Forward-Looking Statements

This discussion contains forward-looking statements which are based on assumptions and describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the word "believe," "expect," "intend," anticipate," "estimate," "project," or similar words. The Company's ability to predict results or the actual effect of future plans or strategies is uncertain. These forward-looking statements relate to, among other things, expectations of the business environment in which we operate, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs that may be impacted by deterioration in the housing and commercial real estate markets and may lead to increased losses and non-performing assets in our loan portfolio, result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; deposit flows; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; adverse changes in the securities markets; results of examinations by our banking regulators including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; the possibility that we will be unable to comply with the conditions imposed upon us in the Orders entered into with the OTS, as determined by its successors, the OCC for the Bank and the Federal Reserve for the Company; computer systems on which we depend could fail or experience a security breach, or the implementation of new technologies may not be successful; our ability to retain key members of our senior management team; legislative or regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") that adversely affect our business including changes in regulatory policies and principles, and the interpretation of regulatory capital or other rules; the time it may take to lease excess space in Company-owned buildings; future legislative changes in the United States Department of Treasury TARP Capital Purchase Program; and other risks detailed in our reports filed with the SEC, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Accordingly, these factors should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. We undertake no responsibility to update or revise any forward-looking statements.

Regulatory Matters

On September 28, 2010, the Company and the Bank each entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist with the OTS (individually an "Order" and collectively the "Orders"). As a result of the elimination of the OTS on July 21, 2011, compliance with the Orders is now determined by the Company's new primary regulator, the Federal Reserve, and the Bank's new primary regulator, the OCC. For purposes of this discussion regarding the Order, the Federal Reserve and the OCC are collectively referred to as the "Banking Regulators."

Under the terms of the Orders, the Company and the Bank, without the prior written approval of the Banking Regulators, may not:

· Increase assets during any quarter;

· Pay dividends;

· Increase brokered deposits;

· Repurchase shares of the Company's outstanding Common Stock;

· Issue any debt securities or incur any debt (other than that incurred in the normal course of business); and

· Make payments on any existing debt.

Other material provisions of the Orders require the Bank and the Company to:

· develop a capital plan for preserving and enhancing capital levels that is acceptable to the Banking Regulators;

· develop a business plan for enhancing, measuring and maintaining profitability, increasing earnings, acceptable to the Banking Regulators;

· submit a comprehensive plan for reducing classified assets, acceptable to the Banking

· Regulators;

· develop and submit a policy for the management and maintenance of liquidity, which includes a contingency plan for anticipating funding needs and alternative funding sources, acceptable to the Banking Regulators;

· develop and submit a plan to internally audit the nature, scope and risk of activities and operations, acceptable to the Banking Regulators;

· revise and submit a plan to comply with applicable consumer and related compliance laws and regulations, including a risk assessment process to measure such compliance, acceptable to the Banking Regulators;

· develop and submit a plan regarding information technology ("IT") management, including a succession plan for key personnel, duties/responsibilities and training of IT personnel, acceptable to the Banking Regulators;

· develop and implement a risk based IT audit program that complies with all laws and regulations;

· develop and submit a plan for addressing contingency planning related to any back-up IT server(s);

· not appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without notifying the Banking Regulators;

· not enter into, renew, extend or revise any compensation or benefit agreements for directors or senior executive officers;

· not make any indemnification, severance or golden parachute payments;

· not enter into any arrangement or contract with a third party service provider that is significant to the overall operation or financial condition of the Bank, or that is outside the normal course of business;

· ensure the Bank's compliance with applicable laws, rules, regulations and agency guidelines, including the terms of the order; and

· prepare and submit progress reports to the Banking Regulators regarding compliance with the capital plan, business plan, certain classified assets.

The Orders will remain in effect until modified or terminated by the Banking Regulators.

All customer deposits remain fully insured to the fullest extent permitted by the FDIC. The Bank expects to continue to serve its customers in all areas including making loans, establishing lines of credit, accepting deposits and processing banking transactions.

For additional information regarding the terms of the Orders, please see our Form 8-K that we filed with the SEC on October 4, 2010. Further, we may be subject to more severe future regulatory enforcement actions, including but not limited to civil money penalties, if we do not comply with the terms of the Orders.

Critical Accounting Policies

The discussion and analysis of the Company's financial condition and results of operations are based upon the Company's condensed consolidated interim financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the financial statements. The most significant estimates are the allowance for loan losses, valuation of real estate owned, valuation of deferred tax assets and valuation of mortgage servicing rights. Actual results may differ from these estimates under different assumptions or conditions.

Accounting for the allowance for loan losses involves significant judgment and assumptions by management, which has a material impact on the carrying value of net loans. Management considers this accounting policy to be a critical accounting policy. We maintain an allowance for loan losses consistent, in all material respects, with the GAAP guidelines outlined in ASC 450, Contingencies. The allowance has three components: (i) a formula allowance for groups of homogeneous loans, (ii) a specific valuation allowance for identified problem loans and (iii) an unallocated allowance. Each of these components is based upon estimates that can change over time. The formula allowance is based primarily on historical experience and as a result can differ from actual losses incurred in the future. The history is reviewed at least quarterly and

adjustments are made as needed. Various techniques are used to arrive at specific loss estimates, including historical loss information, discounted cash flows and fair market value of collateral. The use of these techniques is inherently subjective and the actual losses could be greater or less than the estimates. For further details, see "Results of Operations - Provision for Loan Losses" included in this Form 10-Q.

The allowance for loan losses represents management's best estimate of incurred credit losses inherent in the Company's loan portfolio as of the balance sheet date. The estimate of the allowance is based on a variety of factors, including past loan loss experience, the current credit profile of borrowers, adverse situations that have occurred that may affect a borrower's ability to meet their financial obligations, the estimated value of underlying collateral, general economic conditions, and the impact that changes in interest rates and employment conditions have on a borrower's ability to repay adjustable-rate loans.

The fair value of impaired loans is determined using a discounted cash flow basis or the fair value of each loan's collateral for collateral-dependent loans as determined, when possible, by an appraisal of the property, less estimated costs related to liquidation of the collateral. The appraisal amount may also be adjusted for current market conditions. Adjustments to reflect the fair value of collateral-dependent loans are a component in determining our best estimate of the allowance for loan losses.

Interest is generally not accrued on any loan when its contractual payments are more than 90 days delinquent unless collection of interest is considered probable. In addition, interest is not recognized on any loan where management has determined that collection is not reasonably assured. A nonaccrual loan may be restored to accrual status when delinquent principal and interest payments are brought current and future monthly principal and interest payments are expected to be collected.

Real estate owned and repossessed assets primarily represents real estate and other assets which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, real estate owned and repossessed assets are recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property's new basis. Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically performs valuations when possible, by an appraisal of the property, such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Fair value adjustments on real estate owned and repossessed assets are recognized within results of operations.

As of June 30, 2012 and December 31, 2011, the Company had recorded a net deferred income tax asset (which is included in other assets in the accompanying Condensed Consolidated Balance Sheets) of $497,000 and $544,000, respectively. As of June 30, 2012 and December 31, 2011 the Company had a total valuation allowance of $94,000 against its deferred tax asset of $592,000 and $638,000, respectively, due to uncertainty about the Company's ability to generate sufficient taxable income in the near term. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is "more likely than not" that all or a portion

of the deferred tax asset will not be realized. "More likely than not" is defined as greater than a 50% probability of occurrence. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Management's assessment is primarily dependent on historical taxable income and projections of future taxable income, which are directly related to the Company's core earnings capacity and its prospects to generate core earnings in the future. In assessing the need for a valuation allowance, we examine our historical cumulative trailing three-year pre-tax income (loss) quarterly. If we have historical cumulative income, we consider this to be strong positive evidence. To the extent we do not have cumulative income, we examine this to determine if there were any unusual or non-recurring items which would not be indicative of our operating results or expected to occur in the future. The Company will not be able to recognize the tax benefits on future losses until it can show that it is more likely than not that it will generate enough taxable income in future periods to realize the benefits of its deferred tax asset and loss carryforwards.

The Company, however, cannot give any assurance that in the future its deferred tax asset will not be impaired further since such determination is based on projections of future earnings, which are subject to uncertainty and estimates that may change given uncertain economic outlook, banking industry conditions and other factors.

The Company accounts for MSR in accordance with ASC 860-50, Servicing Assets and Liabilities, which provides that changes in fair value will be reported in earnings in the period in which the change occurs. See Note 2 of the Selected Notes to Condensed Consolidated Interim Financial Statements for information the Company's methodology to estimate the fair value of MSR.

Recent Accounting Pronouncements

FASB ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 , was issued in December 2011 updating and superseding certain pending paragraphs relating to the presentation on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. This Update is effective concurrent with ASU 2011-05, Presentation of Comprehensive Income, and will not have a material effect on the Company's consolidated financial statements at the date of adoption.

In July 2012, the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment. With the Update, a company testing indefinite-lived intangibles for impairment now has the option to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative

impairment test by comparing the fair value with the carrying amount in accordance with current guidance. An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of this ASU will not have a material impact on the Company's consolidated financial statements.

Financial Condition

Total assets of the Company at June 30, 2012 were $177.4 million, an increase of $5.3 million or 3.1%, from $172.1 million at December 31, 2011. The increase is primarily the result of an increase in loans and property plant and equipment.

Loans (excluding loans held for sale and the allowance for loan losses) were $151.7 million at June 30, 2012, a $3.9 million, or 2.6%, increase from $147.8 million at December 31, 2011. Commercial business loans increased $4.9 million, or 25.7%, to $24.1 million offset by a decline in permanent one-to-four family loans of $1.1 million, or 4.3%. Loans held for sale were $985,000 at June 30, 2012, a $9,000 increase from $976,000 at December 31, 2011.

Deposits increased $4.5 million, or 3.0%, to $151.7 million at June 30, 2012, compared with $147.2 million at December 31, 2011. The increase is primarily the result of a seasonal increase in demand deposit accounts.

The Bank began using CDARS deposits in 2005 as an alternative source of funds in addition to advances from the FHLB. These are insured time deposits obtained through the nationwide Certificate of Deposit Account Registry Service. They range in maturities from one month to three years, and are generally priced higher than locally obtained deposits but are generally less expensive than other brokered deposits. Included in certificates of deposit were CDARS deposits of $274,000 at June 30, 2012 and $377,000 at December 31, 2011. The Bank's usage of CDARS is limited by OCC regulation. The Bank is prohibited from obtaining additional brokered deposits by the Order.

Total shareholders' equity decreased by only $59,000, or 0.3% and was $20.5 million at both June 30, 2012 and December 31, 2011. The lack of change in shareholders' equity during the six months ended June 30, 2012 was primarily attributable to net income of $33,000 offset by preferred stock dividends of $120,000.

Results of Operations

Net (Loss) Income. Net (loss) income excluding the preferred stock dividend and discount accretion for the second quarter of 2012 and 2011 was $(141,000) and $197,000, respectively. After preferred stock dividend and discount accretion of $60,000 and $59,000, net (loss) income available to common shareholders for the second quarter of 2012 and 2011 was $(220,000) and $123,000, or $(0.34) and $0.16 per diluted share, respectively.

For purposes of comparison, (loss) income can be separated into major components as follows:

                                    Three Months Ended                               Six Months Ended
                                         June 30,                                        June 30,
                                                        Income                                          Income
(in thousands)            2012          2011         Incr. (Decr.)        2012          2011         Incr. (Decr.)

Net interest income     $   1,930     $   1,990     $           (60 )   $   3,873     $   3,931     $           (58 )
Noninterest income            394           393                   1           807           735                  72
Provision for loan
losses                        (90 )        (193 )               103          (180 )        (253 )                73
Noninterest ex­pense       (2,464 )      (1,993 )              (471 )      (4,443 )      (4,071 )              (372 )
Income before
provision for income
tax                          (230 )         197                (427 )          57           342                (285 )
Benefit (Provision)
for income tax                 89             -                  89           (24 )           -                 (24 )
Net (loss) income       $    (141 )   $     197     $          (338 )   $      33     $     342     $          (309 )

Net Interest Income. Net interest income for the second quarter of 2012 decreased $60,000 compared with the second quarter of 2011. Average loans increased $5.4 million, or 3.7%, to $151.9 million for the second quarter of 2012 compared to $146.5 million for the second quarter of 2011. At the same time, the yield on loans decreased 40 basis points ("bp") for the second quarter of 2012 to 5.37% compared to 5.77% for the second quarter of 2011 as a result of a continued low interest rate environment and non-performing loans. Average interest bearing deposits increased $742,000, or 0.6%, to $114.5 million for the second quarter of 2012 compared to $113.7 million for the second quarter of 2011. The cost of average interest bearing liabilities declined seven bp to 0.50% for the second quarter of 2012 compared to 0.57% for the second quarter of 2011. The interest rate spread, which is the difference between the yield on average interest-earning assets and the average cost of interest-bearing liabilities, decreased 28 bp to 4.68% for the second quarter 2012 compared to 4.96% for the second quarter of 2011.

Provision for Loan Losses. The provision for loan losses decreased to $90,000 for the second quarter of 2012, compared with $193,000 for the second quarter of 2011. The provisions in these periods reflect management's assessment of asset quality, overall risk, and estimated loan impairments and were considered appropriate in order to maintain the allowance for loan losses at a level that represents management's best estimate of the probable credit losses inherent in the loan portfolio. Net loan charge offs were $165,000 for the second quarter of 2012, compared with net loan charge offs of $83,000 for the second quarter of 2011.

Noninterest Income. Noninterest income for the second quarter of 2012 increased $1,000, or 0.3%, to $394,000 compared with $393,000 for the second quarter of 2011.

Noninterest Expense. Noninterest expense for the second quarter of 2012 increased $471,000, or 23.6%, to $2.5 million compared to $2.0 million for the comparable period in 2011. The increase was primarily related to an increase in real estate owned and repossessed asset expense and an increase in FDIC assessment costs associated with a retroactive adjustment.

Benefit for income taxes: Benefit for income taxes was $(89,000) for the second quarter of 2012. There was no provision for income taxes for the second quarter of 2011.

Asset Quality

Nonaccrual loans were $5.7 million at June 30, 2012 compared with $2.6 million at December 31, 2011. The increase is due primarily to two commercial nonresidential loans totaling $2.5 million to the same borrower that were troubled debt restructurings deemed to be impaired and were placed on nonaccrual status due to a decline in the borrowers' net worth and global cash flow.

Loans with balances totaling $11.2 million at June 30, 2012 and $12.0 million at December 31, 2011 were considered to be impaired. At June 30, 2012 and December 31, 2011, there were 20 and 23 impaired loans, respectively. In evaluating the adequacy of the allowance for loan losses, total estimated impairments of $473,000 were specifically reserved on impaired loans at June 30, 2012 and December 31, 2011.

The following table reflects loan balances considered to be impaired by asset type at June 30, 2012 and December 31, 2011.

                                             June 30,       December 31,
             (in thousands)                    2012             2011
             Commercial non residential      $   7,169     $        7,395
             Permanent one- to four-family         223                  -
             Permanent multifamily                   -                659
             Land                                2,207              2,224
             Consumer                               60                 76
             Commercial business                 1,557              1,626
               Total impaired loans          $  11,216     $       11,980

At June 30, 2012, 95% of impaired loans totaling $10.6 million included loans to seven borrowers. Additional information regarding these borrowers, by market area as of June 30, 2012 is provided in the following table:

                         Loan Balance
                         June 30, 2012
Loan Type Market Area   (in thousands)
Land      Alaska        $         2,021



Commercial business                                            Alaska      1,427
Commercial real estate and land                                Alaska      1,569
Commercial real estate                                         Idaho       1,923
Commercial real estate                                         Alaska      2,366
Commercial real estate                                         Alaska        807
Commercial real estate                                         Idaho         532
  Total - Impaired loans of seven largest credit relationships          $ 10,645

The Bank had $258,000 and $880,000 of real estate owned and repossessed assets at June 30, 2012 and December 31, 2011, respectively. The decrease is due to the sale and final charge off of real estate owned from one of the remaining out of state problem credits and additional impairment on another out of state real estate owned property.

Liquidity and Capital Resources

The Company's primary sources of funds are deposits, borrowings, and principal and interest payments on loans. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. The Company's primary investing activity is loan originations. The Company maintains liquidity levels believed to be adequate to fund loan commitments, investment opportunities, deposit withdrawals and other financial commitments. In addition, the Bank has available a line of credit with the FHLB generally equal to the lower of 25% of the Bank's total assets, or pledged collateral of approximately $44.4 million at June 30, 2012, of which $39.4 million was unused. There was $3.0 million outstanding on the line at December 31, 2011. At June 30, 2012, there was $3.0 million outstanding on the line and an additional $2.0 million of the borrowing line was committed to secure public deposits.

As disclosed in our Condensed Consolidated Statements of Cash Flows in Item 1 of . . .