**Table of Contents**

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**UNITED STATES SECURITIES ANDEXCHANGE COMMISSON**

**Washington D.C., 20549**

 

**FORM 10-Q**

 
| **x**      | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934**                                                                                        |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                           |
| ** ** | **For the quarterly period ended March 31,  2009**                                                                                                                                        |
|       |                                                                                                                                                                                           |
| **o**      | **Transition  Report Under Section 13 or 15(d) of the Exchange Act**                                                                                                                 |
|       |                                                                                                                                                                                           |
| ** ** | **For the transition period from               to              ** |

 

**Commission File Number  000-52096**

 

**SKAGIT STATE BANCORP, INC.**

(Exact Name of Registrant asSpecified in Its Charter)

 

| **WASHINGTON**                  | ** ** | **20-5048602**         |
|---------------------------------|------------|------------------------|
| (State or Other Jurisdiction of |       | (I.R.S. Employer       |
| Incorporation or Organization)  |       | Identification Number) |

 

**301 East Fairhaven Avenue**

**Burlington, Washington  98233**

(Address of PrincipalExecutive Offices) (Zip Code)

 

**(360) 755-0411**

(Registrant’s TelephoneNumber, Including Area Code)

 

Indicateby check mark whether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yesx Noo

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerate filer, or a non-accelerated. See the definitions of “large accelerated filer,” “accelerated filer”and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

| Large  accelerated filer o |   | Accelerated filer  o         |
|----------------------------|--------|------------------------------|
|                       |   |                         |
| Non-accelerated  filer o   |   | Smaller  Reporting Company x |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange  Yeso No x

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files).  Yeso No o

 

**Indicate the number of shares outstanding of each of theissuer’s classes of common stock, as of the latest practicable date:**

** **

Thenumber of shares of the issuer’s Common Stock outstanding at May 14, 2009was 588,469.

 

 

 

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Table of Contents

 

**SKAGIT STATE BANCORP, INC.**

 

**TABLE OF CONTENTS**

 
| **PART I.**  | **FINANCIAL INFORMATION** |
|-------------------|---------------------------|
|              |                      |   |   |   |
|              | Item 1.                   | Financial Statements |   |   |
|              |                      |   |   |   |
|              |                      | Consolidated  Balance Sheets as of March 31, 2009 and December 31, 2008 |   | Page 3 |
|              |                      |   |   |   |
|              |                      | Consolidated  Statements of Income for the three months ended March 31, 2009 and 2008 |   | Page 4 |
|              |                      |   |   |   |
|              |                      | Consolidated Statements of Changes in Stockholders’  Equity and Comprehensive Income for the three months ended  March 31, 2009 and 2008 |   | Page 5 |
|              |                      |   |   |   |
|              |                      | Consolidated Statements of Cash Flows for the three  months ended March 31, 2009 and 2008 |   | Page 6 |
|              |                      |   |   |   |
|              |                      | Notes to Consolidated Financial Statements |   | Pages 7-12 |
|              |                      |   |   |   |
|              | Item 2.                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   | Pages 12-23 |
|              |                      |   |   |   |
|              | Item 3.                   | Quantitative  and Qualitative Disclosures About Market Risk |   | Page 23 |
|              |                      |   |   |   |
|              | Item 4T.                  | Controls and  Procedures |   | Page 23 |
|              |                      |   |   |   |
| **PART II.** | **OTHER INFORMATION**     |   |   |
|              |                      |   |   |   |
|              | Item 1.                   | Legal Proceedings |   | Page 23 |
|              |                      |   |   |   |
|              | Item 1 A.                 | Risk Factors |   | Page 23-26 |
|              |                      |   |   |   |
|              | Item 2.                   | Unregistered  Sales of Equity Securities and Use of Proceeds |   | Page 26 |
|              |                      |   |   |   |
|              | Item 3.                   | Defaults Upon  Senior Securities |   | Page 26 |
|              |                      |   |   |   |
|              | Item 4.                   | Submission  of Matters to a Vote of Security Holders |   | Page 26 |
|              |                      |   |   |   |
|              | Item 5.                   | Other Information |   | Page 26 |
|              |                      |   |   |   |
|              | Item 6.                   | Exhibits |   | Page 26 |
|              |                      |   |   |   |
|              |                      | Signatures |   | Page 27 |

 

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**Item 1.    FinancialStatements**

 

**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS(Unaudited)**

** **
| **(dollars in thousands except share data)**                                                                                                                               | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| **ASSETS**                                                                                                                                                                 |       |                    |       |                       |       |
| **ASSETS**                                                                                                                                                                 | ** ** | ** **              | ** ** | ** **                 | ** ** |
| Cash and due from  banks                                                                                                                                                   |       | $                       | 9,746      |                       | $          | 11,954 |   |
| Federal funds  sold and interest-bearing bank balances                                                                                                                     |       | 18,642                  |       | —                     |       |
| Investment  securities                                                                                                                                                     |       |                    |       |                       |       |
| Available-for-sale,  at fair value                                                                                                                                         |       | 100,263                 |       | 102,647                    |       |
| Held-to-maturity,  at amortized cost                                                                                                                                       |       | 37,471                  |       | 36,518                     |       |
| Loans held for  sale                                                                                                                                                       |       | 156                     |       | 350                        |       |
| Loans                                                                                                                                                                      |       | 388,951                 |       | 399,225                    |       |
| Allowance for  loan losses                                                                                                                                                 |       | (5,637                  | )          | (5,450                     | )          |
| Net loans                                                                                                                                                                  |       | 383,314                 |       | 393,775                    |       |
| Bank premises  and equipment, net                                                                                                                                          |       | 11,313                  |       | 11,480                     |       |
| Other real  estate owned                                                                                                                                                   |       | 6,899                   |       | 5,667                      |       |
| Accrued interest  receivable                                                                                                                                               |       | 2,486                   |       | 2,430                      |       |
| Other assets                                                                                                                                                               |       | 1,315                   |       | 2,055                      |       |
| **TOTAL  ASSETS**                                                                                                                                                          |       | $                       | 571,605    |                       | $          | 566,876 |   |
| ** **                                                                                                                                                                 |       |                    |       |                       |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                              |       |                    |       |                       |       |
| **LIABILITIES**                                                                                                                                                            |       |                    |       |                       |       |
| Deposits                                                                                                                                                                   |       |                    |       |                       |       |
| Interest-bearing                                                                                                                                                           |       | $                       | 419,911    |                       | $          | 394,422 |   |
| Non-interest-bearing                                                                                                                                                       |       | 71,696                  |       | 75,116                     |       |
| Total deposits                                                                                                                                                             |       | 491,607                 |       | 469,538                    |       |
| Other borrowings                                                                                                                                                           |       | 15,288                  |       | 32,665                     |       |
| Other  liabilities                                                                                                                                                         |       | 1,545                   |       | 2,872                      |       |
| Total  liabilities                                                                                                                                                         |       | 508,440                 |       | 505,075                    |       |
|                                                                                                                                                                       |       |                    |       |                       |       |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                             |       |                    |       |                       |       |
| Common stock no  par value, 5,000,000 shares authorized, 586,595 and 586,285 shares issued and  outstanding at March 31, 2009 and December 31, 2008 respectively |       | 12,110                  |       | 12,042                     |       |
| Accumulated  other comprehensive income, net of tax                                                                                                                        |       | 2,423                   |       | 2,325                      |       |
| Retained  earnings                                                                                                                                                         |       | 48,632                  |       | 47,434                     |       |
| Total  stockholders’ equity                                                                                                                                           |       | 63,165                  |       | 61,801                     |       |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                       |       | $                       | 571,605    |                       | $          | 566,876 |   |

 

*See accompanying notes to theseconsolidated financial statements*

 

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**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF INCOME(Unaudited)**

 
| ** **                                      | ** ** | **For the three months ended March 31,** |
|-------------------------------------------------|------------|-----------------------------------------------|
| **(dollars in thousands except share data)**    | ** ** | **2009**                                      | ** ** | **2008** | ** ** |
| **INTEREST  INCOME**                            |       |                                          |   |   |   |
| Interest and  fees on loans                     |       | $                                             | 5,907 |   | $ | 6,441 |   |
| Investment  securities                          |       |                                          |   |   |   |
| Taxable                                         |       | 1,070                                         |   | 1,506 |   |
| Exempt from  federal income tax                 |       | 281                                           |   | 325 |   |
| Federal funds  sold                             |       | 1                                             |   | 242 |   |
| Total interest  income                          |       | 7,259                                         |   | 8,514 |   |
| **INTEREST  EXPENSE**                           |       |                                          |   |   |   |
| Deposits                                        |       | 1,734                                         |   | 2,901 |   |
| Securities sold  under agreements to repurchase |       | 89                                            |   | 124 |   |
| Total interest  expense                         |       | 1,823                                         |   | 3,025 |   |
| **NET  INTEREST INCOME**                        |       | 5,436                                         |   | 5,489 |   |
| Provision for  loan losses                      |       | 450                                           |   | — |   |
| **NET  INTEREST INCOME AFTER**                  |       |                                          |   |   |   |
| **PROVISION  FOR LOAN LOSSES**                  |       | 4,986                                         |   | 5,489 |   |
| **NON-INTEREST  INCOME**                        |       |                                          |   |   |   |
| Service charges  on deposits                    |       | 708                                           |   | 750 |   |
| Other                                           |       | 200                                           |   | 200 |   |
| Gain on sale of  assets                         |       | 52                                            |   | 63 |   |
| Total  non-interest income                      |       | 960                                           |   | 1,013 |   |
| **NON-INTEREST  EXPENSES**                      |       |                                          |   |   |   |
| Salaries                                        |       | 1,981                                         |   | 1,921 |   |
| Payroll taxes  and employee benefits            |       | 515                                           |   | 501 |   |
| Bank premises  and equipment                    |       | 242                                           |   | 275 |   |
| Occupancy                                       |       | 224                                           |   | 186 |   |
| State business  taxes                           |       | 98                                            |   | 121 |   |
| Advertising                                     |       | 149                                           |   | 150 |   |
| Other                                           |       | 1,329                                         |   | 909 |   |
| Total  non-interest expenses                    |       | 4,538                                         |   | 4,063 |   |
| **INCOME  BEFORE PROVISION FOR INCOME TAX**     |       | 1,408                                         |   | 2,439 |   |
| **PROVISION  FOR INCOME TAX**                   |       |                                          |   |   |   |
| Provision for  Income Tax                       |       | 210                                           |   | 539 |   |
| **NET  INCOME**                                 |       | $                                             | 1,198 |   | $ | 1,900 |   |
| **BASIC  EARNINGS PER SHARE**                   |       | $                                             | 2.04 |   | $ | 2.85 |   |
| **DILUTED  EARNINGS PER SHARE**                 |       | $                                             | 2.03 |   | $ | 2.83 |   |

 

*Seeaccompanying notes to these consolidated financial statements*

 

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**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OFCHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (Unaudited)**

 

Threemonths ended March 31, 2009 and 2008

 
| ** **                                                               | ** ** | **Common  Stock** | ** ** | **Accum.  Other  Comprehensive** | ** ** | **Retained** | ** ** | **Total  Stockholders’** | ** ** | **Comprehensive** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|--------------|------------|-------------------------------|------------|-------------------|------------|
| **(dollars  in thousands except share and per share amounts)**           | ** ** | **Shares**        | ** ** | **Amount**                       | ** ** | **Income**   | ** ** | **Earnings**                  | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| **BALANCE,****January  1, 2008**                                         |       | 670,997           |       | $                                | 13,564     |         | $          | 694                           |       | $                 | 58,425     |   | $ | 72,683 |   |   |   |
| Comprehensive  income:                                                   |       |              |       |                             |       |         |       |                          |       |              |       |   |   |
| Net income                                                               |       | —            |       | —                           |       | —       |       | 1,900                         |       | 1,900             |       | $ | 1,900 |   |
| Other  comprehensive income:                                             |       |              |       |                             |       |         |       |                          |       |              |       |   |   |
| Unrealized gains  on available-for-sale securities, net of taxes of $604 |       | —            |       | —                           |       | 1,172        |       | —                        |       | 1,172             |       | 1,172 |   |
| Total other  comprehensive income                                        |       |              |       |                             |       |         |       |                          |       |              |       | 1,172 |   |
| Comprehensive  income                                                    |       |              |       |                             |       |         |       |                          |       |              |       | $ | 3,072 |   |
| Common stock  redemption                                                 |       | (85,022           | )          | (13,586                          | )          | —       |       | (1,718                        | )          | (15,304           | )          |   |   |
| Stock  compensation expense                                              |       | —            |       | 40                               |       | —       |       | —                        |       | 40                |       |   |   |
| **BALANCE,**March 31, 2008                                               | ** ** | 585,975           |       | $                                | 18         |         | $          | 1,866                         |       | $                 | 58,607     |   | $ | 60,491 |   |   |   |
|                                                                     |       |              |       |                             |       |         |       |                          |       |              |       |   |   |
| **BALANCE,**January 1, 2009                                              |       | 586,285           |       | $                                | 12,042     |         | $          | 2,325                         |       | $                 | 47,434     |   | $ | 61,801 |   |   |   |
| Comprehensive  income:                                                   |       |              |       |                             |       |         |       |                          |       |              |       |   |   |
| Net income                                                               |       | —            |       | —                           |       | —       |       | 1,198                         |       | 1,198             |       | $ | 1,198 |   |
| Other  comprehensive income:                                             |       |              |       |                             |       |         |       |                          |       |              |       |   |   |
| Unrealized gains  on available-for-sale securities, net of taxes of $50  |       | —            |       | —                           |       | 98           |       | —                        |       | 98                |       | 98 |   |
| Total other  comprehensive income                                        |       |              |       |                             |       |         |       |                          |       |              |       | 98 |   |
| Comprehensive  income                                                    |       |              |       |                             |       |         |       |                          |       |              |       | $ | 1,296 |   |
| Common stock  redemption                                                 |       | —            |       | —                           |       | —       |       | —                        |       | —            |       |   |   |
| Stock options  exercised                                                 |       | 25                |       | 4                                |       | —       |       | —                        |       | 4                 |       |   |   |
| Stock  compensation expense and restricted stock awards                  |       | 285               |       | 64                               |       | —       |       | —                        |       | 64                |       |   |   |
| **BALANCE,**March 31, 2009                                               | ** ** | 586,595           |       | $                                | 12,110     |         | $          | 2,423                         |       | $                 | 48,632     |   | $ | 63,165 |   |   |   |

 

*Seeaccompanying notes to these consolidated financial statements*

 

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**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASHFLOWS (Unaudited**)

 
| **(dollars in thousands)**                                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Three months ended  March 31,**                                                    | ** ** | **2009**   | ** ** | **2008**   | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                  |       |       |       |       |       |
| Net  income                                                                               |       | $          | 1,198      |       | $          | 1,900 |   |
| *Adjustments to reconcile net income to net cash  flows from operating activities*        |       |       |       |       |       |
| Provision  for loan losses                                                                |       | 450        |       | —     |       |
| Depreciation                                                                              |       | 219        |       | 223        |       |
| Gains  on sale of loans                                                                   |       | (52        | )          | (63        | )          |
| Amortization  of investment security premiums and discounts, net                          |       | (40        | )          | (78        | )          |
| Stock  compensation for employee services                                                 |       | 64         |       | 40         |       |
| *Changes in operating assets and liabilities*                                             |       |       |       |       |       |
| Originations  of loans held for sale                                                      |       | (4,314     | )          | (5,342     | )          |
| Proceeds  for sales of loans held for sale                                                |       | 4,560      |       | 5,002      |       |
| Decrease  (increase) in interest receivable                                               |       | (56        | )          | 130        |       |
| Decrease  in other assets                                                                 |       | 689        |       | 82         |       |
| Decrease  in other liabilities                                                            |       | (1,327     | )          | (960       | )          |
| Net  cash flows from operating activities                                                 |       | 1,391      |       | 934        |       |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                                  |       |       |       |       |       |
| Proceeds  from maturities of investment securities — available-for-sale              |       | 2,573      |       | 19,961     |       |
| Purchases  of investment securities — available-for-sale                             |       | —     |       | (19,612    | )          |
| Proceeds  from maturities of investment securities — held-to-maturity                |       | 355        |       | 1,212      |       |
| Purchases  of investment securities — held-to-maturity                               |       | (1,308     | )          | —     |       |
| Net  decrease (increase) in federal funds sold & interest-bearing bank  balances |       | (18,642    | )          | 26,842     |       |
| Net  decrease (increase) in loans                                                         |       | 8,848      |       | (15,859    | )          |
| Purchase  of premises and equipment                                                       |       | (52        | )          | (206       | )          |
| Capitalized  expenditures for improvements to other real estate owned                     |       | (69        | )          | —     |       |
| Proceeds  from premises and equipment                                                     |       | —     |       | 150        |       |
| Net  cash flows from investing activities                                                 |       | (8,295     | )          | 12,488     |       |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                                  |       |       |       |       |       |
| Net  increase in demand deposits, money market, NOW and savings accounts                  |       | 12,580     |       | 2,225      |       |
| Net  increase (decrease) in time deposits                                                 |       | 9,489      |       | (5,751     | )          |
| Amount  paid for redemption of common stock                                               |       | —     |       | (15,304    | )          |
| Net  increase (decrease) in other borrowings                                              |       | (17,377    | )          | 2,285      |       |
| Proceeds  from exercise of stock options                                                  |       | 4          |       | —     |       |
| Net  cash flows from financing activities                                                 |       | 4,696      |       | (16,545    | )          |
| **NET CHANGE IN CASH AND DUE FROM BANKS**                                                 |       | (2,208     | )          | (3,123     | )          |
| **CASH AND DUE FROM BANKS,**beginning of period                                           |       | 11,954     |       | 16,641     |       |
| **CASH AND DUE FROM BANKS,**end of period                                                 |       | $          | 9,746      |       | $          | 13,518 |   |
| **SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION**                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash  paid during the period for income taxes                                             |       | $          | 166        |       | $          | 747 |   |
| Cash  paid during the period for interest                                                 |       | 1,808      |       | 3,131      |       |
| **NONCASH FINANCING AND INVESTING TRANSACTIONS**                                          |       |       |       |       |       |
| Property  taken in settlement of loans                                                    |       | 1,163      |       | 6,202      |       |

 

*Seeaccompanying notes to these consolidated financial statements*

 

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**SKAGIT STATE BANCORP, INC. AND SUBSIDIARY**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1: BASISOF PRESENTATION**

 

The accompanyingconsolidated financial statements include the accounts of Skagit State Bancorp, Inc.and its subsidiary Skagit State Bank, (collectively, “Company” or “Bancorp”).All significant inter-company accounts and transactions have been eliminated.The consolidated financial statements have been prepared in conformity withaccounting principles generally accepted in the United States of America forinterim financial information and with instructions to Form 10-Q.Accordingly they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States of America forcomplete financial statements. In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fairpresentation have been included. Operating results for the three months ended March 31,2009 are not necessarily indicative of the results anticipated for the yearending December 31, 2009. For additional information, refer to the auditedfinancial statements and footnotes for the most recent annual period ended December 31,2008 contained in the Annual Report on Form 10-K.

 

All dollar amounts intables, except share and per share information, are stated in thousands.

 

**Note 2:CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Bancorp’s financialstatements are based upon the selection and application of significantaccounting policies which by their nature are inherently subject to estimationtechniques, valuation assumptions and other subjective assessments. Managementhas identified specific accounting policies that due to judgments, estimatesand assumptions and economic assumptions which may prove inaccurate or aresubject to variation that may significantly affect our reported results ofoperations and financial positions for the periods presented or in futureperiods.  These policies relate to thedetermination of the allowance for loan losses and the valuation of real estateowned. These policies and the judgments, estimates and assumptions aredescribed in the Annual Report on Form 10-K for the year ended December 31,2008.

 

**Note 3: RECLASSIFICATIONS**

 

Certain reclassificationshave been made to the 2008 financial statements to conform to the 2009presentation. Such classifications have no affect on net income.

 

**Note 4: EARNINGS PER SHARE**

 

Basic earnings per shareamounts are computed based on the weighted average number of sharesoutstanding. Diluted earnings per share is calculated by dividing net income bydiluted weighted average shares outstanding, which includes common stockequivalents outstanding using the treasury stock method.

** **

(dollars in thousands except share and per shareamounts)

 
| **Three months ended  March 31,**                                          | ** ** | **2009** | ** ** | **2008** | ** ** |
|---------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Numerator:                                                                      |       |     |       |     |       |
| Net  income                                                                     |       | $        | 1,198      |     | $          | 1,900 |   |
| Denominator:                                                                    |       |     |       |     |       |
| Denominator  for basic earnings per share - Weighted average shares outstanding |       | 586,443  |       | 666,325  |       |
| Effect  of dilutive securities:                                                 |       |     |       |     |       |
| Stock  options and unvested restricted stock grants                             |       | 4,985    |       | 4,419    |       |
| Denominator  for diluted earning per share Weighted average shares outstanding  |       | 591,428  |       | 670,744  |       |
| Basic  earnings per share                                                       |       | $        | 2.04       |     | $          | 2.85 |   |
| Diluted  earnings per share                                                     |       | $        | 2.03       |     | $          | 2.83 |   |

 

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**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 5: ALLOWANCE FOR LOAN LOSSES**

 

The allowance for loanlosses represents management’s best estimate and is maintained at a leveldeemed adequate to provide for estimated future losses and is evaluated on aregular basis. Bancorp’s evaluation of the allowance for loan losses isinherently subjective as it requires estimates that are susceptible tosignificant revision as more information becomes available. The ultimaterecovery of loans is susceptible to future market factors beyond Bancorp’scontrol. These factors may result in losses or recoveries differingsignificantly from those provided in Bancorp’s financial statements. In addition, regulatory agencies, as anintegralpart oftheir examinationprocess, periodically review the estimated losses on loans, and based upontheir judgment, may require Bancorp to make additional provisions oradjustments to its allowance for loan losses

 

The allowance is basedupon Bancorp’s evaluation of the pertinent factors underlying the quality andcomposition of the loan portfolio, levels and trends in losses anddelinquencies, current economic conditions, specific industry conditions andthe estimated value of any underlying collateral. The allowance consists ofspecific, general and unallocated components. The general allowance iscalculated by applying a loss percentage factor to the different loan types andthe different risk gradings.  A specificallowance is calculated based on a review of classified or non-performing loansfor specific weaknesses and evaluation of those loans for impairment and lossexposure. The unallocated component of the allowance reflects the margin ofimprecision inherent in the underlying assumptions used in the methodologiesfor estimated specific and general losses in the loan portfolio. Theunallocated allowance provides for other credit losses inherent in our loanportfolio that may not have been contemplated in the general and specificcomponents of the allowance. The unallocated amount is reviewed periodicallybased on trends in credit losses, the results of credit reviews and overalleconomic trends.

 

Additions to theallowance, in the form of provisions, are reflected in current operatingresults, while charge-offs to the allowance are made when a loss is determinedto have occurred.

 

**Note 6: STOCK-BASED COMPENSATION**

 

Bancorp has oneshare-based payment plan, which is shareholder approved, and permits the grantof share-based awards to its employees and directors up to 100,000 shares andat March 31, 2009, there were 68,710 common shares available for grant. Inaddition to this share-based payment plan, Bancorp has outstanding restrictedstock awards granted pursuant to an employment agreement with an executiveofficer.

 

Total equity compensationexpense was $64,000 and $40,000 for the three months ended March 31, 2009and 2008, respectively.

 

**Stock Options**: All options granted during 2009 and2008 were Incentive Stock Options and were granted at a price equal to themarket value of the stock on the grant date, have a term of 10 years and vestover a five year period.  Bancorpmeasures the fair value of each stock option at the date of the grant, usingthe Black Scholes option valuation model. The application of this valuation model involves assumptions that arejudgmental and sensitive in the determination of compensation expense.

 

The following assumptionswere used in arriving at the fair value of options granted for the three monthsended March 31, 2009:

 
| ** **                               | ** ** | **Employee options** | ** ** |
|------------------------------------------|------------|----------------------|------------|
| Expected price  volatility               |       | 18.41                | %          |
| Risk-free  interest rate                 |       | 2.05                 | %          |
| Dividend yield  on underlying stock      |       | 2.30                 | %          |
| Weighted-average  expected life in years |       | 7.00                 |       |

 

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**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

The following tablesummarizes the activity related to options outstanding during the three monthsended March 31, 2009. The aggregate intrinsic value represents the totalpretax intrinsic value (amount by which the fair value of the underlying stockexceeds the exercise price of an option or award, times the number of shares):

 

(dollars in thousands except share and per shareamounts)

 
| ** **                           | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise/Grant  Price** | ** ** | **Weighted  Average  Remaining  Contractual Terms** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------|------------|
| Outstanding at  January 1, 2009 |       | 18,331     |       | $                                            | 170.48     |                                                | 7.69       |                           | $          | 541 |   |
| Granted                              |       | 10,455     |       | 195.00                                       |       | 10.00                                               |       | —                         |       |
| Exercised                            |       | 25         |       | —                                       |       | —                                              |       | —                         |       |
| Forfeited                            |       | —     |       | —                                       |       | —                                              |       | —                         |       |
| Outstanding at  March 31, 2009  |       | 28,761     |       | $                                            | 179.40     |                                                | 8.33       |                           | $          | 592 |   |
| Exercisable at  March 31, 2009  |       | 6,282      |       | $                                            | 167.54     |                                                | 7.21       |                           | $          | 204 |   |

 

The unrecognizedshare-based compensation cost relating to stock option expense at March 31,2009 is approximately $689,000, which will be recognized over the remainingvesting schedule through 2014. The weighted average grant date fair value ofoptions granted during 2009 was $30.78 per share.

 

**Stock Awards**: Recipients of restricted stock awardsdo not pay any cash consideration to Bancorp for the shares and receive alldividends with respect to all such shares, whether or not shares havevested.  The awards vest over a five yearperiod.  Bancorp measures the fair valueof each stock award at the date of the grant and recognizes compensation basedon the amount the market price of Bancorp’s common stock exceeds the exerciseprice.  The unrecognized share-basedcompensation cost relating to restricted stock awards expense at March 31,2009 was approximately $217,000, which will be recognized over the remaining yearsof the original five year vesting period of the awards. The weighted averagegrant date fair value of restricted stock awards granted for the three monthsended March 31, 2008 was $189.00. There were no awards granted for the three months ended March 31,2009.   The total intrinsic value ofstock awards exercised and vested during the three months ended March 31,2009 was $54,000.

 

The aggregate intrinsicvalue in the table above and following represents the total pretax intrinsicvalue (amount by which the fair value of the underlying stock exceeds theexercise price of an option or award, times the number of shares).  The following table summarizes the activityrelating to restricted stock awards outstanding for the three months ended March 31,2009.

 

(dollars in thousands except share and per shareamounts)

 
| ** **                           | ** ** | **Shares** | ** ** | **Weighted Average  Remaining  Contractual Terms  (in years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------------------------------------------|------------|--------------------------------|------------|------------|------------|------------|
| Outstanding at  January 1, 2009 |       | 2,159      |       | 3.61                                                           |       | $                              | 432        |       |       |       |   |
| Granted                              |       | —     |       | —                                                         |       | —                         |       |       |       |       |
| Vested                               |       | 285        |       | —                                                         |       | —                         |       |       |       |       |
| Forfeited                            |       | —     |       | —                                                         |       | —                         |       |       |       |       |
| Outstanding at  March 31, 2009  |       | 1,874      |       | 3.28                                                           |       | $                              | 375        |       |       |       |   |
| Exercisable at  March 31, 2009  |       | —     |       | —                                                         |       | —                         |       |       |       |       |

 

For additionalinformation on the stock-based equity compensation plan, refer to Bancorp’saudited financial statements and footnotes for the most recent annual periodended December 31, 2008 contained in the Annual Report on Form 10-K.

 

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**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 7: INCOME TAXES**

 

Bancorp files aconsolidated federal income tax return. Bancorp accounts for income taxes using the liability method anddeferred taxes are reflected at currently enacted income tax rates applicableto the period in which the deferred tax assets or liabilities are expected tobe realized or settled.  Deferred taxesresult from temporary differences in the recognition of certain income andexpense amounts between Bancorp’s financial statements and its tax returns.As changes in tax laws or rates areenacted, deferred tax assets and liabilities are adjusted through the provisionfor income taxes.

 

Bancorp adopted FIN 48, “Accountingfor Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”on January 1, 2007. FIN 48 seeks to reduce the diversity in practiceassociated with certain aspects of measurement and recognition in accountingfor income taxes. FIN 48 provides guidance on de-recognition, classification,interest and penalties and accounting in interim periods and requires expandeddisclosure with respect to uncertainty in income taxes.  Our accounting policy with respect tointerest and penalties arising from income tax settlements is to recognize themas non-interest expense.

 

**Note 8: FINANCIAL INSTRUMENTS**

 

In the ordinarycourse of business, Bancorp has entered into off-balance-sheet financialinstruments consisting of commitments to extend credit, commitments undercredit-card arrangements, commercial letters of credit, and standby letters ofcredit. Such financial instruments are recorded in the financial statementswhen they are funded or related fees are incurred or received.

 

The following is a summary of the off-balance-sheet financialinstruments or contracts outstanding as of March 31, 2009: (dollars inthousands)

 
| Unfunded  commitments to extend credit  |   | $      | 71,486 |   |
|-----------------------------------------|--------|--------|--------|--------|
| Credit card  arrangements               |   | 11,566 |   |
| Commitments to  fund municipal warrants |   | 5,245  |   |
| Standby letters  of credit              |   | 2,652  |   |

 

**Note 9: FAIR VALUE**

 

SFAS No. 157, “FairValue Measures” defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements and expandsdisclosures about fair value measurements.

 

SFAS No. 157establishes a hierarchy that prioritizes the use of fair value inputs used inthe valuation methodologies into the following three levels:

 

Level 1 — Quoted pricesfor identical instruments in active markets that Bancorp has the ability toaccess at the measurement date.

 

Level 2 — Significantother observable inputs other than Level 1 prices such as quoted prices forsimilar instruments in active markets, quoted prices for identical or similarinstruments in markets that are not active, or other inputs that are observableor can be derived from or corroborated by observable market data by correlationor other means.

 

Level 3 — Significantunobservable inputs that reflect the Bancorp’s own assumption about theassumptions that market participants would use in pricing an asset orliability.

 

In general, Bancorpdetermines fair value based upon quoted prices when available or through theuse of alternative approaches, such as matrix or model pricing, when marketquotes are not readily accessible or available. The valuation techniques usedare based on observable and unobservable inputs.  Valuation adjustments may be made to ensurethat financial instruments are recorded at fair value.  While management believes Bancorp’s valuationmethodologies are appropriate and consistent with other market participants,the use of different methodologies or assumptions used to determine the fairvalue of certain financial instruments could result in a different estimate offair value at the reporting date.

 

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**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

Investment SecuritiesAvailable for Sale — Securities classified as available for sale are reportedat fair value utilizing Level 2 inputs. For these securities, Bancorp obtainsfair value measurements from an independent pricing service.  The fair value measurements includesconsiderable observable data that may include dealer quotes, market spreads,cash flows, the treasury yield curve, yield/spread relationships, consensusprepayment rates, and the bonds terms and conditions,  among other things.

 

Impaired Loans — Impairedloans are reported at the lower of the recorded amount of the loan or fairvalue of the underlying collateral if repayment is expected from thecollateral.

 

Other Real Estate Owned —Other real estate owned includes properties acquired through foreclosure.  These properties are recorded at the lower ofthe recorded amount of the loan, or estimated fair value less estimated coststo sell based on periodic evaluations using Level 3 inputs.  Valuation of the property occurs when it isforeclosed upon and at least annually thereafter.  Write-downs arising from the acquisition ofproperty, in full or partial satisfaction of loans, are charged to theallowance for loan losses.  Subsequentwrite-downs after acquisition, identified through management’s periodicvaluations, are written down through non-interest expenses.

 

The table below showsassets measured at fair value on a recurring basis as of March 31, 2009.

 

(dollars in thousands)

 
| ** **                     | ** ** | ** ** | ** ** | **Quoted Prices  in Active  Markets for  Identical Assets** | ** ** | **Significant  Other  Observable  Inputs** | ** ** | **Significant  Unobservable**

**Inputs** | ** ** |
|--------------------------------|------------|------------|------------|-------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **Description**                | ** ** | **Total**  | ** ** | **(Level 1)**                                               | ** ** | **(Level 2)**                              | ** ** | **(Level 3)**                             | ** ** |
| Available-for-sale  securities |       | $          | 100,263    |                                                        | $          | —                                     |       | $                                         | 100,263    |   | $ | — |   |
| Total                          |       | $          | 100,263    |                                                        | $          | —                                     |       | $                                         | 100,263    |   | $ | — |   |

 

The table below showsassets measured at fair value on a non-recurring basis as of March 31,2009.

 

(dollars in thousands)

 
| ** **               | ** ** | ** ** | ** ** | **Quoted Prices**

**in Active  Markets for  Identical Assets** | ** ** | **Significant  Other  Observable  Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** |
|--------------------------|------------|------------|------------|-----------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------|------------|
| **Description**          | ** ** | **Total**  | ** ** | **(Level 1)**                                                   | ** ** | **(Level 2)**                              | ** ** | **(Level 3)**                         | ** ** |
| Impaired loans           |       | $          | 5,293      |                                                            | $          | —                                     |       | $                                     | —     |   | $ | 5,293 |   |
| Other real  estate owned |       | $          | 6,899      |                                                            | $          | —                                     |       | $                                     | —     |   | $ | 6,899 |   |
| Total                    |       | $          | 12,192     |                                                            | $          | —                                     |       | $                                     | —     |   | $ | 12,192 |   |

 

Forthe three months ended March 31, 2009, impaired loans were reduced viapartial charge-offs and loan impairment reserves of $174,000 to a fair value of$5.3 million.

 

**Note 10: NEW ACCOUNTINGPRONOUNCEMENTS**

 

In April 2009, theFASB issued SFAS No. 107-1 and APB 28-1, “Interim Disclosures about FairValue of Financial Instruments”.  Thedisclosures require publically traded companies to disclose the fair value offinancial instruments in interim periods previously required in annualfinancial statements.  These FASB’s areeffective for interim and annual periods ending after June 15, 2009 andmanagement does not expect this statement to have a material impact on itsconsolidated financial statements.

 

In April 2009, theFASB issued SFAS No. 115-2 and 124-2, “Recognition and Presentation ofOther-Than-Temporary Impairments”.  ThisFASB amends the other-than-temporary impairment guidance in U.S. GAAP for debtsecurities to make the guidance more operational and to improve thepresentation and disclosure of other-than-

 

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**SKAGITSTATE BANCORP, INC. AND SUBSIDIARY**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

temporary impairments ondebt and equity securities in the financial statements.  These FASB’s are effective for interim andannual periods ending after June 15, 2009 and management is currentlyevaluating the effect that the FSPs may have on Bancorp’s financial statements.

 

In April 2009, theFASB issued FAS 157-4, “Determining Fair Value When the Volume and Level ofActivity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly”. This FASB provides additional guidance for estimating fair value inaccordance with FASB Statement No. 157, when the volume and level ofactivity for the asset or liability have significantly decreased.  This FASB also includes guidance onidentifying circumstances that indicate a transaction in not orderly.  These FASB’s are effective for interim andannual periods ending after June 15, 2009 and management is currentlyevaluating the effect that the FASB’s may have on Bancorp’s financialstatements.

 

**Item 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion shouldbe read in conjunction with the consolidated financial statements and notesthereto presented elsewhere in this report. For additional information, refer to the financial statements andfootnotes for the year ended December 31, 2008 in the Annual Report on Form 10-K.*

 

**FORWARDLOOKING STATEMENTS**

** **

This Form 10Q maycontain forward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995.  Theseforward-looking statements include, but are not limited to, statements aboutmanagement’s plans, objectives, expectations and intentions that are nothistorical facts, and other statements identified by words such as “expects,” “anticipates,”“intends,” “plans,” “believes,” “should,” “projects,” “seeks,” “estimates” orwords of similar meaning. These forward-looking statements are based on currentbeliefs and expectations of management and are inherently subject tosignificant business, economic and competitive uncertainties and contingencies,many of which are beyond Bancorp’s control. In addition, these forward-lookingstatements are subject to assumptions with respect to future businessstrategies and decisions that are subject to change. The following factors,among others, could cause actual results to differ materially from theanticipated results or other expectations in the forward-looking statements,including those set forth in this Form 10-Q, or the documents incorporatedby reference:

 

·              the risks associated with lending and potentialadverse changes in credit quality;

·              increased loan delinquency rates;

·              the risks presented by a continued economic slowdown,which could adversely affect credit quality, loan collateral values, investmentvalues, liquidity levels, and loan originations;

·              changes in market interest rates, which couldadversely affect our net interest income and profitability;

·              legislative or regulatory changes that adverselyaffect our business or our ability to complete pending or prospective futureacquisitions;

·              reduced demand for banking products and services;

·              competition from other financial services companies inour markets; and

·              Bancorp’s success in managing risks involved in theforegoing.

 

Additional factors thatcould cause actual results to differ materially from those expressed in theforward-looking statements are discussed in Risk Factors in Item 1A. Pleasetake into account that forward-looking statements speak only as of the date ofthis Form 10-Q or documents incorporated by reference. Bancorp does notundertake any obligation to publicly correct or update any forward-lookingstatement if we later become aware that it is not likely to be achieved.

 

**BUSINESS**

 

Skagit State Bancorp, Inc.is a bank holding company with one wholly owned subsidiary - Skagit State Bank(collectively, “Company” or “Bancorp”). Skagit State Bank began operations in 1958 and is headquartered inBurlington (Skagit County), Washington. The Bank provides a full range of banking services and products to bothbusinesses and individuals through 12 full service banking offices located inSkagit, Snohomish and Whatcom counties.

 

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**OVERVIEW**

 

Net income was $1.2million and $1.9 million for the three months ended March 31, 2009 and2008, with diluted earnings per share at $2.03 and $2.83, respectively.  The decrease in net income was resultedprimarily from a $450,000 increase in provision for loan losses and $475,000increase in noninterest expenses.

 

Annualized return onaverage assets was 0.85 percent and 1.30 percent for the three months ending March 31,2009, and 2008, respectively.  Annualizedreturn on average equity was 7.67 percent and 10.78 percent for the threemonths ending March 31, 2009 and 2008, respectively.

 

Total assets increased to$571.6 million at March 31, 2009, compared to $566.9 million at December 31,2008.  The increase was primarily due todeposit growth of $22.1 million.  Netloans decreased by $10.5 million or 2.7 percent to $383.3 million at March 31,2009, compared to $393.8 million at December 31, 2008. This decrease wasprimarily in commercial and agricultural loans.

 

**RESULTS OF OPERATIONS**

 

Bancorp’s results ofoperations are dependent to a large degree on net interest income, operatingefficiency and the level of the provision for loan losses. Bancorp’s operationsare sensitive to interest rate changes and the resulting impact on net interestincome. In addition, changes in net interest income are influenced by thevolume of assets and liabilities and the rates earned and paid respectively.  Bancorp generates non-interest incomeprimarily through service charges and other deposit related fees. Bancorp’snon-interest expenses consist primarily of salaries and employee benefitsexpense, bank premises and equipment expenses and other operating expenses.

 

**NET INTEREST INCOME**Net interest income is Bancorp’sprincipal source of revenue and is comprised of interest income on earningsassets (loans and investment securities) less interest expense oninterest-bearing liabilities (deposits and borrowings). Interest income andexpense are affected significantly by general economic conditions, particularlychanges in market interest rates, and by government policies and the actions ofregulatory authorities.

 

Net interest income was$5.4 million and $5.5 million for the three months ended March 31, 2009,and 2008.  The net interest margin is netinterest income expressed as a percent of average interest-earning assets. Netinterest margin is influenced by the level and relative mix of interest-earningassets and interest-bearing liabilities as well as levels of non-interestbearing liabilities.  For the threemonths ended March 31, 2009, the net interest margin was 4.13 percentcompared to 3.98 percent for the like period in 2008. The increase wasprimarily a result of the more rapid decrease in the cost of funds compared tothe yield on interest-earning assets. Also, contributing to the increase in net interest margin for the threemonths in 2009 was $100,000 in interest recoveries from two loan relationshipsduring 2009.  This recovery contributed 8basis points to the net interest margin for the three months ended March 31,2009.

 

*Interest-earning assets*

 

The largest component ofinterest income is interest earned on loans. Total loan interest income decreased to $5.9 million for the threemonths ended March 31, 2009 compared to $6.4 million for the like periodin 2008.  This decrease was primarily aresult of declining interest rates during 2008 which decreased the yield earnedon loans from 7.33 percent to 6.14 percent. Partially offsetting the decrease in yield was a $37.6 million increasein the average balance of loans for the three months ended March 31, 2009compared to the same time period in 2008.

 

Interest earned oninvestments, interest-bearing bank balances and federal funds sold decreased$721,000 for the quarter ended March 31, 2009 compared to the like periodin 2008. Within the total, interest on federal funds sold and interest-earningbank balances decreased $241,000 and interest on investments decreased by $480,000.  For federal funds sold and interest-earningbank balances this was the result of a 323 basis point decrease in yield and a$24.4 million decrease in the average balance. For investments, the decrease was the result of a 32 basis pointdecrease in yield and a $33.1 million decrease in the average balance.

 

*Interest- bearing liabilities*

 

Interest expensedecreased to $1.8 million from $3.0 million for the three months ended March 31,2009 and 2008, respectively. This decrease was a result of a 105 basis pointbasis point decrease in the cost of funds and a decrease in the average balanceof interest bearing liabilities to $429.3 million from $438.4 million for thethree months ended March 31, 2009 compared to 2008. The majority of ourdeposits are short term and re-price within a twelve month period.

 

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The following tablespresent information regarding average balances of assets and liabilities aswell as the total amounts of interest income from average interest-earningassets and interest expense on average interest-bearing liabilities, resultingyield and cost ratios, interest rate spread and net interest margin. Tax exemptsecurities, included in investment securities below are stated at theircontractual interest rate. Loan fees of $223,000 and $261,000 for the threemonths ended March 31, 2009, and 2008 respectively, are included ininterest earned on loans. Non-accruing loans have been included in thecomputation of average loans.

 

**CondensedAverage Balance Sheets**

(dollars in thousands except share data)

** **
| ** **                                              | ** ** | **2009**    | ** ** | ** **   | ** ** | **2008**   | ** ** | ** **  | ** ** |
|---------------------------------------------------------|------------|-------------|------------|--------------|------------|------------|------------|-------------|------------|
| ** **                                              | ** ** | **Average** | ** ** | ** **   | ** ** | **Yield**  | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield** | ** ** |
| **Three months ended March 31,**                   | ** ** | **Balance** | ** ** | **Interest** | ** ** | **/Cost**  | ** ** | **Balance** | ** ** | **Interest** | ** ** | **/Cost** | ** ** |
| **Assets**                                              |       |        |       |         |       |       |       |        |       |   |   |   |   |
| Federal funds  sold and interest- bearing bank balances |       | $           | 4,948      |         | $          | 1          |       | 0.08        | %          | $ | 29,305 |   | $ | 242 |   | 3.31 | % |
| Taxable  investment securities                          |       | 90,056      |       | 1,070        |       | 4.82       |       | 120,692     |       | 1,506 |   | 5.00 |   |
| Tax exempt securities                                   |       | 48,255      |       | 281          |       | 2.36       |       | 50,726      |       | 325 |   | 2.57 |   |
| Loans                                                   |       | 390,280     |       | 5,907        |       | 6.14       |       | 352,648     |       | 6,441 |   | 7.33 |   |
| Total  interest-earning assets                          |       | 533,539     |       | 7,259        |       | 5.52       | %          | 553,371     |       | 8,514 |   | 6.17 | % |
| Non-interest  earning assets                            |       | 32,234      |       |         |       |       |       | 33,251      |       |   |   |   |   |
| Total assets                                            |       | $           | 565,773    |         |       |       |       |        | $          | 586,622 |   |   |   |   |   |
| ** **                                              |       |        |       |         |       |       |       |        |       |   |   |   |   |
| **Liabilities  and Stockholders’ Equity**          | ** ** | ** **  | ** ** | ** **   | ** ** | ** ** | ** ** | ** **  |       |   |   |   |   |
| Interest-bearing  demand                                |       | $           | 87,139     |         | $          | 71         |       | 0.33        | %          | $ | 90,051 |   | $ | 137 |   | 0.61 | % |
| Savings and  money market                               |       | 152,200     |       | 377          |       | 1.00       |       | 144,031     |       | 524 |   | 1.46 |   |
| Certificates of  deposit                                |       | 166,056     |       | 1,286        |       | 3.14       |       | 188,761     |       | 2,240 |   | 4.76 |   |
| Total  interest-bearing deposits                        |       | 405,395     |       | 1,734        |       | 1.73       |       | 422,843     |       | 2,901 |   | 2.78 |   |
| Other borrowings                                        |       | 23,931      |       | 89           |       | 1.51       |       | 15,564      |       | 124 |   | 3.20 |   |
| Total  interest-bearing deposits & liabilities      |       | 429,326     |       | 1,823        |       | 1.72       | %          | 438,407     |       | 3,025 |   | 2.77 | % |
| Non  interest-bearing demand deposits                   |       | 71,809      |       |         |       |       |       | 74,488      |       |   |   |   |   |
| Other  non-interest-bearing liabilities                 |       | 2,128       |       |         |       |       |       | 3,212       |       |   |   |   |   |
| Total  liabilities                                      |       | 503,263     |       |         |       |       |       | 516,107     |       |   |   |   |   |
| Stockholders’  equity                              |       | 62,510      |       |         |       |       |       | 70,515      |       |   |   |   |   |
| Total  liabilities and stockholders equity              |       | $           | 565,773    |         |       |       |       |        | $          | 586,622 |   |   |   |   |   |
| Net interest  income                                    |       |        |       | $            | 5,436      |       |       |        |       |   | $ | 5,489 |   |   |   |
| Interest rate  spread                                   |       |        |       |         |       | 3.80       | %          |        |       |   |   | 3.40 | % |
| Net interest  margin                                    |       |        |       |         |       | 4.13       | %          |        |       |   |   | 3.98 | % |

 

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The following table setsforth information on changes in net interest income which are attributable tochanges in interest rates and changes in volume for the periods indicated.  Changes attributable to the combined effectof volume and interest rates have been allocated proportionately.

 

**Analysis of Changes in InterestIncome and Expense Due to Changes in Volume and Rate**

(dollars in thousands except share data)

 
| ** **                                                   | ** ** | **Increase (Decrease) Due to** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------|------------|
| **Three months ended March 31, 2009 vs. 2008**          | ** ** | **Volume**                     | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest-Earning  Assets**                                 | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal funds  sold and interest-bearing bank balances       |       | $                              | (111       | ) | $ | (130 | ) | $ | (241 | ) |
| Investment  securities                                       |       | (397                           | )          | (83 | ) | (480 | ) |
| Loans                                                        |       | 3,113                          |       | (3,647 | ) | (534 | ) |
| Total net change  in income on interest earning assets       |       | 2,605                          |       | (3,860 | ) | (1,255 | ) |
| **Interest-Bearing  Liabilities**                            |       |                           |       |   |   |   |   |
| Deposits                                                     |       | (89                            | )          | (1,078 | ) | (1,167 | ) |
| Other borrowings                                             |       | 247                            |       | (282 | ) | (35 | ) |
| Total net change  in expense on interest-bearing liabilities |       | 158                            |       | (1,360 | ) | (1,202 | ) |
| Net change in  net interest income                           |       | $                              | 2,447      |   | $ | (2,500 | ) | $ | (53 | ) |

 

***PROVISIONFOR LOAN LOSSES***Theprovision for loan losses was $450,000 for the quarter ended March 31,2009 compared to no provision for loan losses for the like period in 2008. Theincrease in provision is primarily attributable to the deteriorating economy,internal downgrades of credit within the loan portfolio and the growth in loansyear over year. For the quarter ended March 31, 2009 and 2008, respectively,net charge-offs were $263,000 and $437,000.

 

The provision for loanlosses is highly dependent upon Bancorp’s ability to manage asset quality andcontrol the level of net charge-offs through prudent underwriting standards. Inthe future, continued growth of the loan portfolio may or further declines ineconomic conditions could increase future provisions for loan losses and impactBancorp’s net income. Additional discussion on loan quality and the allowancefor loan losses is provided under Allowance for Loan Losses and Asset Quality.

 

**NON-INTEREST INCOME**Non-interest income, which consistsprimarily of fees and service charges on deposits and other income, was$960,000 for the three months ended March 31, 2009 compared to $1.0million for the same time period in 2008.

 

**NON-INTEREST EXPENSE**Non-interest expense was $4.5 million and$4.1 million for the three months ended March 31, 2009 and 2008,respectively.  This increase wasprimarily a result of increased FDIC insurance premium costs, costs related to otherreal estate owned and a 3.1 percent increase in salary expense.

 

The efficiency ratio iscomputed by dividing total operating expenses by non-interest income and netinterest income. An increase in the efficiency ratio indicates that moreresources are being utilized to generate the same or greater volume of income.The efficiency ratio for the quarter ended March 31, 2009 was 71.0 percentand 62.5 percent compared to the same time period in 2008. The increase from2008 was primarily due to increases in non-interest expenses.

 

**INCOME TAX EXPENSE**Income tax expense for the quarter ended March 31,2009 was $210,000 compared to $539,000 the quarter ended March 31,2008.  Bancorp’s effective tax rates were14.9 percent and 22.1 percent for the quarter ended March 31, 2009 and2008, respectively. The effective tax rate is lower than the federal statutoryrate due to tax credits from tax-exempt bonds and tax-exempt interest frommunicipal bonds and loans.  As of March 31,2009 and 2008, Bancorp had $48.9 million and $50.7 million in tax-exemptsecurities, respectively.

 

**REVIEW OF FINANCIAL CONDITION**

 

Total assets increased to$571.6 million at March 31, 2009 compared to $566.9 million at December 31,2008.  This increase was primarily due toa $22.1 million increase in deposits to $491.6 million. Total loans decreased$10.5 million to $383.3 million during the same time period.

 

**INVESTMENTSECURITIES, INTEREST-BEARING BANK BALANCES AND FEDERAL FUNDS SOLD **Total investment securities, including federal fundssold and interest-bearing bank balances increased to $156.4 

 

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million at March 31,2009 compared to $139.2 million at December 31, 2008. Interest-bearingaccount balances at the Federal Reserve increased to $18.6 million at March 31,2009. This increase resulted primarily from the growth in deposits. Theavailable-for-sale investment portfolio is comprised of 59.4 percent GovernmentSponsored Agencies and Government Agencies mortgage-backed pass-throughsecurities, 11.3 percent of state and municipals and 29.3 percent of GovernmentSponsored Agencies and Government Agencies securities.  The held-to-maturity portfolio isconcentrated in municipal securities and Qualified Zone Academy Bonds. Therewere $1.3 million of security purchases in the first three months of 2009 whilematurities, calls and principal pay-downs totaled $2.9 million.

 

The fair values forinvestment securities are based on quoted market prices, where available. Ifquoted market values are not available, fair values are based on quoted marketprices of comparable instruments. The fair values of fixed rate warrants andqualified zone academy bonds, included in state and political subdivisionsinvestment securities, are estimated using discounted cash flow analysis usinginterest rates currently being offered for warrants of similar terms or thecurrent qualified zone academy bond interest rates.

 

Certain investmentsecurities included in the table below currently have fair values less thanamortized cost and, therefore, contain unrealized losses.  Bancorp has the ability to hold available-forsale investments for a period of time management believes to be sufficient fora market price recovery. Bancorp has evaluated these securities and believesthat the decline in value is temporary, with no permanent sector or issuercredit concerns or impairments.

 

Securitiesclassified as available-for-sale are reported at estimated fair value, withunrealized gains and losses (net of income taxes) reported in accumulated othercomprehensive income, as a separate component of stockholders’ equity.   The following table presents the recordedamounts and fair value of the portfolio of investment securities as of thedates indicated.

 

**Investment Securities Composition**

**March 31, 2009 (dollars inthousands)**

** **
| **AFS Securities**                | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses (less  than 12  months)** | ** ** | **Gross  Unrealized  Losses (12  months or  more)** | ** ** | **Aggregate  Fair Value** | ** ** |
|-----------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------|------------|
| US Government  Agencies           |       | $                   | 28,661     |                         | $          | 676                                                   |       | $                                                   | —     |                      | $          | — |   | $ | 29,337 |   |
| Mortgage-backed-securities        |       | 56,802              |       | 2,730                        |       | —                                                |       | —                                              |       | 59,532                    |       |
| State and  Political subdivisions |       | 11,129              |       | 330                          |       | 65                                                    |       | —                                              |       | 11,394                    |       |
|                              |       | 96,592              |       | 3,736                        |       | 65                                                    |       | —                                              |       | 100,263                   |       |
|                              |       |                |       |                         |       |                                                  |       |                                                |       |                      |       |
| **HTM  Securities**               |       |                |       |                         |       |                                                  |       |                                                |       |                      |       |
| State and  political subdivisions |       | 37,471              |       | 315                          |       | 1,428                                                 |       | 4                                                   |       | 36,354                    |       |
|                              |       | 37,471              |       | 315                          |       | 1,428                                                 |       | 4                                                   |       | 36,354                    |       |
|                              |       |                |       |                         |       |                                                  |       |                                                |       |                      |       |
| Total                             |       | $                   | 134,063    |                         | $          | 4,051                                                 |       | $                                                   | 1,493      |                      | $          | 4 |   | $ | 136,617 |   |

 

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December 31,2008 (dollars in thousands)

 
| **AFS Securities**                | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses (less**

**than 12  months)** | ** ** | **Gross  Unrealized  Losses (12  months or  more)** | ** ** | **Aggregate  Fair Value** | ** ** |
|-----------------------------------|------------|---------------------|------------|------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------|------------|
| US Government  Agencies           |       | $                   | 28,669     |                         | $          | 857                                                       |       | $                                                   | —     |                      | $          | — |   | $ | 29,526 |   |
| Mortgage-backed-securities        |       | 59,316              |       | 2,525                        |       | —                                                    |       | —                                              |       | 61,841                    |       |
| State and  Political subdivisions |       | 11,140              |       | 218                          |       | 78                                                        |       | —                                              |       | 11,280                    |       |
|                              |       | 99,125              |       | 3,600                        |       | 78                                                        |       | —                                              |       | 102,647                   |       |
|                              |       |                |       |                         |       |                                                      |       |                                                |       |                      |       |
| **HTM  Securities**               |       |                |       |                         |       |                                                      |       |                                                |       |                      |       |
| State and  political subdivisions |       | 36,518              |       | 167                          |       | 74                                                        |       | 13                                                  |       | 36,598                    |       |
|                              |       | 36,518              |       | 167                          |       | 74                                                        |       | 13                                                  |       | 36,598                    |       |
|                              |       |                |       |                         |       |                                                      |       |                                                |       |                      |       |
| Total                             |       | $                   | 135,643    |                         | $          | 3,767                                                     |       | $                                                   | 152        |                      | $          | 13 |   | $ | 139,245 |   |

 

**LOANS     **Net loans decreased 2.7 percent to $383.3million at March 31, 2009 compared to $393.8 million at December 31,2008.  Net loans represented 67.0 percentof total assets at March 31, 2009. This decrease was primarily in commercial and agricultural loans.

 

Bancorp concentrates onfive areas of lending: loans to individuals for business purposes, loans forsmall and medium-sized businesses, agricultural loans, loans to commercialenterprises for real estate transactions and consumer purpose loans.  Bancorp’s primary lending activities includecommercial real estate loans, commercial loans which include agricultureproduction loans and consumer purpose loans. Most of Bancorp’s businessactivity is with customers located within Skagit, Snohomish and WhatcomCounties. Bancorp originates commercial, real estate and consumer loans.

 

*Real Estate Loans:* Real estate loans comprise the largestcategory of loans and our real estate portfolio consists of commercial andresidential loans which are secured by property such as office buildings,retail buildings, owner occupied commercial business properties, farm land,timber land, residential land development properties and residentialproperties.  Real estate loanscompromised 69.5% of total loans at March 31, 2009.  The primary repayment source of thesespecific loan types are from the cash flows generated by the occupant business,occupant farm operation, or the sale of properties. While Bancorp hassignificant balances secured by real estate, Bancorp believes that its lendingpolicies and concentration policies are sufficient to minimize risks.  However, economic conditions may affect aborrower’s ability to meet the stated repayment terms. Bancorp is committed toproviding competitive commercial real estate lending within our primary marketareas.

 

*Commercial Loans*: Commercial loans, secured andunsecured, are made primarily to small and medium-sized businesses includingfarms operating within Skagit, Snohomish and Whatcom Counties.  These loans are available for general operatingpurposes, acquisition of fixed assets, purchases of equipment and machinery,financing of inventory and accounts receivable, and other businesspurposes.  Bancorp originates SmallBusiness Administration (SBA) loans, including 504 and 7A loans.

 

*Consumer Loans:* Bancorp makes secured and unsecuredconsumer loans including loans to individuals, primarily customers of Bancorp,for various purposes, including home equity loans, purchases of automobiles,mobile homes, boats and other recreational vehicles, home improvement loans andloans for education and personal investments.

 

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The following tablepresents the composition of loans for Bancorp as of the dates indicated.

 

**Loan Composition**

 
| ** **                                            | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|-------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                            | ** ** | **Amount**              | ** ** | **%**                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| Real estate —  residential & commercial |       | $                       | 255,295    |                       | 65.4       | % | $ | 258,958 |   | 64.7 | % |
| Real estate  construction                             |       | 15,834                  |       | 4.1                        | %          | 17,470 |   | 4.4 | % |
| Commercial,  industrial & agricultural       |       | 70,264                  |       | 18.0                       | %          | 79,819 |   | 19.9 | % |
| Consumer                                              |       | 48,693                  |       | 12.5                       | %          | 44,224 |   | 11.0 | % |
| Total loans                                           |       | 390,086                 |       | 100                        | %          | 400,471 |   | 100 | % |
| Less:                                                 |       |                    |       |                       |       |   |   |   |   |
| Allowance for  loan losses                            |       | 5,637                   |       |                       |       | 5,450 |   |   |   |
| Deferred loan  fees                                   |       | 1,135                   |       |                       |       | 1,246 |   |   |   |
| Net loans                                             |       | $                       | 383,314    |                       |       |   | $ | 393,775 |   |   |   |

 

*Concentrations*

 

As shown in the tableabove, a concentration of loans in commercial and residential real estateexisted as of March 31 2009.  At March 31, 2009, Bancorp’s realestate portfolio included $165.4 million in non-farm non-residential realestate loans of which $97.4 million is owner occupied, $59.5 million in rawland, land development and construction loans and $54.6 million in one-to-fourfamily residential loans.  Further declines in the performance of theeconomy, in general, or further declines in real estate values in our marketareas, in particular, could have an adverse impact on collectability, increasethe level of non-performing loans or have other adverse effects which alone orin aggregate could have a material adverse effect on our business, financialcondition, results of operation and cash flows.

 

**PROVISION AND ALLOWANCE FOR LOANLOSSES**          The allowance for loan losses was $5.6million or 1.47 percent of net loans as of March 31, 2009 compared to $5.5million or 1.38 percent of net loans as of December 31, 2008. Additions tothe allowance, in the form of provisions, are reflected in current operatingresults, while charge-offs to the allowance are made when a loss is determinedto have occurred.

 

The allowance for loanlosses represents management’s best estimate and is maintained at a leveldeemed adequate to provide for estimated future losses and is evaluated on aregular basis and reviewed by the Board of Directors. Bancorp’s evaluation ofthe allowance for loan losses is inherently subjective as it requires estimatesthat are susceptible to significant revision as more information becomesavailable.  The allowance is based uponBancorp’s evaluation of the pertinent factors underlying the quality andcomposition of the loan portfolio, levels and trends in losses anddelinquencies, current economic conditions, specific industry conditions andestimated value of any underlying collateral. The allowance consists ofspecific, general and unallocated components. The general allowance iscalculated by applying a loss percentage factor to the different loan types andthe different risk gradings.  A specificallowance is calculated based on a review of classified or non-performing loansfor specific weaknesses and evaluation of those loans for impairment and lossexposure. The unallocated component of the allowance reflects the margin ofimprecision inherent in the underlying assumptions used in the methodologiesfor estimated specific and general losses in the loan portfolio. Theunallocated allowance provides for other credit losses inherent in our loanportfolio that may not have been contemplated in the general and specificcomponents of the allowance. The unallocated amount is reviewed periodicallybased on trends in credit losses, the results of credit reviews and overalleconomic trends.  See discussion under “Loans”and “Concentrations” for details relating to real estate loan composition.

 

Bancorp has assessed andwill continue to assess on an on-going basis, the impact of the economy on thecredit risk in the loan portfolio. While Bancorp believes that it uses the bestinformation available to determine the allowance for loan losses, unforeseenmarket conditions could result in adjustments to the allowance for loan losses,and net income could be significantly affected if circumstances differsubstantially from the assumptions used in making the final determination.  These factors may result in losses orrecoveries differing significantly from those provided in Bancorp’s financialstatements. The growth of the loan portfolio and a further decline in theperformance of the economy, in general, or a further decline in real estatevalues in our market areas, in particular, could have an adverse impact oncollectability, increase the level of non-performing loans or have otheradverse effects which alone or in aggregate could have a material adverseeffect on our business, financial condition, results of operation and cashflows which may require additional provisions to our allowance for loan losses.The ultimate recovery of loans is susceptible to future market factors beyondBancorp’s control. Additionally, loans are subject to 

 

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examinations by regulators,who, based upon their judgment, may require Bancorp to make additionalprovisions or adjustments to its allowance for loan losses.

 

The following tablepresents the activity in the allowance for loan losses for the dates indicated.

 

**Allowance for Loan Losses Activity**

** **
| **(dollars in thousands)**                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|
| **For the three months ended March 31,**                | ** ** | **2009**   | ** ** | **2008**   | ** ** |
| Allowance as of  beginning of year                           |       | $          | 5,450      |       | $          | 4,535 |   |
| Provision  (benefit) for loan losses                         |       | 450        |       | —     |       |
| Charge-offs                                                  |       | (314       | )          | (540       | )          |
| Recoveries                                                   |       | 51         |       | 103        |       |
| Net  (charge-offs) recoveries                                |       | (263       | )          | (437       | )          |
| Balance at end  of period                                    |       | $          | 5,637      |       | $          | 4,098 |   |
| Ratio of net  charge-offs to average loans during the period |       | 0.27       | %          | 0.50       | %          |
| Ratio of  allowance to net loans at end of period            |       | 1.47       | %          | 1.14       | %          |
| Ratio of  non-performing loans to allowance                  |       | 95.23      | %          | 15.98      | %          |

 

*Credit Risk Management*

 

Bancorp monitors its loanportfolio for potential risk of loss according to an internal risk-gradingsystem and monitors its credit quality to identify potential problem creditsand any loss exposure in a timely manner. Bancorp has assessed and will continue to assess on an on-going basis,the impact of the economy on the credit risk in the loan portfolio. Theextension of credit to individuals and businesses is a significant portion ofBancorp’s principal business activity and requires ongoing portfolio and creditmanagement.  As such, Bancorp hasestablished lending policies and procedures to manage and monitor risk. Theselending policies and procedures include guidelines for concentrations of credit,loan terms, loan-to-value ratios, collateral appraisals and loan approvallimits.

 

***ASSETQUALITY*****    **Non-performing assets consist ofnonaccrual loans, accruing loans past due 90 days or more and other real estateowned. At March 31, 2009, non-performing assets increased to $12.3 millionor 2.15 percent of total assets compared to $11.1 million or 1.96 percent as ofDecember 31, 2008.

 

*Non-accrualand impaired loans*- It is Bancorp’s policy to discontinue the accrual of interest on all loansthat are 90 days or more past due and place them on non-accrual.  When a loan is placed on non-accrual status,any accrued but unpaid interest on that date is removed from interest income.Non-accruing loans were $5.4 million as of March 31, 2009 compared to $5.5million as of December 31, 2008 with $1.2 million transferring into otherreal estate owned during the 2009 quarter.

 

At March 31,2009, impaired loans decreased to $5.4 million compared to $5.5 million at December 31,2008.  As noted above, $1.2 million inimpaired loans were transferred to other real estate owned during the quarterended March 31, 2009. Two credit relationships of $4.7 million, accountedfor 87 percent of impaired loans as of March 31, 2009. As of March 31,2009, a $125,000 specific allocation relating to four credit relationships wasincluded in the allowance for loan losses. All material loan restructuringshave been included in impaired loans.

 

*Otherreal estate owned*—   During 2009, Bancorp foreclosed onone non-accrual credit relationships of $1.2 million which was transferred intoother real estate owned.  As a result, asof March 31, 2009, Bancorp held five foreclosed properties which representfour separate land development projects consisting of finished lots with acarrying balance of $5.7 million, and one other commercial real estate propertywith a carrying balance of $1.2 million for an aggregate of $6.9 million.  To prepare certain properties for sell, theBank capitalized $69,000 in property improvements during the quarter.  Other real estate owned as of December 31,2008 was $5.7 million.  Valuation of theproperty occurs when it is foreclosed upon and at least annuallythereafter.  It is Bancorp’s plan tocontinue its collection efforts and liquidation of collateral, as necessary, torecover as large a portion of the non-accrual assets or other real estate ownedas possible.

 

*Potential problem loans* —  Potential problem loans consist of loans that are currently performing,but for which management have identified as having a well defined weakness orweaknesses. These weaknesses may jeopardize the liquidation of the loan and arecharacterized by the distinct possibility that Bancorp may sustain some loss ifthe 

 

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deficiencies creating theweaknesses are not corrected. These loans are identified through our internalrisk grading processes and management monitors these loans closely and reviewstheir performance on a regular basis.  As of March 31, 2009, Bancorphad classified $15.5 million as potential problem loans.

 

The following tablepresents non-performing asset information related to loans accounted for on anon-accrual basis, accruing loans 90 days or more past due and other realestate owned for the dates indicated.

 

**Non-Performing Assets**

** **
| **(dollars in thousands)**                   | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Non-accrual  loans                           |       | $                       | 5,368      |                       | $          | 5,456 |   |
| Loans past due  90 days or more              |       | —                  |       | —                     |       |
| Total  non-performing loans                  |       | 5,368                   |       | 5,456                      |       |
| Other real  estate owned                     |       | 6,899                   |       | 5,667                      |       |
| Total  non-performing assets                 |       | $                       | 12,267     |                       | $          | 11,123 |   |
| Total  non-performing loans to net loans     |       | 1.40                    | %          | 1.39                       | %          |
| Total  non-performing loans to total assets  |       | 0.94                    | %          | 0.96                       | %          |
| Total non-performing  assets to total assets |       | 2.15                    | %          | 1.96                       | %          |

 

**DEPOSITS          **Bancorp offers a full range of deposit services including checkingaccounts, savings accounts, money market accounts and various types ofcertificates of deposit.  The transactionaccounts and certificates of deposit are tailored to Bancorp’s primary marketarea at rates competitive with those offered in the area. Bancorp offers bothinterest and non-interest bearing checking accounts. In December 2008,Bancorp initiated service through the Certificate of Deposit Account RegistryService (CDARS), which allows us to assist customers in maximizing their FDICinsurance.

 

Total deposits increasedto $491.6 million at March 31, 2009 compared to $469.5 million at December 31,2008.  Within the total, core depositsincreased $12.6 million and time deposits increased $9.5 million.  Core deposits, which consist of non-interestand interest bearing demand accounts, money market accounts, and savingaccounts, represented 65.3% and 65.6% of total deposits at March 31, 2009and December 31, 2008, respectively.

 

The following tablepresents the balance and percent of total deposits in the various categories ofdeposits offered by Bancorp as of the dates indicated.

 

**Deposit Composition**

** **
| ** **                   | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|------------------------------|------------|-------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**   | ** ** | **Amount % of Total**   | ** ** | **Amount %  of Total**     | ** ** |
| Non-interest  bearing demand |       | $                       | 71,696     |                       | 14.6       | % | $ | 75,116 |   | 16.0 | % |
| Interest bearing  demand     |       | 89,951                  |       | 18.3                       | %          | 87,091 |   | 18.5 | % |
| Money market                 |       | 78,716                  |       | 16.0                       | %          | 69,548 |   | 14.8 | % |
| Savings                      |       | 80,618                  |       | 16.4                       | %          | 76,646 |   | 16.3 | % |
| Time                         |       | 165,620                 |       | 33.7                       | %          | 157,127 |   | 33.5 | % |
| Brokered time  deposits      |       | 5,006                   |       | 1.0                        | %          | 4,010 |   | 0.9 | % |
| Total deposits               |       | $                       | 491,607    |                       | 100.0      | % | $ | 469,538 |   | 100.0 | % |

** **

**OTHER BORROWINGS     **Borrowings consist of federal funds purchased,discount window borrowings from the Federal Reserve Bank of San Francisco andsecurities sold under agreements to repurchase. Total borrowings decreased to $15.3 million at March 31, 2009compared to $32.7 million as of December 31, 2008.  Bancorp’s deposit growth during the 2009quarter contributed to the $13.4 million reduction in Federal Funds purchasedto zero as of March 31, 2009.

 

Both securities soldunder repurchase and federal funds purchased are overnight funds or borrowingsthat typically mature within one year. Securities sold under agreement torepurchase decrease or increase primarily based on the availability of fundsand current competitive interest rates offered. Securities sold under agreement to repurchase are collateralized bysecurities with an estimated fair value exceeding the face value of theborrowings.

 

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**CAPITAL RESOURCES**    Stockholders’equity increased to $63.2 million at March 31, 2009 from $61.8 million at December 31,2008.  Book value per share at March 31,2009 was $107.68 compared to a book value of $105.41 at December 31, 2008.

 

Bancorp has only oneclass of stock, which is common stock and at March 31, 2009, there were759 shareholders of record.  Bancorp’sstock is not actively traded or quoted and no broker currently makes a marketin the stock. However, sales and transfers of the stock do occur.  Skagit State Bank acts as transfer agent forBancorp stock.  To facilitate trading,the Bank maintains a list of persons interested (known to the Bank) in eitherpurchasing or selling Bancorp stock. Purchasers and sellers then negotiate their own transactions with theBank acting as transfer agent for those transactions. From time to time,Bancorp repurchases shares of its common stock. The number of shares of stockthat will be repurchased and the price that will be paid is the result of manyfactors including market and economic conditions, the number of sharesavailable, Bancorp’s liquidity and capital needs and regulatory requirements.For the quarter ended March 31, 2009, Bancorp repurchased no shares ofstock and for the quarter ended March 31, 2008, Bancorp repurchased 85,022shares of stock at a price of $180.00 per share.

 

On October 3,2008, Congress approved and the President signed the Emergency EconomicStabilization Act of 2008 (the “Act”). The Troubled Assets Relief Program (“TARP”) is the heart of the Act andprovides the Secretary of the Treasury the authority to purchase troubledassets from eligible financial institutions in an aggregate amount of up to$700 billion.  Under the Act, theTreasury created the Capital Purchase Program (“CPP”) that enables the federalgovernment to purchase equity in participating financial institutions to helprestore credit markets.  In November 2008,Bancorp applied to participate under this program.  In January 2009, Bancorp receivedpreliminary approval from the U.S. Department of Treasury for approximately $14million under the program.  After carefulconsideration by Executive Management and our Board of Directors, we determinednot to accept any of the TARP proceeds. In reaching this decision, the Board also considered the uncertaintiesand constraints (including dividend and stock repurchase restrictions)associated with the TARP.

 

Banking regulationsrequire bank holding companies and banks to maintain certain minimum capitallevels.  As the following table indicatesas of March 31, 2009 and December 31, 2008, Skagit State Bancorp, Inc.and Skagit State Bank both exceeded the well-capitalized requirements.

 

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| ** **                      | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | **To Be Well**        | ** ** |
|---------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | **Capitalized Under** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                      | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **(dollars in thousands)**      | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | **Ratio** | ** ** |
| As of March 31, 2009       |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Total Capital                   |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| (to Risk-Weighted Assets)       |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Skagit State Bank               |       | $66,203    |       | 14.61                 | %          | $36,245               |       | > 8.00             | %          | $45,306               |       | >10.00 | % |
| Skagit State Bancorp, Inc. |       | $66,379    |       | 14.65                 | %          | $36,258               |       | > 8.00             | %          | $45,322               |       | >10.00 | % |
| Tier I Capital                  |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| (to Risk-Weighted Assets)       |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Skagit State Bank               |       | $60,566    |       | 13.37                 | %          | $18,123               |       | > 4.00             | %          | $27,184               |       | > 6.00 | % |
| Skagit State Bancorp, Inc. |       | $60,742    |       | 13.40                 | %          | $18,129               |       | > 4.00             | %          | $27,193               |       | > 6.00 | % |
| Tier I Capital                  |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| (to Average Assets)             |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Skagit State Bank               |       | $60,566    |       | 10.75                 | %          | $22,540               |       | > 4.00             | %          | $28,175               |       | > 5.00 | % |
| Skagit State Bancorp, Inc. |       | $60,742    |       | 10.78                 | %          | $22,540               |       | > 4.00             | %          | $28,175               |       | > 5.00 | % |
|                            |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| As of December 31, 2008    |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Total Capital                   |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| (to Risk-Weighted Assets)       |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Skagit State Bank               |       | $64,776    |       | 14.04                 | %          | $36,901               |       | > 8.00             | %          | $46,127               |       | >10.00 | % |
| Skagit State Bancorp, Inc. |       | $64,926    |       | 14.07                 | %          | $36,913               |       | > 8.00             | %          | $46,141               |       | >10.00 | % |
| Tier I Capital                  |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| (to Risk-Weighted Assets)       |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Skagit State Bank               |       | $59,326    |       | 12.86                 | %          | $18,451               |       | > 4.00             | %          | $27,676               |       | > 6.00 | % |
| Skagit State Bancorp, Inc. |       | $59,476    |       | 12.89                 | %          | $18,456               |       | > 4.00             | %          | $27,684               |       | > 6.00 | % |
| Tier I Capital                  |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| (to Average Assets)             |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Skagit State Bank               |       | $59,326    |       | 10.50                 | %          | $22,596               |       | > 4.00             | %          | $28,245               |       | > 5.00 | % |
| Skagit State Bancorp, Inc. |       | $59,476    |       | 10.53                 | %          | $22,596               |       | > 4.00             | %          | $28,245               |       | > 5.00 | % |

 

**LIQUIDITY**

 

The objective ofliquidity risk management is to ensure that Bancorp has the continuing abilityto maintain cash flows that are adequate to fund operations including day today cash flow requirements of either its depositors wanting to withdraw fundsor to provide for customers credit needs. Bancorp has a formal liquidity policythat establishes liquidity guidelines and the maintenance of contingencyliquidity plans that provide for actions and timely responses to liquiditystress situations.

 

Liquidity is generatedfrom both internal and external sources. The majority of funding comes fromcustomer deposits within the Bank’s market area. In addition, funding needs aremet through loan repayments, investment securities repayments, earnings andother borrowings through pre-approved credit lines. Liquidity may also beobtained by maintaining assets that can be converted to cash with little or norisk of loss.  However, in this turbulentmarket environment, assets may be more difficult to convert to cash with orwithout a loss.

 

As part of the Bank’sliquidity management, the Bank utilizes federal funds purchased to supplementthe primary source of funds, which are deposits.  As a result, there could be fluctuations inthese borrowing balances depending on short-term liquidity and longer-termfinancing needs of the Bank.  As of March 31,2009, Bancorp had approximately $47.0 million in approved unsecured creditlines from various financial institutions and had securities with a marketvalue of $59.5 million pledged as collateral for borrowing at the FederalReserve Discount Window.

 

Because the Bank’sprimary sources and uses of funds are deposits and loans, the relationshipbetween net loans and total deposits provides one measure of the Bank’sliquidity.  The Bank’s loan to depositratio decreased to 78.0 percent at March 31, 2009 compared to 83.9 percentat December 31, 2008, as a result of the increase in deposits and thedecrease in loans.

 

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The turmoil in the creditmarkets during the last year did not have a direct impact on Bancorp’sliquidity management practices. Access to our correspondent banks and theFederal Reserve remained open. Management believes that Bancorp’s liquidityposition at March 31, 2009 was adequate to fund ongoing operations.

 

Skagit State Bancorp, Inc.is a separate legal entity from the Bank and must provide for its own liquidity.  Substantially all of Bancorp’s revenues areobtained from dividends declared and paid by the Bank. Skagit State Bank’sability to pay dividends is limited by its earnings, financial condition andcapital requirements, as well as regulatory restrictions.

 

**Item 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

The results of operationsfor financial institutions are largely dependent upon the financial institution’sability to manage market risks which includes interest rate risk.  Interest rate risk refers to the exposure ofearnings and capital arising from changes in interest rates.

 

Bancorp maintains anasset/liability management program which is the responsibility of theAsset/Liability Committee.  The objectiveof asset/liability management is to maximize long-term stockholder returns andto manage, protect and stabilize Bancorp’s net interest income from undueinterest rate risk through various interest rate cycles within the constraintsof credit quality, interest rate risk policies, levels of capital and adequatelevels of liquidity.  The committee meetsto monitor the composition of the balance, to review projected earnings trends,and to formulate strategies consistent with these objectives for liquidity,interest rate risk, and capital adequacy.

 

Bancorp believes thatthere have not been any material changes about Bancorp’s market risk from theinformation that was provided in the Form 10-K for the year ended December 31,2008.

 

# **Item 4T.                  CONTROLS AND PROCEDURES**

# ** **

Evaluation of DisclosureControls and Procedures

 

Bancorp’s Chief ExecutiveOfficer and Chief Financial Officer have reviewed and evaluated theeffectiveness of our disclosure controls and procedures, required by ExchangeAct Rules 13(a) - 15(b), as of the end of the period covered by thisquarterly report.  Based on thatevaluation, the Chief Executive Officer and Chief Financial Officer haveconcluded that Bancorp’s current disclosure controls and procedures areeffective and timely, providing them with material information relating toBancorp required to be disclosed in the reports we file or submit under theExchange Act.

 

Changes in InternalControls

 

There have not been anysignificant changes in our internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of theirevaluation.  Bancorp did not identify norimplement any corrective actions with regard to any significant deficiencies ormaterial weaknesses in its internal controls.

 

**PART II-               OTHER INFORMATION**

 

**Item 1.                    LegalProceedings**

 

From time to time,Bancorp may be a plaintiff and/or defendant in certain claims and legal actionsarising in the ordinary course of commercial banking involving real estatelending transactions and other ordinary routine litigation incidental to thebusiness of Bancorp.  Bancorp is not aparty to any pending legal proceedings that Bancorp believes would have amaterial adverse effect on the financial condition of Bancorp.

 

**Item 1A. RiskFactors**

 

Thereare certain risks inherent to Bancorp’s business.  The material risk and uncertainties thatmanagement believes affect Bancorp are described below.  Although we have risk management policies,procedures and verification procedures in place, additional risks anduncertainties that management is not aware of or focused on or that managementcurrently deems immaterial may also impair Bancorp’s business operations.  If any of the following risks actually occur,our financial condition and results of operations could be materially andadversely affected.

 

**Fluctuatinginterest rates can adversely affect Bancorp’s profitability**

 

Bancorp’s profitabilityis dependent to a large extent upon net interest income. Earnings and cashflows are largely dependent upon our net interest income.  Net interest income is the difference (or “spread”)between the interest earned on loans, securities and other interest-earningassets and Bancorp’s cost of funds, primarily interest expense on deposits andborrowings. Interest rates are highly sensitive to many factors that are beyondour control including, but not limited to, general economic conditions,policies of various governmental and regulatory agencies. Changes in monetarypolicy, including changes in interest rates, impact the level of loans,deposits and investments, the credit 

 

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profile of existing loansand the rates received on loans and investment securities and the rates paid ondeposits and borrowings. If the interest paid on deposits increases at a fasterrate than the interest received on loans and investment securities, Bancorp’snet interest income, and therefore earnings could be adversely affected.  Earnings could also be adversely affected ifinterest received on loans and investments decrease faster than interest paidon deposits.

 

**Bancorp’s concentration in realestate loans could adversely affect Bancorp’s earnings in an economic downturn.**

 

Real estate loanscomprise the largest category of loans and represent 69.5 percent of Bancorp’stotal loans.  Our real estate portfolioconsists of commercial and residential lending. These loans are secured by property such as office buildings, commercialbusiness properties, healthcare buildings, agricultural land, timber land andresidential properties.  Commercial andcommercial real estate loans generally are viewed as having more risk ofdefault than residential real estate loans or certain other types of loans orinvestments.  Typically, these types ofloans are larger than residential real estate loans and other loans.  Because the loan portfolio contains a numberof commercial real estate loans with relatively large balances, thedeterioration of one or a few of these loans may cause a significant increasein nonperforming loans.  An increase innonperforming loans could result in a loss of earnings from these loans, anincrease in the provision for loan losses or an increase in loan charge-offs,which could have an adverse impact on our results of operations and financialcondition.

 

**There hasbeen an economic downturn throughout the country, particularly in the housingand commercial real estate sectors. While the Pacific Northwest economy typically lags the national economy,the effects of the economic downturn are now significantly impacting our marketarea.  Further downturn in the marketareas we serve may cause us to have lower earnings and could increase ourcredit risk associated with our loan portfolio, as the collateral securingthose loans may decrease in value.  Acontinued downturn in the local economy could have a material adverse effect onboth the ability of borrowers to repay loans, as well as the value of the realproperty held as collateral. **Substantially all ofour loans are to businesses and individuals in Skagit, Snohomish or WhatcomCounties and any decline in the economy of this market area could impact usadversely.  As a lender, we are exposedto the risk that our customers will be unable to repay their loans inaccordance with their terms, and that any collateral securing the payment oftheir loans may not be sufficient to assure repayment.

** **

**Our allowance for loan losses maynot be adequate to cover actual loan losses, which could adversely affect ourearnings.**

 

Bancorp maintains anallowance for loan losses in an amount that we believe is adequate to providefor losses inherent in the portfolio.  While we strive to carefullymanage and monitor credit quality and to identify loans that may becomenonperforming, at any time there are loans included in the portfolio that willresult in losses, but that have not been identified as nonperforming orpotential problem loans.  By managing our credit quality, we attemptto identify deteriorating loans before they become nonperforming assets andadjust the loan loss reserve accordingly.  However, because futureevents are uncertain, and if the economy continues to deteriorate, there may beloans that deteriorate to a nonperforming status in an accelerated timeframe.  As a result, future additions to the allowance may benecessary.  Because the loan portfolio contains a number of loanswith relatively large balances, the deterioration of one or a few of theseloans may cause a significant increase in nonperforming loans, requiring anincrease to the loan loss allowance.  Additionally, futuresignificant additions to the allowance may be required based on changes in themix of loans comprising the portfolio, changes in the financial condition ofborrowers, such as may result from changes in economic conditions, or as aresult of incorrect assumptions by management in determining theallowance.  Additionally, banking regulators, as an integral part oftheir supervisory function, periodically review our loan portfolio and theadequacy of our allowance for loan losses.  These regulatory agenciesmay require us to recognize further loan loss provisions or charge-offs basedupon their judgments, which may be different from ours.  Any increasein the allowance for loan losses could have a negative effect on our financialcondition and results of operation.

 

**Acontinued tightening of the credit markets may make it difficult to obtainadequate funding for loan growth, which could adversely affect our earnings.**

 

A continued tightening ofthe credit market and the inability to obtain or retain adequate money to fundcontinued loan growth may negatively affect our asset growth and liquidityposition and, therefore, our earnings capability.  In addition to coredeposit growth, maturity of investment securities and loan payments, Bancorpalso relies on alternative funding sources through correspondent banking, andborrowing lines with the Federal Reserve Bank to fund loans.  In the event the current economic downturncontinues, particularly in the housing market, these 

 

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resources could benegatively affected, both as to price and availability, which would limit andor raise the cost of the funds available to Bancorp.

 

**Competitionin our market area may limit Bancorp’s future success**

 

Commercial banking is ahighly competitive business.  Bancorpcompetes with other commercial banks, savings and loan associations, creditunions and finance companies operating in our market area.  We are subject to substantial competition forloans and deposits from other financial institutions.  Some of our competitors are not subject tothe same degree of regulation and restriction as we are.  Some of our competitors have greaterfinancial resources than we do.  Wecompete for funds with other financial institutions that, in most cases, arelarger and able to provide a greater variety of services than we do and thusmay obtain deposits at lower rates of interest. If we are unable to effectively compete in our market area, our businessand results of operations could be adversely affected.

 

**We couldfind it difficult to attract and retain skilled employees**

 

Competitionfor skilled employees in some areas can be intense and we may not be able tohire or retain the key employees we want or need.  As our success, in large part, is due to ourability to attract and retain key employees, the loss of key employees or if weare unable to attract key employees, could adversely affect our business

 

**Wecannot predict the effect of recently enacted and pending federal legislation.**

 

On October 3, 2008,Congress enacted the Emergency Economic Stabilization Act of 2008 (“EESA”),which provides the United States Treasury Department (“Treasury”) with broadauthority to implement action intended to help restore stability and liquidityto the US financial markets. Pursuant to the EESA, the Treasury has the abilityto purchase or insure up to $700 billion in troubled assets held by financialinstitutions under the Troubled Asset Relief Program (“TARP”) under variousprograms. On October 14, 2008, the Treasury announced it would initiallypurchase equity stakes in financial institutions under a Capital PurchaseProgram (the “CPP”) of up to $350 billion of the $700 billion authorized underthe TARP legislation. The CPP provides direct equity investment of perpetualpreferred stock by the Treasury in qualified financial institutions. The EESAalso increases the amount of deposit account insurance coverage from $100,000to $250,000 effective until December 31, 2009. In early 2009, Treasuryalso announced the Financial Stability Plan which, among other things, providesa new capital program called the Capital Assistance Program, establishes apublic-private investment fund for the purchase of troubled assets and expandsthe Term Asset-Backed Securities Loan Facility. The full effect of this broadlegislation on the national economy and financial institutions, particularly onmid-sized institutions like the Company, cannot now be predicted.

 

**Our ability to access markets forfunding and acquire and retain customers could be adversely affected to theextent the financial service industry’s reputation is damaged.**

 

Reputation risk is therisk to liquidity, earnings and capital arising from negative publicityregarding the financial services industry. The financial services industry continues to be featured in negativeheadlines about the global and national credit crisis and the resultingstabilization legislation enacted by the U.S. federal government.  These reports can be damaging to the industry’simage and potentially erode consumer confidence in insured financialinstitutions, such as our banking subsidiary.

 

**The FDIChas increased insurance premiums to rebuild and maintain the federal depositinsurance fund and we may separately incur state statutory assessments in thefuture.**

 

**Basedon recent events and the state of the economy, the FDIC has increased federaldeposit insurance premiums beginning in the first quarter of 2009.  The increase of these premiums will add toour cost of operations and could have a significant impact on the Company.  Depending on any future losses that the FDICinsurance fund may suffer due to failed institutions, there can be no assurancethat there will not be additional significant premium increases in order toreplenish the fund.**

** **

On February 27, 2009the FDIC issued a press release announcing a special Deposit Insurance Fundassessment of 20 basis points on insured institutions and granting the FDIC theauthority to impose an additional assessment after June 30, 2009 of up to10 basis points if necessary.  Theassessment will be calculated on June 30, 2009 deposit balances andcollected on September 30, 2009. Based upon the Company’s March 31, 2009 deposits subject to FDICinsurance assessments, the special assessment would be approximately $1.0million.  Subject to the passing of 

 

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certain legislation thatwould allow the FDIC increased borrowing from the Treasury, the FDIC hasindicated that it would reduce the special assessment by half; however, therecan be no assurance that this will occur.

 

Further,under Washington state laws, Bancorp may incur additional costs if one or moreWashington state banks that hold public deposits fail, since, as a public depositary,we are subject to Washington statutory pro-rata assessments to cover any netlosses in public deposits not otherwise covered by federal deposit insurance orother means.

 

**We operate in a highly regulated environment and may be adverselyaffected by changes in federal state and local laws and regulations.**

 

We are subject to extensive regulation, supervision and examination by federal and state banking authorities.  Any change in applicable regulations or federal, state or local legislation could have a substantial impact on us and our operations.  Additional legislation and regulations that could significantly affect our powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on our financial condition and results of operations.  Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws or regulations by financial institutions and holding companies in the performance of their supervisory and enforcement duties.  These powers recently have been utilized more frequently due to the serious national, regional and local economic conditions we are facing.  The exercise of regulatory authority may have a negative impact on our financial condition and results of operations.

 

**There islittle trading activity in Bancorp’s stock**

 

There is no active marketfor our outstanding shares, and it is unlikely that an established market forour shares will develop in the near future. We presently do not intend to seek listing of the shares on anysecurities exchange, or quotation on the NASDAQ Stock Market, Inc.. It isnot known whether significant trading activity will take place for severalyears, if at all.  Accordingly, ourshares should be considered as a long-term investment.

** **

**There are restrictions on changes in control ofBancorp that could decrease our shareholders’ chance to realize a premium ontheir shares.**

** **

Provisions in ourArticles of Incorporation include a staggered Board of Directors, andnon-monetary factor provisions and an affirmative vote of two-thirds of shares(entitled to be counted) to approve an interested shareholder transaction, anyor all of which could have the effect of hindering, delaying or preventing atakeover bid.

 
| **Item 2.** |   | **Unregistered  Sales of Equity Securities and Use of Proceeds** |
|-------------|--------|------------------------------------------------------------------|
|        | None   |                                                             |
|        |   |                                                             |
| **Item 3.** |   | **Defaults  Upon Senior Securities**                             |
|        | None   |                                                             |
|        |   |                                                             |
| **Item 4.** |   | **Submission  of Matters to a Vote of Security Holders**         |
|        | None   |                                                             |
|        |   |                                                             |
| **Item 5.** |   | **Other  Information**                                           |
|        | None   |                                                             |
|        |   |                                                             |
| **Item 6.** |   | **Exhibits**                                                     |
|        |   | (a)                                                              | Exhibits. |

 
| 31.1 |   | Certification of CEO,  Pursuant to Exchange Act Rule 13a-14 (as adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002)                 |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certification Chief  Financial Officer Pursuant to Exchange Act Rule 13a-14 (as adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002) |
| 32   |   | Certifications Pursuant  to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                           |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   |              | SKAGIT STATE BANCORP,  INC. |
|--------|-------------------|-----------------------------|
|   |              | (Registrant)                |
|   |              |                        |
|   |              |                        |
| Dated: | May 14, 2009 |                        | /s/ Cheryl R. Bishop |
|   |              |                        | Cheryl R. Bishop |
|   |              |                        | Chief Executive Officer |
|   |              |                        |   |
|   |              |                        |   |
| Dated: | May 14, 2009 |                        | /s/ Carla F. Tucker |
|   |              | Carla F. Tucker             |
|   |              | Executive  Vice-President   |
|   |              | Chief Financial Officer     |

 

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