Attached files
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
Board of Directors and Shareholders of Frontier Financial Corporation
We have audited the accompanying consolidated balance sheets of Frontier Financial Corporation and subsidiary as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements
are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Frontier Financial Corporation and subsidiary at December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended
December 31, 2009, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company’s operating losses, its deteriorating capital position, and its Stipulation and Consent to the Issuance of an Order to Cease and Desist with
the Federal Deposit Insurance Corporation and Washington State Department of Financial Institutions, raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also discussed in Note 2 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Frontier Financial Corporation and subsidiary’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 31, 2010 expressed an adverse opinion thereon.
/s/ Moss Adams LLP
Everett, Washington
March 31, 2010
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (continued)
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Shareholders of Frontier Financial Corporation
We have audited Frontier Financial Corporation and subsidiary’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Frontier Financial Corporation
and subsidiary’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report on Management’s Assessment of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included
obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial
reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. Management identified
and included in its assessment the following material weaknesses: (1) management has not sufficiently adapted it’s policies and procedures for the identification, monitoring and evaluation of impaired loans and for the timely revision to management’s approach for assessing credit risk inherent in the Company’s loan portfolio to reflect changes in the economic environment and (2) management has not adapted its policies and procedures for monitoring and
approving of disbursements, capitalizing of costs and reconciling of accounts for specific other real estate owned.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Frontier Financial Corporation and subsidiary as of December 31, 2009 and 2008 and the related consolidated statements of operations, shareholders’ equity, and cash flows
for each of the three years in the period ended December 31, 2009, and our report dated March 31, 2010 expressed an unqualified opinion on those consolidated financial statements. Our report contains an explanatory paragraph that states the Company’s operating losses, it’s deteriorating capital position, and its Stipulation and Consent to the Issuance of an Order to Cease and Desist with the Federal Deposit Insurance Corporation and Washington State Department of Financial Institutions,
raise substantial doubt about its ability to continue as a going concern. The material weaknesses described above were considered in determining the nature, timing and extent of audit tests applied in our audit of the 2009 financial statements and this report does not affect our report thereon.
In our opinion, because of the affect of the aforementioned material weaknesses on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2009, based on the criteria established in
Internal Control – Integrated Framework issued by the Committee of Sponsoring Organization of the Treadway Commission.
/s/ Moss Adams LLP
Everett, Washington
March 31, 2010
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(In thousands, except for number of shares)
December 31, |
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2009 |
2008 |
|||||||
ASSETS |
||||||||
Cash and due from banks |
$ | 93,761 | $ | 52,022 | ||||
Federal funds sold |
333,819 | 117,740 | ||||||
Securities |
||||||||
Available for sale, at fair value |
85,092 | 90,606 | ||||||
Held to maturity (fair value $2,024 and $3,340) |
2,102 | 3,085 | ||||||
Total securities |
87,194 | 93,691 | ||||||
Loans held for resale |
3,221 | 6,678 | ||||||
Loans |
2,866,277 | 3,772,055 | ||||||
Allowance for loan losses |
(151,349 | ) | (112,556 | ) | ||||
Net loans |
2,718,149 | 3,666,177 | ||||||
Premises and equipment, net |
47,704 | 51,502 | ||||||
Intangible assets |
581 | 794 | ||||||
Federal Home Loan Bank (FHLB) stock |
19,885 | 19,885 | ||||||
Bank owned life insurance (BOLI) |
25,385 | 24,321 | ||||||
Other real estate owned |
169,674 | 10,803 | ||||||
Other assets |
98,832 | 67,510 | ||||||
Total assets |
$ | 3,594,984 | $ | 4,104,445 | ||||
LIABILITIES |
||||||||
Deposits |
||||||||
Noninterest bearing |
$ | 377,258 | $ | 395,451 | ||||
Interest bearing |
2,745,218 | 2,879,714 | ||||||
Total deposits |
3,122,476 | 3,275,165 | ||||||
Federal funds purchased and securities sold under agreements to repurchase |
11,107 | 21,616 | ||||||
Federal Home Loan Bank advances |
375,479 | 429,417 | ||||||
Junior subordinated debentures |
5,156 | 5,156 | ||||||
Other liabilities |
19,280 | 21,048 | ||||||
Total liabilities |
3,533,498 | 3,752,402 | ||||||
Commitments and Contingent Liabilities (Note 18) |
||||||||
SHAREHOLDERS' EQUITY |
||||||||
Preferred stock, no par value; 10,000,000 shares authorized |
- | - | ||||||
Common stock, no par value; 10,000,000 shares authorized; 4,725,076 and |
||||||||
4,709,510 shares issued and outstanding in 2009 and 2008, respectively |
258,202 | 256,137 | ||||||
Retained earnings (accumulated deficit) |
(197,083 | ) | 98,020 | |||||
Accumulated other comprehensive income (loss), net of tax |
367 | (2,114 | ) | |||||
Total shareholders' equity |
61,486 | 352,043 | ||||||
Total liabilities and shareholders' equity |
$ | 3,594,984 | $ | 4,104,445 |
The accompanying notes are an integral part of these financial statements.
-1-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except for number of shares and per share amounts)
For the Year Ended December 31, |
||||||||||||
2009 |
2008 |
2007 |
||||||||||
INTEREST INCOME |
||||||||||||
Interest and fees on loans |
$ | 173,934 | $ | 273,392 | $ | 294,099 | ||||||
Interest on federal funds sold |
766 | 457 | 958 | |||||||||
Interest on investments |
||||||||||||
Taxable |
2,660 | 4,999 | 4,475 | |||||||||
Exempt from federal income tax |
173 | 207 | 140 | |||||||||
Total interest income |
177,533 | 279,055 | 299,672 | |||||||||
INTEREST EXPENSE |
||||||||||||
Interest on deposits |
77,661 | 96,091 | 97,080 | |||||||||
Interest on FHLB advances |
15,555 | 14,244 | 13,402 | |||||||||
Interest on federal funds purchased and securities |
||||||||||||
sold under agreements to repurchase |
246 | 1,850 | 2,559 | |||||||||
Total interest expense |
93,462 | 112,185 | 113,041 | |||||||||
Net interest income |
84,071 | 166,870 | 186,631 | |||||||||
PROVISION FOR LOAN LOSSES |
375,000 | 120,000 | 11,400 | |||||||||
Net interest income (loss) after provision for loan losses |
(290,929 | ) | 46,870 | 175,231 | ||||||||
NONINTEREST INCOME |
||||||||||||
Other-than-temporary impairment loss on securities |
(4,289 | ) | (6,430 | ) | - | |||||||
Net gain (loss) on sale of securities |
(102 | ) | 4,570 | (937 | ) | |||||||
Gain on sale of secondary mortgage loans |
1,675 | 1,321 | 1,586 | |||||||||
Gain on sale of premises and equipment |
136 | 30 | 24 | |||||||||
Net gain (loss) on other real estate owned |
(7,054 | ) | 97 | - | ||||||||
Service charges on deposit accounts |
6,154 | 5,421 | 4,721 | |||||||||
Other noninterest income |
8,394 | 9,821 | 7,915 | |||||||||
Total noninterest income |
4,914 | 14,830 | 13,309 | |||||||||
NONINTEREST EXPENSE |
||||||||||||
Salaries and employee benefits |
46,985 | 48,403 | 48,297 | |||||||||
Occupancy expense |
10,953 | 11,148 | 9,956 | |||||||||
State business taxes |
1,068 | 2,013 | 2,066 | |||||||||
FHLB prepayment penalty |
- | - | 1,534 | |||||||||
Federal Deposit Insurance Corporation (FDIC) assessments |
15,962 | 2,650 | 362 | |||||||||
Other noninterest expense |
24,766 | 18,785 | 14,801 | |||||||||
99,734 | 82,999 | 77,016 | ||||||||||
Goodwill impairment |
- | 77,073 | - | |||||||||
Total noninterest expense |
99,734 | 160,072 | 77,016 | |||||||||
INCOME (LOSS) BEFORE PROVISION (BENEFIT) |
||||||||||||
FOR INCOME TAX |
(385,749 | ) | (98,372 | ) | 111,524 | |||||||
PROVISION (BENEFIT) FOR INCOME TAX |
(90,655 | ) | (8,635 | ) | 37,586 | |||||||
NET INCOME (LOSS) |
$ | (295,094 | ) | $ | (89,737 | ) | $ | 73,938 | ||||
Weighted average number of |
||||||||||||
shares outstanding for the period |
4,713,219 | 4,699,163 | 4,526,572 | |||||||||
Basic earnings (loss) per share |
$ | (62.61 | ) | $ | (19.10 | ) | $ | 16.33 | ||||
Weighted average number of diluted shares |
||||||||||||
outstanding for the period |
4,713,219 | 4,699,163 | 4,560,107 | |||||||||
Diluted earnings (loss) per share |
$ | (62.61 | ) | $ | (19.10 | ) | $ | 16.21 |
The accompanying notes are an integral part of these financial statements.
-2-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(In thousands, except number of shares and per share amounts)
Retained |
Accumulated |
|||||||||||||||||||||||||||
Earnings |
Other |
|||||||||||||||||||||||||||
Common Stock |
Comprehensive |
(Accumulated |
Comprehensive |
|||||||||||||||||||||||||
Shares (1) |
Amount |
Income (Loss) |
Deficit) |
Income (Loss) |
Total |
|||||||||||||||||||||||
Balance, December 31, 2006 |
4,535,032 | 186,163 | 202,945 | 6,175 | 395,283 | |||||||||||||||||||||||
Comprehensive Income: |
||||||||||||||||||||||||||||
Net income |
- | - | $ | 73,938 | 73,938 | - | 73,938 | |||||||||||||||||||||
Other comprehensive income (loss), |
||||||||||||||||||||||||||||
Unrealized loss on available |
||||||||||||||||||||||||||||
for sale securities, net of tax ($699) |
- | - | (1,308 | ) | - | (1,308 | ) | (1,308 | ) | |||||||||||||||||||
Total comprehensive income |
$ | 72,630 | ||||||||||||||||||||||||||
Stock-based compensation |
- | 2,583 | - | - | 2,583 | |||||||||||||||||||||||
Issuances of common stock under stock plans |
7,199 | - | - | - | - | |||||||||||||||||||||||
Stock options exercised |
13,910 | 1,861 | - | - | 1,861 | |||||||||||||||||||||||
Tax benefit from stock options |
- | 237 | - | - | 237 | |||||||||||||||||||||||
Stock issued in connection with merger |
323,079 | 61,613 | - | - | 61,613 | |||||||||||||||||||||||
Fractional shares - merger |
- | - | (1 | ) | - | (1 | ) | |||||||||||||||||||||
Stock repurchased |
(184,133 | ) | (165 | ) | (44,219 | ) | - | (44,384 | ) | |||||||||||||||||||
Cash dividends declared ($6.50 per share) |
- | - | (30,210 | ) | - | (30,210 | ) | |||||||||||||||||||||
Balance, December 31, 2007 |
4,695,087 | 252,292 | 202,453 | 4,867 | 459,612 | |||||||||||||||||||||||
Comprehensive Loss: |
||||||||||||||||||||||||||||
Net loss |
- | - | $ | (89,737 | ) | (89,737 | ) | - | (89,737 | ) | ||||||||||||||||||
Other comprehensive income (loss), |
||||||||||||||||||||||||||||
Unrealized loss on available |
||||||||||||||||||||||||||||
for sale securities, net of tax ($4,085) |
- | - | (6,981 | ) | - | (6,981 | ) | (6,981 | ) | |||||||||||||||||||
Total comprehensive loss |
$ | (96,718 | ) | |||||||||||||||||||||||||
Stock-based compensation |
- | 3,407 | - | - | 3,407 | |||||||||||||||||||||||
Issuances of common stock under stock plans |
13,022 | - | - | - | - | |||||||||||||||||||||||
Stock options exercised |
3,113 | 391 | - | - | 391 | |||||||||||||||||||||||
Tax benefit from stock options |
- | 49 | - | - | 49 | |||||||||||||||||||||||
Stock repurchased |
(1,712 | ) | (2 | ) | (70 | ) | - | (72 | ) | |||||||||||||||||||
Cumulative effect of change in |
||||||||||||||||||||||||||||
accounting principle, net of tax |
- | - | (413 | ) | - | (413 | ) | |||||||||||||||||||||
Cash dividends declared ($4.75 per share) |
- | - | (14,213 | ) | - | (14,213 | ) | |||||||||||||||||||||
Balance, December 31, 2008 |
4,709,510 | $ | 256,137 | $ | 98,020 | $ | (2,114 | ) | $ | 352,043 | ||||||||||||||||||
Comprehensive Loss: |
||||||||||||||||||||||||||||
Net loss |
- | - | $ | (295,094 | ) | (295,094 | ) | - | (295,094 | ) | ||||||||||||||||||
Other comprehensive income (loss), |
||||||||||||||||||||||||||||
Unrealized gain on available |
||||||||||||||||||||||||||||
for sale securities, net of tax $1,336 |
- | - | 2,481 | 2 | - | 2,481 | 2,481 | |||||||||||||||||||||
Total comprehensive loss |
$ | (292,613 | ) | |||||||||||||||||||||||||
Stock-based compensation |
- | 2,067 | - | - | 2,067 | |||||||||||||||||||||||
Issuances of common stock under stock plans |
15,269 | - | - | - | - | |||||||||||||||||||||||
Stock repurchased |
(2,546 | ) | (2 | ) | (9 | ) | - | (11 | ) | |||||||||||||||||||
Stock issued in connection with reverse |
||||||||||||||||||||||||||||
stock split (2) |
2,843 | - | - | - | - | |||||||||||||||||||||||
Balance, December 31, 2009 |
4,725,076 | $ | 258,202 | $ | (197,083 | ) | $ | 367 | $ | 61,486 | ||||||||||||||||||
(1) Adjusted to reflect a one-for-ten reverse stock split, effective November 24, 2009. |
||||||||||||||||||||||||||||
(2) All fractional shares which resulted from the reverse stock split were rounded to the nearest whole share in lieu of fractional shares. |
The accompanying notes are an integral part of these financial statements.
-3-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
For the Year Ended December 31, |
||||||||||||
2009 |
2008 |
2007 |
||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||||||
Net income (loss) |
$ | (295,094 | ) | $ | (89,737 | ) | $ | 73,938 | ||||
Adjustments to reconcile net income (loss) to net cash provided by |
||||||||||||
operating activities |
||||||||||||
Depreciation |
3,923 | 3,750 | 2,733 | |||||||||
Amortization |
848 | 247 | 64 | |||||||||
Intangible amortization |
213 | 283 | 235 | |||||||||
Provision for loan losses |
375,000 | 120,000 | 11,400 | |||||||||
Other-than-temporary impairment loss on securities |
4,289 | 6,430 | - | |||||||||
(Gain) loss on sale of securities |
102 | (4,570 | ) | 937 | ||||||||
Gain on sale of other real estate owned |
(2,648 | ) | (97 | ) | - | |||||||
Valuation adjustment on other real estate owned |
9,702 | 68 | - | |||||||||
Gain on sale of secondary market loans |
(1,675 | ) | (1,321 | ) | (1,586 | ) | ||||||
Gain on sale of premises and equipment |
(136 | ) | (30 | ) | (24 | ) | ||||||
Goodwill impairment |
- | 77,073 | - | |||||||||
Deferred taxes |
37,996 | (20,431 | ) | (5,480 | ) | |||||||
Stock-based compensation |
2,067 | 3,407 | 2,583 | |||||||||
Excess tax benefits associated with stock-based compensation |
- | (49 | ) | (237 | ) | |||||||
Increase in cash surrender value of BOLI |
(1,064 | ) | (587 | ) | (1,536 | ) | ||||||
Changes in operating assets and liabilities |
||||||||||||
Proceeds from sales of mortgage loans |
140,386 | 94,815 | 158,345 | |||||||||
Origination of mortgage loans held for sale |
(135,254 | ) | (93,945 | ) | (155,766 | ) | ||||||
Income taxes receivable |
(73,560 | ) | (8,430 | ) | - | |||||||
Income taxes payable |
185 | 665 | (2,100 | ) | ||||||||
Interest receivable |
8,147 | 1,254 | (2,689 | ) | ||||||||
Interest payable |
(8,787 | ) | 4,332 | 4,292 | ||||||||
Other operating activities |
2,938 | (6,182 | ) | (1,161 | ) | |||||||
Net cash provided by operating activities |
67,578 | 86,945 | 83,948 | |||||||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||||||
Net change in federal funds sold |
(216,079 | ) | (117,735 | ) | 18,668 | |||||||
Purchase of securities available for sale |
(67,642 | ) | (306,126 | ) | (84,724 | ) | ||||||
Proceeds from sales of available for sale securities |
1,360 | 45,568 | 48,039 | |||||||||
Principal repayments on mortgage-backed securities |
8,174 | - | - | |||||||||
Proceeds from maturities of available for sale securities |
62,208 | 288,165 | 21,390 | |||||||||
Purchase of held to maturity securities |
- | - | (1,019 | ) | ||||||||
Proceeds from maturities of held to maturity securities |
975 | 650 | 875 | |||||||||
Purchase of Federal Home Loan Bank stock |
- | (1,147 | ) | (3,116 | ) | |||||||
Net cash flows from loan activities |
351,077 | (242,172 | ) | (510,865 | ) | |||||||
Purchases of premises and equipment |
(1,496 | ) | (7,959 | ) | (16,665 | ) | ||||||
Proceeds from the sale of premises and equipment |
936 | 30 | 24 | |||||||||
Proceeds from the sale of other real estate owned |
52,679 | 3,208 | - | |||||||||
Cash acquired in merger |
- | - | 1,234 | |||||||||
Other investing activities |
(884 | ) | (623 | ) | 2,615 | |||||||
Net cash provided by (used in) investing activities |
$ | 191,308 | $ | (338,141 | ) | $ | (523,544 | ) |
The accompanying notes are an integral part of these financial statements.
-4-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(In thousands)
For the Year Ended December 31, |
||||||||||||
2009 |
2008 |
2007 |
||||||||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||||||
Net change in core deposit accounts |
$ | 30,986 | $ | (304,909 | ) | $ | (35,344 | ) | ||||
Net change in certificates of deposit |
(183,675 | ) | 636,838 | 354,906 | ||||||||
Net change in federal funds purchased and securities sold under |
||||||||||||
agreements to repurchase |
(10,509 | ) | (236,529 | ) | 176,472 | |||||||
Advances from the Federal Home Loan Bank |
45,000 | 410,000 | 324,052 | |||||||||
Repayments to the Federal Home Loan Bank |
(98,938 | ) | (279,219 | ) | (321,023 | ) | ||||||
Stock options exercised |
- | 391 | 1,861 | |||||||||
Excess tax benefits associated with stock-based compensation |
- | 49 | 237 | |||||||||
Repurchase of common stock |
(11 | ) | (72 | ) | (44,384 | ) | ||||||
Cash dividends paid |
- | (22,433 | ) | (29,045 | ) | |||||||
Other financing activities |
- | - | 6,744 | |||||||||
Net cash provided by (used in) financing activities |
(217,147 | ) | 204,116 | 434,476 | ||||||||
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS |
41,739 | (47,080 | ) | (5,120 | ) | |||||||
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR |
52,022 | 99,102 | 104,222 | |||||||||
CASH AND DUE FROM BANKS AT END OF YEAR |
$ | 93,761 | $ | 52,022 | $ | 99,102 | ||||||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION |
||||||||||||
Cash paid during the year for interest |
$ | 102,249 | $ | 107,853 | $ | 107,879 | ||||||
Cash paid during the year for income taxes |
$ | - | $ | 19,700 | $ | 40,000 | ||||||
SUPPLEMENTAL INFORMATION ABOUT NONCASH INVESTING AND FINANCING ACTIVITIES |
||||||||||||
Transfer of loans to other real estate owned |
$ | 217,720 | $ | 12,992 | $ | 367 | ||||||
Change in portion of reserve identified for undisbursed loans and |
||||||||||||
reclassified as a liability |
$ | 1,091 | $ | 1,581 | $ | (117 | ) | |||||
Acquisitions: |
||||||||||||
Assets aquired |
$ | - | $ | - | $ | 247,078 | ||||||
Liabilities assumed |
$ | - | $ | - | $ | 185,270 | ||||||
Net |
$ | - | $ | - | $ | 61,808 |
The accompanying notes are an integral part of these financial statements.
-5-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Summary of Significant Accounting Policies
Nature of Operations
Frontier Financial Corporation (together with its subsidiary, “FFC”, the “Corporation”, “us”, “we” or “our”) is primarily engaged in providing a full range of banking and mortgage services to individual and corporate customers. We also provide other services such as
trust services and insurance and financial service brokerage activities. We are subject to competition from other financial institutions and to regulation by certain federal and state agencies and undergo periodic examinations by those regulatory authorities.
Basis of Presentation
Our financial reporting and accounting policies conform to accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany transactions and balances have been eliminated in preparing the consolidated financial statements. Assets held by the Bank in an agency
or fiduciary capacity are not included in the accompanying financial statements.
All prior period results reflect the one-for-ten reverse stock split, which was effective November 24, 2009.
Consolidation
The consolidated financial statements include the accounts of Frontier Financial Corporation (the “Corporation” or “FFC”), a bank holding company, and its wholly-owned subsidiary, Frontier Bank (the “Bank”). Effective December 30, 2008, Frontier Financial Corporation merged its wholly-owned
subsidiary, FFP, Inc. (“FFP”) into Frontier Bank in a non-cash transaction. FFP owned certain real property and leased it to Frontier Bank for use in its operations. At December 30, 2008, FFP had assets totaling approximately $40.9 million and total equity of approximately $17.6 million. On a consolidated basis, this transaction had no effect on the financial statements of the Corporation for the year ended December 31, 2008.
We have Trusts that were formed for the exclusive purpose of issuing $5.2 million in trust preferred securities (Note 11). The Trusts are considered variable interest entities (“VIE”), but have not been consolidated as we are not the primary beneficiary.
Reclassifications
Certain amounts in prior years' financial statements have been reclassified to conform to the current year presentation. These reclassifications have no effect on the Corporation’s previously reported net income (loss), earnings (loss) per share or shareholder’ equity.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial
statements and accompanying notes. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, deferred income taxes, valuation of intangible assets, fair value measurements, valuation of stock options and the valuation of real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets held for sale, management obtains independent appraisals for significant properties.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1: Summary of Significant Accounting Policies (continued)
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks. Cash equivalents have an original maturity of three months or less and may exceed federally insured limits. Federal Reserve Board regulations require maintenance
of certain minimum reserve balances on deposit with the Federal Reserve Bank. The average amount of such balances was $49.0 million in 2009 and $9.0 million in 2008.
Securities
Securities are classified into one of three categories: held to maturity (“HTM”), available for sale (“AFS”) or trading. Securities are categorized as held to maturity when there is positive intent and ability to hold those securities to maturity. Securities that are held to maturity are stated
at cost and adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income.
Securities categorized as available for sale are generally held for investment purposes (to maturity), although unanticipated future events may result in the sale of some securities. Available for sale securities are recorded at estimated fair value, with the net unrealized gain or loss included in comprehensive income (loss), net of the
related tax effect. Realized gains or losses on dispositions are based on the net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. Purchase premiums and discounts are recognized in interest income using the interest method over the term of the security.
Prior to the second quarter of 2009, we would assess other-than-temporary impairment (“OTTI”), or permanent impairment, based on the nature of the decline and whether we had the ability and intent to hold the securities until a market price recovery. If we determined a security to be other-than-temporarily impaired,
the full amount of impairment would be recognized through earnings in its entirety. New guidance related to the recognition and presentation of OTTI of debt securities became effective in the second quarter of 2009. Rather than asserting whether a Company has the ability and intent to hold an investment until a market price recovery, a Company must consider whether it intends to sell a security or if it is likely that they would be required to sell the security before recovery of the amortized
cost basis of the investment, which may be maturity. For debt securities, if we intend to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If we do not intend to sell the security and it is not likely that we will be required to sell the security, but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment
loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value
of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (loss). Impairment losses related to all other factors are presented as separate categories within other comprehensive income (loss). For securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the amount recorded in other comprehensive
income (loss) increases the carrying value of the security and does not affect earnings. If there is an indication of additional credit losses, the security is re-evaluated according to the procedures described above. For the years ended December 31, 2009 and 2008, OTTI losses totaling $4.3 million and $6.4 million, respectively, were recognized through earnings. No OTTI losses were recognized in the year ended December 31, 2007.
We had no trading securities at December 31, 2009 or 2008.
Federal Home Loan Bank Stock
Our investment in Federal Home Loan Bank (“FHLB”) stock is carried at par value ($100 per share), which reasonably approximates its fair value. As a member of the FHLB system, we are required to maintain a minimum level of investment in FHLB stock based on specific percentages of our outstanding FHLB advances. We
evaluate FHLB stock for other-than-temporary impairment at least annually, and more frequently, when economic or market concerns warrant such evaluation.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1: Summary of Significant Accounting Policies (continued)
Bank Owned Life Insurance (“BOLI”)
BOLI is recorded at its cash surrender value, or the amount that can be realized upon surrender of the policy. Income from these policies and changes in the cash surrender value are recorded in other income.
Loans Held for Resale
Mortgage loans originated and designated as held for resale are carried at the lower of cost or estimated fair value, as determined by quoted market prices, in aggregate. Net unrealized losses are recognized in a valuation allowance by charges to income. Gains or losses on the sale of such loans are based on the specific identification
method.
Loans Held in Portfolio and Related Income
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal, adjusted for unearned discounts, net of unamortized nonrefundable fees and related direct loan origination costs. Interest income is accrued as earned.
Net deferred fees and costs are generally amortized into interest income over the life of the loan as an adjustment to the loan yield using the interest method. Expenses deferred (principally personnel expense) and recognized in the yield adjustment result in a reduction in noninterest expense.
Nonrefundable fees related to lending activities, other than from direct loan origination or purchase, are recognized as credit related fees and included in noninterest income during the period the related service is provided. These include standby letter of credit and loan commitment fees.
Nonaccrual Loans
Loans are placed on nonaccrual status when, in the opinion of management, the collection of additional interest is doubtful or when the loan becomes 90 or more days past due. When a loan is placed on nonaccrual status, all interest previously accrued, but not collected, is reversed and charged against interest income. Income on nonaccrual
loans is then recognized only to the extent cash is received and the future collection of principal is probable. Accruals are resumed only when the loan is brought current, and when, in the opinion of management, the borrower has demonstrated the ability to resume payments of principal and interest. Interest income on restructured loans is recognized pursuant to the terms of the new loan agreement. Interest income on other impaired loans is monitored based upon the terms of the underlying loan agreement. However,
the recorded net investment in impaired loans, including accrued interest, is limited to the present value of the expected cash flows of the impaired loan or the observable fair market value of the loan or the fair market value of the loan's collateral.
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral
value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior
payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral, less selling costs, if the loan is collateral dependent.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1: Summary of Significant Accounting Policies (continued)
Large groups of smaller balance, homogeneous loans or leases are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer loans or leases for impairment disclosures, unless such loans are the subject of a restructuring agreement. Loans are reported as restructured when we grant a concession(s)
to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as the Bank will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement.
Allowance for Loan Losses
The allowance for loan losses is established to absorb probable future loan losses through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. |
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation
is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. |
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired, for which an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The
general component covers nonclassified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimated specific and general losses in the portfolio.
Management believes that the allowance for loan losses was adequate as of December 31, 2009. There is, however, no assurance that future loan losses will not exceed the levels provided for in the allowance and could possibly result in additional charges to the provision for loan losses. In addition, bank regulatory
authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan losses in future periods, if warranted as a result of their review. Approximately 84.0% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the allowance for loan losses. The U.S. recession, the housing market downturn and declining real estate values in our markets have negatively impacted
aspects of our real estate construction, land development and completed lot loan portfolios, and have led to an increase in nonperforming loans, charge-offs and the allowance for loan losses. A continued deterioration in our markets may adversely affect our loan portfolio and may lead to additional charges to the provision for loan losses.
Reserve for Unfunded Commitments
A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements such as letters or lines of credit. Management determines the adequacy of the reserve for unfunded commitments based upon reviews of individual
credit facilities, current economic conditions, the risk characteristics of the various categories of commitments and other relevant factors. The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are evaluated on a regular basis and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Draws on unfunded commitments that are considered uncollectible at the time funds are advanced are charged to the allowance. Provisions
for unfunded commitment losses, and recoveries on loans previously charged off, are added to the reserve for unfunded commitments, which is included in the Other Liabilities section of the consolidated balance sheets.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1: Summary of Significant Accounting Policies (continued)
Premises and Equipment
Premises, leasehold improvements and equipment are shown at cost and depreciated using the straight-line method. Depreciation expense is computed over the following estimated useful lives:
Premises 7 to 40 years
Furniture, fixtures and equipment 3 to 7 years
Intangible Assets
Intangible assets include goodwill which represents the excess of the purchase price over the fair value of tangible and specifically identifiable intangible net assets acquired in business combinations. Goodwill is not amortized but is tested for impairment at least annually. Other intangible assets are amortized,
and included in other noninterest expense, over their estimated useful lives. Additional information on intangible assets is included in Note 6.
Other Real Estate Owned (“OREO”)
OREO consists principally of properties acquired through foreclosure and is stated at the lower of cost or estimated market value less selling costs. Losses arising from the acquisition of property, in full or partial satisfaction of loans, are charged to the allowance for loan losses.
Subsequent to the transfer to OREO, these assets continue to be recorded at the lower of cost or fair value (less estimated costs to sell), based on periodic evaluations. Generally, legal and professional fees associated with foreclosures are expensed as incurred. Costs incurred to improve property prior to sale are capitalized; however,
in no event are recorded costs allowed to exceed fair value. Subsequent gains, losses, or expenses recognized on the sale of these properties are included in noninterest income or expense. The amounts that will ultimately be recovered from foreclosed assets may differ substantially from the carrying value of the assets because of future market factors beyond management’s control. Additional information on OREO is included in Note 7.
Transfer of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated; (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge
or exchange the transferred assets; and (3) we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Segment Reporting
Our operations are solely in the financial services industry and include providing our customers traditional banking and other financial services. We operate primarily within western Washington and northwest Oregon. We make operating decisions and assess performance based on an ongoing review of our consolidated financial
results. We are considered a single operating segment for financial reporting purposes.
Concentrations of Credit Risk
We accept deposits and grant credit primarily within western Washington and northwest Oregon. Historically, our focus has been on real estate construction lending, but we are in the process of diversifying our loan portfolio. Due to the downturn in the economy and the negative impact on the local housing market, we
are rebalancing our loan portfolio to include more commercial and industrial business and consumer loans.
Advertising Costs
Generally, advertising costs are expenses as incurred.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1: Summary of Significant Accounting Policies (continued)
Stock-Based Compensation
We currently have one active stock-based compensation plan that provides for the granting of stock options and restricted stock awards to eligible employees and directors. We recognize in the statement of operations the grant date fair value of stock options and other stock-based forms of compensation issued to employees over
the employees’ requisite service period (generally the vesting period).
Our 2006 Stock Incentive Plan (the “Plan”) provides for granting of stock options and restricted stock awards. Stock options and restricted stock awards generally vest ratably over 3 years and are recognized as expense over that same period of time.
We use the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. The expected term of the options is developed by considering the historical share option exercise experience, historical share retention practices of employees and assumptions about their propensity for early exercise
in the future. Expected volatility is estimated using daily historical volatility. We believe that historical volatility is currently the best estimate of expected volatility. The dividend yield is the annualized yield on our common stock on the date of grant. The risk free interest rate is the yield on the grant date of U.S. Treasury zero coupon issues with a maturity comparable to the expected term of the option. The assumptions used in the Black-Scholes pricing model and
the weighted average grant date fair value of options granted for the years ended December 31, 2009, 2008 and 2007, were as follows:
2009 |
2008 |
2007 |
||||||||||
Risk-free interest rate |
2.72 | % | 1.53 | % | 3.41 | % | ||||||
Expected dividends |
- | 3.63 | % | 2.45 | % | |||||||
Expected volatility |
81.62 | % | 50.72 | % | 36.50 | % | ||||||
Expected term (in years) |
6.2 | 6.1 | 5.7 | |||||||||
Weighted average grant date fair value |
$ | 3.09 | $ | 10.50 | $ | 57.93 |
Income Tax
We report income and expenses using the liability method of accounting and file a consolidated tax return. Deferred taxes are determined using the asset and liability method and are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled.
As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred taxes result from temporary differences in recognition of certain income and expense amounts between our financial statements and our tax returns. The principal items giving rise to these differences include depreciation expense, investment income and the allowance for loan losses. Valuation allowances are established to reduce the net carrying amount
of deferred tax assets, if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized.
We adopted the revised provisions of FASB ASC 740, Income Taxes, relating to the accounting for uncertainty in income taxes on January 1, 2007. Upon the implementation of the revised provisions, we had no unrecognized tax benefits which would require adjustment. We
periodically review our income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. This review takes into consideration the status of current taxing authorities’ examinations of our tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment. At December 31, 2009 and 2008, we had no unrecognized tax benefits.
We recognize interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years ended December 31, 2009, and 2008, we recognized no interest or penalties.
Earnings (Loss) per Share
Basic earnings (loss) per share amounts are computed based on the weighted average number of shares outstanding during the period after giving retroactive effect to stock dividends and stock splits. Diluted earnings (loss) per share are computed by determining the number of additional shares that are deemed outstanding due to
stock options and stock awards under the treasury stock method.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1: Summary of Significant Accounting Policies (continued)
Comprehensive Income (Loss)
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income (loss). Certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, and such
items, along with net income (loss), are components of comprehensive income (loss).
The components of comprehensive income (loss) and related tax effects are as follows (in thousands):
For the Year Ended December 31, |
||||||||||||
2009 |
2008 |
2007 |
||||||||||
Unrealized losses arising during the period on securities available for sale |
$ | (574 | ) | $ | (12,926 | ) | $ | (2,944 | ) | |||
Reclassification adjustment for losses realized in net income (loss), net of tax |
||||||||||||
(tax benefit of $1,537, $651 and $328, respectively) |
2,854 | 1,209 | 609 | |||||||||
Tax effect |
201 | 4,736 | 1,027 | |||||||||
Net unrealized gains (losses) on securities available for sale |
$ | 2,481 | $ | (6,981 | ) | $ | (1,308 | ) |
The components of accumulated other comprehensive income (loss), included in shareholders’ equity, are as follows (in thousands):
For the Year Ended December 31, |
||||||||||||
2009 |
2008 |
2007 |
||||||||||
Unrealized holding gains (losses) on available for sale securities |
$ | 244 | $ | (3,573 | ) | $ | 7,493 | |||||
Tax effect |
123 | 1,459 | (2,626 | ) | ||||||||
Accumulated other comprehensive income (loss), net of tax |
$ | 367 | $ | (2,114 | ) | $ | 4,867 |
Fair Value Measurements
The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price)
in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active and other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1: Summary of Significant Accounting Policies (continued)
Recently Issued Accounting Pronouncements
In May 2009, the FASB amended ASC 855, Subsequent Events. The updated guidance established general standards of accounting for and disclosing of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This
guidance sets forth (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance
sheet date. We adopted the provisions of this guidance for the interim period ended June 30, 2009, and the impact of adoption did not have a material impact on our consolidated financial statements.
In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards CodificationTM and
the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162 (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards CodificationTM (“ASC”) as the source of authoritative generally accepted accounting principles (“GAAP”) for nongovernmental entities. FASB ASC does not change GAAP. Instead, it takes the thousands
of individual pronouncements that currently comprise GAAP and reorganizes them into approximately 90 accounting Topics, and displays all Topics using a consistent structure. Contents in each Topic are further organized first by Subtopic, then Section and finally Paragraph.
In conjunction with the issuance of SFAS 168, the FASB also issued its first Accounting Standards Update No. 2009-1, Topic 105 –Generally Accepted Accounting Principles (“ASU 2009-1”) which includes SFAS 168 in its entirety as a transition to the ASC. ASU
2009-1 is effective for interim and annual periods ending after September 15, 2009, and will not have an impact on the Corporation’s financial position or results of operations but will change the referencing system for accounting standards. Certain of the following pronouncements were issued prior to the issuance of the ASC and adoption of the ASUs. For such pronouncements, citations to the applicable Codification by Topic, Subtopic and Section are provided where applicable in addition to the
original standard type and number.
The FASB issued ASU 2009–05, Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value, in August 2009 to provide guidance when estimating the fair value of a liability. When a quoted price in an active market for the identical
liability is not available, fair value should be measured using (a) the quoted price of an identical liability when traded as an asset; (b) quoted prices for similar liabilities or similar liabilities when traded as assets; or (c) another valuation technique consistent with the principles of Topic 820 such as an income approach or a market approach. If a restriction exists that prevents the transfer of the liability, a separate adjustment related to the restriction is not required when estimating fair
value. The ASU was effective October 1, 2009, and did not have a material impact on our consolidated financial statements.
ASU 2009-12, Fair Value Measurements and Disclosures (Topic 820) - Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), issued in September 2009, allows a company to measure the fair value of an investment that has no readily determinable fair
market value on the basis of the investee’s net asset value per share as provided by the investee. This allowance assumes that the investee has calculated net asset value in accordance with the GAAP measurement principles of Topic 946 as of the reporting entity’s measurement date. Examples of such investments include investments in hedge funds, private equity funds, real estate funds and venture capital funds. The update also provides guidance on how the investment should be classified
within the fair value hierarchy based on the value for which the investment can be redeemed. The amendment is effective for interim and annual periods ending after December 15, 2009, with early adoption permitted. We do not have investments in such entities and, therefore, there will be no impact to our consolidated financial statements.
ASU 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task Force, was issued in October 2009 and provides guidance on accounting for products or services (deliverables) separately rather than as a combined
unit utilizing a selling price hierarchy to determine the selling price of a deliverable. The selling price is based on vendor-specific evidence, third-party evidence or estimated selling price. The amendments in the update are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the standard to have a material impact on our consolidated financial
statements.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1: Summary of Significant Accounting Policies (continued)
Recently Issued Accounting Pronouncements (continued)
Issued October, 2009, ASU 2009-15, Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing, amends ASC Topic 470 and provides guidance for accounting and reporting for own-share lending arrangements issued in contemplation of
a convertible debt issuance. At the date of issuance, a share-lending arrangement entered into on an entity’s own shares should be measured at fair value in accordance with Topic 820 and recognized as an issuance cost, with an offset to additional paid-in capital. Loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs. The amendments also require several disclosures including a description and the terms
of the arrangement and the reason for entering into the arrangement. The effective dates of the amendments are dependent upon the date the share-lending arrangement was entered into and include retrospective application for arrangements outstanding as of the beginning of fiscal years beginning on or after December 15, 2009. We currently have no plans to issue convertible debt and, therefore, do not expect the update to have a material impact on our consolidated financial statements.
ASU 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assets, issued in December 2009, incorporates SFAS 166, Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140 (“SFAS
166”), issued by the FASB in June 2009, within the FASB ASC. This ASU removes the concept of a qualifying special-purpose entity and establishes a new “participating interest” definition that must be met for transfers of portions of financial assets to be eligible for sale accounting, clarifies and amends the derecognition criteria for a transfer to be accounted for as a sale, and changes the amount that can be recognized as a gain or loss on a transfer accounted for as a sale when
beneficial interests are received by the transferor. Enhanced disclosures are also required to provide information about transfers of financial assets and a transferor’s continuing involvement with transferred financial assets. This ASU must be applied as of the beginning of an entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter.
Earlier application is prohibited. We do not expect the standard to have a material impact on our consolidated financial statements.
In December 2009, ASU 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, was issued and incorporates SFAS 167, Amendments
to FASB Interpretation No. 46(R) (“SFAS 167”), issued by the FASB in June 2009, within the FASB ASC. This ASU amends previous accounting related to the Consolidation of Variable Interest Entities to require an enterprise to qualitatively assess the determination of the primary beneficiary of a variable interest entity (“VIE”) based on whether the entity (1) has the power to direct the activities of a VIE that most significantly impact the entity’s economic
performance and (2) has the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. Also, this ASU requires an ongoing reconsideration of the primary beneficiary, and amends the events that trigger a reassessment of whether an entity is a VIE. Enhanced disclosures are also required to provide information about an enterprise’s involvement in a VIE. This ASU will be effective as of the
beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. We do not expect the standard to have a material impact on our consolidated financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on our consolidated financial statements.
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FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2: Regulatory Actions, Strategic Plan and Going Concern Considerations
Regulatory Actions
FDIC Directive
On March 16, 2010, the Federal Deposit Insurance Corporation (“FDIC”) issued a Supervisory Prompt Corrective Action Directive (“Directive”) to Frontier Bank. As of that date, Frontier Bank was already operating subject to all of the restrictions set forth in the FDIC Order as noted below, except that the
Directive imposed a new requirement that Frontier Bank take one or more of the following actions to recapitalize the Bank within 30 days (by April 15, 2010): (1) sell enough voting shares or obligations of Frontier Bank so that it will be “adequately capitalized,” as defined under the Federal Deposit Insurance Act (“FDI Act”) and the related FDIC regulations, after the sale; and/or (2) accept an offer to be acquired by a depository institution holding company or combine with
another insured depository institution.
FDIC Order
On March 20, 2009, Frontier Bank entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “FDIC Order”) with the FDIC and the Washington Department of Financial Institutions (the “Washington DFI”). The regulators alleged that Frontier Bank had engaged in unsafe or unsound
banking practices by operating with inadequate management and board supervision; engaging in unsatisfactory lending and collection practices; operating with inadequate capital in relation to the kind and quality of assets held at Frontier Bank; operating with an inadequate loan valuation reserve; operating with a large volume of poor quality loans; operating in such a manner as to produce low earnings and operating with inadequate provisions for liquidity. By consenting to the FDIC Order, Frontier
Bank neither admitted nor denied the alleged charges.
Under the terms of the FDIC Order, Frontier Bank cannot declare dividends or pay any management, consulting or other fees or funds to the Corporation, without the prior written approval of the FDIC and the Washington DFI. Other material provisions of the FDIC Order require Frontier Bank to: (1) review the qualifications of Frontier
Bank’s management, (2) provide the FDIC with 30 days written notice prior to adding any individual to the Board of Directors of Frontier Bank (the “Frontier Bank Board”) or employing any individual as a senior executive officer, (3) increase director participation and supervision of Frontier Bank affairs, (4) improve Frontier Bank’s lending and collection policies and procedures, particularly with respect to the origination and monitoring of real estate construction and land development
loans, (5) develop a capital plan and increase Tier 1 leverage capital to 10% of Frontier Bank’s total assets by July 29, 2009, and maintain that capital level, in addition to maintaining a fully funded allowance for loan losses satisfactory to the regulators, (6) implement a comprehensive policy for determining the adequacy of the allowance for loan losses and limiting concentrations in commercial real estate and acquisition, development and construction loans, (7) formulate a written plan to reduce Frontier
Bank’s risk exposure to adversely classified loans and nonperforming assets, (8) refrain from extending additional credit with respect to loans charged-off or classified as “loss” and uncollected, (9) refrain from extending additional credit with respect to other adversely classified loans without collecting all past due interest, without the prior approval of a majority of the directors on the Frontier Bank Board or its loan committee, (10) develop a plan to control overhead and other expenses
to restore profitability, (11) implement a liquidity and funds management policy to reduce Frontier Bank’s reliance on brokered deposits and other non-core funding sources, and (12) prepare and submit progress reports to the FDIC and the Washington DFI. The FDIC Order will remain in effect until modified or terminated by the FDIC and the Washington DFI.
The FDIC Order does not restrict Frontier Bank from transacting its normal banking business. Frontier Bank has continued to serve its customers in all areas including making loans, establishing lines of credit, accepting deposits and processing banking transactions. Customer deposits remain fully insured to the highest
limits set by FDIC. The FDIC and Washington DFI did not impose any monetary penalties in connection with the FDIC Order.
-15-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2: Regulatory Actions, Strategic Plan and Going Concern Considerations (continued)
FRB Agreement
In addition, on July 2, 2009, the Corporation entered into a Written Agreement (the “FRB Written Agreement”) with the Federal Reserve Bank of San Francisco (the “FRB”). Under the terms of the FRB Written Agreement, the Corporation has agreed to: (1) refrain from declaring or paying any dividends without
prior written consent of the FRB; (2) refrain from taking dividends or any other form of payment that represents a reduction in capital from Frontier Bank without prior written consent of the FRB; (3) refrain from making any distributions of interest or principal on subordinated debentures or trust preferred securities without prior written consent of the FRB; (4) refrain from incurring, increasing or guaranteeing any debt without prior written consent of the FRB; (5) refrain from purchasing or redeeming any
shares of its stock without prior written consent of the FRB; (6) implement a capital plan and maintain sufficient capital; (7) comply with notice and approval requirements established by the FRB relating to the appointment of directors and senior executive officers as well as any change in the responsibility of any current senior executive officer; (8) not pay or agree to pay any indemnification and severance payments except under certain circumstances, and with the prior approval of the FRB; and (9) provide
quarterly progress reports to the FRB.
Compliance Memorandum of Understanding
Frontier Bank and the Frontier Bank Board also entered into a Memorandum of Understanding with the FDIC dated August 20, 2008, relating to the correction of certain violations of applicable consumer protection and fair lending laws and regulations, principally including the failure to provide certain notices to consumers pursuant to
the Flood Disaster Protection Act of 1973, and certain violations of the Truth in Lending Act and Regulation Z.
The Memorandum of Understanding requires Frontier Bank and the Frontier Bank Board to (1) correct all violations found and implement procedures to prevent their recurrence; (2) increase oversight of the Frontier Bank Board’s compliance function, including monthly reports from Frontier Bank’s compliance officer to the
Frontier Bank Board detailing actions taken to comply with the Memorandum of Understanding; (3) review its compliance policies and procedures and develop and implement detailed operating procedures and controls, where necessary, to ensure compliance with all consumer protection laws and regulations; (4) establish monitoring procedures to ensure compliance with all consumer protection laws and regulations (including flood insurance), including the documentation and reporting of all exceptions to the
Frontier Bank Board and its audit committee; (5) review, expand and improve the quality of such compliance with the frequency of compliance audits to be reviewed and approved annually by the Frontier Bank Board or audit committee, with a goal of auditing compliance at least annually; (6) ensure that Frontier Bank’s compliance management function has adequate staff, resources, training and authority for the size and structure of Frontier Bank; (7) establish flood insurance monitoring procedures
to ensure loans are not closed without flood insurance and prior notices to customers required by law, that lapses of flood insurance do not occur, and to develop methods to ensure that adequate amounts of flood insurance are provided, with Frontier Bank agreeing to force place flood insurance when necessary; (8) provide additional training for all Frontier Bank personnel, including the Frontier Bank Board and audit and compliance staff for applicable laws and regulations and (9) furnish quarterly
progress reports to the Regional Director of the FDIC detailing the actions taken to secure compliance with the Memorandum of Understanding until the Regional Director has released the institution, in writing, from submitting further reports. Frontier Bank was assessed civil monetary penalties of $48,895 for flood insurance violations and required to pay $10,974 in restitution to customers for certain violations of the Truth in Lending Act and Regulation Z.
-16-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2: Regulatory Actions, Strategic Plan and Going Concern Considerations (continued)
Compliance Efforts in Response to Regulatory Actions
We have been actively engaged in responding to the concerns raised by the regulators and have acted promptly on directions received by taking the following actions:
• |
Engaged Patrick M. Fahey as chairman of the board and chief executive officer of Frontier on December 4, 2008; | |
• |
Retained an independent consultant to review and evaluate the loan portfolio in the Fall of 2008, and again in July 2009; | |
• |
Organized a special assets group staffed by 42 managers and employees, to accelerate the collection and resolution of delinquent and adversely classified loans; | |
• |
Developed capital management, liquidity and funds management plans; | |
• |
Increased board and senior management oversight of Frontier Bank, its lending and operations, including special board meetings; | |
• |
Established a communications procedure for reporting progress in all areas to the FDIC, Washington DFI and FRB. |
Strategic Plan
The results for 2009 reflect continued pressure from an uncertain economy and the negative impact of the local housing market. Despite these challenging times, the Board of Directors and management continue to take important steps to strengthen the Corporation.
Diversifying the Loan Portfolio
We continue to reduce our concentrations in real estate construction and land development loans and have successfully reduced these portfolios by $979.7 million, or 48.7%, from December 31, 2008 to December 31, 2009, including undisbursed loan commitments, as defined by the FDIC.
Asset Quality
Management continues to proactively manage credit quality and loan collections and address work out strategies. For the year ended December 31, 2009, net charge-offs totaled $337.3 million.
Capital Preservation
We continue to vigorously pursue contracts and discussions with prospective investors in an effort to strengthen our capital position. Efforts to raise additional capital began in the fourth quarter of 2008, when the Board of Directors retained a highly qualified investment banking firm to assist in raising capital and deleveraging
our balance sheet. Our ability to raise additional capital has been adversely affected by unfavorable conditions in the capital markets and our financial performance, and we have not been able to raise additional capital to date. If we cannot raise additional capital, continue to shrink our balance sheet and/or enter into a strategic merger or sale, we may not be able to sustain further deterioration in our financial condition and further regulatory actions or restrictions may be taken against
us.
On January 20, 2010, we held a special shareholder meeting in which shareholders approved an increase in the total number of shares of common stock that we are authorized to issue from 10 million to 200 million shares. The availability of these additional shares of common stock are intended to allow us the capability and flexibility
to issue new shares for a variety of purposes, including raising additional capital and increasing our regulatory capital ratios.
-17-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2: Regulatory Actions, Strategic Plan and Going Concern Considerations (continued)
As previously announced, on October 5, 2009, the Corporation and SP Acquisition Holdings, Inc. (“SPAH”) mutually agreed to terminate their Agreement and Plan of Merger, dated as of July 30, 2009, effective immediately, due to the fact that certain closing conditions contained in the merger agreement could not be met. Since
the termination of the transaction, we have continued to seek out equity investors and have made numerous contacts with potential investors.
Liquidity
We continue to closely monitor and manage our liquidity position, understanding that this is of critical importance in the current economic environment. At December 31, 2009, total liquidity, as a percentage of assets, was at its highest level for 2009, totaling 13.5%.
In an effort to increase on-balance sheet liquidity, we have been focused on restructuring our balance sheet, and in particular, reducing the loan portfolio and increasing core deposits. As a result, we have increased our federal funds sold balances to $333.8 million at December 31, 2009, an increase of $216.1 million from a
year ago. Year-over-year, total loans decreased $909.2 million, or 24.1%. Total deposits were $3.12 billion at December 31, 2009, compared to $3.28 billion a year ago, a decrease of $152.7 million, or 4.7%. Excluding brokered deposits, total deposits increased $55.0 million for the same period.
During the third quarter 2009, we announced our continued participation in the Federal Deposit Insurance Corporation's (“FDIC”) voluntary Transaction Account Guarantee (“TAG”) portion of the Temporary Liquidity Guarantee Program through June 30, 2010. Under this program, noninterest bearing transaction
accounts and qualified NOW checking accounts are fully guaranteed by the FDIC for an unlimited amount of coverage. The coverage under the TAG program is in addition to, and separate from, the coverage available under the FDIC's general deposit insurance protection.
Expense Reduction Measures
We continue to seek out feasible expense reduction measures. Previously announced expense reduction measures include: a six percent reduction in workforce, the suspension of the Corporation’s matching of employee 401(K) Plan contributions, effective May 1, 2009, and reductions to executive compensation, salary freezes and
the elimination of performance bonuses and discretionary profit sharing contributions to the 401(K) Plan. Additionally, full time equivalents (“FTE”) employees totaled 703 at December 31, 2009, down from 799 at December 31, 2008, a decrease of 12.0%.
Going Concern Considerations
Our consolidated financial statements have been prepared assuming that we will continue as a going concern.
In connection with continuing turmoil in the economy, and more specifically, within the local real estate market, we recorded a net loss of $295.1 million for the year ended December 31, 2009. The 2009 loss was primarily the result of increases in our provision for loan losses during the period and declining net interest margins
caused by increased amounts of nonperforming assets. The net loss for the period has had a negative impact on our operations, capital adequacy and liquidity and could result in further actions by our regulators to restrict our operations.
As of December 31, 2009, Frontier Bank’s Tier 1 leverage capital ratio was 1.65%, thus designating Frontier Bank as “critically undercapitalized” for purposes of Prompt Corrective Action (“PCA”). See Note 13 - Shareholders’ Equity and Regulatory Matters. In addition, Frontier Bank’s
Tier 1 leverage capital ratio remains less than the 10% required by the terms of the FDIC Order. See “Regulatory Actions” above.
In order to achieve compliance with the capital requirements of the FDIC Directive and FDIC Order and return to being “adequately capitalized” for federal regulatory purposes, we will need to either raise capital, sell assets to deleverage, or both. Our ability to accomplish these goals is significantly constricted
by the current adverse economic environment, in which access to capital markets has been limited, and we can give no assurances that we will be able to access any such capital or sell more assets. See “Strategic Plan - Capital Preservation.”
Our ability to decrease our levels of nonperforming assets is also vulnerable to market conditions as many of our borrowers rely on an active real estate market as a source of repayment, particularly our real estate construction and real estate development loan borrowers. If the real estate market does not improve or declines
further, our level of nonperforming assets may not decline.
-18-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2: Regulatory Actions, Strategic Plan and Going Concern Considerations (continued)
As a result of the capital and asset quality concerns affecting us, we have been aggressively addressing our liquidity needs to maintain an adequate cash flow position to sustain operations. We have ceased originating new real estate construction development loans and completed lot loans, although we continue to selectively
fund commitments previously issued. Finally, our special assets group has been aggressively marketing foreclosed real estate in an effort to sell noninterest earning assets at sales prices that do not further deteriorate our capital position.
We have determined that significant additional sources of capital will be required for us to continue operations through 2010 and beyond. We have engaged financial advisors to assist us in our efforts to raise additional capital and explore other strategic alternatives to address our current and expected capital deficiencies. Based
on their assessment of our ability to continue to operate in compliance with the FDIC Directive and Order, our regulators may take other and further actions, including taking possession of the Bank and placing it into conservatorship and receivership, assessing civil money penalties against the Bank or the Corporation and their respective officers, directors and other interested parties, or seeking to enforce the order or agreement in federal court. If the Bank or the Corporation were to engage in
other unsafe and unsound banking practices, the regulators have various enforcement tools available to them including the issuance of capital directives, orders to cease engaging in certain business activities and the issuance of modified or additional orders or agreements. Additionally, the regulators have the authority to take possession of the Bank
There can be no assurances that our actions referred to above will be successful. These events raise substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
-19-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 3: Securities
The following table presents the amortized cost, unrealized gains, unrealized losses and fair value of available for sale and held to maturity securities as of December 31, 2009 and 2008 (in thousands). For the years ended December 31, 2009 and 2008, there were no securities classified as trading.
2009 |
||||||||||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses (less than 12 months) |
Gross Unrealized Losses (12 months or more) |
Aggregate Fair Value |
||||||||||||||||
AFS Securities |
||||||||||||||||||||
Equities |
$ | 1,818 | $ | 315 | $ | - | $ | (34 | ) | $ | 2,099 | |||||||||
U.S. Treasuries |
250 | 61 | - | - | 311 | |||||||||||||||
U.S. Agencies |
39,786 | 101 | (10 | ) | - | 39,877 | ||||||||||||||
Corporate securities |
7,841 | - | (959 | ) | - | 6,882 | ||||||||||||||
Mortgage-backed securities |
32,653 | 739 | (56 | ) | - | 33,336 | ||||||||||||||
Municipal securities |
2,500 | 87 | - | - | 2,587 | |||||||||||||||
84,848 | 1,303 | (1,025 | ) | (34 | ) | 85,092 | ||||||||||||||
HTM Securities |
||||||||||||||||||||
Corporate securities |
1,524 | - | (89 | ) | - | 1,435 | ||||||||||||||
Municipal securities |
578 | 11 | - | - | 589 | |||||||||||||||
2,102 | 11 | (89 | ) | - | 2,024 | |||||||||||||||
Total |
$ | 86,950 | $ | 1,314 | $ | (1,114 | ) | $ | (34 | ) | $ | 87,116 |
2008 |
||||||||||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses (less than 12 months) |
Gross Unrealized Losses (12 months or more) |
Aggregate Fair Value |
||||||||||||||||
AFS Securities |
||||||||||||||||||||
Equities |
$ | 6,107 | $ | 61 | $ | (4,057 | ) | $ | (181 | ) | $ | 1,930 | ||||||||
U.S. Treasuries |
6,304 | 153 | - | - | 6,457 | |||||||||||||||
U.S. Agencies |
51,594 | 461 | - | - | 52,055 | |||||||||||||||
Corporate securities |
4,528 | 153 | - | (242 | ) | 4,439 | ||||||||||||||
Mortgage-backed securities |
22,791 | - | - | - | 22,791 | |||||||||||||||
Municipal securities |
2,855 | 81 | - | (2 | ) | 2,934 | ||||||||||||||
94,179 | 909 | (4,057 | ) | (425 | ) | 90,606 | ||||||||||||||
HTM Securities |
||||||||||||||||||||
Corporate securities |
1,524 | 229 | - | - | 1,753 | |||||||||||||||
Municipal securities |
1,561 | 26 | - | - | 1,587 | |||||||||||||||
3,085 | 255 | - | - | 3,340 | ||||||||||||||||
Total |
$ | 97,264 | $ | 1,164 | $ | (4,057 | ) | $ | (425 | ) | $ | 93,946 |
-20-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 3: Securities (continued)
The following table shows gross unrealized losses and fair value of securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2009 and 2008 (in thousands):
2009 |
Less Than 12 Months |
12 Months or More |
Total |
|||||||||||||||||||||
Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
Fair Value |
|||||||||||||||||||
AFS Securities |
||||||||||||||||||||||||
Equities |
$ | - | $ | - | $ | (34 | ) | $ | 436 | $ | (34 | ) | $ | 436 | ||||||||||
U.S. Agencies |
(10 | ) | 20,244 | - | - | (10 | ) | 20,244 | ||||||||||||||||
Corporate securities |
(959 | ) | 1,556 | - | - | (959 | ) | 1,556 | ||||||||||||||||
Mortgage-backed securities |
(56 | ) | 9,690 | - | - | (56 | ) | 9,690 | ||||||||||||||||
(1,025 | ) | 31,490 | (34 | ) | 436 | (1,059 | ) | 31,926 | ||||||||||||||||
HTM Securities |
||||||||||||||||||||||||
Corporate securities |
(89 | ) | 1,434 | - | - | (89 | ) | 1,434 | ||||||||||||||||
(89 | ) | 1,434 | - | - | (89 | ) | 1,434 | |||||||||||||||||
Total |
$ | (1,114 | ) | $ | 32,924 | $ | (34 | ) | $ | 436 | $ | (1,148 | ) | $ | 33,360 |
2008 |
Less Than 12 Months |
12 Months or More |
Total |
|||||||||||||||||||||
Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
Fair Value |
|||||||||||||||||||
AFS Securities |
||||||||||||||||||||||||
Equities |
$ | (4,057 | ) | $ | 923 | $ | (181 | ) | $ | 425 | $ | (4,238 | ) | $ | 1,348 | |||||||||
Corporate securities |
- | - | (242 | ) | 1,769 | (242 | ) | 1,769 | ||||||||||||||||
Municipal securities |
- | - | (2 | ) | 23 | (2 | ) | 23 | ||||||||||||||||
$ | (4,057 | ) | $ | 923 | $ | (425 | ) | $ | 2,217 | $ | (4,482 | ) | $ | 3,140 |
Certain securities shown above currently have fair values less than amortized cost, and therefore, contain unrealized losses. In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rates, the widening of market spreads subsequent to the initial purchase of the securities or to disruptions to credit markets and not
due to concerns regarding the underlying credit of the issuers or the underlying collateral. There were six securities with unrealized losses at December 31, 2009.
The unrealized loss on equity securities consist of an investment in the common stock of a financial institution. We have evaluated the near term prospects of the issuer and have considered their cash position, earnings and revenue outlook, liquidity and capital levels, among
other factors. Based on this evaluation and our ability and intent to hold this security for a reasonable period of time sufficient for a forecasted recovery of fair value, we do not consider this security to be other-than-temporarily impaired.
-21-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 3: Securities (continued)
The unrealized losses on investments in U.S. Agencies securities were caused by changes in market interest rates. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than par. Because we do not intend to sell the securities and it is not more likely than not
that we will be required to sell the securities before recovery of their amortized cost bases, which may be maturity, the unrealized losses on these securities are not considered other-than-temporarily impaired.
The unrealized losses on corporate securities, which consist of single issuer trust preferred securities, were primarily attributable to temporary disruptions of credit markets and the related impact on the securities within those classes, not deteriorating credit quality of specific securities. Because the decline in fair value
is attributable to disruptions of credit markets and not credit quality, and because we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of their amortized cost bases, which may be maturity, the unrealized losses on these investments are not considered other-than-temporarily impaired.
The unrealized losses on mortgage-backed securities were caused by changes in market interest rates. The contractual cash flows of these securities are guaranteed by an agency of the U.S. government, and accordingly, we do not expect these securities to be settled at a price less than the amortized cost of the investment. Because
the decline in fair value is attributable to changes in interest rates and not credit quality, and because we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of their amortized cost bases, which may be maturity, the unrealized losses on these securities are not considered other-than-temporarily impaired.
Management evaluates securities and FHLB stock for other-than-temporary impairment (“OTTI”) at least on an annual basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to: (1) the length of time and extent to which the fair value has been less than cost, (2) the
financial condition and near term prospects of the issuer, (3) our intent and ability to retain a security for a period of time sufficient to allow for any anticipated recovery in fair value and (4) whether we expect to recover the amortized cost basis of the security. For the years ended December 31, 2009 and 2008, OTTI losses totaling $4.3 million and $6.4 million, respectively, were recognized through earnings. No OTTI losses were recognized in the year ended December 31, 2007.
Contractual maturities of securities as of December 31, 2009, are shown below (in thousands). Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties.
Available for sale |
Held to maturity |
|||||||||||||||
Maturity |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
||||||||||||
0 - 1 years |
$ | 7,008 | $ | 7,033 | $ | 578 | $ | 590 | ||||||||
1 - 5 years |
38,278 | 38,346 | - | - | ||||||||||||
5 - 10 years |
1,604 | 1,695 | - | - | ||||||||||||
Over 10 years |
37,958 | 38,018 | 1,524 | 1,434 | ||||||||||||
$ | 84,848 | $ | 85,092 | $ | 2,102 | $ | 2,024 |
Proceeds from the sale of available for sale securities totaled $1.4 million, $45.6 million and $48.0 million for the years ended December 31, 2009, 2008 and 2007, respectively. Gross realized gains on the sale of available for sale securities totaled $100 thousand and $5.6 million for the years ended December 31, 2009 and 2008,
respectively. There were no gross realized gains in 2007. Gross realized losses on the sale of available for sale securities totaled $202 thousand, $1.0 million and $937 thousand for the years ended December 31, 2009, 2008 and 2007, respectively.
-22-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 3: Securities (continued)
The following table shows securities, which were pledged to secure borrowings, public deposits, repurchase agreements and other items, as permitted or required by law, at December 31, 2009 (in thousands):
Amortized Cost |
Fair Value |
|||||||
To the Federal Home Loan Bank to secure borrowings |
$ | 6,516 | $ | 6,543 | ||||
To state government to secure public deposits |
26,288 | 26,855 | ||||||
To Federal Reserve to secure repurchase agreements |
9,013 | 9,042 | ||||||
To Federal Reserve to secure customer tax payments |
4,508 | 4,578 | ||||||
Other securities pledged |
33,221 | 33,430 | ||||||
Total pledged securities |
$ | 79,546 | $ | 80,448 |
Securities with an amortized cost of $62.8 million and fair values of $63.4 million were pledged at December 31, 2008.
Note 4: Loans and Allowance for Loan Losses
The major classifications of loans, excluding loans held for resale, at December 31 are as follows (in thousands):
2009 |
2008 |
|||||||
Commercial and industrial |
$ | 389,171 | $ | 458,263 | ||||
Real Estate: |
||||||||
Commercial |
968,474 | 1,048,431 | ||||||
Construction |
448,870 | 952,619 | ||||||
Land development |
319,566 | 581,683 | ||||||
Completed lots |
252,966 | 250,405 | ||||||
Residential 1-4 family |
424,193 | 425,874 | ||||||
Installment and other loans |
69,761 | 65,490 | ||||||
2,873,001 | 3,782,765 | |||||||
Unearned fee income |
(6,724 | ) | (10,710 | ) | ||||
Total loans |
$ | 2,866,277 | $ | 3,772,055 |
At December 31, 2009, loans totaling $678.8 million were pledged to secure borrowings.
Changes in the allowance for loan losses for the years ended December 31 are summarized below (in thousands):
2009 |
2008 |
2007 |
||||||||||
Beginning balance |
$ | 114,638 | $ | 57,658 | $ | 44,195 | ||||||
Provision for loan losses |
375,000 | 120,000 | 11,400 | |||||||||
Charge-offs |
(341,531 | ) | (63,526 | ) | (1,906 | ) | ||||||
Recoveries |
4,233 | 506 | 986 | |||||||||
Merger |
- | - | 2,983 | |||||||||
Balance before portion identified for undisbursed loans |
152,340 | 114,638 | 57,658 | |||||||||
Portion of reserve identified for undisbursed |
||||||||||||
loans and reclassified as a liability |
(991 | ) | (2,082 | ) | (3,663 | ) | ||||||
Balance at end of period |
$ | 151,349 | $ | 112,556 | $ | 53,995 |
-23-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 4: Loans and Allowance for Loan Losses (continued)
At December 31, 2009, impaired loans totaled $705.2 million, compared to $435.2 million at December 31, 2008, and $20.9 million at December 31, 2007. Average balances of these loans were $793.1 million, $468.5 million and $15.4 million, for the years ended December 31, 2009, 2008 and 2007, respectively.
At December 31, 2009 and 2008, impaired loans totaling $361.5 million and $96.2 million had related specific reserves in the allowance for loan losses of $54.8 million and $12.9 million, respectively. Impaired loans without related specific reserves in the allowance for loan losses at December 31, 2009 and
2008, totaled $343.7 million and $339.0 million, respectively.
For the years ended December 31, there are certain amounts of interest collected on impaired loans that are included in income and amounts that have not been accrued, which are indicated in the following table (in thousands):
2009 |
2008 |
2007 |
||||||||||
Additional interest income which |
||||||||||||
would have been recorded during the |
||||||||||||
period under original loan terms |
$ | 65,790 | $ | 18,915 | $ | 757 | ||||||
Interest collected and included in |
||||||||||||
net income for the period |
$ | 18,100 | $ | 21,004 | $ | 1,131 | ||||||
Commitments for additional funds |
||||||||||||
related to loans above |
$ | - | $ | - | $ | - |
Note 5: Premises and Equipment
Premises and equipment at December 31 are comprised of the following (in thousands):
2009 |
2008 |
|||||||
Premises |
$ | 44,767 | $ | 44,440 | ||||
Furniture, fixtures and equipment |
25,632 | 25,676 | ||||||
Land |
15,484 | 15,593 | ||||||
Construction in process |
822 | 1,155 | ||||||
86,705 | 86,864 | |||||||
Accumulated depreciation |
(39,001 | ) | (35,362 | ) | ||||
Premises and equipment, net |
$ | 47,704 | $ | 51,502 |
For the years ended December 31, 2009, 2008 and 2007, depreciation expense on premises and equipment totaled $3.9 million, $3.8 million and $2.7 million, respectively.
-24-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 6: Intangible Assets
The following table summarizes the changes in goodwill and other intangible assets for the years ended December 31, 2009 and 2008 (in thousands):
Other Intangible Assets |
||||||||||||||||
Goodwill |
Gross Carrying Amount |
Accumulated Amortization |
Net |
|||||||||||||
Balance, December 31, 2007 |
$ | 77,073 | $ | 1,543 | $ | (466 | ) | $ | 1,077 | |||||||
Amortization |
- | - | (283 | ) | (283 | ) | ||||||||||
Impairment |
(77,073 | ) | - | - | - | |||||||||||
Balance, December 31, 2008 |
- | 1,543 | (749 | ) | 794 | |||||||||||
Amortization |
- | - | (213 | ) | (213 | ) | ||||||||||
Balance, December 31, 2009 |
$ | - | $ | 1,543 | $ | (962 | ) | $ | 581 |
During the fourth quarter of 2008, we recorded a non-cash charge of $77.1 million related to the impairment of goodwill. This write down resulted from goodwill impairment testing that was performed at the end of the fourth quarter due to the quarterly decline in the stock price and the resulting difference between the market
capitalization and book value of the Corporation. The results of the goodwill impairment testing demonstrated that the estimated fair value of the Corporation, or reporting unit, was less than the book value, resulting in full impairment. This impairment charge had no effect on our cash balances or liquidity. In addition, because goodwill is not included in the calculation of regulatory capital, the Corporation’s and Bank’s regulatory ratios were not affected by this
non-cash expense.
Intangible amortization expense of $213 thousand, $283 thousand and $235 thousand was included in other noninterest expense for the years ended December 31, 2009, 2008 and 2007, respectively.
The table below presents the forecasted amortization expense for intangible assets acquired in all mergers (in thousands):
Expected |
|||||
Amortization |
|||||
Year Ending December 31, |
2010 |
$ | 213 | ||
2011 |
140 | ||||
2012 |
87 | ||||
2013 |
87 | ||||
2014 |
54 | ||||
$ | 581 |
Note 7: Other Real Estate Owned
The following table presents the activity related to other real estate owned (“OREO”) for the years ended December 31 (in thousands):
2009 |
2008 |
|||||||||||||||
Amount |
Number |
Amount |
Number |
|||||||||||||
Beginning balance |
$ | 10,803 | 64 | $ | 367 | 1 | ||||||||||
Additions to OREO |
217,720 | 618 | 12,992 | 76 | ||||||||||||
Capitalized improvements |
884 | 623 | ||||||||||||||
Valuation adjustments |
(9,702 | ) | (68 | ) | ||||||||||||
Disposition of OREO |
(50,031 | ) | (188 | ) | (3,111 | ) | (13 | ) | ||||||||
Ending balance |
$ | 169,674 | 494 | $ | 10,803 | 64 |
-25-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 8: Interest Bearing Deposits
The major classifications of interest bearing deposits at December 31 are as follows (in thousands):
2009 |
2008 |
|||||||
Money market, sweep and NOW accounts |
$ | 497,952 | $ | 325,554 | ||||
Savings |
241,261 | 365,114 | ||||||
Time deposits, $100,000 and over |
830,508 | 1,430,685 | ||||||
Other time deposits |
1,175,497 | 758,361 | ||||||
Total interest bearing deposits |
$ | 2,745,218 | $ | 2,879,714 |
At December 31, 2009, the scheduled maturities of time deposits are as follows (in thousands):
Year Ending December 31, |
2010 |
$ | 1,564,745 | ||
2011 |
291,218 | ||||
2012 |
98,026 | ||||
2013 |
23,258 | ||||
2014 |
27,425 | ||||
Thereafter |
1,333 | ||||
$ | 2,006,005 |
Note 9: Securities Sold Under Agreements to Repurchase
We have sold certain securities of the U.S. Government and its agencies and other approved investments under agreements to repurchase on a short-term basis. The securities underlying the agreements were held by a safekeeping agent and had an amortized cost and fair value of $9.0 million at December 31, 2009 (see Note 3). Securities
sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. We may be required to provide additional collateral based on the fair value of the underlying securities.
Securities sold under agreement to repurchase were $6.4 million at December 31, 2009, and $14.8 million at December 31, 2008. The average daily balance of outstanding agreements during the period was $11.6 million in 2009 and $28.8 million in 2008, with maximum outstanding agreements at any month end of $14.7 million and $40.1
million, respectively.
Note 10: Federal Home Loan Bank Advances
We are a member of the Federal Home Loan Bank (“FHLB”) of Seattle. As a member, we have a committed line of credit up to approximately 10% of total Bank assets at December 31, 2009.
Contractual maturities of FHLB advances as of December 31, 2009 are shown below (in thousands). Expected maturities may differ from contractual maturities because FHLB has the right to call without penalties.
Amount |
Interest Rates |
||||||||
Year Ending December 31, |
2010 |
$ | 65,137 | 3.03% - 4.93 | % | ||||
2011 |
15,000 | 2.13 | % | ||||||
2012 |
100,342 | 3.87% - 4.97 | % | ||||||
2013 |
100,000 | 3.04 | % | ||||||
2014 |
- | - | |||||||
Thereafter |
95,000 | 3.71% - 4.66 | % | ||||||
$ | 375,479 |
Advances from FHLB are collateralized by qualifying first mortgage loans, qualifying commercial real estate and government agency securities, as required by the agreement with FHLB.
-26-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 10: Federal Home Loan Bank Advances (continued)
The maximum and average outstanding balances and average interest rates on advances from FHLB were as follows for the years ended December 31 (in thousands):
2009 |
2008 |
|||||||
Maximum outstanding at any month end |
$ | 429,279 | $ | 429,417 | ||||
Average outstanding |
407,015 | 340,350 | ||||||
Weighted average interest rates |
||||||||
Annual |
3.78 | % | 4.09 | % | ||||
End of year |
3.91 | % | 3.91 | % |
Note 11: Junior Subordinated Debentures
On February 1, 2006, we acquired 100 percent of the outstanding shares of NorthStar Financial Corporation. As part of the transaction, we acquired two statutory business trusts which had been formed in December of 2004. NorthStar Financial Corporation Statutory Trust I (“Trust I”) and NorthStar Financial
Corporation Statutory Trust II (“Trust II”), collectively the Trusts, were formed for the exclusive purposes of issuing and selling capital securities and utilizing the proceeds to acquire junior subordinated debt.
The Trusts raised $5.2 million in cash through the issuance of $5.0 million of trust preferred securities and $156 thousand of common stock. The trust preferred securities are owned by third parties and the common stock is owned by the Corporation. The proceeds from the sale of the trust preferred securities and the common stock
were invested by the Trusts in $5.2 million of junior subordinated debentures issued by NorthStar Financial Corporation and assumed by us in the acquisition. On the December 31, 2009, balance sheet, the $5.2 million of junior subordinated debentures is reflected as a liability and the $156 thousand of common stock of the Trusts is included in other assets. There were $5.0 million in trust preferred securities outstanding at December 31, 2009.
The Trusts accrue interest and make cash distributions on the trust preferred securities periodically at rates specified in the trust agreement. The interest rate on Trust I trust preferred securities is fixed at 6.0%. The interest rate on Trust II trust preferred securities is the Three-Month Libor rate plus 2%, and
is adjusted quarterly. As of December 31, 2009, the interest rate on Trust II trust preferred securities was 2.27%. We pay interest on the junior subordinated debentures to the Trusts equal to the rate at which the Trusts accrue and pay interest on their trust preferred securities.
Commencing with the interest payments due in the first quarter of 2009, we elected to defer our quarterly interest payments on the junior subordinated debentures, as permitted by the indenture agreement, although we will continue to accrue the cost of the preferred dividends at the normal interest rate, on a compounded basis, until such
time as the deferred payments have been paid current. This election was the result of the notification by the Federal Reserve Bank of San Francisco (“FRB”), that the Corporation and the Bank had been designated to be in a “troubled condition” for purposes of Section 914 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. As a result of that designation, we are generally prohibited from making any payments to any entity, including dividends
and interest payments (including dividends on its trust preferred securities, and interest at the holding company level) without notifying the FRB for prior approval of such payments.
The junior subordinated debentures mature in February 2035. The Trust’s trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the Trust’s trust
preferred securities are redeemable by us in whole before February 23, 2010, at 100% of the liquidation amount. Upon approval of the Federal Reserve, we may redeem the Trust’s trust preferred securities in whole or in part on or after February 23, 2010, at 100% of the liquidation amount. We fully and unconditionally guarantee the Trust’s trust preferred securities. As of December 31, 2009, $5.0 million of the Trust’s preferred securities qualify as Tier I capital
under the guidelines of the Federal Reserve.
-27-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 12: Income Taxes
The components of the provision (benefit) for income tax for the years ended December 31, are as follows (in thousands):
2009 |
2008 |
2007 |
||||||||||
Current |
$ | (128,651 | ) | $ | 11,796 | $ | 43,066 | |||||
Deferred |
37,996 | (20,431 | ) | (5,480 | ) | |||||||
Provision (benefit) for income tax |
$ | (90,655 | ) | $ | (8,635 | ) | $ | 37,586 |
A reconciliation of the effective income tax rate with the federal statutory tax rate for the years ended December 31 is as follows (in thousands):
2009 |
2008 |
2007 |
||||||||||||||||||||||
Amount |
Rate |
Amount |
Rate |
Amount |
Rate |
|||||||||||||||||||
Income tax provision (benefit) at statutory rate |
$ | (135,012 | ) | (35 | %) | $ | (34,627 | ) | (35 | %) | $ | 39,034 | 35 | % | ||||||||||
Effect of nontaxable interest income |
(930 | ) | (1 | %) | (1,123 | ) | (1 | %) | (1,085 | ) | (1 | %) | ||||||||||||
Goodwill |
- | - | 27,131 | 27 | % | - | - | |||||||||||||||||
Valuation allowance |
46,729 | 12 | % | - | - | - | - | |||||||||||||||||
Other |
(1,442 | ) | 1 | % | (16 | ) | - | (363 | ) | - | ||||||||||||||
Income tax provision (benefit) at effective rate |
$ | (90,655 | ) | (23 | %) | $ | (8,635 | ) | (9 | %) | $ | 37,586 | 34 | % |
The following table shows the nature and components of the net deferred tax assets, established at an estimated tax rate of 35%, at December 31 (in thousands):
2009 |
2008 |
|||||||
Deferred tax assets |
||||||||
Allowance for possible loan losses, in excess of tax reserves |
$ | 49,657 | $ | 40,260 | ||||
Intangible assets |
124 | 900 | ||||||
Unrealized loss on available for sale securities |
123 | 1,459 | ||||||
Stock-based compensation |
1,715 | 841 | ||||||
Other deferred tax assets |
6,239 | 1,256 | ||||||
Total deferred tax assets |
57,858 | 44,716 | ||||||
Deferred tax liabilities |
||||||||
FHLB stock dividends |
(2,589 | ) | (2,589 | ) | ||||
Deferred loan fees |
(5,142 | ) | (2,239 | ) | ||||
Other deferred tax liabilities |
(3,275 | ) | (1,892 | ) | ||||
Total deferred tax liabilities |
(11,006 | ) | (6,720 | ) | ||||
46,852 | 37,996 | |||||||
Valuation allowance |
(46,852 | ) | - | |||||
Net deferred tax assets |
$ | - | $ | 37,996 |
Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be
reported in our income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized. We believe, based upon available information, that some or all of the deferred tax asset may not
be realized in the normal course of operations, and therefore, we established a valuation allowance of $46.9 million for the year ended December 31, 2009.
-28-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 12: Income Taxes (continued)
At December 31, 2009, we had, for tax reporting purposes, a net operating loss carry forward of approximately $331.0 million eligible to offset future Oregon income taxes. The net operating loss will begin to expire in 2023. At December 31, 2009, we also had state tax credits totaling $292 thousand. These tax
credits consist of State of Oregon Business Energy Tax Credits (“BETC”) that can be utilized to offset future Oregon income taxes and expire in 2017 and 2018. We acquired the BETC in our acquisition of Bank of Salem in 2007.
We file federal and various state and local income tax returns. With few exceptions, we are no longer subject to U.S. federal or state/local income tax examinations by tax authorities for years before 2006.
Note 13: Shareholders’ Equity and Regulatory Matters
Regulatory Capital Guidelines: Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements
more sensitive to differences in risk profiles among banks and bank holding companies.
The minimum ratios and the actual capital ratios for the Corporation and Frontier Bank for the years ended December 31, 2009 and 2008 are set forth in the table below (in thousands).
To be Well |
For Capital |
|||||||||||||||||||||||
Actual |
Capitalized |
Adequacy Purposes |
||||||||||||||||||||||
2009 |
Amount |
Ratio |
Amount |
Ratio |
Amount |
Ratio |
||||||||||||||||||
Total Capital (to risk |
||||||||||||||||||||||||
weighted assets) |
||||||||||||||||||||||||
Consolidated |
$ | 102,322 | 3.58 | % | N/A | N/A | $ | 228,823 | 8.00 | % | ||||||||||||||
Frontier Bank |
96,585 | 3.38 | % | 285,775 | 10.00 | % | 228,620 | 8.00 | % | |||||||||||||||
Tier I Capital (to risk |
||||||||||||||||||||||||
weighted assets) |
||||||||||||||||||||||||
Consolidated |
65,543 | 2.29 | % | N/A | N/A | 114,411 | 4.00 | % | ||||||||||||||||
Frontier Bank |
59,837 | 2.09 | % | 171,465 | 6.00 | % | 114,310 | 4.00 | % | |||||||||||||||
Tier I Capital (to |
||||||||||||||||||||||||
average assets) |
||||||||||||||||||||||||
Consolidated |
65,543 | 1.80 | % | N/A | N/A | 145,732 | 4.00 | % | ||||||||||||||||
Frontier Bank |
59,837 | 1.65 | % | 181,863 | 5.00 | % | 145,490 | 4.00 | % | |||||||||||||||
2008 |
||||||||||||||||||||||||
Total Capital (to risk |
||||||||||||||||||||||||
weighted assets) |
||||||||||||||||||||||||
Consolidated |
$ | 402,612 | 10.91 | % | N/A | N/A | $ | 295,126 | 8.00 | % | ||||||||||||||
Frontier Bank |
390,260 | 10.55 | % | 370,006 | 10.00 | % | 296,005 | 8.00 | % | |||||||||||||||
Tier I Capital (to risk |
||||||||||||||||||||||||
weighted assets) |
||||||||||||||||||||||||
Consolidated |
355,653 | 9.64 | % | N/A | N/A | 147,563 | 4.00 | % | ||||||||||||||||
Frontier Bank |
343,165 | 9.27 | % | 222,003 | 6.00 | % | 148,002 | 4.00 | % | |||||||||||||||
Tier I Capital (to |
||||||||||||||||||||||||
average assets) |
||||||||||||||||||||||||
Consolidated |
355,653 | 8.62 | % | N/A | N/A | 164,981 | 4.00 | % | ||||||||||||||||
Frontier Bank |
343,165 | 8.53 | % | 201,146 | 5.00 | % | 160,917 | 4.00 | % |
-29-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 13: Shareholders’ Equity and Regulatory Matters (continued)
Prompt Corrective Action (“PCA”): Under the guidelines, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. The categories
are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized. Institutions that are deemed to be undercapitalized, depending on the category to which they are assigned, are subject to certain mandatory supervisory corrective actions.
As of December 31, 2009, Frontier Bank was categorized by the FDIC as “critically undercapitalized” for purposes of PCA. Under the FDI Act’s PCA capital requirements (12 U.S.C. § 1831o), depository institutions that are “critically undercapitalized”, in addition to being subject to a number
of additional restrictions, must be placed into conservatorship or receivership within 90 days of becoming critically undercapitalized, unless the institution’s primary Federal regulatory authority (the FDIC) determines and documents that “other action” would better achieve the purposes of PCA. See Note 2 for further details regarding our ability to continue as a going concern.
Note 14: Stock-Based Compensation Plans
Stock Incentive Plan
In 2006, Shareholders approved a Stock Incentive Plan (the “Plan”) to promote the best interest of the Corporation, our subsidiary and our shareholders, by providing an incentive to those key employees who contribute to our success. The Plan allows for incentive stock options, stock grants and stock appreciation rights
to be awarded. The maximum number of shares that may be issued under the Plan is 525,000 common shares. At December 31, 2009, 322,357 common shares were available for grant. Shares issued and outstanding are adjusted to reflect common stock dividends, splits, recapitalization or reorganization. The Board of Directors make available sufficient shares for each award granted. Options are granted at fair market value, generally vest over three years and expire ten years
from the date of grant. Dividends are paid on stock grants but not on incentive stock options. Certain options provide for accelerated vesting if there is a change in control.
A summary of option activity under the Plan, as of December 31, 2009, and changes during the year then ended are as follows:
Weighted |
Aggregate |
|||||||||||||||
Average |
Intrinsic |
|||||||||||||||
Options |
Weighted Average |
Contractual |
Value |
|||||||||||||
Outstanding |
Exercise Price |
Term |
(Thousands) |
|||||||||||||
Outstanding, January 1, 2009 |
137,791 | $ | 166.84 | |||||||||||||
Granted |
118,310 | 4.31 | ||||||||||||||
Exercised |
- | - | ||||||||||||||
Forfeited/Expired |
(24,377 | ) | 159.34 | |||||||||||||
Outstanding, December 31, 2009 |
231,724 | $ | 84.65 | 7.7 | $ | - | ||||||||||
Exercisable at December 31, 2009 |
92,819 | $ | 182.53 | 4.7 | $ | - |
-30-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 14: Stock-Based Compensation Plans (continued)
A summary of the status of the nonvested stock awards, as of December 31, 2009, and changes during the year then ended, are presented below:
Weighted Average |
||||||||
Grant-Date |
||||||||
Shares |
Fair Value |
|||||||
Nonvested at January 1, 2009 |
27,018 | $ | 114.87 | |||||
Awarded |
3,600 | 30.15 | ||||||
Released |
(15,269 | ) | 124.81 | |||||
Forfeited |
(2,894 | ) | 119.14 | |||||
Nonvested at December 31, 2009 |
12,455 | $ | 77.21 |
As of December 31, 2009, there was $1.2 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 1.9 years. The total compensation cost that has been charged against income
for the Plan was $2.1 million in 2009, $3.4 million in 2008, and $2.6 million in 2007. The total income tax benefit recognized in the income statement for stock-based compensation arrangements was $723 thousand in 2009, $1.2 million in 2008, and $904 thousand in 2007.
There were no options exercised during the year ended December 31, 2009. The total intrinsic value of options exercised during the years ended December 31, 2008 and 2007, was $160 thousand and $1.6 million, respectively. Cash received from option exercises under all stock-based payment arrangements for the years ended
December 31, 2008 and 2007, was $391 thousand and $1.9 million, respectively. The actual tax benefit realized for the tax deductions from option exercises of the stock-based payment arrangements totaled $49 thousand and $237 thousand for the years ended December 31, 2008 and 2007, respectively.
1999 Employee Stock Award Plan
In 1999, we adopted the 1999 Employee Stock Award Plan to recognize, motivate and reward eligible employees for longstanding performance with us and our subsidiary. Employees eligible to receive stock awards under this Plan must have been employees for at least 20 years, or some other tenure as determined from time to time by
the Board of Directors. The maximum number of shares that may be issued is 4,500 and is adjusted to reflect future common share dividends, splits, recapitalization or reorganization. The stock awards vest immediately when granted. The Plan expired in 2009 and any future grants will be made out of the 2006 Stock Incentive Plan, as noted above.
In 2009, there were no shares awarded under the Plan. In 2008 and 2007, there were 147 and 56 shares with fair values of $25 thousand and $15 thousand, respectively, awarded and vested under this Plan. As of December 31, 2009, 926 shares have been issued under this Plan.
-31-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 15: Employee Benefit Plan
We have a profit sharing and salary deferral plan that covers eligible employees. Contributions to the salary deferral plan were $935 thousand, $1.5 million and $4.7 million for the years ended December 31, 2009, 2008 and 2007, respectively. Contributions to the profit sharing plan are discretionary, with a minimum
of 6% of employee compensation. For the years ended December 31, 2009 and 2008, the Board of Directors elected not to make a contribution to the profit sharing plan as a result of the reported net losses for those years. Employer contributions are funded during the period in which it is committed by the Board of Directors. As part of our ongoing strategy to reduce noninterest expense, the Board of Directors voted to suspend the Corporation’s matching of employee 401(K) Plan
contributions, effective May 1, 2009.
Note 16: Earnings (Loss) per Share
The numerators and denominators of basic and fully diluted earnings (loss) per share are as follows (in thousands, except for number of shares and per share amounts):
2009 |
2008 |
2007 |
||||||||||
Net income (loss) |
$ | (295,094 | ) | $ | (89,737 | ) | $ | 73,938 | ||||
Shares used in the calculation |
||||||||||||
Weighted average shares outstanding |
4,713,219 | 4,699,163 | 4,526,572 | |||||||||
Effect of dilutive stock options and awards |
- | - | 33,535 | |||||||||
Diluted shares |
4,713,219 | 4,699,163 | 4,560,107 | |||||||||
Basic earnings (loss) per share |
$ | (62.61 | ) | $ | (19.10 | ) | $ | 16.33 | ||||
Diluted earnings (loss) per share |
$ | (62.61 | ) | $ | (19.10 | ) | $ | 16.21 |
All options and nonvested restricted shares outstanding during the year ended December 31, 2009 and 2008 were excluded from the computation of diluted loss per share because their effect would be anti-dilutive due to the net loss (see Note 14). Anti-dilutive options and nonvested restricted stock excluded at December 31,
2007 were not significant.
Note 17: Related Party Transactions
Loans to directors, executive officers and their affiliates are subject to regulatory limitations. Such loans had aggregate balances and activity during 2009, 2008 and 2007, as follows (in thousands), and were within regulatory limitations:
2009 |
2008 |
2007 |
||||||||||
Balance at beginning of year |
$ | 56,988 | $ | 52,649 | $ | 85,277 | ||||||
New loans or advances |
1,385 | 6,471 | 10,089 | |||||||||
Repayments |
(2,979 | ) | (2,132 | ) | (42,717 | ) | ||||||
Reclassifications (1) |
(21,670 | ) | - | - | ||||||||
Balance at end of year |
$ | 33,724 | $ | 56,988 | $ | 52,649 | ||||||
(1) Represents loans that were once considered related party, but are no longer considered related party. |
Total deposits beneficially owned by related parties were $1.7 million, $3.2 million and $4.2 million at December 31, 2009, 2008 and 2007, respectively.
-32-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 18: Commitments and Contingent Liabilities
Lease Commitments
We lease various branch offices under agreements, which expire between 2010 and 2024. The agreements contain various renewal options and generally require us to maintain the properties.
The total future minimum lease commitments through 2014, and thereafter, are as follows (in thousands):
Year ending December 31, |
2010 |
$ | 1,692 | ||
2011 |
1,467 | ||||
2012 |
963 | ||||
2013 |
915 | ||||
2014 |
626 | ||||
Thereafter |
879 | ||||
$ | 6,542 |
Rental expense charged to operations was $2.3 million in 2009, $2.1 million in 2008 and $2.3 million in 2007.
Financial Instruments with Off-Balance-Sheet Risk
A summary of the notional amount of financial instruments with off-balance sheet risk at December 31, 2009, are as follows (in thousands):
Amount |
||||
Commitments to extend credit |
$ | 225,882 | ||
Credit card arrangements |
18,903 | |||
Standby and commercial letters of credit |
19,591 | |||
$ | 264,376 |
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet financing needs of our customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. These instruments involve, to varying degrees, elements of credit and interest-rate
risk in excess of the amount recognized in the balance sheet. The contract amount of these instruments reflects the extent of our involvement in particular classes of financial instruments.
Our exposure to credit loss in the event of nonperformance by the other party to the instrument for commitments to extend credit, standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we
do for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash requirements. While most standby letters of credit are not utilized, a significant portion of such utilization is on an immediate payment basis. We evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory,
property, plant, and equipment and income-producing commercial properties.
Standby letters of credit and financial guarantees written are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, bond financing and similar transactions. We underwrite our standby
letters of credit using our policies and procedures applicable to loans in general. Standby letters of credit are made on an unsecured and secured basis. We have not been required to perform on any financial guarantees and did not incur any losses in connection with standby letters of credit during the years ended December 31, 2009, 2008 and 2007. At December 31, 2009, approximately $6.7 million of standby letters of credit expire within one year, and $12.9 million expire thereafter.
-33-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 18: Commitments and Contingent Liabilities (continued)
At December 31, 2009, the reserve for unfunded commitments, which is included in other liabilities on the consolidated balance sheet, was $991 thousand. The adequacy of the reserve for unfunded commitments is reviewed on a quarterly basis, based upon changes in the amounts of commitments, loss experience and economic conditions.
Legal Proceedings
We are a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on our financial condition or results of operations.
Note 19: Fair Values
FASB ASC 820, Fair Value Measurements and Disclosure, and FASB ASC 825, Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the consolidated financial
statements. The following table presents estimated fair values of our financial instruments at December 31, 2009 and 2008 (in thousands):
2009 |
2008 |
|||||||||||||||
Carrying |
Fair |
Carrying |
Fair |
|||||||||||||
Value |
Value |
Value |
Value |
|||||||||||||
Assets |
||||||||||||||||
Cash and due from banks |
$ | 93,761 | $ | 93,761 | $ | 52,022 | $ | 52,022 | ||||||||
Federal funds sold |
333,819 | 333,819 | 117,740 | 117,740 | ||||||||||||
Securities |
||||||||||||||||
Available for sale |
85,092 | 85,092 | 90,606 | 90,606 | ||||||||||||
Held to maturity |
2,102 | 2,024 | 3,085 | 3,340 | ||||||||||||
Loans held for resale |
3,221 | 3,221 | 6,678 | 6,678 | ||||||||||||
Loans, net |
2,714,928 | 2,408,312 | 3,659,499 | 3,714,492 | ||||||||||||
Bank owned life insurance |
25,385 | 25,385 | 24,321 | 24,321 | ||||||||||||
Liabilities |
||||||||||||||||
Noninterest bearing deposits |
377,258 | 377,258 | 395,451 | 395,451 | ||||||||||||
Interest bearing deposits |
2,745,218 | 2,769,458 | 2,879,714 | 2,909,730 | ||||||||||||
Federal funds purchased and securities |
||||||||||||||||
sold under agreements to repurchase |
11,107 | 11,107 | 21,616 | 21,616 | ||||||||||||
FHLB Advances |
375,479 | 386,976 | 429,417 | 444,441 | ||||||||||||
Junior subordinated debentures |
5,156 | 2,191 | 5,156 | 1,676 |
We determined the estimated fair value amounts using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data in the development of the estimates of fair value. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate fair value.
Cash Equivalents and Federal Funds Sold - For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
Securities - Securities fair values is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1), through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily available (Level 2) or through the use
of valuation techniques, such as discounted cash flow models (Level 3).
Loans Held for Resale – For loans held for resale, carrying value approximates fair value.
-34-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 19: Fair Values (continued)
Loans – Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type and each loan category is further segregated by performing and nonperforming categories. The
fair value of loans is generally estimated by discounting contractual cash flows at rates at which similar loans are currently being made and a credit adjustment related to the current market environment. The fair value calculation, however, does not take into consideration the ultimate collectibility of the loan.
Bank Owned Life Insurance – The fair value of Bank owned life insurance policies are based on cash surrender value of the insurance contract, less any applicable surrender charges.
Deposits and Federal Funds Purchased - The fair value of demand deposits, savings accounts, certain money market deposits, and federal funds purchased, is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting
the future cash flows using the rates currently offered for deposits of similar remaining maturities.
FHLB Advances and Securities Sold Under Agreements to Repurchase - Fair value is determined by discounting future cash flows using rates currently available to the Bank for debt with similar terms and remaining maturities.
Junior Subordinated Debentures – The fair value of junior subordinated debentures is estimated using a discounted cash flow model.
The following tables present the balances of assets measured at fair value on a recurring basis at December 31, 2009 and 2008 (in thousands):
Fair Value at December 31, 2009 |
||||||||||||||||
Level 1 |
Level 2 |
Level 3 |
Total |
|||||||||||||
Available for sale securities |
||||||||||||||||
Equities |
$ | 1,461 | $ | 638 | $ | - | $ | 2,099 | ||||||||
U.S. Treasuries |
- | 311 | - | 311 | ||||||||||||
U.S. Agencies |
- | 39,877 | - | 39,877 | ||||||||||||
Corporate securities |
- | 6,282 | 600 | 6,882 | ||||||||||||
Mortgage-backed securities |
- | 33,336 | - | 33,336 | ||||||||||||
Municipal securities |
- | 2,587 | - | 2,587 | ||||||||||||
Total |
$ | 1,461 | $ | 83,031 | $ | 600 | $ | 85,092 |
Fair Value at December 31, 2008 |
||||||||||||||||
Level 1 |
Level 2 |
Level 3 |
Total |
|||||||||||||
Available for sale securities |
||||||||||||||||
Equities |
$ | 1,327 | $ | 603 | $ | - | $ | 1,930 | ||||||||
U.S. Treasuries |
- | 6,457 | - | 6,457 | ||||||||||||
U.S. Agencies |
- | 52,055 | - | 52,055 | ||||||||||||
Corporate securities |
- | 2,939 | 1,500 | 4,439 | ||||||||||||
Mortgage-backed securities |
- | 22,791 | - | 22,791 | ||||||||||||
Municipal securities |
- | 2,934 | - | 2,934 | ||||||||||||
Total |
$ | 1,327 | $ | 87,779 | $ | 1,500 | $ | 90,606 |
-35-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 19: Fair Values (continued)
The following table presents the fair value adjustments using significant unobservable inputs (Level 3) for the year ended December 31, 2009 (in thousand):
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) |
||||
Beginning balance |
$ | 1,500 | ||
Total unrealized gains (losses) |
(900 | ) | ||
Purchases |
- | |||
Transfers into Level 3 |
- | |||
Ending balance |
$ | 600 |
At December 31, 2009, we valued an investment in a single issuer trust preferred security using a discounted cash flow model. As a result of unprecedented disruptions of certain financial markets, we determined that the level and volume of activity for this type of security had significantly decreased, and therefore, there were
insufficient transactions to accurately determine the fair value. Using a discounted cash flow method, the fair value of this security was determined to be $600 thousand at December 31, 2009. In our model, we used a discount factor of 28%, which we estimated based on risk and the current market for this type of security. This determination is considered a Level 3 input. For the year ended December 31, 2009, there were no realized losses with respect to this security.
The following table presents the balance of assets measured at fair value on a nonrecurring basis at December 31, 2009 and 2008, and the total losses resulting from these fair value adjustments in the related years (in thousands):
Fair Value at December 31, 2009 |
For the Year Ended December 31, 2009 |
|||||||||||||||||||
Level 1 |
Level 2 |
Level 3 |
Total |
Total Losses |
||||||||||||||||
Impaired loans (1) |
$ | - | $ | - | $ | 535,734 | $ | 535,734 | $ | 240,124 | ||||||||||
OREO (2) |
- | - | 158,959 | 158,959 | 100,443 | |||||||||||||||
$ | - | $ | - | $ | 694,693 | $ | 694,693 | $ | 340,567 |
Fair Value at December 31, 2008 |
For the Year Ended December 31, 2008 |
|||||||||||||||||||
Level 1 |
Level 2 |
Level 3 |
Total |
Total Losses |
||||||||||||||||
Impaired loans (1) |
$ | - | $ | - | $ | 268,193 | $ | 268,193 | $ | 60,828 | ||||||||||
OREO (2) |
- | - | 10,803 | 10,803 | 3,880 | |||||||||||||||
$ | - | $ | - | $ | 278,996 | $ | 278,996 | $ | 64,708 |
(1) |
The balance of impaired loans measured at fair value at December 31, 2009 and 2008, represents nonaccruing loans that have had charge-offs and/or have a specific reserve in the allowance for loan losses. The loss on impaired loans for the years ended December 31, 2009 and 2008, represents charge-offs or impairments on collateral
dependent loans for fair value adjustments based on the fair value of collateral recognized through the allowance for loan losses. |
(2) |
The balance of OREO measured at fair value at December 31, 2009 and 2008, represents real estate that was recorded at fair value less costs to sell at the time of foreclosure and/or has had a valuation adjustment subsequent to becoming OREO. The loss on OREO for the year ended December 31, 2009, represents charge-offs of $90.7
million at the time of foreclosure and subsequent valuation adjustments of $9.7 million. The loss on OREO for the year ended December 31, 2008, presents charge-offs at the time of foreclosure. |
There were no material liabilities carried at fair value, measured on a recurring or nonrecurring basis, at December 31, 2009 or 2008.
-36-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 19: Fair Values (continued)
The following is a description of the valuation methodologies used to measure and disclose the fair value of assets and liabilities on a recurring or nonrecurring basis:
Securities
Securities available for sale are recorded at fair value on a recurring basis. Fair value is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1), through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily available (Level 2) or through
the use of valuation techniques, such as discounted cash flow models (Level 3).
We use an outside vendor to price our securities, Interactive Data Corporation (“IDC”). IDC provides independent evaluations and is recognized industry-wide as one of the most reliable valuation services. IDC’s evaluations are based on market data. IDC utilizes evaluated pricing models that vary based
on asset class and include available trade, bid and other market information. Methodology includes broker quotes, proprietary modes, vast descriptive terms and conditions databases, as well as extensive quality control programs. IDC uses a pricing model only on our municipal securities totaling $3.1 million, which are subject to IDC’s quality control program.
All pricing information and quotes we obtain from IDC on our securities are reviewed for reasonableness and used directly for the preparation of our financial statement. We have not had to adjust prices provided by IDC, since the majority of our security prices are based on market data.
Impaired Loans
On a nonrecurring basis, fair value adjustments to collateral dependent loans are recorded to reflect partial write-downs based on the current appraised value of the collateral or internally developed models which contain management’s assumptions (Level 3).
Other Real Estate Owned
Other real estate owned (“OREO”) consists principally of properties acquired through foreclosure. At the time of foreclosure, OREO is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the new basis. Subsequent to the transfer of loans to OREO, and on a nonrecurring
basis, fair value adjustments are recorded to reflect partial write-downs based on the current appraised value or internally developed models which contain management’s assumptions (Level 3).
-37-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 20: Parent Company (Only) Financial Information
Condensed balance sheets for Frontier Financial Corporation (only) at December 31 are as follows (in thousands):
2009 |
2008 |
|||||||
ASSETS |
||||||||
Cash |
$ | 2,991 | $ | 5,702 | ||||
Investment in subsidiary |
61,070 | 346,336 | ||||||
Available for sale securities, at fair value |
1,862 | 2,847 | ||||||
Other assets |
992 | 2,343 | ||||||
Total assets |
$ | 66,915 | $ | 357,228 | ||||
LIABILITIES |
||||||||
Junior subordinated debentures |
$ | 5,156 | $ | 5,156 | ||||
Other liabilities |
273 | 29 | ||||||
Total liabilities |
5,429 | 5,185 | ||||||
SHAREHOLDERS' EQUITY |
||||||||
Common stock |
258,202 | 256,137 | ||||||
Retained earnings (accumulated deficit) |
(197,083 | ) | 98,020 | |||||
Accumulated other comprehensive loss, net of tax |
367 | (2,114 | ) | |||||
Total shareholders' equity |
61,486 | 352,043 | ||||||
Total liabilities and shareholders' equity |
$ | 66,915 | $ | 357,228 |
Condensed statements of income for Frontier Financial Corporation (only) for the years ended December 31 are as follows (in thousands):
2009 |
2008 |
2007 |
||||||||||
Income |
||||||||||||
Dividends from subsidiaries |
$ | - | $ | 9,885 | $ | 71,569 | ||||||
Other dividends |
26 | 332 | 819 | |||||||||
Interest |
225 | 174 | 177 | |||||||||
Other-than-temporary impairment loss on securities |
(4,289 | ) | (460 | ) | - | |||||||
Gain on sale of securities |
- | 4,575 | - | |||||||||
Other income |
10 | - | 21 | |||||||||
Total income (loss) |
(4,028 | ) | 14,506 | 72,586 | ||||||||
Expenses |
||||||||||||
Salaries and employee benefits |
2,710 | 3,399 | 2,523 | |||||||||
Depreciation and amortization |
160 | 238 | 260 | |||||||||
Goodwill impairment |
- | 77,073 | - | |||||||||
Other |
2,982 | 1,881 | 2,457 | |||||||||
Total expenses |
5,852 | 82,591 | 5,240 | |||||||||
Income (loss) before provision (benefit) for income tax and equity |
||||||||||||
in undistributed income (loss) of subsidiaries |
(9,880 | ) | (68,085 | ) | 67,346 | |||||||
Benefit for income tax |
(386 | ) | (342 | ) | (1,566 | ) | ||||||
Income (loss) before equity in undistributed income |
||||||||||||
of subsidiaries |
(9,494 | ) | (67,743 | ) | 68,912 | |||||||
Equity in undistributed income (loss) of subsidiaries |
(285,600 | ) | (21,994 | ) | 5,026 | |||||||
Net income (loss) |
$ | (295,094 | ) | $ | (89,737 | ) | $ | 73,938 |
-38-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 20: Parent Company (Only) Financial Information (continued)
Condensed statements of cash flows for the years ended December 31 (in thousands):
2009 |
2008 |
2007 |
||||||||||
Cash flows from operating activities |
||||||||||||
Net income (loss) |
$ | (295,094 | ) | $ | (89,737 | ) | $ | 73,938 | ||||
Adjustments to reconcile net income (loss) to net cash |
||||||||||||
provided by operating activities |
||||||||||||
Equity in undistributed (income) loss of subsidiaries |
285,600 | 21,994 | (5,026 | ) | ||||||||
Intangible amortization |
160 | 238 | 260 | |||||||||
Other-than-temporary impairment loss on securities |
4,289 | 460 | - | |||||||||
Gain on sale of available for sale securities |
- | (4,575 | ) | - | ||||||||
Gain on sale of premises and equipment |
(10 | ) | - | - | ||||||||
Goodwill impairment |
- | 77,073 | - | |||||||||
Deferred taxes |
326 | - | - | |||||||||
Stock-based compensation |
2,067 | 3,407 | 2,583 | |||||||||
Excess tax benefits associated with stock-based compensation |
- | (49 | ) | (237 | ) | |||||||
Other operating activities |
(48 | ) | 229 | (1,940 | ) | |||||||
Net cash flows provided by (used in) operating activities |
(2,710 | ) | 9,040 | 69,578 | ||||||||
Cash flows from investing activities |
||||||||||||
Proceeds from sale of available for sale securities |
- | 20,941 | - | |||||||||
Proceeds from maturity of available for sale securities |
- | - | 460 | |||||||||
Proceeds from sale of premises and equipment |
10 | - | - | |||||||||
Other investment activities |
- | (2,214 | ) | (139 | ) | |||||||
Net cash flows provided by investing activities |
10 | 18,727 | 321 | |||||||||
Cash flows from financing activities |
||||||||||||
Stock options exercised |
- | 391 | 1,861 | |||||||||
Excess tax benefits associated with stock-based compensation |
- | 49 | 237 | |||||||||
Repurchase of common stock |
(11 | ) | (72 | ) | (44,384 | ) | ||||||
Cash dividends paid |
- | (22,433 | ) | (29,045 | ) | |||||||
Other financing activities |
- | - | 75 | |||||||||
Net cash flows used in financing activities |
$ | (11 | ) | $ | (22,065 | ) | $ | (71,256 | ) | |||
Increase (decrease) in cash |
$ | (2,711 | ) | $ | 5,702 | $ | (1,357 | ) | ||||
Cash at beginning of year |
5,702 | - | 1,357 | |||||||||
Cash at end of year |
$ | 2,991 | $ | 5,702 | $ | - |
-39-
FRONTIER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 21: Unaudited Quarterly Financial Data - Condensed Consolidated Statement of Operations
(In thousands) |
2009 Quarter Ended |
|||||||||||||||
(Unaudited) |
||||||||||||||||
December 31 |
September 30 |
June 30 |
March 31 |
|||||||||||||
Interest income |
$ | 39,971 | $ | 41,490 | $ | 45,581 | $ | 50,491 | ||||||||
Interest expense |
19,981 | 22,612 | 24,132 | 26,737 | ||||||||||||
Net interest income |
19,990 | 18,878 | 21,449 | 23,754 | ||||||||||||
Provision for loan losses |
100,000 | 140,000 | 77,000 | 58,000 | ||||||||||||
Net interest loss after provision |
||||||||||||||||
for loan losses |
(80,010 | ) | (121,122 | ) | (55,551 | ) | (34,246 | ) | ||||||||
Non interest income |
(5,876 | ) | 2,878 | 3,590 | 4,322 | |||||||||||
Non interest expense |
26,241 | 24,814 | 25,387 | 23,292 | ||||||||||||
Loss before income tax |
(112,127 | ) | (143,058 | ) | (77,348 | ) | (53,216 | ) | ||||||||
Benefit for income tax |
(41,926 | ) | (1,970 | ) | (27,354 | ) | (19,405 | ) | ||||||||
Net loss |
$ | (70,201 | ) | $ | (141,088 | ) | $ | (49,994 | ) | $ | (33,811 | ) | ||||
Basic earnings (losses) per share |
$ | (14.89 | ) | $ | (29.93 | ) | $ | (10.61 | ) | $ | (7.17 | ) | ||||
Diluted earnings (losses) per share |
$ | (14.89 | ) | $ | (29.93 | ) | $ | (10.61 | ) | $ | (7.17 | ) | ||||
Weighted average basic shares outstanding |
4,715,370 | 4,713,185 | 4,713,185 | 4,712,680 | ||||||||||||
Weighted average diluted shares outstanding |
4,715,370 | 4,713,185 | 4,713,185 | 4,712,680 | ||||||||||||
2008 Quarter Ended |
||||||||||||||||
(Unaudited) |
||||||||||||||||
December 31 |
September 30 |
June 30 |
March 31 |
|||||||||||||
Interest income |
$ | 60,392 | $ | 68,821 | $ | 72,342 | $ | 77,500 | ||||||||
Interest expense |
26,537 | 28,095 | 27,451 | 30,102 | ||||||||||||
Net interest income |
33,855 | 40,726 | 44,891 | 47,398 | ||||||||||||
Provision for loan losses |
44,400 | 42,100 | 24,500 | 9,000 | ||||||||||||
Net interest income (loss) after provision |
||||||||||||||||
for loan losses |
(10,545 | ) | (1,374 | ) | 20,391 | 38,398 | ||||||||||
Non interest income |
7,502 | (3,173 | ) | 4,198 | 6,303 | |||||||||||
Non interest expense |
94,937 | 22,057 | 21,533 | 21,545 | ||||||||||||
Income (loss) before income tax |
(97,980 | ) | (26,604 | ) | 3,056 | 23,156 | ||||||||||
Provision (benefit) for income tax |
(8,464 | ) | (8,808 | ) | 982 | 7,655 | ||||||||||
Net income (loss) |
$ | (89,516 | ) | $ | (17,796 | ) | $ | 2,074 | $ | 15,501 | ||||||
Basic earnings (losses) per share |
$ | (19.03 | ) | $ | (3.79 | ) | $ | 0.44 | $ | 3.30 | ||||||
Diluted earnings (losses) per share |
$ | (19.03 | ) | $ | (3.79 | ) | $ | 0.44 | $ | 3.29 | ||||||
Weighted average basic shares outstanding |
4,703,840 | 4,701,094 | 4,700,673 | 4,698,532 | ||||||||||||
Weighted average diluted shares outstanding |
4,703,840 | 4,701,094 | 4,706,914 | 4,709,865 |
Note 22: Subsequent Events
On January 20, 2010, we held a special shareholders meeting in which shareholders approved the adoption of an amendment to the articles of incorporation of Frontier Financial Corporation to increase the authorized number of shares of common stock from 10,000,000 to 200,000,000 shares (and correspondingly, to increase the total number of
authorized shares of all classes of capital stock, including 10,000,000 shares of preferred stock, none of which have been issued, from 20,000,000 to 210,000,000 shares).
-40-