<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the Quarter ended June 30, 1996
Commission File Number 0-15540
FRONTIER FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Washington 91-1223535
- ------------------------- -------------------------
(State or Other Jurisdiction of (IRS Employer Identification
Incorporation or Organization) Number)
332 SW Everett Mall Way
P. O. Box 2215
Everett, Washington 98203
(Address of Principal Administrative Offices) (Zip Code)
(206) 514-0719
(Registrants Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock (No Par Value)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The issuer has one class of common stock (no par value) with 6,809,196 shares
outstanding as of June 30, 1996.
<PAGE> 2
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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INDEX TO QUARTERLY REPORT ON FORM 10-Q
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June 30, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
<S> <C>
PART I - Financial Information
Item 1. Financial Statements.
Consolidated Balance Sheet - June 30, 1996
and Year End 1995. 1
Consolidated Statement of Income - Three Months and Six Months
Ended June 30, 1996 and 1995. 2
Consolidated Statement of Cash Flows - Six Months
Ended June 30, 1996 and 1995. 3-4
Statement of Changes in Stockholder's Equity -
June 30, 1996. 5
Notes 6-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operation. 9-16
PART II - Other Information
Item 1. Legal Proceedings. 17
Item 4. Submission of Matters to a Vote of Security Holders. 17
Item 5. Other Information. 17
Item 6. Exhibits and Reports on Form 8-K. 17
Signature 18
</TABLE>
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<PAGE> 3
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET (Note 1)
- --------------------------------------------------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
(In thousands)
June 30, December 31,
1996 1995
---- ----
<S> <C> <C>
ASSETS
Cash & Balances Due from Depositary Institutions $24,316 $19,708
Securities: (Note 2)
Available for Sale-Market Value 102,172 102,300
Held to Maturity-Amortized Cost (Market Value 12-31-95, $43,889) 40,826 42,676
-----------------------
Total Securities 142,998 144,976
Federal Funds Sold 12,070 55,930
Loans: (Note 3)
Loans, Net of Unearned Income 565,391 504,717
Less: Allowance for Loan Losses (12,189) (11,897)
-----------------------
Net Loans 553,202 492,820
Mortgage Loans Held for Sale 417 271
Premises & Equipment, Net 12,146 11,758
Other Real Estate Owned 567 590
Intangible assets 435 473
Other Assets 9,701 8,657
-----------------------
TOTAL ASSETS $755,852 $735,183
=======================
LIABILITIES
Deposits:
Non-Interest Bearing $84,163 $83,281
Interest Bearing 543,321 557,937
-------------------------
Total Deposits 627,484 641,218
Federal Funds Purchased 1,869 2,935
Securities sold under repurchase agreements 8,733 4,661
Federal Home Loan Bank advances 40,000 15,000
Long-term debt 137 136
Other Liabilities 5,652 5,880
-------------------------
TOTAL LIABILITIES 683,875 669,830
-------------------------
EQUITY CAPITAL (Note 4)
Common Stock 57,013 44,084
Unrealized Gains/(Losses) on AFS Securities
Net of Tax effect(Note 2) (653) 933
Retained Earnings 15,617 20,336
-------------------------
TOTAL CAPITAL 71,977 65,353
-------------------------
TOTAL LIABILITIES & CAPITAL $755,852 $735,183
- ---------------------------- =========================
</TABLE>
- -----------------------------------------------
The accompanying notes are an integral part of these financial statements.
-1-
<PAGE> 4
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED STATEMENT OF INCOME (Note 1)
- --------------------------------------------------------------------------------
(Unaudited)
(In thousands, Except for Per Share Amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
June 30, June 30, June 30, June 30,
1996 1995 1996 1995
<S> <C> <C> <C> <C>
INTEREST INCOME
Interest & Fees on Loans $14,132 $12,804 $27,443 $25,570
Interest on Investments 2,525 2,503 5,509 4,802
-------------------------------------------------------------
Total Interest Income 16,657 15,307 32,952 30,372
-------------------------------------------------------------
INTEREST EXPENSE
Interest on Deposits 6,825 6,774 14,169 12,531
Interest on Borrowed Funds 375 344 680 952
-------------------------------------------------------------
Total Interest Expense 7,200 7,118 14,849 13,483
-------------------------------------------------------------
Net Interest Income 9,457 8,189 18,103 16,889
-------------------------------------------------------------
PROVISION FOR LOAN LOSSES (300) (150) (500) (850)
NONINTEREST INCOME
Securities Gains/(Losses) 0 (4) 0 (4)
Service Charges on Deposit Accounts 405 408 791 809
Other Noninterest Income 470 417 899 847
-------------------------------------------------------------
Total Noninterest Income 875 821 1,690 1,652
NONINTEREST EXPENSE
Salaries & Employee Benefits 2,671 2,414 5,248 4,961
Occupancy Expense 576 547 1,019 1,128
Other Noninterest Expense 1,399 1,785 2,157 2,786
-------------------------------------------------------------
Total Noninterest Expense 4,646 4,746 8,424 8,875
INCOME BEFORE INCOME TAX 5,386 4,114 10,869 8,816
-------------------------------------------------------------
APPLICABLE INCOME TAX (1,785) (1,147) (3,633) (2,765)
NET INCOME $3,601 $2,967 $7,236 $6,051
=============================================================
Average Number of Shares Outstanding
for the Period 6,783,040 6,743,982 6,783,040 6,743,982
PER SHARE COMMON STOCK $0.53 $0.44 $1.07 $0.90
=============================================================
</TABLE>
- --------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
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<PAGE> 5
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED STATEMENT OF CHANGES IN CASH FLOWS
- --------------------------------------------------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
(In thousands)
SIX MONTHS ENDED
June 30, 1996 June 30, 1995
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $7,236 $6,051
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 678 (166)
Provision for loan losses 500 850
Provision for losses on ORE 0 0
Increase in income taxes payable (367) (915)
Deferred taxes 0 0
Decrease in interest receivable (196) (76)
Increase (Decrease) in interest payable (719) 1,286
Loss on sale of HTM securities 0 (4)
Loans originated for sale (11,031) (7,144)
Proceeds from sale of loans 10,734 6,448
Other operating activities 799 1,504
-------- --------
Net cash provided by operating activities 7,634 7,834
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash flows from Fed Funds Sold 43,860 (53,060)
Proceeds from sales of HTM securities 0 88
Proceeds from maturities of investments 19,741 4,026
Purchase of AFS securities (8,019) (460)
Purchase of HTM securities (11,258) 0
Net cash flows from loan activities (61,203) (8,063)
Purchases of premises and equipment (341) (789)
Proceeds from the sale of other real estate 305 727
Cash invested in other real estate (281) 0
Other investing activities 0 0
-------- --------
Net cash used by investing activities (17,196) (57,531)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in demand deposit accounts 12,127 (50,586)
Net change in certificates of deposit (26,345) 122,353
Proceeds from issuance of stock 69 78
Principal payments on long term debt (73) (747)
Advances from FHLB 25,000 0
Repayment of FHLB advances 0 (15,000)
Net change in Federal Funds purchased 3,006 (8,435)
Other financing activities 386 0
-------- --------
Net cash provided by financing activities 14,170 47,663
-------- --------
</TABLE>
(Continued on next page)
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<PAGE> 6
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED STATEMENT OF CHANGES IN CASH FLOWS-(Continued)
- --------------------------------------------------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
(In thousands)
SIX MONTHS ENDED
June 30, 1996 June 30, 1995
------------- -------------
<S> <C> <C>
INCREASE IN CASH AND DUE FROM BANKS $4,608 ($2,034)
CASH & DUE FROM BANKS AT BEGINNING
OF YEAR 19,708 22,081
------------- ------------
CASH AND DUE FROM BANKS AT END
OF PERIOD $24,316 $20,047
============= ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $15,570 $12,182
Cash paid during the year for income taxes 4,000 3,680
Real estate taken as settlement for loan
obligations 0 883
Real estate taken as settlement for loan
obligations - financed by bank $0 $28
</TABLE>
- ----------------------------------------------
The accompanying notes are an integral part of these financial statements.
-4-
<PAGE> 7
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY (Note 4)
- --------------------------------------------------------------------------------
(Unaudited)
(In thousands, except for number of shares)
<TABLE>
<CAPTION>
Net Unrealized
Common Stock Retained Gains (Losses)
Shares Amount Earnings On Securities Total
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1993 3,799,477 34,678 6,489 41,167
- --------------------------
========================================================================
Adoption of SFAS No. 115 $1,143 1,143
Net Income for 1994 10,360 10,360
Stock Options Exercised 16,100 96 96
10% Stock Dividend 380,295 9,128 (9,128)
Fractional Shares Purchased 563 15 15
Valuation of Available For Sale
Securities (2,322) (2,322)
------------------------------------------------------------------------
Balance, December 31, 1994 4,196,435 43,917 7,721 (1,179) 50,459
- --------------------------
========================================================================
Net Income for 1995 12,615 12,615
Stock Options Exercised 24,821 159 159
Three-for-two Stock Split 2,100,651 0
Fractional Shares Purchased 348 8 8
Unrealized gains on transfer from held to maturity
to available for sale, net of tax effect 237 237
Valuation of Available for Sale
Securities 1,875 1,875
------------------------------------------------------------------------
Balance, December 31, 1995 6,322,255 $44,084 $20,336 $933 $65,353
- --------------------------
========================================================================
Net Income for the first
six months of 1996 7,237 7,237
Stock Options Exercised 12,158 49 49
7% Stock Dividend 442,831 11,956 (11,956) 0
Fractional Shares Purchased 797 20 20
Shares exchanged for minority
investment 31,155 904 904
Valuation of Available for Sale
Securities (1,586) (1,586)
------------------------------------------------------------------------
Balance, June 30, 1996 6,809,196 $57,013 $15,617 ($653) $71,977
- ---------------------
========================================================================
</TABLE>
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<PAGE> 8
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles
for interim financial information, and with instructions to Form 10-Q
and Rule 10-01 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by generally accepted
accounting principles for complete financial statements. All
adjustments made to the unaudited interim financial statements were of
a normal recurring nature. In the opinion of management, all
adjustments considered necessary for a fair presentation have been
included. Operating results for the six months ended June 30, 1996 are
not necessarily indicative of the results that may be expected for
year-end December 31, 1996. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Corporation Annual Report on Form 10-K for the year ended December 31,
1995.
NOTE 2. INVESTMENT SECURITIES
On January 1, 1994, the Corporation adopted Statement of Financial
Accounting Standard No. 115 (FAS 115), "Accounting for Certain
Investments in Debt and Equity Securities". This statement establishes
standards of financial accounting and reporting for investments in debt
and equity securities that have a readily determinable fair value. This
statement requires all securities within the Corporation's portfolio to
be classified in one of three groups: 1) Trading securities; 2)
securities Held-To-Maturity (HTM), and 3) securities Available-For-Sale
(AFS).
At June 30, 1996, the Corporation had no securities classified as
"Trading", and all other securities in the portfolio were classified as
HTM or AFS.
Securities that are classified as HTM, are carried at cost, adjusted
for amortization of premiums and accretion of discounts which are
recognized as adjustments to income. With some exceptions, securities
classified as HTM may only be sold within three months of maturity.
Securities that are classified as AFS, are carried at fair value,
adjusted for amortization of premiums and accretion of discounts which
are recognized as adjustments to income. Unrealized gains and losses
are excluded from earnings and reported as a separate component of
equity capital. AFS securities may be sold at any time.
Gains and losses on both HTM and AFS securities that are disposed of
prior to maturity, are based on the net proceeds and the adjusted
carrying amount of the specific security sold as an adjustment to
income.
-6-
<PAGE> 9
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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NOTE 2 - (Continued)
- --------------------------------------------------------------------------------
The tables below display the characteristics of the AFS and HTM portfolios as of
June 30, 1996:
<TABLE>
<CAPTION>
AGGREGATE FAIR VALUE AND AMORTIZED COST OF INVESTMENTS
(In thousands) Amortized Gross Unreal- Gross Unreal- Aggregate
Cost ized Gains ized Losses Fair Value
----------------------------------------------------------
AFS SECURITIES:
<S> <C> <C> <C> <C>
Equities $8,727 $8,727
U.S. Treasuries 2,759 40 2,799
U.S. Agencies 48,678 100 (953) 47,825
Corporate securities 42,712 312 (520) 42,504
Mortgage Backed Securities 300 17 317
----------------------------------------------------------
103,176 469 (1,473) 102,172
HTM SECURITIES:
U.S. Agencies 1,900 5 (1) 1,904
Municipal securities 31,194 872 (314) 31,752
Corporate securities 4,037 1 (11) 4,027
Mortgage Backed Securities 95 (3) 92
Certificates of deposit 3,600 3,600
----------------------------------------------------------
Totals $40,826 $878 ($329) $41,375
----------------------------------------------------------
Totals $144,002 $1,347 ($1,802) $143,547
==========================================================
</TABLE>
<TABLE>
<CAPTION>
MATURITY SCHEDULE OF SECURITIES
Available For Sale Held To Maturity
Amortized Fair Amortized Fair
MATURITY Cost Value Cost Value
-------- ---- ----- ---- -----
<S> <C> <C> <C> <C>
0-1 Yr $22,709 $22,712 $9,762 $9,751
1-5 Yrs 26,271 26,241 1,244 1,277
5-10 Yrs 52,654 51,677 17,158 17,486
Over 10 Yrs 1,542 1,542 12,662 12,861
------------------------------------------------
$103,176 $102,172 $40,826 $41,375
================================================
</TABLE>
-7-
<PAGE> 10
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - (Continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CHANGES IN AFS AND HTM SECURITIES
For the Quarter Ended June 30, 1996:
<S> <C>
AFS SECURITIES
Proceeds From Sales $0
Gross Realized Gains --
Gross Realized Losses --
Gross Gains & Losses Included In Earnings From
Transfers To The Trading Category --
Net Change In Unrealized Holding Gains Or
Losses Included In The Separate
Component of Equity Capital ($1,586)
HTM SECURITIES
Sales Or Transfers From this Category $0
</TABLE>
NOTE 3. LOANS
The following is an analysis of the loan portfolio by major type
of loans:
<TABLE>
<CAPTION>
June 30, 1996 Dec 31, 1995
------------- ------------
<S> <C> <C>
Commercial $121,942 $127,239
Real Estate:
Commercial 216,852 172,327
Construction 114,769 96,639
Residential 95,540 92,711
Instalment 21,130 19,758
------------ -----------
570,233 508,674
Unearned Fee Income (4,425) (3,686)
------------ -----------
Total Loans $565,808 $504,988
============ ===========
</TABLE>
NOTE 4. The Board of Directors declared a three-for-two stock split
and a 7% stock dividend which were paid March 20, 1995 and March
18, 1996 respectively.
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<PAGE> 11
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- --------------------------------------------------------------------------------
AND RESULTS OF OPERATIONS.
- --------------------------------------------------------------------------------
HIGHLIGHTS
Consolidated net income of the Corporation for the second quarter of 1996 was
$3.6 million versus $3.0 million for the second quarter of 1995, or up 21.4%.
The reasons for the results in 1996 were due to an increase in net interest
income of $1.3 million, or 15.5%, and a reduction in overhead costs of $100
thousand, or 2.1%. This marks the fiftieth consecutive quarter in which
Frontier's earnings exceeded the prior years' comparable quarter. In the
discussion below, comparison is with the second quarter of 1995, unless
otherwise stated.
Annualized return on average assets (ROA) was 1.96% in 1996, and 1.77% in 1995.
Annualized return on average stockholder's equity (ROE) in 1996 was 20.23%, as
compared to 20.96% in 1995. Earnings per share were $.53 for 1996, and $.44 for
1995. Earnings per share have been adjusted for the seven percent stock dividend
paid on March 18, 1996.
FINANCIAL REVIEW - ECONOMIC ENVIRONMENT
The lending and other activities of Frontier are located in Snohomish County,
Washington, but also include the northern part of King County, Washington. The
major city in Snohomish County is Everett, and the major city in King County is
Seattle, the largest city in the state. An important segment of the Snohomish
County economy is the Boeing Company, which has its 747 and 777 assembly plant
in Everett. Boeing also has other assembly plants and facilities in the Puget
Sound area. In 1994, Boeing completed a workforce reduction of 19% which began
in 1993. In 1995, there was an announcement that Boeing will continue its
workforce reductions, which effected 12,000 additional personnel. Recently,
however, Boeing announced they may need to hire 6,700 for new jobs. It has been
reported that Boeing stagnates in the first half of the decade and grows in the
second half. It may take awhile before the impact of increased employment can be
noticed, if at all. Since the first quarter of 1995, management had noticed a
decline in the number of loan applications. This trend continued into the first
quarter of 1996, however, in the second quarter, loan demand has surged. Perhaps
due to Boeing activity, or, perhaps, due to the near-term arrival of the
aircraft carrier group to the new naval facility here in Everett, or, perhaps, a
combination of the two coupled with ambient economic activity in other regions
of Puget Sound. Regardless, the Corporation is experiencing an increase in net
interest income, but remains cautiously optimistic.
BALANCE SHEET
Below are abbreviated balance sheets at the end of the respective quarters which
indicate the changes that have occurred in the major portfolios of the
Corporation over the past year:
<TABLE>
<CAPTION>
Period ended June 30, 1996 1995 $ Change % Change
- --------------------- ---------------------------------------------
<S> <C> <C> <C> <C>
Loans $565,808 $480,891 $84,917 17.7%
Investments* 142,998 134,651 8,347 6.2%
Federal Funds Sold 12,070 54,180 (42,110) -77.7%
Total Assets $755,852 $700,337 $55,515 7.9%
</TABLE>
* Shown at amortized cost.
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<PAGE> 12
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Balance Sheet - (Continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Period ended June 30, 1996 1995 $ Change % Change
- --------------------- ------------------------------------------------------------------
<S> <C> <C> <C> <C>
Noninterest bearing deposits $84,163 $77,263 $6,900 8.9%
Interest bearing deposits 543,321 535,441 7,880 1.5%
------------------------------------------------------------------
Total deposits 627,484 612,704 14,780 2.4%
Federal Funds purchased
and Repurchase Agreements 10,602 1,180 9,422 798.5%
Long-term debt 40,123 22,662 17,461 77.0%
Capital $71,977 $57,698 $14,279 24.7%
</TABLE>
At quarter end 1996, loans were up 17.7% over the previous year, while
investments increased 6.2%. At the end of the first quarter of 1996, loans had
grown $11.8 million, or 2.3%, since the end of 1995. Increased loan demand in
the second quarter added $49.0 million, or 9.5% to the loan totals. The
year-to-date increase in loans for 1996 was $60.8 million, or 12.0%. For the
first six months of 1995, loans increased only $10.4 million, or 2.2%.
To fund the rapid increase in loan demand in the second quarter of 1996, both
the asset and liability sides of the balance sheet contributed. Federal funds
sold decreased $42.1 million, or 77.7%, from the same period ended a year ago.
Almost all of that decrease came in the second quarter, with funds declining
$40.4 million, or 77.0%.
Investments increased over the last year by $8.3 million, or 6.2%, which was
due, mainly, to systematic investing of excess funds in the second half of 1995.
On the liability side, deposits increased only 2.4% during this period, and, as
a result of the increase in loan totals, federal funds purchased, repurchase
agreements and borrowings from the Federal Home Loan Bank (FHLB) accounted for
$26.9 million of the funding.
The mix of the interest bearing deposits looks somewhat different than it has in
quarters prior to 1996. At quarter end 1996, NOW and Money Market accounts had
increased $6.1 million, or 8.9%; savings accounts increased $5.7 million, or
4.0%, and time deposits continued to run off, but at a lower rate, decreasing
$3.9 million, or 1.2%. In quarters prior to 1996, NOW and Money Market accounts
were decreasing and time cd's were increasing.
In 1995, the prime rate hit a peak of 9.0% and leveled off in the third quarter.
From the third quarter 1995 to present, the prime rate has declined three times
to 8.25% today. At the end of the first quarter 1996, the change in net interest
income, which is interest income less interest expense, was a decrease of $79
thousand. At the end of the second quarter 1996, the change was an increase of
$1.3 million. This strong increase in the net interest margin (NIM), which is
net interest income as an annualized percent of total average quarterly assets,
was due to two factors. 1) Time cd's are repricing at lower rates, and 2)
increased loan volume in the second quarter. The NIM for the second quarter of
1996 was 5.29% compared with 4.86% for the first quarter of 1996.
-10-
<PAGE> 13
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Net Interest Income
- --------------------------------------------------------------------------------
NET INTEREST INCOME
Net interest income is the difference between total interest income and total
interest expense. Several factors contribute to changes in net interest income.
These include the effects of changes in average balances, changes in rates on
earning assets and rates paid for interest bearing liabilities, the level of
noninterest bearing deposits, stockholder's equity, and the level of nonaccrual
loans.
The earnings from certain assets are exempt from federal income tax, and it is
customary in the financial services industry to analyze changes in net interest
income on a "tax equivalent" or fully taxable basis. Under this method,
nontaxable income from loans and investments is adjusted to an amount which
would have been earned if such income were subject to federal income tax. The
discussion below presents an analysis based on "taxable equivalent" amounts at a
35% tax rate. (However, there are no tax equivalent additions to interest
expense or noninterest income and expense amounts discussed below.) Abbreviated
quarterly average balance sheets and net interest income data for the periods
are shown below:
<TABLE>
<CAPTION>
(In thousands)
Quarter ended June 30, 1996 1995 $ Change % Change
- ---------------------- ---- ---- -------- --------
<S> <C> <C> <C> <C>
Loans $540,717 $479,328 $61,389 12.8%
Investments * 143,082 135,717 7,365 5.4%
Federal Funds Sold 16,786 26,494 (9,708) NM
Total Earning Assets 700,585 641,539 59,046 9.2%
----------------------------------------------------
Total Assets 733,721 670,402 63,319 9.4%
Noninterest bearing deposits 80,558 70,766 9,792 13.8%
Interest bearing deposits 546,009 512,968 33,041 6.4%
----------------------------------------------------
Total deposits 626,567 583,734 42,833 7.3%
Fed Funds purchased
and repurchase agreements 12,773 329 12,444 3782.4%
Long-term Debt 16,388 22,993 (6,605) -28.7%
Capital 71,229 56,614 14,615 25.8%
Total interest income 16,908 15,565 1,343 8.6%
Total interest expense 7,201 7,118 83 1.2%
----------------------------------------------------
Net Interest Income $9,707 $8,447 $1,260 14.9%
</TABLE>
* Shown at amortized cost.
In 1996, average earning assets as a percent of total average assets were 95.6%,
and 95.7% in 1995. This ratio indicates how efficiently assets are being
utilized. Average loans were 73.7% and 71.5% respectively, indicating a solid
increase in the second quarter of 1996. Investments as a percent of average
assets for the same periods were 19.6% as compared to 20.2%. Federal funds sold
decreased $9.7 million, or 36.6% due to increased loan demand in the second
quarter.
Total deposits, on an average balance basis, increased 7.3%. Not indicated in
the table above are the components of interest bearing deposits which increased
6.4%. NOW and Money Market accounts
-11-
<PAGE> 14
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Net Interest Income - (Continued)
- --------------------------------------------------------------------------------
increased $4.7 million, or 7.0%; savings accounts decreased $3.8 million, or
2.5%, and time cd's increased $32.1 million, or 10.6%.
The yield on earning assets in 1996 decreased .06%, from 9.84% in 1995 to 9.78%
in 1996. The cost of interest bearing liabilities decreased .30%, from a 5.38%
in 1995 to a 5.08% in 1996. When comparing the second quarter of 1996 to the
first quarter of 1996, liabilities are repricing at a faster rate.
On a tax equivalent basis, net interest income was $9.7 million in 1996, versus
$8.4 million in 1995. For an increase in net interest income of $1.3 million.
During the second quarter, interest income increased $1.4 million, and interest
expense increased $.1 million, for a net change in net interest income of $1.3
million.
The increase in the average balance of earning assets increased interest income
by $1.6 million, and a decrease in interest rates decreased interest income by
$.2 million, for a net increase of $1.4 million.
The yield on loans decreased from 10.84% in 1995 to 10.61% in 1996. Real estate
mortgage loans had the only increase in yield from 10.26% to 10.33%. Real estate
commercial loans decreased in yield from 10.28% to 10.12%. Real estate
construction loans declined in yield from 12.69% to 12.24%. Business loans
decreased from 10.73% to 10.41%, and installment loans decreased from 10.00% to
9.58%. The yield on investments increased from 7.05% in 1995 to 7.17% in 1996,
and the yield on Fed Funds sold decreased from 6.13% in 1995 to 5.36% in 1996.
The increase in the average balance of interest bearing liabilities increased
interest expense by $.6 million, and the rates paid on interest bearing
liabilities decreased interest expense by $.5 million, for a total increase
during the period of $.1 million.
The cost of NOW and money market accounts went from 3.16% in 1995, to 2.92% in
1996. Savings accounts cost decreased from 4.24% in 1995 to 4.03% in 1996, and
time cd's decreased in cost from 6.42% in 1995 to 6.00% in 1996. Short term
borrowings decreased from 5.76% to 5.02%, and long term debt cost was 5.98% in
1995 and 5.34% in 1996.
NONINTEREST INCOME AND EXPENSE
Total noninterest income increased in the second quarter by $50 thousand due to
an increase in loan service fee income of $24 thousand, and an increase in trust
department fees of $41 thousand, or 27.9%. Broker loan fees remained almost flat
at $35 thousand. Service charge income was down slightly despite an increase in
demand and interest bearing checking accounts of 251 accounts. Higher average
balances account for the decrease.
The market value of trust assets at quarter end 1996 was $109.6 million, as
compared to $93.0 million for the prior year, or an increase of $16.6 million,
or 17.8%.
Total noninterest expenses decreased $100 thousand, or 2.1% in 1996. Salaries
and Employee Benefits increased $257 thousand, to $2.7 million, or 10.6%.
Salaries, alone, increased $192 thousand to $2.1 million, or 10.0% from $1.9
million a year ago. Employee benefits increased $65 thousand to $.6
-12-
<PAGE> 15
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Noninterest Income and Expense - (Continued)
- --------------------------------------------------------------------------------
million, or 13.1% from $.5 million a year ago. The increase in salaries was due
to an increase in staff over the year and merit raises. The employee benefits
increase of $65 thousand was attributable to an increase in the profit sharing
reserve of $52 thousand, of which part was a timing difference. Deferred
personnel costs associated with deferred loan fees increased $30 thousand, to
$235 thousand.
Occupancy expense increased $28 thousand, or 5.1% in 1996. 39.3%, or $226
thousand of occupancy expense was depreciation in 1996, and $212 thousand, or
38.8% was depreciation expense in 1995. Excluding depreciation, occupancy
expense increased $16 thousand.
Other expense declined $386 thousand in 1996, or 21.6%. This decrease is due
mainly to the elimination of FDIC insurance premiums for the 1996 period. In
1995, the FDIC reached its mandatory funding level, and, if a bank is classified
as "well capitalized", as Frontier is, then no premiums are payable until such
time as the Bank Insurance Fund drops below the level established by law.
LOANS
IMPAIRED ASSETS (Previously known as non-performing assets)
Non-performing assets are summarized as follows:
<TABLE>
<CAPTION>
(In thousands)
Period Ended June 30, 1996 1995
- --------------------------------------- ---- ----
<S> <C> <C>
Non-accruing loans $ 2,121 $ 1,926
Loans past due 90 days or more and
still accruing 0 5
Restructured loans 136 139
Other real estate owned 567 1,246
---------------------
Total non-performing loans $ 2,824 $ 3,316
=====================
Total loans at end of period $565,808 $480,891
---------------------
As a percent of total loans outstanding 0.50% 0.69%
=====================
</TABLE>
It is the banks practice to discontinue accruing interest on loans that are
delinquent in excess of 90 days. Some problem loans which are less than 90 days
delinquent are also placed into non-accrual status if the success of collecting
full principal and interest is in doubt.
Restructured loans are those loans that had problems in the past, and that have
been restructured in such a way that some forgiveness of debt or other terms has
occurred.
Management works diligently on the collection or liquidation of non-performing
assets. The overall level of non-performing assets to total loans is felt to be
modest. Other real estate owned is comprised of four separate parcels of which
one is a house and the remainder are commercial land parcels. There is an
agreement to purchase contingent on building permits on one parcel, and one
other is sold on terms. As of June 30, 1996, all in-substance foreclosures are
included in other real estate owned, and the carrying values of all parcels are
below their market value.
-13-
<PAGE> 16
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Impaired Assets - (Continued)
- --------------------------------------------------------------------------------
CREDIT CONCENTRATIONS
There is some concentration of credit in the real estate construction and land
development industry. These loans totaled $98.1 million in 1996, or 17.3% of
total loans, and $81.2 million in 1995, or 16.9% of total loans. Many years ago,
management established a real estate loan committee which meets quarterly to
review the economic conditions and building industry trends. As a result of
these and other efforts, there have been very limited losses on these types of
loans. The bank's trade area has enjoyed a stable real estate market. Lower
interest rates in the spring of 1996 helped facilitate a strong level of sales
and real estate activity in general. Recently, interest rates have edged up,
however, no significant slowdowns are noted at this time, and management is
cautiously optimistic as to the real estate markets prospects in the months
ahead.
At June 30, 1996 and 1995, the Corporation had an immaterial amount of foreign
loans and no loans related to highly leveraged transactions.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
For the quarter ended June 30, 1996, the allowance for possible loan losses
decreased to $12.2 million, or 2.15% of total loans, from $12.7 million, or
2.63% of total loans in 1995. The current decline is primarily the result of
recent loan portfolio growth. Net loan losses for 1996 are $248 thousand.
Management closely monitors the adequacy of the loan loss reserve, and an
analysis is performed regularly.
In determining the adequacy of the allowance, management considers numerous
factors, including the continuing level of non-performing loans, credit
concentrations, and economic conditions. Real estate values continue to be
stable and show modest rates of appreciation, but a worsening of the economy in
Frontier's market area could negatively affect loan performance and underlying
collateral values. The current level of reserves is deemed to be adequate for
the present conditions, the type of lending undertaken, and provides for some
unforeseen contingencies as well.
LIQUIDITY AND INTEREST RATE SENSITIVITY
LIQUIDITY
The primary function of asset/liability management is to ensure adequate
liquidity and maintain an appropriate balance between interest sensitive earning
assets and liabilities. Liquidity management involves the ability to meet the
cash flow requirements of customers who may be either depositors wanting to
withdraw funds, or depositors who have credit needs.
The statement of cash flows on page 3 and 4 of this report provides information
on the sources and uses of cash for the respective year-to-date periods ending
June 30, 1996 and 1995. This discussion addresses those periods of time.
Net cash provided by operating activities in 1996 totaled $7.6 million as
compared to $7.8 million in 1995. The largest component providing net cash was
income of $7.2 million in 1996 and $6.1 million in 1995.
-14-
<PAGE> 17
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Liquidity - (Continued)
- --------------------------------------------------------------------------------
Real estate secondary market loans originated for sale in 1996 were up $3.9
million, from the same period in 1995. This is a change in the trend from last
year when secondary market loans were declining substantially due to increasing
long-term interest rates. The 1996 year-to-date cash flows from this function
look favorable for increased fee income.
Investing activities for 1996 were heavily concentrated in the loan portfolio
which required $61.2 million in funding. Investment maturities were reinvested
prior to the upswing in loan demand. Net cash flows of $43.9 million from
federal funds sold were used to fund the growth in the loan portfolio.
In 1996, a change in the trend of financing activities has occurred. For several
quarters now, the growth in assets has been funded by core deposits and cd's
were declining. This is evidenced by the large cash flows from cd's in the 1995
period of $122.4 million. Note, however, that in 1996, cd's required cash flows,
while core deposits provided cashflows. Management is responsible for the change
in this trend by reducing the rates paid on cd's in 1995 several times. This is
also true in 1996 up until the second quarter when increased cd rates were
necessary to fund loan growth.
Management has many sources of liquidity, such as the sale of AFS securities,
additional borrowings from the FHLB, participation in the Treasury department's
short-term note program, borrowings from the Federal Reserve Bank, or additional
borrowings at correspondent banks. In addition to AFS securities, treasury and
agency securities in the HTM securities portfolio are also subject to sale under
repurchase agreements. The Corporation has a policy that liquidity of 12.5% of
total assets be maintained as a minimum and has done so.
INTEREST RATE SENSITIVITY
Interest rate sensitivity is closely related to liquidity because each is
directly affected by maturity, or repricing, of assets and liabilities.
Management considers any asset or liability which matures, or is subject to
repricing, within one year to be interest sensitive, although continual
monitoring is also performed for other time intervals. The difference between
interest sensitive assets and liabilities for a defined period of time is known
as the interest sensitive "gap", and may be either positive or negative. If
positive, more assets reprice before liabilities. If negative, the reverse is
true. In theory, if the gap is positive, a decrease in general interest rates
might have an adverse impact on earnings as interest income decreases faster
than interest expense. Conversely, an increase in interest rates would increase
net interest income as interest income increases faster than interest expense.
However, the exact impact of the gap on future income is uncertain both in
timing and amount because interest rates for the Corporation's assets and
liabilities do not necessarily change at the same time, or by the same amount.
Also, the sensitivity of the assets and liabilities can change rapidly as the
result of market conditions and customer patterns.
At the end of the second quarter of 1995, the gap of the Corporation was a
negative (15.7%) of earning assets, with rate sensitive liabilities exceeding
rate sensitive assets. This would suggest that decreasing general interest rates
would increase the NIM. Since that time, the Corporation decreased prime rate
-15-
<PAGE> 18
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Interest Rate Sensitivity - (Continued)
- --------------------------------------------------------------------------------
three times from 9.00% to 8.25%, and the NIM did, in fact, increase from 5.04%
to 5.29% at the end of June 1996. At the end of June 1996, the gap became more
negative and increased to (25.1%) of earning assets. This indicates that over
the past year, the Corporation has become more liability sensitive. Although the
gap acted as defined in this instance, the gap should not be relied upon as an
accurate gauge of what will happen to future earnings if interest rates move.
The gap cannot anticipate management actions with regard to when rates are
actually increased or decreased, and to what degree, but the gap does indicate
the ability management may have to change rates.
THE CORPORATION DOES NOT USE INTEREST RATE RISK MANAGEMENT PRODUCTS SUCH AS
INTEREST RATE SWAPS OR HEDGES, OR OTHER DERIVATIVE SECURITIES.
CAPITAL
In 1994, the Federal Reserve and other regulatory agencies issued final
amendments to its risk-based capital rules. Under these rules, institutions are
directed not to include in Tier I & II capital, the net unrealized holding gains
(losses) on available-for-sale securities. In addition, net unrealized losses on
marketable equity securities should continue to be deducted when computing Tier
I & II capital. This rule has the effect of valuing available-for-sale debt
securities at amortized cost, rather than fair value, for purposes of
calculating the risk-based and leverage capital ratios. Therefore, the
Corporation will now report capital for both financial statement purposes and
regulatory purposes.
Consolidated capital of the Corporation for financial statement purposes at
second quarter end 1996 was $72.0 million. This amount compares to $57.7 million
at June 30, 1995, an increase of $14.3 million, or 24.8%. Almost all of the
increase was attributable to retained earnings.
Under the regulatory rules referred to above, banks and holding companies are
required to maintain a minimum "leverage" ratio (primary capital ratio) of core
capital (which excludes the allowance for loan losses) to total average assets
for the current quarter. For the most highly rated holding companies, this ratio
must be at least 3 percent, and for others, it must be 4 or 5 percent. At June
30, 1996, the Corporation's leverage ratio was 9.85%, compared to 8.56% at
quarter end 1995. In addition, holding companies are required to meet minimum
risk-based capital guidelines, under which risk percentages are assigned to
various categories of assets and off-balance-sheet items to calculate a
risk-adjusted capital ratio. Tier I capital generally consists of common
stockholder's equity, less goodwill and some intangibles, while Tier II capital
includes the allowance for possible loan losses, subject to 1.25% limitation of
risk-adjusted assets. Regulatory capital requires Tier I capital of 4% of
risk-adjusted assets and total capital (combined Tier I and Tier II) of 8%.
Based on these requirements, the Corporation's Tier I and combined Tier II
capital ratios were 11.48% and 12.74% at June 30, 1996, and 10.34% and 11.60% at
June 30, 1995.
Management constantly monitors the level of capital of the Corporation, and
believes that capital is adequate to meet present needs. As an ongoing process,
management considers, among other things, the present and anticipated needs of
the Corporation, current market conditions, and other relevant factors,
including regulatory requirements which may necessitate changes in the level of
capital.
-16-
<PAGE> 19
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. Legal Proceedings
No material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
The 1996 Annual Meeting of Shareholders was held on April 16, 1996. At
that meeting, the only item to be voted upon was the election of
directors. Of 6,770,328 shares outstanding and authorized to vote,
5,373,072 were represented in person or by proxy. There were proxies
representing 4,818,102 shares, and there were persons in attendance
representing 554,970 shares. 79.4% of the total outstanding shares were
represented at the meeting. Each incumbent director was re-elected as
shown below with the affirmative votes cast for each director indicated
next to their name.
<TABLE>
<S> <C> <C> <C>
Robert J. Dickson 5,362,909 J. Donald Regan 5,362,106
David A. Dujardin 5,362,909 Roger L. Rice 5,344,453
Edward D. Hansen 5,361,764 Roy A. Robinson 5,362,325
William H. Lucas 5,354,115 William J. Robinson 5,343,000
James H. Mulligan 5,354,881 Edward C. Rubatino 5,362,909
Alwyn L. Nelson 5,334,921 Arthur W. Skotdal 5,322,290
Edward J. Novack 5,362,909
</TABLE>
Item 5. Other Information
During the month of April 1996, the Bank received regulatory approvals
to open a branch at 2825 NE 125th St., Seattle (Lake City), Washington.
Lake City is in the northern part of Seattle. The branch will be named
the Lake City Office, and will open in August 1996.
At the June 1996 meeting of the Board of Directors, Chairman of the
Board, Mr. Skotdal and Director Nelson resigned from the boards of the
Corporation, Bank and FFP, Inc. Their resignations were not due to a
disagreement on any matter relating to the Corporation's operations,
policies or practices.
Item 6. Exhibits and Reports on Form 8-K
(a)(11) Computation of earnings per share is attached as
Exhibit II.
(27) Financial Data Schedule - This exhibit is included
only in the electronic EDGAR filing version of this
Form 10-Q. The financial data schedule is not a
separate financial statement, but a schedule that
summarizes certain standard financial information
extracted directly from the financial statements in
this filing.
(b) No amendments to filed documents or reports on Form
8-K have been filed in the quarter ended June 30,
1996.
-17-
<PAGE> 20
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
SIGNATURE
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRONTIER FINANCIAL CORPORATION
Date: July 24, 1996 /s/ James F. Felicetty
-------------------- ----------------------------------
James F. Felicetty
Secretary/Treasurer
-18-
<PAGE> 1
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES EXHIBIT II
- --------------------------------------------------------------------------------
COMPUTATION OF EARNINGS PER SHARE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For Six Months Ended June 30,
1996 1995
---------- ----------
<S> <C> <C>
Net Income $7,236,396 $6,051,077
========== ==========
Computation of average
shares outstanding
Shares outstanding at
beginning of year 6,322,255 4,196,435
Additional shares deemed
outstanding because of
stock dividends 443,628 441,195
Additional shares deemed
outstanding because of
stock split 0 2,100,650
Shares issued during the
year times average time
outstanding during the year 17,157 5,702
---------- ----------
Average shares outstanding 6,783,040 6,743,982
========== ==========
Primary earnings per share $1.07 $0.90
========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FRONTIER
FINANCIAL CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S.
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<EXCHANGE-RATE> 1
<CASH> 24,316
<INT-BEARING-DEPOSITS> 3,600
<FED-FUNDS-SOLD> 12,070
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 102,172
<INVESTMENTS-CARRYING> 37,226
<INVESTMENTS-MARKET> 41,375
<LOANS> 565,808
<ALLOWANCE> (12,189)
<TOTAL-ASSETS> 755,852
<DEPOSITS> 627,484
<SHORT-TERM> 10,602
<LIABILITIES-OTHER> 5,789
<LONG-TERM> 40,000
0
0
<COMMON> 57,013
<OTHER-SE> 14,964
<TOTAL-LIABILITIES-AND-EQUITY> 755,852
<INTEREST-LOAN> 27,443
<INTEREST-INVEST> 5,509
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 32,952
<INTEREST-DEPOSIT> 14,169
<INTEREST-EXPENSE> 14,849
<INTEREST-INCOME-NET> 18,103
<LOAN-LOSSES> (500)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 8,424
<INCOME-PRETAX> 10,869
<INCOME-PRE-EXTRAORDINARY> 10,869
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,236
<EPS-PRIMARY> 1.07
<EPS-DILUTED> 1.07
<YIELD-ACTUAL> 5.61
<LOANS-NON> 2,121
<LOANS-PAST> 0
<LOANS-TROUBLED> 136
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 11,898
<CHARGE-OFFS> 1,091
<RECOVERIES> 882
<ALLOWANCE-CLOSE> 12,189
<ALLOWANCE-DOMESTIC> 12,189
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
