Washington
(State or other jurisdiction
of incorporation or organization)

91-1529841
(I.R.S. Employer
Identification No.)

927 Commerce Ave., Longview, Washington 98632
(Address of principal executive offices) (Zip Code)

(360) 423-9800
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(g) of the Act
Common Stock, No par value
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form of this form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes[ ] No [X]

The aggregate market value of Registrant's Common Stock held by non-affiliates of the Registrant on June 28, 2002, was $20,758,000.

Common Stock, no par value on February 28, 2003: 3,818,632

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K into which the document is incorporated: Portions of the registrants proxy statement for the 2003 annual meeting of shareholders are incorporated by reference in Part III hereof.

Note: This document has not been reviewed, or confirmed for accuracy or relevancy by the Federal Deposit Insurance Corporation.

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Cowlitz Bancorporation (the "Company") was organized in 1991 under Washington law to become the holding company for Cowlitz Bank (the "Bank"), a Washington state chartered bank that commenced operations in 1978. The principal executive offices of the Company are located in Longview, Washington. The Company operates as a community bank under the names Cowlitz Bank with five branches in Cowlitz County and southwest Washington; Northern Bank of Commerce ("NBOC") in Portland, Oregon with one full service and one limited service branch; and Bay Bank operating one branch in Bellevue, Washington. Cowlitz Bank also provides mortgage banking services through its Bay Mortgage and Bay Escrow divisions with offices in Seattle, Bellevue, Longview, and Vancouver, Washington.

The Company offers or makes available a broad range of financial services to its customers, primarily small and medium-sized businesses, professionals, and retail customers. The Bank's commercial and personal banking services include commercial and real estate lending, consumer lending, mortgage origination and trust services. The Company also provided asset-based lending services to companies throughout the Western United States through its subsidiary, Business Finance Corporation ("BFC"), from 1998 until its sale in February 2002. The Company's goals are to offer exceptional customer service and to invest in the markets it serves through its business practices and community service.

The Company offers a broad portfolio of products and services tailored to meet the financial needs of individuals and small business customers in its market areas. It believes this portfolio is generally competitive with the products and services of its competitors, including major regional and national banks. These products and services include:

Deposit Products. The Company offers non-interest-bearing checking accounts, interest-bearing checking and savings accounts, money market accounts and certificates of deposit. These accounts generally earn interest at rates established by management based on competitive market factors and management's desire to increase certain types or alter maturities of deposit liabilities. During times of asset growth, or as liquidity needs arise, the Company utilizes brokered deposits as a source of funding. The Company strives to establish customer relationships to attract core deposits in non-interest-bearing transactional accounts and thus to reduce its cost of funds.

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Loan Products. The Company offers a broad range of loan products to retail and business customers. The Company maintains loan underwriting standards with written loan policies, conservative individual and branch limits and reviews by the loan committee. Further, in the case of particularly large loan commitments or loan participations, loans are reviewed by the Company's board of directors. Underwriting standards are designed to achieve a high-quality loan portfolio, compliance with lending regulations and the desired mix of loan maturities and industry concentrations. Management seeks to minimize credit losses by closely monitoring the financial condition of its borrowers and the value of collateral.

Commercial Loans. Commercial lending is the primary focus of the Company's lending activities, and a significant portion of its loan portfolio consists of commercial loans. The Company offers specialized loans for its business and commercial customers. These include equipment and inventory financing, operating lines of credit and accounts receivable financing. For reporting purposes, a substantial portion of the Company's commercial loans are designated as real estate loans, as the loans are secured by mortgages and trust deeds on real property, although the loans may be made for purposes of financing commercial activities, such as accounts receivable, equipment purchases and inventory or other working capital needs. Lending decisions are based on careful evaluation of the financial strength, management and credit history of the borrower, and the quality of the collateral securing the loan. Commercial loans secured by real property are generally limited to 80% of the value of collateral. In s ome cases, the Company may require personal guarantees and secondary sources of repayment. In competing with major regional and national banks, the Company is limited by its single borrower lending limits imposed by law.

Real Estate Loans. Real estate loans are available for construction, purchasing and refinancing residential owner-occupied and rental properties. Borrowers can choose from a variety of fixed and adjustable rate options and terms. Real estate loans reflected in the loan portfolio also include loans made to commercial customers that are secured by real property. The Company provides customers access to long-term conventional real estate loans primarily through Bay Mortgage. Bay Mortgage specializes in all facets of residential lending from single family homes to small multi-plexes, including FHA and VA loans, construction and bridge loans. The majority of the residential loans, excluding construction and bridge loans, are sold into the secondary market.

Consumer Loans. The Company provides loans to individual borrowers for a variety of purposes, including secured and unsecured personal loans, home equity, personal lines of credit and motor vehicle loans. Consumer loans can carry significantly greater risks than other loan products, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are dependent on borrowers' continuing financial stability, and are sensitive to job loss, illness and other personal factors. The Company attempts to manage the risks inherent in consumer lending by following strict credit guidelines and conservative underwriting practices. The Company also offers Visa and MasterCard credit cards to its customers.

Other Banking Products and Services. In support of its focus on personalized service, the Company offers additional products and services for the convenience of its customers. These services include a debit card program, automated teller machines at five branch locations and an automated telephone banking service with 24-hour access to accounts that also allows customers to speak directly with a customer service representative during normal banking hours. The Company does not currently charge fees for any of these services, with the exception of ATM transactions through other financial institutions. The Company provides drive-through facilities at four of its branches, including the Triangle Mall branch in Longview, which is exclusively a drive-up facility. In 2001, the Company implemented a website, internet banking, and cash management system to enhance the services available to both business and private account holders. Account inquires, wire transfers, bill pay services, and general manag ement of account portfolios are services now available on line. The Company's website address is www.cowlitzbancorp.com. The contents of this website are not incorporated into this document or into the Company's other filings with the SEC.

Trust Services. Cowlitz Bank is the only bank in Cowlitz County to offer complete in-house trust services. The trust department, located in the offices of the Main Branch in Longview, WA, focuses on the needs of the customer, providing trust services to individuals, partnerships, corporations and institutions and acting as fiduciary of living trusts, estates and conservatorships. The trust department also acts as trustee under wills, trusts, and other plans. The Company believes these services add to the value of Cowlitz Bank as a community bank by providing local access to services that have been previously sought from out of the area institutions.

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Internet Banking. Continuing the Company's desire to provide valuable financial services to its customers, a website and Internet banking and cash management system was introduced in the second quarter of 2001. Through this upgrade of our technology capabilities, the Company is able to provide our clients secure access, information, and services while enhancing the advantages they presently enjoy. Business clients can avail themselves of a comprehensive cash management program which allows them to easily and securely move money between accounts, wire funds, receive funds, pay bills, and generally manage their financial resources. Retail customers now have the ability to access account information, pay bills, and manage their accounts from the comfort of their homes. By offering on-line banking services, the Company hopes to strengthen existing customer relationships and to attract new customers in the future.

Other Financial Services. The Company believes that providing its customers a full range of financial services is an important element of its strategy to attract and retain customers. To this end, the Company has entered into a lease arrangement with Raymond James Financial Services, Inc., a securities broker. This organization rents an office on the main floor of the Cowlitz Financial Center, where the main office of the Company is located, and has access to space in the Company's other branches to allow representatives of Raymond James to meet with clients. The Company has no other financial interest in Raymond James Financial Services, Inc.

In February 2002, the Company sold substantially all assets of Business Finance Corporation (BFC) for a pre-tax gain of $423,000. The sale represents the disposal of a business segment and the gain from disposition has been recorded within discontinued operations for the year ended December 31, 2002. The following table summarizes the sale transaction:

On July 1, 2000, the Company acquired Northern Bank of Commerce (NBOC), of Portland, Oregon for approximately $3.8 million in cash, including acquisition costs. Under the terms of the agreement, the shareholders of NBOC received $2.48 in cash in exchange for each share of NBOC stock. The Company accounted for the transaction using the purchase method of accounting and, as part of the transaction, goodwill of $946,000 was recorded.

The following table summarizes the acquisition of NBOC.

The following unaudited pro forma financial information for the Company gives effect to the acquisitions of NBOC, as if it had occurred on January 1, 2000. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had the acquisition occurred on the dates indicated, or which may result in the future for the combined companies under the ownership and management of the Company. The pro forma results include certain adjustments, such as additional expense resulting from the amortization of goodwill.

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The Company's primary market areas in which it accepts deposits and makes loans are Cowlitz County, in southwest Washington, King County, Washington, the Portland metropolitan area in Oregon, and the surrounding counties in Washington and northwest Oregon. As a community bank, Cowlitz Bank has certain competitive advantages due to its local focus, but is also more closely tied to the local economy than many of its competitors, which serve a number of geographic markets. Bay Mortgage is concentrated in western Washington and northwest Oregon.

As of December 31, 2002, the Company employed a total of 200 full-time equivalent employees. None of the employees are subject to a collective bargaining agreement and the Company considers its relationships with its employees to be favorable.

The Company is extremely sensitive to the economy of Cowlitz County, which is firmly dependent on manufacturing industries, including pulp and paper and wood products. These industries have been in a state of decline for the past 15 years, and Cowlitz County felt the impact particularly in 2002 and 2001. The permanent loss of at least 800 manufacturing jobs during 2001, double-digit unemployment, two contentious strikes, and increasing power rates are factors that have severely dampened the local economy. The county's unemployment rate has been 25% or more than the average of the state of Washington in all but one of the past 23 years. The Company's expansion into the Seattle, Washington, and Portland, Oregon markets has greatly reduced its dependence on the economy of Cowlitz County. However, the Company is still dependent on the economy in the Pacific Northwest region, which has experienced similar challenges in unemployment, increased utility costs, and general economic wea kness in the Portland and Seattle metro areas. In the recent past, the unemployment rates of both Washington and Oregon have exceeded national levels, and growth rates for jobs, wages, and commodity prices has been slow. The Pacific Northwest has a higher concentration of technology and aerospace companies than the balance of the nation, and these industries, have been impacted greatly during the recent economic weakness.

The Company, like other lenders, is subject to credit risk, which is the risk of losing principal and interest due to customers' failure to repay loans in accordance with their terms. Although the Company has established lending criteria and most loans are secured by collateral, continued economic weakness or a rapid increase in interest rates could have a negative effect on collateral values or borrowers' ability to repay. The Company's targeted customers are small to medium-size businesses, professionals, and retail customers that may have limited capital resources to repay loans during a prolonged economic downturn.

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The Company's earnings are largely derived from net interest income, which is interest income and fees earned on loans, interest-earning cash deposits, and investments, less interest expense paid on deposits and other borrowings. Interest rates are highly sensitive to many factors which are beyond the control of the Company's management, including general economic conditions, and the policies of various governmental and regulatory authorities. As interest rates change, net interest income is affected. With fixed rate assets (such as fixed rate loans) and liabilities (such as certificates of deposit), the effect on net interest income depends on maturities of these assets and liabilities. Although the Company strives to minimize interest rate risk through asset/liability management policies, from time to time maturities are not balanced. Further, an unanticipated rapid decrease or increase in interest rates could have an adverse effect on the spreads between the interest rates earned on assets and the rates of interest paid on liabilities and, therefore, on the level of net interest income.

The banking industry in the market areas in which the Company operates is generally characterized by well established, large banks based outside of the region. In addition, thrift institutions, other community banks, and credit unions compete for deposits and consumer loans. Non-traditional banking entities such as investment banking firms, insurance companies, payday loan offices, and related industries offering bank-like products, have also increased competition for deposits and loans.

The major competition for commercial and mortgage banking services in Cowlitz County comes from U.S. Bank, Key Bank, Bank of America and Columbia State Bank. None of these competitors are headquartered in Cowlitz County and many have relocated key functions (such as loan decisions) to regional offices outside of the area. Three community banks located in Longview, Hometown National Bank, Riverview Community Bank, and Twin City Bank, also compete with the Company and offer community based decision-making and the personal service associated with community banking. Bay Bank and Bay Mortgage's offices, in the greater Seattle market area, compete with U.S. Bank, Key Bank, Bank of America, Wells Fargo, Washington Mutual, Evergreen State Bank, Western Bank, Columbia Bank, First Horizon, and community banks and mortgage companies located in the King County market. For NBOC in the Portland area, competition comes from banks such as Washington Mutual, US Bank, Bank of America, Wells Fargo, Centennia l Bank, Pacific Northwest Bank, and Key Bank. The retirement center branch competes with smaller, in-store branches (such as Washington Mutual branches in Fred Meyer stores) and credit unions.

Offices of the major financial institutions have competitive advantages over the Company in that they have high public visibility, may offer a wider variety of products and are able to maintain advertising and marketing activities on a much larger scale than the Company can economically maintain. Since single borrower lending limits imposed by law are dependent on the capital of the institution, the branches of larger institutions with substantial capital bases also have an advantage with respect to loan applications that are in excess of the Company's legal lending limits.

In competing for deposits, the Company is subject to certain limitations not applicable to non-bank financial institution competitors. Previous laws limiting the deposit instruments and lending activities of savings and loan associations have been substantially eliminated, thus increasing the competition from these institutions. In Cowlitz County, the main source of competition for deposits is the relatively large number of credit unions.

With significant competition in the Company's market areas, there can be no assurance that the Company can continue to attract significant loan and deposit customers. The inability to attract these customers could have an adverse effect on the Company's financial position and results of operations.

The Company and the Bank are subject to extensive regulations under federal and state laws. These laws and regulations are intended primarily to protect depositors and the deposit insurance fund, rather than shareholders. Cowlitz Bank is a state chartered commercial bank, which is not a member of the Federal Reserve System, and is subject to primary regulation and supervision by the Director of Financial Institutions of the State of Washington (the "Washington Director") and by the Federal Deposit Insurance Corporation (the "FDIC"), which also insures bank deposits. The Company is also subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). Federal and state regulations place banks at a competitive disadvantage compared to less regulated competitors such as finance companies, credit unions, mortgage banking companies and leasing companies. Although the Company has been able to compete effectively in its market area in the past, there can be no assurance that it will be able to continue to do so. Any future changes in federal and state banking regulations could adversely affect the Company's operating results and ability to continue to compete effectively.

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The Company and the Bank are subject to extensive regulation under federal and state laws. The laws, together with the regulations promulgated under them, significantly affect respective activities of the Company and the Bank and the competitive environment in which they operate. The laws and regulations are primarily intended to protect depositors and the deposit insurance fund, rather than shareholders.

The description herein of the laws and regulations applicable to the Company and the Bank, does not purport to be a complete description of the laws and regulations mentioned herein or of all such laws and regulations. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Company and the Bank. The operations of the Company and the Bank may be affected by legislative and regulatory changes as well as by changes in the policies of various regulatory authorities. The Company cannot accurately predict the nature or the extent of the effects that such changes may have in the future on its business and earnings.

Bank Holding Company Regulation. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended ("BHCA") and, as such, is subject to the regulations of the Federal Reserve. Bank holding companies are required to file periodic reports with, and are subject to periodic examination by, the Federal Reserve. The Federal Reserve has issued regulations under the BHCA requiring bank holding companies to serve as a source of financial and managerial strength to their subsidiary banks. It is the policy of the Federal Reserve that, pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. Additionally, under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become "underca pitalized" (as defined in the statute) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution's total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan. Under the BHCA, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the Federal Reserve's determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

Capital Adequacy Guidelines for Bank Holding Companies. The Federal Reserve is the federal regulatory and examining authority for bank holding companies. The Federal Reserve has adopted capital adequacy guidelines for bank holding companies. These guidelines are similar to, although not identical with, the guidelines applicable to banks. See "Bank Capital Requirements."

Bank Regulation. The Bank is organized under the laws of the State of Washington and is subject to the supervision of the Department of Financial Institutions ("DFI"), whose examiners conduct periodic examinations of state banks. Cowlitz Bank is not a member of the Federal Reserve System, so its principal federal regulator is the FDIC, which also conducts periodic examinations of the Bank. The Bank's deposits are insured, to the maximum extent permitted by law, by the Bank Insurance Fund ("BIF") administered by the FDIC and are subject to the Federal Deposit Insurance Corporation's ("FDIC") rules and regulations respecting the insurance of deposits. See "Deposit Insurance."

Both federal and state laws extensively regulate various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Current federal law also requires banks, among other things, to make deposited funds available within specified time periods.

Insured state-chartered banks are generally prohibited under FDICIA from engaging as principal in activities that are not permitted for national banks, unless (i) the FDIC determines that the activity would pose no significant risk to the appropriate deposit insurance fund, and (ii) the bank is, and continues to be, in compliance with all applicable capital standards. The Company believes that these restrictions do not have a material adverse effect on its current operations.

Bank Capital Requirements. The FDIC has adopted risk-based capital ratio guidelines to which the Bank is subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk.

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These guidelines divide a bank's capital into two tiers. Tier 1 includes common equity, certain non-cumulative perpetual preferred stock (excluding auction rate issues) and minority interest in equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets (except mortgage servicing rights and purchased credit card relationships, subject to certain limitations). Supplementary (Tier 2) capital includes, among other items, cumulative perpetual and long-term, limited-life, preferred stock, mandatory convertible securities, certain hybrid capital instruments, term-subordinated debt and the allowance for loan and lease losses, subject to certain limitations, less required deductions. Banks are required to maintain a total risk-based capital ratio of 8%, of which 4% must be Tier 1 capital. The FDIC may, however, set higher capital requirements when a bank's particular circumstances warrant. Banks experiencing or anticipating significant growth are expected to maintain capital ra tios, including tangible capital positions, well above the minimum levels.

In addition, the FDIC has established guidelines prescribing a minimum Tier 1 leverage ratio (Tier 1 capital to adjusted total assets as specified in the guidelines). These guidelines provide for a minimum Tier 1 leverage ratio of 3% for banks that meet certain specified criteria, including that they have the highest regulatory rating and are not experiencing or anticipating significant growth. All other banks are required to maintain a Tier 1 leverage ratio of not less than 4%.

At December 31, 2002, the regulatory capital ratios for the Company and the Bank were:

Dividends. The principal source of the Company's cash revenues is dividends from Cowlitz Bank. Under Washington law, Cowlitz Bank may not pay dividends in an amount greater than its retained earnings as determined by generally accepted accounting principles. In addition, the DFI has the authority to require a state-chartered bank to suspend payment of dividends. The FDIC has the authority to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the bank or if it would cause a bank to become undercapitalized. Currently, the FDIC requires the Bank to gain permission prior to paying dividends to the Holding Company.

Lending Limits. Under Washington law, the total loans and extensions of credit by a Washington-chartered bank to a borrower outstanding at one time may not exceed 20% of such bank's capital and surplus. However, this limitation does not apply to loans or extensions of credit which are fully secured by readily marketable collateral having market value of at least 115% of the amount of the loan or the extension of credit at all times.

Branches and Affiliates. Establishment of bank branches is subject to approval of the DFI and FDIC and geographic limits established by state laws. Washington's branch banking law permits a bank having its principal place of business in the State of Washington to establish branch offices in any county in Washington without geographic restrictions. A bank may also merge with any national or state chartered bank located anywhere in the State of Washington without geographic restrictions.

Under Oregon law, an out-of-state bank or bank holding company may merge with or acquire an Oregon state chartered bank or bank holding company if the Oregon bank, or in the case of a bank holding company, the subsidiary bank, has been in existence for a minimum of three years, and the law of the state in which the acquiring bank is located permits such merger. Branches may not be acquired or opened separately, but once an out-of-state bank has acquired branches in Oregon, either through a merger with or acquisition of substantially all of the assets of an Oregon bank, the bank may open additional branches.

The Bank is subject to Sections 22 (h), 23A and 23B of the Federal Reserve Act, which restrict financial transactions between banks and affiliated companies. The statute limits credit transactions between a bank and its executive officers and its affiliates, prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a bank's extension of credit to an affiliate.

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FDICIA. FDICIA requires, among other things, federal bank regulatory authorities to take "prompt corrective action" with respect to banks which do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.

The FDIC has adopted regulations to implement the prompt corrective action provisions of FDICIA. Among other things, the regulations define the relevant capital measures for the five capital categories. An institution is deemed to be "well capitalized" if it has a total, risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater, and is not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure. The Federal Reserve Board classifies a bank holding company as "well capitalized" if it has a total, risk-based capital ratio of 10% or greater and a Tier 1 risk-based capital ratio of 6% or greater. The Company and the Bank currently exceed all of these ratios.

FDICIA further directs that each federal banking agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, management compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value of publicly traded shares and such other standards as the agency deems appropriate.

Deposit Insurance. The Bank's deposits are insured up to $100,000 per insured account by the Bank Insurance Fund (BIF). As an institution whose deposits are insured by BIF, Cowlitz Bank is required to pay deposit insurance premiums to BIF. FDICIA required the FDIC to issue regulations establishing a system for setting deposit insurance premiums based upon the risks a particular bank or savings association poses to the deposit insurance funds. This system bases an institution's risk category partly upon whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. Each insured depository institution is also assigned to one of three "supervisory" categories based on reviews by regulators, statistical analysis of financial statements and other relevant information. An institution's assessment rate depends upon the capital category and supervisory category to which it is assigned. Annual assessment rates currently range from no premium for the highest r ated institution to $0.27 per $100 of domestic deposits for an institution in the lowest category. During 2002, the Bank paid an assessment rate of $0.17 per $100 of domestic deposits. Under legislation enacted in 1996 to recapitalize the Savings Association Insurance Fund, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation ("FICO") to service FICO debt incurred in the 1980's. The current FICO assessment rate for BIF insured deposits is $0.0168 per $100 of deposits per year. Any increase in deposit insurance or FICO assessments could have an adverse effect on Cowlitz Bank's earnings.

Gramm-Leach-Bliley Act. On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was signed into law, which significantly reformed various aspects of the financial services business. Among the provisions in the GLB Act are those which:

Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires financial institutions regulated by the federal financial supervisory agencies to ascertain and help meet the credit needs of their delineated communities, including low-income and moderate-income neighborhoods within those communities, while maintaining safe and sound banking practices. The regulatory agency assigns one of four possible ratings to an institution's CRA performance and is required to make public an institution's rating and written evaluation. The four possible ratings are "outstanding," "satisfactory," "needs to improve" and "substantial non-compliance."

Many factors play a role in assessing a financial institution's CRA performance. The institution's regulator must consider its financial capacity and size, legal impediments, local economic conditions and demographics and the competitive environment in which it operates. The evaluation does not rely on absolute standards and financial institutions are not required to perform specific activities or to provide specific amounts or types of credit.

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The Company's most recent rating under CRA is "satisfactory." This rating reflects the Company's commitment to meeting the credit needs of the communities it serves. Although the Company strives to maintain a satisfactory or higher rating, no assurance can be given that the Company will maintain this rating in the future.

Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The new law addresses public company corporate governance, auditing, accounting, executive compensation, and enhanced and timely disclosure of corporate information.

The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

The Sarbanes-Oxley Act provides for, among other matters:

• a prohibition on personal loans by Cowlitz to its directors and executive officers except loans in the ordinary course of business made by its subsidiary, Cowlitz Bank;
• independence requirements for Board audit committee members and our auditors;
• certification of Exchange Act reports by the chief executive officer and the chief financial officer;
• disclosure of off-balance sheet transactions;
• expedited reporting of stock transactions by insiders; and
• increased criminal penalties for violations of securities laws.

Provisions of the Sarbanes-Oxley Act become effective at various times during the 18 months beginning July 30, 2002. The SEC has been delegated the task of adopting rules to implement various provisions, including disclosure in periodic filings pursuant to the Exchange Act. Also, in response to the Sarbanes-Oxley Act, the NASD will adopt new standards for listed companies. While we believe the Sarbanes-Oxley Act may, to some degree, affect our reporting expenses, we do not believe that the Act will have a material adverse effect on our business and operations.

Additional Matters. In addition to the matters discussed above, the Company and Cowlitz Bank are subject to additional regulation of their activities, including a variety of consumer protection regulations affecting their lending, deposit and collection activities and regulations affecting secondary mortgage market activities.

The earnings of financial institutions, including the Company and Cowlitz Bank, are also affected by general economic conditions and prevailing interest rates, both domestic and foreign and by the monetary and fiscal policies of the U.S. Government and its various agencies, particularly the Federal Reserve.

Additional legislation and administrative actions affecting the banking industry may be considered by the United States Congress, the Washington Legislature and various regulatory agencies, including those referred to above. It cannot be predicted with certainty whether such legislation or administrative action will be enacted or the extent to which the banking industry in general or the Company and Cowlitz Bank in particular would be affected.

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The Company owns its main office space at the Cowlitz Financial Center (CFC) in Longview, Washington. Cowlitz Bank occupies approximately 27,500 square feet of this facility. The Company leases space in the CFC to Raymond James Financial Services, Inc., which provides investment-related services to Cowlitz Bank customers. The Company owns branches in Kelso and Kalama and leases facilities for banking branches in the Triangle Mall in Longview, Castle Rock, and Bellevue, and mortgage branches in Bellevue, Seattle, and Vancouver, Washington. Five of these offices have automated teller machines and four provide drive-up services, including the Triangle Mall location, which is exclusively a drive-up branch facility. In Portland, Oregon the Company leases downtown office space for the Northern Bank of Commerce main office and operates a limited service branch in a retirement center in Wilsonville, Oregon. During 2002 and January of 2003, the Company closed 11 of its retirement center branches locat ed in the greater Portland area, and its Silverdale, Washington mortgage office. Business Finance Corporation leased its facilities in Bellevue, Washington, until it was sold in the 1^st quarter of 2002. The following are all of the Company's locations.

The Company from time to time enters into routine litigation resulting from the collection of secured and unsecured indebtedness as part of its business of providing financial services. In some cases, such litigation will involve counterclaims or other claims against the Company. Such proceedings against financial institutions sometimes also involve claims for punitive damages in addition to other specific relief. The Company is not a party to any litigation other than in the ordinary course of business, except as noted below. In the opinion of management, the ultimate outcome of all pending legal proceedings will not individually or in the aggregate have a material adverse effect on the financial condition or the results of operations of the Company.

On March 8, 2002, a lawsuit was filed in the King County, Washington Superior Court against the Company by Independent Financial Network, Inc. ("IFN"), and one of IFN's shareholders, Scott Rerucha. The Company acquired certain assets and operations from IFN in 1999 pursuant to a purchase agreement with IFN, Mr. Rerucha, and other individuals. The operations acquired from IFN are the core of the Company's Bay Mortgage division. The complaint alleged, among other things, that the Company had materially breached its obligations under the purchase agreement and requested that the plaintiffs be awarded unspecified damages and that Mr. Rerucha be relieved of his non-competition obligations under the purchase agreement. An out of court settlement was reached between the Company and the plaintiff on February 27, 2003, and the Company does not expect the results of the settlement to have a material impact on its results of operation.

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No matters were presented for a vote of the Company's shareholders during the fourth quarter of 2002.

Cowlitz Bancorporation stock trades on the Nasdaq National Market under the symbol "CWLZ".

During 2002, the Company neither declared nor paid any dividends to its stockholders. During 2001, the Company paid three dividends, including a dividend of $.018 declared in the fourth quarter of 2000, which was paid in the first quarter of 2001. The Company suspended dividends indefinitely after the 2^nd quarter of 2001. As of February 28, 2003 there were 3,818,632 shares of common stock outstanding and 289 shareholders of record, which excludes shares held in street name.

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(dollars in thousands, except per share data)

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For the 12 months ended December 31, 2002, Cowlitz Bancorporation (the "Company") recorded net income of $1.5 million or $.39 per diluted share of common stock ("per share"). This net income compares to a net loss of $1.5 million or $(.39) per share and net income of $869,000 or $.22 per share for the corresponding periods ended December 31, 2001, and 2000, respectively.

During 2002, the Company's continuing operations contributed $2.0 million or $.53 per diluted share, which compares to $608,000 or $.16 per share during 2001, and $356,000 or $.09 per share during 2000. Much of the increase in net income from continuing operations between 2001 and 2002 is the result of an increase in net interest income after the provision for loan losses of $1.4 million. Non-interest income also increased $2.3 million from 2001 to 2002, but was offset by an increase in non-interest expenses of $2.7 million for the same period.

The Company's results of operation for the year ended December 31, 2002 were characterized by a declining commercial loan portfolio, high mortgage lending volumes, continuous reductions in certificate of deposit rates and volumes, and the sale of its wholly-owned, asset-based lending subsidiary, Business Finance Corporation ("BFC"). Interest rates were relatively stable throughout 2002, with a single .5% decline of the federal funds rate by the Federal Reserve Board during November.

The Company's subsidiary, Cowlitz Bank (also the "Company" or the "Bank") experienced a significant decline in loan volumes during 2002. Under the current low rate environment, many borrowers began shopping the marketplace. While the Bank makes every effort to be competitive for and retain favorable client relationships, management also sees this time as an opportunity to encourage some customers representing weaker credits to seek alternative lending relationships. Excluding loans held-for-sale, loan volumes declined $37.7 million to $194.5 million at December 31, 2002 from $232.2 million at December 31, 2001.

The mortgage re-finance market was very strong during 2002 as the Bank's mortgage segment, Bay Mortgage, originated just over one-half billion dollars in mortgage loans. This segment continued to be the strongest contributor to earnings, with $1.5 million of net income. Although non-interest income increased by $1.8 million from 2001 to 2002 at Bay Mortgage, non-interest expense also increased by $2.1 million. This segment had substantial employee turnover during the year, contributing to higher employment and training costs, and inhibiting cost efficiencies.

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As lending rates remained fairly stable through most of 2002, rates on certificates of deposit declined substantially. Many certificates of deposits that were opened during prior years at much higher rates matured during 2002. The Company chose not to renew many of these higher rate certificates as they matured, or they were renewed at lower current rates. Total certificates of deposit declined $41.1 million to $134.6 million at December 31, 2002 from $175.7 million at December 31, 2001. Maturity of brokered certificates accounted for $27.0 million of this decline.

Total assets at December 31, 2002 were $345.2 million, down 6.2% compared to total assets from continuing operations of $367.9 million at December 31, 2001. Loans, net of deferred fees, decreased $37.7 million or 16.2% to $194.5 million at December 31, 2002 from $232.2 million at December 31, 2001. Non-performing assets from continuing operations as a percentage of total assets from continuing operations increased to 2.14% at December 31, 2002 from 1.98% at December 31, 2001, even though total non-performing assets from continuing operations decreased slightly from $7.5 million to $7.4 million over the same period. Total liabilities from continuing operations for the Company decreased 8.1% or $27.7 million to $313.9 million at December 31, 2002 from $341.6 million at December 31, 2001. Under the same comparison, deposits decreased from $315.5 million to $290.1 million, a decline of $25.4 million or 8.1%.

The Company has identified its most critical accounting policy to be that related to the allowance for loan losses. The Company utilizes both quantitative and qualitative considerations in establishing an allowance for loan losses believed to be appropriate as of each reporting date. Quantitative factors include historical loss experience, recent delinquency and charge-off experience, changes in the levels of non-performing loans, portfolio size, and other known factors regarding specific loans. Qualitative factors include assessments of the types and quality of the loans within the loan portfolio as well as current local, regional, and national economic considerations. Changes in the above factors could have a significant affect on the determination of the allowance for loan losses. Therefore, a full analysis is performed by management on a quarterly basis 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 Loan Losses."

Another critical accounting policy of the Company is that related to the carrying value of goodwill. During the first quarter of 2002, the Company recorded an impairment charge to the carrying amount of its goodwill related to the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142). The impairment charge is recognized as a result of a transitional goodwill impairment test required by SFAS No. 142. The Company adopted a market valuation approach in assessing goodwill impairment and will measure the carrying value similarly at least annually under the new accounting rules. Ongoing impairment analysis of the fair value of the remaining goodwill will involve a substantial amount of judgment, as will establishing and monitoring estimated amounts and lives of other intangible assets. Also as required upon adoption of SFAS No. 142, the Company ceased amortization of goodwill on January 1, 2002.

SFAS No. 123, "Accounting for Stock-Based Compensation," requires disclosure about stock-based compensation arrangements regardless of the method used to account for them. As permitted by SFAS No. 123, the Company has decided to apply the accounting provisions of Accounting Principles Board (APB) Opinion No. 25, and therefore discloses the difference between compensation cost included in net income and the related cost measured by the fair value-based method defined by SFAS No. 123, including tax effects, that would have been recognized in the statement of operations if the fair value method had been used. Under APB Opinion No. 25, no compensation cost has been recognized for the Company's stock option plans. Had compensation cost for these plans been determined consistent with SFAS No. 123 and recognized over the vesting period, the Company's net income (loss) and earnings (loss) per share would have been reduced to the following pro forma amounts:

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The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for December 31, 2002, 2001, and 2000:

On February 15, 2002, the Company sold its asset-based lending subsidiary, Business Finance Corporation (BFC), to an independent third party. An after-tax gain of $279,000 was recorded on the sale, and, along with the results of operations of BFC, is recorded within the consolidated income statement as net income from discontinued operations. All previously issued consolidated financial statements have been restated to also disclose the assets, liabilities, and operations of BFC as discontinued operations. BFC's discontinued operations resulted in income net of tax of $285,000 or $.07 per diluted share during 2002, a net loss of $2.1 million or $(.55) per diluted share during 2001, and $513,000 or $.13 per diluted share during 2000.

The net loss from discontinued operations during 2001 was partially due to a $1.6 million provision for loan losses recorded to fully reserve for the charge-off of certain accounts receivable at BFC in which collection was considered doubtful. An extensive internal review of BFC receivables, including the adequacy of underlying collateral and the financial strength of borrowers, uncovered numerous deficiencies. Although these receivables were previously monitored in accordance with the Company's existing loan loss allowance procedures, the rapid decline in the economy during 2001 prompted management to further review, evaluate, and charge-off problem credits beginning in early 2001. Preliminary market research and discussions with potential buyers of BFC during the summer of 2001 also indicated that many of these credits were not saleable under the declining economic conditions, the resulting weakness of collateral values, and these borrowers' decreasing ability to repay. Many of the borrowers that had been working with management earlier in the year to avoid defaulting on their financing were adversely affected by the continued weakening of the economy, pushing several of them to file bankruptcy in mid to late 2001. These borrowers' pending bankruptcies accounted for over $1.1 million of the impairment charge taken in 2001, and $822,000 of the $1.1 million was to one real estate company. Of the $1.6 million charge-off, $954,000 was related to construction or real estate companies, $293,000 was for companies in the communications industry, and $48,000 was related to manufacturing and industrial companies.

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Another major contributor to the loss from discontinued operations in 2001 was a charge against income of $1.2 million related to impairment of the carrying value of goodwill on the balance sheet of BFC. An accounts receivable analysis performed during the year, combined with management's low market valuation assessment of the BFC segment, were part of the decision to record impairment of goodwill by writing off the entire asset value. This decision resulted in a charge against income of $1.2 million, which contributed to the $2.1 million loss from discontinued operations. Management's assessment of the value of BFC was largely determined from preliminary discussions with several potential buyers of BFC who indicated an unwillingness to purchase the segment for a premium above the book value of the segment's stronger receivables. Since these preliminary market valuations of the BFC segment did not support the goodwill asset value, and the decline in the economy had weakened many of the receivables, management wrote down the goodwill asset value to zero.

Unless noted otherwise, the results of operation of the discontinued segment are excluded from the following presentation and discussions. The footnotes to the accompanying consolidated financial statements include additional presentation and discussions regarding the discontinued operations of BFC.

Cumulative Effect of a Change in Accounting Principles

During 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets". The adoption of this statement resulted in the cessation of the amortization of goodwill and management's assessment of an impairment charge relating to the Company's previous acquisition of Bay Mortgage. As a result, a charge to income, net of tax, of $791,000 was recorded during the first quarter of 2002. Ongoing annual, or more often if conditions dictate, analysis of the fair value of remaining goodwill for impairment will involve a substantial amount of judgment, as will establishing and monitoring estimated amounts and lives of other intangible assets.

Net Interest Income

For financial institutions, the primary component of 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 result from changes in "volume," "spread" and "margin." Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. 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 level and relative mix of interest-earning assets and interest-bearing liabilities.

The following table sets forth, for the periods indicated, information with regard to average balances of assets and liabilities, the total dollar amount of interest income on interest-earning assets and interest expense on interest-bearing liabilities, the resulting yields or costs, net interest income, and net interest spread. Non-accrual loans have been included in the table as loans carrying a zero yield. Loan fees are recognized as income using the interest method over the life of the loan.

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

(2) Loans and loans held-for-sale include loans on which the accrual of interest has been discontinued

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

The yield earned on loans outstanding (including residential mortgage loans held-for-sale) during 2002 was 7.95% compared to 8.71% in 2001, and 9.70% in 2000. The rate and average volume of loans from 2001 to 2002 both declined, causing the total interest income on loans to decrease to $19.7 million in 2002 compared to $24.0 million for 2001 and $19.8 million in 2000. The yield earned on taxable securities decreased to 3.65% in 2002 from 5.09% in 2001 as longer term securities earning a higher rate have matured and been replaced at current, lower rates. The combination of average interest-earning balances due from banks and federal funds sold remained virtually unchanged during 2002 when compared to 2001, but the yield earned on these assets declined considerably. The total yield earned on all interest-earning assets declined to 6.78% in 2002 from 8.05% and 9.31% for the years 2001 and 2000, respectively. As discussed above, the decline is due to interest rate cuts, refinancing of higher rate loans, and the maturity of higher rate securities.

The rate paid for each category of interest-bearing liabilities was significantly lower during 2002 than during 2001 and 2000. The yield on savings and interest-bearing demand deposit accounts decreased to 1.72% compared to 2.91% and 3.35% in 2001 and 2000, respectively. Certificates of deposit also showed a decline in average rates paid to 4.04% during 2002 from 5.70% in 2001 and 6.31% in 2000. As certificates of deposit matured during 2002, they were either not renewed or replaced at lower rates. The decline in certificates of deposit volume is also due to the maturity of brokered deposits that management brought in to fill liquidity needs during the mortgage lending growth experienced during 2001. Long-term borrowings had a decline in rate, volume and interest expense in 2002 when compared to 2001. For all interest-bearing liabilities, the average rate paid decreased to 3.21% in 2002 from 4.82% in 2001, and 5.33% in 2000.

Net interest income for the year ended December 31, 2002 was $13.4 million, an increase of 5.5% from $12.7 million in 2001, which was $1.3 million higher than 2000. The net interest margins for the periods ended December 31, 2002, 2001, and 2000 were 4.13%, 3.92%, and 4.97%, respectively. Interest expense as a percentage of average earning assets decreased to 2.65% in 2002, compared to 4.13% in 2001 and 4.34% in 2000.

The following factors affected the Company's interest yields, margins, and spread when comparing the twelve months ending December 31, 2002 to the same period for 2001. During 2002, the national federal funds interest rate, and the Company's prime rate, experienced one decline of .5% in November. This compares to 2001 when those rates fell 11 times for a total decrease of 4.75%. In addition, both interest-earning assets and interest-bearing liabilities have seen a change in the mix of their respective components. Loan and certificates of deposit volumes are noticeably lower with offsetting increases to investment securities and saving and interest-bearing demand balances. Interest spread and interest margin have both increased when comparing 2002 to 2001, while yields and costs have declined under the same comparison.

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Under the falling rate environment of 2001, the Company saw a narrowing of its interest spread of .74% as overall interest-earning asset rates declined more rapidly than the cost of interest-bearing liabilities. Approximately 40% of the Company's loans are variable rate and adjust to changes in the prime rate. During 2001, the rates on this portion of the loan portfolio declined rapidly, dropping the total yield on interest-earning assets by 1.26% from the prior year. The cost of interest-bearing liabilities declined by only ..51% under the same comparison, because the rate on liabilities, particularly certificates of deposit declined more slowly. This trend was reversed during the relatively stable rate environment of 2002, as the interest spread increased by ..34%. Certificates of deposit that were opened during the higher rate environments matured and either were not renewed, or were renewed at lower current rates. Compared to the average rates paid during 2001, the average cost of interest-bearing liabilities decreased by 1.61% during 2002. However, the increase in the interest rate spread was not as pronounced as the decline in 2001 because the average yield on interest-earning assets declined by 1.27%. The average yield on the loan portfolio declined .76% as many borrowers took the opportunity to refinance higher rate loans at the current, lower rates.

Total interest earned and total interest paid both decreased significantly in 2002 when compared to 2001. Total volumes of interest-earning assets and average interest-bearing liabilities changed very little from year to year, but the mix changed significantly. The average loan volume has decreased $27.0 million, but was offset by an increase of $27.4 of average investment securities. The average certificate of deposit balance declined $18.1 million, and average saving and interest bearing demand deposit balances increased $10.3 million. This change in mix has caused a slight increase in the net interest margin, which increased .21% to 4.13% during 2002.

The amount of the allowance for loan 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 loan losses is recorded, the amount is based on past charge-off experience, a careful analysis of the current loan portfolio, 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 potential 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 Loan Losses" disclosure for a more detailed discussion.

The Company's provision for loan losses was $2.8 million for the year ended December 31, 2002. For the years ending December 31, 2001 and 2000 the provision was $3.5 million and $1.0 million, respectively. Charge-offs, net of recoveries, were $2.3 million in 2002, $2.2 million in 2001, and $793,000 in 2000.

The 2002 provision for loan losses includes $1.2 million resulting from the charge-off of $900,000 for a portion of one loan involving the invoice factoring business, and a $300,000 increase in the allowance for loan loss associated with the remaining balance due from this borrower. The additional provisions of $1.6 million were taken during 2002 to increase the reserve against potential losses on loans that were downgraded within the Company's "watch list." See the "Allowance for Loan Losses" disclosure for a more detailed discussion of the Company's internal risk rating system.

As the local, regional, and national economies struggle, management continues to closely monitor the Bank's credits, and is conservative when assessing them. Any deficiencies in collateral valuations or a borrower's ability to repay results in prompt action by management to more closely scrutinize, downgrade, allocate specific reserves against, or charge-off the loan. During 2001, an estimated $2.2 million provision was recorded to reserve for downgraded or newly identified potential problem loans. In connection with the NBOC acquisition in 2000, a $1.0 million escrow account was established by NBOC stockholders to reimburse the Company for potential charge-offs of impaired loans discovered after the purchase. Subsequent to the purchase of NBOC, $1.2 million of loans to a group of related borrowers, which were performing at the purchase date, became impaired. In December 2001, these loans were charged-off, and a recovery of $1.0 million was recorded from the reimbursement of the escrow account. At December 31, 2002, the allowance for loan losses was 3.16% of total loans compared to 2.46% and 1.94% at December 31, 2001 and 2000, respectively.

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Non-interest income consists of the following components:

Total non-interest income has increased year-to-year to $11.9 million in 2002, from $9.6 million in 2001 and $5.2 million in 2000. The majority of the increase is from the brokerage fees and gains on loans sold, both of which have been generated by the increased volume of residential mortgage loans originated by Bay Mortgage. With the low mortgage interest rates beginning in 2001 and continuing throughout 2002, there has been significant mortgage lending activity. These lower interest rates have continued to attract consumers to refinance existing mortgages, apply for new mortgage or construction loans, or request bridge loans for short-term financing. Each of these types of loans generates additional non-interest income for the Bank, with mortgage and escrow non-interest income increasing to $10.0 million during 2002 from $8.2 million and $3.6 million during 2001 and 2000, respectively. Gains on loan sold increased approximately $800,000 to $5.7 million in 2002 from $4.9 million in 2001, which was an increase from the 2000 level of $1.8 million. Escrow fees increased over $200,000 to $1.1 million in 2002 from $895,000 in 2001 and $316,000 in 2000. Brokerage fees, which includes points and processing fees on loans held-for-sale and fees collected from lenders the Bank brokers loans to, also remained high. In 2002, the Company recorded $3.2 million of such fees, an increase of over $700,000 from $2.5 million in 2001, which compares to the 2000 level of $1.5 million. Non-interest income declined in 2002 by $113,000 and by $429,000 in 2001 in losses taken on the sales of repossessed assets. These losses occur when the Bank's recorded value in a repossessed asset, usually real property, is higher than the amount actually realized upon sale of the asset. The Company recorded gains on the sale of securities available-for-sale of $183,000 and $89,000 during 2002 and 2001, respectively.

Non-interest Expense

Non-interest expense consists of the following components:

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Non-interest expense increased 15.1% to $20.2 million for the year ended December 31, 2002 compared to $17.5 million for the year ended December 31, 2001, which was an increase of 19.0% compared to $14.7 million for the year ended December 31, 2000. Much of the increase in non-interest expense from 2001 to 2002 was the direct result of the continued high volume of mortgage lending at Bay Mortgage. Non-interest expenses for the mortgage segment during 2001 were $6.7 million and were $8.8 million during 2002, an increase of $2.1 million or 77.8% of the total increase in non-interest expense of $2.7 million. Salaries and employee benefits, professional fees, and the FDIC insurance charges are the categories that account for the majority of the increase during 2002 when compared to 2001.

A measure of the Company's ability to contain non-interest expenses is the efficiency ratio. This measurement is derived by dividing total non-interest expense by the sum of total net interest income and non-interest income. The Company's efficiency ratio increased slightly to 79.8% for the year ended December 31, 2002 compared to 78.6% for the corresponding period in 2001 and 88.8% for the year ended December 31, 2000.

Salaries, benefits, and commissions expense of $10.7 million in 2002 represented an increase of $1.6 million or 17.6% from the $9.1 million reported in 2001 which was $700,000 or 8.3% higher than the $8.4 million reported in 2000. Much of the increase in salaries and related expenses during 2002 were the result of higher commissions paid to mortgage loan officers during the year. From 2001 to 2002, commission expense increased nearly $1.0 million based on the higher level of fee income generated by the mortgage segment. Employee turnover has also contributed to higher salary costs as severance or hiring bonuses were paid, or salaries for specific positions overlapped during training periods. The increase from 2000 to 2001 is partially due to NBOC employee wages paid for a full year in 2001, but only for half of the year in 2000. Also contributing was the overall increase in the number of employees at Bay Mortgage, where the full time equivalent count increased from 64 at the end of 2000 to 88 at the end of 2001 resulting in approximately $1.1 million increased salary expenses from year to year. These additional employees were brought in to help process and sell the increased volume of loans originated during the year. The increase of 24 employees in the mortgage division was offset by a staff reduction of ten full time equivalent employees in other divisions. Also contributing to the increases in both years were ordinary wage increases for existing employees, which generally range from three to six percent each year. At December 31, 2002, the Company had 200 full-time equivalent employees compared to 199 and 185 at December 31, 2001 and 2000, respectively.

Net occupancy and equipment expenses consist of depreciation on premises, lease costs, equipment, maintenance and repair expenses, utilities and related expenses. The Company's net occupancy expense was relatively steady during 2002, 2001, and 2000 with expenses of $2.3 million, $2.4 million, and $2.1 million, respectively.

During 2002, amortization of intangibles decreased to $265,000 from $489,000 during 2001 and $458,000 during 2000. The decrease in 2002 is the result of the Company's adoption of SFAS No. 142, in which amortization expense is no longer recognized on unidentifiable intangible assets, including the Company's goodwill. Prior to the adoption of SFAS No. 142, which effectively stopped goodwill amortization, all goodwill had been amortized on a straight-line basis over a 15-year period.A non-interest expense will be recognized in the future only if the unidentifiable intangible asset is deemed to be impaired. The intangible asset associated with the deposit premium continues to amortize and resulted in the amortization expense of $265,000 for 2002. The balance of the deposit premium, net of accumulated amortization was $502,000, and $767,000 for the year ended December 31, 2002, and 2001, respectively. The deposit premium is being amortized using an accelerated method over a ten-year life. The balance of goodwill, net of accumulated amortization, at December 31, 2002 and 2001 was $2.4 million and $3.6 million, respectively. Goodwill represents the unamortized portion of excess of acquisition costs over the fair value of net assets that arose in connection with the Company's business acquisitions. Goodwill at Bay Mortgage increased by $772,000 at December 31, 2001 as the result of additional payments recorded relating to an earn-out agreement specified in the purchase contract.

Professional fees include exam and audit expenses, consulting costs, legal fees, and other professional fees. The increase in these expenses in 2002 is the result of many factors, including higher legal fees relating to the repossession of assets on defaulted loans; the retention of an outside firm to conduct internal audits and regulatory compliance reviews; consultation regarding profit enhancement projects; legal fees and consulting relating to various strategic alternatives; and legal and consulting fees regarding management employee turnover.

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FDIC insurance premium expense increased during 2002 when compared with 2001 because of a higher assessment rate imposed on the Company during the year. The FDIC has regulations establishing a system for setting deposit insurance premiums based upon the risks a particular bank or savings association poses to the deposit insurance funds. This system bases an institution's risk category partly upon whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. Each insured depository institution is also assigned to one of three "supervisory" categories based on reviews by regulators, statistical analysis of financial statements and other relevant information. An institution's assessment rate depends upon the capital category and supervisory category to which it is assigned. Annual assessment rates currently range from no charge for the highest rated institution to $0.27 per $100 of domestic deposits for an institution in the lowest category. During 2002, the Bank paid an assessment rate of $.17 per $100 of domestic deposits. This compares to 2001 when, in the first and second quarters, the Bank paid an assessment rate of $0.10 per $100 of domestic deposits, and $0.03 for the third and fourth quarters. During 2000, the Bank was not required to pay an assessment charge on deposits. In addition, under legislation enacted in 1996 to recapitalize the Savings Association Insurance Fund, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation ("FICO") to service FICO debt incurred in the 1980's. The current FICO assessment rate for BIF insured deposits is $0.0168 per $100 of deposits per year. Any increase in deposit insurance or FICO assessments could have an adverse effect on Cowlitz Bank's earnings.

Total loan processing and related costs were $503,000 during 2002, $564,000 during 2001, and $230,000 during 2000. Loan expenses were much higher in 2001 compared to 2000 due to the volume increases experienced at Bay Mortgage, and the increased loan costs associated with booking those loans. Mortgage related loan expenses were $399,000 during 2001, compared to $84,000 during 2000. Another factor contributing to the increase was the expenses related to repossessed assets such as carrying costs and repossession costs of assets obtained in exchange for defaulted loans which were $316,000 in 2001, and $105,000 in 2000.

Costs related to the operation and disposition of other real estate owned has increased from year to year as the number and value of properties has increased. These costs, net of related rental and other income, were $260,000 in 2002, $150,000 in 2001, and $13,000 in 2000.

All other operating expenses including business taxes, travel, meals, and education, postage and freight, advertising, data and credit card processing costs, office supplies, and other business expenses were $4.1 million during 2002, $4.2 million during 2001, and $3.2 million during 2000. The increase from 2000 to 2001 was due primarily to the Company's growth and expansion, specifically the growth experienced at Bay Mortgage.

The provision for income taxes from continuing operations was $339,000, $669,000, and $494,000 for 2002, 2001, and 2000, respectively. The provision for income taxes from discontinued operations was $135,000 for 2002, a benefit of $519,000 during 2001, and $117,000 for 2000. In addition, a provision for income taxes of $417,000 was recorded in 2002 for the cumulative effect of a change in accounting principle related to the goodwill impairment charge.

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The following table summarizes the dollar and percentage change from year to year for selected balance sheet items: