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, 2001
Commission File Number 000-15540
FRONTIER FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Washington 91-1223535
- ------------ -----------------
(State or Other Jurisdiction of (IRS Employer Identification
Incorporated 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 (ss.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 February 28,
2002 was $414,793,665 based on the average high/low price at February 28, 2002.
The issuer has one class of common stock (no par value) with 19,184,879 shares
outstanding as of December 31, 2001, and 19,193,107 outstanding as of February
28, 2002.
Documents Incorporated by Reference
Annual Report to Shareowners for the year ended December 31, 2001 Proxy
Statement dated March 8, 2002
TABLE OF CONTENTS
Annual
Shareholders' Proxy
Form 10-K Report Statement
Item Number Page Page Page
- ----------- ------------ ------------------- -----------------
PART I
1 Business 1-11
Statistical Disclosure Index 13
2 Properties 23
3 Legal Proceedings 23
4 Submission of Matters to
a Vote of Shareowners 23
PART II
5 Market for Registrant's Common
Equity and Related Shareowner
Matters 24 17, 41
6 Selected Financial Data 24
7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations 29-41
7a Quantitative and Qualitative
Disclosures about Market Risk 36-40
8 Financial Statements and
Supplementary Data 25
9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure 25
PART III
10 Directors and Executive
Officers of Frontier
Financial Corporation 26 2-9
11 Executive Compensation 7-11
12 Security Ownership of Certain 26
Beneficial Owners and
Management 5-6
13 Certain Relationships and
Related Transactions 26 21 14
PART IV
14 Exhibits, Financial Statement
Schedules, and Reports on Form 8-K 28
Signatures 29
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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 financial
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 in the State of Washington,
including the acceptance of demand, time and savings deposits and the making of
loans. As of December 31, 2001, the Bank conducted its business operations out
of 38 offices located in Clallam, Jefferson, King, Kitsap, Pierce, Skagit,
Snohomish, and Whatcom counties, which is the Bank's principal market area. Four
offices are located in Everett, one office each is located in Arlington, Duvall,
Snohomish, Smokey Point, Lake Stevens, Kirkland, Marysville, Lynnwood, Mill
Creek, Mount Vernon, Edmonds, Stanwood, Bothell, Woodinville, Monroe, Lake City
(Seattle), Totem Lake, Tacoma, Kent, Redmond, Burlington, Bellingham and four
offices located in Pierce county in the cities of Sumner, Puyallup, Orting and
Buckley. In addition, the following eight branches are located in Clallam,
Jefferson and Kitsap counties; two branches in Poulsbo, and one each are in
Bainbridge Island, Port Angeles, Port Hadlock, Port Townsend, Sequim and
Silverdale. Acquired in the merger with Interbancorp, Inc. (InterBank) which was
consummated in February 2001, were three branches located in King County in the
cities of Duvall, Kirkland and Totem Lake.
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,
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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.
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, the Bank
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 began use in the second quarter of 2001.
In May 2001, the Bank opened an office in Kent, Washington, which is south of
Seattle. In July 2001, the Bank acquired, through merger, North Sound Bank, with
eight offices, a real estate origination department and a financial services
company. These offices provide a full range of consumer and commercial banking
services.
In February 2001, the Bank acquired, through merger, InterBank, with two
operating offices and one office approved but not yet opened, which has
subsequently been opened for business. Additionally, Inter Bank had a real
estate origination office. These offices provide a full range of consumer and
commercial banking services
Employees
At December 31, 2001, the Bank had 579 full time equivalent employees. The Bank
considers its relations with employees to be good.
Competition
All phases of the Bank's activities are highly competitive. Management believes
that the principal competitive factors affecting the Corporation's markets
include interest rates paid on deposits and charged on loans, the range of
banking products available, and customer service and support. 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,
2001, the Bank had total assets of $1.807 billion and deposits of $1.498
billion.
REGULATION AND SUPERVISION
To the extent that the following information describes statutory and regulatory
provisions, it is qualified in its entirety by reference to the full text of
those provisions. Also, such statutes, regulations and policies are continually
under review by Congress and state legislatures and federal and state regulatory
agencies. A change in statutes, regulations or regulatory policies applicable to
FFC could have a material effect on the business of FFC.
2
Introduction
FFC, its banking and nonbanking subsidiaries, are subject to extensive
regulation by federal and state agencies. The regulation of bank holding
companies and their subsidiaries is intended primarily for the protection of
depositors, federal deposit insurance funds and the banking system as a whole
and not for the protection of security holders.
As discussed in more detail below, this regulatory environment, among other
things, may restrict FFC's ability to diversify into certain areas of financial
services and pay dividends on its capital stock. It may also require FFC to
provide financial support to its banking subsidiary, maintain capital balances
in excess of those desired by management and pay higher deposit insurance
premiums as a result of the deterioration in the financial condition of
depository institutions in general.
Holding Company Structure
FFC 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 (the "Bank
Holding Company Act"). As part of a plan of reorganization consummated following
the close of business on 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. Effective October 28, 2000, FFC became a financial holding company.
Source of Strength Doctrine. Under current FRB policy, FFC is expected to act as
a source of financial and managerial strength to its subsidiary bank and, under
appropriate circumstances, to commit resources to support such subsidiary bank.
Capital loans from FFC to its subsidiary bank is subordinate in right of payment
to deposits and certain other indebtedness of the subsidiary bank. In the event
of FFC's bankruptcy, any commitment by FFC to a federal bank regulatory agency
to maintain the capital of a subsidiary bank will be assumed by the bankruptcy
trustee and entitled to a priority of payment.
Depositor Preference. The Federal Deposit Insurance Act ("FDI Act") provides
that, in the event of the "liquidation or other resolution" of an insured
depository institution, the claims of depositors of the institution, including
the claims of the FDIC as subrogee of insured depositors, and certain claims for
administrative expenses of the FDIC as a receiver will have priority over other
general unsecured claims against the institution. If an insured depository
institution fails, insured and uninsured depositors, along with the FDIC, will
have priority in payment ahead of unsecured, nondeposit creditors, including
FFC, with respect to any extensions of credit they have made to such insured
depository institution.
Regulatory Agencies
Bank Holding Company. FFC, as a bank holding company, is subject to regulation
under the Bank Holding Company Act and to inspection, examination and
supervision by the Board of Governors of the Federal Reserve System (Federal
Reserve Board) ("FRB") under the Bank Holding Company Act. As of October 28,
2000, FFC became a financial holding company under the Bank Holding Company Act.
Subsidiary Bank. FFC's subsidiary bank is subject to regulation and examination
primarily by the Department of Financial Institutions for the State of
Washington and by the Federal Deposit Insurance Corporation ("FDIC").
3
Bank Holding Company Activities
"Financial in Nature" Requirement. As a bank holding company that has elected
also to become a financial holding company pursuant to the Bank Holding Company
Act, FFC may affiliate with securities firms and insurance companies and engage
in other activities that are financial in nature or are incidental or
complementary to activities that are financial in nature. "Financial in nature"
activities include securities underwriting, dealing and market making,
sponsoring mutual funds and investment companies, insurance underwriting and
agency, merchant banking, and activities that the FRB determines from time to
time to be so closely related to banking or managing or controlling banks as to
be a proper incident thereto. A bank holding company that is not also a
financial holding company is limited to engaging in banking and such other
activities as determined by the FRB to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto.
No FRB approval is required for FFC to acquire a company (other than a bank
holding company, bank or savings association) engaged in activities that are
financial in nature or incidental to activities that are financial in nature, as
determined by the FRB. Prior FRB approval is required before FFC may acquire the
beneficial ownership or control of more than 5% of the voting shares or
substantially all of the assets of a bank holding company, bank or savings
association.
If the subsidiary bank of FFC receives a rating under the Community Reinvestment
Act of 1977 of less than satisfactory, FFC will be prohibited from engaging in
new activities or acquiring companies other than bank holding companies, banks
or savings associations.
Interstate Banking. Under the Riegle-Neal Interstate Banking and Branching Act
(Riegle-Neal Act), a bank holding company may acquire banks in states other than
its home state, subject to any state requirement that the bank has been
organized and operating for a minimum period of time, not to exceed five years,
and the requirement that the bank holding company not control, prior to or
following the proposed acquisition, more than 10% of the total amount of
deposits of insured depository institutions nationwide or, unless the
acquisition is the bank holding company's initial entry into the state, more
than 30% of such deposits in the state, or such lesser or greater amount set by
the state.
The Riegle-Neal Act also authorizes banks to merge across state lines, thereby
creating interstate branches. States were permitted for a period of time to opt
out of the interstate merger authority provided by the Riegle-Neal Act and, by
doing so, prohibit interstate mergers in the state. Banks are also permitted to
acquire and to establish de novo branches in other states where authorized under
the laws of those states.
Regulatory Approval. In determining whether to approve a proposed bank
acquisition, federal banking regulators will consider, among other factors, the
effect of the acquisition on competition, the public benefits expected to be
received from the acquisition, the projected capital ratios and levels on a
post-acquisition basis, and the acquiring institution's record of addressing the
credit needs of the communities it serves, including the needs of low and
moderate income neighborhoods, consistent with the safe and sound operation of
the bank, under the Community Reinvestment Act of 1977.
4
Dividend Restrictions
FFC is a legal entity separate and distinct from its subsidiary bank. Its
principal source of funds to pay dividends on its common stock and debt service
on its debt is dividends from its subsidiary bank. The Bank, by statute, cannot
declare or pay any dividend in an amount greater than its retained earnings
without the approval of the Director of the Division of Banks for the State of
Washington.
Deposit Insurance Assessments
Through the Bank Insurance Fund (BIF), the FDIC insures the deposits of FFC's
depository institution subsidiaries up to prescribed limits for each depositor.
The amount of FDIC assessments paid by each BIF member institution is based on
its relative risk of default as measured by regulatory capital ratios and other
factors. Specifically, the assessment rate is based on the institution's
capitalization risk category and supervisory subgroup category. An institution's
capitalization risk category is based on the FDIC's determination of whether the
institution is well capitalized, adequately capitalized or less than adequately
capitalized. An institution's supervisory subgroup category is based on the
FDIC's assessment of the financial condition of the institution and the
probability that FDIC intervention or other corrective action will be required.
The BIF assessment rate currently ranges from zero to 27 cents per $100 of
domestic deposits. The FDIC may increase or decrease the assessment rate
schedule on a semi-annual basis. An increase in the BIF assessment rate could
have a material adverse effect on FFC's earnings, depending on the amount of the
increase. The FDIC is authorized to terminate a depository institution's deposit
insurance upon a finding by the FDIC that the institution's financial condition
is unsafe or unsound or that the institution has engaged in unsafe or unsound
practices or has violated any applicable rule, regulation, order or condition
enacted or imposed by the institution's regulatory agency.
All FDIC-insured depository institutions must pay an annual assessment to
provide funds for the payment of interest on bonds issued by the Financing
Corporation, a federal corporation chartered under the authority of the Federal
Housing Finance Board. The bonds, commonly referred to as FICO bonds, were
issued to capitalize the Federal Savings and Loan Insurance Corporation. The
FDIC established the FICO assessment rates effective for the first quarter of
2002 at approximately $.0196 per $100 annually for BIF-assessable deposits. The
FICO assessments are adjusted quarterly to reflect changes in the assessment
bases of the FDIC's insurance funds and do not vary depending on a depository
institution's capitalization or supervisory evaluations.
FDIC-insured depository institutions pay an assessment rate equal to the rate
assessed on deposits insured by the Savings Association Insurance Fund.
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.
5
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.
Fiscal and Monetary Policies
FFC's business and earnings are affected significantly by the fiscal and
monetary policies of the federal government and its agencies. FFC is
particularly affected by the policies of the FRB, which regulates the supply of
money and credit in the United States. Among the instruments of monetary policy
available to the Federal Reserve are (a) conducting open market operations in
United States government securities, (b) changing the discount rates of
borrowings of depository institutions, (c) imposing or changing reserve
requirements against depository institutions' deposits, and (d) imposing or
changing reserve requirements against certain borrowing by banks and their
affiliates. These methods are used in varying degrees and combinations to
directly affect the availability of bank loans and deposits, as well as the
interest rates charged on loans and paid on deposits. For that reason alone, the
policies of the FRB have a material effect on the earnings of FFC.
Privacy Provisions of Gramm-Leach-Bliley Act
Under the Gramm-Leach-Bliley Act ("GLB Act"), federal banking regulators are
required to adopt rules that will limit the ability of banks and other financial
institutions to disclose non-public information about consumers to nonaffiliated
third parties. These limitations will require disclosure of privacy policies to
consumers and, in some circumstances, will allow consumers to prevent disclosure
of certain personal information to a nonaffiliated third party. Federal banking
regulators issued final rules May 10, 2000 and compliance was optional until
July 1, 2001. The privacy provisions of the GLB Act will affect how consumer
information is transmitted through diversified financial companies and conveyed
to outside vendors. It is not possible at this time to assess the impact of the
privacy provisions on FFC's financial condition or results of operations.
Future Legislation
Various legislation, including proposals to substantially change the financial
institution regulatory system and to expand or contract the powers of banking
institutions and bank holding companies, is from time to time introduced in the
Congress. This legislation may change banking statutes and the operating
environment of FFC and its subsidiaries in substantial and unpredictable ways.
If enacted, such legislation could increase or decrease the cost of doing
business, limit or expand permissible activities or affect the competitive
balance among banks, savings associations, credit unions, and other financial
institutions. FFC cannot predict whether any of this potential legislation will
be enacted, and if enacted, the effect that it, or any implementing regulations,
would have on the financial condition or results of operations of FFC or any of
its subsidiaries.
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.
6
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, 2001 the Bank
was in compliance with applicable loans-to-one borrower requirements.
FDIC INSURANCE. Generally, customer deposit accounts in banks are insured by the
FDIC for up to a maximum amount of $100,000. The FDIC has adopted a risk-based
insurance assessment system under which depository institutions contribute funds
to the Bank Insurance Fund ("BIF"), based on their risk.
On September 30, 1996, the Deposit Insurance Fund Act of 1996 ("Funds Act") was
enacted. The Funds Act provides, among other things, for the recapitalization of
the SAIF through a special assessment on all depository institutions that hold
SAIF insured deposits. The one-time assessment was designed to place the SAIF at
its 1.25 reserve ratio goal.
The Funds Act, for the three-year period beginning in 1997, subjects BIF insured
deposits to a Financing Corporation ("FICO") premium assessment on domestic
deposits at one-fifth the premium rate (approximately 1.3 basis points) imposed
on SAIF insured deposits (approximately 6.5 basis points).
Beginning in the year 2000, BIF insured institutions were 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. 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
7
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.
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.
8
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, 2001, the Bank was well
capitalized and maintained a leverage ratio of 9.70 percent, a risk-based Tier 1
capital ratio of 10.75 percent, and a risk-based total capital ratio of 12.00
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.
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
9
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.
The agencies recently adopted regulations, under which banks are prohibited from
using their interstate branches primarily for deposit production. The Agencies
have accordingly implemented a loan-to-deposit ratio screen to ensure compliance
with this prohibition.
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.
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
10
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. For further
details, please see page 23 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, 2002. 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 was accounted for using the
"pooling-of-interests" method. In March 2000, the Board of Directors of FFC
cancelled its Stock Repurchase Program. On January 23, 2001, the Corporation
approved a new program. On October 17, 2001 the Board authorized an additional
5%. Since beginning the programs, the Corporation has repurchased 94,400,
1,402,400 and 33,000 in 2000, 2001 and year-to-date 2002, respectively. There
are 450,194 remaining under the current plan.
11
Forward-Looking Statement
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 Private Securities
Litigation Reform Act of 1995. Forward-looking statements are subject to risks
and uncertainties that may cause actual future results to differ materially.
Sentences containing words such as "may", "will", "expect", "anticipate",
"believe", "estimate", "should", "projected", or similar words may constitute
forward-looking statements. The Corporation may have used these statements to
describe expectations and estimates in various areas, including, but not limited
to: changes in the economy of the markets in which it operates; interest rate
movements; future acquisition and growth strategies; system conversions and
integration activities; the impact of competitive products, services and
pricing; and legislative, regulatory and accounting changes affecting the
banking and financial service industry. Actual results could vary materially
from the future results covered in forward-looking statements. Factors such as
interest rate trends and loan delinquency rates, as well as the general state of
the economy in Washington state and the United States as a whole, could also
cause actual results to vary materially from the future results anticipated in
such forward-looking statements. These factors should be considered in
evaluating the forward-looking statements and undue reliance should not be
placed on such statements.
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.
Annual
I. Distribution of Assets, Liabilities Form 10-K Report
and Shareowners' Equity; Interest Page Page
-------------- ----------
Rates and Interest Differential:
A. Consolidated Average Balance
Sheets/Interest Income and
Expense/Rates 43
B. Changes in Net Interest Income
and Expense due to Rate and
Volume 44
II. Investment Portfolio
A. Analysis of Investment Securities
at Year-end 14 11 & 12
B. Maturity Distribution of Investment
Securities 14 12
III. Loan Portfolio
A. Types of Loans 15 13
B. Loan Maturities and Sensitivity to
Changes in Interest Rates 15 13, 38 & 40
C. Risk Elements 16
D. Credit Concentrations 20
IV. Summary of Loan Loss Experience
A. Analysis 19
B. Allocation of Allowance for Possible
Loan Losses 19
V. Deposits
Average Interest and Noninterest
Bearing Deposit Balances 43
VI. Return on Equity and Assets
Significant Financial Ratios 22
VII. Short-term Borrowings 22
13
Analysis of Investment Securities
The aggregate amortized recorded values of investment securities at December 31
are as follows:
2001 2000 1999
(In thousands) Amortized Amortized Amortized
Cost Cost Cost
----------------- ----------------- -----------------
U.S. Treasuries $251 $251 $252
U.S. Agencies 1,653 78,562 90,312
Municipal Bonds 23,487 26,084 29,317
Corporate Bonds 30,140 24,045 25,124
Equities 17,263 16,165 15,394
Certificates of Deposit 8,000 0 0
----------------- ----------------- -----------------
Totals $80,794 $145,107 $160,399
======== ========= =========
Maturity Distribution of Investment Securities
The following table sets forth the maturities of investment securities at
December 31, 2001. Taxable equivalent values are used in calculating yields
assuming a tax rate of 35%.
(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
----------------- ----------------- ----------------- ----------------- --------------
U.S. Treasury $0 $0 $0 $251 $251
0.00% 0.00% 0.00% 7.16% 7.16%
U.S. Agencies 500 644 214 295 1,653
6.41% 6.23% 6.54% 5.51% 6.20%
Municipal Bonds 370 20,436 2,632 50 23,488
8.00% 8.19% 8.24% 7.77% 8.19%
Corporate Bonds 2,684 24,466 0 2,989 30,139
7.25% 5.98% 0.00% 10.50% 6.54%
Equities 17,263 0 0 0 17,263
6.19% 0.00% 0.00% 0.00% 6.19%
CD's 8,000 0 0 0 8,000
1.72% 0.00% 0.00% 0.00% 1.72%
----------------- ----------------- ----------------- ----------------- --------------
TOTALS $28,817 $45,546 $2,846 $3,585 $80,794
================= ================= ================= ================= ==============
5.07% 6.98% 8.11% 9.82% 6.46%
================= ================= ================= ================= ==============
14
Types of Loans
Major classifications of loans, net of deferred loan fees, at December 31 are as
follows:
(In thousands) 2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Commercial $316,947 $283,287 $240,058 $231,666 $190,493
Real Estate Commercial 659,982 585,283 507,006 427,322 337,285
Real Estate Construction 412,501 335,667 277,126 190,477 166,576
Real Estate Mortgage 137,768 126,657 124,901 120,207 126,471
Installment 47,833 47,221 38,200 37,982 33,794
--------------- ---------------- --------------- ---------------- -------------
TOTAL $1,575,031 $1,378,115 $1,187,291 $1,007,654 $854,619
=========== =========== =========== =========== =========
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, 2001. Also, the amounts are classified as to fixed and
variable rate sensitivity for amounts due after one year.
Maturity
--------------------------------------------------------------------
(In thousands) Within 1 - 5 After
1 Year Years 5 Years Total
--------------------------------------------------------------------
Commercial $181,094 $117,186 $18,667 $316,947
Real Estate Commercial 70,839 429,753 159,390 659,982
Real Estate Construction 338,880 67,365 6,256 412,501
Real Estate Mortgage 33,087 94,403 10,278 137,768
Installment 12,713 19,460 15,660 47,833
--------------------------------------------------------------------
TOTAL $636,613 $728,167 $210,251 $1,575,031
========= ========= ========= ===========
Loans maturing after one year with:
1 - 5 After
Years 5 Years
---------------------------------
Fixed Rates $608,816 $125,405
Variable Rates 119,351 84,846
---------------------------------
TOTAL $728,167 $210,251
========= =========
It is not uncommon to rollover loans at the maturity period, provided that the
rate and terms of the loan conform to the current policy.
15
Loan Administration
The Bank provides revolving lines of credit to many of its borrowers. Such lines
are approved by the Directors' Loan Committee ("Loan Committee") or other
administrative level committee or person if the amount exceeds the lending units
authorized loan limit.
Credit Review personnel, under the direction of the Credit Administrator,
examine the loan portfolio regularly. Reports are made by the Senior Vice
President/Credit Administrator to senior management and the Directors' 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 adversely 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
NONACCRUING LOANS
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, and 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.
IMPAIRED LOANS
Loans are considered impaired when, based on current information and events, it
is probable that the Corporation will be unable to collect all amounts due
according to the contractual terms of the loan agreement, including scheduled
interest payments. For a loan that has been restructured, the contractual terms
of the loan agreement refer to the contractual terms specified by the original
loan agreement, not the contractual terms specified by the restructuring
agreement.
This assessment for impairment occurs when and while such loans are on
nonaccrual, or the loan has been restructured. When a loan with unique risk
characteristics has been identified as being impaired, the amount of impairment
will be measured by the Corporation. If the measurement of the impaired loan is
less than the recorded investment in the loan an impairment is recognized by
creating or adjusting an existing allocation of the allowance for loan losses.
16
RESTRUCTURED LOANS
In cases where a borrower experiences financial difficulties and the Corporation
makes certain concessionary modifications to the contractual terms, the loan is
classified as a restructured (accruing) loan. Loans restructured at a rate equal
to or greater than that of a new loan with comparable risk at the time of the
contract is modified may be excluded from the impairment assessment and may
cease to be considered impaired.
On the following table the dollar amount of loans past due 90 days or more
whether accruing or not, nonaccrual loans, past due, restructured loans and
other real estate owned as a percentage of total loans and ORE was .78%, .31%,
and .23% for year-end 2001, 2000 and 1999, respectively. These loans have a
variety of situations, some of which may lead to foreclosure or involve a
bankruptcy case and while some of these loans are in active legal collection
processes, others are under active repayment plans and may continue payment as
the borrower's financial situation improves. At year-end 1999, the number of
loans in nonaccrual was 25, totaling $1.8 million, or .15% of total loans. The
year-end 2000 balance of $4.0 million was comprised of 30 loans. The year-end
2001 balance of $11.5 million was comprised of 60 loans. One loan accounts for
$2.5 million of the year-end nonaccrual balances and including this a total of
$4.9 million (26 loans) was comprised of loans acquired from the Bank's most
recent merger.
Management monitors these loans on a frequent basis and conducts aggressive
collection efforts, unless constraints are placed on the Bank by the bankruptcy
courts. These efforts are directed toward the best long-term results for the
Bank, and to the extent reasonable, to the borrower as well. If, in the opinion
of management, it is felt, or if it can be determined, that full collection of
these loans or their payment streams will not occur, then they are charged off
against the loan loss reserve.
Loans past due 90 days or more and still accruing, nonaccruing, past due,
restructured and other real estate owned (OREO) on which the accrual of interest
has been discontinued as of December 31st are as follows:
-------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------------------------------------------------------------------------
Commercial $ 823 $ 106 $ 380 $ 142 $ 402
Agriculture 409 386 - - -
Real Estate 10,086 3,439 1,355 1,170 4,901
Installment 133 95 78 38 29
-------------------------------------------------------------------------------
Total non-accruing loans 11,451 4,026 1,813 1,350 5,332
Other real estate owned 769 256 870 1,605 1,989
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Total non-performing loans $ 12,220 $ 4,282 $ 2,683 $ 2,955 $ 7,321
===============================================================================
Restructured 6,200 - - - 109
-------------------------------------------------------------------------------
Total loans at end of period $1,575,031 $1,378,115 $1,187,291 $1,007,654 $ 854,691
===============================================================================
Total assets at end of period $1,806,740 $1,690,818 $1,425,411 $1,334,540 $1,141,293
===============================================================================
Total non-performing loans
to total loans 0.78% 0.31% 0.23% 0.29% 0.86%
Total non-performing loans .
to total assets 0.68% 0.25% 0.19% 0.22% 0.64%
Total impaired assets to
total assets 1.02% 0.25% 0.19% 0.22% 0.65%
17
There are certain amounts of interest collected on the above loans and included
in income, and amounts that have not been accrued which are indicated in the
table below:
(In thousands)
At December 31, 2001 2000 1999 1998 1997
- --------------- ---- ---- ---- ---- ----
Total interest income which
would have been recorded
during the period under
original terms of loans above $958 $407 $100 $42 $382
Portion of interest
income included in
net income for the
period $1,600 $284 $161 $41 $384
Commitments for additional
funds related to loans
above -0- -0- -0- -0- -0-
Restructured loans are those loans that had problems in the past, and a
concession was made in the interest rate, principal amount, and/or the repayment
schedule has been modified to the extent that there has been tangible impairment
of value. These loans are monitored on a regular basis for performance.
The Bank originates commercial, commercial real estate, real estate
construction, residential mortgage and installment loans in its market area.
Total loans as of December 31, 2001, 2000 and 1999 were $1.6 billion, $1.4
billion, and $1.2 billion, respectively.
Other Real Estate Owned
As of December 31, 2001, the Bank had two separate residential lots and three
houses as other real estate owned which totaled $769 thousand. This was up from
the low year-end 2000 figure of $256 thousand at which time there were two
residential lots. At year-end 1999 there were ten properties comprising the
total of $870 thousand. No losses are expected on sales of OREO which are
recorded at the lower of cost or fair value, less estimated cost to sell. The
current levels are felt to be nominal relative to the size of the loan
portfolio. At any point in time the Bank has other loans which are in the
process of foreclosure and are included in nonaccrual loans. Due to the
possibilities of sales or other favorable resolutions, or of bankruptcy
declaration and processes, or other legal actions, it is difficult to estimate
future levels of OREO.
The table below shows the carrying value of OREO at December 31st:
(In thousands) 2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Other Real Estate Owned $769 $256 $870 $1,605 $1,989
18
Summary of Loan Loss Experience
The following table provides an analysis of net losses by loan type for the last
five years at December 31st:
(In thousands) 2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Balance at beginning
of year $21,907 $21,007 $19,288 $17,040 $15,163
Provision charged to
operating expense 13,600 1,007 2,266 2,230 2,278
Loans charged-off:
Commercial (10,044) (156) (797) (460) (416)
Real Estate (383) (461) (55) (1,209) (1,358)
Installment (266) (316) (71) (97) (137)
-----------------------------------------------------------------------------
Total charged-off loans (10,693) (933) (923) (1,766) (1,911)
Less recoveries:
Commercial 240 54 243 653 285
Real Estate 625 598 105 1,110 1,175
Installment 27 174 28 21 50
-----------------------------------------------------------------------------
Total recoveries 892 826 376 1,784 1,510
Net charge-offs (9,801) (107) (547) 18 (401)
Reserve acquired in merger 652 - - - -
Balance at end of year $26,358 $21,907 $21,007 $19,288 $17,040
=============================================================================
Total loans at
end of period $1,575,031 $1,378,115 $1,187,291 $1,007,654 $854,619
Daily average loans $1,524,181 $1,327,699 $1,095,626 $927,821 $814,828
Ratio of net charged-off
loans during period to
average loans outstanding 0.64% 0.01% 0.05% 0.00% 0.05%
=============================================================================
It is the policy of the Corporation and its subsidiary to charge-off any loan or
portion of a loan that is deemed uncollectible in the ordinary course of
business. The entire allowance for possible loan losses is available to absorb
such charge-offs.
Allocation of Allowance for Possible Loan Losses
Based on certain characteristics of the portfolio, potential losses can be
anticipated for major loan categories. In the following table, the allowance for
possible loan losses at year-end, for the last five years has been allocated
among major loan categories based primarily on their historical net charge-off
experience, along with consideration of factors such as quality, volume,
anticipated economic conditions and other business considerations.
(In thousands, except percents)
Loan Loan Loan Loan Loan
2001 Category 2000 Category 1999 Category 1998 Category 1997 Category
Reserve Percent Reserve Percent Reserve Percent Reserve Percent Reserve Percent
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Commercial $14,608 20.1% $11,611 20.6% $11,134 20.2% $10,223 23.0% $9,542 22.3%
Real Estate 11,070 76.8% 9,858 76.0% 9,453 76.6% 8,680 73.2% 6,986 73.7%
Installment 680 3.1% 438 3.4% 420 3.2% 385 3.8% 512 4.0%
------------------------------------------------------------------------------------------------------------------
TOTAL $26,358 100.0% $21,907 100.0% $21,007 100.0% $19,288 100.0% $17,040 100.0%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
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.
19
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 greater amount is specifically allocated to
the reserve.
Setting the level of loan loss reserve includes consideration of subjective
factors in addition to historical loss rates. Actual historical results (over
the past 5 years, which average approximately $2,163,600 per year net losses)
indicate that Frontier may have an excess of the necessary reserves required.
Our analysis and calculations take into consideration the inherent risks of a
loan portfolio such as loan types, current and expected economic conditions,
industry data for loan losses within different business cycles, growth of the
loan portfolio, as well as other factors, and management believes that the
reserve is adequate based upon those inherent risks. Loan concentrations,
quality, terms and basic underlying assumptions remained substantially unchanged
during the period.
The analysis/formula for computing the allowance for possible loan losses was
further refined in 2001 and is consistent with SEC Accounting Bulletin No. 102,
Selected Loan Loss Allowance Methodology and Documentation Issues, dated July 6,
2001. From time to time estimated loss factors on certain types or categories of
loans may be changed and/or loans may be sorted into more or different
categories base on similar characteristics and perceived risk profiles by loan
type or industry.
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 has declined over the last five years, mainly due to
mergers with institutions which had a lower reserve comparably, and due to loan
portfolio quality.
Effects of Changing Interest Rates
The year 2001 saw eleven decreases in the discount rate by the Federal Reserve
during the year, down to 1.25%. During the year, the Corporation experienced a
decline in the net interest margin as approximately 43% of the Corporation's
loan portfolio consists of variable rate loans that reprice immediately as
interest rates change. Since much of the loan portfolio funding is provided by
cd's and short-term borrowings that reprice over longer periods of time,
interest income has declined while interest expense will take a longer time to
decline to current market rates.
Concentrations of Credit
At year-end 2001, 21.7% of the Bank's loan portfolio was in residential and
commercial construction and land development projects centered in the Bank's
market area. The Bank has experienced strong demand for such loans and the
current percentage represents an increase from 21.2% in 2000. Management has
established a Real Estate Review Committee which meets periodically to monitor
local economic conditions and the performance of borrowers in this industry.
20
The chart below indicates the amount of those loans, and as a percent of total
loans for the period:
(In Thousands)
At December 31, 2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Construction $242,582 $184,288 $161,105 $107,226 $88,972
Land Development 115,772 108,044 85,430 58,635 45,304
------------------------------------------------------------------------------
TOTAL $358,354 $292,332 $246,535 $165,861 $134,276
==============================================================================
Total Loans at end of period $1,575,031 $1,378,115 $1,187,291 $1,007,654 $854,619
==================================================================================================================
Construction and Land
Development loans as a
percent of total loans 22.8% 21.2% 20.8% 16.5% 15.7%
==================================================================================================================
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 increased in the fourth quarter of
2001 million to $12.2 million, from $8.7 million in the third quarter.
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. The
current level represents a 40% increase by dollar amount from the previous
quarter. At .78% of total loans and ORE the totals are within industry norms.
Trends in Volume and Terms of Loans
Loans grew by 16% in the first nine months of 2001 and declined in the fourth
quarter by $23.8 million giving loan growth of 14.3% for all of 2001. This
appears somewhat similar to the pattern of 2000 where after growing over 30% in
the first nine months of 2000, loans actually declined slightly in the fourth
quarter of 2000 by $506 thousand or .03%. This pattern may be somewhat based on
seasonal fluctuations of demand, but also may be somewhat representative of a
slower, post 9/11 economy, coupled with a lower interest rate environment that
is conducive to borrowers seeking long-term (low) fixed rate financing.
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. Based upon actual historical loan loss rates the loan loss
reserve may appear to be somewhat larger than might be necessary, however our
analysis includes subjective factors that cause us to believe the reserve is
adequate, but not unduly conservative.
21
Deposits
For the average amount of deposits and rates paid on such deposits for years
ended December 31, 2001, 2000, and 1999 please refer to page 43 of 2001 Annual
Report to Shareowners.
Maturities of time certificates of deposit $100,000 and over at year-end 2001
are shown below:
(In thousands)
3 months or less $137,061
Over 3 months through 6 months 32,480
6 months through 12 months 84,353
Over 12 months 45,226
-------------
TOTAL $299,120
=========
Significant Financial Ratios
Ratios for the years ended December 31, are as follows:
2001 2000 1999
---- ---- ----
Return on Average Assets 1.35% 2.03% 2.06%
Return on Average Equity 11.63% 17.60% 17.76%
Dividend payout ratio 44.91% 33.10% 17.10%
Average Equity to Average Assets 11.59% 11.52% 11.59%
Borrowings
Short-Term Borrowings
- --------------------- Weighted Weighted Weighted
(In thousands) Average Average Average
Interest Interest Interest
At December 31, 2001 Rate 2000 Rate 1999 Rate
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Year-end balance: $7,696 3.26% $10,088 5.86% $29,191 4.56%
Highest month end
balance during
the period: $23,765 $63,499 $61,724
For information regarding average balances and yields, please refer to page 43
of 2001 Annual Report to Shareowners.
Long-Term Debt
There is no long-term debt for years ended December 31, 2001 and 2000.
22
ITEM 2 - PROPERTIES
At December 31, 2001 the Bank had 38 offices, including the main office, all of
which are located in the State of Washington. These offices are located in
Arlington, Bainbridge Island, Bellingham, Bothell, Buckley, Burlington, Duvall,
Edmonds, Everett (4), Kent, Kirkland, Lake City, Lake Stevens, Lynnwood,
Marysville, Puyallup, Mill Creek, Monroe, Mount Vernon, Orting, Port Angeles,
Port Hadlock, Port Townsend, Poulsbo (2), Redmond, Sequim, Silverdale, Smokey
Point, Snohomish, Stanwood, Sumner, Tacoma, Totem Lake and Woodinville. All of
its branches are located in properties owned by FFP, Inc., a real estate holding
subsidiary, except for the offices located in Bellingham (lease expires May
2004), Burlington (lease expires May 2002), Edmonds (lease expires July 2004),
one office in Everett (lease expires October 2014), Lake Stevens (lease expires
May 2006), Mill Creek (lease expires November 2010), Puyallup (building is
owned, land lease expires 2009), Mount Vernon (building owned, lease expires
March 2023), Kent (lease expires March 2003), Bainbridge Island (lease expires
July 2012) Poulsbo (lease expires on October 2003 on one of the two branches
there), Port Angeles (lease expires January 2019), Port Hadlock, (lease expires
January 2017), Tacoma (lease expires September 2011), Totem Lake (lease expires
June 2005) and three branches (Port Townsend, Poulsbo, and Silverdale) that are
owned by Frontier Financial Corporation, but are currently being transferred to
FFP, Inc. FFP, Inc. also owns the building and land in South Everett where
Frontier Bank data processing and operations departments are located.
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
2001.
23
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND SHAREOWNER MATTERS
(a) Frontier Financial Corporation's common stock is traded on the Nasdaq stock
market under the symbol FTBK. The table below indicates the high/low
trading range of Frontier stock over the last eight quarters:
High Low
1st quarter 2000 22.375 17.00
2nd quarter 2000 19.125 16.25
3rd quarter 2000 19.75 17.125
4th quarter 2000 26.00 16.5625
1st quarter 2001 25.34 21.94
2nd quarter 2001 28.00 22.06
3rd quarter 2001 29.00 26.50
4th quarter 2001 28.00 25.11
(b) Frontier Financial Corporation has only one class of stock outstanding,
which is common stock. At February 28, 2002 there were 19,193,107 shares
outstanding.
(c) The table below indicates the cash dividends paid on its common stock over
the last two years:
Dividend Declared Record Date Payment Date
----------------- ----------- ------------
$.09 January 28, 2000 February 11, 2000
.10 May 1, 2000 May 15, 2000
.11 July 31, 2000 August 14, 2000
.12 October 2, 2000 October 23, 2000
$.125 January 8, 2001 January 22, 2001
.13 April 16, 2001 April 30, 2001
.135 July 9, 2001 July 23, 2001
.14 October 15, 2001 October 29, 2001
ITEM 6 - SELECTED FINANCIAL DATA
Please refer to the 2001 Annual Report to Shareowners.
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Please see 2001 Annual Report to Shareowners, page 29 through 44.
ITEM 7a - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please see 2001 Annual Report to Shareowners, page 37-40.
24
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Annual
Form Report to
10-K Shareowners
Page Page
----- --------------
Report of Management 1
Independent Auditor's Report 2
Consolidated Balance Sheet at
December 31, 2001 and 2000 3
Consolidated Statement of Income for the years
Ended December 31, 2001, 2000 and 1999 4
Consolidated Statement of Shareowners' Equity 5
Consolidated Statement of Cash Flows for the
Years ended December 31, 2001, 2000 and 1999 6
Condensed Balance Sheet (Parent Only) at
December 31, 2001 and 2000 25
Condensed Statement of Income (Parent Only) for the
Years Ended December 31, 2001, 2000 and 1999 25
Condensed Statement of Cash Flows (Parent Only)
for Years Ended December 31, 2001, 2000 and 1999 26
Notes to Consolidated Financial Statements 7 - 28
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
25
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF FRONTIER FINANCIAL
CORPORATION
Please see pages 2-9 of 2002 Proxy Statement.
ITEM 11 - EXECUTIVE COMPENSATION
Please see pages 7-9 of 2002 Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Please see page 5-6 of 2002 Proxy Statement.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Please see page 14 of 2002 Proxy Statement; and, Note 14, page 21 of 2001 Annual
Report to Shareowners; and, Page 27 of this Form 10-K report.
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 2001 Annual Report to
Shareowners, attached hereto as an exhibit.
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 (File No.
000-15540).
(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 27, 1998 (File No. 333-48805).
(10)(b) Frontier Financial Corporation 1999 Employee Stock Award
Plan, is incorporated herein by reference to Exhibit 99.1 to
Registration Statement on Form S-8, filed March 2, 1999
(File No. 333-73217).
(10)(c) Frontier Financial Corporation 2001 Stock Award Plan, is
incorporated herein by reference to Exhibit 99.1 to
Registration Statement on Form S-8, filed January 26, 2001,
(File No. 333-54362).
(10)(d) Frontier Financial Corporation Employee Stock Option Plan
and Interbancorp, Inc. Director Stock Option Plan, is
incorporated herein by reference to Exhibit 10.1 to
Registration Statement on Form S-8, filed January 26, 2001
(File No. 333-37242).
(10)(e) Interbancorp, Inc. Employee Stock Option Plan and
Interbancorp, Inc. Director Stock Option Plan, is
incorporated herein by reference to Exhibit 10.1 to
Registration Statement on Form S-8, filed February 13, 2001
(File No. 333-50882).
(11) Statement Regarding Computation of Earnings Per Share.
(13) Annual Report to Shareowners for the year ended December 31,
2001.
(21) Subsidiaries of Registrant is incorporated by reference to
Part I, page 1 through 9 of this report.
(23.1) Consent of Moss Adams LLP, independent auditors.
27
(b) Reports on Form 8-K:
On January 31, 2001, Form 8-K was filed announcing reinstatement of
the Share Repurchase Program.
On February 7, 2001, Form 8-K was filed announcing consummation of the
merger with Interbancorp, Inc., and Inter Bank into Frontier Financial
Corporation and Frontier Bank.
On March 23, 2001, Form 8-K was filed announcing earnings guidance for
the first fiscal quarter of 2001.
On October 25, 2001, Form 8-K was filed announcing the adoption of a
stock repurchase program authorizing the Corporation to repurchase an
additional 5% of its outstanding stock.
On November 16, 2001, Form 8-K was filed announcing an increase in the
Bank's loan loss reserve in anticipation of a possible loan loss, and
provide earnings guidance for the fourth quarter of and year-end 2001.
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FRONTIER FINANCIAL CORPORATION
March 20, 2002 /s/ Robert J. Dickson
- ----------------------- ----------------------------------------
Date Robert J. Dickson
President & Chief Executive Officer
March 20, 2002 /s/ James F. Felicetty
- ----------------------- ----------------------------------------
Date James F. Felicetty
Secretary/Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:
March 20, 2002 /s/George Barber
- ----------------------- ----------------------------------------
George E. Barber, Director
March 20, 2002 /s/ Michael Clements
- ----------------------- ----------------------------------------
Michael Clements, Director
March 20, 2002 /s/Michael Corliss
- ----------------------- ----------------------------------------
Michael J. Corliss, Director
March 20, 2002 /s/ Lucy DeYoung
- ----------------------- ----------------------------------------
Lucy DeYoung, Director
March 20, 2002 /s/ Robert J. Dickson
- ----------------------- ----------------------------------------
Robert J. Dickson, Director
March 20, 2002 /s/ David A. Dujardin
- ----------------------- ----------------------------------------
David A. Dujardin, Chairman of the Board
March 20, 2002 /s/ Edward D. Hansen
- ----------------------- ----------------------------------------
Edward D. Hansen, Secretary of the Board
March 20, 2002 /s/ William H. Lucas
- ----------------------- ----------------------------------------
William H. Lucas, Director
- ----------------------- ----------------------------------------
James H. Mulligan, Director
March 20, 2002 /s/ J. Donald Regan
- ----------------------- ----------------------------------------
J. Donald Regan, Director
March 20, 2002 /s/ Roger L. Rice
- ----------------------- ----------------------------------------
Roger L. Rice, Director
March 20, 2002 /s/ William J. Robinson
- ----------------------- ----------------------------------------
William J. Robinson, Director
March 20, 2002 /s/ Edward C. Rubatino
- ----------------------- ----------------------------------------
Edward C. Rubatino, Director
March 20, 2002 /s/ Darrell J. Storkson
- ----------------------- ----------------------------------------
Darrell J. Storkson, Director
29
EXHIBIT 11
FRONTIER FINANCIAL CORPORATION
COMPUTATION OF BASIC AND DILUTED EARNINGS PER SHARE
2001 2000 1999
---- ---- ----
Net Income (in thousands) $24,499 $32,116 $28,299
=================================================
Computation of average shares outstanding:
Shares outstanding at
beginning of year 19,768 17,545 8,697
Additional shares deemed
outstanding because of
stock dividends or splits - - 8,759
Average shares issued pursuant
to merger 629 2,252 2,252
Shares issued or repurchased
during the year times average
time outstanding during
the year (297) (62) 72
-------------------------------------------------
-------------------------------------------------
Basic average shares outstanding 20,100 19,735 19,780
-------------------------------------------------
Average number of dilutive shares
assumed to be outstanding 165 94 163
-------------------------------------------------
Average dilutive shares
outstanding 20,265 19,829 19,943
=================================================
Basic earnings per share $1.22 $1.63 $1.43
=================================================
Diluted earnings per share $1.21 $1.62 $1.42
=================================================
30
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITOR
We consent to the inclusion in this Annual Report on Form 10-K of Frontier
Financial Corporation for the year ended December 31, 2001 and to the
incorporation by reference in Registration Statement Numbers 333-48805,
333-73217, 333-54362, 333-37242 and 333-50882 on Forms S-8 of our report
dated January 18, 2002.
/s/ Moss Adams LLP
Everett, Washington
March 21, 2002
31