# UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

# FORM 10-Q

(Mark One)[X]       Quarterly
report pursuant to Section 13 or l5(d) of the Securities Exchange Act           of 1934
For the quarterly period ended September 30, 2003

[   ]       Transition report
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the transition
period from ________ to ________

Commission File Number
000-24503

WASHINGTON BANKING
COMPANY (Exact name of
registrant as specified in its charter)

| | Washington                                                     |  | 91-1725825                              | 
| | -------------------------------------------------------------- |  | --------------------------------------- | 
| | (State or other jurisdiction of
incorporation or organization) |  | (I.R.S. Employer
Identification Number) | 

# 

450 SW Bayshore DriveOak Harbor, Washington
        98277(Address of principal
executive offices) (Zip Code)

# 

(360) 679-3121(Issuers
telephone number, including area code)

(Former name, former
address and former fiscal year, if changed since last report)

Indicate by check mark whether the
issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes  [X]    No  [   ]

Indicate  by check mark if the
 registrant  is an  accelerated  filer  within the  meaning of Rule 12b-2  under the
Securities Exchange Act of 1934, as amended.   Yes  [   ]    No  [X]

The number of shares of
the issuers Common Stock outstanding at November 10, 2003 was 4,656,378.

---

|Table of Contents
PART I                                                                                                 | Page | 
|------------------------------------------------------------------------------------------------------------------------ | ---- | 
|Item 1.        Financial Statements                                                                                      |      | 
|Condensed Consolidated Statements of Financial Condition -                                                              
|September 30, 2003 and December 31, 2002                                                                                 | 1   
|                                                                                                                        
|Condensed Consolidated Statements of Income -                                                                           
|Three and Nine Months Ended September 30, 2003 and 2002                                                                  | 2   
|                                                                                                                        
|Condensed Consolidated Statements of Shareholders' Equity and                                                           
|Comprehensive Income -                                                                                                  
|Nine Months Ended September 30, 2003 and 2002                                                                            | 3   
|                                                                                                                        
|Condensed Consolidated Statements of Cash Flows -                                                                       
|Nine Months Ended September 30, 2003 and 2002                                                                            | 4   
|                                                                                                                        
|Notes to Condensed Consolidated Financial Statements                                                                     | 5   
|                                                                                                                        
|Item 2.      Management's Discussion and Analysis of Financial Condition and Results of                       Operations | 11   | 
|Item 3.       Quantitative and Qualitative Disclosures about Market Risk                                                 | 22   | 
|Item 4.       Controls and Procedures                                                                                    | 22   | 

|PART II                                        |    | 
|---------------------------------------------- | -- | 
|Item 6.       Exhibits and Reports on Form 8-K | 23 | 
|Signatures                                     | 24 | 

---

# PART I

# Item 1. Financial
Statements

WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed Consolidated
Statements of Financial ConditionSeptember 30, 2003 and December
31, 2002
(Dollars in thousands,
except per share data)

|Assets                                                     | September 30,
2003 | December 31,
2002
|---------------------------------------------------------- | ------------------ | -----------------
|
|Cash and due from banks                                    |                    |                  
|($3,673 and $1,316, respectively, are restricted)          |                    |                  
|Interest-earning deposits                                  |                    |                  
|Federal funds sold                                         |                    |                  
|                                                           |                    |                  
|Total cash, restricted cash and cash equivalents           |                    |                  
|                                                           |                    |                  
|                                                           |                    |                  
|Investment securities available for sale                   |                    |                  
|Investment securities held to maturity                     |                    |                  
|                                                           |                    |                  
|Total investment securities                                |                    |                  
|                                                           |                    |                  
|Federal Home Loan Bank stock                               |                    |                  
|                                                          
|Loans held for sale                                        |                    |                  
|Loans receivable                                           |                    |                  
|Allowance for loan losses                                  |                    |                  
|                                                           |                    |                  
|Total loans, net                                           |                    |                  
|                                                           |                    |                  
|                                                           |                    |                  
|Premises and equipment, net                                |                    |                  
|Other real estate owned                                    |                    |                  
|Deferred tax assets                                        |                    |                  
|Other assets                                               |                    |                  
|                                                           |                    |                  
|Total assets                                               |                    |                  
|                                                           |                    |                  
|                                                           |                    |                  
|Liabilities and Shareholders Equity                       |                    |                  
|Liabilities:                                               |                    |                  
|Deposits                                                   |                    |                  
|Noninterest-bearing                                        |                    |                  
|Interest-bearing                                           |                    |                  
|                                                           |                    |                  
|Total deposits                                             |                    |                  
|                                                           |                    |                  
|                                                           |                    |                  
|Other borrowed funds                                       |                    |                  
|Trust preferred securities                                 |                    |                  
|Other liabilities                                          |                    |                  
|                                                           |                    |                  
|Total liabilities                                          |                    |                  
|                                                           |                    |                  
|Commitments and contingencies                              |                    |                  
|                                                          
|Shareholders equity:                                      |                    |                  
|Preferred stock, no par value.  Authorized 20,000 shares:  |                    |                  
|no shares issued or outstanding                            |                    |                  
|Common stock, no par value.  Authorized 10,000,000 shares: |                    |                  
|issued and outstanding 4,656,378 and 4,541,123 shares      |                    |                  
|at September 30, 2003 and December 31, 2002, respectively  |                    |                  
|Retained earnings                                          |                    |                  
|Accumulated other comprehensive income (loss), net         |                    |                  
|                                                           |                    |                  
|Total shareholders equity                                 |                    |                  
|                                                           |                    |                  
|Total liabilities and shareholders equity                 |                    |                  
|                                                           |                    |                  
|                                                           |                    |                  

See accompanying notes to condensed
consolidated financial statements.

1

---

# 

# 

WASHINGTON BANKING
COMPANYAND SUBSIDIARIES Condensed Consolidated Statements of IncomeThree and Nine
months ended September 30, 2003 and 2002 (unaudited)(Dollars
in thousands, except per share data)

|                                              | Three Months Ended
September 30 | Nine Months Ended
September 30
|--------------------------------------------- | ------------------------------- | ------------------------------
|
|Interest income:                              |                                 |                               
|Interest and fees on loans                    |                                 |                               
|Interest on taxable investment securities     |                                 |                               
|Interest on tax-exempt investment securities  |                                 |                               
|Other                                         |                                 |                               
|                                              |                                 |                               
|Total interest income                         |                                 |                               
|Interest expense:                             |                                 |                               
|Interest on deposits                          |                                 |                               
|Interest on other borrowings                  |                                 |                               
|Interest on trust preferred securities        |                                 |                               
|                                              |                                 |                               
|Total interest expense                        |                                 |                               
|                                              |                                 |                               
|Net interest income                           |                                 |                               
|Provision for loan losses                     |                                 |                               
|                                              |                                 |                               
|Net interest income after                     |                                 |                               
|provision for loan losses                     |                                 |                               
|Noninterest income:                           |                                 |                               
|Service charges and fees                      |                                 |                               
|Gain on sale of loans                         |                                 |                               
|Secondary market fees                         |                                 |                               
|Gain on sale of assets                        |                                 |                               
|Other                                         |                                 |                               
|                                              |                                 |                               
|Total noninterest income                      |                                 |                               
|Noninterest expense:                          |                                 |                               
|Salaries and benefits                         |                                 |                               
|Occupancy                                     |                                 |                               
|Office supplies and printing                  |                                 |                               
|Data processing                               |                                 |                               
|Consulting and professional fees              |                                 |                               
|Other                                         |                                 |                               
|                                              |                                 |                               
|Total noninterest expense                     |                                 |                               
|                                              |                                 |                               
|Income before income taxes                    |                                 |                               
|Provision for income taxes                    |                                 |                               
|                                              |                                 |                               
|Net income                                    |                                 |                               
|                                              |                                 |                               
|Net income per share, basic                   |                                 |                               
|                                              |                                 |                               
|Net income per share, diluted                 |                                 |                               
|                                              |                                 |                               
|Average number of shares outstanding, basic   |                                 |                               
|Average number of shares outstanding, diluted |                                 |                               

See accompanying notes to condensed
consolidated financial statements.

2

---



WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed Consolidated Statements of Shareholders Equity
and Comprehensive IncomeNine months ended September 30, 2003 and 2002 (unaudited) (Dollars
and shares in thousands, except per share data)

|                                     | Common stock | Stock
dividends
to be | Retained | Accumulated
other
comprehensive
income | Total
shareholders
|------------------------------------ | ------------ | --------------------- | -------- | -------------------------------------- | -------------------
|
|Balances at December 31, 2001        |              |                       | $        | 4,055                                  |                    
|Comprehensive income:                |              |                      
|Net income                           |              |                       |          |                                       |                    
|Net change in unrealized gain (loss) |              |                      
|on securities available for sale,    |              |                      
|net of tax of $13                    |              |                       |          |                                       |                    
|                                     |              |                       |          |                                        |                    
|Total comprehensive income (1)       |              |                       |          |                                        |                    
|Cash dividend, $0.195 per share      |              |                       |          |                                       |                    
|10% Stock dividend                   |              |                       |          |                                       |                    
|Stock options exercised              |              |                       |          | 23                                     |                    
|                                     |              |                       |          |                                        |                    
|Balances at September 30, 2002       |              |                       | $        | 4,078                                  |                    
|                                     |              |                       |          |                                        |                    
|                                     |              |                       |          |                                        |                    
|                                    
|Balances at December 31, 2002        |              |                       | $        | 4,541                                  |                    
|Comprehensive income:                |              |                      
|Net income                           |              |                       |          |                                       |                    
|Net change in unrealized gain (loss) |              |                      
|on securities available for sale,    |              |                      
|net of tax of ($43)                  |              |                       |          |                                       |                    
|                                     |              |                       |          |                                        |                    
|Total comprehensive income (1)       |              |                       |          |                                        |                    
|Cash dividend, $0.21 per share       |              |                       |          |                                       |                    
|Stock option compensation            |              |                       |          |                                       |                    
|Stock options exercised              |              |                       |          | 115                                    |                    
|                                     |              |                       |          |                                        |                    
|Balances at September 30, 2003       |              |                       | $        | 4,656                                  |                    
|                                     |              |                       |          |                                        |                    

(1)Comprehensive income for the
three months ended September 30, 2003 and 2002 was $1,671 and $1,322, respectively

See accompanying notes to condensed
consolidated financial statements.

3

---

WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed
Consolidated Statements of Cash Flows Nine months ended September 30, 2003 and 2002
(unaudited)(Dollars in thousands)

|                                                             | Nine Months Ended September 30
|------------------------------------------------------------ | ------------------------------
|
|Cash flows from operating activities:                        |                               
|Net income                                                   |                               
|Adjustments to reconcile net income to net cash              |                               
|provided by operating activities:                            |                               
|Federal Home Loan Bank stock dividends                       |                               
|Deferred income tax benefit                                  |                               
|Amortization (accretion) of investment                       |                               
|premiums (discounts), net                                    |                               
|Provision for loan losses                                    |                               
|Net increase in loans held for sale                          |                               
|Depreciation of premises and equipment                       |                               
|Net gain on sale of premises and equipment and real estate   |                               
|Net increase in other assets                                 |                               
|Stock option compensation                                    |                               
|Net (decrease) increase in other liabilities                 |                               
|                                                             |                               
|Net cash provided by operating activities                    |                               
|                                                             |                               
|Cash flows from investing activities:                        |                               
|Purchases of investment securities available for sale        |                               
|Maturities/calls of investment securities available for sale |                               
|Principal payments on mortgage-backed securities             |                               
|Purchases of investment securities held to maturity          |                               
|Maturities/calls of investment securities held to maturity   |                               
|Net increase in loans                                        |                               
|Purchases of premises and equipment                          |                               
|Proceeds from the sale of premises and equipment             |                               
|Proceeds from the sale of other real estate owned            |                               
|                                                             |                               
|Net cash used in investing activities                        |                               
|                                                             |                               
|Cash flows from financing activities:                        |                               
|Net increase in deposits                                     |                               
|Net decrease in other borrowed funds                         |                               
|Proceeds from trust preferred securities                     |                               
|Dividends paid on common stock                               |                               
|Proceeds from stock options exercised                        |                               
|                                                             |                               
|Net cash provided by financing activities                    |                               
|                                                             |                               
|Net (decrease) increase in cash and cash equivalents         |                               
|Cash and cash equivalents at beginning of period             |                               
|                                                             |                               
|Cash and cash equivalents at end of period                   |                               
|                                                             |                               
|Supplemental information:                                    |                               
|Loans foreclosed and transferred to other real estate owned  |                               
|Loans made on bank-owned property sold                       |                               
|Cash paid for interest                                       |                               
|Cash paid for taxes                                          |                               

See accompanying notes to condensed
consolidated financial statements.

4

---

NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSNine months ended September 30, 2003 and 2002 (unaudited)
(Dollars in thousands, except per share data)

# (1) Description of
Business and Summary of Significant Accounting Policies

(a) Description
of Business

Washington Banking Company
(WBCO) is a registered bank holding company formed on April 30, 1996. At
September 30, 2003, WBCO had three wholly-owned subsidiaries  Whidbey Island Bank
(WIB or the Bank), the Companys principal subsidiary;
Washington Banking Capital Trust I (the Trust); and Washington Funding Group,
Inc. (WFG). The business of the Bank, which is focused in the northern area of
Western Washington, consists primarily of attracting deposits from the general public and
originating loans. During the 1990s, the region experienced strong population growth and
economic diversification. The regions economy has evolved from one that was once
heavily dependent upon forestry, fishing and farming to an economy with a much more
diverse blend of industries including retail trade, services, manufacturing, tourism and a
large military base presence. Although the Bank has a diversified loan portfolio, a
substantial portion of its borrowers ability to repay their loans is dependent upon
the economic conditions affecting this area.

The Trust, the second subsidiary of
WBCO, was formed in June 2002 for the exclusive purpose of issuing trust preferred
securities and common securities and using the $15,000 in proceeds from the issuance to
acquire junior subordinated debentures issued by WBCO.

WFG, the third subsidiary of WBCO,
was formed in January 2003 for the purpose of expanding the Banks current wholesale
mortgage real estate lending platform. In addition to an existing office in Burlington,
Washington, WFG opened offices in Bend, Coos Bay and Clackamas (Portland area), Oregon
during the first quarter of 2003. WFG underwrites loans originated by mortgage brokers
primarily in the Washington, Oregon and Idaho markets, and then sells a large majority of
them to secondary market investors, including Freddie Mac and Fannie Mae.

(b)
Basis of Presentation

The accompanying interim condensed
consolidated financial statements include the accounts of WBCO and its subsidiaries
(together, the Company). The accompanying interim condensed consolidated
financial statements have been prepared, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Accordingly, they do not include
all of the information and footnotes required by generally accepted accounting principles
for complete financial statements. These condensed consolidated financial statements
should be read in conjunction with the December 31, 2002 audited consolidated financial
statements and notes thereto included in the Companys Annual Report on Form 10-K
filed with the Securities and Exchange Commission on March 20, 2003. In managements
opinion, all adjustments (consisting of normal recurring adjustments) considered necessary
for a fair presentation have been included. Operating results for the nine months ended
September 30, 2003 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2003. In preparing the consolidated financial statements,
estimates and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses are required. Actual results could differ from those estimates.

(c)
Segments

Pursuant to Statement of Financial
Accounting Standards (SFAS) No. 131, Disclosure about Segments of an
Enterprise and Related Information, the Company has evaluated the requirements of this
standard and have identified two reportable segments: Whidbey Island Bank and Washington
Funding Group, Inc., both wholly-owned subsidiaries of Washington Banking Company.
Disclosures required by this standard are included in Note 6.

(d)
Reclassifications

Certain amounts in prior years
financial statements may have been reclassified to conform to the 2003 presentation.

5

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NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSNine months ended September 30, 2003 and 2002 (unaudited)
(Dollars in thousands, except per share data)

(e)
Recent Financial Accounting Pronouncements

In November 2002 the Financial
Accounting Standards Board (FASB) issued FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, (FIN
45). FIN 45 requires that a liability be recognized at the inception of certain
guarantees for the fair value of the obligation, including the ongoing obligation to stand
ready to perform over the term of the guarantee. Guarantees, as defined in FIN 45, include
contracts that contingently require the Company to make payments to a guaranteed party
based on changes in an underlying that is related to an asset, liability or equity
security of the guaranteed party, performance guarantees, indemnification agreements or
indirect guarantees of indebtedness of others. This new accounting is effective for
certain guarantees issued or modified after December 31, 2002. In addition, FIN 45
requires certain additional disclosures, for interim and annual periods, which are located
in Note 5. The Company has adopted the provisions of FIN 45 and has properly disclosed
their affect in the current period financial statements.

In January 2003, the FASB issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN
46). FIN 46 explains how to identify variable interest entities and how an
enterprise assesses its interest in a variable interest entity to decide whether to
consolidate that entity. FIN 46 requires existing unconsolidated variable interest
entities to be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. Variable interest entities that
effectively disperse risks will not be consolidated unless a single party holds an
interest or combination of interest that effectively recombines risks that were previously
dispersed. FIN 46 applies immediately to variable interest entities created after January
31, 2003, and to variable interest entities in which an enterprise obtains an interest
after that date. It applies in the first fiscal year or interim period beginning after
June 15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The adoption of FIN 46 did not have a
material effect on the Companys financial position or results of operations.

In April 2003, the FASB issued SFAS
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. This statement amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities under FASB
Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
This statement is effective for contracts entered into or modified after and for hedging
relationships designated after June 30, 2003. The Company does not expect the adoption of
SFAS No. 149 to have a material impact on its financial statements.

In May 2003, the FASB issued SFAS No.
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. This statement establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. This statement is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 had no material impact on the Companys financial
statements.

6

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NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSNine months ended September 30, 2003 and 2002 (unaudited)
(Dollars in thousands, except per share data)

# (2) Earnings Per Share

The following table sets forth the
reconciliation of the numerators and denominators of the basic and diluted earnings per
share (EPS) computations:

|                                             | Three Months Ended September 30, 2003
|-------------------------------------------- | -------------------------------------
|
|Basic EPS                                    |                                      
|Income available to common shareholders      |                                      
|Effect of dilutive securities: stock options |                                      
|                                             |                                      
|Diluted EPS                                  |                                      
|                                             |                                      



|                                             | Three Months Ended September 30, 2002
|-------------------------------------------- | -------------------------------------
|
|Basic EPS                                    |                                      
|Income available to common shareholders      |                                      
|Effect of dilutive securities: stock options |                                      
|                                             |                                      
|Diluted EPS                                  |                                      
|                                             |                                      



|                                             | Nine Months Ended September 30, 2003
|-------------------------------------------- | ------------------------------------
|
|Basic EPS                                    |                                     
|Income available to common shareholders      |                                     
|Effect of dilutive securities: stock options |                                     
|                                             |                                     
|Diluted EPS                                  |                                     
|                                             |                                     



|                                             | Nine Months Ended September 30, 2002
|-------------------------------------------- | ------------------------------------
|
|Basic EPS                                    |                                     
|Income available to common shareholders      |                                     
|Effect of dilutive securities: stock options |                                     
|                                             |                                     
|Diluted EPS                                  |                                     
|                                             |                                     



On October 24, 2002, the Company
issued a 10% stock dividend to shareholders of record as of October 8, 2002. All periods
presented have been restated to reflect the stock dividend. At September 30, 2003 and
2002, there were options to purchase 364,789 and 493,611 shares of common stock
outstanding, respectively. There were no shares of common stock that were antidilutive,
and therefore all were included in the computation of diluted net income per share.

7

---

NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSNine months ended September 30, 2003 and 2002 (unaudited)
(Dollars in thousands, except per share data)

# (3) Stock-Based
Compensation

The Company recognizes the financial
effects of stock-based employee compensation based on the intrinsic value method of
accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25) and FASB Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation (FIN
44). Generally, stock options are issued at a price equal to the fair value of the
Companys stock as of the grant date. Under APB 25, options issued in this manner do
not result in the recognition of employee compensation in the Companys financial
statements. The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value provisions of FASB SFAS 123, Accounting
for Stock-Based Compensation.

The following table sets forth the
reconciliation of pro forma net income and pro forma earnings per share:

|                              | Three Months Ended
September 30 | Nine Months Ended
September 30
|----------------------------- | ------------------------------- | ------------------------------
|
|Net income, as reported       |                                 |                               
|Stock compensation recognized |                                 |                               
|Additional compensation for   |                                 |                               
|fair value of stock options   |                                 |                               
|                              |                                 |                               
|Pro forma net income          |                                 |                               
|                              |                                 |                               
|Basic earnings per share:     |                                 |                               
|As reported                   |                                 |                               
|Pro forma                     |                                 |                               
|Diluted earnings per share:   |                                 |                               
|As reported                   |                                 |                               
|Pro forma                     |                                 |                               

# (4) Subsequent Event

On October 16, 2003, the Board of
Directors declared a cash dividend of $0.07 per share to shareholders of record as of
November 10, 2003 and payable on November 26, 2003.

# (5) Commitments

Standby letters of credit and
financial guarantees are conditional commitments issued by the Company to guarantee the
performance of a customer to a third party or payment by a customer to a third party.
Those guarantees are primarily issued in international trade or to support public and
private borrowing arrangements, including commercial paper, bond financing and similar
transactions. Except for certain long-term guarantees, the majority of guarantees expire
in one year. The credit risk involved in issuing letters of credit is essentially the same
as that involved in extending loan facilities to customers. Collateral supporting those
commitments, for which collateral is deemed necessary, generally amounts to one hundred
percent of the commitment amount at September 30, 2003. The Company routinely charges a
fee for these credit facilities. Such fees are amortized into income over the life of the
agreement, and unamortized amounts are not significant as of September 30, 2003.

As of September 30, 2003, the
commitments under these agreements were as follows:

| | Standby letters
of credit and financial guarantees   $536
| | ---------------------------------------------------------

8

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NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSNine months ended September 30, 2003 and 2002 (unaudited)
(Dollars in thousands, except per share data)

# (6) Segments

The Company is organized based on the
products and services that it offers. Under its current organizational structure, the
Company is comprised of four individual companies: Washington Banking Company (the holding
company) and three wholly-owned subsidiaries  Whidbey Island Bank; Washington
Funding Group, Inc.; and Washington Banking Capital Trust I. The Company has identified
two reportable segments: Whidbey Island Bank and Washington Funding Group. Washington
Banking Company and Washington Banking Capital Trust I have been combined and are reported
as Other. The Bank offers a full range of commercial banking services, while
WFG generates loan fee income from the origination and sale of residential mortgage loans.

The principal activities conducted by
the Bank are the origination of commercial business loans, commercial real estate loans,
singly-family residential mortgages, multi-family residential mortgages, consumer loans
and the associated loan servicing activities. The Bank also offers private banking
services and deposit products and generates income from investment activities. The Bank
derives a majority of its revenue from interest.

WFG was formed in January 2003 and
began operations in April 2003. It provides a loan funding source for mortgage brokers. It
does not service any loans for secondary market investors. Although WFG sells the loans to
several secondary market investors, two investors  Principal Residential Mortgage
and Freddie Mac  purchase a significant portion of these loans.

The Trust was formed for the
exclusive purpose of issuing trust preferred securities and common securities and using
the proceeds from the issuance to acquire junior subordinated debentures issued by WBCO.

The Bank and WFG are stand-alone
business entities and have their own financial statements. Certain intercompany related
income and expenses are allocated to each company. The accounting policies for each
segment are described in the summary of Significant Accounting Policies.

The following table sets forth the
financial information for the Companys segments:

|                             | Three Months Ended September 30, 2003
|---------------------------- | -------------------------------------
|
|Net interest income after    |                                      
|provision for loan losses    |                                      
|Other income                 |                                      
|Other expenses               |                                      
|                             |                                      
|Income (loss) before tax     |                                      
|                             |                                      
|Income tax (expense) benefit |                                      
|                             |                                      
|Net income (loss)            |                                      
|                             |                                      
|Total assets                 |                                      
|                             |                                      



9

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NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSNine months ended September 30, 2003 and 2002 (unaudited)
(Dollars in thousands, except per share data)

|                             | Three Months Ended September 30, 2002
|---------------------------- | -------------------------------------
|
|Net interest income after   
|provision for loan losses    |                                      
|Other income                 |                                      
|Other expenses               |                                      
|                             |                                      
|Income (loss) before tax     |                                      
|Income tax (expense) benefit |                                      
|                             |                                      
|Net income (loss)            |                                      
|                             |                                      
|Total assets                 |                                      
|                             |                                      

# 

|                             | Nine Months Ended September 30, 2003
|---------------------------- | ------------------------------------
|
|Net interest income after    |                                     
|provision for loan losses    |                                     
|Other income                 |                                     
|Other expenses               |                                     
|                             |                                     
|Income (loss) before tax     |                                     
|Income tax (expense) benefit |                                     
|                             |                                     
|Net income (loss)            |                                     
|                             |                                     
|Total assets                 |                                     
|                             |                                     

# 

|                             | Nine Months Ended September 30, 2002
|---------------------------- | ------------------------------------
|
|Net interest income after    |                                     
|provision for loan losses    |                                     
|Other income                 |                                     
|Other expenses               |                                     
|                             |                                     
|Income (loss) before tax     |                                     
|Income tax (expense) benefit |                                     
|                             |                                     
|Net income (loss)            |                                     
|                             |                                     
|Total assets                 |                                     
|                             |                                     

# 

10

---

# Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

---

Note Regarding Forward-Looking
Statements: This Form 10-Q includes forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange
Act). These forward-looking statements describe Washington Banking Companys
(the Company) managements expectations regarding future events and
developments such as future operating results, growth in loans and deposits, continued
success of the Companys business plan and the strength of the local economy. The
words will, believe, expect, should,
anticipate and words of similar construction are intended in part to help
identify forward-looking statements. Future events are difficult to predict, and the
expectations described below are necessarily subject to risk and uncertainty that may
cause actual results to differ materially and adversely. In addition to discussions about
risks and uncertainties set forth from time to time in the Companys filings with the
Securities and Exchange Commission (the SEC), factors that may cause actual
results to differ materially from those contemplated in such forward-looking statements
include, among others, the following possibilities: (1) local and national general and
economic conditions, including the possible impact of international conflict or further
terrorist events, are less favorable than expected or have a more direct and pronounced
effect than expected on the Company and adversely affect the Companys ability to
continue its internal growth at historical rates and maintain the quality of its earning
assets; (2) changes in interest rates reduce interest margins more than expected or
negatively affect liquidity; (3) projected business increases following strategic
expansion or opening or acquiring new branches are lower than expected; (4) greater than
expected costs or difficulties related to the integration of acquisitions; (5) increased
competitive pressure among financial institutions; (6) legislation or regulatory
requirements or changes that adversely affect the banking and financial services sector;
and (7) the Companys ability to realize the efficiencies it expects to derive from
its investment in personnel and infrastructure. However, you should be aware that these
factors are not an exhaustive list, and you should not assume that these are the only
factors that may cause actual results to differ from expectations. In addition, you should
note that we do not intend to update any of the forward-looking statements or the
uncertainties that may adversely impact those statements.

---

The following discussion and analysis
should be read in conjunction with the financial statements and notes thereto presented
elsewhere in this report.

# Overview

Washington Banking Company
(WBCO or the Company) is a registered bank holding company with
three wholly-owned subsidiaries: Whidbey Island Bank (the Bank), Washington
Banking Capital Trust I (the Trust) and Washington Funding Group, Inc.
(WFG). The Companys principal subsidiary, the Bank, is a Washington
state-chartered bank that conducts a full-service community commercial banking business.
Its business includes commercial, real estate and construction loan portfolios, and is
active in the consumer banking field, providing personal and consumer-oriented loan
programs. The Bank also provides a wide range of deposit services, insured by the Federal
Deposit Insurance Corporation (the FDIC), for individuals and businesses
including checking and savings accounts as well as money market accounts, certificates of
deposit, individual retirement accounts, safe deposit boxes and other consumer and
business related financial services. The Bank also offers nondeposit managed investment
portfolios, which are not FDIC insured, through the investment advisory company Elliott
Cove Capital Management LLC. Several Whidbey Island Bank employees have been registered in
Washington State as investment advisor representatives. These employees work with
individuals, companies and institutions to help them determine their risk preferences and
select a portfolio. Since 1993 until recently, non-FDIC insured investment products were
offered through the Banks wholly-owned subsidiary, WIB Financial Services, Inc.

The Banks primary market area
is located in northwestern Washington State between Seattle and the Canadian border. Its
geographical expansion to date has been concentrated along the I-5 corridor from Snohomish
to Whatcom Counties, however, additional areas will be considered if they meet the
Companys criteria.

The Trust was formed in June 2002 for
the exclusive purpose of issuing trust preferred securities to acquire junior subordinated
debentures issued by the Company. Those debentures are the sole assets of the Trust and
payments on the debt will be the sole revenues of the Trust. The Company has fully and
unconditionally guaranteed all obligations of the Trust.

11

---

WFG, a wholesale mortgage real estate
lending company, is a Washington State corporation formed in January 2003. The primary
purpose of this subsidiary is to provide a loan funding source for brokers of mortgage
loans. The loans are originated and sold in the name of the Bank. In addition to an
existing office in Burlington, Washington, WFG set up offices in Bend, Coos Bay and
Clackamas (Portland area), Oregon during the first quarter of 2003. Washington Funding
Group underwrites loans originated by mortgage brokers primarily in the Washington, Oregon
and Idaho markets, and then sells most of them to secondary market sources.

Headquartered in Oak Harbor, the
Companys market area has been expanded through the activities of WFG. Previously,
the market area was that of the Bank, limited to northwestern Washington. WFGs
process of brokering mortgages has extended the Companys market area beyond
Washington State and includes Oregon and Idaho. Washington, Oregon and Idaho all
experienced population growth of above 20% during the 1990s, compared to a national
average of 13.1%. The market areas encompass distinct economies, and none are particularly
dependent upon a single industrial or occupational source. In Washington, the economies
within the market areas have evolved from being heavily dependent upon forestry, fishing
and farming to economies with much more diverse blends of industries including retail
trade, services, manufacturing, tourism and a large military presence. Although
unemployment levels in the Pacific Northwest over the past couple of years have been
higher than national averages, the business impact to the Company has not been atypical.
Timing of a total economic recovery for the Pacific Northwest region remains uncertain.

The Companys strategy is one of
value-added growth. Management believes that qualitative and sustainable growth of the
Company, coupled with maintaining profitability, is currently the most appropriate path to
providing good value for its shareholders. To date, the Companys growth has been
achieved organically and it attributes its reputation for focusing on customer service and
satisfaction as one of the cornerstones to the Companys success. Acquisition of
banks or branches may also be used as a means of expansion if appropriate opportunities
are presented. Management recognizes that growth requires expenditures of substantial sums
to purchase or lease real property and equipment and to hire experienced personnel, and
that earnings may be negatively affected. The Companys primary long-term objectives
are to improve profitability and operating efficiencies, to increase market penetration in
areas currently served and to continue an expansion strategy in appropriate market areas.

# Financial Condition

Total Assets.Total assets
grew to $587.2 million at September 30, 2003 from $535.4 million at December 31, 2002, an
increase of 9.7%. This increase resulted mainly from growth in the loan and investment
portfolios, which was funded by deposit growth and proceeds from trust preferred
securities.

Total Loans.Total loans were
$491.1 million at September 30, 2003, an increase of 12.4% from $436.7 million at December
31, 2002. The Company increased its allowance for loan losses to $6.3 million at September
30, 2003 representing 1.29% of total loans, from $5.5 million or 1.26% of total loans at
December 31, 2002. The allowance was increased to keep pace with loan growth and
prospective losses inherent in the loan portfolio, while remaining conservative and
maintaining adequate coverage.

Total Investment Securities.Total investment securities were $31.1 million and $24.2 million at September 30, 2003
and December 31, 2002, respectively, an increase of 28.8% due to the purchase of
available-for-sale investment securities. The continued availability of excess funds, low
interest rate environment and slower loan demand prompted management to purchase
short-term investments, building the portfolio with laddered (staggered
maturities) securities that reflect the Companys investment policy guidelines and to
help achieve the objectives of the business plan of the Company.

Premises and Equipment.Premises and equipment, net of depreciation, were $18.4 million and $16.8 million at
September 30, 2003 and December 31, 2002, respectively. The increase reflects the
construction of a new building for the Camano office, three leased offices for WFG, all
with related furniture and fixtures, as well as remodeling improvements at the Burlington
Financial Center and the Clinton branch. The increase in premises and equipment is an
indication of future expectations as the Company continues its strategy of value-added
growth.

12

---

Deposits.Deposits grew 10.3% to $510.9 million at September 30, 2003 from $463.0
          million at December 31, 2002. Managements philosophy is to develop
          long-term customer relationships. Management believes that the best way to
          establish customer loyalty is by placing an emphasis on meeting customers
          financial needs and providing exceptional service. Management attributes the
          Companys successful deposit growth to its continuing deposit promotions,
          cross-sales efforts, strategic planning and other means. In addition, many
          customers are seeking the security of FDIC-insured deposit vehicles given the
          recent volatility of the investment market.

At September 30, 2003, average
noninterest-bearing deposits increased 45.3% from September 30, 2002, while average
interest-bearing deposits increased 12.7% for the same period. In addition to this
increase, the Company experienced a shift in the deposit mix. Average interest demand and
money market deposits represented 46.58% of total average interest-bearing deposits at
September 30, 2003 compared to 41.07% a year ago.

Average savings deposits and average
CDs represented 8.86% and 44.56%, respectively, of total average interest-bearing deposits
at September 30, 2003 compared to 7.84% and 51.09%, respectively, a year ago. All
non-maturing deposit product averages increased during 2003 as management focused on
establishing customer relationships and attracting deposits.

Shareholders Equity.The
Companys shareholders equity increased 9.3% to $43.1 million at September 30,
2003 from $39.4 million at December 31, 2002. The increase reflects earnings, proceeds
from stock options exercised and stock option compensation offset by the payment of cash
dividends and a decrease in unrealized gain on available-for-sale securities, net of tax,
during the first nine months of 2003.

13

---

# Consolidated Average
Balance Sheet and Analysis of Net Interest Income and Expense

The following table sets forth at the Companys
consolidated average balance sheet and analysis of net interest income and expense:

|                                      | Three months ended September 30, 2003 | Three months ended September 30, 2002
|------------------------------------- | ------------------------------------- | -------------------------------------
|
|Assets                                |                                       |                                      
|Loans (2)                             |                                       |                                      
|Federal funds sold                    |                                       |                                      
|Interest-earning cash                 |                                       |                                      
|Investments:                          |                                       |                                      
|Taxable                               |                                       |                                      
|Non-taxable (3)                       |                                       |                                      
|                                      |                                       |                                      
|Interest-earning assets               |                                       |                                      
|                                      |                                       |                                      
|Noninterest-earning assets            |                                       |                                      
|                                      |                                       |                                      
|Total assets                          |                                       |                                      
|                                      |                                       |                                      
|                                      |                                       |                                      
|                                      |                                       |                                      
|Liabilities and                       |                                       |                                      
|shareholders' equity                  |                                       |                                      
|Deposits                              |                                       |                                      
|Interest demand and                   |                                       |                                      
|money market                          |                                       |                                      
|Savings                               |                                       |                                      
|CDs                                   |                                       |                                      
|                                      |                                       |                                      
|Interest-bearing deposits             |                                       |                                      
|                                      |                                       |                                      
|Trust preferred securities            |                                       |                                      
|Other interest-bearing liablilities   |                                       |                                      
|                                      |                                       |                                      
|Interest-bearing liabilites           |                                       |                                      
|Noninterest-bearing deposits          |                                       |                                      
|Other noninterest-bearing liabilities |                                       |                                      
|                                      |                                       |                                      
|Total liabilities                     |                                       |                                      
|Shareholders' equity                  |                                       |                                      
|                                      |                                       |                                      
|Total liabilities and                 |                                       |                                      
|shareholders' equity                  |                                       |                                      
|                                      |                                       |                                      
|                                      |                                       |                                      
|                                      |                                       |                                      
|Net Interest Income (3)               |                                       |                                      
|                                      |                                       |                                      
|Net Interest Spread (1)               |                                       |                                      
|                                      |                                       |                                      
|Net Interest Margin (1)               |                                       |                                      
|                                      |                                       |                                      
|                                      |                                       |                                      

(1)    Annualized
(2)    Includes
loan fees of $406 and $231 for the three months ended September 30, 2003 and 2002,
respectively.(3)    Interest
income on non-taxable investments is presented on a fully taxable-equivalent basis using
the federal statutory rate of 34%. These adjustments were $57 and $63 for the three
months ended September 30, 2003 and 2002, respectively.

14

---

# Results of Operations

The Companys results of
operations are dependent to a large degree on net interest income. Interest income and
cost of funds are affected significantly by general economic conditions, particularly
changes in market interest rates, and by government policies and the actions of regulatory
authorities. The Company generates noninterest income generally through service charges
and fees, gain on sale of loans and other sources. The Companys noninterest expenses
consist primarily of compensation and employee benefit expense, and occupancy expense.

Net Income.Net income for the
third quarter of 2003 increased 32.6% to $1.8 million or $0.36 per diluted share as
compared to the third quarter of 2002. Net income for the nine months ended September 30,
2003 increased 6.3% to $4.4 million, or $0.92 per diluted share, from $4.1 million, or
$0.87 per diluted share, for the nine months ended September 30, 2002.

Net Interest Income. Net
interest income for the third quarter of 2003 increased 18.5% to $7.2 million from $6.1
million for the third quarter of 2002. For the first nine months of 2003, net interest
income increased 14.0% to $20.7 million from $18.1 million for the like period in 2002.
The increase is largely due to interest income from increased average loan volume,
combined with a decrease in the cost of funds. The continued low rate environment has
improved the Companys cost of funds and helped offset the lower interest-earning
asset yield.

Average interest-earning assets for
the third quarter increased to $547.1 million at September 30, 2003, compared to $476.7
million at September 30, 2002, a growth of 14.8%, while the average yield on
interest-earning assets decreased to 6.89% compared to 7.59% in third quarter of the prior
year. The average yield on loans decreased to 7.33% for the quarter ended September 30,
2003 from 8.07% for the third quarter of 2002.

The average cost of interest-bearing
liabilities decreased in the third quarter of 2003 to 1.86% from 2.79% for the quarter
ended September 30, 2002. Average interest-bearing liabilities for the quarter increased
to $457.6 million at September 30, 2003 compared to $413.4 million a year ago, a growth of
10.7%.

The overall result of these changes
was a increase in the net interest spread to 5.03% for the quarter ended September 30,
2003 from 4.80% for the quarter ended September 30, 2002. Net interest margin (net
interest income divided by average interest-earning assets) increased to 5.33% in the
third quarter of 2003 from 5.18% in the third quarter of 2002.

Noninterest Income.Noninterest income increased $1.4 million, or 152.7%, in the third quarter of 2003
compared to the like period in 2002. This increase was primarily due to the gain on sale
of loans.

For the first nine months of 2003,
noninterest income increased $2.2 million, or 72.7% compared to the like period a year
ago. This increase was due to secondary market fees and the gain on sale of loans offset
by the sale of the vacated North Whidbey branch property in the first quarter of 2002.

The Company began hedging mortgage
interest rate risk for WFG real estate loans in the second quarter of 2003. At September
30, 2003, net loss on hedging activities was $135,000. The net loss is included in the
gain on sale of loans.

Noninterest Expense.Noninterest expense increased $1.7 million in the third quarter of 2003, or 38.3% from
a year ago. Three major components of noninterest expense, employee compensation,
occupancy and other noninterest expense, increased 36.0%, 35.6% and 44.3%, respectively,
for the quarter compared with the like period in 2002.

For the first nine months of 2003,
noninterest expense rose to $16.8 million from $12.4 million one year ago, a 35.4%
increase. The majority of these expenses reflect costs associated with the newly formed
Washington Funding Group, the overall expansion of the Company and the increasing costs of
doing business. This was primarily due to employee compensation, including a cost increase
in employee benefits.

15

---

The efficiency ratio (noninterest
expense divided by the sum of net interest income plus noninterest income less
non-recurring gains) was 63.54% for the third quarter 2003 compared to 62.71% for the like
period in 2002. For the first nine months of 2003 and 2002, the efficiency ratio was
64.79% and 58.62%, respectively.

Income Taxes.For the third
quarters of 2003 and 2002, the Company recorded an income tax provision of $919,000 and
$720,000, respectively. For the first nine months of 2003 and 2002, the Company recorded
income tax provisions of $2.3 million and $2.2 million, respectively. The overall
effective tax rate was approximately 34% and 35% for the three months ended September 30,
2003 and 2002, respectively. For the nine months ended September 30, 2003 and 2002, the
overall effective tax rate was approximately 34%.

# Lending Activities

Loan Portfolio Composition.The Company originates a wide variety of loans including commercial, real estate and
consumer loans. The following table sets forth the Companys loan portfolio
composition by type of loan:

|                                | September 30, 2003 | December 31, 2002
|------------------------------- | ------------------ | -----------------
|
|Commercial                      |                    |                  
|Real estate mortgages:          |                    |                  
|One-to-four family residential  |                    |                  
|Five-or-more family             |                    |                  
|residential and commercial      |                    |                  
|                                |                    |                  
|Total real estate mortgages     |                    |                  
|                                |                    |                  
|Real estate construction        |                    |                  
|Consumer                        |                    |                  
|                                |                    |                  
|Subtotal                        |                    |                  
|                                |                    |                  
|Less: allowance for loan losses |                    |                  
|Deferred loan fees, net         |                    |                  
|                                |                    |                  
|Loans, net                      |                    |                  
|                                |                    |                  

Total loans, net, increased to $484.7
million at September 30, 2003, representing a 12.4% increase from year-end 2002. The
majority of the increase was in real estate mortgage and real estate construction loans,
which increased 22.3% and 53.5%, respectively at September 30, 2003 from year-end 2002.
Included in real estate mortgages are loans originated and held for sale on the secondary
market. At September 30, 2003, loans held for sale were $12.3 million as compared to $6.6
million at December 31, 2002, an increase of 85.9%. Of those loans, $8.9 million were
originated by WFG and $3.4 million were originated by the Banks retail real estate
division, as compared to all of the loans originating from the Banks retail real
estate division at December 31, 2002. The majority of the increase in real estate
construction loans was due to residential construction, residential land development
projects and a few large commercial construction loans.

The Company makes automobile and
recreational vehicle loans for new and used vehicles originated indirectly by selected
automobile dealers located in the Companys market areas. Indirect dealer loans were
$100.6 million, or 60.76% of the consumer loan portfolio and 20.48% of the total loan
portfolio at September 30, 2003. At December 31, 2002, indirect dealer loans were $94.2
million, or 57.64% of the consumer loan portfolio and 21.56% of the total loan portfolio.

16

---

Nonperforming Assets.The following table sets forth an analysis of the composition of the Company's
nonperforming assets:

|(Dollars in thousands)                           | September 30, 2003 | December 31, 2002
|------------------------------------------------ | ------------------ | -----------------
|Nonaccrual loans                                 |                    |                  
|Restructured loans                               |                    |                  
|                                                 |                    |                  
|Total nonperforming loans                        |                    |                  
|Other real estate owned                          |                    |                  
|                                                 |                    |                  
|Total nonperforming assets                       |                    |                  
|                                                 |                    |                  
|Accruing loans past due > 90 days                |                    |                  
|Potential problem loans                          |                    |                  
|Allowance for loan losses                        |                    |                  
|                                                 |                    |                  
|Nonperforming loans to loans                     |                    |                  
|Allowance for loan losses to loans               |                    |                  
|Allowance for loan losses to nonperforming loans |                    |                  
|Nonperforming assets to total assets             |                    |                  

Nonperforming loans increased to $4.1
million, or 0.84% of total loans, at September 30, 2003 from $3.2 million, or 0.74% of
total loans, at December 31, 2002. The current allowance for loan losses of $6.3 million
represents 153.86% of nonperforming loans as compared to 171.14% of nonperforming loans at
December 31, 2002. The allowance for loan losses is 1.29% of total loans at September 30,
2003 as compared to 1.26% at December 31, 2002.

Provision and Allowance for Loan
Losses.The Company recorded an $838,000 provision for loan losses for the third
quarter of 2003, compared with $589,000 for the like period a year ago. Net loan
charge-offs were $443,000, representing 0.09% of average loans for the third quarter of
2003, compared with $691,000, or 0.16% of average loans for the like period last year.

For the nine months ended September
30, 2003, the Company recorded a $2.4 million provision for loan losses, compared with
$2.5 million for the like period a year ago. The Company recorded $1.6 million in net loan
charge-offs, representing 0.34% of average loans during the first nine months of 2003,
compared with $1.3 million or 0.32% of average loans in net charge-offs for the like
period in 2002. The increase in charge-offs is attributed to a progressively tighter
stance on consumer delinquencies and to certain loans to the construction trades.
Management has tightened consumer-lending standards, formalized its credit review
department, and established additional commercial guidelines and limits on lending to
certain industries to mitigate risk.

Indirect vehicle loans may involve
greater risk than other consumer loans, including direct automobile loans, due to the
nature of third-party transactions. To mitigate these risks, the Company limits its
indirect automobile loan purchases primarily to dealerships that are established and well
known in their market areas and to applicants that are not classified as sub-prime. In
addition, the Company has increased its oversight of the approval process and uses a loan
grading system, which limits the risks inherent in dealer originated loans.

17

---

The following table sets forth the
Companys consumer charge-offs and recoveries:

|                                                   | Three Months Ended
September 30 | Nine Months Ended
September 30
|-------------------------------------------------- | ------------------------------- | ------------------------------
|
|Consumer charge-offs                               |                                 |                               
|Consumer recoveries                                |                                 |                               
|                                                   |                                 |                               
|Net consumer charge-offs                           |                                 |                               
|                                                   |                                 |                               
|Net dealer charge-offs                             |                                 |                               
|Average dealer loans                               |                                 |                               
|                                                  
|Net dealer charge-offs to net consumer charge-offs |                                 |                               
|Net dealer charge-offs to average dealer loans     |                                 |                               

Net loan charge-offs attributed to indirect
dealer loans were $234,000, representing 80.69% of net consumer charge-offs during the
third quarter of 2003, compared to $312,000, or 73.41% of net consumer charge-offs for the
like period in 2002. For the nine months ended September 30, 2003, net charge-offs
attributed to indirect dealer loans were $682,000, or 78.66%, of net consumer charge-offs,
as compared with $574,000, or 74.84%, for the like period in 2002.

The allowance for loan losses is
maintained at a level considered adequate by management to provide for anticipated loan
losses based on managements assessment of various factors affecting the loan
portfolio. This includes a review of problem loans, general business and economic
conditions, seasoning of the loan portfolio, bank regulatory examination results and
findings of internal credit examiners, loss experience and an overall evaluation of the
quality of the underlying collateral. Management reviews the allowance quarterly. The
allowance is increased by provisions charged to operations and reduced by loans charged
off, net of recoveries.

The following table sets forth the
changes in the Companys allowance for loan losses. The allocation is based on an
evaluation of defined loan problems, historical ratios of loan losses and other factors
that may affect future loan losses in the categories of loans shown:

|                                 | Three Months Ended
September 30 | Nine Months Ended
September 30
|-------------------------------- | ------------------------------- | ------------------------------
|
|Balance at beginning of period   |                                 |                               
|Charge-offs:                     |                                 |                               
|Commercial                       |                                 |                               
|Real estate                      |                                 |                               
|Consumer                         |                                 |                               
|                                 |                                 |                               
|Total charge-offs                |                                 |                               
|Recoveries:                      |                                 |                               
|Commercial                       |                                 |                               
|Real estate                      |                                 |                               
|Consumer                         |                                 |                               
|                                 |                                 |                               
|Total recoveries                 |                                 |                               
|                                 |                                 |                               
|Net charge-offs                  |                                 |                               
|Provision for loan losses        |                                 |                               
|                                 |                                 |                               
|Balance at end of period         |                                 |                               
|                                 |                                 |                               
|Net charge-offs to average loans |                                 |                               

18

---

While management believes that it
uses the best information available to determine the allowance for loan losses, unforeseen
market conditions and/or circumstances that differ substantially from the assumptions used
in making the final determination could result in adjustments to the allowance for loan
losses, and net income could be significantly affected. Management anticipates that normal
growth of the loan portfolio, coupled with potential credit weakness that could occur, may
require increases in the provisions to the allowance for loan losses.

# Deposits

The Company provides an array of
deposit services, including noninterest-bearing checking accounts, interest-bearing
checking and savings accounts, money market accounts and certificates of deposit
(CDs). These accounts generally earn interest at rates established by
management based on competitive market factors and managements desire to increase or
decrease certain types or maturities of deposits. The Company does not pay brokerage
commissions to attract deposits. It strives to establish customer relations to attract
core deposits in noninterest-bearing transactional accounts and thus reduce its costs of
funds.

The following table sets forth the
average balances outstanding and average interest rates for each major category of
deposits:

|                                | Three Months Ended September 30
|------------------------------- | -------------------------------
|
|
|Interest-bearing demand and     |                                
|money market deposits           |                                
|Savings deposits                |                                
|CDs                             |                                
|                                |                                
|Total interest-bearing deposits |                                
|Demand and other                |                                
|noninterest-bearing deposits    |                                
|                                |                                
|Total average deposits          |                                
|                                |                                

# Liquidity and Sources of
Funds

Sources of Funds.The
Companys sources of funds are customer deposits, loan repayments, current earnings,
cash and demand balances due from other banks, federal funds, short-term investments,
investment securities available for sale and trust preferred securities. These funds are
used for loan originations and deposit withdrawals, to satisfy other financial commitments
and to support continuing operations. The Company relies primarily upon customer deposits
and investments to provide liquidity. The Company will mainly use such funds to make loans
and to purchase securities, the majority of which are issued by federal, state and local
governments. Additional funds are available through established Federal Home Loan Bank
(FHLB) and correspondent bank lines of credit, which the Company may use to
supplement funding sources.

The Companys strategy includes
maintaining a well-capitalized status for regulatory purposes, while
maintaining a favorable liquidity position and proper asset/liability mix. With this
strategy in mind, management evaluated potential capital-raising alternatives such as
trust preferred securities, issuance of common stock and other sources. Management
determined that issuing trust preferred securities would be in the best interest of the
Company and on June 27, 2002, the Trust issued $15.0 million of trust preferred
securities. Trust preferred securities are held as debt for tax purposes, while the
proceeds of the offering count as Tier I capital without increasing the shareholder base,
and therefore not diluting earnings per share.

19

---

Deposits.Total deposits increased 10.3% to $510.9 million at September 30, 2003 from
          $463.0 million at December 31, 2002. The Company has not accepted
          brokered deposits. It has made a concerted effort to attract deposits in the
          market area it serves through competitive pricing and delivery of quality
          service. Historically, the Company has been able to retain a considerable amount
          of its deposits as they mature.

The Companys deposits are
expected to fluctuate according to the level of the Companys deposit market share,
economic conditions and normal seasonal variations, among other things. Certificates of
deposit are the only deposit group that has stated maturity dates. At September 30, 2003,
the Company had $187.1 million in CDs, of which approximately $119.0 million, or 63.6%,
are scheduled to mature within one year. Declining interest rate markets and uncertain
economic conditions may cause some customers to choose to move funds into core deposit
accounts or withdraw funds, rather than renew CDs as they mature. That notwithstanding,
management anticipates that a sizable portion of outstanding CDs will renew upon maturity.

Borrowings.At September 30, 2003 the Company had a line of credit with the FHLB of
          $87.9 million, of which $15.0 million was advanced in long-term borrowings. The
          Company also had unused lines of credit with correspondent banks in the amount
          of $17.0 million at September 30, 2003.

Investments.The Companys total portfolio of investment securities increased 28.8%
          to $31.1 million at September 30, 2003 from $24.2 million at December 31, 2002.
          The investment portfolio consists of government agency securities, pass-through
          securities, corporate securities, municipal securities and preferred stock. No
          investment exceeds 10% of the shareholders equity. The following table
          summarizes the amortized cost, market value and recorded value of securities in
          the Companys portfolio by contractual maturity groups:

|                  | September 30, 2003
|----------------- | ------------------
|
|Amounts maturing: |                   
|Within one year   |                   
|One to five years |                   
|Six to ten years  |                   
|Over ten years    |                   
|                  |                   
|Total             |                   
|                  |                   

At September 30, 2003, the
Companys investment portfolio consisted of $16.1 million, or 51.58% in
held-to-maturity investments at carrying value, as compared with $15.1 million, or 62.35%,
at December 31, 2002, and $15.1 million, or 48.42%, in available-for-sale securities at
carrying value, as compared with $9.1 million, or 37.65%, at December 31, 2002. For
liquidity purposes, the Companys future security purchases will primarily be
designated as available-for-sale and will increase as a percent of total investment
securities at carrying value.

# Capital and Capital
Ratios

The Companys shareholders
equity increased to $43.1 million at September 30, 2003 from $39.4 million at December 31,
2002. This increase is due to net income of $4.4 million, proceeds from stock options
exercised in the amount of $311,000 and stock option compensation of $17,000 offset by the
payment of cash dividends of $977,000 and a decrease in unrealized gain on
available-for-sale securities, net of tax of $81,000, during the first nine months of
2003. Total assets increased to $587.2 million at September 30, 2003 from $535.4 million
at December 31, 2002, an increase of 9.7%. Shareholders equity to total assets was
7.3% at September 30, 2003 compared to 7.4% at December 31, 2002.

Banking regulations require bank
holding companies and banks to maintain a minimum leverage ratio of core capital to
adjusted average total assets of at least 4%. In addition, banking regulators have adopted
risk-based capital guidelines, under which risk percentages are assigned to various
categories of assets and off-balance sheet items to calculate a risk-adjusted capital
ratio. Tier I capital generally consists of common shareholders equity (which does
not include unrealized gains and losses on securities), less goodwill and certain
identifiable intangible assets, while Tier II capital includes the allowance for loan
losses and subordinated debt, both subject to certain limitations.

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The FDIC established the
qualifications necessary to be classified as a well-capitalized bank,
primarily for assignment of FDIC insurance premium rates. As the following table
indicates, the Company (on a consolidated basis) and the Bank qualified as
well-capitalized at September 30, 2003 and December 31, 2002:

|                                | FDIC Requirements | Actual Ratios
|------------------------------- | ----------------- | -------------
|
|Total risk-based capital ratio  |                   |              
|Consolidated                    |                   |              
|Whidbey Island Bank             |                   |              
|Tier 1 risk-based capital ratio |                   |              
|Consolidated                    |                   |              
|Whidbey Island Bank             |                   |              
|Leverage ratio                  |                   |              
|Consolidated                    |                   |              
|Whidbey Island Bank             |                   |              

There can be no assurance that
additional capital will not be required in the near future due to greater-than-expected
growth, unforeseen expenses or revenue shortfalls, or otherwise.

# Capital Expenditures and
Commitments

On July 23, 2003, the Company
purchased the land and building that houses the Burlington Financial Center for $719,000.
In addition, the Company has entered into an agreement to purchase land at an estimated
price of $625,000 for a future site of a Whidbey Island Bank branch in the northern
Bellingham area. The purchase is expected to be finalized in the fourth quarter of 2003.

# Significant Accounting
Policies

See Notes to Condensed
Consolidated Financial Statements.

# Anticipated Financial
Performance

In March 2003 the Company announced
its 2003 targets of 10%  15% earnings growth, 10%  15% loan growth, and 5%
 10% deposit growth. While management believes, at this time, that the targets will
be met, it anticipates that 2003 fourth quarter performance will be negatively affected by
a number of factors. These include: fluctuating mortgage interest rates, resulting in
decreasing residential real estate loan volumes; slowing deposit rate repricing
contributing to the tightening of the net interest margin; an increase in operating
expenses due to the rising costs of doing business; and a commercial loan environment
recovering from a stagnate economy coupled with strong rate competition. Management has
begun to see a significant decline in residential loan volumes.

Historically, as real estate loan
volumes decline, commercial loan activity increases. In managements opinion, the
banking industry is currently in the transition period from that of heavy mortgage loan
volumes into a period of increasing commercial lending activity.

The Companys long-term targets
over the next several years include ROE in excess of 18%, an efficiency ratio in the
mid-50% range, earnings per share growth rate of at least 10% annually and cash dividend
per share increases of 8% per year. The Company believes that these long-term goals can be
attained through continuing its strategy of qualitative and sustainable growth.

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Future events are difficult to
predict, and the expectations of management are necessarily subject to uncertainty and
risk that may cause actual results to differ materially from those stated here. One of the
areas subject to uncertainty is economic stability. Although there are concerns regarding
the economy, management expects growth to continue in the Pacific Northwest region and
believes that the Company will have opportunities to participate in that growth. These
opportunities will be pursued while applying rigorous credit discipline and thorough
analysis to ensure quality growth. Other unexpected changes, such as significant declines
in the economy or substantial credit deterioration, could further reduce the anticipated
performance of the Company.

Readers should not construe these
goals as assurances of future performance, and should note that management does not plan
to update these projections.

# Item 3. Quantitative and
Qualitative Disclosures about Market Risk

A number of measures are used to
monitor and manage interest rate risk, including income simulations and interest
sensitivity (gap) analyses. An income simulation model is the primary tool used to assess
the direction and magnitude of changes in net interest income resulting from changes in
interest rates. Key assumptions in the model include prepayment speeds on mortgage-related
assets, cash flows and maturities of other investment securities, loan and deposit
volumes, and pricing. These assumptions are inherently uncertain and, as a result, the
model cannot precisely estimate net interest income or precisely predict the impact of
higher or lower interest rates on net interest income. Actual results will differ from
simulated results due to timing, magnitude and frequency of interest rate changes, changes
in market conditions and management strategies, among other factors. At September 30,
2003, based on the measures used to monitor and manage interest rate risk, there had not
been a material change in the Companys interest rate risk since December 31, 2002.
Should rates increase, the Company could be negatively impacted due to its current
slightly liability sensitive position. For additional information, refer to the
Companys Form 10-K for year ended December 31, 2002 filed with the SEC on March 20,
2003.

# Item 4. Controls and
Procedures

As of the end of the period covered
by this report, management evaluated the effectiveness of the design and operation of its
disclosure controls and procedures. The principal executive and financial officers
supervised and participated in this evaluation. Based on this evaluation, the chief
executive and financial officer each concluded that the Companys disclosure controls
and procedures are effective in timely alerting them to material information required to
be included in the periodic reports to the SEC. The design of any system of controls is
based in part upon various assumptions about the likelihood of future events, and there
can be no assurance that any of the Companys plans, products, services or procedures
will succeed in achieving their intended goals under future conditions. In addition, there
have been no significant changes in the internal controls or in other factors known to
management that could significantly affect the internal controls subsequent to the most
recent evaluation. Management found no facts that would require WBCO to take any
corrective actions with regard to significant deficiencies or material weaknesses.

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# PART II

# Item 6. Exhibits and
Reports on Form 8-K

(a) Exhibits

|31 | Certification of Chief Executive
Officer and Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|-- | ------------------------------------------------------------------------------------------------------------------------
|32 | Certification of Chief Executive Officer
and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002

(b)    
          Reports on Form 8-K

| | During
the quarter ended September 30, 2003, the Company filed a report on Form 8-K in regard to
the release of the Companys second quarter 2003 earnings and cash dividend
notification. The report was filed on July 25, 2003.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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# SIGNATURES

Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

# WASHINGTON BANKING
COMPANY

|Date: November 13, 2003 | By | /s/  Michal D. Cann                                                 
|----------------------- | -- | --------------------------------------------------------------------
|                        |    |                                                                     
|                        |    | Michal D. Cann
      President and
  Chief Executive Officer        
|                        |    |                                                                     
|Date: November 13, 2003 | By | /s/ Phyllis A. Hawkins                                              
|                        |    |                                                                     
|                        |    | Phyllis A. Hawkins
Senior Vice President and
Chief Financial Officer

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