##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
     
  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




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##### 



Table of Contents
 PART I  FINANCIAL INFORMATION
    
    PageItem 1.
    
    Financial StatementsCondensed Consolidated Statements of Financial Condition -
March 31, 2007 and December 31, 2006
    
    1Condensed Consolidated Statements of Income -
Three Months Ended March 31, 2007 and 2006
    
    2Condensed Consolidated Statements of Shareholders Equity and Comprehensive Income -
Three Months Ended March 31, 2007 and 2006
    
    3Condensed Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2007 and 2006
    
    4Notes to Condensed Consolidated Financial Statements
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    10Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    18Item 4.
    
    Controls and Procedures
    
    18PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    19Item 1A.
    
    Risk Factors
    
    19Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    19Item 3.
    
    Defaults Upon Senior Securities
    
    19Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    19Item 5.
    
    Other Information
    
    19Item 6.
    
    Exhibits
    
    19Signatures
    
    20EXHIBIT 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
 
   March 31,

    
    
    
    
    
    December 31,Assets

    
    2007

    
    
    
    
    
    2006Cash and due from banks
    
    
    
    
    $
    
    21,516
    
    
    
    $
    
    18,984($3,365 and $3,703, respectively, are restricted)Interest-bearing deposits
    
    
    
    
    
    
    783
    
    
    
    
    
    
    
    761Federal funds sold
    
    
    
    
    
    
    4,640
    
    
    
    
    
    
    
    Total cash, restricted cash, and cash equivalents
    
    
    
    
    
    
    26,939
    
    
    
    
    
    
    
    19,745Investment securities available for sale
    
    
    
    
    
    
    16,748
    
    
    
    
    
    
    
    16,790Federal Home Loan Bank stock
    
    
    
    
    
    
    1,984
    
    
    
    
    
    
    
    1,984Loans held for sale
    
    
    
    
    
    
    4,717
    
    
    
    
    
    
    
    2,458Loans receivable
    
    
    
    
    
    
    731,895
    
    
    
    
    
    
    
    719,580Allowance for loan losses
    
    
    
    
    
    
    (10,212)
    
    
    
    
    
    
    
    (10,048)Total loans, net
    
    
    
    
    
    
    721,683
    
    
    
    
    
    
    
    709,532Premises and equipment, net
    
    
    
    
    
    
    23,235
    
    
    
    
    
    
    
    23,372Bank owned life insurance
    
    
    
    
    
    
    11,017
    
    
    
    
    
    
    
    10,930Other assets
    
    
    
    
    
    
    9,566
    
    
    
    
    
    
    
    9,734Total assets
    
    
    $
    
    815,889
    
    
    
    $
    
    794,545Liabilities and Shareholders EquityLiabilities:DepositsNoninterest-bearing
    
    
    $
    
    101,222
    
    
    
    $
    
    96,858Interest-bearing
    
    
    
    
    
    
    315,197
    
    
    
    
    
    
    
    303,979Time deposits
    
    
    
    
    
    
    309,954
    
    
    
    
    
    
    
    302,930Total deposits
    
    
    
    
    
    
    726,373
    
    
    
    
    
    
    
    703,767FHLB overnight borrowings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,075Junior subordinated debentures
    
    
    
    
    
    
    15,007
    
    
    
    
    
    
    
    15,007Other liabilities
    
    
    
    
    
    
    5,728
    
    
    
    
    
    
    
    6,303Total liabilities
    
    
    
    
    
    
    747,108
    
    
    
    
    
    
    
    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 9,445,867 at 3/31/2007 and
9,388,600 at 12/31/2006(1)
    
    
    
    
    
    
    33,587
    
    
    
    
    
    
    
    33,016Retained earnings
    
    
    
    
    
    
    35,217
    
    
    
    
    
    
    
    33,422Accumulated other comprehensive loss
    
    
    
    
    
    
    (23)
    
    
    
    
    
    
    
    (45)Total shareholders equity
    
    
    
    
    
    
    68,781
    
    
    
    
    
    
    
    66,393Total liabilities and shareholders equity
    
    
    $
    
    815,889
    
    
    
    $
    
    794,545
 (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.
 1




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARIES
 
 
 Three Months EndedMarch 31,2007

    
    
    
    
    
    2006Interest income:Interest and fees on loans
    
    
    $
    
    14,495
    
    
    
    $
    
    12,407Interest on taxable investment securities
    
    
    
    
    
    
    121
    
    
    
    
    
    
    
    103Interest on tax exempt investment securities
    
    
    
    
    
    
    71
    
    
    
    
    
    
    
    80Other
    
    
    
    
    
    
    43
    
    
    
    
    
    
    
    59Total interest income
    
    
    
    
    
    
    14,730
    
    
    
    
    
    
    
    12,649Interest expense:Interest on deposits
    
    
    
    
    
    
    5,323
    
    
    
    
    
    
    
    3,095Interest on other borrowings
    
    
    
    
    
    
    34
    
    
    
    
    
    
    
    150Interest on junior subordinated debentures
    
    
    
    
    
    
    338
    
    
    
    
    
    
    
    309Total interest expense
    
    
    
    
    
    
    5,695
    
    
    
    
    
    
    
    3,554Net interest income
    
    
    
    
    
    
    9,035
    
    
    
    
    
    
    
    9,095Provision for loan losses
    
    
    
    
    
    
    550
    
    
    
    
    
    
    
    500Net interest income after provision for loan losses
    
    
    
    
    
    
    8,485
    
    
    
    
    
    
    
    8,595Noninterest income:Service charges and fees
    
    
    
    
    
    
    816
    
    
    
    
    
    
    
    817Income from the sale of loans
    
    
    
    
    
    
    155
    
    
    
    
    
    
    
    182SBA premium income
    
    
    
    
    
    
    72
    
    
    
    
    
    
    
    135Other
    
    
    
    
    
    
    695
    
    
    
    
    
    
    
    749Total noninterest income
    
    
    
    
    
    
    1,738
    
    
    
    
    
    
    
    1,883Noninterest expense:Salaries and benefits
    
    
    
    
    
    
    4,411
    
    
    
    
    
    
    
    4,276Occupancy and equipment
    
    
    
    
    
    
    956
    
    
    
    
    
    
    
    858Office supplies and printing
    
    
    
    
    
    
    130
    
    
    
    
    
    
    
    181Data processing
    
    
    
    
    
    
    141
    
    
    
    
    
    
    
    82Consulting and professional fees
    
    
    
    
    
    
    171
    
    
    
    
    
    
    
    119Other
    
    
    
    
    
    
    1,115
    
    
    
    
    
    
    
    1,166Total noninterest expense
    
    
    
    
    
    
    6,924
    
    
    
    
    
    
    
    6,682Income before provision for income taxes
    
    
    
    
    
    
    3,299
    
    
    
    
    
    
    
    3,796Provision for income taxes
    
    
    
    
    
    
    1,032
    
    
    
    
    
    
    
    1,244Net income
    
    
    $
    
    2,267
    
    
    
    $
    
    2,552Net income per share, basic(1)
    
    
    $
    
    0.24
    
    
    
    $
    
    0.28Net income per share, diluted(1)
    
    
    $
    
    0.24
    
    
    
    $
    
    0.27Average number of shares outstanding, basic(1)
    
    
    
    
    
    
    9,389,000
    
    
    
    
    
    
    
    9,204,000Average number of shares outstanding, diluted(1)
    
    
    
    
    
    
    9,558,000
    
    
    
    
    
    
    
    9,473,000
 (1)
  2




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARIES
 
  
 Accumulatedother

    
    
    
    
    
    TotalCommon stock

    
    
    
    
    
    Retained

    
    
    
    
    
    Deferred

    
    
    
    
    
    comprehensive

    
    
    
    
    
    shareholdersShares

    
    
    
    
    
    Amount

    
    
    
    
    
    earnings

    
    
    
    
    
    compensation

    
    
    
    
    
    loss

    
    
    
    
    
    equityBalances at December 31, 2005 (1)
    
    
    9,228
    
    
    
    $
    
    32,492
    
    
    
    $
    
    25,789
    
    
    
    $
    
    (386)
    
    
    
    $
    
    (46
    )
    
    
    $
    
    57,849Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,552
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,552Net unrealized loss on securities available
for sale, net of tax of ($18)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (35)
    
    
    
    
    
    
    
    (35)Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,517Transition adjustment for adoption of SFAS 123(R)
    
    
    
    
    
    
    
    
    
    
    (386)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    386
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cash dividend, $0.05 per share(1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (463)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (463)Stock based compensation expense
    
    
    
    
    
    
    
    
    
    
    54
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54Issuance of
common stock- stock options (1)
    
    
    29
    
    
    
    
    
    
    
    91
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    91Issuance of restricted stock (1)
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balances at March 31, 2006
    
    
    9,261
    
    
    

    $
    
    32,251
    
    
    
    $
    
    27,878
    
    
    
    $
    
    
    
    
    
    $
    
    (81
    )
    
    
    $
    
    60,048Balances at December 31, 2006 (1)
    
    
    9,389
    
    
    
    $
    
    33,016
    
    
    
    $
    
    33,422
    
    
    
    $
    
    
    
    
    
    $
    
    (45
    )
    
    
    $
    
    66,393Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,267
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,267Net unrealized gain on securities available
for sale, net of tax of $12
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22
    
    
    
    
    
    
    
    22Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,289Cash dividend, $0.05 per share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (472)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (472)Stock based compensation expense
    
    
    
    
    
    
    
    
    
    
    142
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142Issuance of common stock- stock options
    
    
    55
    
    
    
    
    
    
    
    382
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    382Issuance restricted stock
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Tax benefit associated with stock awards
    
    
    
    
    
    
    
    
    
    
    47
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47Balances at March 31, 2007
    
    
    9,446
    
    
    
    $
    
    33,587
    
    
    
    $
    
    35,217
    
    
    
    $
    
    
    
    
    
    $
    
    (23
    )
    
    
    $
    
    68,781
 (1)
  3




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARIES
 
   Three Months EndedMarch 31,2007

    
    
    
    
    
    2006Cash flows from operating activities:Net income from continuing operations
    
    
    $
    
    2,267
    
    
    
    $
    
    2,552Adjustments to reconcile net income to net cash
provided by operating activities:Amortization of investment premiums, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3Deferred income tax expense (benefit)
    
    
    
    
    
    
    164
    
    
    
    
    
    
    
    (122)Depreciation and amortization
    
    
    
    
    
    
    443
    
    
    
    
    
    
    
    408Earnings on bank owned life insurance
    
    
    
    
    
    
    (87)
    
    
    
    
    
    
    
    (88)Provision for loan losses
    
    
    
    
    
    
    550
    
    
    
    
    
    
    
    500Net loss on sale of premises and equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    127Net loss on sale of other real estate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6)Write-downs of other real estate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Excess tax benefits from stock based compensation
    
    
    
    
    
    
    (47)
    
    
    
    
    
    
    
    Amortization of stock-based compensation
    
    
    
    
    
    
    142
    
    
    
    
    
    
    
    54Net change in assets and liabilities:Net decrease in subsidiary investment
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    12Net (increase) decrease in loans held for sale
    
    
    
    
    
    
    (2,259)
    
    
    
    
    
    
    
    1,404Increase in other assets
    
    
    
    
    
    
    (336)
    
    
    
    
    
    
    
    (705)Decrease in other liabilities
    
    
    
    
    
    
    (575)
    
    
    
    
    
    
    
    (1,071)Cash provided by operating activities
    
    
    
    
    
    
    273
    
    
    
    
    
    
    
    3,078Cash flows from investing activities:Purchases of investment securities, available for sale
    
    
    
    
    
    
    (928)
    
    
    
    
    
    
    
    Maturities/calls/principal payments of investment and
mortgage-backed securities, available for sale
    
    
    
    
    
    
    1,005
    
    
    
    
    
    
    
    8Net increase in loans
    
    
    
    
    
    
    (12,701)
    
    
    
    
    
    
    
    (21,056)Purchases of premises and equipment
    
    
    
    
    
    
    (306)
    
    
    
    
    
    
    
    (612)Proceeds from the sale of other real estate owned and premises and equipment
    
    
    
    
    
    
    363
    
    
    
    
    
    
    
    65Cash flows used by investing activities
    
    
    
    
    
    
    (12,567)
    
    
    
    
    
    
    
    (21,595)Cash flows from financing activities:Net increase in deposits
    
    
    
    
    
    
    22,606
    
    
    
    
    
    
    
    8,517Net decrease in FHLB overnight borrowings
    
    
    
    
    
    
    (3,075)
    
    
    
    
    
    
    
    Dividends paid on common stock
    
    
    
    
    
    
    (472)
    
    
    
    
    
    
    
    (463)Excess tax benefits from stock based compensation
    
    
    
    
    
    
    47
    
    
    
    
    
    
    
    Proceeds from issuance of common stock- stock options
    
    
    
    
    
    
    382
    
    
    
    
    
    
    
    91Cash flows provided by financing activities
    
    
    
    
    
    
    19,488
    
    
    
    
    
    
    
    8,145Net change in cash and cash equivalents
    
    
    
    
    
    
    7,194
    
    
    
    
    
    
    
    (10,372)Cash and cash equivalents at beginning of period
    
    
    
    
    
    
    19,745
    
    
    
    
    
    
    
    42,027Cash and cash equivalents at end of period
    
    
    $
    
    26,939
    
    
    
    $
    
    31,655Supplemental information:Loans foreclosed and transferred to other real estate owned
    
    
    $
    
    
    
    
    
    $
    
    69Cash paid for interest
    
    
    
    
    
    
    5,714
    
    
    
    
    
    
    
    3,572Cash paid for income taxes
    
    
    
    
    
    
    810
    
    
    
    
    
    
    
    
  4




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##### Table of Contents



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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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (3)
    
    Earnings Per Share
   Three Months EndedMarch 31,2007

    
    2006Weighted average shares-basic
    
    
    9,389,000
    
    
    
    9,204,000Effect of dilutive securities: stock awards
    
    
    169,000
    
    
    
    269,000Weighted average shares-diluted
    
    
    9,558,000
    
    
    
    9,473,000
  (4)
    
    Stock-Based Compensation
 (a) Stock Options:
 Three Months EndedMarch 31,2007
    
    2006Risk-free interest rate
    
    
    4.85
    %
    
    
    4.32
    %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
    
    
    331,944
    
    
    $
    
    
    6.03Granted
    
    
    1,000
    
    
    
    
    
    
    
    15.77Exercised
    
    
    (77,627)
    
    
    
    
    
    
    
    5.16

    


    
    
    
    
    $
    
    
    817Forfeited, expired or cancelled
    
    
    (4,900)
    
    
    
    
    
    
    
    9.64Outstanding at March 31, 2007
    
    
    250,417
    
    
    $
    
    
    6.31

    


    
    
    3.96
    
    $
    
    
    2,257Exercisable at March 31, 2007
    
    
    202,630
    
    
    $


    
    
    5.09

    


    
    
    3.05
    
    $


    
    
    2,069
  (b) Restricted Stock Awards:
  Weighted average

    




    Weighted average remainingShares

    
    
    
    
    
    grant price per share

    




    contractual terms (in years)Outstanding at January 1, 2007
    
    
    50,123
    
    
    
    $
    
    
    12.50Granted
    
    
    2,536
    
    
    
    
    
    
    
    
    15.80Vested
    
    
    (15,640)
    
    
    
    
    
    
    
    
    11.37Forfeited, expired or cancelled
    
    
    (2,678)
    
    
    
    
    
    
    
    
    12.59Outstanding at March 31, 2007
    
    
    34,341
    
    
    
    $
    
    
    13.26

    




    
    
    3.70
  (5)
    
    Income Taxes
 Accounting for Uncertainty in Income Taxes, Accounting for Income Taxes,
 7




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  Three Months EndedMarch 31,2007

    
    
    
    
    
    2006Federal:Current tax expense
    
    
    $
    
    868
    
    
    
    $
    
    1,366Deferred tax expense (benefit)
    
    
    
    
    
    
    164
    
    
    
    
    
    
    
    (122)Total
    
    
    $
    
    1,032
    
    
    
    $
    
    1,244
  Three Months EndedMarch 31,2007

    
    
    
    
    
    2006Income tax expense at federal statutory
rates
    
    
    $
    
    1,155
    
    
    
    $
    
    1,302Federal tax credits
    
    
    
    
    
    
    (100)
    
    
    
    
    
    
    
    Tax-exempt securities
    
    
    
    
    
    
    (78)
    
    
    
    
    
    
    
    (75)Other items
    
    
    
    
    
    
    55
    
    
    
    
    
    
    
    17Total
    
    
    $
    
    1,032
    
    
    
    $
    
    1,244
   March 31,

    
    
    
    
    
    December 31,2007

    
    
    
    
    
    2006Deferred tax assets:Loan loss allowances
    
    
    $
    
    3,574
    
    
    
    $
    
    3,517Deferred compensation
    
    
    
    
    
    
    306
    
    
    
    
    
    
    
    404Other
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    20Market value adjustment of investment
securities available for sale
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    25Total deferred tax assets
    
    
    
    
    
    
    3,924
    
    
    
    
    
    
    
    3,966Deferred tax liabilities:Deferred loan fees
    
    
    
    
    
    
    1,639
    
    
    
    
    
    
    
    1,552Premises and equipment
    
    
    
    
    
    
    394
    
    
    
    
    
    
    
    433Investment in partnership
    
    
    
    
    
    
    175
    
    
    
    
    
    
    
    140FHLB stock
    
    
    
    
    
    
    152
    
    
    
    
    
    
    
    152Prepaid expenses
    
    
    
    
    
    
    116
    
    
    
    
    
    
    
    111Other
    
    
    
    
    
    
    68
    
    
    
    
    
    
    
    23Total deferred tax liabilities
    
    
    
    
    
    
    2,544
    
    
    
    
    
    
    
    2,411Deferred tax assets, net
    
    
    $
    
    1,380
    
    
    
    $
    
    1,555
 8




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  (6)
    
    Subsequent Events
    (7)
    
    Commitments and Guarantees
   9




---



##### 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:
 10




---



##### 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
  The following tables set forth various components of the balance sheet that affect interest income
and expense, and their respective yields or rates: Average Balance Sheet and Analysis of Net Interest Income and Yields/RatesThree Months Ended
    
    Three Months EndedMarch 31, 2007
    
    March 31, 2006Average
    
    Interest
    
    Average
    
    Average
    
    Interest
    
    Average(Dollars in thousands)
    
    balance
    
    earned/paid
    
    yield
    
    balance
    
    earned/paid
    
    yieldAssetsLoans (1) (2)
    $
    
    723,735
    
    $
    
    14,628
    
    
    
    8.20
    %
    $
    
    639,742
    
    $
    
    12,433
    
    
    
    7.88
    %Federal funds sold
    
    
    1,771
    
    
    
    22
    
    
    
    5.04
    %
    
    
    3,457
    
    
    
    39
    
    
    
    4.58
    %Interest-earning cash
    
    
    770
    
    
    
    10
    
    
    
    5.27
    %
    
    
    867
    
    
    
    11
    
    
    
    5.15
    %Investments:Taxable
    
    
    12,393
    
    
    
    133
    
    
    
    4.35
    %
    
    
    13,696
    
    
    
    112
    
    
    
    3.32
    %Non-taxable (2)
    
    
    6,798
    
    
    
    104
    
    
    
    6.22
    %
    
    
    7,589
    
    
    
    124
    
    
    
    6.63
    %Interest-earning assets
    
    
    745,467
    
    
    
    14,897
    
    
    
    8.10
    %
    
    
    665,351
    
    
    
    12,719
    
    
    
    7.75
    %Noninterest-earning assets
    
    
    51,717
    
    
    
    
    
    
    
    
    
    
    
    46,702Total assets
    $
    
    797,184
    
    
    
    
    
    
    
    
    
    $
    
    712,053Liabilities and
Shareholders EquityDeposits:Interest demand and
money market
    $
    
    252,937
    
    $
    
    1,583
    
    
    
    2.54
    %
    $
    
    216,038
    
    $
    
    814
    
    
    
    1.53
    %Savings
    
    
    49,176
    
    
    
    91
    
    
    
    0.75
    %
    
    
    57,690
    
    
    
    112
    
    
    
    0.79
    %Time deposits
    
    
    308,592
    
    
    
    3,649
    
    
    
    4.80
    %
    
    
    247,336
    
    
    
    2,169
    
    
    
    3.56
    %Interest-bearing deposits
    
    
    610,705
    
    
    
    5,323
    
    
    
    3.53
    %
    
    
    521,064
    
    
    
    3,095
    
    
    
    2.41
    %Federal funds purchased
    
    
    2,291
    
    
    
    34
    
    
    
    5.84
    %
    
    
    4,519
    
    
    
    54
    
    
    
    4.85
    %Junior subordinated debentures
    
    
    15,007
    
    
    
    338
    
    
    
    9.13
    %
    
    
    15,007
    
    
    
    309
    
    
    
    8.35
    %Other borrowed funds
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    0.00
    %
    
    
    10,046
    
    
    
    96
    
    
    
    3.88
    %Interest-bearing liabilities
    
    
    628,003
    
    
    
    5,695
    
    
    
    3.68
    %
    
    
    550,636
    
    
    
    3,554
    
    
    
    2.62
    %Noninterest-bearing deposits
    
    
    96,097
    
    
    
    
    
    
    
    
    
    
    
    98,780Other noninterest-bearing liabilities
    
    
    5,920
    
    
    
    
    
    
    
    
    
    
    
    4,094Total liabilities
    
    
    730,020
    
    
    
    
    
    
    
    
    
    
    
    653,510Shareholders equity
    
    
    67,164
    
    
    
    
    
    
    
    
    
    
    
    58,543Total liabilities and
shareholders equity
    $
    
    797,184
    
    
    
    
    
    
    
    
    
    $
    
    712,053Net interest income
    
    
    
    
    $
    
    9,202
    
    
    
    
    
    
    
    
    
    $
    
    9,165Net interest spread
    
    
    
    
    
    
    
    
    
    
    4.42
    %
    
    
    
    
    
    
    
    
    
    
    5.13
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    5.01
    %
    
    
    
    
    
    
    
    
    
    
    5.59
    %
 11




---



##### Table of Contents



(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 35.0% and 34.3% in 2007 and 2006, respectively. These adjustments were $167 and $70 for the three months ended March
31, 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.
   Three Months EndedMarch 312007 vs. 2006Increase (decrease) due to(2):Volume
    
    Rate
    
    TotalAssets:Loans (1) (3)
    $
    
    1,632
    
    $
    
    563
    
    $
    
    2,195Federal funds sold
    
    
    (19)
    
    
    
    2
    
    
    
    (17)Interest-bearing cash
    
    
    (1)
    
    
    
    3⁄4
    
    
    
    (1)Investments (1)
    
    
    (24)
    
    
    
    25
    
    
    
    1Total interest earning assets
    
    
    1,589
    
    
    
    590
    
    
    
    2,178Liabilities:Deposits:Interest demand and money market
    
    
    139
    
    
    
    630
    
    
    
    769Savings
    
    
    (17)
    
    
    
    (4)
    
    
    
    (21)Time deposits
    
    
    537
    
    
    
    943
    
    
    
    1,480Interest on other borrowed funds
    
    
    (27)
    
    
    
    6
    
    
    
    (21)Junior subordinated debentures
    
    
    3⁄4
    
    
    
    29
    
    
    
    29Other interest-bearing liabilities
    
    
    (95)
    
    
    
    3⁄4
    
    
    
    (95)Total interest-bearing liabilities
    
    
    538
    
    
    
    1,603
    
    
    
    2,141Total increase (decrease) in net interest income
    $
    
    1,050
    
    $
    
    (1,013)
    
    $
    
    37
 (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:
 12




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##### Table of Contents



Noninterest Expense:
 Income Taxes:
 Financial Condition Overview
  Loans:
  Loan Portfolio Composition as of:March 31, 2007
    
    December 31, 2006
    
    Change(Dollars in thousands)
    
    Balance
    
    % of total
    
    Balance
    
    % of total
    
    2007 vs. 2006Commercial
    $
    
    88,781
    
    
    
    12.2
    %
    $
    

    82,990
    
    
    
    11.6
    %
    $
    
    5,791Real estate mortgages:One-to-four family residential
    
    
    54,045
    
    
    
    7.4
    %
    
    
    54,509
    
    
    
    7.6
    %
    
    
    (464)Commercial
    
    
    250,399
    
    
    
    34.3
    %
    
    
    249,109
    
    
    
    34.7
    %
    
    
    1,290Total real estate mortgages
    
    
    304,444
    
    
    
    41.7
    %
    
    
    303,618
    
    
    
    42.3
    %
    
    
    826Real estate construction:One-to-four family residential
    
    
    96,627
    
    
    
    13.2
    %
    
    
    96,107
    
    
    
    13.3
    %
    
    
    520Multi-family and commercial
    
    
    47,849
    
    
    
    6.6
    %
    
    
    46,329
    
    
    
    6.5
    %
    
    
    1520Total real estate construction
    
    
    144,476
    
    
    
    19.8
    %
    
    
    142,436
    
    
    
    19.8
    %
    
    
    2,040Consumer:Indirect
    
    
    109,466
    
    
    
    15.0
    %
    
    
    104,794
    
    
    
    14.6
    %
    
    
    4,672Direct
    
    
    82,510
    
    
    
    11.3
    %
    
    
    83,741
    
    
    
    11.7
    %
    
    
    (1,231)Total consumer
    
    
    191,976
    
    
    
    26.3
    %
    
    
    188,535
    
    
    
    26.3
    %
    
    
    3,441Subtotal
    
    
    729,677
    
    
    
    100.0
    %
    
    
    717,579
    
    
    
    100.0
    %
    
    
    12,098Deferred loan fees, net
    
    
    2,218
    
    
    
    
    
    
    
    2,001
    
    
    
    
    
    
    
    217Total loans, net
    $
    

    731,895
    
    
    
    
    
    $
    
    719,580
    
    
    
    
    
    $
   
    12,315
 13




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##### Table of Contents



Allowance for Loan Losses:
  Three Months EndedMarch 31,(Dollars in thousands)
    
    2007
    
    2006Balance at beginning of period
    $
    
    10,048
    
    $
    
    8,810Charge-offs:Commercial
    
    
    (370)
    
    
    
    (163)Real estate
    
    
    3⁄4
    
    
    
    (60)Consumer:Direct
    
    
    (88)
    
    
    
    (101)Indirect
    
    
    (135)
    
    
    
    (231)Total charge-offs
    
    
    (593)
    
    
    
    (555)Recoveries:Commercial
    
    
    48
    
    
    
    191Real estate
    
    
    71
    
    
    
    3⁄4Consumer:Direct
    
    
    34
    
    
    
    53Indirect
    
    
    54
    
    
    
    131Total recoveries
    
    
    207
    
    
    
    375Net charge-offs
    
    
    (386)
    
    
    
    (180)Provision for loan losses
    
    
    550
    
    
    
    500Balance at end of period
    $
    
    10,212
    
    $
    
    9,130Indirect net charge-offs to average indirect loans (1)
    
    
    0.31%
    
    
    
    0.43%Other net charge-offs to average other loans (1)
    
    
    0.20%
    
    
    
    0.06%Net charge-offs to average loans (1)
    
    
    0.21%
    
    
    
    0.11%(1)Excludes loans held for sale.
   14




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##### Table of Contents



Allocation of the Allowance for Loan Losses as of:March 31, 2007

    
    December 31, 2006

    
    March 31, 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
    $
    
    813
    
    
    
    8.0%
    
    
    
    12.2%
    
    $
    
    782
    
    
    
    7.8%
    
    
    
    11.6%
    
    $

    
    769
    
    
    
    8.4%
    
    
    
    12.4%Real estate mortgage
    
    
    3,220
    
    
    
    31.5%
    
    
    
    41.7%
    
    
    
    3,303
    
    
    
    32.9%
    
    
    
    42.3%
    
    
    
    3,005
    
    
    
    32.9%
    
    
    
    42.1%Real estate construction
    
    
    1,761
    
    
    
    17.2%
    
    
    
    19.8%
    
    
    
    1,781
    
    
    
    17.7%
    
    
    
    19.8%
    
    
    
    1,473
    
    
    
    16.1%
    
    
    
    18.5%Consumer
    
    
    2,578
    
    
    
    25.2%
    
    
    
    26.3%
    
    
    
    2,593
    
    
    
    25.8%
    
    
    
    26.3%
    
    
    
    2,407
    
    
    
    26.4%
    
    
    
    27.0%Unallocated
    
    
    1,840
    
    
    
    18.1%
    
    
    
    N/A

    
    
    1,589
    
    
    
    15.8%
    
    
    
    N/A

    
    
    1,476
    
    
    
    16.2%
    
    
    
    N/ATotal
    $
    
    10,212
    
    
    
    100.0%
    
    
    
    100.0%
    
    $
    
    10,048
    
    
    
    100.0%
    
    
    
    100.0%
    
    $
    
    9,130
    
    
    
    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:March 31,

    
    December 31,(Dollars in thousands)
    
    2007

    
    2006Nonaccrual loans
    $
    
    3,609
    
      $
    
    3,638Restructured loans
    
    
    3⁄4
    
    
    
    3⁄4Total nonperforming loans
    
    
    3,609
    
    
    
    3,638Other real estate owned
    
    
    3⁄4
    
    
    
    363Total nonperforming assets
      $
    
    3,609
    
      $
    
    4,001Total impaired loans
      $
    
    3,609
    
      $
    
    4,001Accruing
loans past due 3 90 days
    
    
    3⁄4
    
    
    
    30Potential problem loans
    
    
    3⁄4
    
    
    
    3⁄4Allowance for loan losses
      $
    
    10,212
    
      $
    
    10,048Nonperforming loans to loans
    
    
    0.49%
    
    
    
    0.51%Allowance for loan losses to nonperforming loans
    
    
    282.95%
    
    
    
    276.19%Allowance for loan losses to nonperforming assets
    
    
    282.95%
    
    
    
    251.13%Nonperforming assets to total assets
    
    
    0.44%
    
    
    
    0.50%
 Deposits:
 15




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##### Table of Contents



Deposit Composition as of:March 31, 2007

    
    December 31, 2006

    
    Change(Dollars in thousands)
    
    Balance

    
    % of total

    
    Balance

    
    % of total

    
    2007 vs. 2006Noninterest-bearing demand
    $
    
    101,222
    
    
    
    13.9%
    
    $
    
    96,858
    
    
    
    13.8%
    
    $
    
    4,364NOW accounts
    
    
    155,997
    
    
    
    21.5%
    
    
    
    152,087
    
    
    
    21.6%
    
    
    
    3,910Money market
    
    
    109,918
    
    
    
    15.1%
    
    
    
    101,856
    
    
    
    14.5%
    
    
    
    8,062Savings
    
    
    49,282
    
    
    
    6.8%
    
    
    
    50,036
    
    
    
    7.1%
    
    
    
    (754
    )Time deposits
    
    
    309,954
    
    
    
    42.7%
    
    
    
    302,930
    
    
    
    43.0%
    
    
    
    7,024Total deposits
    $
    
    726,373
    
    
    
    100.0%
    

    $
    
    703,767
    
    
    
    100.0%
    
    $
    
    22,606
 Junior Subordinated Debentures:
 Capital
 Shareholders Equity:
  Regulatory Capital Requirements:
  Regulatory Requirements
    
    Actual RatiosAdequately-
    
    Well-
    
    March 31,
    
    December 31,capitalized
    
    capitalized
    
    2007
    
    2006Total risk-based capital ratioCompany (consolidated)
    
    
    8
    %
    
    
    N/A

    
    
    11.61
    %
    
    
    11.52
    %Whidbey Island Bank
    
    
    8
    %
    
    
    10
    %
    
    
    11.34
    %
    
    
    11.19
    %Tier 1 risk-based capital ratioCompany (consolidated)
    
    
    4
    %
    
    
    N/A

    
    
    10.35
    %
    
    
    10.27
    %Whidbey Island Bank
    
    
    4
    %
    
    
    6
    %
    
    
    10.09
    %
    
    
    9.94
    %Leverage ratioCompany (consolidated)
    
    
    4
    %
    
    
    N/A
    
    
    10.50
    %
    
    
    10.24
    %Whidbey Island Bank
    
    
    4
    %
    
    
    5
    %
    
    
    10.23
    %
    
    
    9.92
    %
  16




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##### Table of Contents



Liquidity and Cash Flows
 Liquidity:
  Consolidated Cash Flows: Condensed Consolidated Statements of Cash Flows
 Capital Resources:
 Off-Balance Sheet Items:
 17




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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
  18




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##### Table of Contents



PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 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
  31.1
    
    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
 
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##### Table of Contents



SIGNATURES
  WASHINGTON BANKING COMPANY
 Date: May 8, 2007
    
    By
    
    /s/ Michal D. CannMichal D. CannPresident andChief Executive Officer
 Date: May 8, 2007
    
    By
    
    /s/ Richard A. Shields`
    
    
    
    Richard A. ShieldsExecutive Vice President andChief Financial Officer
 20