General

Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding the consolidated financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto included in Item 8 of this Annual Report on Form 10-K.

Special Note Regarding Forward-Looking Statements

Management's Discussion and Analysis and Results of Operations and other portions of this Form 10-K contain certain "forward-looking statements" concerning future operations of the Company. Management desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing the Company of the protections of such safe harbor with respect to all "forward-looking statements" contained in this Annual Report. The Company has used "forward-looking statements" to describe future plans and strategies, including its expectations of the Company's future financial results. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the Company's market area and the country as a whole, the ability of the Company to control expenses, deposit flows, demand for mortgages and other loans, real estate values, vacancy rates, results of examinations by banking regulatory agencies, competition, loan delinquency rates, and changes in federal and state regulation. These factors should be considered in evaluating the "forward-looking statements," and undue reliance should not be placed on such statements. The Company does not undertake to update any "forward-looking statement" that may be made on behalf of the Company.

Critical Accounting Policies and Estimates

The Company has established various accounting policies that govern the application of accounting principles generally accepted in the United States of America ("GAAP") in the preparation of the Company's Consolidated Financial Statements. The Company has identified two policies, that as a result of judgments, estimates and assumptions inherent in those policies, are critical to an understanding of the Company's Consolidated Financial Statements. These policies relate to the methodology for the determination of the allowance for loan losses and the valuation of mortgage servicing rights ("MSRs"). These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of Management's Discussion and Analysis contained herein and in the notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. In particular, Note 1 of the Notes to Consolidated Financial Statements, "Summary of Significant Accounting Policies," generally describes the Company's accounting policies. Management believes that the judgments, estimates and assumptions used in the preparation of the Company's Consolidated Financial Statements are appropriate given the factual circumstances at the time. However, given the sensitivity of the Company's Consolidated Financial Statements to these critical policies, the use of other judgments, estimates and assumptions could result in material differences in the Company's results of operations or financial condition.

Allowance for Loan Losses. The allowance for loan losses is maintained at a level sufficient to provide for probable loan losses based on evaluating known and inherent risks in the portfolio. The allowance is based upon management's comprehensive analysis of the pertinent factors underlying the quality of the loan portfolio. These factors include changes in the amount and composition of the loan portfolio, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectibility may not be assured. The detailed analysis includes methods to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The appropriate allowance for loan loss level is estimated based upon factors and trends identified by management at the time the consolidated financial statements are prepared.

Mortgage Servicing Rights. Mortgage servicing rights are capitalized when acquired through the origination of loans that are subsequently sold with servicing rights retained and are amortized to servicing income on loans sold in proportion to and over the period of estimated net servicing income. The value of MSRs at the date of the sale of loans is determined based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans.

The estimated fair value is evaluated at least annually for impairment by comparing actual cash flows and estimated cash flows from the servicing assets to those estimated at the time servicing assets were originated. The effect of changes in market interest rates on estimated rates of loan prepayments represents the predominant risk characteristic underlying the MSRs' portfolio. The Company's methodology for estimating the fair value of MSRs is highly sensitive to changes in assumptions. For example, the determination of fair value uses anticipated prepayment speeds. Actual prepayment experience may differ and any difference may have a material effect on the fair value. Thus, any measurement of MSRs' fair value is limited by the conditions existing and assumptions as of the date made. Those assumptions may not be appropriate if they are applied at different times.

New Accounting Pronouncements

For a discussion of new accounting pronouncements and their impact on the Company, see Note 1 of the Notes to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."

Operating Strategy

The Company is a bank holding company which operates primarily through its subsidiary, the Bank. The Bank is a community-oriented bank which has traditionally offered a wide variety of savings products to its retail customers while concentrating its lending activities on real estate loans. The primary elements of the Bank's operating strategy include:

Diversify Primary Market Area by Expanding Branch Office Network. In an effort to lessen its dependence on the Grays Harbor County market whose economy has historically been tied to the timber and fishing industries, the Bank has opened branch offices in Pierce, King, Thurston and Kitsap Counties. Pierce, King, Thurston and Kitsap Counties contain the Olympia, Bremerton, and Seattle-Tacoma metropolitan areas and their economies are more diversified with the presence of government, aerospace and computer technology industries. In October 2004, the Bank continued its geographic diversification by acquiring two branches in Lewis County as part of a seven-branch acquisition. In August 2008, the Bank announced plans to open an additional full-service branch in Lewis County. The Bank's existing loan production office in Lewis County will be consolidated into the new facility, which is expected to open in 2009.

Limit Exposure to Interest Rate Risk. In recent years, a majority of the loans that the Bank has retained in its portfolio generally have periodic interest rate adjustment features or have been relatively short-term in nature. Loans originated for portfolio retention primarily have included ARM loans and short-term construction loans. Longer term fixed-rate mortgage loans have generally been originated for sale in the secondary market. Management believes that the interest rate sensitivity of these adjustable-rate and short-term loans more closely match the interest rate sensitivity of the Bank's funding sources than other longer duration assets with fixed-interest rates.

Emphasize Residential Mortgage Lending. The Bank has historically attempted to establish itself as a niche lender in its primary market areas by focusing a part of its lending activities on the origination of loans secured by one-to four-family residential dwellings, including loans for the construction of residential dwellings. In an effort to meet the credit needs of borrowers in its primary market areas, the Bank originates one- to four-family mortgage loans that do not qualify for sale in the secondary market under FHLMC guidelines. The Bank has also been an active participant in the secondary market, originating residential loans for sale to the FHLMC on a servicing retained basis. The Bank occasionally retains fixed-rate one- to four-family mortgage loans in its portfolio for yield and asset-liability management purposes.

Emphasize the Origination of Commercial Real Estate and Commercial Business Loans. The Bank has hired additional commercial loan officers since 2006 for the purpose of increasing the Bank's origination of commercial real estate and commercial business loans.

Increase the Consumer Loan Portfolio. In 2001 the Bank hired a consumer loan specialist to increase the origination of consumer loans. The consumer loans generated since that time have been secured primarily by real estate. The Bank expects to continue expanding its portfolio of consumer loans.

Pursue Low Cost Core Deposits and Deposit Related Fee Income. The Bank has placed an emphasis on attracting commercial and personal checking accounts. These transactional accounts typically provide a lower cost of funding than certificates of deposit accounts and generate non-interest fee income. In October 2004, the Bank increased its transaction account base by acquiring seven branches and the related deposits.

Market Risk and Asset and Liability Management

General. Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its lending, investment, deposit and borrowing activities. The Bank, like other financial institutions, is subject to interest rate risk to the extent that its interest-earning assets reprice differently than its interest-bearing liabilities. Management actively monitors and manages its interest rate risk exposure. Although the Bank manages other risks, such as credit quality and liquidity risk, in the normal course of business management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Bank's financial condition and results of operations. The Bank does not maintain a trading account for any class of financial instruments nor does it engage in hedging activities. Furthermore, the Bank is not subject to foreign currency exchange rate risk or commodity price risk.

Qualitative Aspects of Market Risk. The Bank's principal financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates. The Bank has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the difference between asset and liability maturities and interest rates. The principal element in achieving this objective is to increase the interest-rate sensitivity of the Bank's interest-earning assets by retaining in its portfolio, short-term loans and loans with interest rates subject to periodic adjustments. The Bank relies on retail deposits as its primary source of funds. As part of its interest rate risk management strategy, the Bank promotes transaction accounts and certificates of deposit with terms of up to six years.

The Bank has adopted a strategy that is designed to substantially match the interest rate sensitivity of assets relative to its liabilities. The primary elements of this strategy involve originating ARM loans for its portfolio, maintaining residential construction loans as a portion of total net loans receivable because of their generally shorter terms and higher yields than other one- to four-family residential mortgage loans, matching asset and liability maturities, investing in short-term securities, originating fixed-rate loans for retention or sale in the secondary market, and retaining the related mortgage servicing rights.

Sharp increases or decreases in interest rates may adversely affect the Bank's earnings. Management of the Bank monitors the Bank's interest rate sensitivity through the use of a model provided for the Bank by FIMAC Solutions, LLC ("FIMAC"), a company that specializes in providing the financial services industry interest risk rate risk and balance sheet management services. Based on a rate shock analysis prepared by FIMAC, an immediate increase in interest rates of 200 basis points would increase the Bank's projected net interest income by approximately 5.7%, primarily because a larger portion of the Bank's interest rate sensitive assets than interest rate sensitive liabilities would reprice within a one year period. Similarly, an immediate 200 basis point decrease in interest rates would negatively affect net interest income by approximately 7.0%, as repricing would have the opposite effect. See "- Quantitative Aspects of Market Risk" below for additional information. Management has sought to sustain the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Pursuant to this strategy, the Bank actively originates adjustable-rate loans for retention in its loan portfolio. Fixed-rate mortgage loans with maturities greater than seven years generally are originated for the immediate or future resale in the secondary mortgage market. At September 30, 2008, adjustable-rate mortgage loans constituted $216.1 million or 58.6%, of the Bank's total mortgage loan portfolio due after

one year. Although the Bank has sought to originate ARM loans, the ability to originate such loans depends to a great extent on market interest rates and borrowers' preferences. Particularly in lower interest rate environments, borrowers often prefer fixed-rate loans.

Consumer loans and construction and land development loans typically have shorter terms and higher yields than permanent residential mortgage loans, and accordingly reduce the Bank's exposure to fluctuations in interest rates. At September 30, 2008, the construction and land development, and consumer loan portfolios amounted to $186.3 million and $59.3 million, or 30.5% and 9.7% of total loans receivable (including loans held for sale), respectively.

Quantitative Aspects of Market Risk. The model provided for the Bank by FIMAC estimates the changes in net portfolio value ("NPV") and net interest income in response to a range of assumed changes in market interest rates. The model first estimates the level of the Bank's NPV (market value of assets, less market value of liabilities, plus or minus the market value of any off-balance sheet items) under the current rate environment. In general, market values are estimated by discounting the estimated cash flows of each instrument by appropriate discount rates. The model then recalculates the Bank's NPV under different interest rate scenarios. The change in NPV under the different interest rate scenarios provides a measure of the Bank's exposure to interest rate risk. The following table is provided by FIMAC based on data at September 30, 2008.

                   Net Interest Income(1)(2)       Current Market Value
  Projected    ------------------------------  -------------------------------
Interest Rate  Estimated  $ Change   % Change  Estimated  $ Change   % Change
  Scenario       Value    from Base  from Base   Value    from Base  from Base
-------------  ---------  ---------  --------- ---------  ---------  ---------
                                   (Dollars in thousands)

    +300        $26,633    $ 2,059      8.38%   $80,443    $(7,750)   (8.79)%
    +200         25,981      1,407      5.72     82,749     (5,444)   (6.17)
    +100         25,330        756      3.07     85,849     (2,344)   (2.66)
    BASE         24,574         --        --     88,193         --       --
    -100         23,906       (668)    (2.72)    87,030     (1,163)   (1.32)
    -200         22,844     (1,730)    (7.04)    84,869     (3,324)   (3.77)
    -300         21,942     (2,632)   (10.71)    82,193     (6,000)   (6.80)

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Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan repayments and deposit decay, and should not be relied upon as indicative of actual results. Furthermore, the computations do not reflect any actions management may undertake in response to changes in interest rates.

In the event of a 200 basis point decrease in interest rates, the Bank would be expected to experience a 3.8% decrease in NPV and a 7.0% decrease in net interest income. In the event of a 200 basis point increase in interest rates, a 6.2% decrease in NPV and a 5.7% increase in net interest income would be expected. Based upon the modeling described above, the Bank's asset and liability structure generally results in decreases in net interest income in a declining interest rate scenario and increases in net interest income in a rising rate scenario. This structure also generally results in decreases in NPV in rising and declining rate scenarios.

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates,

expected rates of prepayments on loans and early withdrawals from certificates could possibly deviate significantly from those assumed in calculating the table.

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

The Company's total assets increased by $37.1 million, or 5.7%, to $681.9 million at September 30, 2008 from $644.8 million at September 30, 2007, primarily attributable to a $42.4 million increase in net loans receivable and a $26.2 million increase in cash equivalents. These increases were partially offset by a $32.7 million decrease in investment and mortgage-backed securities. This asset growth was primarily funded by a $31.9 million increase in deposits and a $4.9 million increase in FHLB advances.

The Company's capital increased by $294,000, or 0.4%, to $74.8 million at September 30, 2008 from $74.5 million at September 30, 2007, primarily as a result of retained net income and proceeds from the exercise of stock options, reduced by the payment of cash dividends and share repurchases. The Company remains well capitalized with a total capital to risk-weighted assets ratio of 13.6% at September 30, 2008.

A more detailed explanation of the changes in significant balance sheet categories follows:

Cash Equivalents: Cash equivalents increased by $26.2 million or 157.2% to $42.9 million at September 30, 2008 from $16.7 million at September 30, 2007. The increase was primarily reflected in a $21.7 million increase in federal funds sold as the Company increased its liquidity position.

Investment Securities and Mortgage-backed Securities and FHLB Stock:
Investment and mortgage-backed securities (including FHLB stock) decreased by $32.7 million or 46.8% to $37.0 million at September 30, 2008 from $69.7 million at September 30, 2007, primarily as the result of the maturity or call of U.S. agency securities, the redemption of mutual funds, and regular amortization and prepayments on mortgage-backed securities. In June 2008, the Company redeemed its $29.1 million investment in the AMF family of mutual funds for the underlying securities and cash, and recorded a loss of $2.8 million. The Company used the proceeds from the security maturities and prepayments to fund loan growth rather than reinvesting into investment securities. For additional details on investments and mortgage-backed securities, see "Item 1. Business - Investment Activities" and Note 3 of the Notes to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplemental Data."

Loans Receivable and Loans Held for Sale, Net of Allowance for Loan Losses: Net loans receivable, including loans held for sale, increased by $42.4 million or 8.2% to $557.7 million at September 30, 2008 from $515.3 million at September 30, 2007. The increase in the portfolio was primarily a result of a $22.4 million increase in construction loans (net of the undisbursed portion of construction loans in process), an $18.4 million increase in commercial real estate loans, a $9.9 million increase in one- to four-family mortgage loans, and a $2.9 million increase in commercial business loans. These increases were partially offset by a $9.2 million decrease in multi-family loans.

Loan originations (including participation interests purchased) decreased by 12.7% to $261.4 million for the year ended September 30, 2008 from $299.4 million for the year ended September 30, 2007. The decrease in loan originations was primarily a result of lower demand for financing in the Bank's market areas due to a slowing economy and a tightening in the Bank's underwriting standards. The Bank sold $45.3 million in fixed rate one- to four-family mortgage loans during the year ended September 30, 2008 compared to $29.9 million for the fiscal year ended September 30, 2007. For additional information on loans, see "Item 1. Business - Lending Activities" and Note 4 of the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."

Premises and Equipment: Premises and equipment increased by $309,000 to $16.9 million at September 30, 2008 from $16.6 million at September 30, 2007. The increase was primarily as a result of the purchase of land for the Bank's new branch facility that will be constructed in Lewis County, and remodeling costs associated with several branch offices. These increases were partially offset by depreciation and the sale of a building in Grays Harbor County that previously served as a branch facility. For additional information on premises and equipment, see "Item 2. Properties"

and Note 6 of the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."

Other Real Estate Owned ("OREO"): OREO and other repossessed items totaled $511,000 at September 30, 2008 and consisted of one single family residence in Pierce County and two vehicles. The Company did not have any OREO or other repossessed items at September 30, 2007. For additional information on OREOs, see "Item 1. Business - Lending Activities - Non-performing Assets" and Note 7 of the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."

Goodwill and Core Deposit Intangible ("CDI"): Goodwill and CDI decreased by $249,000 to $6.6 million at September 30, 2008 from $6.9 million at September 30, 2007 due to scheduled amortization of CDI. The Company recorded goodwill and CDI in connection with the October 2004 acquisition of seven branches and related deposits. The Company performed its annual review of goodwill as of June 30, 2008 and determined that there was no impairment to goodwill. For additional information of Goodwill and CDI, see Note 1 and Note 8 of the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplemental Data."

Deposits: Deposits increased by $31.9 million, or 6.8%, to $498.6 million at September 30, 2008 from $466.7 million at September 30, 2007, primarily due to a $22.3 million increase is money market accounts, a $10.1 million increase in N.O.W. checking accounts, and a $2.5 million increase in certificates of deposit accounts. These increases were partially offset by a $3.0 million decrease in non-interest bearing accounts. The increase in money market accounts was partially a result of a $10.5 million short-term deposit by a commercial customer that was transferred out of the deposit base and into the Bank's Certificate of Deposit Registry Service ("CDARS") program in early October 2008. For additional information on deposits, see "Item 1. Business - Deposit Activities and Other Sources of Funds" and Note 9 of the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."

FHLB Advances and Other Borrowings: FHLB advances and other borrowings increased by $5.1 million, or 5.1%, to $105.4 million at September 30, 2008 from $100.3 million at September 30, 2007 as the Bank used additional advances to fund loan portfolio growth. For additional information on borrowings, see "Item 1. Business - Deposit Activities and Other Sources of Funds - Borrowings" and Notes 10 and 11 of the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."

Shareholders' Equity: Total shareholders' equity increased by $294,000, or 0.4%, to $74.8 million at September 30, 2008 from $74.5 million at September 30, 2007, primarily as a result net income of $4.0 million and proceeds from the exercise of stock options of $857,000 and a $323,000 net increase in the fair value of investment securities available for sale. These increases to shareholders' equity were partially offset by the payment of $3.0 million in cash dividends to shareholders and share repurchases of $1.9 million.

During the year ended September 30, 2008 the Company repurchased 144,950 shares of its common stock for $1.9 million (an average price of $13.26 per share.) The Company had 343,468 shares remaining to be purchased on its existing stock repurchase plan at September 30, 2008. Cumulatively, the Company has repurchased 7,783,934 shares (58.9%) of the 13,225,000 shares that were issued in its 1998 initial public offering, at an average price of $8.98 per share. For additional information on shareholders' equity, see the Consolidated Statements of Shareholders' Equity contained in "Item 8. Financial Statements and Supplementary Data."

Comparison of Operating Results for the Years Ended September 30, 2008 and 2007

The Company's net income decreased by $4.16 million, or 50.9%, to $4.01 million for the year ended September 30, 2008 from $8.16 million for the year ended September 30, 2007. The decrease was primarily as a result of increased provision for loan losses, decreased non-interest income due to a loss on the redemption of mutual funds, and increased non-interest expenses, which were partially offset by increased net interest income. Diluted earnings per share decreased by 47.9% to $0.61 for the year ended September 30, 2008 from $1.17 for the year ended September 30, 2007.

The increased provision for loan losses was primarily a result of an increase in the level of non-performing loans, an increase in the level of performing loans classified as substandard under the Bank's loan grading system, loan portfolio growth, and uncertainties in the housing market in certain markets of the Pacific Northwest. Net charge-offs were $647,000 during the year ended September 30, 2008, which was equivalent to 0.12% of the average outstanding loans.

The decreased non-interest income was primarily a result of a $2.82 million loss on the sale of securities, as the Company redeemed its investment . . .