<PAGE> 1
UNITED STATES
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 September 30, 1997
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)
(425) 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 7,335,550 shares
outstanding as of September 30, 1997.
<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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September 30, 1997
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<TABLE>
<CAPTION>
PART I - Financial Information Page
- ------------------------------ ----
<S> <C> <C>
Item 1. Financial Statements.
Consolidated Balance Sheet - September 30, 1997
and Year End 1996. 1
Consolidated Statement of Income - Three Months and Nine Months
Ended September 30, 1997 and 1996. 2
Consolidated Statement of Cash Flows - Nine Months
Ended September 30, 1997 and 1996. 3-4
Statement of Changes in Stockholder's Equity -
September 30, 1997. 5
Notes 6-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operation. 9-17
PART II - Other Information
Item 1. Legal Proceedings. 18
Item 4. Submission of Matters to a Vote of Security Holders. 18
Item 6. Exhibits and Reports on Form 8-K. 18
Signature 19
</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)
Sept. 30, December 31,
ASSETS 1997 1996
- ------ --------- ------------
<S> <C> <C>
Cash & Balances Due from Depositary Institutions $ 31,955 $ 35,105
Securities: (Note 3)
Available for Sale-Market Value 84,057 96,628
Held to Maturity-Amortized Cost (Fair Value 12-31-96, 33,187 34,502
---------------------------
Total Securities $ 35,574) 117,244 131,130
Federal Funds Sold 46,345 25,050
Loans: (Note 4)
Loans, Net of Unearned Income 661,517 600,059
Less: Allowance for Loan Losses (14,639) (13,268)
---------------------------
Net Loans 646,878 586,791
Mortgage Loans Held for Sale 396 335
Premises & Equipment, Net 13,949 14,202
Other Real Estate Owned 245 444
Intangible assets 339 396
Other Assets 10,348 10,166
---------------------------
TOTAL ASSETS $ 867,699 $ 803,619
===========================
LIABILITIES
Deposits:
Non-Interest Bearing $ 101,833 $ 82,275
Interest Bearing 620,196 588,241
---------------------------
Total Deposits 722,029 670,516
Federal Funds Purchased 3,913 2,533
Securities sold under repurchase agreements 10,783 9,478
Federal Home Loan Bank advances 30,000 35,000
Long-term debt 77 100
Other Liabilities 7,130 5,675
---------------------------
TOTAL LIABILITIES 773,932 723,302
---------------------------
EQUITY CAPITAL (Note 5)
Common Stock 71,243 57,191
Unrealized Gains/(Losses) on AFS Securities
Net of Tax effect (Note 3) 344 129
Retained Earnings 22,180 22,997
---------------------------
TOTAL CAPITAL 93,767 80,317
---------------------------
TOTAL LIABILITIES & CAPITAL $ 867,699 $ 803,619
===========================
</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 NINE MONTHS ENDED
------------------------------- -------------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
INTEREST INCOME
Interest & Fees on Loans 17,050 14,877 48,933 $ 42,320
Interest on Investments 2,438 2,318 7,287 7,826
------------------------------- -------------------------------
Total Interest Income 19,488 17,195 56,220 50,146
------------------------------- -------------------------------
INTEREST EXPENSE
Interest on Deposits 7,511 6,721 22,030 20,889
Interest on Borrowed Funds 617 716 1,739 1,396
------------------------------- -------------------------------
Total Interest Expense 8,128 7,437 23,769 22,285
------------------------------- -------------------------------
Net Interest Income 11,360 9,758 32,451 27,861
------------------------------- -------------------------------
PROVISION FOR LOAN LOSSES (350) (700) (700) (1,200)
NONINTEREST INCOME
Securities Gains/(Losses) 0 0 0 0
Service Charges on Deposit Accounts 407 388 1,235 1,179
Other Noninterest Income 547 740 1,676 1,639
------------------------------- -------------------------------
Total Noninterest Income 954 1,128 2,911 2,818
NONINTEREST EXPENSE
Salaries & Employee Benefits 3,003 2,695 9,072 7,943
Occupancy Expense 690 616 2,083 1,635
Other Noninterest Expense 1,100 797 3,601 2,955
------------------------------- -------------------------------
Total Noninterest Expense 4,793 4,108 14,756 12,533
INCOME BEFORE INCOME TAX 7,171 6,078 19,906 16,946
------------------------------- -------------------------------
APPLICABLE INCOME TAX (2,488) (2,097) (6,847) (5,729)
NET INCOME $ 4,683 $ 3,981 $ 13,059 $ 11,217
=============================== ===============================
Average Number of Shares Outstanding
for the Period 7,322,337 7,268,590 7,322,337 7,268,590
PER SHARE COMMON STOCK $ 0.64 $ 0.55 $ 1.78 $ 1.54
=============================== ===============================
</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)
NINE MONTHS ENDED
CASH FLOWS FROM OPERATING ACTIVITIES Sept. 30, 1997 Sept. 30, 1996
-------------- --------------
<S> <C> <C>
Net Income $ 13,059 $ 11,217
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 1,124 1,017
Provision for loan losses 700 1,200
FHLB stock dividends (480) (421)
Increase in income taxes payable (179) 411
Decrease in interest receivable (81) (588)
Increase(Decrease) in interest payable 80 (461)
Loss on sale of HTM or AFS securities 0 0
Loans originated for sale (13,900) (16,389)
Proceeds from sale of loans 13,839 16,216
Other operating activities 1,239 1,327
-------- --------
Net cash provided by operating activities 15,401 13,529
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash flows from Fed Funds Sold (21,295) 48,135
Proceeds from sales of HTM securities 0 0
Proceeds from maturities of AFS & HTM securities 32,115 26,206
Purchase of AFS securities (6,494) (8,237)
Purchase of HTM securities (10,922) (14,276)
Net cash flows from loan activities (60,677) (84,312)
Purchases of premises and equipment (647) (880)
Proceeds from the sale of other real estate 199 305
Cash invested in other real estate 0 (281)
Other investing activities 0 1
-------- --------
Net cash used by investing activities (67,721) (33,339)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in core deposits 44,673 11,440
Net change in certificates of deposit 6,449 (11,922)
Proceeds from issuance of stock 176 119
Principal payments on long term debt (143) (112)
Advances from FHLB 40,000 35,000
Repayment of FHLB advances (45,000) (12,500)
Net change in Federal Funds purchased 2,685 3,244
Pre-paid expenses (63) (49)
Other financing activities 393 484
-------- --------
Net cash provided by financing activities 49,170 25,704
-------- --------
</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)
NINE MONTHS ENDED
Sept. 30, 1997 Sept. 30, 1996
-------------- --------------
<S> <C> <C>
INCREASE IN CASH AND DUE FROM BANKS ($ 3,150) $ 5,894
CASH & DUE FROM BANKS AT BEGINNING
OF YEAR 35,105 19,708
-------- --------
CASH AND DUE FROM BANKS AT END
OF PERIOD $ 31,955 $ 25,602
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 23,689 $ 22,764
Cash paid during the year for income taxes 7,025 5,416
Real estate taken as settlement for loan
obligations 0 0
Real estate taken as settlement for loan
obligations - financed by bank $ 0 $ 570
</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, 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 1996 14,617 14,617
Stock Options Exercised 31,283 160 160
7% Stock Dividend 442,831 11,956 (11,956) 0
Fractional Shares Purchased 797 20 20
Shares exchanged for minority
investment 33,500 971 971
Valuation of Available for Sale
Securities (804) (804)
---------------------------------------------------------------------
Balance, December 31, 1996 6,830,666 57,191 22,997 129 80,317
=====================================================================
Net income for first nine
months of 1997 13,059 13,059
Stock Options Exercised 25,402 150 150
7% Stock Dividend 478,609 13,876 (13,876) 0
Fractional Shares Purchased 873 26 26
Valuation of Available for Sale
Securities 215 215
---------------------------------------------------------------------
Balance, September 30, 1997 7,335,550 $ 71,243 $ 22,180 $ 344 $ 93,767
=====================================================================
</TABLE>
-5-
<PAGE> 8
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. PRINCIPLES OF CONSOLIDATION - RESULTS OF OPERATIONS
The consolidated financial statements of Frontier Financial
Corporation include the accounts of Frontier Financial
Corporation and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated. These statements
are unaudited and should be read in conjunction with the December
31, 1996 Annual Report on Form 10-K of Frontier Financial
Corporation. Accordingly, they do not include all of the
information and footnotes required by generally accepted
accounting principles for complete financial statements.
Operating results for the nine months ended September 30, 1997
are not necessarily indicative of the results that may be
expected for year-end December 31, 1997.
Certain reclassifications of 1996 amounts were made in order to
conform to the 1997 presentation, none of which affect previously
reported net income.
The bank subsidiary of Frontier Financial Corporation is Frontier
Bank.
NOTE 2. ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1997, the Corporation adopted two recently
issued Statements of Financial Accounting Standards (SFAS).
SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities", establishes
criteria for distinguishing between sales and secured borrowings
of financial assets. Management believes that SFAS No. 125 will
not have a material effect on the Corporation's financial
condition or reported results of operations.
SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB No. 125", defers certain requirements of SFAS
No. 125 until 1998.
NOTE 3. INVESTMENT SECURITIES
The investment portfolio of the Corporation is classified in one
of three groups: 1) Trading securities; 2) securities
Held-To-Maturity (HTM), and 3) securities Available-For-Sale
(AFS).
At September 30, 1997, 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.
-6-
<PAGE> 9
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3 - (Continued)
- --------------------------------------------------------------------------------
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.
The tables below display the characteristics of the AFS and HTM portfolios as of
September 30, 1997:
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 $ 9,750 $ 9,750
U.S. Treasuries 755 29 784
U.S. Agencies 41,409 181 (129) 41,461
Corporate securities 31,613 491 (42) 32,062
---------------------------------------------------
Totals 83,527 701 (171) 84,057
---------------------------------------------------
HTM SECURITIES:
Municipal securities 29,637 1,297 (4) 30,930
Certificates of deposit 3,550 3,550
---------------------------------------------------
Totals $ 33,187 $ 1,297 ($4) $ 34,480
---------------------------------------------------
Totals $116,714 $ 1,998 ($175) $118,537
===================================================
</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 $18,686 $18,674 $ 3,795 $ 3,797
1-5 Yrs 19,223 19,658 1,297 1,344
5-10 Yrs 45,138 45,206 24,905 26,006
Over 10 Yrs 480 519 3,190 3,333
----------------------------------------------------------
$83,527 $84,057 $33,187 $34,480
==========================================================
</TABLE>
-7-
<PAGE> 10
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3 - (Continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CHANGES IN AFS AND HTM SECURITIES
---------------------------------
<S> <C>
For the Quarter Ended September 30, 1997:
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 $375
HTM SECURITIES
Sales Or Transfers From this Category $ 0
</TABLE>
NOTE 4. LOANS
The following is an analysis of the loan portfolio by major type of
loans:
<TABLE>
<CAPTION>
September 30, 1997 Dec 31, 1996
------------------ ------------
<S> <C> <C>
Commercial $ 126,163 $ 117,551
Real Estate:
Commercial 267,623 231,379
Construction 144,634 133,582
Residential 104,252 99,099
Installment 23,991 23,077
--------- ---------
666,663 604,688
Unearned Fee Income (4,750) (4,294)
--------- ---------
Total Loans $ 661,913 $ 600,394
========= =========
</TABLE>
NOTE 5. The Board of Directors declared 7% stock dividends which were paid
March 18, 1996 and March 17, 1997 respectively.
-8-
<PAGE> 11
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS.
- --------------------------------------------------------------------------------
HIGHLIGHTS
Consolidated net income of the Corporation for the third quarter of 1997 was
$4.7 million versus $4.0 million for the third quarter of 1996, or up 17.6%. The
reason for the increase in net income in 1997 was due to an increase in net
interest income of $1.6 million, or 16.4%. This marks the fifty-fifth
consecutive quarter in which Frontier's earnings exceeded the prior years'
comparable quarter. In the discussion below, comparison is with the third
quarter of 1996, unless otherwise stated.
Annualized return on average assets (ROA) was 2.21% in 1997, and 2.10% in 1996.
Annualized return on average stockholder's equity (ROE) in 1997 was 20.41%, as
compared to 21.18% in 1996. Earnings per share were $.64 for 1997, and $.55 for
1996. Earnings per share have been adjusted for the seven percent stock dividend
paid on March 17, 1997.
FINANCIAL REVIEW - ECONOMIC ENVIRONMENT
The Bank's lending and other activities are concentrated in Snohomish County,
Washington, but also includes the northern and eastern part of King County, by
having branches located in Bothell, Woodinville, the Lake City area of north
Seattle and Redmond. In 1996, the Bank opened a branch in Skagit County, which
is the contiguous county north of Snohomish County. These three counties would
be considered the market or service area of the Corporation. The Boeing airplane
manufacturing plant for 747's and 777's is located in the city of Everett, as is
the headquarters of the Corporation. Microsoft, the worlds largest software
company, is located in Redmond, Washington, 25 miles from Everett. The Bank
opened a branch office in Redmond in the first quarter of 1997.
The financial performance of the Corporation is directly influenced by the
economic conditions in its service area. In recent years leading up to 1996,
Washington's growth moderated due to employment cutbacks in aerospace
manufacturing, however, renewed economic strength and momentum were evident in
the fourth quarter of 1995, in 1996, and thusfar in 1997. Expanded export
markets combined with continued new product development by Boeing and high
technology companies, especially Microsoft, fuel the economy.
The forecast for Snohomish County, and Everett, appears bright. The aircraft
carrier Abraham Lincoln arrived at the Everett Home Port in December 1996, and
will eventually be home for an multi-ship task force. A study performed on the
impact of this Home Port on the Washington economy, shows that in 1996, military
salaries, direct and indirect multipliers and procurement will total $387.6
million. That number is estimated to grow to $411.2 million through 1998.
While the forecast appears bright for a stable economic environment, management
continues to be cautiously optimistic regarding the level of future earnings.
BALANCE SHEET
On the next page, 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:
-9-
<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>
At September 30, 1997 1996 $ Change % Change
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Loans $661,913 $587,952 $ 73,961 12.6%
Investments * 116,714 139,870 (23,156) -16.6%
Federal Funds Sold 46,345 7,795 38,550 494.5%
---------------------------------------------------------------
Total Assets $867,699 $772,820 $ 94,879 12.3%
Noninterest bearing deposits $101,833 $ 82,923 $ 18,910 22.8%
Interest bearing deposits 620,196 558,296 61,900 11.1%
---------------------------------------------------------------
Total deposits 722,029 641,219 80,810 12.6%
Federal Funds purchased
and Repurchase Agreements 14,696 10,840 3,856 35.6%
Long-term debt 30,077 37,629 (7,552) -20.1%
Capital $ 93,767 $ 76,098 $ 17,669 23.2%
</TABLE>
* Shown at amortized cost.
At quarter end 1997, loans were up $74.0 million, or 12.6% over the previous
year. This increase in loans over the last year, was due, for the most part, by
the economic growth of the region. However, the growth rate in the third quarter
of 1997 falls short of the growth rate in loans in the same quarter of 1996. At
that time a year ago, loans were up $93.2 million, or 18.8% over 1995. Declining
loan demand is also noticeable by the year-to-date increase in loans in 1996
when compared to 1997. Year-to-date loan growth in 1996 was $84 million, whereas
year-to-date loan growth in 1997 has been $62 million. Management is aware of
this slowing, and is reacting appropriately.
Investments declined $23.2 million, or 16.6% for the period. This decline was
planned by management so that proceeds of maturing investments can be placed
into the loan portfolio.
Consistent with funding of the loan portfolio with maturing investments, federal
funds sold has become a temporary, overnight investment until funds are needed
for loans. Federal funds sold increased $38.6 million, or 494.5% from the same
period a year ago. Due to the present yield curve, the opportunity cost of
liquidity is not substantial at this time.
Continuing to break the trend in little or no growth from year-to-year,
noninterest bearing accounts have increased 22.8%, or $18.9 million over the
last year. Management attributes this increase, for the most part, to the
fallout from major regional bank mergers.
The mix of interest bearing deposits looks somewhat different from a year ago.
At September 30, 1996, NOW and Money Market accounts made up 14.0% of total
interest bearing deposits. At September 30, 1997, those deposits made up 16.4%.
Savings deposits, a year ago, made up 26.0% of interest bearing deposits, and
24.5% in 1997. Time deposits were 60.0% of total interest bearing deposits in
1996, and 59.1% in 1997.
Over the last year, NOW and Money Market deposits increased $23.2 million, or
29.5%; savings deposits increased $6.8 million, or 4.7%, and time deposits
increased $31.9 million, or 9.5%. During this past year, it was interest rates
paid and business development efforts that caused the growth in interest bearing
deposits.
-10-
<PAGE> 13
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Balance Sheet - (Continued)
- --------------------------------------------------------------------------------
The increase of $3.9 million, or 35.6% in federal funds purchased and securities
sold under agreements to repurchase (repo's) for the period, was caused by
continuing demand for sweep accounts by local businesses. Due to excessive
liquidity during the period, long-term debt was reduced by $7.6 million. The $30
million in long-term debt remaining, are FHLB borrowings, of which a block of
$20 million has an option whereby the FHLB can request return of the funds at
any time on a quarterly basis. Such a contingency has been planned for by
management.
Capital has grown $17.7 million over the past year, or 23.2%. Management has
recognized that the capital of the Corporation is excessive, and is currently
reviewing strategies to offset the negative effect that excessive capital has on
the return on equity ratio.
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)
For quarter ended September 30, 1997 1996 $ Change % Change
-------- -------- -------- ----
<S> <C> <C> <C> <C>
Loans $652,047 $578,439 $ 73,608 12.7%
Investments * 117,252 142,136 (24,884) -17.5%
Federal Funds Sold 37,803 4,417 33,386 755.9%
Total Earning Assets 807,102 724,992 82,110 11.3%
--------------------------------------------------------------
Total Assets 846,619 756,701 89,918 11.9%
Noninterest bearing deposits 100,001 79,926 20,075 25.1%
Interest bearing deposits 601,503 542,511 58,992 10.9%
--------------------------------------------------------------
Total deposits 701,504 622,437 79,067 12.7%
Fed Funds purchased
and repurchase agreements 15,594 12,065 3,529 29.2%
Long-term Debt 30,087 39,943 (9,856) -24.7%
Capital 91,782 75,195 16,587 22.1%
Total interest income 19,731 17,445 2,286 13.1%
Total interest expense 8,128 7,437 691 9.3%
--------------------------------------------------------------
Net Interest Income $ 11,603 $ 10,008 $ 1,595 15.9%
</TABLE>
* Shown at amortized cost. -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)
- --------------------------------------------------------------------------------
In 1997, average total earning assets as a percent of average total assets were
95.3%, and 95.8% in 1996. This ratio indicates how efficiently assets are being
utilized. Average loans were 77.0% and 76.4%, and investments as a percent of
average assets for the same periods were 13.8% as compared to 18.8%. As
previously mentioned, management has intentionally allowed the investment
portfolio to run off to provide liquidity for growth of the loan portfolio. At
the same time, however, management has recognized that short to medium term
yields on investments were not sufficient to warrant re-investing excess
liquidity in those maturities. This is why average federal funds sold increased
from $4.4 million to $37.8 million, or 755.9% over the period. Average total
deposits increased $79.1 million, or 12.7%. Not indicated in the table above are
the components of interest bearing deposits which, in total, increased $59.0
million, or 10.9%. Average NOW and Money Market accounts increased $17.4
million, or 24.3%; savings accounts increased $3.1 million, or 2.1%, and time
cd's increased $38.4 million, or 11.9%.
Earning Assets
The yield on total earning assets in 1997 increased .15%, from 9.76% in 1996 to
9.91% in 1997. The cost of total interest bearing liabilities increased .02%,
from a 5.07% in 1996 to a 5.09% in 1997.
On a tax equivalent basis, net interest income was $11.6 million in 1997, versus
$10.0 million in 1996, for an increase in net interest income of $1.6 million.
Total interest income increased $2.3 million, and total interest expense
increased $.7 million, for an increase in net interest income of $1.6 million.
The increase in the average balance of earning assets increased interest income
by $1.9 million, and an increase in interest rates increased interest income by
$.4 million, for a net increase of $2.3 million.
The yield on total loans increased from 10.44% in 1996 to 10.61% in 1997. Real
estate commercial loans increased in yield from 9.83% to 9.89%. Real estate
construction loans increased in yield from 12.10% to 12.89%. Business loans
increased from 10.44% to 10.46%, and installment loans decreased from 10.15% to
9.76%. Real estate mortgage loans increased from 9.89% in 1996 to 9.90%. The
yield on investments increased from 7.14% in 1996 to 7.39% in 1997, and the
yield on federal funds sold increased from 5.19% in 1996 to 5.68% in 1997.
Interest Bearing Liabilities
The increase in the average balance of total interest bearing liabilities
increased interest expense by $.6 million, and the rates paid on interest
bearing liabilities increased interest expense by $.1 million, for a net change
of $.7 million.
The cost of NOW and money market accounts went from 3.02% in 1996, to 2.99% in
1997. Savings accounts cost stayed the same at 4.09%, and time cd's increased in
cost from 5.89% in 1996 to 5.98% in 1997. Short term borrowings increased from
4.94% to 5.17%, and long-term debt cost decreased from 5.77% in 1996 to 5.64% in
1997.
-12-
<PAGE> 15
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Net Interest Income - (Continued)
- --------------------------------------------------------------------------------
NONINTEREST INCOME AND EXPENSE
Total noninterest income decreased in 1997 to $1.0 million, down $174 thousand,
or 15.4% from a year ago. Service charges increased from $388 thousand to $407
thousand, or 4.9%. This is below the 8.9% growth in the number of accounts
susceptible to service charge during the period. Management believes that the
growth in service charge income falls short of the growth in the number of
susceptible accounts due to higher average balances.
Other income for the period was down $193 thousand, or 26.1%. In 1996, however,
there was a non-recurring gain on the sale of ORE of $294 thousand. Without this
one-time gain, other income would have been up $101 thousand. That increase was
due to increased trust department income of $37 thousand, or 21.0%; insurance
and financial services income increased $30 thousand, or 68.2%, and broker loan
fees increased $23 thousand, or 41.1%.
The market value of trust assets at quarter end 1997 was $138.5 million, as
compared to $112.1 million in 1996, an increase of $26.4 million, or 23.6%.
Total noninterest expenses increased $685 thousand, or 16.7% in 1997. Salaries
and Employee Benefits increased $308 thousand, to $3.0 million, or 11.4%.
Salaries, alone, increased $232 thousand to $2.3 million, or 11.0% from $2.1
million a year ago. Employee benefits increased $76 thousand to $.7 million, or
13.1% from $.6 million a year ago. The increase in salaries was due to an
increase in staff over the year of 4.3%, and merit raises or bonuses of 6.7%.
The employee benefits increase of $76 thousand was attributable to related
increases in benefits due to the increase in staff over the year, and medical
insurance premiums.
Total occupancy expense increased $74 thousand, or 12.0%. 45.5%, or $314
thousand of occupancy expense was depreciation in 1997, and $226 thousand, or
36.7% was depreciation in 1996. Excluding depreciation, occupancy expense
decreased $14 thousand, or 3.6%, in 1997. The decrease was attributable to a
decrease in maintenance and repairs.
Other expense increased $303 thousand, or 38.0%, to $1.1 million. Most of this
increase was due to increases in the cost of operations due to the growth of the
Corporation over the last year. Approximately one-third of the increase, or $100
thousand, was due to increased state and local taxes.
Many banks and bank holding companies use a computation called the "efficiency
ratio" to measure overhead. This ratio is then compared to others in the
industry. The ratio is arrived at by dividing total noninterest expense by the
sum of net interest income and other noninterest income. The lower the number,
the more efficient the organization. The Corporation's efficiency ratio for the
year-to-date 1997 period was 41.7%, and 40.9% for 1996. The Corporation's ratio
is considered excellent for the industry.
-13-
<PAGE> 16
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations Impaired Assets
- --------------------------------------------------------------------------------
LOANS
- -----
IMPAIRED ASSETS (Previously known as non-performing assets)
- -----------------------------------------------------------
<TABLE>
<CAPTION>
Impaired assets are summarized as follows: (In thousands)
Period Ended September 30, 1997 1996
-------- --------
<S> <C> <C>
Non-accruing loans $ 5,743 $ 4,148
Loans past due 90 days or more and still accruing 0 0
Restructured loans 112 124
Other real estate owned 245 444
---------------------------
Total non-performing loans $ 6,100 $ 4,716
===========================
Total loans at end of period $661,913 $587,952
---------------------------
As a percent of total loans outstanding 0.92% 0.80%
===========================
</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 impaired assets to total loans is felt to be
modest. Other real estate owned is comprised of one parcel of commercial land,
which is for sale. As of September 30, 1997, 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 loan portfolio comprised of real
estate construction and land development loans. These loans totaled $122.1
million in 1997, or 18.4% of total loans, and $108.4 million in 1996, or 18.4%
of total loans. Many years ago, management established a real estate loan
committee which meets semi-annually 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 is now
enjoying a real estate market that is stable, but there are signs of
accelerating property values due to the bright employment opportunities in the
area. Stable interest rates have helped facilitate a strong level of sales and
real estate activity in general, and, absent an abrupt upward movement in
interest rates, management is cautiously optimistic as to the real estate
markets prospects in the months ahead.
At September 30, 1997 and 1996, 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 September 30, 1997, the allowance for possible loan losses
increased to $14.6 million, or 2.21% of total loans, from $13.0 million, or
2.18% of total loans in 1996. Net loan losses for 1997 are, actually, net
recoveries of $671 thousand for the year-to-date period ended September 30,
1997. Management closely monitors the adequacy of the loan loss reserve, and an
analysis is performed regularly.
-14-
<PAGE> 17
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Allowance for Possible Loan Losses - (Continued)
- --------------------------------------------------------------------------------
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 RISK
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 pages 3 and 4 of this report provides information
on the sources and uses of cash for the respective year-to-date periods ending
September 30, 1997 and 1996. This discussion addresses those periods of time.
Net cash provided by operating activities in 1997 totaled $15.4 million, as
compared to $13.5 million in 1996. The largest component providing net cash was
income of $13.1 million in 1997 and $11.2 million in 1996.
Real estate secondary market loans originated for sale in 1997 were down $2.5
million, or 15.2%, from the same period in 1996. This is a continuation of a
downward trend which began several quarters ago. Increased volume from this
operation is questionable for the remainder of the year.
Investing activities for 1996 and 1997 were heavily concentrated in the loan
portfolio which required $84.3 and $60.7 million in funding, respectively. Of
the $32.1 million of investment securities which matured during the current
period, $17.4 million was reinvested, and the remaining was used to fund loan
growth. In 1996, $26.2 million matured, and $22.5 million was re-invested. In
1997, federal funds sold required funding of $21.3 million, whereas in 1996,
federal funds sold provided $48.1 million. The additional funding of the loans
came from financing activities.
Financing the investment activities in 1997 was mainly accomplished by
acquisition of core deposits (including NOW, Money Market and Savings accounts)
of $44.7 million, and $6.4 million of certificates of deposit. Repayment of FHLB
advances exceeded borrowings by $5.0 million due to excess liquidity during the
current period. In 1996, the majority of the funding of investment activities
came from FHLB advances and increased core deposit balances.
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.
-15-
<PAGE> 18
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Interest Rate Risk
- --------------------------------------------------------------------------------
INTEREST RATE RISK
Interest rate risk refers to the exposure of earnings and capital arising from
changes in interest rates. Management's objectives are to control interest rate
risk and to ensure predictable and consistent growth of earnings and capital.
Interest rate risk management focuses on fluctuations in net interest income
identified through computer simulations to evaluate volatility under varying
interest rate, spread and volume assumptions. The risk is quantified and
compared against tolerance levels. The model the Corporation will use for
measuring this risk has been put into place, and should become fully operational
in 1997.
Meanwhile, the Corporation continues to utilize the "gap" theory for measurement
of interest rate sensitivity, the previous method used. 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 third quarter of 1996, the gap of the Corporation was a
negative (25.8%) of earning assets, with rate sensitive liabilities exceeding
rate sensitive assets. This would suggest that decreasing general interest rates
would increase the net interest margin ("NIM"), which is annualized net interest
income divided by average assets. Since that time, the NIM has increased from
5.13% to 5.36% at the end of September 1997, while general interest rates
increased approximately 7 basis points. During this period of time, the
Corporation had increased and decreased rates paid on time deposits several
times, with rates on those deposits up 5 basis points at the end of September
1997.
Because of how the gap acted 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
Consolidated capital of the Corporation for financial statement purposes at
third quarter end 1997 was $93.8 million. This amount compares to $76.1 million
at September, 1996, an increase of $17.7 million, or 23.2%. Almost all of the
increase was attributable to retained earnings.
-16-
<PAGE> 19
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Capital - (Continued)
- --------------------------------------------------------------------------------
Under regulatory capital rules, the minimum "leverage" ratio (primary capital
ratio) of core capital that the most highly rated holding companies must
maintain is 3 percent. At September 30, 1997, the Corporation's leverage ratio
was 11.00%, compared to 10.10% at quarter end 1996. In addition, Regulatory
capital requires a minimum of Tier I capital of 4% of risk-adjusted assets and
total capital (combined Tier I and Tier II) of 8%. The Corporation's Tier I and
combined Tier II capital ratios were 12.99% and 14.25% at September 30, 1997,
and 11.82% and 13.08% at September 30, 1996.
Management constantly monitors the level of capital of the Corporation, and
believes that capital is excessive to meet present needs, considering, 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.
FORWARD-LOOKING INFORMATION
Except for historical financial information contained herein, the matters
discussed in this quarterly report on Form 10Q may be considered
"forward-looking" statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended and subject to the safe harbor created by the Securities Litigation
Reform Act of 1995. Forward-looking statements are subject to risks and
uncertainties that may cause actual future results to differ materially. Such
risks and uncertainties with respect to Frontier Financial Corporation include
those related to the economic environment, particularly in the areas in which
Frontier operates, competitive products and pricing, fiscal and monetary
policies of the U. S. government, changes in governmental regulations affecting
financial institutions, including regulatory fees and capital requirements,
changes in prevailing interest rates, acquisitions and the integration of
acquired businesses, credit risk management and asset/liability management, the
financial and securities markets, and the availability of and costs associated
with sources of liquidity.
-17-
<PAGE> 20
- --------------------------------------------------------------------------------
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 shareholders during the third
quarter.
Item 6. Exhibits and Reports on Form 8-K
(a) (11) Computation of earnings per share is attached as Exhibit 11.
(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 September 30, 1997.
-18-
<PAGE> 21
- --------------------------------------------------------------------------------
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: October 22, 1997 /s/ James F. Felicetty
---------------------------- ----------------------------
James F. Felicetty
Secretary/Treasurer
-19-
<PAGE> 22
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES EXHIBIT 11
- --------------------------------------------------------------------------------
COMPUTATION OF EARNINGS PER SHARE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For Nine Months Ended September 30,
1997 1996
----------- -----------
<S> <C> <C>
Net Income $13,058,523 $11,217,245
=========== ===========
Computation of average
shares outstanding
Shares outstanding at
beginning of year 6,830,666 6,322,255
Additional shares deemed
outstanding because of
stock dividends 479,482 919,143
Additional shares deemed
outstanding because of
stock split 0 0
Shares issued during the
year times average time
outstanding during the year 12,189 27,192
----------- -----------
Average shares outstanding 7,322,337 7,268,590
=========== ===========
Primary earnings per share $ 1.78 $ 1.54
=========== ===========
</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 10Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 31,955
<INT-BEARING-DEPOSITS> 3,550
<FED-FUNDS-SOLD> 46,345
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 80,507
<INVESTMENTS-CARRYING> 33,187
<INVESTMENTS-MARKET> 34,480
<LOANS> 661,913
<ALLOWANCE> (14,639)
<TOTAL-ASSETS> 867,699
<DEPOSITS> 722,029
<SHORT-TERM> 14,696
<LIABILITIES-OTHER> 7,130
<LONG-TERM> 30,077
0
0
<COMMON> 71,243
<OTHER-SE> 22,524
<TOTAL-LIABILITIES-AND-EQUITY> 93,767
<INTEREST-LOAN> 48,933
<INTEREST-INVEST> 7,287
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 56,220
<INTEREST-DEPOSIT> 22,030
<INTEREST-EXPENSE> 23,769
<INTEREST-INCOME-NET> 32,451
<LOAN-LOSSES> (700)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 14,756
<INCOME-PRETAX> 19,906
<INCOME-PRE-EXTRAORDINARY> 13,059
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,059
<EPS-PRIMARY> 1.78
<EPS-DILUTED> 1.78
<YIELD-ACTUAL> 5.63
<LOANS-NON> 5,743
<LOANS-PAST> 0
<LOANS-TROUBLED> 112
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 13,268
<CHARGE-OFFS> (565)
<RECOVERIES> 1,236
<ALLOWANCE-CLOSE> 14,639
<ALLOWANCE-DOMESTIC> 14,639
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
