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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year ended December 31, 2003

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition period from to
_____

Commission File Number 0 - 24024

VENTURE FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)

Principal Executive Offices
721 College St. S.E., P.O. Box 3800, Lacey, WA 98509

Registrant's telephone number, including area code (360) 459-1100

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

Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 5(d) of the Securities Exchange Act of 1934 during the preceding 12 months 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 in response 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 by Exchange Act Rule 12b-2).

Yes     [_]            No        [X]

There is no active trading market for the Registrant's voting common equity. The Registrant's voting common stock is not listed on any exchange or quoted on Nasdaq. The aggregate market value of the voting common equity held by non-affiliates as of June 30, 2003 (the last business day of the most recent second quarter),was $65,522,175 (based on the last sale of $21.50 per share on June 30, 2003).

        The number of shares of no par value Common Stock outstanding as of March 25, 2004, was 4,293,910.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement (the "Proxy Statement") for use in connection with the Annual Meeting of Shareholders to be held on May 6, 2004, are incorporated by reference into Part III of this Annual Report on Form 10-K.

Venture Financial Group, Inc.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2003
TABLE OF CONTENTS

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PART I

ITEM 1 - BUSINESS

General

Venture Financial Group, Inc. ("VFG" or "the Company"), formerly known as First Community Financial Group, was incorporated under the laws of the State of Washington in November 1983 as First Community Bancorp, Inc. and is a bank holding company. The Company changed its name to First Community Financial Group, Inc. in July 1992 and again in May 2003 to Venture Financial Group, Inc. In 1984, pursuant to a plan of reorganization, VFG acquired First Community Bank of Washington, and in May 2003 the bank changed its name to Venture Bank ("VB" or "Bank"). The Bank, organized in 1979, is a Washington state-chartered banking corporation. The principal offices of VFG and Venture Bank are located in Lacey, Washington. References to "we", "us", or "our" refer to VFG.

The Company expanded solely through internal growth until 1993 when it began a series of acquisitions to more rapidly expand its market area and to achieve greater economies of scale.

On October 1, 2002, the Company completed the acquisition of Harbor Bank, National Association ("Harbor Bank") pursuant to an Agreement and Plan of Merger under the terms of which Harbor Bank merged with and into the Bank. Harbor Bank shareholders received $10.75 in cash for each share of Harbor Bank common stock outstanding as of the effective date of the merger. The total estimated value of the acquisition was approximately $7 million. The acquisition was financed out of existing capital, including the proceeds of a $13 million offering of trust preferred securities completed in July 2002. For additional information regarding trust preferred securities, see "Item 7-Management's Discussion & Analysis of Financial Condition and Results of Operations - Liquidity and Financial Condition." The Harbor Bank acquisition added two branches in Gig Harbor, Washington.

In addition to growth by acquisition, during the past five years we have opened branches in the following areas:

• Canyon Road-Puyallup (1999)
• Hawks Prairie area of Lacey (2000)
• Meridian-Puyallup (2001)
• West Olympia (2001)
• Downtown Tacoma (2001)

In September 2003, we consolidated the two Puyallup branches into one financial center located in the South Hill area.

The Bank primarily focuses on business and commercial real estate lending, which represent approximately 90% of the Bank's loan profit. The Bank provides a full range of banking services including:

• savings and checking accounts,
• time deposits,
• consumer installment loans,
• mortgage and commercial lending,
• safe deposit facilities,
• electronic banking via ATMs, Internet and telephone.

We offer a broad range of investment services to our consumer and commercial customers, including retirement and estate planning, profit sharing plans and the sale of non-deposit investment products, through Venture Investment Services. In 2003 we reorganized Venture Investment Services, formerly a wholly owned subsidiary of the Bank, into a department of the Bank.

In April 2001, the Bank entered into a Marketing and Servicing Agreement with Advance America. Advance America is a

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Delaware company formed in 1997 and is comprised of a group of "parent-subsidiary" companies whose function is to develop, own, acquire and manage cash advance centers throughout the United States. Under this agreement, the Bank offers short-term consumer loans (commonly known as "payday loans") to customers in the state of Arkansas. Payday loans are small dollar ($700 or less), short-term unsecured loans that borrowers promise to repay out of their next paycheck. The Bank charges a fixed dollar fee, rather than simple interest. In a typical payday loan transaction, the borrower provides the Bank with a post-dated check for the loan amount plus the fee. The Bank agrees to defer deposit of the check until the check date, usually two weeks or less. Advance America acts as the Bank's agent in marketing and collecting these loans.

In November 2000, the Bank entered into a Marketing and Servicing Agreement with Advance America to offer short-term loans to customers in the state of Alabama. In 2003 the Alabama legislature passed the Deferred Presentment Services Act. The Act created a regulatory framework within which licensed, non-bank lenders could originate small loans in Alabama. Due to these changes in Alabama law, the Bank and Advance America terminated the original Marketing and Servicing Agreement effective July 11, 2003. The agreement was due to expire on October 31, 2003, and pursuant to the terms of the early termination, Advance America agreed to remit to the Bank a portion of the fees earned for the period from July 11, 2003 through October 31, 2003. We negotiated the termination payments to keep the Bank financially whole as if the Alabama agreement had continued through the original termination date.

The Company is taking steps to forestall any negative effect that may occur from these developments, including discussions with Advance America and other small loan providers to develop small loan programs in other states. While the Company believes it will be able to minimize any negative impact on its earnings from the developments in Alabama, we cannot assure that our efforts will be successful. Because of the significance of the small loan division's operations in Alabama to the Company's earnings, (represents 68% of total 2003 small loan income), unsuccessful or delayed substitution of other states, providers or programs could have a material adverse effect on the Company's earnings.

The agreement with Advance America for Arkansas is immediately terminable if any bank regulatory agency with jurisdiction over the Bank or the Company determines that the Bank's performance of the agreements is unlawful or an unsafe or unsound practice. Financial highlights on this segment of the Company are found in Management's Discussion & Analysis of Financial Condition and Results of Operations and Note 22-Business Segment Information to the Company's consolidated financial statements. The federal bank regulators' perspective on payday lending is generally described below in the section titled, "Business - Supervision and Regulation-Safety and Soundness Standards."

Competition

Commercial banking in the state of Washington is highly competitive with respect to providing banking services, including making loans and attracting deposits. The Bank competes with other banks, as well as with savings and loan associations, savings banks, credit unions, mortgage companies, investment banks, insurance companies, securities brokerages, and other financial institutions. Banking in Washington is significantly affected by several large banking institutions, including U.S. Bank, Wells Fargo Bank, Bank of America, Key Bank, and Washington Mutual Bank, which together account for a majority of the total commercial and savings bank deposits in Washington. These competitors have significantly greater financial resources and offer a greater number of branch locations (with statewide branch networks), higher lending limits, and a variety of services not offered by the Bank. The Bank has positioned itself successfully as a local alternative to banking conglomerates that may be perceived by customers or potential customers, to be impersonal, out-of-touch with the community, or simply not interested in providing banking services to some of the Bank's target customers. Over the past few years, numerous "community" banks have been formed or moved into the Bank's market areas and have developed a similar focus. This growing number of similar banks and an increased focus by larger institutions on the Bank's market segments in response to declining market perception and/or market share has led to intensified competition.

The adoption of the Gramm-Leach-Bliley Act of 1999 intensified competition in the banking industry. The Act eliminated many of the barriers to affiliation among providers of various types of financial services and permits business combinations among banks, insurance companies, securities and brokerage firms, and other financial service providers. This has led to increased competition in both the market for providing financial services and in the market for acquisitions in which the Bank also participates. For additional information, see "Business - Supervision and Regulation - Financial Services Modernization." In general, the financial services industry has experienced widespread consolidation over the last decade. It is anticipated that consolidation among financial institutions in the Company's market area will continue. Other financial institutions, many with substantially greater resources, compete in the acquisition market against the Bank. Some of these institutions, have greater access to capital markets, larger cash reserves and a more liquid currency. Additionally, the rapid adoption of financial services through the Internet has reduced the barrier to entry by financial services providers physically located outside the Bank's market area. Although the Bank has been able to compete effectively in the financial services markets to date, there can be no assurance that it will be able to continue to do so in the future.

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The Bank's small loan division offers short-term consumer loans in Arkansas pursuant to an agreement with Advance America. The Bank believes that the principal competitive factors in the check-cashing industry are location, customer service, fees, convenience, and range of services offered. The Bank faces intense competition and believes that the short-term consumer loan market is becoming more competitive as the industry matures and consolidates. Some of the Bank's competitors have larger and more established customer bases and substantially greater financial, marketing, and other resources. There is no assurance that the Bank's small loan division will be able to compete successfully with its competitors.

Market Area

The Bank engages in general banking business through 20 offices in Thurston, Grays Harbor, Lewis and Pierce Counties, Washington. All four counties experienced a stable economic environment in 2003. Thurston County's growth, although minimal, has been spurred by increased government employment and several larger companies moving into the County.

Lewis and Grays Harbor Counties have experienced flat growth and derive the majority of its economic livelihood from Thurston County and more specifically the government jobs centered in Olympia.

Pierce County is well diversified with the principal industries being shipping (via the Port of Tacoma), military employment at Fort Lewis and McCord Air Force Base, and forest products.

Employees

VFG and its subsidiaries employed a total of 241 employees, consisting of 199 full time and 42 part time employees at December 31, 2003. A number of benefit programs are available to eligible employees, including group medicals plans, paid sick leave, paid vacation, group life insurance, a 401(k) plan, deferred compensation plans, and a stock incentive plan. Such employees are not represented by a union organization or other collective bargaining group, and management considers relations with employees to be very good.

Supervision and Regulation

The Bank is extensively regulated under federal and state law. These laws and regulations are primarily intended to protect depositors, not shareholders. The discussion below describes and summarizes applicable statutes and regulations and is qualified in its entirety by reference to the particular statute or regulation. Changes in applicable laws or regulations may have a material effect on the Bank's business and prospects. The Bank's operations may also be affected by changes in the policies of banking and other government regulators. The nature or extent of the possible future effects on business and earnings of changes in fiscal or monetary policies, or new federal or state laws and regulations cannot accurately be predicted.

Significant Changes In Banking Laws And Regulations

Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 (the "Act") to address corporate and accounting fraud. The Act:

• requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the Securities and Exchange Commission (the "SEC");
• imposes new disclosure requirements regarding internal controls, off-balance-sheet transactions, and pro forma (non-GAAP) disclosures;
• accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies; and
• requires additional disclosures regarding codes of ethics for senior financial officers, shareholder communication procedures, director nomination procedures, and audit committees.

The Act also requires the SEC to regularly and systematically review corporate filings. To deter wrongdoing, the Act:

• subjects bonuses issued to top executives to disgorgement if a restatement of a company's financial statements was due to corporate misconduct;
• prohibits an officer or director from misleading or coercing an auditor;
• prohibits insider trades during pension fund "blackout periods";
• imposes new criminal penalties for fraud and other wrongful acts; and
• extends the period during which certain securities fraud lawsuits can be brought against a company or its officers.

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As an SEC reporting company, we are subject to the Act's requirements. We are in the process of complying with the Act and related rules and regulations issued by the SEC. At the present time, and subject to the final rules and regulations the SEC may adopt, the Company anticipates that it will incur additional expense as a result of the Act, but it is not expected that such compliance will have a material impact on business.

Federal Bank Holding Company Regulation

General. The Company is a bank holding company as defined in the Bank Holding Company Act of 1956, as amended, and is therefore subject to regulation, supervision and examination by the Federal Reserve. In general, the Bank Holding Company Act limits the business of bank holding companies to owning or controlling banks and engaging in other activities closely related to banking. The Company must also file reports and provide additional information to the Federal Reserve.

Under the Financial Services Modernization Act of 1999, a bank holding company may apply to the Federal Reserve to become a financial holding company, and thereby engage (directly or through a subsidiary) in certain expanded activities deemed financial in nature, such as securities brokerage and insurance underwriting. We have not applied to become a financial holding company.

Holding Company Bank Ownership. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before merging with another institution or acquiring ownership or control of more than 5% of the voting shares or substantially all of the assets of another bank or bank holding company.

Holding Company Control of Nonbanks. With some exceptions, the Bank Holding Company Act also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks.

Transactions with Affiliates. Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities, and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Company's ability to obtain funds from the Bank for its cash needs, including funds for payment of dividends, interest and operational expenses.

Tie-in Arrangements. The Company is prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither the Company nor its subsidiaries may condition an extension of credit to a customer on either a requirement that the customer obtain additional services provided by the Company or an agreement by the customer to refrain from obtaining services from a competitor.

Support of Subsidiary Banks. Under Federal Reserve policy, the Company is expected to act as a source of financial and managerial strength to the Bank. This means that the Company is required to commit, as necessary, resources to support the Bank. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks.

Federal and State Regulation of Venture Bank

General. The Bank is a Washington chartered commercial bank with deposits insured by the FDIC. As a result, the Bank is subject to supervision and regulation by the Washington Department of Financial Institutions, Division of Banks and the FDIC. These agencies have the authority to prohibit banks from engaging in what they believe constitute unsafe or unsound banking practices.

Lending Limits. Washington State banking law generally limits the amount of funds that a bank may lend to a single borrower to 20% of the bank's capital and surplus.

Community Reinvestment. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their jurisdiction, the Federal Reserve or the FDIC evaluate the record of the financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility.

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Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons. Extensions of credit (1) must be made on substantially the same terms as comparable transactions with other customers and must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to insiders. A violation of these restrictions may result in the assessment of substantial civil monetary penalties, the imposition of a cease and desist order, and other regulatory sanctions.

Regulation of Management. Federal law sets forth circumstances under which officers or directors of a bank may be removed by the institution's federal supervisory agency. Federal law also prohibits management personnel of a bank from serving as a director or in a management position of another financial institution whose assets exceed a specified amount or which has an office within a specified geographic area.

Safety and Soundness Standards. Federal law imposes upon banks certain non-capital safety and soundness standards. These standards cover, among other things, internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation and benefits. Additional standards apply to asset quality, earnings and stock valuation. An institution that fails to meet these standards must develop a plan acceptable to its regulators, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions.

Payday Lending. In July 2003 the FDIC issued Guidelines for state chartered, nonmember banks that participate in small loan programs with third party contractors. The Guidelines cover safety and soundness considerations, including loan concentrations, capital adequacy, allowance for loan and lease losses (ALLL), and loan classification guidelines. Compliance considerations, such as Community Reinvestment Act performance, Truth in Lending, and consumer privacy are also covered. The Guidelines allow examiners wide discretion to review and, where necessary, criticize a bank's loan program based upon these considerations.

Recently the Office of the Comptroller of the Currency ("OCC"), the primary federal regulator of national banks, the Office of Thrift Supervision ("OTS"), the primary regulator of federal savings banks and the Federal Reserve Bank ("FRB"), the primary regulator of federal reserve member banks, have increased their scrutiny of banks involved in payday lending. Published regulatory guidance indicates that regulators are concerned about certain potential risks to banks. Those risks include strategic, reputation, compliance, transaction and credit risks. Management is expected to measure, monitor and establish controls to manage these risks and to avoid taking risks that threaten the safety and soundness of the Bank. The OCC, FRB, and OTS will enforce these expectations through the examination process and have the power to order banks under their jurisdiction to discontinue their participation in payday lending. The OCC and FRB have ordered banks they regulate to discontinue their payday lending operations.

Management believes that the Bank has taken appropriate steps to manage and control the risks of its payday lending activities consistent with currently applicable regulatory guidance. However, there can be no assurance that the Bank's regulators would not seek to restrict or terminate the Bank's participation in payday lending.

Interstate Banking and Branching

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act") permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit these purchases. Additionally, banks are permitted to merge with banks in other states, as long as the home state of neither merging bank has opted out under the legislation. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.

FDIC regulations prohibit banks from using their interstate branches primarily for deposit production. The FDIC has implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition.

Washington enacted "opting in" legislation in accordance with the Interstate Act, allowing banks to engage in interstate merger transactions, subject to certain "aging" requirements. Washington restricts an out-of-state bank from opening de novo branches. However, once an out-of-state bank has acquired a bank within the state, either through merger or acquisition of all or substantially all of the bank's assets, the out-of-state bank may open additional branches within the state. We do not have the authority to open de novo branches in any state other than Washington.

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Deposit Insurance

The Bank's deposits are currently insured to a maximum of $100,000 per depositor through the Bank Insurance Fund administered by the FDIC. The Bank is required to pay deposit insurance premiums, which are assessed semiannually and paid quarterly. The premium amount is based upon a risk classification system established by the FDIC. Banks with higher levels of capital and a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern. The Bank qualifies for the lowest premium level, and currently pays only the statutory minimum rate.

The FDIC is also empowered to make special assessments on insured depository institutions in amounts determined by the FDIC to be necessary to give it adequate assessment income to repay amounts borrowed from the U.S. Treasury and other sources or for any other purpose the FDIC deems necessary.

Dividends

Along with the issuance of trust preferred securities, dividends paid by the Bank provide substantially all of the Company's cash flow. Under the Washington state law, and the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the Bank is subject to restrictions on the payment of cash dividends to its parent company. A bank may not pay cash dividends if that payment would reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. In addition, the amount of the dividend may not be greater than retained earnings.

Regulatory authorities are authorized to prohibit banks and bank holding companies from paying dividends that would constitute an unsafe or unsound banking practice. We are not currently subject to any regulatory restrictions on dividends other than those noted above.

Capital Adequacy

Regulatory Capital Guidelines. Federal and state bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are "risk-based," meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets.

If capital falls below the minimum levels established by these guidelines, a holding company or a bank may be denied approval to acquire or establish additional banks or non-bank businesses or to open new facilities.

Federal regulations establish minimum requirements for the capital adequacy of depository institutions, such as the Bank. Banks with capital ratios below the required minimums are subject to certain administrative actions, including prompt corrective action, the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing.

Tier I and Tier II Capital. Under the guidelines, an institution's capital is divided into two broad categories, Tier I capital and Tier II capital. Tier I capital generally consists of common stockholders' equity, surplus and undivided profits. Tier II capital generally consists of the allowance for loan losses, hybrid capital instruments, and subordinated debt. The sum of Tier I capital and Tier II capital represents an institution's total capital. The guidelines require that at least 50% of an institution's total capital consist of Tier I capital.

Risk-based Capital Ratios. The adequacy of an institution's capital is gauged primarily with reference to the institution's risk-weighted assets. The guidelines assign risk weightings to an institution's assets in an effort to quantify the relative risk of each asset and to determine the minimum capital required to support that risk. An institution's risk-weighted assets are then compared with its Tier I capital and total capital to arrive at a Tier I risk-based ratio and a total risk-based ratio, respectively. The guidelines provide that an institution must have a minimum Tier I risk-based ratio of 4% and a minimum total risk-based ratio of 8%. Our ratios are 11.20% and 13.04%, respectively.

Leverage Ratio. The guidelines also employ a leverage ratio, which is Tier I capital as a percentage of total average assets, less intangibles. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank holding company may leverage its equity capital base. The minimum leverage ratio is 3%; however, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, regulators expect an additional cushion of at least 1% to 2%. Our ratio is 10.7%.

Prompt Corrective Action. Under the guidelines, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. The categories

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range from "well capitalized" to "critically undercapitalized." Institutions that are "undercapitalized" or lower are subject to certain mandatory supervisory corrective actions. FDICIA requires federal banking regulators to take "prompt corrective action" with respect to a capital-deficient institution, including requiring a capital restoration plan and restricting certain growth activities of the institution. The Company could be required to guarantee any such capital restoration plan required of the Bank if the Bank became undercapitalized. Under the regulations, the Bank is "well-capitalized."

Financial Services Modernization

Gramm-Leach-Bliley Act of 1999. The Financial Services Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act, brought about significant changes to the laws affecting banks and bank holding companies. The Act:

• repealed restrictions on preventing banks from affiliating with securities firms;
• provided a uniform framework for the activities of banks, savings institutions and their holding companies;
• broadened the activities that may be conducted by national banks and banking subsidiaries of bank holding companies;
• provided an enhanced framework for protecting the privacy of consumer information; and
• addressed a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.

Bank holding companies that qualify and elect to become financial holding companies can engage in a wider variety of financial activities than permitted under previous law, particularly with respect to insurance and securities underwriting activities. In addition, in a change from previous law, bank holding companies will be in a position to be owned, controlled or acquired by any company engaged in financially related activities, so long as the company meets certain regulatory requirements. The act also permits national banks (and, in states with wildcard statutes, certain state banks), either directly or through operating subsidiaries, to engage in certain non-banking financial activities.

The Company does not believe that the act will negatively affect operations in the short term. However, to the extent the legislation permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. This consolidation could result in a growing number of larger financial institutions that offer a wider variety of financial services than currently offered, and these companies may be able to aggressively compete in the markets the Company currently serves.

Anti-terrorism Legislation

USA Patriot Act of 2001. On October 26, 2001, President Bush signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism ("USA Patriot Act") of 2001. Among other things, the USA Patriot Act:

• prohibits banks from providing correspondent accounts directly to foreign shell banks;
• imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals;
• enhance customer identification procedures;
• requires financial institutions to establish an anti-money-laundering compliance program; and
• eliminates civil liability for persons who file suspicious activity reports.

The Act also increases governmental powers to investigate terrorism, including expanded government access to account records. The Department of the Treasury is empowered to administer and make rules to implement the Act. While the Bank believes the USA Patriot Act may, to some degree, affect recordkeeping and reporting expenses, it does not believe that the Act will have a material adverse effect on business and operations.

Effects Of Government Monetary Policy

The Bank's earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve can and does implement national monetary policy for such purposes as curbing inflation and combating recession, but its open market operations in U.S. government securities, control of the discount rate applicable to borrowings from the Federal Reserve, and establishment of reserve requirements against certain deposits, influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans or paid on deposits. The nature and impact of future changes in monetary policies and their impact cannot be predicted with certainty.

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The Bank owns the property and buildings on which the Aberdeen, Elma, Hoquiam, Lacey, Yelm, Fircrest, downtown Tacoma, Gig Harbor Pioneer, Winlock, Toledo, Montesano, Centralia, and Downtown Olympia branches are situated. The Bank also owns the Gig Harbor Loan Center building as part of its Pioneer Location. The Tumwater and Eatonville branches are operated in buildings owned by VB that are situated on leased property. The Hawks Prairie, Panorama City, West Olympia, South Hill Puyallup, and Gig Harbor Pt. Fosdick branches are operated in leased space. The aggregate monthly rental on all properties leased by the Bank is approximately $56,000.

ITEM 3 - LEGAL PROCEEDINGS

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

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PART II

ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

No broker makes a market in VFG's common stock, and trading has not been extensive. Trades that have occurred cannot be characterized as amounting to an active market. The stock is traded by individuals on a personal basis and is not listed on any exchange or traded on the over-the-counter market. Due to the limited information available, the following price information may not accurately reflect the actual market value of VFG's shares. The following data includes trades between individual investors. It does not include the exercise of stock options nor does it include shares repurchased by the Company as discussed below.

At December 31, 2003, options for 412,430 shares of VFG common stock were outstanding. See Note 16 of the consolidated financial statements for additional information.

On April 23, 2002, the Board approved a stock repurchase program that allowed the repurchase of up to 100,000 shares of VFG's Common Stock in purchases over time, through open market transactions, block purchases, or through privately negotiated transactions, including, from time to time, the purchase of shares from directors and executive officers of VFG. Under this plan 91,746 shares were repurchased in 2002 for a total of $950,000.

On December 11, 2002, the Board approved a stock repurchase program that allowed for the repurchase of up to 132,000 shares of VFG Common Stock in purchases over time, through open market transactions or through privately negotiated transactions. No purchases were made under this plan in 2002. As of March 11, 2003 a total of 69,572 shares have been repurchased under this plan for a total of $1,174,792.

On February 19, 2003 The Board approved a stock repurchase program to allow for the repurchase of 87,580 shares of VFG Common Stock in purchases over time in either privately negotiated transactions or through the open market. On June 18, 2003 this plan was amended and an additional 37,430 shares were added to the plan. On October 17, 2003 this plan was amended again and an additional 150,000 shares were added to this plan bringing the total to 275,000 shares. Under this plan 177,399 shares have been repurchased for a total of $3,652,464.

On November 4, 2002, the Board of Directors announced a two-for-one stock split on VFG stock for shareholders of record on November 15, 2002.

Number of Equity Holders

As of December 31, 2003, there were 1,322 holders of record of VFG's common stock.

Dividends

VFG paid cash dividends of $.05 per share on February 12, and May 16, 2003. VFG paid cash dividends of $.07 per share on August 8, and November 14, 2003. Cash dividends of $.05 per share were issued on February 15, May 10, August 9, and November 18, 2002. Cash Dividends of $.05 per share were issued on February 16, May 11, August 10, and November 9, 2001. Cash dividends of $.05 per share were issued on February 11, May 5, August 11 and November 10, 2000. Cash dividends of $ .20, $ .045 and $.045 per share were issued on April 15, 1999, July 30, 1999 and October 30, 1999, respectively. The prior year

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amounts reported reflect an adjustment for the November 2002 stock split.

Washington law limits the ability of the Bank to pay dividends to the Company. Under these restrictions, a bank may not declare or pay any dividend in an amount greater than its retained earnings without approval of the Division of Banks. All of the retained earnings of the Bank are available for the payment of dividends to the Company under these restrictions, subject to the federal capital regulations discussed above. See "Business - Supervision and Regulation - Dividends".

Securities Authorized for Issuance Under Equity Compensation Plans

Incorporated by reference to the sections entitled Information Regarding the Board of Directors and its Committees - Director Compensation and Executive Compensation, as set forth in the Proxy Statement.

ITEM 6 - SELECTED FINANCIAL DATA

The selected financial data should be read in conjunction with VFG's consolidated financial statements and the accompanying notes presented in this report. The per share information has been adjusted retroactively for all stock dividends and splits.

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Company's audited consolidated financial statements and the notes to those statements as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003, included in this report.

Forward-Looking Information

Statements appearing in this report which are not historical in nature, including the discussions of the adequacy of the Company's capital resources and allowance for credit losses, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements that expressly or implicitly predict future results, performance, or events should be considered forward-looking. Forward-looking statements are subject to the risks and uncertainties that may cause actual future results to differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report. VFG does not undertake any obligation to publicly release any revisions to forward-looking statements contained in this Annual Report, with respect to events or circumstances after the date of this Annual Report, or to reflect the occurrence of unanticipated events.

Such risks and uncertainties with respect to the Company include, among others, the risk of regulatory changes in Arkansas regarding payday lending, the inability to replace the Alabama payday lending program with a similar program in another state, risks related to the general economic environment, particularly in the region in which the Company operates, competitive products and pricing, that may lead to pricing pressures on rates the Bank charges on loans and pays on deposits, loss of customers of greatest value to the Bank, or other losses, fiscal and monetary policies of the federal government, changes in government regulations affecting financial institutions and small loan practices, including regulatory fees and capital

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requirements, changes in prevailing interest rates that could lead to decreased net interest margin, acquisitions and the integration of acquired businesses, credit risk management and asset/liability management, the financial and securities markets, changes in technology or required investments in technology, and the availability of and costs associated with sources of liquidity.

Critical Accounting Policies and Estimates

The Company's financial statements are based on the selection and application of significant accounting policies which require management to make significant estimates and assumptions (see Note 1 to the consolidated financial statements). The Company believes that the allowance for credit losses is one of the more critical judgment areas in the application of its accounting policies that affect financial condition and results of operations. The allowance for credit losses is more fully described in the Liquidity and Financial Condition section.

Performance Overview

In 2003, the Company earned $9,056,000. This represents the Company's most profitable year to date, surpassing the 2002 record of $6,212,000 by $2,844,000, or 46%. Earnings for 2002 increased by $1,775,000 or 40% over 2001 earnings of $4,437,000. Highlights for 2003 include:

• a 60% increase in non-interest income, primarily due to a 34% increase in mortgage origination fees and gains on sales of loans;
• Harbor Bank acquisition in 2002 becomes accretive to 2003 earnings;
• an 8% increase in net interest income, primarily due to a 22% reduction in deposit interest expense; and
• a $2,100,000 gain on sale of foreclosed real estate which related to a loan that had been previously charged off in 1999.

Asset growth in 2003 was 8% as total assets have grown to $513,900,000. Securities available-for-sale increased $51,256,000 with a reduction in cash and due from banks of $11,917,000. These two fluctuations account for the majority of 2003 net asset growth totaling $39,427,000. Gross loans fluctuated only slightly year over year with a $1,361,000 or .6% increase. Total deposits decreased $1,984,000, or .5%, to $382,223,000. Short term and long term borrowings increased $35,847,000 in 2003, and were primarily utilized to purchase securities. Basic earnings per share for 2003 were $2.07 per share compared to $1.42 per share for 2002 and $1.02 per share for 2001.

The 34% increase in mortgage origination fees and gains on sale of loans is primarily attributed to the mortgage originations and refinance activity associated with low mortgage rates in 2003. Management expects the mortgage activity and the corresponding income to be lower in 2004.

On July 15, the Company sold property that had been acquired as a result of a failed loan identified in 1999. The sale resulted in a $2,100,000 "Gain on Sale of Foreclosed Real Estate" and is reflected in the Company's 2003 results as "Other noninterest income". This transaction increased 2003 earnings per share by $.32.

The Bank's small loan division contributed $2,289,000 to net income in 2003. The small loan division provided small, short-term consumer loans to customers in Arkansas during all of 2003 and Alabama during a portion of 2003, pursuant to agreements with Advanced America. We discontinued operations in Alabama, which accounted for 68% of the small loan division's net income in 2003, and have not substituted those operations with similar lending operations in other states. See "Business - General." Financial highlights on this segment of the Company are found in Note 20-Business Segment Information, in the Company's consolidated financial statements.

The following table sets forth certain operating and capital ratios for the Company at December 31:

Return on Average Assets and Return on Average Equity at December 31, 2003 without the $2.1 million gain on sales of foreclosed real estate would have been 1.59% and 16.55% respectively.

The Company acquired Harbor Bank, NA on October 1, 2002 in a strategic expansion of its presence in the Pierce County marketplace. The acquisition provides two branches and lending opportunities in Gig Harbor. The Company had been considering expansion into the Gig Harbor area via a de novo branch, but this acquisition provided an opportunity to acquire

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significant market share in a single transaction. Total assets, loans, and deposits of Harbor Bank on the date of acquisition were $81,546,000, $54,761,000 and $74,163,000, respectively. The effect on 2002 net income was not material as the net revenues generated were offset by costs related to the acquisition and integration of the organizations' personnel and information systems. See Note 2 to the consolidated financial statements for more information on this acquisition. In addition to the growth in the Company's assets and liabilities from this transaction, it also contributed to a significant increase in the Company's problem loans. For further discussion, please see the discussion on Asset Quality in the Management's Discussion and Analysis of Financial Condition and Results of Operations.

Results of Operations

Net Interest Income

Net interest income is comprised of the difference between interest income, primarily from loans and investments, less interest expense incurred on interest bearing liabilities, primarily from deposits and borrowed funds. Changes in net interest income from year to year are influenced by both the volume of the assets and the liabilities, and the rates earned. Net interest income in 2003 increased by $1,768,000 or 8% over 2002. Net interest income in 2002 increased by $4,024,000 or 21% over 2001. The net increase in 2003 was due to the decrease in interest expense incurred on interest bearing liabilities and additional interest income resulting from an increased volume of loans, although this was partially offset by the reduction in the rate earned. The net increase in 2002 was due primarily to the volume of Harbor Bank loans.

During 2003, the net interest margin decreased 93 basis points to 5.91% from 6.84% in 2002. This reduction is primarily a direct result of ongoing short-term interest rates causing earning assets to continue downward repricing in 2003. Interest rate cuts in 2003 and 2002 were less dramatic than in 2001, when the prime rate, a benchmark rate that generally represents the rate at which banks lend to the most credit worthy borrowers, was cut 11 times. In 2003 and 2002 rates remained low and included additional rate cuts in June 2003 and September 2002. For comparison, the prime rate dropped from 9.5% to 4.75% in 2001, and as of December 31, 2002 and 2003, stood at 4.25% and 4.00%, respectively. Similarly, the Federal Funds rate, which represents banks' overnight borrowing rate experienced similar rate cuts and dropped from 6.5% to 1.75% in 2001 and as of December 31, 2002 and 2003 stood at 1.25% and 1.00%, respectively. As the rates stayed low, the effects of those dramatic reductions in 2001 continued to have an effect on both assets and liabilities as they matured and repriced as well as on new volume generated.

Total interest income earned from loans in 2003 increased by $506,000. On the one hand, $4,162,000 resulted from an increase in the average volume of loans during the year. On the other hand, a reduction in the average yield on loans, which decreased from 9.08% in 2002 to 8.00% in 2003, reduced interest income by $3,656,000. The reduction in interest yield is due primarily to repricing pressures; however, included in the $3,656,000 of reduced interest income is $1,180,000 of Alabama loan fees which would have been previously classified as interest income but was reclassified into miscellaneous income for the period July 12, 2003 through October 31, 2003. This amount represents the monies the Company would have collected on loans originated in Alabama if the Alabama legislature had not passed the Deferred Presentment Services Act. Despite the reduction in average yield, the Bank is able to maintain a relatively high yield due to participation in the small loan program, which began in late 2000. These short-term consumer loans carry substantially higher yields than those in the Bank's traditional portfolio, and, because they are a convenience product the price does not rise and fall with changing interest rates.

Adding to the increased loan interest was an increase in the interest earned on investment securities, which increased by $858,000 over the prior year. The most significant reason for this increase was additional volume which increased from an average volume of $23,935,000 to $54,046,000 generating an additional $1,240,000 in additional interest earned. The interest earned was offset by a reduction in yield which dropped from 5.27% in 2002 to 3.92% in 2003.

Interest expense on deposits in 2003 decreased 22%, or $1,321,000 from 2002. The reason for this decrease is due to the reduction in the rate of interest paid on deposits. The average rate decline on deposits to 1.53% in 2003 from 2.15% in 2002 resulted in $1,523,000 of savings on interest expense while additional volume of average deposits, an increase of 8.8%, increased interest expense $202,000. Interest expense on other borrowings increased $935,000. The reduction in average interest rate to 2.88% from 3.32% saved $102,000 in interest expense. However the increased average volume of borrowings, primarily the issuance of trust preferred securities totaling $19,000,000 and notes payable of $27,700,000 to Citigroup, increased interest expense by $1,037,000.

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An analysis of the change in net interest income is as follows (dollars in thousands):

The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

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Average consolidated statements of financial position and analysis of net interest spread were as follows (dollars in thousands):

(1) For purposes of these computations, non-accrual loans are included in the average loan balance outstanding. Loan fees and late charges of $1,033,000, $727,000, and $1,492,000, are included in interest income in 2003, 2002, and 2001, respectively.

Non-Interest Income

Total non-interest income increased $4,695,000 to $12,560,000, a 60% increase over 2002. Non-interest income includes service charges on deposit accounts, origination fees and gains on sale of loans, earnings on bank-owned life insurance, small loan miscellaneous income, and gain on sale of foreclosed real estate. Service charges on deposit accounts increased by $536,000, or 17% over 2002 due to increased number of deposit accounts. These revenues increased in 2002 by $670,000, or 27% from 2001 due to increased deposits and the full year effect of the 2001 introduction of a new overdraft privilege program. Origination fees and gains on sale of loans increased $861,000, or 34% from 2002 and 2002 increased $472,000, or 23% over 2001. These increases are due to an increased market share in home mortgage financings, which remain attractive to consumers due to the continued low interest rate environment. An increase in interest rates in the last quarter of 2003 had the effect of

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reducing mortgage financing and refinancing activity. Other operating income increased $3,298,000, or 149% over 2002. This increase was primarily due to a $2,100,000 gain on sale of foreclosed real estate and $1,180,000 in small loan miscellaneous income associated with the termination of small loan originations in Alabama. Other operating income increased $399,000 in 2002 from 2001 due to increases in rental income on foreclosed real estate and cash surrender value of Company owned life insurance of $236,000 and $174,000 respectively.

Non-Interest Expense

Total non-interest expense in 2003 increased 11% over 2002 and amounted to $22,192,000. Total non-interest expense in 2002 increased 13% over 2001 to total $20,073,000. Salaries and benefits, the largest component of non-interest expense, in 2003 increased $1,771,000, or 17% over 2002. This increase includes a full year salary for those employees acquired in the Harbor Bank acquisition as well as increased commissions related to mortgage origination. These expenses for 2002 increased $658,000, or 7% from 2001 due to three months salaries for those employees acquired in the Harbor Bank acquisition and also increased commissions related to mortgage origination. Occupancy costs and equipment expenses increased 28% in 2003 due primarily to a full years' depreciation related to the Harbor Bank facilities acquired in October 2002 and costs associated with the Bank's branding efforts in 2003. Occupancy costs and equipment expenses increased 17% in 2002 due primarily to the acquisition of Harbor Bank and continued upgrades to infrastructure. Other expenses in 2003 decreased 7% or $468,000 over 2002. The reduction is primarily attributed to a reduction in tax expense from a state business tax refund in 2003, offset by an increase in branding expenses incurred in 2003. Other expenses in 2002 increased $1,882,000, or 36% over 2001. The primary increases in 2002 were $264,000 recognized for long-term care benefits for directors, $235,000 in legal fees primarily related to the Harbor Bank acquisition and issuance of trust preferred securities, $182,000 related to the operations of the small loan program, $180,000 in integration costs related to the Harbor Bank acquisition, $141,000 in other professional fees related to the Harbor Bank acquisition, issuance of trust preferred securities and an ongoing branding project, and $123,000 in expenses related to foreclosed real estate.

Liquidity and Financial Condition

Asset growth in 2003 was 8% as total assets have grown to $513,900,000. Securities available for sale increased $51,256,000 with a reduction in cash and due from banks of $11,917,000. These two fluctuations account for the majority of 2003 asset growth totaling $39,427,000. Gross loans fluctuated only slightly year over year with a $1,361,000 or .4% increase. Total deposits decreased $1,984,000, or .5%, to $382,223,000. Short term and long term borrowings increased $35,847,000 in 2003, which were primarily used to purchase securities.

The principal sources of the Company's cash are dividends from the Bank and, in 2003, the proceeds of a $6 million offering of trust preferred securities completed in April. The Bank's ability to pay dividends is regulated by federal and state law. See "Business - Supervision and Regulation - Dividends."

The Bank's primary sources of funds are customer deposits, maturities of investment securities, loan sales, loan repayments, net income, advances from the Federal Home Loan Bank of Seattle ("FHLB"), the use of the Federal Funds markets, and long-term borrowings.

In June 2002 and April 2003, the Company raised $13,000,000 (VFG Capital Trust I) and $6,000,000 (VFG Capital Trust II), respectively through its participation in pooled trust preferred securities offerings. The floating rate trust preferred securities issued by VFG Capital Trust I accrue interest at a variable rate of interest, calculated quarterly, at LIBOR plus 3.65% per annum on the outstanding balance. The stated maturity date of this offering is July 2032. The floating rate trust preferred securities issued by VFG Capital Trust II accrue interest at a variable rate of interest, calculated quarterly, at LIBOR plus 3.25% per annum on the outstanding balance. The stated maturity date of this offering is October 2033. The majority of these funds were utilized for the purchase of Harbor Bank in 2002, to repurchase Company stock and pay cash dividends to the Shareholders.

Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and unscheduled loan prepayments are not. Deposit inflows and unscheduled loan prepayments are influenced by general interest rate levels, interest rates available on other investments, competition, economic conditions, and other factors.

Deposits are the primary source of new funds. Total deposits were $382,223,000 at December 31, 2003, down slightly from $384,207,000 at December 31, 2002. See "Deposits" below. The Bank has attempted to attract deposits in its market areas through competitive pricing and delivery of quality products.

Liquidity management involves the ability to meet cash flow requirements of customers who may be either depositors withdrawing funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Liquidity is generated from both internal and external sources. Internal sources include assets that can be converted to cash with little or no risk of loss. These include overnight investments in federal funds sold and investment securities available for sale, particularly those of shorter maturity, which are the principal source of asset liquidity. At December 31, 2003 cash, deposits in banks,

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interest-bearing deposits in banks and securities available for sale totaled $109,669,000. External sources refer to the ability to attract new liabilities and capital, including increasing savings and demand deposits, federal funds purchased, and the issuance of capital and debt securities. At December 31, 2003, overnight and federal funds lines of credit totaled $48,553,000. These credit lines were accessed regularly as a source of funding during 2003 and amounted to $10,000,000 at December 31, 2003.

Management believes the Bank's liquidity position at December 31, 2003, was adequate to meet its short-term funding requirements.

Management expects to continue relying on customer deposits, maturity of investment securities, sales of "Available for Sale" securities, loan sales, loan repayments, net income, Federal Funds markets, advances from FHLB, and other borrowings to provide liquidity. Management may also consider engaging in further offerings of trust preferred securities if the opportunity presents an attractive means of raising funds in the future. Although deposit balances at times have shown historical growth, such balances may be influenced by changes in the financial services industry, interest rates available on other investments, general economic conditions, competition, customer management of cash resources and other factors. Borrowings may be used on a short-term and long-term basis to compensate for reductions in other sources of funds. Borrowings may also be used on a long-term basis to support expanded lending activities and to match maturities or repricing intervals of assets. The sources of such funds will include Federal Funds purchased, reverse repurchase agreements and borrowings from the FHLB.

Investments

In 2003 the Company's securities available for sale and securities held to maturity increased $51,256,000 to $85,383,000. In August, September and October the Company purchased mortgage-backed securities totaling approximately $48,000,000. The securities purchased were funded with cash and a combination of short and long term borrowings. The securities have an estimated average life of five years with continual cash flow via periodic paydowns. These mortgage-backed securities were purchased to take advantage of the steep short term yield curve. Because the available-for-sale portfolio is carried at fair value, its carrying value fluctuates with changes in market factors, primarily interest rates. The recorded amounts of securities and their fair value at December 31 are found in Note 4-Securities, in the Company's consolidated financial statements.

The stated maturities and weighted average yield of debt securities were as follows (dollars in thousands):

Weighted average yield is reported on tax-equivalent basis.

There were no gross realized gains or gross realized losses on sales of securities available for sale in 2003, 2002, or 2001.

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Loans

Total loans excluding loans held for sale increased by $1,361,000 to $363,493,000 in 2003. The composition of the loan portfolio was as follows at December 31 (dollars in thousands):

The Bank's loan portfolio is concentrated in real estate secured loans which include real estate construction loans and real estate mortgage loans. Real estate mortgage loans primarily consist of commercial loans secured by real estate. The Bank made 334,788 small loans in 2003, representing $115,829,000 in total advances.

The following table shows the maturity analysis of commercial, real estate construction, and real estate mortgage loans outstanding as of December 31, 2003 (dollars in thousands):

Of these loans maturing after one year, $77,403,000 have predetermined or fixed interest rates and $73,213,000 have floating or adjustable interest rates.

Asset Quality

Non-performing assets consist of loans on which interest is no longer accrued, accruing loans past due 90 days or more and foreclosed real estate and other assets. Total non-performing assets amounted to $4,205,000 at December 31, 2003, a decrease of 67% or $8,570,000 from December 31, 2002. Non-accrual loans decreased $4,339,000 during 2003 from the December 31, 2002 balance of $6,543,000. Total foreclosed real estate amounted to $1,996,000 at December 31, 2003. Accruing loans past due 90 days or more were $2,000 at December 31, 2003 compared to $1,278,000 for the same period in 2002. Any anticipated losses on these loans have been adequately reserved for in the allowance for credit losses. The Company has allocated significant resources towards improving its asset quality in 2003. As evidenced in the table below , the majority of these asset quality issues were a direct result of the Harbor Bank acquisition in October 2002.

Loans will be placed on non-accrual using the following guidelines: (1) a loan will be placed on nonaccrual when collection of all principal or all interest is deemed unlikely; and (2) a loan will automatically be placed on nonaccrual when principal or interest is 90 days or more past due unless the loan is both well secured and in the process of being collected. Placing a loan on non-accrual does not diminish in anyway the Company's claims against the borrower.

Non-performing assets were as follows at December 31 (Dollars in thousands):

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The gross interest income that would have been recorded in 2003 if the loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination, if held for part of the period, totaled $100,000. No interest income on these loans was included in net income in 2003.

Applicable regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, regulatory examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. When an insured institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for credit losses in an amount deemed prudent by management. These allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities and the risks associated with particular problem assets. When an insured institution classifies problem assets as loss, it charges off the balance of the asset against the allowance for credit losses. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated as special mention. The Bank's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the FDIC which can order the establishment of additional loss allowances.

The aggregate amounts of the Bank's classified assets (as determined by the Bank), and of the Bank's allowance for credit losses at the dates indicated, were as follows:

The Bank's classified assets decreased by $6,303,000 at December 31, 2003 primarily in the substandard category. As mentioned previously 2002 classified asset numbers are primarily a result of the acquisition of the Harbor Bank loan portfolio. These loans were acquired along with the related allowance for credit losses, resulting in a significant increase in the Bank's total allowance for credit losses.

Substandard loans are classified as those loans that are inadequately protected by the current net worth, and paying capacity of the obligor, or of the collateral pledged. Assets classified as substandard have a well-defined weakness, or weaknesses that jeopardize the repayment of the debt. If the weakness, or weaknesses are not corrected there is the distinct possibility that some loss will be sustained. At December 31, 2003, 93 loans were classified as substandard compared to 101 at December 31, 2002. One loan accounts for $1,113,000 or 18% of the total. The loan is secured by a first mortgage position on two commercial properties located in Vashon Island and Buckley, Washington. Management believes the Bank is adequately provisioned against losses that might occur with this loan.

Special mention loans are defined as those credits deemed by management to have some potential weakness that deserve management's close attention. If left uncorrected these potential weaknesses may result in the deterioration of the payment prospects of the loan. Assets in this category are not adversely classified and currently do not expose the Bank to sufficient risk to warrant a substandard classification. There were three relationships in this category as of December 31, 2003 aggregating $5,498,000 or 47% of the total, with no other concentrations. One relationship was for $1,804,000 secured by a first mortgage on commercial property and business assets in Gig Harbor, Washington, the second for $2,006,000 was secured by a first mortgage position on a hotel located in Kent, Washington, and the third for $1,688,000 secured by a first mortgage on commercial property in Algona, Washington. Management believes none of these relationships will result in a loss for the Bank. Each of these loans is current and paying in accordance with the required loan terms.

The Company is not aware of any loans continuing to accrue interest at December 31, 2003 that represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital

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resources. Material credits about which management is aware of any information that would raise serious doubts as to the ability of such borrowers to comply with the loan repayment terms, have been adequately reserved in the allowance for credit losses.

Allowance for Credit Losses

The allowance for credit losses reflects management's current estimate of the amount required to absorb probable losses on existing loans and commitments to extend credit. Loans deemed uncollectible are charged against and reduce the allowance. Periodically, the provision for credit losses is charged to current expense. This provision acts to replenish the allowance for credit losses and to maintain the allowance at a level that management deems adequate.

There is no precise method of predicting specific credit losses or amounts that ultimately may be charged off on segments of the loan portfolio. The determination that a loan may become uncollectible, in whole or in part, is a matter of judgment. Similarly, the adequacy of the allowance for credit losses can be determined only on a judgmental basis, after full review, including:

• consideration of economic conditions and the effect on particular industries and specific borrowers;
  
• a review of borrowers' financial data, together with industry data, the competitive situation, the borrowers' management capabilities and other factors;
  
• a continuing evaluation of the loan portfolio, including monitoring by lending officers and staff credit personnel of all loans which are identified as being of less than acceptable quality;
  
• an in-depth appraisal, on a monthly basis, of all loans judged to present a possibility of loss (if, as a result of such monthly appraisals, the loan is judged to be not fully collectible, the carrying value of the loan is reduced to that portion considered collectible); and
  
• an evaluation of the underlying collateral for secured lending, including the use of independent appraisals of real estate properties securing loans.
  

Periodic provisions for loan losses are made to maintain the allowance for credit losses at an appropriate level. The provisions are based on an analysis of various factors including historical loss experience for the bank and for the industry as a whole, based on volumes and types of loans, volumes and trends in delinquencies and non-accrual loans, trends in portfolio volume, results of internal and independent external credit reviews, and anticipated economic conditions. Provisions for loan losses on small loans are made monthly to maintain this segment of the allowance for credit losses at a level sufficient to absorb losses on existing loans. This portion of the allowance is generally maintained at a level sufficient to cover all small loans that have defaulted, as well as an amount sufficient to absorb the anticipated losses on two small loan operating cycles (approximately one month in duration), based on both the Bank's and the industry's historical loss experience.

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Transactions in the allowance for credit losses for the five years ended December 31, 2003 are as follows (dollars in thousands):

The Bank charged off $1,882,000 in small loans, and recovered $935,000. The net charge-offs as a percent of total small loan advances for 2003 was .82%.

In May 1993, the Financial Accounting Standards Board (FASB) issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" and in October 1996, issued SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition Disclosures, an amendment to SFAS No. 114". The Company measures impaired loans based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair market value of the collateral if the loan is collateral dependent. The Company excludes loans that are currently measured at fair value or at the lower of cost or fair value, and certain large groups of smaller balance homogeneous loans that are collectively measured for impairment. The following table summarizes the Bank's impaired loans at December 31 (dollars in thousands):

No allocation of the allowance for credit losses was considered necessary for the remaining impaired loans. The balance of the allowance for credit losses in excess of these specific reserves is available to absorb losses from all loans.

It is the Company's policy to charge-off any loan or portion of a loan that is deemed uncollectible in the ordinary course of business. The entire allowance for credit losses is available to absorb such charge-offs. The Company allocates its allowance for credit losses primarily on the basis of historical data. Based on certain characteristics of the portfolio, losses can be anticipated for major loan categories.

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In the following table, the allowance for credit losses at December 31, 2003, 2002, 2001, 2000 and 1999 has been allocated among major loan categories based on a number of factors including quality, volume, economic outlook and other business considerations (dollars in thousands):

(1) Real estate includes real estate mortgage and real estate construction.

Deposits

Total deposits decreased by $1,984,000, or .52% from 2002 to $382,223,000. 2002 deposits included $74,163,000 acquired in the Harbor Bank, NA acquisition. Non-interest bearing deposits experienced minimal increase while savings and interest-bearing demand deposits increased 17% to $182,545,000 in 2003. Time deposits decreased 19% to $118,334,000. To reduce the effect of continuous short-term interest rates on the Company's net interest margin, Management decided in 2003 to focus growth in its core or lower cost deposits. We pursued this strategy through marketing, implementation and expansion of value-added products associated with these accounts and product pricing.

The Bank's average deposits for the year(s) ended December 31 are summarized as follows (dollars in thousands):

Time deposits at December 31, 2003 are scheduled to mature as follows (dollars in thousands):

Capital Resources

Consolidated capital of VFG increased $4,464,000 during 2003 to $48,673,000. Net earnings of $9,056,000 provided the largest increase to capital while exercising of stock options provided $1,608,000. Decreases to capital were $4,828,000 in stock repurchased by the Company and cash dividends of $0.24 per share, or $1,048,000. Cash dividends totaling $0.20 per share after the effect of the stock split, were paid in 2002 and 2001.

There are regulatory constraints placed upon capital adequacy, and it is necessary to maintain an appropriate ratio between capital and assets. Regulations require banks and holding companies to maintain a minimum "leverage" ratio (primary capital ratio) of total assets. For the most highly rated holding companies this ratio must be at least 3%, and for others it must be 4% to 5%. At December 31, 2003, the Company's leverage ratio was 10.70%, compared to 11.60% at year-end 2002. For regulatory purposes, any goodwill and other intangible assets are treated as a reduction of capital. In addition, holding companies are

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required to meet minimum risk-based capital guidelines under which risk percentages are assigned to various categories of assets and off-balance-sheet items to calculate a risk-adjusted capital ratio. Tier I capital generally consists of common stockholders' equity, less goodwill and other intangible assets, while Tier II capital includes the allowance for credit losses, subject to 1.25% limitation of risk-adjusted assets. The rules require Tier II capital of 4% of risk-adjusted assets and total capital (combined Tier I and Tier II) of 8%. At December 31, 2003, the Tier I capital ratio was 11.20%, and total capital was 13.04%. The similar ratios at December 31, 2002 were a Tier I capital ratio of 10.23% and a total capital ratio of 11.49%. For additional information, see "Item 1-Business-Supervision and Regulation-Capital Adequacy".

Borrowings

Information concerning short-term borrowings is summarized as follows (dollars in thousands):

Short-term borrowings represent federal funds purchased, generally maturing within one to four days, demand notes from the U.S. Treasury, two notes with Citigroup and advances from the FHLB, normally maturing within one year.

Long-term borrowings include trust preferred securities, term advances from the FHLB, and two notes with Citigroup.

The following table shows the long-term borrowing contractual obligations as of December 31, 2003 (dollars in thousands):

Off Balance Sheet Arrangements

Information concerting Off-Balance Sheet Arrangements is found in Note 13 - Commitments and Contingent Liabilities, in the Companies consolidated financial statements.

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Supplementary Quarterly Data

ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's assets and liabilities are managed to maximize long-term shareholder returns by optimizing net interest income within the constraints of maintaining high credit quality, conservative interest rate risk disciplines and prudent levels of liquidity. The Asset/Liability Committee meets regularly to monitor the composition of the balance sheet, to assess current and projected interest rate trends, and to formulate strategies consistent with established objectives for liquidity, interest rate risk and capital adequacy.

Interest rate sensitivity is closely related to liquidity, as each is directly affected by the maturity of assets and liabilities. The Company's net interest margin is affected by changes in the level of market interest rates. Management's objectives are to monitor and control interest rate risk and ensure predictable and consistent growth in net interest income. See "Management's Discussion and Analysis - Liquidity and Financial Condition - Results of Operations - Net Interest Income".

Management considers any asset or liability that matures, or is subject to repricing within one year to be interest sensitive, although continual monitoring is performed for other time intervals as well. The difference between interest sensitive assets and liabilities for a defined period of time is known as the interest sensitivity "gap", and may be either positive or negative. If positive, more assets reprice before liabilities. If negative, the reverse is true. A Static Gap analysis as presented below provides a general measure of interest rate risk but does not address complexities such as prepayment risk, interest rate floors and ceilings imposed on financial instruments, interest rate dynamics and customers' response to interest rate changes. Based on the Bank's static interest sensitivity gap is negative within one year. However, this assumes that general market interest rate changes affect the repricing of assets and liabilities in equal magnitudes.

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As indicated above , the effect of rising interest rates on the Company would be a decrease in the net interest margin, whereas falling interest rates would cause a corresponding increase in the margin. Based on historical data, however, Management believes the opposite to be true. Based on an interest rate shock analysis, in a rising rate environment, repricing of liabilities will lag the upward pricing of assets and accordingly, the Company's net interest margin will increase in a rising rate environment. Rate shock is a process wherein the characteristics of the financial assets of the Company are reviewed in the event they are subjected to an instantaneous and complete adjustment in the market rate of interest. These results are modeled to determine the effects on interest rate margin for the succeeding twelve months from the repricing of variable rate assets and liabilities where applicable. The level of impact on the various assets and liabilities are also estimated for their sensitivity to pricing changes of such a market interest rate change.

According to this model and its assumptions, the change in net interest margin in the event market interest rates were to immediately rise or fall by 100 basis points is estimated to be $750,000. This amount represents approximately 2.8% of the 2003 net interest income.

The Company's market risk is impacted by changes in interest rates. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business.

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ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors and Shareholders
Venture Financial Group, Inc.

We have audited the accompanying consolidated balance sheet of Venture Financial Group, Inc. and its subsidiaries (the Company) as of December 31, 2003, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of Venture Financial Group, Inc. and its subsidiaries (formerly First Community Financial Group, Inc.) as of December 31, 2002, and for the years ending December 31, 2002 and 2001, were audited by other auditors whose report dated January 10, 2003, expressed an unqualified opinion on those statements.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the 2003 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Venture Financial Group, Inc. and its subsidiaries as of December 31, 2003, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

Everett, Washington
January 14, 2004

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Independent Auditor's Report

Board of Directors
Venture Financial Group, Inc.

 Lacey, Washington

We have audited the accompanying consolidated balance sheet of Venture Financial Group, Inc. and Subsidiaries as of December 31, 2002, and the related consolidated statements of income, shareholders' equity and cash flows for the years ended December 31, 2002 and 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Venture Financial Group, Inc. and Subsidiaries as of December 31, 2002, and the results of their operations and their cash flows for the years ended December 31, 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America.

Tacoma, Washington
January 10, 2003

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See accompanying notes

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