##### 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 September 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 
incorporation or organization)
    
    (I.R.S. Employer
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, 2006 and December 31, 2005
    
    
    1Condensed Consolidated Statements of Income  
Three and Nine Months Ended September 30, 2006 and 2005
    
    
    2Condensed Consolidated Statements of Shareholders
Equity and Comprehensive Income  
Nine Months Ended September 30, 2006 and 2005
    
    
    3Condensed Consolidated Statements of Cash Flows  
Nine Months Ended September 30, 2006 and 2005
    
    
    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
    
    
    22Item 4.
    
    Controls and Procedures
    
    
    22PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    23Item 1A.
    
    Risk Factors
    
    
    23Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    23Item 3.
    
    Defaults Upon Senior Securities
    
    
    23Item 4.
    
    Other Information
    
    
    23Item 5.
    
    Exhibits
    
    
    23Signatures
    
    
    24EXHIBIT 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
 September 30,
    
    
    December 31,2006
    
    
    2005AssetsCash and due from banks
($2,248 and $3,313, respectively, are restricted)
    
    $
    20,062
    
    
    $
    19,949Interest-bearing deposits
    
    
    789
    
    
    
    983Federal funds sold
    
    
    
    
    
    
    21,095Total cash, restricted cash, and cash equivalents
    
    
    20,851
    
    
    
    42,027Investment securities available for sale
    
    
    17,514
    
    
    
    19,077Federal Home Loan Bank stock
    
    
    1,984
    
    
    
    1,984Loans held for sale
    
    
    1,940
    
    
    
    2,829Loans receivable
    
    
    713,638
    
    
    
    630,258Allowance for loan losses
    
    
    (9,985
    )
    
    
    (8,810
    )Total loans, net
    
    
    703,653
    
    
    
    621,448Premises and equipment, net
    
    
    22,024
    
    
    
    20,514Bank owned life insurance
    
    
    10,831
    
    
    
    10,558Other assets
    
    
    10,280
    
    
    
    7,539Total assets
    
    $
    789,077
    
    
    $
    725,976Liabilities and Shareholders EquityLiabilities:DepositsNoninterest-bearing
    
    $
    97,277
    
    
    $
    105,365Interest-bearing
    
    
    307,051
    
    
    
    287,214Time deposits
    
    
    296,392
    
    
    
    244,910Total deposits
    
    
    700,720
    
    
    
    637,489FHLB overnight borrowings
    
    
    3,000
    
    
    
    Other borrowed funds
    
    
    
    
    
    
    10,000Junior subordinated debentures
    
    
    15,007
    
    
    
    15,007Other liabilities
    
    
    5,915
    
    
    
    5,631Total liabilities
    
    
    724,642
    
    
    
    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 13,679,757 shares:
issued and outstanding 9,285,439 at 9/30/2006 and
9,227,763 at 12/31/2005 (1)
    
    
    32,934
    
    
    
    32,106Retained earnings
    
    
    31,573
    
    
    
    25,789Accumulated other comprehensive income
    
    
    (72
    )
    
    
    (46
    )Total shareholders equity
    
    
    64,435
    
    
    
    57,849Total liabilities and shareholders equity
    
    $
    789,077
    
    
    $
    725,976
 
 (1)
    
    Adjusted to reflect a 5-for-4 stock split distributed by the Company on September 6, 2006  1




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Interest income:Interest and fees on loans
    
    $
    14,177
    
    
    $
    11,386
    
    
    $
    39,872
    
    
    $
    32,423Interest on taxable investment securities
    
    
    97
    
    
    
    91
    
    
    
    301
    
    
    
    259Interest on tax exempt investment securities
    
    
    77
    
    
    
    78
    
    
    
    238
    
    
    
    237Other
    
    
    84
    
    
    
    233
    
    
    
    192
    
    
    
    299Total interest income
    
    
    14,435
    
    
    
    11,788
    
    
    
    40,603
    
    
    
    33,218Interest expense:Interest on deposits
    
    
    4,614
    
    
    
    2,600
    
    
    
    11,429
    
    
    
    7,066Interest on other borrowings
    
    
    45
    
    
    
    97
    
    
    
    422
    
    
    
    443Interest on junior subordinated debentures
    
    
    351
    
    
    
    278
    
    
    
    995
    
    
    
    775Total interest expense
    
    
    5,010
    
    
    
    2,975
    
    
    
    12,846
    
    
    
    8,284Net interest income
    
    
    9,425
    
    
    
    8,813
    
    
    
    27,757
    
    
    
    24,934Provision for loan losses
    
    
    750
    
    
    
    550
    
    
    
    2,050
    
    
    
    1,500Net interest income after provision for loan losses
    
    
    8,675
    
    
    
    8,263
    
    
    
    25,707
    
    
    
    23,434Noninterest income:Service charges and fees
    
    
    812
    
    
    
    836
    
    
    
    2,481
    
    
    
    2,306Income from the sale of loans
    
    
    168
    
    
    
    280
    
    
    
    499
    
    
    
    664SBA premium income
    
    
    73
    
    
    
    212
    
    
    
    276
    
    
    
    503Other
    
    
    672
    
    
    
    663
    
    
    
    2,032
    
    
    
    2,061Total noninterest income
    
    
    1,725
    
    
    
    1,991
    
    
    
    5,288
    
    
    
    5,534Noninterest expense:Salaries and benefits
    
    
    4,245
    
    
    
    3,786
    
    
    
    12,494
    
    
    
    11,019Occupancy and equipment
    
    
    907
    
    
    
    881
    
    
    
    2,656
    
    
    
    2,529Office supplies and printing
    
    
    149
    
    
    
    147
    
    
    
    470
    
    
    
    503Data processing
    
    
    136
    
    
    
    138
    
    
    
    340
    
    
    
    394Consulting and professional fees
    
    
    195
    
    
    
    174
    
    
    
    472
    
    
    
    469Other
    
    
    1,123
    
    
    
    1,210
    
    
    
    3,400
    
    
    
    3,568Total noninterest expense
    
    
    6,755
    
    
    
    6,336
    
    
    
    19,832
    
    
    
    18,482Income before income taxes
    
    
    3,645
    
    
    
    3,918
    
    
    
    11,163
    
    
    
    10,486Provision for income taxes
    
    
    1,003
    
    
    
    1,239
    
    
    
    3,483
    
    
    
    3,415Net income
    
    $
    2,642
    
    
    $
    2,679
    
    
    $
    7,680
    
    
    $
    7,071Net income per share, basic (1)
    
    $
    0.29
    
    
    $
    0.30
    
    
    $
    0.83
    
    
    $
    0.78Net income per share, diluted (1)
    
    $
    0.28
    
    
    $
    0.28
    
    
    $
    0.81
    
    
    $
    0.75Average number of shares outstanding, basic (1)
    
    
    9,240,000
    
    
    
    9,114,000
    
    
    
    9,216,000
    
    
    
    9,086,000Average number of shares outstanding, diluted (1)
    
    
    9,525,000
    
    
    
    9,452,000
    
    
    
    9,489,000
    
    
    
    9,415,000
 
 (1)
    
    Adjusted to reflect a 5-for-4 stock split distributed by the Company on September 6, 2006  2




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WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 Accumulatedother
    
    
    TotalCommon stock
    
    
    Retained
    
    
    Deferred
    
    
    comprehensive
    
    
    shareholdersShares
    
    
    Amount
    
    
    earnings
    
    
    compensation
    
    
    income
    
    
    equityBalances at December 31, 2004 (1)
    
    
    9,048
    
    
    $
    31,516
    
    
    $
    17,928
    
    
    $
    
    
    
    $
    147
    
    
    $
    49,591Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    7,071
    
    
    
    
    
    
    
    
    
    
    
    7,071Net unrealized loss on securities available
for sale, net of tax of ($96)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (167
    )
    
    
    (167
    )Plus adjustment for losses included in
net income, net of income tax of $17
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33
    
    
    
    33Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,937Tax benefit associated with stock options
    
    
    
    
    
    
    87
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    87Cash dividend, $0.13 per share(1)
    
    
    
    
    
    
    
    
    
    
    (1,203
    )
    
    
    
    
    
    
    
    
    
    
    (1,203
    )Stock option compensation
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17Stock options exercised (1)
    
    
    74
    
    
    
    236
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    236Restricted stock (1)
    
    
    44
    
    
    
    483
    
    
    
    
    
    
    
    (483
    )
    
    
    
    
    
    
    Unearned restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    67
    
    
    
    
    
    
    
    67Balances at September 30, 2005
    
    
    9,166
    
    
    $
    32,339
    
    
    $
    23,796
    
    
    $
    (416
    )
    
    $
    13
    
    
    $
    55,732Balances at December 31, 2005 (1)
    
    
    9,228
    
    
    $
    32,492
    
    
    $
    25,789
    
    
    $
    (386
    )
    
    $
    (46
    )
    
    $
    57,849Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    7,680
    
    
    
    
    
    
    
    
    
    
    
    7,680Net unrealized loss on securities available
for sale, net of tax of ($15)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26
    )
    
    
    (26
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,654Cash dividend, $0.15 per share(1)
    
    
    
    
    
    
    
    
    
    
    (1,394
    )
    
    
    
    
    
    
    
    
    
    
    (1,394
    )Stock option compensation
    
    
    
    
    
    
    70
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70Stock options exercised (1)
    
    
    40
    
    
    
    136
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136Issuance of restricted stock (1)
    
    
    17
    
    
    
    236
    
    
    
    
    
    
    
    (236
    )
    
    
    
    
    
    
    Amortization of stock compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    120
    
    
    
    
    
    
    
    120Balances at September 30, 2006
    
    
    9,285
    
    
    $
    32,934
    
    
    $
    32,075
    
    
    $
    (502
    )
    
    $
    (72
    )
    
    $
    64,435
 
 (1)
    
    Adjusted to reflect a 5-for-4 stock split distributed by the Company on September 6, 2006  3




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##### Table of Contents



WASHINGTON BANKING COMPANY
AND SUBSIDIARY
 Nine Months EndedSeptember 30,2006
    
    
    2005Cash flows from operating activities:Net income from continuing operations
    
    $
    7,680
    
    
    $
    7,071Adjustments to reconcile net income to net cash
provided by operating activities:Federal Home Loan Bank stock dividends
    
    
    
    
    
    
    (8
    )Amortization of investment premiums, net
    
    
    9
    
    
    
    28Depreciation and amortization
    
    
    1,218
    
    
    
    1,213Earnings on bank owned life insurance
    
    
    (273
    )
    
    
    (255
    )Provision for loan losses
    
    
    2,050
    
    
    
    1,500Net gain on sale of premises and equipment
    
    
    
    
    
    
    (103
    )Net loss on the sale of securities
    
    
    
    
    
    
    50Net gain on sale of other real estate
    
    
    (6
    )
    
    
    (13
    )Write-downs of other real estate
    
    
    10
    
    
    
    229Amortization of stock-based compensation
    
    
    190
    
    
    
    67Tax benefit associated with stock options
    
    
    
    
    
    
    (87
    )Net change in assets and liabilities:Net decrease in subsidiary investment
    
    
    35
    
    
    
    61Net decrease in loans held for sale
    
    
    889
    
    
    
    3,226Increase in other assets
    
    
    (2,398
    )
    
    
    (461
    )Increase in other liabilities
    
    
    284
    
    
    
    463Cash provided by operating activities
    
    
    9,688
    
    
    
    12,981Cash flows from investing activities:Purchases of investment securities, available for sale
    
    
    (2,948
    )
    
    
    (1,420
    )Maturities/calls/principal payments of investment and
mortgage-backed securities, available for sale
    
    
    4,461
    
    
    
    1,091Sales of investment securities, available for sale
    
    
    
    
    
    
    455Net increase in loans
    
    
    (84,687
    )
    
    
    (35,170
    )Purchases of premises and equipment
    
    
    (2,728
    )
    
    
    (1,828
    )Proceeds from the sale of other real estate owned and premises and
equipment
    
    
    65
    
    
    
    903Cash flows used by investing activities
    
    
    (85,837
    )
    
    
    (35,969
    )Cash flows from financing activities:Net increase in deposits
    
    
    63,231
    
    
    
    74,324Net increase (decrease) in FHLB overnight borrowings
    
    
    3,000
    
    
    
    (22,000
    )Gross payments on other borrowed funds
    
    
    (26,845
    )
    
    
    New borrowings on other borrowed funds
    
    
    16,845
    
    
    
    5,000Dividends paid on common stock
    
    
    (1,394
    )
    
    
    (1,203
    )Proceeds from stock options exercised
    
    
    136
    
    
    
    236Cash flows provided by financing activities
    
    
    54,973
    
    
    
    56,357Net change in cash and cash equivalents
    
    
    (21,176
    )
    
    
    33,369Cash and cash equivalents at beginning of period
    
    
    42,027
    
    
    
    17,933Cash and cash equivalents at end of period
    
    $
    20,851
    
    
    $
    51,302Supplemental information:Loans foreclosed and transferred to other real estate owned
    
    $
    432
    
    
    $
    53Cash paid for interest
    
    
    12,213
    
    
    
    8,153Cash paid for income taxes
    
    
    4,010
    
    
    
    3,140
  4




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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
 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
    
    Nine Months EndedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Weighted average shares-basic
    
    
    9,239,732
    
    
    
    9,114,460
    
    
    
    9,216,354
    
    
    
    9,086,169Effect of dilutive securities: stock awards
    
    
    285,025
    
    
    
    337,969
    
    
    
    273,466
    
    
    
    328,630Weighted average shares-diluted
    
    
    9,524,757
    
    
    
    9,452,429
    
    
    
    9,489,820
    
    
    
    9,414,799
  (4)
    
    Stock-Based Compensation
 Share Based Payment
  6




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Accounting for Stock-Based Compensation Transition and Disclosure
 September 30, 2005Three Months Ended
    
    
    Nine Months EndedNet income, as reported
    
    $
    2,679
    
    
    $
    7,071Stock compensation recognized, net of tax
    
    
    4
    
    
    
    12Additional compensation for
fair value of stock options, net of tax
    
    
    (15
    )
    
    
    (44
    )Pro forma net income
    
    $
    2,668
    
    
    $
    7,039Basic earnings per share:Net income, as reported
    
    $
    0.30
    
    
    $
    0.78Net income, pro forma
    
    $
    0.30
    
    
    $
    0.78Diluted earnings per share:Net income, as reported
    
    $
    0.28
    
    
    $
    0.75Net income, pro forma
    
    $
    0.28
    
    
    $
    0.75
  2006Risk-free interest rate
    
    
    4.95
    %Dividend yield rate
    
    
    1.40
    %Price volatility
    
    
    38.13
    %Expected life of options
    
    7 years
 7




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Weighted
    
    Weighted averageaverage
    
    remaining
    
    Aggregateexercise price
    
    contractual terms
    
    intrinsicShares
    
    per share
    
    (in years)
    
    valueOutstanding at January 1, 2006
    
    
    441,624
    
    
    $
    4.79Granted
    
    
    31,100
    
    
    
    14.59Exercised
    
    
    (40,411
    )
    
    
    3.40
    
    
    
    
    
    
    $
    461Forfeited, expired or cancelled
    
    
    (1,557
    )
    
    
    8.58Outstanding at September 30, 2006
    
    
    430,756
    
    
    $
    5.61
    
    
    
    3.75
    
    
    $
    5,272Exercisable at September 30, 2006
    
    
    348,475
    
    
    $
    4.83
    
    
    
    2.92
    
    
    $
    4,537
    Weighted averageWeighted average
    
    remaininggrant price per
    
    contractual termsShares
    
    share
    
    (in years)Outstanding at January 1, 2006
    
    
    43,374
    
    
    $
    11.01Granted
    
    
    18,624
    
    
    
    13.36Vested
    
    
    (11,349
    )
    
    
    10.92Forfeited, expired or cancelled
    
    
    (872
    )
    
    
    11.77Outstanding at September 30, 2006
    
    
    49,777
    
    
    $
    11.89
    
    
    
    3.12
  8




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (5) Income Taxes
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Federal:Current tax expense
    
    $
    1,023
    
    
    $
    1,683
    
    
    $
    4,185
    
    
    $
    4,253Deferred tax
expense (benefit)
    
    
    (20
    )
    
    
    (444
    )
    
    
    (702
    )
    
    
    (838
    )Total
    
    $
    1,003
    
    
    $
    1,239
    
    
    $
    3,483
    
    
    $
    3,415
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Income tax expense at
federal statutory rates
    
    $
    1,273
    
    
    $
    1,344
    
    
    $
    3,874
    
    
    $
    3,597Federal tax credits
    
    
    (300
    )
    
    
    
    
    
    
    (300
    )
    
    
    Tax-exempt securities
    
    
    (73
    )
    
    
    (73
    )
    
    
    (222
    )
    
    
    (216
    )Other items
    
    
    103
    
    
    
    (32
    )
    
    
    131
    
    
    
    34Total
    
    $
    1,003
    
    
    $
    1,239
    
    
    $
    3,483
    
    
    $
    3,415
   September 30,
    
    
    December 31,2006
    
    
    2005Deferred tax assets:Loan loss allowances
    
    $
    3,435
    
    
    $
    3,022Deferred compensation
    
    
    350
    
    
    
    310Other
    
    
    24
    
    
    
    61Market value adjustment of investment
securities available for sale
    
    
    39
    
    
    
    25Total deferred tax assets
    
    
    3,848
    
    
    
    3,418Deferred tax liabilities:
 9




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 September 30,
    
    
    December 31,2006
    
    
    2005Deferred loan fees
    
    
    1,477
    
    
    
    1,799Premises and equipment
    
    
    407
    
    
    
    505FHLB stock
    
    
    150
    
    
    
    149Prepaid expenses
    
    
    140
    
    
    
    111Other
    
    
    103
    
    
    
    Total deferred tax liabilities
    
    
    2,277
    
    
    
    2,564Deferred tax assets, net
    
    $
    1,571
    
    
    $
    854
  (6) Subsequent Event
  (7) 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: Share Based Payment Notes to Condensed Consolidated Financial Statements
 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/Rates
 Three Months Ended
    
    
    Three Months EndedSeptember 30, 2006
    
    
    September 30, 2005Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average(Dollars in thousands)
    
    balance
    
    
    earned/paid
    
    
    yield
    
    
    balance
    
    
    earned/paid
    
    
    yieldAssetsLoans (1) (2)
    
    $
    697,972
    
    
    $
    14,199
    
    
    
    8.07
    %
    
    $
    618,042
    
    
    $
    11,410
    
    
    
    7.32
    %Federal funds sold
    
    
    4,740
    
    
    
    63
    
    
    
    5.27
    %
    
    
    24,964
    
    
    
    217
    
    
    
    3.45
    %Interest-earning cash
    
    
    759
    
    
    
    20
    
    
    
    10.46
    %
    
    
    816
    
    
    
    7
    
    
    
    3.40
    %Investments:Taxable
    
    
    11,744
    
    
    
    97
    
    
    
    3.28
    %
    
    
    14,180
    
    
    
    100
    
    
    
    2.80
    %Non-taxable (2)
    
    
    7,271
    
    
    
    114
    
    
    
    6.22
    %
    
    
    6,854
    
    
    
    118
    
    
    
    6.83
    %Interest-earning assets
    
    
    722,486
    
    
    
    14,493
    
    
    
    7.96
    %
    
    
    664,856
    
    
    
    11,852
    
    
    
    7.07
    %Noninterest-earning assets
    
    
    52,534
    
    
    
    
    
    
    
    
    
    
    
    50,494Total assets
    
    $
    775,020
    
    
    
    
    
    
    
    
    
    
    $
    715,350Liabilities and
Shareholders EquityDeposits:Interest demand and
money market
    
    $
    238,097
    
    
    $
    1,258
    
    
    
    2.10
    %
    
    $
    241,386
    
    
    $
    653
    
    
    
    1.07
    %Savings
    
    
    55,947
    
    
    
    111
    
    
    
    0.79
    %
    
    
    56,857
    
    
    
    112
    
    
    
    0.78
    %CDs
    
    
    289,908
    
    
    
    3,246
    
    
    
    4.44
    %
    
    
    229,491
    
    
    
    1,835
    
    
    
    3.17
    %Interest-bearing deposits
    
    
    583,952
    
    
    
    4,615
    
    
    
    3.14
    %
    
    
    527,734
    
    
    
    2,600
    
    
    
    1.95
    %Federal funds purchased
    
    
    2,267
    
    
    
    31
    
    
    
    5.43
    %Junior subordinated
debentures
    
    
    15,007
    
    
    
    351
    
    
    
    9.28
    %
    
    
    15,007
    
    
    
    278
    
    
    
    7.35
    %Other borrowed funds
    
    
    978
    
    
    
    14
    
    
    
    5.68
    %
    
    
    10,043
    
    
    
    97
    
    
    
    3.83
    %Interest-bearing liabilities
    
    
    602,204
    
    
    
    5,011
    
    
    
    3.30
    %
    
    
    552,784
    
    
    
    2,975
    
    
    
    2.14
    %Noninterest-bearing deposits
    
    
    103,643
    
    
    
    
    
    
    
    
    
    
    
    103,346Other noninterest-bearing
liabilities
    
    
    6,383
    
    
    
    
    
    
    
    
    
    
    
    5,163Total liabilities
    
    
    712,230
    
    
    
    
    
    
    
    
    
    
    
    661,293Shareholders equity
    
    
    62,790
    
    
    
    
    
    
    
    
    
    
    
    54,057Total liabilities and
shareholders equity
    
    $
    775,020
    
    
    
    
    
    
    
    
    
    
    $
    715,350Net interest income
    
    
    
    
    
    $
    9,482
    
    
    
    
    
    
    
    
    
    
    $
    8,877Net interest spread
    
    
    
    
    
    
    
    
    
    
    4.67
    %
    
    
    
    
    
    
    
    
    
    
    4.93
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    5.22
    %
    
    
    
    
    
    
    
    
    
    
    5.30
    %
 
 (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 $57 and $64 for the three months ended September 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. 13




---



##### Table of Contents



Average Balance Sheet and Analysis of Net Interest Income and Yields/Rates
 Nine Months Ended
    
    
    Nine Months EndedSeptember 30, 2006
    
    
    September 30, 2005Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average(Dollars in thousands)
    
    balance
    
    
    earned/paid
    
    
    yield
    
    
    balance
    
    
    earned/paid
    
    
    yieldAssetsLoans (1) (2)
    
    $
    669,746
    
    
    $
    39,947
    
    
    
    7.97
    %
    
    $
    604,471
    
    
    $
    32,488
    
    
    
    7.19
    %Federal funds sold
    
    
    3,509
    
    
    
    132
    
    
    
    5.03
    %
    
    
    9,994
    
    
    
    249
    
    
    
    3.33
    %Interest-earning cash
    
    
    781
    
    
    
    60
    
    
    
    10.27
    %
    
    
    887
    
    
    
    18
    
    
    
    2.71
    %Investments:Taxable
    
    
    12,783
    
    
    
    301
    
    
    
    3.15
    %
    
    
    14,210
    
    
    
    291
    
    
    
    2.74
    %Non-taxable (2)
    
    
    7,460
    
    
    
    353
    
    
    
    6.33
    %
    
    
    6,942
    
    
    
    357
    
    
    
    6.88
    %Interest-earning assets
    
    
    694,279
    
    
    
    40,793
    
    
    
    7.86
    %
    
    
    636,504
    
    
    
    33,403
    
    
    
    7.02
    %Noninterest-earning assets
    
    
    50,079
    
    
    
    
    
    
    
    
    
    
    
    50,647Total assets
    
    $
    744,358
    
    
    
    
    
    
    
    
    
    
    $
    687,151Liabilities and
Shareholders equityDeposits:Interest demand and
money market
    
    $
    225,963
    
    
    $
    3,007
    
    
    
    1.78
    %
    
    $
    228,526
    
    
    $
    1,741
    
    
    
    1.02
    %Savings
    
    
    56,233
    
    
    
    330
    
    
    
    0.78
    %
    
    
    56,298
    
    
    
    331
    
    
    
    0.79
    %CDs
    
    
    268,156
    
    
    
    8,092
    
    
    
    4.03
    %
    
    
    219,799
    
    
    
    4,994
    
    
    
    3.04
    %Interest-bearing deposits
    
    
    550,352
    
    
    
    11,429
    
    
    
    2.78
    %
    
    
    504,623
    
    
    
    7,066
    
    
    
    1.87
    %Federal funds purchased
    
    
    6,198
    
    
    
    239
    
    
    
    5.16
    %
    
    
    7,675
    
    
    
    159
    
    
    
    2.77
    %Junior subordinated
debentures
    
    
    15,007
    
    
    
    995
    
    
    
    8.86
    %
    
    
    15,007
    
    
    
    775
    
    
    
    6.90
    %Other borrowed funds
    
    
    5,592
    
    
    
    183
    
    
    
    4.38
    %
    
    
    9,781
    
    
    
    284
    
    
    
    3.88
    %Interest-bearing liabilities
    
    
    577,149
    
    
    
    12,846
    
    
    
    2.98
    %
    
    
    537,086
    
    
    
    8,284
    
    
    
    2.06
    %Noninterest-bearing deposits
    
    
    100,827
    
    
    
    
    
    
    
    
    
    
    
    94,233Other noninterest-bearing
liabilities
    
    
    5,705
    
    
    
    
    
    
    
    
    
    
    
    3,945Total liabilities
    
    
    683,681
    
    
    
    
    
    
    
    
    
    
    
    635,264Shareholders equity
    
    
    60,677
    
    
    
    
    
    
    
    
    
    
    
    51,887Total liabilities and
shareholders equity
    
    $
    744,358
    
    
    
    
    
    
    
    
    
    
    
    687,151Net interest income
    
    
    
    
    
    $
    27,947
    
    
    
    
    
    
    
    
    
    
    $
    25,119Net interest spread
    
    
    
    
    
    
    
    
    
    
    4.88
    %
    
    
    
    
    
    
    
    
    
    
    4.96
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    5.38
    %
    
    
    
    
    
    
    
    
    
    
    5.28
    %
 
 (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 $190 and $185 for the nine months ended September 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. 14




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006 vs. 2005
    
    
    2006 vs. 2005Increase (decrease) due to(2):
    
    
    Increase (decrease) due to(2):Volume
    
    
    Rate
    
    
    Total
    
    
    Volume
    
    
    Rate
    
    
    TotalAssets:Loans (1) (3)
    
    $
    1,476
    
    
    $
    1,313
    
    
    $
    2,789
    
    
    $
    3,508
    
    
    $
    3,951
    
    
    $
    7,459Federal funds sold
    
    
    (176
    )
    
    
    22
    
    
    
    (154
    )
    
    
    (162
    )
    
    
    45
    
    
    
    (117
    )Interest-bearing cash
    
    
    
    
    
    
    13
    
    
    
    13
    
    
    
    (2
    )
    
    
    44
    
    
    
    42Investments (1)
    
    
    (10
    )
    
    
    3
    
    
    
    (7
    )
    
    
    (2
    )
    
    
    8
    
    
    
    6Total interest earning assets
    
    $
    1,290
    
    
    $
    1,351
    
    
    $
    2,641
    
    
    $
    3,342
    
    
    $
    4,048
    
    
    $
    7,390Liabilities:Deposits:Interest demand and money market
    
    $
    (9
    )
    
    $
    614
    
    
    $
    605
    
    
    $
    (20
    )
    
    $
    1,286
    
    
    $
    1,266Savings
    
    
    (2
    )
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )Time deposits
    
    
    483
    
    
    
    928
    
    
    
    1,411
    
    
    
    1,099
    
    
    
    1,999
    
    
    
    3,098Interest on other borrowed funds
    
    
    
    
    
    
    31
    
    
    
    31
    
    
    
    (31
    )
    
    
    111
    
    
    
    80Junior subordinated debentures
    
    
    
    
    
    
    73
    
    
    
    73
    
    
    
    
    
    
    
    220
    
    
    
    220Other interest-bearing liabilities
    
    
    (88
    )
    
    
    5
    
    
    
    (83
    )
    
    
    (122
    )
    
    
    21
    
    
    
    (101
    )Total interest-bearing liabilities
    
    $
    384
    
    
    $
    1,652
    
    
    $
    2,036
    
    
    $
    926
    
    
    $
    3,636
    
    
    $
    4,562
 
 (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. 15




---



##### Table of Contents



Noninterest Income:
  Noninterest Expense:
  Income Taxes:
 Financial Condition Overview
  Loans:
 16




---



##### Table of Contents



Loan Portfolio Composition as of:September 30, 2006
    
    
    December 31, 2005
    
    
    Change(Dollars in thousands)
    
    Balance
    
    
    % of total
    
    
    Balance
    
    
    % of total
    
    
    2006 vs. 2005Commercial
    
    $
    82,192
    
    
    
    11.5
    %
    
    $
    79,341
    
    
    
    12.6
    %
    
    $
    2,851Real estate mortgages:One-to-four family residential
    
    
    52,552
    
    
    
    7.4
    %
    
    
    45,278
    
    
    
    7.2
    %
    
    
    7,274Commercial
    
    
    241,802
    
    
    
    33.9
    %
    
    
    218,260
    
    
    
    34.6
    %
    
    
    23,542Total real estate mortgages
    
    
    294,354
    
    
    
    41.3
    %
    
    
    263,538
    
    
    
    41.8
    %
    
    
    30,816Real estate construction:One-to-four family residential
    
    
    105,547
    
    
    
    14.8
    %
    
    
    79,016
    
    
    
    12.5
    %
    
    
    26,531Multi-family and commercial
    
    
    46,426
    
    
    
    6.5
    %
    
    
    34,645
    
    
    
    5.5
    %
    
    
    11,781Total real estate construction
    
    
    151,973
    
    
    
    21.3
    %
    
    
    113,661
    
    
    
    18.0
    %
    
    
    38,312Consumer:Indirect
    
    
    100,933
    
    
    
    14.2
    %
    
    
    90,290
    
    
    
    14.3
    %
    
    
    10,643Direct
    
    
    82,401
    
    
    
    11.6
    %
    
    
    82,425
    
    
    
    13.1
    %
    
    
    (24
    )Total consumer
    
    
    183,334
    
    
    
    25.9
    %
    
    
    172,715
    
    
    
    27.6
    %
    
    
    10,619Subtotal
    
    
    711,853
    
    
    
    100.0
    %
    
    
    629,255
    
    
    
    100.0
    %
    
    
    82,598Less: allowance for loan losses
    
    
    (9,985
    )
    
    
    
    
    
    
    (8,810
    )
    
    
    
    
    
    
    (1,175
    )Deferred loan fees, net
    
    
    1,785
    
    
    
    
    
    
    
    1,003
    
    
    
    
    
    
    
    782Total loans, net
    
    $
    703,653
    
    
    
    
    
    
    $
    621,448
    
    
    
    
    
    
    $
    82,205
 Allowance for Loan Losses:
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(Dollars in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Balance at beginning of period
    
    $
    9,606
    
    
    $
    8,554
    
    
    $
    8,810
    
    
    $
    7,903Charge-offs:Commercial
    
    
    (285
    )
    
    
    (145
    )
    
    
    (751
    )
    
    
    (285
    )Real estate
    
    
    
    
    
    
    (1
    )
    
    
    (86
    )
    
    
    (29
    )Consumer:Direct
    
    
    (67
    )
    
    
    (158
    )
    
    
    (261
    )
    
    
    (343
    )Indirect
    
    
    (161
    )
    
    
    (329
    )
    
    
    (562
    )
    
    
    (764
    )Total charge-offs
    
    $
    (513
    )
    
    $
    (633
    )
    
    $
    (1,660
    )
    
    $
    (1,421
    )
 17




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(Dollars in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Recoveries:Commercial
    
    
    12
    
    
    
    56
    
    
    
    313
    
    
    
    160Real estate
    
    
    3
    
    
    
    
    
    
    
    5
    
    
    
    131Consumer:Direct
    
    
    37
    
    
    
    20
    
    
    
    158
    
    
    
    72Indirect
    
    
    90
    
    
    
    46
    
    
    
    309
    
    
    
    248Total recoveries
    
    $
    142
    
    
    $
    122
    
    
    $
    785
    
    
    $
    611Net charge-offs
    
    
    (371
    )
    
    
    (511
    )
    
    
    (875
    )
    
    
    (810
    )Provision for loan losses
    
    
    750
    
    
    
    550
    
    
    
    2,050
    
    
    
    1,500Balance at end of period
    
    $
    9,985
    
    
    $
    8,593
    
    
    $
    9,985
    
    
    $
    8,593Indirect net charge-offs to average indirect loans
(1)
    
    
    0.29
    %
    
    
    1.20
    %
    
    
    0.35
    %
    
    
    0.72
    %Other net charge-offs to average other loans (1)
    
    
    0.20
    %
    
    
    0.18
    %
    
    
    0.15
    %
    
    
    0.08
    %Net charge-offs to average loans (1)
    
    
    0.21
    %
    
    
    0.33
    %
    
    
    0.17
    %
    
    
    0.18
    %
 
 (1)
    
    Excludes loans held for sale.     Allocation of the Allowance for Loan Losses as of:September 30, 2006
    
    
    December 31, 2005
    
    
    September 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
    
    $
    786
    
    
    
    7.9
    %
    
    
    11.5
    %
    
    $
    737
    
    
    
    8.4
    %
    
    
    12.6
    %
    
    $
    789
    
    
    
    9.2
    %
    
    
    13.3
    %Real estate mortgage
    
    
    3,250
    
    
    
    32.5
    %
    
    
    41.3
    %
    
    
    2,844
    
    
    
    32.3
    %
    
    
    41.8
    %
    
    
    2,856
    
    
    
    33.2
    %
    
    
    41.4
    %Real estate construction
    
    
    1,898
    
    
    
    19.0
    %
    
    
    21.3
    %
    
    
    1,378
    
    
    
    15.6
    %
    
    
    18.0
    %
    
    
    1,358
    
    
    
    15.8
    %
    
    
    17.2
    %Consumer
    
    
    2,541
    
    
    
    25.4
    %
    
    
    25.9
    %
    
    
    2,308
    
    
    
    26.2
    %
    
    
    27.6
    %
    
    
    2,405
    
    
    
    28.0
    %
    
    
    28.1
    %Unallocated
    
    
    1,510
    
    
    
    15.2
    %
    
    
    N/A
    
    
    
    1,543
    
    
    
    17.5
    %
    
    
    N/A
    
    
    
    1,185
    
    
    
    13.8
    %
    
    
    N/ATotal
    
    $
    9,985
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    $
    8,810
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    $
    8,593
    
    
    
    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. 18




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##### Table of Contents



Nonperforming Assets:
 Nonperforming Assets as of:September 30,
    
    
    December 31,(Dollars in thousands)

    
    2006
    
    
    2005Nonaccrual loans
    
    $
    3,758
    
    
    $
    2,159Restructured loans
    
    
    
    
    
    
    Total nonperforming loans
    
    
    3,758
    
    
    
    2,159Other real estate owned
    
    
    363
    
    
    
    Total nonperforming assets
    
    $
    4,121
    
    
    $
    2,159Total impaired loans
    
    $
    4,121
    
    
    $
    2,159Accruing
loans past due 3 90 days
    
    
    
    
    
    
    Potential problem loans
    
    
    
    
    
    
    Allowance for loan losses
    
    $
    9,985
    
    
    $
    8,810Nonperforming loans to loans
    
    
    0.53
    %
    
    
    0.34
    %Allowance for loan losses to nonperforming loans
    
    
    265.70
    %
    
    
    408.06
    %Allowance for loan losses to nonperforming assets
    
    
    242.30
    %
    
    
    408.06
    %Nonperforming assets to total assets
    
    
    0.52
    %
    
    
    0.30
    %
 Deposits:
 Deposit Composition as of:September 30, 2006
    
    
    December 31, 2005
    
    
    Change(Dollars in thousands)
    
    Balance
    
    
    % of total
    
    
    Balance
    
    
    % of total
    
    
    2006 vs. 2005Noninterest-bearing demand
    
    $
    97,277
    
    
    
    13.9
    %
    
    $
    105,365
    
    
    
    16.5
    %
    
    $
    (8,088
    )NOW accounts
    
    
    157,820
    
    
    
    22.5
    %
    
    
    143,042
    
    
    
    22.4
    %
    
    
    14,778Money market
    
    
    95,531
    
    
    
    13.6
    %
    
    
    84,537
    
    
    
    13.3
    %
    
    
    10,994Savings
    
    
    53,700
    
    
    
    7.7
    %
    
    
    59,635
    
    
    
    9.4
    %
    
    
    (5,935
    )Time deposits
    
    
    296,392
    
    
    
    42.3
    %
    
    
    244,910
    
    
    
    38.4
    %
    
    
    51,482Total deposits
    
    $
    700,720
    
    
    
    100.0
    %
    
    $
    637,489
    
    
    
    100.0
    %
    
    $
    63,231
 Other Borrowings:
 19




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##### Table of Contents



Capital
 Shareholders Equity:
 Regulatory Capital Requirements:
  Regulatory Requirements
    
    Actual RatiosAdequately-
    
    Well-
    
    September 30,
    
    December 31,capitalized
    
    capitalized
    
    2006
    
    2005Total risk-based capital ratioCompany (consolidated)
    
    
    8
    %
    
    
    N/A
    
    
    
    11.28
    %
    
    
    11.52
    %Whidbey Island Bank
    
    
    8
    %
    
    
    10%
    
    
    
    11.02
    %
    
    
    11.21
    %Tier 1 risk-based capital ratioCompany (consolidated)
    
    
    4
    %
    
    
    N/A
    
    
    
    10.03
    %
    
    
    10.28
    %Whidbey Island Bank
    
    
    4
    %
    
    
    6%
    
    
    
    9.77
    %
    
    
    9.96
    %Leverage ratioCompany (consolidated)
    
    
    4
    %
    
    
    N/A
    
    
    
    10.26
    %
    
    
    10.26
    %Whidbey Island Bank
    
    
    4
    %
    
    
    5%
    
    
    
    10.00
    %
    
    
    9.93
    %
  Liquidity and Cash Flows
 Liquidity:
  Consolidated Cash Flows: Condensed Consolidated Statements of Cash Flows
 20




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##### Table of Contents



Capital Resources:
 Off-Balance Sheet Items:
 Capital Expenditures and Commitments:
 21




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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
  22




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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. 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 5. Exhibits
 Exhibits31.1
    
    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
 23




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##### Table of Contents



SIGNATURES
  WASHINGTON BANKING COMPANYDate: November 8, 2006
    By
    /s/ Michal D. CannMichal D. CannPresident and
Chief Executive OfficerDate: November 8, 2006
    By
    /s/ Richard A. ShieldsRichard A. ShieldsExecutive Vice President and
Chief Financial Officer 24