Back to GetFilings.com

U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Securities and Exchange act of 1934
For the fiscal year ended December 31, 2003
Commission file number 0-23881

COWLITZ BANCORPORATION
(Exact name of registrant as specified in its charter)

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(b) of the Act:
None

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 this Form 10-K or any amendment to this Form 10-K. [ ]

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 30, 2003, was $26,093,000.

Common Stock, no par value, outstanding as of February 29, 2004: 3,907,352

DOCUMENTS INCORPORATED BY REFERENCE

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 2004 annual meeting of shareholders are incorporated by reference in Part III hereof.

TABLE OF CONTENTS

2

Forward-Looking Statements

This discussion and information in the document and the accompanying financial statements contains certain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the company, are generally identifiable by words such as "expect", "believe", "intend", "anticipate", "estimate" or similar expressions, and are subject to risks and uncertainties that could cause actual results to differ materially from those stated. Examples of such risks and uncertainties that could have a material adverse affect on the operations and future prospects of the company, and could render actual results different from those expressed in the forward-looking statement, include, without limitation: changes in general economic conditions, competition for financial services in the market area of the company, the level of demand for loans, quality of the loan and investment portfolio, deposit flows, legislative and regulatory initiatives, and monetary and fiscal policies of the U.S. Government affecting interest rates. The reader is advised that this list of risks is not exhaustive and should not be construed as any prediction by the Company as to which risks would cause actual results to differ materially from those indicated by the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements.

PART I

Item 1. Business

Introduction

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. Cowlitz Bank operates four branches in Cowlitz County in southwest Washington. Outside of Cowlitz County, the Bank does business under the name Bay Bank with branches in Bellevue, Washington, and Portland, Oregon, a loan production office in Vancouver, Washington, and a limited service branch in a retirement center in Wilsonville, Oregon. The Oregon branches of Bay Bank were previously operated under the name Northern Bank of Commerce (NBOC). Cowlitz Bank also provides mortgage banking services through its Bay Mortgage division with offices in Longview and Vancouver, Washington. During much of 2003, the Company also operated Bay Mortgage and Bay Escrow offices in Bellevue and Seattle, Washington. As part of a strategy to consolidate resources into commercial banking, and reduce reliance on mortgage lending activities, those offices were closed during the fourth quarter of 2003.

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, 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.

During 2003, the Company recorded net income of $117,000 or $0.03 per diluted share. At December 31, 2003, the Company had total assets of $268.8 million, total liabilities of $237.0 million, and total shareholders' equity of $31.8 million. At December 31, 2003, total loans, net of deferred fees, were $163.5 million and total deposits were $226.5 million.

Products and Services

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 interest-bearing 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 to reduce its cost of funds.

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 and individual and branch lending limits. All new loans and renewals are reported monthly to the Company's Board of Directors. Particularly large loan commitments or participations are approved by the loan committee of the Board of Directors. Underwriting standards are designed to achieve a high-quality loan portfolio, compliance with lending regulations and an appropriate 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.

3

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 operating lines of credit that support accounts receivables and inventory, as well as secured term loans for financing machinery and equipment. 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 or 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 75% of the value of collateral. In most cases, the Company requires 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, purchase, or refinancing of residential owner-occupied or 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 residential real estate loans through Bay Mortgage and its branch network, focusing on all facets of residential lending from single family homes to small multi-plexes, including FHA and VA loans, construction and bridge loans.

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 or 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 conservative credit guidelines and underwriting practices. The Company also offers Visa credit cards to its customers.

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, Washington, focuses on the needs of the customer, providing trust services to individuals, partnerships, corporations and institutions and acts 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 provided by out of the area financial institutions.

Internet Banking. Internet banking and cash management systems are available to both business and individual customers providing secure access to information and services from the Company's website. 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 have the ability to access account information, pay bills, and manage their accounts by way of the internet. 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.

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 four branches and one off-site location 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 provides drive-through facilities at three of its branches. The Company does not currently charge fees for any of these services, with the exception of a charge to non-Bank customers for ATM usage.

4

Sale of Business Segment

In February 2002, the Company sold substantially all of the net 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:

Market areas

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 southwestern Washington and northwest Oregon.

Employees

As of December 31, 2003, the Company employed a total of 131 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.

Risk Factors

Exposure to Regional Economy. 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 2001 and 2002. 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 state of Washington average in all but one of the past 23 years. Although there have been some signs of potential improvement during 2003 including a slightly lower jobless rate and strong residential housing sales and increased values, recovery is expected to be slow. 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 weakness in the Portland and Seattle metropolitan 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. As with Cowlitz County, there have been some positive trends, but the Pacific Northwest will most likely lag behind any national economic recovery.

Credit Risk. 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.

5

Interest Rate Risk. The Company's earnings are largely derived from net interest income, which includes interest income, fees earned on loans and investment income, less interest expense paid on deposits and other borrowings. Interest rates are highly sensitive to many factors that are beyond the control of 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 the maturities of the assets and liabilities. The Company's primary objective in managing interest rate risk is to moderate the adverse impact of changes in interest rates on the Company's net interest income and capital, while structuring the Company's asset/liability position to obtain the maximum yield-cost spread on that structure. Interest rate risk is managed through the monitoring of the Company's gap position and sensitivity to interest rate risk by subjecting the Company's balance sheet to hypothetical interest rate shocks. In a falling rate environment, the spread between interest yields earned and interest rates paid may narrow, depending on the relative level of fixed and variable rate assets and liabilities. In a stable or increasing rate environment the Company's variable rate loans will remain steady or increase immediately with changes in interest rates, while fixed rate liabilities, particularly certificates of deposit will only reprice as the liability matures.

Competition. 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. The Bay Bank branches in Bellevue, Washington and in the Portland area are faced with a large number of competitors.

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.

Regulation and Supervision

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

The description of the laws and regulations applicable to the Company and the Bank is not 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.

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 subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve").

6

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.

Regulatory Consent Order. On March 17, 2004, the Company received notification from the FDIC, the Bank's primary federal regulator, that the Consent Order (the "Order") issued on May 15, 2003, effective May 25, had been terminated on March 12, 2004. The Order required a series of affirmative actions to address weaknesses and deficiencies identified in an earlier examination of the Bank with respect to its condition as of September 30, 2002. Under the Order, the Bank, among other things, was required to: have and maintain qualified management as defined in the Order; refrain from paying any dividends without FDIC consent; review its strategic, profitability and liquidity plans; provide progress reports to the FDIC; maintain its well-capitalized status pursuant to a capital plan to ensure Tier 1 capital equaling or exceeding 8.0% of the Bank's total assets; establish and maintain an adequate allowance for loan and lease losses; refrain from extending credit to borrowers whose previous loans have been charged off; undertake a full internal audit of its Bay Mortgage division; retain an internal auditor and formulate and implement an effective internal audit policy; and reduce the amount of classified assets identified in the examination to no more than 50% of Tier 1 capital plus the allowance for loan and lease losses by November 30, 2003 and further reduce the amount to no more than 25% by December 31, 2004. If the Bank failed to adhere to the terms of the Order, the FDIC could have assessed civil monetary penalties or initiate other enforcement actions against the Bank, its management or the Board of Directors.

During a recent examination conducted by the FDIC and the State of Washington, the Bank's condition as of September 30, 2003 and compliance with the Order were reviewed. The regulators found evidence that the Bank was in compliance with all aspects of the Order, and authorized it to be terminated. Specifically, the Bank had: hired and maintained an effective management team; not paid any dividends; adequately revised its strategic, profitability, and liquidity plans; and provided progress reports as required by the Order. The Bank's Tier 1 leverage ratio at December 31, 2003 is 11.75%, exceeding the requirement to maintain Tier 1 capital at 8% of the Bank's total assets. The Bank has established and maintained an adequate allowance for loan losses and has refrained from extending credit to borrowers as outlined in the Order. During 2003, the Bank conducted a full internal audit of its mortgage division and hired an internal auditor who has begun to formulate and implement an effective internal audit policy. At December 31, 2003, the amount of classified assets identified in the examination had been reduced to 16.03% of Tier 1 capital plus the allowance for loan and lease losses. The objectives of no more than 50% at November 30, 2003, and 25% at December 31, 2004 were exceeded well ahead of schedule.

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 "undercapitalized" (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 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 FDIC's rules and regulations respecting the insurance of deposits. See "Deposit Insurance."

7

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.

FDICIA. FDICIA requires, among other things, federal bank regulatory authorities to take "prompt corrective action" with respect to banks that 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 are both "well-capitalized."

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.

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.

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 ratios, 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, 2003, 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

8

accounting principles. In addition, the DFI has the authority to require a state-chartered bank to suspend the 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. Under the terms of the Consent Order, the FDIC had required the Bank to gain permission prior to paying dividends to the Company. However, because the Consent Order was terminated on March 12, 2004, this requirement is no longer in effect.

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 provisions of the Federal Reserve Act that 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.

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. FDIC regulations set 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 rated institution to $0.27 per $100 of domestic deposits for an institution in the lowest category. During 2003, 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 $0.0154 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:

• establish a new framework under which bank holding companies and banks can own securities firms, insurance companies and other financial companies;
• provide consumers with new protections regarding the transfer and use of their non-public personal information by financial institutions; and
• change the Federal Home Loan Bank ("FHLB") system in numerous ways including the manner of calculating the Resolution Funding Corporation obligations payable by the FHLB and a broadening of the purposes for which FHLB advances may be used.

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."

 9

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.

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. Effective July 30, 2002, the Sarbanes-Oxley Act of 2002 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 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 adopted new standards for listed companies. While management believes the Sarbanes-Oxley Act will increase the Company's reporting expenses, management does not believe that the Act will have a material adverse effect on the Company's business and operations.

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

The earnings of financial institutions, including the Company and the 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 the Bank in particular would be affected.

10

Item 2. Properties

The Company owns its main office space in Longview, Washington, occupying approximately 27,500 square feet. The Company owns branches in Kelso and Kalama, Washington, and leases facilities for banking branches in Castle Rock, and Bellevue, Washington. Four of these banking offices have automated teller machines and three provide drive-up services. Space is also leased in Vancouver, Washington for a Bay Bank loan production office and a Bay Mortgage office. In Portland, Oregon the Company leases downtown office space for a Bay Bank office and operates a limited service branch in a retirement center in Wilsonville, Oregon. Until their closure in the fourth quarter of 2003, the Company operated mortgage branches and secondary market loan sales operations in Bellevue and Seattle, Washington. During 2002 and January of 2003, the Company closed 11 of its retirement center branches located 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 first quarter of 2002. The following are all of the Company's locations.

11

Item 3. Legal Proceedings

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. 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.

Item 4. Submission of Matters to a Vote of Securities Holders

No matters were presented for a vote of the Company's shareholders during the fourth quarter of 2003.

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

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

During 2003 and 2002, the Company neither declared nor paid any dividends to its stockholders. As of February 29, 2004 there were 3,907,352 shares of common stock outstanding and 261 shareholders of record, which excludes shares held in street name.

12

13

Item 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

This discussion and information in the document and the accompanying financial statements contains certain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the company, are generally identifiable by words such as "expect", "believe", "intend", "anticipate", "estimate" or similar expressions, and are subject to risks and uncertainties that could cause actual results to differ materially from those stated. Examples of such risks and uncertainties that could have a material adverse affect on the operations and future prospects of the company, and could render actual results different from those expressed in the forward-looking statement, include, without limitation: changes in general economic conditions, competition for financial services in the market area of the company, the level of demand for loans, quality of the loan and investment portfolio, deposit flows, legislative and regulatory initiatives, and monetary and fiscal policies of the U.S. Government affecting interest rates. The reader is advised that this list of risks is not exhaustive and should not be construed as any prediction by the Company as to which risks would cause actual results to differ materially from those indicated by the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements.

Results of Operations for the Year Ended December 31, 2003

For the twelve months ended December 31, 2003, Cowlitz Bancorporation (the "Company") recorded net income of $117,000 or $0.03 per diluted share of common stock ("per share"). This compares to net income of $1.5 million or $0.39 per share and a net loss of $1.5 million or $(0.39) per share for the corresponding periods ended December 31, 2002, and 2001, respectively. Net income for 2003 was hampered by reduced net interest income and non-interest income, without a reduction in non-interest expense. However, a relatively low provision for loan losses helped offset the higher non-interest expense.

During 2003, management devoted considerable effort to reducing the level of non-performing assets. Through charge-offs, pay-downs, foreclosures, re-negotiations with borrowers, and sales of loans and foreclosed assets, non-performing assets, which include non-accrual loans, loans past due 90 days or more, and foreclosed assets, declined 56.8% during 2003. Non-performing assets at December 31, 2002, 2001 and 2000 averaged over $7.5 million, but declined $4.2 million from $7.4 million at December 31, 2002 to $3.2 million at December 31, 2003.

During the fourth quarter of 2003, in an effort to refocus resources on its core commercial banking business and reduce earnings reliance on the cyclical mortgage lending industry, the Company's subsidiary, Cowlitz Bank (also the "Company" or the "Bank") decided to close its Bay Escrow operations and its Bay Mortgage offices and secondary market operations in Bellevue and Seattle, Washington. The Bank will no longer originate mortgage loans for sale into the secondary market, unless Management and the Board of Directors decide at some future time to recommence that form of operation. During the fourth quarter of 2003, the Company recorded non-interest expenses of approximately $1.8 million for goodwill impairment, staffing reductions, termination of building and equipment leases, and other charges related to the office closures. A substantial reduction of both non-interest income and expense is expected, as is a lessened reliance on earnings from the cyclical mortgage industry. Because the Company continues with a mortgage operation in other locations, closing the Bellevue and Seattle offices is not considered a discontinued operation for financial reporting purposes.

The Company's results of operation for the year ended December 31, 2003 were further characterized by reductions in impaired and non-performing assets, lower average interest rates on both assets and liabilities, continued maturity of higher rate certificates of deposit, and increased investment in securities and other earning assets. Interest rates were stable throughout 2003, with no significant changes to short term interest rates or to the Company's prime rate.

Just as in 2002, the Bank experienced a significant decline in loan volumes during 2003. Under the current low rate environment, many borrowers sought lower rates. 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 $31.0 million to $163.5 million at December 31, 2003 from $194.5 million at December 31, 2002. Under the same comparison, mortgage loans held-for-sale declined $55.2 million, a direct result of the Company's decision to cease its mortgage secondary market operations. The average balance of loans and loans held-for-sale were $197.4 million during 2003 compared with an average balance of $248.0 during 2002. Primarily because of the decline in loan and loans held-for-sale volumes, total interest income was $5.7 million lower during 2003 than during 2002.

14

Interest-bearing liabilities and the associated interest expense experienced similar declines during 2003 when compared to the levels of 2002. Certificates of deposits and borrowings from the Federal Home Loan Bank (FHLB) declined significantly. Certificates of deposit were $79.5 million at December 31, 2003, $55.1 million lower than $134.6 million at December 31, 2002, while the average balance was reduced to $99.7 million during 2003 from $146.6 million during 2002. Much of the reduction in certificates of deposit is due to the maturity of out-of-area and brokered certificates. FHLB borrowings were paid down $10.1 million from December 31, 2002 to December 31, 2003 and the average balance declined $8.1 million when comparing 2003 to 2002. As a result, interest expense was reduced to $5.0 million during 2003 compared to $8.6 million during 2002.

The provision for loan losses recorded during 2003 was much lower than during 2002 and 2001. Overall reductions in loan volumes from year to year have reduced the level of allowance for loan loss necessary to absorb potential losses, and required lower provision charges to support anticipated losses. As discussed above, reductions in non-performing assets have further reduced the allowance requirements as the loans remaining in the portfolio are, on average, of better quality than in the past two years. In addition, $663,000 in recoveries of previously charged-off loans recognized by Cowlitz Bancorporation were recorded as a reduction of the provision expense. These loans were associated with the Company's previously owned subsidiary, Business Finance Corporation. Normally, a recovery is recorded as an increase to the allowance for loan losses, but because there is no longer an allowance for BFC loans, these recoveries reduced the Company's overall provision.

Non-interest income was lower during 2003 when compared to 2002 and 2001 primarily due to reduced volumes of mortgage loans originated and sold into the secondary market. The majority of non-interest income for the years ended December 31, 2003, 2002, and 2001 resulted from the mortgage secondary market operations. The Bank will continue to offer mortgage lending products, but on a much smaller scale than in the recent past. Non-interest income from these activities will continue to decline in 2004.

Non-interest expense for 2003 was relatively unchanged when compared to 2002, primarily because of expenses related to the closure of Bay Escrow and the Bay Mortgage offices in Bellevue and Seattle. Because of the closure, the Bank recorded goodwill impairment of $1.5 million, the remaining value of goodwill associated with the original purchase of Bay Mortgage and Bay Escrow in 1999. In addition, expenses to terminate building and equipment leases, reduce staffing at those offices, and other related charges were recorded during 2003, further increasing non-interest expenses.

Critical Accounting Policies

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 fourth quarter of 2003, the Company recorded an impairment charge to the carrying amount of its goodwill due to the Bay Escrow and Bay Mortgage office closures and cessation of the related secondary market operations. The Company still carries goodwill associated with the purchase of Northern Bank of Commerce ("NBOC"), now Bay Bank, during 2000. Under Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142), the Company will measure, the carrying value at least annually. 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.

15

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 periods of the options, the Company's net income (loss) and earnings (loss) per share would have been reduced, or losses increased, to the following pro forma amounts:

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, 2003, 2002, and 2001:

Discontinued Operations

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 $0.07 per diluted share during 2002, a net loss of $2.1 million or $(0.55) per diluted share during 2001, and $513,000 or $0.13 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 attributable 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.

16

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.

17

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.

18

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:

Interest-Earnings Assets. The yield earned on loans outstanding (including residential mortgage loans held-for-sale) during 2003 was 7.39% compared to 7.95% in 2002, and 8.71% in 2001. The rate and average volume of loans from 2002 to 2003 both declined, causing the total interest income on loans to decrease to $14.6 million in 2003 compared to $19.7 million for 2002 and $24.0 million in 2001. The yield earned on taxable securities decreased to 3.08% in 2003 from 3.65% in 2002 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 increased slightly during 2003 when compared to 2002 and 2001, but the yield earned on these assets continued to decline. The total tax-equivalent yield earned on all interest-earning assets declined to 6.01% in 2003 from 6.78% and 8.05% for the years 2002 and 2001, respectively. The decline in yields earned is primarily due to borrowers taking advantage of the current low rate environment by refinancing their higher rate loans with the Company or establishing lending relationships elsewhere.

Interest-Bearing Liabilities. With the exception of FHLB and other borrowings, the rates paid for each category of interest-bearing liabilities was significantly lower during 2003 than during 2002 and 2001. The yield on savings and interest-bearing demand deposit accounts decreased to 1.18% during 2003 compared to 1.72% and 2.91% in 2002 and 2001, respectively. Certificates of deposit also showed a decline in average rates paid to 3.13% during 2003 from 4.04% in 2002 and 5.70% in 2001. As certificates of deposit matured during 2003, 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 2002 and 2001. FHLB and other borrowings declined in volume, but the average rate increased as short-term low rate borrowings matured during 2003 and were not re-borrowed. For all interest-bearing liabilities, the average rate paid decreased to 2.37% in 2003 from 3.21% in 2002, and 4.82% in 2001.

Net interest income for the year ended December 31, 2003 was $11.3 million, a decrease of 15.7% from $13.4 million in 2002, which was $700,000 higher than 2001. The tax-equivalent net interest margins for the periods ended December 31, 2003, 2002, and 2001 were 4.18%, 4.13%, and 3.92%, respectively. Interest expense as a percentage of average earning assets decreased to 1.83% in 2003, compared to 2.65% in 2002 and 4.13% in 2001.

During 2003, the national federal funds interest rate, and the Company's prime rate, remained unchanged, while there was one decline of 0.50% in November 2002. 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. The average volume of loans, taxable investment securities, certificates of deposit, and FHLB and other borrowings are noticeably lower. Interest spread and interest margin have both increased when comparing 2003 to 2002, while yields and costs have declined under the same comparison.

19

Total interest earned and total interest paid both decreased significantly from 2001 to 2002 and again in 2003. Both volumes and rates declined in almost every category comparing 2003 to 2002, accounting for the decreases in interest income and expense. Declines in both rates and average balances on loans and certificates of deposit affected 2003 most significantly as set forth in the previous table. Total volumes of interest-earning assets and average interest-bearing liabilities changed very little from 2001 to 2002, but the mix changed significantly. The average loan volume comparing 2002 to 2001 decreased $27.0 million, but was offset by an increase of $27.4 million 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 caused a slight increase in the net interest margin, which increased 0.21% to 4.13% during 2002.

Provision for Loan Losses

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 the current volume of loans, anticipated changes in loan volumes, past charge-off experience, management's assessment of the risk of loss on current loans, the level of non-performing and impaired loans, evaluation of future economic trends in the Company's market area, and other factors relevant to the loan portfolio. An internal loan risk grading system is used to evaluate 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 $237,000 for the year ended December 31, 2003. For the years ending December 31, 2002 and 2001 the provision was $2.8 million and $3.5 million, respectively. At December 31, 2003, the allowance for loan losses was 2.43% of total loans compared to 3.16% and 2.46% at December 31, 2002 and 2001, respectively.

Several factors contributed to a lower provision expense during 2003 compared to 2002 and 2001. The primary factor is a reduction in overall loan volumes during the periods. Total loans declined to $163.5 million at December 31, 2003 from $194.5 million at December 31, 2002. As loan volumes are reduced, the allowance for losses associated with those loans remains, and smaller provisions are necessary to maintain an adequate reserve. In addition, the level of non-performing loans has declined significantly at December 31, 2003 when compared to the levels at the same period of 2002 and 2001. As the quality of the loan portfolio improves, the necessary allowance for loan losses decreases resulting in a lower loan loss provision. Finally, the provision for 2003 was reduced by recoveries of loans previously charged-off at the Company's former subsidiary, Business Finance Corporation. These recoveries would normally be credited to the allowance for loan losses of the entity that recorded the original charge-off, but because BFC was no longer a part of the Company, there was no allowance to credit. Instead, these recoveries were recorded at the Holding Company as a reduction of the overall provision expense. Without these recoveries totaling $663,000, the provision for loan losses in 2003 would have been $900,000.

The 2002 provision for loan losses included $1.2 million resulting from the charge-off of $900,000 for a portion of one loan involving invoice factoring, 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."

During 2001, an estimated $2.2 million provision was recorded to reserve for downgraded or newly identified potential problem loans. As the local, regional, and national economies struggled during 2001, management closely monitored the Bank's credits, and was conservative when assessing them. Any deficiencies in collateral valuations or a borrower's ability to repay resulted in prompt action by management to more closely scrutinize, downgrade, allocate specific reserves against, or charge-off the loan. 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.

20

Non-interest income

Non-interest income consists of the following components:

Total non-interest income was $9.4 million for the year ended December 31, 2003 compared to $11.9 million and $9.6 million for the year ended December 31, 2002 and 2001, respectively. The majority of non-interest income has been generated from income on residential mortgage loans originated by Bay Mortgage. During 2003, the Bank decided to cease its secondary market and escrow operations and close its Bellevue and Seattle mortgage offices in order to focus more Company resources on commercial lending activities. This shift will ultimately reduce the level of non-interest income significantly by eliminating gains on loans sold, escrow fees, and reducing mortgage brokerage fees in future periods.

Low mortgage interest rates during 2002 and 2001, generated significant mortgage lending activity, but tapered off toward the end of 2003, resulting in lower non-interest income from mortgage and escrow activities. Relatively low mortgage interest rates attracted 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 non-interest income for the Bank. Mortgage and escrow non-interest income was $7.4 million during 2003, a decrease from $10.0 million during 2002 and $8.2 million during 2001. Gains on loans sold decreased approximately $1.3 to $4.4 million in 2003 from $5.7 million in 2002. Escrow fees were $961,000 during 2003 compared to $1.1 million and $895,000 in 2002 and 2001, respectively. Brokerage fees, which include points and processing fees on loans held-for-sale and fees collected from lenders Bay Mortgage brokers loans to, also declined during 2003. Brokerage fees were $2.0 million in 2003 compared to $3.2 million in 2002 and $2.5 million in 2001.

During 2003, the Bank made an $8.0 million investment in bank owned life insurance (BOLI). These policies insure the lives of officers of the Bank, and name the Bank as beneficiary. Non-interest income is generated tax-free from the increase in the policies' underlying investments made by the insurance company. Non-interest income was reduced, however, in 2003 by $13,000, by $113,000 in 2002, and by $429,000 in 2001 for 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 a net loss on the sale of securities available-for-sale of $9,000 and net gains of $183,000 and $89,000 during 2003, 2002 and 2001, respectively.

21

Non-interest Expense

Non-interest expense consists of the following components:

Total non-interest expense was relatively unchanged during 2003 compared to 2002 and $2.9 million higher than during 2001. Much of the increase in non-interest expense from 2001 to 2002 and 2003 was the direct result of a high volume of mortgage lending at Bay Mortgage. Additionally, non-interest expenses of approximately $1.8 million were recorded during 2003 in connection with the Bank's decision to close its Bay Mortgage offices in Bellevue and Seattle and cease its secondary market function. These expenses include the write-off of the carrying value of goodwill associated with the acquisition of Bay Mortgage and Bay Escrow in 1999, charges to terminate building and equipment leases, costs of staff reductions, and other related expenses. Non-interest expense for the mortgage segment during 2003 was $9.3 million compared to $8.8 million in 2002 and $6.7 million in 2001. The mortgage segment accounted for 77.8% of the total increase in non-interest expense between 2001 and 2002. 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. With the reduction in mortgage operations, management expects to see a significant decline in non-interest expenses in future periods.

A measure of the Company's ability to contain non-interest expenses is the efficiency ratio. This ratio is calculated by dividing total non-interest expense by the sum of net interest income and non-interest income. The Company's efficiency ratio was 98.5%, 79.8%, and 78.6% for the years ended December 31, 2003, 2002, and 2001, respectively. The 2003 ratio would have been approximately 89.8% excluding the $1.8 million in expenses related to the Bay Mortgage office closure discussed above.

Salaries, benefits, and commissions expense were $9.5 million during 2003 compared to $10.7 million during 2002 and $9.1 million during 2001. A decline in mortgage lending activity during 2003 reduced fee income and the resulting commissions paid to mortgage loan originators. Mortgage commission expense was approximately $1.2 million lower during 2003, accounting for the majority of the decline in salary and employee benefits expense. 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 also contributed to higher salary costs during 2002 as severance or hiring bonuses were paid, or salaries for specific positions overlapped during training periods. Also included in salary expenses are ordinary wage increases for existing employees, which generally range from three to six percent each year. At December 31, 2003, the Company had 131 full-time equivalent employees compared to 200 and 199 at December 31, 2002 and 2001, respectively. The majority of the decline is from the Bay Mortgage and Escrow offices that were closed during the fourth quarter of 2003.

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 increased to $2.6 million from the 2002 and 2001 levels of $2.3 million and $2.4 million, respectively. The increase in 2003 was primarily due to the prepayment of lease expenses on the closure of Bay Mortgage Bellevue and Seattle offices.

22

During 2003 and 2002, amortization of intangibles was $265,000 compared to $489,000 during 2001. The decrease from 2001 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. The intangible asset associated with the deposit premium continues to amortize and resulted in the amortization expense of $265,000 for 2003 and 2002. The balance of the deposit premium, net of accumulated amortization was $236,000, and $502,000 for the year ended December 31, 2003, and 2002, respectively. The deposit premium is being amortized using an accelerated method over a ten-year life, and is scheduled to become fully amortized during the fourth quarter of 2004.

According to the provisions of SFAS No. 142, a non-interest expense should only be recognized on an unidentifiable intangible asset if that asset is deemed to be impaired. During the fourth quarter of 2003, an impairment test was performed on the goodwill associated with the 1999 acquisition of Bay Mortgage and Bay Escrow. Because the offices and employees associated with the purchase were no longer with the Company, the full carrying value of $1.5 million was considered impaired and was recognized as non-interest expense. The balance of goodwill, net of accumulated amortization, at December 31, 2003 and 2002 was $852,000 and $2.4 million, respectively. The remaining balance of 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 2000 acquisition of NBOC.

Professional fees include exam and audit expenses, consulting costs, legal fees, and other professional fees. These expenses were approximately $1.5 million during 2003 and 2002. The increase from the 2001 level 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; placement fees upon hire of members of executive management; legal fees and consulting relating to various strategic alternatives; and legal and consulting fees regarding management employee turnover.

FDIC insurance premium expense was lower in 2003 compared to 2002 due to a reduction in deposit volume, while the rate remained stable. This expense was higher during 2002 when compared with 2001 because of a higher assessment rate imposed on the Company during that 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 2003 and 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. 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 $0.0154 per $100 of deposits per year. Any increase in deposit insurance or FICO assessments could have an adverse effect on Cowlitz Bank's earnings. Because the Order discussed in the "Regulation and Supervision" section has been terminated, Management expects a reduced FDIC assessment rate during the third or fourth quarter of 2003.

Total loan processing and related costs were $746,000, $503,000 and $564,000 for the years ended December 31, 2003, 2002, and 2001, respectively. The relatively high expense during 2003 was related to mortgage loan origination costs not charged to the borrower, but absorbed by Bay Mortgage.

Costs related to the operation and disposition of other real estate owned has remained relatively higher as the number and value of properties has increased. These costs, net of related rental and other income, were $196,000 in 2003, $260,000 in 2002, and $150,000 in 2001.

Business tax expense was only $12,000 for the year ended December 31, 2003 compared to $606,000 and $602,000 for the years ended December 31, 2002 and 2001, respectively. A portion of the decline is related to lower income levels during 2003, which is the basis for the majority of these taxes. In addition, an audit of prior year state business and occupation tax expense revealed allowable deductions that had not been taken on prior returns. The effect of these deductions was a refund of $351,000 offsetting the 2003 expense.

23

All other operating expenses including travel, meals, and education, postage and freight, advertising, data and credit card processing costs, office supplies, temporary help, and other business expenses remained unchanged at $3.6 million during 2003 $3.5 million during 2002, and $3.6 million during 2001.

Income Taxes

The benefit for income taxes was $38,000 for 2003 compared to a provision for income taxes from continuing operations of $339,000 and $669,000 for 2002 and 2001, respectively. The provision for income taxes from discontinued operations was $135,000 for 2002, and a benefit of $519,000 during 2001. In addition, a benefit 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.

Financial Condition

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

Investment Securities

At December 31, 2003, the Company's portfolio of investment securities totaled $55.1 million, an increase of $21.5 million from $33.6 million at December 31, 2002. The Company seeks additional opportunities to invest in securities, depending on cash, liquidity, and earnings considerations at the time. In order to maximize earning potential, management may also sell investment securities from time-to-time to realize built-in gains, or to re-invest the funds in an alternate investment opportunity.

The Company follows financial accounting principles that require the identification of investment securities as held-to-maturity, available-for-sale or trading assets. Securities designated as held-to-maturity are those that the Company has the intent and ability to hold until they mature or are called. Available-for-sale securities are those that management may sell if circumstances warrant. Trading assets are purchased and held principally for the purpose of reselling them within a short period of time. The mix of available-for-sale and held-to-maturity investment securities is considered in the context of the Company's overall asset-liability management policy and illustrates management's assessment of the relative liquidity of the Company. At December 31, 2003, the investment portfolio consisted of 85.3% available-for-sale securities and 14.7% held-to-maturity investments. At December 31, 2002, available-for-sale securities were 99.1% and held-to-maturity investments were 0.9% of the investment portfolio. The Company did not hold any trading securities during 2003, 2002, or 2001.

24

The following table provides the amortized cost and fair value of the Company's investment securities as of December 31, 2003, 2002, and 2001.

At December 31, 2003, the Company's available-for-sale and held-to-maturity investments had total net unrealized gains of approximately $468,000 compared to net unrealized gains of approximately $522,000 at December 31, 2002. Unrealized gains and losses reflect changes in market conditions and do not represent the amount of actual profits or losses the Company may ultimately realize. Actual realized gains and losses occur at the time investment securities are sold or redeemed.

At December 31, 2003, net unrealized gains on available-for-sale securities were $342,000 representing 0.6% of the total investment portfolio. Management has no current plans to sell any of these securities, but may choose to sell available-for-sale securities in the future depending on cash, liquidity, and earnings considerations.

The following table summarizes the contractual or estimated maturities and weighted average yields of both available-for-sale and held-to-maturity investment securities at December 31, 2003.