<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 June 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 7,323,416 shares
outstanding as of June 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
- --------------------------------------------------------------------------------
June 30, 1997
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<TABLE>
<S> <C>
PART I - Financial Information Page
Item 1. Financial Statements
Consolidated Balance Sheet - June 30, 1997
and Year End 1996 1
Consolidated Statement of Income - Three Months and Six Months
Ended June 30, 1997 and 1996 2
Consolidated Statement of Cash Flows - Six Months
Ended June 30, 1997 and 1996 3-4
Statement of Changes in Stockholder's Equity -
June 30, 1997 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 6. Exhibits and Reports on Form 8-K 17
Signature 18
</TABLE>
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<PAGE> 3
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET (Note 1)
- --------------------------------------------------------------------------------
(unaudited)
<TABLE>
<CAPTION>
(In thousands)
June 30, December 31,
ASSETS 1997 1996
- ------ ---- ----
<S> <C> <C>
Cash & Balances Due from Depositary Institutions $ 32,074 $ 35,105
Securities: (Note 3)
Available for Sale-Market Value 86,896 96,628
Held to Maturity-Amortized Cost (Fair Value 12-31-96, $35,574) 33,386 34,502
--------------------------
Total Securities 120,282 131,130
Federal Funds Sold 28,595 25,050
Loans: (Note 4)
Loans, Net of Unearned Income 642,297 600,059
Less: Allowance for Loan Losses (14,213) (13,268)
--------------------------
Net Loans 628,084 586,791
Mortgage Loans Held for Sale 506 335
Premises & Equipment, Net 14,183 14,202
Other Real Estate Owned 245 444
Intangible assets 358 396
Other Assets 10,525 10,166
--------------------------
TOTAL ASSETS $ 834,852 $ 803,619
==========================
LIABILITIES
Deposits:
Non-Interest Bearing $ 98,509 $ 82,275
Interest Bearing 595,392 588,241
--------------------------
Total Deposits 693,901 670,516
Federal Funds Purchased 5,586 2,533
Securities sold under repurchase agreements 10,062 9,478
Federal Home Loan Bank advances 30,000 35,000
Long-term debt 85 100
Other Liabilities 6,582 5,675
--------------------------
TOTAL LIABILITIES 746,216 723,302
--------------------------
EQUITY CAPITAL (Note 5)
Common Stock 71,170 57,191
Unrealized Gains/(Losses) on AFS Securities
Net of Tax effect (Note 3) (31) 129
Retained Earnings 17,497 22,997
--------------------------
TOTAL CAPITAL 88,636 80,317
--------------------------
TOTAL LIABILITIES & CAPITAL $ 834,852 $ 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 SIX MONTHS ENDED
---------------------- ---------------------------
June 30, June 30, June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
INTEREST INCOME
Interest & Fees on Loans 16,433 14,132 31,883 $27,443
Interest on Investments 2,404 2,525 4,849 5,509
-------------------------------------------------------------
Total Interest Income 18,837 16,657 36,732 32,952
-------------------------------------------------------------
INTEREST EXPENSE
Interest on Deposits 7,281 6,825 14,520 14,169
Interest on Borrowed Funds 585 375 1,121 680
-------------------------------------------------------------
Total Interest Expense 7,866 7,200 15,641 14,849
-------------------------------------------------------------
Net Interest Income 10,971 9,457 21,091 18,103
-------------------------------------------------------------
PROVISION FOR LOAN LOSSES (250) (300) (350) (500)
NONINTEREST INCOME
Securities Gains/(Losses) 0 0 0 0
Service Charges on Deposit Accounts 426 405 827 791
Other Noninterest Income 740 470 1,131 899
-------------------------------------------------------------
Total Noninterest Income 1,166 875 1,958 1,690
NONINTEREST EXPENSE
Salaries & Employee Benefits 3,128 2,671 6,069 5,248
Occupancy Expense 727 576 1,394 1,019
Other Noninterest Expense 1,673 1,399 2,501 2,157
-------------------------------------------------------------
Total Noninterest Expense 5,528 4,646 9,964 8,424
INCOME BEFORE INCOME TAX 6,359 5,386 12,735 10,869
-------------------------------------------------------------
APPLICABLE INCOME TAX (2,158) (1,785) (4,359) (3,633)
NET INCOME 4,201 3,601 8,376 $7,236
=============================================================
Average Number of Shares Outstanding
for the Period 7,317,683 7,257,853 7,317,683 7,257,853
PER SHARE COMMON STOCK $0.57 $0.50 $1.14 $1.00
=============================================================
</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)
(In thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
CASH FLOWS FROM OPERATING ACTIVITIES June 30, 1997 June 30, 1996
- ------------------------------------ ------------- -------------
<S> <C> <C>
Net Income $8,376 $7,236
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 752 678
Provision for loan losses 350 500
FHLB stock dividends (306) (278)
Increase in income taxes payable (391) (367)
Decrease in interest receivable (32) (196)
Increase(Decrease) in interest payable 131 (719)
Loss on sale of HTM securities 0 0
Loans originated for sale (8,216) (11,031)
Proceeds from sale of loans 8,046 10,734
Other operating activities 939 1,077
-------- --------
Net cash provided by operating activities 9,649 7,634
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash flows from Fed Funds Sold (3,545) 43,860
Proceeds from sales of HTM securities 0 0
Proceeds from maturities of AFS & HTM securities 21,281 19,741
Purchase of AFS securities (2,999) (8,019)
Purchase of HTM securities (7,373) (11,258)
Net cash flows from loan activities (41,574) (61,203)
Purchases of premises and equipment (566) (341)
Proceeds from the sale of other real estate 199 305
Cash invested in other real estate 0 (281)
Other investing activities 0 0
-------- --------
Net cash used by investing activities (34,577) (17,196)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in core deposits 25,028 12,127
Net change in certificates of deposit (2,025) (26,345)
Proceeds from issuance of stock 102 69
Principal payments on long term debt (99) (73)
Advances from FHLB 40,000 25,000
Repayment of FHLB advances (45,000) 0
Net change in Federal Funds purchased 3,637 3,006
Other financing activities 254 386
-------- --------
Net cash provided by financing activities 21,897 14,170
-------- --------
</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)
(In thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
----------------
June 30, 1997 June 30, 1996
------------- -------------
<S> <C> <C>
INCREASE IN CASH AND DUE FROM BANKS ($ 3,031) $ 4,608
CASH & DUE FROM BANKS AT BEGINNING
OF YEAR 35,105 19,708
-------- --------
CASH AND DUE FROM BANKS AT END
OF PERIOD $32,074 $ 24,316
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $15,510 $ 15,570
Cash paid during the year for income taxes 4,750 4,000
Real estate taken as settlement for loan
obligations 0 0
Real estate taken as settlement for loan
obligations - financed by bank $0 $0
</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 six months
of 1997 8,376 8,376
Stock Options Exercised 13,268 78 78
7% Stock Dividend 478,609 13,876 (13,876) 0
Fractional Shares Purchased 873 25 25
Valuation of Available for Sale
Securities (160) (160)
-------------------------------------------------------------------------------
Balance, June 30, 1997 7,323,416 $71,170 $17,497 ( 31) $88,636
===============================================================================
</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
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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 six months
ended June 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 June 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
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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
June 30, 1997:
<TABLE>
<CAPTION>
AGGREGATE FAIR VALUE AND AMORTIZED COST OF INVESTMENTS
------------------------------------------------------
(In thousands) Amortized Gross Unreal- Gross Unreal- Aggregate
Cost ized Gains ized Losses Fair Value
<S> <C> <C> <C> <C>
--------------------------------------------------------
AFS SECURITIES:
Equities $ 9,576 $ 9,576
U.S. Treasuries 756 20 776
U.S. Agencies 42,977 133 (319) 42,791
Corporate securities 33,634 358 (239) 33,753
--------------------------------------------------------
Totals 86,943 511 (558) 86,896
--------------------------------------------------------
HTM SECURITIES:
Municipal securities 29,836 1,048 (26) 30,858
Certificates of deposit 3,550 3,550
--------------------------------------------------------
Totals $ 33,386 $ 1,048 ($ 26) $ 34,408
--------------------------------------------------------
Totals $120,329 $ 1,559 ($ 584) $121,304
========================================================
</TABLE>
MATURITY SCHEDULE OF SECURITIES
<TABLE>
<CAPTION>
Available For Sale Held To Maturity
------------------ ----------------
Amortized Fair Amortized Fair
MATURITY Cost Value Cost Value
- -------- ---- ----- ---- -----
<S> <C> <C> <C> <C>
0-1 Yr $17,065 $17,093 $ 3,765 $ 3,767
1-5 Yrs 23,307 23,589 1,277 1,323
5-10 Yrs 45,082 44,696 25,119 25,985
Over 10 Yrs 1,489 1,518 3,225 3,333
-----------------------------------------------------
$86,943 $86,896 $33,386 $34,408
=====================================================
</TABLE>
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<PAGE> 10
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3 - (Continued)
- --------------------------------------------------------------------------------
CHANGES IN AFS AND HTM SECURITIES
For the Quarter Ended June 30, 1997:
<TABLE>
<S> <C>
AFS SECURITIES
Proceeds From Sales $ 0
Gross Realized Gains --
Gross Realized Losses --
Gross Gains & Losses Included In Earnings From
Transfers To The Trading Category --
Net Change In Unrealized Holding Gains Or
Losses Included In The Separate
Component of Equity Capital $744
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>
June 30, 1997 Dec 31, 1996
------------- ------------
<S> <C> <C>
Commercial $ 125,157 $ 117,551
Real Estate:
Commercial 263,164 231,379
Construction 128,482 133,582
Residential 105,776 99,099
Installment 24,758 23,077
--------- ---------
647,337 604,688
Unearned Fee Income (4,534) (4,294)
--------- ---------
Total Loans $ 642,803 $ 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 second quarter of 1997 was
$4.2 million versus $3.6 million for the second quarter of 1996, or up 16.6%.
The reason for the increase in net income in 1997 was due to an increase in net
interest income of $1.5 million, or 16.0%. This marks the fifty-fourth
consecutive quarter in which Frontier's earnings exceeded the prior years'
comparable quarter. In the discussion below, comparison is with the second
quarter of 1996, unless otherwise stated.
Annualized return on average assets (ROA) was 2.04% in 1997, and 1.96% in 1996.
Annualized return on average stockholder's equity (ROE) in 1997 was 19.16%, as
compared to 19.63% in 1996. Earnings per share were $.57 for 1997, and $.50 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 and in 1996.
Expanded export markets combined with continued new product development by
Boeing and high technology companies, especially Microsoft, fuel an improving
economy. However, what impact this increased volume will have on the local
economy is somewhat unclear, given that a majority of support companies had
reduced production lines and employment due to the past slowdowns.
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 eleven-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.
However, 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:
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Balance Sheet - (Continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Period ended June 30, 1997 1996 $ Change % Change
- --------------------- -------------------------------------------------------
<S> <C> <C> <C> <C>
Loans $642,803 $565,808 $ 76,995 13.6%
Investments* 120,329 144,002 (23,673) -16.4%
Federal Funds Sold 28,595 12,070 16,525 136.9%
----------------------------------------------------
Total Assets $834,852 $755,852 $ 79,000 10.5%
Noninterest bearing deposits $ 98,509 $ 84,163 $ 14,346 17.0%
Interest bearing deposits 595,392 543,321 52,071 9.6%
----------------------------------------------------
Total deposits 693,901 627,484 66,417 10.6%
Federal Funds purchased
and Repurchase Agreements 15,648 10,602 5,046 47.6%
Long-term debt 30,085 40,137 (10,052) -25.0%
Capital $ 88,636 $ 71,977 $ 16,659 23.1%
* Shown at amortized cost.
</TABLE>
At quarter end 1997, loans were up $77.0 million, or 13.6% over the previous
year. This substantial increase in loans over the last year, as compared to the
same quarter end in 1996, was due, for the most part, by the economic growth of
the region. At this same time a year ago, loans were up $84.9 million, or 17.7%.
To fund the increase in loans, deposits contributed $66.4 million and maturities
and calls of investments, and increased capital, contributed the remainder.
During this period, $10 million in FHLB borrowings were repaid which reduced
long-term debt to $30.1 million.
The mix of interest bearing deposits looks somewhat different from a year ago.
At June 30, 1996, NOW and Money Market accounts made up 11.8% of total deposits.
At June 30, 1997, those deposits made up 12.8%. Savings deposits, a year ago,
made up 23.7% of interest bearing deposits, and 21.4% in 1997. Time deposits
were 51.0% of total interest bearing deposits in 1996, and 51.6% in 1997.
Over the last year, NOW and Money Market deposits increased $14.8 million, or
19.9%; savings deposits decreased $.1 million, or (.4)%, and time deposits
increased $37.9 million, or 11.8%. During this past year, it was managements
adjustments of interest rates paid on time deposits (cd's) that caused the
growth in cd's.
Breaking the trend in little or no growth from year-to-year, noninterest bearing
accounts have increased 17.0%, or $14.3 million in the last year. Management
attributes this increase, for the most part, to the increase in business
deposits due to the fallout from major regional bank mergers.
The increase of $5.0 million, or 47.6% 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 $10.0 million. Of the
$30 million in FHLB borrowings remaining, 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.
-10-
<PAGE> 13
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Net Interest Income
- --------------------------------------------------------------------------------
NET INTEREST INCOME
Net interest income is the difference between total interest income and total
interest expense. Several factors contribute to changes in net interest income.
These include the effects of changes in average balances, changes in rates on
earning assets and rates paid for interest bearing liabilities, the level of
noninterest bearing deposits, stockholder's equity, and the level of nonaccrual
loans.
The earnings from certain assets are exempt from federal income tax, and it is
customary in the financial services industry to analyze changes in net interest
income on a "tax equivalent" or fully taxable basis. Under this method,
nontaxable income from loans and investments is adjusted to an amount which
would have been earned if such income were subject to federal income tax. The
discussion below presents an analysis based on "taxable equivalent" amounts at a
35% tax rate. (However, there are no tax equivalent additions to interest
expense or noninterest income and expense amounts discussed below.) Abbreviated
quarterly average balance sheets and net interest income data for the periods
are shown below:
<TABLE>
<CAPTION>
(In thousands)
For quarter ended June 30, 1997 1996 $ Change % Change
- -------------------------- ---- ---- -------- --------
<S> <C> <C> <C> <C>
Loans $631,563 $540,717 $ 90,846 16.8%
Investments* 123,626 143,985 (20,359) -14.1%
Federal Funds Sold 28,936 16,786 12,150 72.4%
Total Earning Assets 784,125 701,488 82,637 11.8%
-----------------------------------------------------
Total Assets 823,285 733,721 89,564 12.2%
Noninterest bearing deposits 92,627 80,558 12,069 15.0%
Interest bearing deposits 590,919 546,009 44,910 8.2%
-----------------------------------------------------
Total deposits 683,546 626,567 56,979 9.1%
Fed Funds purchased
and repurchase agreements 14,496 12,773 1,723 13.5%
Long-term Debt 30,087 16,513 13,574 82.2%
Capital 87,674 71,229 16,445 23.1%
Total interest income 19,066 16,908 2,158 12.8%
Total interest expense 7,866 7,201 665 9.2%
-----------------------------------------------------
Net Interest Income $ 11,200 $ 9,707 $ 1,493 15.4%
* Shown at amortized cost.
</TABLE>
In 1997, average total earning assets as a percent of average total assets were
95.2%, and 95.5% in 1996. This ratio indicates how efficiently assets are being
utilized. Average loans were 76.7% and 73.7% respectively, indicating the
Corporation could use more loans at the present time. Investments as a percent
of average assets for the same periods were 15.0% as compared to 19.5%.
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
-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)
- --------------------------------------------------------------------------------
investments were not sufficient to warrant re-investing excess liquidity in
those maturities. This is why average federal funds sold increased from $16.8
million to $28.9 million, or 72.4% over the period. Average total deposits
increased $57.0 million, or 9.1%. Not indicated in the table above are the
components of interest bearing deposits which, in total, increased $44.9
million, or 8.2%. Average NOW and Money Market accounts increased $11.6 million,
or 15.9%; savings accounts increased $3.7 million, or 2.6%, and time cd's
increased $29.6 million, or 9.0%.
Earning Assets
The yield on total earning assets in 1997 increased .08%, from 9.78% in 1996 to
9.86% in 1997. The cost of total interest bearing liabilities decreased .06%,
from a 5.08% in 1996 to a 5.02% in 1997.
On a tax equivalent basis, net interest income was $11.2 million in 1997, versus
$9.7 million in 1996, for an increase in net interest income of $1.5 million.
Total interest income increased $2.2 million, and total interest expense
increased $.7 million, for an increase in net interest income of $1.5 million.
The increase in the average balance of earning assets increased interest income
by $2.2 million, with no change in interest rates for a net increase of $2.2
million.
The yield on total loans decreased from 10.61% in 1996 to 10.55% in 1997. Real
estate commercial loans decreased in yield from 10.12% to 10.10%. Real estate
construction loans increased in yield from 12.24% to 12.27%. Business loans
decreased from 10.41% to 10.32%, and installment loans increased from 9.58% to
9.85%. Real estate mortgage loans declined from 10.33% in 1996 to 10.09% in the
current year. The yield on investments increased from 7.17% in 1996 to 7.33% in
1997, and the yield on federal funds sold increased from 5.36% in 1996 to 5.95%
in 1997.
Interest Bearing Liabilities
The increase in the average balance of total interest bearing liabilities
increased interest expense by $.8 million, and the rates paid on interest
bearing liabilities decreased interest expense by $.1 million, for a net change
of $.7 million.
The cost of NOW and money market accounts went from 2.92% in 1996, to 2.95% in
1997. Savings accounts cost increased from 4.03% in 1996 to 4.04% in 1997, and
time cd's decreased in cost from 6.00% in 1996 to 5.88% in 1997. Short term
borrowings increased from 5.02% to 5.08%, and long-term debt cost increased from
5.34% in 1996 to 5.41% in 1997.
NONINTEREST INCOME AND EXPENSE
Total noninterest income increased in 1997 to $1.1 million, up $291 thousand ,
or 33.3% from a year ago. Service charges increased from $405 thousand to $426
thousand, or 5.2%. This is below the 8.3% 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.
-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)
- --------------------------------------------------------------------------------
Other income for the period was up $270 thousand, or 57.4%. For the most part,
this was attributable to a non-recurring gain on ORE of $195 thousand. However,
sales of insurance, annuities and mutual funds netted an increase of $58
thousand, or 252.2% for the period, and broker loan fees increased $23 thousand,
or 65.7%.
Trust department fees were up $35 thousand, or 18.6% for the period. The market
value of trust assets at quarter end 1997 was $135.0 million, as compared to
$109.6 million in 1996, an increase of $25.4 million, or 23.2%.
Total noninterest expenses increased $882 thousand, or 19.0% in 1997. Salaries
and Employee Benefits increased $457 thousand, to $3.1 million, or 17.1%.
Salaries, alone, increased $222 thousand to $2.0 million, or 12.2% from $1.8
million a year ago. Employee benefits increased $235 thousand to $1.1 million,
or 27.8% from $.8 million a year ago. The increase in salaries was due an
increase in staff over the year of 6.8%, and merit raises of 5.4%. The employee
benefits increase of $235 thousand was attributable to a timing difference
increase in the profit sharing reserve of $153 thousand, or 35.8%, increased
social security taxes of $22 thousand, or 14.5%, and an increase in medical
insurance premiums of $11 thousand, or 10.7%.
Total occupancy expense increased $152 thousand, or 26.4%. 41.5%, $302 thousand
of occupancy expense was depreciation in 1997, and $226 thousand, or 39.3% was
depreciation in 1996. Excluding depreciation, occupancy expense increased $76
thousand, or 21.8%, in 1997. The increase was attributable to increased
furniture and equipment purchases, and rent.
Other expense increased $274 thousand, or 19.6%, to $1.7 million. This is due to
normal increases in the cost of operations due to the growth of the Corporation
over the last year.
Many banks and bank holding companies use a computation called the "efficiency
ratio" to measure overhead and costs. 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 43.2%, and 42.6% for 1996. The
Corporation's ratio is considered excellent for the industry.
LOANS
IMPAIRED ASSETS (Previously known as non-performing assets)
Non-performing assets are summarized as follows:
<TABLE>
<CAPTION>
(In thousands)
Period Ended June 30, 1997 1996
---- ----
<S> <C> <C>
Non-accruing loans $ 4,951 $ 2,121
Loans past due 90 days or more and still accruing 0 0
Restructured loans 115 136
Other real estate owned 245 567
------------------------
Total non-performing loans $ 5,311 $ 2,824
========================
Total loans at end of period $642,803 $565,808
-------- --------
As a percent of total loans outstanding 0.83% 0.50%
========================
</TABLE>
-13-
<PAGE> 16
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Impaired Assets - (Continued)
- --------------------------------------------------------------------------------
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 one parcel of commercial land,
which is for sale. As of June 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 real estate construction and land
development industry. These loans totaled $112.3 million in 1997, or 17.5% of
total loans, and $98.1 million in 1996, or 17.3% 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 stable real estate market. Stable
interest rates have helped facilitate a strong level of sales and real estate
activity in general, and management is cautiously optimistic as to the real
estate markets prospects in the months ahead.
At June 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 June 30, 1997, the allowance for possible loan losses
increased to $14.2 million, or 2.21% of total loans, from $12.2 million, or
2.15% of total loans in 1996. Net loan losses for 1997 are, actually, net
recoveries of $595 thousand for the year-to-date period ended June 30, 1997.
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.
-14-
<PAGE> 17
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Liquidity
- --------------------------------------------------------------------------------
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
June 30, 1997 and 1996. This discussion addresses those periods of time.
Net cash provided by operating activities in 1997 totaled $9.6 million, as
compared to $7.6 million in 1996. The largest component providing net cash was
income of $8.4 million in 1997 and $7.2 million in 1996.
Real estate secondary market loans originated for sale in 1997 were down $2.8
million, or 34.3%, 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 1997 were heavily concentrated in the loan portfolio
which required $41.6 million in funding. Of the $21.3 million of investment
securities which matured during the current period, $10.4 million was
reinvested, and the remaining was used to fund loan growth. In 1996, $43.9
million came out of federal funds sold to fund loans, and the investment
portfolio maturities were reinvested.
Financing the investment activities in 1997 was mainly accomplished by
acquisition of core deposits (including NOW, Money Market and Savings accounts)
of $25.0 million. 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.
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.
-15-
<PAGE> 18
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
- --------------------------------------------------------------------------------
Interest Rate Risk - (Continued)
- --------------------------------------------------------------------------------
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 second quarter of 1996, the gap of the Corporation was a
negative (25.1%) 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
5.16% to 5.41% at the end of June 1997. During this period of time, the
Corporation had increased and decreased rates paid on time deposits several
times, with rates on those deposits up 10 basis points at the end of June 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
second quarter end 1997 was $88.6 million. This amount compares to $72.0 million
at June, 1996, an increase of $16.6 million, or 23.1%. Almost all of the
increase was attributable to retained earnings.
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 June 30, 1997, the Corporation's leverage ratio was
10.74%, compared to 9.85% 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%. Based on these requirements, the
Corporation's Tier I and combined Tier II capital ratios were 12.82% and 14.08%
at June 30, 1997, and 11.48% and 12.74% at June 30, 1996.
Management constantly monitors the level of capital of the Corporation, and
believes that capital is excessive to meet present needs. As an ongoing process,
management considers, among other things, the present and anticipated needs of
the Corporation, current market conditions, and other relevant factors,
including regulatory requirements which may necessitate changes in the level of
capital.
-16-
<PAGE> 19
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. Legal Proceedings
No material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
The 1997 Annual Meeting of Shareholders was held on April 17, 1997.
At that meeting, the only item to be voted upon was the election of
directors. Of 7,316,968 shares outstanding and authorized to vote,
5,093,996 were represented in person or by proxy. There were
proxies representing 4,826,928 shares, and there were persons in
attendance representing 267,068 shares. 69.6% of the total
outstanding shares were represented at the meeting. Eleven
incumbent directors and three new directors were elected as shown
below with the affirmative votes cast for each director indicated
next to their name:
<TABLE>
<S> <C> <C>
George E. Barber 5,081,514 Edward J. Novack 5,084,360
Lucy DeYoung 5,066,671 J. Donald Regan 5,084,360
Robert J. Dickson 5,084,360 Roger L. Rice 5,063,717
David A. Dujardin 5,084,360 Roy A. Robinson 5,071,747
Edward D. Hansen 5,072,446 William J. Robinson 5,052,368
William H. Lucas 5,073,672 Edward C. Rubatino 5,092,521
James H. Mulligan 5,073,511 Darrell J. Storkson 5,084,360
</TABLE>
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 June 30,
1997.
-17-
<PAGE> 20
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
SIGNATURE
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRONTIER FINANCIAL CORPORATION
Date: July 28, 1997 /s/ James F. Felicetty
--------------------- -----------------------------
James F. Felicetty
Secretary/Treasurer
-18-
<PAGE> 1
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES EXHIBIT 11
- --------------------------------------------------------------------------------
COMPUTATION OF EARNINGS PER SHARE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For Six Months Ended June 30,
1997 1996
---------- ----------
<S> <C> <C>
Net Income $8,375,821 $7,236,396
========== ==========
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 479,482 917,240
Additional shares deemed
outstanding because of
stock split 0 0
Shares issued during the
year times average time
outstanding during the year 7,535 18,358
---------- ----------
Average shares outstanding 7,317,683 7,257,853
========== ==========
Primary earnings per share $ 1.14 $ 1.00
========== ==========
</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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 32,074
<INT-BEARING-DEPOSITS> 3,550
<FED-FUNDS-SOLD> 28,595
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 83,346
<INVESTMENTS-CARRYING> 33,386
<INVESTMENTS-MARKET> 34,408
<LOANS> 642,297
<ALLOWANCE> (14,213)
<TOTAL-ASSETS> 843,852
<DEPOSITS> 693,901
<SHORT-TERM> 15,648
<LIABILITIES-OTHER> 6,582
<LONG-TERM> 30,085
0
0
<COMMON> 71,170
<OTHER-SE> 17,466
<TOTAL-LIABILITIES-AND-EQUITY> 834,852
<INTEREST-LOAN> 31,883
<INTEREST-INVEST> 4,849
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 36,732
<INTEREST-DEPOSIT> 14,520
<INTEREST-EXPENSE> 15,641
<INTEREST-INCOME-NET> 21,091
<LOAN-LOSSES> (350)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 9,964
<INCOME-PRETAX> 12,735
<INCOME-PRE-EXTRAORDINARY> 8,376
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,376
<EPS-PRIMARY> 1.14
<EPS-DILUTED> 1.14
<YIELD-ACTUAL> 5.38
<LOANS-NON> 4,951
<LOANS-PAST> 0
<LOANS-TROUBLED> 115
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 13,268
<CHARGE-OFFS> 385
<RECOVERIES> 976
<ALLOWANCE-CLOSE> 14,209
<ALLOWANCE-DOMESTIC> 14,209
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
