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, 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. To date, the Company's growth has been achieved organically and it attributes its reputation for focusing on customer service and satisfaction as one of the cornerstones to the Company's success. The Company's primary objectives are to improve profitability and operating efficiencies and increase market penetration in areas currently served.

Summary of Critical Accounting Policies

Significant accounting policies are described in Note (1) of the Notes to Consolidated Financial Statements for the year ended December 31, 2008 as filed in Form 10-K. Not all of these accounting policies require management to make difficult, subjective or complex judgments or estimates. Management believes that the following accounting policies could be considered critical under the SEC's definition.

Allowance for Loan Losses: There have been no material changes in the accounting policy relating to allowance for loan losses as compared to that contained in Note (1) of the Notes to Consolidated Financial Statements for the year ended December 31, 2008 as filed in Form 10-K.

Stock-based Compensation: There have been no material changes in the accounting policy relating to stock-based compensation as compared to that contained in Note (1) of the Notes to Consolidated Financial Statements for the year ended December 31, 2008 as filed in Form 10-K.

The Company's net income available to common shareholders decreased to $1.2 million or $0.13 per diluted share, in the first quarter of 2009, compared with $2.3 million or $0.25 per diluted share in the first quarter of 2008. The decrease in net income was principally attributable to a $1.4 million increase in provision for loan losses, from the same period in 2008 and the accrual of $359,000 in preferred dividends on preferred stock issued to the U.S. Treasury under the TARP program. The decreases were partially offset by increases in noninterest income and decreases in noninterest expense.

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:

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

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

º The volume of noninterest-earning assets;

º Market interest rate fluctuations; and,

º Nonaccrual loans

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

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

                                          Three Months Ended                            Three Months Ended
                                              March 31, 2009                              March 31, 2008
                                  Average       Interest      Average         Average        Interest      Average
(Dollars in thousands)            balance      earned/paid     yield          balance       earned/paid     yield
Assets
Loans (1)(2)                   $  825,694   $       13,107       6.44 %    $  811,128    $       15,490       7.68 %
Federal funds sold                  3,565                2       0.25 %           266                 2       2.90 %
Interest-earning cash                 307                 -      0.01 %           282                 3       3.70 %
Investments:
         Taxable                   13,522              136       4.08 %         9,717               110       4.57 %
         Non-taxable (2)            8,012              100       5.04 %         5,266                75       5.69 %

Interest-earning assets           851,100           13,345       6.36 %       826,659            15,680       7.63 %
Noninterest-earning assets         53,337                                      53,623
         Total assets          $  904,437                                  $  880,282

Liabilities and
Shareholders' Equity
Deposits:
         Interest demand
and
       money market            $  260,298   $          566       0.88 %    $  271,268    $        1,351       2.00 %
         Savings                   41,914               26       0.25 %        41,928                51       0.49 %
         Time deposits            354,686            2,927       3.35 %       336,955             3,893       4.65 %
Interest-bearing deposits         656,898            3,519       2.17 %       650,151             5,295       3.28 %
Federal funds purchased             2,086                4       0.82 %        18,581               176       3.80 %
Junior subordinated
debentures                         25,774              224       3.52 %        25,774               405       6.32 %
Other borrowed funds               21,556              129       2.43 %        15,495               129       3.34 %
Interest-bearing
liabilities                       706,314            3,876       2.23 %       710,001             6,005       3.40 %
Noninterest-bearing
deposits                           93,908                                      92,527
Other noninterest-bearing
liabilities                         1,336                                       3,490
Total liabilities                 801,558                                     806,018
Shareholders' equity              102,880                                      74,264
         Total liabilities
and
         shareholders'
equity                         $  904,437                                  $  880,282

Net interest income                         $        9,469                               $        9,675

Net interest spread                                              4.13 %                                       4.23 %
Net interest margin                                              4.51 %                                       4.71 %

(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 35.0% and 35.0% in 2009 and 2008, respectively. These adjustments were $140 and $152 for the three months ended March 31, 2009 and 2008, 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.

Net interest income on a taxable-equivalent basis totaled $9.5 million at March 31, 2009 compared with $9.7 million during the first quarter of 2008. Changes in net interest income during the year were principally caused by an increase in average interest-earning assets due to strong loan growth, coupled with a decrease in rates paid on average interest-bearing liabilities.

The Company's yields were impacted due to the changing interest rate environment. The yield on interest-earning assets was 6.36% for the first quarter of 2009, a decrease of 127 basis points as compared to the same period in 2008. This decrease is primarily attributable to a decrease in the rates charged on new loans and the repricing of variable rate loans. The large majority of the Company's variable rate loans did not have interest rate floors in place during 2008. The Company is currently implementing interest rate floors on its variable rate loans when they renew. The yield on interest-bearing liabilities was 2.23%, a decrease of 118 basis points as compared to the same period in 2008. This decrease is primarily attributable to a decrease in rates offered on interest-bearing deposits, lower interest rates on short term borrowings, and lower interest rates on the Company's junior subordinated debentures.

Net interest margin (net interest income as a percentage of average interest-earning assets) on a taxable-equivalent basis was 4.51% for the first quarter of 2009, a decrease of 20 basis points as compared to the same period in 2008. The decrease in net interest margin in the first quarter of 2009 resulted from the increase in average interest-earning assets, coupled with a decrease in net interest income.

The following table shows how changes in yields or rates and average balances affected net interest income for the first quarters of 2009 and 2008:

                                                      Three Months Ended
                                                           March 31,
                                                         2009 vs. 2008
                                               Increase (decrease) due to(2):
                                           Volume            Rate          Total
Assets:
Loans (1)(3)                            $      299      $    (2,682 )  $    (2,383 )
Federal funds sold                               -                -              -
Interest-bearing cash                            -               (3 )          ( 3 )
Investments (1)                                 68              (17 )           51
Total interest earning assets                  366           (2,702 )       (2,335 )
Liabilities:
Deposits:
   Interest demand and money market            (53 )           (732 )        ( 785 )
   Savings                                       -              (25 )         ( 25 )
   Time deposits                               224           (1,190 )        ( 966 )
Interest on other borrowed funds               (92 )            (80 )        ( 172 )
Junior subordinated debentures                   -             (181 )        ( 181 )
Other interest-bearing liabilities               -                -              0
Total interest-bearing liabilities              79           (2,208 )       (2,129 )
Total increase (decrease) in net
interest income                         $      287      $     ( 494 )  $     ( 206 )

(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.

During the first quarter of 2009, the provision for loan losses increased 139% to $2.5 million, compared with $1.0 million in the same period in 2008. Changes in the provision were due to higher net charge-offs of $1.4 million in the first quarter of 2009, compared with $747,000 in the same period in 2008 and continued loan portfolio growth and internal downgrades of credits within the portfolio. At March 31, 2009, the allowance for loan losses as a percent of total loans was 1.61% as compared to 1.40% for the same period in 2008.

Noninterest Income: Noninterest income remains a key focus of the Company. The Company has focused on diversifying the noninterest income mix. The diversification of the noninterest income mix resulted primarily from the introduction of nondeposit investment products consisting primarily of annuity sales, investment service fees, and income from the Company's Bank Owned Life Insurance ("BOLI"). The following table presents the key components of noninterest income:

                           Noninterest Income as of:

                                      Periods Ended March 31,         Change
(Dollars in thousands)                 2009            2008        2009 vs. 2008
Service charges and fees          $         858   $         726  $           132
Electronic banking income                   310             314               (4 )
Investment products                         170             129               41
Bank owned life insurance                    94             101               (7 )
Income from sale and servicing
of SBA loans                                 18             144             (126 )
Income from sale of mortgage
loans                                       270              90              180
Other income                                283             291               (8 )
Total noninterest expense        $        2,003   $       1,795  $           208

The changes in noninterest income in the first quarter of 2009 compared to 2008 were related to the following areas:

º Service charges and fees increases are principally attributable to a change in service charges instituted in October of 2008. The full impact of this change is reflected in the income in the first quarter of 2009.

º Income from the sale and servicing of SBA loans decreased due to lower volumes of SBA loan originations. Additionally, the Company did not sell SBA loans during the first quarter of 2009 due to unfavorable premiums for SBA loans in the secondary financial market.

º Income from the sale of loans increased due to strong refinancing activity during the first quarter of 2009. Additionally, income from the same period in 2008 was negatively impacted by the proposed merger with Frontier Financial Corporation. Under the proposed merger, the department originating real estate loans for sale on the secondary market was to be closed by April 2008.

Noninterest Expense: The Company continues to focus on controlling noninterest expenses and addressing long term operating expenses. The Company continued to successfully manage noninterest expense during the first quarter of 2009 and the same period in 2008. The Company's efficiency ratio was at 57.07% at March 31, 2009 as compared to 59.98% at March 31, 2008.

                                Noninterest Expense as of:
                                        Periods Ended March 31               Change
(Dollars in thousands)                  2009               2008           2009 vs. 2008
Salaries and benefits             $       4,019        $     4,552      $          (533 )
     Less: loan origination
costs                                      (595 )             (562 )                (33 )
Net salaries and benefits (as
reported)                                 3,424              3,990                 (566 )
Occupancy expense                         1,033                949                   84
Consulting and professional
fees                                        278                215                   63
Data processing                             131                161                  (30 )
Office supplies and printing                171                119                   52
FDIC premiums                               147                123                   24
OREO & Repossession Expense                 202                 29                  173
Other                                     1,160              1,293                 (133 )
   Total noninterest expense      $       6,546        $     6,879      $          (333 )

The changes in noninterest expense in the first quarter of 2009 compared to 2008 were related to the following areas:

º Salaries and benefits decreased due to management's decision not to accrue a bonus for 2009 and to implement a salary freeze in 2009 for all exempt positions. During the same period the number of full time equivalent employees (FTEs) decreased to 263 at March 31, 2009 from 270 at March 31, 2008. FTE's decreased between the two periods due to a number of employees leaving subsequent to the announcement of the proposed merger with Frontier Financial Corporation. However, the Company believes that staffing levels are adequate for continuing operations.

º FDIC premiums had a minimal increase as compared between the two periods. However, in February 2009, the FDIC adopted final rules which increase the assessment rates paid on deposits. Assessment rates in 2008, for well capitalized banks, ranged from $0.05 to $0.07 per $100 of deposits annually. Assessment rates in 2009 will range from $0.12 to $0.16 per $100 of deposits annually. The Company anticipates its FDIC premiums to double in 2009.

º OREO and repossession expense represents costs the Company incurs in reclaiming, repairing and selling real estate properties and automobiles. The increase in expense during the first quarter of 2009 is primarily related to repairs on several OREO properties in preparing them for sale.

Income Taxes: The Company's consolidated effective tax rates for the first quarters of 2009 and 2008 were 32.62% and 31.53%, respectively. The effective tax rates are below the federal statutory rate of 35% principally due to nontaxable income generated from investments in bank owned life insurance, tax-exempt municipal bonds and loans. Additionally, the Company's tax rate reflects a benefit from the New Market Tax Credit Program whereby a subsidiary of Whidbey Island Bank has been awarded approximately $3.1 million in future federal tax credits. The tax benefits related to these credits will be recognized in the same periods that the credits are recognized on the Company's income tax returns.

Financial Condition Overview

During the first quarter of 2009, the Company focused on maintaining its loan portfolio and deposit funding base. Loans at March 31, 2009 grew 1.7% to $829.1 million compared to $814.9 million at March 31, 2008. Deposits at March 31, 2009 increased 2.3% to $763.0 million compared to $745.8 million at March 31, 2008. Shareholders' equity increased $27.2 million to $107.7 million at March 31, 2009, with the issuance of $26.4 million of preferred stock to the U.S. Treasury Department.

Loans: During the first quarter of 2009, loans, excluding net deferred loan costs, increased $6.1 million to $826.5 million compared to $820.4 million at December 31, 2008. During the first quarter of 2009, real estate mortgages and commercial loans were the primary source of growth, adding an additional $14.4 million in loans. This increase was offset by decreases in the Company construction and indirect consumer loan portfolios. The Company attempts to balance the diversity of its portfolio, believing that this provides a good means of managing risk. Active portfolio management has resulted in solid loan growth and a diversified portfolio that is not heavily concentrated in any one industry or in any one community.

Loan Portfolio Composition as of:

                                March 31, 2009                December 31, 2008            Change
                                                                                            2009
                                                                                            vs.
 (Dollars in thousands)      Balance      % of total          Balance      % of total       2008
 Commercial               $   98,503          11.9 %    $     94,522           11.5 %    $  3,981
 Real estate mortgages:
     One-to-four family
residential                   61,946           7.5 %          58,099            7.1 %       3,847
     Commercial              334,236          40.5 %         327,704           40.0 %       6,532
           Total real
estate mortgages             396,182          48.0 %         385,803           47.1 %      10,379
 Real estate
construction:
     One-to-four family
residential                   93,587          11.3 %         101,022           12.3 %      (7,435 )
     Multi-family and
commercial                    44,206           5.3 %          44,401            5.4 %       ( 195 )
           Total real
estate construction          137,793          16.6 %         145,423           17.7 %      (7,630 )
 Consumer:
     Indirect                106,139          12.9 %         108,266           13.2 %      (2,127 )
     Direct                   87,877          10.6 %          86,364           10.5 %       1,513
           Total
consumer                     194,016          23.5 %         194,630           23.7 %       ( 614 )
Subtotal                     826,494         100.0 %         820,378          100.0 %       6,116
 Less: allowance for
loan losses                  (13,323 )                       (12,250 )                     (1,073 )
 Deferred loan fees,
net                            2,648                           2,690                         ( 42 )
       Total loans, net   $  815,819                    $    810,818                     $  5,001

Credit Risks and Asset Quality

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

The Company manages its credit risk through lending limits, credit review, approval policies and extensive, ongoing internal monitoring. Through this monitoring process, nonperforming loans are identified. Nonperforming assets consist of nonaccrual loans, restructured loans, past due loans and other real estate owned. Nonperforming assets are assessed for potential loss exposure on an individual or homogeneous group basis. The following table summarizes the Company's nonperforming assets:

                             Nonperforming Assets as of:

(Dollars in thousands)                              March 31,         December 31,
                                                      2009                2008
Nonaccrual loans                                  $     8,474      $         1,918
Restructured loans                                          -                    -
Total nonperforming loans                               8,474                1,918
Other real estate owned                                 1,799                2,226
         Total nonperforming assets               $    10,273      $         4,144
Total impaired loans                              $     8,474      $         1,918
Accruing loans past due >  90 days                          -                    1
Potential problem loans(1)                              1,031                5,168
Allowance for loan losses                         $    13,323      $        12,250
Interest foregone on nonaccrual loans                     190                  118
Nonperforming loans to loans                             1.02 %               0.23 %
Allowance for loan losses to loans                       1.61 %               1.49 %
Allowance for loan losses to nonperforming loans       157.22 %             638.67 %
Nonperforming assets to total assets                     1.12 %               0.46 %

(1) 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.

º 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. . . .