FDIC Investigating Bremerton Bank

The FDIC is investigating Westsound Bank.

A month ago the company announced it was laying off 33 employees.

Among the issues being investigated is possible fraud by former employees, according to Westsound’s 8-K filing with the Securities and Exchange Commission.

The 8-K is below.

Item 2.02 Results of Operations and Financial Condition

The company reported its preliminary financial results for the third quarter and year-to-date period ended September 30, 2007, on October 23, 2007. The press release is included in this current report as Exhibit 99.1. This release is also being furnished for purposes of Regulation FD and Regulation G of the Securities and Exchange Commission.

The company cautioned, however, that its financial results and financial statements for the period are preliminary and unaudited and subject to the completion of the pending examination of the mortgage lending practices and construction loan portfolio of the company’s subsidiary, Westsound Bank by the Federal Deposit Insurance Corporation, or FDIC, and the Washington Department of Financial Institutions, or DFI. The FDIC and DFI recently indicated to the company’s management that in the opinion of the regulators, the Bank violated certain banking laws and regulations which are primarily related to the origination, administration and monitoring of construction and mortgage loans. The examiners advised that they intend to recommend that the FDIC and DFI take regulatory action against the Bank with respect to such lending practices and activities, which may include a cease and desist order, monetary penalties, further increases in allowances for loan losses, reserves and/or charge-offs.

Additionally, the company has been cooperating in an investigation by the regulators pertaining to certain past activities involving former employees and third parties, including possible fraud, misconduct and other violations with respect to the application, processing and approval of certain loans previously made. The company is also conducting its own internal investigation into the issues surrounding the past activities of mortgage and construction loan origination, and plans to retain an independent auditor to analyze these loans, particularly construction loans and assist the company and its management in determining the appropriate level of loan loss allowances, reserves or charge-offs with respect to such loans.

The company and the Bank are cooperating with the regulatory investigation. The company has no further comment at this time regarding the regulatory investigation or its own internal investigation. There have been no findings issued to date and these investigations are continuing.

The company cannot currently comment on the timing for completion of, or the ultimate scope or outcome of, these investigations, the audit or any necessary restatements.

The company previously announced its decision to downsize its mortgage division and eliminate 33 positions in this division, generating an estimated pre-tax charge of approximately $200,000 in the third and fourth quarters of 2007.
Item 2.06 Material Impairments.

Our board of directors and its audit committee have decided to retain an independent auditor to help the company and its outside counsel to conduct an internal investigation of mortgage and construction loans previously originated. The company and its management expect that upon completion of its internal investigation, that a material additional charge for impairment to certain of its loans, particularly construction loans, may be required under generally accepted accounting principles and regulatory guidelines pertaining to the Bank. The company’s board of directors and officers have determined, however, that at the time of this filing they are unable in good faith to make a determination of an estimate of the amount or range of amounts of the impairment charge. The company will file an amended report on Form 8-K under this Item 2.06 promptly and in any event, within 4 business days after it makes a determination of such an estimate or range of estimates, or include such information in its next quarterly report on Form 10-Q which is currently due to be filed under the Securities Exchange Act of 1934, by November 14, 2007.
Item 5.02 Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers.

On October 22, 2007, the company’s executive vice president and chief financial officer, Mark D. Freeman, advised the company that for personal health reasons he was requesting a temporary paid leave of absence from October 22 through December 31, 2007. The company has decided to recruit and retain a qualified individual from outside the company to serve as chief financial officer on an interim or temporary basis during Mr. Freeman’s absence. Until such individual can be retained, the responsibilities of Mr. Freeman will be shared by the company’s chief executive officer, David K. Johnson, its chief risk officer, Veronica R. Colburn, and its AVP staff accountant, Janet M. Hobson.
Item 7.01 Regulation FD Disclosure.

The company filed its Call Report with the FDIC for the third quarter of 2007 online with the FDIC on October 19, 2007, which is available on its website at fdic.gov. and incorporated by reference in this report.
Item 8.01 Other Items.

Pending examination and related investigations by the FDIC and DFI.

The FDIC and DFI recently indicated to the company’s management that in the opinion of the regulators, the Bank violated certain banking laws and regulations which are primarily related to the previous lending practices of Westsound Bank’s mortgage division, and the administration and monitoring of mortgage and construction loans. The examiners advised that they intend to recommend that the FDIC and DFI take regulatory action against the Bank with respect to such lending practices and activities, which may include a cease and desist order, monetary penalties, additional increases in allowances for loan losses, reserves and/or charge-offs.

Additional Risk Factors.

Since our Annual Report on Form 10-K for the year ended December 31, 2006, we have identified additional risk factors which could materially affect our business, financial condition or future results. Any of the following factors could materially and adversely affect our business, financial condition and results of operations after December 31, 2006, and the risks described below are not the only risks that we may face. Additional risks and uncertainties not currently known to us may also materially and adversely affect our business, financial condition or results of operations.

The examination and related investigations by the FDIC and DFI could result in costs, fines, penalties and restrictions that could have an adverse effect on us.

The FDIC and DFI recently indicated to the company’s management that in the opinion of the regulators, the Bank violated certain banking laws and regulations which are primarily related to the origination, administration and monitoring of construction and mortgage loans.

The FDIC has requested documents and information from us in the course of their examination and related investigation. We have provided our cooperation. The company is also conducting its own internal investigation. The costs incurred in connection with these investigations to date have been immaterial, but future costs related to these investigations, including the company’s own internal investigation, could be significant. However, we cannot predict the ultimate impact, if any, that the pending examination by FDIC and DFI and the related investigations may have on our business operations or results. While we cannot predict the ultimate impact, if any, that these investigations may have on our business operations or results, a material adverse result is possible, including but not limited to imposition of fines or other financial penalties, restriction of our business and lending activities, removal or resignation of one or more members of our senior management and board of directors, and additional loan losses, reserves and/or charge-offs.

Item 9.01 Financial Statements and Exhibits

(d) Exhibits

99.1
Press Release dated October 23, 2007

WSB Financial Posts Preliminary Third Quarter 2007 Earnings

Bremerton, WA — October 23, 2007 — WSB Financial Group (NASDAQ: WSFG), the parent company of Westsound Bank, today reported preliminary third quarter 2007 earnings of $1.3 million, compared to $1.1 million in the third quarter a year ago, and year-to-date net income grew to $3.8 million, compared to $3.1 million a year ago. Earnings per diluted share totaled $0.21 per diluted share, compared to the pre-IPO EPS of $0.36 per diluted share, a year ago. Year-to-date, EPS was $0.64 per diluted share, compared to $0.99 per diluted share in the first nine months of 2006. WSB Financial issued 2.6 million shares in its initial public offering in August 2006.

“Inadvertently, our preliminary financial results for the bank were filed with the FDIC and became publicly available this week. As a result, we are providing preliminary financial results for the company.. While the results discussed in this release are accurate as of last Friday, they may change prior to the filing of our 10-Q in November,” said David K. Johnson, President and CEO. “In fact, due to the recommendations of our bank regulators, it is likely that we will be adding to our reserves.

“In addition, I am saddened to report that Mark Freeman, our Chief Financial Officer, has requested and been granted a leave of absence due to health concerns. Mark is a valued member of our management team, and we wish him a speedy recovery,” said Johnson. “In the meantime, we are seeking an interim Chief Financial Officer.”
Third quarter preliminary results show that 38% loan growth and 30% deposit growth fueled a 24% increase in net interest income before provision for loan losses and a 15% increase in revenues compared to a year ago. Net interest margin, while still healthy, fell to 4.83% in the third quarter compared to 5.06% in the second quarter and 5.71% a year ago. Year-to-date net interest margin dropped 82 basis points to 4.98% from 5.80% a year ago. Asset quality declined during the quarter with non-performing loans growing to 0.63% of total loans and non-performing assets increasing to 0.94% of total assets at September 30, 2007.

“In coordination with our regulatory review, we have initiated a thorough review of our loan portfolio and decided to downsize our mortgage operation,” Johnson said. “In the course of these reviews, certain deficiencies in our origination, administration and servicing of certain lending products were identified. We expect the regulators to follow up with further regulatory actions. Until the finalization of the regulatory exam, however, we are not able to quantify the requirements they may have.

We have also identified a number of loans that fall into the 30 to 89 day past due category, and placed some of these loans on nonaccrual status and boosted our reserves for loan losses. Based on the preliminary results, the allowance for loan losses grew 34% to $5.0 million at September 30, 2007, from $3.7 million a year ago. The allowance for loan losses represents 186% of non-performing loans and 1.17% of total loans as of the end of the third quarter.

WSB Financial remains well capitalized with equity to assets of 13.8% at September 30, 2007.

WSB Financial expects to report final results for the third quarter of 2007 on November 14, 2007.