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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 1997
Commission File Number 0-15540
FRONTIER FINANCIAL CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
Washington 91-1223535
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(State or Other Jurisdiction of (IRS Employer Identification
Incorporation or Organization) Number)
332 S.W. Everett Mall Way
P. O. Box 2215
Everett, Washington 98203
(Address of Principal Executive Office) (Zip Code)
(425) 514-0719
(Registrant's Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock (No Par Value)
(Title of Class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (S229.405 of this chapter) is not contained herein, and will
not be contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [X]
The aggregate market value of common stock held by nonaffiliates at December 31,
1997 was $216,944,690 based on the price at December 31, 1997.
The issuer has one class of common stock (no par value) with 7,357,935 shares
outstanding as of February 28, 1998.
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Documents Incorporated by Reference
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Portions of Annual Report to Shareholders for the year ended:
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December 31, 1997..................Part II
1998 Proxy Statement...............Part III
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TABLE OF CONTENTS
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Annual
Item Number Shareholders' Proxy
Form 10-K Report Statement
PART I Page Page Page
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1 Business 1-10
Statistical Disclosure Index 11
2 Properties 20
3 Legal Proceedings 21
4 Submission of Matters to
a Vote of Security Holders 21
PART II
5 Market for Registrant's Common
Stock and Related Shareholder
Matters 36
6 Selected Financial Data 21
7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations 25-39
7a Quantitative and Qualitative Disclosures
About Market Risks 34-35
8 Financial Statements and
Supplementary Data 22
9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure 22
PART III
10 Directors and Executive
Officers of Frontier
Financial Corporation 2-4, 8-9
11 Executive Compensation 9-10
12 Security Ownership of Certain
Beneficial Owners and
Management 8
13 Certain Relationships and
Related Transactions 25 20 11
PART IV
14 Exhibits, Financial Statement
Schedules, and Reports on
Form 8-K 24
Signatures 27
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PART I
ITEM 1 - BUSINESS
Frontier Financial Corporation ("FFC" or "the Corporation") is a Washington
corporation which was incorporated in 1983 and is registered as a bank holding
company under the Bank Holding Company Act of 1956. As part of a plan of
reorganization consummated following the close of business September 30, 1983,
FFC acquired all of the stock of Frontier Bank (the Bank), issuing its common
stock in an exchange for the Bank's common stock on a share-for-share basis. FFC
has two subsidiaries; the Bank, which is engaged in a general banking business
and in businesses related to banking, and FFP, Inc., a nonbank corporation which
leases property to the Bank.
The Bank
The Bank is a state-chartered banking association with its principal office
located in Everett, Snohomish County, Washington. It was founded in September,
1978 by Robert J. Dickson and local business persons. The Bank is an "insured
bank" as defined in the Federal Deposit Insurance Act.
The Bank engages in general banking business, including the acceptance of
demand, time and savings deposits and the making of loans. As of December 31,
1997, the Bank conducted its business operations out of 19 offices located in
Snohomish, King and Skagit Counties, which is the bank's principal market area.
Four offices are located in Everett, one office each is located in Arlington,
Snohomish, Smokey Point, Lake Stevens, Marysville, Lynnwood, Mill Creek,
Edmonds, Stanwood, Bothell, Woodinville, Monroe, Lake City (Seattle), Redmond
and Burlington.
Banking Services
The Bank provides a full range of consumer banking services including savings
accounts, checking accounts, installment and commercial lending, safe deposit
facilities, time deposits and other consumer and business related financial
services. In addition to consumer oriented activities, the Bank maintains a
strong commercial lending program, servicing businesses headquartered in the
Bank's principal market area. At the end of 1983, the Bank began to offer a
discount brokerage service to its customers. In September of 1984, the Bank
opened its Real Estate Division, offering a broad range of home, construction
and commercial long-term financing. The Trust Department opened for business in
March of 1985. This department offers a full array of trust services to its
customers. In May 1988, the Bank opened a Private Banking Office to give
personal service to upscale customers. In August 1989, the Bank acquired,
through a merger, three banking offices of Citizens Bank of Snohomish County,
and a real estate origination department. In January 1991, the Bank opened an
office in Mill Creek, providing a full range of consumer banking services.
In March 1991, the Bank opened an Insurance and Investment Center which markets
annuities, life insurance products, and mutual funds to Bank customers and the
general public. In July 1992, the Bank opened its Stanwood Office. In November
1992, the Bank acquired through merger, Edmonds National Bank, which had one
office. In July 1993, the Bank acquired through merger, The Bank of Northshore,
which had two offices located in Bothell and Woodinville, King County,
Washington. This merger marked the first time the Bank branched outside of
Snohomish County. In June 1995, the Bank opened an office in Monroe, providing a
full range of consumer banking services. In August 1996, the Bank opened the
Lake City Office, (North Seattle) and in December 1996 opened its first office
in Skagit county, in Burlington, named the Skagit County Office. In May 1997,
the Bank opened an office in Redmond, Washington, which also houses a Commercial
Banking Office. This is the Bank's first office in eastern King county.
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Employees
At December 31, 1997, the Bank had 269 full and 51 part time employees. The Bank
considers its relations with employees to be very good.
Competition
All phases of the Bank's activities are highly competitive. The Bank competes
actively with national and state banks, mutual savings banks, savings and loan
associations, finance companies, credit unions, brokerage houses, and other
financial institutions operating in its service area. Some of these financial
institutions have greater resources than those of the Bank. On December 31,
1997, the Bank had total assets of $882.9 million and deposits of $730.9
million.
Supervision and Regulation
The following refers to certain statutes and regulations affecting the banking
industry. These references are only intended to provide brief summaries and
therefore are not complete and are qualified by the statutes and regulations
referenced. In addition, due to the numerous statutes and regulations which
apply to and regulate the operation of the banking industry, many are not
referenced below.
FRONTIER FINANCIAL CORPORATION ("FFC")
GENERAL. FFC is a bank holding company by virtue of its ownership of Frontier
Bank (the "Bank"), and is registered as such with the Federal Reserve Bank
("FRB"). As a bank holding company, FFC is subject to the Bank Holding Company
Act ("BHCA"), which governs and subjects FFC to supervision and examination by
the FRB. Under the BHCA, FFC files with the FRB quarterly and annual reports of
its operations and such additional information as the FRB may require.
BANK HOLDING COMPANY STRUCTURE. In general, the BHCA limits bank holding company
business to owning or controlling banks and engaging in other banking-related
activities. Certain recent legislation designed to expand interstate branching
and relax federal restrictions on interstate banking may expand opportunities
for bank holding companies (see below under "Interstate Banking and Branching").
However, the impact that this legislation may have on FFC and the Bank is
unclear at this time.
FRB REGULATION. Bank holding companies must obtain the FRB's approval before
they: (1) acquire direct or indirect ownership or control of any voting shares
of any bank if, after such acquisition, they would own or control, directly or
indirectly, more than 5 percent of the voting shares of such bank; (2) merge or
consolidate with another bank holding company; and (3) acquire substantially all
of the assets of any additional banks. Until September of 1995, the BHCA also
prohibited bank holding companies from acquiring any such interest in any bank
or bank holding company located in a state other than the state in which the
bank holding company was located, unless the laws of both states expressly
authorized the acquisition. Now, subject to certain state laws, such as age and
contingency laws, a bank holding company that is adequately capitalized and
adequately managed may acquire the assets of an out-of-state bank.
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CONTROL OF NONBANKS. With certain exceptions, the BHCA also prohibits bank
holding companies from acquiring direct or indirect ownership or control of
voting shares in any company other than a bank or a bank holding company unless
the FRB finds FFC's business to be incidental to the business of banking. When
making this determination, the FRB in part considers whether allowing a bank
holding company to engage in those activities would offer advantages to the
public that would outweigh possible adverse effects.
The Economic Growth and Regulatory Paperwork Reductions Act of 1996 ("Economic
Growth Act") amended the BHCA to eliminate the requirement that a bank holding
company seek FRB approval before engaging de novo in permissible nonbanking
activities, if the holding company is well capitalized and meets certain other
criteria specified in the statute. A bank holding company meeting the
specifications is now required only to notify the FRB within 10 business days
after the activity has begun. The FRB has issued a final rule incorporating the
changes enacted by the Economic Growth Act, and as of April 21, 1997, a well-run
bank holding company, without any prior notice or FRB approval, may commence
immediately any activity that is currently or at the time of commencement,
included in the FRB's list of acceptable nonbanking activities.
Acceptable nonbanking activities include: (1) operating an industrial loan
company, mortgage company, finance company, trust company, or credit card
company; (2) performing certain data processing operations; and (3) providing
investment and financial advice. In contrast, prohibited nonbanking activities
include real estate brokerage and syndication, and land development, property
management, and the underwriting of life insurance not related to credit
transactions permissible for bank holding companies.
CONTROL TRANSACTIONS. The Change in Bank Control Act of 1978, as amended,
requires a person or group of persons acquiring "control" of a bank holding
company to provide the FRB with at least 60 days' prior written notice of the
proposed acquisition. Following receipt of the notice, the FRB has 60 days to
issue a notice disapproving the proposed acquisition, but the FRB may extend
this time period for up to another 30 days. An acquisition may be completed
before the disapproval period expires if the FRB issues written notice of its
intent not to disapprove the action. Under a rebuttable presumption established
by the FRB, the acquisition of 10 percent of more of a class of voting stock of
a bank holding company with a class of securities registered under Section 12 of
the Exchange Act would, under the circumstances, set forth in the presumption,
constitute the acquisition of control. In addition, any "company" would be
required to obtain the approval of the FRB under the BHCA before acquiring 25
percent (5 percent if the "company" is a bank holding company) or more of the
outstanding shares of FFC, or otherwise obtain control over FFC.
TRANSACTIONS WITH AFFILIATES. FFC and the Bank are deemed affiliates within the
meaning of the Federal Reserve Act, and transactions between affiliates are
subject to certain restrictions. These restrictions apply to FFC and the Bank
through the BHCA, which provide that transactions between an insured subsidiary
of a holding company and its affiliates are subject to restrictions applicable
to transactions between banks that are members of the Federal Reserve System and
their affiliates in accordance with Sections 23A and 23B of the Federal Reserve
Act. Generally, Sections 23A and 23B: (1) limit the extent to which the
financial institution or its subsidiaries may engage in "covered transactions"
with an affiliate, as defined, to an amount equal to 10 percent of such
institutions capital and surplus and an aggregate limit on all such transactions
with all affiliates to an amount equal to 20 percent of such capital and
surplus, and (2) require all transactions with an affiliate, whether or not
"covered transactions," to be
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on terms substantially the same, or at least as favorable to the institution or
subsidiary, as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
other similar types of transactions.
REGULATION OF MANAGEMENT. Federal law: (1) sets forth circumstances under which
officers or directors of a financial institution may be removed by the
institution's federal supervisory agency; (2) places restraints on lending by an
institution to its executive officers, directors, principal shareowners, and
their related interests; and (3) prohibits management personnel from serving as
a director or in other management positions of another financial institution
whose assets exceed a specified amount or which has an office within a specified
geographic area.
FIRREA. The Financial Institution Reform, Recovery and Enforcement Act of 1989
("FIRREA") became effective on August 9, 1989. Among other things, this
far-reaching legislation (1) phased in significant increases in the FDIC
insurance premiums paid by commercial banks; (2) created two deposit insurance
pools within the FDIC, one to insure commercial bank and savings bank deposits
and the other to insure savings association deposits; (3) for the first time,
permitted bank holding companies to acquire healthy savings associations; (4)
permitted commercial banks that meet certain housing-related assets requirements
to secure advances and other federal services from their local Federal Home Loan
Banks; and (5) greatly enhanced the regulators' enforcement powers by removing
procedural barriers and sharply increasing the civil and criminal penalties for
violating statutes and regulations.
TIE-IN ARRANGEMENTS. FFC and the Bank, are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit, sale or lease of
property or furnishing of services. For example, with certain exceptions,
neither FFC, nor the Bank, may condition an extension of credit on either (1) a
requirement that the customer obtain additional services provided by it or (2)
an agreement by the customer to refrain from obtaining other services from a
competitor. Effective April 1997, the FRB has adopted significant amendments to
its anti-tying rules that; (1) remove FRB-imposed anti-tying restrictions on
bank holding companies and their non-bank subsidiaries; (2) create exemptions
from the statutory restriction on bank tying arrangements to allow banks greater
flexibility to package products with their affiliates; and (3) establish a safe
harbor from the tying restrictions for certain foreign transactions. These
amendments are designed to enhance competition in banking and nonbanking
products and allow banks and their affiliates to provide more efficient and
lower-cost services to customers. However, the impact of the amendments on FFC
and the Bank is unclear at this time.
STATE LAW RESTRICTIONS. As a corporation chartered under the laws of the State
of Washington, FFC may be subject to certain limitations and restrictions as
provided under applicable Washington corporate laws.
SECURITIES REGISTRATION AND REPORTING. FFC Common Stock is registered as a class
with the SEC under Section 12(g) of the Securities Exchange Act of 1934 and thus
is subject to the periodic reporting and proxy solicitation requirements and the
insider-trading restrictions of that Act. The periodic reports, proxy
statements, and other information filed by FFC under that Act can be inspected
and copied at or obtained from the Washington D.C., office of the SEC. In
addition, the securities issued by FFC are subject to the registration
requirements of the Securities Act of 1933 and applicable state securities laws
unless exemptions are available.
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THE BANK
GENERAL. Applicable federal and state statutes and regulations governing a
bank's operations relate, among other matters, to capital requirements, required
reserves against deposits, investments, loans, legal lending limits, certain
interest rates payable, mergers and consolidations, borrowings, issuance of
securities, payment of dividends (see below), establishment of branches, and
dealings with affiliated persons. The FDIC has authority to prohibit banks under
their supervision from engaging in what they consider to be an unsafe and
unsound practice in conducting their business.
The Bank is a state-chartered commercial bank subject to extensive regulation
and supervision by the Washington State Department of Financial Institutions
Division of Banks (the "Division"). The Bank is also subject to regulation and
examination by the FDIC which insures the deposits of the Bank to the maximum
extent permitted by law and by requirements established by the FRB. The federal
laws that apply to the Bank regulate, among other things, the scope of its
business, investments, reserves against deposits, the timing of the availability
of deposited funds and the nature and amount of and collateral for loans. The
laws and regulations governing the Bank generally have been promulgated to
protect depositors and not to protect stockowners of such institutions or their
holding companies.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
requires federal banking regulators to adopt regulations or guidelines in a
number of areas to ensure bank safety and soundness, including: internal
controls, credit underwriting, asset growth, management compensation, ratios of
classified assets to capital, and earnings. FDICIA also contains provisions
which are intended to change independent auditing requirements; restrict the
activities of "undercapitalized banks" to borrow from the FRB's discount window;
and require regulators to perform annual on-site bank examinations and set
standards for real estate lending.
LOANS TO ONE BORROWER. The Bank is subject to limitations on the aggregate
amount of loans that it can make to any one borrower, including related
entities. Applicable regulations generally limit loans-to-one borrower to 15 to
20 percent of unimpaired capital and surplus. As of December 31, 1997, the Bank
was in compliance with applicable loans-to-one borrower requirements.
FDIC INSURANCE. Generally, customer deposit accounts in banks are insured by the
FDIC for up to a maximum amount of $100,000. The FDIC has adopted a risk-based
insurance assessment system under which depository institutions contribute funds
to the Bank Insurance Fund ("BIF"), based on their risk.
On September 30, 1996, the Deposit Insurance Fund Act of 1996 ("Funds Act") was
enacted. The Funds Act provides, among other things, for the recapitalization of
the SAIF through a special assessment on all depository institutions that hold
SAIF insured deposits. The one-time assessment was designed to place the SAIF at
its 1.25 reserve ratio goal.
The Funds Act, for the three-year period beginning in 1997, subjects BIF insured
deposits to a Financing Corporation ("FICO") premium assessment on domestic
deposits at one-fifth the premium rate (approximately 1.3 basis points) imposed
on SAIF insured deposits (approximately 6.5 basis points).
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Beginning in the year 2000, BIF insured institutions will be required to pay the
FICO obligations on a pro-rata basis with all thrift institutions; annual
assessments are expected to equal approximately 2.4 basis points until 2017, to
be phased out completely by 2019.
For the remainder of 1997 and until further action by the FDIC, BIF premiums
will be maintained at their current level.
Banking regulations are empowered under the Funds Act to prohibit insured
institutions and their holding companies from facilitating or encouraging the
shifting of deposits from the SAIF to the BIF in order to avoid higher
assessment rates. The Funds Act also provides for the merger of the BIF and SAIF
on January 1, 1999, only if no thrift institutions exist on that date. It is
expected that Congress will continue to address comprehensive legislation on the
merger of the funds and elimination of the thrift charter.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determined after a hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations, or has violated any applicable law. The insurance may be
terminated permanently, if the institution has no tangible capital. If deposit
insurance is terminated, the accounts at the institution at the time of the
termination, less subsequent withdrawals, will continue to be insured for a
period of six months to two years, as determined by the FDIC.
CAPITAL ADEQUACY REQUIREMENTS. The FRB and the FDIC (collectively, the
"Agencies") have adopted risk-based capital guidelines for banks and bank
holding companies that are designed to make regulatory capital requirements more
sensitive to differences in risk profiles among banks and bank holding companies
and account for off-balance sheet items. The guidelines are minimums, and the
federal regulators have noted that banks and bank holding companies
contemplating significant expansion programs should not allow expansion to
diminish their capital ratios and should maintain ratios in excess of the
minimums. Failure to achieve and maintain adequate capital levels may give rise
to supervisory action through the issuance of a capital directive to ensure the
maintenance of required capital levels.
The current guidelines require all federally-regulated banks to maintain a
minimum risk-based total capital ratio equal to 8 percent, of which at least 4
percent must be Tier 1 capital. Tier 1 capital includes common shareowners'
equity, qualifying perpetual preferred stock, and minority interest in equity
accounts of consolidated subsidiaries, but excludes goodwill and most other
intangibles and the allowance for losses on loans. Total capital includes the
excess of any preferred stock not included in Tier 1 capital, mandatory
convertible securities, hybrid capital instruments, subordinated debt and
intermediate term preferred stock, and the allowance for losses on loans up to
1.25 percent of risk-weighted assets. The Bank has not received notice
indicating that it will be subject to higher capital requirements.
Under these guidelines, banks' assets are given risk-weights of 0 percent, 20
percent, 50 percent or 100 percent. In addition, certain off-balance sheet items
are given credit conversion factors to convert them to asset equivalent amounts
to which an appropriate risk-weight will apply. These computations result in the
total risk-weighted assets. Most loans are assigned to the 100 percent risk
category, except for first
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mortgage loans fully secured by residential property and, under certain
circumstances, residential construction loans (both carry a 50 percent rating).
Most investment securities are assigned to the 20 percent category, except for
municipal or state revenue bonds (which have a 50 percent rating) and direct
obligations of or obligations guaranteed by the United States Treasury or United
States Government Agencies (which have a 0 and 20 percent rating, respectively).
The Agencies have also implemented a leverage ratio, which is equal to Tier 1
capital as a percentage of average total assets less intangibles, to be used as
a supplement to the risk-based guidelines. The principal objective of the
leverage ratio is to limit the maximum degree to which a bank may leverage its
equity capital base. The minimum required leverage ratio for top-rated
institutions is 3 percent, but most institutions are required to maintain an
additional cushion of at least 100 to 200 basis points. Any institution
operating at or near the 3 percent level is expected to have well-diversified
risk, including no undue interest rate risk exposure, excellent asset quality,
high liquidity and good earnings, and in general, to be a strong banking
organization without any supervisory, financial or operational weaknesses or
deficiencies. Any institutions experiencing or anticipating significant growth
would be expected to maintain capital ratios, including tangible capital
positions, well above the minimum levels.
PROMPT CORRECTIVE ACTION. Regulations adopted by the Agencies as required by
FDICIA impose even more stringent capital requirements. The regulators require
the FDIC and other Federal Banking Agencies to take certain "prompt corrective
action" when a bank fails to meet certain capital requirements. The regulations
establish and define five capital levels: (1) "well-capitalized," (2)
"adequately capitalized," (3) "undercapitalized," (4) significantly
undercapitalized" and (5) "critically under capitalized." To qualify as "well
capitalized", an institution must maintain at least 10 percent total risk-based
capital, 6 percent Tier 1 risk-based capital, and a leverage ratio of no less
than 5 percent. Increasingly severe restrictions are imposed on the payment of
dividends and management fees, asset growth and other aspects of the operations
of institutions that fall below the category of being "adequately capitalized"
(which requires at least 8 percent total risk-based capital, 4 percent Tier 1
risk-based capital, and a leverage ratio of at least 4 percent).
Undercapitalized institutions are required to develop and implement capital
plans acceptable to the appropriate federal regulatory agency. Such plans must
require that any company that controls the undercapitalzed institution must
provide certain guarantees that the institution will comply with the plan until
it is adequately capitalized. As of December 31, 1997, the Bank was well
capitalized and maintained a leverage ratio of 10.65 percent, a risk-based Tier
1 capital ratio of 13.09 percent, and a risk-based total capital ratio of 14.35
percent.
In August of 1995, the Federal Banking Agencies adopted a final rule
implementing the portion of Section 305 of FDICIA that requires the banking
agencies to revise their risk-based capital standards to ensure that those
standards take adequate account of interest rate risk. Effective September 1,
1995, when evaluating the capital adequacy of a bank, the Federal Banking
Agencies' examiners will consider exposure to declines in the economic value of
the bank's capital due to changes in interest rates. A bank may be required to
hold additional capital for interest rate risk if it has a significant exposure
or a weak interest rate risk management process.
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RESTRICTIONS ON CAPITAL DISTRIBUTIONS. Dividends paid to FFC by the Bank are a
material source of FFC's cash flow. Various federal and state statutory
provisions limit the amount of dividends the Bank is permitted to pay to FFC
without regulatory approval.
FRB policy further limits the circumstances under which bank holding companies
may declare dividends. For example, a bank holding company should not continue
its existing rate of cash dividends on its common stock unless its net income is
sufficient to fully fund each dividend and its prospective rate of earnings
retention appears consistent with its capital needs, asset quality, and overall
financial condition.
If, in the opinion of the applicable federal banking agency, a depository
institution under its jurisdiction is engaged in or is about to engage in an
unsafe or unsound practice (which depending on the financial condition of the
institution, could include the payment of dividends), the agency may require,
after notice and hearing, that such institution cease and desist from such
practice. In addition, the FRB and the FDIC have issued policy statements which
provide that insured banks and bank holding companies should generally pay
dividends only out of current operating earnings.
According to Washington law, the Bank may not declare or pay a cash dividend in
an amount greater than its retained earnings, without the approval of the
Director of the Division.
INTERSTATE BANKING AND BRANCHING. The Riegle-Neal Interstate Banking and
branching Efficiency Act of 1994 ("Interstate Act") generally permits nationwide
interstate banking and branching by relaxing federal law restrictions on
interstate banking and providing general authorization for interstate branching.
Subject to certain state laws, such as age and contingency laws, the Interstate
Act allows adequately capitalized and adequately managed bank holding companies
to purchase the assets of out-of-state banks. Additionally, since June 1, 1997,
the Interstate Act permits interstate bank mergers, subject to these state laws,
unless the home state of either merging bank has "opted-out" of these provisions
by enacting "opt-out" legislation. The Interstate Act does allow states to
impose certain conditions on interstate bank mergers within their borders; for
example, states may require that the in-state merging bank exist for up to five
years before the interstate merger. Under the Interstate Act, states may also
"opt-in" to de novo branching, allowing out-of-state banks to establish de novo
branches within the state.
In 1996, Washington enacted "opting-in" legislation authorizing interstate
mergers pursuant to the Interstate Act. Accordingly, as of June 6, 1996, an
out-of-state bank holding company may now acquire more than 5 percent of the
voting shares of a Washington-based bank, regardless of reciprocity, provided
such bank or its predecessor has been doing business for at least five years
prior to the acquisition. Further, an out-of-state bank may engage in banking in
Washington if the requirement of Washington's interstate banking statute are
met, and either (1) was lawfully engaged in banking in Washington on June 6,
1996, (2) resulted from an interstate combination pursuant to Washington law,
(3) resulted from a relocation of a head office of a state bank or a main office
of a national bank pursuant to federal law, or (4)
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resulted from the establishment of a savings bank branch in compliance with
applicable Washington law. Additionally, the Director of the Division may
approve interstate combinations if the basis for such approval does not
discriminate against out-of-state banks, out-of-state holding companies, or
their subsidiaries.
REGULATORY IMPROVEMENT. In 1994, Congress enacted the Community Development and
Regulatory Improvement Act ("Regulatory Improvement Act"), with the intent of,
among other things, reducing the regulatory burden on financial institutions.
This Act is intended to streamline certain regulatory procedures and relax
certain regulatory compliance requirements. In addition, the Regulatory
Improvement Act specifically directs each federal banking agency to review and
streamline its regulations and written supervisory policies.
Effect of Governmental Policies
The Bank is affected not only by general economic conditions, but also by the
monetary and fiscal policies of the United States Government and various
agencies, particularly the Federal Reserve System. In its role of implementing
its monetary policy, the Federal Reserve Board has the power to regulate the
national supply of bank credit through such methods as open market operations in
the United States Government securities markets, control of the discount rate on
member bank borrowings, and establishment of reserve requirements against bank
deposits. These means are used in varying combinations and have an influence
over the growth of bank loans, investments, and deposits. They may also affect
interest rates charged on loans or paid on deposits. The nature and timing of
future changes in monetary policies and their impact on the Bank are not
predictable. As a consequence of extensive regulation of commercial banking
activities in the United States, the Bank's business is particularly susceptible
to being affected by Federal legislation and regulations which may have the
effect of increasing the cost of doing business or limiting permissible
activities.
FFP, Inc.
On April 4, 1988, the Corporation formed a new subsidiary corporation called
FFP, Inc. The purpose of this corporation is to purchase and lease real property
to the Bank. The reason for this approach was to preclude placing nonearning
assets on the books of the Bank or the Corporation. As of December 31, 1997, all
banking offices have been moved into FFP, except those offices which are leased.
For further details, please see page 20 of this Form 10-K Report, "Properties."
It is intended that future purchases of real property will be made by FFP, Inc.
At this time, it is not anticipated that FFP, Inc. will engage in any other type
of business.
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Washington Banking Company ("WBC")
In April 1996, the Corporation purchased 4.99% of the common stock of Whidbey
Island Bank, located approximately 15 miles west of Everett. Shortly thereafter,
the bank converted to the holding company structure and is now called Washington
Banking Company. Subsequent to the initial investment, the Corporation made
application to the Board of Governors of the Federal Reserve System to purchase
up to 10.0% ownership in the company. Approval was received, and the Corporation
has since purchased an additional .5% ownership, to total 5.4%. The Corporation
intends to purchase more of the stock in WBC if it becomes available.
-10-
<PAGE> 13
STATISTICAL DISCLOSURE INDEX
The schedules listed below set forth the statistical information relating to
Frontier Financial Corporation and subsidiaries (unless otherwise stated) in
accordance with Guide 3. This information should be read in conjunction with the
consolidated financial statements.
<TABLE>
<CAPTION> Annual
I.Distribution of Assets, Liabilities Form 10-K Report
and Stockholders' Equity; Interest Page Page
Rates and Interest Differential: --------- ------
<S> <C> <C>
A. Consolidated Average Balance
Sheets/Interest Income and
Expense/Rates 38
B. Changes in Net Interest Income
and Expense due to Rate and Volume 39
II.Investment Portfolio:
A. Analysis of Investment Securities
at Year-end 12 10
B. Maturity Distribution of Investment
Securities 12 11
III.Loan Portfolio:
A. Types of Loans 13 11
B. Loan Maturities and Sensitivity to
Changes in Interest Rates 13 12
C. Risk Elements 14
D. Credit Concentrations 19
IV.Summary of Loan Loss Experience:
A. Analysis 17
B. Allocation of Allowance for Possible
Loan Losses 18
V.Deposits:
Average Interest and Noninterest
Bearing Deposit Balances 38
VI.Return on Equity and Assets:
Selected Financial Ratios 21
VII.Short-term Borrowings 20
</TABLE>
-11-
<PAGE> 14
Analysis of Investment Securities
The Aggregate amortized recorded values of investment securities at December 31
are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
(In thousands) Amortized Amortized Amortized
Cost Cost Cost
--------------------------------------------
<S> <C> <C> <C>
U.S. Treasuries $ 754 $ 758 $ 2,759
U.S. Agencies 43,490 45,824 48,591
Municipal Bonds 28,531 29,727 30,046
Corporate Bonds 28,151 40,578 51,567
Equities 9,927 9,270 7,542
Certificates of Deposit 3,550 4,775 3,050
--------------------------------------------
Totals $ 114,403 $ 130,932 $ 143,555
============================================
</TABLE>
Maturity Distribution of Investment Securities
The following table sets forth the maturities of investment securities at
December 31, 1997. Taxable equivalent values are used in calculating yields
assuming a tax rate of 35%.
<TABLE>
<CAPTION>
(In thousands) After 1 Yr After 5 Yrs Totals &
(Amortized cost used) Within But Within But Within After Weighted
1 Year/ 5 Years/ 10 Years/ 10 Years/ Average
Yield Yield Yield Yield Yield
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. Treasury $ 501 $ 0 $ 0 $ 253 $ 754
7.71% 0.00% 0.00% 7.16% 7.53%
U.S. Agencies 9,397 3,026 30,863 204 43,490
5.26% 7.20% 7.01% 8.86% 6.65%
Municipal Bonds 195 1,940 24,439 1,957 28,531
9.87% 10.19% 8.51% 8.96% 8.66%
Corporate Bonds 1,417 10,364 16,370 0 28,151
7.81% 7.54% 6.65% 0.00% 7.04%
Equities 9,927 0 0 0 9,927
7.13% 0.00% 0.00% 0.00% 7.13%
Certificates of 3,550 0 0 0 3,550
5.54% 0.00% 0.00% 0.00% 5.54%
------------------------------------------------------------------------------------------------
TOTALS $ 24,987 $ 15,330 $ 71,672 $ 2,414 $ 114,403
================================================================================================
6.27% 7.81% 7.44% 8.76% 7.26%
================================================================================================
</TABLE>
-12-
<PAGE> 15
Types of Loans
Major classifications of loans, net of deferred loan fees, at December 31 are as
follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995 1994 1993
-------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Commercial $123,569 $117,258 $126,914 $121,218 $118,871
Real Estate Commercial 270,899 230,341 171,590 151,829 89,430
Real Estate Construction 144,978 131,148 94,393 99,278 71,355
Real Estate Mortgage 101,436 98,580 92,342 79,264 70,600
Installment 24,448 23,067 19,749 18,923 19,350
------------------------------------------------------------------------
TOTAL $665,330 $600,394 $504,988 $470,512 $369,606
========================================================================
</TABLE>
Loan Maturities and Sensitivity to Changes in Interest Rates
The following table shows the amounts and maturity analysis of loans outstanding
as of December 31, 1997. Also, the amounts are classified as to fixed and
variable rate sensitivity for amounts due after one year.
<TABLE>
<CAPTION>
Maturity
------------------------------------------------------------------------
(In thousands) Within 1 - 5 After
1 Year Years 5 Years Total
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial $ 62,890 $ 53,815 $ 6,864 $ 123,569
Real Estate Commercial 54,289 210,095 6,515 270,899
Real Estate Construction 97,938 42,266 4,774 144,978
Real Estate Mortgage 32,013 65,028 4,395 101,436
Installment 6,349 10,560 7,539 24,448
------------------------------------------------------------------------
TOTAL $ 253,479 $ 381,764 $ 30,087 $ 665,330
========================================================================
</TABLE>
Loans maturing after one year with:
<TABLE>
<CAPTION>
1 - 5 After
Years 5 Years
----------------------------
<S> <C> <C>
Fixed Rates $ 323,498 $ 13,073
Variable Rates 58,266 17,014
----------------------------
TOTAL $ 381,764 $ 30,087
============================
</TABLE>
It is not uncommon to rollover loans at the maturity period, provided that the
rate and terms of the loan conform to the current policy.
-13-
<PAGE> 16
Loan Administration
The Bank provides revolving lines of credit to many of its borrowers. Such lines
are approved by the Director's Loan Committee ("Loan Committee") or other
administrative level committee or person if the amount exceeds the lending units
authorized loan limit.
Credit Review personnel, under the direction of the Credit Administrator,
examine the loan portfolio regularly. Reports are made by the Senior Vice
President/Credit Administrator to senior management and the Loan Committee, and
follow-up corrective action is monitored. Problem loan reports are prepared for
management review on a regular basis.
Certain problem loans are placed on a nonaccrual basis in conformance with
defined policy. The Loan Committee and other administrative personnel regularly
review information reports on classified and delinquent loans. Comparative
summaries of delinquent loans are also provided on a regular basis to senior
management and to the Board of Directors.
Management closely monitors the adequacy of the loan loss reserve and an
analysis is performed four times a year. The allowance is maintained at a level
deemed sufficient to meet potential losses.
The reviews, examinations and actions described above are in addition to the
periodic examinations by federal and state regulatory agencies, as well as the
Bank's internal audit department and the Bank's outside public accounting firm.
Risk Elements - Impaired Assets
Loans are placed in a nonaccrual status when, in the opinion of management, the
collection of additional interest is doubtful, or when the loan becomes ninety
(90) days past due in principal or interest. When a loan is placed in a
nonaccrual status, all interest previously accrued but not collected is reversed
and charged against interest income. Income on nonaccrual loans is then
recognized only to the extent cash is received and where the future collection
of principal is probable. Accruals are resumed only when the loan is brought
current, or when, in the opinion of management, the borrower has demonstrated
the ability to resume payments of principal and interest on a regular basis. As
a consequence, some of these loans are current in their payments at this time.
The dollar amount of loans placed in nonaccrual, past due 90 days or more,
restructured loans and other real estate owned as a percentage of total loans
was .67%, .62%, and .90% for year-end 1997, 1996 and 1995, respectively. These
loans have a variety of situations, some of which may lead to foreclosure or
involve a bankruptcy case. Others may continue payment as the borrower's
financial situation improves. A very small amount represents federally insured
loans. The rise at year-end 1995 occurred primarily as a result of two borrowers
which, together, constituted $4.0 million, or 91% of total nonaccruing loans.
Although these loans were adequately secured by real estate, it was nonetheless
felt prudent to place them in nonaccrual. At year-end 1996, two borrowers
comprise 72% of the totals, the majority of which is real estate secured. At
year-end 1997, the total represented 21 different loans, 8 out of those 21 were
real estate in nature. However, there does not appear to be any trend
developing.
-14-
<PAGE> 17
Management monitors these loans on a frequent basis and conducts aggressive
collection efforts, unless constraints are placed on the Bank by the bankruptcy
courts. These efforts are directed toward the best long-term results for the
Bank, and to the extent reasonable, to the borrower as well. If, in the opinion
of management, it is felt, or if it can be determined, that full collection of
these loans or their payment streams will not occur, then they are charged off
against the loan loss reserve.
Loans past due 90 days or more, nonaccruing, restructured and other real estate
owned (OREO) on which the accrual of interest has been discontinued as of
December 31st are as follows:
<TABLE>
<CAPTION>
(In thousands)
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Commercial $ 254 $ 478 $ 175 $ 866 $ 893
Real Estate 4,087 3,144 4,228 1,736 721
Installment 14 4 14 59 26
Restructured 109 121 122 126 131
----------------------------------------------------------------------------
Total Non-Performing Loans 4,464 3,747 4,539 2,787 1,771
----------------------------------------------------------------------------
Other real estate owned 1,000 444 590 1,118 683
----------------------------------------------------------------------------
Total Impaired Assets $ 5,464 $ 4,191 $ 5,129 $ 3,905 $ 2,454
============================================================================
Total Loans at end
of period $665,330 $600,394 $504,988 $470,512 $369,606
============================================================================
As a percent of
total loans 0.67% 0.62% 0.90% 0.59% 0.48%
============================================================================
</TABLE>
There are certain amounts of interest collected on the above loans and included
in income, and amounts that have not been accrued which are indicated in the
table below:
<TABLE>
<CAPTION>
(In thousands)
At December 31, 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Total interest income which
would have been recorded
during the period under
original terms of loans above $ 237 $ 289 $ 501 $ 261 $ 203
Portion of interest
income included in
net income for the
period 384 $ 264 $ 378 $ 207 $ 98
Commitments for additional
funds related to loans
above -0- -0- -0- -0- -0-
</TABLE>
-15-
<PAGE> 18
Restructured loans are those loans that had problems in the past, and a
concession was made in the interest rate, principal amount, and/or the repayment
schedule has been modified to the extent that there has been tangible impairment
of value. These loans are monitored on a regular basis for performance.
The Bank originates commercial, commercial real estate, residential mortgage and
installment loans primarily in Snohomish, north King and Skagit Counties. Loan
growth in 1997 and 1996 was much stronger than in 1995. Total loans as of
December 31, 1997, 1996 and 1995 were $665.3, $600.4 and $505.0 million,
respectively.
The area's economy is diversified with trade, high-tech, military and service
industries. Military personnel assigned to the new Everett Naval facility began
arriving in the later part of 1995, and it is expected that continuing increases
in personnel will serve to further diversify and stabilize the local economy.
While management estimates that the loan portfolio is reasonably diversified,
the quality of the portfolio is significantly related to the strength and
stability of real estate values which are controlled by the local economy.
The Boeing Company continues to be one of the major employers in Snohomish
County. It would appear that concerns over the past (1994-1995) downsizing at
Boeing were somewhat mitigated by the increased diversification of the local
economy. Boeing is now showing significant net employment growth. However,
concern still persists regarding the employment stability of Boeing, and,
accordingly, management will continue to exercise caution in the execution of
the Bank's lending activities.
A concern on the national level is the continued negotiations on balancing the
federal budget and policies going forward. Changes in the monetary and fiscal
policies, as well as military base locations, may have adverse effects on the
credit and equity markets, which could affect consumer and business confidence
locally.
Other Real Estate Owned
As of December 31, 1997, the Bank had three parcels of other real estate owned
(OREO) on its books, which totaled $1.0 million. One residential parcel is soon
to be under an earnest money agreement to sell. The remaining two parcels are
commercial land. No losses are expected on sales of OREO which are recorded at
the lower of cost or fair value, less estimated costs to sell. The current
levels are felt to be nominal, and no particular trends are noted at this time.
The table below shows the carrying value of OREO at December 31st:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Other Real Estate Owned $ 1,000 $ 444 $ 590 $ 1,118 $ 683
</TABLE>
-16-
<PAGE> 19
Summary of Loan Loss Experience
The following table provides an analysis of net losses by loan type for the last
five years at December 31st:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Balance at beginning
of year $ 13,268 $ 11,897 $ 10,410 $ 7,368 $ 5,906
Provision charged to
operating expense 1,850 1,980 1,525 3,900 3,012
Deduct:
Loans charged-off:
Commercial (338) (526) (1,250) (1,111) (1,886)
Real Estate (1,324) (1,333) (875) (879) (290)
Installment (77) (84) (87) (100) (93)
----------------------------------- -----------------------------------------------
Total charged-off loans (1,739) (1,943) (2,212) (2,090) (2,269)
Less recoveries:
Commercial 283 752 1,245 613 500
Real Estate 1,161 535 901 557 151
Installment 22 47 28 62 68
----------------------------------- -----------------------------------------------
Total recoveries 1,466 1,334 2,174 1,232 719
Net charge-offs (273) (609) (38) (858) (1,550)
Balance at end of year $ 14,845 $ 13,268 $ 11,897 $ 10,410 $ 7,368
=====================================================================================
Net total loans at
end of period $ 665,330 $ 600,394 $ 504,988 $ 470,512 $ 369,606
Daily average loans $ 640,415 $ 555,105 $ 485,430 $ 426,344 $ 338,029
Ratio of net charged-off
loans during period to
average loans outstanding 0.04% 0.11% 0.01% 0.20% 0.46%
=====================================================================================
</TABLE>
-17-
<PAGE> 20
It is the policy of Frontier Financial Corporation and its subsidiary to
charge-off any loan or portion of a loan that is deemed uncollectible in the
ordinary course of business. The entire allowance for possible loan losses is
available to absorb such charge-offs.
In the opinion of management, if a loan represents a long-term liquidation
project, particularly when the liquidation is under the control of the
bankruptcy courts, a decision may be made to write off the asset. Many
charge-offs will ultimately have recoveries in full or a significant part, and
some are currently under repayment programs.
For fiscal year-end 1997, net loan losses were $273 thousand, or .04% of average
loans outstanding. This amount represents less than half the 1996 net
charge-offs of $609 thousand.
As indicated by the previous chart, the Bank has recovered a significant portion
of its charged-off loans for fiscal years 1996 and 1995. The chart also
indicates that the Bank's net charge-offs for fiscal year 1993 were
substantially higher. The higher level, at that time, was primarily attributed
to loans acquired through merger.
Charged-off loans that continue to be actively pursued for collection as of
fiscal year-end 1997, total over $3 million. While additional recoveries are
expected, the amounts and timing cannot be determined with certainty.
Based on certain characteristics of the portfolio, potential losses can be
anticipated for major loan categories. In the following table, the allowance for
possible loan losses at year-end, for the last five years, has been allocated
among major loan categories based primarily on their historical net charge-off
experience, along with consideration of factors such as quality, volume,
anticipated economic conditions, and other business considerations.
<TABLE>
<CAPTION>
(In thousands, except percents)
Loan Loan Loan Loan Loan
1997 Category 1996 Category 1995 Category 1994 Category 1993 Category
Reserve Percent Reserve Percent Reserve Percent Reserve Percent Reserve Percent
-------- -------- --------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial $8,010 18.6% $ 7,960 19.5% $ 7,138 25.1% $ 6,246 25.8% $ 4,781 32.2%
Real Estate 6,485 77.8% 4,953 76.7% 4,283 71.0% 3,748 70.2% 2,425 62.6%
Installment 350 3.6% 355 3.8% 476 3.9% 416 4.0% 162 5.2%
-----------------------------------------------------------------------------------------------------------
TOTAL $14,845 100.0% $13,268 100.0% $11,897 100.0% $10,410 100.0% $ 7,368 100.0%
===========================================================================================================
</TABLE>
Historical net charge-offs are not necessarily accurate indicators of future
losses since net charge-offs vary from period to period due to economic
conditions and other factors that cannot be accurately predicted. Thus, an
evaluation based on historical loss experience of individual loan categories is
only one of many factors considered by management in evaluating the adequacy of
the overall allocation, and in determining the amount of the provision for
possible loan losses. Other factors are the continuing level of nonperforming
loans, credit concentrations, and uncertain economic conditions. At December 31,
1997, based on current economic conditions, the total of the allocation for
possible loan losses is, in management's opinion, adequate to provide for future
losses. However, a worsening of the economy in the Bank's market area could
negatively affect loan performance and underlying collateral values. The full
impact of such a trend on the condition of the Bank cannot be estimated.
-18-
<PAGE> 21
Credit Concentrations
At year-end 1997, 17.7% of the Bank's loan portfolio was in residential and
commercial construction and land development projects centered in Snohomish,
King and Skagit Counties. Management has established a Real Estate Review
Committee which meets periodically to monitor local economic conditions, and the
performance of borrowers in this industry. The chart below indicates the amount
of those loans, and as a percent of total loans for the period:
<TABLE>
<CAPTION>
At December 31,
(In thousands) 1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Construction $ 74,759 $ 66,065 $ 50,675 $ 55,551 $ 38,324
Land Development 43,015 52,186 33,946 38,582 28,835
--------------------------------------------------------------------------------------
TOTAL $ 117,774 $ 118,251 $ 84,621 $ 94,133 $ 67,159
======================================================================================
Total Loans at end of period $ 665,330 $ 600,394 $ 504,988 $ 470,512 $ 369,606
======================================================================================
Construction and Land
Development loans as a
percent of total loans 17.7% 19.7% 16.8% 20.0% 18.2%
======================================================================================
</TABLE>
Deposits
For the average amount of deposits and rates paid on such deposits for years
ended December 31, 1997, 1996, and 1995 please refer to page 38 of 1997 Annual
Report to Shareowners.
Maturities of time certificates of deposit $100,000 and over at year end 1997,
are shown below:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
3 months or less $ 28,362
Over 3 months through 6 months 25,897
6 months through 12 months 34,266
Over 12 months 20,907
----------
TOTAL $ 109,432
==========
</TABLE>
Significant Financial Ratios
Ratios for the years ended December 31, 1997, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Return on Average Assets 2.02% 1.94% 1.82%
Return on Average Equity 18.84% 20.01% 21.59%
Cash dividends paid/dividend payout -0- -0- -0-
Average Equity to Average Assets 10.71% 9.70% 8.45%
</TABLE>
-19-
<PAGE> 22
<TABLE>
<CAPTION>
Borrowings
Short-Term Borrowings Weighted Weighted Weighted
(In thousands) Average Average Average
Interest Interest Interest
At December 31, 1997 Rate 1996 Rate 1995 Rate
---------------------------------------- ---------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
Year-end balance: $ 17,962 5.00% $ 12,011 4.89% $ 7,596 5.51%
Highest month end
balance during
the period: $ 22,245 $ 12,390 $ 12,400
</TABLE>
For information regarding average balances and yields, please refer to page 38
of 1997 Annual Report to Shareowners.
Long-Term Debt
For detailed information relating to long-term debt, please refer to Note 9,
page 15, of 1997 Annual Report to Shareowners.
ITEM 2 - PROPERTIES
FFC's main office, which is owned by FFP, is located in Everett, Washington. At
December 31, 1997, the Bank had 19 offices, including the main office, all of
which are located in the state of Washington. These offices are located in
Arlington, Bothell, Burlington, Edmonds, Everett (4), Lake City (North Seattle),
Lake Stevens, Lynnwood, Marysville, Mill Creek, Monroe, Redmond, Smokey Point,
Snohomish, Stanwood and Woodinville. All of its branches are located in
properties owned by FFP, Inc., a real estate holding subsidiary, except for the
offices located in Burlington (lease expires May 1999), Edmonds, (lease expires
July 31, 2004), one office in Everett (lease expires October 2014), Lake Stevens
(lease expires May 2001), Mill Creek (lease expires November 2000), and
Woodinville (lease expires March 1998). The Bank has acqired property in
Woodinville, and anticipates moving its Woodinville office to that site in the
fall of 1998. The total net book value of the investment in premises and
equipment at December 31, 1997, totaled $13.8 million.
-20-
<PAGE> 23
ITEM 3 - LEGAL PROCEEDINGS
There are no material legal proceedings.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to security holders during the fourth
quarter of 1997.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
STOCKOWNER MATTERS
Please see 1997 Annual Report to Shareholders, page 36.
ITEM 6 - SELECTED FINANCIAL DATA
(In thousands, except per share data)
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
% Change
AT YEAR-END 1997 1996 1995 1994 1993 1996-1997
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Total assets $ 882,880 $ 803,619 $ 735,183 $ 642,568 $ 558,043 9.9%
Net loans 650,485 587,126 493,091 460,102 362,238 10.8%
Deposits 730,931 670,516 641,218 539,603 506,538 9.0%
Long-term debt 56 100 136 565 737 -44.0%
Investment securities 115,100 131,130 144,976 136,326 151,509 -12.2%
Shareowners' equity 97,839 80,317 65,353 50,459 41,167 21.8%
FOR THE YEAR
Interest income 76,311 68,000 63,086 52,945 44,324 12.2%
Interest expense 32,160 30,100 29,347 20,639 17,782 6.8%
Securities gains(losses) 0 0 (4) (355) 0 nm
Provision for loan losses 1,850 1,980 1,525 3,900 3,012 -6.6%
Net income 16,902 14,617 12,615 10,360 7,746 15.6%
Basic earnings per share $ 2.31 $ 2.01 $ 1.75 $ 1.44 $ 1.08 15.0%
Fully diluted earnings per share $ 2.28 $ 1.99 $ 1.72 $ 1.41 $ 1.05 15.2%
Return on Average
Assets 2.02% 1.94% 1.82% 1.69% 1.50%
Equity 18.84% 20.01% 21.59% 22.21% 20.59%
Avg. equity/avg. assets 10.71% 9.70% 8.45% 7.63% 7.28%
nm=Not meaningful
</TABLE>
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Please see 1997 Annual Report to Shareholders, pages 25 through 39.
-21-
<PAGE> 24
ITEM 7a - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Please see 1997 Annual Report to Shareowners, page 34 and 35.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Annual
Form Report to
10-K Shareholders
Page Page
-----------------------
<S> <C> <C>
Independent Auditors Report 26
Report of Management 1
Consolidated Balance Sheet at
December 31, 1997 and 1996 3
Consolidated Statement of Income for the Years
Ended December 31, 1997, 1996 and 1995 4
Consolidated Statement of Changes in
Shareowners' Equity 5
Consolidated Statement of Cash Flows for the
Years Ended December 31, 1997, 1996 and 1995 6
Condensed Balance Sheet (Parent Only) at
December 31, 1997 and 1996 23
Condensed Statement of Income (Parent Only) for the
Years Ended December 31, 1997, 1996 and 1995 23
Condensed Statement of Cash Flows (Parent Only)
for Years Ended December 31, 1997, 1996 and 1995 24
Notes to Consolidated Financial Statements 7-24
</TABLE>
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
-22-
<PAGE> 25
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF FRONTIER FINANCIAL
CORPORATION
Please see pages 2,3 and 9 of 1998 Proxy Statement.
ITEM 11 - EXECUTIVE COMPENSATION
Please see pages 9 and 10 of 1998 Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Please see page 8 of 1998 Proxy Statement.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Please see page 11 of 1998 Proxy Statement; and,
Note 14, page 20 of 1997 Annual Report to Shareowners; and,
Page 25 of this Form 10-K report.
-23-
<PAGE> 26
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of the report:
1.Financial Statements.
Financial statements required by Item 8 of this report are
incorporated by reference, from the 1997 Annual Report to
Shareowners, attached hereto as an exhibit.
2.Financial Statement Schedules.
Additional financial statement schedules filed with this report are
included in Item 14(d) and are as follows:
Schedule I - Amounts Receivable from Certain Persons
Schedules other than those listed above are omitted
because of the absence of the condition under which they
are required or because the information called for is
included in the financial statements or notes thereto.
3. Exhibits.
(3) Articles of Incorporation and By-Laws are incorporated
herein by reference to Exhibits 3(a) and 3(b) to
Registration on Form S-14, File No. 2-82420.
(11) Statement Regarding Computation of Earnings Per Share.
(13) Annual Report to Shareowners for the year ended December
31, 1997. (Pages 1 to 39, inclusive)
(21) Subsidiaries of Registrant is incorporated by reference
from Part I, page 1 thru 9 of this report.
(27.1) Financial Data Schedule / Jan 1, 1997 - Dec 31, 1997
(This exhibit is included only in the electronic EDGAR
filing version of this Form 10-K. 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.)
(27.2) Financial Data Schedule / Restated and Amended Jan 1, 1995
- Dec 31, 1996 (This exhibit is included only in the
electronic EDGAR filing version of this Form 10-K. 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 for the period referred to.)
(27.3) Financial Data Schedule / Restated and Amended Jan 1, 1997
- Dec 31,1997 (This exhibit is included only in the
electronic EDGAR filing version of this Form 10-K. 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 for the period referred to.)
(b) Reports on Form 8-K:
No Form 8-K's were filed, nor required to be filed for any event
during the fourth quarter ended December 31, 1997.
(c) Exhibits - See list of exhibits set forth above at Item 14 (a)3.
(d) Financial Statement Schedules:
Schedules required to be filed in response to this portion of Item
14 are listed above in Item 14 (a)1 and 2. The independent auditors'
report covering these items is included on page 26 of this
Form 10-K.
-24-
<PAGE> 27
SCHEDULE I
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
AMOUNTS RECEIVABLE FROM CERTAIN PERSONS
<TABLE>
<CAPTION>
(In thousands)
Balance at
Year Ended Balance at Deductions December 31
December 31 January 1 Additions Collections Write-offs all current
- ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
1997
Eleven $ 6,502 $ 21,542 $ (6,140) $ 0 $ 21,904
Directors
and Two
Officers
1996
Nine 8,552 3,218 (5,268) 0 6,502
Directors
and Two
Officers
1995
Ten 10,044 4,123 (5,615) 0 8,552
Directors
and Two
Officers
1994
Nine $ 5,969 $ 7,695 $ (3,620) $ 0 $ 10,044
Directors
and Two
Officers
</TABLE>
-25-
<PAGE> 28
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareowners
Frontier Financial Corporation
We have audited the consolidated financial statements and related financial
statement schedule of Frontier Financial Corporation and subsidiaries listed
in item 14(a)1 and 2 of the Annual Report on Form 10-K of Frontier Financial
Corporation for the year ended December 31, 1997. These financial statements are
the responsibility of the Corporation's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Frontier Financial
Corporation and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted
accounting principles. In our opinion, the financial statement schedule
referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly the information required to be
included therein.
/s/ Moss Adams LLP
Everett, Washington
January 20, 1998
-26-
<PAGE> 29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
March 18, 1998 /s/ Robert J. Dickson
- -------------- -------------------------------------------
Date Robert J. Dickson
President & Chief Executive Officer
March 18, 1998 /s/ James F. Felicetty
- -------------- -------------------------------------------
Date James F. Felicetty
Secretary/Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:
March 18, 1998 /s/ George E. Barber
- -------------- -------------------------------------------
George E. Barber, Director
March 18, 1998 /s/ Lucy DeYoung
- -------------- -------------------------------------------
Lucy DeYoung, Director
March 18, 1998 /s/ Robert J. Dickson
- -------------- -------------------------------------------
Robert J. Dickson, Director
March 18, 1998 /s/ David A. Dujardin
- -------------- -------------------------------------------
David A. Dujardin, Director
March 18, 1998 /s/ Edward D. Hansen
- -------------- -------------------------------------------
Edward D. Hansen, Director
March 18, 1998 /s/ William H. Lucas
- -------------- -------------------------------------------
William H. Lucas, Director
- -------------- -------------------------------------------
James H. Mulligan, Director
March 18, 1998 /s/ Edward J. Novack
- -------------- -------------------------------------------
Edward J. Novack, Secretary of the Board
March 18, 1998 /s/ J. Donald Regan
- -------------- -------------------------------------------
J. Donald Regan, Director
March 18, 1998 /s/ Roger L. Rice
- -------------- -------------------------------------------
Roger L. Rice, Director
March 18, 1998 /s/ Roy A. Robinson
- -------------- -------------------------------------------
Roy A. Robinson, Director
March 18, 1998 /s/ William J. Robinson
- -------------- -------------------------------------------
William J. Robinson, Chairman of the Board
March 18, 1998 /s/ Edward C. Rubatino
- -------------- -------------------------------------------
Edward C. Rubatino, Director
- -------------- -------------------------------------------
Darrell J. Storkson, Director
-27-
<PAGE> 1
FRONTIER FINANCIAL CORPORATION EXHIBIT 11
COMPUTATION OF BASIC AND FULLY DILUTED EARNINGS PER SHARE
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Net Income $16,901,563 $14,616,844 $12,614,926
=================================================
Computation of average shares outstanding:
Shares outstanding at
beginning of year 6,830,666 6,322,255 4,196,435
Additional shares deemed
outstanding because of
stock dividends 479,347 919,595 913,895
Shares issued pursuant
to stock splits 2,100,651
Shares issued during
the year times average
time outstanding during
the year 16,962 35,061 9,987
-------------------------------------------------
Average basic shares outstanding 7,326,975 7,276,911 7,220,968
-------------------------------------------------
Average number of dilutive shares
assumed to be outstanding 70,897 75,456 97,639
-------------------------------------------------
Average fully diluted shares
outstanding 7,397,872 7,352,367 7,318,607
=================================================
Basic earnings per share $ 2.31 $ 2.01 $ 1.75
=================================================
Fully diluted earnings per share $ 2.28 $ 1.99 $ 1.72
=================================================
</TABLE>
<PAGE> 1
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
REPORT OF MANAGEMENT
The management of Frontier Financial Corporation and its subsidiaries has
prepared and is responsible for the integrity and fairness of the financial
statements and other financial information included in this annual report. The
financial statements are prepared in accordance with generally accepted
accounting principles and prevailing practices of the banking industry and, when
appropriate, include amounts based on management's best estimates and judgment.
Management has established and is responsible for maintaining an internal
control environment designed to provide reasonable assurance that transactions
are properly authorized, assets are safeguarded and financial records are
reliably maintained. The internal control environment includes: an effective
financial accounting structure; a comprehensive internal audit function; an
independent Audit Committee of the Board of Directors; and extensive financial
and operating policies and procedures. The Corporation's management also fosters
an ethical climate supported by a code of conduct along with appropriate
selection and training of personnel.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with management, the independent accountants and
the internal auditors to ensure that each is properly discharging its
responsibilities with regard to the financial statements and internal accounting
controls. The independent accountants have full and free access to the Audit
Committee and meets with it to discuss auditing and financial matters.
The Corporation's financial statements are audited by Moss Adams LLP, the
Corporation's independent auditors. Their audits were conducted in accordance
with generally accepted auditing standards and include a consideration of the
internal control structure, tests of accounting records and other audit
procedures necessary to allow the auditors to express their opinion on the
fairness of the financial statements.
Management recognizes that there are inherent limitations in the effectiveness
of any internal control environment. However, management believes that, as of
December 31, 1997, the Corporation's internal control environment provided
reasonable assurance as to the integrity and reliability of the financial
statements and related financial information.
Management is responsible for compliance with the federal and state laws and
regulations concerning restrictions and loans to insiders designated by the FDIC
as safety and soundness laws and regulations.
Management assessed the Corporation's compliance with the designated laws and
regulations relating to safety and soundness. Based on this assessment,
management believes that the Corporation complied, in all significant respects,
with the designated laws and regulations related to safety and soundness for the
year ended December 31, 1997.
/s/ ROBERT J. DICKSON /s/ JAMES F. FELICETTY
ROBERT J. DICKSON JAMES F. FELICETTY
President and Chief Executive Officer Secretary/Treasurer
-1-
<PAGE> 2
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareowners
Frontier Financial Corporation
We have audited the accompanying consolidated balance sheet of Frontier
Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, changes in shareowners' equity, and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion of these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Frontier Financial
Corporation and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ MOSS ADAMS LLP
Everett, Washington
January 20, 1998
-2-
<PAGE> 3
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In Thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1996
--------- ---------
<S> <C> <C>
ASSETS
Cash and due from banks $ 30,496 $ 35,105
Federal funds sold 61,350 25,050
Investment securities
Available for sale, at fair value 83,019 96,628
Held to maturity (Fair value 1997: $33,590; 1996: $35,574) 32,081 34,502
--------- ---------
Total investment securities 115,100 131,130
Loans 665,330 600,394
Less allowance for loan losses (14,845) (13,268)
--------- ---------
Net loans 650,485 587,126
Premises and equipment, net 13,787 14,202
Other real estate owned 1,000 444
Other assets 10,662 10,562
--------- ---------
Total assets $ 882,880 $ 803,619
========= =========
LIABILITIES
Deposits
Noninterest bearing accounts $ 101,278 $ 82,275
Interest bearing accounts 629,653 588,241
--------- ---------
Total deposits 730,931 670,516
Federal funds purchased and securities sold under agreements
to repurchase 17,962 12,011
Other liabilities 6,092 5,675
Federal Home Loan Bank advances 30,000 35,000
Long-term debt 56 100
--------- ---------
Total liabilities 785,041 723,302
--------- ---------
COMMITMENTS -- --
SHAREOWNERS' EQUITY
Common stock, no par value; 20,000,000 shares authorized;
7,350,561 and 6,830,666 shares issued and outstanding
in 1997 and 1996 71,363 57,191
Retained earnings 26,023 22,997
Unrealized gains on available for sale securities,
net of tax effect 453 129
--------- ---------
Total shareowners' equity 97,839 80,317
--------- ---------
Total liabilities and shareowners' equity $ 882,880 $ 803,619
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-3-
<PAGE> 4
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(In Thousands, except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 66,375 $ 57,545 $ 52,146
Interest on federal funds sold 2,102 1,331 2,194
Interest on investment securities
Taxable 6,145 7,350 6,781
Exempt from federal income tax 1,689 1,774 1,965
-------- -------- --------
Total interest income 76,311 68,000 63,086
-------- -------- --------
INTEREST EXPENSE
Interest on deposits 29,760 28,078 27,855
Interest on FHLB advances 1,632 1,470 1,297
Interest on federal funds purchased and securities
sold under agreements to repurchase 761 538 175
Interest on long-term debt 7 14 20
-------- -------- --------
Total interest expense 32,160 30,100 29,347
-------- -------- --------
Net interest income 44,151 37,900 33,739
PROVISION FOR LOAN LOSSES (1,850) (1,980) (1,525)
-------- -------- --------
Net interest income after provision for loan losses 42,301 35,920 32,214
-------- -------- --------
NON INTEREST INCOME
Service charges 1,645 1,562 1,578
Securities losses -- -- (4)
Other 2,230 2,146 1,843
-------- -------- --------
Total other income 3,875 3,708 3,417
-------- -------- --------
NON INTEREST EXPENSE
Salaries 9,021 7,868 7,109
Employee benefits 3,673 3,225 2,868
Occupancy 2,958 2,535 2,494
FDIC insurance premium 86 2 633
State business taxes 945 872 859
Other 4,210 3,429 3,201
-------- -------- --------
Total other expense 20,893 17,931 17,164
-------- -------- --------
INCOME BEFORE INCOME TAX 25,283 21,697 18,467
PROVISION FOR INCOME TAX (8,381) (7,080) (5,852)
-------- -------- --------
NET INCOME $ 16,902 $ 14,617 $ 12,615
======== ======== ========
BASIC EARNINGS PER SHARE $2.31 $2.01 $1.75
===== ===== =====
FULLY DILUTED EARNINGS PER SHARE $2.28 $1.99 $1.72
===== ===== =====
</TABLE>
The accompanying notes are an integral part of these financial statements
-4-
<PAGE> 5
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREOWNERS' EQUITY
(In Thousands, except number of shares)
<TABLE>
<CAPTION>
Common Stock Net Unrealized
---------------------- Retained Gains (Losses)
Shares Amount Earnings on Securities Total
--------- ------- -------- ------------- --------
<S> <C> <C> <C> <C> <C>
Balance at 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 split 2,100,651 -- -- -- --
Fractional shares purchased, (net) 348 8 -- -- 8
Unrealized gains on transfer from
held to maturity to available
for sale, net of tax effect -- -- -- 237 237
Unrealized gains on available
for sale securities, net of tax
effect -- -- -- 1,875 1,875
--------- ------- -------- ------- --------
Balance at 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
Stock dividend 442,831 11,956 (11,956) -- --
Fractional shares purchased, (net) 797 20 -- -- 20
Stock issued for Washington
Banking Company stock 33,500 971 -- -- 971
Unrealized losses on available
for sale securities, net of tax
effect -- -- -- (804) (804)
--------- ------- -------- ------- --------
Balance at December 31, 1996 6,830,666 57,191 22,997 129 80,317
Net income for 1997 -- -- 16,902 -- 16,902
Stock options exercised 40,548 270 -- -- 270
Stock dividend 478,475 13,876 (13,876) -- --
Fractional shares purchased, (net) 872 26 -- -- 26
Unrealized gains on available
for sale securities, net of tax
effect -- -- -- 324 324
--------- ------- -------- ------- --------
Balance at December 31, 1997 7,350,561 $71,363 $ 26,023 $ 453 $ 97,839
========= ======= ======== ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements
-5-
<PAGE> 6
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
-------- -------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 16,902 $ 14,617 $ 12,615
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 1,494 1,404 959
Provision for loan losses 1,850 1,980 1,525
Deferred taxes (605) (842) (398)
Increase (decrease) in income taxes payable (290) 2 177
Increase (decrease) in interest receivable 344 (135) (409)
Increase (decrease) in interest payable 132 (223) 1,611
Proceeds from sales of mortgage loans 20,054 20,711 17,241
Origination of mortgage loans held for sale (19,950) (20,884) (17,512)
Dividend income from Federal Home Loan Bank (657) (654) (427)
Loss on sale of available for sale securities -- -- 4
Increase (decrease) in Other operating activities 293 (451) (160)
-------- -------- ---------
Net cash provided by operating activities 19,567 15,525 15,226
-------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Net federal funds sold (36,300) 30,880 (54,810)
Proceeds from sales of available for sale securities -- -- 87
Proceeds from maturities of available for sale
and held to maturity securities 49,151 42,026 19,577
Purchase of investment securities available for sale (17,492) (11,013) --
Purchase of investment securities held to maturity (14,472) (16,554) (24,165)
Net cash flows from loan activities (65,156) (97,663) (35,587)
Purchases of premises and equipment (817) (1,359) (450)
Proceeds from sale of other real estate owned 199 305 1,423
Cash invested in other real estate owned (755) (281) (101)
Other investing activities 10 (478)
-------- -------- ---------
Net cash used by investing activities (85,632) (54,137) (94,026)
-------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in core deposit accounts 43,982 16,021 (43,205)
Net change in certificates of deposit 16,595 13,635 144,820
Net change in federal funds purchased 5,951 4,415 (2,019)
Advances from the Federal Home Loan Bank 40,000 55,000 --
Repayments to the Federal Home Loan Bank (45,000) (35,000) (22,500)
Principal payments on long-term debt and repurchase agreements (44) (36) (812)
Other financing activities (28) (26) 143
-------- -------- ---------
Net cash provided by financing activities 61,456 54,009 76,427
-------- -------- ---------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (4,609) 15,397 (2,373)
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 35,105 19,708 22,081
-------- -------- ---------
CASH AND DUE FROM BANKS AT END OF YEAR $ 30,496 $ 35,105 $ 19,708
======== ======== =========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
Cash paid during the year for interest $ 32,029 $ 30,323 $ 27,736
Cash paid during the year for income taxes $ 9,275 $ 7,920 $ 6,073
</TABLE>
SUPPLEMENTAL INFORMATION ABOUT NON-CASH INVESTING AND FINANCING ACTIVITIES
Other real estate acquired in settlement of loans in 1995 was $883 thousand.
Sales of other real estate financed by the Bank in 1996 and 1995 were $570
thousand, and $90 thousand, respectively. During 1996 the Corporation issued
common stock for Washington Banking Company common stock in the
amount of $971 thousand.
The accompanying notes are an integral part of these financial statements
-6-
<PAGE> 7
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of Frontier Financial Corporation (the Corporation or FFC), a bank
holding company, and its wholly-owned subsidiaries, Frontier Bank (the Bank),
and FFP, Incorporated (FFP). FFP owns certain real property which is leased to
the Bank for use in its operations. Significant intercompany account balances
and transactions have been eliminated. Assets held by the Bank in an agency or
fiduciary capacity are not included in the accompanying financial statements.
NATURE OF OPERATIONS - The Corporation is primarily engaged in providing a full
range of banking and mortgage services to individual and corporate customers
through the Bank. The Bank also provides other services such as trust services
and insurance and financial service brokerage activities. The Corporation is
subject to competition from other financial institutions. The Corporation is
also subject to regulation by certain federal and state agencies and undergoes
periodic examinations by those regulatory authorities.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) INVESTMENT SECURITIES - Investments in equity and debt securities are
classified into one of three categories: 1) held to maturity, 2) available for
sale, or 3) trading. Investment securities are categorized as held to maturity
when the Corporation has the positive intent and ability to hold those
securities to maturity. Securities which are held to maturity are stated at
cost, adjusted for amortization of premiums and accretion of discounts which are
recognized as adjustments to interest income. Investment securities categorized
as available for sale are generally held for investment purposes (to maturity),
although unanticipated future events may result in the sale of some securities.
Available for sale securities are recorded at fair value, with the net
unrealized gain or loss included as a separate component of shareowners' equity
net of the related tax effect. Realized gains or losses on dispositions are
based on the net proceeds and the adjusted carrying amount of securities sold,
using the specific identification method. The Corporation did not have any
investment securities categorized as trading securities at December 31, 1997 and
1996.
(b) FEDERAL HOME LOAN BANK STOCK - The Bank's investment in Federal Home Loan
Bank (the FHLB) stock is carried at par value ($100 per share), which reasonably
approximates its fair value. As a member of the FHLB system, the Bank is
required to maintain a minimum level of investment in FHLB stock based on
specific percentages of its outstanding FHLB advances. The Bank may request
redemption at par value of any stock in excess of the amount the Bank is
required to hold. Stock redemptions are at the discretion of the FHLB.
(c) LOANS AND RELATED INCOME - Loans that management has the intent and ability
to hold for the foreseeable future, or until maturity or payoff are reported at
their outstanding principal, are adjusted for unearned discounts, the net of
unamortized nonrefundable fees and related direct loan origination costs, and
direct charge-offs. Interest income is accrued as earned.
Net deferred fees and costs are generally amortized into interest income as an
adjustment to the loan yield. Expenses deferred (principally personnel expense)
and recognized in the yield adjustment result in a reduction in noninterest
expense.
-7-
<PAGE> 8
NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Nonrefundable fees related to lending activities other than direct loan
origination or purchase are recognized as credit related fees and included in
noninterest income during the period the related service is provided. These fees
include agency, standby letter of credit, loan commitment, and loan servicing
fees.
A loan is considered impaired when management determines it is probable that all
contractual amounts of principal and interest will not be paid as scheduled in
the loan agreement. These loans include non-accruing loans past due 90 days or
more, loans restructured in the current year, and other loans that management
considers impaired.
Loans are placed on nonaccrual status when, in the opinion of management, the
collection of additional interest is doubtful or when the loan becomes 90 or
more days past due. When a loan is placed on nonaccrual status, all interest
previously accrued, but not collected, is reversed and charged against interest
income. Income on nonaccrual loans is then recognized only to the extent cash is
received and where the future collection of principal is probable. Accruals are
resumed only when the loan is brought current, or when, in the opinion of
management, the borrower has demonstrated the ability to resume payments of
principal and interest. Interest income on restructured loans is recognized
pursuant to the terms of the new loan agreement. Interest income on other
impaired loans is monitored and based upon the terms of the underlying loan
agreement. However, the recorded net investment in impaired loans, including
accrued interest, is limited to the present value of the expected cash flows of
the impaired loan or the observable fair market value of the loan or the fair
market value of the loan's collateral.
(d) ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is maintained at
a level management believes is adequate to provide for potential loan, loan
commitment and standby letter of credit losses. The allowance is based on a
continuing review of loans, loan commitments and standby letters of credit which
includes consideration of actual loss experience, changes in the size and
character of the portfolio, identification of individual problem situations
which may affect the borrower's ability to repay, and evaluations of the
prevailing and anticipated economic conditions.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses and the valuation
of real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowance for loan losses and
the valuation of foreclosed assets held for sale, management obtains independent
appraisals for significant properties.
Management believes the allowance for loan losses and the valuation of
foreclosed assets held for sale are adequate. While management uses available
information to recognize losses on loans and foreclosed assets held for sale,
changes in economic conditions may necessitate revision of these estimates in
future years. In addition, various regulatory agencies, as an integral part of
their examination processes, periodically review the Corporation's allowance for
loan losses and valuation of foreclosed assets held for sale. Such agencies may
require the Corporation to recognize additional losses based on their judgment
using information available to them at the time of their examination.
(e) LOANS HELD FOR SALE - Mortgage loans originated and designated as held for
sale are carried at the lower of cost or estimated fair value, as determined by
quoted market prices, in aggregate. Net unrealized losses are recognized in a
valuation allowance by charges to income. Gains or losses on the sale of such
loans are based on the specific identification method.
(f) PREMISES AND EQUIPMENT - Premises and equipment are shown at cost and
depreciated using the straight-line and accelerated methods. Depreciation
expense is computed over the following estimated useful lives:
<TABLE>
<S> <C>
Premises 7 to 40 years
Furniture, fixtures and equipment 3 to 7 years
</TABLE>
-8-
<PAGE> 9
NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(g) OTHER REAL ESTATE OWNED - Other real estate owned consists principally of
properties acquired through foreclosure and is stated at the lower of cost or
estimated market value. Losses arising from the acquisition of property, in full
or partial satisfaction of loans, are charged to the allowance for loan losses.
Subsequent to the transfer to foreclosed assets held for sale, these assets
continue to be recorded at the lower of cost or fair value (less estimated costs
to sell), based on periodic evaluations. Generally, legal and professional fees
associated with foreclosures are expensed as incurred. Costs incurred to improve
property prior to sale are capitalized, however, in no event are recorded costs
allowed to exceed fair value. Subsequent gains, losses, or expenses recognized
on the sale of these properties are included in noninterest income or expense.
(h) INCOME TAX - The Corporation reports income and expenses using the accrual
method of accounting and files a consolidated tax return. Deferred tax assets
and liabilities are reflected at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes.
Deferred taxes result from temporary differences in recognition of certain
income and expense amounts between the Bank's financial statements and its tax
returns.
(i) RETIREMENT PLANS - The Corporation has a profit sharing and salary deferral
plan and a money purchase pension plan which covers eligible employees. The
Corporation's contributions to the plans were $1.4 million in 1997, $1.3 million
in 1996, and $1.2 million in 1995. Contributions to the profit sharing plan are
discretionary while contributions to the money purchase pension plan are
currently 5% of employee's eligible salaries. Both plans are funded during the
period in which they are committed by the Board of Directors.
(j) ADVERTISING COSTS - The Bank expenses advertising costs as they are incurred
and are not considered to be material.
(k) FINANCIAL INSTRUMENTS - In the ordinary course of business the Bank has
entered into off-balance sheet financial instruments consisting of commitments
to extend credit, commitments under credit card arrangements, commercial letters
of credit, and standby letters of credit. Such financial instruments are held
for purposes other than trading and are recorded in the financial statements
when the credits are funded or related fees are earned.
(l) STOCK OPTION PLANS - The Corporation has elected to continue following the
guidance of Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employees" (APB 25) for purposes of measurement and recognition of
stock-based transactions with employees. Stock options are issued at a price
equal to the fair value of the Corporation's stock as of the grant date. Under
APB 25, no compensation expense is recognized pursuant to these stock options.
(m) EARNINGS PER SHARE - In January 1, 1998 the Corporation adopted Statement
of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." This
Statement supersedes Accounting Principles Board (APB) No. 15 "Earnings Per
Share" and establishes standards for computing and presenting earnings per
share. All prior years presented have been restated to conform with the new
requirements.
Basic earnings per share amounts are computed based on the weighted average
number of shares outstanding during the period after giving retroactive effect
to stock dividends and stock splits. Diluted earnings per share amounts are
computed by determining the number of additional shares that are deemed
outstanding due to stock options under the treasury stock method.
(n) CASH EQUIVALENTS - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, and amounts due from banks. Cash and cash
equivalents have an original maturity of three months or less.
-9-
<PAGE> 10
NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(o) USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
(p) RECLASSIFICATIONS - Certain amounts in prior years' financial statements
have been reclassified to conform to the 1997 presentation.
NOTE TWO - INVESTMENTS
Investments in federal funds sold are made with major banks which are approved
by the Board of Directors. The Bank has an investment policy that permits
holding securities rated only in one of the four highest rating categories by a
nationally recognized credit rating organization.
The aggregate amortized cost and fair values of investment securities at
December 31 are as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
In Thousands Cost Gains Losses Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
1997
Available for sale
U.S. Treasury bonds $ 754 $ 38 -- $ 792
U.S. Agency bonds 43,490 173 $ (96) 43,567
Corporate bonds 28,151 589 (7) 28,733
Equities 9,927 -- -- 9,927
-------- ------- ----- --------
82,322 800 (103) 83,019
-------- ------- ----- --------
Held to maturity
State and municipal bonds 28,531 1,511 (2) 30,040
Certificates of deposit 3,550 -- -- 3,550
-------- ------- ----- --------
32,081 1,511 (2) 33,590
-------- ------- ----- --------
$114,403 $ 2,311 $(105) $116,609
======== ======= ===== ========
1996
Available for sale
U.S. Treasury bonds $ 758 $ 30 -- $ 788
U.S. Agency bonds 45,824 187 $ (308) 45,703
Corporate bonds 40,578 491 (202) 40,867
Equities 9,270 -- -- 9,270
-------- ------- ------ --------
96,430 708 (510) 96,628
-------- ------- ------ --------
Held to maturity
State and municipal bonds 29,727 1,106 (34) 30,799
Certificates of deposit 4,775 -- -- 4,775
-------- ------- ------ --------
34,502 1,106 (34) 35,574
-------- ------- ------ --------
$130,932 $ 1,814 $ (544) $132,202
======== ======= ====== ========
</TABLE>
-10-
<PAGE> 11
NOTE TWO - INVESTMENTS (CONTINUED)
Contractual maturities of investment securities as of December 31, 1997 are
shown below. Expected maturities will differ from contractual maturities because
issuers may have the right to call or prepay obligations with or without
prepayment penalties.
<TABLE>
<CAPTION>
In Thousands
Available for Sale Held to Maturity
---------------------- ----------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------- ------- ------- -------
<S> <C> <C> <C> <C>
Maturity
Less than one year $21,242 $21,206 $ 3,745 $ 3,747
One to five years 13,390 13,838 1,940 2,060
Five to ten years 47,234 47,471 24,439 25,714
Over ten years 456 504 1,957 2,069
------- ------- ------- -------
$82,322 $83,019 $32,081 $33,590
======= ======= ======= =======
</TABLE>
Proceeds from sales of available for sale securities in 1995 were $87 thousand.
Gross losses were $4 thousand in 1995.
Investments in state and political subdivisions represent purchases of municipal
bonds, with localities principally in western Washington. Investments in
corporate bonds are made in companies located and doing business throughout the
United States. Approximately 51% and 49% of the investments in corporate bonds
at December 31, 1997 and 1996, respectively, consisted of investments in
companies doing business in the financial services sector. Approximately 26% and
27% of the investments in corporate bonds at December 31, 1997 and 1996,
respectively, consisted of investments in companies doing business in the
industrial sector.
Investment securities, with a book value of $31.2 million and $27.2 million with
fair values of $31.2 million and $27.1 million in 1997 and 1996, respectively,
were pledged to secure public deposits and securities sold under agreements to
repurchase as required by law.
NOTE THREE - LOANS
The Bank originates commercial, real estate mortgage, construction and land
development, and installment loans primarily in Snohomish, Skagit and north King
Counties. Although the Bank has a diversified loan portfolio, local economic
conditions may affect borrowers' ability to meet the stated repayment terms.
Collateral for each loan is based on a credit evaluation of the customer, and
such collateral may, depending on the loan, include accounts receivable,
inventory, equipment, real estate or other collateral. Loans are originated at
both fixed and variable interest rates.
Major classifications of loans at December 31 are as follows:
<TABLE>
<CAPTION>
In Thousands 1997 1996
--------- ---------
<S> <C> <C>
Commercial $ 123,904 $ 117,551
Real estate commercial 272,218 231,379
Real estate construction 147,232 133,582
Real estate mortgage 102,117 99,099
Installment 24,457 23,077
--------- ---------
669,928 604,688
Less deferred loan fees (4,598) (4,294)
--------- ---------
$ 665,330 $ 600,394
========= =========
</TABLE>
-11-
<PAGE> 12
NOTE THREE - LOANS (CONTINUED)
Contractual maturities of loans as of December 31, 1997 are shown below.
Expected maturities will differ from contractual maturities because borrowers
may have the right to prepay loans with or without prepayment penalties.
<TABLE>
<CAPTION>
In Thousands Within 1-5 After
1 Year Years 5 Years Total
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Commercial $ 62,890 $ 53,815 $ 6,864 $123,569
Real estate commercial 54,289 210,095 6,515 270,899
Real estate construction 97,938 42,266 4,774 144,978
Real estate mortgage 32,013 65,028 4,395 101,436
Installment 6,349 10,560 7,539 24,448
-------- -------- -------- --------
$253,479 $381,764 $ 30,087 $665,330
======== ======== ======== ========
<CAPTION>
Loans maturing after 1-5 After
one year with: Years 5 Years
--------- ---------
<S> <C> <C>
Fixed rates $323,498 $13,073
Variable rates 58,266 17,014
-------- -------
$381,764 $30,087
======== =======
</TABLE>
LOAN LOSS RESERVE
Changes in the allowance for loan losses are summarized below:
<TABLE>
<CAPTION>
In Thousands 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Balance at beginning of year $ 13,268 $ 11,897 $ 10,410
Provision charged to operating expense 1,850 1,980 1,525
Deduct
Loans charged-off (1,739) (1,943) (2,212)
Less recoveries 1,466 1,334 2,174
-------- -------- --------
Net charged-off loans (273) (609) (38)
-------- -------- --------
Balances at year end $ 14,845 $ 13,268 $ 11,897
======== ======== ========
</TABLE>
The Bank had loans amounting to $4.3 million at December 31, 1997 and $3.6
million at December 31, 1996 that were specifically classified as impaired with
an average balance of $4.0 million and $3.7 million, respectively. The allowance
for loan losses related to these loans was approximately $1.1 million in 1997
and $662 thousand in 1996. Interest collected on these loans in cash and
included in income amounted to $384 thousand in 1997 and $264 thousand in 1996.
If interest on these loans had been accrued, such income would have approximated
$237 thousand in 1997 and $289 thousand in 1996. At December 31, 1997 there were
no commitments to lend additional funds to borrowers whose loans were classified
as impaired.
The effects of troubled debt restructurings are not considered material to the
Corporation's financial position and results of operations.
-12-
<PAGE> 13
NOTE THREE - LOANS (CONTINUED)
OTHER REAL ESTATE OWNED
From time-to-time management has written-off various parcels of other real
estate owned due to unresolved issues relating to permitting, zoning and
wetlands. Management is attempting to work through the above mentioned issues to
be able to effectively market these properties. Contingent gains could be
realized should the above issues be favorably resolved.
NOTE FOUR - PREMISES AND EQUIPMENT
Premises and equipment at December 31 are comprised of the following:
<TABLE>
<CAPTION>
In Thousands 1997 1996
-------- --------
<S> <C> <C>
Premises $ 9,948 $ 10,106
Furniture, fixtures and equipment 5,703 5,144
Land 5,011 4,510
Construction in progress 66 254
-------- --------
20,728 20,014
Less accumulated depreciation (6,941) (5,812)
-------- --------
$ 13,787 $ 14,202
======== ========
</TABLE>
Depreciation expense on premises and equipment totaled $1.2 million in 1997,
$954 thousand in 1996, and $881 thousand in 1995.
NOTE FIVE - INTEREST BEARING DEPOSITS
The major classifications of interest bearing deposits at December 31 are as
follows:
<TABLE>
<CAPTION>
In Thousands 1997 1996
-------- --------
<S> <C> <C>
Money market and NOW accounts $100,994 $ 81,010
Savings 151,833 147,000
Time deposits, $100,000 and over 109,432 108,955
Other time deposits 267,394 251,276
-------- --------
$629,653 $588,241
======== ========
</TABLE>
The total remaining maturity schedule for time deposits is as follows:
<TABLE>
<CAPTION>
In Thousands
<S> <C> <C>
Year ending December 31, 1998 $306,214
1999 33,310
2000 19,550
2001 9,751
2002 6,096
Thereafter 1,905
--------
$376,826
========
</TABLE>
-13-
<PAGE> 14
NOTE SIX - CREDIT ARRANGEMENTS
The Bank is a member of the Federal Home Loan Bank (FHLB) of Seattle. As a
member, the Bank has a committed line of credit up to 15% of total assets,
subject to the Bank pledging sufficient collateral. At December 31, 1997,
committed lines of credit agreements totaling approximately $28 million were
available to the Bank from unaffiliated banks. Such lines generally provide for
interest at the lending bank's federal funds rate or other money market rates.
There were no borrowings outstanding or compensating balance requirements under
these credit arrangements at December 31, 1997 and 1996.
In addition, at December 31, 1997 the Bank has a committed line of credit up to
$4.1 million from The Federal Reserve Bank (FRB). Borrowings generally provide
for interest at rates as published by the FRB and are secured by U.S. Treasury
and Agency securities. There were no borrowings outstanding at December 31, 1997
and 1996.
NOTE SEVEN - FEDERAL HOME LOAN BANK (FHLB) ADVANCES
At December 31, 1997, FHLB advances were scheduled to mature as follows:
<TABLE>
<CAPTION>
Interest
In Thousands Amount Rates
------- --------------
<S> <C> <C>
Within one year -- --
Two to three years $ 5,000 5.4%
Four to five years 25,000(1) 5.39% - 5.80%
---------
$30,000
=========
</TABLE>
(1) $20 million of this advance may be put by the FHLB quarterly.
Advances from the FHLB are collateralized by qualifying first mortgage loans and
government agency securities as required by the agreement with the FHLB.
The maximum outstanding and average outstanding balances and average interest
rates on advances from the FHLB were as follows for the year ended December 31:
<TABLE>
<CAPTION>
In Thousands 1997 1996
------- -------
<S> <C> <C>
Maximum outstanding at any month-end $30,000 $40,000
Average outstanding 30,274 26,544
Weighted average interest rates:
Annual 5.39% 5.54%
End of year 5.46% 5.12%
</TABLE>
NOTE EIGHT - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Bank has sold certain securities of the U.S. Government and its agencies and
other approved investments under agreements to repurchase. The securities
underlying the agreements were held by a safekeeping agent under control of the
Bank.
Securities sold under agreement to repurchase were $13.2 million in 1997 and
$9.5 million in 1996. The average daily balance of outstanding agreements during
the period was $11 million in 1997 and $7.5 million 1996, with maximum
outstanding agreements at any month-end of $16.4 million and $9.9 million,
respectively.
-14-
<PAGE> 15
NOTE NINE - LONG-TERM DEBT
At December 31, long-term debt was as follows:
<TABLE>
<CAPTION>
In Thousands 1997 1996
----- ----
<S> <C> <C>
Mortgage note, due in monthly installments of $3,100, including interest
at 7.5% per annum. The principal is due upon demand.
Collateralized by a deed of trust. $56 $100
=== ====
</TABLE>
NOTE TEN - INCOME TAX
The components of the provision for income tax are as follows:
<TABLE>
<CAPTION>
In Thousands 1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Current $ 8,986 $ 7,922 $ 6,250
Deferred (605) (842) (398)
------- ------- -------
$ 8,381 $ 7,080 $ 5,852
======= ======= =======
</TABLE>
Deferred taxes result from temporary differences in recognition of income and
expense which are reported in different periods for financial reporting purposes
and for income tax purposes. The sources of the differences and the resulting
deferred income tax provision are as follows:
<TABLE>
<CAPTION>
In Thousands 1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Loan fees $ 89 $(230) $ (49)
Provision for loan losses (552) (687) (596)
Other items, net (142) 75 247
----- ----- -----
$(605) $(842) $(398)
===== ===== =====
</TABLE>
The following table shows the nature and components of the Corporation's net
deferred tax assets, established at an estimated tax rate of 35% at December 31:
<TABLE>
<CAPTION>
In Thousands 1997 1996
------- -------
<S> <C> <C>
DEFERRED TAX ASSETS
Allowance for possible loan losses,
in excess of tax reserves $ 5,196 $ 4,644
Other deferred tax assets 1,195 862
------- -------
Total deferred tax assets 6,391 5,506
------- -------
DEFERRED TAX LIABILITIES
Other deferred tax liabilities (1,375) (1,095)
------- -------
Total deferred tax liabilities (1,375) (1,095)
------- -------
Net deferred tax assets $ 5,016 $ 4,411
======= =======
</TABLE>
-15-
<PAGE> 16
NOTE TEN - INCOME TAX (CONTINUED)
The Corporation believes, based upon the available information, that all
deferred assets will be realized in the normal course of operations.
Accordingly, these assets have not been reduced by a valuation allowance.
A reconciliation of the effective income tax rate with the federal statutory tax
rate is as follows:
<TABLE>
<CAPTION>
In Thousands 1997 1996 1995
--------------------- --------------------- -------------------
Amount Rate Amount Rate Amount Rate
------- ------ ------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
Income tax provision
at statutory rate $ 8,814 35% $ 7,662 35% $ 6,502 35%
Effect of nontaxable
interest income (513) -2% (536) -3% (574) -3%
Other 80 -- (46) -- (76) --
------- ------ ------- ------ ------- ------
$ 8,381 33% $ 7,080 32% $ 5,852 32%
======= ====== ======= ====== ======= ======
</TABLE>
NOTE ELEVEN - SHAREOWNERS' EQUITY AND REGULATORY MATTERS
On January 21, 1998, the Board of Directors declared a 7% stock dividend,
payable March 16, 1998, to shareowners of record as of January 21, 1998.
The Corporation and Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's financial statements. Under capital
adequacy guidelines in the regulatory framework for prompt corrective action,
the Corporation must meet specific capital adequacy guidelines that involve
quantitative measures of each entity's assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require maintenance of minimum amounts and ratios (set forth in the table). Tier
I capital includes common stock, retained earnings, surplus and undivided
profits of the Bank less goodwill. Total capital includes Tier I capital and
1.25% of weighted risk assets. Tier I capital to average assets is referred to
as the leverage ratio. Management believes, as of December 31, 1997 and 1996
that the Corporation and Bank meet capital adequacy requirements to which they
are subject.
As of the most recent notification from the Bank's primary regulator, the Bank
was categorized as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set
forth in the table. There are no conditions or events since that notification
that management believes have changed this category.
-16-
<PAGE> 17
NOTE ELEVEN - SHAREOWNERS' EQUITY AND REGULATORY MATTERS (CONTINUED)
<TABLE>
<CAPTION>
In Thousands To Be Well
Capitalized Under
Prompt Corrective For Capital
Actual Action Provisions Adequacy Purposes
--------------------- ------------------------- -------------------------
Amount Ratio Amount Ratio Amount Ratio
--------- --------- ------------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
1997
Total capital (to risk-
weighted assets)
Consolidated $106,055 14.92% $71,097 10.00% $56,878 8.00%
Frontier Bank 101,743 14.35% 70,878 10.00% 56,702 8.00%
Tier I capital (to risk-
weighted assets)
Consolidated 97,094 13.65% 42,658 6.00% 28,438 4.00%
Frontier Bank 92,810 13.09% 42,527 6.00% 28,351 4.00%
Tier I capital (to
average assets)
Consolidated 97,094 11.59% 41,895 5.00% 33,516 4.00%
Frontier Bank 92,810 10.65% 43,560 5.00% 34,848 4.00%
1996
Total capital (to risk-
weighted assets)
Consolidated $ 88,145 13.40% $65,774 10.00% $52,619 8.00%
Frontier Bank 86,645 13.20% 65,665 10.00% 52,532 8.00%
Tier I capital (to risk-
weighted assets)
Consolidated 79,861 12.14% 39,464 6.00% 26,310 4.00%
Frontier Bank 78,375 11.94% 39,399 6.00% 26,266 4.00%
Tier I capital (to
average assets)
Consolidated 79,861 10.13% 39,452 5.00% 31,561 4.00%
Frontier Bank 78,375 9.95% 39,372 5.00% 31,497 4.00%
</TABLE>
Under federal regulations, the Bank is limited, unless previously approved, as
to the amount it may loan the holding company and other affiliates to 10% of its
capital stock and surplus (approximately $3.4 million at both December 31, 1997
and 1996).
Federal Reserve Board regulations require maintenance of certain minimum reserve
balances on deposit with the Federal Reserve Bank. The average amount of such
balances was $7.9 million in 1997 and $5.8 million in 1996.
-17-
<PAGE> 18
NOTE TWELVE - EMPLOYEE STOCK OPTION PLAN
In 1992, the shareowners of the Corporation approved an Incentive Stock Option
Plan (the Plan) to promote the best interest of the Corporation, its
subsidiaries and its shareowners, by providing an incentive to those key
employees who contribute to the operating success of the Corporation.
The maximum number of shares that may be issued under the Plan is ten percent
(10%) of the common stock of the Corporation. Options issued and outstanding are
adjusted to reflect any future common stock dividends, splits, recapitalization
or reorganization. The Board of Directors make available sufficient shares for
each option granted, subject to the remaining number of shares.
Options are granted at the then fair market value and vest in six months.
Options expire ten years from the date of grant, and are subject to certain
restrictions and limitations.
Proforma information regarding net income and earnings per share is required by
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." The proforma recognizes, as compensation, the estimated present
value of stock options granted using an option valuation model known as the
Black-Scholes model. Proforma earnings per share amounts reflect an adjustment
as if the present value of the options were recognized as compensation for the
period.
For the most part, variables and assumptions are used in the model. For the
periods 1997 and 1996, respectively, the risk-free interest rate is 5.67% and
6.35%, the dividend yield rate is 0.00% as the Corporation pays no cash
dividends; the price volatility is 15.59% and 11.87%; and the weighted average
expected life of the options has been measured at 7 years.
Management believes that the variables and assumptions used in the options
pricing model are subjective and represent only one estimate of possible value.
The fair value of options granted that are recognized in proforma earnings is
shown below:
<TABLE>
<CAPTION>
In Thousands, except for per share amounts
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Proforma disclosures
Net income as reported $16,902 $14,617 $12,615
Additional compensation for
fair value of stock options 185 140 120
------- ------- -------
Proforma net income $16,717 $14,477 $12,495
======= ======= =======
Earnings per share
Basic
As reported $2.31 $2.01 $1.75
===== ===== =====
Proforma $2.28 $1.99 $1.73
===== ===== =====
Diluted
As reported $2.28 $1.99 $1.72
===== ===== =====
Proforma $2.26 $1.97 $1.71
===== ===== =====
</TABLE>
-18-
<PAGE> 19
NOTE TWELVE - EMPLOYEE STOCK OPTION PLAN (CONTINUED)
Stock option transactions were:
<TABLE>
<CAPTION>
Weighted
Shares of Common Stock Average of
--------------------------- Exercisable Price
Available for Under of Shares
Option/Award Plan Under Plan
---------- -------- ------------------
<S> <C> <C> <C> <C>
Balance at January 1, 1995 825,405 114,815 $ 9.63
Authorized 1,000,000 -- --
Granted (12,876) 12,876 29.00
Three-for-two split (54,975) 54,975 --
Exercised -- (24,821) 6.39
Forfeited 404 (404) --
---------- -------- ------
Balance at December 31, 1995 1,757,958 157,441 10.84
Authorized -- -- --
Granted (12,624) 12,624 31.00
7% stock dividend (10,687) 10,687 --
Exercised -- (31,283) 5.11
Forfeited 813 (813) --
---------- -------- ------
Balance at December 31, 1996 1,735,460 148,656 12.92
Authorized -- -- --
Granted (14,220) 14,220 37.00
7% stock dividend (10,093) 10,093 --
Exercised -- (40,548) 6.66
Forfeited 175 (175) --
---------- -------- ------
Balance at December 31, 1997 1,711,322 132,246 $16.38
========== ======== ======
</TABLE>
The following table summarizes information concerning currently outstanding and
exercisable options:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------ -------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- --------- ----------- ----------- ---------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 1-10 62,781 2.40 $ 7.28 62,781 $ 7.28
10-20 16,510 4.20 13.23 16,510 13.23
20-30 38,735 5.59 24.92 38,735 24.92
30-40 14,220 7.00 37.00
</TABLE>
-19-
<PAGE> 20
NOTE THIRTEEN - EARNINGS PER SHARE
The numerators and denominators of basic and fully diluted earnings per share
are as follows:
<TABLE>
<CAPTION>
In Thousands, except for share amounts 1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Net income (numerator) $ 16,902 $ 14,617 $ 12,615
========== ========== ==========
Shares used in the calculation
(denominator)
Weighted average shares outstanding 7,326,975 7,276,911 7,220,968
Effect of dilutive stock options 70,897 75,456 97,639
---------- ---------- ----------
Fully diluted shares 7,397,872 7,352,367 7,318,607
========== ========== ==========
Basic Earnings per share $2.31 $2.01 $1.75
===== ===== =====
Fully diluted earnings per share $2.28 $1.99 $1.72
===== ===== =====
</TABLE>
NOTE FOURTEEN - RELATED PARTY TRANSACTIONS
Loans to directors, executive officers and their affiliates are subject to
regulatory limitations. Such loans had aggregate balances and activity during
1997, 1996 and 1995 as follows and were within regulatory limitations:
<TABLE>
<CAPTION>
In Thousands 1997 1996 1995
-------- ------- --------
<S> <C> <C> <C>
Balance at beginning of year $ 6,502 $ 8,552 $ 10,044
New loans or advances 21,542 3,218 4,123
Repayments (6,140) (5,268) (5,615)
-------- ------- --------
Balance at end of year $ 21,904 $ 6,502 $ 8,552
======== ======= ========
</TABLE>
NOTE FIFTEEN - COMMITMENTS AND CONTINGENT LIABILITIES
The Bank leases various branch offices under agreements which expire between
1998 and 2014. The agreements contain various renewal options and require the
Bank to maintain the properties.
The total future minimum rental commitment through 2002 and thereafter is as
follows:
<TABLE>
<CAPTION>
In Thousands
<S> <C> <C>
Year ending December 31, 1998 $ 324
1999 294
2000 261
2001 244
2002 235
Thereafter 2,771
------
$4,129
======
</TABLE>
Rental expense charged to operations was $426 thousand in 1997, $383 thousand in
1996 and $380 thousand in 1995.
-20-
<PAGE> 21
NOTE FIFTEEN - COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet financing needs of its customers. These
financial instruments include commitments to extend credit, standby letters of
credit and financial guarantees. Those instruments involve, to varying degrees,
elements of credit and interest-rate risk in excess of the amount recognized in
the balance sheet. The contract amount of those instruments reflect the extent
of the Bank's involvement in particular classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the instrument for commitments to extend credit, standby letters of
credit, and financial guarantees written is represented by the contractual
amount of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
COMMITMENTS TO EXTEND CREDIT AND FINANCIAL GUARANTEES - Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. The Bank's experience has been that approximately 49 percent of
loan commitments are drawn upon by customers. While approximately 100 percent of
commercial letters of credit are utilized, a significant portion of such
utilization is on an immediate payment basis. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
it is deemed necessary by the Bank upon extension of credit, is based on
management's credit evaluation of the borrower. Collateral held varies but may
include accounts receivable, inventory, property, plant, and equipment, and
income-producing commercial properties.
Standby letters of credit and financial guarantees written are conditional
commitments issued by the Bank to guarantee the performance of a customer to a
third party. Those guarantees are primarily issued to support public and private
borrowing arrangements, bond financing, and similar transactions. The Bank
underwrites its standby letters of credit using its policies and procedures
applicable to loans in general. Standby letters of credit are made on an
unsecured and secured basis. The Bank has not been required to perform on any
financial guarantees during the past two years. The Bank has not incurred any
significant losses on its commitments in 1997 or 1996.
Year 2000 Compliance - The Corporation has and will continue to make certain
investment in its software systems and applications to ensure the Corporation is
year 2000 compliant. The financial impact to the Corporation has not yet been
determined and is not anticipated to be material to its financial position or
results of operations in any given year.
NOTE SIXTEEN - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, "Disclosures About
Fair Value of Financial Instruments." The estimated fair value amounts have been
determined by the Bank using available market information and appropriate
valuation methodologies. However, considerable judgment is necessary to
interpret market data in the development of the estimates of fair value. The use
of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts. The following methods and
assumptions were used to estimate the fair value of each class of financial
instrument for which it is practicable to estimate that value:
(a) CASH EQUIVALENTS AND FEDERAL FUNDS SOLD - For those short-term instruments,
the carrying amount is a reasonable estimate of fair value.
(b) INVESTMENT SECURITIES - For investment securities fair values are based on
quoted market prices or dealer quotes, if available. If a quoted market price is
not available, fair value is estimated using quoted market prices for similar
securities.
-21-
<PAGE> 22
NOTE SIXTEEN - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
(c) LOANS - The fair value of loans generally is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities.
For certain homogeneous categories of loans, such as Small Business
Administration guaranteed loans, fair value is estimated using the quoted market
prices for securities backed by similar loans, adjusted for differences in loan
characteristics.
(d) DEPOSITS AND FEDERAL FUNDS PURCHASED - The fair value of demand deposits,
savings accounts, certain money market deposits, and federal funds purchased, is
the amount payable on demand at the reporting date. The fair value of
fixed-maturity certificates of deposit is estimated by discounting the future
cash flows using the rates currently offered for deposits of similar remaining
maturities.
(e) FHLB ADVANCES AND LONG-TERM DEBT - Fair value is determined by discounting
future cash flows using rates currently available to the Bank for debt with
similar terms and remaining maturities.
(f) OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - Commitments to extend credit and
letters of credit represent the principal categories of off-balance sheet
financial instruments. The fair value of these commitments is not material since
they are for a short period of time and subject to customary credit terms.
<TABLE>
<CAPTION>
In Thousands 1997 1996
------------------------ ------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Assets
Cash and due from banks $ 30,496 $ 30,496 $ 35,105 $ 35,105
Federal funds sold 61,350 61,350 25,050 25,050
Investment securities
Available for sale 83,019 83,019 96,628 96,628
Held to maturity 32,081 33,590 34,502 35,574
Net loans 650,485 657,855 587,126 592,320
Liabilities
Noninterest bearing deposits 101,278 101,278 82,275 82,275
Interest bearing deposits 629,653 630,902 588,241 589,443
Federal funds purchased
and securities sold under
agreements to repurchase 17,962 17,962 12,011 12,011
FHLB advances 30,000 29,930 35,000 34,807
Long-term debt 56 56 100 100
</TABLE>
A summary of the notional amount of the Bank's financial instruments with
off-balance sheet risk at December 31, 1997 is as follows:
<TABLE>
<CAPTION>
In Thousands Amount
--------
<S> <C>
Commitments to extend credit
Credit card arrangements $119,862
Commercial letters of credit 5,645
Standby letters of credit --
1,998
</TABLE>
-22-
<PAGE> 23
NOTE SEVENTEEN - PARENT COMPANY (ONLY) FINANCIAL INFORMATION
Condensed balance sheets at December 31:
<TABLE>
<CAPTION>
In Thousands 1997 1996
------- -------
<S> <C> <C>
Cash $ 254 $ 220
Investment in subsidiaries:
Bank 93,716 78,475
Nonbank 2,418 157
Investment in Washington Banking Company 971 971
Other assets 480 494
------- -------
$97,839 $80,317
======= =======
Other liabilities -- --
Shareowners' equity $97,839 $80,317
------- -------
$97,839 $80,317
======= =======
</TABLE>
Condensed statements of income for the years ended December 31:
<TABLE>
<CAPTION>
In Thousands 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Income
Dividend from Bank $ 100 $ 100 $ 210
Other dividends 19 18 --
Rental -- 1 54
Interest 5 4 2
-------- -------- --------
Total income 124 123 266
-------- -------- --------
Expenses
Interest -- -- 13
Personnel 226 97 89
Depreciation and amortization 77 77 81
Other 257 203 184
-------- -------- --------
Total expenses 560 377 367
-------- -------- --------
Loss before benefit equivalent to income
taxes and equity in undistributed
income of subsidiaries (436) (254) (101)
Benefit equivalent to income taxes 161 97 79
-------- -------- --------
Loss before equity in undistributed income
of subsidiaries (275) (157) (22)
Equity in undistributed
income of subsidiaries 17,177 14,774 12,637
-------- -------- --------
Net income $ 16,902 $ 14,617 $ 12,615
======== ======== ========
</TABLE>
-23-
<PAGE> 24
NOTE SEVENTEEN - PARENT COMPANY (ONLY) FINANCIAL INFORMATION (CONTINUED)
Condensed statements of cash flows for the years ended December 31:
<TABLE>
<CAPTION>
In Thousands 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 16,902 $ 14,617 $ 12,615
Adjustments to reconcile net income to net cash
provided by operating activities
Equity in income of subsidiaries (17,277) (14,874) (12,847)
Depreciation and amortization 77 77 81
Other operating activities (64) (18) (12)
-------- -------- --------
Net cash flows from operating activities (362) (198) (163)
-------- -------- --------
Cash flows from investing activities
Dividends received 100 100 210
-------- -------- --------
Cash flows from financing activities
Sales of common stock 296 180 167
Principal payments of long-term debt -- -- (84)
Other financing activities -- -- (5)
-------- -------- --------
Net cash flows from financing activities 296 180 78
-------- -------- --------
Increase in cash 34 82 125
Cash at beginning of year 220 138 13
-------- -------- --------
Cash at end of year $ 254 $ 220 $ 138
======== ======== ========
</TABLE>
NOTE EIGHTEEN - NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130
"Reporting Comprehensive Income." This Statement establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statement. This Statement requires that all items
that are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. The Statement becomes
effective January 1, 1998, for the Company.
The financial Accounting Standards Board also issued SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information" in June 1997. The
Statement establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements.
Management believes that the provisions of SFAS No. 131 will not have a material
effect on its financial condition or reported results of operations. This
Statement becomes effective January 1, 1998, for the Company.
These pronouncements provide additional disclosures about the Corporation's
operations and are not anticipated to have material effect on financial position
or results of operations.
-24-
<PAGE> 25
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
- -------------------------------------------------------------------------------
OVERVIEW OF REPORTED RESULTS
The Corporation completed the most profitable year since opening, and the
nineteenth consecutive year of increased net income. Net income for 1997 was
$16.9 million, up 15.6% from 1996. Net income in 1996 was $14.6 million, or up
15.9% as compared to 1995 net income of $12.6 million, which was up 21.8%
compared to 1994 income of $10.4 million. Highlights of 1997 include the
continuation of double-digit growth in net income accented by excellent expense
control, outstanding asset quality, and a strong allowance for credit losses.
Capital increased 22% and earnings per share increased 15% to $2.31. Earnings
per share have been adjusted to reflect the 7% stock dividend paid in 1997.
Return on average assets (ROA) was 2.02% in 1997; 1.94% in 1996; and 1.82% for
1995. Return on average equity (ROE) for 1997 was 18.84%; in 1996 was 20.01%;
and in 1995 was 21.59%. The declining return on average equity is due to the
continued increase in capital due to strong earnings of the Corporation.
STATE AND REGIONAL ECONOMY
The Bank's lending and other activities are concentrated in Snohomish County,
Washington, but also includes the northern part of King County, by having
branches located in Bothell, Redmond, Woodinville and the Lake City area in
north Seattle, and Skagit County by having a branch located in Burlington.
Skagit County is the contiguous county north of Snohomish County. The major city
in Snohomish County is Everett, and the major city in King County is Seattle,
the largest city in the state. These three counties would be considered the
market or service area of the Corporation.
The financial performance of the Corporation is directly influenced by 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. The information below regarding the Washington State and local
economy was, for the most part, obtained from the Snohomish County Economic
Development Council.
The Washington state economy picked up momentum on a seasonally adjusted basis
starting in May 1997 and then proceeded to build strongly through the summer
months. Employment growth in the three months, ending in August, averaged 5.6%
on a seasonally adjusted annual basis, the highest in seven and a half years,
and a marked pickup from the 2.8% average in 1996. Unemployment, likewise, shows
significant improvement both over the quarter and over the year with the
seasonally adjusted rate averaging 5.0% in the past six months, the lowest since
the third quarter of 1990.
Currently, Washington ranks fourth highest in the nation in terms of non-farm
wage and salary employment growth. Washington excels in the number of new
high-paying manufacturing jobs added in the past 12 months representing 7.4%.
Business services in particular on the leading edge with year-to-year employment
growth of 8.7%, nearly twice the national average.
The near-term outlook is for continued expansion in the months ahead, only with
slower growth. All three major reporting divisions will contribute:
specifically, manufacturing, trade and services. According to the latest state
Forecast Council projections, the rate of non-farm wage and salary employment
growth on a seasonally adjusted basis, will continue outpacing the state's long
run historical average through at least mid 1998. Comparisons against the U.S.
average continue in the 2 to 1 range. No particular change in inflation is
expected with the U.S. Implicit Price Deflator hovering between 2.0% and 2.5%,
and translating to a 3.0% to 4.0% increase in real personal income.
-25-
<PAGE> 26
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION - CONTINUED
Manufacturing payrolls expanded by 3,200 in July and 5,100 in August to a total
count of 376,800. The largest employer in Snohomish County is The Boeing
Company, and they are still hard pressed to meet targeted delivery dates of 747s
and 737s this year despite a surge of new workers in 1997. Expected deliveries
were cut in 1997 from 340-350 to 335, with the 1998 forecast calling for 480
deliveries.
From the period October 1996 through October 1997, the county's manufacturing
employment has jumped by 9,300 workers over the year. Aerospace payrolls,
primarily at The Boeing Company, have swelled by 8,600 for an annual increase of
26%. Employment in related durable goods manufacturing industries has increased
as well.
The county's goods producing industries altogether (manufacturing plus
construction and mining) generated 11,000 new payroll spots since last year, up
16%. Construction employment has been particularly strong in 1997, up 14%.
The last available figures for the County's unemployment rate are 3.1% averaged
across the county. This is down sharply from last year's 5.1%. Consequently, the
labor market can be characterized as being tight. Unemployment is at the level
of the county's last boom period in 1990.
Looking forward to what can be expected in 1998, is generally characterized as a
slowing boom. The Puget Sound Business Journal (Jan 2-8, 1998 edition) concludes
that job growth in all sectors will continue, but drop to an estimated 4.3%
growth rate.
Snohomish County still has abundant resources for industrial expansion such as,
vacant land with entitlements, a good supply of trained labor, and a good supply
of industrial water and sewer capacity, and the perception is that traffic in
Snohomish County is much more palatable than elsewhere in the Puget Sound
region.
Although the Corporation expects to be successful in competing with the
abundance of financing sources, which may, or may not, have regulatory
constraints, management continues to be cautiously optimistic regarding the
level of future business opportunities for the Corporation.
FINANCIAL REVIEW/BALANCE SHEET
The Corporation manages its balance sheet to meet the needs of its business
strategy, which adapts to the changing economic environment, and business and
competitive factors.
Based on the balances at year-end 1997, assets increased $79.3 million or 9.9%;
increased $68.4 million, or 9.3% in 1996; and increased $92.6 million in 1995,
or 14.4%. Average earning assets as a percent of total average assets (see
page 38) were 95.4%, or $799.0 million in 1997; 95.7%, or $720.5 million
in 1996; and 95.6%, or $661.1 million in 1995. Local economic conditions were
the largest factor contributing to the growth in earning assets during the
three years.
Total loans increased $64.9 million, or 10.8% in 1997; $95.4 million, or 18.9%
in 1996, increasing substantially over the 1995 growth of $34.5 million, or
7.3%. In 1997, the investment portfolio decreased $16.0 million or 12.2%. In
1996, the investment portfolio decreased $13.8 million or 9.6%, and in 1995 it
increased $8.6 million, or 6.3%. The reason for the decline in 1997 was to shift
funds from maturing investments into the loan portfolio. The earning asset with
the largest increase for 1996 and 1997 was real estate commercial loans, which
increased $40.8 million or 17.7% in 1997, and $59.1 million, or 34.3% in 1996.
Management attributes this increase to improving local economic conditions and
the ability to be very competitive in this type of lending. In 1997, federal
funds sold increased $36.3 million, or 144.9% due to the unattractive
intermediate to long-term rates on investments, and less than expected loan
demand. However, 1997 was a year of an exceptional number of early calls for
redemption of investments which contributed substantially to the increase in
federal funds sold for the period. In 1995, federal funds sold had the largest
increase, which reflects the decrease in loan demand during that period.
-26-
<PAGE> 27
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
The primary source of funds for earning assets are deposits and borrowings.
Total deposits were up $60.4 million, or 9.0% in 1997; up $29.3 million, or 4.6%
in 1996 and increased $101.6 million, or 18.8% in 1995. Money Market and NOW
accounts were up $20.0 million, or 24.7% in 1997, and had the largest increase
of all deposit categories for the year. These deposits were up $11.1 million, or
15.8% in 1996 and in 1995, these balances were down $.7 million, or 1.0%.
Savings accounts were up $4.8 million or 3.3% in 1997; up $5.7 million, or 4.0%
in 1996, reversing a previous downward trend and in 1995, these deposits were
down $54.0 million or 27.6%. Time certificates of deposit (cd's) increased $16.6
million, or 4.6% in 1997; increased $13.6 million, or 3.9% in 1996, which growth
is substantially below that of 1995, when cd's increased $144.8 million, or
71.8%. A slowing of the growth in deposits in 1997 and 1996, (as compared to the
growth of loans) was planned by management, due to the slower growth in 1995 of
the loan portfolio.
The 1997 results of operations include the following contributing factors, which
are discussed more fully in the following pages of the financial review.
1. Net interest income increased $6.3 million, or 16.5%;
2. Net income increased $2.3 million in 1997, or 15.6%;
3. The reserve for loan losses is strong at 2.23% of total loans.
NET INTEREST INCOME
Net interest income is the Corporation's principal source of revenue and is
comprised of interest income on earning assets, less interest expense on
interest bearing liabilities. The net interest margin is net interest income
expressed as a percent of average earning assets and represents the difference
between the yield on earning assets and the composite interest rate paid on all
sources of funds.
Net interest income is adjusted to a taxable equivalent basis to present income
earned on taxable and tax-exempt assets on a comparable basis. References to net
interest income and net interest margin in this discussion represent taxable
equivalent amounts using a tax rate of 35%, and applies to loans and investments
only.
The asset yields and cost of funds for the Corporation during the last three
years reflect the level of general interest rates, and the competitive nature of
the financial services industry. For the year 1997 the average yield on earning
assets increased 9 basis points, and the average cost of interest bearing
liabilities decreased 10 basis points, for a net increase in the spread of 19
basis points. For the year 1996, the average yield on earning assets dropped 12
basis points and the average cost of interest bearing liabilities dropped 22
basis points. In 1995, the yield on average assets was up 31 basis points, and
the average cost of interest bearing liabilities increased 107 basis points. In
1997, increased yield on assets was due to an increase in the yield of the
investment portfolio of 10 basis points, increasing from 7.16% in 1996 to 7.26%
in 1997. Additionally, the yield on federal funds sold increased from 5.41% to
5.51%, and the yield on total loans remained the same at 10.37%. The decrease in
the cost of funds was due to a decrease in interest bearing deposits of 10 basis
points, decreasing from 5.06% to 4.96%, and a decrease in the cost of long-term
debt from 5.56% to 5.40%. (Please refer to page 39 for further detail.) In 1996,
rates leveled out and were subject to liquidity adjustments and competitive
factors. The net yield on interest earning assets was 5.65% in 1997, 5.40% in
1996, and 5.26% in 1995. (See "Liquidity and Interest Sensitivity" in this
section.) 1995 was a difficult year for the interest rate spread due to less
than dynamic loan demand and paying deposit rates consistent with prudent
liquidity management. As noted on page 39 of this report, it was the growth, or
volume, which contributed mostly to the increased net interest earnings of the
Corporation for all three years. The following is a more detailed discussion of
the factors comprising net interest income.
-27-
<PAGE> 28
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
Net interest income is impacted primarily by changes in the volume and mix of
earning assets and funding sources, market rates and asset quality. Tables 1 and
2 of this report present an analysis of the changes in net interest income.
Table 1 (Average Balances) indicates the changes in the average balance of
accounts, and Table 2 (Rate/Volume Analysis) indicates the causes of the changes
in net interest income, whether by changes in the average balance (Volume) or
changes in interest (Rate).
Table 1 indicates that net interest income totaled $45.1 million, an increase of
$6.2 million, or 16.0%. In 1996 net interest income totaled $38.9 million, an
increase of $4.1 million, or 11.8%, and in 1995 net interest income totaled
$34.8 million, an increase of 4.2%. Table 2 indicates that of the $6.2 million
increase in net interest income, there was an increase in interest income of
$8.3 million and an increase in interest expense of $2.1 million, which leaves a
net increase in net interest income of $6.2 million. In 1996 there was a $4.1
million increase in net interest income. There was an increase in interest
income of $4.9 million and an increase in interest expense of $.8 million, which
left a net increase in net interest income of $4.1 million. Using the tables in
the same fashion, Table 1 indicates that net interest income for 1995 totaled
$34.8 million, which was $1.4 million over 1994. Table 2 indicates there was an
increase in interest income of $10.1 million and an increase in interest expense
of $8.7 million, which leaves an increase in net interest income of $1.4
million.
LOAN PORTFOLIO
Average loans grew $85.3 million, or 15.4% in 1997; $69.7 million, or 14.4% in
1996, and $59.1 million, or 13.9% in 1995. In 1997, average real estate
commercial loans had the largest dollar growth by increasing $48.3 million, or
23.1%. Real estate construction loans had the second largest dollar and percent
growth increase of $23.6 million, or 21.4%. In 1996, real estate commercial
loans again had the largest dollar growth by increasing $48.4 million, or 30.1%.
This was followed by real estate construction loans, which increased by $19.5
million, or 21.5%. For 1995, real estate commercial loans had the largest growth
of $43.4 million, or 37.0%. This was followed by real estate residential loans
which increased $15.7 million, or 20.8% for the year.
The yield on total loans remained the same as 1996 at 10.37%. Although the
Corporation did raise the prime rate in March of 1997, this was offset by
competitive pressures on rates during the year. The yield on loans eased in
1996, dropping from a 1995 average of 10.74% to 10.37%. The yield in 1995
increased 51 basis points, however, during the last two quarters of 1995, they
trended lower due to lack of demand. At December 31, 1997, 70% of the portfolio
was fixed rate and 30% variable rate. At year-end 1996, 74% was fixed rate and
26% was variable rates. At year-end 1995, 63% of the portfolio was fixed rate
and 37% was variable rate. Management has recognized that the number of fixed
rate loans in the portfolio increased significantly in 1996, and reversed that
trend in 1997 by increasing the level of variable rate loans by 4.5% of the
portfolio. While it would be desirable to have more variable rate loans if
general interest rates were to increase, it should be recognized that many of
the fixed rate loans are real estate construction loans that have short (less
than one year) maturities. For more information on repricing of assets and
liabilities, please see the section "Interest Rate Risk" later in this report.
Interest and fee income from loans increased $8.8 million, or 15.4% in 1997;
$5.4 million, or 10.4% in 1996; and $8.6 million, or 19.6% in 1995. The earnings
on the $85.3 million increase in the 1997 average balance of loans, resulted in
increased income of $8.9 million, and a decline in rates decreased income by $.1
million. The earnings on the $69.7 million increase in the 1996 average balance
of loans, resulted in increased income of $7.5 million, while a decrease in
interest rates decreased interest income by $2.1 million. The earnings on the
$59.1 million increase in 1995 average balance of loans resulted in increased
income of $5.8 million, while an increase in interest rates increased income by
$2.8 million. Loan fee income totaled $5.0 million in 1997; $4.5 million in
1996, and $3.9 million in 1995.
-28-
<PAGE> 29
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
The Bank has a VISA credit card department which began operations in 1993. At
year-end 1997, the department had $7.2 million in credit lines and $1.6 million
in outstanding balances. At year-end 1996, the department had $5.6 million in
credit lines and outstanding balances of $1.2 million, and at year-end 1995, the
department had $4.0 million in credit lines, and $.9 million in active balances.
The Bank also provides debit cards to customers.
In 1998, management expects loan demand to remain consistent with the growth
rate in 1997.
LOAN LOSS PROVISION
The provision for loan losses decreased $130 thousand, or 6.56% in 1997; $455
thousand, or 29.8% in 1996, and decreased $2.4 million, or 60.9% in 1995.
Although the Corporation had excellent loan quality in 1997, the reason for the
substantial increase in the reserve was that recoveries of prior period losses
of $1.5 million almost equaled the current losses of $1.7 million. In 1996, the
growth of the reserves set aside for loan losses was consistent with the growth
in total loans. The small growth of the loan portfolio in 1995 and continued
loan quality did not require as large a contribution in 1995 as compared to
prior years.
The allowance for loan losses was 2.23% of total loans in 1997; 2.21% in 1996,
and 2.36% at year-end 1995. This ratio changes when 1) loans are charged-off to
the reserve; 2) a provision is charged to expense and added to the reserve; 3)
when prior loans charged-off are recovered, or 4) when total loans increase or
decrease. At year-end 1995, 1996 and 1997, management considered the reserve to
be adequate. Please refer to Note 3, page 12 of this report for details
regarding changes in the level of the allowance.
The allowance for loan losses as a percent of impaired loans was 272% in 1997,
317% in 1996, and 232% in 1995. Management evaluates the adequacy of the
allowance for loan losses based upon a number of factors and estimates its
allowance for loan losses in relation to the entire portfolio's estimated losses
over the life of the portfolio. Accordingly, the ratio of the allowance for loan
losses to impaired loans may vary greatly because the timing of certain events
described in the previous paragraph cannot be controlled. General conditions
leading to management's decision to increase the allowance include concerns
about the Northwest's economic environment, regional trends, and adverse effect
of changes in government regulation and taxation.
INVESTMENTS
Total interest income from investments, including federal funds sold, decreased
$519 thousand in 1997, or 5.2%; decreased $485 thousand in 1996, or 4.5%, and
increased $1.6 million in 1995, or 14.8%. The decrease in average balances of
$6.9 million, decreased interest income by $645 thousand, while an increase in
rates increased interest income by $82 thousand in 1997. The decrease in average
balances of $10.2 million in 1996, decreased income by $630 thousand, while an
increase in rates increased interest income by $88 thousand. The increase in
average investment balances of $26.9 million in 1995, contributed $.9 million to
income, while rate changes accounted for an increase of $.6 million to income.
There were no realized losses in securities during 1997 or 1996, and no
significant losses in securities in 1995.
INTEREST EXPENSE
Total interest and borrowing expense for 1997 increased $2.1 million, or 6.8%;
increased $753 thousand, or 2.6% in 1996, and increased $8.7 million in 1995, or
42.2%. The increase of $52.9 million in the average balances of interest bearing
liabilities contributed $2.6 million to interest expense, while decreased
interest rates reduced interest expense by $.5 million. The increase of $39.5
million in the 1996 average balances of interest bearing
-29-
<PAGE> 30
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
liabilities, contributed $2.5 million to interest expense, while declining
interest rates decreased interest expense by $1.7 million. The increase of $65.5
million in the 1995 average balance of interest bearing liabilities contributed
$4.9 million to expense, while an increase in average rates accounted for an
increase of $3.8 million in interest expense.
In 1997, increases in the average balance of interest bearing core deposits
increased interest expense by $2.2 million, and a decrease in rates reduced
interest expense by $.5 million. Increases in the balances of short-term and
long-term debt increased interest expense by $409 thousand, and a net reduction
in the rates of two categories decreased interest expense by $31 thousand. In
1996, increases in the average balance of interest bearing deposits increased
interest expense by $1.8 million, while declining interest rates decreased
interest expense by $1.6 million. Increased balances of short-term borrowings
and long-term debt increased interest expense by $649 thousand, and decreasing
interest rates decreased interest expense by $99 thousand. In 1995, increases in
the average balances of interest bearing deposits increased interest expense by
$5.4 million and rates increased interest expense by $3.7 million. Short-term
borrowings and long-term debt increased interest expense by $461 thousand, and
increased rates increased interest expense by $58 thousand.
OTHER NONINTEREST INCOME
Noninterest income totaled $3.9 million in 1997, up $167 thousand, or 4.5%.
Noninterest income totaled $3.7 million, up $291 thousand, or 8.5% in 1996; and
totaled $3.4 million in 1995, up $507 thousand, or 17.4%. In 1997 service
charges increased $83 thousand, or 5.3%; decreased $16 thousand, or 1.0% in
1996, and increased a slight $4 thousand in 1995. Deposits have grown at a
substantially higher rate than service charges. Management estimates that more
customers are maintaining higher balances to avoid service charges. The number
of accounts susceptible to service charges increased by 1,232, or 8.5% in 1997;
increased 535 in 1996, or 2.8%, and decreased 237 accounts in 1995.
Other income increased $84 thousand in 1997, or 3.9%; increased $303 thousand in
1996, or 16.4%, and increased $152 thousand, or 9.0% in 1995. The increase in
1997 was due to several factors, but the majority of the increase was due to an
increase in insurance and financial service fees of $126 thousand or 93.3%; and
an increase in trust department fees of $122 thousand, or 17.0%. Partially
offsetting these increases was a decline in gain on sale of other real estate
owned to $195 thousand in 1997 from $346 thousand in 1996 or a 43.6% decline.
The increase in 1996 was due to an increase in trust department fees of $151
thousand and an increase in non-recurring income of $189 thousand on gain on
sale of other real estate owned. The increase in 1995 is due to non-recurring
income of $157 thousand on gain on sale of other real estate owned, and interest
of $98 thousand on amended tax returns. In 1996, insurance and financial service
fees increased $50 thousand, or 58.8% for the year. Broker loan fees, (secondary
market loan origination fees) increased only $5 thousand. In 1995, insurance and
financial service income was down $118 thousand, or 58.1% for the year, along
with a decrease of $142 thousand, or 45.0% in broker loan fees. Income from gain
on sale of mortgage loans dropped in 1995 to $174 thousand from $316 thousand in
1994, or 44.9%. The reason for this large decline is due to high long-term
interest rates in 1994 which all but halted the mortgage loan and refinance
business. Although 1995 brought with it lower interest rates, it was not until
the fourth quarter of 1995 that the Corporation began experiencing a slight
increase in fee income from those activities.
As previously stated, trust department income increased $122 thousand, or 17.0%
in 1997; $151 thousand, or 26.7% in 1996, and in 1995, income increased $116
thousand, or 25.8% to $565 thousand. The market value of trust assets managed at
year-end 1997 was $143.2 million, up $23.7 million, or 19.8%. In 1996 assets
increased to $119.5 million, up $12.6 million, or 11.8%, and in 1995 assets
increased to $106.9 million, up $34.2 million, or 47.0%.
-30-
<PAGE> 31
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
OTHER NONINTEREST EXPENSE
Total noninterest expenses increased $3.0 million, or 16.5% to $20.9 million in
1997; increased $767 thousand to $17.9 million, or 4.5% in 1996, and increased
$513 thousand, or 3.1% in 1995.
Salaries and employee benefits increased $1.6 million, or 14.4% in 1997;
increased $1.1 million, or 11.2% in 1996, and increased $.7 million or 7.0% in
1995. The increase in salaries, only, for 1997 was $1.2 million, up 14.7%; in
1996 was up $.8 million, or 10.7% over 1995. The increase in 1997 was
attributable to an increase in staff of 6.0%, and the remainder is attributable
to merit raises. In 1996 the increase was attributable to an increase in staff
of 7.5%, and the remainder is attributable to merit raises. The increase in
salaries of 4.7% in 1995 was attributable to an increase in staff.
Employee benefits increased $448 thousand, or 13.9% in 1997; increased $357
thousand in 1996, and increased $335 thousand in 1995. This increase is due to
an increase in the profit sharing contributions of $180 thousand or 10.3%. An
increase of 6% is attributable to the increase in staff in 1997, and increased
medical premiums of $75 thousand, or 19.4%. In 1996, this increase is due, for
the most part, to an increase in the profit sharing contributions of $252
thousand. In 1995, the increase was attributable to an increase of $160
thousand, or 11.9% in profit sharing contributions, and an increase of $41
thousand, or 7.2% in social security taxes.
Occupancy expense was up $423 thousand, or 16.7% in 1997; up $41 thousand or
1.6% in 1996, and up $178 thousand, or 7.7% in 1995. In 1997, 41% of occupancy
expense was depreciation, which increased $269 thousand, or 28.2%. The remainder
of the increase in 1997 was due to increased furniture and equipment expense of
$103 thousand, due to the opening of branches, and other miscellaneous expense
of $34 thousand. In 1996, 38% of occupancy expense was depreciation. The
remainder of the increase in 1996 was due to an increase in facilities expense.
The increase in 1995 was due to office rental costs which increased $146
thousand to $389 thousand, or $60.1%.
Other expense increased $781 thousand, or 22.8% in 1997. Most of this increase
was attributable to four areas. Marketing expenses increased $95 thousand, or
29.9%, due to new branch openings and product promotions; foreclosure expenses
increased $123 thousand, or 164.0%, much of which was due to prior period
foreclosures, and utilities and postage increased $107 thousand, or 10.5%. Other
expenses decreased $228 thousand in 1996, or 8.4%. Although state and local
taxes increased $254 thousand, FDIC insurance premiums dropped to $2 thousand in
1996, compared with premiums of $633 thousand paid in 1995. Additionally FDIC
insurance premiums for 1995 were down $477 thousand or 43.0% due to the Bank
Insurance Fund reaching its congressionally mandated level. FDIC insurance
premium increases in prior years were the result of increases imposed by the
Financial Institutions Reform and Recovery Act of 1989, and higher deposit
balances. Other expense, increased $25 thousand, or .8% in 1995 to $3.2 million,
reflecting the continued emphasis on maintaining low overhead costs.
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 other 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 1997 was 43.5%; 1996 was 43.1%; and 46.2% in 1995. The
Corporation's ratio is considered excellent for the industry.
-31-
<PAGE> 32
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
ASSET AND LIABILITY MANAGEMENT
Assets and liabilities are managed to maximize long-term shareholder returns by
optimizing net interest income within the constraints of maintaining high credit
quality, conservative interest rate risk policies and prudent levels of leverage
and liquidity. The Asset and Liability Committee meets monthly to monitor the
composition of the balance sheet, to assess and project interest rate trends and
to formulate strategies consistent with established objectives for liquidity,
interest rate risk and capital adequacy.
LIQUIDITY
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all financial commitments and to capitalize on
opportunities for profitable business expansion. Cash flows from operations
contribute significantly. As indicated on page 4 of this report, net income for
1997 contributed $16.9 million to liquidity, and $14.6 million to liquidity in
1996. In 1995, net income from operations contributed $12.6 million. Borrowing
represents an important and manageable source of liquidity based on the
Corporation's ability to raise new funds and renew maturing liabilities in a
variety of markets. Liquidity is also obtained by maintaining assets that are
readily convertible to cash at minimal cost through maturities and sales.
Deposits generated through the Corporation's branch network is the most
important source of liquidity. In 1997, core deposits (Money Market, NOW and
savings accounts) funded $44.0 million of the $65.2 million growth in loans.
Contributing to that growth in loans were cd's which funded $16.6 million.
Federal funds sold also made a contribution to loan growth. Some of the proceeds
from maturing investments, along with cash provided by operating activities
funded the growth in federal funds sold during the year. In 1996 core deposits
funded $16.0 million of the growth in assets. Whereas, net borrowings from
Federal Home Loan Bank of Seattle (FHLB) funded $20.0 million of the growth.
Additional funds of $13.6 million came from cd's, and $4.4 million came from
federal funds purchased and securities sold under agreements to repurchase. In
1996, maturing securities totaled $42.0 million and represents a highly
accessible source of liquidity. Net maturities provided $14.5 million in
liquidity, with $27.6 million of the total $42.0 million in maturities being
reinvested in the portfolio.
Funding sources were somewhat different in 1995. Core deposits were running off,
federal funds purchased and the FHLB were repaid, so all funding of assets came
from increased cd balances of $144.8 million. In 1995 maturing securities
provided $19.6 million in liquidity, and $24.2 million was reinvested in the
portfolio.
Over the last three years, the financing of investment activities has changed.
The changes in the financing methods in 1995 were planned by management. In
years going forward, core deposits and FHLB borrowings became more important in
the financing process. It is the Corporation's intention to continue this type
of funding in the future.
In addition to deposit acquisition and borrowings as a source of liquidity,
maturing loans and investments with maturities of less than one year and
overnight federal funds purchased are considered to be available for liquidity
needs.
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<PAGE> 33
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
The charts below indicate the maturity schedule for earning assets as of
December 31, 1997 and 1996:
MATURITY SCHEDULE FOR EARNING ASSETS
(Amortized cost used for investment)
<TABLE>
<CAPTION>
Percent
Total Total of Total
0-1 1-5 After Carrying Fair Fair
In Thousands Year Years 5 Years Cost Value Value
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1997
Investments $ 24,987 $ 15,330 $ 74,086 $114,403 $116,609 13.7%
Loans 253,479 381,764 30,087 665,330 672,700 79.1%
Federal Funds sold 61,350 -- -- 61,350 61,350 7.2%
-------- -------- -------- -------- -------- -----
Total $339,816 $397,094 $104,173 $841,083 $850,659 100.0%
======== ======== ======== ======== ======== =====
</TABLE>
<TABLE>
<CAPTION>
Percent
Total Total of Total
0-1 1-5 After Carrying Fair Fair
In Thousands Year Years 5 Years Cost Value Value
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1996
Investments $ 27,115 $ 23,838 $ 79,979 $130,932 $132,202 17.4%
Loans 212,486 359,492 28,416 600,394 601,643 79.3%
Federal Funds sold 25,050 -- -- 25,050 25,050 3.3%
-------- -------- -------- -------- -------- -----
Total $264,651 $383,330 $108,395 $756,376 $758,895 100.0%
======== ======== ======== ======== ======== =====
</TABLE>
As indicated in the chart, in 1997 $339.8 million, or 40.4% in aggregate assets
were available for liquidity at year-end. In 1996, $264.7 million in aggregate
loans, investments and federal funds sold were available liquidity at year-end,
or 35.0% of carrying value. At year-end 1995, $253.9 million in aggregate loans,
investments and federal funds sold were available, or 36.0% of carrying value.
The Corporation also has other sources of liquidity not indicated above. For
example, at year-end 1997, the bank has a pre-approved credit line up to $95.5
million from Seattle FHLB. However, assets must be pledged to secure these
borrowings. Currently borrowings are $30 million. AFS securities totaling $83.0
million could be sold for liquidity purposes. The Corporation could also issue
cd's to public entities exceeding $75.0 million more than currently issued.
Additionally, participation in the treasury department's short-term note program
is available along with potential borrowings from the Federal Reserve Bank of
San Francisco and other correspondent banks.
-33-
<PAGE> 34
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
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 these
differences in its simulations. At December 31, 1997, 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.
Interest rate sensitivity is closely related to liquidity because each is
directly affected by the maturity of assets and liabilities. Management
considers any asset or liability which matures, or is subject to repricing over
one year, to be interest-sensitive, although continual monitoring is also
performed for other time intervals. The difference between interest-sensitive
assets and liabilities for a defined period of time is known as the
interest-sensitive "gap" and may be either positive or negative. If positive,
more assets reprice before liabilities; if negative, the reverse is true. In
theory, if the gap is positive, a decrease in general interest rates might have
an adverse impact on earnings as interest income decreases faster than interest
expense. This assumes that management adjusts asset and liability rates equally
as general interest rates fall. 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 can change rapidly as a result of market conditions and customer
patterns.
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.
The simulation model process provides a dynamic assessment of interest rate
sensitivity, whereas a static interest rate gap table is compiled as of a point
in time. The model simulations differ from a traditional gap analysis because a
traditional gap analysis does not reflect the multiple effects of interest rate
movement on the entire range of assets, liabilities and ignores the future
impact of new business strategies.
The table on the next page gives yet another picture of the assets and
liabilities of the Corporation. The table sets forth the balances of the
Corporation's instruments at the expected maturity dates, as well as the fair
value of those financial instruments as of December 31, 1997. The expected
maturities do not take into consideration contractual principal payments for
loans and securities, or when an asset or liability is susceptible to repricing
as interest rates increase or decrease.
In the table on the next page the expected maturities for financial liabilities
with no stated maturity, reflect assumptions based on historical run-off rates.
The run-off rates for noninterest bearing deposits is 6.4% per year; for NOW and
money market accounts is 7.6% per year; and for savings accounts is 9.1% per
year. The weighted average interest rates for financial instruments presented
are actual for 1997, and are shown on page 38 of this report. Please refer to
Note 16 on page 21 of this report for details regarding estimated fair value
amounts.
-34-
<PAGE> 35
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MARKET RISK
The Corporation's interest rate sensitive positions at December 31, 1997 is
shown in the following table:
<TABLE>
<CAPTION>
Expected Maturity Date
---------------------------------------------------------------- Fair
In Thousands 1998 1999 2000 2001 2002 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and cash equivalents
Noninterest bearing $30,496 -- -- -- -- -- $30,496 $30,496
Weighted average interest rate
Federal funds sold
Variable rate 61,350 -- -- -- -- -- 61,350 61,350
Weighted average interest rate 5.51% 5.51%
Securities available for sale
Fixed rate 21,242 $2,616 $4,567 $3,145 $3,062 $47,690 82,322 83,019
Weighted average interest rate 5.95% 8.19% 7.13% 7.55% 7.36% 6.74% 6.66%
Securities held to maturity
Fixed rate 3,745 200 155 357 1,228 26,396 32,081 33,590
Weighted average interest rate 8.08% 10.00% 9.19% 9.84% 10.18% 8.81% 8.80%
Loans Receivable, net
Fixed rate 129,160 58,524 52,785 103,488 108,701 13,073 465,731 464,729
Weighted average interest rate 9.38% 9.08% 9.48% 9.21% 9.32% 8.85% 9.28%
Variable rate 124,319 31,948 7,733 8,107 10,478 17,014 199,599 199,210
Weighted average interest rate 10.10% 10.06% 10.02% 10.06% 9.68% 9.78% 10.04%
FINANCIAL LIABILITIES
Noninterest bearing deposits 6,482 6,067 5,679 5,315 4,975 72,760 101,278 101,278
Weighted average interest rate
NOW & Money Market accounts 7,676 7,092 6,553 6,055 5,595 68,023 100,994 100,994
Weighted average interest rate 2.97% 2.97% 2.97% 2.97% 2.97% 2.97% 2.97%
Savings accounts 13,817 12,559 11,417 10,378 9,433 94,229 151,833 151,833
Weighted average interest rate 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
Time Certificates
Fixed rate 244,081 27,019 19,550 9,751 6,096 1,812 308,309 309,426
Weighted average interest rate 5.69% 6.10% 6.72% 5.87% 5.89% 6.80% 5.81%
Variable rate 62,132 6,291 -- -- -- 93 68,516 68,649
Weighted average interest rate 5.88% 5.66% 6.18% 5.86%
Federal funds purchased
Variable rate 4,796 -- -- -- -- -- 4,796 4,796
Weighted average interest rate 5.05% 5.05%
Securities sold under agreement
to repurchase
Variable rate 13,166 -- -- -- -- -- 13,166 13,166
Weighted average interest rate 5.00% 5.00%
FHLB advances
Fixed rate -- 20,000 5,000 -- -- 5,000 30,000 29,930
Weighted average interest rate 5.39% 5.40% 5.80% 5.46%
</TABLE>
-35-
<PAGE> 36
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
CAPITAL
Consolidated capital of the Corporation for financial statement purposes,
increased $17.5 million in 1997, or 21.8% to $97.8 million; increased $15.0
million in 1996, or 22.9% to $80.3 million, and increased $14.9 million in 1995
to $65.4 million, or 29.5%. In 1997, almost all of the increase was attributable
to the net income of the Bank. In 1996, $1 million of the capital increase was
attributable to the investment in Washington Banking Company; a decrease of $.8
million was attributable to the change in fair market value of the AFS
portfolio, and the remainder was almost all due to net profits of the Bank. In
1995, $2.1 million of the increase was attributable to the increase in the
market value of the AFS securities, and almost all of the remainder of the
increase was the retained earnings of the Bank. Please see Note 11 on page 16 of
this report for other information of shareowner's equity and regulatory capital.
MARKET FOR FRONTIER FINANCIAL CORPORATION'S COMMON STOCK
AND RELATED SHAREOWNER MATTERS
Trading in Frontier Financial Corporation's common stock has not been extensive,
however could be considered active. In 1997, based on shares outstanding at
year-end, private trades and transfers totaled approximately 17%. In 1996,
private trades and transfers totaled approximately 11%, and in 1995 totaled
approximately 7%. Prior to 1998 the Corporation's common stock had not listed on
any exchange, or the National Association of Securities Dealers' Automated
Quotation System (Nasdaq). However, in February 1998, the Board of Directors of
the Corporation announced that application has been made for quotation of the
common stock of the Corporation on the Nasdaq National Market. Management has
been informed that the application process generally takes 60 to 90 days, and
that trading will commence at the conclusion of that process. During 1997, the
market price of common stock ranged from $29.00 to $37.00 per share (prices have
been adjusted for the stock dividend paid in 1997).
At December 31, 1997, the total number of shareowners of record of Frontier
Financial Corporation's common stock was 3,425, and there were 7,350,561 shares
outstanding.
Management has established an objective to maximize the rate of internal capital
growth as the means of maintaining capital adequacy. The Corporation has not
paid cash dividends in the past. However, the Bank, or the Corporation, has paid
a stock dividend each year since 1981, except for 1995, when a 3-for-2 split was
declared. Management believes that distributing the profits of the Corporation
by issuing stock accomplishes much more than a cash dividend. The amount of cash
that could be distributed to shareowners would be far less than the liquidation
value of a stock dividend, and cash dividends reduce capital which is needed to
fund the continued growth of the Bank. Annually, the Board of Directors reviews
various methods to distribute the earnings of the Corporation to the
shareowners, including cash dividends.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue results because many computer programs were written using
two digits rather than four to define the applicable year. Any of the
Corporation's computer programs which have date-sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send statements, or other business activities.
The Corporation established a Year 2000 Committee in February 1997 with
representatives from all functional areas within the Corporation which reports
to the Board of Directors monthly. A Year 2000 Plan has been adopted along with
established timelines. As a critical part of this plan, inventories of software
has been completed and
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<PAGE> 37
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
each software application has been risk assessed based upon dependency to the
Corporation. Based upon a recent assessment, the Corporation has determined that
it will be required to modify or replace significant portions of identified
software applications so that its computer systems will properly utilize dates
beyond December 31, 1999. The Corporation presently believes that with
modifications to existing software and conversions to new software, the Year
2000 Issue can be mitigated. However, if such modifications and conversions are
not made, or are not completed timely, the Year 2000 Issue could have a material
impact on the operations of the Corporation.
The Corporation has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which the Corporation
is vulnerable to those third parties failure to remediate their own Year 2000
Issue. The Corporation's total Year 2000 project cost and estimates to complete
include the estimated costs and time associated with the impact of a third
party's Year 2000 Issue, and are based on presently available information.
However, there can be no guarantee that the systems of other companies on which
the Corporation's systems rely will be timely converted, or that a failure to
convert by another Corporation, or a conversion that is incompatible with the
Corporation's systems, would not have material adverse effect on the
Corporation.
The Corporation will utilize both internal and external resources to reprogram,
or replace, and test the software for Year 2000 modification. The Corporation
plans to complete the Year 2000 project within one year. Management's best
estimate at this time for the total year 2000 project is roughly $550 thousand,
which will be funded through cash flows of operations. To date, the Corporation
has incurred and expensed approximately $200 thousand related to the assessment
of, and preliminary efforts in connection with, its Year 2000 project and the
development of a remediation plan.
The costs of the project and the date on which the Corporation plans to complete
the Year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plan and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material difference include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
The Corporation is also in the process of determining the incremental credit
risk in the loan portfolio relating to individual customers' preparedness to
understand and successfully address Year 2000 software and hardware issues. For
those over an established dollar threshold, a credit risk assessment is being
performed on each borrower to insure that they are aware and what actions they
can take to become Year 2000 compliant. Follow-up with the borrower has been
made a part of the Corporation's internal due diligence. This will be an ongoing
process for the next two years.
FORWARD LOOKING STATEMENTS
Except for historical financial information contained herein, the matters
discussed in this annual report of the Corporation may be considered
"forward-looking" statement within the meaning of Section 27A of the Securities
Act of 1993, 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.
-37-
<PAGE> 38
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
AVERAGE BALANCES AND TAX-EQUIVALENT NET INTEREST MARGIN - TABLE 1
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------------------------------------
1997 1996 1995(1)
------------------------------- ------------------------------- --------------------------------
Average Average Average
Interest Rates Interest Rates Interest Rates
Average Income/ Earned/ Average Income/ Earned/ Average Income/ Earned/
In Thousands Balance Expense Paid Balance Expense Paid Balance Expense Paid
----------- -------- -------- --------- -------- --------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS
Taxable investments $ 90,733 $ 6,146 6.77% $110,391 $ 7,349 6.66% $ 106,320 $ 6,781 6.38%
Nontaxable investments (2) 29,630 2,598 8.77% 30,405 2,730 8.98% 31,872 2,977 9.34%
-------- ------- ----- -------- ------- ----- --------- ------- -----
Total 120,363 8,744 7.26% 140,796 10,079 7.16% 138,192 9,758 7.06%
-------- ------- ----- -------- ------- ----- --------- ------- -----
Federal funds sold 38,180 2,103 5.51% 24,625 1,331 5.41% 37,477 2,194 5.85%
Loans(3)
Installment 23,806 2,317 9.73% 21,180 2,072 9.78% 19,193 1,916 9.98%
Commercial(2) 122,992 12,522 10.18% 120,370 12,339 10.25% 124,356 13,218 10.63%
Real estate
Commercial 257,122 25,451 9.90% 208,816 20,568 9.85% 160,466 16,345 10.19%
Construction 133,538 15,775 11.81% 109,983 13,194 12.00% 90,506 11,501 12.71%
Residential 102,957 10,367 10.07% 94,756 9,408 9.93% 90,909 9,175 10.09%
-------- ------- ----- -------- ------- ----- --------- ------- -----
Total 640,415 66,432 10.37% 555,105 57,581 10.37% 485,430 52,155 10.74%
-------- ------- ----- -------- ------- ----- --------- ------- -----
Total earning assets/total
interest income 798,958 $ 77,279 9.67% 720,526 $68,991 9.58% 661,099 $64,107 9.70%
-------- ------- ----- -------- ------- ----- --------- ------- -----
Reserve for loan losses (14,066) (12,509) (12,467)
Cash and due from banks 28,029 22,258 20,885
Other assets 24,975 22,551 21,810
--------- -------- ---------
TOTAL ASSETS $ 837,896 $752,826 $691,327
========= ======== ========
INTEREST BEARING LIABILITIES
Money Market &
NOW accounts $ 86,419 $ 2,562 2.97% $ 71,712 $ 2,133 2.97% $ 68,511 $ 2,159 3.15%
Savings accounts 149,383 5,974 4.00% 144,629 5,813 4.02% 151,798 6,349 4.18%
Other time deposits 364,146 21,224 5.83% 338,542 20,132 5.95% 306,724 19,350 6.31%
--------- ------- ----- -------- ------- ----- --------- ------- -----
Total interest bearing
deposits 599,948 29,760 4.96% 554,883 28,078 5.06% 527,033 27,858 5.29%
Short-term borrowings 15,198 762 5.00% 11,018 539 4.89% 3,173 175 5.51%
Long-term debt 30,358 1,638 5.40% 26,679 1,483 5.56% 22,848 1,297 5.68%
--------- ------- ----- -------- ------- ----- --------- ------- -----
Total interest bearing
liabilities/total
interest expense 645,504 32,160 4.98% 592,580 30,100 5.08% 553,054 29,330 5.30%
--------- ------- ----- -------- ------- ----- --------- ------- -----
Noninterest bearing
deposits 95,153 80,131 73,001
Other liabilities 7,522 7,062 6,832
Shareowners' equity 89,717 73,053 58,440
-------- -------- ---------
TOTAL LIABILITIES
AND CAPITAL $ 837,896 $752,826 $691,327
========= ======== ========
NET INTEREST INCOME $ 45,119 $38,891 $34,777
======== ======= =======
NET YIELD ON INTEREST
EARNING ASSETS 5.65% 5.40% 5.26%
==== ==== ====
</TABLE>
(1) Prior period data restated to conform to current presentation.
(2) Includes amounts to convert nontaxable amounts to a fully taxable equivalent
basis at a 35% tax rate.
(3) Includes nonaccruing loans.
-38-
<PAGE> 39
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME - TABLE 2
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------------------------------------------------------
1997 versus 1996 1996 versus 1995 1995 versus 1994
---------------------------------- --------------------------------- -----------------------------------
Increase (Decrease) Due Increase (Decrease) Due Increase (Decrease) Due
In Thousands to Change in to Change in to Change in
---------------------------------- --------------------------------- -----------------------------------
Total Total Total
Average Average Increase Average Average Increase Average Average Increase
Volume Rate (Decrease) Volume Rate (Decrease) Volume Rate (Decrease)
--------- -------- ---------- -------- ---------- ---------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Taxable investments $ (1,309) $ 106 $ (1,203) $ 260 $ 308 $ 568 $ (538) $ 82 $ (456)
Nontaxable investments (70) (62) (132) (137) (110) (247) (77) (69) (146)
-------- ------- --------- ------- --------- --------- -------- -------- -------
Total (1,379) 44 (1,335) 123 198 321 (615) 13 (602)
Federal funds sold 734 38 772 (753) (110) (863) 1,492 650 2,142
Loans
Installment 257 (12) 245 199 (43) 156 (22) 119 97
Commercial 270 (87) 183 (424) (455) (879) 388 1,157 1,545
Real estate
Commercial 4,757 126 4,883 4,926 (703) 4,223 4,168 835 5,003
Construction 2,825 (244) 2,581 2,475 (782) 1,693 (291) 1,379 1,088
Residential 815 144 959 388 (155) 233 1,554 (734) 820
-------- ------- --------- ------- --------- --------- -------- -------- -------
Total 8,924 (73) 8,851 7,564 (2,138) 5,426 5,797 2,756 8,553
TOTAL INTEREST
INCOME 8,279 9 8,288 6,934 (2,050) 4,884 6,674 3,419 10,093
-------- ------- --------- ------- --------- --------- -------- -------- -------
INTEREST EXPENSE
Money Market &
NOW accounts 437 (8) 429 101 (127) (26) (194) 353 159
Savings accounts 192 (31) 161 (300) (236) (536) (2,791) 534 (2,257)
Other time deposits 1,523 (431) 1,092 2,007 (1,225) 782 8,387 2,805 11,192
-------- ------- --------- ------- --------- --------- -------- -------- -------
Total interest
bearing
deposits 2,152 (470) 1,682 1,808 (1,588) 220 5,402 3,692 9,094
Short-term borrowings 205 18 223 432 (68) 364 (393) 30 (363)
Long-term debt 204 (49) 155 217 (31) 186 (68) 28 (40)
-------- ------- --------- ------- --------- --------- -------- -------- -------
TOTAL INTEREST
EXPENSE 2,561 (501) 2,060 2,457 (1,687) 770 4,941 3,750 8,691
-------- ------- --------- ------- --------- --------- -------- -------- -------
CHANGE IN NET
INTEREST INCOME $ 5,718 $ 510 $ 6,228 $ 4,477 $ (363) $ 4,114 $ 1,733 $ (331) $ 1,402
======== ======= ========= ======= ========= ========= ======== ======== =======
</TABLE>
-39-
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINACIAL INFORMATION EXTRACTED FROM FRONTIER
FINANCIAL CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 30,496
<INT-BEARING-DEPOSITS> 3,550
<FED-FUNDS-SOLD> 61,350
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 83,019
<INVESTMENTS-CARRYING> 28,531
<INVESTMENTS-MARKET> 30,040
<LOANS> 665,330
<ALLOWANCE> (14,845)
<TOTAL-ASSETS> 882,880
<DEPOSITS> 730,931
<SHORT-TERM> 17,962
<LIABILITIES-OTHER> 6,092
<LONG-TERM> 30,056
0
0
<COMMON> 71,363
<OTHER-SE> 26,476
<TOTAL-LIABILITIES-AND-EQUITY> 882,880
<INTEREST-LOAN> 66,375
<INTEREST-INVEST> 9,936
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 76,311
<INTEREST-DEPOSIT> 29,760
<INTEREST-EXPENSE> 32,160
<INTEREST-INCOME-NET> 44,151
<LOAN-LOSSES> (1,850)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 20,893
<INCOME-PRETAX> 25,283
<INCOME-PRE-EXTRAORDINARY> 16,902
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 16,902
<EPS-PRIMARY> 2.31<F1>
<EPS-DILUTED> 2.28
<YIELD-ACTUAL> 5.65
<LOANS-NON> 4,355
<LOANS-PAST> 0
<LOANS-TROUBLED> 109
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 13,268
<CHARGE-OFFS> (1,739)
<RECOVERIES> 1,466
<ALLOWANCE-CLOSE> 14,845
<ALLOWANCE-DOMESTIC> 14,845
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
<FN>
<F1>For purposes of This Exhibit, Primary means Basic.
</FN>
</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 10K.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-START> JAN-01-1995 JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996
<PERIOD-END> DEC-31-1995 DEC-31-1996 MAR-31-1996 JUN-30-1996 SEP-30-1996
<CASH> 19,708 35,105 26,005 24,316 25,602
<INT-BEARING-DEPOSITS> 3,050 4,775 4,020 3,600 4,275
<FED-FUNDS-SOLD> 55,930 25,050 52,425 12,070 7,795
<TRADING-ASSETS> 0 0 0 0 0
<INVESTMENTS-HELD-FOR-SALE> 102,300 96,628 99,626 102,172 100,985
<INVESTMENTS-CARRYING> 39,626 29,727 37,554 37,226 34,610
<INVESTMENTS-MARKET> 40,839 30,799 38,429 37,775 35,250
<LOANS> 504,988 600,394 516,763 565,808 587,952
<ALLOWANCE> (11,897) (13,268) (12,350) (12,189) (13,010)
<TOTAL-ASSETS> 735,183 803,619 746,765 755,852 772,820
<DEPOSITS> 641,218 670,516 647,530 627,484 641,219
<SHORT-TERM> 7,596 12,011 8,842 10,602 10,840
<LIABILITIES-OTHER> 5,880 5,675 7,167 5,789 7,034
<LONG-TERM> 15,136 35,100 15,144 40,000 37,629
0 0 0 0 0
0 0 0 0 0
<COMMON> 44,084 57,191 56,086 57,013 57,130
<OTHER-SE> 21,269 23,126 11,996 14,964 18,968
<TOTAL-LIABILITIES-AND-EQUITY> 735,183 803,619 746,765 755,852 772,820
<INTEREST-LOAN> 52,146 57,545 13,311 27,443 42,320
<INTEREST-INVEST> 10,940 10,455 2,984 5,509 7,826
<INTEREST-OTHER> 0 0 0 0 0
<INTEREST-TOTAL> 63,086 68,000 16,295 32,952 50,146
<INTEREST-DEPOSIT> 27,855 28,078 7,343 14,169 20,889
<INTEREST-EXPENSE> 29,347 30,100 7,648 14,849 22,285
<INTEREST-INCOME-NET> 33,739 37,900 8,647 18,103 27,861
<LOAN-LOSSES> (1,525) (1,980) (200) (500) (1,200)
<SECURITIES-GAINS> (4) 0 0 0 0
<EXPENSE-OTHER> 17,164 17,931 3,778 8,424 12,533
<INCOME-PRETAX> 18,467 21,697 5,483 10,869 16,946
<INCOME-PRE-EXTRAORDINARY> 12,615 14,617 3,635 7,636 11,217
<EXTRAORDINARY> 0 0 0 0 0
<CHANGES> 0 0 0 0 0
<NET-INCOME> 12,615 14,617 3,635 7,236 11,217
<EPS-PRIMARY> 2.00<F1> 2.15<F1> 0.54<F1> 1.07<F1> 1.65<F1>
<EPS-DILUTED> 1.98 2.13 0.52 1.05 1.63
<YIELD-ACTUAL> 5.26 5.40 5.07 5.61 5.48
<LOANS-NON> 4,417 3,626 3,013 2,121 4,148
<LOANS-PAST> 4 0 0 0 0
<LOANS-TROUBLED> 122 121 120 136 124
<LOANS-PROBLEM> 0 0 0 0 0
<ALLOWANCE-OPEN> 10,410 11,898 11,898 11,898 11,898
<CHARGE-OFFS> 2,212 1,944 101 1,091 1,257
<RECOVERIES> 2,174 1,334 353 882 1,169
<ALLOWANCE-CLOSE> 11,897 13,268 12,350 12,189 13,010
<ALLOWANCE-DOMESTIC> 11,897 13,268 12,350 12,189 13,010
<ALLOWANCE-FOREIGN> 0 0 0 0 0
<ALLOWANCE-UNALLOCATED> 0 0 0 0 0
<FN>
<F1>For purposes of This Exhibit, Primary means Basic.
</FN>
</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 10K.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 JAN-01-1997 JAN-01-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<CASH> 33,551 32,074 31,955
<INT-BEARING-DEPOSITS> 3,550 3,550 3,550
<FED-FUNDS-SOLD> 45,610 28,595 46,345
<TRADING-ASSETS> 0 0 0
<INVESTMENTS-HELD-FOR-SALE> 90,580 86,896 84,057
<INVESTMENTS-CARRYING> 29,727 29,836 29,937
<INVESTMENTS-MARKET> 30,316 30,858 30,930
<LOANS> 616,819 642,297 661,913
<ALLOWANCE> (13,503) (14,213) (14,639)
<TOTAL-ASSETS> 832,572 843,852 867,699
<DEPOSITS> 697,322 693,901 722,029
<SHORT-TERM> 13,533 15,648 14,696
<LIABILITIES-OTHER> 7,969 6,582 7,130
<LONG-TERM> 30,092 30,085 30,077
0 0 0
0 0 0
<COMMON> 71,134 71,170 71,243
<OTHER-SE> 12,522 17,466 22,524
<TOTAL-LIABILITIES-AND-EQUITY> 832,572 834,852 93,767
<INTEREST-LOAN> 15,450 31,883 48,933
<INTEREST-INVEST> 2,445 4,849 7,287
<INTEREST-OTHER> 0 0 0
<INTEREST-TOTAL> 17,895 36,732 56,220
<INTEREST-DEPOSIT> 7,238 14,520 22,030
<INTEREST-EXPENSE> 7,775 15,641 23,769
<INTEREST-INCOME-NET> 10,120 21,091 32,451
<LOAN-LOSSES> (100) (350) (700)
<SECURITIES-GAINS> 0 0 0
<EXPENSE-OTHER> 4,436 9,964 14,756
<INCOME-PRETAX> 6,376 12,735 19,906
<INCOME-PRE-EXTRAORDINARY> 4,175 8,376 13,059
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 4,175 8,376 13,059
<EPS-PRIMARY> 0.57<F1> 1.14<F1> 1.78<F1>
<EPS-DILUTED> 0.55 1.12 1.75
<YIELD-ACTUAL> 5.37 5.38 5.63
<LOANS-NON> 3,516 4,951 5,743
<LOANS-PAST> 0 0 0
<LOANS-TROUBLED> 118 115 112
<LOANS-PROBLEM> 0 0 0
<ALLOWANCE-OPEN> 13,268 13,268 13,268
<CHARGE-OFFS> 73 385 (565)
<RECOVERIES> 208 976 1,236
<ALLOWANCE-CLOSE> 13,503 14,209 14,639
<ALLOWANCE-DOMESTIC> 13,503 14,209 14,639
<ALLOWANCE-FOREIGN> 0 0 0
<ALLOWANCE-UNALLOCATED> 0 0 0
<FN>
<F1>For purposes of This Exhibit, Primary means Basic.
</FN>
</TABLE>
