S-1/A 1 v31640a1sv1za.htm AMENDMENT TO FORM S-1 sv1za
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As filed with the Securities and Exchange Commission on September 7, 2007
Registration No. 333-144664
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Pre-Effective Amendment No. 1
Form S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
Venture Financial Group, Inc.
(Exact name of registrant as specified in its charter)
 
         
Washington   6022   91-1277503
(State or Other Jurisdiction
of Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (IRS Employer
Identification No.)
 
1495 Wilmington Dr., P.O. Box 970
DuPont,Washington 98327
(253) 441-4000
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
 
Ken F. Parsons, Sr.
Chief Executive Officer and Chairman of the Board
1495 Wilmington Dr., P.O. Box 970
DuPont,Washington 98327
(253) 441-4000
(Name, address, including zip code, and telephone number, including area code, of agent for service)
Copies of communications to:
     
Andrew H. Ognall, Esq. 
  Stephen M. Klein, Esq.
Foster Pepper LLP
  Graham & Dunn P.C.
601 SW Second Avenue, Suite 1800
  Pier 70, 2801 Alaskan Way, Suite 300
Portland, Oregon 97204
  Seattle, Washington 98121-1128
Telephone: (503) 221-0607
  Telephone: (206) 340-9648
Facsimile: (503) 221-1510
  Facsimile: (206) 340-9599
 
Approximate date of commencement of proposed sale to the public:  As soon as practicable after this Registration Statement becomes effective.
 
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box:  o
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
 


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The information contained in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.
 
SUBJECT TO COMPLETION, DATED SEPTEMBER 7, 2007
 
PRELIMINARY PROSPECTUS
 
           Shares
 
VENTURE
 
Common Stock
 
We are the bank holding company for Venture Bank, a Washington state-chartered bank with operations in the southern Puget Sound region. This is an initial public offering of 1,800,000 shares of our common stock. All of the offered shares will be purchased by the underwriters on a firm-commitment basis.
 
Prior to this offering there has been no public market for our common stock. We currently estimate that the initial public offering price will be between $21.00 and $23.00 per share. See “Underwriting” for a discussion of the factors considered in determining the initial public offering price. The market price of the shares after the offering may be higher or lower than the initial public offering price. We have applied to list our common stock on the Nasdaq Global® Market under the symbol “VNBK.”
 
Investing in our common stock involves risk. See “Risk Factors” beginning on page 9 to read about the factors you should consider before investing in our common stock.
 
                 
    Per Share     Total  
 
Initial public offering price
  $           $        
Underwriting discounts and commissions
  $       $    
Proceeds, before expenses, to us
  $       $  
 
We have granted the underwriters an option to purchase up to 270,000 additional shares of our common stock at the initial public offering price within 30 days following the date of this prospectus to cover over-allotments, if any.
 
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
 
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS OR DEPOSIT ACCOUNTS OR OTHER OBLIGATIONS OF ANY BANK SUBSIDIARY OF VENTURE FINANCIAL GROUP, INC., AND THEY ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENTAL AGENCY.
 
The underwriters expect that the shares of our common stock will be ready for delivery to purchasers on or about          , 2007.
 
Keefe, Bruyette & Woods, Inc.
D.A. Davidson & Co.
 
 
The date of this prospectus is          , 2007.


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 EXHIBIT 1.1
 EXHIBIT 4.1
 EXHIBIT 5.1
 EXHIBIT 21
 EXHIBIT 23.1
 
 
You should rely only on the information contained in this prospectus or in any related free writing prospectus filed with the Securities and Exchange Commission and used or referred to in this offering. We have not authorized anyone to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.
 
Information contained on our website is not part of this prospectus.
 
Until          , 2007, all dealers that buy, sell or trade our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as an underwriter and with respect to their unsold allotments or subscriptions.


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PROSPECTUS SUMMARY
 
This is only a summary and does not contain all of the information that you should consider before investing in our common stock. You should read the entire prospectus, including “Risk Factors” and our consolidated financial statements and related notes appearing elsewhere in this prospectus, before deciding to invest in our common stock.
 
Unless we indicate otherwise, the number of shares as well as all share, per share and financial information in this prospectus:
 
  •  assumes a public offering price of $22.00 per share, which is the mid-point of the range indicated on the front cover of this prospectus;
 
  •  does not give effect to the use of proceeds of the offering; and
 
  •  assumes that the underwriters do not exercise the over-allotment option to purchase any of the additional 270,000 shares of our common stock subject to that option.
 
Venture Financial Group, Inc.
 
We are the bank holding company for Venture Bank, a rapidly growing Washington state-chartered bank. We foster an entrepreneurial, innovative culture focused on creating (i) a positive environment for employees, (ii) a unique customer experience and (iii) superior results for our shareholders. At June 30, 2007 we had total assets of $1.1 billion, net loans of $738.0 million, total deposits of $838.5 million and shareholders’ equity of $84.8 million. Based on information as of June 30, 2007, upon completion of this offering we will be one of the top five publicly-traded commercial banks headquartered in the Puget Sound region as measured by total assets.
 
We operate 18 full-service financial centers located primarily along the Interstate 5 corridor in the Puget Sound region of western Washington. We were established in 1979 and have grown through a combination of de novo branching and acquisitions. Since 1993, we have completed the following acquisitions:
 
  •  Citizens First Bank (1993);
 
  •  Northwest Community Bank (1995);
 
  •  Prairie Security Bank (1997);
 
  •  Wells Fargo Bank — Four Financial Centers (1997);
 
  •  Harbor Bank, N.A. (2002); and
 
  •  Redmond National Bank (2005).
 
In 2003, we unveiled a new brand under the Venture Bank name as part of our strategy to position us for future growth in our key target markets. The Venture Bank brand is embodied in every aspect of our business, from our advertising to the design of our financial centers to our employee training. We emphasize a relationship-building style of banking through our focus on developing a culture of empowered and well-trained employees.
 
Our business model has produced strong growth and consistent profitability. From December 31, 2002 to June 30, 2007 we have more than doubled our size by increasing:
 
  •  Total assets from $474.5 million to $1.1 billion;
 
  •  Total net loans from $361.6 million to $738.0 million;
 
  •  Total deposits from $384.2 million to $838.5 million; and
 
  •  Trailing twelve months diluted earnings per share from $0.93 to $1.73.


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Our Market Area
 
We operate in diverse, vibrant communities that enjoy a growing population base and strong economic activity. Our market areas are in Thurston, Pierce, King and Lewis Counties and include:
 
  •  Washington’s State Capitol, Olympia;
 
  •  Washington’s third largest city, Tacoma; and
 
  •  Suburban communities east of Washington’s largest city, Seattle.
 
Washington State has a population of 6.4 million, 2.9 million of whom are located in the counties we currently serve. As of July 2007, the unemployment rate in the State of Washington was at an historically low rate, 4.9%, with more than 89,100 jobs being added over the past year, and the unemployment rate in our market areas was 4.2%. Over the past few years, the Puget Sound region has experienced vibrant economic activity and has developed a diversified economy driven by real estate, technology, aerospace, international trade, medical and manufacturing industries and by a significant government and military presence.
 
According to publicly available FDIC data, bank and thrift deposits in our current markets have grown at a compound annual growth rate of 9.8% since 2002, from $40.7 billion at June 30, 2002 to $59.1 billion at June 30, 2006. The median household income of our markets for 2006 was $63,324, which outpaced both the national and state median household income of $46,326 and $56,473, respectively.
 
Our Business
 
We focus on meeting the commercial banking needs associated with the continued population and economic growth of the greater Puget Sound region. Our customers are businesses that generally have up to $15 million in annual revenues and require highly personalized commercial banking products and services. We also serve retail customers in our communities with traditional consumer banking products. We believe our customers prefer locally managed banks that provide responsive, personalized service and customized products. We emphasize a sales and service culture that offers our customers direct access to decision-makers empowered to provide timely solutions to their financial needs. A substantial portion of our business is with customers who have long-standing relationships with our officers or directors or who have been referred to us by existing customers.
 
Construction and commercial real estate lending are the primary focus of our lending activities. At June 30, 2007, our loan portfolio consisted of:
 
  •  46.2% construction loans;
 
  •  36.1% commercial real estate loans;
 
  •  11.7% commercial and industrial loans;
 
  •  4.6% residential real estate loans;
 
  •  0.8% consumer loans; and
 
  •  0.6% loans held for sale.
 
Our loan portfolio is diversified by property type, geographic market, a wide-ranging customer base, and loan purpose. While real estate lending continues to be a large part of our business, we see significant opportunities in growing our commercial and industrial, or C&I, business.
 
On the deposit side, we continue to seek to establish core deposit relationships. We emphasize growing lower cost deposits by offering a wide array of commercial banking products and developing strong personal relationships that allow us to meet all the needs of our commercial customers. For our retail deposit customers, we offer competitive retail banking products and differentiate ourselves from our competitors with a warm, friendly hometown atmosphere at our financial centers including Internet workstations, fresh coffee and home-made cookies.


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We also originate residential mortgage loans for resale through our mortgage banking team and offer a variety of investment services and products through Venture Wealth Management, a wholly owned subsidiary of Venture Bank.
 
Our corporate headquarters is located at 1495 Wilmington Drive, DuPont, Washington 98327, and our telephone number is (253) 441-4000. Venture Bank is chartered by the State of Washington at 721 College Street SE, Lacey, Washington 98503. We maintain a website at www.venture-bank.com.
 
Our Strategy
 
We strive to be a high performing community bank with a focus on profitable growth for the long-term benefit of our shareholders, customers and employees. Our culture distinguishes us from our competition. The key elements of our strategy, including our distinctive culture, are:
 
  •  Expand our franchise through additional acquisitions or the opening of new financial centers in attractive markets. We have completed six acquisitions since 1993, most recently acquiring Redmond National Bank in 2005. We will continue to look for accretive acquisitions that will expand our franchise. We also intend to continue to grow through de novo branching opportunities, having opened two new financial centers in 2007.
 
  •  Continue to develop new products and services to grow our core customer relationships by offering competitive products for both commercial and retail customers. We provide our commercial lending customers a full range of products to support working capital or to finance equipment, real estate, construction, or land acquisition. We offer leading-edge products such as remote deposit capture, online cash management and bill pay. We also seek to provide our retail customers with a full complement of value-added products with high levels of service. We pride ourselves on continually seeking new, innovative products that enhance our relationships with our existing customers, and make us attractive to new customers.
 
  •  Maintain strong credit quality by knowing our customers and our markets, and focusing on underwriting and risk controls. We believe our strong asset quality is the result of a stable Puget Sound area economy, prudent underwriting standards, experienced commercial lenders and diligent monitoring of our loan portfolio. At June 30, 2007, our nonperforming assets were 0.07% of our total assets.
 
  •  Continue to actively manage our balance sheet to support both earnings and asset growth by focusing on our capital, funding sources, and investments in both loans and securities. We concentrate on efficient capital utilization while remaining well-capitalized under federal banking regulations.
 
  •  Continue to actively manage interest rate and market risks by closely monitoring and managing the volume, cash flow, pricing, and market price aspects of both our interest rate sensitive assets and our interest rate sensitive liabilities. We focus on this in order to mitigate adverse net income effects of rapid changes in interest rates on either side of our balance sheet.
 
  •  Hire, train and retain experienced and qualified employees to support our planned expansion and growth strategies. We carefully select the right people to join the Venture Bank team — people who are technically qualified and fit our unique culture and style. We seek to attract and retain relationship-oriented and experienced employees who want to participate in a high-achieving, growth-oriented community bank. We believe that our emphasis on culture and professional training results in low turnover and the successful development and advancement of our employees.
 
  •  Foster a culture that produces superior quality service to our customers with empowered employees. The Venture Bank experience is best demonstrated when a customer interacts with employees who are trained and empowered to provide a memorable banking experience. Every employee starts with a two-day training program that immerses the employee in our culture, brand, values, and philosophies. We reinforce that training through our “Venture Bank University,” which provides all of our employees an ongoing curriculum for career growth with customized training to develop quality sales and service relationships with our customers. Venture Bank University includes required courses on culture, sales,


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  service, technical skills, management, coaching and product knowledge for employees at all levels including our senior and executive management teams.
 
  •  Build on our strong brand of Identity, Place, and Culture. In May 2003, we enhanced awareness of our company and positioned ourselves for growth through a significant rebranding effort. The key elements of our brand are our Identity, Place, and Culture. Our visual “Identity” is portrayed by our logo, image art and merchandising that reflect our Pacific Northwest roots and our independent, innovative and entrepreneurial nature. Our “Place” is how we reach our customers and is illustrated by the design of our state-of-the-art financial centers and other channels of delivery. The final component of our brand is our “Culture” that brings all this together through empowered employees who are committed to our values, our approach to service and our community participation. We continue to build our brand around the phrase “As Independent as You.” We believe that our customers associate our brand with our culture of superior, personalized products and services.
 
Our Employees and Management Team
 
We are led by an experienced and local Board of Directors and a dedicated executive management team. We also have a talented, motivated management team at the next level that is active in the decision making process at Venture Bank. The Board and our management team have a proven record of working together during challenging times, whether completing acquisitions, managing growth, or responding to changes in the regulatory environment and changes in the management team itself.
 
Our Chairman and Chief Executive Officer Ken Parsons, a founding Director of Venture Bank and our largest single shareholder, has served as CEO since 1990. James “Jim” Arneson returned to Venture Bank in September 2005 when we acquired Redmond National Bank where he held the role of President and CEO. Jim Arneson has served as our President and as President and Chief Executive Officer of Venture Bank since his return and has successfully transitioned into responsibilities previously managed by Mr. Parsons, which has allowed Mr. Parsons to focus on strategic oversight. Mr. Parsons will remain as our Chairman and CEO through 2010.
 
Our experienced executive management team consists of the following individuals:
 
  •  Ken F. Parsons, Sr., a founder of Venture Bank in 1979, serves as our Chairman and Chief Executive Officer. He has served as our CEO since 1990 and served as President from 1990 to 2005, when Mr. Arneson returned to the Company as President. From 1981 to 1990, Mr. Parsons was the first President of a national telecommunications company. Mr. Parsons holds leadership positions with the Washington Independent Community Bankers Association and the Independent Community Bankers of America.
 
  •  James F. Arneson, is President and Chief Executive Officer of Venture Bank, and President of the Company. He returned to the Company in September 2005, when we acquired Redmond National Bank where he served as President and Chief Executive Officer. During his first tenure at Venture Bank, Mr. Arneson served as Executive Vice President/Chief Financial Officer for 10 years, while being mentored to become President, and was instrumental in helping create and execute our strategic plan. Mr. Arneson’s background includes seven years as a CPA for a major accounting firm in the State of Washington that specialized in financial institutions.
 
  •  Sandra L. Sager, CPA, Executive Vice President and Chief Financial Officer, joined us in late 2005. In 2005, Ms. Sager was Senior Vice President and Chief Financial Officer of Columbia Trust Bank. From 2002 to 2004, Ms. Sager served as President and Chief Executive Officer of North Cascades Bancshares and North Cascades National Bank, served as its Chief Financial Officer from 1988 through 2001, and was a founding employee in 1986. Ms. Sager was a director of North Cascades Bancshares, Inc., from 1992 to 2004. Ms. Sager has over 23 years in banking, with initial experience from 1983 to 1986 as a bank examiner with the FDIC.


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  •  Bruce H. Marley, Executive Vice President and Chief Lending Officer, has been with us in that role since 2003, having joined us in 2002 as Senior Vice President and Credit Administrator. In addition to his 33 years in banking, Mr. Marley served as Treasurer for Labor Ready from 2000 to 2002.
 
  •  Patricia A. Graves, Executive Vice President/Retail Banking, a role she has held since 2003, joined us in 1993. Previously, Ms. Graves was Senior Vice President of Operations. In her 26 years in banking, Ms. Graves has held numerous operational positions within the banking industry.
 
  •  Catherine J. Mosby, Senior Vice President/Human Resources, joined us in 2002 with our acquisition of Harbor Bank, where she was Chief Financial Officer. Ms. Mosby has over 25 years of banking experience and has held various positions within the banking industry.
 
  •  Joseph P. Beaulieu, Senior Vice President/Marketing, has served us since 1994. Prior to joining us, Mr. Beaulieu was President of the Thurston County Chamber of Commerce, and is a Certified Financial Marketing Professional (by the American Bankers Association Institute of Certified Bankers) in the State of Washington.


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The Offering
 
 
Common stock offered by Venture Financial Group, Inc 1,800,000 Shares
 
Common stock to be outstanding immediately after the offering 8,997,226 Shares(1)
 
Use of Proceeds We estimate that our net proceeds from this offering will be approximately $36.2 million, or $41.8 million if the over-allotment option is exercised by the underwriters, based on an assumed price of $22.00 per share (which is the mid-point of the range indicated on the front of this prospectus).
 
We expect to use the net proceeds we will receive from this offering for expansion through acquisition and de novo branching, to reduce existing junior subordinated debt and for general corporate purposes. Our use of proceeds is more fully described under “Use Of Proceeds.”
 
Dividend Policy We have historically paid a quarterly cash dividend. In 2007, we paid quarterly cash dividends of $0.08 per share, on February 8 and May 11, and of $0.085 per share on August 10. We intend to continue paying cash dividends, but our payment of dividends in the future will depend on a number of factors. We cannot assure you that we will continue to pay dividends or that the amount of dividends we pay will remain the same in the future.
 
Proposed Nasdaq Global® Market Symbol We have applied to have our common stock listed for quotation on the Nasdaq Global® Market under the symbol “VNBK.”
 
 
(1) The number of shares of our common stock outstanding after this offering is based on the number of shares outstanding on June 30, 2007 and excludes 234,558 shares of common stock issuable upon the exercise of vested stock options at the date hereof.
 
Risk Factors
 
See “Risk Factors” beginning on page 9 for a description of material risks related to an investment in our common stock.


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Summary Consolidated Financial Information
 
You should read the summary consolidated financial data set forth below in conjunction with our historical consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this prospectus. The summary consolidated statement of income data for the years ended December 31, 2006, 2005 and 2004 and the summary consolidated balance sheet data as of December 31, 2006 and 2005 have been derived from our audited financial statements included elsewhere in this prospectus. The summary consolidated statement of income data for the years ended December 31, 2003 and 2002 and the summary consolidated balance sheet data as of December 31, 2004, 2003 and 2002 have been derived from our audited financial statements that are not included in this prospectus.
 
The summary consolidated financial data as of and for the six-month periods ended June 30, 2007 and 2006 is derived from our unaudited condensed consolidated financial statements, which are included elsewhere in this prospectus. The unaudited condensed consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and include all adjustments (consisting only of normal recurring accruals) that we consider necessary for a fair presentation of our financial position and operating results for such periods. Historical results are not necessarily indicative of future results and results for the six -month period ended June 30, 2007 are not necessarily indicative of our expected results for the full year ending December 31, 2007.
 
                                                         
    Six Months Ended
                               
    June 30,     Years Ended December 31,  
    2007     2006     2006     2005     2004     2003     2002  
    (Dollars in thousands)  
 
Consolidated Income Data:
                                                       
Interest income
  $ 38,138     $ 28,449     $ 64,671     $ 41,379     $ 31,828     $ 31,356     $ 29,974  
Interest expense
    18,837       12,164       28,855       12,932       6,694       6,166       6,552  
                                                         
Net interest income
    19,301       16,285       35,816       28,447       25,134       25,190       23,422  
Provision for credit losses
    750       300       1,075       753       227       2,329       2,343  
                                                         
Net interest income after provision for credit losses
    18,551       15,985       34,741       27,694       24,907       22,861       21,079  
Non-interest income
    4,830       4,250       8,666       8,210       13,569       12,560       7,865  
Non-interest expense
    14,307       12,652       26,668       22,800       21,078       22,192       20,073  
                                                         
Income before provision for income taxes
    9,074       7,583       16,739       13,104       17,398       13,229       8,871  
Provision for income taxes
    2,710       2,640       5,670       4,076       5,621       4,173       2,659  
                                                         
Net income
  $ 6,364     $ 4,943     $ 11,069     $ 9,028     $ 11,777     $ 9,056     $ 6,212  
                                                         
Share Data:
                                                       
Earnings per common share (basic)
  $ 0.89     $ 0.69     $ 1.54     $ 1.33     $ 1.82     $ 1.38     $ 0.95  
Earnings per common share (diluted)
  $ 0.88     $ 0.67     $ 1.52     $ 1.30     $ 1.77     $ 1.32     $ 0.93  
Dividends declared per common share
    0.160       0.140       0.290       0.275       0.207       0.160       0.132  
Dividends paid — in thousands
    1,148       1,016       2,092       1,855       1,325       1,048       878  
Dividend payout ratio
    18.0 %     20.6 %     18.9 %     20.5 %     11.3 %     11.6 %     14.1 %
Book value per common share
  $ 11.78     $ 10.67     $ 11.83     $ 10.55     $ 8.86     $ 7.52     $ 6.72  
Tangible book value per common share
  $ 8.20     $ 7.06     $ 8.26     $ 6.88     $ 7.41     $ 5.73     $ 4.94  
Weighted average shares outstanding (basic)
    7,150,777       7,203,233       7,172,290       6,768,229       6,487,613       6,560,403       6,569,865  
Weighted average shares outstanding (diluted)
    7,271,854       7,324,506       7,295,569       6,930,533       6,652,139       6,855,342       6,697,355  
Total number of shares outstanding at period end
    7,197,226       7,194,047       7,186,349       7,218,152       6,527,507       6,474,244       6,583,854  
 


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    As of and for the
                               
    Six Months Ended
                               
    June 30,     Years Ended December 31,  
    2007     2006     2006     2005     2004     2003     2002  
    (Dollars in thousands)  
 
Selected Consolidated Balance Sheet Data:
                                                       
Cash and cash equivalents
  $ 19,335     $ 34,495     $ 24,544     $ 24,329     $ 13,861     $ 24,791     $ 38,041  
Investment securities
  $ 236,560     $ 145,154     $ 162,447     $ 60,911     $ 73,291     $ 85,383     $ 34,127  
Gross loans(1)
  $ 747,043     $ 665,583     $ 716,095     $ 602,335     $ 432,641     $ 367,631     $ 369,564  
Allowance for credit losses
  $ (9,067 )   $ (8,110 )   $ (8,917 )   $ (8,434 )   $ (7,189 )   $ (7,589 )   $ (7,947 )
Goodwill and other intangible assets
  $ 25,737     $ 26,010     $ 25,874     $ 26,508     $ 9,487     $ 11,597     $ 11,708  
Total assets
  $ 1,084,032     $ 917,269     $ 978,108     $ 752,793     $ 556,216     $ 513,900     $ 474,450  
Total deposits
  $ 838,505     $ 711,703     $ 771,250     $ 514,028     $ 326,721     $ 382,223     $ 384,207  
Junior subordinated debentures(2)
  $ 22,829     $ 22,682     $ 22,682     $ 22,682     $ 19,589     $ 19,000     $ 13,000  
Long term debt
  $     $ 30,000     $ 20,000     $ 30,000     $ 15,000     $ 23,000     $ 11,000  
Total shareholders’ equity
  $ 84,765     $ 76,776     $ 85,232     $ 76,154     $ 57,840     $ 48,673     $ 44,209  
Selected Financial Ratios:
                                                       
Return on average shareholders’ equity(3)
    14.82 %     12.82 %     14.05 %     14.87 %     22.99 %     19.55 %     15.13 %
Return on average assets(3)
    1.24 %     1.21 %     1.25 %     1.46 %     2.23 %     1.88 %     1.56 %
Net interest margin(3)
    4.14 %     4.41 %     4.44 %     4.93 %     5.28 %     5.91 %     6.84 %
Efficiency ratio
    58.85 %     61.01 %     59.22 %     61.87 %     54.18 %     58.45 %     63.66 %
Capital Ratios:
                                                       
Average shareholders’ equity to average assets
    8.35 %     9.41 %     8.87 %     9.82 %     9.70 %     9.60 %     10.28 %
Tangible equity to tangible assets
    5.58 %     5.70 %     6.23 %     6.84 %     8.84 %     7.38 %     7.02 %
Leverage capital ratio
    8.52 %     9.59 %     9.44 %     12.01 %     12.94 %     10.70 %     11.60 %
Tier 1 risk-based capital ratio
    9.28 %     9.52 %     10.27 %     9.37 %     12.24 %     11.20 %     10.23 %
Total risk-based capital ratio
    10.27 %     10.53 %     11.39 %     10.46 %     13.49 %     13.04 %     11.49 %
Selected Asset Quality Ratios:
                                                       
Non-performing loans to total loans
    0.09 %     0.32 %     0.10 %     0.37 %     1.18 %     0.60 %     2.16 %
Non-performing loans to total loans and foreclosed real estate
    0.09 %     0.32 %     0.10 %     0.37 %     1.17 %     0.60 %     2.09 %
Non-performing assets to total assets
    0.07 %     0.28 %     0.07 %     0.36 %     1.05 %     0.82 %     2.69 %
Allowance for credit losses to total loans
    1.22 %     1.23 %     1.25 %     1.41 %     1.66 %     2.06 %     2.20 %
Allowance for credit losses to non-peforming loans
    1345 %     384 %     1290 %     379 %     141 %     344 %     102 %
Allowance for credit losses to non-performing assets
    1222 %     313 %     1230 %     312 %     124 %     180 %     62 %
Net charge-offs (recoveries) to average loans
    0.08 %     0.10 %     0.09 %     0.13 %     0.16 %     0.74 %     0.75 %
 
 
(1) Includes loans held for sale
 
(2) At fair value for the six months ended June 30, 2007
 
(3) Annualized for the six month periods ended June 30, 2007 and 2006

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RISK FACTORS
 
An investment in our common stock involves a high degree of risk. The material risks and uncertainties described below may affect our market, business and the value of the shares offered through this prospectus. Before you decide to invest in our securities, you should carefully consider the risks described below and all of the other information contained in this prospectus. If any of the events described in the following risks actually occur, our business, financial condition and operating results could be materially adversely affected, the trading price of our common stock could decline and you could lose all or part of your investment.
 
RISKS RELATED TO OUR BUSINESS
 
We have a significant concentration in real estate loans and a downturn in the Puget Sound economy or real estate market could significantly hurt our business and our prospects for growth.
 
As of June 30, 2007 our loan portfolio consisted of:
 
  •  46.2% construction loans;
 
  •  36.1% commercial real estate loans, primarily comprised of retail, small office, warehouse, and industrial properties;
 
  •  11.7% commercial loans;
 
  •  4.6% residential real estate;
 
  •  0.8% consumer loans; and
 
  •  0.6% loans held for sale.
 
Substantially all of our loans are to individuals and small businesses in the Puget Sound region. We are particularly susceptible to fluctuating land values and economic downturns that affect the level of real estate investment activity. Changes in regional economic conditions could result in increased loan delinquencies. Collateral for our loans could decline in value and, as a result, our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would be diminished and we would be more likely to suffer losses on defaulted loans. Any economic decline in our market areas could also reduce demand for loans and other products and services and, accordingly, reduce our income.
 
Construction lending involves special risks not associated with other types of lending.
 
Construction and development loans are subject to the risks inherent in most other loans, but also carry higher levels of risk predicated on whether the project can be completed on-time and on-budget, and, for non-owner occupied projects, whether the customer can find tenants at rates that will service the debt. Construction loans are typically based upon estimates of costs to complete the project, and an appraised value associated with the completed project. Cost estimates, and completed appraised values, are subject to changes in the market, and such values may in fact change between the time a loan is approved and the final project is complete. Delays or cost overruns in completing a project may arise from labor problems, material shortages and other unpredicted contingencies. If actual construction costs exceed budget, the borrower may need to put more capital into the project, or we may need to increase the loan amount to ensure the project is completed, potentially resulting in a higher loan-to-value than anticipated. Where a non-owner occupied project is not pre-leased, changes in the market could result in a slow lease-up period or rents below what were anticipated. For residential land development loans, a general slowdown in home buying can result in slow sales or reduced prices. Either situation will strain the borrower’s cash flows, and potentially cause deterioration in the loan.
 
Our ability to grow depends upon our ability to increase our deposits and fund our lending activities.
 
Our primary source of funding growth is through deposit accumulation. Our ability to attract deposits is significantly influenced by general economic conditions, changes in prevailing interest rates and competition. If we are not successful in increasing our current deposit base to a level commensurate with our funding needs and pricing objectives, we may have to seek alternative sources of funds which may be at a higher cost. Or we


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may have to curtail our growth. Our mix of funding sources currently include: deposits comprised of retail and business customer deposits, public deposits, and brokered deposits; borrowings; and repurchase agreements. Our inability to increase deposits or to access other sources of funds could have a negative effect on our ability to meet customer needs, could slow loan growth and could adversely affect our results of operations.
 
Our ability to successfully transition executive management is critical to our future prospects.
 
Our Chief Executive Officer Ken Parsons is a founding director of Venture Bank and has served as CEO since 1990. Jim Arneson rejoined us in September 2005 when we acquired Redmond National Bank. Effective July 1, 2007, pursuant to our management transition plan, Ken Parsons moved to a strategic oversight role until his planned retirement in 2010. We believe that our success to date has been significantly influenced by the role Mr. Parsons has played, and further believe that it is important for Mr. Parsons to remain active as our Chairman and Chief Executive Officer until his planned retirement. Jim Arneson, in his previous role as our Executive Vice President and Chief Financial Officer, worked closely with Mr. Parsons for ten years. Mr. Arneson has served as our President and as President and Chief Executive Officer of Venture Bank since his return in 2005, and has transitioned into positions previously held by Mr. Parsons. The loss of Mr. Parsons’ services, or our failure to successfully complete the transition of leadership from Mr. Parsons to Mr. Arneson, could materially adversely affect our ability to successfully implement our strategic plan. We could have difficulty replacing any of our senior management team or senior officers with equally competent persons who also are familiar with our market area.
 
We may grow through acquisitions, which strategy introduces risks of successfully integrating and managing acquisitions.
 
As part of our growth strategy, we intend to pursue acquisitions of financial institutions within and outside of our current market. At this time we have no agreements or understandings to acquire any financial institution, and we may not find suitable acquisition opportunities. Acquisitions involve numerous risks, any of which could harm our business, including:
 
  •  difficulties in integrating the operations, technologies, accounting processes and personnel of the target;
 
  •  failing to realize the anticipated synergies of the combined businesses;
 
  •  loss of customers of the target company during the transition following an acquisition;
 
  •  diversion of financial and management resources from existing operations;
 
  •  entering new markets or areas in which we have limited or no experience;
 
  •  loss of key employees from either our business or the target’s business;
 
  •  assumption of unanticipated problems or latent liabilities of the target; and
 
  •  inability to generate sufficient revenue to offset acquisition costs.
 
Acquisitions also frequently result in the recording of goodwill and other intangible assets which are subject to charge-off if it is subsequently determined that goodwill recorded has become impaired under applicable accounting rules. In addition, if we finance acquisitions by issuing our securities, our existing shareholders may be diluted, which could affect the market price of our common stock. If we fail to properly evaluate or integrate acquisitions, we may not achieve the anticipated benefits of any such acquisitions and we may incur costs in excess of what we anticipate, which could materially harm our business and financial results.
 
We may not be able to control costs or generate revenue as we open new financial centers.
 
A key component of our business strategy is to expand into adjacent growing markets and to attempt to increase our market share in our current markets by opening new financial centers. Because of the marketing, staffing, site development and construction costs associated with de novo branching, we believe that it can


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take up to three years for new financial centers to generate sufficient new business to first achieve operational profitability. If we open or remodel financial centers, we are likely to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our financial results.
 
Rapid growth could strain our resources, systems and controls, which could adversely affect business and operations.
 
Our ability to manage growth successfully will depend upon our ability to maintain our asset quality, control costs and monitor and control risk. If we grow too quickly and are unable to successfully manage this growth, our financial performance could be materially and adversely affected.
 
Our business and financial condition may be adversely affected by competition.
 
Financial services and banking are mature, highly competitive businesses. The banking business in our market area is currently dominated by a number of large regional and national financial institutions. In addition, there are many smaller commercial banks that operate in our market areas. We compete for loans and deposits with banks, savings and loan associations, finance companies, credit unions, insurance companies, brokerage and investment banking companies and mortgage bankers. The rapid increase in Internet banking permits institutions outside our market area to compete for customers in our geographic markets. We also compete for loans with non-bank companies and governmental agencies that make available low-cost or guaranteed loans to certain borrowers. The industry could become even more competitive as a result of legislative, regulatory and technological changes. Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have greater resources than we have or are not subject to the same level of regulation and restriction that we face, which may enable them to offer more products and services, offer lower priced products due to greater economies of scale, maintain more banking locations and ATMs or conduct more extensive promotional and advertising campaigns. Competitors seeking to expand market share or enter our market area often offer lower priced loans and higher priced deposits, which can have an adverse result on our interest margin as we seek to remain competitive. The loss of customers to our competitors could adversely affect our results. We may not be able to compete successfully against current and future competitors.
 
Our allowance for credit losses may not be adequate to cover actual loan losses.
 
As a lender, a significant source of risk arises from the possibility that we could sustain losses due to our customers being unable to repay their loans according to their terms. Credit losses are inherent in the lending business and could have a material adverse effect on our operating results. We maintain an allowance for credit losses, or the Allowance, in accordance with accounting principles generally accepted in the United States to provide for customer defaults and other non-performance. The level of the Allowance is based on management’s judgments and various assumptions about the loan portfolio. The determination of the appropriate level of the Allowance is an inherently difficult process. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond our control. In addition, our underwriting policies, adherence to credit monitoring processes, and risk management systems and controls may not prevent unexpected losses. The Allowance may not be adequate to cover our actual loan losses. The actual amount of future provisions for the Allowance cannot now be accurately determined and may exceed the amounts of past provisions. Any increase to the Allowance could decrease our net income.
 
If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable.
 
We may need to raise additional capital in the future to support our continued growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of financial markets at that time. We may not be able to obtain


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additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to raise additional capital as needed.
 
An interruption in or breach in security of our systems may result in a loss of business.
 
We rely heavily on communications and information systems to conduct our business, some of which are outsourced to third parties. Our customer relationship management, general ledger, deposits, loan origination and loan servicing systems are all driven by computer technology. We use technology-based systems to process new and renewed loans, facilitate collections and share data internally. Any failure or interruptions of these systems or of third parties that operate or support them could result in disruptions in our ability to deliver products and services to our customers and consequently have a material adverse effect on our results of operations and financial condition.
 
If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business could be adversely affected.
 
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal controls over financial reporting as of the end of 2007, and to include a management report assessing the effectiveness of our internal controls over financial reporting in our 2007 annual report. In 2008, Section 404 will require our independent registered public accounting firm to attest to and report on the effectiveness of our internal controls over financial reporting. Our management, including our CEO and CFO, does not expect that our internal controls over financial reporting will prevent all errors and all fraud. We cannot assure you that any design of internal controls will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We or our independent registered public accounting firm could identify a material weakness in our internal controls in the future. A material weakness in our internal controls over financial reporting would require management and our independent registered public accounting firm to evaluate our internal controls as ineffective. If our internal controls over financial reporting are not considered adequate, we may experience a loss of public confidence, which could have an adverse effect on our business and our stock price.
 
RISKS RELATED TO THE BANKING INDUSTRY
 
Changes in interest rates may affect our profitability.
 
Our earnings depend primarily on net interest income — the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of governmental and regulatory agencies. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect our ability to originate loans and obtain deposits and the fair value of our financial assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. In addition, an increase in interest rates may adversely affect the ability of some of our borrowers or potential customers to pay the principal or interest on their loans and reduce the demand for new loans. This may lead to an increase in our nonperforming assets, a decrease in loan originations, or a reduction in the value of and income from our loans, any of which could have a material and negative effect on our results of operations.


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We are subject to extensive government regulation and supervision, and regulatory changes may adversely affect us.
 
The banking industry is heavily regulated under both federal and state law. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not our shareholders. As a bank holding company, we are also subject to extensive regulation by the Federal Reserve Board, in addition to other regulatory and self-regulatory organizations. The level of regulation has increased in recent years with the adoption of the Bank Secrecy Act and the privacy requirements of Gramm-Leach-Bliley Act. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Such changes could affect us in substantial and unpredictable ways and could subject us to additional costs necessary to comply with new rules and regulations, limit the types of financial services and products we may offer or increase the ability of non-banks to offer competing financial services and products. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of such changes, which could have a material adverse effect on our profitability or financial condition. If government regulation and supervision become more burdensome, our costs of complying could increase and we could be less competitive compared to unregulated competitors.
 
Recent supervisory guidance on commercial real estate concentrations could restrict our activities and impose financial requirements or limitations on the conduct of our business.
 
The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation recently finalized guidance on sound risk management practices for concentrations in commercial real estate lending. This guidance is intended to help ensure that institutions pursuing a significant commercial real estate lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities. The federal agencies are concerned that rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in commercial real estate markets. The regulatory guidance reinforces and enhances existing regulations and guidelines for safe and sound real estate lending. The guidance provides supervisory criteria, including numerical indicators to assist in identifying institutions with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny.
 
There are two numerical measures in the regulatory guidance. The thresholds of numerical indicators in the guidance that indicate significant commercial real estate loan concentrations are as follows: (1) loans and loan commitments in the Call Report (the quarterly Report of Condition required to be filed with federal banking regulators) categories of Construction, Land Development and Other Land loans are greater than 100% of the institution’s Tier 1 Capital; and (2) commercial real estate loans and loan commitments, as defined in the guidance, are greater than 300% of the institution’s total Tier 1 Capital. The first numerical indicator, the aggregate of construction, land development and other land loans and unfunded loan commitments related to these loans divided by our Tier 1 Capital was 595% as of June 30, 2007. The second numerical indicator, the aggregate of our non-owner-occupied commercial real estate loans and unfunded loan commitments related to these loans, divided by our Tier I Capital was 792% as of June 30, 2007. Thus, our portfolio meets the definition of a concentration, as set forth in the guidelines. If we exclude unfunded commitments from the first and second numerical indicators, then the ratios would have been 410% and 594%, respectively.
 
The guidance does not limit banks’ commercial real estate lending, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. Our lending and risk management practices are taken into account in supervisory evaluations of our capital adequacy.


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Real estate properties securing our loans are subject to a variety of environmental laws that can diminish the value of our collateral or a borrower’s ability to repay a loan.
 
Under federal, state or local law, a current or previous owner or operator of real property may be liable for the cost of removal or remediation of hazardous or toxic substances on such property or damage to property or personal injury. Environmental laws may impose liability whether or not the owner or operator was responsible for the presence of hazardous or toxic substances. If a property is exposed to such liability, its value is often diminished and could be reduced to an amount less than the principal amount of our loan. If foreclosure is necessary and no guarantees exist, a loan loss would result.
 
Environmental laws also may impose restrictions on the manner in which properties may be used or businesses may be operated, and these restrictions may require unexpected expenditures by our borrowers. Changes in environmental laws that set forth new or more stringent standards could also require our borrowers to make unexpected expenditures, some of which could be significant. Additionally, our borrowers could be held responsible for sanctions for noncompliance or significant expense related to the cost of defending against claims of liability, of compliance with environmental regulatory requirements or of remediating any contaminated property, which would diminish the ability of any such borrowers to repay our loans.
 
We are exposed to risk of environmental liabilities with respect to properties to which we take title.
 
Most of our outstanding loan portfolio at June 30, 2007 was secured by real estate. In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third-parties for property damage, personal injury, investigation or clean-up costs, or we may be required to investigate or clean up hazardous or toxic substances at a property. The costs associated with investigation or remediation activities could be substantial. If we are the owner or former owner of a contaminated site, we may also be subject to common law claims by third-parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.
 
The financial services industry frequently adopts new technology-driven products and services that we may be unable to effectively implement or compete with.
 
The effective use of technology increases efficiency and enables financial institutions to reduce costs and provide better service to our customers. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We cannot assure you that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
 
We face a variety of threats from technology-based frauds and scams.
 
Financial institutions are a prime target of criminal activities through various channels of information technology. Risks of business interruption, fraud losses, business recovery expenses, and other potential losses or expenses that we may incur from a significant event are not readily predictable and, therefore, are not easily mitigated or prevented and could have a negative impact on our results of operations.
 
RISKS RELATED TO THE OFFERING
 
There is no existing market for our common stock and our stock price may trade below the initial public offering price.
 
Prior to this offering, there has been no public market for our common stock. The initial public offering price for our common stock will be determined by negotiations between the underwriters and us and may not


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be indicative of prices that will prevail in the open market following this offering. You may not be able to resell your shares at or above the initial public offering price.
 
You will experience immediate and substantial dilution in the book value of the shares you purchase in this offering.
 
Based upon the issuance and sale of 1,800,000 shares of our common stock at an assumed initial public offering price of $22.00 per share, which is the mid-point of the price range set forth on the cover page of this prospectus, if you purchase common stock in this offering, you will incur immediate dilution of approximately $11.41 in the pro forma net tangible book value per share of our stock.
 
We cannot be sure that an active public trading market will develop or be maintained.
 
We cannot predict the extent to which investor interest in us will lead to the development of an active trading market on the Nasdaq Global® Market or otherwise, or how liquid that market may become. If few stock analysts follow our stock or issue research reports concerning our business, an active trading market may not develop. Neither the underwriters nor any other market maker in our common stock will be obligated to make a market in our shares, and any such market making activity may be discontinued at any time in the sole discretion of each market maker. In addition, we estimate that immediately following this offering, approximately 21.7% of our outstanding common stock will be beneficially owned by our executive officers and directors who also will hold options exercisable more than 60 days after the date of this prospectus for an additional 90,510 shares of our common stock. The substantial amount of common stock that is owned by and issuable to our executive officers and directors may adversely affect the development of an active and liquid trading market. If an active trading market does not develop, you may have difficulty selling any shares that you buy in this offering.
 
Management will have broad discretion to use of the proceeds from this offering, and we may not use the proceeds effectively.
 
Although we plan to use the net proceeds from this offering for expansion purposes, including funding loan growth, seeking out possible acquisitions or developing new financial centers, we have not designated the amount of net proceeds we will use for any particular purpose. Accordingly, our management will have broad discretion in deciding how and when to apply the proceeds. Management could use the proceeds for purposes other than those contemplated at the time of this offering. Our shareholders may not agree with the manner in which management chooses to allocate and spend the net proceeds. Management may use the proceeds for corporate purposes that may not increase our market value or profitability.
 
A significant number of shares of our common stock will become eligible for sale in the public market 180 days after the date of this offering, which could cause the price of our common stock to decline.
 
Our officers, directors, and principal shareholders (shareholders holding more than 5% of our common stock), have entered into lock-up agreements with the underwriters not to sell or otherwise dispose of any of their shares for a period of 180 days after the date of this prospectus. When these lock-up agreements expire, shares held by these individuals will become eligible for sale, in some cases subject only to the volume, manner of sale and notice requirements of Rule 144 of the Securities Act of 1933. Sales of these shares could cause the market price of our common stock to decline and adversely affect the market for our common stock.
 
Provisions of our articles of incorporation and bylaws could delay, deter or prevent our acquisition by another party.
 
Our articles of incorporation and bylaws contain provisions that may make it substantially more difficult for a third-party to acquire control of us without the approval of our Board of Directors, even if doing so might be beneficial to our shareholders. These provisions, among other things, permit us to issue blank-check preferred stock and require supermajority voting for certain business combinations, which can make an acquisition difficult to complete. Our articles of incorporation require that 90% of our outstanding shares


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approve any business combination transaction unless (i) two-thirds of our directors approve the transaction, or (ii) the consideration to be received by our shareholders satisfies certain “fair price” criteria. See “Description of Capital Stock — Defensive Provisions in Articles of Incorporation or Bylaws — Fair Price Provision”. In addition, we have a staggered Board of Directors, require advance notice for nomination of directors, and limit the ability of shareholders to call a special meeting of shareholders, all of which can make shareholder representation on the Board of Directors more difficult to achieve.
 
The Washington Business Corporation Act contains provisions designed to protect Washington corporations and employees from the adverse effects of hostile corporate takeovers.
 
Statutory provisions applicable to us reduce the possibility that a third party could effect a change in control without the support of our incumbent directors and may also strengthen the position of current management by restricting the ability of shareholders to change the composition of the Board of Directors, to affect our policies generally or to benefit from actions which are opposed by the current Board of Directors. These statutory provisions may delay, prevent or deter a merger, acquisition, tender offer, proxy contest or other transaction that might otherwise result in our shareholders receiving a premium over the then current market price for their common stock.
 
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This prospectus contains certain forward-looking statements, which are not historical facts, but rather predictions or goals. These statements may include statements regarding projected performance for periods following the completion of this offering. These statements can generally be identified by use of phrases such as “believe,” “expect,” “will,” “seek,” “should,” “anticipate,” “estimate,” “intend,” “plan,” “target,” “foresee,” or other words of similar import. Any statements that expressly or implicitly describe our future financial condition, results of operations, objectives, strategies, plans, goals or future performance and business are also forward-looking statements.
 
Forward-looking statements are not guarantees of performance. They involve known and unknown risks and uncertainties, assumptions and other factors, including, but not limited to, those described in the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections and other parts of this prospectus. If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those anticipated and expressed in, or implied by, forward-looking information and statements contained in this prospectus.
 
The following factors, among others, could cause our financial performance to differ materially from our goals, objectives, intentions, expectations and other forward-looking statements:
 
  •  changes in general economic conditions, either nationally or particularly in the Puget Sound area;
 
  •  increases in competitive products and pricing, that may lead to pressure on rates we charge on loans and pay on deposits;
 
  •  changes in prevailing interest rates that could lead to decreased net interest margin;
 
  •  fiscal and monetary policies of the federal government;
 
  •  changes in government regulations affecting financial institutions including regulatory fees and capital requirements;
 
  •  the integration of acquired businesses;
 
  •  our ability to effectively deploy the proceeds of the offering to support our growth;
 
  •  loss of customers;
 
  •  credit risk management and asset/liability management;


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  •  changes in technology or required investments in technology; and
 
  •  the availability of, and costs associated with, sources of liquidity.
 
We caution you not to rely on our forward-looking information and statements. You should read this prospectus and the documents that we reference in this prospectus and that are exhibits to the registration statement on Form S-1, of which this prospectus is a part, that we have filed with the SEC, completely and with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements. We do not undertake any obligation to release publicly our revisions to such forward-looking statements to reflect events or circumstances after the date of this prospectus.
 
USE OF PROCEEDS
 
This prospectus relates to shares of our common stock being offered by us. Our net proceeds from the sale of our shares are expected to be $36.2 million (or $41.8 million if the underwriters’ over-allotment option is exercised in full) assuming an initial public offering price of $22.00 per share (the mid-point of the range set forth on the cover page of this prospectus), after deducting the underwriters’ discounts and estimated offering expenses.
 
We plan to use the net proceeds from this offering for general corporate purposes including:
 
  •  financing acquisitions in the Puget Sound area and potentially in growth markets north of Seattle to the Canadian border and south of Olympia to the Portland metropolitan area;
 
  •  opening new financial centers;
 
  •  paying off existing junior subordinated debentures; and
 
  •  contributing proceeds to Venture Bank to provide it with capital to support growth.
 
The amounts actually expended for working capital purposes may vary significantly and will depend on a number of factors including: market conditions, Venture Bank’s funding requirements and availability of other funds and other factors. Accordingly, our management will retain broad discretion in the allocation of the net proceeds of this offering. Pending such uses, we will invest the net proceeds in securities or Fed funds.


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TRADING HISTORY AND DIVIDEND POLICY
 
Prior to this offering, there has been no public market for our common stock. Our common stock has been traded, from time to time, by individuals on a negotiated basis between the parties. Trades that have occurred cannot be characterized as amounting to an active market. The following table sets forth those trades since January 1, 2005 through August 31, 2007 of which we have knowledge, including the quarter in which the trades occurred, the aggregate number of shares traded during such quarter and the range of sales price per share and the per share amount of dividends declared:
 
                         
    # of Shares
          Dividends
 
Period
  Traded     Price per Share     Declared  
 
2005
                       
1st Quarter
    75,100     $ 20.00 - $22.90     $ 0.065  
2nd Quarter
    67,250     $ 18.00 - $21.00     $ 0.070  
3rd Quarter
    23,555     $ 19.00 - $21.50     $ 0.070  
4th Quarter
    53,987     $ 18.00 - $21.50     $ 0.070  
2006
                       
1st Quarter
    41,940     $ 19.00 - $20.50     $ 0.070  
2nd Quarter
    105,678     $ 19.50 - $20.25     $ 0.070  
3rd Quarter
    42,840     $ 19.00 - $21.25     $ 0.075  
4th Quarter
    40,242     $ 21.00 - $22.00     $ 0.075  
2007
                       
1st Quarter
    23,131     $ 21.00 - $21.75     $ 0.080  
2nd Quarter
    37,703     $ 21.60 - $23.00     $ 0.080  
3rd Quarter (through August 31, 2007)
    20,950     $ 22.00 - $22.75     $ 0.085  
 
We have applied to have our common stock listed on the Nasdaq Global® Market under the symbol “VNBK.” On August 31, 2007, there were 1,782 holders of record of our common stock.
 
Under Washington law, our Board of Directors may authorize payment of a dividend. However, we may not pay a dividend if, after giving effect to the dividend: (i) we would not be able to pay our liabilities as they become due in the usual course of business, or (ii) our total assets would be less than the sum of our total liabilities plus the amount that would be needed, if we were to be dissolved at the time of the payment of the dividend, to satisfy the dissolution rights of any shareholders with preferential rights superior to those receiving the distribution.
 
Additionally, our junior subordinated debt agreement prohibits us from paying dividends if we have deferred payment of interest on any of our outstanding trust preferred securities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources.”
 
We have paid quarterly cash dividends since April 1999, and we intend to continue to pay dividends on a quarterly basis. We are a legal entity separate and distinct from Venture Bank. Because we are a holding company with no significant assets other than ownership of the common stock of Venture Bank, we depend on dividends from Venture Bank for cash with which to pay dividends to our shareholders.
 
Washington law limits the ability of Venture Bank to pay dividends to us. A Washington state-chartered bank may not declare or pay any dividend in an amount greater than its retained earnings without approval of the Director of the Washington State Department of Financial Institutions. For a discussion of the Washington and federal regulatory limitations on Venture Bank’s ability to pay dividends, see “Supervision and Regulation — Federal and State Regulation of Venture Bank — Dividends.”
 
In the future, our ability to declare and pay cash dividends will be subject to evaluation by our Board of Directors of our and Venture Bank’s operating results, capital levels, financial condition, future growth plans, general business and economic conditions, and other relevant considerations, and we cannot assure you that we will continue to pay cash dividends on any particular schedule or that we will not reduce the amount of or cease paying dividends in the future.


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CAPITALIZATION
 
The following table sets forth our capitalization as of June 30, 2007 on an actual and as adjusted basis. The as adjusted basis reflects the receipt and application by us of the estimated net proceeds from the sale of 1,800,000 shares of our common stock in this offering at an assumed public offering price of $22.00 per share (the mid-point of the range set forth on the cover page of this prospectus), after deducting estimated underwriting discounts and commissions and offering expenses payable by us, but without the exercise of over-allotment option granted to the underwriter.
 
You should read this table in conjunction with the consolidated financial statements and the other financial information included in this prospectus.
 
                 
    June 30, 2007  
    Actual     As Adjusted  
    (Dollars in thousands, except per share data)  
 
Indebtedness:
               
Junior subordinated debt at fair value
  $ 22,829     $ 22,829  
Shareholders’ Equity:
               
Common stock (no par value), shares authorized: 30,000,000; shares outstanding: 7,197,226 at June 30, 2007(1)
    5,974       71,946  
Additional paid-in capital
    29,744        
Retained earnings
    54,629       54,629  
Advance to KSOP
    (634 )     (634 )
Accumulated other comprehensive loss
    (4,948 )     (4,948 )
Total shareholders’ equity
    84,765       120,993  
Total capitalization
    107,594       143,822  
Ratios:
               
Book value per share
  $ 11.78     $ 13.45  
Tangible book value per share
  $ 8.20     $ 10.59  
Shareholders’ equity to total assets
    7.8 %     10.8 %
Tangible shareholders’ equity to tangible assets
    5.6 %     8.7 %
Regulatory capital ratios(2) 
               
Tier 1 leverage capital ratio
    8.52 %     12.46 %
Tier 1 risk-based capital ratio
    9.28 %     13.69 %
Total risk-based capital ratio
    10.27 %     14.68 %
 
 
(1) Effective July 1, 2007, additional paid-in capital was reclassified into common stock to reflect the no par value of the Company’s common stock.
 
(2) The net proceeds from our sale of common stock in this offering are presumed to be invested in 0% risk weighted U.S. Treasury bonds for the purposes of as adjusted risk-based regulatory capital ratios.
 
DILUTION
 
If you invest in our common stock, you will experience dilution to the extent that the initial public offering price per share of our common stock exceeds the tangible book value of our common stock immediately after this offering. The tangible book value of our common stock as of June 30, 2007 was approximately $59.0 million, or $8.20 per share of common stock. The tangible book value per share represents total tangible assets less total liabilities, divided by the 7,197,226 shares of our common stock outstanding as of that date.
 
After giving effect to the issuance and sale of 1,800,000 shares of our common stock in this offering and our receipt of approximately $36.2 million in net proceeds from such sale, based on an assumed public


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offering price of $22.00 per share (the mid-point of the range set forth on the cover page of this prospectus), and after deducting the estimated underwriters’ discounts and commissions and the expenses of the offering, our as adjusted tangible book value as of June 30, 2007 would have been approximately $95.3 million, or $10.59 per share. This amount represents an immediate increase in tangible book value per share of $2.39 to existing shareholders and an immediate dilution of $11.41 per share to purchasers of our common stock in this offering. Dilution is determined by subtracting the tangible book value per share as adjusted for this offering from the amount of cash paid by a new investor for a share of our common stock.
 
The following table illustrates the per share dilution as of June 30, 2007:
 
                 
Offering price per share
          $ 22.00  
Tangible book value per share as of June 30, 2007
  $ 8.20          
Increase in tangible book value per share attributable to new investors
  $ 2.39          
As adjusted tangible book value per share after this offering
          $ 10.59  
Dilution per share to new investors
          $ 11.41  
 
The shares of common stock outstanding exclude shares of common stock granted and unexercised under our 2004 Stock Incentive Plan. As of June 30, 2007, a total of 425,028 option shares were outstanding, at a weighted average exercise price of $14.61 per share. Of the option shares outstanding, 234,588 were then currently exercisable. At June 30, 2007, 112,600 shares were reserved for future option or restricted stock grants. To the extent that options are exercised or other options are awarded, there may be further dilution to new investors.


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
You should read the following discussion and analysis of our financial condition and results of operations together with “Selected Consolidated Financial and Other Data” and our financial statements and related notes appearing elsewhere in this prospectus. This discussion and analysis may contain forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.
 
Overview
 
Venture Financial Group, Inc. is the bank holding company for Venture Bank, a Washington state chartered bank established in 1979. For the purpose of this discussion, “we,” “us” and “our” refers to the holding company and Venture Bank as a single, consolidated entity unless the context otherwise indicates.
 
The following table sets forth key financial measures:
 
                                         
    As of and for the Six
       
    Months Ended
    As of and for the Years Ended
 
    June 30,     December 31,  
    2007     2006     2006     2005     2004  
    (Dollars in thousands, except per share data)  
 
Net income
  $ 6,364     $ 4,943     $ 11,069     $ 9,028     $ 11,777  
Diluted earnings per share
  $ 0.88     $ 0.67     $ 1.52     $ 1.30     $ 1.77  
Total assets
  $ 1,084,032     $ 917,269     $ 978,108     $ 752,793     $ 556,216  
Investment securities
  $ 236,560     $ 145,154     $ 162,447     $ 60,911     $ 73,291  
Gross loans(1)
  $ 747,043     $ 665,583     $ 716,095     $ 602,335     $ 432,641  
Total deposits
  $ 838,505     $ 711,703     $ 771,250     $ 514,028     $ 326,721  
Return on average assets(2)
    1.24 %     1.21 %     1.25 %     1.46 %     2.23 %
Return on average equity(2)
    14.82 %     12.82 %     14.05 %     14.87 %     22.99 %
Net interest margin(2)
    4.14 %     4.41 %     4.44 %     4.93 %     5.28 %
Efficiency ratio
    58.8 %     61.0 %     59.2 %     61.9 %     54.2 %
Dividend payout ratio
    18.0 %     20.6 %     18.9 %     20.5 %     11.3 %
 
 
(1) Includes loans held for sale
 
(2) Annualized for the six month periods ended June 30, 2007 and 2006
 
On October 8, 2004, we sold seven financial centers. Excluding the $3.5 million net gain on the sale, our return on average assets and return on average equity at December 31, 2004 would have been 1.56% and 16.32%, respectively. On September 2, 2005, we completed a merger with Washington Commercial Bancorp and its wholly owned subsidiary Redmond National Bank. At closing we acquired $131.8 million of assets, $107.1 million of loans and $86.9 million of deposits.
 
Trends and Developments
 
  •  Diversification of assets for more effective capital utilization.  Our asset mix has changed significantly since December 31, 2005 to include more securities, which are available for liquidity and for pledging toward funding sources. This allows us to leverage our growing capital base to expand earnings. At December 31, 2005, securities available-for-sale constituted 8.1% of total assets, gross loans including loans held for sale constituted 80.0% and other assets were 11.9%. At June 30, 2007, securities available-for-sale constituted 21.0% of total assets, gross loans including loans held for sale constituted 68.9% and goodwill and other assets were 10.1%.
 
  •  Net interest margin changes.  The changes in our asset mix since December 31, 2005 have provided a more liquid balance sheet position, but also reduced our net interest margin. We believe we have


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attained the desired asset mix and that in future periods the comparative net interest margins will move based on pricing decisions and term decisions of assets and liabilities more than on significant changes in mix. Net interest margin reductions have been impacted primarily by the highly competitive and rising cost of funding. Asset yields have increased also but at less than half the cost of the funding. From December 31, 2005 through June 30, 2007, loan yields increased 119 basis points and securities yields increased 152 basis points, while interest-bearing deposit costs increased 214 basis points and other borrowing costs increased 157 basis points over the same period.
 
  •  Diversification of liabilities and less reliance on borrowings.  The funding mix of our balance sheet has been changing in response to the availability of various types of deposits and other sources of funding at reasonable prices. Both the volume and pricing of various liabilities has been significantly impacted.
 
At December 31, 2005, deposits comprised 76.0% of total liabilities. Brokered deposits as a percent of total deposits were 11.6%, public deposits were 7.0%, and the remaining 81.4% was in other customer deposits. Short and long-term borrowings and repurchase agreements comprised 19.5% of our total liabilities at that same time. Non-interest bearing deposits as a percentage of total deposits were 19.3% at December 31, 2005.
 
At June 30, 2007, deposits comprised 83.9% of total liabilities which included brokered deposits at 16.4%, public deposits of 19.9% and the remaining 63.7% of total deposits in other customer deposits. Short and long-term borrowings and repurchase agreements comprised 12.8% of our total liabilities at that same time. Non-interest bearing deposits as a percentage of total deposits were 12.3% at June 30, 2007.
 
Historically, alternative sources of funds such as brokered deposits or borrowings have been more expensive than our certificates of deposit. At June 30, 2007, brokered certificates of deposit were either less expensive or the same cost as a certificate of deposit competitively priced with one of our local customers. Additionally, borrowing costs were also competitive or less costly than certificates of deposits with our customers.
 
  •  Investments in infrastructure and the impact of increased non-interest expense.  We have been adding staff to position us for future growth, especially if economic conditions warrant an acceleration of growth. We have also been adding facilities to expand our footprint in the Puget Sound. Additionally, as we reach our goal of becoming a “public company,” other non-interest expense items, including professional expenses and other costs related to compliance with the reporting requirements of the securities laws and compliance with the Sarbanes-Oxley Act of 2002, will increase significantly.
 
  •  Impact of various business decisions on profitability.  Our strategic decision in 2004 to sell financial centers in less desirable market areas created a significant one-time gain, but also increased our reliance on higher cost funding to grow. In 2005, we started to phase out of our contractual relationships with third party small-dollar loan (payday lending) providers for regulatory reasons, and as a result our return on equity has declined from 2004 levels, but so has the risk associated with that business.
 
Summary of Critical Accounting Estimates and Accounting Policies
 
Our accounting policies are integral to understanding our financial results. Our most critical accounting estimates and policies require management to make subjective, complex judgments, often as a result of the need to estimate the effect of matters that are inherently uncertain. Management has identified several accounting estimates and policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These estimates and policies relate to items such as the methodology for the determination of the allowance for credit losses, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, income taxes, the impairment of investments, share-based compensation, employer’s accounting for defined benefit pension and other post-retirement plans, and fair value measurements. Our significant accounting policies are set forth in Note 1 to


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our Audited Consolidated Financial Statements for the year ended December 31, 2006 included in this prospectus.
 
Allowance for Credit Losses.  The allowance for credit losses, or the Allowance, is established through a provision for credit losses charged against earnings. The Allowance is maintained at the amount management believes will be adequate to absorb known and inherent losses in the loan portfolio. The appropriate balance of the Allowance is determined by applying estimated loss factors to the credit exposure from outstanding loans. Estimated loss factors are based on subjective measurements including management’s assessment of the internal risk classifications, changes in the nature of the loan portfolio, industry concentrations, and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are possible and may have a material impact on our consolidated financial statements, results of operation, or liquidity.
 
For additional information regarding the Allowance, its relation to the provision for credit losses, and the risk related to asset quality, see Note 5 to our audited Consolidated Financial Statements for the year ended December 31, 2006, and “Management’s Discussion and Analysis of Financial Condition — Allowance for Credit Losses.”
 
Foreclosed Assets.  Assets acquired through, or in lieu of, foreclosure are initially recorded at the lower of cost or fair value, less estimated costs of disposal. Any write-down to fair value at the time of transfer or within a reasonable period thereafter is charged to the Allowance. Properties are evaluated regularly to ensure that the recorded amounts are supported by their current fair values, and that valuation allowances to reduce the recorded amounts to fair value, less estimated costs to dispose, are recorded as necessary. Any subsequent reductions in carrying values, and revenue and expense from the operation of properties, are charged to operations.
 
For additional information regarding foreclosed assets, see Note 7 to our audited Consolidated Financial Statements for the year ended December 31, 2006.
 
Income Taxes.  Deferred tax assets and liabilities result from differences between financial statement recorded amounts and the tax bases of assets and liabilities, and are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled under the liability method. The accounting for uncertainty in income taxes requires recognition and measurement of uncertain tax positions using a “more-likely-than-not” approach. This approach was effective beginning January 1, 2007.
 
For additional information regarding income taxes, see Note 11 to our audited Consolidated Financial Statements for the year ended December 31, 2006 and Note 1 — “Recent Accounting Pronouncements”.
 
Securities Available-for-Sale.  Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires that available-for-sale securities be carried at fair value. We believe this requires “a critical accounting estimate” in that the fair market value of a security is based on quoted market prices or if quoted market prices are not available, fair values are extrapolated from the quoted prices of similar instruments. Management utilizes the services of a third-party vendor to assist with the determination of estimated fair values. Adjustments to the available-for-sale securities fair value impact the consolidated financial statements by increasing or decreasing assets and shareholders’ equity.
 
For additional information regarding the available-for-sale securities, see Note 4 to our audited Consolidated Financial Statements for the year ended December 31, 2006, and “Management’s Discussion and Analysis of Financial Condition — Investments.”
 
Share-Based Compensation.  Prior to January 1, 2006, the Company accounted for stock-based awards to employees and directors using the intrinsic value method. Accordingly, no compensation expense was recognized in the consolidated financial statements when the grant price was equal to the market price on the date of grant. Effective January 1, 2006, the Company adopted SFAS No. 123(R) and began expensing share-based awards under the fair value method. SFAS No. 123R requires that management make assumptions about employee turnover that are utilized to measure compensation expense recorded in the financial statements. The


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fair value of stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions such as expected volatility, expected dividends, expected terms, and risk-free rate. For additional information regarding Stock Based Compensation, see Note 15 to our audited Consolidated Financial Statements for the year ended December 31, 2006.
 
Benefit Plans.  We have a nonqualified retirement plan covering a select group of employees, which is called the supplemental executive retirement plan (SERP). The SERP is available to key employees designated by our Board of Directors. In accounting for the plan, we must determine the obligation associated with the plan benefits. In estimating the annual SERP expense we must make assumptions and estimates based upon our judgment and also on information we receive from an independent third party actuary. The actuarial assumptions and estimates are reviewed at least annually for any adjustments that may be required.
 
For additional information regarding Benefit Plans, see Note 14 to our audited Consolidated Financial Statements for the year ended December 31, 2006.
 
Fair Value.  In February 2007, the FASB issued SFAS No. 159. We early adopted SFAS No. 157 and No. 159 effective January 1, 2007 with respect to our junior subordinated debentures. The fair value standards are required to be adopted January 1, 2008. Both standards address aspects of the expanding application of fair value accounting.
 
SFAS No. 157 establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. We use a discounted cash flow model to determine the fair value of the junior subordinated debentures using market discount rate assumptions.
 
SFAS No. 159 provides a fair value option election that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities, with changes in fair value recognized in earnings as they occur. SFAS No. 159 permits the fair value option election on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
 
For additional information regarding fair value and the level of pricing transparency associated with financial instruments carried at fair value, see Note 8 to our unaudited Condensed Consolidated Financial Statements for the quarter ended June 30, 2007 included in this prospectus.
 
Results of Operations
 
Our results of operations depend primarily on net interest income, which is the difference between interest income, primarily from loans and investments, and interest expense from interest bearing liabilities, primarily deposits and borrowed funds. Changes in net interest income are influenced by the volume of assets and liabilities and the rates earned and paid respectively. Other factors that determine the level of net income include fee income, non-interest expense, the level of non-performing loans and other non-earning assets, and the amount of non-interest bearing liabilities supporting earning assets. Non-interest income includes service charges and other deposit related fees, origination fees and net gains and losses on the sale of loans and securities and income from bank owned life insurance. Non-interest expense consists primarily of employee compensation and benefits, occupancy, equipment and depreciation expense and other operating expenses.
 
The following discussion of our results of operations compares the six months ended June 30, 2007 to the six months ended June 30, 2006, followed by a comparison of the years ended December 31, 2006 to December 31, 2005 and the years ended December 31, 2005 to December 31, 2004.


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Comparison of the Six Months Ended June 30, 2007 and 2006
 
                         
    For the Six Months Ended June 30,     Increase /
 
    2007     2006     (Decrease)  
    (Dollars in thousands
 
    except per share data)  
 
Interest income
  $ 38,138     $ 28,449     $ 9,689  
Interest expense
    18,837       12,164       6,673  
                         
Net interest income
    19,301       16,285       3,016  
Provision for credit losses
    750       300       450  
                         
Net interest income after provision for credit losses
    18,551       15,985       2,566  
Non-interest income
    4,830       4,250       580  
Non-interest expense
    14,307       12,652       1,655  
                         
Income before provision for income taxes
    9,074       7,583       1,491  
Provision for income taxes
    2,710       2,640       70  
                         
Net income
  $ 6,364     $ 4,943     $ 1,421  
                         
Earnings per share — basic
  $ 0.89     $ 0.69     $ 0.20  
                         
Earnings per share — diluted
  $ 0.88     $ 0.67     $ 0.21  
                         
 
Our net income grew by 30.6% or $1.5 million to $6.4 million for the six months ended June 30, 2007 as compared to $4.9 million for the six months ended June 30, 2006. In the 2007 six month period, net income increased primarily due to growth in our loan and investment portfolios. Our return on average equity was 14.82% and return on average assets was 1.24% for the six months ended June 30, 2007 compared to 12.82% and 1.21%, respectively, for the six months ended June 30, 2006.
 
Net Interest Income and Net Interest Margin.  Net interest income for the six months ended June 30, 2007 increased over the six months ended June 30, 2006 by $3.0 million or 18.4% to $19.3 million from $16.3 million. During the first half of 2006, the Federal Reserve increased its targeted federal funds rate by 125 basis points to 5.25%, where it remained through the first half of 2007. The prime rate, as published in The Wall Street Journal, is based on a survey of what the 30 largest banks charge their customers. In recent years, the prime rate has moved in lockstep at a 300 basis point margin above the federal funds rate. The published prime rate is used as a base index on many of our loans. As rates increased in the first half of 2006 our net interest margin declined due to the fact that rates on deposits and borrowings increased at a much faster pace than loans. During the first half of 2007 competition for loans limited the increase in yield, while at the same time competition for deposits increased those rates. The net effect was a continued decrease in net interest margins.
 
For the six months ended June 30, 2007 net interest margin decreased to 4.14% as compared to 4.41% for the same period in 2006. The 27 basis point decrease in net interest margin was the result of: (1) a higher cost of funding from the increase in deposit rates due to competition and the use of more wholesale funds such as brokered deposits and (2) a larger percent of assets held in securities, which generally carry lower yields than our loans.
 
The largest component of interest income is interest earned on loans. Total interest income earned from loans for the six months ended June 30, 2007 increased by $6.6 million compared to the same period in 2006. The average balance of our loan portfolio increased by $99.2 million; from $633.1 million at June 30, 2006 to $732.3 million at June 30, 2007, resulting in an increase of $4.3 million in our interest income. The yield on our loans increased by 69 basis points for the six months ended June 30, 2007 compared to the same period in 2006, resulting in an increase of $2.3 million in interest income.
 
Interest earned on federal funds sold and interest bearing deposits in other banks decreased by $97 thousand in the first six months of 2007 over the prior year. The most significant reason for this decrease was


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the change in average volume from $6.5 million to $2.4 million, generating a decrease in interest income in the amount of $96 thousand. We shifted the funds to higher yielding assets. The yield on federal funds sold decreased for the same period from 4.65% to 4.61% resulting in a decrease in interest income of $1 thousand. Interest earned on investments increased by $3.2 million in the first six months of 2007 over the prior year primarily due to an increase in volume of debt securities which went from an average balance of $104.3 million at June 30, 2006 to $205.9 million at June 30, 2007, providing an increase in interest income of $2.8 million for the six months ended June 30, 2007 compared to the six months ended June 30, 2006. The yield on investments increased from 4.82% to 5.60% providing an increase of $459 thousand in interest income from June 30, 2006 compared to June 30, 2007.
 
Interest expense on deposits increased by $6.8 million for the first six months in 2007 compared to the first six months in 2006, from $8.1 million to $14.9 million. This increase was partially due to the increase in the average balance of our interest bearing deposits from $477.3 million at June 30, 2006 to $686.2 million at June 30, 2007, resulting in an increase of $3.6 million in interest expense. The average rate on deposits increased to 4.39% for the first six months in 2007 from 3.44% in the first six months of 2006 which resulted in an increase of $3.2 million in interest expense.
 
Over the past year, we have funded our incremental earning asset growth with public fund deposits (primarily money market), brokered CDs, retail CDs, and retail money market specials. As of June 30, 2007, public fund deposits were $166.7 million, or 19.9% of our total deposits of $838.5 million, compared to $95.1 million, or 13.4% of our total deposits of $711.7 million at June 30, 2006. Wholesale CDs were $137.3 million, or 16.4% of our deposits at June 30, 2007, compared to $97.8 million, or 13.7% of our deposits at June 30, 2006. Our borrowings and repurchase agreements increased $30.3 million from $97.9 million at June 30, 2006 to $128.2 million at June 30, 2007.
 
Interest expense on other borrowings had a modest decrease of $138 thousand for the first six months in 2007 compared to the first six months in 2006, due to a decrease in volume offset by increased borrowing rates.
 
The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield and cost of funds for the periods presented. Average balances are


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derived from daily balances, and non-accrual loans are included as interest earning assets for purposes of this table.
 
                                                 
    Six Months Ended
 
    June 30,  
    2007     2006  
          Interest
                Interest
       
    Average
    Income
    Average
    Average
    Income
    Average
 
    Balance     (Expense)     Rates(3)     Balance     (Expense)     Rates(3)  
    (Dollars in thousands)  
 
Assets
Earning Assets:
                                               
Loans (Interest and fees)(1)
  $ 732,290     $ 32,367       8.91 %   $ 633,080     $ 25,806       8.22 %
Federal funds sold
    2,360       54       4.61 %     6,546       151       4.65 %
Investment securities(2)
    205,870       5,717       5.60 %     104,257       2492       4.82 %
                                                 
Total earning assets and interest income
    940,520       38,138       8.18 %     743,883       28,449       7.71 %
Other assets:
                                               
Cash and due from banks
    14,511                       14,905                  
Bank premises and equipment
    30,525                       20,607                  
Other assets
    52,747                       48,868                  
Allowance for credit losses
    (9,286 )                     (8,656 )                
                                                 
Total assets
  $ 1,029,017                     $ 819,607                  
                                                 
Liabilities and Shareholders Equity
                                               
Interest bearing liabilities:
                                               
Deposits:
                                               
Savings, NOW, MMDA
  $ 331,345     $ (6,233 )     3.79 %   $ 192,223     $ (1,892 )     1.98 %
Time deposits
    354,872       (8,714 )     4.95 %     285,087       (6,244 )     4.42 %
                                                 
Total interest bearing deposits
    686,217       (14,947 )     4.39 %     477,310       (8,136 )     3.44 %
Other borrowings
    143,334       (3,890 )     5.47 %     158,139       (4,028 )     5.14 %
                                                 
Total interest bearing liabilities and interest expense
    829,551       (18,837 )     4.58 %     635,449       (12,164 )     3.86 %
Non interest bearing liabilities
    104,117                       100,038                  
Other liabilities
    9,459                       6,979                  
Shareholders equity
    85,890                       77,141                  
                                                 
Total liabilities and shareholders equity
  $ 1,029,017                     $ 819,607                  
                                                 
Net interest income
          $ 19,301                     $ 16,285          
                                                 
Net interest margin as a percent of average earning assets
                    4.14 %                     4.41 %
                                                 
 
 
(1) Average loan balance includes non-accrual loans. Loan fees and late charges of $1,826 thousand and $1,295 thousand are included in interest for the six months ended June 30, 2007 and 2006, respectively.
 
(2) The yield on investment securities is calculated using historical cost basis. The yield on assets is calculated on a pre-tax, book value basis which does not consider the effect of tax exempt securities.
 
(3) Annualized


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An analysis of the change in net interest income is set forth on the following table. Changes due to both rate and volume are allocated in proportion to the relationship of the absolute dollar amounts of the change in each. Balances of non-accrual loans, if any, and related income recognized have been included for purposes of this table.
 
                         
    For the Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006  
    Total Change     Rate     Volume  
    (Dollars in thousands)  
 
Interest earned on:
                       
Loans
  $ 6,561     $ 2,295     $ 4,266  
Federal Funds sold and deposits in banks
    (97 )     (1 )     (96 )
Investment Securities
    3,225       459       2,766  
Total interest income
    9,689       2,753       6,936  
                         
Interest paid on:
                       
Savings, NOW, MMDA
    4,341       2,419       1,922  
Time Deposits
    2,470       818       1,652  
Other Borrowings
    (138 )     569       (707 )
Total interest expense
    6,673       3,806       2,867  
                         
Net Interest income
  $ 3,016     $ (1,053 )   $ 4,069  
                         
 
The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
Provision for Credit Losses.  The provision for credit losses is a charge against earnings in that period. The provision is the amount required to maintain the allowance for credit losses at a level that, in management’s judgment, is adequate to absorb estimated loan losses inherent in the loan portfolio.
 
The provision for credit losses for the six months ended June 30, 2007 was $750 thousand compared to $300 thousand for the six months ended June 30, 2006. Net charge-offs for the first and second quarters of 2007 totaled $600 thousand compared to $624 thousand in net charge-offs for the same periods in 2006.
 
The increase in provision expense during the second quarter primarily reflects the growth of our loan portfolio, our assessment of the potential impact on our region of the national economic trends, and our concentration in real estate lending. Each of these components influences our assessment of the adequacy of the Allowance, and we elected to increase the Provision to ensure we are adequately reserved to account for these factors.
 
Non-Interest Income.  The following table presents, for the periods indicated, the major categories of non-interest income.
 
                         
    For the Six Months Ended June 30,     Increase /
 
    2007     2006     (Decrease)  
    (Dollars in thousands)  
 
Non-Interest Income
                       
Service charges on deposit accounts
  $ 1,955     $ 1,979     $ (24 )
Origination fees and gain on sales of loans
    865       882       (17 )
Net gain on sale of securities
    139       27       112  
Income from bank owned life insurance
    515       319       196  
Gross income from Venture Wealth Management
    327       332       (5 )
Other non-interest income
    1,029       711       318  
                         
Total non-interest income
  $ 4,830     $ 4,250     $ 580  
                         


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Total non-interest income increased $500 thousand or 11.6% to $4.8 million for the six months ended June 30, 2007 compared to $4.3 million for the six months ended June 30, 2006. The increase was primarily due to a $139 thousand gain on sale of securities for the six months ended June 30, 2007 compared to the $27 thousand gain on sale of securities for the same period in 2006. An increase in income of bank owned life insurance in the amount of $196 thousand also contributed to the increase as well as an increase of $318 thousand of other non-interest income. The increase in other non-interest income was primarily due to income of $194 thousand associated with the change in fair value of junior subordinated debentures for the six months ended June 30, 2007, $75 thousand insurance reimbursement of legal fees and $60 thousand for a semi-annual installment fee under the merchant service agreement with a third party vendor.
 
Non-Interest Expense.  The following table presents, for the periods indicated, the major categories of non-interest expense.
 
                         
    For the Six Months Ended June 30,     Increase/
 
    2007     2006     (Decrease)  
    (Dollars in thousands)  
 
Non-Interest Expense
                       
Salaries and employee benefits
  $ 7,794     $ 6,840     $ 954  
Occupancy and equipment
    2,292       2,092       200  
Advertising/public relations
    1,064       903       161  
Amortization of intangible assets
    143       143        
Office supplies, telephone and postage
    481       398       83  
Director fees
    87       86       1  
Expense from foreclosed assets
    12       31       (19 )
Washington State excise tax
    683       442       241  
Other non-interest expense
    1,751       1,717       34  
                         
Total non-interest expense
  $ 14,307     $ 12,652     $ 1,655  
                         
 
Total non-interest expense increased 12.6% or $1.6 million to $14.3 million for the six months ended June 30, 2007 compared to $12.7 million for the six months ended June 30, 2006. Salaries and benefits represent the largest component of non-interest expense, which increased $954 thousand, or 13.9%, primarily due to internal growth. The number of full time equivalent employees increased to 250 as of June 30, 2007 compared to 223 at June 30 2006. Occupancy costs and equipment expenses increased $200 thousand or 9.6% for the six months ended June 30, 2007 from the six months ended June 30, 2006 due to the building and relocation of the administrative offices and the addition of two new financial centers as well as increased real estate property taxes and depreciation expense. Other non-interest expense did not change significantly for the six months ended June 30, 2007 from the same period in 2006. It is comprised mainly of legal, accounting, consulting, ATM processing fees, and insurance expense.
 
Provision for Income Taxes.  We recorded tax provisions of $2.7 million for the six months ended June 30, 2007 compared to $2.6 million for the six months ended June 30, 2006. Our effective tax rate was approximately 29.9% for the six months ended June 30, 2007 and approximately 34.8% for the six months ended June 30, 2006. The effective tax rate in 2007, has been lower than our historical effective tax rate primarily due to an overall increase in permanent tax differences and an adjustment to reflect the re-evaluation of our taxes payable. We expect our effective tax rate to range between 30% and 34% for the remainder of 2007 depending on our mix of assets.


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Comparison of the Years Ended December 31, 2006 and 2005
 
                         
    For the Years Ended December 31,        
    2006     2005     Increase  
    (Dollars in thousands
 
    except per share data)  
 
Interest income
  $ 64,671     $ 41,379     $ 23,292  
Interest expense
    28,855       12,932       15,923  
                         
Net interest income
    35,816       28,447       7,369  
Provision for credit losses
    1,075       753       322  
                         
Net interest income after provision for credit losses
    34,741       27,694       7,047  
Non-interest income
    8,666       8,210       456  
Non-interest expense
    26,668       22,800       3,868  
                         
Income before provision for income taxes
    16,739       13,104       3,635  
Provision for income taxes
    5,670       4,076       1,594  
                         
Net income
  $ 11,069     $ 9,028     $ 2,041  
                         
Earnings per share — basic
  $ 1.54     $ 1.33     $ 0.21  
                         
Earnings per share — diluted
  $ 1.52     $ 1.30     $ 0.22  
                         
 
Our net income grew by 22.6% to $11.1 million for the year ended December 31, 2006 as compared to $9.0 million for the year ended December 31, 2005. In 2006, net income increased primarily due to growth in our loan and investment portfolios and the effect of a full year of operations from the Redmond National Bank acquisition, which we completed in September 2005. Our return on average equity was 14.05% and return on average assets was 1.25% for the year ended December 31, 2006 compared to 14.87% and 1.46% for the year ended December 31, 2005.
 
Net Interest Income and Net Interest Margin.  Net interest income in 2006 increased over 2005 by $7.4 million or 25.9%. In 2006, net interest income increased largely from the increased volume in loans and investments coupled with the fact that the volume of assets earning interest increased at a faster rate than interest-earning liabilities.
 
During 2005 and the first half of 2006 interest rates increased rapidly. The Federal Reserve increased its target federal funds rate by 200 basis points in 2005 and 100 basis points in 2006. The prime rate, as published in The Wall Street Journal, is based on a survey of what the 30 largest banks charge their customers. In recent years, the prime rate has moved in lockstep at a 300 basis point margin above the federal funds rate. The published prime rate is used as a base index on many of our loans. As rates increased in 2005, our net interest margin declined. The effect of a rising rate environment started to impact net interest income in 2005 because the increases in loan and investment rates lagged behind the deposit and borrowing rate increases. As market rates increased in 2005 and 2006, rates on deposits and borrowings increased at a much faster pace than rates on interest-earning assets.
 
Over the two year period of 2006 and 2005, market rates increased 300 basis points and our net interest margin declined from 4.93% to 4.44%. This 49 basis point decrease in the margin was due to two factors: (1) deposits repriced upward at a faster pace than loans and investments in a rising rate environment and (2) a larger percentage of assets were held in securities.
 
Interest earned on federal funds sold and interest bearing deposits decreased by $128 thousand in 2006 over the prior year. The most significant reason for this decrease was the change in average volume from $12.4 million to $6.3 million, generating a decrease in interest income in the amount of $241 thousand. The volume decreased and was shifted to higher yielding assets. The decrease in volume was offset by the increase in yield which increased from 3.32% to 4.46%, generating an additional $113 thousand in interest income from the rate increases. Interest earned on investments increased by $3.7 million in 2006 over the prior year


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primarily due to an increase in volume of debt securities which went from $71.8 million to $131.2 million. The yield on investments increased from 4.08% to 5.09% providing $862 thousand in interest income from December 31, 2005 to December 31, 2006.
 
The largest component of interest income is interest earned on loans. Total interest income earned from loans in 2006 increased by $19.7 million; the net effect of an increase of $14.8 million due to an increase in the average volume of loans during the year plus an increase in the average yield on loans of $4.9 million. The average yield on loans increased from 7.72% from December 31, 2005 to 8.63% at December 31, 2006.
 
Interest expense on deposits in 2006 increased 181.5% or $13.8 million from 2005, largely due to the increase in volume and rate of interest paid on time deposits. The average rate increased on time deposits to 4.60% in 2006 from 3.28% in 2005 which resulted in an increase of $2.7 million in interest expense. In 2006, the average volume of time deposits increased $158.3 million from the average 2005 balance causing an increase in interest expense of $6.7 million. The total impact to interest expense from time deposits from both volume and rate movements was $9.4 million. Interest bearing checking (negotiable order of withdrawal or “NOW”), savings and money market deposit accounts (“MMDA”) also contributed to the increase in interest expense. The average rate on these accounts increased to 2.82% in 2006 from 1.33% in 2005 which resulted in an increase of $3.4 million in interest expense. The average year-to-date volume of NOW, savings and MMDA increased $61.7 million from the average year-to-date 2005 balance causing an increase in interest expense of $1.0 million. Interest expense on other borrowings increased $2.2 million from $5.3 million in 2005 to $7.5 million in 2006. The increase in the average interest rate for other borrowings to 5.31% from 3.90% cost $2.0 million in interest expense including junior subordinated debentures which were tied to LIBOR (London Inter-Bank Offering Rate index) and increased from a weighted average rate of 7.66% at December 31, 2005 to 8.93% at December 31, 2006.
 
Over the two year period of 2006 and 2005, market rates moved up 300 basis points and Venture Bank’s net interest margin declined from 4.93% to 4.44%.


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The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield and cost of funds for the periods presented. Average balances are derived from daily balances, and non-accrual loans are included as interest earning assets for purposes of this table.
 
                                                   
    December 31,  
    2006       2005  
          Interest
                  Interest
       
    Average
    Income
    Average
      Average
    Income
    Average
 
    Balance     (Expense)     Rates       Balance     (Expense)     Rates  
    (Dollars in thousands)  
                                       
Assets
                                                 
Earning Assets:
                                                 
Loans(1)
  $ 668,443     $ 57,717       8.63 %     $ 492,506     $ 38,043       7.72 %
Federal funds sold and interest bearing deposits in banks
    6,325       282       4.46 %       12,357       410       3.32 %
Investment securities(2)
    131,177       6,672       5.09 %       71,765       2,926       4.08 %
                                                   
Total earning assets and interest income
    805,945       64,671       8.02 %       576,628       41,379       7.19 %
Other Assets:
                                                 
Cash and due from banks
    14,904                         16,611                  
Bank premises and equipment
    22,989                         15,458                  
Other assets
    52,478                         25,542                  
Allowance for credit losses
    (8,583 )                       (7,631 )                
                                                   
Total Assets
  $ 887,733                       $ 626,608                  
                                                   
Liabilities and Shareholders’ Equity
                                                 
Interest bearing liabilities:
                                                 
Deposits:
                                                 
NOW,Savings, and MMDA
  $ 239,261     $ (6,754 )     2.82 %     $ 177,577     $ (2,355 )     1.33 %
Time deposits
    318,055       (14,619 )     4.60 %       159,788       (5,237 )     3.28 %
                                                   
Total interest bearing deposits
    557,316       (21,373 )     3.83 %       337,365       (7,592 )     2.25 %
Other borrowings
    140,881       (7,482 )     5.31 %       136,780       (5,340 )     3.90 %
                                                   
Total interest bearing liabilities and interest expense
    698,197       (28,855 )     4.13 %       474,145       (12,932 )     2.73 %
                                                   
Non-interest bearing deposits
    103,057                         83,670                  
Other liabilities
    7,701                         5,681                  
Shareholders’ equity
    78,778                         63,112                  
                                                   
Total liabilities, shareholders’ equity and net interest income
  $ 887,733     $ 35,816               $ 626,608     $ 28,447          
                                                   
Net interest income as a percentage of average of earnings assets:
                                                 
Interest Income
                    8.02 %                       7.19 %
Interest Expense
                    4.13 %                       2.73 %
                                                   
Net Interest Margin
                    4.44 %                       4.93 %
                                                   
                                                   


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(1) Average loan balance includes non-accrual loans. Interest income on non-accrual loans has been included. Loan fees and late charges of $3.3 and $2.3 are included in interest income in 2006 and 2005, respectively.
 
(2) The yield on investment securities is calculated using historical cost basis. The yield on assets is calculated on a pre-tax, book value basis, which does not consider the effect of tax exempt securities.
 
An analysis of the change in net interest income is set forth in the following table:
 
                         
    Twelve Months Ended December 31, 2006
 
    Compared to Twelve Months Ended December 31, 2005  
    Total Change     Rate     Volume  
    (Dollars in thousands)  
 
Interest earned on:
                       
Loans
  $ 19,674     $ 4,880     $ 14,794  
Federal Funds sold and deposits in banks
    (128 )     113       (241 )
Investment Securities
    3,746       862       2,884  
                         
Total interest income
    23,292       5,855       17,437  
Interest paid on:
                       
Savings, NOW, MMDA
    4,400       3,365       1,035  
Time Deposits
    9,381       2,709       6,672  
Other Borrowings
    2,142       1,977       165  
                         
Total interest expense
    15,923       8,051       7,872  
                         
Net Interest income
  $ 7,369     $ (2,196 )   $ 9,565  
                         
 
The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
Non-Interest Income.  The following table presents, for the periods indicated, the major categories of non-interest income.
 
                         
    Year Ended December 31,     Increase/
 
    2006     2005     (Decrease)  
    (Dollars in thousands)  
 
Non-Interest Income
                       
Service charges on deposit accounts
  $ 3,953     $ 3,569     $ 384  
Origination fees and gain on sales of loans
    1,809       1,634       175  
Net gain (loss) on sale of securities
    52       0       52  
Income from bank owned life insurance
    693       722       (29 )
Gross income from Venture Wealth Management
    751       507       244  
Other non-interest income
    1,408       1,778       (370 )
                         
Total non-interest income
  $ 8,666     $ 8,210     $ 456  
                         
 
Total non-interest income increased $456 thousand in 2006 to $8.7 million. The 5.6% increase over the same period in 2005 is primarily due to service charges on deposit accounts increasing by 10.8%, mainly due to increases in both NSF income and bounce protection fee income. Origination fees and gains on the sale of residential real estate loans increased in 2006 by $175 thousand or 10.7% over 2005 mainly due to a higher volume of loans sold. Venture Wealth Management increased its gross income 48.1% due to increased sales and commissions, due to the hiring of a new President of the subsidiary and improved market conditions. Other non-interest income decreased 20.8% primarily due to a one time recognition in 2005 of other income


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related to a demutualization of an insurance policy in the amount of $260 thousand and to the termination of a small loan (payday lending) contract in which the we received $170 thousand.
 
Non-Interest Expense.  The following table presents, for the periods indicated, the major categories of non-interest expense.
 
                         
    Year Ended December 31,     Increase/
 
    2006     2005     (Decrease)  
    (Dollars in thousands)  
 
Non-Interest Expense
                       
Salaries and employee benefits
  $ 14,985     $ 12,093     $ 2,892  
Occupancy and equipment
    4,072       3,754       318  
Advertising/public relations
    1,119       981       138  
Amortization of intangible assets
    287       155       132  
Office supplies, telephone and postage
    843       736       107  
Director fees
    178       130       48  
Expense from foreclosed assets
    34       105       (71 )
Washington State excise tax
    1,047       708       339  
Other non-interest expense
    4,103       4,138       (35 )
                         
Total non-interest expense
  $ 26,668     $ 22,800     $ 3,868  
                         
 
Total non-interest expense increased 17.1% or $3.9 million in 2006 compared to 2005. Salaries and benefits represent the largest component of non-interest expense, and increased $2.9 million, or 24.0%, primarily due to the Redmond National Bank acquisition; in 2006 those employees were employed for a full year compared to only four months in 2005 from the date of acquisition in September 2005. Employee bonuses were also higher in 2006 from 2005 due to our increased profitability. We hired an additional 23 employees and the related salaries and benefits are reflected in 2006. Occupancy costs and equipment expenses increased $318 thousand or 8.5% in 2006 from 2005 due to increased real estate property taxes, maintenance contracts, and depreciation expense. Other expenses in 2006 increased $658 thousand or 9.5% over 2005 mainly due to increase in advertising and public relations, business and occupation (excise) taxes and travel expenses. Other non-interest expense did not change significantly from 2005 to 2006. It is comprised mainly of legal, accounting, consulting, ATM processing fees, and insurance expense.


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Comparison of the Years Ended December 31, 2005 and 2004
 
                                 
    For the Years Ended December 31,     Increase/
       
    2005     2004     (Decrease)        
    (Dollars in thousands
       
    except per share data)        
 
Interest income
  $ 41,379     $ 31,828     $ 9,551          
Interest expense
    12,932       6,694     $ 6,238          
                                 
Net interest income
    28,447       25,134       3,313          
Provision for credit losses
    753       227       526          
                                 
Net interest income after provision for credit losses
    27,694       24,907       2,787          
Non-interest income
    8,210       13,569       (5,359 )        
Non-interest expense
    22,800       21,078       1,722          
                                 
Income before provision for income taxes
    13,104       17,398       (4,294 )        
Provision for income taxes
    4,076       5,621       (1,545 )        
                                 
Net income
  $ 9,028       11,777       (2,749 )        
                                 
Earnings per share — basic
  $ 1.33     $ 1.82     $ (0.49 )        
                                 
Earnings per share — diluted
  $ 1.30     $ 1.77     $ (0.47 )        
                                 
 
Net income for the year ended December 31, 2005 was $9.0 million compared to $11.8 million in 2004 including an after tax gain of $3.5 million in 2004 on the divestiture of seven financial centers. Excluding such gain in 2004, net income would have been $8.3 million.
 
Our return on average equity and return on average assets were 14.87% and 1.46% for the year ended December 31, 2005 compared to 22.99% and 2.23% respectively, for the prior year. Excluding the one time gain from the sale of seven financial centers, return on average equity and return on average assets for the year ended December 31, 2004 would have been 16.32% and 1.56% respectively. The return on average equity and return on average assets ratios that exclude the one-time gain in 2004 from the sale of seven financial centers are non-GAAP financial measures that we believe provide information useful in understanding our financial performance.
 
We acquired Washington Commercial Bancorp and its wholly owned subsidiary Redmond National Bank on September 2, 2005. Total assets, loans and deposits of Redmond National Bank on the date of acquisition were $131.8 million, $107.1 million, and $86.9 million, respectively. The effect on 2005 net income was not material as the net revenues generated were largely offset by costs related to the acquisition and integration of personnel and information systems.
 
Net Interest Income and Net Interest Margin.  Net interest income increased in 2005 by $3.3 million from 2004. In 2005, net interest income increased largely from increased volume in loans coupled with the fact that the volume of assets earning interest increased at a faster rate than the liabilities earning interest in both 2005 and 2004.
 
Prior to 2004, interest rates were declining. In 2004 and 2005 rates increased rapidly with The Wall Street Journal published prime rate increasing 125 basis points and 200 basis points, respectively. The effect of a rising rate environment did not impact net interest income until 2005 because the increases in loan rates lagged behind the market rate increases. As market rates increased in 2004 and 2005, rates on liabilities, however, increased at a much faster pace than rates on interest-earning assets.
 
During 2005, our net interest margin decreased 35 basis points to 4.93% from 5.28% in 2004. The decrease was largely attributable to the shift in the mix of our liabilities from lower rate deposits to higher rate time deposits and long term borrowings. In 2004, we sold $88.0 million of deposits in connection with the divestiture of seven financial centers. We replaced those deposits with higher cost funding.


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Interest earned on federal funds sold and interest bearing deposits increased by $386 thousand over the prior year. The most significant reason for this increase was additional volume which increased from an average volume of $2.2 million to $12.4 million, generating an additional $266 thousand in additional interest income. The yield on federal funds sold increased from 1.08% to 3.32%, generating an additional $120 thousand in interest income.
 
Interest earned on investments decreased by $270 thousand over the prior year. The most significant reason for this decrease was a reduction in volume which went from $78.9 million to $71.8 million causing a decrease in income of $281 thousand. The majority of this decrease in volume was due to $14.7 million principal payments and other investment maturities. The yield on investments increased from 4.05% to 4.08% providing $11 thousand in interest income.
 
The largest component of interest income is interest earned on our loan portfolio. Total interest income earned from loans in 2005 increased by $9.4 million, the net effect of an increase of $7.5 million due to an increase in the average volume of loans during the year, as well as an increase in the average yield on loans of $1.9 million. The average yield on loans increased from 7.25% in 2004 to 7.72% in 2005. The increase in interest yield was due primarily to the segment of our variable rate loans tied to a variety of indices affected by the changes in the prime rate in 2005. The loan rates increased but lagged in comparison to the increase in deposit rates.
 
Interest expense on deposits in 2005 increased 86.9% or $3.5 million from 2004. The increase was largely due to the increase in volume and rate of interest paid on time deposits in particular. The average rate increased on time deposits to 3.28% in 2005 from 2.25% in 2004 which resulted in an increase of $1.3 million in time deposit interest expense. The average volume of time deposits increased $53.8 million from the average 2004 balance which caused an increase in interest expense of $1.5 million. Interest expense on other borrowings increased $2.7 million. The increase in average interest rate to 3.90% from 2.69% cost $1.4 million in interest expense including junior subordinated debentures, which were tied to LIBOR and increased from a weighted average rate of 6.08% in 2004 to 7.66% in 2005. The increase in borrowing volume in 2005 to an average balance of $136.8 million from $97.4 million in 2004 accounted for $1.3 million of the $2.7 million interest expense increase. Short term borrowings decreased $35.3 million or 29% while long term borrowings increased $32.1 million or 93% in 2005. The increase in borrowings was primarily due to the divestiture of branches in 2004 as well as continued loan volume growth.


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The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield and cost of funds for the periods presented. Average balances are derived from daily balances, and non-accrual loans are included as interest earning assets for purposes of this table.
 
                                                   
    December 31,  
    2005       2004  
          Interest
                  Interest
       
    Average
    Income
    Average       Average
    Income
    Average
 
    Balance     (Expense)     Rates       Balance     (Expense)     Rates  
    (Dollars in thousands)  
                                       
Assets
                                                 
Earning Assets:
                                                 
Loans(1)
  $ 492,506     $ 38,043       7.72 %     $ 394,611     $ 28,608       7.25 %
Federal funds sold and interest bearing deposits in banks
    12,357       410       3.32 %       2,220       24       1.08 %
Investment securities(2)
    71,765       2,926       4.08 %       78,870       3,196       4.05 %
                                                   
Total earning assets and interest income
    576,628       41,379       7.19 %       475,701       31,828       6.69 %
Other Assets:
                                                 
Cash and due from banks
    16,611                         19,613                  
Bank premises and equipment
    15,458                         12,198                  
Other assets
    25,542                         28,875                  
Allowance for credit losses
    (7,631 )                       (7,506 )                
                                                   
Total Assets
  $ 626,608                       $ 528,881                  
                                                   
Liabilities and Shareholders’ Equity Interest bearing liabilities:
                                                 
Deposits:
                                                 
NOW, Savings, and MMDA
  $ 177,577     $ (2,355 )     1.33 %     $ 185,880     $ (1,677 )     0.90 %
Time deposits
    159,788       (5,237 )     3.28 %       105,940       (2,386 )     2.25 %
                                                   
Total interest bearing deposits
    337,365       (7,592 )     2.25 %       291,820       (4,063 )     1.39 %
Other borrowings
    136,780       (5,340 )     3.90 %       97,373       (2,631 )     2.69 %
                                                   
Total interest bearing liabilities and interest expense
    474,145       (12,932 )     2.73 %       389,193       (6,694 )     1.72 %
                                                   
Non-interest bearing deposits
    83,670                         85,690                  
Other liabilities
    5,681                         2,767                  
Shareholders’ equity
    63,112                         51,231                  
                                                   
Total liabilities, shareholders’ equity and net interest income
  $ 626,608     $ 28,447               $ 528,881     $ 25,134          
                                                   
Net interest income as a percentage of average of earnings assets:
                                                 
Interest Income
            7.19 %                               6.69 %
Interest Expense
            2.73 %                               1.72 %
                                                   
Net Interest Margin
            4.93 %                               5.28 %
                                                   
 
 
(1) Average loan balance includes non-accrual loans. Interest income on non-accrual loans has been included. Loan fees and late charges of $2.3 and $1.5 million are included in interest income in 2005 and 2004, respectively.


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(2) The yield on investment securities is calculated using historical cost basis. The yield on assets is calculated on a pre-tax, book value basis, which does not consider the effect of tax exempt securities.
 
An analysis of the change in net interest income is set forth in the following table:
 
                         
    Twelve Months Ended December 31, 2005
 
    Compared to Twelve Months Ended December 31, 2004  
    Total Change     Rate     Volume  
    (Dollars in thousands)  
 
Interest earned on:
                       
Loans
  $ 9,435     $ 1,900     $ 7,535  
Federal Funds sold and deposits in banks
    386       120       266  
Investment Securities
    (270 )     11       (281 )
                         
Total interest income
    9,551       2,031       7,520  
Interest paid on:
                       
Savings, NOW, MMDA
    678       756       (78 )
Time Deposits
    2,851       1,347       1,504  
Other Borrowings
    2,708       1,418       1,290  
                         
Total interest expense
    6,237       3,521       2,716  
                         
Net Interest income
  $ 3,314     $ (1,490 )   $ 4,804  
                         
 
The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
Non-Interest Income.  The following table presents, for the periods indicated, the major categories of non-interest income.
 
                         
    December 31,     Increase /
 
    2005     2004     (Decrease)  
 
Non-Interest Income
                       
Service charges on deposit accounts
  $ 3,569     $ 3,803     $ (234 )
Origination fees and gain on sales of loans
    1,634       1,325       309  
Net gain (loss) on sale of securities
    0       (21 )     21  
Income from bank owned life insurance
    722       675       47  
Gain on branch divestiture
    0       5,462       (5,462 )
Gross income from Venture Wealth Management
    507       530       (23 )
Other non-interest income
    1,778       1,795       (17 )
                         
Total non-interest income
  $ 8,210     $ 13,569     $ (5,359 )
                         
 
Total non-interest income decreased $5.4 million in 2005 from 2004 to $8.2 million. The 39.5% decrease was primarily due to the inclusion of a one-time $5.5 million gain on the divestiture of seven financial centers in 2004. Excluding the one-time gain, non-interest income was $8.2 million in 2004. Service charges on deposit accounts decreased in 2005 by $234 thousand or 6.2% over 2004, largely due to the divestiture of seven financial centers in late 2004. Origination fees and gains on sale of loans increased $309 thousand or 23% from 2004 to 2005.


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Non-Interest Expense.  The following table presents, for the periods indicated, the major categories of non-interest expense.
 
                         
    Year Ended December 31,     Increase /
 
    2005     2004     (Decrease)  
    (Dollars in thousands)  
 
Non-Interest Expense
                       
Salaries and employee benefits
  $ 12,093     $ 10,675     $ 1,418  
Occupancy and equipment
    3,754       3,461       293  
Advertising / public relations
    981       820       161  
Amortization of intangible assets
    155       110       45  
Office supplies, telephone and postage
    736       757       (21 )
Director fees
    130       233       (103 )
Expense from foreclosed assets
    105       217       (112 )
Washington State excise tax
    708       592       116  
Other non-interest expense
    4,138       4,213       (75 )
                         
Total non-interest expense
  $ 22,800     $ 21,078     $ 1,722  
                         
 
Total non-interest expense increased $1.7 million or 8% in 2005 compared to 2004. In 2005, salaries and benefits, the largest component of non-interest expense, increased $1.4 million or 13% over 2004 due largely to the expansion of our mortgage loan originations operation and commission income paid and the effect of the additional employees from Redmond National Bank. Occupancy costs and equipment expenses increased $293 thousand or 8% in 2005 due primarily to the continued financial center facility branding and remodeling and the opening of two new financial centers. Other non-interest expense individual items did not change significantly from 2004 to 2005. It is comprised mainly of legal, accounting, consulting, ATM processing fees, and insurance expense.
 
Financial Condition
 
Our total consolidated assets at June 30, 2007, December 31, 2006 and December 31, 2005 were $1.1 billion, $978.1 million and $752.8 million, respectively. Total deposits at June 30, 2007, December 31, 2006 and December 31, 2005 were $838.5 million, $771.3 million and $514.0 million, respectively.
 
Loans
 
Total loans and loans held for sale at June 30, 2007, December 31, 2006 and December 31, 2005 were $747.0 million, $716.1 million and $602.3 million, respectively, an annual increase of 12.2% (from June 30, 2006), 18.9% and 39.2% over the prior period, respectively. Our loan growth has been focused in commercial and real estate construction lending.


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The following table sets forth the relative composition of our loan portfolio at the end of the periods indicated:
 
                                                                 
    June 30,
    December 31,  
    2007     2006     2005     2004  
    (Dollars in thousands)  
 
Commercial
  $ 87,730       11.7 %   $ 75,017       10.5 %   $ 74,921       12.4 %   $ 58,556       13.5 %
Real Estate
                                                               
Residential 1-4
    34,159       4.6 %     40,371       5.6 %     15,777       2.6 %     9,415       2.2 %
Commercial
    269,389       36.1 %     276,637       38.6 %     310,284       51.5 %     250,947       58.0 %
Construction
    344,676       46.2 %     305,606       42.8 %     187,514       31.2 %     101,509       23.5 %
Consumer
    6,287       0.8 %     13,822       1.9 %     8,140       1.4 %     5,275       1.2 %
Small Loans
    0       0.0 %     0       0.0 %     0       0.0 %     3,821       0.9 %
                                                                 
Total Loans
    742,241       99.4 %     711,453       99.4 %     596,636       99.1 %     429,523       99.3 %
Loans Held for Sale
    4,802       0.6 %     4,642       0.6 %     5,699       0.9 %     3,118       0.7 %
                                                                 
Total Loans and Loans Held for Sale
  $ 747,043       100.0 %   $ 716,095       100.0 %   $ 602,335       100.0 %   $ 432,641       100.0 %
                                                                 
 
The following tables show the amounts of loans as of June 30, 2007 and December 31, 2006. Of the loans maturing after one year, as of June 30, 2007, $89.7 million had fixed interest rates and $245.5 million had adjustable interest rates, and as of December 31, 2006, $68 million had predetermined or fixed interest rates and $264 million had floating or adjustable interest rates. As of June 30, 2007, 76.9% of our floating rate loans were tied to the prime rate.
 
As of June 30, 2007:
 
                                 
          Maturity
    After
       
    Within
    After One But
    Five
       
    One Year     Within Five Years     Years     Total  
    (Dollars in thousands)  
 
Commercial
  $ 64,237     $ 17,348     $ 6,145     $ 87,730  
Real Estate
                               
Residential 1-4
    15,185       4,086       14,887       34,158  
Commercial
    58,236       61,582       149,569       269,387  
Construction
    273,954       60,892       9,832       344,678  
Consumer and other
    1,211       1,135       3,942       6,288  
                                 
Total
  $ 412,823     $ 145,043     $ 184,375     $ 742,241  
                                 
 
As of December 31, 2006:
 
                                 
          Maturity
    Five
       
    Within
    After One But
    Years
       
    One Year     Within Five Years     After     Total  
    (Dollars in thousands)  
 
Commercial
  $ 52,568     $ 13,182     $ 9,267     $ 75,017  
Real Estate
                               
Residential 1-4
    22,046       6,448       11,877       40,371  
Commercial
    71,155       53,191       152,291       276,637  
Construction
    259,814       41,913       3,879       305,606  
Consumer and other
    8,288       2,040       3,494       13,822  
                                 
Total
  $ 413,871     $ 116,774     $ 180,808     $ 711,453  
                                 
 
Concentrations.  As of June 30, 2007, in management’s judgment, a concentration of loans existed in real estate related loans. At June 30, 2007, our portfolio was centered in real estate loans with construction loans at 46.2% of the portfolio, commercial real estate loans at 36.1% and residential 1-4 family units at 4.6%. Although management believes the loans within the real estate related concentration have no more than the


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normal risk of collectibility, a substantial decline in the performances of the economy, in general, or a decline in real estate values in our market areas, in particular, could have an adverse impact on collectibility, increase the level of real estate related non-performing loans, or have other adverse effects which alone or in the aggregate could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
 
Asset Quality.  Generally, loans are placed on non-accrual status when they become 90 days or more past due or at such earlier time as management determines timely recognition of interest to be in doubt. Accrual of interest is discontinued on a loan when management believes collection of interest is unlikely after considering economic and business conditions and collection efforts.
 
The following table summarizes our non-performing assets, which consist of loans on which interest is no longer accrued, accruing loans past due 90 days or more, foreclosed real estate and other assets.
 
                 
    June 30,
    December 31,
 
    2007     2006  
    (Dollars in thousands)  
 
Non-accrual loans
  $ 674     $ 691  
Accruing loans past due 90 days or more
           
Total non-performing loans (NPLs)
    674       691  
Foreclosed real estate
    68       34  
Other assets
           
                 
Total non-performing assets (NPAs)
  $ 742     $ 725  
                 
Selected ratios
               
NPLs to total loans
    0.09 %     0.10 %
NPAs to total loans and foreclosed real estate
    0.09 %     0.10 %
NPAs to total assets
    0.07 %     0.07 %
 
Impaired and Non-accrual Loans.  These loans generally are loans for which it is probable that we will not be able to collect all amounts due according to the original contractual terms of the loan agreement. We typically classify these loans as Substandard, Doubtful, or Loss. Impaired loans, specifically Substandard or Doubtful loans, may not be on non-accrual status as we continue to accrue interest if borrowers continue to make payments. By definition, the category “impaired loans” is broader than the category “non-accrual loans.” Non-accrual loans are those loans on which the accrual of interest is discontinued when collectibility of principal and interest is uncertain or payments of principal or interest have become contractually past due 90 days. Management may choose to categorize a loan as impaired, i.e. Substandard, Doubtful or Loss, due to payment delinquency or uncertain collectibility, and will closely monitor the loan to ensure performance and collection of amounts due in accordance with the original contractual terms of the loan.
 
The following table summarizes our non-accrual loans at the periods indicated. Non-accrual loans with valuation allowance refers to the portion of our total non-accrual loans that have been identified as having loss exposure and have a specific amount set aside for them in the Allowance. We refer to the specific amount set aside for these loans as the allocation of the Allowance.
 
                 
    At June 30,
    At December 31,
 
    2007     2006  
    (Dollars in thousands)  
 
Total non-accrual loans
  $ 674     $ 691  
Non-accrual loans with valuation allowance
  $ 447     $ 365  
Allocation of allowance for credit losses
  $ 213     $ 116  
 
Gross interest income of $35 thousand would have been recorded for the six months ended June 30, 2007 if the non-accrual loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination. Interest income on these loans was not included in net income in 2007.


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As of June 30, 2007, there were no loans as to which we had serious doubts about the ability of the borrower to comply with the loan repayment terms and which may result in disclosure of these loans as non-accrual loans.
 
Foreclosed Real Estate.  As of June 30, 2007, we held two foreclosed properties, represented by two single family residential building lots. The carrying value of the properties aggregated $68 thousand. As of December 31, 2006, we held one foreclosed property carried at $34 thousand. Valuation occurs when a property is foreclosed upon, and annually thereafter. We typically use the lesser of an appraised value or tax assessed value to establish the carrying values. For the properties noted, we have used assessed value due to the relative amounts involved. The change over the two periods reflected a second property being foreclosed upon, with the December 31, 2006 property included in the June 30, 2007 balance.
 
Allowance for Credit Losses
 
We must maintain an adequate allowance for credit losses, the Allowance, based on a comprehensive methodology that assesses the estimated losses inherent in our loan portfolio. The Allowance reflects our current estimate of the amount required to absorb estimated losses on existing loans and commitments to extend credit. There is no precise method of predicting specific credit losses or amounts that ultimately may be charged off on segments of the loan portfolio. The determination that a loan may become uncollectible, in whole or in part, is a matter of judgment. Similarly, the adequacy of the Allowance is determined based on management’s judgment, and on the analysis of various factors including historical loss experience based on volumes and types of loans; volumes and trends in delinquencies and non-accrual loans; trends in portfolio volume; results of internal credit reviews; and economic conditions.
 
Management conducts a full review of the Allowance on a regular basis, including:
 
  •  consideration of economic conditions and the effect on particular industries and specific borrowers;
 
  •  a review of borrowers’ financial data, together with industry data, the competitive situation, the borrowers’ management capabilities and other factors;
 
  •  a continuing evaluation of the loan portfolio, including monitoring by lending officers and staff, of all loans which are identified as being of less than acceptable quality;
 
  •  an in-depth appraisal, on a monthly basis, of all loans judged to present a possibility of loss (if, as a result of such monthly appraisals, the loan is judged to be not fully collectible, the carrying value of the loan is reduced to that portion considered collectible); and
 
  •  an evaluation of the underlying collateral for secured lending, including the use of independent appraisals of real estate properties securing loans.
 
Our quarterly analysis of the adequacy of the Allowance is reviewed by our Board of Directors. We consider the Allowance to be adequate to cover estimated loan losses relating to the loans outstanding as of each reporting period.
 
Losses on loans are charged against and reduce the Allowance in the period in which such loans, in our opinion, become uncollectible. Recoveries during the period are credited to the Allowance. Periodically, a provision for credit losses is charged to current income. This provision acts to replenish the Allowance and to maintain the Allowance at a level that management deems adequate.
 
Specific Allocations.  All classified loans are evaluated for potential loss exposure. If a loan is classified, our loss exposure on that loan is measured based on expected cash flows or collateral values, and if necessary, a specific portion of the Allowance for credit losses is allocated to that loan.
 
General Allowances.  Each loan officer recommends grades for each loan in their assigned portfolio, beginning at loan inception, and annually thereafter when financial statements of the borrower are received and reviewed. All loan grades require the approval of the manager of Credit Administration and the Chief Lending Officer. Grading changes may also occur if, for example, a loan is delinquent or the collateral deteriorates. Grades range from “excellent” loans graded a “1”, to “loss” loans graded a “7”.


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We perform a portfolio segmentation based on risk grading. The loss factors for each risk grade are determined by management based on management’s assessment of the overall credit quality at quarter end, taking into account various qualitative and quantitative factors such as trends of past due and non-accrual loans, asset classifications, collateral value, loan grades, historical loss experience and economic conditions. The following table sets forth activity in the allowance for credit losses for the periods indicated:
 
                 
    Six Months Ended
    Year Ended
 
    June 30,
    December 31,
 
    2007     2006  
    (Dollars in thousands)  
 
Balance at beginning of period
  $ 8,917     $ 8,434  
Provision for credit losses
    750       1,075  
Charge-offs:
               
Commercial
    (565 )     (804 )
Real Estate Mortgage and Construction
    (44 )      
Consumer
    (5 )     (49 )
                 
Total charge-offs
    (614 )     (853 )
                 
Recoveries:
               
Commercial
    2       128  
Real Estate Mortgage and Construction
    10        
Consumer
    2       133  
                 
Total recoveries
    14       261  
                 
Net charge-offs
    (600 )     (592 )
Balance at end of period
  $ 9,067     $ 8,917  
Gross loans
  $ 747,043     $ 716,095  
Average loans
  $ 732,290     $ 668,443  
Non-performing loans
  $ 674     $ 691  
Selected ratios:
               
Net charge-offs to average loans
    (0.08 )%     (0.09 )%
Provision for credit losses to average loans
    0.10 %     0.16 %
Allowance for credit losses to loans outstanding at end of period
    1.22 %     1.25 %
Allowance for credit losses to non-performing loans
    1345 %     1290 %
 
We allocate the Allowance by assigning general percentages to our major loan categories (construction, commercial real estate, residential real estate, C&I and consumer), and assign specific reserves to each loan rated from 4 through 7.
 
In determining the amount of the general reserve portion of our allowance for loan losses, we consider factors such as our historical loan loss experience, the growth, composition and diversification of our loan portfolio, current delinquency levels, adverse situations that may generally affect groups of borrower’s ability to repay, adverse situations that may affect the estimated value of the underlying collateral of groups of borrowers, the results of recent regulatory examinations and general economic conditions. Our emphasis on continued growth of our loan portfolio through the origination of C&I, commercial real estate, residential real estate, and construction loan categories has been one of the more significant factors we have taken into account in evaluating the general reserve. Based on these factors, we apply estimated percentages to the various categories of loans, based on our historical experience, portfolio trends and economic and industry trends. We use this information to set the general reserve portion of the allowance for loan losses at a level we deem prudent. In accordance with FAS 114, we also make specific allocations on individual loans when factors are present requiring a greater reserve, typically the result of reviews of updated appraisals, or other collateral analysis.


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The following table indicates management’s allocation of the allowance for credit losses among major loan categories:
 
                                 
    June 30,
    December 31,
 
    2007     2006  
          % of
          % of
 
          Total
          Total
 
    Amount     Loans     Amount     Loans  
    (Dollars in thousands)  
 
Commercial
  $ 1,775       19.6 %   $ 2,309       25.9 %
Real Estate
                               
Commercial
    4,325       47.7 %     3,193       35.8 %
Construction
    2,225       24.6 %     2,690       30.2 %
Residential
    687       7.5 %     668       7.5 %
Consumer
    55       0.6 %     57       0.6 %
Small Loans
                       
                                 
Total
  $ 9,067       100.0 %   $ 8,917       100.0 %
                                 
 
We consider many factors to determine the amount and allocation of the Allowance, centered on overall portfolio performance by loan category/type, local and national economic trends, and assessments of categories of collateral. These statistics are measured against our current allocation and our historical loss record for the previous five-year period to aid in assessing the adequacy of the Allowance.
 
For commercial banks, the commercial loans that are not secured by real estate generally represent the highest risk category. The commercial portfolio made up approximately 11.7% of our total loans as of June 30, 2007. While the majority of our historical loan charge-offs have occurred in the commercial portfolio, we believe the Allowance allocation is adequate.
 
Our commercial real estate loans are a mixture of new and seasoned properties, retail, office, warehouse, and some industrial properties. Loans on properties are generally underwritten at a loan-to-value ratio of less than 80% with a minimum debt coverage ratio of 1.20:1. Our grading system allows our loan portfolio, including real estate, to be ranked across three “pass” risk grades. Generally, the real estate loan portfolio is rated as a Grade 3, reflective of the overall quality of the existing portfolio, notwithstanding the various risks inherent in the real estate portfolio, such as large size and complexity of individual credits, and overall concentration of credit risk.
 
Our construction portfolio reflects some borrower concentration risk, and also carries the enhanced risks generally encountered with construction loans. We also finance contractors who construct homes or commercial properties that are not pre-sold. These construction loans are generally more risky than permanent mortgage loans because they are dependent upon the borrower’s ability to complete the construction on time and within budget and then to generate cash to service the loan by selling or leasing the project. The value of the collateral depends on project completion when market conditions may have changed. For these reasons, a higher allocation is sometimes justified in this loan category.
 
We have been engaged in an ongoing and active initiative to ensure we are compliant with both the spirit and letter of the new commercial real estate guidelines promulgated by the regulatory agencies. Our framework for such evolution is multi-faceted and robust in scope, and we believe our systems and methodologies subscribe to the precepts of the guidelines at all levels. Our practices include active and ongoing senior management involvement, including informed oversight by the Board of Directors.
 
Small Loans.  Beginning July 1, 2005 we exited our payday lending relationship. Provisions for credit losses on small loans were made monthly. We allocated a portion of the Allowance at a level sufficient to cover all small loans that have defaulted, as well as an amount sufficient to absorb the anticipated losses on two small loan operating cycles (approximately one month in duration), based both our historical loss experience and that of the industry. Losses in the small loan portfolio were limited by agreement to a percentage of revenue earned from the portfolio by Venture Bank’s agent.


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During a regulatory examination during the fourth quarter of 2004, the FDIC directed us to charge-off all payday loans that had been outstanding to borrowers for 60 days from the original loan date. The FDIC requested that we charge-off the principal balance of loans meeting the above criteria for the periods of December 31, 2003, September 30, 2004 and December 31, 2004. We believed that under generally accepted accounting principles, and based on our actual experience, a total loss of all payday loans outstanding for 60 days from the origination date was not probable, and the specific Allowance allocated to the payday lending portfolio, together with the stop-loss provisions in the marketing and servicing agreement with our payday lending partner, was adequate. All actual charge-offs and recoveries for December 31, 2003 and September 30, 2004 were recognized and run through the Allowance as of December 31, 2003 and September 30, 2004. As a result of the regulatory charge-off, we had a difference between our regulatory accounting principles (RAP) financials and our generally accepted accounting principles (GAAP) financials.
 
The financial entries made for regulatory purposes resulted in a $746 thousand reduction in loan balances with a corresponding reduction in the Allowance as of December 31, 2003. Additional charge-offs of $1.2 million and recoveries of $501 thousand were required for regulatory accounting purposes for the year ended December 31, 2004, and additional charge-offs of $311 thousand and recoveries of $35 thousand were required through June 30, 2005, as compared to the financial statements presented under GAAP.
 
Investment Portfolio
 
The carrying value of our investment securities at June 30, 2007 totaled $236.6 million compared to $162.4 million at December 31, 2006, $60.9 million at December 31, 2005, and $73.3 million at December 31, 2004. Securities available-for-sale are carried at fair value on our balance sheet; securities held-to-maturity are carried at amortized cost. We purchased $133.8 million in securities in the first two quarters, which was offset by maturities, principal pay downs, and sales totaling $51.9 million. We adjusted the portfolio mix during the six months ended June 30, 2007 to include additional mortgage-backed, corporate and equity securities. The risk weighting of securities are considered in purchase decisions to maximize the utilization of capital.


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The recorded amounts of investment securities held by us and their fair value at the dates indicated are set forth in the following table:
 
                                         
                Gross
    Gross
       
                Unrealized
    Unrealized
       
          Gross
    Losses
    Losses
       
    Amortized
    Unrealized
    Less Than
    Greater Than
    Fair
 
    Cost     Gains     12 Months     12 Months     Value  
                (Dollars in thousands)        
 
Securities Available-for-sale
                                       
June 30, 2007
                                       
U. S. Government and agency securities
  $     $     $     $     $  
Mortgage-backed securities
    166,743       1             5,032       161,712  
Municipal securities
    13,144       17             397       12,764  
Corporate Securities
    32,000                         32,000  
Equity securities
    21,987                   1,903       20,084  
                                         
    $ 233,874     $ 18     $     $ 7,332     $ 226,560  
Securities Held-to-maturity
                                       
June 30, 2007
                                       
Corporate Securities
  $ 10,000     $     $     $ 141     $ 9,859  
                                         
Total at June 30, 2007
  $ 243,874     $ 18     $     $ 7,473     $ 236,419  
                                         
December 31, 2006
                                       
U.S. Government and agency securities
  $ 3,974     $ 15     $ 2     $ 20     $ 3,967  
Mortgage backed securities
    127,790       1,145             909       128,026  
Municipal securities
    29,631       796             10       30,417  
Equity securities
    37                         37  
                                         
    $ 161,432     $ 1,956     $ 2     $ 939     $ 162,447  
                                         
 
The following tables show the stated maturities and weighted average yields of investment securities held by us at June 30, 2007 and December 31, 2006:
 
                                                 
    June 30, 2007  
    Held-to-Maturity Securities     Available-For-Sale Securities  
    Amortized
    Fair
    Weighted Average
    Amortized
    Fair
    Weighted Average
 
    Cost     Value     Yield     Cost     Value     Yield(1)  
    (Dollars in thousands)  
 
Due in one year or less
  $     $       %   $ 85     $ 85       7.08 %
Due after one year through five years
                %     798       802       6.92 %
Due after five years through ten years
                %     439       445       6.26 %
Due after ten years
    10,000       9,859       9.99 %     43,822       43,432       6.54 %
No maturity investment
                %     21,987       20,084       5.68 %
Mortgage backed securities
                %     166,743       161,712       5.56 %
                                                 
Total
  $ 10,000     $ 9,859             $ 233,874     $ 226,560          
                                                 
 
 
(1) Weighted average yield is reported on tax-equivalent basis.


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    December 31, 2006  
    Held-to-Maturity Securities     Available-For-Sale Securities  
                Weighted
                   
                Average
    Amortized
    Fair
    Weighted Average
 
    Amortized Cost     Fair Value     Yield     Cost     Value     Yield(1)  
    (Dollars in thousands)  
 
Due in one year or less
  $     $       %   $ 1,085     $ 1,084       4.15 %
Due after one year through five years
                %     1,796       1,786       5.17 %
Due after five years through ten years
                %     2,404       2,440       5.39 %
Due after ten years
                %     28,320       29,074       6.41 %
No maturity investment
                %     37       37       5.38 %
Mortgage backed securities
                %     127,790       128,026       5.83 %
                                                 
Total
  $     $             $ 161,432     $ 162,447          
                                                 
 
 
(1) Weighted average yield is reported on tax-equivalent basis.
 
Deposits
 
Total deposits were $838.5 million at June 30, 2007 compared to $771.3 million at December 31, 2006, $514.0 million at December 31, 2005, and $326.7 million at December 31, 2004. During 2007 and 2006 we looked to the wholesale funding market to augment traditional sources of asset funding. We increased brokered deposits by $48.0 million during the first six months of 2007. As part of our strategy, in 2006 and 2007 we also expanded our market share of deposits of public funds, which represented 19.9% of our total deposits at June 30, 2007 up from 13.4% at June 30, 2006. Interest-bearing deposits are comprised of money market accounts or MMDA, interest-bearing checking accounts, or NOW, savings accounts, time deposits of under $100,000 and time deposits of $100,000 or more.
 
The following table presents average balances not total balances as discussed above. Our average balances of deposits and average interest rates paid for the periods indicated are summarized in the following table.
 
                                                                                                 
    June 30,
    December 31,  
    2007     2006     2005     2004  
                Weighted
                Weighted
                Weighted
                Weighted
 
                Average
    Average
    % of
    Average
    Average
    % of
    Average
    Average
    % of
    Average
 
    Average Balance     % of Total     Rate     Balance     Total     Rate     Balance     Total     Rate     Balance     Total     Rate  
    (Dollars in thousands)  
 
Non-interest checking
  $ 104,117       13.2 %         $ 103,058       15.6 %         $ 83,670       19.9 %         $ 85,690       22.7 %      
                                                                                                 
NOW and MMDA
    308,367       39.0 %     4.18 %     214,246       32.4 %     3.88 %     152,539       36.2 %     1.48 %     153,793       40.7 %     1.11 %
                                                                                                 
Savings accounts
    22,978       2.9 %     0.51 %     25,015       3.8 %     0.54 %     25,038       5.9 %     0.51 %     32,087       8.5 %     0.51 %
                                                                                                 
Time deposits
    354,872       44.9 %     4.95 %     318,054       48.2 %     4.81 %     159,788       38.0 %     3.72 %     105,940       28.1 %     2.50 %
                                                                                                 
                                                                                                 
Total
  $ 790,334       100.0 %           $ 660,373       100.0 %           $ 421,035       100.0 %           $ 377,510       100.0 %        
                                                                                                 
 
The following table shows the maturities of our time deposits:
 
                         
    June 30, 2007  
          $100,000 and
       
    Under $100,000     over     Total  
    (Dollars in thousands)  
 
0-90 days
  $ 43,240     $ 81,687     $ 124,927  
91-180 days
    19,352       40,433       59,785  
181-365 days
    61,296       84,497       145,793  
Over 1 year
    14,363       34,491       48,854  
                         
    $ 138,251     $ 241,108     $ 379,359  
                         


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Borrowings
 
Short term borrowings and repurchase agreements increased $61.1 million, or 91.1%, to $128.2 million in the six months ended June 30, 2007. Short-term borrowings represent Federal Funds Purchased, borrowings from the U.S. Treasury, repurchase agreements with Citigroup, advances from the FHLB, and customer repurchase agreements, normally maturing within one year.
 
The following table sets forth information concerning short-term borrowings at the periods indicated:
 
                 
    June 30,
    December 31,
 
    2007     2006  
 
Average balance during period
  $ 120,524     $ 82,815  
Average interest rate during period
    4.83 %     4.39 %
Maximum month-end balance during the year
    128,220       118,010  
Weighted average rate at period end
    4.79 %     4.78 %
Balance at period end
  $ 128,220     $ 53,070  
 
Contractual Obligations and Off-Balance Sheet Arrangements
 
The following tables show contractual obligations as of June 30, 2007 and December 31, 2006:
 
                                         
                June 30,
             
                2007
             
                Payments Due by Period
             
    Less Than
    After One But
    After Three But
    More Than Five
       
    One Year     Within Three Years     Within Five Years     Years     Total  
    (Dollars in thousands)  
 
Contractual Obligations
                                       
Demand Note issued to US Treasury
  $ 16,289     $     $     $     $ 16,289  
FHLB overnight borrowings
    13,050                               13,050  
Citigroup Repurchase Agreements
    14,000                         14,000  
FHLB Term Advances
    65,000                         65,000  
Overnight repurchase agreements with customers
    19,881                         19,881  
Junior subordinated debentures (at fair value)
                      22,829       22,829  
Premise leases
    767       1,275       1,328       6,786       10,156  
                                         
Total contractual obligations
  $ 128,987     $ 1,275     $ 1,328     $ 29,615     $ 161,205  
                                         
 


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                December 31, 2006
             
                Payments Due by Period
    More
       
    Less Than
    After One But
    After Three But
    Than Five
       
    One Year     Within Three Years     Within Five Years     Years     Total  
    (Dollars in thousands)  
 
Contractual Obligations
                                       
Demand Note issued to US Treasury
  $ 3,529     $     $     $     $ 3,529  
Citigroup Repurchase Agreements
        $ 14,000                   14,000  
FHLB Term Advances
    30,000       20,000                   50,000  
Overnight repurchase agreements with customers
    19,541                         19,541  
Junior Subordinated Debentures
                      22,682       22,682  
Premise Leases
    765       1,291       1,304       7,127       10,487  
                                         
Total contractual obligations
  $ 53,835     $ 35,291     $ 1,304     $ 29,809     $ 120,239  
                                         
 
We are party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These instruments include unfunded commitments to extend credit and standby letters of credit. The following table summarizes our commitments at the periods indicated:
 
                 
    June 30,
    December 31,
 
    2007     2006  
    (Dollars in thousands)  
 
Unfunded commitments to extend credit
               
Real estate secured
  $ 167,107     $ 161,245  
Credit card lines
    3,104       3,059  
Other
    61,716       70,356  
                 
Total commitments to extend credit
  $ 231,927     $ 234,660  
                 
Standby letters of credit
  $ 663     $ 799  
                 
 
Capital
 
Current risk-based regulatory capital standards generally require banks and bank holding companies to maintain a minimum ratio of “core” or “Tier I” capital (consisting principally of common equity) to risk-weighted assets of at least 4%, a ratio of Tier I capital to adjusted total assets (leverage ratio) of at least 4% and a ratio of total capital (which includes Tier I capital plus certain forms of subordinated debt, a portion of the allowance for credit losses and preferred stock) to risk-weighted assets of at least 8%. Risk-weighted assets are calculated by multiplying the balance in each category of assets by a risk factor, which ranges from zero for cash assets and certain government obligations to 100% for some types of loans, and adding the products together.
 
                                 
    Regulatory Requirements
       
    (Greater Than or Equal to
       
    Stated Percentage)     Actual at June 30, 2007  
    Adequately
                Venture Financial
 
    Capitalized     Well Capitalized     Venture Bank     Group, Inc.  
 
Tier 1 leverage capital ratio
    4.00 %     5.00 %     8.41 %     8.52 %
Tier 1 risk-based capital
    4.00 %     6.00 %     9.16 %     9.28 %
Total risk-based capital
    8.00 %     10.00 %     10.15 %     10.27 %
 

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    Regulatory Requirements
       
    (Greater Than or Equal to
       
    Stated Percentage)     Actual at December 31, 2006  
    Adequately
                Venture Financial
 
    Capitalized     Well Capitalized     Venture Bank     Group, Inc.  
 
Tier 1 leverage capital ratio
    4.00 %     5.00 %     8.51 %     9.44 %
Tier 1 risk-based capital
    4.00 %     6.00 %     10.14 %     10.27 %
Total risk-based capital
    8.00 %     10.00 %     11.27 %     11.39 %
 
We were well capitalized at both Venture Bank and the holding company at June 30, 2007 and December 31, 2006 for federal regulatory purposes.
 
In order to manage our capital position more efficiently, we have formed statutory trusts for the sole purpose of issuing trust preferred securities. We had junior subordinated debentures with a fair value of $22.8 million at June 30, 2007 and carrying value of $22.6 million at December 31, 2006. At June 30, 2007, 100% of the total issued amount, had interest rates that were adjustable on a quarterly basis based on a spread over LIBOR. Increases in short-term market interest rates during 2006 have resulted in increased interest expense for junior subordinated debentures. Although any additional increases in short-term market interest rates will increase the interest expense for junior subordinated debentures, we believe that the near term refinance of these obligations will serve to mitigate the impact to net interest income on a consolidated basis. In July 2007, we called $13.4 million of junior subordinated debentures originally issued by FCFG Capital Trust I in 2002. We immediately replaced these with a new issuance in the same amount by VFG Capital Trust I. Our capital did not change as a result of this transaction. We paid quarterly interest payments at the 3-month LIBOR rate plus 365 basis points on the FCFG Capital Trust I issuance. The rate on the new issuance is the 3-Month LIBOR rate plus 145 basis points, which re-prices quarterly, and will provide a significant savings. The stated maturity date of this issuance is September 2037, and the debentures may be prepaid without penalty beginning September 2012.
 
In April 2003, we raised $6.2 million (FCFG Capital Trust II) through a participation in a pooled junior subordinated debentures offering. The floating rate junior subordinated debentures issued by FCFG Capital Trust II accrue interest at a variable rate of interest, calculated quarterly, at LIBOR plus 325 basis points per annum on the outstanding balance. The stated maturity date of this issuance is October 2033, and the debentures may be prepaid without penalty beginning April 2008. The majority of these funds were utilized for the purchase of Harbor Bank in 2002 and to repurchase our common stock. In December 2003, Washington Commercial Bancorp raised $3.1 million (Washington Commercial Statutory Trust I) through its participation in a pooled junior subordinated debentures offering. The floating rate junior subordinated debentures issued by Washington Commercial Statutory Trust I accrue interest at a variable rate of interest, calculated quarterly at LIBOR plus 285 basis points per annum on the outstanding balance. The stated maturity date of this issuance is December 2033, and these debentures may be prepaid without penalty beginning December 2008. We acquired the Washington Commercial Bancorp junior subordinated debentures upon completion of our merger.
 
On March 5, 2005 the Federal Reserve adopted regulations that mandate the maximum amount of junior subordinated debentures that may be included in our Tier 1 Capital calculation. Our capital ratios are calculated in accordance with this regulation and the entire issued amount of junior subordinated debentures qualified as Tier 1 Capital for regulatory capital purposes. We retain the ability to issue additional junior subordinated debentures and have such securities qualify as Tier 1 Capital under the new rules.
 
Liquidity
 
Liquidity management involves the ability to meet cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Liquidity is generated from both internal and external sources. Internal sources are those assets that can be converted to cash with little or no risk of loss. Internal sources include overnight investments in interest bearing deposits in banks, federal funds sold and all or a portion of available for sale investment securities.

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We have a formal liquidity policy, and in the opinion of management, our liquid assets are considered adequate to meet our anticipated cash flow needs for loan funding and deposit withdrawals.
 
At June 30, 2007, cash, deposits in banks, federal funds sold and all securities available for sale totaled $245.9 million of which $138.3 million was pledged. External sources refer to the ability to access new deposits, new borrowings and capital and include increasing savings and demand deposits, certificates of deposit, federal funds purchased, re-purchase agreements, short and long term debt, and the issuance of capital and debt securities. At June 30, 2007 short and long term borrowing lines of credit totaled $231.7 million. These credit facilities are being used regularly as a source of funds. At June 30, 2007, $78.1 million was borrowed against these lines of credit in the form of short and long term debt.
 
We will manage our liquidity by changing the relative distribution of our asset portfolios, i.e., reducing investment or loan volumes, or selling or encumbering assets. Further, we will increase liquidity by soliciting higher levels of deposit accounts through promotional activities or borrowing from our correspondent banks as well as the Federal Home Loan Bank, or other borrowing sources. At the current time, our long-term liquidity needs primarily relate to funds required to support loan originations and commitments and deposit withdrawals. All of these needs can currently be met by cash flows from investment payments and maturities, and investment sales if the need arises. Another attractive source of liquidity if necessary to fund our future growth could be the issuance of additional trust preferred securities.
 
Our liquidity is comprised of three primary classifications: cash flows from or used in operating activities; cash flows from or used in investing activities; and cash flows provided by or used in financing activities.
 
Our primary investing activities are the origination of real estate, commercial and consumer loans and purchase of securities. Increases in gross loans including loans held for sale for the six months ended June 30, 2007 and for the year ended December 31, 2006 were $30.9 million and $113.8 million. Investment securities were $236.6 million at June 30, 2007 and $162.4 million at December 31, 2006. At June 30, 2007 we had outstanding loan commitments of $231.9 million and outstanding letters of credit of $0.7 million. We anticipate that we will have sufficient funds available to meet current loan commitments.
 
Net cash provided by financing activities has been impacted significantly by increases in deposit levels. During the six months ended June 30, 2007 and for the year ended December 31, 2006 deposits increased by $67.2 million and $257.2 million.
 
Management believes that the Company’s liquidity position at June 30, 2007 was adequate to fund ongoing operations.
 
Quantitative and Qualitative Disclosures about Market Risk
 
Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Our market risk arises primarily from interest rate risk inherent in our lending, investment, and deposit taking activities. To that end, management actively monitors and manages our interest rate risk exposure. We do not have any market risk sensitive instruments entered into for trading purposes. We manage our interest rate sensitivity by matching the re-pricing opportunities on our earning assets to those on our funding liabilities.
 
Management uses various asset/liability strategies to manage the re-pricing characteristics of our assets and liabilities designed to ensure that exposure to interest rate fluctuations is limited within our guidelines of acceptable levels of risk-taking. Hedging strategies, including the terms and pricing of loans and deposits, and managing the deployment of our securities, are used to reduce mismatches in interest rate re-pricing opportunities of portfolio assets and their funding sources.
 
Interest Rate Risk.  Interest rate risk is the current and prospective risk to earnings or capital arising from movements in interest rates. Changes in interest rates affect income earned from assets and the cost of funding those assets. We structure our balance sheet in such a manner that earnings will be relatively stable regardless of current or prospective movements in interest rates. We monitor interest rate risk by analyzing the potential


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impact on the economic value of equity and net interest income from potential changes in interest rates, and consider the impact of alternative strategies or changes in balance sheet structure.
 
Our exposure to interest rate risk is reviewed on at least a quarterly basis by our Board Asset Liability Committee, or Board ALCO, which is comprised of three independent directors. Our Chief Financial Officer works closely with the Board ALCO Committee. Our Chief Financial Officer develops and implements policies and procedures that translate the Board’s goals, objectives, and risk limits, and chairs the Management ALCO committee, which meets to assist in formulating and implementing operating strategies to execute the Board ALCO policies. On a day-to-day basis, the monitoring of interest rate risk and management of our balance sheet to stay within Board policy limits is the responsibility of our Chief Financial Officer and Treasury staff. The Management ALCO committee members represent various areas of our operations and participate in product creation, product pricing, and implementation of asset/liability strategies.
 
Economic Value of Equity.  We measure the impact of market interest rate changes on the present value of all interest bearing instruments on the balance sheet using a simulation model. This simulation model assesses the changes in the market value of interest rate sensitive financial instruments that would occur in response to an instantaneous and sustained increase or decrease (shock) in market interest rates of 200 basis points.
 
At June 30, 2007, our economic value of equity exposure related to these hypothetical changes in market interest rates was within our current guidelines. The following table shows the projected change in the economic value of our equity for this set of rate shocks as of June 30, 2007.
 
                 
    Percentage
    Percentage
 
    Change
    of Total
 
Interest Rate Scenario
  from Base     Assets  
 
Up 200 basis points
    (12.90 )%     (0.20 )%
BASE
    0.00 %     0.00 %
Down 200 basis points
    8.40 %     0.30 %
 
The computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, asset prepayments and deposit reduction, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions we may undertake in response to changes in interest rates. Actual amounts may differ from the projections set forth above should market conditions vary from the underlying assumptions.
 
Net Interest Income Simulation.  In order to measure interest rate risk at June 30, 2007, we used a simulation model to project changes in net interest income that result from forecasted changes in interest rates. This analysis calculates the difference between net interest income forecasted using a rising and a falling interest rate scenario and a net interest income forecast using a flat rate scenario. In each of these instances, Fed Funds is used as the driving rate. The income simulation model includes various assumptions regarding the re-pricing relationships for each of our products. Many of our assets are floating rate loans, which are assumed to re-price immediately, and to the same extent as the change in market rates according to their contracted index. The model begins by disseminating data into appropriate repricing buckets. Assets and liabilities are then assigned a “multiplier” or beta to simulate how much that particular balance sheet item will reprice when interest rates change. The final step is to simulate the timing effect of assets and liabilities with a month-by-month simulation to estimate the change in interest income and expense over the next 12 months.
 
This analysis indicates the impact of changes in net interest income for the given set of rate changes and assumptions. It assumes the balance sheet grows modestly, but that its structure will remain similar to the structure at year-end. It does not account for all factors that impact this analysis, including changes by management to mitigate the impact of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates change.
 
Furthermore, loan prepayment rate estimates and spread relationships change regularly. Interest rate changes create changes in actual loan prepayment rates that will differ from the market estimates incorporated


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in this analysis. Changes that vary significantly from the assumptions may have significant effects on our net interest income.
 
For the rising and falling interest rate scenarios, the base market interest rate forecast was increased or decreased, on an instantaneous and sustained basis, by 100 and 200 basis points. At June 30, 2007, our net interest income exposure related to these hypothetical changes in market interest rates was within the current guidelines established by us.
 
Interest Rate Risk
June 30, 2007
 
                                         
    (Dollars in thousands)  
 
Rate Shock
    (2 )%     (1 )%     Annualized       +1 %     +2 %
Fed Funds Rate
    3.25 %     4.25 %     5.25 %     6.25 %     7.25 %
Interest Income
  $ 71,276     $ 75,160     $ 79,044     $ 82,928     $ 86,812  
Interest Expense
    (28,605 )   $ (33,121 )   $ (37,636 )   $ (42,151 )   $ (46,667 )
                                         
Net Interest Income (static)
  $ 42,671     $ 42,039     $ 41,408     $ 40,777     $ 40,145  
Optionality Impact
  $ (228 )   $ (11 )         $ (230 )   $ (462 )
                                         
Net Interest Income
  $ 42,443     $ 42,028     $ 41,408     $ 40,547     $ 39,683  
Change
  $ 1,035     $ 620           $ (861 )   $ (1,725 )
% of Change
    2.5 %     1.5 %           (2.1 )%     (4.2 )%
 
Gap Analysis.  Another way to measure the impact that future changes in interest rates will have on net interest income is through a cumulative gap measure. The gap represents the net position of assets and liabilities subject to re-pricing in specified time periods.
 
The following table sets forth the distribution of re-pricing opportunities of our interest-earning assets and interest-bearing liabilities, the interest rate sensitivity gap (that is, interest rate sensitive assets less interest rate sensitive liabilities), cumulative interest-earning assets and interest-bearing liabilities, the cumulative interest rate sensitivity gap, the ratio of cumulative interest-earning assets to cumulative interest-bearing liabilities and the cumulative gap as a percentage of total assets and total interest-earning assets, as of June 30, 2007. The table also sets forth the time periods during which interest-earning assets and interest-bearing liabilities will mature or may re-price in accordance with their contractual terms. The interest rate relationships between the re-priceable assets and re-priceable liabilities are not necessarily constant and may be affected by many factors, including the behavior of customers in response to changes in interest rates. This table should, therefore, be used only as a guide as to the possible effect changes in interest rates might have on our net interest margins.


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Interest Rate Gap Analysis
June 30, 2007