<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 March 31, 1998
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 7,876,430 shares
outstanding as of March 31, 1998.
<PAGE> 2
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
March 31, 1998
<TABLE>
<CAPTION>
PART I - Financial Information Page
- ------------------------------ ----
<S> <C>
Item 1.Financial Statements.
Consolidated Balance Sheet - March 31, 1998
and Year End 1997. 1
Consolidated Statement of Income - Three Months
Ended March 31, 1998 and 1997. 2
Consolidated Statement of Cash Flows - Three Months
Ended March 31, 1998 and 1997. 3-4
Statement of Changes in Stockholder's Equity -
March 31, 1998. 5
Notes 6-8
Item 2.Management's Discussion and Analysis of Financial Condition
and Results of Operation. 9-17
Item 3 Quantitative and Qualitative Disclosures about
Market Risk 16
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>
-i-
<PAGE> 3
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Note 1)
(Unaudited)
<TABLE>
<CAPTION>
(In thousands)
March 31, December 31,
ASSETS 1998 1997
------------ ------------
<S> <C> <C>
Cash & Balances Due from Depositary Institutions $ 42,183 $ 30,496
Securities: (Note 3)
Available for Sale-Market Value 84,889 83,019
Held to Maturity-Amortized Cost (Fair Value 12-31-97, 31,333 32,081
$33,590) ------------------------------
Total Securities 116,222 115,100
Federal Funds Sold 74,910 61,350
Loans: (Note 4)
Loans, Net of Unearned Income 692,272 665,330
Less: Allowance for Loan Losses (15,832) (14,845)
------------------------------
Net Loans 676,440 650,485
Premises & Equipment, Net 14,194 13,787
Other Real Estate Owned 1,000 1,000
Intangible assets 300 319
Other Assets 11,178 10,343
------------------------------
TOTAL ASSETS $ 936,427 $ 882,880
==============================
LIABILITIES
Deposits:
Non-Interest Bearing $ 115,648 $ 101,278
Interest Bearing 656,886 629,653
------------------------------
Total Deposits 772,534 730,931
Federal Funds Purchased 6,488 4,796
Securities sold under repurchase agreements 15,520 13,166
Federal Home Loan Bank advances 30,000 30,000
Long-term debt 48 56
Other Liabilities 9,268 6,092
------------------------------
TOTAL LIABILITIES 833,858 785,041
------------------------------
EQUITY CAPITAL (Note 5)
Common Stock 89,289 71,363
Accumulated other comprehensive income,
Net of Tax effect(Note 3) 393 453
Retained Earnings 12,887 26,023
------------------------------
TOTAL CAPITAL 102,569 97,839
------------------------------
TOTAL LIABILITIES & CAPITAL $ 936,427 $ 882,880
==============================
</TABLE>
The accompanying notes are an integral part of these financial statements.
-1-
<PAGE> 4
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME (Note 1)
(Unaudited)
(In thousands, Except for Per Share Amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
March 31, March 31,
1998 1997
----------- -----------
<S> <C> <C>
INTEREST INCOME
Interest & Fees on Loans 17,444 15,450
Interest on Investments 2,710 2,445
----------- -----------
Total Interest Income 20,154 17,895
----------- -----------
INTEREST EXPENSE
Interest on Deposits 7,818 7,238
Interest on Borrowed Funds 647 537
----------- -----------
Total Interest Expense 8,465 7,775
----------- -----------
Net Interest Income 11,689 10,120
----------- -----------
PROVISION FOR LOAN LOSSES (250) (100)
NONINTEREST INCOME
Securities Gains/(Losses) 0 0
Service Charges on Deposit Accounts 404 401
Other Noninterest Income 618 391
----------- -----------
Total Noninterest Income 1,022 792
NONINTEREST EXPENSE
Salaries & Employee Benefits 3,380 2,941
Occupancy Expense 683 667
Other Noninterest Expense 1,126 828
----------- -----------
Total Noninterest Expense 5,189 4,436
INCOME BEFORE INCOME TAX 7,272 6,376
----------- -----------
APPLICABLE INCOME TAX (2,599) (2,201)
NET INCOME $ 4,673 $ 4,175
=========== ===========
Average Number of Shares Outstanding
for the Period 7,873,580 7,826,945
Basic earnings per share $ 0.59 $ 0.53
=========== ===========
Fully diluted earnings per share $ 0.59 $ 0.53
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-2-
<PAGE> 5
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
(In thousands)
THREE MONTHS ENDED
------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES March 31, 1998 March 31, 1997
- ------------------------------------ -------------- --------------
<S> <C> <C>
Net Income $ 4,673 $ 4,175
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 362 374
Provision for loan losses 250 100
FHLB stock dividends (171) (148)
Increase in income taxes payable 2,599 2,051
Decrease in interest receivable (796) (383)
Increase(Decrease) in interest payable 70 204
Loss on sale of HTM or AFS securities 0 0
Loans originated for sale (11,078) (3,471)
Proceeds from sale of loans 9,621 3,167
Other operating activities 689 (85)
-------- --------
Net cash provided by operating activities 6,219 5,984
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Net cash flows from Fed Funds Sold (13,560) (20,560)
Proceeds from sales of HTM securities 0 0
Proceeds from maturities of AFS & HTM securities 15,737 9,581
Purchase of AFS securities (13,981) 0
Purchase of HTM securities (2,800) (3,550)
Net cash flows from loan activities (25,213) (15,949)
Purchases of premises and equipment (355) (246)
Proceeds from the sale of other real estate 0 0
Cash invested in other real estate 0 0
Other investing activities 136 0
-------- --------
Net cash used by investing activities (40,036) (30,724)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Net change in core deposits 30,449 22,505
Net change in certificates of deposit 10,832 3,919
Proceeds from issuance of stock 117 67
Principal payments on long term debt (39) (54)
Advances from FHLB 0 20,000
Repayment of FHLB advances 0 (25,000)
Net change in Federal Funds purchased 4,046 1,522
Pre-paid expenses (210) (144)
Other financing activities 309 371
-------- --------
Net cash provided by financing activities 45,504 23,186
-------- --------
</TABLE>
(Continued on next page)
-3-
<PAGE> 6
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN CASH FLOWS-(Continued)
(Unaudited)
<TABLE>
<CAPTION>
(In thousands)
THREE MONTHS ENDED
------------------------------
Mar. 31, 1998 Mar. 31, 1997
------------- -------------
<S> <C> <C>
INCREASE IN CASH AND DUE FROM BANKS $ 11,687 ($ 1,554)
CASH & DUE FROM BANKS AT BEGINNING
OF YEAR 30,496 35,105
-------- --------
CASH AND DUE FROM BANKS AT END
OF PERIOD $ 42,183 $ 33,551
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- -------------------------------------------------
Cash paid during the year for interest $ 8,396 $ 7,570
Cash paid during the year for income taxes 0 150
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
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF
CHANGES IN STOCKHOLDER'S EQUITY (Note 5)
(Unaudited)
(In thousands, except for number of shares)
<TABLE>
<CAPTION>
Accumulated
Common Stock other
---------------------- Comprehensive Retained Comprehensive
Shares Amount Income Earnings income/(loss) Total
--------- -------- ------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 6,322,255 $ 44,084 $ 20,336 $ 933 $65,353
====================== =====================================
Net Income for 1996 $ 14,617 14,617 14,617
Other comprehensive income, net of tax
Unrealized losses on AFS, net of tax effect (804) (804) (804)
-------------
Comprehensive income 13,813
=============
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
---------------------- -------------------------------------
Balance, December 31, 1996 6,830,666 57,191 22,997 129 80,317
====================== =====================================
Net income for 1997 16,902 16,902 16,902
Other comprehensive income, net of tax
Unrealized gains on AFS, net of tax effect 324 324 324
-------------
Comprehensive income 17,226
=============
Stock Options Exercised 40,548 270 270
7% Stock Dividend 478,475 13,876 (13,876) 0
Fractional Shares Purchased 872 26 26
---------------------- -------------------------------------
Balance, December 31, 1997 7,350,561 71,363 26,023 453 97,839
====================== =====================================
Net income for the first
three months of 1998 4,673 4,673 4,673
Other comprehensive income, net of tax
Unrealized losses on AFS, net of tax effect (60) (60) (60)
-------------
Comprehensive income $ 4,613
=============
Stock Options Exercised 9,834 81 81
7% Stock Dividend 514,999 17,809 (17,809) 0
Fractional Shares Purchased 1,036 36 36
---------------------- -------------------------------------
Balance, March 31, 1998 7,876,430 $89,289 $12,887 $393 $102,569
================================================================================
</TABLE>
-5-
<PAGE> 8
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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, 1997 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 three months ended March 31,
1998 are not necessarily indicative of the results that may be
expected for year-end December 31, 1998.
Certain reclassifications of 1997 amounts were made in order to
conform to the 1998 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, 1998, the Corporation adopted two recently
issued Statements of Financial Accounting Standards (SFAS).
SFAS No. 130, "Reporting Comprehensive Income" establishes standards
for reporting and display of comprehensive, or all inclusive income.
In the Corporation's case, based on current operations, it includes
as an addition or deduction to reported net income, the net change
in unrealized gains or losses on securities. This statement has no
effect on net income of the Corporation. All prior periods shown on
the financial statements have been restated to conform with the
statement.
SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information" establishes standards for the way that public
business enterprises report information about operating segments in
annual financial statements. Management believes that the provisions
of the statement will not have a material effect on its financial
condition or reported results of operations.
NOTE 3. INVESTMENT SECURITIES
The investment portfolio of the Corporation is classified in one of
two groups: 1) securities Held-To-Maturity (HTM), and 2) securities
Available-For-Sale (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
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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
March 31, 1998:
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 $ 10,098 $ 10,098
U.S. Treasuries 752 34 786
U.S. Agencies 46,120 142 (150) 46,112
Corporate securities 27,314 586 (7) 27,893
----------------------------------------------------------
Totals 84,284 762 (157) 84,889
----------------------------------------------------------
HTM SECURITIES:
Municipal securities 28,533 1,409 (2) 29,940
Certificates of deposit 2,800 2,800
----------------------------------------------------------
Totals $ 31,333 $ 1,409 $ (2) $ 32,740
----------------------------------------------------------
Totals $ 115,617 $ 2,171 $ (159) $117,629
==========================================================
</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 $20,650 $20,637 $ 2,995 $ 2,996
1-5 Yrs 18,473 18,960 1,940 2,050
5-10 Yrs 44,775 44,864 24,440 25,636
Over 10 Yrs 386 428 1,958 2,058
------------------------------------------------------
$84,284 $84,889 $31,333 $32,740
======================================================
</TABLE>
-7-
<PAGE> 10
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - (Continued)
CHANGES IN AFS AND HTM SECURITIES
<TABLE>
<CAPTION>
For the Quarter Ended March 31, 1998:
- -------------------------------------
<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 $(60)
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>
March 31, 1998 Dec 31, 1997
-------------- ------------
<S> <C> <C>
Commercial $ 142,171 $ 123,904
Real Estate:
Commercial 285,799 272,218
Construction 142,317 147,232
Residential 102,321 102,117
Installment 24,315 24,457
--------- ---------
696,923 669,928
Unearned Fee Income (4,651) (4,598)
--------- ---------
Total Loans $ 692,272 $ 665,330
========= =========
</TABLE>
NOTE 5. The Board of Directors declared 7% stock dividends which were paid March
17, 1997 and March 16, 1998 respectively.
-8-
<PAGE> 11
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
HIGHLIGHTS
Consolidated net income of Frontier Financial Corporation ("the Corporation")
for the first quarter of 1998 was $4.7 million versus $4.2 million for the first
quarter of 1997, or up 11.9%. The reason for the increase in net income in 1998
was due to an increase in net interest income of $1.6 million, or 15.5%. This
marks the fifty-seventh consecutive quarter in which Frontier's earnings
exceeded the prior years' comparable quarter. In the discussion below,
comparison is with the first quarter of 1997, unless otherwise stated.
Annualized return on average assets (ROA) was 2.07% in 1998, and 2.07% in 1997.
Annualized return on average stockholder's equity (ROE) in 1998 was 18.59%, as
compared to 20.15% in 1997. Earnings per share were $.59 for 1998, and $.53 for
1997. Earnings per share have been adjusted for the seven percent stock dividend
paid on March 16, 1998.
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, to
the south, and Skagit County to the north. 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 also
has a branch office in Redmond.
As a follow up to comments regarding the state and regional economy in the
annual report to shareowners for year-ended 1997, it would appear that instead
of a continued expansion, with slower growth, the local economy may have peaked.
However, as quoted by the Everett Herald Business Journal (April 1998) from
Roberta Pauer, analyst for the state Department of Employment Security "a
slowdown from almost overheated growth doesn't mean a poor economy. It doesn't
mean a slow economy."
We would expect a slowdown ahead as Boeing reduces employment as previously
announced, as Boeing and support companies employ about 18% of the county's
jobs. However, the ripple effect from Boeing employment changes take about two
years to flow through the economy, says the Herald.
The Naval Station Everett is solidly in place, and this stable economic
influence should not follow the Boeing ripple effect.
Housing continues on a fast pace. Due to the lack of planning by King county to
provide adequate housing for the job growth, more people are buying in Snohomish
county. This is causing property values to increase as the inventory is reduced.
Residential building permits are up 12% in January 1998, versus December 1997,
and single family home sales are up 9% from February 1997 to February 1998.
(Source: Snohomish County Planning Department) Regardless, management remains
cautiously optimistic regarding the future effect of Boeing on the local
economy.
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
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Balance Sheet - (Continued)
<TABLE>
<CAPTION>
At March 31, 1998 1997 $ Change % Change
-----------------------------------------------------------
<S> <C> <C> <C> <C>
Loans $ 692,272 $ 616,819 $ 75,453 12.2%
Investments* 115,617 125,049 (9,432) -7.5%
Federal Funds Sold 74,910 45,610 29,300 64.2%
-----------------------------------------------------------
Total Assets $ 936,427 $ 832,572 $ 103,855 12.5%
Noninterest bearing deposits $ 115,648 $ 93,915 $ 21,733 23.1%
Interest bearing deposits 656,886 603,407 53,479 8.9%
-----------------------------------------------------------
Total deposits 772,534 697,322 75,212 10.8%
Federal Funds purchased
and Repurchase Agreements 15,520 13,533 1,987 14.7%
Long-term debt 30,048 30,092 (44) -0.1%
Capital* $ 102,176 $ 84,431 $ 17,745 21.0%
</TABLE>
* Shown at amortized cost, or adjusted for unrealized gain/(loss)
At quarter end 1998, loans were up $75.5 million, or 12.2% 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. This growth rate in the first quarter of
1998, compares with a growth of $100.1 million at the end of the first quarter
of 1997, which would support a slowing of the rapid economic growth of the
region discussed above. However, from December 31, 1996 to March 31, 1997, loans
increased $16.1 million, whereas from December 31, 1997 to March 31, 1998, loans
increased $26.9 million. The first quarter of 1998 has experienced a solid
growth in both loans and deposits.
Investments declined $9.4 million, or 7.5% 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 $29.3 million, or 64.2% 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 23.1%, or $21.7 million over the
last year, with most of the increase occurring in business checking accounts.
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 March 31, 1997, NOW and Money Market accounts made up 14.1% of total interest
bearing deposits. At March 31, 1998, those deposits made up 16.3%. Savings
deposits, a year ago, made up 25.6% of interest bearing deposits, and 24.7% in
1998. Time deposits were 60.3% of total interest bearing deposits in 1997, and
59.0% in 1998.
-10-
<PAGE> 13
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Balance Sheet - (Continued)
Over the last year, NOW and Money Market deposits increased $22.0 million, or
25.9%; savings deposits increased $7.9 million, or 5.1%, and time deposits
increased $23.6 million, or 6.5%. During this past year, it was the interest
rates paid and business development efforts that caused the growth in interest
bearing deposits.
The increase of $2.0 million, or 14.7% 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. A block of $20 million
of the FHLB borrowings 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 21.0%. 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 March 31, 1998 1997 $ Change % Change
- --------------------------- --------------------------------------------------------
<S> <C> <C> <C> <C>
Loans $683,512 $612,649 $ 70,863 11.6%
Investments* 117,340 128,105 (10,765) -8.4%
Federal Funds Sold 58,459 29,649 28,810 97.2%
Total Earning Assets 859,311 770,403 88,908 11.5%
--------------------------------------------------------
Total Assets 902,035 806,314 95,721 11.9%
Noninterest bearing deposits 102,279 82,957 19,322 23.3%
Interest bearing deposits 642,384 590,938 51,446 8.7%
--------------------------------------------------------
Total deposits 744,663 673,895 70,768 10.5%
Fed Funds purchased
and repurchase agreements 19,173 11,574 7,599 65.7%
Long-term Debt 30,051 31,114 (1,063) -3.4%
Capital 100,570 82,887 17,683 21.3%
</TABLE>
* Shown at amortized cost, or adjusted for unrealized gain/(loss)
(Continued)
-11-
<PAGE> 14
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Net Interest Income - (Continued)
<TABLE>
<CAPTION>
For quarter ended March 31, 1998 1997 $ Change % Change
- --------------------------- ---- ---- -------- --------
<S> <C> <C> <C> <C>
Total interest income 20,375 18,123 2,252 12.4%
Total interest expense 8,465 7,775 690 8.9%
-----------------------------------------------------
Net Interest Income $11,910 $10,348 $ 1,562 15.1%
</TABLE>
In 1998, average total earning assets as a percent of average total assets were
95.3%, and 95.5% in 1997. This ratio indicates how efficiently assets are being
utilized. Average loans were 75.8% and 76.0%, and investments as a percent of
average assets for the same periods were 13.0% as compared to 15.9%. 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 $29.6 million to $58.5 million, or 97.2% over the period. Average total
deposits increased $70.8 million, or 10.5%. Not indicated in the table above are
the components of interest bearing deposits which, in total, increased $51.4
million, or 8.7%. Average NOW and Money Market accounts increased $18.4 million,
or 23.6%; savings accounts increased $4.1 million, or 2.7%, and time cd's
increased $28.9 million, or 7.9%.
Earning Assets
The yield on total earning assets in 1998 increased .08%, from 9.54% in 1997 to
9.62% in 1998. The cost of total interest bearing liabilities decreased .02%,
from a 4.98% in 1997 to a 4.96% in 1998.
On a tax equivalent basis, net interest income was $11.9 million in 1998, versus
$10.3 million in 1997, 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 $2.0 million, and an increase in interest rates increased interest income by
$.3 million, for a net increase of $2.3 million.
The yield on total loans increased from 10.23% in 1997 to 10.36% in 1998.
Business loans increased from 10.04% to 10.22%; real estate commercial loans
increased in yield from 9.68% to 9.84%; Real estate construction loans increased
in yield from 11.67% to 11.72%; real estate mortgage loans increased from 9.98%
to 10.06%, and installment loans increased from 9.70% to 9.79%.
The yield on investments increased from 7.23% in 1997 to 7.32% in 1998, and the
yield on federal funds sold increased from 5.33% in 1997 to 5.56% in 1998.
Interest Bearing Liabilities
The increase in the average balance of total interest bearing liabilities
increased interest expense by $.7 million, and the rates paid on interest
bearing liabilities remaining flat for a net change of $.7 million.
-12-
<PAGE> 15
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Earning Assets - (Continued)
The cost of NOW and money market accounts went from 2.92% in 1997, to 2.79% in
1998. Savings accounts cost stayed the same at 4%, and time cd's increased in
cost from 5.80% in 1997 to 5.83% in 1998. Short term borrowings increased from
4.83% to 5.05%, and long-term debt cost increased from 5.22% in 1997 to 5.51% in
1998.
NONINTEREST INCOME AND EXPENSE
Total noninterest income increased in 1998 to $1.0 million, up $230 thousand, or
29.0% from a year ago. Service charges increased slightly from $401 thousand to
$404 thousand, or .7%. This is below the 8.5% 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 up sharply by $227 thousand, or 58.1%. The gain
was due to increases in several fee generating sources. Loan servicing fees were
up by $67 thousand, or 268.0%. Broker loan fees increased $55 thousand, or
229.2%, and real estate settlement fees were up $17 thousand, or 212.5%. These
are fees generated by the real estate division of the Bank, and they had a
record quarter ended March 31, 1998. Management attributes this growth due to
the low interest rate environment, and other internal changes, and would expect
this activity to level off or slightly decrease in subsequent quarters. Other
areas of fee income increases were insurance and financial services fees
increased $18 thousand, or 62.1%, and trust department fees increased $33
thousand, or 17.4%.
The market value of trust assets at quarter end 1998 was $159.2 million, as
compared to $123.6 million in 1997, an increase of $35.6 million, or 28.8%.
Total noninterest expenses increased $753 thousand, or 17.0% for the period.
Salaries and benefits increased $439 thousand, or 14.9%. Salaries themselves,
increased $278 thousand, or 11.6%. 4.8% of the increased was due to an increase
in staff, and 6.8% was attributable to merit raises and bonuses. Benefits
increased $161 thousand, or 29.6%. $92 thousand, or 57.1% of the increase was
attributable to the increase in staff over the year, and $29 thousand, or 18.0%
was attributable to an increase in the profit sharing contribution.
Total occupancy expense increased $16 thousand, or 2.4%. 42.6%, or $284 thousand
of occupancy expense was depreciation in 1998, and $322 thousand, or 47.1% was
depreciation in 1997. Excluding depreciation, occupancy expense decreased $21
thousand, or 5.5%, in 1998. The decrease was attributable to less maintenance
and repairs.
Other expense increased $297 thousand, or 35.9%, to $1.1 million. The majority
of this increase was due to Nasdaq entry and related fees of $100 thousand.
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
-13-
<PAGE> 16
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Noninterest Income and Expenses - (Continued)
lower the number, the more efficient the organization. The Corporation's
efficiency ratio for the year-to-date 1998 period was 41.0%, and 40.7% for 1997.
The Corporation's ratio is considered excellent for the industry.
LOANS
IMPAIRED ASSETS
<TABLE>
<CAPTION>
Impaired assets are summarized as follows: (In thousands)
Period Ended March 31, 1998 1997
---------------------- ---- ----
<S> <C> <C>
Non-accruing loans $ 4,836 $ 3,516
Loans past due 90 days or more and still accruing 0 0
Restructured loans 107 118
Other real estate owned 1,000 444
-------------------------
Total non-performing loans $ 5,943 $ 4,078
=========================
Total loans at end of period $692,272 $616,819
-------------------------
As a percent of total loans outstanding 0.86% 0.66%
=========================
</TABLE>
Delinquent and problem loans are a part of any lending enterprise. When a
borrower fails to make payments, the Bank implements collection activities
commencing with simple past due notices. This then progresses to phone calls and
letters, followed by legal activity when and if necessary. At one month past
due, the loan is tracked and reported as a delinquency.
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, in a timely manner, 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 two parcels of undeveloped
commercial land and one house. Efforts are underway to improve the marketability
of these two contiguous land parcels, and locate end users of the sites. The
house property is currently under an earnest money agreement. As of March 31,
1998, 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 $115.4
million in 1998, or 16.7% of total loans, and $106.2 million in 1997, or 17.2%
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.
-14-
<PAGE> 17
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Credit Concentrations - (Continued)
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 March 31, 1998 and 1997, the Corporation had an immaterial amount of foreign
loans and no loans related to highly leveraged transactions.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
For the quarter ended March 31, 1998, the allowance for possible loan losses
increased to $15.8 million, or 2.29% of total loans, from $13.5 million, or
2.19% of total loans in 1997. Net loan losses for 1998 are actually net
recoveries of $737 thousand for the year-to-date period ended March 31, 1998.
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. Management believes that the allowance for loan losses is
adequate given the composition and risks of the portfolio, although there can be
no assurance that the allowance will be adequate to cover all contingencies.
Year 2000 Issue.
A portion of the allowance has been designated to offset possible losses due to
the Year 2000 (Y2K) issue. The Y2K issue is related to the century date change
and the impact on computer systems and business operations worldwide.
Specifically, the issue is whether computer systems will properly recognize date
sensitive information when the year changes to 2000. Systems that do not
properly recognize such information, could generate erroneous data or cause a
system to fail. The Bank is currently evaluating its large borrower's abilities
to respond to their internal Year 2000 issues, which could impair their ability
to make timely payments and, ultimately, to repay their obligations.
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.
-15-
<PAGE> 18
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Liquidity - (Continued)
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
March 31, 1998 and 1997. This discussion addresses those periods of time.
Net cash provided by operating activities in 1998 totaled $6.2 million, as
compared to $6.0 million in 1997. The largest component providing net cash was
income of $4.7 million in 1998 and $4.2 million in 1997.
Loans originated in the real estate secondary market for the first quarter of
1998 were three fold that of the prior period. As indicated, loan originations
in 1998 were $11.1 million, up $7.6 million from the 1997 activity, or 217.1%.
As explained earlier, the increase in activity is due mainly to the lower
interest rate environment. Management estimates that activity should level off
at this point, perhaps decreasing through the remainder of 1998.
Investing activities were mostly in the loan area, even though federal funds
sold utilized in excess of $20 million, those funds were earmarked for the loan
portfolio. Management was anticipating increased loan volume which fell short of
expectations. In 1998, both the loan and federal funds sold volume increased
which was funded by financing activities. Maturing investments were rolled over
during the period.
Financing the investment activities in 1998 was mainly accomplished by
acquisition of core deposits (including NOW, Money Market and Savings accounts)
of $30.4 million, and $10.8 million of certificates of deposit. In 1997, the
majority of the funding of investment activities came from increased core
deposit and cd 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 simulation model used by the Corporation combines the significant factors
that affect interest rate sensitivity into a comprehensive earnings simulation.
Earning assets and interest-bearing liabilities with longer lives may be subject
to more volatility than those with shorter lives. The model accounts for
-16-
<PAGE> 19
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Interest Rate Risk - (Continued)
these differences in its simulations. At March 31, 1998, the simulation modeled
the impact of assumptions that interest rates would increase or decrease 200
basis points. Results indicated that the Corporation was positioned such that
equity would not drop below that point where the Corporation, for regulatory
purposes, would continue to be classified "well capitalized". It should be
emphasized that the model is static in nature and does not take into
consideration possible management actions to minimize the impact on equity.
Management also matches assets and liabilities on a static "gap" report monthly
to assist in interest rate sensitivity measurements.
MANAGEMENT DOES NOT USE INTEREST RATE RISK MANAGEMENT PRODUCTS SUCH AS INTEREST
RATE SWAPS, OPTIONS, HEDGES, OR DERIVATIVES, NOR DOES MANAGEMENT CURRENTLY HAVE
ANY INTENTION TO USE SUCH PRODUCTS IN THE FUTURE.
CAPITAL
Consolidated capital of the Corporation for financial statement purposes at
first quarter end 1998 was $102.6 million. This amount compares to $83.7 million
at March 31, 1997, an increase of $18.9 million, or 22.6%. 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 March 31, 1998, the Corporation's leverage ratio was
11.30%, compared to 10.44% at quarter end 1997. 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 13.50% and 14.77% at March 31, 1998, and
12.50% and 13.76% at March 31, 1997.
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 first
quarter.
Item 5. Other Information.
(a) Please see Item 6(b) below. The shareowners of the Corporation
began trading on the Nasdaq National Market on April 16, 1998.
(b) On January 21, 1998, the Board of Directors of the Corporation
declared a 7% stock dividend to shareowners of record as of
January 21, 1998, and payable on March 16, 1998.
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 10-Q. The financial
data schedule is not a separate financial statement, but a
schedule that summarizes certain standard financial information
extracted directly from the financial statements in this filing.
(b) On February 25, 1998, the Corporation filed Form 8-K disclosing
that the Corporation has made an application for quotation of
its Common Stock on the Nasdaq National Market under the trading
symbol "FTBK". There were no financial statements filed with the
report.
-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: May 5, 1998 /s/ James F. Felicetty
---------------------- -------------------------------------
James F. Felicetty
Secretary/Treasurer
-19-
<PAGE> 22
EXHIBIT INDEX
Exhibit Description
Number
- ------- ---------------------------------------------------------------
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 10-Q. The financial
data schedule is not a separate financial statement, but a
schedule that summarizes certain standard financial information
extracted directly from the financial statements in this filing.
<PAGE> 1
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES EXHIBIT 11
COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
For Three Months Ended March 31,
1998 1997
---------- ----------
<S> <C> <C>
Net Income $4,672,845 $4,175,208
========== ==========
Computation of average
shares outstanding
Shares outstanding at
beginning of year 7,350,561 6,830,666
Additional shares deemed
outstanding because of
stock dividends 516,035 991,388
Additional shares deemed
outstanding because of
stock split 0 0
Shares issued during the
year times average time
outstanding during the year 6,984 4,891
---------- ----------
Average basic shares outstanding 7,873,580 7,826,945
---------- ----------
Dilutive shares 67,333 76,570
---------- ----------
Average fully diluted shares outstanding 7,940,913 7,903,515
---------- ----------
Basic earnings per share $ 0.59 $ 0.53
========== ==========
Fully diluted earnings per share $ 0.59 $ 0.53
========== ==========
</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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 42,183
<INT-BEARING-DEPOSITS> 2,800
<FED-FUNDS-SOLD> 74,910
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 84,889
<INVESTMENTS-CARRYING> 28,533
<INVESTMENTS-MARKET> 29,940
<LOANS> 692,272
<ALLOWANCE> (15,832)
<TOTAL-ASSETS> 936,427
<DEPOSITS> 772,534
<SHORT-TERM> 22,008
<LIABILITIES-OTHER> 9,268
<LONG-TERM> 30,048
0
0
<COMMON> 89,289
<OTHER-SE> 13,280
<TOTAL-LIABILITIES-AND-EQUITY> 936,427
<INTEREST-LOAN> 17,444
<INTEREST-INVEST> 2,710
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 20,154
<INTEREST-DEPOSIT> 7,818
<INTEREST-EXPENSE> 8,465
<INTEREST-INCOME-NET> 11,689
<LOAN-LOSSES> (250)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 5,189
<INCOME-PRETAX> 7,272
<INCOME-PRE-EXTRAORDINARY> 4,673
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,673
<EPS-PRIMARY> 0.59
<EPS-DILUTED> 0.59
<YIELD-ACTUAL> 5.54
<LOANS-NON> 4,836
<LOANS-PAST> 0
<LOANS-TROUBLED> 107
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 14,845
<CHARGE-OFFS> (115)
<RECOVERIES> 852
<ALLOWANCE-CLOSE> 15,832
<ALLOWANCE-DOMESTIC> 15,832
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
