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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)



þ		Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
		For the fiscal year ended December 31, 2007
OR
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		(I.R.S. Employer
incorporation or organization)		Identification Number)

450 SW Bayshore Drive

Oak Harbor, Washington 98277

(Address of principal executive offices) (Zip Code)

Registrant’s Telephone Number, Including Area Code: (360) 679-3121

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, No Par Value

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 and 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 disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (17 C.F.R. 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy of information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, and accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Ruler 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting Company 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 aggregate market value of Common Stock held by non-affiliates of registrant at June 29, 2007 was approximately $153,133,215 based upon the closing price of the registrant’s common stock as quoted on the Nasdaq National Market on June 29, 2007 of $15.15.

The number of shares of registrant’s Common Stock outstanding at March 06, 2008 was 9,465,464.

Documents incorporated by reference and parts of Form 10-K into which incorporated:


Registrant’s definitive Proxy Statement to be filed within 120 days of our 2007 fiscal year end		Part III, except the reports of the audit and compensation committees

Note Regarding Forward-Looking Statements: This Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) may contain forward-looking statements that are subject to risks and uncertainties. These forward-looking statements describe management’s expectations regarding future events and developments such as future operating results, growth in loans and deposits, credit quality and loan losses, and continued success of the Company’s business plan. Readers should not place undue reliance on forward-looking statements, which reflect management’s views only as of the date hereof. The words “anticipate,” “expect,” “will,” “believe,” and words of similar meaning are intended, in part, to help identify forward-looking statements. Future events are difficult to predict, and the expectations described above are subject to risk and uncertainty that may cause actual results to differ materially. 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, factors that may cause actual results to differ materially from those contemplated in these 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; (5) the ability to realize the efficiencies expected from investment in personnel and infrastructure; and (6) successful completion of our previously announced merger with Frontier Financial, the closing of which remains subject to customary closing conditions. Washington Banking Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements were made. Any such statements are made in reliance on the safe harbor protections provided under the Securities Exchange Act of 1934, as amended.

PART I


Item 1.	Business

General

Washington Banking Company (the “Company”) was formed on April 30, 1996 and is a registered bank holding company whose primary business is conducted by its wholly-owned subsidiary, Whidbey Island Bank (the “Bank”). 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 Company and the Bank have formed several subsidiaries for various purposes as follows:

Whidbey Island Bank is a Washington state-chartered bank that conducts a full-service community commercial banking business. The Bank also offers nondeposit managed investment products and services, which are not Federal Deposit Insurance Corporation (“FDIC”) insured. These programs are provided through the investment advisory companies Elliott Cove Capital Management LLC and DFC Services & DFC Insurance Services. Another nondeposit product offered through the Bank, which is not FDIC insured, is a sweep investment option available through a brokerage account.

Washington Banking Capital Trust I (“The Trust”) is a wholly-owned subsidiary of the Company. 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 are the sole revenues of the Trust. The Company has fully and unconditionally guaranteed all obligations of the Trust.

Washington Banking Master Trust (the “Master Trust”) is a wholly-owned subsidiary of the Company. The Master Trust was formed in April 2007 for the exclusive purpose of issuing trust preferred securities. See Note 8- Trust Preferred Securities and Junior Subordinated Debentures for further details.

Rural One, LLC (“Rural One”) is a majority-owned subsidiary of the Bank and is certified as a Community Development Entity by the Community Development Financial Institutions Fund of the United Stated Department of Treasury. Rural One was formed in September 2006, for the exclusive purpose of an investment in Federal tax credits related to the New Markets Tax Credit program.

At December 31, 2007, the Company had total assets of $882.3 million, total deposits of $758.4 million and shareholders’ equity of $73.6 million. A more thorough discussion of the Company’s financial performance appears in Item 7– Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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.

Growth Strategy

On September 26, 2007, the board of directors announced that the Company had entered into a definitive merger agreement with Frontier Financial Corporation (NASDAQ: FTBK) which provides, subject to certain conditions, for a merger of the Company with and into Frontier Financial Corporation and the Bank will merge with and into Frontier Bank, a wholly owned subsidiary of Frontier Financial Corporation. At announcement date the cash and stock transaction was valued at approximately $191.1 million, or $21.40 per share, subject to certain conditions. It is anticipated that the merger will closed in the second quarter of 2008.

Market Areas

The Company’s primary market area currently consists of Island, Skagit, Whatcom, Snohomish and San Juan counties in northwest Washington State. Although the Pacific Northwest is typically associated with industries such as computer technology, aerospace and coffee, the Company’s market encompasses distinct economies that are somewhat removed from the Seattle metropolitan region.

Island County’s largest population center, Oak Harbor, is dominated by a large military presence with naval operations at NAS Whidbey Island. The jobs generated by NAS Whidbey contribute significantly to the county’s economy. Other primary industries providing employment for county residents are: education; health and social services; retail trade; and manufacturing. Due to its natural beauty, the county attracts tourism and has a number of retirement communities.

The economy of Skagit County is primarily comprised of agriculture, fishing, wood products, tourism, international trade, and specialized manufacturing. With its accessible ports and refineries, Skagit County is the center of the state’s petroleum industry.

Whatcom County, which borders Canada, has an economy with a prominent manufacturing base, as well as a significant academic-research and vocational-technical base, as it is the home of Western Washington University, one of Washington’s largest four-year academic centers. The United States Customs and Border Patrol and municipal, county and state governments give Whatcom County an additional employment base.

Snohomish County is one of the fastest growing areas in the state. Industrial sectors include aerospace, biotechnology, and electronics, as well as a military naval base and large retail influences.

The economy of San Juan County is predominantly comprised of retail trade, tourism, finance and insurance, and real estate services. The county is known for its beautiful locale, which attracts many visitors, and serves as a second home to an affluent sector of the population.

Competition

The Company operates in a highly competitive banking environment, competing for deposits, loans and other financial services with a number of larger and well-established commercial banks, savings banks, savings and loan associations, credit unions and other institutions, including nonbanking financial services companies.

Some of the Bank’s competitors are not subject to the same regulations as the Bank; they may have substantially higher lending limits, and may offer certain services that the Bank does not provide. Federal law allows mergers or other combinations, relocations of a bank’s main office and branching across state lines. Recent amendments to the federal banking laws to eliminate certain barriers between banking and commercial firms are expected to result in

even greater competition in the future. Although the Company has been able to compete effectively in its market areas to date, there can be no assurance that the Company’s competitive efforts will continue to be successful.

Executive Officers of the Company

The following table sets forth certain information about the executive officers of the Company:


				Has served as an
				executive officer
				of the Company or
Name	Age		Position	Bank since

Michal D. Cann		59	President and Chief Executive Officer		1992
Joseph W. Niemer		56	Executive Vice President and Chief Credit Officer		2005
Richard A. Shields		48	Executive Vice President and Chief Financial Officer		2004
John L. Wagner		64	Executive Vice President and Chief Operating Officer		2004

Michal D. Cann. Mr. Cann, 59, has been the President and Chief Executive Officer of the Company since its inception in 1996, the President and Chief Executive Officer of the Bank since 1993, and a director of the Bank since 1992. Mr. Cann has over 30 years of banking experience, previously having served as the President of Valley Bank, Mount Vernon, Washington, and in other senior management positions in other banks and a bank holding company.

Joseph W. Niemer. Mr. Niemer, 56, is the Executive Vice President and Chief Credit Officer of the Bank. Mr. Niemer has over 30 years of experience in various credit-related positions with Pacific Northwest-based banks. Most recently, he was the Senior Vice President and Chief Credit Officer for Washington Mutual Bank’s Commercial Group, where he oversaw commercial and commercial real estate credit decisions.

Richard A. Shields. Mr. Shields, 48, is the Executive Vice President and Chief Financial Officer of the Company and the Bank. Mr. Shields joined the Bank in 2004 and has over 20 years of experience in various accounting-related positions with Pacific Northwest-based banks. Most recently, he was the Vice President and Controller at Umpqua Bank that has grown substantially both organically and through multiple acquisitions.

John L. Wagner. Mr. Wagner, 64, is the Executive Vice President and Chief Operating Officer of the Bank. He joined the Bank in 1999 as Senior Vice President and Regional Manager in Whatcom County. In 2002, Mr. Wagner was selected to oversee branch administration and was promoted to COO in 2004. Mr. Wagner has an extensive background in banking and international finance as well as comprehensive administrative experience as former President of Bank of Washington in Bellingham, Washington.

Employees

The Company had 283 full time equivalent employees at December 31, 2007. None of the Company’s employees are covered by a collective bargaining agreement or represented by a collective bargaining group. Management considers its relations with employees to be good.

The Company’s principal subsidiary, Whidbey Island Bank, provides services through nineteen bank branches in five counties located in northwestern Washington. The Company’s executive officers are fully involved and responsible for managing the day-to-day business of the Bank.

Supervision and Regulation

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (“BHC Act”) registered with and subject to examination by the Federal Reserve Board (“FRB”). The Bank is a Washington state-chartered commercial bank and is subject to examination, supervision and regulation by the Washington State Department of Financial Institutions – Division of Banks (“Division”). FDIC insures the Bank’s deposits and in that capacity also regulates the Bank.

The Company’s earnings and activities are affected by legislation, by actions of the FRB, the Division, the FDIC and other regulators, by local legislative and administrative bodies, and by decisions of courts in Washington State.

These include limitations on the ability of the Bank to pay dividends to the Company, and numerous federal and state consumer protection laws imposing requirements on the making, enforcement, and collection of consumer loans, and restrictions by regulators on the sale of mutual funds and other uninsured investment products to customers.

Gramm-Leach-Bliley Financial Services Modernization Act. Congress enacted major federal financial institution reform legislation in 1999. Title I of the Gramm-Leach-Bliley Act (the “GLB Act”), which became effective March 11, 2000, allows bank holding companies to elect to become financial holding companies. In addition to activities previously permitted bank holding companies, financial holding companies may engage in nonbanking activities that are financial in nature, such as securities, insurance and merchant banking activities, subject to certain limitations.

The activities of bank holding companies, such as the Company that are not financial holding companies, are generally limited to managing or controlling banks. A bank holding company is required to obtain the prior approval of the FRB for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Nonbank acquisitions by bank holding companies such as the Company are generally limited to 5% of voting shares of a company and activities previously determined by the FRB by regulation or order to be so closely related to banking as to be a proper incident to banking or managing or controlling banks.

The GLB Act also included the most extensive consumer privacy provisions ever enacted by Congress. These provisions, among other things, require full disclosure of the Company’s privacy policy to consumers and mandate offering the consumer the ability to “opt out” of having non-public personal information disclosed to third parties. Pursuant to these provisions, the federal banking regulators have adopted privacy regulations. In addition, the states are permitted to adopt more extensive privacy protections through legislation or regulation. The Company does not disclose any nonpublic personal information about its customers or former customers to anyone, except as permitted by law.

Additional legislation may be enacted or regulations imposed to further regulate banking and financial services or to limit finance charges or other fees or charges earned in such activities. There can be no assurance whether any such legislation or regulation will place additional limitations on the Company’s operations or adversely affect its earnings.

There are various legal restrictions on transactions between the Company and any nonbank subsidiaries, and between the Company and the Bank. With certain exceptions, federal law also imposes limitations on, and requires collateral for, extensions of credit by insured depository institutions, such as the Bank, to their nonbank affiliates, such as the Company.

Interstate Banking and Branching. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Act”) permits nationwide interstate banking and branching under certain circumstances. Subject to certain limitations and restrictions, a bank holding company, with prior approval of the FRB, may acquire an out-of-state bank. Banks in states that do not prohibit out-of-state mergers may merge with the approval of the appropriate federal banking agency. A state bank may establish a de novo branch out of state if such branching is expressly permitted by the other state.

Federal and State Bank Regulation. Among other things, applicable federal and state statutes and regulations which govern a bank’s activities relate to minimum capital requirements, required reserves against deposits, investments, loans, legal lending limits, mergers and consolidations, borrowings, issuance of securities, payment of dividends, establishment of branches and other aspects of its operations. The Division and the FDIC also have authority to prohibit banks under their supervision from engaging in what they consider to be unsafe and unsound practices.

Specifically with regard to the payment of dividends, there are certain limitations on the ability of the Company to pay dividends to its shareholders. It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank

holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.

Various federal and state statutory provisions also limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval. Additionally, depending upon the circumstances, the FDIC or the Division could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

Under longstanding FRB policy, a bank holding company is expected to act as a source of financial strength for its subsidiary banks and to commit resources to support such banks. The Company could be required to commit resources to the Bank in circumstances where it might not do so, absent such policy.

The Bank is required to file periodic reports with the FDIC and the Division and is subject to periodic examinations and evaluations by those regulatory authorities. These examinations must be conducted every 12 months. The FDIC and the Division may each accept the results of an examination by the other in lieu of conducting an independent examination.

In the liquidation or other resolution of a failed insured depository institution, deposits in offices and certain claims for administrative expenses and employee compensation are afforded a priority over other general unsecured claims, including nondeposit claims, and claims of a parent company such as the Company. Such priority creditors would include the FDIC, which succeeds to the position of insured depositors

Capital Adequacy. The Company and the Bank are subject to risk-based capital and leverage guidelines issued by federal banking agencies for banks and bank holding companies. These agencies are required by law to take specific prompt corrective actions with respect to institutions that do not meet minimum capital standards. As of December 31, 2007, the Company and the Bank exceeded the minimum capital standards.

Sarbanes-Oxley Act of 2002. The Company is also subject to the periodic reporting, information disclosure, proxy solicitation, insider trading restrictions and other requirements of the Securities Exchange Act of 1934, as amended, including provisions of the Sarbanes Oxley Act of 2002.

USA Patriot Act of 2001. Under the USA Patriot Act of 2001 (“Patriot Act”), adopted by the U.S. Congress on October 26, 2001 to combat terrorism, FDIC-insured banks and commercial banks are required to increase their due diligence efforts for correspondent accounts and private banking customers. The Patriot Act requires the Bank to engage in additional record keeping or reporting, requiring identification of owners of accounts, or of the customers of foreign banks with accounts, and restricting or prohibiting certain correspondent accounts. While management believes that the Patriot Act may affect recordkeeping and reporting expenses to some degree, it does not believe that it will have a material adverse effect on the Company’s business and operations.

Effects of Governmental Monetary Policies

Profitability in banking depends on interest rate differentials. In general, the difference between the interest earned on a bank’s loans, securities and other interest-earning assets and the interest paid on a bank’s deposits and other interest-bearing liabilities is the major source of a bank’s earnings. Thus, the earnings and growth of the Company are affected not only by general economic conditions, but also by the monetary and fiscal policies of the United States and its agencies, particularly the FRB. The FRB implements national monetary policy for such purposes as controlling inflation and recession by its open market operations in United States government securities, control of the discount rate applicable to borrowing from the FRB and the establishment of reserve requirements against certain deposits. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans and paid on deposits. The nature and impact of future changes in monetary policies and their impact on the Company are not predictable.


Item 1A.	Risk Factors

Historical performance may not be indicative of future performance and, as noted elsewhere in this report, the Company has included forward-looking statements about its business, plans and prospects that are subject to change. Forward-looking statements are particularly located in, but not limited to, the sections Item 1 – Business and Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations. In addition

to the other risks or uncertainties contained in this report, the following risks may affect operating results, financial condition and cash flows. If any of these risks occur, either alone or in combination with other factors, the Company’s business, financial condition or operating results could be adversely affected. Moreover, readers should note this is not an exhaustive list; that some risks are unknown or not quantifiable, and other risks that are currently perceived as immaterial may ultimately prove more significant than expected. Statements about plans, predictions or expectations should not be construed to be assurances of performance or promises to take a given course of action.

Adequacy of the Allowance for Loan Losses. The Company has established a reserve for possible losses expected in connection with loans in the credit portfolio. This allowance reflects estimates of the collectibility of certain identified loans, as well as an overall risk assessment of total loans outstanding. The determination of the amount of loan loss allowance is subjective; although the method for determining the amount of the allowance uses criteria such as risk ratings and historical loss rates, these factors may not be adequate predictors of future loan performance. Accordingly, the Company cannot offer assurances that these estimates ultimately will prove correct or that the loan loss allowance will be sufficient to protect against losses that ultimately may occur. If the loan loss allowance proves to be inadequate, it may require unexpected charges to income, which would adversely impact results of operations and financial condition. Moreover, bank regulators frequently monitor banks’ loan loss allowances, and if regulators were to determine that the allowance was inadequate, they may require the Company to increase the allowance, which also would adversely impact revenues and financial condition.

Growth and Management. Financial performance and profitability will depend on the Company’s ability to manage recent growth and successful completion of the previously announced merger with Frontier Financial Corporation is a key factor in potential future growth. In addition, if the merger is not completed that could have an adverse effect on the Company’s business, financial condition and results of operations. Accordingly, there can be no assurance that the Company will be able to execute a growth strategy or maintain the level of profitability that it has achieved in the past.

Changes in Market Interest Rates. The Company’s earnings are impacted by changing interest rates. Changes in interest rates affect the demand for new loans, the credit profile of existing loans, the rates received on loans and securities, and rates paid on deposits and borrowings. The relationship between the rates received on loans and securities and the rates paid on deposits and borrowings is known as the net interest spread. Based on the Company’s current volume and mix of interest-bearing liabilities and interest-earning assets, net interest spread could be expected to increase during times when interest rates rise in a parallel shift along the yield curve and, conversely, to decline during times of similar falling interest rates. Exposure to interest rate risk is managed by monitoring the re-pricing frequency of rate-sensitive assets and rate-sensitive liabilities over any given period. Although management believes the current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates could potentially have an adverse affect on the Company’s business, financial condition and results of operations.

Liquidity. Liquidity measures the ability to meet loan demand and deposit withdrawals and to service liabilities as they come due. Dramatic fluctuations in loan or deposit balances make it challenging to manage liquidity. A sharp reduction in deposits could force the Company to borrow heavily in the wholesale deposit market. In addition, rapid loan growth during periods of low liquidity could induce the Company to purchase federal funds from correspondent banks, borrow at the Federal Home Loan Bank of Seattle or Federal Reserve discount window, raise deposit interest rates and/or decline loans.

Geographic Concentration. Substantially, all of the Company’s business is derived from a five-county area in northwest Washington State. Employment opportunities within these communities have traditionally been primarily in the areas of military spending, oil and gas industries, tourism and manufacturing. While the Company’s expansion strategy has been built around these growing and diverse geographic markets, the Company’s business is, and will remain, sensitive to economic factors that relate to these industries and to local and regional business conditions. As a result, local or regional economic downturns, or downturns that disproportionately affect one or more of the key industries in the Company’s markets, may have a more pronounced effect upon it’s business than they might on an institution that is more broadly diverse in geographic concentration. The extent of the future impact of these events on economic and business conditions cannot be predicted; however, prolonged or acute

fluctuations could have a material and adverse impact upon the Company’s results of operation and financial condition.

Regulation. The Company is subject to government regulation that could limit or restrict it’s activities, which in turn could adversely impact operations. The financial services industry is regulated extensively. Federal and state regulation is designed primarily to protect the deposit insurance funds and consumers, as well as shareholders. These regulations can sometimes impose significant limitations on operations. Moreover, federal and state banking laws and regulations undergo frequent, significant changes. Changes in laws and regulations may affect the cost of doing business, limit permissible activities (including insurance and securities activities), or the Company’s competitive position in relation to credit unions, savings associations and other financial institutions. These changes could also reduce federal deposit insurance coverage, broaden the powers or geographic range of financial holding companies, alter the taxation of financial institutions and change the structure and jurisdiction of various regulatory agencies.

Federal monetary policy, particularly as implemented through the Federal Reserve System, can significantly affect credit availability. Other federal legislation such as the Sarbanes-Oxley Act can dramatically shift resources and costs to ensure adequate compliance.

Competition. Competition may adversely affect the Company’s performance. The financial services business is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers. The Company faces competition both in attracting deposits and in originating loans. Competition for loan’s principally through the pricing of interest rates and loan fees, and the efficiency and quality of services. Increasing levels of competition in the banking and financial services industries may reduce market share or cause the prices charged for services to fall. Results may differ in future periods depending upon the nature or level of competition.

Credit Risk. A source of risk arises from the possibility that losses will be sustained if a significant number of borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans. The Company has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, which management believes are appropriate to minimize risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially affect results of operations.

Merger with Frontier. Our management has expended substantial time and effort in negotiating the merger agreement and the related arrangements connected with the merger with Frontier. Moreover, the board of directors has agreed to certain arrangements intended to avert any unsolicited attempt to gain control of the Company during the pendency of this transaction, including certain breakup fees and expense reimbursements. Additionally, the merger reflects a substantial aspect of management’s strategic planning for the Company’s future. Were the merger with Frontier not to be consummated, the Company would be forced to make substantial adjustments in its strategic plans, which would require additional management time and effort and which might not be successful. Therefore, if the merger with Frontier is not consummated, the Company may experience adverse impacts on its strategic direction and its operating capabilities, and these impacts may be material. Finally, the termination or abandonment of the merger with Frontier may have an adverse impact upon investors’ views as to the attractiveness of the Company’s common stock, which may result in a reduced market price for the Company’s common stock, and such reduction may be material.


Item 1B.	Unresolved Staff Comments

The Company had no unresolved staff comments from the Securities and Exchange Commission.


Item 2.	Properties

The executive offices of the Company are located at 450 Southwest Bayshore Drive in Oak Harbor, WA in a building that is owned by the Company on leased land. The building also houses the Bank’s Oak Harbor branch. At December 31, 2007, the Bank conducted business at 20 branch locations, thirteen of which are owned by the Bank, including the main office in Coupeville, WA, and seven are leased under various agreements. The Company owns two additional facilities for administrative purposes.

The Company purchased property in the Smokey Point/Arlington, WA area and completed construction of a new building with plans to relocate the Smokey Point branch, which is currently leased. Management anticipates branch opening during the second quarter of 2008.


Item 3.	Legal Proceedings

The Company and its subsidiaries are, from time to time, defendants in, and are threatened with, various legal proceedings arising from regular business activities. Management believes that its liability for damages, if any, arising from such claims or contingencies will not have a material adverse effect on the Company’s results of operations, financial conditions or cash flows.


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

No matters were submitted to a vote of securities holders of the Company during the quarter ended December 31, 2007.

PART II


Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common stock is traded on the Nasdaq National Market System under the symbol “WBCO.”

The Company is aware that blocks of its stock are held in street name by brokerage firms. As a result, the number of shareholders of record does not include the actual number of beneficial owners of the Company’s stock. As of March 6, 2008, the Company’s common stock was held of record by approximately 309 shareholders, a number which does not include beneficial owners who hold shares in “street name.”

The following are the high and low adjusted closing prices for the Company’s stock as reported by the Nasdaq National Market System and the quarterly cash dividends paid by the Company to its shareholders on a per share basis during 2007 and 2006, as adjusted for stock dividends and splits:


	2007						2006
	High		Low		Dividend		High		Low		Dividend

First quarter	$	15.12	$	15.12	$	0.05	$	15.52	$	14.21	$	0.050
Second quarter		15.99		15.02		0.06		17.97		14.42		0.050
Third quarter		20.24		13.60		0.06		18.39		15.20		0.050
Fourth quarter		20.94		14.90		0.06		18.09		16.13		0.050

The Company’s dividend policy requires the Board of Directors to review the Company’s financial performance, capital adequacy, cash resources, regulatory restrictions, economic conditions and other factors, and if such review is favorable, the Board may declare and pay dividends. For 1997 and prior years, cash dividends were paid on an annual basis. After completion of the initial public offering in 1998, the Company has paid cash dividends on a quarterly basis. The Company declared a 5-for-4 stock split, which was distributed on September 6, 2006. The ability of the Company to pay dividends will depend on the profitability of the Bank, the need to retain or increase capital, and the dividend restrictions imposed upon the Bank by applicable banking law. Although the Company anticipates payment of a regular quarterly cash dividend, future dividends are subject to these limitations and to the discretion of the Board of Directors, and could be reduced or eliminated.

Sales of Unregistered Securities

The Company had no sales of unregistered securities during the fourth quarter of 2007.

Purchases of Equity Securities

The Company had no purchases of its equity securities during the fourth quarter of 2007.

Five-Year Stock Performance Graph

The following chart compares the yearly percentage change in the cumulative shareholder return on the Company’s common stock during the five years ended December 31, 2007, with (1) the Total Return for the NASDAQ Stock Market Index (which is a broad nationally recognized index of stock performance by companies traded on the NASDAQ Market System and the NASDAQ Small Cap Market) (2) the Total Return Index for SNL Bank NASDAQ (comprised of banks listed on the NASDAQ National Market System) and (3) Total Return for SNL Bank $500M to $1 Billion Bank Index (comprised of publicly-traded banks located in the U.S. with total assets between $500 million and $1 billion).

The graph assumes $100.00 was invested on December 31, 2002, in the Company’s common stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends.


	*Period Ending*
*Index*	12/31/02		12/31/03		12/31/04		12/31/05		12/31/06		12/31/07


Washington Banking Company		100.00		139.43		182.14		247.51		288.49		275.29
NASDAQ Composite		100.00		150.01		162.89		165.13		180.85		198.60
SNL Bank NASDAQ		100.00		129.08		147.94		143.43		161.02		126.42
SNL Bank $500M – $1B		100.00		144.19		163.41		170.41		193.81		155.31

Source: SNL Financial LC,


Item 6.	Selected Financial Data

Consolidated Five-Year Statements of Operations and Selected Financial Data

The following table sets forth selected audited consolidated financial information and certain financial ratios for the Company. This information is derived in part from the audited consolidated financial statements and notes thereto of the Company set forth in Item 8 – Financial Statements and Supplementary Data and should be read in conjunction with the Company’s financial statements and the management discussion set forth in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.


	Years Ended December 31
(Dollars in thousands, except per share amounts)	2007			2006			2005			2004			2003

Operating data:
Total interest income	$	62,368		$	55,185		$	45,582		$	38,319		$	35,803
Total interest expense		24,810			18,441			11,566			8,837			8,737

Net interest income		37,558			36,744			34,016			29,482			27,066
Provision for loan losses		(3,000	)		(2,675	)		(2,250	)		(3,500	)		(3,200	)

Net interest income after provision		34,558			34,069			31,766			25,982			23,866
Service charges on deposits		3,135			3,296			3,150			2,986			2,127
Other noninterest income		4,355			3,954			4,357			3,830			3,824

Total noninterest income		7,490			7,250			7,507			6,816			5,969
Noninterest expense		28,471			27,530			25,225			23,637			21,070

Income before income taxes		13,577			13,789			14,048			9,161			8,765
Provision for income taxes		4,179			4,298			4,580			2,985			2,798

Loss from discontinued operations, net of tax		—			—			—			(370	)		(56	)

Net income	$	9,398		$	9,491		$	9,468		$	6,176		$	5,967

Average number of shares outstanding, basic		9,365,000			9,217,000			9,098,000			9,012,000			8,902,000
Average number of shares outstanding, diluted		9,493,000			9,490,000			9,428,000			9,326,000			9,248,000
Per share data⁽¹⁾:
Net income per share, basic	$	1.00		$	1.03		$	1.04		$	0.69		$	0.67
Net income per share, diluted		0.99			1.00			1.00			0.66			0.65
Book value per share		7.78			7.07			6.27			5.48			4.97
Dividends per share		0.23			0.20			0.18			0.18			0.14
Balance sheet data:
Total assets	$	882,289		$	794,545		$	725,976		$	657,724		$	581,741
Loans receivable		805,862			719,580			630,258			579,980			499,919
Allowance for loan losses		11,126			10,048			8,810			7,903			6,116
Other real estate owned		1,440			363			—			1,222			504
Federal funds sold		—			—			21,095			—			4,795
Deposits		758,354			703,767			637,489			563,001			501,497
Other borrowed funds		—			—			10,000			5,000			12,500
Junior subordinated debentures		25,774			15,007			15,007			15,007			—
Trust preferred securities		—			—			—			—			15,000
Shareholders’ equity		73,570			66,393			57,849			49,591			44,360


⁽¹⁾		Per share data adjusted for the 5-for-4 stock split distributed on September 6, 2006, 4-for-3 stock split distributed on May 17, 2005 and 15% stock dividend distributed February 26, 2004.

(Continued)


	Years Ended December 31
	2007		2006		2005		2004		2003

Selected performance ratios:
Return on average assets		1.12%		1.25%		1.37%		0.98%		1.06%
Return on average equity		13.53%		15.36%		17.87%		13.37%		14.43%
Net interest margin (fully tax-equivalent)		4.89%		5.25%		5.33%		5.12%		5.19%
Net interest spread		4.32%		4.73%		4.99%		4.86%		4.90%
Noninterest expense to average assets		3.40%		3.64%		3.64%		3.71%		3.73%
Efficiency ratio (fully tax-equivalent)		62.31%		62.07%		60.37%		63.55%		62.96%
Dividend payout ratio		23.07%		19.58%		16.97%		23.24%		21.63%
Asset quality ratios:
Nonperforming loans to period-end loans		0.35%		0.51%		0.34%		0.48%		0.83%
Allowance for loan losses to period-end loans		1.38%		1.40%		1.40%		1.36%		1.22%
Allowance for loan losses to nonperforming loans		395.41%		276.19%		408.06%		281.05%		147.09%
Nonperforming assets to total assets		0.49%		0.50%		0.30%		0.61%		0.80%
Net loan charge-offs to average loans outstanding		0.25%		0.20%		0.22%		0.32%		0.56%
Capital ratios:
Total risk-based capital		12.45%		11.52%		11.52%		11.40%		12.01%
Tier 1 risk-based capital		11.14%		10.27%		10.28%		10.15%		10.85%
Leverage ratio		10.29%		10.24%		10.26%		9.87%		10.17%
Average equity to average assets		8.30%		8.17%		7.65%		7.36%		7.33%
Other data:
Number of banking offices		20		20		19		18		17
Number of full time equivalent employees		283		324		296		289		300

Summary of Quarterly Financial Information

See Item 8 – Financial Statements and Supplementary Data, Note 21- Selected Quarterly Financial Data (Unaudited)


Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with Item 8 – Financial Statements and Supplementary Data.

Executive Overview

For the year ended December 31, 2007, the Company reported total assets of $882.3 million, total loans of $805.9 million, total deposits of $758.4 million and shareholders’ equity of $73.6 million. Some of the Company’s achievements were not necessarily reflected in the operating results. Events in 2007 included:


•	Organic loan growth was 12% and deposit growth was 8%.

•	Maintained exceptional credit quality standards, with net charge-offs of only 0.25% of average loans for 2007. The ratio of nonperforming assets to total assets at December 31, 2007 was 0.49%.

•	Increased cash dividend by 20% to $0.06 per quarter.

•	The Company entered into a merger agreement with Frontier Financial Corporation, whereby the Company will be acquired by Frontier Financial. The merger is expected to close during the second quarter of 2008.

The Company also dealt with some challenges in the past year including:


•	Diluted earnings per share were flat at $0.99 and $1.00 for the years ended 2007 and 2006, respectively. Diluted earnings per share for both years were impacted by net interest margin compression. One time charges of


	$513,000 for merger related expenses, and $308,000 for net deferred loan costs impacted 2007 earnings. Additionally, a one time restructuring charge of $575,000 related to restructuring backroom operations and reducing the workforce by twenty employees impacted 2006 earnings.


•	The Company’s net interest margin compressed during 2007 due to increasing deposit costs and the inverted yield curve (where short-term interest rates were higher than longer term rates). The fully tax-equivalent net interest margin for 2007 was 4.89%, down 36 basis points from 2006.

Summary of Critical Accounting Policies

Significant accounting policies are described in Item 8 – Financial Statements and Supplementary Data, Note 1 – Summary of Significant Accounting Policies. 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: The allowance for loan losses is established to absorb known and inherent losses attributable to loans outstanding. The adequacy of the allowance is monitored on a regular basis and is based on management’s evaluation of numerous factors. These factors include the quality of the current loan portfolio; the trend in the loan portfolio’s risk ratings; current economic conditions; loan growth rates; past-due and nonperforming trends; historical charge-offs and recovery experience; and other pertinent information.

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.

Results of Operations Overview

Net income for the year 2007 was $9.4 million, compared with $9.5 million in 2006, and $9.5 million in 2005. Diluted earnings per share for the years ended 2007, 2006 and 2005 were $0.99, $1.00 and $1.00, respectively. Return on average equity decreased to 13.53% in 2007, compared with 15.36% in 2006. Return on average equity in 2005 was 17.87%.

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.

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


	Net Interest Income Analysis as of:
	Years Ended December 31
	2007							2006						2005
	Average		Interest		Average			Average		Interest		Average		Average		Interest		Average
(Dollars in thousands)	balance		earned/paid		yield			balance		earned/paid		yield		balance		earned/paid		yield


Assets

Loans⁽¹⁾⁽²⁾	$	759,242	$	61,911		8.15	%	$	682,939	$	54,450		7.97%	$	608,998	$	44,499		7.31%

Federal funds sold		2,395		121		5.06	%		2,686		135		5.02%		12,365		440		3.56%

Interest-bearing cash		964		52		5.39	%		844		43		5.10%		897		28		3.12%

Investments:

Taxable		12,198		547		4.48	%		12,618		457		3.62%		14,158		399		2.82%

Non-taxable⁽²⁾		6,497		384		5.91	%		7,306		458		6.27%		6,810		477		7.00%



Interest-earning assets		781,296		63,015		8.07	%		706,393		55,543		7.86%		643,228		45,843		7.13%

Noninterest-earning assets		55,442							50,384						49,832

Total assets	$	836,738						$	756,777					$	693,060


Liabilities and Shareholders’ Equity

Deposits:

Interest-bearing demand and money market	$	268,817	$	7,049		2.62	%	$	231,316	$	4,521		1.95%	$	227,588	$	2,485		1.09%

Saving deposits		46,152		311		0.67	%		55,139		432		0.78%		57,131		448		0.78%

Time deposits		316,308		15,309		4.84	%		276,211		11,604		4.20%		224,002		7,024		3.14%

Interest-bearing deposits		631,277		22,669		3.59	%		562,666		16,557		2.94%		508,721		9,957		1.96%

Fed funds purchased		4,480		242		5.40	%		6,850		362		5.29%		5,740		159		2.77%

Junior subordinated debentures		23,061		1,762		7.64	%		15,007		1,337		8.91%		15,007		1,071		7.14%

Other interest-bearing liabilities		2,493		137		5.49	%		4,183		185		4.41%		9,846		379		3.85%



Interest-bearing liabilities		661,311		24,810		3.75	%		588,706		18,441		3.13%		539,314		11,566		2.14%

Noninterest-bearing deposits		100,830							100,267						96,511

Other noninterest-bearing liabilities		5,109							6,004						4,250

Total liabilities		767,250							694,977						640,075

Shareholders’ equity		69,488							61,800						52,985


Total liabilities and shareholders’ equity	$	836,738						$	756,777					$	693,060


Net interest income⁽²⁾			$	38,205						$	37,102					$	34,277


Net interest spread						4.32	%						4.73%						4.99%



Net interest margin⁽²⁾						4.89	%						5.25%						5.33%


⁽¹⁾		Of this amount, loan fees accounted for $2,406, $2,001, and $1,003, for the years ended December 31, 2007, 2006 and 2005, respectively. Loan totals include both current and nonaccrual loans.

⁽²⁾		Interest income on non-taxable assets is presented on a fully tax-equivalent basis using a federal statutory rate of 35.0%, 34.4% and 34.3%, for the years ended December 31, 2007, 2006 and 2005, respectively. These adjustments were $647, $358, and $259, for the years ended December 31, 2007, 2006 and 2005, respectively.

Net interest income on a taxable-equivalent basis totaled $38.2 million at December 31, 2007 compared with $37.1 million in 2006. Changes in net interest income during the year were principally caused by an increase in average earning assets due to strong loan growth and higher yields on earning assets. The yields on interest earning assets increased 21 basis points to 8.07% at December 31, 2007. Competition for deposits caused the average cost of interest-bearing liabilities to increase 62 basis points during 2007, which was exacerbated by the change in deposit mix towards higher-cost time deposit and money market products. As a result, the interest rate spread contracted 41 basis points in 2007 to end the year at 4.32%.

Net interest income on a tax-equivalent basis totaled $37.1 million at December 31, 2006. Changes in net interest income were principally due to an increase in average earning assets due to strong loan growth and higher yields on earning assets. The yields on interest-earning assets increased 73 basis points to 7.86% at December 31, 2006. Pricing pressure caused the average cost of interest-bearing liabilities to increase 99 basis points during 2006, which was exacerbated by the change in deposit mix towards higher cost time deposit and money market products. As a result, the interest rate spread contracted 26 basis points in 2006 to end the year at 4.73%.

The following table details the effects of the interest changes over the last two years:


	Interest Rate & Volume Analysis
	2007 compared to 2006									2006 compared to 2005
	Increase (decrease) due to⁽²⁾									Increase (decrease) due to⁽²⁾
(Dollars in thousands)	Volume			Rate			Total			Volume			Rate			Total

Loans⁽¹⁾⁽³⁾	$	6,199		$	1,263		$	7,462		$	5,711		$	4,289		$	10,000
Federal funds sold		(15	)		1			(14	)		(645	)		340			(305	)
Interest-earning cash		6			3			9			(2	)		60			58
Securities⁽¹⁾		(64	)		79			15			14			(17	)		(3	)

Total interest income	$	6,126		$	1,346		$	7,472		$	5,078		$	4,672		$	9,750

Interest-bearing demand deposits	$	813		$	1,714		$	2,527		$	41		$	1,995		$	2,036
Savings deposits		(65	)		(56	)		(121	)		(16	)		—			(16	)
Time deposits		1,810			1,895			3,705			1,863			2,717			4,580
Fed funds purchased		(128	)		7			(121	)		36			167			203
Junior subordinated debentures		579			(153	)		426			—			266			266
Trust preferred securities		—			—			—			—			—			—
Other borrowings		(121	)		73			(48	)		(257	)		61			(196	)

Total interest expense	$	2,888		$	3,480		$	6,368		$	1,667		$	5,206		$	6,873


⁽¹⁾		Interest income on non-taxable investments is presented on a fully tax-equivalent basis using the federal statutory rate of 35.0%, 34.4% and 34.3%, for the years ended December 31, 2007, 2006 and 2005, respectively.

⁽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.

Provision for Loan Losses: The provision for loan losses is highly dependent on the Company’s ability to manage asset quality and control the level of net charge-offs through prudent underwriting standards. In addition, decline in general economic conditions could increase future provisions for loan loss and materially impact the Company’s net income. For further discussion of the Company’s asset quality see the Credit Risks and Asset Quality section found in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

In 2007, the provision for loan losses increased 12% to $3.0 million, compared with $2.7 million in 2006. Changes in the provision were due to slightly higher net charge-offs of $1.9 million in 2007, compared with $1.4 million in 2006 and continued loan portfolio growth as compared to 2006. During 2007, the allowance for loan losses as a percent of total loans was 1.38% as compared to 1.40% in 2006.

In 2006, the provision for loan losses increased 19% to $2.7 million, compared with $2.3 million in 2005. Changes in the provision were due to slightly higher net charge-offs of $1.4 million in 2006, compared with $1.3 million in 2005 and continued loan portfolio growth as compared to 2005. During 2006, the allowance for loan losses as a percent of total loans remained the same at 1.40% as compared to 2005.

Noninterest Income: Noninterest income remains a key focus of the Company. Since 2005, the Company has focused on diversifying the noninterest income mix. In 2005, 52% of noninterest income consisted of income from sale of loans and service charges, while in 2006, 55% of noninterest income was derived from these products. In 2007, 51% of noninterest income came from income from sale of loans and service charges. The diversification of the noninterest income mix resulted primarily from the introduction of nondeposit investment products consisting primarily of annuity sales, and investment service fees, and income from the Company’s Bank Owned Life Insurance (“BOLI”).

In 2007, noninterest income increased 3% to $7.5 million, compared with $7.3 million in 2006. Changes in noninterest income were primarily due to increases in electronic banking fees of $200,000 and BOLI income of $214,000 as compared to 2006. These increases in noninterest income were offset by a decline in service charges of $161,000, Small Business Administration (“SBA”) loan sale premiums of $107,000 and income from the sale of mortgage loans of $42,000 as compared to 2006.

In 2006, noninterest income declined 3% to $7.3 million, compared with $7.5 million in 2005. Changes in noninterest income were primarily due to increases in service charges and fees of $146,000 and electronic banking fees of $288,000 as compared to 2005. These increases in noninterest income were offset by a decline in annuity sales commissions of $388,000, SBA loan sale premiums of $418,000 and income from the sale of mortgage loans of $64,000 as compared to 2005.

Noninterest Expense: The Company continues to focus on controlling noninterest expenses and addressing long term operating expenses. As a result of consolidating back office operations and improving operating efficiencies, the Company continued to successfully manage noninterest expense in 2007 and 2006. Due to this focused effort, noninterest expense grew by only $941,000 and $2.3 million in 2007 and 2006, respectively.

The Company’s efficiency ratio was relatively stable at 62.31% in 2007 as compared to 62.07% in 2006. As detailed in the table below, the efficiency ratios for 2007 and 2006 were directly impacted by one time charges for merger-related expenses and restructuring charges, respectively.


		Years Ended December 31												Change				Change
(Dollars in thousands)		2007				2006				2005				2007 vs. 2006				2006 vs. 2005

Salaries and benefits	$		19,777		$		19,757		$		17,993		$		20		$		1,764

Less: loan origination costs			(2,695	)			(2,950	)			(2,918	)			255				(32	)

Net salaries and benefits (as reported)			17,082				16,807				15,075				275				1,732
Occupancy expense			3,805				3,596				3,373				209				223
Office supplies and printing			558				640				659				(82	)			(19	)
Consulting and professional fees			735				769				829				(34	)			(60	)
Data processing			663				479				493				184				(14	)
Merger related expenses			513				—				—				513				—
Restructuring charge			—				575				—				(575	)			575
Other			5,115				4,664				4,796				451				(132	)

Total noninterest expense	$		28,471		$		27,530		$		25,225		$		941		$		2,305

The changes in noninterest expenses in 2007 compared to 2006 were related to the following areas:


•	Salaries and benefits were flat due to the Company maintaining employee benefit expenses at 2006 levels and the reduction of full time equivalent employees (FTE’s). The Company’s number of FTE’s decreased to 283 at December 31, 2007 from 324 at year end 2006. However, in December 2006, the Company eliminated twenty positions within the Bank; this reduction in workforce was primarily in back office operations. These employees were included in total FTE’s at December 31, 2006.

•	Occupancy expense was $3.8 million in 2007 compared to $3.6 million in 2006. The increase in occupancy expense was primarily due to the addition of new locations.

•	The Company incurred $513,000 in expenses related to the previously announced merger with Frontier Financial Corporation.


•	The increase in other expenses was due primarily to a one-time adjustment of $308,000 in net deferred loan costs which were written off on closed loans. In 2007, a review of the Company’s loan system found active amortizing net deferred loan costs on closed loans; the Company’s accounting policy is to recognize all remaining unamortized net deferred loan costs at time of loan payoff.

The changes in noninterest expenses in 2006 compared to 2005 were related to the following areas:


•	The increase in salaries and benefits expense in 2006 was primarily a result of the following items:

•	The Company recorded $133,000 of pre-tax stock option expense in 2006 under Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” compared to no stock option expense in 2005. Additionally, the Company issued restricted stock awards in 2005 and 2006 which attributed an additional $183,000 of expense in 2006. See Item 8 – Financial Statements and Supplementary Data, Note 12 – Stock Incentive Plans.

•	Salaries increased by $1.7 million or 11% compared to 2005. The increase was attributable to general wage increases and commissions paid on sales of nondeposit investment products. The Company’s number of full time equivalent employees increased to 324 from 296 at December 31, 2006 and 2005, respectively. However, in December 2006, the Company eliminated twenty positions within the Bank; this reduction in workforce was primarily in back office operations. The Company recorded a one-time restructuring charge of $575,000 consisting primarily of severance packages and early vesting of stock awards.

•	Employee benefits paid by the Company increased $139,000 or 9% as compared to 2005. This increase was due primarily to increased costs of health insurance.

•	Occupancy expense was $3.6 million in 2006 compared to $3.4 million in 2005. The increase in occupancy expense was primarily due to the addition of new locations.

•	The Company had related expenses on several foreclosed properties totaling $43,000, and $253,000 in 2006 and 2005, respectively. These properties were subsequently sold. For further details concerning foreclosed properties, see the Credit Risks and Asset Quality section found in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Income Tax: The Company’s consolidated effective tax rate, as a percentage of pre-tax income from continuing operations, decreased to 30.78%, in 2007 compared to an effective tax rate of 31.17% and 31.60% for 2006 and 2005, respectively. The effective tax rate is lower than the federal statutory rate of 35.00% due to nontaxable income generated from investments in BOLI, tax-exempt municipal bonds and loans. Additionally, the Company’s 2007 and 2006 tax rates reflect a benefit from the New Market Tax Credit Program whereby a subsidiary of the Bank will be 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. Additional information on income taxes is provided in Item 8 – Financial Statements and Supplementary Data, Note 9 – Income Taxes.

Financial Condition Overview

In 2007, the Company continued to focus on growing its loan portfolio and deposit funding base. Loans at December 31, 2007 grew 12% to $805.9 million compared to $719.6 million at December 31, 2006. Deposits at December 31, 2007 grew 8% to $758.4 million compared to $703.8 million at December 31, 2006. Shareholders’ equity increased $7.2 million to $73.6 million, with a book value of $7.78 per share at December 31, 2007. The Company’s ability to sustain continued loan and deposit growth is dependent on many factors, including the effects of competition, economic conditions, retention of key personnel and valued customers, and the Company’s ability to close loans.

Investment Securities: The composition of the Company’s investment portfolio reflects management’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of investment income. The investment securities portfolio mitigates interest rate risk inherent in the loan portfolio, while providing a vehicle for the investment of available funds and a source of liquidity.

In 2007, total investment securities decreased $3.0 million compared to 2006. The decrease was a result of the maturity of investment securities that were not replaced due to the low rate environment coupled with an anticipated increase in loan demand. During 2006, total investment securities decreased $2.3 million compared to 2005. The decrease was a result of the maturity of investment securities that were not replaced due to the low rate environment coupled with an anticipated increase in loan demand. The Company’s investment portfolio mix, based upon amortized cost, is outlined in the table below:

Investment Portfolio as of:


	Years Ended December 31
(Dollars in thousands)	2007		2006		2005

U.S. government agency securities	$	8,537	$	9,872	$	10,361
Pass-through securities		78		101		127
Corporate obligations		—		—		987
Preferred stock		—		—		—
State & political subdivisions		5,217		6,817		7,602

Total⁽¹⁾	$	13,832	$	16,790	$	19,077


⁽¹⁾		No investment in aggregate, to a single issuer, exceeds 10% of shareholders’ equity.

The average life of the Company’s investment portfolio in 2007 increased to 4.4 years from 3.9 years in 2006. The following table further details the Company’s investment portfolio, based upon market value at December 31, 2007. Additional information about the investment portfolio is provided in Item 8 – Financial Statements and Supplementary Data, Note 3 – Investment Securities.


	Investment Portfolio Maturities and Average Yield
	December 31, 2007
	Within						Over
(Dollars in thousands)	1 year		1-5 years		5-10 years		10 years		Total

U.S. government agency securities
Balance	$	1,999	$	6,538	$	—	$	—	$	8,537
Weighted average yield		4.41%		7.48%		—		—		4.23%
Pass-through securities
Balance		—		78		—		—		78
Weighted average yield		—		5.28%		—		—		4.84%
State and political subdivisions
Balance		850		1,978		2,389		—		5,217
Weighted average yield		3.80%		4.12%		3.75%		—		3.75%

Total balance	$	2,849	$	8,594	$	2,389	$	—	$	13,832

Weighted average yield

Loans: Interest and fees earned on the Company’s loan portfolio is the primary source of revenue. In 2007, loans increased 12% or $86.3 million to $805.6 million compared to $719.6 million in 2006. In 2007, commercial and commercial real estate segments were the primary source of growth, adding an additional $67.1 million in loans. The Company attempts to balance the diversity of its portfolio, believing that this provides a good means of minimizing risk due to loss and interest rate sensitivity. Active portfolio management has resulted in solid loan growth and a diversified portfolio that is not heavily concentrated in any one industry or in any one community. The following table further details the loan portfolio:


	Loan Portfolio Composition as of:
	December 31
	2007					2006					2005					2004					2003
				% of					% of					% of					% of					% of
(Dollars in thousands)	Balance			total		Balance			total		Balance			total		Balance			total		Balance			total



Commercial	$	102,284			12.7%	$	82,990			11.6%	$	78,723			12.6%	$	80,927			14.0%	$	87,371			17.5%

Real estate mortgages:

One-to-four family residential		56,636			7.0%		54,554			7.6%		45,326			7.2%		46,242			8.0%		35,209			7.1%

Commercial		296,902			37.0%		249,109			34.7%		218,260			34.7%		173,280			29.9%		133,539			26.7%




Total real estate mortgages		353,538			44.0%		303,663			42.3%		263,586			41.9%		219,522			37.9%		168,748			33.8%

Real estate construction		146,647			18.3%		142,436			19.8%		113,661			18.1%		105,940			18.3%		70,974			14.2%

Consumer		200,987			25.0%		188,490			26.3%		173,270			27.4%		172,249			29.8%		171,734			34.5%




Subtotal		803,456			100.0%		717,579			100.0%		629,240			100.0%		578,638			100.0%		498,827			100.0%


Less: allowance for loan losses		(11,126	)				(10,048	)				(8,810	)				(7,903	)				(6,116	)

Deferred loan fees, net		2,406					2,001					1,018					1,342					1,092


Loans, net	$	794,736				$	709,532				$	621,448				$	572,077				$	493,803

The Company’s loan portfolio is comprised of the following loan types:


•	Commercial Loans: Commercial loans include both secured and unsecured loans for working capital and expansion. Short-term working capital loans generally are secured by accounts receivable, inventory and/or equipment, while longer-term commercial loans are usually secured by equipment.

•	Real Estate Mortgage Loans: Real estate loans consist of two types: one-to-four family residential and commercial properties.


		One-to-Four Family Residential Loans: One-to-four family residential loans are secured principally by 1st deeds of trust on residential properties principally located within the Company’s market area.

		Commercial Real Estate Loans: Commercial real estate loans are secured principally by manufacturing facilities, apartment buildings and commercial buildings for office, storage and warehouse space. Loans secured by commercial real estate may involve a greater degree of risk than one-to-four family residential loans. Payments on such loans are often dependent on successful business management operations.


•	Real Estate Construction Loans: Real estate construction loans consist of three types: 1) commercial real estate, 2) one-to-four family residential construction, and 3) speculative construction.


		Commercial Real Estate: Commercial real estate construction loans are primarily for owner-occupied properties.

		One-to-Four Family Residential: One-to-four family residential construction loans are for the construction of custom homes, where the homebuyer is the borrower.

		Speculative Construction: Speculative construction provides financing to builders for the construction of pre-sold homes and speculative residential construction. With few exceptions, the Company limits the number of unsold homes being built by each builder. The Company lends to qualified builders who are building in markets that management believes it understands and in which it is comfortable with the economic conditions.


•	Consumer Loans: The Company’s consumer loan portfolio consists of automobile loans, boat and recreational vehicle financing, home equity and home improvement loans, and miscellaneous secured and unsecured personal loans.


		Direct Consumer Loans: Direct consumer loans consist of automobile loans, boat and recreational vehicle financing, home equity and home improvement loans, and miscellaneous secured and unsecured personal loans originated directly by the Bank’s loan officers.

		Indirect Consumer Loans: The Company makes loans for new and used automobile and recreational vehicles that are originated indirectly by selected dealers located in the Company’s market areas. The Company has limited its indirect 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.

The Company makes certain loans which are guaranteed by the SBA. The SBA, an independent agency of the federal government, provides loan guarantees to qualifying small and medium sized businesses for up to 85% of the principal loan amount. The Company currently sells the guaranteed portion of each loan to investors in the secondary market. The guaranteed portion of an SBA loan is generally sold at a premium. In 2007, the Company sold total guaranteed portions of SBA loans in the amount of $6.1 million, compared with $5.4 million in 2006. The Company retains the unguaranteed portion of the loan. The retained portion of the SBA loan is classified within the portfolio by loan type.

Specific types of loans within the Company’s portfolio are more sensitive to interest rate changes. Commercial and real estate construction loan interest rates are primarily based upon current market rates plus a basis point spread charged by the Company. To better understand the Company’s risk associated with these loans, the following table sets forth the maturities by loan type:

Maturity and Sensitivity of Loans to Changes in Interest Rates


	Maturing
(Dollars in thousands)	Within 1 year		1 - 5 years		After 5 years		Total

Commercial	$	38,619	$	37,408	$	26,257	$	102,284
Real estate construction:
One-to-four family residential		69,112		30,813		1,987		101,912
Commercial		27,086		13,567		4,082		44,735

Total real estate construction		96,198		44,380		6,069		146,647

Total	$	134,817	$	81,788	$	32,326	$	248,931

Fixed-rate loans	$	25,240	$	37,751	$	6,620	$	69,611
Variable-rate loans		109,577		44,037		25,706		179,320

Total	$	134,817	$	81,788	$	32,326	$	248,931

Credit Risks and Asset Quality

Credit Risks: The extension of credit, in the form of loans or other credit substitutes, to individuals and businesses is a major portion of the Company’s principal business activity. Company policies and applicable laws and regulations require risk analysis as well as ongoing portfolio and credit management.

The Company manages its credit risk through lending limit constraints, credit review, approval policies and extensive, ongoing internal monitoring. Through this monitoring process, nonperforming loans are identified. Nonperforming assets consist of nonaccrual loans, restructured loans, past due loans and other real estate owned. Additional information on nonperforming assets is provided in Item 8 – Financial Statements and Supplementary Data, Note 1 – Significant Accounting Policies. Nonperforming assets are assessed for potential loss exposure on an individual or homogeneous group basis. Further details on the loss analysis are provided below in the Allowance for Loan Losses section. The following table summarizes the Company’s nonperforming assets for the past five years:


	Nonperforming Assets as of:
	Years Ended December 31
(Dollars in thousands)	2007		2006		2005		2004		2003

Nonaccrual loans	$	2,839	$	3,638	$	2,159	$	2,812	$	4,158
Restructured loans		—		—		—		—		—

Total nonperforming loans		2,839		3,638		2,159		2,812		4,158
Other real estate owned		1,440		363		—		1,222		504

Total nonperforming assets	$	4,279	$	4,001	$	2,159	$	4,034	$	4,662

Impaired loans	$	2,839	$	3,668	$	2,159	$	3,417	$	6,721
Accruing loans past due ³ 90 days		—		30		—		—		—
Potential problem loans		—		—		—		356		314
Allowance for loan losses		11,126		10,048		8,810		7,903		6,116
Interest foregone on nonaccrual loans		164		265		185		204		224

Nonperforming loans to loans		0.35%		0.51%		0.34%		0.48%		0.83%
Allowance for loan losses to loans		1.38%		1.40%		1.40%		1.36%		1.22%
Allowance for loan losses to nonperforming loans		395.41%		276.19%		408.06%		281.05%		147.09%
Allowance for loan losses to nonperforming assets		262.34%		251.13%		408.06%		195.91%		131.19%
Nonperforming assets to total assets		0.49%		0.50%		0.30%		0.61%		0.80%

Allowance for Loan Losses: 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 Company’s methodology for making such assessments and determining the adequacy of the allowance includes the following key elements:


•	Specific allowances for identified problem loans and portfolio segments.

•	A formula allowance based upon the historical loss experience of the loan portfolio, mix of the portfolio by loan type and the loan grade quality.

•	A general unallocated allowance consistent with SFAS No. 5, “Accounting for Contingencies.”

The evaluation of each element and the overall allowance is based on a continuing assessment of nonperforming assets, recent and historical loss experience, and other factors, including regulatory guidance and economic factors. The allocation of the allowance is based on an evaluation of nonperforming assets, historical ratios of loan losses and other factors that may affect future loan losses in specific categories of loans.

The following table shows the allocation of the allowance for loan losses, by loan type, for the past five years:


	Allocation of Allowance for Loan Losses as of:
	Years Ended December 31
	2007				2006				2005				2004				2003
			% of				% of				% of				% of				% of
(Dollars in thousands)	Amount		total⁽¹⁾		Amount		total⁽¹⁾		Amount		total⁽¹⁾		Amount		total⁽¹⁾		Amount		total⁽¹⁾

Balance applicable to:
Commercial	$	976		12.8%	$	782		11.5%	$	737		12.6%	$	772		14.0%	$	799		17.5%
Real estate mortgage		3,928		44.0%		3,303		41.3%		2,844		41.8%		2,352		37.9%		1,762		33.8%
Real estate construction		1,812		18.3%		1,781		21.3%		1,378		18.0%		1,399		18.2%		912		14.2%
Consumer		2,773		24.9%		2,593		25.9%		2,308		27.6%		2,449		29.9%		2,415		34.5%
Unallocated		1,637		N/A		1,589		N/A		1,543		N/A		931		N/A		228		N/A

Total	$	11,126		100%	$	10,048		100.0%	$	8,810		100.0%	$	7,903		100.0%	$	6,116		100.0%


⁽¹⁾		Represents the total of outstanding loans in each category as a percent of total loans outstanding.

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. Based on the assessment of loan quality, the Company believes that the current allowance for loan losses is appropriate under the current circumstances and economic conditions.

Asset Quality: The Company’s asset quality has been stable over the past two years. Additionally, increased recoveries of prior charged-off amounts have helped decrease net charge-offs to average loans by 31 basis points since 2003. The following table sets forth historical information regarding the Company’s net charge-offs and average loans for the past five years:


	Net Loan Charge-Offs as of:
	Years Ended December 31
	2007			2006			2005			2004			2003

(Dollars in thousands)
Indirect net charge-offs	$	(677	)	$	(332	)	$	(837	)	$	(926	)	$	(1,055	)
Other net charge-offs		(1,245	)		(1,105	)		(506	)		(787	)		(1,543	)

Total net charge-offs	$	(1,922	)	$	(1,437	)	$	(1,343	)	$	(1,713	)	$	(2,598	)

Average indirect loans	$	111,542		$	98,889		$	95,126		$	103,278		$	100,684
Average other loans		647,700			581,890			508,201			436,678			359,560

Total average loans	$	759,242		$	680,779		$	603,327		$	539,956		$	460,244

Indirect net charge-offs to average indirect loans		0.61%			0.34%			0.88%			0.90%			1.05%
Other net charge-offs to average other loans		0.19%			0.25%			0.10%			0.18%			0.43%
Net charge-offs to average loans		0.25%			0.21%			0.22%			0.32%			0.56%

The following table sets forth historical information regarding changes in the Company’s allowance for loan losses:

Summary of Loan Loss Experience as of:


	Years Ended December 31
(Dollars in thousands)	2007			2006			2005			2004			2003

Balance at beginning of period	$	10,048		$	8,810		$	7,903		$	6,116		$	5,514
Charge-offs:
Commercial		(1,090	)		(1,239	)		(524	)		(467	)		(1,293	)
Real estate		(20	)		(86	)		(98	)		(206	)		(177	)
Consumer and other		(1,672	)		(1,062	)		(1,594	)		(1,668	)		(1,725	)

Total charge-offs		(2,782	)		(2,387	)		(2,216	)		(2,341	)		(3,195	)

Recoveries:
Commercial		265			345			227			184			208
Real estate		77			12			143			79			—
Consumer and other:		518			593			503			365			389

Total recoveries		860			950			873			628			597

Net charge-offs		(1,922	)		(1,437	)		(1,343	)		(1,713	)		(2,598	)
Provision for loan losses		3,000			2,675			2,250			3,500			3,200

Balance at end of period	$	11,126		$	10,048		$	8,810		$	7,903		$	6,116

Deposits and Borrowings

Deposits: In 2007, the Company continued its efforts to expand its deposit base through competitive pricing and delivery of quality service. The Company’s efforts were successful with a 8% increase in total deposits over 2006. The Company was particularly successful in growing money market deposits by attracting an additional $31.4 million in 2007. As outlined in the following table, the Company increased average deposit balances during 2007. Additional information regarding deposits is provided in Item 8 – Financial Statements and Supplementary Data, Note 6 – Deposits.


	Average Deposit Balances as of:
	Years Ended December 31
	2007				2006				2005
	Average		Average		Average		Average		Average		Average
(Dollars in thousands)	balance		rate		balance		rate		balance		rate

Interest-bearing demand and money market deposits	$	268,817		2.62%	$	231,316		1.95%	$	227,588		1.09%
Savings deposits		46,152		0.67%		55,139		0.78%		57,131		0.78%
Time deposits		316,308		4.84%		276,211		4.20%		224,002		3.14%
Total interest-bearing deposits		631,277		3.59%		562,666		2.94%		508,721		1.96%
Demand and other noninterest-bearing deposits		100,830				100,267				96,511

Total average deposits	$	732,107			$	662,933			$	605,232

Time deposits were approximately 43% of the total deposit base as of December 31, 2007. In 2007, average time deposits increased 15% or $40.1 million, compared to 2006, due to a shift in consumer demand toward time deposits and more aggressive pricing of time deposits by the Company to support strong loan growth.

Although a significant amount of time deposits will mature and reprice in the next twelve months, the Company expects to retain the majority of such balances. In the short term, time deposits have limited impact on the liquidity of the Company and these deposits can generally be retained and expanded with increases in rates paid which might, however, increase the cost of funds more than anticipated.

The following table sets forth the amounts and maturities of time deposits at December 31, 2007:


	Maturities of Time Deposits
	Less than		3 to 6		6 to 12		Over 12
(Dollars in thousands)	3 months		months		months		months		Total

Time deposits of $100,000 or more	$	83,110	$	47,711	$	38,357	$	12,294	$	181,472
All other time deposits		45,955		52,937		49,324		11,829		160,045

Total time deposits	$	129,065	$	100,648	$	87,681	$	24,123	$	341,517

Borrowings: Total borrowings outstanding increased to $46.3 million at December 31, 2007 compared to $18.1 million in 2006. The change in borrowings is attributable to $20.5 million in short term borrowings from the Federal Home Loan Bank (the “FHLB”) and issuance of $10.3 million in additional junior subordinated debentures by the Company. The Company’s sources of funds consist of borrowings from correspondent banks, the FHLB and junior subordinated debentures.

FHLB Borrowings: The Company relies upon advances from the FHLB to supplement funding needs. The FHLB provides credit for member financial institutions in the form of overnight borrowings, short term and long term advances. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the pledge of certain of its mortgage loans and other assets (principally, securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. At December 31, 2007 the Company had an outstanding $20.5 million in overnight borrowings, with a remaining unused line of credit of $118.0 million, subject to certain collateral requirements. Additional information regarding FHLB borrowings is provided in Item 8 – Financial Statements and Supplementary Data, Note 7 – FHLB Advances and Stock.

Junior Subordinated Debentures: On April 2, 2007, a newly created wholly-owned subsidiary of the Company issued $10.3 million of trust preferred securities with a quarterly adjustable rate based upon the London Interbank Offered Rate (“LIBOR”) plus 1.56%. Additionally, on June 29, 2007, the Company prepaid $15.0 million of outstanding trust preferred securities with a quarterly adjustable rate of LIBOR plus 3.65%. On the same day, the Company replaced the called securities with another issuance of $15.5 million of trust preferred securities with a quarterly adjustable rate of LIBOR plus 1.56%. The debentures, within certain limitations, are considered Tier 1 capital for regulatory capital requirements.

Capital

Shareholders’ Equity: Shareholders’ equity increased $7.2 million to $73.6 million at December 31, 2007 from $66.4 million at December 31, 2006. The increase in shareholders’ equity was due to $9. 4 million of net income for the year and proceeds from the exercise of stock options of $1.1 million. These increases were offset by the payment of cash dividends of $2.2 million and repurchases of Company stock of $1.9 million. The following table represents the cash dividends declared and dividend payout ratio for the past three years:


	Cash Dividends & Payout Ratios
	Years Ended December 31
	2007		2006		2005

Dividend declared per share	$	0.23	$	0.20	$	0.18
Dividend payout ratio		23.07%		19.58%		17.46%

Cash dividends are approved by the Board of Directors in connection with its review of the Company’s capital plan. The cash dividend is subject to regulatory limitation as described in Item I- Business, Supervision and Regulation Section. There is no assurance that future cash dividends will be declared or increased. In 2007, the Company issued restricted stock units valued at $292,000, with vesting periods of three to five years. In 2006, the Company declared a 5-for-4 stock split payable on September 6, 2006. Additionally, net restricted stock awards valued at $276,000, with vesting periods ranging from one to five years, were granted in 2006. For further information on

shareholders’ equity, see Item 8 – Financial Statements and Supplementary Data, Consolidated Statements of Shareholders’ Equity.

Regulatory Capital Requirements: The Company (on a consolidated basis) and the Bank are subject to minimum capital requirements, under which risk percentages are assigned to various categories of assets and off-balance sheet items to calculate a risk-adjusted capital ratio. The Federal Reserve and FDIC regulations set forth the qualifications necessary for bank holding companies and banks to be classified as “well capitalized,” primarily for assignment of insurance premium rates. Failure to qualify as “well capitalized” can: (a) negatively impact a bank’s ability to expand and to engage in certain activities, (b) cause an increase in insurance premium rates, and (c) impact a bank holding company’s ability to utilize certain expedited filing procedures, among other things. The Company’s and Bank’s current capital ratios are located in Item 8 – Financial Statements and Supplementary Data, Note 13 – Regulatory Capital Matters.

Liquidity and Cash Flow

Whidbey Island Bank: The principal objective of the Bank’s liquidity management program is to maintain the ability to meet day-to-day cash flow requirements of its customers who either wish to withdraw funds or to draw upon credit facilities to meet their cash needs. The Bank monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. In addition to liquidity from core deposits and the repayment and maturities of loans, the Bank can utilize established lines of credit with correspondent banks, sale of investment securities or borrowings from the FHLB.

Washington Banking Company: The Company is a separate legal entity from the Bank and must provide for its own liquidity. Substantially all of the Company’s revenues are obtained from dividends declared and paid by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Company. However, management believes that such restrictions will not have an adverse impact on the ability of the Company to meets its ongoing cash obligations, which consist principally of debt service on the $25.8 million of outstanding junior subordinated debentures, which totaled approximately $1.8 million in 2007. Further information on the Company’s cashflows can be found in Item 8 – Financial Statements and Supplementary Data, Note 15 – Washington Banking Company Information.

Consolidated Cashflows: The consolidated cashflows of the Company and its subsidiary the Bank are disclosed in the Consolidated Statement of Cash Flows found in Item 8- Financial Statements and Supplementary Data. Net cash provided by operating activities was $13.9 million during 2007. The principal source of cash provided by operating activities was net income from continuing operations. Investing activities used $94.6 million in 2007. The net use of cash was principally for loan growth of $90.8 million and the purchase of $5.0 million of BOLI. Financing activities provided $80.1 million, primarily through net deposit growth of $54.6 million, $17.4 million in net FHLB borrowings and $25.8 million from the issuance of junior subordinated debentures. This was offset by the payoff of junior subordinated debentures of $15.0 million, $1.9 million in the repurchase of Company stock and cash dividends to shareholders of $2.2 million.

Capital Resources

Off-Balance Sheet Commitments: Standby letters of credit, commercial letters of credit, and financial guarantees written, are conditional commitments issued by the Company to guarantee the performance of a customer to a third party or payment by a customer to a third party. Those guarantees are primarily issued in international trade or to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. Except for certain long-term guarantees, the majority of guarantees expire in one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral supporting those commitments, for which collateral is deemed necessary, generally amounts to one hundred percent of the commitment amount at December 31, 2007. The Company routinely charges a fee for these

credit facilities. The Company has not been required to perform on any financial guarantees. The following table summarizes the Company’s commitments to extend credit:

Commitments to Extend Credit


(Dollars in thousands)	December 31, 2007

Loan commitments
Fixed rate	$	11,207
Variable rate		167,203
Standby letters of credit		1,207

Total commitments	$	179,617

Contractual Commitments: The Company is party to many contractual financial obligations, including repayment of borrowings and operating lease payments. The following table summarizes the contractual obligations of the Company as of December 31, 2007:


	Future Contractual Obligations
			Within						Over
(Dollars in thousands)	Total		1 year		1-3 years		3-5 years		5 years

Debt	$	—	$	—	$	—	$	—	$	—
Operating leases		1,265		227		294		78		666
Junior subordinated debentures		25,774		—		—		—		25,774

Total	$	27,039	$	227	$	294	$	78	$	26,440


Item 7A.	Quantitative and Qualitative Disclosures about Market Risk

Asset/Liability Management

The purpose of asset/liability management is to provide stable net interest income by protecting the Company’s earnings from undue interest rate risk that arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk, and capital adequacy. The Company maintains an asset/liability management policy that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analyses: liquidity, equity, volatile liability dependence, portfolio maturities, maturing assets and maturing liabilities. The Company’s policy is to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a narrow range around an “earnings neutral position,” which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.

Market Risk

Interest Rate Risk: The Company is exposed to interest rate risk. Interest rate risk is the risk that financial performance will decline over time due to changes in prevailing interest rates and resulting yields on interest-earning assets and costs of interest-bearing liabilities. Generally, there are three sources of interest rate risk as described below:

Re-pricing Risk: Generally, re-pricing risk is the risk of adverse consequences from a change in interest rates that arises because of differences in the timing of when those interest rate changes affect an institution’s assets and liabilities.

Basis Risk: Basis risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different instruments with the same maturity.

Option Risk: In banking, option risks are known as borrower options to prepay loans and depositor options to make deposits, withdrawals, and early redemptions. Option risk arises whenever bank products give customers the right, but not the obligation, to alter the quantity of the timing of cash flows.

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 fixed rate assets, cash flows and maturities of other investment securities, and 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 and changes in market conditions and management strategies, among other factors.


	Interest Rate Simulation Impact on Net Interest Income
	2007							2006
	Change in net interest			Percentage				Change in net interest			Percentage
Scenario	income from scenario			change				income from scenario			change


Up 100 basis points	$	(181,000	)		(0.5	)	%	$	175,000			0.5		%
Down 100 basis points	$	65,000			0.2		%	$	(219,000	)		(0.6	)	%

Interest Rate Sensitivity: The analysis of an institution’s interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is another standard tool for the measurement of the exposure to interest rate risk. The Company believes that because interest rate gap analysis does not address all factors that can affect earnings performance, it should be used in conjunction with other methods of evaluating interest rate risk.

The following table sets forth the estimated maturity or repricing, and the resulting interest rate gap of the Company’s interest-earning assets and interest-bearing liabilities at December 31, 2007. The interest rate gaps reported in the table arise when assets are funded with liabilities having different repricing intervals. The amounts shown in the following table could be significantly affected by external factors such as changes in prepayment assumptions, early withdrawals of deposits and competition:


	Estimated Maturity and Repricing at December 31, 2007
(Dollars in thousands)	0–3 months			4–12 months			1–5 years			Over 5 years		Total

Interest-earning assets:
Interest-earning deposits	$	257		$	—		$	—		$	—	$	257
Investment securities		—			2,849			9,743			1,240		13,832
Investment in subsidiary		—			—			—			774		774
FHLB stock		1,984			—			—			—		1,984
Loans held for sale		2,347			—			—			—		2,347
Loans		269,203			59,999			346,308			127,946		803,456

Total interest-earning assets	$	273,791		$	62,848		$	356,051		$	129,960	$	822,651
Percent of interest-earning assets		33.28%			7.64%			43.28%			15.80%		100%
Interest-bearing liabilities:
Interest-bearing demand deposits	$	140,145		$	—		$	—		$	—	$	140,145
Money market deposits		133,265			—			—			—		133,265
Savings deposits		41,888			—			—			—		41,888
CDs		129,065			188,329			24,123			—		341,517
FHLB overnight borrowings		20,500			—			—			—		20,500
Junior subordinated debentures		25,774			—			—			—		25,774
Other borrowed funds		—			—			—			—		—

Total interest-bearing liabilities	$	490,637		$	188,329		$	24,123		$	—	$	703,089
Percent of interest-bearing liabilities		69.78%			26.79%			3.43%			0.00%		100%
Interest sensitivity gap	$	(216,846	)	$	(125,481	)	$	331,928		$	129,960	$	119,562
Interest sensitivity gap, as a percentage of total assets		(24.58%	)		(14.22%	)		37.62%			14.73%
Cumulative interest sensitivity gap	$	(216,846	)	$	(342,327	)	$	(10,399	)	$	119,561
Cumulative interest sensitivity gap, as a percentage of total assets		(24.58%	)		(38.80%	)		(1.18%	)		13.55%

Impact of Inflation and Changing Prices

The primary impact of inflation on the Company’s operations is increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The Company’s management, including its Chief Executive Officer and its Chief Financial Officer, together with its consolidated subsidiary, is responsible for establishing, maintaining and assessing adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principals generally accepted in the United States of America.

The Company’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principals generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s financial statements.

Management recognizes that there are inherent limitations in the effectiveness of any system of internal control, and accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation and fair presentation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in the Internal Control-Integrated Framework. Based on this assessment, management believes that, as of December 31, 2007, the Company’s internal control over financial reporting was effective based on those criteria.

The Company’s registered public accounting firm has audited the Company’s consolidated financial statements as of and for the year ended December 31, 2007 that are included in this annual report and issued their Report of Independent Registered Public Accounting Firm, appearing under Item 8, which includes an attestation report on the Company’s internal control over financial reporting. The attestation report expresses an unqualified opinion on the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2007.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
Washington Banking Company and Subsidiaries

We have audited the accompanying consolidated statements of financial condition of Washington Banking Company and Subsidiaries (the Company) as of December 31, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risks. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and Directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

WASHINGTON BANKING COMPANY
AND SUBSIDIARIES
Consolidated Statements of Financial Condition
December 31, 2007 and 2006
(Dollars in thousands, except per share data)


	2007			2006

Assets
Cash and due from banks	$	18,795		$	18,984
($3,496 and $3,703, respectively, are restricted)
Interest-bearing deposits		257			761

Total cash, restricted cash, and cash equivalents		19,052			19,745
Investment securities available for sale		13,832			16,790

Total investment securities		13,832			16,790
Federal Home Loan Bank stock		1,984			1,984
Loans held for sale		2,347			2,458
Loans receivable		805,862			719,580
Allowance for loan losses		(11,126	)		(10,048	)

Total loans, net		794,736			709,532
Premises and equipment, net		25,138			23,372
Bank owned life insurance		16,517			10,930
Other assets		8,683			9,734

Total assets	$	882,289		$	794,545



Liabilities and Shareholders’ Equity
Liabilities:
Deposits
Noninterest-bearing	$	101,539		$	96,858
Interest-bearing		315,298			303,979
Time deposits		341,517			302,930

Total deposits		758,354			703,767
Other borrowed funds		20,500			3,075
Junior subordinated debentures		25,774			15,007
Other liabilities		4,091			6,303

Total liabilities		808,719			728,152
Commitments and contingencies (See Notes 16, and 18)		—			—
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 9,453,767 and 9,388,600 shares at December 31, 2007 and 2006, respectively		32,812			33,016
Retained earnings		40,652			33,422
Accumulated other comprehensive income (loss), net		106			(45	)

Total shareholders’ equity		73,570			66,393

Total liabilities and shareholders’ equity	$	882,289		$	794,545

See accompanying notes to consolidated financial statements.

WASHINGTON BANKING COMPANY
AND SUBSIDIARIES

Consolidated Statements of Income

Years Ended December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)


	2007		2006		2005

Interest income:
Interest and fees on loans	$	61,385	$	54,240	$	44,407
Interest on taxable investment securities		547		457		399
Interest on tax-exempt investment securities		263		310		310
Other		173		178		467

Total interest income		62,368		55,185		45,583
Interest expense:
Interest on time deposits		15,309		11,604		7,024
Interest on savings and money market deposits		4,837		2,919		1,995
Interest on NOW deposits		2,523		2,034		938
Interest on other borrowings		379		547		538
Interest on junior subordinated debentures		1,762		1,337		1,071

Total interest expense		24,810		18,441		11,566

Net interest income		37,558		36,744		34,017
Provision for loan losses		3,000		2,675		2,250

Net interest income after provision for loan losses		34,558		34,069		31,767
Noninterest income:
Service charges and fees		3,135		3,296		3,150
Income from the sale of loans		667		709		773
(Loss) on sale of securities		—		—		(50	)
Electronic banking income		1,252		1,052		764
SBA premium income		491		597		965
Other		1,945		1,596		1,906

Total noninterest income		7,490		7,250		7,508

Noninterest expense:
Salaries and benefits		17,082		16,807		15,075
Occupancy and equipment		3,805		3,596		3,373
Office supplies and printing		558		640		659
Data processing		663		479		493
Merger related expenses		513		—		—
Restructuring charge		—		575		—
Consulting and professional fees		735		769		829
Other		5,115		4,664		4,796

Total noninterest expense		28,471		27,530		25,225

Income before provision for income taxes		13,577		13,789		14,048
Provision for income taxes		4,179		4,298		4,580

Net income	$	9,398	$	9,491	$	9,468

Earnings per common share, basic⁽¹⁾
Net income per share	$	1.00	$	1.03	$	1.04

Earnings per common share, diluted
Net income per share	$	0.99	$	1.00	$	1.00

Average number of shares outstanding, basic		9,365,000		9,217,000		9,098,000
Average number of shares outstanding, diluted		9,493,000		9,490,000		9,428,000


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

See accompanying notes to consolidated financial statements.

WASHINGTON BANKING COMPANY
AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

Years Ended December 31, 2007, 2006 and 2005

(Dollars and shares in thousands, except per share data)


													Accumulated
													other			Total
	Common stock						Retained			Deferred			comprehensive			shareholders’
	Shares			Amount			earnings			compensation			income			equity

Balance at December 31, 2004⁽¹⁾		9,049		$	31,516		$	17,928			—		$	147		$	49,591
Net income		—			—			9,468			—			—			9,468
Net change in unrealized (loss) on securities available for sale		—			—			—			—			(226	)		(226	)
Plus adjustment for losses included in net income, net of tax of $17		—			—			—			—			33			33
Tax benefit associated with stock options		—			113			—			—			—			113
Cash dividend, $0.22 per share		—			—			(1,607	)		—			—			(1,607	)
Stock option compensation		—			23			—			—			—			23
Issuance of restricted stock		44			483			—			(483	)		—			—
Amortization of restricted stock		—			—			—			97			—			97
Stock options exercised		135			357			—			—			—			357

Balance at December 31, 2005⁽¹⁾		9,228		$	32,492		$	25,789			(386	)	$	(46	)	$	57,849
Net income		—			—			9,491			—			—			9,491
Net change in unrealized (loss) on securities available for sale		—			—			—			—			1			1
Tax benefit associated with stock options		—			29			—			—			—			29
Cash dividend, $0.20 per share		—			—			(1,858	)		—			—			(1,858	)
Stock option compensation		—			316			—			—			—			316
Transition adjustment SFAS No. 123R		—			(386	)		—			386			—			—
Issuance of restricted stock		18			—			—			—			—			—
Stock options exercised		143			565			—			—			—			565

Balance at December 31, 2006		9,389		$	33,016		$	33,422		$	—		$	(45	)	$	66,393
Net income		—			—			9,398			—			—			9,398
Net change in unrealized (loss)														151			151
on securities available for sale								—			—			—			—
Tax benefit associated with stock options		—			253			—			—			—			253
Cash dividend, $0.20 per share		—			—			(2,168	)		—			—			(2,168	)
Stock option compensation		—			345			—			—			—			345
Forfeited and cancelled restricted stock		(2	)		—			—			—			—			—
Common stock repurchased and retired		(116	)		(1,851	)		—			—			—			(1,851	)
Stock options exercised		183			1,049			—			—			—			1,049

Balance at December 31, 2007		9,454		$	32,812		$	40,652		$	—		$	106		$	73,570


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

See accompanying notes to consolidated financial statements.

WASHINGTON BANKING COMPANY
AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years Ended December 31, 2007, 2006 and 2005

(Dollars in thousands)


	2007			2006			2005

Cash flows from operating activities:
Net income from operations	$	9,398		$	9,491		$	9,468
Adjustments to reconcile net income to net cash provided by operating activities:
Federal Home Loan Bank stock dividends		—			—			(8	)
Deferred income tax expense (benefit)		1			(684	)		1,440
Amortization (accretion) of investment premiums, net		(10	)		11			2
Earnings on bank owned life insurance		(587	)		(372	)		(341	)
Provision for loan losses		3,000			2,675			2,250
Depreciation and amortization of premises and equipment		1,796			1,629			1,605
Net loss on sale of securities		—			—			50
Net loss on sale of premises and equipment		—			(17	)		(103	)
Net gain on sale of other real estate		(24	)		(6	)		(20	)
Write downs on other real estate		—			10			254
Excess tax benefit from stock-based compensation		(253	)		(29	)		(113	)
Amortization of stock-based compensation		345			316			120
Net Changes in assets and liabilities
Loans held for sale		111			371			5,482
Other assets		2,296			(1,119	)		(2,359	)
Other liabilities		(2,212	)		674			2,506

Cash flows from operating activities		13,861			12,950			20,233

Cash flows from investing activities:
Purchases of investment securities available for sale		(2,635	)		(3,675	)		(6,110	)
Maturities/calls/principal payments of investment and mortgage-backed securities available for sale		5,838			5,951			5,503
Sale of investment securities available for sale		—			—			504
Purchase of bank owned life insurance		(5,000	)		—			—
Net increase in loans		(90,756	)		(91,191	)		(51,681	)
Purchases of premises and equipment		(3,562	)		(4,470	)		(2,112	)
Proceeds from sale of other real estate owned and premises and equipment		1,499			65			1,519

Cash flows from investing activities		(94,616	)		(93,320	)		(52,377	)

Cash flows from financing activities:
Net increase in deposits		54,587			66,277			74,488
Gross payments on other borrowed funds		—			(26,845	)		(17,315	)
New borrowings on other borrowed funds		—			16,845			22,315
Net Increase (decrease) in FHLB overnight borrowings		17,425			3,075			(22,000	)
Gross payments on junior subordinated debentures		(15,007	)		—			—
New borrowings on junior subordinated debentures		25,774			—			—
Dividends paid on common stock		(2,168	)		(1,858	)		(1,607	)
Common stock repurchased		(1,851	)		—			—
Excess tax benefit from stock-based compensation		253			29			—
Proceeds from issuance of common stock- stock options		1,049			565			357

Cash flows from financing activities		80,062			58,088			56,238

Net change in cash and cash equivalents		(693	)		(22,282	)		24,094
Cash and cash equivalents at beginning of period		19,745			42,027			17,933

Cash and cash equivalents at end of period	$	19,052		$	19,745		$	42,027

Loans foreclosed and transferred to other real estate owned	$	2,552		$	432		$	53
Cash paid for interest		24,572			17,574			11,221
Cash paid for income taxes		4,123			5,210			4,170

See accompanying notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)


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

(a) Description of Business:


•	Washington Banking Capital Trust I (the “Trust”) was a wholly-owned subsidiary of the Company. The Trust, was formed in June 2002 for the exclusive purpose of issuing trust preferred securities. In 2003, the Trust subsidiary was consolidated. In 2004, pursuant to Financial Accounting Standards Board (“FASB”) Financial Interpretation No. 46R (“FIN 46R”), the Company deconsolidated the Trust. During the second quarter of 2007 the Trust was closed after the trust preferred securities were paid off. See Note 8- Trust Preferred Securities and Junior Subordinated Debentures for further details.

•	Washington Banking Master Trust (the “Master Trust”) is a wholly-owned subsidiary of the Company. The Master Trust was formed in April 2007 for the exclusive purpose of issuing trust preferred securities. See Note 8- Trust Preferred Securities and Junior Subordinated Debentures for further details.

•	Rural One, LLC (“Rural One”) is a majority-owned subsidiary of the Bank and is certified as a Community Development Entity by the Community Development Financial Institutions Fund of the United States Department of Treasury. Rural One was formed in September 2006, for the exclusive purpose of investing in Federal tax credits related to the New Markets Tax Credit program. See Note 9- Income Taxes for further details.


(b)	Basis of Presentation:

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries as described above. The consolidated financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America. All significant intercompany balances and transactions have been eliminated in consolidation. In preparing the consolidated financial statements, in conformity with generally accepted accounting principles, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the reported periods. Actual results could differ from these estimates. Management considers the estimates used in developing the allowance for loan losses to be particularly sensitive estimates that may be subject to revision in the near term.


(c)	Recent Financial Accounting Pronouncements:

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (including an amendment of FASB Statement No. 115). This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is effective for entities’ first fiscal year that begins after November 15, 2007. The Company did not early adopt and has declined to adopt the fair value option of the standard beginning on January 1, 2008.

In December 2007, FASB issued SFAS No. 141 (revised), Business Combinations. SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

effects of the business combination. This statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. Accordingly, we will apply SFAS 141(R) to business combinations occurring on or after January 1, 2009.

In December 2007, the FASB issues SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51. The standard requires ownership interests, sometime called minority interest, in subsidiaries held by parties other than the parent be clearly identified and presented within the equity section of the consolidated balance sheet, with the associated amount of net income clearly identified on the income statement providing sufficient disclosures to clearly identify and distinguish between the interests of the parent and interests of any noncontrolling owners. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008, and is not expected to have a material impact on Company’s financial statements

In September 2006, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue No. 06-4, “Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” EITF 06-4 requires employers to recognize a liability for future benefits provided through endorsement split-dollar life insurance arrangements that extend into postretirement periods in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” or APB Opinion No. 12, “Omnibus Opinion – 1967.” EITF 06-4 is effective for fiscal years beginning after December 15, 2007. Entities should recognize the effects of applying EITF 06-4 through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. The adoption of EITF 06-04 will result in a cumulative-effect adjustment to retained earnings of approximately $587,610 at January 1, 2008.


(d)	Cash and Cash Equivalents:

For purposes of reporting cash flows, cash and cash equivalents include cash on hand and due from banks, interest-earning deposits and federal funds sold, all of which have original maturities of three months or less.

(e) Federal Home Loan Bank Stock:

The Bank’s investment in FHLB stock is carried at par value, which approximates its fair value. As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of the Bank’s outstanding mortgages, total assets or FHLB advances. At December 31, 2007, the Bank’s minimum required investment was approximately $923. Amounts in excess of the required minimum for FHLB membership may be redeemed at par at FHLB’s discretion, which is subject to their capital plan, bank policies, and regulatory requirements, which may be amended or revised periodically.


(f)	Investment Securities:

Investment securities available for sale include securities that management intends to use as part of its overall asset/liability management strategy and that may be sold in response to changes in interest rates and resultant prepayment risk and other related factors. Securities available for sale are carried at market value, and unrealized gains and losses (net of related tax effects) are excluded from net income but are included as a separate component of comprehensive income. Upon realization, such gains and losses will be included in net income using the specific identification method. Declines in the fair value of individual securities available-for-sale below their cost that are other than temporary result in write-downs of the individual securities to their fair value. Such write-downs are included in earnings as realized losses.

Investment securities held to maturity are comprised of debt securities for which the Company has positive intent and ability to hold to maturity and are carried at cost, adjusted for amortization of premiums and accretion of discounts using the interest method over the estimated lives of the securities. Amortization of premiums and accretion of discounts are recognized in interest income over the period to maturity.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

Management determines the appropriate classification of investment securities at the purchase date in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.


(g)	Loans Held for Sale:

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. When a loan is sold, the gain is recognized in the consolidated statement of income as the proceeds less the book value of the loan including unamortized fees and capitalized direct costs.


(h)	Loans Receivable, Net:

Loans receivable, net, are stated at the unpaid principal balance, net of: premiums, unearned discounts, net deferred loan origination fees and costs, and the allowance for loan losses.

Interest on loans is calculated using the simple interest method based on the daily balance of the principal amount outstanding and is credited to income as earned.

Loans are placed on nonaccrual status when collection of principal or interest is considered doubtful (generally, loans 90 days or more past due).

A loan is considered impaired when, based upon currently known information, it is deemed probable that the Company will be unable to collect all amounts due as scheduled according to the original terms of the agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, based on the loan’s observable market price or the fair value of collateral, if the loan is collateral dependent.

Interest income previously accrued on nonaccrual loans, but not yet received, is reversed in the period the loan is placed on nonaccrual status. Payments received are generally applied to principal. However, based on management’s assessment of the ultimate collectibility of an impaired or nonaccrual loan, interest income may be recognized on a cash basis. Nonaccrual loans are returned to an accrual status when management determines the circumstances have improved to the extent that there has been a sustained period of repayment performance and both principal and interest are deemed collectible.

Loan fees and certain direct loan origination costs are deferred and the net fee or cost is recognized in interest income using the interest method over the estimated life of the individual loans, adjusted for actual prepayments.


(i)	Allowance for Loan Losses:

The allowance for loan losses is based upon the Company’s estimates. The Company determines the adequacy of the allowance for loan losses based on evaluations of the loan portfolio, recent loss experience and other factors, including economic and market conditions. The Company determines the amount of the allowance for loan losses required for certain sectors based on relative risk characteristics of the loan portfolio. Actual losses may vary from current estimates. These estimates are reviewed periodically and as adjustments become necessary, are reported in earnings in the periods in which they become known. The allowance for loan losses is increased by expensing to the provisions for loan losses. Losses are charged to the allowance and recoveries are credited to the allowance.


(j)	Premises and Equipment:

Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives used to compute depreciation and amortization include buildings and building improvements, 15 to 40 years; land improvements, 15 to 25 years; furniture, fixtures and equipment, 3 to 7 years; and leasehold improvements, lesser of useful life or life of the lease.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(k)	Bank Owned Life Insurance:

During the second quarter of 2007 and 2004, the Bank made a $5,000 and $10,000 investment, respectively, in bank owned life insurance (“BOLI”). These policies insure the lives of officers of the Bank, and name the Bank as beneficiary. Noninterest income is generated tax-free (subject to certain limitations) from the increase in the policies’ underlying investments made by the insurance company. The Bank is capitalizing on the ability to partially offset costs associated with employee compensation and benefit programs with the BOLI.


(l)	Other Real Estate Owned:

Other real estate owned includes properties acquired through foreclosure. These properties are recorded at the lower of cost or estimated fair value. Losses arising from the acquisition of property, in full or partial satisfaction of loans, are charged to the allowance for loan losses.

Subsequent to the transfer to other real estate owned, these assets continue to be recorded at the lower of cost or fair value (less estimated cost to sell), based on periodic evaluations. Generally, legal and professional fees associated with foreclosures are expensed as incurred. However, in no event are recorded costs allowed to exceed fair value. Subsequent gains, losses or expenses recognized on the sale of these properties are included in noninterest income or expense.


(m)	Federal Income Taxes:

The Company files a consolidated federal income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the periods in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date.


(n)	Stock-Based Compensation:

Prior to January 1, 2006, the Company accounted for stock-based compensation under the intrinsic value method of accounting prescribed by APB 25, Accounting for Stock Issued to Employees and FASB Interpretation No. 44 (“FIN 44”), Accounting for Certain Transactions Involving Stock Compensation. At January 1, 2006, the Company began recognizing compensation expense for stock-based compensation with the adoption of SFAS No. 123R, Share Based Payments. For further details on the impact to the Company’s financial statements please refer to Note (12)- Stock-Based Compensation.


(o)	Reclassifications:

Certain amounts in previous years may have been reclassified to conform to the 2007 financial statement presentation.


(2)	Restrictions on Cash Balance

The Company is required to maintain an average reserve balance with the Federal Reserve Bank or maintain such reserve balance in the form of cash. The amount of the required reserve balance on December 31, 2007 and 2006 was $3,496 and $3,703, respectively, and was met by holding cash with the Federal Reserve Bank.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(3)	Investment Securities

The amortized costs and market values of investment securities at December 31, 2007 and 2006 were as summarized:


					Gross		Gross
					unrealized		unrealized
			Gross		losses		losses
	Amortized		unrealized		less than		greater than			Market
	cost		gains		12 months		12 months			value

December 31, 2007:
Investments available for sale:
U.S. government agency securities	$	8,395	$	144	$	—	$	(2	)	$	8,537
Pass-through securities		78		—		—		—			78
State and political subdivisions		5,195		22				—			5,217

Total investment securities available for sale	$	13,668	$	166	$	—	$	(2	)	$	13,832


					Gross			Gross
					unrealized			unrealized
			Gross		losses			losses
	Amortized		unrealized		less than			greater than			Market
December 31, 2006:	cost		gains		12 months			12 months			value

Investments available for sale:
U.S. government agency securities	$	9,941	$	2	$	—		$	(71	)	$	9,872
Pass-through securities		101		—		—			—			101
State and political subdivisions		6,819		27		(8	)		(21	)		6,817

Total investment securities available for sale	$	16,861	$	29	$	(8	)	$	(92	)	$	16,790

Certain investment securities shown in the preceding table currently have fair values less than amortized cost and therefore contain unrealized losses. As of December 31, 2007 and 2006, the Company had 3 and 22 investment securities that were in an unrealized loss position. The Company has evaluated these securities and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase. The decline in value is not related to any company or industry specific event.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

The amortized cost and market value of investment securities by contractual maturity at December 31, 2007 are as follows:


	Dates of Maturities
	Under		1-5		5-10		Over
	1 year		years		years		10 years		Total

Investments available for sale:
U.S. government agency securities:
Amortized cost	$	1,998	$	6,397	$	—	$	—	$	8,395
Market value		1,999		6,538		—		—		8,537
Pass-through securities:
Amortized cost		—		78		—		—		78
Market value		—		78		—		—		78
State and political subdivisions:
Amortized cost		848		1,970		2,377		—		5,195
Market value		850		1,978		2,389		—		5,217

Total amortized cost	$	2,846	$	8,445	$	2,377	$	—	$	13,668

Total market value	$	2,849	$	8,594	$	2,389	$	—	$	13,832

At December 31, 2007 and 2006, investment securities with recorded values of $7,280 and $6,397, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law.


(4)	Loans and Allowance for Loan Losses

The loan portfolio composition, based upon the purpose and primary source of repayment of the loans, was as follows:


	December 31
	2007			2006

Commercial loans	$	102,284		$	82,990
Real estate mortgages		353,538			303,663
Real estate construction loans		146,647			142,436
Consumer loans		200,987			188,490

Subtotal		803,456			717,579
Less:
Allowance for loan losses		(11,126	)		(10,048	)
Deferred loan fees, net		2,406			2,001

Net loans	$	794,736		$	709,532

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

The following is an analysis of the changes in the allowance for loan losses:


	December 31
	2007			2006			2005

Beginning balance	$	10,048		$	8,810		$	7,903
Provision for loan losses		3,000			2,675			2,250
Recoveries		860			950			873
Charge-offs		(2,782	)		(2,387	)		(2,216	)

Ending balance	$	11,126		$	10,048		$	8,810

The Company had impaired loans which consisted of nonaccrual and accrual loans. As of December 31, 2007, the Company had no commitments to extend additional credit on these impaired loans. Impaired loans and their related reserve for loan losses were as follows:


	December 31
	2007		2006		2005

Impaired loans
Nonaccrual loans	$	2,839	$	3,638	$	2,159
Accrual loans		—		30		—

Total impaired loans	$	2,839	$	3,668	$	2,159

Reserve for impaired loans
Nonaccrual loans	$	500	$	551	$	239
Accrual loans		—		30		—

Total reserve for loan losses	$	500	$	581	$	239

The average balance on impaired loans was as follows:


	December 31
	2007		2006		2005

Average balance impaired loans
Nonaccrual loans	$	2,538	$	2,518	$	2,521
Accrual loans		—		14		—
Ending balance	$	2,538	$	2,532	$	2,521

The following table details the interest income which would have been recognized if the loans had accrued interest, in accordance with their original terms, and the interest actually recognized.


	December 31
	2007		2006		2005

Interest income not recognized on impaired loans	$	154	$	265	$	185
Interest income recognized on impaired loans	$	164	$	189	$	38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(5)	Premises and Equipment

Premises and equipment consisted of the following:


	December 31
	2007			2006

Land and buildings	$	20,684		$	20,432
Furniture and equipment		9,467			9,242
Land improvements		2,268			2,212
Computer software		2,705			2,110
Construction in progress		3,010			650

Subtotal		38,134			34,646
Less: accumulated depreciation		(12,996	)		(11,274	)

Total	$	25,138		$	23,372


(6)	Deposits

Deposits are summarized as follows:


	December 31
	2007		2006

Time deposits	$	341,517	$	302,930
Savings		41,888		50,036
Money market		133,265		101,856
Negotiable orders of withdrawal (“NOWs”)		140,145		152,087
Noninterest-bearing demand		101,539		96,858

Total	$	758,354	$	703,767

Time deposits mature as follows:


	December 31, 2007
	Less than
	1 year		1-2 years		2-3 years		3-4 years		4-5 years		Over 5 years		Total

Time deposits of $100,000 or more	$	169,178	$	8,545	$	1,865	$	400	$	1,484	$	—	$	181,472
All other Time deposits		148,216		9,566		1,228		460		575		—		160,045

Total	$	317,394	$	18,111	$	3,093	$	860	$	2,059	$	—	$	341,517


(7)	FHLB Advances and Stock

The Bank is required to maintain an investment in the stock of FHLB. The requirement is based on the following components:


	•	3.5% of the average daily balance of advances outstanding during the most recent quarter; plus

	•	the greater of $500 or 0.75% of mortgage loans and pass-through securities; or

	•	5.0% of the outstanding balance of loans sold to the FHLB minus the membership requirement.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

During 2005, the FHLB suspended payment of dividends and resumed the payment of dividends during 2007. The Company evaluated this suspension and subsequent resumption of dividends and has determined that the stock is not considered impaired as of December 31, 2007.

A credit line has been established by the FHLB for Whidbey Island Bank. At December 31, 2007, the line of credit available to the Bank was $118,095. The Bank may borrow from the FHLB in amounts up to 15% of its total assets, subject to certain restrictions and collateral. Advances on the line are collateralized by securities pledged and held in safekeeping by the FHLB, as well as supported by eligible real estate loans. As of December 31, 2007, collateral consisted entirely of eligible real estate loans in the amount of $210,041. At December 31, 2007 the Bank had $20,500 of overnight borrowings outstanding.


	December 31
	2007		2006

Year to average balance	$	4,316	$	6,780
Maximum amount outstanding at any month end		20,500		18,000
Weighted average interest rate on amount outstanding a December 31,		4.44%		5.78%


(8)	Trust Preferred Securities and Junior Subordinated Debentures

Washington Banking Capital Trust I, a statutory business trust, was a wholly-owned subsidiary of the Company created for the exclusive purposes of issuing and selling capital securities and utilizing sale proceeds to acquire junior subordinated debt issued by the Company. On June 27, 2002, the Trust issued $15,000 of trust preferred securities with a 30-year maturity, callable after the fifth year by the Company. On June 29, 2007, the Company called the $15,000 of trust preferred securities issued. The Trust was subsequently closed.

Washington Banking Master Trust, a statutory business trust, is a wholly-owned subsidiary of the Company created for the exclusive purposes of issuing and selling capital securities and utilizing sale proceeds to acquire junior subordinated debt issued by the Company. During the second quarter of 2007, the Master Trust issued $25,000 of trust preferred securities with a 30-year maturity, callable after the fifth year by the Company. The trust preferred securities have a quarterly adjustable rate based upon the London Interbank Offered Rate (“LIBOR”) plus 1.56%. On December 31, 2007 the rate was 6.55%.

The junior subordinated debentures are the sole assets of the Master Trust, and payments under the junior subordinated debentures are the sole revenues of the Trust. All of the common securities of the Master Trust are owned by the Company. Washington Banking Company has fully and unconditionally guaranteed the capital securities along with all obligations of the Master Trust under the trust agreements.


(9)	Income Taxes

The Company adopted FIN 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. FIN 48 is an interpretation of SFAS No. 109, Accounting for Income Taxes, and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, and accounting in interim periods and requires expanded disclosure with respect to uncertainty in income taxes. As a result of the implementation of FIN 48, the Company recognized no material adjustments in the liability for unrecognized income tax benefits, all of which would affect the Company’s effective income tax rate if recognized.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

Income tax expense (benefit) consisted of the following:


	December 31
	2007		2006			2005

Federal:
Current tax expense	$	4,178	$	4,982		$	3,140
Deferred tax expense (benefit)		1		(684	)		1,440

Total	$	4,179	$	4,298		$	4,580

Reconciliation between the statutory federal income tax rate and the effective tax rate is as follows:


	December 31
	2007						2006						2005

Income tax expense at federal statutory rate	$	4,752		35.0		%	$	4,744		34.4		%	$	4,857		34.3		%
Federal tax credits		(400	)	(2.9	)	%		(400	)	(2.9	)	%		—		—
Interest income on tax-exempt securities		(382	)	(2.8	)	%		(305	)	(2.2	)	%		(285	)	(1.7	)	%
Other liabilities		209		1.5		%		259		1.9		%		8		—

Total	$	4,179		30.8		%	$	4,298		31.2		%	$	4,580		32.6		%

The effective tax rate for 2007 is impacted by Federal tax credits related to the New Markets Tax Credit program, whereby a subsidiary of Whidbey Island Bank has been awarded $3,100 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 Company believes that it will comply with the various regulatory provisions of the New Markets Tax Credit program in 2007, and therefore has reflected the impact of the credits in its estimated annual effective tax rate for 2007.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

The following table presents major components of the net deferred income tax asset resulting from differences between financial reporting and tax basis:


	December 31
	2007		2006

Deferred tax assets:
Allowance for loan loss	$	3,894	$	3,517
Deferred compensation		394		404
Other		6		20
Market value adjustment of investment securities available for sale		—		25

Total deferred tax assets		4,294		3,966
Deferred tax liabilities:
Deferred loan fees		1,859		1,552
Premises and equipment		304		433
FHLB stock dividend		152		152
Investment in partnership		280		140
Prepaid expenses		127		111
Market value adjustment of investment securities available for sale		57		—
Other		45		23

Total deferred tax liabilities		2,824		2,411

Deferred tax assets, net	$	1,470	$	1,555

There was no valuation allowance for deferred tax assets as of December 31, 2007 or 2006. 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 asset will be realized in the normal course of business.


(10)	Earnings Per Share

The following illustrates the reconciliation of the numerators and denominators of the basic and diluted earnings per share (“EPS”) computations:


	Year Ended December 31, 2007
	Income		Weighted average shares		Per share amount

Basic EPS
Income available to common shareholders	$	9,398		9,365,000	$	1.00
Effect of dilutive securities: stock options		—		128,000		(0.01	)

Diluted EPS	$	9,398		9,493,000	$	0.99


	Year Ended December 31, 2006
	Income		Weighted average shares		Per share amount

Basic EPS
Income available to common shareholders	$	9,491		9,217,000	$	1.03
Effect of dilutive securities: stock options		—		273,000		(0.03	)

Diluted EPS	$	9,491		9,490,000	$	1.00

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(10)	Earnings Per Share- (Continued)


	Year Ended December 31, 2005
	Income		Weighted average shares		Per share amount

Basic EPS
Income available to common shareholders	$	9,468		9,098,000	$	1.04
Effect of dilutive securities: stock options		—		330,000		(0.04	)

Diluted EPS	$	9,468		9,428,000	$	1.00

On September 6, 2006, the Company issued a 5-for-4 stock split to shareholders of record as of August 21, 2006. On May 17, 2005, the Board of Directors issued a 4-for-3 stock split to shareholders of record as of May 2, 2005. All periods presented have been restated to reflect the stock splits and dividend.


(11)	Employee Benefit Plans


(a)	401(k) and Profit Sharing Plan:

During 1993, the Board of Directors approved a defined contribution plan (“the Plan”). The Plan covers substantially all full-time employees and many part-time employees once they meet the age and length of service requirements. The Plan allows for a voluntary salary reduction, under which eligible employees are permitted to defer a portion of their salaries, with the Company contributing a percentage of the employee’s contribution to the employee’s account. Employees are fully vested in their elected and employer-matching contributions at all times. At the discretion of the Board of Directors, an annual profit sharing contribution may be made to eligible employees. Profit sharing contributions vest over a six-year period.

The Company’s contributions for the years ended December 31, 2007, 2006 and 2005 under the employee matching feature of the plan were $280, $230 and $222, respectively. This represents a match of the participating employees’ salary deferral of 50% of the first 6% of the compensation deferred for 2007 and 5% for 2006 and 2005. There were no contributions under the profit sharing portion of the plan for the years presented.


(b)	Deferred Compensation Plan:

In December 2000, the Bank approved the adoption of an Executive Deferred Compensation Plan (“Comp Plan”) to take effect January 2001, under which select participants may elect to defer receipt of a portion of eligible compensation. The following is a summary of the principal provisions of the Compensation Plan:

Purpose: The purpose of the Comp Plan is to (1) provide a deferred compensation arrangement for a select group of management or highly compensated employees within the meaning of Sections 201(2) and 301(a)(3) of ERISA and directors of the Bank, and (2) attract and retain the best available personnel for positions of responsibility with the Bank and its subsidiaries. The Comp Plan is intended to be an unfunded deferred compensation agreement. Participation in the Comp Plan is voluntary.

Source of Benefits: Benefits under the Comp Plan are payable solely by the Bank. To enable the Bank to meet its financial commitment under the Comp Plan, assets may be set aside in a corporate-owned vehicle. These assets are available to all general creditors of the Bank in the event of the Bank’s insolvency. Participants of the Comp Plan are unsecured general creditors of the Bank with respect to the Comp Plan benefits. Deferrals under the Comp Plan may reduce compensation used to calculate benefits under the Bank’s 401(k) Plan.

During the second quarter of 2004 and 2007, the Bank made a $10,000 and $5,000 investment, respectively in BOLI. These policies insure the lives of officers of the Bank, and name the Bank as beneficiary. Noninterest income is generated tax-free (subject to certain limitation) from the increase in the policies’ underlying investments made by the insurance company.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(12)	Stock-Based Compensation

The Company adopted the 2005 Stock Incentive Plan (“2005 Plan”) following stockholder’s approval at the 2005 Annual Meeting of Stockholders. Subsequent to the adoption of the 2005 Plan, no additional grants may be issued under the prior plans.

The 2005 Plan provides grants of up to 833,333 shares, which includes any remaining shares subject to stock awards under the prior plans for future awards, or which have been forfeited, cancelled or expire. Grants from the 2005 Plan may take any of the following forms: incentive stock options, nonqualified stock options, restricted stock, restricted units, performance shares, performance units, stock appreciation rights or dividend equivalent rights. As of December 31, 2007, the Company had 709,924 shares available for grant.


(a)	Stock Options:

Under the terms of the 2005 Plan, the exercise price of each incentive stock option must be greater than or equal to the market price of the Company’s stock on the date of the grant. The plan further provides that no stock option granted to a single grantee may exceed $100 in aggregate fair market value in a single calendar year. Stock options vest over a period of no greater than five years from the date of grant. Additionally, the right to exercise the option terminates ten years from the date of grant.

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 twelve months ended December 31, 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.

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 2005:


	Years Ended
	December 31
	2005

Basic earnings per share:
As reported	$	1.04

Pro forma	$	1.04

Diluted earnings per share:
As reported	$	1.00

Pro forma	$	1.00

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

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 2007 and 2006 was $5.11 and $6.10 per share, respectively. There were no stock options issued during 2005. The following assumptions were used in arriving at the fair value of options granted:


	2007		2006

Risk-free interest rate		4.59%		4.32 to 4.95%
Dividend yield rate		1.50%		1.20 to 1.40%
Price volatility		33.00%		38.13%
Expected life of options		5 years		7 years

The following table summarizes information about stock options outstanding at December 31, 2007:


	Outstanding						Exercisable
			Weighted						Weighted
			average		Average				average
Exercise Price Range	Shares		exercise price		Life⁽¹⁾		Shares		exercise price		Average Life⁽¹⁾

$ 4.50 to 5.00		54,555	$	4.50		3.88		54,555	$	4.50		3.88
5.01 to 8.50		57,994		6.17		3.95		46,976		6.14		3.95
8.51 to 12.00		—		—		—		—		—		—
12.01 to 15.50		22,834		14.59		8.29		4,927		14.60		8.29
15.51 to 17.35		57,235		16.04		9.29		560		17.35		9.29

		192,618	$	9.63		6.03		107,018	$	5.75		4.03


⁽¹⁾		Average contractual life remaining in years.

The following table summarizes information on stock option activity during 2007:


				Weighted				Aggregate
				average		Average		intrinsic
	Shares			exercise price		Life⁽¹⁾		value

Outstanding at January 1, 2007		331,145		$	6.06
Granted		56,586			15.98
Exercised		(183,275	)		5.07			$	1,976
Forfeited, expired or cancelled		(11,838	)		9.40

Outstanding at December 31, 2007		192,618		$	9.63		6.03	$	1,201

Exercisable at December 31, 2007		107,018		$	5.75		4.03	$	1,075


⁽¹⁾		Average contractual life remaining in years.

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 December 31, 2007 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 December 31, 2007. This amount changes based upon the fair market value of the Company’s stock.

The total intrinsic value of options exercised for the years ended December 31, 2007, 2006 and 2005 was $1,976, $1,709 and $1,398, respectively.

For the year ended December 31, 2007 and 2006, the Company recognized $109 and $110, respectively, in stock option compensation expense as a component of salaries and benefits. As of December 31, 2007 and 2006, there was approximately $324 and $212, respectively of total unrecognized compensation cost related to non-vested options.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(b)	Restricted Stock Awards:

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 2007:


				Weighted average		Weighted average
				grant price per		remaining contractual
	Shares			share		terms (in years)

Outstanding at January 1, 2007		50,123		$	12.64
Granted		2,536			15.80
Vested		(19,403	)		12.40
Forfeited, expired or cancelled		(3,696	)		12.52

Outstanding at December 31, 2007		29,560		$	13.08		1.94

The total intrinsic value of restricted stock vested for the years ended December 31, 2007 and 2006 was $300 and $204, respectively. No restricted stock vested for the year ended December 31, 2005.

For years ended December 31, 2007, 2006 and 2005 the Company recognized $192, $183 and $96 respectively, in restricted stock compensation expense as a component of salaries and benefits. As of December 31, 2007 there was $261 of total unrecognized compensation costs related to non-vested restricted stock.


(c)	Restricted Stock Units:

The Company grants restricted stock units periodically for the benefit of employees. Recipients of restricted stock units receive shares of the Company’s stock upon the lapse of their related restrictions and do not pay any cash consideration to the Company for the shares. Restrictions are based on continuous service.

The following table summarizes information on restricted stock unit activity during 2007:


					Weighted average
			Weighted average		remaining
			grant price per		contractual terms
	Shares		share		(in years)

Outstanding at January 1, 2007		—	$	—
Granted		18,293		15.98
Vested		—		—
Forfeited, expired or cancelled		478		15.98

Outstanding at December 31, 2007		17,815	$	15.98		3.93

For year ended December 31, 2007 the Company recognized $44, in restricted stock unit compensation expense as a component of salaries and benefits. As of December 31, 2007 there was $241 of total unrecognized compensation costs related to non-vested restricted stock units.


(13)	Regulatory Capital Matters

The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

classification are also subject to qualitative judgments by the regulators about risk components, asset risk weighting and other factors.

Risk-based capital guidelines issued by the FDIC establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures for banks. The Bank’s Tier 1 capital is comprised primarily of common equity and trust preferred securities, and excludes the equity impact of adjusting available-for-sale securities to fair value. Total capital also includes a portion of the allowance for loan losses, as defined according to regulatory guidelines. In addition, under Washington State banking regulations, the Bank is limited as to the ability to declare or pay dividends to the Company up to the amount of the Bank’s retained earnings then on hand. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital to risk-weighted assets (as defined in the regulations), and of Tier 1 capital to average assets (as defined in the regulations). As of December 31, 2007, the Company and Bank met the minimum capital requirements to which it is subject and is considered to be “well-capitalized.”

The following tables describe the Company’s and Bank’s regulatory capital and threshold requirements for the 2007 and 2006 periods:


											To be well-capitalized
						For capital					under prompt corrective
						adequacy purposes					action provisions
	Actual							Minimum					Minimum
	Amount		Ratio			Amount		ratio			Amount		ratio


December 31, 2007:
Total risk-based capital (to risk-weighted assets)
Consolidated	$	109,436		12.45	%	$	70,327		8.00	%	$	N/A
Whidbey Island Bank		105,629		12.03	%		70,218		8.00	%		87,772		10.00%
Tier 1 capital (to risk-weighted assets)
Consolidated		97,934		11.14	%		35,163		4.00	%		N/A
Whidbey Island Bank		94,658		10.78	%		35,109		4.00	%		52,663		6.00%
Tier 1 capital (to average assets)
Consolidated		97,934		11.29	%		34,694		4.00	%		N/A
Whidbey Island Bank		94,658		10.92	%		34,659		4.00	%		43,324		5.00%


											To be well-capitalized
						For capital					under prompt corrective
						adequacy purposes					action provisions
	Actual							Minimum					Minimum
	Amount		Ratio			Amount		ratio			Amount		ratio


December 31, 2006:
Total risk-based capital (to risk-weighted assets)
Consolidated	$	91,331		11.52	%	$	63,453		8.00	%	$	N/A
Whidbey Island Bank		88,522		11.19	%		63,299		8.00	%		79,123		10.00%
Tier 1 capital (to risk-weighted assets)
Consolidated		81,416		10.27	%		31,727		4.00	%		N/A
Whidbey Island Bank		78,630		9.94	%		31,649		4.00	%		47,474		6.00%
Tier 1 capital (to average assets)
Consolidated		81,416		10.24	%		31,796		4.00	%		N/A
Whidbey Island Bank		78,630		9.92	%		31,711		4.00	%		39,637		5.00%


(14)	Fair Value of Financial Instruments

Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. Fair valuations are management’s estimates of values. These calculations are subjective in nature, involve uncertainties and matters of

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

significant judgment and do not include tax ramifications, therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, which could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

When possible, quoted market prices are used to determine fair value. In cases where a quoted market price is not available, the fair value of financial instruments is estimated using the present value of future cash flows or other valuation methods.


(a)	Cash and Cash Equivalents:

The carrying value of cash and cash equivalent instruments approximates fair value.

(b) Interest-bearing Deposits:

The carrying values of interest-bearing deposits maturing within ninety days approximate their fair values. Fair values of other interest-earning deposits are estimated using discounted cash flow analyses based on current rates for similar types of deposits.


(c)	Federal Funds Sold:

The carrying value of federal funds sold approximates fair value.

(d) Securities:

The fair value of all investment securities, excluding FHLB stock, is based upon quoted market prices. FHLB stock is not publicly traded, however, it may be redeemed on a dollar-for-dollar basis for any amount the Bank is not required to hold. The fair value is therefore equal to the carrying value.


(e)	Loans:

The loan portfolio is composed of commercial, consumer, real estate construction and real estate loans. The carrying value of variable rate loans approximates their fair value. The fair value of fixed rate loans is estimated by discounting the estimated future cash flows of loans, sorted by type and security, by the weighted average rate of such loans and rising rates currently offered by the Bank for similar loans.


(f)	Deposits:

For deposits with no contractual maturity such as checking accounts, money market accounts and savings accounts, fair values approximate book values. The fair value of certificates of deposit are based on discounted cash flows using the difference between the actual deposit rate and an alternative cost of funds rate, currently offered by the Bank for similar types of deposits.


(g)	Trust Preferred Securities/Junior Subordinated Debentures:

The fair value of trust preferred securities is estimated at their recorded value due to the cost of the instrument re-pricing on a quarterly basis.


(h)	Other Borrowed Funds:

Other borrowed funds consist of FHLB advances. The carrying amount of FHLB advances is estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates of similar types of borrowing arrangements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(i)	Off-Balance Sheet Items:

Commitments to extend credit represent the principal category of off-balance sheet financial instruments (see Note 16). The fair value of these commitments is not material since they are for relatively short periods of time and are subject to customary credit terms, which would not include terms that would expose the Company to significant gains or losses.

The table below presents the carrying value amount of the Company’s financial instruments and their corresponding fair values:


	December 31
	2007				2006
	Carrying		Fair		Carrying		Fair
	value		value		value		value

Financial assets:
Cash and cash equivalents	$	18,795	$	18,795	$	18,984	$	18,984
Interest-earning deposits		257		257		761		761
Federal funds sold		—		—		—		—
FHLB stock		1,984		1,984		1,984		1,984
Investment securities:
Available for sale		13,832		13,832		16,790		16,790
Loans held for sale		2,347		2,347		2,458		2,458
Loans		805,862		801,728		719,580		713,543
Financial liabilities:
Deposits		758,354		761,875		703,767		702,971
FHLB overnight borrowings		20,500		20,500		3,075		3,075
Junior subordinated debentures		25,774		23,463		15,007		15,007
Other borrowed funds		—		—		—		—

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(15)	Washington Banking Company Information

The summarized condensed financial statements for Washington Banking Company (parent company only) are presented in the following table:


	December 31
	2007		2006

Condensed Balance Sheets
Assets:
Cash and cash equivalents	$	3,304	$	1,123
Other assets		549		1,469
Investment in subsidiaries		95,557		78,808

Total assets	$	99,410	$	81,400


Liabilities:
Junior subordinated debentures	$	25,774	$	15,007
Other liabilities		66		—
Shareholders’ equity:
Common stock		32,812		33,016
Retained earnings		40,652		33,422
Accumulated other comprehensive income (loss), net		106		(45	)

Total shareholders’ equity		73,570		66,393

Total liabilities and shareholders’ equity	$	99,410	$	81,400


	Years Ended December 31
Condensed Statements of Income	2007			2006			2005

Interest income:
Interest-earning deposits	$	39		$	26		$	18
Common securities		54			41			33

Total interest income		93			67			51
Interest expense:
Junior subordinated debentures		1,762			1,337			1,071

Net interest income (loss)		(1,669	)		(1,270	)		(1,020	)
Noninterest expense		1,356			482			600

Loss before income tax benefit and undistributed earnings of subsidiaries		(3,025	)		(1,752	)		(1,620	)
Income tax benefit		1,075			603			556

Loss before undistributed earnings of subsidiaries		(1,950	)		(1,149	)		(1,064	)
Undistributed earnings of subsidiaries		10,548			7,790			8,182
Dividend income from the Bank		800			2,850			2,350
Loss from discontinued operations		—			—			—

Net income	$	9,398		$	9,491		$	9,468

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


	Years Ended December 31
Condensed Statements of Cash Flows	2007			2006			2005

Operating activities:
Net income from continuing operations	$	9,398		$	9,491		$	9,468
Adjustments to reconcile net income to net cash used in operating activities:
Equity in undistributed earnings of subsidiaries		(10,383	)		(7,790	)		(8,182	)
Stock option compensation		10			23			24
Other assets		985			(191	)		(801	)

Cash flows provided by operating activities		10			1,533			509

Investing activities:
Investment in subsidiaries		(5,741	)		(41	)		(293	)
Financing activities:
Gross payments on junior subordinated debentures		(15,007	)		—			—
New borrowings on junior subordinated debentures		25,774			—			—
Dividends paid on common stock		(2,168	)		(1,858	)		(1,607	)
Common stock repurchased		(1,851	)		—			—
Proceeds from issuance of common stock- stock options		1,164			594			357

Cash flows used in financing activities		7,912			(1,264	)		(1,250	)

Net increase (decrease) in cash and cash equivalents		2,181			228			(488	)
Cash and cash equivalents at beginning of year		1,123			895			1,343

Cash and cash equivalents at end of year	$	3,304		$	1,123		$	895


(16)	Commitments


(a)	Leasing Arrangements:

The Company is obligated under a number of noncancelable operating leases for land and buildings. The majority of these leases have renewal options. In addition, some of the leases contain escalation clauses tied to the consumer price index with caps.

At December 31, 2007 the Company’s future minimum rental payments required under land, buildings and equipment operating leases that have initial or remaining noncancelable lease terms of one year or more are as follows:


	2008		2009		2010		2011		2012		Thereafter		Total

Minimum Payments	$	227	$	144	$	72	$	78	$	78	$	666	$	1,265

Rent expense applicable to operating leases for the years ended December 31, 2007, 2006 and 2005 was $426, $419, and $374, respectively.


(b)	Commitments to Extend Credit:

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include: property, plant and equipment; accounts receivable; inventory; and income-producing commercial properties.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)

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, the majority of guarantees expire in one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral supporting those commitments, for which collateral is deemed necessary, generally amounts to one hundred percent of the commitment amount at December 31, 2007.

The Bank has not been required to perform on any financial guarantees and did not incur any losses on its commitments in 2007 and 2006.

Commitments to extend credit were as follows:


	December 31, 2007

Loan commitments
Fixed rate	$	11,207
Variable rate		167,203
Standby letters of credit		1,207

Total commitments		179,617


(17)	Related Party Transactions

As of December 31, 2007 and 2006, the Bank had loans to persons serving as directors and executive officers, and to entities related to such individuals aggregating $6,111 and $3,314, respectively. All loans were made on essentially the same terms and conditions as comparable transactions with other persons, and do not involve more than the normal risk of collectibility. During the year ended December 31, 2007, total principal additions were $8,943 and total principal payments were $6,527.

Deposits from related parties held by the Bank at December 31, 2007 and 2006 totaled $6,875 and $7,080, respectively.


(18)	Contingencies

The Company and its subsidiaries are from time to time defendants in and are threatened with various legal proceedings arising from regular business activities. Management believes the ultimate liability, if any, arising from such claims or contingencies will not have a material adverse effect on the Company’s results of operations or financial condition.


(19)	Subsequent Events

On January 24, 2008, the Board of Directors declared a cash dividend of $0.06 per share to shareholders of record as of February 05, 2008, payable on February 21, 2008.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share data)


(20)	Selected Quarterly Financial Data (Unaudited)

Results of operations on a quarterly basis were as follows:


	Year Ended December 31, 2007
	First		Second		Third		Fourth
	quarter		quarter		quarter		quarter

Interest income	$	14,664	$	15,456	$	16,221	$	16,028
Interest expense		5,695		6,100		6,465		6,550

Net interest income		8,969		9,356		9,756		9,478
Provision for loan losses		550		850		800		800

Net interest income after provision for loan losses		8,419		8,506		8,956		8,678
Noninterest income		1,804		1,953		1,923		1,808
Noninterest expense		6,924		6,870		6,827		7,850

Income before provision for income taxes		3,299		3,589		4,052		2,636

Provision for income taxes		1,032		1,129		1,232		785
Net income	$	2,267	$	2,460	$	2,820	$	1,851

Basic earnings per share	$	0.24	$	0.26	$	0.30	$	0.20
Diluted earnings per share	$	0.24	$	0.26	$	0.30	$	0.19
Cash dividends declared per share	$	0.05	$	0.06	$	0.06	$	0.06


	Year Ended December 31, 2006
	First		Second		Third		Fourth
	quarter		quarter		quarter		quarter

Interest income	$	12,589	$	13,452	$	14,369	$	14,775
Interest expense		3,554		4,283		5,010		5,594

Net interest income		9,035		9,169		9,359		9,181
Provision for loan losses		500		800		750		625

Net interest income after provision for loan losses		8,535		8,369		8,609		8,556
Noninterest income		1,944		1,746		1,791		1,769
Noninterest expense		6,683		6,393		6,755		7,698

Income before provision for income taxes		3,796		3,722		3,645		2,627

Provision for income taxes		1,244		1,236		1,003		816

Net income	$	2,552	$	2,486	$	2,642	$	1,811

Basic earnings per share	$	0.28	$	0.27	$	0.29	$	0.20
Diluted earnings per share	$	0.27	$	0.26	$	0.28	$	0.19
Cash dividends declared per share	$	0.05	$	0.05	$	0.05	$	0.05


Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None


Item 9A.	Controls and Procedures

As of the end of the fiscal period covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. The principal executive and financial officers supervised and participated in this evaluation. Based on this evaluation, the principal executive and financial officers 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.

Management’s Report on Internal Control Over Financial Reporting

See “Management’s Report on Internal Control Over Financial Reporting” set forth in Item 8- Financial Statements and Supplementary Data, immediately preceding the financial statement audit report of Moss Adams LLP.


Item 9B.	Other Information

None

PART III


Item 10.	Directors and Executive Officers of the Registrant

Information concerning directors of the Company is incorporated herein by reference to the section entitled “Election of Directors” in the Company’s definitive Proxy Statement to be filed with 120 days of our 2007 fiscal year end.

The required information with respect to the executive officers of the Company is included under the caption “Executive Officers of the Company” in Part I of this report. Part I of this report is incorporated herein by reference.

The required information with respect to compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the section entitled “Beneficial Ownership and Section 16(a) Reporting Compliance,” of the Proxy Statement.


Item 11.	Executive Compensation

For information concerning executive compensation see “Executive Compensation” of the Proxy Statement, which is incorporated herein by reference. The Report of the Compensation Committee on Executive Compensation which is contained in the Proxy Statement is not incorporated by this reference.


Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

For information concerning security ownership of certain beneficial owners and management see “Security Ownership of Certain Beneficial Owners and Management” of the Proxy Statement, which is incorporated herein by reference.


Item 13.	Certain Relationships and Related Transactions

For information concerning certain relationships and related transactions, see “Interest of Management in Certain Transactions” of the Proxy Statement, which is incorporated herein by reference.


Item 14.	Principal Accounting Fees and Services

For information concerning principal accounting fees and services, see “Relationship with Independent Public Accountants” of the Proxy Statement, which is incorporated herein by reference.

PART IV


Item 15.	Exhibits, Financial Statement Schedules

(a) (1) Financial Statements: The financial statements and related documents listed in the index set forth in Item 8 of this report are filed as part of this report.

(2) Financial Statement Schedules: All other schedules to the consolidated financial statements are omitted because they are no applicable or not material or because the information is included in the consolidated financial statements or related notes in Item 8 of this report.

(3) Exhibits: The exhibits filed as part of this report and exhibits incorporated herein by reference to other documents are listed in the Index of Exhibits to this annual report.

INDEX TO EXHIBITS


Exhibit No.			Exhibit Description

	2	.1	Agreement and Plan of Merger, dated as of September 26,2007, between Frontier Financial Corporation and Washington Banking Company(1)
	3	.1	Articles of Amendment to Articles of Incorporation of the Company(2)
	3	.2	Amended and Restated Articles of Incorporation of the Company(2)
	3	.3	Articles of Amendment to the Amended and Restated Articles of Incorporation of the Company(7)
	3	.4	Bylaws of the Company(2)
	4	.1	Form of Common Stock Certificate(2)
	4	.2	Stock Repurchase Plan(4)
	4	.3	Pursuant to Section 601(b)(4)(iii)(A) of Regulation S-K, copies of instruments defining the rights of holders of long-term debt and preferred securities are not filed. The Company agrees to furnish a copy thereof to the Securities and Exchange Commission upon request.
	10	.1	1992 Employee Stock Option Plan(2)
	10	.2	1993 Director Stock Option Plan(2)
	10	.3	1998 Stock Option and Restricted Stock Award Plan(3)
	10	.4	Form of Severance Agreement(2)
	10	.5	Executive Employment Agreements(5)
	10	.6	2005 Stock Incentive Plan(6)
	21		Subsidiaries of the Registrant
	23		Consent of Moss Adams LLP
	24		Power of Attorney
	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


(1)		Incorporated by reference to Form 10-Q dated November 8, 2007, previously filed by the Company.

(2)		Incorporated by reference to the Form SB-2 (Registration No. 333-49925) previously filed by the Company, declared effective on June 22, 1998.

(3)		Incorporated by reference to the definitive proxy statement dated August 19, 1998 for the Annual Meeting of Shareholders held September 24, 1998.

(4)		Incorporated by reference to the Form 8-K dated April 30, 1999, previously filed by the Company.

(5)		Incorporated by reference to Forms 8-K dated May 12, 2005 and September 30, 2005, previously filed by the Company.

(6)		Incorporated by reference to Form S-8 dated November 10, 2005, previously filed by the Company.

(7)		Incorporated by reference to Form 8-K dated July 14, 2005, and Form 8-K dated August 24, 2006, previously filed by the Company.


		Page

Item 1	Business		1
Item 1A	Risk Factors		5
Item 1B	Unresolved Staff Comments		7
Item 2	Properties		7
Item 3	Legal Proceedings		8
Item 4	Submission of Matters to a Vote of Security Holders		8

PART II
Item 5	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		8
Item 6	Selected Financial Data		10
Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 7A	Quantitative and Qualitative Disclosures about Market Risk		25
Item 8	Financial Statements and Supplementary Data		28
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		59
Item 9A	Controls and Procedures		59
Item 9B	Other Information		59

PART III
Item 10	Directors and Executive Officers and Corporate Governance		59
Item 11	Executive Compensation		59
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		59
Item 13	Certain Relationships, Related Transactions and Director Independence		60
Item 14	Principal Accountant Fees and Services		60

PART IV
Item 15	Exhibits, Financial Statement Schedules		60
EXHIBIT 21
EXHIBIT 23
EXHIBIT 24
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2


	Page

Management’s Report on Internal Control over Financial Reporting		29
Report of Independent Registered Public Accounting Firm		30
Consolidated Statements of Financial Condition at December 31, 2007 and 2006		32
Consolidated Statements of Income for the years ended December 31, 2007, 2006 and 2005		33
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2007, 2006 and 2005		34
Consolidated Statements of Comprehensive Income for the years ended December 31, 2007, 2006 and 2005		35
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005		36
Notes to Consolidated Financial Statements		37


Comprehensive Income:	2007		2006		2005

Net income	$	9,398	$	9,491	$	9,468
Change in unrealized gains (losses) on securities available for sale, net of tax, of $84 $1 and ($85), for years ended 2007, 2006 and 2005, respectively		151		1		(226	)
Less: adjustment for losses included in net income, net of tax, $47, for year ended 2005		—		—		33

Comprehensive income	$	9,549	$	9,492	$	9,275


Signature		Title

/s/ Michal D. Cann Michal D. Cann		Director

/s/ Karl C. Krieg Karl C. Krieg, III		Director

/s/ Jay T. Lien Jay T. Lien		Director

/s/ Robert B. Olson Robert B. Olson		Director

/s/ Anthony B. Pickering Anthony B. Pickering		Director

/s/ Edward J. Wallgren Edward J. Wallgren		Director

/s/ Dennis A. Wintch Dennis A. Wintch		Director

1.		I have reviewed this annual report on Form 10-K of Washington Banking Company;

2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	(a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	(c)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(d)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	(a)		All significant deficiencies in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	(b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: March 13, 2008		/s/ Michal D. Cann

		Michal D. Cann
		Chief Executive Officer


Date: March 13, 2008		/s/ Richard A. Shields

		Richard A. Shields
		Chief Financial Officer