##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
  þ
    
    Quarterly report pursuant to Section 13 or l5(d) of the Securities Exchange Act of 1934
 For the quarterly period ended June 30, 2006
 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 DriveOak Harbor, Washington
    
    98277(Address of principal executive offices)
    
    (Zip Code)
 (360) 679-3121
  þ o
  o þ o
 o þ




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##### 



Table of Contents
 PagePART I 
FINANCIAL INFORMATIONItem
1.
    

Financial
Statements
    
    
    1Condensed Consolidated Statements of Financial Condition -
June 30, 2006 and December 31, 2005
    
    
    1Condensed Consolidated Statements of Income -
Three and Six Months Ended June 30, 2006 and 2005
    
    
    2Condensed Consolidated Statements of Shareholders Equity and Comprehensive Income -
Six Months Ended June 30, 2006 and 2005
    
    
    3Condensed Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2006 and 2005
    
    
    4Notes
to Condensed Consolidated Financial Statements
    
    
    5Item
2.
    

Managements
Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    9Item
3.
    

Quantitative
and Qualitative Disclosures about Market Risk
    
    
    18Item
4.
    

Controls
and Procedures
    
    
    19PART II 
OTHER INFORMATIONItem
1.
    

Legal
Proceedings
    
    
    20Item
1A.
    

Risk
Factors
    
    
    20Item
2.
    

Unregistered
Sales of Equity Securities and Use of Proceeds
    
    
    20Item
3.
    

Defaults
Upon Senior Securities
    
    
    20Item
4.
    

Submission
of Matters to a Vote of Security Holders
    
    
    20Item
5.
    

Other
Information
    
    
    20Item 6.
    

Exhibits
    
    
    21Signatures
    
    
    22EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  i




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 
 
 June 30,
    
    
    December 31,2006
    
    
    2005AssetsCash and due from banks
($4,204 and $3,313, respectively, are restricted)
    
    $
    24,543
    
    
    $
    19,949Interest-bearing deposits
    
    
    659
    
    
    
    983Federal funds sold
    
    
    5,275
    
    
    
    21,095Total cash, restricted cash, and cash equivalents
    
    
    30,477
    
    
    
    42,027Investment securities available for sale
    
    
    17,945
    
    
    
    19,077Federal Home Loan Bank stock
    
    
    1,984
    
    
    
    1,984Loans held for sale
    
    
    867
    
    
    
    2,829Loans receivable
    
    
    686,108
    
    
    
    630,258Allowance for loan losses
    
    
    (9,606
    )
    
    
    (8,810
    )Total loans, net
    
    
    676,502
    
    
    
    621,448Premises and equipment, net
    
    
    20,847
    
    
    
    20,514Bank owned life insurance
    
    
    10,736
    
    
    
    10,558Other assets
    
    
    8,662
    
    
    
    7,539Total assets
    
    $
    768,020
    
    
    $
    725,976Liabilities and Shareholders EquityLiabilities:DepositsNoninterest-bearing
    
    $
    104,832
    
    
    $
    105,365Interest-bearing
    
    
    298,221
    
    
    
    287,214Time deposits
    
    
    276,805
    
    
    
    244,910Total deposits
    
    
    679,858
    
    
    
    637,489FHLB overnight borrowings
    
    
    2,000
    
    
    
    Other borrowed funds
    
    
    5,000
    
    
    
    10,000Junior subordinated debentures
    
    
    15,007
    
    
    
    15,007Other liabilities
    
    
    4,041
    
    
    
    5,631Total liabilities
    
    
    705,906
    
    
    
    668,127Commitments and contingencies
    
    
    
    
    
    
    Shareholders equity:Preferred stock, no par value. Authorized 20,000
shares: no shares issued or outstanding
    
    
    
    
    
    
    Common stock, no par value. Authorized 11,822,706 shares:
issued and outstanding 7,423,791 at 6/30/2006 and
7,382,210 at 12/31/2005
    
    
    32,880
    
    
    
    32,106Retained earnings
    
    
    29,354
    
    
    
    25,789Accumulated other comprehensive income
    
    
    (120
    )
    
    
    (46
    )Total shareholders equity
    
    
    62,114
    
    
    
    57,849Total liabilities and shareholders equity
    
    $
    768,020
    
    
    $
    725,976
  1




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Interest income:Interest and fees on loans
    
    $
    13,289
    
    
    $
    10,943
    
    
    $
    25,695
    
    
    $
    21,037Interest on taxable investment securities
    
    
    111
    
    
    
    80
    
    
    
    223
    
    
    
    168Interest on tax exempt investment securities
    
    
    80
    
    
    
    79
    
    
    
    161
    
    
    
    159Other
    
    
    38
    
    
    
    35
    
    
    
    88
    
    
    
    66Total interest income
    
    
    13,518
    
    
    
    11,137
    
    
    
    26,167
    
    
    
    21,430Interest expense:Interest on deposits
    
    
    3,720
    
    
    
    2,359
    
    
    
    6,814
    
    
    
    4,466Interest on other borrowings
    
    
    229
    
    
    
    177
    
    
    
    378
    
    
    
    346Interest on junior subordinated debentures
    
    
    334
    
    
    
    260
    
    
    
    644
    
    
    
    497Total interest expense
    
    
    4,283
    
    
    
    2,796
    
    
    
    7,836
    
    
    
    5,309Net interest income
    
    
    9,235
    
    
    
    8,341
    
    
    
    18,331
    
    
    
    16,121Provision for loan losses
    
    
    800
    
    
    
    525
    
    
    
    1,300
    
    
    
    950Net interest income after provision for loan losses
    
    
    8,435
    
    
    
    7,816
    
    
    
    17,031
    
    
    
    15,171Noninterest income:Service charges and fees
    
    
    852
    
    
    
    771
    
    
    
    1,669
    
    
    
    1,470Loss on sale of securities
    
    
    
    
    
    
    (50
    )
    
    
    
    
    
    
    (50
    )Income from the sale of loans
    
    
    150
    
    
    
    212
    
    
    
    332
    
    
    
    384SBA premium income
    
    
    68
    
    
    
    179
    
    
    
    203
    
    
    
    291Other
    
    
    610
    
    
    
    780
    
    
    
    1,359
    
    
    
    1,448Total noninterest income
    
    
    1,680
    
    
    
    1,892
    
    
    
    3,563
    
    
    
    3,543Noninterest expense:Salaries and benefits
    
    
    3,973
    
    
    
    3,802
    
    
    
    8,249
    
    
    
    7,233Occupancy and equipment
    
    
    891
    
    
    
    863
    
    
    
    1,751
    
    
    
    1,652Office supplies and printing
    
    
    140
    
    
    
    171
    
    
    
    321
    
    
    
    356Data processing
    
    
    122
    
    
    
    138
    
    
    
    204
    
    
    
    256Consulting and professional fees
    
    
    157
    
    
    
    15
    
    
    
    276
    
    
    
    318Other
    
    
    1,110
    
    
    
    1,170
    
    
    
    2,275
    
    
    
    2,331Total noninterest expense
    
    
    6,393
    
    
    
    6,159
    
    
    
    13,076
    
    
    
    12,146Income before income taxes
    
    
    3,722
    
    
    
    3,549
    
    
    
    7,518
    
    
    
    6,568Provision for income taxes
    
    
    1,236
    
    
    
    1,200
    
    
    
    2,480
    
    
    
    2,176Net income
    
    $
    2,486
    
    
    $
    2,349
    
    
    $
    5,038
    
    
    $
    4,392Net income per share, basic
    
    $
    0.34
    
    
    $
    0.32
    
    
    $
    0.68
    
    
    $
    0.60Net income per share, diluted
    
    $
    0.33
    
    
    $
    0.31
    
    
    $
    0.67
    
    
    $
    0.58Average number of shares outstanding, basic
    
    
    7,376,000
    
    
    
    7,302,000
    
    
    
    7,369,000
    
    
    
    7,276,000Average number of shares outstanding, diluted
    
    
    7,582,000
    
    
    
    7,573,000
    
    
    
    7,579,000
    
    
    
    7,546,000
  2




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 Accumulatedother
    
    
    TotalCommon stock
    
    
    Retained
    
    
    Deferred
    
    
    comprehensive
    
    
    ShareholdersShares
    
    
    Amount
    
    
    earnings
    
    
    compensation
    
    
    income
    
    
    equityBalances at December 31, 2004
    
    
    5,429
    
    
    $
    31,516
    
    
    $
    17,928
    
    
    
    
    
    
    $
    147
    
    
    $
    49,591Comprehensive income:Net income
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    4,392
    
    
    
    3⁄4

    
    
    
    3⁄4
    
    
    
    4,392Net unrealized loss on securities
available for sale, net of tax of
($90)
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4

    
    
    
    (155
    )
    
    
    (155
    )Plus adjustment for losses included in
net income, net of income tax of $17
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33
    
    
    
    33Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,270Tax benefit associated with stock options
    
    
    3⁄4
    
    
    
    30
    
    
    
    3⁄4
    
    
    
    3⁄4

    
    
    
    3⁄4
    
    
    
    30Cash dividend, $0.109 per share
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (800
    )
    
    
    3⁄4

    
    
    
    3⁄4
    
    
    
    (800
    )Stock option compensation
    
    
    3⁄4
    
    
    
    12
    
    
    
    3⁄4
    
    
    
    3⁄4

    
    
    
    3⁄4
    
    
    
    12Four-for-three stock split
    
    
    1,810
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4

    
    
    
    3⁄4
    
    
    
    3⁄4Stock options exercised
    
    
    47
    
    
    
    188
    
    
    
    3⁄4
    
    
    
    3⁄4

    
    
    
    3⁄4
    
    
    
    188Restricted stock
    
    
    35
    
    
    
    483
    
    
    
    3⁄4
    
    
    
    (483
    )

    
    
    3⁄4
    
    
    
    3⁄4Unearned restricted stock
    
    
    3⁄4
    
    
    

    3⁄4
    
    
    
    3⁄4
    
    
    
33
    
    
    
    3⁄4
    
    
    
    33Balances at June 30, 2005
    
    
    7,321
    
    
    $
    32,229
    
    
    $
    21,520
    
    
    $
    (450
    )
    
    $
    25
    
    
    $
    53,324Balances at December 31, 2005
    
    
    7,382
    
    
    $
    32,492
    
    
    $
    25,789
    
    
    $
    (386
    )
    
    $
    (46
    )
    
    $
    57,849Comprehensive income:Net income
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    5,038
    
    
    
3⁄4
    
    
    
    3⁄4
    
    
    
    5,038Net unrealized loss on securities
available for sale, net of tax of
($38)
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
3⁄4
    
    
    
    (74
    )
    
    
    (74
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,964Cash dividend, $0.125 per share
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (926
    )
    
    
3⁄4
    
    
    
    3⁄4
    
    
    
    (926
    )Stock option compensation
    
    
    3⁄4
    
    
    
    43
    
    
    
    3⁄4
    
    
    
3⁄4
    
    
    
    3⁄4
    
    
    
    43Stock options exercised
    
    
    29
    
    
    
    109
    
    
    
    3⁄4
    
    
    

3⁄4
    
    
    
    3⁄4
    
    
    
    109Issuance of restricted stock
    
    
    13
    
    
    
    236
    
    
    
    3⁄4
    
    
    
    (236
    )
    
    
    3⁄4
    
    
    
    3⁄4Amortization of stock compensation
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    75
    
    
    
    3⁄4
    
    
    
    75Balances at June 30, 2006
    
    
    7,424
    
    
    $
    32,880
    
    
    $
    29,901
    
    
    $
    (547
    )
    
    $
    (120
    )
    
    $
    62,114
  3




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 Six Months Ended June 30,2006
    
    
    2005Cash flows from operating activities:Net income from continuing operations
    
    $
    5,038
    
    
    $
    4,392Adjustments to reconcile net income to net cash
provided by operating activities:Federal Home Loan Bank stock dividends
    
    
    
    
    
    
    (8
    )Amortization of investment premiums, net
    
    
    6
    
    
    
    14Net decrease in subsidiary investment
    
    
    24
    
    
    
    39Earnings on bank owned life insurance
    
    
    (178
    )
    
    
    (168
    )Provision for loan losses
    
    
    1,300
    
    
    
    950Net decrease (increase) in loans held for sale
    
    
    1,962
    
    
    
    (3,028
    )Net loss on the sale of securities
    
    
    
    
    
    
    50Depreciation and amortization of premises and equipment
    
    
    823
    
    
    
    806Net gain on sale of premises and equipment
    
    
    
    
    
    
    (101
    )Net gain on sale of other real estate
    
    
    (6
    )
    
    
    (7
    )Write-downs of other real estate
    
    
    10
    
    
    
    85Tax benefit associated with stock options
    
    
    
    
    
    
    (30
    )Stock-based compensation
    
    
    118
    
    
    
    33Increase in other assets
    
    
    (1,108
    )
    
    
    (612
    )(Decrease) increase in other liabilities
    
    
    (1,591
    )
    
    
    597Cash provided by operating activities
    
    
    6,398
    
    
    
    3,012Cash flows from investing activities:Maturities/calls/principal payments of investment and
mortgage-backed securities available for sale
    
    
    1,014
    
    
    
    366Sales of investment securities, available for sale
    
    
    
    
    
    
    455Net increase in loans
    
    
    (56,423
    )
    
    
    (31,077
    )Purchases of premises and equipment
    
    
    (1,156
    )
    
    
    (1,661
    )Proceeds from the sale of other real estate owned and premises and
equipment
    
    
    65
    
    
    
    783Cash flows used by investing activities
    
    
    (56,500
    )
    
    
    (31,134
    )Cash flows from financing activities:Net increase in deposits
    
    
    42,369
    
    
    
    60,015Net increase (decrease) in FHLB overnight borrowings
    
    
    2,000
    
    
    
    (22,000
    )Gross payments on other borrowed funds
    
    
    (21,845
    )
    
    
    (5,000
    )New borrowings on other borrowed funds
    
    
    16,845
    
    
    
    10,000Dividends paid on common stock
    
    
    (926
    )
    
    
    (800
    )Proceeds from stock options exercised
    
    
    109
    
    
    
    188Cash flows provided by financing activities
    
    
    38,552
    
    
    
    42,403Net change in cash and cash equivalents
    
    
    (11,550
    )
    
    
    14,281Cash and cash equivalents at beginning of period
    
    
    42,027
    
    
    
    17,933Cash and cash equivalents at end of period
    
    $
    30,477
    
    
    $
    32,214Supplemental information:Loans foreclosed and transferred to other real estate owned
    
    $
    69
    
    
    $
    53Cash paid for interest
    
    
    7,357
    
    
    
    5,183Cash paid for income taxes
    
    
    3,010
    
    
    
    2,380
  4




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (1) Description of Business and Summary of Significant Accounting Policies
       (2) Recent Financial Accounting Pronouncements
 Shared
Based Payment, Accounting for Stock-Based Compensation. Accounting for
Stock Issued to Employees Statement of Cash Flows Stock-Based Compensation.
 Accounting for Certain Hybrid Financial Instruments
 5




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Accounting for Servicing of Financial Assets Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities,
 (3) Earnings Per Share
  Three Months Ended June 30,
    
    Six Months Ended June 30,2006
    
    2005
    
    2006
    
    2005Weighted average shares-basic
    
    
    7,376,000
    
    
    
    7,301,000
    
    
    
    7,369,000
    
    
    
    7,275,000Effect of
dilutive securities: stock
    
    
    206,000
    
    
    
    272,000
    
    
    
    210,000
    
    
    
    271,000Weighted average shares-diluted
    
    
    7,582,000
    
    
    
    7,573,000
    
    
    
    7,579,000
    
    
    
    7,546,000
  (4) Stock-Based Compensation
 Share Based Payment
  Accounting for Stock-Based Compensation -Transition and Disclosure
 6




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2005Net income, as reported
    
    $
    2,349
    
    
    $

    4,392Stock compensation recognized, net of tax
    
    
    4
    
    
    
    8Additional compensation for
fair value of stock options, net of tax
    
    
    (14
    )
    
    
    (29
    )Pro forma net income
    
    $

    2,339
    
    
    $

    4,371Basic earnings per share:Net income, as reported
    
    $
    0.32
    
    
    $

    0.60Net income, pro forma
    
    $

    0.32
    
    
    $

    0.60Diluted earnings per share:Net income, as reported
    
    $
    0.31
    
    
    $

    0.58Net income, pro forma
    
    $
    0.31
    
    
    $

    0.58
  2006Risk-free interest rate
    
    
    4.95
    %Dividend yield rate
    
    
    1.40
    %Price volatility
    
    
    38.13
    %Expected life of options
    
    7 years
 Weighted AverageWeighted
    
    
    RemainingAverage Exercise Price
    
    
    Contractual
    
    
    AggregateShares
    
    
    Per Share
    
    
    Terms (in years)
    
    
    Intrinsic ValueOutstanding at January 1, 2006
    
    
    336,493
    
    
    $
    5.93Granted
    
    
    24,897
    
    
    
    18.24Exercised
    
    
    (28,965
    )
    
    
    3.85
    
    
    
    
    
    
    $
    413Forfeited, expired or cancelled
    
    
    (1,282
    )
    
    
    10.73Outstanding at June 30, 2006
    
    
    331,143
    
    
    $
    7.02
    
    
    
    4.04
    
    
    $
    4,988Exercisable at June 30, 2006
    
    
    265,307
    
    
    $
    5.99
    
    
    
    3.18
    
    
    $
    4,269
  7




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
   WeightedAverage GrantShares
    

Price Per ShareOutstanding at January 1, 2006
    
    
    34,709
    
    
    $
    13.73Granted
    
    
    13,569
    
    
    
    18.36Vested
    
    
    (9,073
    )
    
    
    13.65Forfeited, expired or cancelled
    
    
    (700
    )
    
    
    15.37Outstanding at June 30, 2006
    
    
    38,505
    
    
    $
    15.39
  (5) Subsequent Event
  (6) Commitments and Guarantees
   8




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##### 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:
 9




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##### Table of Contents



Stock-based Compensation: Share Based Payment Notes to Condensed Consolidated
Financial Statements
 Results of Operations Overview
   Net Interest Income:
 §
    
    The volume, pricing, mix and maturity of 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
  Average Balance Sheet and Analysis of Net Interest Income and Yields/Rates
 Three Months Ended June 30, 2006
    
    
    Three Months Ended June 30, 2005Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average(Dollars in thousands)
    
    balance
    
    
    earned/paid
    
    
    yield
    
    
    balance
    
    
    earned/paid
    
    
    yieldAssetsLoans (1) (2)
    
    $
    670,884
    
    
    $
    13,311
    
    
    
    7.96
    %
    
    $
    609,066
    
    
    $
    10,966
    
    
    
    7.22
    %Federal funds sold
    
    
    2,316
    
    
    
    29
    
    
    
    5.02
    %
    
    
    3,082
    
    
    
    22
    
    
    
    2.86
    %Interest-earning cash
    
    
    718
    
    
    
    9
    
    
    
    5.03
    %
    
    
    802
    
    
    
    5
    
    
    
    2.50
    %Investments:Taxable
    
    
    13,395
    
    
    
    108
    
    
    
    3.22
    %
    
    
    14,047
    
    
    
    88
    
    
    
    2.51
    %Non-taxable (2)
    
    
    7,522
    
    
    
    119
    
    
    
    6.34
    %
    
    
    6,890
    
    
    
    118
    
    
    
    6.87
    %Interest-earning assets
    
    
    694,835
    
    
    
    13,576
    
    
    
    7.84
    %
    
    
    633,887
    
    
    
    11,199
    
    
    
    7.09
    %Noninterest-earning assets
    
    
    49,152
    
    
    
    
    
    
    
    
    
    
    
    52,211Total assets
    
    $
    743,987
    
    
    
    
    
    
    
    
    
    
    $
    686,098
 10




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##### Table of Contents



Three Months Ended June 30, 2006
    
    
    Three Months Ended June 30, 2005Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average(Dollars in thousands)
    
    balance
    
    
    earned/paid
    
    
    yield
    
    
    balance
    
    
    earned/paid
    
    
    yieldLiabilities and
Shareholders equityDeposits:Interest demand and
money market
    
    $
    223,040
    
    
    $
    935
    
    
    
    1.68
    %
    
    $
    226,599
    
    
    $
    595
    
    
    
    1.05
    %Savings
    
    
    55,081
    
    
    
    108
    
    
    
    0.78
    %
    
    
    55,748
    
    
    
    110
    
    
    
    0.79
    %CDs
    
    
    266,755
    
    
    
    2,677
    
    
    
    4.03
    %
    
    
    219,225
    
    
    
    1,654
    
    
    
    3.03
    %Interest-bearing deposits
    
    
    544,876
    
    
    
    3,720
    
    
    
    2.74
    %
    
    
    501,572
    
    
    
    2,359
    
    
    
    1.89
    %Federal funds purchased
    
    
    11,833
    
    
    
    153
    
    
    
    5.20
    %
    
    
    8,734
    
    
    
    69
    
    
    
    3.17
    %Junior subordinated
debentures
    
    
    15,007
    
    
    
    334
    
    
    
    8.93
    %
    
    
    15,007
    
    
    
    260
    
    
    
    6.95
    %Other borrowed funds
    
    
    5,879
    
    
    
    75
    
    
    
    5.11
    %
    
    
    11,096
    
    
    
    108
    
    
    
    3.90
    %Interest-bearing liabilities
    
    
    577,595
    
    
    
    4,282
    
    
    
    2.97
    %
    
    
    536,409
    
    
    
    2,796
    
    
    
    2.09
    %Noninterest-bearing deposits
    
    
    100,008
    
    
    
    
    
    
    
    
    
    
    
    94,129Other noninterest-bearing
liabilities
    
    
    5,733
    
    
    
    
    
    
    
    
    
    
    
    3,894Total liabilities
    
    
    683,336
    
    
    
    
    
    
    
    
    
    
    
    634,432Shareholders equity
    
    
    60,651
    
    
    
    
    
    
    
    
    
    
    
    51,666Total liabilities and
shareholders equity
    
    $
    743,987
    
    
    
    
    
    
    
    
    
    
    $
    686,098Net interest income
    
    
    
    
    
    $
    9,294
    
    
    
    
    
    
    
    
    
    
    $
    8,403Net interest spread
    
    
    
    
    
    
    
    
    
    
    4.87
    %
    
    
    
    
    
    
    
    
    
    
    5.00
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    5.37
    %
    
    
    
    
    
    
    
    
    
    
    5.32
    %
 
 (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 $58 and $62 for the three months ended June 30, 2006
and 2005, 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. Average Balance Sheet and Analysis of Net Interest Income and Yields/Rates
 Six Months Ended June 30, 2006
    
    
    Six Months Ended June 30, 2005Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average(Dollars in thousands)
    
    balance
    
    
    earned/paid
    
    
    yield
    
    
    balance
    
    
    earned/paid
    
    
    yieldAssetsLoans (1) (2)
    
    $
    655,399
    
    
    $
    25,742
    
    
    
    7.92
    %
    
    $
    597,573
    
    
    $
    21,078
    
    
    
    7.11
    %Federal funds sold
    
    
    2,883
    
    
    
    68
    
    
    
    4.76
    %
    
    
    2,385
    
    
    
    32
    
    
    
    2.71
    %Interest-earning cash
    
    
    792
    
    
    
    19
    
    
    
    4.96
    %
    
    
    925
    
    
    
    12
    
    
    
    2.62
    %Investments:Taxable
    
    
    13,544
    
    
    
    223
    
    
    
    3.32
    %
    
    
    14,224
    
    
    
    191
    
    
    
    2.71
    %Non-taxable (2)
    
    
    7,555
    
    
    
    238
    
    
    
    6.36
    %
    
    
    6,987
    
    
    
    239
    
    
    
    6.90
    %Interest-earning assets
    
    
    680,173
    
    
    
    26,290
    
    
    
    7.80
    %
    
    
    622,094
    
    
    
    21,552
    
    
    
    6.99
    %Noninterest-earning assets
    
    
    48,600
    
    
    
    
    
    
    
    
    
    
    
    50,852Total assets
    
    $
    728,773
    
    
    
    
    
    
    
    
    
    
    $
    672,946
 11




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##### Table of Contents



Six Months Ended June 30, 2006
    
    
    Six Months Ended June 30, 2005Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average(Dollars in thousands)
    
    balance
    
    
    earned/paid
    
    
    yield
    
    
    balance
    
    
    earned/paid
    
    
    yieldLiabilities and
Shareholders equityDeposits:Interest demand and
money market
    
    $
    219,795
    
    
    $
    1,749
    
    
    
    1.60
    %
    
    $
    221,990
    
    
    $
    1,087
    
    
    
    0.99
    %Savings
    
    
    56,378
    
    
    
    219
    
    
    
    0.78
    %
    
    
    56,014
    
    
    
    220
    
    
    
    0.79
    %CDs
    
    
    257,099
    
    
    
    4,846
    
    
    
    3.80
    %
    
    
    214,872
    
    
    
    3,159
    
    
    
    2.96
    %Interest-bearing deposits
    
    
    533,272
    
    
    
    6,814
    
    
    
    2.58
    %
    
    
    492,876
    
    
    
    4,466
    
    
    
    1.83
    %Federal funds purchased
    
    
    8,196
    
    
    
    207
    
    
    
    5.10
    %
    
    
    11,576
    
    
    
    159
    
    
    
    2.77
    %Junior subordinated
debentures
    
    
    15,007
    
    
    
    644
    
    
    
    8.65
    %
    
    
    15,007
    
    
    
    497
    
    
    
    6.68
    %Other borrowed funds
    
    
    7,938
    
    
    
    170
    
    
    
    4.32
    %
    
    
    9,648
    
    
    
    187
    
    
    
    3.91
    %Interest-bearing liabilities
    
    
    564,413
    
    
    
    7,835
    
    
    
    2.80
    %
    
    
    529,107
    
    
    
    5,309
    
    
    
    2.02
    %Noninterest-bearing deposits
    
    
    99,396
    
    
    
    
    
    
    
    
    
    
    
    89,561Other noninterest-bearing
liabilities
    
    
    5,361
    
    
    
    
    
    
    
    
    
    
    
    3,494Total liabilities
    
    
    669,170
    
    
    
    
    
    
    
    
    
    
    
    622,162Shareholders equity
    
    
    59,603
    
    
    
    
    
    
    
    
    
    
    
    50,784Total liabilities and
shareholders equity
    
    $
    728,773
    
    
    
    
    
    
    
    
    
    
    $
    672,946Net interest income
    
    
    
    
    
    $
    18,455
    
    
    
    
    
    
    
    
    
    
    $
    16,243Net interest spread
    
    
    
    
    
    
    
    
    
    
    5.00
    %
    
    
    
    
    
    
    
    
    
    
    4.97
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    5.47
    %
    
    
    
    
    
    
    
    
    
    
    5.27
    %
 
 (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 $123 and $122 for the six months ended June 30, 2006
and 2005, 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.   12




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##### Table of Contents



Three Months Ended June 30
    
    
    Six Months Ended June 302006 vs. 2005
    
    
    2006 vs. 2005Increase (decrease) due to(2):
    
    
    Increase (decrease) due to(2):Volume
    
    
    Rate
    
    
    Total
    
    
    Volume
    
    
    Rate
    
    
    TotalAssets:Loans (1) (3)
    
    $
    1,113
    
    
    $
    1,232
    
    
    $
    2,345
    
    
    $
    2,040
    
    
    $
    2,624
    
    
    $
    4,664Federal funds sold
    
    
    (5
    )
    
    
    12
    
    
    
    7
    
    
    
    7
    
    
    
    29
    
    
    
    36Interest-bearing cash
    
    
    (1
    )
    
    
    5
    
    
    
    4
    
    
    
    (2
    )
    
    
    9
    
    
    
    7Investments (1)
    
    
    7
    
    
    
    14
    
    
    
    21
    
    
    
    10
    
    
    
    21
    
    
    
    31Total interest earning assets
    
    $
    1,114
    
    
    $
    1,263
    
    
    $
    2,377
    
    
    $
    2,055
    
    
    $
    2,683
    
    
    $
    4,738Liabilities:Deposits:Interest demand and money market
    
    $
    (9
    )
    
    $
    349
    
    
    $
    340
    
    
    $
    (11
    )
    
    $
    673
    
    
    $
    662Savings
    
    
    (1
    )
    
    
    (1
    )
    
    
    (2
    )
    
    
    1
    
    
    
    (2
    )
    
    
    (1
    )Time deposits
    
    
    359
    
    
    
    664
    
    
    
    1,023
    
    
    
    621
    
    
    
    1,066
    
    
    
    1,687Interest on other borrowed funds
    
    
    24
    
    
    
    60
    
    
    
    84
    
    
    
    (46
    )
    
    
    95
    
    
    
    48Junior subordinated debentures
    
    
    0
    
    
    
    74
    
    
    
    74
    
    
    
    0
    
    
    
    147
    
    
    
    147Other interest-bearing liabilities
    
    
    (51
    )
    
    
    18
    
    
    
    (33
    )
    
    
    (33
    )
    
    
    16
    
    
    
    (17
    )Total interest-bearing liabilities
    
    $
    322
    
    
    $
    1,164
    
    
    $
    1,486
    
    
    $
    532
    
    
    $
    1,995
    
    
    $
    2,526
 
 (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:
  13




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##### Table of Contents



Income Taxes:
 Financial Condition Overview
  Loans:
  Loan Portfolio Composition as of:June 30, 2006
    
    
    December 31, 2005
    
    
    Change(Dollars in thousands)
    
    Balance
    
    
    % of total
    
    
    Balance
    
    
    % of total
    
    
    2006 vs. 2005Commercial
    
    $
    83,553
    
    
    
    12.2
    %
    
    $
    79,341
    
    
    
    12.6
    %
    
    $
    4,212Real estate mortgages:One-to-four family residential
    
    
    51,491
    
    
    
    7.5
    %
    
    
    45,278
    
    
    
    7.2
    %
    
    
    6,213Commercial
    
    
    231,547
    
    
    
    33.8
    %
    
    
    218,260
    
    
    
    34.6
    %
    
    
    13,287Total real estate mortgages
    
    
    283,038
    
    
    
    41.3
    %
    
    
    263,538
    
    
    
    41.8
    %
    
    
    19,500Real estate construction:One-to-four family residential
    
    
    94,430
    
    
    
    13.8
    %
    
    
    79,016
    
    
    
    12.5
    %
    
    
    15,414Multi-family and commercial
    
    
    45,675
    
    
    
    6.6
    %
    
    
    34,645
    
    
    
    5.5
    %
    
    
    11,030Total real estate construction
    
    
    140,105
    
    
    
    20.4
    %
    
    
    113,661
    
    
    
    18.0
    %
    
    
    26,444Consumer:Indirect
    
    
    96,946
    
    
    
    14.1
    %
    
    
    91,251
    
    
    
    14.5
    %
    
    
    5,695Direct
    
    
    82,037
    
    
    
    12.0
    %
    
    
    82,425
    
    
    
    13.1
    %
    
    
    (388
    )Total consumer
    
    
    178,983
    
    
    
    26.1
    %
    
    
    173,676
    
    
    
    27.6
    %
    
    
    5,307Subtotal
    
    
    685,679
    
    
    
    100.0
    %
    
    
    630,216
    
    
    
    100.0
    %
    
    
    55,463Less: allowance for loan losses
    
    
    (9,606
    )
    
    
    
    
    
    
    (8,810
    )
    
    
    
    
    
    
    (796
    )Deferred loan fees, net
    
    
    429
    
    
    
    
    
    
    
    42
    
    
    
    
    
    
    
    387Total loans, net
    
    $
    676,502
    
    
    
    
    
    
    $
    621,448
    
    
    
    
    
    
    $
    55,054
 14




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##### Table of Contents



Allowance for Loan Losses:
  Three Months Ended
    
    
    Six Months EndedJune 30
    
    
    June 30(Dollars in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Balance at beginning of period
    
    $
    9,130
    
    
    $
    8,052
    
    
    $
    8,810
    
    
    $
    7,903Charge-offs:Commercial
    
    
    (303
    )
    
    
    (32
    )
    
    
    (466
    )
    
    
    (141
    )Real estate
    
    
    (26
    )
    
    
    (1
    )
    
    
    (86
    )
    
    
    (26
    )Consumer:Direct
    
    
    (94
    )
    
    
    (55
    )
    
    
    (194
    )
    
    
    (185
    )Indirect
    
    
    (169
    )
    
    
    (116
    )
    
    
    (401
    )
    
    
    (434
    )Total charge-offs
    
    $
    (592
    )
    
    $
    (204
    )
    
    $
    (1,147
    )
    
    $
    (786
    )Recoveries:Commercial
    
    
    111
    
    
    
    22
    
    
    
    301
    
    
    
    104Real estate
    
    
    1
    
    
    
    8
    
    
    
    1
    
    
    
    130Consumer:Direct
    
    
    68
    
    
    
    31
    
    
    
    121
    
    
    
    52Indirect
    
    
    88
    
    
    
    120
    
    
    
    220
    
    
    
    201Total recoveries
    
    $
    268
    
    
    $
    181
    
    
    $
    643
    
    
    $
    487Net charge-offs
    
    
    (324
    )
    
    
    (23
    )
    
    
    (504
    )
    
    
    (299
    )Provision for loan losses
    
    
    800
    
    
    
    525
    
    
    
    1,300
    
    
    
    950Balance at end of period
    
    $
    9,606
    
    
    $
    8,554
    
    
    $
    9,606
    
    
    $
    8,554Indirect net charge-offs to average indirect loans
(1)
    
    
    0.34
    %
    
    
    (0.02
    %)
    
    
    0.39
    %
    
    
    0.48
    %Other net charge-offs to average other loans (1)
    
    
    0.17
    %
    
    
    0.02
    %
    
    
    0.12
    %
    
    
    0.03
    %Net charge-offs to average loans (1)
    
    
    0.19
    %
    
    
    0.02
    %
    
    
    0.15
    %
    
    
    0.10
    %
 
 (1)
    
    Excludes loans held for sale.  15




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##### Table of Contents



Allocation of the Allowance for Loan Losses as of:June 30, 2006

    
    December 31, 2005
    

    June 30, 2005% 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
    
    $
    788
    
    
    
    8.2
    %
    
    
    12.2
    %
    
    $
    737
    
    
    
    8.4
    %
    
    
    12.6
    %
    
    $
    822
    
    
    
    9.6
    %
    
    
    13.8
    %Real estate mortgage
    
    
    3,072
    
    
    
    32.0
    %
    
    
    41.3
    %
    
    
    2,844
    
    
    
    32.3
    %
    
    
    41.8
    %
    
    
    2,635
    
    
    
    30.8
    %
    
    
    38.5
    %Real estate construction
    
    
    1,751
    
    
    
    18.2
    %
    
    
    20.5
    %
    
    
    1,378
    
    
    
    15.6
    %
    
    
    18.0
    %
    
    
    1,549
    
    
    
    18.1
    %
    
    
    18.6
    %Consumer
    
    
    2,420
    
    
    
    25.2
    %
    
    
    26.0
    %
    
    
    2,308
    
    
    
    26.2
    %
    
    
    27.6
    %
    
    
    2,508
    
    
    
    29.3
    %
    
    
    29.1
    %Unallocated
    
    
    1,575
    
    
    
    16.4
    %
    
    
    N/A
    
    
    
    1,543
    
    
    
    17.5
    %
    
    
    N/A
    
    
    
    1,040
    
    
    
    12.2
    %
    
    
    N/ATotal
    
    $
    9,606
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    $
    8,810
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    $
    8,554
    
    
    
    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:(Dollars in thousands)
    
    June 30, 2006
    
    
    December 31, 2005Nonaccrual loans
    
    $
    1,079
    
    
    $
    2,159Restructured loans
    
    
    
    
    
    
    Total nonperforming loans
    
    
    1,079
    
    
    
    2,159Other real estate owned
    
    
    
    
    
    
    Total nonperforming assets
    
    $
    1,079
    
    
    $
    2,159Total impaired loans
    
    $
    1,079
    
    
    $
    2,159Accruing
loans past due 3 90 days
    
    
    
    
    
    
    Potential problem loans
    
    
    
    
    
    
    Allowance for loan losses
    
    $
    9,606
    
    
    $
    8,810Nonperforming loans to loans
    
    
    0.16
    %
    
    
    0.34
    %Allowance for loan losses to nonperforming loans
    
    
    890.27
    %
    
    
    408.06
    %Allowance for loan losses to nonperforming assets
    
    
    890.27
    %
    
    
    408.06
    %Nonperforming assets to total assets
    
    
    0.14
    %
    
    
    0.30
    %
 16




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##### Table of Contents



Deposits:
 Deposit Composition as of:June 30, 2006
    
    
    December 31, 2005
    
    
    Change(Dollars in thousands)
    
    Balance
    
    
    % of total
    
    
    Balance
    
    
    % of total
    
    
    2006 vs. 2005Noninterest-bearing demand
    
    $
    104,832
    
    
    
    15.6
    %
    
    $
    105,365
    
    
    
    16.5
    %
    
    $
    (533
    )NOW accounts
    
    
    149,910
    
    
    
    22.2
    %
    
    
    143,042
    
    
    
    22.4
    %
    
    
    6,868Money market
    
    
    90,913
    
    
    
    13.5
    %
    
    
    84,537
    
    
    
    13.3
    %
    
    
    6,376Savings
    
    
    57,398
    
    
    
    8.5
    %
    
    
    59,635
    
    
    
    9.4
    %
    
    
    (2,237
    )Time deposits
    
    
    276,805
    
    
    
    40.2
    %
    
    
    244,910
    
    
    
    38.4
    %
    
    
    31,895Total deposits
    
    $
    679,858
    
    
    
    100.0
    %
    
    $
    637,489
    
    
    
    100.0
    %
    
    $
    42,369
 Other Borrowings:
 Capital
 Shareholders Equity:
 Regulatory Capital Requirements:
  Regulatory Requirements
    
    Actual RatiosAdequately-
    
    Well-
    
    
    
    
    
    December 31,capitalized
    
    capitalized
    
    June 30, 2006
    
    2005Total risk-based capital ratioCompany (consolidated)
    
    
    8
    %
    
    
    N/A
    
    
    
    11.31
    %
    
    
    11.52
    %Whidbey Island Bank
    
    
    8
    %
    
    
    10
    %
    
    
    11.05
    %
    
    
    11.21
    %Tier 1 risk-based capital ratioCompany (consolidated)
    
    
    4
    %
    
    
    N/A
    
    
    
    10.06
    %
    
    
    10.28
    %Whidbey Island Bank
    
    
    4
    %
    
    
    6
    %
    
    
    9.80
    %
    
    
    9.96
    %Leverage ratioCompany (consolidated)
    
    
    4
    %
    
    
    N/A
    
    
    
    10.38
    %
    
    
    10.26
    %Whidbey Island Bank
    
    
    4
    %
    
    
    5
    %
    
    
    10.13
    %
    
    
    9.93
    %
  17




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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:
 Capital Expenditures and Commitments:
 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
  18




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##### Table of Contents



Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Control over Disclosure and Reporting
  19




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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
   For
    
    Against
    
    WithheldKarl C. Krieg, III
    
    
    5,895,027
    
    
    
    0
    
    
    
    143,107Robert B. Olson
    
    
    5,904,324
    
    
    
    0
    
    
    
    133,810Anthony B. Pickering
    
    
    5,979,246
    
    
    
    0
    
    
    
    58,888
  
 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.
 20




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##### Table of Contents



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
 21




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##### Table of Contents



SIGNATURES
  WASHINGTON BANKING COMPANY
 Date: August 8, 2006
    
    By
    
    /s/ Michal D. CannMichal D. CannPresident andChief Executive OfficerDate: August 8, 2006
    
    By
    
    /s/ Richard A. ShieldsRichard A. ShieldsSenior Vice President andChief Financial Officer
 22