EXHIBIT

NUMBER

DESCRIPTION

Reports of Independent Registered Public Accounting Firms

Financial Statements

Statements of Net Assets Available for Benefits

Statement of Changes in Net Assets Available for Benefits

Notes to Financial Statements

Supplemental Schedules

Schedule of Assets (Held at End of Year)

Schedule of Reportable Transactions

December 31,

Assets

Investments at fair value:

Participant directed:

Registered investment company funds

Heritage Financial Corporation common stock

Money market funds

Participant loans

Non-participant directed:

Heritage Financial Corporation common stock

Money market funds

Total investments

Cash

Receivables:

Employer contributions

Participant contributions

Accrued investment income

Total receivables

Total assets

Liabilities

Loan payable to Heritage Financial Corporation

Excess deferrals

Accounts payable and other

Total liabilities

Net assets available for benefits

Year ended December 31, 2005

Additions

Investment income:

Net appreciation in fair value of investments

Interest and dividends

Contributions:

Participant salary deferrals

Participant rollovers

Employer

ESOP loan payments

Fund transfers

Total additions

Deductions

Benefits paid to participants

Excess deferrals

Administrative expenses

Interest expense

Total deductions

Net increase

Net assets available for benefits,
beginning of year

Net assets available for benefits,
end of year

General

Heritage Financial Corporation (the Company) is a bank holding company with headquarters in Olympia, Washington.

Eligibility

Employees of the Company are generally eligible to participate in the Plan after three months of service, providing they worked at least 250 hours during a three-month period and have reached the age of twenty-one.

Contributions

Participants may elect to contribute up to the lesser of 75% of their eligible compensation or $14,000 (in 2005), subject to certain eliminations under the IRC. Additionally, participants over age 50 may make catch-up contributions up to $4,000 (in 2005). Participants may also contribute amounts representing distributions from other qualified plans.

The Company makes contributions to participant accounts as follows:

1) a matching contribution equal to 50% of the participant’s contribution up to 6% of the participant’s eligible compensation.

2) required contribution of 2% of the participant’s eligible compensation.

3) discretionary contributions beyond the required 2% contribution.

4) Employee Stock Ownership Plan (ESOP) allocation calculated based on the current year ESOP loan principal and interest payment. See note 3.

Participants’ Accounts

Each participant’s account is credited with the participant’s contribution and allocations of the Company’s contributions and Plan earnings net of expenses. Allocations are made on a quarterly basis and based on participant earnings or account balances as defined. The benefit to which a participant is entitled is the benefit that can be provided from the participant’s account.

Vesting

Vesting in the Company’s contributions plus earnings thereon is based on years of continuous service. A participant’s matching contribution is 100% vested after six years of credited service or upon death, disability or retirement with 20% vesting at two years of service increasing by an additional 20% with each additional year of service. All other employer contributions are 100% vested after seven years of credited service or upon death, disability or retirement with 20% vesting at three years of service increasing by an additional 20% with each additional year of service. The vesting schedule applicable to the prior plans merged into the Plan will continue to apply to existing accounts and on an ongoing basis to accounts after October 1, 1999. However, no credit for service prior to

Description of Plan

(Continued)

Investment Options

The Plan’s ESOP component is designed to invest primarily in Company common stock in order to comply with Section 4975(e)(7) of the IRC and Income Tax Regulation 54.4975-11. The Plan’s assets are maintained in funds and Company stock held in a trust account at U.S. Bank. Upon enrollment in the Plan, a participant may direct his or her employee contributions in 1% increments among five registered investment company funds, a money market fund, and Company stock.

Payment of Benefits

No distributions from the Plan will be made until a participant retires, dies (in which case, payment shall be made to his or her beneficiary or, if none, to his or her legal representatives), becomes disabled or otherwise terminates employment with the Company. Distributions are made in cash, Company stock, or both.

Description of Plan

(Continued)

Diversification

Participants who are at least age 55 with 10 years of participation in the Plan may elect to diversify a portion of their account invested in Company stock. The qualified election period is the six-year period commencing with the Plan year in which the participant becomes a qualified participant. In each of the first five years, a participant may diversify up to 25 percent of the number of post-1986 shares allocated to his or her account, less any shares previously diversified. In the sixth year, the diversification percentage changes to 50 percent.

Voting and Dividend Rights

No participant shall have any voting or dividend rights or other rights of a stockholder prior to the time that shares are allocated to the participant.

Forfeitures

Forfeitures may be used to reduce employer contributions. At December 31, 2005 and 2004, forfeited non-vested accounts totaled $40,362 and $51,811. Forfeitures used to reduce employer contributions during 2005 totaled $55,085.

Description of Plan

(Continued)

Participant Loans

Participants may borrow, upon written application, any amount provided that the aggregate amount of all outstanding loans to the participant from the Plan and from any other qualified plan maintained by the employer, including accrued interest thereon, shall not exceed the lesser of $50,000 or 50% of the participant’s vested account balance. Loan terms shall not exceed five years, except for the purchase of a primary residence. The loans are collateralized by the balance in the participant’s account and bear interest at a rate commensurate with local prevailing rates. Principal and interest is paid ratably not less than quarterly through payroll deductions. The interest rate on outstanding loans as of December 31, 2005 ranged from 4.25% to 7.0% and the loans mature through March 2014.

Administrative Expenses

Administrative expenses including trust, recordkeeping, audit, legal and investment fees are paid by the Plan. Some other expenses may be paid by the Company.

Basis of Accounting

The accompanying financial statements have been prepared under the accrual method of accounting.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and changes therein, and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.

Risks and Uncertainties

The Plan allows participants to direct contributions into a money market fund, various registered investment company funds, and Company stock. Company contributions are used to purchase Company stock. The underlying investment securities of these funds and Company stock are exposed to various risks, such as interest rate, market and credit risk. Due to the level of risk associated with certain underlying investment securities and the level of uncertainty related to changes in the value of the funds and the Company stock, it is reasonably possible that changes in the value of investment securities will occur in the near term and that such changes could materially affect participants’ account balances and the amounts reported in the statement of net assets available for benefits and the statement of changes in net assets available for benefits.

Investment Valuation and Income Recognition

The Plan’s investments are stated at fair value. Shares of registered investment company funds and the Company stock are valued at quoted market prices. Fair value of the Company stock is based on the closing price of stock on the NASDAQ National Market System on the last trading day of the Plan year. Participant loans and money market funds are valued at cost.

Payment of Benefits

Benefits are recorded when paid. At December 31, 2005 and 2004, assets allocated to withdrawing participants totaled $10,453 and $271,807, respectively.

Excess Deferrals

Excess deferrals over maximum IRS limits totaled $9,052 for the year ended December 31, 2005. The excess deferrals were returned to participants in the first quarter of 2006.

The Plan purchased shares of the Company’s stock using the proceeds of a borrowing from the Company and holds the stock in a trust established under the Plan. The borrowing is to be repaid over a period of 15 years by deductible Company contributions to the trust fund.

Under the ESOP feature of the Plan, the Company is obligated to make contributions in cash to the Plan which, when aggregated with the Plan’s dividends and interest earnings, equal the amount necessary to enable the Plan to make its regularly scheduled payments of principal and interest due on its term indebtedness to the Company. As the Plan makes each payment of principal and interest, an appropriate percentage of stock is allocated to eligible employees’ accounts in accordance with applicable regulations under the IRC.

The loan is collateralized by all unallocated shares of Company stock. The lender has no rights against shares once they are allocated under the Plan. Accordingly, the table below presents separately the assets and liabilities and changes therein pertaining to:

(a)    accounts of employees with rights in allocated stock and

(b)    stock not yet allocated to employees.

(a)

(b)

Identity of Issue, Borrower,

Lessor, or Similar Party

(c )

Description of Investment

including Maturity Date,

Rate of Interest, Collateral,

Par or Maturity Value

(d)

Cost

(e)

Current Value

Participant Directed Investments

Registered Investment Company Funds:

Frank Russell Fixed Income I Fund, Class I

Frank Russell Fixed Income III Fund, Class I

Frank Russell Equity I Fund, Class I

Frank Russell Equity II Fund, Class I

Frank Russell International Fund, Class I

Frank Russell Emerging Markets Fund, Class S

Frank Russell Real Estate Securities Fund, Class S

Frank Russell Equity Q Fund, Class I

Fidelity Advisory Mid Cap Fund, Class A

*

First American Equity Index Fund

T. Rowe Price Blue Chip Growth Fund

*

U.S. Bank - First American Prime Obligation Fund

*

Heritage Financial Corporation of Washington

*

Participant Loans

Non-Participant Directed Investments

*

Heritage Financial Corporation of Washington

*

U.S. Bank - First American Prime Obligation Fund

(a)

Identity of party involved

(b)

Description of assets

(d)

Purchase Price

(e)

Number of
sales or
disbursements

(f)

Selling Price

(g)

Book value
at sale

(h)

Net gain
(loss)

Category (iii) – Series of transactions in excess of 5% of plan assets at January 1, 2005:

First American Prime Obligation

Heritage Financial Corporation