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Washington Banking Company 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31
  3. Ex-31
  4. Ex-32
  5. Ex-32
  6. Ex-32
3Q 2003

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, 2005

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

The number of shares of the issuer’s Common Stock outstanding at April 30, 2005 was 5,470,628.


Table of Contents
PART I-FINANCIAL INFORMATION
Page
Item 1.   Financial Statements        
                    Condensed Consolidated Statements of Financial Condition -  
                         March 31, 2005 and December 31, 2004    1  
     
                    Condensed Consolidated Statements of Income -  
                         Three Months Ended March 31, 2005 and 2004    2  
     
                    Condensed Consolidated Statements of Shareholders’ Equity and                          Comprehensive Income -  
                         Three Months Ended March 31, 2005 and 2004    3  
     
                    Condensed Consolidated Statements of Cash Flows -  
                         Three Months Ended March 31, 2005 and 2004    4  
     
                    Notes to Condensed Consolidated Financial Statements    5  
     
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of                     Operations    9  
     
Item 3.   Quantitative and Qualitative Disclosures about Market Risk    19  
Item 4.   Controls and Procedures    19  
     
                                                                 PART II-OTHER INFORMATION  
     
Item 1.   Legal Proceedings    20  
Item 2.   Unregistered Sale of Equity Securities and Use of Proceeds    20  
Item 3.   Defaults Upon Senior Securities    20  
Item 4.   Submission of Matters to a Vote of Security Holders    20  
Item 5.   Other Information    20  
Item 6.   Exhibits    20  
                    Signatures    21  

i


PART I — FINANCIAL INFORMATION

Item 1.     Financial Statements

WASHINGTON BANKING COMPANY
AND SUBSIDIARY

Condensed Consolidated Statements of Financial Condition
March 31, 2005 and December 31, 2004 (unaudited)
(Dollars in thousands)

Assets March 31,
2005

December 31,
2004

Cash and due from banks     $ 20,855   $ 16,814  
      ($435 and $2,686, respectively, are restricted)        
Interest-bearing deposits    736    1,119  
Federal funds sold    1,005      


              Total cash, restricted cash, and cash equivalents    22,596    17,933  
Investment securities available for sale    19,059    19,304  
     
Subsidiary investment in the Trust    283    295  
Federal Home Loan Bank stock    1,984    1,976  
     
Loans held for sale    5,684    8,311  
     
Loans receivable    590,431    579,980  
Allowance for loan losses    (8,052 )  (7,903 )


              Total loans, net    582,379    572,077  
Premises and equipment, net    20,987    20,375  
Bank owned life insurance    10,302    10,217  
Other assets    8,842    7,236  


              Total assets   $ 672,116   $ 657,724  


               Liabilities and Shareholders’ Equity  
Liabilities:      
    Deposits  
       Noninterest-bearing   $ 85,891   $ 77,820  
       Interest-bearing    288,159    274,999  
       Time deposits    213,489    210,182  


              Total deposits    587,539    563,001  
    Other borrowed funds    14,000    27,000  
    Junior subordinated debentures    15,007    15,007  
    Other liabilities    4,395    3,125  


              Total liabilities    620,941    608,133  
Commitments and contingencies          
     
Shareholders’ equity:  
    Preferred stock, no par value. Authorized 20,000 shares:      
       no shares issued or outstanding          
    Common stock, no par value. Authorized 10,000,000 shares:  
       issued and outstanding 7,290,824 and 7,239,052 shares  
       at March 31, 2005 and December 31, 2004, respectively (1)    31,586    31,516  
    Retained earnings    19,576    17,928  
    Accumulated other comprehensive income    13    147  


              Total shareholders’ equity    51,175    49,591  


              Total liabilities and shareholders’ equity   $ 672,116   $ 657,724  


(1)  Adjusted for the 4-for-3 stock split declared on March 24, 2005.
See accompanying notes to condensed consolidated financial statements.

1


WASHINGTON BANKING COMPANY
AND SUBSIDIARY

Condensed Consolidated Statements of Income
Three months ended March 31, 2005 and 2004 (unaudited)
(Dollars in thousands, except per share data)

Three Months Ended
March 31
2005
2004
Interest income:        
     Interest and fees on loans   $ 10,094   $ 8,773  
     Interest on taxable investment securities    88    108  
     Interest on tax exempt investment securities    80    163  
     Other    31    41  
 

              Total interest income    10,293    9,085  
     
Interest expense:      
     Interest on deposits    2,117    1,773  
     Interest on other borrowings    169    146  
     Interest on junior subordinated debentures    237    180  
 

              Total interest expense    2,523    2,099  
 

                    Net interest income    7,770    6,986  
Provision for loan losses    425    825  
 

              Net interest income after provision for loan losses    7,345    6,161  
Noninterest income:      
     Service charges and fees    699    746  
     Income from the sale of loans    172    278  
     SBA premium income    112    36  
     Other    678    322  
 

              Total noninterest income    1,661    1,382  
Noninterest expense:      
     Salaries and benefits    3,431    3,485  
     Occupancy and equipment    957    971  
     Office supplies and printing    185    153  
     Data processing    118    116  
     Consulting and professional fees    266    131  
     Other    1,030    849  
 

              Total noninterest expense    5,987    5,705  
 

              Income before income taxes and discontinued operations    3,019    1,838  
Provision for income taxes    976   620 
 

Income from continuing operations    2,043    1,218  
Loss from discontinued operations, net of tax        (123 )
 

              Net income   $ 2,043   $ 1,095  
 

Earnings (loss) per common share, basic (1)  
     Continuing operations   $0.28 $0.17 
     Discontinued operations        (0.02 )
 

     Net income per share   $0.28   $0.15 
 

Earnings (loss) per common share, diluted (1)       
     Continuing operations   $0.27  $0.17 
     Discontinued operations        (0.02 )
 

     Net income per share   $0.27 $ 0.15 
 

Average number of shares outstanding, basic (1)    7,249,213   7,185,039 
Average number of shares outstanding, diluted (1)    7,521,261   7,461,497 

(1) Adjusted for the 4-for-3 stock split declared on March 24, 2005.
See accompanying notes to condensed consolidated financial statements.

2


WASHINGTON BANKING COMPANY
AND SUBSIDIARY

Condensed Consolidated Statements of Shareholders’ Equity
and Comprehensive Income
Three months ended March 31, 2005 and 2004 (unaudited)
(Dollars and shares in thousands, except per share data)

Common stock
Retained Accumulated
other
comprehensive
Total
shareholders’
Shares
Amount
earnings
income (loss)
equity
Balances at December 31, 2003      5,358   $ 31,125   $ 13,273   $ (38 ) $ 44,360  
Comprehensive income:            
    Net income            1,095        1,095  
    Net unrealized gain on securities       available for sale, net of tax of $50                97    97  

Total comprehensive income            1,192 
Cash dividend, $0.054 per share (1)            (343 )      (343 )
Stock option compensation        6            6  
Stock options exercised    51    150            150  





Balances at March 31, 2004     5,409   $ 31,281   $ 14,025   $ 59   $ 45,365  





Balances at December 31, 2004     5,429   $ 31,516   $ 17,928   $ 147   $ 49,591  
Comprehensive income:            
    Net income            2,043        2,043  
    Net unrealized loss on securities       available for sale, net of tax of ($79)                (134 )  (134 )

Total comprehensive income            1,909  
Cash dividend, $0.054 per share (1)            (395 )      (395 )
Stock option compensation        6            6  
Four-for-three stock split    1,810                  
Stock options exercised (1)    16    64            64  
Restricted Stock (1)    35    637            637  
Unearned Restricted Stock (1)        (637 )          (637 )





Balances at March 31, 2005     7,290   $ 31,586   $ 19,576   $ 13   $ 51,175  





(1) Adjusted for the 4-for-3 stock split declared on March 24, 2005.
See accompanying notes to condensed consolidated financial statements.

3


WASHINGTON BANKING COMPANY
AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 2005 and 2004 (unaudited)
(Dollars in thousands)

Three Months Ended March 31
2005
2004
Cash flows from operating activities:            
     Net income from continuing operations   $ 2,043   $ 1,218  
     Adjustments to reconcile net income to net cash      
       provided by operating activities:      
         Federal Home Loan Bank stock dividends    (8 )  (23 )
         Amortization of investment premiums, net    7    8  
         Net decrease (increase) in subsidiary investment    19    (327 )
         Earnings on bank owned life insurance    (85 )    
         Provision for loan losses    425    825  
         Net decrease (increase) in loans held for sale    2,627    (685 )
         Depreciation and amortization of premises and equipment    399    450  
         Net gain on sale of premises and equipment    (95 )    
         Net (gain) loss on sale of other real estate    (7 )  14  
         Write-downs of other real estate    85      
         Increase in other assets    (1,236 )  (122 )
         Increase (decrease) in other liabilities    680    (351 )


             Cash flows from continuing operating activities    4,854    1,007  
                Loss from discontinued operations        (123 )


                  Cash flows from operating activities    4,854    884  


Cash flows from investing activities:      
     Maturities/calls/principal payments of investment and  
         mortgage-backed securities available for sale    25    3,063  
     Maturities/calls of investment securities held to maturity        160  
     Net increase in loans    (10,780 )  (22,243 )
     Purchases of premises and equipment    (1,357 )  (483 )
     Proceeds from the sale of other real estate owned and premises and equipment    714    47  


                  Cash flows from investing activities    (11,398 )  (19,456 )


Cash flows from financing activities:  
     Net increase in deposits    24,538    45,838  
     Net decrease in FHLB overnight borrowings    (13,000 )  (5,000 )
     Dividends paid on common stock    (395 )  (343 )
     Proceeds from stock options exercised    64    150  


                  Cash flows from financing activities    11,207    40,645  


                  Net change in cash and cash equivalents    4,663    22,073  
Cash and cash equivalents at beginning of period    17,933    20,605  


Cash and cash equivalents at end of period   $ 22,596   $ 42,678  


Supplemental information:      
     Loans foreclosed and transferred to other real estate owned   $ 53   $  
     Cash paid for interest    2,510    2,046  
     Cash paid for income taxes    220      
     Deconsolidation of trust preferred securities        15,000  

See accompanying notes to condensed consolidated financial statements.

4


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three months ended March 31, 2005 and 2004 (unaudited)
(Dollars in thousands, except per share data)

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

         (a)      Description of Business

              Washington Banking Company (the “Company” or “WBCO”) is a registered bank holding company formed on April 30, 1996. At March 31, 2005, WBCO had two wholly owned subsidiaries – Whidbey Island Bank (“WIB” or the “Bank”), the Company’s principal subsidiary, and Washington Banking Capital Trust I (the “Trust”). The business of the Bank, which is focused in the northern area of Western Washington, consists primarily of attracting deposits from the general public and originating loans. The region’s economy has evolved from one that was once heavily dependent upon forestry, fishing and farming to an economy with a much more diverse blend of industries including retail trade, services, manufacturing, tourism and a large military base presence. Although the Bank has a diversified loan portfolio, a substantial portion of its borrowers’ ability to repay their loans is dependent upon the economic conditions affecting this area.

              The Trust was formed in June 2002 for the exclusive purpose of issuing trust preferred securities and common securities and using the $15,000 in proceeds from the issuance to acquire junior subordinated debentures issued by WBCO. The Company deconsolidated the Trust in 2004, pursuant to Financial Accounting Standards Board (“FASB”) Financial Interpretation No. 46R (“FIN 46R”).

              Washington Funding Group, Inc., a wholesale mortgage real estate lending company (“WFG”), was a former subsidiary of the Company, which was a Washington State corporation formed in January 2003. The primary purpose of this subsidiary was to provide a loan-funding source for brokers of mortgage loans. The loans were originated and sold in the name of the Bank. The Company closed WFG’s operations effective June 30, 2004.

         (b)     Basis of Presentation

              The accompanying interim condensed consolidated financial statements include the accounts of WBCO and its subsidiaries described above. The accompanying interim condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the December 31, 2004 audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC on March 25, 2005. 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, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. In preparing the condensed consolidated financial statements, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses are required. Actual results could differ from those estimates.

         (c)     Segments

              Pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosure about Segments of an Enterprise and Related Information, the Company has evaluated the requirements of this standard and identified two reportable segments: WIB and the discontinued operations of WFG, both wholly-owned subsidiaries of Washington Banking Company. Due to the discontinuation of WFG in the second quarter of 2004, the Company currently has only one segment, WIB, and is not required to disclose segment reporting by this standard.

         (d)     Reclassifications

              Certain amounts in prior year’s financial statements may have been reclassified to conform to the 2005 presentation. These reclassifications had no significant impact on the Company’s financial position or results of operations.

5


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three months ended March 31, 2005 and 2004 (unaudited)
(Dollars in thousands, except per share data)

(2)     Recent Financial Accounting Pronouncements

              In December 2004, FASB issued SFAS No. 123R, Shared Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. Statement No. 123R supersedes Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows.

              As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using APB 25 intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. The adoption of SFAS No. 123R’s fair value method will have an impact on the Company’s result of operations, although it will have no impact on the overall financial position. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123. Also, SFAS No. 123R requires the benefit of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.

              The SEC recently announced the adoption of a new rule that amends the compliance dates for SFAS No. 123R for public companies. Under the Statement as issued by the FASB, fair-value accounting would have been mandatory for the first interim or annual reporting period beginning after June 15, 2005, for public companies that are not small business issuers; all other companies, including all nonpublic companies, were to begin using the new rules for reporting periods after December 15, 2005. The SEC’s new rule allows public companies to implement SFAS No. 123R at the beginning of the next fiscal year, instead of the next reporting period, after June 15 or December 15, 2005, as applicable. The SEC’s new rule does not change the accounting required by SFAS No. 123R; only the compliance deadlines have been altered. With the recent extension, the Company expects to adopt SFAS No. 123R on January 1, 2006.

(3)     Earnings Per Share

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

Three Months Ended March 31
2005
2004
Weighted average shares-basic      7,249,213    7,185,039  
Effect of dilutive securities: stock options    272,048    276,458  


Weighted average shares-diluted    7,521,261    7,461,497  


Adjusted for the 4-for -3 stock split declared March 24, 2005.

              The Company declared a 4-for-3 stock split on March 24, 2005. On February 26, 2004, the Company issued a 15% stock dividend to shareholders of record as of February 10, 2004. All periods presented have been restated to reflect the stock split and dividends. At March 31, 2005 and 2004, there were options to purchase 436,118 and 487,165 shares of common stock outstanding, respectively. For the three months ended March 31, 2005 and 2004 no options were antidilutive and therefore all were included in the computation of diluted net income per share.

(4)     Junior Subordinated Debentures

              The Trust issued $15,000 of trust preferred securities with a 30-year maturity, callable after the fifth year by Washington Banking Company on June 27, 2002. The rate adjusts quarterly based on Three-Month LIBOR plus 3.65%. On March 31, 2005 the rate was 6.31%. These securities, within certain limitations, are considered Tier I capital for the purposes of regulatory capital requirements.

6


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three months ended March 31, 2005 and 2004 (unaudited)
(Dollars in thousands, except per share data)

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

              Pursuant to FIN 46R, the Company deconsolidated the trust beginning first quarter of 2004 and began to report the junior subordinated debentures within the liabilities section of the statement of financial condition. Prior to deconsolidation, the Trust and the related trust preferred securities were included within borrowings as a separate line item in WBCO’s statement of financial condition.

(5)     Stock-Based Compensation

              The Company currently recognizes the financial effects of stock-based employee compensation based on the intrinsic value method of accounting prescribed by APB 25, Accounting for Stock Issued to Employees and FASB Interpretation No. 44 (“FIN 44”), Accounting for Certain Transactions Involving Stock Compensation. Generally, stock options are issued at a price equal to the fair value of the Company’s stock as of the grant date. Under APB 25, options issued in this manner do not result in the recognition of employee compensation in the Company’s financial statements.

        The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:

Three Months Ended March 31
2005
2004
Net income, as reported     $2,043   $1,095  
Stock compensation recognized, net of tax    4    4  
Additional compensation for  
     fair value of stock options, net of tax    (15 )  (15 )


Pro forma net income   $2,032   $1,084  


Basic earnings per share:   
     As reported  
Income from continuing operations   $ 0.28   $ 0.17  
Loss from discontinued operations        (0.02 )


Net Income   $ 0.28   $ 0.15  


     Pro forma  
Income from continuing operations   $ 0.28   $ 0.17  
Loss from discontinued operations        (0.02 )


Net Income   $ 0.28   $ 0.15  


Diluted earnings per share:   
     As reported  
Income from continuing operations   $ 0.27   $ 0.17  
Loss from discontinued operations        (0.02 )


Net Income   $ 0.27   $ 0.15  


     Pro forma  
Income from continuing operations   $ 0.27   $ 0.16  
Loss from discontinued operations        (0.02 )


Net Income   $ 0.27   $ 0.14  


Adjusted for the 4-for -3 stock split declared March 24, 2005.

7


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three months ended March 31, 2005 and 2004 (unaudited)
(Dollars in thousands, except per share data)

(6)     Subsequent Event

              On April 28, 2005, the Board of Directors declared a cash dividend of $.055 per share to shareholders of record as of May 10, 2005, payable on May 24, 2005.

(7)     Commitments

              Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Except for certain long-term guarantees, most guarantees expire in one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral supporting those commitments, for which collateral is deemed necessary, generally amounts to one hundred percent of the commitment amount at March 31, 2005. The Company routinely charges a fee for these credit facilities. Such fees are amortized into income over the life of the agreement, and unamortized amounts are not significant as of March 31, 2005.

              As of March 31, 2005 the commitments under these agreements were as follows:

Standby letters of credit and financial guarantees     $917

              At March 31, 2005, the Company was the guarantor of trust preferred securities. The Company has issued junior subordinated debentures to a wholly owned special purpose trust, which has issued trust preferred securities. The sole assets of the special purpose trust are the junior subordinated debentures issued by the Company. Washington Banking Company has fully and unconditionally guaranteed the capital securities along with all obligations of the Trust under the trust agreements. The maximum amount of future payments the Company will be required to make under these agreements is the principal and interest of the trust preferred securities, the principal of which totaled $15,000 at March 31, 2005.

(8)     Investment Securities

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

              During the second quarter of 2004, the Company transferred all of the municipal securities from held to maturity to available for sale as a result of management’s review of the Company’s liquidity needs, the asset/liability position, the scheduled maturities and the rate environment trends. This transfer caused a related net unrealized gain of $412. In addition, the Company sold $5,799 of available for sale securities to help reposition the Company’s liability sensitive position against the anticipation of a rising rate environment. For liquidity purposes, the Company’s future security purchases will primarily be designated as available for sale. The investment portfolio consists of government agency securities, pass-through securities, corporate securities, municipal securities and preferred stock. No investment exceeds 10% of the shareholders’ equity.

8


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


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


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

Overview

              Washington Banking Company (the “Company” or “WBCO”) is a registered bank holding company with two wholly-owned subsidiaries: Whidbey Island Bank (the “Bank”) and Washington Banking Capital Trust I (the “Trust”). A third subsidiary, Washington Funding Group, Inc., (“WFG”) was dissolved effective June 30, 2004.

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

Financial Highlights

              The Company’s focus on improving credit quality at its Whidbey Island Bank subsidiary contributed to record net income in the first quarter of 2005. Revenues, on a fully tax-equivalent basis, grew from $8.5 million to $9.5 million, a 12.0% increase, while net income grew 87% to $2.0 million in the quarter ended March 31, 2005, compared to $1.1 million for the like quarter a year ago. The increase in net income is primarily the result of an improvement in the credit quality of our loan portfolio leading to a reduction in our allowance for loan losses and increases in our noninterest income primarily related to SBA premiums, ATM income and a nominal gain on the sale of premises and equipment.

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              Earnings per diluted share increased 80% to $0.27, compared to $0.15 per diluted share in the first quarter of 2004. Results in the first quarter last year were negatively impacted by $0.02 per diluted share from the operating loss associated with WFG. Excluding this discontinued operation, earnings per diluted share grew 59% to $0.27, versus $0.17 in the first quarter of 2004. All per share data has been adjusted to reflect the 4-for-3 stock split.

              The Company’s profitability ratios have shown substantial improvement from a year ago, partially due to maximizing efficiencies. Return on average equity (“ROE”) improved to 16.38% and return on average assets (“ROA”) grew to 1.24% in the first quarter of 2005. In the first quarter last year, ROE was 9.85% and ROA was 0.74%, due in part to the operating loss of WFG.

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

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

Three Months Ended March 31, 2005
Three Months Ended March 31, 2004
(Dollars in thousands) Average
balance

Interest
earned/paid

Average
yield

Average
balance

Interest
earned/paid

Average
yield

     
           Assets                                  
             
Loans (1) (2)   $ 585,952 $ 10,112   7.00%  $ 515,732 $ 8,796  6.86%  
Federal funds sold    1,680   10   2.41%   5,002   11   0.88%  
Interest-earning cash    1,049   6   2.32%   684   2   1.18%  
Investments:  
     Taxable    14,404   103   2.90%   17,303   136   3.16%  
     Non-taxable (2)    7,085   119   6.81%   14,584   242   6.67%  






Interest-earning assets    610,170   10,350   6.88%   553,305   9,187   6.68%  
Noninterest-earning assets    49,477            38,625           

   
   
     Total assets   $ 659,647           $ 591,930           

   
   
       Liabilities and   
    Shareholders’ equity   
             
Deposits:  
     Interest demand and  
      money market   $ 217,329 $ 492   0.92%  $ 190,866 $ 360   0.76%  
     Savings    56,283   110   0.79%   43,480   85   0.79%  
     CDs    210,471   1,515   2.92%   198,656   1,328   2.69%  






Interest-bearing deposits    484,083   2,117   1.77%   433,002   1,773   1.65%  
             
Federal funds purchased    14,450   90   2.53%   5,489   15   1.10%  
Junior subordinated debentures    15,007   237   6.40%   15,007   180   4.82%  
Other borrowed funds    8,185   79   3.91%   12,592   131   4.18%  






Interest-bearing liabilities    521,725   2,523   1.96%   466,090   2,099   1.81%  
Noninterest-bearing deposits    85,022            78,728           
Other noninterest-bearing liabilities    3,009            2,623           

   
   
Total liabilities    609,756            547,441           
Shareholders’ equity    49,891            44,489           

   
   
     Total liabilities and                             
       shareholders’ equity   $ 659,647           $ 591,930           

   
   
         
Net interest income      $ 7,827          $ 7,088       
 
   
 
           
Net interest spread            4.92%           4.87%  
   
   
           
Net interest margin            5.20%           5.15%  
   
   

(1) Average balance includes nonaccrual loans. Interest earned includes loan fees of $291 and $227 for the three months ended March 31, 2005 and 2004, respectively.
(2) Interest income on non-taxable investments and loans is presented on a fully tax-equivalent basis using the federal statutory rate of 34%. These adjustments were $57 and $102 for the three months ended March 31, 2005 and 2004, respectively. Fully tax-equivalent is a nonGAAP performance measurement that management believes provides investors with a more accurate picture of the net interest margin efficiency ratio for comparative purposes.

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              The following table sets forth the amounts of the changes in consolidated net interest income attributable to changes in volume and to changes in interest rates, presented on a 90/365-day basis. Changes attributable to the combined effect of volume and interest rates have been allocated proportionately:

Three months ended March 31
2005 vs. 2004
Increase (decrease) due to

Volume
Rate
Total
Assets:                
Loans (1)   $ 1,211   $ 105   $ 1,316  
Federal funds sold    1    (2 )  (1 )
Interest earning cash    1    3    4  
Investments (1)    (112 )  (44 )  (156 )



  Total interest earning assets    $ 961   $ 202   $ 1,163  



Liabilities:   
Deposits  
   Interest demand and money  
     market   $ 54   $ 78   $ 132  
   Savings    25        25  
   Time deposits    82    105    187  
Interest on other borrowed funds    42    33    75  
Junior subordinated debentures        57    57  
Other interest bearing liabilities    (43 )  (9 )  (52 )



Total interest bearing liabilities    $262   $ 162   $ 424  



(1) Interest on loans and investments is presented on a fully tax-equivalent basis.

Results of Operations

              Net Interest Income. The primary component of earnings for financial institutions is net interest income. Net interest income is the difference between interest income, primarily from loans and investments, and interest expense on deposits and borrowings. Changes in net interest income result from changes in “volume”, changes in “spread,” and change in “margin.” Volume refers to the level of average interest-earning assets or interest-bearing liabilities. Spread refers to the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Margin refers to the ratio of net interest income to average earning assets and is influenced by the mix of interest-earning assets and interest-bearing liabilities as well as the relative proportion of interest-bearing liabilities to interest-earning assets.

              Average interest-earning assets for the first quarter of 2005 increased to $610.2 million, compared to $553.3 million for the quarter ended March 31, 2004, an increase of 10.3%, while the average yield on interest-earning assets increased to 6.88% in the first quarter of 2005, compared to 6.68% in first quarter of the prior year.

              Net interest income, on a fully tax-equivalent basis, for the first quarter of 2005 increased 10.4% to $7.8 million from $7.1 million for the first quarter of 2004, which was primarily due to earning higher yields on higher average volumes in commercial real estate and construction loans. The average yield on loans increased to 7.00% for the quarter ended March 31, 2005 from 6.86% for the first quarter of 2004.

              Offsetting the increase in interest income from loans was the Company’s reduced average investment in its securities portfolio during the first three months of 2005 compared to the like period in 2004. The Company sold $5.8 million in available-for-sale investment securities and did not reinvest the proceeds of $5.5 million in investment maturities during the second half of 2004 in anticipation of shifts in the interest rate market, as well as management’s review of the Company’s liquidity needs and asset/liability position.

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              The Company incurred more expense in maintaining and generating additional funding during the first three months of 2005 compared to the like period in 2004. Average interest-bearing liabilities for the quarter ended March 31, 2005 increased to $521.7 million compared to $466.1 million a year ago, a growth of 11.9%. The average cost of interest-bearing liabilities increased in the first quarter of 2005 to 1.96% from 1.81% for the quarter ended March 31, 2004. Aside from competitive pressures to generate more deposit share in the market through CD campaigns and competitive offering rates, the Company’s junior subordinated debentures continued to contribute to the overall increase in interest expense. The Company’s recorded cost of the junior subordinated debentures is tied to the Three-Month LIBOR index plus 3.65% and is adjusted on a quarterly basis. The index has increased 59 basis points from 2.07% at December 31, 2004 to 2.66% at March 31, 2005.

              As a result of the above changes, the net interest spread widened to 4.92% for the quarter ended March 31, 2005 from 4.87% for the quarter ended March 31, 2004. In addition, net interest margin (net interest income, on a fully tax-equivalent basis, divided by average interest-earning assets) increased to 5.20% in the first quarter of 2005 from 5.15% in the first quarter of 2004. Management’s strategic objectives in utilizing low-cost funding sources have allowed the Company to maintain its net margin over time despite changes in the interest rate market.

              Provision for Loan Losses. The Company recorded a $425,000 provision for loan losses for the first quarter of 2005, compared to $825,000 for the like period a year ago. Net loan charge-offs were $276,000 for the first quarter of 2005, compared with $461,000 for the like period in the prior year. Due to improvements in credit quality, changes in the loan mix and moderate loan growth in the first quarter, the Company reduced the provision for loan losses. See additional discussion in the Total Loans section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

              Noninterest Income. Noninterest income increased $279,000, or 20.2%, in the first quarter of 2005 compared to the like period in 2004. Changes in noninterest income were primarily due to an increase of $203,000 from ATM income, premium income from the sale of SBA loans and a nominal gain from the sale of the Company’s former operations center located in Oak Harbor, Washington. In addition, the Company earned $161,000 in noninterest income generated by its Bank Owned Life Insurance (“BOLI”) investment and annuity income from non-deposit investment products. The Company did not earn BOLI income nor annuity income during the first three months of 2004 given that these investments were not introduced until the second half of 2004. Offsetting these increases were a decline of $47,000 in income from service charges and fees and a drop of $107,000 in income from the sale of loans. In the past, selling single-family residential loans to the secondary market contributed significantly to noninterest income, but slowing of refinancing mortgage activity caused a decrease in income from the sale of loans.

              Noninterest Expense. Noninterest expense increased by $282,000 in the first quarter of 2005, or 4.9% from a year ago. Two major contributors to noninterest expense — consulting and professional fees and other noninterest expense — increased 103.1% and 21.3%, respectively, for the quarter compared with the like period in 2004. During the first three months of 2005, the Company retained outside consultants to: evaluate operational efficiencies, provide a branch site analysis, and assess the Company’s strategic position. Salaries and benefits and occupancy and equipment remained flat during the first three months of 2005 compared to the like period one year ago.

              The Company focused its efforts on keeping expenses to a minimum despite initial costs generated by the opening of a new branch in Friday Harbor, Washington and the on-going costs associated with Sarbanes-Oxley Act compliance. As a result of consolidating back office operations and improving operating efficiencies, the company successfully managed noninterest expense during the first quarter of 2005.

              The efficiency ratio (noninterest expense divided by the sum of net interest income, on a fully tax-equivalent basis, plus noninterest income) improved to 63.10% for the first quarter 2005 compared to 67.36% for the like period in 2004.

              Income Taxes. For the first quarters of 2005 and 2004, the Company recorded income tax provisions of $976,000 and $620,000, respectively. The overall effective tax rate was approximately 32.3% and 33.7% for the three months ended March 31, 2005 and 2004, respectively.

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Financial Condition

              Total Assets. Total assets grew to $672.1 million at March 31, 2005 from $657.7 million at December 31, 2004, an increase of 2.2%. This increase resulted mainly from growth in the loan portfolio, which was funded by deposit growth and earnings.

              Investment Securities. The Company’s total portfolio of investment securities decreased 1.3% to $19.1 million at March 31, 2005 from $19.3 million at December 31, 2004. The slight decrease was a result of the declines in market value and maturities of investments. No investment securities were purchased during the first quarter of 2005.

              Total Loans. The Company’s loan portfolio represents management’s efforts to diversify risk across a wide range of loan types and industries. Loan products include residential and commercial real estate loans, construction loans and consumer loans. Total loans were $590.4 million at March 31, 2005, representing a 1.8% increase from $580.0 million at December 31, 2004. The majority of the growth was in commercial real estate and direct consumer loans, which increased 4.6% and 4.1%, respectively, at March 31, 2005 compared to December 31, 2004. The increase in real estate commercial loans was due primarily to a few large commercial construction loans and land development projects. Home equity loans, as a portion of direct consumer loans increased by $2.2 million during the first quarter of 2005 compared to December 31, 2004, while remaining constant as a percentage of total loans between both periods. At March 31, 2005, loans held for sale were $5.7 million as compared to $8.3 million at December 31, 2004, a decrease of 31.6%. The rising interest rate environment has slowed mortgage-refinancing activity.

              The Company makes automobile and recreational vehicle loans for new and used vehicles originated indirectly by selected automobile dealers located in the Company’s market areas. Indirect loans were $98.1 million, or 55.5% of the consumer loan portfolio and 16.6% of the total loan portfolio at March 31, 2005. At December 31, 2004, indirect loans were $97.9 million, or 56.5% of the consumer loan portfolio and 16.9% of the total loan portfolio.

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

March 31, 2005
December 31, 2004
(Dollars in thousands) Balance
% of total
Balance
% of total
Commercial     $ 81,741    13.9 % $ 80,927    14.0 %
Real estate mortgages:  
  One-to-four family residential (1)    43,825    7.4 %  46,242    8.0 %
  Commercial    181,190    30.7 %  173,280    29.9 %




     Total real estate mortgages    225,015    38.1 %  219,522    37.9 %
Real estate construction:  
  One-to-four family residential    65,625    11.1 %  65,190    11.2 %
  Multi-family and commercial    41,164    7.0 %  40,750    7.0 %




     Total real estate construction    106,789    18.1 %  105,940    18.2 %
Consumer:  
  Indirect    98,059    16.6 %  97,856    16.9 %
  Direct    78,476    13.3 %  75,360    13.0 %




     Total consumer    176,535    29.9 %  173,216    29.9 %




       Subtotal    590,080    100.0 %  579,605    100.0 %
Less: allowance for loan losses    (8,052 )       (7,903 )     
Deferred loan fees, net    351         375       


     Total loans, net   $ 582,379        $ 572,077       


(1) Excludes loans held for sale.

              Allowance for Loan Losses. The Company increased its allowance for loan losses to $8.1 million at March 31, 2005 representing 1.36% of loans (excluding loans held for sale), from $7.9 million or 1.36% of loans (excluding loans held for sale) at December 31, 2004.

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

  Three Months Ended March 31
(Dollars in thousands) 2005
2004
Balance at beginning of period     $ 7,903   $ 6,116  
Charge-offs:  
      Commercial    (108 )  (131 )
      Real estate    (27 )    
      Consumer  
         Direct    (131 )  (124 )
         Indirect    (318 )  (407 )


      Total charge-offs   $(584 ) $(662 )
     

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(Continued) Three Months Ended March 31
(Dollars in thousands) 2005
2004
Recoveries:            
      Commercial   $82   $44  
      Real estate    123    2  
      Consumer  
         Direct    21    38  
         Indirect    82    117  


      Total recoveries    308    201  


Net charge-offs    (276 )  (461 )
Provision for loan losses    425    825  


Balance at end of period   $ 8,052   $ 6,480  


Indirect net charge-offs to average indirect loans (2)    0.96 %  1.10 %
Other net charge-offs to average other loans (1) (2)    0.03 %  0.17 %
Net charge-offs to average loans (1) (2)    0.19 %  0.36 %
     
(1) Excludes loans held for sale        
(2) Net charge-offs are annualized        

              Net loan charge-offs attributed to indirect loans were $236,000, representing 68.2% of net consumer charge-offs during the first quarter of 2005, compared to $290,000 or 77.1% of net consumer charge-offs for the like period in 2004.

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

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

              Nonperforming Assets. Nonperforming loans decreased to $2.7 million, or 0.45% of loans (excluding loans held for sale), at March 31, 2005 from $2.8 million, or 0.48% of loans (excluding loans held for sale), at December 31, 2004. The current allowance for loan losses of $8.1 million represents 303.28% of nonperforming loans as compared to 281.05% of nonperforming loans at December 31, 2004. Total impaired loans were $2.7 million at March 31, 2005, compared to $3.4 million at December 31, 2004.

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              The following table sets forth an analysis of the composition of the Company’s nonperforming assets:

(Dollars in thousands) March 31, 2005
December 31, 2004
Nonaccrual loans     $ 2,655   $ 2,812  
Restructured loans          


    Total nonperforming loans    2,655    2,812  
Other real estate owned    924    1,222  


    Total nonperforming assets   $ 3,579   $ 4,034  


Impaired loans        605  
Total impaired loans (1)   $ 2,655   $ 3,417  
     
Accruing loans past due > 90 days          
     
Potential problem loans    993    356  
Allowance for loan losses    8,052    7,903  
     
Nonperforming loans to loans (2)    0.45 %  0.48 %
Allowance for loan losses to loans (2)    1.36 %  1.36 %
Allowance for loan losses to nonperforming loans    303.28 %  281.05 %
Allowance for loan losses to nonperforming assets    224.98 %  195.91 %
Nonperforming assets to total assets    0.53 %  0.61 %
     
(1) A change in presentation of impaired loans from December 31, 2004  
(2) Excludes loans held for sale  

              Premises and Equipment. Premises and equipment, net of depreciation, was $21.0 million at March 31, 2005 and $20.4 million at December 31, 2004. The Company sold the former operations building located in Oak Harbor, Washington, earning a nominal gain of $95,000 during the first quarter of 2005. In addition, the Company made leasehold improvements to the new Friday Harbor branch location during the first three months of 2005.

              The Company has purchased property in the Burlington, WA area to protect the ingress and egress of the Company’s existing branch facility.

              Other Assets. Other assets were $8.8 million and $7.2 million at March 31, 2005 and December 31, 2004, respectively. The balances reflect the interest accrual on loans and investments and an increase to deferred tax assets. Offsetting these increases, the Company recorded, at amortized cost, a valuation allowance of $85,000 and disposed of $266,000 in other real estate owned properties (“OREO”) during the first three months of 2005.

              Deposits. Deposits grew 4.4% to $587.5 million at March 31, 2005 from $563.0 million at December 31, 2004. Certificates of deposit are the only deposit group that has stated maturity dates. At March 31, 2005, the Company had $213.5 million in CDs, of which approximately $79.0 million, or 37.0%, are scheduled to mature within one year. To date, the Company has not accepted brokered deposits. It has made a concerted effort to attract deposits in the market area it serves through competitive pricing and delivery of quality service. Historically, the Company has been able to retain a considerable amount of its deposits as they mature.

              Noninterest-bearing deposits increased by 10.4% in the first quarter of 2005 compared to the first quarter of 2004. For the same period, total interest bearing deposits increased 3.4%, while the weighted average offering rate increased as a result of the Company’s objective to remain competitive and increase its market share of deposits.

              Savings deposits and CDs represented 11.4% and 42.6%, respectively, of total interest-bearing deposits at March 31, 2005 compared to 11.5% and 43.3%, respectively, at December 31, 2004. All interest-bearing deposit products increased during the first quarter of 2005 as management focused on establishing customer relationships and attracting deposits.

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              Other Borrowings. The Company reduced its other borrowed funds by $13.0 million for the first three months of 2005 from year-end 2004. All reductions consisted of Federal Home Loan Bank (“FHLB”) overnight borrowings. At March 31, 2005 the Company had a line of credit with the FHLB of $100.5 million, of which $9.0 million was FHLB overnight cash management borrowings and a $5.0 million long-term advance that will mature in the second quarter of 2005. The Company also had unused lines of credit with correspondent banks in the amount of $27.0 million at March 31, 2005.

              Off-Balance Sheet Items. WBCO is a party to financial instruments with off-balance-sheet risk. Among the off-balance sheet items entered into in the ordinary course of business are commitments to extend credit and the issuance of letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheet. Certain commitments are collateralized. As of March 31, 2005 and December 31, 2004, the Company’s commitments under letters of credit and financial guarantees amounted to $917,000 and $467,000, 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.

              Shareholders’ Equity. The Company’s shareholders’ equity increased to $51.2 million at March 31, 2005 from $49.6 million at December 31, 2004. This increase is due to net income of $2.0 million, proceeds from stock options exercised in the amount of $64,000, stock option compensation of $6,000, offset by the payment of cash dividends of $395,000 and an unrealized loss on available-for-sale securities, net of tax, of $134,000 during the first three months of 2005. Shareholders’ equity to total assets was 7.6% at March 31, 2005 compared to 7.5% at December 31, 2004.

Liquidity and Sources of Funds

              Sources of Funds. The Company’s sources of funds are customer deposits, loan repayments, current earnings, cash and demand balances due from other banks, federal funds, short-term investments, investment securities available for sale and trust preferred securities. The Company’s strategy includes maintaining a “well-capitalized” status for regulatory purposes, while maintaining a favorable liquidity position and proper asset/liability mix. With this strategy in mind, management anticipates that the Bank will rely primarily upon customer deposits and investments to provide liquidity in 2005. These funds will be used for loan originations and deposit withdrawals, to satisfy other financial commitments and to support continuing operations. Additional funds are available through established FHLB and correspondent bank lines of credit, which the Company may use to supplement funding sources.

Capital and Capital Ratios

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

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              The FDIC established the qualifications necessary to be classified as a “well-capitalized” bank, primarily for assignment of FDIC insurance premium rates. As the following table indicates, the Bank qualified as “well-capitalized” at March 31, 2005 and December 31, 2004:

Regulatory Requirements
Actual Ratios
Adequately-capitalized
Well-capitalized
March 31, 2005
December 31,
2004

Total risk-based capital ratio                    
    Consolidated    8 %  N/ A  11 .47%  11 .40%
    Whidbey Island Bank    8 %  10 %  11 .23%  11 .03%
Tier 1 risk-based capital ratio  
    Consolidated    4 %  N/ A  10 .23%  10 .15%
    Whidbey Island Bank    4 %  6 %  9 .98%  9 .79%
Leverage ratio  
    Consolidated    4 %  N/ A  10 .03%  9 .87%
    Whidbey Island Bank    4 %  5 %  9 .79%  9 .51%

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

Capital Expenditures and Commitments

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

Significant Accounting Policies

See “Notes to Condensed Consolidated Financial Statements.”

Item 3.     Quantitative and Qualitative Disclosures about Market Risk

              At March 31, 2005, based on the measures used to monitor and manage interest rate risk, there had not been a material change in the Company’s interest rate risk since December 31, 2004. Should rates increase, the Company may, or may not be negatively impacted due to its current slightly liability sensitive position. For additional information, refer to the Company’s Form 10-K for year ended December 31, 2004 filed with the SEC on March 25, 2005.

Item 4.     Controls and Procedures

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

19


PART II – OTHER INFORMATION

Item 1.   Legal Proceedings

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

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

               (a)– (c) None

Item 3.   Defaults Upon Senior Securities

              None

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

              No matters were submitted to a vote of the Company’s security holders in the quarter ended March 31, 2005.

Item 5.   Other Information

              (a)   Not applicable

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

Item 6.   Exhibits

Exhibits

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

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

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

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

20


SIGNATURES

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

WASHINGTON BANKING COMPANY

Date: May 13, 2005 By /s/ Michal D. Cann

     Michal D. Cann
      President and
  Chief Executive Officer




 
   
Date: May 13, 2005 By /s/ Richard A. Shields

   Richard A. Shields
Senior Vice President and
Chief Financial Officer

21


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