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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, 2004

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

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, 2004 (the last business day of the most recent second quarter), was $66,268,499 (based on the last sale of $15.50 per share on June 30, 2004).

The number of shares of no par value Common Stock outstanding as of March 24, 2005, was 6,520,714.

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 5, 2005, are incorporated by reference into Part III of this Annual Report on Form 10-K.

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PART I

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 the stock of 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 Junior Subordinated Debentures completed in July 2002. For additional information regarding Junior Subordinated Debentures, see "Item 7-Management's Discussion & Analysis of Financial Condition and Results of Operations - Liquidity and Financial Condition." The Harbor Bank acquisition added two financial centers in Gig Harbor, Washington.

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

• Hawks Prairie area of Lacey (2000)
• Meridian-Puyallup (2001)
• West Olympia (2001)
• Downtown Tacoma (2001)
• Kent (2004)

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

In April 2004, the Bank acquired Washington Asset Management Tacoma, LLC, a financial services and wealth management company. The acquired firm was consolidated with the Bank's existing Investment Services Department and Venture Wealth Management, a wholly owned subsidiary of Venture Bank, was formed. Venture Wealth Management is headquartered in Downtown Tacoma.

In October 2004, the Bank sold seven of its financial centers. These financial centers were located in Grays Harbor (Aberdeen, Elma, Montesano, and Hoquiam), Lewis (Toledo, Winlock) and Thurston (Panorama City) Counties. We sold $88 million in deposits and $1.8 million in real estate, furniture and fixtures, and recorded a $5.2 million gain on the sale of deposits, and a $200,000 gain on the sale of real estate, furniture and fixtures.

In October 2004, the bank agreed to lease land in Lakewood for a financial center scheduled to open in the third quarter 2005.

In December 2004, the Bank opened its first South King County financial center located in the Kent East 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:

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• savings and checking accounts,
• time deposits,
• consumer installment loans,
• mortgage and commercial lending,
• safe deposit facilities, and
• 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 Wealth Management.

In April 2001, the Bank entered into a Marketing and Servicing Agreement with Advance America. Advance America is a 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 has taken steps to forestall any negative effect that may have occurred from these developments, including expansion of core banking operations. Small loan income lost in 2004 from discontinued operation in Alabama was offset with increased investment and loan interest income.

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. On March 2, 2005, the Federal Deposit Insurance Corporation ("FDIC"), our primary regulator, issued revised payday lending guidelines. The full text of such guidelines is available on the FDIC website at http://www.fdic.gov/ . Payday loans are funded by the Bank in the State of Arkansas for amounts between $100 and $700 and are short-term (30 days or less), unsecured loans, generally with high interest rates, that borrowers promise to repay out of their next paycheck. We have offered payday loans in Arkansas since April 2001 and we will be affected by the revised guidelines. Financial highlights on this segment of the Company are found in Management's Discussion & Analysis of Financial Condition and Results of Operations and Note 21-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-Federal and State Regulation of Venture Bank".

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 commercial 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 financial center locations (with statewide financial center 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, as 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

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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 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.

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.

The Bank engages in general banking business through 14 offices in Thurston, Lewis, Pierce and King Counties, Washington. All four counties experienced a stable economic environment in 2004. Thurston County's growth, although minimal, has been spurred by increased government employment and several larger companies moving into the County.

Lewis County has experienced flat growth and derives 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.

King County is very well diversified with a strong industrial and service industry base, the Port of Seattle, Seattle-Tacoma International airport, and as the headquarters for Costco, Microsoft, and Starbucks.

VFG and its subsidiaries employed a total of 205 employees, consisting of 175 full time and 30 part time employees at December 31, 2004. A number of benefit programs are available to eligible employees, including group medical 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.

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.

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:

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• 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.

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 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.

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.

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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 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 financial center or facility.

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 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.

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 potential risks to banks, including 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, OTS, and FRB, 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. On March 2, 2005, the Federal Deposit Insurance Corporation ("FDIC"), our primary regulator, issued revised payday lending guidelines. The full text of such guidelines is available on the FDIC website at http://www.fdic.gov/ . Payday loans are funded by the Bank in the State of Arkansas for amounts between $100 and $700 and are short-term (30 days or less), unsecured loans, generally with high interest rates, that borrowers promise to repay out of their next paycheck. We have offered payday loans in Arkansas since April 2001 and we will be affected by the revised guidelines.

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.

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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 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.

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.

Along with the issuance of Junior Subordinated Debentures, dividends paid by the Bank provide substantially all of the Company's cash flow. Under Washington 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.

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, undivided profits, and Junior

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Subordinated Debentures up to 25% of Tier I capital. Tier II capital generally consists of the allowance for loan losses up to 1.25% of risk weighted assets, 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 12.24% and 13.49%, 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 12.94% .

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 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."

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.

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;

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• enhances 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.

The USA Patriot Act has required a greater use of resources due to the requirement of an enhanced anti-money laundering program. The Company does not believe the enhanced anti-money laundering program will have a material adverse effect on business and operations.

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.

The Bank owns the property and buildings on which the Kent, Lacey, Yelm, Fircrest, Downtown Tacoma, Gig Harbor Pioneer, Centralia, and Downtown Olympia financial centers are situated. The Bank also owns the Gig Harbor Loan Center building as part of its Pioneer location. The Tumwater and Eatonville financial centers are operated in buildings owned by VB that are situated on leased property. The Hawks Prairie, West Olympia, South Hill Puyallup, and Gig Harbor Pt. Fosdick financial centers are operated in leased space. The aggregate monthly rental on all properties leased by the Bank is approximately $56,000.

The Lacey office is a two story building with a basement and a drive-up, which has approximately 17,500 square feet and is fully utilized as a bank financial center, administrative offices, customer care center and data processing facility. The South Hill Puyallup, Tumwater, Yelm, Eatonville, West Olympia, Centralia, and Pt. Fosdick financial centers are single story structures with drive-up facilities. The Downtown Olympia, Hawks Prairie, and Downtown Tacoma financial centers are two story structures with drive-up facilities. The Kent and Pioneer financial centers are single story structures with walk up ATMs. The Fircrest financial center is an office condominium, of which the Bank occupies approximately one-half the space.

In December 2004, the Bank entered into an agreement, upon satisfaction of certain contingencies, to purchase land in DuPont Washington for $2 million to construct a three story, 50,000 square foot corporate office building. The purchase of this property was finalized on February 17, 2005. In October 2004 the Bank agreed to lease property for $9,140 per month in Lakewood Washington for a financial service center currently scheduled to open in the third quarter 2005.

From time to time in the ordinary course of business, VFG or its subsidiaries may be involved in litigation. At the present time neither VFG nor any of its subsidiaries are involved in any threatened or pending material litigation.

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

During the fourth quarter of the year ended December 31, 2004, no matters were submitted to the security holders through the solicitation of proxies or otherwise.

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PART II

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

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. 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. This information has been adjusted to reflect the three-for-two stock split effective May 16, 2004.

At December 31, 2004 options for 436,045 shares of VFG common stock were outstanding. See Note 15 of the consolidated financial statements for additional information.

Number of Equity Holders

As of December 31, 2004, there were 1,426 holders of record of VFG's common stock.

VFG paid cash dividends of $0.047 on February 13 and May 14, and $0.05 on August 16 and $0.06 on November 19, 2004. VFG paid cash dividends of $0.033 per share on February 12, and May 16, 2003. VFG paid cash dividends of $0.047 per share on August 8, and November 14, 2003. The amounts reported reflect an adjustment for the May 2004 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".

Purchases of Equity Securities by Venture Financial Group, Inc.

On December 11, 2002, the Board approved a stock repurchase program that allowed for the repurchase of up to 198,000 shares of VFG Common Stock in purchases over a three month period, 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 104,358 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 131,370 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 56,130 shares were added to the plan. On October 15, 2003 this plan was amended again and an additional 225,000 shares were added to this plan bringing the total to 412,500 shares. Under this plan 266,097 shares were repurchased in 2003 and 146,403 have been repurchased in 2004 for a total of $2,226,290. All shares have been adjusted for the three-for-two stock split effective May 16, 2004.

On June 16, 2004 the Board approved a stock repurchase program to allow for the repurchase of 200,000 shares of VFG Common Stock in purchases over time in either privately negotiated transactions or through the open market. Under this plan 50,779 shares have been repurchased for a total of $780,424.

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On May 6, 2004, the Board of Directors announced a three-for-two stock split on VFG stock for shareholders of record on May 16, 2004.

The following table sets forth the Company's repurchase of its outstanding common stock during the fourth quarter of the year ended December 31, 2004.

Securities Authorized for Issuance Under Equity Compensation Plans

Equity Compensation Plan Information

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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.

Net income for the years ended December 31, 2004 and 2003 included extraordinary items as discussed in Item 7 below under the headings "Performance Overview" and "Non-Interest Income."

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, 2004 and 2003 and for each of the three years in the period ended December 31, 2004, included in this report.

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 federal or state regulatory changes regarding payday lending; 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; fiscal and monetary policies of the federal government; changes in government regulations affecting financial institutions and small loan practices, including regulatory fees and capital requirements; changes in prevailing interest rates that could lead to decreased net interest margin; the integration of acquired businesses; credit risk management and asset/liability management; changes in technology or required investments in technology; and the availability of and costs associated with sources of liquidity.

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

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In 2004, the Company earned $11,777,000. This represents the Company's most profitable year to date, surpassing the 2003 record of $9,056,000 by $2,721,000, or 30%. Earnings for 2003 increased by $2,844,000 or 46% over 2002 earnings of $6,212,000. Highlights for 2004 include:

• a $5,462,000 gain on the sale of seven branches
• net interest income before provision for credit losses remains the same from 2003 to 2004 despite the fact that 2003 included $1,500,000 from discontinued operations in Alabama
• non interest income increases by $1,009,000

On October 8, 2004, the Company sold seven of its branches. Of the seven branches, one was in Thurston County, two were in Lewis County and four were in Grays Harbor County. Deposits transferred totaled $88,000,000. The Company retained all loans originated through the seven branches. The Company realized a $3,500,000 gain net of tax and previously recorded goodwill with respect to such branches.

The Company continues to move forward with its strategic plan of reallocating resources to the more populated and growing areas in Pierce and King Counties. A financial center was opened in Kent in King County in December 2004, and plans are underway to open another financial center in Lakewood in Pierce County in the third quarter 2005. In addition, existing financial centers are in the process of being remodeled to better suit the company's branding effort. In December 2004, the Company entered into an agreement, upon satisfaction of certain contingencies, to purchase land in DuPont in Pierce County Washington for $2 million to construct a corporate office. The purchase of this property was finalized February 17, 2005. Management believes that centralizing administration functions will create long term efficiencies.

Asset growth in 2004 was 8% as total assets have grown to $556,216,000. Total loans have increased $66,000,000 while securities available for sale have decreased $11,500,000 and cash and Federal Funds Sold have both decreased $5,000,000. These four fluctuations account for the majority of 2004 net asset growth totaling $42,316,000. Total deposits decreased $55,502,000, or 14.5% to $326,721,000. Federal Funds Purchased, short term borrowings and long term borrowings increased a total of $86,898,000. Basic earnings per share for 2004 were $1.82 per share compared to $1.38 per share for 2003 and $0.95 for 2002.

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, 2004 without the $3.5 million net gain on sales of the seven branches would have been 1.56% and 16.32% respectively. Return on average assets and return on average equity at December 31, 2003 without the $1.4 million net gain on sale 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 financial centers and lending opportunities in Gig Harbor. The Company had been considering expansion into the Gig Harbor area via a de novo financial center, but this acquisition provided an opportunity to acquire 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.

Net interest income is comprised of the difference between interest income, primarily from loans and investments, and interest

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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 and paid, respectively. Net interest income in 2004 decreased by $56,000 over 2003. Net interest income in 2003 increased by $1,768,000 or 8% over 2002. The Bank discontinued Alabama small loan originations in 2003 and accordingly, loan interest income for the twelve months ending December 31, 2003 included $1,500,000 in small loan income not included in 2004. Excluding Alabama small loan income from the 2003 numbers, net interest income year-over-year increased $1,500,000 or 6.1% .

During 2004, our interest margin decreased 63 basis points to 5.28% from 5.91% in 2003. This reduction is partially a result of discontinued small loan production in Alabama. In 2003 the operations in Alabama resulted in $1,500,000 in interest income. Without this operation the net interest margin in 2003 would have been 5.06% and 4.82% in 2004, a decrease of 24 basis points. This 24 basis point decrease in net interest margin is attributable to the shift in funding source from deposits to short term borrowings as a result of the transfer of $88,000,000 in deposits in connection with the sale of seven branches previously discussed.

Total interest income earned from loans in 2004 decreased by $560,000, the net effect of an increase of $2,241,000 due to an increase in the average volume of loans during the year, offset by a reduction in the average yield on loans of $2,801,000, attributable to a decline in the average yield from 8.00% in 2003 to 7.27% in 2004. The reduction in interest yield is due primarily to repricing pressures; however, included in the $2,801,000 of reduced interest income is $1,500,000 of Alabama loan fees which were included in 2003 but not in 2004. Despite the reduction in average yield, the Bank is able to maintain a relatively high yield due to participation in the small loan program in Arkansas, which began in April of 2001. 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.

Offsetting the decrease in loan interest income was an increase in the interest earned on investment securities, which increased by $1,076,000 over the prior year. The most significant reason for this increase was additional volume which increased from an average volume of $54,046,000 to $78,870,000 generating an additional $1,015,000 in additional interest earned. The yield on investments increased from 3.92% to 4.05%, generating an additional $61,000 in interest income.

Interest expense on deposits in 2004 decreased 11.5%, or $528,000 from 2003. The decrease is partially due to the reduction in the rate of interest paid on deposits. The average rate declined on deposits to 1.39% in 2004 from 1.53% in 2003 which resulted in $121,000 of savings on interest expense while reduced volume of average deposits, a decrease of 2.5%, decreased interest expense $407,000. Interest expense on other borrowings increased $1,056,000. The reduction in average interest rate to 2.69% from 2.84% saved $84,000 in interest expense. However the increased volume of borrowings, primarily the increase in short term borrowings to $123,128,000 from $34,394,000 due to the divestiture of seven branches, increased interest expense by $1,140,000.

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 $1,532,000, $1,033,000, and $727,000, are included in interest income in 2004, 2003, and 2002, respectively.

Total non-interest income increased $1,009,000 to $13,569,000, an increase of 8% over 2003. This increase is primarily due to a $5,462,000 gain on sale of seven branches in 2004. 2003 included 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. 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 $135,000 or 4% over 2003. These revenues increased in 2003 by $536,000, or 17% over 2002 due to increased number of deposit accounts. Origination fees and gains on sale of loans decreased by $2,055,000, or 61% from 2003 to 2004 and increased $861,000, or 34% from 2002 to 2003. An increase in interest rates in the last quarter of 2003 had the effect of reducing mortgage financing and refinancing activity that carried over into 2004. Other operating income increased $2,929,000, or 46.5% over 2003. Other operating income increased by $3,298,000 in 2003 from 2002.

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Total non-interest expense in 2004 decreased 5% over 2003 and amounted to $21,078,000. Total non-interest expense in 2003 increased 11% over 2002 to total $22,192,000. Salaries and benefits, the largest component of non-interest expense, in 2004 decreased $1,343,000 or 11% over 2003. This decrease is due to a decrease in salary and benefits from the reduction in mortgage commissions and a reduction in salary expense associated with the branch divestiture. These expenses for 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 and also increased commissions related to mortgage originations. Occupancy costs and equipment expenses increased $87,000 or 2.6% in 2004. These expenses increased 28% in 2003 due primarily to a full years' depreciation related to the Harbor Bank facilities acquired in October 2002. Other expenses in 2004 increased $143,000, or 2%. This increase is due to a $329,000 write down on foreclosed property offset by $550,000 in expenses realized in 2003 associated with the re-branding of the company. These expenses decreased 7% or $468,000 over 2002 primarily attributed to a reduction in tax expense from a state business tax refund in 2003, offset by an increase in branding expense incurred in 2003.

Asset growth in 2004 was 8% as total assets have grown to $556,216,000. Loan growth was 18%, or $66,030,000. This growth was offset by a decrease in securities available for sale of $11,587,000, a decrease in cash and due from banks of $5,252,000 and a decrease in Federal Funds Sold of $5,530,000. Total deposits decreased $55,502,000, or 14.5% to $326,721,000. Short term borrowings increased 258% or $88,734,000 in 2004. Long term debt decreased $8,000,000.

The principal sources of the Company's cash are dividends from the Bank and, in 2003, the proceeds of a $6 million offering of Junior Subordinated Debentures 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. At December 31, 2004, the Bank's short-term borrowings totaled $128,123,000, including $86,700,000 at the Federal Home Loan Bank.

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 Junior Subordinated Debentures offerings. The floating rate Junior Subordinated Debentures 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 Junior Subordinated Debentures 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 to pay cash dividends.

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 $326,721,000 at December 31, 2004, down from $382,223,000 at December 31, 2003. As discussed previously, this decrease is due to the divestiture of seven branches in October 2004. The bank has attempted to attract deposits in its market areas through competitive pricing and delivery of quality products as well as opening branches in new markets such as south King County.

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, 2004 cash, deposits in banks, interest-bearing deposits in banks and securities available for sale totaled $87,152,000. 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, 2004, overnight and federal funds lines of credit totaled $41,100,000. These credit lines were accessed regularly as a source of funding during 2004 and amounted to $5,575,000 at December 31, 2004.

Management believes the Bank's liquidity position at December 31, 2004, was adequate to meet its short-term funding requirements.

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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 Junior Subordinated Debentures 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.

In 2004 the Company's securities available for sale and securities held to maturity decreased $12,092,000. This decrease is due to the principal payments on mortgage-backed securities totaling $11,767,000, securities maturing and called totaling $13,773,000, offset by the purchase of mortgage-backed securities totaling $15,005,000. 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 notes to the Company's consolidated financial statements.

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

There was a gross realized loss on sales of securities available for sale of $21,000 in 2004, and no gains or losses in 2003 or 2002.

Total loans excluding loans held for sale increased by $66,030,000 to $429,523,000 in 2004. 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 173,796 small loans in 2004, representing $62,766,000 in total advances. Balances include deferred loan fees.

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The following table shows the maturity analysis of commercial, real estate construction, and real estate mortgage loans outstanding as of December 31, 2004 (dollars in thousands):

Of the loans maturing after one year, $9,437 have predetermined or fixed interest rates and $206,442 have floating or adjustable interest rates.

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 $5,810,000 at December 31, 2004, an increase of $1,605,000 or 38% from December 31, 2003. Non-accrual loans increased $877,000 during 2004 from the December 31, 2003 balance of $2,204,000. Loans 90 days past due and still accruing interest increased $2,003,000 during 2004 from a balance of $2,000. Foreclosed real estate decreased $1,278,000 or 64% in 2004 to $718,000. Any anticipated losses on these loans have been adequately reserved for in the allowance for credit losses.

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 the validity of the Company's claims against the borrower.

The gross interest income that would have been recorded in 2004 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 2004.

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.

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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 increased by $9,292,000 at December 31, 2004. $5,358,000 was in the Special Mention category and $3,839,000 was 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 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, 2004, substandard loans of $10,026,000 represented an increase of $3,839,000 or 62%, over the December 31, 2003 total. Recent FDIC guidelines, in a change from protocol used on December 31, 2003, require us to classify the Bank's Small Loan portfolio totaling $3,821,333, as substandard. The balance of the substandard loans on December 31, 2004, of $6,207,000 was comprised of 59 loans, compared to 93 loans at December 31, 2003. One loan accounts for $2,003,733, or 20% of the total, and 32% of the $6,207,000. That loan is secured by a first mortgage position on a commercial property in Kent, 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 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 five relationships in this category as of December 31, 2004 aggregating $11,638,146, or 68% of the total, with no other concentrations. One relationship was for $4,160,000 secured by a first mortgage on commercial property in Chehalis, Washington, a second for $1,070,143 secured by first mortgage positions on two commercial properties, one located in Vashon Island and the second in Buckley, Washington, a third for $1,688,461 secured by a first mortgage on commercial property in Algona-Pacific, Washington, the fourth for $2,378,216 secured by a first mortgage on commercial property located in Federal Way, Washington, and the fifth relationship for $2,341,326 secured by a first mortgage on commercial properties and equipment located in Gig Harbor, 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 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;

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• 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.

A formal analysis of the adequacy of the allowance is conducted quarterly and reviewed by the Board of Directors. Based on this analysis, management considers the allowance for credit losses to be adequate.

During a regulatory examination during the fourth quarter of 2004, the Bank's federal regulator, the Federal Deposit Insurance Corporation (FDIC), directed the Bank to charge-off all payday loans that had been outstanding to borrowers for 60 days from the original loan date. The regulators requested that the Bank charge-off the principal balance of loans meeting the above criteria for the periods of December 31, 2003, September 30, 2004 and December 31, 2004. The Company believes that under generally accepted accounting principles, a total loss of all payday loans outstanding for 60 days from the origination date is not probable and the specific allowance allocated to the payday lending portfolio partnered with the stop-loss gap in the marketing and servicing agreement with the Company's payday lending partner is adequate. All actual charge-offs and recoveries for December 31, 2003 and September 30, 2004 have been recognized and run through the allowance for loan losses as of December 31, 2003 and September 30, 2004. As a result of the regulatory charge-off, the Company has a difference between its regulatory accounting principles (RAP) books and its generally accepted accounting principles (GAAP) books. The financial entries made for regulatory purposes resulted in a $746 thousand reduction in loan balances with a corresponding reduction in the allowance for loan losses as of December 31, 2003. Additional charge-offs of $3.1 million and recoveries of $3.1 million were also required for regulatory accounting purposes for the year ended December 31, 2004, as compared to the financial statements presented under GAAP in this Form 10-K.

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. Losses in the small loan portfolio are limited by agreement to a percentage of revenue earned from the portfolio by the Bank's agent.

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Transactions in the allowance for credit losses for the five years ended December 31, 2004 are as follows (dollars in thousands):

The Bank charged off $1,165,000 in small loans, and recovered $737,000. The net charge-offs as a percent of total small loan advances for 2004 was .68%.

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.

In the following table, the allowance for credit losses at December 31, 2004, 2003, 2002, 2001 and 2000 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):

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Total deposits decreased by $55,502,000, or 14.5 % from 2003 to $326,721,000. This is primarily due to the transfer of $88,000,000 in deposits associated with the seven branch divestiture. Demand - noninterest bearing deposits decreased 11%, or $9,094,000, savings and interest-bearing demand deposits decreased 17%, or 31,392,000, and time deposits decreased 13%, or $15,016,000. The $88,000,000 in deposits transferred due to the branch divestiture was offset by increased deposits of $32,498,000 in the remaining fourteen branches.

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

Time deposits at December 31, 2004 are scheduled to mature as follows (dollars in thousands):

Consolidated capital of VFG increased $9,167,000 during 2004 to $57,840,000. Net earnings of $11,777,000 provided the largest increase to capital while exercising of stock options provided $1,464,000. Decreases to capital were $3,007,000 in stock repurchased by the Company and cash dividends of $0.20 per share, or $1,325,000. Cash dividends totaling $0.16 were paid in 2003 and $0.13 in 2002.

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, 2004, the Company's leverage ratio was 12.94%, compared to 10.70% at year-end 2003. For regulatory purposes, any goodwill and other intangible assets are treated as a reduction of capital. In addition, holding companies are 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

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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, 2004, the Tier I capital ratio was 12.24%, and total capital was 13.49% . The similar ratios at December 31, 2003 were a Tier I capital ratio of 11.20% and a total capital ratio of 13.04% . For additional information, see "Item 1-Business-Supervision and Regulation-Capital Adequacy".

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

Short-term borrowings represent demand notes from the U.S. Treasury, two notes with Citigroup, advances from the FHLB, and repurchase agreements, normally maturing within one year.

Long-term borrowings include junior subordinated debentures, term advances from the FHLB, and one note with Citigroup. The following table shows the long-term borrowing and contractual obligations as of December 31, 2004 (dollars in thousands):

Information concerning Off-Balance Sheet Arrangements is found in Note 12 - Commitments and Contingent Liabilities, in the Companies consolidated financial statements.

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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. 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.

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 not increase as rapidly as 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 $870,000. This amount represents approximately 3.1% of the 2004 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

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have audited the accompanying consolidated balance sheets of Venture Financial Group, Inc. and its subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for the years 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 audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board of 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 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 its subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have audited the accompanying consolidated statements of income, shareholders' equity and cash flows of Venture Financial Group, Inc. and Subsidiary for the year ended December 31, 2002. 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.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 consolidated financial statements referred to above present fairly, in all material respects, the results of Venture Financial Group Inc. and Subsidiary's operations and their cash flows for the year ended December 31, 2002 in conformity with U. S. generally accepted accounting principles.

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VENTURE FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEET
(dollars in thousands)

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VENTURE FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENT OF INCOME
(dollars in thousands, except per share data)