KLAMATH FIRST BANCORP INC - 10-K Annual Report

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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 September 30, 1997

OR

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

Commission File Number: 0-26556

KLAMATH FIRST BANCORP, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)

Oregon 93-1180440
- --------------------------------------------- ----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)

540 Main Street, Klamath Falls, Oregon 97601
- --------------------------------------------- ---------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (541) 882-3444
--------------

Securities registered pursuant to Section 12(b) of the Act: None
--------

Securities registered pursuant
to Section 12(g) of the Act: Common Stock, par value $.01 per share
--------------------------------------
(Title of Class)

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

Indicate by check mark whether disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or other information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K.
YES X NO

As of December 22, 1997, there were issued and outstanding 10,429,534 shares of
the Registrant's Common Stock. The Registrant's voting stock is traded
over-the-counter and is listed on the Nasdaq National Market under the symbol
"KFBI." The aggregate market value of the voting stock held by nonaffiliates of
the Registrant, based on the closing sales price of the Registrant's common
stock as quoted on the Nasdaq National Market on December 10, 1996 of $21.50,
was $194,738,959.

DOCUMENTS INCORPORATED BY REFERENCE

1. Portions of Registrant's Annual Report to Shareholders for the Fiscal Year
Ended September 30, 1997
("Annual Report") (Parts I and II).

2. Portions of Registrant's Definitive Proxy Statement for the 1998 Annual
Meeting of Shareholders
(Part III).

3. Registrant's Current Report on Form 8-K dated August 1, 1997, as amended on
September 29, 1997
(Part II, Item 9).

PART I
Item 1. Business

General

Klamath First Bancorp, Inc. ("Company"), an Oregon corporation, was organized on
June 16, 1995 for the purpose of becoming the holding company for Klamath First
Federal Savings and Loan Association ("Association") upon the Association's
conversion from a federal mutual to a federal stock savings and loan association
("Conversion"). The Conversion was completed on October 4, 1995. At September
30, 1997, the Company had total assets of $980.1 million, total deposits of
$674.0 million and shareholders' equity of $144.5 million. All references to the
Company herein include the Association where applicable.

The Association was organized in 1934. The Association is regulated by the
Office of Thrift Supervision ("OTS") and its deposits are insured up to
applicable limits under the Savings Association Insurance Fund ("SAIF") of the
Federal Deposit Insurance Corporation ("FDIC"). The Association also is a member
of the Federal Home Loan Bank ("FHLB") System through the FHLB of Seattle.

In July 1997, the Association acquired 25 former First Interstate Bank branches
from Wells Fargo Bank, N.A. The new branches are located in rural communities
throughout Oregon, expanding and complementing the existing network of branches.
The acquisition was accounted for as a purchase and resulted in the addition of
approximately $241.3 million in deposits.

The Association is a traditional, community-oriented savings and loan
association that focuses on customer service within its primary market area.
Accordingly, the Association is primarily engaged in attracting deposits from
the general public through its offices and using those and other available
sources of funds to originate permanent residential one- to four-family real
estate loans within its market area and to a lesser extent on commercial
property and multi-family dwellings. At September 30, 1997, permanent
residential one- to four-family real estate loans totaled $498.5 million, or
86.51% of the total loans. While the Association has historically emphasized
fixed rate mortgage lending, during the fiscal year ended September 30, 1997, it
began diversifying its loan portfolio by focusing on increasing the number of
originations of commercial real estate loans, multi-family residential loans,
residential construction loans, small business loans and non-mortgage consumer
loans. A significant portion of these newer loan products carry adjustable
rates, higher yields, or shorter terms than the traditional fixed rate
mortgages. This lending strategy is designed to enhance earnings, reduce
interest rate risk, and provide a more complete range of financial services to
customers and the local communities served by the Association. At September 30,
1997, the Association's total loan portfolio consisted of 87.98% fixed rate and
12.02% adjustable rate loans, after loans in process and non-performing loans.

Market Area

As a result of the branch acquisition, the Association's market area expanded to
include 33 locations in 22 of Oregon's 36 counties. The Association's market
area, which encompasses the state of Oregon and some adjacent areas of
California and Washington, can be characterized as a predominantly rural area
containing a number of communities that are experiencing moderate to rapid
population growth. The favorable population growth in the market area,
particularly in Southern Oregon, has been supported in large part by the
favorable climate, and by favorable real estate values. The economy of the
market area is still based primarily on agriculture and lumber and wood
products, but is experiencing diversification into light manufacturing,
services, and other sectors. Tourism is a significant industry in many regions
of the market area including Central Oregon and the southern Oregon coast.

1

Yields Earned and Rates Paid

The following table sets forth, for the periods and at the date indicated, the
weighted average yields earned on interest-earning assets, the weighted average
interest rates paid on interest-bearing liabilities, and the interest rate
spread between the weighted average yields earned and rates paid.

Years Ended
At September 30,
September 30, ---------------------
1997 1997 1996 1995
---- ---- ---- ----

Weighted average yield:
Loans receivable ..................... 7.82% 7.92% 8.00% 7.89%
Mortgage backed and related securities 7.09 6.34 6.00 --
Investment securities ................ 6.15 6.10 6.12 7.43
Federal funds sold ................... 5.23 5.31 7.09 7.32
Interest-earning deposits ............ 5.11 5.32 4.95 4.01
FHLB stock ........................... 8.00 7.70 7.64 6.86

Combined weighted average yield on ...... 7.24 7.40 7.45 7.75
interest-bearing assets
---- ---- ---- ----

Weighted average rate paid on:
Tax and insurance reserve ............ 2.50 2.97 3.30 3.97
Passbook and statement savings ....... 2.75 3.15 2.87 2.78
Interest-bearing checking ............ 1.92 2.20 2.47 2.44
Money market ......................... 3.92 3.85 3.88 3.95
Certificates of deposit .............. 5.87 5.76 5.94 5.79
FHLB advances/Short term borrowings .. 5.64 5.68 5.60 6.21

Combined weighted average rate on ....... 4.88 5.12 5.23 5.02
interest-bearing liabilities
---- ---- ---- ----

Net interest spread ..................... 2.36% 2.28% 2.22% 2.73%
==== ==== ==== ====

Average Balances, Net Interest Income and Yields Earned and Rates Paid

Reference is made to the section entitled "Average Balances, Net
Interest Income and Yields Earned and Rates Paid" on page 12 of the Annual
Report, which section is incorporated herein by reference.

Interest Sensitivity Gap Analysis

Reference is made to the section entitled "Interest Sensitivity Gap
Analysis" on page 10 of the Annual Report, which section is incorporated
herein by reference.

Rate/Volume Analysis

Reference is made to the section entitled "Rate/Volume Analysis" on
page 13 of the Annual Report, which section is incorporated herein by
reference.

2

Lending Activities

General. As a federally chartered savings and loan association, the
Association has authority to originate and purchase loans secured by real estate
located throughout the United States. Notwithstanding this nationwide lending
authority, over 93% of the mortgage loans in the Association's portfolio are
secured by properties located in Klamath, Jackson and Deschutes counties in
Southern and Central Oregon. With the expanded market area provided by the
branch acquisition in 1997, the Association anticipates its mortgage lending
will diversify throughout the state of Oregon. It is management's intention,
subject to market conditions, that the Association will remain a traditional
financial institution originating long-term mortgage loans for the purchase,
construction or refinance of one- to four-family residential real estate.
However, to enhance interest income and reduce interest rate risk, the
Association is placing increased emphasis on the origination or purchase of
adjustable rate loans secured by multi-family residential and commercial real
estate, the majority of which are located outside Klamath, Jackson, and
Deschutes counties.

Permanent residential one- to four-family mortgage loans amounted to $498.5
million, or 86.51%, of the Association's total loan portfolio before net items,
at September 30, 1997. The Association originates other loans secured by
multi-family residential and commercial real estate, construction and land
loans. Those loans amounted to $71.7 million, or 12.44%, of the total loan
portfolio, before net items, at September 30, 1997. Approximately 1.05%, or $6.0
million, of the Association's total loan portfolio, before net items, as of
September 30, 1997 consisted of non-real estate loans.

Permissible loans-to-one borrower by the Association are generally limited
to 15% of unimpaired capital and surplus. The Association's loan-to-one borrower
limitation was $17.4 million at September 30, 1997. At September 30, 1997, the
Association had thirteen borrowing relationships with outstanding balances in
excess of $1.0 million, the largest of which amounted to $3.5 million and
consisted of ten loans, all of which were secured by multi-family residential or
commercial real estate. All of those loans have performed in accordance with
their terms since origination.

The Association has placed a growing emphasis on the origination of
adjustable rate mortgage ("ARM") loans in order to increase the interest rate
sensitivity of its loan portfolio. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Asset Liability Management and
Interest Rate Risk" and "INTEREST SENSITIVITY GAP ANALYSIS" in the Annual
Report. At September 30, 1997, $67.2 million, or 12.02% of loans in the
Association's total loan portfolio, after loans in process and non-performing
loans, consisted of ARM loans.

3

Loan Portfolio Analysis. The following table sets forth the composition of
the loan portfolio by type of loan at the dates indicated.

At September 30,
---------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------- ----------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
(Dollars in Thousands)
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------

Real estate loans:
Permanent residential
1-4 family ............. $498,486 86.51% $447,004 91.50% $381,683 91.68% $337,212 90.06% $291,317 90.54%
Multi-family residential . 16,881 2.93 6,555 1.34 7,433 1.79 8,209 2.19 7,797 2.42
Construction ............. 30,596 5.31 14,276 2.92 9,807 2.36 12,625 3.37 8,298 2.58
Commercial ............... 22,639 3.93 15,645 3.20 13,984 3.36 13,425 3.58 11,227 3.49
Land ..................... 1,586 0.27 1,152 0.24 1,072 0.25 1,180 0.32 1,270 0.39
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Total real estate loans .... 570,188 98.95 484,632 99.20 413,979 99.44 372,651 99.52 319,909 99.42
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------

Non-real estate loans:
Savings accounts ......... 1,711 0.30 1,640 0.34 1,966 0.47 1,316 0.35 1,250 0.39
Home improvement and ..... 3,511 0.61 1,977 0.40 -- -- -- -- -- --
home equity loans
Other .................... 804 0.14 302 0.06 367 0.09 472 0.13 615 0.19
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Total non-real estate loans 6,026 1.05 3,919 0.80 2,333 0.56 1,788 0.48 1,865 0.58
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Total loans ............... 576,214 100.00% 488,551 100.00% 416,312 100.00% 374,439 100.00% 321,774 100.00%
======= ======= ======= ======= =======
Less:
Undisbursed portion of loans 17,096 8,622 7,203 9,310 7,148
Deferred loan fees ......... 6,358 5,445 4,757 4,252 3,330
Allowance for loan losses .. 1,296 928 808 755 628
Net loans .................. $551,464 $473,556 $403,544 $360,122 $310,668
======== ======== ======== ======== ========

4

The following table sets forth the amount of fixed-rate and adjustable rate
loans, net of loans in process and non-performing loans, included in the total
loan portfolio at the dates indicated.

At September 30,
---------------- ----------------
1997 1996
Amount Percent Amount Percent
-------- ------- -------- -------
(Dollars in thousands)

Fixed rate .............. $491,703 87.98% $428,528 89.32%
Adjustable-rate ......... 67,189 12.02 51,250 10.68
-------- ------ -------- ------
Total .............. $558,892 100.00% $479,778 100.00%
======== ====== ======== ======

Permanent Residential One- to Four-Family Mortgage Loans. The primary
lending activity of the Association is the origination of permanent residential
one- to four-family mortgage loans. Management believes that this policy of
focusing on single-family residential mortgage loans has been successful in
contributing to interest income while keeping delinquencies and losses to a
minimum. At September 30, 1997, $498.5 million, or 86.51%, of the Association's
total loan portfolio, before net items, consisted of permanent residential one-
to four-family mortgage loans. As of such date, the average balance of the
Association's permanent residential one- to four-family mortgage loans was
$65,149.

The Association presently originates both fixed-rate mortgage loans and ARM
loans secured by one- to four-family properties with terms of 15 to 30 years.
Historically, most of the loans originated by the Association have been fixed
rate loans secured by one- to four-family properties. At September 30, 1997,
$471.3 million, or 84.32% of the total loans after loans in process and
non-performing loans were fixed rate one- to four-family loans and $39.1
million, or 7.00%, were ARM loans. Borrower demand for ARM loans versus
fixed-rate mortgage loans is a function of the level of interest rates, the
expectations of changes in the level of interest rates and the difference
between the initial interest rates and fees charged for each type of loan. The
relative amount of fixed-rate mortgage loans and ARM loans that can be
originated at any time is largely determined by the demand for each in a
competitive environment.

The Association qualifies the ARM loan borrower based on the borrower's
ability to repay the loan using the fully indexed rate. As a result, the
Association believes that the potential for delinquencies and defaults on ARM
loans when rates adjust upwards is lessened.

The loan fees charged, interest rates and other provisions of the
Association's ARM loans are determined by the Association on the basis of its
own pricing criteria and competitive market conditions. At September 30, 1997,
the Association charged 1.75% origination fees on its ARM loans.

The Association has placed greater emphasis on the origination of ARM loans
for permanent one- to four-family residences. In an attempt to increase this
type of business, the Association uses below market "teaser" rates which are
competitive with other institutions originating mortgages in the Association's
primary market area. Initially, ARM loans are priced at the competitive teaser
rate and after one year reprice at 2.875% over the One-Year Constant Maturity
Treasury Bill Index, with a maximum increase or decrease of 2.00% in any one
year and 6.00% over the life of the loan.

The retention of ARM loans in the Association's loan portfolio helps reduce
the Association's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased costs due
to changed rates to be paid by the customer. It is possible that, during periods
of rising interest rates, the risk of default on ARM loans may increase as a
result of repricing with increased costs to the borrower. Furthermore, the ARM
loans originated by the Association generally provide, as a marketing incentive,
for initial rates of interest below

5

the rates which would apply were the adjustment index used for pricing initially
(discounting). These loans are subject to increased risks of default or
delinquency because of this. Another consideration is that although ARM loans
allow the Association to increase the sensitivity of its asset base to changes
in the interest rates, the extent of this interest sensitivity is limited by the
periodic and lifetime interest rate adjustment limits. Because of these
considerations, the Association has no assurance that yields on ARM loans will
be sufficient to offset increases in the Association's cost of funds.

The loan-to-value ratio, maturity and other provisions of the loans made by
the Association generally have reflected the policy of making less than the
maximum loan permissible under applicable regulations, in accordance with sound
lending practices, market conditions and underwriting standards established by
the Association. The Association's lending policies on permanent residential
one- to four-family mortgage loans generally limit the maximum loan-to-value
ratio to 90% of the lesser of the appraised value or purchase price of the
property and generally all permanent residential one- to four-family mortgage
loans in excess of an 80% loan-to-value ratio require private mortgage
insurance. Programs for 95% and 97% loan-to-value are available for owner
occupied purchase transactions.

The Association also has a limited amount of non-owner-occupied permanent
residential one- to four-family mortgage loans in its portfolio. These loans are
underwritten using generally the same criteria as owner-occupied permanent
residential one- to four-family mortgage loans, except that the maximum
loan-to-value ratio is generally 75% of the lesser of the appraised value or
purchase price of the property and such loans are generally provided at an
interest rate higher than owner-occupied loans.

The Association offers fixed-rate, permanent residential one- to
four-family mortgage loans with terms of 15 to 30 years. Substantially all
permanent one- to four-family loans have original contractual terms to maturity
of 30 years. Such loans are amortized on a monthly basis with principal and
interest due each month and customarily include "due-on-sale" clauses. The
Association enforces due-on-sale clauses to the extent permitted under
applicable laws. Substantially all of the Association's mortgage loan portfolio
consists of conventional loans.

Historically, the Association has not originated significant amounts of
mortgage loans on second residences. However, with the branch office in Bend and
the loan center in Redmond, near popular ski areas and other outdoor activities,
and the addition of branches along the southern Oregon coast, an increasingly
popular resort and vacation area, the Association believes that there is an
opportunity to engage in such lending within the parameters of its current
underwriting policies. At September 30, 1997, $3.2 million, or 0.55%, of the
Association's loan portfolio consisted of loans on second homes.

Commercial and Multi-Family Real Estate Loans. The Association has
historically engaged in a limited amount of multi-family and commercial real
estate lending. During 1997, the Association purchased participations in loans
secured by multi-family and commercial real estate in order to increase the
balance of adjustable rate loans in the portfolio. See "-- Loan Originations,
Purchases, and Sales." At September 30, 1997, $16.9 million, or 2.93%, of the
Association's total loan portfolio, before net items, consisted of loans secured
by existing multi-family residential real estate and $22.6 million, or 3.93%, of
the Association's total loan portfolio, before net items, consisted of loans
secured by existing commercial real estate. The Association's commercial and
multi-family real estate loans include primarily loans secured by office
buildings, small shopping centers, churches, mini-storage warehouses and
apartment buildings. All of the Association's commercial and multi-family real
estate loans are secured by properties located in the state of Oregon. The
average outstanding balance of commercial and multi-family real estate loans was
$215,201 at September 30, 1997, the largest of which was a $1.3 million land
development loan secured by land and improvements. The loan has performed in
accordance with its terms since origination. Originations of commercial real
estate and multi-family residential real estate amounted to 4.87%, 2.58%, and
1.35% of the Association's total loan originations in the fiscal year ended
September 30, 1997, 1996, and 1995, respectively. The Association also purchased
$9.3 million in multi-family residential loan participations and $6.4 million in
commercial real estate participations during the year ended September 30, 1997.

6

The Association's commercial and multi-family loans have terms which range up to
25 years and loan-to-value ratios of up to 75%. The Association currently
originates fixed and adjustable rate commercial and multi-family real estate
loans. Commercial real estate and multi-family adjustable rate loans are priced
to be competitive with other commercial lenders in the Association's market
area. A variety of terms are available to meet specific commercial and
multi-family residential financing needs. As of September 30, 1997, $24.0
million, or 4.30%, after loans in process and non-performing loans, of other
mortgage loans, including commercial and multi-family residential real estate
loans, had adjustable rates of interest.

Multi-family residential and commercial real estate lending is generally
considered to involve a higher degree of risk than permanent residential one- to
four-family lending. Such lending typically involves large loan balances
concentrated in a single borrower or groups of related borrowers. In addition,
the payment experience on loans secured by income-producing properties is
typically dependent on the successful operation of the related real estate
project and thus may be subject to a greater extent to adverse conditions in the
real estate market or in the economy generally. The Association generally
attempts to mitigate the risks associated with multi-family commercial and
residential real estate lending by, among other things, lending on collateral
located in its market area and following strict underwriting standards. Loans
considered for purchase are subjected to the same underwriting standards as
those originated in- house.

Construction Loans. The Association makes construction loans primarily to
individuals for the construction of their single-family residences. The
Association also makes loans to builders for the construction of single-family
residences which are not presold at the time of origination ("speculative
loans"). The Association generally limits loans to builders to not more than two
residences under construction at a given time. With the exception of a limited
number of 18-month speculative loans, construction loans generally begin to
amortize as permanent residential one- to four-family mortgage loans within one
year of origination unless extended. At September 30, 1997, construction loans
amounted to $30.6 million (including $14.1 million of speculative loans), or
5.31%, of the Association's total loan portfolio before net items. Construction
loans have rates and terms which generally match the non-construction loans then
offered by the Association, except that during the construction phase, the
borrower pays only interest on the loan. The Association's construction loan
agreements generally provide that loan proceeds are disbursed in increments as
construction progresses. The Association periodically reviews the progress of
the underlying construction project. Construction loans are underwritten
pursuant to the same general guidelines used for originating permanent one- to
four-family loans. Construction lending is generally limited to the
Association's primary market area.

Construction financing is generally considered to involve a higher degree
of risk of loss than financing on improved, owner-occupied real estate because
of the uncertainties of construction, including the possibility of costs
exceeding the initial estimates and, in the case of speculative loans, the need
to obtain a purchaser. The Association has sought to minimize the risks
associated with permanent construction lending by limiting construction loans to
qualified owner-occupied borrowers with construction performed by qualified
state licensed builders located primarily in the Association's market area.
During 1997, the Association began originating construction loans in the
Portland, Oregon metropolitan area through mortgage brokers. These loans are
underwritten using the same standards as loans from the branch locations.

The Association's underwriting criteria are designed to evaluate and
minimize the risks of each construction loan. Interim construction loans are
qualified at permanent rates in order to ensure the capability of the borrower
to repay the loan.

Loan proceeds are disbursed only as construction progresses and inspections
warrant. These loans are underwritten to the same standards and to the same
terms and requirements as one- to four-family purchase mortgage loans, except
the loans provide for disbursement of funds during a construction period of up
to one year. During this period, the borrower is required to make monthly
payments of accrued interest on the outstanding loan balance. Disbursements
during the construction period are limited to no more than the percent of
completion. Up to 95% loan-to-value upon completion of construction may be
disbursed if private mortgage insurance above 80% loan-to-value is in place.

7

Land Loans. The Association makes loans to individuals for the purpose of
acquiring land to build a permanent residence. These loans generally have terms
not exceeding 15 years and maximum loan-to-value ratios of 75%. As of September
30, 1997, $1.6 million, or 0.27%, of the Association's total loan portfolio
consisted of land loans.

Non-Real Estate Loans. Non-real estate lending has traditionally been a
small part of the Association's business. During 1997, the Association
introduced several new business and consumer loan products, including home
equity lines of credit, automobile and recreational vehicle loans, and personal
and business lines of credit, among others. Non-real estate loans generally have
shorter terms to maturity or repricing and higher interest rates than real
estate loans. As of September 30, 1997, $6.0 million, or 1.05%, of the
Association's total loan portfolio consisted of non-real estate loans. As of
that date, $1.7 million, or .30%, of such loans were secured by savings
accounts. At September 30, 1997, $2.1 million, or 0.36%, of non-real estate
loans consisted of Title I home improvement loans insured by the Federal Housing
Administration and most are secured by liens on the real property.

Loan Maturity and Repricing. The following table sets forth certain
information at September 30, 1997 regarding the dollar amount of total loans,
after loans in process and non-performing loans, maturing in the Association's
portfolio, based on the contractual terms to maturity. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less.

After One Year
Within One Year Through 5 Years After 5 Years Total
--------------- --------------- ------------- --------
(In thousands)

Permanent residential
1-4 family:
Adjustable rate ...................... $37,603 $ 1,495 $ -- $ 39,098
Fixed rate ........................... 8,252 2,150 460,880 471,282
Other mortgage loans:
Adjustable rate ...................... 16,402 7,605 -- 24,007
Fixed rate ........................... 705 5,736 12,057 18,498
Non-real estate loans:
Adjustable rate ..................... 1,112 979 1,993 4,084
Fixed rate .......................... 1,762 161 -- 1,923
------- ------- -------- --------
Total loans ........................ $65,836 $18,126 $474,930 $558,892
======= ======= ======== ========

Scheduled contractual amortization of loans does not reflect the actual
term of the Association's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments and
due-on-sale clauses, which gives the Association the right to declare a
conventional loan immediately due and payable in the event, among other things,
that the borrower sells the real property subject to the mortgage and the loan
is not repaid.

The dollar amount of all loans, net of loans in process and non-performing
loans, due one year after September 30, 1997, which have fixed interest rates
and have adjustable rates, was $481.0 million and $12.1 million, respectively.

Loan Commitments. The Association issues commitments for fixed and
adjustable rate loans conditioned upon the occurrence of certain events. Such
commitments are made on specified terms and conditions and are honored for up to
60 days from commitment. The Association had outstanding loan commitments of
approximately $11.5 million at September 30, 1997 consisting of $4.2 million of
variable rate loans and $7.3 million of fixed rate loans. See Note 17 of Notes
to the Consolidated Financial Statements.

8

Loan Solicitation and Processing. The Association originates real estate
and other loans at each of its offices. Loan originations are obtained by a
variety of sources, including mortgage brokers, developers, builders, existing
customers, newspapers, radio, periodical advertising and walk-in customers,
although referrals from local realtors has been the primary source. Loan
applications are taken by lending personnel, and the loan processing department
obtains credit reports, appraisals and other documentation involved with a loan.
All of the Association's lending is subject to its written nondiscriminatory
underwriting standards, loan origination procedures and lending policies
prescribed by the Association's Board of Directors. Property valuations are
required on all real estate loans and are prepared by employees experienced in
the field of real estate or by independent appraisers approved by the
Association's Board of Directors. Additionally, all appraisals on loans in
excess of $250,000 must meet applicable regulatory standards.

The Association's loan approval process is intended to assess the
borrower's ability to repay the loan, the viability of the loan, the adequacy of
the value of the property that will secure the loan, the location of the real
estate, and, in the case of commercial and multi-family real estate loans, the
cash flow of the project and the quality of management involved with the
project. The Association generally requires title insurance on all loans and
also that borrowers provide evidence of fire and extended casualty insurance in
amounts and through insurers that are acceptable to the Association. A loan
application file is first reviewed by a loan officer of the Association and then
is submitted to the loan committee for underwriting and approval. The
Association generally originates loans for its own portfolio which has enabled
it to develop an expedited loan application and approval process which
management believes provides it with a competitive advantage in its primary
market area. The Association can make loan commitments, subject to property
valuation and possible other conditions of approval, in three to five days if
income and credit data of the borrower are readily available.

Loan Originations, Purchases and Sales. The Association has originated
substantially all of the loans in its portfolio and generally holds them until
maturity. During the year ended September 30, 1997, the Association originated
$120.1 million in total loans, compared to $135.6 million in the same period of
1996. The decrease in loan originations was attributable to a return to more
normal origination rates which are at a slower rate than that experienced in the
prior year.

Between 1989 and 1992, the Association purchased permanent residential one-
to four-family jumbo mortgage loans (i.e., loans with principal balances over
$203,150) on detached residences from various localities throughout the Western
United States, primarily Oregon, Washington, California and Arizona. At one time
the aggregate balance of such loans was approximately $64.6 million. At
September 30, 1997, the balance was $4.8 million. These loans were underwritten
on the same basis as permanent residential one- to four-family real estate loans
originated by the Association.

During 1997, the Association purchased multi-family and commercial real
estate mortgage loans secured by properties within the Association's primary
market area. At September 30, 1997, the balance of such loans was $15.6 million.
These loans were underwritten on the same basis as similar loans originated by
the Association.

9

The following table shows total loans originated, purchased and sold, loan
reductions and the net increase in the Association's loans during the periods
indicated.

Years Ended September 30,
---------------------------------
1997 1996 1995
--------- --------- ---------
(In thousands)

Total net loans at beginning of period ...... $ 473,556 $ 403,544 $ 360,122
Loans originated:
Real estate loans originated (1) ........... 116,502 133,814 83,344
Real estate loans purchased ................ 15,648 -- --
Non-real estate loans originated ........... 3,571 1,753 1,370
--------- --------- ---------
Total loans originated ................... 135,721 135,567 84,714
--------- --------- ---------

Loan reductions:
Principal paydowns ......................... (56,518) (64,530) (40,408)
Loans sold ................................. -- -- --
Other reductions (2) ....................... (1,295) (1,025) (884)
--------- --------- ---------
Total loan reductions ................... (57,813) (65,555) (41,292)
--------- --------- ---------

Total net loans at end of period ............ $ 551,464 $ 473,556 $ 403,544
========= ========= =========

(1) Includes decreases/increases from loans-in-process.

(2) Includes net reductions due to deferred loans fees, discounts net of
amortization, provision for loan loss and transfers to real estate owned.

Loan Origination and Other Fees. In addition to interest earned on loans,
the Association receives loan origination fees or "points" for originating
loans. Loan points are a percentage of the principal amount of the real estate
loan and are charged to the borrower in connection with the origination of the
loan. The amount of points charged by the Association varies, though it
generally amounts to 1.75% on permanent loans and 2.00% on construction loans.

In accordance with Statement of Financial Accounting Standards ("SFAS") No.
91, which deals with the accounting for non-refundable fees and costs associated
with originating or acquiring loans, the Association's loan origination fees and
certain related direct loan origination costs are offset, and the resulting net
amount is deferred and amortized as income over the contractual life of the
related loans as an adjustment to the yield of such loans, or until the loan is
paid in full. At September 30, 1997, the Association had $6.4 million of net
loan fees which had been deferred and are being recognized as income over the
contractual maturities of the related loans.

10

Asset Quality

Delinquent Loans. The following table sets forth information concerning
delinquent loans at September 30, 1997, in dollar amount and as a percentage of
the Association's total loan portfolio. The amounts presented represent the
total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.

Permanent
residential Non-real
1-4 family Estate Loans Total
-------------------- ---------------------- --------------------
Amount Percentage Amount Percentage Amount Percentage
------ ---------- ------ ---------- ------ ----------
(Dollars in Thousands)

Loans delinquent

for 90 days and more............. $245 0.04% $9 --% $254 0.04%

Delinquency Procedures. When a borrower fails to make a required payment on
a loan, the Association attempts to cure the delinquency by contacting the
borrower. In the case of loans past due, appropriate late notices are sent on
the fifth and fifteenth days after the due date. If the delinquency is not
cured, the borrower is contacted by telephone after the fifteenth day after the
payment is due.

For real estate loans, in the event a loan is past due for 45 days or more,
the Association will attempt to arrange an in-person interview with the borrower
to determine the nature of the delinquency; based upon the results of the
interview and its review of the loan status, the Association may negotiate a
repayment program with the borrower. If a loan remains past due at 60 days, the
Association performs an in-depth review of the loan status, the condition of the
property and the circumstances of the borrower. If appropriate, an alternative
payment plan is established. At 90 days past due, a letter prepared by the
Association's legal counsel is sent to the borrower describing the steps to be
taken to collect the loan, including acceptance of a voluntary deed-in-lieu of
foreclosure, and of the initiation of foreclosure proceedings. A decision as to
whether and when to initiate foreclosure proceedings is made by senior
management, with the assistance of legal counsel, at the direction of the Board
of Directors, based on such factors as the amount of the outstanding loan in
relation to the value of the property securing the original indebtedness, the
extent of the delinquency and the borrower's ability and willingness to
cooperate in curing the delinquency.

For consumer loans, at 60 days past due a letter demanding payment is sent
to the borrower. If the delinquency is not cured prior to becoming 90 days past
due, repossession procedures are implemented for collateralized loans. At 90
days past due, consumer loans are generally charged off.

Non-Performing Assets. The Association's non-performing assets consist of
non-accrual loans, accruing loans greater than 90 days delinquent, real estate
owned and other repossessed assets. All loans are reviewed on a regular basis
and are placed on a non-accrual status when, in the opinion of management, the
collection of additional interest is deemed insufficient to warrant further
accrual. Generally, the Association places all loans more than 90 days past due
on non-accrual status. Uncollectible interest on loans is charged-off or an
allowance for losses is established by a charge to earnings equal to all
interest previously accrued and interest is subsequently recognized only to the
extent cash payments are received until delinquent interest is paid in full and,
in management's judgment, the borrower's ability to make periodic interest and
principal payments is back to normal in which case the loan is returned to
accrual status.
11

Real estate acquired by foreclosure or accounted for as "in substance"
foreclosure is classified as real estate owned until such time as it is sold.
See Note 1 of Notes to the Consolidated Financial Statements. When such property
is acquired, it is recorded at the lower of the balance of the loan on the
property at the date of acquisition (not to exceed the net realizable value) or
the estimated fair value. Costs, excluding interest, relating to holding the
property are expensed. Valuations are periodically performed by management and
an allowance for losses is established by a charge to operations if the carrying
value of the property exceeds its estimated net realizable value. From time to
time, the Association also acquires personal property, generally mobile homes,
which are classified as other repossessed assets and are carried on the books at
their estimated fair market value and disposed of as soon as commercially
reasonable.

As of September 30, 1997, the Association's total non-performing loans
amounted to $254,000, or 0.04% of total loans, before net items, consistent with
$191,000, or 0.04% of total loans, before net items, at September 30, 1996.

The following table sets forth the amounts and categories of the
Association's non-performing assets at the dates indicated. The Association had
no material troubled debt restructurings as defined by SFAS No. 15 at any of the
dates indicated.

At September 30,
--------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(Dollars in thousands)

Non-accruing loans (1) .................. $ 254 $191 $734 $183 $198
Accruing loans greater than 90 .......... -- -- -- -- --
days delinquent
------ ------ ------ ------ ------
Total non-performing loans .......... 254 191 734 183 198

Real estate owned ....................... -- 69 24 59 84
Other repossessed assets ................ -- -- -- -- 16
------ ------ ------ ------ ------
Total repossessed assets ............ -- 69 24 59 100
------ ------ ------ ------ ------
Total non-performing assets ......... $ 254 $260 $758 $242 $298
====== ====== ====== ====== ======

Total non-performing assets as a ........ 0.03% 0.04% 0.12% 0.05% 0.07%
percentage of total assets
====== ====== ====== ====== ======

Total non-performing loans as a ......... 0.04% 0.04% 0.18% 0.05% 0.06%
percentage of total loans,
before net items
====== ====== ====== ====== ======

Allowance for loan losses as a .......... 510.38% 356.92% 106.80% 311.98% 210.74%
percentage of total non-performing
assets
====== ====== ====== ====== ======

Allowance for loan losses as a percentage 510.38% 485.86% 110.08% 412.57% 317.19%
of total non-performing loans
====== ====== ====== ====== ======

(1) Consists of permanent residential one- to four-family mortgage loans and
loans on commercial real estate.

For the year ended September 30, 1997, the amount of gross income that
would have been recorded in the period then ended if non-accrual loans and
troubled debt restructurings had been current according to their original terms,
and the amount of interest income on such loans that was included in net income
for each of such periods, were, in both cases, less than 1% of total interest
income.
12

Classified Assets. Federal regulations require that each insured savings
association classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are four
categories used to classify problem assets: "special mention", "substandard",
"doubtful", and "loss." Special mention assets are not considered classified
assets, but assets of questionable quality that have potential or past
weaknesses that deserve management's close attention and monitoring. 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 loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. Special mention
assets and assets classified as substandard or doubtful require the institution
to establish general allowances for loan losses. If an asset or portion thereof
is classified loss, the insured institution must either establish specific
allowances for loan losses in the amount of 100% of the portion of the asset
classified loss or charge-off such amount. General loss allowances established
to cover possible losses related to special mention assets and assets classified
substandard or doubtful may be included in determining an institution's
regulatory capital, while specific valuation allowances for loan losses do not
qualify as regulatory capital. Federal examiners may disagree with an insured
institution's classifications and the amounts reserved.

As of September 30, 1997, total classified assets amounted to 0.12% of
total assets. At September 30, 1997 and 1996, the aggregate amounts of the
Association's classified assets, exclusive of amounts classified loss and which
have been fully reserved, were as follows:

At September 30,
-----------------------------
1997 1996
----- -----
(In thousands)

Loss......................... $ -- $ --
Doubtful..................... -- --
Substandard assets........... 304 281
Special mention.............. 843 645

General loss allowances...... 1,296 928
Specific loss allowances..... -- --
Charge offs.................. 2 --

Allowance for Loan Losses. The allowance for loan losses is maintained at a
level considered adequate by management to provide for anticipated loan losses
based on management's assessment of various factors affecting the loan
portfolio, including a review of all loans for which full collectibility may not
be reasonably assured, an overall evaluation of the quality of the underlying
collateral, economic conditions, historical loan loss experience and other
factors that warrant recognition in providing for an adequate loan loss
allowance. While management believes it uses the best information available to
determine the allowance for loan losses, unforeseen market conditions could
result in adjustments to the allowance for loan losses and net earnings could be
significantly affected, if circumstances differ substantially from the
assumptions used in making the final determination. At September 30, 1997, the
Association had an allowance for loan losses of $1.3 million, which was equal to
510.4% of non-performing assets and 0.22% of total loans.

Provisions for loan losses are charged to earnings to bring the total
allowance for loan losses to a level deemed appropriate by management based on
historical loan loss experience, the volume and type of lending conducted by the
Association, industry standards, the amount of non-performing assets, general
economic conditions (particularly as they relate to the Association's market
area), and other factors, which exist at the time the determination of the
adequacy of the provision is made, related to the collectibility of the
Association's loan portfolio. The provisions for loan losses charged against
income for the years ended September 30, 1997, 1996 and 1995 were $370,000,
$120,000 and $120,000, respectively. Management believes that the amount
maintained in the allowance will be adequate to absorb possible losses in the
portfolio.

13

The following table sets forth for the periods indicated information
regarding changes in the Association's allowance for loan losses. All
information is before net items.

Years Ended September 30,
----------------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- ---------- ---------- ---------
(Dollars in thousands)

Total loans outstanding ................. $ 576,214 $ 488,551 $ 416,312 $ 374,439 $ 321,774
========= ========= ========== ========== =========

Average loans outstanding ............... $ 515,555 $ 440,510 $ 381,689 $ 338,679 $ 298,481
========= ========= ========== ========== =========

Allowance at beginning of period ........ $ 928 $ 808 $ 755 $ 628 $ 572

Charge-offs ............................. (2) -- (67) (23) (64)

Recoveries .............................. -- -- -- -- --

Provision for loan losses ............... 370 120 120 150 120
--------- --------- ---------- ---------- ---------

Allowance at end of period .............. $ 1,296 $ 928 $ 808 $ 755 $ 628
========= ========= ========== ========== =========

Allowance for loan losses as a percentage 0.22% 0.19% 0.19% 0.20% 0.20%
of total loans outstanding
========= ========= ========== ========== =========

Ratio of net charge-offs to average loans -- % -- % 0.02% 0.01% 0.02%
outstanding during the period
========= ========= ========== ========== =========

14

The following table sets forth the breakdown of the allowance for loan
losses by loan category and summarizes the percentage of total loans, before net
items, in each category to total loans, before net items, at the dates
indicated.

At September 30,
-------------------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------------- ----------------------------------- -----------------------------------
Percent of Percent of Percent of
Amount Allowance Percent of Amount Allowance Percent of Amount Allowance Percent of
of Category to Total Loans of Category to Total Loans of Category to Total Loans
Allowance Total Loans by Category Allowance Total Loans by Category Allowance Total Loans by Category
--------- ----------- ----------- --------- ----------- ----------- --------- ----------- -----------
(Dollars in thousands)

Permanent
residential

1-4 family .. $ 887 0.15% 86.51% $925 0.19% 91.50% $807 0.19% 91.68%
Multi-family .. 121 0.02 2.93 -- -- 1.34 -- -- 1.79
residential
Construction .. -- -- 5.31 -- -- 2.92 -- -- 2.36
Commercial .... 250 0.04 3.93 -- -- 3.20 -- -- 3.36
Land .......... 12 -- 0.27 -- -- 0.24 -- -- 0.25
Non-real estate 26 .01 1.05 3 -- 0.80 1 -- 0.56

Total ...... $1,296 0.22% 100.00% $928 0.19% 100.00% $808 0.19% 100.00%

At September 30,
------------------------------------------------------------------------
1994 1993
----------------------------------- -----------------------------------
Percent of Percent of
Amount Allowance Percent of Amount Allowance Percent of
of Category to Total Loans of Category to Total Loans
Allowance Total Loans by Category Allowance Total Loans by Category
--------- ----------- ----------- --------- ----------- -----------
(Dollars in thousands)

Permanent
residential

1-4 family .. $713 0.19% 90.06% $599 0.19% 90.54%
Multi-family .. -- -- 2.19 -- -- 2.42
residential
Construction .. -- -- 3.37 -- -- 2.58
Commercial .... 41 0.01 3.58 28 0.01 3.49
Land .......... -- -- 0.32 -- -- 0.39
Non-real estate 1 -- 0.48 1 -- 0.58

Total ...... $1,296 0.22% 100.00% $928 0.19% 100.00%

15

Although the Association believes that it has established its allowance for
loan losses in accordance with generally accepted accounting principles
("GAAP"), there can be no assurance that regulators, in reviewing the
Association's loan portfolio, will not request the Association to significantly
increase its allowance for loan losses, thereby reducing the Association's net
worth and earnings. In addition, because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
the existing allowance for loan losses is adequate or that substantial increases
will not be necessary should the quality of any loans deteriorate as a result of
the factors discussed above. Any material increase in the allowance may
adversely affect the Association's financial condition and results of operation.

Investment Activities

Federally chartered savings institutions have the authority to invest in
securities of various federal agencies, certain insured certificates of deposit
of banks and savings institutions, certain bankers' acceptances, repurchase
agreements and federal funds. Subject to various restrictions, federally
chartered savings institutions may also invest their assets in commercial paper,
investment grade corporate debt securities and mutual funds whose assets conform
to the investments that a federally chartered savings institution is otherwise
authorized to make directly. OTS regulations restrict investments in corporate
debt securities of any one issuer in excess of 15% of the Association's
unimpaired capital and unimpaired surplus, as defined by federal regulations,
which totaled $115.7 million at September 30, 1997, plus an additional 10% if
the investments are fully secured by readily marketable collateral. See
"REGULATION -- Loans to One Borrower" for a discussion of additional
restrictions on the Association's investment activities.

The investment securities portfolio is managed in accordance with a written
investment policy adopted by the Board of Directors and administered by the
Investment Committee, which consists of the President and four Board members.
Generally, the investment policy is to invest funds among various categories of
investments and maturities based upon the need for liquidity, to achieve the
proper balance between its desire to minimize risk and maximize yield, and to
fulfill the asset/liability management policy. The President and the Chief
Financial Officer may independently invest up to 1% of total assets of the
Company within the parameters set forth in the Investment Policy, to be
subsequently reviewed with the Investment Committee at their next scheduled
meeting. Transactions or investments in any one security determined by type,
maturity and coupon in excess of $10.0 million or 1.0% of assets are not
permitted.

Investment securities held to maturity are carried at cost and adjusted for
amortization of premiums and accretion of discounts. As of September 30, 1997,
the investment securities portfolio held to maturity had $1.0 million in
tax-exempt securities issued by states and municipalities and $21.9 million in
investment grade corporate obligations. Securities to be held for indefinite
periods of time and not intended to be held to maturity are classified as
available for sale and carried at fair value. Securities available for sale
include securities that management intends to use as part of its asset/liability
management strategy that may be sold in response to changes in interest rates or
significant prepayments risks or both. As of September 30, 1997, the portfolio
of securities available for sale consisted of $185.9 million in securities
issued by the U.S. Treasury and other federal government agencies, $8.9 million
in tax exempt securities issued by states and municipalities, and $67.1 million
in investment grade corporate investments.

On November 15, 1995, the Financial Accounting Standards Board published
implementation guidance on SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities", that allows a corporation to reassess the
appropriateness of the classification of its debt securities under a special
transition provision. Debt securities classified as "held to maturity" are
reported in financial statements at amortized cost while those classified as
"available for sale" are reported at fair value and unrealized gains and losses
on such securities are reported as a net amount in a separate component of
shareholders' equity. The net unrealized gain or loss on securities classified
as available for sale fluctuates based on several factors, including market
interest rates, prepayment rates and the portfolio amount. Subsequent to
September 30, 1995, the Association reclassified and transferred $27.2 million
of its debt securities from the held-to-maturity portfolio to the
available-for-sale portfolio.

16

During the years ended September 30, 1997, 1996 and 1995, neither the
Company nor the Association held any off-balance sheet derivative financial
instruments in their investment portfolios to which the provisions of SFAS No.
119, "Disclosure about Derivative Financial Instruments and Fair Value of
Financial Instruments," would apply.

The following tables set forth certain information relating to the
investment securities portfolio held to maturity and securities available for
sale at the dates indicated.

At September 30,
-----------------------------------------------------------------------
1997 1996 1995
--------------------- -------------------- --------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- -------- --------- -------- --------- --------
(In thousands)
Held to maturity:

U.S. Government obligations ... $ -- $ -- $ -- $ -- $ 28,961 $ 28,873
State and municipal obligations 1,042 1,069 1,227 1,249 512 552
Corporate obligations ......... 21,895 21,900 8,600 8,611 12,736 12,753

Available for sale:
U.S. Federal securities........ -- -- 12,080 12,080 12,606 12,606
mutual bond fund
U.S. Government obligations ... 185,861 185,601 59,717 58,624 -- --
State and municipal obligations 8,861 9,087 250 251 -- --
Corporate obligations ......... 67,147 67,158 5,024 5,032 -- --
-------- -------- -------- -------- -------- --------
Total ....................... $284,806 $284,815 $ 86,898 $ 85,847 $ 54,815 $ 54,784
======== ======== ======== ======== ======== ========

17

At September 30,
--------------------------------------------------------------------------------------
1997 1996 1995
------------------------ ------------------------ ------------------------
Amortized Percent of Amortized Percent of Amortized Percent of
Cost Portfolio Cost Portfolio Cost Portfolio
(Dollars in Thousands)
Held to maturity: --------- ---------- --------- ---------- --------- ----------

U.S. Government obligations ... $ -- 0.00% $ -- 0.00% $ 28,961 52.84%
State and municipal obligations 1,042 0.36 1,227 1.41 512 0.93
Corporate obligations ......... 21,895 7.69 8,600 9.90 12,736 23.23

Available for sale:
U.S. Federal securities ....... -- 0.00 12,080 13.90 12,606 23.00
mutual bond fund
U.S. Government obligations ... 185,861 65.26 59,717 68.72 -- --
State and municipal obligations 8,861 3.11 250 0.29 -- --
Corporate obligations ......... 67,147 23.58 5,024 5.78 -- --
--------- ---------- --------- ---------- --------- ----------
Total ....................... $ 284,806 100.00% $ 86,898 100.00% $ 54,815 100.00%
========= ========== ========= ========== ========= ==========

The following table sets forth the maturities and weighted average yields
of the debt securities in the investment
portfolio at September 30, 1997.

Less Than One to Five to Over Ten
One Year Five Years Ten Years Years
----------------- ----------------- ----------------- ---------------
Amount Yield Amount Yield Amount Yield Amount Yield Totals
-------- ----- -------- ----- -------- ----- ------ ----- --------
(Dollars in thousands)

Held to maturity:

State and municipal . $ 151 6.29% $ 891 6.60% $ -- -- -- -- $ 1,042
obligations
Corporate obligations 19,895 5.57% 2,000 5.95% -- -- -- -- 21,895

Available for sale:
U.S. Government ..... 13,966 6.11% 162,907 6.11% 8,988 6.83% -- -- 185,861
obligations
State and municipal . -- -- 794 6.61% 100 6.38 7,967 8.00 8,861
obligations
Corporate obligations 18,220 5.87 48,927 6.22% -- -- -- -- 67,147
-------- -------- -------- ------ --------
Total ............. $ 52,232 $215,519 $ 9,088 $7,967 $284,806
======== ======== ======== ====== ========

At September 30, 1997 the Association did not hold any securities from a single
issuer, other than the U.S. Government, whose aggregate book value was in excess
of 10% of stockholders' equity, or $14.4 million.

Mortgage Backed and Related Securities

At September 30, 1997, the Company's net mortgage backed and related
securities totaled $70.4 million at fair value ($69.5 million at amortized cost)
and had a weighted average yield of 7.09%. At September 30, 1997, all of the
mortgage backed and related securities were adjustable rate securities.

18

Mortgage backed and related securities (which also are known as mortgage
participation certificates or pass- through certificates) typically represent a
participation interest in a pool of single-family or multi-family mortgages. The
principal and interest payments on these mortgages are passed from the mortgage
originators, through intermediaries (generally U.S. Government agencies and
government sponsored enterprises) that pool and resell the participation
interests in the form of securities, to investors such as the Company. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and interest to investors, primarily include the Federal
Home Loan Mortgage Corporation ("FHLMC"), Fannie Mae ("FNMA") (formerly the
Federal National Mortgage Association), the Government National Mortgage
Association ("GNMA") and the U.S. Small Business Administration ("SBA").
Mortgage backed and related securities typically are issued with stated
principal amounts, and the securities are backed by pools of mortgages that have
loans with interest rates that fall within a specific range and have varying
maturities. Mortgage backed and related securities generally yield less than the
loans that underlie such securities because of the cost of payment guarantees
and credit enhancements. In addition, mortgage backed and related securities are
usually more liquid than individual mortgage loans and may be used to
collateralize certain liabilities and obligations of the Company. These types of
securities also permit the Association to optimize its regulatory capital
because they have low risk weighting.

Expected maturities of mortgage backed and related securities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties. Prepayments
that are faster than anticipated may shorten the life of the security and may
result in a loss of any premiums paid and thereby reduce the net yield on such
securities. Although prepayments of underlying mortgages depend on many factors,
including the type of mortgages, the coupon rate, the age of mortgages, the
geographical location of the underlying real estate collateralizing the
mortgages and general levels of market interest rates, the difference between
the interest rates on the underlying mortgages and the prevailing mortgage
interest rates generally is the most significant determinant of the rate of
prepayments. During periods of declining mortgage interest rates, if the coupon
rate of the underlying mortgages exceeds the prevailing market interest rates
offered for mortgage loans, refinancing generally increases and accelerates the
prepayment of the underlying mortgages and the related security. Under such
circumstances, the Company may be subject to reinvestment risk because, to the
extent that the Company's mortgage backed securities amortize or prepay faster
than anticipated, the Company may not be able to reinvest the proceeds of such
repayments and prepayments at a comparable rate.

Subsequent to September 30, 1995, the Company reclassified $1.7 million of
mortgage backed and related securities from held to maturity to available for
sale at fair values, with an unrealized loss of $100,421, consistent with the
implementation guidance discussed under above "-- Investment Activities."

19

The following tables set forth certain information relating to the mortgage
backed and related securities portfolio held to maturity and available for sale
at the dates indicated.

At September 30,
---------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- --------- --------- --------- --------- ---------
(Dollars in thousands)

Held to maturity:

GNMA ............ $ 5,447 $ 5,518 $ 6,783 $ 6,736 $-- $--

Available for sale:

FNMA ............ 12,775 12,897 15,905 15,959 -- --
FHLMC ........... 25,881 26,574 39,205 39,179 -- --
GNMA ............ 9,709 9,808 -- -- -- --
SBA ............. 15,732 15,590 19,139 18,971 -- --
--------- --------- --------- --------- --------- ---------
Total ......... $ 69,544 $ 70,387 $ 81,032 $ 80,845 $-- $--
--------- --------- --------- --------- --------- ---------

At September 30,
---------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
Amortized Percent of Amortized Percent of Amortized Percent of
Cost Portfolio Cost Portfolio Cost Portfolio
--------- ---------- --------- ---------- --------- ----------
(Dollars in Thousands)
Held to maturity:

GNMA ............ $ 5,447 7.83% $ 6,783 8.37% $-- --%

Available for sale:

FNMA ............ 12,775 18.37 15,905 19.63 -- --
FHLMC ........... 25,881 37.22 39,205 48.38 -- --
GNMA ............ 9,709 13.96 -- -- -- --
SBA ............. 15,732 22.62 19,139 23.62 -- --
--------- ---------- --------- ---------- --------- ----------
Total ......... $ 69,544 100.00% $ 81,032 100.00% $-- --%
========= ========== ========= ========== ========= ==========

Interest-Earning Deposits

The Company also had interest-earning deposits in the FHLB of Seattle
amounting to $1.4 million and $3.1 million at September 30, 1997 and 1996,
respectively.
20

Deposit Activities and Other Sources of Funds

General. Deposits are the primary source of the Association's funds for
lending and other investment purposes. In addition to deposits, the Association
derives funds from loan principal repayments. Loan repayments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings may
be used on a short-term basis to compensate for reductions in the availability
of funds from other sources. They may also be used on a longer term basis for
general business purposes.

Deposits. The Association's deposits are attracted principally from within
the Association's primary market area through the offering of a broad selection
of deposit instruments, including checking accounts, NOW accounts, money market
deposit accounts, passbook and statement savings accounts, and certificates of
deposit. Included among these deposit products are individual retirement account
("IRA") certificates of approximately $86.4 million at September 30, 1997.
Deposit account terms vary, with the principal differences being the minimum
balance required, the time period the funds must remain on deposit and the
interest rate.

Beginning in 1996, the Association began accepting deposits from outside
its primary market area through both private placements and brokered deposits if
the terms of the deposits fit the Association's specific needs and are at a rate
lower than the rates on similar maturity borrowings through the FHLB of Seattle.
At September 30, 1997, these deposits totaled $10.0 million, or 1.49% of total
deposits.

Interest rates paid, maturity terms, service fees and withdrawal penalties
are established by the Association on a periodic basis. Determination of rates
and terms are predicated on funds acquisition and liquidity requirements, rates
paid by competitors, growth goals and federal regulations.

In July 1997, the Association acquired 25 Wells Fargo Bank branches in
Oregon, adding $241.3 million in deposit accounts. In addition to the increase
from the acquisition, the Association experienced a net increase in deposits
(before interest credited) of $14.1 million for the year ended September 30,
1997 as customers deposited funds and new customers were added. To augment this
deposit inflow, the Association has relied on increased borrowings from the FHLB
of Seattle. See "-- Borrowings." The acquired deposit base included a
significant proportion of non-interest bearing checking accounts, thereby
reducing the cost of deposits and contributing to the Association's interest
rate spread increasing from 2.22% for the year ended September 30, 1996 to 2.28%
for the year ended September 30, 1997. Concurrent with the acquisition, the
Association's deposit product offerings were expanded, allowing customers to
choose the accounts best suited to their needs, whether their focus is low cost
or additional services.

At September 30, 1997, certificate accounts maturing during the year ending
September 30, 1998 totaled $242.2 million. Based on historical experience, the
Association expects that a significant amount will be renewed with the
Association at maturity. In the event a significant amount of such accounts are
not renewed at maturity, the Association would not expect a resultant adverse
impact on operations and liquidity because of the Association's borrowing
capacity. See "-- Borrowings."

In the unlikely event the Association is liquidated, depositors will be
entitled to full payment of their deposit accounts prior to any payment being
made to the Company, which is the sole shareholder of the Association.
Substantially all of the Association's depositors are residents of the State of
Oregon.

21

The following table indicates the amount of certificate accounts with
balances of $100,000 or greater by time remaining until maturity as of September
30, 1997.

Certificate
Maturity Period Accounts
--------
(In thousands)

Three months or less................................... $12,502
Over three through six months.......................... 10,452
Over six through twelve months......................... 15,362
Over twelve months..................................... 32,407
--------
Total.............................................. $70,723
========

The following table sets forth the deposit balances in the various types of
savings accounts offered by the Association at the dates indicated.

At September 30,
----------------------------------------------------------------------------------------
1997 1996 1995
------------------------------- -------------------------------- --------------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
-------- ------- -------- -------- ------- -------- -------- -------
(Dollars in thousands)

Certificates of deposit ......... $375,603 55.73% $ 86,415 $289,188 72.36% $ 12,093 $277,095 72.09%

Transaction accounts:

Non-interest checking ........... 52,578 7.80 52,417 161 0.04 161 -- --
Interest-bearing checking ....... 75,044 11.14 50,762 24,282 6.08 2,245 22,037 5.73
Passbook and statement savings .. 63,179 9.37 29,468 33,711 8.43 (3,526) 37,237 9.69
Money market deposits ........... 107,574 15.96 55,243 52,331 13.09 4,320 48,011 12.49
-------- ------- -------- -------- ------- -------- -------- -------
Total transaction accounts ...... 298,375 44.27 187,890 110,485 27.64 3,200 107,285 27.91
-------- ------- -------- -------- ------- -------- -------- -------
Total deposits .................. $673,978 100.00% $274,305 $399,673 100.00% $ 15,293 $384,380 100.00%
======== ======= ======== ======== ======= ======== ======== =======

The following table sets forth the savings activities of the Association
for the periods indicated.

Years Ended September 30,
---------------------------------
1997 1996 1995
--------- --------- ---------
(In thousands)

Beginning balance ......................... $ 399,673 $ 384,380 $ 389,751
Increase due to acquired deposits ......... 241,272
Net inflow (outflow) of deposits before ... 14,077 (2,364) (21,109)
interest credited
Interest credited ......................... 18,956 17,657 15,738
--------- --------- ---------
Net increase (decrease) in deposits ....... 274,305 15,293 (5,371)
--------- --------- ---------
Ending balance ............................ $ 673,978 $ 399,673 $ 384,380
========= ========= =========

22

Borrowings. Savings deposits are the primary source of funds for the
Association's lending and investment activities and for its general business
purposes. The Association may rely upon advances from the FHLB of Seattle,
reverse repurchase agreements and a bank line of credit to supplement its supply
of lendable funds and to meet deposit withdrawal requirements. The FHLB of
Seattle serves as the Association's primary borrowing source after deposits.

The FHLB of Seattle functions as a central reserve bank providing credit
for savings and loan associations and certain other member financial
institutions. As a member, the Association is required to own capital stock in
the FHLB of Seattle and is authorized to apply for advances on the security of
certain of its mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the U.S. Government) provided certain
creditworthiness standards have been met. Advances are made pursuant to several
different credit programs. Each credit program has its own interest rate and
range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. As a member of the FHLB,
the Association maintains a credit line that is a percentage of its regulatory
assets, subject to collateral requirements. At September 30, 1997, the credit
line was 30% of total assets of the Association. Advances are collateralized in
aggregate, as provided for in the Advances, Security and Deposit Agreements with
the FHLB, by certain mortgages or deeds of trust and securities of the U.S.
Government and agencies thereof.

During the year ended September 30, 1997 the Company sold under agreements
to repurchase specific securities of the U.S. Government and its agencies and
other approved investments to a broker-dealer. The securities underlying these
repurchase agreements were delivered to the broker-dealer who arranged the
transaction. Securities delivered to the broker-dealer may be loaned out in the
ordinary course of operations. All of the reverse repurchase agreements at
September 30, 1997 were due within 48 days and will be renewed subsequent to
year end.

The following table sets forth certain information regarding borrowings by
the Company and Association at the end of and during the periods indicated:

At September 30,
----------------
1997 1996
---- ----
Weighted average rate paid on:

FHLB advances ................... 5.62% 5.50%
Reverse repurchase agreements ... 5.75 5.65

Years Ended
September 30,
--------------------
1997 1996
-------- --------
(Dollars in thousands)
Maximum amount outstanding
at any month end:

FHLB advances ............................. $151,000 $ 90,000
Reverse repurchase agreements ............. 19,118 14,904

Approximate average balance:
FHLB advances ............................. 110,737 47,986
Reverse repurchase agreements ............. 16,804 3,531

Approximate weighted average rate paid on:
FHLB advances ............................. 5.66% 5.60%
Reverse repurchase agreements ............. 5.82 5.55

The Association also has an uncommitted line of credit of $15.0 million
with a commercial bank. At September 30, 1997, the Association had no borrowings
outstanding under this credit facility.

23

REGULATION OF THE ASSOCIATION

The Association is subject to extensive regulation, examination and
supervision by the OTS as its chartering agency, and the FDIC, as the insurer of
its deposits. The activities of federal savings institutions are governed by the
Home Owners' Loan Act, as amended (the "HOLA") and, in certain respects, the
Federal Deposit Insurance Act ("FDIA") and the regulations issued by the OTS and
the FDIC to implement these statutes. These laws and regulations delineate the
nature and extent of the activities in which federal savings associations may
engage. Lending activities and other investments must comply with various
statutory and regulatory capital requirements. In addition, the Association's
relationship with its depositors and borrowers is also regulated to a great
extent, especially in such matters as the ownership of deposit accounts and the
form and content of the Association's mortgage documents. The Association must
file reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other financial
institutions. There are periodic examinations by the OTS and the FDIC to review
the Association's compliance with various regulatory requirements. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the OTS, the FDIC or Congress, could have a
material adverse impact on the Holding Company, the Association and their
operations. The Holding Company, as a savings and loan holding company, is also
required to file certain reports with, and otherwise comply with the rules and
regulations of, the OTS.

Federal Regulation of Savings Associations

Office of Thrift Supervision. The OTS is an office in the Department of the
Treasury subject to the general oversight of the Secretary of the Treasury. The
OTS generally possesses the supervisory and regulatory duties and
responsibilities formerly vested in the Federal Home Loan Bank Board. Among
other functions, the OTS issues and enforces regulations affecting federally
insured savings associations and regularly examines these institutions.

Federal Home Loan Bank System. The FHLB System, consisting of 12 FHLBs, is
under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The
designated duties of the FHFB are to supervise the FHLBs, to ensure that the
FHLBs carry out their housing finance mission, to ensure that the FHLBs remain
adequately capitalized and able to raise funds in the capital markets, and to
ensure that the FHLBs operate in a safe and sound manner.

The Association, as a member of the FHLB of Seattle, is required to acquire
and hold shares of capital stock in the FHLB of Seattle in an amount equal to
the greater of (i) 1.0% of the aggregate outstanding principal amount of
residential mortgage loans, home purchase contracts and similar obligations at
the beginning of each year, or (ii) 1/20 of its advances (borrowings) from the
FHLB of Seattle. The Association is in compliance with this requirement with an
investment in FHLB of Seattle stock of $7.2 million at September 30, 1997.

Among other benefits, the FHLB provides a central credit facility primarily
for member institutions. It is funded primarily from proceeds derived from the
sale of consolidated obligations of the FHLB System. It makes advances to
members in accordance with policies and procedures established by the FHFB and
the Board of Directors of the FHLB of Seattle.

Federal Deposit Insurance Corporation. The FDIC is an independent federal
agency established originally to insure the deposits, up to prescribed statutory
limits, of federally insured banks and to preserve the safety and soundness of
the banking industry. In 1989 the FDIC also became the insurer, up to the
prescribed limits, of the deposit accounts held at federally insured savings
associations and established two separate insurance funds: the Bank Insurance
Fund ("BIF") and the SAIF. As insurer of deposits, the FDIC has examination,
supervisory and enforcement authority over all savings associations.

24

The majority of the Association's accounts are insured by the SAIF,
however, the $241.3 million of deposits acquired in July 1997 from Wells Fargo
Bank, N.A., a BIF-insured institution, will continue to be BIF-insured deposits
and will be assessed premiums based on the lower BIF rates. These deposits are
known as Oakar deposits, indicating that they are deposits held by a
SAIF-insured institution, but insured by the BIF. The FDIC insures deposits at
the Association to the maximum extent permitted by law. The Association
currently pays deposit insurance premiums to the FDIC based on a risk-based
assessment system established by the FDIC for all SAIF-member institutions.
Under applicable regulations, institutions are assigned to one of three capital
groups that are based solely on the level of an institution's capital -- "well
capitalized", "adequately capitalized", and "undercapitalized" -- which are
defined in the same manner as the regulations establishing the prompt corrective
action system, as discussed below. These three groups are then divided into
three subgroups which reflect varying levels of supervisory concern, from those
which are considered to be healthy to those which are considered to be of
substantial supervisory concern. The matrix so created results in nine
assessment risk classifications, with rates currently ranging from .23% for well
capitalized, financially sound institutions with only a few minor weaknesses to
.31% for undercapitalized institutions that pose a substantial risk of loss to
the SAIF unless effective corrective action is taken. The FDIC is authorized to
raise assessment rates under certain circumstances. The Association's
assessments expensed for the year ended September 30, 1997, totaled $376,029.

Until the second half of 1995, the same matrix applied to BIF-member
institutions. As a result of the BIF having reached its designated reserve
ratio, effective January 1, 1996, the FDIC substantially reduced deposit
insurance premiums for well-capitalized, well-managed financial institutions
that are members of the BIF. Under the new assessment schedule, rates were
reduced to a range of 0 to 27 basis points, with approximately 92% of BIF
members paying the statutory minimum annual assessment rate of $2,000. Pursuant
to the Deposit Insurance Fund Act ("DIF Act"), which was enacted on September
30, 1996, the FDIC imposed a special one-time assessment on each depository
institution with SAIF-assessable deposits so that the SAIF may achieve its
designated reserve ratio. The Association's assessment amounted to $2.5 million
and was assessed during the quarter ended September 30, 1996. Beginning January
1, 1997, the assessment schedule for SAIF members will be the same as that for
BIF members. In addition, beginning January 1, 1997, SAIF members were charged
an assessment of 0.064% of SAIF-assessable deposits for the purpose of paying
interest on the obligations issued by the Financing Corporation ("FICO") in the
1980s to help fund the thrift industry cleanup. BIF-assessable deposits will be
charged an assessment to help pay interest on the FICO bonds at a rate of
approximately 0.013% until the earlier of December 31, 1999 or the date upon
which the last savings association ceases to exist, after which time the
assessment will be the same for all insured deposits.

The DIF Act provides for the merger of the BIF and the SAIF into the
Deposit Insurance Fund on January 1, 1999, but only if no insured depository
institution is a savings association on that date. The DIF contemplates the
development of a common charter for all federally chartered depository
institutions and the abolition of separate charters for national banks and
federal savings associations. It is not known what form the common charter may
take and what effect, if any, the adoption of a new charter would have on the
operation of the Association.

The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations, or has violated any applicable law, regulation, order or
any condition imposed by an agreement with the FDIC. It also may suspend deposit
insurance temporarily during the hearing process for the permanent termination
of insurance, if the institution has no tangible capital. If insurance of
accounts is terminated, the accounts at the institution at the time of
termination, less subsequent withdrawals, shall continue to be insured for a
period of six months to two years, as determined by the FDIC. Management is
aware of no existing circumstances that could result in termination of the
deposit insurance of the Association.

25

Liquidity Requirements. Under OTS regulations, each savings institution is
required to maintain an average daily balance of liquid assets (cash, certain
time deposits and savings accounts, bankers' acceptances, and specified U.S.
Government, state or federal agency obligations and certain other investments)
equal to a monthly average of not less than a specified percentage (5.0% for
regulations in effect at September 30, 1997) of its net withdrawable accounts
plus short-term borrowings. OTS regulations also require each savings
institution to maintain an average daily balance of short term liquid assets at
a specified percentage (1.0% for regulations in effect at September 30, 1997) of
the total of its net withdrawable savings accounts and borrowings payable in one
year or less. Monetary penalties may be imposed for failure to meet liquidity
requirements. The Association's short- and long-term monthly liquidity ratios
were 3.71% and 31.56%, respectively, at September 30, 1997. Effective November
24, 1997, the OTS has revised the liquid asset requirement from 5.00% to 4.00%,
and eliminated the short term cash liquidity requirement of 1.00%.

Prompt Corrective Action. Under the FDIA, each federal banking agency is
required to implement a system of prompt corrective action for institutions that
it regulates. The federal banking agencies have promulgated substantially
similar regulations to implement this system of prompt corrective action. Under
the regulations, an institution shall be deemed to be (i) "well capitalized" if
it has a total risk-based capital ratio of 10.0% or more, has a Tier I
risk-based capital ratio of 6.0% or more, has a leverage ratio of 5.0% or more
and is not subject to specified requirements to meet and maintain a specific
capital level for any capital measure; (ii) "adequately capitalized" if it has a
total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital
ratio of 4.0% or more and a leverage ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized;" (iii)
"undercapitalized" if it has a total risk-based capital ratio that is less than
8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a leverage
ratio that is less than 4.0% (3.0% under certain circumstances); (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio that
is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a
leverage ratio that is less than 3.0%; and (v) "critically undercapitalized" if
it has a ratio of tangible equity to total assets that is equal to or less than
2.0%.

A federal banking agency may, after notice and an opportunity for a
hearing, reclassify a well capitalized institution as adequately capitalized and
may require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category if the institution is in an unsafe or unsound condition or has received
in its most recent examination, and has not corrected, a less than satisfactory
rating for asset quality, management, earnings or liquidity. (The OTS may not,
however, reclassify a significantly undercapitalized institution as critically
undercapitalized.)

An institution generally must file a written capital restoration plan that
meets specified requirements, as well as a performance guaranty by each company
that controls the institution, with the appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. Immediately upon becoming undercapitalized, an
institution shall become subject to various mandatory and discretionary
restrictions on its operations.

At September 30, 1997, the Association was categorized as "well
capitalized" under the prompt corrective action regulations of the OTS.

Standards for Safety and Soundness. The FDIA requires the federal banking
regulatory agencies to prescribe, by regulation, standards for all insured
depository institutions relating to: (i) internal controls, information systems
and internal audit systems; (ii) loan documentation; (iii) credit underwriting;
(iv) interest rate risk exposure; (v) asset growth; and (vi) compensation, fees
and benefits. The federal banking agencies adopted regulations and Interagency
Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") to
implement safety and soundness standards required by the FDIA. The Guidelines
set forth the safety and soundness standards that the federal banking agencies
use to identify and address problems at insured depository institutions before
capital becomes impaired. The agencies also proposed asset quality and earnings
standards which, if adopted, would be added to the Guidelines. If the OTS
determines that the Association fails to meet any standard prescribed by the
Guidelines, the agency may require the Association to submit to the agency an
acceptable plan to achieve compliance with the standard, as required by the
FDIA. OTS regulations establish deadlines for the submission and review of such
safety and soundness compliance plans.

26

Qualified Thrift Lender Test. All savings associations are required to meet
a qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. A savings institution that fails to become or remain a QTL shall
either become a national bank or be subject to the following restrictions on its
operations: (i) the association may not make any new investment or engage in
activities that would not be permissible for national banks; (ii) the
association may not establish any new branch office where a national bank
located in the savings institution's home state would not be able to establish a
branch office; (iii) the association shall be ineligible to obtain new advances
from any FHLB; and (iv) the payment of dividends by the association shall be
subject to the rules regarding the statutory and regulatory dividend
restrictions applicable to national banks. Also, beginning three years after the
date on which the savings institution ceases to be a QTL, the savings
institution would be prohibited from retaining any investment or engaging in any
activity not permissible for a national bank and would be required to repay any
outstanding advances to any FHLB. In addition, within one year of the date on
which a savings association controlled by a company ceases to be a QTL, the
company must register as a bank holding company and become subject to the rules
applicable to such companies. A savings institution may requalify as a QTL if it
thereafter complies with the QTL test.

Currently, the QTL test requires that 65% of an institution's "portfolio
assets" (as defined) consist of certain housing and consumer-related assets on a
monthly average basis in nine out of every 12 months. Assets that qualify
without limit for inclusion as part of the 65% requirement are loans made to
purchase, refinance, construct, improve or repair domestic residential housing
and manufactured housing; home equity loans; mortgage backed securities (where
the mortgages are secured by domestic residential housing or manufactured
housing); FHLB stock; and direct or indirect obligations of the FDIC. In
addition, the following assets, among others, may be included in meeting the
test subject to an overall limit of 20% of the savings institution's portfolio
assets: 50% of residential mortgage loans originated and sold within 90 days of
origination; 100% of consumer and educational loans (limited to 10% of total
portfolio assets); and stock issued by the FHLMC or Fannie Mae. Portfolio assets
consist of total assets minus the sum of (i) goodwill and other intangible
assets, (ii) property used by the savings institution to conduct its business,
and (iii) liquid assets up to 20% of the institution's total assets. At
September 30, 1997, the qualified thrift investments of the Association were
approximately 81.13% of its portfolio assets.

Capital Requirements. Financial institutions are graded or evaluated by
regulatory authorities based on their capital adequacy, asset quality,
management quality, earnings, liquidity, and sensitivity to market risk ("CAMELS
rating"). A major component of the CAMELS rating is capital. Under OTS
regulations a savings association must satisfy three minimum capital
requirements: core capital, tangible capital and risk-based capital. Savings
associations must meet all of the standards in order to comply with the capital
requirements.

OTS capital regulations establish a 3% core capital or leverage ratio
(defined as the ratio of core capital to adjusted total assets). Core capital is
defined to include common shareholders' equity, noncumulative perpetual
preferred stock and any related surplus, and minority interests in equity
accounts of consolidated subsidiaries, less (i) any intangible assets, except
for certain qualifying intangible assets; (ii) certain mortgage servicing
rights; and (iii) equity and debt investments in subsidiaries that are not
"includable subsidiaries," which are defined as subsidiaries engaged solely in
activities not impermissible for a national bank, engaged in activities
impermissible for a national bank but only as an agent for its customers, or
engaged solely in mortgage-banking activities. In calculating adjusted total
assets, adjustments are made to total assets to give effect to the exclusion of
certain assets from capital and to account appropriately for the investments in
and assets of both includable and nonincludable subsidiaries. Institutions that
fail to meet the core capital requirement would be required to file with the OTS
a capital plan that details the steps they will take to reach compliance. In
addition, the OTS's prompt corrective action regulation provides that a savings
institution that has a leverage ratio of less than 4% (3% for institutions
receiving the highest CAMELS examination rating) will be deemed to be
"undercapitalized" and may be subject to certain restrictions. See "-- Federal
Regulation of Savings Associations -- Prompt Corrective Action."

27

As required by federal law, the OTS has proposed a rule revising its
minimum core capital requirement to be no less stringent than that imposed on
national banks. The OTS has proposed that only those savings associations rated
a composite one (the highest rating) under the CAMELS rating system for savings
associations will be permitted to operate at or near the regulatory minimum
leverage ratio of 3%. All other savings associations will be required to
maintain a minimum leverage ratio of 4% to 5%. The OTS will assess each
individual savings association through the supervisory process on a case-by-case
basis to determine the applicable requirement. No assurance can be given as to
the final form of any such regulation, the date of its effectiveness or the
requirement applicable to the Association.

Savings associations also must maintain "tangible capital" not less than
1.5% of the Association's adjusted total assets. "Tangible capital" is defined,
generally, as core capital minus any "intangible assets" other than purchased
mortgage servicing rights.

Each savings institution must maintain total risk-based capital equal to at
least 8% of risk-weighted assets. Total risk-based capital consists of the sum
of core and supplementary capital, provided that supplementary capital cannot
exceed core capital, as previously defined. Supplementary capital includes (i)
permanent capital instruments such as cumulative perpetual preferred stock,
perpetual subordinated debt and mandatory convertible subordinated debt, (ii)
maturing capital instruments such as subordinated debt, intermediate-term
preferred stock and mandatory convertible subordinated debt, subject to an
amortization schedule, and (iii) general valuation loan and lease loss
allowances up to 1.25% of risk-weighted assets.

The risk-based capital regulation assigns each balance sheet asset held by
a savings institution to one of four risk categories based on the amount of
credit risk associated with that particular class of assets. Assets not included
for purposes of calculating capital are not included in calculating
risk-weighted assets. The categories range from 0% for cash and securities that
are backed by the full faith and credit of the U.S. Government to 100% for
repossessed assets or assets more than 90 days past due. Qualifying residential
mortgage loans (including multi-family mortgage loans) are assigned a 50% risk
weight. Consumer, commercial, home equity, land and residential construction
loans are assigned a 100% risk weight, as are nonqualifying residential and
multi-family mortgage loans and nonresidential construction loans. The book
value of assets in each category is multiplied by the weighting factor (from 0%
to 100%) assigned to that category. These products are then totaled to arrive at
total risk-weighted assets. Off-balance sheet items are included in
risk-weighted assets by converting them to an approximate balance sheet "credit
equivalent amount" based on a conversion schedule. These credit equivalent
amounts are then assigned to risk categories in the same manner as balance sheet
assets and included in risk-weighted assets.

The OTS has proposed incorporation of an interest rate risk component into
its regulatory capital rule. Under the rule, savings associations with "above
normal" interest rate risk exposure would be subject to a deduction from total
capital for purposes of calculating their risk-based capital requirements. A
savings association's interest rate risk is measured by the decline in the net
portfolio value of its assets (i.e., the difference between incoming and
outgoing discounted cash flows from assets, liabilities and off-balance sheet
contracts) that would result from a hypothetical 200 basis point increase or
decrease in market interest rates divided by the estimated economic value of the
association's assets, as calculated in accordance with guidelines set forth by
the OTS. A savings association whose measured interest rate risk exposure
exceeds 2% must deduct an interest rate risk component in calculating its total
capital under the risk-based capital rule. The interest rate risk component is
an amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
association's assets. That dollar amount is deducted from an association's total
capital in calculating compliance with its risk-based capital requirement. Under
the rule, there is a two quarter lag between the reporting date of an
institution's financial data and the effective date for the new capital
requirement based on that data. A savings association with assets of less than
$300 million and a risk-based capital ratio in excess of 12% is not subject to
the interest rate risk component, unless the OTS determines otherwise. The rule
also provides that the Director of the OTS may waive or defer an association's
interest rate risk component on a case-by-case basis. Under certain
circumstances, a savings association may request an adjustment to its interest
rate risk component if it believes that the OTS-calculated interest rate risk
component overstates its interest rate risk exposure. In addition, certain
"well-capitalized" institutions may obtain authorization to use their own
interest rate risk model to calculate their interest rate risk component in lieu
of the OTS-calculated amount. The OTS has postponed indefinitely the date that
the component will first be deducted from an institution's total capital.

28

The following table presents the Association's capital levels at
September 30, 1997.

To Be
Categorized as "Well
Capitalized" Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
---------------------- --------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ----- ----------- ----- ----------- -----

Total Capital ................ $103,325,941 23.1% $35,755,744 8.0% $44,694,680 10.0%
(To Risk Weighted Assets)
Tier I Capital ............... 102,029,490 22.8 -- -- 26,816,808 6.0
(To Risk Weighted Assets)
Tier I Capital ............... 102,029,490 11.1 27,643,595 3.0 46,072,658 5.0
(To Total Assets)
Tangible Capital ............. 102,029,490 11.1 13,821,797 1.5 -- --
(To Tangible Assets)

Limitations on Capital Distributions. OTS regulations impose uniform
limitations on the ability of all savings associations to engage in various
distributions of capital such as dividends, stock repurchases and cash-out
mergers. In addition, OTS regulations require the Association to give the OTS 30
days' advance notice of any proposed capital distributions, and the OTS has the
authority under its supervisory powers to prohibit the capital distributions.
The regulation utilizes a three-tiered approach which permits various levels of
distributions based primarily upon a savings association's capital level.

A Tier 1 savings association has capital in excess of its fully phased-in
capital requirement (both before and after the proposed capital distribution).
Tier 1 savings associations may make (without application but upon prior notice
to, and no objection made by, the OTS) capital distributions during a calendar
year up to 100% of its net income to date during the calendar year plus one-half
its surplus capital ratio (i.e., the amount of capital in excess of its fully
phased-in requirement) at the beginning of the calendar year or the amount
authorized for a Tier 2 association. Capital distributions in excess of such
amount require advance notice to the OTS. A Tier 2 savings association has
capital equal to or in excess of its minimum capital requirement but below its
fully phased-in capital requirement (both before and after the proposed capital
distribution). Such an association may make (without application) capital
distributions up to an amount equal to 75% of its net income during the previous
four quarters depending on how close the association is to meeting its fully
phased-in capital requirement. Capital distributions exceeding this amount
require prior OTS approval. Tier 3 associations are savings associations with
capital below the minimum capital requirement (either before or after the
proposed capital distribution). Tier 3 associations may not make any capital
distributions without prior approval from the OTS.

The Association is currently meeting the criteria to be designated a Tier 1
association and, consequently, could at its option (after prior notice to, and
no objection made by, the OTS) distribute up to 100% of its net income during
the calendar year plus 50% of its surplus capital ratio at the beginning of the
calendar year less any distributions previously paid during the year.

Loans to One Borrower. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans to one borrower. Generally, this
limit is 15% of the Association's unimpaired capital and surplus, plus an
additional 10% of unimpaired capital and surplus, if such loan is secured by
readily-marketable collateral, which is defined to include certain financial
instruments and bullion. The OTS by regulation has amended the loans to one
borrower rule to permit savings associations meeting certain requirements,
including capital requirements, to extend loans to one borrower in additional
amounts under circumstances limited essentially to loans to develop or complete
residential housing units. At September 30, 1997, the Association's limit on
loans to one borrower was $17.4 million. At September 30, 1997, the
Association's largest aggregate amount of loans to one borrower was $3.5
million, which were performing according to their terms.

29

Activities of Associations and Their Subsidiaries. When a savings
association establishes or acquires a subsidiary or elects to conduct any new
activity through a subsidiary that the association controls, the savings
association must notify the FDIC and the OTS 30 days in advance and provide the
information each agency may, by regulation, require. Savings associations also
must conduct the activities of subsidiaries in accordance with existing
regulations and orders.

The OTS may determine that the continuation by a savings association of its
ownership control of, or its relationship to, the subsidiary constitutes a
serious risk to the safety, soundness or stability of the association or is
inconsistent with sound banking practices or with the purposes of the FDIA.
Based upon that determination, the FDIC or the OTS has the authority to order
the savings association to divest itself of control of the subsidiary. The FDIC
also may determine by regulation or order that any specific activity poses a
serious threat to the SAIF. If so, it may require that no SAIF member engage in
that activity directly.

Transactions with Affiliates. Savings associations must comply with
Sections 23A and 23B of the Federal Reserve Act ("Sections 23A and 23B")
relative to transactions with affiliates in the same manner and to the same
extent as if the savings association were a Federal Reserve member bank. A
savings and loan holding company, its subsidiaries and any other company under
common control are considered affiliates of the subsidiary savings association
under the HOLA. Generally, Sections 23A and 23B: (i) limit the extent to which
the insured association or its subsidiaries may engage in certain covered
transactions with an affiliate to an amount equal to 10% of such institution's
capital and surplus and place an aggregate limit on all such transactions with
affiliates to an amount equal to 20% of such capital and surplus, and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable to the institution or subsidiary, as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans, the
purchase of assets, the issuance of a guarantee and similar types of
transactions.

Three additional rules apply to savings associations: (i) a savings
association may not make any loan or other extension of credit to an affiliate
unless that affiliate is engaged only in activities permissible for bank holding
companies; (ii) a savings association may not purchase or invest in securities
issued by an affiliate (other than securities of a subsidiary); and (iii) the
OTS may, for reasons of safety and soundness, impose more stringent restrictions
on savings associations but may not exempt transactions from or otherwise
abridge Section 23A or 23B. Exemptions from Section 23A or 23B may be granted
only by the Federal Reserve Board, as is currently the case with respect to all
FDIC-insured banks. The Association has not been significantly affected by the
rules regarding transactions with affiliates.

The Association's authority to extend credit to executive officers,
directors and 10% shareholders, as well as entities controlled by such persons,
is currently governed by Sections 22(g) and 22(h) of the Federal Reserve Act,
and Regulation O thereunder. Among other things, these regulations require that
such loans be made on terms and conditions substantially the same as those
offered to unaffiliated individuals (unless the loan or extension of credit is
made under a benefit program generally available to all other employees and does
not give preference to any insider over any other employee) and not involve more
than the normal risk of repayment. Regulation O also places individual and
aggregate limits on the amount of loans the Association may make to such persons
based, in part, on the Association's capital position, and requires certain
board approval procedures to be followed. The OTS regulations, with certain
minor variances, apply Regulation O to savings institutions.

REGULATION OF THE COMPANY

General

30 The Company is a unitary savings and loan holding company within the
meaning of the HOLA. As such, it is registered with the OTS and is subject to
OTS regulations, examinations, supervision and reporting requirements. The
Company is also subject to the information, proxy solicitation, insider trading
restrictions, and other requirements of the Securities Exchange Act of 1934, as
amended.

Company Acquisitions

The HOLA and OTS regulations issued thereunder generally prohibit a savings
and loan holding company, without prior OTS approval, from acquiring more than
5% of the voting stock of any other savings association or savings and loan
holding company or controlling the assets thereof. They also prohibit, among
other things, any director or officer of a savings and loan holding company, or
any individual who owns or controls more than 25% of the voting shares of such
holding company, from acquiring control of any savings association not a
subsidiary of such savings and loan holding company, unless the acquisition is
approved by the OTS.
30

Holding Company Activities

As a unitary savings and loan holding company, the Company generally is not
subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company. There generally are more restrictions on the
activities of a multiple savings and loan holding company than a unitary savings
and loan holding company. Specifically, if either federally insured subsidiary
savings association fails to meet the QTL test, the activities of the Company
and any of its subsidiaries (other than the Company or other federally insured
subsidiary savings associations) would thereafter be subject to further
restrictions. The HOLA provides that, among other things, no multiple savings
and loan holding company or subsidiary thereof which is not an insured
association shall commence or continue for more than two years after becoming a
multiple savings and loan association holding company or subsidiary thereof, any
business activity other than: (i) furnishing or performing management services
for a subsidiary insured institution, (ii) conducting an insurance agency or
escrow business, (iii) holding, managing, or liquidating assets owned by or
acquired from a subsidiary insured institution, (iv) holding or managing
properties used or occupied by a subsidiary insured institution, (v) acting as
trustee under deeds of trust, (vi) those activities previously directly
authorized by regulation as of March 5, 1987 to be engaged in by multiple
holding companies or (vii) those activities authorized by the Federal Reserve
Board as permissible for bank holding companies, unless the OTS by regulation,
prohibits or limits such activities for savings and loan holding companies.
Those activities described in (vii) above also must be approved by the OTS prior
to being engaged in by a multiple holding company.

Affiliate Restrictions

The affiliate restrictions contained in Sections 23A and 23B of the Federal
Reserve Act apply to all federally insured savings associations and any such
"affiliate." A savings and loan holding company, its subsidiaries and any other
company under common control are considered affiliates of the subsidiary savings
association under the HOLA. Generally, Sections 23A and 23B: (i) limit the
extent to which the insured association or its subsidiaries may engage in
certain covered transactions with an affiliate to an amount equal to 10% of such
institution's capital and surplus, and contain an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital and
surplus, and (ii) require that all such transactions be on terms substantially
the same, or at least as favorable to the institution or subsidiary, as those
provided to a non-affiliate. The term "covered transaction" includes the making
of loans, purchase of assets, issuance of a guarantee and other similar types of
transactions. Also, a savings association may not make any loan to an affiliate
unless the affiliate is engaged only in activities permissible for bank holding
companies. Only the Federal Reserve may grant exemptions from the restrictions
of Sections 23A and 23B. The OTS, however, may impose more stringent
restrictions on savings associations for reasons of safety and soundness.

Qualified Thrift Lender Test

The HOLA requires any savings and loan holding company that controls a
savings association that fails the QTL test, as explained under "-- Qualified
Thrift Lender Test," must, within one year after the date on which the
association ceases to be a QTL, register as and be deemed a bank holding company
subject to all applicable laws and regulations.

31

TAXATION

Federal Taxation

General. The Company and the Association report their income on a fiscal
year basis using the accrual method of accounting and are subject to federal
income taxation in the same manner as other corporations, with some exceptions.
The following discussion of tax matters is intended only as a summary and does
not purport to be a comprehensive description of the tax rules applicable to the
Company and the Association.

Bad Debt Reserve. Historically, savings institutions such as the
Association which met certain definitional tests primarily related to their
assets and the nature of their business ("qualifying thrift") were permitted to
establish a reserve for bad debts and to make annual additions thereto, which
may have been deducted in arriving at their taxable income. The Association's
deductions with respect to "qualifying real property loans," which are generally
loans secured by certain interest in real property, were computed using an
amount based on the Association's actual taxable income, computed with certain
modifications and reduced by the amount of any permitted additions to the non-
qualifying reserve. Each year the Association selected the most favorable way to
calculate the deduction attributable to an addition to the tax bad debt reserve.

The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." The new
rules eliminate the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all thrifts for tax years beginning after December 31,
1995. These rules also require that all institutions recapture all or a portion
of their bad debt reserves added since the base year (last taxable year
beginning before January 1, 1988). The Association has previously recorded a
deferred tax liability equal to the bad debt recapture and as such the new rules
will have no effect on net income or federal income tax expense. For taxable
years beginning after December 31, 1995, the Association's bad debt deduction
will be determined on the basis of net charge-offs during the taxable year. The
new rules allow an institution to suspend bad debt reserve recapture for the
1996 and 1997 tax years if the institution's lending activity for those years is
equal to or greater than the institution's average mortgage lending activity for
the six taxable years preceding 1996 adjusted for inflation. For this purpose,
only home purchase or home improvement loans are included and the institution
can elect to have the tax years with the highest and lowest lending activity
removed from the average calculation. If an institution is permitted to postpone
the reserve recapture, it must begin its six year recapture no later than the
1998 tax year. The unrecaptured base year reserves will not be subject to
recapture as long as the institution continues to carry on the business of
banking. In addition, the balance of the pre-1988 bad debt reserves continue to
be subject to provisions of present law referred to below that require recapture
in the case of certain excess distributions to shareholders.

Distributions. To the extent that the Association makes "nondividend
distributions" to the Company, such distributions will be considered to result
in distributions from the balance of its bad debt reserves as of December 31,
1987 (or a lesser amount if the Association's loan portfolio decreased since
December 31, 1987) and then from the supplemental reserve for losses on loans
("Excess Distributions"), and an amount based on the Excess Distributions will
be included in the Association's taxable income. Nondividend distributions
include distributions in excess of the Association's current and accumulated
earnings and profits, distributions in redemption of stock and distributions in
partial or complete liquidation. However, dividends paid out of the
Association's current or accumulated earnings and profits, as calculated for
federal income tax purposes, will not be considered to result in a distribution
from the Association's bad debt reserve. The amount of additional taxable income
created from an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. The
Association does not intend to pay dividends that would result in a recapture of
any portion of its tax bad debt reserve.

32

Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. The excess of the tax bad debt
reserve deduction using the percentage of taxable income method over the
deduction that would have been allowable under the experience method is treated
as a preference item for purposes of computing the AMTI. In addition, only 90%
of AMTI can be offset by net operating loss carryovers. AMTI is increased by an
amount equal to 75% of the amount by which the Association's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses). For taxable years beginning after
December 31, 1986, and before January 1, 1996, an environmental tax of 0.12% of
the excess of AMTI (with certain modification) over $2.0 million is imposed on
corporations, including the Association, whether or not an Alternative Minimum
Tax ("AMT") is paid.

Dividends-Received Deduction. The Company may exclude from its income 100%
of dividends received from the Association as a member of the same affiliated
group of corporations. The corporate dividends-received deduction is generally
70% in the case of dividends received from unaffiliated corporations with which
the Company and the Association will not file a consolidated tax return, except
that if the Company or the Association owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.

Other Federal Tax Matters. There have not been any Internal Revenue Service
audits of the Company's or the Association's federal income tax returns during
the past five years.

Oregon Taxation

The Company and the Association are subject to an Oregon corporate excise
tax at a statutory rate of 6.6% (3.3% for the fiscal year ended September 30,
1996) of income. Neither the Company's nor the Association's state income tax
returns have been audited during the past five years.

Competition

The Association originates most of its loans to and accepts most of its
deposits from residents of Klamath, Jackson and Deschutes counties. The
Association is the oldest financial institution headquartered in Klamath Falls.
The Association believes that it is a major competitor in the markets in which
it operates. Nonetheless, the Association faces competition in attracting
deposits and making real estate loans from various financial institutions,
including banks, savings associations and mortgage brokers. In addition, the
Association has faced additional significant competition for investors' funds
from short-term money market securities and other corporate and government
securities. The financial institution industry in the Association's market area
is characterized by a mix of local independent financial institutions and
offices of larger out-of-state financial institutions, including several
multi-national bank holding companies. The ability of the Association to attract
and retain savings deposits depends on its ability to generally provide a rate
of return and liquidity risk comparable to that offered by competing investment
opportunities. The Association competes for loans principally through the
interest rates and loan fees it charges and the efficiency and quality of
services it provides borrowers. Competition may increase as restrictions on the
interstate operations of financial institutions continue to be reduced.

Personnel

As of September 30, 1997, the Association had 183 full-time and 72
part-time employees. The employees are not represented by a collective
bargaining unit. The Association believes its relationship with its employees is
good.

33

Executive Officers. The following table sets forth certain information
regarding the executive officers of the Company.

Name Age(1) Position
- ---- ------ --------

Gerald V. Brown .............. 61 President and Chief Executive Officer

Robert A. Tucker ............. 49 Senior Vice President and Chief Operating Officer

George L. Hall ............... 46 Senior Vice President and Chief Lending Officer/Secretary

Marshall J. Alexander ........ 47 Vice President and Chief Financial Officer

______________
(1) At September 30, 1997.

Gerald V. Brown has been employed by the Association since 1957. He was
appointed a director and the President of the Association in June 1994 to
succeed the retiring President, James Bocchi. From 1982 until his appointment as
President, Mr. Brown served as Senior Vice President and Secretary, supervising
all loan activities of the Association.

Robert A. Tucker has been employed by the Association since 1973. He has
served as Senior Vice President since November 1989. He has served as Chief
Operating Officer since March 1997.

George L. Hall has been employed by the Association since 1988. He has
served as Senior Vice President and Secretary since June 1994.

Marshall J. Alexander has been employed by the Association since 1986. He
has served as Vice President and Chief Financial Officer since August 1994.

34

Item 2. Properties

The following table sets forth the location of the Association's offices
and other facilities used in operations as well as certain additional
information relating to these offices and facilities as of September 30, 1997.

Year Square
Description/Address Opened Leased/Owned Footage
- ------------------- ------ ------------ -------
Main Office

540 Main Street .............................. 1939 Owned 25,660
Klamath Falls, Oregon

Branch Offices

2943 South Sixth Street ...................... 1972 Owned 3,820
Klamath Falls, Oregon

2323 Dahlia Street ........................... 1979 Owned 1,876
Klamath Falls, Oregon

512 Walker Avenue ............................ 1977 Owned 4,216
Ashland, Oregon

1420 East McAndrews Road ..................... 1990 Owned 4,006
Medford, Oregon

61515 S. Highway 97 .......................... 1993 Owned 5,415
Bend, Oregon

2300 Madison Street .......................... 1995 Owned 5,000
Klamath Falls, Oregon

721 Chetco Avenue ............................ 1997 Owned 5,409
Brookings, Oregon

293 North Broadway ........................... 1997 Owned 5,087
Burns, Oregon

111 West Main Street ......................... 1997 Owned 1,958
Carlton, Oregon

103 South Main Street ........................ 1997 Owned 2,235
Condon, Oregon

259 North Adams .............................. 1997 Owned 5,803
Coquille, Oregon

106 Southwest 1st Street ..................... 1997 Owned 4,700
Enterprise, Oregon

555 1st Street ............................... 1997 Owned 1,844
Fossil, Oregon

35

Year Square
Description/Address Opened Leased/Owned Footage
- ------------------- ------ ------------ -------

708 Garibaldi Avenue ......................... 1997 Owned 1,400
Garibaldi, Oregon

29804 Ellensburg Avenue ...................... 1997 Owned 3,136
Gold Beach, Oregon

111 North Main Street ........................ 1997 Owned 4,586
Heppner, Oregon

810 South Highway 395 ........................ 1997 Leased 6,000
Hermiston, Oregon

200 West Main Street ......................... 1997 Owned 4,552
John Day, Oregon

1 South E Street ............................. 1997 Owned 5,714
Lakeview, Oregon

206 East Front Street ........................ 1997 Owned 2,920
Merrill, Oregon

165 North 5th Street ......................... 1997 Owned 2,370
Monroe, Oregon

217 Main Street .............................. 1997 Owned 6,067
Nyssa, Oregon

48257 East 1st Street ........................ 1997 Owned 3,290
Oakridge, Oregon

227 West Main Street ......................... 1997 Owned 2,182
Pilot Rock, Oregon

716 Northeast Highway 101 .................... 1997 Owned 2,337
Port Orford, Oregon

178 Northwest Front Street ................... 1997 Owned 2,353
Prairie City, Oregon

315 North Main Street ........................ 1997 Owned 3,638
Riddle, Oregon

38770 North Main Street ...................... 1997 Owned 2,997
Scio, Oregon

508 Main Street .............................. 1997 Owned 2,282
Moro, Oregon

144 South Main Street ........................ 1997 Owned 2,146
Union, Oregon

36

Year Square
Description/Address Opened Leased/Owned Footage
- ------------------- ------ ------------ -------

165 North Maple Street ....................... 1997 Owned 2,192
Yamhill, Oregon

Loan Center

585 SW 6th, Suite #2 ......................... 1996 Leased 900
Redmond, Oregon

The net book value of the Association's investment in office, properties
and equipment totaled $11.7 million at September 30, 1997. See Note 5 of the
Notes to the Consolidated Financial Statements in the Annual Report.

Data processing for the Company is provided by a third party service
bureau. Software purchased from a service bureau affiliate is used for
applications such as accounts payable and fixed assets. As with other
organizations, the data processing programs were originally designed to
recognize calendar years by their last two digits. Calculations performed using
these truncated fields will not work properly with dates beyond 1999. The
Company has established a committee to address "Year 2000" issues related to
data processing. The service bureau has stated that all their processing will be
Year 2000 compliant by the end of 1998, including the application software used
for fixed assets and accounts payable. All personal computers ("PCs") and
related software throughout the Company have been inventoried and non-compliant
PC's have been identified. As of September 30, 1997, approximately 90% of the
Company's PCs and software are Year 2000 compliant. The Company believes that
the Year 2000 problem will not pose significant operational problems and is not
anticipated to be material to its financial position or results of operations in
any given year.

Item 3. Legal Proceedings

Periodically, there have been various claims and lawsuits involving the
Association, mainly as a defendant, such as claims to enforce liens,
condemnation proceedings on properties in which the Association holds security
interests, claims involving the making and servicing of real property loans and
other issues incident to the Association's business. The Association is not a
party to any pending legal proceedings that it believes would have a material
adverse effect on the financial condition or operations of the Association.

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

No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 1997.

PART II

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

The information contained under the section captioned "Common Stock
Information" on page 16 of the Annual Report is incorporated herein by
reference.

Item 6. Selected Financial Data

The information contained under the section captioned "Selected
Consolidated Financial Data" on page 4 of the Annual Report is incorporated
herein by reference.

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations

The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" beginning on page
8 of the Annual Report is incorporated herein by reference.

37

Item 7a. Quantitative and Qualitative Disclosures About Market Risk

The Company's financial performance is impacted by, among other factors,
interest rate risk and credit risk. The Company utilizes no derivatives to
mitigate its credit risk, relying instead on strict underwriting standards, loan
review, and an adequate loan loss reserve. See "--Management's Discussion and
Analysis of Financial Condition and Results of Operations."

Interest rate risk is the risk of loss in value due to changes in interest
rates. This risk is addressed by the Company's Asset Liability Management
Committee ("ALCO"), which includes senior management representatives. The ALCO
monitors and considers methods of managing interest rate risk by monitoring
changes in net portfolio value ("NPV") and net interest income under various
interest rate scenarios. The ALCO attempts to manage the various components of
the Company's balance sheet to minimize the impact of sudden and sustained
changes in interest rates on NPV and net interest income.

The Company's exposure to interest rate risk is reviewed on at least a
quarterly basis by the Board of Directors and the ALCO. Interest rate risk
exposure is measured using interest rate sensitivity analysis to determine the
Company's change in NPV in the event of hypothetical changes in interest rates.
If potential changes to NPV and net interest income resulting from hypothetical
interest rate swings are not within the limits established by the Board, the
Board may direct management to adjust its asset and liability mix to bring
interest rate risk within Board-approved limits.

In order to reduce the exposure to interest rate fluctuations, the Company
has developed strategies to manage its liquidity, shorten the effective
maturities of certain interest-earning assets, and increase the effective
maturities of certain interest-bearing liabilities. First, the Company has put
greater emphasis on ARMs for residential lending, which generally reprice in one
year. This strategy includes purchasing high quality adjustable rate loans real
estate loans for the portfolio. Second, the Company has focused its
non-residential lending on adjustable or floating rate and/or short-term loans.
Third, the Company has focused its investment activities on short- and
medium-term securities. Fourth, the Company has attempted to maintain and
increase its regular savings and transaction deposit accounts, which are
considered to be relatively resistant to changes in interest rates. The branch
acquisition and new deposit product offerings provided significant progress on
this aspect of interest rate risk management. Fifth, the Company has utilized
long-term borrowings and deposit marketing programs to adjust the term to
repricing of its liabilities.

Interest rate sensitivity analysis is used to measure the Company's
interest rate risk by computing estimated changes in NPV of its cash flows from
assets and liabilities in the event of a range of assumed changes in market
interest rates. NPV represents the market value of portfolio equity and is equal
to the market value of assets minus the market value of liabilities. This
analysis assesses the risk of loss in market rate sensitive instruments in the
event of sudden and sustained increases and decreases in market interest rates
ranging from one hundred to four hundred basis points. The Company's Board of
Directors has adopted an interest rate risk policy which establishes maximum
decreases in the NPV ranging from 10% to 95% in the event of sudden and
sustained increases and decreases in market interest rates. The following tables
present the Association's projected change in NPV and net interest income for
the various rate shock levels as of September 30, 1997 and the Board's
established limitations relating thereto. NPV values and impact on net interest
income for the Association only are regularly calculated by the OTS and
internally per regulatory recommendations. The assets and liabilities at the
parent company level are not considered in the analysis. The exclusion of
holding company assets and liabilities does not have a significant effect on the
analysis of NPV sensitivity. All market rate sensitive instruments presented in
these tables are classified as either held to maturity or available for sale.
The Association has no trading securities.

38

CHANGES IN NET PORTFOLIO VALUE

Change in Market Value of Actual Percent Change Board
Interest Rates Portfolio Equity Change Actual Limit
- -------------- ---------------- ------------ -------------- -----

400 basis point rise ......... $ 41,406,000 $(78,660,000) (65.5%) (95%)
300 basis point rise ......... 62,156,000 (57,909,000) (48.2%) (75%)
200 basis point rise ......... 82,490,000 (37,576,000) (31.3%) (45%)
100 basis point rise ......... 102,883,000 (17,183,000) (14.3%) (25%)
Base Rate Scenario ........... 120,066,000 -- -- --
100 basis point decline ...... 127,433,000 7,368,000 6.1% (10%)
200 basis point decline ...... 127,243,000 7,177,000 6.0% (10%)
300 basis point decline ...... 129,062,000 8,996,000 7.5% (10%)
400 basis point decline ...... 132,813,000 12,747,000 10.6% (10%)

CHANGES IN NET INTEREST INCOME

Change in Net Interest Actual Percent Change Board
Interest Rates Income Change Actual Limit
- -------------- ------------ ------------ -------------- -----

400 basis point rise ......... $ 18,967,000 $ (8,403,000) (30.7%) (35%)
300 basis point rise ......... 21,272,000 (6,098,000) (22.3%) (25%)
200 basis point rise ......... 23,518,000 (3,852,000) (14.1%) (15%)
100 basis point rise ......... 25,609,000 (1,761,000) (6.4%) (10%)
Base Rate Scenario ........... 27,370,000 -- -- --
100 basis point decline ...... 28,428,000 1,058,000 3.9% (10%)
200 basis point decline ...... 28,925,000 1,556,000 5.7% (10%)
300 basis point decline ...... 29,605,000 2,235,000 8.2% (10%)
400 basis point decline ...... 30,294,000 2,924,000 10.7% (10%)

The preceding table indicates that at September 30, 1997, in the event of a
sudden and sustained increase in prevailing market interest rates, the
Association's NPV and net interest income would be expected to decrease. At
September 30, 1997, the Association's estimated changes in NPV were within the
targets established by the Board of Directors.

NPV is calculated based on the net present value of estimated cash flows
utilizing market prepayment assumptions and market rates of interest provided by
independent broker quotations and other public sources.

Computation of forecasted effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan prepayments, and deposit decay, and should not be relied upon as
indicative of actual future results. Further, the computations do not
contemplate any actions the ALCO could undertake in response to changes in
interest rates.

Certain shortcomings are inherent in the method of analysis presented in
the computation of NPV. Actual values may differ from those projections
presented, should market conditions vary from assumptions used in the
calculation of NPV. Certain assets, such as adjustable rate loans, have features
which restrict changes in interest rates on a short-term basis and over the life
of the assets. In addition, the proportion of adjustable rate loans in the
Association's portfolio could decrease in future periods if market interest
rates remain at or decrease below current levels due to refinance activity.
Further, in the event of a change in interest rates, prepayment and early
withdrawal levels would likely deviate significantly from those assumed in the
NPV. Finally, the ability of many borrowers to repay their adjustable rate
mortgage loans may decrease in the event of interest rate increases.

39

Item 8. Financial Statements and Supplementary Data

(a) Financial Statements Independent Auditors' Reports* Consolidated
Balance Sheets as of September 30, 1997 and 1996* Consolidated
Statements of Earnings for the Years Ended September 30, 1997, 1996
and 1995* Consolidated Statements of Shareholders' Equity for the
Years Ended September 30, 1997, 1996 and 1995* Consolidated Statements
of Cash Flows for the Years Ended September 30, 1997, 1996 and 1995*
Notes to the Consolidated Financial Statements*

* Included in the Annual Report attached as Exhibit 13 hereto and
incorporated herein by reference. All schedules have been omitted as the
required information is either inapplicable or included in the Consolidated
Financial Statements or related Notes contained in the Annual Report.

(b) Supplementary Data

The information contained in Note 19 to the Consolidated Financial
Statements included in the Annual Report is incorporated herein by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

There have been no changes in or disagreements with Accountants on
accounting and financial disclosure during the year ended September 30, 1997.

PART III

Item 10. Directors and Executive Officers of the Registrant

The information contained under the section captioned "Proposal I -
Election of Directors" contained in the Company's Proxy Statement, and "Part I
- -- Business -- Personnel -- Executive Officers" of this report, is incorporated
herein by reference. Reference is made to the cover page of this report for
information regarding compliance with Section 16(a) of the Exchange Act.

Item 11. Executive Compensation

The information contained under the sections captioned "Executive
Compensation", "Directors' Compensation" and "Benefits" under "Proposal I -
Election of Directors" in the Proxy Statement is incorporated herein by
reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management

(a) Security Ownership of Certain Beneficial Owners

Information required by this item is incorporated herein by reference to
the section captioned "Security Ownership of Certain Beneficial Owners and
Management" of the Proxy Statement

(b) Security Ownership of Management

40

The information required by this item is incorporated herein by
reference to the sections captioned "Proposal I - Election of
Directors" and "Security Ownership of Certain Beneficial owners and
Management" of the Proxy Statement.

(c) Changes in Control

The Company is not aware of any arrangements, including any pledge by
any person of securities of the Company, the operation of which may at
a subsequent date result in a change in control of the Company.

The information required by this item is incorporated herein by reference
to the sections captioned "Proposal I - Election of Directors" and "Security
Ownership of Certain Beneficial Owners and Management" of the Proxy Statement.

Item 13. Certain Relationships and Related Transactions

The information set forth under the section captioned "Proposal I -
Election of Directors - Certain Transactions with the Association" in the Proxy
Statement is incorporated herein by reference.

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) Exhibits

3(a) Articles of Incorporation of the Registrant*
3(b) Bylaws of the Registrant*
10(a) Employment Agreement with Gerald V. Brown***
10(b) Employment Agreement with Marshall J. Alexander***
10(c) Employment Agreement with George L. Hall***
10(d) Employment Agreement with Robert A. Tucker***
10(e) 1996 Stock Option Plan**
10(f) 1996 Management Recognition and Development Plan**
13 Annual Report to Shareholders
21 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP with respect to financial
statements of the Registrant
23.2 Consent of KPMG Peat Marwick with respect to financial
statements of the Registrant
27 Financial Data Schedule
___________________
* Incorporated by reference to the Registrant's Registration Statement on
Form S-1, filed on June 19, 1995.
** Incorporated by reference to the Registrant's Definitive Proxy Statement
for the 1996 Annual Meeting of Shareholders.
*** Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 1995.

(b) Reports on Form 8-K

Reference is made to the Company's Current Report on Form 8-K dated August
1, 1997, as amended on September 29 ,1997, which are incorporated herein by
reference:

41

SIGNATURES

Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

KLAMATH FIRST BANCORP, INC.

Date: December 29, 1997 By: /s/ Gerald V. Brown
Gerald V. Brown
President and Chief Executive Officer

Pursuant to the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.

SIGNATURES TITLE DATE

/s/ Gerald V. Brown President, Chief December 29, 1997
Gerald V. Brown Executive Officer and
Director (Principal
Executive Officer)

/s/ Marshall J. Alexander Vice President and December 29, 1997
Marshall J. Alexander Chief Financial Officer
(Principal Financial
and Accounting Officer)

/s/ Rodney N. Murray Chairman of the Board December 29, 1997
Rodney N. Murray of Directors

/s/ Bernard Z. Agrons Director December 29, 1997
Bernard Z. Agrons

/s/ Timothy A. Bailey Director December 29, 1997
Timothy A. Bailey

/s/ James D. Bocchi Director December 29, 1997
James D. Bocchi

/s/ William C. Dalton Director December 29, 1997
William C. Dalton

/s/ J. Gillis Hannigan Director December 29, 1997
J. Gillis Hannigan

/s/ Dianne E. Spires Director December 29, 1997
Dianne E. Spires

42