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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, 1999
Commission File Number 0-15540
FRONTIER FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Washington 91-1223535
(State or Other Jurisdiction of (IRS Employer Identification
Incorporation or Organization) Number)
332 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 short 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 (Section 229.405 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 January 31,
2000 was $303,715,475 based on the average high/low price at January 31, 2000.
The issuer has one class of common stock (no par value) with 17,545,587 shares
outstanding as of December 31, 1999, and 17,552,193 outstanding as of January
31, 2000.
Documents Incorporated by Reference
Portions of Annual Report to Shareholders for the year ended:
December 31, 1999..................Part I
2000 Proxy Statement...............Part II
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Annual
Shareholders' Proxy
Form 10-K Report Statement
Item Number Page Page Page
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<S> <C> <C> <C>
PART I
1 Business 1-9
Statistical Disclosure Index 10
2 Properties 20
3 Legal Proceedings 20
4 Submission of Matters to
a vote of Shareowners 20
PART II
5 Market for Registrant's Common
Equity and Related Shareowner
Matters 39
6 Selected Financial Data 21
7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations 27-41
7a Quantitative and Qualitative
Disclosures about Market Risk 36-38
8 Financial Statements and
Supplementary Data 22
9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure 22
PART III
10 Directors and Executive
Officers of Frontier
Financial Corporation 2-8
11 Executive Compensation 7-9
12 Security Ownership of Certain
Beneficial Owners and
Management 5-6
13 Certain Relationships and
Related Transactions 25 21 11
PART IV
14 Exhibits, Financial Statement
Schedules, and Reports on Form 8-K 24
Signatures 27
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PART I
ITEM 1 - BUSINESS
Frontier Financial Corporation ("FFC" or "the Corporation") is a Washington
corporation which was incorporated in 1983 and is registered as a bank holding
company under the Bank Holding Company Act of 1956. As part of a plan of
reorganization consummated following the close of business September 30, 1983,
FFC acquired all of the stock of Frontier Bank (the "Bank"), issuing its common
stock in an exchange for the Bank's common stock on a share-for-share basis. FFC
has two subsidiaries: the Bank, which is engaged in a general banking business
and in businesses related to banking, and FFP, Inc., a nonbank corporation which
leases property to the Bank.
The Bank
The Bank is a state-chartered banking association with its 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,
1999, the Bank conducted its business operations out of 25 offices located in
Snohomish, Pierce, King, Skagit and Whatcom 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, Mount Vernon, Edmonds, Stanwood, Bothell, Woodinville,
Monroe, Lake City (Seattle), Redmond, Burlington, Bellingham 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, installments 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 October 1993, FFP, Inc. a bank premises holding company
subsidiary, purchased land for construction of the Administrative offices which
were relocated from the Evergreen Way Office. This building was placed in
service in 1995. 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. In May 1997, the Bank opened an office in
Redmond, Washington. This is the Bank's first office in eastern King County.
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In December 1998, the Bank acquired, through merger, the Bank of Sumner, with
four offices, and a real estate origination department. These offices provide a
full range of consumer and commercial banking services. In July 1999, opened its
Bellingham office, which is the Bank's first office in Whatcom County. In
September 1999, the Bank opened its Mount Vernon office which is the Bank's
second office in Skagit County. In December 1999, FFP Inc., purchased property
and a building two miles south of the current Administrative Building for the
Bank's Operations Center which will begin occupancy in the second quarter of
2000.
Employees
At December 31, 1999, the Bank had 410 full time equivalent 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,
1999, the Bank had total assets of $1.246 billion and deposits of $966.8
million.
Pending Merger
On March 15, 2000, FFC entered into a definitive agreement to acquire Liberty
Bay Financial Corporation ("Liberty") of Poulsbo, Washington. Liberty's
commercial banking subsidiary, North Sound Bank, operates eight banking offices
on the Olympic Peninsula in Washington State. As of December 31, 1999, Liberty
had total consolidated assets of $180 million, and shareowners' equity of 14%.
Under the terms of the agreement, shareowners of Liberty will receive 10.5
shares of FFC common stock for each share of Liberty Stock outstanding. It is
anticipated that the acquisition will be completed during 2000, following
approval of applicable regulatory authorities and the shareowners of Liberty. It
is expected that the transaction will be accounted for using the
pooling-of-interests method.
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.
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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.
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 find 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 which 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.
Under the Financial Services Modernization Act of 1999 (the "Financial Services
Act") which was signed into law on November 12, 1999, a bank holding company may
now engage in a wider variety of financial activities, particularly with respect
to insurance and securities activities.
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 this 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 or 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 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.
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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 provides 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.
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.
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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 SEC's Public Reference Room at 450 Fifth
Street, NW Washington D.C. 20549. The public may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. FFC
is an electronic filer with the SEC and the FFC filings may be obtained at the
SEC website (http://www.sec.gov). 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.
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 "Restrictions on Capital Distributions"
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 shareowners 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, 1999 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.
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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).
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 1999 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 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,
gains or losses on available for sale securities 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 debts 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.
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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 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 4 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 4 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, 1999, the Bank was well capitalized and maintained a leverage
ratio of 11.43 percent, a risk-based Tier 1 capital ratio of 13.03 percent, and
a risk-based total capital ratio of 14.29 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 of Financial Institutions.
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 of Financial Institutions 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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FINANCIAL MODERNIZATION. In 1999, the Financial Service Act was enacted which:
(1) repealed historical restrictions on preventing banks from affiliating with
securities firms, (2) broadens the activities that may be conducted by national
banks and banking subsidiaries of holding companies, and (3) provides an
enhanced framework for protecting the privacy of consumers' information. In
addition, bank holding companies may be owned, controlled or acquired by any
company engaged in financially related activities, as long as such company meets
regulatory requirements. To the extent that this legislation permits banks to
affiliate with financial services companies, the banking industry may experience
further consolidation, although the impact of this legislation on FFC and the
Bank is unclear at this time.
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 improved 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, 1999, all banking offices have been moved into FFP, except those offices
where the land and/or buildings are leased. For further details, please see page
21 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 9.9% ownership in WBC. Approval was received, and the Corporation
has since purchased a total ownership of 9.2%, as of March 1, 2000. The FRB
approval for further purchases of WBC stock by FFC terminated in December, 1999.
FFC does not anticipate further investment in WBC stock at this time. If FFC
were to seek to increase its ownership in WBC, FRB regulatory approval would
again need to be obtained.
Share Repurchase Program
On September 11, 1999, the FFC Board of Directors adopted a Share Repurchase
Program, authorizing the Corporation to repurchase up to five percent (5%) of
the outstanding shares of its common stock.
The Board of Directors of FFC announced on March 15, 2000, the signing of a
definitive agreement to acquire Liberty Bay Financial Corporation located in
Poulsbo, Washington. The transaction is being accounted for using the
"pooling-of-interests" method. In order to qualify to use that method of
accounting, the Board of Directors of FFC has discontinued is Stock Repurchase
Program.
-9-
<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 Shareowners' Equity; Interest
Rates and Interest Differential:
A. Consolidated Average Balance
Sheets/Interest Income and
Expense/Rates 40
B. Changes in Net Interest Income
and Expense due to Rate and
Volume 41
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 & 13
B. Loan Maturities and Sensitivity to
Changes in Interest Rates 12 13, 36 & 38
C. Risk Elements 13
D. Credit Concentrations 17
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 40
VI. Return on Equity and Assets
Selected Financial Ratios 19
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>
1999 1998 1997
(In thousands) Amortized Amortized Amortized
Cost Cost Cost
--------- --------- ---------
<S> <C> <C> <C>
U.S. Treasuries $ 252 $ 252 $ 754
U.S. Agencies 70,608 74,516 44,039
Municipal Bonds 27,597 28,144 28,881
Corporate Bonds 23,602 25,054 28,151
Equities 14,521 11,923 9,927
Certificates of Deposit 0 4,750 3,550
-------- -------- --------
Totals $136,580 $144,639 $115,302
======== ======== ========
</TABLE>
Maturity Distribution of Investment Securities
The following table sets forth the maturities of investment securities at
December 31, 1999. 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 1,006 3,501 61,967 4,134 70,608
7.37% 5.84% 6.28% 7.56% 6.35%
Municipal Bonds 155 7,009 19,842 591 27,597
9.45% 9.16% 8.30% 9.21% 8.54%
Corporate Bonds 2,514 18,838 1,750 500 23,602
7.47% 6.84% 7.11% 9.88% 6.99%
Equities 14,521 0 0 0 14,521
5.97% 0.00% 0.00% 0.00% 5.97%
------- ------- ------- ------ --------
TOTALS $18,196 $29,348 $83,559 $5,477 $136,580
======= ======= ======= ====== ========
6.28% 7.27% 6.78% 7.93% 6.86%
</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) 1999 1998 1997 1996 1995
---------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Commercial $ 209,915 $200,035 $157,319 $129,457 $137,618
Real Estate Commercial 441,882 388,402 293,243 255,807 192,104
Real Estate Construction 265,092 173,217 151,793 144,028 102,426
Real Estate Mortgage 102,932 104,338 106,438 103,810 98,404
Installment 33,393 32,150 28,153 24,575 21,567
---------- -------- -------- -------- --------
TOTAL $1,053,214 $898,142 $736,946 $657,677 $552,119
========== ======== ======== ======== ========
</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, 1999. 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 $115,786 $ 81,834 $ 12,295 $ 209,915
Real Estate Commercial 31,365 292,369 118,148 441,882
Real Estate Construction 194,111 68,643 2,338 265,092
Real Estate Mortgage 20,315 69,324 13,293 102,932
Installment 8,423 13,506 11,464 33,393
-------- -------- -------- ----------
TOTAL $370,000 $525,676 $157,538 $1,053,214
======== ======== ======== ==========
</TABLE>
Loans maturing after one year with:
<TABLE>
<CAPTION>
1 - 5 After
Years 5 Years
-------- --------
<S> <C> <C>
Fixed Rates $463,534 $116,938
Variable Rates 62,142 40,600
-------- --------
TOTAL $525,676 $157,538
======== ========
</TABLE>
It is not uncommon to rollover loans at the maturity period, provided that that
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 Credit Review
personnel 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 .22%, .26%, and .78% for year-end 1999, 1998 and 1997,
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. At year-end 1997, the total represented
21 different loans, 8 out of those 21 were real estate in nature. At year-end
1998, the number of loans in nonaccrual was 15, totaling slightly more than $1
million, or .12% of total loans. At year-end 1999, the number of loans in
nonaccrual increased to 25, totaling slightly more than $1.5 million, or .15% of
total loans. The largest loan in nonaccrual represented less than 2% of the
total amount in nonaccrual.
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:
<TABLE>
<CAPTION>
(In thousands)
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial $ 211 $ 112 $ 327 $ 478 $ 175
Real Estate 1,266 932 4,097 3,144 4,402
Installment 61 21 17 4 14
Restructured -- -- 109 121 122
------------------------------------------------------------------
Total Non-Performing Loans 1,538 1,065 4,550 3,747 4,713
------------------------------------------------------------------
Other real estate owned 736 1,287 1,200 444 590
------------------------------------------------------------------
Total Impaired Assets $ 2,274 $ 2,352 $ 5,750 $ 4,191 $ 5,303
==================================================================
Total Loans at end
of period $1,053,214 $898,142 $736,946 $657,677 $552,119
==================================================================
As a percent of
total loans 0.22% 0.26% 0.78% 0.64% 0.96%
==================================================================
</TABLE>
There are certain amounts of interest collected on the above loans and included
in income, and amounts that have not been accrued which are indicated in the
table below:
<TABLE>
<CAPTION>
(In thousands)
At December 31, 1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total interest income which
would have been recorded
during the period under
original terms of loans above $100 $42 $289 $289 $518
Portion of interest
income included in
net income for the
period $161 $41 $384 $264 $378
Commitments for additional
funds related to loans
above -0- -0- -0- -0- -0-
</TABLE>
Restructured loans are those 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, Skagit and Whatcom Counties. Total loans as of December 31, 1999,
1998 and 1997 were $1.1 billion, $898.1 million and $736.9 million respectively.
-14-
<PAGE> 17
Other Real Estate Owned
As of December 31, 1999, the Bank had eight parcels of other real estate owned
(OREO) on it books, which totaled $736 thousand. The OREO parcels consist of
five residential lots in two locations, two houses and a small commercial
building. 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 normal, 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) 1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Other Real Estate Owned $736 $1,287 $1,200 $444 $590
</TABLE>
The following table provides an analysis of net losses by loan type for the last
five years at December 31st.
<TABLE>
<CAPTION>
(In thousands) 1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance at beginning
of year $ 18,098 $ 15,824 $ 14,033 $ 12,601 $ 11,019
Provision charged to
operating expense 2,050 1,800 2,095 2,133 1,621
Loans charged-off:
Commercial (796) (438) (393) (621) (1,257)
Real Estate 0 (779) (1,324) (1,336) (875)
Installment (71) (66) (81) (84) (88)
-------------------------------------------------------------
Total charged-off loans (867) (1,283) (1,798) (2,041) (2,220)
Less recoveries:
Commercial 241 653 283 752 1,245
Real Estate 101 1,083 1,161 535 902
Installment 28 21 50 53 34
-------------------------------------------------------------
Total recoveries 370 1,757 1,494 1,340 2,181
Net charge-offs (497) 474 (304) (701) (39)
-------------------------------------------------------------
Balance at end of year $ 19,651 $ 18,098 $ 15,824 $ 14,033 $ 12,601
=============================================================
Total loans at
end of period $1,053,214 $898,142 $736,946 $657,677 $552,119
Daily average loans $ 975,293 $811,866 $703,275 $608,190 $531,297
Ratio of net charged-off
loans during period to
average loans outstanding 0.05% -0.06% 0.04% 0.12% 0.01%
=============================================================
</TABLE>
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.
-15-
<PAGE> 18
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 Loan Loan
1999 Category 1998 Category 1997 Category 1996 Category 1995 Category
Reserve Percent Reserve Percent Reserve Percent Reserve Percent Reserve Percent
------- -------- ------- -------- ------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial $10,439 19.9% $ 9,592 23.1% $ 8,920 21.4% $ 8,702 19.7% $ 7,758 24.9%
Real Estate 8,842 76.9% 8,144 73.3% 6,485 74.8% 4,976 76.6% 4,283 71.2%
Installment 370 3.2% 362 3.6% 419 3.8% 355 3.7% 560 3.9%
---------------------------------------------------------------------------------------------
TOTAL $19,651 100.0% $18,098 100.0% $15,824 100.0% $14,033 100.0% $12,601 100.0%
======= ===== ======= ===== ======= ===== ======= ===== ======= =====
</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. For those loans where the "worse case" loss is greater
than the background percentage, the worse case loss amount is considered
specifically allocated to the reserve.
Based on actual historical results (over the past 6 years, which average
approximately $300 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, and still potential Year 2000 losses, so management believes that
the reserve is adequate, based on those inherent risks.
The analysis/formula for computing the allowance for possible loan losses has
not changed significantly for several years. The last substantive change
occurred in 1998 when a specific reserve component regarding potential Y2K
losses was added. That component was consistent during all of 1999.
Loan concentrations, quality, terms and basic underlying assumptions remained
substantially unchanged during the period. The actual loan loss reserve as a
percentage of total loans did not materially change during all of 1999.
-16-
<PAGE> 19
National and Local Economic Trends and Conditions
In addition to the economic discussion in Management's Discussion and Analysis
of Financial Condition and Results of Operations (page 27-29, 1999 Annual Report
to Shareowners), there are other qualitative factors considered when analyzing
the adequacy of the loan loss reserve.
Year 2000 Risk
As part of Year 2000 due diligence, a specific loan loss allowance was
maintained to offset any potential losses incurred due to business failures or
setbacks caused by the millennium change. Although no actual losses have
surfaced yet, we have risk rated our loan portfolio and assigned a specific loan
loss reserve of .1% of the loan balance to the loans assigned a high-risk
rating. As of March 1, 2000, the millennium change has had no known impact on
our customer base. Also, the February 29 leap-year day was also a "non-event",
with business as usual throughout the Bank. Management will continue to closely
monitor the matter going forward for any signs of problems arising from these
potential problems.
Effects of Changing Interest Rates
1999 saw three increases in the discount rate by the Federal Reserve in the
second half of the year. A fourth increase in February 2000 brought the total
increase to 1.0%. Subsequently, the Bank's base rate increased the same 1.0%.
Fears of inflation, which have failed to materialize, brought on by what is
considered an overheated economy and tight labor market are the primary causes.
We have seen some signs of slowing in the economy, which we consider healthy.
To date no noticeable adverse effects on loan volumes and borrower's viability
have been noted from these recent rates increases. The Bank, while offering
conventional home mortgage origination services, has not been a high volume
producer in this area, which is considered the most vulnerable to slow downs in
activity levels (and reductions in fee income, etc.) as rates rise. See comments
on interest rate sensitivity for a discussion of effect on yields.
The majority of the bank's loans have short-term maturities of up to five years,
and typically 45% of the loan portfolio reprices within one year, which
decreases the interest rate risk.
Concentrations of Credit
At year-end 1999, 21.6% of the Bank's loan portfolio was in residential and
commercial construction and land development projects centered in Snohomish,
Pierce, King, Skagit and Whatcom Counties. The Bank has experienced strong
demand for such loans and the current percentage represents an increase from
16.8% in 1998. 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 on the following page indicates the amount
of those loans, and as a percent of total loans for the period:
-17-
<PAGE> 20
<TABLE>
<CAPTION>
(In Thousands)
At December 31, 1999 1998 1997 1996 1995
---------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Construction $ 151,623 $ 99,312 $ 80,233 $ 70,201 $ 54,341
Land Development 76,384 51,902 43,015 52,186 33,946
------------------------------------------------------
TOTAL $228,007 $151,214 $123,248 $122,387 $ 88,287
======================================================
Total Loans at end of period $1,053,214 $898,142 $736,946 $657,677 $552,119
======================================================
Construction and Land
Development loans as a
percent of total loans 21.6% 16.8% 16.7% 18.6% 16.0%
======================================================
</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 the real estate values, which
could be affected by several factors.
Levels of, and Trends in, Delinquencies and Nonaccruals
Nonperforming loans and other real estate remained consistent in 1999 at the
same low 1998 level with a modest increase in nonaccrual loans and a decrease in
other real estate owned. No real trends are noted. 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 first, second, and third quarters
of 1999. Total loans increased $16.6 million in the fourth quarter, or 1.6% to
$1.1 billion, a growth rate slower than the previous three quarters. Overall
loan growth was 17.3% for 1999. Following the merger with the former Bank of
Sumner, the Bank was able to accommodate several clients who were previously not
able to be fully accommodated by the Bank of Sumner due to lending limit
capacity. In addition, the opening of new locations and additions of personnel
have fostered growth, as well as the growth of existing portfolios. At this
time, no real trends are noted in the levels of loan activity and growth.
Although some concerns can be expressed over the future impact of recent rate
increases on levels of economic activity.
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
Boeing, and an anticipated slowing of the economy, any excess reserve is not
considered by management to be material.
-18-
<PAGE> 21
Deposits
For the average amount of deposits and rates paid on such deposits for years
ended December 31, 1999, 1998, and 1997 please refer to page 40 of 1999 Annual
Report to Shareowners.
Maturities of time certificates of deposit $100,000 and over at year-end 1999,
are shown below:
(In thousands)
<TABLE>
<S> <C>
3 months or less $ 94,633
Over 3 months through 6 months 28,697
6 months through 12 months 57,695
Over 12 months 19,504
--------
TOTAL $200,529
========
</TABLE>
Significant Financial Ratios
Ratios for the years ended December 31, 1999, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Return on Average Assets 2.15% 2.06% 2.03%
Return on Average Equity 18.43% 18.27% 18.84%
Dividend payout ratio 17.1% 1.6% 1.5%
Average Equity to Average Assets 11.65% 11.30% 10.78%
</TABLE>
<TABLE>
<CAPTION>
Borrowings
Short-Term Borrowings Weighted Weighted Weighted
(In thousands) Average Average Average
Interest Interest Interest
At December 31, 1999 Rate 1998 Rate 1997 Rate
------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Year-end balance: $28,552 4.56% $31,858 4.88% $17,962 5.01%
Highest month end
balance during
the period: $61,569 $31,858 $22,245
</TABLE>
For information regarding average balances and yields, please refer to page 40
of 1999 Annual Report to Shareowners.
Long-Term Debt
There is no long-term debt for years ended December 31, 1999 and 1998.
ITEM 2 - PROPERTIES
-19-
<PAGE> 22
FFC's main office, which is owned by FFP, is located in Everett, Washington. At
December 31, 1999, the Bank had 25 offices, including the main office, all of
which are located in the state of Washington. These offices are located in
Arlington, Bellingham, Bothell, Buckley, Burlington, Edmonds, Everett (4), Lake
City (North Seattle), Lake Stevens, Lynnwood, Marysville, Meridian Place
(Puyallup), Mill Creek, Monroe, Mount Vernon, Orting, Redmond, Smokey Point,
Snohomish, Stanwood, Sumner and Woodinville. FFP also owns the building and land
recently purchased (December 1999) for the Bank's new Operations Center. All of
its branches are located in properties owned by FFP, Inc., a real estate holding
subsidiary, except for the offices located in Bellingham (lease expires May
2004) 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), Meridian Place
Office (which lease expires in September 1999) and Mount Vernon (building owned,
lease expires March 2023).
The total net book value of the investment in premises and equipment at December
31, 1999, totaled $18.3 million.
ITEM 3 - LEGAL PROCEEDINGS
There are no material legal proceedings.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SHAREOWNERS
No matters were submitted to security holders during the fourth quarter
of 1999.
-20-
<PAGE> 23
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND SHAREOWNER MATTERS
Please see 1999 Annual Report to Shareowners, page 39.
ITEM 6 - SELECTED FINANCIAL DATA
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
% Change
AT YEAR-END 1999 1998 1997 1996 1995 1998-1999
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Total assets $1,245,616 $1,147,873 $973,052 $874,946 $ 796,730 8.5%
Net loans 1,033,563 880,044 721,122 643,644 539,517 17.4%
Deposits 966,780 926,642 810,348 732,389 694,278 4.3%
Long-term debt 0 0 695 1,059 1,394 nm
Investment securities 131,514 145,601 115,999 132,340 146,645 -9.7%
Shareowners' equity 147,369 129,249 107,384 88,351 72,214 14.0%
FOR THE YEAR
Interest income 103,689 93,562 83,324 73,971 68,443 10.8%
Interest expense 40,737 37,890 34,369 32,062 31,091 7.5%
Securities gains(losses) 0 0 0 0 (4) nm
Provision for loan losses 2,050 1,800 2,095 2,133 1,621 13.9%
Net income 25,660 21,649 18,594 16,012 13,837 18.5%
Basic earnings per share $ 1.46 $ 1.25 $ 1.08 $ 0.94 $ 0.81 16.8%
Diluted earnings per share $ 1.46 $ 1.23 $ 1.07 $ 0.92 $ 0.80 18.7%
Return on Average
Assets 2.15% 2.06% 2.03% 1.96% 1.84%
Equity 18.43% 18.27% 18.84% 20.15% 21.34%
Avg. equity/avg. assets 11.65% 11.30% 10.78% 9.71% 8.63%
</TABLE>
nm=Not meaningful
(In Thousands, except per share data)
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Please see 1999 Annual Report to Shareowners, page 27 through 41.
ITEM 7a - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please see 1999 Annual Report to Shareowners, page 36-38.
-21-
<PAGE> 24
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Annual
Form Report to
10-K Shareowners
Page Page
---- -----------
<S> <C> <C>
Independent Auditor's Report 26
Report of Management 1
Consolidated Balance Sheet at
December 31, 1999 and 1998 3
Consolidated Statement of Income for the years
Ended December 31, 1999, 1998 and 1997 4
Consolidated Statement of Changes in
Shareowners' Equity 5
Consolidated Statement of Cash Flows for the
Years ended December 31, 1999, 1998 and 1997 6
Condensed Balance Sheet (Parent Only) at
December 31, 1999 and 1998 24
Condensed Statement of Income (Parent Only) for the
Years Ended December 31, 1999, 1998 and 1997 24
Condensed Statement of Cash Flows (Parent Only)
for Years Ended December 31, 1999, 1998, and 1997 25
Notes to Consolidated Financial Statements 7 - 26
</TABLE>
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
-22-
<PAGE> 25
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF FRONTIER FINANCIAL CORPORATION
Please see pages 2-8 of 2000 Proxy Statement.
ITEM 11 - EXECUTIVE COMPENSATION
Please see pages 6-8 of 2000 Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS MANAGEMENT
Please see page 8 of 2000 Proxy Statement.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Please see page 11 of 2000 Proxy Statement; and,
Note 14, page 21 of 1999 Annual Report to Shareowners; and,
Page 25 of this Form 10-K report.
-23-
<PAGE> 26
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of the report:
1. Financial Statements.
Financial statements required by Item 8 of this report are
incorporated by reference, from the 1999 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.
(3)(a) 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.
(3)(b) By-Laws are incorporated herein by reference to Exhibit
3(b) to Registration on Form S-14, File No. 2-82420.
(10)(a) Amended and Restated Frontier Financial Corporation
Incentive Stock Option Plan incorporated by reference to
Exhibit 99.1 to Registration Statement on Form S-8, filed
March 2, 1999 (File No. 333-73217).
(11) Statement Regarding Computation of Earnings Per Share.
(13) Annual Report to Shareowners for the year ended December
31, 1999.
(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, 1999.
(b) Reports on Form 8-K:
Form 8-K was filed on February 3, 1999 reporting consolidated
operating results for the month of January 1999.
-24-
<PAGE> 27
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>
1999 $22,119 $17,310 ($9,824) $0 $29,605
Ten
Directors
and one
Officer
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 one
Officer
</TABLE>
-25-
<PAGE> 28
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareowners
Frontier Financial Corporation
We have audited the consolidated financials 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, 1999. 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, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999, 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 18, 2000
-26-
<PAGE> 29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FRONTIER FINANCIAL CORPORATION
March 15, 2000 /s/ Robert J. Dickson
- ------------------- ----------------------------------------
Date Robert J. Dickson
President & Chief Executive Officer
March 15, 2000 /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:
- ------------------- ----------------------------------------
George E. Barber, Director
March 15, 2000 /s/ Michael J. Corliss
- ------------------- ----------------------------------------
Michael J. Corliss, Director
March 15, 2000 /s/ Lucy DeYoung
- ------------------- ----------------------------------------
Lucy DeYoung, Director
March 15, 2000 /s/ Robert J. Dickson
- ------------------- ----------------------------------------
Robert J. Dickson, Director
March 15, 2000 /s/ David A. Dujardin
- ------------------- ----------------------------------------
David A. Dujardin, Director
March 15, 2000 /s/ Edward D. Hansen
- ------------------- ----------------------------------------
Edward D. Hansen, Secretary of the Board
March 15, 2000 /s/ William H. Lucas
- ------------------- ----------------------------------------
William H. Lucas, Director
March 15, 2000 /s/ James H. Mulligan
- ------------------- ----------------------------------------
James H. Mulligan, Chairman of the Board
March 15, 2000 /s/ J. Donald Regan
- ------------------- ----------------------------------------
J. Donald Regan, Director
March 15, 2000 /s/ Roger L. Rice
- ------------------- ----------------------------------------
Roger L. Rice, Director
- ------------------- ----------------------------------------
William J. Robinson, Director
March 15, 2000 /s/ Edward C. Rubatino
- ------------------- ----------------------------------------
Edward C. Rubatino, Director
March 15, 2000 /s/ Darrell J. Storkson
- ------------------- ----------------------------------------
Darrell J. Storkson, Director
-27-
<PAGE> 1
EXHIBIT 11
FRONTIER FINANCIAL CORPORATION
COMPUTATION OF BASIC AND DILUTED EARNINGS PER SHARE
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Net Income (in thousands) $ 25,660 $ 21,649 $ 18,594
===========================================
Computation of average shares outstanding:
Shares outstanding at
beginning of year 8,697,261 7,350,561 6,830,666
Additional shares deemed
outstanding because of
stock dividends or splits 8,758,499 8,382,631 8,815,136
Shares issued pursuant
to merger -- 1,587,800 1,587,800
Shares issued during
the year times average
time outstanding during
the year 72,231 35,074 33,924
-------------------------------------------
Average shares outstanding 17,527,991 17,356,066 17,267,526
-------------------------------------------
Average number of dilutive shares
assumed to be outstanding 77,525 215,110 113,704
-------------------------------------------
Average dilutive shares
outstanding 17,605,516 17,571,176 17,381,230
===========================================
Basic earnings per share $ 1.46 $ 1.25 $ 1.08
===========================================
Diluted earnings per share $ 1.46 $ 1.23 $ 1.07
===========================================
</TABLE>
<PAGE> 1
EXHIBIT 13
To our Shareowners and Staff
The final year of the twentieth century for Frontier Financial Corporation was
one of operational excellence -- and stock market frustration.
The results produced by our 400 staff members during the year were impressive:
Earnings for 1999 increased 18.5% over the previous twelve month period; we
successfully completed the merger of Bank of Sumner into Frontier Bank and we
expanded by opening two new offices.
Conversely, the price of our stock floundered throughout the year and closed at
$20.00, down 12 1/2% from 1998. This is the first year in our 21 year history
that our stock price was down and it was particularly disappointing in view of
our outstanding performance during 1999. Bank stock prices were punished
throughout the year because of expected interest rate increases and the dramatic
shift in the stock market from "value stocks" to "momentum stocks" which
transferred huge sums of capital from the more conservative stocks to high
flying internet, high tech and biotech stocks. We do not discourage easily, and
we will persevere to continue to produce both growth and quality during this
year. Hopefully, the market will reassess bank stocks in a more favorable light
and Frontier will be a leader among those stocks when the market turns.
Looking at the positive results for 1999, earnings increased to $25,660,000 or
$1.46 per fully diluted share compared to $21,649,000 or $1.25 per fully diluted
share in 1998. The numbers were adjusted to reflect the 2-for-1 stock split
issued in March, 1999. This marks the 21st consecutive year of record earnings
for Frontier, and the fourth quarter of 1999 was the 64th consecutive quarter in
which earnings exceeded the same quarter of the prior year. We are not aware of
any other commercial bank in the United States that can match our consecutive
quarterly income gains at this time.
Total assets of the bank increased by $98 million during the year to $1.24
billion or 8.5% while deposits grew by $40 million to $967 million or 4.3%. The
main driver of our growth was loan growth which increased by $155 million or
17.3% and ended the year by reaching the billion dollar milestone for the first
time. Shareowners' equity exceeded $147 million, up $18.1 million over the year,
an increase of 14.0% and this was after payment of $4.4 million for our first
cash dividend.
<PAGE> 2
The investment portfolio was the only major area of decline on the balance sheet
as totals fell from $146 million to $132 million, a decrease of 9.7%. This
occurred because funds received from maturing investments were used to help fund
the growth in the loan portfolio, and the return on loans is considerably higher
than we receive in investments. Steadily increasing interest rates throughout
the year created downward pressure on the value of our investment portfolio and
at year end, the cost of our investment portfolio exceeded the market value by
$4.7 million.
Our return on average assets outstanding during the year (ROAA) was 2.15%
compared to 2.06% and return on average equity (ROAE) was 18.43% compared to
18.27% in 1999 and 1998 respectively, which places Frontier among the leaders
when comparing peer group performance.
Some of the highlights of 1999 include:
Frontier Financial Corporation was rated as the #1 mid-sized bank in the United
States based on our operating results for 1998. The ratings were compiled by US
Banker magazine and included 200 publicly traded banks ranging in asset size
from $400 million to $2.9 billion. The ranking recognizes well-balanced
institutions with strong asset quality, ample capital, strong earnings, and low
efficiency ratios. It is indeed an honor to be ranked #1.
A new milestone was reached when total revenues exceeded $100 million for the
first time. Revenues for the year were almost $110 million, an increase of 10.8%
over the $99 million generated in 1998.
New loan originations throughout the year exceeded $583 million, our best year
ever.
Opened new offices in Bellingham, our first in Whatcom County, and Mount Vernon,
our second office in Skagit County. Bellingham was opened in July and was
profitable by year-end. Mount Vernon, which opened in September, has not
attained profitability.
Successfully planned for the much heralded Y2K event and all of our computers
began the new year without a glitch.
Paid our first cash dividend of $.25 per share in March and also split our stock
2- for-1. An original one share investment when Frontier Bank was opened in 1978
<PAGE> 3
would have grown to 502 shares as a result of stock splits and stock dividends.
In monetary terms, an original $1,000 investment in Frontier stock would have a
market value of over $100,000.
Our loan portfolio continued to reflect high quality. Non-performing loans as a
percentage of total loans at year end were .18% of total assets compared to .26%
at year-end 1998. Net charge-offs during the year were a modest .05% of the
average loans outstanding and year end loan loss reserve of $19.6 million
represented 1.87% of total loans.
Our marketing department received national recognition by receiving two creative
marketing achievement awards from the Independent Community Bankers of America
organization.
Excellent expense management was reflected by our efficiency ratio of 41% in
1999 down from 43% in 1998. The efficiency ratio is like a golf score -- the
lower, the better.
Frontier Bank initiated internet banking service during the month of December.
The initial response to this service has been excellent and full scale promotion
will not occur until late in the first quarter, 2000.
As we look to the future, we recognize tremendous opportunity and certainly many
challenges. The financial services business, of which banking is a part, is
changing rapidly. Late in the year, Congress passed the Gramm-Leach-Bliley Act
which allows banks to affiliate with securities firms and insurance companies,
but even without an affiliation, banks will be able to offer an expanded product
line including insurance and a broad line of investment products. Internet use,
including on-line banking, continues to grow at an astonishing rate. In
addition, we recognize the increasing competition, both from other banks and
from non-bank sources.
Part of our founding philosophy has always been "when there is change - there is
opportunity". We believe we have the people who possess the desire, commitment
and creativity to take advantage of the opportunities. We are very proud of our
company and are excited about the future.
We would like to publicly acknowledge and thank our director, Roy Robinson, who
retired from our board in 1999, for his 21 years of service to Frontier. Roy
<PAGE> 4
was a charter member of the board who served with distinction and was an active
participant. We will certainly miss his common sense, business acumen and good
humor.
In closing, thanks again to our hardworking, highly motivated staff, and to a
dedicated Board of Directors. Thanks to all of our shareowners for your interest
and loyal support over the years.
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,
President & CEO
<PAGE> 5
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Report of Management............................... 1
Independent Auditor's Report....................... 2
Consolidated Balance Sheet......................... 3
Consolidated Statement of Income................... 4
Consolidated Statement of Changes in
Shareowners' Equity.............................. 5
Consolidated Statement of Cash Flows............... 6
Notes to Financial Statements...................... 7-26
Management's Discussion and Analysis of
Financial Condition and Results of Operation..... 27-39
Average Balances and Tax-Equivalent
Net Interest Margin - Table 1.................... 40
Rate/Volume Analysis of Changes in
Net Interest Income - Table 2.................... 41
</TABLE>
<PAGE> 6
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
REPORT OF MANAGEMENT
The management of Frontier Financial Corporation and its subsidiaries has
prepared and is responsible for the integrity and fairness of the financial
statements and other financial information included in this annual report. The
financial statements are prepared in accordance with generally accepted
accounting principles and prevailing practices of the banking industry and, when
appropriate, include amounts based on management's best estimates and judgment.
Management has established and is responsible for maintaining an internal
control environment designed to provide reasonable assurance that transactions
are properly authorized, assets are safeguarded and financial records are
reliably maintained. The internal control environment includes: an effective
financial accounting structure; a comprehensive internal audit function; an
independent Audit Committee of the Board of Directors, and extensive financial
and operating policies and procedures. The Corporation's management also fosters
an ethical climate supported by a code of conduct along with appropriate
selection and training of personnel.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with management, the independent accountants and
the internal auditors to ensure that each is properly discharging its
responsibilities with regard to the financial statements and internal accounting
controls. The independent accountants have full and free access to the Audit
Committee and meets with it to discuss auditing and financial matters.
The Corporation's financial statements are audited by Moss Adams LLP, the
Corporation's independent auditors. Their audits were conducted in accordance
with generally accepted auditing standards and include a consideration of the
internal control structure, tests of accounting records and other audit
procedures necessary to allow the auditors to express their opinion on the
fairness of the financial statements.
Management recognizes that there are inherent limitations in the effectiveness
of any internal control environment. However, management believes that, as of
December 31, 1999, 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, 1999.
/s/ ROBERT J. DICKSON /s/ JAMES F. FELICETTY
- ------------------------------------ -------------------------------
ROBERT J. DICKSON JAMES F. FELICETTY
President and Chief Executive Officer Secretary/Treasurer
-1-
<PAGE> 7
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, 1999 and 1998, 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, 1999.
These financial statements are the responsibility of the Corporation's
management. Our responsibility it 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, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999, in conformity with generally accepted accounting
principles.
/s/ Moss Adams LLP
-----------------------
Everett, Washington
January 18, 2000
-2-
<PAGE> 8
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In Thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
ASSETS 1999 1998
---------- ----------
<S> <C> <C>
Cash and due from banks $ 44,858 $ 44,233
Federal funds sold -- 45,712
Investment securities
Available for sale, at fair value 103,467 112,707
Held to maturity (Fair value 1999: $28,408; 1998: $34,517) 28,047 32,894
---------- ----------
Total investment securities 131,514 145,601
Loans 1,053,214 898,142
Less allowance for loan losses (19,651) (18,098)
---------- ----------
Net loans 1,033,563 880,044
Premises and equipment, net 18,290 15,647
Other real estate owned 736 1,287
Intangible assets 1,264 1,396
Other assets 15,391 13,953
---------- ----------
Total assets $1,245,616 $1,147,873
========== ==========
LIABILITIES
Deposits
Noninterest bearing accounts $ 145,565 $ 147,981
Interest bearing accounts 821,215 778,661
---------- ----------
Total deposits 966,780 926,642
Federal funds purchased and securities sold under agreements to repurchase 28,552 31,858
Other liabilities 7,726 9,910
Federal Home Loan Bank advances 95,189 50,214
---------- ----------
Total liabilities 1,098,247 1,018,624
---------- ----------
SHAREOWNERS' EQUITY
Common stock, no par value; 100,000,000 shares authorized; 17,545,587 and
8,697,261 shares issued and outstanding in 1999 and 1998 91,302 90,547
Retained earnings 59,360 38,076
Accumulated comprehensive income (loss), net of tax (3,293) 626
---------- ----------
Total shareowners' equity 147,369 129,249
---------- ----------
Total liabilities and shareowners' equity $1,245,616 $1,147,873
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-3-
<PAGE> 9
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(In Thousands, except for per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
-------- -------- -------
<S> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $ 93,825 $ 82,450 $72,898
Interest on federal funds sold 824 3,417 2,515
Interest on investment securities
Taxable 7,483 6,092 6,222
Exempt from federal income tax 1,557 1,603 1,689
-------- -------- -------
Total interest income 103,689 93,562 83,324
-------- -------- -------
INTEREST EXPENSE
Interest on deposits 35,378 34,748 31,907
Interest on FHLB advances 3,788 1,946 1,632
Interest on federal funds purchased and securities
sold under agreements to repurchase 1,571 1,196 761
Interest on long-term debt - - 69
-------- -------- -------
Total interest expense 40,737 37,890 34,369
-------- -------- -------
Net interest income 62,952 55,672 48,955
PROVISION FOR LOAN LOSSES (2,050) (1,800) (2,095)
-------- -------- -------
Net interest income after provision for loan losses 60,902 53,872 46,860
-------- -------- -------
NON INTEREST INCOME
Service charges 2,289 1,999 1,956
Other 3,595 3,329 2,409
-------- -------- -------
Total other income 5,884 5,328 4,365
-------- -------- -------
NON INTEREST EXPENSE
Salaries 12,232 11,638 10,099
Employee benefits 4,957 4,253 4,113
Occupancy 3,657 3,307 3,253
FDIC insurance premium 133 100 86
State business taxes 1,270 1,147 945
Other 6,072 6,257 5,049
-------- -------- -------
Total other expense 28,321 26,702 23,545
-------- -------- -------
INCOME BEFORE INCOME TAX 38,465 32,498 27,680
PROVISION FOR INCOME TAX (12,805) (10,849) (9,086)
-------- -------- -------
NET INCOME $ 25,660 $ 21,649 $18,594
======== ======== =======
BASIC EARNINGS PER SHARE $ 1.46 $ 1.25 $ 1.08
======== ======== =======
DILUTED EARNINGS PER SHARE $ 1.46 $ 1.23 $ 1.07
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
-4-
<PAGE> 10
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREOWNERS' EQUITY
(In Thousands, except number of shares)
<TABLE>
<CAPTION>
Common Stock
-------------------------- Comprehensive Retained
Shares Amount Income Earnings
------ ------ ------------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1996 7,624,566 $58,044 $ 30,178
Comprehensive Income
Net income for 1997 -- -- $18,594 18,594
Other comprehensive income, net of tax $174 -- -- --
Unrealized gain (loss) on available
for sale securities -- -- 324 --
-------
Total comprehensive income $18,918
-------
Stock options exercised 40,548 365 --
Stock dividend 478,475 13,920 (13,920)
Fractional shares purchased, (net) 872 25 --
Cash dividend paid by VBC -- -- (275)
---------- ------- --------
Balance, December 31, 1997 8,144,461 72,354 34,577
Comprehensive Income
Net income for 1998 -- -- $21,649 21,649
Other comprehensive income, net of tax $93 -- -- --
Unrealized gain (loss) on available
for sale securities -- -- 173 --
=======
Total comprehensive income $21,822
=======
Stock options exercised 36,765 356 --
Stock dividend 514,999 17,809 (17,809)
Fractional shares purchased, (net) 1,036 28 --
Cash dividend paid by VBC -- -- (341)
---------- ------- --------
Balance, December 31, 1998 8,697,261 90,547 38,076
Comprehensive Income
Net income for 1999 -- -- $25,660 25,660
Other comprehensive income, net of tax $2,110 -- -- --
Unrealized gain (loss) on available
for sale securities -- -- (3,919) --
-------
Total comprehensive income $21,741
=======
Stock options exercised 89,827 755 --
Cash dividend paid -- (4,376)
Two-for-one stock split 8,758,499 -- --
---------- ------- --------
Balance, December 31, 1999 17,545,587 $91,302 $ 59,360
========== ======= ========
</TABLE>
<TABLE>
Accumulated
Other
Comprehensive
Income/(Loss) Total
-------------- --------
<S> <C> <C>
Balance, December 31, 1996 $ 129 $ 88,351
Comprehensive Income
Net income for 1997 -- 18,594
Other comprehensive income, net of tax $174 -- --
Unrealized gain (loss) on available
for sale securities 324 324
Total comprehensive income
Stock options exercised -- 365
Stock dividend -- --
Fractional shares purchased, (net) -- 25
Cash dividend paid by VBC -- (275)
-------- --------
Balance, December 31, 1997 453 107,384
Comprehensive Income
Net income for 1998 -- 21,649
Other comprehensive income, net of tax $93 -- --
Unrealized gain (loss) on available
for sale securities 173 173
Total comprehensive income
Stock options exercised -- 356
Stock dividend -- --
Fractional shares purchased, (net) -- 28
Cash dividend paid by VBC -- (341)
-------- --------
Balance, December 31, 1998 626 129,249
Comprehensive Income
Net income for 1999 -- 25,660
Other comprehensive income, net of tax $2,110 -- --
Unrealized gain (loss) on available
for sale securities (3,919) (3,919)
Total comprehensive income
Stock options exercised -- 755
Cash dividend paid -- (4,376)
Two-for-one stock split -- --
-------- --------
Balance, December 31, 1999 $ (3,293) $147,369
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-5-
<PAGE> 11
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 25,660 $ 21,649 $ 18,594
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 1,747 1,675 1,708
Provision for loan losses 2,050 1,800 2,095
Gain on sale of other real estate owned (732) (232) -
Loss on sale of fixed assets 70 - -
Changes in operating assets and liabilities
Deferred taxes 204 (742) (727)
Increase (decrease) in income taxes payable (1,570) 1,088 (290)
(Increase) decrease in interest receivable (739) (751) 267
Increase (decrease) in interest payable 477 394 (2,740)
Proceeds from sales of mortgage loans 23,053 34,788 20,054
Origination of mortgage loans held for sale (21,430) (36,180) (19,950)
Dividend income from Federal Home Loan Bank (771) (525) (685)
Increase (decrease) in other operating activities (94) (977) 438
--------- --------- ---------
Net cash provided by operating activities 27,925 21,987 18,764
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Net federal funds sold 45,712 26,173 (35,800)
Proceeds from maturities of available for sale
and held to maturity securities 40,445 86,225 49,564
Purchase of investment securities available for sale (10,328) (87,406) (17,492)
Purchase of investment securities held to maturity (21,288) (27,146) (14,822)
Cash dividends paid (4,376) (341) (275)
Net cash flows from loan activities (157,122) (159,813) (79,843)
Purchases of premises and equipment (4,334) (1,394) (1,262)
Proceeds from the sale of other real estate owned 1,744 1,537 261
Cash invested in other real estate owned - - (755)
Net cash provided from acquisition of branch - - 13,136
Other investing activities 100 341 94
--------- --------- ---------
Net cash used by investing activities (109,447) (161,824) (87,194)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in core deposit accounts 9,981 63,976 47,122
Net change in certificates of deposit 30,157 52,318 16,595
Proceeds from issuance of stock 755 384 390
Net change in federal funds purchased and securities sold under
agreements to repurchase (3,306) 13,896 5,951
Advances from the Federal Home Loan Bank 155,000 20,240 40,000
Repayments to the Federal Home Loan Bank (110,025) (26) (45,000)
Principal payments on long-term debt - (695) (364)
Other financing activities (415) 273 (599)
--------- --------- ---------
Net cash provided by financing activities 82,147 150,366 64,095
--------- --------- ---------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 625 10,529 (4,335)
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 44,233 33,704 38,039
--------- --------- ---------
CASH AND DUE FROM BANKS AT END OF YEAR $ 44,858 $ 44,233 $ 33,704
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for interest $ 40,280 $ 37,504 $ 34,211
Cash paid during the year for income taxes $ 14,769 $ 9,650 $ 9,995
</TABLE>
SUPPLEMENTAL INFORMATION ABOUT NONCASH INVESTING AND FINANCING ACTIVITIES
Other real estate acquired in settlement of loans in 1999 and 1998 were $501
thousand and $1.7 million, respectively. Sales of other real estate financed by
the Bank in 1998 was $1.4 million.
The accompanying notes are an integral part of these financial statements.
-6-
<PAGE> 12
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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, 1999 and 1998.
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 call
or 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.
Interest income is accrued as earned.
-7-
<PAGE> 13
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 using the interest method. 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, 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> 14
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 determined using the liability method and 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 $1.8 million in 1999, $1.4 million
in 1998, and $1.3 million in 1997. Contributions to the profit sharing plan are
discretionary while contributions to the money purchase pension plan are
currently 6% 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 such costs 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> 15
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 1999 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 pursuant to
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
- ------------ --------
Revenues
<S> <C>
The Corporation (as previously reported) $ 80,186
VBC 7,503
--------
As Restated $ 87,689
========
Net Income
The Corporation (as previously reported) $ 16,902
VBC 1,692
--------
As Restated $ 18,594
========
Shareowners' equity
The Corporation (as previously reported) $ 97,839
VBC 9,545
--------
As Restated $107,384
========
</TABLE>
-10-
<PAGE> 16
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 generally
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
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
1999
Available for sale
U.S. Treasury bonds $ 252 $ 11 - $ 263
U.S. Agency bonds 70,608 15 $(4,814) 65,809
Municipal securities 50 - (7) 43
Corporate bonds 23,102 63 (295) 22,870
Equities 14,521 - (39) 14,482
-------- ------ ------- --------
108,533 89 (5,155) 103,467
-------- ------ ------- --------
Held to maturity
Municipal securities 27,547 429 (68) 27,908
Corporate bonds 500 - - 500
-------- ------ ------- --------
28,047 429 (68) 28,408
-------- ------ ------- --------
Total Securities $136,580 $ 518 $(5,223) $131,875
======== ====== ======= ========
1998
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>
-11-
<PAGE> 17
NOTE THREE - INVESTMENTS (CONTINUED)
Contractual maturities of investment securities as of December 31, 1999 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.
In Thousands
- ------------
<TABLE>
<CAPTION>
Available for Sale Held to Maturity
------------------------- -----------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- -------- -------- -------
<S> <C> <C> <C> <C>
Maturity
Less than one year $ 18,041 $ 18,023 $ 155 $ 157
One to five years 22,339 22,033 7,009 7,153
Five to ten years 63,717 59,176 19,842 20,071
Over ten years 4,436 4,235 1,041 1,027
-------- -------- ------- -------
$108,533 $103,467 $28,047 $28,408
======== ======== ======= =======
</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 54% and 52% of the investments in corporate bonds
at December 31, 1999 and 1998, respectively, consisted of investments in
companies doing business in the financial services sector. Approximately 22% and
25% of the investments in corporate bonds at December 31, 1999 and 1998,
respectively, consisted of investments in companies doing business in the
industrial sector.
Investment securities, with a book value of $67.5 million and $49.4 million with
fair values of $63.7 million and $49.4 million in 1999 and 1998, 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, Whatcom, 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 1999 1998
- ------------ ---------- --------
<S> <C> <C>
Commercial $ 210,327 $200,471
Real estate commercial 445,009 389,959
Real estate construction 266,969 175,929
Real estate mortgage 103,661 105,091
Installment 33,370 32,153
---------- --------
1,059,336 903,603
Less deferred loan fees (6,122) (5,461)
---------- --------
$1,053,214 $898,142
========== ========
</TABLE>
-12-
<PAGE> 18
NOTE FOUR - LOANS (CONTINUED)
Contractual maturities of loans as of December 31, 1999 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 $115,786 $ 81,834 $ 12,295 $ 209,915
Real estate commercial 31,365 292,369 118,148 441,882
Real estate construction 194,111 68,643 2,338 265,092
Real estate mortgage 20,315 69,324 13,293 102,932
Installment 8,423 13,506 11,464 33,393
-------- -------- -------- ----------
$370,000 $525,676 $157,538 $1,053,214
======== ======== ======== ==========
</TABLE>
<TABLE>
<CAPTION>
Loans maturing after 1-5 After
one year with: Years 5 Years
-------- --------
<S> <C> <C>
Fixed rates $463,534 $116,938
Variable rates 62,142 40,600
-------- --------
$525,676 $157,538
======== ========
</TABLE>
LOAN LOSS RESERVE
Changes in the allowance for loan losses are summarized below:
<TABLE>
<CAPTION>
In Thousands 1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Balance at beginning of year $18,098 $15,824 $14,033
Provision charged to operating expense 2,050 1,800 2,095
Deduct
Loans charged-off (867) (1,283) (1,798)
Less recoveries 370 1,757 1,494
------- ------- -------
Net recoveries (charge-offs) (497) 474 (304)
------- ------- -------
Balance at year-end $19,651 $18,098 $15,824
======= ======= =======
</TABLE>
The Bank had loans amounting to $1.5 million at December 31, 1999, $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 $2.5 million,
$1.1 million and $4.2 million, respectively. The allowance for loan losses
related to these loans was approximately $1.0 million in 1999, $46 thousand in
1998, and $1.1 million in 1997. Interest collected on these loans in cash and
included in income amounted to $161 thousand in 1999, $41 thousand in 1998 and
$384 thousand in 1997. If interest on these loans had been accrued, such income
would have approximated $100 thousand in 1999, $42 thousand in 1998 and $289
thousand in 1997. At December 31, 1999 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> 19
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 1999 1998
- ------------ -------- -------
<S> <C> <C>
Premises $ 14,620 $12,679
Furniture, fixtures and equipment 7,647 7,445
Land 5,780 5,160
Construction in progress 1,020 98
-------- -------
29,067 25,382
Less accumulated depreciation (10,777) (9,735)
-------- -------
$ 18,290 $15,647
======== =======
</TABLE>
Depreciation expense on premises and equipment totaled $1.3 million in 1999,
$1.3 million in 1998, and $1.4 million in 1997.
NOTE SIX - INTEREST BEARING DEPOSITS
The major classifications of interest bearing deposits at December 31 are as
follows:
<TABLE>
<CAPTION>
In Thousands 1999 1998
- ------------ -------- --------
<S> <C> <C>
Money market and NOW accounts $138,884 $137,000
Savings 194,739 184,226
Time deposits, $100,000 and over 200,529 164,829
Other time deposits 287,063 292,606
-------- --------
$821,215 $778,661
======== ========
</TABLE>
The total remaining maturity schedule for time deposits is as follows:
In Thousands
- ------------
<TABLE>
<CAPTION>
<S> <C> <C>
December 31, 2000 $419,441
2001 32,412
2002 8,945
2003 13,449
2004 12,197
Thereafter 1,148
--------
$487,592
========
</TABLE>
-14-
<PAGE> 20
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, 1999, committed lines of credit agreements totaling approximately
$29 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 borrowings of $1.5 million outstanding at
December 31, 1999 and no borrowings outstanding or compensating balance
requirements under these credit arrangements at December 31, 1998.
In addition, at December 31, 1999 the Bank has a committed line of credit up to
$450 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, 1999
and 1998.
NOTE EIGHT - FEDERAL HOME LOAN BANK (FHLB) ADVANCES
At December 31, FHLB advances were expected to mature as follows:
<TABLE>
<CAPTION>
1999 1998
-------------------------- ---------------------------
Interest Interest
In Thousands Amount Rates Amount Rates
- ------------ ------- ------------ -------- ------------
<S> <C> <C> <C> <C>
Within one year $75,000 4.62%-5.45% $40,000 4.13%-5.52%
Two to three years 10,019 4.84%-7.08% 5,028 5.80%-7.08%
Four to nine years 10,080 5.52%-7.32% 90 7.32%
Ten to fifteen years 90 5.67% 5,096 5.58%-5.67%
------- -------
$95,189 $50,214
======= =======
</TABLE>
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 1999 1998
- ------------ ------- -------
<S> <C> <C>
Maximum outstanding at any month-end $95,189 $50,214
Average outstanding 71,934 35,274
Weighted average interest rates:
Annual 5.27% 5.51%
End of year 5.32% 5.24%
</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 $21.9 million in 1999 and
$26.3 million in 1998. The average daily balance of outstanding agreements
during the period was $26 million in 1999 and $18 million 1998, with maximum
outstanding agreements at any month-end of $29.1 million and $26.3 million,
respectively.
-15-
<PAGE> 21
NOTE TEN - INCOME TAX
The components of the provision for income tax are as follows:
<TABLE>
<CAPTION>
In Thousands 1999 1998 1997
- ------------ ------- ------- ------
<S> <C> <C> <C>
Current $12,601 $11,591 $9,813
Deferred 204 (742) (727)
------- ------- ------
$12,805 $10,849 $9,086
======= ======= ======
</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 1999 1998
- ------------ ------- -------
<S> <C> <C>
Deferred tax assets
Allowance for possible loan losses,
in excess of tax reserves $ 6,920 $ 6,334
Other deferred tax assets 955 1,195
------- -------
Total deferred tax assets 7,875 7,529
------- -------
Deferred tax liabilities
Other deferred tax liabilities (2,038) (1,488)
------- -------
Total deferred tax liabilities (2,038) (1,488)
------- -------
Net deferred tax assets $ 5,837 $ 6,041
======= =======
</TABLE>
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>
1999 1998 1997
------------------ ------------------ ------------------
In Thousands Amount Rate Amount Rate Amount Rate
- ------------ ------- ---- ------- ---- ------- ----
<S> <C> <C> <C> <C> <C> <C>
Income tax provision
at statutory rate $13,463 35% $11,374 35% $9,688 35%
Effect of nontaxable
interest income (678) -2% (486) -2% (613) -2%
Other 20 - (39) - 11 -
------- -- ------- -- ------ --
$12,805 33% $10,849 34% $9,086 33%
======= == ======= == ====== ==
</TABLE>
-16-
<PAGE> 22
NOTE ELEVEN - SHAREOWNERS' EQUITY AND REGULATORY MATTERS
In addition to 100 million shares of common stock authorized, the Corporation is
authorized to issue up to 10 million shares of preferred stock with no par
value. The Board of Directors has the authority to determine the rights and
privileges to be granted to holders of preferred stock.
In January 2000, the Board of Directors declared a $.09 per share cash dividend
to shareowners of records as of January 28, 2000, and payable on February 11,
2000.
The Board also announced adoption of a stock repurchase program authorizing the
repurchase of up to 5% of its outstanding stock over the next two years. Under
the repurchase program, the Corporation will purchase shares from time to time
in the open market depending on market price and other considerations. Most of
the shares will be retired, however, some will be used to meet obligations under
the Corporation's key employee stock option plan, and other purposes permitted
by accounting rules.
The Corporation and Bank are subject to various regulatory capital requirements
administered by the federal and state 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 a portion of
the loan loss reserve. Tier I capital to average assets is referred to as the
Tier I ratio. Management believes, as of December 31, 1999 and 1998 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> 23
NOTE ELEVEN - SHAREOWNERS' EQUITY AND REGULATORY MATTERS (CONTINUED)
<TABLE>
<CAPTION>
In Thousands To Be Well
- ------------ Capitalized Under
Prompt Corrective For Capital
Actual Action Provisions Adequacy Purposes
--------------------- --------------------- ----------------------
1999 Amount Ratio Amount Ratio Amount Ratio
- ---- -------- ------ -------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
Total Capital (to risk
weighted assets)
Consolidated $163,114 14.95% $109,138 10.00% $ 87,311 8.00%
Frontier Bank 154,006 14.29% 107,769 10.00% 86,215 8.00%
Tier I Capital (to risk
weighted assets)
Consolidated 149,398 13.69% 65,483 6.00% 43,655 4.00%
Frontier Bank 140,458 13.03% 64,662 6.00% 43,108 4.00%
Tier I Capital (to
average assets)
Consolidated 149,398 11.87% 62,954 5.00% 50,363 4.00%
Frontier Bank 140,458 11.43% 61,459 5.00% 49,167 4.00%
1998
- ----
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%
</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 $4.2 million at
December 31, 1999 and 1998, 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 $8.8 million in 1999 and $10.7 million in 1998.
-18-
<PAGE> 24
NOTE TWELVE - EMPLOYEE STOCK OPTION PLAN
In 1992, the shareowners of the Corporation approved an Incentive Stock Option
Plan (the Plan) to promote the best interest of the Corporation, its
subsidiaries and its shareowners, by providing an incentive to those key
employees who contribute to the operating success of the Corporation.
The maximum number of shares that may be issued under the Plan is ten percent
(10%) of the common stock of the Corporation. Options issued and outstanding are
adjusted to reflect any future common stock dividends, splits, recapitalization
or reorganization. The Board of Directors make available sufficient shares for
each option granted, subject to the remaining number of shares.
Options are granted at the then fair market value and vest immediately. 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 information 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 1999, 1998 and 1997 the risk-free interest rate is 6.47%, 4.70% and
5.67%; the dividend yield rate is 1.09%, .09% and not meaningful; the price
volatility is 63.67%, 54.73% and 15.59%; and the weighted average expected life
of the options has been measured at 6 years, 7 years and 7 years, respectively.
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 1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Net income as reported $25,660 $21,649 $18,594
Additional compensation for
fair value of stock options 260 378 465
------- ------- -------
Proforma net income $25,400 $21,271 $18,129
======= ======= =======
Earnings per share
Basic
As reported $ 1.46 $ 1.25 $ 1.08
======= ======= =======
Proforma $ 1.45 $ 1.23 $ 1.05
======= ======= =======
Diluted
As reported $ 1.46 $ 1.23 $ 1.07
======= ======= =======
Proforma $ 1.44 $ 1.21 $ 1.05
======= ======= =======
</TABLE>
-19-
<PAGE> 25
NOTE TWELVE - EMPLOYEE STOCK OPTION PLAN (CONTINUED)
Stock option transactions were:
<TABLE>
<CAPTION>
Weighted
Shares of Common Stock Average of
--------------------------- Exercisable Price
Available for Under of Shares
Option/Award Plan Under Plan
------------ ------- -----------------
<S> <C> <C> <C>
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
Authorized - - -
Granted (30,165) 30,165 22.00
2-for-1 stock split 356,213 106,856
Exercised - (89,827) 8.40
Forfeited 426 (426) N/M
------- ------- ------
Balance, December 31, 1999 789,151 214,445 $13.22
======= ======= ======
</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 79,310 2.12 $6 .01 79,310 $ 6.01
10-20 78,951 4.50 13 .89 78,951 13.89
20-30 56,184 6.02 22 .46 56,184 22.46
</TABLE>
-20-
<PAGE> 26
NOTE THIRTEEN - EARNINGS PER SHARE
The numerators and denominators of basic and fully diluted earnings per share
are as follows:
<TABLE>
<CAPTION>
In Thousands, except for per share amounts
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Net income (numerator) $ 25,660 $ 21,649 $ 18,594
=========== =========== ===========
Shares used in the calculation
(denominator)
Weighted average shares outstanding 17,527,991 17,356,066 17,267,526
Effect of dilutive stock options 77,525 215,110 113,704
Diluted shares 17,605,516 17,571,176 17,381,230
----------- ----------- -----------
Basic Earnings per share $ 1.46 $ 1.25 $ 1.08
=========== =========== ===========
Diluted Earnings per share $ 1.46 $ 1.23 $ 1.07
=========== =========== ===========
</TABLE>
NOTE FOURTEEN - RELATED PARTY TRANSACTIONS
Loans to directors, executive officers and their affiliates are subject to
regulatory limitations. Such loans had aggregate balances and activity during
1999, 1998 and 1997 as follows and were within regulatory limitations:
<TABLE>
<CAPTION>
In Thousands 1999 1998 1997
<S> <C> <C> <C>
Balance at beginning of year $22,119 $21,960 $ 7,028
New loans or advances 17,310 8,630 22,219
Repayments (9,824) (8,471) (7,287)
------- ------- -------
Balance at end of year $29,605 $22,119 $21,960
======= ======= =======
</TABLE>
NOTE FIFTEEN - 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 2004 and thereafter is as
follows:
In Thousands
<TABLE>
<S> <C>
Year ending December 31,2000 $ 492
2001 421
2002 396
2003 356
2004 312
Thereafter 3,588
------
$5,565
======
</TABLE>
-21-
<PAGE> 27
Rental expense charged to operations was $525 thousand in 1999, $452 thousand in
1998 and $453 thousand in 1997.
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 1999 or 1998.
A summary of the notional amount of the Bank's financial instruments with
off-balance sheet risk at December 31, 1999 follows:
<TABLE>
<S> <C>
Commitments to extend credit $209,219
Credit card arrangements 14,877
Commercial letters of credit 396
Standby letters of credit 1,777
</TABLE>
NOTE SIXTEEN - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, Disclosures About Fair
Value of Financial Instruments. The estimated fair value amounts have been
determined by the Corporation 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> 28
NOTE SIXTEEN - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
(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 AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - 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 15). 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 1999 1998
---------------------------- ------------------------
Carrying Fair Carrying Fair
Assets Value Value Value Value
- ------ ---------- ---------- -------- --------
<S> <C> <C> <C> <C>
Cash and due from banks $ 44,858 $ 44,858 $ 44,233 $ 44,233
Investment securities
Available for sale 103,467 103,467 112,707 112,707
Held to maturity 28,047 28,408 32,894 34,517
Federal funds sold - - 45,712 45,712
Net loans 1,033,563 1,031,374 880,044 898,441
Liabilities
- -----------
Noninterest bearing deposits 145,565 145,565 147,981 147,981
Interest bearing deposits 821,215 820,032 778,661 782,017
Federal funds purchased
and securities sold under
agreements to repurchase 28,552 28,552 31,858 31,858
FHLB Advances 95,189 93,818 50,214 49,641
</TABLE>
-23-
<PAGE> 29
NOTE SEVENTEEN - PARENT COMPANY (ONLY) FINANCIAL INFORMATION
Condensed balance sheets at December 31:
<TABLE>
<CAPTION>
In Thousands 1999 1998
- ------------ --------- ---------
ASSETS
<S> <C> <C>
Cash $ 50 $ 121
Investment in subsidiaries:
Bank 137,193 123,714
Nonbank 3,956 2,499
Investment securities
Available for sale, at fair market 4,035 1,929
Held to maturity (Fair value 1999: $500) $ 500
Other assets 1,861 1,177
--------- ---------
$ 147,595 $ 129,440
========= =========
LIABILITIES
Other liabilities $ 226 $ 191
--------- ---------
SHAREOWNERS' EQUITY
Common stock 91,302 90,547
Retained earnings 59,360 38,076
Accumulated comprehensive income (loss), net of tax (3,293) 626
--------- ---------
Total Shareowners' equity 147,369 129,249
--------- ---------
$ 147,595 $ 129,440
========= =========
</TABLE>
Condensed statements of income for the years ended December 31:
<TABLE>
<CAPTION>
In Thousands 1999 1998 1997
- ------------ ------- ------- -------
Income
<S> <C> <C> <C>
Dividend from Bank $ 6,479 $ 2,173 $ 765
Other dividends 50 21 19
Interest 75 3 5
------- ------- -------
Total income 6,604 2,197 789
------- ------- -------
Expenses
Interest 5 1 42
Personnel 268 241 268
Depreciation and amortization 329 64 77
Other 391 1,031 269
------- ------- -------
Total expenses 993 1,337 656
------- ------- -------
Income before equity in undistributed income
of subsidiaries and benefit equivalent to
income taxes 5,611 860 133
Benefit equivalent to income taxes 289 438 194
------- ------- -------
Income before equity in undistributed income
of subsidiaries 5,900 1,298 327
Equity in undistributed
income of subsidiaries 19,760 20,351 18,267
------- ------- -------
Net income $25,660 $21,649 $18,594
======= ======= =======
</TABLE>
-24-
<PAGE> 30
NOTE SEVENTEEN - PARENT COMPANY (ONLY) FINANCIAL INFORMATION (CONTINUED)
Condensed statements of cash flows for the years ended December 31:
<TABLE>
<CAPTION>
In Thousands 1999 1998 1997
- ------------ -------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 25,660 $ 21,649 $ 18,594
Adjustments to reconcile net income to net cash
provided by operating activities
Equity in undistributed income of subsidiaries (26,239) (22,524) (19,032)
Depreciation and amortization 329 64 77
Other operating activities 148 (618) (99)
-------- -------- --------
Net cash flows from operating activities (102) (1,429) (460)
-------- -------- --------
Cash flows from investing activities
Dividends received from bank 7,530 2,173 765
Cash dividends paid to shareowners (4,376) - -
Purchase of available for sale securities (2,328) (779)
Purchases of held to maturity securities (500) - -
Other investment activities (1,054) - -
-------- -------- --------
Net cash flows from investing activities (728) 1,394 765
-------- -------- --------
Cash flows from financing activities
Sales of common stock 755 384 390
Principal payments of long-term debt - (283) (294)
Other financing activities 4 (299) (274)
-------- -------- --------
Net cash flows from financing activities 759 (198) (178)
-------- -------- --------
Increase (decrease) in cash (71) (233) 127
Cash at beginning of year 121 354 227
Cash at end of year -------- -------- --------
$ 50 $ 121 $ 354
======== ======== ========
</TABLE>
NOTE EIGHTEEN - NEW ACCOUNTING PRONOUNCEMENTS
In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 137 entitled Accounting for
Derivative Instruments and Hedging Activities -Deferral of the Effective Date of
SFAS Statement No. 133. The statement amends SFAS No. 133 to defer its effective
date to all fiscal quarters of all fiscal years beginning after June 15, 2000.
Management does not believe the adoption of this statement will have a material
effect on its financial condition or results of operation.
-25-
<PAGE> 31
NOTE NINETEEN - UNAUDITED QUARTERLY FINANCIAL DATA - CONDENSED CONSOLIDATED
STATEMENT OF INCOME
<TABLE>
<CAPTION>
1999 Quarter Ended
In Thousands (Unaudited)
- ------------ -------------------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ -------- --------
<S> <C> <C> <C> <C>
Interest income $ 27,632 $ 26,568 $ 25,182 $ 24,307
Interest expense 10,946 10,304 9,814 9,673
-------- -------- -------- --------
Net interest income 16,686 16,264 15,368 14,634
Provision for loan losses (450) (1,100) (200) (300)
-------- -------- -------- --------
Net interest income after provision
for loan losses 16,236 15,164 15,168 14,334
Non interest income 1,267 2,023 1,350 1,244
Non interest expense 8,128 7,013 6,878 6,302
-------- -------- -------- --------
Income before income tax 9,375 10,174 9,640 9,276
Provision for federal income tax (2,860) (3,397) (3,266) (3,282)
-------- -------- -------- --------
Net Income $ 6,515 $ 6,777 $ 6,374 $ 5,994
======== ======== ======== ========
Basic earnings per common share $ 0.37 $ 0.39 $ 0.36 $ 0.34
Diluted earnings per common share $ 0.37 $ 0.38 $ 0.36 $ 0.34
Average basic shares outstanding 17,528 17,525 17,520 17,512
Average diluted shares outstanding 17,606 17,609 17,619 17,622
</TABLE>
<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 $ 0.33 $ 0.32 $ 0.31 $ 0.29
Diluted earnings per common share $ 0.32 $ 0.31 $ 0.30 $ 0.29
Average basic shares outstanding 17,356 17,350 17,344 17,335
Average diluted shares outstanding 17,571 17,598 17,576 17,550
</TABLE>
-26-
<PAGE> 32
FRONTIER FINANCIAL CORPORATION
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
- --------------------------------------------------------------------------------
OVERVIEW OF REPORTED RESULTS
The Corporation completed the most profitable year ever, and the twenty-first
consecutive year of increased net income. Net income for 1999 was $25.7 million,
up $4.0 million or 18.5%. Net income for 1998 was $21.6 million, up $3.1 million
or 16.4%, and net income in 1997 was $18.6 million, up 16.1% from 1996.
Highlights of 1999 include a 13.1% growth in net interest income, excellent
expense control, outstanding asset quality, and a strong allowance for credit
losses. Capital increased 14.0% and diluted earnings per share increased from
$1.23 to $1.46. Earnings per share have been adjusted to reflect the two-for-one
stock split in March 1999.
Return on average assets (ROA) was 2.15% in 1999; 2.06% in 1998; and 2.03% for
1997. Return on average equity (ROE) for 1999 was 18.43%; 1998 was 18.27%; and
1997 was 18.84%.
ECONOMIC CONDITIONS
The Bank's lending and other activities are concentrated in Snohomish County,
Washington. Snohomish County is located north of Seattle and is the state's
third largest county with an estimated population of 583,000. Everett, the
largest city in Snohomish County, is located approximately 30 miles north of
Seattle, and is home to the Corporation and the Boeing 747/777 plant. The
Corporation has diversified its geographic concentration over the years and now
has a market area which encompasses Skagit County, the contiguous county to the
north, and Whatcom County, which borders Canada, and is the contiguous county to
the north of Skagit County. The largest city in Skagit County is Mount Vernon,
and the largest city in Whatcom County is Bellingham. To the south of Snohomish
County, The Corporation has offices in King County and, in 1998 expanded further
south to Pierce County, which is the contiguous county south of King County. The
largest city in King County is Seattle, and the largest city in Pierce County is
Tacoma. All of these major cities are located on Interstate 5.
NATIONAL ECONOMIC CONDITIONS
The national economy continues to shift from manufacturing to services. The
results of re-engineering, downsizing, and new management programs are keeping
labor costs low and productivity growing. The economy has absorbed a swing from
a large budget deficit to a surplus with little adverse impact. While this has
occurred the national economy has exhibited some inflationary or wage pressures
as evidenced by the three increases in interest rates by the Federal Reserve
Board (FRB) in 1999, and one already in 2000.
Continued national real growth in the 2.5% to 3.5% range during the next 18
months will be good for the local area. Strength in the high technology, health
care, and telecommunication sectors will boost the local economy and keep demand
for Pacific Northwest output growing. Even the recent findings in the Microsoft
monopoly case should not have any significant adverse impacts in the immediate
future.
Fiscal policy will be neutral at best for the Puget Sound Region. The national
mood does not favor expanded federal government spending. Entitlement program
expenditures should remain relatively constant in real terms. While some
expansionary effects could be generated by a surplus-induced tax cut, only some
small tax reductions and code changes are expected.
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<PAGE> 33
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
Monetary policy is expected to remain mildly accommodating. The FRB will
continue watching for signs of inflation. While the FRB has recently moved
interest rates upward, it will take time for the increase to filter through the
economy before it is known if another increase is necessary.
STATE AND REGIONAL CONDITIONS
Boeing and Microsoft will have an effect on the region. Currently it is reported
that Airbus Industrie is outselling the Boeing Company throughout 1999 by a
ratio of two-to-one, making it the first year ever that this ratio is tilted
towards Airbus. However, company-wide, Wall Street is pleased with Boeing's
recent financial performance. Analysts support Boeing's decision to not pursue
unprofitable sales deals and focus on addressing costs. Resultantly, Boeing
stock rose 30% from the 1999 low. It is widely believed by the analysts that
once the company has regained cost controls, then Boeing will again take back
the market share with reduced prices and higher quality. It is reported that
Boeing has laid off more than 20,000 in 1999 in an effort to cut costs.
Worldwide demand for commercial aircraft is estimated to remain strong for
several years. Analysts project the annual growth rate for commercial aircraft
at around 7%. Because future growth is estimated to come from new customers
(developing nations), it will be important for Boeing to gain a strong
percentage of early orders. Boeing currently has an estimated worldwide market
share of 80%.
In the year 2000 the Puget Sound area will continue to slow in job growth as the
Boeing layoffs continue into the summer months. By the end of the year, another
8,000 to 10,000 jobs will be cut from Boeing in the region. The area can expect
the unemployment rate to reach into the "fours" for the first time since
February of 1997. Snohomish County may not fare quite as well. With most of the
Boeing labor reductions happening at the Everett facility, Snohomish County's
job growth rate will be in the negative numbers.
The ruling that Microsoft is a monopoly could also have a regional impact. While
a break-up of the company may be ordered, the decision will be appealed and may
take several years to resolve. During this time, Microsoft will probably
continue business as usual adding about 2,000 jobs per year. The only immediate
concern is the possible dampening effect of a collapse in the stock price, since
most of the stock is held by Puget Sound residents.
High technology/software technology is becoming more important in the Puget
Sound area. According to the Puget Sound Business Journal, software has
surpassed aerospace as the largest source of personal income in the Puget Sound
region. In 1998, 23,500 software workers received $6.77 billion in compensation
(most of this valuation is due to software stock options), while the 110,000
aerospace workers received $5.98 billion.
Increased construction of multifamily units has occurred throughout the Puget
Sound region. In fact, the rental and vacancy research firm of Dupree & Scott
believe that 1999/2000 will be the biggest construction year since 1990. Their
latest forecast indicates 6,400 multifamily units will open in the Puget Sound
region throughout this time period. That compares to a reported 3,363 units
opened in 1998. However, it should be noted that while the economy begins to
slow down the firm believes that about half of the new units scheduled to open
this year will be needed. This potential oversupply of units will most likely
keep vacancies on the rise and put a downward pressure on rent price increases.
The Corporation is cautiously optimistic regarding the regional economy and the
level of future business opportunities for the Corporation.
The economic facts noted above came from the following sources: Pierce and
Snohomish County Economic Development Councils and the Puget Sound Business
Journal.
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<PAGE> 34
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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 1999, assets increased $97.7 million, or 8.5%;
increased $174.8 million or 18.0% in 1998; and increased $98.1 million, or 11.2%
in 1997. Average earning assets and their percentage of total average assets
(see page 40), were $1.1 billion in 1999, or 95.0%, $994.7 million or 94.9% in
1998; and 95.1%, or $870.7 million in 1997. Local economic conditions, the
merger with Valley Bancorporation in 1998, and a strong business development
plan were the largest factors contributing to the growth in earning assets from
1997 through 1999.
Total loans increased $155.1 million, or 17.3% in 1999; $161.2 million, or 21.9%
in 1998; and $79.3 million or 12.1% in 1997. See page 30 for detailed discussion
of loans. Investment securities declined $14.1 million last year, or 9.7% from
the previous year. In 1998 the investment portfolio increased $29.6 million or
25.5%, 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%. The reason for the decline in 1997
was to shift funds from maturing investments into the loan portfolio. In 1999
federal funds sold ran off due to loan growth. 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 reason for the change in the
size of the portfolio over the last three years is due to asset/liability
management of funding sources necessary when loan growth fluctuates. If loan
growth exceeds funding from the liability side of the balance sheet, it becomes
necessary to allow investments to run-off so the funds can be used for loan
growth. It is expected that these types of fluctuations in the size of the
portfolio will continue in the future.
The primary source of funds for earning assets are deposits and borrowings. In
1999 total deposits were up $40.1 million or 4.3%. Total deposits were up $116.3
million, or 14.4% in 1998; and $78.0 million, or 10.6% in 1997. At periods ended
December 31, 1999, Money Market and NOW accounts were up $1.9 million, or 1.4%
in 1999; up $17.2 million, or 14.4% in 1998; and up $24.8 million, or 26.1% in
1997. Savings deposits were up $10.5 million, or 5.7% in 1999; up $18.6 million,
or 11.2% in 1998; and up $8.1 million, or 5.1% in 1997. The category which had
the largest deposit increase for 1999 and 1998 was time deposits, which
increased $30.2 million in 1999 or 6.6%; increased $52.3 million, or 12.9% in
1998; and increased $19.5 million or 5.1% in 1997. A slowing of the growth in
deposits in 1999 and 1997, (as compared to the growth of loans) was planned by
management, due to the growth of the loan portfolio.
Borrowings from the FHLB increased $45.0 million in 1999, or 89.6%. In 1998
borrowings increased $20.2 million, or 67.4% and in 1997 decreased $5.3 million,
or 14.9%. Over the last two years the Corporation has become more dependent on
FHLB borrowings to fund asset growth. This is for two reasons. First, FHLB
borrowings are, most of the time, less costly than cd's. Second, the Corporation
can take on a specific size of borrowing and with a specific maturity date. This
helps make asset/liability management easier. For the immediate future, the
Corporation will continue to rely on this type of funding.
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<PAGE> 35
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 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 1999, the average yield on earning assets declined 27 basis points and the
average cost of interest bearing liabilities decreased 28 basis points. 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. In 1999, the decrease in spread was anticipated
due to the rising cost of funds, and competition factors. Loans took the largest
drop in yield from 10.17% in 1998 to 9.66% in 1999. On the liability side of the
balance sheet, time deposits declined in cost to 5.37% from 5.72%, or 35 basis
points. Three prime rate increases of 25 basis points each helped to maintain
the net interest margin during 1999. 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 40 for further detail.)
The net yield on interest earning assets (net interest margin) was 5.65% in
1999, 5.69% in 1998, and 5.73% in 1997. (See "Liquidity and Interest
Sensitivity" in this section.) As noted on page 41 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.
(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 $64.1 million in 1999, an
increase of $7.6 million or 13.4%; totaled $56.5 million in 1998, an increase of
$6.6 million, or 13.3% and totaled $49.9 million in 1997, an increase of $7.0
million, or 16.3% over 1996. Table 2 indicates that of the $7.6 million increase
in net interest income in 1999, there was an increase in interest income of
$10.4 million and an increase in interest expense of $2.8 million, which leaves
a net increase in net interest income of $7.6 million. 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 an increase of $9.3 million in interest income, and
an increase in interest expense of $2.3 million, which leaves a net increase in
interest income of $7.0 million.
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<PAGE> 36
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
LOAN PORTFOLIO
Average loans grew by $163.4 million or 20.1% in 1999; by $108.6 million, or
15.4% in 1998; and by $95.1 million, or 15.6% in 1997. In 1999, average real
estate construction loans had the largest dollar increase of $80.5 million, or
an increase of 53.2%, followed by real estate commercial loans which increased
$76.6 million or 22.9%. 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%.
The average yield on loans declined in 1999 to 9.66% from 10.17%. During this
period the Corporation increased its prime rate three times from 7.75% to 8.50%.
Approximately 30% of the loan portfolio repriced during this period which helped
to maintain a net interest margin in the 5.60% to 5.70% range. The average yield
on loans in 1998 slipped to 10.17% from 10.37% in 1997. 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. 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 $11.4 million in 1999, or 13.8%;
$9.5 million, or 13.1% in 1998; and $9.8 million, or 15.6% in 1997. The earnings
on the $163.4 million increase in average balance of loans increased interest
income $17.4 million and a decline in the average rates decreased interest
income by $5.7 million. 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 Bank has a VISA card department which began operations in 1993. At year-end
1999, the department had $17.9 million in credit lines and $3.0 million in
outstanding balances. 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. The Bank also provides debit cards to customers, and had nineteen ATM's
at year-end 1999.
LOAN LOSS PROVISION
The provision for loan losses increased $250 thousand, or 13.9% in 1999;
decreased $295 thousand in 1998, or 14.1%; and decreased $38 thousand, or 1.8%
in 1997. The Corporation has had excellent loan quality over the last several
years, and excellent recoveries as well.
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<PAGE> 37
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
The allowance for loan losses was 1.87% of the total loans in 1999; 2.01% of
total loans in 1998; and 2.15% of total loans in 1997. 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 1999, 1998, and 1997,
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
and to the Corporation's Report on Form 10-K for year then ended 1999.
The allowance for loan losses as a percent of impaired loans was 864% in 1999;
769% in 1998, and 275% in 1997. 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 or decrease the allowance include
concerns about the Northwest's economic environment, regional trends, and
adverse effect of changes in government regulation and taxation.
INVESTMENTS
Total interest income from investments, including federal funds sold, decreased
$1.2 million in 1999, or 11.2%; increased $686 thousand in 1998, or 6.6%; and
decreased $459 thousand in 1997, or 4.2%. The decrease of $22.2 million in the
average balance of investments decreased interest income by $832 thousand, and
the drop in rates decreased income by $404 thousand. The increase 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.
There were no realized gains or losses in securities during the last three
years.
INTEREST EXPENSE
Total interest and borrowing expense for 1999 increased $2.8 million, or 7.5%;
increased $3.5 million, or 10.2% in 1998; and increased $2.3 million, or 7.2% in
1997. The increase of $109.6 million in the average balances of interest bearing
liabilities increased interest expense by $5.5 million, and the decline in rates
decreased interest expense by $2.6 million. 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 1999, the increase in the average balances of interest bearing core deposits
increased interest expense by $3.0 million, while a decline in interest rates
decreased interest expense by $2.4 million. Increases of $46.3 million in the
average balances of borrowings increased interest expense by $2.5 million, while
a decline in rates reduced interest expense by $258 thousand. 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-term and
other borrowings 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 other borrowings increased interest expense by $378 thousand, and a net
reduction in the rates of two categories decreased interest expense by $5
thousand.
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<PAGE> 38
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
OTHER NONINTEREST INCOME
Noninterest income totaled $5.9 million in 1999, up $556 thousand, or 10.4%;
$5.3 million in 1998, up $1 million from 1997, or 22.1%; and totaled $4.4
million in 1997, up $203 thousand, or 4.9%. In 1999, service charges totaled
$2.3 million, up from $2.0 million or 14.5%. In 1998, service charges increased
$43 thousand, or 2.2%; and increased $110 thousand, or 5.6% in 1997. The number
of accounts susceptible to service charges increased by 518 in 1999, or 2.5%; by
1,172, or 5.8% in 1998; and increased by 2,248, or 12.5% in 1997.
Other income increased $266 thousand, or 8.0% in 1999; increased $920 thousand
in 1998, or 38.2%; and increased $93 thousand in 1997, or 4.0%. However, other
income for 1999 and 1998 contain gains realized on the sale of other real estate
owned of $732 thousand and $232 thousand, respectively. If those amounts are
extracted, core other income earnings were $2.9 million and $3.1 million,
respectively or a decrease in 1999 of $234 thousand or 7.6%. The major reasons
for this decline in 1999 was a decrease in real estate broker loan fees of $205
thousand, or 47.7% and a decrease in real estate servicing fees of $130 thousand
or 37.6%. Areas where increases occurred were the Trust Department which posted
a 1999 gain in net income of $103 thousand over 1998, or 10.5% and insurance and
financial service fees which increased to $365 thousand from $304 thousand in
1998, or a 20.1% increase. Due to the increase in interest rates over the past
year, and the potential for higher rates in 2000, management does not expect
that broker loan fees and loan servicing fees will increase in the near future.
The increase in 1998 was due to several factors. Trust department net 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
in 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 net income 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.
As previously stated, trust department income increased $103 thousand, or 10.5%;
in 1999; $144 thousand, or 17.2% in 1998; and increased $122 thousand, or 17.0%
in 1997. The market value of trust assets managed at year-end 1999 were $197.1
million, up $38.3 million or 24.0%; 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.
OTHER NONINTEREST EXPENSE
Total noninterest expenses increased $1.6 million in 1999, or 6.1% to $28.3
million; $3.2 million, or 13.4% to $26.7 million in 1998; and increased $3.3
million, or 16.2% to $23.5 million in 1997.
Salary and employee benefits increased $1.3 million in 1999, or 8.2%; $1.7
million, or 11.8% in 1998; and increased $1.8 million, or 14.7% in 1997. The
increase in salaries, only, for 1999 was $594 thousand or 5.1%. This increase
was due to increased staff of 8.0%. The increase in salaries for 1998 was $1.5
million, or 15.2%; and in 1997 was $1.3 million, up 14.9%. 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.
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<PAGE> 39
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
Employee benefits for 1999 increased $704 thousand or 16.6%. Employee benefits
increased $140 thousand, or 3.4% in 1998; and increased $512 thousand, or 14.2%
in 1997. The majority of the increase was due to increased profit sharing
contributions and Christmas bonuses of $531 thousand, or 26.3% over 1998, and
medical insurance premium increases of $106 thousand or 16.7%. The increase in
1998 was due to an increase in medical insurance premium of $66 thousand, and an
increase in the vacation accrual 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%.
Occupancy expense was up $350 thousand, or 10.6% in 1999; $54 thousand in 1998,
or 1.7%; and up $515 thousand, or 18.8% in 1997. In 1999, 36% of occupancy
expense was depreciation, which declined from $1.4 million in 1998 to $1.3
million, or 7.4%. The increase in occupancy expense was due to increase in
janitorial, building maintenance and utilities of $197 thousand, software
expense and maintenance agreements, which increased $214 thousand. 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 $341 thousand.
The remaining other expenses decreased $29 thousand in 1999 to $7.5 million.
Adjustments for core expenses reduced expenses by $243 thousand in 1999 and $130
thousand in 1998. The decline in expenses in 1999 was primarily due to operating
expenses pursuant to the merger with Valley Bancorporation in 1998. Legal fees
were down $392 thousand or 79.2%; professional fees were down $180 thousand or
100%, and data processing services were down $198 thousand, or 68.3%. The only
significant increase in other expenses in 1999 was marketing expenses which
increased $175 thousand due mainly to promotion of the franchise. 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.
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 amortization of intangibles, gains and losses on ORE and sale of
assets, and other non-recurring gains or losses. The lower the number, the more
efficient the organization. The Corporation's efficiency ratio for 1999 was 41%,
1998 was 43%, and 44% for 1997. 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.
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<PAGE> 40
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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
1999 contributed $25.7 million to liquidity; net income for 1998 contributed
$21.6 million to liquidity; and in 1997 contributed $18.6 million to liquidity.
Borrowing represents an important and manageable source of liquidity based on
the Corporation's ability to raise new funds and renew maturing liabilities in a
variety of markets. Liquidity is also obtained by maintaining assets that are
readily convertible to cash at minimal cost through maturities and sales.
Deposits generated through the Corporation's branch network is the most
important source of liquidity. In 1999, core deposits (Money Market, NOW and
Savings accounts) funded $10.0 million of the $157.5 million growth in loans.
Contributing to that growth was cd's in the amount of $30.2 million and the
primary contributor of a net $45.0 million in advances from the FHLB. Also
contributing to the growth was the maturity of available for sale and held to
maturity securities in the net amount of $54.8 million. In 1998, core deposits
funded $64.0 million of the $159.8 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 $28.3 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.
Prior to 1999, the financing of investment activities was mainly through core
deposit growth and cd's. In 1999, net FHLB advances were the primary funding
source and it is expected that this trend will continue into 2000.
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.
-35-
<PAGE> 41
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
The charts below indicate the maturity schedule for earning assets as of
December 31, 1999 and 1998:
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, 1999 Year Years 5 Years Cost Value Value
-------- -------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Investments $ 18,196 $ 29,348 $ 89,036 $ 136,580 $ 131,875 11.3%
Loans 370,000 525,676 157,538 1,053,214 1,031,374 88.7%
-------- -------- -------- ---------- ---------- -------
Total $388,196 $555,024 $246,574 $1,189,794 $1,163,249 100.0%
======== ======== ======== ========== ========== ======
</TABLE>
<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>
As indicated in the chart, in 1999, $388.2 million or 33.4% of aggregate fair
value assets were available for liquidity at year-end. In 1998 $400.6 million,
or 36.7% 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 1999, the bank has a pre-approved credit line up to $185.4
million from Seattle FHLB. However, assets must be pledged to secure these
borrowings. Currently borrowings are $95.2 million. AFS securities totaling
$103.5 million could be sold for liquidity purposes. The Corporation could also
issue cd's to public entities exceeding $79.6 million more than currently
issued. Additionally, participation in the treasury department's short-term note
program is available along with potential borrowings from the Federal Reserve
Bank of San Francisco and other correspondent banks.
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.
-36-
<PAGE> 42
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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, 1999, 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.
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, 1999. 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 6.5% per year; for NOW and
money market accounts is 7.7% per year; and for savings accounts is 9.0% per
year. The weighted average interest rates for financial instruments presented
are actual for 1999, and are shown on page 40 of this report. Please refer to
Note 16 on page 23 of this report for details regarding estimated fair value
amounts.
-37-
<PAGE> 43
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, 1999 is
shown in the following table:
<TABLE>
<CAPTION>
Expected Maturity Date
---------------------------------------------------------------------------
In Thousands 2000 2001 2002 2003 2004
- ------------ -------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Financial Assets
Cash and cash equivalents
Noninterest bearing $ 44,858 - - - -
Securities available for sale
Fixed Rate 18,041 $ 2,820 $ 3,699 $ 12,921 $ 2,897
Weighted average interest rate 6.26% 7.60% 6.73% 6.43% 6.85%
Variable rate - - - - -
Weighted average interest rate
Securities held to maturity
Fixed Rate 155 256 1,009 2,273 3,471
Weighted average interest rate 9.45% 9.26% 10.24% 9.04% 8.92%
Loans Receivable, net
Fixed Rate 112,347 78,357 92,011 128,188 164,978
Weighted average interest rate 8.83% 9.03% 9.05% 8.68% 8.47%
Variable rate 257,653 39,671 5,608 12,002 4,861
Weighted average interest rate 9.61% 9.64% 9.49% 9.29% 9.42%
Financial Liabilities
Noninterest bearing deposits 9,462 8,847 8,272 7,734 7,231
NOW and Money Market accounts 10,694 9,871 9,111 8,409 7,762
Weighted average interest rate 3.28% 3.28% 3.28% 3.28% 3.28%
Savings accounts 17,527 15,949 14,514 13,207 12,019
Weighted average interest rate 2.87% 2.87% 2.87% 2.87% 2.87%
Time Certificates
Fixed Rate 416,864 32,412 8,945 13,449 12,197
Weighted average interest rate 5.41% 5.53% 5.71% 5.79% 5.64%
Variable rate 2,578 - - - -
Weighted average interest rate 4.93%
Federal funds purchased
Variable rate 6,660 - - - -
Weighted average interest rate 4.96%
Securities sold under agreements
to repurchase
Variable rate 21,892 - - - -
Weighted average interest rate 4.90%
FHLB advances
Fixed Rate 75,000 5,019 5,000 5,000 -
Weighted average interest rate 5.28% 5.80% 4.84% 5.52%
</TABLE>
<TABLE>
Fair
In Thousands Thereafter Total Value
- ------------ ---------- --------- --------
<S> <C> <C> <C>
Financial Assets
Cash and cash equivalents
Noninterest bearing - $ 44,858 $ 44,858
Securities available for sale
Fixed Rate $ 67,655 108,033 102,967
Weighted average interest rate 6.37% 6.41%
Variable rate 500 500 500
Weighted average interest rate 8.62% 8.62%
Securities held to maturity
Fixed Rate 20,883 28,047 28,408
Weighted average interest rate 8.34% 8.55%
Loans Receivable, net
Fixed Rate 116,938 692,819 678,735
Weighted average interest rate 7.94% 8.64%
Variable rate 40,600 360,395 352,639
Weighted average interest rate 8.56% 9.48%
Financial Liabilities
Noninterest bearing deposits 104,019 145,565 145,565
NOW and Money Market accounts 93,037 138,884 138,884
Weighted average interest rate 3.28% 3.28%
Savings accounts 121,523 194,739 194,739
Weighted average interest rate 2.87% 2.87%
Time Certificates
Fixed Rate 1,147 485,014 483,831
Weighted average interest rate 5.75% 5.44%
Variable rate - 2,578 2,578
Weighted average interest rate 4.93%
Federal funds purchased
Variable rate - 6,660 6,660
Weighted average interest rate 4.96%
Securities sold under agreements
to repurchase
Variable rate - 21,892 21,892
Weighted average interest rate 4.90%
FHLB advances
Fixed Rate 5,170 95,189 93,818
Weighted average interest rate 5.61% 5.42%
</TABLE>
-38-
<PAGE> 44
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 $18.1 million, or 14.0% in 1999 to $147.4 million; $21.9 million or
20.4% in 1998 to $129.2 million, and increased $19.0 million in 1997, or 21.5%
to $107.4 million. In 1999, capital increased by $25.7 million due to retained
earnings which were offset by cash dividends paid of $4.4 million, and the
decrease in the market value of available for sale securities of $3.9 million.
The remaining $700 thousand difference is the capital acquired through exercise
of stock options. 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.
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 1999, based on the average number of shares outstanding for the
year, NASDAQ reported trade volume was approximately 1,402,000 shares, or 8%.
During 1999, the market price of the common stock ranged from $19.00 to $26.00.
The average price for the year was $22.76.
At December 31, 1999, the total number of shareowners of record of Frontier
Financial Corporation's common stock was 3,401, and there were 17,545,587 shares
outstanding.
Management has established an objective to maximize the rate of internal capital
growth as the means of maintaining capital adequacy. Prior to 1999 the
Corporation had always paid stock dividends which ranged from 10% to 7%. In
1999, the Board of Directors declared the first annual cash dividend of $.25 per
share on post two-for-one split shares. On January 19, 2000, the Board of
Directors declared the first quarterly dividend of $.09 per share to shareowners
of record as of January 28, 2000 and payable on February 11, 2000. The Board
will continue to review the dividend policy on a quarterly basis. Concurrently,
the Board announced the adoption of a stock repurchase program authorizing the
Corporation to repurchase up to 5% of its outstanding stock in the open market
over the next two years. Additionally, the Corporation has had six stock splits
since the Bank opened in 1978.
IMPACT OF THE YEAR 2000 ISSUE
The rollover into the Year 2000 was a non-event for the Corporation and it does
not anticipate any problems during 2000, however the Corporation continues to be
vigilant monitoring its loan portfolio and customer base for potential emerging
problems.
FORWARD LOOKING STATMENTS
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.
-39-
<PAGE> 45
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
AVERAGE BALANCES AND TAX-EQUIVALENT NET INTEREST MARGIN - TABLE 1
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------
1999 1998
-------------------------------- ----------------------------------
In Thousands Average Average
Interest Rates Interest Rates
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
---------- -------- ------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest Earning Assets
Taxable investments $ 116,464 $ 7,483 6.43% $ 90,359 $ 6,092 6.74%
Nontaxable investments (1) 27,879 2,396 8.59% 28,557 2,428 8.50%
--------- -------- ----- ---------- ------- -----
Total 144,343 9,879 6.84% 118,916 8,520 7.16%
--------- -------- ----- ---------- ------- -----
Federal funds sold 16,530 823 4.98% 63,962 3,417 5.34%
Loans(2)
Installment 31,882 3,041 9.54% 29,830 2,849 9.55%
Commercial(1) 200,239 18,763 9.37% 190,307 18,938 9.95%
Real estate
Commercial 410,794 37,612 9.16% 334,235 32,228 9.64%
Construction 231,861 25,337 10.93% 151,384 17,620 11.64%
Residential 100,517 9,428 9.38% 106,110 10,897 10.27%
--------- -------- ----- ---------- ------- -----
Total 975,293 94,181 9.66% 811,866 82,532 10.17%
--------- -------- ----- ---------- ------- -----
Total earning assets/total interest income 1,136,166 $104,883 9.23% 994,744 $94,469 9.50%
---------- -------- ----- ---------- ------- -----
Reserve for loan losses (18,733) (16,936)
Cash and due from banks 44,332 39,635
Other assets 32,972 31,011
---------- ----------
TOTAL ASSETS $1,194,737 $1,048,454
========== ==========
Interest Bearing Liabilities
Money Market & NOW accounts $ 132,100 $ 3,396 2.57% $ 121,932 $ 3,491 2.86%
Savings accounts 190,935 6,918 3.62% 174,311 6,652 3.82%
Other time deposits 466,951 25,064 5.37% 430,472 24,605 5.72%
---------- -------- ----- ---------- ------- -----
Total interest bearing deposits 789,986 35,378 4.48% 726,715 34,748 4.78%
-----
Short-term borrowings 34,449 1,571 4.56% 24,530 1,196 4.88%
Other borrowings 71,934 3,788 5.27% 35,565 1,946 5.47%
---------- -------- ----- ---------- ------- -----
Total interest bearing liabilities/
total interest expense 896,369 40,737 4.54% 786,810 37,890 4.82%
---------- -------- ----- ---------- ------- -----
Noninterest bearing deposits 148,441 133,340
Other liabilities 10,710 9,806
Shareowners' equity 139,217 118,498
========== ==========
TOTAL LIABILITIES AND CAPITAL $1,194,737 $1,048,454
========== ==========
NET INTEREST INCOME $ 64,146 $56,579
======== =======
NET YIELD ON INTEREST EARNING ASSETS 5.65% 5.69%
==== =====
</TABLE>
<TABLE>
Year Ended December 31,
--------------------------------
1997
--------------------------------
In Thousands Average
- ------------- Interest Rates
Average Income/ Earned/
Balance Expense Paid
---------- -------- -------
<S> <C> <C> <C>
Interest Earning Assets
Taxable investments $ 91,874 $ 6,218 6.77%
Nontaxable investments (1) 30,309 2,661 8.78%
-------- ------- -----
Total 122,183 8,879 7.27%
-------- ------- -----
Federal funds sold 45,198 2,479 5.48%
Loans(2)
Installment 27,271 2,651 9.72%
Commercial(1) 148,786 15,534 10.44%
Real estate
Commercial 282,904 27,846 9.84%
Construction 138,271 16,233 11.74%
Residential 106,043 10,691 10.08%
-------- ------- -----
Total 703,275 72,955 10.37%
-------- ------- -----
Total earning assets/total interest income 870,656 $84,313 9.68%
-------- ------- -----
Reserve for loan losses (14,931)
Cash and due from banks 31,240
Other assets 28,183
--------
TOTAL ASSETS $915,148
========
Interest Bearing Liabilitie
Money Market & NOW accounts $102,704 $ 3,071 2.99%
Savings accounts 161,542 6,282 3.89%
Other time deposits 388,585 22,554 5.80%
-------- ------- -----
Total interest bearing deposits 652,831 31,907 4.89%
Short-term borrowings 15,198 762 5.01%
Other borrowings 31,201 1,720 5.51%
-------- ------- -----
Total interest bearing liabilities/
total interest expense 699,230 34,389 4.92%
-------- ------- -----
Noninterest bearing deposits 109,340
Other liabilities 7,882
Shareowners' equity 98,696
========
TOTAL LIABILITIES AND CAPITAL $915,148
========
NET INTEREST INCOME $49,924
=======
NET YIELD ON INTEREST EARNING ASSETS 5.73%
=====
</TABLE>
(1) Includes amounts to convert nontaxable amounts to a fully taxable equivalent
basis at a 35% tax rate.
(2) Includes nonaccruing loans.
-40-
<PAGE> 46
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME - TABLE 2
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------------------------------
1999 versus 1998 1998 versus 1997
----------------------------------------------------------------------
Increase (Decrease) Due Increase (Decrease) Due
In Thousands to Change in to Change in
- ------------ ----------------------------------- ---------------------------------
Total Total
Average Average Increase Average Average Increase
Volume Rate (Decrease) Volume Rate (Decrease)
-------- ------- ---------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Taxable investments $ 1,761 $ (370) $ 1,391 $ (103) $ (23) $ (126)
Nontaxable investments (58) 26 (32) (154) (79) (233)
------- ------- ------- ------- ------- ------
Total 1,703 (344) 1,359 (257) (102) (359)
------- ------- ------- ------- ------- ------
Federal funds sold (2,534) (60) (2,594) 1,029 (91) 938
Loans
Installment 196 (4) 192 249 (51) 198
Commercial 988 (1,163) (175) 4,335 (931) 3,404
Real estate
Commercial 7,381 (1,997) 5,384 5,052 (670) 4,382
Construction 9,367 (1,650) 7,717 1,539 (153) 1,386
Residential (574) (895) (1,469) 7 199 206
------- ------- ------- ------- ------- ------
Total 17,358 (5,709) 11,649 11,182 (1,606) 9,576
TOTAL INTEREST INCOME 16,527 (6,113) 10,414 11,954 (1,799) 10,155
------- ------- ------- ------- ------- ------
INTEREST EXPENSE
Money Market &
NOW accounts 291 (386) (95) 575 (155) 420
Savings accounts 634 (368) 266 497 (127) 370
Other time deposits 2,084 (1,625) 459 2,431 (381) 2,050
------- ------- ------- ------- ------- ------
Total interest
bearing
deposits 3,009 (2,379) 630 3,503 (663) 2,840
Short-term borrowings 484 (109) 375 468 (34) 434
Long-term debt 1,991 (149) 1,842 241 (15) 226
------- ------- ------- ------- ------- ------
TOTAL INTEREST EXPENSE 5,484 (2,637) 2,847 4,212 (712) 3,500
------- ------- ------- ------- ------- ------
CHANGE IN NET INTEREST INCOME $11,043 $(3,476) $ 7,567 $ 7,742 $(1,087) $6,655
======= ======= ======= ======= ======= ======
</TABLE>
<TABLE>
Year ended December 31,
---------------------------------------
1997 versus 1996
---------------------------------------
Increase (Decrease) Due
In Thousands to Change in
- ------------ ----------------------------------------
Total
Average Average Increase
Volume Rate (Decrease)
------- ------- ----------
<S> <C> <C> <C>
INTEREST INCOME
Taxable investments $(1,295) $ 104 $(1,191)
Nontaxable investments (92) (61) (153)
------- ----- -------
Total (1,387) 43 (1,344)
Federal funds sold 784 49 833
Loans
Installment 323 (21) 302
Commercial 206 246 452
Real estate
Commercial 5,603 (182) 5,421
Construction 2,906 (279) 2,627
Residential 884 147 1,031
------- ----- -------
Total 9,922 (89) 9,833
TOTAL INTEREST INCOME 9,319 3 9,322
------- ----- -------
INTEREST EXPENSE
Money Market &
NOW accounts 589 28 617
Savings accounts 244 (43) 201
Other time deposits 1,571 (445) 1,126
------- ----- -------
Total interest
bearing
deposits 2,404 (460) 1,944
Short-term borrowings 204 19 223
Long-term debt 174 (14) 160
------- ----- -------
TOTAL INTEREST EXPENSE 2,782 (455) 2,327
------- ----- -------
CHANGE IN NET INTEREST INCOME $ 6,537 $ 458 $ 6,995
======= ===== =======
</TABLE>
-41-
<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>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 44,796
<INT-BEARING-DEPOSITS> 62
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 103,467
<INVESTMENTS-CARRYING> 28,047
<INVESTMENTS-MARKET> 28,408
<LOANS> 1,053,214
<ALLOWANCE> (19,651)
<TOTAL-ASSETS> 1,245,616
<DEPOSITS> 966,780
<SHORT-TERM> 28,552
<LIABILITIES-OTHER> 7,726
<LONG-TERM> 95,189
0
0
<COMMON> 91,302
<OTHER-SE> 56,067
<TOTAL-LIABILITIES-AND-EQUITY> 1,245,616
<INTEREST-LOAN> 93,825
<INTEREST-INVEST> 9,864
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 103,689
<INTEREST-DEPOSIT> 35,378
<INTEREST-EXPENSE> 40,737
<INTEREST-INCOME-NET> 62,952
<LOAN-LOSSES> (2,050)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 28,321
<INCOME-PRETAX> 38,465
<INCOME-PRE-EXTRAORDINARY> 25,660
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 25,660
<EPS-BASIC> 1.46
<EPS-DILUTED> 1.46
<YIELD-ACTUAL> 5.65
<LOANS-NON> 1,538
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 18,098
<CHARGE-OFFS> (867)
<RECOVERIES> 370
<ALLOWANCE-CLOSE> 19,651
<ALLOWANCE-DOMESTIC> 19,651
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
