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Executives

John Dickson - President and CEO

Lyle Ryan - President and CBO

Rob Robinson - EVP and CCO

Carol Wheeler - CFO

Analysts

Dave Rochester - FBR

Matthew Clark - KBW

Brett Rabatin - FTN Midwest

Sara Hasan - McAdams Wright Ragen

Jeff Rulis - D.A. Davidson

Tim Coffey - FIG Partners

Frontier Financial Corporation (OTCPK:FTBK) Q2 2008 Earnings Call July 22, 2008 4:00 PM ET

Operator

I'd like to welcome everyone to Frontier Financial Corporation's second quarter 2008 Earnings Call.

Throughout the duration of this presentation today, all audio participants will remain in a listen-only format. However, at the conclusion of today's presentation, we will be conducting an interactive question-and-answer session via telephone lines.

This conference call may contain forward-looking statements as defined in Section 27A of the Securities Act of 1933 as amended, including statements regarding, amongst 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 this company's expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond their control. Due to developments, actual results could differ materially from those set forth and contemplated by or underlying 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 an offer to purchase any securities nor solicitation of a proxy, consent authorization or agent designation with respect to a meeting of company stockholders.

At this time, I would like to turn the call over to John Dickson, President and Chief Executive Officer of Frontier Financial Corporation. You may now proceed.

John Dickson

Thank you, Joe, and thank you, everyone, for joining us on the call today. With me, I have once again, Lyle Ryan, our President and Chief Banking Officer; Rob Robinson, our Chief Credit Officer; and Carol Wheeler, our Chief Financial Officer, available for comments and questions.

Before I get into the details of the quarter, I'd like to make a few overall comments about the quarter and the marketplace. We were again pleased with the diversity of our loan growth and the loan growth that we had in the quarter. We are focusing on growing deposits with a focus to enhance liquidity, and we are pleased with our deposit growth. Our capital ratios remain strong, and I'll get into some more detail later in the call.

Obviously, we are disappointed with the earnings, but after having provided $24.5 million to bolster our loan loss reserve, we are pleased to end the quarter with a total loan loss reserve of $81.6 million, or 2.14% of total loans. And that's before the reclass for undispersed loans.

With the challenging housing market, we feel good about that loan loss reserve. And then finally, we continue to have interest margin in the pressure in the quarter. That coming from variable rate loans that were previously at their floors, and came up for maturity during the quarter and were renewed at lower rates.

As far as the marketplace is concerned, we continue to be in one of the best areas in the country as it relates to the economy. Unemployment rate has crept up a little bit since our first quarter call. Unemployment rates in Washington State most recently were at about 5.5%, very near the national average. More locally, in Snohomish County, unemployment rates run at 4.5% with steady job growth, particularly in the aerospace and manufacturing space.

Population growth continues to exceed the U.S. average, running at about 1.6% to 1.7% annually. And as it relates to the home sales in our marketplace, the home sales have been fairly flat over the last several months. The spring selling season that normally takes place and starts ramping up as we get closer to summer did not materialize, but we're still seeing houses sell and prices hold up fairly well.

As a matter of fact, on prices in the three major counties that we have the concentration of our loans in, King County is up slightly from March, with average prices up 3.3%. Pierce County home prices, up slightly at 3%. In Snohomish County here, where we are headquartered, prices are down 4.3%. And compared to a year ago, King County average price is down. This is for sales in the month of June. Sales prices are down 3% in King County, 7% in Pierce County year-over-year and about 11.5% in Snohomish County.

Inventories have remained fairly flat over the last three months since our last call. And that's creating flat sales and flat inventory, creating relative inventories in King County, about eight to nine months of inventory; Pierce County, 9 to 10 months; and in Snohomish County, 14 to 15 months. So, houses are selling, but still the market is a bit soft.

Related to our balance sheet for the quarter, we had loan growth in the second quarter of $90.3 million. And, I mentioned the diversity of the loan growth, we had growth of $32 million in the commercial C&I category. We had $23 million of growth in the commercial real estate area, and about $48 million of growth in the residential classification. And that growth in the residential is split fairly evenly between apartments and homes being put into rental pools.

The good news for the quarter is our construction loan balances were down $36 million. And when you combine construction development and lot inventory loans on a net basis, they were down $12 million for the quarter.

Loan originations in the second quarter were running at a pace of $297 million. That compares pretty closely to the first quarter at $287 million and compared to the second quarter of 2007 of $643 million. So, on a year-over-year basis, loan originations are down about 54%. Obviously, we are not making a lot of loans in the construction and land development space right now, but we are taking care of existing relationships and working through those loan commitments.

Related to unused commitments, our unused commitments were down to $893 million at the end of June compared to $986 million at the end of March. And so, commitments are down $93.5 million, or 9.5%.

Before I turn the call over to Rob to talk about credit quality, I do want to remind the callers that we have not engaged in subprime lending, nor do we hold any assets, either loans or investments, that are backed by mortgages or subprime mortgages.

So, with that I'll turn it over to Rob to talk about credit quality.

Rob Robinson

Thanks, John.

Starting with our nonperforming assets, we ended our second quarter with 2.97% of assets in a nonperforming status that compares to 0.97% at the end of the first quarter. Breaking out our non-accrual loans into categories, 80% of those were in residential construction loans, 11% in residential land development loans and 7% are in residential lot loans.

On the residential construction side, of the $96.7 million in that category, 49% of that was located in King County. Over half of that amount is tied up in a condo project that has just been slow to complete. 17% is located in Pierce County.

The majority of this is in two spec builders still working to complete and sell out 25 and 17 units, respectively, projects. And then, 10% are located in Clark County. And most of that is in one project, a 66-unit residential spec project, in Vancouver, Washington.

On the residential land and development side, of the $13.4 million non-accruing, 40% of that is located in King County. $5.1 million of that dollar amount is in a single project that we are moving forward with foreclosure on. And 37%, or $5 million, is located in Kitsap County. That, again, is one project that we are moving forward with foreclosure on.

On the residential lot loan side, of the $7.9 million in non-accruing, 77% of that, or $6.1 million, is located in King County. And most of that is in a single project that we are also moving forward to foreclosure on. And I want to point out that when I described that we are moving forward on foreclosures, in every case, we are still in active negotiations with our borrower, attempting to work out a reasonable solution outside of ultimate foreclosure.

On the ORE side, at the quarter end, we had $3.7 million represented in 16 properties, centered in two projects, mainly townhome project located in Deschutes County, Oregon, and a spec construction project in North King County. We've had good activity in both of these properties with several of the units now under purchase and sale agreements.

On the allowance for loan loss, we continue to take steps necessary to maintain a strong loan loss reserve. In our second quarter, we added, as John mentioned, $24.5 million resulting in a quarter-end allowance, totaling $78.7 million or 2.07% of total loans outstanding. The allowance for loan loss including reclassification allocation for undispersed loans would have amounted to $81.6 million or 2.14% of total loans outstanding as of June 30th.

The increase in loan loss reserves is a reflection of the market conditions obviously. With that said, we believe that our reserves are substantial and provide adequate support for any losses that may arise as we work closely with our lenders and our customers get through these very challenging times.

On the charge-offs side, in the second quarter, we wrote down loans by $6.8 million. Most of these were partial charge-offs on various projects with the largest being a $1.6 million write-down on a spec construction project that was requiring some short sales to get homes sold. Based on some of those sales, that looks like we'll be recovering a material amount of that $1.6 million.

And then on the delinquency ratio, as of June 30th, our delinquency ratio was 3.2% of loans. We're showing past due. And I just want to clarify that this ratio includes all loans over 30 days past due, including all loans placed in non-accrual status.

John?

John Dickson

Thank you, Rob. I just also want to reiterate and clarify in our press release that we did include additional information on the allowance for loan losses for both the period ending March 31st and June 30th.

The June 30th numbers are cumulative numbers year-to-date. So, I did get several calls this morning, questioning our press release stating we had net charge-offs of $6.5 million versus a year-to-date of $9.5 million. We had $3 million in the first quarter, and $6.5 million in the second quarter. The June 30 numbers are cumulative numbers.

On the funding side of the balance sheet, our deposits grew $117.2 million for the quarter or 4.2%. The majority of that growth was in the time certificate of deposit category, as competition for deposits remains difficult. Also, we saw some tightening of the spreads between wholesale rates, brokered CD rates and the retail marketplace in the first quarter. We are seeing spreads as much as 75, 85 basis points. In the second quarter, we saw those spreads tightened up substantially. So, we were active in cumulating retail CDs.

In addition, we had good growth in savings of $82 million and noninterest bearing deposits growth of $16 million. We did see some runoff in our premier treasury account and money market accounts as our depositors were looking towards our CDs there. Fed funds purchased was down $30 million for the quarter; and federal home loan bank advances, up $12 million.

We've added a section in our press release this quarter about liquidity. In this marketplace, liquidity becomes extremely important. And at the end of the second quarter, we had over $730 million of liquidity, both on-balance sheet and off-balance sheet sources. And subsequent to the end of the quarter, we were approved for the Federal Reserve Bank borrowing program called Borrower-in-Custody program.

Similar to being able to get advances from the Federal Home Loan Bank, the Borrower-in-Custody program allows us to use our existing loans as collateral for those borrowings. With that capability, we have liquidity in excess of $1 billion right now to meet any of the needs of our depositors.

We'll talk a couple of minutes about capital. We finished the quarter with $462 million of capital. That was down $5.7 million from March 31st, as a result of the second quarter dividend paid out in April being netted out of our net income from the quarter.

As we indicated in the press release, our capital ratios remained very strong with leverage ratio at 9.69%, our Tier I capital ratio at 9.69%, and our total risk-based capital at 11.22%. And let me remind the callers that our total risk-based capital does not include all of our loan loss reserve. Only about $49 million of our loan loss reserve is accounted in that ratio. So, over and above that, we have $32.8 million of our loan loss reserve available.

Another way to look at our capital position is, if you take away our intangible capital from the $462 million, we have about $384 million of tangible capital. Added to that, the $81.6 million in reserves that we have and, we feel very good about our capital and reserve position.

In addition to that, on a net operating income basis, before tax provision, before loan loss provision, in the last two quarters, we've been generating $25 million to $30 million in net operating income, which is available to bolster our loan loss reserve in the future. So, as we stand today, we have no intent on raising additional capital.

If it is needed somewhere in the future, dilution to our common equity would be our last resort. We would look at other solutions that will be non-dilutive, if and when we did need capital. But at this point, we do not believe we need to raise capital.

On the income statement, our net interest margin on a tax equivalent basis for the quarter was 4.63%. That's down from 5.01% in the first quarter of '08. And we continue again to see our loans re-pricing, particularly loans that were at floors, down 200 to 250 basis points, which is having an impact on our earning asset yields. And looking at our construction and land development yields, they are down anywhere from 93 to 167 basis points since the first quarter.

In addition, we did have loans go into non-accrual. The impact of that $1.471 million of interest being reversed weathered off 15 basis points on our net interest margin. And that compares to a net reduction in the first quarter of about $480,000.

Our funding costs did go down during the quarter, but not as quickly as our earning asset yields, and we did see the mix move to the higher yielding CDs. But that being said, we did see our CD yields drop 42 basis points from 478 down to 436, first quarter to second quarter.

And of CDs coming up in the next quarter, our maturities in July had a net yield of 471. Many of those CDs, that's $448 million, many of those CDs were originated in 2007 on a CD special that had a yield of 575 on the top tier. Those are re-pricing in July at about 4%. For the quarter, we have $698 million of CDs carrying a cost of 4.46, maturing in the third quarter.

Noninterest income, we did see an increase in our service charges for the quarter, up $96,000 to $1.421 million or 7.2%. Most of that increase is split between service charges on our checking accounts and business checking accounts as well as NSF and OD fee income.

We did have some unusual activity in the first quarter relating to gain on sale of securities. So, the gain on sale of securities was down $2,180,000 for the quarter. In the first quarter, we liquidated our position in Skagit State Bank at a gain of about $2 million, and we also had a liquidation of our stock in Visa for a gain of about $300,000.

On noninterest expenses, most of our variances were driven on a year-over-year basis by the opening of six offices in the second half of 2007 and one loan production office. The six offices, three of which came from our merger with the Bank of Salem, and three of them were de novo openings during, again, the second half of the year. So that drove some of our year-over-year increases.

On a quarterly basis, our salary and benefits were down $1.4 million to $12.592 million. And about half of that decrease was related to our accrual for profit sharing, and with our profits being down. We did back down on the accruals. And in addition, there are other areas, incentive pay, that have been reduced in the quarter.

Occupancy expenses, up $400,000 to $2.991 million. About half of that is related to hardware and software-related items, as we're gearing up for the Whidbey Island Bank merger. Any expenses related to that merger were expensed in the second quarter, and this is hardware and software that can be utilized there within the bank as we move forward, but like we would not have outlaid the money without that merger pending.

And finally, in the other expense category up 945,000 to 5,000,356 about half of that increase is related to expenses to the merger with Whidbey Island Bank, which has been terminated. Again, those expenses had all been expensed in the second quarter. All told in the second quarter, I mean noninterest expenses we had about 667,000 of merger-related expenses expensed.

Looking forward, I guess I'd like to point out that we're going to continue to focus internally on improving our credit quality and collecting our loans working with our relationships. I'd like to point out to the callers that we have a very experienced management team. Lyle Ryan has been with the Bank for 29 years; he been through a few cycles.

Jim Ries, the President of our Real Estate Division has been with the Bank for 29 years and again has a very close relationship with our builders and developers in that real estate division. Rob Robinson has been in banking for more than 25 years and has actually spent some time in the sacramental area and so he has some good experience behind him.

In addition, we've got three ex-bankers that are on our Board Directors, my father Mike Clementz and Pat Fahey. Between those three we have over 150 years of bank experience to help guide us through these challenging times.

We're going to continue to focus on growing deposits and enhancing our liquidity position, which is at a very strong $1 billion level. And we feel very good about our capital and reserves, again, producing $25 million to $30 million in pre-tax pre-provision funds from our income statements that will help provide that cushion going forward.

At this point, Joe, I'd like to open the lines for questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. (Operator Instructions).

Our first question will be from Dave Rochester from FBR. Please go ahead. Your line is now open.

Dave Rochester - FBR

Good afternoon, guys.

John Dickson

Good afternoon Dave.

Dave Rochester - FBR

On the capital, I know in the release and just now you gave the capital levels of the holding company, I am not sure if you gave the bank level I may have missed that.

John Dickson

No, I didn't. At the bank level, we're at 10.43% on total risk-based capital at the end of the quarter. The difference between the holding company capital and the bank capital rest in the holding company; we have some investments that we are leveraging and we have some investments at the holding company that creates a part of that 30 plus million in capital at the property subsidiary, which holds all of our bank branches.

We have equity in those bank branches. Our strategy to push that capital down to the bank level is to have the bank loan money to the subsidiary in the holding company and that capital, when it will, in turn be pushed out as contributed capital at the bank level. So, when I focus on 11.22%, I expect some of that internal strategy will be able to have that bank capital level above 11%.

Dave Rochester - FBR

Okay. And that's something we should see in the third quarter?

John Dickson

We're hopeful to get it in the third quarter. Well, we've got appraisals on our bank branches in process at this time and we should have those in and that strategy completed by the end of the third quarter.

Dave Rochester - FBR

Okay. And I know you'd mentioned you are comfortable with capital today. Is there a level of NPA's, charge-offs or some kind of metric, say, for example, that we saw a doubling in NPAs from today's level, at which you would reconsider that and say, it might make sense to become more active in considering raising capital, given where things could go from here?

John Dickson

I don't think there is a strict level there, Dave. We're constantly monitoring our capital ratios and the adequacy of our loan loss reserve. I guess, I'd like to focus and point out that our net charge-offs in the quarter were only $6.5 million. That's on a loan loss reserve base of $81.6 million and that tangible capital base of $384 million.

So, its not as much an NPA level that we'd be looking at as a net charge-off level, perhaps, that would prompt us to look at how do we shore up some capital. And again, we would use all of the alternatives open to us before getting to dilutive common equity type of a capital raise.

Dave Rochester - FBR

Okay. And on those charge-offs of $6.5 million, could you tell us what kind of severity that reflects?

John Dickson

Could you explain severity, Dave?

Dave Rochester - FBR

Sure, just in terms of the write-down on the loan amount. Was that 10% on average, 20%, 50%, that kind of thing?

John Dickson

Rob, do you want to talk about that?

Rob Robinson

Sure. Dave, it depends on where the projects were. If we find, in general, the further south we go so when we get into the Oregon market, we're finding that write-downs I [presented] in my short sale can be as much as 25%.

Dave Rochester - FBR

25% of appraisal value?

Rob Robinson

The appraised value.

Dave Rochester - FBR

Yes, okay,

Rob Robinson

The original appraised value. And so as we more further north, I think we've seen 15% of appraised value.

Dave Rochester - FBR

And that's in Snohomish and King and Pierce, 15%?

Rob Robinson

Well, in Pierce and Snohomish and King, we really so far haven't seen much of a discount there at all.

Dave Rochester - FBR

Okay.

Rob Robinson

And in fact if we've written things down in King County, it's more from the fact that it's going to take a little longer to get our project finished. And we just took the prudent route.

Dave Rochester - FBR

Okay.

Rob Robinson

And we do expect to get recovery on it.

Dave Rochester - FBR

Okay. And just one quick question on some of these said earlier, the 30 to 89-day metric to 3.21, you'd said that that includes all non-accrual loans?

Rob Robinson

I didn't say it was 30 to 89 days. I said it was anything over 30 days.

Dave Rochester - FBR

Yes, everything over 30 days. And that includes the non-accruals?

Rob Robinson

It does.

Dave Rochester - FBR

Okay. And so, I mean by my math, are we looking at from the 3.21, something around $122 million in total of which the non-accrual loans are maybe roughly $120 million?

Rob Robinson

Correct.

Dave Rochester - FBR

Okay. So --.

John Dickson

$119 million

Rob Robinson

Yes.

John Dickson

Yes.

Dave Rochester - FBR

Okay, got you. All right. And let's see, in terms of --.

Rob Robinson

Dave, I should point out in that math that it is possible that we have a loan that's less than 30 days past due that's in non-accrual.

Dave Rochester - FBR

Okay.

Rob Robinson

I think other banks have referred to those as nonperforming loans or something like that.

Dave Rochester - FBR

I got you. Alright. And in terms of a watch list, the special mention, substandard, you guys had provided some great detail last quarter. I was wondering if we could just get an update on what those numbers look like this quarter?

Rob Robinson

Sure. Our watch list credits totaled $423 million at the end of the quarter. And that's up 18% quarter-over-quarter. Our grade 4 loans ended the quarter at $218 million. That's up 60% quarter-over-quarter.

Dave Rochester - FBR

And those are special mention loans?

Rob Robinson

Those are special mention loans.

Dave Rochester - FBR

Okay.

Rob Robinson

And then the next category, which is classified category, so this will be both grade 5 and grade 6. All grade 6 credits are in non-accrual status. So, $120 million of this number is already in non-accrual. That number is $258 million, and that rose nearly 160% quarter-over-quarter.

Dave Rochester - FBR

Okay.

Rob Robinson

So we're being pretty aggressive about migrating loans into the appropriate grades based on current economic conditions.

Dave Rochester - FBR

That sounds good. And in terms of the way you think about the reserve methodology going forward, the last time you gave us the breakdowns of special mention and substandard and what you're reserving for. But on just a question on the methodology, what kind of absorption rates and price declines are you factoring in as you look out over the next six months? Are you looking for flat to declining sales rates and another maybe 5% or 10% decline in home prices at the end of the year or you're basing your reserve on stability or an improvement in those trends?

Rob Robinson

I think we're being pretty conservative when it comes to the specific reserve category, which would all non-accrual loans, where you're doing a FAS 114 analysis. In those cases, for the most part, we are taking a 30% discount of the appraised value, so hopefully, leaving ourselves plenty of leeway for further deterioration in the market.

Dave Rochester - FBR

Got you. Alright. And just one last question to your point, would you happen to have the total amount of construction loans that were extended this quarter alone? And if you happened to have the number of the total amount of construction loans that sat in, any extended state at the end of the second quarter?

Rob Robinson

The second quarter loans that sat in any extended state beginning in non-accrual?

Dave Rochester - FBR

No, just the loans that you have extended for not just this quarter but in prior quarters that are still in extended mode at the end of the second quarter?

John Dickson

Well, we do have, Rob, that statistic on loans renewed past original maturity which at the end of the second quarter I believe was 450 loans. And at the end of the third quarter, it was about 371 loans. And as I say that, I am looking up the report just to make sure that that's accurate. But I believe that's correct.

Rob Robinson

I've got it right here.

Dave Rochester - FBR

And the total volume of that, the dollar amount?

Rob Robinson

Sure. Well, at least I can give you the total committed and the total outstanding currently at this point in time. But in March '08, we had renewed [pat-riddled], maturing 392 unit homes. In June '08, that number was 450. Over the last three months, that number has been pretty stable. And the total outstanding on those dollars is $171 million.

Dave Rochester - FBR

Okay, great. Alright. Thank you very much.

John Dickson

Thanks, Dave.

Operator

Thank you. The next question will be from Matthew Clark of KBW. Please go ahead. Your line is now open.

Matthew Clark - KBW

Good afternoon, guys.

John Dickson

Good afternoon Matthew.

Matthew Clark - KBW

I guess, discuss your appetite to shrink the balance sheet? I mean, I guess, we're little surprised to see the growth in balances and I know some of that is behind your control and you are starting to see the construction balances from all over. But, I guess, are you willing or would you like to pursue that type of strategy to shrink the overall risk weighted assets going forward?

John Dickson

That certainly could be a strategy. I guess my comments on that, Matthew, is if we looked at the sale of assets that would likely be performing loans and the marketplace out there right now -- the reason why we would shrink our balance sheet is to improve capital ratios and in the marketplace that at least I am familiar with out there, everybody is looking to heavily discount even performing loans. And what you may gain by selling assets or shrinking the balance sheet, you may loose in the discount.

So we haven't found a situation there that looked attractive enough to move on as it relates to organic situations. We've got our real estate divisions and 51 offices out there, all out there trying to generate business and make loans. And we're not going to go out there and tell them on a whim that, okay, no more loans. We're cognizant of taking care of existing relationship and allowing the bank to continue to grow at a reasonable pace. And we're not looking for growth's sake, but on good relationships at least, we're not going to discourage him.

Matthew Clark - KBW

Okay. And can you give us a breakdown of the loan originations this quarter by chance, by type?

John Dickson

I don't have that handy right now, Mathew. I'll have to get back to you on that.

Matthew Clark - KBW

Okay. And then the city promotion that you did during the quarter, can you give us just -- what the terms were and all -- but in terms of rate and duration on that lead product?

John Dickson

Sure

Matthew Clark - KBW

And whether or not that would be continued into the third quarter?

John Dickson

Sure. In the month of June, we ran a CD campaign that was APY of 3.8 for eight months and that was well received. In the month of July, we continued with that CD special and added to that a 13 months special at 4% APY. Keep in mind, during the month of July, we had our 13 months CD special from June of '07 maturing with the top tier of 575. So we're interested in retaining some of those deposits throughout the month of July. Our results have been very successful. On both months, we've seen good influx of deposits and desired results that we wanted.

Matthew Clark - KBW

Okay. And whether or not that has been extended in to this quarter, is that the case? I'm sorry, July, you mentioned in July. Got it.

John Dickson

Yeah

Matthew Clark - KBW

And then the new balling program with the -- in fact it appears -- is that a capacity is what, $250 million, is that fair?

John Dickson

Actually, I believe we have qualified loans in excess of $500 million. We can borrow at a 75% rate. But that number will change and we'll have to audit that number. So it's somewhere north to $300 million let's say.

Matthew Clark - KBW

Okay. And you obviously haven't used that facility just yet?

John Dickson

No. We just got approval of this last week. And in case, I didn't really explain it, this is the new program that Fed came out with, I believe in April and it allows for better access to the discount window.

Matthew Clark - KBW

Okay. Great. Thank you.

John Dickson

You bet, Matt.

Operator

Thank you. The next question will be from Brett Rabatin from FTN Midwest. Please go ahead. Your line is now open.

Brett Rabatin - FTN Midwest

Hi, John, good afternoon.

John Dickson

Good afternoon, Brett

Brett Rabatin - FTN Midwest

I wanted to ask on the increase in the non-performers, the reserving in the charge-offs. I'm curious, is there a new impairment reserve for the loans that move to non-accrual status during 2Q or was the provision more a function of just risk migration trends and what you see from the watch less perspective?

Rob Robinson

Brett, this is Rob. It was primarily because of the migration of loans in the higher risk category. We did have a number of loans going into non-accrual status, which then resulted in the FAS 114 analyses that we didn't have a whole lot of in first quarter but it's primarily just because of migration.

Brett Rabatin - FTN Midwest

And what was this FAS 114 number, do you know?

Rob Robinson

It ended up being just approximately $5.3 million. Had we not charged it off, it would have been included in that figure.

Brett Rabatin - FTN Midwest

Say that again. If you hadn't charged it off, it would have been -- okay, all right. Just secondly, I was curious that you mentioned a little bit about the Washington Banking Company termination. I didn't know if you guys want to say anything more about that deal and, from both sides, certain terms of litigation. And I didn't see anything foul here in the past week or two. But I just didn't know if you guys want to say anything about that terminated acquisition.

John Dickson

I guess my comment would be, you're absolutely correct. We have not been served with a lawsuit from them nor have we initiated any legal action towards them.

Brett Rabatin - FTN Midwest

Okay, then, about the dividend of $0.06 a share. You're obviously doing some things to get capital from the parent down to the bank. I'm curious if there might be any additional process on the cash dividend that you have with the parent company?

John Dickson

The board looks at the cash dividend on a quarterly basis, and we will reevaluate our position in September for the fourth quarter dividend that would be paid in October. So, I guess I don't have a thought about that right now. There was a lot of discussion at the Board meeting.

Obviously, with the amount that we were setting aside for the loan loss reserve, we knew in June that our income levels would be down, and therefore, it would be prudent to reduce the dividend. We chose to reduce it from that $0.18 level to the $0.06 level. Our preference is to not reduce it again. And again, we will evaluate as time goes on. And when we can work through this cycle, we look forward to the date that we can be raising that dividend.

Brett Rabatin - FTN Midwest

Okay, great. Thanks for the color.

John Dickson

You bet, Brett.

Operator

Thank you. (Operator Instructions)

Your next question will be from Sara Hasan from McAdams Wright Ragen. Please go ahead. Your line is now open.

Sara Hasan - McAdams Wright Ragen

Hi guys.

John Dickson

Hi, Sara.

Sara Hasan - McAdams Wright Ragen

I was wondering can you give us the average loan to value for each of those, the construction and land development and lot bucket, maybe LTV at origination on average. Do you have that by chance?

Rob Robinson

Yes. With originations, those LTVs are going to range. It depends on the type, anywhere between 70% and 85% of retail, slightly higher than that on a discounted basis. But the fact is right now, Sara, with the prices that are coming back in was more important than what the current market is on those buckets.

Sara Hasan - McAdams Wright Ragen

Right.

John Dickson

Typically, our policy is 80% of retail value at origination on construction and land development.

Sara Hasan - McAdams Wright Ragen

And you talked earlier about the markdowns on appraisals to clear some of those projects. But were those recent appraisals, or were those appraisals at origination?

Rob Robinson

Most of those are appraisals at origination. So, most of those appraisals would be 12 to 18 months old.

Sara Hasan - McAdams Wright Ragen

Okay.

Rob Robinson

What we are finding, interestingly enough, is most of our markets are poor markets, like Kings, Snohomish and Pierce. The new appraisals on a retail basis are coming in very close to the original appraisals. The discounts are significant and quite volatile from one market to the next.

Sara Hasan - McAdams Wright Ragen

Okay. And then I think you talked about it a little bit before, but just to see your thought process. When you move things to non-accrual, how much do you charge off, or when do you decide when to charge and what to charge?

Rob Robinson

Well, it's a decision that's made as a group. Credit team gets together, reviews the situation. When we decide that a write-off is prudent at that moment in time, that's generally because we're looking at saying that the probability of recovery on that is very low. We choose to reserve and wait, because we believe that we have a good opportunity to recover a portion of that reserve and maybe all of it.

Sara Hasan - McAdams Wright Ragen

Okay. And --.

Rob Robinson

And then one other thing I just saw that one of the earlier questions had been; when we do move it into non-accrual, we have over 20-plus names, just off the top of my head in non-accrual right now that are less than 30 days past due. So, if we see a project that we believe is going to end up in non-accrual, we're going to move it in there as quickly as we can.

Sara Hasan - McAdams Wright Ragen

Are you seeing any areas of weakness outside of that construction and development portfolio? This anecdote will be even?

Rob Robinson

On the business side or the C&I side, because as you know, we are not as much of a consumer lender.

Sara Hasan - McAdams Wright Ragen

Great.

Rob Robinson

Not really. In fact, if we look across our branches and we look at their past dues, any of our branches that focus primarily on business lending have immaterial past due [loans] right now.

John Dickson

There is nothing in non-accrual?

Rob Robinson

Nothing in non-accrual.

Sara Hasan - McAdams Wright Ragen

Okay. And then where are you on the regulatory exam schedule again?

John Dickson

We were visited by the examiners for the safety and soundness exam two days ago on Monday. It's generally a three to four-week process. And so, it's just started.

Sara Hasan - McAdams Wright Ragen

Okay. Thank you very much. I appreciate it.

John Dickson

No problem, Sara.

Operator

Thank you. The next question will be from Jeff Rulis of D.A. Davidson. Please go ahead. Your line is now open.

Jeff Rulis - D.A. Davidson

Good afternoon.

John Dickson

Good afternoon, Jeff.

Jeff Rulis - D.A. Davidson

A couple of my questions were asked already, but I don't know if you could provide some commentary on the release you had in late June, commenting on an elevated provision. Now that we've sort of seen Q2's level, if you can make any sort of broad or word-specific comments on the pre-visiting level or ranges of as it compares to Q2 or sort of maybe a month later, and what has changed from that view point?

John Dickson

Well, that's a tough one, Jeff. One of the reasons why we didn't pre-announce what that provision would be in the third week in June is that things change daily, if not weekly. I can't tell you how many times I come in and there is a rumor that one of our builders has filed bankruptcy only to find out that the rumor is not true.

We're constantly evaluating. And one thing that we remain steadfast on and that is we will maintain good capital reserves and good loan loss reserves. I wish I could tell you this is what the future is going to bring. Based on the trends, the deterioration in the portfolio, we are more likely to continue to see elevated provisioning, but I really couldn't tell you where I think that's going to fall in the third quarter or beyond.

Jeff Rulis - D.A. Davidson

So, wasn't it a comment necessarily just Q2 that was going to be elevated. It was elevated going forward.

John Dickson

Yes, I guess my intent was to, without giving a specific number, make it clear that our second quarter provision was going to be well north of our first quarter provision. Beyond this, it's going to depend on how our borrowers work through these situations, how our lenders do on collecting the loans and the marketplace in general.

Jeff Rulis - D.A. Davidson

I got it. That's it from me. Thanks, John.

John Dickson

Okay. Thanks, Jeff.

Operator

Thank you. We have a question from Tim Coffey from FIG Partners. Go ahead. Your line is now open.

Tim Coffey - FIG Partners

Thank you. Good afternoon, guys.

John Dickson

Good afternoon, Tim.

Tim Coffey - FIG Partners

I have just a quick question about the watch list and the classified loans. The growth in those categories, was that a surprise?

John Dickson

The question, was the growth in our watch and substandard a surprise? Tim, we've seen deterioration in the portfolio. I think we were all hopeful that in the months of April, May and June, we would see an increase in home sales every month. That would have provided more liquidity for our builders. In fact, home sales were fairly flat. And so, I guess, relative to that, in some cases, we had borrowers that ran out of liquidity. And so, based on that, I guess it's not a surprise.

Anytime you look at numbers like this, you certainly don't plan on it, but we anticipated that we'd have some builders that were able to weather cash flow through the winter, and we knew that they were going to need a strong selling season to continue to stay liquid. And for some of them, the sales weren't adequate.

Tim Coffey - FIG Partners

Okay. There are some questions about deposits with NOW. The drop in NOW and money market accounts, do those come from a particular type of client?

John Dickson

I would say a particular product, Tim. We have a money market type account called a premier treasury account, and it's tied to the treasury auction rates. And as Fed was lowering rates, we saw the rates on those accounts drop significantly, from in the 4's down to in the 1% to 1.5% type range. And so, a lot of movement out of that product into our savings product, which has been pretty steady on rates, as well as some of our CDs.

Tim Coffey - FIG Partners

Okay. With the CD promotions, did your percentage for the jumbo CDs to the time deposits fall?

John Dickson

I don't have that number right now, Tim. I'd have to get back to you.

Tim Coffey - FIG Partners

No problem.

John Dickson

My commentary is I think the jumbo amount being 100,000 20 or 30 years ago, when that was a jumbo category, was a much bigger number than it is today, although with FDIC insurance concerns, it probably becomes a bigger issue for a lot of depositors.

Tim Coffey - FIG Partners

Okay. And then what was the quarter-to-quarter growth rate on the non-interest bearing deposits?

John Dickson

$16 million was the quarter-end-to-quarter-end growth.

Tim Coffey - FIG Partners

Okay. Great. Those are my questions. Thanks.

John Dickson

Thanks, Tim.

Operator

Thank you. There are no further questions registered at this time, Mr. Dickson.

John Dickson

Great. Well, I'd just like to wrap up by again reiterating that we're disappointed with the net income for the quarter, but we feel good about our loan loss reserve exceeding 2%.

I am very confident that the experienced management team that I have here with me that got us to be number one in the nation for performance last year, are the same ones who will see us through this difficult scenario that we are in right now, this difficult marketplace, and we are confident that we will return to those high performing numbers that we have experienced throughout our history.

So, thank you again for joining us on this call.

Operator

Thank you. The conference call has concluded. You may disconnect your telephone lines at this time. We thank you very much for your participation.

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Source: Frontier Financial Corporation Q2 2008 Earnings Call Transcript
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