response to declining market perception and/or market sharehas led to intensified competition.

 

The adoption of the Gramm-Leach-Bliley Act of1999 in November 1999 has led to further intensification of competition in thebanking industry.  The Act haseliminated many of the barriers to affiliation among providers of various typesof financial services and has permitted business combinations among financialproviders such as banks, insurance companies, securities or brokerage firms,and other financial service providers. This has led to increased competition inboth the market for providing financial services and in the market foracquisitions in which the Bank also participates.  For additional information, see “Business – Supervision andRegulation – Financial Services Modernization.”

 

In general, the financialservices industry has experienced widespread consolidation over the lastdecade.  It is anticipated thatconsolidation among financial institutions in the Company’s market area willcontinue, although at a slower pace. Other financial institutions, many withsubstantially greater resources, compete in the acquisition market against theBank. Some of these institutions, have greater access to capital markets,larger cash reserves and a more liquid currency.  Additionally, the rapid adoption of financial services throughthe Internet has reduced the barrier to entry by financial services providersphysically located outside the Bank’s market area.  Although the Bank has been able to compete effectively in thefinancial services markets to date, there can be no assurance that it will beable to continue to do so in the future.

 

As noted above, the Bank’s small loandivision offers short-term consumer loans in Arkansas and Alabama pursuant toagreements with Advance America.  TheBank believes that the principal competitive factors in the check-cashingindustry are location, customer service, fees, convenience, and range ofservices offered.  The Bank facesintense competition and believes that the short-term consumer loan market isbecoming more competitive as the industry matures and consolidates. Some of theBank’s competitors have larger and more established customer bases andsubstantially greater financial, marketing, and other resources.  There is no assurance that the Bank’s smallloan division will be able to compete successfully with its competitors.  

 

**Employees**

 

FCFG and its subsidiaries employed a total of242 employees, consisting of 200 full time and 42 part time employees atDecember 31, 2002.  A number of benefitprograms are available to eligible employees, including group medicals plans,paid sick leave, paid vacation, group life insurance, a 401(k) plan, deferredcompensation plans, and stock incentive plan. Such employees are not represented by a union organization or other collectivebargaining group, and management considers relations with employees to be very good.

 

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**SUPERVISIONAND REGULATION**

 

*General*

 

The Bank is extensively regulated underfederal and state law. These laws and regulations are primarily intended toprotect depositors, not shareholders. The discussion below describes andsummarizes certain statutes and regulations. These descriptions and summariesare qualified in their entirety by reference to the particular statute orregulation. Changes in applicable laws or regulations may have a materialeffect on the Bank’s business and prospects. The Bank’s operations may also be affected by changes in the policies ofbanking and other government regulators. The nature or extent of the possible future effects on business andearnings of changes in fiscal or monetary policies, or new federal or statelaws and regulations cannot accurately be predicted.

 

***Significant Changes In Banking Laws AndRegulations***

 

Sarbanes-Oxley Act of 2002.*** ***On July 30, 2002, the President signed into law theSarbanes-Oxley Act of 2002 (the “Act”) to address corporate and accountingfraud.  The Act establishes a newaccounting oversight board that will enforce auditing standards and restrictsthe scope of services that accounting firms may provide to their public companyaudit clients. Among other things, the Act also (i) requires chief executiveofficers and chief financial officers to certify to the accuracy of periodicreports filed with the Securities and Exchange Commission (the “SEC”); (ii)imposes new disclosure requirements regarding internal controls,off-balance-sheet transactions, and pro forma (non-GAAP) disclosures; (iii)accelerates the time frame for reporting of insider transactions and periodicdisclosures by public companies; and (iv) requires companies to disclosewhether or not they have adopted a code of ethics for senior financial officersand whether the audit committee includes at least one “audit committeefinancial expert.”

 

The Act also requires the SEC, based oncertain enumerated factors, to regularly and systematically review corporatefilings.  To deter wrongdoing, the Act:(i) subjects bonuses issued to top executives to disgorgement if a restatementof a company’s financial statements was due to corporate misconduct; (ii)prohibits an officer or director from misleading or coercing an auditor; (iii)prohibits insider trades during pension fund “blackout periods”; (iv) imposesnew criminal penalties for fraud and other wrongful acts; and (v) extends theperiod during which certain securities fraud lawsuits can be brought against acompany or its officers.

 

As a publicly reporting company, the Companyis subject to the requirements of the Act and are in the process of complyingwith, and establishing procedures for, compliance with the Act and relatedrules and regulations issued by the SEC. At the present time, and subject to the final rules and regulations theSEC may adopt, the Company anticipates that it will incur additional expense asa result of the Act, but it is not expected that such compliance will have amaterial impact on business.

 

***Federal Bank Holding Company Regulation***

 

General.  TheCompany is a bank holding company as defined in the Bank Holding Company Act of1956, as amended, and is therefore subject to regulation, supervision andexamination by the Federal Reserve. In general, the Bank Holding Company Actlimits the business of bank holding companies to owning or controlling banksand engaging in other activities closely related to banking. The Company mustalso file reports and provide additional information with the FederalReserve.  Under the Financial ServicesModernization Act of 1999, a bank holding company may apply to the FederalReserve to become a financial holding company, and thereby engage (directly orthrough a subsidiary) in certain expanded activities deemed financial innature, such as securities brokerage and insurance underwriting.

 

Holding Company BankOwnership.  The Bank Holding Company Act requires everybank holding company to obtain the prior approval of the Federal Reserve before(1) acquiring, directly or indirectly, ownership or control of any votingshares of another bank or bank holding company if, after such acquisition, itwould own or control more than 5% of such shares, (2) acquiring all orsubstantially all of the assets of another bank or bank holding company, or (3)merging or consolidating with another bank holding company.

 

Holding Company Control ofNonbanks.  With some exceptions, the Bank HoldingCompany Act also prohibits a bank holding company from acquiring or retainingdirect or indirect ownership or control of more than 5% of the voting shares ofany company which is not a bank or bank holding company, or from engagingdirectly or indirectly in activities other than those of banking, managing orcontrolling banks or providing services for its subsidiaries. The principalexceptions to these prohibitions involve certain non-bank activities which, bystatute or by Federal Reserve regulation or order, have been identified asactivities closely related to the business of banking or of managing orcontrolling banks.

 

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Transactions with Affiliates. Subsidiary banks of a bank holding company are subject to restrictionsimposed by the Federal Reserve Act on extensions of credit to the holdingcompany or its subsidiaries, on investments in their securities, and on the useof their securities as collateral for loans to any borrower. These regulationsand restrictions may limit the Company’s ability to obtain funds from the Bankfor its cash needs, including funds for payment of dividends, interest andoperational expenses.

 

Tie-in Arrangements.  TheCompany is prohibited from engaging in certain tie-in arrangements inconnection with any extension of credit, sale or lease of property orfurnishing of services. For example, with certain exceptions, neither theCompany nor its subsidiaries may condition an extension of credit to a customeron either (1) a requirement that the customer obtain additional servicesprovided by the Company 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 is expected to act as a sourceof financial and managerial strength to the Bank.  This means that the Company is required to commit, as necessary,resources to support the Bank. Any capital loans a bank holding company makesto its subsidiary banks are subordinate to deposits and to certain otherindebtedness of those subsidiary banks.

 

State Law Restrictions.  Asa Washington corporation, the Company is subject to certain limitations andrestrictions under applicable Washington corporate law. For example, state lawrestrictions in Washington include limitations and restrictions relating toindemnification of directors, distributions to shareholders, transactionsinvolving directors, officers or interested shareholders, maintenance of books,records, and minutes, and observance of certain corporate formalities.

 

***Federal and State Regulation of First Community Bank***

 

General.  TheBank is a Washington chartered commercial bank with deposits insured by theFDIC.  As a result, the Bank is subjectto supervision and regulation by the Washington Department of FinancialInstitutions, Division of Banks and the FDIC. These agencies have the authorityto prohibit banks from engaging in what they believe constitute unsafe orunsound banking practices.

 

Lending Limits. Washington state banking law generally limits the amount of funds that abank may lend to a single borrower to 20% of the bank’s capital and surplus.

 

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 facility.

 

Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the FederalReserve Act on extensions of credit to executive officers, directors, principalshareholders or any related interests of such persons. Extensions of credit (1)must be made on substantially the same terms, including interest rates andcollateral as, and follow credit underwriting procedures that are not lessstringent than, those prevailing at the time for comparable transactions withpersons not covered above and who are not employees, and (2) must not involvemore than the normal risk of repayment or present other unfavorable features.Banks are also subject to certain lending limits and restrictions on overdraftsto insiders. A violation of these restrictions may result in the assessment ofsubstantial civil monetary penalties, the imposition of a cease and desist order,and other regulatory sanctions.

 

Regulation of Management. Federal law sets forth circumstances under which officers or directorsof a bank may be removed by the institution’s federal supervisory agency.  Federal law also prohibits managementpersonnel of a bank from serving as a director or in a management position ofanother financial institution whose assets exceed a specified amount or whichhas an office within a specified geographic area.

 

Safety and SoundnessStandards.  Federal law imposes upon banks certainnon-capital safety and soundness standards. These standards cover, among otherthings, internal controls, information systems, internal audit systems, loandocumentation, credit underwriting, interest rate exposure, asset growth,compensation and benefits.  Additionalstandards apply to asset quality, earnings and stock valuation. An institutionthat fails to meet these standards must develop a plan acceptable to itsregulators, specifying the steps that the institution will take to meet the standards.  Failure to submit or implement such a planmay subject the institution to regulatory sanctions.

 

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Recently the Office of theComptroller of the Currency (the “OCC”), the primary federal regulator ofnational banks, and the Office of Thrift Supervision (the “OTS”), the primaryregulator of federal savings banks, have increased their scrutiny of banksinvolved in payday lending.  Publishedregulatory guidance indicates that regulators are concerned about certainpotential risks to banks.  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. The OCC and OTS will enforce these expectations through the examinationprocess and have the power to order banks under their jurisdiction todiscontinue their participation in payday lending.  The OCC has recently ordered two national banks to discontinuetheir payday lending operations.

 

In January of 2003, the FDIC issued draftguidelines for state chartered nonmember banks involved in payday lending.  The draft guidelines, if adopted in theircurrent form, would prescribe safety and soundness and complianceconsiderations for FDIC-supervised banks engaged in payday lending.  The draft guidelines assume that paydaylending involves a higher level of risk than typical subprime lending.  The guidelines suggest, among other things,that banks engaged in payday lending may be required to hold additional capitalagainst payday loans on a dollar-for-dollar basis.  The guidelines further suggest that payday loan portfoliosshould, on a blanket basis, be classified “substandard.”  The guidelines also contain additionalprovisions relating to a bank’s allowance for loan and lease losses, recoveryand charge off practices, third-party relationships, and numerous complianceissues considered by the FDIC to be significant to payday lendingactivities.  The comment period for thedraft guidelines closed on March 14, 2003.

 

Management believes that the Bank has takenappropriate steps to manage and control the risks of its payday lendingactivities consistent with currently applicable regulatory guidance.  Management is also evaluating the potentialeffects of the FDIC’s draft guidelines on its payday lending activities, shouldthe guidelines be adopted in their current form.  However, there can be no assurance that the final guidelines,once adopted, will allow the Bank to continue its payday lending activities inthe same manner and to the same extent as it does currently.  Also, there can be no assurance that theBank’s regulators would not seek to restrict or terminate the Bank’s participationin payday lending.

 

***Interstate Banking And Branching***

 

The Riegle-Neal Interstate Banking andBranching Efficiency Act of 1994 (“Interstate Act”) permits nationwideinterstate banking and branching under certain circumstances.  This legislation generally authorizesinterstate branching and relaxes federal law restrictions on interstatebanking. Currently, bank holding companies may purchase banks in any state, andstates may not prohibit these purchases. Additionally, banks are permitted to mergewith banks in other states, as long as the home state of neither merging bankhas opted out under the legislation. The Interstate Act requires regulators toconsult with community organizations before permitting an interstateinstitution 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, allowing banks to engage in interstatemerger transactions, subject to certain “aging” requirements. Washingtonrestricts an out-of-state bank from opening de novo branches. However, once anout-of-state bank has acquired a bank within the state, either through mergeror acquisition of all or substantially all of the bank’s assets, theout-of-state bank may open additional branches within the state.

 

***Deposit Insurance***

 

The Bank’s deposits are currently insured toa maximum of $100,000 per depositor through the Bank Insurance Fundadministered by the FDIC. The Bank is required to pay deposit insurancepremiums, which are assessed semiannually and paid quarterly.  The premium amount is based upon a risk classificationsystem established by the FDIC.  Bankswith higher levels of capital and a low degree of supervisory concern areassessed lower premiums than banks with lower levels of capital or a higherdegree of supervisory 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.

 

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***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 below thatnecessary to meet minimum applicable regulatory capital requirements. Statelaws also limit a bank’s ability to pay dividends.

 

***Capital Adequacy***

 

RegulatoryCapital Guidelines.  Federalbank regulatory agencies use capital adequacy guidelines in the examination andregulation of bank holding companies and banks. The guidelines are“risk-based,” meaning that they are designed to make capital requirements moresensitive to differences in risk profiles among banks and bank holdingcompanies.

 

TierI and Tier II Capital.  Under theguidelines, an institution’s capital is divided into two broad categories, TierI capital and Tier II capital.  Tier Icapital generally consists of common stockholders’ equity, surplus andundivided profits.  Tier II capitalgenerally consists of the allowance for loan losses, hybrid capitalinstruments, and subordinated debt.  Thesum of Tier I capital and Tier II capital represents an institution’s totalcapital.  The guidelines require that atleast 50% of an institution’s total capital consist of Tier I capital.  

 

Risk-basedCapital Ratios.  Theadequacy of an institution’s capital is gauged primarily with reference to theinstitution’s risk-

weightedassets.  The guidelines assign riskweightings to an institution’s assets in an effort to quantify the relativerisk of each asset and to determine the minimum capital required to supportthat risk.  An institution’srisk-weighted assets are then compared with its Tier I capital and total capitalto arrive at a Tier I risk-based ratio and a total risk-based ratio,respectively.  The guidelines providethat an institution must have a minimum Tier I risk-based ratio of 4% and aminimum total risk-based ratio of 8%.

 

Leverage Ratio.  Theguidelines also employ a leverage ratio, which is Tier I capital as apercentage of total assets, less intangibles. The principal objective of the leverage ratio is to constrain themaximum degree to which a bank holding company may leverage its equity capitalbase. The minimum leverage ratio is 3%; however, for all but the most highlyrated bank holding companies and for bank holding companies seeking to expand,regulators expect an additional cushion of at least 1% to 2%.

 

Prompt Corrective Action. Under the guidelines, 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. The categories range from “well capitalized”to “critically undercapitalized.”  Institutionsthat are “undercapitalized” or lower are subject to certain mandatorysupervisory corrective actions.

 

***Financial Services Modernization***

 

Gramm-Leach-Bliley Act of1999.  The Financial Services Modernization Act of1999, also known as the Gramm-Leach-Bliley Act, brought about significantchanges to the laws affecting banks and bank holding companies.  Generally, the Act (i) repealed thehistorical restrictions on preventing banks from affiliating with securitiesfirms, (ii) provided a uniform framework for the activities of banks, savingsinstitutions and their holding companies, (iii) broadened the activities thatmay be conducted by national banks and banking subsidiaries of bank holdingcompanies, (iv) provided an enhanced framework for protecting the privacy ofconsumer information and (v) addressed a variety of other legal and regulatoryissues affecting both day-to-day operations and long-term activities offinancial institutions.

 

Bank holding companies that qualify and electto become financial holding companies can engage in a wider variety offinancial activities than permitted under previous law, particularly withrespect 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 believe that the actwill negatively affect operations in the short term.  However, to the extent the legislation permits banks, securitiesfirms and insurance companies to affiliate, the financial services industry mayexperience further consolidation.  Thisconsolidation could result in a growing number of larger financial institutionsthat offer a wider variety of financial services than currently offered, andthese companies may be able to aggressively compete in the markets the Companycurrently serves.

 

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***Anti-terrorism Legislation***

 

USA Patriot Act of 2001.  OnOctober 26, 2001, President Bush signed the Uniting and Strengthening Americaby Providing Appropriate Tools Required to Intercept and Obstruct Terrorism(“USA Patriot Act”) of 2001.  Amongother things, the USA Patriot Act (1) prohibits banks from providingcorrespondent 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 investigateterrorism, including expanded government access to account records.  The Department of the Treasury is empoweredto administer and make rules to implement the Act.  While the Bank believes the USA Patriot Act may, to some degree,affect recordkeeping and reporting expenses, it does not believe that the Actwill have a material adverse effect on business and operations.

 

***Effects Of Government Monetary Policy***

 

The Bank’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 rate applicableto 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 cannot be predicted with certainty.

 

## **ITEM 2** - PROPERTIES

 

The Bank owns the property and buildings onwhich the Aberdeen, Elma, Hoquiam, Lacey, Yelm, Fircrest, downtown Tacoma ,Winlock, Toledo, Montesano, Centralia, and downtown Olympia branches aresituated. The Bank also owns the Gig Harbor Loan Center building as part of itsPioneer Location.  The Tumwater,Eatonville and Meridian Road branches are operated in buildings owned by FCBthat are situated on leased property. The Hawks Prairie, Panorama City, WestOlympia,  Puyallup Canyon Road, GigHarbor Pioneer, and Gig Harbor Pt. Fosdick branches are operated in leasedspace.  The aggregate monthly rental onall properties leased by the Bank is approximately $45,000.

 

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 Road, Tumwater, Yelm, Eatonville,West Olympia, Winlock, Centralia, Aberdeen, Pt. Fosdick, and Hoquiam branchesare single story structures with drive-up facilities.  The Elma, Downtown Olympia, Hawks Prairie, Downtown Tacoma andMontesano branches are two story structures with drive-up facilities.  The Panorama City branch is located on theground floor of a retirement center. The Toledo and Pioneer branches are singlestory structures with walk up ATMs. The Fircrest facility is an office condominium,of which the Bank occupies approximately one-half.  The Puyallup Canyon Road branch is a single story structure.

 

**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, 2002, no matters were submitted to the security holders throughthe solicitation of proxies or otherwise.

 

9

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**PART II**

 

**ITEM 5****- MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATEDSTOCKHOLDER 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 repurchased bythe Company as discussed below.  Thenumber of shares and per share information has been adjusted retroactively,  to reflect the two-for-one stock spliteffective November 15, 2002.

 
| **Period** |    | **# of  Shares Traded** |    | **Price  Range** |             |
|------------|---------|-------------------------|---------|------------------|------------------|
|       |    |                    |    |             |             |
| 2001       |    |                    |    |             |             |
| 1st        | Quarter |                    | 8,494   |             | $10.00  - $11.23 |   |
| 2nd        | Quarter |                    | 5,322   |             | $10.00  - $10.38 |   |
| 3rd        | Quarter |                    | 101,376 |             | $9.25  - $11.50  |   |
| 4th        | Quarter |                    | 24,680  |             | $10.00  - $10.50 |   |
|       |    |                    |    |             |             |   |
| 2002       |    |                    |    |             |             |
| 1st        | Quarter |                    | 20,564  |             | $10.00  - $10.25 |   |
| 2nd        | Quarter |                    | 81,108  |             | $9.50  - $11.50  |   |
| 3rd        | Quarter |                    | 16,974  |             | $11.38  - $11.75 |   |
| 4th        | Quarter |                    | 14,052  |             | $11.75  - $15.00 |   |

 

At December 31, 2002, options for 588,595shares of FCFG common stock were outstanding. See Note 16 of the consolidated financial statements for additionalinformation.

 

On April 23, 2002, the Board approved a stockrepurchase program that allowed the repurchase of up to 100,000 shares ofFCFG’s Common Stock or 2% of the Company in scheduled purchases over time,through open market transactions, block purchases, or through privatelynegotiated transactions, including, from time to time, the purchase of sharesfrom directors and executive officers of FCFG. Under this plan 91,746 shares were repurchased in 2002 for a total of$950,000.

 

On December 11, 2002, the Board approvedstock repurchase program that allowed for the repurchase of up to 132,000shares of FCFG Common Stock or approximately 3% of the Company in purchasesover time, through open market transactions or through privately negotiatedtransactions.  No purchases were madeunder this plan in 2002.  As of March11, 2003 a total of 67,572 shares have been repurchased under this plan for atotal of $1,134,792.

 

On February 19, 2003 The Board approved astock repurchase program to allow for the repurchase of 87,580 shares of FCFGCommon Stock or approximately 2% of the Company in scheduled purchases overtime in either privately negotiated transactions or through the open market. Nopurchases have been made under this plan.

 

On November 4, 2002, the Board of Directorsannounced a two-for-one stock split on FCFG stock for shareholders of record onNovember 15, 2002.

 

Number of Equity Holders

 

As of December 31, 2002, there were 1,310 holdersof record of FCFG’s common stock.

 

Dividends

FCFG paid cash dividends of $.05 per share onFebruary 15, May 10, August 9, and November 18, 2002.  The amounts reported for 2002 reflect the stock split whichoccurred on November 15, 2002.   CashDividends of $.10 per share were issued on February 16, May 11, August 10, andNovember 9, 2001.  Cash dividends of$.10 per share were issued on February 11, May 5, August 11 and November 10,2000. Cash dividends of $ .40, $ .09 and $.09 per share were issued on April15, 1999, July 30, 1999 and October 30, 1999, respectively.  There were no cash dividends declared in1998 or 1997.  Stock dividends of 5%were issued on May 6, 1998 and April 15, 1997, respectively.

 

10

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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 ofthe Bank are available for the payment of dividends to the Company under theserestrictions, subject to the federal capital regulations discussed above.  See “Business – Supervision and Regulation –Dividends”.

 

Securities Authorized for Issuance UnderEquity Compensation Plans

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 6****- SELECTED FINANCIAL DATA**

 

The selectedfinancial data should read in conjunction with FCFG’s consolidated financialstatements and the accompanying notes presented in this report.  The per share information has been adjustedretroactively for all stock dividends and splits.

 
| **($ in thousands, except per share  data)**         |   | **2002**       |    | **2001** |   | **2000** |   | **1999** |    | **1998** |   |
|------------------------------------------------------|--------|----------------|---------|----------|--------|----------|--------|----------|---------|----------|--------|
| For the Year                                         |   |           |    |     |   |     |   |     |    |     |   |
| Net interest income after provisionfor credit losses |   | $              | 21,079  |     | $      | 17,682   |   | $        | 16,604  |     | $      | 11,348 |   | $ | 14,302 |   |
| Non-interest income                                  |   | 7,865          |    | 6,324    |   | 4,975    |   | 4,619    |    | 4,883    |   |
| Non-interest expense and taxes                       |   | 22,732         |    | 19,569   |   | 17,218   |   | 14,607   |    | 15,580   |   |
|                                                 |   |           |    |     |   |     |   |     |    |     |   |
| Net income                                           |   | $              | 6,212   |     | $      | 4,437    |   | $        | 4,361   |     | $      | 1,360 |   | $ | 3,605 |   |
|                                                 |   |           |    |     |   |     |   |     |    |     |   |
| Per Common Share                                     |   |           |    |     |   |     |   |     |    |     |   |
| Basic Earnings Per Share                             |   | $              | 1.42    |     | $      | 1.02     |   | $        | 1.01    |     | $      | .32 |   | $ | .87 |   |
|                                                 |   |           |    |     |   |     |   |     |    |     |   |
| Stock Dividends declared                             |   | —    |    | —   |   | —   |   | —   |    | 5        | %      |
| Cash Dividends Paid                                  |   | $              | .20     |     | $      | .20      |   | $        | .20     |     | $      | .29 |   | — |   |
|                                                 |   |           |    |     |   |     |   |     |    |     |   |
| Balance Sheet Data:                                  |   |           |    |     |   |     |   |     |    |     |   |
| Total Assets                                         |   | $              | 474,450 |     | $      | 364,623  |   | $        | 324,235 |     | $      | 293,773 |   | $ | 271,566 |   |
| Long-term debt                                       |   | 24,000         |    | 575      |   | 1,303    |   | 2,030    |    | 2,808    |   |
| Stockholders’ equity                            |   | 44,209         |    | 38,795   |   | 34,373   |   | 30,618   |    | 30,341   |   |

 

**ITEM 7****- MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

The following discussion should be read inconjunction with the Company’s audited consolidated financial statements andthe notes to those statements as of December 31, 2002 and 2001 and for each ofthe three years in the period ended December 31, 2002, included in this report.

** **

**Forward****-Looking Information**

 

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”).  Any statements that expressly orimplicitly predict future results, performance, or events should be consideredforward-looking.  Forward-lookingstatements are subject to the risks and uncertainties that may cause actualfuture results to differ materially.  Readers are cautioned not to placeundue reliance on these forward-looking statements, which speak only as of thedate of this Annual Report.  FCFG does not undertake any obligation topublicly release any revisions to forward-looking statements contained in thisAnnual Report, with respect to events or circumstances after the date of thisAnnual Report, or to reflect the occurrence of unanticipated events.

 

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

 

11

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asset/liability management, the financial andsecurities markets, changes in technology or required investments intechnology, and the availability of and costs associated with sources ofliquidity.

# ** **

# **CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

The Company’s financialstatements are based on the selection and application of significant accountingpolicies which require management to make significant estimates and assumptions(see Note 1 to the consolidated financial statements).  The Company believes that the following isone of the more critical judgment areas in the application of its accountingpolicies that affect financial condition and results of operations.

 

Allowance for Credit Losses  The allowance for credit losses is establishedthrough a provision for credit losses charged to operations. The allowance forcredit losses is a significant estimate and management and the Board ofDirectors regularly evaluate its adequacy by considering a number of factors,including, among other things, current loan grades and delinquency trends,historical loss rates, changes in the composition of the loan portfolio,overall portfolio quality, industry concentrations, and current economicfactors and the effect of those factors on a borrower’s repayment ability.  The use of different estimates orassumptions could produce different provisions for credit losses.  In addition, the allowance for credit lossesis also subject to regulatory supervision and examination.

 

**PERFORMANCE OVERVIEW**

 

In 2002, the Company earned $6,212,000.  This represents the Company’s mostprofitable year to date, surpassing the 2001 record of $4,437,000 by$1,775,000, or 40%.  Earnings for 2001increased by $76,000, or 2% over 2000 earnings of $4,361,000.  Highlights for 2002 include:

 

•                  the acquisition of Harbor Bank, NA in October2002

•                  a 21% increase in net interest income,primarily due to a 37% reduction in interest expense, and

•                  a 24% increase in non-interest income.

 

Asset growth in 2002 was 30% as total assetshave grown to $474,450,000.  Gross loansaccounted for $74,667,000 of the $109,827,000 growth in total assets.  Total deposits increased $70,477,000, or22%, to $384,207,000.  The acquisitionof Harbor Bank accounted for $81,546,000, $54,761,000 and $74,163,000 of thegrowth in total assets, loans, and deposits, respectively.

 

Basic earnings per share for 2002 were $1.42per share as compared to $1.02 per share for 2001 and $1.01 per share for 2000.

 

The Bank’s small loan division contributedsignificantly to net income in 2002. The small loan division provides small, short-term consumer loans tocustomers in Alabama and Arkansas pursuant to agreements with AdvancedAmerica.  See “Business – General.”

 

12

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Financial highlights by line ofbusiness as of and for the year ended December 31, 2002 were as follows *(thousands)*:

 
|                                                   |   | **Community  Banking** |        | **Small  Loans** |   | **Total**  |       |
|--------------------------------------------------------|--------|------------------------|-------------|------------------|--------|------------|------------|
| Net interest income after provision for  credit losses |   | $                      | 17,845      |             | $      | 3,234      |       | $ | 21,079 |   |
| Non-interest income                                    |   | 7,864                  |        | 1                |   | 7,865      |       |
| Non-interest expense                                   |   | 19,292                 |        | 781              |   | 20,073     |       |
| Income taxes                                           |   | 1,832                  |        | 827              |   | 2,659      |       |
|                                                   |   |                   |        |             |   |       |       |
| **Net income**                                         |   | **$**                  | **4,585**   | ** **       | **$**  | **1,627**  | ** ** | **$** | **6,212** | ** ** |
|                                                   |   |                   |        |             |   |       |       |
| **Total assets**                                       |   | **$**                  | **457,159** | ** **       | **$**  | **17,291** | ** ** | **$** | **474,450** | ** ** |
|                                                   |   |                   |        |             |   |       |       |
| **Total loans**                                        |   | **$**                  | **353,165** | ** **       | **$**  | **8,967**  | ** ** | **$** | **362,132** | ** ** |

 

See Note 22 – Business Segment Information ofthe enclosed financial statements for prior period comparisons.

 

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

 
|                                   |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|----------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
|                                   |   |     |   |     |   |     |   |     |   |     |   |
| Return on Average Assets               |   | 1.56     | %      | 1.27     | %      | 1.40     | %      | 0.48     | %      | 1.26     | %      |
| Return on Average Equity               |   | 15.13    | %      | 12.12    | %      | 13.62    | %      | 4.26     | %      | 12.61    | %      |
| Average Equity to Average Assets Ratio |   | 10.28    | %      | 10.45    | %      | 10.25    | %      | 11.32    | %      | 9.96     | %      |
| Dividend Payout Ratio                  |   | 14.13    | %      | 19.70    | %      | 19.88    | %      | 92.79    | %      | —   |   |

 

The Company acquired HarborBank, NA on October 1, 2002 in a strategic expansion of its presence in thePierce County marketplace.  Theacquisition provides two branches and lending opportunities in Gig Harbor.  The Company had been considering expansioninto the Gig Harbor area via a de novo branch, but this acquisition provided anopportunity to acquire significant market share in a single transaction.  Total assets, loans, and deposits of HarborBank on the date of acquisition were $81,546,000, $54,761,000 and $74,163,000,respectively.  The effect on 2002 netincome was not material as the net revenues generated were offset by costsrelated to the acquisition and integration of the organizations’ personnel andinformation systems. (See Note 2 to the consolidated financial statements formore information on this acquisition.) In addition to the growth in the Company’s assets and liabilities fromthis transaction, it also contributed to a significant increase in theCompany’s problem loans.  For furtherdiscussion, please see the discussion on Asset Quality in the Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

 

**RESULTS OF OPERATIONS**

 

**NetInterest Income**

 

Net interest income is the Bank’s principalsource of revenue, and is comprised of the difference between the interestearned on interest earning assets, less the interest expense incurred oninterest bearing liabilities.  Changesin net interest income from year to year are influenced by both the volume ofthe assets and the liabilities, and the rates paid on them.  Net interest income in 2002 increased by$4,024,000, or 21% over 2001.  Netinterest income in 2001 increased by $2,844,000, or 17% over 2000.  The increase in 2002 was primarily due tothe decrease in interest expense incurred on interest bearing liabilities.  The increased volume of loans contributedadditional interest income, although this was largely offset by the reductionin the rate earned.  The 2001 increasewas primarily the result of increased loan volume.  During 2002, interest income increased $186,000, or 1% as theeffect of increased loan volume on interest income was nearly completely offsetby the effects of falling interest rates on interest expense.  During 2001, interest income increased$2,824,000, or 10%.  Interest expense in2002 decreased $3,838,000, or 37%, despite a 14% increase in average interestbearing liabilities, and decreased $20,000 in 2001.  During 2002, the net interest margin increased 47 basis points to6.84% from 6.37% in 2001 and 5.84% in 2000.

 

Interest rate cuts in 2002 were less dramaticthan in 2001, when the prime rate, a benchmark rate that generally representsthe rate at which banks lend to the most credit worthy borrowers, was cut 11times.  In 2002 rates remained low andincluded an additional rate cut in September 2002.  For comparison, the prime rate dropped from 9.5% to 4.75% in 2001,and as of December 31, 2002, stood at 4.25%. Similarly, the Federal Funds rate, which represents banks’ overnightborrowing rate experienced similar rate cuts and has dropped from 6.5% to 1.75%in 2001 and as of December 31, 2002 stood at 1.25%.  As the rates stayed low, the effects of those dramatic reductionsin 2001 continued to have an effect on both assets and liabilities as theymatured and repriced as well as on new volume generated.

 

13

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Total interest income earned from loans in2002 increased by $465,000.  On the onehand, $3,684,000 resulted from an increase in the average volume of loansduring the year.  On the other hand, areduction in the average yield on loans, which decreased from 10.18% in 2001 to9.08% in 2002, reduced interest income by $3,219,000.  Despite the reduction in average yield, the Bank is able tomaintain a relatively high yield due to participation in the small loanprogram, which began in late 2000. These short-term consumer loans carry substantially higher yields thanthose in the Bank’s traditional portfolio, and, because they are a convenienceproduct the price does not rise and fall with changing interest rates.  These loans serve as a stabilizing influenceto the Bank’s overall loan yield. Partially offsetting the increased loaninterest was a decline in the interest earned on investment securities, whichdecreased by $207,000.  The mostsignificant reason for this decrease was the reduction in yield, which droppedfrom 5.98% in 2001 to 5.27% in 2002.  A3% decrease in average investment balance also reduced interest income by$37,000.

 

Interest expense on deposits in 2002decreased 41%, or $4,161,000 from 2001. The reason for this decrease is due to the reduction in the rate ofinterest paid on deposits.  The averagerate decline on deposits to 2.15% in 2002 from 4.02% in 2001 resulted in$4,400,000 of savings on interest expense while additional volume of averagedeposits, an increase of 10%, increased interest expense $239,000.  Interest expense on other borrowingsincreased $323,000.  The reduction inaverage interest rate to 3.32% from 4.36% saved $92,000 in interestexpense.  However the increased averagevolume of borrowings, primarily the issuance of trust preferred securitiestotaling $13,000,000, increased interest expense by $415,000.

 

An analysis of the change in net interestincome is as follows (*thousands*):

 
|                                     |   | **2002  compared to 2001   Increase (decrease) due to** |   | **2001  compared to 2000********Increase  (decrease) due to** |   |
|------------------------------------------|--------|---------------------------------------------------------|--------|---------------------------------------------------------------|--------|
|                                     |   | **Volume**                                              |   | **Rate**                                                      |   | **Net** |   | **Volume** |   | **Rate** |   | **Net** |   |
| Interest earned on:                      |   |                                                    |   |                                                          |   |   |   |   |   |   |   |   |   |
| Loans                                    |   | $                                                       | 3,684  |                                                          | $      | (3,219 | ) | $ | 465 |   | $ | 2,335 |   | $ | 752 |   | $ | 3,087 |   |
| Federal funds sold and deposits in banks |   | 11                                                      |   | (83                                                           | )      | (72 | ) | 53 |   | (29 | ) | 24 |   |
| Investment securities                    |   | (37                                                     | )      | (170                                                          | )      | (207 | ) | (215 | ) | (72 | ) | (287 | ) |
| Total interest income                    |   | 3,658                                                   |   | (3,472                                                        | )      | 186 |   | 2,173 |   | 651 |   | 2,824 |   |
|                                     |   |                                                    |   |                                                          |   |   |   |   |   |   |   |   |   |
| Interest paid on:                        |   |                                                    |   |                                                          |   |   |   |   |   |   |   |   |   |
| Savings, NOW and MMA                     |   | 541                                                     |   | (1,269                                                        | )      | (728 | ) | 274 |   | (238 | ) | 36 |   |
| Time deposits                            |   | (302                                                    | )      | (3,131                                                        | )      | (3,433 | ) | 1,175 |   | (529 | ) | 646 |   |
| Other borrowings                         |   | 415                                                     |   | (92                                                           | )      | 323 |   | (388 | ) | (314 | ) | (702 | ) |
| Total Interest expense                   |   | 654                                                     |   | (4,492                                                        | )      | (3,838 | ) | 1,061 |   | (1,081 | ) | (20 | ) |
|                                     |   |                                                    |   |                                                          |   |   |   |   |   |   |   |   |   |
| Net interest income                      |   | $                                                       | 3,004  |                                                          | $      | 1,020 |   | $ | 4,024 |   | $ | 1,112 |   | $ | 1,732 |   | $ | 2,844 |   |

 

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

 

14

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Average consolidated statements of financialposition and analysis of net interest spread were as follows *(dollars in thousands):*

 
|                                                                     |   | **2002**             |    | **2001**                       |   | **2000**           |   |
|--------------------------------------------------------------------------|--------|----------------------|---------|--------------------------------|--------|--------------------|--------|
|                                                                     |   | **Average  Balance** |    | **Interest  Income (Expense)** |   | **Average  Rates** |   | **Average  Balance** |   | **Interest  Income (Expense)** |   | **Average  Rates** |   | **Average  Balance** |   | **Interest  Income (Expense)** |   | **Average  Rates** |   |
| Earning Assets:                                                          |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans(1)                                                                 |   | $                    | 315,595 |                           | $      | 28,662             |   | 9.08 | % | $ | 277,063 |   | $ | 28,197 |   | 10.18 | % | $ | 253,963 |   | $ | 25,110 |   | 9.89 | % |
| Federal funds sold and interest bearing deposits in banks                |   | 2,954                |    | 50                             |   | 1.69               | %      | 2,699 |   | 122 |   | 4.52 | % | 1,618 |   | 98 |   | 6.06 | % |
| Investment securities                                                    |   | 23,935               |    | 1,262                          |   | 5.27               | %      | 24,560 |   | 1,469 |   | 5.98 | % | 28,118 |   | 1,756 |   | 6.25 | % |
| Total earning assets and interest income                                 |   | 342,484              |    | 29,974                         |   | 8.75               | %      | 304,322 |   | 29,788 |   | 9.79 | % | 283,699 |   | 26,964 |   | 9.50 | % |
|                                                                     |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Assets:                                                            |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                                  |   | 28,479               |    |                           |   |               |   | 19,511 |   |   |   |   |   | 11,667 |   |   |   |   |   |
| Bank premises and equipment                                              |   | 10,438               |    |                           |   |               |   | 10,405 |   |   |   |   |   | 9,540 |   |   |   |   |   |
| Other assets                                                             |   | 23,349               |    |                           |   |               |   | 19,471 |   |   |   |   |   | 13,655 |   |   |   |   |   |
| Allowance for credit losses                                              |   | (5,415               | )       |                           |   |               |   | (3,492 | ) |   |   |   |   | (6,066 | ) |   |   |   |   |
| Total Assets                                                             |   | $                    | 399,335 |                           |   |               |   |   | $ | 350,217 |   |   |   |   |   | $ | 312,495 |   |   |   |   |   |
|                                                                     |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Liabilities and Stockholders’ Equity                                |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                                            |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                                |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings, NOW, and Money Market Deposits                                  |   | $                    | 141,734 |                           | $      | (1,695             | )      | 1.20 | % | $ | 111,752 |   | $ | (2,423 | ) | 2.17 | % | $ | 99,656 |   | $ | (2,387 | ) | 2.40 | % |
| Time deposits                                                            |   | 133,263              |    | (4,217                         | )      | 3.16               | %      | 138,957 |   | (7,650 | ) | 5.51 | % | 118,085 |   | (7,004 | ) | 5.93 | % |
| Total interest bearing deposits                                          |   | 274,997              |    | (5,912                         | )      | 2.15               | %      | 250,709 |   | (10,073 | ) | 4.02 | % | 217,741 |   | (9,391 | ) | 4.31 | % |
| Other borrowings                                                         |   | 19,305               |    | (640                           | )      | 3.32               | %      | 7,265 |   | (317 | ) | 4.36 | % | 14,147 |   | (1,019 | ) | 7.20 | % |
| Total interest bearing liabilities and interest expense                  |   | 294,302              |    | (6,552                         | )      | 2.23               | %      | 257,974 |   | (10,390 | ) | 4.03 | % | 231,888 |   | (10,410 | ) | 4.49 | % |
|                                                                     |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing deposits                                            |   | 59,559               |    |                           |   |               |   | 52,692 |   |   |   |   |   | 45,857 |   |   |   |   |   |
| Other liabilities                                                        |   | 4,429                |    |                           |   |               |   | 2,957 |   |   |   |   |   | 2,722 |   |   |   |   |   |
| Stockholders’ equity                                                |   | 41,045               |    |                           |   |               |   | 36,594 |   |   |   |   |   | 32,028 |   |   |   |   |   |
| Total liabilities, stockholders’ equity and net interest income     |   | $                    | 399,335 |                           | $      | 23,422             |   |   |   | $ | 350,217 |   | $ | 19,398 |   |   |   | $ | 312,495 |   | $ | 16,554 |   |   |   |
| Net interest income as a percentage of  average of earnings assets: |   |                 |    |                           |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Income                                                          |   |                 |    |                           |   | 8.75               | %      |   |   |   |   | 9.79 | % |   |   |   |   | 9.50 | % |
| Interest Expense                                                         |   |                 |    |                           |   | 1.91               | %      |   |   |   |   | 3.41 | % |   |   |   |   | 3.67 | % |
| Net Interest Income                                                      |   |                 |    |                           |   | 6.84               | %      |   |   |   |   | 6.37 | % |   |   |   |   | 5.84 | % |

 

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(1) For purposes of these computations,non-accrual loans are included in the average loan balance outstanding. Loan fees and late charges of $762,000, $1,492,000, and $1,933,000 are includedin interest income in 2002, 2001, and 2000, respectively.

 

15

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**Non-InterestIncome**

 

Total non-interest income increased$1,541,000 to $7,865,000, a 24% increase over 2001.  Non-interest income includes service charges on deposit accounts,origination fees on mortgage loans and refinancings, rental income onforeclosed real estate and cash surrender value of life insurance.  Service charges on deposit accountsincreased by $670,000, or 27% over 2001 due to increased deposits and the fullyear effect of the 2001 introduction of a new overdraft privilege program.  These revenues increased in 2001 by$540,000, or 28% from 2000 due to increased deposits and the partial yeareffects of the introduction of a new overdraft privilege program.  Origination fees on mortgage loans increased$472,000, or 23% from 2001 and 2001 increased $1,048,000, or 105% over2000.  These increases are related tocontinued low interest rate environment which is positive for mortgage loanrefinancings due to an increased market share in home mortgage financings.  An increase in interest rates would likelyhave the effect of sharply reducing mortgage financing and refinancingactivity.  Other operating incomeincreased $399,000, or 22% over 2001. This increase was primarily due to increases in rental income on foreclosedreal estate and cash surrender value of Company owned life insurance of$236,000 and $174,000 respectively. Other operating income declined $239,000 in 2001 from 2000 due to a gainon sale of assets in 2000 which did not recur in 2001.

 

**Non-InterestExpense**

 

Total non-interest expense in 2002 increased13% over 2001 and amounted to $20,073,000. Total non-interest expense in 2001 increased 17% over 2000 to total$17,701,000.  Salaries and benefits, thelargest component of non-interest expense, in 2002 increased $658,000, or 7%over 2001.  This increase includes theaddition of the employees acquired in the Harbor Bank acquisition as well asincreased commissions related to mortgage origination fees.  These expenses for 2001 increased$1,518,000, or 19% from 2000 due to additional staff required for new branchesand due to increases in mortgage related commissions.  Occupancy costs and equipment expenses increased 9% and 8%respectively in 2002, due primarily to the acquisition of the Harbor Bank facilitiesand continued upgrades to infrastructure. Occupancy costs and equipment expenses increased 15% and 8% respectivelyin 2001 due to the branch openings of that year.  Amortization of goodwill and intangible assets were reduced by$380,000 in 2002 while 2001 was unchanged from 2000.  The goodwill and intangibles which had been amortized in 2001 and2000 were subjects of new accounting pronouncements which eliminated theamortization of those particular intangible assets (see Note 1 to theconsolidated financial statements).  The2002 amortization of $28,000 represents three months of amortization of thecore deposit intangible acquired in the Harbor Bank acquisition.  Other expenses in 2002 increased $1,882,000,or 36% over 2001.  The primary increasesin 2002 were $264,000 recognized for long-term care benefits for directors,$235,000 in legal fees primarily related to the Harbor Bank acquisition andissuance of trust preferred securities, $182,000 related to the operations ofthe small loan program, $180,000 in integration costs related to the HarborBank acquisition, $141,000 in professional fees related to the Harbor Bankacquisition, issuance of trust preferred securities and an ongoing brandingproject, and $123,000 in expenses related to foreclosed real estate.  Other expenses in 2001 increased $842,000over 2000 due to operational expenses related to the small loan program, andadvertising expenses related to the opening of the new branches.

 

**LIQUIDITYAND FINANCIAL CONDITION**

 

Total assets increased by $109,827,000, or30% to $474,450,000.  Included in thisincrease are the assets acquired in the purchase of Harbor Bank, which totaled$81,546,000.  Asset growth was greatestin loans, which increased $70,808,000, or 24% net of the allowance for creditlosses, and totaled $361,617,000 at December 31, 2002.  Total deposits increased $70,477,000, or 22%to $384,207,000.  Borrowings increasedduring 2002 by $34,317,000 and included $13,000,000 in proceeds from theissuance of trust preferred securities, $10,000,000 in long-term notes of fiveyear maturities and $12,993,000 in overnight repurchase agreements related tofund sweep obligations.

 

The principal source of the Company’s cash isdividends received from the Bank.  TheBank’s ability to pay dividends is regulated by federal and state law.  See “Business – Supervision and Regulation –Dividends.”

 

The Bank’s primary sources of funds arecustomer deposits, maturities of investment securities, sales of “Available forSale” securities, loan sales, loan repayments, net income, advances from theFederal Home Loan Bank of Seattle (“FHLB”), and the use of Federal Fundsmarkets.  In addition, in June 2002, theBank raised $13,000,000 through its participation in a pooled trust preferredsecurities offering.  The floating ratetrust preferred securities issued by FCFG Capital Trust I accrue interest at avariable rate of interest, calculated quarterly, at LIBOR plus 3.65% per annumon the outstanding balance. The stated maturity date of this offering is July 2032.

 

Scheduled loan repayments are relativelystable sources of funds, while deposit inflows and unscheduled loan prepaymentsare not.  Deposit inflows andunscheduled loan prepayments are influenced by general interest rate levels,interest rates available on other investments, competition, economicconditions, and other factors.

 

Deposits are the primary source of new funds.Total deposits were $384,207,000 (including deposits of $74,163,000 acquired inthe Harbor Bank, NA acquisition) at December 31, 2002, up from$313,730,000 at December 31, 2001. See

 

16

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“Deposits” below.  The Bank has attempted to attract deposits in its market areasthrough competitive pricing and delivery of a quality product.

 

Liquidity management involves the ability tomeet cash flow requirements of customers who may be either depositorswithdrawing funds or borrowers needing assurance that sufficient funds will beavailable to meet their credit needs. Liquidity is generated from both internal and external sources.  Internal sources include assets that can beconverted to cash with little or no risk of loss.  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 December 31, 2002, cash, deposits inbanks, interest-bearing deposits in banks and securities available for saletotaled $71,663,000.  External sourcesrefer to the ability to attract new liabilities and capital.  They include increasing savings and demanddeposits, federal funds purchased, and the issuance of capital and debtsecurities.  At December 31, 2002,overnight and federal funds lines of credit totaled $39,416,000.  These credit lines were accessed regularlyas a source of funding during 2002 and amounted to $10,000,000 at December 31,2002.

 

Management believes the Bank’s liquidityposition at December 31, 2002, was adequate to meet its short-term fundingrequirements.

 

Management expects to continue relying oncustomer deposits, maturity of investment securities, sales of “Available forSale” securities, loan sales, loan repayments, net income, Federal Fundsmarkets, advances from FHLB, and other borrowings to provide liquidity.  Management may also consider engaging infurther offerings of trust preferred securities if the opportunity presents anattractive means of raising funds in the future.  Although deposit balances at times have shown historical growth,such balances may be influenced by changes in the financial services industry,interest rates available on other investments, general economic conditions,competition, customer management of cash resources and other factors.  Borrowings may be used on a short-term andlong-term basis to compensate for reductions in other sources of funds.  Borrowings may also be used on a long-termbasis to support expanded lending activities and to match maturities orrepricing intervals of assets. The sources of such funds will include FederalFunds purchased, reverse repurchase agreements and borrowings from the FHLB.

 

**Investments**

 

In 2002 the Company’s securities availablefor sale and securities held to maturity increased $15,517,000 to$34,127,000.  The primary reason for theincrease in the securities available for sale is to provide collateral requiredby overnight repurchase agreements initiated in 2002.  Because the available-for-sale portfolio is carried at fairvalue, its carrying value fluctuates with changes in market factors, primarilyinterest rates.

 

17

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The carrying amount of securities and theapproximate fair values were as follows *(dollars in thousands)*:

 
|                                  |   | **Amortized   Cost** |   | **Gross   Unrealized   Gains** |   | **Gross   Realized   Losses** |   | **Fair   Value** |   |
|---------------------------------------|--------|----------------------|--------|--------------------------------|--------|-------------------------------|--------|------------------|--------|
| Available-for-Sale Securities         |   |                 |   |                           |   |                          |   |             |   |
| December 31, 2002                     |   |                 |   |                           |   |                          |   |             |   |
| U.S. Government and agency securities |   | $                    | 21,874 |                           | $      | 337                           |   | $                | 28     |   | $ | 22,183 |   |
| Corporate Securities                  |   | 3,999                |   | 109                            |   | —                        |   | 4,108            |   |
| Mortgage backed securities            |   | 997                  |   | 17                             |   | —                        |   | 1,014            |   |
| State and municipal securities        |   | 5,904                |   | 371                            |   | —                        |   | 6,275            |   |
| Equity Securities                     |   | 42                   |   | —                         |   | —                        |   | 42               |   |
|                                  |   | $                    | 32,816 |                           | $      | 834                           |   | $                | 28     |   | $ | 33,622 |   |
|                                  |   |                 |   |                           |   |                          |   |             |   |
| 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 |   |
| Held-to-Maturity Securities           |   |                 |   |                           |   |                          |   |             |   |
|                                  |   |                 |   |                           |   |                          |   |             |   |
| December 31, 2002                     |   |                 |   |                           |   |                          |   |             |   |
| State and municipal securities        |   | $                    | 505    |                           | $      | 36                            |   | $                | 1      |   | $ | 540 |   |
|                                  |   |                 |   |                           |   |                          |   |             |   |
| December 31, 2001                     |   |                 |   |                           |   |                          |   |             |   |
| State and municipal securities        |   | $                    | 506    |                           | $      | 49                            |   | $                | 1      |   | $ | 554 |   |
|                                  |   |                 |   |                           |   |                          |   |             |   |
| December 31, 2000                     |   |                 |   |                           |   |                          |   |             |   |
| State and municipal securities        |   | $                    | 676    |                           | $      | 27                            |   | $                | 1      |   | $ | 702 |   |

 

The stated maturities of debt securities wereas follows *(dollarsin thousands)*:

 
|                                   |   | **Held-to-Maturity  Securities** |   | **Available-For-Sale  Securities** |   |
|----------------------------------------|--------|----------------------------------|--------|------------------------------------|--------|
|                                   |   | **Amortized  Cost**              |   | **Fair   Value**                   |   | **Weighted   Average Yield** |   | **Amortized  Cost** |   | **Fair********Value** |   | **Weighted  Average Yield** |   |
|                                   |   |                             |   |                               |   |   |   |   |   |   |   |   |   |
| Due in one year or less                |   | $                                | — |                               | $      | — |   | — | % | $ | 3,167 |   | $ | 3,227 |   | 6.63 | % |
| Due after one year through five years  |   | 505                              |   | 540                                |   | 8.91 | % | 24,262 |   | 24,705 |   | 3.73 | % |
| Due after five years through ten years |   | —                           |   | —                             |   | — | % | 3,328 |   | 3,541 |   | 7.11 | % |
| Due after 10 years                     |   | —                           |   | —                             |   | — | % | 1,020 |   | 1,093 |   | 7.86 | % |
| Mortgage Backed Securities             |   |                             |   |                               |   |   |   | 997 |   | 1,014 |   | 6.50 | % |
|                                   |   | $                                | 505    |                               | $      | 540 |   |   |   | $ | 32,774 |   | $ | 33,580 |   |   |   |

 

18

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Weighted average yield is reported ontax-equivalent basis.

 

There were no gross realized gains or grossrealized losses on sales of securities available for sale in 2002, 2001, or2000.

 

**Loans**

 

Total loans excluding loans held for saleincreased by $73,431,000 to $362,132,000 in 2002.

 

The composition of the loan portfolio was asfollows at December 31 *(dollars in thousands)*:

 
|                     |   | **2002**   |    | **2001**    |   | **2000**   |   | **1999**    |   | **1998**   |   |
|--------------------------|--------|------------|---------|-------------|--------|------------|--------|-------------|--------|------------|--------|
|                     |   | **Amount** |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                     |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Commercial               |   | $          | 64,716  |        | 17.9   | %          | $      | 40,870      |   | 14.2       | %      | $ | 37,989 |   | 14.9 | % | $ | 34,981 |   | 15.0 | % | $ | 29,446 |   | 15.2 | % |
| Real estate construction |   | 70,385     |    | 19.4        | %      | 50,798     |   | 17.6        | %      | 39,486     |   | 15.5 | % | 19,169 |   | 8.2 | % | 17,390 |   | 8.9 | % |
| Real estate mortgage     |   | 207,346    |    | 57.3        | %      | 185,012    |   | 64.1        | %      | 167,680    |   | 65.7 | % | 170,203 |   | 73.1 | % | 141,120 |   | 72.6 | % |
| Consumer                 |   | 10,718     |    | 3.0         | %      | 4,732      |   | 1.6         | %      | 6,792      |   | 2.6 | % | 8,472 |   | 3.7 | % | 6,405 |   | 3.3 | % |
| Small loans              |   | 8,967      |    | 2.4         | %      | 7,289      |   | 2.5         | %      | 3,236      |   | 1.3 | % | — |   | — |   | — |   | — |   |
|                     |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
|                     |   | $          | 362,132 |        | 100.0  | %          | $      | 288,701     |   | 100.0      | %      | $ | 255,183 |   | 100.0 | % | 232,825 |   | 100 | % | $ | 194,361 |   | 100.0 | % |
|                          |        |            |         |             |        |            |        |             |        |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Bank’s loan portfolio is concentrated inreal estate secured loans which include real estate construction loans and realestate mortgage loans.  Real estatemortgage loans primarily consist of commercial loans secured by real estate.  The Bank made 444,852 small loans in 2002,representing $152,951,393 in total advances.

 

The following table shows the maturityanalysis of commercial and real estate construction loans outstanding as ofDecember 31, 2002 *(dollars in thousands)*:

 

|                     |   | **Within  One  Year** |   | **After One  But Within  Five Years** |   | **After  Five  Years** |   | **Total** |   |
|--------------------------|--------|-----------------------|--------|---------------------------------------|--------|------------------------|--------|-----------|--------|
|                     |   |                  |   |                                  |   |                   |   |      |   |
| Commercial               |   | $                     | 40,151 |                                  | $      | 17,836                 |   | $         | 6,729  |   | $ | 64,716 |   |
| Real estate construction |   | 36,477                |   | 19,421                                |   | 14,487                 |   | 70,385    |   |
|                     |   |                  |   |                                  |   |                   |   |      |   |
|                     |   | $                     | 76,628 |                                  | $      | 37,257                 |   | $         | 21,216 |   | $ | 135,101 |   |

 

Of these loans maturing after one year,$45,024,000 have predetermined or fixed interest rates and $13,449,000 havefloating   or adjustable interest rates.

 

**AssetQuality**

 

Non-performing assets consist of loans onwhich interest is no longer accrued, accruing loans past due 90 days or moreand foreclosed real estate and other assets.  Total non-performing assetsamounted to $12,775,000 at December 31, 2002, an increase of 96% from December31, 2001.  Non-accrual loans increased$4,713,000 during 2002 from the December 31, 2001 balance of $1,830,000.  Total foreclosed real estate, net of a$250,000 allowance for losses, amounted to $4,899,000 at December 31,2002.  Of this amount, $3,250,000represents one commercial property that is leased to a Washington State Agencyand is currently under a purchase option by a third party.  Accruing loans past due 90 days or moreincreased from $284,000 to $1,278,000.  Any anticipated losses on theseloans have been adequately reserved for in the allowance for credit losses.

 

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Loans will be placed on non-accrual using thefollowing guidelines: 1) a loan will be placed on nonaccrual when collection ofall principal or all interest is deemed unlikely; and 2) a loan willautomatically be placed on nonaccrual when principal or interest is 90 days ormore past due unless the loan is both well secured and in the process of beingcollected.  Placing a loan on non-accrual does not diminish in any way theBank’s claims against the borrower.

 

Non-performing assets were as follows atDecember 31 *(thousands):*

 
|                                    |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|-----------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
|                                    |   |     |   |     |   |     |   |     |   |     |   |
| Non-accrual loans                       |   | $        | 6,543  |     | $      | 1,830    |   | $        | 857    |     | $      | 1,476 |   | $ | 2,492 |   |
| Accruing loans past due 90 days or more |   | 1,278    |   | 284      |   | 1,264    |   | 28       |   | 471      |   |
| Foreclosed real estate                  |   | 4,899    |   | 4,387    |   | 4,097    |   | 1,890    |   | 1,996    |   |
| Other assets                            |   | 55       |   | 7        |   | 7        |   | 24       |   | —   |   |
|                                    |   | $        | 12,775 |     | $      | 6,508    |   | $        | 6,225  |     | $      | 3,276 |   | $ | 4,959 |   |

 

The gross interest income that would havebeen recorded in 2002 if the loans had been current in accordance with theiroriginal terms and had been outstanding throughout the period or sinceorigination, if held for part of the period, totaled $412,642.  Nointerest income on these loans was included in net income in 2002.

 

Applicable regulations require that eachinsured institution review and classify its assets on a regular basis. Inaddition, in connection with examinations of insured institutions, regulatoryexaminers have authority to identify problem assets and, if appropriate,require them to be classified. There are three classifications for problemassets: substandard, doubtful and loss. Substandard assets have one or moredefined weaknesses and are characterized by the distinct possibility that theinsured institution will sustain some loss if the deficiencies are notcorrected.  Doubtful assets have theweaknesses of substandard assets with the additional characteristic that theweaknesses make collection or liquidation in full on the basis of currentlyexisting facts, conditions and values questionable, and there is a highpossibility of loss. An asset classified as loss is considered uncollectibleand of such little value that continuance as an asset of the institution is notwarranted. When an insured institution classifies problem assets as eithersubstandard or doubtful, it is required to establish general allowances forcredit losses in an amount deemed prudent by management. These allowancesrepresent loss allowances which have been established to recognize the inherentrisk associated with lending activities and the risks associated withparticular problem assets. When an insured institution classifies problemassets as loss, it charges off the balance of the asset against the allowancefor credit losses.  Assets which do notcurrently expose the insured institution to sufficient risk to warrantclassification in one of the aforementioned categories but possess weaknessesare required to be designated as special mention. The Bank’s determination asto the classification of its assets and the amount of its valuation allowancesis subject to review by the FDIC which can order the establishment ofadditional loss allowances.

 

The aggregate amounts of the Bank’sclassified assets (as determined by the Bank), and of the Bank’s allowance forcredit losses at the dates indicated, were as follows:

 
|                        |   | **At  December 31,** |   |
|-----------------------------|--------|----------------------|--------|
|                        |   | **2002**             |   | **2001** |   | **2000** |   |
|                        |   | ***(In thousands)*** |   |
|                        |   |                 |   |   |   |   |   |
| Doubtful                    |   | $                    | 1,081  |   | $ | 900 |   | $ | 0 |   |
| Substandard                 |   | 11,722               |   | 2,904 |   | 2,320 |   |
| Special mention             |   | 12,214               |   | 2,692 |   | 4,194 |   |
| Allowance for credit losses |   | 7,947                |   | 4,088 |   | 3,503 |   |
|                             |        |                      |        |  |  |  |  |  |  |  |

 

The Bank’s classified assets increased by$18,521,000 at December 31, 2002, primarily as a result of the acquisition ofthe Harbor Bank loan portfolio.  Theseloans were acquired along with the related allowance for credit losses,resulting in a significant increase in the Bank’s total allowance for creditlosses.

 

Substandard loans are classified as thoseloans that are inadequately protected by the current net worth, and payingcapacity of the obligor, or of the collateral pledged.  Assets classified as substandard have awell-defined weakness, or weaknesses that jeopardize the repayment of the debt.If the weakness, or weaknesses are not corrected there is the distinctpossibility that some loss will be sustained. At December 31, 2002, 101 loanswere classified as substandard compared to 24 at

 

20

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December 31, 2001. Two loans account for$3,155,000 or 27% of the total, one for $1,466,000 secured by a first mortgageposition on commercial property in Gig Harbor, Washington, the second for$1,689,000 secured by a first mortgage position in a commercial income propertyin Tacoma, Washington. The Gig Harbor property is a nursery operation that isbeing impacted by the weak economy, and the Tacoma property is a multi-tenantwarehouse facility that lost a major tenant. Management believes the Bank isadequately provisioned against losses that might occur with either loan.

 

Special mention loans are defined as thosecredits deemed by management to have some potential weakness that deserve 

management’s close attention.  If left uncorrected these potentialweaknesses may result in the deterioration of the payment prospects of theloan.  Assets in this category are notadversely classified and currently do not expose the Bank to sufficient risk towarrant a substandard classification. There were two loans in this category asof December 31, 2002 aggregating $5,131,000 or 42% of the total, with no otherconcentrations.  One loan was for$3,985,000 secured by a first mortgage position on a hotel in Federal Way,Washington, and the second for $1,146,000 was secured by a first mortgageposition on a gas station and convenience store operation near Puyallup,Washington.  Subsequent to year end, thehotel loan was reclassified as substandard. Management believes neither loan will result in a loss for the Bank.  Each of these loans is current and paying inaccordance with the required loan terms.

 

The Company is not aware of any loanscontinuing to accrue interest at December 31, 2002 that represent or resultfrom trends or uncertainties which management reasonably expects willmaterially impact future operating results, liquidity, or capital resources. Material credits about which management is aware of any information that wouldraise serious doubts as to the ability of such borrowers to comply with theloan repayment terms, have been adequately reserved in the allowance for creditlosses.

 

**Allowancefor Credit Losses**

 

The allowance for credit losses reflectsmanagement’s current estimate of the amount required to absorb probable losseson existing loans and commitments to extend credit.  Loans deemed uncollectible are charged against and reduce theallowance.  Periodically, the provisionfor credit losses is charged to current expense.  This provision acts to replenish the allowance for credit lossesand to maintain the allowance at a level that management deems adequate.

 

There is no precise method of predictingspecific credit losses or amounts that ultimately may be charged off onsegments of the loan portfolio.  Thedetermination that a loan may become uncollectible, in whole or in part, is amatter of judgment.  Similarly, theadequacy of the allowance for credit losses can be determined only on ajudgmental basis, after full review, including (a) consideration of economicconditions and the effect on particular industries and specific borrowers; (b)a review of borrowers’ financial data, together with industry data, thecompetitive situation, the borrowers’ management capabilities and otherfactors; (c) a continuing evaluation of the loan portfolio, includingmonitoring by lending officers and staff credit personnel of all loans whichare identified as being of less than acceptable quality; (d) an in-depthappraisal, on a monthly basis, of all loans judged to present a possibility ofloss (if, as a result of such monthly appraisals, the loan is judged to be notfully collectible, the carrying value of the loan is reduced to that portionconsidered collectible); and (e) an evaluation of the underlying collateral forsecured lending, including the use of independent appraisals of real estateproperties securing loans.  A formalanalysis of the adequacy of the allowance is conducted quarterly and isreviewed by the Board of Directors.  Based on this analysis, managementconsiders 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 of the allowance isgenerally maintained at a level sufficient to cover all small loans that havedefaulted, as well as an amount sufficient to absorb the anticipated losses ontwo small loan operating cycles (approximately one month in duration), based onboth the Bank’s and the industry’s historical loss experience.

 

21

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Transactions in the allowance for creditlosses for the five years ended December 31, 2002 are as follows *(dollars inthousands)*: 

 
|                                                       |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
| Balance at beginning of year                               |   | $        | 4,088  |     | $      | 3,503    |   | $        | 5,825  |     | $      | 2,290 |   | $ | 2,122 |   |
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
| Provision for credit losses                                |   | 2,343    |   | 1,716    |   | (50      | )      | 3,730    |   | 425      |   |
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
| Transfer from acquisition of Harbor Bank, N.A.             |   | 3,868    |   | —   |   | —   |   | —   |   | —   |   |
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
| Charge offs:                                               |   |     |   |     |   |     |   |     |   |     |   |
| Commercial                                                 |   | (60      | )      | (60      | )      | (2,217   | )      | (116     | )      | (219     | )      |
| Real Estate Mortgage and Construction                      |   | —   |   | —   |   | (77      | )      | (65      | )      | (98      | )      |
| Small Loans                                                |   | (2,398   | )      | (2,051   | )      | —   |   | —   |   | —   |   |
| Consumer                                                   |   | (36      | )      | (36      | )      | (57      | )      | (66      | )      | (94      | )      |
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
|                                                       |   | (3,274)  |   | (2,147   | )      | (2,351   | )      | (247     | )      | (411     | )      |
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
| Recoveries:                                                |   |     |   |     |   |     |   |     |   |     |   |
| Commercial                                                 |   | 12       |   | 12       |   | 43       |   | 17       |   | 72       |   |
| Real Estate Mortgage and Construction                      |   | 8        |   | 8        |   | 8        |   | 12       |   | 61       |   |
| Small Loans                                                |   | 862      |   | 983      |   | —   |   | —   |   | —   |   |
| Consumer                                                   |   | 13       |   | 13       |   | 28       |   | 23       |   | 17       |   |
|                                                       |   | 922      |   | 1,016    |   | 79       |   | 52       |   | 154      |   |
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
| Net charge-offs                                            |   | (2,352   | )      | (1,131   | )      | (2,272   | )      | (195     | )      | (257     | )      |
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
| Balance at end of year                                     |   | $        | 7,947  |     | $      | 4,088    |   | $        | 3,503  |     | $      | 5,825 |   | $ | 2,290 |   |
|                                                       |   |     |   |     |   |     |   |     |   |     |   |
| Ratio of net charge-offs to average loans outstanding |   | .75      | %      | .41      | %      | .89      | %      | .09      | %      | .13      | %      |

 

The Bank’s small loan division made 444,852small loans in 2002, representing $152,951,393 in total advances.  The Bank charged off $2,398,000 in smallloans, and recovered $862,000.  The netcharge-offs as a percent of total small loan advances for 2002 was 1.00%.

 

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

 

22

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present value of expectedfuture cash flows discounted at the loan’s effective interest rate or, as apractical expedient, at the loan’s observable market price or the fair marketvalue of the collateral if the loan is collateral dependent.  The Companyexcludes loans that are currently measured at fair value or at the lower ofcost or fair value, and certain large groups of smaller balance homogeneousloans that are collectively measured for impairment.  The following tablesummarizes the Bank’s impaired loans at December 31:

 

|                                          |   | **2002** |      | **2001** |   | **2000**  |   | **1999** |    | **1998** |   |
|-----------------------------------------------|--------|----------|-----------|----------|--------|-----------|--------|----------|---------|----------|--------|
| Total Impaired Loans                          |   | $        | 6,543,000 |     | $      | 1,830,000 |   | $        | 857,000 |     | $      | 4,726,000 |   | $ | 2,492,000 |   |
| Total Impaired Loans with Valuation Allowance |   | $        | 5,795,000 |     | $      | 928,000   |   | $        | 817,000 |     | $      | 3,680,000 |   | $ | 362,000 |   |
| Allocation of Allowance for Credit Losses     |   | $        | 908,000   |     | $      | 528,000   |   | $        | 308,000 |     | $      | 3,347,000 |   | $ | 227,000 |   |

 

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

 

It is the Company’spolicy to charge-off any loan or portion of a loan that is deemed uncollectiblein the ordinary course of business.  The entire allowance for creditlosses is available to absorb such charge-offs.  TheCompany allocates its allowance for credit losses primarily on the basisof historical data.  Based on certain characteristics of the portfolio,losses can be anticipated for major loan categories.

 

In the following table,the allowance for credit losses at December 31, 2002, 2001, 2000, 1999 and 1998has been allocated among major loan categories based on a number of factorsincluding quality, volume, economic outlook and other business considerations *(dollars inthousands)*:

 
|           |   | **2002**   |   | **2001**                  |   | **2000**   |   | **1999**                  |   | **1998**   |   |
|----------------|--------|------------|--------|---------------------------|--------|------------|--------|---------------------------|--------|------------|--------|
|           |   | **Amount** |   | **%****of  Total  Loans** |   | **Amount** |   | **%****of  Total  Loans** |   | **Amount** |   | **%****of  Total  Loans** |   | **Amount** |   | **%****of  Total  Loans** |   | **Amount** |   | **%****of  Total  Loans** |   |
|           |   |       |   |                      |   |       |   |                      |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Commercial     |   | $          | 3,705  |                      | 17.9   | %          | $      | 1,581                     |   | 14.2       | %      | $ | 1,626 |   | 14.9 | % | $ | 3,616 |   | 15.0 | % | $ | 576 |   | 15.2 | % |
| Real Estate(1) |   | 3,523      |   | 76.7                      | %      | 2,132      |   | 81.7                      | %      | 1,800      |   | 81.2 | % | 2,112 |   | 81.3 | % | 1,633 |   | 81.5 | % |
| Consumer       |   | 301        |   | 3.0                       | %      | 31         |   | 1.6                       | %      | 23         |   | 2.6 | % | 97 |   | 3.7 | % | 81 |   | 3.3 | % |
| Small Loans    |   | 418        |   | 2.4                       | %      | 344        |   | 2.5                       | %      | 54         |   | 1.3 | % | — |   | — |   | — |   | — |   |
|           |   |       |   |                      |   |       |   |                      |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Total          |   | $          | 7,947  |                      | 100.0  | %          | $      | 4,088                     |   | 100.0      | %      | $ | 3,503 |   | 100 | % | $ | 5,825 |   | 100.0 | % | $ | 2,290 |   | 100.0 | % |

 

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(1)Real estate includes real estate mortgage and real estate construction.

 

**Deposits**

 

Total deposits increased by $70,477,000, or22% from 2001 to $384,207,000.  Depositstotaling $74,163,000 were acquired in the Harbor Bank, NA acquisition.  Non-interest bearing deposits increased 50%to $82,267,000 in 2002.  Savings andinterest-bearing demand deposits increased 27% to $156,031,000 in 2002.

 

The Bank’s averagedeposits for the year ended December 31, 2002 are summarized as follows(dollars in thousands):

 
|                                  |   | **2002**   |    | **2001** |   | **2000**                    |   |
|---------------------------------------|--------|------------|---------|----------|--------|-----------------------------|--------|
|                                  |   | **Amount** |    | **%**    |   | **Weighted  Average  Rate** |   | **Amount** |   | **%** |   | **Weighted  Average  Rate** |   | **Amount** |   | **%** |   | **Weighted  Average  Rate** |   |
|                                  |   |       |    |     |   |                        |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand Deposits- non-interest bearing |   | $          | 59,559  |     | 17.8   |                        | — |   | $ | 52,692 |   | 17.4 |   | — |   | $ | 45,857 |   | 17.4 |   | — |   |
| Interest bearing demand               |   | 110,085    |    | 32.9     |   | 1.31                        | %      | 87,465 |   | 28.8 |   | 2.30 | % | 75,245 |   | 28.5 |   | 2.47 | % |
| Savings Accounts                      |   | 31,649     |    | 9.5      |   | .79                         | %      | 24,287 |   | 8.0 |   | 1.69 | % | 24,411 |   | 9.3 |   | 2.18 | % |
| Other time deposits                   |   | 133,263    |    | 39.8     |   | 3.16                        | %      | 138,957 |   | 45.8 |   | 5.46 | % | 118,085 |   | 44.8 |   | 5.93 | % |
|                                  |   |       |    |     |   |                        |   |   |   |   |   |   |   |   |   |   |   |   |   |
| TOTAL                                 |   | $          | 334,556 |     | 100.0  |                        |   |   | $ | 303,401 |   | 100.0 |   |   |   | $ | 263,598 |   | 100.0 |   |   |   |
|                                       |        |            |         |          |        |                             |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Time deposits at December31, 2002 are scheduled to mature as follows (dollars in thousands):

 

|         |   | **Under    $100,000** |   | **$****100,000   and over** |   | **Total** |   |
|--------------|--------|----------------------------|--------|-----------------------------|--------|-----------|--------|
|         |   |                       |   |                        |   |      |   |
| 0-90 days    |   | $                          | 27,524 |                        | $      | 28,580    |   | $ | 56,104 |   |
| 91-180 days  |   | 23,292                     |   | 14,917                      |   | 38,209    |   |
| 181-365 days |   | 20,569                     |   | 6,433                       |   | 27,002    |   |
| Over 1 year  |   | 18,124                     |   | 6,470                       |   | 24,594    |   |
|         |   | $                          | 89,509 |                        | $      | 56,400    |   | $ | 145,909 |   |

 

**CAPITAL RESOURCES**

 

Consolidated capital of FCFG increased$5,414,000 during 2002 to $44,209,000. Net earnings of $6,212,000 provided the largest increase tocapital.  Exercising of stock optionsprovided $784,000, the fair value of securities available for sale increased$221,000, and elimination of the debt related to the Company’s Employee StockOwnership Plan amounted to $25,000. Decreases to capital were $950,000 in stock repurchased by the Companyand cash dividends of $0.20 per share, adjusted for the November 2002 stocksplit, or $878,000.  Cash dividendstotaling $0.20 per share after the effect of the stock split, were paid in 2001and 2000.

 

There are regulatoryconstraints placed upon capital adequacy, and it is necessary to maintain anappropriate ratio between capital and assets.  Regulations require banksand holding companies to maintain a minimum “leverage” ratio (primary capitalratio) of total assets.  For the most highly rated holding companies thisratio must be at least 3%, and for others it must be 4% to 5%.  AtDecember 31, 2002, the Company’s leverage ratio was 11.60%, compared to 8.91%at year-end 2001.  For regulatory purposes, any goodwill and otherintangible assets are treated as a reduction of capital.  In addition,holding companies are required to meet minimum risk-based capital guidelinesunder which risk percentages are assigned to various categories of assets andoff-balance-sheet items to calculate a risk-adjusted capital ratio.  TierI capital generally consists of common stockholders’ equity, less goodwill andother intangible assets, while Tier II capital includes the allowance forcredit losses, subject to 1.25% limitation of risk-adjusted assets.  Therules require Tier II capital of 4% of risk-adjusted assets and total capital(combined Tier I and Tier II) of 8%.  At December 31, 2002, the Tier Icapital ratio was 10.23%, and total capital was 11.49%.  The similarratios at December 31, 2001 were a Tier I capital ratio of 9.34% and a totalcapital ratio of 10.52%.  For additionalinformation, See “Item 1-Business-Bank Supervision and Regulation-CapitalAdequacy”.

 

**Borrowings**

 

Information concerningshort-term borrowings is summarized as follows *(thousands)*:

 
|                                      |   | **2002** |   | **2001** |   | **2000** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Average balance during the year           |   | $        | 11,450 |     | $      | 6,441    |   | $ | 14,050 |   |
| Average interest rate during the year     |   | 1.8      | %      | 4.0      | %      | 6.4      | %      |
| Maximum month-end balance during the year |   | $        | 27,802 |     | $      | 17,202   |   | $ | 20,148 |   |
| Weighted average rate at December 31,     |   | .90      | %      | 2.0      | %      | 6.8      | %      |
| Balance at end of year                    |   | $        | 16,547 |     | $      | 7,055    |   | $ | 14,001 |   |

 

Short-term borrowingsrepresent federal funds purchased, generally maturing within one to four days,demand notes from the U.S. Treasury, and advances from the Federal Home LoanBank of Seattle (FHLB), normally maturing within one year.

 

Long-termborrowings include trust preferred securities, term advances from the FHLB, anda note payable to Key Bank.  (See Note11 of the Consolidated Financial Statements.)

 

**SupplementaryQuarterly Data**

 
|                                                 |   | **Quarter  Ended** |   |
|------------------------------------------------------|--------|--------------------|--------|
| **(Dollars in thousands, except per share amounts)** |   | **Dec   2002**     |   | **Sept   2002** |   | **June   2002** |   | **March 2002** |   | **Dec   2001** |   | **Sept   2001** |   | **June   2001** |   | **March 2001** |   |
| Interest income                                      |   | $                  | 8,716  |   | $ | 7,327 |   | $ | 6,995 |   | $ | 6,936 |   | $ | 6,990 |   | $ | 7,968 |   | $ | 7,664 |   | $ | 7,166 |   |
| Interest expense                                     |   | 1,740              |   | 1,632 |   | 1,464 |   | 1,716 |   | 2,221 |   | 2,580 |   | 2,755 |   | 2,834 |   |
| Net interest income                                  |   | 6,976              |   | 5,695 |   | 5,531 |   | 5,220 |   | 4,769 |   | 5,388 |   | 4,909 |   | 4,332 |   |
|                                                 |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Provision for credit losses                          |   | 735                |   | 623 |   | 364 |   | 621 |   | 758 |   | 513 |   | 300 |   | 145 |   |
| Non-interest income                                  |   | 2,181              |   | 2,040 |   | 1,828 |   | 1,816 |   | 1,936 |   | 1,601 |   | 1,296 |   | 1,491 |   |
| Non-interest expense                                 |   | 6,509              |   | 4,614 |   | 4,541 |   | 4,409 |   | 4,445 |   | 4,664 |   | 4,476 |   | 4,119 |   |
| Income taxes                                         |   | 439                |   | 816 |   | 777 |   | 627 |   | 396 |   | 547 |   | 437 |   | 488 |   |
|                                                 |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                           |   | $                  | 1,474  |   | $ | 1,682 |   | $ | 1,677 |   | $ | 1,379 |   | $ | 1,106 |   | $ | 1,268 |   | $ | 992 |   | $ | 1,071 |   |
|                                                 |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic earnings per share                             |   | $                  | 0.34   |   | $ | 0.38 |   | $ | 0.38 |   | $ | 0.32 |   | $ | 0.26 |   | $ | 0.29 |   | $ | 0.23 |   | $ | 0.25 |   |
| Diluted earnings per share                           |   | $                  | 0.33   |   | $ | 0.37 |   | $ | 0.38 |   | $ | 0.31 |   | $ | 0.25 |   | $ | 0.28 |   | $ | 0.22 |   | $ | 0.24 |   |

 

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**ITEM 7A- 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.

 

Interest rate sensitivityis closely related to liquidity, as each is directly affected by the maturityof assets and liabilities.  The Company’s net interest margin is affectedby changes 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. See “Management’s Discussion and Analysis — Liquidity and Financial Condition — Results of Operations — Net Interest Income”.

 

Management considers anyasset or liability that matures, or is subject to repricing within one year tobe interest sensitive, although continual monitoring is performed for othertime intervals as well.  The difference between interest sensitive assetsand liabilities for a defined period of time is known as the interestsensitivity “gap”, and may be either positive or negative.  If positive,more assets reprice before liabilities.  If negative, the reverse istrue.  Gap analysis provides a general measure of interest rate risk butdoes not address complexities such as prepayment risk, interest rate floors andceilings imposed on financial instruments, interest rate dynamics andcustomers’ response to interest rate changes.  Currently the Bank’sinterest sensitivity gap is negative within one year.  Assuming thatgeneral market interest rate changes affect the repricing of assets andliabilities in equal magnitudes, the effect of rising interest rates on theCompany would be a decrease in the net interest margin, whereas fallinginterest rates would cause a corresponding increase in the margin.

 

**Interest Rate Gap AnalysisDecember 31, 2002**

 

| **(thousands)**                               |   | **Within  One Year** |     | **After One  But Within   Five Years** |   | **After  Five Years** |   | **Total** |   |
|-----------------------------------------------|--------|----------------------|----------|----------------------------------------|--------|-----------------------|--------|-----------|--------|
| Loans                                         |   | $                    | 160,598  |                                   | $      | 159,370               |   | $         | 42,164 |   | $ | 362,132 |   |
| Securities:                                   |   |                 |     |                                   |   |                  |   |      |   |
| Available for sale                            |   | 3,298                |     | 24,815                                 |   | 5,509                 |   | 33,622    |   |
| Held to maturity                              |   | —               |     | 505                                    |   | —                |   | 505       |   |
| Federal Funds Sold                            |   | 7,000                |     | —                                 |   | —                |   | 7,000     |   |
| Interest bearing deposits with banks          |   | 76                   |     | —                                 |   | —                |   | 76        |   |
| Total Earning Assets                          |   | $                    | 170,972  |                                   | $      | 184,690               |   | $         | 47,673 |   | $ | 403,335 |   |
|                                          |   |                 |     |                                   |   |                  |   |      |   |
| Deposits:                                     |   |                 |     |                                   |   |                  |   |      |   |
| Savings, NOW and money market                 |   | $                    | 156,031  |                                   | $      | —                |   | $         | — |   | $ | 156,031 |   |
| Time deposits                                 |   | 121,380              |     | 24,529                                 |   | —                |   | 145,909   |   |
| Short-term borrowings                         |   | 16,547               |     | —                                 |   | —                |   | 16,547    |   |
| Long-term debt                                |   | 1,000                |     | 10,000                                 |   | 13,000                |   | 24,000    |   |
|                                          |   |                 |     |                                   |   |                  |   |      |   |
| Total Interest Bearing Liabilities            |   | $                    | 294,958  |                                   | $      | 34,529                |   | $         | 13,000 |   | $ | 342,487 |   |
|                                          |   |                 |     |                                   |   |                  |   |      |   |
| Net Interest Rate Sensitivity Gap             |   | $                    | (123,986 | )                                      | $      | 150,161               |   | $         | 34,673 |   | $ | 60,848 |   |
| Cumulative Interest Rate Sensitivity Gap      |   | $                    | (123,986 | )                                      | $      | 26,176                |   | $         | 60,848 |   |   |   |
| Cumulative Gap as a Percent of Earning Assets |   | (31                  | )%       | 6                                      | %      | 15                    | %      |      |   |

 

25

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The Company’s market riskis impacted 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 marketrisk in the form of interest rate risk on its financial assets.  In aneffort to understand the relative impact of this risk on the Company’s currentfinancial situation, a process known as a rate shock is applied to the currentfinancial assets.

 

Rate shock is a processwherein the characteristics of the financial assets of the Company are reviewedin the event they are subjected to an instantaneous and complete adjustment inthe market rate of interest.  These results are modeled to determine theeffects on interest rate margin for the succeeding twelve months from therepricing of variable rate assets and liabilities where applicable.  Thelevel of impact on the various assets and liabilities are also estimated fortheir sensitivity to pricing changes of such a market interest rate change.

 

According to this modeland its assumptions, the change in net interest margin in the event marketinterest rates were to immediately rise or fall by 100 basis points isestimated to be $320,000.  This amount represents approximately 1.4% ofthe 2002 net interest income.

 

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

 

**Independent Auditor’s Report**

 

Board of Directors

**First Community Financial Group, Inc.**

Lacey, Washington

 

Wehave audited the accompanying consolidated balance sheets of **FirstCommunity Financial Group, Inc. and Subsidiaries** as of December 31,2002 and 2001, and the related consolidated statements of income, stockholders’equity and cash flows for the years then ended.  These financial statements are the responsibility of theCompany’s management.  Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

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

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of **First Community Financial Group, Inc. and Subsidiaries**as of December 31, 2002 and 2001, and the results of their operations and theircash flows for the years then ended, in conformity with accounting principlesgenerally accepted in the United States of America.

 

26

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Asdescribed in Note 1 to the consolidated financial statements, the Companychanged its method of accounting for goodwill in 2002.

 

 

Tacoma,Washington

January10, 2003

 

27

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**Independent Auditor’s Report**

 

Board of Directors

**First Community Financial Group, Inc.**

Lacey, Washington

 

Wehave audited the accompanying consolidated statements of income, stockholders’equity and cash flows of **First Community Financial Group, Inc. and Subsidiary**for the year ended December 31, 2000. These financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audit.

 

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

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the results ofoperations and cash flows of **First Community Financial Group, Inc. and Subsidiary**for the year ended December 31, 2000, in conformity with accounting principlesgenerally accepted in the United States of America.

 

Tacoma,Washington

January12, 2001

 

28

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**Consolidated Balance Sheets**

(Dollars in Thousands)

 

First Community Financial Group, Inc. andSubsidiaries

December 31, 2002 and 2001

 
|                                                                                                                  |   | **2002**    |        | **2001**    |       |
|-----------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|-------------|------------|
|                                                                                                                  |   |        |        |        |       |
| Assets                                                                                                                |   |        |        |        |       |
| Cash  and due from banks                                                                                              |   | $           | 30,965      |        | $          | 21,383 |   |
| Interest bearing deposits at other financial institutions                                                             |   | 76          |        | 74          |       |
| Federal funds sold                                                                                                    |   | 7,000       |        | —      |       |
| Securities available for sale                                                                                         |   | 33,622      |        | 18,104      |       |
| Securities held to maturity (market value:  2002 - $540; 2001 - $554)                                            |   | 505         |        | 506         |       |
| Federal Home Loan Bank  stock, at cost                                                                                |   | 877         |        | 1,985       |       |
| Loans  held for sale                                                                                                  |   | 7,432       |        | 6,196       |       |
|                                                                                                                  |   |        |        |        |       |
| Loans                                                                                                                 |   | 362,132     |        | 288,701     |       |
| Allowance for credit losses                                                                                           |   | (7,947      | )           | (4,088      | )          |
| **Net loans**                                                                                                         |   | **354,185** | ** **  | **284,613** | ** ** |
|                                                                                                                  |   |        |        |        |       |
| Premises and equipment                                                                                                |   | 11,141      |        | 10,382      |       |
| Foreclosed real estate                                                                                                |   | 4,899       |        | 4,387       |       |
| Accrued interest receivable                                                                                           |   | 1,884       |        | 1,471       |       |
| Cash value of life insurance                                                                                          |   | 8,863       |        | 8,453       |       |
| Goodwill                                                                                                              |   | 10,961      |        | 4,159       |       |
| Other intangible assets                                                                                               |   | 747         |        | 2,109       |       |
| Other assets                                                                                                          |   | 1,293       |        | 801         |       |
|                                                                                                                  |   |        |        |        |       |
| **Total  assets**                                                                                                     |   | **$**       | **474,450** | ** **  | **$**      | **364,623** | ** ** |
|                                                                                                                  |   |        |        |        |       |
| **Liabilities**                                                                                                       |   |        |        |        |       |
| Deposits:                                                                                                             |   |        |        |        |       |
| Demand — noninterest bearing                                                                                     |   | $           | 82,267      |        | $          | 55,013 |   |
| Savings and interest-bearing demand                                                                                   |   | 156,031     |        | 123,093     |       |
| Time                                                                                                                  |   | 145,909     |        | 135,624     |       |
| **Total  deposits**                                                                                                   |   | **384,207** | ** **  | **313,730** | ** ** |
|                                                                                                                  |   |        |        |        |       |
| Federal funds purchased                                                                                               |   | —      |        | 1,400       |       |
| Short-term borrowings                                                                                                 |   | 16,547      |        | 5,655       |       |
| Accrued interest payable                                                                                              |   | 315         |        | 364         |       |
| Long-term debt:                                                                                                       |   |        |        |        |       |
| Guaranteed preferred beneficial interest in subordinated debt                                                         |   | 13,000      |        | —      |       |
| Other long-term debt                                                                                                  |   | 11,000      |        | 575         |       |
| Other liabilities                                                                                                     |   | 5,172       |        | 4,104       |       |
|                                                                                                                  |   |        |        |        |       |
| **Total  liabilities**                                                                                                |   | **430,241** | ** **  | **325,828** | ** ** |
|                                                                                                                  |   |        |        |        |       |
| **Commitments  and Contingent Liabilities**                                                                           |   | **—**  | ** **  | **—**  | ** ** |
|                                                                                                                  |   |        |        |        |       |
| **Stockholders’  Equity**                                                                                        |   |        |        |        |       |
| Preferred stock (no par value); 200,000 shares authorized, none  issued                                               |   | —      |        | —      |       |
| Common stock, (no par value); 10,000,000 shares authorized, shares  issued:  2002 - 4,389,236; 2001 -  2,186,681 |   | 5,487       |        | 5,467       |       |
| Additional paid-in capital                                                                                            |   | 22,943      |        | 23,129      |       |
| Retained earnings                                                                                                     |   | 15,246      |        | 9,912       |       |
| Accumulated other comprehensive income                                                                                |   | 533         |        | 312         |       |
| Unearned KSOP shares                                                                                                  |   | —      |        | (25         | )          |
| **Total  stockholders’ equity**                                                                                  |   | **44,209**  | ** **  | **38,795**  | ** ** |
|                                                                                                                  |   |        |        |        |       |
| **Total  liabilities and stockholders’ equity**                                                                  |   | **$**       | **474,450** | ** **  | **$**      | **364,623** | ** ** |

 

*See notes to consolidated financial statements.*

 

29

----

 

**Consolidated Statements of Income**

(Dollars in Thousands, Except Per Share Data)

 

First Community Financial Group, Inc. andSubsidiaries

Years Ended December 31, 2002, 2001 and 2000

 
|                                                       |   | **2002**   |       | **2001**   |       | **2000**   |       |
|------------------------------------------------------------|--------|------------|------------|------------|------------|------------|------------|
|                                                       |   |       |       |       |       |       |       |
| **Interest  Income**                                       |   |       |       |       |       |       |       |
| Loans                                                      |   | $          | 28,662     |       | $          | 28,197     |       | $ | 25,110 |   |
| Federal funds sold and deposits in banks                   |   | 50         |       | 122        |       | 98         |       |
| Investment securities:                                     |   |       |       |       |       |       |       |
| Taxable                                                    |   | 939        |       | 1,091      |       | 1,369      |       |
| Non-taxable                                                |   | 323        |       | 378        |       | 387        |       |
| **Total  interest income**                                 |   | **29,974** | ** ** | **29,788** | ** ** | **26,964** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Interest  Expense**                                      |   |       |       |       |       |       |       |
| Deposits                                                   |   | 5,912      |       | 10,073     |       | 9,391      |       |
| Short-term borrowings                                      |   | 208        |       | 256        |       | 900        |       |
| Long-term debt                                             |   | 432        |       | 61         |       | 119        |       |
| **Total  interest expense**                                |   | **6,552**  | ** ** | **10,390** | ** ** | **10,410** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Net  interest income**                                   |   | **23,422** | ** ** | **19,398** | ** ** | **16,554** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Provision  for Credit Losses**                           |   | 2,343      |       | 1,716      |       | (50        | )          |
|                                                       |   |       |       |       |       |       |       |
| **Net  interest income after provision for credit losses** |   | **21,079** | ** ** | **17,682** | ** ** | **16,604** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Non-Interest  Income**                                   |   |       |       |       |       |       |       |
| Service charges on deposit accounts                        |   | 3,132      |       | 2,462      |       | 1,922      |       |
| Origination fees and gains on sales of loans               |   | 2,519      |       | 2,047      |       | 999        |       |
| Other  operating income                                    |   | 2,214      |       | 1,815      |       | 2,054      |       |
| **Total  non-interest income**                             |   | **7,865**  | ** ** | **6,324**  | ** ** | **4,975**  | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Non-Interest  Expenses**                                 |   |       |       |       |       |       |       |
| Salaries and employee benefits                             |   | 10,247     |       | 9,589      |       | 8,071      |       |
| Occupancy                                                  |   | 1,285      |       | 1,174      |       | 1,023      |       |
| Equipment                                                  |   | 1,356      |       | 1,255      |       | 1,163      |       |
| Amortization  of goodwill                                  |   | —     |       | 207        |       | 207        |       |
| Amortization  of intangible assets                         |   | 28         |       | 201        |       | 201        |       |
| Other                                                      |   | 7,157      |       | 5,275      |       | 4,433      |       |
| **Total  non-interest expenses**                           |   | **20,073** | ** ** | **17,701** | ** ** | **15,098** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Income  before income taxes**                            |   | **8,871**  | ** ** | **6,305**  | ** ** | **6,481**  | ** ** |
|                                                       |   |       |       |       |       |       |       |
| **Income  Taxes**                                          |   | 2,659      |       | 1,868      |       | 2,120      |       |
|                                                       |   |       |       |       |       |       |       |
| **Net income**                                             |   | **$**      | **6,212**  | ** ** | **$**      | **4,437**  | ** ** | **$** | **4,361** | ** ** |
|                                                       |   |       |       |       |       |       |       |
| Earnings Per Share                                         |   |       |       |       |       |       |       |
| Basic                                                      |   | $          | 1.42       |       | $          | 1.02       |       | $ | 1.01 |   |
| Diluted                                                    |   | 1.39       |       | 0.99       |       | 0.98       |       |

 

*See notes to consolidated financial statements.*

 

30

----

 

**ConsolidatedStatements of Stockholders’ Equity**

(Dollars in Thousands)

 

First Community Financial Group, Inc. andSubsidiaries

Years Ended December 31, 2002, 2001 and 2000

 
|                                                   |   | **Shares of****Common  Stock** |       | **Common  Stock** |       | **Additional****Paid-in  Capital** |       | **Retained  Earnings** |       | **Accumulate  Other****Comprehensive  Income (Loss)** |       | **Unearned****KSOP  Shares** |   | **Total**  |       |
|--------------------------------------------------------|--------|--------------------------------|------------|-------------------|------------|------------------------------------|------------|------------------------|------------|-------------------------------------------------------|------------|------------------------------|--------|------------|------------|
|                                                   |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| 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** | ** ** |
|                                                   |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| 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** | ** ** |
|                                                   |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| Comprehensive  income:                                 |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| Net  income                                            |   | —                         |       | —            |       | —                             |       | 6,212                  |       | —                                                |       | —                       |   | 6,212      |       |
| Other  comprehensive income, net of tax:               |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| Change  in fair value of securities available for sale |   | —                         |       | —            |       | —                             |       | —                 |       | 221                                                   |       | —                       |   | 221        |       |
| **Comprehensive income**                               |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   | **6,433**  |       |
|                                                   |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| 2-for-1  stock split                                   |   | 2,186,681                      |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| Stock  options exercised                               |   | 107,620                        |       | 135               |       | 597                                |       | —                 |       | —                                                |       | —                       |   | 732        |       |
| Stock  repurchased                                     |   | (91,746                        | )          | (115              | )          | (835                               | )          | —                 |       | —                                                |       | —                       |   | (950       | )          |
|                                                   |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| Cash  dividends paid ($.20 per share)                  |   | —                         |       | —            |       | —                             |       | (878                   | )          | —                                                |       | —                       |   | (878       | )          |
| Income  tax benefit from exercise of stock options     |   | —                         |       | —            |       | 52                                 |       | —                 |       | —                                                |       | —                       |   | 52         |       |
| Net  decrease in unearned KSOP shares                  |   | —                         |       | —            |       | —                             |       | —                 |       | —                                                |       | 25                           |   | 25         |       |
|                                                   |   |                           |       |              |       |                               |       |                   |       |                                                  |       |                         |   |       |       |
| **Balance, December 31, 2002**                         |   | **4,389,236**                  | ** ** | **$**             | **5,487**  | ** **                         | **$**      | **22,943**             | ** ** | **$**                                                 | **15,246** | ** **                   | **$**  | **533**    | ** ** | **$** | **—** | ** ** | **$** | **44,209** |   |

 

*See notes to consolidated financial statements*

 

31

----

 

**ConsolidatedStatements of Cash Flows**

(Dollars in Thousands)

 

First Community Financial Group, Inc. andSubsidiaries

Years Ended December 31, 2002, 2001 and 2000

 
|                                                                               |   | **2002**    |       | **2001**    |       | **2000**    |       |
|------------------------------------------------------------------------------------|--------|-------------|------------|-------------|------------|-------------|------------|
|                                                                               |   |        |       |        |       |        |       |
| **Cash  Flows from Operating Activities**                                          |   |        |       |        |       |        |       |
| Net income                                                                         |   | $           | 6,212      |        | $          | 4,437       |       | $ | 4,361 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |        |       |        |       |        |       |
| Provision for credit losses                                                        |   | 2,343       |       | 1,716       |       | (50         | )          |
| Depreciation and amortization                                                      |   | 1,149       |       | 1,134       |       | 1,085       |       |
| Deferred income taxes (benefit)                                                    |   | 130         |       | (215        | )          | 942         |       |
| Stock dividends received                                                           |   | (104        | )          | (131        | )          | (115        | )          |
| Amortization of goodwill                                                           |   | —      |       | 207         |       | 207         |       |
| Amortization of other intangible asset                                             |   | 28          |       | 201         |       | 201         |       |
| Origination of loans held for sale                                                 |   | (119,336    | )          | (99,491     | )          | (44,119     | )          |
| Proceeds  from sales of loans held for sale                                        |   | 118,100     |       | 97,824      |       | 43,154      |       |
| Increase in cash value of life insurance                                           |   | (312        | )          | (264        | )          | (96         | )          |
| Gain on sales of foreclosed real estate                                            |   | (12         | )          | (22         | )          | (48         | )          |
| Gain on sale of premises and equipment                                             |   | —      |       | —      |       | (198        | )          |
| (Increase) decrease in accrued interest receivable                                 |   | (68         | )          | 346         |       | (591        | )          |
| Increase (decrease) in accrued interest payable                                    |   | (151        | )          | (86         | )          | 151         |       |
| Other - net                                                                        |   | 211         |       | 2,640       |       | (510        | )          |
| **Net cash  provided by operating activities**                                     |   | **8,190**   | ** ** | **8,296**   | ** ** | **4,374**   | ** ** |
|                                                                               |   |        |       |        |       |        |       |
| **Cash  Flows from Investing Activities**                                          |   |        |       |        |       |        |       |
| Purchase of Harbor Bank, net of cash received                                      |   | (4,035      | )          | —      |       | —      |       |
| Net (increase) decrease in interest bearing deposits in banks                      |   | (2          | )          | 98          |       | (36         | )          |
| Net decrease in federal funds sold                                                 |   | 7,905       |       | —      |       | —      |       |
| Activity in securities available for sale:                                         |   |        |       |        |       |        |       |
| Maturities, prepayments and calls                                                  |   | 5,822       |       | 7,987       |       | 2,602       |       |
| Purchases                                                                          |   | (19,435     | )          | (9          | )          | —      |       |
| Activity in securities held to maturity:                                           |   |        |       |        |       |        |       |
| Maturities, prepayments and calls                                                  |   | —      |       | 170         |       | —      |       |
| Proceeds from sale of FHLB stock                                                   |   | 1,370       |       | —      |       | —      |       |
| Proceeds from sale of Federal Reserve Stock                                        |   | 142         |       | —      |       | —      |       |
| Net increase in loans                                                              |   | (18,058     | )          | (35,544     | )          | (28,167     | )          |
| Purchase of life insurance policies                                                |   | (98         | )          | (5,079      | )          | —      |       |
| Proceeds from sales of foreclosed assets                                           |   | 337         |       | 263         |       | 817         |       |
| Additions to premises and equipment                                                |   | (716        | )          | (1,449      | )          | (2,175      | )          |
| Proceeds from sales of premises and equipment                                      |   | —      |       | —      |       | 408         |       |
| Other - net                                                                        |   | —      |       | —      |       | (12         | )          |
| **Net cash  used in investing activities**                                         |   | **(26,768** | **)**      | **(33,563** | **)**      | **(26,563** | **)**      |
|                                                                               |   |        |       |        |       |        |       |
| **Cash  Flows from Financing Activities**                                          |   |        |       |        |       |        |       |
| Net increase (decrease) in deposits                                                |   | $           | (3,686     | )           | $          | 42,353      |       | $ | 25,850 |   |
| Net increase (decrease) in short-term borrowings                                   |   | 9,492       |       | (6,946      | )          | 466         |       |
| Proceeds from exercise of stock options                                            |   | 732         |       | 27          |       | 515         |       |
| Proceeds from long term debt                                                       |   | 24,000      |       | —      |       | —      |       |
| Repayment of long-term debt                                                        |   | (550        | )          | (550        | )          | (550        | )          |
| Repurchase of common stock                                                         |   | (950        | )          | —      |       | (934        | )          |
| Payment of cash dividends                                                          |   | (878        | )          | (874        | )          | (867        | )          |
| **Net cash  provided by financing activities**                                     |   | **28,160**  | ** ** | **34,010**  | ** ** | **24,480**  | ** ** |
|                                                                               |   |        |       |        |       |        |       |
| **Net  increase in cash and due from banks**                                       |   | **9,582**   | ** ** | **8,743**   | ** ** | **2,291**   | ** ** |
|                                                                               |   |        |       |        |       |        |       |
| **Cash and  Due from Banks**                                                       |   |        |       |        |       |        |       |
| Beginning of year                                                                  |   | 21,383      |       | 12,640      |       | 10,349      |       |
|                                                                               |   |        |       |        |       |        |       |
| **End of  year**                                                                   |   | **$**       | **30,965** | ** **  | **$**      | **21,383**  | ** ** | **$** | **12,640** | ** ** |
|                                                                               |   |        |       |        |       |        |       |
| **Supplemental  Disclosures of Cash Flow Information**                             |   |        |       |        |       |        |       |
| Cash payments for:                                                                 |   |        |       |        |       |        |       |
| Interest                                                                           |   | $           | 6,499      |        | $          | 10,476      |       | $ | 10,259 |   |
| Income taxes                                                                       |   | 2,835       |       | 1,695       |       | 2,127       |       |
|                                                                               |   |        |       |        |       |        |       |
| **Supplemental  Disclosures of Non-Cash Investing and Financing Activities**       |   |        |       |        |       |        |       |
| Foreclosed real estate acquired in settlement of loans                             |   | $           | 904        |        | $          | 497         |       | $ | 4,147 |   |
| Financed sale of foreclosed real estate                                            |   | —      |       | —      |       | 610         |       |
| Fair value adjustment of securities available for sale, net                        |   | 221         |       | 644         |       | 396         |       |
| Net decrease in unearned KSOP shares                                               |   | (25         | )          | (178        | )          | (177        | )          |
| Income tax benefit from exercise of stock options                                  |   | 52          |       | 10          |       | 107         |       |

 

*See notes to consolidated financial statements*.

 

32

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**Notes to Consolidated Financial Statements**

 

First Community Financial Group, Inc. andSubsidiaries

December 31, 2002 and 2001

 

**Note 1 - Summary of Significant Accounting Policies**

 

**Nature of Operations**

 

First Community Financial Group, Inc. (theCompany) provides commercial banking services in Washington State through 21offices concentrated in and around Thurston, Grays Harbor, Pierce and LewisCounties.  The Company provides loan anddeposit services to customers who are predominately small- and middle-marketbusinesses and middle-income individuals in western Washington.  The Company also provides real estatemortgage lending services and the sale of non-deposit investment productsthrough its branch network.  Inaddition, the Company is engaged in the small loan business in Alabama andArkansas, making short-term loans primarily to individuals in those states.

 

**Principles of Consolidation**

 

The consolidated financial statements includethe accounts of the Company and its wholly owned subsidiaries, FCFG CapitalTrust I and First Community Bank of Washington (the Bank); and the Bank’swholly owned subsidiary, First Community Financial Services.  All significant intercompany transactionsand balances have been eliminated.

 

**Consolidated Financial Statement Presentation**

 

The consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America and practices within the banking industry.  The preparation of financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, and the disclosure of contingent assets andliabilities, as of the date of the balance sheet, and the reported amounts ofrevenues and expenses during the reporting period.  Actual results could differ significantly from thoseestimates.  Material estimates that areparticularly susceptible to significant change in the near term relate to thedetermination of the allowance for credit losses and the valuation offoreclosed real estate.

 

Certainprior year amounts have been reclassified to conform to the 2002presentation.  The reclassifications hadno effect on net income or retained earnings as previously reported.  All dollar amounts, except per shareinformation, are stated in thousands.

 

**Securities Available for Sale**

 

Securities available forsale consist of debt securities that the Company intends to hold for anindefinite period, but not necessarily to maturity, and certain equitysecurities.  Such securities may be soldto implement the Company’s asset/liability management strategies and inresponse to changes in interest rates and similar factors.  Securities available for sale are reportedat fair value.  Unrealized gains andlosses, net of the related deferred tax effect, are reported as a net amount ina separate component of stockholders’ equity entitled “accumulated othercomprehensive income (loss).”  Realizedgains and losses on securities available for sale, determined using thespecific identification method, are included in earnings.  Amortization of premiums and accretion ofdiscounts are recognized in interest income over the period to maturity.

 

33

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**Securities Held to Maturity**

 

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

 

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

 

**Loans Held for Sale**

 

Mortgage loans originated for sale in theforeseeable future in the secondary market are carried at the lower ofaggregate cost or estimated market value. Gains and losses on sales of loans are recognized at settlement date andare determined by the difference between the sales proceeds and the carryingvalue of the loans.  All sales are madewithout recourse.  Net unrealized lossesare recognized through a valuation allowance established by charges to income.

 

**Loans**

 

Loans are stated at the amount of unpaidprincipal, reduced by deferred loan origination fees and an allowance forcredit losses.  Interest on loans isaccrued daily based on the principal amount outstanding.  Interest on small loans is recognized whenthe loan is repaid by the borrower.

 

Generally the accrual of interest on loans isdiscontinued when, in management’s opinion, the borrower may be unable to meetpayments as they become due or when they are past due 90 days as to eitherprincipal or interest, unless they are well secured and in the process ofcollection.  When interest accrual isdiscontinued, all unpaid accrued interest is reversed against currentincome.  If management determines thatthe ultimate collectibility of principal is in doubt, cash receipts onnonaccrual loans are applied to reduce the principal balance on a cash-basis method, until the loansqualify for return to accrual status. Loans are returned to accrual status when all principal and interestamounts contractually due are brought current and future payments arereasonably assured.

 

Loan originationand commitment fees and certain direct loan origination costs are deferred andamortized as an adjustment of the yield of the related loan.

 

**Allowance for Credit Losses**

 

The allowance for credit losses is maintainedat a level considered adequate to provide for probable losses on existing loansbased on evaluating known and inherent risks in the loan portfolio.  The allowance is reduced by loans chargedoff, and increased by provisions charged to earnings and recoveries on loanspreviously charged off.  The allowanceis based on management’s periodic, systematic evaluation of factors underlyingthe quality of the loan portfolio, including changes in the size andcomposition of the loan portfolio, the estimated value of any underlyingcollateral, actual loan loss experience, current economic conditions, anddetailed analysis of individual loans for which full collectibility may not beassured.  This evaluation is inherentlysubjective as it requires estimates that are susceptible to significantrevision as more information becomes available.  While management uses the best information available to make itsestimates, future adjustments to the allowance may be necessary if there is asignificant change in economic conditions.

 

34

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Whenavailable information confirms that specific loans or portions thereof are uncollectible,these amounts are charged off against the allowance for credit losses.  The existence of some or all of 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.

 

Whenmanagement determines that it is probable that a borrower will be unable torepay all amounts due according to the terms of the loan agreement, includingscheduled interest payments, the loan is considered impaired.  Factors considered by management indetermining impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments whendue.  Loans that experienceinsignificant payment delays and payment shortfalls are generally notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofshortfall in relation to the principal and interest owed.  The amount of impairment is measured basedon the present value of expected future cash flows discounted at the loan’seffective interest rate or, when the primary source of repayment is provided byreal estate collateral, at the fair value of the collateral less estimatedselling costs.  In addition, regulatoryagencies, as an integral part of their examination process, periodically reviewthe Bank’s allowance for credit losses, and may require the Bank to makeadditions to the allowance based on their judgment about information availableto them at the time of their examinations.

 

The ultimate recovery ofall loans is susceptible to future market factors beyond the Bank’scontrol.  These factors may result inlosses or recoveries differing significantly from those provided for in thefinancial statements.

 

**Transfers of Financial Assets**

 

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

 

**Premises and Equipment**

 

Premises and equipment are stated at costless accumulated depreciation, which is computed on the straight-line methodover the estimated useful lives of the assets. Leasehold improvements are amortized over the term of the lease or theestimated useful life of the improvement, whichever is less.  Gains or losses on dispositions arereflected in earnings.

 

35

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**Goodwill**

 

Goodwill represents costs in excess of netassets acquired, and is evaluated periodically for impairment.  (see “Recent Accounting Pronouncements” forthe effect of a new accounting standard effective January 1, 2002.)

 

**OtherIntangible Assets**

 

Other intangible assets at December 31, 2002represent the deposit premium acquired in the purchase of Harbor Bank, NA (see Note 2).  The core deposit premium isbeing amortized on the straight-line method over seven years.  (See “Recent Accounting Pronouncements” forinformation related to a reclassification in 2002 from Other Intangible Assetsto Goodwill.)

 

**Foreclosed Real Estate**

 

Realestate properties acquired through, or in lieu of, foreclosure are initiallyrecorded at the lower of cost or fair value of the properties less estimatedcosts of disposal.  Any write-down tofair value at the time of transfer to foreclosed real estate is charged to theallowance for credit losses.  Propertiesare evaluated regularly to ensure that the recorded amounts are supported bytheir current fair values, and that valuation allowances to reduce the recordedamounts to fair value less estimated costs to dispose are recorded asnecessary.  Any subsequent reductions incarrying values, and revenue and expense from the operations of properties arecharged to operations.

 

**Income Taxes**

 

Deferred tax assets and liabilities resultfrom differences between the financial statement recorded amounts and the taxbases of assets and liabilities, and are reflected at currently enacted incometax rates applicable to the period in which the deferred tax assets orliabilities are expected to be realized or settled.  The deferred tax provision represents the difference between thenet deferred tax asset/liability at the beginning and end of the year.  As changes in tax laws or rates are enacted,deferred tax assets and liabilities are adjusted through the provision forincome taxes.

 

The Company files a consolidated income taxreturn with the Bank.  The Bank providesfor tax on a separate company basis and remits to the Company amounts currentlydue.

 

**Stock-Based Compensation**

 

The Company accounts for stock-based awardsto employees and directors using the intrinsic value method, in accordance withAPB No. 25, *Accountingfor Stock Issued to Employees*. Accordingly, no compensation expense has been recognized in theconsolidated financial statements for employee and director stock arrangementswhere the grant price is equal to market price.  However, the required pro forma disclosures of the effects of alloptions granted on or after January 1, 1995**have been provided in accordance withSFAS No. 123, *Accounting for Stock-Based Compensation*.

 

36

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At December 31, 2002, the Company has twostock-based employee and director compensation plans, which are described morefully in Note 16.  The Company accountsfor those plans under the recognition and measurement principles of APB OpinionNo. 25 *Accountingfor Stock Issued to Employees,* and related interpretations.  Accordingly, no stock-based compensationcost is reflected in net income as all options granted under those plans had anexercise price equal to the market value of the underlying common tock on thedate of grant.  The followingillustrates the effect on net income and earnings per share if the Company hadapplied the fair value recognition provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation,*to stock-based compensation awards forthe effects of all options granted on or after January 1, 1995 for the yearsended December 31:

 
|                                                                                                      |   | **2002** |      | **2001**   |   | **2000**  |       |
|-----------------------------------------------------------------------------------------------------------|--------|----------|-----------|------------|--------|-----------|------------|
|                                                                                                      |   |     |      |       |   |      |       |
| Net income, as reported                                                                                   |   | $        | 6,212     |       | $      | 4,437     |       | $ | 4,361 |   |
| Less total stock-based compensation expense determined  under fair value method for all qualifying awards |   | 143      |      | 146        |   | 254       |       |
|                                                                                                      |   |     |      |       |   |      |       |
| **Pro forma net income**                                                                                  |   | **$**    | **6,069** | ** ** | **$**  | **4,291** | ** ** | **$** | **4,107** | ** ** |
|                                                                                                      |   |     |      |       |   |      |       |
| **Earnings Per Share**                                                                                    |   |     |      |       |   |      |       |
| Basic:                                                                                                    |   |     |      |       |   |      |       |
| As reported                                                                                               |   | $        | 1.42      |       | $      | 1.02      |       | $ | 1.01 |   |
| Pro forma                                                                                                 |   | 1.39     |      | .98        |   | .95       |       |
| Diluted:                                                                                                  |   |     |      |       |   |      |       |
| As reported                                                                                               |   | 1.39     |      | .99        |   | .98       |       |
| Pro forma                                                                                                 |   | 1.37     |      | .98        |   | .95       |       |

 

**Fair Values of Financial Instruments**

 

The following methods and assumptions wereused by the Company in estimating the fair values of financial instrumentsdisclosed in the consolidated balance sheets:

 

**Cash and Due From Banks, InterestBearing Deposits at Other Financial Institutions, and Federal Funds Sold**

The recorded amounts of cashand due from banks, interest bearingdeposits at other financial institutions, and federal funds sold.

 

**Securities Available for Sale andHeld to Maturity**

Fair values for securitiesare based on quoted market prices.

 

**Federal Home Loan Bank Stock**

Thecarrying value of Federal Home Loan Bank stock approximates its fair value.

 

37

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**Loans**

For variable rate loans thatreprice frequently and have no significant change in credit risk, fair valuesare based on recorded values.  Fairvalues for fixed rate loans are estimated using discounted cash flow analyses,using interest rates currently being offered for loans with similar terms toborrowers of similar credit quality. Fair values of loans held for sale are based on their estimated marketprices.  Fair values for impaired loansare estimated using discounted cash flow analyses or underlying collateralvalues, where applicable.

 

**Deposits**

The fair value of depositswith no stated maturity date is included at the amount payable on demand.  The fair value of fixed maturitycertificates of deposit is estimated by discounting future cash flows usingrates currently offered by the Bank for deposits of similar remainingmaturities.

 

**Federal Funds Purchased andShort-Term Borrowings**

The recorded amounts offederal funds purchased and short-term borrowings maturing within 90 daysapproximate their fair values.  Fairvalues of other short-term borrowings are estimated using discounted cash flowanalyses based on the Company’s current incremental borrowing rates for similartypes of borrowing arrangements.

 

**Long-Term Debt**

The fair values ofthe Company’s long-term, fixed rate debt are estimated using discounted cashflow analyses based on the Company’s current incremental borrowing rates forsimilar types of borrowing arrangements. The recorded amounts of variable rate debt approximate their fair value.

 

**Accrued Interest**

The carrying amounts ofaccrued interest approximate their fair values.

 

**Off-Balance Sheet Instruments**

The fair value ofcommitments to extend credit and standby letters of credit was estimated usingthe fees currently charged to enter into similar agreements, taking intoaccount the remaining terms of the agreements and the present creditworthinessof the customers.  Since the majority ofthe Bank’s off-balance sheet instruments consist of non-fee producing,variable-rate commitments, the Bank has determined they do not have adistinguishable fair value.

 

**Cash Equivalents and Cash Flows**

 

The Company considers all amounts included inthe balance sheets caption “Cash and due from banks” to be cashequivalents.  Cash flows from loans,federal funds purchased and sold, deposits and short-term borrowings arereported net.

 

**Earnings Per Share**

 

Basic earnings per share exclude dilution andare computed by dividing net income by the weighted average number of commonshares outstanding.  Diluted earningsper share reflect the potential dilution that could occur if common shares wereissued pursuant to the exercise of options under the Company’s stock optionplans.

 

38

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**Recent Accounting Pronouncements**

 

In June 2001, the FASBalso issued SFAS No. 143, *Accounting forAsset Retirement Obligations*. This statement addresses financial accounting and reporting forobligations associated with the retirement of tangible long-lived assets andthe associated asset retirement costs. This statement is effective for all fiscal years beginning after June15, 2002.  The Company does notanticipate that the adoption of SFAS Nos. 143 will have a material effect onits financial position or results of operations.

 

In October 2002, the FASBissued SFAS No. 147, *Acquisitions of CertainFinancial Institutions*, an amendment of FASB Statements No. 72 and144, and FASB Interpretation No. 9. This Statement removes acquisitions of financial institutions from thescope of both Statement 72 and Interpretation 9, and requires that thosetransactions be accounted for in accordance with FASB Statements No. 141, *Business Combinations*, and No. 142, *Goodwill and Other Intangible Assets*.  In addition, this Statement amends FASBStatement No. 144, *Accounting for Impairmentor Disposal of Long-Lived Assets*, to include in its scope long-termcustomer-relationship intangible assets of financial institutions such asdepositor- and borrower-relationship intangible assets and credit cardholderintangible assets.  This Statement iseffective for acquisitions for which the date of the transaction is on or afterOctober 1, 2002.  It also containstransition provisions that relate to transactions in which unidentifiableintangible assets were  recognized.  If those transactions were businesscombinations, the Statement requires that the carrying amount of anyunidentified intangible assets be reclassified to goodwill as of the later ofthe date of acquisition or the date that SFAS No. 142, *Goodwill and Other Intangible Assets*, isapplied in its entirety (January 1, 2002 for the Company).  As a result of adopting this statementthe  Company reclassified $2,109 ofunidentifiable intangible assets to goodwill effective January 1, 2002 andceased amortizing the goodwill which reduced expenses by $133, net of tax, forthe year ended December 31, 2002.

 

In December 2002, the Financial AccountingStandards Board issued FASB Statement No. 148, *Accountingfor Stock-Based Compensation*–*Transition and Disclosure*. This Statement amends FASB Statement No. 123, *Accounting for Stock-Based Compensation*, and APB Opinion No.28, *Interim Financial Reporting*,to provide alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  This statement does not require any changefrom the method currently used by the Company to account for stock-basedcompensation, but does require more prominent disclosure in the annual andinterim financial statements about the method of accounting for suchcompensation and the effect of the method used on reported results.  This statement was effective for yearsending after December 15, 2002.  TheCompany has adopted the disclosure provisions of SFAS No. 148 in theaccompanying financial statements, and accordingly, the disclosure requirementsare set forth in Note 1, in the Stock Based Compensation section.

 

The Financial Accounting Standards Board hasissued Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” – an interpretation of FASB Statements No. 5, 57 and 107 and rescissionof FASB Interpretation No. 34.”  ThisInterpretation elaborates on the disclosures to be made by a guarantor in itsinterim and annual financial statements about its obligations under certainguarantees that it has issued.  It alsoclarifies that a guarantor is required to recognize, at the inception of aguarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee.  The initialrecognition and measurement provisions of this Interpretation are applicable ona prospective basis to guarantees issued or modified after December 31,2002.  Implementation of theseprovisions of the Interpretation is not expected to have a material impact onthe Company’s consolidated financial statements.  The disclosure requirements of the Interpretation are effectivefor financial statements of interim or annual periods ending after December 15,2002, and have been adopted in the accompanying financial statements forDecember 31, 2002, with no additional disclosure required.

 

39

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**Note2 – Acquisitions**

 

Toexpand the Company’s market presence in Pierce County, on October 1, 2002 theCompany purchased all of the common stock of Harbor Bank, N.A. (Harbor),located in Gig Harbor, Washington, for $6,929 in cash.  The Company had been considering a possiblebranch expansion into Gig Harbor and determined that this acquisition would bemore cost effective than de novo branching.  After acquisition, Harbor was merged into the Bank.  Results of operations of Harbor are includedin the Company’s consolidated financial statements from October 1, 2002, theeffective date of the merger.  Goodwillof approximately $4,693, and core deposit intangible of approximately $775 wererecorded, as a result of the acquisition. The goodwill is not being amortized, but is subject to annual impairmenttests with the other goodwill recorded in the Company’s financial statements.None of the goodwill will be deductible for income tax purposes. The coredeposit intangible is being amortized on a straight-line basis over sevenyears.

 

The following table summarizes the estimatedfair values of the assets acquired and liabilities assumed of Harbor at thedate of acquisition:

** **
| Cash and due from banks       |   | $      | 2,894  |   |
|-------------------------------|--------|--------|--------|--------|
| Federal funds sold            |   | 14,905 |   |
| Securities available for sale |   | 1,819  |   |
| Loans                         |   | 54,761 |   |
| Core deposit premium          |   | 775    |   |
| Goodwill                      |   | 4,693  |   |
| Other assets                  |   | 1,699  |   |
| Total assets acquired         |   | 81,546 |   |
| Total deposits                |   | 74,163 |   |
| Other liabilities             |   | 454    |   |
| Total liabilities             |   | 74,617 |   |
| Net assets acquired           |   | $      | 6,929  |   |

 

Assuming the acquisition of Harbor had occurred on January 1, 2001, the Company’s results of operations would have been as follows for the years ended December 31, 2002 and 2001 :

 
|                        |   | **Unaudited** |   |
|-----------------------------|--------|---------------|--------|
|                        |   | **2002**      |   | **2001** |   |
|                        |   |          |   |   |   |
| Interest income             |   | $             | 33,970 |   | $ | 36,286 |   |
| Interest expense            |   | 7,921         |   | 13,412 |   |
| Net interest income         |   | 26,049        |   | 22,873 |   |
| Provision for credit losses |   | 5,526         |   | 4,568 |   |
| Noninterest income          |   | 8,131         |   | 6,681 |   |
| Noninterest expense         |   | 23,980        |   | 21,178 |   |
| Net income                  |   | 2,015         |   | 1,941 |   |
| Earnings per share:         |   |          |   |   |   |
| Basic                       |   | $             | .46    |   | $ | .45 |   |
| Diluted                     |   | .45           |   | .43 |   |

 

40

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**Note 3 - Restricted Assets**

 

FederalReserve Board regulations require that the Bank maintain reserves in the formof cash on hand and deposit balances with the Federal Reserve Bank.  The amounts of such balances for the yearsended December 31, 2002 and 2001 were approximately $5,991 and $4,359,respectively.

 

**Note 4 - Securities**

 

Securities have been classified according tomanagement’s intent.  The recordedamounts of securities and their fair value at December 31 were as follows:

 
|                                  |   | **Amortized  Cost** |       | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |       | **Fair  Value** |    |
|---------------------------------------|--------|---------------------|------------|------------------------------|--------|-------------------------------|------------|-----------------|---------|
|                                  |   |                |       |                         |   |                          |       |            |    |
| **Securities  Available for Sale**    |   |                |       |                         |   |                          |       |            |    |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **December  31, 2002**                |   |                |       |                         |   |                          |       |            |    |
| U.S. Government and agency securities |   | $                   | 21,874     |                         | $      | 337                           |       | $               | 28      |   | $ | 22,183 |   |
| Corporate securities                  |   | 3,999               |       | 109                          |   | —                        |       | 4,108           |    |
| Mortgage backed securities            |   | 997                 |       | 17                           |   | —                        |       | 1,014           |    |
| State and municipal securities        |   | 5,904               |       | 371                          |   | —                        |       | 6,275           |    |
| Equity securities                     |   | 42                  |       | —                       |   | —                        |       | 42              |    |
|                                  |   |                |       |                         |   |                          |       |            |    |
|                                  |   | **$**               | **32,816** |                         | **$**  | **834**                       | ** ** | **$**           | **28**  | ** ** | **$** | **33,622** |   |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **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** |   |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **Securities  Held to Maturity**      |   |                |       |                         |   |                          |       |            |    |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **December  31, 2002**                |   |                |       |                         |   |                          |       |            |    |
| State and municipal securities        |   | **$**               | **505**    | ** **                   | **$**  | **36**                        | ** ** | **$**           | **1**   | ** ** | **$** | **540** | ** ** |
|                                  |   |                |       |                         |   |                          |       |            |    |
| **December  31, 2001**                |   |                |       |                         |   |                          |       |            |    |
| State and municipal securities        |   | **$**               | **506**    | ** **                   | **$**  | **49**                        | ** ** | **$**           | **1**   | ** ** | **$** | **554** | ** ** |

 

41

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Thecontractual maturities of securities held to maturity and available for sale atDecember 31, 2002 are shown below. Expected maturities may differ from contractual maturities because borrowersmay have the right to call or prepay obligations, with or without call orprepayment penalties.  Therefore, themortgage backed securities have been classified separately in the maturitytable.

 
|                                    |   | **Held to Maturity** |    | **Available for Sale** |   |
|-----------------------------------------|--------|----------------------|---------|------------------------|--------|
|                                    |   | **Amortized  Cost**  |    | **Fair  Value**        |   | **Amortized  Cost** |   | **Fair  Value** |   |
|                                    |   |                 |    |                   |   |   |   |   |   |
| Due  in one year or less                |   | $                    | —  |                   | $      | — |   | $ | 3,167 |   | $ | 3,227 |   |
| Due  after one year through five years  |   | 505                  |    | 540                    |   | 24,262 |   | 24,705 |   |
| Due  after five years through ten years |   | —               |    | —                 |   | 3,328 |   | 3,541 |   |
| Due  after ten years                    |   | —               |    | —                 |   | 1,020 |   | 1,093 |   |
| Mortgage backed  securities             |   | —               |    | —                 |   | 997 |   | 1,014 |   |
|                                    |   |                 |    |                   |   |   |   |   |   |
|                                    |   | **$**                | **505** |                   | **$**  | **540** | ** ** | **$** | **32,774** | ** ** | **$** | **33,580** |   |

 

Securities recorded at approximately $27,360at December 31, 2002 and $4,978 at December 31, 2001 were pledged to securepublic deposits and for other purposes required or permitted by law.

 

42

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**Note 5 - Loans**

 

Loans at December 31 consist of thefollowing:

 
|                              |   | **2002**      |        | **2001**                  |      |
|-----------------------------------|--------|---------------|-------------|---------------------------|-----------|
|                              |   | **Portfolio** |        | **Percent of  Portfolio** |      | **Portfolio** |   | **Percent of  Portfolio** |   |
|                              |   |          |        |                      |      |   |   |   |   |
| Commercial                        |   | $             | 64,798      |                      | 17.9      | % | $ | 41,268 |   | 14.2 | % |
| Real estate:                      |   |          |        |                      |      |   |   |   |   |
| Residential 1-4 family            |   | 15,386        |        | 4.2                       |      | 9,993 |   | 3.4 |   |
| Commercial                        |   | 192,493       |        | 53.0                      |      | 175,019 |   | 60.1 |   |
| Construction                      |   | 70,613        |        | 19.5                      |      | 50,798 |   | 17.5 |   |
| Consumer                          |   | 10,690        |        | 2.9                       |      | 4,732 |   | 1.6 |   |
| Small loans                       |   | 8,967         |        | 2.5                       |      | 7,289 |   | 2.5 |   |
|                              |   |          |        |                      |      |   |   |   |   |
| **Loans, net of unearned income** |   | **$**         | **362,947** | ** **                | **100.0** | **%** | **$** | **289,099** | ** ** | **100.0** | **%** |
| Unearned income                   |   | (815          | )           |                      |      | (398 | ) |   |   |
| Allowance for credit losses       |   | (7,947        | )           |                      |      | (4,088 | ) |   |   |
| **Total loans, net**              |   | **$**         | **354,185** | ** **                | **100.0** | **%** | **$** | **284,613** | ** ** | **100.0** | **%** |

 

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

 
|                                                   |   | **2002**   |      | **2001**   |   | **2000**   |       |
|--------------------------------------------------------|--------|------------|-----------|------------|--------|------------|------------|
|                                                   |   |       |      |       |   |       |       |
| Balance at beginning of year                           |   | $          | 4,088     |       | $      | 3,503      |       | $ | 5,825 |   |
| Provision charged (credited) to operations             |   | 2,343      |      | 1,716      |   | (50        | )          |
|                                                   |   |       |      |       |   |       |       |
| Transfer from Harbor Bank                              |   | 3,868      |      | —     |   | —     |       |
|                                                   |   |       |      |       |   |       |       |
| Charge-offs (community banking)                        |   | (876       | )         | (96        | )      | (2,351     | )          |
| Recoveries (community banking)                         |   | 60         |      | 33         |   | 79         |       |
| Charge-offs (small loans)                              |   | (2,398     | )         | (2,051     | )      | —     |       |
| Recoveries (small loans)                               |   | 862        |      | 983        |   | —     |       |
|                                                   |   |       |      |       |   |       |       |
| **Net  charge-offs**                                   |   | **(2,352** | **)**     | **(1,131** | **)**  | **(2,272** | **)**      |
|                                                   |   |       |      |       |   |       |       |
| **Balance  at end of year**                            |   | **$**      | **7,947** | ** ** | **$**  | **4,088**  | ** ** | **$** | **3,503** | ** ** |
|                                                   |   |       |      |       |   |       |       |
| Ratio  of net charge-offs to average loans outstanding |   | 0.75       | %         | 0.41       | %      | 0.89       | %          |

 

43

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Following is a summary ofinformation pertaining to impaired loans:

 
|                                                          |   | **2002** |      | **2001**   |   | **2000**  |       |
|---------------------------------------------------------------|--------|----------|-----------|------------|--------|-----------|------------|
|                                                          |   |     |      |       |   |      |       |
| **December 31**                                               |   |     |      |       |   |      |       |
| Impaired loans without a valuation allowance                  |   | $        | 748       |       | $      | 902       |       | $ | 40 |   |
| Impaired loans with a valuation allowance                     |   | 5,795    |      | 928        |   | 817       |       |
|                                                          |   |     |      |       |   |      |       |
| **Total impaired loans**                                      |   | **$**    | **6,543** | ** ** | **$**  | **1,830** | ** ** | **$** | **857** | ** ** |
|                                                          |   |     |      |       |   |      |       |
| **Valuation allowance related to impaired loans**             |   | **$**    | **908**   | ** ** | **$**  | **528**   | ** ** | **$** | **308** | ** ** |
|                                                          |   |     |      |       |   |      |       |
| **Years Ended December 31**                                   |   |     |      |       |   |      |       |
| Average investment in impaired loans                          |   | $        | 2,925     |       | $      | 1,258     |       | $ | 1,623 |   |
| Interest income recognized on a cash basis  on impaired loans |   | —   |      | —     |   | —    |       |

 

At December 31, 2002, therewere no commitments to lend additional funds to borrowers whose loans wereimpaired.  Loans over 90 days past duestill accruing interest were $1,278 and $284 at December 31, 2002 and 2001,respectively.

 

Certain related parties of the Company,principally Bank directors and their associates, were loan customers of theBank in the ordinary course of business during 2002 and 2001.  Total loans outstanding at December 31, 2002and 2001 to key officers and directors were $8,447 and $16,412, respectively.  During 2002, advances totaled $1,603, andrepayments totaled $9,568 on these loans. In the opinion of management, these related party loans were made onsubstantially the same terms, including interest rates and collateralrequirements, as those terms prevailing at the date these loans were made.  During 2002 and 2001, there were no loans torelated parties that were considered to be classified or impaired.

 

### **Note 6 - Premises and Equipment**

 

The components of premisesand equipment at December 31 are as follows:

 
|                                           |   | **2002**   |             | **2001**   |       |
|------------------------------------------------|--------|------------|------------------|------------|------------|
|                                           |   |       |             |       |       |
| Land                                           |   | $          |  1,695      |       | $          |  1,445 |   |
| Buildings and leasehold improvements           |   | 9,149      |             | 8,484      |       |
| Equipment, furniture and fixtures              |   | 9,643      |             | 8,633      |       |
| Construction in progress                       |   | 70         |             | 66         |       |
| **Total  cost**                                |   | **20,557** | ** **       | **18,628** | ** ** |
| Less accumulated depreciation and amortization |   | 9,416      |             | 8,246      |       |
|                                           |   |       |             |       |       |
| **Premises  and equipment**                    |   | **$**      | ** 11,141** | ** ** | **$**      | ** 10,382** | ** ** |

 

44

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The Bank leases premises and equipment underoperating leases.  Rental expense ofleased premises and equipment was $509, $468 and $365 for 2002, 2001 and 2000,respectively, which is included in occupancy expense.

 

Minimum net rental commitments undernoncancellable leases having an original or remaining term of more than oneyear for future years ending December 31 are as follows:

 
| 2003                                 |   | $      | 313       |       |
|--------------------------------------|--------|--------|-----------|------------|
|                                 |   |   |      |
| 2004                                 |   | 264    |      |
| 2005                                 |   | 120    |      |
| 2006                                 |   | 47     |      |
| 2007                                 |   | 47     |      |
| Thereafter                           |   | 950    |      |
|                                 |   |   |      |
| **Total  minimum payments required** |   | **$**  | **1,741** | ** ** |

 

Certain leases contain renewal options offive years and escalation clauses based on increases in property taxes andother costs.

 

**Note 7 - Foreclosed Real Estate**

 

Foreclosed real estateconsisted of the following at December 31:

 
|                                     |   | **2002** |      | **2001**   |   |
|------------------------------------------|--------|----------|-----------|------------|--------|
|                                     |   |     |      |       |   |
| Real estate acquired through foreclosure |   | $        | 5,149     |       | $      | 4,637 |   |
| Allowance for losses                     |   | (250     | )         | (250       | )      |
|                                     |   |     |      |       |   |
| **Total foreclosed real estate**         |   | **$**    | **4,899** | ** ** | **$**  | **4,387** | ** ** |

 

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

 
|                       |   | **2002** |    | **2001**   |   | **2000** |       |
|----------------------------|--------|----------|---------|------------|--------|----------|------------|
|                       |   |     |    |       |   |     |       |
| Balance, beginning of year |   | $        | 250     |       | $      | 500      |       | $ | — |   |
| Provision for losses       |   | —   |    | (250       | )      | 500      |       |
|                       |   |     |    |       |   |     |       |
| **Balance,  end of year**  |   | **$**    | **250** | ** ** | **$**  | **250**  | ** ** | **$** | **500** | ** ** |

 

 

45

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**Note 8 – Goodwill and Other Intangible Assets**

 

Effective January1, 2002, the Company applied FASB Statement No. 142, Goodwill and OtherIntangible Assets.  Among its provisionsis a requirement to disclose what reported net income would have been in allperiods presented exclusive of amortization expense (net of related income taxeffects) recognized in those periods related to goodwill and intangible assetsno longer being amortized, and changes in amortization periods for intangibleassets that will continue to be amortized together with related per shareamounts.

 
|                                  |   | **2002** |   | **2001** |   | **2000** |   |
|---------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                  |   |     |   |     |   |     |   |
| Net income, as reported               |   | $        | 6,212  |     | $      | 4,437    |   | $ | 4,361 |   |
| Add goodwill amortization, net of tax |   | —   |   | 133      |   | 133      |   |
| Adjusted net income                   |   | $        | 6,212  |     | $      | 4,570    |   | $ | 4,494 |   |
|                                  |   |     |   |     |   |     |   |
| Earnings per share:                   |   |     |   |     |   |     |   |
| Basic:                                |   |     |   |     |   |     |   |
| As reported                           |   | $        | 1.42   |     | $      | 1.02     |   | $ | 1.01 |   |
| Goodwill amortization                 |   | —   |   | 0.03     |   | 0.03     |   |
| Adjusted net income                   |   | $        | 1.42   |     | $      | 1.05     |   | $ | 1.04 |   |
|                                  |   |     |   |     |   |     |   |
| Diluted:                              |   |     |   |     |   |     |   |
| As reported                           |   | $        | 1.39   |     | $      | 0.99     |   | $ | 0.98 |   |
| Goodwill amortization                 |   | —   |   | 0.03     |   | 0.03     |   |
| Adjusted net income                   |   | $        | 1.39   |     | $      | 1.02     |   | $ | 1.01 |   |

 

After the transition date the Company had nointangible assets remaining to amortize prior to its Harbor Bank N.A. purchase.

 

**Note 9 - Deposits**

 

The composition ofdeposits at December 31 is as follows:

 
|                                  |   | **2002** |        | **2001**   |   |
|---------------------------------------|--------|----------|-------------|------------|--------|
|                                  |   |     |        |       |   |
| Demand deposits, non-interest bearing |   | $        | 82,267      |       | $      | 55,013 |   |
| NOW and money market accounts         |   | 124,431  |        | 98,250     |   |
| Savings deposits                      |   | 31,600   |        | 24,843     |   |
| Time certificates, $100,000 or more   |   | 56,400   |        | 45,828     |   |
| Other time certificates               |   | 89,509   |        | 89,796     |   |
|                                  |   |     |        |       |   |
| **Total**                             |   | **$**    | **384,207** | ** ** | **$**  | **313,730** | ** ** |

 

46

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Scheduled maturities of time deposits forfuture years ending December 31 are as follows:

 
| 2003      |   | $      | 121,315     |   |
|-----------|--------|--------|-------------|--------|
| 2004      |   | 10,509 |        |
| 2005      |   | 1,183  |        |
| 2006      |   | 113    |        |
| 2007      |   | 12,789 |        |
|      |   |   |        |
| **Total** |   | **$**  | **145,909** |   |

 

**Note 10 - Federal Funds Purchased and Short-Term Borrowings**

 

Federal funds purchased generally maturewithin one to four days from the transaction date.  The balances at December 31, 2002 and 2001 represent advancesfrom a line of credit agreement with KeyBank (agreement had a limit of $8,000and $7,000 at December 31, 2002 and 2001, respectively). 

 

Short-term borrowings at December 31 are asfollows:

 
|                                                                                                                                                                                                                                                                                                                               |   | **2002** |       | **2001**   |       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|------------|------------|------------|
|                                                                                                                                                                                                                                                                                                                               |   |     |       |       |       |
| Demand note issued to U. S. Treasury, bearing interest at the federal  funds rate less .25% (0.99% at December 31, 2002), due on demand, secured by  securities pledged to the Federal Reserve Bank of San Francisco in the amount  of $3,430.                                                                                     |   | $        | 3,554      |       | $          | 655 |   |
|                                                                                                                                                                                                                                                                                                                               |   |     |       |       |       |
| Overnight repurchase agreements with customers.  Balances of repurchase agreements fully  collateralized by separate portfolio of securities pledged to Federal Home  Loan Bank of Seattle in the amount of $17,813 for this purpose. The weighted  average interest rate on these agreements at December 31, 2002 was 0.92%. |   | 12,993   |       | 5,000      |       |
|                                                                                                                                                                                                                                                                                                                               |   |     | ** ** |       | ** ** |
| **Total short-term borrowings**                                                                                                                                                                                                                                                                                                    |   | **$**    | **16,547** | ** ** | **$**      | **5,655** | ** ** |

 

Information concerning short-term borrowingsis summarized as follows:

 
|                                      |   | **2002** |   | **2001** |   | **2002** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                      |   |     |   |     |   |     |   |
| Average balance during the year           |   | $        | 11,450 |     | $      | 6,441    |   | $ | 14,050 |   |
| Average interest rate during the year     |   | 1.8      | %      | 4.0      | %      | 6.4      | %      |
| Maximum month-end balance during the year |   | $        | 27,802 |     | $      | 17,202   |   | $ | 20,148 |   |
| Weighted average rate at December 31      |   | 0.9      | %      | 2.0      | %      | 6.8      | %      |

 

47

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**Note 11 - Long-Term Debt**

 

Long-term debt at December 31 is as follows:

 
|                                                                                                                                                                                                                                                                    |   | **2002** |       | **2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|------------|----------|--------|
|                                                                                                                                                                                                                                                                    |   |     |       |     |   |
| 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% at December 31, 2001), collateralized by 10,968 shares of  Company stock; guaranteed by the Company. |   | $        | —     |     | $      | 25 |   |
|                                                                                                                                                                                                                                                                    |   |     |       |     |   |
| Note payable to Key Bank, maturing May 2003; interest-only payments  due quarterly at prime rate (4.25% at December 31, 2002), unsecured.                                                                                                                               |   | 1,000    |       | —   |   |
|                                                                                                                                                                                                                                                                    |   |     |       |     |   |
| 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% at December 31, 2001), collateralized by  investment in First Community Bank.                      |   | —   |       | 550      |   |
|                                                                                                                                                                                                                                                                    |   |     |       |     |   |
| Term advances from Federal Home Loan Bank of Seattle, maturing  December 2007; two advances of $5,000 each, interest-only monthly payments  prior to maturity, fixed interest rates on advances are 3.78% and 3.58%.                                                    |   | 10,000   |       | —   |   |
|                                                                                                                                                                                                                                                                    |   |     |       |     |   |
| Trust preferred securities issued July 2002, maturing July 2032;  interest only payments due quarterly at a rate of LIBOR plus 3.65% (5.425% at  December 31, 2002.                                                                                                     |   | 13,000   |       | —   |   |
|                                                                                                                                                                                                                                                                    |   |     |       |     |   |
|                                                                                                                                                                                                                                                                    |   | **$**    | **24,000** |     | **$**  | **575** |   |

 

Guaranteed Preferred Beneficial Interests inSubordinated Debt:

On July 11, 2002, $13,000 of floating ratecapital securities were issued by FCFG Capital Trust I (the Trust).  The trust is a business trust organized in2002, owned 100% by the Company.

 

The proceeds of the offering were invested bythe Trust in junior subordinated debentures of the Company.  The debentures held by the Trust are thesole assets of the Trust.  Distributionson the capital securities issued by the Trust are payable quarterly at afloating rate, calculated quarterly, of LIBOR plus 3.65% per annum, which isequal to the interest rate being earned by the Trust on the debentures held bythe Trust.  The capital securities aresubject to mandatory redemption, in whole or in part, upon repayment of thedebentures.  The Company entered intothe agreements which, taken collectively, fully and unconditionally guaranteethe capital securities subject to the terms of each of the guarantees.  The Company used the proceeds for generalcorporate purposes including the acquisition of Harbor Bank and stockrepurchases.  The capital securitiesqualify as Tier I capital, provided they do not exceed 25 percent of total Tier1 capital, under the capital guidelines of the Federal Reserve Board.

 

48

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At the Company’s option, the debentures willnot mature earlier than July 7, 2007 and not later than October 7, 2032.  After July 7, 2007, the debentures can beredeemed, in whole or in part, at 100% of the principal amount of the debtsecurities being redeemed plus any accrued and unpaid interest.

 

Scheduled maturities of long-term debt forfuture years ending December 31 are as follows:
|       |   | **Parent** |       | **Consolidated** |   |
|------------|--------|------------|------------|------------------|--------|
| 2003       |   | $          | 1,000      |             | $      | 1,000 |   |
| 2007       |   | —     |       | 10,000           |   |
| Thereafter |   | 13,000     |       | 13,000           |   |
|       |   | **$**      | **14,000** |             | **$**  | **24,000** |   |

 

### **Note 12 - Income Taxes**

 

Income taxes are comprised of the followingfor the years ended December 31:

 
|                    |   | **2002** |      | **2001**   |   | **2000**  |       |
|-------------------------|--------|----------|-----------|------------|--------|-----------|------------|
|                    |   |     |      |       |   |      |       |
| Current                 |   | $        | 2,529     |       | $      | 2,083     |       | $ | 1,178 |   |
| Deferred (benefit)      |   | 130      |      | (215       | )      | 942       |       |
|                    |   |     |      |       |   |      |       |
| **Total  income taxes** |   | **$**    | **2,659** | ** ** | **$**  | **1,868** | ** ** | **$** | **2,120** | ** ** |

 

The following is a reconciliation between thestatutory and the effective federal income tax rate for the years endedDecember 31:

 
|                                |   | **2002**   |      | **2001**                       |     | **2000**   |   |
|-------------------------------------|--------|------------|-----------|--------------------------------|----------|------------|--------|
|                                |   | **Amount** |      | **Percent  of Pretax  Income** |     | **Amount** |   | **Percent  of Pretax  Income** |   | **Amount** |   | **Percent  of Pretax  Income** |   |
|                                |   |       |      |                           |     |       |   |   |   |   |   |   |   |
| Income tax based on statutory  rate |   | $          | 3,105     |                           | 35.0     | %          | $      | 2,207 |   | 35.0 | % | $ | 2,268 |   | 35.0 | % |
| Adjustments resulting from:         |   |       |      |                           |     |       |   |   |   |   |   |   |   |
| Tax-exempt income                   |   | (156       | )         | (1.7                           | )        | (150       | )      | (2.4 | ) | (151 | ) | (2.3 | ) |
| Goodwill amortization               |   | —     |      | —                         |     | 70         |   | 1.1 |   | 70 |   | 1.1 |   |
| Life insurance income               |   | (136       | )         | (1.5                           | )        | (81        | )      | (1.3 | ) | (21 | ) | (.3 | ) |
| Tax credits                         |   | (115       | )         | (1.3                           | )        | (115       | )      | (1.8 | ) | (115 | ) | (1.8 | ) |
| Other                               |   | (39        | )         | (.5                            | )        | (63        | )      | (1.0 | ) | 69 |   | 1.0 |   |
|                                |   |       |      |                           |     |       |   |   |   |   |   |   |   |
| **Total income taxes**              |   | **$**      | **2,659** | ** **                     | **30.0** | **%**      | **$**  | **1,868** | ** ** | **29.6** | **%** | **$** | **2,120** | ** ** | **32.7** | **%** |

 

49

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The tax effects of temporary differences thatgive rise to significant portions of deferred tax assets and liabilities atDecember 31 are:

 
|                                             |   | **2002** |      | **2001**   |   |
|--------------------------------------------------|--------|----------|-----------|------------|--------|
|                                             |   |     |      |       |   |
| **Deferred  Tax Assets**                         |   |     |      |       |   |
| Allowance for credit losses                      |   | $        | 813       |       | $      | 1,031 |   |
| Deferred compensation                            |   | 773      |      | 668        |   |
| Other deferred tax assets                        |   | 94       |      | 56         |   |
| **Total  deferred tax assets**                   |   | **$**    | **1,680** | ** ** | **$**  | **1,755** | ** ** |
|                                             |   |     |      |       |   |
| **Deferred  Tax Liabilities**                    |   |     |      |       |   |
| Deferred income                                  |   | 1,982    |      | 2,032      |   |
| Unrealized gain on securities available for sale |   | 273      |      | 161        |   |
| Accumulated depreciation                         |   | 108      |      | 3          |   |
| **Total deferred tax liabilities**               |   | **$**    | **2,363** | ** ** | **$**  | **2,196** | ** ** |
|                                             |   |     |      |       |   |
| **Net  deferred tax liabilities**                |   | **$**    | **683**   | ** ** | **$**  | **441** | ** ** |

 

**Note 13 - Commitments and Contingent Liabilities**

 

The Bank is party to financial instrumentswith off-balance-sheet risk in the normal course of business to meet thefinancing needs of its customers.  Thefinancial instruments include commitments to extend credit and standby lettersof credit.  These instruments involve,to varying degrees, elements of credit risk in excess of the amount recognizedon the consolidated balance sheets.

 

The Bank’s exposure to credit loss in theevent of nonperformance by the other party to the financial instrument forcommitments to extend credit and standby letters of credit is represented bythe contractual amount of those instruments. The Bank uses the same credit policies in making commitments andconditional obligations as it does for on-balance-sheet instruments.  A summary of the Bank’s commitments atDecember 31 is as follows:

 
|                                      |   | **2002** |       | **2001**   |   |
|-------------------------------------------|--------|----------|------------|------------|--------|
|                                      |   |     |       |       |   |
| Commitments to extend credit:             |   |     |       |       |   |
| Real estate secured                       |   | $        | 40,852     |       | $      | 19,180 |   |
| Credit card lines                         |   | 2,900    |       | 1,301      |   |
| Other                                     |   | 28,345   |       | 27,805     |   |
|                                      |   |     |       |       |   |
| **Total  commitments to extended credit** |   | **$**    | **72,097** | ** ** | **$**  | **48,286** | ** ** |
|                                      |   |     |       |       |   |
| Standby letters of credit                 |   | $        | 6,585      |       | $      | 215 |   |

 

50

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Commitments to extend credit are agreementsto lend to a customer as long as there is no violation of any conditionestablished in the contract.  Since manyof the commitments are expected to expire without being drawn upon, the totalcommitment amounts do 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 conditionalcommitments issued by the Bank to guarantee the performance of a customer to athird party.  Those guarantees areprimarily issued to support public and private borrowing arrangements.  The credit risk involved in issuing lettersof credit is essentially the same as that involved in extending loan facilitiesto customers.  Collateral held varies asspecified above, and is required in instances where the Bank deems necessary.

 

**Contingencies**

 

Because of the nature of its activities, theCompany is subject to various pending and threatened legal actions which arisein the ordinary course of business.  Inthe opinion of management, liabilities arising from these claims, if any, willnot have a material effect on the financial position of the Company.

 

The Company has entered into contracts withcertain of its executives and others, which provide for contingent paymentssubject to future events.

 

**Note 14 - Significant Concentrations of Credit Risk**

 

The Bank has credit risk exposure, includingoff-balance-sheet credit risk exposure, related to real estate loans asdisclosed in Notes 5 and 13.  Theultimate collectibility of a substantial portion of the loan portfolio issusceptible to changes in economic and market conditions in the region.  The Bank generally requires collateral onall real estate lending arrangements and typically maintains loan-to-valueratios of no greater than 80%.

 

Investments in state and municipal securitiesgenerally involve governmental entities within Washington State.  Loans are generally limited, by statebanking regulation, to 20% of the Bank’s stockholder’s equity, excludingaccumulated other comprehensive income (loss). The Bank, as a matter of practice, generally does not extend credit toany single borrower or group of related borrowers in excess of $6,000.

 

The contractual amounts of credit-relatedfinancial instruments such as commitments to extend credit, credit-cardarrangements, and letters of credit represent the amounts of potentialaccounting loss should the contract be fully drawn upon, the customer defaults,and the value of any existing collateral become worthless.

 

51

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**Note 15 - Benefit Plans**

 

**Employee Stock Ownership Plan**

 

The Company has a combined employee stockownership and profit sharing plan with 401(k) provisions (KSOP) which coverssubstantially all employees who have completed at least one year ofservice.  The Company accounts for theKSOP in accordance with Statement of Position 93-6, *Employers’ Accounting for EmployeeStock Ownership Plans*. Accordingly, the balance of the debt of the KSOP is included inlong-term debt on the accompanying consolidated balance sheets, with acorresponding deduction from stockholders’ equity.  KSOP shares were pledged as collateral for the debt.  As the debt is repaid, shares are releasedbased on the proportion of debt paid and allocated to active employees.  As shares are released from collateral, theCompany reports compensation expense equal to the current market price of theshares less basis in the shares.  Sharesbecome outstanding for earnings per share computations at the time ofallocation to the active employees.

 

Eligible employees may defer up to 15% oftheir annual compensation on a pre-tax basis subject to certain IRS limits. TheCompany contributes to the plan one-half the employees’ contributions up to 3%of the employees’ compensation.  Profitsharing contributions to the plan may also be made at the discretion of theBoard of Directors.  The Company alsomakes contributions equal to the amount required to service the plan’s debtunder the terms of the KSOP note. Company contributions to this plan totaled $600, $450 and $350 in 2002,2001 and 2000, respectively.  Cashdividends paid on unallocated shares which are collateral for debt are used toreduce the principal of the debt. Dividends paid on allocated shares are distributed to the employeeaccount.

 

The KSOP shares as of December 31 were asfollows:

 
|                                       |   | **2002**    |       | **2001**    |       | **2000**    |       |
|--------------------------------------------|--------|-------------|------------|-------------|------------|-------------|------------|
|                                       |   |        |       |        |       |        |       |
| Allocated shares                           |   | 439,430     |       | 398,644     |       | 354,552     |       |
| Unallocated shares                         |   | —      |       | 2,718       |       | 21,936      |       |
|                                       |   |        |       |        |       |        |       |
| **Total  KSOP shares**                     |   | **439,430** | ** ** | **401,362** | ** ** | **376,488** | ** ** |
|                                       |   |        |       |        |       |        |       |
| Estimated fair value of unallocated shares |   | —      |       | $           | 27,197     |        | $          | 232,419 |   |
|                                            |        |             |            |             |            |             |            |  |  |

 

Upon termination from the plan, a participantmay choose to have his account distributed in Company stock, to the extent of hisinvestment in stock, or in cash. Certain participants may also be eligible to diversify a certainpercentage of their accounts.  Adistribution of stock in the event of termination or diversification requiresthe Company to issue put options to the participant.  This permits the participant to sell the stock to the Company atfair value at any time during the option periods, which can be as long as 18months.  At December 31, 2002, 2001 and2000, outstanding put options were not material.

 

52

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**Incentive Compensation Plan**

 

Incentive compensation is awarded to officersand qualified employees based on the financial performance of the Company.Awards are payable if the Company and the Bank meet earnings and otherperformance 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 2002 and 2001totaled $576 and $340, respectively.

 

**SalaryContinuation Plan**

 

The Companyprovides a Salary Continuation Plan (SCP) covering certain managementpersonnel.  The post-retirement benefitprovided by the SCP is designed to supplement a participating officer’sretirement benefits from social security. This plan which was established in 2001, is a successor plan to theExecutive Supplemental Income Plan described below.  Expenses related to this plan totaled $416, $497 in 2002 and2001.

 

Benefits toemployees may be funded by life insurance policies purchased by the Company,which had cash surrender values of $8,836 and $8,427 at December 31, 2002 and2001.  Liabilities to employees, whichare being accrued over their expected time to retirement, were $1,564 and$1,268 at December 31, 2002 and 2001.

 

**Executive Supplemental Income Plan**

 

The Company provided an ExecutiveSupplemental Income (ESI) plan covering certain management personnel.  This plan has been superceded by the SalaryContinuation Plan.  Former employees arecurrently receiving benefits under this plan. Expenses related to this plan totaled $23, $25 and $94 in 2002, 2001 and2000, respectively.

 

Liabilities to employees were $301 and $314at December 31, 2002 and 2001, respectively.

 

**Director Deferred Income Plan**

 

In 1992 the Board of Directors approved aplan under which a director may elect to defer director fees until retirement,and to provide a death benefit.

 

Benefits to directors may be funded by lifeinsurance policies purchased by the Company, which had cash surrender values of$27 and $26 at December 31, 2002 and 2001, respectively.  Accrued liabilities to directors at December31, 2002 and 2001 totaled $328 and $326, respectively.  Expenses associated with this plan were $36and $82 in 2001 and 2000, respectively. There was no expense in 2002.

 

**Long-Term Care Plan**

 

In 2002,the Company purchased long-term care insurance on certain board members andmanagement personnel.  Benefits underthis plan vest over ten years from the date of initial service to the Company.  Expense associated with this plan was $398in 2002.

 

53

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**Note 16 - Stock Option Plans**

 

The Company maintains non-qualified stockoption plans for non-employee members of the Board of Directors and incentivestock option plans for key employees. The exercise price of the stock options under the plans is usually notless than the fair market value of the stock at the date of grant.  The Company has the first right of refusalto purchase any shares issued under the plans prior to their sale on the openmarket.

 

The fair value of each option grant isestimated on the date of grant, based on the Black-Scholes option pricing modeland using the following weighted average assumptions:

 
|                    |   | **2002** |   | **2001** |   | **2000** |   |
|-------------------------|--------|----------|--------|----------|--------|----------|--------|
|                    |   |     |   |     |   |     |   |
| Dividend yield          |   | 1.7      | %      | 2.0      | %      | 1.8      | %      |
| Expected life           |   | 8  years |   | 8  years |   | 8  years |   |
| Risk-free interest rate |   | 5.1      | %      | 4.9      | %      | 6.7      | %      |
| Expected volatility     |   | 19.5     | %      | 12.0     | %      | 2.0      | %      |

 

The weighted average fair value of optionsgranted during 2002, 2001 and 2000 was $3.72, $2.14 and $3.22,respectively.  In the opinion ofmanagement, the assumptions used in the option pricing model are subjective andrepresent only one estimate of possible value, as there is no active market forCompany options granted.

 

Options granted during 2002, 2001 and 2000are 20% vested on each of the five subsequent anniversaries of the grant date.

 

54

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Stock option and per share amounts forcurrent and prior periods have been adjusted to reflect the effect of stocksplits, and are as follows:

 
|                                     |   | **Employee****Options** |       | **Director****Options** |       | **Total****Options** |       | **Weighted  Average  Exercise****Price** |     |
|------------------------------------------|--------|-------------------------|------------|-------------------------|------------|----------------------|------------|------------------------------------------|----------|
|                                     |   |                    |       |                    |       |                 |       |                                     |     |
| Under option at December 31, 1999        |   | 595,864                 |       | 119,340                 |       | 715,204              |       | $                                        | 8.57     |   |
| Granted                                  |   | 49,000                  |       | 4,000                   |       | 53,000               |       | 11.50                                    |     |
| Exercised                                |   | (48,886                 | )          | (44,782                 | )          | (93,668              | )          | 5.50                                     |     |
| Forfeited                                |   | (21,686                 | )          | (2                      | )          | (21,688              | )          | 10.81                                    |     |
| **Under  option at December 31, 2000**   |   | **574,292**             | ** ** | **78,556**              | ** ** | **652,848**          | ** ** | **$**                                    | **9.18** | ** ** |
| Granted                                  |   | 18,000                  |       | —                  |       | 18,000               |       | 10.00                                    |     |
| Exercised                                |   | —                  |       | (5,356                  | )          | (5,356               | )          | 4.90                                     |     |
| Forfeited                                |   | (5,200                  | )          | —                  |       | (5,200               | )          | 12.62                                    |     |
|                                     |   |                    |       |                    |       |                 |       |                                     |     |
| **Under  option at December 31, 2001**   |   | **587,092**             | ** ** | **73,200**              | ** ** | **660,292**          | ** ** | **$**                                    | **9.20** | ** ** |
|                                     |   |                    |       |                    |       |                 |       |                                     |     |
| Granted                                  |   | 21,000                  |       | 28,000                  |       | 49,000               |       | 10.25                                    |     |
| Exercised                                |   | (69,762                 | )          | (37,858                 | )          | (107,620             | )          | 6.80                                     |     |
| Forfeited                                |   | (13,072                 | )          | (5                      | )          | (13,077              | )          | 7.62                                     |     |
|                                     |   |                    |       |                    |       |                 |       |                                     |     |
| **Under  option at December 31, 2002**   |   | **525,258**             | ** ** | **63,337**              | ** ** | **588,595**          | ** ** | **$**                                    | **9.77** | ** ** |
|                                     |   |                    |       |                    |       |                 |       |                                     |     |
| Options exercisable at December 31, 2002 |   | 446,458                 |       | 32,937                  |       | 479,395              |       | $                                        | 9.41     |   |

 

Options becoming exercisable under both stockoption plans in future years ending December 31 are as follows:

2003 – 32,400; 2004 – 31,200; 2005 – 22,400;2006 – 13,400; and 2007 – 9,800.

 

Options for 72,491 shares remain available tobe granted under the director plan at December 31, 2002.  None are available under the employee plan.

 

The following summarizes information aboutstock options outstanding at December 31, 2002:

 

| **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 $7.00                    |   | 106,565                  |   | 1.5 |   | $ | 6.79 |   | 106,565 |   | $ | 6.79 |   |
| $8.64                          |   | 209,530                  |   | 3.2 |   | 8.64 |   | 209,530 |   | 8.64 |   |
| $10.00 to $11.25               |   | 169,500                  |   | 6.6 |   | 10.78 |   | 106,100 |   | 11.13 |   |
| $11.50 to $12.00               |   | 45,000                   |   | 7.1 |   | 11.56 |   | 18,000 |   | 11.56 |   |
| $15.00                         |   | 58,000                   |   | 6.1 |   | 15.00 |   | 39,200 |   | 15.00 |   |
|                           |   |                     |   |   |   |   |   |   |   |   |   |
|                           |   | **588,595**              |   |   |   |   |   | **479,395** |   |   |   |
|                                |        |                          |        |  |  |  |  |  |  |  |  |  |  |

 

55

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**Note 17 - Condensed Financial Information - Parent CompanyOnly**

 

**Condensed Balance Sheets - December 31**

 
|                                            |   | **2002** |       | **2001**   |   |
|-------------------------------------------------|--------|----------|------------|------------|--------|
|                                            |   |     |       |       |   |
| **Assets**                                      |   |     |       |       |   |
| Cash                                            |   | $        | 5,411      |       | $      | 44 |   |
| Investment in the Bank                          |   | 52,064   |       | 39,389     |   |
| Other assets                                    |   | 866      |       | 45         |   |
|                                            |   |     |       |       |   |
| **Total  assets**                               |   | **$**    | **58,341** | ** ** | **$**  | **39,478** | ** ** |
|                                            |   |     |       |       |   |
| **Liabilities  and Stockholders’ Equity**  |   |     |       |       |   |
|                                            |   |     |       |       |   |
| **Liabilities**                                 |   |     |       |       |   |
| Long-term debt                                  |   | 14,000   |       | $          | 575    |   |
| Other liabilities                               |   | 132      |       | 108        |   |
| Total liabilities                               |   | 14,132   |       | 683        |   |
|                                            |   |     |       |       |   |
| **Stockholders’  Equity**                  |   | 44,209   |       | 38,795     |   |
|                                            |   |     |       |       |   |
| Total liabilities and stockholders’ equity |   | $        | 58,341     |       | $      | 39,478 |   |

 

**Condensed Statements of Income - Years Ended December 31**

 
|                                                                           |   | **2002**  |       | **2001**   |       | **2000**  |       |
|--------------------------------------------------------------------------------|--------|-----------|------------|------------|------------|-----------|------------|
|                                                                           |   |      |       |       |       |      |       |
| **Operating  Income**                                                          |   |      |       |       |       |      |       |
| Dividends from the  Bank                                                       |   | $         | 1,220      |       | $          | 695       |       | $ | 1,946 |   |
| Interest                                                                       |   | 7         |       | 3          |       | 3         |       |
| **Total  operating income**                                                    |   | **1,227** | ** ** | **698**    | ** ** | **1,949** | ** ** |
|                                                                           |   |      |       |       |       |      |       |
| **Operating  Expenses**                                                        |   |      |       |       |       |      |       |
| Interest                                                                       |   | 409       |       | 61         |       | 119       |       |
| Other                                                                          |   | 374       |       | 110        |       | 77        |       |
| **Total  operating expenses**                                                  |   | **783**   | ** ** | **171**    | ** ** | **196**   | ** ** |
|                                                                           |   |      |       |       |       |      |       |
| **Income  before income taxes and equity in undistributed income of the Bank** |   | **444**   | ** ** | **527**    | ** ** | **1,753** | ** ** |
|                                                                           |   |      |       |       |       |      |       |
| **Income  Tax Benefit**                                                        |   | (224      | )          | (58        | )          | (66       | )          |
|                                                                           |   |      |       |       |       |      |       |
| **Income  before equity in undistributed income of the Bank**                  |   | **668**   | ** ** | **585**    | ** ** | **1,819** | ** ** |
|                                                                           |   |      |       |       |       |      |       |
| **Equity in  Undistributed Income of the Bank**                                |   | 5,544     |       | 3,852      |       | 2,542     |       |
|                                                                           |   |      |       |       |       |      |       |
| **Net  income**                                                                |   | **$**     | **6,212**  | ** ** | **$**      | **4,437** | ** ** | **$** | **4,361** | ** ** |

 

56

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**Condensed Statements of Cash Flows - Years Ended December 31**

 
|                                                                                         |   | **2002**   |       | **2001**   |       | **2000**   |       |
|----------------------------------------------------------------------------------------------|--------|------------|------------|------------|------------|------------|------------|
|                                                                                         |   |       |       |       |       |       |       |
| **Cash  Flows from Operating Activities**                                                    |   |       |       |       |       |       |       |
| Net income                                                                                   |   | $          | 6,212      |       | $          | 4,437      |       | $ | 4,361 |   |
| Adjustments to reconcile net income to net cash provided by (used in)  operating activities: |   |       |       |       |       |       |       |
| Equity in undistributed income of the Bank                                                   |   | (5,544     | )          | (3,852     | )          | (2,542     | )          |
| Other - net                                                                                  |   | (726       | )          | 570        |       | 45         |       |
| **Net cash  provided by (used in) operating activities**                                     |   | **(58**    | **)**      | **1,155**  | ** ** | **1,864**  | ** ** |
|                                                                                         |   |       |       |       |       |       |       |
| **Cash  Flows from Investing Activities**                                                    |   |       |       |       |       |       |       |
| Cash investment in the Bank                                                                  |   | (6,929     | )          | —     |       | —     |       |
|                                                                                         |   |       |       |       |       |       |       |
| **Cash  Flows from Financing Activities**                                                    |   |       |       |       |       |       |       |
| Proceeds from exercise of stock options                                                      |   | 732        |       | 27         |       | 515        |       |
| Repurchase of common stock                                                                   |   | (950       | )          | —     |       | (934       | )          |
| Proceeds from long-term debt                                                                 |   | 14,000     |       | —     |       | —     |       |
| Payments on long-term debt                                                                   |   | (550       | )          | (550       | )          | (550       | )          |
| Payment of dividends                                                                         |   | (878       | )          | (874       | )          | (867       | )          |
| **Net cash  provided by (used in) financing activities**                                     |   | **12,354** | ** ** | **(1,397** | **)**      | **(1,836** | **)**      |
|                                                                                         |   |       |       |       |       |       |       |
| **Net  increase (decrease) in cash**                                                         |   | **5,367**  | ** ** | **(242**   | **)**      | **28**     | ** ** |
|                                                                                         |   |       |       |       |       |       |       |
| **Cash**                                                                                     |   |       |       |       |       |       |       |
| Beginning of year                                                                            |   | 44         |       | 286        |       | 258        |       |
|                                                                                         |   |       |       |       |       |       |       |
| **End of  year**                                                                             |   | **$**      | **5,411**  | ** ** | **$**      | **44**     | ** ** | **$** | **286** | ** ** |

 

**Note 18 - Regulatory Matters**

 

The Company and the Bank are subject tovarious regulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory — and possibly additionaldiscretionary — actions by regulators that, if undertaken, could have a directmaterial effect on the Company’s consolidated financial statements.  Under capital adequacy guidelines on theregulatory framework for prompt corrective action, the Bank must meet specificcapital adequacy guidelines that involve quantitative measures of the Bank’sassets, liabilities, and certain off-balance-sheet items as calculated underregulatory accounting practices.  TheCompany’s and the Bank’s capital classification is also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.

 

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

 

57

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As of December 31, 2002, the most recentnotification from the Bank’s regulator categorized the Bank as well capitalizedunder the regulatory framework for prompt corrective action.  To be categorized as well capitalized, theBank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverageratios as set forth in the table.  Thereare no conditions or events since that notification that management believeshave changed the institution’s category.

 

The actual capital amounts and ratios are asfollows:

 
|                                         |   | **Actual  Amount** |       | **Ratio** |      | **Capital  Adequacy  Purposes** |   | **To be Well  Capitalized********Under  Prompt********Corrective  Action********Provisions** |   |
|----------------------------------------------|--------|--------------------|------------|-----------|-----------|---------------------------------|--------|----------------------------------------------------------------------------------------------|--------|
| **Amount**                                   |   | **Ratio**          | **Amount** |      | **Ratio** |
|                                         |   |               |       |      |      |                            |   |                                                                                         |   |   |   |   |   |
| **December 31, 2002**                        |   |               |       |      |      |                            |   |                                                                                         |   |   |   |   |   |
| *Tier 1  capital (to average assets):*       |   |               |       |      |      |                            |   |                                                                                         |   |   |   |   |   |
| Consolidated                                 |   | $                  | 44,968     |      | 11.60     | %                               | $      | 15,505                                                                                       |   | 4.00 | % | N/A |   | N/A |   |
| FCB                                          |   | 39,823             |       | 10.03     |      | 15,884                          |   | 4.00                                                                                         |   | 19,855 |   | 5.00 | % |
| *Tier 1  capital (to risk-weighted assets):* |   |               |       |      |      |                            |   |                                                                                         |   |   |   |   |   |
| Consolidated                                 |   | 44,968             |       | 10.23     | %         | 17,582                          |   | 4.00                                                                                         |   | N/A |   | N/A |   |
| FCB                                          |   | 39,823             |       | 9.07      |      | 17,569                          |   | 4.00                                                                                         |   | 26,353 |   | 6.00 | % |
| *Total  capital (to risk-weighted assets):*  |   |               |       |      |      |                            |   |                                                                                         |   |   |   |   |   |
| Consolidated                                 |   | 50,493             |       | 11.49     | %         | 35,165                          |   | 8.00                                                                                         |   | N/A |   | N/A |   |
| FCB                                          |   | 45,344             |       | 10.32     |      | 35,138                          |   | 8.00                                                                                         |   | 43,922 |   | 10.00 | % |
|                                         |   |               |       |      |      |                            |   |                                                                                         |   |   |   |   |   |
| **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 |   |
|                                              |        |                    |            |           |           |                                 |        |                                                                                              |        |  |  |  |  |  |  |  |  |  |

 

**Restrictions on Retained Earnings**

 

The Bank is subject to certain restrictionson the amount of dividends that it may declare without prior regulatoryapproval. At December 31, 2002, the Bank could pay dividends to its parent ofup to $1,422 and still be well capitalized under prompt corrective actionprovisions.

 

58

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**Note 19 - Fair Values of Financial Instruments**

 

The estimated fair values of the Company’sfinancial instruments at December 31 were as follows:

 
|                                                                                   |   | **2002  Recorded  Amount** |    | **Fair  Value** |   | **2001  Recorded  Amount** |   | **Fair  Value** |    |
|----------------------------------------------------------------------------------------|--------|----------------------------|---------|-----------------|--------|----------------------------|--------|-----------------|---------|
| **Financial  Assets**                                                                  |   |                       |    |            |   |                       |   |            |    |
| Cash and due from banks, interest bearing deposits with banks, and  federal funds sold |   | $                          | 38,041  |            | $      | 38,041                     |   | $               | 21,457  |   | $ | 21,457 |   |
| Securities available for sale                                                          |   | 33,622                     |    | 33,622          |   | 18,104                     |   | 18,104          |    |
| Securities held to maturity                                                            |   | 505                        |    | 540             |   | 506                        |   | 554             |    |
| Loans held for sale                                                                    |   | 7,432                      |    | 7,542           |   | 6,196                      |   | 6,250           |    |
| Loans receivable, net                                                                  |   | 354,185                    |    | 360,318         |   | 284,613                    |   | 284,930         |    |
| Accrued interest receivable                                                            |   | 1,884                      |    | 1,884           |   | 1,471                      |   | 1,471           |    |
|                                                                                   |   |                       |    |            |   |                       |   |            |    |
| **Financial  Liabilities**                                                             |   |                       |    |            |   |                       |   |            |    |
| Deposits                                                                               |   | $                          | 384,207 |            | $      | 385,950                    |   | $               | 313,730 |   | $ | 316,153 |   |
| Long-term debt                                                                         |   | 24,000                     |    | 24,000          |   | 575                        |   | 575             |    |
| Federal funds purchased                                                                |   | —                     |    | —          |   | 1,400                      |   | 1,400           |    |
| Short-term borrowings                                                                  |   | 16,547                     |    | 16,547          |   | 5,655                      |   | 5,655           |    |
| Accrued interest payable                                                               |   | 315                        |    | 315             |   | 364                        |   | 364             |    |

 

The Company assumes interest rate risk (therisk that general interest rate levels will change) as a result of its normaloperations.  As a result, the fairvalues of the Company’s financial instruments will change when interest ratelevels change and that change may either be favorable or unfavorable to the Company.  Management attempts to match maturities ofassets and liabilities to the extent believed necessary to minimize interestrate risk.  However, borrowers withfixed rate obligations are less likely to prepay in a rising rate environmentand more likely to prepay in a falling rate environment.  Conversely, depositors who are receivingfixed rates are more likely to withdraw funds before maturity in a rising rateenvironment and less likely to do so in a falling rate environment.  Management monitors rates and maturities ofassets and liabilities, and attempts to minimize interest rate risk byadjusting terms of new loans, and deposits and by investing in securities withterms that mitigate the Company’s overall interest rate risk.

 

**Note20 - Other Operating Income and Expenses**

 

Other operating income and expenses includethe following amounts which are in excess of 1% of the total of interest incomeand non-interest income for the years ended December 31:

 
|                                                                         |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                                         |   |     |   |     |   |     |   |
| **Other  Operating Income**                                                  |   |     |   |     |   |     |   |
| Commission on sale of non-deposit investment products                        |   | $        | 524    |     | $      | 605      |   | $ | 741 |   |
| Earnings on bank owned life insurance                                        |   | 441      |   | 267      |   | 60       |   |
| Rent from foreclosed real estate                                             |   | 381      |   | 145      |   | 53       |   |
|                                                                         |   |     |   |     |   |     |   |
| **Other  Operating Expense**                                                 |   |     |   |     |   |     |   |
| State taxes                                                                  |   | $        | 856    |     | $      | 777      |   | $ | 470 |   |
| Telephone                                                                    |   | 291      |   | 233      |   | 256      |   |
| Advertising and marketing                                                    |   | 569      |   | 621      |   | 510      |   |
| Expenses of salary continuation plan and executive supplemental  income plan |   | 439      |   | 522      |   | 94       |   |
| Consulting fees                                                              |   | 467      |   | 273      |   | 192      |   |

 

59

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# **Note 21 - Earnings Per Share Disclosures**

 

In November 2002 the Company’s Board ofDirectors approved a 2 for 1 stock split to stockholders of record on November15, 2002.  The earnings per share, theshares used for purposes of recalculating earnings per share, and the optionamounts and prices for the years ended December 31, 2001 and 2000 have beenretroactively adjusted for this split as if it took place prior to 2000.

 

Following is information regarding thecalculation of basic and diluted earnings per share for the years indicated:

# ** **

|                              |   | **Net Income  (Numerator)** |       | **Shares  (Denominator)** |          | **Per Share  Amount** |       |
|-----------------------------------|--------|-----------------------------|------------|---------------------------|---------------|-----------------------|------------|
|                              |   |                        |       |                      |          |                  |       |
|                              |   |                        | ** ** |                      | ** **    |                  | ** ** |
| **Year  Ended December 31, 2002** |   |                        | ** ** |                      | ** **    |                  | ** ** |
| Basic earnings per share:         |   |                        |       |                      |          |                  |       |
| Net income                        |   | $                           | 6,212      |                      | 4,379,910     |                  | $          | 1.42 |   |
| Effect of dilutive securities:    |   |                        |       |                      |          |                  |       |
| Options                           |   | —                      |       | 84,993                    |          | (.03                  | )          |
| Diluted earnings per share:       |   |                        |       |                      |          |                  |       |
| **Net  income**                   |   | **$**                       | **6,212**  | ** **                | **4,464,903** | ** **            | **$**      | **1.39** | ** ** |
|                              |   |                        | ** ** |                      | ** **    |                  | ** ** |
| **Year  Ended December 31, 2001** |   |                        | ** ** |                      | ** **    |                  | ** ** |
| Basic earnings per share:         |   |                        |       |                      |          |                  |       |
| Net income                        |   | $                           | 4,437      |                      | 4,360,258     |                  | $          | 1.02 |   |
| Effect of dilutive securities:    |   |                        |       |                      |          |                  |       |
| Options                           |   | —                      |       | 108,184                   |          | (.03                  | )          |
| Diluted earnings per share:       |   |                        |       |                      |          |                  |       |
| **Net  income**                   |   | **$**                       | **4,437**  | ** **                | **4,468,442** | ** **            | **$**      | **0.99** | ** ** |
|                              |   |                        | ** ** |                      | ** **    |                  | ** ** |
| **Year  Ended December 31, 2000** |   |                        | ** ** |                      | ** **    |                  | ** ** |
| Basic earnings per share:         |   |                        |       |                      |          |                  |       |
| Net income                        |   | $                           | 4,361      |                      | 4,317,386     |                  | $          | 1.01 |   |
| Effect of dilutive securities:    |   |                        |       |                      |          |                  |       |
| Options                           |   | —                      |       | 138,420                   |          | (.03                  | )          |
| Diluted earnings per share:       |   |                        |       |                      |          |                  |       |
| **Net  income**                   |   | **$**                       | **4,361**  | ** **                | **4,455,806** | ** **            | **$**      | **0.98** | ** ** |

 

The number of shares shown for“options” is the number of incremental shares that would result from exerciseof options and use of the proceeds to repurchase shares at the average marketprice during the year.

 

60

----

 

**Note 22 -Business Segment Information**

 

The Company is managed along two major linesof business; community banking, its core business, and the small loan division,which was entered into late in the fourth quarter of 2000.  Community banking consists of all lending,deposit and administrative operations conducted through its 21 offices inWashington State.  The small loandivision provides small, short-term consumer loans to customers in Alabama andArkansas.

 

Prior to 2001, the Company was managed as awhole, not by discrete operating segments. When the Company began offering small loans, its operating results weresegregated in the general ledger system to better manage financialperformance.  The financial performanceof the business lines is measured by the Company’s profitability reporting process,which utilizes various management accounting techniques to more accuratelyreflect each business line’s financial results.  Revenues and expenses are primarily assigned directly to businesslines.  The small loan division was in astart-up phase in 2000.  Revenues andexpenses for the period were immaterial and disclosure of segment for 2000information is not considered meaningful.

 

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

 

Financial highlights by line of business asof and for the years ended December 31, 2002 and 2001 were as follows:

 
|                                                  |   | **Community  Banking** |        | **Small  Loans** |       | **2002  Total** |       |
|-------------------------------------------------------|--------|------------------------|-------------|------------------|------------|-----------------|------------|
|                                                  |   |                   |        |             |       |            |       |
| Net interest income after provision for credit losses |   | $                      | 17,845      |             | $          | 3,234           |       | $ | 21,079 |   |
| Non-interest income                                   |   | 7,864                  |        | 1                |       | 7,865           |       |
| Non-interest expense                                  |   | 19,292                 |        | 781              |       | 20,073          |       |
| Income taxes                                          |   | 1,832                  |        | 827              |       | 2,659           |       |
|                                                  |   |                   |        |             |       |            |       |
| **Net income**                                        |   | **$**                  | **4,585**   | ** **       | **$**      | **1,627**       | ** ** | **$** | **6,212** | ** ** |
|                                                  |   |                   | ** **  |             | ** ** |            | ** ** |
| **Total assets**                                      |   | **$**                  | **457,159** | ** **       | **$**      | **17,291**      | ** ** | **$** | **474,450** | ** ** |
|                                                  |   |                   |        |             |       |            |       |
| **Total loans**                                       |   | **353,165**            | ** **  | **8,967**        | ** ** | **362,132**     | ** ** |

 
|                                                  |   | **Community  Banking** |        | **Small  Loans** |       | **2001  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** | ** ** |

 

61

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**Note 23 - Subsequent Event**

 

Subsequent to December 31, 2002, the Companydeclared a dividend in the amount of $.05 per share to be paid on February 12,2003 for shareholders of record as of February 3, 2003.

 

**Note 24 - Selected Quarterly Financial Data(Unaudited)**

 

The following selectedfinancial 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, 2002** |   |            |       |             |       |        |       |         |       |
| Interest and dividend income     |   | $               | 8,716      |             | $          | 7,327       |       | $            | 6,995      |   | $ | 6,936 |   |
| Interest expense                 |   | (1,740          | )          | (1,632           | )          | (1,464      | )          | (1,716       | )          |
| **Net interest income**          |   | **6,976**       | ** ** | **5,695**        | ** ** | **5,531**   | ** ** | **5,220**    | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Provision for loan losses        |   | (735            | )          | (623             | )          | (364        | )          | (621         | )          |
| Noninterest income               |   | 2,181           |       | 2,040            |       | 1,828       |       | 1,816        |       |
| Noninterest expenses             |   | (6,509          | )          | (4,614           | )          | (4,541      | )          | (4,409       | )          |
|                             |   |            |       |             |       |        |       |         |       |
| **Income before income taxes**   |   | **1,913**       | ** ** | **2,498**        | ** ** | **2,454**   | ** ** | **2,006**    | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Income taxes                     |   | (439            | )          | (816             | )          | (777        | )          | (627         | )          |
|                             |   |            |       |             |       |        |       |         |       |
| **Net income**                   |   | **$**           | **1,474**  | ** **       | **$**      | **1,682**   | ** ** | **$**        | **1,677**  | ** ** | **$** | **1,379** | ** ** |
|                             |   |            |       |             |       |        |       |         |       |
| Earnings per share:              |   |            |       |             |       |        |       |         |       |
| Basic                            |   | $               | 0.34       |             | $          | 0.38        |       | $            | 0.38       |   | $ | 0.32 |   |
| Diluted                          |   | $               | 0.33       |             | $          | 0.37        |       | $            | 0.38       |   | $ | 0.31 |   |
|                             |   |            |       |             |       |        |       |         |       |
| **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                            |   | $               | 0.26       |             | $          | 0.29        |       | $            | 0.23       |   | $ | 0.25 |   |
| Diluted                          |   | 0.25            |       | 0.28             |       | 0.22        |       | 0.24         |       |

 

62

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**ITEM 9****- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE**

 

There were no changes in anddisagreements with accountants on accounting and financial disclosures.

 

**PART III**

 

**ITEM 10****- DIRECTORS AND EXECUTIVEOFFICERS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT**

 

Incorporatedby reference to the sections entitled ***Election of Directors - Information with Respect to Nomineesand Directors Whose Terms Continue, Management, and Section 16(a) BeneficialOwnership Reporting Compliance*,** as set forth in the ProxyStatement.

 

 

**ITEM 11****- EXECUTIVE COMPENSATION**

 

Incorporatedby reference to the sections entitled ***Information Regarding the Board of Directors and itsCommittees - Director Compensation and Executive Compensation***,as set forth in the Proxy Statement.

 

 

**ITEM 12****- SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

Incorporatedby reference to the sections entitled***Election of Directors - Information with Respect toNominees and Directors Whose Terms Continue, and Security Ownership of CertainBeneficial Owners and Management***, as set forth in the ProxyStatement.

 

 

**ITEM 13****- CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

Incorporatedby reference to the section entitled ***Certain Relationships and Related Transactions***,as set forth in the Proxy Statement.

 

**ITEM 14****- CONTROLSAND PROCEDURES**

 

TheCompany’s disclosure controls and procedures are designed to ensure thatinformation FCFG must disclose in its reports filed or submitted under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded,processed, summarized, and reported on a timely basis. Within 90 days prior tothe filing of this report, the Company carried out an evaluation, under thesupervision and with the participation of the Chief Executive Officer (“CEO”)and principal financial officer, of the effectiveness of disclosure controlsand procedures. Based on that evaluation, the CEO and principal financialofficer have concluded that FCFG’s disclosure controls and procedures areeffective in bringing to their attention on a timely basis information requiredto be disclosed by FCFG reports that it files or submits under the ExchangeAct.   Also, since the date of theirevaluation, there have not been any significant changes in FCFG’s internalcontrols or in other factors that could significantly affect those controls,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

63

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**ITEM 15****- EXHIBITS, FINANCIALSTATEMENT SCHEDULES, AND REPORTS ON FORM 8-K**

 

Thefollowing exhibits are filed as part of this 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, 2002 and 2001

 

Consolidated statements ofincome for the years endedDecember 31, 2002, 2001 and 2000

 

Consolidated statements ofstockholders’ equity for the years ended December 31, 2002, 2001 and 2000

 

Consolidated statements of cashflows for the years endedDecember 31, 2002, 2001 and 2000

 

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:                                                                                                                           |   |                        |
|   |   |                                                                                                                                            |   |                        |
|   |   | Form 8-K on  October 16, 2003, announcing the completion of the acquisition of Harbor  Bank, N.A. and including pro forma financial statements. |
|   |   | Form 8-K on  November 21, 2003, announcing the appointment of Jon M. Jones as President of  the Bank.                                           |
|   |   |                                                                                                                                            |   |                        |
| (3)    |   | Exhibits.                                                                                                                                       |   | See separate  Exhibit Index |
|   |   |                                                                                                                                            |   |                        |
| (4)    |   | Financial  Statement Schedules:                                                                                                                 |   | None                        |

 

64

----

 

**SIGNATURES**

 

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

 

 

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

 

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

 
| **Signatures**                              |   | **Title**                                                      |
|---------------------------------------------|--------|----------------------------------------------------------------|
|                                        |   |                                                           |
| Principal  Executive Officer                |   |                                                           |
|                                        |   |                                                           |
| /s/ Ken F.  Parsons, Sr.                    |   | President,  Chief Executive Officer, and Chairman of the Board |
| Ken F.  Parsons, Sr.                        |   |                                                           |
|                                        |   |                                                           |
| Principal  Financial and Accounting Officer |   |                                                           |
|                                        |   |                                                           |
| /s/ Thomas  L. Dhamers                      |   | Vice  President/Controller                                     |
| Thomas L.  Dhamers                          |   |                                                           |
|                                        |   |                                                           |
| Remaining  Directors:                       |   |                                                           |
|                                        |   |                                                           |
| /s/  Lowell  E.(Sonny) Bridges         |   | Director                                                       |
| Lowell E.  (Sonny) Bridges                  |   |                                                           |
|                                        |   |                                                           |
| /s/ Linda  Buckner                          |   | Director                                                       |
| Linda  Buckner                              |   |                                                           |
|                                        |   |                                                           |
| /s/ E. Paul  DeTray                         |   | Director                                                       |
| E. Paul  DeTray                             |   |                                                           |
|                                        |   |                                                           |
| /s/ Jewell  C. Manspeaker                   |   | Director                                                       |
| Jewell C.  Manspeaker                       |   |                                                           |
|                                        |   |                                                           |
| /s/ Patrick  L. Martin                      |   | Director                                                       |
| Patrick L.  Martin                          |   |                                                           |
|                                        |   |                                                           |
| /s/ A.  Richard Panowicz                    |   | Director                                                       |
| A. Richard  Panowicz                        |   |                                                           |
|                                        |   |                                                           |
| /s/ Lawrence  Schorno                       |   | Director                                                       |
| Lawrence  Schorno                           |   |                                                           |

 

65

----

 

**CERTIFICATIONS**

 

I, Ken F. Parsons, Sr., certifythat:

 

1.             I have reviewed this annual report on Form 10-K of FirstCommunity Financial Group, Inc.;

 

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

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this annual report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this annual report;

 

4.                                       Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                    designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b)                   evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c)                    presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                   allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                  anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officer and I have indicated in this annualreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: March 19, 2003

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

 

66

----

 

**CERTIFICATIONS**

 

I, Thomas L. Dhamers, certifythat:

 

1.             I have reviewed this annual report on Form 10-K of FirstCommunity Financial Group, Inc.;

 

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

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report;

 

4.                                       Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                   designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b)                  evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c)                   presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                   allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                  anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officer and I have indicated in this annualreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date:  March 19, 2003

 
|   |   | /s/ Thomas  L. Dhamers     |   |
|--------|--------|----------------------------|--------|
|   |   | Thomas L.  Dhamers         |
|   |   | Vice  President/Controller |

 

67

----

 

**EXHIBITINDEX**

 
| **Exhibit  No.** |   | **Exhibit Description**                                                                                                    |
|------------------|--------|----------------------------------------------------------------------------------------------------------------------------|
| 3 (a)            |   | Articles of  Amendment to Articles of Incorporation.                                                                       |
|             |   |                                                                                                                       |
| 3 (b)            |   | Amended and  Restated Articles of Incorporation.                                                                           |
|             |   |                                                                                                                       |
| 3 (c)            |   | Bylaws.(1)                                                                                                                 |
|             |   |                                                                                                                       |
| 10 (a)           |   | Employment  Contract for Ken F. Parsons, Sr.(2)                                                                            |
|             |   |                                                                                                                       |
| 10 (b)           |   | 1992 Stock  Option Plan for Non-Employee Directors.(3)                                                                     |
|             |   |                                                                                                                       |
| 10 (c)           |   | Executive  Supplemental Income Plan.(3)                                                                                    |
|             |   |                                                                                                                       |
| 10 (d)           |   | Employee  Stock Option and Restricted Stock Award Plan dated April 19, 1989.(3)                                            |
|             |   |                                                                                                                       |
| 10 (e)           |   | 1994 Stock  Option Plan for Non-employee Directors.(4)                                                                     |
|             |   |                                                                                                                       |
| 10 (f)           |   | Employment  contract for James F. Arneson.(5)                                                                              |
|             |   |                                                                                                                       |
| 10 (g)           |   | 1999  Employee Stock Option and Restricted Award Plan and form of agreements.(6)                                           |
|             |   |                                                                                                                       |
| 10 (h)           |   | Marketing  and Service Agreement with Advance America.(7)                                                                  |
|             |   |                                                                                                                       |
| 10 (i)           |   | Marketing  and Service Agreement with Advance America dated March 21, 2001.(1)                                             |
|             |   |                                                                                                                       |
| 10 (j)           |   | Employment  contract for Jon M. Jones.(8)                                                                                  |
|             |   |                                                                                                                       |
| 10 (k)           |   | Amended and Restated First Community  Financial Group, Inc. Employee Stock Ownership Plan with 401(k)  Provisions.(1)      |
|             |   |                                                                                                                       |
| 10 (l)           |   | Form of  Long-Term Care Agreement.(1)                                                                                      |
|             |   |                                                                                                                       |
| 21               |   | Subsidiaries  of Registrant.                                                                                               |
|             |   |                                                                                                                       |
| 23(a)            |   | Consent of  Independent Auditors (McGladrey & Pullen, LLP).                                                            |
|             |   |                                                                                                                       |
| 23(b)            |   | Consent of  Independent Auditors (Knight Vale & Gregory PLLC).                                                         |
|             |   |                                                                                                                       |
| 99               |   | Certifications Pursuant to 18 U.S.C.  Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |

 

----

| (1)    | Incorporated  by reference to Exhibit 3(b) of the Registrant’s Annual Report on Form 10-K  for the fiscal year ending December 31, 2001.   |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                            |
| (2)    | Incorporated  by reference to Exhibit 10 of the Registrant’s Quarterly Report on form  10-QSB for the quarter ended September 30, 1996.    |
|   |                                                                                                                                            |
| (3)    | Incorporated  by reference from Exhibit 10 of the Registrant’s Annual Report on Form 10-KSB  for the fiscal year ending December 31, 1992. |
|   |                                                                                                                                            |
| (4)    | Incorporated  by reference to Exhibit 10 of the Registrant’s Annual Report on Form 10-KSB  for the fiscal year ending December 31, 1994.   |
|   |                                                                                                                                            |
| (5)    | Incorporated  by reference to Exhibit 10 of the Registrant’s Annual Report on Form 10-K for  the fiscal year ending December 31, 1998.     |
|   |                                                                                                                                            |
| (6)    | Incorporated  by reference to Exhibit 10 of the Registrant’s Annual Report on Form 10-K for  the fiscal year ending December 31, 1999.     |
|   |                                                                                                                                            |
| (7)    | Incorporated  by reference to Exhibit 10 of the Registrant’s Annual Report on Form 10-K for  the fiscal year ending December 31, 2000.     |
|   |                                                                                                                                            |
| (8)    | Incorporated  by reference to Exhibit 10 of the Registrant’s Quarterly Report on Form 10-Q  for the quarter ended September 30, 2001.      |

 

68

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