UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ Quarterly report pursuant to Section 13 or l5(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2006

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission File Number 000-24503

WASHINGTON BANKING COMPANY

(Exact name of registrant as specified in its charter)

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

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

(360) 679-3121
(Registrant’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 registrant: (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 þ No o

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o                     Accelerated filer þ                     Non-Accelerated filer o

Indicate by check mark if the registrant is a shell company as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Yes o No þ

The number of shares of the issuer’s Common Stock outstanding at October 31, 2006 was 9,288,336.

Table of Contents

		Page
PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Statements of Financial Condition — September 30, 2006 and December 31, 2005		1
	Condensed Consolidated Statements of Income — Three and Nine Months Ended September 30, 2006 and 2005		2
	Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income — Nine Months Ended September 30, 2006 and 2005		3
	Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2006 and 2005		4
	Notes to Condensed Consolidated Financial Statements		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		22
Item 4.	Controls and Procedures		22
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings		23
Item 1A.	Risk Factors		23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		23
Item 3.	Defaults Upon Senior Securities		23
Item 4.	Other Information		23
Item 5.	Exhibits		23
	Signatures		24
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

i

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Financial Condition (unaudited)
(Dollars in thousands)

	September 30,			December 31,
	2006			2005
Assets
Cash and due from banks ($2,248 and $3,313, respectively, are restricted)	$	20,062		$	19,949
Interest-bearing deposits		789			983
Federal funds sold		—			21,095
Total cash, restricted cash, and cash equivalents		20,851			42,027
Investment securities available for sale		17,514			19,077
Federal Home Loan Bank stock		1,984			1,984
Loans held for sale		1,940			2,829
Loans receivable		713,638			630,258
Allowance for loan losses		(9,985	)		(8,810	)
Total loans, net		703,653			621,448
Premises and equipment, net		22,024			20,514
Bank owned life insurance		10,831			10,558
Other assets		10,280			7,539
Total assets	$	789,077		$	725,976
Liabilities and Shareholders’ Equity
Liabilities:
Deposits
Noninterest-bearing	$	97,277		$	105,365
Interest-bearing		307,051			287,214
Time deposits		296,392			244,910
Total deposits		700,720			637,489
FHLB overnight borrowings		3,000			—
Other borrowed funds		—			10,000
Junior subordinated debentures		15,007			15,007
Other liabilities		5,915			5,631
Total liabilities		724,642			668,127
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 13,679,757 shares: issued and outstanding 9,285,439 at 9/30/2006 and 9,227,763 at 12/31/2005 (1)		32,934			32,106
Retained earnings		31,573			25,789
Accumulated other comprehensive income		(72	)		(46	)
Total shareholders’ equity		64,435			57,849
Total liabilities and shareholders’ equity	$	789,077		$	725,976

⁽¹⁾ Adjusted to reflect a 5-for-4 stock split distributed by the Company on September 6, 2006

See accompanying notes to condensed consolidated financial statements.

1

WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Income (unaudited)
(Dollars and shares in thousands, except per share data)

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

⁽¹⁾ Adjusted to reflect a 5-for-4 stock split distributed by the Company on September 6, 2006

See accompanying notes to condensed consolidated financial statements.

2

WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Shareholders’ Equity
and Comprehensive Income (unaudited)
(Dollars and shares in thousands, except per share data)

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

⁽¹⁾ Adjusted to reflect a 5-for-4 stock split distributed by the Company on September 6, 2006

See accompanying notes to condensed consolidated financial statements.

3

WASHINGTON BANKING COMPANY
AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows (unaudited)
(Dollars in thousands)

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

See accompanying notes to condensed consolidated financial statements.

4

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine months ended September 30, 2006 and 2005 (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 (the “Company” or “WBCO”) is a registered bank holding company formed on April 30, 1996. At September 30, 2006, 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”). The business of the Bank, which is focused in the northern area of Western Washington, consists primarily of attracting deposits from the general public and originating loans. The region’s economy has evolved from one that was once heavily dependent upon forestry, fishing and farming to an economy with a much more diverse blend of industries including retail trade, services, manufacturing, tourism and a large military base presence. Although the Bank has a diversified loan portfolio, a substantial portion of its borrowers’ ability to repay their loans is dependent upon the economic conditions affecting this area.

(b) Basis of Presentation

The accompanying interim condensed consolidated financial statements include the accounts of WBCO and its subsidiaries described above. The accompanying interim condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“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, 2005 audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC. In management’s opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. In preparing the condensed 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) Reclassifications

Certain amounts in prior year’s financial statements may have been reclassified to conform to the 2006 presentation. These reclassifications had no significant impact on the Company’s financial position or results of operations.

(2) Recent Financial Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, Shared Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. Statement No. 123R supersedes Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS No. 123R requires that the costs resulting from all stock-based compensation be measured at fair value and recognized in the Company’s financial statements. Application of the Statement is effective for reporting periods after December 15, 2005. The Company has adopted SFAS No. 123R effective January 1, 2006. For further details on the impact to the Company’s financial statements please refer to Note (4)- Stock-Based Compensation.

In February 2006, FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. SFAS No. 155 resolves issues addressed in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of SFAS No. 155 to have a material impact on its financial statements.

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine months ended September 30, 2006 and 2005 (unaudited)
(Dollars in thousands, except per share data)

In March 2006, FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, which amended FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 permits an entity to reclassify certain available-for-sale securities to trading securities, regardless of the restriction in paragraph 15 of Statement No. 115, provided that those available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value. SFAS No. 156 is effective at the date an entity adopts the requirements of this Statement. The adoption of SFAS No. 156 had no material impact on the Company’s financial statements.

(3) Earnings Per Share

On September 6, 2006 the Company issued a 5-for-4 stock split to shareholders of record as of August 21, 2006. All periods presented have been restated to reflect the stock split.

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

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
Weighted average shares-basic		9,239,732		9,114,460		9,216,354		9,086,169
Effect of dilutive securities: stock awards		285,025		337,969		273,466		328,630
Weighted average shares-diluted		9,524,757		9,452,429		9,489,820		9,414,799

At September 30, 2006 and 2005, there were options to purchase 430,756 and 503,625 shares of common stock outstanding, respectively. For the nine months ended September 30, 2006 and 2005 no options were antidilutive and therefore all were included in the computation of diluted net income per share.

(4) Stock-Based Compensation

On January 1, 2006, the Company adopted the provisions of SFAS 123R, Share Based Payment, requiring the Company to recognize expense related to the fair value of stock option awards. The Company elected to use the modified prospective transition method as permitted by SFAS 123R and therefore has not restated the financial results for prior periods. Under this transition method, stock option compensation expense for the nine months ended September 30, 2006 includes compensation expense for all stock option compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. Stock option compensation expense for all stock option compensation awards granted subsequent to January 1, 2006 was based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes compensation expense for stock option awards on a straight-line basis over the requisite service period of the award.

For the three and nine months ended September 30, 2006 the Company recognized $22 and $70, respectively, in stock option compensation expense as a component of salaries and benefits. As of September 30, 2006 there was approximately $221 of total unrecognized compensation cost related to nonvested options.

6

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine months ended September 30, 2006 and 2005 (unaudited)
(Dollars in thousands, except per share data)

Prior to the adoption of SFAS 123R, the Company applied SFAS No. 123, amended by SFAS No. 148, “Accounting for Stock-Based Compensation —Transition and Disclosure” (“SFAS 148”), which allowed companies to apply the existing accounting rules under APB 25 and related Interpretations. In general, as the exercise price of options granted under these plans was equal to the market price of the underlying common stock on the grant date, no stock-option employee compensation cost was recognized in the Company’s net income. As required by SFAS 148 prior to the adoption of SFAS 123R, the Company provided pro forma net income and pro forma net income per common share disclosures for stock-option awards, as if the fair-value-based method defined in SFAS 123 had been applied. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the three and nine month periods ended September 30, 2005:

	September 30, 2005
	Three Months Ended			Nine Months Ended
Net income, as reported	$	2,679		$	7,071
Stock compensation recognized, net of tax		4			12
Additional compensation for fair value of stock options, net of tax		(15	)		(44	)
Pro forma net income	$	2,668		$	7,039
Basic earnings per share:
Net income, as reported	$	0.30		$	0.78
Net income, pro forma	$	0.30		$	0.78
Diluted earnings per share:
Net income, as reported	$	0.28		$	0.75
Net income, pro forma	$	0.28		$	0.75

The Company measures the fair value of each stock option grant at the date of the grant, using the Black Scholes option pricing model. The weighted average grant date fair value of options granted during the nine months ended September 30, 2006, was $5.98 per share. There were no stock options issued during fiscal year 2005. The following assumptions were used in arriving at the fair value of options granted during the nine months ended September 30, 2006:

	2006
Risk-free interest rate		4.95	%
Dividend yield rate		1.40	%
Price volatility		38.13	%
Expected life of options	7 years

7

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine months ended September 30, 2006 and 2005 (unaudited)
(Dollars in thousands, except per share data)

				Weighted		Weighted average
				average		remaining		Aggregate
				exercise price		contractual terms		intrinsic
	Shares			per share		(in years)		value
Outstanding at January 1, 2006		441,624		$	4.79
Granted		31,100			14.59
Exercised		(40,411	)		3.40			$	461
Forfeited, expired or cancelled		(1,557	)		8.58
Outstanding at September 30, 2006		430,756		$	5.61		3.75	$	5,272
Exercisable at September 30, 2006		348,475		$	4.83		2.92	$	4,537

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between the Company’s closing stock price on September 30, 2006 and the exercise price, times the number of shares) that would have been received by the option holders had all the option holders exercised their options on September 30, 2006. This amount changes based upon the fair market value of the Company’s stock.

The Company grants restricted stock periodically for the benefit of employees. Recipients of restricted stock do not pay any cash consideration to the Company for the shares and receive all dividends with respect to such shares, whether or not the shares have vested. Restrictions are based on continuous service.

The following table summarizes information on restricted stock activity during the nine months ended September 30 2006:

						Weighted average
				Weighted average		remaining
				grant price per		contractual terms
	Shares			share		(in years)
Outstanding at January 1, 2006		43,374		$	11.01
Granted		18,624			13.36
Vested		(11,349	)		10.92
Forfeited, expired or cancelled		(872	)		11.77
Outstanding at September 30, 2006		49,777		$	11.89		3.12

For the three and nine months ended September 30, 2006 the Company recognized $45 and $120, respectively, in restricted stock compensation expense as a component of salaries and benefits. As of September 30, 2006 there was $502 of total unrecognized compensation costs related to non-vested restricted stock, which is expected to be recognized over a weighted-average period of 3.12 years.

8

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine months ended September 30, 2006 and 2005 (unaudited)
(Dollars in thousands, except per share data)

(5) Income Taxes

Income tax expense attributable to income for the three and nine months ended September 30, 2006 and 2005 consisted of the following:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
Federal:
Current tax expense	$	1,023		$	1,683		$	4,185		$	4,253
Deferred tax expense (benefit)		(20	)		(444	)		(702	)		(838	)
Total	$	1,003		$	1,239		$	3,483		$	3,415

The Company’s effective tax rate varies from the federal income tax statutory rates of 34.4% in 2006 and 34.3% in 2005. A reconciliation of the differences for the three and nine months ended September 30, 2006 and 2005 is as follows:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
Income tax expense at federal statutory rates	$	1,273		$	1,344		$	3,874		$	3,597
Federal tax credits		(300	)		—			(300	)		—
Tax-exempt securities		(73	)		(73	)		(222	)		(216	)
Other items		103			(32	)		131			34
Total	$	1,003		$	1,239		$	3,483		$	3,415

The effective tax rate for 2006 is impacted by Federal tax credits related to the New Markets Tax Credit program whereby a subsidiary of Whidbey Island Bank has been awarded $3.1 million in future Federal tax credits which are available through 2012. Tax benefits related to these credits will be recognized for financial reporting purposes in the same periods that the credits are recognized in the Company’s income tax returns. The credit that is available for the year ending December 31, 2006 is $400. The Company believes that it will comply with the various regulatory provisions of the New Markets Tax Credit program in 2006, and therefore has reflected the impact of the credits in its estimated annual effective tax rate for 2006.

The components of deferred income tax included in other assets in the accompanying consolidated financial statements at September 30, 2006 and December 31, 2005 are as follows:

	September 30,		December 31,
	2006		2005
Deferred tax assets:
Loan loss allowances	$	3,435	$	3,022
Deferred compensation		350		310
Other		24		61
Market value adjustment of investment securities available for sale		39		25
Total deferred tax assets		3,848		3,418
Deferred tax liabilities:

9

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine months ended September 30, 2006 and 2005 (unaudited)
(Dollars in thousands, except per share data)

	September 30,		December 31,
	2006		2005
Deferred loan fees		1,477		1,799
Premises and equipment		407		505
FHLB stock		150		149
Prepaid expenses		140		111
Other		103		—
Total deferred tax liabilities		2,277		2,564
Deferred tax assets, net	$	1,571	$	854

There was no valuation allowance for deferred tax assets as of September 30, 2006 or December 31, 2005. The Company has determined that it is not required to establish a valuation allowance for the deferred tax assets as management believes it is more likely than not that the deferred tax assets will be realized in the normal course of business.

(6) Subsequent Event

On October 24, 2006, the Company announced that its Board of Directors declared a cash dividend of $0.05 per share to shareholders of record as of November 6, 2006, payable on November 21, 2006.

(7) Commitments and Guarantees

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 September 30, 2006. The Company routinely charges a fee for these credit facilities. Such fees are amortized into income over the life of the agreement, and unamortized amounts are not significant as of September 30, 2006. As of September 30, 2006 the commitments under these agreements were $2,113.

At September 30, 2006, the Company was the guarantor of trust preferred securities. The Company has issued junior 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 junior 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 September 30, 2006.

10

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

Note Regarding Forward-Looking Statements: This Quarterly Report on 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: (1) local and national general and economic condition; (2) changes in interest rates and their impact on net interest margin; (3) competition among financial institutions; (4) legislation or regulatory requirements; and (5) the ability to realize efficiencies expected from 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 (referred to in this report as the “Company”) is a registered bank holding company with two wholly-owned subsidiaries: Whidbey Island Bank (the “Bank”), the Company’s principal subsidiary and Washington Banking Capital Trust I (the “Trust”). 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.

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. The Company’s primary objectives are to improve profitability and operating efficiencies, increase market penetration in areas currently served, and to continue an expansion strategy in appropriate market areas.

Summary of Critical Accounting Policies

Significant accounting policies are described in Note (1) of the Notes to Consolidated Financial Statements for the year ended December 31, 2005 as filed in Form 10-K. Not all of these accounting policies require management to make difficult, subjective or complex judgments or estimates. Management believes that the following accounting policies could be considered critical under the SEC’s definition.

Allowance for Loan Losses: There have been no material changes in the accounting policy relating to allowance for loan losses as compared to that contained in Note (1) of the Notes to Consolidated Financial Statements for the year ended December 31, 2005 as filed in Form 10-K.

Stock-based Compensation: Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share Based Payment, a revision to the previously issued guidance on accounting for stock options and other forms of equity-based compensation. Additional information is included in Note 4 of the Notes to Condensed Consolidated Financial Statements of this report.

11

Results of Operations Overview

The Company’s net income was flat at $2.6 million or $0.28 per diluted share, in the third quarter of 2006, compared with $2.7 million or $0.28 per diluted share in the third quarter of 2005. Return on average equity decreased to 16.69% in the third quarter of 2006, compared with 19.66% in the corresponding quarter of 2005.

For the first nine months of 2006, net income increased 9% to $7.7 million and diluted earnings per share increased to $0.81, compared with $7.1 million or $0.75 per diluted share for the same period last year. Return on average equity decreased 130 basis points to 16.92% for the first nine months of 2006, compared with 18.22% last year.

Net Interest Income: One of the Company’s key sources of earnings is net interest income. To make it easier to compare results among several periods and the yields on various types of earning assets (some of which are taxable and others which are not), net interest income is presented in this discussion on a “taxable-equivalent basis” (i.e., as if it were all taxable at the same rate). There are several factors that affect net interest income including:

• The volume, pricing, mix and maturity of interest-earning assets and interest-bearing liabilities;

• The volume of free funds (consisting of noninterest-bearing deposits and other liabilities and shareholders’ equity);

• The volume of noninterest-earning assets;

• Market interest rate fluctuations; and

• Asset quality

12

The following tables set forth various components of the balance sheet that affect interest income and expense, and their respective yields or rates:

Average Balance Sheet and Analysis of Net Interest Income and Yields/Rates

	Three Months Ended							Three Months Ended
	September 30, 2006							September 30, 2005
	Average		Interest		Average			Average		Interest		Average
(Dollars in thousands)	balance		earned/paid		yield			balance		earned/paid		yield
Assets
Loans (1) (2)	$	697,972	$	14,199		8.07	%	$	618,042	$	11,410		7.32	%
Federal funds sold		4,740		63		5.27	%		24,964		217		3.45	%
Interest-earning cash		759		20		10.46	%		816		7		3.40	%
Investments:
Taxable		11,744		97		3.28	%		14,180		100		2.80	%
Non-taxable (2)		7,271		114		6.22	%		6,854		118		6.83	%
Interest-earning assets		722,486		14,493		7.96	%		664,856		11,852		7.07	%
Noninterest-earning assets		52,534							50,494
Total assets	$	775,020						$	715,350
Liabilities and Shareholders’ Equity
Deposits:
Interest demand and money market	$	238,097	$	1,258		2.10	%	$	241,386	$	653		1.07	%
Savings		55,947		111		0.79	%		56,857		112		0.78	%
CDs		289,908		3,246		4.44	%		229,491		1,835		3.17	%
Interest-bearing deposits		583,952		4,615		3.14	%		527,734		2,600		1.95	%
Federal funds purchased		2,267		31		5.43	%
Junior subordinated debentures		15,007		351		9.28	%		15,007		278		7.35	%
Other borrowed funds		978		14		5.68	%		10,043		97		3.83	%
Interest-bearing liabilities		602,204		5,011		3.30	%		552,784		2,975		2.14	%
Noninterest-bearing deposits		103,643							103,346
Other noninterest-bearing liabilities		6,383							5,163
Total liabilities		712,230							661,293
Shareholders’ equity		62,790							54,057
Total liabilities and shareholders’ equity	$	775,020						$	715,350
Net interest income			$	9,482						$	8,877
Net interest spread						4.67	%						4.93	%
Net interest margin						5.22	%						5.30	%

(1)

Average balance includes nonaccrual loans.

(2)

Interest income on non-taxable investments and loans is presented on a taxable-equivalent basis using the federal statutory rate of 35%. These adjustments were $57 and $64 for the three months ended September 30, 2006 and 2005, respectively. Taxable-equivalent is a Non GAAP performance measurement that management believes provides investors with a more accurate picture of the net interest margin and efficiency ratio for comparative purposes.

13

Average Balance Sheet and Analysis of Net Interest Income and Yields/Rates

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

(1)

Average balance includes nonaccrual loans.

(2)

Interest income on non-taxable investments and loans is presented on a taxable-equivalent basis using the federal statutory rate of 35%. These adjustments were $190 and $185 for the nine months ended September 30, 2006 and 2005, respectively. Taxable-equivalent is a Non GAAP performance measurement that management believes provides investors with a more accurate picture of the net interest margin and efficiency ratio for comparative purposes.

14

Taxable-equivalent net interest income of $9.5 million in the third quarter of 2006 was 7% higher than in the corresponding quarter in 2005. There were two principal causes of this growth in the third quarter of 2006: an increase in average earning assets due to strong loan growth in commercial real estate and construction loans; and a higher yield on earnings assets, which increased 89 basis points to 7.96% from 7.07% in the same period in 2005. However, the interest rate spread contracted 26 basis points from the third quarter of 2005 as a result of competitive pressure on loan and deposit pricing during the third quarter of 2006. This pricing pressure caused the average cost of interest-bearing liabilities to increase 116 basis points from the corresponding quarter in 2005. These changes caused the net interest margin to decrease 8 basis points in the third quarter of 2006 to 5.22% from 5.30% in the same period last year. The Company expects moderate net interest margin erosion during the fourth quarter of 2006.

Taxable-equivalent net interest income for the first nine months of 2006 rose 12% to $28.0 million, compared with $25.1 million last year. This increase was primarily due to a higher net interest margin for the first nine months of 2006, which increased 10 basis points to 5.38% over last year. However, the interest rate spread decreased compared to last year by 8 basis points to 4.88% for the first nine months of 2006 as a result of competitive pressure on loan and deposit pricing. This pricing pressure caused the average cost of interest-bearing liabilities to increase 92 basis points as compared to the prior year.

The following table shows how changes in yields or rates and average balances affected net interest income for the third quarters of 2005 and 2006, as well as the first nine months of 2005 and 2006:

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

(1)	Interest on loans and investments is presented on a fully tax-equivalent basis.
(2)	The changes attributable to the combined effect of volume and interest rates have been allocated proportionately.
(3)	Interest income previously accrued on nonaccrual loans is reversed in the period the loan is placed on nonaccrual status.

15

Noninterest Income: Noninterest income in the third quarter of 2006 decreased 13% to $1.7 million compared to $2.0 million in the corresponding quarter of 2005. Changes in noninterest income were primarily due to an $139,000 decline in SBA premiums and an $112,000 decline in income from the sale of loans as compared to the corresponding quarter in 2005. Additionally, annuity income, a component of other noninterest income, decreased $90,000 in the third quarter of 2006, as compared to the third quarter of 2005. These decreases were offset by an increase in electronic banking fees, a component of other noninterest income, of $66,000.

Noninterest income of $5.3 million for the first nine months of 2006 declined 4%, compared with $5.5 million in the same period last year. Changes in noninterest income in the first nine months of 2006 were primarily due to increases in service charges and fees of $175,000 and electronic banking fees of $210,000 as compared to the first nine months of 2005. These increases in noninterest income were offset by declines in annuity sales of $343,000, SBA premiums of $227,000 and income from the sale of loans of $165,000 as compared to last year.

Noninterest Expense: Noninterest expense of $6.8 million in the third quarter of 2006 was $419,000 higher than the corresponding quarter of 2005. Salaries and benefits for the third quarter of 2006 increased $459,000 due to an increase in full time equivalent employees (“FTE”). These additions were primarily front office personnel. Consulting and professional fees increased $21,000 in the third quarter of 2006. The efficiency ratio increased to 60.28% for the third quarter of 2006 compared to 58.30% for the corresponding quarter in 2005.

Noninterest expense for the first nine months of 2006 was $19.8 million, a 7% increase over last year. The increase was principally attributed to an increase in salaries and benefits of $1.5 million, linked with the increase in FTEs. The Company’s FTEs increased to 324 at September 30, 2006 from 290 at September 30, 2005. The efficiency ratio improved for the first nine months of 2006 to 59.67% compared to 60.29% in the first nine months of 2005.

Income Taxes: The Company’s consolidated effective tax rates for the third quarters of 2006 and 2005 were 27.5% and 31.6%, respectively. The effective tax rate for the first nine months of 2006 was 31.2%, and 32.6% for the corresponding period in 2005. The effective tax rates are below the federal statutory rate of 35% principally due to nontaxable income generated from investments in bank owned life insurance, tax-exempt municipal bonds and loans. Additionally, the Company’s third quarter 2006 tax rate reflects a benefit from the New Market Tax Credit Program whereby a subsidiary of Whidbey Island Bank has been awarded approximately $3.1 million in future federal tax credits. The tax benefits related to these credits will be recognized in the same periods that the credits are recognized on the Company’s income tax returns.

Financial Condition Overview

Total assets were $789.1 million at September 30, 2006, an increase of $63.1 million from December 31, 2005. During the first nine months of 2006 the Company continued to focus on growing the loan and deposit portfolios. Loans at September 30, 2006 grew 13% to $713.6 million compared to December 31, 2005. Deposits at September 30, 2006 were $700.7 million, an increase of 10% from December 31, 2005.

Loans: Total loans outstanding as of September 30, 2006 were $713.6 million, an increase of $83.4 million from December 31, 2005. The total loan portfolio at September 30, 2006 represented 90% of total assets as compared to 87% of total assets at December 31, 2005. The increase reflects continued market demand for real estate related loan products in the Company’s markets. Real estate mortgages and real estate construction represents 37% and 46%, respectively, of the year to date growth in the loan portfolio.

16

Active portfolio management has resulted in a diversified portfolio that is not heavily concentrated in any one industry or community. The following table further details the major components of the loan portfolio:

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

Allowance for Loan Losses: The allowance for loan losses at September 30, 2006 was $10.0 million or 1.40% of total loans and 266% of total non-performing loans. This compares with an allowance of $8.8 million or 1.40% of total loans and 408% of total non-performing loans at December 31, 2005.

The allowance for loan losses is maintained at a level considered adequate by management to provide for loan losses inherent in the portfolio. The Company assesses the allowance on a quarterly basis. The evaluation of the allowance is based on a continuing assessment of nonperforming assets, recent and historical loss experience, and other factors, including regulatory guidance and economic factors. While the Company 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. The Company anticipates that normal growth of the loan portfolio will require continued increases in the allowance for loan losses. The following table details the activity of the allowance for loan losses:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands)	2006			2005			2006			2005
Balance at beginning of period	$	9,606		$	8,554		$	8,810		$	7,903
Charge-offs:
Commercial		(285	)		(145	)		(751	)		(285	)
Real estate		—			(1	)		(86	)		(29	)
Consumer:
Direct		(67	)		(158	)		(261	)		(343	)
Indirect		(161	)		(329	)		(562	)		(764	)
Total charge-offs	$	(513	)	$	(633	)	$	(1,660	)	$	(1,421	)

17

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands)	2006			2005			2006			2005
Recoveries:
Commercial		12			56			313			160
Real estate		3			—			5			131
Consumer:
Direct		37			20			158			72
Indirect		90			46			309			248
Total recoveries	$	142		$	122		$	785		$	611
Net charge-offs		(371	)		(511	)		(875	)		(810	)
Provision for loan losses		750			550			2,050			1,500
Balance at end of period	$	9,985		$	8,593		$	9,985		$	8,593
Indirect net charge-offs to average indirect loans (1)		0.29	%		1.20	%		0.35	%		0.72	%
Other net charge-offs to average other loans (1)		0.20	%		0.18	%		0.15	%		0.08	%
Net charge-offs to average loans (1)		0.21	%		0.33	%		0.17	%		0.18	%

⁽¹⁾ Excludes loans held for sale.

The changes in the allocation of the allowance for loan losses in the first nine months of 2006 were due primarily to changes in the loan portfolio and its mix, changes in the risk grading of loans, and charge-off and recovery activity.

During the third quarter of 2006, the Company recorded a $750,000 provision for loan losses compared to $550,000 for the third quarter in 2005. Net charge-offs for third quarter of 2006 were $371,000, a $140,000 decrease over the third quarter of 2005. This decrease is the result of an unusually high level of indirect charge-offs in the third quarter of 2005.

During the first nine months of 2006, the Company recorded a $2.1 million provision for loan losses compared to $1.5 million for the corresponding period in 2005. Net charge-offs for the first nine months of 2006 rose 8% to $875,000, compared with $810,000 in the same period last year.

The table below details the Company’s allocation of the allowance for loan losses by loan type and remaining unallocated allowances:

	Allocation of the Allowance for Loan Losses as of:
	September 30, 2006								December 31, 2005								September 30, 2005
			% of			% of					% of			% of					% of			% of
(Dollars in thousands)	Amount		Allowance(2)			Loans (1)			Amount		Allowance(2)			Loans (1)			Amount		Allowance(2)			Loans (1)
Balance applicable to:
Commercial	$	786		7.9	%		11.5	%	$	737		8.4	%		12.6	%	$	789		9.2	%		13.3	%
Real estate mortgage		3,250		32.5	%		41.3	%		2,844		32.3	%		41.8	%		2,856		33.2	%		41.4	%
Real estate construction		1,898		19.0	%		21.3	%		1,378		15.6	%		18.0	%		1,358		15.8	%		17.2	%
Consumer		2,541		25.4	%		25.9	%		2,308		26.2	%		27.6	%		2,405		28.0	%		28.1	%
Unallocated		1,510		15.2	%		N/A			1,543		17.5	%		N/A			1,185		13.8	%		N/A
Total	$	9,985		100.0	%		100.0	%	$	8,810		100.0	%		100.0	%	$	8,593		100.0	%		100.0	%

(1)	Represents the total of all outstanding loans in each category as a percent of total loans outstanding.
(2)	Represents the total allowance allocated to each loan category as a percent of total allowance for loan losses.

18

Nonperforming Assets: The table below shows the composition of the Company’s nonperforming assets. These assets total $4.1 million and represented 0.53% of loans compared with $2.2 million, or 0.34% at December 31, 2005. The increase in nonperforming assets for the first nine months of 2006 was primarily the result of one relationship, totaling $2.7 million, being placed on nonaccrual status during the third quarter. This one relationship represented 72% of total loans on nonperforming status.

	Nonperforming Assets as of:
	September 30,			December 31,
(Dollars in thousands)	2006			2005
Nonaccrual loans	$	3,758		$	2,159
Restructured loans		—			—
Total nonperforming loans		3,758			2,159
Other real estate owned		363			—
Total nonperforming assets	$	4,121		$	2,159
Total impaired loans	$	4,121		$	2,159
Accruing loans past due ³ 90 days		—			—
Potential problem loans		—			—
Allowance for loan losses	$	9,985		$	8,810
Nonperforming loans to loans		0.53	%		0.34	%
Allowance for loan losses to nonperforming loans		265.70	%		408.06	%
Allowance for loan losses to nonperforming assets		242.30	%		408.06	%
Nonperforming assets to total assets		0.52	%		0.30	%

Deposits: In the first nine months of 2006, the Company made a concerted effort to attract deposits through competitive pricing and delivery of quality service. Total deposits in the first nine months of 2006 increased 10%, or $63.2 million. Time deposits were the largest portion of the deposit growth, a $51.5 million increase for the period. The following table further details the major components of the deposit portfolio:

	Deposit Composition as of:
	September 30, 2006					December 31, 2005					Change
(Dollars in thousands)	Balance		% of total			Balance		% of total			2006 vs. 2005
Noninterest-bearing demand	$	97,277		13.9	%	$	105,365		16.5	%	$	(8,088	)
NOW accounts		157,820		22.5	%		143,042		22.4	%		14,778
Money market		95,531		13.6	%		84,537		13.3	%		10,994
Savings		53,700		7.7	%		59,635		9.4	%		(5,935	)
Time deposits		296,392		42.3	%		244,910		38.4	%		51,482
Total deposits	$	700,720		100.0	%	$	637,489		100.0	%	$	63,231

Other Borrowings: Other borrowings, comprised of FHLB overnight borrowings and other borrowings, totaled $3.0 million as of September 30, 2006, compared with $10.0 million at December 31, 2005. Other borrowings decreased due to the payoff of a $10.0 million one year borrowing with the FHLB.

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Capital

Shareholders’ Equity: Total shareholders’ equity increased 11% to $64.4 million at September 30, 2006 from $57.8 million at December 31, 2005. This was principally due to the retention of $6.3 million, or approximately 82% of net income for the first nine months, partially offset by an increase in accumulated other comprehensive loss as a result of unrealized loss in the investment portfolio.

Regulatory Capital Requirements: 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 and Bank qualified as “well-capitalized” at September 30, 2006 and December 31, 2005:

	Regulatory Requirements					Actual Ratios
	Adequately-			Well-		September 30,			December 31,
	capitalized			capitalized		2006			2005
Total risk-based capital ratio
Company (consolidated)		8	%		N/A		11.28	%		11.52	%
Whidbey Island Bank		8	%		10%		11.02	%		11.21	%
Tier 1 risk-based capital ratio
Company (consolidated)		4	%		N/A		10.03	%		10.28	%
Whidbey Island Bank		4	%		6%		9.77	%		9.96	%
Leverage ratio
Company (consolidated)		4	%		N/A		10.26	%		10.26	%
Whidbey Island Bank		4	%		5%		10.00	%		9.93	%

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.

Liquidity and Cash Flows

Liquidity: The principal objective of the liquidity management program is to maintain the Bank’s ability to meet the day to day cash flow requirements of its customers who either wish to withdraw funds or draw upon credit facilities to meet their needs.

Management monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. 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. 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 anticipates that the Bank will rely primarily upon customer deposits and investments to provide liquidity in 2006. These funds will be used for loan originations and deposit withdrawals, to satisfy other financial commitments and to support continuing operations. Additional funds are available through established FHLB and correspondent bank lines of credit, which the Bank may use to supplement funding sources.

Consolidated Cash Flows: As disclosed in the Condensed Consolidated Statements of Cash Flows, net cash provided by operating activities was $9.7 million for the first nine months of 2006. Net cash of $85.8 million was used in investing activities consisted principally of $84.7 million in net loan growth. The $55.0 million of cash provided by financing activities consisted principally of $63.2 million in net deposit growth offset by $10.0 million in net repayments of borrowings and $1.4 million in dividends to shareholders.

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Capital Resources:

Off-Balance Sheet Items: The Company is a party to financial instruments with off-balance-sheet risk. Among the off-balance sheet items entered into in the ordinary course of business are commitments to extend credit and the issuance of letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheet. Certain commitments are collateralized. As of September 30, 2006 and December 31, 2005, the Company’s commitments under letters of credit and financial guarantees amounted to $2.1 million and $1.6 million, respectively. Since many of the commitments are expected to expire without being drawn upon, these total commitment amounts do not necessarily represent future cash requirements.

Capital Expenditures and Commitments: The Company entered into an option to purchase agreement for a 70,000 square-foot property located in the Smokey Point / Arlington, WA area for the purpose of relocating the Smokey Point branch, which is currently in leased space. Management completed the purchase of the property in October 2006.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

At September 30, 2006, 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, 2005. Should rates increase, the Company may, or may not be positively impacted due to its current slightly asset sensitive position. For additional information, refer to the Company’s Form 10-K for year ended December 31, 2005 filed with the SEC.

Item 4. Controls and Procedures

Evaluation of Disclosure 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 the Company to take any corrective actions with regard to significant deficiencies or material weaknesses.

Changes in Internal Control over Disclosure and Reporting

There was no change in the Company’s internal control over financial reporting that occurred during the quarterly period ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

The Company may be involved in legal proceedings in the regular course of business. At this time, management does not believe that there is pending litigation resulting in an unfavorable outcome of which would result in a material adverse change to the Company’s financial condition, results of operations or cash flows.

Item 1A. Risk Factors

For information regarding risk factors, please refer to Part I, Item 1A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. There have been no material changes in the Company’s risk factors from those disclosed in the 2005 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     (a) — (c) None

Item 3. Defaults Upon Senior Securities

     None

Item 4. Other Information

(a)	Not applicable
(b)	There have been no material changes in the procedures for shareholders to nominate directors to the Company’s board.

Item 5. Exhibits

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

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SIGNATURES

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

WASHINGTON BANKING COMPANY
Date: November 8, 2006	By	/s/ Michal D. Cann
		Michal D. Cann
		President and Chief Executive Officer
Date: November 8, 2006	By	/s/ Richard A. Shields
		Richard A. Shields
		Executive Vice President and Chief Financial Officer

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