WSB Financial (WSFGQ) 10-K 2007 FY Annual report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                           to                                           

Commission file number: 001-33188

WSB Financial Group, Inc.

(Exact name of registrant as specified in its charter)

Washington (State of incorporation or organization)	20-3153598 (I.R.S. Employer Identification No.)
607 Pacific Avenue Bremerton, Washington (Address of principal executive offices)	98337 (Zip Code)

Registrant’s telephone number, including area code:(360) 405-1200

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
Common Stock ($1.00 par value)	The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yeso     Noþ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yeso     Noþ

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. Yesþ      Noo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.o

Indicate by check mark whether 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. (Check one):

Large accelerated filero  Accelerated filero  Non-accelerated filerþ
(Do not check if a smaller reporting company) Smaller reporting companyo 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso      Noþ

As of March 15, 2008, 5,574,853 shares of the registrant’s common stock were outstanding. The aggregate market value of shares of common stock held by non-affiliates as of June 30, 2007 was $72,516,407 (based upon the closing sales price of $15.80 per share).

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Annual Report to Shareholders for fiscal year ended December 31, 2007 – Part II.

Portions of Definitive Proxy Statement to be filed with the Securities and Exchange Commission, relating to the 2008 Annual Meeting of Shareholders, to be held on May 14, 2008 – Part III.

TABLE OF CONTENTS

Item
Number		Page
PART I
1	Business	1 – 21
1A	Risk Factors	21 – 26
1B	Unresolved Staff Comments		26
2	Properties	26 – 27
3	Legal Proceedings		27
4	Submission of Matters to a Vote of Stockholders		27
PART II
5	Market for Registrant’s Common Equity and Related Stockholder Matters	28 – 29
6	Selected Financial Data	29 – 30
7	Management’s Discussion and Analysis of Financial Condition and Results of Operations		30
7A	Quantitative and Qualitative Disclosures about Market Risk		30
8	Financial Statements and Supplementary Data		30
9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		30
9A(T)	Controls and Procedures	31 – 32
9B	Other Information		32
PART III
10	Directors, Executive Officers and Corporate Governance		33
11	Executive Compensation		33
12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		33
13	Certain Relationships and Related Transactions, and Director Independence		33
14	Principal Accountant Fees and Services		33
PART IV
15	Exhibits and Financial Statement Schedules		34
	Signatures	35 – 36
EXHIBIT 11
EXHIBIT 13
EXHIBIT 23
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

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PART I

     This Report includes a number of forward-looking statements that reflect the Company’s current views with respect to future events and financial performance. Please refer to the section addressing forward-looking information on pages 20-21 for further discussion. In this report, “we,” “our,” “us,” “Company,” and “WSB Financial” refer to WSB Financial Group, Inc. and subsidiaries, unless otherwise noted or context otherwise indicates.

Item 1. Business

     We are a bank holding company headquartered in Bremerton, Washington. We emphasize a service-oriented culture with a sales-based delivery model focused primarily on real estate lending products and supplemented by commercial banking products and services. We deliver these products through nine full service branches that are located primarily in the west Puget Sound area. At December 31, 2007, we had total assets of $489.3 million, net loans of $393.4 million, total deposits of $421.4 million and stockholders’ equity of $56.7 million.

     Westsound Bank, our wholly owned subsidiary, is a Washington commercial bank that was opened for business in March 1999 by local community leaders and experienced bankers with the mission of providing a superior community banking service model to the west Puget Sound area. We believe this is an attractive market that benefits not only from its proximity to the economic activity in the Seattle Metropolitan Statistical Area, but also the high quality of living it offers its residents and seasonal visitors. We formed our holding company, WSB Financial Group, Inc., in 2005.

     Our headquarters and administrative offices are located at our downtown branch at 607 Pacific Avenue, Bremerton, Washington 98337 and our telephone number is (360) 405-1200. We maintain a website at www.westsoundbank.com.

Our Business Strategy

     Our current business strategy emphasizes the following:

• Focusing on our compliance, internal audit and risk management function, including our interest, credit and operational risks.

• Proactively managing loan collections, credit quality and internal controls within loan operations, to correct deficiencies and comply with the FDIC order. See Part II, Item 9A(T) of this report.

• Expanding our business and commercial lending activities, including our commercial and industrial, or C&I, lending and diversifying our loan portfolio through our existing branches.

• Managing our liquidity and maintain and improving our capital position on a risk-adjusted basis in compliance with regulatory guidelines, while exploring prudent means to grow our business internally.

• Growing our local, core deposits in order to fund loans and help maintain our net interest margins.

• Retaining well-trained, motivated personnel who provide superior customer service.

     The Company and its subsidiary, Westsound Bank, are subject to regulatory actions with respect to their operations, including a cease and desist order (“FDIC order” or “regulatory order”) with the Federal Deposit Insurance Corporation, or FDIC, and the Washington Department of Financial Institutions, or DFI, which primarily addresses deficiencies in the Bank’s lending department and the determination of allowance for loan losses, described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments.”

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Our Business Activities

     The principal business of the bank is to utilize deposits and other funding sources in making loans which generate interest income. The principal sources of funds for the bank’s loans and investments are demand, time, savings and other deposits, repayment of loans and borrowings. The principal expenses associated with the bank are interest paid on deposits, employee compensation, office expenses and other operating expenses. The bank does not currently offer trust or fiduciary services.

     We provide banking services throughout our primary market area to real estate developers, contractors and small- to medium-sized businesses in our market. Many of our real estate customers are involved in the development, construction and resale of commercial and residential properties in and around the west Puget Sound and the Seattle Metropolitan Statistical Area. Our business customers are involved in light manufacturing, distribution or other services. We also provide a broad range of banking services and products to individuals, including personal checking and savings accounts and other consumer banking products, including electronic banking.

Lending

     While our historical focus has been on real estate lending, we also offer a full range of short- to long-term C&I and consumer lending products and services. We have established portfolio thresholds for each of our lending categories and constantly monitor the diversification of our portfolio. We originate a variety of types of loans, including construction, commercial real estate, residential real estate, commercial, and to a lesser extent consumer based loans. From time to time we purchase and sell commercial loan participations to or from other banks within our market area. All loan participations purchased have been underwritten using the bank’s standard and customary underwriting criteria and are performing.

     Our customers are generally comprised of the following groups:

• Real estate developers and contractors in need of land, construction and permanent financing for commercial and residential developments;

• Small- to medium-sized businesses in need of secured and unsecured lines of credit or permanent C&I loans;

• Individuals in need of residential mortgage products and consumer loan products; and

• Professionals and professional firms, such as architectural, engineering, and insurance and financial firms, in need of operating facilities.

     Our lending activities are concentrated in two main categories: real estate and commercial/consumers.

Real Estate:

     We are focused on commercial and residential real estate lending throughout a project’s life cycle, from acquisition and development loans to acquire property, to permanent, long-term mortgage financing.

     Construction and Development Loans.Our construction loan portfolio consists of single-family residential properties, multi-family properties and commercial projects. Construction lending entails significant additional risks compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans also involve additional risks since funds are advanced while the property is under construction, which property has uncertain value prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and whether related loan-to-value ratios will be sufficient to compensate for fluctuations in the real estate market to minimize the risk of loss. Maturities for construction loans generally range from 6 to 18 months for residential property and from 12 to 24 months for non-residential and multifamily properties.

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     Our development loans are secured by the entire property being platted and developed. Lending on raw land carries the significant risk of a change in market conditions during the development process. Our borrowers’ projects currently range from short plats (2-6 lots) to subdivisions with up to 55 lots. During the development process, we fund costs for site clearing and grading and infrastructure, including utilities and roads. Lot release minimum prices are agreed upon at loan closing. We target most developments to be paid out at 75% of sales. Loan to value ratios typically range from 65% to 75%, depending on the financial strength and experience of the developer. Most development loans have maturities of 18 to 30 months.

     Commercial Mortgage Loans.We also originate commercial mortgage loans. These loans are primarily secured by commercial real estate, including office, retail, warehouse, industrial, and other non-residential properties and are made to the owners and/or occupants of such properties. The majority of these loans have maturities generally ranging from one to ten years.

     Commercial mortgage lending entails significant additional risk compared with the residential mortgage lending. Commercial mortgage loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income-producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent than is the case with residential mortgage loans, to adverse conditions in the commercial real estate market or in the general economy. Our commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower’s creditworthiness and prior credit history and reputation, and we generally require personal guarantees or endorsements with respect to these loans. In the loan underwriting process, we also carefully consider the location of the property that will be collateral for the loan.

     Loan-to-value ratios for commercial mortgage loans generally do not exceed 75%. We permit loan-to-value ratios of up to 80% if the property is owner occupied and the borrower has unusually strong liquidity, net worth and cash flow. We have been active in both the construction lending and permanent financing of our commercial real estate portfolio. Construction and raw land loans are short-term in nature and generally do not exceed 18 months.

     Permanent commitments are primarily restricted to no greater than 10 year maturities with rate adjustment periods at least every 60 months when fixed commitments exist.

     Residential Mortgage Loans.Our residential mortgage loans consist of residential first and second mortgage loans, residential construction loans and home equity line of credit and term loans secured by first and second mortgages on the residences of borrowers. Second mortgage loans and home equity lines of credit are used for home improvements, education and other personal expenditures. We make mortgage loans with a variety of terms, including fixed, floating and variable interest rates and a variety of loan maturities. The majority of the residential mortgage loans that we originate are sold in the secondary market.

     Residential mortgage loans generally are made on the basis of the borrower’s ability to repay the loan from his or her salary and other income and are secured by residential real estate, the value of which is generally readily ascertainable. These loans are made consistent with our appraisal and real estate lending policies, which detail maximum loan-to-value ratios and maturities. Residential mortgage loans and home equity lines of credit secured by owner-occupied property generally are made with a loan-to-value ratio of up to 80%.

Commercial and Consumer:

     Commercial and Industrial Loans.We make C&I loans to qualified businesses in our market area. Our commercial lending portfolio consists primarily of commercial and industrial loans for the financing of accounts receivable, inventory, property, plant and equipment. We also offer loans guaranteed by the U.S. Small Business Administration, or SBA.

     Commercial and industrial loans generally have a higher degree of risk than commercial real estate loans, but have commensurately higher yields. Commercial real estate loans generally are made on the basis of the value of an income-producing property and the ability to repay the loan is dependent upon the successful operation of a business. In contrast, C&I loans typically are made on the basis of the borrower’s ability to repay the loan from the

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cash flow from its business and are secured by business assets with less easily determinable or achievable value, such as accounts receivable, equipment and inventory. Lines of credit typically have a 12 month commitment and will be secured by the trading asset that is being financed. In cases of larger commitments, a borrowing base certificate may be required to determine eligible collateral and advance parameters. Term loans seldom exceed 60 months, but in no case exceed the depreciable life of the tangible asset being financed.

     To manage these risks, our policy is to secure the commercial loans we make with both the assets of the borrowing business and other additional collateral and guarantees that may be available. In addition, we actively monitor certain measures of the borrower, including advance rate, cash flow, collateral value and other appropriate credit factors.

     Consumer Loans.Our consumer loans consist primarily of installment loans made to individuals for personal, family and household purposes. The specific types of consumer loans we make include home improvement loans, automobile loans, debt consolidation loans and general consumer lending.

     Consumer loans may entail greater risk than real estate loans, particularly in the case of consumer loans that are unsecured, such as lines of credit, or secured by rapidly depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. A loan may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loan, such as the bank, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral.

     Our policy for consumer loans is to accept moderate risk while minimizing losses, primarily through a careful credit and financial analysis of the borrower. In evaluating consumer loans, we require our lending officers to review the borrower’s level and stability of income, past credit history, amount of debt currently outstanding and the impact of these factors on the ability of the borrower to repay the loan in a timely manner. In addition, we require our banking officers to maintain an appropriate margin between the loan amount and collateral value.

     We also issue credit cards to certain of our customers. In determining to whom we will issue credit cards, we evaluate the borrower’s level and stability of income, past credit history and other factors. Finally, we make additional loans that are not classified in one of the above categories. In making such loans, we attempt to ensure that the borrower meets our loan underwriting standards.

Credit Policies:

     Generally, the developers of multifamily construction loans for apartment type dwellings do not have any leases in place for these projects, but we require a maximum loan to value of 80%, minimum debt service coverage ratio of 1.2:1 at stabilized occupancy, full recourse to the borrower and personal guarantees from the principals of corporate borrowers to reduce our risks associated with these loans. For construction loans for commercial and industrial projects, we usually require a minimum of 50% of the space leased with reasonable projections supporting a minimum debt service coverage ratio of 1.2:1 at stabilized occupancy, or executed leases must be in place to provide a minimum debt service coverage ratio of 1.1:1 with reasonable projections to meet the minimum stabilized coverage ratio of 1.2:1. While we prefer a minimum of 50% of the project’s space to be leased, a lesser percentage may be approved depending on the amount by which the projected debt service coverage ratio exceeds the minimum debt service coverage ratio. Because this type of loan represents a higher degree of risk to the Bank, normally this loan is only made to developers with well-established track records in the industry, substantial cash flow, and with tenants with strong credit supporting the loan. We also provide land development loans to qualified developers and builders who are experienced and well-capitalized. Normally the principals of the developer are required to personally guarantee the loan, although exceptions may be made on a case-by-case basis for well-established builders/developers or exceptionally strong properties that have a substantial debt coverage ratios. Where possible,

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permanent take out commitments from financially sound lenders or other evidence of a source of repayment acceptable to the Bank may be required, or the Bank may offer permanent financing at the conclusion of the project.

     The board of directors of Westsound Bank establishes our lending policies. These lending policies are reviewed at least annually and evaluated from time to time by the board. Key elements of our current policies are debt service coverage, monitoring concentration levels and maintaining strict approval and underwriting procedures. In the FDIC order, our regulators found that the Bank had failed to adhere to these credit policies in certain respects resulting in significant provisioning to our allowance for loan loss. Specifically, internal routine policies and procedures were not followed resulting in violation of various banking laws and regulations relating to internal audits and controls, real estate appraisal and lending guidelines, and responsibilities of bank directors and officers. A number of corrective actions to credit policies and procedures have been addressed and implemented by the Company, while others are in the process of being evaluated and addressed. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Recent Developments”.

     Debt Service Coverage.Our risk management philosophy is to extend credit only when an applicant has proven cash flow to service the proposed debt. Additionally, it is generally necessary for the applicant to demonstrate an independent secondary source of repayment.

     Monitor Concentration Levels.We have established maximum levels of concentration levels for each loan type to ensure diversification of our loan portfolio and mitigate concentration risks.

     Strict Approval and Underwriting Procedures.If a credit falls outside of the guidelines set forth in our lending policies, the loan is not approved until it is reviewed by a higher level of credit approval authority. Credit approval authority has three levels, as listed below from lowest to highest level. Based on the historical strong emphasis on business development, the board of directors of Westsound Bank has intentionally kept approval authorities low to assure a high degree of secondary review for a credit consideration. Management believes that the current authority levels provide satisfactory management and a reasonable percentage of secondary review. Any conditions placed on loans in the approval process must be satisfied before our credit administration will release loan documentation for execution. Our credit administration works entirely independent of loan production and has full responsibility for all loan disbursements.

• Individual Authorities. Individual loan officers have approval authority of various levels based on experience and abilities up to $100,000 for secured and unsecured loans.The chief lending officer has approval authority of up to $250,000 for secured and unsecured loans.

• Senior Loan Committee.The senior loan committee consists of the chief executive officer and the chief lending officer. The committee has approval authority up to $500,000 for secured and unsecured loans.

• Directors Loan Committee.The directors loan committee consists of three directors of Westsound Bank, the chief executive officer and the chief lending officer. It has approval authority up to our legal lending limit, which was approximately $12.6 million at December 31, 2007.

     Loan Grading and Loan Review.We seek to quantify the risk in our lending portfolio by maintaining a loan grading system consisting of seven different categories (Grades 1-7). The grading system is used to determine, in part, the provision for loan losses. The first three grades in the system are considered satisfactory. The other four grades range from a “Watch” category to a “Loss” category. These four grades are further discussed below under the section subtitled “Classified Assets.”

     The originating loan officer initially assigns a grade to each credit as part of the loan approval process. Such grade may be changed as a loan application moves through the approval process. In addition to any dollar limitations that may require higher credit approval authority, each loan that is graded “Watch” or worse requires prior approval of the directors loan committee of Westsound Bank.

     The grade on each individual loan is subject to review from time to time, and may be changed if warranted. The board of directors of Westsound Bank reviews monthly the aggregate amount of all loans graded as special mention, substandard or loss. Additionally, changes in the grade for a loan may occur through any of the following means:

• random reviews of the loan portfolio conducted by loan administration;

• annual reviews conducted by an outside loan reviewer;

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• bank regulatory examinations; or

• quarterly action plans submitted to loan administration by the responsible lending officers for each credit graded 4-7.

     Loan Delinquencies.When a borrower fails to make a committed payment, we attempt to cure the deficiency by contacting the borrower to seek payment. Habitual delinquencies and loans delinquent 10 days or more are reviewed at the weekly directors loan committee meeting for possible changes in grading.

     Classified Assets.Federal regulations require that each insured bank classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, examiners have authority to identify problem assets, and, if appropriate, classify them. We use grades 4-7 of our loan grading system to identify potential problem assets. There were $15.0 million, $3.3 million and $637,000 in classified loans at December 31, 2007, December 31, 2006 and December 31, 2005, respectively.

     The following describes grades 4-7 of our loan grading system:

• Special Mention — Grade 4.These assets have potential weaknesses that may result in deterioration of the repayment prospects and, therefore, deserve the attention of management. Usually, these assets are long-term problems that are likely to remain and require management action plans. These loans exhibit an increasing reliance on collateral for repayment.

• Substandard — Grade 5.These assets are inadequately protected by the current worth and paying capacity of the borrower or of the collateral pledged, if any. Although loss may not be imminent, if the weaknesses are not corrected, there is a good possibility that we will sustain some loss.

• Doubtful — Grade 6.These assets have all the weaknesses inherent in an asset classified as “substandard,” with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, condition and values, highly questionable and improbable. At the point where a loss is identified, all or that portion deemed a loss is immediately classified as “Loss” and charged off.

• Loss — Grade 7.These assets have been determined to have identifiable, uncollectible components. Typically, a partial charge-off of the loss will have occurred, and the balance remaining would be reflective of management’s best estimate of collectibility.

Our Investment Activities

     Our investment strategy is designed to be complementary to and interactive with the our other activities (i.e. cash position; borrowed funds; quality, maturity, stability and earnings of loans; nature and stability of deposits; capital and tax planning). Investment securities consist primarily of U.S. Agency issues and municipal bonds. In addition, for bank liquidity purposes, we use Fed Funds Sold which are temporary overnight sales of excess funds to correspondent banks. Our securities portfolio is managed in accordance with guidelines set by our investment policy. Specific day-to-day transactions affecting the securities portfolio are managed by our chief financial officer. These securities activities are reviewed monthly or more often, as needed, by our investment committee and are reported monthly to our board of directors.

     Our general objectives with respect to our investment portfolio are to:

• maintain collateral for pledging requirements;

• achieve an acceptable asset/liability gap position (based on our separate policy related to asset/liability management that provides guidance for how investments are to be used to manage asset/liability gaps); and

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• provide a suitable balance of quality and diversification to our assets.

Deposit Products and Other Sources of Funds

     Our primary sources of funds for use in our lending and investing activities consist of:

• deposits;

• maturities and principal and interest payments on loans and securities;

• other borrowings; and

• funds down-streamed into Westsound Bank from time to time by WSB Financial Group.

     We closely monitor rates and terms of competing sources of funds and utilize those sources we believe to be the most cost effective, consistent with our asset and liability management policies.

     Deposits.An important balance sheet component affecting our net interest margin is the composition and cost of our deposit base. We can improve our net interest margin to the extent that growth in deposits can be focused in the less volatile and somewhat more traditional core deposits, or total deposits less CDs greater than $100,000, commonly referred to as Jumbo CDs. We attempt to price our deposit products in order to promote deposit growth and satisfy our liquidity requirements and offer a variety of deposit products in order to satisfy our customers’ needs.

     We provide a wide array of deposit products. We have historically relied upon, and expect to continue to rely upon, deposits to satisfy our needs for sources of funds. We offer regular checking, savings, NOW and money market deposit accounts. We also offer fixed-rate, fixed maturity retail CDs ranging in terms from 30 days to five years, individual retirement accounts and Jumbo CDs. The primary sources of deposits are small-and medium-sized businesses and individuals within our target market. Senior management has the authority to set rates within specified parameters in order to remain competitive with other financial institutions in our market area. All deposits are insured by the Federal Deposit Insurance Corporation up to the maximum amount permitted by law. We have a service fee schedule, which is competitive with other financial institutions in our market, covering such matters as maintenance fees on checking accounts, per item processing fees on checking accounts, returned check charges and other similar fees.

     We intend to continue our efforts at attracting deposits from our business lending relationships in order to reduce our cost of funds and improve our net interest margin. Also, we believe that we have the ability to attract sufficient additional funding by re-pricing the yields on our CDs in order to meet loan demands during times that growth in core deposits differs from loan demand. We have also utilized wholesale funding from time to time, as well as Internet-based rate offerings to attract large sums of deposits, which are now restricted by the FDIC order described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments.” The FDIC order prohibits Westsound Bank from increasing the amount of broker deposits above the amount outstanding on the effective date of the FDIC order, or soliciting, retaining or rolling over broker deposits except as approved by FDIC.

     In addition to our traditional marketing methods, we attract new clients and deposits by:

• expanding long-term business customer relationships, including referrals from our customers; and

• building deposit relationships through our branch relationship officers who are compensated based upon the profitability of such relationships.

     Other Borrowings.We may occasionally use our Fed funds lines of credit to support liquidity needs created by seasonal deposit flows, to temporarily satisfy funding needs from increased loan demand, and for other short-term purposes. We have two Fed funds lines with other financial institutions pursuant to which we can borrow up to $20 million on an unsecured basis. These lines may be terminated by the respective lending institutions at any time.

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     We can also borrow from the Federal Home Loan Bank, or FHLB. However, our credit line of $16 million has been placed on hold until FHLB completes its credit analysis of the Bank and will probably be collateral dependent. We had no FHLB borrowings in 2007.

Other Products and Services

     We offer a variety of other products and services, including:

• Courier Services.We offer courier services to our business customers. Courier services permit us to provide the convenience and personalized service that our customers require by scheduling pick-ups of deposits and facilitating other banking transactions.

• Telephone and Internet Banking.We believe there is a strong demand within our market for telephone and Internet banking. These services allow both consumer and business customers to access detailed account information and manage their accounts, including on-line balance transfers and bill payment. These services enable our customers to conduct their banking business and monitor their bank accounts from remote locations and at any time. We believe our telephone and Internet banking services are invaluable in attracting and retaining customers and encourage them to consider Westsound Bank for all their banking and financial needs.

• Automatic Teller Machines (ATM).In 2005 we analyzed our ATM services and found that it would be more cost effective for us, and more beneficial to our customers, to discontinue ATMs at our branches and instead offer ATM fee reimbursement to our customers, allowing them to use ATMs nationwide without paying a per transaction fee. Each checking and deposit account has a monthly reimbursement limit.

• Real Estate Services.We offer certain fee-based services to real estate contractors, including project inspections and mortgage banking consulting.

• Other Products.We offer other banking-related specialized products and services to our customers, such as cashier’s checks, money orders, debit/credit cards, wire transfers, travelers’ checks and safe deposit services. While we sell many of our consumer and commercial real estate term loans, we have not engaged in any securitizations of loans.

Our Concentrations/Customers

     No individual or single group of related accounts is considered material in relation to our assets or deposits or in relation to our overall business. However, approximately 91.5% of our loan portfolio at December 31, 2007 consisted of real estate-secured loans, including commercial loans secured by real estate, construction loans and real estate mortgage loans. Moreover, our business activities are currently focused in west Puget Sound, particularly Kitsap County. Consequently, our business is dependent on the trends of this local economy, and in particular, the commercial and residential real estate markets. At December 31, 2007, we had 29 loans in excess of $1.5 million each, totaling $63.9 million. These loans comprise approximately 1.9 % of our loan portfolio by number of loans and 15.4% by total loans outstanding. Not including credit card and consumer overdraft lines and purchased participation loans, our average loan size as of December 31, 2007 was approximately $273,000.

     Our lending policies also establish customer and product concentration guidelines to control single customer and product exposures. As these guidelines are not absolute, at any particular point in time the ratios may be higher or lower because of funding on outstanding commitments. Set forth below are our concentration guidelines and the segmentation of our loan portfolio by loan type as of December 31, 2007.

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	Percent of
	Total Tier
	1 Capital			Percent of Total Loans
	Actual			Policy Limit			Actual
Real Estate
Construction		307	%		50.0	%		47	%
Land development		93	%		25.0	%		14	%
Commercial real estate		114	%		40.0	%		17	%
Residential real estate		84	%		40.0	%		13	%
Commercial and industrial		50	%		50.0	%		8	%
Consumer		6	%		25.0	%		1	%

Risk Management

     We are committed to maintaining internal controls to manage the risks of our business. Our audit committee has defined our most significant risks and measures the trends from low to high. The committee has identified credit risk as the main area that could have the greatest impact on capital. In order to mitigate and proactively manage this area of risk, we have established sound procedures and committed experienced human resources to this effort.

     We have focused on enhancing credit administration as a result of the issues and weaknesses identified in 2007, including the FDIC order described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Recent Developments”:

• The board of directors appointed Charles L. Turner as the Bank’s chief lending officer in mid 2007. Credit administration has been staffed to maintain all credit policies and procedures, loan documentation, board and management reporting, disbursement of loan proceeds and to review the integrity of the credit risk rating system;

• Credit administration has been enhanced by the creation of the special assets department in late 2007. This department is responsible for the identification of problem loans. The primary duties of the department include tracking maturing, past due and non accrual loans, analyzing current collateral values, analyzing current financial status of borrower, the collection of non-performing loans and the foreclosure process; and

• Loan operations support has been enhanced by the selection of a new loan operations manager in late 2007 that is well versed in the loan and audit documentation area. The department also created a new position in early 2008 focusing on quality control within the loan department.

     We believe that this reorganization of the lending area will allow management to maintain an accurate understanding of risk levels at all times. With this level of understanding, strategic plans are developed with the necessary risk parameters to adequately protect our capital.

Training Program

     We have a state-of-the-art training facility at our headquarters in Bremerton, Washington which houses 16 interactive training stations in a classroom type setting. We use the training program to provide both continuing education and regulatory training, as well as general operational and sales training for all new hires. The program covers all aspects of banking, from regulatory and financial topics to customer courtesy and sales.

     Our marketing department has also taken advantage of the training facility by offering classes to our customers and the general public, to better educate our customers on our products and services. Some recent topics have included accounting for builders, banking on-line, and balancing a checkbook.

Information Technology Systems

     We made significant investments in core informational technology systems in recent years for our banking and lending operations and management activities. These computer systems automate bank transactions for our

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branches, mortgage originations, other loans and electronic banking, database and direct response marketing, and provide cash management, streamlined reporting and reconciliation support as well as sales support.

     With this investment in technology, the bank offers Internet-based delivery of products for both its consumer and business customers. Customers can open accounts, apply for loans, check balances, check account history, transfer funds, pay bills, use interactive calculators and correspond via e-mail with the bank over the Internet. The Internet provides an inexpensive way for the bank to expand its geographic reach and branch activities while providing the kinds of services one would expect from larger banks.

     We outsource our major systems including our EFT, credit card and transaction processing and our online Internet bill payment and banking services to third-party service providers to the banking and lending industries, principally Fiserv, Inc. and its affiliates. While there are risks associated with outsourcing these systems, including the potential interruption of our operations as a result of the failure of a third-party’s system or the termination of its service, we believe these risks are outweighed by the advantages of outsourcing, particularly the flexibility these systems offer us to upgrade and scale these systems and services to accommodate our growth without requiring us to invest substantial additional capital and staff resources.

Our Market Area

     We operate primarily in the west Puget Sound area, which encompasses the Kitsap and Olympic peninsulas and islands west of Seattle, along the I-5 corridor in Federal Way, Washington. According to our federal banking regulator, the Federal Deposit Insurance Corporation, or FDIC, our headquarters in downtown Bremerton is located in “a low income” area and our other branches are located in “middle income” areas. The west Puget Sound market benefits from a high quality of life, with significant outdoor recreational opportunities, median home prices significantly below the Seattle Metropolitan Statistical Area and a small community lifestyle. In addition, our markets are benefiting from a growing base of small- and medium-sized businesses, as well as a number of growing military operations. We also benefit from the significant economic activity generated in and around the Seattle Metropolitan Statistical Area as defined by the U.S. Census Bureau, which includes King, Pierce and Snohomish counties. While we have a limited presence in the Seattle Metropolitan Statistical Area with our Federal Way and Gig Harbor branches, these locations have not yet greatly impacted our overall performance and we do not have any locations in the city of Seattle. The Seattle Metropolitan Statistical Area has a diversified economy with major employers in a number of growth industries including aerospace, technology, health care, computer and telecommunications. Approximately 6,000 commuters ride the state ferries each day between their homes on Bainbridge Island and in other Kitsap County communities and downtown Seattle.

Kitsap County

     With four branches, Kitsap County is the largest market we serve. Along with our headquarters, approximately 63.4% of our deposits and approximately 53.6% of our loans, are in Kitsap County. Based on FDIC data as of June 30, 2007, we had a 10% deposit market share in Kitsap County. As of third quarter 2007, the unemployment rate for Kitsap County was 4.5% which was slightly above the rate for the Seattle Metropolitan Statistical Area for the same period of 4.0%.

     The military is a major source of employment, providing approximately one-quarter of the employment within the county. Most of the military jobs in the county are associated with two major U.S. Navy bases, the nuclear submarine base in Bangor (which is the only deep water port for nuclear submarines on the West Coast) and the ship repair and dry dock facilities in Bremerton (which is the only facility with the capacity for aircraft carriers on the West Coast). While many naval installations were being considered for downsizing during the latest Base Realignment and Closure Committee review in 2005, Kitsap was slated for a modest gain in jobs. Although a number of military bases have been closed in recent years in other parts of the country, we believe the risk of a base closure is remote because of these bases’ unique capabilities and strategic importance on the West Coast.

     We believe Kitsap County, and Bremerton in particular, are attractive markets. Inc. magazine ranked Bremerton as one of the country’s “hottest small cities for entrepreneurs,” in its May 1, 2006 issue for cities with an employment base under 150,000 people. In addition, in June 2004 MONEY magazine called Bremerton “one of the top 5 up and coming ‘hot’ cities in the country with populations under 250,000.”

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Clallam County

     We have two branches in Clallam County. Based on FDIC data as of June 30, 2007, we had a 7% deposit market share in Clallam County. Unemployment in the county as of third quarter 2007 is 5.7%. Health care and tourism from Canada are among the key industries. The Kiplinger Letter named Port Angeles as a top area to start a new business several years ago. The city of Sequim, long known as a retirement haven, is establishing itself as a regional shopping center for the Olympic Peninsula.

Seattle Metropolitan Statistical Area

     We currently have one branch in Pierce County in Gig Harbor, approximately thirty-five miles from the city of Seattle. Based on FDIC data as of June 30, 2007, we had a deposit market share of less than 1.0% in Pierce County, which includes the city of Tacoma, located thirty miles south of Seattle. The Port of Tacoma is a major center of business in the county. A second Tacoma Narrows bridge linking Pierce County commuters with Gig Harbor in west Puget Sound was completed in 2007, making commuting from Tacoma and the south King County area to Seattle a viable option.

     We opened a loan production office in south King County in Federal Way in 2005 and converted it into a branch in February 2007. Federal Way is approximately twenty miles from the city of Seattle. Like our west Puget Sound market area, south King County enjoys lower housing costs than the Seattle Metropolitan Statistical Area generally. The largest employer in south King County is Weyerhaeuser Company, a paper and wood products manufacturer.

     As of December 31, 2007 we estimate that 38.1% of our loans and 7.6% of our deposits originated in our two Seattle Metropolitan Statistical Area locations. We do not have any locations in the city of Seattle. Unemployment in the Seattle Metropolitan Statistical Area was 4.0% as of third quarter 2007.

Our Competition

     The banking and financial services business in the west Puget Sound and Seattle Metropolitan Statistical Area is highly competitive. This competitive environment is a result primarily of growth in community banks, changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. We compete for loans, deposits and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader range of financial services than we offer.

     According to the FDIC’s deposit market share report, as of June 30, 2007 18 banks operated in Kitsap County and 14 operated in Clallam county. In Kitsap County, two large national banks, Bank of America, N.A. and Washington Mutual Bank, had approximately 33.1% of all deposits and two other community banks, American Marine Bank and Kitsap Bank, had approximately 28.4% of all deposits.

     We believe that our focus on customer service and relationship-banking distinguishes us from the larger banks, and can provide us with a sustainable competitive advantage over our competitors in the west Puget Sound market, including other community banks.

     Management believes that the principal competitive factors affecting our markets include interest rates paid on deposits and charged on loans, the range of banking products available and customer service and support. Although management believes that our products currently compete favorably with respect to these factors, there can be no assurance that we can maintain our competitive position against current and potential competitors, especially those with significantly greater financial resources.

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Employees

     We had a total of 103 full-time equivalent employees at December 31, 2007. Our employees are not represented by a labor organization, and we are not aware of any activity seeking such organization. We believe that our relationship with our employees is good.

SUPERVISION AND REGULATION

     The following discussion is only intended to provide summaries of significant statutes and regulations that affect the banking industry and is therefore not complete. Changes in applicable laws or regulations, and in the policies of regulators, may have a material effect on our business and prospects. We cannot accurately predict the nature or extent of the effects on our business and earnings that fiscal or monetary policies, or new federal or state laws, may have in the future.

General

     We are extensively regulated under federal and state law. These laws and regulations are primarily intended to protect depositors, not shareholders. The discussion below describes and summarizes certain statutes and regulations. These descriptions and summaries are qualified in their entirety by reference to the particular statute or regulation. Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may also be affected by changes in the policies of banking and other government regulators. We cannot accurately predict the nature or extent of the possible future effects on our business and earnings of changes in fiscal or monetary policies, or new federal or state laws and regulations.

Compliance

     In order to assure that we are in compliance with the laws and regulations that apply to our operations, including those summarized below, we employ a compliance officer, and we engage an independent compliance auditing firm. We are regularly reviewed by the Federal Reserve, the FDIC, and the Washington Department of Financial Institutions, Division of Banks, or DFI, during which reviews such agencies assess our compliance with applicable laws and regulations. We are currently subject to regulatory orders as result of recent examinations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments.”

Federal Bank Holding Company Regulation

     General.WSB Financial Group, Inc. is a registered financial holding company as defined in the Bank Holding Company Act of 1956, as amended, or the Bank Holding Company Act, and is therefore subject to regulation, supervision and examination by the Federal Reserve. In general, the Bank Holding Company Act limits the business of bank holding companies to owning or controlling banks and engaging in other activities closely related to banking. WSB Financial Group must file reports with the Federal Reserve and must provide it with such additional information as it may require.

     The Federal Reserve may require WSB Financial Group to terminate an activity or terminate control or liquidate or divest certain subsidiaries, affiliates or investments when the Federal Reserve believes the activity or the control of the subsidiary or affiliates constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries.

     The Federal Reserve also has the authority to regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, WSB Financial Group must file written notice and obtain Federal Reserve approval prior to purchasing or redeeming its equity securities. Additionally, WSB Financial Group is required by the Federal Reserve to maintain certain levels of capital. See “Capital Adequacy” below and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” for a discussion of the applicable federal capital requirements.

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     Acquisition of Banks.The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve Board’s prior approval before:

• acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;

• acquiring all or substantially all of the assets of any bank; or

• merging or consolidating with any other bank holding company.

     Additionally, the Bank Holding Company Act provides that the Federal Reserve Board may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve Board is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve Board’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.

     Restrictions on Ownership of WSB Financial Group.The Bank Holding Company Act requires any “bank holding company” (as defined in that Act) to obtain the approval of the Board of Governors of the Federal Reserve System prior to acquiring more than 5% of WSB Financial Group’s outstanding common stock. Any person other than a bank holding company is required to obtain prior approval of the Federal Reserve Board to acquire 10% or more of WSB Financial Group’s outstanding common stock under the Change in Bank Control Act. Any holder of 25% or more of WSB Financial Group’s outstanding common stock, other than an individual, is subject to regulation as a bank holding company under the Bank Holding Company Act.

     Holding Company Control of Nonbanks.With some exceptions, the Bank Holding Company Act also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks.

     Transactions with Affiliates.Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit WSB Financial Group’s ability to obtain funds from Westsound Bank for its cash needs, including funds for payment of dividends, interest and operational expenses.

     Tying Arrangements.We are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither WSB Financial Group nor Westsound Bank may condition an extension of credit to a customer on either (i) a requirement that the customer obtain additional services provided by us or (ii) an agreement by the customer to refrain from obtaining other services from a competitor.

     Support of Subsidiary Banks.Under Federal Reserve policy, WSB Financial Group is expected to act as a source of financial and managerial strength to Westsound Bank. This means that WSB Financial Group is required to commit, as necessary, resources to support Westsound Bank. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks.

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Federal and State Regulation of Westsound Bank

     General. Westsound Bank is a Washington chartered commercial bank with deposits insured by the FDIC. As a result, Westsound Bank is subject to supervision and regulation by the Washington DFI and the FDIC. These agencies have the authority to prohibit banks from engaging in what they believe constitute unsafe or unsound banking practices.

     Lending Limits.Washington banking law generally limits the amount of funds that a bank may lend to a single borrower to 20% of stockholders’ equity.

     Control of Financial Institutions.The acquisition of 25% or more of a state chartered bank’s voting power by any individual, group or entity, is deemed a change in control under Washington banking law, requiring notice and application and prior approval of the DFI.

     Community Reinvestment.The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their jurisdiction, the FDIC evaluate the record of the financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility.

     Insider Credit Transactions.Banks are also subject to certain FDIC restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons (i.e., insiders). Extensions of credit (i) must be made on substantially the same terms and pursuant to the same credit underwriting procedures as those for comparable transactions with persons who are neither insiders nor employees, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to insiders. A violation of these restrictions may result in regulatory sanctions on the bank or its insiders.

     Regulation of Management.Federal law sets forth circumstances under which officers or directors of a bank may be removed by the institution’s federal supervisory agency. Federal law also prohibits management personnel of a bank from serving as a director or in a management position of another financial institution whose assets exceed a specified amount or which has an office within a specified geographic area.

     Safety and Soundness Standards.Federal law imposes upon banks certain non-capital safety and soundness standards. These standards cover internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation and benefits. Additional standards apply to asset quality, earnings and stock valuation. An institution that fails to meet these standards must develop a plan acceptable to its regulators, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. Under Washington state law, if the stockholders’ equity of a Washington state-chartered bank becomes impaired, the Commissioner of the Washington DFI will require the bank to make the impairment good. Failure to make the impairment good may result in the Commissioner’s taking possession of the bank and liquidating it.

     Dividends.The principal source of WSB Financial Group’s cash reserves will be dividends received from Westsound Bank. Washington law limits the bank’s ability to pay cash dividends. Under these restrictions, a bank may not declare or pay any dividend greater than its retained earnings without approval of the Washington DFI. The Washington DFI has the power to require any state-chartered bank to suspend the payment of any and all dividends.

     In addition, a bank may not pay cash dividends if doing so would reduce its capital below minimum applicable federal capital requirements. See “Capital Adequacy” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” below for a discussion of the applicable federal capital requirements.

     Other Regulations.The loan operations of our Bank are subject to state usury laws and federal laws concerning interest rates.

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     Federal Laws Applicable to Credit Transactions.The loan operations of our Bank are also subject to federal laws applicable to credit transactions, such as the:

• Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

• Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

• Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

• Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

• Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies;

• Servicemembers Civil Relief Act, which amended the Soldiers’ and Sailors’ Civil Relief Act of 1940, governing the repayment terms of, and property rights underlying, secured obligations of persons in military service; and

• the rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

     Federal Laws Applicable to Deposit Operations.The deposit operations of our Bank are subject to:

• the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

• the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

     Brokered Deposits.Under the Federal Deposit Insurance Corporation Improvement Act, or FDICIA, banks may be restricted in their ability to accept brokered deposits, depending on their capital classification. “Well-capitalized” banks are permitted to accept brokered deposits, but all banks that are not well-capitalized are not permitted to accept such deposits. The FDIC may, on a case-by-case basis, permit banks that are adequately capitalized to accept brokered deposits if the FDIC determines that acceptance of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank. As of December 31, 2007, we had $65.0 million of brokered deposits. As a result of the FDIC order described below in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments,” the Bank is subject to limitations with respect to its brokered deposits. The FDIC order prohibits Westsound Bank from increasing the amount of broker deposits above the amount outstanding on the effective date of the FDIC order, or soliciting, retaining or rolling over broker deposits except as approved by FDIC.

     Check Clearing for the 21st Century Act.The Check Clearing for the 21st Century Act, also known as Check 21, was enacted in 2003. The law gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check. Some of the major provisions include:

• allowing check truncation without making it mandatory;

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• demanding that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their rights under the law;

• legalizing substitutions for and replacements of paper checks without agreement from consumers;

• retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;

• requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and

• requiring recrediting of funds to an individual’s account on the next business day after a consumer proves that the financial institution has erred.

     This legislation will likely affect bank capital spending as many financial institutions assess whether technological or operational changes are necessary to stay competitive and take advantage of the new opportunities presented by Check 21.

     Federal Home Loan Bank System.The Federal Home Loan Bank, or FHLB system, of which our Bank is a member, consists of 12 regional FHLBs governed and regulated by the Federal Housing Finance Board. The FHLBs serve as reserve or credit facilities for member institutions within their assigned regions. They are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. They make loans (i.e., advances) to members in accordance with policies and procedures established by the FHLB and the boards of directors of each regional FHLB.

     As a system member, our Bank is entitled to borrow from the FHLB of its region and is required to own a certain amount of capital stock in the FHLB. Our Bank is in compliance with the stock ownership rules described above with respect to such advances, commitments and letters of credit and home mortgage loans and similar obligations. All loans, advances and other extensions of credit made by the FHLB to our Bank are secured by a portion of its mortgage loan portfolio, certain other investments and the capital stock of the FHLB held by the Bank.

     Mortgage Banking Operations.Our Bank is subject to the rules and regulations of FHA, VA, FNMA, FHLMC and GNMA with respect to originating, processing, selling and servicing mortgage loans and the issuance and sale of mortgage-backed securities. Those rules and regulations, among other things, prohibit discrimination and establish underwriting guidelines which include provisions for inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts, and, with respect to VA loans, fix maximum interest rates. Mortgage origination activities are subject to, among others, the Equal Credit Opportunity Act, Federal Truth-in-Lending Act and the Real Estate Settlement Procedures Act and the regulations promulgated thereunder which, among other things, prohibit discrimination and require the disclosure of certain basic information to mortgagors concerning credit terms and settlement costs.

     Commercial Real Estate Guidance.The FDIC and the Federal Reserve Board issued joint Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices on December 6, 2006. The Guidance provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (1) commercial real estate loans exceed 300% of capital and increased 50% or more in the preceding three years, or (2) construction and development loans exceed 100% of capital. The Guidance does not limit banks’ levels of commercial real estate lending activities. The Guidance applies to Westsound Bank, based on our current loan portfolio.

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Privacy

     Federal banking rules limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third-parties. Pursuant to these rules, financial institutions must provide:

• initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third-parties and affiliates;

• annual notices of their privacy policies to current customers; and

• a reasonable method for customers to “opt out” of disclosures to nonaffiliated third-parties.

     These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. We have implemented privacy policies in accordance with the law.

Interstate Banking And Branching

     The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Act”) permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit these purchases. Additionally, banks are permitted to merge with banks in other states, as long as the home state of neither merging bank has opted out under the legislation. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.

     FDIC regulations prohibit banks from using their interstate branches primarily for deposit production. The FDIC has implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition.

     Washington enacted “opting in” legislation in accordance with the Interstate Act, allowing banks to engage in interstate merger transactions, subject to certain “aging” requirements. Until recently, Washington restricted out-of-state banks from opening de novo branches; however, in 2005, Washington interstate branching laws were amended so that an out-of-state bank may, subject to the DFI’s approval, open de novo branches in Washington or acquire an in-state branch so long as the home state of the out-of-state bank has reciprocal laws with respect to de novo branching or branch acquisitions. Once an out-of-state bank has acquired a bank within Washington, either through merger or acquisition of all or substantially all of the bank’s assets or through authorized de novo branching, the out-of-state bank may open additional branches within the state.

Deposit Insurance

     Westsound Bank’s deposits are currently insured to a maximum of $100,000 per depositor through the Bank Insurance Fund administered by the FDIC. Westsound Bank is required to pay deposit insurance premiums, which are assessed semiannually and paid quarterly. The premium amount is based upon a risk classification system established by the FDIC. Banks with higher levels of capital and a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments.”

     The FDIC is also empowered to make special assessments on insured depository institutions in amounts determined by the FDIC to be necessary to give it adequate assessment income to repay amounts borrowed from the U.S. Treasury and other sources or for any other purpose the FDIC deems necessary.

     Legislative reforms to modernize the Federal Deposit Insurance System, including merging the Bank Insurance Fund and the Savings Association Insurance Fund into a new Deposit Insurance Fund, were approved by Congress on February 15, 2006. In addition to merging the insurance funds, the legislation:

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• raised the deposit insurance limit on certain retirement accounts to $250,000 and indexes that limit for inflation;

• requires the FDIC and National Credit Union Administration boards, starting in 2010 and every succeeding five years, to consider raising the standard maximum deposit insurance; and

• eliminated the current fixed 1.25 percent Designated Reserve Ratio and provides the FDIC with the discretion to set the DRR within a range of 1.15 to 1.50 percent for any given year.

Capital Adequacy

     Regulatory Capital Guidelines.Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies.

     Tier I and Tier II Capital.Under the guidelines, an institution’s capital is divided into two broad categories, Tier I capital and Tier II capital. Tier I capital generally consists of common stockholders’ equity, surplus and undivided profits. Tier II capital generally consists of the allowance for loan losses, hybrid capital instruments, and subordinated debt. The sum of Tier I capital and Tier II capital represents an institution’s total capital. The guidelines require that at least 50% of an institution’s total capital consist of Tier I capital.

     Risk-based Capital Ratios.The adequacy of an institution’s capital is gauged primarily with reference to the institution’s risk weighted assets. The guidelines assign risk weightings to an institution’s assets in an effort to quantify the relative risk of each asset and to determine the minimum capital required to support that risk. An institution’s risk weighted assets are then compared with its Tier I capital and total capital to arrive at a Tier I risk-based ratio and a total risk-based ratio, respectively. The guidelines provide that an institution must have a minimum Tier I risk-based ratio of 4% and a minimum total risk-based ratio of 8%.

     Leverage Ratio.The guidelines also employ a leverage ratio, which is Tier I capital as a percentage of total assets less intangibles, to be used as a supplement to risk-based guidelines. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank holding company may leverage its equity capital base. The minimum leverage ratio is 3%; however, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, regulators generally expect an additional cushion of at least 1% to 2%.

     Prompt Corrective Action.Under the guidelines, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. The categories range from “well capitalized” to “critically undercapitalized.” Institutions that are deemed to be “undercapitalized,” depending on the category to which they are assigned, are subject to certain mandatory supervisory corrective actions.

State Corporate Law Restrictions

     As a Washington corporation, WSB Financial Group is subject to certain limitations and restrictions under applicable Washington corporate law. For example, state law restrictions in Washington include limitations and restrictions relating to indemnification of directors; distributions to shareholders; transactions involving directors, officers, or interested shareholders; maintenance of books, records, and minutes; and observance of certain corporate formalities.

Corporate Governance and Accounting Legislation

     Sarbanes-Oxley Act of 2002.On July 30, 2002, the Sarbanes-Oxley Act of 2002, or SOX, was signed into law to address corporate and accounting fraud. SOX establishes a new accounting oversight board that will enforce auditing standards and restricts the scope of services that accounting firms may provide to their public company audit clients. Among other things, SOX also (i) requires chief executive officers and chief financial officers to

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certify to the accuracy of periodic reports filed with the SEC; (ii) imposes new disclosure requirements regarding internal controls, off-balance-sheet transactions, and pro forma (non-GAAP) disclosures; (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by public companies; and (iv) requires companies to disclose whether or not they have adopted a code of ethics for senior financial officers and whether the audit committee includes at least one “audit committee financial expert.”

     Under SOX, the SEC is required to regularly and systematically review corporate filings, based on certain enumerated factors. To deter wrongdoing, SOX (i) subjects bonuses issued to top executives to disgorgement if a restatement of a company’s financial statements was due to corporate misconduct; (ii) prohibits an officer or director from misleading or coercing an auditor; (iii) prohibits insider trades during pension fund “blackout periods”; (iv) imposes new criminal penalties for fraud and other wrongful acts; and (v) extends the period during which certain securities fraud lawsuits can be brought against a company or its officers.

     As a public reporting company, we are subject to the requirements of SOX and related rules and regulations issued by the SEC and Nasdaq.

Anti-terrorism Legislation

     USA Patriot Act of 2001.Among other things, the Patriot Act (i) prohibits banks from providing correspondent accounts directly to foreign shell banks; (ii) imposes due diligence requirements on banks opening or holding accounts for foreign financial institutions or wealthy foreign individuals; (iii) requires financial institutions to establish an anti-money-laundering compliance program; and (iv) eliminates civil liability for persons who file suspicious activity reports. The Patriot Act also increases governmental powers to investigate terrorism, including expanded government access to account records. The Department of the Treasury is empowered to administer and make rules to implement the Patriot Act. While we believe the Patriot Act may, to some degree, affect our recordkeeping and reporting expenses, we do not believe that it will have a material adverse effect on our business and operations.

Effects of Government Monetary Policy

     Our earnings and growth are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government, particularly the Federal Reserve. The Federal Reserve can and does implement national monetary policy for such purposes as curbing inflation and combating recession. The nature and impact of future changes in monetary policies and their impact on us cannot be predicted with certainty.

Nonbank Subsidiary

     Our non-bank subsidiary, WSB Financial Group Trust I, a Delaware statutory trust, is subject to the laws and regulations of both the federal government and the state in which it conducts business.

Available Information of the Registrant

     The Company is subject to the information reporting requirements of the Securities Exchange Act of 1934, as amended, or Securities Exchange Act, and files reports, proxy statements and other information with the Securities and Exchange Commission, or SEC. Reports, proxy statements and other information filed by the Company may be reviewed and copied at the SEC’s public reference facilities at 100 F Street, NE, Washington, D.C. 20549. You may also obtain information on the operation of the public reference rooms by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website that contains periodic reports, proxy statements and other information about issuers, like us, that we file electronically with the SEC. The address of that site is http://www.sec.gov.

     We also maintain a website at http://www.westsoundbank.com. We make available through our website, free of charge, copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to

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the SEC. Our corporate governance guidelines and charters for our board committees, and our Code of Ethics and Professional Conduct, which includes a code of ethics applicable to our accounting and financial employees, including our chief executive officer and chief financial officer, are also available on our website. Each of these documents is also available in print (at no charge) to any shareholder upon request. Our website and the information contained therein or connected thereto are not incorporated by reference into this Report.

Executive Officers of the Registrant

     The names and ages of all executive officers of the Company and the positions and offices held by such persons as of March 15, 2008 are as follows:

Name	Position with the Company	Age
Mark D. Freeman	Interim President and Chief Executive Officer, Executive Vice President of Finance and Operations, Chief Financial Officer		55
Veronica R. Colburn	Senior Vice President, Chief Risk Officer		45
Charles L. Turner	Senior Vice President, Chief Lending Officer		47
Robin A. Seelye	Senior Vice President, Operations		37

Notice About Forward-Looking Statements

     This annual report onForm 10-K includes forward-looking statements. These statements may be identified by the use of forward-looking terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should” or “will” or the negative thereof or other variations thereon or comparable terminology. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which are beyond our control. These and other important factors, including those discussed in this report under the headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Some of the key factors that could cause actual results to differ from our expectations are:

• changes in general economic conditions, either nationally or locally in the west Puget Sound and Seattle Metropolitan Statistical Area;

• inflation, interest rate, market and monetary fluctuations;

• legislative or regulatory changes or changes in accounting principles, policies or guidelines;

• the adequacy of our credit risk management and the allowance for loan losses, Westsound Bank’s asset quality, and our ability to collect on delinquent loans, including the residential construction loans;

• the availability of and costs associated with sources of liquidity;

• changes in real estate values generally, within the markets in which we generate loans, which could adversely affect the demand for loans and may adversely affect collateral held on outstanding loans;

• our ability to successfully defend against claims asserted against us in lawsuits arising out of, or related to, our lending operations or any regulatory action taken against us, as well as any unanticipated litigation, regulatory, or other judicial proceedings;

• our ability to successfully operate under the terms of the FDIC order;

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• the success of the Company at managing the risks involved in the foregoing; and

• other risks which may be described in our future filings with the SEC under the Securities Exchange Act of 1934.

     Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included or incorporated by reference into this report are made only as of the date hereof. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments.

Item 1A. Risk Factors

     An investment in our common stock involves a high degree of risk. Before investing in our common stock, you should carefully consider the risks described below, as well as the other information contained in this report, including our consolidated financial statements and the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Any of the risks described below could significantly and adversely affect our business, prospects, financial condition and results of operations. If one or more of these risks and uncertainties is realized, the trading price of our common stock could decline, and you could lose all or part of your investment.

Risks Relating to Our Business and Market

Restrictions imposed by regulatory actions could have an adverse effect on us and failure to comply with any of their provisions could result in further regulatory action or restrictions.

     The Company and its subsidiary, Westsound Bank, are subject to regulatory actions, including an FDIC order, with respect to their operations, described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments.”

     The FDIC order identified deficiencies within credit administration in connection with a lack of sufficient or adequate policies, procedures, and control with respect to the underwriting, documentation and monitoring of loans, the detection of risks related to the concentration and other risks associated with the residential construction and other loans, the determination of our provision for loan losses and possible violations or contraventions of law.

     Further, in 2006 the FDIC found that we violated the reporting requirements of the Home Mortgage Disclosure Act and other consumer banking laws, imposed penalties of $6,000 and required our board to enter into a memorandum of understanding to correct the violations and related deficiencies in our internal controls.

    These regulatory actions may limit our growth and adversely affect our earnings.

Our future prospects and competitive position could be diminished and our profitability could be reduced, as a result of adverse conditions in the markets in which we operate.

     Our rapid growth prior to 2007 was driven in large part by a strong residential housing market in west Puget Sound and our ability to identify attractive expansion opportunities. A downturn in local economic market conditions, particularly in the real estate market, a failure to attract and retain high performing employees, heightened competition from other financial services providers, and an inability to attract additional core deposits and lending customers, among other factors, could limit our ability to grow in the future.

Over 91% of our loans are real estate related, including loans for construction and land development projects and for the purchase, improvement or refinancing of residential and commercial real estate. An adverse change in the real estate market could cause collateral for loans made by us to decline in value, and loan delinquencies and problem assets to increase.

     Approximately 91.5% of our loan portfolio as of December 31, 2007 was comprised of loans secured by real estate, including construction and development, commercial and residential real estate loans. Approximately 73% of our residential real estate loans are single family (1-4 units) and 27% are multifamily. A downturn in the real estate market could increase loan delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it is also more likely that we would be required to increase our allowance for loan losses. If during a period of reduced real estate values we are required to liquidate the property collateralizing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition.

Over 61.2% of our loans are real estate construction and development loans, which have a higher degree of risk and a greater potential for losses that would reduce our earnings.

     Approximately 61.2% of our loan portfolio as of December 31, 2007 consisted of real estate construction and development loans, which generally have a higher degree of risk than long-term financing of existing properties because repayment depends on the completion of the project and usually on the sale of the property.

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     In addition, these loans are normally interest only. Interest-only loans carry greater risk than principal and interest loans do, to the extent that no principal is paid prior to maturity, particularly during a period of rising interest rates and declining real estate values. If there is a significant decline in the real estate market due to a material increase in interest rates or for other reasons, many of these loans could default and result in foreclosure. Moreover, most of these loans are for projects located in the west Puget Sound area. If we are forced to foreclose on a project prior to completion, we may not be able to recover all of the unpaid portion of the loan or we may be required to fund additional money to complete the project or hold the property for an indeterminate period of time. Any of these outcomes may result in losses and reduce our earnings.

Our allowance for loan losses may not be adequate to cover actual losses.

     A significant source of risk arises from the possibility that we could sustain losses due to loan defaults and non-performance on loans. We maintain an allowance for loan losses in accordance with accounting principles generally accepted in the United States to provide for such defaults and other non-performance. As of December 31, 2007, our allowance for loan losses as a percentage of loans was 4.71%. The determination of the appropriate level of loan loss allowance is an inherently difficult process and is based on numerous assumptions. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond our control. In addition, our underwriting policies, adherence to credit monitoring processes, and risk management systems and controls may not prevent unexpected losses. Our allowance for loan losses may not be adequate to cover actual loan losses. Moreover, any increase in our allowance for loan losses will adversely affect our earnings.

We serve a limited geographic area, and an economic downturn in the west Puget Sound or Seattle Metropolitan Statistical Area could limit our growth and reduce our profitability.

     Our current geographic market consists primarily of the west Puget Sound area, including Kitsap County. The FDIC has characterized our headquarters in downtown Bremerton as being located in a “low income” area and our other branches and loan production offices as being located in “middle income” areas. As of December 31, 2007, our Kitsap County customers accounted for approximately 63% of our deposits and 54% of our loans. Because of our relatively small size and geographic concentration, adverse changes in local economic conditions, such as income levels, deposits and housing starts, would have a relatively greater affect on us than they would on the larger national and regional competitors that are active in our market areas. If local or regional economic conditions were to deteriorate, demand for our products and services likely would decline and the quality of our loan portfolio could be reduced.

     Kitsap County’s economy substantially depends on the military and tourism. While we believe that the local economy is diverse, the military has a significant presence in Kitsap County, including two major Navy bases which account for significant employment in the county. Although the federal government recently decided not to close any military bases in our market area, we cannot be certain that it will not do so in the future. We believe that few of our customers come from the military or its members, because most of their needs are met by a credit union. However, a significant reduction in the military presence in our market could have a material adverse effect on the local economy and potentially on our customers and business. In addition, the west Puget Sound area serves as a seasonal destination for many residents of the Seattle Metropolitan Statistical Area and a decline in that economy could affect real estate prices due to a slowdown in purchases by Seattle area residents as well as service businesses that rely on the seasonal traffic.

Our loan portfolio is concentrated in real estate and a substantial majority of our loans and operations are in west Puget Sound, and therefore our business is particularly vulnerable to a downturn in the local real estate market.

     As of December 31, 2007 approximately 91.5% of our loans were secured by real estate, primarily located in our west Puget Sound market. If the local economy, and particularly the real estate market, declines, the rates of delinquencies, foreclosures, bankruptcies and losses in our loan portfolio would likely increase. As a result of this lack of diversification in our loan portfolio a downturn in the local real estate market could significantly reduce our profitability and adversely affect our financial condition.

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We have a relatively high percentage of unseasoned credits, which are considered to pose a potential greater repayment risk than loans that have been outstanding for a longer period of time.

     As a result of our rapid growth prior to 2007 and our focus on real estate construction and development lending, a significant portion of our loan portfolio is represented by new credits. Generally, loans that are relatively new, referred to as unseasoned loans, do not have sufficient repayment history to determine the likelihood of repayment in accordance with their terms. At December 31, 2007, 85.1% of our total loan portfolio consisted of loans booked within the past two years, including loan renewals.

We are subject to extensive government regulation. Non-compliance with or material changes to existing regulations could adversely affect our business, financial condition, results of operations or cash flows.

     We are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Because our business is highly regulated, the laws, rules and regulations applicable to us are subject to regular modification and change. For example, the FDIC and the Federal Reserve Board recently issued joint Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, that sets forth supervisory criteria to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny. The Guidance applies to Westsound Bank, based on our current loan portfolio, and we expect that our business and operations will be subject to enhanced regulatory review for the foreseeable future. Our failure to comply with applicable laws and regulations, or changes to the existing regulatory structure, could adversely affect our business, financial condition, results of operations or cash flows.

Our profitability depends on interest rates generally, and we may be adversely affected by changes in market interest rates.

     Our profitability depends in substantial part on our net interest income. Our net interest income depends on many factors that are partly or completely outside of our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally. Our net interest income will be adversely affected if market interest rates change so that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments. In addition, an increase in interest rates could adversely affect borrowers’ ability to pay the principal or interest on existing loans or reduce their desire to borrow more money. This may lead to an increase in our nonperforming assets, a decrease in loan originations, or a reduction in the value of and income from our loans, any of which could have a material and negative effect on our results of operations. Fluctuations in market rates and other market disruptions are neither predictable nor controllable and may adversely affect our financial condition and earnings.

     The ratio of variable to fixed rate loans in our loan portfolio, the ratio of short-term (maturing at a given time within 12 months) to long-term loans, and the ratio of our demand, money market and savings deposits to CDs (and their time periods), are the primary factors affecting the sensitivity of our net interest income to changes in market interest rates. As of December 31, 2007, 39.4% of our $414.0 million gross loan portfolio were variable rate loans and 60.6% were fixed rate loans. Our short-term loans are typically priced at prime plus a margin, and our long-term loans are typically priced based on a U.S. Treasury index for comparable maturities, plus a margin. In

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addition, approximately 75.4% of our fixed-rate loans receivable were short-term and approximately 24.6% were long-term, and 30.0% of our deposits were demand, money market and savings accounts and 70.0% were CDs. The composition of our rate sensitive assets or liabilities is subject to change and could result in a more unbalanced position that would cause market rate changes to have a greater impact on our earnings.

We face strong competition from banks and other financial services providers that offer banking services, which may limit our ability to attract and retain banking clients.

     Competition in the banking industry generally, and in our geographic market specifically, is intense. Competitors include banks, as well as other financial services providers, such as savings and loan institutions, consumer finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, our competitors include several larger national and regional financial institutions whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and ATMs, offer a wider array of banking services and conduct extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of a broader customer base than us. Larger competitors may also be able to offer better lending and deposit rates to customers, and could increase their competition as we become a public company and our growth becomes more visible. Moreover, larger competitors may not be as vulnerable as us to downturns in the local economy and real estate market since they have a broader geographic area and their loan portfolio is diversified. We also compete against community banks that have strong local ties. These smaller institutions are likely to cater to the same small- and medium-sized businesses that we target. If we are unable to attract and retain banking customers, we may be unable to grow or maintain our loan and deposit portfolios and our results of operations and financial condition may otherwise be adversely affected. Ultimately, we may be unable to compete successfully against current and future competitors.

If we need additional capital in the future, we may not be able to obtain it on terms that are favorable. This could negatively affect our performance and the value of our common stock.

     We may need to raise additional capital in the future to maintain our capital levels or take advantage of growth opportunities. Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on terms satisfactory to us.

The unexpected loss of key officers would materially and adversely affect our ability to execute our business strategy, and diminish our future prospects.

     The loss of the services of our interim chief executive officer and chief financial officer, Mark D. Freeman or that of other key executives could materially and adversely affect our ability to successfully implement our business plan and, as a result, our future prospects. In light of the relatively small pool of persons involved in the banking industry in western Washington, we could have difficulty replacing any of our senior management team or senior officers with equally competent persons who also are familiar with our market area.

We are exposed to risk of environmental liabilities with respect to properties to which we take title.

     Approximately 91.5% of our outstanding loan portfolio at December 31, 2007 was secured by real estate. In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third-parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third-parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.

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Our future earnings will be significantly affected by the legal and regulatory actions taken against us, as well as those legal actions that we have and may pursue.

     The Company and Westsound Bank have been sued or named in the securities class action lawsuits identified in Part I, Item 3 of this Form 10-K, which, if adversely determined, could have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Further, Westsound Bank is also involved in the regulatory, collection and potential foreclosure actions and proceedings described in Part I, Item 3 of this Form 10-K. Because we are unable to predict the impact or resolution of these outstanding litigation and regulatory matters or to reasonably estimate the potential loss, if any, and no reserves have yet been established therefor.

     In this regard, we may determine in the future that it is necessary to establish such reserves and, if so established, such reserves could have a material adverse impact on our financial condition. Accordingly, our ability to successfully defend against claims asserted against us in various lawsuits arising out of the circumstances surrounding the loans, or any regulatory action taken against us, as well as any unanticipated litigation, regulatory, or other judicial proceedings may have a substantial impact on the profitability of the Company.

Our future liquidity depends in part on our ability to attract and retain deposits, which could be adversely affected by adverse publicity in our market area related to the legal and regulatory actions in which we are involved.

     Our liquidity could be adversely affected by unexpected deposit outflows, excessive interest rates by competitors, adverse publicity relating to regulatory and legal actions in which we are involved and similar matters. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity.”

We may be unable to, or choose not to, pay dividends on our common stock.

     Our ability to pay dividends depends on the following factors, among others:

• we may not have sufficient earnings since our primary source of income, the payment of dividends to us by our subsidiary, Westsound Bank, is subject to federal and state laws that limit the ability of the Bank to pay dividends;

• Federal Reserve Board policy requires bank holding companies to pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition;

• we are also restricted from paying dividends on our common stock if we have deferred payments of the interest on, or an event of default has occurred with respect to, our junior subordinated debentures; and

• our board of directors may determine that, even though funds are available for dividend payments, retaining the funds for internal uses, such as expansion of our operations, is a better strategy.

     We have not paid, and currently have no plans to pay, cash dividends to our shareholders, and the FDIC order prohibits us from doing so. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments.”

We face a variety of threats from technology based frauds and scams.

     Financial institutions are a prime target of criminal activities through various channels of information technology. We attempt to mitigate risk from such activities through policies, procedures, and preventative and defensive measures. In addition, we maintain insurance coverage designed to provide a level of financial protection to our business. However, risks posed by business interruption, fraud losses, business recovery expenses, and other potential losses or expenses that we may incur from a significant event are not readily predictable and, therefore, could have an impact on our results of operations.

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We rely on our information technology and telecommunications systems and third-party servicers, and the failure of these systems could adversely affect our business.

     Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. We outsource our major systems including our electronics funds transfer, or EFT, credit card and transaction processing and our online Internet bill payment and banking services. We rely on these systems to process new and renewal loans, provide customer service, facilitate collections and share data across our organization. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans and provide customer service or compromise our ability to collect loan payments in a timely manner.

Item 1B. Unresolved Staff Comments

     There are no unresolved SEC staff comments.

Item 2. Properties

     We own the buildings and land for four of our offices, in addition to our headquarters. These properties are not subject to any mortgages or encumbrances and consist of the following:

• Headquarters located at 607 Pacific Avenue, Bremerton, Washington, which is 20,196 square feet. Our headquarters and administrative offices are located in the main branch.

• Bremerton support facility located at 190 Pacific Avenue, Bremerton, Washington, which is 6,668 square feet.

• Port Angeles branch located at 602 E. Front Street, Port Angeles, Washington, which is 2,358 square feet.

• Poulsbo branch located at 21895 Viking Way NW, Poulsbo, Washington, which is 2,000 square feet.

• Sequim branch located at 1320 W. Washington, Sequim, Washington, which is 6,480 square feet.

We lease four of our branches:

• Port Orchard branch located at 100 Bethel Avenue, Port Orchard, Washington, which is 1,400 square feet. The lease is for a five-year term, expiring May 2008. Our current monthly rent is $2,100.

• Silverdale branch located at 9960 Silverdale Way NW, Silverdale, Washington, which is 6,031 square feet. The lease expires in October 2011. Our current monthly rent is $6,869, which increases to $7,874 by the end of the lease.

• Gig Harbor branch located at 5775 Soundview Drive, Gig Harbor, Washington, which is 3,950 square feet. The lease is for a five-year term, expiring April 2010. Our current monthly rent is $4,967, which increases to $5,296 by the end of the lease.

• Federal Way branch located at 2505 South 320th Street, Federal Way, Washington, which is 3,420 square feet. The lease is for a five-year term, expiring June 2010. Our current monthly rent is $9,167, which increases to $9,452 by the end of the lease.

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• Port Townsend branch located at 2500 West Sims Way, Port Townsend, Washington, which is 1,300 square feet. Our current monthly rent is $2,282 per month. The lease is for a three year term, expiring February 2010.

     We believe that our existing facilities are adequate for our present purposes. We presently have no preliminary agreements or understandings with any third-party to acquire additional branch locations.

Item 3. Legal Proceedings.

     As previously reported, a purported securities fraud class action lawsuit was commenced in the United States District Court for the Western District of Washington against the Company and certain of its directors and current and former officers alleging violations of Sections 11 and 15 of the Securities Act of 1933 and seeking an unspecified amount of compensatory damages and other relief in connection with the Company’s initial public offering. Since then four additional, similar actions have been filed in the U.S. District Court in the Western District of Washington. As is typical in these types of cases, all the actions have been consolidated into a single action, In Re: WSB Financial Group Securities Litigation, Master File No. CO7-1747 RAJ. The lead plaintiff is the Police and Fire Retirement System for the City of Detroit, whose consolidated complaint is due March 28, 2008.

     The Company received a letter dated December 13, 2007, from the San Francisco Regional Office of the Securities and Exchange Commission (“SEC”) requesting that the Company produce certain documents concerning various issues that have been the subject of recent public disclosure by the Company. The SEC’s letter notes that the request should not be construed as any indication by the SEC or its staff that any violation of law has occurred, or as an adverse reflection upon any person, entity or security. The Company provided documents in response to the SEC’s request. The Company intends to cooperate with the SEC staff.

     As of March 14, 2008, the Company had commenced collection proceedings on approximately 171 real estate loans by sending notices of default to the borrowers. Some or all of these loans could result in foreclosure actions.

     The Company is unable to predict the outcome of these matters. Our cash expenditures, including legal and other fees, associated with the pending litigation and the regulatory proceedings described above (see Management’s Discussion and Analysis of Finalized Condition and Results of Operations) cannot be reasonably predicted at this time. Litigation and any potential regulatory actions or proceedings can be time-consuming and expensive and could divert management time and attention from our business, which could have a material adverse effect on our revenues and results of operations. The adverse resolution of any specific lawsuit or potential regulatory action or proceeding could have a material adverse effect on our business, results of operations, and financial condition.

     In addition to the above, the Company and Westsound Bank are periodically a party to or otherwise involved in legal proceedings arising in the normal and ordinary course of business, such as claims to enforce liens, foreclose on loan defaults, and other issues incident to our business. Other than the legal and regulatory proceedings described or referenced above and the anticipated institution of additional lawsuits or claims arising out of or related to the impaired loans, management does not believe that there is any proceeding threatened or pending against the Company or the Bank which, if determined adversely, would have a material effect on the business, results of operations, cash flows, or financial position of the Company or the Bank.

Item 4. Submission of Matters to a Vote of Stockholders

No matters were submitted to stockholders during the fourth quarter of 2007.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

     (a) Market for Registrant’s Common Stock.Prior to our initial public offering there was no public market for our common stock. Our common stock and prior to the formation of WSB Financial Group, the common stock of Westsound Bank, has been traded, from time to time, by individuals on a negotiated basis between the parties. The following table sets forth those trades since January 1, 2006 through December 31, 2007 of which we have knowledge, and the trading history on NASDAQ from December 14, 2006 to December 31, 2007, including the quarter in which the trades occurred, the aggregate number of shares traded during such quarter and the range of sales price per share:

Quarter of Trade	Number of Shares		Price Per Share
1st ‘06		112		10.74
2nd ‘06		3,600		12.14
3rd ‘06		3,225		12.06
4th ‘06
(through 12/31/06)		14,068		13.15

Quarter of Trade	Average Volume		Low/High
12/14/06 through 12/31/06)		981,700	18.56/19.20
1st ‘07		30,700	17.40/20.82
2nd ‘07		59,500	14.93/18.44
3rd ‘07		59,900	11.20/15.98
4th ‘07		236,200	4.03/12.48

     On March 17, 2008, there were 2,281 holders of record of our common stock.

     The principal market for our common stock is The NASDAQ Stock Market LLC.

     (b) Recent Sales of Unregistered Securities.The following sets forth information regarding all unregistered securities sold by the registrant in the three month period ended December 31, 2007:

          (1)Securities Issued Upon Exercise of Stock Options.The following shares of common stock were issued by registrant in the fiscal quarter ended December 31, 2007 pursuant to the exercise of stock options under the 1999 Incentive Stock Option Plan (the “Plan”): 10,748 shares to employees in March, 6,757 shares to — employees in April, 4,300 shares to employees in June, 2007, and 7,375 shares to an employee in July, 2007, for an aggregate purchase price of $136,504.

     Such shares of common stock were issued pursuant to a written compensatory benefit plan under circumstances that comply with the requirements of Rule 701 promulgated under the Securities Act, and are thus exempted from the registration requirements of the Securities Act by virtue of Rule 701.

     (c) Dividends.We have not paid, and currently have no plans to pay, cash dividends to our shareholders. The payment of dividends is within the discretion of our board of directors and will depend upon our earnings, capital requirements and operating and financial position, among other factors.

     Additionally, our junior subordinated debt agreement prohibits us from paying dividends if we have deferred payment of interest on outstanding trust preferred securities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources.” We are deferring interest on our trust preferred securities. See Note 7 of the Notes to Consolidated Financial Statements.

     We are a legal entity separate and distinct from Westsound Bank. Because we are a holding company with no significant assets other than Westsound Bank, we will be dependent upon dividends from Westsound Bank for cash with which to pay dividends when, and if, our dividend policy changes. For a discussion of the regulatory

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limitations on Westsound Bank’s ability to pay dividends. See “Supervision and Regulation — Federal and State Regulation of Westsound Bank — Dividends” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments.”

     (d) Initial Public Offering.On December 19, 2006, the Company completed its initial public offering. The net proceeds of the offering, including the exercise of the over-allotment option, to the Company (after deducting expenses) were $40.2 million. Presently, the net proceeds are temporarily being held as available cash in Westsound Bank, which in turn allows the Bank to use the proceeds in its normal day to day funding needs. There has been no material change in the planned use of proceeds from this initial public offering as described in the Company’s final prospectus filed with the SEC.

Item 6. Selected Financial Data

     You should read the summary consolidated financial data set forth below in conjunction with our historical consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this report. The summary consolidated statement of operations data for the years ended December 31, 2007, 2006 and 2005 and the summary consolidated balance sheet data as of December 31, 2007 and 2006 have been derived from our audited consolidated financial statements included elsewhere in this report. The summary consolidated statement of operations data for the years ended December 31, 2004 and 2003 and the summary consolidated balance sheet data as of December 31, 2004 and 2003 have been derived from our audited financial statements that are not included in this report.

     During the year ended December 31, 2005, shareholders of Westsound Bank exchanged their common stock in Westsound Bank for common stock in the newly formed holding company, WSB Financial Group, Inc. The transaction was accounted for based on historical carrying amounts. The consolidated financial statements include the accounts of WSB Financial Group, Inc. and its wholly owned subsidiary, Westsound Bank. Year-end data for 2003 and 2004 reflect financial data for Westsound Bank.

	Years Ended December 31,
	2007			2006		2005		2004		2003
	(Dollars in thousands, except share and per share data)
Consolidated Balance Sheet Data:
Cash and due from banks	$	10,026		$	9,048	$	8,158	$	2,534	$	2,852
Federal funds sold		56,900			17,150		18,400		8,650		6,500
Investment securities		8,832			8,244		8,235		4,558		6,273
Loans, net(1)		393,436			340,208		207,172		117,623		58,222
Total assets		489,333			386,754		249,998		137,416		76,012
Deposits		421,445			315,022		224,167		123,593		68,003
Junior subordinated debt		8,248			8,248		8,248		0		0
Stockholders’ equity		56,720			61,657		16,006		12,912		7,901
Consolidated Income Data:
Interest income	$	37,396		$	28,342	$	15,693	$	7,943	$	4,396
Interest expense		17,514			11,785		5,182		1,705		1,110
Net interest income		19,882			16,557		10,511		6,238		3,286
Provision for loan losses		15,879			1,523		1,351		654		231
Net interest income after provision for loan losses		4,003			15,034		9,160		5,584		3,055
Non-interest income		4,531			4,672		5,241		2,806		293
Non-interest expense		16,494			13,854		10,692		6,370		2,384
Income (loss) before income taxes		(7,960	)		5,852		3,709		2,020		964
Provision (benefit) for income taxes		(2,760	)		1,967		1,297		680		333
Net Income (loss)	$	(5,200	)	$	3,885	$	2,412	$	1,340	$	631
Share Data:											��
Earnings (loss) per share-basic	$	(0.93	)	$	1.35	$	0.91	$	0.59	$	0.36
Earnings (loss) per share – diluted		(0.93	)		1.18		0.82		0.55		0.35
Book Value per share	$	10.17		$	11.12	$	5.88	$	4.98	$	3.91
Shares outstanding at period end		5,574,853			5,545,673		2,722,048		2,594,485		2,019,171

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	Years Ended December 31,
	2007			2006			2005			2004			2003
	(Dollars in thousands, except share and per share data)
Weighted average shares outstanding – basic		5,565,123			2,870,022			2,642,628			2,270,211			1,734,434
Weighted average shares outstanding – diluted		5,565,123			3,285,622			2,925,092			2,429,577			1,801,667
Selected Performance Ratios:
Return on average assets		-1.17	%		1.28	%		1.28	%		1.37	%		1.04	%
Return on average stockholders’ equity		-8.4	%		19.6	%		16.6	%		13.6	%		9.9	%
Net interest margin		4.62	%		5.65	%		5.90	%		6.77	%		5.71	%
Efficiency ratio		67.6	%		65.3	%		67.9	%		70.4	%		66.6	%
Selected Liquidity and Assets Ratios:
Net Loans to deposit ratio		93.4	%		108.0	%		92.4	%		95.2	%		85.6	%
Average stockholders’ equity to average assets		14.0	%		6.5	%		7.8	%		10.1	%		10.4	%
Risk-based capital ratios:
Leverage capital		13.9	%		19.8	%		9.3	%		10.6	%		11.8	%
Tier 1 risk-based capital		15.4	%		20.2	%		10.2	%		11.2	%		13.1	%
Total risk-based capital		16.7	%		21.4	%		12.8	%		12.2	%		14.0	%
Selected Asset Quality Ratios:
Non-performing loans to total loans		6.12	%		0.06	%		0.06	%		0.09	%		0.00	%
Non-performing assets to total assets		5.38	%		0.06	%		0.05	%		0.09	%		0.04	%
Allowance for loan losses to total loans		4.71	%		1.15	%		1.20	%		1.00	%		0.98	%
Allowance for loan losses to non-performing loans		77.1	%		1813.7	%		1968.8	%		1189.0	%		N/A
Net charge-offs (recoveries) to average loans		0.08	%		0.01	%		0.00	%		0.03	%		-0.01	%

(1) Includes loans held for sale.

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

     Management’s Discussion and Analysis of Financial Condition and Results of Operations is included in the Annual Report to Shareholders for the fiscal year ended December 31, 2007 and is hereby incorporated by reference. This portion of the Annual Report to Shareholders is included in Exhibit 13 to this report, and set forth in Exhibit 13.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

     See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Continuing Operations – Quantitative and Qualitative Disclosures About Market Risk.”

Item 8. Financial Statements and Supplementary Data

     The report of Moss Adams LLP, Independent Registered Public Accounting Firm, and the consolidated financial statements are included in the Annual Report to Shareholders for the fiscal year ended December 31, 2007 and are hereby incorporated by reference. Unaudited quarterly results of operations are reported in Note 21 of the Company’s Annual Report to Shareholders for the fiscal year ended December 31, 2007 and 2006 are hereby incorporated by reference. This portion of the Annual Report to Shareholders is included in Exhibit 13 to this report.

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

     None.

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Item 9A(T). Controls and Procedures

Evaluation of Controls and Procedures

     Regulations under the Securities Exchange Act of 1934 require public companies to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Our interim chief executive officer who is also our chief financial officer, with the assistance of our principal accounting officer, based on their evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report concluded that, as disclosed below with respect to material weakness and changes in our internal control over financial reporting, the Company’s disclosure controls and procedures were not effective as of December 31, 2007.

     Management’s Report on Internal Control over Financial Reporting

     Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Securities Act of 1934. The Company’s internal control framework and processes are designed to provide reasonable assurance to management and the board of directors regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements in accordance with the accounting principles generally accepted in the United States of America. Management has assessed the effectiveness of our internal control over financial reporting as of December 31, 2007 based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission inInternal Control—Integrated Framework. As a result of this assessment, management concluded that, as of December 31, 2007, our internal control over financial reporting was not effective. Management’s conclusion was based upon their review of the FDIC order (described below and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments”) and their findings of control deficiencies that constituted a material weakness in connection with a lack of or sufficient or adequate policies, procedures, and controls with respect to the underwriting, documentation and monitoring of loans, the detection of risks related to the concentration and other risks associated with the residential construction and other loans, and the determination of our provision for loan losses and related allowance for loan losses.

     Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s financial statements are prevented or timely detected.

     Limitations on Controls

     Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

     Changes in Internal Control Over Financial Reporting.

     The FDIC determined the Bank had engaged in unsafe or unsound banking practices, by engaging in unsatisfactory lending and collection practices, operating with inadequate management and board supervision, with less than satisfactory capital in relation to its large volume of poor quality loans and with an inadequate loan valuation reserve, and with inadequate provisions for liquidity, inadequate internal routine and control policies, and in violation of various banking laws and regulations relating to internal audits and controls, real estate appraisal and lending guidelines, and responsibilities of bank directors and officers.

     We have made or are in the process of implementing the following managerial and operational changes to correct these deficiencies and to improve our internal controls over financial reporting, including:

• the audit committee has engaged the services of Young and Associates to perform a compensation analysis to include a peer analysis for the board of directors, senior management and department heads.

• the Bank retained an experienced credit manager that had recently been hired from outside the Bank as a regional manager, as chief lending officer in June, 2007 to manage its loan origination and approval process, credit administration and controls, timely identification of risk and problem loans and emerging risks in the loan portfolio in compliance with company policies and procedures and banking laws and regulations. Credit administration now validates loan grades through an internal loan approval process developed by the chief lending officer. The chief lending officer reports to the Bank’s chief executive officer.

• in November, 2007 the Bank established a new special assets department managed by a new vice president and manager of special assets recruited from outside the Bank. The Special Assets Department is responsible for construction, commercial real estate and commercial loan collections, reporting to the chief lending officer and the board. The Company plans to hire additional personnel needed to fully staff the special assets department in 2008.

• the Company retained a new independent loan consulting firm in the fourth quarter of 2007 to perform external reviews of the Company’s loan portfolio.

• the chief lending officer is revising lending policies and developing a series of new or improved reports for credit administration to better monitor credit risks internally and provide more detail about loans and credits to senior management, the Board and its loan committee, including but not limited to,

31

	concentrations, exceptions to loan policies, special assets and OREO reports, and monthly delinquent, non-accrual, classified loans and exposure.
•	a comprehensive risk assessment of the Bank was performed by Audit One, an independent auditor, in first quarter 2008. As a result of this assessment, the preliminary audit plan has been adopted by the audit committee, focusing on the lending area.
•	the audit committee and the Board have made changes to the internal audit function. Rather than add staff to our internal audit department and take the time to train, we chose to engage third party firms that are strong, reputable companies that will provide an independent and timely audit, including Audit One and Young and Associates. All third party firms will report directly to the audit committee.
•	the audit committee has or will engage several companies, such as accounting, audit, compliance and information technology consultants to conduct extensive internal audits in the operational and lending area. The scope of the audit will be identified and approved by the audit committee and will include loan process review, procedural review, compliance with consumer regulations, privacy, loan documentation, information reporting, reserve for loan and lease loss methodology and calculations, enterprise risk assessment, holding company activities, administrative activities, liquidity, central operations, compliance with the Bank Secrecy Act. Internal audit results are reported regularly to the audit committee on a continual basis using a modified tracking system. The department head is responsible for providing a management response to the audit committee if there are weaknesses noted in their area. Tracking of the audits will be performed by the Company’s chief risk officer.
•	establishing a communications procedure for reporting progress in all areas to the FDIC and DFI.

     We believe that these corrective actions, taken as a whole, will mitigate the control deficiencies identified above but we still need to test the effectiveness of these actions. We plan to continue an on-going review and evaluation of our internal control over financial reporting, and we may make other changes as appropriate based on the results of management’s reviews and evaluations.

     Except as described above, through the filing date of this report on Form 10-K, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information

     None.

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PART III

Item 10. Directors, Executive Officers and Corporate Governance

     We hereby incorporate by reference the information set forth under Shareholder Proposals, Code of Ethics, “Proposal 1: Election of Directors,” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the definitive form of the Company’s Proxy Statement, relating to its Annual Meeting of Shareholders to be held on May 14, 2008.

     Information regarding our executive officers required by this item appears in Item 1 of this report under “Executive Officers of the Registrant.”

Item 11. Executive Compensation

     We hereby incorporate by reference the information set forth under “Executive Compensation” and “Compensation of Directors,” in the definitive form of the Company’s Proxy Statement, relating to its Annual Meeting of Shareholders to be held on May 14, 2008.

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

     The following table gives information about the shares of Common Stock that may be issued upon the exercise of options, warrants and rights under the 1999 Incentive Stock Option Plan, or the Stock Option Plan, the only equity compensation plan of the Company in effect as of the end of the Company’s last fiscal year.

	Equity Compensation Plan Information
					Number of securities
					remaining available for
					future issuance under
	Number of securities to		Weighted-average		equity compensation
	be issued upon exercise		exercise price of		plans (excluding
	of outstanding options,		outstanding options,		securities reflected in the
Plan Category	warrants and rights		warrants and rights		first column)
Equity compensation plans approved by security holders		887,080	$	7.99		370,678
Equity compensation plans not approved by security holders		—		—		—
Total		887,080	$	7.99		370,678

     We hereby incorporate by reference the information set forth under “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in the definitive form of the Company’s Proxy Statement, relating to its Annual Meeting of Shareholders to be held on May 14, 2008.

Item 13. Certain Relationships and Related Transactions, and Director Independence

     The information required by this Item is incorporated by reference from the information in the section entitled “Certain Transactions” in the Proxy Statement.

Item 14. Principal Accountant Fees and Services

     We hereby incorporate by reference the information set forth under “Proposal 2: Ratification of Selection of Independent Registered Public Accountants – Fees for Professional Services” in the definitive form of the Company’s Proxy Statement relating to the 2008 Annual Meeting of Shareholders to be held on May 14, 2008.

33

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a)(1) Financial Statements.

     The following consolidated financial statements of WSB Financial Group, Inc. and Subsidiaries, together with the report of Moss Adams LLP, Independent Registered Public Accounting Firm, dated March 31, 2008, appearing in the Company’s Annual Report to Shareholders for the fiscal year ended December 31, 2007.

	Annual Report
	Reference
Report of Moss Adams LLP, Independent Registered Public Accountant	2007 Annual Report Consolidated Financial Statements
Consolidated Statement of Financial Condition – December 31, 2007 and December 31, 2006	2007 Annual Report Consolidated Financial Statements
Consolidated Statement of Operations – Fiscal years 2007, 2006, and 2005	2007 Annual Report Consolidated Financial Statements
Consolidated Statement of Changes in Stockholders’ Equity and Other Comprehensive Income (Loss) – Fiscal years 2007, 2006, and 2005	2007 Annual Report Consolidated Financial Statements
Consolidated Statement of Cash Flows – Fiscal years 2007, 2006, and 2005	2007 Annual Report Consolidated Financial Statements
Notes to Consolidated Fiscal Statements – December 31, 2007	2007 Annual Report Consolidated Financial Statements

* Incorporated by reference to the Annual Report to Shareholders for the fiscal year ended December 31, 2007. This portion of the Annual Report to Shareholders is included as Exhibit 13 to this Report.

     Refer also to Part II, Item 8 – Financial Statements and Supplementary Data for additional information.

(a)(2) Financial Statement Schedules.

     All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.

(a)(3) Exhibits.

     See Exhibit Index on pages 37 — 38.

34

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

WSB FINANCIAL GROUP, INC.
(Registrant)
By:	/s/ Mark D. FreemanDavid K. Johnson
	Interim President and Chief Executive Officer
	(Principal Executive Officer)

Dated: March 31, 2008.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

/s/ MARK D. FREEMAN		March 31, 2008
Mark D. Freeman	Interim President and Chief Executive	Date
	Officer (Principal Executive Officer)
/s/ MARK D. FREEMAN		March 31, 2008
Mark D. Freeman	Executive Vice President of Finance	Date
	and Operations and Chief Financial
	Officer (Principal Financial Officer)
/s/ JANET M. HOBSON		March 31, 2008
Janet M. Hobson	Vice President, Chief Accounting	Date
	Officer (Principal Accounting Officer)
/s/ LOUIS J. WEIR		March 31, 2008
Louis J. Weir	Director, Chairman of the Board	Date
/s/ LARRY C. WESTFALL		March 31, 2008
Larry C. Westfall	Vice Chairman of the Board	Date
/s/ RICHARD N. CHRISTOPHERSON		March 31, 2008
Richard N. Christopherson	Director	Date

35

/s/ DONALD F. COX, JR.		March 31, 2008
Donald F. Cox, Jr.	Director	Date
/s/ JAMES H. LAMB		March 31, 2008
James H. Lamb	Director	Date
/s/ BRIAN B. McLELLAN		March 31, 2008
Brian B. McLellan	Director	Date
/s/ DEAN REYNOLDS		March 31, 2008
Dean Reynolds	Director	Date
/s/ DONALD H. TUCKER		March 31, 2008
Donald H. Tucker	Director	Date

36

Exhibit
Number	Exhibit Index
3.1+	Articles of Incorporation of WSB Financial Group, Inc.
3.2+	Articles of Amendment
3.3+	Bylaws of WSB Financial Group, Inc.
3.4+	Amendment to Bylaws
10.1*+	1999 Stock Option Plan
10.2*+	Forms of 1999 Incentive Stock Option Plan Agreements
(a)+	Directors
(b)+	Employees
10.3+	Lease for Port Orchard branch, dated May 28, 2001
10.4+	Lease for Silverdale branch, dated October 1, 2001 and October 1, 2003
10.5+	Lease for Gig Harbor branch, dated March 2, 2004
10.6+	Lease for Federal Way branch, dated March 30, 2005
10.7+	Lease for Port Townsend LPO, dated August 18, 2006
10.8†+	Agreement between Westsound Bank and Fiserv Solutions Inc. dated August 11, 2006
10.9*+	Westsound Bank 401(k) Profit Sharing Plan
10.10+	Placement Agreement among the registrant, WSB Financial Group Trust I and Cohen Bros. & Company dated July 25, 2005
10.11+	Indenture by and between the registrant and JPMorgan Chase Bank, National Association, dated July 27, 2005
10.12+	Guarantee Agreement by and between the registrant and JPMorgan Chase Bank, National Association, dated July 27, 2005
10.13*+	Employment Agreement with David K. Johnson
10.14*+	Employment Agreement with Mark D. Freeman
10.15*+	Form of Employment Agreement with other executive officers
10.16+	Form of Indemnification Agreement with directors
10.17+	Audit Committee Charter
10.18+	Compensation Committee Charter

37

Exhibit
Number	Exhibit Index
10.19+	Corporate Governance/Nominating Committee Charter
10.20*	Separation Agreement with David K. Johnson (previously filed with the Securities and Exchange Commission on Form 8-K on February 4, 2008)
11	Schedule setting forth computation of earnings per share for the five fiscal years ended December 31, 2006.
13	Portions of the Annual Report to Shareholders for the fiscal year ended December 31, 2006, are incorporated by reference herein.
14	Code of Ethics and Professional Conduct (previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2006).
21+	Subsidiaries of the registrant
23	Consent of Independent Registered Public Accounting Firm, Moss Adams LLP
24	A power of attorney is set forth on the signature page of this registration statement
31.1	Certification of Chief Executive Officer.
31.2	Certification of Chief Financial Officer.
32.1	Certification (of Mark D. Freeman) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification (of Mark D. Freeman) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Compensatory plan or arrangement
†	Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
+	Previously filed with the Company’s Amendment No. 5 to the S-1 registration statement filed with the Securities and Exchange Commission on December 8, 2006, file no. 333-137058.

38