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Patrick M. Fahey – Chairman and Chief Executive Officer

John Dickson – President and Chief Executive Officer

Rob Robinson – Chief Credit Officer


Dave Rochester – FBR Capital Markets

[Casey Ambridge] – Millennium

Matthew Clark – Keefe, Bruyette & Woods

Jeff Rulis – D. A. Davidson

Frontier Financial Corp. (OTCPK:FTBK) Q4 2008 Earnings Call January 29, 2009 2:30 PM ET


I'd like to welcome everyone for today's Frontier Financial Corporation's fourth quarter and year end 2008 earnings conference call. (Operator Instructions)

This call may contain forward looking statements including statements regarding among other things the company’s business strategy and growth strategy. Expressions which identify forward-looking statements speak only as of the date the statement is made.

These forward-looking statements are based largely on the company’s expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified are beyond our control.

Future developments and actual results could differ materially from those set forth in, contemplated by or underlining the forward-looking statements. In light of these risks and uncertainties there can be no assurance that the forward-looking information will prove to be accurate.

This conference call does not constitute any offer to purchase any securities nor a solicitation of proxy, consent authorization or agent designation with respect to a meeting of company stock holders.

At this time I would now like to turn the conference over to Mr. Patrick M. Fahey, CEO of Frontier Financial Corporation, you may now proceed.

Patrick M. Fahey

This is kind of like old time sake for me. With some of you, I haven't done this since the days of Pacific Northwest Bancorp before our merger with Wells Fargo so it's good to be back in the groove.

I'd like to welcome all of you and just indicate that in the room with me are Mike Clements, who is the President of Frontier Financial Corporation and CEO of Frontier Bank, Rob Robinson, who is the Executive Vice President and Chief Credit Officer, John Dixon, President of Frontier Bank, and Carol Wheeler, Executive Vice President and Chief Financial Officer of the corporation.

I'm just going to give a brief overview you noted, of course, in our press release that we reported a loss of $89.5 million for the quarter or $1.90 per share, which, as you hopefully noted, was comprised in large part of a $77.1 million non-cash charge related to the impairment of goodwill and a $44.4 million provision for loan loss.

So, that's going to be a big focus of our conversation today, I'm sure, and I'm going to ask John Dixon, shortly, to get into the details of that.

In the mean time, just for a bit of perspective on the company where it's been recently and sort of where we are and where we think we will head in the future.

As you know, the board of directors, reacting to the challenges that we faced in the later part of the year and actually which became apparent, fairly significantly, just about a year ago this time, what a difference a year makes.

Actually, the changes that were made involved a restructuring of the management and leadership of the bank. Basically to enhance the bank's efforts to restructure its balance sheet and redirect it's business focus in order to reduce the concentration we have in residential construction and development loans and to reduce the risk profile of the bank.

Mike Clements, formerly CEO of North [Sound] Bank and the Director of the bank since about 2001 or 2000 or so and myself, previously the Founder/CEO of Pacific Northwest Bancorp and Pacific Northwest Bank, having joined the board in about 2006, were asked to step in and to assist John Dixon with the retirement of Bob Dixon as Chairman and previously the CEO of the company and the bank, to bring about these changes and we set about to do so as rapidly as possible.

One of the things we did and part of the reason Mike and I were asked to step in and help is to establish a business banking group and that's an initiative that Mike Clements' is leading.

My good friend Mike recruited, or I should say stole from Pacific Northwest Bank, when we were merging with Wells Fargo, two very, very successful and highly experienced business banking teams from our Seattle banking business group and our Belleview banking business group. They are still with us today and represent, I think, some of the most experienced and seasoned and relationship oriented business bankers in our marketplace.

Additionally, that group has approximately 38 business bankers distributed throughout the system, previously focused on real estate, who will continue to manage those accounts.

But as we get capacity from running that portfolio down, will direct their attention, under the leadership of Milt Douglas, who previously headed up the business banking team in Belleview to bring about a stronger momentum in developing small to medium business relationships with a particular focus on deposit generation and that'll be a big initiative for us in the coming year.

One of the things that obviously we've done, as you can see, beginning in the third quarter, we announced a number of strategies to improve our asset quality, including the special assets group with Rob Robinson ramping that group up from approximately five to now a total of 31 special assets group officers. Some of whom handle a few of their former good accounts, but mainly focused on resolution of our problem assets in the residential construction and development area.

These are not additions that came from within the bank, but virtually all of them have previous experience in workouts, which has been a strength of this company in the past, as I observed from the outside, although certainly none of us have seen a business cycle downturn like we're currently experiencing.

Our focus is on reducing the non-performing assets. We were able to make a reduction in our real estate residential construction and development of $107 million in the fourth quarter we expect those reductions to continue.

Some of it was done the hard way, but we are seeing pay downs and sales of some of our troubled properties. Rob Robinson will get into that in greater detail in just a few minutes.

Certainly the housing market remains troubled and we are unable, as I'm sure almost all of you and maybe anybody you would ask is unable to predict exactly when that bottom will occur, but again we do see a few strong signs, although, I wouldn't call it riskily optimistic.

In an effort to preserve capital, the board of directors voted to suspend the payment of the dividend, which would have been paid this month, after reducing if by two thirds in July. A difficult decision, but obviously necessary, as it has proven to be for many, many other banks in recent times.

I will mention that we are working on achieving some capital infusion to the bank. We re-engage Sandler O'Neil, actually, as far back as September, looking at opportunities to improve the capital position of the bank by acquiring some outside capital and then along came TARP and that market just essentially froze and dried up.

The current situation on our TARP is, contrary to some rumors that floated around a while back, we have not been turned down, nor have we been asked to withdraw our application.

Only about 300 banks, as best we can tell, have been approved and that leaves approximately 8000 banks that have not received an approval for TARP at this point in time, and I'm not sure that any of us know precisely where TARP is headed.

We are not sitting by idly waiting for TARP. We're continuing our efforts to acquire additional capital and we have a number of parties who are in discussions with us through the efforts of Sandler O'Neil, I think, on our behalf.

As a part of our efforts to reduce our non-interest expense, I think you may be aware from previous reports that the board led the way and eliminating its own meeting fees. John Dixon and the rest of the management team took the initiative to accept lower salaries. There were no cash bonuses paid this past year to anyone and there was a reversal in the quarter, and there were no payments of profit sharing. The only thing that was paid was the 401(k) match for our employees, which was a commitment to them.

One of the things that I will mention, in terms of deposit [rules], we intend to reduce our reliance on non-core deposits. And part of the strategy for going into business banking is to focus intensely on those core type deposits for both businesses and consumers.

Understandably, because of the nature of the real estate lending activity, in general, many of those loans and loan relationships are more transactual in nature, although certainly deposits do come from them. They don't come from my experience to the same degree that they come from small to medium business banking and from consumers.

Small to medium businesses, obviously, although they may try to manage their cash generally don't do so and that's a source that we intend to focus on dramatically over the next year and beyond.

One of the things that we've done is to enhance our communications efforts. You'll see a shareholder letter going out. You've seen—you may not be aware that we've ramped up such things such as a conference call that John has previously conducted. It's being done more intensely now with our staff.

We had one of them for example, this morning to prepare them for the release that we've just put out, as well as a letter to customers and we've set up a two-way communication program through our website for customer questions and emphasizing, of course, that our deposits are fully insured by FDIC up to 250, and the customers can, in fact, increase the level of their insurance by the way that they structure our accounts, and we can help them do that.

Interest bearing demand deposits, because we pay less than 50 basis points as I think probably as almost everybody else, and the non-interest bearing demand deposits are fully insured without limit. And we're communicating that and reaching out to our high balance customers to explain and attempt to re-insure them at this time.

John will talk about capital ratios, which actually improved during the quarter through some actions that were taken that John, will discuss. And the other thing I'd like to mention and I'd like to say that I don't think Mike and I would have stepped into these positions if we didn't have a great deal of confidence that the staff of this bank, and the fact that we believe that it can continue to be a productive bank in the community with the steps that we're taking.

And then also, it's a very forthright institution, and we believe that we have recognized the problems, that as best anyone can. We have our arms around them through own intensive reviews that Rob Robinson has led, but also with an external review that confirms our feeling about what our credit issues are.

And while I suppose I will dare to make a forward looking observation, as best we know at this time, we do not believe that you will see, as has been seen with a number of other institutions, a big surprise provision for loan loss.

I can't promise you that conditions won't change if there was a severe deterioration beyond where the economy and our customer base stands, but I'm telling you that, as best we now know, that we would not expect to see an erratic or large surprise jump in our provision going forward. In fact, we're making every effort, obviously, to hope that we can reduce that, in time.

So that's kind of a perspective on the picture as we see it at this point. We're all working very hard to accomplish those things, and much of what I've said has already been accomplished.

With that, in the interest of time, let me turn it over to John, who will lead you through some of the details of our release.

John J. Dickson

Thanks, Pat, I'll start out with some general comments on the marketplace, and then go into our results for the fourth quarter.

Again, the Pacific Northwest economy continues to be one of the strongest in the country, but is succumbing to some of the slowdowns that we've seen nationally. Obviously, in the news just recently, the frequency of layoffs increases unemployment both for the local county and the state in December, with 7.1% in Oregon, it was 9% so we have seen increase in unemployment.

Commercial real estate still is holding up well in the Seattle area and continues to be ranked highly as far as places in the country for commercial real estate.

As it relates to residential housing, some of the information from the Northwest multiple listing statistics, based on closed sales in December for residential and condominiums inventory levels are very similar at the end of 2008 that they were at the end of 2007, and down 20% to 30% from September, a good portion of which is cyclical it's very typical, in December, for active listings to decrease over the holidays.

Closed sales in December were down 20% to 35%, compared to December a year ago so that is the biggest challenge in the housing market, is the lack of sales. On a relative inventory basis, we're looking at about 10 months of inventory in King County, 12 months of inventory in Pierce County, and 12.3 months of inventory in Snohomish County. Those are the three counties where two thirds to three quarters of our construction and land development loans are centered.

Average prices, as a general rule, are down 10% to 15% in those counties from a year ago, with prices in the Seattle area holding up better than the outlying areas.

For the quarter, certainly the net loss results are disappointing, and credit deterioration is something that we're focused on. As Pat mentioned, our special assets group is very focused on addressing that, and has made some progress.

Our margin compression for the quarter was disappointing, and that was due, in part, to three different areas, one as we've been aggressively addressing our loan issues and putting loans in a non-accrual on a timely basis that had an impact on our margin.

Secondly, the rate reductions by Fed during the quarter had an impact on our margin. And in addition, with the slowdown of our loan originations, the loan fee portion that goes into our net interest margin also came off during the quarter, and I'll talk about that in a minute.

Obviously, with the weakening economy and all the layoffs being announced in the news that affects consumer confidence and the good will write-down that we took in the fourth quarter, which was a complete 100% write-off of good will is, as Pat indicated, a non-cash item but for those not familiar with good will, it can give the appearance of something that's pretty dramatic.

There's a lot of positives that we have going in the quarter. We continue to generate $18 million to $20 million per quarter of net operating income before the tax provision and the loan loss provision, and of course, excluding one-time events like good will write-downs. A lot of our peers don't have the operating income generation machine that we do, and it continues to be strong.

Another positive – our capital ratios continue to be above regulatory minimums for well-capitalized. Our reserve for loan losses exceeds 3% of total loans. Our liquidity exceeded 28% at the end of the year, and that's a strong liquidity ratio and, as Pat mentioned, our reduction in construction and land development loans was beneficial to us, as well.

And we continue to have an experienced management team, and a very loyal and dedicated staff that continues to provide excellent service to our customers.

Let me get into the balance sheet and income statement a bit. First I want to address capital as Pat has already mentioned, we're taking actions to preserve capital. In our press release, our consolidated capital ratios were disclosed at the bank-only level. Our leverage ratio, 8.53%, our tier-one regulatory risk-based capital ratio, 9.31%, and our total risk-based capital, 10.58% at the bank level again, all these above the regulatory minimum.

Pat had mentioned we used to spend at our dividend and reduce the construction and development loans outstanding. In addition in the balance sheet, we focused on items with risk weightings for regulatory capital purposes, and we were able to shift some securities, and our bank owned life insurance from higher risk weightings to lower risk weightings.

And again, on our expense reduction initiative that we started at the beginning of the fourth quarter, it's been very effective. The identified areas of expenses that we were focusing on were down 20% in the second half of 2008, relative to the first half of 2008.

Now, some of those other areas of expenses, such as FDIC insurance and the costs of working through our challenging loans will offset some of those savings but we continue to focus on those expenses.

In the asset area of our balance sheet, on a net basis our loans were down $53.3 million or 1.4% for the quarter and that again was focused on construction being down $80.7 million or 7.8% and land development loans being down $27 million or 4.5%. One category that was increased in our fourth quarter was residential real estate, these are completed homes and a lot of that migration occurred from homes that had been in the construction category that have been leased out or rented out and have moved over into that residential real estate category.

New loan originations for the quarter at $58.6 million were down significantly from the third quarter, down 66% from the third quarter origination of $175 million and down 72% from fourth quarter of 2007.

Again Pat mentioned our business banking team that was recently formed has just been formed and they’re out there working to develop our business banking relationships. I also want to emphasize that in our lending category in an effort to manage our asset quality we are not taking on any new construction or development relationships and we’re very much limiting originations in that area with our existing customers.

At this point I’d like Rob to address our asset quality and talk a little bit about our loan portfolio.

Rob Robinson

As expected our market conditions to impact our loan portfolio in the fourth quarter. I’m not sure where the high water mark is, but I do know that we’re making prudent decisions under the assumption that the challenges we face now will continue into this year.

Let’s talk about our loan loss reserve and charge offs for the quarter. As you know in the third quarter we had a $42.1 million for a loan loss reserve as a percentage of total loans that increased it from 2.07% in Q2 to 2.84% as of September 30th. Now, that increase reflected migration of loans within the portfolio to higher risk ratings primarily. In the fourth quarter we provisioned $44.4 million boosting overall reserves to 3.03% with total loans outstanding as of December 31st 2008 or 2.98% if you included [re-class].

As we work through the fourth quarter we experienced continuing loan deterioration resulting in a substantial number of loans moving from classified status into a non-accrual status and once non-accrual we took a very aggressive approach writing down these impaired loans. As John mentioned our charge off for the quarter totaled $39.5 million centered primarily in real estate construction and land development loans.

One final note on our allowance for loan losses there we believe our current reserves assigned to risk ratings are appropriate; however, exposure in construction lending makes us particularly vulnerable to the volatility that continues in the housing market. Because of this management believes that a material and sustained increase to the fund allocation portion of our reserve was warranted as a result we increased total dollars for unallocated reserves from $5.2 million as of September 30th of 2008 to $11.5 million for the year ending December 31st 2008.

So as a percentage of total reserves this moved unallocated portion from 4.7% to 10.05% at year end. Because of these decisions we believe our reserve is substantial and provides adequate support for losses that may arise as our lenders and special assets teams work through the portfolio of problem loans.

Non-performing loans, as we reported in our press release we ended the year with non-performing assets of 10.87%. Non-accrual loans remain concentrated in our real estate portfolio with the largest portion of course centered in residential spec instructions accounting for 42% of that total non-performing loan and land development loans which made up 41% of non-performers.

I want to point out here that as a bank early in I guess mid-2008 we took a very aggressive stance on interest reserves in our underwriting practices. We ceased to include those and have for the most part materially eliminated the use of interest reserve on a go forward basis unless it, a particular credit warrants it and it must substantially warrant it for us to consider it.

Back to the numbers again, on non-performing loans they totaled $435.2 million at the end of the quarter, up from $205.2 million in the third quarter. The ORE portion of our non-performing assets totaled $10.8 million at the end of the year and that was up from $3.7 million.

We show we have 65 properties in ORE at year-end; 33 of those properties represent a single finished flat in our local county here. It’s just the way we book our loans that it shows as 33 separate loans.

The balance of properties that are primarily finished or nearly finished spec construction loans with no specific area of concentration. Geographically our NPA shows a concentration in Kings, Snohomish and Peirce County, residential construction, single family residence, condos, total $181.9 million which is 42% of total non-performing loans. That’s up from $135 million.

Those are focused in as I mentioned King County, Snohomish County and Peirce County. In King we had $85.3 million or 47% of that total represented in six relationships, three condo projects, a townhome mixed used project and a commercial project that included the town homes and then two detached single family residential projects. Those particular projects represented 52% of King County’s NPA.

Snohomish has $32.1 million or 18% of our residential construction NPAs. A majority of those dollars were centered in four relationships in four separate projects, and they were four detached single family residential projects. They represented 60% of the total in Snohomish.

And then in Peirce we had $25.6 million or 14% of residential construction NPAs. A majority of those dollars were centered in four relationships that involved two condo projects and two detached single family residential projects.

On the land development side, there was $177.1 million or 41% of the non-performing loans up from $40.6 million in the third quarter and again those are focused in King County where we had $22.8 million or 13% of that total focused in two relationships that involved a 67 lot project and a 27 lot project. These represented 74% of the total in King County.

In Snohomish we had $43.1 million or 24% for the residential land development NPAs. Those are focused in three relationships that involved 142 lot project, a 35 lot project and a 23 lot project, representing 72% of the total in Snohomish County.

And then Pierce County we had $30.6 million or 17% of the NPAs. Again those were focused in four relationships that involved 183 lot project, 92 lot project, a 29 and 20 lot project, that represented 71% of the Pierce total.

We had some isolated but larger NPAs in Thurston and Whatcom Counties, Thurston we have $33.3 million representing 19% of our NPAs. Those are centered in two master planned developments and one 150 lot development. And then in Whatcom we have a $32.3 million or 18% of our NPA totals and the majority of these dollars are centered in one mixed use project.

Then on the residential lot loan side $34 million of which is 8% of our non-performing loans up from $18 million in the third quarter. King County had $11.1 million of that. A majority of those dollars are centered in four relationships involving four projects. Pierce County had $7.9 million of that total. The majority of those dollars centered in four relationships that involve a lot holding loan and a separate land holding loan.

And Snohomish County represented $9.7 million or 29% of the residential NPAs and the majority of those dollars are centered in one relationship; two projects both of them residential lot programs.

Moving onto the delinquency ratio, first thing I want to point out is that 25 relationships make up nearly one half of the past due loans in our portfolio. Our delinquency ratio end of the year at 14.81%, just to clarify our past due ratio includes all loans over 30 days past due and includes all loans placed in non-accrual status. If you eliminated the non-accrual loans the past due dollar amount would be $97 million between 30 and 90 days past due.

Sixteen and a half percent of our past dues are centered in real estate; 42% of total is in residential construction, 41% of total is in residential and development, 8% in residential lot loan and 9% in other commercial consumer and term real estate.

With that said let's take some questions. I'll turn it back over to John.

John Dickson

We’ll open it up to questions in a few minutes. Thanks Rob. Continuing on the balance sheet on the liability side of the balance sheet, deposits were down $147 million for the quarter 4.9%. We did see decreases in money market, sweep and interest checking areas. We believe that’s a function of the economy in part. We do require deposits of our builders and developers. We’ve seen those deposits shrink during the quarter as well particularly in the money market area.

We’ve had an account tied to the Treasury bill rates which saw substantial run off as the T-bill rates during the quarter fell to almost zero, so we did see some migration out of those categories into non-interest bearing deposits and CDs.

Again we’re focusing on deposit growth. Our business banking team is focused on developing business deposits as well as loans and in addition we have developed an incentive program which is rolled out just this last week that focuses on incenting individuals in our organization for the first time per generating core deposits and we’re looking at that program to help add to our deposits and our liquidity during the quarter.

We also took advantage of low rates during the quarter and added to our Federal Home Loan Bank advances. We acquired those advances at lower rates than retail deposits and were able to lengthen our liabilities by doing that.

Moving on to the income statement we did see margin compression in the fourth quarter, a tax equivalent interest margin of 3.42 versus 4.05 in the third quarter, again, a good portion of that margin compression related to the loans migrating to non-accrual.

We had 5.5 million of interest reversals in the quarter. That would have represented 55 basis points of additional margin in the fourth quarter had those reversals not taken place. In the third quarter those reversals were $1.8 million which would have represented 18 basis points for that third quarter margin level.

In addition I mentioned our loan fee generation has diminished as our new loans originations have decreased. During the fourth quarter loan fees amortized 3,091 represented about 35 basis points of our margin versus about 50 basis in the third quarter and a higher level a year ago in the fourth quarter. And finally the rate decreases by the Federal Reserve did negatively impact some of our earning asset rates.

On non-interest income the one item to mention there is we did have a gain on sale of investment. We liquidated our position in Washington Banking Company in the fourth quarter for a gain and as well we sold some bonds for a gain during the fourth quarter.

Compared to the third quarter we had some losses both from bond sales and from impairments so there’s a big disparity between those two quarters. Non-interest expenses as Pat mentioned on salaries and benefits that we had a nice reduction of 24.3% on a linked quarter basis.

That was primarily driven by the reversal of accruals that we had been making during the year for incentives, bonuses and profit sharing. As Pat mentioned we did not pay out any incentives or bonuses at the end of the year and profit sharing was also suspended. All we did was the 401(k) match for our employees, and in addition our FTE count was down by 3.4% in the quarter. We are not focusing on a big staff reduction, however when we do have natural attrition and turn over we’re being very judicious at replacing those positions.

In addition in non-interest income areas business taxes were down 25.7% and that’s a function of revenues in the State of Washington. We have a revenue tax and other non-interest expenses down 4.8% as a result of our focus on expense control. A lot of those expense reductions are centered around consulting fees, and marketing type expenses.

Finally to wrap it up I just want to mention that we continue to focus on three areas for the bank, one being asset quality. Rob mentioned his group and some of the progress that they’ve made in reducing our exposure to construction and land development; also our limiting of any dollars in that area.

Secondly we’re focused on capital preservation. We’ve taken a lot of measures in the third and fourth quarter to preserve capital and as Pat mentioned we’re continuing to look at sources to have additional capital to get us through these tough economic times.

And finally our third focus on funding and liquidity, again, with our business banking team and our core deposit incentive we’re focused on attracting new and retaining existing deposits. At this time Pat I’ll turn it back over to you for final comments and question.

Patrick M. Fahey

I think I pretty well covered it and I don’t want to repeat or dwell on that but I put it in the appetizer and I’ll save the desert for the questions. So I think at this point I’ll ask [Jacquelyn] if you could open it up for questions [Jacquelyn] and we’ll remain as long as anyone wishes to ask them.

Question-and-Answer Session


(Operator Instructions). Your first question is from Dave Rochester – FBR Capital Markets..

Dave Rochester – FBR Capital Markets

Hey guys thanks for taking my questions. Rob I was wondering could you update us on the watch list, special mention sub-standard data that you provided the past couple quarters?

Rob Robinson

Sure. Before I do that I just want to -- as I was speaking I think I misquoted on one of the ratios where I talked about total past dues where they’re centered. I just want to make sure it’s clear 96.5% of our past dues are centered in real estate. I think I said 16.5; my reading glasses slipped off my nose.

So on the risk rating on the watch the total for the year end in our watch category was 334.7 million. And our risk rating for loan that was 363.5 million. In our, what would be considered our substandard grade five, 290.3 million. And then in our non-accrual status that number was 400, 435.2.

Dave Rochester – FBR Capital Markets

So let me just make sure I heard the special mention number was that 363.5? Did I get that right?

Rob Robinson


Dave Rochester – FBR Capital Markets

OK. And then the substandard 290.3 and then the non-accrual which I guess is broken down separately from the sub-standard; none of the non-accruals are in the substandard right? It’s 435.2.

Rob Robinson


Dave Rochester – FBR Capital Markets

My next question related to the NPAs is it given the rate of growth that we’ve seen I know it's impossible to say you know how far you guys think that that can get, but do you have a sense for what kind of range just given the continue ramp that you’ve seen in January and what, given your outlook for unemployment and ultimately you know home price decline in your area. Are you looking at something in the 15 to 20% range for NPAs or something lower than that?

Rob Robinson

It's really tough to project forward, but that figure would be – I don't believe we've hit that figure. But one thing that we see happening right now is, as you recall, we had this group of loans that was coming through into non-accrual, and once they get into non-accrual, or after going into non-accrual, you're working on – many of them are in liquidation. And I think we'll get some of those liquidations of the larger loans resolved in this quarter, which will help us with our NPA.

Of course there's going to be more coming in, but I'm thinking that, although I started off say I wasn't sure the high water mark had been hit, yet, I think we can see the high water mark from where we're at.

Dave Rochester – FBR Capital Markets

Okay. Do you have a sense for what the total average mark is that you've taken on the NPA so far? Like, what the total average charge-off has been.

Rob Robinson

Yes, I do, actually. But now, keep in mind it depends on location what that mark could be because, of course, we've had some instances where we've got land that we've taken a hit on as much as 38, 40%. And then most of our stick-build finished product is below 10%. So on average, I think in the quarter, we calculated approximately 14% on marks that we took, on hits that we took.

Dave Rochester – FBR Capital Markets

And it was just for the quarter, the stuff that you moved to NPA status and charged off, it was on average a 14% hit on those values?

Rob Robinson


Dave Rochester – FBR Capital Markets

And in terms of, I guess, moving to capital strategies real quick, I know you brought some capital into the bank by consolidating the real estate subsidiary into the bank. Are there any other strings that you can pull that can boost capital, in terms of regulatory capital, or even common [tangible] equity? Or are you pretty much dependent right now on the capital markets at this point?

Patrick M. Fahey

Well, if I understood your question, are there any other accounting type things that we can do or internal things?

Dave Rochester – FBR Capital Markets

Or sell lease-backs to those branches, like, anything else that you can do?

Patrick M. Fahey

We've considered some of those. And I'll let John address it, too, but we weigh such things as sale of assets, what kind of a discount, and so forth as to whether it'll actually improve the capital positions. And with market conditions the way they are on even really strong, solid performing loans, it's difficult to come up with a sale that will improve the capital position. I'll let, maybe, John address that further.

John J. Dickson

Absolutely right, Pat. Ironically, Dave, in the quarter when we saw rates and yields go down, my expectation was the discounts on some potential commercial real estate properties that we could potentially sell. I expected those discounts to decrease and that we could get closer to par because of the established yield that we're getting on some of those properties. But I think a concern with investors, what I found out was the discounts were even greater as the economy seems to be deteriorating.

So we have looked at asset sales. We certainly could continue to look at asset sales and that could include our bank properties, which we have on the balance sheet. But we could employ a sale and lease-back strategy. We've been holding off on that. We prefer to own our real estate and control our destiny in that respect, but there is that option.

We did sell the consumer portion of our credit card portfolio in the quarter. That wasn't a huge amount, but we've pulled some of the levers, but not all of the levers. The marketplace is dictating what some of our options are, and that's why we're focused on attracting some outside or private equity capital to help us weather these economic times and not have to strip down our balance sheet.

Patrick M. Fahey

I'd just quickly add, Dave, that I don't want to put a rosy glow on this, but the folks at Sandler have brought to us, and with whom we've met, and whom we've had some repeat meetings very recently, and also some individuals with whom Mike Clementz and John and I have had previous contact. I think their view is that the Pacific Northwest is a pretty good place to invest. They also know and feel that Frontier Bank is the largest commercial bank headquartered in western Washington, and they think it becomes even more valuable as they shift the balance sheet toward a more traditional community commercial bank structure.

And so there is interest. I think the big issue for everyone is how big is the hole in credit? And we think we've refined that quite a bit, and we're having good discussions, and we haven't had a lot of disagreement. So these things take time. None of this is going to happen overnight. All I can tell you is that I can't assure you that we're going to be successful, but I'm very encouraged, so far, that there is a considerable level of interest.

Dave Rochester – FBR Capital Markets

But yet again your comments right there when you were talking about trying to figure out how big the hole is, how much capital do you think that you need at this point? Or what is the capital range that would make you more comfortable, given what you're seeing in the portfolio?

Patrick M. Fahey

Let me dodge that one a little bit, if you will. I think that's refining a little more than we're prepared to refine. With what we're looking at right now, we think it's a reasonable level; none of the folks that we've talked to disagree. Our effort will be to accomplish the resolution of our problems as we've defined them and know them, to the best of our ability.

And as some additional cushion both to maintain the capital ratios at a strong level with cushion and position the bank to be able to develop new business and grow in a marketplace that we think is right for growth for a bank like this. Because I think you're well aware, good, strong business banking customers in the small-to-medium business range, and even some pretty large ones which we can handle, are getting roughed up quite a bit by banks these days.

It's a nationwide problem. It certainly exists in our area. And because of the expertise we do have in that business banking area, we think there's opportunity if we get the capital ratio. So if you'll allow me, I'm going to decline to put a number out in the atmosphere at this point in time, but I think that'll become more clear as we move through, perhaps, this quarter.

Dave Rochester – FBR Capital Markets

Sure, no problem. I understand. And one last one, just back on credit, a smaller point. I saw that C&I charge-offs moved up. Can you provide a little color as to what industries you're seeing that in? is it fairly well diversified across the sectors, or are you seeing any particular points of weakness?

Rob Robinson

No, actually those charge-offs that are on the C&I side are one-off real estate-related. They're individuals that are in the industry.


Your next question will come from [Casey Ambridge] – Millennium.

[Casey Ambridge] – Millennium

Hi, thank you very much for taking the question. A couple of similar follow-ups, you said the company was trolling for capital in September, right before TARP, right?

Patrick M. Fahey

We had engaged Sandler, and actually had a strategic retreat with the board to begin looking at our capital and projecting and so forth, and to develop strategies to a acquire capital, which would include any and all of the above of common preferred private equity and so forth. And then that initiative kind of came apart at the seams when the TARP situation was announced recently.

[Casey Ambridge] – Millennium

Okay. And you guys are declining to comment on how much you need right here, right? Or you're looking for?

Patrick M. Fahey

Yes. I decline to do so.

[Casey Ambridge] – Millennium

Okay. So right now, just at the back of the envelope, it looks like if you add up your tangible equity in your reserves you get $463 million. And if you add up all of your problem loans, sub-standard and special mention, you get $1.1 billion. So that's about $600 million. There's a delta there of $600 million, but your market cap is $100 million after today's move.

So I guess my question is what is plan B, if you can't raise capital? Because as the stock goes lower and you continue to warehouse these NPAs and not move them off, and the 14% mark doesn't seem too conservative. I was just wondering what the regulators – what they're thinking? Because I would imagine they're becoming uncomfortable with your predicament right now.

Rob Robinson

[Casey], a billion – what was your figure?

[Casey Ambridge] – Millennium

If you add up your special mention, your sub-standard and your non-accrual loans, you're at $1.1 billion. And you have your tangible equity plus your reserves; you have $463 million.

Rob Robinson

Special mention doesn't necessarily mean that it's going to migrate further down. Of course, it can. We also feel pretty comfortable that we have identified the larger credit and have already migrated them down into the sub-standard and non-accrual status. So I think you probably would be better to focus on our Grade 5 and 6 credit to do your matrix that you're doing.

[Casey Ambridge] – Millennium

Okay. I guess the gist of my question is you have a $100 million market cap right now. You probably need another $400 to $500 million in equity. What are the regulators telling you to do? What’s plan B?

Patrick M. Fahey

I’m not going to put out a figure but I will tell you we don’t think we need that much in equity. The regulators, I think I have had over my career, an excellent relationship with the regulators. We’re communicating with them; they’re communicating with us. I can’t tell you what their actions are going to be. They are obviously very skittish as everybody is about what’s going on in banking.

I can tell you that, given what we now know, while I can’t assure you that we would not on an ongoing basis without capital, drop below well capitalized and possibly into the adequately capitalized, which a number of banks have. What I can say from what we know is that we can resolve this problem and continue to move forward and if necessary take some other steps which could include some of the things [John] mentioned; further shrinkage of assets keeping us above water, if you will, while we work through this.

If things deteriorate rapidly, that’s another or much more severely, that’s another issue. But I don’t have a crystal ball on that but I can tell you that we are not ignoring the regulators. We are in communication with them and I will say that my impression, I can’t speak for them, is they have appreciated if not applauded the steps that the company has taken thus far and they understand our plan and I haven’t heard anything negative from them about it. So, I can’t say much more than that I don’t think.


(Operator instructions). We’ll move along to Matthew Clark with Keefe, Bruyette & Woods.

Matthew Clark – Keefe, Bruyette & Woods

Just a tad more detail on the, I guess, the breakout of the $435 million in terms of delinquencies. Could you break out that 30 to 89-day bucket, the 90 -and then we obviously know you’re not in accrual, but I guess the 30 to 89-day would be helpful.

Patrick M. Fahey

The 30 to 89, well the 90, I think I said 97 million approximately if we’re just looking at the 30 to 90. And quite frankly, it breaks down the same as the balance of what would be considered delinquent in the portfolio. Ninety plus percent of that is in real estate categories, approximately 42% in residential construction and 41% in land development.

Matthew Clark – Keefe, Bruyette & Woods

I’m sorry I missed that.

Patrick M. Fahey

That’s okay. That really is where our problems are. There is no getting around that.

Matthew Clark – Keefe, Bruyette & Woods

And then the classified number that you quoted, the $290 million, I assume that’s grade five and six and excludes non-accruals in delinquencies?

Patrick M. Fahey

No, that is just grade five.

Matthew Clark – Keefe, Bruyette & Woods

How about grade six?

Patrick M. Fahey

Grade six is a 435.2.


And our next question will come from Jeff Rulis – D.A. Davidson.

Jeff Rulis – D. A. Davidson

As it relates back to the TARP subject, obviously you guys have stated that you weren't turned down on that. Has there been any correspondence with the regulators? In other words, have they come back with you with any requests for information or has it been pretty radio silent?

Patrick M. Fahey

I think we can say, you know, we provided them with a good deal of additional information over and above the application. We haven’t seen any requests from them that I’m, not even before [Mike] and I got involved. We didn’t get any written requests for any new information. They have not put anything in writing related to that and quite frankly, it kind of seems to me that they’re not putting a lot of stuff in writing these days, so no.

Jeff Rulis – D. A. Davidson

And then Pat, to your comment on you mentioned briefly at the beginning of the call, you don’t expect to see a big jump in the loan loss provision. Would you consider the Q4 provision as a big provision or is that, I mean if we continue at this pace, is that – that’s certainly not, in terms of your jump, is that made from historical standards or from –

Patrick M. Fahey

No, no let me clarify that [Jeff]. I think the third and fourth I consider to be similar and I’m referring to that level but we're certainly hopeful that it’s going to go down. And intuitively and anecdotally, we feel that unless something cataclysmic happens, that that will occur. But what I meant to say if I didn’t say it correctly, is we have seen some banks that suddenly go from like where we are to, you know, a provision that comes out of the blue at three, four times or more what they’ve been providing.

And what I meant to say was we don’t, at this point as best we know, based on a very intensive internal review from two or three different perspectives and external independent review, as best we now know, we don’t see that happening with our portfolio. Is that correct?

Jeff Rulis – D. A. Davidson

Yes, your comment was in reference to the previous two quarters, no big jump from there.

Patrick M. Fahey

I meant from where we have been recently providing if I didn’t say it or clarify that.


It appears we have no further questions at this time. I would now like to turn the conference back over to our speakers for any additional remarks and closing statements.

Patrick M. Fahey

I think we have taken enough of your time. I want to thank all of you for participating and I hope this has been helpful and we certainly would be willing to answer your questions at any time if you want to get in contact with us. Have a good day.


This does conclude today's teleconference. We want to thank each of you for your participation.

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