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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 September 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 October 24, 2003
- -------------------------------- --------------------------------------
Common Stock, no par value 18,520,131
- --------------------------------------------------------------------------------
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 -September 30, 2003
and Year End 2002 1
Consolidated Statement of Income - Three and nine months
Ended September 30, 2003 and 2002 2
Consolidated Statement of Cash Flows - Nine months
Ended September 30, 2003 and 2002 3-4
Notes to the Consolidated Financial Statements 5-7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8-19
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
Signatures 23
Certifications 25-28
Restated Bylaws 29-35
-ii-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- ---------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
- ---------------------------------------------------------------------------------------------------------------------------------
(In thousands, except shares)
September 30 December 31
ASSETS 2003 2002
---------------- -----------------
Cash & due from banks $ 72,000 $ 88,647
Federal funds sold 3,049 13,528
Securities:
Available for sale-market value 199,320 109,429
Held to maturity-amortized cost 22,212 30,608
---------------- -----------------
Total securities 221,532 140,037
Loans, net of unearned income 1,719,323 1,658,684
Less allowance for loan losses (28,678) (28,175)
---------------- -----------------
Net loans 1,690,645 1,630,509
Premises & equipment, net 26,859 26,697
Other real estate owned 7,544 6,532
Goodwill 6,476 6,476
Other assets 31,801 31,301
---------------- -----------------
TOTAL ASSETS $ 2,059,906 $ 1,943,727
================ =================
LIABILITIES
Deposits:
Noninterest bearing $ 274,021 $ 237,972
Interest bearing 1,399,232 1,322,904
---------------- -----------------
Total deposits 1,673,253 1,560,876
Federal funds purchased and
securities sold under repurchase agreements 10,744 11,809
Federal Home Loan Bank advances 150,108 160,121
Other liabilities 12,678 12,058
---------------- -----------------
TOTAL LIABILITIES 1,846,783 1,744,864
---------------- -----------------
SHAREOWNERS' EQUITY
Common stock, no par value; 100,000,000 shares authorized; 18,516,734 118,030 116,925
and 18,817,684 shares issued and outstanding in 2003 and 2002
Retained earnings 91,333 79,841
Accumulated other comprehensive income,
net of tax effect 3,760 2,097
---------------- -----------------
TOTAL SHAREOWNERS' EQUITY 213,123 198,863
---------------- -----------------
TOTAL LIABILITIES AND SHAREOWNERS' EQUITY $ 2,059,906 $ 1,943,727
================ =================
The accompanying notes are an integral part of these financial statements.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED STATEMENT OF INCOME
- ----------------------------------------------------------------------------------------------------------------------------------
(In Thousands, Except for Per Share Amounts) Three Months Ended Nine Months Ended
------------------------------------ ------------------------------------
September 30 September 30 September 30 September 30
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
INTEREST INCOME
Interest and fees on loans $ 31,226 $ 33,377 $ 95,301 $ 97,455
Interest on investments 2,264 1,998 6,249 5,426
----------------- ----------------- ----------------- -----------------
Total interest income 33,490 35,375 101,550 102,881
----------------- ----------------- ----------------- -----------------
INTEREST EXPENSE
Interest on deposits 7,173 9,671 23,268 29,455
Interest on borrowed funds 1,937 1,924 5,864 5,113
----------------- ----------------- ----------------- -----------------
Total interest expense 9,110 11,595 29,132 34,568
----------------- ----------------- ----------------- -----------------
Net interest income 24,380 23,780 72,418 68,313
----------------- ----------------- ----------------- -----------------
PROVISION FOR LOAN LOSSES (850) (1,500) (2,600) (3,100)
----------------- ----------------- ----------------- -----------------
NONINTEREST INCOME
Gain (loss) on sale of securities 99 (187) 190 (187)
Service charges on deposit accounts 1,169 1,086 3,354 3,045
Other noninterest income 2,172 1,444 6,189 4,756
----------------- ----------------- ----------------- -----------------
Total noninterest income 3,440 2,343 9,733 7,614
----------------- ----------------- ----------------- -----------------
NONINTEREST EXPENSE
Salaries and employee benefits 7,142 6,243 20,916 18,492
Occupancy expense 1,499 1,528 4,684 4,624
Other noninterest expense 2,644 2,537 8,101 7,387
----------------- ----------------- ----------------- -----------------
Total noninterest expense 11,285 10,308 33,701 30,503
----------------- ----------------- ----------------- -----------------
INCOME BEFORE INCOME TAX 15,685 14,315 45,850 42,324
PROVISION FOR INCOME TAX (5,208) (4,707) (15,564) (14,377)
----------------- ----------------- ----------------- -----------------
NET INCOME $ 10,477 $ 9,608 $ 30,286 $ 27,947
================= ================= ================= =================
Weighted average number of
shares outstanding for the period 18,505,346 19,187,846 18,561,698 19,197,166
Basic earnings per share $ 0.57 $ 0.50 $ 1.63 $ 1.46
================= ================= ================= =================
Weighted average number of diluted shares
outstanding for period 18,619,111 19,294,901 18,648,682 19,307,608
Diluted earnings per share $ 0.56 $ 0.50 $ 1.62 $ 1.45
================= ================= ================= =================
The accompanying notes are an integral part of these financial statements.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED STATEMENT OF CASH FLOWS
- ----------------------------------------------------------------------------------------------------------------------------------
(In thousands)
Sept. 30, 2003 Sept. 30, 2002
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net Income $ 30,286 $ 27,947
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 2,817 2,477
Provision for loan losses 2,600 3,100
Deferred taxes - (111)
Increase in income taxes payable 2,338 2,340
Increase (decrease) in interest receivable (49) (584)
Decrease in interest payable (803) (2,135)
Gain (loss) on sale of OREO 30 (72)
Gain on sale of securities 190 -
Gain (loss) on sale of fixed assets (12) 9
Proceeds from sale of mortgage loans 202,594 37,642
Origination of mortgage loans held for sale (197,980) (38,132)
Dividend income from FHLB (609) (616)
Decrease in other operating activities (3,552) (1,820)
------------------- -------------------
Net cash provided by operating activities 37,850 30,045
------------------- -------------------
CASH FLOWS FROM INVESTMENT ACTIVITIES
- -------------------------------------
Net cash flows from fed funds sold 10,479 (24,595)
Proceeds from the sale of AFS securities 4,381 1,010
Proceeds from maturities of AFS & HTM securities 57,155 5,193
Purchase of AFS securities (143,102) (62,543)
Net cash flows from loan activities (67,350) (78,097)
Purchases of premises and equipment (1,582) (896)
Proceeds from the sale of OREO 251 2,395
Proceeds from sale of property and equipment 31 -
Cash invested in ORE - 131
Increase in other investing activities 2,551 1,071
------------------- -------------------
Net cash used by investing activities (137,186) (156,331)
------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Net change in core deposits 168,444 191,105
Net change in certificates of deposit (56,067) (95,896)
Stock options exercised 896 873
Purchase of common shares (9,148) (5,680)
Cash dividends paid (9,490) (8,643)
Advances from FHLB - 50,000
Repayment of FHLB advances (10,013) (12)
Net change in Federal Funds purchased and securities
sold under repurchase agreements (1,065) 2,640
Increase (decrease) in other financing activities (868) 548
------------------- -------------------
Net cash provided by financing activities 82,689 134,935
------------------- -------------------
The accompanying notes are an integral part of these financial statements.
(Continued on next page)
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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CONSOLIDATED STATEMENT OF CASH FLOWS
- ----------------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS $ (16,647) $ 8,649
CASH AND DUE FROM BANKS AT BEGINNING
OF YEAR 88,647 64,062
------------------- -------------------
CASH AND DUE FROM BANKS AT END
OF PERIOD $ 72,000 $ 72,711
=================== ===================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
- ------------------------------------------------
Cash paid during the period for interest $ 29,935 $ 36,728
Cash paid during the period for income taxes 14,337 12,750
Real estate taken as settlement for loan obligations 2,055 8,879
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.
-4-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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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 Frontier Bank (the "Bank") and FFP, Inc. 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 nine
months ending September 30, 2003 are not necessarily indicative of the results
that may be expected for year-end December 31, 2003.
At September 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, except per share amounts)
---------------------------------------
For the quarter ended September 30,
-----------------------------------
Proforma disclosures 2003 2002
---- ----
Net income as reported $ 10,477 $ 9,608
Additional compensation for
fair value of stock options - -
--------- ---------
Proforma net income $ 10,477 $ 9,608
========= =========
Earnings per share
Basic
As reported $ 0.57 $ 0.50
Proforma $ 0.57 $ 0.50
========= =========
Diluted
As reported $ 0.56 $ 0.50
Proforma $ 0.56 $ 0.50
========= =========
The Corporation did not issue any options in the quarters ending September 30,
2003 and 2002. As of September 30, 2003 there were outstanding options to
purchase 371,071 shares under the plan, representing 2.3% of total shares
outstanding.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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). 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. 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
September 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 $ 27,081 $ 3,427 $ (344) $ 30,164
U.S. Treasuries 251 66 - 317
U.S. Agencies 82,378 352 (37) 82,693
Corporate securities 83,780 2,426 (101) 86,105
Municipal securities 45 - (4) 41
--------------------------------------------------------------------------
Totals 193,535 6,271 (486) 199,320
--------------------------------------------------------------------------
HTM SECURITIES
Municipal securities 20,682 621 (33) 21,270
Corporate securities 1,530 - (42) 1,488
--------------------------------------------------------------------------
Totals 22,212 621 (75) 22,758
--------------------------------------------------------------------------
Totals $ 215,747 $ 6,892 $ (561) $ 222,078
==========================================================================
MATURITY SCHEDULE OF SECURITIES
-------------------------------
Available for Sale Held to Maturity
Amortized Fair Amortized Fair
MATURITY Cost Value Cost Value
--------
--------------------------------------------------------------------------
0-1 Yr $58,310 $62,004 $895 $900
1-5 Yrs 90,071 91,835 17,897 18,300
5-10 Yrs 42,325 42,424 1,890 2,070
Over 10 Yrs 2,829 3,057 1,530 1,488
--------------------------------------------------------------------------
$193,535 $199,320 $22,212 $22,758
==========================================================================
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2 - (Continued)
CHANGES IN AFS AND HTM SECURITIES
---------------------------------
For the Quarter Ended September 30, 2003
----------------------------------------
AFS SECURITIES
--------------
Proceeds from sales $2,031
Gross realized gains $99
Gross realized losses $0
Gross gains & losses included in earnings
transfers to the trading category $0
Net change in unrealized holding gains or
losses included in the separate
components of shareowners' equity ($42)
NOTE 3. LOANS
The following is an analysis of the loan portfolio by major type of loans:
(In Thousands)
- --------------
September 30, 2003 December 31, 2002
------------------ -----------------
Commercial $ 281,013 $ 272,787
Real Estate:
Commercial 761,329 759,228
Construction 503,397 450,236
Residential 143,422 137,627
Installment 40,138 47,192
------------------- -----------------
1,729,299 1,667,070
Unearned Fee Income (9,976) (8,386)
------------------- -----------------
Total Loans $ 1,719,323 $ 1,658,684
=================== =================
NOTE 4. Please see Item 5, page 22 for dividend information.
-7-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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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 third quarter of 2003 was $10.5 million versus $9.6 million for the
third quarter of 2002, or up 9.0%. Net interest income increased $.6 million, or
2.5 %; noninterest income increased $1.1 million, or 46.8% and the provision for
loan losses was down $.65 million, or 43.3% from a year ago. Earnings per
diluted share were $.56 in the current quarter as compared to $.50 in the third
quarter of 2002. A contributing factor to the 14% growth in earnings per share
was 675,790 fewer average diluted shares in the current quarter compared to the
third quarter of 2002. In the discussion below, comparison is with the third
quarter of 2003 and 2002, unless otherwise stated.
The annualized return on average assets (ROA) was 2.05% in 2003 as compared to
2.03% in 2002. Annualized return on average shareowners' equity (ROE) in 2003
was 20.13%, as compared to 19.14% in 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. Its economy
has become more diversified over the past years with company headquarters for
Amazon, Costco, Starbucks, Weyerhauser and Microsoft.
BALANCE SHEET - September 30, 2003/December 31, 2002
- ----------------------------------------------------
In the third quarter of 2003, investment securities increased $81.5 million, or
58.2%. The substantial increase was due to two asset/liability planning
decisions. First, loan growth through the first two quarters of 2003 was $8.2
million, representing a growth of .5% in loans since year-end 2002. As a result,
overnight federal funds sold had accumulated to $113.9 million at the end of
June, 2003. In addition to lowering rates paid on deposits, management began
purchasing investment securities, mainly government agencies, which increased
yields by approximately 250 basis points. This lowered federal funds sold to a
reasonable level at the end of the third quarter of 2003 to $3.0 million from
$13.5 million at year-end.
Loans, net of unearned income, increased $60.6 million, or 3.7% to a balance of
$1.72 billion at September 30, 2003 compared to $1.66 billion at December 31,
2002. In the third quarter new loan originations were $281 million and
year-to-date were in excess of $725 million. Loan maturities and payoffs kept
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.
-8-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Balance Sheet - (Continued)
- --------------------------------------------------------------------------------
Historically low interest rates have also created an additional level of
competition as commercial borrowers sought out alternative funding sources.
Despite these competitive pressures the Bank's loan portfolio grew 3.7% over the
past twelve months from $1.66 billion at December 31, 2002 to $1.72 billion at
September 30, 2003.
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 September 30, 2003, 16.3% of our loan
portfolio was in commercial loans, 44.3% was in real estate commercial, 28.8%
was in real estate construction, 8.3% was in residential, and 2.3% installment.
On the liability side of the balance sheet, noninterest bearing deposits
increased $36.0 million, or 15.1% and interest bearing deposits increased $76.3
million, or 5.8%. NOW, Money Market, and sweep accounts decreased $35.5 million,
or 11.5%; savings accounts increased $42.3 million, or 7.8%; and Time Deposits,
(cd's) declined $33.5 million, or 6.2%. The reason for the increase in savings
accounts is growth in the Corporation's "premium" savings account whose rate is
higher than that of short term cd's or other transaction accounts.
BALANCE SHEET - September 30, 2003/September 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)
September 30, 2003 2002 $ Change % Change
- -------------
----------------- ----------------- ------------------ ---------------
Loans $ 1,719,323 $ 1,642,817 $ 76,506 4.7%
Investments 221,532 139,747 81,785 58.5%
Federal funds sold 3,049 69,395 (66,346) -95.6%
----------------- ----------------- ------------------ ---------------
Total earning assets $ 1,943,904 $ 1,851,959 $ 91,945 5.0%
================= ================= ================== ===============
Total assets $ 2,059,906 $ 1,969,334 $ 90,572 4.6%
================= ================= ================== ===============
Noninterest bearing deposits $ 274,021 $ 252,184 $ 21,837 8.7%
Interest bearing deposits 1,399,232 1,341,395 57,837 4.3%
----------------- ----------------- ------------------ ---------------
Total deposits $ 1,673,253 $ 1,593,579 $ 79,674 5.0%
================= ================= ================== ===============
Federal funds purchased and securities
sold under repurchase agreements 10,744 10,336 408 3.9%
FHLB advances 150,108 155,125 (5,017) -3.2%
Shareowners' equity $ 213,123 $ 198,929 $ 14,194 7.1%
Loans, investments, and federal 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 the degree of risk.
At September 30, 2003, loans were up $76.5 million, or 4.7% 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 $81.8 million, or
58.5% for the period and federal funds sold decreased $66.3 million, or 95.6%.
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.
-9-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Balance Sheet - (Continued)
- --------------------------------------------------------------------------------
Noninterest bearing deposits increased $21.8 million, or 8.7% to $274.0 million.
The number of noninterest bearing accounts increased 2,770 over the past year
which indicates an increase in the balances of those types of deposit accounts
of approximately 6% when compared to a year ago. Interest bearing deposits
increased $57.8 million, or 4.3%, with all of the increase attributable to
growth in premium savings accounts.
At September 30, 2003, NOW, Money Market and Sweep accounts made up 19% of total
interest bearing deposits. At September 30, 2002 those deposits made up 23%. In
2003, savings deposits made up 45% of total interest bearing deposits versus 32%
in 2002 and time deposits made up 36% in 2003 versus 45% in 2002.
Over the last year, NOW, Money Market and Sweep deposits decreased $30.6
million, or 10.1%; savings deposits increased $196.5 million, or 45.2%; and time
deposits decreased $108.1 million or 17.9%. The reason for the significant
change in the mix over the last year was due mainly to maturing certificates of
deposits moving into higher yielding premium savings accounts.
FHLB borrowings decreased $5.0 million or 3.2% over the year, due to maturing
advances.
Capital has increased $14.2 million over the past year, or 7.1%. In accordance
with previously approved capital management plans, over the past year, the
Corporation repurchased $15.5 million in stock in the open market, representing
612,300 shares. Also during the same period, the Corporation paid $12.5 million
in cash dividends. There were no stock repurchases during the third quarter.
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 on the next page.)
-10-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Net Interest Income
- --------------------------------------------------------------------------------
Determination of Tax Equivalent Amounts:
In Thousands
- ------------
FOR THE QUARTER
- ---------------
At September 30, 2003 2002 $ Change % Change
---------------- ---------------- -------------- -----------
Total interest income, as reported $ 33,490 $ 35,375 $ (1,885) -5.33%
Effect of tax exempt loans and
municipal bonds 237 269 (32) -11.90%
---------------- ---------------- -------------- -----------
Tax equivalent (TE) interest income 33,727 35,644 (1,917) -5.38%
Total interest expense 9,110 11,595 (2,485) -21.43%
---------------- ---------------- -------------- -----------
TE net interest income $ 24,617 $ 24,049 $ 568 2.36%
================ ================ ============== ===========
Calculation of TE Net Interest Margin (annualized)
TE interest income $ 134,908 $ 142,576 $ (7,668) -5.38%
Total interest expense (36,440) (46,380) 9,940 -21.43%
---------------- ---------------- -------------- -----------
TE net interest income $ 98,468 $ 96,196 $ 2,272 2.36%
================ ================ ============== ===========
Average earning assets $ 1,930,756 $ 1,789,693 $ 141,063 7.88%
---------------- ---------------- -------------- -----------
TE NIM 5.10% 5.38% -0.28%
================ ================ ==============
FOR THE YEAR-TO-DATE PERIOD
At September 30, 2003 2002 $ Change % Change
---------------- ---------------- -------------- -----------
Total interest income, as reported $ 101,550 $ 102,881 $ (1,331) -1.3%
Effect of tax exempt loans and
municipal bonds 728 858 (130) -15.2%
---------------- ---------------- -------------- -----------
Tax equivalent (TE) interest income 102,278 103,739 (1,461) -1.4%
Total interest expense 29,132 34,568 (5,436) -15.7%
---------------- ---------------- -------------- -----------
TE net interest income $ 73,146 $ 69,171 $ 3,975 5.7%
================ ================ ============== ===========
Calculation of TE Net Interest Margin (annualized)
TE interest income $ 136,371 $ 138,319 $ (1,948) -1.4%
Total interest expense (38,843) (46,091) 7,248 -15.7%
---------------- ---------------- -------------- -----------
TE net interest income $ 97,528 $ 92,228 $ 5,300 5.7%
================ ================ ============== ===========
Average earning assets $ 1,888,358 $ 1,727,398 $ 160,960 9.3%
---------------- ---------------- -------------- -----------
TE NIM 5.16% 5.34% -0.17%
================ ================ ==============
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.
-11-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Net Interest Income
- --------------------------------------------------------------------------------
Abbreviated quarterly average balance sheets and net interest income data for
the periods are shown below:
(In thousands)
For quarter ended September 30, 2003 2002 $ Change % Change
- --------------------------------
----------------- ----------------- ------------------ ---------------
Loans $ 1,683,241 $ 1,630,220 $ 53,021 3.3%
Investments* 170,147 138,259 31,888 23.1%
Federal funds sold 77,368 21,214 56,154 264.7%
----------------- ----------------- ------------------ ---------------
Total earning assets 1,930,756 1,789,693 141,063 7.9%
================= ================= ================== ===============
Total assets $ 2,043,891 $ 1,893,709 $ 150,182 7.9%
================= ================= ================== ===============
Noninterest bearing deposits $ 261,975 $ 233,783 $ 28,192 12.1%
Interest bearing deposits 1,400,042 1,288,949 111,093 8.6%
----------------- ----------------- ------------------ ---------------
Total deposits $ 1,662,017 $ 1,522,732 $ 139,285 9.1%
================= ================= ================== ===============
Federal funds purchased
and repurchase agreements $ 10,797 $ 9,965 $ 832 8.3%
FHLB advances 150,653 148,061 2,592 1.8%
Shareowners' equity* $ 208,236 $ 200,768 $ 7,468 3.7%
================= ================= ================== ===============
*Shown at amortized cost, or adjusted for unrealized gain (loss).
In the first nine months of 2003, average total earning assets as a percent of
average total assets were 94.4% and 94.5% in 2002. This ratio indicates how
efficiently assets are being utilized. Average loans were 82.4% and 86.1% of
average assets, respectively and investments were 8.3% and 7.3%, for the same
periods. Average federal funds sold were 3.8% and 1.1% over the period. Average
total loan-to-deposits ratios were 101.3% and 107.1%. Not shown in the table
are the components of interest bearing deposits. Average NOW, Sweep and Money
Market accounts were 19.8% of total interest bearing liabilities ("IBL");
savings accounts were 43.9% of total IBL and time certificates were 36.3% of
total IBL. Average borrowings were 10.3% of total IBL. Tax equivalent net
interest income increased $.6 million, or 2.4% on a quarter-to-quarter
comparison, and $4.0 million, or 5.7%, on a year-to-date basis.
Earning Assets
- --------------
Using a 365-day base, the TE yield on total earning assets decreased 97 basis
points in the third quarter of 2003 to 6.93% compared to 7.90% 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;
refinancing of fixed rate loans to a lower rate and maturing investments. The
cost of total interest bearing liabilities decreased 87 basis points from 3.18%
in 2002 to 2.31% in 2003. The TE Net Interest Margin ("NIM") for the quarter was
5.10% in 2003 as compared to 5.38% at the end of the third quarter 2002. The
year-to-date TE NIM was 5.16% in 2003 and 5.34% in 2002.
On a quarterly TE basis, net interest income was $24.6 million in 2003, versus
$24.0 million in 2002, for an increase in net interest income of $.6 million.
This increase was the result of total interest income decreasing $1.9 million,
and total interest expense decreasing $2.5 million.
The increase of $141.1 million in the average balance of earning assets
increased interest income by $1.8 million and a decrease in interest rates
decreased interest income by $3.7 million, for a net increase of $1.9 million.
-12-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Earning Assets (continued)
- --------------------------------------------------------------------------------
The annualized yield on total loans decreased from 8.15% in 2002 to 7.38% in
2003. Commercial loans decreased from 7.43% to 6.63%; real estate commercial
loans decreased in yield from 8.14% to 7.25%; real estate construction loans
decreased in yield from 8.44% to 7.83%; real estate residential loans decreased
from 8.48% to 7.69%, and installment loans decreased from 9.21% to 8.55%.
The yield on investments decreased from 5.95% in 2002 to 5.19% in 2003 and the
yield on federal funds sold decreased from 1.65% in 2002 to .92% in 2003.
Interest Bearing Liabilities
- ----------------------------
The increase in the average balance of interest bearing deposits of $111.1
million increased interest expense by $.6 million, and the rate paid on interest
bearing deposits decreased interest expense by $3.0 million, for a net decrease
of $2.4 million.
The increase in the average balance of other borrowings of $3.4 million
increased interest expense by $36 thousand and the rates paid on these
borrowings decreased interest expense by $23 thousand.
The cost of NOW, Money Market and Sweep accounts decreased from 1.56% in 2002,
to .8% in 2003. Savings account costs were 2.69% in 2002, and 1.66% in 2003.
Time cd's decreased in cost from 3.82% in 2002 to 3.15% in 2003. Short-term
borrowings decreased from 1.27% to .55%, and FHLB borrowings decreased from
5.07% in 2002 to 5.06% in 2003.
NONINTEREST INCOME AND EXPENSE - September 30, 2003/September 30, 2002
- ----------------------------------------------------------------------
Total noninterest income increased $1.1 million in the third quarter of 2003, or
46.8% from a year ago. The loss on securities in the third quarter of 2002 was
due to the sale of a security which had been downgraded to below investment
grade. The gain on security sales in 2003 was due to a tender offer by the
issuer. Service charges increased $83 thousand to $1.2 million, or 7.6%. The
increase in service charges was due to increased business service charges of $74
thousand. Other noninterest income increased $728 thousand or 50.4% in the
current quarter. The main components of the increase in 2003 were: servicing
release fees of $396 thousand related to increased mortgage originations, and
increased revenues of $111 thousand in trust and financial services.
The market value of trust assets at quarter-end September 2003 was $250.6
million, as compared to $219.3 million in 2002, an increase of $31.3 million, or
14.3%. Trust department revenue for the third quarter of 2003 was $312 thousand,
up $44 thousand, or 16.4%. Trust assets are not included in the Corporation's
consolidated balance sheet.
There were 603 FTE employees at September 30, 2003. Total noninterest expenses
increased $1.0 million or 9.5% for the period. Salaries and benefits increased
$.9 million or 14.4%. Salaries alone were up $474 thousand, or 10.9%; and
benefits alone were up $425 thousand, or 22.7%. The increase in salaries of
10.9% represents an increase in staff of 4.3%, and the remainder represents
merit raises for the year. The increase in benefits was due to increases in
profit sharing contributions, medical insurance premiums, payroll taxes,
incentive pay and other increases attributable to normal operations.
Occupancy expense decreased $29 thousand, or 1.9%. Depreciation expense was 36%
of occupancy expense for 2003 and 2002. The decrease in 2003 of $29 thousand was
decreased depreciation expense.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Noninterest income and expenses (continued)
- --------------------------------------------------------------------------------
Other noninterest expense increased $107 thousand, or 4.2%. This increase was
due to increased loan underwriting expenses of $46 thousand and Visa marketing
fees of $67 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
third quarter was 40% for 2003 and 38% 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.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Impaired Assets (continued)
- --------------------------------------------------------------------------------
Nonperforming loans and impaired assets are summarized as follows:
(In thousands)
Period ended September 30, 2003 2002
- -------------------------- ---- ----
Nonaccruing loans:
Commercial $ 246 $ 519
Agriculture - 731
Real Estate 7,744 12,241
Installment and other 16 566
----------------- -----------------
Total nonaccruing loans $ 8,006 $ 14,057
Other real estate owned 7,544 7,307
----------------- -----------------
Total nonperforming assets $ 15,550 $ 21,364
================= =================
Restructured loan $ 6,178 $ 6,178
Total loans at end of period $ 1,719,323 $ 1,642,817
Total assets at end of period $ 2,059,906 $ 1,969,334
Total nonperforming assets to total loans 0.90% 1.30%
Total nonperforming assets to total assets 0.75% 1.08%
Total impaired assets to total assets 1.05% 1.40%
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 $6.1 million to $8.0
million as of September 30, 2003. As of quarter end this balance included 19
loans ranging in size from $4.9 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.
OTHER REAL ESTATE OWNED
- -----------------------
OREO ended the quarter with a portfolio of nine properties totaling $7.5 million
representing .37% of total assets. The modest increase over the previous year's
OREO balance reflects the transition of troubled assets through an orderly
collection process. Since December 31, 2002 seven OREO properties have been sold
and closed and seven have been added. Seventy-seven percent of the OREO
portfolio is concentrated in two properties with balances of $3.8 million and
$2.0 million, respectively. The $3.8 million property consists of three high-end
condominium units. Construction delays have slowed the marketing time. The $2.0
million property is sold and scheduled to close in the fourth quarter. Four of
the remaining seven properties are also scheduled to close during the fourth
quarter of 2003. The remaining properties are being actively managed for timely
sale.
-15-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Other Real Estate Owned (continued)
- --------------------------------------------------------------------------------
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
non-performing 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) September 30, 2003 December 31, 2002
-------------------------------- ------------------------
Amount % of total Amount % of total
-------------- --------------- ---------- -----------
Installment $ 40,219 2.3% $47,217 2.8%
Commercial 280,570 16.3% 272,440 16.4%
Real estate commercial 760,848 44.3% 758,826 45.8%
Real estate construction 495,321 28.8% 443,461 26.7%
Real estate residential 142,365 8.3% 136,740 8.3%
------------- --------- ----------- ---------
Total $ 1,719,323 100.0% $ 1,658,684 100.0%
============= ========= =========== =========
As shown in the table above the Corporation emphasizes commercial and commercial
real estate related lending. The commercial real estate portfolio generally
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. To date,
the Corporation's lending activities have avoided those real estate sectors that
have been most impacted by the current economic slump. Management devotes
considerable time and 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 September 30, 2003 and 2002, the Corporation had an immaterial amount of
foreign loans and no loans related to highly leveraged transactions.
ALLOWANCE FOR POSSIBLE LOAN LOSSES - QUALITATIVE FACTORS
- --------------------------------------------------------
For the nine months ending September 30, 2003, the reserve for possible loan
loss balance totaled $28.7 million, or 1.67% of total loans, as compared to
$28.2 million, or 1.70% of total loans at year-end 2002. Year-to-date net loan
losses were $2.1 million.
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
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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 (continued)
- --------------------------------------------------------------------------------
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 non-accruing 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.
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
September 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 5.3 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, federal funds sold increased, whereas in 2003, federal funds sold
supplied liquidity and declined to $3.0 million. Proceeds from maturing
securities helped to fund the purchase of securities in both years. However, for
reasons previously stated, the need for funding the growth of the portfolio in
2003 was far greater than in 2002.
-17-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Liquidity and Interest Rate Risk (continued)
- --------------------------------------------------------------------------------
Cash flows from financing activities were quite similar for the two periods,
except for FHLB advances. Core deposits and FHLB advances funded asset growth in
2002, whereas only core deposits funded growth in 2003.
Management has the ability to access 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 to total assets of 12.5% 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.
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 June 30, 2003
the model predicted that net interest income will increase if interest rates
rise and remain relatively stable if rates fall. This behavior is heavily
influenced by loans going on and off interest rate floors. If rates decline by
1%, net interest income will increase by approximately .1%. If rates increase by
1%, net interest income will increase by 2.9% and 8.2% if rates increased 2%.
The actual change in earnings will 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
third quarter end 2003 was $213.1 million. This amount compares to $198.9
million at December 31, 2002, an increase of $14.3 million, or 7.2%. During the
third quarter of 2003 the Corporation did not repurchase shares of common stock
in the open market, but paid a third quarter dividend of $3.2 million. Please
see page 10, paragraph 5, for dividends and stock repurchases since the end of
the third quarter 2002.
-18-
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations Capital (continued)
- --------------------------------------------------------------------------------
The Corporation's regulatory capital ratios were as follows:
Minimum Ratio
for Well-Capitalized Actual Actual
Purposes September 30, 2003 December 31, 2002
------------------------------- -------------------------- -------------------------
Tier I Capital 6.0% 10.16% 10.37%
Tier I & II Capital 10.0% 11.41% 11.62%
(Total Risk-based Capital)
Leverage Ratio 5.0% 9.94% 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
Corporation, current market conditions, and other relevant factors, including
regulatory requirements which may necessitate changes in the level of capital.
-19-
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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 September 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.
-20-
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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.
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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
(a) There were no matters submitted to security holders in the third
quarter.
Item 5. Other Information
(a) On September 17, 2003, the Board of Directors of the Corporation
declared an $.18 per share fourth quarter 2003 cash dividend to
shareowners of record as of October 6, 2003 and payable October
27, 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.
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 attached as Exhibit
31.1.
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 attached as Exhibit
31.2.
32.1 Certification of Chief Executive Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 attached as Exhibit
32.1.
32.2 Certification of Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 attached as Exhibit
32.2.
3(ii)2003 Restated Bylaws of Frontier Financial Corporation
attached as Exhibit 3(ii).
(b) Reports on Form 8-K:
On July 16, 2003, Form 8-K was filed providing guidance on
second quarter earnings.
On July 25, 2003, Form 8-K was filed announcing second quarter
2003 earnings.
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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: October 27, 2003 /s/ Carol E. Wheeler
Carol E. Wheeler
Chief Financial Officer
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