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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, 1998
Commission File Number 0-15540
FRONTIER FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
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Washington 91-1223535
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(State or Other Jurisdiction of (IRS Employer Identification
Incorporation or Organization) Number)
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332 S.W. Everett Mall Way
P. O. Box 2215
Everett, Washington 98203
(Address of Principal Executive Office) (Zip Code)
(425) 514-0700
(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. [ ]
The aggregate market value of common stock held by nonaffiliates at December 31,
1998 was $333,386,106 based on the price at December 31, 1998.
The issuer has one class of common stock (no par value) with 8,697,261 shares
outstanding as of December 31, 1998.
Documents Incorporated by Reference
Portions of Annual Report to Shareholders for the year ended:
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December 31, 1998..................Part II
1999 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 1-9
Statistical Disclosure Index 10
2 Properties 19
3 Legal Proceedings 20
4 Submission of Matters to
a Vote of Security Holders 20
PART II
5 Market for Registrant's Common
Stock and Related Shareholder
Matters 39
6 Selected Financial Data 20
7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations 27-43
7a Quantitative and Qualitative Disclosures
About Market Risks 36-39
8 Financial Statements and
Supplementary Data 21
9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure 21
PART III
10 Directors and Executive
Officers of Frontier
Financial Corporation 2-4
11 Executive Compensation 7-8
12 Security Ownership of Certain
Beneficial Owners and
Management 5
13 Certain Relationships and
Related Transactions 22 21 8&11
PART IV
14 Exhibits, Financial Statement
Schedules, and Reports on
Form 8-K 23
Signatures 26
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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 headquarters 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,
1998, the Bank conducted its business operations out of 23 offices located in
Snohomish, Pierce, 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, Burlington, and four offices located in Pierce county in the cities of
Sumner, Puyallup, Orting and Buckley.
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. This is the Bank's first
office in eastern King county. In December 1998, the Bank acquired, through
merger, the Bank of Sumner, and four of its offices, and a real estate
origination department. These offices provide a full range of consumer and
commercial banking services.
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Employees
At December 31, 1998, the Bank had 375 full and 36 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,
1998, the Bank had total assets of $1.142 billion and deposits of $927.1
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 of 1956, as amended ("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. 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.
If a holding company is well capitalized and meets other criteria specified by
the FRB, it may engage de novo in certain permissible 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 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.
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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.
NASD. FFC Common Stock is traded on The Nasdaq Stock Market under the symbol
FTBK. The National Association of Securities Dealers ("NASD") is the
self-regulatory organization of the Nasdaq Stock Market. FFC is subject to the
rules of the NASD.
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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, 1998, 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 1998 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. 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 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
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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 undercapitalized." 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 undercapitalized institution must
provide certain guarantees that the institution will comply with the plan until
it is adequately capitalized. As of December 31, 1998, the Bank was well
capitalized and maintained a leverage ratio of 10.90 percent, a risk-based Tier
1 capital ratio of 12.67 percent, and a risk-based total capital ratio of 13.92
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.
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.
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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) 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.
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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, 1998, all
banking offices have been moved into FFP, except those offices which are leased,
and except those acquired in the 1998 merger with the Bank of Sumner. For
further details, please see page 19 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.
Washington Banking Company
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 ("WBC"). 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 WBC. Approval was received, and the
Corporation has since purchased a total ownership of 6.62%, as of March 15,
1999. The Corporation intends to purchase more stock.
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<PAGE> 12
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
Form 10-K Report
Page Page
---- ----
<S> <C> <C>
I. Distribution of Assets, Liabilities
and Stockholders' Equity; Interest
Rates and Interest Differential:
A. Consolidated Average Balance
Sheets/Interest Income and
Expense/Rates 42
B. Changes in Net Interest Income
and Expense due to Rate and 43
Volume
II. Investment Portfolio:
A. Analysis of Investment Securities
at Year-end 11 11
B. Maturity Distribution of Investment
Securities 11 12
III. Loan Portfolio:
A. Types of Loans 12 12
B. Loan Maturities and Sensitivity to
Changes in Interest Rates 12 13 & 38
C. Risk Elements 13
D. Credit Concentrations
IV. Summary of Loan Loss Experience:
A. Analysis 15
B. Allocation of Allowance for Possible
Loan Losses 16
V. Deposits:
Average Interest and Noninterest
Bearing Deposit Balances 42
VI. Return on Equity and Assets:
Selected Financial Ratios 18 & 20
VII. Short-term Borrowings 19
</TABLE>
-10-
<PAGE> 13
Analysis of Investment Securities
The Aggregate amortized recorded values of investment securities at December 31
are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands) Amortized Amortized Amortized
Cost Cost Cost
-------- -------- --------
<S> <C> <C> <C>
U.S. Treasuries $ 252 $ 754 $ 758
U.S. Agencies 74,516 44,039 46,022
Municipal Bonds 28,144 28,881 30,491
Corporate Bonds 25,054 28,151 40,578
Equities 11,923 9,927 9,270
Certificates of Deposit 4,750 3,550 4,775
-------- -------- --------
Totals $144,639 $115,302 $131,894
======== ======== ========
</TABLE>
Maturity Distribution of Investment Securities
The following table sets forth the maturities of investment securities at
December 31, 1998. 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 $ 0 $ 0 $ 0 $ 252 $ 252
0.00% 0.00% 0.00% 7.16% 7.16%
U.S. Agencies 1,851 4,516 64,004 4,145 74,516
6.98% 6.18% 6.37% 7.56% 6.44%
Municipal Bonds 350 3,918 23,389 487 28,144
10.32% 9.49% 8.43% 9.40% 8.62%
Corporate Bonds 1,579 18,707 4,768 0 25,054
8.17% 6.92% 6.87% 0.00% 6.99%
Equities 11,923 0 0 0 11,923
6.77% 0.00% 0.00% 0.00% 6.77%
Certificates of Deposit 4,750 0 0 0 4,750
5.16% 0.00% 0.00% 0.00% 5.16%
----------- ----------- ----------- ----------- -----------
TOTALS $ 20,453 $ 27,141 $ 92,161 $ 4,884 $ 144,639
=========== =========== =========== =========== ===========
6.58% 7.17% 6.92% 7.72% 6.95%
=========== =========== =========== =========== ===========
</TABLE>
-11-
<PAGE> 14
Types of Loans
Major classifications of loans, net of deferred loan fees, at December 31 are as
follows:
<TABLE>
<CAPTION>
(In thousands) 1998 1997 1996 1995 1994
- -------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial $207,439 $157,319 $129,457 $137,618 $130,164
Real Estate Commercial 382,203 293,243 255,807 192,104 170,939
Real Estate Construction 173,192 151,793 144,028 102,426 107,533
Real Estate Mortgage 103,205 106,438 103,810 98,404 86,149
Installment 32,103 28,153 24,575 21,567 20,136
-------- -------- -------- -------- --------
TOTAL $898,142 $736,946 $657,677 $552,119 $514,921
======== ======== ======== ======== ========
</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, 1998. 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 $121,013 $ 75,605 $ 10,741 $207,359
Real Estate Commercial 48,685 262,850 70,691 382,226
Real Estate Construction 125,017 42,169 6,039 173,225
Real Estate Mortgage 31,133 62,607 9,476 103,216
Installment 8,634 13,566 9,916 32,116
-------- -------- -------- --------
TOTAL $334,482 $456,797 $106,863 $898,142
======== ======== ======== ========
</TABLE>
Loans maturing after one year with:
<TABLE>
<CAPTION>
1 - 5 After
Years 5 Years
-------- --------
<S> <C> <C>
Fixed Rates $403,992 $ 75,837
Variable Rates 52,805 31,026
-------- --------
TOTAL $456,797 $106,863
======== ========
</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.
-12-
<PAGE> 15
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 past due 90 days or more and still accruing,
nonaccrual loans, restructured loans and other real estate owned as a percentage
of total loans was .26%, .78%, and .64% for year-end 1998, 1997 and 1996,
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. 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. At year-end
1998, the number of loans in nonaccrual was 15, totaling slightly more than $1
million, or .12% of total loans.
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.
-13-
<PAGE> 16
Loans past due 90 days or more and still accruing, nonaccruing, restructured and
other real estate owned (OREO) on which the accrual of interest has been
discontinued as of December 31st are as follows:
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Commercial $ 112 $ 327 $ 478 $ 175 $ 877
Real Estate 932 4,097 3,144 4,402 1,872
Installment 21 17 4 14 107
Restructured 0 109 121 122 126
-------- -------- -------- -------- --------
Total Non-Performing Loans 1,065 4,550 3,747 4,713 2,982
-------- -------- -------- -------- --------
Other real estate owned 1,287 1,200 444 590 1,118
-------- -------- -------- -------- --------
Total Impaired Assets $ 2,352 $ 5,750 $ 4,191 $ 5,303 $ 4,100
======== ======== ======== ======== ========
Total Loans at end
of period $898,142 $736,946 $657,677 $552,119 $514,921
======== ======== ======== ======== ========
As a percent of
total loans 0.26% 0.78% 0.64% 0.96% 0.80%
======== ======== ======== ======== ========
</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:
(In thousands)
<TABLE>
<CAPTION>
At December 31, 1998 1997 1996 1995 1994
- --------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total interest income which
would have been recorded
during the period under
original terms of loans above $ 42 $289 $289 $518 $280
Portion of interest
income included in
net income for the
period 41 384 $264 $378 $207
Commitments for additional
funds related to loans
above -0- -0- -0- -0- -0-
</TABLE>
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, real estate
construction, residential mortgage and installment loans primarily in Snohomish,
Pierce, King and Skagit Counties. Total loans as of December 31, 1998, 1997 and
1996 were $898.1, $736.9 and $657.7 million, respectively.
-14-
<PAGE> 17
Other Real Estate Owned
As of December 31, 1998, the Bank had seven parcels of other real estate owned
(OREO) on its books, which totaled $1.3 million. 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) 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Other Real Estate Owned $1,287 $1,200 $444 $590 $1,118
</TABLE>
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) 1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance at beginning
of year $ 15,824 $ 14,033 $ 12,601 $ 11,019 $ 7,850
Provision charged to
operating expense 1,800 2,095 2,133 1,621 4,059
Loans charged-off:
Commercial (438) (393) (621) (1,257) (1,120)
Real Estate (778) (1,324) (1,336) (875) (892)
Installment (66) (81) (84) (88) (120)
-------- -------- -------- -------- --------
Total charged-off loans (1,282) (1,798) (2,041) (2,220) (2,132)
Less recoveries:
Commercial 653 283 752 1,245 614
Real Estate 1,082 1,161 535 902 557
Installment 21 50 53 34 71
-------- -------- -------- -------- --------
Total recoveries 1,756 1,494 1,340 2,181 1,242
Net charge-offs 474 (304) (701) (39) (890)
Balance at end of year $ 18,098 $ 15,824 $ 14,033 $ 12,601 $ 11,019
======== ======== ======== ======== ========
Total loans at
end of period $898,142 $736,946 $657,677 $552,119 $514,921
Daily average loans $811,866 $703,275 $608,190 $531,297 $472,198
Ratio of net charged-off
loans during period to
average loans outstanding -0.06% 0.04% 0.12% 0.01% 0.19%
======== ======== ======== ======== ========
</TABLE>
-15-
<PAGE> 18
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.
Allocation of Allowance for Possible Loan Losses
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.
(In thousands, except percents)
<TABLE>
<CAPTION>
Loan Loan Loan
1998 Category 1997 Category 1996 Category
Reserve Percent Reserve Percent Reserve Percent
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Commercial $ 9,592 23.1% $ 8,920 21.4% $ 8,702 19.7%
Real Estate 8,144 73.3% 6,485 74.8% 4,976 76.6%
Installment 362 3.6% 419 3.8% 355 3.7%
------- ----- ------- ----- ------- -----
TOTAL $18,098 100.0% $15,824 100.0% $14,033 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
<TABLE>
<CAPTION>
Loan Loan
1995 Category 1994 Category
Reserve Percent Reserve Percent
------- ----- ------- -----
<S> <C> <C> <C> <C>
Commercial $ 7,758 24.9% $ 6,374 25.3%
Real Estate 4,283 71.2% 3,937 70.8%
Installment 560 3.9% 708 3.9%
------- ----- ------- -----
TOTAL $12,601 100.0% $11,019 100.0%
======= ===== ======= =====
</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.
Determination of the Reserve for Loan Losses - Qualitative Factors
The loan portfolio is separated by quality and then by loan type. Loans of
acceptable quality are evaluated as a group, by loan type, with a specific
reserve percent assigned to the total loans in each type, but unallocated to any
individual loan. Conversely, each adversely classified loan is individually
analyzed, to determine a "worst case" loss. A valuation allowance is also
assigned to these adversely classified loans, but at a higher percent due to the
greater risk of loss. Those loans where the "worse case" loss is greater than
the background percentage, that amount is considered specifically allocated to
the reserve.
Based on actual historical results (over the past 5 years, which average
approximately $600 thousand per year net losses), Frontier has an excess of the
necessary reserves required. However, this does not take into consideration the
inherent risks of a loan portfolio, the current or expected local economic
conditions, so management believes that the reserve is adequate, based on those
inherent risks.
National and Local Economic Trends and Conditions
In addition to the economic discussion in Managements Discussion and Analysis of
Financial Condition and Results of Operations (page 27-29, 1998 Annual Report to
Shareowners), there are other qualitative factors considered when analyzing the
adequacy of the loan loss reserve.
-16-
<PAGE> 19
Year 2000 Risk
As part of Year 2000 due diligence, a specific loan loss allowance is maintained
to offset any potential losses incurred due to business failures or setbacks
caused by the millennium change. Although actual losses are impossible to
predict, we are in the process of risk rating our loan portfolio and assigning a
specific loan loss reserve of .1% of the loan balance to the loans assigned a
high risk rating. A background reserve amount of $500 thousand is set aside and
is adjusted as information is updated from time to time. However, there can be
no guarantee that this estimate is accurate and actual results could differ
materially from those anticipated. Also, because of the merger with the Bank of
Sumner, an additional $100 thousand background amount was added to the Y2K
reserve to mitigate the unknown risk assumed.
Effects of Changing Interest Rates
The three recent decreases in the discount rate by the Federal Reserve and the
subsequent Prime rate reductions, totaling .75%, bring the Prime rate down to
7.75%. The "pipeline" is filling up again with another round of residential real
estate refinances. Inflation remains low and adds some stability to an economy
that is anticipated to slow.
The majority of the bank's loans have short term maturities of up to 5 years,
and typically, 47% of the loan portfolio reprices within 1 year, which decreases
the interest rate risk.
Concentrations of Credit
At year-end 1998, 16.8% of the Bank's loan portfolio was in residential and
commercial construction and land development projects centered in Snohomish,
Pierce, 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) 1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Construction $ 99,312 $ 80,233 $ 70,201 $ 54,341 $ 60,173
Land Development 51,902 43,015 52,186 33,946 38,582
-------- -------- -------- -------- --------
TOTAL $151,214 $123,248 $122,387 $ 88,287 $ 98,755
======== ======== ======== ======== ========
Total Loans at end of period $898,142 $736,946 $657,677 $552,119 $514,921
======== ======== ======== ======== ========
Construction and Land
Development loans as a
percent of total loans 16.8% 16.7% 18.6% 16.0% 19.2%
======== ======== ======== ======== ========
</TABLE>
At this time, management considers the loan portfolio reasonably diversified,
providing the proper mix of risk and return. However, the quality of many of the
loans is related to the strength and stability of real estate values, which
could be affected by several factors.
-17-
<PAGE> 20
Levels of, and Trends in, Delinquencies and Nonaccruals
Nonperforming loans and other real estate declined significantly in the fourth
quarter of 1998, when compared to the end of the third quarter, due to the
resolution of two well secured problem loans. Management monitors delinquencies
monthly and reports are prepared for the Board of Directors review.
Delinquencies for the commercial, personal, real estate and credit lines
categories are charted separately when presented to the Board. At this time, the
data indicates a generally stable to declining trend.
Trends in Volume and Terms of Loans
The rate of loan growth was consistent in the second, third and fourth quarters
of 1998. Total loans increased $39 million in the fourth quarter, or 5% to
$898.1 million. The merger with the Bank of Sumner added approximately $92
thousand in loans.
Conclusion of Qualitative Factors
The allowance for loan losses is the amount which, in the opinion of management,
is necessary to absorb inherent loan losses regardless of source. Management's
evaluation of the adequacy of the allowance is based on the market area served,
local economic conditions, the growth and mix of the portfolio and their related
risk characteristics.
The loan loss reserve may be somewhat larger than the indicated amount based on
formulas, however, based on upcoming cutbacks at the Boeing Company, and an
anticipated slowing of the economy, any excess reserve is not considered by
management to be material.
Deposits
For the average amount of deposits and rates paid on such deposits for years
ended December 31, 1998, 1997, and 1996 please refer to page 42 of 1998 Annual
Report to Shareowners.
Maturities of time certificates of deposit $100,000 and over at year-end 1998,
are shown below:
(In thousands)
<TABLE>
<S> <C>
3 months or less $ 62,137
Over 3 months through 6 months 35,128
6 months through 12 months 46,564
Over 12 months 21,000
--------
TOTAL $164,829
========
</TABLE>
Significant Financial Ratios
Ratios for the years ended December 31, 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Return on Average Assets 2.06% 2.03% 1.96%
Return on Average Equity 18.27% 18.84% 20.15%
Cash dividends paid/dividend payout 14.9% 15.3% 16.0%
Average Equity to Average Assets 11.30% 10.78% 9.71%
</TABLE>
-18-
<PAGE> 21
Borrowings
<TABLE>
<CAPTION>
Short-Term Borrowings Weighted Weighted Weighted
(In thousands) Average Average Average
Interest Interest Interest
At December 31, 1998 Rate 1997 Rate 1996 Rate
------- ------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Year-end balance: $31,858 4.88% $17,962 5.01% $12,011 4.88%
Highest month end
balance during
the period: $31,858 $22,245 $12,390
</TABLE>
For information regarding average balances and yields, please refer to page 42
of 1998 Annual Report to Shareowners.
Long-Term Debt
For detailed information relating to long-term debt, please refer to Note 10,
page 16, of 1998 Annual Report to Shareowners.
ITEM 2 - PROPERTIES
FFC's main office, which is owned by FFP, is located in Everett, Washington. At
December 31, 1998, the Bank had 23 offices, including the main office, all of
which are located in the state of Washington. These offices are located in
Arlington, Bothell, Buckley, Burlington, Edmonds, Everett (4), Lake City (North
Seattle), Lake Stevens, Lynnwood, Marysville, Mill Creek, Monroe, Orting,
Meridian Place (Puyallup), Redmond, Smokey Point, Snohomish, Stanwood, Sumner
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). Additionally, three of the four
offices recently acquired by merger with the Bank of Sumner (Valley
Bancorporation) have not yet been transferred to FFP, and the fourth, Meridian
Place Office, is leased (which lease expires in September 1999).
The Bank has leased property in Mt. Vernon, which will become the 24th office
during 1999. The total net book value of the investment in premises and
equipment at December 31, 1998, totaled $15.6 million.
-19-
<PAGE> 22
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 1998.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Please see 1998 Annual Report to Shareowners, page 39.
ITEM 6 - SELECTED FINANCIAL DATA
(In thousands, except per share data)
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
% Change
AT YEAR-END 1998 1997 1996 1995 1994 1997-1998
---- ---- ---- ---- ---- ---------
<S> <C> <C> <C> <C> <C> <C>
Total assets $1,147,873 $ 973,052 $ 874,946 $ 796,730 $ 704,115 18.0%
Net loans 880,044 721,122 643,644 539,517 506,528 22.0%
Deposits 926,642 810,348 732,389 694,278 592,663 14.4%
Long-term debt 0 695 1,059 1,394 1,823 -100.0%
Investment securities 145,601 115,999 132,340 146,645 137,995 25.5%
Shareowners' equity 129,249 107,384 88,351 72,214 57,321 20.4%
FOR THE YEAR
Interest income 93,562 83,324 73,971 68,443 58,302 12.3%
Interest expense 37,890 34,369 32,062 31,091 22,383 10.2%
Securities gains(losses) 0 0 0 (4) (355) nm
Provision for loan losses 1,800 2,095 2,133 1,621 3,996 -14.1%
Net income 21,649 18,594 16,012 13,837 11,620 16.4%
Basic earnings per share $ 2.49 $ 2.15 $ 1.87 $ 1.62 $ 1.37 15.8%
Fully diluted earnings per share $ 2.46 $ 2.14 $ 1.84 $ 1.59 $ 1.34 15.0%
Return on Average
Assets 2.06% 2.03% 1.96% 1.84% 1.82%
Equity 18.27% 18.84% 20.15% 21.34% 22.26%
Avg. equity/avg. assets 11.30% 10.78% 9.71% 8.63% 8.18%
</TABLE>
nm=Not meaningful
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Please see 1998 Annual Report to Shareowners, pages 27 through 43.
-20-
<PAGE> 23
ITEM 7a - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Please see 1998 Annual Report to Shareowners, page 36-39.
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 25
Report of Management 1
Consolidated Balance Sheet at
December 31, 1998 and 1997 3
Consolidated Statement of Income for the Years
Ended December 31, 1998, 1997 and 1996 4
Consolidated Statement of Changes in
Shareowners' Equity 5
Consolidated Statement of Cash Flows for the
Years Ended December 31, 1998, 1997 and 1996 6
Condensed Balance Sheet (Parent Only) at
December 31, 1998 and 1997 24
Condensed Statement of Income (Parent Only) for the
Years Ended December 31, 1998, 1997 and 1996 24
Condensed Statement of Cash Flows (Parent Only)
for Years Ended December 31, 1998, 1997 and 1996 25
Notes to Consolidated Financial Statements 7-26
</TABLE>
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
-21-
<PAGE> 24
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF FRONTIER FINANCIAL
CORPORATION
Please see pages 2-8 of 1999 Proxy Statement.
ITEM 11 - EXECUTIVE COMPENSATION
Please see pages 6-8 of 1999 Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Please see pages 5, 6 and 10 of 1999 Proxy Statement.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Please see page 8 & 11 of 1999 Proxy Statement; and, Note 15, page 21 of
1998 Annual Report to Shareowners; and, Page 24 of this Form 10-K report.
-22-
<PAGE> 25
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 1998 Annual
Report to Shareowners, attached hereto as an exhibit.
2. Financial Statement Schedules.
Financial Statement Schedule is included in the notes
to consolidated financial statements.
3. Exhibits.
(3a) Articles of Incorporation are incorporated
herein by reference to Appendix A to the
registrant's definitive Proxy Statement on
Schedule 14A filed on March 20, 1998 in
connection with its 1998 Annual Meeting.
(3b) By-Laws are incorporated herein by reference to
Exhibit 3(b) to Registration on Form S-14,
File No. 2-82420.
(10a) Amended and Restated Frontier Financial
Corporation Incentive Stock Option Plan
(10b) Frontier Financial Corporation 1999 Employee
Stock Award Plan, is incorporated herein by
reference to Exhibit 99.1 to registration
statement on Form S-8, filed March 2, 1999.
(11) Statement Regarding Computation of Earnings Per
Share.
(13) Annual Report to Shareowners for the year ended
December 31, 1998.
(21) Subsidiaries of Registrant is incorporated by
reference from Part I, page 1 through 9 of this
report.
The following exhibit is included only in the electronic EDGAR filing version
of this Form 10-K:
(27) Financial Data Schedule for fiscal year ended
December 31, 1998.
(b) Reports on Form 8-K:
Form 8-K was filed on December 30, 1998, announcing that the
merger with Valley Bancorporation (Bank of Sumner) was completed
December 21, 1998. No financials were included.
-23-
<PAGE> 26
SCHEDULE I
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
AMOUNTS RECEIVABLE FROM CERTAIN PERSONS
(In thousands)
<TABLE>
<CAPTION>
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>
1998 $21,960 $ 8,630 ($8,471) $0 $22,119
Twelve
Directors
and two
Officers
1997
Eleven 7,028 22,219 (7,287) 0 21,960
Directors
and Two
Officers
1996
Nine $ 9,475 $ 3,808 ($6,255) $0 $ 7,028
Directors
and Two
Officers
</TABLE>
-24-
<PAGE> 27
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, 1998. 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, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, 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 19, 1999
-25-
<PAGE> 28
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 17, 1998 /s/ ROBERT J. DICKSON
- -------------- -------------------------------------------
Date Robert J. Dickson
President & Chief Executive Officer
March 17, 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 17, 1999 /s/ GEORGE E. BARBER
- -------------- -------------------------------------------
George E. Barber, Director
March 17, 1999 /s/ MICHAEL J. CORLISS
- -------------- -------------------------------------------
Michael J. Corliss, Director
March 17, 1999 /s/ LUCY DEYOUNG
- -------------- -------------------------------------------
Lucy DeYoung, Director
March 17, 1999 /s/ ROBERT J. DICKSON
- -------------- -------------------------------------------
Robert J. Dickson, Director
March 17, 1999 /s/ DAVID A DUJARDIN
- -------------- -------------------------------------------
David A. Dujardin, Director
March 17, 1999 /s/ EDWARD D. HANSEN
- -------------- -------------------------------------------
Edward D. Hansen, Secretary of the Board
March 17, 1999 /s/ WILLIAM H. LUCAS
- -------------- -------------------------------------------
William H. Lucas, Director
March 17, 1999 /s/ JAMES H. MULLIGAN
- -------------- -------------------------------------------
James H. Mulligan, Director
March 17, 1999 /s/ J. DONALD REGAN
- -------------- -------------------------------------------
J. Donald Regan, Chairman of the Board
March 17, 1999 /s/ ROGER L. RICE
- -------------- -------------------------------------------
Roger L. Rice, Director
March 17, 1999 /s/ ROY A. ROBINSON
- -------------- -------------------------------------------
Roy A. Robinson, Director
March 17, 1999 /s/ WILLIAM J. ROBINSON
- -------------- -------------------------------------------
William J. Robinson, Director
March 17, 1999 /s/ EDWARD C. RUBATINO
- -------------- -------------------------------------------
Edward C. Rubatino, Director
March 17, 1999 /s/ DARRELL J. STORKSON
- -------------- -------------------------------------------
Darrell J. Storkson, Director
-26-
<PAGE> 1
EXHIBIT 10(A)
AMENDED AND RESTATED
FRONTIER FINANCIAL CORPORATION
INCENTIVE STOCK OPTION PLAN
1. PURPOSE
This Incentive Stock Option Plan (the "Plan") is intended to promote the
best interests of FRONTIER FINANCIAL CORPORATION and its subsidiaries
("Frontier" or the "Corporation") and its shareowners by providing an incentive
and reward for those key top-management officers and employees who contribute to
the operating progress and success of Frontier.
1.1 FAVORABLE TAX TREATMENT
Implementation of this Plan is designed to take advantage of the
favorable income tax treatment afforded to the recipient of incentive stock
options pursuant to Internal Revenue Code Sections 421 to 425 and its associated
regulations.
1.2 ADVANTAGES TO KEY EMPLOYEES
This plan provides a means whereby certain key employees of Frontier are
afforded the opportunity of investing in the common stock of Frontier under
beneficial income tax consequences. Upon the exercise of the incentive stock
options granted pursuant to this plan, employees will not recognize either
ordinary or capital gain income, but may trigger the application of the
alternative minimum tax. Income realization is deferred until such time as the
employee sells the stock obtained pursuant to the exercise of the incentive
stock option and the income may be characterized as capital gain, instead of
ordinary income, upon such subsequent sale.
1.3 ADVANTAGES TO FRONTIER
The Plan advances the interest of Frontier by enhancing the ability of
Frontier to attract and retain the services of highly qualified and highly
motivated employees and provides such key employees with additional incentive to
exert their best efforts on behalf of Frontier to maximize the appreciation of
the value of Frontier stock.
2. STOCK AVAILABLE PURSUANT TO PLAN
Shares of stock that may be issued under the Plan shall be authorized
and unissued shares of common stock of Frontier. The maximum number of shares
that may be issued pursuant to this Plan shall be 750,000 shares of common
stock.
-1-
<PAGE> 2
2.1 ADJUSTMENTS
The quantity of common stock available under this Plan shall be
proportionally adjusted to reflect any future common stock dividends, common
stock splits, recapitalization, and reorganization of Frontier as is further
described in paragraphs 4.7 and 4.8. Subject to the obtainment of shareowner
approval pursuant to the provisions of paragraph 7, the Board of Directors may
increase the amount of authorized but unissued common stock available under this
Plan.
2.2 UNEXERCISED OPTIONS
Shares of common stock reserved for stock option grants pursuant to this
Plan that are not exercised shall again become available for new option grant
upon the expiration or termination of the unexercised option.
3. ELIGIBILITY
The following rules are applicable concerning the determination of
eligibility of any employees of Frontier.
3.1 BOARD OF DIRECTORS
The Board of Directors shall have the authority and responsibility of
determining which employees of Frontier shall be eligible to receive incentive
stock options pursuant to this Plan. The Board of Directors may establish a
committee consisting of three (3) or more directors who are not employees of
Frontier, who may make recommendations to the Board of Directors as to which key
employees should receive incentive stock options, the number of options to be
offered to each key employee, and the fair market value of such stock at the
time an incentive stock option is granted.
3.2 KEY EMPLOYEES
The Board of Directors may grant incentive stock options pursuant to
this Plan only to persons deemed "key employees". Key employees are defined as
those employees of Frontier who, in the absolute sole discretion and judgment of
the Board of Directors or a committee thereof, have substantial responsibility
in the direction, management, and profitability of Frontier or any branch or
division of Frontier.
-2-
<PAGE> 3
3.3 EMPLOYMENT STATUS
Except as otherwise permitted by this Plan, for the entire time commencing on
the date that an incentive stock option is granted pursuant to this Plan until
three (3) months before its exercise, the option holder must continually be an
employee of Frontier. Such three-month period shall be extended to one year in
the case of permanent and total disability, but not death, of the employee.
3.4 STOCK OWNERSHIP
At the time an incentive stock option is granted, a key employee may not
own Frontier stock possessing more than ten per cent (l0%) of the total combined
voting power of all classes of the stock of Frontier. An exception to this
ownership limitation shall be if exercise price of the stock granted pursuant to
the option shall equal or exceed 110% of the fair market value of the stock on
the date the option is granted and the option must be exercised within five (5)
years from the date of the grant.
4. INCENTIVE STOCK OPTION AGREEMENT REQUIREMENTS
In granting incentive stock options to key employees pursuant to this
Plan, Frontier shall enter into written agreements with its key employees,
"Frontier Financial Corporation Incentive Stock Option Agreement." Said written
agreements must, among other things, provide that the substance of the following
terms and conditions be included therein, subject, however, to amendment as may
be necessary to comply with the Internal Revenue Code and regulations thereto,
Securities and Exchange Commission requirements, and amendments made pursuant to
paragraph 7 below.
4.1 OPTION PRICE
The option price shall not be less than the fair market value of the
stock at the time such option is granted. However, in the event the option is
granted to a key employee who at the time of the grant owns ten per cent or more
of the combined voting power of all classes of Frontier stock, then the option
price shall equal or exceed 110% of the fair market value of the stock at the
time such option is granted. The Board of Directors of Frontier shall make a
good faith attempt to value the Frontier stock accurately. The Incentive Stock
Option Agreement shall specifically set forth the option price in terms of
American Dollars.
4.2 TERM OF OPTION
No Incentive Stock Option may be exercisable after the expiration of the
(l0) years from the date such option is granted and, is subject to the rules and
regulations
-3-
<PAGE> 4
promulgated by the Internal Revenue Service and the Securities and Exchange
Commission. However, the ten year period shall be limited to five (5) years for
any option granted to a key employee who at the time of the grant owns ten per
cent or more of the combined voting power of all classes of Frontier stock. The
Incentive Stock Option Agreement shall provide that in the event a key employee
terminates employment with Frontier prior to the expiration of an option, that
the option shall be deemed to expire upon the earlier of the expiration of the
option or three (3) months following the termination of employment.
4.3 EXERCISE OF OPTION
An option shall be deemed exercised when written notice of such exercise
has been given to the Corporation at its principal business office by the person
entitled to exercise the Option and full payment in cash or cash equivalents (or
with shares of Common Stock as hereafter provided) for the shares with respect
to which the Option is exercised has been received by the Corporation. As soon
as practicable after any proper exercise of an Option in accordance with the
provisions of this Plan, the Corporation shall deliver to the Optionee at the
main office of the Corporation, or such other place as shall be mutually
acceptable, a certificate or certificates representing the shares of Common
Stock as to which the Option has been exercised.
The Board of Directors may provide that, upon exercise of the Option,
the Optionee may elect to pay for all or some of the shares of Common Stock
underlying the Option with shares of Common Stock of the Corporation previously
acquired and owned at the time of exercise by the Optionee, subject to all
restrictions and limitations of applicable laws, rules, and regulations,
including Section 424(c)(3) of the Internal Revenue Code, and provided that the
Optionee makes representations and warranties satisfactory to the Corporation
regarding his or her title to the shares used to effect the purchase, including
without limitation representations and warranties that the Optionee has good and
marketable title to such shares free and clear of any and all liens,
encumbrances, charges, equities, claims, security interests, options or
restrictions and has full power to deliver such shares without obtaining the
consent or approval of any person or governmental authority other than those
which have already given consent or approval in a form satisfactory to the
Corporation. The equivalent dollar value of the shares used to effect the
purchase shall be the fair market value of the shares on the date of the
purchase as determined by the Board of Directors or the President and Secretary
of the Corporation in its/their sole discretion, exercised in good faith.
-4-
<PAGE> 5
4.4 TIME LIMIT FOR GRANTING OPTIONS
Any Incentive Stock Option issued pursuant to this Plan must be granted
within ten (10) years from the earlier of date on which this Plan is adopted by
the Board of Directors of Frontier or the date such plan is approved by the
shareowners of Frontier. However, this Plan shall be void unless the shareowners
of Frontier approve of its adoption either 12 months before or after it is
adopted by the Board of Directors.
4.5 TRANSFERABILITY OF OPTION RIGHTS
No option granted pursuant to this Plan may be assigned or transferred;
provided, however, that upon the death of a key employee, who at death was
actively employed by Frontier, the spouse and/or children of the key employee or
personal representative of his/her estate shall have the right to exercise an
unexpired option for a period of six (6) months immediately following the death
of the key employee. During the life of the key employee, the option may be
exercised only by the key employee; provided, however, that in the case of
permanent and total disability, the option may be exercised by a court-appointed
legal representative of the key employee at any time within one year of the
termination of employment.
4.6 TERMINATION OF EMPLOYMENT
Any option granted pursuant to this Plan shall terminate and expire
three (3) months following termination of employment of the key employee by
Frontier for any reason other than death or permanent disability.
4.7 RECAPITALIZATION
In the event there is any increase or decrease in the number of issued
shares of common stock of Frontier resulting from a subdivision or consolidation
of shares, a capital adjustment, the issuance of a stock dividend, the
declaration of a stock split, or other increase or decrease in such shares,
there shall be a proportional adjustment effected without receipt of
consideration by Frontier as follows:(a)in the aggregate number of shares of
common stock on which options may be granted to all key employees under this
Plan;(b)in the aggregate number of shares of common stock on which options have
been granted to any one key employee;(c)in the number of shares covered by each
outstanding option; and (d)in the price per share of stock, subject to the
provisions of Section 4.1 above in each such option.
-5-
<PAGE> 6
4.8 MERGER OR CONSOLIDATION
Subject to any required action by the shareowners of Frontier, if
Frontier shall be the surviving or resulting corporation in any merger or
consolidation, any option granted hereunder shall pertain to and apply to the
securities to which an owner of the number of shares of common stock subject to
the option would have been entitled; that a dissolution or liquidation of
Frontier or a merger or consolidation in which Frontier is not the surviving or
resulting corporation shall cause every option outstanding hereunder to
terminate, except that the surviving or resulting corporation may, in its
absolute and uncontrolled discretion, tender options to purchase its shares on
its own terms and conditions, both as to the number of shares and otherwise. In
any event, however, a key employee with an unexercised option granted pursuant
to this plan shall have the right to immediately prior to such dissolution,
liquidation, merger or consolidation, exercise the option granted hereby to the
full extent therefore not exercised. Any options exercised pursuant to this
paragraph can be exercised by providing written notice and the exercise price
shall be due and payable concurrent with the closing of the dissolution,
liquidation, consolidation or merger of Frontier.
4.9 LIMITATIONS ON DISPOSITION
In order to preserve the favorable income tax treatment afforded to
incentive stock options, disposition of stock acquired by the exercise of an
incentive stock option cannot occur within two (2) years from the date the
option was granted nor within one (l) year after the transfer of such shares to
the key employee by the exercising of such option. Nothing in this Plan shall
prevent an employee from making a disqualifying disposition. However, if the key
employee transfers, except by bequest or inheritance, such stock within the
above two and/or one year periods, the key employee shall be obligated to use
Frontier as the transfer agent and inform Frontier in writing the number of
shares transferred, the consideration received in such transfer and the original
exercise price of the stock transferred. If any key employee disposes of stock
obtained pursuant to this Plan and such disposition generates a payroll tax
withholding obligation, it is agreed that the key employee shall make
appropriate arrangements with Frontier to fund his/her requisite share of such
payroll tax obligation.
4.10 INVESTMENT PURPOSE
The key employee at the time of the exercise of an Incentive Stock
Option shall state in writing that said employee is purchasing Frontier stock
for investment purposes and that said key employee has no present intention of
selling the Frontier stock.
-6-
<PAGE> 7
4.11 NONALIENABILITY
The key employee must agree that he or she will not in any way assign,
pledge, encumber, or otherwise transfer any right, title and interest in his or
her right to purchase Frontier stock, or any other right under this Plan.
4.12 RIGHTS BEFORE EXERCISE
Except as provided in paragraphs 4.7 and 4.8, a key employee with an
unexercised stock option shall have no rights as a shareowner with respect to
any shares of common stock of Frontier subject to option until said key employee
has delivered payment for such stock to the duly authorized officer of Frontier.
The employee shall have no right to any cash dividends for which the record date
precedes the date of Frontier's receipt of the payment for such stock.
4.13 SEQUENTIAL EXERCISE OF OPTIONS ISSUED BEFORE JANUARY 1, 1987
Frontier previously adopted an Incentive Stock Option Plan, which
terminated according to the ten year provisions on March 10, 1992. Accordingly,
after the effective date of this Plan, there will be outstanding unexpired
options from the prior plan. Any option granted before January 1, 1987 pursuant
to the prior plan must be exercised sequentially on a first issued, first
exercised basis. Any option granted after January 1, 1987 under the prior plan
does not have to be exercised in a sequential manner. Any option granted
pursuant to this Plan does not have to be exercised in a sequential manner.
4.14 AGGREGATE FAIR MARKET VALUE LIMITATION
In order to preserve the preferential income tax treatment afforded to
Incentive Stock Options, this Plan places a limit on the options to be granted
to a key employee. The limitation is determined by placing a limit of $l00,000
on the aggregate value of option stock that can be exercised for the first time
in a calendar year. Aggregate value is determined on the date the option is
granted, in accordance with Internal Revenue Code Section 422(d). This does not
place a $l00,000 limit on the exercise stock options in any one year. Rather,
the limit is imposed on the first calendar year which an option can be
exercised. In the event said IRC Section 422(d) is subsequently amended by
Congress, this dollar limitation shall be deemed amended commensurately.
-7-
<PAGE> 8
4.15 IDENTIFICATION NUMBERS
Each Incentive Stock Option Agreement between Frontier and a key
employee shall include an identification number. Agreements shall be numbered
consecutively, commencing with the first agreement authorized by the Board of
Directors. For example, the first Incentive Stock Option Agreement may have the
identification number "ISOK-001". Subsequent Incentive Option Agreements would
then be numbered ISOK-002, ISOK-003, ISOK-004, etc.
4.16 NON REGISTERED STOCK
Unless Frontier, in its sole discretion, determines to register the
common stock that may be issued pursuant to this Plan any stock of Frontier
obtained by a key employee pursuant to this plan is not registered stock and
accordingly, is a restricted security. Therefore, any disposition of such stock
by a key employee shall be made in accordance with the applicable rules and
regulations of the Securities and Exchange Commission.
5. ADMINISTRATION
This Plan shall be administered by the Board of Directors of Frontier.
However, the Board of Directors may establish a special committee, including the
Personnel Committee of Frontier, to administer this Plan and appoint members of
the Board of Directors to such committee. No director who is an active officer
or employee of Frontier may serve as a member of the committee administering
this Plan. No member of such committee shall be eligible to participate in this
Plan. However, such committee may solicit input and recommendations from any
officer or employee of Frontier who shall not, by virtue of offering such
information or recommendations, be considered ineligible for Incentive Stock
Options. The committee shall make recommendations periodically to the Board of
Directors including recommendations as to the key employees who should be
granted stock options and the quantity and fair market value of such stock
options. The final decisions as to Incentive Stock Options, however, shall be
made by the Board of Directors and such decisions shall be set forth in the
Minutes of the meeting of the Board of Directors at which the action was taken.
5.1 INTERPRETATION AND CONSTRUCTION
The committee appointed by the Board of Directors, if any, shall have
the responsibility and authority for interpreting and constructing any
provisions of the plan, any option granted pursuant to the plan, or any other
agreement pertaining to the plan. The decision of the Board shall be final and
conclusive and binding upon all key employees.
-8-
<PAGE> 9
5.2 PERSONAL LIABILITY
No member of the Board of Directors or committee of the Board shall be
liable for any action or determination made hereunder.
6. EFFECTIVE DATE
This Plan shall become effective upon its approval by both of the
following: The Board of Directors of Frontier and the owners of a majority of
the outstanding shares of common stock of Frontier at a duly called meeting of
said shareowners. Said shareowner approval must occur within either 12 months
before or after the plan is adopted by the Board of Directors. No option may be
granted by the Board of Directors under this Plan after the expiration of ten
(10) years following said effective date.
7. AMENDMENTS
The Board of Directors may from time to time alter, amend, suspend or
discontinue this Plan or alter or amend any and all option agreements granted
pursuant to this Plan.
7.1 ADDITIONAL APPROVAL REQUIRED
The approval of the shareowners of Frontier by vote of the shareowners
representing a majority of the outstanding capital stock of Frontier shall be
required for amendments or alterations to the Plan that will: (a) Increase the
maximum number of shares as to which options may be granted under this Plan; (b)
decrease the minimum option price; (c) decrease, directly or indirectly by
cancellation and substitution of options or otherwise, the option price
applicable to any option granted under this Plan; (d) be treated as the adoption
of a new plan pursuant the Internal Revenue Code and its applicable regulations;
and (e) result in a material modification of the plan eligibility requirements.
7.2 EXCEPTIONS
Provided, however, that the provisions of this clause shall not (a)
prevent the granting to any key employee holding an unexpired option under this
plan, of an additional option(s) under this plan; (b) withdraw the
administration of this Plan from the committee; (c) permit any member of the
committee to be eligible to receive or hold an option under the Plan; and (d)
alter any outstanding option agreement to the detriment of the key employee
holding the option without the consent of such employee.
-9-
<PAGE> 10
8. USE OF PROCEEDS
The proceeds received by Frontier from the sale of its common stock
pursuant to the exercise of options by key employees shall be used for general
corporate purposes.
9. REDEMPTION OF STOCK UPON TERMINATION
Frontier, solely at Frontier's option, shall have the right to redeem
any stock owned by a key employee resulting from the exercising of a stock
option pursuant to this Plan upon the key employee's termination of employment.
The term of Frontier's option to redeem such stock shall be three months,
commencing on the later of the option exercise date or the employment
termination date. The redemption price shall be the fair market value of the
stock on the date of redemption and the redemption price shall be paid in cash
by Frontier upon the redemption.
10. FINANCING THE EXERCISE OF THE OPTIONS
Frontier may initiate a financing program that would allow a key
employee to finance up to 75% of the exercise price of any option granted
pursuant to this Plan. If such financing is offered, it shall be in Frontier's
sole discretion to determine the terms and conditions of such financing.
Frontier shall be allowed to make an independent assessment of whether financing
should be provided to any individual based on that individual's credit history.
Thus, if a financing plan is adopted, the decision whether a key employee is
entitled to utilize such financing is solely a credit decision to be made by
Frontier.
11. ADOPTION AND/OR GRANT OF OPTIONS OUTSIDE THIS PLAN
Nothing in this Plan shall be construed as limiting Frontier from
establishing another stock option plan (statutory or nonstatutory) that would
operate concurrently with this Plan; provided, however, that the approval of the
shareowners of Frontier by vote of the shareowners representing a majority of
the outstanding capital stock of Frontier shall be required to adopt any
additional plan. Moreover, if any additional plan is adopted, no option granted
under this plan shall be contingent upon the exercise or nonexercise of any
option granted under the additional plan.
12. PARAGRAPH HEADINGS
The paragraph headings used in this Plan are for the reference
convenience of the reader. In the event of a conflict between he language of a
particular paragraph and a paragraph heading, the language of the paragraph
shall prevail.
-10-
<PAGE> 1
EXHIBIT 11
FRONTIER FINANCIAL CORPORATION
COMPUTATION OF BASIC AND FULLY DILUTED EARNINGS PER SHARE
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net Income (in thousands) $21,649 $ 18,594 $16,012
============================================
Computation of average shares
outstanding:
Shares outstanding at
beginning of year 7,350,561 6,830,666 6,322,255
Additional shares deemed
outstanding because of
stock dividends 516,035 992,235 1,428,979
Shares issued pursuant
to merger 793,900 793,900 793,900
Shares issued during
the year times average
time outstanding during
the year 17,537 16,962 35,061
--------------------------------------------
Average basic shares outstanding 8,678,033 8,633,763 8,580,195
--------------------------------------------
Average number of dilutive shares
assumed to be outstanding 107,555 56,852 81,005
--------------------------------------------
Average fully diluted shares
outstanding 8,785,588 8,690,615 8,661,200
============================================
Basic earnings per share $ 2.49 $ 2.15 $ 1.87
============================================
Fully diluted earnings per share $ 2.46 $ 2.14 $ 1.84
============================================
</TABLE>
<PAGE> 1
EXHIBIT 13
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
THANKS FOR HELPING US FULFILL OUR BILLION DOLLAR DREAM
Frontier Bank, which began as a dream for a group of successful and dedicated
business men and women of Snohomish County, has made history.
Our dream was to build a "high-touch" bank with one-on-one personal service,
where customers interact with caring, sensitive employees. Today we have reached
over one billion dollars in assets. Frontier Bank is the first financial
institution headquartered in Snohomish County to exceed $1 billion...and we
thank you for helping us get there!
Frontier Bank pledged to continue offering innovative products and value-added
service to our countless business clients and professionals, to our consumer
customers, our many loyal shareowners, and the dedicated group of senior clients
whom we serve. All of you are very important to us.
1
<PAGE> 2
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
% CHANGE
AT YEAR END 1998 1997 1996 1995 1994 1997-1998
---------- ---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Total assets $1,147,873 $ 973,052 $ 874,946 $ 796,730 $ 704,115 +18.0%
Net loans 880,044 721,122 643,644 539,517 506,528 +22.0%
Deposits 926,642 810,348 732,389 694,278 592,663 +14.4%
Long-term debt 0 695 1,059 1,394 1,823 -100.0%
Investment securities 145,601 115,999 132,340 146,645 137,995 +25.5%
Shareowner's equity 129,249 107,384 88,351 72,214 57,321 +20.4%
FOR THE YEAR
Interest income $ 93,562 $ 83,324 $ 73,971 $ 68,443 $ 58,302 +12.3%
Interest expense 37,890 34,369 32,062 31,091 22,383 +10.2%
Securities gains (losses) 0 0 0 (4) (355) nm
Provision for loan losses 1,800 2,095 2,133 1,621 3,996 -14.1%
Net income 21,649 18,594 16,012 13,837 11,620 +16.4%
Basic earnings per share $ 2.49 $ 2.15 $ 1.87 $ 1.62 $ 1.37 +15.8%
Fully diluted earnings per share $ 2.46 $ 2.14 $ 1.84 $ 1.59 $ 1.34 +15.0%
Return on Average
Assets 2.06% 2.03% 1.96% 1.84% 1.82%
Equity 18.27% 18.84% 20.15% 21.34% 22.26%
Ave. equity/avg. assets 11.30% 10.78% 9.71% 8.63% 8.18%
</TABLE>
2
<PAGE> 3
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
A REMARKABLE YEAR!
A REMARKABLE YEAR!
The twentieth anniversary year for Frontier Bank was truly remarkable. We
celebrated with record earnings, substantial growth in total assets, loans,
deposits, capital, and an expanded servicing area. Three major events occurred,
any one of which would have stood out in any prior year.
First, Frontier Financial Corporation stock began trading on April 16, 1998 on
the NASDAQ National Market under the symbol FTBK. Our goal was to (1) reduce
paperwork within the bank which was becoming excessive, due to our expanding
shareowner base; (2) obtain greater liquidity for our shareowners; and (3) to
create a currency for future acquisitions by having a stock whose value is
established in a public market.
The second major event was our merger with Valley Bancorporation and its
subsidiary, Bank of Sumner. The merger was completed on December 21, 1998 and
expands Frontier's servicing area into Pierce County with offices in Buckley,
Orting, Puyallup, and Sumner. It added approximately $100 million in assets plus
an experienced staff.
On October 13, 1998, total assets of Frontier Bank surpassed one billion dollars
for the first time. Thus, Frontier becomes the first bank headquartered in
Snohomish County to reach "a billion," our third achievement in 1998.
Earnings increased 16.4% in 1998 to $21.6 million, or $2.46 per fully diluted
share, up from $18.6 million, or $2.14 per fully diluted share in 1997. The
numbers were adjusted to reflect the 7% stock dividend paid in March, 1998. This
marks the 20th consecutive year of record earnings for Frontier, and the fourth
quarter of 1998 was the 60th consecutive quarter in which earnings exceeded the
same quarter of the prior year. I don't know of any other commercial bank I the
United States that can match our record for consecutive quarterly income gains
at this time.
Assets increased $175 million during the year to $1.15 billion or 18% while
deposits grew by $116 million to $927 million or 14.4%. Loans increased by $161
million to $898 million, and shareowners' equity increased from $107 million to
$129 million reflecting gains of 22% and 20%, respectively.
The investment portfolio totaled $146 million up from $116 million in 1997, a
gain of 26%. At year-end, the market value of our investment portfolio exceeded
our cost by over $2.6 million reflecting an unrealized gain.
The above numbers include Bank of Sumner's totals for both 1997 and 1998 to
comply with "pooling of interests" accounting requirements.
The corporation earned 2.06% on average assets (ROA) compared to 2.03% and
18.27% on average equity (ROE) compared to 18.84% in 1998 and 1997 respectively,
which places Frontier among the leaders when comparing peer group performance.
Some of the other achievements during 1998 include:
- - Completed another record year in the Trust Department where department assets
increased by 11% and earnings grew by 28% over 1997.
- - Expense management was solid, reflected by our efficiency ratio of 43.3%
- - Increased the number of ATM's from 8 to 15.
- - Continued to maintain a quality loan portfolio. During the year recoveries
from prior year losses exceeded 1998 loan losses by $500 thousand.
- - Paid a 7% stock dividend in March, 1998. This was our seventeenth stock
dividend paid to shareowners, and, in addition, we have had five stock splits.
As a results of stock splits and stock dividends, an original one share
investment, when Frontier Bank was opened in 1978, would have grown to 251
shares. In monetary terms, an original $1,000 investment in Frontier stock would
have a market value of almost $115,000 at year-ended 1998. While we have had
greater volatility in the stock price since we started public trading,
nonetheless, Frontier stock increased in value by 32.3% from January 1 to
December 31, 1998.
- - Both our Investment Center, which handles the sales of mutual funds and other
investments, and our Real Estate Mortgage Center had record performances.
1
<PAGE> 4
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
The Year 2000 problem, or Y2K, has been receiving increasing media coverage. Our
"Year 2000 Task Force" has been working diligently for almost two years to make
certain that all Frontier systems and all vendor systems are Year 2000
compliant. We have also been working closely with larger borrowing clients to
make certain that their systems will be compliant. Obviously, this is a big
challenge for every business. We believe that our early preparations and close
monitoring of all associated costs will enable our bank to be ready well ahead
of 2000, and without squandering valuable financial resources to get there. In
spite of the past year's success, our spirits were saddened by the loss of our
director, Ed Novack. Ed was very active in the initial organization of Frontier
Bank, and always displayed great pride in our achievements. He served as the
first Chairman of the Board of Directors. We will miss Ed's wisdom and good
counsel. Our deepest sympathy has been conveyed to his wife, Lorraine, and to
the Novack family.
Looking forward, we continue to recognize the challenges that face us. Rapidly
changing technology and keen competition keep us on our toes. Not only is the
competition from other banks, but specialized non-regulated national firms have
increased their presence and aggressively compete for business.
While we have been blessed with a strong local economy for several years, we do
expect some slowdown in the rate of growth in 1999. Nationally, we expect
continued strength in the economy marked by a low interest rates and low rate
of inflation.
As we look to the future, there is no shortage of opportunities for Frontier
Financial Corporation.
All it takes to succeed is the desire, commitment, and creativity to take
advantage of these opportunities, and we know Frontier staff members possess
these qualities in abundance. We are very proud of our company and are excited
about the future.
Again, thanks to our Board of Directors for their leadership during 1998, and to
our hard working staff for their commitment to serving our clients with skill
and dedication. We want to thank you, our fellow shareowners for your support,
and we want you to know that we are going to do everything we can to continue to
reward your commitment.
All of us working together as a team will move this organization to further
growth and success... "it's really the people who make the difference."
Sincerely,
/s/ Bob Dickson
Bob Dickson
President & CEO
2
<PAGE> 5
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; and
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, 1998, 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, 1998.
/s/ Robert J. Dickson /s/ James F. Felicetty
ROBERT J. DICKSON JAMES F. FELICETTY
President and Chief Executive Officer Secretary/Treasurer
-1-
<PAGE> 6
MOSS ADAMS LLP
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, 1998 and 1997, and the
related consolidated statements of income, changes in shareowner's equity, and
cash flows for each of the three years in the period ended December 31, 1998.
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, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Moss Adams LLP
MOSS ADAMS LLP
Everett, Washington
January 19, 1999
-2-
<PAGE> 7
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In Thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
ASSETS 1998 1997
----------- -----------
<S> <C> <C>
Cash and due from banks $ 44,233 $ 33,704
Federal funds sold 45,712 71,885
Investment securities
Available for sale, at fair value 112,707 83,019
Held to maturity (Fair value 1998: $34,517; 1997:$34,491) 32,894 32,980
----------- -----------
Total investment securities 145,601 115,999
Loans 898,142 736,946
Less allowance for loan losses (18,098) (15,824)
----------- -----------
Net loans 880,044 721,122
Premises and equipment, net 15,647 15,757
Other real estate owned 1,287 1,200
Other assets 15,349 13,385
----------- -----------
Total assets $ 1,147,873 $ 973,052
=========== ===========
LIABILITIES
Deposits
Noninterest bearing accounts $ 147,981 $ 119,808
Interest bearing accounts 778,661 690,540
----------- -----------
Total deposits 926,642 810,348
Federal funds purchased and securities sold under agreements to repurchase 31,858 17,962
Other liabilities 9,910 6,663
Federal Home Loan Bank advances 50,214 30,000
Long-term debt - 695
----------- -----------
Total liabilities 1,018,624 865,668
----------- -----------
SHAREOWNERS' EQUITY
Common stock, no par value; 50,000,000 shares authorized; 8,697,261 and
8,144,461 shares issued and outstanding in 1998 and 1997 90,547 72,354
Retained earnings 38,076 34,577
Accumulated comprehensive income, net of tax 626 453
----------- -----------
Total shareowners' equity 129,249 107,384
----------- -----------
Total liabilities and shareowners' equity $ 1,147,873 $ 973,052
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-3-
<PAGE> 8
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(In Thousands, except for per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 82,450 $ 72,898 $ 63,086
Interest on federal funds sold 3,417 2,515 1,676
Interest on investment securities
Taxable 6,092 6,222 7,435
Exempt from federal income tax 1,603 1,689 1,774
-------- -------- --------
Total interest income 93,562 83,324 73,971
-------- -------- --------
INTEREST EXPENSE
Interest on deposits 34,748 31,907 29,963
Interest on FHLB advances 1,946 1,632 1,470
Interest on federal funds purchased and securities
sold under agreements to repurchase 1,196 761 538
Interest on long-term debt - 69 91
-------- -------- --------
Total interest expense 37,890 34,369 32,062
Net interest income 55,672 48,955 41,909
PROVISION FOR LOAN LOSSES (1,800) (2,095) (2,133)
-------- -------- --------
Net interest income after provision for loan losses 53,872 46,860 39,776
-------- -------- --------
NON INTEREST INCOME
Service charges 1,999 1,956 1,846
Other 3,329 2,409 2,316
-------- -------- --------
Total other income 5,328 4,365 4,162
-------- -------- --------
NON INTEREST EXPENSE
Salaries 11,638 10,099 8,787
Employee benefits 4,253 4,113 3,601
Occupancy 3,307 3,253 2,738
FDIC insurance premium 100 86 2
State business taxes 1,147 945 872
Other 6,257 5,049 4,255
-------- -------- --------
Total other expense 26,702 23,545 20,255
-------- -------- --------
INCOME BEFORE INCOME TAX 32,498 27,680 23,683
PROVISION FOR INCOME TAX (10,849) (9,086) (7,671)
-------- -------- --------
NET INCOME $ 21,649 $ 18,594 $ 16,012
======== ======== ========
BASIC EARNINGS PER SHARE $ 2.49 $ 2.15 $ 1.87
======== ======== ========
DILUTED EARNINGS PER SHARE $ 2.46 $ 2.14 $ 1.84
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-4-
<PAGE> 9
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREOWNERS' EQUITY
(In Thousands, except number of shares)
<TABLE>
<CAPTION>
Accumulated
Common Stock Compre- Other
---------------------- hensive Retained Comprehensive
Shares Amount Income Earnings Income/(Loss) Total
---------- ---------- ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 7,116,155 $ 44,540 $ 26,741 $ 933 $ 72,214
Comprehensive Income
Net income for 1996 - - $ 16,012 16,012 - 16,012
Other comprehensive income, net of tax $433 - - - - -
Unrealized gain (loss) on available
for sale securities - - (804) - (804) (804)
----------
Total comprehensive income $ 15,208
==========
Ten-for-one stock split - 371 (371) - -
Stock options exercised 31,283 186 - - 186
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
Cash dividend declared by VBC - - (248) - (248)
---------- ---------- ---------- ----------- ----------
Balance, December 31, 1996 7,624,566 58,044 30,178 129 88,351
Comprehensive Income
Net income for 1997 - - $ 18,594 18,594 - 18,594
Other comprehensive income, net of tax $174 - - - - -
Unrealized gain (loss) on available
for sale securities - - 324 - 324 324
----------
Total comprehensive income $ 18,918
==========
Stock options exercised 40,548 365 - - 365
Stock dividend 478,475 13,920 (13,920) - -
Fractional shares purchased, (net) 872 25 - - 25
Cash dividend declared by VBC - - (275) - (275)
---------- ---------- ---------- ---------- ----------
Balance, December 31, 1997 8,144,461 72,354 34,577 453 107,384
Comprehensive Income
Net income for 1998 - - $ 21,649 21,649 - 21,649
Other comprehensive income, net of tax $93 - - - - -
Unrealized gain (loss) on available
for sale securities - - 173 - 173 173
----------
Total comprehensive income $ 21,822
==========
Stock options exercised 36,765 356 - - 356
Stock dividend 514,999 17,809 (17,809) - -
Fractional shares purchased, (net) 1,036 28 - - 28
Cash dividend declared by VBC - - (341) - (341)
---------- ---------- ---------- ---------- ----------
Balance, December 31, 1998 8,697,261 $ 90,547 $ 38,076 $ 626 $ 129,249
========== ========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-5-
<PAGE> 10
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 21,649 $ 18,594 $ 16,012
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 1,675 1,708 1,567
Provision for loan losses 1,800 2,095 2,133
Loss on sale of other real estate owned (230) - -
Deferred taxes (742) (727) (870)
Increase (decrease) in income taxes payable 1,088 (290) 2
Increase (decrease) in interest receivable (751) 267 (305)
Increase (decrease) in interest payable 394 (2,740) (580)
Proceeds from sales of mortgage loans 34,788 20,054 20,712
Origination of mortgage loans held for sale (36,180) (19,950) (20,884)
Dividend income from Federal Home Loan Bank (525) (685) (672)
Increase (decrease) in other operating activities (979) 438 (405)
--------- --------- ---------
Net cash provided by operating activities 21,987 18,764 16,710
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Net federal funds sold 26,173 (35,800) 31,380
Proceeds from maturities of available for sale
and held to maturity securities 86,225 49,564 42,700
Purchase of investment securities available for sale (87,406) (17,492) (11,013)
Purchase of investment securities held to maturity (27,146) (14,822) (16,750)
Net cash flows from loan activities (159,813) (79,843) (108,058)
Purchases of premises and equipment (1,394) (1,262) (1,404)
Proceeds from the sale of other real estate owned 1,537 261 349
Cash invested in other real estate owned - (755) (281)
Net cash provided from acquisition of branch - 13,136 -
Other investing activities - (181) (478)
--------- --------- ---------
Net cash used by investing activities (161,824) (87,194) (63,555)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in core deposit accounts 63,976 47,122 24,834
Net change in certificates of deposit 52,318 16,595 13,635
Net change in federal funds purchased and securities sold under
agreements to repurchase 13,896 5,951 (336)
Advances from the Federal Home Loan Bank 20,240 40,000 4,415
Repayments to the Federal Home Loan Bank (26) (45,000) 55,000
Principal payments on long-term debt (695) (364) (35,000)
Other financing activities 657 (209) (250)
--------- --------- ---------
Net cash provided by financing activities 150,366 64,095 62,298
--------- --------- ---------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 10,529 (4,335) 15,453
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 33,704 38,039 22,586
--------- --------- ---------
CASH AND DUE FROM BANKS AT END OF YEAR $ 44,233 $ 33,704 $ 38,039
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
Cash paid during the year for interest $ 37,504 $ 34,211 $ 32,258
Cash paid during the year for income taxes $ 9,650 $ 9,995 $ 8,595
SUPPLEMENTAL INFORMATION ABOUT NONCASH INVESTING AND FINANCING ACTIVITIES Other
real estate acquired in settlement of loans in 1998 was $1.7 million.
Sales of other real estate financed by the Bank in 1998 and 1996 were $1.4
million and $570 thousand, respectively.
</TABLE>
The accompanying notes are an integral part of these financial statements.
-6-
<PAGE> 11
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 in comprehensive income, 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, 1998 and 1997.
Declines in the fair value of individual held to maturity and available for sale
securities below their cost that are other than temporary are recognized by
write-downs of the individual securities to their fair value. Such write-downs
would be included in earnings as realized losses. Premiums and discounts are
recognized in interest income using the interest method over the period to
maturity.
(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.
-7-
<PAGE> 12
NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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 nonaccruing loans past due 90 days or
more, loans restructured in the current year, and other loans that management
considers to be 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.
-8-
<PAGE> 13
NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(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>
(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 1998, $1.3 million
in 1997, and $1.3 million in 1996. Contributions to the profit sharing plan are
discretionary while contributions to the money purchase pension plan are
currently 5% of employees eligible salaries. Both plans are funded during the
period in which they are committed by the Board of Directors.
(j) ADVERTISING COSTS - The Corporation 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
recorded in the financial statements when they are funded or related fees are
incurred or received.
(l) STOCK OPTION PLANS - The Corporation recognizes the financial effects of
stock options in accordance with Accounting Principles Board Opinion No. 25
Accounting for Stock Issued to Employees (APB 25). 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 options issued in this manner do not result in the recognition of
employee compensation in the Corporation's financial statements.
(m) EARNINGS PER SHARE - 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, stock splits and mergers accounted for as
poolings of interests. Diluted earnings per share are computed by determining
the number of additional shares that are deemed outstanding due to stock options
under the treasury stock method.
-9-
<PAGE> 14
NOTE ONE - BASIS OF PRESENTATION, NATURE OF OPERATIONS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(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.
(o) COMPREHENSIVE INCOME - On January 1, 1998 the Corporation adopted Statement
of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. The unrealized gain or loss on investments is the only
component of comprehensive income for the Corporation and is displayed in the
statement of changes in shareowners' equity, net of tax. All prior periods have
been restated to conform with the Statement.
(p) 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.
(q) RECLASSIFICATIONS - Certain amounts in prior years' financial statements
have been reclassified to conform to the 1998 presentation.
NOTE TWO - MERGER CONSUMMATED DURING 1998
In December 1998, Valley Bancorporation and Subsidiary (VBC) was merged into the
Corporation. In connection with this transaction, the Corporation issued 793,900
shares of common stock to the shareowners of VBC in an exchange that gave VBC
shareowners .8625 shares of the Corporation's stock for one share of VBC stock.
The merger has been accounted for as a pooling of interests as allowed by
generally accepted accounting principles. Accordingly, the Corporation's
consolidated financial statements have been restated for all periods prior to
the acquisition to include the financial position, results of operations, and
cash flow of VBC. At the date of acquisition, VBC had total assets of $95.8
million, revenue of $6.1 million, and net income of $2.1 million. The effects of
the restatement on revenues, net income and shareowner's equity are shown below:
<TABLE>
<CAPTION>
In Thousands 1997 1996
-------- --------
<S> <C> <C>
Revenues
The Corporation (as previously reported) $ 80,186 $ 71,708
VBC 7,503 6,425
-------- --------
As Restated $ 87,689 $ 78,133
======== ========
Net Income
The Corporation (as previously reported) $ 16,902 $ 14,617
VBC 1,692 1,395
-------- --------
As Restated $ 18,594 $ 16,012
======== ========
Shareowners' equity
The Corporation (as previously reported) $ 97,839 $ 80,317
VBC 9,545 8,034
-------- --------
As Restated $107,384 $ 88,351
======== ========
</TABLE>
-10-
<PAGE> 15
NOTE THREE - 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>
In Thousands
Gross Gross
1998 Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Available for sale
U.S. Treasury bonds $ 252 $ 50 - $ 302
U.S. Agency bonds 74,516 132 $(290) 74,358
Corporate bonds 25,054 896 (6) 25,944
Equities 11,923 180 - 12,103
--------- --------- ----- ---------
111,745 1,258 (296) 112,707
--------- --------- ----- ---------
Held to maturity
Municipal securities 28,144 1,623 - 29,767
Certificates of deposit 4,750 - - 4,750
--------- --------- ----- ---------
32,894 1,623 - 34,517
--------- --------- ----- ---------
Total Securities $ 144,639 $ 2,881 $(296) $ 147,224
========= ========= ===== =========
</TABLE>
<TABLE>
<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
U.S. Agency 549 - - 549
Municipal securities 28,881 1,513 (2) 30,392
Certificates of deposit 3,550 - - 3,550
-------- -------- ------ --------
32,980 1,513 (2) 34,491
-------- -------- ------ --------
Total Securities $115,302 $ 2,313 $(105) $117,510
======== ======== ====== ========
</TABLE>
-11-
<PAGE> 16
NOTE THREE - INVESTMENTS (CONTINUED)
Contractual maturities of investment securities as of December 31, 1998 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 $ 15,353 $ 15,581 $ 5,100 $ 5,103
One to five years 23,222 23,922 3,919 4,156
Five to ten years 68,723 68,719 23,438 24,798
Over ten years 4,447 4,485 437 460
-------- -------- -------- --------
$111,745 $112,707 $ 32,894 $ 34,517
======== ======== ======== ========
</TABLE>
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 52% and 51% of the investments in corporate bonds
at December 31, 1998 and 1997, respectively, consisted of investments in
companies doing business in the financial services sector. Approximately 25% and
26% of the investments in corporate bonds at December 31, 1998 and 1997,
respectively, consisted of investments in companies doing business in the
industrial sector.
Investment securities, with a book value of $49.4 million and $31.2 million with
fair values of $49.4 million and $31.2 million in 1998 and 1997, respectively,
were pledged to secure public deposits and securities sold under agreements to
repurchase as required by law.
NOTE FOUR - LOANS
The Bank originates commercial, real estate mortgage, construction and land
development, and installment loans primarily in Snohomish, Skagit, King and
Pierce 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 1998 1997
--------- ---------
<S> <C> <C>
Commercial $ 207,887 $ 158,394
Real estate commercial 383,840 295,297
Real estate construction 176,036 152,770
Real estate mortgage 103,998 107,024
Installment 32,106 28,348
--------- ---------
903,867 741,833
Less deferred loan fees (5,725) (4,887)
--------- ---------
$ 898,142 $ 736,946
========= =========
</TABLE>
-12-
<PAGE> 17
NOTE FOUR - Loans (continued )
Contractual maturities of loans as of December 31, 1998 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 $121,013 $ 75,605 $ 10,741 $207,359
Real estate commercial 48,685 262,850 70,691 382,226
Real estate construction 125,017 42,169 6,039 173,225
Real estate mortgage 31,133 62,607 9,476 103,216
Installment 8,634 13,566 9,916 32,116
-------- -------- -------- --------
$334,482 $456,797 $106,863 $898,142
======== ======== ======== ========
Loans maturing after 1-5 After
one year with: Years 5 Years
-------- --------
Fixed rates $403,992 $ 75,837
Variable rates 52,805 31,026
-------- --------
$456,797 $106,863
======== ========
</TABLE>
LOAN LOSS RESERVE
Changes in the allowance for loan losses are summarized below:
<TABLE>
<CAPTION>
In Thousands 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Balance at beginning of year $ 15,824 $ 14,033 $ 12,601
Provision charged to operating expense 1,800 2,095 2,133
Deduct
Loans charged-off (1,283) (1,798) (2,041)
Less recoveries 1,757 1,494 1,340
-------- -------- --------
Net recoveries (charge-offs) 474 (304) (701)
-------- -------- --------
Balance at year-end $ 18,098 $ 15,824 $ 14,033
======== ======== ========
</TABLE>
The Bank had loans amounting to $972 thousand at December 31, 1998 and $4.4
million at December 31, 1997 that were specifically classified as impaired with
an average balance of $1.1 million and $4.2 million, respectively. The allowance
for loan losses related to these loans was approximately $46 thousand in 1998
and $1.1 million in 1997. Interest collected on these loans in cash and included
in income amounted to $41 thousand in 1998 and $384 thousand in 1997. If
interest on these loans had been accrued, such income would have approximated
$42 thousand in 1998 and $289 thousand in 1997. At December 31, 1998 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.
-13-
<PAGE> 18
NOTE FOUR - 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 FIVE - Premises And Equipment
Premises and equipment at December 31 are comprised of the following:
<TABLE>
<CAPTION>
In Thousands 1998 1997
-------- --------
<S> <C> <C>
Premises $ 12,679 $ 11,956
Furniture, fixtures and equipment 7,445 6,816
Land 5,160 5,160
Construction in progress 98 66
-------- --------
25,382 23,998
Less accumulated depreciation (9,735) (8,241)
-------- --------
$ 15,647 $ 15,757
======== ========
</TABLE>
Depreciation expense on premises and equipment totaled $1.3 million in 1998,
$1.4 million in 1997, and $1.1 million in 1996.
NOTE SIX - Interest Bearing Deposits
The major classifications of interest bearing deposits at December 31 are as
follows:
<TABLE>
<CAPTION>
In Thousands 1998 1997
-------- --------
<S> <C> <C>
Money market and NOW accounts $137,000 $119,780
Savings 184,226 165,643
Time deposits, $100,000 and over 164,829 118,309
Other time deposits 292,606 286,808
-------- --------
$778,661 $690,540
======== ========
</TABLE>
The total remaining maturity schedule for time deposits is as follows:
<TABLE>
<CAPTION>
In Thousands
<S> <C> <C>
Year ending December 31, 1999 $382,840
2000 35,598
2001 17,433
2002 6,772
2003 13,074
Thereafter 1,718
--------
$457,435
========
</TABLE>
-14-
<PAGE> 19
NOTE SEVEN - 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. At
December 31, 1998, committed lines of credit agreements totaling approximately
$31 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, 1998 and 1997.
In addition, at December 31, 1998 the Bank has a committed line of credit up to
$900 thousand 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, 1998
and 1997.
NOTE EIGHT - Federal Home Loan Bank (FHLB) Advances
At December 31, 1998, FHLB advances were scheduled to mature as follows:
<TABLE>
<CAPTION>
Interest
In Thousands Amount Rates
- ------------ ------- -----------
<S> <C> <C>
Within one year $ 5,000 5.4%
Two to three years 5,028 5.80%-7.08%
Four to nine years 25,090(1) 4.34%-7.32%
Ten to fifteen years 15,096(2) 4.13%-5.67%
-------
$50,214
=======
</TABLE>
- ------------
(1) $25 million of this advance may be put by the FHLB quarterly.
(2) $10 million of this advance may be put by the FHLB quarterly.
Advances from 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 1998 1997
------------ ---- ----
<S> <C> <C>
Maximum outstanding at any month-end $50,214 $30,000
Average outstanding 35,274 30,274
Weighted average interest rates:
Annual 5.51% 5 .39%
End of year 5.24% 5 .46%
</TABLE>
NOTE NINE - 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 by the
Bank.
Securities sold under agreement to repurchase were $26.3 million in 1998 and
$13.2 million in 1997. The average daily balance of outstanding agreements
during the period was $18 million in 1998 and $11 million 1997, with maximum
outstanding agreements at any month-end of $26.3 million and $16.4 million,
respectively.
-15-
<PAGE> 20
NOTE TEN - Long-Term Debt
At December 31, long-term debt was as follows:
<TABLE>
<CAPTION>
In Thousands 1998 1997
- ------------ -------- ------
<S> <C> <C>
Installment note, due in monthly principal payments of $3,378, including
interest at rates varying between 5.67% and 7.32%. Collateralized by
a blanket pledge agreement - $240
Installment note, due in monthly payments of $27,821, including interest
at 7% per annum. Collateralized by shares of common stock - 399
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
----- ----
- $695
===== ====
</TABLE>
NOTE ELEVEN - Income Tax
The components of the provision for income tax are as follows:
<TABLE>
<CAPTION>
In Thousands 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Current $ 11,591 $ 9,813 $ 8,541
Deferred (742) (727) (870)
-------- -------- --------
$ 10,849 $ 9,086 $ 7,671
======== ======== ========
</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 1998 1997
------- -------
<S> <C> <C>
Deferred tax assets
Allowance for possible loan losses,
in excess of tax reserves $ 6,334 $ 5,483
Other deferred tax assets 1,195 1,372
------- -------
Total deferred tax assets 7,529 6,855
------- -------
Deferred tax liabilities
Other deferred tax liabilities (1,488) (1,556)
------- -------
Total deferred tax liabilities (1,488) (1,556)
------- -------
Net deferred tax assets $ 6,041 $ 5,299
======= =======
</TABLE>
-16-
<PAGE> 21
NOTE ELEVEN - 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 1998 1997 1996
--------------------------- --------------------------- -------------------------
Amount Rate Amount Rate Amount Rate
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Income tax provision
at statutory rate $ 11,374 35% $ 9,688 35% $ 8,289 35%
Effect of nontaxable
interest income (486) -2% (613) -2% (620) -3%
Other (39) - 11 - 2 -
-------- -------- -------- -------- -------- --------
$ 10,849 34% $ 9,086 33% $ 7,671 32%
======== ======== ======== ======== ======== ========
</TABLE>
NOTE TWELVE - Shareowners' Equity And Regulatory Matters
The Corporation is authorized to issue up to 10 million shares of preferred
stock with no par value. The Board of Directors have the authority to determine
the rights and privileges to be granted to holders of the stock.
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, surplus, retained earnings and undivided
profits less goodwill. Total capital includes Tier I capital and the loan loss
reserve. Tier I capital to average assets is referred to as the average ratio.
Management believes, as of December 31, 1998 and 1997 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.
-17-
<PAGE> 22
NOTE TWELVE - Shareowners' Equity And Regulatory Matters (continued )
<TABLE>
<CAPTION>
In Thousands To Be Well
Capitalized Under
Prompt Corrective For Capital
Actual Action Provisions Adequacy Purposes
----------------------- ------------------------- -------------------------
1998 Amount Ratio Amount Ratio Amount Ratio
- ---- -------- ----- --------- ------ -------- -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital (to risk
weighted assets)
Consolidated $139,469 14.42% $ 96,695 10.00% $ 77,356 8.00%
Frontier Bank 134,168 13.92% 96,635 10.00% 38,678 8.00%
Tier I Capital (to risk
weighted assets)
Consolidated 127,227 13.16% 58,017 6.00% 38,678 4.00%
Frontier Bank 122,065 12.67% 57,811 6.00% 38,541 4.00%
Tier I Capital (to
average assets)
Consolidated 127,227 12.11% 52,423 5.00% 41,938 4.00%
Frontier Bank 122,065 11.64% 52,504 5.00% 42,003 4.00%
1997
1997
- ----
Total Capital (to risk
weighted assets)
Consolidated $115,300 14.68% $ 78,535 10.00% $ 62,828 8.00%
Frontier Bank 111,115 14.19% 78,315 10.00% 62,652 8.00%
Tier I Capital (to risk
weighted assets)
Consolidated 105,409 13.46% 47,121 6.00% 31,414 4.00%
Frontier Bank 101,252 12.93% 46,989 6.00% 31,326 4.00%
Tier I Capital (to
average assets)
Consolidated 105,409 9.23% 45,956 5.00% 36,605 4.00%
Frontier Bank 101,252 9.09% 47,752 5.00% 38,202 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 $4.2 million and $3.4 million at
December 31, 1998 and 1997, respectively).
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 $10.7 million in 1998 and $7.9 million in 1997.
-18-
<PAGE> 23
NOTE THIRTEEN - 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 1998 and 1997, the risk-free interest rate is 4.70% and 5.67%, the
dividend yield rate is not meaningful; the price volatility is 54.73% and
15.59%; 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:
In Thousands, except for per share amounts
<TABLE>
<CAPTION>
Proforma disclosures 1998 1997 1996
-------- -------- ----------
<S> <C> <C> <C>
Net income as reported $ 21,649 $ 18,594 $ 16,012
Additional compensation for
fair value of stock options 378 465 140
-------- -------- ----------
Proforma net income $ 21,271 $ 18,129 $ 15,872
======== ======== ==========
Earnings per share
Basic
As reported $ 2.49 $ 2.15 $ 1.87
======== ======== ==========
Proforma $ 2.45 $ 2.10 $ 1.85
======== ======== ==========
Diluted
As reported $ 2.46 $ 2.14 $ 1.84
======== ======== ==========
Proforma $ 2.42 $ 2.09 $ 1.83
======== ======== ==========
</TABLE>
-19-
<PAGE> 24
NOTE THIRTEEN - 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>
Balance, December 31, 1995 77,543 206,200 $10.84
Authorized - - -
Granted (12,624) 12,624 31.00
7% stock dividend (2,083) 10,687 -
Exercised - (31,283) 5.11
Forfeited 810 (810) N/M
------- ------- ------
Balance, December 31, 1996 63,646 197,418 12.92
Authorized - - -
Granted (18,748) 18,748 28.55
7% stock dividend (3,767) 10,093 -
Exercised - (40,548) 6.66
Forfeited 174 (174) N/M
------- ------- ------
Balance, December 31, 1997 41,305 185,537 16.38
Authorized 434,950 -
Granted (13,836) 13,836 46.00
7% stock dividend 4 5,323
Exercised - (36,765) 9.70
Forfeited 254 (254) N/M
------- ------- ------
Balance, December 31, 1998 462,677 167,677 $17.00
======= ======= ======
</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 89,531 1.31 $ 7.86 89,531 $ 7.86
10-20 25,875 3.83 15.75 25,875 15.75
20-30 24,461 5.25 25.38 24,461 25.38
30-40 13,974 6.30 34.58 13,974 34.58
40-50 13,836 7.00 46.00
</TABLE>
-20-
<PAGE> 25
NOTE FOURTEEN - Earnings Per Share
The numerators and denominators of basic and fully diluted earnings per share
are as follows:
In Thousands, except for per share amounts
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net income (numerator) $ 21,649 $ 18,594 $ 16,012
========== ========== ==========
Shares used in the calculation
(denominator)
Weighted average shares outstanding 8,678,033 8,633,763 8,580,195
Effect of dilutive stock options 107,555 56,852 81,005
--------- --------- ---------
Fully diluted shares 8,785,588 8,690,615 8,661,200
========= ========= =========
Basic Earnings per share $ 2.49 $ 2.15 $ 1.87
========== ========== ==========
Fully Diluted Earnings per share $ 2.46 $ 2.14 $ 1.84
========== ========== ==========
</TABLE>
NOTE FIFTEEN - Related Party Transactions
Loans to directors, executive officers and their affiliates are subject to
regulatory limitations. Such loans had aggregate balances and activity during
1998, 1997 and 1996 as follows and were within regulatory limitations:
<TABLE>
<CAPTION>
In Thousands 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Balance at beginning of year $ 21,960 $ 7,028 $ 9,475
New loans or advances 8,630 22,219 3,808
Repayments (8,471) (7,287) (6,255)
-------- -------- --------
Balance at end of year $ 22,119 $ 21,960 $ 7,028
======== ======== ========
</TABLE>
NOTE SIXTEEN - Commitments and Contingent Liabilities
The Bank leases various branch offices under agreements which expire between
1999 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:
In Thousands
<TABLE>
<S> <C>
Year ending December 31, 1999 $ 332
2000 302
2001 244
2002 235
2003 235
Thereafter 2,535
------
$3,883
======
</TABLE>
-21-
<PAGE> 26
Rental expense charged to operations was $1.4 million in 1998, $453 thousand in
1997 and $410 thousand in 1996.
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 1998 or 1997.
A summary of the notional amount of the Bank's financial instruments with
off-balance sheet risk at December 31, 1998 follows:
<TABLE>
<CAPTION>
Amount
--------
<S> <C>
Commitments to extend credit $190,124
Credit card arrangements 10,423
Commercial letters of credit 156
Standby letters of credit 3,024
</TABLE>
NOTE SEVENTEEN - 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
instruments for which it is practicable to estimate that value:
-22-
<PAGE> 27
NOTE SEVENTEEN - Fair Value of Financial Instruments (continued)
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
(a) CASH EQUIVALENTS AND FEDERAL FUNDS SOLD - For these 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.
(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, SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 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 (see Note 16). 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 1998 1997
------------------------- --------------------------
Carrying Fair Carrying Fair
Assets Value Value Value Value
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Cash and due from banks $ 44,233 $ 44,233 $ 33,704 $ 33,704
Investment securities
Available for sale 112,707 112,707 83,019 83,019
Held to maturity 32,894 34,517 32,980 34,491
Federal funds sold 45,712 45,712 71,885 71,885
Net loans 880,044 898,441 721,122 729,390
Liabilities
Noninterest bearing deposits 147,981 147,981 119,808 119,808
Interest bearing deposits 778,661 782,017 690,540 691,805
Federal funds purchased
and securities sold under
agreements to repurchase 31,858 31,858 17,962 17,962
FHLB Advances 50,214 49,641 30,000 30,173
Long-term debt - - 695 695
</TABLE>
-23-
<PAGE> 28
NOTE EIGHTEEN - Parent Company (Only) Financial Information
Condensed balance sheets at December 31:
<TABLE>
<CAPTION>
In Thousands 1998 1997
-------- --------
<S> <C> <C>
ASSETS
Cash $ 121 $ 354
Investment in subsidiaries:
Bank 123,714 103,637
Nonbank 2,499 2,418
Investment in Washington Banking Company 1,929 971
Other assets 1,177 480
-------- --------
$129,440 $107,860
======== ========
LIABILITIES
Other liabilities $ 191 $ 476
-------- --------
SHAREOWNERS' EQUITY
Common stock 90,547 72,353
Retained earnings 38,586 35,031
Accumulated comprehensive income, net of tax 116 -
-------- --------
Total Shareowners' equity 129,249 107,384
-------- --------
$129,440 $107,860
======== ========
</TABLE>
Condensed statements of income for the years ended December 31:
<TABLE>
<CAPTION>
In Thousands 1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Income
Dividend from Bank $ 2,173 $ 765 $ 691
Other dividends 21 19 18
Rental - - 1
Interest 3 5 4
------- ------- -------
Total income 2,197 789 714
------- ------- -------
Expenses
Interest 1 42 58
Personnel 241 268 124
Depreciation and amortization 64 77 77
Other 1,031 269 209
------- ------- -------
Total expenses 1,337 656 468
------- ------- -------
Income before equity in undistributed income
of subsidiaries and benefit equivalent to
income taxes 860 133 246
Benefit equivalent to income taxes 438 194 123
------- ------- -------
Income before equity in undistributed income
of subsidiaries 1,298 327 369
Equity in undistributed
income of subsidiaries 20,351 18,267 15,643
------- ------- -------
Net income $21,649 $18,594 $16,012
======= ======= =======
</TABLE>
-24-
<PAGE> 29
NOTE EIGHTEEN - Parent Company (Only) Financial Information (continued)
Condensed statements of cash flows for the years ended December 31:
<TABLE>
<CAPTION>
In Thousands 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 21,649 $ 18,594 $ 16,012
Adjustments to reconcile net income to net cash
provided by operating activities
Equity in undistributed income of subsidiaries (22,524) (19,032) (16,334)
Depreciation and amortization 63 77 77
Other operating activities (617) (99) (46)
-------- -------- --------
Net cash flows from operating activities (1,429) (460) (291)
-------- -------- --------
Cash flows from investing activities
Dividends received 2,173 765 691
Purchase of available for sale securities (779)
-------- -------- --------
Net cash flows from investing activities 1,394 765 691
-------- -------- --------
Cash flows from financing activities
Sales of common stock 384 390 206
Principal payments of long-term debt (283) (294) (274)
Other financing activities (299) (274) (249)
-------- -------- --------
Net cash flows from financing activities (198) (178) (317)
-------- -------- --------
Increase (decrease) in cash (233) 127 83
Cash at beginning of year 354 227 144
-------- -------- --------
Cash at end of year $ 121 $ 354 $ 227
======== ======== ========
</TABLE>
NOTE NINETEEN - New Accounting Pronouncements
The Financial Accounting Board issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities . This Statement establishes accounting and
reporting standards for derivative financial instruments and for hedging
activities. Upon adoption of the Statement, all derivatives must be recognized
at fair value as with assets of liabilities in the statement of financial
position. Changes in the fair value of the derivatives not designated as hedging
instruments are to be recognized currently in earnings or are to be recognized
as a component of other comprehensive income, depending on the intended use of
the derivatives and the resulting designations. Upon adoption, retroactive
application of this Statement to financial statements in prior periods is not
permitted. The standard becomes effective January 1, 2000 for the Corporation,
and is not anticipated to have a material effect on its financial position or
results of operation. The Corporation does not use interest rate risk management
products such as interest rate swaps, hedges, or derivatives, nor does
management intend to use such products in the future.
The Financial Accounting Standards Board also issued SFAS No. 134 , Accounting
for Mortgage-Backed Securities Retained After Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise in October of 1998. The Statement
establishes accounting and reporting standards for certain activities of
mortgage banking enterprises. SFAS No. 134 becomes effective for fiscal quarters
beginning after December 15, 1998. Management believes that adoption of this
standard will not have a material impact on its reported financial condition or
results of operation.
-25-
<PAGE> 30
NOTE TWENTY - Unaudited Quarterly Financial Data - Condensed Consolidated
Statement of Income
<TABLE>
<CAPTION>
1998 Quarter Ended
In Thousands (Unaudited)
- ------------ ---------------------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ ------- --------
<S> <C> <C> <C> <C>
Interest income $ 24,874 $ 23,809 $ 22,766 $ 22,113
Interest expense 9,920 9,672 9,207 9,091
-------- -------- -------- --------
Net interest income 14,954 14,137 13,559 13,022
Provision for loan losses (875) (425) (175) (325)
-------- -------- -------- --------
Net interest income after provision
for loan losses 14,079 13,712 13,384 12,697
Non interest income 1,604 1,209 1,365 1,150
Non interest expense 7,611 6,278 6,833 5,980
-------- -------- -------- --------
Income before income tax 8,072 8,643 7,916 7,867
Provision for federal income tax (2,375) (3,109) (2,579) (2,786)
-------- -------- -------- --------
Net Income $ 5,697 $ 5,534 $ 5,337 $ 5,081
======== ======== ======== ========
Basic earnings per common share $ 0.66 $ 0.64 $ 0.62 $ 0.59
Diluted earnings per common share $ 0.65 $ 0.63 $ 0.61 $ 0.58
Average basic shares outstanding 8,678 8,675 8,672 8,667
Average diluted shares outstanding 8,786 8,799 8,788 8,775
</TABLE>
<TABLE>
<CAPTION>
1997 Quarter Ended
In Thousands (Unaudited)
- ------------ ---------------------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ -------- --------
<S> <C> <C> <C> <C>
Interest income $ 22,052 $ 21,369 $ 20,458 $ 19,445
Interest expense 8,981 8,713 8,380 8,295
-------- -------- -------- --------
Net interest income 13,071 12,656 12,078 11,150
Provision for loan losses (1,215) (410) (310) (160)
-------- -------- -------- --------
Net interest income after provision
for loan losses 11,856 12,246 11,768 10,990
Non interest income 1,099 1,093 1,281 892
Non interest expense 6,957 5,467 6,079 5,042
-------- -------- -------- --------
Income before income taxe 5,998 7,872 6,970 6,840
Provision for federal income tax (1,689) (2,708) (2,347) (2,342)
-------- -------- -------- --------
Net Income $ 4,309 $ 5,164 $ 4,623 $ 4,498
======== ======== ======== ========
Basic earnings per common share $ 0.50 $ 0.60 $ 0.54 $ 0.52
Diluted earnings per common share $ 0.50 $ 0.59 $ 0.53 $ 0.51
Average basic shares outstanding 8,634 8,629 8,624 8,621
Average diluted shares outstanding 8,691 8,734 8,735 8,736
</TABLE>
-26-
<PAGE> 31
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
OVERVIEW OF REPORTED RESULTS
The Corporation again completed the most profitable year since opening, and the
twentieth consecutive year of increased net income. Net income for 1998 was
$21.6 million, up $3.1 million or 16.4%. Net income for 1997 was $18.6 million,
up 16.1% from 1996 and net income in 1996 was $16.0 million, or up 14.3% as
compared to 1995. Highlights of 1998 include a 13.7% growth in net interest
income, excellent expense control, outstanding asset quality, and a strong
allowance for credit losses. Capital increased 20.4% and diluted earnings per
share increased from $2.14 to $2.46. Earnings per share have been adjusted to
reflect the 7% stock dividend paid in 1998.
Return on average assets (ROA) was 2.06% in 1998; 2.03% for 1997; and 1.96% for
1996. Return on average equity (ROE) for 1998 was 18.27%; 1997 was 18.84%; and
20.15% for 1996.
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; Skagit County by having a branch located in Burlington; and
Pierce county, by having branches located in Sumner, Orting, Puyallup and
Buckley. The major city in Snohomish County is Everett; the major city in King
County is Seattle, the largest city in the state; and the largest city in Pierce
County is Tacoma. These four counties would be considered the market or service
area of the Corporation. The information below regarding the Washington State
and local economy was written by Mr. Michael Cade, Vice President, Snohomish
County Economic Council.
1998 REVIEW OF SNOHOMISH COUNTY
Within the Seattle/Bellevue/Everett PMSA, the labor market maintained excellent
strength. Payrolls of area employers increased the number of wages and salary
jobs in the PMSA at an annual growth rate of 3.3% above the prior year's levels.
Business and government in King, Snohomish and Island counties have created over
43,000 jobs. Strictly within Snohomish County, job growth in the public and
private sectors combined registered 2.5% over the year. By comparison,
employment in Snohomish County rose 7.1% averaged throughout 1997. The margin of
over the year job gains has slipped steadily throughout 1998. In Washington
State, 1998 was closing with a seasonally adjusted unemployment rate of 4 .8%
with a resident civilian labor force of 3,100,100. Statewide, manufacturing
employment payrolls fell somewhat during the last quarter of 1998. (Several
issues outside of the Everett, Snohomish County region had a large impact upon
the statewide figures. These including the Kaiser Aluminum labor-management
disputes that has disrupted production at plans in Tacoma and Spokane.)
Additionally, a declining work force in computer and office equipment and
aircraft and parts continued to tug away at the year-to-year spread.
Meanwhile statewide, construction and services continue bolstering the economy.
Over the year job growth in the services producing industries registered in the
3.7% range in October--up from 3.1% a year ago. Construction came in at 4.5%;
wholesale and retail trade at 3.9%; and services at 5.3%. The most spectacular
run-up over the past 12 months has been centered in business
services--specifically temporary help agencies (up 13%) and computer data
processing and software (up 20%). These two sectors, more than any other has
consistently led the economy throughout the lengthy business up-cycle and both
are expected to continue strong into the new year.
-27-
<PAGE> 32
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
1999 PREVIEW OF SNOHOMISH COUNTY
The following section is intended to address the significance of technology
based industries in the Snohomish County economy. What is most important in any
discussion of the future performance of the local economy is whether or not the
recent announcements by the Boeing Company to reduce payroll or employee counts
in western Washington will have any major impacts on the economy's overall
performance. What the following stresses is that while Boeing still is the "800
pound gorilla" the remainder of the economy, and in particular Snohomish County,
is no longer the "80 pound weakling." Recently, Washington CEO magazine
published an article regarding the changing economy of the Puget Sound basin.
From the article, they quoted several expert opinions regarding the trends and
the changing dynamics of our area. Ms. Roberta Pauer is the Regional Analyst for
the Research Branch of the Washington State Employment Security and is easily
recognized as the expert on economic trends for labor and market in Snohomish
County. In the article Ms. Pauer addresses the differences between Snohomish
County in latter part of the 90's and the middle to early 80's. A very telling
quote from her reads in part:
The Snohomish County economy is so extremely strong in a fundamental
structural sense. Snohomish County never was a slouch county, but is
much stronger now. That bodes so well for the coming decades. Snohomish
County is economically quite a bit different in this last part of the
90's than it ever has been.
The current 1998 population estimate for Snohomish County is 568,100. The year
2012 forecasted population for the County is 714,244, an increase of 146,144.
The City of Everett has a 1998 estimated population of 84,240; the forecasted
2012 population is 96,000 (an increase of 11,750). The southwest Snohomish
County planning areas have a combined 1998 estimated population of 350,110. The
year 2012 forecasted population for the southwest Snohomish County area is
443,740 (an increase of 93,630). This 26% projected countywide growth represents
a fairly significant residential growth for the community of Everett and for all
of Snohomish County.
PIERCE COUNTY
The following economic data was provided by the Tacoma-Pierce County Chamber of
Commerce:
Five years after it started in 1992, Pierce County economy continued its growth
through the first half of 1998. The local economy has grown at an average rate
of just under 2.5% which is .5% above the long-term historical growth rate. The
outlook is for some cooling off and slower growth through 1999.
After a combination of running at or near capacity for two years, and
deteriorating external forces, the local economy is expected to experience a
mild recession of short duration in the second quarter of 1999. While mild by
historical standards, the two consecutive quarters of decline does represent a
local recession. The beginnings of a recovery is expected in the forth quarter
of 1999.
However, a mild recession hitting a strong economy may not be very perceptible.
National and international events are primarily responsible for the change in
the Pierce County economy. Local conditions will keep the downturn from becoming
more sever.
Most of the new jobs and employment opportunities will come from small to medium
sized manufacturing plants or from the service sector located in the metro areas
of Pierce County. The dollar volume of retail sales was expected to grow by 7.5%
in 1998. Each quarter in 1999 will have dollar sales activity expected to exceed
the 1998 level. 1999 may see a record $4.1 billion in total retail sales.
-28-
<PAGE> 33
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
The pace of sales activity for single-family housing is expected to moderate,
but remain strong, into the first half of 1999. However, the fourth quarter of
1999 is expected to decline a moderate 1% from the same time in 1998.
The growth of real personal income is expected to be 2.7% in 1998, and it is
expected to slow further in 1999. When inflation is included, nominal income
growth will be 4-5%. By the end of 1999, per capita income is expected to reach
a record high of $20,440, measure in 1992 constant dollars.
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, along with business
and competitive factors.
Based on the balances at year-end 1998, assets increased $174.8 million, or
18.0%; increased $98.1 million or 11.2% in 1997; and increased $78.2 million, or
8.9% in 1996. Average earning assets as a percent of total average assets (see
page 42), were $994.7 million or 94.9% in 1998; 95.1% or $870.7 million in 1997;
and 95.5%, or $781.5 million in 1996. Local economic conditions and the merger
with Valley Bancorporation was the largest factor contributing to the growth in
earning assets from 1994 through 1997.
Total loans increased $161.2 million, or 21.9% in 1998; $79.3 million, or 12.1%
in 1997; and $105.6 million or 19.1% in 1996. In 1998 the investment portfolio
increased $29.1 million or 25%, reversing the trend over the last five years.
This was due mainly to management taking advantage of the medium-term,
short-call yields available in 1998. Most of the securities purchased during
this time had three to six month call dates with yields to the call in excess of
6.00%. In 1997, the investment portfolio decreased $16.1 million, or 12.2%. In
1996 decreased $14.3 million or 9.8%. The reason for the decline in 1997 was to
shift funds from maturing investments into the loan portfolio. In 1998 federal
funds sold decreased $26.2 million or 36.4% due to the substantial increase in
the loan portfolio for the year, and increase in the investment portfolio
activity. In 1997, federal funds sold had increased $38.8 million or 117.2% 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 that period.
The primary source of funds for earning assets are deposits and borrowings.
Total deposits were up $116.3 million, or 14.4% in 1998; $78.0 million, or 10.6%
in 1997; and up $38.1 million, or 5.5% in 1996. At periods ended December 31,
1998, Money Market and NOW accounts were up $17.2 million, or 14.4% in 1998; up
$24.8 million, or 26.1% in 1997; and up $14.5 million, or 18% in 1996. Savings
deposits were up $18.6 million, or 11.2% in 1998; up $8.1 million, or 5.1% in
1997; and up $4.9 million, or 3.2% in 1996. The category which had the largest
deposit increase for 1998 and 1996 was time deposits, which increased $52.3
million in 1998 or 12.9%; increased $19.5 million, or 5.1% in 1997; and $18.9
million or 5.2% in 1996. 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.
-29-
<PAGE> 34
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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 do reflect the level of interest rates as set by the Federal Reserve
Board, but more so the competitive nature of the financial services industry.
For the year 1998, the average yield on earning assets decreased 18 basis
points, and the average cost of interest bearing liabilities decreased 10 basis
points, for a net decrease in the spread of minus 8 basis points. For the year
1997, the average yield on earning assets increased 8 basis points and the
average cost of interest bearing liabilities decreased 10 basis points, for a
net increase in the spread of 18 basis points. For the year 1996, the average
yield on earning assets dropped 11 basis points and the average cost of interest
bearing liabilities dropped 20 basis points. In 1998, management expected a
decrease in the spread due to the prime rate decreases during the year and
increased rate competition from regulated and non-regulated lenders. The major
decrease in earning assets came from the loan portfolio which declined from a
yield of 10.37% in 1997 to a 10.17% yield in 1998. On the deposit side, time
deposits led the way decreasing from a 5.80% yield in 1997, to a 5.72% yield in
1998. In 1997, increased yield on assets was due to an increase in the yield of
the investment portfolio of 10 basis points, increasing from 7.17% in 1996 to
7.27% in 1997. Additionally, the yield on federal funds sold increased from
5.38% to 5.48%, 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 4.99% to 4.89% (refer to page 42 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 5.69% in
1998, 5.73% in 1997 and 5.49% in 1996. (See "Liquidity and Interest Sensitivity"
in this section.) As noted on page 43 of this report, it was the growth, or
volume, which contributed 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.
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 $56.6 million in 1998 an
increase of $6.7 million, or 13.3% from 1997. In 1997 net interest income
totaled $49.9 million, and increase of $7.0 million, or 16.3% over 1996. In 1996
net interest income totaled $42.9 million, an increase of $4.5 million, or 11.7%
over 1995. Table 2 indicates that of the $6.7 million increase in net interest
income in 1998; there was an increase in interest income of $10.2 million and an
increase in interest expense of $3.5 million which leaves a net increase in net
interest income of $6.7 million. In 1997 there was a $7.0 million increase in
net interest income. There was an increase in interest income of $9.3 million
and an increase in interest expense of $2.3 million, which leaves a net increase
in net interest income of $7.0 million. In 1996 there was a $4.5 million
increase in net interest income. There was an increase in interest income of
$5.5 million and an increase in interest expense of $1.0 million, which left a
net increase in net interest income of $4.5 million.
-30-
<PAGE> 35
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
LOAN PORTFOLIO
Average loans grew $108.6 million, or 15.4% in 1998; $95.1 million, or 15.6% in
1997; and $76.9 million, or 14.5% in 1996. In 1998, average real estate
commercial had the largest dollar growth by increasing $51.3 million, or 18.1%.
This is followed by commercial loans increasing $41.5 million, or 27.9%. In
1997, average real estate commercial loans again had the largest dollar growth
by increasing $56.6 million, or 25%. Real estate construction loans, had the
second largest dollar and percent growth increase of $24.3 million, or 21.4%. In
1996, real estate commercial loans had the largest dollar growth by increasing
$51.4 million, or 29.4%. This was followed by real estate construction loans,
which increased by $18 million, or 18.7%.
The average yield on loans in 1998 slipped to 10.17% from 10.37% the year
before. During 1998, the Corporation decreased its base lending rate three times
from 8.50% at the beginning of the year to 7.75% at year-end. Variable rate
loans make up approximately 30% of the Corporation's loan portfolio. While
one-third of the loan portfolio will adjust immediately to a move in the prime
rate, it takes several months to adjust the deposit side of the balance sheet,
which may never fully adjust to rate decreases due to competitive factors. Along
with base rate decreases, 1998 was a year which saw intensified rate competition
from regulated and non-regulated lenders. At times, the Corporation did not step
up to meet the competition due to safety and soundness reasons, and lost
business. Nonetheless, the Corporation had a record year of loan growth. In
1997, the yield on total loans dropped 1 basis point to 10.37%, from a 1996
average of 10.38%. Although the Corporation raised 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 10.73% to 10.38%.
At year-end 1996, 74% of the portfolio was fixed rate and 26% was variable rate.
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 $9.5 million, or 13.1% in 1998;
$9.8 million, or 15.6% in 1997; and $6.1 million, or 10.8% in 1996. The earnings
on the $108.6 million increase in the 1998 average balance of loans, resulted in
increased income of $11.2 million, and a decline in rates decreased income $1.6
million. The earnings on the $95.1 million increase in the 1997 average balance
of loans resulted in increased income of $9.9 million, and a decline in rates
was insignificant. The earnings on the $76.9 million increase in the 1996
average balance of loans, resulted in increased income of $8.3 million, while a
decrease in interest rates decreased interest income by $2.2 million.
The Bank has a VISA card department which began operations in 1993. At year-end
1998, the department had $12.7 million in credit lines and $2.3 million in
outstanding balances. At year-end 1997, the department had $7.2 million in
credit lines and outstanding balances of $1.6 million. At year-end 1996, the
department had $5.6 million in credit lines, and $1.2 million in active
balances. The Bank also provides debit cards to customers, and had fifteen ATM's
at year-end 1998.
LOAN LOSS PROVISION
The provision for loan losses decreased $295 thousand in 1998, or 14.1%;
decreased $38 thousand, or 1.8% in 1997 and decreased $512 thousand, or 31.6% in
1996. The Corporation has had excellent loan quality over the last several
years, and excellent recoveries as well. For those reasons, the provision has
declined over the years, while a strong, total allowance has been maintained.
-31-
<PAGE> 36
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
The allowance for loan losses was 2.01% of total loans in 1998; 2.15% of total
loans in 1997 and 2.13% of total loans in 1996. 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 1998, 1997, and 1996, management
considered the reserve to be adequate. Please refer to Note 4, page 13 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 769% in 1998,
275% in 1997, and 335% for year-end 1996. 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, increased
$686 thousand in 1998, or 6.6%; decreased $459 thousand in 1997, or 4.2%; and
decreased $19 thousand in 1996, or .1%. The decrease of $15.5 million in the
average balance of investments in 1998 decreased income by $772 thousand, and a
decrease in yield decreased income by $193 thousand . In 1997 the decrease in
average balances of $5.9 million, decreased interest income by $603 thousand,
while an increase in rates increased interest income by $92 thousand. The
decrease in average balances of $11.3 million in 1996, decreased income by $713
thousand, while and increase in rates increased interest income by $57 thousand.
There were no realized losses in securities during the last three years.
INTEREST EXPENSE
Total interest and borrowing expense for 1998 increased $3.5 million, or 10.2%;
increased $2.3 million, or 7.2% in 1997 and increased $53 thousand, or 3.1% in
1996. The increase of $87.6 million in the average balances of interest bearing
liabilities in 1998, increased interest expense $4.2 million, while a decrease
in the cost of funds lowered interest expense by $712 thousand. In 1997, the
increase of $60.0 million in the average balances of interest bearing
liabilities, contributed $2.8 million to interest expense, while decreased
interest rates reduced interest expense by $.5 million. In 1996, the increase of
$43.9 million in the 1996 average balance of interest bearing liabilities
contributed $2.7 million to expense, while declining interest rates decreased
interest expense by $1.7 million.
In 1998, the increases in the average balances of interest bearing core deposits
increased interest expense by $3.5 million, and decreased interest rates reduced
interest expense by $663 thousand. Increases in the average balances of short
and long-term debt increased interest expense $709 thousand, while dropping
rates reduced interest expense by $49 thousand. In 1997, increases in the
average balance of interest bearing core deposits (Money Market, NOW and savings
accounts) increased interest expense by $2.4 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 $378 thousand, and a net
reduction in the rates of two categories decreased interest expense by $5
thousand. In 1996, increases in the average balance of interest bearing deposits
increased interest expense by $2.0 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 $653 thousand, and
decreasing interest rates decreased interest expense by $126 thousand.
-32-
<PAGE> 37
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
OTHER NONINTEREST INCOME
Noninterest income totaled $5.3 million in 1998, up $1 million from 1997, or
22.1%; totaled $4.4 million in 1997, up $203 thousand, or 4.9% and totaled $4.2
million, up $234 thousand, or 6.0% in 1996. In 1998, service charges increased
$43 thousand, or 2.2%; increased $110 thousand, or 5.6%; and decreased $4
thousand, or .2% in 1996. 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 1,172, or 5.8% in 1998; increased by 2,248, or
12.5% in 1997; and increased by 532, or 3.0% in 1996.
Other income increased $.9 million in 1998, or 38.2%; increased $93 thousand in
1997, or 4.0%; and decreased $158 thousand in 1996, or 6.8%. The increase in
1998 was due to several factors. Trust department income was up $144 thousand,
or 17.2%; insurance and financial services income was up $38 thousand, or 10.1%;
broker loan fees were up $113 thousand, or 35.6%; and loan servicing fee income
was up $227 thousand. Gain on other real estate owned sold for 1998 was $232
thousand. The increase in 1997 was also due to several factors, but the majority
of the increase was due to an increase in insurance and financial service fees
of $124 thousand, or 81.6%; 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 of $314 thousand on gain on
sale of other real estate owned. In 1996, insurance and financial service fees
decreased $103 thousand, or 40.4% for the year. Broker loan fees, (secondary
market loan origination fees) decreased $119 thousand.
As previously stated, trust department income increased $144 thousand, or 17.2%
in 1998; increased $122 thousand, or 17.0% in 1997 and $151 thousand, or 26.7%
in 1996. The market value of trust assets managed at year-end 1998 was $158.8
million, up $15.6 million, or 10.9%; was $143.2 million, up $23.7 million, or
19.8% in 1997. In 1996 assets increased to $119.5 million, up $12.6 million, or
11.8%.
OTHER NONINTEREST EXPENSE
Total noninterest expenses increased $3.2 million, or 13.4% to $26.7 million in
1998; increased $3.3 million, or 16.2% to $23.5 million in 1997 and increased
$813 thousand to $20.3 million, or 4.2% in 1996.
Salary and employee benefits increased $1.7 million, or 11.8% in 1998; increased
$1.8 million, or 14.7% in 1997 and increased $1.2 million, or 11% in 1996. The
increase in salaries, only, for 1998 was $1.5 million, or 15.2%; 1997 was $1.3
million, up 14.9%; and in 1996 was up $.8 million, or 10.3% over 1995. The
increase in 1998 was due to an increase in staff of 5.6%, and the remaining
increase was due to increases in bonuses and merit raises. The increase in 1997
was attributable to an increase in staff of 9.0%, and the remainder is
attributable to merit raises. In 1996 the increase was attributable to an
increase in staff of 4.4%, and the remainder is attributable to merit raises.
Employee benefits increased $140 thousand, or 3.4% in 1998; increased $512
thousand, or 14.2% in 1997 and increased $405 thousand or 12.7% in 1996. The
increase in 1998 was due to an increase in medical insurance premium of $66
thousand, and an increase in the vacation reserve of $47 thousand. In 1997, the
increase was due to an increase in the profit sharing contributions of $195
thousand, or 10.6%. An increase of 6% is attributable to the increase in staff
in 1997, and increased medical premiums of $102 thousand, or 21.8%. In 1996 this
increase is due, for the most part, to an increase in the profit sharing
contributions of $270 thousand.
-33-
<PAGE> 38
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
Occupancy expense was up $54 thousand in 1998, or 1.7%; up $515 thousand, or
18.8% in 1997 and down $49 thousand or 1.8% in 1996. In 1998, 44% of occupancy
expense was depreciation, which increased $219 thousand, or 17.9%. The remaining
expenses decreased $165 thousand. In 1997, 38% of occupancy expense was
depreciation, which increased $174 thousand, or 16.6%. The remainder of the
increase in 1997 was due to increased building, furniture and equipment expense
of $341thousand. In 1996, 38% of occupancy expense was depreciation. The
remainder of the increase in 1996 was due to an increase in building, furniture
and equipment expense.
Other expense increased $1.2 million in 1998, or 23.9%. Most of the increase is
comprised in four areas. Legal fees increased $395 thousand, or 395% in 1998.
This was almost all due to the merger with Valley Bancorporation. Additionally,
consulting fees of $180 thousand were due to the merger. Also, goodwill
amortization increased $51 thousand and account services fees paid increased $84
thousand. Other expense increased $794 thousand, or 18.7% in 1997. Most of this
increase was attributable to four areas. Marketing expenses increased $94
thousand, or 26.1%, due to product promotions; foreclosure expenses increased
$227 thousand, much of which was due to prior period foreclosures, and self
insurance reserves increased $234 thousand, or 354.5%. Other expenses increased
$344 thousand in 1996, or 8.8%. FDIC insurance premiums dropped to $23 thousand
in 1996, compared with premiums of $692 thousand paid in 1995 and legal expenses
increased $49 thousand, or 158.1%. ATM card expenses increased $14 thousand, or
40% and foreclosure expenses increased $70 thousand.
Many banks and bank holding companies use a computation called the "efficiency
ratio" to measure overhead 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, on a tax equivalent basis, and other noninterest
income, minus non-recurring gains or losses. The lower the number, the more
efficient the organization. The Corporation's efficiency ratio for 1998 was
43.3%, 43.5% for 1997, and 43.3% for 1996. The Corporation's ratio is considered
excellent for the industry.
ASSET AND LIABILITY MANAGEMENT
Assets and liabilities are managed to maximize long-term shareowner 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 6 of this report, net income for
1998 contributed $21.6 million to liquidity and in 1997 contributed $18.6
million to liquidity, and $16.0 million to liquidity in 1996. 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.
-34-
<PAGE> 39
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
Deposits generated through the Corporation's branch network is the most
important source of liquidity. In 1998, core deposits (Money Market, NOW and
savings accounts) funded $64.4 million of the $158.9 million growth in loans.
Contributing to that growth in loans were cd's which funded $52.3 million.
Federal funds purchased and securities sold under agreements to repurchase also
made a contribution to loan growth of $13.9 million, and FHLB advances
contributed $20.2 million. Other funding for loan growth, and net investment
purchases of $27.1 million, came from Federal funds sold and net profit. In
1997, core deposits funded $47.1 million of the $79.8 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 of $35.8 million.
Some of the proceeds from maturing investments funded the growth in loans during
the year. In 1996, core deposits funded $24.8 million of the growth in assets
and net borrowings 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 $42.7 million and represent a highly accessible source of liquidity. Net
maturities provided $14.9 million in liquidity, with $27.8 million of the total
$42.7 million in maturities being reinvested in the portfolio.
Over the last three years, the financing of investment activities has changed
from mainly cd's to core deposits. In years going forward, core deposits and
FHLB borrowings will become more important in the financing process.
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.
The charts below indicate the maturity schedule for earning assets as of
December 31, 1998 and 1997:
MATURITY SCHEDULE FOR EARNING ASSETS
(AMORTIZED COST USED FOR INVESTMENT)
<TABLE>
<CAPTION>
Percent
In Thousands Total Total of Total
0-1 1-5 After Carrying Fair Fair
December 31, 1998 Year Years 5 Years Cost Value Value
---------- ---------- ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Investments $ 20,453 $ 27,141 $ 97,045 $ 144,639 $ 147,224 13.5%
Loans 334,482 456,797 106,863 898,142 898,441 82.3%
Federal Funds sold 45,712 - - 45,712 45,712 4.2%
---------- ---------- ---------- ---------- ---------- -----
Total $ 400,647 $ 483,938 $ 203,908 $1,088,493 $1,091,377 100.0%
========== ========== ========== ========== ========== =====
</TABLE>
<TABLE>
<CAPTION>
Percent
In Thousands Total Total of Total
0-1 1-5 After Carrying Fair Fair
December 31, 1997 Year Years 5 Years Cost Value Value
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Investments $ 25,187 $ 16,029 $ 74,086 $115,302 $117,510 12.9%
Loans 284,510 407,872 30,087 736,946 729,390 80.3%
Federal Funds sold 71,885 - - 71,885 71,885 6.8%
-------- -------- -------- -------- -------- -----
Total $381,582 $423,901 $104,173 $924,133 $918,785 100.0%
======== ======== ======== ======== ======== =====
</TABLE>
-35-
<PAGE> 40
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
As indicated in the chart, in 1998, $400.6 million or 36.8% of aggregate assets
were available for liquidity at year-end. In 1997 $381.6 million, or 41.3% in
aggregate assets were available for liquidity at year-end. The Corporation also
has other sources of liquidity not indicated above. For example, at year-end
1998, the bank has a pre-approved credit line up to $172 million from Seattle
FHLB. However, assets must be pledged to secure these borrowings. Currently
borrowings are $50.2 million. AFS securities totaling $111.7 million could be
sold for liquidity purposes. The Corporation could also issue cd's to public
entities exceeding $95 million more than currently issued. Additionally,
participation in the treasury department's short-term note program is available
along with potential borrowings form the Federal Reserve Bank of San Francisco
and other correspondent banks.
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 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, 1998, the simulation modeled the
impact of assumptions that interest rates would increase or decrease 200 basis
points. Results indicated the Corporation was positioned so 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 measurement.
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 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, HEDGES, OR DERIVATIVES, NOR DOES MANAGEMENT INTEND 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.
-36-
<PAGE> 41
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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, 1998. 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 rate.
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 1998, and are shown on page 42 of this report. Please refer to
Note 17 on page 23 of this report for details regarding estimated fair value
amounts.
-37-
<PAGE> 42
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
The Corporation's interest rate sensitive positions at December 31, 1998 and
1997 are shown in the following tables:
<TABLE>
<CAPTION>
Expected Maturity Date
---------------------- Fair
In Thousands 1999 2000 2001 2002 2003 Thereafter Total Value
- ------------ ---- ---- ---- ---- ---- ---------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and cash equivalents
Noninterest bearing $ 44,233 - - - - - $ 44,233 $ 44,233
Federal funds sold
Variable rate 45,712 - - - - - 45,712 45,712
Weighted average interest rate 5.51% 5.51%
Securities available for sale
Fixed Rate 14,503 $ 3,395 $ 2,979 $ 3,807 $ 13,470 $ 74,553 112,707 112,707
Weighted average interest rate 6.43% 8.33% 8.31% 7.04% 6.60% 7.43% 7.24%
Securities held to maturity
Fixed Rate 5,100 155 257 1,018 2,309 24,055 32,894 34,517
Weighted average interest rate 5.21% 6.15% 6.28% 6.64% 5.91% 5.44% 5.48%
Loans Receivable, net
Fixed Rate 124,740 46,936 97,443 104,265 155,487 77,708 606,579 606,794
Weighted average interest rate 9.00% 9.10% 9.16% 9.24% 8.72% 8.08% 8.88%
Variable rate 209,606 23,930 5,391 7,371 16,388 28,864 291,550 291,647
Weighted average interest rate 9.06% 9.09% 9.28% 8.85% 8.80% 8.43% 8.98%
FINANCIAL LIABILITIES
Noninterest bearing deposits 9,560 8,948 8,375 7,839 7,338 105,921 147,981 147,981
NOW and Money Market accounts 10,412 9,621 8,890 8,214 7,590 92,273 137,000 137,000
Weighted average interest rate 3.28% 3.28% 3.28% 3.28% 3.28% 3.28% 3.28%
Savings accounts 16,564 15,239 13,852 12,592 11,446 114,533 184,226 184,226
Weighted average interest rate 3.69% 3.69% 3.69% 3.69% 3.69% 3.69% 3.69%
Time Certificates
Fixed Rate 351,260 28,618 17,433 6,772 13,074 1,717 418,874 421,947
Weighted average interest rate 5.40% 6.05% 5.73% 5.84% 5.74% 5.71% 5.48%
Variable rate 31,580 6,980 - - - - 38,560 38,843
Weighted average interest rate 5.42% 5.60% 5.45%
Federal funds purchased
Variable rate 5,524 - - - - - 5,524 5,524
Weighted average interest rate 4.39% 4.39%
Securities sold under agreement
to repurchase
Variable rate 26,334 - - - - - 26,334 26,334
Weighted average interest rate 4.39% 4.39%
FHLB advances
Fixed Rate 5,000 - 5,028 25,000 - 15,186 50,214 49,641
Weighted Average interest rate 5.40% 5.81% 5.81% 5.09% 5.24%
</TABLE>
-38-
<PAGE> 43
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 $21.9 million or 20.4% in 1998 to $129.2 million, increased $19.0
million in 1997, or 21.5% to $107.4 million, and increased $16.2 million in 1996
or 22.4% to $88.4 million. In 1998, $356 thousand of increase came from the
issuance of stock under the Corporation's stock option plan. Almost all of the
remainder came from the net earnings of the Bank. In 1997, almost all of the
increase was attributable to its net income of the Bank. In 1996, $1 million of
the increase was attributable to the investment in Washington Banking Company; a
decrease of $.7 million was attributable to the change in fair market value of
the AFS portfolio, and the remainder was almost all due to net profits to the
Bank.
MARKET FOR FRONTIER FINANCIAL CORPORATION'S COMMON STOCK
AND RELATED SHAREOWNERS' MATTERS
Frontier Financial Corporation's common stock began trading on the National
Association of Securities Dealers' Automated Quotation System (NASDAQ) on April
16, 1998. In 1998, based on the average number of shares outstanding for the
year, stock trades totaled approximately 7% (including the shares issued
pursuant to the merger with Valley Bancorporation. During 1998, the market price
of the common stock ranged from $34.00 to $62.50. The average price, on NASDAQ
trading, was $50.57 for the year.
At December 31, 1998, the total number of shareowners of record of Frontier
Financial Corporation's common stock was 3,617, and there were 8,697,261 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, in February 1999, the Board of
Directors of the Corporation declared the first cash dividend since the Bank
opened in 1978 and has had five stock splits over the same period. Annually, the
Board of Directors reviews various methods to distribute the earnings of the
Corporation to the shareowners.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000. The century date change creates a problem because computer
programs and systems were designed to store calendar years with only two
numbers, rather than four numbers. Because of this design, computer programs and
systems may recognize a date using "00" as 1900 rather than the Year 2000. The
extent of the potential impact of this Year 2000 problem is not yet known and
could affect the global economy and every organization.
Only one thing is certain about the impact of the Year 2000--it is difficult to
predict with any degree of certainty what will happen after December 31, 1999.
The Corporation is committed to address and is addressing these Year 2000 issues
and the uncertainty that is presented by these Year 2000 issues. The total
financial effect that the Year 2000 problem will have on the Corporation is
uncertain and will not be known until the year 2000 arrives. The Corporation is
working to mitigate the Year 2000 problem, the success of Corporation's efforts
will not be known until the year 2000 arrives. The Corporation's Year 2000
progress and efforts continue to be monitored by the banking regulatory
agencies.
The challenges faced by the Corporation. The Year 2000 problem is of particular
concern to the Corporation and other financial institutions because most
financial transactions, such as interest accruals and payments, are date
sensitive. The Year 2000 problem will impact both information technology ("IT")
systems, such as computers, and non-IT systems. Non-IT systems typically include
embedded technology such as microcontrollers, and include automated teller
machines, elevators, alarm systems, and vaults. Non-IT systems are more
difficult to assess and repair than IT systems.
-39-
<PAGE> 44
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
The Corporation's state of readiness. The Corporation established a Year 2000
Committee in February 1997 with representatives from all significant functional
areas which report to the Corporation's Board of Directors. Detailed inventories
for all IT systems and all identified non-IT systems have been conducted to
catalog potential hardware and software problems. The Corporation has identified
certain systems as business-critical systems and testing of those
business-critical systems has commenced. The Corporation has identified the end
of April, 1999 as the projected deadline to complete the Year 2000 testing on
business-critical systems. Additional testing will continue during the year
1999. The Corporation has determined that modifications to certain systems are
required and that such modifications will be conducted to mitigate, but not
eliminate, the risks associated with the Year 2000 problem.
Third party concerns. The Corporation interacts with numerous customers, vendors
and third party service providers whose failure to address the Year 2000 problem
may create significant business disruption and costs to the Corporation. Due to
the interdependence of computer systems today, it is simply impossible for any
one party to eliminate the risks related to the Year 2000 problem. It is even
possible that the Year 2000 problem could disrupt the Corporation's business
through the loss of electric power or phone service, or for other reasons
outside of the Corporation's control. The Corporation has initiated formal
communications with certain significant suppliers and large customers to attempt
to determine the extent to which the Corporation is vulnerable to those third
parties' failure to remediate their own Year 2000 issues. Systems of other
companies on which Corporation's systems rely may not be timely converted, which
might well result in significant costs to the Corporation.
The Corporation is in the process of assessing the incremental credit risk in
loan portfolio relating to individual customers' ability to successfully address
Year 2000 IT and non-IT issues. For those over an established dollar threshold,
credit risk assessments are being performed on each borrower. This process will
be ongoing until the Year 2000.
The Corporation's contingency plans. The Year 2000 Committee is in the process
of developing and implementing contingency plans to handle the most reasonably
likely worst case scenarios. Since these worst case scenarios are difficult or
even impossible to predict at this time, these contingency plans are
particularly challenging. The Corporation intends to develop contingency plans
that are reasonably necessary to address the Year 2000 problem and to revise
those contingency plans on an ongoing basis until the problem is confronted and
resolved.
Estimated costs. It is impossible to predict with any degree of certainty the
costs that the Corporation will incur as a result of the Year 2000 problem. The
Corporation's current estimates for the total Year 2000 testing and remediation
is roughly $550,000, which will be funded through cash flows of operations. The
Corporation has reserved approximately $400,000 addressing the Year 2000
problem. The future financial estimates are just rough estimates, as these are
"forward-looking" statements subject to risks and uncertainties that may cause
future results to differ materially. It is uncertain to what extent the actual
costs of the Year 2000 problem will have on the Corporation's results of
operations, liquidity, and financial condition. Actual lost revenue resulting
from the Year 2000 problem is impossible to predict because of the inherent
uncertainty of the Year 2000 problem. The Corporation, through its Year 2000
Committee, is analyzing and determining how to best handle and mitigate this
uncertainty. The Corporation presently believes that costs associated with
compliance efforts will not have a significant impact on the Corporation's
ongoing operations or financial condition, although there can be no assurance in
this regard. There can be no assurance that there will not be a delay in, or
increased costs associated with, the implementation of the necessary changes to
address the Year 2000 problem, the Corporation's inability to implement such
changes could have an adverse effect on future results of operations. In
addition, the failure of certain Corporation's customers, vendors and third
party service providers to appropriately address the Year 2000 problem could
have a material adverse effect on the Corporation.
-40-
<PAGE> 45
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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 statements" 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.
-41-
<PAGE> 46
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES Average Balances and
Tax-Equivalent Net Interest Margin - Table 1
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------ ----------------------------- ------------------------------------
In Thousands Average Average Average
- ------------ Interest Rates Interest Rates Interest Rates
Average Income/ Earned/ Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid Balance Expense Paid
------- ------- ---- ------- ------- ---- ------- ------- ---------
INTEREST EARNING ASSETS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Taxable investments $ 90,359 $ 6,092 6.74% $ 91,874 $ 6,218 6.77% $ 111,330 $ 7,409 6.65%
Nontaxable investments(1) 28,557 2,428 8.50% 30,309 2,661 8.78% 31,336 2,814 8.98%
------- -------- ---- ------- ----------- ---- ------- ----------- ----
Total 118,916 8,520 7.16% 122,183 8,879 7.27% 142,666 10,223 7.17%
------- -------- ---- ------- ----------- ---- ------- ----------- ----
Federal funds sold 63,962 3,417 5.34% 45,198 2,479 5.48% 30,615 1,646 5.38%
Loans(2)
Installment 29,830 2,849 9.55% 27,271 2,651 9.72% 23,973 2,349 9.80%
Commercial(1) 190,307 18,938 9.95% 148,786 15,534 10.44% 146,778 15,082 10.28%
Real estate
Commercial 334,235 32,228 9.64% 282,904 27,846 9.84% 226,348 22,425 9.91%
Construction 151,384 17,620 11.64% 138,271 16,233 11.74% 113,939 13,606 11.94%
Residential 106,110 10,897 10.27% 106,043 10,691 10.08% 97,152 9,661 9.94%
------- -------- ---- ------- ----------- ---- ------- ----------- ----
Total 811,866 82,532 10.17% 703,275 72,955 10.37% 608,190 63,123 10.38%
------- -------- ---- ------- ----------- ---- ------- ----------- ----
Total earning assets/total
interest income 994,744 $ 94,469 9.50% 870,656 $ 84,313 9.68% 781,471 $ 74,992 9.60%
------- -------- ---- ------- ----------- ---- ------- ----------- ----
Reserve for loan losses (16,936) (14,931) (13,252)
Cash and due from banks 39,635 31,240 25,077
Other assets 31,011 28,183 25,052
----------- -------- ---------
TOTAL ASSETS $ 1,048,454 $915,148 $ 818,348
=========== ======== =========
INTEREST BEARING LIABILITIES
Money Market &
NOW accounts $ 121,932 $ 3,491 2.86% $102,704 $ 3,071 2.99% $ 82,817 $ 2,454 2.96%
Savings accounts 174,311 6,652 3.82% 161,542 6,282 3.89% 155,314 6,081 3.92%
Other time deposits 430,472 24,605 5.72% 388,585 22,554 5.80% 362,037 21,429 5.92%
------- -------- ---- ------- ----------- ---- ------- ----------- ----
Total interest bearing
deposits 726,715 34,748 4.78% 652,831 31,907 4.89% 600,168 29,964 4.99%
Short-term borrowings 24,530 1,196 4.88% 15,198 762 5.01% 11,018 539 4.88%
Long-term debt 35,565 1,946 5.47% 31,201 1,720 5.51% 28,068 1,560 5.56%
------- -------- ---- ------- ----------- ---- ------- ----------- ----
Total interest bearing
liabilities/total
interest expense 786,810 37,890 4.82% 699,230 34,389 4.92% 639,254 32,063 5.02%
------- -------- ---- ------- ----------- ---- ------- ----------- ----
Noninterest bearing
deposits 133,340 109,340 91,386
Other liabilities 9,806 7,882 8,253
Shareowners' equity 118,498 98,696 79,455
----------- -------- ---------
TOTAL LIABILITIES
AND CAPITAL $ 1,048,454 $915,148 $ 818,348
=========== ======== =========
NET INTEREST INCOME $56,579 $49,924 $ 42,929
======= ========== =========
NET YIELD ON INTEREST
EARNING ASSETS 5.69% 5.73% 5.49%
==== ==== ====
</TABLE>
- --------------
(1) Includes amounts to convert nontaxable amounts to a fully taxable equivalent
basis at a 35% tax rate.
(2) Includes nonaccruing loans.
-42-
<PAGE> 47
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Rate/Volume Analysis of Changes in Net Interest Income - Table 2
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------------------------------------------------------
1998 versus 1997 1997 versus 1996 1996 versus 1995
------------------------------- ------------------------------- --------------------------------
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 $ (103) $ (23) $ (126) $ (1,295) $ 104 $ (1,191) $ 269 $ 312 $ 581
Nontaxable investments (154) (79) (233) (92) (61) (153) (195) (108) (303)
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total (257) (102) (359) (1,387) 43 (1,344) 74 204 278
Federal funds sold 1,029 (91) 938 784 49 833 (787) (147) (934)
Loans
Installment 249 (51) 198 323 (21) 302 207 (45) 162
Commercial 4,335 (931) 3,404 206 246 452 127 (457) (330)
Real estate
Commercial 5,052 (670) 4,382 5,603 (182) 5,421 5,253 (705) 4,548
Construction 1,539 (153) 1,386 2,906 (279) 2,627 2,269 (781) 1,488
Residential 7 199 206 884 147 1,031 430 (165) 265
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total 11,182 (1,606) 9,576 9,922 (89) 9,833 8,286 (2,153) 6,133
TOTAL INTEREST
INCOME 11,954 (1,799) 10,155 9,319 3 9,322 7,573 (2,096) 5,477
-------- -------- -------- -------- -------- -------- -------- -------- --------
INTEREST EXPENSE
Money Market &
NOW accounts 575 (155) 420 589 28 617 166 (133) 33
Savings accounts 497 (127) 370 244 (43) 201 (344) (225) (569)
Other time deposits 2,431 (381) 2,050 1,571 (445) 1,126 2,216 (1,218) 998
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest
bearing
deposits 3,503 (663) 2,840 2,404 (460) 1,944 2,038 (1,576) 462
Short-term borrowings 468 (34) 434 204 19 223 432 (68) 364
Long-term debt 241 (15) 226 174 (14) 160 221 (58) 163
-------- -------- -------- -------- -------- -------- -------- -------- --------
TOTAL INTEREST
EXPENSE 4,212 (712) 3,500 2,782 (455) 2,327 2,691 (1,702) 989
-------- -------- -------- -------- -------- -------- -------- -------- --------
CHANGE IN NET
INTEREST INCOME $ 7,742 $ (1,087) $ 6,655 $ 6,537 $ 458 $ 6,995 $ 4,882 $ (394) $ 4,488
======== ======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
-43-
<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>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 44,233
<INT-BEARING-DEPOSITS> 4,750
<FED-FUNDS-SOLD> 45,712
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 112,707
<INVESTMENTS-CARRYING> 28,144
<INVESTMENTS-MARKET> 29,767
<LOANS> 898,142
<ALLOWANCE> (18,098)
<TOTAL-ASSETS> 1,147,873
<DEPOSITS> 926,642
<SHORT-TERM> 31,858
<LIABILITIES-OTHER> 9,910
<LONG-TERM> 50,214
0
0
<COMMON> 90,547
<OTHER-SE> 38,702
<TOTAL-LIABILITIES-AND-EQUITY> 1,147,873
<INTEREST-LOAN> 82,450
<INTEREST-INVEST> 11,112
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 93,562
<INTEREST-DEPOSIT> 34,748
<INTEREST-EXPENSE> 37,890
<INTEREST-INCOME-NET> 55,672
<LOAN-LOSSES> (1,800)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 26,702
<INCOME-PRETAX> 32,498
<INCOME-PRE-EXTRAORDINARY> 21,649
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 21,649
<EPS-PRIMARY> 2.49
<EPS-DILUTED> 2.46
<YIELD-ACTUAL> 5.69
<LOANS-NON> 1,065
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 15,824
<CHARGE-OFFS> (1,282)
<RECOVERIES> 1,756
<ALLOWANCE-CLOSE> 18,098
<ALLOWANCE-DOMESTIC> 18,098
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
