<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 March 31, 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 6,770,370 shares
outstanding as of March 31, 1996.
<PAGE> 2
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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INDEX TO QUARTERLY REPORT ON FORM 10-Q
- -------------------------------------------------------------------------------
March 31, 1996
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PART I - Financial Information Page
- ------------------------------ ----
<S> <C>
Item 1. Financial Statements.
Consolidated Balance Sheet - March 31, 1996
and Year End 1995. 1
Consolidated Statement of Income - Three Months
Ended March 31, 1996 and 1995. 2
Consolidated Statement of Cash Flows - Three Months
Ended March 31, 1996 and 1995. 3-4
Statement of Changes in Stockholder's Equity -
March 31, 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
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CONSOLIDATED BALANCE SHEET (Note 1)
- --------------------------------------------------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
(In thousands)
March 31, December 31,
ASSETS 1996 1995
- ------ ---- ----
<S> <C> <C>
Cash & Balances Due from Depositary Institutions $ 26,005 $ 19,708
Securities: (Note 2)
Available for Sale-Market Value 99,626 102,300
Held to Maturity-Amortized Cost (Market Value 12-31-95, 41,574 42,676
-------- --------
Total Securities $43,889) 141,200 144,976
Federal Funds Sold 52,425 55,930
Loans: (Note 3)
Loans, Net of Unearned Income 516,174 504,717
Less: Allowance for Loan Losses (12,350) (11,897)
-------- --------
Net Loans 503,824 492,820
Mortgage Loans Held for Sale 589 271
Premises & Equipment, Net 11,658 11,758
Other Real Estate Owned 835 590
Intangible assets 454 473
Other Assets 9,775 8,657
-------- --------
TOTAL ASSETS $746,765 $735,183
======== ========
LIABILITIES
Deposits:
Non-Interest Bearing $83,565 $83,281
Interest Bearing 563,965 557,937
-------- --------
Total Deposits 647,530 641,218
Federal Funds Purchased 4,000 2,935
Securities sold under repurchase agreements 4,842 4,661
Federal Home Loan Bank advances 15,000 15,000
Long-term debt 144 136
Other Liabilities 7,167 5,880
-------- --------
TOTAL LIABILITIES 678,683 669,830
-------- --------
EQUITY CAPITAL (Note 4)
Common Stock 56,086 44,084
Unrealized Gains/(Losses) on AFS Securities
Net of Tax effect(Note 2) (19) 933
Retained Earnings 12,015 20,336
-------- --------
TOTAL CAPITAL 68,082 65,353
-------- --------
TOTAL LIABILITIES & CAPITAL $746,765 $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
------------------
March 31, March 31,
1996 1995
INTEREST INCOME ---- ----
<S> <C> <C>
Interest & Fees on Loans $ 13,311 $ 12,765
Interest on Investments 2,984 2,299
---------- ----------
Total Interest Income 16,295 15,064
---------- ----------
INTEREST EXPENSE
Interest on Deposits 7,343 5,758
Interest on Borrowed Funds 305 607
---------- ----------
Total Interest Expense 7,648 6,365
---------- ----------
Net Interest Income 8,647 8,699
---------- ----------
PROVISION FOR LOAN LOSSES (200) (700)
NONINTEREST INCOME
Securities Gains/(Losses) 0 0
Service Charges on Deposit Accounts 386 402
Other Noninterest Income 428 429
---------- ----------
Total Noninterest Income 814 831
NONINTEREST EXPENSE
Salaries & Employee Benefits 2,577 2,547
Occupancy Expense 443 581
Other Noninterest Expense 758 1,000
---------- ----------
Total Noninterest Expense 3,778 4,128
INCOME BEFORE INCOME TAX 5,483 4,702
---------- ----------
APPLICABLE INCOME TAX (1,848) (1,618)
NET INCOME $ 3,635 $ 3,084
========== ==========
Average Number of Shares Outstanding
for the Period 6,769,615 6,741,347
PER SHARE COMMON STOCK $ 0.54 $ 0.46
========== ==========
</TABLE>
- ----------------------------------------------
The accompanying notes are an integral part of these financial statements.
-2-
<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)
THREE MONTHS ENDED
------------------
CASH FLOWS FROM OPERATING ACTIVITIES March 31, 1996 March 31, 1995
- ------------------------------------ -------------- --------------
<S> <C> <C>
Net Income $ 3,635 $ 3,084
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 244 (80)
Provision for loan losses 200 700
Provision for losses on ORE 0 0
Increase in income taxes payable 1,599 1,015
Deferred taxes 0 0
Decrease in interest receivable (323) (557)
Increase(Decrease) in interest payable (285) 973
Loss on sale of HTM securities 0 0
Loans originated for sale (5,752) (3,413)
Proceeds from sale of loans 5,435 3,071
Other operating activities (264) 254
-------- --------
Net cash provided by operating activities 4,489 5,047
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Net cash flows from Fed Funds Sold 3,505 (26,505)
Proceeds from sales of HTM securities 0 0
Proceeds from maturities of investments 13,826 1,845
Purchase of AFS securities (11,405) 0
Purchase of HTM securities 0 (154)
Net cash flows from loan activities (11,173) (4,975)
Purchases of premises and equipment (124) (61)
Proceeds from the sale of other real estate 0 696
Cash invested in other real estate (245) 0
Other investing activities 486 8
-------- --------
Net cash used by investing activities (5,130) (29,146)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Net change in demand deposit accounts 7,940 (36,160)
Net change in certificates of deposit (2,109) 72,262
Proceeds from issuance of stock 46 53
Principal payments on long term debt (38) (675)
Advances from FHLB 0 7,500
Repayment of FHLB advances 0 (7,500)
Net change in Federal Funds purchased 1,246 (9,615)
Other financing activities (147) 0
-------- --------
Net cash provided by financing activities 6,938 25,865
-------- --------
</TABLE>
(Continued on next page)
-3-
<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)
THREE MONTHS ENDED
------------------
March 31, 1996 March 31, 1995
-------------- --------------
<S> <C> <C>
INCREASE IN CASH AND DUE FROM BANKS $ 6,297 $ 1,766
CASH & DUE FROM BANKS AT BEGINNING
OF YEAR 19,708 22,081
------- -------
CASH AND DUE FROM BANKS AT END
OF PERIOD $26,005 $23,847
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 7,934 $ 5,386
Cash paid during the year for income taxes 250 600
Real estate taken as settlement for loan
obligations 0 0
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, 1992 1,144,898 27,974 5,283 33,257
================================================================
Net Income for 1993 7,746 7,746
Stock Options Exercised 10,377 138 138
10% Stock Dividend 114,557 6,540 (6,540)
Fractional Shares Purchased (Net) 441 26 26
Three-For-One Split 2,529,204
----------------------------------------------------------------
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
three months of 1996 3,635 3,635
Stock Options Exercised 4,487 26 26
7% Stock Dividend 442,831 11,956 (11,956) 0
Fractional Shares Purchased 797 20 20
Valuation of Available for Sale
Securities (952) (952)
----------------------------------------------------------------
Balance, March 31, 1996 6,770,370 $56,086 $12,015 ($19) $68,082
================================================================
</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 three months ended March 31, 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 three groups: 1) Trading securities; 2) securities
Held-To-Maturity (HTM), and 3) securities Available-For-Sale (AFS).
At March 31, 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
- --------------------------------------------------------------------------------
NOTE 2 - (Continued)
- --------------------------------------------------------------------------------
The tables below display the characteristics of the AFS and HTM portfolios as of
March 31, 1996:
AGGREGATE FAIR VALUE AND AMORTIZED COST OF INVESTMENTS
------------------------------------------------------
<TABLE>
<CAPTION>
(In thousands) Amortized Gross Unreal- Gross Unreal- Aggregate
Cost ized Gains ized Losses Fair Value
-----------------------------------------------------------
<S> <C> <C> <C> <C>
AFS SECURITIES:
Equities $ 7,680 $ 7,680
U.S. Treasuries 2,759 60 2,819
U.S. Agencies 44,785 202 (550) 44,437
Corporate securities 44,120 598 (359) 44,359
Mortgage Backed Securities 310 21 331
------------------------------------------------------------
99,654 881 (909) 99,626
HTM SECURITIES:
U.S. Agencies 1,906 12 (5) 1,913
Municipal securities 29,743 1,000 (110) 30,633
Corporate securities 5,802 (22) 5,780
Mortgage Backed Securities 103 103
Certificates of deposit 4,020 (2) 4,018
------------------------------------------------------------
Totals $ 41,574 $ 1,012 ($139) $ 42,447
------------------------------------------------------------
Totals $141,228 $ 1,893 ($1,048) $142,073
============================================================
</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 $ 19,925 $19,985 $ 11,942 $ 11,930
1-5 Yrs 28,523 28,672 1,125 1,165
5-10 Yrs 50,644 50,374 16,065 16,695
Over 10 Yrs 562 595 12,442 12,657
---------------------------------------------------------
$ 99,654 $99,626 $ 41,574 $ 42,447
=========================================================
</TABLE>
* Contractural maturity.
-7-
<PAGE> 10
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - (Continued)
- --------------------------------------------------------------------------------
CHANGES IN AFS AND HTM SECURITIES
For the Quarter Ended March 31, 1996:
<TABLE>
<CAPTION>
AFS SECURITIES
<S> <C>
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 ($952)
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>
March 31, 1996 Dec 31, 1995
-------------- ------------
<S> <C> <C>
Commercial $121,998 $127,239
Real Estate:
Commercial 186,497 172,327
Construction 99,015 96,639
Residential 92,458 92,711
Instalment 20,486 19,758
-------- --------
520,454 508,674
Unearned Fee Income (3,691) (3,686)
-------- --------
Total Loans $516,763 $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.
-8-
<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 reached a new high in the first
quarter of 1996. Net income was $3.6 million versus $3.1 million for the first
quarter of 1995, or up 17.9%. The reasons for the results in 1996 were due to a
reduction in the provision for loan losses, reflecting good loan quality, and a
decrease in noninterest expenses. This marks the forty-nineth consecutive
quarter in which Frontier's earnings exceeded the prior years' comparable
quarter. In the discussion below, comparison is with the first quarter of 1995,
unless otherwise stated.
Annualized return on average assets (ROA) was 1.99% in 1996, and 1.89% in 1995.
Annualized return on average stockholder's equity (ROE) in 1996 was 21.8%, as
compared to 22.9% in 1995. Earnings per share were $.54 for 1996, and $.46 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 has noted a
decline in the number of loan applications. This trend continues into 1996. In
1995, loan growth was only 7.2%, while deposits grew 18.8%. For the first three
months of 1996, loans grew $11.8 million, or 2.3%, a slightly higher growth rate
than 1995. Perhaps this is some indication of the effect of past employment
reductions on the local economy. In responding to this trend, management placed
increased emphasis on loan development beginning in the first quarter of 1995
and continues to do so. Management remains cautiously optimistic regarding the
future.
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 March 31, 1996 1995 $ Change % Change
- ---------------------- ---- ---- -------- --------
<S> <C> <C> <C> <C>
Loans $516,763 $477,226 $39,537 8.3%
Investments * 141,228 136,565 4,663 3.4%
Federal Funds Sold 52,425 27,625 24,800 89.8%
Total Assets $746,765 $674,608 $72,157 10.7%
</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 March 31, 1996 1995 $ Change % Change
- --------------------- -------- -------- --------- --------
<S> <C> <C> <C> <C>
Noninterest bearing deposits $ 83,565 $ 70,375 $ 13,190 18.7%
Interest bearing deposits 563,965 505,330 58,635 11.6%
-------- -------- --------- --------
Total deposits 647,530 575,705 71,825 12.5%
Federal Funds purchased
and Repurchase Agreements 8,842 0 8,842 NM
Long-term debt 15,144 37,879 (22,735) -60.0%
Capital $ 68,083 $ 54,075 $ 14,008 25.9%
</TABLE>
At quarter end 1996, loans were up 8.3% over the previous year, and investments
increased only 3.4%. The decreased loan activity was due to lack of qualified
loan applicants, and the decreased investment activity was due to the low yields
in the bond market on maturities up to 10 years. As a result, management opted
to have funds accumulate in overnight federal funds sold, which increased $24.8
million, or 89.8%, during the period.
While loan growth was disappointing, deposit growth was solid, increasing $71.8
million, or 12.5%. Money Market and NOW accounts grew $5.5 million, or 7.7% for
the first time in several quarters, but savings accounts ran off $17.3 million,
or 10.8%. Time deposits (cd's) increased $70.4 million, or 25.7% over the
period. Noninterest bearing deposits grew nicely at an increase of $13.2
million, or 18.7% for the period.
On a quarterly average balance basis, the same trend is also noticed. Cd's
increased, but NOW and Money Market accounts decreased $2.3 million, or 3.2%.
Savings accounts decreased $31.0 million, or 17.9%, and average cd's increased
$107.8 million, or 45.0%. In 1996, the net interest margin (NIM), which is net
interest income as an annualized percent of total average quarterly assets, of
the Corporation decreased. 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. The net interest margin for
the first quarter of 1996 was 4.86%, compared with 5.50% for the first quarter
of 1995. The decrease was attributable to declining yields on interest earning
assets outpacing the reduction in the cost of interest bearing liabilities. This
resulted from the lowering of Frontier's prime rate over the short period
mentioned above, and the slower repricing of interest bearing liabilities.
Management expects that the NIM will continue to decline until the third quarter
of this year.
The yield on earning assets in 1996 decreased .42%, from 9.99% in 1995 to 9.57%
in 1996. The cost of interest bearing liabilities increased .42%, from a 4.92%
in 1995 to a 5.34% in 1996. It would appear that the continued increase in the
cost of funds is slowing. Please see below for a further discussion.
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.
-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 - (Continued)
- --------------------------------------------------------------------------------
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:
(In thousands)
<TABLE>
<CAPTION>
Quarter ended March 31, 1996 1995 $ Change % Change
- ----------------------- ---- ---- -------- --------
<S> <C> <C> <C> <C>
Loans $506,752 $476,258 $30,494 6.4%
Investments *141,184 137,247 3,937 2.9%
Federal Funds Sold 52,543 8,960 43,583 NM
Total Earning Assets 700,479 620,889 79,590 12.8%
-------- -------- -------- ----
Total Assets 731,283 651,355 79,928 12.3%
Noninterest bearing deposits 76,613 67,938 8,675 12.8%
Interest bearing deposits 557,518 482,964 74,554 15.4%
-------- -------- -------- ----
Total deposits 634,131 550,902 83,229 15.1%
Fed Funds purchased 8,770 3,764 5,006 133.0%
Long-term Debt 15,145 38,352 (23,207) -60.5%
Capital 66,643 52,822 13,821 26.2%
Total interest income 16,533 15,329 1,204 7.9%
Total interest expense 7,648 6,365 1,283 20.2%
Net Interest Income $8,885 $8,964 ($79) -0.9%
</TABLE>
* Shown at amortized cost.
In 1996, average earning assets as a percent of total average assets were 95.8%,
and 95.3% in 1995. This ratio indicates how efficiently assets are being
utilized. Average loans were 69.3% and 73.1% respectively, indicating the
Corporation needs more good loans. Investments as a percent of average assets
for the same periods were 19.3% as compared to 21.1%. As noted from the table
above, federal funds sold increased to over $52 million due to lack of loan
demand. In the first quarter of 1996, management has began shifting some funds
from federal funds sold, into the investment portfolio to take advantage of
higher yields.
On a tax equivalent basis, net interest income was $8.9 million in 1996, versus
$9.0 million in 1995. For the first time, the net interest margin has decreased
from the same period a year earlier.
During the first quarter, interest income increased $1.2 million, and interest
expense increased $1.3 million, for a net change in net interest income of ($.1)
million.
-11-
<PAGE> 14
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Net Interest Income - (Continued)
- --------------------------------------------------------------------------------
The increase in the average balance of earning assets increased interest income
by $1.5 million, and a decrease in interest rates decreased interest income by
$.3 million, for a net increase of $1.2 million.
The yield on loans decreased from 10.87% in 1995 to 10.65% in 1996. Real estate
construction loans had an increase in yield from 12.27% to 12.73%. Real estate
commercial loans increased in yield from 8.87% to 10.06%. However, commercial
loans and real estate mortgage loans declined in yield. Commercial loans
decreased from 10.86% to 10.52%, and real estate mortgage loans decreased from
13.53% to 9.98%. The yield on investments increased from 7.17% in 1995 to 7.21%
in 1996, and the yield on Fed Funds sold decreased from 6.03% in 1995 to 5.48%
in 1996.
The increase in the average balance of interest bearing liabilities increased
interest expense by $1.0 million, and the rates paid on interest bearing
liabilities increased interest expense by $.3 million, for a total increase
during the period of $1.3 million.
The cost of NOW and money market accounts went from 3.02% in 1995, to 3.07% in
1996. Savings accounts cost decreased from 4.16% in 1995 to 4.11% in 1996, and
time cd's increased in cost from 5.85% in 1995 to 6.29% in 1996. Short term
borrowings decreased to 4.94% from 5.91%, and long term debt cost was 5.84% in
1995 and 5.35% in 1996. The cost of total interest-bearing liabilities increased
from 4.92% in 1995 to 5.34% in 1996.
NONINTEREST INCOME AND EXPENSE
Total noninterest income decreased in the first quarter by $16 thousand due to a
decrease in service charge income of the same amount. Although the total number
of deposit accounts increased by 2,400 over the past year, demand deposit
accounts decreased 406 over the period. This decline in the number of accounts
susceptible to service charges, and higher average balances, account for the
decrease.
Other income remained flat from a year ago, however, in 1995, a nonrecurring
gain on the sale of ORE was recorded in the first quarter which distorts the
comparative periods. If that gain is not considered, other income was up $75
thousand from the prior period. That increase is comprised of an increase in
trust department fees of $56 thousand, or 48.3%, and a slight increase in broker
loan fees of $3 thousand, which, hopefully, marks the "bottoming out" of the
decline in the secondary market loan origination business.
The market value of trust assets at quarter end 1996 was $105.4 million, as
compared to $77.3 million for the prior year, or an increase of 26.6%.
Total noninterest expenses decreased $350 thousand, or 8.5% in 1996. Salaries
and Employee Benefits increased $30 thousand, to $2.6 million, or 1.2%.
Salaries, alone, increased $142 thousand to $2.0 million, or 7.6% from $1.9
million a year ago. Employee benefits decreased $90 thousand to $.8 million, or
10.3% from $.9 million a year ago. The increase in salaries was due an increase
in staff over the year of 4.5%, and merit raises. The employee benefits decrease
of $90 thousand was attributable to a decrease in the profit sharing reserve of
$83 thousand, and a decrease in medical insurance costs of $21 thousand.
Deferred personnel costs associated with deferred loan fees increased $22
thousand, to $214 thousand.
-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)
- --------------------------------------------------------------------------
Occupancy expense decreased $138 thousand, or 23.8% in 1996. 50.6%, or $224
thousand of occupancy expense was depreciation in 1996, and $219 thousand, or
37.7% was depreciation expense in 1995. Excluding depreciation, occupancy
expense decreased $143 thousand, due mainly to relocation of several offices and
departments to permanent/owned quarters in 1995, and lower maintenance and
repairs for the period.
Other expense declined $242 thousand in 1996, or 24.3%. This decrease is due to
no FDIC insurance premiums for the 1996 period. In 1995, the FDIC reached it's
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 March 31, 1996 1995
- --------------------------------------- ---- ----
<S> <C> <C>
Non-accruing loans $ 3,013 $ 1,630
Loans past due 90 days or more and
still accruing 0 0
Restructured loans 120 125
Other real estate owned 835 394
--------- --------
Total non-performing loans $ 3,968 $ 2,149
========= ========
Total loans at end of period $516,763 $477,226
As a percent of total loans outstanding 0.77% 0.45%
========= ========
</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 five separate parcels of which
two are new houses and the remainder are commercial land parcels. There are
earnest money agreements on three of the parcels, and one home is sold. As of
March 31, 1996, all in-substance foreclosures are included in other real estate
owned, and the carrying values of all parcels are below their market value.
CREDIT CONCENTRATIONS
There is some concentration of credit in the real estate construction and land
development industry. These loans totaled $80.4 million in 1996, or 15.6% of
total loans, and $76.1 million in 1995, or 15.9%
-13-
<PAGE> 16
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Credit Concentrations - (Continued)
- --------------------------------------------------------------------------------
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. A slowdown in construction lending was
noted in 1995, however, with lower loan interest rates, activity should remain
stable to increasing during the first quarter.
At March 31, 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 March 31, 1996, the allowance for possible loan losses
decreased to $12.4 million, or 2.39% of total loans, from $12.5 million, or
2.61% of total loans in 1995. 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
March 31, 1996 and 1995. This discussion addresses those periods of time.
Net cash provided by operating activities in 1996 totaled $4.5 million as
compared to $5.0 million in 1995. The largest component providing net cash was
income of $3.6 million in 1996 and $3.1 million in 1995.
Real estate secondary market loans originated for sale in 1996 were up $2.3
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 equally concentrated in the loan and
investment portfolio's, with
-14-
<PAGE> 17
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Liquidity - (Continued)
- --------------------------------------------------------------------------------
loans requiring $11.2 million in funding, and investments requiring $11.4
million. In 1995, slack loan demand reduced funding to $5.0 million, whereas,
excess liquidity of $26.5 million went into federal funds sold. Most of the
funding in 1996 came from maturing investments of $13.8 million, and positive
cash flows from demand deposit accounts (core deposits). In 1995, funding of
investment activities came almost exclusively from cd cashflows.
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 $72.3 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. Management would expect this trend to continue until the NIM
improves.
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. Additionally, treasury and agency securities
in the HTM securities portfolio are 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 first quarter of 1995, the gap of the Corporation was a
negative (24.0%) 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
three times from 9.00% to 8.25%, and the NIM decreased from 5.50% to 4.86% at
the end of March 1996. At the end of March 1996, the gap was a negative (17.1%)
of earning assets. This indicates that over the past year, the Corporation has
become more asset sensitive. Since 1995, management has
-15-
<PAGE> 18
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Interest Rate Sensitivity - (Continued)
- --------------------------------------------------------------------------------
responded to the reduction in the NIM by reducing rates paid on liabilities, and
continued emphasis on overhead cost containment. 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
During 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
first quarter end 1996 was $68.1 million. This amount compares to $54.1 million
at March 31, 1996, an increase of $14.0 million, or 25.9%. Almost all of the
increase was attributable to retained earnings.
Under the 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 March 31,
1996, the Corporation's leverage ratio was 9.26%, compared to 8.35% 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 11.55% and
12.81% at March 31, 1996, and 10.08% and 11.35% at March 31, 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
There were no matters submitted to a vote of security holders in
the first quarter of 1996.
Item 5. Other Information
At the January 17, 1996 meeting of the Board of Directors of the
Corporation, a 7% stock dividend was declared, payable on March
18, 1996, to shareholders of record January 17, 1996.
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
the third quarter of 1996.
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 10Q. 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 March 31,
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: May 6, 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 Three Months Ended March 31,
1996 1995
---------- ----------
<S> <C> <C>
Net Income $3,634,974 $3,084,229
========== ==========
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 443,628 441,023
Additional shares deemed
outstanding because of
stock split 2,100,650
Shares issued during the
year times average time
outstanding during the year 3,732 3,239
---------- ----------
Average shares outstanding 6,769,615 6,741,347
========== ==========
Primary earnings per share $0.54 $0.46
========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FRONTIER
FINANCIAL CORP. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S.
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<EXCHANGE-RATE> 1
<CASH> 26,005
<INT-BEARING-DEPOSITS> 563,965
<FED-FUNDS-SOLD> 52,425
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 99,626
<INVESTMENTS-CARRYING> 41,574
<INVESTMENTS-MARKET> 42,447
<LOANS> 516,763
<ALLOWANCE> 12,350
<TOTAL-ASSETS> 746,765
<DEPOSITS> 647,530
<SHORT-TERM> 8,842
<LIABILITIES-OTHER> 7,167
<LONG-TERM> 15,144
56,086
0
<COMMON> 0
<OTHER-SE> 11,996
<TOTAL-LIABILITIES-AND-EQUITY> 746,765
<INTEREST-LOAN> 13,311
<INTEREST-INVEST> 2,984
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 16,295
<INTEREST-DEPOSIT> 7,343
<INTEREST-EXPENSE> 7,648
<INTEREST-INCOME-NET> 8,647
<LOAN-LOSSES> 200
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 3,778
<INCOME-PRETAX> 5,483
<INCOME-PRE-EXTRAORDINARY> 3,635
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,635
<EPS-PRIMARY> .54
<EPS-DILUTED> 0
<YIELD-ACTUAL> 4.23
<LOANS-NON> 3,013
<LOANS-PAST> 0
<LOANS-TROUBLED> 120
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 11,898
<CHARGE-OFFS> 101
<RECOVERIES> 353
<ALLOWANCE-CLOSE> 12,350
<ALLOWANCE-DOMESTIC> 12,350
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
