Management's Discussion and Analysis and other portions of this report on Form 10-Q contain certain forward-looking statements concerning our future operations. Management desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement so that we may rely on the protections of such safe harbor with respect to all forward-looking statements contained in this report and our Annual Report on form 10-K for the year ended December 31, 2007. We have used forward-looking statements to describe future plans and strategies, including expectations of our future financial results. Our ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could cause actual results to differ materially include, but are not limited to, the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; fluctuations in the value of financial assets and liabilities recorded at fair value, including any future impairment of goodwill; results of examinations of the Company by the Federal Reserve and the Banks by the FDIC, the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses or write-down assets: fluctuations in agricultural commodity prices, crop yields and weather conditions; our ability to control operating costs and expenses; our ability to successfully implement our branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames; our ability to manage loan delinquency rates; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; legislative or regulatory changes that adversely affect our business; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board; war or terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and other risks detailed from time to time in our filings with the Securities and Exchange Commission. We caution readers not to place undue reliance on any forward-looking statements. We do not undertake and specifically disclaim any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for 2008 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us.

As used throughout this report, the terms "we", "our", "us", or the "Company" refer to Banner Corporation and its consolidated subsidiaries.

Executive Overview

We are a bank holding company incorporated in the State of Washington. We are primarily engaged in the business of planning, directing and coordinating the business activities of our wholly owned subsidiaries, Banner Bank and, subsequent to May 1, 2007, Islanders Bank. Banner Bank is a Washington-chartered commercial bank that conducts business from its main office in Walla Walla, Washington and, as of September 30, 2008, its 83 branch offices and 12 loan production offices located in Washington, Oregon and Idaho. Islanders Bank is also a Washington-chartered commercial bank and conducts its business from three locations in San Juan County, Washington. As of September 30, 2008, we had total consolidated assets of $4.7 billion, total loans of $3.9 billion, total deposits of $3.8 billion and total stockholders' equity of $387 million.

Banner Bank is a regional bank which offers a wide variety of commercial banking services and financial products to individuals, businesses and public sector entities in its primary market areas. Islanders Bank is a community bank which offers similar banking services to individuals, businesses and public entities located in the San Juan Islands. The Banks' primary business is that of traditional banking institutions, accepting deposits and originating loans in locations surrounding their offices in portions of Washington, Oregon and Idaho. Banner Bank is also an active participant in the secondary market, engaging in mortgage banking operations largely through the origination and sale of one- to four-family residential loans. Lending activities include commercial business and commercial real estate loans, agriculture business loans, construction and land development loans, one- to four-family residential loans and consumer loans.

Branch expansion has been a significant element in our strategy to grow loans, deposits and customer relationships. Over the past several years, we have invested significantly in expanding our branch and distributions systems with a primary emphasis on expanding our presence in the four largest areas of commerce in the Northwest: the Puget Sound region of Washington and the greater Boise, Idaho, Portland, Oregon, and Spokane, Washington markets. As a result of our aggressive franchise expansion, we have added 18 new branches through acquisitions, opened 28 new branches and relocated eight others since March, 2004. In 2007 alone, we opened ten branches, relocated five others and closed three acquisitions; and in the quarter ended June 30, 2008, we opened two additional branches. In large part because of this expansion activity, we have experienced loan growth of $2.0 billion and deposit growth of $1.9 billion over the last four-year period. The acquisitions and new branches have increased our presence within desirable markets and allow us to better serve existing and future customers. This emphasis on growth has resulted in an elevated level of operating expenses; however, we believe that over time these new branches should help improve profitability by providing lower cost core deposits which will allow us to proportionately reduce higher cost borrowings as a source of funds. We have reached our goal in terms of the number of branches we believe are needed to generate deposit growth sufficient to fund our expected loan growth and produce significant fee generating opportunities. As a result, we do not expect to open any additional branches for the remainder of 2008 and we plan a more moderate pace of branch expansion going forward.

We completed the acquisitions of F&M Bank and San Juan Financial Holding Company effective May 1, 2007, and NCW Community Bank effective October 10, 2007. SJFHC was merged into Banner and its wholly owned subsidiary, Islanders Bank, has continued operations as a subsidiary of Banner. F&M and NCW were merged into Banner Bank upon acquisition and now operate under the Banner Bank name. The

financial results for the quarter ended September 30, 2008 include the assets, liabilities and results of operations for all three of the recently acquired companies.

For the quarter ended September 30, 2008, we had a net loss of $1.0 million, or $0.06 per diluted share, compared to net income of $10.0 million, or $0.64 per diluted share, for the quarter ended September 30, 2007. The current quarter's results were adversely affected by a significant reduction in the fair value of the Company's investment in Fannie Mae and Freddie Mac equity securities, as well as by a substantial provision for loan losses and a narrower net interest margin. The provision for loan losses was $8.0 million for the quarter ended September 30, 2008, an increase of $6.5 million compared to the quarter ended September 30, 2007. The increase in the provision for loan losses in the current quarter reflects an increase in delinquencies, non-performing loans and a higher level of net charge-offs, particularly for loans for the construction of one- to four-family homes and for acquisition and development of land for residential properties. While the provision for loan losses decreased compared to the immediately preceding quarter, housing markets remained weak in many of our primary services areas, resulting in the increase in delinquencies and non-performing assets, deterioration in property values and the need to provide for an elevated level of losses. By contrast, other non-housing related segments of the loan portfolio have performed as expected with only normal levels of credit problems. Still, for the first nine months of 2008, the higher than historical provision for loan losses has been the most significant factor affecting our operating results and, looking forward, we anticipate our credit costs will remain elevated for the next three to five quarters.

In September 2008, the United States Treasury announced a plan to place the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac") into conservatorship under the authority of the Federal Housing Finance Agency. As of June 30, 2008, Banner Corporation owned both common and preferred equity securities issued by Fannie Mae and Freddie Mac with a combined book value of $6.9 million. At September 30, 2008, the fair value of these securities had declined to approximately $569,000. The decrease in the value of these securities was included in the $6.1 million ($3.9 million after tax) net fair value adjustments recorded for the quarter ended September 30, 2008 (see Note 8, Fair Value Accounting and Measurement). The events that led to the significant valuation adjustment for the Fannie Mae and Freddie Mac stock were disappointing and, unlike most fair value adjustments, we do not anticipate a meaningful recovery with respect to the valuation of that stock in future periods. However, our holdings were not disproportionate to our asset size and net worth and the subsequent charge was not threatening to our "well capitalized" status or indicative of our recurring operations. Banner's net operating income, excluding net fair value adjustments (which in the current quarter predominantly reflects the decreased valuation of the Fannie Mae and Freddie Mac equity securities), was $2.9 million, or $0.18 per diluted share, for the quarter ended September 30, 2008, compared to net operating income, excluding fair value adjustments, of $8.0 million, or $0.51 per diluted share, for the quarter ended September 30, 2007.

Aside from the level of loan loss provision (and in the current quarter the significant reduction in the fair value of the Company's investment in Fannie Mae and Freddie Mac equity securities), our operating results depend primarily on our net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of customer deposits, FHLB advances, other borrowings and junior subordinated debentures. Net interest income is primarily a function of our interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balances of interest-earning assets and interest-bearing liabilities. As more fully explained below, our net interest income before provision for loan losses decreased by $3.0 million for the quarter ended September 30, 2008 to $37.6 million as compared to $40.7 million for the same quarter in the prior year, primarily as a result of a contraction in our net interest margin as asset yields have declined sharply over the past twelve months in response to the Federal Reserve's action designed to dramatically lower short-term interest rates. Further, increased delinquencies and the slowdown in the sale and construction of new homes over the year have had an adverse impact on our net interest margin, as well as on the amount of our loan loss provision.

Our net income also is affected by the level of our other income, including deposit service charges, loan origination and servicing fees, and gains and losses on the sale of loans and securities, as well as our operating expenses and income tax provisions. Other operating income, excluding the fair value adjustments, increased by $620,000, or 8%, to $8.1 million for the quarter ended September 30, 2008 from $7.5 million for the quarter ended September 30, 2007, primarily as a result of increased deposit fees and other service charges reflecting growth in our customer base and related payment processing activities. Revenues (net interest income before the provision for loan losses plus other operating income), excluding fair value adjustments, decreased $2.4 million to $45.7 million for the quarter ended September 30, 2008, compared to $48.1 million for the quarter ended September 30, 2007. By contrast, other operating expenses decreased $846,000 to $34.0 million for the quarter ended September 30, 2008 from $34.8 million for the quarter ended September 30, 2007, a decrease of 2%. Most significantly, the decrease in expenses reflects reductions in compensation, information/computer data services and advertising, offset in part by additional occupancy expense, costs associated with problem loan collection activities, charges related to real estate owned and increased deposit insurance expense.

In the quarter ended September 30, 2008, our net income included a net decrease in the valuation of the selected financial assets and liabilities we record at fair value pursuant to the adoption of SFAS No. 159. The fair value adjustment resulted in a decrease of $3.9 million (net after tax), or $0.24 per share (diluted) to net income reported for the quarter ended September 30, 2008. In contrast, the fair value adjustment for the same quarter one year earlier resulted in an increase of $2.0 million (net after tax), or $0.13 per share (diluted). Excluding the net fair value adjustments in each quarter, net income from recurring operations was $2.9 million, or $0.18 per share (diluted), for the quarter ended September 30, 2008, compared to net income from recurring operations of $8.0 million, or $0.51 per share (diluted), for the quarter ended September 30, 2007. Earnings or loss from recurring operations and other earnings information excluding the change in valuation of financial instruments carried at fair value and the goodwill impairment charge recorded in the quarter ended June 30, 2008, represent non-GAAP financial measures. Management has presented these non-GAAP financial measures in this discussion and analysis because it believes that they provide more useful and comparative information to assess trends in our core operations. Where applicable, we have also presented comparable earnings information using GAAP financial measures. The decrease in earnings from recurring operations despite a larger earning asset base primarily reflects the increased loan loss provisioning and narrower net interest margin.

Non-GAAP Measurements (Unaudited):

In our discussion of net earnings, earnings per share and comparisons to prior
periods we use certain non-GAAP financial measures because we believe that they
provide more useful and comparative information to assess trends in the
Company's core operations reflected in the current and comparative financial
statement (in thousands) (rates/ratios annualized).

                                              Quarters Ended        Nine Months Ended
                                               September 30           September 30
                                                2008       2007         2008       2007

NET INCOME (LOSS) under GAAP                $   (991 ) $  9,987   $  (49,462 ) $ 24,911

ADJUSTMENTS FOR CHANGE IN VALUATION OF
FINANCIAL INSTRUMENTS AND GOODWILL
WRITE-OFF
Net change in valuation of financial
instruments carried at fair value              6,056     (3,062 )      4,584     (2,365 )
Goodwill write-off                                --         --       50,000         --
Income tax provision (benefit) related to
above items                                   (2,180 )    1,102       (1,650 )      851
Above items, net of income tax provision
(benefit)                                      3,876     (1,960 )     52,934     (1,514 )

NET INCOME (LOSS) FROM RECURRING OPERATIONS $  2,885      8,027        3,472     23,397

Earnings (Loss) per share EXCLUDING the
effects of change in valuation of financial
instruments carried at fair value and
goodwill write-off
Basic                                       $   0.18   $   0.52   $     0.22   $   1.66
Diluted                                         0.18       0.51         0.22       1.62

Operating performance for the periods
presented excluding the effects of change
in valuation of financial instruments
carried at fair value and goodwill
write-off
Other operating income (Loss) EXCLUDING
change in valuation of financial
instruments carried at fair value and
goodwill write-off/Average assets               0.69 %     0.69 %       0.68 %     0.66 %
Other operating expense EXCLUDING goodwill
write-off/Average assets                        2.91       3.23         3.00       3.13
Efficiency ratio (other operating
expense/revenue) EXCLUDING change in
valuation of financial instruments carried
at fair value and goodwill write-off           74.37      72.38        76.01      70.69
Return (Loss) on average assets EXCLUDING
change in valuation of financial
instruments carried at fair value and
goodwill write-off                              0.25       0.74         0.10       0.80
Return (Loss) on average equity EXCLUDING
change in valuation of financial
instruments carried at fair value and
goodwill write-off                              2.95       7.79         1.10       9.02
Return (Loss) on average tangible equity
EXCLUDING change in valuation of financial
instruments carried at fair value and
goodwill write-off                              3.61      10.74         1.46      11.69

We offer a wide range of loan products to meet the demands of our customers; however, we do not now and have not previously engaged in any sub-prime lending programs. Historically, our lending activities have been primarily directed toward the origination of real estate and commercial loans. Real estate lending activities have been significantly focused on residential construction and first mortgages on owner occupied, one- to four-family residential properties; however, over the past year our origination of construction and land development loans has declined materially. Our total construction and land development loan originations in 2007 were $855 million, which was approximately 36% lower than in the previous year, and this trend has continued as construction and land development loan originations in the first nine months of 2008 totaled $333 million, more than 51% lower than in the same period of 2007. Our lending activities have also included the origination of multifamily and commercial real estate loans. Our commercial business lending has been directed toward meeting the credit and related deposit needs of various small- to medium-sized business and agri-business borrowers operating in our primary market areas. We have also increased our emphasis on consumer lending, although the portion of the loan portfolio invested in consumer loans is still relatively small. While reducing our commitment to construction and residential lending, we expect commercial lending (including commercial real estate, commercial business and agricultural loans) and consumer lending to become increasingly important activities for us.

Deposits, customer retail repurchase agreements and loan repayments are the major sources of our funds for lending and other investment purposes. We compete with other financial institutions and financial intermediaries in attracting deposits. There is strong competition for transaction balances and savings deposits from commercial banks, credit unions and nonbank corporations, such as securities brokerage companies, mutual funds and other diversified companies, some of which have nationwide networks of offices. Much of the focus of our recent branch expansion, relocations and renovation has been directed toward attracting additional deposit customer relationships and balances. The success of our deposit gathering activities is reflected not only in the growth of deposit balances, but also in increases in the level of deposit fees, service charges and other payment processing revenues.

We generally attract deposits from within our primary market areas by offering a broad selection of deposit instruments, including demand checking accounts, negotiable order of withdrawal (NOW) accounts, money market deposit accounts, regular savings accounts, certificates of deposit, cash management services and retirement savings plans. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of deposit accounts, we consider current market interest rates, profitability, matching deposit and loan products, and customer preferences and concerns.

Management's discussion and analysis of results of operations is intended to assist in understanding our financial condition and results of operations. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Selected Notes to the Consolidated Financial Statements contained in Item 1 of this Form 10-Q.

Comparison of Financial Condition at September 30, 2008 and December 31, 2007

General. Total assets increased $158 million, or 4%, from $4.493 billion at December 31, 2007, to $4.650 billion at September 30, 2008. Net loans receivable (gross loans less loans in process, deferred fees and discounts, and allowance for loan losses) increased $177 million, or 5%, from $3.764 billion at December 31, 2007, to $3.940 billion at September 30, 2008. Loan growth was largely due to the growth of $133 million, or 12%, in commercial/multifamily real estate, including construction loans, $116 million, or 26%, in single family residential and $62 million, or 29%, in consumer loans. In addition, agricultural loans increased by $27 million, or 15%, largely because of seasonal disbursements, at September 30, 2008 compared to December 31, 2007. We continue to maintain a significant, although decreasing, investment in construction and land loans; however, production of new loans has declined appreciably over the last seven quarters. As a result of a much slower pace of new originations and continuing payoffs on existing loans, loans to finance the construction of one- to four-family residential real estate decreased by $131 million, or 21%, since December 31, 2007. By contrast, land and development loans remained relatively unchanged, primarily reflecting disbursements on loans originated in earlier periods and a slower pace of sales for these properties than for completed homes. Given the current housing and economic environment, we anticipate that construction and land loan balances will continue to decline for another three to five quarters.

Securities increased $38 million, or 15%, from $256 million at December 31, 2007, to $294 million at September 30, 2008, as purchases, primarily for liquidity and collateral purposes, exceeded sales and repayments. Effective January 1, 2007, we elected to reclassify all our securities available for sale to fair value following our adoption of SFAS No. 159. At September 30, 2008, the fair value of our securities at fair value was $18 million less than their amortized cost. The reduction in the fair value of these securities compared to their amortized cost primarily reflects a decrease of $6.3 million in the value of Fannie Mae and Freddie Mac common and preferred equity securities as well as a net decrease of $10 million in the value of single issuer and pooled trust preferred securities issued by bank holding companies and insurance companies. (See paragraph below and Note 8, Fair Value Accounting and Measurement.) Real estate owned acquired through foreclosures increased $8 million from $2 million at December 31, 2007 to $10 million at September 30, 2008. This included $6 million in land or land development projects and $4 million in single family home construction. (See Asset Quality discussion below.)

Deposits increased $170 million, or 5%, from $3.621 billion at December 31, 2007, to $3.791 billion at September 30, 2008. Non-interest-bearing deposits increased $38 million to $522 million, while interest-bearing deposits increased $133 million, or 4%, to $3.269 billion at September 30, 2008. Increasing core deposits is a key element of our expansion strategy, including the recent and planned additions and renovations of branch locations. Unfortunately, during the first nine months of this year and notwithstanding good growth in the number of accounts and customer relationships, growth in aggregate deposit balances was dampened by meaningful decreases in the average account balances of many of our real estate-related customers, reflecting the slowdown of home sales and other transaction closings. As a result, the aggregate total of transaction and savings accounts, including money market accounts, decreased by $164 million, or 9%, to $1.609 billion. Further, despite internally generated account growth and the effects of the acquisitions, transaction and savings accounts declined to 43% of total deposits at September 30, 2008, compared to 49% a year earlier, as customers have chosen to move more of their balances to certificate accounts and as we have experienced strong growth in public funds balances which primarily are carried in certificate accounts. In the quarter just ended, we also had an increase of $127 million in brokered certificates of deposit, and compared to December 31, 2007 brokered certificates have increased by $179 million. FHLB advances increased $42 million, excluding fair value adjustments, from $167 million at December 31, 2007, to $209 million at September 30, 2008, while other borrowings increased $13 million to $104 million at September 30, 2008. The increase in other borrowings reflects an increase in short-term overnight borrowings of $1 million and a $12 million increase in retail repurchase agreements that are primarily related to customer cash management accounts. Junior subordinated debentures decreased by $12 million since December 31, 2007, reflecting the cumulative fair value adjustments recorded subsequent to the adoption of SFAS 159, as changes in credit market conditions had a particularly significant impact on the valuation of this type of security. However, as a result of the unprecedented disruption of certain financial markets, we determined that there were insufficient transactions or other market indicators during the most recent quarter to support changes in the fair values of our junior subordinated debentures and similar securities in our investment portfolio, including single issuer and pooled trust preferred securities, from their carrying values as of June 30, 2008. (See Note 8, Fair Value Accounting and Measurement.)

During the nine months ended September 30, 2008, we repurchased 613,903 shares (including 8,103 shares as consideration for the exercise of stock options) of Banner Corporation common stock for an aggregate price of approximately $14 . . .