# 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 June 30, 2004

[   ]       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 ofincorporation or organization) |  | (I.R.S. EmployerIdentification 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 August 6, 2004 was 5,409,999.

---

|        | Table of ContentsPART I                                                               | Page
|------- | ------------------------------------------------------------------------------------- | ----
|Item 1. | Financial Statements                                                                  |     
|       
|        | Condensed Consolidated Statements of Financial Condition -                           
|        | June 30, 2004 and December 31, 2003                                                   | 1   
|       
|        | Condensed Consolidated Statements of Income -                                        
|        | Three and Six Months Ended June 30, 2004 and 2003                                     | 2   
|       
|        | Condensed Consolidated Statements of Shareholders Equity and Comprehensive Income - 
|        | Six Months Ended June 30, 2004 and 2003                                               | 4   
|       
|        | Condensed Consolidated Statements of Cash Flows -                                    
|        | Six Months Ended June 30, 2004 and 2003                                               | 5   
|       
|        | Notes to Condensed Consolidated Financial Statements                                  | 7   
|       
|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations | 11  
|       
|Item 3. | Quantitative and Qualitative Disclosures about Market Risk                            | 23  
|       
|Item 4. | Controls and Procedures                                                               | 23  
|       
|        | Part II                                                                               |     
|       
|Item 2. | Changes in Securities and Use of Proceeds                                             | 24  
|       
|Item 4. | Submission of Matters to a Vote of Security Holders                                   | 24  
|       
|Item 5. | Other Information                                                                     | 24  
|       
|Item 6. | Exhibits and Reports on Form 8-K                                                      | 24  
|       
|        | Signatures                                                                            | 25  

---

# Item 1. Financial
Statements

WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed Consolidated
Statements of Financial ConditionJune 30, 2004 and
December 31, 2003 (unaudited)(Dollars in thousands)

|Assets                                                    | June 30,2004 | December 31,2003
|--------------------------------------------------------- | ------------ | ----------------
|Cash and due from banks                                   |              |                 
|($1,221 and $1,138, 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                               |              |                 
|                                                         
|Subsidiary investment                                     |              |                 
|Federal Home Loan Bank stock                              |              |                 
|                                                         
|Loans held for sale                                       |              |                 
|Loans receivable                                          |              |                 
|Allowance for loan losses                                 |              |                 
|                                                          |              |                 
|Total loans, net                                          |              |                 
|                                                         
|Premises and equipment, net                               |              |                 
|Bank owned life insurance                                 |              |                 
|Other assets                                              |              |                 
|                                                          |              |                 
|Total assets                                              |              |                 
|                                                          |              |                 
|Liabilities and Shareholders Equity                      |              |                 
|Liabilities:                                              |              |                 
|Deposits                                                  |              |                 
|Noninterest-bearing                                       |              |                 
|Interest-bearing                                          |              |                 
|Time deposits                                             |              |                 
|                                                          |              |                 
|Total deposits                                            |              |                 
|                                                         
|Other borrowed funds                                      |              |                 
|Junior subordinated debentures                            |              |                 
|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 5,409,999 and 5,357,880 shares     |              |                 
|at June 30, 2004 and December 31, 2003, respectively      |              |                 
|Retained earnings                                         |              |                 
|Accumulated other comprehensive income (loss), net        |              |                 
|                                                          |              |                 
|Total shareholders equity                                |              |                 
|                                                          |              |                 
|Total liabilities and shareholders equity                |              |                 
|                                                          |              |                 

See accompanying notes to
consolidated financial statements.

1

---

WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed Consolidated
Statements of IncomeThree and Six months ended June
30, 2004 and 2003 (unaudited)(Dollars in thousands, except per share data)

|                                                                                                                                                          | Three Months EndedJune 30 | Six Months EndedJune 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 junior subordinated debentures                                                                                                                |                           |                        
|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 securities                                                                                                                                |                           |                        
|Gain on sale of loans                                                                                                                                     |                           |                        
|Secondary market fees                                                                                                                                     |                           |                        
|ATM income                                                                                                                                                |                           |                        
|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                                                                                                                                |                           |                        
|                                                                                                                                                          |                           |                        
|Income from continuing operations                                                                                                                         |                           |                        
|Loss from discontinued operations, net of tax benefit of $156, $47, $238 and $76 for the three and six months ended June 30, 2004 and 2003, respectively. |                           |                        
|                                                                                                                                                          |                           |                        
|Net income                                                                                                                                                |                           |                        
|                                                                                                                                                          |                           |                        
|(Continued)                                                                                                                                              

2

---

WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed Consolidated
Statements of IncomeThree and Six months ended June
30, 2004 and 2003 (unaudited)(Dollars in thousands, except per share data)

|                                              | Three Months EndedJune 30 | Six Months EndedJune 30
|--------------------------------------------- | ------------------------- | -----------------------
|
|                                              |                          
|Net income per share, basic                   |                           |                        
|Continuing operations                         |                           |                        
|Discontinued operations                       |                           |                        
|                                              |                           |                        
|Net Income                                    |                           |                        
|                                              |                           |                        
|Net income per share, diluted                 |                           |                        
|Continuing operations                         |                           |                        
|Discontinued operations                       |                           |                        
|                                              |                           |                        
|Net Income                                    |                           |                        
|                                              |                           |                        
|Average number of shares outstanding, basic   |                           |                        
|Average number of shares outstanding, diluted |                           |                        

See accompanying notes to condensed
consolidated financial statements.

3

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WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed Consolidated
Statements of Shareholders Equityand Comprehensive IncomeSix months ended June
30, 2004 and 2003 (unaudited)(Dollars and shares in
thousands, except per share data)

|                                                   | Common stock | Retained | Accumulatedothercomprehensiveincome | Totalshareholders
|-------------------------------------------------- | ------------ | -------- | ----------------------------------- | ------------------
|
|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 $1    |              |          |                                    |                   
|                                                   |              |          |                                     |                   
|Total comprehensive income (1)                     |              |          |                                     |                   
|Cash dividend, $0.12 per share                     |              |          |                                    |                   
|Stock option compensation                          |              |          |                                    |                   
|Stock options exercised                            |              |          | 115                                 |                   
|                                                   |              |          |                                     |                   
|Balances at June 30, 2003                          |              |          | 4,656                               |                   
|                                                   |              |          |                                     |                   
|                                                  
|Balances at December 31, 2003                      |              |          | 5,358                               |                   
|Comprehensive income:                              |              |         
|Net income                                         |              |          |                                    |                   
|Net change in unrealized gain (loss) on            |              |         
|securities available for sale, net of tax of $(84) |              |          |                                    |                   
|                                                   |              |          |                                     |                   
|Total comprehensive income (1)                     |              |          |                                     |                   
|Cash dividend, $0.145 per share                    |              |          |                                    |                   
|Stock option compensation                          |              |          |                                    |                   
|Stock options exercised                            |              |          | 52                                  |                   
|                                                   |              |          |                                     |                   
|Balances at June 30, 2004                          |              |          | 5,410                               |                   
|                                                   |              |          |                                     |                   

(1)    
          Comprehensive income for the three months ended June 30, 2004 and 2003 was
          $1,289 and $1,415, respectively.

See accompanying notes to condensed
consolidated financial statements.

4

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WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed Consolidated
Statements of Cash FlowsSix months ended June
30, 2004 and 2003 (unaudited)(Dollars in thousands)

|                                                                   | Six Months Ended June 30
|------------------------------------------------------------------ | ------------------------
|
|Cash flows from operating activities:                              |                         
|Net income from continuing operations                              |                         
|Adjustments to reconcile net income to net cash                    |                         
|provided by operating activities:                                  |                         
|Federal Home Loan Bank stock dividends                             |                         
|Deferred income tax benefit                                        |                         
|Amortization of investment premiums, net                           |                         
|Net increase in subsidiary investment                              |                         
|Earnings on bank owned life insurance                              |                         
|Provision for loan losses                                          |                         
|Net increase in loans held for sale                                |                         
|Depreciation of premises and equipment                             |                         
|Net gain on sale of securities                                     |                         
|Net loss on sale of other real estate and premises and equipment   |                         
|Net (increase) decrease in other assets                            |                         
|Stock option compensation                                          |                         
|Net decrease in other liabilities                                  |                         
|                                                                   |                         
|Net cash used in continuing operating activities                   |                         
|Net loss from discontinued operations                              |                         
|                                                                   |                         
|Net cash used in 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                   |                         
|Sale of investment securities, available for sale                  |                         
|Maturities/calls of investment securities held to maturity         |                         
|Purchase of bank-owned life insurance                              |                         
|Net increase in loans                                              |                         
|Purchases of premises and equipment                                |                         
|Proceeds from the sale of other real estate owned and premises and |                         
|equipment                                                          |                         
|                                                                   |                         
|Net cash used in investing activities                              |                         
|                                                                   |                         
|Cash flows from financing activities:                              |                         
|Net increase in deposits                                           |                         
|Net decrease in other borrowed funds                               |                         
|Net decrease in federal funds purchased                            |                         
|Dividends paid on common stock                                     |                         
|Proceeds from stock options exercised                              |                         
|                                                                   |                         
|Net cash provided by financing activities                          |                         
|                                                                   |                         
|Net increase (decrease) in cash and cash equivalents               |                         
|Cash and cash equivalents at beginning of period                   |                         
|                                                                   |                         
|Cash and cash equivalents at end of period                         |                         
|                                                                   |                         
|(Continued)                                                        |                         

5

---

WASHINGTON BANKING
COMPANYAND SUBSIDIARIESCondensed Consolidated
Statements of Cash FlowsSix months ended June
30, 2004 and 2003 (unaudited)(Dollars in thousands)

|                                                            | Six Months Ended June 30
|----------------------------------------------------------- | ------------------------
|
|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                                         |                         
|Transfer of investments from HTM to AFS                     |                         

See accompanying notes to condensed
consolidated financial statements.

6

---

NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSix months ended June 30, 2004 and 2003 (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 June
30, 2004, WBCO had two wholly-owned subsidiaries  Whidbey Island Bank
(WIB or the Bank), the Companys principal subsidiary and
Washington Banking Capital Trust I (the Trust). On May 26, 2004, WBCO
announced plans to close its wholesale lending subsidiary, Washington Funding Group, Inc.
(WFG) effective June 30, 2004. WFG was formed in January 2003 for the purpose
of expanding the Banks wholesale mortgage real estate lending platform. During the
second quarter of 2004, the Company decided to concentrate corporate resources toward the
Banks retail operations and close WFGs operations. Although the wholesale
business enhanced the Companys noninterest income during 2003, the operation of
those offices did not provide a satisfactory financial return.

The business of the Bank, WBCOs
principal subsidiary, which is focused in the northern area of Western Washington,
consists primarily of attracting deposits from the general public and originating loans.
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.

The Companys website address is
www.wibank.com. Exchange Act reports are available free of charge from the Companys
website. The reports can also be obtained through the Securities and Exchange
Commissions (the SEC) EDGAR database at http://www.sec.gov. The contents
of the Companys Internet website are not incorporated into this report or into any
other communication delivered to security holders or furnished to the SEC.

|(b) | Basis
of Presentation
|--- | ---------------------

The accompanying interim condensed
consolidated financial statements include the accounts of WBCO and two of its
subsidiaries, WIB and WFG, (together, the Company). The accompanying interim
condensed consolidated financial statements have been prepared, without audit, pursuant to
the rules and regulations of the SEC. 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, 2003 audited consolidated financial statements
and notes thereto included in the Companys Annual Report on Form 10-K filed with the
SEC on March 24, 2004. In managements opinion, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation have been included.
Operating results for the six months ended June 30, 2004 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2004. 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 had identified two reportable segments: Whidbey Island Bank and the
discontinued operations of Washington Funding Group, Inc., both wholly-owned subsidiaries
of Washington Banking Company. Due to the discontinuation of WFG in the second quarter of
2004, the Company currently has only one segment, Whidbey Island Bank and is not required
to disclose segment reporting by this standard.

7

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NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSix months ended June 30, 2004 and 2003 (unaudited)(Dollars in
thousands, except per share data)

|(d) | Reclassifications
|--- | -----------------

Certain amounts in prior years
financial statements may have been reclassified to conform to the 2004 presentation.

|(e) | Recent
Financial Accounting Pronouncements
|--- | ------------------------------------------

In January 2003, the Financial
Accounting Standards Board (FASB) issued Interpretation No. 46,
Consolidation of Variable Interest Entities, which was replaced by FASB
Interpretation No. 46R (FIN 46R) in December 2003. FIN 46R became effective in
the first quarter of 2004 and defined a variable interest entity (VIE) as a
corporation, partnership, trust, or any other legal structure used for the business
purpose that either does not have equity investors with voting rights or has equity
investors that do not provide sufficient financial resources for the entity to support its
activities. This interpretation requires a VIE to be consolidated or deconsolidated by a
company generally based on the risk of loss or return. Most of the original provisions of
Interpretation No. 46 were delayed until March 31, 2004 through the issuance of FIN 46R.
The Company has a VIE in the form of a trust set up to issue trust preferred securities
and accordingly, the implementation of FIN 46R required the deconsolidation of the Trust.
The Companys adoption of FIN 46R did not have a material impact on the
Companys financial position and results of operations. The restatement of prior
years financial statements was not required by FIN 46R and the Company did not restate the
prior years financial statements.

# (2) Earnings Per Share

The following table reconciles the
denominator of the basic and diluted earnings per share computation.

|                                             | Three Months EndedJune 30 | Six Months EndedJune 30
|-------------------------------------------- | ------------------------- | -----------------------
|
|Weighted average shares-basic                |                           |                        
|Effect of dilutive securities: stock options |                           |                        
|                                             |                           |                        
|Weighted average shares-diluted              |                           |                        
|                                             |                           |                        

On February 26, 2004, the Company
issued a 15% stock dividend to shareholders of record as of February 10, 2004. 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 dividends. At June
30, 2004 and 2003, there were options to purchase 364,124 and 419,507 shares of common
stock outstanding, respectively. For the three and six months ended June 30, 2004 and 2003
no shares were antidilutive and therefore all were included in the computation of diluted
net income per share.

# (3) Trust Preferred
Securities

Washington Capital Trust I (the
Trust), a wholly-owned subsidiary of WBCO, is a statutory business trust
created for the exclusive purposes of issuing and selling capital securities and utilizing
sale proceeds to acquire junior subordinated debt issued to WBCO. On June 27, 2002, the
Trust issued $15,000 of trust preferred securities with a 30-year maturity, callable after
the fifth year by Washington Banking Company. The rate adjusts quarterly based on LIBOR
plus 3.65%. These securities, within certain limitations, are considered Tier I capital
for the purposes of regulatory capital requirements. Accordingly, the junior subordinated
debentures are the sole assets of the Trust, and payments under the junior subordinated
debentures will be the sole revenues of the Trust. All of the common securities of the
Trust are owned by WBCO. Washington Banking Company has fully and unconditionally
guaranteed the capital securities along with all obligations of the Trust under the trust
agreements. Prior to FIN 46R, the Trust was a consolidated subsidiary of the Company. As a
result of the adoption of FIN 46R, the Company deconsolidated the special purpose trust,
as the Company is not considered to be the primary beneficiary under this accounting
standard. Accordingly, on the Companys Consolidated Statements of Financial
Condition, the trust preferred securities that were issued by the Trust have been replaced
by the junior subordinated debentures issued to the Trust by WBCO.

8

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NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSix months ended June 30, 2004 and 2003 (unaudited)(Dollars in
thousands, except per share data)

The following table sets forth the
financial data pertaining to the previously consolidated special purpose trust:

|Name of trust      | Aggregateliquidationamount of trustpreferred securities | Aggregateliquidationamount ofcommon securities | Aggregateprincipalamount of notes | Statedmaturity of notes | Per annuminterest rateof notes | Redemptionoption
|------------------ | ------------------------------------------------------- | ---------------------------------------------- | --------------------------------- | ----------------------- | ------------------------------ | ----------------
|Washington Banking |                                                         |                                                |                                   |                         |                                |                 
|Capital Trust I    |                                                         |                                                | $                                 | 15,000                  |                                | $               

# (4) 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 EndedJune 30 | Six Months EndedJune 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                                |                           |                        
|Income from continuing operations          |                           |                        
|Income (loss) from discontinued operations |                           |                        
|                                           |                           |                        
|Net Income                                 |                           |                        
|                                           |                           |                        
|Pro forma                                  |                           |                        
|Income from continuing operations          |                           |                        
|Income (loss) from discontinued operations |                           |                        
|                                           |                           |                        
|Net Income                                 |                           |                        
|                                           |                           |                        
|Diluted earnings per share:                |                           |                        
|As reported                                |                           |                        
|Income from continuing operations          |                           |                        
|Income (loss) from discontinued operations |                           |                        
|                                           |                           |                        
|Net Income                                 |                           |                        
|                                           |                           |                        
|Pro forma                                  |                           |                        
|Income from continuing operations          |                           |                        
|Income (loss) from discontinued operations |                           |                        
|                                           |                           |                        
|Net Income                                 |                           |                        
|                                           |                           |                        

9

---

NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSix months ended June 30, 2004 and 2003 (unaudited)(Dollars in
thousands, except per share data)

# (5) Subsequent Event

On July 15, 2004, the Board of
Directors declared a cash dividend of $0.0725 per share to shareholders of record as of
August 10, 2004, which is payable on August 25, 2004.

# (6) Commitments

Standby letters of credit are
conditional commitments issued by the Bank to guarantee the performance of a customer to a
third party. Those guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing and similar transactions. Except
for certain long-term guarantees, most 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 June 30, 2004. 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 June 30, 2004.

As of June 30, 2004 the commitments
under these agreements were as follows:

| | Standby
letters of credit and financial guarantees   $245
| | ---------------------------------------------------------

At June 30, 2004, the Company is the
guarantor of trust preferred securities. The Company has issued subordinated debentures to
a wholly-owned special purpose trust, which has issued trust preferred securities. The
sole assets of the special purpose trust are the subordinated debentures issued by the
Company. Washington Banking Company has fully and unconditionally guaranteed the capital
securities along with all obligations of the Trust under the trust agreements. The maximum
amount of future payments the Company will be required to make under these agreements is
the principal and interest of the trust preferred securities, the principal of which
totaled $15,000 at June 30, 2004.

# (7) Closing of Subsidiary

The Company closed its Washington
Funding Group, Inc. (WFG) subsidiary effective June 30, 2004. The subsidiary
provided a loan funding source for mortgage loan brokers, primarily in Washington, Oregon
and Idaho. Business in process was transferred to the Banks Burlington, WA office.

WFG was formed in January 2003 and
began operations in April 2003 as a way to expand services and grow revenues. It provided
a loan funding source for mortgage brokers. While gain on sale of loans increased, WFG
continued to have a negative impact on WBCOs earnings in spite of efforts to improve
WFGs performance. Whidbey Island Bank will continue to offer retail mortgages and
wholesale mortgage funding to brokers as it did before the funding group was established.

10

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# 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 the opening or acquisition of new branches are lower than expected; (4) there
are greater than expected costs or difficulties related to the integration of
acquisitions; (5) there is 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 is unable 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
two wholly-owned subsidiaries: Whidbey Island Bank (the Bank or
WIB) and Washington Banking Capital Trust I (the Trust); and one
discontinued subsidiary, 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 it 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. Prior
to the Banks affiliation with Elliott Cove, non-FDIC insured investment products
were offered through the Banks wholly-owned subsidiary, WIB Financial Services, Inc.
Another nondeposit product offered through WIB, which is not FDIC insured, is a sweep
investment option available through a brokerage account.

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

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WFG, a wholesale mortgage real estate
lending company, was a Washington State corporation formed in January 2003. The primary
purpose of this subsidiary was to provide a loan funding source for brokers of mortgage
loans. The loans were originated and sold in the name of the Bank. During the second
quarter of 2004, the Company decided to concentrate corporate resources toward the
Banks retail operations and close WFGs wholesale lending operations. Although
the wholesale business enhanced the Companys noninterest income during 2003, the
operation of those offices did not provide a satisfactory financial return.

Headquartered in Oak Harbor, the
Companys market area is primarily northwestern Washington. The market area
encompasses distinct economies, and none are particularly dependent upon a single
industrial or occupational source. The economies within the market areas have evolved from
being heavily dependent upon forestry, fishing and farming to a more diverse blend of
industries including retail trade, services, manufacturing, tourism and a large military
presence. Unemployment levels in the Pacific Northwest over the past few years have been
higher than national averages, but the region appears to be showing signs of a slow, but
steady economic recovery.

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 $633.5 million at June 30, 2004 from $581.7 million at December 31, 2003, an
increase of 8.9%. This increase resulted mainly from growth in the loan portfolio and the
investment in bank owned life insurance, which was funded by deposit growth and the sale
of investment securities.

Total Loans.Total loans were
$556.2 million at June 30, 2004, an increase of 9.5% from $508.2 million at December 31,
2003. The Company increased its allowance for loan losses to $6.9 million at June 30, 2004
representing 1.28% of loans (excluding loans held for sale), from $6.1 million or 1.22% of
loans (excluding loans held for sale) at December 31, 2003. 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 $19.3 million and $30.2 million at June 30, 2004 and
December 31, 2003, respectively. The decrease of 36.2% was a result of the sale and
maturity of available-for-sale investment securities that were not replaced due to the low
rate environment coupled with an anticipated increase in loan demand and purchase of bank
owned life insurance (BOLI).

Premises and Equipment.Premises and equipment, net of depreciation, were $20.5 million at June 30, 2004 and
$19.8 million on December 31, 2003. The Company purchased a building located in Oak
Harbor, WA for the purpose of consolidating its back room operating functions. The Company
is in the process of selling the Oak Harbor property that was previously used as an
operations center. The Company has continued its expansion strategy by opening a new
grocery store branch in Arlington, WA; and by leasing space for a future branch site in
Friday Harbor, WA; and additional office space in Bellingham, WA.

Deposits.Deposits grew 11.3% to $558.0 million at June 30, 2004 from $501.5 million
          at December 31, 2003. 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 continue to seek the security of FDIC-insured deposit vehicles in
          contrast to the potential volatility of the investment market.

12

---

At June 30, 2004, average
noninterest-bearing deposits increased 23.2% from June 30, 2003, while average
interest-bearing deposits increased 12.3% for the same period. Average interest demand and
money market deposits represented 45.00% of total average interest-bearing deposits at
June 30, 2004 compared to 45.09% a year ago.

Average savings deposits and average
CDs represented 9.63% and 45.37%, respectively, of total average interest-bearing deposits
at June 30, 2004 compared to 8.28% and 46.63%, respectively, a year ago. All deposit
product averages increased during the second quarter of 2004 as management focused on
establishing customer relationships and attracting deposits.

Shareholders Equity.The
Companys shareholders equity increased 4.3% to $46.3 million at June 30, 2004
from $44.4 million at December 31, 2003. The increase reflects earnings, proceeds from
stock options exercised, stock option compensation and an increase in unrealized gain on
available-for-sale securities, net of tax, offset by the payment of cash dividends during
the first six months of 2004.

13

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

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

|                                      | Three Months Ended June 30, 2004 | Three Months Ended June 30, 2003
|------------------------------------- | -------------------------------- | --------------------------------
|
|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             |                                  |                                 
|Federal funds purchased               |                                  |                                 
|Junior subordinated debentures        |                                  |                                 
|Trust preferred securities            |                                  |                                 
|Other interest-bearing liabilites     |                                  |                                 
|                                      |                                  |                                 
|Interest-bearing liabilities          |                                  |                                 
|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 $338 and $387 for the three months ended June 30, 2004 and
          2003, 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 $47 and $56 for the three months ended June 30, 2004 and 2003,
respectively.

14

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# 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
second quarter of 2004 decreased 12.3% to $1.2 million or $0.22 per diluted share as
compared to the second quarter of 2003. Net income for the six months ended June 30, 2004
decreased 12.0% to $2.3 million, or $0.42 per diluted share, from $2.7 million, or $0.48
per diluted share, for the six months ended June 30, 2003. The decrease was due largely to
the increase in noninterest expense, the reduction in gain on sale of loans, and the
operating losses and costs associated with closing the Washington Funding Group, Inc.
subsidiary.

Income from continuing operations for
the second quarter of 2004 increased 3.3% to $1.5 million from $1.4 million for the second
quarter of 2003. The Companys loss from discontinued operations for the second
quarter of 2004 increased to a loss of $247,000 from a loss of $24,000 for the second
quarter of 2003. The major portion of this loss was attributable to the costs of closing
the operations of WFG.

Income from continuing operations for
the six months ended June 30, 2004 and 2003 remained level at $2.7 million for both
periods. The Companys loss from discontinued operations for the six month period in
2004 increased to a loss of $370,000 from a loss of $81,000 for the like period one year
ago.

Net Interest Income. Net
interest income for the second quarter of 2004 increased 6.4% to $7.3 million from $6.9
million for the second quarter of 2003. For the first six months of 2004, net interest
income increased 7.3% to $14.4 million from $13.4 million for the like period in 2003. The
increase is largely due to interest income from increased average loan volume, combined
with a decrease in the cost of funds.

Average interest-earning assets for
the second quarter increased to $581.4 million at June 30, 2004, compared to $520.6
million at June 30, 2003, a growth of 11.7%, while the average yield on interest-earning
assets decreased to 6.59% compared to 7.08% in second quarter of the prior year. The
average yield on loans decreased to 6.79% for the quarter ended June 30, 2004 from 7.52%
for the second quarter of 2003.

The average cost of interest-bearing
liabilities decreased in the second quarter of 2004 to 1.77% from 2.01% for the quarter
ended June 30, 2003. Average interest-bearing liabilities for the quarter increased to
$493.6 million at June 30, 2004 compared to $447.0 million a year ago, a growth of 10.4%.

The overall result of these changes
was a decrease in the net interest spread to 4.82% for the quarter ended June 30, 2004
from 5.07% for the quarter ended June 30, 2003. Net interest margin (net interest income
divided by average interest-earning assets) decreased to 5.09% in the second quarter of
2004 from 5.35% in the second quarter of 2003.

Noninterest Income.Noninterest income increased $264,000, or 20.3%, in the second quarter of 2004
compared to the like period in 2003. For the first six months of 2004, noninterest income
increased $297,000, or 11.5% compared to the like period a year ago. This increase was
primarily due to an increase in service charges and fees on deposits in association with
the Banks new overdraft product, Whidbey Overdraft Coverage and a gain on sale of
securities offset by a decrease in gain on sale of loans.

In the past, selling single-family
residential loans to the secondary market contributed significantly to the noninterest
income, but slowing of mortgage activity caused a decrease in income from the gain on sale
of loans.

Noninterest Expense.Noninterest expense increased $760,000 in the second quarter of 2004, or 14.8% from a
year ago. Three major components of noninterest expense  employee compensation,
occupancy and other noninterest expense  increased 13.5%, 13.3% and 20.1%,
respectively, for the quarter compared with the like period in 2003.

For the first six months of 2004,
noninterest expense rose to $11.6 million from $10.2 million one year ago, a 13.7%
increase. Employee compensation, occupancy and other noninterest expense increased 14.4%,
14.7% and 12.0%, respectively, compared with the like period in 2003.

15

---

The Company experienced a cost
increase in employee benefits. Additionally, increased costs associated with insurance,
operating fees and advertising have contributed to other noninterest expense, primarily as
a result of the expansion of the Company. With the purchase of an office building on Oak
Harbor, WA to consolidate back office operations into one building, the Company expects to
improve operating efficiencies.

The
efficiency ratio (noninterest expense divided by the sum of net interest income plus
noninterest income less non-recurring gains) was 66.25% for the second quarter 2004
compared to 62.69% for the like period in 2003. For the first six months of 2004 and 2003,
the efficiency ratio was 67.18% and 63.78%, respectively.

Income Taxes.For the second
quarters of 2004 and 2003, the Company recorded an income tax provision of $742,000 and
$781,000, respectively. For the first six months of 2004 and 2003, the Company recorded
income tax provisions of $1.4 million and $1.5 million, respectively. The overall
effective tax rate was approximately 33% and 35% for the three months ended June 30, 2004
and 2003, respectively. For the six months ended June 30, 2004 and 2003, the overall
effective tax rate was approximately 33% and 35%, respectively.

The results from discontinued
operations disclosed on the consolidated statement of income are net of tax.

# 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:

|                                | June 30, 2004 | December 31, 2003
|------------------------------- | ------------- | -----------------
|
|Commercial                      |               |                  
|Real estate mortgages:          |               |                  
|1  4 Family residential        |               |                  
|Commercial                      |               |                  
|                                |               |                  
|Total real estate mortgages     |               |                  
|Real estate construction        |               |                  
|Consumer                        |               |                  
|                                |               |                  
|Subtotal                        |               |                  
|                                |               |                  
|Less: allowance for loan losses |               |                  
|Deferred loan fees, net         |               |                  
|                                |               |                  
|Loans, net                      |               |                  
|                                |               |                  

Total loans, net, were $549.3 million
at June 30, 2004, representing a 9.4% increase from year-end 2003. The majority of the
increase was in real estate mortgage and real estate construction loans, which increased
14.3% and 23.4%, respectively, at June 30, 2004 from year-end 2003. Included in real
estate mortgages are loans originated and held for sale on the secondary market. At June
30, 2004, loans held for sale were $15.9 million as compared to $8.3 million at December
31, 2003, an increase of 92.2%. The Company has $10.0 million of indirect consumer loans
in loans held for sale as of June 30, 2004. Due to the liability sensitivity of our
balance sheet, the Company opted to sell these fixed rate loans without recourse to
increase liquidity for core lending activity. WBCO plans on selling the loans by the end
of the third quarter. Of the remaining loans held for sale, $2.8 million were originated
by WFG and $3.1 million were originated by the Banks retail real estate division,
compared to $3.8 million originated by WFG and $4.5 million originated from the
Banks retail real estate division at December 31, 2003. 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.

16

---

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 loans were $109.0
million, or 60.00% of the consumer loan portfolio and 19.60% of the total loan portfolio
at June 30, 2004. At December 31, 2003, indirect loans were $105.6 million, or 61.27% of
the consumer loan portfolio and 20.79% of the total loan portfolio.

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

|(Dollars in thousands)                           | June 30, 2004 | December 31, 2003 |  
|------------------------------------------------ | ------------- | ----------------- | -
|Nonaccrual loans                                 |               |                   | $
|Restructured loans                               |               |                   |  
|                                                 |               |                   |  
|Total nonperforming loans                        |               |                   |  
|Other real estate owned                          |               |                   |  
|                                                 |               |                   |  
|Total nonperforming assets                       |               |                   | $
|                                                 |               |                   |  
|Impaired loans                                   |               |                   | $
|Accruing loans past due > 90 days                |               |                   |  
|Potential problem loans                          |               |                   |  
|Allowance for loan losses                        |               |                   |  
|Nonperforming loans to loans (1)                 |               |                   |  
|Allowance for loan losses to loans (1)           |               |                   |  
|Allowance for loan losses to nonperforming loans |               |                   |  
|Nonperforming assets to total assets             |               |                   |  
|                                                 |               |                   |  

(1)Excludes loans held for sale

Nonperforming loans increased to $4.8
million, or 0.89% of loans (excluding loans held for sale), at June 30, 2004 from $4.2
million, or 0.83% of loans (excluding loans held for sale), at December 31, 2003. The
current allowance for loan losses of $6.9 million represents 143.43% of nonperforming
loans as compared to 147.09% of nonperforming loans at December 31, 2003. The allowance
for loan losses is 1.28% of loans (excluding loans held for sale) at June 30, 2004 as
compared to 1.22% at December 31, 2003. A loan in the amount of $2.6 million listed as
impaired since December 2003 has been removed from impaired status. The balance has been
significantly reduced and the credit is performing. Due to subsequent events since quarter
end, nonaccraul loans have been reduced by $1.2 million from $4.8million to $3.6 million
as of the date of this report.

Provision and Allowance for Loan
Losses.The Company recorded a $775,000 provision for loan losses for the second
quarter of 2004, compared with $837,000 for the like period a year ago. Net loan
charge-offs were $329,000, representing 0.06% of average loans (excluding loans held for
sale), for the second quarter of 2004, compared with $765,000, or 0.17% of average loans
(excluding loans held for sale), for the like period last year.

For the six months ended June 30,
2004 and 2003, the Company recorded a $1.6 million provision for loan losses in both
periods. The Company recorded $790,000 in net loan charge-offs, representing 0.15% of
average loans (excluding loans held for sale) during the first six months of 2004,
compared with $1.2 million or 0.26% for the like period in 2003.

Indirect 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 an
analysis of the Companys indirect and other net charge-offs to average loans:

|                                                   | Three Months EndedJune 30 | Six Months EndedJune 30
|-------------------------------------------------- | ------------------------- | -----------------------
|
|Indirect net charge-offs                           |                           |                        
|Other net charge-offs                              |                           |                        
|                                                   |                           |                        
|Total net charge-offs                              |                           |                        
|                                                   |                           |                        
|Average indirect loans                             |                           |                        
|Average other loans (1)                            |                           |                        
|                                                   |                           |                        
|Total average loans (1)                            |                           |                        
|                                                   |                           |                        
|Indirect net charge-offs to average indirect loans |                           |                        
|Other net charge-offs to average other loans (1)   |                           |                        
|Net charge-offs to average loans (1)               |                           |                        

(1)Excludes loans held for sale

Net loan charge-offs attributed to
indirect loans were $244,000, representing 69.32% of net consumer charge-offs during the
second quarter of 2004, compared to $252,000 or 92.65% of net consumer charge-offs for the
like period in 2003. For the six months ended June 30, 2004, net charge-offs attributed to
indirect dealer loans were $534,000, or 73.35% of net consumer charge-offs, as compared
with $448,000, or 77.64%, for the like period in 2003.

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 provision 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:

18

---

|                               | Three Months EndedJune 30 | Six Months EndedJune 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       |                           |                        
|                               |                           |                        

While management believes that it
uses the best information available to determine the allowance for loan losses, unforeseen
market conditions could result in adjustments to the allowance for loan losses, and net
income could be significantly affected if circumstances differ substantially from the
assumptions used in making the final determination. Management anticipates that normal
growth of the loan portfolio may require continued increases in 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 relationships 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 June 30
|------------------------------- | --------------------------
|
|
|Interest-bearing demand and     |                           
|money market deposits           |                           
|Savings deposits                |                           
|CDs                             |                           
|                                |                           
|Total interest-bearing deposits |                           
|Demand and other                |                           
|noninterest-bearing deposits    |                           
|                                |                           
|Total average deposits          |                           
|                                |                           

19

---

Average balances in
noninterest-bearing deposits increased 23.2% in the second quarter of 2004 compared to the
second quarter of 2003. For the same period, average balances in total interest-bearing
deposits increased 12.3%, while the smallest portion of the increase was in the higher
cost CDs.

# 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. Due to FIN 46R, the Trust was
deconsolidated in current period financial statements.

Deposits.Total deposits increased 11.3% to $558.0 million at June 30, 2004 from
          $501.5 million at December 31, 2003. Certificates of deposit are the only
          deposit group that has stated maturity dates. At June 30, 2004, the Company had
          $215.0 million in CDs, of which approximately $125.0 million, or 58.11%, are
          scheduled to mature within one year. Management anticipates that a sizable
          portion of outstanding CDs will renew upon maturity.

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.

Borrowings.At June 30, 2004 the Company had a line of credit with the FHLB of $94.8
          million, of which $7.5 million was advanced in short-term borrowings and $4.0
          million in federal funds. The Company also had unused lines of credit with
          correspondent banks in the amount of $27.0 million at June 30, 2004.

Investments.The Companys total portfolio of investment securities decreased 36.2%
          to $19.3 million at June 30, 2004 from $30.2 million at December 31, 2003. The
          Company transferred its held-to-maturity municipal security portfolio of $14.3
          million to available-for-sale investments. Available-for-sale investments are
          recorded at market value and this transfer caused an increase in accumulated
          other comprehensive income of $272,000. During the second quarter of 2004, $5.8
          million were sold to help reposition the Companys liability sensitive
          balance sheet against the anticipation of a rising rate environment. 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.

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The following table summarizes the
amortized cost, market value and recorded value of securities in the Companys
portfolio by contractual maturity groups:

|                  | June 30, 2004
|----------------- | -------------
|
|Amounts maturing: |              
|Within one year   |              
|One to five years |              
|Six to ten years  |              
|Over ten years    |              
|                  |              
|Total             |              
|                  |              

At June 30, 2004, the Companys
investment portfolio consisted of no held-to-maturity investments, as compared with $14.7
million, or 48.88% at December 31, 2003. Available-for-sale securities, which are carried
at market value, were $19.3 million, or 100.0% of the investment portfolio as compared
with $15.4 million, or 51.12% at December 31, 2003. In the second quarter of 2004, the
Company changed the designation of the municipal securities from held-to-maturity to
available-for-sale. 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 market value.

During the second quarter of 2004,
the Bank made a $10.0 million investment in bank owned life insurance (BOLI).
These policies insure the lives of officers of the Bank, and names the Bank as
beneficiary. Noninterest income is generated tax-free from the increase in the
policies underlying investments made by the insurance company. WIB is capitalizing
on the ability to partially offset costs associated with employee compensation and benefit
programs with the BOLI.

# Capital and Capital
Ratios

The Companys shareholders
equity increased to $46.3 million at June 30, 2004 from $44.4 million at December 31,
2003. This increase is due to net income of $2.3 million, proceeds from stock options
exercised in the amount of $155,000, stock option compensation of $11,000 and an increase
in unrealized gain on available-for-sale securities (net of tax) of $141,000, offset by
the payment of cash dividends of $735,000 during the first six months of 2004. Total
assets increased to $633.5 million at June 30, 2004 from $581.7 million at December 31,
2003, an increase of 8.9%. Shareholders equity to total assets was 7.3% at June 30,
2004 compared to 7.6% at December 31, 2003.

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.

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 June 30, 2004 and December 31, 2003:

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|                                | FDIC Requirements | Actual Ratios
|------------------------------- | ----------------- | -------------
|
|Total risk-based capital ratio  |                   |              
|Consolidated                    | 8%                | 10%          
|Whidbey Island Bank             | 8%                | 10%          
|Tier 1 risk-based capital ratio
|Consolidated                    | 4%                | 6%           
|Whidbey Island Bank             | 4%                | 6%           
|Leverage ratio                 
|Consolidated                    | 4%                | 5%           
|Whidbey Island Bank             | 4%                | 5%           

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

The Company purchased a building
commonly known as the Bayshore building located in Oak Harbor, WA. The building was
purchased as a new operations center to consolidate back office functions and improve
efficiencies.

# Significant Accounting
Policies

See Notes to Condensed
Consolidated Financial Statements.

# Anticipated Future
Performance

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. In making
the following statements, management has made a number of assumptions including that: (1)
the interest rate environment will gradually increase throughout the remainder of 2004,
(2) the local economy will continue on a steady course of improvement, and (3) residential
real estate loan volumes will decline from 2003.

WBCO expects to continue its growth
strategy and expand its presence in the Pacific Northwest. The Companys commitment
to maintaining asset quality, improving operating efficiency, being attentive to customer
satisfaction and maximizing shareholder value remains strong. WBCO has identified
long-term performance measurement targets. Those targets include a return on equity in
excess of 18%, an efficiency ratio in the mid-50% range, earnings per share growth of at
least 10% per year, and dividend growth of at least 8% annually. Management does not
expect to attain these targets in the short-term, but rather measures its business plan
progression against these long-term goals.

Management anticipates that 2004
performance will be affected by a number of factors. A primary consideration, and one that
is subject to uncertainty, is the stability of the economy. In managements opinion,
the Company is in a transition from that of heavy residential mortgage loan volumes into a
period of increasing commercial lending activity. In light of this transition and an
expected increase in competition for loans, management believes that the Company will
achieve loan growth in the range of 10%  15% for the year 2004.

The Company is projecting a modest
increase in deposits for 2004. If deposit rate repricing is required to maintain deposits
or should rates increase more than expected, the net interest margin could be negatively
impacted due to the Companys current position of being slightly liability sensitive.
Other unexpected changes, such as significant changes in the economy, substantial credit
deterioration, or depositors moving sizeable amounts of their funds back into the stock
market, could also affect the anticipated performance of the Company.

Residential real estate loan volumes
have declined from the high volumes experienced in recent years, and therefore have
generated less fee income. WFG, the Companys wholesale lending subsidiary, continued
to negatively impact earnings. In response, the Company closed WFG during the second
quarter of 2004.

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Management had expected WFG to
contribute to 2004 earnings when earnings growth projections were identified earlier in
the year. Considering the impact caused by the closure and losses of the mortgage
subsidiary, and given the preceding assumptions, management expects that it will be
difficult to substantially increase profits over 2003. The Bank has a large portion of
market share in Island County, which is where the Company was founded and has an
established identity and reputation within the community. Management believes there are
significant opportunities to gain a larger share of the market in the other three counties
where the branches are still relatively young and not as well known. Opportunities will be
pursued while applying credit discipline and deliberate analysis to ensure quality growth.

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

# 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 June 30, 2004,
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, 2003. 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, 2003 filed with the SEC on March 24, 2004.

# 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.

23

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# PART II

# Item 2.
Changes in Securities and Use of Proceeds

(a)    (e) Not applicable

# Item 4.  Submission of
Matters to a Vote of Security Holders

The annual  meeting of  shareholders
 was held at Oak Harbor,  Washington at 3:00 p.m. on April 29, 2004. The total number of
shares of common stock were  4,746,637 and were  represented  in person or by proxy at
the meeting.  This represented  88% of the  5,401,274  shares held by  shareholders  as
of March 10, 2004 and  entitled to vote at the meeting.  The following issue came before
the shareholders for vote:

| | Election
 of  directors  to  serve  on the  Board  of  Directors  until  the  annual  meeting  of
         shareholders  in the year 2007, or until their  successors are duly elected and
qualified - three          of the nine  director  position  terms had expired and were
open for  election.  The nominees for          these  positions  were Michal D. Cann;
 Jerry C. Chambers;  and Marlen L. Knutson,  who were each          elected with the
following vote totals:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                   | For       | Against | Withheld
| | ----------------- | --------- | ------- | --------
| | Michal D. Cann    | 4,721,050 | 0       | 25,587  
| | Jerry C. Chambers | 4,720,321 | 0       | 26,316  
| | Marlen L. Knutson | 4,716,372 | 0       | 30,265  

The other six directors who continue
in office are: Karl C. Krieg, III; Jay T. Lien; Robert B. Olson; Anthony B. Pickering;
Alvin J. Sherman; and Edward J. Wallgren.

# Item 5.
Other Information

(a)     Not applicable

(b)     There have been no material
 changes in the procedures for shareholders to nominate directors to the Companys board.

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

(a)     Exhibits

31.1     Certification
 of Chief Executive Officer required by Rule 13a-14(b) or Rule 15d-14(a) and Section 302 of the                    
 Sarbanes Oxley Act of 2002

31.2     Certification
 of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(a) and Section 302 of the                    
 Sarbanes Oxley Act of 2002

32.1     Certification
 of Chief Executive Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the                    
 Sarbanes Oxley Act of 2002, 18 U.S.C. Section 1350

32.2     Certification
 of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the                    
 Sarbanes Oxley Act of 2002, 18 U.S.C. Section 1350

(b)     Reports on Form 8-K

During the quarter ended June 30,
2004, the Company filed two reports on Form 8-K. The first 8-K filed during the quarter
announced the release of the Companys first quarter 2004 earnings and the second
quarter cash dividend and was filed on May 3, 2004. The second Form 8-K contained the
Companys press release announcing the Companys intent to close WFG, and was
filed on June 16, 2004.

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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: August 13, 2004 | By | /s/ Michal D. Cann                                                
|--------------------- | -- | ------------------------------------------------------------------
|                      |    |                                                                   
|                      |    | Michal D. Cann      President and  Chief Executive Officer        
|                      |    |                                                                   
|Date: August 13, 2004 | By | /s/ Phyllis A. Hawkins                                            
|                      |    |                                                                   
|                      |    | Phyllis A. HawkinsSenior Vice President andChief Financial Officer

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