##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    Quarterly report pursuant to Section 13 or l5(d) of the Securities Exchange Act of 1934
 For the quarterly period ended September 30, 2007
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the transition period from to
 Commission File Number 000-24503
 WASHINGTON BANKING COMPANY
  Washington
    
    91-1725825(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification Number)
 450 SW Bayshore Drive
Oak Harbor, Washington 98277
 (360) 679-3121
  þ o
  o þ o
 o þ




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##### 



Table of Contents
 PagePART I  FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsCondensed Consolidated Statements of Financial Condition -
September 30, 2007 and December 31, 2006
    
    1Condensed Consolidated Statements of Income 
Three and Nine Months Ended September 30, 2007 and 2006
    
    2Condensed Consolidated Statements of Shareholders Equity and Comprehensive Income -
Nine Months Ended September 30, 2007 and 2006
    
    3Condensed Consolidated Statements of Cash Flows 
Nine Months Ended September 30, 2007 and 2006
    
    4Notes to Condensed Consolidated Financial Statements
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    11Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    21Item 4.
    
    Controls and Procedures
    
    21PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    22Item 1A.
    
    Risk Factors
    
    22Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    22Item 3.
    

Defaults Upon Senior Securities
    
    22Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    22Item 5.
    
    Other Information
    
    22Item 6.
    
    Exhibits
    
    22Signatures
    
    23EXHIBIT 2.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 WASHINGTON BANKING COMPANY
AND SUBSIDIARIES
 
   September 30,
    
    
    December 31,2007
    
    
    2006AssetsCash and due from banks ($4,218 and $3,703, are restricted, respectively,)
    
    $
    20,984
    
    
    $
    18,984Interest-bearing deposits
    
    
    278
    
    
    
    761Federal funds sold
    
    
    4,600
    
    
    
    Total cash, and cash equivalents
    
    
    25,862
    
    
    
    19,745Investment securities available for sale
    
    
    16,908
    
    
    
    16,790Federal Home Loan Bank stock
    
    
    1,984
    
    
    
    1,984Loans held for sale
    
    
    1,504
    
    
    
    2,458Loans receivable
    
    
    782,095
    
    
    
    719,580Allowance for loan losses
    
    
    (10,755
    )
    
    
    (10,048
    )Total loans, net
    
    
    771,341
    
    
    
    709,532Premises and equipment, net
    
    
    24,586
    
    
    
    23,372Bank owned life insurance
    
    
    16,363
    
    
    
    10,930Other assets
    
    
    8,865
    
    
    
    9,734Total assets
    
    $
    867,413
    
    
    $
    794,545Liabilities and Shareholders EquityLiabilities:DepositsNoninterest-bearing
    
    $
    107,648
    
    
    $
    96,858Interest-bearing
    
    
    332,384
    
    
    
    303,979Time deposits
    
    
    326,276
    
    
    
    302,930Total deposits
    
    
    766,308
    
    
    
    703,767FHLB overnight borrowings
    
    
    
    
    
    
    3,075Junior subordinated debentures
    
    
    25,774
    
    
    
    15,007Other liabilities
    
    
    3,608
    
    
    
    6,303Total liabilities
    
    
    795,691
    
    
    
    728,152Commitments and contingencies
    
    
    
    
    
    
    Shareholders equity:Preferred stock, no par value.
Authorized 20,000 shares: no shares issued or outstanding
    
    
    
    
    
    
    Common stock, no par value. Authorized 13,679,757
shares: issued and outstanding 9,396,875 at 9/30/2007
and 9,388,600 at 12/31/2006
    
    
    32,335
    
    
    
    33,016Retained earnings
    
    
    39,365
    
    
    
    33,422Accumulated other comprehensive income (loss)
    
    
    22
    
    
    
    (45
    )Total shareholders equity
    
    
    71,722
    
    
    
    66,393Total liabilities and shareholders equity
    
    $
    867,413
    
    
    $
    794,545
  1




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARIES
 
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Interest income:Interest and fees on loans
    
    $
    15,959
    
    
    $
    14,110
    
    
    $
    45,573
    
    
    $
    39,679Interest on taxable investment securities
    
    
    143
    
    
    
    108
    
    
    
    412
    
    
    
    332Interest on tax exempt investment securities
    
    
    65
    
    
    
    77
    
    
    
    204
    
    
    
    238Other
    
    
    54
    
    
    
    73
    
    
    
    153
    
    
    
    161Total interest income
    
    
    16,221
    
    
    
    14,369
    
    
    
    46,342
    
    
    
    40,410Interest expense:Interest on deposits
    
    
    5,849
    
    
    
    4,615
    
    
    
    16,652
    
    
    
    11,429Interest on other borrowings
    
    
    147
    
    
    
    45
    
    
    
    317
    
    
    
    423Interest on junior subordinated debentures
    
    
    469
    
    
    
    351
    
    
    
    1,291
    
    
    
    995Total interest expense
    
    
    6,465
    
    
    
    5,010
    
    
    
    18,260
    
    
    
    12,847Net interest income
    
    
    9,756
    
    
    
    9,359
    
    
    
    28,082
    
    
    
    27,563Provision for loan losses
    
    
    800
    
    
    
    750
    
    
    
    2,200
    
    
    
    2,050Net interest income after provision for loan losses
    
    
    8,956
    
    
    
    8,609
    
    
    
    25,882
    
    
    
    25,513Noninterest income:Service charges and fees
    
    
    749
    
    
    
    812
    
    
    
    2,362
    
    
    
    2,481Income from the sale of loans
    
    
    192
    
    
    
    168
    
    
    
    558
    
    
    
    499SBA premium income
    
    
    74
    
    
    
    140
    
    
    
    335
    
    
    
    469Other
    
    
    908
    
    
    
    672
    
    
    
    2,425
    
    
    
    2,032Total noninterest income
    
    
    1,923
    
    
    
    1,792
    
    
    
    5,680
    
    
    
    5,481Noninterest expense:Salaries and benefits
    
    
    4,166
    
    
    
    4,245
    
    
    
    12,709
    
    
    
    12,494Occupancy and equipment
    
    
    932
    
    
    
    907
    
    
    
    2,867
    
    
    
    2,656Office supplies and printing
    
    
    146
    
    
    
    149
    
    
    
    455
    
    
    
    470Data processing
    
    
    185
    
    
    
    136
    
    
    
    493
    
    
    
    340Consulting and professional fees
    
    
    172
    
    
    
    195
    
    
    
    441
    
    
    
    472Other
    
    
    1,226
    
    
    
    1,123
    
    
    
    3,655
    
    
    
    3,399Total noninterest expense
    
    
    6,827
    
    
    
    6,755
    
    
    
    20,620
    
    
    
    19,831Income before provision for income taxes
    
    
    4,052
    
    
    
    3,645
    
    
    
    10,942
    
    
    
    11,163Provision for income taxes
    
    
    1,232
    
    
    
    1,003
    
    
    
    3,394
    
    
    
    3,483Net income
    
    $
    2,820
    
    
    $
    2,642
    
    
    $
    7,548
    
    
    $
    7,680Net income per share, basic
    
    $
    0.30
    
    
    $
    0.29
    
    
    $
    0.80
    
    
    $
    0.83Net income per share, diluted(1)
    
    $
    0.30
    
    
    $
    0.28
    
    
    $
    0.79
    
    
    $
    0.81Average number of shares outstanding, basic
    
    
    9,323,000
    
    
    
    9,240,000
    
    
    
    9,392,000
    
    
    
    9,216,000Average number of shares outstanding, diluted
    
    
    9,435,000
    
    
    
    9,525,000
    
    
    
    9,525,000
    
    
    
    9,489,000
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WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 
    Accumulatedother
    
    
    TotalCommon stock
    
    

Retained
    
    

Deferred
    
    
    comprehensive
    
    
    ShareholdersShares
    
    
    Amount
    
    
    earnings
    
    
    compensation
    
    
    income (loss)
    
    
    equityBalances at December 31, 2005 (1)
    
    
    9,228
    
    
    $
    32,492
    
    
    $
    25,789
    
    
    $
    (386
    )
    
    $
    (46
    )
    
    $
    57,849Comprehensive income:Net income
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    7,680
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    7,680Net unrealized loss on securities
available for sale, net of tax of ($15)
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (26
    )
    
    
    (26
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,654Transition adjustment for adoption of SFAS
123(R)
    
    
    3⁄4
    
    
    
    (386
    )
    
    
    3⁄4
    
    
    
    386
    
    
    
    3⁄4
    
    
    
    3⁄4Cash dividend, $0.15 per share(1)
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (1,394
    )
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (1,394
    )Stock based compensation expense
    
    
    3⁄4
    
    
    
    190
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    190Issuance of common stock-stock options(1) 1)
    
    
    40
    
    
    
    136
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    136Issuance of restricted stock(1)
    
    
    17
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4Balances at September 30, 2006
    
    
    9,285
    
    
    $
    32,432
    
    
    $
    32,075
    
    
    $
    3⁄4
    
    
    $
    (72
    )
    
    $
    64,435Balances at December 31, 2006
    
    
    9,389
    
    
    $
    33,016
    
    
    $
    33,422
    
    
    $
    3⁄4
    
    
    $
    (45
    )
    
    $
    66,393Comprehensive income:Net income
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    7,548
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    7,548Net unrealized gain on securities
available for sale, net of tax of ($37)
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    67
    
    
    
    67Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,615Tax benefit associated with stock-based
compensation
    
    
    3⁄4
    
    
    
    138
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    138Cash dividend, $0.17 per share
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (1,605
    )
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (1,605
    )Stock-based compensation
    
    
    3⁄4
    
    
    
    250
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    250Common stock repurchased and retired
    
    
    (116
    )
    
    
    (1,851
    )
    
    
    
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (1,851
    )Stock options exercised (1)
    
    
    126
    
    
    
    782
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    782Forfeited and cancelled restricted stock
    
    
    (2
    )
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4Balances at September 30, 2007
    
    
    9,397
    
    
    $
    32,335
    
    
    $
    39,365
    
    
    $
    3⁄4
    
    
    $
    22
    
    
    $
    71,722
 
 (1)
    
    Adjusted to reflect a 5-for-4 stock split distributed by the Company on September 6, 2006
See accompanying notes to condensed consolidated financial statements.
 3




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 
   Nine Months EndedSeptember 30,2007
    
    
    2006Cash flows from operating activities:Net income from continuing operations
    
    $
    7,548
    
    
    $
    7,680Adjustments to reconcile net income to net cash
provided by operating activities:Amortization (accretion) of investment premiums, net investment
    
    
    (6
    )
    
    
    9Deferred tax provision (benefit)
    
    
    325
    
    
    
    (717
    )Depreciation and amortization
    
    
    1,331
    
    
    
    1,218Earnings on bank owned life insurance
    
    
    (433
    )
    
    
    (273
    )Provision for loan losses
    
    
    2,200
    
    
    
    2,050Net gain on sale of other real estate
    
    
    (78
    )
    
    
    (6
    )Write-downs of other real estate
    
    
    3⁄4
    
    
    
    10Amortization of stock-based compensation
    
    
    250
    
    
    
    190Excess tax benefit from stock-based compensation
    
    
    (138
    )
    
    
    3⁄4Net change in assets and liabilities:Loans held for sale
    
    
    954
    
    
    
    889Other assets
    
    
    1,612
    
    
    
    (1,646
    )Other liabilities
    
    
    (2,694
    )
    
    
    284Cash flows from operating activities:
    
    
    10,871
    
    
    
    9,688Cash flows from investing activities:Purchases of available-for-sale securities
    
    
    (2,635
    )
    
    
    (2,948
    )Maturities/calls/principal payments of available-for-sale securities
    
    
    2,628
    
    
    
    4,461Net increase in loans
    
    
    (65,846
    )
    
    
    (84,687
    )Purchases of premises and equipment
    
    
    (2,545
    )
    
    
    (2,728
    )Purchases of bank owned life insurance
    
    
    (5,000
    )
    
    
    3⁄4Proceeds from the sale of other real estate owned and premises and
equipment
    
    
    947
    
    
    
    65Cash flows used by investing activities
    
    
    (72,451
    )
    
    
    (85,837
    )Cash flows from financing activities:Net increase in deposits
    
    
    62,541
    
    
    
    63,231Gross payments on other borrowed funds
    
    
    3⁄4
    
    
    
    (26,845
    )New borrowings on other borrowed funds
    
    
    3⁄4
    
    
    
    16,845Net increase in FHLB overnight borrowings
    
    
    (3,075
    )
    
    
    3,000Gross payments on junior subordinated debentures
    
    
    (15,007
    )
    
    
    3⁄4New borrowings on junior subordinated debentures
    
    
    25,774
    
    
    
    3⁄4Dividends paid on common stock
    
    
    (1,605
    )
    
    
    (1,394
    )Common stock repurchased and retired
    
    
    (1,851
    )
    
    
    3⁄4Excess tax benefits from stock-based compensation
    
    
    138
    
    
    
    3⁄4Proceeds from issuance of common stock; stock options
    
    
    782
    
    
    
    136Cash flows from financing activities
    
    
    67,697
    
    
    
    54,973Net change in cash and cash equivalents
    
    
    6,117
    
    
    
    (21,176
    )Cash and cash equivalents at beginning of period
    
    
    19,745
    
    
    
    42,027Cash and cash equivalents at end of period
    
    $
    25,862
    
    
    $
    20,851Supplemental information:Loans foreclosed and transferred to other real estate owned
    
    $
    1,838
    
    
    $
    432Cash paid for interest
    
    
    18,290
    
    
    
    12,213Cash paid for income taxes
    
    
    2,660
    
    
    
    4,010
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (1) Description of Business and Summary of Significant Accounting Policies
 (a) Description of Business:
 (b) Basis of Presentation:
 (c) Reclassifications:
 (2) Recent Financial Accounting Pronouncements
 The Fair
Value Option for Financial Assets and Financial Liabilities
 5




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (3) Earnings Per Share
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006Weighted average shares-basic
    
    
    9,323,000
    
    
    
    9,240,000
    
    
    
    9,392,000
    
    
    
    9,216,000Effect of dilutive securities: stock awards
    
    
    112,000
    
    
    
    285,000
    
    
    
    133,000
    
    
    
    273,000Weighted average shares-diluted
    
    
    9,435,000
    
    
    
    9,525,000
    
    
    
    9,525,000
    
    
    
    9,489,000
  (4) Stock-Based Compensation
 (a) Stock Options:
 Nine Months EndedSeptember 30,2007
    
    2006Risk-free interest rate
    
    
    4.59
    %
    
    
    4.95
    %Dividend yield rate
    
    
    1.50
    %
    
    
    1.40
    %Price volatility
    
    
    33.00
    %
    
    
    38.13
    %Expected life of stock options
    
    5 years
    
    7 years
  6




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Weighted
    
    Weighted average
    
    Aggregateaverage exercise
    
    remaining contractual
    
    intrinsicShares
    
    price per share
    
    terms (in years)
    
    valueOutstanding at January 1, 2007
    
    
    331,145
    
    
    $
    6.06Granted
    
    
    56,586
    
    
    
    15.98Exercised
    
    
    (127,817
    )
    
    
    5.24
    
    
    
    
    
    
    $
    1,316Forfeited, expired or cancelled
    
    
    (10,308
    )
    
    
    8.90Outstanding at September 30, 2007
    
    
    249,606
    
    
    $
    8.55
    
    
    
    5.11
    
    
    $
    2,922Exercisable at September 30, 2007
    
    
    161,511
    
    
    $
    5.24
    
    
    
    3.06
    
    
    $
    2,414
  (b) Restricted Stock Awards:
  Weighted average
    
    Weighted average remainingShares
    
    grant price per share
    
    contractual terms (in years)Outstanding at January 1, 2007
    
    
    50,123
    
    
    $
    12.64Granted
    
    
    2,536
    
    
    
    15.80Vested
    
    
    (18,836
    )
    
    
    12.27Forfeited, expired or cancelled
    
    
    (3,696
    )
    
    
    12.52Outstanding at September 30, 2007
    
    
    30,127
    
    
    $
    13.14
    
    
    
    2.19
  (c) Restricted Stock Units:
  Weighted average
    
    Weighted average remainingShares
    
    grant price per share
    
    contractual terms (in years)Outstanding at January 1, 2007
    
    
    3⁄4
    
    
    $
    3⁄4Granted
    
    
    18,293
    
    
    
    15.98Vested
    
    
    3⁄4
    
    
    
    3⁄4Forfeited, expired or cancelled
    
    
    (478
    )
    
    
    15.98Outstanding at September 30, 2007
    
    
    17,815
    
    
    $
    15.98
    
    
    
    4.18
 7




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  (5) Income Taxes
 Accounting for Uncertainty in Income Taxes, Accounting for Income Taxes,
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Federal:Current tax expense
    
    $
    1,194
    
    
    $
    1,023
    
    
    $
    3,069
    
    
    $
    4,200Deferred tax expense (benefit)
    
    
    38
    
    
    
    (20
    )
    
    
    325
    
    
    
    (717
    )Total
    
    $
    1,232
    
    
    $
    1,003
    
    
    $
    3,394
    
    
    $
    3,483
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Income tax expense at
federal statutory rates
    
    $
    1,389
    
    
    $
    1,273
    
    
    $
    3,827
    
    
    $
    3,874Federal tax credits
    
    
    (100
    )
    
    
    (300
    )
    
    
    (300
    )
    
    
    (300
    )Tax-exempt securities
    
    
    (109
    )
    
    
    (73
    )
    
    
    (289
    )
    
    
    (222
    )Other items
    
    
    52
    
    
    
    103
    
    
    
    156
    
    
    
    131Total
    
    $
    1,232
    
    
    $
    1,003
    
    
    $
    3,394
    
    
    $
    3,483
  8




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  September 30,
    
    
    December 31,2007
    
    
    2006Deferred tax assets:Loan loss allowances
    
    $
    3,764
    
    
    $
    3,517Deferred compensation
    
    
    360
    
    
    
    404Other
    
    
    47
    
    
    
    20Market value adjustment of investment securities available for sale
    
    
    
    
    
    
    25Total deferred tax assets
    
    
    4,171
    
    
    
    3,966Deferred tax liabilities:Deferred loan fees
    
    
    1,935
    
    
    
    1,552Premises and equipment
    
    
    423
    
    
    
    433Investment in partnership
    
    
    152
    
    
    
    140FHLB stock
    
    
    245
    
    
    
    152Prepaid expenses
    
    
    143
    
    
    
    111Other
    
    
    68
    
    
    
    23Market value adjustment of investment securities available for sale
    
    
    12
    
    
    
    3⁄4Total deferred tax liabilities
    
    
    2,978
    
    
    
    2,411Deferred tax assets, net
    
    $
    1,193
    
    
    $
    1,555
  (6) Subsequent Event
  (7) Merger with Frontier Financial Corporation
   9




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (8) Commitments and Guarantees
  
 10




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Note Regarding Forward-Looking Statements
  Overview
   Summary of Critical Accounting Policies
  Allowance for Loan Losses:
 Stock-based Compensation:
 11




---



##### Table of Contents



Results of Operations Overview
   Net Interest Income:
 
    
    The volume, pricing, mix and maturity of interest-earning assets and interest-bearing
liabilities;
    
    The volume of free funds (consisting of noninterest-bearing deposits and other
liabilities and shareholders equity);
    
    The volume of noninterest-earning assets;
    
    Market interest rate fluctuations; and
    
    Asset quality
 12




---



##### Table of Contents



Average Balance Sheet and Analysis of Net Interest Income and Yields/RatesThree Months Ended
    
    
    Three Months EndedSeptember 30, 2007
    
    
    September 30, 2006Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average(Dollars in thousands)
    
    balance
    
    
    earned/paid
    
    
    yield
    
    
    balance
    
    
    earned/paid
    
    
    yieldAssetsLoans (1) (2)
    
    $
    773,145
    
    
    $
    16,091
    
    
    
    8.26
    %
    
    $
    697,972
    
    
    $
    14,130
    
    
    
    8.03
    %Federal funds sold
    
    
    3,899
    
    
    
    47
    
    
    
    4.80
    %
    
    
    4,740
    
    
    
    63
    
    
    
    5.31
    %Interest-bearing cash
    
    
    371
    
    
    
    7
    
    
    
    7.13
    %
    
    
    759
    
    
    
    10
    
    
    
    5.10
    %Investments
Taxable
    
    
    12,388
    
    
    
    143
    
    
    
    4.57
    %
    
    
    11,744
    
    
    
    108
    
    
    
    3.65
    %Non-taxable (2)
    
    
    6,443
    
    
    
    95
    
    
    
    5.84
    %
    
    
    7,271
    
    
    
    114
    
    
    
    6.24
    %Interest-earning assets
    
    
    796,246
    
    
    
    16,382
    
    
    
    8.16
    %
    
    
    722,486
    
    
    
    14,425
    
    
    
    7.92
    %Noninterest-earning assets
    
    
    57,662
    
    
    
    
    
    
    
    
    
    
    
    52,534Total assets
    
    $
    853,908
    
    
    
    
    
    
    
    
    
    
    $
    775,020
 Liabilities and shareholders equityDeposits:Interest demand and
money market
    
    $
    278,977
    
    
    $
    1,898
    
    
    
    2.70
    %
    
    $
    238,097
    
    
    $
    1,258
    
    
    
    2.10
    %Savings
    
    
    44,873
    
    
    
    78
    
    
    
    0.69
    %
    
    
    55,947
    
    
    
    111
    
    
    
    0.79
    %CDs
    
    
    315,003
    
    
    
    3,873
    
    
    
    4.88
    %
    
    
    289,908
    
    
    
    3,246
    
    
    
    4.44
    %Total interest-bearing deposits
    
    
    638,853
    
    
    
    5,849
    
    
    
    3.63
    %
    
    
    583,952
    
    
    
    4,615
    
    
    
    3.14
    %Federal funds purchased
    
    
    3,482
    
    
    
    53
    
    
    
    6.08
    %
    
    
    2,267
    
    
    
    31
    
    
    
    5.45
    %Junior subordinated debentures
    
    
    25,774
    
    
    
    469
    
    
    
    7.22
    %
    
    
    15,007
    
    
    
    351
    
    
    
    9.28
    %Other
interest-bearing liabilities
    
    
    6,413
    
    
    
    94
    
    
    
    5.78
    %
    
    
    978
    
    
    
    14
    
    
    
    5.56
    %Total interest bearing liabilities
    
    
    674,522
    
    
    
    6,465
    
    
    
    3.80
    %
    
    
    602,204
    
    
    
    5,011
    
    
    
    3.30
    %Noninterest-bearing DDA
    
    
    104,989
    
    
    
    
    
    
    
    
    
    
    
    103,643Other liabilities
    
    
    4,489
    
    
    
    
    
    
    
    
    
    
    
    6,383Total liabilities
    
    
    784,000
    
    
    
    
    
    
    
    
    
    
    
    712,230Total shareholders equity
    
    
    69,908
    
    
    
    
    
    
    
    
    
    
    
    62,790Total liabilities and shareholders
equity
    
    $
    853,908
    
    
    
    
    
    
    
    
    
    
    $
    775,020Net interest income /Spread
    
    
    
    
    
    $
    9,917
    
    
    
    4.36
    %
    
    
    
    
    
    $
    9,414
    
    
    
    4.62
    %Credit for noninterest-bearing funds
    
    
    
    
    
    
    
    
    
    
    0.58
    %
    
    
    
    
    
    
    
    
    
    
    0.55
    %Net interest margin (2)
    
    
    
    
    
    
    
    
    
    
    4.94
    %
    
    
    
    
    
    
    
    
    
    
    5.17
    %
 
 (1) Average balance includes nonaccrual loans.(2) Interest income on non-taxable investments and loans is
presented on a taxable-equivalent basis using the federal statutory rate of
35%. These adjustments were $162 and $57 for the three months ended September
30, 2007 and 2006, respectively. Taxable-equivalent is a Non GAAP performance
measurement that management believes provides investors with a more accurate
picture of the net interest margin and efficiency ratio for comparative
purposes.  13




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##### Table of Contents



Average Balance Sheet and Analysis of Net Interest Income and Yields/RatesNine Months Ended
    
    
    Nine Months EndedSeptember 30, 2007
    
    
    September 30, 2006Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average(Dollars in thousands)
    
    balance
    
    
    earned/paid
    
    
    yield
    
    
    balance
    
    
    earned/paid
    
    
    yieldAssetsLoans (1) (2)
    
    $
    748,356
    
    
    $
    45,972
    
    
    
    8.21
    %
    
    $
    669,746
    
    
    $
    39,754
    
    
    
    7.94
    %Federal funds sold
    
    
    2,765
    
    
    
    104
    
    
    
    5.02
    %
    
    
    3,509
    
    
    
    132
    
    
    
    5.01
    %Interest-bearing cash
    
    
    1,191
    
    
    
    49
    
    
    
    5.46
    %
    
    
    781
    
    
    
    29
    
    
    
    5.01
    %Investments
Taxable
    
    
    12,362
    
    
    
    412
    
    
    
    4.46
    %
    
    
    12,783
    
    
    
    332
    
    
    
    3.47
    %Non-taxable (2)
    
    
    6,685
    
    
    
    299
    
    
    
    5.98
    %
    
    
    7,460
    
    
    
    353
    
    
    
    6.33
    %Interest-earning assets
    
    
    771,359
    
    
    
    46,835
    
    
    
    8.12
    %
    
    
    694,279
    
    
    
    40,600
    
    
    
    7.82
    %Non-earning assets
    
    
    55,061
    
    
    
    
    
    
    
    
    
    
    
    50,079Total assets
    
    $
    826,420
    
    
    
    
    
    
    
    
    
    
    $
    744,358
 Liabilities and shareholders equityDeposits:Interest demand and money market
    
    $
    264,736
    
    
    $
    5,171
    
    
    
    2.61
    %
    
    $
    225,963
    
    
    $
    3,007
    
    
    
    1.78
    %Savings
    
    
    47,062
    
    
    
    253
    
    
    
    0.72
    %
    
    
    56,233
    
    
    
    330
    
    
    
    0.78
    %Time deposits
    
    
    310,147
    
    
    
    11,228
    
    
    
    4.84
    %
    
    
    268,156
    
    
    
    8,092
    
    
    
    4.03
    %Total interest-bearing deposits
    
    
    621,945
    
    
    
    16,652
    
    
    
    3.58
    %
    
    
    550,352
    
    
    
    11,429
    
    
    
    2.78
    %Federal funds purchased
    
    
    4,200
    
    
    
    180
    
    
    
    5.73
    %
    
    
    6,198
    
    
    
    239
    
    
    
    5.15
    %Junior subordinated debentures
    
    
    22,146
    
    
    
    1,291
    
    
    
    7.79
    %
    
    
    15,007
    
    
    
    995
    
    
    
    8.86
    %Other interest-bearing liabilities
    
    
    3,333
    
    
    
    137
    
    
    
    5.49
    %
    
    
    5,592
    
    
    
    185
    
    
    
    4.41
    %Total interest-bearing liabilities
    
    
    651,624
    
    
    
    18,260
    
    
    
    3.75
    %
    
    
    577,149
    
    
    
    12,848
    
    
    
    2.98
    %Noninterest-bearing DDA
    
    
    100,872
    
    
    
    
    
    
    
    
    
    
    
    100,827Other liabilities
    
    
    5,430
    
    
    
    
    
    
    
    
    
    
    
    5,705Total liabilities
    
    
    757,926
    
    
    
    
    
    
    
    
    
    
    
    683,681Total equity
    
    
    68,493
    
    
    
    
    
    
    
    
    
    
    
    60,677Total liabilities and shareholders
equity
    
    $
    826,420
    
    
    
    
    
    
    
    
    
    
    $
    744,358Net interest income /Spread
    
    
    
    
    
    $
    28,575
    
    
    
    4.37
    %
    
    
    
    
    
    $
    27,752
    
    
    
    4.83
    %Credit for noninterest-bearing funds
    
    
    
    
    
    
    
    
    
    
    0.58
    %
    
    
    
    
    
    
    
    
    
    
    0.51
    %Net interest margin (2)
    
    
    
    
    
    
    
    
    
    
    4.95
    %
    
    
    
    
    
    
    
    
    
    
    5.34
    %
 
 (1) Average balance includes nonaccrual loans.(2) Interest income on non-taxable investments and loans is
presented on a taxable-equivalent basis using the federal statutory rate of
35%. These adjustments were $494 and $190 for the nine months ended September
30, 2007 and 2006, respectively. Taxable-equivalent is a Non-GAAP performance
measurement that management believes provides investors with a more accurate
picture of the net interest margin and efficiency ratio for comparative
purposes.  14




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302007 vs. 2006
    
    
    2007 vs. 2006Increase (decrease) due to (2):
    
    
    Increase (decrease) due to(2):Volume
    
    
    Rate
    
    
    Total
    
    
    Volume
    
    
    Rate
    
    
    TotalAssets:Loans (1) (3)
    
    $
    1,556
    
    
    $
    405
    
    
    $
    1,961
    
    
    $
    4,792
    
    
    $
    1,426
    
    
    $
    6,218Federal funds sold
    
    
    (10
    )
    
    
    (6
    )
    
    
    (16
    )
    
    
    (28
    )
    
    
    
    
    
    
    (28
    )Interest-bearing cash
    
    
    (15
    )
    
    
    12
    
    
    
    (3
    )
    
    
    17
    
    
    
    3
    
    
    
    20Investments (1)Taxable (included invest in sub)
    
    
    6
    
    
    
    28
    
    
    
    34
    
    
    
    (11
    )
    
    
    91
    
    
    
    80Non-taxable(2)
    
    
    (12
    )
    
    
    (7
    )
    
    
    (19
    )
    
    
    (35
    )
    
    
    (19
    )
    
    
    (54
    )Total interest earning assets
    
    $
    1,525
    
    
    $
    432
    
    
    $
    1,957
    
    
    $
    4,735
    
    
    $
    1,501
    
    
    $
    6,236Liabilities:Deposits:Interest demand and money market
    
    $
    239
    
    
    $
    401
    
    
    $
    640
    
    
    $
    581
    
    
    $
    1,584
    
    
    $
    2,165Savings
    
    
    (20
    )
    
    
    (13
    )
    
    
    (33
    )
    
    
    (51
    )
    
    
    (27
    )
    
    
    (78
    )Time deposits
    
    
    294
    
    
    
    333
    
    
    
    627
    
    
    
    1,378
    
    
    
    1,758
    
    
    
    3,136Total interest bearing depositsFed Funds Purchased
    
    
    19
    
    
    
    4
    
    
    
    23
    
    
    
    (90
    )
    
    
    32
    
    
    
    (58
    )Junior subordinated debentures
    
    
    171
    
    
    
    (53
    )
    
    
    118
    
    
    
    397
    
    
    
    (100
    )
    
    
    297Other interest-bearing liabilities
    
    
    79
    
    
    
    1
    
    
    
    80
    
    
    
    (121
    )
    
    
    73
    
    
    
    (48
    )Total interest-bearing liabilities
    
    $
    782
    
    
    $
    673
    
    
    $
    1,455
    
    
    $
    2,094
    
    
    $
    3,320
    
    
    $
    5,414
 
 (1)
    
    Interest on loans and investments is presented on a fully tax-equivalent basis.(2)
    
    The changes attributable to the combined effect of volume and interest rates have
been allocated proportionately.(3)
    
    Interest income previously accrued on nonaccrual loans is reversed in the period the
loan is placed on nonaccrual status. Noninterest Income:
  Noninterest Expense:
 15




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##### Table of Contents



Income Taxes:
 Financial Condition Overview
  Loans:
  Loan Portfolio Composition as of:September 30, 2007
    
    
    December 31, 2006
    
    
    Change(Dollars in thousands)
    
    Balance
    
    
    % of total
    
    
    Balance
    
    
    % of totalCommercial
    
    $
    103,004
    
    
    
    13.2
    %
    
    $
    82,990
    
    
    
    11.6
    %
    
    $
    20,014Real estate mortgages:One-to-four family residential
    
    
    53,543
    
    
    
    6.9
    %
    
    
    54,509
    
    
    
    7.6
    %
    
    
    (966
    )Multi-family residential & commercial
    
    
    276,244
    
    
    
    35.4
    %
    
    
    249,109
    
    
    
    34.7
    %
    
    
    27,135Total real estate mortgages
    
    
    329,788
    
    
    
    42.3
    %
    
    
    303,618
    
    
    
    42.3
    %
    
    
    26,170Real estate construction:One-to-four family residential
    
    
    97,287
    
    
    
    12.5
    %
    
    
    96,107
    
    
    
    13.3
    %
    
    
    1,180Multi-family and commercial
    
    
    44,464
    
    
    
    5.7
    %
    
    
    46,329
    
    
    
    6.5
    %
    
    
    (1.865
    )Total real estate construction
    
    
    141,751
    
    
    
    18.2
    %
    
    
    142,436
    
    
    
    19.8
    %
    
    
    (685
    )Consumer:Indirect
    
    
    117,384
    
    
    
    15.1
    %
    
    
    104,794
    
    
    
    14.6
    %
    
    
    12,590Direct
    
    
    87,439
    
    
    
    11.2
    %
    
    
    83,741
    
    
    
    11.7
    %
    
    
    3,698Total consumer
    
    
    204,824
    
    
    
    26.3
    %
    
    
    188,535
    
    
    
    26.3
    %
    
    
    16,289Subtotal
    
    
    779,366
    
    
    
    100
    %
    
    
    717,579
    
    
    
    100.0
    %
    
    
    61,787Deferred loan fees, net
    
    
    2,730
    
    
    
    
    
    
    
    2,001
    
    
    
    
    
    
    
    729Total loans, net
    
    $
    782,095
    
    
    
    
    
    
    $
    719,580
    
    
    
    
    
    
    $
    62,515
 16




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##### Table of Contents



Allowance for Loan Losses:
  Three Months Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 30(Dollars in thousands)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Balance at beginning of period
    
    $
    10,526
    
    
    $
    9,606
    
    
    $
    10,048
    
    
    $
    8,810Charge-offs:Commercial
    
    
    (312
    )
    
    
    (285
    )
    
    
    (928
    )
    
    
    (751
    )Real estate
    
    
    (20
    )
    
    
    
    
    
    
    (20
    )
    
    
    (86
    )Consumer:Direct
    
    
    (241
    )
    
    
    (67
    )
    
    
    (526
    )
    
    
    (261
    )Indirect
    
    
    (200
    )
    
    
    (161
    )
    
    
    (598
    )
    
    
    (562
    )Total charge-offs
    
    $
    (773
    )
    
    $
    (513
    )
    
    $
    (2,072
    )
    
    $
    (1,660
    )Recoveries:Commercial
    
    
    64
    
    
    
    12
    
    
    
    168
    
    
    
    313Real estate
    
    
    2
    
    
    
    3
    
    
    
    75
    
    
    
    5Consumer:Direct
    
    
    53
    
    
    
    37
    
    
    
    136
    
    
    
    158Indirect
    
    
    82
    
    
    
    90
    
    
    
    200
    
    
    
    309Total recoveries
    
    $
    202
    
    
    $
    142
    
    
    $
    579
    
    
    $
    785Net charge-offs
    
    
    (571
    )
    
    
    (371
    )
    
    
    (1,493
    )
    
    
    (875
    )Provision for loan losses
    
    
    800
    
    
    
    750
    
    
    
    2,200
    
    
    
    2,050Balance at end of period
    
    $
    10,755
    
    
    $
    9,985
    
    
    $
    10,755
    
    
    $
    9,985Indirect net charge-offs to average indirect loans
    
    
    0.42
    %
    
    
    0.29
    %
    
    
    0.49
    %
    
    
    0.35
    %Other net charge-offs to average other loans (1)
    
    
    0.27
    %
    
    
    0.20
    %
    
    
    0.23
    %
    
    
    0.15
    %Net charge-offs to average loans (1)
    
    
    0.29
    %
    
    
    0.21
    %
    
    
    0.27
    %
    
    
    0.17
    %
 
 (1)
    
    Excludes loans held for sale.    17




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##### Table of Contents



Allocation of the Allowance for Loan Losses as of:September 30, 2007
    
    
    December 31, 2006
    
    
    September 30, 2006% of
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    % of(Dollars in thousands)
    
    Amount
    
    Allowance(2)
    

    Loans(1)
    
    Amount
    
    Allowance(2)
    
    
    Loans(1)
    
    
    Amount
    
    
    Allowance(2)
    
    
    Loans(1)Balance applicable to:Commercial
    
    $
    954
    
    
    
    8.9
    %
    
    
    13.2
    %
    
    $
    782
    
    
    
    7.8
    %
    
    
    11.6
    %
    
    $
    786
    
    
    
    7.9
    %
    
    
    11.5
    %Real estate mortgage
    
    
    3,541
    
    
    
    32.9
    %
    
    
    42.3
    %
    
    
    3,303
    
    
    
    32.9
    %
    
    
    42.3
    %
    
    
    3,250
    
    
    
    32.5
    %
    
    
    41.3
    %Real estate construction
    
    
    1,709
    
    
    
    15.9
    %
    
    
    18.2
    %
    
    
    1,781
    
    
    
    17.7
    %
    
    
    19.8
    %
    
    
    1,898
    
    
    
    19.0
    %
    
    
    21.3
    %Consumer
    
    
    2,756
    
    
    
    25.6
    %
    
    
    26.3
    %
    
    
    2,593
    
    
    
    25.8
    %
    
    
    26.3
    %
    
    
    2,541
    
    
    
    25.4
    %
    
    
    25.9
    %Unallocated
    
    
    1,795
    
    
    
    16.7
    %
    
    
    N/A
    
    
    
    1,589
    
    
    
    15.8
    %
    
    
    N/A
    
    
    
    1,510
    
    
    
    15.2
    %
    
    
    N/ATotal
    
    $
    10,755
    
    
    
    100
    %
    
    
    100
    %
    
    $
    10,048
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    $
    9,985
    
    
    
    100.0
    %
    
    
    100.0
    %
 
 (1)
    
    Represents the total of all outstanding loans in each category as a percent of total
loans outstanding.(2)
    
    Represents the total allowance allocated to each loan category as a percent of total
allowance for loan losses. Nonperforming Assets:
 Nonperforming Assets as of:September 30,
    
    
    December 31,(Dollars in thousands)
    
    2007
    
    
    2006Nonaccrual loans
    
    $
    1,324
    
    
    $
    3,638Restructured loans
    
    
    
    
    
    
    Total nonperforming loans
    
    
    1,324
    
    
    
    3,638Other real estate owned
    
    
    1,332
    
    
    
    363Total nonperforming assets
    
    $
    2,656
    
    
    $
    4,001Total impaired loans
    
    $
    2,656
    
    
    $
    4,001Accruing loans past due 3 90 days
    
    
    
    
    
    
    30Potential problem loans
    
    
    
    
    
    
    Allowance for loan losses
    
    $
    10,755
    
    
    $
    10,048Nonperforming loans to loans
    
    
    0.17
    %
    
    
    0.51
    %Allowance for loan losses to nonperforming loans
    
    
    812.27
    %
    
    
    276.19
    %Allowance for loan losses to nonperforming assets
    
    
    404.91
    %
    
    
    251.13
    %Nonperforming assets to total assets
    
    
    0.31
    %
    
    
    0.50
    %
 18




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##### Table of Contents



Deposits:
 Deposit Composition as of:September 30, 2007
    
    
    December 31, 2006
    
    
    Change(Dollars in thousands)
    
    Balance
    
    
    % of total
    
    
    Balance
    
    
    % of total
    
    
    2007 vs. 2006Noninterest-bearing demand
    
    $
    107,648
    
    
    
    14.0
    %
    
    $
    96,858
    
    
    
    13.8
    %
    
    $
    10,790NOW accounts
    
    
    140,854
    
    
    
    18.4
    %
    
    
    152,087
    
    
    
    21.6
    %
    
    
    (11,233
    )Money market
    
    
    147,195
    
    
    
    19.2
    %
    
    
    101,856
    
    
    
    14.5
    %
    
    
    45,339Savings
    
    
    44,335
    
    
    
    5.8
    %
    
    
    50,036
    
    
    
    7.1
    %
    
    
    (5,701
    )Time deposits
    
    
    326,276
    
    
    
    42.6
    %
    
    
    302,930
    
    
    
    43.0
    %
    
    
    23,346Total deposits
    
    $
    766,308
    
    
    
    100.0
    %
    
    $
    703,767
    
    
    
    100.0
    %
    
    $
    62,541
 Other Borrowings:
 FHLB Borrowings:
 Junior Subordinated Debentures:
 Capital
 Shareholders Equity:
 Regulatory Capital Requirements:
 19




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##### Table of Contents



Regulatory Requirements
    
    Actual RatiosAdequately-
    
    Well-
    
    September 30,
    
    December 31,capitalized
    
    capitalized
    
    2007
    
    2006Total risk-based capital ratioCompany (consolidated)
    
    
    8
    %
    
    
    N/A
    
    
    
    12.46
    %
    
    
    11.52
    %Whidbey Island Bank
    
    
    8
    %
    
    
    10
    %
    
    
    11.92
    %
    
    
    11.19
    %Tier 1 risk-based capital ratioCompany (consolidated)
    
    
    4
    %
    
    
    N/A
    
    
    
    11.08
    %
    
    
    10.27
    %Whidbey Island Bank
    
    
    4
    %
    
    
    6
    %
    
    
    10.67
    %
    
    
    9.94
    %Leverage ratioCompany (consolidated)
    
    
    4
    %
    
    
    N/A
    
    
    
    11.19
    %
    
    
    10.24
    %Whidbey Island Bank
    
    
    4
    %
    
    
    5
    %
    
    
    10.78
    %
    
    
    9.92
    %
  Liquidity and Cash Flows
 Liquidity:
  Consolidated Cash Flows: Condensed Consolidated Statements of Cash Flows
 Capital Resources:
 Off-Balance Sheet Items:
 20




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures about Market Risk
  
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Control over Disclosure and Reporting
  21




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##### Table of Contents



PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  If the
merger is not approved, the Company may experience adverse
consequences.
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
 (a)
    
    Not applicable(b)
    
    There have been no material changes in the procedures for shareholders to
nominate directors to the Companys board.
 
 Item 6. Exhibits
  2.1
    
    Agreement and Plan of Merger, dated
as of September 26, 2007, between Frontier Financial Corporation
and Washington Banking Company31.1
    
    Certification of Chief Executive Officer required by Rule 13a-14(b) or Rule
15d-14(a) and Section 302 of the Sarbanes Oxley Act of 200231.2
    
    Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule
15d-14(a) and Section 302 of the Sarbanes Oxley Act of 200232.1
    
    Certification of Chief Executive Officer required by Rule 13a-14(b) or Rule
15d-14(b) and Section 906 of the Sarbanes Oxley Act of 2002, 18 U.S.C. Section 135032.2
    
    Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule
15d-14(b) and Section 906 of the Sarbanes Oxley Act of 2002, 18 U.S.C. Section 1350
 22




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##### Table of Contents



SIGNATURES
  WASHINGTON BANKING COMPANY
 Date: November 8, 2007
    
    By
    
    /s/ Michal D. CannMichal D. CannPresident and Chief Executive OfficerDate: November 8, 2007
    
    By
    
    /s/ Richard A. ShieldsRichard A. Shields Executive Vice President andChief Financial Officer
 23