UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2012

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

For the transition period from ________ to ________

Commission File Number 000-24503

WASHINGTON BANKING COMPANY

(Exact name of registrant as specified in its charter)

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

450 SW Bayshore Drive

Oak Harbor, Washington    98277

(Address of principal executive offices)   (Zip Code)

(360) 679-3121

(Registrant’s telephone number, including area code)

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

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

Yes [X]   No [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X]    No [  ]

Indicate by check mark if the registrant is a large accelerated filer, an 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 Rule 12b-2 of the Exchange Act.

 Large accelerated filer [   ]    Accelerated filer [X]       Non-Accelerated filer [   ]        Smaller reporting company [   ]

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 [   ]  No [ X ]

The number of shares of the issuer’s Common Stock outstanding at May 1, 2012 was 15,421,034

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements
	Condensed Consolidated Statements of Financial Condition (unaudited)
	March 31, 2012 and December 31, 2011		1
	Condensed Consolidated Statements of Income (unaudited)
	Three Months Ended March 31, 2012 and 2011		2
	Condensed Consolidated Statements of Comprehensive Income (unaudited)
	Three Months Ended March 31, 2012 and 2011		3
	Condensed Consolidated Statements of Shareholders' Equity (unaudited)
	Three Months Ended March 31, 2012 and 2011		4
	Condensed Consolidated Statements of Cash Flows (unaudited)
	Three Months Ended March 31, 2012 and 2011		5
	Notes to Condensed Consolidated Financial Statements		7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		34
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		52
Item 4.	Controls and Procedures		52
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings		53
Item 1A.	Risk Factors		53
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		53
Item 3.	Defaults Upon Senior Securities		53
Item 4.	Mine Safety Disclosures		53
Item 5.	Other Information		53
Item 6.	Exhibits		54
	Signatures		55

WASHINGTON BANKING COMPANY AND SUBSIDIARY

Condensed Consolidated Statements of Condition (unaudited)

(Dollars in thousands, except per share data)

	March 31,		December 31,
	2012		2011
Assets
Cash and due from banks	$	22,010	$	25,399
($3,340 and $653, respectively, are restricted)
Interest-bearing deposits		109,154		80,514
Total cash, restricted cash and cash equivalents		131,164		105,913
Investment securities available for sale, at fair value		322,784		297,874
Federal Home Loan Bank stock		7,576		7,576
Loans held for sale		10,011		22,421
Non-covered loans, net of allowance for loan losses		800,657		794,798
Covered loans, net of allowance for loan losses		255,020		268,211
Total loans		1,055,677		1,063,009
Premises and equipment, net		37,426		37,492
Bank owned life insurance		17,573		17,513
Goodwill and other intangible assets, net		5,088		5,214
Non-covered other real estate owned		1,830		1,976
Covered other real estate owned		25,973		26,622
FDIC indemnification asset		60,898		65,586
Other assets		20,596		19,417
Total assets	$	1,696,596	$	1,670,613
Liabilities and Shareholders' Equity
Liabilities:
Deposits
Noninterest-bearing demand	$	242,568	$	219,250
Interest-bearing		1,243,457		1,247,094
Total deposits		1,486,025		1,466,344
Junior subordinated debentures		25,774		25,774
Other liabilities		11,040		7,744
Total liabilities		1,522,839		1,499,862
Commitments and contingencies (See Note 12)
Shareholders' Equity:
Common stock, no par value; 35,000,000 shares authorized; 15,419,472 and
15,398,197 shares issued and outstanding at March 31, 2012 and
December 31, 2011, respectively		84,853		84,564
Retained earnings		86,031		83,107
Accumulated other comprehensive income		2,873		3,080
Total shareholders' equity		173,757		170,751
Total liabilities and shareholders' equity	$	1,696,596	$	1,670,613

-1-

WASHINGTON BANKING COMPANY AND SUBSIDIARY

Condensed Consolidated Statements of Income (unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended
	March 31,
	2012			2011
Interest income:
Interest and fees on non-covered loans	$	11,753		$	12,640
Interest and fees on covered loans		9,868			8,310
Interest on taxable investment securities		1,356			793
Interest on tax-exempt investment securities		255			210
Other		51			45
Total interest income		23,283			21,998
Interest expense:
Interest on deposits		1,845			2,591
Interest on junior subordinated debentures		136			120
Total interest expense		1,981			2,711
Net interest income		21,302			19,287
Provision for loan losses, non-covered loans		2,000			3,000
Net interest income after provision for loan losses		19,302			16,287
Noninterest income:
Service charges and fees		893			963
Electronic banking income		896			693
Investment products		362			222
Gain on sale of investment securities, net		342			-
Bank owned life insurance income		60			80
Income from the sale of mortgage loans		705			338
SBA premium income		87			121
Change in FDIC indemnification asset		(2,991	)		(1,316	)
Gain on disposition of covered assets		629			2,218
Other		314			413
Total noninterest income		1,297			3,732
Noninterest expense:
Salaries and benefits		7,334			6,819
Occupancy and equipment		1,729			1,667
Office supplies and printing		413			432
Data processing		528			470
Consulting and professional fees		243			444
Intangible amortization		126			157
Merger related expenses		-			119
FDIC premiums		336			589
FDIC clawback liability		40			-
Non-covered OREO and repossession expenses		374			300
Covered OREO and repossession expenses		574			770
Other		1,958			2,289
Total noninterest expense		13,655			14,056
Income before provision for income tax		6,944			5,963
Provision for income tax		2,171			1,887
Net income before preferred dividends		4,773			4,076
Preferred stock dividends and discount accretion		-			1,084
Net income available to common shareholders	$	4,773		$	2,992
Net income available per common share, basic	$	0.31		$	0.20
Net income available per common share, diluted	$	0.31		$	0.19
Average number of common shares outstanding, basic		15,409,000			15,329,000
Average number of common shares outstanding, diluted		15,441,000			15,467,000

-2-

WASHINGTON BANKING COMPANY AND SUBSIDIARY

Condensed Consolidated Statements of Comprehensive Income (unaudited)

(Dollars in thousands)

	Three Months Ended
	March 31,
	2012			2011
Net income	$	4,773		$	4,076
Investment securities available for sale:
Unrealized gains (losses) arising in period		25			(27	)
Reclassification adjustment for net gains realized in earnings		(342	)		-
Other comprehensive loss before tax		(317	)		(27	)
Income tax benefit		110			9
Other comprehensive loss, net		(207	)		(18	)
Total comprehensive income	$	4,566		$	4,058

-3-

WASHINGTON BANKING COMPANY AND SUBSIDIARY

Condensed Consolidated Statements of Shareholders’ Equity (unaudited)

(Dollars in thousands)

												Accumulated
	Preferred											other			Total
	stock			Common stock					Retained			comprehensive			shareholders'
	amount			Shares		Amount			earnings			income (loss)			equity
Balance at December 31, 2010	$	25,334		$	15,321	$	85,264		$	71,307		$	(259	)	$	181,646
Comprehensive income:
Net income		-			-		-			4,076			-			4,076
Other comprehensive loss		-			-		-			-			(18	)		(18	)
Redemption of preferred stock
issued to U.S. Treasury		(26,380	)		-		-			-			-			(26,380	)
Repurchase of warrant issued
to U.S. Treasury		-			-		(1,625	)		-			-			(1,625	)
Preferred stock dividends and accretion		1,046			-		-			(1,084	)		-			(38	)
Cash dividends on common stock,
$0.05 per share		-			-		-			(766	)		-			(766	)
Stock-based compensation expense		-			-		218			-			-			218
Issuance of common stock under stock plans		-			12		7			-			-			7
Tax benefit associated with stock awards		-			-		5			-			-			5
Balance at March 31, 2011	$	-		$	15,333	$	83,869		$	73,533		$	(277	)	$	157,125
Balance at December 31, 2011	$	-		$	15,398	$	84,564		$	83,107		$	3,080		$	170,751
Comprehensive income:
Net income		-			-		-			4,773			-			4,773
Other comprehensive loss		-			-		-			-			(207	)		(207	)
Cash dividends on common stock,
$0.12 per share		-			-		-			(1,849	)		-			(1,849	)
Stock-based compensation expense		-			-		137			-			-			137
Issuance of common stock under stock plans		-			21		141			-			-			141
Tax benefit associated with stock awards		-			-		11			-			-			11
Balance at March 31, 2012		-			15,419		84,853			86,031			2,873			173,757

-4-

WASHINGTON BANKING COMPANY AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows (unaudited)

(Dollars in thousands)

	Three Months Ended
	March 31,
	2012			2011
Cash flows from operating activities:
Net income	$	4,773		$	4,076
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of investment security premiums, net		519			173
Depreciation		578			493
Intangible amortization		126			157
Provision for loan losses, non-covered loans		2,000			3,000
Earnings on bank owned life insurance		(60	)		(80	)
Net gain on sale of investment securities		(342	)		-
Net (gain) loss on sale of premises and equipment		10			(85	)
Net loss on sale of non-covered other real estate owned		94			-
Net gain on sale of covered other real estate owned		(1,139	)		-
Net gain on sales of loans held for sale		(705	)		(338	)
Origination of loans held for sale		(40,286	)		(32,640	)
Proceeds from sales of loans held for sale		53,401			40,499
Valuation adjustment on non-covered other real estate owned		208			-
Deferred taxes		2,419			1,991
Change in FDIC indemnification asset		2,991			1,316
Stock-based compensation		137			218
Excess tax benefit from stock-based compensation		(11	)		(5	)
Net change in assets and liabilities:
Net increase in other assets		(3,477	)		(717	)
Net increase in other liabilities		3,296			1,128
Net cash provided by operating activities		24,532			19,186
Cash flows from investing activities:
Purchases of investment securities, available for sale		(55,888	)		(3,000	)
Maturities/calls/principal payments of investment and
mortgage-backed securities available for sale		30,484			18,978
Net decrease in non-covered loans and covered loans		2,092			21,900
Purchases of premises and equipment		(530	)		(770	)
Proceeds from the sale of premises and equipment		8			494
Proceeds from sale of non-covered other real estate owned		358			289
Proceeds from sale of covered other real estate owned		4,514			7,611
Capitalization of covered other real estate owned improvements		-			(73	)
Net proceeds from FDIC indemnification asset		1,697			7,888
Net cash provided by (used in) investing activities	$	(17,265	)	$	53,317

-5-

WASHINGTON BANKING COMPANY AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows (continued) (unaudited)

(Dollars in thousands)

	Three Months Ended
	March 31,
	2012			2011
Cash flows from financing activities:
Net increase in deposits	$	19,681		$	2,293
Redemption of preferred stock		-			(26,380	)
Repurchase of common stock warrant		-			(1,625	)
Proceeds from exercise of stock options		141			7
Excess tax benefits from stock-based compensation		11			5
Dividends paid on preferred stock		-			(38	)
Dividends paid on common stock		(1,849	)		(766	)
Net cash provided by (used in) financing activities		17,984			(26,504	)
Net change in cash and cash equivalents		25,251			45,999
Cash, restricted cash and cash equivalents at beginning of period		105,913			81,687
Cash, restricted cash and cash equivalents at end of period	$	131,164		$	127,686
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	2,101		$	2,846
Income taxes	$	-		$	1,200
Supplemental disclosures about noncash investing and financing activities:
Change in fair value of investment securities available for sale, net of taxes	$	(207	)	$	(18	)
Transfer of non-covered loans to non-covered other real estate owned	$	514		$	1,012
Transfer of covered loans to covered other real estate owned	$	2,726		$	6,598

-6-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(a) Description of Business: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:

§   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.

§   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.

(b) Basis of Presentation: The accompanying interim condensed consolidated financial statements include the accounts of the Company and its subsidiaries described above.  The accompanying interim condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States of America for complete financial statements.  These condensed consolidated financial statements should be read in conjunction with the December 31, 2011 audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC.

In preparing these financial statements, the Company has evaluated events and transactions subsequent to March 31, 2012 for potential recognition or disclosure.  In management’s opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Operating results for the three months ended March 31, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.  In preparing the condensed consolidated financial statements, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses are required.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change relate the allowance for loan losses, the valuation of other real estate owned and the underlying collateral of loans in the process of foreclosure and the fair value of financial instruments.

(c) Reclassifications: Certain amounts in prior year’s financial statements may have been reclassified to conform to the 2012 presentation. These reclassifications had no significant impact on the Company’s financial position or results of operations.

(d) Significant Accounting Policies: The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements and the accompanying notes.  Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the consolidated financial statements and thus actual results could differ from the amounts reported and disclosed herein.  A more detailed description of the Company’s significant accounting policies are described in Note (1) of the Notes to Consolidated Financial Statements for the year ended December 31, 2011, as filed on Form 10-K.

-7-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(2)  Recent Financial Accounting Pronouncements

In April 2011, the FASB issued ASU No. 2011-03, Reconsideration of Effective Control for Repurchase Agreements. The update amends existing guidance to remove from the assessment of effective control, the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and, as well, the collateral maintenance implementation guidance related to that criterion. ASU No. 2011-03 is effective for the Company’s reporting period beginning on or after December 15, 2011. The guidance applies prospectively to transactions or modification of existing transactions that occur on or after the effective date and early adoption is not permitted. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

In April 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The update amends existing guidance regarding the highest and best use and valuation premise by clarifying these concepts are only applicable to measuring the fair value of nonfinancial assets.  The update also clarifies that the fair value measurement of financial assets and financial liabilities which have offsetting market risks or counterparty credit risks that are managed on a portfolio basis, when several criteria are met, can be measured at the net risk position. Additional disclosures about Level 3 fair value measurements are required including a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, a description of the valuation process in place, and discussion of the sensitivity of fair value changes in unobservable inputs and interrelationships about those inputs as well disclosure of the level of the fair value of items that are not measured at fair value in the financial statements but disclosure of fair value is required. The provisions of ASU No. 2011-04 are effective for the Company’s reporting period beginning after December 15, 2011 and are applied prospectively. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. The update amends current guidance to allow a company the option of presenting the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The provisions do not change the items that must be reported in other comprehensive income or when an item of other comprehensive must to reclassified to net income. The amendments do not change the option for a company to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense (benefit) related to the total of other comprehensive income items. The amendments do not affect how earnings per share is calculated or presented.  The provisions of ASU No. 2011-05 are effective for the Company’s reporting period beginning after December 15, 2011 and are applied retrospectively. Early adoption was permitted and there are no required transition disclosures.  In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The ASU defers indefinitely the requirement to present reclassification adjustments and the effect of those reclassification adjustments on the face of the financial statements where net income is presented, by component of net income, and on the face of the financial statements where other comprehensive income is presented, by component of other comprehensive income.   The adoption of the ASUs did not have a material impact on the Company’s consolidated financial statements.

In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment. With the update, a company testing goodwill for impairment now has the option of performing a qualitative assessment before calculating the fair value of the reporting unit (the first step of goodwill impairment test). If, on the basis of qualitative factors, the fair value of the reporting unit is more likely than not greater than the carrying amount, a quantitative calculation would not be needed.  Additionally, new examples of events and circumstances that an entity should consider in performing its qualitative assessment about whether to proceed to the first step of the goodwill impairment have been made to the guidance and replace the previous guidance for triggering events for interim impairment assessment. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

-8-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(2)  Recent Financial Accounting Pronouncements (continued)

In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities. The update requires an entity to offset, and present as a single net amount, a recognized eligible asset and a recognized eligible liability when it has an unconditional and legally enforceable right of setoff and intends either to settle the asset and liability on a net basis or to realize the asset and settle the liability simultaneously. The ASU requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013. The Company does not expect this ASU will have a material impact on the Company’s consolidated financial statements.

(3)  Investment Securities

The following table presents the amortized cost, unrealized gains, unrealized losses and fair value of investment securities available for sale at March 31, 2012 and December 31, 2011.  At March 31, 2012 and December 31, 2011, there were no investment securities as held to maturity or trading.

(dollars in thousands)	March 31, 2012
	Amortized cost		Unrealized gains		Unrealized losses			Fair value
U.S. government agencies	$	80,290	$	1,159	$	(57	)	$	81,392
U.S. Treasuries		27,012		115		-			27,127
Pass-through securities		139,985		1,529		(247	)		141,267
Taxable state and political subdivisions		9,136		815		-			9,951
Tax exempt state and political subdivisions		36,947		1,693		(114	)		38,526
Corporate obligations		11,000		-		(372	)		10,628
Agency-issued collateralized mortgage obligations		9,941		-		(142	)		9,799
Investments in mutual funds and other equities		4,044		65		(15	)		4,094
Total investment securities available for sale	$	318,355	$	5,376	$	(947	)	$	322,784

(dollars in thousands)	December 31, 2011
	Amortized cost		Unrealized gains		Unrealized losses			Fair value
U.S. government agencies	$	75,383	$	1,207	$	(16	)	$	76,574
U.S. Treasuries		42,077		520		-			42,597
Pass-through securities		116,219		1,295		(116	)		117,398
Taxable state and political subdivisions		9,142		615		-			9,757
Tax exempt state and political subdivisions		35,263		2,100		(28	)		37,335
Corporate obligations		11,000		-		(713	)		10,287
Investments in mutual funds and other equities		4,044		-		(118	)		3,926
Total investment securities available for sale	$	293,128	$	5,737	$	(991	)	$	297,874

-9-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(3)  Investment Securities (continued)

Investment securities that were in an unrealized loss position at March 31, 2012 and December 31, 2011, are presented in the following tables, based on the length of time individual securities have been in an unrealized loss position. In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral.

(dollars in thousands)	March 31, 2012
	Less than 12 Months					12 Months or Longer					Total
	Fair value		Unrealized losses			Fair value		Unrealized losses			Fair value		Unrealized losses
U.S. government agencies	$	10,198	$	(57	)	$	-	$	-		$	10,198	$	(57	)
Pass-through securities		33,295		(247	)		-		-			33,295		(247	)
Tax exempt state and political subdivisions		6,795		(114	)		-		-			6,795		(114	)
Corporate obligations		5,805		(195	)		4,823		(177	)		10,628		(372	)
Agency-issued collateralized mortgage obligations		9,799		(142	)		-		-			9,799		(142	)
Investments in mutual funds and other equities		2,018		(15	)		-		-			2,018		(15	)
Total investment securities available for sale	$	67,910	$	(770	)	$	4,823	$	(177	)	$	72,733	$	(947	)

(dollars in thousands)	December 31, 2011
	Less than 12 Months					12 Months or Longer					Total
	Fair value		Unrealized losses			Fair value		Unrealized losses			Fair value		Unrealized losses
U.S. government agencies	$	10,499	$	(16	)	$	-	$	-		$	10,499	$	(16	)
Pass-through securities		29,838		(116	)		-		-			29,838		(116	)
Tax exempt state and political subdivisions		1,255		(28	)		-		-			1,255		(28	)
Corporate obligations		10,287		(713	)		-		-			10,287		(713	)
Investments in mutual funds and other equities		-		-			4,044		(118	)		4,044		(118	)
Total investment securities available for sale	$	51,879	$	(873	)	$	4,044	$	(118	)	$	55,923	$	(991	)

At March 31, 2012 and December 31, 2011, there were 23 and 10 investment securities in unrealized loss positions, respectively.  For each security in an unrealized loss position, the Company assesses whether it intends to sell the security, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. For debt securities that are considered other-than-temporarily impaired and that the Company does not intend to sell and will not be required to sell prior to recovery of its amortized cost basis, the Company will separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is calculated as the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.

The Company does not intend to sell the securities that are temporarily impaired, and it is more likely than not that the Company will not have to sell those securities before recovery of the cost basis. Additionally, the Company has evaluated the credit ratings of its investment securities and their issuers and/or insurers, as applicable. Based on the Company’s evaluation, management has determined that no investment security in the Company’s investment portfolio was other-than-temporarily impaired at March 31, 2012 or December 31, 2011.

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WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(3)  Investment Securities (continued)

The amortized cost and fair value of investment securities, presented by contractual maturity, are shown in the table below.  Expected maturities may differ from contractual maturities because issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

(dollars in thousands)	March 31, 2012
	Amortized cost		Fair value
Three months or less	$	12,053	$	12,079
Over three months to one year		28,019		28,281
After one year through three years		8,981		9,314
After three years through five years		73,680		74,295
After five years through ten years		43,273		44,443
After ten years		152,349		154,372
Total	$	318,355	$	322,784

The following table presents investment securities which were pledged to secure borrowings and public deposits as permitted or required by law:

(dollars in thousands)	March 31, 2012
	Amortized cost		Fair value
To state and local governments to secure public deposits	$	65,314	$	67,488
To Federal Reserve Bank to secure borrowings		22,511		23,071
To Federal Home Loan Bank to secure borrowings		1,147		1,173
Other securities pledged, principally to secure deposits		15,905		16,323
Total pledged investment securities	$	104,877	$	108,055

For the three months ended March 31, 2012, the Company realized gross gains of $344 thousand and gross losses of $2 thousand on the sale of investment securities available for sale.  There were no investment security sales during the three months ended March 31, 2011.

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WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(4)  Non-Covered Loans

The following table presents the major types of non-covered loans at March 31, 2012 and December 31, 2011.  The classification of non-covered loan balances presented is reported in accordance with the regulatory reporting requirements.

(dollars in thousands)	March 31, 2012			December 31, 2011
Commercial	$	156,594		$	150,386
Real estate mortgage		417,342			411,113
Real estate construction		88,199			90,356
Consumer		154,647			159,122
		816,782			810,977
Deferred loan costs, net		1,868			1,853
Allowance for loan losses		(17,993	)		(18,032	)
Total non-covered loans, net	$	800,657		$	794,798

(5)  Allowance for Non-Covered Loan Losses and Credit Quality

Activity in the Non-Covered Allowance for Loan Losses

The following table summarizes activity related to the allowance for loan losses on non-covered loans, by portfolio segment, for the three months ended March 31, 2012 and 2011:

(dollars in thousands)	Three Months Ended March 31, 2012
	Commercial			Real estate mortgage			Real estate construction			Consumer			Total
Beginning balance	$	4,034		$	6,500		$	4,046		$	3,452		$	18,032
Provision		573			581			647			199			2,000
Charge-offs		(585	)		(561	)		(600	)		(487	)		(2,233	)
Recoveries		19			18			2			155			194
Ending Balance	$	4,041		$	6,538		$	4,095		$	3,319		$	17,993

(dollars in thousands)	Three Months Ended March 31, 2011
	Commercial			Real estate mortgage			Real estate construction		Consumer			Total
Beginning balance	$	3,915		$	6,507		$	4,947	$	3,443		$	18,812
Provision		1,302			558			511		629			3,000
Charge-offs		(469	)		(1,285	)		-		(1,145	)		(2,899	)
Recoveries		81			88			1		155			325
Ending Balance	$	4,829		$	5,868		$	5,459	$	3,082		$	19,238

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WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

The following table provides a summary of the allowance for loan losses and related non-covered loans, by portfolio segment, at March 31, 2012 and December 31, 2011:

(dollars in thousands)	March 31, 2012
	Commercial		Real estate mortgage		Real estate construction		Consumer		Total
Allowance for loan losses:
Individually evaluated for impairment	$	730	$	1,258	$	1,722	$	91	$	3,801
Collectively evaluated for impairment		3,311		5,280		2,373		3,228		14,192
Total allowance for loan losses	$	4,041	$	6,538	$	4,095	$	3,319	$	17,993
Non-covered loans
Individually evaluated for impairment	$	7,148	$	16,672	$	25,648	$	874	$	50,342
Collectively evaluated for impairment		149,446		400,670		62,551		153,773		766,440
Total non-covered loans (1)	$	156,594	$	417,342	$	88,199	$	154,647	$	816,782
(1) Total non-covered loans excludes deferred loan costs of $1.9 million.

(dollars in thousands)	December 31, 2011
	Commercial		Real estate mortgage		Real estate construction		Consumer		Total
Allowance for loan losses:
Individually evaluated for impairment	$	588	$	1,212	$	1,869	$	79	$	3,748
Collectively evaluated for impairment		3,446		5,288		2,177		3,373		14,284
Total allowance for loan losses	$	4,034	$	6,500	$	4,046	$	3,452	$	18,032
Non-covered loans
Individually evaluated for impairment	$	6,525	$	14,032	$	27,483	$	553	$	48,593
Collectively evaluated for impairment		143,861		397,081		62,873		158,569		762,384
Total non-covered loans (1)	$	150,386	$	411,113	$	90,356	$	159,122	$	810,977
(1) Total non-covered loans excludes deferred loan costs of $1.9 million.

Credit Quality and Nonperforming Non-Covered Loans

The Company manages credit quality and controls its credit risk through lending limits, credit review, approval policies and extensive, ongoing internal monitoring. Through this monitoring process, nonperforming loans are identified. Non-covered nonperforming loans consist of non-covered nonaccrual loans.  Non-covered nonperforming loans are assessed for potential loss exposure on an individual or homogeneous group basis.

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.

-13-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

Loans are placed on nonaccrual status when collection of principal or interest is considered doubtful (generally, loans are 90 days or more past due).   Loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospects for future payments, in accordance with the loan agreement, appear relatively certain.

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 collectability 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.

Non-Covered Impaired Loans

The Company had non-covered impaired loans which consisted of nonaccrual loans and restructured loans.  As of March 31, 2012, the Company had no commitments to extend additional credit on these non-covered impaired loans.  Non-covered impaired loans and the related allowance for loan losses at March 31, 2012 and December 31, 2011 were as follows:

(dollars in thousands)	March 31, 2012				December 31, 2011
	Recorded investment		Allowance		Recorded investment		Allowance
With no related allowance recorded
Nonaccrual loans	$	13,124	$	-	$	18,744	$	-
Restructured loans		13,854		-		11,208		-
Total with no related allowance	$	26,978	$	-	$	29,952	$	-
With an allowance recorded
Nonaccrual loans	$	9,216	$	197	$	3,356	$	262
Restructured loans		14,148		3,604		15,285		3,486
Total with an allowance recorded		23,364		3,801		18,641		3,748
Total	$	50,342	$	3,801	$	48,593	$	3,748

-14-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

The following table further summarizes impaired non-covered loans, by class, at March 31, 2012 and December 31, 2011:

(dollars in thousands)	March 31, 2012						December 31, 2011
	Recorded investment		Unpaid principal balance		Related allowance		Recorded investment		Unpaid principal balance		Related allowance
With no related allowance recorded
Commercial	$	4,371	$	4,401	$	-	$	3,801	$	5,692	$	-
Real estate mortgages:
One-to-four family residential		1,868		3,369		-		1,557		3,217		-
Multi-family and commercial		8,963		9,601		-		7,062		8,791		-
Total real estate mortgages		10,831		12,970		-		8,619		12,008		-
Real estate construction:
One-to-four family residential		11,254		12,334		-		16,932		21,803		-
Multi-family and commercial		100		100		-		387		387		-
Total real estate construction		11,354		12,434		-		17,319		22,190		-
Consumer:
Indirect		-		-		-		-		-		-
Direct		422		422		-		213		900		-
Total consumer		422		422		-		213		900		-
Total with no related allowance recorded	$	26,978	$	30,227	$	-	$	29,952	$	40,790	$	-
With an allowance recorded
Commercial	$	2,777	$	3,116	$	730	$	2,724	$	3,128	$	588
Real estate mortgages:
One-to-four family residential		168		186		12		174		190		13
Multi-family and commercial		5,673		5,672		1,246		5,238		5,238		1,199
Total real estate mortgages		5,841		5,858		1,258		5,412		5,428		1,212
Real estate construction:
One-to-four family residential		14,294		19,245		1,722		10,164		10,845		1,869
Multi-family and commercial		-		-		-		-		-		-
Total real estate construction		14,294		19,245		1,722		10,164		10,845		1,869
Consumer:
Indirect		-		-		-		-		-		-
Direct		452		452		91		341		341		79
Total consumer		452		452		91		341		341		79
Total with an allowance recorded		23,364		28,671		3,801		18,641		19,742		3,748
Total impaired non-covered loans	$	50,342	$	58,898	$	3,801	$	48,593	$	60,532	$	3,748

The average recorded investment in non-covered impaired loans was approximately $49.5 million and $47.5 million for the three months ended March 31, 2012 and 2011, respectively.  For the three months ended March 31, 2012 and 2011, the Company recognized interest income on non-covered impaired loans of $54 thousand and $7 thousand, respectively.  Additional interest income of $206 thousand and $50 thousand would have been recognized had the non-covered impaired loans accrued interest, in accordance with their original terms, for the three months ended March 31, 2012 and 2011, respectively.

-15-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

Troubled Debt Restructurings

A troubled debt restructured loan (“TDR”) is classified as a restructuring when the Company grants a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are considered impaired as the Company will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement.

Troubled debt restructurings at March 31, 2012 and December 31, 2011 were as follows:

(dollars in thousands)	March 31, 2012						December 31, 2011
	Accrual status		Nonaccrual status		Total modifications		Accrual status		Nonaccrual status		Total modifications
Troubled debt restructurings:
Commercial	$	4,077	$	285	$	4,362	$	3,341	$	-	$	3,341
Real estate mortgages:
One-to-four family residential		-		933		933		-		933		933
Multi-family and commercial		10,317		937		11,254		9,420		937		10,357
Total real estate mortgage		10,317		1,870		12,187		9,420		1,870		11,290
Real estate construction:
One-to-four family residential		13,269		11,932		25,201		13,391		13,283		26,674
Multi-family and commercial		-		-		-		-		387		387
Total real estate construction		13,269		11,932		25,201		13,391		13,670		27,061
Consumer:
Indirect		-		-		-		-		-		-
Direct		339		-		339		341		-		341
Total consumer		339		-		339		341		-		341
Total restructured loans	$	28,002	$	14,087	$	42,089	$	26,493	$	15,540	$	42,033

The Company’s policy is that loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appear relatively certain.  The Company’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

-16-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

Troubled Debt Restructurings Modification Terms

The Company offers a variety of modifications to borrowers. In restructuring a loan with a borrower, the Company normally employs several types of modifications terms. The modification terms offered by the Company are as follows:

Rate Modification: A modification in which the interest rate is changed.

Term Modification: A modification in which the maturity date, the timing of payments, or frequency of payments is changed.

Interest Only Modification: A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification: A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification: Any other type of modification, including the use of multiple terms above.

-17-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

The following tables present loans restructured during the three months ended March 31, 2012 and 2011. During the periods presented, all modification terms were a combination of terms employed by the Company.

(dollars in thousands)	For the Three Months Ended March 31, 2012
	Number of contracts		Pre-modification recorded investment		Post-modification recorded investment
Troubled debt restructurings:
Commercial		1	$	285	$	285
Real estate mortgages:
One-to-four family residential		-		-		-
Multi-family and commercial		-		-		-
Total real estate mortgage		-		-		-
Real estate construction:
One-to-four family residential		-		-		-
Multi-family and commercial		-		-		-
Total real estate construction		-		-		-
Consumer:
Indirect		-		-		-
Direct		-		-		-
Total consumer		-		-		-
Total restructured loans		1	$	285	$	285

(dollars in thousands)	For the Three Months Ended March 31, 2011
	Number of contracts		Pre-modification recorded investment		Post-modification recorded investment
Troubled debt restructurings:
Commercial		2	$	742	$	742
Real estate mortgages:
One-to-four family residential		-		-		-
Multi-family and commercial		3		3,290		3,290
Total real estate mortgage		3		3,290		3,290
Real estate construction:
One-to-four family residential		1		879		879
Multi-family and commercial		-		-		-
Total real estate construction		1		879		879
Consumer:
Indirect		-		-		-
Direct		-		-		-
Total consumer		-		-		-
Total restructured loans		6	$	4,911	$	4,911

For the three months ended March 31, 2012 and 2011, there were no troubled debt restructuring that subsequently defaulted within the first twelve months of restructure.

-18-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

Non-Covered Nonaccrual Loans and Loans Past Due

The following table summarizes non-covered nonaccrual loans and past due loans, by class, as of March 31, 2012 and December 31, 2011:

(dollars in thousands)	March 31, 2012
	30 - 59 Days past due		60 - 89 Days past due		Greater than 90 days and accruing		Total past due		Nonaccrual		Current		Total non-covered loans
Commercial	$	1,387	$	373	$	131	$	1,891	$	3,071	$	151,632	$	156,594
Real estate mortgages:
One-to-four family residential		519		-		-		519		2,036		36,432		38,987
Multi-family and commercial		415		577		-		992		4,319		373,044		378,355
Total real estate mortgages		934		577		-		1,511		6,355		409,476		417,342
Real estate construction:
One-to-four family residential		-		-		-		-		12,279		44,684		56,963
Multi-family and commercial		25		-		-		25		100		31,111		31,236
Total real estate construction		25		-		-		25		12,379		75,795		88,199
Consumer:
Indirect		1,123		112		-		1,235		-		77,574		78,809
Direct		1,068		334		-		1,402		535		73,901		75,838
Total consumer		2,191		446		-		2,637		535		151,475		154,647
Total	$	4,537	$	1,396	$	131	$	6,064	$	22,340	$	788,378		816,782
Deferred loan costs, net														1,868
Total non-covered loans													$	818,650

(dollars in thousands)	December 31, 2011
	30 - 59 Days past due		60 - 89 Days past due		Greater than 90 days and accruing		Total past due		Nonaccrual		Current		Total non-covered loans
Commercial	$	1,482	$	4	$	-	$	1,486	$	3,183	$	145,717	$	150,386
Real estate mortgages:
One-to-four family residential		53		154		-		207		1,732		38,392		40,331
Multi-family and commercial		1,687		484		-		2,171		2,881		365,730		370,782
Total real estate mortgages		1,740		638		-		2,378		4,613		404,122		411,113
Real estate construction:
One-to-four family residential		27		-		-		27		13,705		45,078		58,810
Multi-family and commercial		100		-		-		100		387		31,059		31,546
Total real estate construction		127		-		-		127		14,092		76,137		90,356
Consumer:
Indirect		1,288		198		-		1,486		-		78,910		80,396
Direct		1,023		294		-		1,317		212		77,197		78,726
Total consumer		2,311		492		-		2,803		212		156,107		159,122
Total	$	5,660	$	1,134	$	-	$	6,794	$	22,100	$	782,083		810,977
Deferred loan costs, net														1,853
Total non-covered loans													$	812,830

-19-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

Non-Covered Credit Quality Indicators

The Company’s internal risk rating methodology assigns risk ratings from 1 to 9, where a higher rating represents higher risk.  The nine risk ratings can be generally described by the following groups:

Pass/Watch: Pass/watch loans, risk rated 1 through 5, range from minimal credit risk to lower than average, but still acceptable, credit risk.

Special Mention:  Special mention loans, risk rated 6,are loans that present certain potential weaknesses that require management’s attention.  Those weaknesses, if left uncorrected, may result in deterioration of the borrower’s repayment ability or the Company’s credit position in the future.

Substandard:  Substandard loans, risk rated 7, are inadequately protected by the current worth and paying capacity of the borrower or of the collateral pledged, if any.  There are well-defined weaknesses that may jeopardize the repayment of debt.  Such weaknesses include deteriorated financial condition of the borrower resulting from insufficient income, excessive expenses or other factors that result in inadequate cash flows to meet all scheduled obligations.

Doubtful/Loss:  Doubtful/loss loans are risk rated 8 and 9.  Loans assigned as doubtful have all the weaknesses inherent with substandard loans, with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions and values, highly questionable.  The possibility of loss is high, but because of certain important and reasonably specific pending factors that may work to the advantage of, and strengthen the credit, its classification as an estimated loss is deferred until a more exact status may be determined.  The Company charges off loans that would otherwise be classified loss.

-20-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  Allowance for Non-Covered Loan Losses and Credit Quality (continued)

The following table summarizes our internal risk rating, by class, as of March 31, 2012 and December 31, 2011:

(dollars in thousands)	March 31, 2012
	Pass/Watch		Special mention		Substandard		Doubtful/Loss		Total
Commercial	$	128,432	$	8,163	$	19,999	$	-	$	156,594
Real estate mortgages:
One-to-four family residential		32,080		1,770		5,137		-		38,987
Multi-family and commercial		313,251		31,512		33,592		-		378,355
Total real estate mortgages		345,331		33,282		38,729		-		417,342
Real estate construction:
One-to-four family residential		27,148		1,087		28,728		-		56,963
Multi-family and commercial		24,500		4,196		2,540		-		31,236
Total real estate construction		51,648		5,283		31,268		-		88,199
Consumer:
Indirect		77,156		12		1,641		-		78,809
Direct		69,306		840		5,692		-		75,838
Total consumer		146,462		852		7,333		-		154,647
Total	$	671,873	$	47,580	$	97,329	$	-		816,782
Deferred loan costs, net										1,868
									$	818,650

(dollars in thousands)	December 31, 2011
	Pass/Watch		Special mention		Substandard		Doubtful/Loss		Total
Commercial	$	122,189	$	7,791	$	20,406	$	-	$	150,386
Real estate mortgages:
One-to-four family residential		33,609		1,462		5,260		-		40,331
Multi-family and commercial		307,402		26,220		37,160		-		370,782
Total real estate mortgages		341,011		27,682		42,420		-		411,113
Real estate construction:
One-to-four family residential		26,110		2,313		30,387		-		58,810
Multi-family and commercial		24,402		4,416		2,728		-		31,546
Total real estate construction		50,512		6,729		33,115		-		90,356
Consumer:
Indirect		78,531		15		1,850		-		80,396
Direct		72,602		844		5,280		-		78,726
Total consumer		151,133		859		7,130		-		159,122
Total	$	664,845	$	43,061	$	103,071	$	-		810,977
Deferred loan costs, net										1,853
									$	812,830

-21-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(6)  Covered Assets and FDIC Indemnification Asset

(a) Covered Loans: Loans acquired in an FDIC-assisted acquisition that are subject to a loss share agreement are referred to as “covered loans” and reported separately in the Condensed Consolidated Statements of Financial Condition.  Covered loans are reported exclusive of the expected cash flow reimbursements from the FDIC.

The following table presents the major types of covered loans at March 31, 2012 and December 31, 2011. The classification of covered loan balances presented is reported in accordance with the regulatory reporting requirements.

(dollars in thousands)	March 31, 2012
	City Bank			North County Bank			Total
Commercial	$	16,472		$	21,889		$	38,361
Real estate mortgages:
One-to-four family residential		4,035			10,900			14,935
Multi-family residential and commercial		157,377			62,765			220,142
Total real estate mortgages		161,412			73,665			235,077
Real estate construction:
One-to-four family residential		8,481			5,270			13,751
Multi-family and commercial		17,623			16,483			34,106
Total real estate construction		26,104			21,753			47,857
Consumer - direct		3,157			3,227			6,384
Subtotal		207,145			120,534			327,679
Fair value discount		(42,017	)		(29,951	)		(71,968	)
Total covered loans		165,128			90,583			255,711
Allowance for loan losses		(477	)		(214	)		(691	)
Total covered loans, net	$	164,651		$	90,369		$	255,020

(dollars in thousands)	December 31, 2011
	City Bank			North County Bank			Total
Commercial	$	17,380		$	26,208		$	43,588
Real estate mortgages:
One-to-four family residential		4,673			11,080			15,753
Multi-family residential and commercial		163,028			67,282			230,310
Total real estate mortgages		167,701			78,362			246,063
Real estate construction:
One-to-four family residential		6,102			5,773			11,875
Multi-family and commercial		21,479			12,991			34,470
Total real estate construction		27,581			18,764			46,345
Consumer - direct		3,562			11,206			14,768
Subtotal		216,224			134,540			350,764
Fair value discount		(46,099	)		(35,584	)		(81,683	)
Total covered loans		170,125			98,956			269,081
Allowance for loan losses		(655	)		(215	)		(870	)
Total covered loans, net	$	169,470		$	98,741		$	268,211

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WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(6)  Covered Assets and FDIC Indemnification Asset (continued)

In estimating the fair value of the covered loans at the acquisition date, we (a) calculated the contractual amount and timing of undiscounted principal and interest payments and (b) estimated the amount and timing of undiscounted expected principal and interest payments. The difference between these two amounts represents the nonaccretable difference.

On the acquisition date, the amount by which the undiscounted expected cash flows exceed the estimated fair value of the acquired loans is the “accretable yield.”  The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the loans.

The following table presents the changes in the accretable yield for the three months ended March 31, 2012 and 2011, for each respective acquired loan portfolio:

(dollars in thousands)	Three Months Ended March 31,
	2012						2011
	City Bank			North County Bank			City Bank			North County Bank
Balance, beginning of period	$	78,004		$	29,574		$	56,079		$	27,880
Accretion to interest income		(5,750	)		(3,908	)		(6,064	)		(2,417	)
Disposals		(1,215	)		(2,030	)		(4,211	)		-
Reclassification (to) from nonaccretable difference		(22	)		1			-			-
Balance, end of period	$	71,017		$	23,637		$	45,804		$	25,463

(b) Covered Other Real Estate Owned: All OREO acquired in FDIC-assisted acquisitions that are subject to an FDIC loss share agreement are referred to as “covered OREO” and reported separately in the Condensed Consolidated Statements of Financial Condition.  Covered OREO is reported exclusive of expected reimbursement cash flows from the FDIC. Foreclosed covered loan collateral is transferred into covered OREO at the lower of the loan’s appraised value, less selling costs, or the carrying value.

The following tables summarize the activity related to covered OREO for the three months ended March 31, 2012 and 2011:

(dollars in thousands)	Three Months Ended March 31, 2012
	City Bank			North County Bank			Total
Balance, beginning of period	$	19,341		$	7,281		$	26,622
Additions to covered OREO		(326	)		3,052			2,726
Dispositions of covered OREO		(720	)		(2,655	)		(3,375	)
Balance, end of period	$	18,295		$	7,678		$	25,973

(dollars in thousands)	Three Months Ended March 31, 2011
	City Bank			North County Bank			Total
Balance, beginning of period	$	17,906		$	11,860		$	29,766
Additions to covered OREO		6,008			590			6,598
Capitalized improvements		-			73			73
Dispositions of covered OREO		(6,451	)		(1,160	)		(7,611	)
Balance, end of period	$	17,463		$	11,363		$	28,826

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WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(6)  Covered Assets and FDIC Indemnification Asset (continued)

(c) FDIC Indemnification Asset:The following table summarizes the activity related to the FDIC indemnification asset for the three months ended March 31, 2012 and 2011:

(dollars in thousands)	Three Months Ended March 31, 2012
	City Bank			North County Bank			Total
Balance, beginning of period	$	43,235		$	22,351		$	65,586
Change in FDIC indemnification asset		(2,865	)		(126	)		(2,991	)
Reduction due to loans paid in full		(573	)		(1,880	)		(2,453	)
Transfers to (due from) FDIC		1,179			(423	)		756
Balance, end of period	$	40,976		$	19,922		$	60,898

(dollars in thousands)	Three Months Ended March 31, 2011
	City Bank			North County Bank			Total
Balance, beginning of period	$	66,560		$	39,507		$	106,067
Change in FDIC indemnification asset		(1,697	)		381			(1,316	)
Reduction due to loans paid in full		(2,926	)		-			(2,926	)
Transfers due from FDIC		(324	)		(4,638	)		(4,962	)
Balance, end of period	$	61,613		$	35,250		$	96,863

(7)  Non-Covered Other Real Estate Owned

The following table presents the changes in non-covered other real estate owned for the three months ended March 31, 2012 and 2011:

(dollars in thousands)	Three Months Ended
	March 31,
	2012			2011
Balance, beginning of period	$	1,976		$	4,122
Additions to OREO		514			1,012
Dispositions of OREO		(452	)		(289	)
Valuation adjustments		(208	)		-
Balance, end of period	$	1,830		$	4,845

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WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(8)  Earnings per Common Share

Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed in the same manner as basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if certain shares issuable upon exercise of options and non-vested restricted stock were included.

The following table reconciles the numerators and denominators of the basic and diluted earnings per common share computations:

(dollars in thousands)	Three Months Ended March 31,
	2012		2011
Income available to common shareholders	$	4,773	$	2,992
Weighted average number of common shares, basic		15,409,000		15,329,000
Effect of dilutive stock awards and CPP warrants		32,000		138,000
Weighted average number of common shares, diluted		15,441,000		15,467,000
Earnings per common share
Basic	$	0.31	$	0.20
Diluted	$	0.31	$	0.19
Antidulitive stock awards excluded from the
computation of diluted earnings per common share		48,633		53,964

-25-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(9)  Stock-Based Compensation

(a) Stock Options:  The Company measures the fair value of each stock option grant at the date of the grant, using the Black-Scholes option pricing model.  There were no options granted during the three months ended March 31, 2012 and 2011.

The Company recognizes compensation expense for stock option grants on a straight-line basis over the requisite service period of the grant.  For the three months ended March 31, 2012 and 2011, the Company recognized $6 thousand and $39 thousand in stock-based compensation expense, as a component of salaries and benefits, respectively.  As of March 31, 2012, there was approximately $2 thousand of total unrecognized compensation cost related to nonvested stock option grants.

The following table summarizes information on stock option activity during 2012:

	Shares			Weighted average exercise price per share		Weighted average remaining contractual terms (in years)		Total intrinsic value (in thousands)
Outstanding, January 1, 2012		155,224		$	10.71
Granted		-			-
Exercised		(19,108	)		7.37
Forfeited, expired or cancelled		(3,776	)		15.58
Outstanding, March 31, 2012		132,340			11.06		5.29	$	442
Exercisable at March 31, 2012		127,330		$	10.87		5.29	$	442

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (i.e., the difference between the Company’s closing stock price on March 31, 2012, 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 March 31, 2012.  This amount changes based upon the fair market value of the Company’s stock.

(b) Restricted Stock Awards: The Company grants restricted stock awards (“RSA”) periodically for the benefit of employees and directors.  Recipients of RSAs 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 requirements with the Company.   At March 31, 2012 and December 31, 2011, there were no RSAs outstanding.

For the three months ended March 31, 2012, the Company did not recognize any RSA compensation expense, as a component of salaries and benefits, compared to $5 thousand for the three months ended March 31, 2011.  As of March 31, 2012, there was no remaining unrecognized compensation costs related to nonvested RSAs.

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WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(9)  Stock-Based Compensation (continued)

(c) Restricted Stock Units: The Company grants restricted stock units (“RSU”) periodically for the benefit of employees and directors. Recipients of RSUs 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 RSU activity during 2012:

	Shares			Weighted average exercise price per share		Weighted average remaining contractual terms (in years)
Outstanding, January 1, 2012		71,744		$	12.80
Granted		68,800			13.28
Vested		(2,167	)		8.66
Forfeited, expired or cancelled		(1,000	)		13.08
Outstanding, March 31, 2012		137,377		$	13.10	3.29

For the three months ended March 31, 2012 and 2011, the Company recognized $131 thousand and $174 thousand in RSU compensation expense, as a component of salaries and benefits, respectively.  As of March 31, 2012, there was $1.5 million of total unrecognized compensation costs related to nonvested RSUs.

(10)  Shareholders’ Equity

On January 16, 2009, in exchange for an aggregate purchase price of $26.4 million, the Company issued and sold to the United States Department of the Treasury pursuant to the Troubled Asset Relief Program Capital Purchase Program the following: (i) 26,380 shares of the Company’s newly designated Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value per share, and liquidation preference $1,000 per share ($26.4 million liquidation preference in the aggregate) and (ii) a warrant to purchase up to 492,164 shares of the Company’s common stock, no par value per share, at an exercise price of $8.04 per share, subject to certain anti-dilution and other adjustments.

In connection with the issuance and sale of the Company’s securities, the Company entered into a Letter Agreement including the Securities Purchase Agreement - Standard Terms, dated January 16, 2009, with the United States Department of the Treasury (the “Agreement”). The Agreement contained limitations on the payment of quarterly cash dividends on the Company’s common stock in excess of $0.065 per share and on the Company’s ability to repurchase its common stock.

The Series A Preferred Stock paid cumulative dividends at a rate of 5% per annum, applied to the $1,000 per share liquidation preference, as and if declared by the Company’s Board of Directors out of funds legally available. The Series A Preferred Stock had no maturity date and ranked senior to common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company.

On January 12, 2011, the Company redeemed all 26,380 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A.  The Company paid a total of $26.6 million to the Treasury, consisting of $26.4 million in principal and $209 thousand in accrued and unpaid dividends. The Company's redemption of the shares was not subject to additional conditions.

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WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(10)  Shareholders’ Equity (continued)

On March 2, 2011, the Company completed the repurchase of Warrant to Purchase Common Stock issued to the U.S. Department of the Treasury pursuant to the Troubled Asset Relief Program Capital Purchase Program. The Company repurchased the Warrant for $1.6 million. The Warrant repurchase, together with the Company’s earlier redemption of the entire amount of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, issued to the U.S. Treasury, represents full repayment of all TARP obligations and cancellation of all equity interests in the Company held by the U.S. Treasury.

(11)       Fair Value Measurements

(a) Fair Value Hierarchy and Fair Value Measurement: The Company groups its assets and liabilities that are recorded at fair value in three levels, based on the markets, if any, in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1:  Quoted prices for identical instruments in active markets.

Level 2:  Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drives are observable.

Level 3:   Significant inputs to the valuation model are unobservable.

The following table presents the Company’s financial instruments measured at fair value on a recurring basis at March 31, 2012 and December 31, 2011:

(dollars in thousands)	Fair value at March 31, 2012
	Level 1		Level 2		Level 3		Total
U.S. government agencies	$	-	$	81,392	$	-	$	81,392
U.S. Treasuries		-		27,127		-		27,127
Pass-through securities		-		141,267		-		141,267
Taxable state and political subdivisions		-		9,951		-		9,951
Tax exempt state and political subdivisions		-		38,526		-		38,526
Corporate obligations		-		10,628		-		10,628
Agency-issued collateralized mortgage obligations		-		9,799		-		9,799
Investments in mutual funds and other equities		-		4,094		-		4,094
Total	$	-	$	322,784	$	-	$	322,784

There were no transfers between Level 1 and Level 2 during the three months ended March 31, 2012.

(dollars in thousands)	Fair value at December 31, 2011
	Level 1		Level 2		Level 3		Total
U.S. government agencies	$	-	$	76,574	$	-	$	76,574
U.S. Treasuries		-		42,597		-		42,597
Pass-through securities		-		117,398		-		117,398
Taxable state and political subdivisions		-		9,757		-		9,757
Tax exempt state and political subdivisions		-		37,335		-		37,335
Corporate obligations		-		10,287		-		10,287
Investments in mutual funds and other equities		-		3,926		-		3,926
Total	$	-	$	297,874	$	-	$	297,874

There were no transfers between Level 1 and Level 2 during the year ended December 31, 2011.

-28-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(11)  Fair Value Measurements (continued)

When available, the Company uses quoted market prices to determine the fair value of investment securities. These investments are included in Level 1. When quoted market prices are unobservable, the Company uses quotes from independent pricing vendors based on recent trading activity and other relevant information including market interest rate curves, referenced credit spreads and estimated prepayment rates where applicable. These investments are included in Level 2 and comprise the Company’s portfolio of U.S. agency securities, U.S. treasury securities, pass-through securities, municipal bonds and other corporate bonds.

Certain financial assets of the Company may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from application of lower-of-cost-or-market accounting or write-downs of individual assets. For example, when a loan is identified as impaired, it is reported at the lower of cost or fair value, measured based on the loan’s observable market price (Level 1), the present value of expected future cash flows discounted at the loan’s original effective interest rate (Level 2), or the current appraised value of the underlying collateral securing the loan if the loan is collateral dependent (Level 3).  

The following table presents the carrying value of financial instruments by level within the fair value hierarchy, for which a non-recurring change in fair value has been recorded:

(dollars in thousands)	Fair value at March 31, 2012
	Level 1		Level 2		Level 3		Total		Total losses for the period
Non-covered impaired loans (1)	$	-	$	-	$	46,541	$	46,541	$	(4,494	)
Non-covered other real estate owned (2)		-		-		1,830		1,830		(208	)
Covered other real estate owned (2)		-		-		25,973		25,973		-
Total	$	-	$	-	$	74,344	$	74,344	$	(4,702	)

(dollars in thousands)	Fair value at December 31, 2011
	Level 1		Level 2		Level 3		Total		Total losses for the period
Non-covered impaired loans (1)	$	-	$	-	$	44,845	$	44,845	$	(8,182	)
Non-covered other real estate owned (2)		-		-		1,976		1,976		(272	)
Covered other real estate owned (2)		-		-		26,622		26,622		-
Total	$	-	$	-	$	73,443	$	73,443	$	(8,454	)

(1) Represents carrying value and related specific valuation allowances, which are included in the allowance for loan losses.

(2) Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as non-covered other real estate owned and covered other real estate owned.

-29-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(11)  Fair Value Measurements (continued)

Following is a description of methods and assumptions used to estimate the fair value of each class of financial instrument for which a non-recurring change in fair value has been recorded:

Non-covered impaired loans: 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. The non-covered impaired loans above represent impaired, collateral dependent loans that have been adjusted to fair value using the current fair value of the collateral, less selling costs.

Non-covered and covered other real estate owned: Non-covered and covered other real estate owned includes properties acquired through foreclosure. These properties are recorded at the lower of cost or estimated fair value (less estimated cost to sell), based on periodic evaluations.

The Company generally obtains appraisals for collateral dependent loans on an annual basis.  Depending on the loan, the Company may obtain appraisals more frequently than 12 months, particularly if the credit is deteriorating.  If the loan is performing and market conditions are stable, the Company may not obtain appraisals on an annual basis. This policy does not vary by loan type.

The Company deducts a minimum of 10% of the appraised value for selling costs.  If the property has been actively listed for sale for more than nine months and has had limited interest, the Company will typically reduce the fair value further based upon input from third party industry experts. This includes adjustments for outdated appraisals based on knowledgeable third party opinions.

Impaired loans that are collateral dependent are reviewed quarterly.  The review involves a collateral valuation review, which also contemplates an assessment of whether the last appraisal is outdated.  Recent appraisals, adjustments to outdated appraisals, knowledgeable third party opinions of value and current market conditions are combined to determine whether a specific reserve and/or a loan charge-off is required.  The Company does not specifically consider the potential for outdated appraisals in its calculation of the formula portion of the allowance for loan losses.

In the rare case where an appraisal is not available, the Company consults with third party industry specific experts for estimates as well as relies upon the Company’s market knowledge and expertise.

-30-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(11)  Fair Value Measurements (continued)

(b) Disclosures about Fair Value of Financial Instruments: The table below is a summary of fair value estimates for financial instruments at March 31, 2012 and December 31, 2011, excluding financial instruments recorded at fair value on a recurring basis (summarized in a separate table). The carrying amounts in the following table are recorded in the statement of condition under the indicated captions. The Company has excluded non-financial assets and non-financial liabilities defined by the Codification (ASC 820-10-15-1A), such as Bank premises and equipment, deferred taxes and other liabilities.  In addition, the Company has not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of the Financial Instruments Topic of the Codification (ASC 825-10-50-8), such as Bank-owned life insurance policies.

(dollars in thousands)	March 31, 2012
			Fair value measurements using:
	Carrying value		Total		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	22,010	$	22,010	$	22,010	$	-	$	-
Interest-bearing deposits		109,154		109,154		109,154		-		-
Investment securities available for sale		322,784		322,784		-		322,784		-
FHLB stock		7,576		7,576		7,576		-		-
Loans held for sale		10,011		10,011		-		10,011		-
Non-covered loans		818,650		799,328		-		-		799,328
Covered loans		255,711		277,694		-		-		277,694
FDIC indemnification asset		60,898		45,511		-		-		45,511
Financial liabilities:
Deposits		1,486,025		1,490,234		-		-		1,490,234
Junior subordinated debentures		25,774		12,190		-		-		12,190

(dollars in thousands)	December 31, 2011
			Fair value measurements using:
	Carrying value		Total		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	25,399	$	25,399	$	25,399	$	-	$	-
Interest-bearing deposits		80,514		80,514		80,514		-		-
Investment securities available for sale		297,874		297,874		-		297,874		-
FHLB stock		7,576		7,576		7,576		-		-
Loans held for sale		22,421		22,421		-		22,421		-
Non-covered loans		812,830		796,663		-		-		796,663
Covered loans		269,081		304,145		-		-		304,145
FDIC indemnification asset		65,586		41,041		-		-		41,041
Financial liabilities:
Deposits		1,466,344		1,471,615		-		-		1,471,615
Junior subordinated debentures		25,774		9,802		-		-		9,802

-31-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(11)  Fair Value Measurements (continued)

Following is a description of methods and assumptions used to estimate the fair value of each class of financial instrument not recorded at fair value but required for disclosure purposes:

Cash and Cash Equivalents:The carrying value of cash and cash equivalent instruments approximates fair value.

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.

Investment Securities: Fair values for investment securities are based on quoted market prices when available or through the use of alternative approaches, such as matrix or model pricing, or broker indicative bids, when market quotes are not readily accessible or available.

FHLB stock: The Bank’s investment in FHLB stock is carried at par value, which approximates its fair value.

Loans Held for Sale:The carrying value of loans held for sale approximates fair value.

Non-covered 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.

Covered Loans: Covered loans are measured at estimated fair value on the date of acquisition. Subsequent to acquisition, the fair value of covered loans is measured using the same methodology as that of non-covered loans.

FDIC Indemnification Asset: The FDIC indemnification asset is calculated as the expected future cash flows under the loss share agreement discounted by a rate reflective of a U.S. government agency security.

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.

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.

Off-Balance Sheet Items: Commitments to extend credit represent the principal category of off-balance sheet financial instruments. The fair value of these commitments are 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.

-32-

WASHINGTON BANKING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(12)       Commitments and Contingencies

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions.  Except for certain long-term guarantees, most guarantees expire within 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 amounted to one hundred percent of the commitment amount at March 31, 2012. The Company routinely charges a fee for these credit facilities.  Such fees are amortized into income over the life of the agreement and unamortized amounts were not significant as of March 31, 2012.  At March 31, 2012, the commitments under these agreements totaled $1.3 million.

At March 31, 2012, the Company was the guarantor of trust preferred securities. The Company issued junior subordinated debentures to a wholly owned special purpose trust, which has issued trust preferred securities.  The sole assets of the special purpose trust are the junior subordinated debentures issued by the Company.  Washington Banking Company has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust agreements. The maximum amount of future payments the Company will be required to make under these agreements is the principal and interest of the trust preferred securities, the principal of which totaled $25.8 million at March 31, 2012 and December 31, 2011.

(13)       Subsequent Events

On April 26, 2012, the Company announced that its Board of Directors declared a cash dividend of $0.14 per share to shareholders of record as of May 7, 2012, payable on May 21, 2012.

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

Note Regarding Forward-Looking Statements: This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements describe Washington Banking Company’s (the “Company”) management’s expectations regarding future events and developments such as future operating results, growth in loans and deposits, credit quality and adequacy of the allowance for 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 “will,” “believe,” “expect,” “should,” “anticipate” 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 below are necessarily 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 (the “SEC”), factors that may cause actual results to differ materially from those contemplated in such forward-looking statements include, among others: (1) local and national general and economic condition; (2) changes in interest rates and their impact on net interest margin; (3) competition among financial institutions; (4) legislation or regulatory requirements; and (5) the ability to realize efficiencies expected from investment in personnel and infrastructure.  However, the reader should be aware that these factors are not an exhaustive list, and it should not be assumed that these are the only factors that may cause actual results to differ from expectations.  In addition, the reader should note that the Company does not intend to update any of the forward-looking statements or the uncertainties that may adversely impact those statements.

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

Overview

Washington Banking Company (referred to in this report as the “Company”) is a registered bank holding company with two wholly-owned subsidiaries: Whidbey Island Bank (the “Bank”), the Company’s principal subsidiary and Washington Banking Master Trust (the “Trust”). Headquartered in Oak Harbor, the Company’s market area is primarily northwestern Washington. The market area encompasses distinct economies and none are particularly dependent upon a single industrial or occupational source.  The economies within the market areas have evolved from being heavily dependent upon forestry, fishing and farming to a more diverse blend of industries including retail trade, services, manufacturing, tourism and a large military presence.

The Company’s strategy is one of value-added growth.  Management believes that qualitative and sustainable growth of the Company, coupled with maintaining profitability, is currently the most appropriate path to providing good value for its shareholders.  Prior to 2010, the Company’s growth had been primarily achieved organically.  On April 16, 2010 and September 24, 2010, the Bank acquired certain assets and assumed certain liabilities of City Bank and North County Bank, respectively, from the Federal Deposit Insurance Corporation (“FDIC”) in FDIC-assisted transactions.

The Company attributes its reputation for focusing on customer service and satisfaction as one of the cornerstones to the Company’s success.  The Company’s primary objectives are to improve profitability and operating efficiencies, increase market penetration in areas currently served and to continue an expansion strategy in appropriate market areas.

The Company’s geographical expansion to date has primarily been concentrated along the I-5 corridor from Snohomish to Whatcom Counties; however, additional areas will be considered if they meet the Company’s criteria.  Acquisition of banks or branches may also be used as a means of expansion if appropriate opportunities are presented.  The primary factors considered in determining the areas of geographic expansion are the availability of knowledgeable personnel, such as managers and lending officers with experience in their fields of expertise, longstanding community presence and extensive banking relationships, customer demand and perceived market potential.  The 2010 acquisition of City Bank resulted in expansion into King County.

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Executive Overview

Significant items for the first quarter of 2012 were as follows:

·   Net income available to common shareholders per diluted share was $0.31 and $0.19 for the three months ended March 31, 2012 and 2011, respectively. Diluted operating earnings per common share, a non-GAAP financial measure, defined as earnings available to common shareholders before the acceleration of the accretion of the remaining preferred stock discount and merger related expenses, net of tax, divided by the same diluted share total used in determining diluted earnings per common share, was $0.31 and $0.27 for the three months ended March 31, 2012 and 2011, respectively.  This measurement and reconciliation to the comparable GAAP measurement is provided under the heading Results of Operations—Overview below.

·   Net interest margin, on a tax equivalent basis, was 5.81% for the three months ended March 31, 2012, compared to 5.42% for the same period a year ago.

·   Non-covered loans, net of allowance for loan losses, totaled $800.7 million at March 31, 2012, an increase of $5.9 million, compared to December 31, 2011.

· Total risk-based capital was 19.94% at March 31, 2012, compared to 19.73% at December 31, 2011.  The FDIC requires a minimum total risk-based capital ratio of 10% to be considered “well-capitalized.”

·   Tangible book value per common share increased to $10.94 at March 31, 2012, compared to $9.88 a year ago.

·   Return on average assets and return on average common equity totaled 1.15% and 11.16%, annualized, as of March 31, 2012, respectively.

Summary of Critical Accounting Policies

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements and the accompanying notes.  Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the consolidated financial statements and thus actual results could differ from the amounts reported and disclosed herein.  Significant accounting policies are described in Note (1) of the Notes to Consolidated Financial Statements for the year ended December 31, 2011, as filed on Form 10-K.  Not all of these accounting policies require management to make difficult, subjective or complex judgments or estimates. Management believes that the following accounting policies could be considered critical under the SEC’s definition.

Allowance for Loan Losses: 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 quantitative and qualitative factors. Quantitative factors include our historical loss experience, delinquency and charge-off trends, estimates of, and changes in, collateral values, changes in risk ratings on loans and other factors. Qualitative factors include the general economic environment in our markets and, in particular, the state of the real estate market and specific relevant industries. Other qualitative factors that are considered in our methodology include, size and complexity of individual loans in relation to the lending officer’s background and experience levels, loan structure, extent and nature of waivers of existing loan policies, and pace of loan portfolio growth.

As the Company adds new products, increases the complexity of the loan portfolio, and expands its geographic coverage, the Company intends to enhance and adapt its methodology to keep pace with the size and complexity of the loan portfolio. Changes in any of the above factors could have a significant effect on the calculation of the allowance for credit losses in any given period. The Company believes that its systematic methodology continues to be appropriate given our size and level of complexity.

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Acquired Loans: In accordance with FASB ASC 310-30, acquired loans are aggregated into pools, based on individually evaluated common risk characteristics, and aggregate expected cash flows were estimated for each pool. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. The Bank aggregated all of the loans acquired in the FDIC-assisted acquisitions of City Bank and North County Bank into 18 and 14 pools, respectively. A loan will be removed from a pool of loans only if the loan is sold, foreclosed, assets are received in satisfaction of the loan, or the loan is written off, and will be removed from the pool at the carrying value. If an individual loan is removed from a pool of loans due to a payoff, the difference between its carrying amount and the cash received will be recognized in income immediately and would not affect the effective yield used to recognize the accretable difference on the remaining pool. Loans originally placed into a performing pool will not be reported individually as 30-89 days past due, non-performing (90+ days past due or nonaccrual) or accounted for as a troubled debt restructuring as the pool is the unit of accounting. Rather, these metrics related to the underlying loans within a performing pool will be considered in our ongoing assessment and estimates of future cash flows. If, at acquisition, the loans are collateral dependent and acquired primarily for the rewards of ownership of the underlying collateral, or if cash flows expected to be collected cannot be reasonably estimated, accrual of income is inappropriate. Such loans will be placed into nonperforming (nonaccrual) loan pools.

The cash flows expected to be received over the life of the pool were estimated by management with the assistance of a third party valuation specialist. These cash flows were input into an ASC 310-30 compliant accounting loan system which calculates the carrying values of the pools and underlying loans, book yields, effective interest income and impairment, if any, based on actual and projected events. Default rates, loss severity and prepayment speed assumptions will be periodically reassessed and updated within the accounting model to update the expectation of future cash flows. The excess of the cash flows expected to be collected over the pool’s carrying value is considered to be the accretable yield and is recognized as interest income over the estimated life of the loan or pool using the effective yield method. The accretable yield will change due to changes in the timing and amounts of expected cash flows. For the performing loan pools, a prepayment assumption as documented by the valuation specialist is initially applied. Changes in the accretable yield will be disclosed quarterly.

The excess of the contractual balances due over the cash flows expected to be collected is considered to be the nonaccretable difference. The nonaccretable difference represents the estimate of the credit losses expected to occur and was considered in determining the fair value of the loans as of the acquisition date. Subsequent to the acquisition date, any increases in expected cash flows over those expected at purchase date in excess of fair value are adjusted through the accretable difference on a prospective basis. Any subsequent decreases in expected cash flows over those expected at purchase date are recognized by recording a provision for loan losses. Any disposals of loans, including sales of loans, payments in full or foreclosures, result in the removal of the loan from the pool at its carrying amount.

FDIC Indemnification Asset: The Company has elected to account for amounts receivable under the loss share agreement as an indemnification asset in accordance with FASB ASC 805, Business Combinations. The FDIC indemnification asset is initially recorded at fair value, based on the discounted value of expected future cash flows under the loss share agreement. The difference between the present value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted into noninterest income over the life of the FDIC indemnification asset.

The FDIC indemnification asset is reviewed periodically and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered portfolio. These adjustments are measured on the same basis as the related covered loans and covered other real estate owned. Any increases in cash flow of the covered assets over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the covered assets under those expected will increase the FDIC indemnification asset. Increases and decreases to the FDIC indemnification asset are recorded as adjustments to noninterest income.

Stock-based Compensation:The Company recognizes in the income statement the grant-date fair value of stock awards issued to employees over the employees’ requisite service period (generally the vesting period). The fair value of each stock option grant is estimated as of the grant date using the Black-Scholes option-pricing model. Significant variables used to estimate the fair value of the stock options granted include volatility, forfeiture rate and expected life. The Company’s assumptions utilized at the time of grant impact the fair value of the stock option calculated under the Black-Scholes methodology, and ultimately, the expense that will be recognized over the life of the stock award.

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Results of Operations Overview

For the three months ended March 31, 2012, net income available to common shareholders increased to $4.8 million, or $0.31 per diluted common share, as compared to net income available to common shareholders of $3.0 million, or $0.19 per diluted common share, for the same period a year ago.  The increase in net income available to common shareholders was primarily attributable to the decrease in provision for loan losses for non-covered loans and the decrease in preferred dividends.  For the three months ended March 31, 2012, the provision for loan losses for non-covered loans totaled $2.0 million, compared to $3.0 million for the same period a year ago.  The Company did not pay dividends on the preferred stock for the three months ended March 31, 2012, as the Company redeemed all of the outstanding shares of preferred stock during the first quarter of 2011.  For the three months ended March 31, 2011, the Company paid dividends on preferred stock totaling $1.1 million.

In addition to results presented in accordance with generally accepted accounting principles in the United States of America (“GAAP”), this filing presents certain non-GAAP financial measures. Management believes that certain non-GAAP financial measures provide investors with information useful in understanding the Company's financial performance; however, readers of this report are urged to review these non-GAAP measures in conjunction with the GAAP results, as reported.

Operating earnings are not a measure of performance calculated in accordance with GAAP.  However, management believes that operating earnings are an important indication of the ability to generate earnings through the Company's fundamental banking business.  Since operating earnings exclude the effects of certain items that are unusual and/or difficult to predict, management believes that operating earnings provide useful supplemental information to both management and investors in evaluating the Company's financial results.

Operating earnings should not be considered in isolation or as a substitute for net income, cash flows from operating activities or other income or cash flow statement data calculated in accordance with GAAP.  Moreover, the manner in which the Company calculates operating earnings may differ from that of other companies reporting measures with similar names.

The following table provides the reconciliation of the Company's GAAP earnings to operating earnings (non-GAAP) for the periods presented:

(dollars in thousands)	Three Months Ended
	March 31,
	2012		2011
GAAP earnings available to common shareholders	$	4,773	$	2,992
Provision for income taxes		2,171		1,887
GAAP earnings available to common shareholders
before provision for income taxes		6,944		4,879
Adjustments to GAAP earnings available to common shareholders
Merger related expenses		-		119
Accelerated accretion of remaining preferred stock discount		-		1,046
Operating earnings before taxes		6,944		6,044
Provision for income taxes		2,171		1,929
Net operating earnings	$	4,773	$	4,115
Diluted GAAP earnings per common share	$	0.31	$	0.19
Diluted operating earnings per common share	$	0.31	$	0.27

Tangible common equity, tangible assets and tangible book value per common share are not measures that are calculated in accordance with GAAP.  However, management uses these non-GAAP measures in their analysis of the Company's performance. Management believes that these non-GAAP measures are an important indication of the Company's ability to grow both organically and through business combinations, and with respect to tangible common equity, the Company's ability to pay dividends and to engage in various capital management strategies.

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Neither tangible common equity, tangible assets nor tangible book value per common share should be considered in isolation or as a substitute for common shareholders' equity or book value per common share or any other measure calculated in accordance with GAAP. Moreover, the manner in which the Company calculates tangible common equity, tangible assets and tangible book value per share may differ from that of other companies reporting measures with similar names.

The following table provides the reconciliation of the Company's shareholders' equity (GAAP) to tangible common equity (non-GAAP) and total assets (GAAP) to tangible assets (non-GAAP) for the periods presented:

(dollars in thousands)	March 31, 2012			December 31, 2011
Total shareholders' equity	$	173,757		$	170,751
Adjustments to shareholders' equity
Goodwill and other intangible assets, net		(5,088	)		(5,214	)
Tangible common equity	$	168,669		$	165,537
Total assets	$	1,696,596		$	1,670,613
Adjustments to total assets
Goodwill and other intangible assets, net		(5,088	)		(5,214	)
Tangible assets	$	1,691,508		$	1,665,399
Common shares outstanding at end of period		15,419,472			15,398,197
Tangible common equity ratio		9.97	%		9.94	%
Tangible book value per common share	$	10.94		$	10.75

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.

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

(dollars in thousands)	Three Months Ended March 31,
	2012							2011
			Interest							Interest
	Average		earned/		Average			Average		earned/		Average
	balance		paid		yield/rate			balance		paid		yield/rate
Assets
Non-covered loans (1)(2)	$	826,528	$	11,886		5.78	%	$	835,122	$	12,782		6.21	%
Covered loans		262,580		9,868		15.11	%		352,663		8,310		9.56	%
Federal funds sold		-		-		0.00	%		832		-		0.00	%
Interest-bearing deposits		83,700		51		0.25	%		72,339		45		0.25	%
Investments
Taxable		282,245		1,356		1.93	%		177,583		793		1.81	%
Non-taxable (2)		38,269		387		4.07	%		22,495		319		5.76	%
Interest-earning assets		1,493,322		23,548		6.34	%		1,461,034		22,249		6.18	%
Noninterest-earning assets		172,275							226,636
Total assets	$	1,665,597						$	1,687,670
Liabilities and shareholders' equity
Deposits:
NOW accounts and MMA	$	603,477	$	396		0.26	%	$	559,793	$	720		0.52	%
Savings		100,917		27		0.11	%		96,176		64		0.27	%
Time deposits		532,281		1,422		1.07	%		653,520		1,807		1.12	%
Total interest-bearing deposits		1,236,675		1,845		0.60	%		1,309,489		2,591		0.80	%
Junior subordinated debentures		25,774		136		2.12	%		25,774		120		1.89	%
Total interest-bearing liabilities		1,262,449		1,981		0.63	%		1,335,263		2,711		0.82	%
Noninterest-bearing deposits		222,621							186,915
Other liabilities		8,552							6,034
Total liabilities		1,493,622							1,528,212
Total shareholders' equity		171,975							159,458
Total liabilities and
shareholders' equity	$	1,665,597						$	1,687,670
Net interest income/spread			$	21,567		5.71	%			$	19,538		5.36	%
Credit for interest-bearing funds						0.10	%						0.06	%
Net interest margin (2)						5.81	%						5.42	%
(1) Average balance includes nonaccrual loans.
(2) Interest income on non-taxable investments and loans is presented on a taxable-equivalent basis using the federal statutory rate of 35%. These adjustments totaled $265 thousand and $251 thousand for the three months ended March 31, 2012 and 2011,
respectively. Taxable-equivalent is a non- GAAP performance measurement that management believes provides investors with a more accurate picture of the net interest margin and efficiency ratio for comparative purposes.

Taxable-equivalent net interest income totaled $21.6 million for the first quarter of 2012, compared to $19.5 million for the first quarter of 2011.  Changes in net interest income during the first quarter of 2012 reflect a $1.3 million increase in interest income on interest-earning assets income related to covered loans and investments. Additionally, interest expense on interest-bearing liabilities decreased by $730 thousand for the period.

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Net interest margin (net interest income as a percentage of average interest-earning assets) on a taxable-equivalent basis was 5.81% for the first quarter of 2012, compared to 5.42% for the same period a year ago.  The yield on interest-earning assets was 6.34% for the three months ended March 31, 2012, an increase of 16 basis points as compared to the same period in 2011. This increase was primarily attributable to the 15.11% average yield on covered loans.  For the same period, the average yield on non-covered loans decreased 43 basis points to 5.78% from 6.21% due to lower yields in nearly every category of non-covered loans.  The rate on interest-bearing liabilities was 0.63% for the three months ended March 31, 2012, a decrease of 19 basis points as compared to the same period in 2011. This decrease was primarily attributable to a decrease in rates offered on interest-bearing deposits.

The following table details the effects of changes in rates and volume for the periods indicated:

	Three Months Ended March 31,
(dollars in thousands)	2012 compared to 2011
	Increase (decrease) due to (2):
	Volume			Rate			Total
Assets
Non-covered loans (1)(3)	$	(117	)	$	(779	)	$	(896	)
Covered loans		(1,220	)		2,778			1,558
Interest-bearing deposits		6			-			6
Investments (1)
Taxable		505			58			563
Non-taxable		117			(49	)		68
Interest-earning assets	$	(709	)	$	2,008		$	1,299
Liabilities
Deposits:
NOW accounts and money market	$	54		$	(378	)	$	(324	)
Savings		3			(40	)		(37	)
Time deposits		(314	)		(71	)		(385	)
Total interest-bearing deposits		(257	)		(489	)		(746	)
Junior subordinated debentures		-			16			16
Total interest-bearing liabilities	$	(257	)	$	(473	)	$	(730	)
(1) Interest on loans and investments is presented on a fully tax-equivalent basis.
(2) The changes attributable to the combined effect of volume and interest rates have been allocated proportionately.
(3) Interest income previously accrued on nonaccrual loans is reversed in the period the loan is placed on nonaccrual status.

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

For the three months ended March 31, 2012 the Company recorded a $2.0 million provision for non-covered loan losses, compared to $3.0 million for the same period a year ago.  Net charge-offs for the first quarter of 2012 were $2.0 million, compared to $2.6 million for the first quarter 2011.  At March 31, 2012 and 2011, the allowance for non-covered loan losses, as a percent of total non-covered loans, was 2.20% and 2.33%, respectively.

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Noninterest Income:  Noninterest income remains a key focus of the Company. The Company has focused on diversifying the noninterest income mix through 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”) policies. The following table presents the key components of noninterest income for the three months ended March 31, 2012 and 2011:

(dollars in thousands)	Three Months Ended March 31,						Change
	2012			2011			2012 vs. 2011
Service charges and fees	$	893		$	963		$	(70	)
Electronic banking income		896			693			203
Investment products		362			222			140
Gain on sale of investment securities, net		342			-			342
Bank owned life insurance income		60			80			(20	)
Income from the sale of mortgage loans		705			338			367
SBA premium income		87			121			(34	)
Change in FDIC indemnification asset		(2,991	)		(1,316	)		(1,675	)
Gain on disposition of covered assets		629			2,218			(1,589	)
Other		314			413			(99	)
Total noninterest income	$	1,297		$	3,732		$	(2,435	)

§   Electronic banking income increase was primarily attributable to an increase in interchange fees on new deposit accounts gained through the acquisitions of City Bank and North County Bank in 2010.

§   Investment products increased due to increased sales of annuity products.   In addition, at March 31, 2012, the Company had 22 licensed branch investment sales representatives, compared to 11 at March 31, 2011.

§   Gain on sale of investment securities, net represents the net gain recognized on the sale of four available for sale investment securities during the first quarter of 2012.

§   Income from the sale of mortgage loans increased due to the increase in sales volume of loans held for sale.  For the three months ended March 31, 2012, proceeds from the sale of loans held for sale totaled $53.4 million, compared to $40.5 million for the same period a year ago.

§   Change in FDIC indemnification asset represents the amortization of the FDIC indemnification asset. Based upon the collections madeon the indemnification asset and subsequent revaluations of the estimated remaining cash flows, amortization was required to reduce the asset over the remaining term.

§   Gain on disposition of covered assets is the income the Company recognizes when a covered asset is paid off or sold and the proceeds exceed its carrying value.

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Noninterest Expense: The Company continues to focus on controlling noninterest expenses and addressing long term operating expenses. The following table presents the key elements of noninterest expense:

(dollars in thousands)	Three Months Ended March 31,				Change
	2012		2011		2012 vs. 2011
Salaries and benefits	$	7,334	$	6,819	$	515
Occupancy and equipment		1,729		1,667		62
Office supplies and printing		413		432		(19	)
Data processing		528		470		58
Consulting and professional fees		243		444		(201	)
Intangible amortization		126		157		(31	)
Merger related expenses		-		119		(119	)
FDIC premiums		336		589		(253	)
FDIC clawback liability		40		-		40
Non-covered OREO and repossession expenses		374		300		74
Covered OREO and repossession expenses		574		770		(196	)
Other		1,958		2,289		(331	)
Total noninterest expense	$	13,655	$	14,056	$	(401	)

§   Salaries and benefits increased primarily due to the $500 thousand bonus accrual recorded in the first quarter of 2012.  There was no accrual for bonuses recorded in the first quarter of 2011.

§   Consulting and professional fees decreased due to the decrease in legal and accounting fees.  During the three months ended March 31, 2011, the Company was incurring legal and accounting fees resulting from the 2010 acquisitions of City Bank and North County Bank.

§   Merger related expenses relate to non-recurring expenses of the City Bank and North County Banks acquisitions. Merger related expenses include conversion expense, severance and professional and consulting services. The Company does not anticipate future merger related expenses related to these acquisitions.

§   FDIC premiums decreased due to the new assessment basis instituted by the FDIC during the third quarter of 2011. The Company anticipates the FDIC premiums to be forty to forty five percent less on a comparative basis for the remainder of 2012.

§   Non-covered and covered OREO and repossession expense represents costs the Company incurs in reclaiming, repairing and selling real estate properties and automobiles, as well as any write-downs or losses on the sale of non-covered and covered OREO properties.

§   Other noninterest expense was primarily affected by the decrease in Business and Occupation (B&O) tax.  During the first quarter of 2011, the Bank paid the B&O tax on the bargain purchase gain on acquisition recognized during the third quarter of 2010.

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Income Taxes: The Company’s consolidated effective tax rates for the three months ended March 31, 2012 and 2011, was 31.3% and 31.6%, respectively. The quarterly effective tax rates are below the federal statutory rate of 35% principally due to nontaxable income generated from investments in bank owned life insurance, tax-exempt municipal bonds and loans. Additionally, the Company’s tax rates reflect a benefit from the New Market Tax Credit Program. The tax benefits related to these credits will be recognized in the same periods that the credits are recognized on the Company’s income tax returns.

Financial Condition Overview

Total assets at March 31, 2012, were $1.70 billion, compared to $1.67 billion at December 31, 2011.  For the period, investment securities increased $24.9 million and total non-covered loans, net of allowance for loan losses, increased $5.9 million.  Total shareholders’ equity was $173.8 million at March 31, 2012, compared to $170.8 million at December 31, 2011, an increase of $3.0 million.

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 provides a vehicle for the investment of available funds and a source of liquidity.   At March 31, 2012, total investment securities increased $24.9 million to $322.8 million, compared to $297.9 million at December 31, 2011.  The increase was primarily attributable to the Company actively purchasing investment securities during the first quarter of 2012 as it continues to deploy funds acquired from the City Bank and North County Bank acquisitions, as well as, funds generated through the resolution of acquired assets.

The Company’s investment portfolio mix, based upon fair value, is outlined in the table below:

(dollars in thousands)	March 31, 2012		December 31, 2011
U.S. government agencies	$	81,392	$	76,574
U.S. Treasuries		27,127		42,597
Pass-through securities		141,267		117,398
State and political subdivisions		48,477		47,092
Corporate obligations		10,628		10,287
Agency-issued collateralized mortgage obligations		9,799		-
Investments in mutual funds and other equity securities		4,094		3,926
Total investment securities available for sale	$	322,784	$	297,874

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Non-Covered Loans: Non-covered loans, net of allowance for loans losses, totaled $800.7 million at March 31, 2012, compared to $794.8 million at December 31, 2011. 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 a diversified portfolio that is not heavily concentrated in any one industry or community.

The following table further details the major components of the non-covered loan portfolio:

(dollars in thousands)	March 31, 2012						December 31, 2011
	Balance			% of total			Balance			% of total
Commercial	$	156,594			19.2	%	$	150,386			18.5	%
Real estate mortgages:
One-to-four family residential		38,987			4.8	%		40,331			5.0	%
Multi-family and commercial		378,355			46.3	%		370,782			45.7	%
Total real estate mortgages		417,342			51.1	%		411,113			50.7	%
Real estate construction:
One-to-four family residential		56,963			7.0	%		58,810			7.3	%
Multi-family and commercial		31,236			3.8	%		31,546			3.9	%
Total real estate construction		88,199			10.8	%		90,356			11.2	%
Consumer:
Indirect		78,809			9.6	%		80,396			9.9	%
Direct		75,838			9.3	%		78,726			9.7	%
Total consumer		154,647			18.9	%		159,122			19.6	%
Subtotal		816,782			100.0	%		810,977			100.0	%
Deferred loan costs, net		1,868						1,853
Allowance for loan losses		(17,993	)					(18,032	)
Total non-covered loans	$	800,657					$	794,798

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Credit Risks and Asset Quality

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 limits, credit review, approval policies and extensive, ongoing internal monitoring. Through this monitoring process, nonperforming loans are identified. Nonperforming assets consist of nonaccrual loans and other real estate owned.  Nonperforming assets are assessed for potential loss exposure on an individual or homogeneous group basis.

Loans are placed on nonaccrual status when collection of principal or interest is considered doubtful (generally, loans are 90 days or more past due).   Loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospects for future payments, in accordance with the loan agreement, appear relatively certain.

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 collectability 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.

Loans are reported as restructured when the Bank grants a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as the Bank will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement.

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Non-Covered Nonperforming Assets

The following table summarizes the Company’s non-covered, nonperforming assets at March 31, 2012 and December 31, 2011:

(dollars in thousands)	March 31, 2012			December 31, 2011
Non-covered nonperforming loans		22,340			22,100
Non-covered other real estate owned		1,830			1,976
Total non-covered nonperforming assets	$	24,170		$	24,076
Restructured Loans (1)	$	28,002		$	26,493
Total non-covered impaired loans	$	50,342		$	48,593
Non-covered accruing loans past due 90
days or more	$	-		$	-
Non-covered potential problem loans (2)	$	2,381		$	2,179
Allowance for loan losses	$	17,993		$	18,032
Non-covered nonperforming loans to total
non-covered loans		2.73	%		2.72	%
Allowance for loan losses to total non-covered loans		2.20	%		2.22	%
Allowance for loan losses to non-covered
nonperfoming loans		80.54	%		81.59	%
Non-covered nonperforming assets to total assets		1.42	%		1.44	%
(1) Represents accruing restructured loans performing according to their restructured terms.
(2) Non-covered potential problem loans represent loans where known information about possible credit problems of borrowers causes management to have serious doubts about the ability of such borrowers to comply with the present loan repayment terms.

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The following table summarizes the Company’s non-covered, nonperforming assets, by location, at March 31, 2012:

(dollars in thousands)	Island County			King County			San Juan County			Skagit County			Snohomish County			Whatcom County			Total			Percent of total Non-Covered NPA by loan type
Commercial loans	$	-		$	-		$	285		$	2,431		$	51		$	304		$	3,071			12.71	%
Real estate mortgage loans:
One-to-four family residential		433			933			-			168			-			502			2,036			8.42	%
Multi-family and commercial		841			951			937			726			769			95			4,319			17.87	%
Real estate construction loans:
One-to-four family residential		1,867			-			-			5,585			-			4,827			12,279			50.80	%
Multi-family and commercial		-			-			-			-			100			-			100			0.41	%
Consumer loans:
Direct		535			-			-			-			-			-			535			2.21	%
Other Real Estate Owned		588			-			-			842			-			400			1,830			7.57	%
Total	$	4,264		$	1,884		$	1,222		$	9,752		$	920		$	6,128		$	24,170			100.00	%
Percent of total non-covered NPA
by location		17.64	%		7.79	%		5.06	%		40.35	%		3.81	%		25.35	%		100.00	%

Allowance for Loan Losses: The allowance for loan losses is maintained at a level considered adequate by management to provide for potential loan losses inherent in the portfolio. The Company assesses the allowance for loan losses 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: A specific allowance is established when management has identified unique or particular risks that are related to a specific loan that demonstrate risk characteristics consistent with impairment. Specific allowances may also be established to address the unique risks associated with a group of loans or particular type of credit exposure.

·   Formula Allowance: The calculations of expected loss rates are determined utilizing a two factor approach; loss given default (“LGD”) and probability of default (“PD”). Taken together, these two factors produce the expected loss rate.

Ø   LGD is defined as the rate of loss as determined by dividing the expected net charge-off by defaulted loans, where defaulted loans are defined as loans that have 30 days or greater payment delinquency plus nonaccrual and gross loans charged off.  LGD rates utilized reflect industry experience as determined by state and loan type, and are based upon banks with total assets below one billion dollars.  Banks falling into these size and state groupings will better capture state/geographic differences that occur in LGD rates, as well as provide a sufficient number of observations to be statistically meaningful. LGD rates will be based upon industry experience starting in 1992 and applied at a two standard deviation level. Bank specific LGD rates will be utilized when there are sufficient observations to generate a meaningful result, and these observations should include at least three observations as observed over a minimum of at least one full economic cycle for each type/sector/subsector/geographic combination to be considered meaningful.

Ø   PD is defined as the actual payment default rate (defined as the number of times a loan has been delinquent 30 or more days divided by the number of months the loan has been outstanding from the origination date to the valuation date), or for loans which have not generated an actual payment default rate, the rate applied is based upon industry experience for such loans as applied by loan type and state in which the loan applies to (in the case of real estate loans, the state determination is based upon were the collateral resides), where the expected payment default rate is defined as the sum loans where payment delinquencies are 30 or more days delinquent, plus nonaccrual and gross loans charged off divided by total loans for each group. Expected payment default rates are then scaled against the Bank’s loan risk grades with the Bank’s lowest pass/non-watch grade set to equal the industry PD and then scaled lower or higher against the Bank’s remaining loan grades.

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The following table summarizes the Company’s allocation of allowance for non-covered loan losses at March 31, 2012 and December 31, 2011:

(dollars in thousands)	March 31, 2012					December 31, 2011
	Amount		% of Loans (1)			Amount		% of Loans (1)
Commercial	$	4,041		19.2	%	$	4,034		18.5	%
Real estate mortgage		6,538		51.1	%		6,500		50.7	%
Real estate construction		4,095		10.8	%		4,046		11.2	%
Consumer		3,319		18.9	%		3,452		19.6	%
Total	$	17,993		100.0	%	$	18,032		100.0	%

(1): Represents the total outstanding non-covered loans in each category as a percentage of total non-covered loans outstanding.

While the Company believes that it uses the best information available to determine the allowance for non-covered loan losses, unforeseen market conditions could result in adjustments to the allowance for non-covered 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 non-covered loan losses is appropriate under the current circumstances and economic conditions.

The following table sets forth historical information regarding the Company's allowance for non-covered loan losses and net charge-offs for the three months ended March 31, 2012 and 2011:

(dollars in thousands)	Three Months Ended
	March 31,
	2012			2011
Balance at beginning of period	$	18,032		$	18,812
Provision for non-covered loan losses		2,000			3,000
Charge-offs:
Commercial		(585	)		(469	)
Real estate mortgage		(561	)		(1,285	)
Real estate construction		(600	)		-
Consumer
Direct		(196	)		(797	)
Indirect		(291	)		(348	)
Total charge-offs		(2,233	)		(2,899	)
Recoveries:
Commercial		19			81
Real estate mortgage		18			88
Real estate construction		2			1
Consumer
Direct		20			19
Indirect		135			136
Total recoveries		194			325
Net charge-offs		(2,039	)		(2,574	)
Balance at end of period	$	17,993		$	19,238

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Deposits: Total deposits increased $19.7 million for the period ended March 31, 2012, compared to December 31, 2011.

The following table further details the major components of the Company’s deposit portfolio:

(dollars in thousands)	March 31, 2012					December 31, 2011
	Balance		% of total			Balance		% of total			Change
Noninterest-bearing demand	$	242,568		16.3	%	$	219,250		15.0	%	$	23,318
NOW accounts		293,819		19.8	%		276,288		18.8	%		17,531
Money market		323,645		21.8	%		327,256		22.3	%		(3,611	)
Savings		103,462		7.0	%		99,882		6.8	%		3,580
Time deposits		522,531		35.1	%		543,668		37.1	%		(21,137	)
Total deposits	$	1,486,025		100.0	%	$	1,466,344		100.0	%	$	19,681

Wholesale Deposits: The following table further details wholesale deposits, which are included in total deposits shown above:

(dollars in thousands)	March 31, 2012						December 31, 2011
	Balance			% of total			Balance			% of total
Mutual fund money market deposits		24,704			65.1	%		24,704			75.1	%
CDARS deposits		13,223			34.9	%		8,174			24.9	%
Total wholesale deposits	$	37,927			100.0	%	$	32,878			100.0	%
Wholesale deposits to total deposits		2.6	%					2.2	%

Mutual fund money market deposits are obtained from an intermediary that provides cash sweep services to broker-dealers and clearing firms.  Currently, the Company anticipates limiting the growth of these types of deposits. The deposits are payable upon demand.

Certificate Deposit Account Registry System (“CDARS”) deposits are obtained through a broker and represent a reciprocal agreement, whereby the Company obtains a portion of time deposits from another financial institution, not to exceed $250,000 per customer. In return, the other financial institution obtains a portion of the Company’s time deposits. All CDARS deposits represent direct customer relationships with the Company, but for regulatory purposes are required to be classified as brokered deposits. Deposit maturities range between four weeks and twenty four months.

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Borrowings: At March 31, 2012 and December 31, 2011, borrowings totaled $25.8 million. The Company’s sources of funds consist of borrowings from correspondent banks, the FHLB and junior subordinated debentures.  

·   FHLB Overnight Borrowings:  The Company can use 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 March 31, 2012, the Company had no outstanding overnight borrowings, with an unused line of credit of $173.4 million, subject to certain collateral and stock requirements.

·   Federal Funds Purchased: The Company also uses lines of credit at correspondent banks to purchase federal funds for short-term funding. There were no outstanding borrowings at March 31, 2012.  Available borrowings under these lines of credit totaled $35.0 million at March 31, 2012.

·   Federal Reserve Bank Overnight Borrowings: The Company can use advances from the Federal Reserve Bank (“FRB”) of San Francisco to supplement funding needs. The FRB provides credit for financial institutions in the form of overnight borrowings. The Bank is required to pledge certain of its 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.  There were no outstanding overnight borrowings at March 31, 2012, with an unused line of credit of $22.6 million.

·   Junior Subordinated Debentures: Washington Banking Master Trust (the “Master Trust”), a wholly-owned subsidiary of the Company, issued $25.8 million of trust preferred securities with a quarterly adjustable rate based upon the London Interbank Offered Rate (“LIBOR”) plus 1.56%. The debentures, within certain limitations, are considered Tier 1 capital for regulatory capital requirements.

Capital

Shareholders’ Equity: Shareholders’ equity increased $3.0 million to $173.8 million at March 31, 2012, from $170.8 million at December 31, 2011. The increase in shareholders’ equity was primarily attributable to net income available to common shareholders of $4.8 million partially reduced by $1.8 million in cash dividends on common stock.

On April 26, 2012, the Company announced that its Board of Directors declared a cash dividend of $0.14 per share to shareholders of record as of May 7, 2012, payable on May 21, 2012.  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. There is no assurance that future cash dividends will be declared or increased.

TARP-CPP Capital: On January 16, 2009, in exchange for an aggregate purchase price of $26.4 million, the Company issued and sold to the United States Department of the Treasury pursuant to the Troubled Asset Relief Program Capital Purchase Program the following: (i) 26,380 shares of the Company’s newly designated Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value per share, and liquidation preference $1,000 per share ($26.4 million liquidation preference in the aggregate) and (ii) a warrant to purchase up to 492,164 shares of the Company’s common stock, no par value per share, at an exercise price of $8.04 per share, subject to certain anti-dilution and other adjustments.

In connection with the issuance and sale of the Company’s securities, the Company entered into a Letter Agreement including the Securities Purchase Agreement - Standard Terms, dated January 16, 2009, with the United States Department of the Treasury (the “Agreement”). The Agreement contained limitations on the payment of quarterly cash dividends on the Company’s common stock in excess of $0.065 per share and on the Company’s ability to repurchase its common stock.

The Series A Preferred Stock paid cumulative dividends at a rate of 5% per annum, applied to the $1,000 per share liquidation preference, as and if declared by the Company’s Board of Directors out of funds legally available. The Series A Preferred Stock had no maturity date and ranked senior to common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company.

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On January 12, 2011, the Company redeemed all 26,380 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A.  The Company paid a total of $26.6 million to the Treasury, consisting of $26.4 million in principal and $209 thousand in accrued and unpaid dividends. The Company's redemption of the shares was not subject to additional conditions.

On March 2, 2011, the Company completed the repurchase of Warrant to Purchase Common Stock issued to the U.S. Department of the Treasury pursuant to the Troubled Asset Relief Program Capital Purchase Program. The Company repurchased the Warrant for $1.6 million. The Warrant repurchase, together with the Company’s earlier redemption of the entire amount of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, issued to the U.S. Treasury, represents full repayment of all TARP obligations and cancellation of all equity interests in the Company held by the U.S. Treasury.

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

The FDIC established the qualifications necessary to be classified as a “well-capitalized” bank, primarily for assignment of FDIC insurance premium rates.  As the following table indicates, the Company and Bank qualified as “well-capitalized” at March 31, 2012 and December 31, 2011:

	Regulatory Requirements						Actual Ratios
	Adequately- capitalized			Well-capitalized			March 31, 2012			December 31, 2011
Total risk-based capital ratio
Company (consolidated)		8.00	%		N/A			19.94	%		19.73	%
Whidbey Island Bank		8.00	%		10.00	%		19.32	%		19.09	%
Tier 1 risk-based capital ratio
Company (consolidated)		4.00	%		N/A			18.69	%		18.47	%
Whidbey Island Bank		4.00	%		6.00	%		18.07	%		17.84	%
Tier 1 leverage ratio
Company (consolidated)		4.00	%		N/A			11.49	%		11.16	%
Whidbey Island Bank		4.00	%		5.00	%		11.10	%		10.77	%

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

Liquidity and Cash Flows

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.

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Consolidated Cash Flows: As disclosedin the Condensed Consolidated Statements of Cash Flows, net cash provided by operating activities was $24.5 million for the three months ended March 31, 2012.  For the same period, net cash used in investing activities was $17.3 million.  Purchases of available for sale investment securities accounted for $55.9 million, which was partially offset by $30.5 million in maturities, calls and principal payments of investment securities and mortgage-backed securities.  Net cash provided financing activities was $18.0 million for the three months ended March 31, 2012, and primarily consisted of the net increase in deposits of $20.0 million and the $1.8 million payment of cash dividends on common stock.

Capital Resources:

Off-Balance Sheet Items: The Company is a party to financial instruments with off-balance sheet risk.  Among the off-balance sheet items entered into in the ordinary course of business are commitments to extend credit and the issuance of letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheet.  Certain commitments are collateralized. At March 31, 2012 and December 31, 2011, the Company’s commitments under letters of credit and financial guarantees amounted to $1.3 million and $1.1 million, respectively. Since many of the commitments are expected to expire without being drawn upon, these total commitment amounts do not necessarily represent future cash requirements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

At March 31, 2012, based on the measures used to monitor and manage interest rate risk, there has not been a material change in the Company's interest rate risk since December 31, 2011.  Should rates increase, the Company may, or may not be positively impacted due to its current slightly liability sensitive position.  For additional information, refer to the Company's Form 10-K for year ended December 31, 2011 filed with the SEC.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Control over Disclosure and Reporting

There was no change in the Company’s internal control over financial reporting that occurred during the period ended March 31, 2012, that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company is involved in legal proceedings from time to time in the regular course of business. At this time, based on information currently available, we believe that the eventual outcome of such pending litigation will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

Item 1A. Risk Factors

For information regarding risk factors, please refer to Part I, Item 1A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

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

(a) – (c) None

Item 3. Defaults Upon Senior Securities

(a) – (b) None

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

Not applicable

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Item 6. Exhibits

	3.1		Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to Form 10-Q filed August 9, 2011)
	3.2		Bylaws of the Company (1)
	4.1		Form of Common Stock Certificate (1)
	4.2		Pursuant to Section 601(b)(4)(iii)(A) of Regulation S-K, copies of instruments defining the rights of holders of long-term debt are not filed.  The Company
			agrees to furnish a copy thereof to the Securities and Exchange Commission upon request
	10.1		Form of Employment Agreement (with executive officers Bowen, Eng and Kuenzi) (2)
	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
101.INS Instance Document **
101.SCH Taxonomy Extension Scheme Document **
101.CAL Taxonomy Extension Calculation Linkbase Document **
101.DEF Taxonomy Extension Definition Linkbase Document **
101.LAB Taxonomy Extension Label Linkbase Document **
101.PRE Taxonomy Extension Presentation Linkbase Document **
** Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the
Securities Act of 1933, as amended, or Section 18 of the Securities and Exchange Act of 1934, as amended and otherwise are not subject to liability under those sections.
		(1)	Incorporated by reference to the Company's registration statement Form SB-2 (File No. 333-49925), filed April 10, 1998
		(2)	Incorporated by reference to the Company's Current Report on Form 8-K filed January 5, 2012

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SIGNATURES

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

WASHINGTON BANKING COMPANY

 /s/ John L. Wagner

 John L. Wagner

 President and Chief Executive Officer

 (Principal Executive Officer)

May 10, 2012

 /s/ Richard A. Shields

 Richard A. Shields

 Executive Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

 May 10, 2012

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