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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
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
Incorporation of Organization) Number)
332 SW Everett Mall Way
P.O. Box 2215
Everett, Washington 98203
(Address of Principal Administrative Offices) (Zip Code)
(425)-514-0700
(Registrant's Telephone Number, Including Area Code)
(Former name, former address and former fiscal year,
if changed since last report)
------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ] Indicate by a check mark
whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Act) [X] Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at July 21, 2003
- -------------------------------------- ----------------------------------
Common Stock, no par value 18,502,578
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
PART I - Financial Information Page
- ------------------------------
Item 1. Financial Statements
Consolidated Balance Sheet - June 30, 2003
` and Year End 2002 1
Consolidated Statement of Income - Three and six months
Ended June 30, 2003 and 2002 2
Consolidated Statement of Cash Flows - Six months
Ended June 30, 2003 and 2002 3-4
Notes to the Consolidated Financial Statements 5-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9-19
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 20
Item 4. Controls and Procedures 20-21
PART II - Other Information
- ---------------------------
Item 1. Legal Proceedings 22
Item 4. Submission of Matters to a Vote by Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22-23
Signatures 24
Certifications 25-29
-i-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
- ------------------------------------------------------------------------------------------------------------------------------
(In thousands, except shares)
June 30, December 31,
ASSETS 2003 2002
----------------- -----------------
Cash & due from banks $ 97,510 $ 88,647
Federal funds sold 113,934 13,528
Securities:
Available for sale-market value 111,663 109,429
Held to maturity-amortized cost 29,326 30,608
----------------- -----------------
Total securities 140,989 140,037
Loans, net of unearned income 1,666,839 1,658,684
Less allowance for loan losses (28,966) (28,175)
----------------- -----------------
Net loans 1,637,873 1,630,509
Premises & equipment, net 26,285 26,697
Other real estate owned 6,280 6,532
Goodwill 6,476 6,476
Other assets 31,125 31,301
----------------- -----------------
TOTAL ASSETS $2,060,472 $1,943,727
================= =================
LIABILITIES
Deposits:
Noninterest bearing $ 250,142 $ 237,972
Interest bearing 1,425,878 1,322,904
----------------- -----------------
Total deposits 1,676,020 1,560,876
Federal funds purchased and
securities sold under repurchase agreements 11,668 11,809
Federal Home Loan Bank advances 155,112 160,121
Other liabilities 11,969 12,058
----------------- -----------------
TOTAL LIABILITIES 1,854,769 1,744,864
----------------- -----------------
SHAREOWNERS' EQUITY
Common stock, no par value; 100,000,000 shares authorized; 18,500,618 117,710 116,925
and 18,817,684 shares issued and outstanding in 2003 and 2002
Retained earnings 84,190 79,841
Accumulated other comprehensive income,
net of tax effect 3,803 2,097
----------------- -----------------
TOTAL SHAREOWNERS' EQUITY 205,703 198,863
----------------- -----------------
TOTAL LIABILITIES AND SHAREOWNERS' EQUITY $2,060,472 $ 1,943,727
================= =================
The accompanying notes are an integral part of these financial statements.
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
- ------------------------------------------------------------------------------------------------------------------
(In Thousands, Except for Per Share Three Months Ended Six Months Ended Nine Months Ended
Amounts)
------------------------- ------------------------- -------------------------
June 30, June 30, June 30, June 30, September 30, September
30,
2003 2002 2003 2002 2002 2001
----------- ----------- ----------- ----------- ----------- -----------
INTEREST INCOME
Interest and fees on loans $ 32,027 $ 31,692 $ 64,075 $ 64,078 $ 97,455 $ 104,062
Interest on investments 1,962 1,926 3,985 3,428 5,426 9,490
----------- ----------- ----------- ----------- ----------- -----------
Total interest income 33,989 33,618 68,060 67,506 102,881 113,552
----------- ----------- ----------- ----------- ----------- -----------
INTEREST EXPENSE
Interest on deposits 7,822 9,636 16,095 19,784 29,455 46,911
Interest on borrowed funds 1,971 1,640 3,927 3,189 5,113 4,801
----------- ----------- ----------- ----------- ----------- -----------
Total interest expense 9,793 11,276 20,022 22,973 34,568 51,712
----------- ----------- ----------- ----------- ----------- -----------
Net interest income 24,196 22,342 48,038 44,533 68,313 61,840
----------- ----------- ----------- ----------- ----------- -----------
PROVISION FOR LOAN LOSSES (900) (1,100) (1,750) (1,600) (3,100) (600)
----------- ----------- ----------- ----------- ----------- -----------
NONINTEREST INCOME
Gain on sale of securities - - 91 - (187) -
Service charges on deposit accounts 1,121 1,061 2,185 1,959 3,045 2,385
Other noninterest income 2,118 1,619 4,017 3,312 4,756 3,749
----------- ----------- ----------- ----------- ----------- -----------
Total noninterest income 3,239 2,680 6,293 5,271 7,614 6,134
----------- ----------- ----------- ----------- ----------- -----------
NONINTEREST EXPENSE
Salaries and employee benefits 6,808 6,005 13,774 12,249 18,492 17,389
Occupancy expense 1,569 1,522 3,185 3,096 4,624 4,625
Other noninterest expense 2,879 2,643 5,457 4,850 7,387 7,925
----------- ----------- ----------- ----------- ----------- -----------
Total noninterest expense 11,256 10,170 22,416 20,195 30,503 29,939
----------- ----------- ----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAX 15,279 13,752 30,165 28,009 42,324 37,435
PROVISION FOR INCOME TAX (5,131) (4,686) (10,356) (9,670) (14,377) (12,843)
----------- ----------- ----------- ----------- ----------- -----------
NET INCOME $ 10,148 $ 9,066 $ 19,809 $ 18,339 $ 27,947 $ 24,592
=========== =========== =========== =========== =========== ===========
Weighted average number of
shares outstanding for the period 18,493,353 19,203,850 18,590,320 19,201,900 19,197,166 20,309,675
Basic earnings per share $ 0.55 $ 0.47 $ 1.07 $ 0.96 $ 1.46 $ 1.21
=========== =========== =========== =========== =========== ===========
Weighted average number of diluted
shares
outstanding for period 18,577,748 19,327,290 18,661,893 19,314,122 19,307,608 20,467,610
Diluted earnings per share $ 0.55 $ 0.47 $ 1.06 $ 0.95 $ 1.45 $ 1.20
=========== =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
2
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------
(In thousands)
June 30, 2003 June 30, 2002
--------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES
- -------------------------------------------------------------------
Net Income $19,809 $18,339
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 1,438 1,852
Provision for loan losses 1,750 1,600
Deferred taxes (9)
Increase in income taxes payable 1,254 1,458
Increase (decrease) in interest receivable 544 (467)
Decrease in interest payable (496) (1,838)
Gain on sale of OREO 30 -
Gain on sale of securities 91 -
Gain (loss) on sale of fixed assets (15) 9
Proceeds from sale of mortgage loans 81,297 34,657
Origination of mortgage held for sale (80,902) (33,178)
Dividend income from FHLB (424) (409)
Decrease in other operating activities (1,830) (1,545)
--------------- -----------------
Net cash provided by operating activities 22,546 20,469
--------------- -----------------
CASH FLOWS FROM INVESTMENT ACTIVITIES
- -------------------------------------------------------------------
Net cash flows from fed funds sold (100,406) 28,800
Proceeds from the sale of AFS securities 2,350 11,144
Proceeds from maturities of AFS & HTM securities 45,973 (67,585)
Purchase of AFS securities (49,285) -
Net cash flows from loan activities (9,509) (13,300)
Purchases of premises and equipment (464) (721)
Proceeds from the sale of OREO 251 -
Proceeds from sale of property and equipment 31 -
Increase in other investing activities 2,551 1,201
--------------- -----------------
Net cash used by investing activities (108,508) (40,461)
--------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
- -------------------------------------------------------------------
Net change in core deposits 137,726 82,777
Net change in certificates of deposit (22,582) (84,973)
Stock options exercised 576 747
Purchase of common shares (9,148) (969)
Cash dividends paid (6,385) (5,665)
Advances from FHLB - 25,000
Repayment of FHLB advances (5,009) (8)
Net change in Federal Funds purchased and securities
sold under repurchase agreements (141) 6,285
Increase (decrease) in other financing activities (212) 1,493
--------------- -----------------
Net cash provided by financing activities 94,825 24,687
--------------- -----------------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS $8,863 $4,695
CASH AND DUE FROM BANKS AT BEGINNING
OF YEAR 88,647 64,062
--------------- -----------------
CASH AND DUE FROM BANKS AT END
OF PERIOD $97,510 $68,757
=============== =================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- -------------------------------------------------
Cash paid during the period for interest $20,518 $24,830
Cash paid during the period for income taxes 8,900 8,100
Real estate taken as settlement for loan obligations 869 2,024
SUPPLEMENTAL INFORMATION ABOUT NON CASH INVESTING AND
FINANCING ACTIVITIES
- -----------------------------------------------------
Other real estate acquired in settlement of loans in 2003 and 2002
were $869 thousand and $2.0 million, respectively.
The accompanying notes are an integral part of these financial statements.
3
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. PRINCIPLES OF CONSOLIDATION - RESULTS OF OPERATIONS
The consolidated financial statements of Frontier Financial Corporation, ("FFC
or Corporation") include the accounts of Frontier Financial Corporation and its
subsidiaries. All significant intercompany accounts and transactions have been
eliminated. The consolidated financial statements have been prepared
substantially consistent with the accounting principles applied in the 2002
Annual Report on Form 10-K for the year ended December 31, 2002. In the opinion
of management, the consolidated financial statements reflect all adjustments
necessary for a fair statement of the results for the interim periods presented.
Operating results for the six months ending June 30, 2003 are not necessarily
indicative of the results that may be expected for year-end December 31, 2003.
The bank subsidiary of Frontier Financial Corporation is Frontier Bank, ("the
Bank").
At June 30, 2003, the Corporation has a stock-based employee compensation plan.
The Corporation accounts for the plan under recognition and measurement
principles of APB Opinion No.25, Accounting for Stock Issued to Employees, and
related interpretations. No stock based employee compensation costs are
reflected in net income, as all options granted under this plan had an exercise
price equal to the market value of the underlying common stock on the date of
grant. The following table illustrates the effect on net income and earnings per
share if the Corporation had applied the fair value recognition provisions of
FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
In Thousands
------------
For the quarter ended June 30,
-------------------------------
Proforma disclosures 2003 2002
--------- ---------
Net income as reported $10,148 $9,273
Additional compensation for
fair value of stock options - -
--------- ---------
Proforma net income $10,148 $9,273
========= =========
Earnings per share
Basic
As reported $0.55 $0.47
Proforma $0.55 $0.47
========= =========
Diluted
As reported $0.55 $0.47
Proforma $0.55 $0.47
========= =========
The Corporation did not issue any options in the June 30, 2003 and 2002 quarter.
As of June 30, 2003 there were 391,153 outstanding under the plan.
NOTE 2. INVESTMENT SECURITIES
The investment portfolio of the Corporation is classified in one of two groups:
1) securities Held-to-Maturity (HTM), and 2) securities Available-For-Sale
(AFS).
4
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - (Continued)
Securities that are classified as HTM, are carried at cost, adjusted for
amortization of premiums and accretion of discounts which are recognized as
adjustments to income.
Securities that are classified as AFS, are carried at fair value, adjusted for
amortization of premiums and accretion of discounts which are recognized as
adjustments to income. Unrealized gains and losses are excluded from earnings
and reported as a separate component of equity capital. AFS securities may be
sold at any time.
Gains and losses on both HTM and AFS securities that are disposed of prior to
maturity, are based on the net proceeds and the adjusted carrying amount of the
specific security sold.
The tables below display the characteristics of the AFS and HTM portfolios as of
June 30, 2003:
AGGREGATE FAIR VALUE AND AMORTIZED COST OF INVESTMENTS
---------------------------------------------------------------------------------
(In thousands)
Gross Gross
Amortized Unrealized Unrealized Aggregate
Cost Gains Losses Fair Value
----------------------------------------------------------
AFS SECURITIES
---------------------------
Equities $20,787 $3,125 ($10) $23,902
U.S. Treasuries 251 86 - 337
U.S. Agencies 8,022 72 - 8,094
Corporate securities 76,703 2,603 (24) 79,282
Municipal securities 50 - (2) 48
----------------------------------------------------------
Totals 105,813 5,886 (36) 111,663
----------------------------------------------------------
HTM SECURITIES
---------------------------
Municipal securities 19,796 821 - 20,617
Corporate securities 1,530 31 - 1,561
Certificates of deposit 8,000 - - 8,000
----------------------------------------------------------
Totals 29,326 852 - 30,178
----------------------------------------------------------
Totals $135,139 $6,738 ($36) $141,841
==========================================================
MATURITY SCHEDULE OF SECURITIES
-------------------------------------------
Available for Sale Held to Maturity
Amortized Fair Amortized Fair
MATURITY Cost Value Cost Value
---------------- ----------------------------------------------------------
0-1 Yr $44,663 $48,239 $9,045 $9,058
1-5 Yrs 52,070 54,145 16,832 17,423
5-10 Yrs 6,245 6,258 1,919 2,136
Over 10 Yrs 2,835 3,021 1,530 1,561
----------------------------------------------------------
$105,813 $111,663 $29,326 $30,178
==========================================================
`
5
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
CHANGES IN AFS AND HTM SECURITIES
---------------------------------
For the Quarter Ended June 30, 2003
-----------------------------------
AFS SECURITIES
--------------
Proceeds from sales $0
Gross realized gains -
Gross realized losses -
Gross gains & losses included in earnings
transfers to the trading category -
Net change in unrealized holding gains or
losses included in the separate
components of shareowners' equity $1,061
NOTE 3. LOANS
The following is an analysis of the loan portfolio by major type of loans:
In Thousands
- -------------
June 30, 2003 December 31, 2002
--------------- ------------------
Commercial $275,276 $272,787
Real Estate:
Commercial 760,127 759,228
Construction 462,854 450,236
Residential 136,309 137,627
Installment 40,971 47,192
--------------- -------------
1,675,537 1,667,070
Unearned Fee Income (8,698) (8,386)
--------------- -------------
Total Loans $1,666,839 $1,658,684
=============== =============
NOTE 4. Please see Item 5, page 22 for dividend information.
NOTE 5. IMPACT OF NEW ACCOUNTING ISSUES
During the second quarter of 2003 the Financial Accounting Standard Board
("FASB") issued the following new accounting pronouncements.
6
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 5 - (Continued)
In April 2003, FASB issued Statement No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under FASB
Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
This Statement is effective for contracts entered into or modified after June
30, 2003 and is not expected to have an impact on the Corporation's statement of
financial position or results of operations.
In May 2003, FASB issued Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003, except for mandatory redeemable financial instruments of nonpublic
entities. Adoption of the Statement did not result in an impact on the
Corporation's statement of financial position or results of operations.
7
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- --------------------------------------------------------------------------------
AND RESULTS OF OPERATIONS.
- --------------------------------------------------------------------------------
HIGHLIGHTS
- ----------
Consolidated net income of Frontier Financial Corporation, ("the Corporation")
for the second quarter of 2003 was $10.1 million versus $9.1 million for the
second quarter of 2002, or up 11.9%. The main reasons for the record quarter was
an increase in net interest income of $1.9 million, or 8.3%; an increase in
other noninterest income of $.6 million, or 20.9%; and 749,542 fewer average
diluted shares in 2003 versus 2002. In the discussion below, comparison is with
the second quarter of 2003 and 2002, unless otherwise stated.
Annualized return on average assets (ROA) was 2.03% in 2003, and 2.01% in 2002.
Annualized return on average shareowners' equity (ROE) in 2003 was 20.18%, as
compared to 18.57% in 2002. Diluted earnings per share were $.55 for 2003, and
$.47 for 2002.
FINANCIAL REVIEW
- ----------------
MARKET AREA
- -----------
Frontier Financial Corporation, headquartered in Everett, Washington, is the
parent of Frontier Bank, which operates thirty-eight banking offices in Clallam,
Jefferson, King, Kitsap, Pierce, Snohomish, Skagit and Whatcom counties. These
eight counties are considered the market or service area of the Corporation and
comprise the area referred to as the Puget Sound Region. The Puget Sound Region
is home to approximately 80% of the population of Washington State. The Boeing
airplane manufacturing plant for 747's and 777's is located in the city of
Everett. Microsoft, the world's largest software company, is located in Redmond,
Washington, 25 miles from Everett. The Bank also has a branch office in Redmond.
Over the past decade, state employment has become increasingly diversified,
relying less on aerospace and timber.
BALANCE SHEET - June 30, 2003/December 31, 2002
- -----------------------------------------------
In the second quarter of 2003, investment securities increased $1.0 million, or
0.7%. The small increase is due to the current unfavorable yield curve and
during the remainder of 2003, it is uncertain if investment securities will
increase due to this environment.
Federal funds sold increased since year-end 2002 by $100.4 million, or 742.2%
due to the lack of net loan growth and increased deposits in premium savings
accounts.
Loans, net of unearned income, increased $8.2 million, or 0.5% to a balance of
$1.67 billion at June 30, 2003 compared to $1.66 billion at December 31, 2002.
This increase was modest, however, in the second quarter new loan originations
were $255 million and year-to-date were in excess of $440 million. Loan
maturities and payoffs keep loan growth low for the quarter and year-to-date
periods. In addition, the strong housing market in the Puget Sound region, due
to the historically low interest rates, contributed to the high level of
turnover in our construction and land development portfolio. Declining interest
rates have also created an additional level of competition as commercial
borrowers seek out alternative funding sources. Despite these competitive
pressures the Bank's loan portfolio grew 5.3% over the past twelve months from
$1.58 billion at June 30, 2002.
8
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Balance Sheet - (Continued)
- --------------------------------------------------------------------------------
The Bank's loan mix has remained relatively unchanged in the principal areas of
lending which include: installment, commercial, real estate commercial, real
estate construction, and residential. At June 30, 2003, 16.5% of our loan
portfolio was in commercial loans, 45.6% was in real estate commercial, 27.3%
was in real estate construction, 8.1% was in residential, and 2.5% installment.
On the liability side of the balance sheet, noninterest bearing deposits
increased $12.2 million, or 5.1% and interest bearing deposits increased $103.0
million, or 7.8%. NOW, Money Market, and sweep accounts increased $10.3 million,
or 3.5%; savings accounts increased $115.3 million, or 24.3%; and Time Deposits,
(cd's) declined $22.6 million, or 4.1%. The reason for the increase in savings
accounts is growth in the Corporation's "premium" savings account whose rate is
higher than that of cd's or other transaction accounts.
BALANCE SHEET - June 30, 2003/June 30, 2002
- -------------------------------------------
Below are abbreviated balance sheets at the end of the respective quarters which
indicates the changes that have occurred in the major portfolios of the
Corporation over the past year:
(In Thousands)
June 30, 2003 2002 $Change % Change
- ----------------------------------------------------- ------------- -------------- -----------
Loans $1,666,839 $1,583,626 $83,213 5.3%
Investments 140,989 140,827 162 0.1%
Federal Funds Sold 113,934 16,000 97,934 612.1%
-------------- ------------- -------------- -----------
Total Earning Assets $1,921,762 $1,740,453 $181,309 10.4%
============== ============= ============== ===========
Total Assets $2,060,472 $1,849,610 $210,862 11.4%
============== ============= ============== ===========
Noninterest bearing deposits $250,142 $223,050 $27,092 12.1%
Interest bearing deposits 1,425,878 1,273,124 152,754 12.0%
-------------- ------------- -------------- -----------
Total deposits $1,676,020 $1,496,174 $179,846 12.0%
============== ============= ============== ===========
Federal Funds purchased and Securities
Sold under Repurchase Agreements 11,668 13,906 (2,238) -16.1%
FHLB advances 155,112 130,129 24,983 19.2%
Shareowners' equity $205,703 $198,002 $7,701 3.9%
Loans, investments, and fed funds sold are the components of earning assets. One
of the challenges of management is to allocate liquidity from the liability side
of the balance sheet to those earning assets which maximize yield in concert
with degree of risk.
At June 30, 2003, loans were up $83.2 million, or 5.3% over the previous year.
The increase in loans over the last year was due, for the most part, to
continued emphasis on loan development. Investments increased $.2 million, or
..1% for the period and fed funds sold increased $97.9 million, or 612.1%. The
Corporation would like to have increased loans and investments more than federal
funds sold, however we experienced high levels of payoffs and turnover in the
loan portfolio and there were unattractive investment opportunities in the bond
portfolio.
9
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Balance Sheet - (Continued)
- --------------------------------------------------------------------------------
Noninterest bearing deposits increased $27.1 million, or 12.1% to $250.1
million. Since the number of accounts grew at a 3.5% rate, the increase in
dollars is representative of normal core growth. Interest bearing deposits
increased $152.8 million, or 12.0%, with all of the increase attributable to
premium savings accounts.
At June 30, 2003, NOW, Money Market and Sweep accounts made up 22% of total
interest bearing deposits. At June 30, 2002 those deposits made up 23%. In 2003,
savings deposits made up 41% of total interest bearing deposits versus 29% in
2002 and time deposits made up 37% in 2003 versus 48% in 2002.
Over the last year, NOW, Money Market and Sweep deposits increased $14.9
million, or 5.1%; savings deposits increased $223.4 million, or 61.1%; and time
deposits decreased $85.5 million or 13.9%. The reason for the significant change
in the mix over the last year was due mainly to maturing certificates of deposit
moving into competitively priced premium savings accounts.
FHLB borrowings increased $25.0 million or 19.2% over the year due to low,
long-term rates available.
Capital has increased $7.7 million over the past year, or 3.9%. Due to
previously approved capital management plans, over the past year, the
Corporation repurchased $20.2 million in stock in the open market, representing
797,300 shares. Also during the same period, the Corporation paid $12.3 million
in cash dividends. This was offset by the income of the Corporation for the same
time period.
NET INTEREST INCOME
- -------------------
Net interest income is the difference between total interest income and total
interest expense. Several factors contribute to changes in net interest income.
These include the effects of changes in average balances, changes in rates on
earning assets and rates paid for interest bearing liabilities, the level of
noninterest bearing deposits, shareowners' equity, and the level of nonaccrual
loans.
The earnings from certain assets are exempt from federal income tax, and it is
customary in the financial services industry to analyze changes in net interest
income on a "tax equivalent" ("TE") or fully taxable basis. Under this method,
nontaxable income from loans and investments is adjusted to an amount which
would have been earned if such income were subject to federal income tax. The
discussion below presents an analysis based on TE amounts at a 35% tax rate.
(However, there are no tax equivalent additions to interest expense or
noninterest income and expense amounts discussed below.)
Determination of Tax Equivalent Amounts:
In Thousands
At June 30, 2003 2002 $ Change % Change
-------------- -------------- -------------- ------------
Net income as reported $ 33,989 $ 33,618 $ 371 1.1%
Effect of tax exempt loans and
municipal bonds 241 275 (34) -12.4%
-------------- -------------- -------------- ------------
Tax equivalent (TE) net interest income 34,230 33,893 337 1.0%
Total interest expense 9,793 11,276 (1,483) -13.2%
-------------- -------------- -------------- ------------
TE net interest income $ 24,437 $ 22,617 $ 1,820 8.0%
============== ============== ============== ============
Calculation of TE Net Interest Margin (annualized)
TE net interest income $ 136,920 $ 135,572 $ 1,348 1.0%
Total interest expense (39,172) (45,104) 5,932 -13.2%
-------------- -------------- -------------- ------------
$ 97,748 $ 90,468 $ 7,280 8.0%
============== ============== ============== ============
Average Earning Assets $ 1,891,481 $ 1,707,283 $ 184,198 10.8%
-------------- -------------- -------------- ------------
TE NIM 5.17% 5.30% -0.13%
============== ============== ==============
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Net Interest Income
- --------------------------------------------------------------------------------
TE is a non-GAAP performance measurement used by management in operating the
business, which management believes provides investors with a more accurate
picture of the net interest margin for comparative purposes.
Abbreviated quarterly average balance sheets and net interest income data for
the periods are shown below:
(In thousands)
For quarter ended June 30, 2003 2002 $Change % Change
- ----------------------------------------------------- ------------- -------------- -----------
Loans $1,670,361 $1,556,775 $113,586 7.3%
Investments* 132,775 132,738 37 0.0%
Federal funds sold 88,345 17,770 70,575 397.2%
-------------- ------------- -------------- -----------
Total earning assets 1,891,481 1,707,283 184,198 10.8%
============== ============= ============== ===========
Total assets $2,000,599 $1,806,909 $193,690 10.7%
============== ============= ============== ===========
Noninterest bearing deposits $249,634 $231,986 $17,648 7.6%
Interest bearing deposits 1,367,821 1,238,769 129,052 10.4%
-------------- ------------- -------------- -----------
Total deposits $1,617,455 $1,470,755 $146,700 10.0%
============== ============= ============== ===========
Federal funds purchased
and repurchase agreements $10,146 $11,986 $(1,840) -15.4%
FHLB advances 159,839 115,954 43,885 37.8%
Shareowners' equity* $201,152 $195,304 $5,848 3.0%
============== ============= ============== ===========
*Shown at amortized cost, or adjusted for unrealized gain (loss).
In the first six months of 2003, average total earning assets as a percent of
average total assets were 94.5% and 94.5% in 2002. This ratio indicates how
efficiently assets are being utilized. Average loans were 83.5% and 86.2% of
average assets, respectively and investments were 6.6% and 7.3%, for the same
periods. Average federal funds sold were 4.4% and 1.0% over the period. Average
total loan-to-deposits ratio's were 103.3% and 105.8%. Not shown in the table
are the components of interest bearing deposits. Average NOW, Sweep and Money
Market accounts were 17.9% of total interest bearing liabilities ("IBL");
savings accounts were 36.6% of total IBL and time certificates were 34.5% of
total IBL. Average borrowings were 9.2% of total IBL. Tax equivalent net
interest income increased $1.8 million, or 8.0%.
Earning Assets
- --------------
Using a 365-day base, the TE yield on total earning assets decreased .70% in the
second quarter of 2003 to 7.26% compared to 7.96% in 2002. This was due to a
decrease in interest rates as the result of two Base (Prime) lending rate
decreases over the period in response to Federal Reserve Board action, and
refinancing of fixed rate loans to a lower rate and maturing investments. The
cost of total interest bearing liabilities decreased .76% from 3.31% in 2002 to
2.55% in 2003. The tax equivalent ("TE") net interest margin ("NIM") decreased
..13% from the second quarter of 2002 to the first quarter of 2003 as shown in
table on page 11.
On a TE basis, net interest income was $24.4 million in 2003, versus $22.6
million in 2002, for an increase in net interest income of $1.8 million. This
increase was the result of total interest income increasing $337 thousand, and
total interest expense decreasing $1.5 million.
10
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Earning Assets (continued)
- --------------------------------------------------------------------------------
The increase of $184.2 million in the average balance of earning assets
increased interest income by $2.6 million and a decrease in interest rates
decreased interest income by $2.3 million, for a net increase of $337 thousand.
The annualized yield on total loans decreased from 8.19% in 2002 to 7.71% in
2003. Commercial loans decreased from 7.60% to 7.11%; real estate commercial
loans decreased in yield from 8.41% to 7.60%; real estate construction loans
increased in yield from 7.93% to 8.01% mainly due to turnover rate of these
types of loans; real estate residential loans decreased from 8.96% to 8.02%, and
installment loans increased from 9.22% to 9.39%.
The yield on investments decreased from 6.10% in 2002 to 5.60% in 2003 and the
yield on federal funds sold decreased from 1.69% in 2002 to 1.15% in 2003.
Interest Bearing Liabilities
- ----------------------------
The increase in the average balance of interest bearing deposits of $129.1
million increased interest expense by $.6 million, and the rate paid on interest
bearing deposits decreased interest expense by $2.4 million.
The increase in the average balance of other borrowings increased interest
expense by $.6 million and the rates paid on these borrowings decreased interest
expense by $.3 million.
The cost of NOW, Money Market and Sweep accounts decreased from 1.64% in 2002,
to 1.08% in 2003. Savings account costs were 2.73% in 2002, and 1.97% in 2003.
Time cd's decreased in cost from 3.99% in 2002 to 3.26% in 2003. Short-term
borrowings decreased from 1.41% to .79%, and FHLB borrowings decreased from
5.53% in 2002 to 4.90% in 2003.
NONINTEREST INCOME AND EXPENSE - June 30, 2003/June 30, 2002
- ------------------------------------------------------------
Total noninterest income increased $559 thousand in the second quarter of 2003,
or 20.9% from a year ago. Service charges increased $60 thousand to $1.1
million, or 5.7%. The increase in service charges was due to increased NSF/OD
fees of $22 thousand and increased business service charges of $49 thousand.
Other noninterest income increased $499 thousand or 30.8% in the current
quarter. The main component of the increase in 2003 was servicing release fees
of $398 thousand due to increased mortgage originations. In 2003 there were
operational recoveries of $14 thousand and a gain on the sale of assets and
Other Real Estate Owned (OREO) of $30 thousand.
The market value of trust assets at quarter-end June 2003 was $247.0 million, as
compared to $223.8 million in 2002, an increase of $23.2 million, or 10.4%.
Trust department revenue for the second quarter of 2003 was $335 thousand, up
$19 thousand, or 6.0%. Trust assets are not included in the Corporation's
consolidated balance sheet.
Total noninterest expenses increased $1.1 million or 10.7% for the period.
Salaries and benefits increased $.8 million or 13.4%. There were 593 FTE
employees at June 30, 2003. Salaries, only, were up $377 thousand; benefits were
up $426 thousand, and deferred loan costs were up by $29 thousand. The increase
in salaries of 9.0% represents an increase in staff of 3.1%, and the remainder
represents merit raises for the year. The increase in benefits was due to
increased profit sharing contributions of $150 thousand; increased incentive and
commissions of $149 and other increases attributable to normal operations.
11
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Noninterest income and expenses (continued)
- --------------------------------------------------------------------------------
Occupancy expense increased $47 thousand, or 3.1%. Depreciation expense was 37%
of occupancy expense for 2003 and 2002. The remaining increase in 2003 of $57
thousand was increased maintenance agreement expense.
Other noninterest expense increased $236 thousand, or 8.9%. This increase was
due to increased collection expenses of $118 thousand; Visa marketing fees of
$53 thousand, and taxes of $30 thousand. Additionally, there were operational
losses of $44 thousand in 2003, and loss on sale of bank assets and OREO of $15
thousand.
Banks and bank holding companies use a computation called the "efficiency ratio"
to measure overhead. This ratio is then compared to others in the industry. The
ratio is calculated by dividing total noninterest expense, less intangible
amortization expense, certain losses and other nonrecurring charges, by the sum
of net interest income on a taxable equivalent basis, and other noninterest
income, less the same type of non-recurring items. The lower the number, the
more efficient the organization. The Corporation's efficiency ratio for the
second quarter was 40% for 2003 and 40% for 2002. The Corporation's ratio places
it among the performance leaders in the industry.
ASSET QUALITY
- -------------
The Corporation manages its credit risk through diversification of its loan
portfolio and the application of prudent underwriting policies, procedures, and
monitoring practices. Delinquent and problem loans, however, are a part of any
lending enterprise. When a borrower fails to make payments, the Corporation
implements procedures with an organized practical approach to collection of
delinquent loans.
IMPAIRED ASSETS
- ---------------
Loans are considered impaired, based on current information and events, when 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.
The assessment of impairment occurs when and while such loans are on nonaccrual,
or the loan has been restructured. When a loan with unique characteristics has
been identified as being impaired, the Corporation will measure the amount of
the impairment. If the measurement is less than the recorded investment in the
loan, impairment is recognized by creating or adjusting an existing allocation
of the allowance for loan losses. 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 the contract is modified may be
excluded from the impairment assessment and may cease to be considered impaired.
12
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Impaired Assets
- --------------------------------------------------------------------------------
Nonperforming loans and impaired assets are summarized as follows:
(In thousands)
Period ended June 30, 2003 2002
- ------------------------------------------ ----------- -----------
Nonaccruing loans:
Commercial $1,153 $938
Agriculture - 731
Real Estate 3,854 16,026
Installment and other 28 236
----------- -----------
Total nonaccruing loans $5,035 $17,931
Other real estate owned 6,280 2,663
----------- -----------
Total nonperforming assets $11,315 $20,594
=========== ===========
Restructured loans $6,178 $6,178
Total loans at end of period $1,666,839 $1,583,625
Total assets at end of period $2,060,472 $1,849,610
Total nonperforming assets to total loans 0.68% 1.30%
Total nonperforming assets to total assets 0.55% 1.11%
Total impaired assets to total assets 0.85% 1.45%
For nonaccrual loans, it is the Corporation's practice to discontinue accruing
interest on virtually all loans that are delinquent in excess of 90 days
regardless of risk of loss, collateral, etc. Some problem loans which are less
than 90 days delinquent are also placed into nonaccrual status if the success of
collecting full principal and interest in a timely manner is in doubt and some
loans will remain in nonaccrual even after improved performance until a
consistent timely payment pattern is exhibited and/or timely performance is
considered to be reliable.
The table above reflects nonaccrual loans decreased by $12.9 million to $5.0
million as of June 30, 2003. As of quarter end this balance included 18 loans
ranging in size from $1.4 million to nominal amounts. Efforts are continuing to
collect these loans with many involving some measure of legal action. Ninety
percent of these loans are real estate secured and, while there is always some
risk of loss present, management feels it is not substantial as a proportion of
the overall portfolio.
Other real estate owned (OREO) is carried at the lesser of book value or market
value. The costs related to completion, repair, maintenance, or other costs of
such properties, are generally expensed with any gains or inadvertent shortfalls
from the ultimate sale of OREO being shown as other income or expense.
13
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Other Real Estate Owned
- --------------------------------------------------------------------------------
OTHER REAL ESTATE OWNED
- -----------------------
OREO ended the quarter with a portfolio of six properties totaling $6.3 million
representing .30% of total assets. The increase over last years OREO balance
reflects the transition of troubled assets through an orderly collection
process. Since December 31, 2002 activity has included the sale of six
properties and the addition of three properties. Of the six properties held, one
property totaling $3.6 million is expected to close over the next 90 days.
Balances in the remaining five properties total $2.6 million and is concentrated
in one property identified as a completed retail structure. All properties are
being actively managed for timely removal.
Certain other loans, currently in nonaccrual are in the process of foreclosure
and there is a likelihood these foreclosures will be completed and the loans
will then become OREO. Management views this as an ordinary part of the
collection process and efforts are maintained to reduce and minimize such
nonperforming assets.
CREDIT CONCENTRATIONS
- ---------------------
The table below indicates the changes to the loan portfolio mix as of the dates
indicated, net of deferred loan fees:
(In thousands) June 30, 2003 December 31, 2002
--------------------------- ---------------------------
Amount % of total Amount % of total
------------- ------------- -------------- ------------
Installment $41,058 2.5% $47,217 2.8%
Commercial 274,870 16.5% 272,440 16.4%
Real estate commercial 759,708 45.6% 758,826 45.8%
Real estate construction 455,816 27.3% 443,461 26.7%
Real estate residential 135,387 8.1% 136,740 8.3%
------------- ------------- -------------- ------------
Total $1,666,839 100.0% $1,658,684 100.0%
============= ============= ============== ============
As shown in the table above we do emphasize commercial and commercial real
estate related lending. The commercial real estate portfolio consists of a wide
cross-section of retail, small office, warehouse, and industrial type
properties. These loans are secured by first trust deeds with maturities from 3
to 10 years and original loan to value ratios generally from 65% to 75%. A
substantial number of these properties are owner occupied. While the Corporation
has significant balances within this lending category, management believes that
its lending policies and underwriting standards are sufficient to minimize risk
even during these uncertain economic times. The Corporation's lending activities
have avoided those real estate sectors that have been most impacted by the
economic slump. As an example loans to hotel/motel operations comprise less then
2.9% of the loan portfolio, and Class A properties are an insignificant portion.
Management devotes considerable attention to the risks associated with the loan
portfolio and continually monitors the effects of current, and expected market
conditions and other factors that may influence the repayment of these loans.
At June 30, 2003 and 2002, the Corporation had an immaterial amount of foreign
loans and no loans related to highly leveraged transactions.
14
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Allowance for Possible Loan Losses
- --------------------------------------------------------------------------------
ALLOWANCE FOR POSSIBLE LOAN LOSSES - QUALITATIVE FACTORS
- --------------------------------------------------------
For the six months ending June 30, 2003, the reserve for possible loan losses
increased to $29.0 million, or 1.74% of total loans, from $28.2 million, or
1.70% of total loans at year-end 2002. Year-to-date net loan losses were $959
thousand.
Management and the Board review policies and procedures annually, or more often,
and changes are made to reflect the current operating environment integrated
with regulatory requirements. Partly out of these policies has evolved an
internal credit risk review process. During this process the quality grade of
loans are reviewed and loans are assigned a dollar value of the loan loss
reserve by degree of risk. This analysis is performed quarterly and reviewed by
senior management who makes the determination if the risk is reasonable, and if
the reserve is adequate.
Taken into consideration when the analysis is performed is the national and
local economic trends and conditions. The analysis also takes into consideration
the level of, or trends in, delinquencies and nonaccruing loans. Management
monitors delinquencies monthly and reports are prepared for the Board of
Directors to review. Delinquencies for commercial, personal and real estate
loans are charted separately by their types and by portfolio geographic
locations.
Another consideration is the volume and terms of loans. Management reviews the
growth and terms of loans so that the allowance can be adjusted for current and
anticipated future needs.
Conclusion of Qualitative Factors
The allowance for loan losses is the amount which, in the opinion of management,
is necessary to absorb loan losses. Management's evaluation of the adequacy of
the allowance is based on the market area served, local and national economic
conditions, the growth and composition of the loan portfolio and the related
risk characteristics, by continual review by management of the quality of the
portfolio.
In addition, regulatory agencies, as an integral part of their examination
process, periodically review the estimated losses on loans. Such agencies may
require the Corporation to change the allowance based on their judgment about
information available to them at the time of their examination. It is the
Corporation's policy to be in compliance with all accounting and regulatory
standards related to loan loss reserves and all accounting policies promulgated
by GAAP.
15
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Liquidity and Interest Rate Risk
- --------------------------------------------------------------------------------
LIQUIDITY AND INTEREST RATE RISK
- --------------------------------
LIQUIDITY
- ---------
The primary function of asset/liability management is to ensure adequate
liquidity and maintain an appropriate balance between interest sensitive earning
assets and liabilities. Liquidity management involves the ability to meet the
cash flow requirements of customers who may be either depositors wanting to
withdraw funds, or depositors who have credit needs.
The statement of cash flows on pages 3 and 4 of this report provides information
on the sources and uses of cash for the respective year-to-date periods ending
June 30, 2003 and 2002. This discussion addresses those periods of time.
When comparing the cash flows from operating activities for the two quarters,
the most prominent items are mortgage loans originated and sold. This function
is dependent on the level of long-term interest rates and represents refinancing
activity, and, as indicated, the activity in this area was 2.3 times greater in
2003 than 2002. These numbers also reflect the substantial increase that the
Corporation had in servicing release fee income described earlier.
Cash flows from investing activities for the two periods were quite different.
In 2002, fed funds sold supplied liquidity to other earning assets, whereas in
2003, fed funds sold absorbed liquidity and grew to $113.9 million. While loan
growth funding only totaled $9.5 million for 2003, over $443 million of new
loans were made during the first six months. This growth in loans was offset by
payoffs and maturities.
Cash flows from financing activities were quite similar for the two periods.
Core deposit and FHLB advances funded asset growth in 2002, whereas core
deposits, only, funded growth in 2003.
Management has many sources of liquidity, such as the sale of AFS securities,
additional borrowings from the FHLB, increased participation in the Treasury
department's short-term note program, borrowings from the Federal Reserve Bank,
or additional borrowings at correspondent banks. The Corporation has a policy
that liquidity of 12.5% of total assets be maintained as a minimum and has done
so.
INTEREST RATE RISK
- ------------------
Interest rate risk refers to the exposure of earnings and capital arising from
changes in interest rates. Management's objectives are to control interest rate
risk and to ensure predictable and consistent growth of earnings and capital.
Interest rate risk management focuses on fluctuations in net interest income
identified through computer simulations to evaluate volatility under varying
interest rate, spread and volume assumptions. The risk is quantified and
compared against tolerance levels.
16
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Interest Rate Risk (continued)
- --------------------------------------------------------------------------------
The Corporation uses a simulation model to estimate the impact of changing
interest rates on the Corporation's earnings and capital. The model calculates
the change in net interest income under various rate shocks. As of March 31,
2003 the model predicted that net interest income would increase whether rates
went up or down, however, at different magnitudes. This behavior is heavily
influenced by loans going on and off floors. If rates declined by 1%, net
interest income would increase by approximately 0.6%. If rates increased by 1%,
net interest income would increase by 1.8% and 5.4% if rates increased 2%. The
actual change in earnings would be dependent upon the dynamic changes that occur
when rates change. Many of these changes are predictable, but the exact amount
is difficult to predict and actual events may vary substantially from the
simulation model results.
Management does not use interest rate risk management products such as interest
rate swaps, options, hedges, or derivatives, nor does management currently have
any intention to use such products in the future.
CAPITAL
- -------
Consolidated capital of the Corporation for financial statement purposes at
second quarter end 2003 was $205.7 million. This amount compares to $198.9
million at December 31, 2002, an increase of $6.8 million, or 3.4%. During the
second quarter of 2003 the Corporation repurchased 15,000 shares of common stock
in the open market for $362 thousand and also paid a second quarter dividend of
$3.1 million. Please see page 11, paragraph 5, for dividends and stock
repurchases since the end of the second quarter 2002.
The Corporation's regulatory capital ratios were as follows:
For Capital Actual Actual
Adequacy Purposes June 30, 2003 December 31, 2002
------------------- --------------- -----------------
Tier I Capital 4.0% 10.18% 10.37%
Tier II Capital 8.0% 11.43% 11.62%
Leverage Ratio 4.00% 9.80% 9.85%
It is the policy of the Corporation that capital be maintained above the point
where, for regulatory purposes, it would continue to be classified as "well
capitalized".
Management constantly monitors the level of capital of the Corporation,
considering, among other things, the present and anticipated needs of the
Corporations, current market conditions, and other relevant factors, including
regulatory requirements which may necessitate changes in the level of capital.
17
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- --------------------------------------------------------------------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
Management considers interest rate risk to be a market risk that could have a
significant effect on the financial condition of the Corporation. There have
been no material changes in the reported market risks faced by the Corporation
since the end of the most recent fiscal year-end that have not been included in
this discussion.
ITEM 4. CONTROLS AND PROCEDURES
- --------------------------------
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the
Registrant's disclosure controls and procedures (as defined in section
13(a) - 14(c) of the Securities Exchange Act of 1934 (the "Act")) was
carried out under the supervision and with the participation of the
Registrant's Chief Executive Officer, Chief Financial Officer and
several other members of the registrant's senior management within the
90-day period preceding the filing date of this quarterly report. The
Registrant's Chief Executive Officer and Chief Financial Officer
concluded that the Registrant's disclosure controls and procedures as
currently in effect are effective in ensuring that the information
required to be disclosed by the Registrant in the reports it files or
submits under the Act is (i) accumulated and communicated to the
Registrant's management (including the Chief Executive Officer and
Chief Financial Officer) in a timely manner, and (ii) recorded,
processed, summarized and reported within the time periods specified
in the SEC's rules and forms.
(b) Changes in Internal Controls: In the quarter ended June 30, 2003, the
Registrant did not make any significant changes in, nor take any
corrective actions regarding, its internal controls or other factors
that could significantly affect these controls.
Disclosure Controls and Internal Controls. Disclosure controls are
procedures that are designed with the objective of ensuring that
information required to be disclosed in FFC's reports filed under the
Securities Exchange Act of 1934 (Exchange Act) is recorded, processed,
summarized and reported within the time periods specified in the
Securities and Exchange Commission's (SEC) rules and forms. Disclosure
controls are also designed with the objective of ensuring that such
information is accumulated and communicated to our management, as
appropriate to allow timely decisions regarding required disclosure.
Internal Controls are procedures which are designed with the objective
of providing reasonable assurance that (1) transactions are properly
authorized; (2) assets are safeguarded against unauthorized or
improper use; and (3) transactions are properly recorded and reported,
all to permit the preparation of financial statement in conformity
with accounting principles generally accepted in the United States of
America.
18
- --------------------------------------------------------------------------------
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Item 4. Controls and Procedures
- --------------------------------------------------------------------------------
Limitations on the Effectiveness of Controls. FFC's management does
not expect that our disclosure controls or our internal controls will
prevent all errors and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further,
the design of control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any,
within FFC have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of some persons,
by collusion of two or more people, or by management override of the
control. The design of any system of controls also is based in part
upon certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving
its stated goals under all potential future conditions; over time,
controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective
control system, misstatements due to error or fraud may occur and not
be detected.
FORWARD-LOOKING INFORMATION
- ---------------------------
Except for historical financial information contained herein, the matters
discussed in this 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. The Corporation shall not be responsible to update
any such forward-looking statements.
19
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. Legal Proceedings
The Corporation is involved in ordinary routine litigation arising in
the normal course of business. In the opinion of management,
liabilities (if any) arising from such claims will not have a material
effect on the business, results of operations or financial condition
of the Corporation.
Item 4. Submission of Matters to a Vote of Security Holders
On April 16, 2003 the annual shareowner's meeting was held in Everett,
Washington. The only matter voted upon was the election of a class of
Directors to a term expiring in 2006. Those incumbent directors were
elected by more than a majority of the shareowner's as follows:
Lucy J. Donald William J. Edward C.
DeYoung Regan Robinson Rubatino
------------- ------------- ------------- -------------
(in thousands)
Votes for 15,334 15,336 15,393 15,356
Votes against/withheld 76 74 17 55
The terms of the following continued after the meeting: George E.
Barber, Michael J. Clementz, David A. Dujardin, James H. Mulligan,
Roger L. Rice D.D.S., Robert J. Dickson, Edward D. Hansen, William H.
Lucas, Michael J. Corliss and Darrell J. Storkson.
Item 5. Other Information
(a) On June 18, 2003, the Board of Directors of the Corporation
declared a $.175 per share third quarter 2003 cash dividend to
shareowners of record as of July 7, 2003 and payable July 28,
2003.
Item 6. Exhibits and Reports on Form 8-K
(a) THE FOLLOWING EXHIBITS ARE FILED AS A PART OF THIS QUARTERLY
REPORT ON FORM 10-Q.
(11) Computation of basic and diluted earnings per share is
attached as Exhibit 11.
20
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
(b) Reports on Form 8-K:
On January 17, 2003, Form 8-K was filed reporting that its wholly
owned subsidiary, Frontier Bank, has announced the reorganization
of senior management.
On March 20, 2003, Form 8-K was filed announcing a second quarter
cash dividend detailed above in Item 5(b).
On April 17, 2003, Form 8-K was filed announcing first quarter
2003 earnings.
On April 18, 2003, Form 8-K was filed announcing executive
realignment.
On May 22, 2003, Form 8-K was filed announcing that Carol E.
Wheeler has been named as Chief Financial Officer.
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
SIGNATURE
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRONTIER FINANCIAL CORPORATION
Date: July 24, 2003 /s/ Carol E. Wheeler
------------------- ----------------------
Carol E. Wheeler
Chief Financial Officer
21
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CERTIFICATION
- --------------------------------------------------------------------------------
CERTIFICATION
I, Michael J. Clementz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Frontier Financial
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the Audit
Committee of registrant's Board of Directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
July 24, 2003 /s/Michael J. Clementz
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Date Michael J. Clementz
President & CEO
22
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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CERTIFICATION
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CERTIFICATION
I, Carol E. Wheeler, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Frontier Financial
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the Audit
Committee of registrant's Board of Directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
July 24, 2003 /s/ Carol E. Wheeler
---------------------- ---------------------
Date Carol E. Wheeler
Chief Financial Officer
23
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Michael J. Clementz, the Chief Executive Officer of Frontier Financial
Corporation (the "Company"), hereby certify, pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. the Form 10-Q of the Company for the quarter ended June 30, 2003 (the "Form
10-Q"), fully complies with requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
2. the information contained in the Form 10-Q fairly presents, in all material
respects, the financial condition and results of operations of the Company.
July 24, 2003 /s/ Michael J. Clementz
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Date President and Chief Executive Officer
A signed original of this written statement required by Section 906, or other
documents authenticating, acknowledging, or otherwise adopting the signature
that appears in typed form within the electronic version of this written
statement required by Section 906, has been provided to Frontier Financial
Corporation and will be retained by Frontier Financial Corporation and furnished
to the Securities and Exchange Commission or its staff upon request.
24
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Carol E. Wheeler, the Chief Financial Officer of Frontier Financial
Corporation (the "Company"), hereby certify, pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. the Form 10-Q of the Company for the quarter ended June 30, 2003 (the "Form
10-Q"), fully complies with requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
2. the information contained in the Form 10-Q fairly presents, in all material
respects, the financial condition and results of operations of the Company.
July 24, 2003 /s/ Carol E. Wheeler
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Date Chief Financial Officer
A signed original of this written statement required by Section 906, or other
documents authenticating, acknowledging, or otherwise adopting the signature
that appears in typed form within the electronic version of this written
statement required by Section 906, has been provided to Frontier Financial
Corporation and will be retained by Frontier Financial Corporation and furnished
to the Securities and Exchange Commission or its staff upon request.