WEST COAST BANCORP /NEW/OR/ - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934

For the fiscal year ended December 31, 1997 Commission file number 0-10997

WEST COAST BANCORP
(Exact name of registrant as specified in its charter)

Oregon 93-0810577
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

5335 Meadows Road -- Suite 201
Lake Oswego, Oregon 97035
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (503) 684-0884

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

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The approximate aggregate market value of Registrant's Common Stock held
by non-affiliates of the Registrant on February 28, 1998, was $341,277,381.

The number of shares of Registrant's Common Stock outstanding on February
28, 1998, was 12,639,903.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the West Coast Bancorp Definitive Proxy Statement dated March 20,
1998 are incorporated by reference into Part III of Form 10-K.

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INDEX

Page
PART I ----

Item 1. BUSINESS................................................................. 1
General................................................................ 1
Recent Developments.....................................................1
Subsidiaries............................................................2
Employees...............................................................3
Competition.............................................................3
Governmental Policies...................................................4
Supervision and Regulation..............................................4
Item 2. PROPERTIES...............................................................11
Item 3. LEGAL PROCEEDINGS........................................................12
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................12

PART II

Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS......................................................13
Item 6. SELECTED FINANCIAL DATA..................................................14
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS..........................15
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..............................27
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE....................................51

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......................51
Item 11. EXECUTIVE COMPENSATION...................................................51
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.............................................................51
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...........................51

PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K...............................................................52
SIGNATURES...........................................................................53
EXHIBIT INDEX........................................................................54

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PART I

ITEM 1. BUSINESS

GENERAL

West Coast Bancorp ("Bancorp" or the "registrant"), an Oregon corporation,
was organized in August 1981 as a bank holding company under the name Commercial
Bancorp. Pursuant to an Agreement and Plan of Reorganization dated November 30,
1981, Bancorp acquired all of the common stock of The Commercial Bank, an Oregon
state-chartered bank, in a transaction effective July 12, 1982.

As discussed in more detail under "Recent Developments," pursuant to an
Agreement and Plan of Merger dated as of October 24, 1994, between former West
Coast Bancorp ("Old WCB") and the registrant, as amended as of December 12,
1994, Old WCB and the registrant were merged on February 28, 1995, with the
registrant as the surviving corporation. Old WCB was a one bank holding company
headquartered in Newport, Oregon. The combined company commenced operations on
March 1, 1995, under the name West Coast Bancorp.

Bancorp is headquartered in Lake Oswego, Oregon. Bancorp's principal
business activities are conducted through its three bank subsidiaries, The
Commercial Bank and The Bank of Newport located in Oregon and Bank of Vancouver
located in Washington (collectively, the "Banks"), each of which is a
state-chartered, full-service commercial bank with deposits insured by the
Federal Deposit Insurance Corporation ("FDIC"). At December 31, 1997, the Banks
had facilities in a total of 32 cities and towns in Oregon and southwest
Washington, operating a total of 37 full-service branches and 3 limited service
branches. Bancorp's subsidiary, Valley Commercial Bank, was merged into The Bank
of Newport in the first quarter of 1997. The Bank of Newport continues to
operate three branches under the assumed business name "Valley Commercial Bank."
The registrant also operates West Coast Trust Company, Inc. which provides
agency, fiduciary, and other related trust services. The market value of assets
managed for others at December 31, 1997 totaled $203.6 million.

RECENT DEVELOPMENTS
RESULTS

For the year ended December 31, 1997, the operations of the registrant on a
combined basis earned net income of $11.9 million, or $1.12 per diluted share.
The combined equity of the registrant at December 31, 1997, was $79.3 million,
with 10.2 million shares outstanding and a book value of $7.78 per share. Net
loans of the Banks (combined) of $580.7 million at December 31, 1997,
represented approximately 68.3 percent of combined total assets. Combined
deposits total $714 million at year-end 1997.

MANAGEMENT REORGANIZATION

Effective February 10, 1997, Victor L. Bartruff, formerly Co-President and
Chief Executive Officer of Bancorp, assumed the role of President and Chief
Executive Officer of Bancorp. Mr. Rodney Tibbatts, formerly Co-President and
Chief Executive Officer has taken the role of Executive Vice President and
Director of Corporate Development and is primarily responsible for investor
relations and corporate development including acquisitions. Each affiliate is
continuing to operate in its respective local communities with local decision
making authority under the guidance of community boards of directors and local
management. In addition, Mr. Bartruff relinquished his position as President and
Chief Executive Officer of The Bank of Newport. Mr. Timothy P. Dowling was hired
to fill the position of President of The Bank of Newport.

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ACQUISITION OF CENTENNIAL HOLDINGS, LTD. ("CHL")

On February 28, 1998, Bancorp consummated a Plan and Agreement of Merger
("Agreement") with Centennial Holdings, Ltd. ("CHL") of Olympia, Washington.
Under the Agreement, CHL's principle subsidiary, Centennial Bank, became a
wholly-owned subsidiary of Bancorp. The transaction was accounted for as a
pooling-of-interest under generally accepted accounting principles.

CHL was a bank holding company, headquartered in Olympia, Washington. Its
principal business activities were conducted through its only commercial bank
subsidiary, Centennial Bank, a Washington state chartered, full-service
commercial bank, whose deposits are insured by the FDIC. At December 31, 1997,
CHL had assets totaling $268.4 million, and equity capital totaling $21.8
million. CHL earned $2.8 million and $1.9 million for the years ended December
31, 1997 and 1996, respectively. Centennial Bank was organized in 1974 and
serves customers in southwestern Washington through eight branches and two real
estate offices. Based in Olympia, Centennial Bank also has offices in Lacey,
Whelton, Hoodsport, Centralia, Chehalis, Fife, and Puyallup.

FUTURE EXPANSION STRATEGY

Bancorp's acquisition of CHL is consistent with Bancorp's strategy of
growing the company through the acquisition of community banks in Oregon and
Washington that share Bancorp's supercommunity banking philosophy. Accordingly,
Bancorp will continue to explore future opportunities to expand its banking
network and other closely related businesses as attractive opportunities may
arise from time to time. In furtherance of that strategy on March 5, 1997,
Bancorp entered into an agreement with Wells Fargo and Company to acquire the
approximately $11.3 million in deposits of the Waldport, Oregon branch. The
branch was merged with the Bank of Newport's former branch in Waldport,
effective July, 1997.

SUBSIDIARIES
THE BANKS

The Commercial Bank was organized in 1954. The Commercial Bank's main
office is located in Salem, Oregon; it has three additional branches in Salem,
three branches in Keizer, two branches in Newberg and branches in Dallas, King
City, Molalla, Monmouth, Silverton, Sublimity, Tigard, Wilsonville, and
Woodburn. At December 31, 1997, it had deposits totaling $358.9 million and
loans totaling $253.5 million.

The Bank of Newport, established in 1925, currently conducts business
through nine branches in western Oregon, located in the cities of Newport (two
branches), Lincoln City, Waldport, Depoe Bay, Toledo, Portland, Lake Oswego and
Clackamas. The Bank of Newport operates three additional branches, located in
Forest Grove, North Plains, and Hillsboro, Oregon under the assumed business
name "Valley Commercial Bank." At December 31, 1997, The Bank of Newport had
deposits totaling $248.2 million and loans totaling $223.6 million.

Bank of Vancouver was organized in 1989. Bank of Vancouver has two offices,
both located in Vancouver, Washington. At December 31, 1997, it had deposits
totaling $111.5 million and loans totaling $112.2 million.

The primary business strategy of the affiliates is to provide community
banking and related services to individuals, professionals, and small- and
medium-sized businesses, emphasizing customer relationships, a high level of
service, and attention to customer needs. Small to medium-sized business, real
estate construction and commercial customers are a significant focus of
activity. The Banks offer deposit accounts, safe-deposit boxes, consumer
lending, commercial and residential real estate lending, commercial loans,
including operating lines secured by accounts receivable and inventory, and
other traditional bank products. Their loan portfolios have some concentration
in real estate secured loans, agricultural and light manufacturing related
businesses. Deposit products include regular and special checking accounts,
savings accounts, certificates of deposit, and money market accounts. Consumer
credit products include residential first and second mortgages, automobile
loans, credit cards, lines of credit, and other products. Lending services
include short to intermediate-term loans, inventory financing, equipment
leasing, revolving lines of credit, and other types of credit. The Banks also
offer VISA credit card programs as part of their retail banking services.

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Bancorp also operates a commercial real estate loan brokerage division
which originates and brokers commercial real estate loans to other banks,
insurance companies, pension funds, and other sophisticated investors.

In order to provide convenient banking services to their customers, the
Banks offer extended banking hours in selected branches. Automatic teller
machines are available in 35 branch and other locations offering 24-hour
transaction services, including cash withdrawals, deposits, account transfers,
and balance inquiries. The Banks offer electronic banking services through
telephone and personal computers. The Banks also offer tax-deferred annuities,
single-premium whole life insurance, other insurance investment products, and
securities products.

BANK LOCATIONS

The principal offices of the Banks are as follows:

The Commercial Bank 301 Church Street, N.E., Salem, OR 97301 (503) 399-2900
The Bank of Newport 506 SW Coast Highway, Newport, OR 97365 (541) 265-6666
Bank of Vancouver 801 Main Street, Vancouver, WA 98660 (360) 693-1246

WEST COAST TRUST COMPANY

West Coast Trust provides trust services to individuals, partnerships,
corporations, and institutions. West Coast Trust acts as fiduciary of estates
and conservatorships, and as a trustee under various wills, trust, and pension
and profit-sharing plans. These trust and annuity services are available and
offered through a third party broker-dealer with offices at branches of West
Coast Bancorp affiliates. The main office of West Coast Trust is located at 301
Church Street, Salem, OR 97301 (503) 399-2993.

COBAN, INC.

In December 1967, The Commercial Bank incorporated Coban, Inc. ("Coban"),
an Oregon corporation. Coban was established to hold selected fixed assets of
The Commercial Bank and to provide additional flexibility for real property
transactions. In addition, Coban serves as an intermediary to purchase Common
Stock for the voluntary employee stock purchase plan and the shareholder
dividend reinvestment plan. Effective December 31, 1997, Coban was dissolved and
its assets and liabilities were transferred to Bancorp.

BV CORPORATION

In 1996, Bank of Vancouver incorporated BV Corporation, a Washington
Corporation. BV Corporation was established to serve as trustee under deeds of
trust.

EMPLOYEES

At December 31, 1997, Bancorp and its subsidiaries had approximately 498
full-time equivalent employees. None of these employees are represented by labor
unions. A number of benefit programs are available to eligible employees
including group medical plans, paid sick leave, paid vacation, group life
insurance, 401(k) plan, stock option plans and an optional employee stock
purchase plan.

COMPETITION

At September, 1997, The Commercial Bank and the Bank of Newport were the
5th, and 6th largest, respectively, of the 48 commercial and savings banks in
Oregon. Bank of Vancouver was the 45th largest of the commercial and savings
banks in Washington. The Banks compete with other banks, as well as with savings
and loan associations, savings banks, credit unions, mortgage companies,
investment banks, insurance companies, securities brokerages, and other
financial institutions. Banking in Oregon and Washington is dominated by several
significant banking institutions which include the U. S. Bank, Wells Fargo Bank,
Bank of America, and Washington Mutual Savings Bank, which together account for
a majority of the total commercial and savings bank deposits in Oregon and
Washington. These competitors offer a greater number of branch locations (with
statewide branch networks in the case of the two largest competitors), the
ability to offer higher lending limits,

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and a variety of services not offered by the Banks. Bancorp has attempted to
offset some of the advantages of the larger competitors by arranging
participations with other banks for loans above its subsidiaries' legal lending
limits. Emphasis is placed on local banking featuring quality service, local
responsive decision making, and money reinvested into the community, and
participation in nationwide services such as VISA, The Exchange, Interlink,
Plus, and Accel.

GOVERNMENTAL POLICIES

The earnings and growth of Bancorp, the Banks and Bancorp's other
subsidiaries, as well as their existing and future business activities, are
affected not only by general economic conditions, but also by the fiscal and
monetary policies of the Federal government and its agencies, particularly the
Board of Governors of the Federal Reserve System ("FRB"). The FRB implements
national monetary policies (intended to curb inflation and combat recession) by
its open-market operations in United States Government securities, by adjusting
the required level of reserves for financial institutions subject to its reserve
requirements, and by varying the discount rates applicable to borrowings by
banks from the Federal Reserve Banks. The actions of the FRB in these areas
influence the growth of bank loans, investments and deposits, and also affect
interest rates charged on loans and deposits. As banking is a business which
depends largely on interest rate differentials (in general, the difference
between the interest rates paid by the Banks on their deposits and their other
borrowings and the interest rates received by the Banks on loans extended to
their customers and on securities held in the Banks' investment portfolios), the
influence of economic conditions and monetary policies on interest rates will
directly affect earnings. The nature and impact of any future changes in
monetary policies cannot be predicted.

SUPERVISION AND REGULATION

GENERAL

INTRODUCTION

The following generally refers to certain statutes and regulations
affecting the banking industry. These references provide brief summaries only
and are not intended to be complete. These references are qualified in their
entirety by the referenced statutes and regulations. In addition, some statutes
and regulations may exist that apply to and regulate the banking industry but
are not referenced below. Changes in applicable statutes and regulations may
have a material effect on the business of WCB and its subsidiaries.

WCB

GENERAL

As a bank holding company, WCB is subject to the Bank Holding Company Act
of 1956 ("BHCA"), as amended, which places it under the supervision of the Board
of Governors of the FRB. In general, the BHCA limits the business of bank
holding companies to owning or controlling banks and engaging in other
activities related to banking. Certain recent legislation has expanded
interstate branching and relaxed federal restrictions on interstate banking and
may expand opportunities for bank holding companies (for additional information
see below under the heading "The Banks -- Interstate Banking and Branching".
However, the full impact of this legislation on WCB is unclear at this time.

HOLDING COMPANY STRUCTURE

FRB Regulation. A bank holding company must obtain the approval of the FRB:
(1) before acquiring direct or indirect ownership or control of any voting
shares of any bank if, after such acquisition, it would own or control, directly
or indirectly, more than 5% of the voting shares of such bank; (2) before
merging or consolidating with another bank holding company; and (3) before
acquiring substantially all of the assets of any additional banks.

WCB must file annual and certain interim reports required from time to time
by the FRB. In addition, the FRB performs periodic examinations of WCB.

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Holding Company Control of Nonbanks. With certain exceptions, the BHCA
prohibits bank holding companies from acquiring direct or indirect ownership or
control of voting shares in any company which is not a bank or a bank holding
company, unless the FRB determines that the activities of such company are so
closely related to banking or managing or controlling banks as to be a proper
incident thereto. In making such determinations, the FRB considers whether the
performance of such activities by a bank holding company would offer advantages
to the public that would outweigh possible adverse effects. The Economic Growth
and Regulatory Paperwork Reduction Act of 1996 ("Economic Growth Act") amended
the BHCA to eliminate the requirement that bank holding companies seek FRB
approval before engaging de novo in permissible nonbanking activities if the
holding company is well-capitalized and meets certain other specified criteria.
A bank holding company meeting those specifications need only notify the FRB
within 10 business days after beginning the activity.

The Economic Growth Act also established an expedited procedure for
well-capitalized bank holding companies meeting certain criteria to obtain FRB
approval to acquire smaller companies that engage in permissible non-banking
activities pre-approved by FRB order.

Transactions With Affiliates. WCB and the Banks are deemed affiliates
within the meaning of the Federal Reserve Act, and transactions between
affiliates are subject to certain restrictions. Covered transactions include,
subject to specific exceptions, loans by bank subsidiaries to affiliates,
investments by bank subsidiaries in securities issued by an affiliate, the
taking of such securities as collateral, and the purchase of assets by a bank
subsidiary from an affiliate.

Support of Subsidiary Banks. Under FRB policy, a bank holding company is
expected to act as a source of financial and managerial strength to, and commit
resources to support, each of its subsidiary banks. Any capital loans a bank
holding company makes to its subsidiary banks are subordinate to deposits and to
certain other indebtedness of those subsidiary banks. The Crime Control Act of
1990 provides that, in the event of a bank holding company's bankruptcy, the
bankruptcy trustee will assume any commitment the bank holding company has made
to a federal bank regulatory agency to maintain the capital of a subsidiary bank
and this obligation will be entitled to a priority of payment.

Tie-In Arrangements. WCB and its subsidiaries are prohibited from engaging
in certain tie-in arrangements in connection with any extension of credit, sale
or lease of property or furnishing of services. For example, with certain
exceptions, neither WCB nor its subsidiaries may condition an extension of
credit to a customer on either (1) a requirement that the customer obtain
additional services provided by it or (2) an agreement by the customer to
refrain from obtaining other services from a competitor. Effective April 21,
1997, the FRB has also adopted significant amendments to its anti-tying rules
that: (1) remove FRB-imposed anti-tying restrictions on bank holding companies
and their non-bank subsidiaries; (2) allow banks greater flexibility to package
products with their affiliates; and (3) establish a safe harbor from the tying
restrictions for certain foreign transactions. These amendments are designed to
enhance competition in banking and nonbanking products and allow banks and their
affiliates to provide more efficient, lower cost service to their customers.
However, the impact of these amendments on WCB and its subsidiaries is unclear
at this time.

State Law Restrictions. As an Oregon corporation, WCB is subject to certain
limitations and restrictions under applicable Oregon corporate law. For example,
state law restrictions in Oregon include limitations and restrictions relating
to: indemnification of directors, distributions to shareholders, transactions
involving directors, officers or interested shareholders, maintenance of books,
records, and minutes, and observance of certain corporate formalities.

Securities Registration and Reporting. The common stock of WCB is
registered as a class with the SEC under the 1934 Act and thus is subject to the
periodic reporting and proxy solicitation requirements and the insider-trading
restrictions of that Act. The periodic reports, proxy statements, and other
information filed by WCB under that Act can be inspected and copied at or
obtained from the office of the SEC in Washington, D.C. In addition, the
securities issued by WCB are subject to the registration requirements of the
1933 Act and applicable state securities laws unless exemptions are available.

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CONTROL TRANSACTIONS

The Change in Bank Control Act of 1978, as amended, prohibits a person or
group of persons from acquiring "control" of a bank holding company unless the
FRB has been given 60 days' prior written notice of the proposed acquisition,
and within that time period, the FRB has not issued a notice disapproving the
proposed acquisition or extending for up to another 30 days the period during
which such a disapproval may be issued. An acquisition may be made before the
expiration of the disapproval period if the FRB issues written notice of its
intent not to disapprove the action. Under a rebuttable presumption established
by the FRB, the acquisition of 10% or more of a class of voting stock of a bank
holding company with a class of securities registered under Section 12 of the
Exchange Act would, under the circumstances set forth in the presumption,
constitute the acquisition of control.

In addition, any company would be required to obtain the approval of the
FRB under the BHCA before acquiring 25% (5% if the company is a bank holding
company) or more of the outstanding shares of WCB or to otherwise obtain control
over the WCB.

THE BANKS

GENERAL

Despite some recent legislative initiatives to reduce regulatory burdens,
banking remains a highly regulated industry. Legislation enacted from time to
time may increase the cost of doing business, limit or expand permissible
activities, or affect the competitive balance between banks and other financial
and nonfinancial institutions. Proposals to change the laws and regulations
governing the operations and taxation of banks and other financial institutions
are frequently made in Congress, in state legislatures, and before various bank
regulatory agencies. In addition, there continue to be proposals in Congress to
restructure the banking system.

Some of the significant areas of bank regulation, including significant
federal legislation affecting state-chartered banks, are generally discussed
below.

REGULATION OF STATE BANKS

Oregon state banks, such as The Bank of Newport and The Commercial Bank are
subject to primary regulation and examination by the Oregon Department of
Consumer and Business Services ("Oregon Department"). As a Washington State
bank, the Bank of Vancouver is subject to primary regulation and examination by
the Washington Director of the Washington Department of Financial Institutions
("Washington Director"). The Banks are also subject to supervision, examination,
and regulation by certain federal banking agencies. The deposits of the Banks
are insured (to applicable limits) by, and therefore are subject to regulation
by, the FDIC.

Applicable federal and state statutes and regulations governing a bank's
operations relate, among other matters, to capital requirements, required
reserves against deposits, investments, loans, legal lending limits, certain
interest rates payable, mergers and consolidations, borrowings, issuance of
securities, payment of dividends (see below), establishment of branches, and
dealings with affiliated persons. The FDIC has authority to prohibit banks under
their supervision from engaging in what they consider to be an unsafe and
unsound practice in conducting their business. Depository institutions, such as
the Banks are affected significantly by the actions of the FRB as it attempts to
control the money supply and credit availability in order to influence the
economy.

Washington state banking law provides that the amount of funds which a bank
may lend to a single borrower is generally limited to 20% of capital and
surplus. For this purpose, capital includes (1) the amount of common stock
outstanding and unimpaired, (2) the amount of preferred stock outstanding and
unimpaired, and (3) capital notes or debentures issued pursuant to RCW 30.36.
Surplus includes capital surplus, reflecting the amounts paid in excess of the
par or stated value of capital stock, or amounts contributed to the bank other
than for capital stock, and undivided profits.

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DIVIDENDS

Dividends paid to WCB by the Banks are a material source of WCB's cash
flow. Various federal and state statutory provisions limit the amount of
dividends the Banks are permitted to pay to WCB without regulatory approval. FRB
policy further limits the circumstances under which bank holding companies may
declare dividends. For example, a bank holding company should not continue its
existing rate of cash dividends on its common stock unless its net income is
sufficient to fully fund each dividend and its prospective rate of earnings
retention appears consistent with its capital needs, asset quality, and overall
financial condition.

If, in the opinion of the applicable federal banking agency, a depository
institution under its jurisdiction is engaged in or is about to engage in an
unsafe or unsound practice (which, depending on the financial condition of the
institution, could include the payment of dividends), the agency may require,
after notice and hearing, that such institution cease and desist from such
practice. In addition, the FRB and the FDIC have issued policy statements which
provide that insured banks and bank holding companies should generally pay
dividends only out of current operating earnings.

Oregon law imposes the following limitations on the payment of dividends by
Oregon state banks: (1) no dividends may be paid that would impair capital; (2)
until the surplus fund of a bank is equal to 50% of its paid-in capital, no
dividends may be declared unless at least 20% of the bank's net profits for the
dividend period have been carried to the surplus account; (3) dividends cannot
be greater than net undivided profits then on hand minus losses, certain bad
debts, certain charged-off assets or depreciation and accrued expenses,
interest, and taxes; and (4) if the surplus fund does not exceed 50% of paid-in
capital at the time of a reduction in the surplus due to losses, dividends
cannot be declared or paid in excess of 50% of net earnings until the surplus
fund is restored to at least the amount from which the surplus was originally
reduced.

Under these restrictions, as of December 31, 1997, the Banks could have
declared dividends of approximately $19.3 million in the aggregate, without
obtaining prior regulatory approval. The payment of dividends by banks may also
be affected by other factors, such as capital maintenance requirements.

Washington statutes prohibit a bank from paying any dividends in an amount
greater than the bank's retained earnings, without approval of the Washington
Director. The Washington Director has authority to require a bank to suspend
payment of all dividends until the bank has complied with any requirements made
by the Washington Director.

REGULATION OF MANAGEMENT

Federal law: (1) sets forth circumstances under which officers or directors
of a bank may be removed by the institution's federal supervisory agency; (2)
places restraints on lending by a bank to its executive officers, directors,
principal shareholders, and their related interests; and (3) prohibits
management personnel of a bank from serving as a director or in other management
positions of another financial institution whose assets exceed a specified
amount or which has an office within a specified geographic area.

CONTROL OF FINANCIAL INSTITUTIONS

No person may acquire "control" of a bank unless the appropriate federal
agency has been given 60 days prior written notice and within that time the
agency has not disapproved the acquisition. Substantial monetary penalties may
be imposed for violation of the change in control or other provisions of banking
laws. Washington banking laws further require that 30 days before the
acquisition of control, defined as direct or indirect ownership, control or
power to vote 25% or more of the outstanding stock of a bank, the acquiring
party must file with the Washington Director an application containing certain
specified information. Acquisitions of control in violation of the statute are
deemed void.

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FIRREA

The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") became effective on August 9, 1989. Among other things, this
far-reaching legislation (1) phased in significant increases in the FDIC
insurance premiums paid by commercial banks; (2) created two deposit insurance
pools within the FDIC, one to insure commercial bank and savings bank deposits
and the other to insure savings association deposits; (3) for the first time,
permitted bank holding companies to acquire healthy savings associations; (4)
permitted commercial banks that meet certain housing-related asset requirements
to secure advances and other federal services from their local Federal Home Loan
Banks; and (5) greatly enhanced the regulators' enforcement powers by removing
procedural barriers and sharply increasing the civil and criminal penalties for
violating statutes and regulations.

FDICIA

The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") was enacted into law in late 1991. As required by FDICIA, numerous
regulations have been adopted by federal bank regulatory agencies, including the
following: (1) federal bank regulatory authorities have established five
different capital levels for banks and, as a general matter, enable banks with
higher capital levels to engage in a broader range of activities; (2) the FRB
has issued regulations requiring standardized disclosures with respect to
interest paid on deposits; (3) the FDIC has imposed restrictions on the
acceptance of brokered deposits by weaker banks; (4) the FDIC has implemented
risk-based deposit insurance premiums; and (5) the FDIC has issued regulations
requiring state-chartered banks to comply with certain restrictions with respect
to equity investments and activities in which the banks act as a principal.

FDICIA recapitalized the Bank Insurance Fund ("BIF") and required the FDIC
to maintain the BIF and Savings Association Insurance Fund ("SAIF") at 1.25% of
insured deposits by increasing deposit insurance premiums as necessary to
maintain such ratio. FDICIA also required federal bank regulatory authorities to
prescribe, by December 1, 1993, (1) non-capital standards of safety and
soundness; (2) operational and managerial standards for banks; (3) asset and
earnings standards for banks and bank holding companies addressing such areas as
classified assets, capital, and stock price; and (4) standards for compensation
of executive officers and directors of banks. However, this provision was
modified by later legislation to allow federal regulatory agencies to implement
these standards through either guidelines or regulations.

INTERSTATE BANKING AND BRANCHING

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Interstate Act") permits nationwide interstate banking and branching under
certain circumstances. This legislation generally authorizes interstate
branching and relaxes federal law restrictions on interstate banking. As of
September 29, 1995, bank holding companies may purchase banks in any state, and
states may not prohibit such purchases. Additionally, as of June 1, 1997, banks
are permitted to merge with banks in other states as long as the home state of
neither merging bank has opted out. The Interstate Act requires regulators to
consult with community organizations before permitting an interstate institution
to close a branch in a low-income area.

Under recent FDIC regulations, banks are prohibited from using their
interstate branches primarily for deposit production. The FDIC has accordingly
implemented a loan-to-deposit ratio screen to ensure compliance with this
prohibition.

Oregon, effective as of February 27, 1995, and Washington, effective June
6, 1996, each enacted "opting in" legislation in accordance with the Interstate
Act provisions allowing banks to opt-in early to the interstate merger
provisions. Accordingly, both states generally permit interstate mergers,
subject to certain restrictions. Given that Oregon and Washington have permitted
interstate banking for a number of years, this legislation is not expected to
have a profound impact on banking in Oregon or Washington or on WCB's or the
banks' operations in particular. Nevertheless, the impact that the Interstate
Act might have on WCB and the banks' subsidiaries is impossible to predict at
this time.

8
11

CAPITAL ADEQUACY REQUIREMENTS

The FRB, the FDIC, and the OCC (collectively, "Federal Banking Agencies")
have established uniform capital requirements for all commercial banks. Bank
holding companies are also subject to certain minimum capital requirements. A
bank that does not achieve and maintain required capital levels may be subject
to supervisory action through the issuance of a capital directive to ensure the
maintenance of adequate capital levels. In addition, banks are required to meet
certain guidelines concerning the maintenance of an adequate allowance for loan
and lease loss.

The Federal Banking Agencies' "risk-based" capital guidelines establish a
systematic, analytical framework that makes regulatory capital requirements more
sensitive to differences in risk profiles among banking organizations, takes
off-balance sheet exposures into explicit account in assessing capital adequacy,
and minimizes disincentives to holding liquid, low-risk assets. The risk-based
ratio is determined by allocating assets and specified off-balance sheet
commitments into several categories, with high levels of capital being required
for the categories perceived as representing greater risk. The risk weights
assigned to assets and credit equivalent amounts of off-balance sheet items are
based primarily on credit risk. Other types of exposure, such as interest rate,
liquidity and funding risks, as well as asset quality problems, are not factored
into the risk-based ratio. Such risks, however, will be taken into account in
determining a final assessment of an organization's capital adequacy. Under
these new regulations, banks were required to achieve a minimum total risk-based
capital ratio of 8% and a minimum Tier 1 risk-based capital ratio of 4%.

The Federal Banking Agencies also have adopted leverage ratio standards
that require commercial banks to maintain a minimum ratio of core capital to
total assets ("Leverage Ratio") of 3%. Any institution operating at or near this
level is expected to have well-diversified risk, including no undue interest
rate risk exposure, excellent asset quality, high liquidity and good earnings,
and in general, to be a strong banking organization without any supervisory,
financial or operational weaknesses or deficiencies. Any institutions
experiencing or anticipating significant growth would be expected to maintain
capital ratios, including tangible capital positions, well above the minimum
levels (e.g., an additional cushion of at least 100 to 200 basis points,
depending upon the particular circumstances and risk profile).

Regulations adopted by the Federal Banking Agencies as required by FDICIA
impose even more stringent capital requirements. The regulators require the FDIC
and other Federal Banking Agencies to take certain "prompt corrective action"
when a bank fails to meet certain capital requirements. The regulations
establish and define five capital levels at which an institution is deemed to be
"well-capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." In order to be
"well-capitalized," an institution must maintain, at least 10% total risk-based
capital, 6% Tier 1 risk-based capital, and a 5% Leverage Ratio. Increasingly
severe restrictions are imposed on the payment of dividends and management fees,
asset growth, and other aspects of the operations of institutions that fall
below the category of "adequately capitalized" (which requires at least 8% total
risk-based capital, 4% Tier 1 risk-based capital, and a 4% Leverage Ratio).
Undercapitalized institutions are required to develop and implement capital
plans acceptable to the appropriate federal regulatory agency. Such plans must
require that any company that controls the undercapitalized institution must
provide certain guarantees that the institution will comply with the plan until
it is adequately capitalized. As of December 31, 1997, none of the Banks were
subject to any regulatory order, agreement, or directive to meet and maintain a
specific capital level for any capital measure.

The Oregon Department has authority under Oregon law to require
shareholders of an Oregon state bank to contribute additional capital to the
bank if its capital becomes impaired. The capital of a bank is deemed to be
impaired under Oregon law if the value of the bank's assets is insufficient to
pay its liabilities (excluding any liability on outstanding capital debentures)
plus the amount of its paid-in capital.

The minimum ratio of total capital to risk-adjusted assets (including
certain off-balance sheet items, such as stand-by letters of credit) required by
the FRB for bank holding companies is 8%. At least one-half of the total capital
must be Tier 1 capital; the remainder may consist of Tier 2 capital. Bank
holding companies are also subject to minimum Leverage Ratio guidelines. These
guidelines provide for a minimum Leverage Ratio of 3% for bank holding companies
meeting certain specified criteria, including achievement of the highest
supervisory rating. All other bank holding companies are required to maintain a
Leverage Ratio which is at least 100 to 200 basis points higher (4% to 5%).
These guidelines provide that

9
12

banking organizations experiencing internal growth or making acquisitions are
expected to maintain strong capital positions substantially above the minimum
supervisory levels, without significant reliance on intangible assets.

In 1995, the Federal Banking Agencies adopted a final rule implementing the
portion of Section 305 of FDICIA that requires the banking agencies to revise
their risk-based capital standards to ensure that those standards take adequate
account of interest rate risk. Effective September 1, 1995, when evaluating the
capital adequacy of a bank, the Federal Banking Agencies' examiners will
consider exposure to declines in the economic value of the bank's capital due to
changes in interest rates. A bank may be required to hold additional capital for
interest rate risk if it has a significant exposure or a weak interest rate risk
management process.

The Federal Banking Agencies published a joint final rule on September 6,
1996, amending their respective risk-based capital standards to incorporate a
measure for market risk to cover all positions located in an institution's
trading account and foreign exchange and commodity positions wherever located.
This final rule, effective January 1, 1997, implements an amendment to the Basle
Capital Accord that sets forth a supervisory framework for measuring market
risk. The final rule effectively requires banks and bank holding companies with
significant exposure to market risk to measure that risk using its own internal
value-at-risk model, subject to the parameters of the final rule, and to hold a
sufficient amount of capital to support the institution's risk exposure.

Institutions subject to this final rule must be in compliance with it as of
January 1, 1998. This final rule applies to any bank or bank holding company,
regardless of size, whose trading activity equals 10% or more of its total
assets or amounts to $1 billion or more. The Federal Banking Agencies may
require an institution not otherwise subject to the final rule to comply with it
for safety and soundness reasons and, under certain circumstances, also may
exempt an institution otherwise subject to the final rule from compliance.

FDIC INSURANCE

Generally, customer deposit accounts in banks are insured by the FDIC for
up to a maximum amount of $100,000. The FDIC has adopted a risk-based insurance
assessment system. Under this system, depository institutions, such as the bank
subsidiaries, with BIF-insured deposits, are required to pay an assessment to
the BIF ranging from $.0 to $.27 per $100 of deposits based on the institution's
risk classification. On September 30, 1996, the Deposit Insurance Funds Act of
1996 ("Funds Act") was enacted. The Funds Act provides, among other things, for
the recapitalization of the SAIF through a special assessment on all depository
institutions that hold SAIF-insured deposits. The one-time assessment is
designed to place the SAIF at its 1.25 reserve ratio goal.

The Funds Act, for the three-year period beginning in 1997, subjects
BIF-insured deposits to a Financing Corporation ("FICO") premium assessment on
domestic deposits at one-fifth the premium rate (roughly 1.3 basis points)
imposed on SAIF-insured deposits (roughly 6.5 basis points). In addition,
service debt funding on FICO bonds for the first half of 1997 is expected to
result in BIF-insured institutions paying .64 cents for each $100 of assessed
deposits, and SAIF-insured institutions paying 3.2 cents on each $100 of
deposits. Beginning in the year 2000, BIF-insured institutions will be required
to pay the FICO obligations on a pro-rata basis with all thrift institutions;
annual assessments are expected to equal approximately 2.4 basis points until
2017, to be phased out completely by 2019.

Banking regulators are empowered under the Funds Act to prohibit insured
institutions and their holding companies from facilitating or encouraging the
shifting of deposits from the SAIF to the BIF in order to avoid higher
assessment rates. The Funds Act also provides for the merger of the BIF and SAIF
on January 1, 1999, only if no thrift institutions exist on that date.

The risk classification is based on an assignment of the institution by the
FDIC to one of three capital groups and to one of three supervisory subgroups.
The capital groups are "well capitalized," "adequately capitalized," and
"undercapitalized." The three supervisory subgroups are Group "A" (for
financially sound institutions with only a few minor weaknesses), Group "B" (for
those institutions with weaknesses which, if uncorrected, could cause
substantial deterioration of the institution and increase risk to the deposit
insurance fund), and Group "C" (for those institutions with a substantial
probability of loss to the fund absent effective corrective action).

10
13

COMMUNITY REINVESTMENT ACT ("CRA")

The Federal Banking Agencies have each adopted regulations and examination
procedures to ensure that a bank is helping to meet the credit needs of all
segments of its communities, including low-and-moderate-income neighborhoods.

ITEM 2. PROPERTIES

The principal properties of the registrant are comprised of banking
facilities owned by the registrant's affiliates.

The main offices of The Commercial Bank are located in downtown Salem,
Oregon, in remodeled two-story buildings totaling approximately 40,000 square
feet of space. The main offices, which are owned by The Commercial Bank, include
land and administrative offices, the main branch, and drive-up teller
facilities. The Commercial Bank also operates 17 other branches, of which 9 are
owned and 8 are leased. The Commercial Bank owns the land under 8 of the 9 owned
branches. In addition, The Commercial Bank owns an approximately
8,000-square-foot building, including the land, in Salem, Oregon that is
currently leased by Bancorp housing administrative staff. The Commercial Bank's
aggregate monthly rental on all leased properties is $16,000.

The Bank of Newport owns the land and building housing its main offices
located in Newport, Oregon, consisting of approximately 15,640 square feet of
space. At December 31, 1997, The Bank of Newport also owned five buildings and
leased three additional spaces housing branches and offices. The Bank of Newport
owns the land under three of the five buildings, while leasing the land under
two of the buildings. The aggregate monthly rental of leased buildings and land
is approximately $30,500.

In addition, The Bank of Newport owns two buildings housing branches
operated under the assumed business name of Valley Commercial Bank. These
branches are located in (1) Forest Grove, Oregon, in a building and land
formerly owned by a subsidiary of The Commercial Bank, and (2) North Plains,
Oregon. The Bank of Newport also leases the space occupied by a branch in
Hillsboro, Oregon. This space is leased for approximately $3,152 per month and
the branch is operated under the assumed business name "Valley Commercial Bank."

The main office of the Bank of Vancouver is located in Vancouver,
Washington, in a building consisting of approximately 14,400 square feet of
space on land that is leased. Bank of Vancouver also operates a branch on the
east side of Vancouver in a leased facility shared with Bancorp. In addition,
Bank of Vancouver owns the building in which its former office was located in
Vancouver, Washington, which is subject to a ground lease. The building is
leased out at a monthly rate of $6,250. Bank of Vancouver's aggregate monthly
rental on leased property to non-affiliates is $15,726.

West Coast Trust's main office is in Salem where it leases space from The
Commercial Bank. West Coast Trust also has offices in Portland, Oregon, Newport,
Oregon and Vancouver, Washington where it leases space from The Bank of Newport
and Bank of Vancouver.

Bancorp leases office space housing its headquarters in Lake Oswego,
Oregon. In addition, Bancorp leases space in Vancouver, Washington and Lake
Oswego, Oregon to house offices for its commercial brokerage department. Bancorp
also leases a building and land in Salem, Oregon, housing its data center. The
aggregate monthly rental of the office space is approximately $11,918.

11
14

ITEM 3. LEGAL PROCEEDINGS

In the fall of 1994, The Commercial Bank and the manager of The Commercial
Bank's Trust Department consented to the entry of an order by the SEC finding
that certain violations of various provisions of the Securities Act of 1933, and
the Investment Company Act of 1940, had occurred by offering interests in an IRA
Fund without registration under such laws. The Commercial Bank paid a civil
penalty in the amount of $75,000 and retained an independent consultant to
conduct a review of compliance procedures, to recommend policies and procedures
to prevent and detect violations of federal securities laws, and to report to
the Board of Directors of The Commercial Bank.

The independent consultant's January 1996 report included recommendations
addressing The Commercial Bank's systems, processes and controls in place to
ensure that the common trust funds continue to operate in a manner consistent
with their respective Plan of Operation and Declaration of Trust. In addition,
an opinion of counsel was obtained that concluded the remaining common trust
funds were exempt from registration under the Securities Act of 1933 ( the 1933
Act) and the Investment Company Act of 1940, although the interests of a Keough
Fund were not exempt from registration under the 1933 Act due to the inclusion
of one ineligible participant.

During 1996, West Coast Trust, formerly Commercial Bank's Trust Department,
implemented changes to its governance and organizational structure, expanded
staff compliance and industry training programs, designated a chief compliance
officer, and incorporated additional changes to its operations to satisfy the
recommendations of the independent consultant. In addition, West Coast Trust
offered rescission rights to all eligible participants in the Keough Fund, which
rescission rights have since expired and the effects of which were not
significant.

The SEC consent order also required the independent consultant to conduct a
review one year following the issuance of its report to evaluate the
implementation of its recommendations. In March 1997, the independent consultant
issued its update report to the Boards of Directors of West Coast Trust and The
Commercial Bank, concluding that their recommendations had been appropriately
addressed and no further recommendations were necessary. This report has been
submitted to the SEC by the independent consultant and Bancorp is awaiting
formal resolution of this matter.

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

NONE

12
15

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS
MATTERS

STOCK PRICE AND DIVIDENDS

West Coast Bancorp common stock trades on The Nasdaq Stock Market under the
symbol "WCBO" and its primary market makers are: Black & Company, Inc.; Dain
Rauscher, Incorporated; Herzog, Heine, Geduld, Inc.; Hoefer & Arnett; Keefe,
Bruyette & Woods, Inc.; Pacific Crest Securities; and Piper Jaffray Companies,
Inc. The respective high and low sale prices of West Coast Bancorp's common
stock for the periods indicated are shown below. The prices below do not include
retail mark-ups, mark-downs or commissions, and may not represent actual
transactions. The per share information has been adjusted retroactively for all
stock dividends and splits previously issued. As of December 31, 1997, there
were approximately 3,975 shareholders of record of Bancorp common stock.

1997 1996
------------------------------------ -------------------------------------
Market Price Market Price
--------------------- Cash dividend --------------------- Cash dividend
High Low declared High Low declared
------------------------------------ --------------------- -------------

1st Quarter........ $15.17 $11.67 $0.04 $10.40 $8.53 $0.03
2nd Quarter........ $21.33 $13.92 $0.04 $10.40 $9.47 $0.03
3rd Quarter........ $20.67 $16.92 $0.04 $10.67 $9.33 $0.04
4th Quarter........ $27.50 $18.00 $0.05 $12.50 $10.67 $0.04

13
16

ITEM 6. SELECTED FINANCIAL DATA

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

(Dollars in thousands, except per share data) Year ended December 31,
- ----------------------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ---------- ----------

Interest income...................................... $ 66,678 $ 56,624 $ 47,293 $ 38,918 $ 35,585
Interest expense..................................... 23,947 19,834 17,429 11,506 10,647
----------- ----------- ----------- ---------- ----------
Net interest income.............................. 42,731 36,790 29,864 27,412 24,938
Provision for loan loss.............................. 2,196 2,175 944 777 1,083
----------- ----------- ----------- ---------- ----------
Net interest income after provision
for loan loss...................................... 40,535 34,615 28,920 26,635 23,855
Noninterest income................................... 10,919 8,879 8,095 7,087 6,644
Noninterest expense.................................. 33,653 28,851 25,520 24,654 21,535
----------- ----------- ----------- ---------- -----------
Income before income taxes........................... 17,801 14,643 11,495 9,068 8,964
Provision for income taxes........................... 5,935 4,841 3,246 2,752 2,425
----------- ----------- ----------- ---------- ----------
Net income........................................... $ 11,866 $ 9,802 $ 8,249 $ 6,316 $ 6,539
=========== =========== =========== ========== ==========

Per share data:
Basic earnings per share........................ $ 1.18 $ 0.98 $ 0.83 $ 0.67 $ 0.72
Diluted earnings per share...................... $ 1.12 $ 0.95 $ 0.81 $ 0.66 $ 0.71
Cash dividends.................................. $ 0.17 $ 0.14 $ 0.14 $ 0.12 $ 0.12
Period end book value........................... $ 7.78 $ 6.68 $ 5.93 $ 4.92 $ 4.41
Average common equivalent shares outstanding.... 10,615,911 10,289,491 10,130,929 9,610,392 9,191,423

Total assets......................................... $ 849,951 $ 712,343 $ 595,574 $ 515,750 480,153
Total deposits....................................... $ 713,953 $ 604,902 $ 512,774 437,175 413,935
Total long-term borrowings........................... $ 22,446 $ 28,583 $ 10,188 10,046 9,095
Net loans............................................ $ 580,749 $ 528,755 $ 395,319 319,698 284,184
Stockholders' equity................................. $ 79,270 $ 67,145 $ 58,981 48,884 40,342
Financial ratios:
Return on average assets........................ 1.55% 1.51% 1.49% 1.28% 1.50%
Return on average equity........................ 16.58% 15.86% 15.66% 14.17% 18.02%
Average equity to assets........................ 9.33% 9.51% 9.54% 9.04% 8.31%
Dividend payout ratio........................... 14.58% 14.48% 16.60% 17.93% 16.67%
Efficiency ratio................................ 62.61% 63.20% 67.25% 71.11% 68.50%
Net loans to assets............................. 68.33% 74.23% 66.38% 61.99% 59.19%
Yield on earning assets(1)...................... 9.49% 9.70% 9.71% 8.97% 9.19%
Average rates paid.............................. 4.14% 4.09% 4.25% 3.16% 3.20%
Net interest spread(1).......................... 5.35% 5.61% 5.46% 5.81% 5.99%
Net interest margin(1).......................... 6.14% 6.38% 6.24% 6.41% 6.54%
Nonperforming assets to total assets............ 0.40% 0.28% 0.14% 0.11% 0.44%
Allowance for loan loss to total loans.......... 1.45% 1.31% 1.39% 1.56% 1.53%
Allowance for loan loss to
nonperforming assets......................... 252.11% 356.17% 679.15% 927.95% 210.64%

- ----------
(1) Interest earned in nontaxable securities has been computed on a 34% tax
equivalent basis.

14
17

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

RESULTS OF OPERATIONS

Years Ended December 31, 1997, 1996 and 1995.

NET INCOME. For the three years ended December 31, 1997, Bancorp's net
income was $11.9 million, $9.8 million and $8.2 million, respectively. 1997 net
income increased $2.1 million or 21.06% over 1996, which increased $1.6 million
or 18.82% over 1995's income. Diluted earnings per share for the three years
ended 1997 were $1.12, $0.95 and $0.81. Bancorp increased operating income in
1997 primarily due to increased net interest income resulting from larger
balances of interest earning assets. Net interest income on a tax equivalent
basis totaled $44.0 million for the year ended December 31, 1997, a 15.41%
increase over $38.1 million for the same period in 1996, which was a 21.68%
increase over 1995. Growth of noninterest income was due to increased customer
bases and transaction volumes. Noninterest expenses increased primarily due to
bank branch expansion.

NET INTEREST INCOME. During the years ended December 31, 1997, 1996 and
1995, average interest earning assets grew to $716.0 million, from $597.2
million and $502.1 million, respectively. For the same periods, average interest
bearing liabilities were $578.5 million, $484.9 million and $410.5 million,
respectively. Additionally, during the same periods, net interest margins were
6.14%, 6.38% and 6.24%, respectively; fluctuations are due mainly to a changing
interest rate environment, increased pricing competition, a shift in some of its
asset mix, and an increase of certificates of deposits and long-term funding
sources. Net interest income on a tax-equivalent basis increased $5.9 million,
or 15.41%, to $44.0 million in 1997 from $38.1 million in 1996 and $31.3 million
in 1995. The increased net interest income was caused mainly by asset growth.
Average interest earning assets increased 19.89% in 1997 from 1996 and 18.93% in
1996 over 1995. Bancorp experienced a decrease in the net interest spread of 26
basis points in 1997 to 5.35% from 5.61% in 1996 which was up 15 basis points
from 5.46% in 1995. The average yield earned on interest earning assets was
9.49% in 1997, 9.70% in 1996 and 9.71% in 1995. Average interest bearing
liabilities increased $93.6 million, or 19.31%, to $578.5 million for the period
ended December 31, 1997, from $484.9 million in 1996 and $410.5 million in 1995,
while the average rates paid were 4.14%, 4.09%, and 4.25%, respectively.
Bancorp's loan portfolio experienced growth in 1997 ending the year at $580.7
million up $51.9 million from $528.8 million at December 31, 1996. Bancorp's
deposit base grew to $714.0 million at December 31, 1997 up $109.1 million or
18.0% from $604.9 million at the end of 1996. Bancorp also had a shift in its
asset mix from the loan portfolio to investment securities.

Analysis of Net Interest Income. The following table presents information
regarding yields on interest-earning assets, expense on interest-bearing
liabilities, and net yields on interest-earning assets for the periods
indicated on a tax equivalent basis:

Year Ended December 31, Increase (Decrease) Change
-----------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995 97-96 96-95 97-96 96-95
-------------------- ----------- ----------- ---------- ---------- --------- --------- -------

Interest and fee income(1)............... $ 67,918 $ 57,935 $ 48,742 $ 9,983 $ 9,193 17.23% 18.86%
Interest expense......................... $ 23,947 $ 19,834 $ 17,429 $ 4,113 $ 2,405 20.74% 13.80%
Net interest income...................... $ 43,971 $ 38,101 $ 31,313 $ 5,870 $ 6,788 15.41% 21.68%

Average interest earning assets.......... $ 715,998 $ 597,189 $502,142 $118,809 $ 95,047 19.89% 18.93%
Average interest bearing liabilities..... $ 578,514 $ 484,900 $410,461 $ 93,614 $ 74,439 19.31% 18.14%
Average yields earned.................... 9.49% 9.70% 9.71% (0.21) (.01)
Average rates paid....................... 4.14% 4.09% 4.25% 0.05 (.16)
Net interest spread...................... 5.35% 5.61% 5.46% (0.26) .15
Net interest margin...................... 6.14% 6.38% 6.24% (0.24) .14

- ----------
(1) Interest earned on nontaxable securities has been computed on a 34% tax
equivalent basis.

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18

Average Balances and Average Rates Earned and Paid. The following table
sets forth, for the periods indicated, information with regard to (i) average
balances of assets and liabilities, (ii) the total dollar amounts of interest
income on interest earning assets and interest expense on interest bearing
liabilities, (iii) resulting yields or costs, (iv) net interest income, and (v)
net interest spread. Nonaccrual loans have been included in the tables as loans
carrying a zero yield. Loan fees are recognized as income using the interest
method over the life of the loan.

Year Ended December 31,
(Dollars in thousands) 1997 1996 1995
- -------------------- -------------------------------------------------------------------------------------------------
Average Interest Average Interest Yield/ Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Rate Outstanding Earned/ Yield/
Balance Paid Rate(1) Balance Paid (1) Balance Paid Rate(1)
-------------------------------------------------------------------------------------------------

ASSETS:
Interest earning balances
due from banks ............... $ 17,730 $ 978 5.52% $ 5,852 $ 305 5.21% $ 2,998 152 5.07%

Federal funds sold ............ 1,026 53 5.15 6,490 396 6.10 11,375 641 5.64
Taxable securities ............ 93,127 6,188 6.65 73,975 4,861 6.57 77,333 4,849 6.27
Nontaxable securities(2) ...... 42,761 3,649 8.53 42,965 3,857 8.98 47,698 4,261 8.93
Loans, including fees(3) ...... 561,354 57,050 10.16 467,907 48,516 10.37 362,738 38,839 10.71
--------- -------- --------- ------- -------- --------
Total interest
earning assets.............. 715,998 67,918 9.49% 597,189 57,935 9.70% 502,142 48,742 9.71%

Allowance for loan loss ....... (7,885) (5,983) (5,341)
Premises and equipment ........ 18,420 17,383 15,979
Other assets .................. 40,428 41,056 39,123
--------- --------- --------
Total assets ................ $ 766,961 $ 649,645 $551,903
========= ========= ========
LIABILITIES AND
SHAREHOLDERS' EQUITY:
Savings and interest bearing
demand deposits ............... $ 350,590 $ 11,364 3.24% $ 302,211 $ 9,912 3.28% $250,292 $ 8,634 3.45%

Certificates of deposit ....... 202,999 11,178 5.51 160,369 8,680 5.41 143,500 7,837 5.46
Short-term borrowings ......... 2,378 127 5.34 9,448 553 5.85 5,932 379 6.39
Long-term borrowings .......... 22,547 1,278 5.67 12,872 689 5.35 10,737 579 5.39
--------- -------- --------- ------- -------- -------
Total interest bearing
liabilities ............... 578,514 23,947 4.14% 484,900 19,834 4.09 410,461 17,429 4.25
Demand deposits ............... 109,919 97,006 82,695
Other liabilities ............. 6,956 5,948 6,082
--------- --------- --------
Total liabilities ........... 695,389 587,854 499,238
Shareholders' equity .......... 71,572 61,791 52,665
--------- --------- --------

Total liabilities and
shareholders' equity ...... $ 766,961 $ 649,645 $551,903
========= ========= ========

Net interest income ........... $ 43,971 $ 38,101 $31,313
======== ======== =======

Net interest spread ........... 5.35% 5.61% 5.46%
==== ===== =====

- ----------
(1) Yield/rate calculations have been based on more detailed information than
presented and therefore may not recompute exactly due to rounding.
(2) Interest earned on nontaxable securities has been computed on a 34 percent
tax equivalent basis.
(3) Includes balances for loans held for sale.

16
19

Analysis of Changes in Interest Differential. The following table sets
forth the amounts of the changes in consolidated net interest income
attributable to changes in volume and to changes in interest rates. Changes not
due solely to volume or rate are allocated to rate and changes due to new
product lines are allocated to volume.

Year Ended December 31,
--------------------------------------------------------------------
1997 versus 1996 1996 versus 1995
-------------------------------- --------------------------------
Increase (Decrease) Total Increase (Decrease)
Due To Increase Due To Total
-------------------- (Decrease) -------------------- Increase
(Dollars in thousands) Volume Rate ---------- Volume Rate (Decrease)
- ---------------------- -------- -------- -------- -------- ----------

Interest income:
Interest earning balances due
from banks........................... $ 619 $ 54 $ 673 $ 144 $ 9 $ 153
Federal funds sold ..................... (333) (10) (343) (276) 31 (245)
Investment security income:
Taxable securities ................... 1,259 68 1,327 (211) 223 12
Nontaxable securities(1) ............. (18) (190) (208) (423) 19 (404)
Loans, including fees on loans ......... 9,689 (1,155) 8,534 11,264 (1,587) 9,677
-------- -------- -------- -------- -------- --------
Total interest income(1) ............ 11,216 (1,233) 9,983 10,498 (1,305) 9,193

Interest expense:
Savings and interest bearing demand .... 1,587 (135) 1,452 1,791 (513) 1,278
Certificates of deposit ................ 2,307 191 2,498 921 (78) 843
Short-term borrowings .................. (414) (12) (426) 225 (51) 174
Long-term borrowings ................... 518 71 589 115 (5) 110
-------- -------- -------- -------- -------- --------
Total interest expense ............. 3,998 115 4,113 3,052 (647) 2,405
-------- -------- -------- -------- -------- --------
Net interest spread(1) ............. $ 7,218 $ (1,348) $ 5,870 $ 7,446 $ (658) $ 6,788
======== ======== ======== ======== ======== ========

- ----------
(1) Tax-exempt income has been adjusted to a tax-equivalent basis at a 34
percent rate.

PROVISION FOR LOAN LOSS. Bancorp recorded provisions for loan loss of
$2,196,000, $2,174,987 and $943,460 for the years ended December 31, 1997, 1996
and 1995 respectively. The increase each year in the provision is attributed
mainly to Bancorp's loan growth. Bancorp incurred net charge-offs of $704,476,
$706,771, and $444,404, in 1997, 1996 and 1995 respectively. The allowance for
loan loss as a percentage of loan totals at December 31, 1997 and 1996 was 1.45%
and 1.31% of total loans, respectively. Bancorp's allowance for loan loss
represents 252.11% of its non-performing assets as of December 31, 1997,
compared to 356.17% at December 31, 1996.

NONINTEREST INCOME. Noninterest income for the year ended December 31, 1997
was $10,919,281 up from $8,878,585 in 1996 and $8,094,759 in 1995. Other service
charges, commissions and fees, service charges on deposit accounts, trust
revenues and loan servicing fees increased over the last three years, due to an
increased customer base and transaction volumes serviced. In 1997 gains on sales
of loans increased $364,463 to $1,542,515 from $1,178,052 in 1996 which was an
increase from $852,954 reported in 1995. In 1997 and 1996 Bancorp benefitted
from the low fairly stable interest rate environment that increased the
refinance activity on loans sold into the secondary market. Other noninterest
income fluctuated over the three year period with some non-recurring activity.
Net securities losses were $99,635 in 1997, with gains in 1996 and 1995 of
$17,030 and $9,838, respectively. Overall increases in noninterest income were
due to increased market presence in existing and expanding markets.

NONINTEREST EXPENSE. Noninterest expenses have increased during the last
three years to $33,652,974 in 1997 from $28,851,340 in 1996 and $25,520,456 in
1995. Increases in salaries, equipment, occupancy, marketing, printing and
office supplies, communications and other noninterest expenses have been caused
mainly by Bancorp's expansion of its branch system and services and the costs
associated with entering new markets. Bancorp's branch system grew to 32 office
locations at the end of 1997 from 27 at the beginning of 1995. Bancorp intends
to continue to grow through strategically placed offices in 1998 and beyond. In
general, the opening of new branches results in higher costs for Bancorp which
are not offset until a certain

17
20

level of growth in deposits and loans is achieved. Thus, at least initially, new
branches tend to have an adverse effect on results of operations, until earnings
grow to cover overhead. At the end of 1997, Bancorp employed 498 full-time
equivalent employees compared to 467 in 1996 and 409 in 1995. Other increases in
noninterest expense generally were caused by higher operating activity levels
associated with Bancorp's internal growth. Equipment, occupancy and
communications expenses also increased beginning in 1995 due to the opening of
Bancorp's data processing facilities. During 1997, 1996 and 1995 Bancorp
incurred additional costs as a result of the consolidation and reorganization of
certain operating activities. From 1995 to 1997 expenses in ATM and Bankcard
have increased due to continued expansion of the ATM network and an increase in
the customer base for The Bank of Newport's bankcard services. FDIC deposit
insurance expense fluctuated in 1997, 1996 and 1995 due to changes in insurance
premiums charged, expenses were $90,374, $10,432 and $517,847 for the years
ended December 31, 1997, 1996 and 1995, respectively.

INCOME TAXES

Income tax expense for 1997 was $5,934,861 or 33 percent of income before
income taxes, 1996 was $4,840,510 or 33 percent of income before income taxes
and 1995 was $3,245,720 or 28 percent of income before income taxes. Income tax
expense has fluctuated over time due to state income tax credits and
capitalization of certain merger related expenditures for income tax purposes.
It is anticipated that Bancorp's tax expense will increase in future years both
due to increased income before income taxes and a smaller percentage of
Bancorp's income being generated from tax exempt items. Any future merger
related capitalized costs may also increase Bancorp tax provisions.

MARKET RISK

Interest rate, credit and operations credit risks are the most significant
market risks impacting Bancorp's performance. Other types of market risk, such
as foreign currency exchange rate risk and commodity price risk, do not arise in
the normal course of Bancorp's business activities. Bancorp relies on loan
reviews, prudent loan underwriting standards and an adequate allowance of loan
loss to mitigate credit risk.

Bancorp uses an asset/liability management simulation model to measure
interest rate risk. The model quantifies interest rate risk through simulating
forecasted net interest income over a 12-month time period under various rate
scenarios as well as monitoring the change in the present value of equity under
the same rate scenarios. The present value of equity is defined as the
difference between the market value of current assets less current liabilities.
By measuring the change in the present value of equity under different rate
scenarios, management is able to identify interest rate risk that may not be
evident in simulating changes in forecasted net interest income. The following
table presents an analysis of the approximate percent change in projected net
interest income over a 12-month period along with the approximate change in the
present value of equity relative to earnings in the current interest rate
environment. All percent changes are compared to the current interest rate yield
curve. The change in interest rates assumes an immediate, parallel and sustained
shift in the interest rate yield curve.

Percent Change in Percent Change in
Change in Interest Rates Net Interest Income Present Value of Equity
------------------------ ------------------- -----------------------

-200 Basis Points +2.32% +9.83%
-100 Basis Points +1.07% +4.49%
+100 Basis Points -1.12% -5.50%
+200 Basis Points -1.96% -8.40%

As illustrated in the above table, Bancorp is currently slightly liability
sensitive, meaning that interest bearing liabilities mature or reprice more
quickly than interest-earning assets in a given period, therefore, a significant
increase in market rates of interest could adversely affect net interest income.
In contrast, a decreasing rate environment may slightly improve Bancorp's
margin. Bancorp's strategy will be to continue to limit its loss exposure
through managing the repricing characteristics of its assets and liabilities.
Bancorp has also placed increased emphasis on its non-interest revenue products
to additionally stabilize earnings strength.

18
21

It should be noted that the simulation model does not take into account
future management actions that could be undertaken, if there were a change in
actual market interest rates during the year. Also, certain assumptions are
required to perform modeling simulations that may have significant impact on the
results. These include assumptions regarding the level of interest rates and
balance changes on deposit products that do not have stated maturities. These
assumptions have been developed through a combination of industry standards and
future expected pricing behavior. The model also includes assumptions about
changes in the composition or mix of the balance sheet. The results stated above
could vary significantly by external factors such as changes in the prepayment
assumptions, early withdrawals of deposits and competition. Merger activity will
also have an impact on Bancorp's asset/liability position as new assets are
acquired and added.

INTEREST RATE SENSITIVITY (GAP) TABLE

The primary objective of Bancorp's asset/liability management is to
maximize net interest income while maintaining acceptable levels of
interest-rate sensitivity. The corporation seeks to meet this objective through
influencing the maturity and repricing characteristics of its assets and
liabilities.

The following table sets forth the estimated maturity and repricing and the
resulting interest rate gap between interest earning assets and interest bearing
liabilities at December 31, 1997. The amounts in the table are derived from
internal data from the Banks based on maturities and next repricing dates
including contractual repayments.

Estimated Maturity or Repricing at December 31, 1997
--------------------------------------------------------------------
(Dollars in thousands) Due After
-------------------- 0-3 Months 4-12 Months 1 -5 Years Five Years Total
--------------------------------------------------------------------

Interest Earning Assets:
Interest earning balances due
from banks ............................ $ 381 $ -- $ -- $ -- $ 381
Federal funds sold ...................... -- -- -- -- --
Investments available for sale (1)(2) ... 14,551 20,343 73,000 71,851 179,745
Investments held to maturity ............ -- 62 1,315 1,140 2,517
Loans held for sale ..................... 5,949 -- -- -- 5,949
Loans, including fees ................... 230,116 87,182 238,842 33,138 589,278
--------- --------- --------- --------- ---------
Total interest earning assets ......... $ 250,997 $ 107,587 $ 313,157 $ 106,129 $ 777,870
Allowance for loan loss ................. ========= ========= ========= ========= (8,529)
Cash and due from banks ................. 45,603
Other assets ............................ 35,007
---------
Total assets ......................... $ 849,951
=========
Interest Bearing Liabilities:
Savings and interest demand deposits(3) . $ 41,249 $ 124,701 $ 198,457 $ -- $ 364,407
Certificates of deposit ................. 75,602 116,707 25,855 5,247 223,411
Borrowings .............................. 29,491 2,433 18,452 894 51,270
--------- --------- --------- --------- ---------
Total interest bearing liabilities ... $ 146,342 $ 243,841 $ 242,764 $ 6,141 $ 639,088
========= ========= ========= =========
Other liabilities ....................... 131,593
---------
Total liabilities ....................... 770,681
Shareholders' equity .................... 79,270
---------
Total liabilities & shareholders' equity $ 849,951
=========

Interest sensitivity gap ................ $ 104,655 $(136,254) $ 70,393 $ 99,988 $ 138,782
Cumulative interest sensitivity gap ..... $ 104,655 $ (31,599) $ 38,794 $ 138,782
Cumulative interest sensitivity gap
as a percentage of total assets ..... 12.31% (3.72)% 4.56% 16.33%

- ----------
(1) Equity investments have been placed in the 0-3 month category.
(2) Repricing is based on anticipated call dates, and may vary from contractual
maturities.
(3) Repricing is based on historical average lives.

19
22

Certain shortcomings are inherent in the method of analysis presented in
the foregoing table. For example, although certain assets and liabilities may
have similar maturities and periods of repricing, they may react differently to
changes in market interest rates. Also, interest rates on assets and liabilities
may fluctuate in advance of changes in market interest rates. Also, interest
rates on assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other assets and liabilities may follow
changes in market interest rates. Given these shortcomings, management believes
that rate risk is best measured by simulation modeling as opposed to measuring
interest rate risk through interest rate gap measurement.

LIQUIDITY AND SOURCES OF FUNDS

Bancorp's primary sources of funds are customer deposits, maturities of
investment securities, sales of "available for sale" securities, loan sales,
loan repayments, net income, advances from the Federal Home Loan Bank of Seattle
(FHLB), and the use of Federal Funds markets. Scheduled loan repayments are
relatively stable sources of funds while deposit inflows and unscheduled loan
prepayments are not. Deposit inflows and unscheduled loan prepayments are
influenced by general interest rate levels, interest rates available on other
investments, competition, economic conditions, and other factors.

Deposits are Bancorp's primary source of new funds. Total deposits were
$714.0 million at December 31, 1997, up from $604.9 million at December 31,
1996, of which $223.4 million at December 31, 1997 were in certificates of
deposits. Bancorp does not generally accept brokered deposits. A concerted
effort has been made to attract deposits in the market area it serves through
competitive pricing and delivery of quality products. Increases over the period
are due primarily to the opening of new branch facilities, marketing efforts,
and new business development programs initiated by Bancorp.

Management anticipates that Bancorp will continue relying on customer
deposits, maturity of investment securities, sales of "available for sale"
securities, loan sales, loan repayments, net income, Federal Funds markets, and
FHLB borrowings to provide liquidity. Although deposit balances have shown
historical growth, such balances may be influenced by changes in the banking
industry, interest rates available on other investments, general economic
conditions, competition and other factors. Borrowings may be used on a
short-term basis to compensate for reductions in other sources of funds.
Borrowings may also be used on a long-term basis to support expanded lending
activities and to match maturities or repricing intervals of assets. The sources
of such funds will most likely be Federal Funds purchased, borrowings from the
FHLB, or capital markets. Bancorp may also use borrowings as a source of funds
for merger and acquisition activities

CAPITAL RESOURCES

The Federal Reserve Bank (FRB) and Federal Deposit Insurance Corporation
(FDIC) have established minimum requirements for capital adequacy for bank
holding companies and member banks. The requirements address both risk-based
capital and leveraged capital. The regulatory agencies may establish higher
minimum requirements if, for example, a corporation has previously received
special attention or has a high susceptibility to interest rate risk. The FRB
and FDIC risk-based capital guidelines require banks and bank holding companies
to have a ratio of tier one capital to total risk-weighted assets of at least 4
percent and a ratio of total capital to total risk-weighted assets of 8 percent
or greater. In addition, the leverage ratio of tier one capital to total assets
less intangibles is required to be at least 3 percent. As of December 31, 1997,
Bancorp and all of its subsidiary banks are considered "Well Capitalized" per
the regulatory risk based capital guidelines.

Shareholders' equity increased to $79.3 million at December 31, 1997 from
$67.1 million at December 31, 1996 an increase of $12.2 million, or 18.06%, over
that period of time. At December 31, 1997, Bancorp's shareholders' equity, as a
percentage of total assets, was 9.33%, compared to 9.43% at December 31, 1996.
The change was primarily a result of asset growth outpacing income recognition
and the change in net value of Bancorp's available for sale investment
portfolio. In a rising interest rate environment, the value of Bancorp's
available for sale portfolio will decline, thus negatively impacting equity. The
opposite would occur in a falling rate environment. Equity grew at 18.06% over
the period from December 31, 1996 to December 31, 1997, while assets grew by
19.32% over the same period.

23

As the following table indicates, Bancorp currently exceeds the regulatory
minimum capital ratio requirements.

December 31, 1997
--------------------------
(Dollars in thousands) Amount Ratio
-------------------- --------------------------

Tier 1 capital .................................. $ 77,098 11.65%
Tier 1 capital minimum requirement .............. 26,472 4.00
-------- -----
Excess Tier 1 capital ........................... $ 50,626 7.65%
========

Total capital ................................... $ 85,367 12.90%
Total capital minimum requirement ............... 52,944 8.00
-------- -----
Excess total capital ............................ $ 32,423 4.90%
========

Risk-adjusted assets ............................ $661,536
========
Leverage ratio .................................. 9.37%
Minimum leverage requirement .................... 3.00
-----
Excess leverage ratio ........................... 6.37%

Adjusted total assets ........................... $822,736
========

INVESTMENT PORTFOLIO

The following table shows the amortized cost and fair value of Bancorp's
investments.

(Dollars in thousands) 1997 1996 1995
- ---------------------- ---------------------------------------------------------------
Amortized Fair Amortized Fair Amortized Fair
Available for sale Cost Value Cost Value Cost Value
- ------------------ ---------------------------------------------------------------

U.S. Treasury securities ...................... $ 2.803 $ 2,807 $ 8,819 $ 8,827 $ 18,926 $ 18,972
U.S. Agency securities ........................ 75,362 75,775 38,261 38,338 36,082 36,581
Obligations of state and political subdivisions 61,218 63,296 34,983 36,617 43,983 46,335
Other Securities .............................. 37,684 37,867 23,601 23,386 19,516 19,493
-------- -------- -------- -------- -------- --------
Total $177,067 $179,745 $105,664 $107,168 $118,507 $121,381
======== ======== ======== ======== ======== ========

(Dollars in thousands) 1997 1996 1995
- ---------------------- ---------------------------------------------------------------
Amortized Fair Amortized Fair Amortized Fair
Held to maturity Cost Value Cost Value Cost Value
- ---------------- ---------------------------------------------------------------

U.S. Treasury securities ...................... $ -- $ -- $ -- $ -- $ 408 $ 442
U.S. Agency securities ........................ -- -- -- -- -- --
Obligations of state and political subdivisions 2,517 2,573 2,623 2,652 2,592 2,615
Other Securities .............................. -- -- -- -- 4,783 4,742
------ ------ ------ ------ ------ ------
Total ...................................... $2,517 $2,573 $2,623 $2,652 $7,783 $7,799
====== ====== ====== ====== ====== ======

At December 31, 1997 the net unrealized gains on the investment portfolio
was $2,734,000 representing 1.50% of the total portfolio. Management has no
current plans to sell any of these securities that would result in a material
impact on the results of operation. The following table summarized the
contractual maturities and weighted average yields of investment securities.

(Dollars in thousands)
-------------------- One Year One Year One Year One Year One Year
Or Less Or Less Or Less Or Less Or Less
December 31, 1996 Yield Yield Yield Yield Yield
- ----------------- ----------------------------------------------------------------------------------------

U.S. Treasury securities ......... $ 2,299 5.83% $ 508 6.51% $ -- 0.00% $ -- 0.00% $ 2,807 5.96%
U.S. Agency securities ........... 4,583 6.97% 20,131 6.16% 34,278 6.74% $16,783 6.59% 75,775 6.56%
Obligations of state and political
subdivisions(1) ................ 2,675 8.69% 16,918 8.84% 27,007 8.50% 19,213 7.58% 65,813 8.33%
Other Securities(2) .............. 6,794 6.66% 19,973 6.53% 7,287 6.43% 3,813 6.27% 37,867 6.51%
------- ------- ------- ------- --------
Total (1) ..................... $16,351 6.96% $57,530 7.08 $68,572 7.40% $39,809 7.04% $182,262 7.18%
======= ======= ======= ======= ========

(1) Yields are stated on a federal tax-equivalent basis at 34 percent.
(2) Does not reflect anticipated maturity from prepayments on mortgage-based
and asset-based securities. Anticipated lives are shorter than contractual
maturities.

24
LENDING AND CREDIT MANAGEMENT

Interest earned on the loan portfolio is the primary source of income for
Bancorp. Net loans represented 68.33% of total assets as of December 31, 1997.
Although the Banks strive to serve the credit needs of their service areas, the
primary focus is on real estate related and commercial credits. The Banks make
substantially all of their loans to customers located within the Banks' service
areas. The Banks have no loans defined as highly leveraged transactions by the
FRB.

Although a risk of nonpayment exists with respect to all loans, certain
specific types of risks are associated with different types of loans. Owing to
the nature of the Banks' customer base and the growth experienced in the market
areas served, real estate is frequently a material component of collateral for
the Banks' loans. The expected source of repayment of these loans is generally
the operations of the borrower's business or personal income, but real estate
provides an additional measure of security. Risks associated with real estate
loans include fluctuating land values, local economic conditions, changes in tax
policies, and a concentration of loans within any one area.

The Banks mitigate risk on construction loans by generally lending funds to
customers who have been pre-qualified for long-term financing and are using
experienced contractors approved by the Banks. The commercial real estate risk
is further mitigated by making the majority of commercial real estate loans to
owner-occupied users of the property.

The Banks manage the general risks inherent in the loan portfolio by
following loan policies and underwriting practices designed to result in prudent
lending activities.

Year Ended December 31,
------------------------------------------------------------------------------------------------------
Dollars in thousands) 1997 1996 1995 1994 1993
- --------------------- ---- ---- ---- ---- ----
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------------------------------------------------------------------------------------------------------

Commercial loans ..... $ 92,880 15.99% $ 97,515 18.44% $ 66,214 16.75% $ 66,212 20.71% $ 62,220 21.89%
Real estate
construction ....... 80,240 13.82 69,917 13.22 52,894 13.38 35,514 11.11 17,394 6.12
Real estate-mortgage . 90,609 15.60 92,060 17.41 75,293 19.05 98,480 30.80 87,527 30.80
Real estate-commercial 288,761 49.72 235,935 44.62 165,734 41.92 83,031 25.97 76,413 26.89
Installment and other
consumer ........... 36,788 6.33 40,366 7.64 40,753 10.31 41,531 13.00 45,034 15.85
-------- -------- -------- -------- --------
Total loans ..... 589,278 101.46 535,793 101.33 400,888 101.41 324,768 101.59 288,588 101.55
Allowance for loan
loss ............... (8,529) (1.46) (7,038) (1.33) (5,569) (1.41) (5,070) (1.59) (4,404) (1.55)
-------- -------- -------- -------- --------
Total loans, net ... $580,749 100.00% $528,755 100.00% $395,319 100.00% $319,698 100.00% $284,184 100.00%
======== ====== ======== ====== ========= ====== ======== ====== ======== ======

The maturity distribution of selected categories of Bancorp's loan
portfolio at December 31, 1997, and the interest sensitivity are estimated in
the following table.

Commercial Real Estate
(Dollars in thousands) Loans Construction Total
- ---------------------- ---------------------------------------

Maturity distribution:
Due within one year ......................... $ 74,762 $ 70,001 $144,763
Due after one through five years ............ 17,521 10,239 27,760
Due after five years ........................ 597 -- 597
-------- -------- --------
Total ..................................... $ 92,880 $ 80,240 $173,120
======== ======== ========

Interest sensitivity:
Fixed-interest rate loans .................... $ 24,495 $ 5,851 $ 30,346
Floating or adjustable interest rate loans(1) 68,385 74,389 142,774
-------- -------- --------
Total .................................... $ 92,880 $ 80,240 $173,120
======== ======== ========

- ----------
(1) Some loans contain provisions which place maximum or minimum limits on
interest rate charges.

21
25

The Banks manage the general risks inherent in the loan portfolio by
following loan policies and underwriting practices designed to result in prudent
lending activities. The following table presents information with respect to
nonperforming assets.

December 31,
--------------------------------------------------
(Dollars in thousands) 1997 1996 1995 1994 1993
- ---------------------- ------ ------ ------ ------ ------

Loans on nonaccrual status ................ $3,008 $1,884 $ 804 $ 476 $1,240
Loans past due 90 days or more but not on
nonaccrual status 44 92 16 39 244
Other real estate owned ................... 331 -- 1 31 607
------ ------ ------ ------ ------
Total nonperforming assets ............ $3,383 $1,976 $ 821 $ 546 $2,091
====== ====== ====== ====== ======
Percentage of nonperforming assets to total
assets .................................... 0.40% 0.28% 0.14% 0.11% 0.44%

Interest income on loans is accrued daily on the principal balance
outstanding. Generally, no interest is accrued on loans when factors indicate
collection of interest is doubtful or when the principal or interest payment
becomes 90 days past due. Increases in nonaccrual loans in recent years are due
substantially from growth in Bancorp's loan portfolio. The nonaccrual loans
consist of a number of loans in different categories and are largely secured.
For such loans previously accrued but uncollected interest is charged against
current earnings, and income is only recognized to the extent payments are
subsequently received. Interest income foregone on nonaccrual loans was
approximately $357,627 at December 31, 1997.

At December 31, 1997, there was no concentration of loans exceeding 10
percent of the total loans to a multiple number of borrowers engaged in a
similar business.

22
26

LOAN LOSS ALLOWANCE AND PROVISION

The provision for loan loss charged to operating expense is based on the
Banks' loan loss experience and such other factors that, in management's
judgment, deserve recognition in estimating loan losses. Management monitors the
loan portfolio to ensure that the allowance for loan loss is adequate to cover
outstanding loans. In determining the allowance for loan loss, management
considers the level of non-performing loans, loan mix, loan growth, historical
loss experience for each loan category, potential economic influences, and other
relevant factors related to the loan portfolio.

Year ended December 31,
----------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995 1994 1993
- --------------------- -------- -------- -------- -------- --------

Loans outstanding at end of period ......... $580,749 $535,793 $400,888 $324,768 $288,588
Average loans outstanding during the period $558,917 $466,623 $363,863 $307,339 $261,452

Allowance for loan loss, beginning of period $ 7,038 $ 5,569 $ 5,070 $ 4,404 $ 3,710
Recoveries:
Commercial ............................. 87 143 58 244 200
Real estate ............................ 5 11 -- 2 2
Installment and consumer ............... 39 40 22 73 38
-------- -------- -------- -------- --------
Total recoveries ....................... $ 131 $ 194 $ 80 $ 319 $ 240
-------- -------- -------- -------- --------
Loans charged off:
Commercial ............................. 295 715 298 278 401
Real estate ............................ 180 50 19 24 21
Installment and consumer ............... 361 135 208 128 207
-------- -------- -------- -------- --------
Total loans charged off ................ $ 836 $ 900 $ 525 $ 430 $ 629
======== ======== ======== ======== ========
Net loans charged off .................... (705) (706) (445) (111) (389)
Provision for loan loss .................... 2,196 2,175 944 777 1,083
-------- -------- -------- -------- --------
Allowance for loan loss, end of period ..... $ 8,529 $ 7,038 $ 5,569 $ 5,070 $ 4,404
======== ======== ======== ======== ========

Ratio of net loans charged off to average
loans outstanding ........................ .13% .15% .12% .04% .15%

23
27

Bancorp, during its normal loan review procedures considers a loan to be
impaired when it is probable that Bancorp will be unable to collect all amounts
due according to the contractual terms of the loan agreement. A loan is not
considered to be impaired during a period of minimal delay (less than 90 days).
Bancorp measures impaired loans based on the present value of expected future
cash flows discounted at the loan's effective interest rate or, as a practical
expedient, at the loan's observable market price or the fair market value of the
collateral if the loan is collateral dependent. Bancorp excludes loans that are
currently measured at fair value or at lower of cost or fair value, leases and
certain large groups of smaller balance homogeneous loans that are collectively
measured for impairment. Impaired loans are charged to the allowance when
management believes, after considering economic and business conditions,
collection efforts and collateral position, that the borrower's financial
condition is such that collection of principle is not probable.

At December 31, 1997 and 1996, Bancorp's recorded investment in certain
loans that were considered to be impaired was $2,873,000 and $1,696,000,
respectively, all of which was classified as non-performing. Of these impaired
loans, $570,000 and $452,000 had a related valuation allowance of $267,000 and
$388,000, while $2,303,000 and $1,244,000 did not have a valuation allowance.
The balance of the allowance for loan loss in excess of these specific reserves
is available to absorb losses from all loans. The average recorded investment in
certain impaired loans for the years ended December 31, 1997 and 1996 was
approximately, $1,091,000 and $965,000, respectively. For the years ended
December 31, 1997 and 1996, interest income recognized on impaired loans totaled
$122,000 and $28,000, respectively, all of which was recognized on a cash basis.

The amount of the allowance for loan loss is assessed by management on a
regular basis to ensure that it is sufficient to cover potential future loan
losses. Percentages are assigned for each class of specifically identified
problem loans and then combined with an assessment of the balance of the loan
portfolio based upon historical charge-off experience and other such criteria.
This analysis is used in evaluating the adequacy of the allowance for loan loss.
The allowance balance and amount of provision charged to operations is based
primarily on management's evaluation of the entire portfolio. This analysis
includes review of the following factors: (a) the volume and mix of the existing
loan portfolio, including the volume and severity of nonperforming loans and
adversely classified credits, as well as analysis of net charge-offs experienced
on previously classified loans; (b) the extent to which loan renewals and
extensions are used to maintain loans on a current basis and the degree of risk
associated with such loans; (c) the nature and value of the collateral securing
a loan; (d) the trend in loan growth, including any rapid increase in loan
volume within a relatively short period of time; (e) general and local economic
conditions affecting the collectibility of the Bancorp's loans; (f) the
relationship and trend over the past several years of recoveries as a percentage
of previous years' charge-offs; and (g) available outside information of a
comparable nature regarding the loan portfolios of other banks, including peer
group banks.

25

28

DEPOSITS AND BORROWINGS

The following table summarizes the average amount of, and the average rate
paid on, each of the deposit and borrowing categories for the periods shown.

Year Ended December 31
----------------------------------------------------------------
1997 1996 1995
----------------------------------------------------------------
(Dollars in thousands) Amount Rate Paid Amount Rate Paid Amount Rate Paid
- ---------------------- ----------------------------------------------------------------

Demand................................. $109,919 - $ 97,006 - $ 82,695 -
Savings and interest bearing demand.... 350,590 3.24% 302,211 3.28% 250,292 3.45%
Certificates of deposit................ 202,999 5.51% 160,369 5.41% 145,500 5.46%
Short-term borrowings.................. 2,378 5.34% 9,448 5.85% 5,932 6.39%
Long-term borrowings................... 22,547 5.67% 12,872 5.35% 10,737 5.39%
-------- -------- --------
Total deposits and borrowings...... $688,433 $581,906 $493,156
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As of December 31, 1997 time deposit liabilities are presented below at the
earlier of the next repricing date or maturity.