The following Management's Discussion and Analysis of Financial Condition and Results of Operations includes a discussion of significant business trends and uncertainties as well as certain forward-looking statements and is intended to be read in conjunction with and is qualified in its entirety by reference to the consolidated financial statements of the Company and accompanying notes included elsewhere in this report. For a discussion of important factors that could cause actual results to differ materially from such forward-looking statements, see Item 1A. "Risk Factors" and the risk factors discussed on page 1 immediately following the table of contents.

Critical Accounting Estimates

The Company's most critical accounting policy is related to the allowance for credit losses, which consists of two components: the allowance for loan losses and the reserve for unfunded commitments. The Company utilizes both quantitative and qualitative considerations in establishing an allowance for credit losses believed to be appropriate as of each reporting date.

Quantitative factors include:

• the volume and severity of non-performing loans and adversely classified credits,

• the level of net charge-offs experienced on previously classified loans,

• the nature and value of collateral securing the loans,

• the trend in loan growth and the percentage of change,

• the level of geographic and/or industry concentration,

• the relationship and trend over the past several years of recoveries in relation to charge-offs, and

• other known factors regarding specific loans.

Qualitative factors include:

• the effectiveness of credit administration,

• the adequacy of loan review,

• the adequacy of loan operations personnel and processes,

• the effect of competitive issues that impact loan underwriting and structure,

• the impact of economic conditions including interest rate trends,

• the introduction of new loan products or specific marketing efforts,

• large credit exposure and trends, and

• industry segments that are exhibiting stress.

Changes in the above factors could significantly affect the determination of the adequacy of the allowance for credit losses. Management performs a full analysis, no less often than quarterly, to ensure that changes in estimated loan loss levels are adjusted on a timely basis. For further discussion of this significant management estimate, see "Allowance for Credit Losses."

Another critical accounting policy of the Company is that related to the carrying value of goodwill. Impairment analysis of the fair value of goodwill involves a substantial amount of judgment. Under Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142), the Company ceased amortization of goodwill on January 1, 2002 and periodically tests goodwill for impairment.

The goodwill impairment analysis requires management to make highly subjective judgments in determining if an indicator of impairment has occurred. Events and factors that may significantly affect the analysis include: a significant decline in the Company's expected future cash flows, a substantial increase in the discount factor, a sustained, significant decline in the Company's stock price and market capitalization, a significant adverse change in legal factors or in the business climate. Other factors might include changing competitive forces, customer behaviors and attrition, revenue trends and cost structures, along with specific industry and market conditions. Adverse change in these factors could have a significant impact on the recoverability of intangible assets and could have a material impact on the Company's consolidated financial statements.

The goodwill impairment analysis involves a two-step process. The first step is a comparison of the Company's fair value to its carrying value. Management estimates fair value using a combination of the income approach and market approach with the best information available, including market information and discounted cash flow analysis. The income approach uses a reporting unit's projection of estimated operating results and cash flows that is discounted using a weighted-average cost of capital that reflects current market conditions. For purposes of the goodwill impairment test, the Company was identified as a single reporting unit. The market approach estimates the fair value of a company by examining the price at which similar companies, or shares of similar companies, are exchanged. Based on management's goodwill impairment analysis, it was determined that the Company's fair value exceeded its carrying value and therefore indicated no potential impairment under step one of the process. Further erosion of the Company's stock price could lead to a future goodwill impairment write down.

If the carrying value of the reporting unit was determined to have been higher than its fair value, there would have been an indication that impairment may have existed and the second step would have been performed to measure the amount of impairment loss. The amount of impairment is determined by comparing the implied fair value of reporting unit goodwill to the carrying value of the goodwill in the same manner as if the reporting unit was being acquired in a business combination. Specifically, a company would allocate the fair value to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that would calculate the implied fair value of goodwill. If the implied fair value of goodwill is less than the recorded goodwill, the Company would record an impairment charge for the difference.

Due to the ongoing uncertainty in market conditions, which may continue to negatively impact the performance of the Company as well as the market valuations of financial institutions, including Cowlitz Bancorporation, management will continue to monitor and evaluate the carrying value of goodwill. Goodwill impairment could be recorded in future periods and such impairment could be material to the Company's results of operations.

Recent Industry and Regulatory Developments

On October 3, 2008, Congress approved the $700 billion Emergency Economic Stabilization Act of 2008 (EESA). The first phase of implementation of EESA included a $250 billion Treasury Capital Purchase Program. The Company applied for up to three percent of its total risk-weighted assets in capital, which would be in the form of non-cumulative perpetual preferred stock of the institution with a dividend rate of 5% until the fifth anniversary of the investment, and 9% thereafter. The Company's application is currently pending. In addition, the Company is currently exploring the possibility, should economic conditions continue to deteriorate or strategic opportunities present themselves, of seeking additional capital to bolster the Company's capital and liquidity positions in this time of uncertainty and economic challenge. The Company may not be able to obtain either TARP or private equity financing or it may be only available on terms that are unfavorable to the Company and its shareholders. The Company believes that an investment by the Treasury through the TARP Program may be conditioned on the Company's receipt of private equity capital. If as a result of a regulatory exam the Bank is downgraded to "adequately capitalized" by regulatory standards, the Bank may no longer be eligible to receive funds through the TARP Program. In the event additional capital is not available from the TARP Program or on

acceptable terms through available financing sources, the Company may instead take additional steps to preserve capital, including slowing or reducing lending, selling certain assets, and/or increasing loan participations. The Company does not pay cash dividends.

In October, 2008, the FDIC introduced the Temporary Liquidity Guarantee Program (the "TLGP"), a program designed to improve the functioning of the credit markets and to strengthen capital in the financial system during this period of economic distress. The TLGP has two components: 1) a debt guarantee program, guaranteeing newly issued senior unsecured debt, and 2) a transaction account guarantee program, providing a full guarantee of non-interest-bearing deposit transaction accounts, Negotiable Order of Withdrawal (or "NOW") accounts paying less than 0.5% annual interest, and Interest on Lawyers Trust Accounts, regardless of the amount. The Bank is presently participating in the transaction account guarantee program and, as such, all funds in covered accounts held through December 31, 2009 will be covered with a full guarantee.

On February 25, 2009, the Treasury announced the terms and conditions for the Capital Assistance Program (CAP). The purpose of the CAP is to restore confidence throughout the financial system by providing that the nation's largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers. Under CAP, federal banking supervisors will conduct forward-looking assessments to evaluate the capital needs of the major U.S. banking institutions under a more challenging economic environment. Should that assessment indicate that an additional capital buffer is warranted, banks will have an opportunity to turn first to private sources of capital. In light of the current challenging market environment, the Treasury is making government capital available immediately through the CAP to eligible banking institutions to provide this buffer. Eligible U.S. banking institutions with assets in excess of $100 billion on a consolidated basis are required to participate in the coordinated supervisory assessments, and may access the CAP immediately as a means to establish any necessary additional buffer. Eligible U.S. banking institutions with consolidated assets below $100 billion may also obtain capital from the CAP.

Capital provided under the CAP will be in the form of a preferred security that is convertible into common equity at a 10 percent discount to the price prevailing prior to February 9, 2009. CAP securities will carry a 9 percent dividend yield and would be convertible at the issuer's option (subject to the approval of their regulator). After 7 years, the security would automatically convert into common equity if not redeemed or converted before that date. Companies who participate in the CAP will be subject to similar conditions as are imposed under the TARP program.

Results of Operations-Overview

For the year ended December 31, 2008, the Company's net loss was $8.1 million, or ($1.60) per diluted share. This compares with net income of $86,000, or $0.02 per diluted share, and $4.8 million, or $0.93 per share, for the corresponding periods ended December 31, 2007, and 2006, respectively. Average loans in 2008 totaled $428.0 million, an increase of 12% over 2007, and up significantly from $319.6 million in 2006. This loan growth, mostly in commercial and real estate loans, was funded primarily by the growth in deposits, with a significant portion consisting of certificates of deposits.

Net interest income was down slightly compared with 2007 and 2006 results. The net interest margin (on a fully tax-equivalent basis) was 4.55% in 2008, compared with 5.12% and 5.90% in 2007 and 2006, respectively. The decline in net interest margin in 2008 related to several factors, including recent Federal Reserve rate cuts, competitive loan and deposit pricing, and interest reversals on nonaccrual loans, as well as a higher level of nonaccrual loans.

The Company's provision for credit losses was $17.6 million in 2008, compared with $7.8 million in 2007 and $2.6 million in 2006. Net charge-offs of $9.6 million were recorded in 2008, compared with $6.6 million and $2.5 million in 2007 and 2006, respectively. The higher provision in 2008 primarily reflected unfavorable

conditions in the Company's Seattle, Washington and Portland, Oregon/Southwest Washington residential real estate markets, national as well as regional, that affected home builders and developers and resulted in an increase in loans charged-off during the period. A slowdown in home buying has resulted in slower sales and rapidly declining real estate valuations, which have significantly affected these borrowers' liquidity and ability to repay loans. At December 31, 2008, total nonperforming assets were $20.5 million compared with $13.1 million at year-end 2007 and $1.8 million at December 31, 2006.

Non-interest income decreased $1.8 million in 2008 when compared with 2007 primarily due to securities losses. An other-than-temporary impairment (OTTI) charge in 2008 of $1.7 million was recognized on FNMA preferred stock, reflecting the extraordinarily unsettled equity market for this government-sponsored enterprise.

Non-interest expenses totaled $19.4 million in 2008 compared with $18.7 million in 2007. The most significant items affecting 2008 non-interest expense compared with 2007 were costs related to foreclosed assets and amounts related to interest rate contracts. Foreclosed asset costs included valuation adjustments of $2.1 million in 2008 on other real estate owned to reflect current appraised values. Partially affecting these expenses in 2008 was a non-cash credit of $1.1 million in 2008 was recorded for the ineffective portion of the change in the fair value of the Company's cash flow hedges.

At December 31, 2008, total assets were $587.4 million, an increase of $73.2 million, or 14%, from December 31, 2007. Total loans increased 9% to $433.2 million, from $397.3 million at December 31, 2007. Total deposits increased 18% to $521.6 million at December 31, 2008 from $441.2 million at December 31, 2007.

The Company maintained capital ratios in excess of defined regulatory levels required to be "well-capitalized" as of December 31, 2008. In addition, management believes the Company has adequate sources of liquidity readily available.

Analysis of Net Interest Income

The primary component of the Company's earnings is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities portfolios, and interest expense, principally on customer deposits and other borrowings. Changes in net interest income, net interest spread, and net interest margin result from changes in asset and liability volume mix and to rates earned or paid. Net interest spread refers to the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Net interest margin is the ratio of net interest income to total interest-earning assets and is influenced by the volume and relative mix of interest-earning assets and interest-bearing liabilities. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities.

Interest income from certain of the Company's earning assets is non-taxable. The following table presents interest income and expense, including adjustments for non-taxable interest income, and the resulting tax-adjusted yields earned, rates paid, interest rate spread, and net interest margin for the periods indicated. Nonaccrual loans have been included in the table as loans carrying a zero yield. Loan fees are amortized to interest income over the life of the loan.

                                                                                      Year Ended December 31,
                                                       2008                                     2007                                     2006
                                          Average        Interest                  Average        Interest                  Average        Interest
                                        Outstanding       Earned/    Yield/      Outstanding       Earned/    Yield/      Outstanding       Earned/    Yield/
(dollars in thousands)                    Balance          Paid       Rate         Balance          Paid       Rate         Balance          Paid       Rate
Assets
Interest-Earning Assets:
Loans (1) (2) (3)                      $     428,014     $  33,081     7.73 %   $     383,477     $  33,191     8.66 %   $     319,577     $  28,521     8.92 %
Taxable securities                            25,080         1,363     5.43 %          34,010         1,865     5.48 %          36,594         1,925     5.26 %
Non-taxable securities (2)                    23,496         1,555     6.62 %          21,747         1,383     6.36 %          19,690         1,096     5.57 %
Federal funds sold                            16,968           270     1.59 %           5,207           262     5.03 %           5,919           268     4.53 %
Interest-earning balances due from
banks and FHLB stock                           1,901            31     1.63 %           1,896            42     2.22 %           2,471           140     5.67 %

Total interest-earning assets (2)            495,459        36,300     7.33 %         446,337        36,743     8.23 %         384,251        31,950     8.31 %

Cash and due from banks                       15,688                                   18,427                                   15,941
Allowance for loan losses                    (10,340 )                                 (5,141 )                                 (5,074 )
Other assets                                  40,712                                   29,518                                   27,015

Total assets                           $     541,519                            $     489,141                            $     422,133

Liabilities and Shareholders Equity
Interest-Bearing Liabilities:
Savings, money market and
interest-bearing demand deposits       $     111,458     $   1,696     1.52 %   $     104,310     $   2,260     2.17 %   $      96,101     $   1,321     1.37 %
Certificates of deposit                      274,065        11,420     4.17 %         210,174        10,602     5.04 %         156,655         7,022     4.48 %
Federal funds purchased                        1,494            41     2.74 %           2,313           121     5.23 %           1,467            83     5.66 %
Junior subordinated debentures                12,372           604     4.88 %          12,372           875     7.07 %          12,372           815     6.59 %
FHLB and other borrowings                         86             7     8.14 %             175            13     7.43 %             297            22     7.41 %

Total interest-bearing liabilities           399,475        13,768     3.45 %         329,344        13,871     4.21 %         266,892         9,263     3.47 %

Noninterest-bearing deposits                  85,799                                  100,817                                  102,201
Other liabilities                              4,328                                    5,048                                    5,398

Total liabilities                            489,602                                  435,209                                  374,491
Shareholders' Equity                          51,917                                   53,932                                   47,642

Total liabilities and shareholders'
equity                                 $     541,519                            $     489,141                            $     422,133

Net interest income (2)                                  $  22,532                                $  22,872                                $  22,687

Net interest spread                                                    3.88 %                                   4.02 %                                   4.84 %

Yield on average interest-earning
assets                                                                 7.33 %                                   8.23 %                                   8.31 %
Interest expense to average
interest-earning assets                                                2.78 %                                   3.11 %                                   2.41 %

Net interest income to average
interest- earning assets (net
interest margin)                                                       4.55 %                                   5.12 %                                   5.90 %

(1) Loans include loans on which the accrual of interest has been discontinued.

(2) Interest earned on non-taxable securities and loans has been computed on a 34 percent tax-equivalent basis.

(3) Loan interest income includes net loan fee amortization of $1.5 million, $1.8 million, and $1.8 million for 2008, 2007, and 2006, respectively.

The net interest margin as a percentage was 4.55% for 2008, compared with 5.12% and 5.90% in 2007 and 2006, respectively. The lower net interest margin in 2008 relative to 2007 and 2006 was due to several factors, including rate cuts by the Federal Reserve of 500 basis points between September 2007 and December 31, 2008, continued competitive market pricing on both sides of the balance sheet, a higher level of nonaccrual loans and a lower level of non-interest-bearing demand deposit accounts.

Foregone interest income of $0.8 million contributed to a 15 basis point decline in the net interest margin for 2008. The $1.0 million of foregone interest in 2007 contributed to a 22 basis point decline in the net interest margin for 2007.

The following table shows the dollar amount of the increase (decrease) in the Company's net interest income and expense, on a tax equivalent basis, and attributes such dollar amounts to changes in volume or changes in rates. Rate/volume variances have been allocated to volume changes:

                                                                   Year Ended December 31,
                                               2008 vs. 2007                                    2007 vs. 2006

                                    Increase (Decrease)            Total            Increase (Decrease)            Total
                                          Due to                 Increase                 Due to                  Increase
                                   Volume           Rate        (Decrease)         Volume           Rate         (Decrease)
Interest Income:
Interest-earning balances due
from banks                       $       -        $    (11 )    $       (11 )    $      (13 )     $    (85 )    $        (98 )
Federal funds sold                      187           (179 )              8             (36 )           30                (6 )
Investment security income:
Taxable securities                     (485 )          (17 )           (502 )          (142 )           82               (60 )
Nontaxable securities                   116             56              172             131            156               287
Loans                                 3,455         (3,565 )           (110 )         5,531           (861 )           4,670

Total interest income                 3,273         (3,716 )           (443 )         5,471           (678 )           4,793

Interest Expense:
Savings, money market and
interest-bearing demand
deposits                                109           (673 )           (564 )           178            761               939
Certificates of deposit               2,652         (1,834 )            818           2,700            880             3,580
Federal funds purchased                 (22 )          (58 )            (80 )            44             (6 )              38
Junior subordinated
debentures                               -            (271 )           (271 )            -              60                60
FHLB and other borrowings                (7 )            1               (6 )            (9 )           -                 (9 )

Total interest expense                2,732         (2,835 )           (103 )         2,913          1,695             4,608

Net Interest Spread              $      541       $   (881 )    $      (340 )    $    2,558       $ (2,373 )    $        185

Interest Income. Total average earning assets increased $49.1 million in 2008 to $495.5 million, compared with $446.3 million in 2007. Average loans in 2008 increased $44.5 million, or 12%. The average yield on earning assets in 2008 was 7.33% compared with 8.23% in 2007. The decrease in interest income due to the decrease in loan yields was partially offset by the increase in average loans. In both 2008 and 2007, the yield on the loan portfolio was negatively affected by the level of nonaccrual loans during the years and related foregone interest. The Bank's prime rate stood at 3.25% at year-end 2008 compared to 7.25% at year-end 2007. Approximately two-thirds of the Company's loan portfolio was composed of variable-rate loans during 2008 and 2007. Interest income was also negatively affected by the lower volume of taxable securities.

Comparing 2007 to 2006, total average interest earning assets increased $62.1 million. Average loans increased $63.9 million. The average yields earned on loans in 2007 was 8.66% compared with 8.92% in 2006. The Bank's prime rate stood at 7.25% at year-end 2007, compared with 8.25% at year-end 2006.

Interest Expense. The average rate paid on interest-bearing liabilities paid in 2008 was 3.45%, compared with 4.21% in 2007, a decrease of 76 basis points. This decrease in the average cost of interest-bearing liabilities partially offset the decrease in the average yield on interest-earning assets, resulting in a 14 basis point decrease in the net interest spread in 2008 compared with 2007.

In 2007, the average rate paid on interest-bearing liabilities was 4.21% compared with 3.47% in 2006, an increase of 74 basis points. The higher interest costs in 2007 reflected the volatility in short-term market rates and the competitive climate for deposits.

Provision for Credit Losses

The amount of the allowance for credit losses is analyzed by management on a regular basis to ensure that it is adequate to absorb losses inherent in the loan portfolio as of the reporting date. When a provision for credit losses is recorded, the amount is based on the current volume of loans and commitments to extend credit, anticipated changes in loan volumes, past charge-off experience, management's assessment of the risk of loss on current loans, the level of non-performing and impaired loans, evaluation of future economic trends in the Company's market area, and other factors relevant to the loan portfolio. An internal loan risk grading system is used to evaluate probable losses of individual loans. The Company does not, as part of its analysis, group loans together by loan type to assign risk. See the "Allowance for Credit Losses" disclosure for a more detailed discussion.

The Company's provision for credit losses was $17.6 million for the year ended December 31, 2008, compared with $7.8 million and $2.6 million the years ended December 31, 2007 and 2006, respectively. The significant increase in the 2008 provision for credit losses was primarily related to an increase in nonperforming loans and downgrades within the portfolio primarily attributable to the continued weak housing market and its impact on the Bank's land acquisition and development portfolio, the increase in loans charged-off and the . . .